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

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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 September 30, 2004

or

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

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Commission File Number: 0-29625

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Summus, Inc. (USA)
(Exact Name of Registrant as Specified in its Charter)

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434 Fayetteville Street, Suite 600
Raleigh, North Carolina 27601
(919) 807-5600
(Address, Including Zip Code, and Telephone Number, Including Area Code
of Registrant's Principal Executive Offices)

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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  þ   No  ¨

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

As of November 10, 2004 , the registrant had 104,147,494 shares of its Common Stock, par value $.001 per share, issued and outstanding.

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SUMMUS, INC. (USA)

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004

  TABLE OF CONTENTS 

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PART I.
FINANCIAL INFORMATION

Item 1. Financial Statements

SUMMUS, INC. (USA)
CONSOLIDATED BALANCE SHEETS

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

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SUMMUS, INC. (USA)

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

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

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SUMMUS, INC. (USA)

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

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

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SUMMUS, INC. (USA)

CONSOLIDATED STATEMENT OF SHAREHOLDERS' (DEFICIT) EQUITY (UNAUDITED)

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

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SUMMUS, INC. (USA)

CONSOLIDATED STATEMENT OF SHAREHOLDERS'  (DEFICIT) EQUITY (UNAUDITED)

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

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SUMMUS, INC. (USA)

CONSOLIDATED STATEMENT OF SHAREHOLDERS' (DEFICIT) EQUITY (UNAUDITED)

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

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SUMMUS, INC. (USA)

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

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

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SUMMUS, INC. (USA)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. Business, Organization and Basis of Presentation

Business

Summus, Inc. (USA) ("Summus” or the "Company") is engaged primarily in the development of applications that optimize the consumer wireless experience.  The core of the Company's business plan is to focus on the emerging wireless and mobile market and partner with leading content brands to bring branded products to mobile phones.  Our major content brands include Sports Illustrated, The Associated Press, Fuji Film and Phil Hellmuth.  Through September 30, 2004, we have executed contracts with a variety of content providers to build applications for  the distribution of their content.  

Summus has developed software, technology and applications to enable information processing and resource management to include, but not be limited to, the creation, transmission, playing and management of content over wireless networks.  We currently offer products in various categories, including games, personalization, photo services, and news/information. The Company's technology, which provides the foundation for its current products, is designed to address the usability constraints of the existing wireless network infrastructure. This technology will enable more efficient use of existing and future bandwidth allocations, resulting in a perceived bandwidth increase by the mobile end-user.

Summus builds end-user applications for all major mobile platforms, including QUALCOMM’s Binary Runtime Environment for Wireless™ (BREW™), Java™ 2 Platform, Micro Edition (J2ME™), Symbian™ OS and Wireless Application Protocol (WAP).  We distribute our applications through major wireless carriers who make our products available to their customers. Summus currently has relationships with carriers that account for 98% of all U.S. wireless subscribers. We also have relationships with international carriers covering Canada, Latin America, Australia, Israel and the U.K. 

We have completed development of and launched twenty-eight (28) wireless applications. Twelve (12) wireless carriers in the United States and ten (10) international wireless carriers currently deploy at least one or a combination of the twenty-eight (28) wireless applications that have been completed by the Company.  Summus launched its first wireless application during the second quarter of 2002.  These applications can be purchased by the end-user as a one-time purchase, or a monthly subscription, depending on content, product function, and/or carrier preferences.

The majority of the applications completed and deployed by the Company, as well as planned future applications, have been developed by the Company through a process that involves securing agreements with content providers and carriers, and developing and launching the applications. The Company outsources the infrastructure needed to host and deliver the transactions for its application end-users.

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1. Business, Organization and Basis of Presentation (continued)

 Basis of Presentation

The consolidated financial statements of the Company included in this quarterly report on Form 10-Q are unaudited. In the opinion of management, such financial statements contain all adjustments (consisting of normal recurring adjustments) necessary to present fairly the financial position of the Company as of September 30, 2004; the results of operations for the three and nine-month periods ended September 30, 2004 and 2003; shareholders' (deficit) equity as of September 30, 2004; and cash flows for the nine-month periods ended September 30, 2004 and 2003.

The accompanying unaudited consolidated financial statements as of and for the three and nine-month periods ended September 30, 2004 and 2003, have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and in accordance with Article 10 of Regulation S-X. Certain information and note disclosures normally included in the Company's annual financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted. These unaudited consolidated financial statements should be read in conjunction with the financial statements and accompanying notes included in the Company’s audited financial statements for the year ended December 31, 2003, which were filed with the Securities and Exchange Commission on March 31, 2004, in the Company's annual report on Form 10-K for the fiscal year ended December 31, 2003. The Form 10-K is available through the Internet in the SEC's EDGAR website at www.sec.gov, on the Company’s website at www.summus.com or from the Company upon request.

The accompanying unaudited consolidated financial statements have been prepared as if the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the financial statements at September 30, 2004, the Company incurred a net loss for the quarter of $957,088, has negative working capital of $500,130 at September 30, 2004, and experienced negative cash flows from operations. The Company’s continuation as a going concern is dependent on its ability to generate sufficient cash flow to meet its obligations on a timely basis, to obtain additional financing, and ultimately to attain profitability. The Company is actively promoting and expanding its product line and pursuing additional financing for capital to expand its operations.  Management expects to be able to attract additional capital to continue to fund and expand operations and also expects that increased revenues will reduce its operating losses in future periods. However, there can be no assurance that management’s plan will be executed as anticipated. The financial statements presented herein do not include any adjustments relating to the recoverability of assets and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

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2. Summary of Significant Accounting Policies

Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Revenue Recognition and Related Costs

Change in Revenue Recognition Policy

After a careful review of the Company’s revenue recognition policies and giving consideration to guidance provided for in Emerging Issues Task Force No. 99-19 Reporting Revenue Gross as a Principal versus Net as an Agent (“EITF 99-19”), the Company changed certain revenue recognition policies affecting revenues earned by wireless applications and contracts during the 4^th quarter of 2003.  Prior to 4^th quarter 2003, the Company reported revenues earned by wireless applications and contracts and cost of revenues for wireless applications and contracts net of certain third-party costs in the statement of operations. These transactions have been reclassified to reflect a gross revenue presentation with no effect on gross profit or net loss. The amount by which revenues and costs of revenues have been reclassified for the three and nine-month periods ended September 30, 2004, is $149,042 and $363,936, respectively.

Wireless applications and contracts

Commencing during the second quarter of 2002, our resources were dedicated to the development of solutions for the mobile and wireless markets. Revenues earned from wireless applications are recognized upon delivery and acceptance by the end-user either as a one-time purchase or a monthly subscription. For content delivery partner arrangements, whereby the Company remits a portion of the revenues earned through the sale of the Company’s applications, revenue is recorded on a gross basis in accordance with EITF 99-19. The Company recognizes the cost of payments to the content providers as a cost of revenues. Wireless applications and contracts cost of revenues include all third-party hosting, testing and/or carrier distribution fees. These costs are incurred on a monthly basis and are primarily fixed in nature regardless of the revenue generated by the related applications.

Periodically, we enter into non-recurring engineering arrangements with our content partners. Generally, under the terms of these agreements, we receive funding upfront to complete projects. The funding we receive upfront is recorded as deferred revenue and is recognized as revenue under the terms of the individual arrangements. Deferred revenue represents amounts received for which the Company has not yet completed its contractual obligations.

Wireless License Fees

We recognize revenue from licensee fees for wireless software applications in accordance with the provisions of AICPA Statement of Position 97-2, “Software Revenue Recognition”, as amended by AICPA Statement of Position 98-9 “Modification of SOP No. 97-2 Software Revenue Recognition with Respect to Certain Transactions.” Revenue from software license fees is generally recognized upon delivery provided that a contract has been executed, the vendor fee is fixed or determinable, no significant vendor obligations or uncertainties surrounding customer acceptance remain, and collection of the resulting receivable is deemed probable.

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2. Summary of Significant Accounting Policies (continued)

There were no costs related to the wireless license fee revenue generated during the three and nine months ended September 30, 2004, as the license fee revenue related to technology that had been previously developed by the Company, and there were no costs for installation, delivery or customization, or other related costs.

Contracts and license fees

We derive certain revenues from research and development contracts for governmental agencies and the commercial licensing of our technology. We recognize revenue on these contracts at the time services are rendered based upon the terms of individual contracts. Regarding the commercial licensing of our technology, we follow the provisions of AICPA Statement of Position 97-2, “Software Revenue Recognition”, as amended by AICPA Statement of Position 98-9 “Modification of SOP No. 97-2 Software Revenue Recognition with Respect to Certain Transactions.” Revenue from software license fees is generally recognized upon delivery provided that a contract has been executed, the vendor fee is fixed or determinable, no significant vendor obligations or uncertainties surrounding customer acceptance remain, and collection of the resulting receivable is deemed probable.

Segments

Management has structured the Company's internal organization as one business segment from which all operating decisions are made and all operating results are evaluated.

Equipment and Furniture

Equipment and furniture is stated at cost. Depreciation is computed over the estimated useful lives of the assets (generally three to seven years) using the straight-line method. Amortization of capital lease assets is included in depreciation expense.

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2. Summary of Significant Accounting Policies (continued)

Income Taxes

Income taxes are accounted for using the liability method in accordance with Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." Under SFAS 109, deferred tax assets or liabilities are computed based upon the difference between the financial statement and income tax basis of assets and liabilities using the enacted marginal tax rate applicable when the related asset or liability is expected to be realized or settled. Deferred income tax expenses or benefits are based on the changes in the asset or liability from period to period. If available evidence suggests that it is more likely than not that some portion or all of the deferred tax assets will not be realized, a valuation allowance is required to reduce the deferred tax assets to the amount that is more likely than not to be realized. Future changes in such valuation allowance would be included in the provision for deferred income taxes in the period of change.

Stock-Based Compensation

The Company has stock-based compensation plans for employees, consultants and directors. The Company accounts for those plans under the intrinsic value method prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”) and related interpretations. For options granted under those plans with an exercise price equal to the market value of the stock on the date of grant, no compensation cost is recognized in net operations as reported in the consolidated statement of operations. Compensation cost is recognized in net earnings/loss for awards granted under those plans with an exercise price less than the market value of the underlying common stock on the date of grant. Such costs are recognized ratably over the vesting period. The Company recorded non-cash compensation related to the issuance of fully-vested stock options with exercise prices below the fair market value of the underlying stock plus the amortization of deferred compensation arising from stock option issuances subject to vesting totaling $56,177 and $132,442 for the nine months ended September 30, 2004 and 2003, respectively, and $2,475 and $44,148 for the three months ended September 30, 2004 and 2003, respectively.

The following table illustrates the effect on net loss and net loss per share if the Company had applied the fair value recognition provision of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS 123”). In accordance with SFAS 123, the fair value of each option grant was determined by using the Black-Scholes option pricing model with the following weighted average assumptions for the three and nine-month periods ended September 30, 2004 and 2003: dividend yield of 0%; volatility ranging from 1.218 to 1.789; risk-free interest rate ranging from 2.75% to 5.00%; and expected option lives of 5 years for employees and 10 years for Board members.

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2. Summary of Significant Accounting Policies (continued)

The Company accounts for stock-based compensation to non-employees of the Company, primarily consultants and advisors, at the fair value of the equity instrument in accordance with the provisions of SFAS No. 123.  Non-cash consulting expense related to such stock based compensation was $70,432 and $110,192 for the nine-month periods ended September 30, 2004 and 2003, respectively, and $41,415 and $5,454 for the three-month periods ended September 30, 2004 and 2003, respectively.

Net Loss Per Share

Loss per share has been calculated in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share." Basic loss per share was computed by dividing the net loss for each period presented by the weighted average number of shares of common stock outstanding for such period, as adjusted for the recapitalization. Although the Company has potential common stock equivalents related to its outstanding stock options, warrants and preferred stock, these potential common stock equivalents were not included in diluted loss per share for each period presented because the effect would have been antidilutive.

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2. Summary of Significant Accounting Policies (continued)

New Accounting Pronouncements

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" (the "Interpretation"), which addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. The Interpretation applies immediately to variable interests in variable interest entities created after January 31, 2003.  The Interpretation becomes effective for entities created before February 1, 2003,  at the beginning of the first interim period ending after March 31, 2004.  The adoption of the provisions of the Interpretation did not have a material impact on the Company's financial statements.

3. Convertible Notes Payable

In May 2004, the Company entered into senior convertible debt agreements with certain investors to provide up to $2,000,000 of financing in the form of convertible notes payable (the "Notes"). The Notes do not bear interest and are convertible into shares of the Company’s common stock at the option of the holder. The Notes mature three years from the date of issuance. Once the Notes mature, the Company has the sole right to pay off the debt or require conversion by the holders of any unconverted portion thereof into shares of the Company’s common stock.  At the closing of the senior convertible debt agreements, each investor received 7,143 shares of the Company’s common stock for each $1,000 invested, for a total of 14,286,000 shares of the Company’s common stock. Upon the conversion of each $1,000 of senior convertible debt issued and outstanding, the holder shall receive an additional 14,286 shares of the Company’s common stock. 

Upon closing, the Company received $1,000,000 in cash and the remaining $1,000,000 of proceeds received were placed in an escrow account with American Stock Transfer Company (the “Escrow Agent”). The Company was not to have access to this escrowed $1,000,000 until it achieved positive EBITDA, as defined in the senior convertible debt agreements, for a one-month period.  Summus achieved positive EBITDA  for the month of August 2004 and sent the Escrow Agent a certificate of its Chief Financial Officer notifying it of such, which gives the Company access to the escrowed funds.  There can be no assurances that the Company will achieve positive EBITDA in succeeding months.  The Company is not required to access these escrowed funds, and as of the date of this quarterly report, Summus has not drawn down any of these funds.  Any of the escrowed funds not drawn down by Summus by  March 31, 2005, shall be released by the Escrow Agent to the holders of the Notes on a pro rata basis. Any of the escrowed funds not released by the Escrow Agent to the Company shall have no conversion rights into the Company’s common stock as set forth above.

The Company allocated the $1,000,000 of proceeds received in connection with the financing in May 2004 between the Notes and the 14,286,000 shares of common stock issued on a relative fair value basis.  Accordingly, the Company allocated $500,000 to the Notes and $500,000 to the common stock issued.  Since the Notes were issued at a discount to the principal balance, which is the basis for conversion, the effective conversion price of the Notes was less than the fair value of the Company's common stock on the date of issuance.  Accordingly, a beneficial conversion feature of $500,000 was recorded as a discount to the Notes and a corresponding credit to additional paid-in capital on the date of issuance. Since the Notes have a term of three years, the aggregate discount of $1,000,000 will be amortized to interest expense over a thirty-six month period commencing on the date of issuance.  In September 2004, notes totaling $600,000 were converted into 8,571,600 shares of common stock.  The remaining discount on these Notes was fully amortized to interest expense in the three months ended September 30, 2004.  Amortization of the discount of the Notes for the three and nine months ended September 30, 2004 was $611,653 and $654,210, respectively.

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4. Common Stock, Options and Warrants

Common Stock Reserved for Future Issuance

As of September 30, 2004, the Company had reserved shares of its authorized 185,000,000 shares of common stock for future issuance as follows:

5. Preferred Stock

Series A Convertible Preferred Stock

The Company has 2,407 shares of Series A convertible preferred stock (“Series A preferred stock”) outstanding as of September 30, 2004. These shares are valued based upon the liquidation preference of Series A preferred stock of $1,000 per share.  Shares of the Series A preferred stock rank on parity with Summus’ Series C, Series D and Series E convertible preferred stock as to liquidation preference upon dissolution, liquidation or the winding up of Summus.

The holders of the Series A preferred stock are entitled to receive cumulative cash dividends at a rate of 8% per annum of the initial liquidation preference of $1,000 per share. These dividends are accrued monthly. The Company, at its election, can provide for the payment of dividends on the Series A preferred stock through the issuance of additional shares of Series A preferred stock having an aggregate initial liquidation preference equal to the amount of cash dividends otherwise payable. Dividends are cumulative from the date of issuance and are payable, when, as and if declared by the Board of Directors, on March 31 and September 30 of each year. The Company is restricted from paying dividends on common stock until dividends are paid on Series A preferred in full. The Company recorded preferred stock dividends of $41,565 and $124,695 for the three and nine months ended September 30, 2004, respectively.  On August 26, 2004, the Company issued 329 shares of Series A preferred stock as consideration for accrued dividends of $328,983.  As of September 30, 2004, the Company had recorded $13,855 in accrued dividends, which is reflected in current liabilities in the accompanying consolidated balance sheet.

The holders of the outstanding shares of Series A preferred stock are not entitled to vote on matters submitted to the Company’s shareholders for voting, except as may be required by Florida law.  However, approval of holders of a majority of the outstanding shares of Series A preferred stock is required prior to the issuance of a new series of preferred stock that ranks senior to the Series A preferred stock. Each share of the Series A preferred stock is convertible at the option of the holder, at any time after the date of issuance, into shares of common stock equal to the Liquidation Preference divided by the initial conversion price of $14.24. The conversion price is subject to adjustment in accordance with the Company’s articles of incorporation.  At the Company’s election, it has the right to redeem any outstanding shares of the Series A preferred stock at the liquidation preference of $1,000 per share.

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5. Preferred Stock (continued)

Series C Convertible Preferred Stock

In June 2003, the Company amended its articles of incorporation to establish its Series C convertible preferred stock (“Series C preferred stock”). The Series C preferred stock has an issue price of $1,000 per share and has the following rights and privileges:

• no voting rights except with respect to (i) the amendment or alteration of the statement of rights and preferences applicable to the Series C preferred stock, and (ii) any matters for which voting rights are provided under Florida law;
• shares of the Series C preferred stock shall rank on a parity with Summus’ Series A, Series D and Series E convertible preferred stock as to liquidation preference upon dissolution, liquidation or the winding up of Summus;
• a liquidation preference, subject to adjustment for any combinations, consolidations, stock distributions or stock dividends with respect to the Series C preferred stock, of $1,000 per share payable in the event of any liquidation, dissolution or winding up of Summus; and
• the right to convert each share of Series C preferred stock into shares of our common stock at any time, at the option of the Series C preferred stockholder, after nine (9) months from the date of its issuance. Each share of Series C preferred stock shall be convertible into 4,000 fully paid and non assessable shares of the Company’s common stock.

During the three and nine month periods ended September 30, 2004, certain holders of the Series C preferred stock converted 60 and 1,310 shares of Series C preferred stock into 240,000 and 5,240,000 shares of the Company’s common stock, respectively.

All shares of the Series C preferred stock have been converted into shares of the Company’s common stock as of September 30, 2004.

Series D Convertible Preferred Stock

In September 2003, the Company amended its articles of incorporation to establish its Series D convertible preferred stock (“Series D preferred stock”). The newly established Series D preferred stock has an issue price of $1,000 per share and has the following rights and privileges:

• no voting rights except with respect to (i) the amendment or alteration of the statement of rights and preferences applicable to the Series D preferred stock, and (ii) any matters for which voting rights are provided under Florida law;
• shares of the Series D preferred stock shall rank on a parity with Summus’ Series A, Series C and Series E preferred stock as to liquidation preference upon dissolution, liquidation or the winding up of Summus;
• a liquidation preference, subject to adjustment for any combinations, consolidations, stock distributions or stock dividends with respect to the Series D preferred stock, of $1,000 per share payable in the event of any liquidation, dissolution or winding up of Summus, Inc.; and
• the right to convert each share of Series D preferred stock into shares of our common stock at any time, at the option of the Series D preferred stockholder. Each share of Series D preferred stock shall be convertible into 5,000 fully paid and nonassessable shares of the Company’s common stock.

During the three and nine month periods ended September 30, 2004, certain holders of the Series D preferred stock converted 250 and 625 shares of Series D preferred stock into 1,250,000 and 3,125,000 shares of the Company’s common stock, respectively.  As of September 30, 2004, 2,275 shares of Summus’ Series D preferred stock are issued and outstanding. 

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5. Preferred Stock (continued)

Series E Convertible Preferred Stock

In November 2003, the Company amended its articles of incorporation to establish its Series E convertible preferred stock (“Series E preferred stock”). The Series E preferred stock has an issue price of $1,000 per share and has the following rights and privileges:

• no voting rights except with respect to (i) the amendment or alteration of the statement of rights and preferences applicable to the Series E preferred stock, and (ii) any matters for which voting rights are provided under Florida law;
• shares of the Series E preferred stock shall rank on a parity with Summus’ Series A, Series C and Series D preferred stock as to liquidation preference upon dissolution, liquidation or the winding up of Summus;
• a liquidation preference, subject to adjustment for any combinations, consolidations, stock distributions or stock dividends with respect to the Series E preferred stock, of $1,000 per share payable in the event of any liquidation, dissolution or winding up of Summus; and
• the right to convert each share of Series E preferred stock into shares of our common stock at any time, at the option of the Series E preferred stockholder. Each share of Series E preferred stock shall be convertible into 5,000 fully paid and nonassessable shares of the Company’s common stock.

All shares of Series E preferred stock have been converted into shares of the Company’s common stock as of September 30, 2004.

The accounting treatment for the Series C, D and E preferred stock (the “Preferred Stock”) involved allocating the value of the principal amount received from the Preferred Stock offerings between the Preferred Stock, the associated warrants and a beneficial conversion feature (“BCF”) associated with the Preferred Stock. A BCF existed because the effective conversion rate of the Preferred Stock was below the traded value of the Company’s common stock on the date the Preferred Stock was issued. The BCF for the Preferred Stock totaling $3,579,695 was recorded as a discount to the Preferred Stock and additional paid-in capital on the date the Preferred Stock was issued. Since the Series C preferred stock became convertible at any time after nine months from its issuance, the value of its BCF totaling $659,010 was amortized to retained deficit over a nine-month period commencing with its issuance through April 2004. Amortization of the Series C preferred stock BCF for the three and nine months ended September 30, 2004 was $0 and $293,444, respectively. Since the Series D and E preferred stock was convertible immediately, the value of its beneficial conversion feature totaling $2,920,685 was fully amortized to retained deficit on the date of issuance during the year ended December 31, 2003.

6. Commitments and Contingencies

Dr. Bjorn Jawerth’s Employment Agreement

The Company entered into a three-year employment agreement with Dr. Bjorn Jawerth, which expired on February 16, 2004, and was not renewed by the Board of Directors. His employment agreement provided for an initial base salary of $350,000, with annual increases of 10%. 

The difference between the increased salary amounts of $385,000 and $423,500, respectively, in the second and third years of his employment agreement, and his original base salary of $350,000 was deferred and accrued by the Company, at Dr. Jawerth’s election, until the Board of Directors and Dr. Jawerth determine when and how these deferred and accrued amounts may be paid. Dr. Jawerth’s deferred salary amount of $81,106 is recorded as accrued salaries in the Company’s balance sheet as of September 30, 2004.

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6. Commitments and Contingencies (continued)

Under the terms of the recapitalization transaction, Summus agreed to use reasonable commercial efforts to assist Dr. Jawerth in the private sale of up to 1,666,667 shares of Summus common stock held by Dr. Jawerth at a per share price of not less than $1.50 per share (representing $2.5 million in value). Under the terms of Dr. Jawerth's employment agreement, the Company was obligated to issue to Dr. Jawerth options, with an exercise price of $1.50 per share, exercisable for three times the number of shares of common stock sold in the private sale as described above. No shares subject to this agreement have been sold. The Company has no further obligations regarding this sale of shares.

Pursuant to the terms of his employment agreement and in accordance with corporate policy, all intellectual property developed by Dr. Jawerth in connection with his employment by the Company is the exclusive property of the Company. Dr. Jawerth’s employment agreement granted him a personal, non-exclusive, non-transferable, world-wide license, without right to sublicense, to make and use New Technology (as defined in the Inventions Award Plan) that was developed during the twelve months following the closing of the recapitalization transaction. Pursuant to the terms of Dr. Jawerth’s employment agreement, the Company terminated Dr. Jawerth’s license on February 4, 2004.

Inventions Awards Plan

The Company established its Inventions Awards Plan, effective October 30, 2000, to provide incentives to certain eligible employees by providing them with opportunities to receive additional compensation as a result of their development of enhancements or new methods that generate revenue for the Company.

Under the terms of this plan, the Company was obligated to reserve 5% of the gross revenues derived from the licensing or sale of “New Technology”, as defined in the agreement, for distribution among eligible employees. If the Company sold the rights to New Technology, eligible employees would have been entitled to an award of 10% of the gross proceeds.

In addition, the Company could, at its option, initiate a spin-off company to develop New Technology.  If the eligible employee were to accept a position in the spin-off company, his or her rights to awards under the plan would have been surrendered for 25% of the founders’ equity in the spin-off company.

Dr. Jawerth sent correspondence to the Company on February 17, 2004, seeking payment for certain inventions under this plan. Management and the Board of Directors of the Company have evaluated these assertions and determined that no amounts are due Dr. Jawerth or other employees under the provisions of this plan. In addition, the Board of Directors terminated this plan effective March 10, 2004. If litigation is pursued by Dr. Jawerth for any payments under the Plan and he is successful in such litigation, there may be a material adverse impact to the Company.

Cancellation of warrants

On July 19, 2002, the Company entered into an irrevocable common stock equity line that was intended to provide funding to the Company in amounts up to $10.0 million. The Company filed a registration statement on Form S-1 with the Securities and Exchange Commission (“SEC”) on July 31, 2002, relating to this common stock equity line agreement. Based on comments received from the Securities and Exchange Commission and related communications with the SEC, the Company understood that the terms of the equity line financing arrangement were such that it would not be able to resolve the staff’s comments in a timely manner and seek effectiveness of the registration statement in a timely manner. Due to these developments, the length of time involved in completing the transaction, and other factors, the Company determined that it was in its best interest to withdraw the registration statement and not proceed with the equity line. Accordingly, on September 17, 2002, the Company submitted to the SEC a request to withdraw the registration statement and cancelled all agreements associated with the common stock equity line.

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6. Commitments and Contingencies (continued)

In connection with the cancellation of the agreements associated with the common stock equity line, Talisman, the intended purchaser under the equity line, indicated to the Company its intention to retain ownership of the warrants to purchase 500,000 shares of the Company’s unregistered common stock at an exercise price of $0.47 per share that were issued to Talisman upon the execution of the equity line agreements. It is management’s position, with the advice of legal counsel, that the cancellation of these warrants became effective with the cancellation of the equity line agreements and that no loss contingency exists. Therefore, the Company has not recorded the issuance of these 500,000 warrants in its consolidated financial statements nor disclosed them as part of outstanding warrants. The Company has sent correspondence to Talisman stating its position that the warrants have been cancelled. To date, the Company has not received correspondence back from Talisman indicating their concurrence.

7. Non-cash Settlements

Bowne Litigation

On February 25, 2003, Bowne of New York City, LLC (“Bowne”), a financial printing firm, filed a civil summons in the Supreme Court of County of New York in the State of New York, claiming that it was entitled payment in the amount of $276,373, plus accrued interest, for past services rendered to the Company.

In August 2004, the Company and Bowne settled the claim between them, whereby both parties agreed to reduce the total amount owed by the Company to Bowne to $150,000.  The parties also agreed that this amount would be paid by (i) an initial payment of $10,000, (ii) monthly installments of $6,000 per month from November 1, 2004 through September 1, 2006 and (iii) a final payment of $2,000 on October 1, 2006 by Summus.  The settlement gain resulting from this transaction was $126,373.  The balance owed as of September 30, 2004, was $140,000, which is included in accounts payable.

8.  Acceleration of Receivables from Qualcomm

On September 23, 2004, Summus entered into an amendment to its BREW developer agreement with QUALCOMM in which it agreed to participate in QUALCOMM’s Quick Pay program, which provides for the acceleration of payments for amounts owed to Summus by QUALCOMM.  Summus entered into this program to reduce its account receivables position with QUALCOMM and convert these receivables into cash.   Summus began receiving payments under this program in October 2004.  Under the terms of the amendment, Summus shall pay QUALCOMM five percent (5%) of the developer application or wholesale price set by Summus for each of its BREW applications for which it is owed payment.  QUALCOMM shall pay amounts owed to Summus within thirty (30) days of the last day of each calendar month regardless of whether QUALCOMM has received payment from the carriers or not.  All amounts received by Summus from QUALCOMM under this program are on a non-recourse basis.  Summus may terminate its participation in the QUALCOMM Quick Pay program upon thirty (30) days written notice to QUALCOMM. 

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

Forward-Looking Statements

This Form 10-Q contains certain forward-looking statements that we believe are within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are intended to be covered by the safe harbors created by such acts. For this purpose, any statements that are not statements of historical fact may be deemed to be forward-looking statements, including the statements under "Management's Discussion and Analysis of Financial Condition and Results of Operations" regarding our strategy, future operations, future expectations or future estimates, financial position and objectives of management. Those statements in this Form 10-Q containing the words "believes," "anticipates," "plans," "expects" and similar expressions constitute forward-looking statements, although not all forward-looking statements contain such identifying words. These forward-looking statements are based on our current expectations and are subject to a number of risks, uncertainties and assumptions relating to our operations, results of operations, competitive factors, shifts in market demand and other risks and uncertainties. The most important factors that could prevent us from achieving our stated goals include, but are not limited to, the following:

• a lack of sufficient financial resources to implement the Company's business plan, which has resulted in the Company's receiving a "going concern" opinion from its independent auditors with respect to its audited financial statements as of and for the year ended December 31, 2003;
• our ability to generate sufficient working capital to meet our operating requirements;
• our ability to develop and enter into strategic relationships with wireless service providers, wireless software developers, semiconductor and device designers, wireless device manufacturers and content providers;
• timely deployment by wireless service providers, semiconductor and device designers, and wireless device manufacturers of our software in their products;
• the continued growth in demand for wireless and mobile usage;
• new product development and acceleration of commercial deployment of such products;
• technological competition, which creates the risk of the Company's technology being rendered obsolete or noncompetitive;
• the lack of patent protection with respect to the Company's technology; and
• potential infringement of the patent rights of third parties.

Although we believe that the assumptions underlying our forward-looking statements are reasonable, any of the assumptions could be inaccurate and actual results may differ from those indicated by the forward-looking statements included in this Form 10-Q. In light of the significant uncertainties inherent in the forward-looking statements included in this Form 10-Q, you should not consider the inclusion of such information as a representation by us or anyone else that we will achieve such results. Moreover, we assume no obligation to update these forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting such forward-looking statements.

Change in Revenue Recognition Policy

After a careful review of the Company’s revenue recognition policies and giving consideration to guidance provided for in Emerging Issues Task Force No. 99-19 Reporting Revenue Gross as a Principal versus Net as an Agent (“EITF 99-19”), the Company changed certain revenue recognition policies affecting revenues earned by wireless applications and contracts during the 4^th quarter of 2003.  Prior to the 4^th quarter of 2003, the Company reported revenues earned by wireless applications and contracts and cost of revenues for wireless applications and contracts net of certain third-party costs in the statement of operations. These transactions have been reclassified to reflect a gross revenue presentation with no effect on gross profit or net loss. The amount by which revenues and costs of revenues have been reclassified for the three and nine-month periods ended September 30, 2003 is $149,042 and $363,936, respectively.

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Overview

Summus is primarily engaged in the development of applications that optimize the consumer wireless experience.  The core of the Company's business plan is to focus on the emerging wireless and mobile market and partner with leading content brands to bring branded products to mobile phones.  Our major content brands include Sports Illustrated, The Associated Press, Fuji Film and Phil Hellmuth.  Through September 30, 2004, we have executed contracts with a variety of content providers to build applications for  the distribution of their content.  

Summus has developed software, technology and applications to enable information processing and resource management to include, but not be limited to, the creation, transmission, playing and management of content over wireless networks.  We currently offer products in various categories, including games, personalization, photo services, and news/information.  The Company's technology, which provides the foundation for its current products, is designed to address the usability constraints of the existing wireless network infrastructure. This technology will enable more efficient use of existing and future bandwidth allocations, resulting in a perceived bandwidth increase by the mobile end-user.

Summus builds end-user applications for all major mobile platforms, including QUALCOMM’s Binary Runtime Environment for Wireless™ (BREW™), Java™ 2 Platform, Micro Edition (J2ME™), Symbian™ OS and Wireless Application Protocol (WAP).  We distribute our applications through major wireless carriers who make our products available to their customers. Summus currently has relationships with carriers that account for 98% of all U.S. wireless subscribers. We also have relationships with international carriers covering Canada, Latin America, Australia, Israel and the U.K. 

We have completed development of and launched twenty-eight (28) wireless applications. Twelve (12) wireless carriers in the United States and ten (10) international wireless carriers currently deploy at least one or a combination of the twenty-eight (28) wireless applications that have been completed by the Company.  Summus launched its first wireless application during the second quarter of 2002.  These applications can be purchased by the end-user as a one-time purchase, or a monthly subscription, depending on content, product function, and/or carrier preferences.

The majority of the applications completed and deployed by the Company, as well as planned future applications, have been developed by the Company through a process that involves securing agreements with content providers and carriers, and developing and launching the applications. The Company outsources the infrastructure needed to host and deliver the transactions for its application end-users.

To date, the Company has experienced significant operating losses as we have made investments in research and development of our underlying technology and application development. We expect to continue to make investments in those areas; however, the Company is more focused on the development and delivery of applications and the marketing of those applications to make substantial progress in revenue generation. We plan to expand our market presence by partnering with additional wireless carriers as well as increasing subscriber adoption of our applications. Our ability to generate profits and positive cash flow from operations will depend primarily on increasing revenues as well as continuing  cost reduction measures.

Acceleration of Receivables from Qualcomm

In September 2004, Summus entered into an amendment to its BREW developer agreement with QUALCOMM in which it agreed to participate in QUALCOMM’s Quick Pay program, which provides for the acceleration of payments for amounts owed to Summus by QUALCOMM.  Summus entered into this program to reduce its account receivables position with QUALCOMM and convert these receivables into cash.  Summus began receiving payments under this program in October 2004.  Under the terms of the amendment, Summus shall pay QUALCOMM five percent (5%) of the developer application or wholesale price set by Summus for each of its BREW applications for which it is owed payment.  QUALCOMM shall pay amounts owed to Summus within thirty (30) days of the last day of each calendar month regardless of whether QUALCOMM has received payment from the carriers or not.  All amounts received by Summus from QUALCOMM under this program are on a non-recourse basis.  Summus may terminate its participation in the QUALCOMM Quick Pay program upon thirty days written notice to QUALCOMM

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Results of Operations

Three-Month Period Ended September 30, 2004 Compared to Three-Month Period Ended September 30, 2003

Revenues

Wireless Applications and Contracts. Revenue from wireless applications and contracts increased $1,135,015 to $1,466,448 in the three-month period ended September 30, 2004, up 342.5% from $331,433 in the three-month period ended September 30, 2003. The increase in revenue from wireless applications and contracts resulted from the increase in sales of existing wireless applications and additional wireless applications developed by the Company, launched by several wireless carriers and purchased by end-users. The Company launched its Sports Illustrated Swimsuit Collection wallpaper and screen saver application in March 2004 and launched its multi-player Texas Hold’em poker game application in May 2004.  The Company has continued to increase its subscriber base as well as expanding to new carriers.

Revenue earned from wireless applications is recognized upon delivery and acceptance by the end-user either as a one-time purchase or a monthly subscription.

Contracts and License Fees. Revenue from contracts and license fees was $30,000 in the three-month period ended September 30, 2004 and was generated from providing governmental contract services.  There was no revenue earned from contracts and license fees during the three-month period ended September 30, 2003.

Wireless License Fees. Revenue from wireless license fees increased $3,250 to $4,250 in the three-month period ended September 30, 2004, up 325.0% from $1,000 in the three-month period ended September 30, 2003.  During the second half of 2003, the Company changed its focus from the commercial licensing of its technology to developing wireless applications.

Costs of Revenues