<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
-------------------------
FORM 10-Q
Mark One
/X/ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the Quarterly Period Ended September 30, 2000.
or
/_/ Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Transition Period From ________ To ________ .
Commission file number: 000-25755
WORLDGATE COMMUNICATIONS, INC.
-------------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Delaware 23-2866697
-------------------------------------------------------------
(State of Incorporation) (I.R.S. Employer Identification No.)
3190 Tremont Avenue
Trevose, Pennsylvania 19053
-------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
(215) 354-5100
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(Registrant's Telephone Number, Including Area Code)
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 /X/ No / /
As of October 26, 2000, there were 23,280,494 shares of common stock, par value
$.01 per share, outstanding.
<PAGE>
WORLDGATE COMMUNICATIONS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS AND NINE MONTHS
ENDED SEPTEMBER 30, 2000
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION
Item 1. Financial Statements and Supplementary Data ................ Page 3
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ...................... Page 9
Item 3. Quantitative and Qualitative Disclosures
about Market Risk ........................................ Page 11
PART II OTHER INFORMATION
Item 1. Legal Proceedings .......................................... Page 12
Item 2. Changes in Securities and Use of Proceeds .................. Page 12
Item 3. Defaults upon Senior Securities ............................ Page 13
Item 4. Submission of Matters to a Vote of Security Holders ........ Page 13
Item 5. Other Information .......................................... Page 13
Item 6. Exhibits and Reports on Form 8-K ........................... Page 13
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
WORLDGATE COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
(UNAUDITED)
------------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 28,282 $ 9,256
Short - term investments 25,602 66,414
Accounts receivable, less allowance for doubtful accounts of $500 at
September 30, 2000 and $150 at December 31, 1999 8,528 3,248
Inventory 12,218 5,600
Prepaid and other assets 923 1,738
--------- ---------
Total current assets 75,553 86,256
--------- ---------
Property and equipment 4,599 2,196
Less: accumulated depreciation and amortization (855) (402)
--------- ---------
Property and equipment, net 3,744 1,794
Prepaid expenses and deposits 1,143 1,120
Investment in Unconsolidated Entity 766 0
Goodwill 3,457 0
--------- ---------
Total assets $ 84,663 $ 89,170
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current portion, notes payable $ 499 $ 796
Current portion, capital leases 5 5
Notes payable - Shareholders DVA 1,332 0
Accounts payable 3,074 2,810
Accrued expenses 1,428 389
Accrued compensation and benefits 2,561 1,844
Contractual obligations related to equity financing 5,110 0
Other 30 30
--------- ---------
Total current liabilities 14,039 5,874
Notes payable 111 377
Capital leases 3 7
Other 233 255
--------- ---------
Total liabilities 14,386 6,513
--------- ---------
Stockholders' equity:
Class A Common Stock, $.01 par value, 50,000,000 shares authorized,
23,233,322 shares issued and outstanding at September 30, 2000
and 21,488,456 shares issued and outstanding at December 31, 1999 232 215
Additional paid-in capital 192,608 170,592
Warrant for Class A Common Stock 1,911 1,911
Accumulated deficit (123,795) (89,085)
Unearned stock-based compensation (679) (976)
--------- ---------
Total stockholders' equity 70,277 82,657
--------- ---------
Total liabilities and stockholders' equity $ 84,663 $ 89,170
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
WORLDGATE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- --------------------------
2000 1999 2000 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues $ 6,618 $ 1,626 $ 11,768 $ 2,916
----------- ----------- ----------- -----------
Costs and expenses:
Cost of revenues 9,043 4,791 18,220 10,574
Engineering and development (excluding depreciation and
amortization amounts of $165 and $46 for the three months
ended September 30, 2000 and 1999, respectively, and $308 and
$94 for the nine months ended September 30, 2000 and 1999,
respectively) 4,365 3,664 12,794 8,428
Sales and marketing (excluding depreciation and amortization amounts
of $62 and $41 for the three months ended September 30, 2000 and
1999, respectively and $178 and $72 for the nine months ended
September 30, 2000 and 1999, respectively) 3,356 2,300 9,784 5,548
General and administrative (excluding depreciation and amortization
amounts of $55 and $1 for the three months ended September 30,
2000 and 1999, respectively and $117 and $24 for the nine
months ended September 30, 2000 and 1999, respectively) 2,678 1,501 7,212 4,081
Depreciation and amortization 282 88 603 190
----------- ----------- ----------- -----------
Total costs and expenses 19,724 12,344 48,613 28,821
----------- ----------- ----------- -----------
Loss from operations (13,106) (10,718) (36,845) (25,905)
Interest and other income 714 1,220 2,678 2,244
Interest expense 17 32 59 201
Loss from Unconsolidated Entity 484 0 484 0
----------- ----------- ----------- -----------
Loss before extraordinary item (12,893) (9,530) (34,710) (23,862)
Extraordinary item - loss on early extinguishment of debt 0 0 0 (1,019)
----------- ----------- ----------- -----------
Net loss (12,893) (9,530) (34,710) (24,881)
Accretion on preferred stock 0 0 0 (2,475)
----------- ----------- ----------- -----------
Net loss available to common stockholders $ (12,893) $ (9,530) $ (34,710) $ (27,356)
=========== =========== =========== ===========
Net loss per common share (basic and diluted) *
Loss before extraordinary item $ (0.57) $ (0.44) $ (1.59) $ (1.58)
Extraordinary item 0 0 0 (0.06)
----------- ----------- ----------- -----------
Net Loss $ (0.57) $ (0.44) $ (1.59) $ (1.64)
=========== =========== =========== ===========
Weighted average common shares outstanding -
basic and diluted 22,462,673 21,439,399 21,893,222 16,663,137
=========== =========== =========== ===========
</TABLE>
* For purposes of computing net loss per common share amounts,
loss before extraordinary item and net loss have been reduced
by the accretion on preferred stock.
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
WORLDGATE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
2000 1999
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (34,710) $ (24,881)
Adjustments to reconcile net loss to cash used in
operating activities:
Depreciation and amortization 453 190
Bad debt expense 350 0
Amortization of deferred compensation 296 297
Amortization of goodwill 150 0
Amortization of debt issue costs 0 108
Loss on the disposition of fixed assets 0 20
Extraordinary loss on early extinguishment of debt 0 1,019
Loss from investment in unconsolidated entity 484 0
Changes in operating assets and liabilities:
Accounts receivable (5,324) (1,421)
Inventories (6,618) (3,263)
Prepaid and other assets 818 (1,698)
Accounts payable 260 (948)
Accrued expenses 942 1,134
Accrued compensation and benefits 607 (184)
Other (23) 0
--------- ---------
Net cash used in operating activities (42,315) (29,627)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (2,361) (1,088)
Proceeds from maturities of short-term investments, net 40,812 (58,427)
Investment in unconsolidated entity (1,250) 0
Net cash acquired - acquisition of DVA 63 0
Restricted cash 0 240
--------- ---------
Net cash provided by (used in) investing activities 37,264 (59,275)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of preferred stock 0 7,672
Proceeds from issuance of common stock 24,530 120,750
Proceeds from exercise of stock options 114 91
Stock issuance costs 0 (9,580)
Proceeds from notes payable 0 6,000
Debt issue costs 0 (530)
Repayments of capital leases and notes payable (567) (5,952)
--------- ---------
Net cash (used in) provided by financing activities 24,077 118,451
--------- ---------
Net (decrease) increase in cash 19,026 29,549
Cash and cash equivalents, beginning of period 9,256 128
--------- ---------
Cash and cash equivalents, end of period $ 28,282 $ 29,677
========= =========
Noncash investing and financing activities:
Issuance of common stock for acquisition of business $ 2,500 0
Issuance of notes payable for acquisition of business $ 1,332 0
Establishment of contractual obligation related to equity financing $ 5,110 0
Accretion on preferred stock 0 $ 2,475
Issuance of warrants in connection with financing agreements 0 1,030
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
WORLDGATE COMMUNICATIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Dollar Amounts are in Thousands, Except per Share Amounts)
(unaudited)
1. Basis of Presentation.
The unaudited financial statements of WorldGate Communications, Inc. (the
"Company") for the three and nine months ended September 30, 2000 and September
30, 1999 presented herein have been prepared by the Company pursuant to the
rules and regulations of the Securities and Exchange Commission for quarterly
reports on Form 10-Q. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. These financial statements should be read in conjunction with the
financial statements for the year ended December 31, 1999 and the notes thereto
included in the Company's Annual Report on Form 10-K.
The financial information in this Report reflects, in the opinion of
management, all adjustments of a normal recurring nature necessary to present
fairly the results for the interim period. Quarterly operating results are not
indicative of the results that may be expected for the year ending December 31,
2000.
2. Recent Accounting Pronouncements.
On April 3, 2000 the Financial Accounting Standards Board (FASB) issued
FASB Interpretation (FIN) 44, "Accounting for Certain Transactions Involving
Stock Compensation - an Interpretation of APB 25." FIN 44 specifically answers
twenty-nine questions on the implementation of APB 25 that were derived from a
survey of members of the Emerging Issues Task Force (EITF) and the task force on
stock compensation. FIN 44 is effective July 1, 2000, but certain conclusions in
FIN 44 cover specific events that occur after December 15, 1998. To the extent
that FIN 44 covers events occurring during the period after December 15, 1998,
but before the effective date of July 1, 2000, the effects of applying FIN 44
are recognized on a prospective basis from July 1, 2000. The adoption of FIN 44
has not had a material effect on the Company's financial position and results of
operations.
On June 26, 2000 the Securities and Exchange Commission issued Staff
Accounting Bulletin (SAB) No. 101B which extended the implementation date of SAB
101, "Revenue Recognition" to the three month period ending December 31, 2000.
SAB 101 provides guidance on the recognition, presentation, and disclosure of
revenue in financial statements. Management is currently assessing the impact,
if any, SAB 101 will have on the Company's financial position and results of
operations.
3. Inventories.
Inventories are summarized as follows:
<TABLE>
<CAPTION>
September 30, 2000 December 31, 1999
------------------- ------------------
<S> <C> <C>
Raw Material $5,606 $3,046
Work in Progress 2,350 340
Finished Goods 4,262 2,214
------------------- ------------------
$12,218 $5,600
=================== ==================
</TABLE>
Customers and vendors held $2,069 and $1,710 of the Company's finished
goods inventories at September 30, 2000 and December 31, 1999, respectively, for
use in system trials and product testing.
6
<PAGE>
4. Stockholders' Equity.
STOCK OPTION PLAN
On May 4, 2000, the Company's Board of Directors increased the number of
shares of common stock issuable under the Company's 1996 Stock Option Plan to
3,200,000 shares. The stockholders of the Company approved the increase on
October 5, 2000.
EARNINGS PER SHARE
The following table is a reconciliation of the computation of net loss per
common share:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30 NINE MONTHS ENDED SEPTEMBER 30
-------------------------------- -------------------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net loss available to common stockholders:
Loss before extraordinary item $ (12,893) $ (9,530) $ (34,710) $ (23,862)
Accretion on preferred stock 0 0 0 (2,475)
------------ ------------ ------------ ------------
Loss available to common stockholders* (12,893) (9,530) (34,710) (26,337)
Extraordinary item - loss on early extinguishment of debt 0 0 0 (1,019)
------------ ------------ ------------ ------------
Net Loss available to common stockholders* $ (12,893) $ (9,530) $ (34,710) $ (27,356)
============ ============ ============ ============
Basic and diluted net loss per common share**:
Weighted average shares outstanding 22,462,673 21,439,399 21,893,222 16,663,137
============ ============ ============ ============
Loss before extraordinary item per share - basic and
diluted $ (0.57) $ (0.44) $ (1.59) $ (1.58)
Extraordinary item - loss on early extinguishment of debt 0 0 0 (0.06)
------------ ------------ ------------ ------------
Net loss per share - basic and diluted $ (0.57) $ (0.44) $ (1.59) $ (1.64)
============ ============ ============ ============
</TABLE>
* Loss and net loss available to common stockholders is the same for purposes
of calculating basic and diluted loss per common share.
** Basic and diluted loss per common share are equal, since common stock
equivalents are not included, as inclusion of such shares would have an
antidilutive effect.
5. Related Party Transactions.
In 1997, the Company entered into an agreement with a cable operator who is
an investor. Revenues recognized from this investor were approximately $2,569
and $119, respectively, for the three months ended September 30, 2000 and
September 30, 1999, and $4,980 and $763, respectively, for the nine months ended
September 30, 2000 and September 30, 1999. Accounts receivable from this
investor amounted to approximately $2,884 at September 30, 2000 and $738 at
December 31, 1999.
In 1997 and 1998, the Company entered into agreements with four
stockholders to provide the Company with engineering and development support. As
a result of these agreements, the Company has expensed approximately $2,168 and
$879, respectively, for the three months ended September 30, 2000 and September
30, 1999 and $5,075 and $2,597, respectively, for the nine months ended
September 30, 2000 and September 30, 1999. Accounts payable to these
stockholders amounted to $632 and $126 at September 30, 2000 and December 31,
1999, respectively. These stockholders are suppliers of technology and
components for the Company's products and services. These agreements provide for
licensing of technology, as well as contracted services, including hardware and
software development, product testing and certification, and the creation and
development of tools and systems to facilitate the Company's engineering
efforts. These agreements do not provide for ongoing royalties, purchase
provisions, nor for any requirement to provide additional funding to the
Company.
6. Digital Video Arts, Inc. Acquisition
On April 28, 2000, the Company completed the acquisition of Digital Video
Arts, Inc. ("DVA"), a Campbell, California based engineering services operation
providing out-sourced product development, with expertise in digital television
and 3D graphics. The acquisition was recorded under the purchase method of
accounting.
7
<PAGE>
The total purchase consideration of $3,977 consisted of approximately
119,000 shares of Common Stock with a value of $2,500, assumption of obligations
totaling $1,332, and acquisition costs of $145. The purchase consideration of
the acquired assets and assumed liabilities were allocated based on fair values
as follows:
<TABLE>
<S> <C>
Assets acquired................................................. $ 582
Liabilities assumed............................................. (213)
Goodwill........................................................ 3,608
---------
Total purchase consideration.................................... $ 3,977
=========
</TABLE>
In addition, the purchase agreement between the Company and DVA provides
for the payment of contingent consideration in shares of Common Stock in
accordance with a specified formula if certain criteria with respect to the
retention of the former management and employees of DVA are met over future
periods ranging from one to three years. Contingent consideration in shares of
Common Stock up to a maximum amount of $4,174 could be payable based on
performance criteria associated with the three years ended December 31, 2003. As
this contingency becomes determinable it will be expensed. Goodwill associated
with the DVA acquisition will be amortized on a straight-line basis over ten
years.
The Company has guaranteed that the consideration for the acquisition will
not be less than the amount that was agreed to based on the WorldGate share
price immediately prior to the close of the transaction or the respective
anniversary dates. In the event the aggregate amount of proceeds received in
consideration as part of the DVA acquisition is less than the amount of
consideration guaranteed under the terms of the merger agreement, WorldGate is
obligated to pay cash or issue additional shares in an amount equal to the
difference between the amount of guaranteed consideration and the value of the
stock at the date consideration is provided.
The pro forma results of operations for DVA for the three and nine months
ended September 30, 2000 and 1999, were not significant.
7. TVGateway Joint Venture and Related Cable Operator Agreements
On July 24, 2000, the Company entered into multi-year agreements with
four cable operators for the digital deployment of the Company's Internet on
EVERY TV-SM- service to a predetermined number of households. In addition to
the deployment agreements, the cable providers purchased an aggregate of
1,531,211 shares of the Company's Common Stock yielding proceeds to the
Company of $24,530. These same cable operators were issued warrants to
purchase additional shares of Common Stock which will vest at varying rates
based on the deployment of the Company's Internet on EVERY TV-SM- service on
the MSO's digital cable system.
Concurrently with the above transaction, the Company formed a separate
joint venture, TVGateway, LLC, with the same four cable operators. The
Company licensed its patented Channel Hyperlinking and Ultra-Thin Client
technology to TVGateway. The licensed technology can provide the
infrastructure support necessary to deploy interactive advertising and
programming for the cable operator's digital set-top boxes. TVGateway also
licensed Application Launcher technology from the Company that enables
multiple applications to be easily interchanged in the digital set-top box.
The Company is providing certain administrative services to the joint venture
on a cost plus management fee basis. For the three months and nine months
ended September 30, 2000, charges for such services totaled $1,435. Accounts
receivable from TVGateway amounted to $1,435 at September 30, 2000 and there
were no open accounts receivable from TVGateway at December 31, 1999.
WorldGate is accounting for its investment in the joint venture under the
equity method. For the three months and nine months ended September 30, 2000,
WorldGate recorded a loss of $484.
Concurrent with the consummation of the multi-year agreements with four
cable operators noted above, the Company entered into a noncancellable supply
agreement with the cable operators whereby the Company agreed to supply these
cable operators, on a prorata basis, products that pertain to the development
and deployment of the WorldGate service. The Company has recorded a liability of
$5,110 for the anticipated cost of satisfying this obligation.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
(Dollar Amounts are in Thousands, Except 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 foregoing Management's Discussion and Analysis
of Financial Condition and Results of Operations. 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) industry competition
factors and other uncertainty that a market for the WORLDGATE-SM- Service will
develop, (4) challenges associated with cable operators (including, uncertainty
that they will offer the WORLDGATE Service, inability to predict the manner in
which they will market and price the WORLDGATE Service and existence of
potential conflicts of interests and contractual limitations impeding their
ability to offer the WORLDGATE Service), (5) challenges associated with cable
box manufacturers (including uncertainty that they will support our technology
in their cable boxes), (6) challenges with advertisers and television
programmers (including uncertainties that they will support our CHANNEL
HYPERLINKING-SM- technology), (7) loss of any one of our largest customers, (8)
departure of one or more key persons and (9) other risks identified in our
filings with the Securities and Exchange Commission. We caution you that the
foregoing list of important factors is not intended to be, and is not,
exhaustive. We do not undertake to update any forward-looking statement that may
be made from time to time by or on behalf of WorldGate.
Results of Operations:
Three and Nine Months Ended September 30, 2000 and September 30, 1999
Revenues. Revenues increased from $1,626 for the three months ended
September 30, 1999, to $6,618 for the three months ended September 30, 2000.
Revenues also increased from $2,916 for the nine months ended September 30, 1999
to $11,768 for the nine months ended September 30, 2000. Substantially all
revenues are attributable to the increase in commercial deployments of
WorldGate's interactive television services. At September 30, 1999 there were 12
commercial deployments and approximately 11,400 cable customers subscribing to
the WorldGate Service. As of September 30, 2000 there were 19 commercial
deployments, with approximately 68,000 cable customers subscribing to the
WorldGate Service. For the three and nine months ended September 30, 2000
revenues were derived primarily from the delivery of headends, keyboards, and
related products and services.
Costs and Expenses.
Cost of Revenues. Cost of revenues consist primarily of product costs
related to initial trials, commercial deployments and WorldGate modules used by
the cable operators in deploying the WorldGate Service to be incorporated into
the set-top boxes. Cost of revenues for the three and nine months ended
September 30, 2000 were $9,043 and $18,220, respectively, or approximately 137%
and 155% of revenues, respectively, compared to the cost of revenues of $4,791
and $10,574, respectively, or approximately 295% and 363% of revenues,
respectively, for the three and nine months ended September 30, 1999. This
reduction in cost of revenues as a percent of revenues is primarily attributable
to the Company's reduction of unit costs, the reduced requirement for WorldGate
to supply modules to be incorporated into set-top box deliveries, and additional
volume to cover manufacturing overheads.
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 $4,365 and $12,794, respectively, for the three and nine months ended
September 30, 2000, an increase of approximately 19% and 52%, respectively, when
compared to $3,664 and
9
<PAGE>
$8,428, respectively, for the three and nine months ended September 30,
1999. The Company anticipates continued increases in expenditures for staff and
new and enhanced products, software and services.
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 three and nine months ended September 30, 2000
sales and marketing expenses were $3,356 and $9,784, respectively. This
represented increases of approximately 46% and 76%, respectively, when compared
to sales and marketing expenses of $2,300 and $5,548, respectively, for the
three and nine months ended September 30, 1999. These increases were primarily
the result of additional trade show costs of approximately $400, together with
increases in marketing and promotional expenditures which the Company
anticipates will continue to increase with the anticipated growth in the number
of new, and the expansion of existing, commercial deployments. Increased
expenditures are also anticipated in the future for advertising and other trade
promotional activities.
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 $2,678 and $7,212,
respectively, for the three and nine months ended September 30, 2000, an
increase of approximately 78% and 77%, respectively, when compared to expenses
of $1,501 and $4,081, respectively, for the same periods in 1999. This increase
of $1,177 and $3,131, respectively, was primarily due to $99 and $297,
respectively, of additional deferred compensation expense related to options
previously granted, facility operating costs of $349 and $856, respectively,
associated with the Company's relocation to a larger facility in June 1999,
additional legal, professional fees, travel and insurance costs of $712 and
$1,508, respectively, and $350 covering increases in our reserve for doubtful
accounts over the nine months ended September 30, 2000. The Company anticipates
that general and administrative expenses will continue to increase as the
Company hires additional personnel to support its expected growth.
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 $1,220 for the three
months ended September 30, 1999 to $714 for the three months ended September 30,
2000, and increased from $2,244 to $2,678 for the nine months ended September
30, 1999 and September 30, 2000, respectively. During the three and nine months
ended September 30, 1999, the Company earned interest on an average cash balance
of approximately $95,000 and $60,000, respectively, and incurred interest
expense related to its $6,000 financing and $1,100 equipment financing facility.
In comparison, during the three and nine months ended September 30, 2000 the
Company earned interest on an average cash balance of approximately $51,400 and
$60,400, respectively, and incurred interest expense related to its $1,100
equipment financing facility.
Extraordinary Loss. As a result of the early extinguishment in April 1999
of Notes issued by the Company in March 1999, the Company recognized a loss of
$1,019 during the second quarter of 1999, primarily related to the remaining
unamortized debt discount balance.
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.
Liquidity and Capital Resources.
As of September 30, 2000, the Company's primary source of liquidity
consisted of cash and debt instruments that are highly liquid, are of high
quality investment grade and have maturities of less than one year.
At September 30, 2000, the Company had cash and cash equivalents of $28,282
(in addition to $25,602 in short-term investments) as compared to $9,256 (in
addition to $66,414 in short-term investments) at December 31, 1999. Net cash
used in operations was $42,315 for the nine months ended September 30, 2000, as
compared to $29,627 used for the same period in 1999. The increase in net cash
used for operations was primarily attributable to the Company's increased
expenditures in 2000, inventory increases in anticipation of future deliveries,
and higher accounts receivable balances due primarily to shipments late in the
third quarter.
10
<PAGE>
Net cash for the nine months ended September 30, 2000 was further reduced
by $567, reflecting the net impact of the Company's repayment of equipment
financing obligations which was partially offset by the proceeds from option
exercises. The Company's net use of cash for operating and financing activities
as well as capital expenditure requirements was offset by proceeds from the
maturity of short-term investments. In comparison, net cash provided from
financing activities was $118,451 during the nine months ended September 30,
1999, primarily resulting from the Company's initial public offering in April
1999, with net proceeds totaling $111,192. The Company reported net cash
provided by financing activities during the nine months ended September 30, 2000
of $24,077, due primarily to the proceeds received from the issuance of Common
Stock. The proceeds were invested in short-term investments.
In July 2000, the Company entered into agreements with four cable
operators regarding the digital deployment of the Company's Internet on EVERY
TV-SM- service. In connection with such agreements, on August 15, 2000, the
cable operators purchased an aggregate of 1,531,211 shares of the Company's
Common Stock yielding proceeds to the Company of $24,530. In addition, the
Company issued warrants to the cable operators to purchase additional shares
of Common Stock which will vest at varying rates based on the deployment of
the Company's Internet on EVERY TV-SM- service on the MSO's digital cable
system.
On April 3, 2000 the Financial Accounting Standards Board (FASB) issued
FASB Interpretation (FIN) 44, "Accounting for Certain Transactions Involving
Stock Compensation - an Interpretation of APB 25." FIN 44 specifically answers
twenty-nine questions on the implementation of APB 25 that were derived from a
survey of members of the Emerging Issues Task Force (EITF) and the task force on
stock compensation. FIN 44 is effective July 1, 2000, but certain conclusions in
FIN 44 cover specific events that occur after December 15, 1998. To the extent
that FIN 44 covers events occurring during the period after December 15, 1998,
but before the effective date of July 1, 2000, the effects of applying the
Interpretation are recognized on a prospective basis from July 1, 2000. The
adoption of FIN 44 has not had a material effect on the Company's financial
position and results of operations.
On June 26, 2000 the Securities and Exchange Commission issued Staff
Accounting Bulletin (SAB) No. 101B which extended the implementation date of SAB
101, "Revenue Recognition" to the three month period ending December 31, 2000.
SAB 101 provides guidance on the recognition, presentation, and disclosure of
revenue in financial statements. Management is currently assessing the impact,
if any, SAB 101 will have on the Company's financial position and results of
operations.
ITEM 3. 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 September 30, 2000, our cash and cash equivalents and short-term
investments were $53,884, most of which were debt securities having a maturity
of less than one year. Due to the average maturity and conservative nature of
our investment portfolio, management believes 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 nine months ended September 30, 2000 would
have decreased by approximately $408. This estimate assumes that the decrease
occurred on the first day of 2000 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 our total
investments.
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<PAGE>
PART II. OTHER INFORMATION
(Dollars Amounts are in Thousands, Except per Share Amounts)
ITEM 1. LEGAL PROCEEDINGS.
On May 11, 1998, Interactive Channel Technologies, Inc. and SMI Holdings,
Inc., subsidiaries of Source Media, Inc. ("Source"), filed a complaint against
us in the U.S. District Court for the District of Delaware, alleging that the
WorldGate Service infringes patents issued to Source. The complaint seeks
injunctive relief, as well as monetary damages and attorney fees. In our answer
filed on June 22, 1998, we have denied these allegations and further asserted
that the patents in suit were invalid. In addition we have filed multiple
counterclaims against Source asserting that Source misappropriated our
confidential information and trade secrets, and intentionally and tortiously
interfered with our existing and prospective business relationships, which
counterclaims Source moved to dismiss. Source's motion was subsequently denied
and discovery is now proceeding. On or about March 6, 2000, Liberate
Technologies, LLC, acquired rights in the patents and was substituted as
plaintiff.
On October 6, 1998, Advanced Interactive, Inc. ("AII") filed a complaint in
the U.S. District Court for the Northern District of Illinois, Eastern Division,
against Matsushita Electric Corporation, Matsushita Electric Industrial Co.
Ltd., Sharp Electronics Corp., Sharp Corp., Interactive Channel Technologies,
Thomson Consumer Electronics, Toshiba Consumer Products, Inc., Toshiba America,
Inc., Toshiba Corporation, General Instrument Corporation, Scientific-Atlanta,
Inc., ATI Technologies, Inc., ADS Technologies, Inc., Gateway 2000, Inc., STB
Systems, Inc., Hauppauge Computer Works, Inc., WebTV Networks, Inc., and us,
alleging that each of the above companies infringed a patent issued to AII. The
complaint seeks monetary damages and attorney fees. In our answer filed on
December 2, 1998, we denied these allegations and further asserted that the
patent in suit was invalid. Subsequently, the defendants have filed a joint
motion for partial summary adjudication of claim construction issues. On
February 27, 2000 the Court agreed with the claim construction proposed by the
defendants and granted defendant's joint motion for partial summary judgement,
and entered judgement accordingly. AII filed an appeal, and the appeal is
pending.
In the opinion of management, the ultimate resolution of these matters will
not have a material effect on the consolidated financial position, operations or
cash flow of the Company.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
On August 15, 2000, the Company completed a private placement of an
aggregate of 1,531,211 shares of its Common Stock (the "MSO Shares") to four
cable operators who are accredited investors (each a "MSO"). The shares were
sold for $16.02 per share, resulting in proceeds from the offering of
$24,530. 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
on Every TV-SM- 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 initiated by the Company or other stockholders
and a "demand" registration right allows holders to require the Company to file
a registration statement to register their shares of Common Stock.
On April 15, 1999, the Company's Registration Statement on Form S-1
(Commission file number 333-71997) covering the initial public offering of
5,750,000 shares of our common stock at twenty one dollars ($21.00) per share
was declared effective.
The net proceeds of the offering to the Company (after deducting the
foregoing expenses associated with such offering) was $111,192. From the
effective date of the Registration Statement to September 30, 2000, the net
proceeds have been used for the following purposes:
12
<PAGE>
<TABLE>
<S> <C>
Construction of plant, building and facilities $ 0
Purchase and installation of machinery and equipment 3,559
Purchase of real estate 0
Acquisition of other business (including transaction costs) 145
Repayment of indebtedness 6,730
Working capital 52,871
Temporary investments, including cash and cash equivalents 28,282
Other purposes (for which at least $100 has been used)
including: investments, including debt instruments of
the United States Government and its agencies and in high
quality corporate issuers 19,605
--------
$111,192
</TABLE>
Except for compensation expenses, all of the foregoing payments were direct
or indirect payments to persons other than (i) directors, officers or their
associates; (ii) persons owning ten percent (10%) or more of the Company's
common stock; or (iii) affiliates of the Company.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES. NONE.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. NONE
ITEM 5. OTHER INFORMATION. NONE.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Exhibit Number Description
-------------- -----------
27.1 Financial Data Schedule
(b) Reports on Form 8-K.
The Company filed a Report on Form 8-K on July 26, 2000. In Item 5 of
the Form 8-K, the Company reported the completion of multi-year
agreements with Adelphia Communications Corporation, Comcast Cable
Communications, Inc., Cox Communications, Inc., and Charter
Communications, Inc. (together, the "MSOs"), for the digital deployment
of the WorldGate Internet on EVERY TV-SM- to a predetermined number of
households. The Company also reported that the MSOs purchased common
stock of the Company and were issued warrants to purchase additional
shares. The Company also reported that it has entered into a separate
joint venture with the MSOs, called TVGateway-SM-. In Item 7 of the
Form 8-K, the Company listed its Press Release, dated July 26, 2000,
which announced the above referenced transactions.
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<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
WORLDGATE COMMUNICATIONS, INC.
------------------------------
DATE: NOVEMBER 9, 2000 By: /s/ Hal M. Krisbergh
-------------------------------------
Hal M. Krisbergh
President and Chief Executive Officer
DATE: NOVEMBER 9, 2000 /s/ James V. Agnello
-------------------------------------
James V. Agnello
Vice President and Chief Financial Officer
14
