724 SOLUTIONS INC - 10-Q Quarterly Report

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

ý Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Quarterly Period Ended June 30, 2004.

o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

Commission File Number: 000-31146

724 SOLUTIONS INC.
(Exact Name of Registrant as Specified in its Charter)

Canada (State or Other Jurisdiction of Incorporation or Organization)		Inapplicable (I.R.S. Employer Identification No.)
1221 State Street, Suite 200 Santa Barbara, CA (Address of Principal Executive Office)		93101 (Zip Code)
(805) 884-8308 (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 ý No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes o No ý

Common Shares, no par value — 5,983,349 shares outstanding as of August 6, 2004
(together with associated rights to purchase additional Common Shares)

724 SOLUTIONS INC.

Table of Contents

			Page
PART I.
FINANCIAL INFORMATION			1
	Item 1. Financial Statements		1
	Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations		17
	Item 3. Quantitative and Qualitative Disclosures About Market Risk		30
	Item 4. Controls and Procedures		30
PART II. OTHER INFORMATION			31
	Item 1. Legal Proceedings		31
	Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities		31
	Item 3. Defaults Upon Senior Securities		32
	Item 4. Submission of Matters to a Vote of Security Holders		32
	Item 5. Other Information		34
	Item 6. Exhibits and Reports on Form 8-K		34
		(a) Exhibits:	34
		(b) Reports on Form 8-K:	34
SIGNATURES

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

724 SOLUTIONS INC.
Consolidated Balance Sheets

(In thousands of U.S. dollars)
June 30, 2004 and December 31, 2003

				2004			2003
				(Unaudited)
Assets
Current assets:
	Cash and cash equivalents (note 2)			$	14,174		$	13,436
	Short-term investments (note 2)				1,500			1,748
	Restricted cash (note 2)				190			198
	Accounts receivable — trade, net of allowance of $31 (2003 — $60)				2,505			2,297
	Prepaid expenses and other receivables				734			648

Total current assets					19,103			18,327
Deferred charges (note 3)					345			—
Fixed assets					891			612

Total assets				$	20,339		$	18,939

Liabilities and Shareholders' Equity
Current liabilities:
	Accounts payable			$	541		$	411
	Accrued liabilities				2,691			3,402
	Deferred revenue				344			410

Total current liabilities					3,576			4,223
Long-term liabilities					188			—
Notes payable (note 3)					8,000			—

Total liabilities					11,764			4,223
Shareholders' equity:
	Share capital (note 5):
		Authorized:
			Unlimited common shares
			Unlimited preferred shares
		Issued and outstanding:
			5,983,349 common shares (December 31, 2003 — 5,983,349)		764,508			764,508
	Contributed surplus				112			62
	Accumulated deficit				(756,146	)		(749,887	)
	Accumulated other comprehensive income				101			33

Total shareholders' equity					8,575			14,716
Contingent liabilities (note 9)

Total liabilities and shareholders' equity				$	20,339		$	18,939

See accompanying notes to consolidated financial statements.

724 SOLUTIONS INC.
Consolidated Statements of Operations

(In thousands of U.S. dollars, except per share amounts)

			Three months ended June 30,						Six months ended June 30,
			2004			2003			2004			2003
			(Unaudited)						(Unaudited)
Revenue:
	Product		$	1,930		$	1,635		$	3,691		$	3,645
	Services			1,119			1,375			2,359			2,880

				3,049			3,010			6,050			6,525
Operating expenses:
	Cost of revenue			1,537			1,422			3,065			2,996
	Research and development			1,433			2,555			3,522			5,505
	Sales and marketing			1,197			2,165			2,576			4,357
	General and administrative			755			1,291			1,588			2,236
	Depreciation			120			203			305			562
	Amortization of intangible assets			—			1,156			—			2,312
	Stock-based compensation:
		Cost of revenue		3			—			5			8
		Research and development		9			682			13			1,211
		Sales and marketing		7			170			11			282
		General and administrative		14			—			21			115
	Restructuring costs (note 6)			(900	)		300			1,200			300

				4,175			9,944			12,306			19,884

Loss from operations				(1,126	)		(6,934	)		(6,256	)		(13,359	)
Interest income (expense)				(19	)		85			(3	)		178

Loss for the period			$	(1,145	)	$	(6,849	)	$	(6,259	)	$	(13,181	)

Basic and diluted loss per share			$	(0.19	)	$	(1.14	)	$	(1.05	)	$	(2.20	)

Weighted average number of shares used in computing basic and diluted loss per share (in thousands)				5,983			5,983			5,983			5,983

See accompanying notes to consolidated financial statements.

724 SOLUTIONS INC.
Consolidated Statements of Shareholders' Equity

(In thousands of U.S. dollars, except number of common shares)
Six months ended June 30, 2004 and 2003
(Unaudited)

		Common shares					Deferred stock-based compensation related to stock options
		Common shares			Contributed Surplus					Accumulated deficit			Accumulated other comprehensive income (loss)			Total shareholders' equity
		Number	Amount		Contributed Surplus					Accumulated deficit			Accumulated other comprehensive income (loss)			Total shareholders' equity
Balances
	December 31, 2002	5,983,349	$	764,508	$	—	$	(1,616	)	$	(721,603	)	$	(43	)	$	41,246
Loss for the period		—		—		—		—			(13,181	)		—			(13,181	)
Cumulative translation adjustment		—		—		—		—			—			94			94

Comprehensive loss																	(13,087	)

Amortization of deferred stock-based compensation		—		—		—		1,616			—			—			1,616

Balances, June 30, 2003		5,983,349	$	764,508	$	—	$	—		$	(734,784	)	$	51		$	29,775

Balances
December 31, 2003		5,983,349	$	764,508	$	62	$	—		$	(749,887	)	$	33		$	14,716
Loss for the period		—		—		—		—			(6,259	)		—			(6,259	)
Cumulative translation adjustment		—		—		—		—			—			68			68

Comprehensive loss																	(6,191	)

Amortization of stock-based compensation		—		—		50		—			—			—			50

Balances, June 30, 2004		5,983,349	$	764,508	$	112	$	—		$	(756,146	)	$	101		$	8,575

The historic common share numbers have been adjusted to reflect the 10 for 1 share consolidation completed in the second quarter of 2003.

See accompanying notes to consolidated financial statements.

724 SOLUTIONS INC.
Consolidated Statements of Cash Flows

(In thousands of U.S. dollars)

			Three months ended June 30,						Six months ended June 30,
			2004			2003			2004			2003
			(Unaudited)						(Unaudited)
Cash flows from operating activities:
	Loss for the period		$	(1,145	)	$	(6,849	)	$	(6,259	)	$	(13,181	)
	Items not affecting cash:
		Depreciation and amortization		127			1,359			312			2,874
		Stock-based compensation		33			852			50			1,616
		Other non-cash expenses		4			104			32			43
	Change in operating assets and liabilities:
		Accounts receivable		119			358			(208	)		(307	)
		Prepaid expenses and other receivables		134			16			(86	)		(272	)
		Deferred charges		(352	)		—			(352	)		—
		Accounts payable		264			(34	)		130			(314	)
		Long-term accounts payable		188			—			188			—
		Accrued liabilities		(2,270	)		(472	)		(711	)		(2,201	)
		Deferred consideration		—			(374	)		—			(374	)
		Deferred revenue		18			(648	)		(66	)		(565	)

	Net cash flows from operating activities			(2,880	)		(5,688	)		(6,970	)		(12,681	)
Cash flows from financing activities:
	Issuance (principal repayment) of notes payable			8,000			—			8,000			(600	)
Cash flows from investing activities:
	Purchase of fixed assets			(546	)		(18	)		(548	)		(88	)
	Sale (purchase) of short-term investments, net			(1,500	)		3,100			248			15,804
	Increase (decrease) in restricted cash			—			257			8			(668	)

	Net cash flows from investing activities			(2,046	)		3,339			(292	)		15,048

Increase (decrease) in cash and cash equivalents				3,074			(2,349	)		738			1,767
Cash and cash equivalents, beginning of period				11,100			23,245			13,436			19,129

Cash and cash equivalents, end of period			$	14,174		$	20,896		$	14,174		$	20,896

See accompanying notes to consolidated financial statements.

1. Basis of presentation:

The accompanying consolidated financial statements include the accounts of 724 Solutions Inc. and its wholly owned subsidiaries (collectively referred to as the "Company"). Inter-company transactions and balances are eliminated on consolidation.

The consolidated financial statements are stated in U.S. dollars, except as otherwise noted.

Our consolidated financial statements have historically been prepared in accordance with Canadian generally accepted accounting principles. As of the second quarter of 2004, our consolidated financial statements have been prepared under U.S. generally accepted accounting principles. We have determined that this is appropriate as the majority of our shareholders reside in the United States. Comparative financial statements have been restated to reflect this change and a reconciliation setting out the differences between U.S. and Canadian generally accepted accounting principles as applied to our consolidated financial statements is provided in note 7.

Except for changes related to differences between U.S. and Canadian generally accepted accounting principles as described in note 7, the interim financial statements follow the same accounting policies and methods of application as the most recent annual financial statements. For further information, reference should be made to the audited annual consolidated financial statements for the year ended December 31, 2003 that are included in the Company's Annual Report filed with the Canadian Securities Administrators on April 1, 2004 and with the Securities and Exchange Commission on Form 10-K filed on March 22, 2004.

The information furnished for the three and six months ended June 30, 2004 and June 30, 2003 reflects, in the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results of the interim periods presented. Interim results are not necessarily indicative of results for a full year.

2. Cash and cash equivalents and short-term investments:

All short-term investments are classified as held-to-maturity because we have the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost, adjusted for amortization of premiums and accretion discounts to maturity. We own no short-term investments that are considered to be trading securities or available-for-sale securities.

We have entered into letters of credit in the amount of $190,000 (December 31, 2003 — $198,000) to guarantee future payments. Letters of credit are secured by segregated instruments and disclosed as restricted cash on the consolidated balance sheets.

3. Secured convertible notes:

On May 14, 2004, the Company entered into a series of agreements, including a Secured Convertible Note Purchase Agreement (the "Purchase Agreement") between 724 Solutions Inc. and its wholly owned subsidiary 724 Solutions Software Inc., and Austin Ventures VI, L.P. ("AV VI"), Austin Ventures VI Affiliates Fund, L.P. ("AV VI A"), and Austin Ventures VIII, L.P. ("AV VIII"), (collectively, the "Lenders" or "Austin Ventures") in connection with the private placement of up to $8,000,000 of Secured Convertible Promissory Notes (the "Notes") for cash. The non-brokered private placement of secured convertible promissory notes was completed in two tranches. The first tranche of the financing involved the issuance of $3,044,000 of convertible notes and was completed on May 14, 2004. The second tranche of the financing involved the issuance of $4,956,000 of convertible notes and was completed on June 29, 2004 after we obtained shareholder approval.

The Notes have a 3-year term and accrue interest at a rate of 2.5% per quarter, of which 1.25% is payable in arrears at the beginning of each quarter and the remainder of which is due at maturity. The principal amounts of the Notes and all interest owing at maturity are convertible at the option of the Lenders into Common Shares at a conversion price of $3.07 per share. The interest payable quarterly is convertible at the option of the Company into Common Shares at a conversion price of $3.07 per share. The conversion price was based on the volume weighted average trading price of the Company's Common Shares on the TSX for the five trading days prior to May 14, 2004. If we issue any Common Shares or securities convertible into Common Shares at a price that is less than the conversion price of the Notes then in effect, then such conversion price shall be subject to a weighted average anti-dilution adjustment, whereby the conversion price will be reduced based on the weighted average price of the additional securities issued. The conversion price will not be lowered by more than 15% of the initial conversion price of $3.07.

Austin Ventures is our largest beneficial shareholder. Assuming that all of the Notes are converted into Common Shares at the lowest possible conversion price on the maturity date, all accrued interest on the Notes is paid with Common Shares, and that no additional Common Shares are issued, Austin Ventures could be deemed to beneficially own up to 44.72% of our issued and outstanding Common Shares.

Joseph C. Aragona is currently a member of our Board of Directors. He is also a general partner of AV Partners VI, L.P., which serves as the general partner of both AV VI and AV VI A. In addition, Mr. Aragona is a general partner of AV Partners VIII, L.P., which serves as the general partner of AV VIII. As a general partner of AVP VI and AVP VIII, Mr. Aragona may have a limited pecuniary interest in the Private Placement Transactions. Mr. Aragona did not participate in the deliberations or voting of our Board with respect to the approval of the Private Placement Transactions.

The Company and its material subsidiaries granted the Lenders a blanket security interest in all of their assets to secure the timely payment and performance in full of all of the obligations under the Notes. The security interest ranks senior to all indebtedness of the Company other than fully-funded indebtedness of up to $1,500,000.

The Notes are subject to customary events of default, including the failure to pay interest or principal, and specified types of bankruptcy events. Additional events of default include the issuance of certain capital securities that, if not for the limitation noted above, would cause the conversion price of the notes to be lowered by more than 15% of the initial conversion price and the Company engaging in specified types of merger or acquisition transactions. An event of default would require the Company to repay all amounts owing under the Notes.

Please see note 7, Reconciliation to Canadian GAAP, for information regarding the treatment of the Notes under Canadian GAAP.

We capitalize costs associated with the issuance of debt instruments and amortize these costs on a straight-line basis over the term of the debt agreements. The amount capitalized in relation to the Notes in the three months ended June 30, 2004 was $352,000. We amortized $7,000 of this amount in the three months ended June 30, 2004 and the remaining $345,000 is identified as deferred charges on the June 30, 2004 consolidated balance sheet.

4. Segmented information:

We operate in a single reportable operating segment; that is, the design and delivery of an Internet infrastructure platform and related applications that enable mobile network operators and other customers to deliver information and services to a range of Internet-enabled devices. The single reportable operating segment derives its revenue from the sale of software and related services.

		Three months ended June 30,				Six months ended June 30,
(In thousands of U.S. dollars)		Three months ended June 30,				Six months ended June 30,
(In thousands of U.S. dollars)		2004		2003		2004		2003
Net revenue by geographic location:
	North America	$	2,748	$	2,416	$	5,428	$	5,513
	Europe		214		552		448		850
	Asia Pacific		87		42		174		162

		$	3,049	$	3,010	$	6,050	$	6,525

In the three months ended June 30, 2004, two customers accounted for 58%, and 20% of revenue and in same period ended June 30, 2003, one customer accounted for 58% of revenue. In the six months ended June 30, 2004, one customer accounted for 66% of revenue and in the same period ended June 30, 2003, three customers accounted for 48%, 16% and 10% of revenue.

At June 30, 2004, one customer accounted for 57% of accounts receivable and at June 30, 2003, two customers accounted for 51% and 18% of accounts receivable.

Geographic asset distribution:

(In thousands of U.S. dollars)	June 30, 2004		December 31, 2003
North America	$	806	$	359
Europe		85		253

	$	891	$	612

5. Share capital:

(a): Reverse stock split:

On April 24, 2003, our shareholders approved a ten for one reverse stock split of the Company's common shares. As a result, the historic number of shares, historic loss per share and the weighted average number of shares used in compiling basic and diluted loss per share have been restated for all periods presented to reflect the reverse stock split.

(b): Stock options:

At June 30, 2004 and December 31, 2003, there were options outstanding to acquire 772,364 and 724,189 common shares of the Company, respectively.

The following table summarizes the Company's options as of June 30, 2004.

Exercise price ranges				Number of options	Weighted average exercise price		Weighted average remaining contractual life (years)	Number of options exerciseable	Weighted average exercise price
$	—	$	5.00	559,008	$	3.82	9.2	44,454	$	3.47
	5.01		10.00	160,036		6.40	8.1	83,361		5.85
	10.01		20.00	19,325		17.92	6.2	17,335		16.77
	20.01		50.00	4,578		34.22	6.3	4,503		33.28
	50.01		100.00	7,729		90.52	6.6	4,854		80.62
	100.01		500.00	21,688		236.81	6.5	13,109		230.34

				772,364	$	14.21	8.5	167,616	$	27.85

(c): Loss per share:

We have excluded from the calculation of diluted earnings per share all common shares potentially issuable upon the exercise of stock options, the convertible notes and other potentially convertible instruments that could dilute basic earnings per share in the future, because to do so would have been anti-dilutive.

(d): Pro forma disclosure for stock-based compensation and other stock-based payments:

Effective January 1, 2003, we adopted, on a prospective basis, the fair value measurement for stock-based compensation. Under the fair value based method, compensation cost for option grants is measured at fair value at the date of grant and is expensed over the award's vesting period. The fair value of options issued in the three months ended June 30, 2004 was $377,000, while the fair value of options issued in the three months ended June 30, 2003 was $31,000. These amounts are being amortized as expenses over the vesting period of 4 years.

The fair value of each option granted in the three months ended June 30, 2004 was estimated at the date of grant using the Black-Scholes option pricing model under the following assumptions: dividend yield of 0% (2003 — 0%), expected volatility of 60% (2003 — 60%), risk-free rate of interest of 3.41% (2003 — 3.82%) and an expected life of the option of five years.

We have assumed no forfeiture rate, as adjustments for actual forfeitures are made in the period in which they occur. The weighted average grant date fair value of options issued in the three months ended June 30, 2004 was $1.74 (2003 — $1.57).

In the three and six months ended June 30, 2003, we recorded stock-based compensation expenses of $852,000 and $1,616,000, respectively, related to the amortization of the deferred stock based compensation arising on the business acquisitions made in 2001.

For options issued prior to January 1, 2003, we are required to disclose the pro forma information as if we had accounted for stock options issued from inception on July 28, 1997 to December 31, 2002 under the fair value method. The following table presents the required disclosure of pro forma earnings and earnings per share.

		Three months ended June 30,						Six months ended June 30,
(In thousands of U.S. dollars, except per share amounts)		June 30, 2004			June 30, 2003			June 30, 2004			June 30, 2003
Loss for the period		$	(1,145	)	$	(6,849	)	$	(6,259	)	$	(13,181	)
	Compensation expense related to the fair value of stock options In excess of amounts recognized		(268	)		(3,704	)		(271	)		(8,226	)

Pro forma loss for the period		$	(1,413	)	$	(10,553	)	$	(6,530	)	$	(21,407	)

Pro forma loss per share:
	Basic and diluted	$	(0.24	)	$	(1.76	)	$	(1.09	)	$	(3.58	)

The fair value of each option granted prior to January 1, 2003, was estimated at the date of grant using the Black-Scholes option pricing model with the assumptions disclosed in the notes to our annual consolidated financial statements.

6. Restructuring costs:

Due to the asset purchase completed in the three months ended June 30, 2004, we determined that we would not carry out some employee terminations planned as of the end of the prior quarter. Therefore, in the three months ended June 30, 2004, we reversed $900,000 in severance costs included in restructuring charges. This amount had been part of the restructuring charge of $2,100,0000 related to the planned termination of approximately forty employees and the consolidation of facilities recorded in the three months ended March 31, 2004. Employee terminations not related to the asset purchase and the consolidation of facilities proceeded as planned.

Changes to our restructuring reserve in the six months ended June 30, 2004 and 2003, are set out in the following tables.

Six months ended June 30, 2004

(In thousands of U.S. dollars)		Severance costs			Lease exit costs			Hosting exit costs			Total
Provision, December 31, 2003		$	292		$	140		$	591		$	1,023
Activity during the period ended June 30, 2004
	Restructuring charges		1,600			500			—			2,100
	Reversal of provision		(900	)		—			—			(900	)
	Cash payments		(913	)		(488	)		(394	)		(1,795	)

Provision, June 30, 2004		$	79		$	152		$	197		$	428

Six months ended June 30, 2003

(In thousands of U.S. dollars)		Severance costs			Lease exit costs			Hosting exit costs			Total
Provision, December 31, 2002		$	967		$	1,528		$	2,487		$	4,982
Activity during the period ended June 30, 2003
	Restructuring charges		525			175			—			700
	Reversal of provision		—			—			(400	)		(400	)
	Cash payments		(783	)		(1,183	)		(587	)		(2,553	)

Provision, December 31, 2002		$	709		$	520		$	1,500		$	2,729

7. Reconciliation to Canadian GAAP:

Under Canadian securities requirements, we are required to provide a reconciliation setting out the differences between U.S. and Canadian GAAP as applied to our financial statements for the interim periods and years ended in the fiscal periods for 2004 and 2005. For the periods presented in this quarterly report, the only difference between U.S. and Canadian GAAP is the difference arising on the accounting for the secured convertible notes issued in the three month period ended June 30, 2004. Therefore, the amounts presented in accordance with U.S. GAAP for the 2003 periods in the quarterly balance sheet, statement of operations, statements of shareholders' equity and statement of cash flows are consistent with Canadian GAAP.

Under U.S. GAAP, the secured convertible notes are classified entirely as debt.

Under Canadian GAAP, the $8,000,000 secured convertible notes are compound instruments that are required to be separated into liability and equity components. We have calculated the liability component of the secured convertible notes as the present value of the future obligation using a discount rate of 15%, representing the estimated rate that we would be required to pay for similar borrowings with no conversion feature. The liability component amounted to $7,067,000. The residual amount of $933,000 represents the estimated equity component for the conversion option and is recorded under Canadian GAAP as the "equity portion of the secured convertible notes". The difference between the amounts allocated to the liability and the principal amount of the notes of $8,000,000 is being amortized as non-cash imputed interest expense over the period to maturity and the liability is being accreted up to its maturity value.

The following tables present the adjustments required to reconcile the 2004 statements presented under U.S. GAAP to Canadian GAAP.

Reconciliation to Canadian GAAP — Balance sheet at June 30, 2004

(In thousands of U.S. dollars)		U.S. GAAP			Adjustments			Canadian GAAP
Assets
Current assets:
	Cash and cash equivalents		14,174			—			14,174
	Short-term investments		1,500			—			1,500
	Restricted cash		190			—			190
	Accounts receivable, net of allowance of $31		2,505			—			2,505
	Prepaid expenses and other receivables		734			—			734

Total current assets			19,103			—			19,103
Deferred charges			345			—			345
Fixed assets			891			—			891

Total assets		$	20,339		$	—		$	20,339

Liabilities and shareholders' equity
Current liabilities:
	Accounts payable		541			—			541
	Accrued liabilities		2,691			—			2,691
	Deferred revenue		344			—			344

Total current liabilities			3,576			—			3,576
Long-term accounts payable			188			—			188
Notes payable			8,000			(919	)		7,081

Total liabilities			11,764			(919	)		10,845
Shareholders' equity:
	Share capital		764,508			—			764,508
	Contributed surplus		112			—			112
	Equity portion of notes payable		—			933			933
	Accumulated deficit		(756,146	)		(14	)		(756,160	)
	Accumulated other comprehensive income		101			—			101

Total shareholders' equity			8,575			919			9,494

Total liabilities and shareholders' equity		$	20,339		$	—		$	20,339

Reconciliation to Canadian GAAP — Statement of operations for the three months ended June 30, 2004

(In thousands of U.S. dollars, except per share amounts)		U.S. GAAP			Adjustments			Canadian GAAP
Revenue:
	Product		1,930			—			1,930
	Services		1,119			—			1,119

		$	3,049		$	—		$	3,049
Operating expenses:
Cost of revenue			1,537			—			1,537
Research and development			1,433			—			1,433
Sales and marketing			1,197			—			1,197
General and administrative			755			—			755
Depreciation			120			—			120
Stock-based compensation:
	Cost of revenue		3			—			3
	Research and development		9			—			9
	Sales and marketing		7			—			7
	General and administrative		14			—			14
Restructuring charges			(900	)		—			(900	)

	Total operating expenses	$	4,175		$	—		$	4,175
Loss from operations			(1,126	)		—			(1,126	)
Interest income (expense)			(19	)		(14	)		(33	)

	Loss for the period	$	(1,145	)	$	(14	)	$	(1,159	)

Basic and diluted loss per share		$	(0.19	)	$	—		$	(0.19	)
Weighted average number of shares used in computing basic and diluted loss per share (000's)			5,983			—			5,983

Reconciliation to Canadian GAAP — Statement of operations for the six months ended June 30, 2004

(In thousands of U.S. dollars, except per share amounts)		U.S. GAAP			Adjustments			Canadian GAAP
Revenue:
	Product		3,691			—			3,691
	Services		2,359			—			2,359

		$	6,050		$	—		$	6,050
Operating expenses:
Cost of revenue			3,065			—			3,065
Research and development			3,522			—			3,522
Sales and marketing			2,576			—			2,576
General and administrative			1,588			—			1,588
Depreciation			305			—			305
Stock-based compensation:
	Cost of revenue		5			—			5
	Research and development		13			—			13
	Sales and marketing		11			—			11
	General and administrative		21			—			21
Restructuring charges			1,200			—			1,200

	Total operating expenses	$	12,306		$	—		$	12,306
Loss from operations			(6,256	)		—			(6,256	)
Interest income (expense)			(3	)		(14	)		(17	)

	Loss for the period	$	(6,259	)	$	(14	)	$	(6,273	)

Basic and diluted loss per share		$	(1.05	)	$	—		$	(1.05	)
Weighted average number of shares used in computing basic and diluted loss per share (000's)			5,983			—			5,983

Reconciliation to Canadian GAAP
Cash flows from operating activities for the three months ended June 30, 2004

(In thousands of U.S. dollars)		U.S. GAAP			Adjustments			Canadian GAAP
Cash flows from (used in) operating activities:
Loss for the period			(1,145	)		(14	)		(1,159	)
Items not affecting cash:
	Accretion on convertible notes payable		—			14			14
	Depreciation and amortization		127			—			127
	Stock-based compensation		33			—			33
	Other non-cash expenses		4			—			4
Changes in operating assets and liabilities:
	Accounts receivable		119			—			119
	Prepaid expenses and other receivables		134			—			134
	Deferred charges		(352	)		—			(352	)
	Accounts payable		264			—			264
	Long-term accounts payable		188			—			188
	Accrued liabilities		(2,270	)		—			(2,270	)
	Deferred revenue		18			—			18

Net cash flows from operating activities		$	(2,880	)	$	—		$	(2,880	)
Cash flows from financing activities:
	Issuance (principal repayment) of notes payable		8,000			—			8,000
Cash flows from investing activities:
	Purchase of fixed assets		(546	)		—			(546	)
Sale (purchase) of short-term investments, net			(1,500	)		—			(1,500	)

Net cash flows from investing activities		$	(2,046	)	$	—		$	(2,046	)

Increase (decrease) in cash and cash equivalents			3,074			—			3,074
Cash and cash equivalents, beginning of period			11,100			—			11,100

Net cash flows from operating activities		$	14,174		$	—		$	14,174

Reconciliation to Canadian GAAP
Cash flows from operating activities for the six months ended June 30, 2004

(In thousands of U.S. dollars)		U.S. GAAP			Adjustments			Canadian GAAP
Cash flows from (used in) operating activities:
Loss for the period			(6,259	)		(14	)		(6,273	)
Items not affecting cash:
	Accretion on convertible notes payable		—			14			14
	Depreciation and amortization		312			—			312
	Stock-based compensation		50			—			50
	Other non-cash expenses		32			—			32
Changes in operating assets and liabilities:
	Accounts receivable		(208	)		—			(208	)
	Prepaid expenses and other receivables		(86	)		—			(86	)
	Deferred charges		(352	)		—			(352	)
	Accounts payable		130			—			130
	Long-term accounts payable		188			—			188
	Accrued liabilities		(711	)		—			(711	)
	Deferred revenue		(66	)		—			(66	)

Net cash flows from operating activities		$	(6,970	)	$	—		$	(6,970	)
Cash flows from financing activities:
	Issuance (principal repayment) of notes payable		8,000			—			8,000
Cash flows from investing activities:
	Purchase of fixed assets		(548	)		—			(548	)
Sale (purchase) of short-term investments, net			248			—			248
Increase (decrease) in restricted cash			8			—			8

Net cash flows from investing activities		$	(292	)	$	—		$	(292	)

Increase (decrease) in cash and cash equivalents			738			—			738
Cash and cash equivalents, beginning of period			13,436			—			13,436

Net cash flows from operating activities		$	14,174		$	—		$	14,174

8. Guarantees:

(a): General indemnities:

In the normal course of operations, we provide indemnification agreements to counterparties in transactions such as purchase contracts, service agreements, and leasing transactions. These indemnification agreements may require us to compensate the counterparties for costs incurred as a result of changes in laws and regulations (including tax legislation) or as a result of litigation claims or statutory sanctions that may be suffered by the counterparty as a consequence of the transaction. The terms of these indemnification agreements will vary based upon the contract. The nature of the indemnification agreements prevents us from making a reasonable estimate of the maximum potential amount we could be required to pay to counterparties. Historically, we have not made any significant payments under such indemnification. No amount has been accrued in the consolidated financial statements with respect to these indemnification agreements.

(b): Product warranties:

Our software license agreements generally include certain provisions for indemnifying customers against liabilities if our software products infringe a third party's intellectual property rights. To date, we have not incurred any material costs as a result of such indemnifications and have not accrued any liabilities related to such obligations in our consolidated financial statements.

Our software license agreements also generally include a warranty that our software products will substantially operate as described in the applicable program documentation for a specified period after delivery. We also warrant that services we perform will be provided in a manner consistent with industry standards and in accordance with applicable specifications for a specified period from performance of the service. To date, we have not incurred any material costs associated with these warranties.

(c): Letters of credit:

At June 30, 2004, we had one outstanding letter of credit in the amount of $190,000 to secure Company credit cards. At December 31, 2003, we had one outstanding letter of credit in the amount of $198,000 to secure Company credit cards. Letters of credit are secured by segregated short-term investments and are disclosed as restricted cash on the consolidated balance sheets.

9. Contingent liabilities:

The Company has been named in several class actions filed in federal court in the Southern District of New York between approximately June 13, 2001 and June 28, 2001 (collectively the "IPO Allocation Litigation"). The IPO Allocation Litigation was filed on behalf of purported classes of plaintiffs who acquired the Company's common shares during certain periods. These lawsuits have since been consolidated into a single action and an amended complaint was filed on or about April 19, 2002. Similar actions have or since been filed against over 300 other issuers that have had initial public offerings since 1998 and all are included in a single coordinated proceeding in the Southern District of New York.

The amended complaint in the IPO Allocation Litigation names as defendants, in addition to the Company, some former directors and officers of the Company (the "Individual Defendants") and certain underwriters of the Company's initial public offering of securities (the "Underwriter Defendants"). In general, the amended complaint alleges that the Underwriter Defendants: (1) allocated shares of the Company's offering of equity securities to certain of their customers, in exchange for which these customers agreed to pay the Underwriter Defendants extra commissions on transactions in other securities; and (2) allocated shares of the Company's initial public offering to certain of the Underwriter Defendants' customers, in exchange for which the customers agreed to purchase additional common shares of the Company in the after-market at certain pre-determined prices. The amended complaint also alleges that the Company and the Individual Defendants failed to disclose these facts and that the Company and the Individual Defendants were aware of, or disregarded, the Underwriter Defendants' conduct. In October 2002, the Individual Defendants were dismissed from the IPO Allocation Litigation without prejudice.

In July 2003, a committee of the Company's Board of Directors conditionally approved a proposed partial settlement with the plaintiffs in this matter. The settlement would provide, among other things, a release of the Company and of the Individual Defendants for the conduct alleged in the action to be wrongful in the amended complaint. The Company would agree to undertake other responsibilities under the partial settlement, including agreeing to assign away, not assert, or release certain potential claims the Company may have against its underwriters. Any direct financial impact of the proposed settlement is expected to be borne by the Company's insurers. The committee agreed to approve the settlement subject to a number of conditions, including the participation of a substantial number of other issuer defendants in the proposed settlement, the consent of the Company's insurers to the settlement, and the completion of acceptable final settlement documentation. Furthermore, the settlement is subject to a hearing on fairness and approval by the Court overseeing the IPO Allocation Litigation.

If the proposed settlement is not consummated, the Company intends to continue to vigorously defend itself and the Individual Defendants against these claims. However, due to the inherent uncertainties of litigation, and because the IPO Allocation Litigation is at a preliminary stage, we cannot accurately predict the ultimate outcome of the IPO Allocation Litigation.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

OVERVIEW

724 Solutions Inc. is a leading provider of next-generation IP-based network and data services. We were incorporated in 1997, and in 1999 we introduced our initial products and solutions for the financial services industry ("FI"). In 2001, we began offering our products to mobile network operators ("MNO's").

During 2002, we concluded that adoption of wireless technologies by the financial services industry had slowed considerably and that such organizations would remain conservative about this type of investment for the foreseeable future. At the same time, our analysis indicated that the opportunity in the MNO sector was potentially larger and also likely to develop sooner. We, therefore, made the decision to principally focus on the MNO market, with a corresponding diminished focus on the delivery of financial services applications.

Accordingly, we have adjusted the size of our investments in these two market segments, substantially reducing the level of investment for the FI market, while bolstering that for the MNO market. We continue to monitor our cost structure to ensure that the investments we make on a product-by-product basis are appropriate to the revenue opportunities we believe exist.

We believe that MNO's planning next-generation data networks face two distinct challenges. Firstly, data networks must be designed to support a wide variety of new revenue opportunities, partnerships and technologies so that the mobile operators can adjust their strategies quickly. Secondly, mobile operators must deploy data networks that can grow smoothly and reliably, without creating economic barriers or compromising return on investment.

724 Solutions designed the X-treme Mobility Suite ("XMS") of products to address the challenges mobile operators face in deploying next-generation data networks. Our XMS gateway products enable mobile operators to implement solutions based on emerging open standards technologies including WAP 2.0, MMS, SMS and J2ME. XMS application enablers support a wide variety of third party content initiatives. The X-treme Mobility Suite provides the flexibility, scalability and total cost of ownership metrics that help ensure both the short-term and long-term success of next-generation mobile data networks.

Our customers currently include leading mobile network operators. With our corporate office in Santa Barbara, California, we have development and sales offices around the world, including Hong Kong, Switzerland, Canada, the United Kingdom and the United States.

DEVELOPMENTS IN THE SECOND QUARTER OF 2004

ADOPTION OF U.S. GENERALLY ACCEPTED ACCOUNTING PRINCIPLES FOR REPORTING PURPOSES

CONVERTIBLE DEBT ISSUANCE

In the second quarter of 2004, we arranged a non-brokered private placement of secured convertible promissory notes with Austin Ventures for a total principal amount of $8,000,000. The first tranche of the financing involved the issuance of $3,044,000 of convertible notes and was completed on May 14, 2004. In accordance with the policies of the Toronto Stock Exchange and the NASDAQ National Market, shareholder approval was required to complete the second tranche of the financing. We obtained such approval on June 29, 2004 and completed the second tranche of the financing by issuing $4,956,000 of convertible notes.

The notes have a three (3) year term and carry an interest rate of 2.5% per quarter. All outstanding principal and interest is convertible into common shares of 724 Solutions at a conversion price of $3.07 per share. 724 Solutions also agreed to include two nominees from Austin Ventures in any slate of Directors proposed for shareholder approval, and that the Board would now consist of seven Directors. See note 3 to our consolidated financial statements for the three and six months ended June 30, 2004 for further details.

ASSET PURCHASE

In the second quarter of 2004, we completed an agreement with Nokia (NYSE: NOK) to acquire the Nokia Multimedia Application Gateway (AGW) product and a separate OEM agreement under which Nokia will continue to offer the product to its existing and future customers.

We have transitioned the development and support of the product to our Toronto development center. The Multimedia Application Gateway joins 724 Solutions' X-treme Mobility Suite and, in addition to distribution through Nokia, will be available to 724 Solutions' mobile operator customers through direct and other partner channels.

RESTRUCTURING AND OTHER CHARGES

Due to the Nokia asset purchase, we determined that we would not carry out some employee terminations planned as of the end of the prior quarter. Therefore, in the three months ended June 30, 2004, we reversed $900,000 in severance costs included in restructuring charges. This amount was part of the restructuring charge of $2.1 million recorded in the prior quarter related to the planned termination of approximately forty employees and the consolidation of facilities. Employee terminations not related to the Nokia asset purchase and the consolidation of facilities proceeded as planned. See note 6 to our consolidated financial statements for the three and six months ended June 30, 2004 for further details.

SUBSEQUENT EVENT

NASDAQ LISTING

Effective at the opening of business on July 13, 2004, we transferred our U.S. listing from the Nasdaq National Market to the Nasdaq Smallcap Market. Our stock continues to trade under the symbol of "SVNX." There is no change to our Toronto Stock Exchange listing where our stock trades under the symbol "SVN."

CRITICAL ACCOUNTING POLICIES

We periodically review our financial reporting and disclosure practices and accounting policies to ensure that they provide accurate and transparent information relative to the current economic and business environment. As part of this process, we have reviewed our selection, application and communication of critical accounting policies and financial disclosures. We have determined that the critical accounting policies relating to our core ongoing business activities are primarily those that relate to revenue recognition. Other important accounting policies are described in note 2 to our audited annual consolidated financial statements for the year ended December 31, 2003.

REVENUE RECOGNITION

SOURCES OF REVENUE

We derive revenue from licensing our products and providing related services, including installation, integration, maintenance and support. We recognize revenue from our license agreements when all the following conditions are met:

•: We have an executed license agreement with the customer;
•: We have delivered the software product to the customer;
•: The amount of the fees to be paid by the customer is fixed and determinable; and
•: Collection of these fees is deemed probable.

Typically, software license agreements are multiple element arrangements that include related maintenance and implementation fees. Accordingly, the fee is allocated to each element in the arrangement based on the respective vendor specific objective evidence of fair value ("VSOE") of each element. For those contracts for which we do not have sufficient VSOE, we use the residual method to record revenues. Under this method, if we have VSOE for all undelivered elements (typically, services and maintenance) we can record the remaining value of the contract as license revenue after allocating full value to the undelivered elements.

For license and services agreements that provide significant commitments to refunds and/or penalties on the services and/or license components should the system not perform according to documented specifications, we defer recognition of revenue for the amount subject to refund or penalty on unproven products until we achieve contractually defined milestones or until customer acceptance has occurred, as the case may be for such agreements.

PRODUCT REVENUE

Product revenue consists of the following:

•: Fixed License Fee Arrangement — a one-time license fee for a fixed number of copies or unlimited use of the software with a perpetual term. We typically recognize the upfront fees in the period the contract is executed or shortly thereafter.
•: Variable License Fee Arrangement — a variable license fee based on the numbers of users in a period. Revenue is recognized on an ongoing basis and will vary with the number of our customers' end users.
•: Reseller Arrangement — the reseller typically pays a non-refundable licensing fee for our software and/or a royalty fee based on the related number of users. We recognize revenue associated with non-refundable license fees when we have met our revenue recognition criteria for license agreements as outlined above. We recognize royalty fee revenue when the amount is determinable and all of our other revenue recognition criteria for license revenue are net.

SERVICE REVENUE

IMPLEMENTATION AND CUSTOMER SERVICE FEES

Revenue from implementation and customer services includes fees for implementation of our product offerings, consulting and training services. Customers are charged a fee based on time and expenses. Revenue from implementation and customer service fees is recognized as the services are performed or deferred until we achieve contractually defined milestones or until customer acceptance has occurred, as the case may be, for such contracts.

MAINTENANCE FEES

We receive revenue from maintaining and servicing our products for customers. The maintenance fee is typically equal to a specified percentage of the customer's license fee. If associated with the fixed fee license model, the maintenance revenues received will be recorded as deferred revenue and recognized on a straight-line basis over the contract period. When associated with the variable fee license model, any maintenance payments will be recognized on a monthly basis as earned.

RESULTS OF OPERATIONS

THREE AND SIX MONTHS ENDED JUNE 30, 2004 COMPARED TO THREE AND SIX MONTHS ENDED JUNE 30, 2003

Our consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America. The significant differences between U.S. and Canadian generally accepted accounting principles as applied to our consolidated financial statements are reconciled in note 7.

REVENUE

PRODUCT REVENUE

Product revenue increased to $1.9 million and $3.7 million for the three and six months ended June 30, 2004, respectively, compared to $1.6 million and $3.6 million in the corresponding periods in 2003. As indicated in the "Overview" section, we have increased our focus on MNO's through our XMS suite of products while we have reduced our focus on the financial services industry. Product revenue from our XMS suite of products increased to $1.8 million and $3.5 million for the three and six months ended June 30, 2004, respectively, from $1.5 million and $2.6 million for the same periods in 2003. Product revenue from the financial services industry was $125,000 and $174,000 for the three and six months ended June 30, 2004, respectively, compared to $109,000 and $1.0 million for the same periods in 2003.

SERVICE REVENUE

Service revenue decreased to $1.1 million and $2.4 million for the three and six months ended June 30, 2004, respectively, compared to $1.4 million and $2.9 million in the corresponding periods in 2003. The decrease resulted from changing our customer focus to MNO's and our product focus to the XMS suite of products. Service revenue from our XMS suite of products increased to $852,000 and $1.8 million for the three and six months ended June 30, 2004, respectively, from $560,000 and $919,000 for the same periods of 2003. Service revenue from the financial services industry decreased to $267,000 and $578,000 for the three and six months ended June 30, 2004, respectively, from $813,000 and $2.0 million for the same periods in 2003.

OPERATING EXPENSES

COST OF REVENUE

Cost of revenue (COR) consists primarily of personnel costs associated with customer support, training and implementation, as well as amounts paid to third-party consulting firms for those services, together with an allocation of expenses for our facilities and administration.

Cost of revenue was $1.5 million and $3.1 million for the three and six months ended June 30, 2004, respectively, compared to $1.4 million and $3.0 million for the corresponding periods in 2003. Cost of revenue, as a percentage of revenue, was 50% and 51% for the three and six months ended June 30, 2004, respectively, compared to 47% and 46% for the corresponding periods in 2003.

RESEARCH AND DEVELOPMENT

Research and development (R&D) expenses include compensation of software development teams working on the continuing enhancement of our products as well as our quality assurance and testing activities. These expenses also include independent contractors and consultants, software licensing expenses and allocated operating expenses.

Research and development decreased to $1.4 million and $3.5 million for the three and six months ended June 30, 2004, respectively, compared to $2.6 million and $5.5 million for the corresponding periods in 2003. The decreases are a result of our restructuring initiatives through which we have reduced our R&D headcount and developed a more streamlined, integrated and focused product road map that reduced duplication in the R&D process. We continue to evaluate our R&D expenditure needs based on our new product architecture and services and the current market environment. R&D expense, as a percentage of revenue, was 47% and 58% for the three and six months ended June 30, 2004, respectively, compared to 85% and 84% for the same periods in 2003.

SALES AND MARKETING

Sales and marketing (S&M) expenses include compensation of sales and marketing personnel as well as expenses related to public relations and advertising, trade shows, marketing materials and allocated operating expenses.

Sales and marketing expenses were $1.2 and $2.6 million for the three and six months ended June 30, 2004, respectively, compared to $2.2 million and $4.4 million for the corresponding periods in 2003. The decrease is a result of the reduction in the number of sales and marketing personnel and reduced spending on discretionary marketing programs. We continue to monitor our sales and marketing expenditures to ensure that they remain aligned with our targeted opportunities as well as prevailing market conditions. S&M expense, as a percentage of revenue, was 39% and 43% for the three and six months ended June 30, 2004, compared to 72% and 67% for the same periods in 2003.

GENERAL AND ADMINISTRATIVE

General and administrative (G&A) expenses include salaries and benefits for corporate personnel and other general and administrative expenses such as facilities, travel and professional consulting costs. Our corporate staff includes several of our executive officers and our business development, financial planning and control, legal, human resources and corporate administration staff.

G&A expenses decreased to $755,000 and $1.6 million for the three and six months ended June 30, 2004, respectively, compared to $1.3 million and $2.2 million for the corresponding periods in 2003. The decrease in G&A expenses reflects our efforts in our restructuring initiatives to reduce complexity in our business and to make our infrastructure efficient in order to support our business in the current market environment. G&A expense, as a percentage of revenue, was 25% and 26% for the three and six months ended June 30, 2004, compared to 43% and 34% for the same periods in 2003.

DEPRECIATION AND AMORTIZATION

Depreciation expense decreased to $120,000 and $305,000 in the three and six months ended June 30, 2004, respectively, from $203,000 and $562,000 in the corresponding periods in 2003. The decreases are a result of the decommissioning of redundant fixed assets and reductions in capital expenditures resulting from our restructuring initiatives.

Amortization expense was nil for the three and six months ended June 30, 2004, compared to $1.2 million and $2.3 million for the same periods in 2003. The amortization expense in 2003 represented the amortization of acquired technology, which was amortized over a period of two to five years. The carrying value of acquired technology is nil.

STOCK-BASED COMPENSATION

Effective January 1, 2003, we prospectively adopted full fair value accounting for stock based awards as prescribed by SFAS 123 "Accounting for Stock Based Compensation". Prior to January 1, 2003, we elected not to apply fair value accounting to stock based awards to employees, other than for direct awards of stock and awards settleable in cash, which required fair value accounting. Prior to January 1, 2003, for awards not accounted for under the fair value method, we accounted for stock based compensation based upon an intrinsic value method of accounting for stock-based compensation. Under this method, compensation cost is measured as the excess, if any, of the quoted market price of the stock issuance at the measurement date over the amount to be paid by the employee.

We adopted full fair value accounting for stock based awards prospectively for all awards granted, modified or settled on or after January 1, 2003. Under the fair value based method, compensation cost is measured at fair value at the date of grant and is expensed over the award's vesting period.

Under the fair value based method, compensation cost is measured at fair value at the date of grant and is expensed over the award's vesting period. In accordance with the prospective transitional option permitted under FAS148, we retroactively applied the fair value based method to all employee stock options granted on or after January 1, 2003. Since the total stock option expense for 2003 using the fair value based method was only $62,000, we have determined that it is not necessary to restate our 2003 quarterly results.

Historically, our stock-based compensation has primarily represented the amortization of deferred stock-based compensation recorded as a result of assuming, through acquisitions, stock option plans that included unvested options and common shares. This stock-based compensation was amortized on a straight-line basis over the vesting period of these options, and was fully amortized by June 30, 2003.

Stock-based compensation decreased to $33,000 and $50,000 for the three and six months ended June 30, 2004, respectively, compared to $852,000 and $1.6 million for the same periods in 2003. The 2004 amounts relate to the amortization of the fair value of stock options granted since January 1, 2003, while the 2003 amounts primarily relate to the amortization of deferred stock compensation associated with acquisitions.

RESTRUCTURING COSTS

As noted in the "Developments in the Second Quarter of 2004" section, due to the asset purchase completed in the three months ended June 30, 2004, we determined that we would not carry out some employee terminations planned as of the end of the prior quarter. Therefore, in the three months ended June 30, 2004, we reversed $900,000 in severance costs included in restructuring charges. This amount was part of the restructuring charge of $2.1 million, including $1.6 million related to the planned termination of approximately forty employees and $500,000 related to the consolidation of facilities, recorded in the prior quarter. Employee terminations not related to the asset purchase and the consolidation of facilities proceeded as planned. The restructuring charge in the six months ended June 30, 2004 was $1.2 million, $700,000 related to severances and $500,000 related to the consolidation of facilities.

In the three months ended June 30, 2003 we recorded a net restructuring charge of $300,000. There was no charge in the first quarter of 2003. The $300,000 net charge in the second quarter of 2003 included $525,000 related to severance costs, $175,000 related to lease exit costs, offset by a $400,000 adjustment to reduce our estimated obligation under our hosting provision.

We have $428,000 Included in our "Accrued Liabilities" as of June 30, 2004 in restructuring reserves. This includes severance costs of $79,000, lease exit costs of $152,000 and hosting exit costs of $197,000. See note 6 to our consolidated financial statements for the three and six months ended June 30, 2004 for further details.

NET LOSS

For the three months ended June 30, 2004, our net loss decreased to $1.1 million from $6.8 million in the same period in 2003. Revenue increased by $39,000 and our restructuring initiatives resulted in significantly lower costs as COR, R&D, S&M and G&A expenses decreased by a total of $2.5 million in the three months ended June 30, 2004 compared to the corresponding period in 2003. Other items positively impacting the results for the three months ended June 30, 2004 compared to the same period in 2003 included: the severance cost reversal of $900,000 described above, compared to a net restructuring charge of $300,000 in 2003; depreciation of $120,000 in 2004 compared to $203,000 in 2003; amortization of nil in 2004 compared to $1.2 million in 2003; and stock-based compensation of $33,000 in 2004 compared to $852,000 in 2003.

For the six months ended June 30, 2004, our net loss decreased to $6.3 million from $13.2 million in the same period in 2003. Despite the revenue decline of $475,000 resulting from our reduced focus on the financial services industry, we improved results through significantly lower costs. COR, R&D, S&M and G&A expenses decreased by a total of $4.3 million in the six months ended June 30, 2004 compared to the corresponding period in 2003. Other items positively impacting results for the six months ended June 30, 2004 compared to the same period in 2003 included: depreciation was $305,000 in 2004 compared to $562,000 in 2003; amortization of intangible assets was nil in the current period verses $2.3 million in 2003, and stock-based compensation was $50,000 in the current period verses $1.6 million in 2003. Items negatively impacting results included: restructuring charges were $1.2 million in 2004 verses $300,000 in the same period in 2003; and there was a net interest expense of $3,000 in the six months ended June 30, 2004 compared to interest income of $178,000 for the same period in 2003.

LIQUIDITY AND CAPITAL RESOURCES

Net cash used in operating activities decreased to $2.9 million and $7.0 million for the three and six months ended June 30, 2004, respectively, compared to $5.7 million and $12.7 million for the corresponding periods in 2003, as we have significantly reduced our workforce and expense structure as a result of our restructuring efforts. Net cash used in operating activities for the three months ended June 30, 2004 consisted of our net loss of $1.1 million and a cash outflow of $1.9 million related to working capital account changes, offset by non-cash items, specifically depreciation and amortization of $127,000 and stock-based compensation expense of $33,000.

Cash flows from financing activities was $8.0 million for the three and six month periods ended June 30, 2004, compared to nil and a cash use of $600,000 in the corresponding periods in 2003. The $8.0 million represents the proceeds from the convertible debt issuance completed in the second quarter of 2004. The $600,000 payment in 2003 represents the final two payments of a note payable that was repaid by the end of the first quarter of 2003. There have been no common shares issuances in 2003 or 2004.

Excluding the sale (purchase) of short-term investments and restricted cash changes, cash used in investing activities was $546,000 and $548,000 for the three and six month periods ended June 30, 2004, respectively, compared to $18,000 and $88,000 in the corresponding periods in 2003. The amounts relate to net purchases of fixed assets.

Total cash flows, excluding the sale (purchase) of short-term investments, and restricted cash changes, was $4.6 million and $482,000 for the three and six month periods ended June 30, 2004, respectively, compared to cash use of $5.7 million and $13.4 million in the corresponding periods in 2003. Cash flows have improved because of the convertible debt issuance in the second quarter of 2004 and because we have significantly reduced operating costs.

As a result of the operational savings resulting from our restructurings and based on current estimates, we expect that cash from the sales of our products and our existing cash and cash equivalents and short-term investments will be sufficient to cover our cash requirements, including planned capital expenditures, for at least the next 12 months. We may require additional financing if we expand our operations at a faster rate than currently expected, if our costs unexpectedly increase, if our revenues decrease or if we seek to effect one or more significant acquisitions.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS — UNITED STATES AND CANADA

In December 2003, the SEC issued Staff Accounting Bulletin No.104 ("SAB 104"), "Revenue Recognition", which supersedes Staff Accounting Bulletin No. 101 ("SAB101"), "Revenue Recognition in Financial Statements." The primary purpose of SAB 104 is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, which was superseded as a result of the issuance of Emerging Issues Task Force 00-21 ("EITF 00-21"), "Accounting for Revenue Arrangement with Multiple Deliverables." SAB 104 also incorporated certain sections of the SEC's "Revenue Recognition in Financial Statements — Frequently Asked Questions and Answers" document. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The adoption of SAB 104 did not have a material impact on our consolidated financial position, results of operations or cash flows.

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46). In December 2003, the FASB issued FIN 46R that supersedes FIN 46 and contains numerous exemptions. FIN 46R applies to financial statements of public entities that have or potentially have interests in entities considered special purpose entities for periods ended after December 15, 2003 and otherwise to interests in VIE's for periods ending after March 15, 2004. VIE's are entities that have insufficient equity and/or their equity investors lack one or more specified essential characteristics of a controlling financial interest. FIN 46R provides specific guidance for determining when an entity is a VIE and who, if anyone, should consolidate the VIE. The adoption of this standard did not have material impact on our consolidated financial statements.

In April 2003, the FASB issued SFAS No. 149. "Amendment of Statement 133 on Derivative Instruments and Hedging". SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". The provisions of SFAS No. 149 are effective for contracts entered into after June 30, 2003. The adoption of SFAS No. 149 did not have a material effect on our consolidated financial statements.

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity". SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or and asset in some circumstances). Many of those instruments were previously classified as equity. The provisions of SFAS No. 150 are effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 did not have a material effect on our consolidated financial statements.

QUARTERLY RESULTS OF OPERATIONS

The following table sets forth certain unaudited consolidated statements of operations data for each of the eight most recent quarters that, in management's opinion, have been prepared on a basis consistent with the unaudited consolidated financial statements contained elsewhere in this interim report and include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the information presented. These operating results are not necessarily indicative of results for any future period. You should not rely on them to predict our future performance.

			Quarter ended
			Jun. 30, 2004			Mar. 31, 2004			Dec. 31, 2003			Sept. 30, 2003			Jun. 30, 2003			Mar. 31, 2003			Dec. 31, 2002			Sept. 30, 2002
			(In thousands of U.S. dollars, except per share amounts)
Revenue:
	Product		$	1,930		$	1,761		$	1,643		$	1,676		$	1,635		$	2,010		$	2,953		$	1,743
	Services			1,119			1,240			1,574			1,437			1,375			1,505			2,702			3,809

Total revenue				3,049			3,001			3,217			3,113			3,010			3,515			5,655			5,552
Operating expenses:
	Cost of revenue			1,537			1,528			1,577			1,458			1,422			1,574			1,680			1,225
	Research and development			1,433			2,089			1,920			2,008			2,555			2,950			3,017			3,761
	Sales and marketing			1,197			1,379			1,241			1,370			2,165			2,192			2,704			3,819
	General and administrative			755			833			1,004			846			1,291			945			1,319			1,708
	Depreciation			120			185			168			178			203			359			574			1,334
	Amortization of intangible assets			—			—			—			1,156			1,156			1,156			1,243			1,011
	Stock-based compensation:
		Cost of revenue		3			2			6			—			—			8			57			54
		Research and development		9			4			16			—			682			529			1,996			1,879
		Sales and marketing		7			4			14			—			170			112			704			662
		General and administrative		14			7			26			—			—			115			512			482
	Restructuring costs			(900	)		2,100			(250	)		—			300			—			—			3,662
		Write-down of fixed assets and goodwill and other intangible assets		—			—			9,097			—			—			—			1,285			2,205

	Total operating expenses			4,175			8,131			14,819			7,016			9,944			9,940			15,091			21,802

Loss from operations				(1,126	)		(5,130	)		(11,602	)		(3,903	)		(6,934	)		(6,425	)		(9,436	)		(16,250	)
Interest income (expense)				(19	)		16			32			44			85			93			166			60
Gain (loss) on sale of investments				—			—			283			—			—			—			150			—
Write-down of long-term investments				—			—			—			—			—			—			(67	)		(5,280	)

Loss for the period			$	(1,145	)	$	(5,114	)	$	(11,287	)	$	(3,859	)	$	(6,849	)	$	(6,332	)	$	(9,187	)	$	(21,470	)

Basic and diluted loss per share			$	(0.19	)	$	(0.85	)	$	(1.89	)	$	(0.64	)	$	(1.14	)	$	(1.06	)	$	(1.54	)	$	(3.60	)
Weighted-average number of shares used in computing basic and diluted loss per share (in thousands)				5,983			5,983			5,983			5,983			5,983			5,983			5,978			5,965

The historic common share numbers have been adjusted to reflect the 10 for 1 share consideration completed in the second quarter of 2003.

INFORMATION REGARDING FORWARD-LOOKING STATEMENTS

Statements contained in this report which are not historical facts are forward-looking statements within the meaning of Section 21E of the U.S. Securities Exchange Act of 1934, as amended. A forward-looking statement may contain words such as "anticipate that," "believes," "continue to," "estimates," "expects to," "hopes," "intends," "plans," "to be," "will be," "will continue to be," or similar words. These forward-looking statements include the statements herein regarding: future developments in our markets and the markets in which we expect to compete, including the wireless communications industry; our estimated cost reductions; our future ability to fund our operations and become profitable; our development of new products and relationships; the rate at which consumers will adopt wireless applications; our ability to increase our customer base; the services that we or our customers will introduce and the benefits that end users will receive from these services; the impact of entering new markets; our plans to use or not to use certain types of technologies in the future; our future cost of revenue, gross margins and net losses; our future restructuring, research and development, sales and marketing, general and administrative, stock-based compensation, depreciation and amortization expenses; our future interest income; the value of our goodwill and other intangible assets; our future capital expenditures and capital requirements; and the anticipated impact of changes in applicable accounting rules.

The accuracy of these statements may be impacted by a number of business risks and uncertainties that could cause actual results to differ materially from those projected or anticipated. These risks include the risks described in our SEC filings, including our annual report on Form 10-K. These risks are also described in our filings with the Canadian Securities Administrators, including our prospectuses, material change reports, Annual Information Form and Management Information Circular. We encourage you to carefully review these risks in order to evaluate an investment in our securities. Some of the key risks that could cause actual results to differ materially from those projected or anticipated also include the risks discussed below. We do not undertake any obligation to update this forward-looking information, except as required under applicable law.

GENERAL INDUSTRY, ECONOMIC AND MARKET CONDITIONS

Our future revenues and operating results are dependent to a large extent upon general economic conditions, conditions in the wireless market and within the wireless market, our primary target markets of mobile network operators and financial institutions. As economic activity slowed in these markets beginning in 2001, our customers began deferring their spending on our products and our revenues began to decline. Our sales cycle has lengthened significantly as potential customers have reduced their spending commitments and their willingness to make investments in new wireless services. Moreover, adoption of wireless services has not proceeded as rapidly as we previously anticipated. If general economic conditions are adverse, if the economies in which our target customers are located enter into a recession, or if demand for our solutions does not expand, our ability to increase our customer base may be limited, and our revenue may decrease further.

ENTERING NEW MARKETS

We have made mobile network operators an important focus of our activities. In order to encourage these potential customers to adopt and implement our solutions, we may incur higher costs than we have in the past, and we may not be able to attract a large number of these customers. In the three months ended June 30, 2004, 58% of our revenue was derived from one North American MNO. Mobile network operators may not be successful in rolling out our services, and subscribers to these services may not seek to use them. Any developments of this kind could limit our ability to sell our solutions to companies in this industry, may increase our expenses and may damage our reputation.

COMPETITIVE LANDSCAPE

Many of our competitors are significantly larger than us in terms of revenue, marketing and research and development expenditures and numbers of employees in their sales, services and support organizations. The competitors we face on our X-treme Mobility Suite ("XMS") sales opportunities include Nokia, Ericsson, Comverse, Alcatel and Openwave. Our success is dependent on our ability to win our share of these opportunities against these larger competitors. Many of these competitors are able to bundle other products (including handsets and/or network equipment) into sales of competitive products, which they might argue reduces risk to their customers. Also, consolidation of mobile network operators increases the competition among our competitors and us.

INTERNATIONAL MARKETS

In December 2000, we first recognized revenues from sales in international markets. We had expected that sales in these regions would be a major factor in our growth, particularly since the use of wireless networks and wireless devices have generally proceeded more rapidly outside North America. However, some key countries in these regions experienced decreasing economic activity, and our sales to these regions declined beginning in the third quarter of 2001. This trend has not reversed to date and it may not reverse in the second half of 2004 or thereafter, resulting in us not being able to increase our customer base, and accordingly, limited growth from these markets.

LIQUIDITY

In order to help ensure that we would have sufficient capital to take advantage of our core business opportunities, we have taken significant actions since the second quarter of 2001 to reduce our operating expenses. However, most of our operating expenses, such as employee compensation and lease payments for facilities and equipment, are relatively stable, and these expense levels are based in part on our expectations regarding future revenues. As a result, any sustained shortfall in our revenues relative to our expectations would negatively impact our operating results. Accordingly, if the cost-cutting actions that we have taken are insufficient, we may not have sufficient capital to fund our operations, and additional capital may not be available on acceptable terms, if at all. Any of these outcomes could adversely impact our ability to respond to competitive pressures or could prevent us from conducting all or a portion of our planned operations. We may need to undertake additional measures to reduce our operating expenses in the future.

INVESTMENTS IN OTHER COMPANIES & NEW TECHNOLOGIES

Because of the continuing volatility in the financial markets, as well as other factors, we may limit equity investments in other companies and the purchase of new technologies during the next few fiscal quarters, and possibly longer. As a result, we may not take advantage of investment opportunities that could provide us significant financial benefits, or that could provide us with the opportunity to build relationships with other companies in our industry and target markets.

RECEIVABLES

A significant portion of our receivables is derived from customers in foreign countries. Due to varying economic conditions and business practices in these countries, our collections cycle from these customers may be longer than with our North American customers. In the event of adverse economic conditions, there will be a greater risk that our customers will have difficulties in paying us in accordance with the terms of their contracts, and our risk of bad debt may increase substantially.

EMPLOYEES

Our ability to execute our business successfully depends in large part upon our ability to have a sufficient number of qualified employees to achieve our goals. However, if our workforce is not properly sized to meet our operating needs, our ability to achieve and maintain profitability is likely to suffer. As indicated in this report, we have substantially reduced the number of our employees. This means that we use a smaller number of employees to conduct some of the operations that were previously performed by a larger workforce, which could cause disruption of our business. In addition, the morale of our current employees may have been adversely affected by previous workforce reductions, impacting performance. Our ability to attract potential new employees in the future may suffer if our reputation suffers as a result of these staffing reductions.

GROSS MARGINS

We believe that certain factors in the current market may contribute to the risk that our gross margins will decrease in future fiscal quarters. We may have to lower our prices in order to accommodate our customers. In addition, many of our customers are reluctant to make a commitment to pay large upfront license fees, which could also cause our revenues to decrease. With a greater percentage of our revenues coming from services, if we are not successful in reducing our costs of sales, and our customers continue to purchase licenses on an as-needed basis, we will experience a decrease in our gross margins.

LITIGATION

The Company and certain of its former officers and directors were named as defendants in a series of purported class actions relating to our initial public offering. Litigation may be time consuming, expensive, and distracting from the conduct of our business, and the outcome of litigation may be difficult to predict. The adverse resolution of any of these proceedings could have a material adverse effect on our business, results of operations, and financial condition.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

IMPACT OF INTEREST RATE EXPOSURE

As of June 30, 2004, we had approximately $15.9 million in cash and cash equivalents, short-term investments and restricted cash. A significant portion of the cash earns interest at variable rates. In addition, although our short-term investments are fixed-rate instruments, the average term is short. Accordingly, our interest income is sensitive to changes in the level of prevailing interest rates.

IMPACT OF FOREIGN EXCHANGE RATE EXPOSURE

Our functional currency is the U.S. dollar. In the foreseeable future the majority of our non-US dollar denominated expenses will be incurred in Canadian dollars, Euros, Swiss francs and United Kingdom pounds sterling. Changes in the value of these currencies relative to the U.S. dollar may result in currency gains and losses, which could affect our operating results. In the three months ended June 30, 2004, we incurred realized and unrealized foreign currency gains relating to the translation of our non-US denominated monetary assets and liabilities of approximately $25,000.

Item 4. Controls and Procedures

Prior to the filing date of this report, management, including the Company's Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness and operation of the Company's disclosure controls and procedures. The Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2004, the disclosure controls and procedures were effective, in all material respects, to ensure that information required to be disclosed in the reports the Company files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required. There have been no significant changes in the Company's internal controls or in other factors, which could significantly affect internal controls subsequent to the date the Company carried out its evaluation. There were no significant deficiencies or material weaknesses identified in the evaluation and therefore, no corrective actions were taken.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

In July 2003, a committee of the Company's Board of Directors conditionally approved a proposed partial settlement with the plaintiffs in this matter. The settlement would provide, among other things, a release of the Company and of the Individual Defendants for the conduct alleged in the action to be wrongful in the amended complaint. The Company would agree to undertake other responsibilities under the partial settlement, including agreeing to assign away, not assert, or release certain potential claims the Company may have against its underwriters. Any direct financial impact of the proposed settlement is expected to be borne by the Company's insurers. In June 2004, an agreement of settlement was submitted to the Court for preliminary approval. The Company is unable to determine whether or when the settlement will be approved or be finalized.

If the proposed settlement is not consummated, the Company intends to continue to vigorously defend itself and the Individual Defendants against these claims. However, due to the inherent uncertainties of litigation, and because the IPO Litigation is at a preliminary stage, we cannot accurately predict the ultimate outcome IPO Allocation Litigation.

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

PRIVATE PLACEMENT. On May 14, 2004, the Company entered into a series of agreements, including a Secured Convertible Note Purchase Agreement, dated May 14, 2004, among the Company, its wholly-owned subsidiary, 724 Solutions Software Inc., and Austin Ventures VI, L.P., Austin Ventures VI Affiliates Fund, L.P., and Austin Ventures VIII, L.P. in connection with the private placement of up to $8 million of secured convertible promissory notes for cash. As a result of these agreements, the Company completed, or agreed to complete, subject to obtaining shareholder approval, the following transactions:

•: The Company issued for cash US$3.04 million aggregate principal amount of secured convertible promissory notes, convertible into common shares; and

•: The Company agreed to issue for cash an additional US$4.96 million aggregate principal amount of secured convertible promissory notes, convertible into common shares, upon obtaining shareholder approval.

Shareholders approved the second tranche of this transaction at a Special Meeting of Shareholders held on June 29, 2004 and it closed that day.

The principal amount of the secured convertible promissory notes and all interest owing under the secured convertible promissory notes, is convertible at the option of the noteholder into common shares at an initial conversion price of $3.07 per share. In the event the Company issues, or is deemed to have issued, common shares at a price per share that is less than the conversion price then in effect (other than certain specified exempt issuances), then the conversion price shall be reduced to the weighted average of the purchase prices of the previously outstanding stock (including common shares issuable upon the conversion or exercise of outstanding convertible securities and stock options) and the newly-issued stock. However, the conversion price shall not be reduced by more than 15 percent, or to a conversion price of less than $2.61 per share.

The Company's Board of Directors also agreed to waive the terms of its shareholder rights plan such that the acquisition by Austin Ventures or its affiliates of up to 49% of the outstanding common shares (whether through the conversion of the Notes or the acquisition of common shares from third-parties) will not result in a flip-in event under the plan.

Exemption from registration for these transactions are claimed pursuant to Section 4(2) of the Securities Act regarding transactions by the issuer not involving a public offering, in that these transactions were made, without general solicitation or advertising, to sophisticated investors with access to all relevant information necessary to evaluate these investments and who represented to the Company that the shares were being acquired for investment.

The Secured Convertible Note Purchase Agreement, the Security Agreement, the Registration Rights Agreement, the Guaranty and the Form of Secured Convertible Promissory Note has been filed with the Securities and Exchange Commission on the Company's Form 8-K on May 18, 2004.

RIGHTS PLAN. The Rights Plan, adopted by the Board of Directors of the Company and initially ratified by the Company's shareholders at the annual shareholders' meeting held on April 24, 2003, was renewed by the Company's shareholders at the annual shareholders' meeting held on April 29, 2004. The Rights Plan will continue until the close of the annual meeting of shareholders of the Company in 2005.

Item 3. Defaults Upon Senior Securities

None.

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

Annual and Special Meeting. The Company's Annual and Special Meeting of Shareholders (the "Annual Meeting") was held on April 29, 2004. The following matters were submitted to the Company's shareholders for their vote, and the results of the vote taken at the Annual Meeting were as follows:

1.: Each of the Company's directors standing for election was elected for a one year term:

(a) John J. Sims: 2,550,435 votes for; 27,771 votes withheld; 0 broker held non-voted shares;

(b) James D. Dixon: 2,548,561 votes for; 29,645 votes withheld; 0 broker held non-voted shares;

(d) Joseph C. Aragona: 2,549,871 votes for; 28,335 votes withheld; 0 broker held non-voted shares;

(e) J. Ian Giffen: 2,554,549 votes for; 23,657 votes withheld; 0 broker held non-voted shares; and

(f) Terry D. Kramer: 2,553,239 votes for; 24,967 votes withheld; 0 broker held non-voted shares.

2.: The appointment of KPMG LLP, as the Company's independent auditors for fiscal 2004:

2,557,438 votes for; 0 votes against; 5,904 abstentions; and 0 broker held non-voted shares.

3.: A resolution renewing and continuing the shareholder rights plan adopted by the Board of Directors of the Company:

1,529,851 votes for; 97,853 votes against; 0 abstentions; and 0 broker held non-voted shares.

Special Meeting. A Special Meeting of Shareholders (the "Special Meeting") was held on June 29, 2004. The following matter was submitted to the Company's shareholders for their vote, and the results of the vote taken at the Special Meeting were as follows:

1. A resolution authorizing the Company to issue and sell certain secured convertible promissory notes in an aggregate principal amount of $8,000,000, reserve for issuance up to 3,973,605 common shares issuable upon the conversion of such notes and the interest payable thereon, and to issue those shares, in an amount which may be greater than 19.9% of the Company's outstanding common shares as of the date of such issuance, and ratifying all such action.

1,347,316 votes for; 733,160 votes against; 29,706 abstentions; and 0 broker held non-voted shares.

Item 5. Other Information

None.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits:

The following exhibits are filed with this Report:

No.		Description
31.1		Rule 13a-14(a)/15d-14(a) Certification of the Chief Executive Officer
31.2		Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial Officer
32.1		Section 1350 Certification of the Chief Executive Officer
32.2		Section 1350 Certification of the Chief Financial Officer

(b) Reports on Form 8-K:

During the period covered by this Report, the Company furnished two reports on Form 8-K:

April 29, 2004:		reporting the Company's results of operations for the three months ended March 31, 2004.
May 18, 2004:		announcing that it has arranged a non-brokered private placement of secured convertible promissory notes with Austin Ventures for a total principal amount of USD $8 million.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Signatures	Titles	Date

/s/ JOHN J. SIMS John J. Sims	Chief Executive Officer (principal executive officer)	August 10, 2004

/s/ GLENN BARRETT Glenn Barrett	Chief Financial Officer (principal financial and accounting officer)	August 10, 2004

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Table of Contents
PART I. FINANCIAL INFORMATION
PART II. OTHER INFORMATION
SIGNATURES