**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

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**FORM 10-K**

(Mark One)

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe fiscal year ended December 31, 2006**

**Or**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe transition period from         to        **

**Commissionfile number: 000-25755**

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**WorldGate Communications, Inc.**

(Exact name of registrantas specified in its charter)

| **Delaware**                              |   | **23-2866697**                        |
|-------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of          |   | (I.R.S. Employer  Identification No.) |
| incorporation or  organization)           |   |                                  |
| **3190 Tremont Avenue**                   |   | ** **                            |
| **Trevose,  Pennsylvania**                |   | **19053**                             |
| (Address of  principal executive offices) |   | (Zip Code)                            |

 

**(215) 354-5100**

(Registrant’s telephonenumber, including area code)

Securities registeredpursuant to Section 12(b) of the Act: **None**

Securities registeredpursuant to Section 12(g) of the Act:

**Common Stock, $0.01 Par Value**

(Title of Class)

Indicate by check markwhether the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act. Yes o   No x

Indicate by check markwhether the registrant is not required to file reports pursuant to Section 13or Section 15 (d) of the Act. o   No x

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 preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes x   No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. Yes x   No o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act.

| Large accelerated filer o |   | Accelerated  filer x |   | Non-accelerated  filer o |
|--------------------------------|--------|---------------------------|--------|-------------------------------|

 

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

The aggregate market valueof the common stock held by non-affiliates of the registrant was approximately$52 million as of June 30, 2006, based on the closing sale price of $1.64per share of common stock, as reported on the NASDAQ Capital Market.

The number of shares of the registrant’s common stockoutstanding as of March 9, 2007 was 42,260,446.

**DOCUMENTS INCORPORATED BYREFERENCE**

**None**

 

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**WORLDGATECOMMUNICATIONS, INC.**

**ANNUAL REPORT ON FORM 10-KFor the Fiscal Year Ended December 31, 2006**

**TABLEOF CONTENTS**
| PART I                                                                                                                                   |   |   |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|
| Item 1.  Business                                                                                                                             |   | 1      |   |
| Item  1A. Risk Factors.                                                                                                                       |   | 8      |   |
| Item 2.  Properties.                                                                                                                          |   | 16     |   |
| Item 3. Legal  Proceedings.                                                                                                                   |   | 16     |   |
| Item 4. Submission of Matters to a Vote of Security  Holders.                                                                                 |   | 17     |   |
| PART II                                                                                                                                  |   |   |   |
| Item 5. Market for Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities.              |   | 18     |   |
| Item 6. Selected Financial Data.                                                                                                              |   | 21     |   |
| Item 7. Management’s Discussion and Analysis of  Financial Condition and Results of Operations.                                          |   | 22     |   |
| Item 7A. Quantitative and Qualitative Disclosures  about Market Risk.                                                                         |   | 38     |   |
| Item 8. Financial Statements and Supplementary Data.                                                                                          |   | F-1    |   |
| Item 9. Changes in and Disagreements with Accountants  on Accounting and Financial Disclosure.                                                |   | 39     |   |
| Item 9A. Controls and Procedures                                                                                                              |   | 39     |   |
| Item  9B. Other Information.                                                                                                                  |   | 42     |   |
| PART III                                                                                                                                 |   |   |   |
| Item 10. Directors, Executive Officers and Corporate  Governance.                                                                             |   | 43     |   |
| Item 11. Executive Compensation.                                                                                                              |   | 47     |   |
| Item 12.  Security Ownership of Certain Beneficial Owners and Management and  Related Stockholder Matters       |   | 53     |   |
| Item 13. Certain Relationships and Related Transactions  and  Director Independence                                                           |   | 56     |   |
| Item 14. Principal Accountant Fees and Services                                                                                               |   | 56     |   |
| Item 15. Exhibits and Financial Statement Schedules.                                                                                          |   | 59     |   |

 

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**WORLDGATECOMMUNICATIONS, INC.**

This report containsforward-looking statements that involve risks and uncertainties. Theseforward-looking statements are based on management’s current expectations andare subject to a number of uncertainties and risks that could cause actualresults to differ significantly from those anticipated in these forward-lookingstatements. Factors that may cause such a difference include, but are notlimited to, those set forth in the “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” as well as those discussedelsewhere in this report.

**PART I**

**Item 1.**                        Business

WorldGate Communications, Inc.was incorporated in Delaware in 1996 to succeed to the business of ourpredecessor, WorldGate Communications, L.L.C., which commenced operations in March 1995.In April 1999, we completed our initial public offering of 5,750,000shares of our common stock. Our common stock is traded on the NASDAQ CapitalMarket under the symbol “WGAT.”  Ourexecutive offices are located at 3190 Tremont Avenue, Suite 100,Trevose,Pennsylvania 19053.

**Overview**

Since our formation in 1995 and until the firstquarter of 2004, we were in the business of developing and selling interactivetelevision, or ITV, technology, products and services for use in conjunctionwith cable TV broadband networks (the “ITV Business”). Using our solutions,cable TV operators branded, marketed, and offered a wide variety of ITVpackages to consumers. These packages included walled gardens of information, communicationssolutions complete with Internet-based e-mail and chat, and Web surfing, allpresented and engaged on the TV set. During 2003 we elected to shift ourbusiness away from the ITV Business and toward a new video phone product andassociated business, and in the third quarter of 2003, we completed a sale ofsignificant assets, including our ITV intellectual property rights and ourmembership interest in TVGateway, LLC, for $3,000,000 in cash to TVGateway,LLC, an ITV oriented company we were instrumental in forming. Although wecontinued to support our ITV Business into the first quarter of 2004, thedevelopment of our video phone product became a primary business focus. Thefunds we received from the sale of assets to TVGateway, LLC, as well as thefunds we subsequently received as a result of several private placements of oursecurities have permitted us to fund the development of our new business.

During 2004, we continued development of a videophone, designed specifically for personal video communication over high speeddata (“HSD”) or broadband networks, that we believe is differentiated, bothfrom competitors and from previous efforts at personal video telephony, byproviding: “true to life” communication (meaning that images and sounds are synchronized,that there are minimum delays between the two ends of the communication, andthat the quality of the images is similar to what we perceive with traditionaltelevision), ease of deployment by HSD operators, ease of use by residentialand business end users, and a highly styled ergonomic design. The design of ourfirst video phone product, branded as Ojo, was substantially completed in late2004 and field trials were commenced. Commercial distribution of this productcommenced in the spring of 2005.

On April 28, 2004, we entered into a multi-yearagreement with General Instrument Corporation d/b/a the Connected HomeSolutions Business of Motorola, Inc. (“General Instrument”) for theworldwide development and distribution of the Ojo personal video phone. Thisagreement provided for General Instrument to be WorldGate’s exclusivedistributor of its broadband video phone products and for WorldGate to beGeneral Instrument’s exclusive supplier of its broadband video phone products. OnFebruary 17, 2006, we mutually agreed with General Instrument to end thisagreement. The ending of this agreement immediately terminated exclusivity forboth parties. In addition to its current role for 

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development andmanufacture of Ojo, WorldGate assumed direct responsibility and control for theadvertising, marketing, and distribution of its products.  Under its agreement with General Instrument,WorldGate had been active in marketing and promoting its products, and workingwith General Instrument to distribute Ojo. WorldGate is continuing the rolloutof Ojo using many of the same distributors, retailers and service providers,and has subsequently expanded distribution to service providers and retailersaround the world. As part of ending its agreement with General Instrument, andin anticipation of our inventory requirements as a result of taking fullresponsibility for product distribution, we negotiated the right to buy backabout two-thirds of the units sold to General Instrument, valued atapproximately $2,765,000 (based upon the original sales price to GeneralInstrument), for approximately $1,064,000. This is less than half of what itwould cost the Company to purchase the same inventory from our manufacturingsources. As a result the Company recorded a reserve for returns and reducedrevenue in the amount of approximately $2,310,000 during the fourth quarter of2005. In addition the Company recorded no revenue for units shipped to GeneralInstrument in the first quarter 2006 and recorded a gain on termination of thisagreement of approximately $1,843,000 for the year ended December 31,2006,  (net of the cost of rework forrebranding the product and the adjustment of the inventory to its currentreplacement value) and reversal of the product refund program reserve ($212,000)as well as an adjustment of the warranty reserve for products repurchased($233,000), both of which resulted from termination of the Company’s agreementwith General Instrument.

HSD network users provide a large, and we believeconducive, target market for a quality video phone offering. Initial videophone sales are expected to be derived from new technology adopters and regularlong distance communicators such as families and close friends. We also expectthat the business-to-business opportunity will be attractive as a video phoneprovides means to improve interpersonal communication and multi-locationproductivity. Furthermore we expect that the growth in the voice over Internetprotocol market (or “VoIP”) will also help to drive sales of our video phonesince it can also serve as a VoIP endpoint.

Our business model isbased on the sale of video phones and related products and services. Ourproducts are being marketed to HSD network operators as well as to consumersthrough traditional consumer electronics distribution channels. We believe thatHSD operators could realize significant recurring revenue streams associatedwith offering our product to end users. We have also developed this product torequire very minimal capital investment or incremental costs by such operators.Our marketing objective is to have our video phones supplement and hopefullyreplace ordinary home and business phones worldwide.

**General ProductDescription**

We have developed a videophone, ergonomically designed specifically for in-home and business, personalvideo communication. We have identified several issues that have interferedwith commercial success and consumer acceptance of video phones and sought toaddress each of these issues within the Ojo video phone. The Ojo video phonewas designed for use on the existing HSD network infrastructure. Certain modelsof the Ojo phone will, however, also connect to the analog phone line forinteroperability with the voice only communications offered by the existingpublic switched telephone network (“PSTN”) and VoIP networks. Ojo, therefore,can be used for video calls, for ordinary voice only calls as well as for voiceover Internet protocol, or VoIP calls. We believe that Ojo is differentiated,both from competitors and from previous efforts at personal video telephony, byproviding: true to life communication (meaning that images and sounds aresynchronized, that there are minimum delays between the two ends of thecommunication, and that the quality of the image is similar to what isexperienced with television), interoperation with the PSTN and VoIP, ease ofdeployment by HSD operators, ease of use by consumers, and a highly styledergonomic design. We believe Ojo uniquely leverages the recent development of astate of the art connectivity infrastructure, as well as the convergence of thelatest improvements in compression 

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technology,processing power and bandwidth availability, to help ensure, enable andmaintain dedicated high quality end-to-end connections.

**MaterialDevelopments for WorldGate since December 31, 2005**

The following is a summary of material developmentsfor us that have occurred since December 31, 2005:

On February 17, 2006, we mutually agreed withGeneral Instrument to end a multi-year agreement with them for the worldwidedevelopment and distribution of the Ojo personal video phone. This agreement,which we entered into on April 28, 2004, provided for General Instrumentto be WorldGate’s exclusive distributor of its broadband video phone productsand for WorldGate to be General Instrument’s exclusive supplier of itsbroadband video phone products. The ending of this agreement immediatelyterminated the exclusivity for both parties, and WorldGate now has directresponsibility and control for the advertising, marketing, and distribution ofits products.

On March 13, 2006 we introduced the OjoTM Shadow,a lower cost version of our personal video phone.

On August 11, 2006,we entered into a purchase agreement with an institutional investor providingfor the issuance of convertible debentures in an aggregate principal amount ofup to $11,000,000, and as part of the initial closing thereunder a convertibledebenture in the principal amount of $6,000,000 (we received $5,615,000 net oftransaction costs) was issued to the investor. This purchase agreement providedfor the issuance of additional convertible debentures in an aggregate principalamount of $5,000,000 subject to certain conditions precedent, includingstockholder approval of the deal and registration of a portion of the shares ofcommon stock issuable in the transaction. These conditions precedent weresatisfied by the Company and on October 13, 2006, we completed a privateplacement with this investor of a convertible debenture in the principal amountof the remaining $5,000,000 (we received $4,700,000 net of transaction costs).These debentures have a maturity of three years, an interest rate of 6% perannum, and are convertible at the option of the investor into our common stockat a conversion price equal to the lesser of $1.75 per share or 90% of theaverage of the five lowest daily volume weighted average closing prices (“VWAP”)of the common stock during the fifteen trading days immediately preceding theconversion date (subject to adjustment in the event of stock dividends andsplits and certain distributions to stockholders, fundamental transactions, andfuture dilutive equity transactions). Interest is payable at maturity, and wemay elect to pay the interest amount in cash or shares of our common stock. Aspart of the private placement, we also issued to the investor 177,419 shares ofour common stock and five-year warrants to purchase a total of up to 2,595,000shares of our common stock, of which 1,145,000 shares were at an exercise priceof $1.85 per share, 1,100,000 shares were at an exercise price of $2.35 pershare and 350,000 shares were at an exercise price of $2.60 per share. Theconvertible debentures provide that we have the right to redeem all or anyportion of the principal amount of the debentures in cash at any time upon notless than four business days notice if the closing price of our stock is lessthan $1.75 per share. Such early redemption will, however, require us to pay a10% prepayment premium. In addition, without any prepayment premium, we havethe right to force the holder to convert a maximum of $500,000 of the aggregateprincipal amount of the debentures in any thirty day period if for fiveconsecutive trading days the VWAP of our common stock is above $1.925 per sharebut less then $3.50 per share and providing the daily trading volume exceeds200,000 shares for these five days, and certain other conditions are met. Ifthe VWAP of our common stock is greater than $3.50 per share for 30 consecutivetrading days, the daily trading volume exceeds 250,000 shares for five daysprior, and if certain other conditions are met, we can also force the holder toconvert all or any portion of the outstanding principal and interest intoshares of our common stock without any prepayment premium.

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**Business Plan**

*General.**  *Our business model is primarilybased upon the sale of Ojo video phones and related products and services. Itis our plan for Ojo video phones to be distributed through and in partnershipswith HSD network providers, as well as through traditional electronicsdistribution channels. Video phone service, using the Ojo video phone, isexpected to be offered by HSD network providers as a means of attracting newHSD subscribers as well as maintaining existing subscribers. We believe thatHSD network providers could realize potentially significant recurringincremental revenue streams associated with offering products such as our Ojovideo phone, and accordingly we believe they will embrace the concept andbusiness model. The suggested consumer offering for a video phone servicefollows the traditional HSD model, which may involve a subsidy of the requiredhardware by the recurring service fee. We anticipate that video phone servicesubscribers will be able to either purchase Ojo or lease a unit from the HSDnetwork provider. There is also a parallel market for sales of video phonesdirectly to consumers through the standard consumer electronic channels. Salesof video phones through this channel still require a video phone service andthe Company is currently offering such a video phone service, using the Ojovideo phone, for units sold through this channel.

*Manufacturing.*   Ojovideo phones are manufactured in Asia, to take advantage of the base of lowerlabor, tooling and component costing. A formal relationship with Mototech Inc.which is not an affiliate of General Instrument or Motorola) has already beenestablished for the volume manufacture of Ojo. Mototech along with U.S.Robotics and SMC Networks, are affiliates of the Accton Technology Group, agroup of Taiwanese manufacturers that we believe are well-known in theelectronics industry. Mototech’s responsibilities in this role include:

·       productdesign finalization for manufacturing;

·       componentselection and procurement;

·       toolsourcing and management;

·       coordinationof Ojo manufacturing;

·       implementationand monitoring of Ojo’s Quality Plan; and

·       productcost reduction.

Under the agreement, Mototech is required tomanufacture products in response to purchase orders issued by our company. Althoughour company has no obligation to purchase any particular volume of productsunder the agreement, Mototech is generally required to accept all purchaseorders, subject to certain limits described in the agreement. As part of ouragreement with Mototech we retain formal sign-off control over any product,specification, or component changes proposed by Mototech. We also maintain allrights to the Ojo technology and intellectual property, as well as the right tosecond source the Ojo product. Our agreement with Mototech permits Mototech andour company to terminate the agreement at any time by giving 90 days writtennotice to the other party. The components and raw materials used in our Ojovideo phone product are generally available from a multitude of vendors and aresourced based, among other factors, on reliability, price and availability.

*Product Sales andDistribution.*   Ojo is being marketed domesticallyand internationally to both the residential and business sectors through thestandard consumer and business electronics channels. In addition we plan tomarket our products through HSD providers in a manner similar to broadbandmodems. Prior to February 17, 2006 we relied upon General Instrument toprovide the marketing and distribution for our products. As a result of amutual agreement with General Instrument our development and distributionagreement with them has ended and we have now assumed full responsibility forproduct sale and distribution in all channels. Under our agreement with GeneralInstrument, WorldGate had been active in marketing and promoting its products,and working with General Instrument to distribute Ojo. 

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WorldGate continuesthe rollout of Ojo using many of the same distributors, retailers and serviceproviders, and plans to expand distribution to service providers and retailersaround the world.

**Competition**

Many of the current video phone manufacturers havefocused on two applications—business video phones and video conferencing.Business video phones are designed to be located on an executive’s desk andused to communicate with colleagues, employees and customers. Videoconferencing units are designed for conference rooms where multiple people onone end engage with multiple people on the other end. The following is a briefdescription of the potential competitors and their impact on the market.

*BusinessPhone Products.**  *Mostof these products are targeted for corporate use and are relatively highpriced. Generally, the ergonomic design of these units emulates that of atraditional office telephone with the addition of a camera and display. Theproducts use standard corporate gray or black material colors, familiar buttonshapes and designs, traditional style handsets for non-speakerphoneconversation and often have business feature sets. For connectivity theseproducts use VoIP, PSTN or ISDN. The main competitors in this sector include8x8 Inc., Motion Media PLC, Grandstream, and Leadtek Research Inc.

*VideoConference Products.**  *D-LinkSystems, Inc. produces a TV-based video phone product that is targeted toconsumers as a lower cost video conferencing device. D-Link uses the hometelevision as the display device and utilizes either the TV’s speaker orconnection to a standard analog phone for the audio portion of the call.Although costing only about two hundred dollars, the main disadvantages of thisproduct is that it requires a television to send and receive calls. In manycases, this would obstruct the ability to watch television while a call is inprogress thereby disrupting family television watching for the length of thecall. Numerous video conferencing products also exist for the business market. Typicallythese devices cost $2,000 or more and involve complex installations of one ormore cameras, monitors, microphones and speakers within a conference roomsetting. The videoconference nature of these products eliminates the ability tocommunicate on a private, one-on-one level. The main competitors in this sectorinclude Sony, Sorenson Media and Polycom Inc.

*TelephoneProducts.**  *Vialta, Inc.produces the “Beamer,” an H.324 (POTS) video phone that is designed forconnection to a standard telephone. The product utilizes a standard analogtelephone for connection to the PSTN and as the listening device. Because theunit uses traditional telephone lines for connectivity it cannot take advantageof the high-speed data systems available through cable and DSL modems.

*WebCam Products.**  *Webcams are different from other competitive products in that they did not arisefrom either business video phones or video conferencing. Rather, they began inthe early days of the Internet when “techies” were expanding the capabilitiesof PC-based content and applications with low-cost attachments to the computer.Currently, web cams are often used to display visual information as well as ameans for personal communication. Many popular web sites use web cams to showtraffic, weather, adult activities and other visually interesting subjects.Software such as Net Meeting, Instant Messenger and MSN messenger are beingsupported in web cams to enable a video chat option to these Internet-basedservices. Current web cams typically lack the quality of dedicated video phonedevices. They also require the utilization of separate personal computers whichmay not be co-located in the same areas where convenient video calls wouldoccur. Competitors in this category include Logitech, Inc., IntelCorporation, 3Com Corporation, and Creative Technology, Ltd.

*Hybrid Web Cam-BusinessPhone Products.**  *Inrecent months, Cisco Systems, Inc. introduced a hybrid video phone productthat is designed for the business phone market. The Cisco product consists of aweb cam device and host software that enables video phone functionality whenused in conjunction with an IP phone and call processing hardware. We believethis product requires a significant capital investment for implementing thecall processing hardware and IP phones.

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**IntellectualProperty**

We plan to rely on patent,trade secret, trademark and copyright law to protect our video phoneintellectual property. Although we have filed multiple patent applications forour products and technology, we currently only hold one issued patent in theUnited States (a design patent issued in December 2006 and valid for a 14year term thereafter. Our patent position is subject to complex factual andlegal issues that may give rise to uncertainty as to the validity, scope andenforceability of a particular patent. Accordingly, there can be no assurancethat additional patents will be issued pursuant to our current or future patentapplications or that patents issued pursuant to such applications will not beinvalidated, circumvented or challenged. Moreover, there can be no assurancethat the rights granted under any such patents will provide competitiveadvantages to us or be adequate to safeguard and maintain our proprietaryrights. In addition, effective patent, trademark, copyright and trade secretprotection may be unavailable, limited or not applied for in certain foreigncountries.

**GovernmentRegulation**

Our Ojo video phone isrequired to comply with various laws and government regulations, includingParts 15 and 68 of the FCC’s regulations in the United States, which relate toradio frequency devices and to terminal equipment that is connected to thetelephone network. The legal and regulatory environment that pertains to ourbusiness is uncertain and changing rapidly. New legislation or regulation, suchas that currently being considered for limiting the environmentally hazardoussubstances that are currently found in most electronic devices, could beintroduced that could substantially impact our ability to distribute our Ojovideo phone products. Similarly the FCC and other comparable regulatorycommissions could undertake an examination of whether to impose surcharges oradditional regulations upon certain providers of Internet protocol, or IP,based communication services. The imposition of regulations on IPcommunications services may negatively impact our business.

**Research andDevelopment**

To date, our engineeringand product development has been a significant focus. The principal focus ofour current engineering activities is the continued development and enhancementof our Ojo video phone. Development of the Ojo video phone has requiredcombining technical experience and knowledge from two historically separateindustries, cable and telephony. Our engineering and development expendituresin connection with our Ojo video phone were approximately $3,557,000, $5,727,000and $6,238,000 for the years ended December 31, 2004, 2005 and 2006respectively, virtually all of which was spent on the development of the videophone product and services.

**Employees**

As of December 31,2006, on a consolidated basis, we had approximately 70 full-time employees.With the exception of one employee located in Houston, Texas, our employees areall located in Trevose, Pennsylvania. None of our employees are represented bya labor union, and we have no collective bargaining agreement. We consider ouremployee relations to be good.

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**Financial Information Relating to Foreign and DomesticOperations and Export Sales from Continuing Operations (Dollars in Thousands)**

| ** **                                                                              | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net revenues from  continuing operations by geographic area:                            |       |     |       |     |       |     |       |
| United States                                                                           |       | $        | 231        |     | $          | 1,558    |       | $ | 1,326 |   |
| Foreign(*)                                                                              |       | 0        |       | 0        |       | 1,450    |       |
| Total                                                                                   |       | $        | 231        |     | $          | 1,558    |       | $ | 2,776 |   |
| Loss from  continuing operations (all from United States operations)                    |       | $        | (19,461    | )        | $          | (6,851   | )          | $ | (17,609 | ) |
| Identifiable  assets within the United States                                           |       | $        | 13,172     |     | $          | 20,684   |       | $ | 14,251 |   |
| Identifiable foreign  assets (hardware and tooling for manufacturing) in Taiwan, R.O.C. |       | $        | 650        |     | $          | 545      |       | $ | 315 |   |

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*                    Net revenuesfor the twelve months ended December 31, 2006 include net revenuesprimarily derived from sales to customers located in Taiwan, R.O.C. ($405), inthe Russian Federation ($718), in Israel ($251), in New Zealand ($59) andothers ($17).

Please refer to “Foreign Currency Exchange Risk” onpage 25 for additional information.

**Available Information**

You may access, free ofcharge, on our website, www.wgate.com, our annual report on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-Kand amendments to those reports filed or furnished pursuant to Section 13(a) or15(d) of the Exchange Act. We endeavor to post these reports on ourwebsite as soon as reasonably practicable after we file such material with, orfurnish it to, the SEC.

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**Item 1A.**                RiskFactors

*In addition to other information in this Form 10-K,the following risk factors should be carefully considered in evaluating ourcompany and our business. Investing in our common stock involves a high degreeof risk, and you should be able to bear the complete loss of your investment.We also caution you that this Form 10-K includes forward-lookingstatements that are based on management’s beliefs and assumptions and oninformation currently available to management. Future events and circumstancesand our actual results could differ materially from those projected in anyforward-looking statements. You should carefully consider the risks describedbelow, the other information in this Form 10-K, the documentsincorporated by reference herein and the risk factors discussed in our otherfilings with the Securities and Exchange Commission when evaluating our companyand our business. The risks and uncertainties described below are not the onlyones we face. Additional risks and uncertainties not presently known by us orthat we currently deem immaterial also may impair our business operations. Ifany of the following risks actually occur, our business could be harmed. Insuch case, the trading price of our common stock could decline and investorscould lose all or part of the money paid to buy our common stock.*

**Our ITV Businesshas accounted for most of our revenues to date; we cannot reliably project ourcontinued revenues, and we expect to incur significant losses for an indefiniteperiod of time.**

Since our formation in1995 and until the first quarter of 2004, we were in the business of developingand selling interactive television, or ITV, technology products and servicesfor use in conjunction with cable television broadband networks. Our ITVbusiness has historically accounted for substantially all of our revenue. Sincewe have discontinued the ITV Business and transitioned to become a developer,manufacturer and seller of video phone products we cannot reliably predict ourfuture revenues, and no assurances can be provided as to the amount of ongoingrevenues, if any, or to the periods in which any such revenues may be received.Our video phone business involves the development of a new product line with nomarket penetration, in an undeveloped market sector. The extent and timing ofour revenues depends on several factors, including the rate of marketacceptance of our products, and the degree of competition we face from similarproducts. We cannot predict to what extent our video phone product will producerevenues, or whether we will ever reach profitability. If we are unable toachieve significant levels of recurring revenue from our video phone business,our losses will likely continue indefinitely. If this occurs, the market priceof our common stock and our viability as a going concern could suffer.

**Our auditors haveexpressed substantial doubt about our company’s ability to continue as a goingconcern.**

The report of theindependent registered public accounting firm for the year ended December 31,2006 included an explanatory paragraph stating that our company has sufferedrecurring losses from operations and had an accumulated deficit of $246,806,000that raised substantial doubt about our company’s ability to continue as agoing concern. No assurances can be given that the issues that led ourindependent registered public accounting firm to this conclusion will beaddressed or that our business will continue to operate as a going concern.

**We are subject tocomplex and changing rules and regulations concerning corporate governanceand financial accounting standards, which may affect our reported financialresults or the way we conduct business, or our ability to ensure properfinancial reporting and adequate internal controls.**

The Sarbanes-Oxley Act, which was signed into law in July 2002,among other things, mandated that companies adopt new corporate governancemeasures and imposed comprehensive reporting and disclosure requirements. Theserules, regulations and requirements increased the scope, complexity, and costof our corporate governance, reporting, and disclosure practices. Furthermore,generally accepted accounting principles in the United States, including thoseaffecting the accounting for complex financial 

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transactions, have beenthe subject of change as well as frequent review and interpretation by the SEC,as well as by national and international accounting standards bodies. Suchchanges, reviews and interpretations may have a significant effect on ourreported results of operations, including the results of transactions enteredinto before the effective date of the changes.  A material weakness is a control deficiency,or a combination of control deficiencies, that results in more than a remotelikelihood that a material misstatement of the annual or interim financialstatements will not be prevented or detected. To address this material weaknessthe Company engaged outside experts to provide counsel and guidance in areaswhere we cannot economically maintain the required expertise internally.  At December 31, 2006 we identified a materialweakness with respect to the Company’s application of GAAP with regard to therecording of inventory at the lower of cost or market. To address the materialweakness related to the application of GAAP with regard to the recording ofinventory at the lower of cost or market the Company intends to implementformal procedures to ensure that period ending inventory is analyzed anddocumented consistent with GAAP. No assurance can be given, however, that suchcounsel and guidance and procedures will be sufficient to remedy materialweaknesses or to ensure that a future material misstatement may not occurwithin our financial statements.

Additionally, section 404of the Sarbanes-Oxley Act of 2002 requires us to assess the design andeffectiveness of our internal control systems. Our independent registeredpublic accounting firm rendered an attestation report on management’sassessment of the effectiveness of our system of internal control over financialreporting which included an adverse opinion on the effectiveness of ourinternal controls over financial reporting because of the existence of amaterial weakness. If any changes or additions are required to these systems wemust complete the documentation, evaluation and any required remediation of oursystems of internal control. The costs associated with such compliance arelikely to be significant and will negatively impact future financial results. Inaddition, there is no assurance that we will be able to conclude that oursystems are appropriately designed or effective, or that a material weaknesswill not be found in our internal controls over financial reporting, whichcould result in a material misstatement in future financial statements.

**We are dependent ona single line of business that currently has no significant history ofrevenues. We cannot predict our future results because our video phone businesshas no operating history.**

Our primary line ofbusiness has become the development of video phone products and technology. Webegan generating revenue from commercial shipment of our Ojo product in April 2005.Given that our video phone business involves the development of a new productline with no market penetration, in an underdeveloped market sector, noassurances can be given that sufficient sales, if any, will materialize. Shouldthis business fail to generate sufficient sales to support ongoing operationsthere can be no assurance that we will be able to develop alternate business lines. Investors should consider the risks anduncertainties that we may encounter as an early-revenue-stage company in a new,single line of business, and in an unproven market. These uncertaintiesinclude:

·       ourability to design, engineer and manufacture products having the technologicalfeatures planned for the video phone product line in a cost efficient manner;

·       ourability to enter into appropriate distribution relationships for the product;

·       ourability to demonstrate the benefits of our products and services to end users;

·       ourability to offer our products at competitive prices;

·       consumerand business demand for, and acceptance of, the video phone products;

·       ourunproven and evolving business model;

·       theentrance of significant competitors into the video phone marketplace

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·       theintroduction of newer video phone technology rendering our technology obsolete

·       unfavorableeconomic conditions in the technology industry;

·       achanging regulatory environment;

·       decreasedcapital spending on technology due to adverse economic conditions; and

·       global economic conditions.

**We will incurincreased risks, costs and expenses for marketing and distributing ourproducts, for collection and accounts receivable issues, and for inventory asthe result of ending our development and distribution agreement with GeneralInstrument.**

Under our development anddistribution agreement with General Instrument, General Instrument wasresponsible for the distribution of our products and for the directrelationship with the distributors, dealers, and other resellers ultimatelyused to sell the products. In addition, General Instrument marketed ourproducts and maintained an inventory of our products. General Instrument alsomaintained the necessary infrastructure to handle the logistics for performingthese functions, including customer ordering, inventory warehousing, billing,customer service, credit and accounts receivable functions for multiplecustomers. In performing these functions General Instrument carried theassociated risks, costs and expenses. As a result of ending our agreement withGeneral Instrument, we are now directly assuming these responsibilities andassociated risks, costs and expenses, and this places increased demands on thecash which we have available. We will also be required to develop new, orexpand existing, infrastructure to handle these logistical functions. There canbe no assurance that the development or expansion of capabilities can beaccomplished in an efficient and cost effective manner. In addition, GeneralInstrument’s price of our product to its reseller customers included a mark-upfrom its cost of the product from us that was intended to reflect its risks,cost and expenses, plus its profit. We are charging these reseller customers alower price and we cannot be assured that the new price will include asufficient mark-up to cover the risks, costs and expenses that is now ourresponsibility going forward. Furthermore all of our revenue for the sale ofour video phones was derived from General Instrument under the development anddistribution agreement and there were minimal administrative costs associatedwith billing and collecting this revenue. We now have multiple customers andbear the associated increased administrative costs and risks of collection.

**Our video phonetechnology and products remain subject to significant uncertainty.**

Our video phonetechnology and products are in the early commercialization stage and have notbeen proven over an extended period of time. The market for products related tovideo telephony is characterized by uncertain user and customer requirements,and the emergence of new communications standards and practices. Each of thesecharacteristics could impact our video phone products, intellectual propertyand system designs. The successful development of our products is subject tothe risks that:

·       ourproposed product is found to be ineffective for the intended purposes;

·       theproposed product is uneconomical to manufacture, or market or does not achievebroad market acceptance; and

·       thirdparties hold proprietary rights that preclude us from marketing the product.

Significant undetectederrors or delays in new products or releases may affect market acceptance ofour product. There can be no assurance that, despite our testing, errors willnot be found in the initial product or subsequent releases after thecommencement of commercial shipments, resulting in loss of customers or failureto achieve market acceptance. In addition, our video phone technology and productwill need to be compatible with a broad array of disparate technologies inorder to be interoperable with 

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otherproducts routinely used in HSD operations such as routers, switches, networkinterfaces, operating systems, security protocols and techniques, communicationprotocols and protocol servers, and billing systems software. Withoutcompatibility, we may not achieve market acceptance or demand for our productswithin our target base of customers because our products will not operate withmany of the applications the target customers currently use.

**We rely on thirdparties to provide certain components and services for our video phoneproducts. If our vendors fail to deliver their products in a reliable, timelyand cost-efficient manner, our business will suffer.**

We depend on relationshipswith third parties such as contract manufacturing companies, chip designcompanies and others who may be sole source providers of key components andservices critical for the product we are developing in our video phonebusiness. A formal relationship with Mototech has been established for thevolume manufacture of Ojo. Our agreement with Mototech allows either party toterminate the agreement with 90 days prior notice. If Mototech or otherproviders of components and/or manufacturing services do not produce thesecomponents or provide their services on a timely basis, if the components orservices do not meet our specifications and quality control standards, or ifthe components or services are otherwise flawed, we may have to delay productdelivery, or recall or replace unacceptable products. In addition, suchfailures could damage our reputation and could adversely affect our operatingresults. As a result, we could lose potential customers and any revenues thatwe may have at that time may decline dramatically.

**We rely on thirdparties to provide certain marketing and distribution services for our videophone products. If our vendors fail to deliver their services in anappropriate, reliable, timely and cost-efficient manner, our business willsuffer.**

Prior to February 17,2006 the Company relied upon General Instrument to provide the marketing anddistribution for its products. As of such date, the Company and GeneralInstrument agreed to end their development and distribution agreement and theCompany assumed full responsibility for product sale and distribution in allchannels. In addition to direct sales on our web site, we will continue to relyupon a distribution organization of dealers, distributors, original equipmentmanufacturers, value added resellers, service providers and other resellers tomarket and sell our video phone products, many of which are the same as thoseused by General Instrument. WorldGate also plans to expand distribution toservice providers and retailers around the world.   Given our limited experience in dealing withthe retail distribution channel, there can no assurance that we will be able tosuccessfully and expeditiously conclude retail distribution agreements with thenecessary retailers and distributors.   These resellers are able to set their ownpolicies regarding the pricing of our products and the advertising, marketingand other promotional efforts applicable to our products. In addition theydetermine how prominently our products are displayed and demonstrated. If ourresellers’ policies are not effective or if our products are not given adequateprominence, our sales of our products may be negatively impacted and ouroperating results would be adversely affected. In this event our revenue couldbe significantly reduced and we could lose potential customers for ourproducts.

**With the end of ourdevelopment and distribution agreement with General Instrument, we are nolonger able to use the Motorola brand in association with our products, orGeneral Instrument’s other resources in marketing and distributing ourproducts.**

The Motorola brand madeavailable by General Instrument is a widely recognized brand that is almostsynonymous with cell phone, radios and other widely distributed electronicproducts. In addition, General Instrument brought significant resources in theareas of advertising, sponsorship, sales force and distribution logistics. Withthe end of our agreement with General Instrument, we have phased out theMotorola branding and we are no longer eligible to benefit from the otherresources that they offered. This 

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maynegatively impact the perception of our products and will require increasedefforts on our part to market and promote our products and to efficiently andsuccessfully sell and distribute our products, and there can be no assurancethat we will be successful in our efforts.

**We may not be ableto meet our product development objectives or market expectations.**

Our video phone productsare complex and use “state of the art” technology. Accordingly, our developmentefforts are inherently difficult to manage and keep on schedule and therecan be no assurance that we will be able to meet our development objectives orto meet market expectations. In addition to development delays, we mayexperience substantial cost overruns in completing development of our product.The technological feasibility for some aspects of the product that we envisionis not completely established. The products developed by us may contain undetectedflaws when introduced. There can be no assurance that, despite testing by usand by potential customers, flaws will not be found in the product, resultingin loss of or delay in market acceptance. We may be unable, for technologicalor other reasons, to develop and introduce products in a timely manner inresponse to changing customer requirements. Further, there can be no assurancethat a competitor will not introduce a similar product. The introduction by acompetitor of either a similar product or a superior alternative to ourproduct, may diminish our technological advantage, render our product andtechnologies partially or wholly obsolete, or require substantialre-engineering of our product in order to become commercially acceptable. Ourfailure to maintain our product development schedules, avoid cost overruns andundetected errors or introduce a product that is superior to competing productswould have a materially adverse effect on our business, financial condition andresults of operations.

**We may not be ableto achieve competitive pricing in the marketplace.**

Because video phoneproducts are relatively new to the marketplace there is no established marketpricing. Our pricing for the Ojo video phone may be considered high for aconsumer product offering. We cannot be assured that we will be able to providecompetitive market pricing.

**We may be subjectto exchange rate fluctuations that could impact on the cost of product and ourrevenues.**

Although our agreementwith Mototech  Inc. (not an affiliate ofGeneral Instruments or Motorola), our contract manufacturer in Taiwan, isdenominated in U.S. dollars, their material acquisition costs are subject toexchange rate changes that could impact our product costs. Unfavorable exchangerate fluctuations could impact our cost of goods and result in increasedproduct pricing that may hamper our ability to sell the units at a priceacceptable to our customers or consumers. Our current revenues are alldenominated in US dollars. In the future, should we derive revenues that aredenominated in foreign currency, our revenue would be subject to exchange ratefluctuations and could be impacted as a result.

**We are highlydependent on our key personnel to manage our business, and because ofcompetition for qualified personnel we may not be able to recruit or retainnecessary personnel.**

Our continued growth andsuccess depend to a significant degree on the continued services of our seniormanagement and other key employees and our ability to attract and retain highlyskilled and experienced technical, managerial, sales and marketing personnel.We have historically been a developer of products related to ITV. Our videophone business represents an expansion into the development of HSDcommunications hardware and software products in which we have limitedexperience. In our new video phone business, we also expect to encounter newproduct development challenges, new customer requirements, new competitors andother new business challenges, with which our existing management may beunfamiliar. There can be no assurance that we will be successful in recruitingnew personnel or in retaining existing personnel. None of our employees aresubject to a long-term employment agreement. 

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The lossof one or more key employees or our inability to attract additional qualifiedemployees could have a material adverse effect on our business, results ofoperations and financial condition. In addition, we may experience increasedcompensation costs in order to attract and retain skilled employees.

**We may not besuccessful in developing or maintaining strong distribution channels for ourvideo phone products.**

The success of the videophone business depends on developing strong relationships with serviceproviders such as cable and DSL operators and other HSD communicationsproviders and distribution channel partners who are selling services and/orconsumer electronic devices to end-users. If we are not successful in creatinga strong distribution channel in a timely manner, we may not gain significantsales.

**We may not be ableto compete successfully in the highly competitive and rapidly evolving HSDcommunications market.**

The market for productsthat utilize HSD communications is still developing and there can be noassurance that our product will ever achieve market acceptance. Businesses,cable operators and other HSD network providers as well as the users of suchHSD networks must be convinced to buy our video phone product. To the extent wedo not achieve growth, it will be difficult for us to generate meaningfulrevenue or to achieve profitability.

**We may not be ableto protect intellectual property of our video phone business againstthird-party infringements or claims of infringement.**

Failure to protect our intellectual property rightsmay result in a loss of our exclusivity or the right to use our video phonetechnology. We plan to rely on patent, trade secret, trademark and copyrightlaw to protect our video phone intellectual property. Although we have filedmultiple patent applications for our technology, and we currently only hold oneissued patent, our patent position is subject to complex factual and legalissues that may give rise to uncertainty as to the validity, scope andenforceability of a particular patent. Accordingly, there can be no assurancethat any patents will be issued pursuant to our current or future patentapplications or that patents issued pursuant to such applications will not beinvalidated, circumvented or challenged. Moreover, there can be no assurancethat the rights granted under any such patents will provide competitiveadvantages to us or be adequate to safeguard and maintain our proprietaryrights. In addition, effective patent, trademark, copyright and trade secretprotection may be unavailable, limited or not applied for in certain foreigncountries.

We also seek to protect our proprietary intellectualproperty, including intellectual property that may not be patented orpatentable, in part by confidentiality agreements and, if applicable, inventor’srights agreements with our current and future strategic partners and employees.We cannot assure you that these agreements will not be breached, that we willhave adequate remedies for any breach or that such persons or institutions willnot assert rights to intellectual property arising out of these relationships.

Some of our video phoneintellectual property includes technologies and processes that may be similarto the patented technologies and processes of third parties. If we do notadequately secure our freedom to use our video phone technology, we may have topay others for rights to use their intellectual property, pay damages forinfringement or misappropriation or be enjoined from using such intellectualproperty. If we are found to be infringing third-party patents, we do not knowwhether we will be able to obtain licenses to use such patents on acceptableterms, if at all. While we are not currently engaged in any materialintellectual property disputes or litigation, we could become subject tolawsuits in which it is alleged that we have infringed the intellectualproperty rights of others or commence lawsuits against others who we believeare infringing upon our rights. Our involvement in intellectual propertylitigation could result in significant expense to us, adversely affecting thedevelopment of the challenged product or intellectual 

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propertyand diverting the efforts of our technical and management personnel, whether ornot such litigation concludes favorably for our company.

**Legal andregulatory developments could have adverse consequences for our business.**

The legal and regulatoryenvironment that pertains to our business is uncertain and changing rapidly.New legislation or regulations could be introduced in any country that couldsubstantially impact our ability to launch and promote the Ojo video phone inthat country. For example the Federal Communications Commission (FCC) or acomparable regulatory authority could undertake an examination of whether toimpose surcharges or additional regulations upon certain providers of Internetprotocol, or IP, based communication services. The imposition of regulations onIP communications services may negatively impact our business. Similarly theadoption of regulations prohibiting the use of certain substances commonlyfound in electronic components could likewise increase the costs of ourproducts, delay product introductions and otherwise negatively impact ourbusiness.

**The use of the highspeed data infrastructure as a commercial marketplace is at an early stage ofdevelopment.**

Demand and marketacceptance for recently introduced products and services over the high speeddata, or HSD, infrastructure are still uncertain. We cannot predict whethercustomers will be willing to shift their traditional telephone activitiesonline. The HSD infrastructure may not prove to be a viable commercialmarketplace for a number of reasons, including:

·       concernsabout security and varying security techniques and protocols;

·       changingand non-uniform standards

·       Internetcongestion;

·       qualityof service issues;

·       inconsistentservice; and

·       lackof cost-effective, high-speed access.

If the use of the HSDinfrastructure as a commercial marketplace does not continue to grow, we maynot be able to grow our customer base, which may prevent us from achievingprofitability.

**We may not havesufficient working capital to fund our continuing video phone business, and wemay be unable to obtain additional capital.**

The extent and timing ofour future capital requirements will depend upon several factors, including therate of market acceptance of our products, the degree of competition for ourproducts, and our level of expenditures, including those for productdevelopment, sales and marketing. If our capital requirements vary materially fromthose currently planned, we may require additional financing sooner thananticipated. Despite the receipt of proceeds from several private placements ofour securities, we may need to seek additional third party investment in orderto provide additional operating capital for our video phone business. We cannotbe certain that financing from third parties will be available on acceptableterms to us or at all. The levels of funding of early-stage companies generallyby both venture funds and strategic investors have fallen dramatically in thepast few years. If we cannot raise funds on acceptable terms, we may not beable to develop our products and services, take advantage of futureopportunities or respond to competitive pressures or unanticipated requirements,any of which could have a material adverse effect on our ability to grow ourbusiness. If we are unable to secure such additional financing, we will have tocurtail or suspend our business activities, we may not be able to continue tooperate our business as a going 

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concernand we may have to seek protection of the bankruptcy courts. If that happens,you could lose your entire investment.

**If we obtainadditional financing, you may suffer significant dilution.**

If we raise additionalcapital by issuing equity securities, our stockholders may experience severedilution of their ownership percentage, which may adversely affect the value ofour common stock. In addition, the new equity securities may have rights,preferences or privileges senior to those of our common stock.

**NASDAQ ListingRequirements may limit our ability to raise additional capital.**

Our common stock is listedon the NASDAQ Capital Market. If our common stock is listed on The NASDAQ GlobalMarket or The NASDAQ Capital Market at the time of a proposed equity financingresulting in the sale and issuance of twenty percent or more of the outstandingshares of our capital stock, we may be required to obtain stockholder approvalof such issuance. There can be no assurance that we will be able to obtain anynecessary stockholder approval, and the failure to obtain such approval couldlimit our ability to obtain needed capital.

**In the event thatour common stock is delisted from NASDAQ Capital Market, it may be subject tothe requirements of the rules relating to “penny stocks.”**

Our common stock iscurrently listed on the NASDAQ Capital Market, which has requirements for thecontinued listing of stock. If we fail to continue to meet these listingrequirements we will become subject to delisting. For example, if our commonstock trades below $1.00 for 30 consecutive trading days, or if we fail to meetany of the other listing requirements including the timely filing of ourrequired financial reports or the market capitalization, minimum stockholders’equity requirements and keeping required filings current, our common stock maybe delisted from the NASDAQ Capital Market. If our shares are delisted from theNASDAQ Capital Market, they are likely to become subject to the SEC penny stockrules, which could adversely affect the market liquidity of our common stock.These rules impose additional sales practice requirements onbroker-dealers that sell low-priced securities to persons other thanestablished customers and institutional accredited investors; and require thedelivery of a disclosure schedule explaining the nature and risks of thepenny stock market. As a result, the ability or willingness of broker-dealersto sell or make a market in our common stock might decline, and you could findit more difficult to sell your stock.

**Our stock price isvolatile.**

The trading price for ourcommon stock has been volatile, ranging from a sales price of $0.22 in March 2003,to a sales price of just under $7.00 per share in the first quarterof 2005. The trading price for our common stock during the period from January 3,2006 to December 29, 2006 ranged from $1.06 to $2.30. The price haschanged dramatically over short periods with changes of over 60% percent in asingle day. An investment in our stock is subject to such volatility and,consequently, is subject to significant risk.

**Prior offerings ofour common stock may have an adverse impact on the market value of our stock.**

On multiple occasions we have issued shares of ourcommon stock as part of various private placements to certain institutionalinvestors and as part of these transaction filed multiple registrationstatements, which provided for the sale or distribution of these shares bythese institutional investors. When these investors sell their shares we willnot receive any proceeds from the sales. The sale of these blocks of stock, oreven the possibility of their sale, may adversely affect the trading market forour common stock and reduce the price available in that market.

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In connection with theseprivate placements, we also issued warrants and additional investment rights topurchase shares of common stock. The existence of such rights to acquire commonstock at fixed prices may prove a hindrance to our efforts to raise futureequity and debt funding, and the exercise of such rights will dilute thepercentage ownership interest of our stockholders and may dilute the value oftheir ownership. The possible future sale of shares issuable on the exercise ofoutstanding warrants and additional investment rights could adversely affectthe prevailing market price of our common stock. Further, the holders of theoutstanding warrants and additional investment rights may exercise them at atime when we would otherwise be able to obtain additional equity capital onterms more favorable to us.

**The Company’sfailure to comply with certain covenants contained in agreements relating toits private placement of securities may have an adverse impact on the cashavailable to the Company.**

On multiple occasions wehave issued shares of our common and preferred stock, issued convertibledebentures, as well as issued warrants and additional rights to acquire ourcommon stock, to certain institutional investors in private placementtransactions. The various agreements providing for these private placementtransactions included numerous provisions intended to protect suchinstitutional investors. For example, the Company is required to continuallymaintain effective registration statements permitting the investors to selltheir shares of common stock. Failure to comply with such requirements mayresult in damages to the investors and result in obligations to make cashpayments to the investors. The investors may also be entitled to receive moreshares than originally allocated in the event the Company subsequently issuesshares to other investors at a lower valuation than that afforded to theinvestors. In addition, the investors may be entitled to receive cash paymentsinstead of shares upon the redemption of certain securities in the event thatcertain defined events occur including a lapse in the registration statement,being de-listed on certain specified exchanges, trading in the Company’s stockis suspended, or a change in control occurs with respect to the Company.

**Our board ofdirectors’ right to authorize additional shares of preferred stock couldadversely impact the rights of holders of our common stock.**

Our board of directorscurrently has the right to designate and authorize the issuance of one or moreseries of our preferred stock with such voting, dividend and other rights asour directors may determine. The board of directors can designate new series ofpreferred stock without the approval of the holders of our common stock. Therights of holders of our common stock may be adversely affected by the rightsof any holders of shares of preferred stock that may be issued in the future,including without limitation dilution of the equity ownership percentage of ourholders of common stock and their voting power if we issue preferred stock withvoting rights. Additionally, the issuance of preferred stock could make it moredifficult for a third party to acquire a majority of our outstanding votingstock.

**Item 2.**                        Properties.

Our corporate headquartersis located in Trevose, Pennsylvania in a leased facility consisting ofapproximately 42,500 square feet at an annual fee of $11.74 per square foot,with a 3% increase annually. The current lease has a five year term effective September 1,2005. The lease is cancelable by either party with eight months notice, with atermination by the tenant including a six months termination fee.

**Item 3.**                        LegalProceedings.

Although from time to timewe may be involved in litigation as a routine matter in conducting ourbusiness, we are not currently involved in any litigation which we believe ismaterial to our operations or balance sheet. We comply with the requirements ofcurrently prevailing accounting standards and provide for accruals where aliability is probable and a reasonable estimate can be made as to the probableamount of such liability.

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**Item 4.**                        Submissionof Matters to a Vote of Security Holders.

At our annual meeting of stockholders held on October 11,2006, our stockholders elected six members to our Board of Directors. Thoseelected to the Board were Hal M. Krisbergh, Steven C. Davidson, Clarence L.Irving, Jr., Martin Jaffe, Jeff Morris and Lemuel Tarshis.

Theresults of the voting for each member of our Board of Directors are as follows:

| **Nominee**                   | ** ** | ** ** | ** ** | **FOR** | ** ** | **WITHHELD** | ** ** |
|-------------------------------|------------|------------|------------|---------|------------|--------------|------------|
| Steven C.  Davidson           |       | 32,539,590 |       |    | 1,169,770  |         |       |
| Martin Jaffe                  |       | 32,540,817 |       |    | 1,168,543  |         |       |
| Clarence L.  Irving, Jr. |       | 32,753,563 |       |    | 955,797    |         |       |
| Hal M. Krisbergh              |       | 32,749,423 |       |    | 959,937    |         |       |
| Jeff Morris                   |       | 32,755,545 |       |    | 933,815    |         |       |
| Lemuel Tarshis                |       | 32,537,499 |       |    | 1,171,861  |         |       |

 

Additionally ourstockholders ratified and approved the Company’s issuance of common stock inaccordance with the terms of the August 2006 private placement, with avote as follows:

| FOR:              |   | 11,835,246 | ** ** |
|-------------------|--------|------------|------------|
| AGAINST:          |   | 1,069,069  | ** ** |
| ABSTENTIONS:      |   | 673,491    | ** ** |
| BROKER NON-VOTES: |   | 20,131,554 | ** ** |

Our stockholders also approved the proposed amendmentof the Company’s Certificate of Incorporation to increase the authorized sharesof the Company’s common stock from 80 million to 120 million with a vote asfollows:

| FOR:         |   | 31,801,365 |   |
|--------------|--------|------------|--------|
| AGAINST:     |   | 1,809,489  |   |
| ABSTENTIONS: |   | 98,503     |   |

 

 

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**PART II**

**Item 5.**                        Marketfor Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of Equity Securities.

**Price Range of Common Stock**

Ourcommon stock, $0.01 par value, is traded on the NASDAQ Capital Market under thesymbol “WGAT.”  The following table showsthe high and low sales price as reported by the NASDAQ Capital Market, for eachquarter of 2005 and 2006.

| ** **                             | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------------------------------|------------|----------|------------|---------|------------|
| **Year Ended December 31,  2005** |       |     |       |    |       |
| First Quarter                          |       | $        | 6.89       |    | $          | 3.30 |   |
| Second Quarter                         |       | 6.03     |       | 2.95    |       |
| Third Quarter                          |       | 4.60     |       | 2.02    |       |
| Fourth Quarter                         |       | 3.40     |       | 1.62    |       |
| **Year Ended December 31,  2006** |       |     |       |    |       |
| First Quarter                          |       | $        | 2.30       |    | $          | 1.06 |   |
| Second Quarter                         |       | 2.16     |       | 1.14    |       |
| Third Quarter                          |       | 1.85     |       | 1.08    |       |
| Fourth Quarter                         |       | 1.60     |       | 1.14    |       |

 

As of March 9, 2007,we had 331 holders of record of our common stock.

**Dividends**

We have never paid ordeclared any cash dividends on our common stock. We do not anticipate payingany cash dividends in the foreseeable future. We currently expect to retainfuture earnings, if any, to finance the growth and development of our business.The terms of our currently issued preferred stock impose a preference to thepayment of any dividend on our common stock.

**Securities Authorized for Issuance Under EquityCompensation Plans**

The following table setsforth information as of December 31, 2006 regarding securities authorizedfor issuance under the Company’s equity compensation plans:

**EquityCompensation Plan Information**

| **Plan Category**                                         | ** ** | ** ** | ** ** | **Number of securities to  be issued upon exercise  of outstanding options,  warrants and rights  (a)** | ** ** | **Weighted-average  exercise price of  outstanding  options, warrants  and rights  (b)** | ** ** | **Number of securities  remaining available  for future issuance  under equity  compensation plans  (excluding securities  reflected in column (a))  (c)** | ** ** |
|----------------------------------------------------------------|------------|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity compensation  plans approved by security holders(1)     |       |       | 4,913,689  |                                                                                                                                                      |       |                                                                                                         | $          | 1.90                                                                                                                                                                                                              |       |   |   | 2,091,682 | (1) |   |
| Equity  compensation plans not approved by security holders(2) |       |       | —     |                                                                                                                                                      |       |                                                                                                         | —     |                                                                                                                                                                                                              |       |   | — |   |   |
| Total                                                          |       |       | 4,913,689  |                                                                                                                                                      |       |                                                                                                         | 1.90       |                                                                                                                                                                                                              |       |   | 2,091,682 | (1) |   |

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(1)          2003Equity Incentive Plan. The 2003 Equity Plan has an automatic annual increase inthe number of shares reserved for issuance in an amount equal to the lesser of4% of the then outstanding shares of our Common Stock or 1,000,000 shares.

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(2)          TheCompany does not maintain any equity compensation plans that have not beenapproved by its stockholders.

In 2003 the Company adopted an equity incentive plan(the “Equity Plan”) which was approved by stockholders in November, 2004. Theprincipal features of our Equity Plan are summarized below, but the summary isqualified in its entirety by reference to our Equity Plan, which was filed asexhibit 10.6 to the Company’s Proxy Statement to shareholders filed September 3,2004.

This plan provides for the grant of equity awards tosuch officers, other employees, consultants and directors of WorldGate and ouraffiliates as the Compensation and Stock Option Committee may determine fromtime to time. Although various types of awards are available under the EquityPlan, including non-qualified and incentive stock options, restricted stock andperformance based awards, currently only stock options have been granted. Suchoptions vest in equal installments over a four-year period, and expire tenyears following the date of its grant, subject to acceleration in the event ofsome changes of control of WorldGate, and earlier termination upon cessation ofemployment. The Equity Plan has an automatic annual increase in the number ofshares reserved for issuance in an amount equal to the lesser of 4% of the thenoutstanding shares of our Common Stock or 1,000,000 shares.

To administer our Equity Plan, the Compensation andStock Option Committee must consist of at least two members of our board ofdirectors, each of whom is a “non-employee director” for purposes of Rule 16b-3under the Securities Exchange Act of 1934, or the Exchange Act and, withrespect to awards that are intended to constitute performance-basedcompensation under Section 162(m) of the Internal Revenue Code of1986, an “outside director” for the purposes of Section 162(m). TheCompensation and Stock Option Committee, among other things, interprets ourEquity Plan, selects award recipients, determines the type of awards to begranted to such recipients and determines the number of shares subject to eachaward and the terms and conditions thereof. The Compensation and Stock OptionCommittee may also determine if or when the exercise price of an option may bepaid in the form of shares of our common stock and the extent to which sharesor other amounts payable with respect to an award can be deferred by theparticipant. Our board of directors may amend or modify our Equity Plan at anytime. In addition, our board of directors is also authorized to adopt, alterand repeal any rules relating to the administration of our Equity Plan andto rescind the authority of the Compensation and Stock Option Committee andthereafter directly administer our Equity Plan. However, subject to certainexceptions, no amendment or modification will impair the rights and obligationsof a participant with respect to an award unless the participant consents tothat amendment or modification.

Our Equity Plan will continue in effect untilterminated by us in accordance with its terms, although incentive stock optionsmay not be granted more than 10 years after the adoption of our Equity Plan.

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Thefollowing performance graph compares the yearly percentage change in thecumulative total return to stockholders on the company’s common stock, assumingreinvestment of dividends, with similar returns for  the Nasdaq Telecommunications Index, NasdaqStock Market (U.S.) Index and the Dow Jones Internet Commerce Index, all ofwhich include the company.

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**Item 6.**                        SelectedFinancial Data.

The following table setsforth selected consolidated financial information for the five-year periodended December 31, 2006. This data should be read in conjunction with ourfinancial statements and notes thereto and “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” included elsewherein this report.

| ** **                                                                       | ** ** | **Year ended December 31,**                                             | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2002**                                                                               | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                                       | ** ** | **(In thousands, except share and per share data)** | ** ** |
| Net revenues                                                                     |       | $                                                                                      | —     |   | $ | — |   | $ | 231 |   | $ | 1,558 |   | $ | 2,776 |   |
| Cost of revenues                                                                 |       | —                                                                                 |       | — |   | 103 |   | 2,012 |   | 3,369 |   |
| Gross margins                                                                    |       | —                                                                                 |       | — |   | 128 |   | (454 | ) | (593 | ) |
| Costs and  expenses:                                                             |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Engineering and development                                                      |       | —                                                                                 |       | 1,963 |   | 3,557 |   | 5,727 |   | 6,238 |   |
| Sales and marketing                                                              |       | —                                                                                 |       | 466 |   | 1,362 |   | 3,755 |   | 3,395 |   |
| General and administrative                                                       |       | —                                                                                 |       | 3,368 |   | 5,119 |   | 5,528 |   | 6,983 |   |
| Depreciation and amortization                                                    |       | —                                                                                 |       | — |   | 477 |   | 693 |   | 720 |   |
| Total expenses from continuing  operations                                       |       | —                                                                                 |       | 5,797 |   | 10,515 |   | 15,703 |   | 17,336 |   |
| Loss from operating activities of continuing  operations                         |       | —                                                                                 |       | (5,797 | ) | (10,387 | ) | (16,157 | ) | (17,929 | ) |
| Interest and other income                                                        |       | —                                                                                 |       | — |   | 1,023 |   | 718 |   | 461 |   |
| Change in fair value of derivative warrants and  conversion options              |       | —                                                                                 |       | — |   | (10,091 | ) | 8,594 |   | (435 | ) |
| Gain on contract termination                                                     |       | —                                                                                 |       | — |   | — |   | — |   | 1,843 |   |
| Amortization of debt discount                                                    |       | —                                                                                 |       | — |   | — |   | — |   | (1,354 | ) |
| Interest and other expense                                                       |       | —                                                                                 |       | — |   | (6 | ) | (6 | ) | (194 | ) |
| Loss from continuing operations                                                  |       | —                                                                                 |       | (5,797 | ) | (19,461 | ) | (6,851 | ) | (17,608 | ) |
| (Loss) income from discontinued operations                                       |       | (19,210                                                                                | )          | (2,908 | ) | 36 |   | — |   | — |   |
| Net loss                                                                         |       | (19,210                                                                                | )          | (8,705 | ) | (19,425 | ) | (6,851 | ) | (17,608 | ) |
| Accretion on preferred stock ,dividends and deemed  dividends                    |       | —                                                                                 |       | — |   | (951 | ) | (3,922 | ) | (106 | ) |
| Net loss available to common stockholders                                        |       | $                                                                                      | (19,210    | ) | $ | (8,705 | ) | $ | (20,376 | ) | $ | (10,773 | ) | $ | (17,714 | ) |
| Basic and diluted loss from continuing operations per  common share              |       | $                                                                                      | 0.00       |   | $ | (0.25 | ) | $ | (0.70 | ) | $ | (0.19 | ) | $ | (0.44 | ) |
| Basic and diluted  (loss) income from discontinued operations per common share   |       | $                                                                                      | (0.81      | ) | $ | (0.12 | ) | $ | (0.00 | ) | $ | (0.00 | ) | $ | 0.00 |   |
| Basic and diluted net loss per common share                                      |       | $                                                                                      | (0.81      | ) | $ | (0.37 | ) | $ | (0.70 | ) | $ | (0.19 | ) | $ | (0.44 | ) |
| Basic and diluted net loss available to common  stockholders per common share(1) |       | $                                                                                      | (0.81      | ) | $ | (0.37 | ) | $ | (0.73 | ) | $ | (0.30 | ) | $ | (0.44 | ) |
| Weighted average common share outstanding—basic and  diluted                |       | 23,573,935                                                                             |       | 23,259,611 |   | 27,881,347 |   | 35,449,225 |   | 39,992,499 |   |
| Net loss available to common stockholders                                        |       | $                                                                                      | (19,219    | ) | $ | (8,705 | ) | $ | (20,376 | ) | $ | (10,733 | ) | $ | (17,714 | ) |
| Basic and diluted net loss available to common  stockholders per common share    |       | $                                                                                      | (0.81      | ) | $ | (0.37 | ) | $ | (0.73 | ) | $ | (0.30 | ) | $ | (0.44 | ) |
| Balance sheet  data:                                                             |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                                        |       | $                                                                                      | 3,807      |   | $ | 3,365 |   | $ | 11,840 |   | $ | 16,277 |   | $ | 10,067 |   |
| Total assets                                                                     |       | 14,019                                                                                 |       | 5,117 |   | 13,822 |   | 21,229 |   | 14,566 |   |
| Redeemable Preferred Stock                                                       |       | —                                                                                 |       | — |   | 2,995 |   | 379 |   | 141 |   |
| Total stockholders’ equity (deficiency)                                     |       | 7,295                                                                                  |       | 3,680 |   | (5,572 | ) | 13,717 |   | 2,002 |   |
| Other data:                                                                      |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Common shares  outstanding                                                       |       | 23,077,963                                                                             |       | 25,706,843 |   | 30,865,777 |   | 39,511,519 |   | 41,535,443 |   |

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(1)             For purposes of computing the net loss percommon share, net loss has been reduced by the accretion on preferred stock,dividends and deemed dividends.

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**Item7.**                        Management’sDiscussion and Analysis of Financial Condition and Results of Operations.(Dollar amounts contained in this Item 7 are in thousands, except pershare amounts)

**FORWARD-LOOKINGAND CAUTIONARY STATEMENTS**

We may from time to timemake written or oral forward-looking statements, including those contained inthe following Management’s Discussion and Analysis of Financial Condition andResults of Operations. The words “estimate,” “project,” “believe,” “intend,” “expect,”and similar expressions are intended to identify forward-looking statements,although not all forward-looking statements contain these identifying words. Inorder to take advantage of the “safe harbor” provisions of the PrivateSecurities Litigation Reform Act of 1995, we are hereby identifying certainimportant factors that could cause our actual results, performance orachievement to differ materially from those that may be contained in or impliedby any forward-looking statement made by or on our behalf. The factors,individually or in the aggregate, that could cause such forward-lookingstatements not to be realized include, without limitation, the following: (1) difficultyin developing and implementing marketing and business plans, (2) industrycompetition factors and other uncertainty that a market for our products willdevelop, (3) challenges associated with distribution channels, includingboth the retail distribution channel and HSD operators (e.g., uncertainty that they will offer our products,inability to predict the manner in which they will market and price ourproducts and existence of potential conflicts of interests and contractuallimitations impeding their ability to offer our products), (4) continuedlosses, (5) difficulty or inability to raise additional financing on termsacceptable to us, (6) departure of one or more key persons, (7) delistingof our Common Stock from the NASDAQ Capital Market, (8) changes inregulatory requirements, and (9) other risks identified in our filingswith the Securities and Exchange Commission. We caution you that the foregoinglist of important factors is not intended to be, and is not, exhaustive. We donot undertake to update any forward-looking statement that may be made fromtime to time by or on our behalf.

**Results of Operations:**

**General**

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

On April 28, 2004, weentered into a multi-year agreement with General Instrument Corporation d/b/athe Connected Home Solutions Business of Motorola, Inc. (“GeneralInstrument”) for the worldwide development and distribution of the Ojo personalvideo phone. This agreement provided for General Instrument to be WorldGate’sexclusive distributor of its broadband video phone products and for WorldGateto be General Instrument’s exclusive supplier of its broadband video phoneproducts. On February 17, 2006, we mutually agreed with General Instrumentto end this agreement. The ending of this agreement immediately terminatedexclusivity for both parties. In addition to its current role for developmentand manufacture of Ojo, WorldGate assumed direct responsibility and control forthe advertising, marketing, and distribution of its products.

Under our development anddistribution agreement with General Instrument, General Instrument wasresponsible for the distribution of our products and for the directrelationship with the distributors, dealers, and other resellers ultimatelyused to sell the products. In addition, General Instrument marketed ourproducts and maintained an inventory of our products. In performing thesefunctions General Instrument carried the associated risks, costs and expenses. Asa result of ending our agreement with General Instrument, we assumed theseresponsibilities and the associated risks, costs and expenses, and this placesincreased demands on the cash which we have available. Although GeneralInstrument’s price of our product to its reseller customers included a mark-upfrom its cost of the product from us that was intended to reflect its risks,cost and expenses, plus its profit, we are charging these reseller customers a 

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lowerprice and we cannot be assured that the new price will include a sufficientmark-up to cover the risks, costs and expenses that is now our responsibilitygoing forward.

Under its agreement withGeneral Instrument, WorldGate had been active in marketing and promoting itsproducts, and working with General Instrument to distribute Ojo. WorldGate iscontinuing the rollout of Ojo using many of the same distributors, retailersand service providers and plans to expand distribution to service providers andretailers around the world. In addition to direct sales on our web site, wewill continue to rely upon a distribution organization of dealers,distributors, original equipment manufacturers, value added resellers, serviceproviders and other resellers to market and sell our video phone products, manyof which are the same as those used by General Instrument. To enable our ownretail distribution efforts we have hired an experienced retail consumerelectronics executive to direct our efforts in this area. To create retail andconsumer interest and build demand for the product, the Company has lowered thewholesale and manufacturer suggested retail prices. As the result of ending ouragreement with General Instrument, we have dropped the Motorola brand.

General Instrument alsomaintained the necessary infrastructure to handle distribution logistics,including customer ordering, inventory warehousing, billing, customer service,credit and accounts receivable functions for multiple customers. All of ourrevenue for the sale of our video phones was derived from General Instrument, asingle customer, and there were minimal administrative costs associated withbilling and collecting this revenue. The Company now has multiple customers andbears the associated increased administrative costs and risks of collection.WorldGate has also had to develop the necessary infrastructure to handlemultiple customers and these other logistical functions.

As part of ending ouragreement with General Instrument, and in anticipation of WorldGate inventoryrequirements as a result of taking full responsibility for productdistribution, WorldGate negotiated the right to buy back approximatelytwo-thirds of the units sold to General Instrument, valued at approximately$2,765 (based upon the original sales price to General Instrument), forapproximately $1,064. This is less than half of what it would cost the Companyto purchase the same inventory from its manufacturing sources.   For more details, refer to Note 3 to ourconsolidated financial statements for the year ended December 31, 2006.

The Company does notbelieve it is necessary to establish a reserve for retailer returns to GeneralInstrument. In the Company’s discussions with the retailers eligible for suchreturns, the retailers have indicated their intention to continue to sell theCompany’s video phone products and to date the Company has not received anyreturned products.

As part of ending thedevelopment and distribution agreement, General Instrument has agreed tocertain restrictions on its development of a stand-alone video phone productwhich has as a primary function of making or receipt of video phone calls overa broadband network. Such restrictions ended in January 2007.

**Critical Accounting Policies and Estimates**

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

Our significant accountingpolicies are described in the notes to the consolidated financial statementsincluded in our annual report on Form 10-K. Judgments and estimatesof uncertainties are required in applying our accounting policies in many areas.Following are some of the areas requiring significant judgments and estimates:revenue recognition, accounts receivable, inventories, cash flow and valuationassumptions in performing asset impairment tests of long-lived assets, incometaxes, stock based 

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compensation,value of redeemable preferred stock, convertible debentures, related warrantsand conversion options.

*Revenue Recognition*

Revenue is recognized whenpersuasive evidence of an arrangement exists, the price is fixed ordeterminable, the collectibility is reasonably assured, and the delivery andacceptance of the equipment has occurred or services have been rendered. Managementexercises judgment in evaluating these factors in light of the terms andconditions of its customer contracts and other existing facts and circumstancesto determine appropriate revenue recognition. Due to our limited commercialsales history, our ability to evaluate the collectibility of customer accountsrequires significant judgment. The Company evaluates its equipment customer andservice customers’ accounts for collectibility at the date of sale and on anongoing basis.

For the year ended December 31,2005, and through mid February 2006, the Company had only one customer forthe purchase of its product and the agreement with this customer includedseveral elements relevant to revenue recognition including: (a) thecustomer had no general right to return the product;  (b) thecustomer earned warrants upon the purchase of significant video telephony unitsand the value of these warrants would result in a reduction of recognizedrevenue (the value of these warrants has been routinely monitored by theCompany and is currently deemed to be insignificant, however, should the valueof these warrants become material an offset would be made against revenues); (c) penaltieswere payable to the customer if certain excessive field failure rates are exceeded; (d) the Company and the customer share in the benefit achieved by productcost reductions; (e) penalties were payable to the customer if the Companyfails to deliver shipments on a timely basis; (f) the Company extended tothe customer a limited product warranty for a term not to exceed three years(the Company maintains a warranty reserve based upon the percentage of productsales consistent with industry comparable failure rates and the warranty periodprovided by the agreement). Beginning in mid February 2006, as a result ofthe termination of the General Instrument marketing and distribution agreement,the Company began selling its products to multiple customers and now evaluatesits revenue recognition policy on a customer by customer basis.

Revenues are also offsetby a reserve for any price refunds and consumer rebates consistent with theEITF Issue 01-9, “Accounting for Consideration Given by a Vendor to aCustomer.”

As an incentive to promotedelivery of the units, a special product launch discount was provided by theCompany to a distributor as a quantity restricted reduction to the unitcontract based price in effect. For the year ended December 31, 2005, thisdiscount was $398. In addition, the Company offered a forward pricing programto its former distributor and a rebate program to consumers, as furtherincentives for the 2005 holiday season. These incentive programs began in thefourth quarter of 2005 and terminated during the first quarter of 2006.Consistent with the EITF Issue 01-9, the Company has offset its revenuesfor the year ended December 31, 2005 by $212 for a reserve for the totalestimated liability for the forward pricing program, and $91 as an estimatedliability associated with the rebate program. The total of the product launchdiscount, refunds and rebates for the year ended December 31, 2005 was$701. The forward pricing program was terminated with the termination on February 17,2006 of the distribution agreement with General Instruments, and this liabilitywas reversed and recorded as a $212 increase to the gain realized fromtermination of this agreement. On March 13, 2006, the Company announcedthat it was going to offer a new consumer rebate program effective April 1,2006 and terminating June 30, 2006. At December 31, 2006, there wasan estimated liability of $48 associated with this rebate program. Also, on March 13,2006 the Company announced a price protection program for certain retailersholding Ojo video phone inventory as of April 1, 2006. At December 31,2006, there was an estimated liability of $2 associated with this priceprotection program. These rebate and price protection programs were recorded asoffsets against revenues in the year ended December 31, 2006.

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As part of ending itsagreement with General Instrument, and in anticipation of WorldGate inventoryrequirements as a result of taking full responsibility for productdistribution, WorldGate negotiated the right to buy back about two-thirds ofthe units sold to General Instrument, valued at approximately $2,765 (basedupon the original sales price to General Instrument), for approximately $1,064.This is less than half of what it would cost the Company to purchase the sameinventory from its manufacturing sources. As a result the Company recorded a reservefor returns and reduced revenue in the amount of approximately $2,310, duringthe fourth quarter of 2005. In addition, the Company has recorded no revenuefor units shipped to General Instrument in the first quarter 2006 and for theyear ended December 31, 2006 has recorded a gain on termination of thisagreement of approximately $1,843 as a result of the lower purchase price ofthe inventory repurchased from General Instrument ($1,393, net of the cost ofrework for rebranding the product and the adjustment of the inventory to itscurrent replacement value) and reversal of the product refund program reserve($212) as well as an adjustment of the warranty reserve for productsrepurchased ($233), both of which resulted from termination of the Company’s agreementwith General Instrument.

During the twelve monthsended December 31, 2006 we shipped several thousand units to customerssubject to a right of return should the units not be sold through to theircustomer.   Revenue for these units weredeferred as of December 31, 2006 in accordance with SFAS 48 “RevenueRecognition when a Right of Return Exists.” We expect to begin recording these shipments as revenue when these unitsare sold by our customers.

*Accounts Receivable*

The Company recordsaccounts receivable at the invoiced amount. Management reviews the receivablebalances on a monthly basis. Management analyzes collection trends, paymentpatterns and general credit worthiness when evaluating collectibility andrequires letters of credit whenever deemed necessary. Additionally, the Companymay establish an allowance for doubtful accounts based upon factors surroundingthe credit risk of specific customers, historical trends related to past lossesand other relevant information. Account balances would be charged off againstthe allowance after all means of collection have been exhausted and thepotential for recovery is considered remote. As of December 31, 2006, theCompany did not have an allowance for doubtful accounts or any off-balancesheet credit exposure related to its customers. At December 31, 2006,approximately 95% of accounts receivable were concentrated with five customers.The Company had two distribution customers that represented 8% of accountsreceivable, and had two major international telecommunications customers thatrepresented 82% of accounts receivable at December 31, 2006. At December 31,2005, approximately 92% of accounts receivable was concentrated with onedomestic customer. Trade accounts receivable at December 31, 2005 and 2006were $133 and $1,005, respectively.

*Inventory.*

Our inventory consistsprimarily of finished goods equipment to be sold to customers. The cost isdetermined on an average cost basis. A periodic review of inventory quantitieson hand is performed in order to determine and record a provision for excessand obsolete inventories. Factors related to current inventories such astechnological obsolescence and market conditions are analyzed to determineestimated net realizable values. A provision is recorded to reduce the cost ofinventories to the estimated net realizable values. To motivate trials andsales of its Ojo product, the Company has historically subsidized, and plans inthe future to continue to subsidize, certain of its product sales to customersthat result in sales of inventory below cost. In accordance with AccountingResearch Bulletin No. 43, the Company reflects such inventory at the lower ofcost or market and has reduced its inventory at December 31, 2006 by $97to reflect such valuation. Any significant unanticipated changes in the factorsnoted above could have an impact on the value of the Company’s inventory andits reported operating results. At December 31, 2005, the Company’sinventory balance was $2,878. This balance includes $2,006 of inventory relatedto the 

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accountingfor product purchased in connection with the ending of the General Instrumentagreement and was recorded as a reserve for returns. At December 31, 2006,our inventory balance was $1,600. In 2006, the Company’s inventory was reducedby $585 to their estimated net realizable values.

*Long-Lived Assets.*

Our long-lived assetsconsist of property and equipment. These long-lived assets are recorded at costand are depreciated or amortized using the straight-line method over theirestimated useful lives. The carrying value of a long-lived asset is consideredimpaired when the anticipated undiscounted cash flows from such assets areseparately identifiable and are less than the carrying value. In that event, aloss is recognized based on the amount by which the carrying value exceeds thefair market value of the long-lived asset. Fair market value is determined byusing the anticipated cash flows discounted at a rate commensurate with therisk involved. Measurement of the impairment, if any, will be based upon thedifference between carrying value and the fair value of the asset. If usefullife estimates or anticipated cash flows change in the future, we may berequired to record an impairment charge.

*Accounting for Income Taxes.*

As part of the process ofpreparing our consolidated financial statements we are required to estimate ourincome taxes in each of the jurisdictions in which we operate. This processinvolves us estimating our actual current tax exposure together with assessingtemporary differences resulting from differing treatment of items, such asdepreciation of property and equipment and valuation of inventories, for taxand accounting purposes. These differences result in deferred tax assets andliabilities. We must then assess the likelihood that our deferred tax assetswill be recovered from future taxable income and, to the extent we believe thatrecovery is more likely than not, we must establish valuation allowances. Tothe extent we establish valuation allowances or increase the allowances in aperiod, we must include an expense within the tax provision in the statement ofoperations.

We have a full valuationallowance against the net deferred tax asset of $99,335 as of December 31,2006, due to our lack of earnings history and the uncertainty as to thereliability of the asset. In the future, if sufficient evidence of our abilityto generate sufficient future taxable income becomes apparent, we would berequired to reduce our valuation allowance, resulting in a benefit from incometax in the consolidated statements of operations.

*Stock-Based Compensation.*

Effective January 1,2006, the Company adopted the fair value recognition provisions of Statement ofFinancial Accounting Standards (“SFAS”)No. 123 (Revised 2004), “Share-BasedPayment,” using the modified-prospective-transition method which requires us torecognize compensation expense on a prospective basis. SFAS No. 123(R) requiresthat all stock based compensation be recognized as an expense in the financialstatements and that such cost be measured at the fair value of the award. Underthis method, in addition to reflecting compensation for new share-based awards,expense is also recognized to reflect the remaining service period of awardsthat had been included in pro-forma disclosure in prior periods. SFAS No. 123(R) alsorequires that excess tax benefits related to stock option exercises bereflected as financing cash inflows instead of operating inflows. Therefore,prior period financial statements have not been restated. As a result, theCompany’s net loss before taxes for the year ended December 31, 2006 isapproximately $827 ($0.02 per share) greater than if it had continued toaccount for share-based compensation under Accounting Principle Board Opinion (“APB”)No. 25 “Accounting for Stock Issued to Employees.”  The stock based compensation expense isincluded in general and administrative expense in the  consolidated statements of operations.

Prior to January 1,2006, the Company’s stock-based employee compensation plans were accounted forunder the recognition and measurement provisions of  APB No. 25, and related Interpretations,as permitted by FASB Statement No. 123, “Accounting for Stock-BasedCompensation.”  The Company did 

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notrecognize stock-based compensation cost in its statement of operations forperiods prior to January 1, 2006 as all options granted had an exerciseprice equal to the market value of the underlying common stock on the date ofgrant. However, compensation expense was recognized for certain options grantedto non employees of the Company based upon fair value.

As was permitted underSFAS No. 148, “Accounting for Stock-Based Compensation - Transition andDisclosure,” which amended SFAS No. 123, the Company elected to continueto follow the intrinsic value method in accounting for its stock-based employeecompensation arrangements as defined by APB No. 25, and relatedinterpretations including FASB Interpretation No. 44, “Accounting forCertain Transactions Involving Stock Compensation,” an interpretation of APB No. 25.No stock-based employee compensation cost is reflected in operations, as alloptions granted under those plans had an exercise price equal to the marketvalue of the underlying common stock on the date of grant.

*Accounting for Preferred Shares and Related Warrants.*

The Company accounts forpreferred stock in accordance with EITF topic D-98 “Classification andMeasurement of Redeemable Securities,” and the Redeemable Preferred Stock wasrecorded in the consolidated financial statements as temporary equity.Additionally, the fair value of warrants and preferred stock conversion optionswere recorded into the consolidated financial statements as liabilities as aresult of their features that require accounting under SFAS 133 “Accounting forDerivative Instruments and Hedging Activities, as amended (“SFAS 133”).”At each reporting balance sheet date, an evaluation is made of these valuationsand marked to market. Fair value is determined using the Black-Scholes method.Key assumptions used in the Black-Scholes method include actual period closestock price, applicable volatility rates, remaining contractual life and periodclose risk free interest rate.

*Accounting for Secured Convertible Debentures andRelated Warrants.*

The Company accounts forconversion options embedded in convertible notes in accordance with SFAS No. 133and EITF 00-19 “Accounting for Derivative Financial Instruments Indexedto, and Potentially Settled in, a Company’s Own Stock” (“EITF 00-19”).SFAS 133 generally requires companies to bifurcate conversion options embeddedin convertible notes from their host instruments and to account for them asfree standing derivative financial instruments in accordance with EITF 00-19. EITF 00-19 states that if theconversion option requires net cash settlement in the event of circumstancesthat are not solely within the Company’s control that they should be classifiedas a liability measured at fair value on the balance sheet.

The Company initiallyaccounted for the warrants issued in this transaction as a liability at fairvalue in accordance with SFAS 133 and EITF 00-19 as there were insufficientauthorized shares.  On October 11, 2006,the Company received shareholder approval to increase the number of authorizedshares and the warrants were reclassified to equity. Fair value is determinedusing the Black-Scholes method.  Keyassumptions used in the Black-Scholes method include actual period close stockprice, applicable volatility rates, remaining contractual life and period closerisk free interest rate.

**2006 versus 2005**

**Revenues.**

*Revenues.**  *Net revenues for the twelve months ended December 31,2006 and 2005 were $2,776 and $1,558, respectively. This increase of $1,218, or78%, primarily reflects the initial product revenues from the Company’s directdistribution of the Ojo product subsequent to the termination of its exclusivedistribution agreement with its former distributor on February 17, 2006.This increase in revenues encompasses deliveries of video phones and relatedservice fees. Revenues during the twelve months ended December 31, 2005reflects the product inventory build up by the Company’s former distributor. Duringthe twelve months ended December 31, 2006 we shipped several thousandunits to customers 

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subject to a rightof return should the units not be sold through to their customer.   Revenue for these units were deferred as of December 31,2006 in accordance with SFAS 48 “Revenue Recognition when a Right of ReturnExists.”  We expect to begin recordingthese shipments as revenue when these units are sold by our customers.

On March 13, 2006, asan incentive to promote delivery of the units, the Company announced a specialprice protection program to certain retailers and a rebate program toconsumers. These incentive programs began on April 1, 2006 and terminatedat the end of the second quarter of 2006. Consistent with the EITF Issue 01-9,“Accounting for Consideration Given by a Vendor to a Customer,” we offset ourrevenues for the twelve months ended December 31, 2006 by $31 for theprice protection program and  $22 for theconsumer rebate program. For more details, refer to Note 3 to our consolidatedfinancial statements for the twelve months ended December 31, 2006. Duringthe twelve months ended December 31, 2006, we provided forward pricingdiscounts to retailers  and certainservice operator sales in order to help promote distribution and consumerpurchases. In the case of retail sales, the Company expects that recurringrevenues from service fees will offset any loss on the sale of the product. Thisforward pricing, coupled with inventory adjustments for obsolescence and lowermarket valuations, has resulted in a net margin loss in 2006 of $593.

During the twelve monthsended December 31, 2005, we provided a special product launch discount asan incentive to promote delivery of the units to our sole customer as aquantity restricted reduction to the unit contract based price in effect. Forthe twelve months ended December 31, 2005, this discount was $398. Inaddition, we offered a forward pricing program to this customer and a rebateprogram to consumers, as further incentives for the holiday season. Theseincentive programs began in the fourth quarter of 2005 and terminated duringthe first quarter of 2006. Consistent with the EITF Issue 01-9, “Accountingfor Consideration Given by a Vendor to a Customer,” we offset the December 31,2005 revenue by $212 with a reserve for the total estimated liability for theforward pricing program. The liability associated with the rebate, $91, hasbeen recorded in the twelve months ending December 31, 2005. The total ofthe product launch discount, rebate and refunds for the twelve months ended December 31,2005 was $701. As a result we had a negative gross margin of $454 for the yearended December 31, 2005. In the first quarter of 2006 we announced that wewere going to offer a new consumer rebate program during the second quarter of2006.

As part of ending ouragreement with General Instrument, and in anticipation of our inventoryrequirements as a result of taking full responsibility for productdistribution, we negotiated the right to buy back about two-thirds of the unitssold to General Instrument, valued at approximately $2,765 (based upon theoriginal sales price to General Instrument), for approximately $1,064. This isless than half of what it would cost us to purchase the same inventory from itsmanufacturing sources. As a result we recorded a reserve for returns andreduced revenue in the amount of approximately $2,310 during the fourth quarterof 2005. In addition we recorded no revenue for units shipped to GeneralInstrument in the twelve months ended December 31, 2006 and recorded again on termination of this agreement of approximately $1,843 during the twelvemonths ended December 31, 2006 as a result of the lower purchase price ofthis inventory (net of the cost of rework for rebranding the product).

**Costs and Expenses.**

*Cost of Revenues.*   Thecost of revenues, consisting of product and delivery costs relating to thedelivery of video phones, was $3,369 and $2,012, respectively, for the twelvemonths ended December 31, 2006 and 2005. Included in these costs for 2006were inventory adjustments for obsolescence and lower market valuations of $585.In addition, reduced inventory valuation, freight charges, product reworkexpenses, reserves for warranty and other costs related to the product furtherincreased the cost of revenues by $234 for the twelve months ended December 31,2006. For the twelve months ended December 31, 2005, the cost of revenueswere reduced by $2,006 for inventory related to the accounting for 

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product purchasedin connection with the ending of the General Instrument agreement which wasrecorded as a reserve for returns.

*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 development costs were $6,238 for the twelve monthsended December 31, 2006, compared with $5,727 for the twelve months ended December 31,2005.   This increase of $511, or 9%,reflects the Company’s increased engineering staff, and related costs, for the further and continuingdevelopment of its video phone product.

*Sales and Marketing.*   Salesand marketing expenses consist primarily of compensation (which includescompensation to manufacturer’s representatives and distributors), andattendance at conferences and trade shows, travel costs, advertising,promotions and other marketing programs (which includes expenditures for co-opadvertising and new market development) related to the continued introductionof the Company’s video phone product. Sales and marketing costs were $3,395 forthe twelve months ended December 31, 2006, compared with $3,755 for thetwelve months ended December 31, 2005. This decrease of $360, or 10%, forthe twelve months ended December 31, 2006, when compared to the sameperiod in 2005, reflects primarily a decrease of $1,115 in televisionadvertising, offset by increases in staff and other advertising and relatedmarketing and promotional expenditures in 2006 associated with the Company’sdistribution and marketing support of its video phone product.

*General and Administrative.*   Generaland administrative expenses consist primarily of expenditures foradministration, office and facility operations, finance and general managementactivities, including legal, accounting and professional fees. General andadministrative expenses were $6,983 for the twelve months ended December 31,2006, compared with $5,528 for the twelve months ended December 31, 2005. Thisincrease of $1,455, or 26%, is primarily attributable to certain expensesincurred during the twelve months ended December 31, 2006 that were notincurred during the twelve months ended December 31, 2005. These expensesincluded a non cash charge of $827 from the Company’s adoption of the fairvalue recognition provisions of SFAS No. 123 (Revised 2004), “Share-BasedPayment,” , using the modified-prospective-transition method. Prior to January 1,2006, the Company’s stock-based employee compensation plans were accounted forunder the recognition and measurement provisions of APB No. 25, andrelated Interpretations, as permitted by SFAS No. 123, “Accounting forStock-Based Compensation”. The Company did not recognize stock-based employeecompensation cost in its statement of operations for periods prior to January 1,2006 as all options granted had an exercise price equal to the market value ofthe underlying common stock on the date of grant (for more details, refer toNote 3 to our consolidated financial statements for the twelve months ended December 31,2006.)  In addition, this increase forthe twelve months ended December 31, 2006 includes an increase of $354 ofaccrued penalties related to the private placement in August 2005 (formore details, refer to Note 3 to our consolidated financial statements for thetwelve months ended December 31, 2006). In addition, rent expenseincreased by $212 for the twelve months ended December 31, 2006 over thesame period in 2005.

*Interest and Other Incomeand Interest Expense.*   Interest and other incomeconsist of interest earned on cash and cash equivalents. Interest expense of$194 consisted primarily of accrued interest on the convertible debentures($193) issued on August 11, 2006 and October 13, 2006 (see Note3  to our consolidated financial statements for the twelve months ended December 31,2006). Interest and other income decreased from $718 for the twelve monthsended December 31, 2005 to $461 for the twelve months ended December 31,2006, primarily due to lower average levels of invested funds during the twelvemonths of 2006 compared to the same period in 2005. During the twelve monthsended December 31, 2006 and 2005, the Company earned interest on averagecash balances of approximately $10,320 and $13,423, respectively.

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*NonCash Change in Fair Value of Derivative Warrants and Conversion Options.*   Forthe twelve months ended December 31, 2006 the non cash change in fairvalue of derivative warrants and conversion options was a loss of $435. For thetwelve months ended December 31, 2005, the non cash change in fair valueof derivative warrants and conversion options was income of $8,594. Thesemarked to market adjustments are primarily a result of changes in our commonstock price at each reporting period related to our June 24, 2004 privateplacement of our Series A Convertible Preferred Stock and Warrants and ourAugust 11, 2006 private placement of secured Convertible Debentures andWarrants.

*Amortizationof Debt Discount.*   For the twelve months endedDecember 31, 2006 the amortization of the debt discount was $1,354,relating to the August 11, 2006 and October 13, 2006 privateplacements of secured convertible debentures. This discount for theAugust 11, 2006 convertible debenture issuance was initially recorded as$4,446, and the discount for the October 13, 2006 convertible debentureissuance was initially recorded as $3,979. These discounts will be amortizedusing the effective interest rate method over the three year term of theconvertible debentures (see Note 3 to our consolidated financial statements forthe twelve months ended December 31, 2006).

*IncomeTaxes.**  *Wehave incurred net operating losses since inception and accordingly have had nocurrent income tax provision and have not recorded any income tax benefit forthose losses.

**2005 versus 2004**

**Revenues**

*Revenues.**  *Revenues from continuing operationsof $1,558 were realized during the twelve months ended December 31, 2005.These revenues represent the initial commercial deliveries of Ojo video phones.Revenues from continuing operations for the twelve months ended December 31,2004 were $231, primarily associated with units sold for pre-market testing.Revenue from the sale of equipment is recognized by the Company when theproducts are delivered and accepted.

As an incentive to promote delivery of the units, aspecial product launch discount was provided to our sole customer as a quantityrestricted reduction to the unit contract based price in effect. For the twelvemonths ended December 31, 2005, this discount was $398. In addition, weoffered a forward pricing program to this customer and a rebate program to consumers,as further incentives for the holiday season. These incentive programs begin inthe fourth quarter of 2005 and terminated during the first quarter of 2006.Consistent with the EITF Issue 01-9, “Accounting for Consideration Givenby a Vendor to a Customer,” we offset the December 31, 2005 revenue by$212 with a reserve for the total estimated liability for the forward pricingprogram. The liability associated with the rebate, $91, has been recorded inthe twelve months ending December 31, 2005. The total of the productlaunch discount, rebate and refunds for the twelve months ended December 31,2005 was $701. As a result we had a negative gross margin of $454 for the yearended December 31, 2005.

As part of ending ouragreement with General Instrument, and in anticipation of our inventoryrequirements as a result of taking full responsibility for productdistribution, we negotiated the right to buy back about two-thirds of the unitssold to General Instrument, valued at approximately $2,765 (based upon theoriginal sales price to General Instrument), for approximately $1,064. This isless than half of what it would cost us to purchase the same inventory from itsmanufacturing sources. As a result we recorded a reserve for returns andreduced revenue in the amount of approximately $2,310 during the fourth quarterof 2005. In addition we recorded no revenue for units shipped to GeneralInstrument in the first quarter 2006 and recorded a gain on termination of thisagreement of approximately $1,843 during the year ended December 31, 2006as a result of the lower purchase price of this inventory (net of the cost ofrework for rebranding the product).

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**Costs and Expenses**

*Costof revenues.**  *Thecost of revenues from continuing operations relating to the initial commercialdeliveries of Ojo video phones was $2,012 for the twelve months ended December 31,2005. Cost of revenues from continuing operations for the twelve months ended December 31,2004 was $103 related to product sold for pre-market testing. The cost ofrevenues for the twelve months ended December 31, 2005 was reduced by$2,006 for inventory related to the accounting for product purchased inconnection with the ending of the General Instrument agreement which is beingrecorded as a reserve for returns.

*Engineeringand Development.*   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 development costs were $5,727 for the twelve monthsended December 31, 2005, compared with $3,557 for the twelve months ended December 31,2004. This increase in 2005 over 2004 of $2,170, or 61%, reflects our increasedengineering and support staffing, and related costs, related to the continuingdevelopment and enhancements of our video phone product.

*Sales,Marketing and Service.*   Sales, marketing andservice expenses consist primarily of compensation, attendance at conferencesand trade shows, travel costs, advertising, promotions and other marketingprograms related to the introduction of our video phone product as well ascosts related to our service business infrastructure and customer support.Sales, marketing, and service costs were $3,755 for the twelve months ended December 31,2005, compared with $1,362 for the twelve months ended December 31, 2004.This increase of $2,393, or 176%, reflects primarily an increase of $1,618 intelevision advertising as well as increased marketing and promotionalexpenditures, trade shows attendance, and service business costs related to thecommercial launch and continued support of our video phone product in themarket place.

*Generaland Administrative.  **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 administrativeexpenses were $5,528 for the twelve months ended December 31, 2005, anincrease of $409, or 8%, compared with $5,119 for the twelve months ended December 31,2004. This increase primarily reflects $535 of accrued penalties related to theprivate placement in August 2005.

*Interest,Other Income and Interest Expense.*   Interest,other income and interest expense from continuing operations consisted ofinterest earned on cash and cash equivalents, and interest expense onshort-term debt. Total interest and other income was $718 for the twelve monthsended December 31, 2005 a decrease of $305 from $1,023 total for thetwelve months ended December 31, 2004. During the twelve months ended December 31,2005, we earned interest income of $442 on average cash balances ofapproximately $13,423, and incurred interest expense of $6 related to insurancefinancing. In comparison, during the twelve months ended December 31,2004, we earned interest of $86 on average cash balances of approximately$6,601, and incurred interest expense of $6 related to our insurance financing.Included in total interest and other income for the period ended December 31,2004 is $928 which represents deferred rent credits of $143 and cancelledunpaid rent of $785 relating to the amendment of our facility lease with aneffective date of June 2004. For more details, refer to Note 11 to ourconsolidated financial statements for the year ended December 31, 2006.

*NonCash Change in Fair Value of Warrants and Conversion Options.*   Forthe twelve months ended December 31, 2005, the non cash change in fairvalue of warrants and conversion option was an income of $8,594. This incomewas the result of a marked to market adjustment primarily related to our commonstock price decline as of December 31, 2005 compared to December 31,2004 as it related to our June 24, 2004 private placement of our Series AConvertible Preferred Stock and Warrants.

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*Income Taxes.**  *We have incurred net operatinglosses since inception and accordingly have had no current income tax provisionand have not recorded any income tax benefit for those losses.

**Liquidity and Capital Resources.**

As of December 31, 2006, our primary source ofliquidity consisted of cash and cash equivalents that are highly liquid, are ofhigh quality investment grade and have original maturities of less than threemonths.

At December 31, 2006, we had cash and cashequivalents of $10,067 as compared to cash and equivalents of $16,277 at December 31,2005. Net cash used in operating activities was $16,154 for the twelve monthsended December 31, 2006, as compared to $13,616 used for the same periodin 2005. This increase of $2,537, or 19%, in net cash used in operatingactivities was primarily attributable to our increase in expenditures duringthe twelve months ended December 31, 2006 compared to the same period in2005, related primarily to an increase in staffing of approximately $811,increased expenditures relating to certain legal settlements of $345 in thethird quarter of 2006, a $480 expenditure during the first quarter of 2006 forrepurchased products previously sold to General Instrument totaling $1,064,which included the offset of $584 of accounts receivables due the Company,increased payments in 2006 over 2005 of $239 relating to a trade show in 2007,and $779 for inventory purchased and recorded as deferred revenue of which thereceivable has not been collected as of December 31, 2006. No bad debtexpense was recorded for the twelve months ended December 31, 2006 and2005.

Cash used for investing activities were primarily aresult of investments in equipment for product development and manufacture aswell as for certain office equipment and leasehold improvements.  For the twelve months ending December 31,2006 and 2005, such investments were $410 and $554, respectively.

Cash provided by financingactivities is primarily a result of various private placements of our Company’ssecurities, the issuance of convertible debt, the exercise of warrants and the exercise of non-executive employees’and prior employees’ stock options during the twelve months ended December 31,2006. Total cash provided by financing activities was $10,354 for the twelvemonths ended December 31, 2006, primarily related to the issuance ofconvertible debt, compared to $18,607 during the same period in 2005 primarilyrelated to the private equity placement of our Company’s securities.

**Operations and Liquidity.**

To date, we have funded operations primarily throughmultiple private sales of equity securities, through the issuance ofconvertible debentures and through an initial public offering of common stockin April 1999. The financing secured on August 11, 2006 and October 13,2006 (see Note 3 to our consolidated financial statements for the twelve monthsended December 31, 2006)  has addedlong term debt to our balance sheet and we have pledged our assets ascollateral. We continue to evaluate the possibilities to obtain furtheradditional financing through public or private equity or debt offerings, bankdebt financing, asset securitizations, or from other sources. Such additionalfinancing would be subject to the risk of availability, may be dilutive to ourstockholders, 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.

The report of the independent registered publicaccounting firm for the year ended December 31, 2006 includes anexplanatory paragraph stating that our Company had suffered recurring lossesfrom operations and had an accumulated deficit of $246,806, and that theseissues raised substantial doubt about our Company’s ability to continue as agoing concern. Our short term cash requirements and obligations includeinventory, accounts payable and capital expenditures from continuingoperations, operating expenses, and the redemption of preferred stock, of which$166 is required to be redeemed in June 2007, although this redemption canbe made in common stock if certain conditions are met.  In addition, the 

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August 2005 privateplacement includes cash payment penalties of 1.5% per month for the period thatthe shares in the transaction fail to be registered. The Registration Statementcovering the shares under this private placement was not declared effectiveuntil June 1, 2006. Until such time as the shares were registered theCompany was subject to the penalty provision under this private placement. Forthe twelve months ended December 31, 2006 and 2005 the Company recordedand expensed related penalties of $1,114 and $535, respectively. The relatedunpaid penalties accrued as of December 31, 2006 and December 31,2005 were $157 and $535, respectively. On July 25, 2006, the Companyamended the terms of the additional investment right that was granted to aninvestor as part of the August 2005 private placement, with respect to aportion of shares of common stock purchasable thereunder and agreed to apply$158 of accrued penalties towards the exercise price of such amended additionalinvestment right, for the purchase of 129,950 shares of common stock. Thepenalties had accrued with respect to the Company’s inability to register theshares acquired by such investor in the private placement within 120 days ofthe transaction. In consideration for this amendment and application of theexercise proceeds the investor agreed to forego any cash payment of thepenalties other than as available through the proceeds of the exercise of theamended investment right and to grant to the Company a release of all claimsrelating to the late registration of the private placement shares, other thanthe aforesaid penalties. The amended additional investment right provides thatthe investor thereof may purchase the 129,950 shares of common stock for aperiod of 760 days beginning June 1, 2006 for an exercise price of $1.515per share. The terms of the additional investment rights with respect to theremaining 1,424,050 shares of common stock purchasable thereunder remainunchanged. On July 26, 2006 this investor exercised the additionalinvestment right for 129,950 shares. On July 31, 2006 the amendedadditional investment right with respect to the remaining 1,424,050 shares ofcommon stock expired. On December 12, 2006 the Company amended the termsof the warrants that were granted to an investor as part of the August 2005private placement, with respect to a portion of shares of common stockpurchasable thereunder and agreed to apply $315 of accrued penalties towardsthe exercise price of such amended warrants, for the purchase of 279,255 sharesof common stock. In addition, the exercise price of 47,412 of the warrants waschanged to $1.41 per share. The penalties had accrued with respect to theCompany’s inability to register the shares acquired by such investor in theprivate placement within 120 days of the transaction. In consideration for thisamendment and application of the exercise proceeds the investor agreed toforego any cash payment of the penalties other than as available through theproceeds of the exercise of the amended warrant and to grant to the Company arelease of all claims relating to the late registration of the privateplacement shares, other than the aforesaid penalties. The amended warrantprovides that the investor thereof may purchase the 326,667 shares of commonstock for a period of 1,330 days beginning December 12, 2006 for anexercise price of $1.41 per share. The terms of the warrants with respect tothe remaining shares of common stock purchasable thereunder remain unchanged. OnDecember 19, 2006 this investor exercised the warrants for the purchase of279,255 shares.

The ending of the General Instrument agreement on February 17,2006 places additional cash burdens on the Company and this could impact ourcash requirements and usage. As part of ending our agreement with GeneralInstrument, and in anticipation of WorldGate inventory requirements as a resultof taking full responsibility for product distribution, WorldGate negotiatedthe right to buy back about two-thirds of the units sold to General Instrument,valued at approximately $2,765 (based upon the original sales price to GeneralInstrument), for approximately $1,064. This is less than half of what it wouldcost the Company to purchase the same inventory from its manufacturing sources.For more details, refer to Note 3 to our consolidated financial statements forthe twelve months ended December 31, 2006.

Management expects, based on our internal forecastsand assumptions including among others, assumptions regarding our short term cashrequirements and our projected revenue growth, and including the completedfunding of $11,000 from the August 11, 2006 transaction, that we havesufficient cash on hand to meet our obligations into the second half of 2007. Asshown in the accompanying consolidated financial statements, we have incurredrecurring net losses and have an accumulated deficit of $246,806 as 

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of December 31, 2006.These factors raise substantial doubt about our ability to continue as a goingconcern. The financial statements do not include any adjustments that might benecessary should we be unable to continue as a going concern.

Our ability to generate cash is dependent upon thesale of our Ojo product and on obtaining cash through capital markets. We begangenerating revenue from commercial shipment of our Ojo product in April 2005and we expect revenues to increase as the product continues to roll out to themarketplace. Depending on the ramp up of sales and the achievable margins, theincreased level of sales activity should have a positive impact on our cashflows from operations, which will support our ability to meet our cashrequirements in the long term. Given that our video phone business involves thedevelopment of a new product line with no market penetration, in an underdevelopedmarket sector, no assurances can be given that sufficient sales, if any, willmaterialize. During the twelve months ended December 31, 2006, we providedforward pricing discounts to retailers and certain service operator sales in order to help promote distributionand consumer purchases. In the case of retail sales, the Company expects thatrecurring revenues from service fees will offset any loss on the sale of theproduct. This forward pricing, coupled with inventory adjustments for obsolescenceand lower market valuations, has resulted in a net margin loss in 2006 of $593.

We, however, remain hopeful that sufficient sales willmaterialize and/or that sufficient funding can be developed through ongoingoperations or further additional financings to continue our operations beyond2007.

Our long term cashrequirement obligations are primarily comprised of the items noted above andthe financing secured on August 11, 2006 and October 13, 2006 (seeNote 3 to our consolidated financial statements for the twelve months ended December 31,2006).  We have limited capacity toreduce our workforce and scale back on capital and operational expenditures todecrease our cash usage.

**Quantitative and QualitativeDisclosures About Market Risk.**

*Interest Rate Risk.*   Ourexposure to market risk related to changes in interest rates relates primarilyto 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 December 31, 2006, our cash and cashequivalents were $10,067, which were securities having an original maturity ofless than three months. Due to the average maturity and conservative nature ofour investment portfolio, management believes a sudden change in interest rateswould not have a material effect on the value of the portfolio. Managementestimates that had the average yield of our investments decreased by 100 basispoints, our interest income for the twelve months ended December 31, 2006would have decreased by approximately $128. This estimate assumes that thedecrease occurred on the first day of 2006 and reduced the yield of each investmentinstrument by 100 basis points. The impact on our future interest income offuture changes in investment yields will depend largely on our totalinvestments.

*Foreign Currency Exchange Risk.*   Althoughwe transact business in various foreign countries, substantially all of ourrevenues and costs to date have been denominated in U.S. dollars. Although ouragreement with Mototech  Inc., ourcontract manufacturer in Taiwan, which is not an affiliate of GeneralInstruments or Motorola, is denominated in U.S. dollars, their materialacquisition costs are subject to exchange rate changes that could impact ourproduct costs.

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*Disclosure ofContractual Obligations*

Payments  due by Period:

| ** **       | ** ** | **Total** | ** ** | **Less than 1  year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **Over 5 years** | ** ** |   |
|------------------|------------|-----------|------------|---------------------------------|------------|--------------------|------------|--------------------|------------|----------------------------|------------|--------|
| Long Term Debt   |       | $         | 9,650      | (1)                             |       |               |       |               | $          | 9,650                      | (1)        |   |   |   |   |   |   |   |   |
| Operating leases |       | 1,945     |       |                            | $          | 517                |       |               | 1,065      |                       |       | $      | 363 |   |   |   | $ | 0 |   |   |
| Totals           |       | $         | 11,595     |                            |       | $                  | 517        |               |       | $                          | 10,715     |   |   | $ | 363 |   |   |   | $ | 0 |   |   |
|                  |            |           |            |                                 |            |                    |            |                    |            |                            |            |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)          Representsthe principle amount of convertible debentures. Recorded in the accompanyingfinancial statements at $1,025 (net of unamortized debt discount of $8,625).

*RelatedParties*

The Company has a currentmulti-year agreement with Mototech, an investor, to provide the Company with engineeringand development support. As a result of this agreement, the Company hasexpensed approximately $59, $427 and $415, respectively for the years ended December 31,2004, 2005 and 2006. Accounts payable to this investor amounted to $1,173 and$1,377 at December 31, 2005 and December 31, 2006, respectively. Thisagreement provides for contracted services, including hardware and softwaredevelopment, and the creation and development of tools to facilitate theCompany’s engineering efforts. This agreement does not provide for ongoingroyalties, purchase provisions, or for any requirement to provide additionalfunding to the Company. Net revenues from operations recognized from Mototechwere approximately $0, $0 and $406 for the years ended December 31, 2004,2005 and 2006, respectively.  Thisinvestor accounted for approximately 0%, 0% and 14% of the revenues for theyears ended December 31, 2004, 2005 and 2006, respectively. Accountsreceivable from this investor were $0 and $1, respectively, as of December 31,2005 and December 31, 2006.

*Inflation*

Inflation affects the costof raw materials, goods and services used by the Company. In recent years,inflation has been modest. However, high oil costs can effect the cost of allraw materials and components. If inflation were to raise the cost of goods andservices materially, we may be forced to increase the price of our productswhich could make the products unattractive to our customers and consumers andcould limit our sales and impact on our viability. The Company seeks tomitigate the adverse effects of inflation primarily through improvedproductivity, technology advancements and in the future, through scale ofvolume efficiencies. The Company does not believe that inflation has a materialimpact on its results of operations for the periods presented.

*Recent AccountingPronouncements*

In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment” that focuses primarily on accounting fortransactions in which an entity obtains employee services in share-basedpayment transactions. This statement replaces SFAS No. 123, “Accountingfor Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accountingfor Stock Issued to Employees.”  In March 2005,the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107(“SAB 107”) relating to the adoption of SFAS 123R. SAB 107 primarily interpretshow the implementation of SFAS 123R is to be applied under SEC rules andregulations. Beginning January 1, 2006, the Company is required to expensethe fair value of employee stock options and similar awards. The Company haselected to utilize the modified prospective transitional method in accountingfor share-based employee payment transactions. Based upon the employee optionsoutstanding as of December 31, 2006, and the transitional provisions ofSFAS No.123R and SAB 107, there are approximately $827 of costs incurred in theyear 

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2006, and $1,633 of futurecosts, utilizing the fair value method that will be expensed over a four yearperiod from 2007 through 2010. Additionally, the Company will utilize the fairvalue method for any future instruments issued after January 1, 2006 (formore details, refer to Note 3 of the consolidated financial statements).

In May 2005, SFAS No. 154, “AccountingChanges and Error Corrections—replacement of APB Opinion No. 20 and FASBStatement No. 3,” was issued. SFAS No. 154 changes the accounting forand reporting of a change in accounting principle by requiring retrospectiveapplication to prior periods’ financial statements of changes in accountingprinciple unless impracticable. SFAS No. 154 is effective for accounting changesmade in fiscal years beginning after December 15, 2005. The adoption ofSFAS No. 154 did not have a material impact on the Company’s consolidatedresults of operations, financial position or cash flows.

In September 2005, the Emerging Issues Task Force(“EITF”) reached consensus on Issue No. 04-13, “*Accounting for Purchases and Sales of Inventory withthe Same Counterparty,”*that inventory purchases and salestransactions with the same counterparty that are entered into in contemplationof one another should be combined for purposes of applying APB Opinion No. 29,“*Accounting for Nonmonetary Transactions.”* The effect reduces reported revenues and costof sales for affected transactions. The consensus on this issue applies to suchtransactions beginning in the first quarter 2006.  The adoption of Issue No. 04-13 didnot have a material effect on the Company’s consolidated financial position orresults of operations.

In September 2005, the FASB ratified the EITFIssue No. 05-7, “Accounting for Modifications to Conversion OptionsEmbedded in Debt Instruments and Related Issues,” which addresses whether amodification to a conversion option that changes its fair value effects therecognition of interest expense for the associated debt instrument after themodification, and whether a borrower should recognize a beneficial conversionfeature, not a debt extinguishment, if a debt modification increases theintrinsic value of the debt (for example, the modification reduces theconversion price of the debt). The adoption of the Issue did not have amaterial effect on our consolidated financial position or results ofoperations.

In September 2005, the FASB also ratified theEITF’s Issue No. 05-8, “Income Tax Consequences of IssuingConvertible Debt with a Beneficial Conversion Feature,” which discusses whetherthe issuance of convertible debt with a beneficial conversion feature resultsin a basis difference arising from the intrinsic value of the beneficialconversion feature on the commitment date (which is  recorded in the stockholder’s equity for bookpurposes, but as a liability for income tax purposes) and, if so, whether thatbasis difference is a temporary difference under SFAS No. 109, “Accountingfor Income Taxes.”  The adoption of theIssue did not have a material effect on the Company’s consolidated financialposition or results of operations.

In February 2006, the FASB issued SFAS No. 155‘‘Accounting for Certain Hybrid Financial Instruments, an amendment of FASBStatements No. 133 and 140’’ (‘‘SFAS 155’’). SFAS 155 clarifies certainissues relating to embedded derivatives and beneficial interests in securitizedfinancial assets. The provisions of SFAS 155 are effective for all financialinstruments acquired or issued for fiscal years beginning after September 15,2006. The Company is currently assessing the impact that the adoption of SFAS155 will have on its results of consolidated operations and financial position.

In March 2006, the FASB issued SFAS No. 156,“Accounting for Servicing of Financial Assets” (“SFAS 156”), whichamends SFAS 140, “Accounting for Transfers and Servicing of Financial Assetsand Extinguishments of Liabilities,” with respect to the accounting forseparately recognized servicing assets and servicing liabilities. SFAS 156 permits the choice of the amortization method or the fairvalue measurement method, with changes in fair value recorded in income, forthe subsequent measurement for each class of separately recognized servicingassets and servicing liabilities. The statement is effective for yearsbeginning after September 15, 2006, with earlier adoptionpermitted. The Company is currently evaluating the effect thatadopting this statement will have on the Company’s consolidatedfinancial position and results of operations.

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In June 2006, the Financial Accounting StandardsBoard issued Interpretation No. 48 “Accounting for Uncertainty in IncomeTaxes”—an Interpretation of FASB Statement No. 109” (the “Interpretation”).The Interpretation establishes for all entities a minimum threshold forfinancial statement recognition of the benefit of tax positions, and requirescertain expanded disclosures. The Interpretation is effective for fiscal yearsbeginning after December 31, 2006, and is to be applied to all open taxyears as of the date of effectiveness. We are is in the process of evaluatingthe impact of the application of the Interpretation to our consolidatedfinancial statements.

In September 2006, the FASB issued Statement ofFinancial Accounting Standard 157 “Fair Value Measurements”, (“SFAS 157”) whichdefines fair value, establishes a framework for measuring fair value ingenerally accepted accounting principles, and expands disclosures about fairvalue measurements. Adoption is required for fiscal years beginning after November 15,2007, and interim periods within those fiscal years. Early adoption of SFAS 157is encouraged. The Company is currently evaluating the expected effect of SFAS157 on its consolidated financial statements and is not currently in a positionto determine such effects.

In September 2006, the FASB ratified EITF Issue No. 06-1,“Accounting for Consideration Given by a Service Provider to Manufacturers orResellers of Equipment Necessary for an End-Customer to Receive Service fromthe Service Provider”(“EITF 06-1”). This guidance requiresthe application of EITF 01-9, “Accounting for Consideration Given by aVendor to a Customer”(“EITF 01-9”), when consideration is given to areseller or manufacturer for benefit to the service provider’s end customer.EITF 01-9 requires the consideration given be recorded as a liability atthe time of the sale of the equipment and, also, provides guidance for theclassification of the expense. EITF 06-1 is effective for thefirst annual reporting period beginning after June 15, 2007. The Companyhas not yet assessed the impact of EITF 06-1 on the Company’sconsolidated financial statements.

In September 2006, the staff of the Securitiesand Exchange Commission issued Staff Accounting Bulletin No. 108 (“SAB 108”)which provides interpretive guidance on how the effects of the carryover orreversal of prior year misstatements should be considered in quantifying acurrent year misstatement. SAB 108 is effective for fiscal years ending on orafter November 15, 2006. The adoption of SAB 108 did not have a materialimpact on the Company’s consolidated financial position, results of operationsor cash flows.

In November 2006, the EITF reached a finalconsensus in EITF Issue 06-6 “Debtor’s Accounting for a Modification (orExchange) of Convertible Debt Instruments” (“EITF 06-6”).  EITF 06-6 addresses the modification ofa convertible debt instrument that changes the fair value of an embeddedconversion option and the subsequent recognition of interest expense for theassociated debt instrument when the modification does not result in a debtextinguishment pursuant to EITF 96-19 , “Debtor’s Accounting for aModification or Exchange of Debt Instruments,”. The consensus should be appliedto modifications or exchanges of debt instruments occurring in interim orannual periods beginning after November 29, 2006. We do not expect theadoption of EITF 06-6 to have a material impact on our consolidatedfinancial position, results of operations or cash flows.

In November 2006, the FASB ratified EITF Issue No. 06-7,Issuer’s Accounting for a Previously Bifurcated Conversion Option in aConvertible Debt Instrument When the Conversion Option No Longer Meets theBifurcation Criteria in FASB Statement No. 133, Accounting for DerivativeInstruments and Hedging Activities (“EITF 06-7”). At the time ofissuance, an embedded conversion option in a convertible debt instrument may berequired to be bifurcated from the debt instrument and accounted for separatelyby the issuer as a derivative under FAS 133, based on the application of EITF 00-19.Subsequent to the issuance of the convertible debt, facts may change and causethe embedded conversion option to no longer meet the conditions for separateaccounting as a derivative instrument, such as when the bifurcated instrumentmeets the conditions of Issue 00-19 to be classified in stockholders’equity. Under EITF 06-7, 

37

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when an embeddedconversion option previously accounted for as a derivative under FAS 133 nolonger meets the bifurcation criteria under that standard, an issuer shalldisclose a description of the principal changes causing the embedded conversionoption to no longer require bifurcation under FAS 133 and the amount of theliability for the conversion option reclassified to stockholders’ equity. EITF06-7 should be applied to all previously bifurcated conversion options inconvertible debt instruments that no longer meet the bifurcation criteria inFAS 133 in interim or annual periods beginning after December 15, 2006,regardless of whether the debt instrument was entered into prior or subsequentto the effective date of EITF 06-7. Earlier application of EITF 06-7is permitted in periods for which financial statements have not yet beenissued. The Company is currently evaluating the impact of this guidance on ourconsolidated financial position, results of operations or cash flows.

In December 2006, the FASB issued FASB StaffPosition (“FSP”) EITF 00-19-2 “Accounting for Registration PaymentArrangements” (“FSP EITF 00-19-2”) which specifies that thecontingent obligation to make future payments or otherwise transferconsideration under a registration payment arrangement should be separatelyrecognized and measured in accordance with FASB Statement No. 5, “Accountingfor Contingencies.”  Adoption of FSP EITF00-19-02 is required for fiscal years beginning after December 15,2006. The Company is currently evaluating the expected effect of FSP EITF 00-19-02on its consolidated financial statements and is currently not yet in a positionto determine such effects.

In February 2007, theFASB issued Statement of Financial Accounting Standard 159 “The Fair ValueOption for Financial Assets and Financial Liabilities—Including an amendment ofFASB Statement No. 115”, which permits entities to choose to measure manyfinancial instruments and certain other items at fair value. The fair valueoption established by this Statement permits all entities to choose to measureeligible items at fair value at specified election dates. A business entityshall report unrealized gains and losses on items for which the fair valueoption has been elected in earnings at each subsequent reporting date. Adoptionis required for fiscal years beginning after November 15, 2007. Earlyadoption is permitted as of the beginning of a fiscal year that begins on orbefore November 15, 2007, provided the entity also elects to apply theprovisions of FASB Statement No. 157, “Fair Value Measurements. “  The Company is currently evaluating theexpected effect of SFAS 159 on its consolidated financial statements and iscurrently not yet in a position to determine such effects.

**Item 7A.**                Quantitativeand Qualitative Disclosures about Market Risk.

Refer to Interest Rate Risk and Foreign CurrencyExchange Risk on page 25 for a discussion of this item.

38

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**Item 8.**                        FinancialStatements and Supplementary Data.

**WORLDGATECOMMUNICATIONS, INC.**

**INDEX TO FINANCIAL STATEMENTS**
| Report of Marcum &  Kliegman LLP, Independent Registered Public Accounting Firm                                                              |   | F-2 |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----|--------|
| Report of Grant Thornton LLP, Independent Registered  Public Accounting Firm                                                                          |   | F-3 |   |
| Consolidated  Balance Sheets as of December 31, 2005 and 2006                                                                                    |   | F-4 |   |
| Consolidated  Statements of Operations for the years ended December 31, 2004, 2005 and  2006                                                     |   | F-5 |   |
| Consolidated  Statements of Stockholders’ (Deficiency) Equity for the years ended  December 31, 2004, 2005 and 2006     |   | F-6 |   |
| Consolidated Statements of Cash Flows for the years  ended December 31, 2004, 2005 and 2006                                                      |   | F-7 |   |
| Notes to Consolidated Financial Statements                                                                                                            |   | F-8 |   |
| Schedule II—Valuation and Qualifying Accounts*                                                                                              |   | 59  |   |

----

*                    All otherschedules for which provision is made in the applicable accounting regulationsof the Securities and Exchange Commission are not required under the relatedinstructions or are inapplicable, and therefore have been omitted.

F-1

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**Reportof Independent Registered Public Accounting Firm**

To the Audit Committee of theBoard of Directors and StockholdersWorldGate Communications, Inc.

We have audited the accompanying consolidated balancesheets of WorldGate Communications, Inc. and subsidiaries (the “Company”)as of December 31, 2006 and 2005, and the related consolidated statementsof operations, stockholders’  equity, andcash flows for the years then ended. Our audits also included the FinancialStatement Schedule II—Valuation and Qualifying Accounts for the Company as of December 31,2006 and 2005 and for the years then ended. These consolidated financialstatements and financial statement schedule are the responsibility of theCompany’s management. Our responsibility is to express an opinion on theseconsolidated financial statements and financial statement schedule based on ouraudits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of WorldGate Communications, Inc. and its subsidiaries as of December 31,2006 and 2005 and the results of its operations and cash flows for the years thenended, in conformity with accounting principles generally accepted in theUnited States of America. Also, in our opinion, the related financial statementschedule, when considered in relation to the basic consolidated financialstatements taken as a whole, presents fairly, in all material respects, theinformation contained therein.

The accompanying financial statements have beenprepared assuming that the Company will continue as a going concern. Asdiscussed in Note 3 to the consolidated financial statements, the Company hassuffered recurring losses from operations and had an accumulated deficit of$247 million at December 31, 2006 which raises substantial doubt about itsability to continue as a going concern. The financial statements do not includeany adjustments that might result from the outcome of this uncertainty.

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of the Company’s internal control overfinancial reporting as of December 31, 2006, based on the criteriaestablished in Internal Control—Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission and our report dated March 7,2007 expressed an unqualified opinion on management’s assessment of theeffectiveness of the Company’s internal control over financial reporting and anadverse opinion on the effectiveness of the Company’s internal control overfinancial reporting because of the existence of a material weakness.

/s/ MARCUM &KLIEGMAN LLPMarcum & Kliegman LLPMelville, New YorkMarch 7 , 2007

F-2

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**Report ofIndependent Registered Public Accounting Firm**

To the Shareholders and Board of DirectorsWorldGate Communications, Inc. and Subsidiaries

We have audited the accompanying consolidatedstatements of operations, stockholders’ deficiency, and cash flows of WorldGateCommunications, Inc. and subsidiaries for the year  ended December 31, 2004. These financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based on ouraudit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. The Company is not required to have, nor were we engaged toperform, an audit of its internal control over financial reporting. Our auditincluded consideration of internal control over financial reporting as a basisfor designing audit procedures that are appropriate in the circumstances, butnot for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express nosuch opinion. An audit also includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessingthe accounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred toabove present fairly, in all material respects, the consolidated resultsof  operations and  cash flows of WorldGate Communications, Inc.and subsidiaries for the year  ended December 31,2004, in conformity with accounting principles generally accepted in the UnitedStates.

Our audit was conducted for the purpose of forming anopinion on the aforementioned financial statements taken as a whole.Schedule II is presented for purposes of additional analysis and is not arequired part of those financial statements. This schedule has beensubjected to the auditing procedures applied in the audit of the basicfinancial statements and, in our opinion, is fairly stated in all materialrespects in relation to those financial statements taken as a whole.

The aforementionedfinancial statements have been prepared assuming that the Company will continueas a going concern. The Company has suffered recurring losses from operationsand had a net accumulated deficiency of $218 million as of December 31,2004 that raises substantial doubt about its ability to continue as a goingconcern. The financial statements do not include any adjustments that mightresult from the outcome of this uncertainty.
| /s/ GRANT THORNTON LLP                                                                                                                                                                                                                                                                                                      |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                                                                                                                                                                                                             |   |
| Philadelphia,  Pennsylvania                                                                                                                                                                                                                                                                                                      |   |
| February 24,  2005 (except for the restatement discussed in Notes 2 and 3 (not presented  herein) to the consolidated financial statements appearing under Item 8  of the Company’s 2005 Annual Report on Form 10-K as to which the dates  are August 24, 2005 and January 10, 2006, respectively) |   |
|                                                                                                                                                                                                                                                                                                                             |   |
|                                                                                                                                                                                                                                                                                                                             |   |

 

F-3

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**WORLDGATE COMMUNICATIONS, INC.CONSOLIDATED BALANCE SHEETS(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)**

| ** **                                                                                                                                                                                                | ** ** | **As of  December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                                                                                                                | ** ** | **2005**                          | ** ** | **2006** | ** ** |
| ASSETS                                                                                                                                                                                                    |       |                              |       |   |   |
| Current assets:                                                                                                                                                                                           |       |                              |       |   |   |
| Cash and cash  equivalents                                                                                                                                                                                |       | $                                 | 16,277     |   | $ | 10,067 |   |
| Trade accounts  receivable less allowance for doubtful accounts of $0 at December 31,  2005 and 2006                                                                                            |       | 133                               |       | 1,005 |   |
| Other receivables                                                                                                                                                                                         |       | 26                                |       | 17 |   |
| Inventory                                                                                                                                                                                                 |       | 2,878                             |       | 1,600 |   |
| Prepaid and other assets                                                                                                                                                                                  |       | 209                               |       | 490 |   |
| Total current assets                                                                                                                                                                                      |       | 19,523                            |       | 13,179 |   |
| Property and equipment                                                                                                                                                                                    |       | 4,084                             |       | 4,494 |   |
| Less: accumulated  depreciation and amortization                                                                                                                                                          |       | (2,508                            | )          | (3,228 | ) |
| Property and equipment,  net                                                                                                                                                                              |       | 1,576                             |       | 1,266 |   |
| Deposits and other  assets                                                                                                                                                                                |       | 130                               |       | 121 |   |
| Total assets                                                                                                                                                                                              |       | $                                 | 21,229     |   | $ | 14,566 |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                                                |       |                              |       |   |   |
| Current liabilities:                                                                                                                                                                                      |       |                              |       |   |   |
| Accounts payable                                                                                                                                                                                          |       | $                                 | 1,695      |   | $ | 1,654 |   |
| Accrued expenses                                                                                                                                                                                          |       | 1,333                             |       | 1,240 |   |
| Accrued compensation and  benefits                                                                                                                                                                        |       | 36                                |       | 48 |   |
| Dividend payable on  Preferred Stock                                                                                                                                                                      |       | 6                                 |       | 2 |   |
| Detachable Warrants                                                                                                                                                                                       |       | 1,038                             |       | 997 |   |
| Conversion option on  Preferred Stock                                                                                                                                                                     |       | 57                                |       | 11 |   |
| Conversion option on  convertible debt                                                                                                                                                                    |       | 0                                 |       | 7,044 |   |
| Incentive sale claims  liability                                                                                                                                                                          |       | 278                               |       | 50 |   |
| Warranty reserve                                                                                                                                                                                          |       | 336                               |       | 85 |   |
| Deferred revenues                                                                                                                                                                                         |       | 44                                |       | 267 |   |
| Returns reserve                                                                                                                                                                                           |       | 2,310                             |       | 0 |   |
| Total current  liabilities                                                                                                                                                                                |       | 7,133                             |       | 11,398 |   |
| Long term liabilities:                                                                                                                                                                                    |       |                              |       |   |   |
| Convertible debenture  payable (net of unamortized discount of $8,625 at December 31, 2006)                                                                                                          |       | 0                                 |       | 1,025 |   |
| Total liabilities                                                                                                                                                                                         |       | 7,133                             |       | 12,423 |   |
| Commitments and contingencies                                                                                                                                                                             |       |                              |       |   |   |
| Redeemable Preferred  Stock; 7,550 shares authorized, 500 shares issued and outstanding at  December 31, 2005, and 166 issued and outstanding at December 31,  2006                             |       | 379                               |       | 141 |   |
| Total Stockholders’ equity:                                                                                                                                                                          |       |                              |       |   |   |
| Preferred Stock, $.01  par value, 13,492,450 shares authorized, and 0 shares issued at  December 31, 2005 and December 31, 2006                                                                 |       | 0                                 |       | 0 |   |
| Common Stock, $.01 par  value; 120,000,000 shares authorized, 39,511,519 shares issued and  outstanding at December 31, 2005 and 41,535,443 shares issued and  outstanding at December 31, 2006 |       | 395                               |       | 415 |   |
| Additional paid-in  capital                                                                                                                                                                               |       | 242,414                           |       | 248,393 |   |
| Accumulated deficit                                                                                                                                                                                       |       | (229,092                          | )          | (246,806 | ) |
| Total stockholders’  equity                                                                                                                                                                          |       | 13,717                            |       | 2,002 |   |
| Total liabilities and stockholders’ equity                                                                                                                                                           |       | $                                 | 21,229     |   | $ | 14,566 |   |

 

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

F-4

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**WORLDGATE COMMUNICATIONS, INC.CONSOLIDATED STATEMENTS OF OPERATIONS(DOLLARS IN THOUSANDS,  EXCEPT PER SHAREAMOUNTS)**

| ** **                                                                                                           | ** ** | **Twelve Months  Ended  December 31, 2004** | ** ** | **Twelve Months  Ended  December 31, 2005** | ** ** | **Twelve Months  Ended  December 31, 2006** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| Net revenues                                                                                                         |       |                                                       | $          | 231                                                        |       |                                                       |       | $ | 1,558 |   |   |   | $ | 2,776 |   |   |
| Cost of revenues                                                                                                     |       |                                                       | 103        |                                                       |       |                                                       | 2,012      |   |   |   | 3,369 |   |   |
| Gross margins                                                                                                        |       |                                                       | 128        |                                                       |       |                                                       | (454       | ) |   |   | (593 | ) |   |
| Engineering and  development (excluding depreciation and amortization amounts of $64, $303,  and $385, respectively) |       |                                                       | 3,557      |                                                       |       |                                                       | 5,727      |   |   |   | 6,238 |   |   |
| Sales and marketing  (excluding depreciation and amortization amounts of $13, $46 and $57,  respectively)       |       |                                                       | 1,362      |                                                       |       |                                                       | 3,755      |   |   |   | 3,395 |   |   |
| General and  administrative (excluding depreciation and amortization amounts of $400, $344  and $279, respectively)  |       |                                                       | 5,119      |                                                       |       |                                                       | 5,528      |   |   |   | 6,983 |   |   |
| Depreciation and  amortization                                                                                       |       |                                                       | 477        |                                                       |       |                                                       | 693        |   |   |   | 720 |   |   |
| Total expenses from  continuing operations                                                                           |       |                                                       | 10,515     |                                                       |       |                                                       | 15,703     |   |   |   | 17,336 |   |   |
| Loss from operating  activities                                                                                      |       |                                                       | (10,387    | )                                                          |       |                                                       | (16,157    | ) |   |   | (17,929 | ) |   |
| Interest and other income                                                                                            |       |                                                       | 1,023      |                                                       |       |                                                       | 718        |   |   |   | 461 |   |   |
| Change in fair value of derivative warrants and  conversion options                                                  |       |                                                       | (10,091    | )                                                          |       |                                                       | 8,594      |   |   |   | (435 | ) |   |
| Gain on contract termination                                                                                         |       |                                                       | 0          |                                                       |       |                                                       | 0          |   |   |   | 1,843 |   |   |
| Amortization of debt discount                                                                                        |       |                                                       | 0          |                                                       |       |                                                       | 0          |   |   |   | (1,354 | ) |   |
| Interest and other expense                                                                                           |       |                                                       | (6         | )                                                          |       |                                                       | (6         | ) |   |   | (194 | ) |   |
| Loss from continuing operations                                                                                      |       |                                                       | (19,461    | )                                                          |       |                                                       | (6,851     | ) |   |   | (17,608 | ) |   |
| Income from discontinued operations                                                                                  |       |                                                       | 36         |                                                       |       |                                                       | 0          |   |   |   | 0 |   |   |
| Net loss                                                                                                             |       |                                                       | (19,425    | )                                                          |       |                                                       | $          | (6,851 | ) |   |   | (17,608 | ) |   |
| Accretion on preferred stock dividends and deemed  dividends                                                         |       |                                                       | (951       | )                                                          |       |                                                       | (3,922     | ) |   |   | (106 | ) |   |
| Net loss available to common stockholders                                                                            |       |                                                       | $          | (20,376                                                    | )          |                                                       |       | $ | (10,773 | ) |   |   | $ | (17,714 | ) |   |
| Loss from continuing operations per common share  (Basic and Diluted)                                                |       |                                                       | $          | (0.70                                                      | )          |                                                       |       | $ | (0.19 | ) |   |   | $ | (0.44 | ) |   |
| Income from discontinued operations per common share  (Basic and Diluted)                                       |       |                                                       | 0.00       |                                                       |       |                                                       | 0.00       |   |   |   | 0.00 |   |   |
| Net loss per common share (Basic and Diluted)                                                                        |       |                                                       | $          | (0.70                                                      | )          |                                                       |       | $ | (0.19 | ) |   |   | $ | (0.44 | ) |   |
| Net loss available to common stockholders per common  share (Basic and Diluted)                                      |       |                                                       | $          | (0.73                                                      | )          |                                                       |       | $ | (0.30 | ) |   |   | $ | (0.44 | ) |   |
| Weighted average  common shares outstanding (Basic and Diluted)                                                      |       |                                                       | 27,881,347 |                                                       |       |                                                       | 35,449,225 |   |   |   | 39,992,499 |   |   |

 

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

F-5

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**WORLDGATECOMMUNICATIONS, INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ (DEFICIENCY) EQUITY(DOLLARS AND SHARES IN THOUSANDS)**

| ** **                                                             | ** ** | **Common Stock** | ** ** | **Additional  Paid-In** | ** ** | **Warrants  for  Class A  Common** | ** ** | **Accumulated** | ** ** | **Unearned  Stock Based  Compen-** | ** ** | **Treasury Stock** | ** ** | **Total  Stock-  holders’  (Deficiency)** | ** ** |
|------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|-----------------------------------------|------------|-----------------|------------|-----------------------------------------|------------|-------------------------|------------|------------------------------------------------|------------|
| ** **                                                             | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Capital**                             | ** ** | **Stock**       | ** ** | **Deficit**                             | ** ** | **sataion**             | ** ** | **Shares**                                     | ** ** | **Amount** | ** ** | **Equity** | ** ** |
| **Balance  at January 1, 2004**                                   |       |                  | 26,207     |                    |       |                                    | $          | 262             |       |                                    |       | $                       | 201,766    |                                           |       |   | $ | 0 |   |   |   | $ | (197,943 | ) |   |   | (400 | ) |   |   | (500 | ) |   |   | $ | (5 | ) |   |   | $ | 3,680 |   |   |
| Amortization of  earned compensation to vendor                         |       |                  |       |                    |       |                                    |       |            |       |                                    |       |                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 400 |   |   |
| Non-cash stock  based Compensation                                     |       |                  |       |                    |       |                                    |       |            |       |                                    | 608        |                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 608 |   |   |
| Cancellation of  Treasury Stock                                        |       |                  | (500       | )                       |       |                                    | (5         | )               |       |                                    |       |                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   | 500 |   |   |   | 5 |   |   |   |   |   |   |
| Issuance of Common  Stock                                              |       |                  | 2,361      |                    |       |                                    | 23         |            |       |                                    | 3,668      |                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 3,691 |   |   |
| Exercise of Stock  Options                                             |       |                  | 446        |                    |       |                                    | 4          |            |       |                                    | 809        |                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 813 |   |   |
| Exercise of  Warrants                                                  |       |                  | 2,352      |                    |       |                                    | 24         |            |       |                                    | 5,588      |                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 5,612 |   |   |
| Accretion on  preferred stock and dividends                            |       |                  |       |                    |       |                                    |       |            |       |                                    |       |                    |       |                                           |       |   |   |   | (951 | ) |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (951 | ) |   |
| Net Loss for the  year                                                 |       |                  |       |                    |       |                                    |       |            |       |                                    |       |                    |       |                                           |       |   |   |   | (19,425 | ) |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (19,425 | ) |   |
| **Balance  at December 31, 2004**                                 |       |                  | 30,866     |                    |       |                                    | 308        |            |       |                                    | 212,439    |                    |       |                                           | 0          |   |   |   | (218,319 | ) |   |   | 0 |   |   |   | 0 |   |   |   | 0 |   |   |   | (5,572 | ) |   |
| Issuance of Common  Stock                                              |       |                  | 4,683      |                    |       |                                    | 47         |            |       |                                    | 16,596     |                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 16,643 |   |   |
| Issuance of Common  Stock upon conversion of preferred stock           |       |                  | 2,720      |                    |       |                                    | 27         |            |       |                                    | 6,248      |                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 6,275 |   |   |
| Reclassification  of conversion option liability                       |       |                  |       |                    |       |                                    |       |            |       |                                    | 4,632      |                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 4,632 |   |   |
| Deemed dividend  upon conversion                                       |       |                  |       |                    |       |                                    |       |            |       |                                    |       |                    |       |                                           |       |   |   |   | (3,102 | ) |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (3,102 | ) |   |
| Issuance of Common  Stock to settle accrued preferred stock dividends  |       |                  | 64         |                    |       |                                    | 1          |            |       |                                    | 216        |                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 217 |   |   |
| Exercise of Stock  Options                                             |       |                  | 373        |                    |       |                                    | 4          |            |       |                                    | 814        |                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 818 |   |   |
| Exercise of  Warrants                                                  |       |                  | 805        |                    |       |                                    | 8          |            |       |                                    | 1,469      |                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 1,477 |   |   |
| Accretion on  preferred stock and dividends                            |       |                  |       |                    |       |                                    |       |            |       |                                    |       |                    |       |                                           |       |   |   |   | (820 | ) |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (820 | ) |   |
| Net Loss for the  year                                                 |       |                  |       |                    |       |                                    |       |            |       |                                    |       |                    |       |                                           |       |   |   |   | (6,851 | ) |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (6,851 | ) |   |
| **Balance  at December 31, 2005**                                 |       |                  | 39,511     |                    |       |                                    | 395        |            |       |                                    | 242,414    |                    |       |                                           | 0          |   |   |   | (229,092 | ) |   |   | 0 |   |   |   | 0 |   |   |   | 0 |   |   |   | 13,717 |   |   |
| Issuance of Common  Stock                                              |       |                  | 18         |                    |       |                                    |       |            |       |                                    | 27         |                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 27 |   |   |
| Issuance of Common  Stock with sale of convertible debenture           |       |                  | 177        |                    |       |                                    | 2          |            |       |                                    | (2         | )                       |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Issuance of Common  Stock upon settlement of penalties                 |       |                  | 415        |                    |       |                                    | 4          |            |       |                                    | 479        |                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 483 |   |   |
| Issuance of Common  Stock upon conversion of preferred stock           |       |                  | 202        |                    |       |                                    | 2          |            |       |                                    | 332        |                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 334 |   |   |
| Issuance of Common  Stock upon conversion of convertible debenture     |       |                  | 1,146      |                    |       |                                    | 11         |            |       |                                    | 1,339      |                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 1,350 |   |   |
| Reclassification  of conversion option liability upon conversion       |       |                  |       |                    |       |                                    |       |            |       |                                    | 1,020      |                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 1,020 |   |   |
| Issuance of  warrants in connection with sale of convertible debenture |       |                  |       |                    |       |                                    |       |            |       |                                    | 230        |                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 230 |   |   |
| Reclassification  of derivative warrants                               |       |                  |       |                    |       |                                    |       |            |       |                                    | 1,521      |                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 1,521 |   |   |
| Non-cash stock  based compensation                                     |       |                  |       |                    |       |                                    |       |            |       |                                    | 837        |                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 837 |   |   |
| Cancellation of  accrued investment fees                               |       |                  |       |                    |       |                                    |       |            |       |                                    | 171        |                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 171 |   |   |
| Deemed dividend  upon conversion                                       |       |                  |       |                    |       |                                    |       |            |       |                                    |       |                    |       |                                           |       |   |   |   | (68 | ) |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (68 | ) |   |
| Issuance of Common  Stock to settle accrued preferred stock dividends  |       |                  | 9          |                    |       |                                    |       |            |       |                                    | 14         |                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 14 |   |   |
| Exercise of Stock  Options                                             |       |                  | 57         |                    |       |                                    | 1          |            |       |                                    | 11         |                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 12 |   |   |
| Accretion on  preferred stock and dividends                            |       |                  |       |                    |       |                                    |       |            |       |                                    |       |                    |       |                                           |       |   |   |   | (38 | ) |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (38 | ) |   |
| Net Loss for the  year                                                 |       |                  |       |                    |       |                                    |       |            |       |                                    |       |                    |       |                                           |       |   |   |   | (17,608 | ) |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (17,608 | ) |   |
| **Balance  at December 31, 2006**                                 |       |                  | 41,535     |                    |       |                                    | $          | 415             |       |                                    |       | $                       | 248,393    |                                           |       |   | $ | 0 |   |   |   | $ | (246,806 | ) |   |   | $ | 0 |   |   |   | $ | 0 |   |   |   | $ | 0 |   |   |   | $ | 2,002 |   |   |
|                                                                        |            |                       |            |                         |            |                                         |            |                 |            |                                         |            |                         |            |                                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

F-6

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**WORLDGATECOMMUNICATIONS, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(DOLLARS IN THOUSANDS)**

| ** **                                                                                         | ** ** | **Twelve Months  Ended  December 31,  2004** | ** ** | **Twelve Months  Ended  December 31,  2005** | ** ** | **Twelve Months  Ended  December 31,  2006** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------|------------|
| Cash flows from operating  activities:                                                             |       |                                                   | ** ** | ** **                                             |       |                                                   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net loss                                                                                           |       |                                                   | $          | (19,425                                                | )          |                                                   |       | $ | (6,851 | ) |   |   | $ | (17,608 | ) |   |
| Income from discontinued operations                                                                |       |                                                   | (36        | )                                                      |       |                                                   | 0          |   |   |   | 0 |   |   |
| Adjustments  to reconcile net loss to cash used in operating activities of continuing  operations: |       |                                                   |       |                                                   |       |                                                   |       |   |   |   |   |   |   |
| Depreciation and amortization                                                                      |       |                                                   | 477        |                                                   |       |                                                   | 693        |   |   |   | 720 |   |   |
| Amortization of debt discount                                                                      |       |                                                   | 0          |                                                   |       |                                                   | 0          |   |   |   | 1,354 |   |   |
| Change in fair value of derivative warrants and  conversion options                                |       |                                                   | 10,091     |                                                   |       |                                                   | (8,594     | ) |   |   | 435 |   |   |
| Gain on contract termination                                                                       |       |                                                   | 0          |                                                   |       |                                                   | 0          |   |   |   | (1,843 | ) |   |
| Write down of inventory                                                                            |       |                                                   | 0          |                                                   |       |                                                   | 0          |   |   |   | 585 |   |   |
| Non-cash stock based compensation                                                                  |       |                                                   | 608        |                                                   |       |                                                   | 3          |   |   |   | 837 |   |   |
| Non-cash stock based compensation to product  development vendor                                   |       |                                                   | 400        |                                                   |       |                                                   | 0          |   |   |   | 0 |   |   |
| Changes  in operating assets and liabilities:                                                      |       |                                                   |       |                                                   |       |                                                   |       |   |   |   |   |   |   |
| Trade accounts receivable                                                                          |       |                                                   | 0          |                                                   |       |                                                   | (133       | ) |   |   | (872 | ) |   |
| Other receivables                                                                                  |       |                                                   | (17        | )                                                      |       |                                                   | 2          |   |   |   | 9 |   |   |
| Inventory                                                                                          |       |                                                   | (46        | )                                                      |       |                                                   | (2,832     | ) |   |   | (162 | ) |   |
| Prepaid and other assets                                                                           |       |                                                   | 219        |                                                   |       |                                                   | 146        |   |   |   | (272 | ) |   |
| Accounts payable                                                                                   |       |                                                   | (218       | )                                                      |       |                                                   | 1,473      |   |   |   | (41 | ) |   |
| Accrued expenses                                                                                   |       |                                                   | 357        |                                                   |       |                                                   | 660        |   |   |   | 487 |   |   |
| Accrued compensation and benefits                                                                  |       |                                                   | 302        |                                                   |       |                                                   | (504       | ) |   |   | 12 |   |   |
| Warranty reserve                                                                                   |       |                                                   | 0          |                                                   |       |                                                   | 336        |   |   |   | (18 | ) |   |
| Deferred revenue                                                                                   |       |                                                   | 204        |                                                   |       |                                                   | (325       | ) |   |   | 223 |   |   |
| Returns reserve                                                                                    |       |                                                   | 0          |                                                   |       |                                                   | 2,310      |   |   |   | 0 |   |   |
| Net operating cash flow used in continuing operations                                              |       |                                                   | (7,084     | )                                                      |       |                                                   | (13,616    | ) |   |   | (16,154 | ) |   |
| Net operating cash flow provided by discontinued  operations                                       |       |                                                   | 135        |                                                   |       |                                                   | 0          |   |   |   | 0 |   |   |
| Net cash used in operating activities                                                              |       |                                                   | (6,949     | )                                                      |       |                                                   | (13,616    | ) |   |   | (16,154 | ) |   |
| Cash flows from  investing activities:                                                             |       |                                                   |       |                                                   |       |                                                   |       |   |   |   |   |   |   |
| Capital expenditures                                                                               |       |                                                   | (925       | )                                                      |       |                                                   | (554       | ) |   |   | (410 | ) |   |
| Net cash used in investing activities                                                              |       |                                                   | (925       | )                                                      |       |                                                   | (554       | ) |   |   | (410 | ) |   |
| Cash flows from  financing activities:                                                             |       |                                                   |       |                                                   |       |                                                   |       |   |   |   |   |   |   |
| Payment of note payable                                                                            |       |                                                   | 0          |                                                   |       |                                                   | (331       | ) |   |   | 0 |   |   |
| Proceeds from issuance of convertible debentures                                                   |       |                                                   | 0          |                                                   |       |                                                   | 0          |   |   |   | 10,315 |   |   |
| Proceeds from issuance of common stock                                                             |       |                                                   | 2,813      |                                                   |       |                                                   | 16,643     |   |   |   | 27 |   |   |
| Proceeds from the issuance of redeemable preferred  stock                                          |       |                                                   | 7,111      |                                                   |       |                                                   | 0          |   |   |   | 0 |   |   |
| Proceeds from the exercise of stock options                                                        |       |                                                   | 813        |                                                   |       |                                                   | 818        |   |   |   | 12 |   |   |
| Proceeds from the exercise of stock rights and  warrants                                           |       |                                                   | 5,612      |                                                   |       |                                                   | 1,477      |   |   |   | 0 |   |   |
| Net cash provided by financing activities                                                          |       |                                                   | 16,349     |                                                   |       |                                                   | 18,607     |   |   |   | 10,354 |   |   |
| **Net  increase (decrease) in cash and cash equivalents**                                          |       |                                                   | 8,475      |                                                   |       |                                                   | 4,437      |   |   |   | (6,210 | ) |   |
| **Cash and  cash equivalents, beginning of year**                                                  |       |                                                   | 3,365      |                                                   |       |                                                   | 11,840     |   |   |   | 16,277 |   |   |
| **Cash and cash equivalents, end  of year**                                                        |       |                                                   | $          | 11,840                                                 |       |                                                   |       | $ | 16,277 |   |   |   | $ | 10,067 |   |   |

 

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

F-7

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**WORLDGATE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Dollars in thousands except  per shareamounts)**

**1.**                 Basisof Presentation

The consolidated financial statements of WorldGateCommunications, Inc. (“WorldGate”, “We”, “Our” or the “Company”) presentedherein have been prepared by the Company pursuant to the rules andregulations of the Securities and Exchange Commission (“SEC”) for annualreports on Form 10-K. WorldGate was incorporated in Delaware in 1996to succeed to the business of the predecessor company, WorldGateCommunications, L.L.C., which commenced operations in March 1995. WorldGatehas developed a video phone designed specifically for personal videocommunication, and is differentiated, both from competitors and from previousefforts at personal video telephony, by providing: true-to-life communication(meaning that images and sounds are synchronized, that there are minimum delaysbetween the two ends of the communication, and that the quality of the imagesis similar to what we perceive with traditional television); ease of deploymentby high-speed data, or HSD, operators as well as businesses; a highly styledergonomic design; and interoperation with the public switched telephonenetwork, or PSTN.

The consolidated financial statements of the Companyinclude the accounts of WorldGate Communications, Inc. and its whollyowned subsidiaries WorldGate Service, Inc., WorldGate Finance, Inc.,Ojo Services LLC, Ojo Video Phone LLC and WorldGate Acquisition Corp. Allsignificant intercompany accounts and transactions have been eliminated inconsolidation.

Our business model isprimarily based upon the sale of Ojo video phones and related products andservices. It is our plan for Ojo video phones to be distributed through and inpartnerships with HSD network providers, as well as through traditionalelectronics distribution channels. Video phone service, using the Ojo videophone, is expected to be offered by HSD network providers as a means ofattracting new HSD subscribers as well as maintaining existing subscribers. Webelieve that HSD network providers could realize recurring incremental revenuestreams associated with offering products such as our Ojo video phone, andaccordingly we believe they will embrace the concept and business model. Thesuggested consumer offering for a video phone service follows the traditionalHSD model, which may involve a subsidy of the required hardware by therecurring service fee. We anticipate that video phone service subscribers willbe able to either purchase Ojo or lease a unit from the HSD network provider. Thereis also a parallel market for sales of video phones directly to consumersthrough the standard consumer electronic channels. Sales of video phonesthrough this channel still require a video phone service and the Company iscurrently offering such a video phone service, using the Ojo video phone, forunits sold through this channel. Ojo is being marketed domestically andinternationally to both the residential and business sectors through thestandard consumer and business electronics channels.

**2.**                 Reclassification

Certain reclassificationshave been made to the consolidated financial statements shown for prior periodsin order to have it conform to the current period’s classifications. Thereclassifications have no effect on previously reported losses.

F-8

----

**3.**                 Summaryof Significant Accounting Policies

*Liquidity and GoingConcern Considerations*

As of December 31, 2006 the Company had cash andcash equivalents of $10,067. The operating cash used in continuing operationsfor the twelve months ended December 31, 2006 was $16,154. The funds wereceived as a result of private placements of our securities on December 1,2003 and December 4, 2003, January 21, 2004, April 22, 2004, June 24,2004, December 15, 2004, August 3, 2005, August 11, 2006 and October 13,2006 have permitted us to fund the development of our business.

In June 2004 we completed a private placement of7,550 shares of Series A Convertible preferred stock to certaininstitutional investors. The shares were sold for $1,000 per share, resultingin gross proceeds from the offering of $7,550. The preferred stock issuedpursuant to this placement is convertible into WorldGate common stock at aconversion price of $2.35 per share. WorldGate has the right to requireconversion of the preferred stock into common stock upon achieving certainprice targets with respect to its common stock and the satisfaction of certainother conditions. Of the 7,550 convertible preferred issued, 500 sharesremained outstanding as of December 31, 2005 and 166 shares remainoutstanding as of December 31, 2006. Between November 2004 and December 2006all but one of the investors has fully converted their preferred sharesresulting in the issuance of 3,142,128 of our common shares. The preferredstock has a dividend rate of 5% per annum, payable quarterly, which may be paideither by cash or through the issuance of common stock at WorldGate’s option(with stock payments being made at a 10% discount to the then current marketprice). Through December 31, 2006, for all quarterly dividend paymentsdue, WorldGate exercised its right to make these dividend payments in stock,resulting in the issuance of an additional 142,389 shares of our common stock.The preferred stock has a staged maturity over three years with scheduledpayments of one third due after 18 months, one half of the remainder due after24 months and the balance due after 36 months. The preferred stock may beredeemed at maturity in cash or through the issuance of an indeterminate numberof shares of common stock, at WorldGate’s option (subject to certainconditions). All dividend and maturity payments made in stock are subject tothe satisfaction of certain conditions including the listing and availabilityof an effective registration statement. As part of the transaction, WorldGateissued five-year warrants to purchase a total of 1,606,380 shares of WorldGatecommon stock, with one-half of the warrants having an exercise price of $2.69 pershare and the remaining half having an exercise price of $3.14 per share.Through December 31, 2006, 125,000 of the $2.69 warrants have beenexercised resulting in the issuance of an additional 125,000 of our commonshares and an additional $336 in gross proceeds; 51,915 of the $3.14 warrantshave been exercised resulting in the issuance of an additional 51,915 of ourcommon shares and an additional $163 in gross proceeds. Based on anti-dilutionprovisions contained within this private placement the $2.69 warrants weremodified to an exercise price of $2.35 as of December 31, 2006 and thenumber of outstanding warrants were increased by 98,164 related to the issuanceof convertible debentures and warrants in August 2006 and October 2006and as a result of the conversion price related to these issuances. Based onanti-dilution provisions contained within this private placement the $3.14warrants were also modified to an exercise price of $2.70 as of December 31,2006 and the number of outstanding warrants were increased by 120,307 relatedto the issuance of convertible debentures and warrants in August 2006 and October 2006and as a result of the conversion price related to these issuances. Theinvestors also received an additional investment right, for a limited period oftime, to purchase 1,606,380 additional common shares at $3.14 a share. During December 2004,all but one of the investors exercised their additional investment rightsresulting in the issuance of an additional 1,500,000 shares and an additional$4,710 in gross proceeds. During the first quarter of 2005, the remaininginvestor exercised its additional investment right resulting in the issuance ofan additional 106,383 shares and an additional $334 in gross proceeds. Theprivate placement includes numerous provisions intended to protect theseinstitutional investors including a cash payment penalty of 1.0% per month forunredeemed preferred shares once registration of the shares lapse and until theregistration again becomes effective.

F-9

----

In August 2005, the Company completed a privateplacement of $17,500 of its common stock and warrants with severalinstitutional investors. The Company issued 4,666,664 shares of its commonstock at $3.75 per share to the participating investors. The Company alsoissued five-year warrants to purchase a total of 1,671,947 shares of its commonstock: 1,633,333 shares to the investors at an exercise price of $5.00 pershare, and 38,614 shares to the placement agent at an exercise price of $4.53per share. The investors also received an additional investment right, fora period of 60 days from the time the shares become registered, to purchase1,554,000 additional shares of common stock at $4.12 per share. The accountingfor these warrants and investment rights is established by analogy toAccounting Principle Board Opinion (“APB”) No. 14 “Accounting forConvertible Debt and Debt Issued with Stock Purchase Warrants,” which addressesdetachable stock purchase warrants issued in conjunction with convertible debtand prescribes that such warrants be accounted for as additional paid incapital measured at fair value. The private placement includes numerousprovisions intended to protect these institutional investors including a cashpayment penalty of 1.5% per month for the period above 120 days from theeffective date of the agreement that the shares in the transaction fail to beregistered. The Registration Statement covering the shares under this privateplacement was not declared effective until June 1, 2006. Until such timeas the shares were registered the Company was subject to the penalty provisionunder this private placement. For the years ended December 31, 2005 and2006 the Company recorded and expensed related penalties of $535 and $1,114,respectively. The related unpaid penalties accrued as of December 31, 2005and December 31, 2006 was $535 and $157, respectively.  On July 25, 2006, the Company amended theterms of the additional investment right that was granted to an investor aspart of the August 2005 private placement, with respect to a portion ofshares of common stock purchasable thereunder and agreed to apply $158 ofaccrued penalties towards the exercise price of such amended additionalinvestment right, for the purchase of 129,950 shares of common stock. Thepenalties had accrued with respect to the Company’s inability to register theshares acquired by such investor in the private placement within 120 days ofthe transaction. In consideration for this amendment and application of theexercise proceeds the investor agreed to forego any cash payment of thepenalties other than as available through the proceeds of the exercise of theamended investment right and to grant to the Company a release of all claimsrelating to the late registration of the private placement shares, other thanthe aforesaid penalties. The amended additional investment right provides thatthe investor thereof may purchase the 129,950 shares of common stock for aperiod of 760 days beginning June 1, 2006 for an exercise price of $1.515per share. The terms of the additional investment rights with respect to theremaining 1,424,050 shares of common stock purchasable thereunder remainunchanged. On July 26, 2006 this investor exercised the additionalinvestment right for 129,950 shares. On July 31, 2006 the amendedadditional investment right with respect to the remaining 1,424,050 shares ofcommon stock expired. On December 12, 2006 the Company amended the termsof the warrants that were granted to an investor as part of the August 2005private placement, with respect to a portion of shares of common stockpurchasable thereunder and agreed to apply $315 of accrued penalties towardsthe exercise price of such amended warrants, for the purchase of 279,255 sharesof common stock. In addition, the exercise price of 47,412 of the warrants waschanged to $1.41 per share. The penalties had accrued with respect to theCompany’s inability to register the shares acquired by such investor in theprivate placement within 120 days of the transaction. In consideration for thisamendment and application of the exercise proceeds the investor agreed toforego any cash payment of the penalties other than as available through theproceeds of the exercise of the amended warrant and to grant to the Company a releaseof all claims relating to the late registration of the private placementshares, other than the aforesaid penalties. The amended warrants provides thatthe investor thereof may purchase the 326,667 shares of common stock for aperiod of 1,330 days beginning December 12, 2006 for an exercise price of$1.41 per share. The terms of the warrants with respect to the remaining sharesof common stock purchasable thereunder remain unchanged. On December 19,2006 this investor exercised the warrants for the purchase of 279,255 shares.

F-10

----

Registration statements for the securities soldpursuant to the June 2004, December 2004 and August 2005 privateplacements were originally filed containing financial statements that werecurrent at the time of the filing. Subsequently, the Company initiated aprocess to amend, restate, and re-file certain of its 2003, 2004 and 2005financial statements to correct an error in the accounting treatment forvarious security components of our private placements. As a result the registrationstatements then on file also needed to be amended to reflect these changes inour financial statements. Amended registration statements were subsequentlyfiled with the SEC to reflect the amended and restated financial statements,and became effective on June 1, 2006.

On August 11, 2006 the Company completed aprivate placement with an institutional investor of  convertible debentures in the aggregateprincipal amount of up to $11,000. These convertible debentures have a maturityof three years, an interest rate of 6% per annum, and are convertible at theoption of the investors into WorldGate common stock at a conversion price equalto the lesser of $1.75 per share or 90% of the average of the five lowest dailyvolume weighted average closing price (“VWAP”) of the common stock during thefifteen trading days immediately preceding the conversion date (subject toadjustment in the event of stock dividends and splits and certain distributionsto stockholders, fundamental transactions, and future dilutive equitytransactions). Interest is payable at maturity, and the Company may elect topay the interest amount in cash or shares of our common stock. Through December 31,2006 the investors converted $1,350 of the convertible debt into 1,146,279shares of the Company’s common stock. During the period January 1, 2007through March 7, 2007 the investors converted an additional $800 of theconvertible debt into 716,063 shares of the Company’s common stock.

The Company received $6,000 upon the closing of thetransaction ($5,615, net of transaction costs) and the remaining $5,000($4,700, net of transaction costs) was received on October 13, 2006 afterreceiving stockholder approval on October 11, 2006 and obtaining aneffective registration of the shares of common stock issued and issuable uponconversion of the debenture in the first tranche of this transaction.

The Company has the right to redeem all or any portionof the principal amount of the convertible debentures in cash at any time uponnot less than four business days notice if the closing price of our stock isless than $1.75 per share. Such early redemption will, however, require theCompany to pay a 10% prepayment premium.  In addition, without any prepayment premium,the Company has the right to force the holders to convert a maximum of $500 ofthe principal amount of the convertible debentures in any thirty day period iffor five consecutive trading days the VWAP of our common stock is above $1.925per share but less then $3.50 per share and providing the daily trading volumeexceeds 200,000 shares for these five days, and certain other conditions aremet. If the VWAP of our common stock is greater than $3.50 per share for 30consecutive trading days, the daily trading volume exceeds 250,000 shares forfive days prior, and if certain other conditions are met, the Company can alsoforce the holder to convert all or any portion of the outstanding principal andinterest into shares of our common stock without any prepayment premium.

There are some restrictions on the holder’s right toconvert the convertible debentures. The holder cannot make any conversionsbelow $1.75 per share (i) until the earlier of the date registered commonstock can be issued pursuant to such conversion or January 1, 2007, (ii) whichwould exceed $500 in principal amount in any calendar month, or (iii) whichwould result in the issuance of more than 840,000 shares of our common stockper calendar month (provided that this maximum share limit will be waived bythe Company unless it elects to pay the holder in cash the difference in valuebetween 840,000 shares and the number of shares the holders wishes to convert,up to the $500 per month conversion limit). If the Company is in default underthe convertible debenture these limitations are waived. The holder is also notrestricted in making conversions at $1.75. In no case, however may the holderconvert the convertible debentures if (x) it would result in beneficialownership of more than 9.99% of our outstanding common stock (though this provisioncan be waived by the holder upon 65 days prior notice), or (y) suchconversion would, without stockholder approval, cause the Company to issue morethan 19.99% of its outstanding 

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shares as determinedimmediately prior to consummation of the transaction. Under certaincircumstances, the convertible debenture holders are entitled to have theconversion price adjusted to correspond to common stock holders’ rights to anystock dividend, stock split, stock combination or reclassification of shares.The $1.75 conversion price is also subject to a weighted average dilutionadjustment if the Company issues shares (apart from certain excluded issuances)of our capital stock at an effective price of less than $1.75 per share. TheCompany also granted the convertible debentures holders a security interest inall of our assets. Moreover, the Company was required to register the shares ofcommon stock issuable to the investor for resale to the public pursuant to aregistration rights agreement, containing customary terms, conditions andindemnities. The private placement includes numerous provisions intended toprotect the institutional investors including a cash payment penalty of 1.0%per month for any period that the shares cannot be traded under an effective registration statement with theaggregate penalty capped at 12%.

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

As part of this private placement the Companyissued  five-year warrants to purchase atotal of up to 2,595,000 shares of WorldGate common stock, with 1,145,000 ofthe warrants having an exercise price of $1.85 per share (with 624,545 of thesewarrants issued at the initial closing and 520,455 warrants issued at theclosing of the second tranche of funding), 1,100,000 of the shares having anexercise price of $2.35 per share (with 600,000 of these warrants issued at theinitial closing and 500,000 warrants issued at the closing of the secondtranche of funding), and 350,000 warrants having an exercise price of $2.60 pershare (with 190,909 of these warrants issued at the initial closing and 159,091warrants issued at the closing of the second tranche of funding).

On April 28, 2004, the Company entered into amulti-year agreement with General Instrument Corporation d/b/a the ConnectedHome Solutions Business of Motorola, Inc. (“General Instrument”) for theworldwide development and distribution of the Ojo personal video phone. Thisagreement provided for General Instrument to be WorldGate’s exclusivedistributor of its broadband video phone products and for WorldGate to beGeneral Instrument’s exclusive supplier of its broadband video phone products. OnFebruary 17, 2006, the Company mutually agreed with General Instrument toend this agreement. The ending of this agreement immediately terminatedexclusivity for both parties. In addition to its current role for developmentand manufacture of Ojo, WorldGate assumed direct responsibility and control forthe advertising, marketing, and distribution of its products.  Under its agreement with General Instrument,WorldGate had been active in marketing and promoting its products, and workingwith General Instrument to distribute Ojo. WorldGate continued the rollout ofOjo using many of the same distributors, retailers and service providers, andhas subsequently expanded distribution to service providers and retailersaround the world. As part of ending its agreement with General Instrument, andin anticipation of WorldGate inventory requirements as a result of taking fullresponsibility for product distribution, WorldGate negotiated the right to buyback about two-thirds of the units sold to General Instrument, valued atapproximately $2,765 (based upon the original sales price to GeneralInstrument), for approximately $1,064. This is less than half of what it wouldcost the Company to purchase the same inventory from its manufacturing sources.As a result, the Company recorded a reserve for returns and reduced revenue inthe amount of approximately $2,310 during the fourth quarter of 2005. Inaddition, the Company  recorded norevenue for units shipped to General Instrument in the first quarter 2006 andfor the year ended December 31, 2006 has recorded a gain on termination ofthis agreement of approximately $1,843 as a result of the lower purchase priceof the inventory repurchased from General Instrument ($1,393, net of the costof rework for rebranding the product and the adjustment of the inventory to itscurrent replacement value) and reversal of the product refund program reserve($212) as well as an 

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adjustment of the warrantyreserve for products repurchased ($233), both of which resulted fromtermination of the Company’s agreement with General Instrument.

The Company had $12,423 of liabilities and its assetsare pledged as collateral as of December 31, 2006. These liabilitiesinclude $1,010 of dividends, detachable warrants and conversion options relatedto the Company’s private placement of preferred stock in June 2004 and$8,069 of debt and conversion option liability related to the Company’sfinancing in August 2006.

Our short term cash requirements and obligationsinclude, inventory, accounts payable and capital expenditures from continuingoperations, operating expenses, and the redemption of preferred stock, of which$166 is required to be redeemed in June 2007, although this redemption canbe made in common stock if certain conditions are met. In addition, the August 2005private placement includes cash payment penalties of 1.5% per month for theperiod that the shares in the transaction fail to be registered. TheRegistration Statement covering the shares under this private placement was notdeclared effective until June 1, 2006. Until such time as the shares wereregistered the Company was subject to the penalty provision under this privateplacement. For the twelve months ended December 31, 2005 and 2006 theCompany recorded and expensed related penalties of $535 and $1,114,respectively. The related unpaid penalties accrued as of December 30, 2005and December 31, 2006 were $535 and $157, respectively.

Management expects, based on our internal forecastsand assumptions, including, among others, assumptions regarding our short termcash requirements and our projected revenue growth that the Company hassufficient cash on hand to meet its obligations into the second half of 2007. Asshown in the accompanying consolidated financial statements, the Company hasincurred recurring net losses and has an accumulated deficit of $246,806 as of December 31,2006. These factors raise substantial doubt about the Company’s ability tocontinue as a going concern. The financial statements do not include anyadjustments that might be necessary should the Company be unable to continue asa going concern.

The Company’s ability to generate cash is dependentupon the sale of Ojo products and on obtaining cash through capitalmarkets. The Company began generating revenue from commercial shipment ofthe Ojo product in April 2005. Initially all product sales were conductedthrough General Instrument, its exclusive distributor and all revenue was basedupon sales of our products to General Instrument for their distribution toresellers. In February 2006, its distributor relationship with GeneralInstrument ended and the Company began to directly distribute and sell itsproducts. This transition process included forming direct relationships withthe resellers and adding incremental distribution. As the Company completes itstransition activities it expects revenues to increase as it continues to rollout its products to the marketplace. Depending on the ramp up of sales and theachievable margin, the increased level of sales activity should have a positiveimpact on our cash flows from operations, which will support our ability tomeet its cash requirements in the long term. Given that the video phonebusiness involves the development of this product line with no marketpenetration, in an underdeveloped market sector, no assurances can be giventhat sufficient sales or achievable margins, if any, will materialize.

Additionally, if and as needed, the Company plans togenerate cash by turning to the capital markets for further funding. Noassurances can be given that, if pursued, additional financing transactions canbe consummated. The Company continues to evaluate possibilities to obtainadditional financing through public or private equity or debt offerings, bankdebt financing, asset securitizations, or from other sources, should theCompany need to obtain such financing. Such additional financing would besubject to the risk of availability, may be dilutive to our stockholders, orcould impose restrictions on operating activities. There can be no assurancethat this additional financing will be available on terms acceptable to theCompany, if at all.

Long term cash requirementobligations are primarily related to the June 2004, and the August andOctober 2006 transactions and the convertible debenture issued on August 11,2006 and October 13, 2006.  

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TheCompany has limited capacity to reduce its workforce and scale back on capitaland operational expenditures to decrease our cash usage.

*Use of Estimates*

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities, at the date of the financialstatements and the reported amount of revenues and expenses during thereporting period. Significant estimates relate to inventory valuation, deferredtax valuation allowances, deferred revenues, valuation of derivativeliabilities and stock based compensation. Actual results could differ fromthose estimates.

*Risks anduncertainties*

Our primary line of business is the development andsale of video phone products and technology. Although the Company has launchedits first product based on this technology and, although the Company hasrealized some revenues for the commercial sale of its product, the revenues todate have not been substantial. Given the early stage of its product and thelack of operating history in the video phone business, it is difficult topredict its future results.

On April 28, 2004, the Company entered into amulti-year agreement with General Instrument for the worldwide development anddistribution of the Ojo personal video phone. This agreement provided forGeneral Instrument to be WorldGate’s exclusive distributor of its broadbandvideo phone products and for WorldGate to be General Instrument’s exclusivesupplier of its broadband video phone products. On February 17, 2006, theCompany mutually agreed with General Instrument to end this agreement. Theending of this agreement immediately terminated this exclusivity for bothparties, and accordingly enabled WorldGate to expand its focus in bringing Ojoto the marketplace. In addition to its current role for development andmanufacture of Ojo, WorldGate became directly responsible for the advertising,marketing, and distribution of its products. Subsequent to the ending of theagreement with General Instrument the Company is depending upon distributionpartners, including, for example, wholesalers, retailers and service providers,to provide the worldwide sales and distribution of the Ojo video phone. If theCompany’s partners are not successful, or if their activities do not lead tosignificant sales of its product, operating results will be adverselyaffected,  revenue could be significantlyreduced and the Company could lose potential customers.

The Company also depends on relationships with thirdparties such as contract manufacturing companies, chip design companies andothers who may be sole source providers of key components and services criticalfor the product the Company is developing in our video phone business. Thecomponents and raw materials used in our Ojo video phone product are generallyavailable from a multitude of vendors and are sourced based, among otherfactors, on reliability, price and availability. A formal relationship withMototech has been established for the volume manufacture of Ojo. Our nonexclusive agreement with Mototech allows either party to terminate theagreement with 90 days prior notice. At the present time Mototech is the Company’ssole manufacturer of our video phones.If Mototech or otherproviders of components and/or manufacturing services do not produce thesecomponents or provide their services on a timely basis, if the components orservices do not meet our specifications and quality control standards, or ifthe components or services are otherwise flawed, the Company may have to delayproduct delivery, or recall or replace unacceptable products. In addition, suchfailures could damage our reputation and could adversely affect our operatingresults. As a result, the Company could lose potential customers and anyrevenues that it may have at that time may decline dramatically.

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*Cash and CashEquivalents*

The Company considers allhighly liquid investments with original maturities of three months or less tobe cash equivalents. The Company maintains cash balances at financialinstitutions, which at times exceed the $100 FDIC limit.

*Accounts Receivable*

The Company recordsaccounts receivable at the invoiced amount. Management reviews the receivablebalances on a monthly basis. Management analyzes collection trends, paymentpatterns and general credit worthiness when evaluating collectibility andrequires letters of credit whenever deemed necessary. Additionally, the Companymay establish an allowance for doubtful accounts based upon factors surroundingthe credit risk of specific customers, historical trends related to past lossesand other relevant information. Account balances would be charged off againstthe allowance after all means of collection have been exhausted and thepotential for recovery is considered remote. As of December 31, 2006, the Company did not have an allowancefor doubtful accounts or any off-balance sheet credit exposure related to itscustomers. At December 31, 2006, approximately 95% of accounts receivablewere concentrated with five customers. The Company had two distributioncustomers that represented 8% of accounts receivable, and had two majorinternational telecommunications customers that represented 82% of accountsreceivable at December 31, 2006. At December 31, 2005, approximately 92%of accounts receivable were concentrated with one domestic customer. Tradeaccounts receivable at December 31, 2005 and 2006 were $133 and $1,005,respectively.

*Inventory*

The Company’s inventoryconsists primarily of finished goods equipment to be sold to customers. Thecost is determined on an average cost basis. A periodic review of inventoryquantities on hand is performed in order to determine and record a provisionfor excess and obsolete inventories. Factors related to current inventoriessuch as technological obsolescence and market conditions are analyzed todetermine estimated net realizable values. A provision is recorded to reducethe cost of inventories to the estimated net realizable values. To motivatetrials and sales of its Ojo product, the Company has historically subsidized,and plans in the future to continue to subsidize, certain of its product salesto customers that result in sales of inventory below cost. In accordance withAccounting Research Bulletin (“ARB”) No. 43, the Company reflects suchinventory at the lower of cost or market and has reduced its inventory at December 31,2006 by $97 to reflect such valuation. Any significant unanticipated changes inthe factors noted above could have an impact on the value of the Company’sinventory and its reported operating results. At December 31, 2005, theCompany’s inventory balance was $2,878. This balance includes $2,006 ofinventory related to the accounting for product purchased in connection withthe ending of the General Instrument agreement and was recorded as a reservefor returns. At December 31, 2006, our inventory balance was $1,600. In2006, the Company’s inventory was reduced by $585 to their estimated netrealizable values.

*Property andEquipment*

Property and equipment is carried at original cost.Depreciation is recorded on a straight-line basis over the estimated usefullives of the related assets. The Company depreciates furniture and fixturesover seven years; office equipment over five years; and computer equipment andtrade show exhibits over three years. Leasehold improvements are capitalizedand amortized on a straight-line basis over the shorter of their useful life orthe term of the lease. Maintenance and repairs are expensed as incurred. Whenthe property or equipment is retired or otherwise disposed of, related costsand accumulated depreciation are removed from the accounts and any resultinggain or loss is included in operations.

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*Long-lived Assets*

The Company periodically evaluates the carrying valueof long-lived assets when events and circumstances warrant such review. Thecarrying value of a long-lived asset is considered impaired when theanticipated undiscounted cash flows from such assets are separatelyidentifiable and are less than the carrying value. In that event, a loss isrecognized based on the amount by which the carrying value exceeds the fairmarket value of the long-lived asset. Fair market value is determined by usingthe anticipated cash flows discounted at a rate commensurate with the riskinvolved. Measurement of the impairment, if any, will be based upon thedifference between carrying value and the fair value of the asset.

SFAS No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets” provides guidance on therecognition of impairment losses on long-lived assets to be held and used or tobe disposed of, and also broadens the definition of what constitutes adiscontinued operation and how the results of a discontinued operation are tobe measured and presented.

*Accounting forPreferred Shares and Derivative Shares*

In June 2004, WorldGate completed a privateplacement of preferred stock. The preferred stock has a dividend rate of 5% perannum, payable quarterly, either by cash or through the issuance of commonstock at the Company’s option. The preferred stock has a staged maturity overthree years with scheduled payments of one third due after 18 months, one halfof the remainder due after 24 months and the balance due after 36 months, andmay be redeemed at maturity in cash or, at the Company’s option, subject tocertain conditions that may not be solely under the control of the Company,through the issuance of the number of shares of common stock determined bydividing the liquidation preference of the preferred shares by the then averagemarket price over the ten consecutive trading days prior to the date ofconversion. If the effectiveness of the registration statement lapses, theCompany ceases to be listed on certain specified exchanges and trading in theCompany’s stock is suspended or a change in control occurs with respect to theCompany, the Company may be required to settle redemption of the preferredstock with cash instead of its common shares. Furthermore, since the marketprice of the Company’s common stock cannot be predicted, the actual number ofshares of the Company’s common stock that will be required if a redemption ismade through the issuance of common stock also cannot be predicted. The privateplacement includes numerous provisions intended to protect these institutionalinvestors including a cash payment penalty of 1.0% per month for unredeemedpreferred shares once registration of the shares lapse and until theregistration again becomes effective.

The preferred stock has embedded conversion options.Specifically, the holders of the preferred stock may convert their shares intothe Company’s common stock at a conversion price of $2.35 per share. Inaddition the Company may force conversion of the preferred stock into commonstock if the Company achieves certain price targets for its common stock andsatisfaction of certain other conditions, such as the existence of an effectiveregistration statement. In either event the conversion price is subject toadjustment if, at any time after the date the preferred shares were issued, theCompany issues or sells, or is deemed to have issued or sold, any shares of theCompany’s common stock for per share consideration less than the conversionprice of the preferred shares on the date of such issuance or sale. Accordingly,the number of common shares issuable upon the conversion of the preferredshares cannot be predicted. Furthermore, net-cash settlement may be required inthe event of conversion default under certain circumstances that may not besolely under the control of the Company. If the effectiveness of theregistration statement lapses, the Company ceases to be listed on certainspecified exchanges and trading in the Company’s stock is suspended or a changein control occurs with respect to the Company, the Company may be required tosettle a conversion of the preferred stock with cash instead of its commonshares.

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Also, as part of the private placement the Companyissued five-year warrants to purchase up to 803,190 shares of our common stockat an exercise price of $2.69 per share and five-year warrants to purchase upto 803,190 shares of our common stock at an exercise price of $3.14 per share.The investors also received an additional investment right, for a limitedperiod of time, to purchase 1,606,383 additional shares of common stock sharesat $3.14 a share. This exercise price of the warrants is subject to adjustmentif, at any time after the date the warrants were issued, the Company issues orsells, or is deemed to have issued or sold, any shares of the Company’s commonstock for per share consideration less than the exercise price of the warrantson the date of such issuance or sale. Accordingly, the number of common sharesthat will be issued upon the exercise of the warrants cannot be predicted. Asof September 30, 2006, 125,000 warrants exercisable at $2.69 had beenexercised and 51,915 warrants exercisable at $3.14 had been exercised. All ofthe additional investment rights had been exercised as of June 30, 2006.Based on anti-dilution provisions contained within this private placement the$2.69 warrants were modified to an exercise price of $2.35 as of December 31,2006 and the number of outstanding warrants were increased by 98,164 related tothe issuance of convertible debentures and warrants in August 2006 and October 2006and as a result of the conversion price related to these issuances. Based onanti-dilution provisions contained within this private placement the $3.14 warrantswere also modified to an exercise price of $2.70 as of December 31, 2006and the number of outstanding warrants were increased by 120,307 related to theissuance of convertible debentures and warrants in August 2006 and October 2006and as a result of the conversion price related to these issuances.

Of the 7,550 preferred shares issued under thisprivate placement, 7,384 shares have been redeemed as of December 31,2006.

With respect to the Company’s accounting for thepreferred stock, Emerging Issues Task Force (“EITF”) Topic D-98,paragraph 4, states that Rule 5-02.28 of Regulation S-X requiressecurities with redemption features that are not solely within the control ofthe issuer to be recorded outside of permanent equity. As described above, theterms of the preferred stock include certain redemption features that may betriggered by events that are not solely within the control of the Company, suchas a potential 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 24, 2004, was the amount received in the transaction minusthe fair value ascribed to the conversion options and warrants. The initialvalue of the redeemable preferred stock is accreted up to the redemption value(the amount received in the transaction) over the future relevant periods usingthe interest method. The value of the redeemable preferred stock at December 31,2006 was $141.

The terms of the preferred stock include certainconversion options that represent derivative financial instruments underparagraph 12 of SFAS No. 133 “Accounting for Derivatives Instruments andHedging Activities” (“SFAS 133”) and thus were separated from the preferredstock and valued using the Black-Scholes option 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 forDerivative Instruments Indexed to, and Potentially Settled in, a Company’s OwnStock,” (“EITF 00-19”) states that if the conversion options require netcash settlement in the event of circumstances that are not solely within theCompany’s control they should be classified as a liability measured at fairvalue on the balance sheet.

The terms of the five-year warrants include cashpenalty provisions in the event that the Company fails to meet its obligationsto deliver registered shares to the warrant holder upon exercise and ananti-dilution provision that could result in a variable number of shares to beissued upon warrant exercise. Additionally, 

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the terms and conditionsof the warrants provide for net settlement through cashless exercise wherebythe shares delivered to the warrant holder would be readily convertible tocash. In accordance with EITF 00-19 and given the terms and conditions ofthe warrants as outlined above, the Company has classified the warrants as aliability on its balance sheet measured at fair value using the Black-Scholesoption pricing model.

The Company accounts for both the conversion optionsand warrants using the fair value method at the end of each quarter, with theresultant gain or loss recognition recorded against earnings. Both the warrantsand conversion options are valued using the Black-Scholes valuation model. At December 31,2005 and 2006, the closing common stock price was $2.06 and $1.34,respectively, applicable volatility rates were 57% and 99%, respectively, andthe period close risk-free interest rates as of December 31, 2005 werebetween 3.8% and 4.2% for the instrument’s contractual remaining lives of 1.5,0.5 and .08 years for the conversion option, and 3.5 years for the warrants,respectively, (continuously compounded), and as of December 31, 2006interest rates were between 4.70% and 4.78% for the instrument’s contractual remaining life of between 0.5 for theconversion option, and 2.5 years for the warrants (continuously compounded),and represent  the key assumptions usedin the valuation calculation. The result was a $10,091 non cash charge for theyear ended December 31, 2004, an $8,594 non cash gain for the year ended December 31,2005, and a non cash charge of $50 for the year ended December 31, 2006.

After the mark to marketadjustments, the balances of the conversion features derivative liability andthe warrants derivative liability were $57 and $1,038, respectively, at December 31,2005, and $11 and $997, respectively, at December 31, 2006.

*Accounting forSecured Convertible Debentures*and Related Warrants.

On August 11, 2006 the Company completed aprivate placement with an institutional investor of a convertible debenture inthe aggregate principal amount of up to $11,000. This convertible debenture hasa maturity of three years, an interest rate of 6% per annum, and is convertibleat the option of the investors into WorldGate common stock at a conversionprice equal to the lesser of $1.75 per share or 90% of the average of the fivelowest daily  VWAP of the common stockduring the fifteen trading days immediately preceding the conversion date(subject to adjustment in the event of stock dividends and splits and certaindistributions to stockholders, fundamental transactions, and future dilutiveequity transactions). Interest is payable at maturity, and the Company mayelect to pay the interest amount in cash or shares of our common stock. Therewas $193 of accrued interest as of December 31, 2006. Through December 31,2006 the investors converted $1,350 of the convertible debt into 1,146,279shares of the Company’s common stock. During the period January 1, 2007through March 7, 2007 the investors converted an additional $800 of theconvertible debt into 716,063 shares of the Company’s common stock.

The Company received $6,000 upon the closing of thetransaction ($5,615, net of transaction costs) and the remaining $5,000($4,700, net of transaction costs) was received on October 13, 2006 afterreceiving stockholder approval on October 11, 2006 and obtaining aneffective registration of the shares of common stock issued and issuable uponconversion of the convertible debentures in the first tranche of thistransaction.

The Company has the right to redeem all or any portionof the principal amount of the convertible debentures in cash at any time uponnot less than four business days notice if the closing price of our stock isless than $1.75 per share. Such early redemption will, however, require us topay a 10% prepayment premium.  Inaddition, without any prepayment premium, the Company has the right to forcethe holders to convert a maximum of $500 of the principal amount of theconvertible debenture in any thirty day period if for five consecutive tradingdays the VWAP of our common stock is above $1.925 per share but less then $3.50per share and providing the daily trading volume exceeds 200,000 shares forthese five days, and certain other conditions are met. If the VWAP of ourcommon stock is greater than $3.50 per share 

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for 30 consecutive tradingdays, the daily trading volume exceeds 250,000 shares for five days prior, andif certain other conditions are met, the Company can also force the holder toconvert all or any portion of the outstanding principal and interest intoshares of our common stock without any prepayment premium.

There are some restrictions on the holder’s right toconvert the convertible debentures. The holder cannot make any conversionsbelow $1.75 per share (i) until the earlier of the date registered commonstock can be issued pursuant to such conversion or January 1, 2007, (ii) whichwould exceed $500 in principal amount in any calendar month, or (iii) whichwould result in the issuance of more than 840,000 shares of our common stockper calendar month (provided that this maximum share limit will be waived bythe Company unless it elects to pay the holder in cash the difference in valuebetween 840,000 shares and the number of shares the holders wishes to convert,up to the $500 per month conversion limit). If the Company is in default underthe convertible debenture these limitations are waived. The holder is also notrestricted in making conversions at $1.75. In no case, however may the holderconvert the convertible debentures if (x) it would result in beneficialownership of more than 9.99% of our outstanding common stock (though thisprovision can be waived by the holder upon 65 days prior notice), or (y) suchconversion would, without stockholder approval, cause the Company to issue morethan 19.99% of its outstanding shares as determined immediately prior toconsummation of the transaction. Under certain circumstances, the convertibledebenture holders are entitled to have the conversion price adjusted tocorrespond to common stock holders’ rights to any stock dividend, stock split,stock combination or reclassification of shares. The $1.75 conversion price isalso subject to a weighted average dilution adjustment if the Company issuesshares (apart from certain excluded issuances) of our capital stock at aneffective price of less than $1.75 per share. The Company also granted theconvertible debentures holders a security interest in all of our assets. Moreover,the Company is required to register the shares of common stock issuable to theinvestor for resale to the public pursuant to a registration rights agreement,containing customary terms, conditions and indemnities. The private placementincludes numerous provisions intended to protect the institutional investorsincluding a cash payment penalty of 1.0% per month for the period above 120days from the effective date of the agreement that the shares in thetransaction fail to be registered with the aggregate penalty capped at 12%.

In addition, the aggregate number of shares to beissued upon conversion, exercise of the warrants, payment for commitmentshares, and payment of liquidated damages pursuant to the registration rightsagreement has been limited to 61,111,111 shares of common stock. On September 19,2006, the Company’s registration statement to register the shares under thisprivate placement was declared effective.

As part of this private placement the Company issuedfive-year warrants to purchase a total of up to 2,595,000 shares of WorldGatecommon stock, with 1,145,000 of the warrants having an exercise price of $1.85per share (with 624,545 of these warrants issued at the initial closing and 520,455warrants issued at the closing of the second tranche of funding), 1,100,000 ofthe shares having an exercise price of $2.35 per share (with 600,000 of thesewarrants issued at the initial closing and 500,000 warrants issued at theclosing of the second tranche of funding), and 350,000 warrants having anexercise price of $2.60 per share (with 190,909 of these warrants issued at theinitial closing and 159,091 warrants issued at the closing of the secondtranche of funding). In connection with the private placement, the Company hasissued to the investor as a commitment fee 177,419 shares of common stock witha fair value at issuance of approximately $222.

Upon any liquidation, dissolution or winding up of ourCompany, the holder of the convertible debenture will be entitled to receivethe principal amount of the convertible debenture, together with accrued andunpaid interest, prior to any payment to the holders of our common andpreferred stock.

The terms of the warrant agreements provide for theadjustment of the exercise price and the number of shares of common stock to beissued upon the Company’s issuance of certain securities deemed to be 

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dilutive under theagreement.   Under certain conditions,the holder may exercise these warrants on a cashless basis.

The market price of the Company’s common stock cannotbe predicted.  Furthermore, subject tothe share limitation, as discussed above, the actual number of shares of theCompany’s common stock that will be required if a conversion of the convertibledebenture is made through the issuance of common stock also cannot be predicted.Should the Company’s requirements to issue shares under these convertibledebenture agreements exceed the share limitation, or if it is not listed orquoted for trading on at least the NASDAQ OTC Bulletin Board, the Company maybe required to settle the conversion of the convertible debentures with cashinstead of its common stock.

The Company accounts for conversion options embeddedin convertible notes in accordance with SFAS No. 133, and EITF 00-19.SFAS 133 generally requires companies to bifurcate conversion options embeddedin convertible notes from their host instruments and to account for them asfree standing derivative financial instruments in accordance with EITF 00-19. EITF 00-19 states that if theconversion option requires net cash settlement in the event of circumstancesthat are not solely within the Company’s control that they should be classifiedas a liability measured at fair value on the balance sheet.

Upon the issuance date there was an insufficientnumber of authorized shares of Common Stock in order to permit exercise of allof the warrants issued on August 11, 2006.  In accordance with EITF 00-19, whenthere are insufficient authorized shares, the obligation for the exercise ofinvestor warrants should be classified as liability measured at fair value onthe balance sheet.  Accordingly, at August 11,2006, in connection with the $6,000 tranche, the convertible feature of theconvertible debenture and the warrants were recorded as derivative liabilitiesof $4,446 and $1,269, respectively. On October 11, 2006 the Companyreceived stockholder approval to increase the authorized shares from 80,000,000to 120,000,000. Upon re-valuation at October 11, 2006, the value of thewarrants at October 11, 2006, was reclassified to equity at fair value inaccordance with the provisions of EITF 00-19.

At October 13, 2006, in connection with the$5,000 tranche, the convertible feature of the convertible debenture was recordedas a derivative liability of $3,449 and the warrants were recorded asadditional paid in capital of $230.

The Company accounts for the conversion option usingthe fair value method at the end of each quarter, with the resultant gain orloss recognition recorded against earnings. The conversion options are valuedusing the Black-Scholes valuation model, applying actual period close commonstock price ($1.34), applicable volatility rate (98.9%), and the period closerisk-free interest rates (4.74%) for the instrument’s remaining contractuallife (2.61 years).

At the initial recording of the August 11, 2006tranche, the sum of the fair values of the convertible feature and thewarrants, $5,714 in the aggregate, exceeded the net proceeds of $5,615.  The difference of $99 was charged to thechange in fair value of derivative warrants of conversion options, uponissuance.   Accordingly, the Companyrecorded a discount equal to the face value of the convertible debenture, whichwill be amortized using the effective interest rate method over the three yearterm. The common stock issued  in thetransaction was recorded at a net value of $0, as there was no residual valueremaining.

For the $5,000 tranche issued on October 13,2006, the Company recorded a discount of $3,979, which will be amortized usingthe effective interest method over the three year term.

During the year ended December 31, 2006, $1,350in face value of the convertible debentures were converted, resulting in theissuance of 1,146,279 shares of common stock. As a result of the conversion,$1,350 of the discount on the convertible debenture has been charged toamortization of debt discount.

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For the year ended December 31, 2006, the companyhas recorded total discount amortization of $1,354 and mark-to-marketadjustments of the conversion feature derivative liability and the warrantsderivative liability resulted in a loss of $133 and a loss of $253,respectively.

At December 31, 2006, the balances of theconvertible debentures and the offsetting related discount were $9,650 and$8,625, respectively.

At December 31, 2006,after the mark to market adjustments, the balance of the conversion featuresderivative liability was $7,044.

*RevenueRecognition.*

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

For the year ended December 31, 2005, and throughmid February 2006, the Company had only one customer for the purchase ofits product and the agreement with this customer included several elementsrelevant to revenue recognition including: (a) the customer had no generalright to return the product;  (b) the customer earned warrants uponthe purchase of significant video telephony units and the value of thesewarrants would result in a reduction of recognized revenue (the value of thesewarrants has been routinely monitored by the Company and is currently deemed tobe insignificant, however, should the value of these warrants become materialan offset would be made against revenues); (c) penalties were payable tothe customer if certain excessive field failure rates are exceeded;  (d) theCompany and the customer shared in the benefit achieved by product costreductions; (e) penalties were payable to the customer if the Companyfailed to deliver shipments on a timely basis; (f) the Company extended tothe customer a limited product warranty for a term not to exceed three years(the Company maintains a warranty reserve based upon the percentage of productsales consistent with industry comparable failure rates and the warranty periodprovided by the agreement). Beginning in mid February 2006, as a result ofthe termination of the General Instrument marketing and distribution agreement,the Company began selling its products to multiple customers and now evaluatesits revenue recognition policy on a customer by customer basis.

Revenues are also offset by a reserve for any price refundsand consumer rebates consistent with the EITF Issue 01-9, “Accounting forConsideration Given by a Vendor to a Customer.”

As an incentive to promote delivery of the units, aspecial product launch discount was provided by the Company to a distributor asa quantity restricted reduction to the unit contract based price in effect. Forthe year ended December 31, 2005, this discount was $398. In addition, theCompany offered a forward pricing program to its former distributor and arebate program to consumers, as further incentives for the 2005 holiday season.These incentive programs began in the fourth quarter of 2005 and terminatedduring the first quarter of 2006. Consistent with the EITF Issue 01-9,the Company has offset its revenues for the year ended December 31, 2005by $212 for a reserve for the total estimated liability for the forward pricingprogram, and $91 as an estimated liability associated with the rebate program. Thetotal of the product launch discount, refunds and rebates for the year ended December 31,2005 was $701. The forward pricing program was terminated with the terminationon February 17, 2006 of the distribution agreement with GeneralInstruments, and this liability was reversed and recorded as a $212 increase tothe gain realized from termination of this agreement. On March 13, 2006,the Company announced that it was 

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going to offer a newconsumer rebate program effective April 1, 2006 and terminating June 30,2006. At December 31, 2006, there was an estimated liability of $48 associatedwith this rebate program. Also, on March 13, 2006 the Company announced aprice protection program for certain retailers holding Ojo video phoneinventory as of April 1, 2006. At December 31, 2006, there was anestimated liability of $2 associated with this price protection program. Theserebate and price protection programs were recorded as offsets against revenuesin the year ended December 31, 2006.

During the year ended December 31, 2006, weshipped several thousand units, with a sales value of $902,to customers with a right of return. These customers may exercise their rightof return only if they do not sell the units to their respective customers. Revenuefor these units was deferred as of December 31, 2006 in accordance withSFAS 48 “Revenue Recognition when a Right of Return Exists.”  We do expect, however, to begin recording thesale of these units as revenue when they are sold by our customers.

As part of ending theCompany’s agreement with General Instrument, and in anticipation of WorldGateinventory requirements as a result of taking full responsibility for productdistribution, WorldGate negotiated the right to buy back about two-thirds ofthe units sold to General Instrument, valued at approximately $2,765 (basedupon the original sales price to General Instrument), for approximately $1,064.This is less than half of what it would cost the Company to purchase the sameinventory from its manufacturing sources. As a result the Company recorded areserve for returns and reduced revenue in the amount of approximately $2,310,during the fourth quarter of 2005. In addition, the Company has recorded norevenue for units shipped to General Instrument in the first quarter 2006 andfor the year ended December 31, 2006 has recorded a gain on termination ofthis agreement of approximately $1,843 as a result of the lower purchase priceof the inventory repurchased from General Instrument ($1,393, net of the costof rework for rebranding the product and the adjustment of the inventory to itscurrent replacement value) and reversal of the product refund program reserve($212) as well as an adjustment of the warranty reserve for productsrepurchased ($233), both of which resulted from termination of the Company’sagreement with General Instrument.

*Cost of Revenues*

Cost of equipment productrevenues reflects primarily the purchase of video phones from the Company’ssupplier Mototech. The components and raw materials used in our Ojo video phoneproduct are generally available from a multitude of vendors and are sourcedbased, among other factors, on reliability, price and availability.

*Engineering andDevelopment Costs*

Engineering anddevelopment costs are expensed as incurred. Engineering and development costsfrom continuing operations were $3,557, $5,727 and $6,238 for the years ended December 31,2004, 2005 and 2006, respectively.

*Advertising Costs*

Advertising costs,included in sales and marketing expense, are expensed in the period incurred.Advertising expenses from continuing operations were $50, $1,743 and $1,036 forthe years ended December 31, 2004, 2005 and 2006, respectively.

*Income Taxes*

Provision for income taxesis determined based on the asset and liability method. The asset and liabilitymethod provides that deferred tax balances are recorded based on the differencebetween the tax basis of assets and liabilities and their carrying amounts forfinancial reporting purposes. Deferred tax liabilities or assets at the end ofeach period are determined using the tax rate enacted under the current 

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tax law.The measurement of net deferred tax assets is reduced by the amount of any taxbenefits that, based on available evidence, are not expected to be realized,and a corresponding valuation allowance is established. The Company hasrecorded a full valuation allowance against its net deferred tax assets at December 31,2005 and 2006 due to the uncertainty regarding whether the deferred tax assetwill be realized.

*Stock-BasedCompensation*

Effective January 1, 2006, the Company adoptedthe fair value recognition provisions of SFAS No. 123 (Revised 2004), “Share-BasedPayment,” (SFAS No. 123(R)) using the modified-prospective-transitionmethod which requires us to recognize compensation expense on a prospectivebasis. Therefore, prior period financial statements have not been restated. SFASNo. 123(R) requires that all stock based compensation be recognizedas an expense in the financial statements and that such cost be measured at thefair value of the award. Under this method, in addition to reflecting compensationfor new share-based awards, expense is also recognized to reflect the remainingservice period of awards that had been included in pro-forma disclosure inprior periods. SFAS No. 123(R) also requires that excess tax benefitsrelated to stock option exercises be reflected as financing cash inflowsinstead of operating inflows. As a result, the Company’s net loss before taxesfor the year ended December 31, 2006 is approximately $827 ($0.02 pershare) greater than if it had continued to account for share-based compensationunder APB Opinion No. 25, “Accounting for Stock Issued to Employees.”  The stock based compensation expense isincluded in general and administrative expense in the consolidated statement ofoperations.

Consistent with the requirements of SFAS 123(R), theCompany has selected a “with-and-without” approach regarding the accounting forthe tax effects of share-based compensation awards. This approach is consistentwith intraperiod allocation guidance in SFASNo. 109, “Accounting for Income Taxes”, and EITF Topic D-32,“Intraperiod Tax Allocation of the Tax Effect of Pretax Income From ContinuingOperations.”

Prior to January 1, 2006, the Company’sstock-based employee compensation plans were accounted for under therecognition and measurement provisions of APB No. 25, and related Interpretations, as permitted by SFAS No. 123,“Accounting for Stock-Based Compensation.” The Company did not recognize stock-based compensation cost in itsstatement of operations for periods prior to January 1, 2006 as alloptions granted had an exercise price equal to the market value of theunderlying common stock on the date of grant. However, compensation expense wasrecognized for certain options granted to non employees of the Company basedupon fair value.

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As waspermitted under SFAS No. 148, “Accounting for Stock-Based Compensation -Transition and Disclosure,” which amended SFAS No. 123, the Companyelected to continue to follow the intrinsic value method in accounting for itsstock-based employee compensation arrangements as defined by APB No. 25,and related interpretations including FASB Interpretation No. 44, “Accountingfor Certain Transactions Involving Stock Compensation,” an interpretation ofAPB No. 25. No stock-based employee compensation cost is reflected inoperations, as all options granted under those plans had an exercise priceequal to the market value of the underlying common stock on the date of grant.The following table illustrates the effect on net loss and net loss  per share as if the Company had applied thefair value recognition provisions of SFAS No. 123 to stock-based employeecompensation:

| ** **                                                                                                                  | ** ** | **Year Ended  December 31** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                                  | ** ** | **2004**                              | ** ** | **2005** | ** ** |
| Net loss                                                                                                                    |       | $                                     | (19,425    | ) | $ | (6,851 | ) |
| Total stock-based  employee compensation expense determined under fair value based method for  all awards, net of tax of $0 |       | (2,072                                | )          | (833 | ) |
| Pro forma net  loss                                                                                                         |       | $                                     | (21,497    | ) | $ | (7,684 | ) |
| Net loss per  share:                                                                                                        |       |                                  |       |   |   |
| Basic and diluted  net loss—as reported                                                                                |       | $                                     | (0.70      | ) | $ | (0.19 | ) |
| Basic and diluted net  loss—pro forma                                                                                  |       | $                                     | (0.77      | ) | $ | (0.22 | ) |

 

Such pro forma disclosuresmay not be representative of future compensation expense because options vestover several years and additional grants are made each year.

*Net Loss Per Share(Basic and Diluted)*

Basic and diluted net lossper 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. The calculation of diluted net loss percommon share excludes potential common shares if the effect is antidilutive. Potentialcommon shares comprise shares of common stock issuable upon the exercise ofstock options and warrants and the conversion of preferred stock andconvertible debt. The number of potential common shares which would have beenassumed to be converted in the years ended December 31, 2004, 2005 and2006 and have a dilutive effect if the Company had income from continuingoperations, or if the options’ exercise price was less than the average marketprice of the common shares, were 11,295,669, 10,990,946 and 20,549,235,respectively.

*Fair Value ofFinancial Instruments*

The Company’s financialinstruments consist primarily of cash and cash equivalents, embeddedderivatives, accounts receivable and accounts payable. The book value of cashand cash equivalents, accounts receivable, and accounts payable is consideredto be representative of their fair value because of their short termmaturities. The carrying value of the Convertible Debentures Payable on thebalance sheet as of December 31, 2006 approximates fair value as termsapproximate those currently available for similar instruments. Embeddedderivatives reported on the balance sheet as of December 31, 2006 arepresented as a liability measured at fair value using the Black-Scholes optionpricing model (refer to Note 10, “Redeemable Preferred Stock” and Note 3, “Accountingfor Secured Convertible Debentures”).

*Concentration ofCredit Risk*

Financial instruments that potentially subject theCompany to a concentration of credit risk principally consist of cash and cashequivalents and accounts receivable. The Company has its cash and 

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cash equivalents placedwith high quality, creditworthy financial institutions. As part of its cashmanagement process, the Company performs periodic evaluation of the relativecredit standing of these institutions.

In 2005, accounts receivable consisted of receivableswith our video phone distribution partner. Due to the credit worthiness of thedistribution partner, and its financial payment history with the Company, noallowance for potential credit losses was recorded as of December 31, 2005.In 2006, accounts receivable primarily consisted of receivables from the salesof our video phones to retailers, distributors, service providers and from ourweb site. As a result of the credit worthiness and payment history related tothese sales, no allowance for potential credit losses has been recorded as of December 31,2006.

Salesto major customers, in excess of 10% of total revenues and accountsreceivables, were as follows for each of the years ended December 31:

| ** **    | ** ** | **Sales**  | ** ** | **Accounts  Receivable** | ** ** |
|---------------|------------|------------|------------|--------------------------|------------|
| **Customer**  | ** ** | ** ** | ** ** | **2004**                 | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** |
| A        |       |       | 100        | %                        |       |   | 99 | % |   |   | 0 |   |   |   | 92 | % |   |   | 0 |   |   |
| B             |       |       | 0          |                     |       |   | 0 |   |   |   | 0 | (1) |   |   | 0 |   |   |   | 76 | % | (1) |
| C   |       |       | 0          |                     |       |   | 0 |   |   |   | 14 | % |   |   | 0 |   |   |   | 0 |   |   |
| D        |       |       | 0          |                     |       |   | 0 |   |   |   | 25 | % |   |   | 0 |   |   |   | 0 |   |   |
|               |            |            |            |                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Shipments totaling $778were deferred at December 31, 2006 pursuant to guidance of SFAS 48.

As of December 31, 2006, Mototech is the solevolume manufacturer of Ojo video phones to the Company. A formal relationshiphad been established with Mototech in 2003. Mototech is a Taiwanesemanufacturer and distributor of high performance, high speed data and computernetworking products. The components and raw materials used in our Ojo videophone product are generally available from a multitude of vendors and aresourced based, among other factors, on reliability, price and availability.

At December 31, 2006,the Company has long-lived assets, with a net book value total of $951, locatedin the United States, and $315 located in Taiwan, R.O.C.

*Recent AccountingPronouncements*

In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment” that focuses primarily on accounting fortransactions in which an entity obtains employee services in share-basedpayment transactions. This statement replaces SFAS No. 123, “Accountingfor Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accountingfor Stock Issued to Employees.”  In March 2005,the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107(“SAB 107”) relating to the adoption of SFAS 123R. SAB 107 primarilyinterprets how the implementation of SFAS 123R is to be applied under SEC rules andregulations. Beginning January 1, 2006, the Company is required to expensethe fair value of employee stock options and similar awards. For the twelvemonths ended December 31, 2006, the Company expensed $827. The Company haselected to utilize the modified prospective transitional method in accountingfor share-based employee payment transactions. Based upon the employee optionsoutstanding as of December 31, 2006 and the transitional provisions ofSFAS No.123R and SAB 107, there are approximately $1,633 of future costs,utilizing the fair value method that will be expensed over a four year periodfrom 2007 through 2010. Additionally, the Company will utilize the fair valuemethod for any future instruments issued after January 1, 2006 (for moredetails, refer to Note 3).

In May 2005, SFAS No. 154, “AccountingChanges and Error Corrections—replacement of APB Opinion No. 20 and FASBStatement No. 3,” was issued. SFAS No. 154 changes the accounting forand reporting of a change in accounting principle by requiring retrospectiveapplication to prior periods’ 

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financial statements ofchanges in accounting principle unless impracticable. SFAS No. 154 iseffective for accounting changes made in fiscal years beginning after December 15,2005. The adoption of SFAS No. 154 did not have a material impact on theCompany’s consolidated results of operations, financial position or cash flows.

In September 2005, the EITF reached consensus onIssue No. 04-13, “Accountingfor Purchases and Sales of Inventory with the Same Counterparty,” thatinventory purchases and sales transactions with the same counterparty that areentered into in contemplation of one another should be combined for purposes ofapplying APB Opinion No. 29, “Accountingfor Nonmonetary Transactions.”  The effect reduces reported revenues and costof sales for affected transactions. The consensus on this issue applies to suchtransactions beginning in the first quarter 2006.  The adoption of Issue No. 04-13 didnot have a material effect on the Company’s consolidated financial position orresults of operations.

In September 2005, the FASB ratified the EITFIssue No. 05-7, “Accounting for Modifications to Conversion OptionsEmbedded in Debt Instruments and Related Issues,” which addresses whether amodification to a conversion option that changes its fair value effects therecognition of interest expense for the associated debt instrument after themodification, and whether a borrower should recognize a beneficial conversionfeature, not a debt extinguishment, if a debt modification increases theintrinsic value of the debt (for example, the modification reduces theconversion price of the debt). The adoption of the Issue did not have amaterial effect on the Company’s consolidated financial position or results ofoperations.

In September 2005, the FASB also ratified theEITF’s Issue No. 05-8, “Income Tax Consequences of IssuingConvertible Debt with a Beneficial Conversion Feature,” which discusses whetherthe issuance of convertible debt with a beneficial conversion feature resultsin a basis difference arising from the intrinsic value of the beneficialconversion feature on the commitment date (which is  recorded in the stockholder’s equity for bookpurposes, but as a liability for income tax purposes) and, if so, whether thatbasis difference is a temporary difference under SFAS No. 109, “Accountingfor Income Taxes.”  The adoption of theIssue did not have a material effect on the Company’s consolidated financialposition or results of operations.

In February 2006, the FASB issued SFAS No. 155‘‘Accounting for Certain Hybrid Financial Instruments, an amendment of FASBStatements No. 133 and 140’’ (‘‘SFAS 155’’). SFAS 155 clarifies certainissues relating to embedded derivatives and beneficial interests in securitizedfinancial assets. The provisions of SFAS 155 are effective for all financialinstruments acquired or issued for fiscal years beginning after September 15,2006. The Company is currently assessing the impact that the adoption of SFAS155 will have on its results of consolidated operations and financial position.

In March 2006, the FASB issued SFAS No. 156,“Accounting for Servicing of Financial Assets” (“SFAS 156”), whichamends SFAS 140, “Accounting for Transfers and Servicing of Financial Assetsand Extinguishments of Liabilities,” with respect to the accounting forseparately recognized servicing assets and servicing liabilities. SFAS 156 permits the choice of the amortization method or the fairvalue measurement method, with changes in fair value recorded in income, forthe subsequent measurement for each class of separately recognized servicingassets and servicing liabilities. The statement is effective for yearsbeginning after September 15, 2006, with earlier adoptionpermitted. The Company is currently evaluating the effect thatadopting this statement will have on the Company’s consolidatedfinancial position and results of operations.

In June 2006, the FASB issued Interpretation No. 48“Accounting for Uncertainty in Income Taxes”—an Interpretation of FASBStatement No. 109” (the “Interpretation”). The Interpretation establishesfor all entities a minimum threshold for financial statement recognition of thebenefit of tax positions, and requires certain expanded disclosures. TheInterpretation is effective for fiscal years beginning after December 31,2006, and is to be applied to all open tax years as of the date ofeffectiveness. 

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The Company is in theprocess of evaluating the impact of the application of the Interpretation toits consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157 “FairValue Measurements”, which defines fair value, establishes a framework formeasuring fair value in generally accepted accounting principles, and expandsdisclosures about fair value measurements. Adoption is required for fiscalyears beginning after November 15, 2007, and interim periods within thosefiscal years. Early adoption of SFAS No. 157 is encouraged. The Company iscurrently evaluating the expected effect of SFAS No. 157 on its consolidatedfinancial statements and is currently not yet in a position to determine sucheffects.

In September 2006, the Staff of the Securitiesand Exchange Commission issued Staff Accounting Bulletin No. 108 (“SAB 108”)which provides interpretive guidance on how the effects of the carryover orreversal of prior year misstatements should be considered in quantifying acurrent year misstatement. SAB 108 is effective for fiscal years ending onor after November 15, 2006. The adoption of SAB 108 did not  have a material impact on the Company’sconsolidated financial position, results of operations or cash flows.

In September 2006, FASB ratified EITF No. 06-1,“Accounting for Consideration Given by a Service Provider to Manufacturers orResellers of Equipment Necessary for an End-Customer to Receive Service fromthe Service Provider”(“EITF 06-1”). This guidance requiresthe application of EITF 01-9, “Accounting for Consideration Given by aVendor to a Customer”(“EITF 01-9”), when consideration is given to areseller or manufacturer for benefit to the service provider’s end customer.EITF 01-9 requires the consideration given be recorded as a liability atthe time of the sale of the equipment and, also, provides guidance for theclassification of the expense. EITF 06-1 is effective for thefirst annual reporting period beginning after June 15, 2007. The Companyhas not yet assessed the impact of EITF 06-1 on the Company’sfinancial statements.

In November 2006, the EITF reached a finalconsensus in EITF Issue 06-6 “Debtor’s Accounting for a Modification (orExchange) of Convertible Debt Instruments” (“EITF 06-6”).  EITF 06-6 addresses the modification ofa convertible debt instrument that changes the fair value of an embeddedconversion option and the subsequent recognition of interest expense for theassociated debt instrument when the modification does not result in a debtextinguishment pursuant to EITF 96-19 , “Debtor’s Accounting for aModification or Exchange of Debt Instruments.” The consensus should be appliedto modifications or exchanges of debt instruments occurring in interim orannual periods beginning after November 29, 2006. We do not expect the adoptionof EITF 06-6 to have a material impact on our consolidated financialposition, results of operations or cash flows.

In November 2006, the FASB ratified EITF Issue No. 06-7,Issuer’s Accounting for a Previously Bifurcated Conversion Option in aConvertible Debt Instrument When the Conversion Option No Longer Meets theBifurcation Criteria in FASB Statement No. 133, Accounting for DerivativeInstruments and Hedging Activities (“EITF 06-7”). At the time ofissuance, an embedded conversion option in a convertible debt instrument may berequired to be bifurcated from the debt instrument and accounted for separatelyby the issuer as a derivative under FAS 133, based on the application of EITF 00-19.Subsequent to the issuance of the convertible debt, facts may change and causethe embedded conversion option to no longer meet the conditions for separateaccounting as a derivative instrument, such as when the bifurcated instrumentmeets the conditions of Issue 00-19 to be classified in stockholders’equity. Under EITF 06-7, when an embedded conversion option previouslyaccounted for as a derivative under FAS 133 no longer meets the bifurcationcriteria under that standard, an issuer shall disclose a description of theprincipal changes causing the embedded conversion option to no longer require bifurcationunder FAS 133 and the amount of the liability for the conversion optionreclassified to stockholders’ equity. EITF 06-7 should be applied to allpreviously bifurcated conversion options in convertible debt instruments thatno longer meet the bifurcation criteria in FAS 133 in interim or annual periodsbeginning after December 15, 2006, 

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regardless of whether thedebt instrument was entered into prior or subsequent to the effective date ofEITF 06-7. Earlier application of EITF 06-7 is permitted in periodsfor which financial statements have not yet been issued. The Company iscurrently evaluating the impact of this guidance on our consolidated financialposition, results of operations or cash flows.

In December 2006, the FASB issued FASB Staff Position(“FSP”) EITF 00-19-2 “Accounting for Registration PaymentArrangements” (“FSP EITF 00-19-2”) which specifies that thecontingent obligation to make future payments or otherwise transferconsideration under a registration payment arrangement should be separatelyrecognized and measured in accordance with SFAS No. 5, “Accounting forContingencies.”    Adoption of FSP EITF 00-19-02is required for fiscal years beginning after December 15, 2006. TheCompany is currently evaluating the expected effect of FSP EITF 00-19-02on its consolidated financial statements and is currently not yet in a positionto determine such effects.

In February 2007, theFASB issued SFAS No. 159 “The Fair Value Option for Financial Assets andFinancial Liabilities—Including an amendment of FASB Statement No. 115”(“SFAS No. 159”), which permits entities to choose to measure many financialinstruments and certain other items at fair value. The fair value optionestablished by this Statement permits all entities to choose to measureeligible items at fair value at specified election dates. A business entityshall report unrealized gains and losses on items for which the fair valueoption has been elected in earnings at each subsequent reporting date. Adoptionis required for fiscal years beginning after November 15, 2007. Earlyadoption is permitted as of the beginning of a fiscal year that begins on orbefore November 15, 2007, provided the entity also elects to apply theprovisions of SFAS Statement No. 159.  The Company is currently evaluating theexpected effect of SFAS No. 159 on its consolidated financial statementsand is currently not yet in a position to determine such effects.

**4.**                 Inventory

The Company’s inventory as carried in its financialstatements is all finished goods inventory. The Company orders, purchases andreceives finished, completed, boxed and ready for sale video phone productsdirectly from its supplier. The Company makes no subsequent hardware changes tothe products. The Company does not maintain work in process inventory,component raw materials or supplies, except for very minimal quantities forrepair work. The Company does not include tooling, deferred start-up or generaland administrative costs in its inventory costs. The Company also does notmaintain specific inventory for any specific long-term contracts or programs. TheCompany tracks and removes inventory only under the “first-in, first-out method”and prices it based upon the Company’s actual cost unless adjustments arerequired for obsolescence or for market valuations. During the years ended December 31,2005 and 2006, the Company reduced inventory by $0 and $585, respectively, forsuch adjustments.

Inventoriesas of December 31, 2005 and 2006 are summarized as follows:

| ** **        | ** ** | **2005** | ** ** | **2006** | ** ** |
|-------------------|------------|----------|------------|----------|------------|
| Raw material      |       | $        | 0          |     | $          | 0 |   |
| Finished goods    |       | 2,878    |       | 1,600    |       |
| Total Inventory   |       | 2,878    |       | 1,600    |       |
| Inventory Reserve |       | 0        |       | 0        |       |
| Inventory, net    |       | $        | 2,878      |     | $          | 1,600 |   |

 

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**5.**                 Propertyand Equipment

Propertyand equipment consist of the following at December 31, 2005 and 2006:

| ** **                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|
| Computer  equipment and system packages         |       | $        | 1,079      |     | $          | 1,247 |   |
| Office equipment                                |       | 225      |       | 309      |       |
| Furniture and  fixtures                         |       | 714      |       | 655      |       |
| Hardware,  software and tooling                 |       | 1,160    |       | 1,328    |       |
| Leasehold  improvements                         |       | 906      |       | 955      |       |
|                                            |       | 4,084    |       | 4,494    |       |
| Less accumulated  depreciation and amortization |       | (2,508   | )          | (3,228   | )          |
| Property and equipment,  net                    |       | $        | 1,576      |     | $          | 1,266 |   |

 

Depreciation andamortization on property and equipment in the amount of $477, $693 and $720 wasrecorded for each of the years ended December 31, 2004, 2005 and 2006,respectively.

**6.**                 WarrantyReserve

The Company provides a warranty covering defectsarising from the sales of its video phone product. This warranty is limited toa specific time period. As of December 31, 2006, the Company has a reserveof $85 that is based on expected and historical loss rate as a percentage ofproduct sales. As of December 31, 2006, the Company has not incurred anymaterial warranty costs related to our product. Warranty costs are charged tocost of revenues when they are probable and reasonably estimable. While theCompany believes its estimate at December 31, 2006 is reasonable andadequate, it is subject to change based on our future sales and experience,which may require an increase or decrease in our reserve.

During the year ended December 31,2006, the Company reduced its warranty reserve of $336 at December 31,2005 by $251. This adjustment reflects a $224 increase to the gain recordedfrom the termination on February 17, 2006 of the Company’s agreement withGeneral Instrument, as a result of the elimination of the warranty exposure forproducts previously sold and then repurchased from General Instrument underthis termination, warranty claims of $52 in 2006 and increases of $25 foradditional warranty costs from increased product sales in 2006.

**7.**                 FinancingAgreements

During 2005, the Companyfinanced its Directors and Officers’ Insurance Policy for the policy periodended April 15, 2006. As of December 31, 2005, the remaining unpaidportion of the note payable had been paid in full. The weighted averageinterest rate on this financing was 5.99%. This expense is currently being paidas due and is no longer financed.

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**8.**                 IncomeTaxes

Thesignificant components of the net deferred tax asset at December 31, 2005and 2006 are as follows:

| ** **                                               | ** ** | **2005** | ** ** | **2006** | ** ** |
|----------------------------------------------------------|------------|----------|------------|----------|------------|
| Federal tax loss  carryforward                           |       | $        | 69,713     |     | $          | 76,098 |   |
| State tax loss  carryforward                             |       | 11,961   |       | 17,612   |       |
| Property and  equipment                                  |       | (188     | )          | 559      |       |
| Research and  experimentation credit                     |       | 3,019    |       | 3,624    |       |
| Officers’  compensation, accrued expenses and other |       | 627      |       | 834      |       |
| Inventory                                                |       | 166      |       | 608      |       |
|                                                     |       | 85,298   |       | 99,335   |       |
| Less: valuation  allowance                               |       | (85,298  | )          | (99,335  | )          |
|                                                     |       | $        | 0          |     | $          | 0 |   |

 

A valuation allowance was established against theCompany’s net deferred tax asset due to the Company’s lack of earnings history and,accordingly, the uncertainty as to the realization of the asset. A portion ofthe gross deferred asset and related valuation allowance is attributable tostock option expense. To the extent that such assets are realized in thefuture, the benefit is applied to equity.

At December 31, 2006,the Company had a net operating loss carryforward of approximately $223,819for federal tax purposes, expiring between2012 and 2026, if not utilized. The net operating loss carryforward for statetax purposes is approximately $176,300, which will expire through 2026. Thesecarryforwards may be applied as a reduction to future taxable income of theCompany, if any. The state net operating loss carryforwards are limited bystate tax law to a maximum utilization of $2,000 per year. The Company also hasfederal research and experimentation credit carryforwards of approximately$3,624. All state research and experimentation credits totaling $23 wererefunded during 2006 and no carryovers remain. The federal research and experimentationcredit carryforwards expire between 2012 and 2026. The Company’s ability toutilize its net operating loss carryforwards and credit carryforwards may besubject to annual limitations as a result of prior or future changes inownership and tax law as defined under Section 382 of the Internal RevenueCode of 1986. Such limitations are based on the market value of the Company atthe time of ownership change multiplied by the long-term exempt rate suppliedby the Internal Revenue Service.

**9.**                  Secured Convertible Debentures

On August 11, 2006 the Company completed aprivate placement with an institutional investor of  convertible debentures in the aggregateprincipal amount of up to $11,000 (for more details, refer to Note 3). Theseconvertible debentures have a maturity of three years, an interest rate of 6%per annum, and are convertible at the option of the investors into WorldGatecommon stock at a conversion price equal to the lesser of $1.75 per share or90% of the average of the five lowest daily volume weighted average closingprices (“VWAP”) of the common stock during the fifteen trading days immediatelypreceding the conversion date (subject to adjustment in the event of stockdividends and splits and certain distributions to stockholders, fundamentaltransactions, and future dilutive equity transactions).  Interest is payable at maturity, and may bepaid in cash or shares of the Company’s common stock.

The convertible debentures provide that we have theright to redeem all or any portion of the principal amount of the debentures incash at any time upon not less than four business days notice if the closingprice of our stock is less than $1.75 per share. Such early redemption will,however, require us to pay a 10% prepayment premium. In addition, without anyprepayment premium, we have the right to force the holder to convert a maximumof $500,000 of the aggregate principal amount of the debentures in any 

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thirty day period if forfive consecutive trading days the VWAP of our common stock is above $1.925 pershare but less then $3.50 per share and providing the daily trading volumeexceeds 200,000 shares for these five days, and certain other conditions aremet. If the VWAP of our common stock is greater than $3.50 per share for 30consecutive trading days, the daily trading volume exceeds 250,000 shares forfive days prior, and if certain other conditions are met, we can also force theholder to convert all or any portion of the outstanding principal and interestinto shares of our common stock without any prepayment premium.

The Company received $6,000 upon the closing of thetransaction ($5,615, net of transaction costs) and the remaining $5,000($4,700, net of transaction costs) was received on October 13, 2006 afterreceiving stockholder approval on October 11, 2006 and obtaining aneffective registration of the shares of common stock issued and issuable uponconversion of the convertible debentures in the first tranche of thistransaction.

As part of this private placement, the Company issuedfive-year warrants to purchase a total of up to 2,595,000 shares of WorldGatecommon stock, with 1,145,000 of the warrants having an exercise price of $1.85per share (with 624,545 of these warrants issued at the initial closing and520,455 warrants issued at the closing of the second tranche of funding),1,100,000 of the shares having an exercise price of $2.35 per share (with600,000 of these warrants issued at the initial closing and 500,000 warrantsissued at the closing of the second tranche of funding), and 350,000 warrantshaving an exercise price of $2.60 per share (with 190,909 of these warrantsissued at the initial closing and 159,091 warrants issued at the closing of thesecond tranche of funding on October 13, 2006).

Pursuant to a registration rights agreement associatedwith this transaction at least 27,227,581 shares of common stock are requiredto be registered, of which 7,975,752 shares of common stock have already beenregistered and 19,251,828 shares of common stock remain to be registered.  Pursuant to a waiver granted by the purchaserof these shares in November 2006, the Company has been given until theearlier of 45 days from the date the Company files with the SEC its annualreport on Form 10-K for the fiscal year ended December 31,2006, or May 15, 2007, to file a registration statement for these shares. Furthermoresuch waiver requires that any failure to file this registration statement or tocause it to be declared effective will not result in any damages becoming duethereunder, liquated or otherwise.

Upon any liquidation, dissolution or winding up of ourCompany, the holder of the convertible debenture will be entitled to receivethe principal amount of the convertible debenture, together with accrued andunpaid interest, prior to any payment to the holders of our common andpreferred stock.

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

The market price of the Company’s common stock cannotbe predicted.  Furthermore, subject tothe share limitation, as discussed above, the actual number of shares of theCompany’s common stock that will be required if a conversion of the convertibledebenture is made through the issuance of common stock also cannot bepredicted. Should the Company’s requirements to issue shares under theseconvertible debenture agreements exceed the share limitation, or if it is notlisted or quoted for trading on at least the NASDAQ OTC Bulletin Board, theCompany may be required to settle the conversion of the convertible debentureswith cash instead of its common stock.

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The Company accounts for conversion options embeddedin convertible notes in accordance with SFAS No. 133, and EITF 00-19.SFAS 133 generally requires companies to bifurcate conversion options embeddedin convertible notes from their host instruments and to account for them asfree standing derivative financial instruments in accordance with EITF 00-19. EITF 00-19 states that if theconversion option requires net cash settlement in the event of circumstancesthat are not solely within the Company’s control that they should be classifiedas a liability measured at fair value on the balance sheet.

Upon the issuance date there was an insufficient numberof authorized shares of Common Stock in order to permit exercise of all of thewarrants issued on August 11, 2006.  In accordance with EITF 00-19, whenthere are insufficient authorized shares, the obligation for the exercise ofinvestor warrants should be classified as liability measured at fair value onthe balance sheet.  Accordingly, at August 11,2006, in connection with the $6,000 tranche, the convertible feature of theconvertible debenture and the warrants were recorded as derivative liabilitiesof $4,446 and $1,269, respectively. On October 11, 2006 the Companyreceived shareholder approval to increase the authorized shares from 80,000,000to 120,000,000. Upon re-valuation at October 11, 2006, the value of thewarrants at October 11, 2006, was reclassified to equity at fair value inaccordance with the provisions of EITF 00-19.

At October 13, 2006, in connection with the$5,000 tranche, the convertible feature of the convertible debenture wasrecorded as a derivative liability of $3,449 and the warrants were recorded asadditional paid in capital of $230.

The Company accounts for the conversion option usingthe fair value method at the end of each quarter, with the resultant gain orloss recognition recorded against earnings. The conversion options are valuedusing the Black-Scholes valuation model, applying actual period close commonstock price ($1.34), applicable volatility rate (98.9%), and the period closerisk-free interest rates (4.74%) for the instrument’s remaining contractuallife (2.61 years).

At the initial recording of the August 11, 2006tranche, the sum of the fair values of the convertible feature and thewarrants, $5,714 in the aggregate, exceeded the net proceeds of $5,615.  The difference of $99 was charged to thechange in fair value of derivative warrants of conversion options, uponissuance.   Accordingly, the Companyrecorded a discount equal to the face value of the convertible debenture, whichwill be amortized using the effective interest rate method over the three yearterm. The common stock issued as fees in the transaction was recorded at a netvalue of $0, as there was no residual value remaining.

For the $5,000 tranche issued on October 13,2006, the Company recorded a discount of $3,979, which will be amortized using theeffective interest method over the three year term.

During the year ended December 31, 2006, $1,350in face value of the convertible debentures were converted, resulting in theissuance of 1,146,279 shares of common stock. As a result of the conversion,$1,350 of the discount on the convertible debenture has been charged todiscount amortization.

For the year ended December 31, 2006, the companyhas recorded total discount amortization of $1,354 and mark-to-marketadjustments of the conversion feature derivative liability and the warrantsderivative liability resulted in a loss of $133 and a loss of $253,respectively.

At December 31, 2006,the balances of the convertible debentures and the offsetting related discountwere $9,650 and $8,625, respectively.

**10.**          Stockholders’Equity

*Preferred Stock*

The Company has theauthority to issue from time to time up to an aggregate of 13,500,000 shares ofpreferred stock in one or more classes or series and to determine thedesignation and the number of shares of any class or series as well as thevoting rights, preferences, limitations and special rights, if any, of the 

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sharesof any class or series. The issuance of preferred stock may have the effect ofdelaying, deferring or preventing a change of control of the Company. At December 31,2005 and 2006 there were 500 and 166, respectively, shares of redeemablepreferred stock outstanding.

*RedeemablePreferred Stock*

In June 2004, WorldGate completed a privateplacement of preferred stock. The preferred stock has a dividend rate of 5% perannum, payable quarterly, either by cash or through the issuance of commonstock at the Company’s option. The preferred stock has a staged maturity overthree years with scheduled payments of one third due after 18 months, one halfof the remainder due after 24 months and the balance due after 36 months, andmay be redeemed at maturity in cash or, at the Company’s option, subject tocertain conditions that may not be solely under the control of the Company,through the issuance of the number of shares of common stock determined bydividing the liquidation preference of the preferred shares by the then averagemarket price over the ten consecutive trading days prior to the date ofconversion. If the effectiveness of the registration statement lapses, theCompany ceases to be listed on certain specified exchanges and trading in theCompany’s stock is suspended or a change in control occurs with respect to theCompany, the Company may be required to settle redemption of the preferredstock with cash instead of its common shares. Furthermore, since the marketprice of the Company’s common stock cannot be predicted, the actual number ofshares of the Company’s common stock that will be required if a redemption ismade through the issuance of common stock also cannot be predicted. The privateplacement includes numerous provisions intended to protect these institutionalinvestors including a cash payment penalty of 1.0% per month for unredeemedpreferred shares once registration of the shares lapse and until theregistration again becomes effective.

The preferred stock has embedded conversion options.Specifically, the holders of the preferred stock may convert their shares intothe Company’s common stock at a conversion price of $2.35 per share. Inaddition the Company may force conversion of the preferred stock into commonstock if the Company achieves certain price targets for its common stock andsatisfaction of certain other conditions, such as the existence of an effectiveregistration statement. In either event the conversion price is subject toadjustment if, at any time after the date the preferred shares were issued, theCompany issues or sells, or is deemed to have issued or sold, any shares of theCompany’s common stock for per share consideration less than the conversionprice of the preferred shares on the date of such issuance or sale. Accordingly,the number of common shares issuable upon the conversion of the preferredshares cannot be predicted. Furthermore, net-cash settlement may be required inthe event of conversion default under certain circumstances that may not besolely under the control of the Company. If the effectiveness of theregistration statement lapses, the Company ceases to be listed on certainspecified exchanges and trading in the Company’s stock is suspended or a changein control occurs with respect to the Company, the Company may be required tosettle a conversion of the preferred stock with cash instead of its commonshares.

Also, as part of the private placement the Companyissued five-year warrants to purchase up to 803,190 shares of our common stockat an exercise price of $2.69 per share and five-year warrants to purchase upto 803,190 shares of our common stock at an exercise price of $3.14 per share.The investors also received an additional investment right, for a limitedperiod of time, to purchase 1,606,383 additional shares of common stock sharesat $3.14 a share. This exercise price of the warrants is subject to adjustmentif, at any time after the date the warrants were issued, the Company issues orsells, or is deemed to have issued or sold, any shares of the Company’s commonstock for per share consideration less than the exercise price of the warrantson the date of such issuance or sale. Accordingly, the number of common sharesthat will be issued upon the exercise of the warrants cannot be predicted. Asof September 30, 2006, 125,000 warrants exercisable at $2.69 had beenexercised and 51,915 warrants exercisable at $3.14 had been exercised. All of theadditional investment rights had been exercised as of June 30, 2006. Basedon anti-

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dilution provisionscontained within this private placement the $2.69 warrants were modified to$2.35 as of December 31, 2006 and the number of outstanding warrants were increasedby 98,164 related to the issuance of convertible debentures and warrants in August 2006and October 2006 and as a result of the conversion price related to theseissuances. Based on anti-dilution provisions contained within this privateplacement the $3.14 warrants were also modified to an exercise price of $2.70as of December 31, 2006 and the number of outstanding warrants wereincreased by 120,307 related to the issuance of convertible debentures andwarrants in August 2006 and October 2006 and as a result of theconversion price related to these issuances.

Of the 7,550 preferred shares issued under thisprivate placement, 7,384 shares have been redeemed as of December 31,2006.

With respect to the Company’s accounting for thepreferred stock, EITF Topic D-98, paragraph 4, states that Rule 5-02.28of Regulation S-X requires securities with redemption features that are notsolely within the control of the issuer to be recorded outside of permanentequity. As described above, the terms of the preferred stock include certainredemption features that may be triggered by events that are not solely withinthe control of the Company, such as a potential failure in the Company’sability to maintain an effective registration statement. Furthermore, the actualnumber of shares of common stock required to satisfy redemption is based uponthe market value of the common stock at the time of the redemption, whichcannot be predicted. Accordingly, the Company has classified the preferredstock as temporary equity and the value ascribed to the redeemable preferredstock upon initial issuance, i.e. at June 24, 2004, was the amountreceived in the transaction minus the fair value ascribed to the conversionoptions and warrants. The initial value of the redeemable preferred stock isaccreted up to the redemption value (the amount received in the transaction)over the future relevant periods using the interest method. The value of theredeemable preferred stock at December 31, 2006 was $141.

The terms of the preferred stock include certainconversion options that represent derivative financial instruments underparagraph 12 of SFAS No. 133 and thus were separated from the preferredstock and valued using the Black-Scholes option 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 states that if theconversion options require net cash settlement in the event of circumstancesthat are not solely within the Company’s control they should be classified as aliability measured at fair value on the balance sheet.

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

The Company accounts for both the conversion optionsand warrants using the fair value method at the end of each quarter, with theresultant gain or loss recognition recorded against earnings. Both the warrantsand conversion options are valued using the Black-Scholes valuation model. At December 31,2005 and 2006, the closing common stock price was $2.06 and $1.34,respectively, applicable volatility rates were 57% and 99%, respectively, andthe period close risk-free interest rates as of December 31, 2005 werebetween 3.8% and 4.2% for the instrument’s contractual remaining lives of 1.5,0.5 and 0.8 years for the conversion option and 3.5 years for the warrants,respectively, (continuously compounded), and as of December 31, 2006interest rates were 4.70% and 4.78%  forthe instrument’s contractual remaining life of 

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between 0.5 and 2.5 years(continuously compounded), are the key assumptions used in the valuationcalculation. The result was a $10,091 non cash charge for the year ended December 31,2004, an $8,594 non cash gain for the year ended December 31, 2005, and anon cash charge of $50 for the year ended December 31, 2006.

After the mark to marketadjustments, the balances of the conversion features derivative liability andthe warrants derivative liability were $57 and $1,038, respectively, at December 31,2005, and $11 and $997, respectively, at December 31, 2006.

*Warrants*

In August 2000, the Company issued warrants tothe TVGateway partners as part of the TVGateway Joint Venture. These warrantsmay be exercised to purchase in the aggregate up to 1,500,000 shares of commonstock at an exercise price of $24.78 and up to 500,000 additional shares ofcommon stock at an exercise price of $12.39. The warrants were subject tovesting at varying rates based on the deployment of the Company’s discontinuedInternet TV service on each operator’s digital cable systems. On September 30,2003, 1,000,000 warrants were cancelled. At December 31, 2006, none of theremaining warrants have vested. These warrants expire on July 24, 2007.

In November 2000, we entered into a deploymentagreement with AT&T Broadband to deploy the Company’s interactive servicesto AT&T digital customers in Cedar Falls and Waterloo, Iowa and Tacoma,Washington. As part of this agreement, the Company issued warrants to AT&Tto purchase up to 1,000,000 shares of the Company’s common stock at a per shareexercise price of $16.02. The warrants are subject to vesting at varying ratesbased on the deployment of the Company’s Internet TV service on AT&T’sdigital cable systems. At December 31, 2006, none of the warrants havevested. These warrants expire on November 12, 2007.In connection with the December 2003and January 2004 private placements, we issued 1,020,000 warrants and10,000 additional investment rights to purchase shares of common stock. For theDecember 2003 transactions the warrants had an exercise price of $1.00 pershare and the additional investment rights were priced at $0.80 per share. Forthe January 2004 transaction the warrants had an exercise price of $1.875per share and the addition investment rights were priced at $1.50 per share. Inaddition, if the selling security holders exercise their additional investmentrights, we will be obligated to issue additional warrants to purchase ourcommon stock at an exercise price of $1.00 per share and $1.875 per share,respectively, for the December 2003 and the January 2004transactions. Included with general and administrative expenses in 2003 and2004 were $117 and $608, respectively, of expenses relating to the valuation ofwarrants and options issued in 2003 and 2004 for investment advice andservices. These valuations were determined by using the Black-Scholes fairvalue option valuation model. The following assumptions were used for thewarrants: expected volatility of 100% for 2003 and 65% for 2004; averagerisk-free interest rates of 1.0% for 2003 and 3.20% for 2004; dividend yieldsof 0% and 0%; and expected lives of up to 5.0 years for both valuations

In connection with the Development and DistributionAgreement with General Instrument, the Company issued warrants in April andSeptember 2004 to General Instrument to purchase 600,000 shares of ourcommon stock, 300,000 at an exercise price of $1.4375 per share with theexecution of the agreement in April 2004, and 300,000 at an exercise priceof $1.75 upon the delivery to General Instrument of acceptable prototypes forthe product. Included in General and Administrative expenses in September 2004were $606 of expenses relating to the valuation of these warrants. Thisvaluation was determined by using the Black-Scholes fair value option model.The following assumptions were used: expected volatility of 65%; averagerisk-free interest rate of 3.43 percent; dividend yield of 0%; and an expectedlife of 5.0 years.

In connection with the June 2004 privateplacement  the Company issued five-year warrants to purchase up to 803,190shares of our common stock at an exercise price of $2.69 per share andfive-year 

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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. This exercise price of the warrants is subject to adjustment if, at anytime after the date the warrants were issued, the Company issues or sells, oris deemed to have issued or sold, any shares of the Company’s common stock forper share consideration less than the exercise price of the warrants on thedate of such issuance or sale. Accordingly, the number of common shares thatwill be issued upon the exercise of the warrants cannot be predicted. As of December 31,2006, 125,000 warrants exercisable at $2.69 had been exercised and 51,915warrants exercisable at $3.14 had been exercised. All of the additionalinvestment rights had been exercised as of December 31, 2006. Based onanti-dilution provisions contained within this private placement the $2.69warrants were modified to an exercise price of $2.35 as of December 31,2006 and the number of outstanding warrants were increased by 98,164 related tothe issuance of convertible debentures and warrants in August 2006 and October 2006and as a result of the conversion price related to these issuances. Based onanti-dilution provisions contained within this private placement the $3.14warrants were also modified to an exercise price of $2.70 as of December 31,2006 and the number of outstanding warrants were increased by 120,307 relatedto the issuance of convertible debentures and warrants in August 2006 and October 2006and as a result of the conversion price related to these issuances.

In December 2004, WorldGate completed a privateplacement of 208,333 shares of our common stock to K. Y. Chou, President andGeneral Manager of Mototech at a sales price of $2.40 per shares, whichresulted in additional gross proceeds to the Company of $500. In connectionwith this placement the Company granted warrants to Mr. Chou to purchaseup to 62,500 shares of our common stock at an exercise price of $2.88 pershare.

In August 2005, the Company completed a privateplacement for $17,500 of its common stock and warrants with severalinstitutional investors. The Company issued 4,666,664 shares of its commonstock at $3.75 per share to the participating investors. The Company alsoissued five-year warrants to purchase a total of 1,671,947 shares of its commonstock: 1,633,333 shares to the investors at an exercise price of $5.00 pershare, and 38,614 shares to the placement agent at an exercise price of $4.53per share. The investors also received an additional investment right, fora period of 60 days from the time the shares become registered, to purchase1,554,000 additional shares of common stock at $4.12 per share. The accountingfor these warrants and investment rights is established by analogy to APB No. 14“Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants,”which addresses detachable stock purchase warrants issued in conjunction withconvertible debt and prescribes that such warrants be accounted for asadditional paid in capital measured at fair value. The private placementincludes numerous provisions intended to protect these institutional investorsincluding a cash payment penalty of 1.5% per month for the period above 120days from the effective date of the agreement that the shares in thetransaction fail to be registered. The Registration Statement covering theshares under this private placement was not declared effective until June 1,2006. Until such time as the shares were registered the Company was subject tothe penalty provision under this private placement. For the years ended December 31,2005 and 2006 the Company recorded and expensed related penalties of $535 and$1,114, respectively. The related unpaid penalties accrued as of December 31,2005 and December 31, 2006 was $535 and $157, respectively.  On July 25, 2006, the Company amended theterms of the additional investment right that was granted to an investor aspart of the August 2005 private placement, with respect to a portion ofshares of common stock purchasable thereunder and agreed to apply $158 ofaccrued penalties towards the exercise price of such amended additionalinvestment right, for the purchase of 129,950 shares of common stock. Thepenalties had accrued with respect to the Company’s inability to register theshares acquired by such investor in the private placement within 120 days ofthe transaction. In consideration for this amendment and application of theexercise proceeds the investor agreed to forego any cash payment of thepenalties other than as available through the proceeds of the exercise of theamended investment right and to grant to the Company a release of all claimsrelating to the late registration of the private placement shares, 

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other than the aforesaidpenalties. The amended additional investment right provides that the investorthereof may purchase the 129,950 shares of common stock for a period of 760days beginning June 1, 2006 for an exercise price of $1.515 per share. Theterms of the additional investment rights with respect to the remaining1,424,050 shares of common stock purchasable thereunder remain unchanged. On July 26,2006 this investor exercised the additional investment right for129,950 shares. On July 31, 2006 the amended additional investmentright with respect to the remaining 1,424,050 shares of common stock expired. OnDecember 12, 2006 the Company amended the terms of the warrants that weregranted to an investor as part of the August 2005 private placement, withrespect to a portion of shares of common stock purchasable thereunder andagreed to apply $315 of accrued penalties towards the exercise price of suchamended warrants, for the purchase of 279,255 shares of common stock. Inaddition, the exercise price of 47,412 of the warrants was changed to $1.41 pershare. The penalties had accrued with respect to the Company’s inability toregister the shares acquired by such investor in the private placement within120 days of the transaction. In consideration for this amendment andapplication of the exercise proceeds the investor agreed to forego any cashpayment of the penalties other than as available through the proceeds of theexercise of the amended warrant and to grant to the Company a release of allclaims relating to the late registration of the private placement shares, otherthan the aforesaid penalties. The amended warrants provide that the investorthereof may purchase the 326,667 shares of common stock for a period of 1,330days beginning December 12, 2006 for an exercise price of $1.41 per share.The terms of the warrants with respect to the remaining shares of common stockpurchasable thereunder remain unchanged. On December 19, 2006 thisinvestor exercised the warrants for the purchase of 279,255 shares.

On August 11, 2006 the Company completed aprivate placement with an institutional investor of a convertible debenture inthe aggregate principal amount of up to $11,000. As part of this privateplacement the Company issued five-year warrants to purchase a total of up to2,595,000 shares of WorldGate common stock, with 1,145,000 of the warrantshaving an exercise price of $1.85 per share (with 624,545 of these warrantsissued at the initial closing and 520,455 warrants issued at the closing of thesecond tranche of funding), 1,100,000 of the shares having an exercise price of$2.35 per share (with 600,000 of these warrants issued at the initial closingand 500,000 warrants issued at the closing of the second tranche of funding),and 350,000 warrants having an exercise price of $2.60 per share (with 190,909of these warrants issued at the initial closing and 159,091 warrants issued atthe closing of the second tranche of funding on October 13, 2006).

As of December 31,2005 and 2006, respectively, there were a total of 6,297,195 and 7,277,378warrants outstanding.

*Stock Option Plan*

In December 1996, the Company adopted the 1996Stock Option Plan (“1996 Plan”). This plan provides for the granting of stockoptions to officers, directors, employees and consultants. Grants under thisplan may consist of options intended to qualify as incentive stock options (“ISOs”),or nonqualified stock options that are not intended to so qualify (“NQSOs”).The option price of any ISO will not be less than the fair market value on thedate the option is granted (110% of fair value in certain instances). Theoption price of NQSOs may be greater than, equal to, or less than the fairmarket value on the date the option is granted. The 1996 Plan originallyauthorized a maximum of 933,333 shares of common stock.

In May 1999 and May 2000, the Boardincreased the total number of shares of common stock available under the 1996Plan to 1,600,000 and 3,200,000 shares, respectively. In October 2000, theCompany’s stockholders approved these increases. In February 2001, theBoard approved an automatic annual increase of shares reserved under the 1996Plan in an amount equal to the lesser of 4% of the then outstanding shares ofthe Company’s common stock or 1,000,000 shares. In October 2001, theCompany’s stockholders approved this increase.

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In October 2004, the Company’s stockholdersapproved the 2003 Equity Incentive Plan (“2003 Plan”). This plan is intended toreplace the 1996 Plan for new grants. No additional shares were reserved forthe new plan but rather all available shares under the 1996 Plan were madeavailable for the new plan. As with the 1996 Plan, the 2003 Plan includes thesame automatic annual increase in the number of shares reserved for use withthe plan equal to the lesser of 4% of the then outstanding shares of the Company’scommon stock or 1,000,000 shares. In addition to ISOs and NQSOs, the new planalso provides for performance based awards and restricted stock.

Both the 1996 Plan and its successor, the 2003 Planare administered by a committee of the Board of Directors. The committeedetermines the term of each award, provided, however, that the exercise periodmay not exceed ten years from the date of grant, and for ISOs, in certaininstances, may not exceed five years. The options granted under this plan vestratably over a four-year period from the date of grant. As of December 31,2006 there were 2,091,682 shares available to grant under the Plan and4,913,689 options outstanding.

The weighted-average fair values of the optionsgranted were $1.16, $1.56 and $1.15 per option during the years ended December 31,2004, 2005 and 2006, respectively. The fair value of each option grant isestimated on the date of grant using the Black-Scholes fair value optionvaluation model. The following weighted-average assumptions were used forgrants in 2004, 2005 and 2006, respectively: expected volatility of 90%, 58%and 91.7%; average risk-free interest rates of 2.97%, 4.23% and 4.62%; dividendyield of 0%; and expected lives of 4.0, 4.0 and 6.2 years.

Asummary of the Company’s stock plan is presented below:

| ** **                           | ** ** | **Stock Options** | ** ** | **Weighted-  Average  Exercise Price** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|--------------------------------------|------------|------------------------|------------|---------------------------------------------|------------|---------------------------------|------------|
| Outstanding, January 1,  2005   |       |                   | 4,536,677  |                                        |       |                            | $          | 1.87 |   |   |   |   |
| Granted                              |       |                   | 494,292    |                                        |       |                            | $          | 3.21 |   |   |   |   |
| Exercised                            |       |                   | (373,352   | )                                           |       |                            | $          | 2.20 |   |   |   |   |
| Cancelled/forfeited                  |       |                   | (176,602   | )                                           |       |                            | $          | 4.55 |   |   |   |   |
| Outstanding,  December 31, 2005 |       |                   | 4,481,015  |                                        |       |                            | $          | 1.94 |   |   |   |   |
| Granted                              |       |                   | 529,523    |                                        |       |                            | $          | 1.53 |   |   |   |   |
| Exercised                            |       |                   | (56,857    | )                                           |       |                            | $          | 0.93 |   |   |   |   |
| Cancelled/forfeited                  |       |                   | (39,992    | )                                           |       |                            | $          | 3.08 |   |   |   |   |
| Outstanding,  December 31, 2006 |       |                   | 4,913,689  |                                        |       |                            | $          | 1.90 |   |   | $ | 1,540,132 |   |
| Exercisable,  December 31, 2006 |       |                   | 3,131,487  |                                        |       |                            | $          | 1.96 |   |   | $ | 1,120,268 |   |

 

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Thefollowing table summarizes information about stock options outstanding at December 31,2006:

| ** **                                  | ** ** | **Stock Options Outstanding** | ** ** | **Stock Options Exercisable** | ** ** |
|---------------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| **Range of Exercise Prices** | ** ** | ** **                              | ** ** | **Shares**                              | ** ** | **Weighted-  Average  Remaining  Contractual  Life (Years)** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
| $0.00 - $0.39                               |       | 297,113                                 |       |                                    | 6.17       |   |   |   | $ | 0.37 |   |   | 217,986 |   |   | $ | 0.37 |   |   |
| $0.40 - $0.59                               |       | 1,081,000                               |       |                                    | 6.75       |   |   |   | 0.52 |   |   | 798,875 |   |   | 0.52 |   |   |
| $0.60 - $0.89                               |       | 199,492                                 |       |                                    | 6.70       |   |   |   | 0.59 |   |   | 191,992 |   |   | 0.59 |   |   |
| $0.90 - $1.34                               |       | 779,250                                 |       |                                    | 6.97       |   |   |   | 1.06 |   |   | 399,250 |   |   | 1.07 |   |   |
| $1.35 - $2.01                               |       | 850,189                                 |       |                                    | 7.51       |   |   |   | 1.59 |   |   | 379,211 |   |   | 1.72 |   |   |
| $2.02 - $3.02                               |       | 1,092,998                               |       |                                    | 6.18       |   |   |   | 2.56 |   |   | 791,901 |   |   | 2.58 |   |   |
| $3.03 - $4.53                               |       | 426,012                                 |       |                                    | 7.42       |   |   |   | 4.23 |   |   | 203,937 |   |   | 4.32 |   |   |
| $4.54 - $6.80                               |       | 112,533                                 |       |                                    | 5.97       |   |   |   | 5.90 |   |   | 73,233 |   |   | 6.17 |   |   |
| $6.81 - $10.20                              |       | 40,000                                  |       |                                    | 4.13       |   |   |   | 8.25 |   |   | 40,000 |   |   | 8.25 |   |   |
| $10.21 - $15.30                             |       | 0                                       |       |                                    | 0          |   |   |   | 0 |   |   | 0 |   |   | 0 |   |   |
| $15.31 - $22.95                             |       | 31,046                                  |       |                                    | 3.10       |   |   |   | 20.44 |   |   | 31,046 |   |   | 20.44 |   |   |
| $22.96 - $34.43                             |       | 4,056                                   |       |                                    | 3.51       |   |   |   | 28.60 |   |   | 4,056 |   |   | 28.60 |   |   |
|                                        |       | 4,913,689                               |       |                                    | 6.75       |   |   |   | $ | 1.90 |   |   | 3,131,487 |   |   | $ | 1.96 |   |   |
|                                             |            |                                         |            |                                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Cash received from option exercises for fiscal years2004, 2005 and 2006 was $813, $818 and $12, respectively. The Company did notrealize an actual tax benefit for the tax deductions from exercises duringthese years.

Thetotal fair value of the shares vested during the years ended December 31,2004, 2005 and 2006 was $2,072, $833 and $827, respectively. The intrinsicvalue of the options exercised during the years ended December 31, 2004,2005 and 2006 was $515, $846 and $27, respectively

Thefollowing table is the summary of the Company’s non-vested shares as of December 31,2006 and changes during the year then ended:

| ** **                               | ** ** | ** **      | ** ** | **Weighted** | ** ** |
|------------------------------------------|------------|-----------------|------------|--------------|------------|
| ** **                               | ** ** | ** **      | ** ** | **Average**  | ** ** |
| ** **                               | ** ** | **Options**     | ** ** | **Exercise** | ** ** |
| ** **                               | ** ** | **Outstanding** | ** ** | **Price**    | ** ** |
| Non-vested as of  January 1, 2006   |       |            | 2,185,210  |         |       |   | $ | 1.73 |   |   |
| Granted                                  |       |            | 529,523    |         |       |   | $ | 1.53 |   |   |
| Forfeited                                |       |            | 19,689     |         |       |   | $ | 2.74 |   |   |
| Vested                                   |       |            | 912,842    |         |       |   | $ | 1.50 |   |   |
| Non-vested as of  December 31, 2006 |       |            | 1,782,202  |         |       |   | $ | 1.78 |   |   |

 

*Employee StockPurchase Plan*

In October 2001, our stockholders approved theWorldGate 2001 Employee Stock Purchase Plan that provides eligible participantswith the opportunity to periodically acquire shares of our common stock throughpayroll deductions. Eligible participants may contribute up to fifteen percentof their compensation towards the purchase of our common stock. At the end ofeach calendar quarter, the contributions of the participants are used topurchase shares of the Company’s common stock at the lower of eighty-fivepercent of the market price of our common stock: (i) at the beginning ofeach calendar quarter or (ii) at the end of each calendar quarter. Amaximum of 750,000 shares of the Company’s 

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common stock (plus anannual increase of 375,000 shares) may be purchased in the aggregate byparticipants in the Stock Purchase Plan.

During 2005 and 2006, theCompany sold 16,639 and 18,040 shares of common stock under the Stock PurchasePlan for proceeds of $35 and $27, respectively.

**11.   Commitmentsand Contingencies**

*Leases*

The Company’s current five year lease was signed on September 1,2005 and covers 42,500 square feet at an annual rate of $11.40 per square footwith a 3% increase annually, cancelable by either party with eight months notice,with a termination by tenant also including six months termination fee. Totalrent expense for the years ended December 31, 2004, 2005 and 2006 amountedto approximately $1,027, $218 and $642, respectively.

In November 2003, theCompany entered into a 60 month lease for office equipment. As of December 31,2006, there remains a total of $11 to be paid over the remaining period of thislease. In October 2005, the Company entered into a 36 month lease foroffice equipment. As of December 31, 2006 there remains a total of $13 tobe paid over the remaining period of this lease.

*Disclosure ofContractual Obligations*

Thefuture minimum contractual rental commitments under non-cancelable leases foreach of the fiscal years ending December 31 are as follows:

| ** ** | ** ** | **(Dollars in  Thousands)** | ** ** |
|------------|------------|----------------------------------|------------|
| 2007       |       |                             | $          | 517 |   |   |
| 2008       |       |                             | 530        |   |   |
| 2009       |       |                             | 535        |   |   |
| 2010       |       |                             | 363        |   |   |
| Total      |       |                             | $          | 1,945 |   |   |

 

*Legal Proceedings*

Although from time to timethe Company may be involved in litigation as a routine matter in conducting itsbusiness, the Company is not currently involved in any litigation which itbelieves is material to its operations or balance sheet. The Company complieswith the requirements of currently prevailing accounting standards and providefor accruals where a liability is probable and a reasonable estimate can bemade as to the probable amount of such liability. In 2006, the Company settledcertain legal claims that resulted in expenditures of $345.

**12.   SignificantAgreements and Transactions**

On April 28, 2004, the Company entered into asix-year distribution agreement with General Instrument for the marketing anddistribution of the Ojo video phone. This agreement provided for GeneralInstrument to be WorldGate’s exclusive distributor of its broadband video phoneproducts and for WorldGate to be General Instrument’s exclusive supplier of itsbroadband video phone products. After a period of eighteen months following thecommercial availability of the Ojo video phone, this mutual exclusivity wouldterminate unless General Instrument elected to continue the mutual exclusivityafter having achieved certain minimum sales targets for the Ojo video phone.General Instrument could have, however, at its option, elected to terminatethis mutual exclusivity at any time. In the event mutual exclusivity terminatesor is terminated, then for a twelve month period thereafter, WorldGate was to 

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continue to be GeneralInstrument’s exclusive supplier of broadband video phones, but would be free tosell video phone products to customers other than certain defined GeneralInstrument accounts. During this twelve month period, General Instrument had aright of first refusal to accept and fill any orders for video phone products thatWorldGate obtained from non-General Instrument accounts, and was obligated touse good faith efforts to solicit and accept product orders from GeneralInstrument accounts in a commercially reasonable manner. During any period ofexclusivity under this agreement the Company was reliant upon GeneralInstrument and its distribution partners, including, for example, wholesalers,retailers and service providers, to provide the worldwide sales anddistribution of the Ojo video phone. Although the agreement required GeneralInstrument to provide for certain marketing and promotional activities for theOjo video phone, there were no required sales quotas for the agreement toremain in effect, and General Instrument controlled the volume of productsbeing distributed by our Company. Neither party was permitted to terminate theagreement except in cases of uncured breaches of the agreement or as a resultof insolvency events suffered by the other party. If General Instrument and itspartners were not successful, or if their activities did not lead tosignificant sales of our product, our operating results could have beenadversely affected, our revenue could be significantly reduced and the Companycould lose potential customers. In connection with the Development andDistribution Agreement with General Instrument, the Company issued warrants toGeneral Instrument to purchase 600,000 shares of our common stock, 300,000 atan exercise price of $1.4375 per share with the execution of the agreement in April 2004,and 300,000 at an exercise price of $1.75 upon the delivery to GeneralInstrument of acceptable prototypes for the product. Additionally, the Companyagreed to issue warrants to purchase up to an additional 1,650,000 shares ofour common stock, upon the achievement of certain sales milestones, at anexercise price based upon the average closing sales price of our common stockduring the 20 day period preceding the issuance of each warrant.

On February 17, 2006, the Company mutually agreedwith General Instrument to end their mutually exclusive distribution agreement.The ending of this agreement immediately terminated this exclusivity for bothparties, and accordingly enabled WorldGate to expand its focus in bringing Ojoto the marketplace. In addition to its current role for development andmanufacture of Ojo, WorldGate became directly responsible for the advertising,marketing, and distribution of its products.

Based upon our actual experience to date, the Companydoes not believe it is necessary to establish a reserve for retailer returns toGeneral Instrument. In the Company’s discussions with the retailers eligiblefor such returns, the retailers have indicated their intention to continue tosell the Company’s video phone products and, to date the Company has receivedminimal returned products.

As part of ending the development and distributionagreement, General Instrument has agreed to certain restrictions on itsdevelopment of a stand-alone video phone product which has as a primaryfunction the making or receipt of video phone calls over a broadband network. Suchrestrictions ended in January 2007.

Net revenues recognized from General Instrument, aninvestor, were approximately $231, $1,596 and $0, respectively, for the yearsended December 31, 2004, 2005 and 2006. This investor accounted forapproximately 100% of the revenues for the years ended December 31, 2004and 2005. Accounts receivable from this investor was $123 and $0 as of December 31,2005 and December 31, 2006, respectively. In April and September 2004,the Company issued warrants to this investor to purchase shares of our commonstock, with the April warrants having an exercise price of $1.4375 pershare and the September warrants having an exercise price of $1.75 pershare. Included in General and Administrative expenses in September 2004were $606 of expenses relating to the valuation of these warrants. Thisvaluation was determined by using the Black-Scholes fair value option model.The following assumptions were used: expected volatility of 65%; averagerisk-free interest rate of 3.43%; dividend yield of 0%; and an expected life of5.0 years.

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The Company has a current multi-year agreement withMototech , an investor, to provide the Company with engineering and developmentsupport. As a result of this agreement, the Company has expensed approximately$59, $427 and $415, respectively for the years ended December 31, 2004,2005 and 2006. Accounts payable to this investor amounted to $1,173 and $1,377at December 31, 2005 and December 31, 2006, respectively. Thisagreement provides for contracted services, including hardware and softwaredevelopment, and the creation and development of tools to facilitate theCompany’s engineering efforts. This agreement does not provide for ongoingroyalties, purchase provisions, or for any requirement to provide additionalfunding to the Company. Net revenues from operations recognized from Mototechwere approximately $0, $0 and $406 for the years ended December 31, 2004,2005 and 2006, respectively. This investor accounted for approximately 0%, 0%and 14% of the revenues for the years ended December 31, 2004, 2005 and2006, respectively. Accounts receivable from this investor were $0 and $1,respectively, as of December 31, 2005 and December 31, 2006.

In August 2005, the Company completed a privateplacement for $17,500 of its common stock and warrants with several institutionalinvestors. The Company issued 4,666,664 shares of its common stock at $3.75 pershare to the participating investors. The Company also issued five-yearwarrants to purchase a total of 1,671,947 shares of its common stock: 1,633,333shares to the investors at an exercise price of $5.00 per share, and 38,614shares to the placement agent at an exercise price of $4.53 per share. Theinvestors also received an additional investment right, for a limited period oftime, to purchase 1,554,000 additional shares of common stock at $4.12 pershare. The private placement includes numerous provisions intended to protectthese institutional investors including a cash payment penalty of 1.5% permonth for the period above 120 days from the effective date of theagreement that the shares in the transaction fail to be registered. TheRegistration Statement covering the shares under this private placement was notdeclared effective until June 1, 2006. Until such time as the shares wereregistered the Company was subject to the penalty provision under this privateplacement.  For the twelve months ended December 31,2006 and 2005 the Company recorded and expensed related penalties of $1,114 and$535, respectively. The related unpaid penalties accrued as of December 31,2006 and December 31, 2005 was $157 and $535, respectively. On July 25,2006, the Company amended the terms of the additional investment right that wasgranted to an investor as part of the August 2005 private placement, withrespect to a portion of shares of common stock purchasable thereunder andagreed to apply $158 of accrued penalties towards the exercise price of suchamended additional investment right, for the purchase of 129,950 shares ofcommon stock. The penalties had accrued with respect to the Company’s inabilityto register the shares acquired by such investor in the private placementwithin 120 days of the transaction. In consideration for this amendment andapplication of the exercise proceeds the investor agreed to forego any cashpayment of the penalties other than as available through the proceeds of theexercise of the amended investment right and to grant to the Company a releaseof all claims relating to the late registration of the private placementshares, other then the aforesaid penalties. The amended additional investmentright provides that the investor thereof may purchase the 129,950 shares ofcommon stock for a period of 760 days beginning June 1, 2006 for anexercise price of $1.515 per share. The terms of the additional investmentrights with respect to the remaining 1,424,050 shares of common stockpurchasable thereunder remain unchanged.  On July 26, 2006 this investor exercisedthe additional investment right for 129,950 shares. On July 31, 2006the amended additional investment right with respect to the remaining 1,424,050shares of common stock expired  On December 12,2006 the Company amended the terms of the warrants that were granted to aninvestor as part of the August 2005 private placement, with respect to aportion of shares of common stock purchasable thereunder and agreed to apply$315 of accrued penalties towards the exercise price of such amended warrants,for the purchase of 279,255 shares of common stock. In addition, the exerciseprice of 47,412 of the warrants was changed to $1.41 per share. The penaltieshad accrued with respect to the Company’s inability to register the sharesacquired by such investor in the private placement within 120 days of thetransaction. In consideration for this amendment and application of theexercise proceeds the investor agreed to forego any cash payment of thepenalties other than as available through the proceeds 

F-42

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of the exercise of theamended warrant and to grant to the Company a release of all claims relating tothe late registration of the private placement shares, other than the aforesaidpenalties. The amended warrants provide that the investor thereof may purchasethe 326,667 shares of common stock for a period of 1,330 days beginning December 12,2006 for an exercise price of $1.41 per share. The terms of the warrants withrespect to the remaining shares of common stock purchasable thereunder remainunchanged. On December 19, 2006 this investor exercised the warrants forthe purchase of 279,255 shares.

Registration statements for the securities soldpursuant to the June 2004, December 2004 and August 2005 privateplacements were originally filed containing financial statements that werecurrent at the time of the filing. Subsequently, the Company initiated aprocess to amend, restate, and re-file certain of its 2003, 2004 and 2005financial statements to correct an error in the accounting treatment forvarious security components of our private placements. As a result theregistration statements then on file also needed to be amended to reflect thesechanges in our financial statements. Amended registration statements weresubsequently filed with the SEC to reflect the amended and restated financialstatements, and became effective on June 1, 2006.

On August 11, 2006 the Company completed aprivate placement with an institutional investor of a convertible debenture inthe aggregate principal amount of up to $11,000. These convertible debentureshave a maturity of three years, an interest rate of 6% per annum, and are convertibleat the option of the investors into WorldGate common stock at a conversionprice equal to the lesser of $1.75 per share or 90% of the average of the fivelowest daily volume weighted average closing price (“VWAP”) of the common stockduring the fifteen trading days immediately preceding the conversion date(subject to adjustment in the event of stock dividends and splits and certaindistributions to stockholders, fundamental transactions, and future dilutiveequity transactions). Interest is payable at maturity, and the Company mayelect to pay the interest amount in cash or shares of our common stock. ThroughDecember 31, 2006 the investors converted $1,350 of the convertible debtinto 1,146,279 shares of the Company’s common stock. During the period January 1,2007 through March 7, 2007 the investors converted an additional $800 ofthe convertible debt into 716,063 shares of the Company’s common stock.

The Company received $6,000 upon the closing of thetransaction ($5,615, net of transaction costs) and the remaining $5,000($4,700, net of transaction costs) was received on October 13, 2006 afterreceiving stockholder approval on October 11, 2006 and obtaining aneffective registration of the shares of common stock issued and issuable uponconversion of the convertible debentures in the first tranche of thistransaction.

The Company has the right to redeem all or any portionof the principal amount of the convertible debentures in cash at any time uponnot less than four business days notice if the closing price of our stock isless than $1.75 per share. Such early redemption will, however, require theCompany to pay a 10% prepayment premium.  In addition, without any prepayment premium,the Company has the right to force the holders to convert a maximum of $500 ofthe principal amount of the convertible debenture in any thirty day period iffor five consecutive trading days the VWAP of our common stock is above $1.925per share but less then $3.50 per share and providing the daily trading volumeexceeds 200,000 shares for these five days, and certain other conditions aremet. If the VWAP of our common stock is greater than $3.50 per share for 30consecutive trading days, the daily trading volume exceeds 250,000 shares forfive days prior, and if certain other conditions are met, the Company can alsoforce the holder to convert all or any portion of the outstanding principal andinterest into shares of our common stock without any prepayment premium.

There are some restrictions on the holder’s right toconvert the convertible debentures. The holder cannot make any conversionsbelow $1.75 per share (i) until the earlier of the date registered commonstock can be issued pursuant to such conversion or January 1, 2007, (ii) whichwould exceed $500 in principal amount in any calendar month, or (iii) whichwould result in the issuance of more than 840,000 

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shares of our common stockper calendar month (provided that this maximum share limit will be waived bythe Company unless it elects to pay the holder in cash the difference in valuebetween 840,000 shares and the number of shares the holders wishes to convert,up to the $500 per month conversion limit). If the Company is in default underthe convertible debenture these limitations are waived. The holder is also notrestricted in making conversions at $1.75. In no case, however may the holderconvert the convertible debentures if (x) it would result in beneficialownership of more than 9.99% of our outstanding common stock (though thisprovision can be waived by the holder upon 65 days prior notice), or (y) suchconversion would, without stockholder approval, cause the Company to issue morethan 19.99% of its outstanding shares as determined immediately prior toconsummation of the transaction. Under certain circumstances, the convertibledebenture holders are entitled to have the conversion price adjusted tocorrespond to common stock holders’ rights to any stock dividend, stock split,stock combination or reclassification of shares. The $1.75 conversion price isalso subject to a weighted average dilution adjustment if the Company issuesshares (apart from certain excluded issuances) of our capital stock at aneffective price of less than $1.75 per share. The Company also granted theconvertible debentures holders a security interest in all of our assets. Moreover,the Company is required to register the shares of common stock issuable to theinvestor for resale to the public pursuant to a registration rights agreement,containing customary terms, conditions and indemnities. The private placementincludes numerous provisions intended to protect the institutional investorsincluding a cash payment penalty of 1.0% per month for the period above 120days from the effective date of the agreement that the shares in the transactionfail to be registered with the aggregate penalty capped at 12%.

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

As part of this private placement the Companyissued  five-year warrants to purchase atotal of up to 2,595,000 shares of WorldGate common stock, with 1,145,000 ofthe warrants having an exercise price of $1.85 per share (with 624,545 of thesewarrants issued at the initial closing and 520,455 warrants issued at theclosing of the second tranche of funding), 1,100,000 of the shares having anexercise price of $2.35 per share (with 600,000 of these warrants issued at theinitial closing and 500,000 warrants issued at the closing of the secondtranche of funding), and 350,000 warrants having an exercise price of $2.60 pershare (with 190,909 of these warrants issued at the initial closing and 159,091warrants issued at the closing of the second tranche of funding).

During 2006, the investorsconverted $1,350 of convertible debt into 1,146,279 shares of the Company’scommon stock. The amortization of the total convertible debenture discount of$9,979 was $1,354 in 2006.

**13.**          EmployeeBenefit Plan

In January of 2005the Company established a new Retirement Savings Plan that is funded by theparticipant’s salary reduction contributions. All employees of the Company areeligible to participate in the plan upon joining the Company. The plan isintended to permit any eligible employee who wishes to participate tocontribute up to 12% of the employee’s compensation on a before-tax basis underSection 401(k) of the Internal Revenue Code. The plan provides fordiscretionary Company matching contributions and discretionary Companyprofit-sharing contributions. Contributions are invested, in such proportionsas the employee may elect in a variety of mutual investment funds. As of December 31,2006, the Company has made no matching or discretionary profit-sharingcontributions to the plan.

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**14.**          Supplementaldisclosure of cash flow information

| ** **                                                                   | ** ** | **Year ended December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                   | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                                   | ** ** | **(dollars in thousands)**       | ** ** |
| Cash paid for  interest                                                      |       | $                                          | 6          |   | $ | 6 |   | $ | 0 |   |
| **Non-cash investing and financing activities:**                             | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Issuance of notes  payable for Directors and Officers’ insurance policy |       | 328                                        |       | 294 |   | 0 |   |
| Conversion of  derivative liability                                          |       | 0                                          |       | 0 |   | 1,020 |   |
| Accretion on  preferred stock                                                |       | 763                                        |       | 682 |   | 28 |   |
| Conversion of  preferred stock to common stock                               |       | 775                                        |       | 6,275 |   | 334 |   |
| Conversion of  convertible debenture to common stock                         |       | 0                                          |       | 0 |   | 1,350 |   |
| Dividends payable  on preferred stock                                        |       | 85                                         |       | 137 |   | 1 |   |
| Deemed dividend  on conversion of preferred stock                            |       | 0                                          |       | 3,102 |   | 68 |   |
| Common stock  issued for accrued dividends                                   |       | 103                                        |       | 217 |   | 14 |   |
| Cancellation of treasury  stock shares                                       |       | 5                                          |       | 0 |   | 0 |   |
|                                                                              |            |                                            |            |  |  |  |  |  |  |  |

 

**15.**          DiscontinuedOperations

During the first quarter of 2004, the Company decidedto transition from the business of developing and selling ITV technology, productsand services for use in conjunction with cable TV broadband networks (the “ITVbusiness”) to the development of videophone products. In accordance with SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets”, all assetsrelated to the ITV business have been written down to their net realizablevalue. Related operating results of the ITV business have been reported asdiscontinued operations for all years presented.

Revenueand net income before income taxes from discontinued operations were asfollows:

| ** **                  | ** ** | **For the Twelve-Month Period ended  December 31,** | ** ** |
|-----------------------------|------------|------------------------------------------------------------------------------|------------|
| ** **                  | ** ** | **2004**                                                                     | ** ** | **2005** | ** ** | **2006** | ** ** |
| Revenues                    |       |                                                                         | $          | 82 |   |   |   | $ | 0 |   |   |   | $ | 0 |   |   |
| Income before income  taxes |       |                                                                         | 36         |   |   |   | 0 |   |   |   | 0 |   |   |

 

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**16.**          SupplementalQuarterly Data (unaudited)

| ** **                                                            | ** ** | **First**                                                                              | ** ** | **Second** | ** ** | **Third**  | ** ** | **Fourth** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                                            | ** ** | **(dollars in thousands  other than per share amounts)** | ** ** |
| **2006**                                                              | ** ** | ** **                                                                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net revenues                                                          |       | $                                                                                      | 509        |       | $          | 186        |       | $          | 962        |   | $ | 1,119 |   |
| Gross margins                                                         |       | 67                                                                                     |       | (553       | )          | 68         |       | (175       | )          |
| Loss from  operating activities                                       |       | (4,742                                                                                 | )          | (4,671     | )          | (3,448     | )          | (5,068     | )          |
| Change in fair  value of derivative warrants and conversion options   |       | 182                                                                                    |       | (520       | )          | 17         |       | (114       | )          |
| Gain (loss) on  contract termination                                  |       | 1,792                                                                                  |       | 0          |       | (15        | )          | 66         |       |
| Amortization of  debt discount                                        |       | 0                                                                                      |       | 0          |       | (201       | )          | (1,153     | )          |
| Other income  (expense)—net                                      |       | 134                                                                                    |       | 100        |       | 40         |       | (7         | )          |
| Net loss                                                              |       | (2,634                                                                                 | )          | (5,091     | )          | (3,607     | )          | (6,276     | )          |
| Accretion on  preferred stock, dividends and deemed dividends         |       | (69                                                                                    | )          | (40        | )          | 16         |       | (13        | )          |
| Net loss  available to common stockholders                            |       | (2,703                                                                                 | )          | (5,131     | )          | (3,591     | )          | (6,289     | )          |
| Net loss per  common share:                                           |       |                                                                                   |       |       |       |       |       |       |       |
| Basic                                                                 |       | (0.07                                                                                  | )          | (0.13      | )          | (0.09      | )          | (0.15      | )          |
| Fully Diluted                                                         |       | (0.07                                                                                  | )          | (0.13      | )          | (0.09      | )          | (0.15      | )          |
| Net loss  available to common stockholders per common share:          |       |                                                                                   |       |       |       |       |       |       |       |
| Basic                                                                 |       | (0.07                                                                                  | )          | (0.13      | )          | (0.09      | )          | (0.15      | )          |
| Fully Diluted                                                         |       | (0.07                                                                                  | )          | (0.13      | )          | (0.09      | )          | (0.15      | )          |
| **2005**                                                              | ** ** | ** **                                                                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net revenues                                                          |       | 179                                                                                    |       | 1,399      |       | 2,290      |       | (2,310     | )          |
| Gross margins                                                         |       | 54                                                                                     |       | 133        |       | (160       | )          | (481       | )          |
| Loss from  operating activities of continuing operations              |       | (2,648                                                                                 | )          | (2,938     | )          | (3,444     | )          | (7,127     | )          |
| Change in fair  value of warrants and conversion options              |       | 5,176                                                                                  |       | 2,466      |       | 1,759      |       | (807       | )          |
| Other income—net                                                 |       | 66                                                                                     |       | 106        |       | 288        |       | 252        |       |
| Net income (loss)                                                     |       | 2,594                                                                                  |       | (366       | )          | (1,397     | )          | (7,682     | )          |
| Accretion on  preferred stock and dividends                           |       | (495                                                                                   | )          | (139       | )          | (85        | )          | (3,203     | )          |
| Net income (loss)  available to common stockholders                   |       | 2,099                                                                                  |       | (505       | )          | (1,482     | )          | (10,885    | )          |
| Net income (loss)  per common share:                                  |       |                                                                                   |       |       |       |       |       |       |       |
| Basic                                                                 |       | 0.08                                                                                   |       | (0.01      | )          | (0.04      | )          | (0.19      | )          |
| Fully Diluted                                                         |       | 0.07                                                                                   |       | (0.01      | )          | (0.04      | )          | (0.19      | )          |
| Net income (loss)  available to common stockholders per common share: |       |                                                                                   |       |       |       |       |       |       |       |
| Basic                                                                 |       | 0.07                                                                                   |       | (0.02      | )          | (0.04      | )          | (0.28      | )          |
| Fully Diluted                                                         |       | 0.05                                                                                   |       | (0.02      | )          | (0.04      | )          | (0.28      | )          |
|                                                                       |            |                                                                                        |            |            |            |            |            |            |            |  |  |  |  |

 

F-46

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**17.**          GeographicalData

FinancialInformation Relating to Foreign and Domestic Operations and Export Sales fromContinuing Operations (Dollars in Thousands)

| ** **                                                                              | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net revenues from  continuing operations by geographic area:                            |       |     |       |     |       |     |       |
| United States                                                                           |       | $        | 231        |     | $          | 1,558    |       | $ | 1,326 |   |
| Foreign (*)                                                                             |       | 0        |       | 0        |       | 1,450    |       |
| Total                                                                                   |       | $        | 231        |     | $          | 1,558    |       | $ | 2,776 |   |
| Loss from  continuing operations (all from United States operations)                    |       | $        | (19,461    | )        | $          | (6,851   | )          | $ | (17,608 | ) |
| Identifiable  assets within the United States                                           |       | $        | 13,172     |     | $          | 20,684   |       | $ | 14,251 |   |
| Identifiable foreign  assets (hardware and tooling for manufacturing) in Taiwan, R.O.C. |       | $        | 650        |     | $          | 545      |       | $ | 315 |   |

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*                    Net revenuesfor the twelve months ended December 31, 2006 include net revenuesprimarily derived from sales to customers located in Taiwan, R.O.C. ($405), inthe Russian Federation ($718), in Israel ($251) in New Zealand ($59) and others($17).

F-47

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**Item 9.**                        Changesin and Disagreements with Accountants on Accounting and Financial Disclosure.

On November 17, 2005, Grant Thornton LLP (GrantThornton), our independent registered public accounting firm, advised theCompany that it would not stand for re-appointment for the audit of the yearending December 31, 2005 and that it would be resigning as the Company’s independent auditor effective upon thecompletion of its engagement which ended with the audit of the restatementdescribed below and the review of the Company’s financial statements includedin its Quarterly Report on Form 10-Q for the quarter ended September 30,2005. As stated in the Company’s Proxy Statement pursuant to Section 14(a) ofthe Securities Exchange Act of 1934, as filed on September 9, 2005 withthe SEC, the Company had withheld any decision as to the retention of anindependent registered public accounting firm for fiscal year 2005.

On January 24, 2006, the Company filed amendmentsto and restatements of its financial statements for the years ended December 31,2003 and 2004 as included in the Company’s Annual Report on Form 10-K/Afor the fiscal year ended December 31, 2004, and the interim financialstatements for the periods ended March 31, 2004 through June 30,2005 included in the Company’s Quarterly Reports on Form 10-Q. Thereport of independent registered public accounting firm issued by GrantThornton dated February 24, 2005 (except for Note 2 *Restatement No. 1* as to which thedate is August 24, 2005 and Note 3 *RestatementNo. 2* as to which the date is January 10, 2006 included inthe Company’s Annual Report on Form 10-K/A for the fiscal year endedDecember 31, 2004 filed on January 24, 2006) contained no adverseopinion or disclaimer of opinion, and was not qualified or modified as touncertainty, audit scope, or accounting principles, except for a modificationrelated to an uncertainty regarding the Company’s ability to continue as agoing concern, and an explanatory paragraph regarding two restatements of theCompany’s consolidated financial statements for the years ended December 31,2003 and 2004.

During the fiscal years ended December 31, 2003and 2004, and any subsequent interim period through the date hereof, there wereno disagreements between the Company and Grant Thornton on any matter ofaccounting principles or practices, financial statement disclosure or auditingscope or procedure, which disagreement(s), if not resolved to the satisfactionof Grant Thornton, would have caused it to make reference to the subject matterof the disagreement(s) in connection with its reports.

On January 5, 2006,the Audit Committee of the Company’s Board of Directors engaged the firm ofMarcum & Kliegman LLP (M&K) as the new independent registeredpublic accountants to audit the Company’s financial statements as of and forthe period ended December 31, 2005. During the Company’s 2004 and 2005fiscal years, and through January 5, 2006, the Company has not consultedwith M&K regarding the application of accounting principles to a specifiedtransaction, either completed or proposed, or the type of audit opinion thatmight be rendered on the Company’s financial statements nor has it consultedwith M&K regarding any matter that was either the subject of adisagreement, as that term is defined in Item 304 (a)(1)(iv) ofRegulation S-K and the related instructions to Item 304 ofRegulation S-K, or a reportable event, as that term is defined inItem 304 (a)(1)(v) of Regulation S-K.

**Item 9A.**                Controlsand Procedures

**(a)**           DisclosureControls and Procedures.

We maintain disclosure controls and procedures (asdefined in Exchange Act Rule 13a-15(e) and 15d-15(e))  that are designed to ensure that informationrequired to be disclosed in reports that we file or submit under the SecuritiesExchange Act of 1934 is recorded, processed, summarized, and reported withinthe time periods specified in the Securities and Exchange Commission's rulesand forms, and that such information is accumulated and communicated to ourmanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate to allow timely decisions regarding the required disclosures. Indesigning and evaluating the disclosure controls and procedures, we recognizethat any controls and 

39

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procedures, no matter howwell designed and operated, can provide only reasonable assurance of achievingthe desired control objectives.

We carried out an evaluation, under the supervisionand with the participation of management, including our Chief Executive Officerand Chief Financial Officer, of the effectiveness of the design and operationof our disclosure controls and procedures as of December 31, 2006.  Our Chief Executive Officer and ChiefFinancial Officer determined that we no longer have a material weakness (asdefined under the standards established by the Public Company AccountingOversight Board) that exists with respect to our control procedure for theaccounting and reporting of complex financial transactions but we identified amaterial weakness with respect to the Company’s application of GAAP with regardto the recording of inventory at the lower of cost or market.  

As previously reported in our Form 10-K for the yearended December 31, 2005, we identified material weaknesses in our controlprocedure for the accounting and reporting of complex financial transactions.These material weaknesses contributed to restatements of our financialstatements in our annual and quarterly reports from the quarter ended March 31,2004 through September 30, 2005.  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).

To address the material weakness related to theapplication of GAAP with regard to the recording of inventory at the lower ofcost or market the Company intends to implement formal procedures to ensurethat period ending inventory is analyzed and documented consistent with GAAP.

As a result of thematerial weakness identified with respect to the Company’s application of GAAPwith regard to the recording of inventory at the lower of cost or market, theChief Executive Officer and Chief Financial Officer concluded that as ofDecember 31, 2006, our disclosure controls and procedures were not designed andwere not effective in ensuring that the information required to be disclosed byour Company in the reports that we file and submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the Commission’s rules and forms.  Other than the engagement of outside experts to provide counsel andguidance in areas where we cannot economically maintain the required expertise internally,there have been no changes in our internal control over financial reportingthat occurred during the year ended December 31, 2006, that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.  The Company isin the process of implementing a financial system that it believes will improvethe internal control over financial reporting and eliminate any identifieddeficiencies. The implementation of this system is expected to be completed in2007.  

**(b)**          Management'sAnnual Report on Internal Control Over Financial Reporting.

Our management is responsible for establishing andmaintaining adequate internal control over financial reporting as defined inRules 13a-15(f) or 15d – 15(f) under the Securities Exchange Act of 1934. Ourinternal control over financial reporting is designed to provide reasonable assuranceregarding the reliability of financial reporting and preparation of financialstatements for external purposes in accordance with generally acceptedaccounting principles.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Therefore,even those systems determined to be effective can provide only reasonableassurance with respect to financial statement preparation and presentation. 

Management assessed the effectiveness of our internalcontrol over financial reporting as of December 31, 2006. In making thisassessment, management used the criteria set forth by the Committee 

40

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of SponsoringOrganizations of the Treadway Commission ("COSO") in Internal Control- Integrated Framework.

Based on management's assessment, management concludedthat, as of December 31, 2006, due solely to a material weakness with respectto the Company’s application of GAAP with regard to the recording of inventoryat the lower of cost or market, our internal control over financial reportingwas not effective.  Management'sassessment of the effectiveness of internal control over financial reporting asof December 31, 2006, has been audited by Marcum & Kliegman LLP("M&K LLP"), the independent registered public accounting firmwho also audited our consolidated financial statements. M&K LLP'sattestation report on management's assessment of our internal control overfinancial reporting is contained below. 

Attestation Report of Independent Registered PublicAccounting Firm on Internal Control Over Financial Reporting

To the AuditCommittee of theBoard of Directors and StockholdersWorldGate Communications, Inc.

We have audited management’s assessment, included inthe accompanying “Management’s Annual Report on Internal Control Over FinancialReporting,” that WorldGate Communications, Inc. and subsidiaries (the “Company”)did not  maintain effective internalcontrol over financial reporting as of December 31, 2006, because of theeffect of a material weakness in the Company’s internal control relating toreporting inventory at the lower of cost or market value based on criteriaestablished in Internal Control—Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission (the “COSO” criteria). TheCompany’s management is responsible for maintaining effective internal controlover financial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting. Our responsibility is to express an opinionon management’s assessment and an opinion on the effectiveness of the Company’sinternal control over financial reporting based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

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A material weakness is a control deficiency, orcombination of control deficiencies, that results in more than a remotelikelihood that a material misstatement of the annual or interim financialstatements will not be prevented or detected. The following material weaknesshas been identified and included in management’s assessment: management doesnot maintain a policy for the application of generally accepted accountingprinciples with regard to recording inventory at the lower of cost or marketvalue. This material weakness was considered in determining the nature, timing,and extent of audit tests applied in our audit of the 2006 consolidatedfinancial statements and financial statement schedule. Our report dated March 7,2007 on those consolidated financial statements and financial statementschedule, expressed an unqualified opinion, and also contains an explanatoryparagraph as to the Company’s ability to continue as a going concern.

In our opinion, management’s assessment that WorldGateCommunications, Inc. and subsidiaries did not  maintain effective internal control overfinancial reporting as of December 31, 2006, is fairly stated, in allmaterial respects, based on the COSO criteria. Also, in our opinion, because ofthe effect of the material weakness described above on the achievement of theobjectives of the control criteria, WorldGate Communications, Inc. andsubsidiaries have not maintained effective internal control over financialreporting as of December 31, 2006, based on the COSO criteria.

We do not express anopinion or any other form of assurance on management’s statements included inthe fourth paragraph of the accompanying Management’s Annual Report on InternalControl Over Financial Reporting.

/s/ MARCUM & KLIEGMAN LLP

Marcum & KliegmanLLPMelville, New YorkMarch 7, 2007

**Item 9B.**               OtherInformation.

**None**

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**PART III**

**Item 10.**                 Directorsand Executive Officers of the Registrant.

Our business is managed by the Company’s executiveofficers under the direction of our Board of Directors, in accordance with theDelaware Business Corporation Law and our Bylaws. Members of the Board are keptinformed of our business through discussions with the Company’s executiveofficers, by reviewing materials provided to them and by participating inregular and special meetings of the Board and its committees. In addition, topromote open discussion among our non-employee Directors, those Directors meetin regularly scheduled executive sessions without the participation ofmanagement or employee Directors.

In accordance with our Bylaws, our Board of Directorshas specified that, as of the date of our 2006 Annual Meeting, the number ofDirectors will be set at six. Five of our six Directors are non-employeeDirectors, and the Board of Directors has determined that each of these fiveDirectors has no relationship which, in the opinion of the Board of Directors,would interfere with the exercise of independent judgment in carrying out theresponsibilities of a Director, and that each meets the objective requirementsfor “independence” under the NASDAQ Marketplace Rules. Therefore, the Board ofDirectors has determined that each of these five Directors is an “independent”Director under the standards currently set forth in the NASDAQ MarketplaceRules. The Director who is not independent is Mr. Krisbergh, the Company’schairman and president.

As of December 31,2006 our executive officers and directors are as follows:
| Name                                | ** ** | ** ** | ** ** | **Age** | ** ** | **Position**                                                    | ** ** |
|-------------------------------------|------------|------------|------------|---------|------------|-----------------------------------------------------------------|------------|
| Hal M. Krisbergh                    |       |       | 59         |    |       | Chairman  of the Board of Directors and Chief Executive Officer |       |
| Joel Boyarski                       |       |       | 60         |    |       | Vice  President and Chief Financial Officer                     |       |
| Randall J. Gort                     |       |       | 57         |    |       | Vice  President, Chief Legal Officer and Secretary              |       |
| James E.  McLoughlin                |       |       | 54         |    |       | Vice  President, Account Development and Marketing              |       |
| Richard Westerfer                   |       |       | 48         |    |       | Vice  President and Chief Operations Officer                    |       |
| Steven C.  Davidson(2)              |       |       | 58         |    |       | Director                                                        |       |
| Clarence L.  Irving, Jr.(1)(3) |       |       | 51         |    |       | Director                                                        |       |
| Martin Jaffe(2)                     |       |       | 60         |    |       | Director                                                        |       |
| Jeff Morris(1)                      |       |       | 54         |    |       | Director                                                        |       |
| Lemuel Tarshis(2)(3)                |       |       | 66         |    |       | Director                                                        |       |

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(1)          Member of CompensationCommittee

(2)          Member of AuditCommittee

(3)          Member of the CorporateGovernance and Nominating Committee

All Executive Officers serve at the pleasure of theBoard. Each director holds office until the election and qualification of thedirector’s successor at the next annual meeting of stockholders or until thedirector’s earlier death, removal or resignation.

Hal M. Krisbergh has served as our Chairman and ChiefExecutive Officer since our inception in March 1995. From September 1981to September 1994, Mr. Krisbergh was an executive officer of GeneralInstrument (now a part of Motorola, Inc.). Mr. Krisbergh served asPresident of General Instrument’s Communications Division and, for the past 25years, has been a well-known figure in the cable industry. He is a recognizedleader in the development of addressable cable boxes, impulse pay-per-view,opto-electronics and digital audio technologies. In 1991, Mr. Krisberghreceived cable television’s prestigious Vanguard award. Prior to joiningGeneral Instrument, Mr. Krisbergh was employed by W. R. Grace &Co., Deloitte & Touche and Raytheon Company.

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Joel I. Boyarski joined our company in October 1999,and was named Vice President and Chief Financial Officer in September 2002.Prior to becoming Vice President and Chief Financial Officer, Mr. Boyarskiserved as General Manager of TVGateway, LLC from December 2001 until September 2002and as Vice President of Business Development for TVGateway, LLC from June 2000until December 2001. From October 1999 to June 2000, he servedas a consultant for our Company. Prior to joining us, Mr. Boyarski was abusiness and financial consultant from June 1998 to October 1999, andfor 23 years prior to June 1998, he held a variety of management positionsat Joseph E. Seagram and Sons, Inc., including Vice President of Financeand Business Planning for several of Seagram’s Domestic and Internationaldivisions including North America, Asia Pacific and Global Duty Free.

Randall J. Gort joined our company in August 1997as Vice President, Legal and Corporate Affairs, General Counsel and Secretary.In January 2003, Mr. Gort became the Company’s Chief Legal Officer.From July 1995 to August 1997, Mr. Gort was General Counsel,Secretary, and Director of Legal and Corporate Affairs for Integrated CircuitSystems, Inc. Mr. Gort was in private practice from August 1994through June 1995. Prior to that time, from May 1987 through July 1994,he was an Associate General Counsel for Commodore International Ltd. Mr. Gortwas with Schlumberger Ltd. from October 1982 through early 1987,originally as Senior Attorney and then as General Counsel, FACTRON Division.From April 1979 through October 1982, Mr. Gort was Counsel forvarious divisions of the 3M Company, including Medical and Surgical ProductsDivisions, Orthopedic Products Division, Electro-Mechanical Resources Divisionand 3M’s four tape divisions.

James E. McLoughlin joined our company in February 2001and in January 2002 was named Vice President, Marketing, Business andAccount Development. Prior to this position, Mr. McLoughlin served as VicePresident, Sales and Marketing. From February 1981 through February 2001,Mr. McLoughlin was Vice President, Affiliate Operations for Home BoxOffice, where he was responsible for sales and marketing of premium televisionservices to affiliated cable television companies.

Richard Westerfer joined our company in February 2000as Vice President of Engineering. In December 2000, Mr. Westerferbecame Senior Vice President of Operations. He served in this position until April 2002,when he became Chief Operations Officer of WorldGate. Prior to joining us, from1979 to February 2000, Mr. Westerfer served as the Senior Director ofEngineering for General Instrument (now a part of Motorola, Inc.).

Steven C. Davidson has been a member of our board ofdirectors since April 2002. From 1979 until his retirement in April 2002,Mr. Davidson held various executive positions with HBO, Inc., mostrecently serving as Senior Vice President and General Manager of AffiliateOperations. In February 2004, Mr. Davidson returned to HBO, Inc.as Executive Vice President of Affiliate Sales. Mr. Davidson is also adirector of Nation Fatherhood Initiative, a non-profit organization.

Clarence L. Irving, Jr. has been a member of ourboard of directors since July 2000. He has been President and ChiefExecutive Officer of Irving Information Group, a consulting services firm,since October 1999 and has served as a director of Covad CommunicationsGroup, Inc. since April 1999. Covad owns and operates the largestnational broadband network, and is a leading supplier of facilities-basedprovider of data, voice, and wireless telecommunications solutions for smalland medium-sized businesses. Covad is also a key supplier of high-bandwidthaccess for telecommunications services providers like EarthLink, AOL, andAT&T. On August 15, 2002, Covad Communications Group, Inc. fileda voluntary petition for relief under Chapter 11 of the Federal bankruptcy codein the United States Bankruptcy Court for the District of Delaware. Mr. Irvingserved as Assistant Secretary of Commerce to the United States Department ofCommerce from June 1993 to October 1999.

Martin Jaffe has been a member of our board ofdirectors since April 2002. Since January 2002, Mr. Jaffe hasbeen the Chief Operating Officer, Managing Director and Co-Founder ofSilvercrest Asset Management Group LLC, an independent, employee-owned,registered investment advisor which provides 

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asset management andfamily office services to families and select institutional investors. From November 2000until September 2001, Mr. Jaffe was Chief Financial Officer of CreditSuisse Asset Management Group LLC, and from 1981 until November 2000,Mr. Jaffe was Chief Operating Officer of Donaldson, Lufkin &Jenrette Asset Management Group. Messrs Jaffe and Tarshis are brothers-in-law.

Jeff Morris has been a member of our board ofdirectors since April 2001. Mr. Morris is currently Senior VicePresident of Long Term Strategy & Technology Development at ShowtimeNetworks Inc., an originator and distributor of entertainment content throughits premium television networks SHOWTIME® ,THE MOVIE CHANNELTM and FLIX®,as well as the multiplex channels SHOWTIME® TOOTM, SHOWTIME® SHOWCASE, SHOWTIME EXTREME®, SHOWTIME BEYOND®, SHOWTIME NEXT®, SHOWTIME WOMEN®, SHOWTIME FAMILYZONE® andTMC xtra. He has been in his current position since August 2005. From June 2001to July 2005, Mr. Morris was the principle of Digital MediaConsulting, a new media consulting company. From July 1999 to April 2001Mr. Morris was President and Chief Executive Officer of Yack, Inc.,an Internet events and program guide. Mr. Morris is a veteran of the cabletelevision industry, including a previous tenure from 1984 through 1999 atShowtime Networks, Inc., where his last position was Senior Vice Presidentof New Media and Technology Development.

Lemuel A. Tarshis has beena member of our board of directors since April 2001. Since August 1991,Dr. Tarshis has been a director for the Howe School Alliance forTechnology Management at the Stevens Institute of Technology. Dr. Tarshisalso currently is a director for both Aequus Technologies Corp. and Life-PackTechnologies, Inc. In addition, he has worked as a management consultantfor Lucent Technologies Inc., Bell Atlantic, GTECH Corporation, AT&TCorporation, Aequus Technologies and Life-Pack Technologies  Messrs Jaffe and Tarshis are brothers-in-law.

**Code of Conduct**

We have adopted a Code ofConduct that applies to all of our directors and employees, including, withoutlimitation, our principal executive officer, our principal financial andaccounting officer, and all of our employees performing financial or accountingfunctions. We have posted our Code of Conduct on our website, www.wgate.com,under the “About Us” section. We intend to satisfy the disclosure requirementsunder Item 10 of Form 8-K regarding an amendment to, or waiver from,any provisions of our Code of Conduct by posting such information on ourwebsite at the location specified above. You can request a copy of our Code ofConduct, at no cost, by contacting Investor Relations, c/o WorldGateCommunications, 3190 Tremont Ave., Trevose, PA 19053.

**CorporateGovernance At WorldGate**

Our Board of Directors has a long-standing commitmentto sound and effective corporate governance practices. The foundation for ourcorporate governance is the Board’s policy that a majority of the members ofthe Board should be independent. We have reviewed internally and with our Boardof Directors the provisions of the Sarbanes-Oxley Act of 2002, the related rules ofthe SEC and current NASDAQ Marketplace Rules regarding corporategovernance policies and procedures. Our corporate governance documents complywith all requirements.

During Fiscal 2006, ourBoard of Directors held seven meetings. Each member of the Board attended atleast 75% of the total number of meetings of the Board and all committees on whichhe sits. From time to time, the Board acts by unanimous written consent aswell.

**Board Committees**

The standing committees of our board of directorsconsist of the Audit Committee, Compensation and Stock Option Committee andCorporate Governance Nominating Committee. The Board has adopted 

45

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a written charter for eachof these committees that is available on the Company’s web site athttp://www.wgate.com/about/board.html. These committees are described below.Our Board of Directors may also establish various other committees to assist itin its responsibilities.

**AuditCommittee.****  **TheAudit Committee is responsible for providing general oversight with respect tothe accounting principles employed in our financial reporting. It operates inaccordance with a written charter adopted by our Board of Directors. The AuditCommittee monitors our financial reporting process and internal control system,reviews and appraises the audit efforts of our independent accountants andprovides an avenue of communication among the independent accountants,financial and senior management and the Board of Directors. The Audit Committeemeets at least each quarter and at least once annually with our management andindependent public accountants to review the scope of auditing procedures, ourpolicies relating to internal auditing and accounting procedures and controls,and to discuss results of the annual audit of our financial statements. TheAudit Committee is currently composed of Dr. Tarshis, Mr. Davidsonand Mr. Jaffe, each of whom is “independent” as such term is defined underRule 4200(a)(15) of the NASDAQ listing standards. The Audit Committee alsocomplies with the financial sophistication requirement under the NASDAQ listingstandards. In addition, the Board has determined that Mr. Jaffe is anaudit committee financial expert as defined by the Instruction to Item407(d)(5)(i) of Regulation S-K. Five separate meetings of this committeewere held in 2006 independent of the general meetings for the full board.

**Compensationand Stock Option Committee.****  **TheCompensation and Stock Option Committee is currently composed of two directors,Messrs. Irving and Morris, each of whom is “independent” as such term isdefined under applicable Nasdaq rules. The Compensation and Stock OptionCommittee met one time in 2006 in addition to meetings held in conjunction withthe full Board of Directors. The 2006 Compensation and Stock Option CommitteeReport on executive compensation, as well as further details concerning theduties of this committee, can be found in Item 11 of this annual report.

**Corporate Governance andNominating Committee.****  **TheCorporate Governance and Nominating Committee is currently composed of twodirectors, Messrs. Irving and Tarshis, each of whom are “independent” assuch term is defined under applicable Nasdaq rules. The primary function ofthis committee is to establish Board membership criteria; assist the Board byidentifying individuals qualified to become Board members; recommend to theBoard matters of corporate governance; facilitate the annual review of theperformance of the Board and its committees; and periodically review CEO andmanagement succession plans. The committee also reviews and evaluatesstockholder nominees for director. In evaluating nominees for director thecommittee considers a number of qualities and skills that it believes arenecessary for directors to possess, including, but not limited to, (i) rolesand contributions valuable to the Company and the general business community; (ii) personalqualities of leadership, character, judgment, and whether the candidatepossesses and maintains throughout service on the Board a reputation in thecommunity at large of integrity, trust, respect, competence and adherence tothe highest ethical standards; (iii) relevant knowledge and diversity ofbackground and experience in such things as business, operations, technology,finance, and accounting, sales, marketing, international business, governmentand the like; and (iv) whether the candidate is free of conflicts and hasthe time required for preparation, participation and attendance at meetings. Adirector’s qualifications in light of these criteria are considered at leasteach time the director is re-nominated for Board membership. Stockholderrecommendations should be submitted to the Company’s Corporate Secretary inwriting no later than the date determined in accordance with the deadlines bywhich a stockholder must give notice of a matter that he or she wishes to bringbefore the Company’s Annual Meeting of Shareholders as described in theStockholder’s Proposals for the 2006 Annual Meeting section of the Company’s2006 Proxy Statement. Any recommendation must include: (i) the name andaddress of the stockholder making the recommendation; (ii) pertinentbiographical information about the recommended candidate; and (iii) adescription of all arrangements or understandings between the stockholder andthe recommended 

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candidate.Recommendations that are received by the Secretary by the deadline will beforwarded to the Chairman of the Governance and Nominating Committee for reviewand consideration. No separate meetings of this committee were held in 2006independent of the general meetings for the full board.

**Section 16(a) BeneficialOwnership Reporting Compliance**

Section 16(a) ofthe Securities Exchange Act of 1934 requires our directors and executive officersand persons who beneficially own more than 10% of our common stock(collectively, the “reporting persons”) to file reports of ownership andchanges in ownership with the Securities and Exchange Commission and to furnishus with copies of these reports. Based solely on our review of those documentsreceived by us, and written representations, if any, received from reportingpersons with respect to the filing of reports on Form 3, 4 and 5, webelieve that all filings required to be made by the reporting persons forfiscal year 2006 were made on a timely basis.

**Item 11.**                 ExecutiveCompensation.

*CompensationDiscussion and Analysis*

**Compensation andStock Option Committee Membership and Organization**

The Compensation and StockOption Committee is currently composed of two directors, Messrs. Irvingand Morris, each of whom is “independent” as such term is defined underapplicable Nasdaq rules. The Compensation and Stock Option Committee hasgeneral supervisory power over, and the power to grant options under, theCompany’s 2003 Equity Incentive Plan. In addition, the Compensation and StockOption Committee recommends to the board the compensation of the Company’sChief Executive Officer, reviews and takes action on the recommendations of theChief Executive Officer as to the compensation of the Company’s other executiveofficers, approves the grants of any bonuses to officers, and reviews theCompany’s compensation strategy for other compensation matters generally. TheBoard has adopted a written charter for the Compensation and Stock OptionCommittee that is available on the Company’s web site athttp://www.wgate.com/about/board.html/. The Compensation and Stock OptionCommittee met one time in 2006 in addition to meetings held in conjunction withthe full board of directors. No member of the Committee is an officer oremployee of the Company.

**CompensationPhilosophy and Objectives**

The Compensation and StockOption Committee’s philosophy and objectives in setting compensation policiesis to align pay with performance, while at the same time providing fair,reasonable and competitive compensation that will allow us to retain andattract superior executive talent. The Committee strongly believes thatexecutive compensation should align executives’ interests with those ofstockholders by rewarding achievement of specific annual, long-term, andstrategic goals by the Company, with the ultimate objective of improvingstockholder value. To that end, the Compensation and Stock Option Committeebelieves executive compensation packages provided by the Company to itsexecutive officers should include a mix of both cash and equity-basedcompensation that reward performance as measured against established goals.

**Setting ExecutiveCompensation**

Based on the foregoingphilosophy and objectives, the Committee has structured the Company’s annualand long-term incentive-based executive compensation to motivate executives toachieve the business goals set by the Company and reward the executives forachieving such goals. The base salaries, targeted bonus amounts and equityincentive awards established for or granted to the Company’s executive officersare based, in part, on the Committee’s understanding of the Company’s currentfinancial position, 

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compensationamounts and forms paid to persons in comparable roles performing at comparablelevels at other companies in the same or related industries, the Company’s needto attract and retain key personnel for whom the Company must compete againstlarger, more established companies, and other market factors. Such amountsreflect the subjective discretion of the members of the Committee based onthese factors as well as the Committee’s evaluation of the Company’s currentand anticipated future performance, the experience of each executive officerand the contribution of the officer to such performance, and the contributionof the individual executive officers to the Company in areas not necessarilyreflected by the Company’s performance.

**Components ofExecutive Compensation for Fiscal Year 2006**

For the fiscal year ended December 31, 2006, theprincipal components of compensation for our executive officers were;

**BaseSalaries.****  **Salarylevels are typically reviewed annually as part of our performance reviewprocess as well as upon a promotion or other change in job responsibility. TheCompany’s 2006 base salaries were established subjectively by the Committeebased on the factors noted above. During 2006 the Company increased basesalaries , by approximately 5%, on average.

**AnnualBonuses.****  **Annualbonuses are normally intended to provide an incentive for improved performancein the short term. Typically the Committee establishes target bonus levels atthe beginning of each year based on the factors noted above, and awards apercentage of such target levels based on individual, department and Companyperformance. No bonuses were paid during 2006.

**Long-TermIncentive Compensation.****  **The Company’s long-term incentive compensation plan,administered through the Company’s equity incentive plan, promotes ownership ofthe Company’s Common Stock, which, in turn, provides a common interest betweenthe stockholders of the Company and the executive officers of the Company. TheCommittee has the authority to administer the long term incentive plans and toexercise all the powers and authorities either specifically granted to itunder, or necessary or advisable in the administration of the plans, including,without limitation, the authority to grant awards; to determine the persons towhom and the time or times at which awards shall be granted; to determine thetype and number of awards to be granted, the number of shares of common stockto which an award may relate and the terms, conditions, restrictions andperformance goals relating to any award; to determine whether, to what extent,and under what circumstances an award may be settled, canceled, forfeited,exchanged, or surrendered; to make adjustments in the performance goals inrecognition of unusual or non-recurring events affecting us or our financialstatements of WorldGate (to the extent not inconsistent with Section 162(m) ofthe Code, if applicable), or in response to changes in applicable laws,regulations, or accounting principles; to construe and interpret the plans andany award; to prescribe, amend and rescind rules and regulations relatingto the plans; to determine the terms and provisions of agreements evidencingawards; and to make all other determinations deemed necessary or advisable forthe administration of the plans.

Typically awards granted under the plan have anexercise price equal to the fair market value of the shares on the date ofgrant, an exercise period of ten years and generally vest over four years,subject to acceleration in the event of some changes of control of WorldGate.In keeping with a philosophy of providing a total compensation package thatfavors at-risk components of pay, long-term incentives comprise a significantcomponent of an executive officer’s total compensation package. Theseincentives are designed to motivate and reward executive officers formaximizing stockholder value and encourage the long-term employment of keyemployees. The size of stock option grants is based primarily on theresponsibilities of the applicable employee in addition to the factorsdiscussed above. Only the Committee may approve stock option grants to ourexecutive officers. However, the Committee has delegated to a 

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committee of executiveofficers the authority to grant options to employees below the level ofexecutive officer in an amount not to exceed 5,000 shares to any one individualin any twelve month period.

*Timingof Grants.*   Stock options are generally grantedby the Committee at their regularly scheduled, predetermined meetings. Onlimited occasion, grants may occur during an interim meeting of the Committeeor upon unanimous written consent of the Committee or pursuant to the delegatedauthority granted to the committee of executive officers, which occursprimarily for the purpose of approving a compensation package for newly hiredor promoted executives.

**Compensationof the Chief Executive Officer.****  **During fiscal year 2006, Mr. Krisbergh’sbase salary was increased by approximately 5%, which amount was consistent withthe increases granted to the Company’s other executive officers. This increasereflects the factors discussed above, the lack of any base salary increasesfrom 2002 to 2004, as well as the significant contribution Mr. Krisberghmade in implementing the change in the Company’s focus from its interactivetelevision business, culminating in the commercial introduction of the Company’snew Ojo video phone.

Accomplishmentsduring 2006 under the leadership of Mr. Krisbergh that were considered bythe committee in establishing his compensation include:

·       Transitionfrom exclusive distribution agreement with Motorola

·       Implementationof new product pricing/cost reductions

·       Introductionof new products

·       Broadeningof product distribution

**Limitationson Deductibility of Compensation.****  **Under the 1993 Omnibus BudgetReconciliation Act, a portion of annual compensation payable after 1993 to anyof the Company’s five highest paid executive officers would not be deductibleby the Company for federal income tax purposes to the extent such officer’soverall compensation exceeds $1,000,000. Qualifying performance-based incentivecompensation, however, would be both deductible and excluded for purposes ofcalculating the $1,000,000 base. Although the Committee does not presentlyintend to award compensation in excess of the $1,000,000 cap, it will continueto address this issue when formulating compensation arrangements for theCompany’s executive officers.

**Accounting for Stock-BasedCompensation.****  **Beginningon January 1, 2006, the Company began accounting for stock-based paymentsincluding its stock options and RSAs in accordance with the requirements ofFASBStatement 123(R).

**Compensationand Stock Option Committee Interlocks and Insider Participation**

None.

**Compensation andStock Option Committee Report**

The Compensation and Stock Option Committee hasreviewed and discussed the Compensation Discussion and Analysis required byItem 402(b) of Regulation S-K with management and, based on suchreview and discussions, the Compensation Committee recommended to the Boardthat the Compensation Discussion and Analysis be included in this Annual Reporton Form 10-K.

Submitted by the Compensation Committee of the Board

Larry IrvingJeffrey Morris

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**SummaryCompensation Table**

The following table setsforth information concerning compensation paid with respect to our chiefexecutive officer and four other most highly compensated officers who wereserving as such as of December 31, 2006, each of whose aggregatecompensation for fiscal 2006 exceeded $100,000, for services rendered in allcapacities for us and our subsidiaries.

**2006SUMMARY COMPENSATION TABLE**

| Name and Principal Position         | ** ** | ** ** | ** ** | **Fiscal  Year** | ** ** | **Salary ($)** | ** ** | **Bonus ($)** | ** ** | **Option  Awards ($)** | ** ** | **All Other  Compensation ($)** | ** ** | **Total ($)** | ** ** |
|----------------------------------------------------|------------|------------|------------|------------------|------------|---------------------|------------|--------------------|------------|-----------------------------|------------|-------------------------------------------|------------|--------------------|------------|
| Hal M. Krisbergh                                   |       |       | 2006       |             |       |                | 387,246    |               |       |                        | —     |                                      |       |               | 1,485      |   |   |   | — |   |   | 388,731 |   |
| Chairman and Chief Executive  Officer              |       |       |       |             |       |                |       |               |       |                        |       |                                      |       |               |       |   |   |   |   |   |   |   |   |
| Richard Westerfer                                  |       |       | 2006       |             |       |                | 244,213    |               |       |                        | —     |                                      |       |               | 825        |   |   |   | — |   |   | 245,038 |   |
| Vice President, Chief  Operations Officer          |       |       |       |             |       |                |       |               |       |                        |       |                                      |       |               |       |   |   |   |   |   |   |   |   |
| Randall J. Gort                                    |       |       | 2006       |             |       |                | 227,298    |               |       |                        | —     |                                      |       |               | 743        |   |   |   | — |   |   | 228,041 |   |
| Vice President, Chief Legal  Officer               |       |       |       |             |       |                |       |               |       |                        |       |                                      |       |               |       |   |   |   |   |   |   |   |   |
| Joel Boyarski                                      |       |       | 2006       |             |       |                | 222,263    |               |       |                        | —     |                                      |       |               | 660        |   |   |   | — |   |   | 222,923 |   |
| Vice President, Chief  Financial Officer           |       |       |       |             |       |                |       |               |       |                        |       |                                      |       |               |       |   |   |   |   |   |   |   |   |
| James McLoughlin                                   |       |       | 2006       |             |       |                | 216,843    |               |       |                        | —     |                                      |       |               | 660        |   |   |   | — |   |   | 217,503 |   |
| Vice President, Account Development  and Marketing |       |       |       |             |       |                |       |               |       |                        |       |                                      |       |               |       |   |   |   |   |   |   |   |   |

 

The following tablesummarizes the grants of plan based awards given to the named executives forfiscal year 2006:

**GRANTSOF PLAN-BASED AWARDSFISCAL 2006**

| **Name**          | ** ** | ** ** | ** ** | **Grant Date** | ** ** | **All Other Stock Awards:  Number of Shares of Stock  or Units (#)(1)** | ** ** | **Exercise or Base Price  of Option Awards ($/Sh)** | ** ** | **Grant Date Fair Value  of Stock Options ($)** | ** ** |
|-------------------|------------|------------|------------|---------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|
| Hal M. Krisbergh  |       | 4/24/06    |       |                | 45,000     |                                                                                                                 |       |                                                                              | 1.53       |                                                                          |       |   | 49,500 |   |   |
| Richard Westerfer |       | 11/13/2006 |       |                | 25,000     |                                                                                                                 |       |                                                                              | 1.40       |                                                                          |       |   | 27,500 |   |   |
| Randall J. Gort   |       | 11/13/2006 |       |                | 22,500     |                                                                                                                 |       |                                                                              | 1.40       |                                                                          |       |   | 24,750 |   |   |
| Joel Boyarski     |       | 11/13/2006 |       |                | 20,000     |                                                                                                                 |       |                                                                              | 1.40       |                                                                          |       |   | 22,000 |   |   |
| James McLoughlin  |       | 11/13/2006 |       |                | 20,000     |                                                                                                                 |       |                                                                              | 1.40       |                                                                          |       |   | 22,000 |   |   |

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(1)          These options vest infour equal annual installments beginning on the first anniversary of the dateof grant.

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Thefollowing table summarizes all outstanding equity awards for the namedexecutives at December 31, 2006:

**OUTSTANDINGEQUITY AWARDS AT 2006 FISCAL YEAR-END**

| Name                | ** ** | ** ** | ** ** | **Number of   Securities  Underlying   Unexercised  Options (#)  Exercisable** | ** ** | **Number of  Securities  Underlying  Unexercised  Options (#)  Unexercisable** | ** ** | **Option  Exercise  Price ($)** | ** ** | **Option  Expiration**

**Date** | ** ** |
|---------------------|------------|------------|------------|----------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|----------------------------------|------------|
| Hal M. Krisbergh    |       |       | 20000      |                                                                                               |       |                                                                                     | —     |                                 |       |                             | 21.57      |   |   | 5/5/2010 |   |
|                     |       |       | 160000     |                                                                                               |       |                                                                                     | —     |                                 |       |                             | 2.50       |   |   | 5/19/2011 |   |
|                     |       |       | 80000      |                                                                                               |       |                                                                                     | —     |                                 |       |                             | 1.59       |   |   | 5/21/2012 |   |
|                     |       |       | 12500      |                                                                                               |       |                                                                                     | 37500      | (1)                                  |       |                             | 3.95       |   |   | 3/9/2015 |   |
|                     |       |       | 11250      |                                                                                               |       |                                                                                     | 33750      | (2)                                  |       |                             | 2.20       |   |   | 12/1/2015 |   |
| Richard Westerfer   |       |       | 145000     |                                                                                               |       |                                                                                     | —     |                                 |       |                             | 2.78       |   |   | 4/26/2011 |   |
|                |       |       | 4000       |                                                                                               |       |                                                                                     | —     |                                 |       |                             | 2.60       |   |   | 5/24/2011 |   |
|                |       |       | 1600       |                                                                                               |       |                                                                                     | —     |                                 |       |                             | 2.61       |   |   | 5/24/2011 |   |
|                |       |       | 2400       |                                                                                               |       |                                                                                     | —     |                                 |       |                             | 2.65       |   |   | 5/24/2011 |   |
|                |       |       | 8000       |                                                                                               |       |                                                                                     | —     |                                 |       |                             | 2.80       |   |   | 5/31/2011 |   |
|                |       |       | 49000      |                                                                                               |       |                                                                                     | —     |                                 |       |                             | 2.40       |   |   | 5/1/2012 |   |
|                |       |       | 27750      |                                                                                               |       |                                                                                     | 9250       | (3)                                  |       |                             | 0.38       |   |   | 2/28/2013 |   |
|                |       |       | 122250     |                                                                                               |       |                                                                                     | 40750      | (4)                                  |       |                             | 0.52       |   |   | 10/1/2013 |   |
|                |       |       | 150000     |                                                                                               |       |                                                                                     | 50000      | (5)                                  |       |                             | 1.06       |   |   | 1/3/2014 |   |
|                |       |       | 12500      |                                                                                               |       |                                                                                     | 12500      | (6)                                  |       |                             | 4.43       |   |   | 12/24/2014 |   |
|                |       |       | 6250       |                                                                                               |       |                                                                                     | 18750      | (7)                                  |       |                             | 2.63       |   |   | 11/10/2015 |   |
|                |       |       | —     |                                                                                               |       |                                                                                     | 25000      | (8)                                  |       |                             | 1.40       |   |   | 11/14/2016 |   |
| Randall J. Gort     |       |       | 127333     |                                                                                               |       |                                                                                     | —     |                                 |       |                             | 2.78       |   |   | 4/26/2011 |   |
|                     |       |       | 24000      |                                                                                               |       |                                                                                     | —     |                                 |       |                             | 2.40       |   |   | 5/1/2012 |   |
|                     |       |       | 27750      |                                                                                               |       |                                                                                     | 9250       | (3)                                  |       |                             | 0.38       |   |   | 2/28/2013 |   |
|                     |       |       | 122250     |                                                                                               |       |                                                                                     | 40750      | (4)                                  |       |                             | 0.52       |   |   | 10/1/2013 |   |
|                     |       |       | 150000     |                                                                                               |       |                                                                                     | 50000      | (5)                                  |       |                             | 1.06       |   |   | 1/3/2014 |   |
|                     |       |       | 11250      |                                                                                               |       |                                                                                     | 11250      | (6)                                  |       |                             | 4.43       |   |   | 12/24/2014 |   |
|                     |       |       | 5625       |                                                                                               |       |                                                                                     | 16875      | (7)                                  |       |                             | 2.63       |   |   | 11/10/2015 |   |
|                     |       |       | —     |                                                                                               |       |                                                                                     | 22500      | (8)                                  |       |                             | 1.40       |   |   | 11/14/2016 |   |
| Joel Boyarski       |       |       | 5738       |                                                                                               |       |                                                                                     | —     |                                 |       |                             | 6.34       |   |   | 12/9/2010 |   |
|                |       |       | 45000      |                                                                                               |       |                                                                                     | —     |                                 |       |                             | 1.93       |   |   | 2/1/2012 |   |
|                |       |       | 20000      |                                                                                               |       |                                                                                     | —     |                                 |       |                             | 1.55       |   |   | 2/28/2012 |   |
|                |       |       | 10000      |                                                                                               |       |                                                                                     | —     |                                 |       |                             | 2.45       |   |   | 4/26/2012 |   |
|                |       |       | 42750      |                                                                                               |       |                                                                                     | 14250      | (3)                                  |       |                             | 0.38       |   |   | 2/28/2013 |   |
|                |       |       | 107250     |                                                                                               |       |                                                                                     | 35750      | (4)                                  |       |                             | 0.52       |   |   | 10/1/2013 |   |
|                |       |       | 131250     |                                                                                               |       |                                                                                     | 43750      | (5)                                  |       |                             | 1.06       |   |   | 1/3/2014 |   |
|                |       |       | 10000      |                                                                                               |       |                                                                                     | 10000      | (6)                                  |       |                             | 4.43       |   |   | 12/24/2014 |   |
|                |       |       | 5000       |                                                                                               |       |                                                                                     | 15000      | (7)                                  |       |                             | 2.63       |   |   | 11/10/2015 |   |
|                |       |       | —     |                                                                                               |       |                                                                                     | 20000      | (8)                                  |       |                             | 1.40       |   |   | 11/14/2016 |   |
| James E. McLoughlin |       |       | 40000      |                                                                                               |       |                                                                                     | —     |                                 |       |                             | 8.25       |   |   | 2/16/2011 |   |
|                     |       |       | 18400      |                                                                                               |       |                                                                                     | —     |                                 |       |                             | 2.40       |   |   | 5/1/2012 |   |
|                     |       |       | 13875      |                                                                                               |       |                                                                                     | 4625       | (3)                                  |       |                             | 0.38       |   |   | 2/28/2013 |   |
|                     |       |       | 107250     |                                                                                               |       |                                                                                     | 35750      | (4)                                  |       |                             | 0.52       |   |   | 10/1/2013 |   |
|                     |       |       | 131250     |                                                                                               |       |                                                                                     | 43750      | (5)                                  |       |                             | 1.06       |   |   | 1/3/2014 |   |
|                     |       |       | 10000      |                                                                                               |       |                                                                                     | 10000      | (6)                                  |       |                             | 4.43       |   |   | 12/24/2014 |   |
|                     |       |       | 5000       |                                                                                               |       |                                                                                     | 15000      | (7)                                  |       |                             | 2.63       |   |   | 11/10/2015 |   |
|                     |       |       | —     |                                                                                               |       |                                                                                     | 20000      | (8)                                  |       |                             | 1.40       |   |   | 11/14/2016 |   |

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(1)          These options vest inthree annual installments beginning on March 8, 2007.

(2)          These options vest inthree annual installments beginning on November 30, 2007.

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(3)          These options vest on February 27,2007.

(4)          These options vest on September 30,2007.

(5)          These options vest intwo annual installments beginning on January 2, 2007.

(6)          These options vest intwo annual installments beginning on December 23, 2007.

(7)          These options vest inthree annual installments beginning on November 9, 2007.

(8)          These options vest infour annual installments beginning on November 13, 2007.

The following tablesummarizes all option exercises and stock vesting for the named executiveofficers during the fiscal year 2006:

**OPTIONEXERCISES AND STOCK VESTED DURING FISCAL 2006**

| ** **        | ** ** | **Option Awards** | ** ** |
|-------------------|------------|------------------------|------------|
| **Name**          | ** ** | ** **             | ** ** | **Number of Shares  Acquired on  Exercise (#)** | ** ** | **Value Realized on  Exercise ($)** | ** ** |
| Hal M. Krisbergh  |       |                   | —     |   |   |   | — |   |   |
| Richard Westerfer |       |                   | —     |   |   |   | — |   |   |
| Randall J. Gort   |       |                   | —     |   |   |   | — |   |   |
| Joel Boyarski     |       |                   | —     |   |   |   | — |   |   |
| James McLoughlin  |       |                   | —     |   |   |   | — |   |   |
|                   |            |                        |            |  |  |  |  |  |  |  |  |

 

The Company has no information to provide with respect toPension Benefits (Reg. S-K 402(h)), Nonqualified Deferred Compensation (Reg.S-K 402(i)), and potential payments upon termination or change-in-control (Reg.S-K 402(j)).

**COMPENSATIONOF DIRECTORSFISCAL 2006**

| ** **                       | ** ** | **Fees Earned or ** | ** ** | **Option Awards**              | ** ** | **All Other** | ** ** | **Total**                 | ** ** |
|----------------------------------|------------|------------------------------------|------------|-------------------------------------|------------|--------------------|------------|---------------------------|------------|
| **Name**                         | ** ** | ** **                         | ** ** | **Paid in Cash ($)** | ** ** | **($)(1)**         | ** ** | **Compensation ($)** | ** ** | **($)** | ** ** |
| Steven C.  Davidson(2)           |       |                               | 12,500     |                                |       |               | 330        |                      |       |   | — |   |   | 12,830 |   |
| Clarence L.  Irving, Jr.(3) |       |                               | 13,000     |                                |       |               | 330        |                      |       |   | — |   |   | 13,330 |   |
| Martin Jaffe(4)                  |       |                               | 15,250     |                                |       |               | 330        |                      |       |   | — |   |   | 15,580 |   |
| Jeff Morris(5)                   |       |                               | 14,250     |                                |       |               | 330        |                      |       |   |   |   |   | 14,580 |   |
| Lemuel Tarshis(6)                |       |                               | 17,750     |                                |       |               | 330        |                      |       |   | — |   |   | 18,080 |   |
|                                  |            |                                    |            |                                     |            |                    |            |                           |            |  |  |  |  |  |  |  |  |

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(1)          The fair value at thedate of grant for these options was $11,000.

(2)          Mr. Davidson had66,500 option awards outstanding as of December 31, 2006.

(3)          Mr. Irving had84,500 option awards outstanding as of December 31, 2006.

(4)          Mr. Jaffe had66,500 option awards outstanding as of December 31, 2006.

(5)          Mr. Morris had77,000 option awards outstanding as of December 31, 2006.

(6)          Dr. Tarshis had89,666 option awards outstanding as of December 31, 2006.

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Pursuant to our 2003 Equity Incentive Plan,non-employee directors, currently Messrs. Davidson, Jaffe, Irving, Morrisand Tarshis, will receive an annual stock grant of 10,000 shares, vesting inequal amounts over four years, issued at the fair market value on the date ofgrant, a stipend of $1,000 for each board or committee meeting the directorattends in person, and $250 for each meeting attended telephonically.Furthermore, we paid an annual stipend of $5,000 for 2005 and will pay $10,000for each year thereafter, as well as an initial stock grant of 30,000 sharesupon becoming a non-employee director. We will continue to reimbursenon-employee directors for reasonable travel expenses for attending board orcommittee meetings.

On October 5,2001, our shareholders approved the WorldGate 2001 Employee Stock Purchase Plan(the “Stock Purchase Plan”). The Stock Purchase Plan provides our eligibleemployees with the opportunity to periodically acquire shares of our commonstock through payroll deductions. In general, the Stock Purchase Plan providesthat:

·       eachemployee who has completed six months of continuous employment with us iseligible to participate in the Stock Purchase Plan so long as the employeecustomarily works at least 20 hours per week and 5 months per year;

·       participantsin the Stock Purchase Plan are permitted to contribute up to fifteen percent oftheir compensation towards the purchase of our common stock;

·       atthe end of each calendar quarter, the contributions of the participants areused to purchase shares of our common stock at the lower of eighty-five percentof the market price of our common stock: (i) at the beginning of eachcalendar quarter or (ii) at the end of each calendar quarter;

·       sharesof our common stock that are purchased under the Stock Purchase Plan are nottransferable by the participant until at least nine months has elapsed from theacquisition of the shares;

·       amaximum of 750,000 shares of our common stock (plus an annual increase of375,000 shares) may be purchased in the aggregate by participants in the StockPurchase Plan; and

·       our Board of Directors hasthe power and authority to administer the Stock Purchase Plan and may, subjectto certain limitations suspend, revise, terminate or amend the Stock PurchasePlan.

**Item12. Security Ownership of Certain Beneficial Owners and Management and Related StockholderMatters**

The following table setsforth information as of December 31, 2006 regarding securities authorizedfor issuance under the Company’s equity compensation plans:

**EquityCompensation Plan Information**

| **Plan Category**                                         | ** ** | ** ** | ** ** | **Number of securities to  be issued upon exercise  of outstanding options,  warrants and rights  (a)** | ** ** | **Weighted-average  exercise price of  outstanding  options, warrants  and rights  (b)** | ** ** | **Number of securities  remaining available  for future issuance  under equity  compensation plans  (excluding securities  reflected in column (a)  (c)** | ** ** |
|----------------------------------------------------------------|------------|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by security holders(1)     |       |       | 4,913,689  |                                                                                                                                                      |       |                                                                                                         | $          | 1.90                                                                                                                                                                                                             |       |   |   | 2,091,682 | (1) |   |
| Equity  compensation plans not approved by security holders(2) |       |       | —     |                                                                                                                                                      |       |                                                                                                         | —     |                                                                                                                                                                                                             |       |   | — |   |   |
| Total                                                          |       |       | 4,913,689  |                                                                                                                                                      |       |                                                                                                         | 1.90       |                                                                                                                                                                                                             |       |   | 2,091,682 | (1) |   |

 

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(1)          2003 Equity IncentivePlan.

(2)          The Company does notmaintain any equity compensation plans that have not been approved by itsstockholders. The Equity Plan has an automatic annual increase in the number ofshares reserved for issuance in an amount equal to the lesser of 4% of the thenoutstanding shares of our Common Stock or 1,000,000 shares.

In 2003 the Company adopted an equity incentive plan(the “Equity Plan”) which was approved by stockholders in November, 2004. Theprincipal features of our Equity Plan are summarized below, but the summary isqualified in its entirety by reference to our Equity Plan, which was filed asexhibit 10.6 to the Company’s Proxy Statement to shareholders filed September 3,2004

This plan provides for the grant of equity awards tosuch officers, other employees, consultants and directors of WorldGate and ouraffiliates as the Compensation and Stock Option Committee may determine fromtime to time. Although various types of awards are available under the EquityPlan, including non-qualified and incentive stock options, restricted stock andperformance based awards, currently only stock options have been granted. Suchoptions vest in equal installments over a four-year period, and expire tenyears following the date of its grant, subject to acceleration in the event ofsome changes of control of WorldGate, and earlier termination upon cessation ofemployment.

To administer our Equity Plan, the Compensation andStock Option Committee must consist of at least two members of our board ofdirectors, each of whom is a “non-employee director” for purposes of Rule 16b-3under the Securities Exchange Act of 1934, or the Exchange Act and, withrespect to awards that are intended to constitute performance-basedcompensation under Section 162(m) of the Internal Revenue Code of1986, an “outside director” for the purposes of Section 162(m). TheCompensation and Stock Committee, among other things, interprets our EquityPlan, selects award recipients, determines the type of awards to be granted tosuch recipients and determines the number of shares subject to each award andthe terms and conditions thereof. The Compensation Committee may also determineif or when the exercise price of an option may be paid in the form of shares ofour common stock and the extent to which shares or other amounts payable withrespect to an award can be deferred by the participant. Our board of directors mayamend or modify our Equity Plan at any time. In addition, our board ofdirectors is also authorized to adopt, alter and repeal any rules relatingto the administration of our Equity Plan and to rescind the authority of theCompensation Committee and thereafter directly administer our Equity Plan.However, subject to certain exceptions, no amendment or modification willimpair the rights and obligations of a participant with respect to an awardunless the participant consents to that amendment or modification.

Our Equity Plan will continue in effect untilterminated by us in accordance with its terms, althoughincentive stock options may not be granted more than 10 years after theadoption of our Equity Plan.

The following tablesets forth information as of March  9, 2007 regarding beneficial ownershipof our common stock by the following persons:

·       eachperson who is known to us to own beneficially more than 5% of the outstandingshares of common stock,

·       eachdirector,

·       eachexecutive officer named in the executive compensation table above, and

·       alldirectors and executive officers as a group.

Unlessotherwise indicated below, to our knowledge, all persons listed below have solevoting and investment power with respect to their shares of common stock, exceptto the extent authority is shared by 

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spouses under applicable law. Beneficial ownership isdetermined in accordance with the rules of the SEC, based on factorsincluding voting and investment power with respect to shares, subject toapplicable community property laws. Shares of common stock subject to optionsor warrants exercisable within 60 days of March 8, 2007 are deemedoutstanding for the purpose of computing the percentage ownership of the personholding such options or warrants, but are not deemed outstanding for computingthe percentage ownership of any other person. Unless otherwise indicated, themailing address of the beneficial owners is 3190 Tremont Avenue, Suite 100,Trevose, Pennsylvania 19053.

| **Name of Beneficial Owner**                           | ** ** | ** ** | ** ** | **Number of Shares of   Common Stock   Beneficially Owned** | ** ** | **Percent of   Ownership** | ** ** |
|-----------------------------------------------------------------------|------------|------------|------------|------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| Hal M.  Krisbergh(1)                                                  |       |       | 5,984,863  |                                                                                           |       |                                 | 14.41      | % |   |
| Randall J.  Gort(2)                                                   |       |       | 652,400    |                                                                                           |       |                                 | 1.57       | % |   |
| Richard  Westerfer(3)                                                 |       |       | 538,241    |                                                                                           |       |                                 | 1.30       | % |   |
| Joel Boyarski(4)                                                      |       |       | 400,609    |                                                                                           |       |                                 |       | * |   |
| James  McLoughlin(5)                                                  |       |       | 330,400    |                                                                                           |       |                                 |       | * |   |
| Steven C.  Davidson(6)                                                |       |       | 49,000     |                                                                                           |       |                                 |       | * |   |
| Martin Jaffe(7)                                                       |       |       | 54,000     |                                                                                           |       |                                 |       | * |   |
| Clarence L.  Irving, Jr.(8)                                      |       |       | 55,375     |                                                                                           |       |                                 |       | * |   |
| Jeff Morris(9)                                                        |       |       | 49,500     |                                                                                           |       |                                 |       | * |   |
| Lemuel  Tarshis(10)                                                   |       |       | 62,700     |                                                                                           |       |                                 |       | * |   |
| All current directors  and executive officers as a group (10 persons) |       |       | 8,177,088  |                                                                                           |       |                                 | 19.69      | % |   |

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*                    Less than 1%of the outstanding Common Stock.

(1)          Includes options topurchase 296,250 shares of common stock. Also includes 3,654,246 shares ofcommon stock held directly, 1,434,429 shares of common stock held withingrantor retained trusts in which either Mr. Krisbergh or his spouse aretrustees, 299,938 shares of common stock held by Mr. Krisbergh’s spouseand 300,000 shares of common stock held by the Krisbergh Family Foundation,with Mr. Krisbergh acting as the custodian for these shares.

(2)          Includes options topurchase 477,458 shares of common stock. Also includes 106,063 shares of commonstock held directly and 68,879 shares of common stock held by Mr. Gort ascustodian for his minor children.

(3)          Includes options topurchase 538,000 shares of common stock and 241 shares of common stock held by Mr. Westerfer’sminor son.

(4)          Includes options topurchase 391,238 shares of common stock. Also includes 9,371 shares of commonstock held directly.

(5)          Includes options topurchase 330,400 shares of common stock.

(6)          Includes options topurchase 39,000 shares of common stock. Also includes 10,000 shares of commonstock held directly.

(7)          Includes options topurchase 39,000 shares of common stock. Also includes 15,000 shares of commonstock held directly.

(8)          Includes options topurchase 55,375 shares of common stock.

(9)          Includes options topurchase 49,500 shares of common stock.

(10)   Includes options to purchase45,500 shares of common stock. Also includes 5,200 shares of common stock helddirectly and 12,000 shares of common stock held by Mr. Tarshis’ spouse.

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**Item 13. CertainRelationships and Related Transactions, and Director Independence**

**Certain Relationships and Related Transactions**

None.

**Director Independence**

Inaccordance with our Bylaws, our Board of Directors has specified that, as ofthe date of our 2006 Annual Meeting, the number of Directors will be set at six.Five of our six Directors are non-employee Directors, and the Board ofDirectors has determined that each of these five Directors has no relationshipwhich, in the opinion of the Board of Directors, would interfere with theexercise of independent judgment in carrying out the responsibilities of aDirector, and that each meets the objective requirements for “independence”under the NASDAQ Marketplace Rules. Therefore, the Board of Directors hasdetermined that each of these five Directors is an “independent” Director underthe standards currently set forth in the NASDAQ Marketplace Rules. The Directorwho is not independent is Mr. Krisbergh, the Company’s chairman andpresident.

As of December 31, 2006 ourdirectors are as follows:

| **Name**                           | ** ** | ** ** | ** ** | **Age** | ** ** | **Position**                                                    | ** ** |
|------------------------------------|------------|------------|------------|---------|------------|-----------------------------------------------------------------|------------|
| Hal M. Krisbergh                   |       |       | 59         |    |       | Chairman of the Board of  Directors and Chief Executive Officer |       |
| Steven C. Davidson(2)              |       |       | 58         |    |       | Director                                                        |       |
| Clarence L. Irving, Jr.(1)(3) |       |       | 51         |    |       | Director                                                        |       |
| Martin Jaffe(2)                    |       |       | 60         |    |       | Director                                                        |       |
| Jeff Morris(1)                     |       |       | 54         |    |       | Director                                                        |       |
| Lemuel Tarshis(2)(3)               |       |       | 66         |    |       | Director                                                        |       |

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(1)          Member of Compensation Committee

(2)          Member of Audit Committee

(3)          Member of the CorporateGovernance and Nominating Committee

**Item 14. PrincipalAccountant Fees and Services**

On November 17, 2005, Grant Thornton LLP (GrantThornton), our independent registered public accounting firm, advised theCompany that it would not stand for re-appointment for the audit of the yearending December 31, 2005 and that it would be resigning as the Company’sindependent auditor effective upon the completion of its engagement which endedwith the audit of the restatement described below and the review of the Company’sfinancial statements included in its Quarterly Report on Form 10-Qfor the quarter ended September 30, 2005. As stated in the Company’s ProxyStatement pursuant to Section 14(a) of the Securities Exchange Act of1934, as filed on September 9, 2005 with the SEC, the Company had withheldany decision as to the retention of an independent registered public accountingfirm for fiscal year 2005. The Company has elected to not seek the re-engagementof Grant Thornton.

On January 24, 2006, the Company filed amendmentsto and restatements of its financial statements for the years ended December 31,2003 and 2004 as included in the Company’s Annual Report on Form 10-K/Afor the fiscal year ended December 31, 2004, and the interim financialstatements for the periods ended March 31, 2004 through June 30, 2005included in the Company’s Quarterly Reports on Form 10-Q. The reportof independent registered public accounting firm issued by Grant Thornton datedFebruary 24, 2005 (except for Note 2 *RestatementNo. 1* as to which the date is August 24, 2005 andNote 3 *Restatement No. 2*as to which the date is January 10, 2006 included in the Company’s AnnualReport on Form 10-K/A for the fiscal year ended December 31,2004 filed on January 24, 2006) contained no adverse 

56

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opinion or disclaimer ofopinion, and was not qualified or modified as to uncertainty, audit scope, oraccounting principles, except for a modification related to an uncertaintyregarding the Company’s ability to continue as a going concern, and anexplanatory paragraph regarding two restatements of the Company’s consolidatedfinancial statements for the years ended December 31, 2004 and 2003.

During the fiscal years ended December 31, 2003and 2004, and any subsequent interim period through the date hereof, there wereno disagreements between the Company and Grant Thornton on any matter ofaccounting principles or practices, financial statement disclosure or auditingscope or procedure, which disagreement(s), if not resolved to the satisfactionof Grant Thornton, would have caused it to make reference to the subject matterof the disagreement(s) in connection with its reports.

On January 5, 2006, the Audit Committee of theCompany’s Board of Directors engaged the firm of Marcum & Kliegman,LLP (M&K) as the new independent registered public accountants to audit theCompany’s financial statements as of and for the period ended December 31,2005. During the Company’s 2004 and 2005 fiscal years, and through January 5,2006, the Company has not consulted with M&K regarding the application ofaccounting principles to a specified transaction, either completed or proposed,or the type of audit opinion that might be rendered on the Company’s financialstatements nor has it consulted with M&K regarding any matter that waseither the subject of a disagreement, as that term is defined in Item 304(a)(1)(iv) of Regulation S-K and the related instructions to Item 304of Regulation S-K, or a reportable event, as that term is defined inItem 304 (a)(1)(v) of Regulation S-K.

Theaggregate fees for professional services rendered to us by Marcum &Kliegman LLP, our independent registered public accounting firm for the fiscalyears ended December 31, 2005 and 2006, are as follows (in whole dollars):

| ** **         | ** ** | **Fiscal Years Ended  December 31** | ** ** |
|--------------------|------------|----------------------------------------------------|------------|
| ** **         | ** ** | **2005**                                           | ** ** | **2006** | ** ** |
| Audit fees         |       | $                                                  | 190,000    |   | $ | 202,600 |   |
| Audit related fees |       | 0                                                  |       | 33,000 |   |
| Tax fees           |       | 0                                                  |       | 25,000 |   |
| All other fees     |       | 0                                                  |       | 0 |   |
| Total              |       | $                                                  | 190,000    |   | $ | 260,600 |   |

*Audit Fees*

The “audit fees” reportedabove were billed to us by Marcum & Kliegman LLP for professionalservices rendered in connection with their audit of our consolidated financialstatements and their limited reviews of our unaudited condensed consolidatedfinancial statements and our unaudited condensed consolidated interim financialstatements included in our quarterly reports, and for services normallyprovided by  Marcum &Kliegman  LLP in connection with otherstatutory and regulatory filings or engagements, including audit consultations,issuance of consents for registration statements and SEC comment letters.

*Audit Related Fees*

The “audit related fees”reported above were billed to us by Marcum & Kliegman LLP   for assurance and related services that werereasonably related to the performance of their audit or review of our financialstatements, but which are not reported as Audit Fees. These services includeaccounting consultations in connection with the impact of prospectiveaccounting pronouncements and stock based compensation matters.

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*Tax Fees*

During the fiscal yearsreported above, Marcum & Kliegman LLP rendered professional servicesto us relating to tax compliance, tax advice, or tax planning.

*All Other Fees*

During the fiscal yearsreported above, Marcum & Kliegman LLP rendered no professionalservices to us other than for those relating to audit, audit related and taxmatters.

*Audit CommitteePre-approval Policies and Procedures*

Our audit committee has adopted a policy requiring thepre-approval of all audit and permissible nonaudit services provided by ourindependent public auditors. Under the policy, the audit committee is tospecifically pre-approve before the end of each fiscal year any recurring auditand audit related services to be provided during the following fiscal year. Theaudit committee also may generally pre-approve, up to a specified maximumamount, any nonrecurring audit and audit related services for the followingfiscal year. All pre-approved matters must be detailed as to the particularservice or category of services to be provided, whether recurring ornon-recurring, and reported to the audit committee at its next scheduledmeeting. Permissible nonaudit services are to be pre-approved on a case-by-casebasis. The audit committee may delegate its pre-approval authority to any ofits members, provided that such member reports all pre-approval decisions tothe audit committee at its next scheduled meeting. Our independent publicauditors and members of management are required to report periodically to theaudit committee the extent of all services provided in accordance with thepre-approval policy, including the amount of fees attributable to suchservices.

In accordance with Section 10A(i)(2) ofthe Securities Exchange Act of 1934, as amended by Section 202 of theSarbanes-Oxley Act of 2002, we are required to disclose the approval by theaudit committee of the Board of Directors of non-audit services to be performedby  Marcum and Kliegman LLP, the Company’sindependent auditors. Non-audit services are services other than those providedin connection with an audit or review of the financial statements. During theperiod covered by this filing, the audit committee approved all audit relatedfees, tax fees and all other fees.

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**PART IV**

**Item 15. Exhibitsand Financial Statement Schedules.**

(a)           Documents filed as partof this report.

**1.****                FinancialStatements**

Thefollowing financial statements have been included as part of this report:
| Report of Marcum &  Kliegman LLP, Independent Registered Public Accounting Firm |
|------------------------------------------------------------------------------------------|
| Report of Grant  Thornton LLP, Independent Registered Public Accounting Firm             |
| Consolidated  Balance Sheets                                                             |
| Consolidated  Statements of Operations                                                   |
| Consolidated  Statements of Stockholders’ Equity                                    |
| Consolidated  Statements of Cash Flows                                                   |
| Notes to  Consolidated Financial Statements                                              |

 

**2.****                FinancialStatement Schedule**

**WORLDGATECOMMUNICATIONS, INC.SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS**

| ** **                                    | ** ** | **Balance at  Beginning of  Year** | ** ** | **Additions Charged  to Cost and  Expenses** | ** ** | **Deductions  Credited to  Costs and  Expenses** | ** ** | **Balance at  end of Year** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------|------------|-------------------------------------------------------------|------------|------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                    | ** ** | **($000 Omitted)**                      | ** ** |
| Allowance for doubtful  accounts:             |       |                                         |       |                                                        |       |                                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Year ended December 31, 2004             |       |                                         | 381        |                                                        |       |                                                       | 0          |                                       |       |   | (381 | ) |   |   | 0 |   |   |
| Year ended December 31, 2005             |       |                                         | 0          |                                                        |       |                                                       | 0          |                                       |       |   | 0 |   |   |   | 0 |   |   |
| Year ended December 31, 2006             |       |                                         | 0          |                                                        |       |                                                       | 0          |                                       |       |   | 0 |   |   |   | 0 |   |   |
| Valuation Allowance for  Deferred Tax Assets: |       |                                         |       |                                                        |       |                                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Year ended December 31, 2004             |       |                                         | 72,618     |                                                        |       |                                                       | 7,094      |                                       |       |   |   |   |   |   | 78,712 |   |   |
| Year ended December 31, 2005             |       |                                         | 78,712     |                                                        |       |                                                       | 6,586      |                                       |       |   |   |   |   |   | 85,298 |   |   |
| Year ended  December 31, 2006            |       |                                         | 85,298     |                                                        |       |                                                       | 14,037     |                                       |       |   |   |   |   |   | 99,335 |   |   |

 

All other schedulesfor which provision is made in the applicable accounting regulations of theSecurities and Exchange Commission are not required under the relatedinstructions or are inapplicable, and therefore have been omitted.

**3.****                Exhibits**

| Exhibit | ** ** | **Description**                                                                                                                                                                       |
|---------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1     |       | Amended and Restated Certificate of Incorporation(11)                                                                                                                                 |
| 3.2     |       | Amended and Restated Bylaws(2)                                                                                                                                                        |
| 3.3     |       | Certificate of Amendment to Certificate of Incorporation,  dated October 18, 2004(11)                                                                                            |
| 3.4     |       | Certificate of Designations, Preferences and Rights  of the Series A Convertible Preferred Stock of the Company dated  June 24, 2004(11)                                    |
| 4.1     |       | Form of Warrant issued by the Company to the  Purchasers (as defined in the Amended and Restated Securities Agreement dated  as of December 4, 2003)(4)                     |
| 4.2     |       | Form of Additional Investment Right issued by  the Company to the Purchasers (as defined in the Amended and Restated  Securities Agreement dated as of December 4, 2003)(4) |

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| 4.3   |   | Form of Warrant issued by the Company to the  Purchasers (as defined in the Securities Purchase Agreement dated as of  January 20, 2004)(7)                                                                                                                                                                                                    |
|-------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.4   |   | Form of Additional Investment Right dated  issued by the Company to the Purchasers (as defined in the Securities  Purchase Agreement dated as of January 20, 2004)(7)                                                                                                                                                                          |
| 4.5   |   | Form of Series A Warrant issued by the  Company to the Investors (as defined in the Securities Purchase Agreement  dated as of June 24, 2004)(8)                                                                                                                                                                                          |
| 4.6   |   | Form of Series B Warrant issued by the Company  to the Investors (as defined in the Securities Purchase Agreement dated as of  June 24, 2004 between the Company and the Investors)(8)                                                                                                                                                    |
| 4.7   |   | Form of Series C Warrant issued by the  Company to the Investors (as defined in the Securities Purchase Agreement  dated as of June 24, 2004 between the Company and the Investors)(8)                                                                                                                                                    |
| 4.8   |   | Form of Warrant issued by the Company to  Mr. K. Y. Chou(13)                                                                                                                                                                                                                                                                                   |
| 4.9   |   | Form of Warrant dated August 3, 2005  issued by the Company to the Investors (as defined in the Securities Purchase  Agreement dated August 3, 2005 among the Company and the Investors)(14)                                                                                                                                              |
| 4.10  |   | Form of Warrant dated August 3, 2005  issued by the Company to the Investors (as defined in the Securities Purchase  Agreement dated August 3, 2005 among the Company and the Investors)(14)                                                                                                                                              |
| 4.11  |   | Investor Registration Rights Agreement, dated  August 11, 2006, by and among the Company and Cornell Capital Partners,  LP(16)                                                                                                                                                                                                                      |
| 4.12  |   | Form of Secured Convertible Debenture issued  and issuable by the Company to Cornell Capital Partners, LP pursuant to the  Securities Purchase Agreement, dated as of August 11, 2006(16)                                                                                                                                                      |
| 10.1  |   | Lease Agreement dated October 7, 1998 between  WorldGate and Balanced Capital LLC, as amended by First Amendment to Lease  Agreement dated December 7, 1998 between WorldGate and Balanced Capital  LLC, as further amended by Second Amendment to Lease Agreement dated  December 17, 1998 between WorldGate and Balanced Capital LLC(1) |
| 10.2  |   | Amendment dated November 18, 2004 to Lease  Agreement dated October 7, 1998 between WorldGate and Balanced Capital  LLC(12)                                                                                                                                                                                                                    |
| 10.3  |   | Manufacturing Agreement between WorldGate and  Mototech Inc. dated September 9, 2003(6)                                                                                                                                                                                                                                                             |
| 10.4  |   | Development and Distribution Agreement dated as of April 28,  2004 between the Company, WorldGate Services, Inc. and General Instrument  Corporation d/b/a the Broadband Communication Sector of Motorola, Inc.(9) (Portions  of this agreement are subject to a confidential treatment request.)                                    |
| 10.5  |   | 1996 Stock Option Plan(3)                                                                                                                                                                                                                                                                                                                                |
| 10.6  |   | 2003 Equity Incentive Plan(10)                                                                                                                                                                                                                                                                                                                           |
| 10.7  |   | Amended and Restated Securities Purchase Agreement dated as of December 4,  2003, by and between the Company and the Purchasers (as defined therein)(5)                                                                                                                                                                                             |
| 10.8  |   | Securities Purchase Agreement dated as of January 20, 2004 by  and between the Company and the Purchasers (as defined therein)(7)                                                                                                                                                                                                                   |
| 10.9  |   | Securities Purchase Agreement dated as of June 24, 2004 by and  between the Company and the Investors (as defined therein)(8)                                                                                                                                                                                                                       |
| 10.11 |   | Securities Purchase Agreement, dated as of August 11, 2006, by  and among the Company and Cornell Capital Partners, LP(16)                                                                                                                                                                                                                          |
| 10.10 |   | Securities Purchase Agreement dated August 3, 2005 among the  Company and the Investors (as defined therein)(14)                                                                                                                                                                                                                                    |
| 16    |   | Letter on Change in Certifying Accountant(15)                                                                                                                                                                                                                                                                                                            |
| 21    |   | Subsidiaries*                                                                                                                                                                                                                                                                                                                                            |
| 23.1  |   | Consent of Marcum & Kliegman   LLP*                                                                                                                                                                                                                                                                                                        |
| 23.2  |   | Consent of Grant Thornton LLP*                                                                                                                                                                                                                                                                                                                           |
| 24    |   | Power of Attorney (included in signature page)                                                                                                                                                                                                                                                                                                           |
| 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)*                                                                                                                                                                                                                                                                                |
|       |        |                                                                                                                                                                                                                                                                                                                                                          |  |

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| 32.1 |   | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350,  as adopted by Section 906 of the Sarbanes-Oxley Act of 2002* |
|------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------|
| 32.2 |   | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350,  as adopted by Section 906 of the Sarbanes-Oxley Act of 2002* |

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                 * Filed herewith

       (1) Incorporated by reference to the exhibits to our RegistrationStatement on Form S-1/A as filed on April 7, 1999 (RegistrationNo. 333-71997).

       (2) Incorporated by reference to the exhibits to our Form 10-QReport for the quarter ended March 31, 1999.

       (3) Incorporated by reference to the exhibits to our Form 10-K/AReport for the fiscal year ended December 31, 2000, as filed onAugust 17, 2001.

       (4) Incorporated by reference to the exhibits to our Current Report onForm 8-K filed December 2, 2003.

       (5) Incorporated by reference to the exhibits to our Current Report onForm 8-K filed December 4, 2003.

       (6) Incorporated by reference to the exhibits to our RegistrationStatement on Form SB-2 as filed on December 24, 2003(Registration No. 333-111571).

       (7) Incorporated by reference to the exhibits to our Current Report onForm 8-K filed January 21, 2004.

       (8) Incorporated by reference to the exhibits to our Current Report onForm 8-K filed June 25, 2004.

       (9) Incorporated by reference to the exhibits to our Current Report onForm 8-K filed July 13, 2004.

(10) Incorporated by reference to the exhibits to the Company’s ProxyStatement to shareholders filed September 3, 2004.

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

(12) Incorporated by reference to the exhibits to our Form 10-KReport for the fiscal year ended December 31, 2004, as filed onMarch 31, 2005.

(13) Incorporated by reference to the exhibits to our RegistrationStatement on Form SB-2 as filed on May 24, 2005.

(14) Incorporated by reference to the exhibits to our Current Report onForm 8-K filed August 8, 2005.

(15) Incorporated by reference to the exhibits to our Current Report onForm 8-K filed November 23, 2005.

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

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
|                            | WORLDGATE COMMUNICATIONS, INC. |
|----------------------------|-------------------------------------|
| Date: March 15,  2007 | By:                                 | /s/  HAL M. KRISBERGH |
|                       |                                | Hal M. Krisbergh |
|                       |                                | Chief Executive  Officer |

 

**Power of Attorney**

Each person whose signature appears below herebyconstitutes and appoints Hal M. Krisbergh and Randall J. Gort the true andlawful attorneys-in-fact and agents of the undersigned, with full power ofsubstitution and resubstitution, for and in the name, place and stead of theundersigned, in any and all capacities, to sign any and all amendments to thisreport, and to file the same, with all exhibits thereto, and other documents inconnection therewith, with the Securities and Exchange Commission, and herebygrants to such attorneys-in-fact and agents full power and authority to do andperform each and every act and thing requisite and necessary to be done, asfully to all intents and purposes as the undersigned might or could do inperson, hereby ratifying and confirming all that said attorneys-in-fact andagents, or their substitute or substitutes, may lawfully do or cause to be doneby virtue hereof.

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.
|                               | **Name** | ** **                                         | ** ** | ** **            | **Capacity** | ** ** | ** ** | ** ** | **Date** | ** ** | ** ** |
|-------------------------------|----------|----------------------------------------------------|------------|-----------------------|--------------|------------|------------|------------|----------|------------|------------|
| /s/ HAL M.  KRISBERGH         |     | Chairman  of the Board and Chief Executive         |       | March 15  , 2007 |         |
| Hal  M. Krisbergh             |     | Officer  (Principal Executive Officer)             |       |                  |         |
| /s/ JOEL  BOYARSKI            |     | Senior  Vice President and Chief Financial Officer |       | March 15  , 2007 |         |
| Joel  Boyarski                |     | (Principal  Financial and Accounting Officer)      |       |                  |         |
|                          |     |                                               |       |                  |         |
| /s/ STEVEN C.  DAVIDSON       |     | Director                                           |       | March 15  , 2007 |         |
| Steven  C. Davidson           |     |                                               |       |                  |         |
| /s/ MARTIN  JAFFE             |     | Director                                           |       | March 15  , 2007 |         |
| Martin  Jaffe                 |     |                                               |       |                  |         |
| /s/ CLARENCE  L. IRVING, JR.  |     | Director                                           |       | March 15  , 2007 |         |
| Clarence  L. Irving, Jr. |     |                                               |       |                  |         |
| /s/ JEFF  MORRIS              |     | Director                                           |       | March 15  , 2007 |         |
| Jeff  Morris                  |     |                                               |       |                  |         |
| /s/ LEMUEL  TARSHIS           |     | Director                                           |       | March 15  , 2007 |         |
| Lemuel Tarshis                |     |                                               |       |                  |         |

 

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**Exhibit Index**
| Exhibit | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                           | ** ** |
|---------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| 3.1     |       | Amended  and Restated Certificate of Incorporation(11)                                                                                                                                                                                                                                                                                                    |       |
| 3.2     |       | Amended  and Restated Bylaws(2)                                                                                                                                                                                                                                                                                                                           |       |
| 3.3     |       | Certificate  of Amendment to Certificate of Incorporation, dated October 18, 2004(11)                                                                                                                                                                                                                                                                |       |
| 3.4     |       | Certificate  of Designations, Preferences and Rights of the Series A Convertible  Preferred Stock of the Company dated June 24, 2004(11)                                                                                                                                                                                                        |       |
| 4.1     |       | Form of  Warrant issued by the Company to the Purchasers (as defined in the Amended  and Restated Securities Agreement dated as of December 4, 2003)(4)                                                                                                                                                                                         |       |
| 4.2     |       | Form of  Additional Investment Right issued by the Company to the Purchasers (as  defined in the Amended and Restated Securities Agreement dated as of  December 4, 2003)(4)                                                                                                                                                                    |       |
| 4.3     |       | Form of  Warrant issued by the Company to the Purchasers (as defined in the Securities  Purchase Agreement dated as of January 20, 2004)(7)                                                                                                                                                                                                     |       |
| 4.4     |       | Form of  Additional Investment Right dated issued by the Company to the Purchasers (as  defined in the Securities Purchase Agreement dated as of January 20,  2004)(7)                                                                                                                                                                          |       |
| 4.5     |       | Form of  Series A Warrant issued by the Company to the Investors (as defined in  the Securities Purchase Agreement dated as of June 24, 2004)(8)                                                                                                                                                                                           |       |
| 4.6     |       | Form of  Series B Warrant issued by the Company to the Investors (as defined in  the Securities Purchase Agreement dated as of June 24, 2004 between the  Company and the Investors)(8)                                                                                                                                                    |       |
| 4.7     |       | Form of  Series C Warrant issued by the Company to the Investors (as defined in  the Securities Purchase Agreement dated as of June 24, 2004 between the  Company and the Investors)(8)                                                                                                                                                    |       |
| 4.8     |       | Form of  Warrant issued by the Company to Mr. K. Y. Chou(13)                                                                                                                                                                                                                                                                                    |       |
| 4.9     |       | Form of  Warrant dated August 3, 2005 issued by the Company to the Investors (as  defined in the Securities Purchase Agreement dated August 3, 2005 among  the Company and the Investors)(14)                                                                                                                                              |       |
| 4.10    |       | Form of  Warrant dated August 3, 2005 issued by the Company to the Investors (as  defined in the Securities Purchase Agreement dated August 3, 2005 among  the Company and the Investors)(14)                                                                                                                                              |       |
| 4.11    |       | Investor  Registration Rights Agreement, dated August 11, 2006, by and among the  Company and Cornell Capital Partners, LP(16)                                                                                                                                                                                                                       |       |
| 4.12    |       | Form of  Secured Convertible Debenture issued and issuable by the Company to Cornell  Capital Partners, LP pursuant to the Securities Purchase Agreement, dated as  of August 11, 2006(16)                                                                                                                                                      |       |
| 10.1    |       | Lease  Agreement dated October 7, 1998 between WorldGate and Balanced Capital  LLC, as amended by First Amendment to Lease Agreement dated December 7,  1998 between WorldGate and Balanced Capital LLC, as further amended by Second  Amendment to Lease Agreement dated December 17, 1998 between WorldGate  and Balanced Capital LLC(1) |       |
| 10.2    |       | Amendment  dated November 18, 2004 to Lease Agreement dated October 7, 1998  between WorldGate and Balanced Capital LLC(12)                                                                                                                                                                                                                     |       |
| 10.3    |       | Manufacturing  Agreement between WorldGate and Mototech Inc. dated September 9, 2003(6)                                                                                                                                                                                                                                                              |       |
| 10.4    |       | Development  and Distribution Agreement dated as of April 28, 2004 between the  Company, WorldGate Services, Inc. and General Instrument Corporation  d/b/a the Broadband Communication Sector of  Motorola, Inc.(9) (Portions of this agreement are subject to a  confidential treatment request.)                                   |       |
| 10.5    |       | 1996  Stock Option Plan(3)                                                                                                                                                                                                                                                                                                                                |       |
| 10.6    |       | 2003  Equity Incentive Plan(10)                                                                                                                                                                                                                                                                                                                           |       |
| 10.7    |       | Amended  and Restated Securities Purchase Agreement dated as of December 4, 2003,  by and between the Company and the Purchasers (as defined therein)(5)                                                                                                                                                                                             |       |
| 10.8    |       | Securities  Purchase Agreement dated as of January 20, 2004 by and between the  Company and the Purchasers (as defined therein)(7)                                                                                                                                                                                                                   |       |

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| 10.9  |   | Securities  Purchase Agreement dated as of June 24, 2004 by and between the Company  and the Investors (as defined therein)(8)                   |   |
|-------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| 10.10 |   | Securities  Purchase Agreement dated August 3, 2005 among the Company and the  Investors (as defined therein)(14)                                |   |
| 10.11 |   | Securities  Purchase Agreement, dated as of August 11, 2006, by and among the  Company and Cornell Capital Partners, LP(16)                      |   |
| 16    |   | Letter  on Change in Certifying Accountant(15)                                                                                                        |   |
| 21    |   | Subsidiaries*                                                                                                                                         |   |
| 23.1  |   | Consent  of Marcum & Kliegman LLP*                                                                                                           |   |
| 23.2  |   | Consent  of Grant Thornton LLP*                                                                                                                       |   |
| 24    |   | Power  of Attorney (included in signature page)                                                                                                       |   |
| 31.1  |   | Certification  of Chief Executive Officer Pursuant to Rule 13a-14(a)*                                                                            |   |
| 31.2  |   | Certification  of Chief Financial Officer Pursuant to Rule 13a-14(a)*                                                                            |   |
| 32.1  |   | Certification  of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as  adopted by Section 906 of the Sarbanes-Oxley Act of 2002* |   |
| 32.2  |   | Certification of Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted by  Section 906 of the Sarbanes-Oxley Act of 2002* |   |

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                 * Filed herewith

       (1) Incorporated by reference to the exhibits toour Registration Statement on Form S-1/A as filed on April 7,1999 (Registration No. 333-71997).

       (2) Incorporated by reference to the exhibits toour Form 10-Q Report for the quarter ended March 31, 1999.

       (3) Incorporated by reference to the exhibits toour Form 10-K/A Report for the fiscal year ended December 31,2000, as filed on August 17, 2001.

       (4) Incorporated by reference to the exhibits toour Current Report on Form 8-K filed December 2, 2003.

       (5) Incorporated by reference to the exhibits toour Current Report on Form 8-K filed December 4, 2003.

       (6) Incorporated by reference to the exhibits toour Registration Statement on Form SB-2 as filed on December 24,2003 (Registration No. 333-111571).

       (7) Incorporated by reference to the exhibits toour Current Report on Form 8-K filed January 21, 2004.

       (8) Incorporated by reference to the exhibits toour Current Report on Form 8-K filed June 25, 2004.

       (9) Incorporated by reference to the exhibits toour Current Report on Form 8-K filed July 13, 2004.

(10) Incorporated by reference to the exhibits tothe Company’s Proxy Statement to shareholders filed September 3, 2004.

(11) Incorporated by reference to the exhibits toour Form 10-Q Report for the quarter ended September 30, 2004,as filed on November 17, 2004.

(12) Incorporated by reference to the exhibits toour Form 10-K Report for the fiscal year ended December 31,2003, as filed on March 31, 2005.

(13) Incorporated by reference to the exhibits toour Registration Statement on Form SB-2 as filed on May 24,2005.

(14) Incorporated by reference to the exhibits toour Current Report on Form 8-K filed August 8, 2005.

(15) Incorporated by reference to the exhibits toour Current Report on Form 8-K filed November 23, 2005.

(16) Incorporated by reference to the exhibits toour Form 10-Q Report for the quarter ended June 30, 2006, asfiled on August 14, 2006.

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