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TABLE OF CONTENTS

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

FORM 10-K

(Mark One)

For the Fiscal Year Ended December 31, 2001

or

For the transition period from                              to                             

Commission file number 000-25755

WORLDGATE COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)

(215) 354-5100
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:

Common Stock $0.01 Par Value
(Title of Class)

        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. [    ]

        The aggregate market value of the common stock held by non-affiliates of the registrant was approximately $25.4 million as of March 18, 2002, based on the closing sale price per share of common stock, as quoted on the Nasdaq National Market.

        The number of shares of the registrant's common stock outstanding as of March 18, 2002 was 23,568,312.

DOCUMENTS INCORPORATED BY REFERENCE

        [None]

WORLDGATE COMMUNICATIONS, INC.

ANNUAL REPORT ON FORM 10-K
For the Fiscal Year Ended December 31, 2001

TABLE OF CONTENTS

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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., or WorldGate or the Company, 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 5,000,000 shares of our common stock. Our common stock is listed on the NASDAQ National Market and is traded under the symbol "WGAT". Our executive offices are located at 3190 Tremont Avenue, Suite 100, Trevose, Pennsylvania 19053.

Overview

        We are a leader in providing interactive television entertainment products and services to the cable television industry. Interactive television, or ITV, is a rapidly growing sector of the cable television industry, with its focus on deploying services and applications to allow television viewers to interact with programs, advertisements and other content on their television sets. Viewers input information via wireless keyboards or other remote control devices. We offer our customers, the cable operators who want to offer ITV applications to their subscribers, a wide array of ITV applications and related services and products.

        We believe that we are unique in that we can offer cable operators a wide variety of ITV solutions tailored to their needs. Our business strategy, as more fully described below, is designed to take advantage of our unique position. ITV has several components. First, cable operators must create the infrastructure to deploy ITV applications. We design, assemble, install and maintain the equipment and computer software, or systems, necessary to provide these ITV applications. Second, cable operators must have the flexibility to concurrently provide multiple ITV applications, including applications such as interactive program guides, or IPGs, Internet over television services, video on demand and enhanced television, or eTV, products. We provide a platform, called middleware, that works in combination with the set-top boxes currently used by cable operators for television programming to provide these ITV applications. Our middleware is designed as an "open standards" platform, which means it will work with a wide variety of applications, including many of the third party applications that are in existence today. Thirdly, in addition to our systems and middleware products, we license a variety of our own ITV applications to our cable operator customers. Finally, our cable operator customers must ensure that the various systems, middleware and applications which they are using are compatible and have the required interoperability such that they do not adversely impact each other. We provide development, testing, certification, training and other support services to help our customers to deploy and maintain their various systems, middleware and applications. This comprehensive approach to providing ITV solutions to our customers distinguishes us from many of our competitors, particularly those that merely license technology without providing the full array of support services that we provide.

        Once our cable operator customers have the necessary systems, middleware and applications installed and deployed, we may receive revenue from advertising and television commerce, or t-commerce, in addition to any licensing fees we receive for the use of our technologies. For example,

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our interactive television service, the WorldGate^SM ITV Service, contains advertisements for which we receive revenues. Our products and services also provide cable subscribers with opportunities to execute transactions via their television sets, for which we also receive revenues. We partner with, and share these revenues with, our content providers and cable operator customers, which ensures that our subscribers have a wide variety of viewer-friendly content when using our service. In addition, we may provide aggregation and packaging services to our cable operator customers for the interactive information and other content that may be offered through their ITV applications. This content may include news, sports, weather, business and entertainment data feeds as well as other types of content. Finally, we provide a full range of aggregating and reporting functions to help our cable operator customers and content providers manage their interactive offerings.

        Furthermore, we are the manager and a partial owner of TVGateway, LLC, a joint venture between us and four of the largest six multiple system operators, or MSOs, in the U.S. This joint venture was formed during 2000 to provide cable operators with interactive applications for their digital products, including an IPG. We receive licensing fees from TVGateway for the use of our proprietary technology in their IPG service, the TVGateway^SM Service, and we receive management fees for managing the joint venture.

Products and Services

        We have tailored our business strategy around the diverse variety of services and products described above. Specifically, the core products and services that we have developed and/or are deploying include:

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WorldGate^SM ITV Service. Developed as our flagship product and now enhanced by a full range of other offerings, the WorldGate ITV Service is the focus of our business strategy. The WorldGate ITV Service provides a variety of compelling ITV applications to our cable operator customers. The WorldGate ITV Service operates on both already existing cable set-top boxes, and on more advanced, next-generation set-top boxes. The WorldGate ITV Service works as an application on our CableWare middleware, and on PowerTV middleware, and is integrated with the TVGateway and TV Guide IPGs. The WorldGate ITV Service includes enhanced television applications such as broadcast data services, access to the Internet over television, news headlines, sports scores, stock quotes, shopping links, e-mail and chat. In addition, the service interfaces with other applications including video on demand, or VOD, and a variety of IPGs and t-commerce features.



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CableWare^SM. CableWare is a middleware product that allows multiple ITV applications to run simultaneously on a television set-top box. CableWare is based upon our patented "Ultra-Thin Client^SM" technology, which uses existing cable television architecture to deploy a centralized interactive system. "Ultra-Thin Client" enables us to install, maintain and upgrade our hardware at the cable operator's plant, also called a headend. Because most of our technology is located at the headend, cable subscribers need only use the currently deployed generation of low cost set-top boxes with limited memory and processing resources to offer ITV applications. This significantly reduces the cost of deploying ITV applications. In addition, our Ultra-Thin Client architecture permits upgrades to be made either at the headend or through software downloads to the set-top boxes. This minimizes the need to repair or upgrade these boxes.



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Services. We provide a comprehensive set of services to support our interactive TV technology, matching our services with the needs of our cable operator customers. We package a variety of support services that include the necessary assistance required to install, launch, and maintain an interactive cable system. Other additional support programs are specifically designed to assist partners in developing applications and content. Our services provided include technical support, monitoring and reporting, customizing content, and training.

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•

Channel HyperLinking^SM. Channel HyperLinking is our patented ITV application that allows cable subscribers to link instantly from television programming and advertising to related internet or other content. This powerful feature supplements the WorldGate ITV Service and the TVGateway Service and has a variety of revenue producing uses for cable operators, broadcasters and advertisers and provides a valuable tool for viewers, who can flip back and forth almost instantly between watching television and enjoying the benefits of interactive TV.

Deployments

        As of December 31, 2001, our products and services were deployed to approximately 472,000 revenue generating units, or RGUs, on more than 60 cable systems in over 12 countries around the world. RGUs represent unique revenue generating opportunities for us, possibly from the same subscriber. For example a subscriber who utilizes both our WorldGate ITV Service and the TVGateway Service would represent two RGUs, reflecting the two revenue streams that WorldGate receives from the cable operator for that subscriber.

        Among the cable operator customers who have deployed or agreed to deploy our services, are five of the six largest MSOs in the U.S., including AT&T Broadband, Comcast Cable Communications, Charter Communications, Inc., Cox Communications, Inc. and Adelphia Communications Corp. We believe that we are currently the only provider in the ITV industry that deploys our interactive television services and products over both analog and digital cable platforms.

        Domestically, we added significant deployments to our list in 2001, including a deployment with AT&T Broadband in Tacoma, Washington and Astound Broadband in Minnesota. Internationally, our business strategy continues to include a significant commitment to deploy our services to cable operators around the world. To that end, in 2001 and early 2002 we have added deployments, or have obtained agreements to deploy, with:

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Retecal Cable, Spain



•

Digital Latin America



•

Cogeco Cable, Canada



•

GigaCable, S.A., Argentina



•

TV Cable, S.A., Colombia



•

Liberty Cablevision, Puerto Rico.

Material Developments for WorldGate in 2001

        The following is a summary of material developments for us that have occurred since December 31, 2000:

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Digital Latin America Distribution Agreement. In March 2001, we signed an agreement with Digital Latin America, or DLA, a distributor of digital cable content to cable operators throughout Central and South America and the Caribbean. This agreement allows DLA to distribute the WorldGate ITV Service to its many cable operator affiliates in these regions. In December 2001, we strengthened our strategic relationship with DLA by developing a digital cable interactive video offering specifically for DLA affiliates, including customized content for specific regions and additional Spanish language features. Four of DLA's cable operator affiliates agreed to deploy this new joint offering in 2002, including Intercable in Venezuela, Amnet in Costa Rica, Cable Onda in Panama and Telecable Nacional in the Dominican Republic.



•

Introduction of New Products. In March 2001, we introduced a new product, the Ultra-Compact Server, that allows our cable operator customers to deploy our service to more subscribers, while

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taking up less space in the cable operator's head-end. In June 2001, we introduced a smaller scale equipment package, called the ITV Starter Kit, to allow our cable operator customers an inexpensive way to begin using our services. These new offerings removed two important hurdles we have experienced when marketing our product, the initial capital expense and the space requirement for our hardware in the limited environment of the cable head-end.

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Issuance of New Patents. In August 2001, the U.S. Patent and Trademark Office issued a fourth patent to us covering a unique method for efficiently encoding digital image data, such as Internet Web pages, for delivery over cable TV network systems. In early 2002, we were informed that the U.S. Patent and Trademark Office issued a notice of allowance for another new patent also related to this encoding technology.



•

Deployment with AT&T Broadband. In June 2001, AT&T Broadband, the nation's largest cable operator, deployed our interactive services to digital cable subscribers in Tacoma, Washington using Motorola DCT-2000 set top boxes, remote controls and optional wireless keyboards.



•

Deployment with Charter Communications. Also in 2001, Charter Communications' Newtown, CT site became WorldGate's largest domestic commercial deployment, growing its WorldGate subscriber base three-fold to over 30,000 subscribers. Charter, which originally launched WorldGate in April 1998, has currently installed WorldGate in 10 locations throughout the country.



•

Deployment with Astound Broadband. WorldGate continued to expand its reach within the United States through a commercial deployment agreement with Astound Broadband in the fourth quarter of 2001. Astound selected WorldGate to provide a robust set of interactive entertainment content to their digital subscribers. Commercial deployment is expected to begin during early 2002.



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Deployment with TV Cable Bogotá. Late 2001 marked the Company's first commercial deployment in Bogotá, Colombia with TV Cable S.A., the largest cable operator in Colombia. WorldGate's ITV services are now being bundled with TV Cable S.A.'s premium cable TV package, creating a valuable consumer offering intended to drive the penetration of premium cable subscriptions in this country.



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Additional International Deployments. Other international deployments and agreements to deploy were finalized in 2001, including those with Cogeco Cable, Canada's fourth largest cable operator, Retecal Cable in Spain, GigaCable S.A. in Argentina, and CableVision Monterrey in Mexico.

Services and Support

        In addition to the various products we offer our customers, the following is a description of the full suite of services and support we also provide as an important complement to these products:

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Customer Support Representatives (CSRs). Our technical support team has in-depth experience with all of our products and a high degree of expertise with the set-top boxes manufactured by Motorola and Scientific Atlanta, the most utilized boxes in the industry. They can answer technical questions for our deployed systems, including questions involving network interfaces, system hardware and software operation. Our CSRs use state-of-the-art technology as well as leading customer service management tools to track customer questions and problems. Reported issues generate a ticket number, which is tracked and escalated according to the situation's severity and priority. Our data shows that the majority of these issues are resolved by our CSRs. Our CSR's have been integrated with many of our cable operator customer call centers to respond seamlessly to issues and to provide effective problem resolutions.

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•

Network Operations Center (NOC). Our Network Operations Center, or NOC, monitors and troubleshoots cable systems where our products are deployed. Our NOC contains network monitoring and system management applications that proactively monitor all installed and deployed systems. The NOC staff of network, systems, and software engineers supports our cable operator customers 24 hours a day, 7 days a week in troubleshooting issues escalated through the CSR center, upgrading software remotely, and performing routine maintenance to ensure optimal system performance. We collect this data using several different processes, all of which are based on industry standards, with procedures in place to ensure the privacy of cable subscribers utilizing our service. Our servers are off-the-shelf units incorporating the latest redundancy techniques, including dual power supplies and hot swappable subsystems (that is, live subsystems that can immediately replace problem subsystems if required). We have tools that monitor our internal servers, our vendor feeds, our local servers at the cable head-end, and our backup systems. With our NOC capabilities, most issues can be identified and resolved before service is interrupted. When the NOC monitoring system detects a problem, it automatically activates alarms, e-mails, and personal pagers as appropriate.



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Field Operations and Deployment. Our staff of experienced project managers, field engineers, and technicians allows us to launch our products and support our customers on an ongoing basis. Our project managers develop the framework for all project communications, contractual obligations and deliverables. They identify critical needs, define responsibilities, establish controls, and manage schedules. Project managers also keep customers informed with reports including Project Planning, Status, Change Management, and Problem Resolution. The maintenance and installation engineers are responsible for installing systems. Before installation, our engineers ensure that the site meets our equipment requirements. The engineers document complex channel mapping issues, environmental, and radio frequency connectivity requirements; they present their report to our cable operator customers and our personnel. The system configuration is fully recorded, maintained, and verified prior to delivery and installation. The project manager can then coordinate the installation and test procedures to ensure the system works as designed.



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Content Customization. We offer a suite of professional services to assist customers in building a user interface design, aggregating content, or other ITV applications. Customers may move beyond our core product by designing a custom interface and content. Working with a WorldGate Account Development Representative, partners can customize their user experience by hand picking the design and content to be included on each site. We will work with specified content partners or will independently provide those resources. Our creative services department can design a user interface from "scratch," or can work with a preferred agency to apply the customer's brand and colors to the custom ITV product.



•

Training. Our training department offers a variety of training classes developed for cable operator personnel ranging from CSRs to headend technicians. The design of the training can be geared from basic to advanced levels. The training department provides flexible options for a variety of standard and customized courses on the WorldGate Interactive Service. Our trainers develop and maintain training modules for customer support representatives, headend technicians, field installers, content developers, and Pay-Per-View schedulers.

WorldGate Business Model

        We derive revenues from cable operators, e-commerce merchants and advertisers and from management and service fees. We expect to enhance these revenue opportunities by implementing the strategies described below.

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        Revenue Derived from Cable Operators.    In most instances, we sell our headend server equipment and wireless keyboards to cable operators and license the software for our various ITV products, including CableWare and the WorldGate ITV Service, to cable operators for a monthly subscriber fee. We believe that cable operators either offer our services to their subscribers as a premium service, requiring subscribers to pay a separate monthly fee for the service, or as a part of a package of services in which the subscriber pays a monthly fee for the entire package. Generally, we receive monthly fees from the cable operators based on the total number of subscribers to our services.

        Revenue Derived from E-commerce and T-commerce Merchants.    We have negotiated agreements with companies in the business of selling products and services online and via ITV through which these companies pay for the opportunity to promote their business through portals by sharing a portion of the revenues they are paid or by paying a fixed fee per transaction. Although such revenues are currently not significant we intend to make access to online shopping opportunities both simple and convenient for our subscribers so that we can participate in the rapid growth forecasted for e-commerce and t-commerce.

        Revenue Derived from Advertisers.    We have space on our various menu pages that is available for banner advertising and other promotions. When subscribers click on these banners, they can be linked quickly to another Web page that gives more detailed information about the subject of the banner ad. Advertisers typically pay fees based on the number of times that their ad is displayed on a page viewed by a subscriber, so as the number of WorldGate subscribers grows, we expect our advertising revenues to grow. We believe we provide advertisers with a particularly attractive opportunity since information derived from the cooperating cable system will permit us to know the general geographic area in which each of our subscribers lives, and in many cases the zip codes and perhaps more extensive demographic information regarding our subscribers if they consent to share that information with us. In order to protect the confidentiality of this information we have designed our system to maintain encrypted subscriber information on separate computers which are independent of the servers for the WorldGate ITV Service. We expect to share the revenues derived from Internet advertising with cable operators. No meaningful revenue was derived from advertising since our inception.

        Our Channel HyperLinking technology will provide one button linking from television and advertising content to a related interactive Internet web site. This sort of advertising is "self targeted" because subscribers themselves decide whether they want to get more information. This is in sharp contrast to traditional television advertising that typically includes sending messages to large numbers of viewers on an unsolicited basis. In addition to the value achieved by self-targeting, the value of our Channel HyperLinking technology is enhanced by both the availability of demographic information and interactivity. By delivering an interactive experience, we are able to give the subscribers the opportunity to follow a variety of paths to gain extensive information about the subject of interest. The interactivity also allows the subscribers in many cases to purchase a product or service online. With the average cable household being exposed to tens of thousands of television advertisements annually, we believe that there are many opportunities for use of our Channel HyperLinking technology.

        Our Channel HyperLinking technology business model is based on a revenue split with our cable operator customers and the television networks. We expect revenue to come from advertisers seeking to engage the WorldGate ITV Service subscribers in some form of interactivity while using our Channel HyperLinking technology. This business model assumes that interactions will be on a pay-for-performance basis such that advertisers and others will pay us based on the number of "clicks" that occur. No meaningful revenue was derived from this service since our inception.

        Revenue Derived from TVGateway Joint Venture.    We are the provider of headend equipment for the TVGateway joint venture and receive licensing and management fee revenue for providing certain technology, development, support, sales and management services to the venture on behalf of its partners. In 2001, approximately 60% of our revenues was attributable to consulting fees from

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TVGateway pursuant to a Management Agreement between TVGateway and us (the "TVGateway Management Agreement"). The TVGateway Management Agreement expires on December 31, 2002 and will automatically renew for one additional year unless TVGateway elects not to renew by providing written notice at least 90 days prior to the expiration of the then current term. TVGateway may also terminate the agreement upon four (4) months notice to us.

Business Strategy

        We offer technology in the form of hardware sales and software licensing; provide services and support for our business partners; and earn revenue from interactive advertising and commerce via our technology and services via the television. The principal elements of our business strategy include the following:

        Provide Compelling Value for End-Users.    Unlike other companies who can offer just one of the many pieces that make up interactive television, we enable our subscribers to access an array of ITV applications. Consumers no longer have to subscribe to several different complicated services in order to get the features they want, with WorldGate they can get it in one simple package. Our products and services were designed to operate on the widely available existing cable television systems, as well as future set-top technologies, and were developed to provide consumers with an easy to use, cost-effective product. For example, to access the WorldGate ITV Service, a consumer needs only their existing television, a WorldGate enabled digital or advanced analog cable set-top box and a wireless remote or keyboard, with all but the television typically supplied by the cable operator. In addition, WorldGate's Channel HyperLinking and CableWare technology have been designed to offer consumers easy, fast and interactive access to content which is associated with a television program or advertisement they are viewing.

        Provide Compelling Value for Cable Operators.    We believe that cable operators assess the viability of an investment in a new service by considering the cost of initial investment in equipment, service reliability, overall operating and maintenance expenses and the incremental revenue that can be generated by such service. The WorldGate ITV Service can be offered to cable subscribers through the cable operators' existing two-way infrastructure, or its one-way infrastructure with certain of our products. Furthermore, the WorldGate ITV Service has been designed to be deployed with low capital costs for headend equipment, as low as $5 per WorldGate subscriber. These systems are also designed to be efficiently upgraded as the cable operator's infrastructure is improved through the deployment of new generation cable boxes or the deployment of cable modem ready plant, i.e. a cable plant that has been upgraded to improve the original transmission quality to permit the use of cable modems, and easily expanded as the number of subscribers grows. There is, however, no need for any costly upgrades to make the plant cable modem ready as a requirement for the WorldGate ITV Service. Accordingly, the WorldGate ITV Service can provide cable operators with the low investment opportunity for immediate incremental revenue streams from subscriber fees and sharing of advertising and online transaction fees.

        Provide Compelling Value for Programmers, Advertisers, Advertising Agencies and E-Commerce Merchants.    Through WorldGate's Channel HyperLinking and CableWare technology, programmers and advertisers may enhance their television content with related Web-based materials by providing their viewers with the ability to interact on a real-time basis with their television programming or advertising. As observed in our deployments, we are facilitating a market of active subscribers for interactive advertising. Giving consumers the ability to link immediately to an advertiser's Internet site to find more information about the product or to place an order is a valuable user feature and an effective way for advertisers to reach their customers using a new method. We believe this ability increases the value of the program or advertising to the television networks or advertisers, and that as a result, programmers and advertisers will be able to increase their revenues, brand extension and loyalty.

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Competition

        The ITV industry is highly competitive in the general categories of applications and middleware. We are likely to encounter significant competition with respect to each of these areas.

Applications

        ITV applications include email, chat, online games, web browsing, electronic program guides, or EPGs, and broadcast data and information services. Various companies are attempting to provide these ITV applications to cable television consumers through a set-top box appliance connected to a television. In some instances this appliance may be a dedicated unit or a cable converter box. The use of a dedicated unit adds incremental costs which are not present when the service is offered directly over a cable box. Generally, these solutions are cable-based and do not use the telephone infrastructure, thus mitigating bandwidth constraints. Several companies have developed and/or are testing these applications. We believe that our major competitors in the ITV applications category are Gemstar International Group Ltd., Microsoft, Liberate Technologies, OpenTV Corporation and Wink Communications. Each of these companies has developed and is marketing one or more of the ITV applications we have developed and are marketing.

Middleware

        Several companies are attempting to leverage the use of their platforms to obtain greater distribution for their ITV applications. For example, our competitors, Gemstar, Liberate, Microsoft and OpenTV are developing and have developed middleware products that compete with our CableWare middleware. We believe that middleware vendors are pursuing a business strategy based on the premise that once a cable operator adopts their middleware platform, that cable operator would be more likely to use their ITV applications as well. Therefore, if our competition is more successful than we are in marketing and deploying our middleware on a large scale, and their business strategy is validated, we may find it more difficult to deploy our applications on a large scale. In addition, a cable set-top box manufacturer, Scientific-Atlanta, Inc., has developed a middleware product, PowerTV, that competes with our CableWare middleware. Scientific-Atlanta could use its position as a set-top box developer to exclude other middleware developers from deploying on its set-top boxes, limiting our ability to successfully deploy our middleware product to cable operators deploying Scientific-Atlanta boxes.

Other

        We will also experience competition from providers of other TV applications. Two examples are the providers of video-on-demand, or VOD, and personal video recording, or PVR. VOD allows television viewers to order movies or television programs when they want them and PVR lets viewers pause, rewind, and replay broadcasts of television programming, as well as record programs. While these personalized television services do not compete directly with the WorldGate's products, they may compete for "space" within the cable set-top box. WorldGate has attempted to mitigate this form of competition by integrating its software with the software provided by the leading providers of VOD technology, including Concurrent Computer Corporation, Diva, nCube, and SeaChange.

Technology

        Our technology can be classified under three major product lines:

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CableWare Middleware



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Ultra-Thin Client platform



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Channel HyperLinking^SM

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CableWare^SM Middleware

        Middleware has become an important new category of product offering for cable operators. Middleware consists of a software layer that allows easier integration of new applications and content services. Ideal middleware would enable application developers to write highly sophisticated applications for the set-top box that seamlessly communicate and interact with other applications. This middleware can also include a presentation engine that would allow content developers to easily offer simple applications, such as stock tickers, without having the cost and schedule burden of engaging professional computer programmers. All of this needs to be implemented in a manner efficient enough to run on low-end set-top boxes, but also needs to include the sophisticated facilities necessary to get the most from advanced set-tops.

        Our CableWare middleware is being designed to meet these disparate goals. CableWare includes a sophisticated software interface layer that enables coexistence and communication of multiple native set-top applications. It also includes an advanced presentation engine that allows artists and content developers to create compelling content for the platform. Additionally, CableWare provides a Java facility.

Ultra-Thin Client Platform

        WorldGate's patented Ultra-Thin Client^SM platform allows substantially all client-related processing to be performed at the cable headend. This platform is comprised of three primary components:

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Servers are located at the cable headend;



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A WorldGate enabled digital or advanced analog cable box; and



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A remote control and/or optional wireless infrared keyboard.

        There are typically two servers located at the cable headend. One server manages all information traveling to and from this server to the Internet. This server also manages individual Internet sessions, processes data for presentation on the television screen, and manages the Web browsing client. The second server manages real-time communications from the cable headend to a subscriber's cable box. This server acts as a bi-directional router for data on a cable network. These servers:

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Are based on a multi-processor architecture



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Can be accessed remotely by WorldGate for performance monitoring and software upgrades



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Are configured such that typical full screen refresh times are:



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Five seconds or less on an analog platform



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One thirtieth (¹/30^th) of a second on a digital platform.

        General Web surfing is provided on this platform by our browser technology using high performance server headend systems. The WorldGate ITV Service browser currently supports HTML Version 3.2, HTTP Version 1.0 and 1.1, HTML Frames, Image formats such as GIF Animations, JPEG, and XBM formats. We believe we are the only company that supports a full Java implementation offering on a set-top platform. Java is used for such applications as chat and instant messaging. The WorldGate platform supports JavaScript that is compatible with the Netscape browser.

Channel HyperLinking

        Our patented Channel HyperLinking technology interactively links a television viewer with enhanced information or other content related to the advertisement and/or program being viewed. When a cable television subscriber makes a Channel HyperLinking request, the subscriber's cable box sends a signal to the cable headend indicating the channel and program information of the program the

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subscriber is viewing. This information is then matched with the corresponding Web address for the program, which has been stored at a cable headend database. The subscriber is then linked to the corresponding Web site for full Internet interactivity. This entire process occurs within seconds.

Intellectual Property

        WorldGate regards its technology as proprietary, and relies on a combination of patents, copyrights, trademarks, trade secret laws, contractual restrictions, restrictions on disclosure and other methods to establish and protect our technology and proprietary rights and information. WorldGate has filed patent applications in the United States and internationally covering aspects of its real-time, two-way interactive systems, including its Ultra-Thin Client architecture, centralized data processing, communications schemes, Channel HyperLinking technology and other aspects of its interactive television products.

        We have devoted significant attention to our research and development efforts that have already been recognized by the issuance of four patents in the United States containing over 170 claims collectively. In addition, we currently have over 50 applications pending worldwide containing over 1,700 claims collectively. Our intellectual property covers numerous facets of interactive television, enhanced television and interactive advertising applications, including systems and techniques for the transmission, retrieval, display and means of navigating through interactive information. In particular, we have received significant intellectual property coverage for our pioneering work in developing ultra-thin client solutions for the cable industry. Given the breadth and pioneering nature of our efforts, we continue to enhance our position as the worldwide leader in the interactive television marketplace. In addition, we have built upon these achievements and our industry leading ability to manage transmission bandwidth and client resources in the home to develop efficient and effective, standards based middleware solutions that are capable of operating within the low resource current generation set-tops while being migratable to the more powerful set-tops being introduced.

Backlog

        The Company typically delivers ordered equipment to customers within a few days of receiving such orders. We do not generally maintain a material amount of orders in backlog.

Research and Development

        To date, engineering and product development has been, and continues to be, a significant focus of WorldGate. Development of the WorldGate ITV Service has required combining technical experience and knowledge from two historically separate industries, the Internet and cable. The principal elements of WorldGate's engineering and development activities during 2001 were enhancing our existing Ultra-Thin Client^SM technology and continuing development of our CableWare middleware and Channel HyperLinking ^SM technologies. Our engineering and development expenditures, excluding engineering and development expenses rendered in connection with our TVGateway management agreement, were approximately $12,440,000, $21,734,000 and $12,894,000 for the years ended December 31, 1999, 2000, and 2001, respectively.

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Financial Information Relating to Foreign and Domestic Operations and Export Sales

*

These represent export sales. Contracts and orders are denominated in U.S. dollars

Employees

        As of December 31, 2001, on a consolidated basis, we had approximately 184 full-time employees. All of our employees are located in Trevose, Pennsylvania, except for 18 employees located at our offices in Campbell, California and a salesperson located in Florida and New York. 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.

Item 2. Properties

        Our corporate headquarters is located in Trevose, Pennsylvania in a leased facility consisting of approximately 72,000 square feet. The lease for this space will expire in June 2009, with an option to extend for an additional 10 years. We also lease a facility in Campbell, California, consisting of approximately 3,800 square feet. The lease for this space will expire in July 2002, and we are negotiating a renewal while considering other premises as well.

Item 3. Legal Proceedings

        None.

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

        WorldGate held its Annual Meeting of Shareholders on October 5, 2001. At this meeting, the shareholders voted in favor of the following items listed in the Proxy Statement dated October 5, 2001:

(1)

Election of Directors:

*

Mr. Gerry and Mr. Walter resigned in November 2001.

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(2)

Proposal to ratify and approve the WorldGate Communications, Inc. 2001 Employee Stock Purchase Plan:

(3)

Proposal to approve amendments to our 1996 Stock Option Plan:

(4)

Ratification of the selection of PricewaterhouseCoopers LLP as our Independent Auditors for the year ending December 31, 2001:

PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters

        Our common stock, $0.01 par value, has been traded on the Nasdaq National Market under the symbol "WGAT" since our initial public offering in April 15, 1999. The following table shows the high and low closing sales price as reported by the Nasdaq National Market for each quarter since we have been public.

        On March 18, 2002, the last reported sale price of our common stock as reported on the Nasdaq National Market was $1.54 per share.

        As of March 18, 2002, we had 356 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)

On March 2, 1999 WorldGate issued its senior secured promissory notes in the aggregate principal amount of $6 million and issued warrants to purchase up to 331,490 shares of common stock. These sales were exempt from registration pursuant to Section 4(2) of the Securities Act.

(2)

On August 15, 2000, we completed a private placement of an aggregate of 1,531,211 shares of our common stock (the "MSO Shares") to four cable operators who are accredited investors (each a

14

"MSO"). The shares were sold for $16.02 per share, resulting in proceeds from the offering of $24.5 million. The MSOs were also issued warrants (the "MSO Warrants") to purchase in the aggregate up to 1,500,000 additional shares of common stock at a per share exercise price of $24.78 and up to 500,000 additional shares of common stock at a per share exercise price of $12.39. The MSO Warrants are subject to vesting at varying rates based on the deployment of the Company's Internet TV service on the MSOs' digital cable system.

The MSO Shares and the MSO 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 MSO Shares issued in the offering have been registered for resale by the MSOs. In addition, the MSO Warrants grant to the MSOs certain "piggyback" and "demand" registration rights. Generally, a "piggyback" registration right allows holders to include their shares of common stock in registration statements we or other stockholders initiate and a "demand" registration right allows holders to require us to file a registration statement to register their shares of common stock.

(3)

In November 2000, we entered into a deployment agreement with AT&T Broadband to deploy our interactive services to AT&T digital customers in Cedar Falls and Waterloo, Iowa and Tacoma, Washington. As part of this agreement, we issued warrants to AT&T to purchase up to 1,000,000 shares of our common stock at a per share exercise price of $16.02. The warrants are subject to vesting at varying rates based on the deployment of our Internet TV service on AT&T's digital cable systems.

The AT&T 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 warrants grant to AT&T certain demand registration rights.

15

Item 6. Selected Financial Data.

        The following selected financial information for each of the years ended December 31, 1997 through 2001 are derived from our audited financial statements. You should read the following information in conjunction with our financial statements and notes thereto and "Management's

16

Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this report.

(1)

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

17

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 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 which 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 behalf of WorldGate. 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) continued losses, (3) difficulty or inability to raise additional financing, if needed, on terms acceptable to us, (4) loss of TVGateway or any one of our other largest customers (5) industry competition factors and other uncertainty that a market for our interactive TV products will develop, (6) challenges associated with cable operators (including, uncertainty that they will offer our interactive TV products, inability to predict the manner in which they will market and price our interactive TV products and existence of potential conflicts of interests and contractual limitations impeding their ability to offer our interactive TV products), (7) challenges with advertisers and television programmers (including uncertainties that they will support our Channel HyperLinking^SM technology), (8) departure of one or more key persons and (9) other risks identified below and 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 behalf of WorldGate.

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 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.

        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. In the event terms of the sale provide for a lapsing customer acceptance period, we recognize revenue based upon the expiration of the lapsing acceptance period or customer acceptance, whichever occurs first. There are inherent difficulties in predicting the timing and magnitude of equipment sales. As such, the potential for fluctuations in quarterly revenues and operating results exists. Revenue related to services is generally recognized upon performance of the services requested by a customer order. Revenue from

18

license agreements is recognized in accordance with the contract terms, generally based on the number of monthly subscribers. Included in our financial statements is a provision for the estimated amount of future returns that we believe is appropriate based on historical experience and current trends. While such returns have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same return rates that we have in the past.

        Accounts Receivable.    We generate accounts receivable primarily from sales of equipment to and services performed for our cable operator customers and from services performed for managing the TVGateway joint venture. This equipment is primarily headend equipment for use in deploying the Company's interactive television services. The services represent fees from the cable operator based on the number of subscribers using our services and fees for managing the TVGateway joint venture. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. If economic or political conditions were to change in the countries where we do business, it could have an impact on the results of our operations, and our ability to realize the full value of our accounts receivable.

        Inventories.    We value our inventories, which consist primarily of raw materials, work in process and finished goods equipment to be sold to our customers for use in deploying interactive television services, at the lower of cost or market. The cost is determined on an average cost basis and includes the cost of merchandise and freight. 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.

        Long-Lived Assets.    Our long-lived assets consist of property and equipment and goodwill. 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 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 $61,350 as of December 31, 2001, due to the Company's 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

19

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.

2001 versus 2000

Revenues

        Revenues decreased from $19,241 for the year ended December 31, 2000 to $16,847 for the year ended December 31, 2001. Substantially all revenues are attributable to the commercial deployments of WorldGate's interactive television products and services and cable subscribers subscribing to these services and consulting fees with TVGateway, an unconsolidated entity, as of December 31, 2001. A substantial portion of the revenue decrease is attributable to approximately $6,824 in shipments of equipment to certain TVGateway partners in 2000 to support the newly introduced TVGateway interactive program guide. Service fee revenues increased by $4,987 in 2001 to $11,340 from a total $6,353 in 2000. This increase in revenues was primarily attributable to revenues from consulting fees with TVGateway of $5,344 in 2000 increasing to $10,045 in 2001, pursuant to the TVGateway Management Agreement described in Note 11 to our financial statements. Our equipment product revenues declined in 2001 by $7,381, primarily reflecting the absence of shipments to the TVGateway partners noted above and the slowdown in ITV deployments within the U.S. cable marketplace. At December 31, 2000, we had deployed our services in 28 cable systems and had agreements to deploy an additional 17 cable systems with approximately 114,000 Revenue Generating Units from deployed systems. As of December 31, 2001, we had deployed our services in 61 cable systems with approximately 472,000 Revenue Generating Units. For the year ended December 31, 2001, there were revenues of $5,507 derived from the delivery of headends, keyboards, and related equipment products, and $1,184 attributable to subscriber fees and advertising fees. For the year ended December 31, 2000, revenues of $12,888 were derived from the delivery of headends, keyboards, and related equipment products and $539 attributable to subscriber fee and advertising revenues.

Costs and Expenses

        Cost of Revenues.    Cost of equipment product revenues consists primarily of equipment product costs related to initial trials and commercial deployments and service fee revenue costs, related primarily to the provision of engineering and administrative services. Costs of equipment product revenues for the year ended December 31, 2001 were $8,770, or approximately 159% of equipment product revenues, compared to the product costs of revenues of $20,314, or approximately 158%, of equipment product revenues for the year ended December 31, 2000. Service fee costs of revenues for the year ended December 31, 2001 were $10,343, or approximately 91% of service fee revenues. Service fee costs of revenues for the year ended December 31, 2000 were $4,849, or 76% of total service fee revenues. The increase in service fee cost of revenues of $5,494 for the year ended December 31, 2001 when compared to 2000 is attributable to increased revenues from consulting fees with TVGateway and additional subscriber fees.

        Engineering and Development.    Engineering and development expenses primarily consist of the cost of design, programming, testing, documentation and support of the Company's hardware, software and services. Engineering and development costs were $12,894 for the year ended December 31, 2001, a decrease of approximately 41% when compared to $21,734 for the year ended December 31, 2000. This decrease in expenses is primarily attributable to significant expense reductions beginning in the second quarter of 2001, activities supporting the TVGateway joint venture for which reimbursement is received, and to operating efficiencies achieved under management's continuing efforts to monitor the Company's growth and development and adjust expenditures appropriately. These actions resulted in employee compensation costs declining by $1,672, or 15%, in 2001 when compared to 2000. Other operating expenses, net of the contingent consideration expensed in 2000 of $4,174 related to our acquisition of Digital Video Art (see Note 12 to our financial statements), declined by $2,995, or 53%,

20

in 2001 when compared to 2000. This decline consisted primarily of decreases in engineering and product development expenditures of $2,910.

        Sales and Marketing.    Sales and marketing costs consist primarily of compensation, attendance at conferences and trade shows, travel costs necessary to cover a domestic and international customer market base, promotions and other marketing programs substantially related to initial trial installations and commercial deployments. For the year ended December 31, 2001 sales and marketing expenses were $6,770. This represents a decrease of approximately 47% when compared to sales and marketing expenses of $12,779 for the year ended December 31, 2000. This decrease in expenses is primarily attributable to significant expense reductions beginning in the second quarter of 2001, activities supporting the TVGateway joint venture for which reimbursement is received, and to operating efficiencies achieved under management's continuing efforts to monitor the Company's growth and development and adjust expenditures appropriately. These actions resulted in employee compensation costs declining by $1,149, or 21%, in 2001 when compared to 2000. Other operating expenses declined by $4,861, or 63%, in 2001 when compared to 2000. This decline consisted primarily of decreases in advertising and marketing expenses of $2,209 and trade show expenditures of $1,076.

        General and Administrative.    General and administrative expenses consist primarily of expenditures for administration, office and facility operations, finance and general management activities, including legal, accounting and other professional fees. General and administrative expenses were $7,629 for the year ended December 31, 2001, a decrease of approximately 27% when compared to expenses of $10,507 for 2000. This decrease in expenses is primarily attributable to significant expense reductions beginning in the second quarter of 2001, activities supporting the TVGateway joint venture for which reimbursement is received, and to operating efficiencies achieved under management's continuing efforts to monitor the Company's growth and development and adjust expenditures appropriately. These actions resulted in employee compensation costs declining by $220, or 11%, in 2001 when compared to 2000. Other operating expenses declined by $4,488, or 54%, in 2001 when compared to 2000. This decline consisted primarily of decreases in facility costs of $2,376 and professional fees and travel expenses of $1,620.

        Interest and Other Income and Interest Expense.    Interest and other income and interest expense consist of interest earned on cash and cash equivalents and short-term investments, and interest expense on equipment financing and short-term debt. Interest and other income decreased from $3,562 for the year ended December 31, 2000 to $1,027 for the year ended December 31, 2001, primarily due to declining average cash balances and to declining interest rates. During the year ended December 31, 2000, the Company earned interest on average cash balances of approximately $57,755 and incurred interest expense related to its equipment financing facility in the amount of $30. In comparison, for the year ended December 31, 2001 the Company earned interest on average cash balances of approximately $27,498 and incurred interest expense related to its equipment financing facility in the amount of $5.

        Income Taxes.    The Company has incurred net operating losses since inception and accordingly had no income taxes due and has not recorded any income tax benefit for those losses.

2000 versus 1999

Revenues

        Revenues increased from $5,594 for the year ended December 31, 1999 to $19,241 for the year ended December 31, 2000. Seventy percent of all revenues were attributable to the commercial deployments of WorldGate's interactive television products and services and cable subscribers subscribing to these services as of December 31, 2000. At December 31, 1999, we had deployed our services in 14 deployed cable systems and approximately 15,000 participating cable customers, representing 15,000 RGUs, subscribing to our interactive products. At December 31, 2000, we had

21

deployed our services in 28 deployed cable systems, with approximately 104,000 cable customers, representing 114,000 RGU's, subscribing to our interactive TV products. Thirty percent of all revenues in 2000 were attributable to consulting fees with TVGateway, an unconsolidated entity.

Costs and Expenses

        Cost of Revenues.    Cost of revenues consists primarily of product costs, related to initial trials, commercial deployments and WorldGate modules to be incorporated into set-top boxes, and consulting revenue costs, related primarily to TVGateway revenues for engineering and administration services we incurred. Product costs of revenues for the years ended December 31, 2000 and 1999 were $20,314 and $15,593, respectively, or approximately 151% and 279%, respectively, of product revenues. Consulting cost of revenues for the year ended December 31, 2000 were $4,849, or approximately 85% of consulting revenues. There were no consulting revenues or cost of revenues in 1999. The reduction in the product cost of revenues as a percent of revenues is primarily attributable to our reduction of unit costs and the reduced requirement for the WorldGate modules to be incorporated into set-top box deliveries.

        Engineering and Development.    Engineering and development expenses primarily consist of compensation of employees, cost of design and programming, testing, documentation and support of our hardware, software and services. Engineering and development costs were $21,734 and $12,440, respectively, for the years ended December 31, 2000 and 1999. Staff increases accounted for approximately $2,400 of this increase along with $7,300 of costs incurred in 2000 relating to our acquisition of Digital Video Art, Inc. on April 28, 2000 and its operations from that date. Digital Video Art, Inc. is an engineering development firm in Campbell, California.

        Sales and Marketing.    Sales and marketing costs consist primarily of compensation, attendance at conferences and trade shows, travel costs necessary to support our domestic and international customer market base, promotions and other marketing programs substantially related to initial trial installations and commercial deployments. For the years ended December 31, 2000 and 1999, sales and marketing expenses were $12,779 and $8,719. The increase of approximately 47% was primarily the result of additional trade show costs of approximately $500 and increases in staff, travel and marketing and promotional expenditures of approximately $3,300 for our growth in system deployment.

        General and Administrative.    General and administrative expenses consist primarily of expenditures for administration, office and facility operations, finance and general management activities, including legal, accounting and other professional fees. General and administrative expenses were $10,507 and $6,270, respectively, for the years ended December 31, 2000 and 1999. This increase of approximately 68% was primarily due to $396 of additional deferred compensation expense related to options previously granted, and $2,300 of additional legal, consulting, travel, facility and insurance costs incurred during the year ended December 31, 2000. Additionally, we recorded an increase in our reserve for doubtful accounts receivable of $1,300 for the year ended December 31, 2000.

        Interest and Other Income and Interest Expense.    Interest and other income and interest expense consist of interest earned on cash and cash equivalents and short-term investments, and interest expense on equipment financing and short-term debt. Interest and other income increased from $3,319 for the year ended December 31, 1999, to $3,562 for the year ended December 31, 2000. During 1999 we earned interest on an average cash balance of approximately $54,000, primarily as a result of the net proceeds received of $111,192 from our initial public offering ("IPO") in April 1999, and incurred interest expense related to our $6,000 financing and $1,100 equipment financing facility. In comparison, during the year ended December 31, 2000, we earned interest on an average cash balance of $57,755, primarily from the net proceeds received from our IPO and the proceeds of $24,530 from the sale of our common stock in July 2000.

22

        Income Taxes.    We have incurred net operating losses since inception and accordingly had no income taxes due and have not recorded any income tax benefit for those losses.

Liquidity and Capital Resources

        As of December 31, 2001, our primary source of liquidity consisted of cash and cash equivalents and short-term investments that are highly liquid, are of high quality investment grade and have maturities of less than one year.

        At December 31, 2001, the Company had cash and cash equivalents of $3,356 and additionally $11,257 in short-term investments, as compared to cash and cash equivalents of $20,415 (in addition to $26,090 in short-term investments) at December 31, 2000. Net cash used in operations was $23,996 for the year ended December 31, 2001, as compared to $49,749 used for the same period in 2000. The decrease in net cash used for operations was primarily attributable to the Company's decrease in expenditures in 2001, including its significant expense reduction program, and accounts receivable and inventory reductions, partially offset by accruals that were paid in the year.

        Cash provided by investing activities during the year ended December 31, 2001 totaled $12,416 compared to $36,813 during the same period in 2000. During the year ended December 31, 2001, we utilized the net proceeds from our maturing short-term investments of $14,833 compared to $40,324 for the year ended December 31, 2000. Capital expenditures were $1,451 and $2,324 for the years ended December 31, 2001 and 2000, respectively. During the years ended December 31, 2001 and 2000 the Company invested $1,000 and $1,250, respectively, in TVGateway, an unconsolidated entity.

        Net cash used in financing activities was $5,481 for the year ended December 31, 2001 compared to cash provided of $24,095 from financing activities for the year ended December 31, 2000. The net cash used in financing activities in 2001 was primarily due to the payment of acquisition consideration due to the shareholders of Digital Video Art, Inc., the company we acquired in April 2000 (See Note 12 to our financial statements). The prior year net cash provided by financing activities was primarily from the sale of our common stock in July 2000.

        We have the following long term financing and lease obligations as of December 31, 2001:

        To date, the Company has funded operations primarily through private sales of equity securities and through an initial public offering of common stock in April 1999. At December 31, 2001, we had cash, cash equivalents, and short-term investments of $14,613. The net cash and short-term investment usage during the fourth quarter ending December 31, 2001 was $4,821. In late 2000 and in April and October 2001, we implemented an organizational restructuring, staff reduction programs and other measures to reduce cash usage and manage inventory. We realized some of the benefits of this program in fiscal 2001. We have continued to aggressively manage our expenses, and we believe the program should have an additional annualized impact of approximately $5,000, or approximately $1,300 of cash savings per quarter. Based on the Company's operating budget and cash flow projections for 2002 we believe that we have sufficient cash and short-term investments to fund our operations beyond December 31, 2002. Even if we meet our budget and cash flow projections, we may need to obtain additional financing in early 2003. Should we miss our budget and cash flow targets, we believe that we

23

have the ability to quickly scale back operations in order to conserve enough cash and short-term investments to fund our operations beyond December 31, 2002.

        We have virtually no outstanding debt and our assets are not pledged as collateral. We continue to evaluate possibilities to obtain additional financing through public or private equity offerings, bank debt financing, asset securitizations or from other sources. Such additional financing would be subject to the risk of availability, may be dilutive to our shareholders, or could impose restrictions on operating activities. There can be no assurance that this additional financing will be available on terms acceptable to us, if at all.

Recent Accounting Pronouncements

        In June 2001, the FASB issued SFAS No. 141, "Business Combinations" ("FAS 141") and SFAS No. 142, "Goodwill and Other Intangible Assets" ("FAS 142"). FAS 141 requires that all business combinations be accounted for under the purchase method, and the use of the pooling-of-interests method is prohibited for business combinations initiated after June 30, 2001. FAS 141 also establishes criteria for the separate recognition of intangible assets acquired in a business combination. FAS 142 requires that goodwill no longer be amortized to earnings, but instead be subject to periodic testing for impairment. As of December 31, 2001, the Company has $3,006 of unamortized goodwill, and incurred $361 of amortization expense in the year ending December 31, 2001. The Company will adopt the provisions of FAS 142 in its first quarter ended March 31, 2002. The Company expects that it will no longer record $361 of annual amortization relating to its existing goodwill.

        FAS 142 requires that goodwill be tested annually for impairment using a two-step process. The first step is to identify a potential impairment and, in transition, this step must be measured as of the beginning of the fiscal year. However, a company has six months from the date of adoption to complete the first step. The Company expects to complete that first step of the goodwill impairment test during the second quarter of 2002. The second step of the goodwill impairment test measures the amount of the impairment loss (measured as of the beginning of the year of adoption), if any, and must be completed by the end of the Company's fiscal year. Any impairment loss resulting from the transitional impairment tests will be reflected as the cumulative effect of a change in accounting principle in the first quarter 2002. The Company has not yet determined what effect these impairment tests will have on the Company's earnings and financial position.

        In August 2001, the FASB issued SFAS no. 143, "Accounting for Asset Retirement Obligations" ("FAS 143"). FAS 143 requires, among other things, retirement obligations to be recognized when they are incurred and displayed as liabilities, with a corresponding amount capitalized as part of the related long-lived asset. The capitalized element is required to be expensed using a systematic and rational method over its useful life. FAS 143 will be adopted by the Company commencing January 1, 2003 and is not expected to have a significant impact on the Company's financial statements.

        In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("FAS 144"). FAS 144 provides new guidance on the recognition of impairment losses on long-lived assets to be held and used or to be disposed of and also broadens the definition of what constitutes a discontinued operation and how the results of a discontinued operation are to be measured and presented. FAS 144 will be adopted by the Company in the first quarter of 2002 and is not expected to have a significant impact on the Company's financial statements.

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FACTORS AFFECTING OUR BUSINESS CONDITION

        In addition to other information in this Form 10-K, the following risk factors should be carefully considered in evaluating our company and our business. Investing in our common stock involves a high degree of 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-looking statements that are based on management's beliefs and assumptions and on information currently available to management. Future events and circumstances and our actual results could differ materially from those projected in any forward-looking statements. You should carefully consider the risks described below, the other information in this Form 10-K, the documents incorporated by reference herein and the risk factors discussed in our other filings with the Securities and Exchange Commission when evaluating our company and our business. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known by us or that we currently deem immaterial also may impair our business operations. If any of the following risks actually occur, our business could be harmed. In such case, the trading price of our common stock would decline.

We may be unable to obtain necessary additional capital to fund operations in the future.

        To date, we have funded operations primarily through private sales of equity securities and through our initial public offering of common stock in April 1999. If we are unable to obtain additional financing on terms acceptable to us as needed, our business, operating results and financial condition will be materially adversely affected. As of December 31, 2001, we had cash, cash equivalents, and short-term investments of $14.6 million. Our quarterly operating cash usage was $4.6 million for the fourth quarter of 2001, and is expected to decrease in 2002. We believe that if we achieve this expected decrease, we could fund our cash requirements from cash-on-hand beyond December 31, 2002. If, however, our operating cash usage increases during one or more quarters, we may not have cash-on-hand necessary to fund our cash requirements for this period without obtaining additional financing.

        If we need additional financing and cannot raise it on acceptable terms, we may not be able to, among other things:

•

continue to operate our business as a going concern,



•

develop or enhance our products and services,



•

hire, train and retain employees, and



•

respond to competitive pressures or unanticipated requirements.

        In addition, we cannot predict with certainty the timing or amount of our capital requirements. Our capital requirements depend on numerous factors, including:

•

the rate of acceptance of our products by cable operators, cable subscribers, advertisers, television programmers, e-commerce companies and Internet content providers,



•

our ability to maintain and increase the number of subscribers, and



•

the rate of commercialization of our products, including the WorldGate ITV Service, and the acquisition of related businesses or technology, if any.

        Any additional equity financing, if available, may be dilutive to our stockholders, and debt financing, if available, may involve significant restrictions on our financing and operating activities.

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If we continue to incur losses, we may not be able to finance the commercial deployment of our products.

        We have experienced losses and have had negative cash flow in each quarter and year since inception, and we expect to continue to operate at a loss for the foreseeable future. We may be unable to sustain our historical revenue growth rates or achieve any growth at all. To achieve profitability, we must increase our revenues and gross profit margin. If we are not able to do so, our losses may extend beyond the foreseeable future and we may not be able to continue financing the commercial deployment, development and enhancement of our products.

        Our aggregate revenues from inception to December 31, 2001 were approximately $43,970,000, and our aggregate accumulated deficit at December 31, 2000 was approximately $169,687,000. We currently are stabilizing our operating expenses and capital expenditures in order to bring us closer to profitability. As a result, we expect to experience additional operating, but smaller than historical, losses and negative cash flow for the foreseeable future.

The loss of our largest customer could adversely affect our revenues and future prospects.

        We have in the past derived, and expect in the future to derive, a significant portion of our revenues from a limited number of customers. In 2001, revenues from consulting fees from our TVGateway joint venture accounted for approximately 60% of our revenues. We cannot assure you that TVGateway will continue to use our consulting and management services. The current term of our management agreement with TVGateway expires on December 31, 2002. This term will automatically renew for an additional one-year term, until December 31, 2003, unless TVGateway elects not to renew the agreement by providing written notice at least 90 days prior to that date. TVGateway may also transition all or part of the services provided by the Company to a third party with four months notice to the Company. If TVGateway stops using our consulting and management services, our business, operating results, financial condition and cash flows could be materially adversely affected.

We may experience difficulties developing and implementing our marketing and business plans.

        We began operations in March 1995 and our service was first made commercially available in the third quarter of 1998. As a result, our operating, sales and marketing and other strategies are still being developed, and though our software is in over 60 systems now, we still are in the early stages of development and have not yet deployed our product widely. If we are not successful in implementing our marketing and business plans on a timely basis or otherwise effectively managing our development, our business, operating results and financial condition will be materially adversely affected.

Because interactive television products and services are new, we cannot be certain that a market or sustainable demand for our products will develop.

        The market for interactive television products and services is new and evolving, and no single technology or approach to providing this access has been widely adopted by consumers or cable operators. As a result, we cannot guarantee that a market for interactive television products and services in general, or for our interactive TV products in particular, will develop or that demand for our interactive TV products and services will be sustainable. If the market does not develop, develops more slowly than expected or becomes saturated with competitors or competing technology becomes more widely accepted, our business, operating results, and financial condition will be materially adversely affected.

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The competitive market for interactive television and services may limit demand or pricing for the WorldGate ITV Service.

        We experience intense competition. Many companies provide and others may in the future provide products and services with functionality similar to any of our products and services. As a result of this and future competition, demand for our products may suffer, we may be restricted in the pricing we can charge for our interactive TV products and our business, financial condition and results of operations may be adversely affected. Competitors provide their services through a variety of technologies, which are in various stages of implementation and adoption. Some of our competitors have significantly greater financial, technical, marketing, distribution, customer support, name recognition, compelling content, access to consumers and other resources, and more established relationships with cable operators, advertisers and content and application providers than we have.

We may not succeed if cable operators do not offer our interactive TV products to their subscribers.

        Because our interactive TV products are made available to cable subscribers through a cable operator's system, our growth and future success depends substantially on cable operators offering our interactive TV products to their subscribers at satisfactory rates. We have entered into a limited number of agreements with cable operators providing for the commercial launch of our interactive TV products in some of the markets served by these cable operators. If cable operators determine that our service is not viable as a business proposition or if they determine that the service does not meet their business or operational expectations or strategies, they will not offer our interactive TV products to their subscribers. Furthermore, because there are a limited number of cable operators, as well as consolidation in the industry, the failure to reach agreements with one or more major cable operators which service a significant number of cable subscribers could materially adversely affect the market for our interactive TV products.

Our international operations are subject to many uncertainties.

        A key component of our strategy is the expansion of our sales of interactive TV products into international markets. International revenues accounted for approximately 24% of our total revenues for fiscal 2001, and international affiliates made up seven of our top ten customers on a percentage of revenue basis. We anticipate that a significant portion of our revenues will continue to be derived from sources outside the United States. Accordingly, our success will depend, in part, upon international economic conditions and our ability to manage international sales and marketing operations. We have limited experience in developing localized versions of our service and in developing relationships with international cable system operators. We may not be successful in expanding our service offerings into foreign markets. In addition to the uncertainty regarding our ability to generate revenues from foreign operations and expand our international presence, there are certain risks inherent in doing business on an international level, such as:

•

difficulties in collecting accounts receivable and longer collection periods,



•

regulatory requirements, including the regulation of Internet access,



•

export and import restrictions, including tariffs and other trade barriers,



•

difficulties in staffing and managing foreign operations,



•

political instability, and



•

fluctuations in currency exchange rates.

        In addition, although substantially all of our revenues and costs to date have been denominated in U.S. dollars, we may enter into agreements resulting in foreign currency payables. Although we may from time to time undertake foreign exchange hedging transactions to cover a portion of our foreign

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currency exposure, we do not currently attempt to cover potential foreign currency exposure. Accordingly, any fluctuation in the value of foreign currency could seriously harm our ability to increase international revenues.

        Any of the above factors could materially adversely affect the success of our current and future domestic and international operations.

Our revenues will depend on the manner in which cable operators market and price our interactive TV products.

        We depend on cable operators to provide our interactive TV products to their subscribers and therefore have limited or no control over a number of important factors, including:

•

the cable operators' advertising or marketing strategy, if any, regarding their offering of our interactive TV products to their subscribers,



•

the monthly fees cable operators charge to their subscribers for our interactive TV products, and



•

the extent to which cable operators purchase additional WorldGate equipment to avoid reduction in performance if subscriber demand grows.

        Our revenues may not meet our expectations if the cable operators' marketing, pricing and operating strategies are inconsistent with our business model.

Cable operators and cable box manufacturers may not offer our interactive TV products because they may have potential conflicts of interest or for other reasons.

        Some cable operators and cable box manufacturers are stockholders of other companies that provide interactive television products and services. To the extent that these cable operators elect not to offer WorldGate's products and services because of these affiliations or other reasons, our business, financial condition and results of operations could be materially adversely affected. Some companies that provide Internet services, such as Microsoft Corporation, are stockholders of cable operators or cable box manufacturers. We cannot assure you that there will not be other investments among providers of interactive television services, cable operators and/or cable box manufacturers. As a result or for other reasons, these cable operators and cable box manufacturers may be reluctant to provide any service, including WorldGate's products and services, or to otherwise work with any entity that provides other Internet services in competition with their affiliates.

Only cable television subscribers who utilize a cable set-top box can receive our interactive TV products.

        For cable television subscribers to receive our interactive TV products, they must have a cable set-top box that can be WorldGate enabled. Currently, many cable television subscribers receive their cable television service through the cable line directly into their televisions, without a set-top box. We cannot assure you that cable operators serving these subscribers will elect to provide them with set-top boxes for the purpose of offering our interactive TV products, or that these customers will choose to utilize a set-top box in order to receive our interactive TV products.

We are subject to capacity constraints and system failures.

        Due to the limited size of our interactive TV deployments, the ability of our service to accommodate a substantial number of users is still being tested. We cannot assure you that we will be able to provide high quality performance and high transaction speeds as the number of subscribers grows or their usage increases. In addition, as subscriber penetration grows it may be necessary for cable operators to purchase additional equipment, and we cannot assure you that they will do so.

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        The performance of our interactive TV products is also subject to reduction in performance and interruption from human errors, telecommunication failures, computer viruses and similar events. Any of these problems in our systems or those of cable operators could result in reduced subscriber demand. We have experienced performance reduction and service interruptions from time to time in the past and we expect that these problems will continue from time to time. Our failure to provide uninterrupted service at a level of performance acceptable to subscribers would have a material adverse effect on our business, financial condition and results of operations.

Intellectual property claims against us could be costly and result in the loss of significant rights.

        Our success depends, in part, on our ability to maintain and continue to develop a strong patent position for our products and technologies both in the United States and other countries. As with most technology companies, our patent position involves complex legal and factual questions. Without our patent and other intellectual property protections, other companies could offer substantially identical products for sale without incurring the sizeable development and testing costs that we have incurred. Our ability to recoup these expenditures and realize profits upon the licensing of our products and services could be diminished.

        The process of obtaining patents is time consuming and expensive. Even if we spend the necessary time and money, a patent may not issue or it may insufficiently protect the technology it was intended to protect. We can never be certain that we were the first to develop the technology or that we were the first to file a patent application for the particular technology because U.S. patent applications are maintained in secrecy until a patent issues and publications in the scientific or patent literature lag behind actual discoveries. Even after the U.S. Patent and Trademark Office issues patent rights to us, our competitors may develop similar or duplicate technologies or design around the patented aspects of our technology, which may decrease sales of our prospective products, therefore causing a negative impact on our profit.

        Competitors and others may also challenge our patent rights in court by alleging patent infringement. If we lose a patent infringement suit, third parties may claim significant damages, require us to license the disputed technology or require us to cease using the disputed technology. We cannot assure you that licenses to the technology owned by any third parties would be available to us on commercially reasonable terms, if at all. Irrespective of the validity or the successful assertion of any patent claims, any litigation could result in significant costs and diversion of management time and resources.

The success of our Channel HyperLinking technology will be adversely affected if advertisers and television programmers do not provide us with necessary content.

        Our future growth and long-term success depends substantially on our ability to convince advertisers and television programmers to use our Channel HyperLinking technology with their advertisements and television programs. We believe that the adoption of the Channel HyperLinking technology is substantially dependent on:

•

our service meeting advertisers' and programmers' business or operational expectations or strategies,



•

subscribers accepting and using our service as part of their television experience, and



•

us achieving a significant number of subscribers to our interactive TV products.

        We cannot assure you that we will achieve either of the above goals. If we fail to incorporate our Channel HyperLinking technology in a substantial number of advertisements and programs, our business, operating results and financial condition could be materially adversely affected.

29

Rapid technological change could render our services obsolete.

        The market for consumer Internet access services and online content is characterized by rapid technological developments, frequent new product introductions and evolving industry standards. The nature of the market for these products and services and their rapid evolution requires that we continually improve the performance, features and reliability of our interactive TV products, particularly in response to competitive offerings. We may not be successful in responding quickly, cost-effectively and adequately to these developments. There may be a time-limited market opportunity for our interactive TV products, and we may not be successful in achieving widespread acceptance of our interactive TV products before competitors offer products and services with speed and performance similar to, or better than, our current offerings.

We may have liability for information retrieved or replicated on the Internet.

        Claims for negligence, copyright or trademark infringement or other legal theories could be made against us because information can be downloaded and redistributed by users of our interactive TV products. Copyright and trademark laws are evolving both domestically and internationally and we are uncertain how they apply to our interactive TV products. The imposition of liability for information carried by us would have a material adverse effect on our business, operating results and financial condition.

We may have liability for e-commerce transactions.

        As part of our business, we are seeking to enter into agreements with content providers, advertisers and e-commerce merchants under which we will receive a share of revenue from the purchase of goods and services by users of our interactive TV products. These arrangements may expose us to additional legal risks and uncertainties, including potential liabilities to consumers of these products and services. Our insurance may not cover potential claims of this type or may not be adequate to indemnify us for all liability that may be imposed.

We could become subject to burdensome government regulation which affects our ability to offer our service or which affects demand for our service.

        We are subject to varying degrees of federal, state, local and foreign regulations as well as laws enacted by the U.S. Congress and other governments. The Federal Communications Commission has established regulations that, among other things, set licensing, access, installation and equipment standards for communications systems. We are uncertain how these regulations may be applied to Internet services offered over cable television systems.

        We also anticipate that due to its increasing popularity and use, the Internet will be subject to increased attention and regulation. These laws and regulations may regulate issues such as:

•

user privacy,



•

defamation,



•

network access,



•

pricing,



•

taxation,



•

content,



•

quality of products and services, and



•

intellectual property ownership and infringement.

30

        These laws and regulations could expose us to liability, materially increase our cost of providing our service, and decrease the growth and acceptance of the Internet in general and access to the Internet over cable systems.

Our business would suffer if we were to lose the services of Hal M. Krisbergh or other key personnel.

        Our success depends in significant part upon the continued service of our key technical, sales and senior management personnel, particularly Mr. Krisbergh, who has significant relevant experience in the cable television industry. No officer or employee of WorldGate is bound by an employment agreement, and any officer or employee of WorldGate could terminate his or her relationship with us at any time. Our future success will also depend on our ability to attract, train, retain and motivate highly qualified senior management, technical, marketing and sales personnel. Because competition for these personnel is intense, we cannot assure you that we will be able to do so.

The ability to influence the outcome of stockholder votes may be limited by the significant ownership interest of our chairman and chief executive officer.

        Hal M. Krisbergh beneficially owns approximately 25.06% of our outstanding common stock as of March 18, 2002. Mr. Krisbergh has the voting power to exercise substantial control over the election of our entire board of directors and all votes on matters requiring stockholder approval. This concentration of ownership may also have the effect of delaying or preventing a change in control of WorldGate.

Anti-takeover provisions in our charter documents could discourage unwanted takeover attempts and could reduce the opportunity for stockholders to get a premium for their shares.

        We are subject to Delaware laws and to provisions of our certificate of incorporation and by-laws that could have the effect of delaying, deterring or preventing a change in control of WorldGate. As a result, our management could attempt to utilize these laws and provisions to discourage or reject unsolicited bids to acquire us, including bids that would have paid stockholders a premium over the then current market price of their shares.

We may be unable to maintain our listing on the Nasdaq National Market, which could cause our stock price to fall and decrease the liquidity of our common stock.

        Our common stock is currently listed on the Nasdaq National Market, which has requirements for the continued listing of stock. One of the continued listing requirements is that our common stock maintain a minimum bid price of $1.00 per share. For the period commencing on September 1, 2001 through March 18, 2002, the high and low closing sales price as reported by the Nasdaq National Market for the period was $2.73 and $1.54, respectively. If our common stock trades below $1.00 for 30 consecutive trading days, or if we fail to meet any of the other listing requirements including the market capitalization and minimum stockholders equity requirements, our common stock may be delisted from the Nasdaq National Market and the trading market for our common stock could decline, which could depress our stock price and adversely affect the liquidity of our common stock.

Our common stock price is likely to be highly volatile.

        The market price of our common stock has been and will likely continue to be highly volatile, as is the stock market in general, and the market for Internet-related and technology companies in particular. Investors may not be able to resell their shares of our common stock following periods of volatility because of the market's adverse reaction to such volatility. Factors that could cause such volatility may include, among other things:

•

actual or anticipated variations in quarterly operating results;

31

•

announcements of technological innovations;



•

new products or services;



•

changes in financial estimates by securities analysts;



•

conditions or trends in the Internet or cable industry;



•

changes in the market valuations of other Internet or cable companies;



•

announcements by us or our competitors of significant acquisitions, strategic partnerships or joint ventures;



•

capital commitments;



•

additions or departures of key personnel; and



•

sales of common stock.

        Many of these factors are beyond our control. These factors may materially adversely affect the market price of our common stock, regardless of our operating performance.

We are at risk of securities class action litigation due to our expected stock price volatility.

        In the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities. This risk is especially acute for us because technology companies have experienced greater than average stock price volatility in recent years and, as a result, have been subject to, on average, a greater number of securities class action claims than companies in other industries. Due to the potential volatility of our stock price, we may in the future be the target of similar litigation. Securities litigation could result in substantial costs and divert management's attention and resources.

Substantial sales of our common stock could lower our stock price.

        The market price for our common stock could drop as a result of sales of a large number of our presently outstanding shares, including shares issued upon the exercise of outstanding options and warrants, or the perception that these sales could occur. These factors also could make it more difficult for us to raise funds through future offerings of our common stock. Certain holders of our common stock have demand and piggy-back registration rights. The exercise of such rights could adversely affect the market price of our common stock. We have filed:

•

on May 20, 1999 a registration statement (Registration No. 333-78943) to register 1,600,000 shares of common stock under our stock option plan;



•

on October 8, 1999, a shelf registration statement (Registration No. 333-87029) under the Securities Act for 380,056 shares of common stock issuable upon exercise of outstanding warrants and 375,363 shares of common stock;



•

on July 28, 2000, a registration statement (Registration No. 333-42526) under the Securities Act for resale of 1,531,211 shares of common stock that we issued to four cable operators;



•

on November 9, 2000, a registration statement (Registration No. 333-49612) to register an additional 1,600,000 shares of common stock under our stock option plan; and



•

on November 29, 2000, a registration statement (Registration No. 333-35936) under the Securities Act for resale of 250,000 shares of common stock that we issued to shareholders of Digital Video Art, a California corporation we acquired in April 2000.

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•

on April 5, 2001, a registration statement (Registration No. 333-58346) to register 750,000 shares of common stock under our 2001 Employee Stock Purchase Plan.



•

on June 11, 2001, a registration statement (Registration No. 333-62810) to register an additional 932,328 shares of common stock under our Stock Option Plan.



•

on June 13, 2001, a registration statement (Registration No. 333-62888) under the Securities Act for resale of 100,000 shares of common stock that we issued to shareholders of Digital Video Art.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk.

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

        As of December 31, 2001, our cash and cash equivalents and investments consisted of $14,613, most of which were cash equivalents having a maturity of less than one year. Due to the average maturity and conservative nature of our investment portfolio, a sudden change in interest rates would not have a material effect on the value of the portfolio. Management estimates that had the average yield of our investments decreased by 100 basis points, our interest income for the year ended December 31, 2001 would have decreased by less than $227. This estimate assumes that the decrease occurred on the first day of 2001 and reduced the yield of each investment instrument by 100 basis points. The impact on our future interest income of future changes in investment yields will depend largely on the gross amount of our investments.

        Foreign Currency Exchange Risk.    Although we transact business in various foreign countries, the principal portion of our business is in the United States and substantially all of our revenues and costs to date have been denominated in U.S. dollars. As a result, adverse movements in foreign currency exchange rates would not have a material adverse effect on us.

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Item 8.

WORLDGATE COMMUNICATIONS, INC.
INDEX TO FINANCIAL STATEMENTS

F-1

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors
of WorldGate Communications, Inc.:

        In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) on page 45 present fairly, in all material respects, the financial position of WorldGate Communications, Inc. and its subsidiaries at December 31, 2001 and December 31, 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule appearing under Item 14 (a) (2) on page 45 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

        The Company has a history of losses from operations and has a limited amount of cash and short-term investments on hand. Management's plans to fund operations beyond 2002 are discussed in Note 2.

PricewaterhouseCoopers LLP
Philadelphia, PA
February 27, 2002

F-2

WORLDGATE COMMUNICATIONS, INC.

CONSOLIDATED BALANCE SHEETS

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

F-3

WORLDGATE COMMUNICATIONS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

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

F-4

WORLDGATE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF
STOCKHOLDERS' EQUITY (DEFICIT) AND REDEEMABLE PREFERRED STOCK