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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

Commission file number: 000-25755

WorldGate Communications, Inc.
(Exact name of registrant as specified in its charter)

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

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes ý

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) Yes o    No ý

        The aggregate market value of the common stock held by non-affiliates of the registrant was approximately $46.7 million as of June 30, 2004, based on the closing sale price of $2.10 per share of common stock, as reported on the NASDAQ Small Cap Market.

        The number of shares of the registrant's common stock outstanding as of March 4, 2005 was 31,705,489.

DOCUMENTS INCORPORATED BY REFERENCE

[None]

WORLDGATE COMMUNICATIONS, INC.

ANNUAL REPORT ON FORM 10-K
For the Fiscal Year Ended December 31, 2004

TABLE OF CONTENTS

WORLDGATE COMMUNICATIONS, INC.

        This report contains forward-looking statements that involve risks and uncertainties. These forward-looking statements are based on management's current expectations and are subject to a number of uncertainties and risks that could cause actual results to differ significantly from those anticipated in these forward-looking statements. Factors that may cause such a difference include, but are not limited to, those set forth in the "Management's Discussion and Analysis of Financial Condition and Results of Operations" as well as those discussed elsewhere in this report.

PART I

Item 1. Business

        WorldGate Communications, Inc. was incorporated in Delaware in 1996 to succeed to the business of our predecessor, WorldGate Communications, L.L.C., which commenced operations in March 1995. In April 1999, we completed our initial public offering of 5,750,000 shares of our common stock. Since January 9, 2003 our common stock has been listed on the NASDAQ Small Cap Market. Previously our common stock was traded on the NASDAQ National Market. Our common stock is traded under the symbol "WGAT". Our executive offices are located at 3190 Tremont Avenue, Suite 100, Trevose, Pennsylvania 19053.

Overview

        Since our formation in 1995 and until recently, we were in the business of developing and selling interactive television, or ITV, technology, products and services for use in conjunction with cable TV broadband networks (the "ITV Business"). Using our solutions, cable TV operators branded, marketed, and offered a wide variety of ITV packages to consumers. These packages included walled gardens of information, communications solutions complete with Internet-based e-mail and chat, and Web surfing, all presented and engaged on the TV set.

        During the third quarter of 2003, we completed a sale of significant assets, including our ITV intellectual property rights and our membership interest in TVGateway, LLC, for $3 million in cash to TVGateway, LLC, an ITV oriented company we were instrumental in forming. Our transaction with TVGateway, LLC marked a shift in our business away from the ITV Business and toward a new video phone product and associated business. Although we continued to support our current ITV Business into the first quarter of 2004, the development of our video phone product became a primary business focus. The funds we received from the sale of assets to TVGateway, LLC, as well as the funds we subsequently received as a result of several private placements of our securities have permitted us to fund the development of our new business.

        During 2004, we continued development of a video phone, designed specifically for personal video communication over high speed data, or HSD or broadband networks, that we believe is differentiated, both from competitors and from previous efforts at personal video telephony, by providing: true to life communication, ease of deployment by HSD operators, ease of use by residential and business end users, a highly styled ergonomic design, and interoperation with the public switched telephone network, or PSTN. The design of our first video phone product was substantially completed in late 2004 and field trials were commenced. Commercial distribution of this product is expected to commence in the spring 2005 time frame.

        On April 28, 2004, we entered into a multi-year agreement with General Instrument Corporation d/b/a the Broadband Communication Sector of Motorola, Inc. for the worldwide development and distribution of the Ojo personal video phone. Under the terms of the agreement, our video phone will be co-branded with our trademark, Ojo™, and Motorola will market the Ojo personal video phone as

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part of its "connected home" portfolio of consumer HSD solutions. Motorola plans to distribute Ojo worldwide through HSD service providers, retailers, and distributors of telecommunications products.

        HSD service users provide a large, and we believe conducive, target market for a quality video phone offering. We believe that Motorola, as a worldwide market leader in the HSD market is well-positioned to assist us with our video phone offering. Initial video phone sales are expected to be derived from new technology adopters and regular long distance communicators such as families and close friends. We also expect that the business-to-business opportunity will be attractive as a video phone provides means to improve interpersonal communication and multi-location productivity. Furthermore we expect that the growth in the voice over Internet protocol market (or "VoIP") will also help to drive sales of our video phone since it can also serve as a VoIP endpoint.

        Our business model is based on the sale of video phones and related products. We expect that our products will be marketed to HSD operators as well as to consumers through traditional consumer electronics distribution channels. We believe that HSD operators could realize significant recurring revenue streams associated with offering our product to end users. We have also developed this product to require very minimal capital investment or incremental costs by such operators. Our marketing objective is to have our video phones supplement and hopefully replace ordinary home and business phones worldwide.

General Product Description

        We have developed a video phone, ergonomically designed specifically for in-home and business, personal video communication. We have identified several issues that have interfered with commercial success and consumer acceptance of video phones and sought to address each of these issues within the Ojo video phone. The Ojo video phone was designed for use on the existing HSD infrastructure. The Ojo phone will, however, also connect to the analog phone line for interoperability with the voice only communications offered by the existing PSTN networks. Ojo, therefore, can be used for video calls, for ordinary voice only calls as well as for voice over Internet protocol, or VoIP calls. We believe that Ojo is differentiated, both from competitors and from previous efforts at personal video telephony, by providing: true to life communication, interoperation with the PSTN, ease of deployment by HSD operators, ease of use by consumers, and a highly styled ergonomic design. We believe Ojo is further differentiated by the development of a state of the art connectivity infrastructure, which leverages the convergence of the latest compression technology, processing power and increased bandwidth availability, to help ensure, enable and maintain dedicated high quality end-to-end connections.

        The Ojo solution consists of two primary components:

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A display unit includes the camera, video screen and external interface ports. The video screen is used to display menus and provide a user interface as well as to view the images of the local and remote parties. Considerable effort has been expended in the ergonomic and stylistic design of the display unit. For example, it is taller than most conventional phones to ensure that the user is looking into the unit and not down at the unit. Similarly the camera of the unit is looking at the user at face level, instead of "up the user's nose." The display unit can be used as a standard speaker phone to receive both audio and audio/video calls. The display unit is designed to be aesthetically usable in any room. Particular attention was given to the user interface to ensure that Ojo was installable and usable without the need to refer constantly to a manual. The display contains two RJ-45 jacks, one for connection to the cable or DSL modem and the other for connection to an external device such as a PC, and an RJ-11 jack for connection to the PSTN or VoIP network. The consumer simply plugs the display unit into the high-speed modem or router and into the standard house power outlet to facilitate access to the necessary data network. In addition to a connection to the high-speed modem or router, the display unit also connects to the standard phone line. This connection,

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while not required for a video phone call, allows the Ojo video phone to also be used as a standard telephone.

2.

The Ojo PVP also has a wireless handset that functions as a typical cordless phone. It includes a cordless telephone with internal speaker and microphone, a monochrome graphical display and most of the user controls for the device (numeric keypad, navigation device, talk, mute and end buttons). Although the handset is discussed as a separate component, it will generally be seated in the lower portion of the display unit where it will serve as the navigation device while its batteries are being charged. The handset fits into a cradle on the display unit. It is designed to be used both as part of a video call, or alone for standard PSTN phone calls. Since the Ojo unit is designed to receive and make audio calls as well as video calls, the handset functions as a typical cordless phone and has the features a user typically expects for a cordless phone. Although video calls can be received at the display unit even when the handset is not present, the handset is intended to be the primary component used to operate the video phone (in a manner similar to a television remote control).

Material Developments for WorldGate since December 31, 2003

        The following is a summary of material developments for us that have occurred since December 31, 2003:

        In January 2004, during the Consumer Electronics Show we successfully demonstrated the capability of delivering high quality video telephone over the Internet. Using our Ojo PVP, we demonstrated repeated quality calls between our headquarters in suburban Philadelphia and Las Vegas. Using a data rate of 150 kbps, we made video calls with full motion video displayed at 30 frames per second, similar to that of broadcast television. The calls provided consistent, true-to-life, synchronized, voice and video communications during peak Internet usage time periods. We believe this was the first successful demonstration of H. 264-based signal processing technology in a personal video phone.

        On January 21, 2004, we completed a private placement resulting in an issuance of 1,000,000 shares of our common stock at a sale price of $1.50 per share, five-year warrants to purchase up to 300,000 shares of our common stock at an exercise price of $1.875 per share, and additional investment rights to purchase, for a limited period of time, up to 200,000 shares of our common stock at an exercise price of $1.50 per share. In addition, we agreed to issue warrants to purchase up to an additional 10,000 shares of our common stock at an exercise price of $1.875 per share upon the exercise of the additional investment rights. The January 2004 private placement resulted in gross proceeds to us of approximately $1.5 million.

        On April 23, 2004, we completed a private placement of 666,666 shares of our common stock with Mototech Inc., at a sale price of $1.50 per share. The private placement resulted in gross proceeds to us of $1 million.

        On May 3, 2004, we announced that we had entered into a multi-year agreement with Motorola, Inc. for the worldwide development and distribution of the Ojo PVP. Under the terms of the agreement, Motorola will market the Ojo personal video phone as part of its "connected home" portfolio of consumer HSD solutions. Motorola will distribute Ojo worldwide through HSD service providers, retailers, and distributors of telecommunications products. Additionally, Motorola and WorldGate will jointly develop future HSD video telephony solutions.

        On June 24, 2004, we completed another private placement that resulted in the issuance of 7,550 shares of Series A preferred stock at a sale price of $1000 per share (which preferred stock is convertible into our common stock at a conversion price of $2.35 per share,) five-year warrants to purchase up to 803,190 shares of our common stock at an exercise price of $2.69 per share, and five-year warrants to purchase up to 803,190 shares of our common stock at an exercise price of $3.14

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per share. The investors also received an additional investment right, for a limited period of time, to purchase 1,606,383 additional shares of common stock shares at $3.14 a share. The June 2004 private placement resulted in gross proceeds to our Company of $7,550,000.

        On November 10, 2004 we announced that the Ojo PVP was awarded a 2005 Consumer Electronics Show (CES) Best of Innovations Award from the Consumer Electronics Association (CEA).

        At the 2005 CES Show, held in Las Vegas on January 6 - 9, we formally introduced our Ojo PVP. The International Consumer Electronics Show (CES) is one of the world's largest annual consumer technology shows. We conducted live demonstrations to attendees and the press of the Ojo phone transmitting full-motion video with synchronized audio over a HSD internet connection.

        During December 2004, and through January 2005, we received cash proceeds of $7,565,000 from the exercise of outstanding warrants issued pursuant to the private placements discussed above, by the exercise of non-executive employees' and prior employees' stock options, and by a private placement of an additional 208,333 shares of our common stock. In connection with this placement, we granted warrants to Mr. K.Y. Chou to purchase up to 62,500 shares of our common stock at an exercise price of $2.88 per share.

Business Strategy

        General.    Our business model, as is typical of a consumer electronics product, is based upon the sale of Ojo PVPs and does not rely upon any service fees or other recurring revenue stream for WorldGate, although such recurring streams may materialize. It is our plan for Ojo PVP to be distributed through and in partnership with HSD service providers, as well as through traditional electronics distribution channels. Video phone service, using the Ojo PVP, is expected to be offered by HSD service providers as a means of attracting new HSD subscribers as well as maintaining existing subscribers. We believe that HSD service operators could realize potentially significant recurring revenue streams associated with offering products such as our Ojo PVP, and accordingly we believe they will embrace the concept and business model. The suggested consumer offering for a video phone service follows the traditional HSD model. We anticipate that video phone service subscribers will be able to either purchase Ojo or lease a unit from the HSD service provider.

        Manufacturing.    Ojo PVPs will be manufactured in Asia, to take advantage of the base of lower labor, tooling and component costing. A formal relationship with Mototech Inc. has already been established for the volume manufacture of Ojo. Mototech, along with U.S. Robotics and SMC Networks, are affiliates of the Accton Technology Group. Mototech's responsibilities in this role include:

Product design finalization for manufacturing;
Component selection and procurement;
Tool sourcing and management;
Coordination of Ojo manufacturing;
Implementation and monitoring of Ojo's Quality Plan; and
Product cost reduction.

        As part of our agreement with Mototech we retain formal sign-off control over any product, specification, or component changes proposed by Mototech. We also maintain all rights to the Ojo technology and intellectual property, as well as the right to second source the Ojo product.

        Product Sales and Distribution.    We have partnered with an experienced distribution partner, Motorola, Inc. to market and distribute the Ojo PVP. Such partnership is intended to reduce our working capital requirements by minimizing our sales and inventory costs, and provide an entree to more extensive and accelerated coverage than would be permitted by an internal organization. The name recognition, "shelf-space" potential and technology/product validation provided by Motorola are

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also expected to provide a significant advantage. In addition we believe we will further benefit from the Motorola relationship as a result of their access to broadband and telephony technology as well as their sourcing expertise. Through Motorola, Ojo will be marketed domestically and internationally to both the residential and business sectors through the standard consumer and business electronics channels, as well as through HSD providers in a manner similar to broadband modems. Under this relationship, Motorola is our exclusive distribution partner and as such is responsible for the worldwide marketing and distribution of the Ojo PVP. If they are not successful our operating results could be adversely affected.

Competition

        Many of the current video phone manufacturers have focused on two applications—business video phones and video conferencing. Business video phones are designed to be located on an executive's desk and used to communicate with colleagues, employees and customers. Video conferencing units are designed for conference rooms where multiple people on one end engage with multiple people on the other end. The following is a brief description of the potential competitors and their impact on the market.

        Business Phone Products.    Most of these products are targeted for corporate use and are priced at $650.00 and up per unit. Generally, the ergonomic design of these units emulates that of a traditional office telephone with the addition of a camera and display. The products use standard corporate gray or black material colors, familiar button shapes and designs, traditional style handsets for non-speakerphone conversation and often have business feature sets. For connectivity these products use VoIP, PSTN or ISDN. The main competitors in this sector include Viseon Inc., 8x8 Inc., Motion Media PLC, and Leadtek Research Inc.

        Video Conference Products.    D-Link Systems, Inc. produces a TV-based video phone product that is targeted to consumers and promotes its compatibility with DSL and cable modem technologies. D-Link uses the home television as the display device and utilizes either the TV's speaker or connection to a standard analog phone for the audio portion of the call. The main disadvantages of this product are convenience and non-personal video. The D-Link requires a television to send and receive calls. In many cases, this would obstruct the ability to watch television while a call is in progress thereby disrupting family television watching for the length of the call. Numerous video conferencing products exist for the business market. Typically these devices cost $2000 or more and involve complex installations of one or more cameras, monitors, microphones and speakers within a conference room setting. The videoconference nature of these products eliminates the ability to communicate on a private, one-on-one level. The main competitors in this sector include Sony, D-Link Systems, Inc., Sorenson Media and Polycom Inc.

        Telephone Products.    Vialta, Inc. produces the "Beamer", an H.324 (POTS) video phone that is designed for connection to a standard telephone. The product utilizes a standard analog telephone for connection to the PSTN and as the listening device. Because the unit uses traditional telephone lines for connectivity it cannot take advantage of the high-speed data systems available through cable and DSL modems.

        Web Cam Products.    Web cams are different from other competitive products in that they did not arise from either business video phones or video conferencing. Rather, they began in the early days of the Internet when "techies" were expanding the capabilities of PC-based content and applications with low-cost attachments to the computer. Currently, web cams are often used to display visual information rather than as a means for personal communication. Many popular web sites use web cams to show traffic, weather, adult activities and other visually interesting subjects. Software such as Net Meeting, Instant Messenger and MSN messenger are being supported in web cams to enable a video chat option

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to these Internet-based services. Competitors in this category include Logitech, Inc., Intel Corporation, 3Com Corporation, and Creative Technology, Ltd.

        Hybrid Web Cam-Business Phone Products.    In recent months, Cisco Systems, Inc. introduced a hybrid video phone product that is designed for the business phone market. The Cisco product consists of a web cam device and host software that enables video phone functionality when used in conjunction with an IP phone and call processing hardware. We believe this product requires a significant capital investment for implementing the call processing hardware and IP phones.

Intellectual Property

        We plan to rely on patent, trade secret, trademark and copyright law to protect our video phone intellectual property. Although we have filed multiple patent applications for our technology, our patent position is subject to complex factual and legal issues that may give rise to uncertainty as to the validity, scope and enforceability of a particular patent. Accordingly, there can be no assurance that any patents will be issued pursuant to our current or future patent applications or that patents issued pursuant to such applications will not be invalidated, circumvented or challenged. Moreover, there can be no assurance that the rights granted under any such patents will provide competitive advantages to us or be adequate to safeguard and maintain our proprietary rights. In addition, effective patent, trademark, copyright and trade secret protection may be unavailable, limited or not applied for in certain foreign countries.

Government Regulation

        Our Ojo PVP will be required to comply with various laws and government regulations, including Parts 15 and 68 of the FCC's regulations, which relate to radio frequency devices and to terminal equipment that is connected to the telephone network. The legal and regulatory environment that pertains to our business is uncertain and changing rapidly. New legislation or regulation could be introduced that could substantially impact our ability to launch and promote the Ojo video phone. For example, in the United States, the FCC and state regulatory commissions could undertake an examination of whether to impose surcharges or additional regulations upon certain providers of Internet protocol, or IP, based communication services. The imposition of regulations on IP communications services may negatively impact our business.

Research and Development

        To date, our engineering and product development has been a significant focus. The principal focus of our current engineering and development activities is the continued development and enhancement of our Ojo PVP. Development of the Ojo PVP has required combining technical experience and knowledge from two historically separate industries, cable and telephony. Our engineering and development expenditures in connection with our Ojo video phone were approximately $0, $3,000 and $4,001 for the years ended December 31, 2002, 2003 and 2004, respectively.

Employees

        As of December 31, 2004, on a consolidated basis, we had approximately 50 full-time employees. All of our employees are located in Trevose, Pennsylvania. None of our employees are represented by a labor union, and we have no collective bargaining agreement. We consider our employee relations to be good.

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Financial Information Relating to Foreign and Domestic Operations and Export Sales from Continuing Operations

Item 2. Properties.

        Our corporate headquarters is located in Trevose, Pennsylvania in a leased facility consisting of approximately 16,000 square feet. Both we and the landlord, however, have the right to terminate this lease at any time on 90 days prior written notice to the other party. In March 2005, the property was sold and our lease was transferred to the new owner. We are currently negotiating a long term lease with the new owner and we anticipate that this facility will be suitable for our needs for the immediate future.

Item 3. Legal Proceedings.

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

Item 4. Submission of Matters to a Vote of Security Holders.

        At our annual meeting of stockholders held on October 13, 2004, our stockholders elected six members to our Board of Directors. Those elected to the Board were Hal M. Krisbergh, Steven C. Davidson, Clarence L. Irving, Jr., Martin Jaffe, Jeff Morris and Lemuel Tarshis. Stockholders also approved the issuance of shares pursuant to a private placement made during the year, an amendment in the Company's Articles of Incorporation to increase the number of authorized shares, and the WorldGate Communications, Inc. 2003 Equity Incentive Plan.

(1)

Election of Directors:

(2)

Ratification and approval of our issuance of common stock in accordance with June, 2004 Private Placement.

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(3)

Amendment of Certificate of Incorporation to increase authorized common shares to 80 million.

(4)

Ratification and approval of WorldGate Communications, Inc. 2003 Equity Incentive Plan.

PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities.

        Our common stock, $0.01 par value, commenced trading on the NASDAQ National Market under the symbol "WGAT" since our initial public offering in April 15, 1999. We applied for and received permission, effective January 9, 2003 to transfer the listing of our common stock to the NASDAQ Small Cap Market. The following table shows the high and low sales price as reported by the NASDAQ National Market and the NASDAQ Small Cap Market, as is applicable, for each quarter of 2003 and 2004.

        On March 4, 2005, the last reported sale price of our common stock as reported on the NASDAQ Small Cap Market was $3.81 per share.

        As of March 4, 2005, we had 342 holders of record of our common stock.

Dividends

        We have never paid or declared any cash dividends on our common stock. We do not anticipate paying any cash dividends in the foreseeable future. We currently expect to retain future earnings, if any, to finance the growth and development of our business.

Sale of Unregistered Securities

(1)

In December 2003 we completed a private placement of 2,000,000 shares (the "December 2003 Shares") of our common stock to certain institutional investors. The shares were sold for $0.80 per share, resulting in gross proceeds from the offering of $1.6 million. The investors also received a right, for a limited period of time, to purchase additional shares of up to 20% of the common stock purchased by the investors in the placement at $0.80 a

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share. During the first quarter of 2004 these additional investment rights were exercised resulting in an additional purchase of 400,000 shares and an additional $320,000 in gross proceeds. The investors were also issued warrants (the "December 2003 Warrants") to purchase in the aggregate up to 720,000 additional shares (including shares available only as a result of the exercise of the above additional investment rights) of common stock at a per share exercise price of $1.00. In December 2004 one of our investors exercised its warrants resulting in an additional purchase of 168,750 shares and an additional $168,750 in gross proceeds. In January 2005 one of the investors exercised its warrants resulting in an additional purchase of 382,500 shares and an additional $382,500 in gross proceeds.

The December 2003 Shares and the December 2003 Warrants were issued in reliance upon the exemption from the registration requirements of the Securities Act of 1933 afforded to transactions not involving a public offering by Section 4(2) of that Act and Rule 506 thereunder. The December 2003 Shares and the December 2003 Warrants issued in the offering were subsequently registered for resale by the investors on January 9, 2004.

(2)

In January 2004 we completed a private placement of 1,000,000 shares (the "January 2004 Shares") of our common stock to certain institutional investors. The shares were sold for $1.50 per share, resulting in gross proceeds from the offering of $1.5 million. The investors also received a right, for a limited period of time, to purchase additional shares of up to 20% of the common stock purchased by the investors in the placement at $1.50 a share. During the second quarter of 2004 these additional investment rights were exercised resulting in an additional purchase of 200,000 shares and an additional $300,000 in gross proceeds. The investors were also issued warrants (the "January 2004 Warrants") to purchase in the aggregate up to 310,000 additional shares (including shares available only as a result of the exercise of the above additional investment rights) of common stock at a per share exercise price of $1.875. In December 2004, one of our investors exercised its warrants resulting in an additional purchase of 60,000 shares and an additional $112,500 in gross proceeds. In January 2005 one of the investors exercised its warrants resulting in an additional purchase of 139,500 shares and an additional $261,527 in gross proceeds.

The January 2004 Shares and the January 2004 Warrants were issued in reliance upon the exemption from the registration requirements of the Securities Act of 1933 afforded to transactions not involving a public offering by Section 4(2) of that Act and Rule 506 thereunder. The January 2004 Shares and the January 2004 Warrants issued in the offering were subsequently registered for resale by the investors on April 19, 2004.

(3)

In June 2004 we completed a private placement of 7,550 shares (the "June 2004 Shares") of Series A Convertible Preferred stock to certain institutional investors. The shares were sold for $1000 per share, resulting in gross proceeds from the offering of $7.55 million. The preferred stock issued pursuant to this placement is convertible into WorldGate common stock at a conversion price of $2.35 per share. WorldGate has the right to require conversion of the preferred stock into common stock upon achieving certain price targets with respect to its common stock and the satisfaction of certain other conditions. Between November 2004 and January 2005 one of the investors has fully converted its preferred shares resulting in the issuance of 372,340 of our common shares. The preferred stock has a dividend rate of 5% per annum, payable quarterly, which may be paid either 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 market price). For the first two quarters for which dividend payments were due, WorldGate exercised its right to make these dividend payments in stock, resulting in the issuance of an additional 87,137 shares of our common stock. The preferred stock has a staged maturity over three years with scheduled payments of one third due after 18 months, one half of the remainder due after 24 months and the balance due after 36 months. The

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preferred stock may be redeemed at maturity in cash or through the issuance of common stock, at WorldGate's option (subject to certain conditions). All dividend and maturity payments made in stock are subject to the satisfaction of certain conditions including the listing and availability of an effective registration statement. As part of the transaction, WorldGate issued five-year warrants to purchase a total of 1,606,380 shares of WorldGate common stock, with one-half of the warrants having an exercise price of $2.69 per share and the remaining half having an exercise price of $3.14 per share. In January 2005 one of the investors has fully exercised its warrants resulting in the issuance of an addition 63,830 of our common shares and an additional $186,064 in gross proceeds. The investors also received an additional investment right, for a limited period of time, to purchase 1,606,380 additional common stock shares at $3.14 a share. During December 2004 all but one of the investors exercised their additional investment rights resulting in the issuance of an additional 1,499,998 shares and an additional $4,709,994 in gross proceeds. During the first quarter of 2005, the remaining investor exercised their additional investment right resulting in the issuance of an additional 106,383 shares and an additional $334,043 in gross proceeds.

The June 2004 Shares and the June 2004 Warrants were issued in reliance upon the exemption from the registration requirements of the Securities Act of 1933 afforded to transactions not involving a public offering by Section 4(2) of that Act and Rule 506 thereunder. The June 2004 Shares and the June 2004 Warrants issued in the offering were subsequently registered for resale by the investors on July 30, 2004.

In December 2004, WorldGate completed a private placement of 208,333 shares of our common stock to K.Y. Chou, president of Mototech, at a sales price of $2.40 per share, which resulted in additional gross proceeds to the Company of $500,000. In connection with this placement, the Company granted warrants to Mr. Chou to purchase up to 62,500 shares of our common stock at an exercise price of $2.88 per share.

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Item 6. Selected Financial Data.

        The following table represents selected consolidated financial information for the five-year period ended December 31, 2004. This data should be read in conjunction with our financial statements and notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this report.

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(1)

For purposes of computing the net loss per common share, net loss has been reduced by the accretion on preferred stock.

(2)

"As adjusted net loss available to common stockholders" and "As adjusted basic and diluted net loss per common share" amounts reflect the exclusion of amortization of goodwill of approximately $241 and $361 for the years ended December 31, 2000 and 2001, respectively. These amounts are presented to comply with SFAS 142 as if this standard had been adopted at the beginning of the respective periods.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. (Dollar amounts contained in this Item 7 are in thousands, except for share and per share amounts)

FORWARD-LOOKING AND CAUTIONARY STATEMENTS

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

Results of Operations:

Critical Accounting Policies and Estimates

        Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. These generally accepted accounting principles require management to make estimates and assumptions that affect the reported amounts of assets and

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liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of net sales and expenses during the reporting period. Actual results could differ from those estimates.

        Our significant accounting policies are described in note 2 to our consolidated financial statements included elsewhere in this report. We believe that the following discussion addresses our critical accounting policies, which are those that are most important to the portrayal of our financial condition and results and require management's most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

        Discontinued Operations.    During the first quarter of 2004, we transitioned from the business of developing and selling interactive television, or ITV, technology, products and services for use in conjunction with cable TV broadband networks (the "ITV business") to the development of our video phone products as our primary business focus. During the twelve months ended December 31, 2003 and 2004, the Company had revenues from discontinued operations of $3,886 and $82, respectively. Cost of revenues for the twelve months ended December 31, 2003 and 2004 were $5,849 and $43, respectively. Concurrently, operating expenses, consisting of Research and Development, Marketing, General and Administration, and Depreciation and Amortization costs were also reduced as a result of the transition from the ITV business. These expenses for discontinued operations were $3,497 and $16 for the twelve months ended December 31, 2003 and 2004, respectively. For the twelve months ended December 31, 2003 and 2004, other income and other expense relating to discontinued operations were $2,552 and $13, respectively. Included in 2003 were $484 of losses incurred on the sale of certain property and equipment, and $3,000 from the sale of intellectual property and other assets to TV Gateway LLC (refer to footnote 13. to our consolidated financial statements).

        Revenue Recognition.    Revenue is recognized when persuasive evidence of an arrangement exists, the price is fixed or determinable, the collectibility is reasonably assured, and either the delivery and the acceptance of the equipment has occurred or services have been rendered.

        Inventories.    Our inventory consists primarily of finished goods equipment to be sold to our customers. The cost is determined on an average cost basis. A periodic review of inventory quantities on hand is performed in order to determine and record a provision for excess and obsolete inventories. Factors related to current inventories such as technological obsolescence and market conditions are analyzed to determine estimated net realizable values. A provision is recorded to reduce the cost of inventories to the estimated net realizable values. Any significant unanticipated changes in the factors noted above could have an impact on the value of our inventories and our reported operating results. With the current shift in focus to our new video phone business, our inventory balance of $1,668 consisted of $1,622 relating solely to our ITV business, which was fully reserved for at December 31, 2004, and $46 related solely to our new video phone business.

        Long-Lived Assets.    Our long-lived assets consist of property and equipment. These long-lived assets are recorded at cost and are depreciated or amortized using the straight-line method over their estimated useful lives. The carrying value of a long-lived asset is considered impaired when the anticipated undiscounted cash flows from such assets are separately identifiable and are less than the carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value of the long-lived asset. Fair market value is determined by using the anticipated cash flows discounted at a rate commensurate with the risk involved. Measurement of the impairment, if any, will be based upon the difference between carrying value and the fair value of the asset. If useful life estimates or anticipated cash flows change in the future, we may be required to record an impairment charge.

        Accounting for Income Taxes.    As part of the process of preparing our consolidated financial statements we are required to estimate our income taxes in each of the jurisdictions in which we

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operate. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as depreciation of property and equipment and valuation of inventories, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not more likely than not, we must establish valuation allowances. To the extent we establish valuation allowances or increase the allowances in a period, we must include an expense within the tax provision in the statement of operations.

        We have a full valuation allowance against the net deferred tax asset of $79,290 as of December 31, 2004, due to our lack of earnings history and the uncertainty as to the reliability of the asset. In the future, if sufficient evidence of our ability to generate sufficient future taxable income becomes apparent, we would be required to reduce our valuation allowance, resulting in a benefit from income tax in the consolidated statement of operations.

        Accounting for Contractual Obligation related to Equity Financing.    In July 2000, four cable operators purchased our shares. As part of the financing arrangement, we agreed to provide the four cable operators with a credit to be used to purchase products that pertain to the development and deployment of our service equal to 25% of the amount they invested. We recorded a liability to satisfy this obligation based on our best estimate of what it would cost to satisfy the credit. Our policy has been not to adjust the liability after it had been established. When equipment credits are utilized by the cable operators, the value of the equipment is reflected in its entirety in the cost of revenues and a port