The accompanying unaudited interim consolidated financial statements of Bluegate Corporation, have been prepared in accordance with accounting principles generally accepted in the United States of America and the rules of the Securities and Exchange Commission, and should be read in conjunction with the audited consolidated financial statements and notes thereto contained in Bluegate's Annual Report filed with the SEC on Form 10-K.  In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of financial position and the results of operations for the interim periods presented have been reflected herein.  The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year.  Notes to the consolidated financial statements which substantially duplicate the disclosure contained in the audited consolidated financial statements for fiscal 20092010 as reported in the Form 10-K have been omitted.

In September 2006, the FASB issued ASC 820 which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The provisions of ASC 820 were effective January 1, 2008. ASC 820 delays the effective date for nonfinancial assets and liabilities, except for items that are recognized or disclosed at fair value in the consolidated financial statements on a recurring basis (at least annually), until fiscal years beginning after November 15, 2008.

As defined in ASC 820, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The Company utilizes market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. The Company classifies fair value balances based on the observability of those inputs. ASC 820 establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurement) a ndand the lowest priority to unobservable inputs (level 3 measurement).

The three levels of the fair value hierarchy defined by ASC 820 are as follows:

Level 1 – Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis. Level 1 primarily consists of financial instruments such as exchange-traded derivatives, marketable securities and listed equities.

Level 2 – Pricing inputs are other than quoted prices in active markets included in level 1, which are either directly or indirectly observable as of the reported date. Level 2 includes those financial instruments that are valued using models or other valuation methodologies. These models are primarily industry-standard models that consider various assumptions, including quoted forward prices for commodities, time value, volatility factors, and current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace throughout the full term of the instrument, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace. Instruments in this category ge nerallygenerally include non-exchange-traded derivatives such as commodity swaps, interest rate swaps, options and collars.

Level 3 – Pricing inputs include significant inputs that are generally less observable from objective sources. These inputs may be used with internally developed methodologies that result in management’s best estimate of fair value.

The derivatives listed above are carried at fair value. The fair value amounts in current period earnings associated with the Company’s derivatives resulted from Level 2 fair value methodologies; that is, the Company is able to value the assets and liabilities based on observable market data for similar instruments. This observable data includes the quoted market prices and estimated volatility factors.

During the ninethree months ended September 30, 2010,March 31, 2011, Bluegate has been unable to generate cash flows sufficient to support its operations and has been dependent on debt and equity raised from qualified individual investors. In addition to negative cash flow from operations, Bluegate has experienced recurring net losses, and has a negative working capital and shareholders’ deficit.

These factors raise substantial doubt about the Company’s ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might be necessary if Bluegate is unable to continue as a going concern.

In order to preserve common shareholder value, avoid bankruptcy and minimize Bluegate’s ongoing loss, effective November 7, 2009, Bluegate entered into the following transactions: 1) disposed of certain Medical Grade Network (“MGN”) assets and business and the elimination of certain liabilities consisting(consisting primarily of: a) furniture, computers and related software and peripherals with a $17,889 book value; b)  contracts, agreements, lists of telephone and fax numbers, licenses, permits, intellectual properties, registered mark for MGN and business name of Bluegate with a -0- net book value; c) eliminated liabilities of $43,607 principally related to customer product prepays which were assumed by the purchaserpurchaser) to Sperco, LLC (“Sperco”) (an entity controlled by Stephen Sperco (“SS”), ou rour CEO/President/Director) for $200,000, with payment made by a combination of $100,000 cash and $100,000 forgiveness of debt to SAI Corporation (“SAIC”) (an entity controlled by SS), plus a net adjustment of $7,100 due to Bluegate from Sperco resulting from Bluegate’s collection of principally accounts receivable totaling $161,900 on behalf of Sperco for the period from November 8, 2009 through December 31, 2009, offset by Sperco’s payment of $169,000 to Bluegate for the personnel, facilities, tools, and resources necessary for Bluegate to support both the MGN and HIMS operations for Sperco for the same period; 2) entered into a Separation Agreement and Mutual Release in Full of all claims with Manfred Sternberg (“MS”) (former Director/Corporate Officer), which included the elimination of $28,499 of accrued director fees and vehicle allowances in exchange for repayment of a loan plus accrued interest totaling $44,369 to MS; and 3) aentered into A Separation Agreement and Mutual Release in Full of al lall claims with William Koehler (“WK”) (former Director/Corporate Officer), which included the elimination of $28,499 of accrued director fees and vehicle allowances in exchange for repayment of a loan plus accrued interest totaling $44,374 with a direct payment to WK’s American Express account and a $1 payment to WK; and 4) disposed of certain Trilliant Technology Group, Inc.’s assets and business (consisting primarily of: a) Computers and related software and peripherals with a -0- net book value; b) lists of telephone and fax numbers and  intellectual properties with a -0- net book value) to Trilliant Corporation (an entity controlled by WK) for a cash payment of $5,000; and 5) disposed of certain Bluegate Healthcare Information Management Systems (“HIMS”) assets and business (consisting primarily of: a) Contracts, agreements and intellectual properties with a -0- net book value) to SAIC in exchange for a Mutual Release in Full of certain claims and a $1 payment to SAIC; and 6) obtained a Fairness Opinion dated November 6, 2009 presented by Convergent Capital Appraisers.

As a result of these transactions, Bluegate received $105,000 cash; reduced the secured note payable to SAIC by $100,000; paid off unsecured notes payable and accrued interest of $88,743 to MS and WK; eliminated $56,998 of accrued liabilities to MS and WK; recorded $24,234 of expenses (principally legal and professional); removed the remaining book value of fixed assets of $17,889, eliminated $43,607 of customer liabilities assumed by Sperco and the net effect of $263,484 as an increase to Additional paid-in capital since the effect was treated as related party forgiveness of debt. There was no income tax (benefit) recorded as a result of the disposition since Bluegate has sufficient unused net operating losses available. Additionally the agreement provided for Sperco, LLC to contract the services of Bluegate employees and resources fr omfrom November 8, 2009 through December 31, 2009 for $169,000 and the $169,000 was treated as an increase to Additional paid-in capital. The revenue and loss applicable to discontinued operations in 2009 were $2,642,450 and 112,180, respectively.

Effective January 1, 2010 there were no Bluegate Corporation employees and Sperco, LLC commenced providing management, accounting and administrative services, as well as, network infrastructure and engineering support to Bluegate as needed in exchange for space and associated services. Effective July 1, 2010 Bluegate agreed to pay $15,000 monthly for those services and as of September 30, 2010March 31, 2011 Bluegate owes $45,000$135,000 for those services. The $45,000$135,000 is included in the $98,656$183,352 balance under the caption accounts payable to related party on the balance sheet.

Bluegate used the holders of warrants, options, convertible debt and preferredBlack-Scholes option pricing model to value stock requested to exercise or convert all of the warrants, options, convertible debt and preferred stock, we would be unable to accommodate 1,969,962 shares of common stock in those requests. The company could have liability in the future if an option holder, warrant holder, preferred stock holder or holder of convertible debt desires to exercis e or convert but cannot because we do not have enough unissued common stock available for issuance. However, the following individual or entities have waived their reservation of common stock underlying options and warrants using the following assumptions: number of options as set forth in the option agreements; no expected dividend yield; expected volatility ranging from 202% to 260%; risk-free interest rates of 5.0%; and expected terms based on the period of time expected to elapse until such time thatexercise. When applicable, Bluegate uses the boardsimplified method of directors deems the waiver is not necessarycalculating expected term as follows: Stephen Sperco and related entities - 2,000,000 shares.described in ASC 718.

In June 2008, the FASB finalized ASC 815-15, "Determining Whether an Instrument (or Embedded Feature) is indexed to an Entity's Own Stock". The EITFASC 815-15 lays out a procedure to determine if an equity-linked financial instrument (or embedded feature) is indexed to its own common stock. The EITFASC 815-15 is effective for fiscal years beginning after December 15, 2008. 9,034,800 of Bluegate’s outstanding warrants that were previously classified in equity were reclassified to derivative liabilities on January 1, 2009 as a result of ASC 815-15.  Bluegate estimated the fair value of these liabilities as of January 1, 2009 to be $84,000 by recording a reduction of $4,600,000 to Additional Paid In Capital and $4,516,000 to Accumulated Deficit.  The effect of this EITF.adjustment is recorded as a cumulative effect of change in accounting principle in our consolidated statement of stockholders’ deficit. The fair value of these liabilities was $17,000$35,000 at September 30, 2010.March 31, 2011. The $8,000$13,000 change in fair value of these liabilities from January 1, 2010 is reported in our consolidated statement of operations as a gainloss on derivative financial instruments. The fair value of these liabilities will be re-measured at the end of every reporting period and the change in fair value will be reported in our consolidated statement of operations as a gain or loss on derivative financial instruments.

Bluegate used the Black-Scholes option pricing model to value the derivativeembedded feature of the liability using the following assumptions: number of options as set forth in the option agreements; no expected dividend yield; expected volatility of 340%; risk-free interest rates of 5.0%; and expected terms based on the contractual term.

The Company operates from leased office space under an operating lease that was to expire in November 2013. Effective July 1, 2010, the Company amendedrenegotiated its lease agreement with the landlord to: (a) reduce the monthly rent to $4,000; (b) a termination date of December 31, 2010; and (c) agree that the landlord and tenant each have the right to cancel the lease with a thirty day written notice. Effective January 1, 2011, we are paying $4,000 month-to-month.

Effective July 1, 2010, the Sperco entities agreed to pay a monthly amount of $4,000 for office space and associated services to Bluegate for the Sperco entities. As of September 30, 2010, Bluegate receivedFor the quarter ended March 31, 2011, $12,000 was recorded as a reduction in rent payments fromexpense and accounts payable to related party.

We are party in the Sperco entities which reduced rent expense for that period.following litigation:

In September 2010, Bluegate Corporation received notice that a prior client of Bluegate, Renaissance Healthcare Systems, Inc. through the Chapter 7 Trustee, filed a summons in an adversary proceeding against Bluegate Corporation while in bankruptcy under the recovery of money/property fraudulent transfer clause, attempting to reach back two years prior to the petition date. The amount in question iswas $68,480, (specifically four monthly payments Bluegate received from its client in the ordinary course of business from March 18, 2008 through June 13, 2008), plus pre-judgment and post judgment interest, costs and attorneys fees.

In November 2010, Bluegate Corporation filed a lawsuit against Electronic Medical Resources, LLC, ET. AL (“EMR”); In the C.C.C.L. No. 3 Harris County, Texas. We filed this lawsuit claiming breach of contract for services provided. In January 2011, the defendants filed a counterclaim. We believed the counterclaim was without merit; however, the parties agreed that they believed it to be in their mutual best interests to eliminate further expense of litigation and $25,000 under the caption “selling, generalinherent risk involved with contested litigation by settling all of their disputed and administrative expenses” on the consolidated statement of operations.

This Management's Discussion and Analysis of Financial Condition and Results of Operations as of September 30, 2010March 31, 2011 and for the ninethree months then ended, should be read in conjunction with the audited consolidated financial statements and notes thereto set forth in our annual report on Form 10-K for 2009.2010.

Certain statements contained in this report, including, without limitation, statements containing the words, "likely", "forecast", "project", "believe", "anticipate", "expect", and other words of similar meaning, constitute "forward-looking statements" within the meaning of Section 27A of the Securities Exchange Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performance, or achievements expressed or implied by such forward-looking statements. Given these uncertainties, readers are cautioned not to place undue reliance on such factors or to announce publicly the results of any revis ionrevision of the forward-looking statements contained or incorporated by reference herein to reflect future events or developments. In addition to the forward-looking statements contained in this Form 10-Q, the following forward-looking factors could cause our future results to differ materially from our forward-looking statements: competition, capital resources, credit resources, funding, government compliance and market acceptance of our products and services.

Bluegate consists of the networking service (carrier/circuit) business that provides internet connectivity to corporate clients on a subscription basis; essentially operating as a broker.value added provider.

COMPETITION

Most of our competitors have greater financial and other resources than we have, and there is no assurance that we will be able to successfully compete.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our financial condition and results of operations are based upon consolidated financial statements which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities.  On an ongoing basis, we evaluate these estimates.  We base our estimates on historical experience and on assumptions that are believed to be reasonable.  These estimates and assumptions provide a basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates under different assumptions or conditions, and these differences may be material.

We believe that the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

REVENUE RECOGNITION

Revenue is recognized based upon contractually determined monthly service charges to individual customers. Some services are billed in advance and, accordingly, revenues are deferred until the period in which the services are provided.

STOCK-BASED COMPENSATION

Accounting Standard 718, "Accounting for Stock-Based Compensation" ("ASC 718") established financial accounting and reporting standards for stock-based employee compensation plans. It defines a fair value based method of accounting for an employee stock option or similar equity instrument. In January 2006, Bluegate implemented ASC 718, and accordingly, Bluegate accounts for compensation cost for stock option plans in accordance with ASC 718.

Bluegate accounts for share based payments to non-employees in accordance with ASC 505-50 “Accounting for Equity Instruments Issued to Non-Employees for Acquiring, or in Conjunction with Selling, Goods or Services”.

Bluegate does not use derivative instruments to hedge exposures to cash flow, market, or foreign currency risks.  Bluegate evaluates all of it financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives.  For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported as charges or credits to income.  For option-based derivative financial instruments, Bluegate uses the Black-Scholes option-pricing model to value the derivative instruments at inception and subsequent valuation dates. The classification of derivative instruments, including whether such instruments should be record edrecorded as liabilities or as equity, is re-assessed at the end of each reporting period.  Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet date.

GOING CONCERN

We remain dependent on outside sources of funding for continuation of our operations.  Our independent registered public accounting firm issued a going concern qualification in their report dated March 15, 201014, 2011 (included in our annual report on Form 10-K for the year ended December 31, 2009)2010), which raises substantial doubt about our ability to continue as a going concern.

During the ninethree months ended September 30, 2010March 31, 2011 and the year ended December 31, 2009,2010, we have been unable to generate cash flows sufficient to support our operations and have been dependent on debt and equity raised from qualified individual investors and loans from a related party.

During the ninethree months ended September 30,March 31, 2011 and 2010, and 2009, we experienced negative financial results as follows:

 

These factors raise substantial doubt about our ability to continue as a going concern.  The consolidated financial statements contained herein do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should we be unable to continue in existence.  Our ability to continue as a going concern is dependent upon our ability to generate sufficient cash flows to meet our obligations on a timely basis, to obtain additional financing as may be required,  and ultimately to attain profitable operations.  However, there is no assurance that profitable operations or sufficient cash flows will occur in the future.

We have supported current operations by: (1) raising additional operating cash through the private sale of our preferred and common stock, (2) selling convertible debt and common stock to certain key stockholders, (3) issuing stock and options as compensation to certain employees and vendors in lieu of cash payments and (4) disposing of certain assets and business (see footnote 3).

Service Revenue.

The decrease in Service Revenue of $49,606 from 2008 to 2009 and $17,290$28,031 from 2009 to 2010 and $3,363 from 2010 to 2011 is due to a reduction in our networking service (carrier/circuit) business that provides internet connectivity to corporate clients on a subscription basis.

Cost of Services.

The net decrease in Cost of Services of $50,155 from 2008 to 2009 and $20,399$9,020 from 2009 to 2010 is dueand $5,576 from 2010 to a reduction in our networking service (carrier/circuit) business that provides internet connectivity to corporate clients on a subscription basis.

Our Gross Profit decreased $36,946 from 2008 to 2009 and $12,487$19,011 from 2009 to 2010.2010 and increased $2,213 from 2010 to 2011. Our Gross Profit as a percentage of Service Revenue increaseddecreased from 29% in 2008 to 39%47% in 2009 and to 43%42% in 2010 and increased to 47% in 2011 primarily as a result of the changes in the Service Revenue and Cost of Services as described above.

Selling, General and Administrative Expenses (SG&A).

The decreaseincrease in SG&A of $89,850 from 2008 to 2009 is due primarily to: (1) the effects of additional cost control measures, and (2) recording miscellaneous income of $54,768 as an offset to SG&A. The $104,474 increase in SG&A$22,945 from 2009 to 2010 is due primarily to: (1) no recording of $54,768 of miscellaneous income as in the prior year,a $10,000 increase related to professional fees and corporate franchise taxes; and (2) recording $25,000no miscellaneous income. The increase of $23,826 from 2010 to 2011 is due primarily to: (1) a $45,000 increase to Sperco, LLC for providing management, accounting and administrative services, as well as, network infrastructure and engineering support to Bluegate as needed; and (2) partially offset by a $26,426 reduction in rent expense, as a result of: (i) the Company renegotiating its lease agreement with the landlord to reduce the monthly rent to $4,000, and (ii) the Sperco entities agreeing to pay $4,000 a month for office space and associated services to Bluegate for the possible settlement of a lawsuit.Sperco entities.

Compensation Expense.

The decrease in Compensation Expense of $1,007,720 from 2008 to 2009 is principally comprised of the following; (1) $519,000 decrease related to conversion of related party debt for common stock; (2) $341,000 decrease related to options issued for employee services; (3) $109,000 decrease related to warrants issued to borrow funds from a related party; and (4) $17,000 decrease related to related party purchase of common stock for cash. The decrease in Compensation Expense of $13,469$13,169 from 2009 to 2010 is principally due to the elimination of the board of directors’ fees.

Interest Expense.

The increasedecrease in Interest Expense of $39,020 from 2008 to 2009 was a result of the increase in borrowings under the secured note payable to related party. The decrease of $78,425$25,192 from 2009 to 2010 was attributable to the $100,000 reduction of the secured note payable and suspension of interest charged for the month of January 2010 to related party as a result of the disposition of certain assets and business effective November 7, 2009. The increase of 25,936 from 2010 to 2011 was due to the resumption of interest on the secured note payable for a full quarter in 2011 as compared to a partial quarter in 2010.

Gain (Loss) Loss on Derivative Financial Instruments.

In June 2008, the FASB finalized ASC 815-15, "Determining Whether an Instrument (or Embedded Feature) is indexed to an Entity's Own Stock". The pronouncement lays out a procedure to determine if an equity-linked financial instrument (or embedded feature) is indexed to its own common stock. The pronouncement is effective for fiscal years beginning after December 15, 2008. Some of Bluegate’s outstanding warrants that were previously classified in equity were reclassified to derivative liabilities on January 1, 2009 as a result of this pronouncement.  Bluegate estimated the fair value of these liabilities as of January 1, 2009 to be $84,000. The fair values of these liabilities were $17,000$35,000 and $132,000$176,000 at September 30,March 31, 2011 and 2010, and 2009, respectively. The $56,000$13,000 and $48,000$151,000 change in fair value for the nine months is re portedreported in our consolidated statement of operations as a gain and loss on derivative financial instruments as of September 30,March 31, 2011 and 2010, and 2009, respectively.

Net Loss from Continuing Operations.

The Net Loss from Continuing Operations decreased $973,604 from 2008 to 2009 and $30,933increased $63,595 from 2009 to 2010 and decreased $90,451 from 2010 to 2011 due to the items described above.

The increase in the Gain From Discontinued Operations of $436,113 from 2008 to 2009 and the decrease in the Gain From Discontinued Operations of $7,736$4,742 from 2009 to 2010 werewas a result of the disposition of certain assets and business effective November 7, 2009.

Net Loss.

The Net Loss decreased $1,409,717 from 2008 to 2009 and $23,197increased $68,337 from 2009 to 2010 and decreased $90,451 from 2010 to 2011 due to the items described above.

Operating Activities.

The net decreaseincrease of $272,303$113,805 in cash used in operations from 2008 to 2009 is primarily attributable to the following discontinued operations effective November 7, 2009: (1) a decrease in personnel related to the completion of certain large application development engagements; (2) a reduction in product sales; (3) the effects of additional cost control measures, and (4) partially offsetprovided by an increase of personnel and salaries related to the implementation project management and consulting services. The decrease of $170,874 in cash used in operations from 2009 to 2010 is primarily due to the effects of the discontinued operations effective November 7, 2009.

Financing Activities.

The decrease of $272,508 in cash provided by financing activities from 2008 to 2009 is due to: (1) a $295,000 decrease in investments in the company’s common stock and warrants; and (2) a $22,000 net increase in related party short term debt. The decrease of $180,000 in cash provided by financing activities from 2009 to 2010 is due to thea decrease in proceedsrelated party short term debt. The increase of $30,000 from 2010 to 2011 is due to an increase in related party short term debt.

BLUEGATE STRATEGY

Our strategy is to stabilize our internet connectivity business and pursue expansion of our market outside of the healthcareHealthcare industry.

We intend to use debt to cover the anticipated negative cash flows until we can operate at a break-even cash flow mode.  We may seek additional capital to fund potential costs associated with possible expansion and/or acquisitions. We believe that future funding may be obtained from public or private offerings of equity securities, debt or convertible debt securities, or other sources. Stockholders should assume that any additional funding will likely be dilutive.

Our ability to achieve profitability will depend upon our ability to execute and deliver high quality, reliable connectivity services.  Our growth is dependent on attaining profit from our operations and our raising additional capital either through the sale of stock or borrowing.  There is no assurance that we will be able to raise any equity financing or sell any of our products at a profit.

In September 2010, Bluegate Corporation received notice that a prior client of Bluegate, Renaissance Healthcare Systems, Inc. through the Chapter 7 Trustee, filed a summons in an adversary proceeding against Bluegate Corporation while in bankruptcy under the recovery of money/property fraudulent transfer clause, attempting to reach back two years prior to the petition date. The amount in question iswas $68,480, (specifically four monthly payments Bluegate received from its client in the ordinary course of business from March 18, 2008 through June 13, 2008), plus pre-judgment and post judgment interest, costs and attorneys fees.