----

----

Table of Contents

**UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, 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**

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

_______________

**Commission File Number: 0-29625**

_______________

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

|        **Florida**        | **7370, 5045**                         | **65-0185306**               |
|---------------------------------------------------------|----------------------------------------|------------------------------|
| **   *(State or other Jurisdiction of***      | ***(Primary Standard***                | ***(I.R.S. Employer***       |
| ***    Incorporation or Organization)*** | ***Industrial Classification Codes)*** | ***Identification Number)*** |

_______________

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

_______________

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to filesuch 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   ̈    No  þ     

As of August 5, 2004, the registrant had 92,860,405 shares of its Common Stock, par value $.001 per share, issued andoutstanding.

----

----

 **SUMMUS, INC. (USA)** 

   **FORM 10-Q** 

   **FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004** 

  **TABLE OF CONTENTS** 

|              |        |                                                                                              |        |                  |
|-------------------|--------|----------------------------------------------------------------------------------------------|--------|------------------|
|              |   |                                                                                         |   | **Page No.**     |
| **PART I**   |   | **CONSOLIDATED FINANCIAL INFORMATION**                                                  |   |             |
|              |
| Item 1.      |   |  Consolidated Financial Statements (Unaudited)                                          |   |             |
|              |
|              |   |      Consolidated Balance Sheets as of June 30, 2004                |   |             |
|              |   |          (Unaudited) and December 31, 2003           |   | **3**       |
|              |
|              |   |      Consolidated Statements of Operations for the Three-Month      |   |             |
|              |   |          Period Ended June 30, 2004 and 2003 (Unaudited)  |   | **4**       |
|              |   |                                                                                              |   |             |
|              |   |      Consolidated Statements of Operations for the Six-Month             |   | ** **       |
|              |   |         Period Ended June 30, 2004 and 2003 (Unaudited)   |   | **5 **      |
|              |   |                                                                                              |   |             |
|              |   |      Consolidated Statement of Shareholders'(Deficit) Equity for the     |   |             |
|              |   |          Six-Month Period Ended June 30, 2004 (Unaudited) |   | **6**       |
|              |
|              |   |      Consolidated Statements of Cash Flows for the Six-Month        |   |             |
|              |   |          Period Ended June 30, 2004 and 2003 (Unaudited)  |   | **9**       |
|              |
|              |   |      Notes to Consolidated Financial Statements (Unaudited)              |   | **10**      |
|              |
| Item 2.      |   | Management's Discussion and Analysis of Financial Condition                             |   |             |
|              |   |      and Results of Operations                                           |   | **22**      |
|              |
| Item 3.      |   | Quantitative and Qualitative Disclosures About Market                                        |   |             |
|              |   |      Risk                                                                |   | **39**      |
|              |
| Item 4.      |   | Controls and Procedures                                                                      |   | **39**      |
|              |
| **PART II**  |   | **OTHER INFORMATION**                                                                        |   |             |
|              |
| Item 2            |        | Changes in Securities and Use of Proceeds                                                    |        | **40**      |
|              |        |                                                                                              |        |                  |
| Item 5.      |   | Other Information                                                                            |   | **4****1**  |
|              |
| Item 6.      |   | Exhibits and Reports on Form 8 –K                                                      |   | **44**      |

2

----

Table of Contents

**PART I.****FINANCIAL INFORMATION**

**Item 1. *Financial Statements***

**SUMMUS, INC. (USA)****CONSOLIDATED BALANCE SHEETS**

|                                                                        |   | **June 30, 2004** | **          ** | **December 31, 2003** |
|-----------------------------------------------------------------------------|--------|-------------------|------------------------------------------------------------------|-----------------------|
|                                                                        |   | **(Unaudited)**   |                                                             |                  |
| **Assets**                                                             |   |              |                                                             |                  |
| Current assets:                                                        |   |              |                                                             |                  |
|    Cash                                                      |   | $ 748,356    |                                                             | $ 2,188,645      |
|    Accounts receivable                                       |   | 922,024      |                                                             | 480,494          |
|    Prepaids and other current assets                         |   | 145,569      |                                                             | 15,800           |
| Total current assets                                                   |   | 1,815,949    |                                                             | 2,684,939        |
| Equipment, software and furniture, net                                 |   | 147,374      |                                                             | 195,999          |
| Total assets                                                           |   | $ 1,963,323  |                                                             | $ 2,880,938      |
|                                                                        |
| **Liabilities and shareholders’ (deficit)**  **equity**           |   |              |                                                             |                  |
| Current liabilities:                                                   |   |              |                                                             |                  |
|    Accounts payable                                          |   | $ 1,380,391  |                                                             | $ 1,350,940      |
|    Accrued salaries and related costs                        |   | 201,080      |                                                             | 439,595          |
|    Accrued interest                                          |   | 88,010       |                                                             | 82,812           |
|    Current portion of notes payable                          |   | 287,869      |                                                             | 270,195          |
|    Capital lease obligations, current portion                |   | -            |                                                             | 17,296           |
|    Preferred stock dividends payable                         |   | 301,273      |                                                             | 218,143          |
|    Deferred revenue                                          |   | 35,000       |                                                             | -                |
| Total current liabilities                                              |   | 2,293,623    |                                                             | 2,378,981        |
| Notes payable, less current portion                                    |   | 132,705      |                                                             | 215,932          |
| Convertible notes payable, net of discount of $957,443                 |   | 42,557       |                                                             | -                |
| Total liabilities                                                           |        | 2,468,885    |                                                                  | 2,594,913        |
|                                                                        |        |                   |                                                                  |                       |
| Shareholders’ (deficit) equity :                                 |   |              |                                                             |                  |
| Series A convertible preferred stock, $0.001 par value;                |   |              |                                                             |                  |
|    10,000 shares designated, 2,078 shares issued and         |   |              |                                                             |                  |
|    outstanding at June 30, 2004 and December 31,             |   |              |                                                             |                  |
|    2003 (liquidation preference of $2,379,273 as of          |   |              |                                                             |                  |
|    June 30, 2004)                                            |   | 2,078,312    |                                                             | 2,078,312        |
| Series C convertible preferred stock, $0.001 par value;                |   |              |                                                             |                  |
|    3,000 shares designated, 1,310 and 60 shares issued and   |   |              |                                                             |                  |
|    outstanding at June 30, 2004 and December 31, 2003        |   |              |                                                             |                  |
|    respectively (liquidation preference of $60,000 as of     |   |              |                                                             |                  |
|    June 30, 2004)                                            |   | 30,184       |                                                             | 365,566          |
| Series D convertible preferred stock, $0.001 par value;                |   |              |                                                             |                  |
|    4,000 shares designated, 2,525 and 2,900 shares issued    |   |              |                                                             |                  |
|    and outstanding at June 30, 2004 and December 31, 2003,   |   |              |                                                             |                  |
|    respectively (liquidation preference of $2,525,000 as of  |   |              |                                                             |                  |
|    June 30, 2004)                                            |   | 1,754,965    |                                                             | 2,015,604        |
| Series E convertible preferred stock, $0.001 par value;                |   |              |                                                             |                  |
|    200 shares designated, zero and 170 shares issued and     |   |              |                                                             |                  |
|    outstanding at June 30, 2004 and December 31, 2003,       |   |              |                                                             |                  |
|    respectively                                              |   | -            |                                                             | 119,460          |
| Common stock, $0.001 par value, 185,000,000 shares                     |   |              |                                                             |                  |
|    authorized; 92,798,153 and 69,408,639 shares issued       |   |              |                                                             |                  |
|    and 92,759,653 and 69,370,139 shares outstanding at       |   |              |                                                             |                  |
|    June 30, 2004 and December 31, 2003, respectively         |   | 92,759       |                                                             | 69,370           |
| Additional paid-in capital                                             |   | 48,498,032   |                                                             | 46,315,321       |
| Deferred compensation                                                  |   | (9,625)           |                                                             | (53,427)              |
| Accumulated deficit                                                         |   | (52,722,570)      |                                                             | (50,396,562)          |
| Treasury stock, at cost (38,500 shares)                                     |   | (227,619)         |                                                             | (227,619)             |
| Total shareholders’ (deficit) equity                                   |   | (505,562)         |                                                             | 286,025          |
| Total liabilities and shareholders’ (deficit) equity                   |   | $ 1,963,323  |                                                             | $ 2,880,938      |

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

3

----

Table of Contents

**SUMMUS, INC. (USA)**

**CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)**

|                                                                             |  **Three-Month Period****Ended** |
|----------------------------------------------------------------------------------|---------------------------------------|
|                                                                             |                                  | **June 30, 2004** |   |         | **June 30, 2003** |   |
| Revenues:                                                                   |                                  |   |   |   |   |   |   |   |
|     Wireless applications and contracts                           |                                  | $ | 1,208,880  |   |   | $  |  332,989  |   |
|    Contracts and license fees                                     |                                  |   | –  |   |   |   |  –  |   |
|    Wireless license fees                                          |                                  |   | –  |   |   |   | 247,201  |   |
|              Total revenues              |                                  |   | 1,208,880  |   |   |   | 580,190  |   |
| Cost of revenues:                                                           |                                  |   |   |   |   |   |   |   |
|    Wireless applications and contracts                            |                                  |   | 627,431  |   |   |   |  228,419  |   |
|    Contracts and license fees                                     |                                  |   | –  |   |   |   |  –  |   |
|    Wireless license fees                                          |                                  |   | –  |   |   |   |  –  |   |
|              Total cost of revenues      |                                  |   |  627,431  |   |   |   |  228,419  |   |
| Gross profit                                                                |                                  |   | 581,449  |   |   |   | 351,771  |   |
| Selling, general and administrative expenses                                |                                  |   | 752,078  |   |   |   |  1,134,532  |   |
| Non-cash compensation                                                       |                                  |   | 6,666  |   |   |   |    44,148  |   |
| Research and development                                                    |                                  |   | 453,097  |   |   |   |  263,631  |   |
| Non-cash consulting expense                                                 |                                  |   | 22,673  |   |   |   | 36,470  |   |
| Non-cash settlements                                                        |                                  |   | –  |   |   |   | (333,950) |   |
| Interest expense                                                            |                                  |   | 55,898  |   |   |   | 14,222  |   |
| Net loss                                                                    |                                  | $  | (708,963) |   |   | $  | (807,282) |   |
|                                                                             |
| Net loss applicable to common shareholders:                                 |                                  |   |   |   |   |   |   |   |
|    Net loss                                                       |                                  | $  | (708,963) |   |   | $  |  (807,282) |   |
|    Accretion of beneficial conversion feature on preferred stock  |                                  |   |  (84,922) |   |   |   |  –  |   |
|    Preferred stock dividends                                      |                                  |   |  (41,565) |   |   |   |  (47,032) |   |
| Net loss applicable to common shareholders                                  |                                  | $  |  (835,450) |   |   | $  |   (854,314) |   |
| Per share amounts (basic and diluted)                                       |                                  | $  |  (0.01) |   |   | $  |   (0.01) |   |
| Weighted average shares of common stock outstanding                         |                                  |   | 84,362,293  |   |   |   |  60,533,019  |   |

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

4

----

Table of Contents

**SUMMUS, INC. (USA)**

**CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)**

|                                                                             |  **Six-Month Period****Ended** |
|----------------------------------------------------------------------------------|-------------------------------------|
|                                                                             | **June 30, 2004**                   |   |         | **June 30, 2003** |   |
| Revenues:                                                                   |                                |   |   |   |   |   |   |   |
|     Wireless applications and contracts                           |                                | $ |  1,982,210  |   |   | $  |  562,424  |   |
|    Contracts and license fees                                     |                                |   |   13,889  |   |   |   |  –  |   |
|    Wireless license fees                                          |                                |   |   750  |   |   |   | 247,201  |   |
|              Total revenues              |                                |   |   1,996,849  |   |   |   | 809,625  |   |
| Cost of revenues:                                                           |                                |   |   |   |   |   |   |   |
|    Wireless applications and contracts                            |                                |   |  1,023,768  |   |   |   |  443,013  |   |
|    Contracts and license fees                                     |                                |   |   3,199  |   |   |   |  –  |   |
|    Wireless license fees                                          |                                |   |  –  |   |   |   |  –  |   |
|              Total cost of revenues      |                                |   |   1,026,967  |   |   |   |  443,013  |   |
| Gross profit                                                                |                                |   |  969,882  |   |   |   | 366,612  |   |
| Selling, general and administrative expenses                                |                                |   |  1,786,532  |   |   |   |  2,490,694  |   |
| Non-cash compensation                                                       |                                |   |  53,702  |   |   |   |    88,294  |   |
| Research and development                                                    |                                |   |  973,319  |   |   |   |  528,971  |   |
| Non-cash consulting expense                                                 |                                |   |  29,017  |   |   |   | 94,706  |   |
| Non-cash settlements                                                        |                                |   |  –  |   |   |   |  (1,339,290) |   |
| Interest expense                                                            |                                |   |  76,746  |   |   |   | 24,441  |   |
| Net loss                                                                    |                                | $  |  (1,949,434) |   |   | $  | (1,521,204) |   |
|                                                                             |
| Net loss applicable to common shareholders:                                 |                                |   |   |   |   |   |   |   |
|    Net loss                                                       |                                | $  |  (1,949,434) |   |   | $  |  (1,521,204) |   |
|    Accretion of beneficial conversion feature on preferred stock  |                                |   |  (293,444) |   |   |   | –  |   |
|    Preferred stock dividends                                      |                                |   |  (83,130) |   |   |   |  (93,192) |   |
| Net loss applicable to common shareholders                                  |                                | $  |  (2,326,008) |   |   | $  |   (1,614,396) |   |
| Per share amounts (basic and diluted)                                       |                                | $  |  (0.03) |   |   | $  |   (0.03) |   |
| Weighted average shares of common stock outstanding                         |                                |   |   77,651,930  |   |   |   |  58,429,235  |   |

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

5

----

Table of Contents

**SUMMUS, INC. (USA)**

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

|                                                   |                            |             |         |                    |         |        |   |             |   |       |   |   |        |   |
|--------------------------------------------------------|---------------------------------|------------------|--------------|-------------------------|--------------|-------------|--------|------------------|--------|------------|--------|--------|-------------|--------|
|                                                   | **Convertible Preferred Stock** |
|                                                   | **Series A**                    | ** **       | **Series C** | ** **              | **Series D** |        |
|                                                   |                            | **Shares**  |         | **Amount**         |         | **Shares**  |   | **Amount**  |   | **Shares** |   |   | **Amount**  |   |
|                                                   |
| **Balance at December 31, 2003**                  |                            | 2,078       |         | $  2,078,312  |         | 1,310  |   | $ 365,566   |   | 2,900      |   |   | $ 2,015,604 |   |
| Accretion of beneficial conversion                |                            |             |         |                    |         |        |   |             |   |       |   |   |        |   |
|    feature of Series C preferred stock  |                            | -           |         | -                  |         | -      |   | 293,444     |   | -     |   |   | -      |   |
| Issuance of common stock in conjunction                |                                 |                  |              |                         |              |             |        |                  |        |            |        |        |             |        |
|    with issuance of convertible debt    |                            | -           |         | -                  |         | -      |   | -           |   | -     |   |   | -      |   |
| Beneficial conversion feature related                  |                                 |                  |              |                         |              |             |        |                  |        |            |        |        |             |        |
|    to issuance of convertible debt      |                            | -           |         | -                  |         | -      |   | -           |   | -     |   |   | -      |   |
| Common stock, options and warrants                |                            |             |         |                    |         |        |   |             |   |       |   |   |        |   |
|    issued for services                  |                            | -           |         | -                  |         | -      |   | -           |   | -     |   |   | -      |   |
| Common stock issued for cash                      |                            | -           |         | -                  |         | -      |   | -           |   | -     |   |   | -      |   |
| Common stock issued for accrued payroll                |                            | -           |         | -                  |         | -      |   | -           |   | -     |   |   | -      |   |
| Preferred stock dividends                         |                            | -           |         | -                  |         | -      |   | -           |   | -     |   |   | -      |   |
| Deferred compensation related to             |                            |             |         |                    |         |        |   |             |   |       |   |   |        |   |
|    issuance of stock options            |                            | -           |         | -                  |         | -      |   | -           |   | -     |   |   | -      |   |
| Amortization of deferred                          |                            |             |         |                    |         |        |   |             |   |       |   |   |        |   |
|    compensation                         |                            | -           |         | -                  |         | -      |   | -           |   | -     |   |   | -      |   |
| Conversion of Series C, D and E                   |                            |             |         |                    |         |        |   |             |   |       |   |   |        |   |
|    preferred stock                      |                            | -           |         | -                  |         | (1,250)     |   | (628,826)        |   | (375)      |   |   | (260,639)   |   |
| Net loss for the period                           |                            | -           |         | -                  |         | -      |   | -           |   | -     |   |   | -      |   |
| **Balance at June 30, 2004**                      |                            | 2,078       |         | $  2,078,312  |         | 60     |   | $ 30,184    |   | 2,525      |   |   | $ 1,754,965 |   |

 

 

 

 

 

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

6

----

Table of Contents

**SUMMUS, INC. (USA)**

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

|                                                        |   |                 |          |       |                                                                        |       |              |                   |       |                 |       | **Additional**           |
|-------------------------------------------------------------|--------|----------------------|---------------|------------|-----------------------------------------------------------------------------|------------|-------------------|------------------------|------------|----------------------|------------|--------------------------|
|                                                        |   | **Series E**         | ** **    | ** ** | **Common Stock **                                                      | ** ** | **Paid-In ** |
|                                                        |   | **Shares**           | ** **    | ** ** | **Amount**                                                                  | ** ** | ** **        | **Shares **       | ** ** | **Amount **     | ** ** | **Capital **        |
|                                                        |
| **Balance at December 31, 2003**                       |   | 170                  |          |       | $ 119,460                                                                   |       |              | 69,370,139        |       | $ 69,370        |       | $ 46,315,321        |
| Accretion of beneficial conversion                     |   |                 |          |       |                                                                        |       |              |                   |       |                 |       |                     |
|    feature of Series C preferred stock  |   | -          |          |       | -                                                                 |       |              |  -      |       |  -    |       |  -        |
| Issuance of common stock in conjunction                     |   |                 |          |       |                                                                        |       |              |                   |       |                 |       |                     |
|    with issuance of convertible debt         |   | -          |          |       | -                                                                 |       |              |  14,286,000  |       |  14,286    |       |  485,714       |
| Beneficial conversion feature related                       |   |                 |          |       |                                                                        |       |              |                   |       |                 |       |                     |
|    to issuance of convertible debt           |   | -          |          |       | -                                                                 |       |              |  -      |       |  -    |       |  500,000       |
| Common stock, options and warrants                     |   |                 |          |       |                                                                        |       |              |                   |       |                 |       |                     |
|    issued for services                       |   |   -   |          |       | -                                                                 |       |              |  300,000     |       |  300       |       |  82,717        |
| Common stock issued for cash                           |   |   -   |          |       | -                                                                 |       |              |  431,034     |       |  431       |       |  19,655        |
| Common stock issued for accrued payroll                     |   |   -   |          |       | -                                                                 |       |              |  647,480     |       |  647       |       |  83,525        |
| Preferred stock dividends                              |   |   -   |          |       |  -                                                           |       |              |  -      |       |  -    |       |  -        |
| Deferred compensation related to                       |   |                 |          |       |                                                                        |       |              |                   |       |                 |       |                     |
|   issuance of stock options                       |   |   -   |          |       | -                                                                 |       |              |  -      |       |  -    |       |  9,900         |
| Amortization of deferred                               |   |                 |          |       |                                                                        |       |              |                   |       |                 |       |                     |
|   compensation                                    |   |   -   |          |       | -                                                                 |       |              |  -      |       |  -    |       |  -        |
| Conversion of Series C, D and E                        |   |                 |          |       |                                                                        |       |              |                   |       |                 |       |                     |
|   preferred stock                                 |   |    (170)   |     |       |  (119,460)                                                             |       |              |  7,725,000   |       |  7,725     |       |  1,001,200     |
| Net loss for the period                                |   |   -   |          |       | -                                                                 |       |              |  -      |       |  -    |       |  -        |
| **Balance at June 30, 2004**                           |   |  -    |          |       | $           -   |       |              |  92,759,653  |       |  $ 92,759  |       |  $ 48,498,032  |

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

* *

* *

* *

* *

7

----

Table of Contents

**SUMMUS, INC. (USA)**

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

|                                                 |   |                 |   |   |                       |   |                           |                |   |   | ** Total**                                |   |
|------------------------------------------------------|--------|----------------------|--------|--------|----------------------------|--------|--------------------------------|---------------------|--------|--------|------------------------------------------------|--------|
|                                                 |   | **Deferred**         |   |   | **Accumulated**            |   |                           | **Treasury**        |   |   | **Shareholders’**                        |   |
|                                                 |   | **Compensation**     |   |   | **Deficit**                |   |                           | **Stock**           |   |   | **(Deficit)** **Equity**                  |   |
|                                                 |
| **Balance at December 31, 2003**                |   | $ (53,427            | )      |   | $  (50,396,562        | )      |       |  $ (227,619    | )      |   | $       286,025  |   |
| Accretion of beneficial conversion              |   |                 |   |   |                       |   |                           |                |   |   |                                           |   |
|  feature of Series C preferred stock       |   |  -    |   |   |  (293,444             | )      |                           |  -   |   |   | -                                    |        |
| Issuance of common stock in conjunction              |   |                 |   |   |                       |   |                           |                |   |   |                                           |   |
|    with issuance of convertible debt  |   |  -    |   |   |  -          |   |                           |  -   |   |   |  500,000                                  |   |
| Beneficial conversion feature related                |   |                 |   |   |                       |   |                           |                |   |   |                                           |   |
|    to issuance of convertible debt    |   |  -    |   |   |  -          |   |                           |  -   |   |   |  500,000                                  |   |
| Common stock, options and warrants              |   |                 |   |   |                       |   |                           |                |   |   |                                           |   |
|    issued for services                |   |  -    |   |   | -                |   |                           |  -   |   |   |  83,017                                   |   |
| Common stock issued for cash                    |   |  -    |   |   | -                |   |                           |  -   |   |   |  20,086                                   |   |
| Common stock issued for accrued payroll              |   |  -    |   |   |  -          |   |                           |  -   |   |   |  84,172                                   |   |
| Preferred stock dividends                       |   |  -    |   |   |   (83,130        | )      |                           |  -   |   |   |  (83,130                                  | )      |
| Deferred compensation related to                |   |                 |   |   |                       |   |                           |                |   |   |                                           |   |
|    issuance of stock options          |   |  (9,900         | )      |   |  -          |   |                           |  -   |   |   |  -                              |   |
| Amortization of deferred                        |   |                 |   |   |                       |   |                           |                |   |   |                                           |   |
|    compensation                       |   | 53,702               |   |   |  -          |   |                           |  -   |   |   |  53,702                                   |   |
| Conversion of Series C, D and E                 |   |                 |   |   |                       |   |                           |                |   |   |                                           |   |
|    preferred stock                    |   |  -    |   |   |  -          |   |                           |  -   |   |   |  -                              |   |
| Net loss for the period                         |   |  -    |   |   |  (1,949,434           | )      |                           |  -   |   |   |  (1,949,434                               | )      |
| **Balance at June 30, 2004**                         |   |  $  (9,625 | )      |   |  $   (52,722,570 | )      |                           |  $ (227,619    | )      |   |  $      (505,562 | )      |

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

* *

* *

* *

* *

* *

8

----

Table of Contents

**SUMMUS, INC. (USA)**

**CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)**

|                                                                                                              |         | **Six-Month Period Ended**     |                           |
|-------------------------------------------------------------------------------------------------------------------|--------------|--------------------------------|--------------------------------|
|                                                                                                              |         | **June 30, 2004**              |       |   | **June 30, 2003** |   |
|                                                                                                              |
| **Operating activities**                                                                                     |         |                           |                           |   |   |   |
| Net loss                                                                                                          | $            |   (1,949,434)             |                           | $ |   (1,521,204) |  |
| Adjustments to reconcile net loss to net cash used in operating                                              |         |                           |                           |   |   |   |
|  activities:                                                                                            |    |                           |                           |   |   |   |
|    Depreciation and amortization                                                                   |         |  80,313              |                           |   |  152,347  |   |
|    Non-cash compensation                                                                           |         |    53,702  |                           |   |    88,294  |   |
|    Common stock,  options and warrants issued for services                                    |         |  83,017              |                           |   |  94,706  |   |
|    Amortization of discount on debt and beneficialconversion      feature |              | 42,557                    |                                |  | –  |  |
|    Non-cash settlements                                                                            |         | –                   |                           |   | (1,339,290) |   |
| Changes in operating assets and liabilities:                                                                 |         |                           |                           |   |   |   |
|    Accounts receivable                                                                             |         | (441,530)                      |                           |   | (170,439) |   |
|    Prepaid and other assets                                                                        |         | (129,769)                      |                           |   | (75,233) |   |
|    Accounts payable and other accrued expenses                                                     |         | 58,649                    |                           |   | 342,610  |   |
|    Accrued salaries and related costs                                                              |         | (178,343)                      |                           |   | 358,436  |   |
|    Deferred revenue                                                                                |         | 35,000                    |                           |   | (7,285) |   |
| Net cash used in operating activities                                                                        |         |  (2,345,838)              |                           |   |  (2,077,058) |   |
|                                                                                                              |         |                           |                           |   |   |   |
| **Investing activities**                                                                                     |         |                 |                           |   |     |   |
| Purchases of equipment and furniture                                                                         |         | (31,688)                       |                           |   | –  |   |
| Net cash used in investing activities                                                                        |         |  (31,688)                 |                           |   |   –  |   |
| **Financing activities**                                                                                     |         |                      |                           |   |    |   |
| Proceeds from sale of common stock and warrants                                                                   |         |  520,086             |                           |   |  1,326,607  |   |
| Proceeds from issuance of convertible debt                                                                        |              | 500,000                   |                                |  | –  |  |
| Proceeds from exercise of warrants                                                                           |         |   –            |                           |   |  779,355  |   |
| Principal payments on capital lease obligations                                                              |         |   (17,296)           |                           |   |   (54,894) |   |
| Principal payments on notes payable and short-term borrowings                                                |         | (65,553)                       |                           |   | –  |   |
| Net cash provided by financing activities                                                                    |         |   937,237            |                           |   |  2,051,068  |   |
| Net decrease in cash                                                                                         |         | (1,440,289)                    |                           |   | (25,990) |   |
| Cash at beginning of period                                                                                  |         | 2,188,645                 |                           |   | 25,990  |   |
| Cash  at end of period                                                                                       | $            | 748,356                   |                           | $ | –   |   |
| **Supplemental disclosure of cash flow information**                                                         |         |                           |                           |   |   |   |
| Cash paid for interest                                                                                       | $            | 8,143                     |                           | $ | 4,847  |   |

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

 

 

9

----

Table of Contents

**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 theconsumer wireless experience.  The core of the Company's business plan is to focus on the emerging wireless and mobile marketand partner with leading content brands to bring branded products to mobile phones.  Summus has developed software, technologyand 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, news/information and entertainment.  The Company's technology, whichprovides the foundation for its current services, is designed to address the usability constraints of the existing wireless networkinfrastructure. This technology will enable more efficient use of existing and future bandwidth allocations, resulting in aperceived bandwidth increase by the mobile end-user. One of our main objectives is to create a superior mobile end-user experience,which will impact devices, wireless carrier infrastructure and mobile applications.

Summus builds products for all major mobile platforms, including QUALCOMM’s Binary Runtime Environment for WirelessTM(BREWTM), JavaTM 2 Platform, Micro Edition (J2METM), Symbian OS and WAP.  We distribute our applicationsthrough major wireless carriers who make our products available totheir customers. Summus currently has relationships with carriers that account for 92% of all U.S. wireless subscribers. We alsohave relationships with international carriers covering Canada, Latin America, Australia, Israel and the U.K. 

The Company has completed development of and has launched twenty-seven (27) wireless applications. Twelve (12) wirelesscarriers in the United States and ten (10) international wireless carriers currently deploy at least one or a combination of thetwenty-seven (27) wireless applications that have been completed by the Company.  Summus launched its first wirelessapplication during the second quarter of 2002.  These applications can be purchased by the end-user as a one-time purchase, ora monthly subscription, depending on content, product function, and/or carrier preferences.

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

10
Table of Contents

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

 *Basis of Presentation*

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

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

The accompanying unauditedconsolidated financial statements have been preparedas if the Company will continue as agoing concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course ofbusiness. As shown in the financial statements at June 30, 2004, the Company incurred a net loss for the quarter of approximately$708,963, has negative working capital of $477,674 at June 30, 2004, and experienced negative cash flows from operations. TheCompany’s continuation as a going concern is dependent on its ability to generate sufficient cash flow to meet itsobligations on a timely basis, to obtain additional financing, and ultimately to attain profitability. The Company is activelypromoting and expanding its product line and pursuing additional financing from existing shareholders and other institutionalinvestors. Management expects to be able to attract additional capital to continue to fund and expand operations and also expectsthat increased revenues will reduce its operating losses in future periods. However, there can be no assurance thatmanagement’s plan will be executed as anticipated. The financial statements presented herein do not include any adjustmentsrelating to the recoverability of assets and classification of liabilities that might be necessary should the Company be unable tocontinue as a going concern.

11
Table of Contents

**2.** **Summary of Significant Accounting Policies**

*Estimates*

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of thefinancial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ fromthose estimates.

*Revenue Recognition and Related Costs*

Change in Revenue Recognition Policy

After a careful review of the Company’s revenuerecognition policies and giving consideration to guidance provided for in Emerging Issues Task Force No. 99-19 *Reporting RevenueGross as a Principal versus Net as an Agent* (“EITF 99-19”), the Company has changed certain revenue recognitionpolicies affecting revenues earned by wireless applications and contracts. Prior to 4th quarter 2003, the Companyreported revenues earned by wireless applications and contracts and cost of revenues for wireless applications and contracts net ofcertain third-party costs in the statement of operations. These transactions have been reclassified to reflect a gross revenuepresentation with no effect on gross profit or net loss. The amount by which revenues and costs of revenues have been reclassifiedfor the three and six-month periods ended June 30, 2003, is $115,679 and $214,894, respectively.

Wireless applications and contracts

Commencing during the second quarter of 2002, our resourceswere dedicated to the development of solutions for the mobile and wireless markets. Revenues earned from wireless applications arerecognized upon delivery and acceptance by the end-user either as a one-time purchase or a monthly subscription. For contentdelivery partner arrangements, whereby the Company remits a portion of the revenues earned through the sale of the Company’sapplications, revenue is recorded on a gross basis in accordance with EITF 99-19. The Company recognizes the cost of payments tothe 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 regardlessof the revenue generated by the related applications.

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

Wireless License Fees

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

12
Table of Contents

**2.** **Summary of Significant Accounting Policies (continued)**

There were no costs related to the wireless license feerevenue generated during the six months ended June 30, 2004, as the license fee revenue related to technology that had beenpreviously developed by the Company, and there were no costs for installation, delivery or customization, or other relatedcosts.

Contracts and license fees

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

*Segments*

Management has structured the Company's internal organizationas 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 iscomputed 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.

*Software Development Costs*

Capitalization of softwaredevelopment costs begins with the establishment of technological feasibility of new or enhanced software products. Technologicalfeasibility of a computer software product is established when the Company has completed all planning, designing, coding andtesting that is necessary to establish that the software product can be produced to meet design specifications including functions,features and technical performance requirements. All costs incurred prior to establishing technological feasibility of a softwareproduct are charged to research and development expense as incurred. No  software development costs werecapitalized duringthe three and six-month periods ended June 30, 2004 and 2003.

Upon capitalization of softwaredevelopment costs, the Company will amortize capitalized software development costs on a product-by-product basis at the greater ofthe amount computed using (a) the ratio of current gross revenues for a product to the total of current and anticipated futuregross revenues or (b) the straight-line method over the estimated remaining economic life of the products, generally three years.Amortization begins when the product is available for general release to customers.

13
Table of Contents

**2.** **Summary of Significant Accounting Policies (continued)**

*Income Taxes*

Income taxes are accounted for using the liability method inaccordance 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 ofassets and liabilities using the enacted marginal tax rate applicable when the related asset or liability is expected to berealized or settled. Deferred income tax expenses or benefits are based on the changes in the asset or liability from period toperiod. If available evidence suggests that it is more likely than not that some portion or all of the deferred tax assets will notbe realized, a valuation allowance is required to reduce the deferred tax assets to the amount that is more likely than not to berealized. Future changes in such valuation allowance would be included in the provision for deferred income taxes in the period ofchange.

S*tock-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 thoseplans with an exercise price equal to the market value of the stock on the date of grant, no compensation cost is recognized in netoperations as reported in the consolidated statement of operations. Compensation cost is recognized in net earnings/loss for awardsgranted 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 offully-vested stock options with exercise prices below the fair market value of the underlying stock plus the amortization ofdeferred compensation arising from stock option issuances subject to vesting totaling $53,702 and $88,294 for the six months endedJune 30, 2004 and 2003, respectively, and $6,666 and $44,148 for the three months ended June 30, 2004 and 2003, respectively.

The following table illustrates the effect on net loss andnet loss per share if the Company had applied the fair value recognition provision of Statement of Financial Accounting StandardsNo. 123, *Accounting for Stock-Based Compensation (“SFAS 123”).* In accordance with SFAS 123, the fair value ofeach option grant was determined by using the Black-Scholes option pricing model with the following weighted average assumptionsfor the three and six-month periods ended June 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 Boardmembers.

14
Table of Contents

**2.** **Summary of Significant Accounting Policies (continued)**

**Three-Month Period EndedJune 30**

**Six-Month Period EndedJune 30**

**2004**

**2003**

**2004**

**2003**
 
**(Unaudited)**

**(Unaudited)**

Net loss applicable to common     shareholders

$   (835,450)

$   (854,314)

$  (2,326,008)

$  (1,614,396)

Non-cash compensation charges     included in net loss applicable to     common shareholders

6,666 

44,148 

53,702 

88,294 

Stock-based compensation cost that     would have been included in net     loss applicable to common     shareholders under the fair value     method

(333,291)

(91,373)

(691,319)

(170,438)

Adjusted net loss applicable to     common shareholders

$   (1,162,075)

$   (901,539)

$   (2,963,625)

$   (1,696,540)

Basic and diluted loss per share:

Reported net loss applicable to     common shareholders

$        (0.01)

$        (0.01)

$         (0.03)

$         (0.03)

Non-cash compensation charges     included in net loss applicable to     common shareholders

0.00 

0.00 

0.00 

0.00 

Stock-based employee     compensation cost that would     have been included in net loss     applicable to common     shareholders under thefair value     method

(0.00)

(0.00)

(0.01)

(0.00)

Adjusted net loss applicable to     common shareholders

$        (0.01)

$        (0.01)

$         (0.04)

$         (0.03)

The Company accounts for stock-based compensation tonon-employees of the Company, primarily consultants and advisors, at the fair value of the equity instrument in accordance with theprovisions of SFAS No. 123.  Non-cash consulting expense related to such stock based compensation was $29,017 and $94,706 forthe six-month periods ended June 30, 2004 and 2003, respectively, and $22,673 and $36,470 for the three-month periods ended June30, 2004 and 2003, respectively.

*Net Loss Per Share*

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

15
Table of Contents

**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 variableinterest entities as defined in the Interpretation. The Interpretation applies immediately to variable interests in variableinterest entities created after January 31, 2003.  The Interpretationbecomes effective for entities created before February 1, 2003,  at thebeginning 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 intosenior convertible debt agreements with certain investors to provide up to $2,000,000of financing in the form of convertible notes payable (the "Notes"). TheNotes do not bear interest and are convertible into shares of the Company’scommon stock at the option of the holder. The Notes mature three years from the date of issuance. Once theNotes mature, the Company has the sole right to pay off the debt or requireconversion by the holders of any unconverted portion thereof into shares of theCompany’s common stock.  At the closing of the seniorconvertible debt agreements, each investor received 7,143 shares of the Company’s commonstock for each $1,000 invested, for a total of 14,286,000 shares of theCompany’s common stock. Upon the conversion of each $1,000 of senior convertibledebt, the holder shall receive an additional 14,286 shares of the Company’scommon stock. 

Upon closing, the Company received$1,000,000 in cash and the remaining $1,000,000 of  proceeds received  havebeen placed in an escrow account with American Stock Transfer Company (the “Escrow Agent”). The Company shall not haveaccess to this escrowed amount until it has achieved positive EBITDA, asdefined,  on a monthly basis. When the Company achieves this milestone,the escrowed funds may be delivered to the Company upon the receipt by the Escrow Agent of a certificate from an officer of theCompany that such financial milestone has been achieved. The Company is not required to access these funds. If the Company has notachieved positive EBITDA, as defined, by March 31, 2005 and had the escrowed funds released to it, the Escrow Agent shall release the escrowedamounts to the holders of the Notes on a pro rata basis. If the escrowed amount is not released by the EscrowAgent to the Company, the escrowed amount shall have no conversion rights into the Company’s common stock as set forthabove.

The Company allocated the $1,000,000of proceeds received in connection with the financing in May 2004 between the Notes and the14,286,000 shares of common stock issued on a relative fair value basis. Accordingly, the Company allocated $500,000 to the Notes and $500,000 to thecommon stock issued.  Since the Notes were issued at a discount to the principal balance, which is thebasis for conversion, the effective conversion price of the Notes was less thanthe fair value of the Company's common stock on the date of issuance. Accordingly, a beneficial conversion feature of $500,000 was recorded as adiscount to the Notes and a corresponding credit to additional paid-in capitalon the date of issuance. Since the Notes have a term of three years, theaggregate discount of $1,000,000 will be amortized to interest expense over athirty-six month period commencing on the date of issuance.  Amortizationof the discount of the Notes for the three months ended June 30, 2004 was$42,557.

16
Table of Contents

**4.** **Common Stock,Options and Warrants**

***Issuance of Common Stock for Services***

During  the three months ended June 30, 2004, the Company entered into a marketing  agreement under which the Company issued 300,000 shares of restricted common  stock valued at $54,000 for marketing services, which has been reflectedwithin selling, general and administrative expenses in the accompanyingstatement of operations.  The agreement also provides  for future issuances of shares of common stock and cash payments for marketing  services based on the achievement of download milestones of a specific wireless application.

***Equity Compensation Plan***

On June 24, 2004, the Board ofDirectors authorized an increase in the number of options available for grantunder the Corporation’s Second Amended and Restated 2000 Equity CompensationPlan from 8,500,000 to 15,000,000 to be used as incentives to all employees,management and the Board of Directors.

***Common Stock Reserved for Future Issuance***

As of June 30, 2004, the Company hadreserved shares of its authorized 185,000,000 shares of common stock for futureissuance as follows:

 

 

 

Series A convertible preferred stock and related dividends 

 

167,084

Series C convertible preferred stock

 

240,000

Series D convertible preferred stock

 

12,625,000

Outstanding common stock warrants

 

44,647,550

Outstanding stock options

 

6,965,725

Possible future issuance under stock option plans

 

6,669,431
Convertible notes payable

14,286,000

Total

 

86,600,790

**5.** **Preferred Stock**

***Series A Convertible Preferred Stock***

The Company has 2,078 shares of SeriesA convertible preferred stock (“Series A preferred stock”) outstanding as ofJune 30, 2004. These shares are valued based upon the liquidation preference(the “Liquidation Preference”) of Series A preferred stock of $1,000 per share.

The holders of the Series A preferredstock are entitled to receive cumulative cash dividends at a rate of 8% perannum of the initial liquidation preference of $1,000 per share. These dividendsare accrued monthly. The Company, at its election, can provide for the paymentof dividends on the Series A preferred stock through the issuance of additionalshares of Series A preferred stock having an aggregate initial liquidationpreference equal to the amount of cash dividends otherwise payable. Dividendsare cumulative from the date of issuance and are payable, when, as and ifdeclared 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 dividendsare paid on Series A preferred in full. The Company recorded preferred stockdividends of $41,565 and $83,130 for the three and six months ended June 30,2004, respectively.  As of June 30, 2004, the Company had recorded$301,273 in accrued dividends, which is reflected in current liabilities in theaccompanying consolidated balance sheet.

The holders of the outstanding sharesof Series A preferred stock are not entitled to vote on matters submitted to theCompany’s shareholders for voting. However, approval of holders of a majority ofthe outstanding shares of Series A preferred stock is required prior to theissuance of a new series of preferred stock that ranks senior to the Series Apreferred stock. Each share of the Series A preferred stock is convertible atthe option of the holder, at any time after the date of issuance, into shares ofcommon stock equal to the Liquidation Preference divided by the initialconversion price of $14.24. The conversion price is subject to adjustment inaccordance with the Company’s articles of incorporation.  At the Company’selection, it has the right to redeem any outstanding shares of the Series Apreferred stock at the Liquidation Preference of $1,000 per share.

17***Table of Contents***
**5.** **Preferred Stock (continued)**

***Series C Convertible Preferred Stock***

In June 2003, the Company amended itsarticles 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 tothe 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 convertiblepreferred 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 dividendswith respect to the Series C preferred stock, of $1,000 per share payable in the event of any liquidation, dissolution or windingup of Summus, Inc.; 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 theSeries C preferred stockholder, after nine (9) months from the date of its issuance. Each share of Series C preferred stock shallbe convertible into 4,000 fully paid and non assessable shares of the Company’s common stock.

During the three and six month periods endedJune 30, 2004, certain holders of the Series C preferred stock converted 1,250 shares ofSeries C preferred stock into 5,000,000 shares of the Company’s unregisteredcommon stock.

***Series D Convertible Preferred Stock***

In September 2003, the Company amendedits articles of incorporation to establish its Series D convertible preferredstock (“Series D preferred stock”). The newly established Series D preferredstock has an issue price of $1,000 per share and has the following rights andprivileges:
- no voting rights except with respect to (i) the amendment or alteration of the statement of rights and preferences applicable tothe 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 stockas 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 dividendswith respect to the Series D preferred stock, of $1,000 per share payable in the event of any liquidation, dissolution or windingup 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 theSeries D preferred stockholder. Each share of Series D preferred stock shall be convertible into 5,000 fully paid and nonassessableshares of the Company’s common stock.

18**Table of Contents**
**5.** **Preferred Stock (continued)**

***Series E Convertible Preferred Stock***

In November 2003, the Company amendedits articles of incorporation to establish its Series E convertible preferredstock (“Series E preferred stock”). The Series E preferred stock has an issueprice 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 tothe 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 stockas 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 dividendswith respect to the Series E preferred stock, of $1,000 per share payable in the event of any liquidation, dissolution or windingup of Summus, Inc.; 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 theSeries E preferred stockholder. Each share of Series E preferred stock shall be convertible into 5,000 fully paid and nonassessableshares of the Company’s common stock.

All shares of Series E preferred stockhave been converted into shares of the Company’s unregistered common stock.

The accounting treatment for the Series C, D and E preferredstock (the “Preferred Stock”) involved allocating the value of the principal amount received from the Preferred Stockofferings between the Preferred Stock, the associated warrants and a beneficial conversion feature (“BCF”) associatedwith the Preferred Stock. A BCF existed because the effective conversion rate of the Preferred Stock was below the traded value ofthe Company’s common stock on the date the Preferred Stock was issued. The BCF for the Preferred Stock totaling $3,579,695was recorded as a discount to the Preferred Stock and additional paid-in capital on the date the Preferred Stock was issued. Sincethe Series C preferred stock becomes convertible at any time after nine months from its issuance, the value of its BCF totaling$659,010 will be amortized to retained deficit over a nine-month period commencing with its issuance. Amortization of the Series Cpreferred stock BCF for the three months ended June 30, 2004 was $84,922. Since the Series D and E preferred stock was convertibleimmediately, the value of its beneficial conversion feature totaling $2,920,685 was fully amortized to retained deficit on the dateof issuance.

**6.** **Commitments and Contingencies**

***Dr. Bjorn Jawerth’s Employment Agreement***

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

The difference between the increasedsalary amounts of $423,500 and $385,000, respectively, in the second and third years of his employment agreement, and his theoriginal base salary of $350,000 was deferred and accrued by the Company, at Dr. Jawerth’s election, until the Board ofDirectors and Dr. Jawerth determine when and how these deferred and accrued amounts may be paid. These amounts have been recordedas accrued salaries in the Company’s balance sheet as of June 30, 2004.

19
Table of Contents

 **6.** **Commitments and Contingencies (continued)**

Under the terms of the recapitalization transaction, Summus, Inc. agreed to use reasonable commercial efforts to assist Dr.Jawerth in the private sale of up to 1,666,667 shares of Summus, Inc. common stock held by Dr. Jawerth at a per share price of notless than $1.50 per share (representing $2.5 million in value). Under the terms of Dr. Jawerth's employment agreement, the Companywas obligated to issue to Dr. Jawerth options, with an exercise price of $1.50 per share, exercisable for three times the number ofshares of common stock sold in the private sale as described above. No shares subject to this agreement have been sold. The Companybelieves it has no further obligations regarding this sale of shares.

Pursuant to the terms of his employment agreement and inaccordance with corporate policy, all intellectual property developed by Dr. Jawerth in connection with his employment by theCompany 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 InventionsAward Plan) that was developed during the twelve months following the closing of the recapitalization transaction. Pursuant to theterms of Dr. Jawerth’s employment agreement, the Company terminated Dr. Jawerth’s license on February 4, 2004.

***Cancellation of warrants***

On July 19, 2002, the Company enteredinto an irrevocable common stock equity line that was intended to providefunding to the Company in amounts up to $10.0 million. The Company filed aregistration 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 andrelated communications with the SEC, the Company understood that the terms ofthe equity line financing arrangement were such that it would not be able toresolve the staff’s comments in a timely manner and seek effectiveness of theregistration statement in a timely manner. Due to these developments, the lengthof time involved in completing the transaction, and other factors, the Companydetermined that it was in its best interest to withdraw the registrationstatement and not proceed with the equity line. Accordingly, on September 17,2002, the Company submitted to the SEC a request to withdraw the registrationstatement and cancelled all agreements associated with the common stock equityline. In connection with the cancellation of the agreements associated with thecommon stock equity line, Talisman, the intended purchaser under the equityline, indicated to the Company its intention to retain ownership of the warrantsto purchase 500,000 shares of the Company’s unregistered common stock at anexercise price of $0.47 per share that were issued to Talisman upon theexecution of the equity line agreements. It is management’s position, with theadvice of legal counsel, that the cancellation of these warrants becameeffective with the cancellation of the equity line agreements and that no losscontingency exists. Therefore, the Company has not recorded the issuance ofthese 500,000 warrants in its consolidated financial statements nor disclosedthem as part of outstanding warrants. The Company has sent correspondence toTalisman stating its position that the warrants have been cancelled. To date,the Company has not received correspondence back from Talisman indicating theirconcurrence.

***Inventions Awards Plan***

The Company established the InventionsAwards Plan (“the Plan”), effective October 30, 2000, to provide incentives tocertain eligible employees by providing them with opportunities to receiveadditional compensation as a result of their development of enhancements or newmethods that generate revenue for the Company.

Under the terms of the plan, theCompany is obligated to reserve 5% of the gross revenues derived from thelicensing or sale of “New Technology”, as defined in the agreement, fordistribution among eligible employees. If the Company sells the rights to NewTechnology, eligible employees shall be entitled to an award of 10% of the grossproceeds.

20
Table of Contents

 **6.** **Commitments and Contingencies (continued)**

In addition, the Company may, at itsoption, initiate a spin-off company to develop New Technology. If the eligibleemployee accepts a position in the spin-off company, his or her rights to awardsunder the plan are to be surrendered for 25% of the founders’ equity in thespin-off company.

Dr. Jawerth sent correspondence to the Company on February17, 2004, seeking payment for certain inventions under the Plan. Management and the Board of Directors of the Company haveevaluated these assertions and determined that no amounts are due Dr. Jawerth or other employees under the provisions of the Plan.In addition, the Board of Directors terminated the Plan effective March 10, 2004. If litigation is pursued by Dr. Jawerth for anypayments under the Plan and he is successful in such litigation, there may be a material adverse impact to the Company.

**7.** **Outstanding Litigation**

***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 ofNew York, claiming that it is entitled payment in the amount of $276,374, plus accrued interest, for past services rendered to theCompany. The Company disputes the total amount Bowne claims the Company owes. The Company has recorded a liability of $276,374relating to this claim as of June 30, 2004 and 2003. The Company is in the process of attempting to negotiate a settlement to thisclaim.

 

 

 

 

 

21
Table of Contents

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

***Forward-Looking Statements***

This Form 10-Q contains certainforward-looking statements that we believe are within the meaning of Section 27Aof the Securities Act of 1933 and Section 21E of the Securities Exchange Act of1934, 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 maybe deemed to be forward-looking statements, including the statements under"Management's Discussion and Analysis of Financial Condition and Results ofOperations" regarding our strategy, future operations, future expectations orfuture estimates, financial position and objectives of management. Thosestatements in this Form 10-Q containing the words "believes," "anticipates,""plans," "expects" and similar expressions constitute forward-lookingstatements, although not all forward-looking statements contain such identifyingwords. These forward-looking statements are based on our current expectationsand are subject to a number of risks, uncertainties and assumptions relating toour operations, results of operations, competitive factors, shifts in marketdemand and other risks and uncertainties. The most important factors that couldprevent us from achieving our stated goals include, but are not limited to, thefollowing:
- a lack of sufficient financial resources to implement the Company's business plan, which has resulted in the Company's receivinga "going concern" opinion from its independent auditors with respect to its audited financial statements as of and for the yearended 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 oursoftware 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 theassumptions underlying our forward-looking statements are reasonable, any of theassumptions could be inaccurate and actual results may differ from thoseindicated by the forward-looking statements included in this Form 10-Q. In lightof the significant uncertainties inherent in the forward-looking statementsincluded in this Form 10-Q, you should not consider the inclusion of suchinformation as a representation by us or anyone else that we will achieve suchresults. Moreover, we assume no obligation to update these forward-lookingstatements to reflect actual results, changes in assumptions or changes in otherfactors affecting such forward-looking statements.

**Change in Revenue Recognition Policy**

After a careful review of the Company’s revenuerecognition policies and giving consideration to guidance provided for in Emerging Issues Task Force No. 99-19 *Reporting RevenueGross as a Principal versus Net as an Agent* (“EITF 99-19”), the Company has changed certain revenue recognitionpolicies affecting revenues earned by wireless applications and contracts. Prior to 4th quarterof 2003, the Companyreported revenues earned by wireless applications and contracts and cost of revenues for wireless applications and contracts net ofcertain third-party costs in the statement of operations. These transactions have been reclassified to reflect a gross revenuepresentation with no effect on gross profit or net loss. The amount by which revenues and costs of revenues have been reclassifiedfor the three and six-month periods ended June 30, 2003 is $115,679 and $214,894, respectively.

22
Table of Contents

**Overview**

 Summus was founded in 1984.  Summus is primarily engaged in the development of applications that optimize theconsumer wireless experience.  The core of the Company's business plan is to focus on the emerging wireless and mobile marketand partner with leading content brands to bring branded products to mobile phones.  Summus has developed software, technologyand 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, news/information and entertainment.  The Company's technology, whichprovides the foundation for its current services, is designed to address the usability constraints of the existing wireless networkinfrastructure. This technology will enable more efficient use of existing and future bandwidth allocations, resulting in aperceived bandwidth increase by the mobile end-user. One of our main objectives is to create a superior mobile end-user experience,which will impact devices, wireless carrier infrastructure and mobile applications.

Summus builds products for all major mobile platforms, including QUALCOMM’s Binary Runtime Environment for WirelessTM(BREWTM), JavaTM 2 Platform, Micro Edition (J2METM), Symbian OS and WAP.  We distribute our applicationsthrough major wireless carriers who make our products available totheir customers. Summus currently has relationships with carriers that account for 92% of all U.S. wireless subscribers. We alsohave relationships with international carriers covering Canada, Latin America, Australia, Israel and the U.K. 

  We have completed development of and  launched twenty-seven (27) wireless applications. Twelve (12) wireless carriersin the United States and ten (10) international wireless carriers currently deploy at least one or a combination of thetwenty-seven (27) wireless applications that have been completed by the Company.  Summus launched its first wirelessapplication during the second quarter of 2002.  These applications can be purchased by the end-user as a one-time purchase, ora monthly subscription, depending on content, product function, and/or carrier preferences.

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

To date, the Company has experiencedsignificant operating losses as we have made investments in research anddevelopment of our underlying technology and application development. We expectto continue to make investments in those areas; however, the Company is morefocused on the development and delivery of applications and the marketing ofthose applications to make substantial progress in revenue generation. We planto expand our market presence by partnering with additional wireless carriers aswell as increasing subscriber adoption of our applications. Our ability togenerate profits and positive cash flow from operations will depend primarily onincreasing revenues as well as implementing cost reduction measures.

23
Table of Contents

**Key Developments in 2004**

*Focus on Mobile and Wireless Market*

Summus is continuing to develop applications and informationprocessing tools that optimize the wireless multimedia experience. Our applications are developed to enable the evolution of mobileand wireless devices for dynamically interacting with information resources. Our vision is to enable mobile end-users to experiencean entirely new mobile environment, one that frees an individual from location and time dependence and opens new possibilities asto how mobile devices are used.

 Summus is focused on delivering compelling end-userapplications across multiple mobile operating systems for remote access to and processing of information via handhelddevices.  Our strategy incorporates the release and distribution of revenue-generating products, each building to theCompany’s vision.

*Relationships with Content Providers and New Application Development*

Summus continues to position itself as a supplier ofsolutions that can run on multiple wireless platforms supporting the mobile and wireless marketplace. Summus has developed, andcontinues to develop, wireless applications designed for efficient and easy interaction with information in the mobileenvironment.  Our technology supports applications and services on the BREWTM, JavaTM 2 Micro Edition (J2METM), SymbianTM OS, PocketPC, Palm OS and Wireless Application Protocol (WAP) wireless operating systems or platforms.

Our business development activitiescontinue to expand with major content brands, such as Sports Illustrated, TheAssociated Press, and Fuji Film. Through June 30, 2004, we have executedcontracts with a variety of content providers to build applications for the distribution of their content.  
Sponsorship Relationship with Phil Hellmuth for Texas Hold’em
In the second quarter of 2004, Summus signed an exclusive agreement with professional poker player Phil Hellmuth to brandSummus’ Texas Hold'em mobile game. Phil Hellmuth is a World Poker Champion with nine World Series of Poker(“WSOP”) wins and is the leader on the WSOP money list with over $3.5 million in earnings.  Summus is using Mr.Hellmuth's name to brand its multiplayer poker game that debuted in May 2004 on several carriers.

*Collaboration Agreement with Fujifilm USA*

In early 2004, Summus and Fujifilm expanded theirrelationship to develop a broad range of mobile imaging solutions that will enable consumers to capture, store, share and print allof their digital images in a suite of easy-to-use mobile applications. Summus will integrate Fujifilm's Get the Picture Onlineservice, an extensive print network that connects picture-takers to retail photofinishers, with mobile data services.  Thissolution will give consumers the option to choose a local retail location via their mobile devices and send their digital images tothe selected retailer for printing.  The application was launched on BREWTM, J2METM and WAP.

*Content Distribution Agreement with Sports Illustrated*

In early 2004, Summus also announced an exclusive agreementwith Sports Illustrated, in which Summus is the provider of mobile wallpaper and screen savers in the United States and Canadafeaturing content from the Sports Illustrated Swimsuit Collection. Summus also has a non-exclusive right to provide this mobilewallpaper and screen savers outside of the United States and Canada.  The application, Sports Illustrated Swimsuit 2004,debuted in March 2004 on several carriers and further carrier deployment is continuing.

24
Table of Contents

*Convertible Debt Funding*

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

Upon closing, the Company received$1,000,000 in cash and the remaining $1,000,000 of  proceeds received  havebeen placed in an escrow account with American Stock Transfer Company (the “Escrow Agent”). The Company shall not haveaccess to this escrowed amount until it has achieved positive EBITDA, asdefined,  on a monthly basis. When the Company achieves this milestone,the escrowed funds may be delivered to the Company upon the receipt by the Escrow Agent of a certificate from an officer of theCompany that such financial milestone has been achieved. The Company is not required to access these funds. If the Company has notachieved positive EBITDA, as defined, by March 31, 2005 and had the escrowed funds released to it, the Escrow Agent shall release the escrowedamounts to the holders of the Notes on a pro rata basis. If the escrowed amount is not released by the EscrowAgent to the Company, the escrowed amount shall have no conversion rights into the Company’s common stock as set forthabove.

The Company allocated the $1,000,000of proceeds received in connection with the financing in May 2004 between the Notes and the14,286,000 shares of common stock issued on a relative fair value basis. Accordingly, the Company allocated $500,000 to the Notes and $500,00 to thecommon stock issued.  Since the Notes were issued at a discount to theprincipal balance, which is the basis for conversion, the effective conversionprice of the Notes was less than the fair value of the Company's common stock onthe date of issuance.  Accordingly, a beneficial conversion feature of$500,000 was recorded as a discount to the Notes and a corresponding credit toadditional paid-in capital on the date of issuance. Since the Notes have a termof three years, the aggregate discount of $1,000,000 will be amortized tointerest expense over a thirty-six month period commencing on the date ofissuance.  Amortization of the discount of the Notes for the three monthsended June 30, 2004 was $42,557.

 
 
 
 
25
Table of Contents

**Results of Operations**

**Three-Month Period Ended June 30, 2004 Compared to Three-Month Period Ended June 30, 2003**

*Revenues*

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Three Months Ended June 30**

 

 

 

 

**% of Total**

 

 

 

 

**% of Total**

 

 

 

 

 

 

 

 

**2004** 

 

**Revenues**

 

 

**2003** 

 

**Revenues**

 

 

**$ Change** 

 

**% Change**

 

  

Revenues by category: 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 Wireless applications and 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   contracts 

 

$ 1,208,880 

 

100.0

%

 

$ 332,989 

 

57.4 

%

 

$ 875,891 

 

263.0 

%

 Contracts and license fees 

 

- 

 

- 

 

 

- 

 

- 

 

 

- 

 

- 

 

 Wireless license fees 

 

- 

 

- 

 

 

247,201 

 

42.6

 

 

(247,201)

 

(100.0)

 

Total revenues 

 

$ 1,208,880 

 

100.0

%

 

$ 580,190 

 

100.0

%

 

$ 628,690 

 

108.4 

%

*Wireless Applications and Contracts.* Revenue fromwireless applications and contracts increased $875,891 to $1,208,880 in the three-month period ended June 30, 2004, up 263.0% from$332,989 in the three-month period ended June 30, 2003. The increase in revenue from wireless applications and contracts resultedfrom 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 Collectionwallpaper and screen saver application in March 2004 and launched its multi-player Texas Hold’em game application in May2004. 

Revenue earned from wirelessapplications is recognized upon delivery and acceptance by the end-user eitheras a one-time purchase or a monthly subscription.

*Wireless License Fees.* During the three-month periodended June 30, 2004, the Company did not generate any revenue from wirelesslicense fees.  During the second half of 2003, the Company changed itsfocus from the commercial licensing of its technology to developing wirelessapplications. Revenue earned from wireless license fees totaled $247,201 in the three-month period ended June 30,2003. During this period, the Company had sold and delivered existing image software for use in wireless transmissionapplications.

26**
Table of Contents

*Costs of Revenues*

 

**Three Months Ended June 30**

 

**  2004**

** **

**  2003**

** **

** $ Change**

** **

**% Change**

 

Cost of revenues by category

 

 

 

 

 

 

 

 

 

 

 

 

   Wireless applications and contracts

$

627,431

 

$

228,419

 

$

399,012

 

 

174.7

%

   Contracts and license fees

 

-

 

 

-

 

 

-

 

 

-

 

   Wireless license fees

 

-

 

 

-

 

 

-

 

 

-

 

Total cost of revenues

$

627,431

 

$

228,419

 

$

399,012

 

 

174.7

%

*Wireless Applications and Contracts.* Costs of wirelessapplications and contracts increased $399,012 to $627,431 in the three-month period ended June 30, 2004, up 174.7% from $228,419 inthe three-month period ended June 30, 2003. The increase in costs of wireless applications and contracts resulted from the increasein sales of existing wireless applications and additional wireless applications developed by the Company, launched by severalwireless carriers and purchased by end-users. These costs are direct costs associated with the sale and delivery of wirelessapplications and primarily consist of third-party hosting fees, carrier distribution and fees associated with content informationprovided by our content providers for wireless applications which were deployed during the three-month period ended June 30, 2004.The costs related to third-party hosting and carrier distribution are incurred on a monthly basis and are primarily fixed in natureregardless of the revenue generated by the related applications.

*Wireless License Fees.* There was no revenue fromwireless license fees during the three-month period ended June 30, 2004; therefore the Company did not record any costs ofrevenues.  During the second half of 2003, the Company changed its focusfrom the commercial licensing of its technology to developing wirelessapplications.  There were no costs of revenues regarding wireless license fees during the three-month period ended June 30, 2003,since the license fee agreements consummated during this period related to technology that had been previously developed by theCompany.

*Gross Profit*

 

 

**Three Months Ended June 30**

 

 

**2004**

 

**2003**

 

**$ Change**

 

**% Change**

 

Gross profit by category: 

 

 

     

 

     

 

     

 

 

   Wireless applications and contracts 

 

$

581,449

 

$

104,570

 

$

476,879 

 

456.0 

%

   Contracts and license fees 

 

 

-   

 

  -   

 

-   

 

-  

 

   Wireless license fees 

 

 

-   

 

   247,201

 

(247,201)

 

(100.0)

 

Total gross profit

 

$

581,449

 

$

351,771

 

$

229,678 

 

65.3 

%

*Wireless Applications and Contracts.* Gross profitresulting from the development and deployment of wireless applications increased $476,879 to $581,449 for the three-month periodended June 30, 2004, an increase of 456.0% over the gross profit for the three-month period ended June 30, 2003 of $104,570. The increase in gross profit resulting from these activities corresponds with the increase in revenues from wireless applicationsand contracts.  The costs for these revenues include costs that are primarily fixed in nature, consisting mostly ofthird-party hosting fees and content information provided by certain of our content providers, and costs that are primarilyvariable in nature, consisting mostly of third-party content information.

*Wireless License Fees.* During the three-month periodended June 30, 2004, the Company did not generate any revenue, costs of revenue or gross profit related to wireless licensefees.   During the second half of 2003, the Company changed its focusfrom the commercial licensing of its technology to developing wirelessapplications.  Gross profit resulting from wireless license fees totaled $247,201 for the three-month period ended June 30,2003.  The Company did not incur any specific direct costs associated with the sale, delivery, or installation of the softwareunderlying the license agreements consummated during the period.  Additionally, the Company does not expect to incur anyfuture obligations relating to these license fees. 

27**
Table of Contents

*Selling, General and Administrative Expenses*

 

 

**Three Months Ended June 30**

 

 

**2004** 

 

**2003** 

 

**$ Change**

 

**% Change**

 

Selling, General and administrative

 

$752,078

 

  $1,134,532

 

 $(382,454)

 

 (33.7)

%

Selling, general and administrativeexpenses consist primarily of salaries, consulting fees, office operations,administrative and general management activities, including legal, accountingand other professional fees. Selling, general and administrative expenses forthe three-month period ended June 30, 2004 were $752,078, compared to $1,134,532for three-month period ended June 30, 2003. The decrease in selling, general andadministrative expenses during the current period as compared to the priorperiod reflect a reduction in several expense categories, namely salaries,third-party consulting fees, travel and general office administration costs. Thereductions in these categories reflect continued cost reduction effortsimplemented by management.

*Non-Cash Compensation Expenses*

 

 

**Three Months Ended June 30**

 

 

**2004** 

 

**2003** 

 

**$ Change**

 

**% Change**

 

Non-cash compensation

 

  $6,666

 

  $44,148

 

  $(37,482)

  

 (84.9)

%

Non-cash compensation for thethree-month period ended June 30, 2004 was $6,666 compared to $44,148 for thethree-month period ended June 30, 2003. Non-cash compensation for each of thethree-month periods reflects the amortization for three months of deferredcompensation resulting from stock options granted in prior years, at pricesbelow the fair value of the underlying common stock. The decrease in the amountrecorded in the current period as compared to the prior period reflects thatprior years’ deferred compensation was fully amortized in the three-month periodended June 30, 2004.

Res*earch and Development Expenses*

 

 

**Three Months Ended June 30**

 

 

**2004** 

 

**2003** 

 

**$ Change**

 

**% Change**

 

Research and development

 

$453,097

 

  $263,631

 

 $189,466

 

 71.9

%

Research and development expenses forthe three-month period ended June 30, 2004, were $453,097 compared to $263,631for the three-month period ended June 30, 2003. The increase in research anddevelopment expenses is a result of the increased number of wirelessapplications the Company has in development.  The Company is focusing itsresources on the development of new products for rapid deployment.

28**
Table of Contents

*Non-Cash Consulting Expenses*

 

 

**Three Months Ended June 30**

 

 

**2004** 

 

**2003** 

 

**$ Change**

 

**% Change**

 

Non-cash consulting expense

 

  $22,673

 

  $36,470

 

$(13,797)

  

(37.8)

%

Non-cash consulting expense for the three-month period endedJune 30, 2004, in the amount of $22,673 is attributable to 90,000 stock options and 54,034 stock warrants granted to consultantsfor services, valued using the Black-Scholes option-pricing model.

Non-cash consulting expense for the three-month period endedJune 30, 2003 in the amount of $36,470 is attributable to: (1) the issuance of 81,869 shares of restricted common stock issued toconsultants for services valued at $27,835; (2) 18,600 stock options granted to consultants for services valued at $6,572, suchvalue was determined by using the Black-Scholes option-pricing model; and (3) $2,063, representing the fair value, as determinedusing the Black-Scholes option-pricing model, of the vested portion of 33,333 options granted to a member on the Company’sadvisory board.

*Non-cash Settlements*

 

 

**Three Months Ended June 30**

 

 

**2004**

 

**2003** 

 

**$ Change**

 

**% Change**

 

Non-cash settlements

 

 $     -     

 

  $(333,950) 

 

 $333,950  

  

100%

The Company did not enter into anylegal settlements during the three-month period ended June 30, 2004.

Non-cash settlements totaling$333,950, resulted from the settlement of unpaid amounts from two of theCompany’s creditors during the three-month period ended June 30, 2003. 
- The first non-cash settlement was in connection with a settlement of a civil law suit by Holland & Knight LLP(“H&K”), a creditor of the Company, seeking payment for prior legal services provided to the Company valued at$867,268.  The aggregate settlement gain resulting from this transaction totaled $351,047. 
- On June 5, 2003, the Company signed and executed an agreement pertaining to the payment of amounts owed to a current serviceprovider.  The aggregate settlement loss resulting from this transaction totaled $17,097. 

*Interest Expense*

 

 

**Three Months Ended June 30**

 

 

**2004** 

 

**2003** 

 

**$ Change**

 

**% Change**

 

Interest

 

$55,898  

 

  $14,222    

 

 $41,676  

 

 23.0%

Interest expense for the three-monthperiod ended June 30, 2004, was $55,898, compared to interest expense of $14,222for the three-month period ended June 30, 2003. Interest expense for each of thethree-month periods includes interest expense related to interest costsassociated with capital lease obligations and note payable agreements. Inaddition, interest expense for the three-month period ended June 30, 2004includes $42,557 of interest expense related to amortization of the discounts onthe convertible notes payable entered into in May 2004.

29**
Table of Contents

*Net Loss*

 

 

**Three Months Ended June 30**

 

 

**2004** 

 

**2003** 

 

**$ Change**

 

**% Change**

 

Net loss

 

$708,963

 

  $807,282

 

 $98,319

  

12.2%

As a result of the factors discussedabove, the net losses for the three-month period ended June 30, 2004 and 2003were $708,963 and $807,282, respectively.

**Six-Month Period Ended June 30, 2004 Compared to Six-Month Period Ended June 30, 2003**

*Revenues*

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Six Months Ended June 30**

 

 

 

 

**% of Total**

 

 

 

 

**% of Total**

 

 

 

 

 

 

 

 

**2004** 

 

**Revenues**

 

 

**2003** 

 

**Revenues**

 

 

**$ Change** 

 

**% Change**

 

  

Revenues by category: 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 Wireless applications and 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   contracts 

 

$ 1,982,210 

 

99.3

%

 

$ 562,424 

 

69.5 

%

 

$ 1,419,786 

 

252.4 

%

 Contracts and license fees 

 

13,889 

 

0.7 

 

 

- 

 

- 

 

 

13,889 

 

- 

 

 Wireless license fees 

 

750 

 

0.0 

 

 

247,201 

 

30.5

 

 

(246,451)

 

(99.7)

 

Total revenues 

 

$ 1,996,849 

 

100.0

%

 

$ 809,625 

 

100.0

%

 

$ 1,187,224 

 

146.6 

%

*Wireless Applications and Contracts. *Revenue from wireless applications and contracts increased $1,419,786 to$1,982,210 in the six-month period ended June 30, 2004, up 252.4% from $562,424in the six-month period ended June 30, 2003. The increase in revenue fromwireless applications and contracts resulted from the increase in sales ofexisting wireless applications and additional wireless applications developed bythe Company, launched by several wireless carriers and purchased by end-users.The Company launched its Sports Illustrated Swimsuit Collection wallpaper andscreen saver application in March 2004 and launched its multi-player TexasHold’em game application in May 2004.

Revenue earned from wirelessapplications is recognized upon delivery and acceptance by the end-user eitheras a one-time purchase or a monthly subscription.

*Contracts and License Fees.* Revenue from contracts andlicense fees was $13,889 in the six-month period ended June 30, 2004 and was generated from providing governmental contractservices.  This government contract commenced in 2003 and was completed in March 2004.  There was no revenue earned fromcontracts and license fees during the six-month period ended June 30, 2003.

*Wireless License Fees.* Revenue earned from wirelesslicense fees totaled $750 in the six-month period ended June 30, 2004.  Revenue earned from wireless license fees totaled$247,201 in the six-month period ended June 30, 2003.  During this period, the Company had sold and delivered existing imagesoftware for use in wireless transmission applications.  During the second half of 2003, the Company changed its focus fromthe commercial licensing of its technology to developing wireless applications.

30**
Table of Contents

*Costs of Revenues*

 

**Six Months Ended June 30**

 

**  2004**

** **

**  2003**

** **

** $ Change**

** **

**% Change**

 

Cost of revenues by category

 

 

 

 

 

 

 

 

 

 

 

 

   Wireless applications and contracts

$

1,023,768

 

$

443,013

 

$

580,755

 

 

131.1

%

   Contracts and license fees

 

3,199

 

 

-

 

 

3,199

 

 

-

 

   Wireless license fees

 

-

 

 

-

 

 

-

 

 

-

 

Total cost of revenues

$

1,026,967

 

$

443,013

 

$

583,954

 

 

131.8

%

*Wireless Applications and Contracts.* Costs of wirelessapplications and contracts increased $580,755 to $1,023,768 in the six-month period ended June 30, 2004, up 131.1% from $443,013 inthe six-month period ended June 30, 2003. The increase in costs of wireless applications and contracts resulted from the increasein sales of existing wireless applications and additional wireless applications developed by the Company, launched by severalwireless carriers and purchased by end-users.  These costs are direct costs associated with the sale and delivery of wirelessapplications and primarily consist of third-party hosting fees, carrier distribution and fees associated with content informationprovided by our content providers for wireless applications which were deployed during the six-month period ended June 30, 2004.The costs related to third-party hosting and carrier distribution are incurred on a monthly basis and are primarily fixed in natureregardless of the revenue generated by the related applications.

*Contracts and License Fees.* Costs of contracts andlicense fees were $3,199 in the six-month period ended June 30, 2004, and were incurred as part of providing services under agovernment contract that commenced in 2003 and was completed in March 2004.  Costs and of contracts and license fees consistedprimarily of salaries and other related costs of providing governmental contract services.  There was no revenue earned fromcontracts and license fees during the six-month period ended June 30, 2003.

*Wireless License Fees. * There were no costs of revenues regarding wireless license fees during the six-month periodsended June 30, 2004 and 2003, since the license fee agreements consummated during this period related to technology that had beenpreviously developed by the Company.

*Gross Profit*

 

 

**Six Months Ended June 30**

 

 

**2004**

 

**2003**

 

**$ Change**

 

**% Change**

 

Gross profit by category: 

 

 

 

 

 

 

 

 

 

   Wireless applications and contracts 

 

$  

958,442

 

$  

119,411

 

$  

839,031 

 

702.6 

%

   Contracts and license fees 

 

 

10,690

 

  -   

 

10,690  

 

-  

 

   Wireless license fees 

 

 

750

 

   247,201

 

(246,451)

 

(99.7)

 

Total gross profit

 

$  

969,882

 

$  

366,612

 

$

603,270 

 

164.6 

%

 *Wireless Applications and Contracts.* Gross profitresulting from the development and deployment of wireless applications increased $839,031 to $958,442 for the six-month periodended June 30, 2004, an increase of 702.6% over the gross profit for the six-month period ended June 30, 2003 of $119,411. The increase in gross profit resulting from these activities corresponds with the increase in revenues from wireless applicationsand contracts. The costs for these revenues include costs that are primarily fixed in nature, consisting mostly of third-partyhosting fees and content information provided by certain of our content providers, and costs that are primarily variable in nature,consisting mostly of third-party content information.

31**
Table of Contents

*Contracts and License Fees.* Gross profit resultingfrom government contract services during the six-month period ended June 30, 2004 totaled $10,690.  The gross profit fromthese services resulted from deducting primarily salaries and other related costs from the related earned revenue.  During thesix-month period ended June 30, 2003, the Company did not generate any revenue, costs of revenue or gross profit related tocontracts and license fees.

*Wireless License Fees.* During the six-month period ended June 30, 2004, the Company did not generate any revenue, costsof revenue or gross profit related to wireless license fees.  Gross profit resulting from wireless license fees totaled $750and $247,201 for the six-month periods ended June 30, 2004 and 2003, respectively.  The Company did not incur any specificdirect costs associated with the sale, delivery, or installation of the software underlying the license agreements consummatedduring the period.  During the second half of 2003, the Company changed its focus from the commercial licensing of itstechnology to developing wireless applications.  Additionally, the Company does not expect to incur any future obligationsrelating to these license fees. 

*Selling, general and Administrative Expenses*

 

 

**Six Months Ended June 30**

 

 

**2004** 

 

**2003** 

 

**$ Change**

 

**% Change**

 

Selling, General and administrative

 

$1,786,532

 

  $2,490,694

 

 $(704,162)

 

 (28.3)%

Selling, general and administrativeexpenses consist primarily of salaries, consulting fees, office operations,administrative and general management activities, including legal, accountingand other professional fees. Selling, general and administrative expenses forthe six-month period ended June 30, 2004 were $1,786,532, compared to $2,490,694for six-month period ended June 30, 2003.  The decrease in selling, generaland administrative expenses during the current period as compared to the priorperiod reflect a reduction in several expense categories, namely salaries,third-party consulting fees, travel and general office administration costs. Thereductions in these categories reflect continued cost reduction effortsimplemented by management.

*Non-Cash Compensation Expenses*

 

 

**Six Months Ended June 30**

 

 

**2004** 

 

**2003** 

 

**$ Change**

 

**% Change**

 

Non-cash compensation

 

  $53,702

 

  $88,294

 

  $(34,592)

  

 (39.2)%

                Non-cash compensation for the six-monthperiod ended June 30, 2004 was $53,702 compared to $88,294 for the six-month period ended June 30, 2003. Non-cash compensation foreach of the six-month periods reflects the amortization for six months of deferred compensation resulting from stock optionsgranted in prior years, at prices below the fair value of the underlying common stock. The decrease in the amount recorded in thecurrent period as compared to the prior period reflects that prior years’ deferred compensation was fully amortized in thesix-month period ended June 30, 2004.

32**
Table of Contents

*Research and Development Expenses*

 

 

**Six Months Ended June 30**

 

 

**2004** 

 

**2003** 

 

**$ Change**

 

**% Change**

 

Research and development

 

$973,319

 

  $528,971

 

 $444,348

 

 84.0%

Research and development expenses forthe six-month period ended June 30, 2004, were $973,319 compared to $528,971 forthe six-month period ended June 30, 2003. The increase in research anddevelopment expenses is a result of the increased number of wirelessapplications the Company has in development.  The Company is focusing itsresources on the development of new products for rapid deployment.

*Non-Cash Consulting Expenses*

 

 

**Six Months Ended June 30**

 

 

** 2004**
 

**2003** 

 

**$ Change**

 

**% Change**

 

Non-cash consulting expense

 

  $29,017

 

  $94,706

 

$(65,689)

  

(69.4)%

 Non-cash consulting expense for the six-month period endedJune 30, 2004, in the amount of $29,017 is attributable to 94,500 stock options and 98,048 stock warrants granted to consultantsfor services, valued using the Black-Scholes option-pricing model.

Non-cash consulting expense for the six-month period endedJune 30, 2003 in the amount of $94,706 is attributable to: (1) the issuance of 219,266 shares of restricted common stock issued toconsultants for services valued at $68,563; (2) 41,700 stock options granted to consultants for services valued at $9,080, suchvalue was determined by using the Black-Scholes option-pricing model; (3) $15,000 of amortization of a deferred expense recorded in2002 relating to the issuance of 55,555 shares of restricted common stock valued at $22,500, for consulting services to be renderedover a 4.5 month period;  and (4) $2,063, representing the fair value, as determined using the Black-Scholes option-pricingmodel, of the vested portion of 33,333 options granted to a member on the Company’s advisory board.

33**
Table of Contents

*Non-cash Settlements*

 

 

**Six Months Ended June 30**

 

 

**2004**

 

**2003** 

 

**$ Change**

 

**% Change**

 

Non-cash settlements

 

 $     -     

 

  $(1,339,290) 

 

 $1,339,290  

  

100%

The Company did not enter into anylegal settlements during the six-month period ended June 30, 2004.

Non-cash settlements totaling$1,339,290, resulted from the settlement of unpaid amounts from four of theCompany’s creditors during the six-month period ended June 30, 2003. 
- The first non-cash settlement was in connection with a settlement of a civil law suit by Holland & Knight LLP(“H&K”), a creditor of the Company, seeking payment for prior legal services provided to the Company valued at$867,268.  The aggregate settlement gain resulting from this transaction totaled $351,047. 
- On June 5, 2003, the Company signed and executed an agreement pertaining to the payment of amounts owed to a current serviceprovider.  The aggregate settlement loss resulting from this transaction totaled $17,097. 
- In February 2003, the Company signed and executed a mutual release of all claims with a former law firm that had provided legalservices to the Company.  Under the terms of the mutual release, all fees owed to the former law firm, totaling $886,557 werecancelled in full.
- In March 2003, the Company settled a claim filed against it by AT&T CORP. for payment of past services rendered to theCompany.  Under the terms of the settlement, all amounts owed by the Company to AT&T CORP. were reduced by $118,783 to$120,000.

*Interest Expense*

 

 

**Six Months Ended June 30**

 

 

**2004** 

 

**2003** 

 

**$ Change**

 

**% Change**

 

Interest

 

$76,746

 

  $24,441

 

 $52,305

 

 214.0%

Interest expense for the six-monthperiod ended June 30, 2004, was $76,746, compared to interest expense of $24,441for six-month period ended June 30, 2003.  Interest expense for each of thesix-month periods includes interest expense related to interest costs associatedwith capital lease obligations and note payable agreements.  In addition,interest expense for the six-month period ended June 30, 2004 includes $42,557of interest expense related to amortization of the discounts on the convertible notespayable entered into in May 2004.

*Net Loss*

 

 

**Six Months Ended June 30**

 

 

**2004** 

 

**2003** 

 

**$ Change**

 

**% Change**

 

Net loss

 

$1,949,434

 

  $1,521,204

 

 $428,230

  

28.2%

As a result of the factors discussedabove, the net losses for the six-month period ended June 30, 2004 and 2003 were$1,949,434 and $1,521,204, respectively.

34**
Table of Contents

**Liquidity and Capital Resources**

As of June 30, 2004 we had $748,356 ofcash on hand, negative working capital of $477,674, and approximately $2.3million in current liabilities.

 In May 2004, the Company entered into senior convertible debtagreements with certain investors that provides up to $2,000,000 in financingthrough the issuance of convertible notes payable (the "Notes"). These Notes do not bear interest and are convertible into shares of theCompany’s common stock.  These Notes mature three years from the date of issuance.  Upon closing of the Notes, the Company received $1,000,000 in cash and $1,000,000 of theproceeds received in this financing have been placed in an escrow account with American Stock Transfer Company (the “EscrowAgent”). The Company shall not have access to this escrowed amount until it has achieved positive EBITDA on a monthlybasis.  The Company is not required to access these funds. If the Company has not achieved positive EBITDA by March 31, 2005, the Escrow Agent shall release the escrowed amounts to the holders of the seniorconvertible debt on a pro rata basis.

We anticipate that the sale of ourdebt and equity securities will continue to represent the primary source of ourliquidity until we are able to generate positive cash flow from operations. Ifwe have to raise additional funding, we cannot guarantee that we will be able toraise the necessary capital or that, if we do so, it will be on favorable terms.We may have to sell equity at below market rates, and any future sales of ourcapital stock to finance our business plan will dilute our existingshareholders' ownership.  Our continuation as a going concern depends onour ability to generate sufficient cash flow to meet our obligations on a timelybasis, to obtain additional financing as may be required and ultimately toattain profitability. In light of our financial condition and operating losses,our auditors have included in their report on our audited consolidated financialstatements an explanatory paragraph which expresses substantial doubt about ourability to continue as a going concern.

Through the end of 2003, we hadentered into settlement agreements or arrangements with several of our vendorsunder which such vendors have agreed to our payment of less than the amountsdue, the extension of payment terms by between 9-36 months and/or thesatisfaction of the amounts due through a combination of cash and stock. As of the date of this filing, we have been able to make all of the requiredpayments established under settlement agreements previously arranged withcertain vendors. We continue to communicate with our vendors to keep theminformed of our situation and discuss payment arrangements amiable to bothparties under the current circumstances.  Additionally, as of June 30,2004, we had approximately $1.4 million in accounts payable, of whichapproximately $0.7 million were greater than 90 days old.

 As of the date of this report, we are a party to oneunsettled lawsuit, whereby the claimant has sued us for non-payment of services provided to the Company.  The aggregate valueof this claim is $276,374, which is included in accounts payable.  Summus has disputed the total amount claimed and is in theprocess of attempting to negotiate a settlement with the creditor.

The success and growth of our businessis dependent in large part on our ability to partner and develop relationshipswithin the wireless industry. In order for us to execute on our business plan,we anticipate that it will require approximately $1.0 to $2.0 million in workingcapital within the next 12 months to achieve positive cash flow, bringadditional applications to market and continue the rollout of our operations.

Subject to our liquidity constraints(including our need to dedicate cash flow to meet our obligations on a timelybasis), we intend to invest a larger portion of our working capital on:
- increasing subscriber adoption of our applications through marketing and promotions;
- securing top-tier brands;
- the development and delivery of new wireless applications; and

35**
Table of Contents
- the marketing of those applications to lay the foundation of future substantial revenue generation.

                                                                                                                      

 

**Six Months Ended****June 30**

 

 

 

 

**2004**

 

 

 

**2003**

Cash used in operating activities 

 

 

  $

(2,345,838)

 

 

$ 

(2,077,058)

Cash provided by investing activities 

   

 

  $

(31,688)

 

 

$ 

- 

Cash  provided by financing activities 

   

 

  $

937,237 

 

 

$ 

2,051,068 

*Cash Flow used in Operating Activities.* Net cash usedin operating activities was $2,077,058 in the six-month period ended June 30, 2004, compared to $2,077,058 in the correspondingperiod of the prior year.  The increase in net cash used in operating activities was primarily due to additional payments madeto reduce accrued salaries and accounts payable for outstanding vendor obligations during the six-month period ended June 30,2004.  In addition, the Company restructured its organization in February 2004 as part of its focus to reduce future operatingexpenses and focus on revenue generation.  During the six-month periodended June 30, 2003, the Company was deferring payment of certain accountspayable and payroll obligations in efforts to conserve cash while raising theSeries C Preferred funding.  During the six-month period ended June 30,2004, the Company was not deferring these payments.

*Cash Flow provided by Investing Activities.* Net cashused in investing activities was $31,688 in the six-month period ended June 30, 2004, representing computer equipmentpurchases.  No cash was used in investing activities in the six-month period ended June 30, 2003.

*Cash Flow provided by  (used in) Financing Activities.* Net cashprovided by financing activities of $937,237 in the six-month period ended June 30, 2004 related to:
- proceeds from issuance of convertible notes payable and  common stock of $1,000,000.
- the sale of  431,034 shares of the Company's common stock for cash proceeds of $20,086.
- principal payments on capital lease obligations of  ($17,296).
- principal payments on note payable obligations of  ($65,553).

36**
Table of Contents

Net cash provided by financing activities of $2,051,068 in the six-month period ended June 30, 2003 related to:
- the sale of  2,703,903 shares of the Company's common stock, along with warrants to purchase an additional 316,000 sharesof common stock, at exercises prices ranging from $1.50 to $1.60 per share and the repricing of 4,242,261 of previously issuedwarrants. These transactions were in two forms. The first form involved purchases of common stock at prices which were above thetraded value and allowed these investors to reduce the exercise price of a certain number of their previously purchased warrants,typically allowing them to reprice 2 warrants for every share purchased. The other form allowed warrant holders to reduce theexercise price of previously purchased warrants if the holder exercised those repriced warrants immediately. The original exerciseprices of the repriced warrants ranged between $0.60 and $5.25 per share.  The repriced exercise prices ranged between $0.25and $1.69 per share. Total cash proceeds from the sale of the shares and issuance of the new warrants were $1,326,607.
- the issuance of 2,776,975 shares of unregistered common stock upon the exercise of warrants with exercise prices ranging from$0.25 to $0.47 per share. Of the 2,776,975 warrants exercised, 2,767,075 were exercised in connection with the repricing of theexercise price of the warrants as described above. The initial exercise prices of the warrants ranged between $0.60 and$5.25.  The repriced exercise prices ranged between $0.25 and $1.69. The exercise of these warrants generated gross proceedsof $779,355.
- principal payments on capital lease obligations of  ($54,894).

**Contractual Obligations**

At June 30, 2004, we did not have anymaterial commitments for capital expenses. Our principal commitments consistedof obligations under capital and operating leases and notes payable.

The following table summarizes ourcontractual obligations at June 30, 2004 and the effect these obligations areexpected to have on our liquidity and cash flows in future periods.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Operating** 

 

**Convertible** 

 

**Notes** 

 

   **Purchase** 

 

 

**Total** 

 

**Leases** 

 

**Notes Payable** 

 

**Payable** 

 

**Obligations** 

Six months ended December 31, 2004 

 

$

417,859

 

$

126,191

 

$

-

 

$

200,668

 

   $

91,000

Year ending December 31, 2005 

 

 

 502,703

 
 
252,851

 
 
-

 
 
221,852

 
 
28,000

Year ending December 31, 2006 

 

 

303,269

 
 
200,682

 
 
-

 
 
102,587

 
 
-

Year ending December 31, 2007 

 

 

1,000,000

 
 
-

 
 
1,000,000

 
 
-

 
 
-

      Total contractual obligations 

 

$

2,223,831

 

$
579,724
 

$
1,000,000

 

$
525,107

 

$
119,000
                
**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 variableinterest entities as defined in the Interpretation. The Interpretation applies immediately to variable interests in variableinterest entities created after January 31, 2003.  The Interpretationbecomes effective for entities created before February 1, 2003  at thebeginning 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.

37**
Table of Contents

**Description of Critical Accounting Policies**

The preparation of our financialstatements in conformity with accounting principles generally accepted in theUnited States requires us to make estimates and judgments that affect ourreported amounts of assets and liabilities, revenues and expenses. We haveidentified the following critical accounting policies that affect the moresignificant estimates and judgments used in the preparation of our financialstatements. On an ongoing basis, we evaluate our estimates, including thoserelated to the matters described below. These estimates are based on theinformation that is currently available to us and on various other assumptionsthat we believe to be reasonable under the circumstances. Actual results couldvary from those estimates under different assumptions or conditions.

*Revenue Recognition and Related Costs*

Change in Revenue Recognition Policy

After a careful review of the Company’s revenuerecognition policies and giving consideration to guidance provided for in Emerging Issues Task Force No. 99-19 *Reporting RevenueGross as a Principal versus Net as an Agent* (“EITF 99-19”), the Company has changed certain revenue recognitionpolicies affecting revenues earned by wireless applications and contracts. Prior to 4th quarter 2003, the Companyreported revenues earned by wireless applications and contracts and cost of revenues for wireless applications and contracts net ofcertain third-party costs in the statement of operations. These transactions have been reclassified to reflect a gross revenuepresentation with no effect on gross profit or net loss. The amount by which revenues and costs of revenues have been reclassifiedfor the three and six-month periods ended June 30, 2003 is $115,679 and $214,894, respectively.

Wireless applications and contracts

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

Periodically, we enter intonon-recurring engineering arrangements with our content partners. Generally,under the terms of these agreements, we receive funding upfront to completeprojects. The funding we receive upfront is recorded as deferred revenue and isrecognized as revenue under the terms of the individual arrangements. Deferredrevenue represents amounts received for which the Company has not yet completedits contractual obligations.

Wireless License Fees

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

38**
Table of Contents

There were no costs related to thewireless license fee revenue generated during the six months ended June 30, 2004and 2003 as the license fee revenue related to technology that had beenpreviously 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 primarily from research anddevelopment contracts for governmental agencies and the commercial licensing of our technology. We recognize revenue on thesecontracts at the time services are rendered based upon the terms of individual contracts. Regarding the commercial licensing of ourtechnology, we follow the provisions of AICPA Statement of Position 97-2, “Software Revenue Recognition”, as amended byAICPA Statement of Position 98-9 “Modification of SOP No. 97-2 Software Revenue Recognition with Respect to CertainTransactions.” Revenue from software license fees is generally recognized upon delivery provided that a contract has beenexecuted, the vendor fee is fixed or determinable, no significant vendor obligations or uncertainties surrounding customeracceptance remain, and collection of the resulting receivable is deemed probable.

*Valuation of Equity Instruments*

We have utilized our equity securities, includingunregistered common stock and options/warrants to purchase unregistered common stock, to pay for services and to settle obligationsowed to or claimed by creditors. The issuance of equity instruments as payment for services rendered to Summus results in therecording of non-cash compensation or consulting expense as the services are performed. We utilize the Black-Scholes option-pricingmodel to determine the value of options or warrants issued as payment for services. Underlying the Black-Scholes option-pricingmodel are several assumptions that are evaluated by management and include: (1) a dividend yield; (2) a common stock volatilityfactor; (3) the risk-free interest rate; and (4) the expected life of the option or warrant. Management evaluates each of theseassumptions on a periodic basis in order to determine the value of the equity instruments used as payment for services as well asto record the associated expense. As conditions change, our evaluation of the assumptions underlying the Black-Scholesoption-pricing model may change resulting in differing values of equity instruments issued for services between reportingperiods.

**Item 3. *Quantitative**and Qualitative Disclosures About Market Risk***

 We do not use any derivative financial instruments forhedging, speculative or trading purposes. Our exposure to market risk iscurrently immaterial.

**Item 4. *Controls**and Procedures***

Within the 90-day period prior to thefiling of this report, an evaluation was carried out under the supervision andwith the participation of the Company's management, including the ChiefExecutive Officer ("CEO") and Chief Financial Officer ("CFO"), of theeffectiveness of our disclosure controls and procedures. Based on thatevaluation, the CEO and CFO have concluded that the Company's disclosurecontrols and procedures are effective to ensure that information required to bedisclosed by the Company in reports that it files or submits under theSecurities Exchange Act of 1934 is recorded, processed, summarized and reportedwithin the time periods specified in Securities and Exchange Commission rulesand forms. Subsequent to the date of their evaluation, there were no significantchanges in the Company's internal controls or in other factors that couldsignificantly affect the disclosure controls, including any corrective actionswith regard to significant deficiencies and material weaknesses.

39**
Table of Contents

**PART II.****OTHER INFORMATION**

**Item 2.  *Changes in Securities and Use of Proceeds***

During the three-month period ended June 30, 2004, the Company issued an aggregate of 20,664,514 shares of its common stock to19 persons and entities.  These securities were not registered under the Securities Act of 1933.  Except as noted below,the securities described below were issued in transactions deemed to be exempt from registration under Section 4(2) of theSecurities Act and Rule 506, as promulgated pursuant to the Securities Act of 1933 as transactions by an issuer not involving anypublic offering.  All of such securities are deemed to be "restricted securities" as defined in Rule 144(a)(3) under theSecurities Act.  No commissions were paid in connection with any of the issuances.

**Stock Issuances for Cash**

From April 1, 2004 to June 30, 2004, the Company issued an aggregate of 431,034 shares of unregistered common stock to 1accredited investor, who is unaffiliated with the Company, for aggregate proceeds of $20,086. 

Name of Purchaser

Number of Shares

    Palisades Equity Fund LP

431,034           

**Stock Issuances Underlying Convertible Securities**

In May 2004, holders of Series C preferred stock converted 1,250 shares of Series C preferred stock into 5,000,000 shares ofSummus, Inc. common stock.

In May 2004, a holder of Series E preferred stock converted 80 shares of Series E preferred stock into 400,000 shares of Summus,Inc. common stock.

**Stock Issuances in conjunction with Convertible Notes Payable**

In May 2004, the Company issued an aggregate of 14,286,000 shares of unregistered common stock to 6 accredited investors inconjunction with the convertible notes payable financing.

Name of Purchaser

Number of Shares
 
Empire Capital Partners LP

3,571,500

Donald Hammett

1,428,600

The Focus Fund LP

2,142,900

Rodney D. Baber Jr.

357,150

JDS Capital LP

5,357,250

John A. Williams

1,428,600

**Stock Issuances for Services**

In May 2004, Summus issued 300,000 shares of restricted common stock to Phil Hellmuth Productions LLC in connection with amarketing agreement.

40**
Table of Contents

**Stock Issuances for Accrued Payroll**

In June 2004, Summus issued 647,480 shares of unregistered common stock to employees in lieu of accrued payroll.

Name of Purchaser

Number of Shares
 
Gary E. Ban

184,654

Do Hyun Chung

48,655

Lang Gao

32,702

Clark Jackson

35,526

Yuwei Liao

40,020

Donald T. Locke

184,616

Leonard Mygatt

85,134

Jiangying Zhou

36,173

**Item 5. *Other Information***

**Employment Agreements**

 On July 28, 2004,  Summus entered into employmentagreements with each of Gary E. Ban, Andrew L. Fox and Donald T. Locke.  All defined terms used in this description of theseemployment agreements shall have the meanings as set forth in the agreements, copies of which are attached as exhibits to thisquarterly report.  The employment agreements name Mr. Ban as Chief Executive Officer; Mr. Fox as Executive Vice-President ofBusiness Development and Sales; and Mr. Locke as Chief Financial Officer and General Counsel.  The current annual basesalaries for each of these officers is as follows:

Name ofExecutive                                              Initial Annual Base Salary

Gary E. Ban                                                                          $175,000

Andrew L.Fox                                                                     $120,000

Donald T. Locke                                                                  $144,000

Under the terms of each of the employment agreements, the Board of Directors will, on an annual basis, review eachexecutive’s base salary in light of the base salaries paid to other executives of Summus and each executive’sperformance.  It may, in its discretion, increase the executive’s annual base salary by an amount deemed appropriate bythe Board.

Under the terms of the agreements of Messrs. Ban and Locke, their annual base salaries shall also automatically be increased to1.5 times their initial base salary once Summus achieves a fiscal year gross revenue of $10,000,000 and to 2.0 times their initialannual base salary once Summus achieves a fiscal year gross revenue of $20,000,000 and it has net income for each such fiscal yearperiod.  Under the terms of Mr. Fox’s agreement, his annual base salary shall automatically be increased to $140,000once Summus achieves positive cash flow for a fiscal quarter. 

In addition to the annual base salary, the Board, in its discretion, may pay each executive a bonus commensurate with otherbonuses paid to employees of Summus and take into account the total compensation paid to executives of other companies which wouldbe competitive for the executive’s services.  Messrs. Ban and Locke shall receive a bonus of 100% of their annual basesalary upon the achievement of Summus’ annual objectives as set by the Board of Directors.   

41**
Table of Contents

Mr. Fox shall receive an annual bonus for the fiscal year ending December 31, 2004, equal to 15% of his annual base salary uponthe achievement by Summus of its annual objectives as set by the Board of Directors.  Mr. Fox shall also receive (i) acommission bonus of $10,000 for each transaction brought to Summus by him that Summus receives a gross profit of $250,000 from;(ii) a three percent (3%) commission bonus of the gross profit received by Summus from all transactions brought to the Company byhim; and (iii) a one percent (1%) commission bonus of the gross profit received by the Company from all other transactions ofSummus brought by personnel under Mr. Fox’s supervision.  No funds under these bonus provisions of Mr. Fox’sagreement shall be payable to him until funds are received by Summus.  Mr. Fox shall receive the commission bonuses set forthin items (ii) and (iii) of this paragraph for a period of eighteen (18) months from the launch of each such product related tothese transactions arranged by him or by personnel under his supervision, as the case may be.  After such eighteen (18) monthperiod has expired, the commission bonuses payable to Mr. Fox for a particular transaction shall expire and no longer be payable tohim.   

Any bonus earned by Messrs. Ban, Fox and Locke pursuant to the provisions of their employment agreements shall not be paid tothem unless and until Summus has achieved a cash flow positive position, which will be certified to the Board of Directors by anexecutive officer of the Company. 

The  Company shall grant to Messrs. Ban, Fox and Locke options to purchase 1,250,000, 1,000,000 and 1,000,000 shares of theCompany’s common stock, respectively.  These options shall vest in equal monthly installments over the thirty-six (36)month period beginning February 18, 2004.  Messrs. Ban and Locke shall also receive options to purchase an additional 250,000and 100,000 shares, respectively, of Summus’ common stock if it achieves cash flow positive at any time during the 2004fiscal year.  This grant of options, if achieved, shall be priced as of the date of the achievement of such milestone, ascertified by an executive officer of the Company and shall be vested in full as of such date.  

All options and/or warrantspreviously granted to each of Messrs. Ban, Fox and Locke in lieu of cash compensation forgone by them shall have a life of ten (10)years from the date of each such respective grant while the executive is employed by Summus or a life of three years from the dateof termination of the executive’s employment.     

The employment agreements withMessrs. Ban, Fox and Locke each have a term of one (1) year, which shall be automatically extended (without further action of Summus or the Board of Directors) each day for an additional day so that the remaining term shall continue to be one (1) year;provided that either party may at any time, by written notice to the other party, fix the term to a finite term of one (1) year,without automatic extension, commencing with the date of such notice.

Each executive’s employment undertheir respective Agreements shall be terminated immediately on his death and maybe terminated by the Board:
- at any time after the Permanent Disability of executive;
- at any time without Cause prior to a Change of Control;
- at any time without Cause upon a Change of Control; or
- at any time for Cause.         

If an executive’s employment is terminated by death, his estate or designated beneficiaries shall be entitled toreceive:
- any accrued but unpaid salary;
- a cash lump sum payment in respect of accrued but unused vacation;
- life insurance benefits pursuant to any life insurance policy purchased by Summus on the executive;  

42**
Table of Contents
- a pro rata portion of the bonus applicable to the calendar year in which such termination occurs, payable when and as such bonusis determined under the Agreement; and
- all stock option grants that have vested as of the executive’s date of death.

If an executive’s employment is terminated by Summus for Permanent Disability,he shall be entitled to receive
- severance compensation equal to his Base Salary for a period of six (6) months, minus any amounts payable under any short-termdisability insurance policy provided by Summus or purchased by executive.
- a pro rata portion of the bonus applicable to the calendar year in which such termination occurs, payable when and as such bonusis determined under the Agreement; 
- continuation of the insurance provided by Summus for 12 months; and
- all stock option grants that have vested as of the executive’s date of termination for the remainder of the term of suchoption grants.

If the executive’s employment is terminated by Summus without Cause prior to a Change of Control, the executive shall beentitled to receive:
- accrued but unpaid Base Salary to the date of such termination;
- a cash lump sum payment in respect of accrued but unused vacation days;
- a pro rata portion of the bonus applicable to the calendar year in which such termination occurs, payable when and as such bonusis determined under the Agreement;
- acceleration of the vesting of one hundred percent (100%) of the unvested portion of executive’s stock options or otherstock-based awards, together with the right to exercise such stock options or awards for a period equal to the remaining term forexercising such options or awards under the applicable agreement and/or plan; and 
- continuation of the insurance provided by Summus for 12 months. 

If executive’s employment is terminated by the Company without Cause upon a Change of Control or by Executive for GoodReason at any time, executive shall be entitled to receive:
- severance compensation equal to his then-current Base Salary for the remaining Term of this Agreement; provided, however, thatthe executive’s severance compensation shall not be less than one (1) year of his then-current Base Salary  
- a cash lump sum payment in respect of accrued but unused vacation days;
- the full amount of any bonus applicable to the calendar year in which such termination occurs, payable when and as such bonus isdetermined under the Agreement; 
- acceleration of the vesting of one hundred percent (100%) of the unvested portion of executive’s stock options or otherstock-based awards, together with the right to exercise such stock options or awards for a period equal to the remaining term forexercising such options or awards under the applicable agreement and/or plan; and
- continuation of the insurance provided by Summus for 12 months. 

43**
Table of Contents

If executive’s employment isterminated by Summus for Cause or by the executive without Good Reason upon a Change of Control (other than as a result ofexecutive’s Permanent Disability or death), the Company shall not have any other or further obligations to executive underthis Agreement, except:
- as may be provided in accordance with the terms of retirement and other benefit plans of Summus;
- as to that portion of any unpaid Base Salary and other benefits accrued and earned under this Agreement through the date of suchtermination;
- all stock option grants that have vested as of the Executive’s date of termination for the remainder of the term of suchoption grants; and
- as to benefits, if any, provided by any insurance policies in accordance with their terms. 

If executive’s employment is terminated by Summus for Cause at any time during the Term, Executive shall immediatelyforfeit any and all unvested stock rights, stock options and other such unvested incentives or awards previously granted to him bythe Company and any Bonus earned by him but not paid pursuant to the Agreement. 

Each of the employment agreements also contains customary covenants with respect to the non-disclosure of confidential orproprietary information regarding our business, prospects, finances, operations and trade secrets that have no finiteduration.  
Increase in Number of Options Available under Equity Compensation Plan
On June 24, 2004, the Board ofDirectors authorized an increase in the number of options available for grantunder the Corporation’s Second Amended and Restated 2000 Equity CompensationPlan from 8,500,000 to 15,000,000 to be used as incentives to all employees,management and the Board of Directors.

**Item 6. *Exhibits**and Reports on Form 8-K***

(a) Exhibits:

Exhibit 10.1

Employment Agreement by and between Gary E. Ban and Summus dated as of July 28, 2004

Exhibit 10.2

Employment Agreement by and between Andrew L. Fox and Summus dated as of July 28, 2004

Exhibit 10.3

Employment Agreement by and between Donald T. Locke and Summus dated as of July 28, 2004

Exhibit 10.4

Third Amended and Restated 2000 Equity Compensation Plan

Exhibit 31.1

 

Rule 13a-14(a)/15a-14(a) Certification of Gary E. Ban, Chief Executive Officer

Exhibit 31.2

 

Rule 13a-14(a)/15a-14(a) Certification of Donald T. Locke, Chief Financial Officer

Exhibit 32.1

 

Section 1350 Certification of Gary E. Ban, Chief Executive Officer

Exhibit 32.2

 

Section 1350 Certification of Donald T. Locke, Chief Financial Officer 

 

 (b) 

Reports on Form 8-K:

 

 (1) 

Current Report on Form 8-K filed on May 10, 2004 (Item 7)

 

 (2) 

Current Report on Form 8-K filed on July 1, 2004 (Items 7 and 12)

44*Table of Contents*
**SIGNATURES**

Pursuant to the requirements of theSecurities and Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned thereunto duly authorized.

 

Date: August 12, 2004

By:     /s/               GARYE. BAN                                            GaryE. Ban                               *Chief Executive Officer*

Date: August 12, 2004

By:     /s/               DONALD T. LOCKE                                            DonaldT. Locke                               *Chief Financial Officer*