| WORLDGATE COMMUNICATIONS INC Item 1A Risk Factors |
| 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 could decline and investors could lose all or part of the money paid to buy our common stock |
| Our ITV Business has accounted for most of our revenues to date; we cannot reliably project our continued revenues, and we expect to incur significant losses for an indefinite period of time |
| Since our formation in 1995 and until the first quarter of 2004, we were in the business of developing and selling interactive television, or ITV, technology products and services for use in conjunction with cable television broadband networks |
| Our ITV business has historically accounted for substantially all of our revenue |
| Since we have discontinued the ITV Business and transitioned to become a developer, manufacturer and seller of video phone products we cannot reliably predict our future revenues, and no assurances can be provided as to the amount of ongoing revenues, if any, or to the periods in which any such revenues may be received |
| Our video phone business involves the development of a new product line with no market penetration, in an undeveloped market sector |
| The extent and timing of our revenues depends on several factors, including the rate of market acceptance of our products, and the degree of competition we face from similar products |
| We cannot predict to what extent our video phone product will produce revenues, or whether we will ever reach profitability |
| If we are unable to achieve significant levels of recurring revenue from our video phone business, our losses will likely continue indefinitely |
| If this occurs, the market price of our common stock and our viability as a going concern could suffer |
| Our auditors have expressed substantial doubt about our company’s ability to continue as a going concern |
| The report of the independent registered public accounting firm for the year ended December 31, 2005 included an explanatory paragraph stating that our company has losses from operations and had an accumulated deficit of dlra229cmam092cmam000 that raised substantial doubt about our company’s ability to continue as a going concern |
| No assurances can be given that the issues that led our independent registered public accounting firm to this conclusion will be addressed or that our business will continue to operate as a going concern |
| We are subject to complex and changing rules and regulations concerning corporate governance and financial accounting standards, which may affect our reported financial results or the way we conduct business, or our ability to ensure proper financial reporting and adequate internal controls |
| The Sarbanes-Oxley Act, which was signed into law in July 2002, among other things, mandated that companies adopt new corporate governance measures and imposed comprehensive reporting and disclosure requirements |
| These rules, regulations and requirements increased the scope, complexity, and cost of our corporate governance, reporting, and disclosure practices |
| Furthermore, generally accepted accounting principles in the United States, including those affecting the accounting for complex financial transactions, have been the subject of change as well as frequent review and interpretation by the SEC, as well as by national and international accounting standards bodies |
| Such changes, reviews and interpretations may have a significant effect on our reported results of operations, including the results of transactions entered into before the effective date of the changes |
| For example, the Company has previously entered into various private placement transactions which included multiple types of securities for which the proper accounting treatment was subject to the correct analysis and interpretation of the applicable rules regulations and standards |
| As a result of subsequent analysis the Company elected to file restatements of certain of its financial statements to correctly account for such securities |
| The need for such restatements also led to the determination that the Company had a material weakness with respect to the reporting of complex transactions |
| A material weakness is a control deficiency, or a combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected |
| To address this material weakness the Company engaged outside experts to provide counsel and guidance in areas where we cannot economically maintain the required expertise internally |
| No assurance can be given, however, that such counsel and guidance will be sufficient to remedy this material weakness or to ensure that a future material misstatement may not occur within our financial statements |
| 6 ______________________________________________________________________ Additionally, section 404 of the Sarbanes-Oxley Act of 2002 requires us to assess the design and effectiveness of our internal control systems |
| Because we are an accelerated filer for SEC reporting purposes as of December 31, 2005, we were required to make our initial assessment for our fiscal year then ended |
| Our independent registered public accounting firm rendered an attestation report on management’s assessment of the effectiveness of our system of internal control over financial reporting which included an adverse opinion on the effectiveness of our internal controls over financial reporting because of the existence of a material weakness |
| If any changes or additions are required to these systems we must complete the documentation, evaluation and any required remediation of our systems of internal control |
| The costs associated with such compliance are likely to be significant and will negatively impact future financial results |
| In addition, there is no assurance that we will be able to conclude that our systems are appropriately designed or effective, or that a material weakness will not be found in our internal controls over financial reporting, which could result in a material misstatement in future financial statements |
| We are dependent on a single line of business that currently has no significant history of revenues |
| We cannot predict our future results because our video phone business has no operating history |
| Our primary line of business has become the development of video phone products and technology |
| We began generating revenue from commercial shipment of our Ojo product in April 2005 |
| Given that our video phone business involves the development of a new product line with no market penetration, in an underdeveloped market sector, no assurances can be given that sufficient sales, if any, will materialize |
| Should this business fail to generate sufficient sales to support ongoing operations there can be no assurance that we will be able to develop alternate business lines |
| Investors should consider the risks and uncertainties that we may encounter as an early-revenue-stage company in a new, single line of business, and in an unproven market |
| These uncertainties include: • our ability to design, engineer and manufacture products having the technological features planned for the video phone product line in a cost efficient manner; • our ability to enter into appropriate distribution relationships for the product; • our ability to demonstrate the benefits of our products and services to end users; • our ability to offer our products at competitive prices; • consumer demand for, and acceptance of, the video phone business products; • our unproven and evolving business model; • unfavorable economic conditions in the technology industry; • a changing regulatory environment; • decreased capital spending on technology due to adverse economic conditions; and • global economic conditions |
| We will incur increased risks, costs and expenses for marketing and distributing our products, for collection and accounts receivable issues, and for inventory as the result of ending our development and distribution agreement with General Instrument |
| Under our development and distribution agreement with General Instrument, General Instrument was responsible for the distribution of our products and for the direct relationship with the distributors, dealers, and other resellers ultimately used to sell the products |
| General Instrument also maintained the necessary infrastructure to handle the logistics for performing these functions, including customer ordering, inventory warehousing, billing, customer service, credit and accounts receivable functions for multiple customers |
| In performing these functions General Instrument carried the associated risks, costs and expenses |
| As a result of ending our agreement with General Instrument, we are now directly assuming these responsibilities and associated risks, costs and expenses, and this places increased demands on the cash which we have available |
| We will also be required to develop new, or expand existing, infrastructure to handle these logistical functions |
| There can be no assurance that the development or expansion of capabilities can be accomplished in an efficient and cost effective manner |
| In addition, General Instrument’s price of our product to its reseller customers included a mark-up from its cost of the product from us that was intended to reflect its risks, cost and expenses, plus its profit |
| We will be charging these reseller customers a lower price and we cannot be assured that the new price will include a sufficient mark-up to cover the risks, costs and expenses that is now our responsibility going forward |
| Furthermore all of our revenue for the sale of our video phones was derived from General Instrument under the development and distribution agreement and there were minimal administrative costs associated with billing and collecting this revenue |
| We will now have multiple customers and bear the associated increased administrative costs and risks of collection |
| Our video phone technology and products remain subject to significant uncertainty |
| Our video phone technology and products are in the early commercialization stage and have not been proven over an extended period of time |
| The market for products related to video telephony is characterized by uncertain user and customer requirements, and the emergence of new communications standards and practices |
| Each of these characteristics could impact our video phone products, intellectual property and system designs |
| The successful development of our products is subject to the risks that: 7 ______________________________________________________________________ • our proposed product is found to be ineffective for the intended purposes; • the proposed product is uneconomical to manufacture, or market or does not achieve broad market acceptance; and • third parties hold proprietary rights that preclude us from marketing the product |
| Significant undetected errors or delays in new products or releases may affect market acceptance of our product |
| There can be no assurance that, despite our testing, errors will not be found in the initial product or subsequent releases after the commencement of commercial shipments, resulting in loss of customers or failure to achieve market acceptance |
| In addition, our video phone technology and product will need to be compatible with a broad array of disparate technologies in order to be interoperable with other products routinely used in HSD operations such as routers, switches, network interfaces, operating systems, security protocols and techniques, communication protocols and protocol servers, and billing systems software |
| Without compatibility, we may not achieve market acceptance or demand for our products within our target base of customers because our products will not operate with many of the applications the target customers currently use |
| We rely on third parties to provide certain components and services for our video phone products |
| If our vendors fail to deliver their products in a reliable, timely and cost-efficient manner, our business will suffer |
| We depend on relationships with third parties such as contract manufacturing companies, chip design companies and others who may be sole source providers of key components and services critical for the product we are developing in our video phone business |
| A formal relationship with Mototech has been established for the volume manufacture of Ojo |
| Our agreement with Mototech allows either party to terminate the agreement with 90 days prior notice |
| If Mototech or other providers of components and/or manufacturing services do not produce these components or provide their services on a timely basis, if the components or services do not meet our specifications and quality control standards, or if the components or services are otherwise flawed, we may have to delay product delivery, or recall or replace unacceptable products |
| In addition, such failures could damage our reputation and could adversely affect our operating results |
| As a result, we could lose potential customers and any revenues that we may have at that time may decline dramatically |
| We will rely on third parties to provide certain marketing and distribution services for our video phone products |
| If our vendors fail to deliver their services in an appropriate, reliable, timely and cost-efficient manner, our business will suffer |
| Prior to February 17, 2006 the Company relied upon General Instrument to provide the marketing and distribution for its products |
| As of such date, the Company and General Instrument agreed to end their development and distribution agreement and the Company assumed full responsibility for product sale and distribution in all channels |
| In addition to direct sales on our web site, we will continue to rely upon a distribution organization of dealers, distributors, original equipment manufacturers, value added resellers, service providers and other resellers to market and sell our video phone products, many of which will be the same as those used by General Instrument |
| WorldGate also plans to expand distribution to service providers and retailers around the world |
| The Company has agreed with General Instrument to work together to ensure a smooth transition for existing customer accounts |
| Given our limited experience in dealing with the retail distribution channel, there can no assurance that we will be able to successfully and expeditiously conclude retail distribution agreements with the necessary retailers and distributors |
| Additionally the Company does not have the same presence or negotiation strength as General Instrument and there can be no assurance that the agreements we negotiate will be as favorable as those negotiated by a party with more presence |
| These resellers are able to set their own policies regarding the pricing of our products and the advertising, marketing and other promotional efforts applicable to our products |
| In addition they determine how prominently our products are displayed and demonstrated |
| If our resellers’ policies are not effective or if our products are not given adequate prominence, our sales of our products may be negatively impacted and our operating results would be adversely affected |
| In this event our revenue could be significantly reduced and we could lose potential customers for our products |
| With the end of our development and distribution agreement with General Instrument, we will no longer be able to use the Motorola brand in association with our products, or General Instrument’s other resources in marketing and distributing our products |
| The Motorola brand made available by General Instrument is a widely recognized brand that is almost synonymous with cell phone, radios and other widely distributed electronic products |
| In addition, General Instrument brought significant resources in the areas of advertising, sponsorship, sales force and distribution logistics |
| With the end of our agreement with General Instrument, we are phasing out the Motorola branding and we are no longer eligible to benefit from the other resources that they offered |
| This may negatively impact the perception of our products and will require increased efforts on our part to market and promote our products and efficiently and successfully to sell and distribute our products, and there can be no assurance that we will be successful in our efforts |
| 8 ______________________________________________________________________ We may not be able to meet our product development objectives or market expectations |
| Our video phone products are complex and use “state of the art” technology |
| Accordingly, our development efforts are inherently difficult to manage and keep on schedule and there can be no assurance that we will be able to meet our development objectives or to meet market expectations |
| In addition to development delays, we may experience substantial cost overruns in completing development of our product |
| The technological feasibility for some aspects of the product that we envision is not completely established |
| The products developed by us may contain undetected flaws when introduced |
| There can be no assurance that, despite testing by us and by potential customers, flaws will not be found in the product, resulting in loss of or delay in market acceptance |
| We may be unable, for technological or other reasons, to develop and introduce products in a timely manner in response to changing customer requirements |
| Further, there can be no assurance that a competitor will not introduce a similar product |
| The introduction by a competitor of either a similar product or a superior alternative to our product, may diminish our technological advantage, render our product and technologies partially or wholly obsolete, or require substantial re-engineering of our product in order to become commercially acceptable |
| Our failure to maintain our product development schedules, avoid cost overruns and undetected errors or introduce a product that is superior to competing products would have a materially adverse effect on our business, financial condition and results of operations |
| We may not be able to achieve competitive pricing in the marketplace |
| Because video phone products are relatively new to the marketplace there is no established market pricing |
| Our pricing for the Ojo video phone may be considered high for a consumer product offering |
| We cannot be assured that we will be able to provide competitive market pricing |
| We are highly dependent on our key personnel to manage our business, and because of competition for qualified personnel we may not be able to recruit or retain necessary personnel |
| Our continued growth and success depend to a significant degree on the continued services of our senior management and other key employees and our ability to attract and retain highly skilled and experienced technical, managerial, sales and marketing personnel |
| We have historically been a developer of products related to ITV Our video phone business represents an expansion into the development of HSD communications hardware and software products in which we have limited experience |
| In our new video phone business, we also expect to encounter new product development challenges, new customer requirements, new competitors and other new business challenges, with which our existing management may be unfamiliar |
| There can be no assurance that we will be successful in recruiting new personnel or in retaining existing personnel |
| None of our employees is subject to a long-term employment agreement |
| The loss of one or more key employees or our inability to attract additional qualified employees could have a material adverse effect on our business, results of operations and financial condition |
| In addition, we may experience increased compensation costs in order to attract and retain skilled employees |
| We may not be successful in developing or maintaining strong distribution channels for our video phone products |
| The success of the video phone business depends on developing strong relationships with service providers such as cable and DSL operators and other HSD communications providers and distribution channel partners who are selling services and/or consumer electronic devices to end-users |
| If we are not successful in creating a strong distribution channel in a timely manner, we may not gain significant sales |
| We may not be able to compete successfully in the highly competitive and rapidly evolving HSD communications market |
| The market for products that utilize HSD communications is still developing and there can be no assurance that our product will ever achieve market acceptance |
| Businesses, cable operators and other HSD network providers as well as the users of such HSD networks must be convinced to buy our video phone product |
| To the extent we do not achieve growth, it will be difficult for us to generate meaningful revenue or to achieve profitability |
| We may not be able to protect intellectual property of our video phone business against third-party infringements or claims of infringement |
| Failure to protect our intellectual property rights may result in a loss of our exclusivity or the right to use our video phone technology |
| We plan to rely on patent, trade secret, trademark and copyright law to protect our video phone intellectual property |
| Although we have filed multiple patent applications for our technology, and we currently only hold one issued patent, our patent position is subject to complex factual and legal issues that may give rise to uncertainty as to the validity, scope and enforceability of a particular patent |
| Accordingly, there can be no assurance that any patents will be issued pursuant to our current or future patent applications or that patents issued pursuant to such applications will not be invalidated, circumvented or challenged |
| Moreover, there can be no assurance that the rights granted under any such patents will provide competitive advantages to us or be adequate to 9 ______________________________________________________________________ safeguard and maintain our proprietary rights |
| In addition, effective patent, trademark, copyright and trade secret protection may be unavailable, limited or not applied for in certain foreign countries |
| We also seek to protect our proprietary intellectual property, including intellectual property that may not be patented or patentable, in part by confidentiality agreements and, if applicable, inventor’s rights agreements with our current and future strategic partners and employees |
| We cannot assure you that these agreements will not be breached, that we will have adequate remedies for any breach or that such persons or institutions will not assert rights to intellectual property arising out of these relationships |
| Some of our video phone intellectual property includes technologies and processes that may be similar to the patented technologies and processes of third parties |
| If we do not adequately secure our freedom to use our video phone technology, we may have to pay others for rights to use their intellectual property, pay damages for infringement or misappropriation or be enjoined from using such intellectual property |
| If we are found to be infringing third-party patents, we do not know whether we will be able to obtain licenses to use such patents on acceptable terms, if at all |
| While we are not currently engaged in any material intellectual property disputes or litigation, we could become subject to lawsuits in which it is alleged that we have infringed the intellectual property rights of others or commence lawsuits against others who we believe are infringing upon our rights |
| Our involvement in intellectual property litigation could result in significant expense to us, adversely affecting the development of the challenged product or intellectual property and diverting the efforts of our technical and management personnel, whether or not such litigation concludes favorably for our company |
| Legal and regulatory developments could have adverse consequences for our business |
| The legal and regulatory environment that pertains to our business is uncertain and changing rapidly |
| New legislation or regulations could be introduced that could substantially impact our ability to launch and promote the Ojo video phone |
| For example the Federal Communications Commission (FCC) or a comparable regulatory authority could undertake an examination of whether to impose surcharges or additional regulations upon certain providers of Internet protocol, or IP, based communication services |
| The imposition of regulations on IP communications services may negatively impact our business |
| Similarly the adoption of regulations prohibiting the use of certain substances commonly found in electronic components could likewise increase the costs of our products, delay product introductions and otherwise negatively impact our business |
| The use of the high speed data infrastructure as a commercial marketplace is at an early stage of development |
| Demand and market acceptance for recently introduced products and services over the high speed data, or HSD, infrastructure are still uncertain |
| We cannot predict whether customers will be willing to shift their traditional telephone activities online |
| The HSD infrastructure may not prove to be a viable commercial marketplace for a number of reasons, including: • concerns about security and varying security techniques and protocols; • changing and non-uniform standards • Internet congestion; • quality of service issues; • inconsistent service; and • lack of cost-effective, high-speed access |
| If the use of the HSD infrastructure as a commercial marketplace does not continue to grow, we may not be able to grow our customer base, which may prevent us from achieving profitability |
| We may not have sufficient working capital to fund our continuing video phone business, and we may be unable to obtain additional capital |
| The extent and timing of our future capital requirements will depend upon several factors, including the rate of market acceptance of our products, the degree of competition for our products, and our level of expenditures, including those for product development, sales and marketing |
| If our capital requirements vary materially from those currently planned, we may require additional financing sooner than anticipated |
| Despite the receipt of proceeds from several private placements of our securities, we may need to seek additional third party investment in order to provide additional operating capital for our video phone business |
| We cannot be certain that financing from third parties will be available on acceptable terms to us or at all |
| The levels of funding of early-stage companies generally by both venture funds and strategic investors have fallen dramatically in the past few years |
| If we cannot raise funds on acceptable terms, we may not be able to develop our products and services, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, any of which could have a material adverse effect on our ability to grow our business |
| If we are unable to secure such additional financing, we will have to curtail or suspend our business activities, we may not be able to continue to operate our business as a going concern and we may have to seek protection of the bankruptcy courts |
| If that happens, you could lose your entire investment |
| 10 ______________________________________________________________________ If we obtain additional financing, you may suffer significant dilution |
| If we raise additional capital by issuing equity securities, our stockholders may experience severe dilution of their ownership percentage, which may adversely affect the value of our common stock |
| In addition, the new equity securities may have rights, preferences or privileges senior to those of our common stock |
| NASDAQ Listing Requirements may limit our ability to raise additional capital |
| Our common stock is listed on the NASDAQ SmallCap Market |
| If our common stock is listed on The NASDAQ National Market or The NASDAQ SmallCap Market at the time of a proposed equity financing resulting in the sale and issuance of twenty percent or more of the outstanding shares of our capital stock, we may be required to obtain stockholder approval of such issuance |
| There can be no assurance that we will be able to obtain any necessary stockholder approval, and the failure to obtain such approval could limit our ability to obtain needed capital |
| In the event that our common stock is delisted from NASDAQ SmallCap Market, it may be subject to the requirements of the rules relating to “penny stocks |
| ” Our common stock is currently listed on the NASDAQ SmallCap Market, which has requirements for the continued listing of stock |
| If we fail to continue to meet these listing requirements we will become subject to delisting |
| For example, if our common stock trades below dlra1dtta00 for 30 consecutive trading days, or if we fail to meet any of the other listing requirements including the timely filing of our required financial reports or the market capitalization, minimum stockholders’ equity requirements and keeping required filings current, our common stock may be delisted from the NASDAQ SmallCap Market |
| If our shares are delisted from the NASDAQ SmallCap Market, they are likely to become subject to the SEC penny stock rules, which could adversely affect the market liquidity of our common stock |
| These rules impose additional sales practice requirements on broker-dealers that sell low-priced securities to persons other than established customers and institutional accredited investors; and require the delivery of a disclosure schedule explaining the nature and risks of the penny stock market |
| As a result, the ability or willingness of broker-dealers to sell or make a market in our common stock might decline, and you could find it more difficult to sell your stock |
| The trading price for our common stock has been volatile, ranging from a sales price of dlra0dtta22 in April 2003, to a sales price of just under dlra7dtta00 per share in the first quarter of 2005 |
| The trading price for our common stock during the period from January 3, 2006 to March 13, 2006 ranged from dlra1dtta06 to dlra2dtta30 |
| The price has changed dramatically over short periods with changes of over 60prca percent in a single day |
| An investment in our stock is subject to such volatility and, consequently, is subject to significant risk |
| Prior offerings of our common stock may have an adverse impact on the market value of our stock |
| During 2003, 2004 and 2005 we issued shares of our common stock as part of various private placements to certain institutional investors and as part of these transaction filed multiple registration statements, which provided for the sale or distribution of these shares by these institutional investors |
| When these investors sell their shares we will not receive any proceeds from the sales |
| The sale of these blocks of stock, or even the possibility of their sale, may adversely affect the trading market for our common stock and reduce the price available in that market |
| In connection with these private placements, we also issued warrants and additional investment rights to purchase shares of common stock |
| The existence of such rights to acquire common stock at fixed prices may prove a hindrance to our efforts to raise future equity and debt funding, and the exercise of such rights will dilute the percentage ownership interest of our stockholders and may dilute the value of their ownership |
| The possible future sale of shares issuable on the exercise of outstanding warrants and additional investment rights could adversely affect the prevailing market price of our common stock |
| Further, the holders of the outstanding warrants and additional investment rights may exercise them at a time when we would otherwise be able to obtain additional equity capital on terms more favorable to us |
| The Company’s failure to comply with certain covenants contained in agreements relating to its private placement of securities may have an adverse impact on the cash available to the Company |
| We issued shares of our common and preferred stock, as well as warrants and additional rights to acquire our common stock, to certain institutional investors in private placement transactions in 2003, 2004 and 2005 |
| The various agreements providing for these private placement transactions included numerous provisions intended to protect such institutional investors |
| For example, the Company is required to continually maintain effective registration statements permitting the investors to sell their shares of common stock |
| Failure to comply with such requirements may result in damages to the investors and result in obligations to make cash payments to the investors |
| The investors may also be entitled to receive more shares than originally allocated in the event the Company subsequently issues shares to other investors at a lower valuation than that afforded to the investors |
| In addition, the 11 ______________________________________________________________________ investors may be entitled to receive cash payments instead of shares upon the redemption of certain securities in the event that certain defined events occur including a lapse in the registration statement, being delisted on certain specified exchanges, trading in the Company’s stock is suspended, or a change in control occurs with respect to the Company |
| Our board of directors’ right to authorize additional shares of preferred stock could adversely impact the rights of holders of our common stock |
| Our board of directors currently has the right to designate and authorize the issuance of one or more series of our preferred stock with such voting, dividend and other rights as our directors may determine |
| The board of directors can designate new series of preferred stock without the approval of the holders of our common stock |
| The rights of holders of our common stock may be adversely affected by the rights of any holders of shares of preferred stock that may be issued in the future, including without limitation dilution of the equity ownership percentage of our holders of common stock and their voting power if we issue preferred stock with voting rights |
| Additionally, the issuance of preferred stock could make it more difficult for a third party to acquire a majority of our outstanding voting stock |