ITEM 1. BUSINESS
Except where otherwise indicated, the terms “Company,” “Summus” , “we,” “us” and “our” refer to Summus, Inc. (USA). Our executive offices are located at 434 Fayetteville Street, Suite 600, Raleigh, N. C. 27601 and our telephone number is (919) 807-5600. Our Internet website address is www.summus.com. We make available free of charge on our website our annual, quarterly and current reports, including amendments to such reports, as soon as practicable after we electronically file such material with, or furnish such material to, the United States Securities and Exchange Commission (“SEC”). Our filings can also be obtained from the SEC website at www.sec.gov or by calling the SEC Office of Public Reference toll free at (800) 942-8090. However, the information found on our website or the SEC website is not part of this annual report.
Corporate Overview
Summus’ predecessor company, High Speed Net Solutions, Inc., was founded in 1984. Summus, Ltd. was merged into High Speed in February 2001. High Speed changed its name in February 2002 to Summus, Inc. (USA). Our goal is to be the leading developer of applications and information processing tools that optimize the wireless multimedia experience. Our solutions are developed using our BlueFuel™ platform and will enable the evolution of mobile and wireless devices for dynamically interacting with information resources. We have designed, developed and deployed a suite of end-user applications built on our BlueFuel platform. Our BlueFuel platform enables information mobility, management and exchange tasks on low-, mid- and high-tier data-enabled cellular handsets, smart phones, personal digital assistants (PDA’s) and other handheld wireless devices. The BlueFuel platform works over existing second generation (2G) wireless networks, as well as 2.5G and 3G networks, and is not generally limited by the wireless network. Our vision is to enable the mobile end-user to carry out everyday tasks by seamlessly integrating the information resources (data, devices, and communication networks) involved in accomplishing those tasks into an efficient, mobile interface.
The Market Opportunity
Market research sources project significant growth in the mobile and wireless market. Revenues in the multi-billions of dollars are predicted over the next 2-4 years in several sectors within the mobile and wireless arena. These sectors include streaming media, multimedia services, location-based services and multimedia messaging. Over the next ten years, Telecompetition, Inc., projects that the market for advanced mobile and wireless services will exceed $275 billion. In addition, mobile data subscribers will increase to over 1.5 billion by 2010, a thirty-fold increase.Summus believes that ultimate success in the mobile and wireless market will require overcoming two significant challenges:
developing and delivering compelling user experiences; and
enabling the value chain through a strong business model, effective partnering strategies, and technical expertise.
The wireless and mobile value chain consists of all the elements necessary to bring a solution to the mobile end-user, including applications, content, network infrastructure, devices and network connection service. No solution for the wireless and mobile environment can be developed in isolation; all parts of the value chain must be considered. The challenge in creating a successful solution is to synchronize the elements of the value chain across companies to deliver the total mobile and wireless solution to the end-user. Critical players include the builders and operators of the global communications infrastructure, the information and content providers, content aggregators, and the mobile and wireless device manufacturers.
Our Strategy
To become a leading provider of efficient information processing solutions for the mobile and wireless market, we intend to use our strategic content relationships, carrier distribution channels and our technology assets to build solutions that provide a compelling user experience for consumers in the mobile and wireless environment. Once established, Summus will employ a carefully designed intellectual property strategy to protect out market position.
Our strategy is to apply our technology assets and experience with the objectives of:
exploiting the market opportunity for mobile and wireless solutions by delivering compelling consumer applications across mobile operating systems for remote access to and processing of information resources via handheld devices, which in-turn will build and validate our BlueFuel platform;
establishing Summus as a leading provider of wireless applications, solutions, tools and services in the wireless and mobile market by utilizing the BlueFuel platform for efficient information processing through mobile and wireless platforms;
engaging a business model that leverages our strategic content relationships, carrier distribution channels and our BlueFuel platform by providing all participants in the mobile information value chain with an economic motivation to offer their respective piece of the solution through the BlueFuel platform;
recruiting partners and entering into agreements that complete and tie together the pieces necessary to deliver a total solution to the consumer; and
once established, providing a set of Application Program Interfaces (“APIs”), tools, and underlying efficient connectivity components comprising the BlueFuel platform, that provide seamless integration with access points into the carrier “pipeline” for participants in the value chain.
We have secured a number of relationships across the value chain and continue to seek additional relationships to ensure that our products and services will be compelling and available to end-users, as described below.
We have designed and developed our BlueFuel platform to be compatible with QUALCOMM's Binary Runtime Environment for Wireless (BREW™) wireless operating system, and other operating systems including Symbian, Java 2 Micro Edition (J2ME) and Pocket PC. BREW is an applications platform for wireless devices using a variety of air interfaces. Among these is Code Division Multiple Access (CDMA), which is expected to be the leading standard for third-generation, high-speed wireless voice and data communications. GSM is currently the de facto standard in Europe and Asia, with a reported 863.6 million subscribers worldwide as of July 2003 (as reported by the GSM Association). CDMA has a reported 162.3 million subscribers worldwide as of July 2003 (as also reported by the GSM Association). CDMA (1) has a greater network capacity, as a result of adjusting the transmission rate when there is no voice or data on the channel, (2) rapid and smooth migration to high-speed data capability, thus minimizing service interruptions during technology upgrades, (3) growing international coverage, and (4) the highest transmission speed. The BREW platform provides a standard programming environment that gives software developers the tools to create compelling wireless applications and services that can be offered by wireless carriers to their customers.
We continue to build applications on the J2ME operating system using our BlueFuel platform. J2ME is deployed on millions of devices around the world and is currently supported by, among others, CDMA and GSM air interfaces. The J2ME platform boasts robust security, a flexible user interface, a broad range of built-in network protocols, and support for networked and disconnected applications. J2ME applications can be downloaded dynamically from the phone or a web interface, which is very convenient to consumers.
Content Providers
In seeking to build relationships with content providers, our approach is to:
seek out major content brands,
provide products for encoding and efficiently storing, viewing, and manipulating multimedia content for viewing on digital cell phones or PDAs,
reduce the burden on the content provider to deliver applications and services on mobile devices, and
provide a quick development cycle along with broad platform deployment support.
Content providers are accustomed to traditional means of message delivery (i.e., print media and the Internet). The mobile and wireless media extend the reach of content providers, thereby offering the potential for increased revenue generation. We have entered into contracts with various content providers to deliver, for example, news, weather, financial information, and sports and entertainment content, using our BlueFuel platform.
Our business development activities continue to expand with major content brands such as Sports Illustrated and Fujifilm. Throughout 2003, we have executed contracts with a variety of content providers to build applications utilizing our BlueFuel platform. We develop applications that enable the content to be delivered to wireless devices and negotiate with carriers directly to gain access to end-users. Summus retains and records revenue generated from the agreement with the carrier and pays the content partner a percentage of revenue or a monthly fee based on a volume matrix of subscribers accessing that particular partners' content.
Some of the content partners with which we have executed agreements and applications which contribute a significant portion to our revenues are listed below. A complete list of our partners and products can be seen at www.summus.com.
ZIO Interactive - We incorporate aspects of our BlueFuel platform and are the primary distributor of ZIO’s mobile and wireless games in the U.S. market. Currently, we have four games developed on the BREW platform:
Nineball, a billiards game;
Ultimate Golf Challenge, a golf simulation game;
Fun2Link, a puzzle game; and
Metallion, an action shooting game.
The games or a subset of the games are available on the Verizon Wireless, US Cellular, ALLTEL, Western Wireless, Midwest Wireless, BellSouth International, Verizon International and Telstra networks for a one-time purchase or through a monthly subscription. Nineball, Ultimate Golf Challenge, Fun2Link and Metallion are also being distributed by VIVO, a Brazilian wireless carrier utilizing the BREW platform. Nineball is available for distribution on the J2ME platform and is currently offered by T-Mobile, Telus and Bell Mobility.
Snapfish- Snapfish Mobile provides subscribers complete access to their film and digital photos stored on the Snapfish.com website. Subscribers are able to store, view, share and print digital camera photos, as well as save photos as wallpaper on the handset display via the Snapfish Mobile application. Snapfish Mobile is available on the BREW platform through the Verizon Wireless and ALLTEL wireless networks and on the WAP platform through the Cingular Wireless and O2 Revolution wireless networks, as well as the AT&T Wireless mMode service network. Snapfish Mobile is also available on the J2ME platform, but it has yet to be deployed on a carrier network in this format.
The Associated Press- We have developed the AP Photo, News & Sports application that provides current events and sports information through a cellular handset. The subscriber logs in to the application to view top headlines, photos and full stories from the Associated Press. The application is available in English and Spanish. AP Photos, News & Sports is available on the BREW platform through the Verizon, US Cellular, ALLTEL, Bellsouth International, and Verizon International networks. This application is also available on the J2ME platform and has been deployed on the Sprint PCS carrier network.
Fuji Photo Film U.S.A. - Summus and Fuji Photo Films U.S.A. have developed and launched “Get the Picture TM” , a new mobile photo services for consumers. This application enables consumers to turn their phones into a photo album to take anywhere. Users can display pictures from their Fujifilm.net album. This new Fujifilm photo portal application is now available through AT&T Wireless’s mMode(SM) service on compatible wireless phones. This application allows subscribers to view, store and share photos taken with traditional digital cameras, as well as Panasonic’s GU87 and Nokia’s 3650 camera phones, through Fujifilm.net. This application is also being developed for the BREW platform for deployment in the second quarter of 2004.
Sports Illustrated - We have entered into an agreement with Sports Illustrated to provide wallpaper and screen savers based on the Sports Illustrated Swimsuit photos. The SI Swimsuit photos are being made available to carriers in the first quarter of 2004. Users can currently purchase the SI Swimsuit content through AT &T Wireless, T-Mobile, Cingular and Bell Mobility. Users will be able to view and set as wallpaper or screen savers a new collection of SI swimsuit photos each month through either a handset application or through their carrier’s wallpaper/screen saver download site.
Cellular Carriers
In building relationships with cellular carriers, we have focused on using our BlueFuel platform to provide the best user experience and facilitate multimedia content transmission via specific carrier air interface networks (e.g., GSM, TDMA, CDMA) in conjunction with carrier device manufacturers. We have launched several applications on multiple handsets on the following wireless carrier networks.
Domestic Wireless Carriers:
International Carriers:
Verizon Wireless
US Cellular
ALLTEL
Cingular Wireless
AT&T Wireless
Sprint PCS
T-Mobile
Midwest Wireless
Western Wireless
Metro PC
Nextel
Telstra in Australia
VIVO in Brazil
O2 in Europe
Bell Mobility in Canada
Telus Mobility in Canada
Telefonica Moviles in Peru
BellSouth International in Latin America
Verizon International in Latin America
Mobile Virtual Network Operators
Mobile Virtual Network Operators (MVNOs) represent an excellent early stage market opportunity for Summus to provide a complete solution to the end-user as this market evolves. An MVNO is a reseller of wireless carrier airtime and services. Our standard offering to MVNOs includes a bundle of preloaded applications on targeted handsets as well as access to other Summus applications and customized development. This will allow MVNOs to provide interoperability with carriers and simplified integration of new multimedia content and services. Our business model for MVNOs includes a guaranteed revenue stream to Summus for preloaded applications and revenue sharing with the MVNO for downloaded premium applications. Primarily, the type of applications included in each bundle will determine price points for preloaded applications. We are structuring the business model for the MVNO’s as a combination of licensing fees and revenue sharing.
Under our agreement with Single Touch Interactive, Inc., an MVNO, they were obligated to pay us guaranteed amounts of approximately $60,000 per month for the 12 months beginning October 14, 2003. We were not receiving those amounts owed to us by Single Touch, and we asked for arbitration pursuant the terms of our agreement. On March 8, 2004, Single Touch and Summus entered into a settlement agreement in which Single Touch agreed (1) to pay Summus $35,000 a month for twelve (12) months and (2) enter into a new agreement in which Summus will provide a suite of wireless applications to Single Touch for use in kiosks and wireless retail outlets to be deployed by Single Touch.
Our Products
Our BlueFuel Platform
Summus’ BlueFuel platform is the foundation upon which mobile and wireless activities can be effectively and efficiently executed and is the foundation for a majority of our applications. BlueFuel occupies a position in the mobile and wireless infrastructure similar to that of the operating system on a PC. BlueFuel coordinates the interaction of information resources under the technical challenges imposed by devices, networks, information content, and the end-user’s personal preferences. BlueFuel incorporates a distributed architecture that operates within information-supplying appliances, network servers, storage devices, and end-user devices, including PDAs, handsets, and PCs. Collectively, these are referred to as “information resources.” The components that comprise the BlueFuel architecture are the “glue” that binds the various elements of the mobile information value chain into a compelling end-user solution and experience and turns the cellphone into a simple, easy-to-use device for the individual’s data services.
The BlueFuel platform is constructed from a set of modules, Application Programmers Interfaces (APIs) and services that connect various elements of the value chain from content provider to mobile devices through the wireless carrier’s channel. Architecturally, these modules, APIs and services are segmented into various layers addressing specific actions involved with information interaction in the mobile environment. The platform occupies the space that bridges across the mobile value chain from content provider to mobile consumer. The architecture is organized into client and server services, each providing access to applications and information resources through specific APIs and toolkits.
The BlueFuel platform is being built from the wireless applications in a systematic development process. As we develop new applications, we extend, adjust, and validate the value and advantages of the BlueFuel platform. Currently, the platform is used in support of the development and deployment of Summus developed applications. In the future, we anticipate offering third party tools for similar development and deployment by independent third parties. The platform is in its second generation, and applications designed on the second-generation platform will be available in the second quarter of 2004.
Picture This!TM
With our Picture This! application, formerly known as exegoTM, a user can load all of their pictures to their Picture This! account to view and share from their mobile phone. A user can easily send pictures phone-to-phone with other Picture This! users, or access their phone’s address book to email pictures to friends and family. Picture This! comes with the enhanced BlueFuel image solution for crystal clear images, plus it allows the user to save pictures locally to the phone, and as wallpaper or caller ID (where available). The Picture This! application is currently available on Verizon Wirless , ALLTEL, Telstra, Verizon International and BellSouth International networks.
Content Provider Applications
Summus has developed several products and services for its content partners using our BlueFuel platform. These applications are described above in “Our Strategy- Content Providers.”
Legacy Products
In addition to our products aimed at the wireless and mobile market, we have legacy proprietary commercial software products for complex imaging, information management, object recognition and multimedia compression with existing applications in the fields of mobile and wireless communications and information processing. Our current product portfolio in this area includes:
Wavelet Image Software Developers Kit (SDK) Version 4.1 - This product allows software developers to incorporate our wavelet compression technology within their applications. Software developers can compress images into smaller file sizes to enable faster downloads without significantly degrading image quality. Optimizing limited storage capabilities and lower bandwidth connections, products incorporating the Wavelet Image SDK can provide viewers with greater viewing enhancement, including image magnification or enlargement, the flexibility to control the compression ratio which determines speed and quality, and the ability to select specific areas or regions of interest for greater levels of detail. The Wavelet Image SDK was updated to include support for JPEG2000, an international still image compression standard approved in January 2001. The Wavelet Image SDK will be updated to support rendering of JPEG2000 images as well as advanced features available only through the our wavelet implementations.
Photo ID Software Developers Kit (SDK) Version 2.0 - This product provides all the standard features of the Wavelet Image SDK with the addition of specialized compression technology to handle portrait-style images - ideal for smartcard, barcoding and identification and security applications.
Future Products
BlueFuel SDK
Our BlueFuel SDK will enable software companies other than Summus to develop mobile applications, that can be used on a variety of wireless devices and capture the advantages of the BlueFuel platform features and capabilities. We expect this to be available before the end of the fourth quarter of 2004.
Personal Server™
Our Personal Server will enable a user to view, share, email and publish documents stored on his or her home PC, connected to the Internet, from a mobile device. This PC application provides all the functions and features needed to enable a user’s PC for secure management and access through their mobile device. This product is expected to be commercially available by the end of the fourth quarter of 2004.
Multimedia Messaging Services (MMS)
Summus has recently developed an MMS client prototype for the BREW platform. This MMS solution will enable BREW handsets to exchange multimedia messages with other MMS handsets, including non-BREW MMS handsets (e.g., WAP). The Summus MMS solution can also provide MMS messaging capability for legacy BREW handsets already in the market that are not MMS enabled. This will allow carriers to reach a larger user base for MMS messaging. Summus plans to incorporate its MMS solution into its BlueFuel platform. We expect this to be available before the end of the third quarter of 2004.
Sales and Marketing
We intend to market our solutions primarily through our direct sales force, through leading device designers and manufacturers, wireless carriers, content partners, distribution portals and programming providers. Our marketing efforts, primarily focused in the U.S., are directed at increasing awareness of our applications, the capabilities of our solutions and developing relationships with content providers, wireless carriers and Internet portals. We market our products through;
industry trade shows;
press releases;
public relations initiatives;
our website;
the wireless carriers’ advertising and promotions;
carrier websites;
partners’ websites
partners’ customer newsletters; and
carrier sales training
As we build closer relationships with wireless carriers we can gain more access to their retail sales channel and end user customers. We have participated in carrier trainings where we go on location to teach sales associates about our products. If the sales associates are familiar with our applications, we believe they will be more inclined to promote the products to their customers. We are also getting involved with carriers by sending product promotional material to retail stores, developing contests for sales associates and consumers, doing giveaways and creating flash demonstrations of our products.
Competition
We compete principally with a growing number of independent developers in the mobile and wireless market. Our primary competition with respect to our Picture This! application is the additional photo applications from Pictavision, Vindigo, Kodak, RunMedia, infrastructure provider Lightsurf, as well as our own Fuji “Get The Picture” and Snapfish Mobile applications. In addition, existing simple messaging services and multimedia messaging services are entering the marketplace from Nokia, LightSurf, OpenWave, Ericsson, as well as specific carrier offerings.
Our primary competition with respect to wireless games is with JAMDAT, and a growing community of independent game developers. JAMDAT is an early market participant and has secured major branded content and is embedded with all major wireless carriers. Our financial resources prohibit us from competing directly by securing branded content for games. Instead, we look for niche opportunities to introduce games into the market.
Our primary competion with respect to wireless information , screensaver and wallpaper applications is Vindigo and UI Evolution. Both utilize the same strategy of partnering with name brand content providers and developing applications for the BREW and J2ME operating environments using their own platforms. Each company has partnered with large brand partners that have strong distribution outlets and are well funded.
Intellectual Property Rights
Currently, we have not been awarded any patents. We have filed for four (4) patent applications. The first is in the video compression technology area, which incorporated six (6) of our previous provisional patents and for which we abandoned three (3) of our previous provisional patents that contained redundant information to the video patent. The second is in the mobile mapping data area, which incorporated two (2) of our previous provisional patents. We have decided not to proceed on five (5) other provisional patents at this time, but the relevant and important information contained in these provisional patents is protected through trade secret and confidentiality agreements. The third is in the image and graphics compression area. The fourth is in the information navigation area. In addition to patents, we rely on copyright and trademark laws, trade secrets, confidentiality provisions and other contractual provisions to protect our proprietary rights. These measures, which require the expenditure of substantial resources, afford our intellectual property only limited protection because our competitors and third parties independently may develop similar technologies or may infringe our intellectual property. We currently have seven trademarks protected by common law trademark marking (tm) and are in the process of securing registered marks in the United States for these marks. We have one trademark registered with the U.S. Patent and Trademark Office.
We regard our copyrights, trademarks, trade secrets and similar intellectual property as critical to our success and attempt to protect our rights by relying on patent, trademark, service mark, copyright and trade secret laws and restrictions on disclosure and transferring title and other methods. We have filed United States trademark applications for various components and concepts upon which the BlueFuel™ platform depends. There can be no assurances that these steps will be adequate to protect our intellectual property completely, that we will be granted the patents we submit, that we will be able to secure trademark registrations for all of our marks in the United States or other countries or that third parties will not infringe upon or misappropriate our copyrights, trademarks, service marks and similar proprietary rights.
Effective trademark, service mark, copyright, trade secret and patent protection may not be available in every country in which our products may be distributed and policing unauthorized use of our proprietary information will be difficult, if not impossible.
We generally enter into confidentiality agreements with our employees and consultants and generally control access to and distribution of our documentation and other proprietary information. However, it may be possible for a third party to copy or otherwise obtain and use our proprietary information without authorization or to develop similar technology independently.
Legal standards relating to the validity, enforceability and scope of protection of certain proprietary rights in internet-related businesses are uncertain and still evolving and no assurance can be given as to the future viability or value of any of our proprietary rights within this market. There can be no assurance that the steps we have taken will prevent misappropriation or infringement of our proprietary information or rights. Any such misappropriation or infringement could have a materially adverse effect on our business, results of operations and financial condition. In addition, litigation may be necessary to enforce and protect our intellectual property rights, or to determine the validity and scope of the proprietary rights of others. Such litigation might result in substantial costs and diversion of resources and management attention and could have a materially adverse effect on our business, results of operations and financial condition.
From time to time, third parties have asserted and may assert exclusive patent, copyright, trademark and other intellectual property rights to technologies and related standards that are important to us or to third party providers of technology to us. We and/or such third party providers of technology may increasingly face infringement claims as the number of competitors in our industry segment grows and the functionality of products and services in different industry segments overlaps. As of the date of annual report, we do not have any intellectual property infringement claims or suits against us of any kind. However, we may be party to additional litigation in the future. Any third-party claims, with or without merit, could be time-consuming to defend, result in costly litigation, divert management's attention and resources or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us, if at all. A successful claim of infringement against us could harm our future competitiveness and profitability.
Government Regulation
We are not otherwise currently subject to direct federal, state, or local government regulation, other than regulations that apply to businesses generally. The telecommunications industry is subject to regulation by federal and state agencies, including the Federal Communications Commission (FCC), and various state public utility and service commissions. While such regulation does not necessarily affect us directly, the effects of these regulations on the wireless network operators with whom we are seeking to develop relationships may, in turn, negatively affect our business. FCC regulatory policies affecting the availability and licensing of bandwidth and other terms on which service providers conduct their business may impede our plans for the deployment of our technology.
Legislative proposals have been made in the U.S. that, if enacted, would afford broader protection to owners of databases of information such as stock quotes, weather and traffic information and sports scores. If enacted, this legislation could result in an increase in the price of services that provide data to wireless communications devices and could create potential liability for unauthorized use of this data.
Employees
As of March 15, 2004, we had 22 full-time employees, including 3 in marketing and sales, 16 in development and 3 in corporate operations and administration. We also have engaged 13 consultants, 12 in product development (of which 7 are in Croatia and 1 in Sweden) and 1 in administration. We are not subject to any collective bargaining agreements and believe that our relationship with our employees is good. Our success depends to a significant extent upon the performance of our executive officers and other key personnel.
ITEM 2.
ITEM 2. PROPERTIES.
Our principal executive offices are located at Two Hannover Square, 434 Fayetteville Street, Suite 600, Raleigh, North Carolina 27601. We occupy 12,078 square feet of leased space at such location. Our lease for this space, representing our principal executive offices, expires October 31, 2006. The current annual base rent for such space is approximately $250,945 and will decrease to approximately $240,816 by the last year of the term.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
Bowne
On February 25, 2003, Bowne of New York City, LLC (“Bowne”) filed a civil lawsuit in the Supreme Court of the State of New York in the County of New York against Summus. In this suit, Bowne claims that it is entitled to $276,374, plus interest, for services rendered to Summus. Summus disputes this amount and is still in the process of negotiating a resolution to this matter.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On December 2, 2003, Summus held its 2003 Annual Meeting of Shareholders. The following items were presented to a vote of the holders (the “Shareholders”) of the Company’s issued and outstanding Common Stock. The holders of the Company’s Series A, C, D and E convertible preferred stock had no voting rights at this Annual Meeting.
(1)
The election of Jere A. Ayers, Neil R. Guenther, Bjorn D. Jawerth and George H. Simmons to the Company’s Board of Directors, whose terms expire at the Company’s 2004 Annual Meeting of Shareholders.
(2)
Amendment to the Company’s Amended and Restated Articles of Incorporation to increase the number of shares of common stock authorized for issuance to 185,000,000 shares.
(3)
The ratification of the appointment of Ernst & Young LLP as the Company’s independent auditors for the 2003 fiscal year.
The number of votes cast for each of the above is summarized in the table below. All numbers in the table below represent shares of Common Stock.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON STOCK AND RELATED SHAREHOLDER MATTERS.
Market Information
Our common stock, par value $.001 per share, currently trades on the Over-the-Counter Bulletin Board®. The following table provides information about the high and low bid per share quotations of our common stock for each full quarterly period during the two years ended December 31, 2003 and 2002, and for the first quarter of 2004 through March 22, 2004, on the OTC Bulletin Board®, as provided by the National Quotation Bureau, Inc. These quotations reflect inter-dealer prices without markup, markdown or commissions and may not necessarily represent actual transactions.
On March 22, 2004, the closing sale price for our common stock as reported on the OTC Bulletin Board® was $0.13. As of March 22, 2004, we had approximately 71,277,220 shares of common stock outstanding and approximately 570 shareholders of record.
We have never declared or paid any cash dividends on our common stock and do not anticipate paying any cash dividends in the foreseeable future. We anticipate that we will retain earnings, if any, to finance the growth and development of our business. Therefore, we do not expect to pay cash dividends on our common stock for the foreseeable future. Any future determination to pay cash dividends will be at the discretion of our Board of Directors and will depend upon our financial condition, operating results, capital requirements, plans for expansion, restrictions imposed by any financing arrangements and whatever other factors that our Board of Directors determines are relevant.
Summus’ 8% Series A convertible preferred stock accrues semi-annual dividends at a rate of 8% per annum of the initial liquidation price of $1,000 per share on each of April 1 and October 1. These dividends are cumulative from the date of original issue, which was February 28, 2000, and shall be payable when, as, and if declared by our Board of Directors. Any dividends payable on the Series A preferred stock may be paid in additional shares of Series A preferred stock at our option.
The holders of Summus’ Series C, D and E convertible preferred stock are not paid any dividends under the their respective terms.
Penny Stock
Our common stock is subject to the provisions of Section 15(g) and Rule 15g-9 of the Securities Exchange Act of 1934 (the “Exchange Act”), commonly referred to as the “penny stock rule.” Section 15(g) sets forth certain requirements for transactions in penny stocks and Rule 15g-9(d)(1) incorporates the definition of penny stock that is found in Rule 3a51-1 of the Exchange Act.
The SEC generally defines penny stock to be any equity security that has a market price less than $5.00 per share, subject to certain exceptions. If our common stock is deemed to be a penny stock, trading in the shares will be subject to additional sales practice requirements on broker-dealers who sell penny stocks to persons other than established customers and “accredited investors” (generally, an individual with a net worth in excess of $1,000,000 or an annual income exceeding $200,000 or $300,000 together with his or her spouse). For transactions covered by this rule, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser’s written consent to the transaction prior to sale. The rule also requires the delivery, prior to the transaction, of a risk disclosure document mandated by the SEC relating to the penny stock market. The broker-dealer must also disclose the commissions payable for the transaction, current quotations for the stock, and, if applicable, the fact that it is the sole market maker in the stock. Consequently, the rule may adversely affect the ability of broker-dealers to sell our securities and may adversely affect the ability of shareholders to sell their shares in the secondary market.
Recent Sales of Unregistered Securities
During the three-month period ended December 31, 2003, the Company issued
an aggregate of 60 shares of our Series C convertible preferred stock to one (1) investor (which is convertible into 240,000 shares of the Company’s common stock);
an aggregate of 3,350 shares of our Series D convertible preferred stock to twelve (12) investors (which is convertible into 16,750,000 shares of the Company’s common stock); and
an aggregate of 200 shares of our Series E convertible preferred stock to one (1) investor (which is convertible into 1,000,000 shares of the Company’s common stock).
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 the Securities Act as transactions by an issuer not involving any public offering. All of such securities are deemed to be "restricted securities" as defined in Rule 144(a)(3) under the Securities Act. Except as noted below, no commissions were paid in connection with any of the issuances. The Company has filed a registration statement on Form S-1 registering the shares of common stock underlying these securities.
Stock Issuances for Cash
Series C Convertible Preferred Stock
On November 11, 2003, we issued an aggregate of 60 shares of our unregistered Series C convertible preferred stock, stated value of $1,000 per share, to one (1) investor for an aggregate consideration of $60,000. Each share of the Series C convertible preferred stock, which has an issue price and liquidation preference of $1,000 per share, is convertible into 4,000 shares of common stock at any time after nine months from its issuance date. In connection with this capital raising activity, we paid no commissions. The shares were issued in transactions deemed to be exempt from registration under the Securities Act in reliance upon the exemption provided by Rule 506 of Regulation D.
Name of Purchaser
Number of Shares
Neil R. Guenther
Series D Convertible Preferred Stock
During October 2003, we issued an aggregate of 3,350 shares of our unregistered Series D convertible preferred stock, stated value of $1,000 per share, to twelve (12) investors for an aggregate consideration of $3,350,000. Each share of the Series D convertible preferred stock, which has an issue price and liquidation preference of $1,000 per share, is convertible into 5,000 shares of our common stock. In connection with this capital raising activity, we paid commissions of $111,000 to J. Winder Hughes, one of our Directors. The shares were issued in transactions deemed to be exempt from registration under the Securities Act in reliance upon the exemption provided by Rule 506 of Regulation D.
Name of Purchaser
Number of Shares
JDS Capital LP
1,500
Empire Capital Partners, LP
London Family Trust
Rodney Baber, Jr.
Ponte Vedra Partners
Peter Massaniso
Stephen M. Finn Revocable Trust
Massiniso & Co.
Massiniso Family Limited Partnership
Pinnacle Asset Management
Frank P. Massaniso Irrevocable Trust
Karen Massaniso
Series E Convertible Preferred Stock
During October 2003, we issued an aggregate of 200 shares of our unregistered Series E convertible preferred stock, stated value of $1,000 per share, to one (1) investor for an aggregate consideration of $200,000. Each share of the Series E convertible preferred stock, which has an issue price and liquidation preference of $1,000 per share, is convertible into 5,000 shares of our common stock. In connection with this capital raising activity, we paid commissions of $6,000 to J. Winder Hughes, one of our Directors . The shares were issued in transactions deemed to be exempt from registration under the Securities Act in reliance upon the exemption provided by Rule 506 of Regulation D.
Name of Purchaser
Number of Shares
RHP Master Fund, Ltd.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
On February 16, 2001, Summus (formerly High Speed Net Solutions, Inc.) acquired all the assets and operations of Summus, Ltd. under the terms of an asset purchase agreement, dated October 30, 2000, as subsequently amended. In legal form, the transaction was effected by Summus issuing shares of its common and Series B convertible preferred stock, and other equity interests, in exchange for the net assets of Summus, Ltd. This transaction has been accounted for as a capital transaction of Summus, Ltd., accompanied by a recapitalization. As a result of the transaction, the historical financial statements of Summus, Ltd. are, for accounting purposes, deemed to be those of Summus.
The following selected historical annual financial data has been derived from the financial statements of Summus (notwithstanding that such selected historical annual financial data has been labeled as that of Summus, Ltd.). The financial statements for each of the three years ended December 31, 2003, 2002 and 2001, have been audited by Ernst & Young LLP, independent auditors, as indicated in their report included elsewhere in this annual report on Form 10-K, which includes an explanatory paragraph which expresses substantial doubt about our ability to continue as a going concern.
The financial data set forth below should be read in conjunction with “Item 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the risk factors included in this report in the section entitled “Factors That May Affect Our Business, Future Operating Results and Financial Condition.” The following discussion is qualified in its entirety by, and should be read in conjunction with, the more detailed information in our consolidated financial statements and the notes thereto appearing elsewhere in this annual report on Form 10-K.
Change in Revenue Recognition Policy
After a careful review of the Company’s revenue recognition policies and giving consideration to guidance provided for in Emerging Issues Task Force No. 99-19 Reporting Revenue Gross as a Principal versus Net as an Agent (“EITF 99-19”), the Company has changed certain revenue recognition policies affecting revenues earned by wireless applications and contracts. Prior to 4th quarter 2003, the Company reported revenues earned by wireless applications and contracts and cost of revenues for wireless applications and contracts net of certain third-party costs in the statement of operations. These transactions have been reclassified to reflect a gross revenue presentation with no effect on gross profit or net loss. The amount by which revenues and costs of revenues have been reclassified for the year ended December 31, 2003 is $635,989. All revenues reported on this Form 10-K for 2003 have been reported on the gross method. Revenues and costs of revenues for 2002 have not been reclassified due to immateriality.
Overview
Summus’ predecessor company, High Speed Net Solutions, Inc., was founded in 1984. Summus, Ltd. was merged into High Speed in February 2001. High Speed changed its name in February 2002 to Summus, Inc. (USA). Our goal is to be a leading developer of applications and information processing tools that optimize the wireless multimedia experience. Our solutions are developed using our BlueFuel™ platform and will enable the evolution of mobile and wireless devices for dynamically interacting with information resources. We have designed, developed and deployed a suite of end-user applications built on our BlueFuel platform. Our BlueFuel platform enables information mobility, management and exchange tasks on low-, mid- and high-tier data-enabled cellular handsets, smart phones, personal digital assistants (PDA’s) and other handheld wireless devices. The BlueFuel platform works over existing second generation (2G) wireless networks, as well as 2.5G and 3G networks, and is not generally limited by the wireless network. Our vision is to enable the mobile end-user to carry out everyday tasks by seamlessly integrating the information resources (data, devices, and communication networks) involved in accomplishing those tasks into an efficient, mobile interface.
During the second half of 2002, the Company shifted its business focus from providing government contract services and the commercial licensing of its established technology to the development of solutions for the mobile and wireless markets. The Company’s focus through 2003 was and continues to be wireless application development and delivery to mobile end-users.
To date, the Company has experienced significant operating losses as we have made investments in research and development of our underlying BlueFuel Platform and application development. We expect to continue to make investments in those areas; however, the Company is more focused on the development and delivery of applications and the marketing of those applications to make substantial progress in revenue generation. We plan to expand our market presence by partnering with additional wireless carriers as well as increasing subscriber adoption of our applications. Our ability to generate profits and positive cash flow from operations will depend primarily on increasing revenues as well as implementing cost reduction measures.
Key Developments in 2003
Focus on Mobile and Wireless Market; Development of BlueFuel™ Platform
Summus is continuing to develop applications and information processing tools that optimize the wireless multimedia experience. Our solutions are developed using our mobile solutions platform, called BlueFuel, which will enable the evolution of mobile and wireless devices for dynamically interacting with information resources. The Company’s vision is to enable mobile end-users to experience an entirely new mobile environment, one that frees an individual from location and time dependence and opens new possibilities as to how mobile devices are used. Focused on the end-user experience, BlueFuel enables application developers, device manufacturers, wireless infrastructure providers, and content providers to bring a reliable, high quality mobile information experience to consumers through their mobile devices.
Summus is focused on delivering compelling end-user applications across multiple mobile operating systems for remote access to and processing of information via handheld devices, which in-turn will build and validate our BlueFuel platform. The strategy incorporates the release and distribution of revenue-generating products, each building to the Company’s vision.
Relationships with Content Providers and New Application Development
Summus continues to position itself as a supplier of solutions that can run on multiple wireless platforms supporting the mobile and wireless marketplace. Summus has developed, and continues to develop, wireless applications utilizing BlueFuel, Summus’ platform designed for efficient and easy interaction with information in the mobile environment. BlueFuel supports applications and services on the BREW™, Java™ 2 Micro Edition (J2ME ™), Symbian™ OS, PocketPC, Palm OS and Wireless Application Protocol (WAP) wireless operating systems or platforms.
Our business development activities continue to expand with major content brands, such as Sports Illustrated, The Associated Press, and Fuji Film. Through 2003, we have executed contracts with a variety of content providers to build applications utilizing our BlueFuel Platform. Currently, up to eleven (11) wireless carriers in the United States and eight (8) international carriers deploy at least one or a combination of the twenty-five (25) wireless applications that have been completed by the Company.
Non-cash settlements
During the year ended December 31, 2003, the Company executed seven settlement agreements with creditors of the Company. The detail of each of the settlement agreements has been provided in the Results of Operations, set forth below. The aggregate gains of these non-cash settlements totaling $1,525,698 have been recorded as reductions to the Company’s operating expenses in the Company’s Statement of Operations for the year ended December 31, 2003.
Results of Operations
The following discussion and analysis of our results of operations and financial condition should be read in conjunction with our financial statements and related notes included in this report.
Year ended December 31, 2003 compared to Year ended December 31, 2002
Change in Revenue Recognition Policy
After a careful review of the Company’s revenue recognition policies and giving consideration to guidance provided for in Emerging Issues Task Force No. 99-19 Reporting Revenue Gross as a Principal versus Net as an Agent (“EITF 99-19”), the Company has changed certain revenue recognition policies affecting revenues earned by wireless applications and contracts. Prior to 4th quarter 2003, the Company reported revenues earned by wireless applications and contracts and cost of revenues for wireless applications and contracts net of certain third-party costs in the statement of operations. These transactions have been reclassified to reflect a gross revenue presentation with no effect on gross profit or net loss. The amount by which revenues and costs of revenues have been reclassified for the year ended December 31, 2003 is $635,989. All revenues reported on this Form 10-K for 2003 have been reported on the gross method. Revenues and costs of revenues for 2002 have not been reclassified due to immateriality.
Revenues
Wireless Applications and Contracts. Revenue from wireless applications and contracts increased $1,191,163 to $1,395,296 during the year ended December 31, 2003, up 584% from $204,133 in the year ended December 31, 2002. The increase in revenue from wireless applications and contracts resulted from the increase in sales of existing wireless applications and additional wireless applications developed by the Company, launched by several wireless carriers and purchased by end-users. During the year ended December 31, 2003, up to eleven (11) wireless carriers in the United States and eight (8) international carriers currently deployed at least one or a combination of the twenty-five (25) wireless applications that have been completed by the Company. Each of the applications deployed were developed following agreements with a content partner to provide access to their content, except the Picture This!™ (formerly exego™) application, which was internally developed by Summus.
Revenue earned from wireless applications is recognized upon delivery and acceptance by the end-user either as a one-time purchase per use or a monthly subscription. Revenue totaling $100,000 from wireless applications and contracts during the year ended December 31, 2002, resulted solely from a strategic partnership agreement related to the mobile and wireless markets. Revenue under this agreement was recognized ratably over the year ended December 31, 2002.
Wireless License Fees. Revenue earned from wireless license fees totaled $249,951 in the year ended December 31, 2003. During this period, the Company had sold and delivered existing image software for use in wireless transmission applications. During the year ended December 31, 2002, the Company did not generate any revenue or costs of revenue related to wireless license fees.
Contracts and License Fees. Revenue from contracts and license fees decreased $148,792 to $54,027 in year ended December 31, 2003, down 73% from $202,819 in the year ended December 31, 2002. The decrease in contract and license fees resulted from the Company shifting its primary focus during the second quarter of 2002 from providing governmental contract services and the commercial licensing of its established technology in non-wireless environments to the development of solutions for the mobile and wireless markets. Revenues earned during the years ended December 31, 2003 and 2002 were generated from providing governmental contract services and the commercial licensing of technology.
Costs of Revenues
Wireless Applications and Contracts. Costs of wireless applications and contracts increased $946,380 to $1,064,643 during the year ended December 31, 2003, up 800% from $118,263 for the year ended December 31, 2002. These costs are direct costs associated with the sale and delivery of wireless applications and primarily consist of third-party hosting fees, carrier distribution and fees associated with content information provided by our content providers for wireless applications which were deployed during the year ended December 31, 2003. The costs related to third-party hosting and carrier distribution are incurred on a monthly basis and are primarily fixed in nature regardless of the revenue generated by the related applications. During the year ended December 31, 2002, there were no direct costs associated with $100,000 of wireless applications and contracts revenue earned from a strategic partnership agreement because there were no specific, direct costs associated with the agreement related to the mobile and wireless markets.
Wireless License Fees. There were no costs of revenues regarding wireless license fees during the year ended December 31, 2003 since the license fee agreements consummated during this period related to technology that had been previously developed by the Company. During the year ended December 31, 2002, the Company did not generate any revenue or costs of revenue related to wireless license fees.
Contracts and License Fees. Costs of contracts and license fees decreased $54,250 to $9,596 during the year ended December 31, 2003, down 85% from $63,846 for the year ended December 31, 2002. The decrease in costs of contract and license fees resulted from the Company shifting its primary focus during the second quarter of 2002 from providing governmental contract services and the commercial licensing of its established technology in non-wireless environments to the development of solutions for the mobile and wireless markets. Costs of contracts and license fess consisted primarily of salaries and other related costs of providing governmental contract services, as well as any direct costs related to the sale, delivery and installation of its commercial software.
Gross Profit
Wireless Applications and Contracts. Gross profit resulting from the development and deployment of wireless applications totaled $330,653 or 24% of wireless applications and contracts revenue for the year ended December 31, 2003. During the year ended December 31, 2002, the Company generated a gross profit of $85,870 or 42% of wireless applications and contract revenue. The gross profit resulting from these activities is a result of deducting costs consisting mostly of third-party hosting fees, testing fees, and content information provided by our content providers, from the related earned revenue. During the year ended December 31, 2002, the Company earned $100,000 under a strategic partnership agreement related to the mobile and wireless markets. There were no specific direct costs associated with this contract.
Wireless License Fees. Gross profit resulting from wireless license fees totaled $249,951. The Company did not incur any specific direct costs associated with the sale, delivery, or installation of the software underlying the license agreements consummated during the year ended December 31, 2003. Additionally, the Company does not expect to incur any future obligations relating to these license fees. During the year ended December 31, 2002, the Company did not generate any revenue, costs of revenue or gross profit related to wireless license fees.
Contracts and License Fees. Gross profit resulting from governmental contract services and the commercial licensing of technology during the year ended December 31, 2003 totaled $44,431 or 82% of contracts and license fee revenue. During the year ended December 31, 2002, the Company generated a gross profit of $138,973 or 69% of contracts and license fees revenue. The gross profit from these activities resulted from deducting primarily salaries and other related costs from the related earned revenue.
Expenses
Selling, General and Administrative Expenses. Selling, general and administrative expenses consist primarily of salaries, consulting fees, office operations, administrative and general management activities, including legal, accounting and other professional fees. Selling, general and administrative expenses for the year ended December 31, 2003, were $4,597,036, compared to $6,155,416 for the year ended December 31, 2002. The decrease in selling, general and administrative expenses during the current period as compared to the prior period reflect a reduction in several expense categories, primarily salaries, third-party consulting fees, travel and general office administration costs. The reductions in these categories reflect continued cost reduction efforts implemented by management.
Non-Cash Compensation. Non-cash compensation for the year ended December 31, 2003 was $185,255 compared to $364,000 for the year ended December 31, 2002. Non-cash compensation for the year ended December 31, 2003, reflects the amortization for twelve months of deferred compensation resulting from stock options granted in prior years and during the year ended December 31, 2003, at prices below the fair value of the underlying common stock.
Non-cash compensation for the year ended December 31, 2002, of $364,000 includes $202,642 of amortization for twelve months of deferred compensation resulting from stock options granted in prior years, at prices below the fair value of the underlying common stock. The remaining amount of $161,358 reflects stock options that were granted to an employee with exercise prices below the estimated fair value of the underlying common stock.
Research and Development. Research and development expenses for the year ended December 31, 2003, were $1,056,770 compared to $918,948 for the year ended December 31, 2002. The increase in research and development expenses is a result of two factors. First, there was an increase in the number of new wireless applications the Company has contracted to develop. In order to minimize these expenses, the Company increased its utilization of software developers in Croatia. Personnel costs in Croatia are lower than those in the United States. Second, the increase of the research and development costs in the current period as compared to the prior period resulted from a reallocation of employees who previously worked on governmental contracts. Beginning in late 2002, the Company shifted its focus to developing wireless applications from providing governmental contract services and the commercial licensing of its technology in non-wireless environments. Accordingly, all employees who were previously assigned to work on such contracts were assigned to work on research and development activities in the mobile and wireless sector.
Non-Cash Consulting Expense. Non-cash consulting expense for the year ended December 31, 2003, in the amount of $119,630 is attributable to: (1) the issuance of 179,257 shares of restricted common stock issued to consultants for services valued at $65,803; (2) 103,400 stock options granted to consultants for services valued at $29,888, such value was determined by using the Black-Scholes option-pricing model; (3) the $20,000 of amortization of a deferred expense recorded in 2002 relating to the issuance of 55,555 shares of restricted common stock, valued at $22,500, for consulting services to be rendered over a 4.5 month period; and (4) $3,939, representing the fair value, as determined using the Black-Scholes option-pricing model, of stock warrants granted to a consultant of the Company.
Non-cash consulting expense for the year ended December 31, 2002, in the amount of $887,992 is attributable to the following: (1) the issuance of 394,567 shares of restricted common stock and 453,532 options and warrants to purchase restricted common stock to consultants for services valued at $765,477; (2) stock options granted to three new members of our Advisory Board during the year ended December 31, 2002, resulting in deferred consulting expense of $103,950, of which $97,515 was charged to expense during the year ended December 31, 2002; and (3) a stock option granted to a member of our Advisory Board for consulting services resulting in total deferred consulting expense of $40,000, of which $25,000 was charged to expense during the year ended December 31, 2002. The remaining amounts of deferred compensation not charged to expense will be charged to expense as future vesting of the stock options occurs. The value of the stock options granted to consultants, including the members of the Board of Advisors, was determined by using the Black-Scholes option-pricing model.
Interest Expense. Interest expense for the year ended December 31, 2003, was $69,343, compared to interest expense of $469,571 for the year ended December 31, 2003. Net interest expense for the year ended December 31, 2003 related to interest costs associated with capital lease obligations and note payable agreements.
Net interest expense for the year ended December 31, 2002, was $469,571 and includes interest costs associated with capital lease obligations and note payable agreements of $49,321, plus the following items related to the convertible debentures issued on July 19, 2002:
$190,000, relating to the value, as determined by the Black-Scholes pricing model, of the 1,724,138 warrants issued to the debentures holders;
$189,655, relating to the value of the beneficial conversion feature associated with the convertible debentures;
$39,310, relating to placement agent fees, consisting of a cash commission of $30,000 and a warrant to purchase 51,724 shares of common stock that was valued at $9,310 using the Black-Scholes pricing model and;
$1,285, relating to interest expense incurred while the debentures remained outstanding based on the stated rate of 6% per annum. At the Company’s election, theses interest costs were paid through the issuance of shares of common stock based on the conversion rate of $0.29, resulting in the issuance of 4,430 shares of common stock.
The value of the warrants issued to the debenture holders was initially recorded as a discount to the $500,000 face value of the debentures. This discount was to be amortized to interest expense over the term of the debentures. Since all of the debentures were converted into common stock during the year ended December 31, 2002, the total value assigned to the warrants was fully amortized to interest expense during this period. The beneficial conversion feature was recorded since the conversion price of the debentures was below the fair market value of our common stock on the date the convertible debentures were issued. This non-cash charge was recorded immediately as interest expense because the debentures were convertible upon issuance.
Non-cash Settlements. Non-cash settlements totaling $1,525,698, during the year ended December 31, 2003, is comprised of settlements with seven creditors of the Company noted below.
On February 21, 2003, the Company signed and executed a mutual release of all claims with a former law firm that had provided legal services to the Company. Under the terms of this agreement, both parties agreed to a mutual release of any and all claims between the parties, as well as a cancellation of the unpaid fees owed by the Company to the law firm, totaling $886,557. The Company did not issue any cash or equity securities or enter into any other obligations in connection with this release. The settlement gain resulting from this transaction was $886,557.
On February 27, 2003, Holland & Knight LLP (“H&K”) filed a civil lawsuit in the Superior Court for the District of Columbia against Summus. In this suit, H&K claims that it was entitled to $867,268, plus interest, for services rendered to Summus. Summus and H&K entered into an agreement on May 23, 2003 settling this litigation, whereby both parties agreed to the following terms:
$217,268 of the total balance due was forgiven by H&K, resulting in a portion of the settlement gain of this transaction.
$325,000 of the total balance due will be paid over a three-year period with monthly installments of $9,028, commencing on June 1, 2003. The settlement agreement did not provide for an interest rate component pertaining to the three-year payment plan. Therefore, an interest rate of 20% per annum was used to present value the note, resulting in a net present value of $242,926. The difference between the face value of $325,000 and the net present value of $242,926, totaling $82,074, was recorded as a portion of the settlement gain. The 20% rate of interest was considered appropriate to fair value the note based on the Company’s financial condition, including its negative working capital and negative net worth position. In the event that the Company fails to make a scheduled payment as set forth in this settlement agreement, H&K may execute on a consent judgment and seek to satisfy the judgment from the assets of the Company in accordance with the laws of the State of North Carolina.
The remaining amount of the recorded liability due to H&K of $325,000 was satisfied through the issuance to H&K of 738,636 shares of the Company’s unregistered common stock, with registration rights. The fair value of the 738,636 shares of unregistered common stock was estimated at $273,295, based on the traded value of the Company’s common stock on the date the settlement agreement became effective. The difference between the estimated fair value of the 738,636 unregistered common shares and the recorded value of the liability of $325,000, totaling $51,705, was recorded as a portion of the settlement gain. The unregistered shares have since been registered, and H&K has contractually agreed to sell no more than 18,000 shares in any one (1)-business day.
Therefore, the aggregate settlement gain resulting from this transaction totaled $351,047.
The settlement agreement also provided that if the Company raised $5.0 million or more in capital at one time, all remaining unpaid amounts owed under the $325,000 note agreement shall become immediately due and payable. This note is unsecured, and upon default of the terms of the agreement, the unpaid balance shall become immediately due and payable and such amount shall include pre-judgment interest in the amount of 6% accruing as of April 3, 2002 and post- judgment interest at a rate to be determined.
On June 7, 2002, AT&T filed a civil lawsuit in the United States District Court for the Eastern District of North Carolina against Summus, Inc. (USA). In this suit, AT&T claims that it is entitled to payment in the amount of $238,783 for telephone calls and services rendered to the Company. In March 2003, the Company and AT&T settled the claim between them, whereby both parties agreed to reduce the total amount owed by the Company to AT&T to $120,000 and this reduced amount to be repaid over an 18 month period commencing in March 2003. The settlement gain resulting from this transaction was $118,783.
On June 5, 2003, the Company signed and executed an agreement pertaining to the payment of amounts owed to a current service provider. Under the terms of the agreement, the Company issued 427,419 shares of its unregistered common stock, with registration rights, for full payment of $132,500 owed to the service provider. The fair value of the 427,419 shares of unregistered common stock was estimated at $149,597, based on the traded value of the Company’s common stock on the date the settlement agreement became effective. The difference between the estimated fair value of the 427,419 unregistered common shares and the recorded value of the liability of $132,500 was recorded as a settlement loss of $17,097. The service provider has contractually agreed to sell no more than 5,000 shares in any one (1) business day.
On August 29, 2003, the Company signed and executed an agreement pertaining to past due amounts owed to a current service provider totaling $62,500. Under the terms of the agreement, the service provider agreed to forgive $14,500 of the total past due amounts. The remaining amount due of $48,000 is to be paid in twelve-monthly installments of $4,000 each. The non-cash settlement gain resulting from this transaction totaled $14,500.
During 1999, the Company entered into an agreement with Raytheon Company (“Raytheon”) to repurchase 1,533 shares of its common stock from Raytheon for an aggregate value of $268,373, of which $268,075 represented a termination fee for a development contract and $298 represented the fair value of the shares repurchased. In connection with this agreement, the Company entered into a promissory note with Raytheon whereby the Company agreed to pay approximately $10,000 per month over a 27-month period to fund this transaction. The Company did not make all required monthly installments and thus defaulted on the promissory note. Consequently, the note began accruing interest at 18% per annum. On September 30, 2003, the Company executed a settlement agreement with Raytheon whereby both parties agreed to the following terms.
$ 49,128 of the total balance due was forgiven by Raytheon, resulting in a portion of the settlement gain of this transaction.
$87,516 of the total balance due will be paid over a 22 month period, with an initial payment of $10,000; six (6) equal monthly installments of $3,000; fourteen (14) monthly installments of $4,000; and one final installment of $3,516. The settlement agreement did not provide for an interest rate component pertaining to the 22-month payment plan. Therefore, an interest rate of 20% per annum was used to present value the note, resulting in a net present value of $74,306. The difference between the face value of $87,516 and the net present value of $74,306, totaling $13,210 was recorded as a portion of the settlement gain. The 20% rate of interest was considered appropriate to fair value the note based on the Company’s financial condition, including its negative working capital and negative net worth position. In the event that the Company fails to make a scheduled payment as set forth in this settlement agreement, Raytheon may execute on a consent judgment and seek to satisfy the judgment from the assets of the Company in accordance with the laws of the State of North Carolina.
The remaining amount of the recorded liability due to Raytheon of $87,516 was satisfied through the issuance to Raytheon of 295,662 shares of the Company’s unregistered common stock, with registration rights. The fair value of the 295,662 shares of unregistered common stock was estimated at $94,613, based on the traded value of the Company’s common stock on the date the settlement agreement became effective. The difference between the estimated fair value of the 295,662 unregistered common shares and the recorded value of the liability of $87,516, totaling $7,097, was recorded as an offset to the settlement gain. Raytheon has contractually agreed to sell no more than 15,000 shares in any one (1) business day.
Therefore, the aggregate settlement gain resulting from this transaction totaled $55,241.
During 2003, the Company issued 333,333 warrants to purchase common stock to a consultant as payment for $200,000 of fees. The warrants were valued at $83,333 using the Black-Scholes option-pricing model. The non-cash settlement gain resulting from this transaction totaled $116,667.
On August 29, 2003, the Company signed and executed an agreement pertaining to past due amounts owed to a current service provider totaling $62,500. Under the terms of the agreement, the service provider agreed to forgive $14,500 of the total past due amounts. The remaining amount due of $48,000 is to be paid in twelve-monthly installments of $4,000 each. The non-cash settlement gain resulting from this transaction totaled $14,500.
The total aggregate settlement gain resulting from these transactions in 2003 was $1,525,698 and has been recorded as a reduction to the Company’s operating expenses in the Company’s Statement of Operations for the year ended December 31, 2003.
Net Loss. As a result of the factors discussed above, the net losses for the years ended December 31, 2003 and 2002 were $3,877,301 and $8,571,084, respectively.
Year ended December 31, 2002 compared to Year ended December 31, 2001
Revenues. Total revenues decreased $342,806 to $406,952 in the year ended December 31, 2002, down 45.7% from $749,758 in the year ended December 31, 2001. The decrease in revenues primarily resulted from a shift in the Company’s focus from providing governmental contract services and the commercial licensing of technology to developing solutions for the mobile and wireless market during the first quarter of 2002.
During the first quarter of 2002, most of the Company’s resources were used to provide governmental contract services generating revenues of $118,343 and to license technology generating license fees of $84,476. All revenue earned during the year ended December 31, 2001 resulted from providing governmental contract services and licensing technology.
Commencing in the second quarter of 2002, the Company’s resources were dedicated to the development of solutions for the mobile and wireless markets. Revenues earned from providing these services totaled $204,133, which included $100,000 earned under a strategic partnership agreement where the Company provided its expertise to assist its partner in the development of market and business plans and opportunities in the wireless and mobile market, $55,980 earned under non-recurring engineering agreements and licensing agreements, and $48,153 earned from the deployment of wireless applications.
Cost of Revenues. Total cost of revenues decreased $117,445 to $182,109 in the year ended December 31, 2002, down 39.2% from $299,554 in the prior year. The decrease in cost of revenues primarily resulted from a shift in the Company’s focus from providing governmental contract services and the commercial licensing of technology to developing solutions for the mobile and wireless market during the first quarter of 2002.
Costs of providing governmental contract services and license fees during the first quarter of 2002 and for the year ended December 31, 2001 were comprised primarily of salaries and related costs of providing government contract services. Specific costs of license-fee revenue have historically been insignificant and not separately maintained.
Commencing in the second quarter of 2002, costs of revenues were primarily comprised of direct costs associated with the sale and delivery of our solutions for the mobile and wireless market. These costs consisted primarily of fixed costs consisting of monthly third-party hosting fees.
Gross Profit. Total gross profit decreased $225,361, or 50.1%, to $224,843 for the year ended December 31, 2002, compared with $450,204 for the year ended December 31, 2001. The decrease in gross profit primarily resulted from a shift in the Company’s focus from providing governmental contract services and the commercial licensing of technology to developing solutions for the mobile and wireless market during the first quarter of 2002.
Gross profit resulting from governmental contract services and commercial licensing of technology during the year ended December 31, 2002, totaled $138,973 or 68.5% compared to $450,204 or 60.1% in the prior year. The increase was primarily attributable to more license-fee income earned in the year ended December 31, 2002 compared to the prior year. License-fee income generates a higher gross profit percentage compared to contract revenues.
Gross profit resulting from the development and deployment of solutions for the mobile and wireless market during the year ended December 31, 2002, totaled $85,870, or 42.1%. The gross profit resulting from these activities is a result of deducting costs that are primarily fixed in nature, primarily third-party hosting fees, from the related earned revenue.
Selling, General and Administrative Expenses. Selling, general and administrative expenses consist primarily of salaries, consulting fees, office operations, administrative and general management activities, including legal, accounting and other professional fees. Selling, general and administrative expenses for the year ended December 31, 2002, were $6,155,416, compared to $7,740,867 for the year ended December 31, 2001. The decrease in selling, general and administrative expenses during the year ended December 31, 2002, as compared to the prior year, reflect the cost reduction efforts during 2002, offset by additional cost associated with the launching of the first commercial applications in the mobile and wireless market. Selling, general and administrative expenses for the year ended December 31, 2001, include legal and administrative costs associated with the Company’s efforts to regain its listing status on the OTC bulletin Board. Similar costs were not incurred in 2002.
Non-Cash Compensation. Non-cash compensation for the year ended December 31, 2002 was $364,000 compared to $956,321 for the prior year. Non-cash compensation for the year ended December 31, 2002 of $364,000 reflects $202,642 of amortization of deferred compensation resulting from stock options granted in prior years, at prices below the fair value of the underlying common stock. The remaining amount of $161,358 reflects stock options that were granted to an employee, who was also a director of Summus, with exercise prices below the estimated fair value of the underlying common stock.
Non-cash compensation for the year ended December 31, 2001, was $956,321. During the year ended December 31, 2001, stock options, net of forfeitures, were granted to employees with exercise prices below the fair market value of the underlying common stock resulting in total compensation of $864,164, of which $754,164 was charged to expense during the year ended December 31, 2001. The remaining amount, $110,000, has been classified as deferred compensation and is being charged to expense as future vesting of the stock options occurs. The remaining amount of non-cash compensation for the year ended December 31, 2001 of $202,157 reflects the amortization of deferred compensation resulting from stock options granted during the year ended December 31, 2000, with exercise prices below the fair value of the underlying common stock.
Research and Development. Research and development costs for the year ended December 31, 2002, were $918,948 compared to $952,605 for the prior year. The decrease in these costs was due primarily to a reduction in the staffing level during 2002 compared to the prior year. Included in the research and development costs in 2001, is $337,451 in previously capitalized software development costs that were written off in the fourth quarter of 2001.
Non-Cash Consulting Expense. Non-cash consulting expense for the year ended December 31, 2002, in the amount of $887,992 is attributable to the following: (1) the issuance of 394,567 shares of unregistered common stock and 453,532 options and warrants to purchase unregistered common stock to consultants for services valued at $765,477; (2) stock options granted to three new members of our Advisory Board during the year ended December 31, 2002, resulting in non-cash consulting expense of $97,515; and (3) a stock option granted to a member of our Advisory Board for consulting services resulting in non-cash consulting expense of $25,000 during the year ended December 31, 2002. The value, as determined using the Black-Scholes pricing model, of the stock options granted to consultants, including the members of the Board of Advisors, was recorded using the fair value method of accounting.
Non-Cash Settlements. Non-cash settlements for the year ended December 31, 2001, in the amount of $1,132,352, are attributable to the settlement of claims of Van Ernst Jakobs N.V. valued at $1,051,915 and the settlement of the ENELF LLC lawsuit valued at $80,437. For further disclosure, see footnote 17 to the audited consolidated financial statements included in this report.
Net Interest Income (Expense). Net interest expense for the year ended December 31, 2002, was $469,571, compared to net interest expense of $56,570 for the corresponding period of the prior year. Net interest expense for the year ended December 31, 2002, includes interest costs associated with capital lease obligations and note payable agreements of $49,321, plus the following items associated with the convertible debentures issued on July 19, 2002:
$190,000, relating to the value, as determined by the Black-Scholes pricing model, of the 1,724,138 warrants issued to the debenture holders;
$189,655, relating to the value of the beneficial conversion feature associated with the convertible debentures;
$39,310, relating to placement agent fees, consisting of a cash commission of $30,000 and a warrant to purchase 51,724 shares of common stock that was valued at $9,310 using the Black-Scholes pricing model; and
$1,285, relating to interest expense incurred while the debentures remained outstanding based on the stated rate of 6% per annum. At the Company’s election, these interest costs were paid through the issuance of shares of common stock based on the conversion rate of $0.29, resulting in the issuance of 4,430 shares of common stock.
The value of the warrants issued to the debenture holders was initially recorded as a discount to the $500,000 face value of the debentures. This discount was to be amortized to interest expense over the term of the debentures. Since all of the debentures were converted into common stock during the year ended December 31, 2002, the total value assigned to the warrants was fully amortized to interest expense during the year. The beneficial conversion feature was recorded since the conversion price of the debentures was below the fair market value of our common stock on the date the convertible debentures were issued. This non-cash charge was recorded immediately as interest expense because the debentures were convertible upon issuance.
Net interest expense for the year ended December 31, 2001, includes interest costs associated with capital lease obligations and note payable agreements of $56,750.
Loss from Discontinued Rich Media Direct Operations. Summus recorded a loss from operations of its “Rich Media Direct” business of $135,798, as well as a loss on disposal of these operations of $215,500, for the year ended December 31, 2001. Our divestiture of this business includes the sale of Douglas May & Co. to Mr. May on September 19, 2001.
Net Loss. As a result of the factors discussed above, the net losses for the years ended December 31, 2002 and 2001 were $8,571,084 and $10,739,809, respectively.
Liquidity and Capital Resources
As of December 31, 2003, we had $2,188,645 of cash on hand, working capital of approximately $305,958, and approximately $2,378,981 in current liabilities. During 2003, we funded our operations primarily through: (1) the sale of 2,704,153 shares of our restricted common stock and warrants to purchase 316,000 shares of common stock to individual accredited investors, for gross cash proceeds of $1,337,582; (2) the sale of 1,310 shares of our unregistered Series C convertible preferred stock along with warrants to purchase 5,240,000 shares of the unregistered common stock to individual accredited investors for gross proceeds of $1,310,000; (3) the sale of 4,000 shares of our unregistered Series D convertible preferred stock along with warrants to purchase 10,000,000 shares of the unregistered common stock to individual accredited investors for gross proceeds of $4,000,000; and (4) the sale of 200 shares of our unregistered Series E convertible preferred stock along with warrants to purchase 500,000 shares of the unregistered common stock to individual accredited investors for gross proceeds of $200,000.
We anticipate that the sale of our equity securities will continue to represent the primary source of our liquidity until we obtain funding from institutional sources and generate positive cash flow from operations. We are currently discussing funding with various institutional investment groups; however, we cannot guarantee that we will be able to raise 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 our capital stock to finance our business plan will dilute our existing shareholders’ ownership. Our continuation as a going concern depends on our ability to generate sufficient cash flow to meet our obligations on a timely basis, to obtain additional financing as may be required and ultimately to attain profitability. In light of our financial condition and operating losses, our auditors have included in their report on our audited consolidated financial statements an explanatory paragraph which expresses substantial doubt about our ability to continue as a going concern.
Through the end of 2003, we had entered into settlement agreements or arrangements with several of our vendors under which such vendors have agreed to our payment of less than the amounts due, the extension of payment terms by between 9-36 months and/or the satisfaction 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 required payments established under settlement agreements previously arranged with certain vendors. We continue to communicate with our vendors to keep them informed of our situation and discuss payment arrangements amiable to both parties under the current circumstances. Additionally, as of December 31, 2003, we had approximately $1.35 million in accounts payable, of which approximately $0.8 million were greater than 90 days old.
As of the date of this report, we are a party to one unsettled lawsuit, whereby the claimant has sued us for non-payment of services provided to the Company. The aggregate value of this claim is $276,374 (which has been accrued), plus interest. Summus has disputed the total amount claimed and is in the process of attempting to negotiate a settlement with the creditor.
Commencing August 15, 2002, the Company adopted an alternative compensation arrangement for its executives. Under the terms of the new arrangement, electing executives may receive a portion of their annual cash compensation in the form of fully vested stock options. The stock options will have an exercise price equal to the fair market value of the Company’s common stock based on the closing prices of the common stock at the end of each respective payroll period. The amount of compensation to be received in stock options (the “target compensation”) is to be determined by the participating executive based on increments of 5% commencing with a minimum level of 15% of the participant’s annual compensation. The number of shares underlying each option will be determined by dividing the dollar value of the target compensation by the closing price at the end of each respective payroll period. Once this election is made, it will remain effective for a minimum of three months and can be terminated early at the full discretion of the Company. Beginning on August 15, 2002, five executives elected to participate in this alternative payment plan at reduced salary levels ranging between 25% and 35% of the participant’s annual compensation. During the years ended December 31, 2003 and 2002, the Company issued 490,292 and 241,431, respectively, fully vested stock options with exercise prices ranging between $0.23 and $0.51 per share under this plan. As of the date of this filing, there are not any executives participating in this arrangement.
The success and growth of our business is dependent in large part on our ability to partner and develop relationships within the wireless industry. In order for us to execute on our business plan, we anticipate that it will require approximately $2.0 to $3.0 million in working capital within the next 12 months to achieve positive cash flow, bring additional applications to market and continue the rollout of our operations. We are currently discussing funding with various institutional investment groups; however, we cannot guarantee that we will be able to raise 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 our capital stock to finance our business plan will dilute our existing shareholders’ ownership.
Subject to our liquidity constraints (including our need to dedicate cash flow to meet our obligations on a timely basis), 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
the marketing of those applications to lay the foundation of future substantial revenue generation.
Cash Flow used in Operating Activities. Net cash used in operating activities was $5,221,600 in the year ended December 31, 2003, compared to $6,794,822 in the prior year. The decrease in net cash used in operating activities was primarily due to a decrease in the net loss for 2003 as compared to 2002, resulting primarily from decreases in operating costs and payments of outstanding vendor obligations. The Company has increased efforts on reducing operating expenses. In addition, cash collections have increased with the corresponding increase in revenues.
Cash Flow from Investing Activities. Net cash provided by investing activities was $949 in the year ended December 31, 2003, representing the net of computer equipment purchases and proceeds received from sale of equipment and furniture. Net cash used in investing activities was $91,212 in the year ended December 31, 2002, representing computer equipment purchases.
Cash Flow from Financing Activities. Net cash provided by financing activities was $7,383,306 in the year ended December 31, 2003, compared to net cash provided by financing activities of $6,796,052 in the prior year. Net cash provided by financing activities in the year ended December 31, 2003 related to:
sale of 2,704,153 shares of unregistered common stock, along with warrants to purchase an additional 316,000 shares of common stock, and the repricing of 6,609,645 previously issued warrants. These transactions were in two forms. The first form involved purchases of common stock at prices which were above the traded 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 the exercise price of previously issued warrants if the holder exercised those repriced warrants immediately. The original exercise prices of the repriced warrants ranged between $0.60 and $5.25, per share. The repriced exercise prices ranged between $0.20 and $1.69, per share. Total cash proceeds from the sale of the shares and issuance of the new warrants were $1,337,582;
sale of 1,310 shares of unregistered Series C convertible preferred stock, along with warrants to purchase an additional 5,240,000 shares of common stock for gross proceeds of $1,310,000;
sale of 4,000 shares of unregistered Series D convertible preferred stock, along with warrants to purchase an additional 10,000,000 shares of common stock for gross proceeds of $4,000,000;
sale of 200 shares of unregistered Series E convertible preferred stock, along with warrants to purchase an additional 500,000 shares of common stock for gross proceeds of $200,000;
issuance of 3,491,243 shares of unregistered common stock upon the exercise of warrants with exercise prices ranging from $0.20 to $0.50 per share. Of the 3,491,243 exercised warrants, 2,881,343 were exercised in connection with the repricing of the exercise price of the warrants as described in the previous paragraph. The initial exercise prices of the warrants ranged between $0.60 and $5.25. The repriced exercise prices ranged between $0.20 and $1.69. The exercise of these warrants generated gross proceeds of $928,675;
payment of stock issuance costs of $184,515; and
principal payments on notes payable and capital lease obligations of $208,436.
Net cash provided by financing activities in the year ended December 31, 2002, related to:
sale of 9,053,167 shares of our common stock, along with warrants to purchase an additional 17,779,104 shares of common stock, at exercises prices ranging aggregate from $0.48 to $4.00 per share, along with cash collections on a stock subscription receivable totaling $10,000, generating proceeds of $6,449,307;
issuance of 6% convertible debentures, along with warrants to purchase an additional 1,724,138 shares of common stock, at exercise prices ranging from $0.47 to $0.59 per share generating aggregate gross proceeds of $500,000;
proceeds from exercise of stock options of $12,750 for 290,300 shares of common stock and the proceeds from the exercise of stock purchase warrants of $79,813 for 189,624 shares of common stock; and
principal payments on notes payable and capital lease obligations of $245,818.
Significant Concentrations
For the year ended December 31, 2003, one customer accounted for 45% and 59% of the Company's consolidated revenues and accounts receivable, respectively. Should this wireless carrier discontinue the demployment of the Company's applications, the Company's business would be adversely affected.
New Accounting Pronouncements
In January 2003, the EITF published EITF Issue 00-21, "Revenue Arrangements with Multiple Deliverables," which requires companies to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. In applying EITF Issue 00-21, revenue arrangements with multiple deliverables should be divided into separate units of accounting if the deliverables in the arrangement meet certain criteria. Arrangement consideration should be allocated among the separate units of accounting based on their relative fair values. EITF Issue 00-21 is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of EITF Issue 00-21 is not expected to have a material impact on the Company's financial statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities", which addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. The Interpretation applies immediately to variable interests in variable interests entities created after January 31, 2003, and to variable interest in variable interest entities obtained after January 31, 2003. The adoption of this Interpretation did not have an impact on the Company's financial statements. The Interpretation becomes effective for entities created before February 1, 2003 as of the beginning of the first period after December 15, 2003. We do not anticipate the application of this provision of the Interpretation to have a material impact on the Company's financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity." SFAS No. 150 establishes standards for how an issuer of financial statements classifies and measures certain financial instruments that have characteristics of both liabilities and equity. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 did not have a material impact on the Company's financial statements.
Description of Critical Accounting Policies
The preparation of our financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and judgments that affect our reported amounts of assets and liabilities, revenues and expenses. We have identified the following critical accounting policies that affect the more significant estimates and judgments used in the preparation of our financial statements. On an ongoing basis, we evaluate our estimates, including those related to the matters described below. These estimates are based on the information that is currently available to us and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could vary 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 revenue recognition policies and giving consideration to guidance provided for in Emerging Issues Task Force No. 99-19 Reporting Revenue Gross as a Principal versus Net as an Agent (“EITF 99-19”), the Company has changed certain revenue recognition policies affecting revenues earned by wireless applications and contracts. Prior to 4th quarter 2003, the Company reported revenues earned by wireless applications and contracts and cost of revenues for wireless applications and contracts net of certain third-party costs in the statement of operations. These transactions have been reclassified to reflect a gross revenue presentation with no effect on gross profit or net loss. The amount by which revenues and costs of revenues have been reclassified for the year ended December 31, 2003 is $635,989. Revenues and costs of revenues for 2002 have not been reclassified due to immateriality.
Wireless applications and contracts
Commencing during the second quarter of 2002, our resources were dedicated to the development of solutions for the mobile and wireless markets. Revenues earned from wireless applications are recognized upon delivery and acceptance by the end-user either as a one-time purchase or a monthly subscription. For content delivery partner arrangements, whereby the Company remits a portion of the revenues earned through the sale of the Company’s applications, revenue is recorded on a gross basis in accordance with EITF 99-19. The Company recognizes the cost of revenue share payments to the content providers as a cost of revenues. Wireless applications and contracts cost of revenues includes all third-party hosting, testing and/or carrier distribution fees. These costs are incurred on a monthly basis and are primarily fixed in nature regardless of the revenue generated by the related applications.
During January of 2002, the Company entered into a strategic partnership agreement with a global leader in semiconductor, telecommunication and digital convergence technology, related to the mobile and wireless markets for which it received $100,000. Revenue earned under this agreement was recognized ratably over the twelve-month term of the agreement.
Periodically, we enter into non-recurring engineering arrangements with our content partners. Generally, under the terms of these agreements, we receive funding upfront to complete projects. The funding we receive upfront is recorded as deferred revenue and is recognized as revenue under the terms of the individual arrangements. Deferred revenue represents amounts received for which the Company has not yet completed its contractual obligations.
Wireless License Fees
We recognize revenue from licensee fees for wireless software applications in accordance with the provisions of AICPA Statement of Position 97-2, “Software Revenue Recognition”, as amended by AICPA Statement of Position 98-9 “Modification of SOP No. 97-2 Software Revenue Recognition with Respect to Certain Transactions.” Revenue from software license fees is generally recognized upon delivery provided that a contract has been executed, the vendor fee is fixed or determinable, no significant vendor obligations or uncertainties surrounding customer acceptance remain, and collection of the resulting receivable is deemed probable.
There were no costs related to the wireless license fee revenue generated during the year ended December 31, 2003 as the license fee revenue related to technology that had been previously developed by the Company, and there were no costs for installation, delivery or customization, or other related costs.
Contracts and license fees
We derive certain revenues primarily from research and development contracts for governmental agencies and the commercial licensing of our technology. We recognize revenue on these contracts at the time services are rendered based upon the terms of individual contracts. Regarding the commercial licensing of our technology, we follow the provisions of AICPA Statement of Position 97-2, “Software Revenue Recognition”, as amended by AICPA Statement of Position 98-9 “Modification of SOP No. 97-2 Software Revenue Recognition with Respect to Certain Transactions.” Revenue from software license fees is generally recognized upon delivery provided that a contract has been executed, the vendor fee is fixed or determinable, no significant vendor obligations or uncertainties surrounding customer acceptance remain, and collection of the resulting receivable is deemed probable.
Valuation of Equity Instruments
We have utilized our equity securities, including unregistered common stock and options/warrants to purchase unregistered common stock, to pay for services and to settle obligations owed to or claimed by creditors. The issuance of equity instruments as payment for services rendered to Summus results in the recording of non-cash compensation or consulting expense as the services are performed. We utilize the Black-Scholes option-pricing model to determine the value of options or warrants issued as payment for services. Underlying the Black-Scholes option-pricing model are several assumptions that are evaluated by management and include: (1) a dividend yield; (2) a common stock volatility factor; (3) the risk-free interest rate; and (4) the expected life of the option or warrant. Management evaluates each of these assumptions on a periodic basis in order to determine the value of the equity instruments used as payment for services as well as to record the associated expense. As conditions change, our evaluation of the assumptions underlying the Black-Scholes option-pricing model may change resulting in differing values of equity instruments issued for services between reporting periods.
FACTORS THAT MAY AFFECT OUR BUSINESS, FUTURE
OPERATING RESULTS AND FINANCIAL CONDITION
An investment in our common stock involves a high degree of risk. You should carefully consider the following risks before making an investment decision. You should also refer to the other information set forth in this annual report on Form 10-K, including our financial statements and the related notes.
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If we are unable to obtain substantial additional financing we may not be able to remain in business.
We require substantial working capital to fund and sustain our business operations. For us to implement our business plan, we anticipate that we will need approximately $2 million to $3 million in additional working capital in the next twelve months. If adequate funds are not available or are not available on acceptable terms, we may be unable to develop further or enhance our products and services, take advantage of future opportunities, respond to competitive pressures or continue in business.
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Our past and potential future issuances of equity securities have diluted and may continue to materially dilute the interests of holders of our common stock.
Because of severe liquidity constraints, we have issued equity securities in several instances in lieu of effecting payment in cash of amounts due (or alleged to be due) vendors, consultants, current and former officers and directors, and shareholders.
In addition, we have the ability to issue options and other stock-based awards under our Amended and Restated 2000 Equity Compensation Plan to directors, officers, employees and consultants, and have reserved up to 8,500,000 shares of our common stock under the plan, 6,993,202 of which have been granted as of March 15, 2004. We also have outstanding warrants for 44,556,228 shares of our common stock as of March 15, 2004.
Issuances of certain shares of our common stock or other equity interests have been at (or are exercisable for) a price that represents a discount to the then traded value of our common stock. In any event, past and anticipated future issuances of additional shares of our common stock or other equity interests have and will continue to dilute the proportional ownership interests of existing shareholders.
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If we are successful in raising additional capital through the issuance of equity securities, our shareholders may experience substantial dilution.
Our primary source of funding for our operations comes from the issuance of shares of our common stock in private placements to investors. The Company currently has 185,000,000 shares of common stock authorized for issuance. As of March 15, 2004, the Company has approximately 141,934,931 shares of its common stock either issued and outstanding or reserved for issuance as follows:
71,277,220 shares are issued and outstanding;
44,556,228 are reserved for the issuance of shares underlying warrants;
163,678 are reserved for the conversion of 2,078 shares of the Company’s Series A Stock, plus accrued but unpaid dividends;
5,240,000 are reserved for the conversion of 1,310 shares of the Company’s Series C Stock;
12,625,000 are reserved for the conversion of 2,525 shares of the Company’s Series D Stock;
650,000 are reserved for the conversion of 130 shares of the Company’s Series E Stock;
6,993,202 are reserved for issuance in connection with the outstanding options granted under the Company’s Amended and Restated 2000 Equity Compensation Plan; and
429,603 are reserved for issuance in connection with outstanding options granted outside of the Company’s Amended and Restated Equity Compensation Plan.
If we are successful in our capital raising efforts, existing shareholders will almost certainly experience dilution of their percentage ownership interests in Summus. In addition, the new equity securities may have rights, preferences or privileges senior to those of existing holders of shares of our common stock.
If we raise additional capital in conjunction with entering into strategic alliances or licensing our technology to wireless carriers, wireless and mobile device manufacturers, or content providers, we may be required to relinquish some rights to our technologies or products, or grant licenses on terms that are not favorable to us.
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We have incurred substantial losses and expect to continue to incur substantial net losses for the foreseeable future.
We have generated (and expect to continue to generate in the foreseeable future) operating losses and negative cash flow. We had net losses, including non-cash charges for stock-based employee compensation and non-cash consulting expenses, of approximately $305,000 and $1,252,000 for the fiscal year periods ended December 31, 2003 and December 31, 2002, respectively. As of December 31, 2003, we had an accumulated deficit of $50,396,562 and working capital of $305,958. As a result, we will need to generate significant revenues to be profitable in the future. In light of our financial condition and operating results, our auditors have included in their report on our consolidated financial statements an explanatory paragraph, which expresses substantial doubt about our ability to continue as a going concern.
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We have a limited operating history and have achieved limited revenues from our operations.
We have a limited operating history and have generated limited revenue from our operations. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by growing companies in new and rapidly evolving markets. We will need to increase significantly our revenues to achieve and maintain profitability. We believe that increasing our revenues will depend in large part on our ability to:
raise additional capital;
deploy our applications and our BlueFuel platform;
generate significant revenue from the sale of our applications using our BlueFuel platform and licensing of BlueFuel and related products and services;
maintain and enhance our brand name;
establish and maintain broad market acceptance for our products and then increase our market share based upon the timing, strength and success of our sales efforts and our ability to enter into strategic and commercial alliances;
convert the acceptance for our products and services into direct and indirect sources of revenue;
develop effective marketing and other promotional activities to penetrate our target customer base;
develop and maintain strategic and commercial relationships that balance our current and long-term ability to capitalize on our technology and solutions approach;
generate and sustain substantial revenue growth while maintaining reasonable expense levels; and
continue to timely and successfully develop new products, product features and services; and increase the functionality and features of existing products and services.
If our revenues grow more slowly than anticipated or if operating expenses increase more than expected, or are not reduced sufficiently, we may never achieve profitability. If we achieve profitability, we cannot be certain that we will be able to sustain or increase that profitability in the future.
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Our limited operating history makes it difficult to evaluate our business and prospects.
For the fiscal year ended December 31, 2003, we had revenues of $1,699,274, of which $1,395,296 relate to the wireless and mobile market. For the fiscal year ended December 31, 2002, we had revenues of $406,952, of which $204,133 relates to the wireless and mobile market. We have only a limited operating history upon which you may evaluate our business and prospects. You should consider our prospects in light of the heightened risks and unexpected expenses and difficulties frequently encountered by companies in an early stage of development. These risks, expenses and difficulties, which are described further in this “Risk Factors” section, particularly apply to us because the mobile and wireless market (i.e., the market for remote access and processing of information resources via small handheld wireless devices) is very much in its infancy and is likely to rapidly evolve.
Successfully commercializing our applications using BlueFuel, as well as our other current and contemplated products will entail significant sales and marketing, competitive, technological and financing risks. We believe our efforts to negotiate and enter into strategic relationships will enable us to market and deploy our products on a commercial basis. These operations provide limited information for you to consider in assessing an investment in our common stock.
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Our operating results are likely to fluctuate significantly, which may cause our stock price to fluctuate.
As a result of our relatively brief operating history and the rapidly changing and uncertain nature of the markets in which we compete, our quarterly and annual revenues and operating results are likely to fluctuate from period to period, and period to period comparisons are not likely to be meaningful. These fluctuations are caused by a number of factors, many of which are beyond our control. Our future operating results could fall below the expectations of public market analysts or investors, which could significantly reduce the market price of our common stock. Fluctuations in our operating results will likely increase the volatility of our stock price. Our research and development and sales and marketing efforts, and other business expenditures generally, are partially based on predictions regarding certain developments for wireless handset availability and carrier deployment of data services. To the extent that these predictions prove inaccurate, our revenues may not be sufficient to offset our expenditures, and our operating results may be harmed.
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A substantial portion of our revenues are derived from our relationship with Verizon Wireless, and the termination or alteration of our contract with Verizon could materially and adversely affect our business.
In fiscal year 2003, we derived approximately 55% of our wireless application revenue from our relationship with Verizon Wireless. If this contract were to be terminated or altered, our business would be materially and adversely affected.
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If our BREW developer agreement with Qualcomm were terminated, it would have a material and adverse effect on our business.
In fiscal year 2003, we derived approximately 90% of our revenues from BREW services offered by a number of BREW carriers in North, South and Central America. Access to these BREW services is enabled through Summus' relationship with Qualcomm. If Summus' agreement with Qualcomm were terminated, Summus' access to BREW services would be materially and adversely affected.
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The price of our common stock has been and may continue to be volatile.
The trading price of our common stock has been and is likely to continue to be highly volatile. Our stock price could be subject to wide fluctuations in response to factors such as:
actual or anticipated variations in quarterly operating results;
announcements of technological innovations, new products or services by us or our competitors;
changes in financial estimates or recommendations by securities analysts;
the addition or loss of strategic relationships or relationships with our key customers;
conditions or trends in the wireless markets;
announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments or of significant new product developments or changes in business strategy;
legal, regulatory or political developments;
additions or departures of key personnel; and
general market conditions.
In addition, the stock market in general, and the OTC Bulletin Board and the market for wireless, wireless-related and technology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of these companies. These broad market and industry factors have in the past and may in the future reduce our stock price, regardless of our operating performance.
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The sale of a large number of shares of our common stock could depress our stock price.
Of the 71,277,220 shares of our common stock outstanding as of March 15, 2004, an aggregate of 38,705,484 shares are freely tradable without restriction in the public market unless the shares are held by "affiliates," as that term is defined in Rule 144(a)(1) under the Securities Act of 1933.
In addition, as of March 15, 2004, there were outstanding warrants to purchase 44,556,228 shares of our common stock and options to purchase 7,422,805 shares of our common stock, 7,004,410 of which were fully vested. The Company has also currently issued:
2,078 shares of its Series A Stock, plus accrued and unpaid dividends, which are convertible into 161,246 shares of the Company’s common stock;
1,310 shares of its Series C Stock, which are convertible into 5,240,000 shares of the Company’s common stock;
2,525 shares of its Series D Stock, which are convertible into 12,625,000 shares of the Company’s common stock; and
130 shares of its Series E Stock, which are convertible into 650,000 shares of the Company’s common stock.
The market price of our common stock could decline as a result of sales of a large number of shares of our common stock in the market, or the perception that such sales could occur. These sales might also make it more difficult for us to sell equity securities in the future at a price that we think is appropriate, if at all. A large volume of sales by the selling shareholders could have a significant adverse impact on the market price of our common stock.
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The mobile and wireless multimedia industry is new and rapidly evolving, and we may not be able to accurately predict its size, needs, development or rate of growth.
The market for our software and technologies is new and rapidly evolving. Wireless service providers are only beginning to offer commercial services that could result in utilization of our software. As a result, we cannot assess current or future demand for remote management of resources, the creation and interaction with multimedia content via cellular handsets and other mobile devices, and enhanced quality of remote communications. We also do not know whether this market will be large enough to sustain our business. We may not be able to develop and introduce software, software enhancements or services that respond to market demands, technology developments, increased competition or industry standards on a timely basis, or at all. If this market does not evolve in the manner or in the timeframe that we anticipate, or if we are unable to respond to new market developments promptly, our business and prospects may suffer.
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The success of our business will greatly depend on 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.
Our business will depend on our ability to develop relationships and enter into agreements with companies in key industry groups, including:
wireless service providers that we expect will deploy our technology and products to deliver multimedia content and services to their subscribers;
wireless software providers who will use our BlueFuel platform to develop third-party mobile software;
semiconductor and device designers and manufacturers that we expect will embed our technology and products in their products to enable the viewing of multimedia content; and
content providers that we expect will rely on our technology and products to deliver multimedia content over wireless networks.
We will need to enter into contractually binding agreements with wireless service providers, device manufacturers, and content providers in order to generate any significant revenues from our technology and product applications. If we are unable to establish a sufficient number of strategic relationships and enter into contractual arrangements on terms commercially favorable to us, our business, revenue, and prospects are likely to be adversely affected.
Ø
Our business will depend on wireless service providers deploying our BlueFuel software and related applications, and on their subscribers' demand for such applications.
Our success will depend heavily on timely deployment by wireless service providers of our applications using our BlueFuel product suite in their networks. Wireless service providers may not deploy, or may be slow in deploying, our software due to a number of factors including the availability of competing products, lack of subscriber demand, as well as interoperability, implementation, support or maintenance concerns. In addition, if our current applications with wireless service providers are unsatisfactory, they may not deploy our software or may require costly or time-consuming modifications to our software before deployment.
Even if wireless service providers offer content services based on our software, their subscribers may not be willing to buy these services. Subscribers are accustomed to viewing content on the comparatively large displays of television screens and PC monitors and may not be willing to use mobile information devices, which typically have smaller screen sizes, to view content. Additionally, subscribers may not be willing to pay to view content on mobile information devices because this content can be viewed at a lower cost using other connections, such as satellite and wireline connections. Moreover, subscribers may not be willing to purchase new devices or upgrade their existing devices to include multimedia content viewing capability.
Ø
If mobile information devices for delivery of content are not widely adopted or if semiconductor and device designers and manufacturers fail to embed our BlueFuel technology in their products, our business will be harmed.
We believe that mobile information devices will be the principal means for the wireless delivery of content. Only a small percentage of these devices are currently capable of receiving and displaying content. In order to enhance the viewing of such content, new or upgraded devices that offer more advanced displays and support higher bandwidth wireless services are required. If semiconductor and device designers and manufacturers are unable to design, manufacture and widely distribute mobile information devices capable of displaying content in a timely manner, our business will suffer.
We are in the early stages of building relationships with semiconductor and device designers and manufacturers. Even if we secure binding agreements with these designers and manufacturers, they may not produce, promote or sell devices that incorporate our technology and products. If we fail to achieve widespread distribution of our technology and products in mobile information devices, our business and prospects are likely to be adversely affected.
Ø
We may not successfully develop new products and services.
Our growth depends on our ability to continue to develop leading edge wireless delivery and distribution products and services. Our business and operating results would be harmed if we fail to develop products and services that achieve widespread market acceptance or that fail to generate significant revenues or gross profits to offset our development and operating costs. We may not timely and successfully identify, develop and market new product and service opportunities. If we introduce new products and services, they may not attain broad market acceptance or contribute meaningfully to our revenues or profitability. In addition, competitive or technological developments may require us to make substantial, unanticipated investments in new products and technologies, and we may not have sufficient resources to make these investments. If we are unable to be a technological leader in our market, our business is likely to be harmed.
Ø
We have in the past experienced delays in carrier testing and deployment and product releases, and we may similarly experience delays in the release of products and upgrades in the future.
We will need to continue to introduce, on a timely basis, new products and product upgrades to add new features, functionality and technology that our target customer base desires. No assurances can be provided that we will be able to successfully complete the development of currently planned or future products in a timely and efficient manner. Due to the complexity of these products, internal quality assurance testing and customer testing of pre-commercial releases may reveal product performance issues or desirable feature enhancements that could lead us to postpone the release of products or product upgrades. In addition, the reallocation of resources associated with any such postponement would likely cause delays in the development and release of other future products or enhancements to our currently available products. This could have a material adverse effect on our results of operations.
Ø
We face intense competition as a solutions provider in the wireless telecommunications industry.
The wireless communications market is highly competitive. Our failure to establish a customer base as a solutions provider to this industry will adversely affect operating results. The competition with other solutions providers to form alliances with wireless service providers and Internet service providers is significant. The loyalty of wireless industry customers we may obtain could be easily influenced by a competitor's new offerings, especially if those offerings provide cost savings or new methods of compression and multimedia technology applicable to wireless communications. We will face significant competition from traditional telecommunications companies, virtually all of which have greater market share and financial resources than we do. These traditional telecommunications companies are better positioned to finance research and development activities relating to compression and multimedia technology. They are also able to provide a wider range of products and services for a greater spectrum of media and have greater resources with which to purchase additional technologies or acquire other companies.
Ø
If we are unable to compete effectively with existing or new competitors, our resulting loss of competitive position could result in price reductions, fewer customer orders, reduced margins and loss of market share, and our results of operations and financial condition would suffer.
We compete in the handheld device, operating system software and wireless services markets. The markets for these products and services are highly competitive, and we expect competition to increase in the future. Some of our competitors or potential competitors have significantly greater financial, technical and marketing resources than we do. These competitors may be able to respond more rapidly than Summus to new or emerging technologies or changes in customer requirements. They may also devote greater resources to the development, promotion and sale of their products.
Certain competitors may have longer and closer relationships with the senior management of enterprise customers who decide which products and technologies will be deployed in their enterprises. Moreover, these competitors may have larger and more established sales forces calling upon potential enterprise customers and therefore could contact a greater number of potential customers with more frequency. Consequently, these competitors could have a better competitive position than we do, which could result in potential enterprise customers deciding not to choose our products and services, which would adversely impact our business, results of operations and financial condition.
Ø
We expect that the wireless communications industry and its technology will undergo significant change in the foreseeable future. If we do not continuously improve our technology in a timely manner, our products could be rendered obsolete.
The wireless communications industry is experiencing rapid and significant technological change. This change includes the increase in pace of upgrades in existing wireless systems, evolving and constantly changing industry standards, ongoing improvements in the capacity and quality of digital and compression technologies, and changes in consumer needs and preferences. Alternative technologies may develop for the provision of wireless services and other compression technologies to wireless services that are superior to those that we plan to offer to the wireless market. These alternative technologies may render our products and technologies obsolete in the future. Accordingly, our success depends on our ability to adapt to these changes, particularly to develop or adapt products and services or acquire new products and services that can compete successfully. There can be no assurance that we will select and develop appropriate technology and products on a timely basis. Our failure to develop or obtain appropriate technology could adversely affect our ability to be competitive.
Ø
Our products are complex, and we may not be able to prevent defects that could decrease their market acceptance, result in product liability or harm our reputation.
Our technology is complex, and the steps we take to ensure that such technology is free of errors or defects, particularly when first introduced or when new versions or enhancements are released, may not be successful. We cannot guarantee that current or enhanced versions of our products will be free of significant software defects or bugs. Despite our testing, and testing by third parties, current or future products may contain serious defects. Serious defects or errors could result in lost revenue or delay in market acceptance of our products and could seriously harm our credibility and materially affect the market acceptance and sales of our products. The occurrence of these types of problems could materially adversely affect our business, results of operations and financial condition.
Errors in our products may also be caused by defects in third-party hardware or software incorporated into our products. If so, we may be unable to fix these defects without the cooperation of third-party providers. Because these defects may not be as significant to these providers as they are to us, we may not receive the rapid cooperation that may be required to avoid serious harm to our business and operating results. Errors, defects or other performance problems with our products could also harm our customers' businesses or result in potential product liability claims. Even if unsuccessful, a product liability claim brought against us would likely be time-consuming, costly and harmful to our reputation.
Ø
If we endeavor to expand our limited presence in international markets we will become subject to additional business risks.
We may decide to expand what is now a limited presence into international operations. To do so, we would likely have to enter into relationships with foreign business partners. This strategy contains risks, including difficulty in managing international operations due to distance, language and cultural differences, and an inability to successfully market and operate services in foreign markets. There are also risks inherent in doing business on an international level, including unexpected changes in regulatory requirements, trade barriers, difficulties in staffing and managing foreign operations, fluctuations in currency exchange rates, longer payment cycles in general, problems in collecting accounts receivable, difficulty in enforcing contracts, political and economic instability, and potentially adverse tax consequences.
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Regulations governing the wireless communications industry may indirectly adversely affect our business.
The wireless communications industry is subject to regulation by the Federal Communications Commission and various state regulatory agencies. From time to time, legislation and regulations could be adopted that could adversely affect this industry.
Changes in regulatory environments governing the wireless telecommunication industry could negatively affect our plans to offer products and services. The licensing, ownership and operation of wireless communications systems and the grant, maintenance or renewal of applicable licenses and radio frequency allocations are all subject to significant government regulation. Government regulation may have an adverse effect on the wireless telecommunications companies to which we plan to market and sell our products and services under development. Delays in receiving required regulatory approvals and licenses or the enactment of new and adverse regulatory requirements may adversely affect our ability to offer our technology and other new products and services. In addition, legislative, judicial and regulatory agency actions could negatively affect our ability to offer new technologies to wireless telecommunications companies.
Ø
We may acquire technologies or companies in the future, and these acquisitions could dilute the value of our stock and disrupt our business.
We may acquire technologies or companies in the future. Entering into an acquisition entails many risks, any of which could harm our business, including:
diversion of management's attention from other business concerns;
failure to integrate the acquired company with our pre-existing business;
failure to motivate, or loss of, key employees from either our existing business or the acquired business;
inability to incorporate acquired technology into our software;
potential impairment of relationships with our employees and companies with whom we have strategic relationships;
additional operating expenses not offset by additional revenue;
incurrence of significant non-recurring charges; and
dilution of our stock as a result of issuing equity securities.
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We may be unable to adequately protect the intellectual property used in our software.
Currently, we have not been awarded any patents. We have filed for four (4) patents. The first is in the video compression technology area, which incorporated six (6) of our previous provisional patents and for which we abandoned three (3) of our previous provisional patents that contained redundant information to the video patent. The second is in the mobile mapping data area, which incorporated two (2) of our previous provisional patents. We have decided not to proceed on five (5) other provisional patents at this time, but the relevant and important information contained in these provisional patents is protected under trade secrets and by confidentiality agreements. The third is in the image and graphics compression area. The fourth is in the information navigation area. These patent applications may not be granted or, if granted, the resulting patents may be challenged or invalidated. In addition to patents, we rely on copyright and trademark laws, trade secrets, confidentiality provisions and other contractual provisions to protect our proprietary rights. These measures, which require the expenditure of substantial resources, afford our intellectual property only limited protection because our competitors and third parties independently may develop similar technologies or may infringe our intellectual property. Infringement is difficult to detect and costly to prevent. With respect to the protection of our proprietary rights internationally, the laws of some foreign countries may not protect our proprietary rights adequately. In addition, we will not have patent protection in countries where we do not file patent applications. Thus, the measures we are taking to protect our proprietary rights in the United States and abroad may not be adequate and our business may be harmed as a result.
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We may be sued by third parties for infringement of their intellectual property.
The wireless equipment and software industries are subject to frequent intellectual property litigation. As the number of entrants into our target market increases, the likelihood of infringement claims also increases. We may unknowingly be infringing the intellectual property of others. In addition, because patent applications can take many years to be approved, there may be one or more patent applications now pending that could lead to infringement actions against us if issued in the future. If we are unable to successfully defend against a product infringement claim, we may be precluded from using the intellectual property or may have to license it on commercially disadvantageous terms, either of which could harm our business. Even if we successfully defend against an infringement claim, we may have to devote significant time and resources to litigation, which could also harm our business.
Ø
We have been and remain in default for non-payment under several contracts with previous and existing vendors and professional service providers and such parties have sought payment through litigation or otherwise.
As of December 31, 2003, we had approximately $1.35 million in accounts payable, of which approximately $0.8 million were greater than 90 days old.
During 2003, we negotiated new settlement agreements with several vendors and service providers that resulted in a reduction in our recorded liabilities of $2.4 million in 2003 resulting in non-cash settlement gains of approximately $1.5 million. Under these settlement agreements, such vendors agreed to our payment of less than the initial amounts due, the extension of payments terms by up to 36 months and/or the satisfaction of amounts due through a combination of cash and common stock of Summus. We have issued approximately 1.5 million shares of our restricted common stock in connection with these settlement agreements during 2003. There can be no assurance that we will be able to generate sufficient funds in order to stay current under these settlement agreements and arrangements and maintain the scheduled payments thereafter.
If the cash flow from our operating and financing activities is insufficient, we may be required to continue to take actions such as delaying or reducing capital expenditures, attempting to restructure or refinance debt, seeking to have creditors agree to payment in the form of our common stock or other equity securities in lieu of cash, selling assets or operations, or taking measures to reduce our expenses. Any or all of these actions may not be sufficient to allow us to service our debts and other obligations, avoid litigation by creditors or continue in business.
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Our Directors and Executive Officers beneficially own approximately 12.26% of our stock; their interests could conflict with yours; significant sales of stock held by them could have a negative effect on our stock price; shareholders may be unable to exercise control.
As of March 15, 2004, our executive officers, directors and affiliated persons beneficially owned approximately 12.26% of our common stock. As a result, our executive officers, directors and affiliated persons will have significant influence to:
elect or defeat the election of our directors;
amend or prevent amendment of our articles of incorporation or bylaws;
effect or prevent a merger, sale of assets or other corporate transaction; and
control the outcome of any other matter submitted to the shareholders for vote.
Management’s stock ownership may discourage a potential acquirer from making a tender offer or otherwise attempting to obtain control of Summus, which in turn could reduce our stock price or prevent our shareholders from realizing a premium over our stock price.
Ø
We depend on the services of key personnel to operate our business and implement our strategy. If we lose the services of our key personnel or are unable to attract other qualified personnel, we may be unable to implement our strategy.
Our future success depends, in part, on our ability to identify, hire and retain qualified employees. We have at-will employment relationships with our management and other employees. We do not currently maintain any "key person" life insurance policies on any members of management or any other employees. Competition for qualified personnel is intense. If we are unsuccessful in attracting new personnel or retaining and motivating our current personnel, our business could be adversely affected. For information on our key personnel, please see “Item 10 - Directors and Executive Officers of the Registrant” in this annual report on Form 10-K.
Ø
Our failure to attract, train or retain highly qualified personnel could harm our business.
Our success also depends on our ability to attract, train and retain qualified personnel in all areas, especially those with management and product development skills. In particular, we must hire additional experienced management personnel to help us continue to grow and manage our business, and skilled software engineers to further our research and development efforts. At times, we have experienced difficulties in hiring personnel with the proper training or experience, particularly in technical and media areas. Competition for qualified personnel is intense, particularly in high-technology centers such as the Research Triangle, where our corporate headquarters are located. If we do not succeed in attracting new personnel or in retaining and motivating our current personnel, our business could be harmed.
In making employment decisions, particularly in the high-technology industries, our current employees and prospective job candidates often consider the value of stock options they hold or that they may receive in connection with their employment. As a result of recent volatility in our stock price, we may be disadvantaged in competing with companies that have not experienced similar volatility or that have not yet sold their stock publicly.
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Our common stock is subject to "penny stock" rules that may hamper a shareholder’s ability to sell shares of such stock in the secondary trading market.
Federal regulations under the Securities Exchange Act of 1934 (the "Exchange Act") regulate the trading of so-called "penny stocks," which are generally defined as any security not listed on a national securities exchange or NASDAQ, priced at less than $5.00 per share and offered by an issuer with limited net tangible assets and revenues. Since our common stock currently trades on the OTC Bulletin Board at less than $5.00 per share, our common stock is a "penny stock" and may not be traded unless a disclosure schedule explaining the "penny stock" market and the risks associated with such stock is delivered to a potential purchaser prior to any trade.
In addition, because our common stock is not listed on the NASDAQ Stock Market or any national securities exchange and currently trades at less than $5.00 per share, trading in our common stock is subject to Rule 15g-9 under the Exchange Act. Under this rule, broker-dealers must take certain steps prior to selling a "penny stock," which include:
obtaining financial and investment information from the investor;
obtaining a written suitability questionnaire and purchase agreement signed by the investor; and
providing the investor a written identification of the shares being offered and the quantity of the shares.
Because of these requirements, many broker-dealers are unwilling to sell penny stocks at all. If these "penny stock" rules are not followed by the broker-dealer, the investor has no obligation to purchase the shares. The application of these comprehensive rules will make it more difficult for broker-dealers to sell our common stock. Accordingly, you may have difficulty in selling shares of our common stock in the secondary trading market. These rules could also hamper our ability to raise funds in the primary market for our common stock.
ITEM 7A
ITEM 7A . QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We do not use any derivative financial instruments for hedging, speculative or trading purposes. Our exposure to market risk is currently immaterial.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements and supplementary data filed with this report are set forth in the “Index to Consolidated Financial Statements and Schedules” following Part IV of this annual report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.
Not Applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES.
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, within 90 days of the filing date of this report (the “Evaluation Date”). Based upon this evaluation, our principal executive officer and principal financial officer concluded as of the Evaluation Date that our disclosure controls and procedures were effective such that the material information required to the included in our Securities and Exchange Commission (“SEC”) reports is recorded, processed summarized and reported within the time periods specified in SEC rules and forms relating to the Company, including, our consolidated subsidiaries, and was made known to them by others within those entities, particularly during the period when this report was being prepared.
In addition, there were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the Evaluation Date. We have not identified any significant deficiencies or material weaknesses in our internal controls, and therefore there were no corrective actions taken.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Board of Directors
The following table provides information regarding the members of our Board of Directors including their ages, the year they were first elected as directors and the expiration of their terms as directors.
Name
Age
First Year
elected as
Director
Term
Expires
Jere A. Ayers
Stephen M. Finn
Neil R. Guenther
J. Winder Hughes
Bjorn D. Jawerth (1)
N/A
George H. Simmons (2)
N/A
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(1) Dr. Jawerth resigned from the Board of Directors effective March 5, 2004.
(2) Dr. Simmons resigned from the Board of Directors effective January 3, 2004.
Pursuant to a letter agreement between Summus and Hughes Capital Investors, L.L.C. dated September 26, 2003, Summus agreed that (i) upon the receipt by the Company of a minimum of $2,000,000 in equity financing from the Series D convertible preferred stock, being arranged by Hughes Capital, it could nominate one (1) director to the Board of Directors of the Company and (ii) upon the receipt by Summus of a minimum cumulative amount of $4,000,000 in equity financing from the Series D convertible preferred stock, Hughes Capital could nominate one (1) additional director (for a total of two (2) Directors) to the Board of Directors of the Company. Subject to (i) the approval of the then current Board of Directors, whose approval was not to be unreasonably withheld, and (ii) the satisfactory completion of an investigation of such nominees by an investigative service selected by the Company, in its sole discretion, such nominees were to be appointed by the Board of Directors to serve as Directors and to be submitted to the shareholders of the Company at its next annual meeting of shareholders for election.
A total of $4,000,000 was raised in the offering of the Series D convertible preferred stock. On December 22, 2003, Hughes Capital nominated J. Winder Hughes to the Board of Directors. On February 2, 2004, Hughes Capital nominated Stephen M. Finn to the Board of Directors. After an investigation of each nominee by an investigative service selected by the Company, each of these nominees were unanimously approved by Summus’ full Board of Directors. Both Mr. Hughes and Mr. Finn will serve until Summus’ 2004 annual meeting of shareholders or until their successors have been appointed or elected and qualified. Mr. Hughes and Mr. Finn will also be nominated and their names submitted to Summus’ shareholders for election as Directors to serve a one-year term beginning with the 2004 annual meeting.
Advisory Board Members
Our Board of Directors has an advisory board. The current member of the advisory board is Bob Bruggeworth. Members of the advisory board are appointed through resolution of the Board and consult and advise the Board and our senior officers as to, among other things:
entering into strategic alliances or other business relationships for purposes of commercially deploying our products and technology;
financing of our operations;
starting or discontinuing a line of business; and
establishing, acquiring and selling other companies or participating interests in other companies.
At the request of the Board, members of the advisory board may attend Board meetings and participate in such meetings, but they have no vote. Members of the advisory board will not be deemed to be directors of Summus and will not be subject to any fiduciary or similar duties to Summus solely by virtue of membership on the advisory board. Each member of the advisory board is required to execute a confidentiality and non-disclosure agreement with Summus and will be considered an “insider” of Summus, subject to our insider trading policies.
Executive Officers
The following table provides information regarding our executive officers, the capacity in which they serve Summus, when they assumed office, and their ages.
Name
Office
Officer Since
Age
Bjorn D. Jawerth (1)
Chief Executive Officer,
President, and Chief Scientist
Gary E. Ban (2)
Chief Executive Officer
Donald T. Locke
General Counsel and Chief Financial Officer
Leonard Mygatt
Executive Vice President-
Technology
Andrew L. Fox
Vice-President - Sales and Business Development
______________________
(1)
The Board of Directors did not renew Dr. Jawerth’s employment contract, which expired on February 16, 2004.
(2)
Mr. Ban was elected as Summus’ Chief Executive Officer on February 17, 2004. Mr. Ban had been Summus’ Chief Operating Officer since February 16, 2001.
Business Experience of Directors, Officers, Advisory Board Members, and Other Key Employees
Jere A. Ayers was appointed to our Board of Directors in August 2003. Mr. Ayers has been the owner of Cari Fabrics, a producer of knitted apparel fabrics since 1989, and founded My Garb, Inc., a producer of printed T-shirts sold through the Internet, in 2000. Mr. Ayers is a founder and formerly a member of the board of directors of ACW Management, a large dry cleaning company located in North Carolina and Virginia. Mr. Ayers is also a member of the advisory board of directors of Wachovia Bank for the High Point, North Carolina area. Mr. Ayers received his Bachelor of Science degree in business and economics from the University of North Carolina in 1964.
Gary E. Ban joined Summus as its Chief Operating Officer in February 2001 and was elected as Summus’ Chief Executive Officer on February 17, 2004. In his past role as Chief Operating Officer of Summus, Ltd., Mr. Ban had supervisory responsibility over company operations, information technology and human resources. Prior to joining Summus, Ltd. in September 1999, Mr. Ban held a variety of executive-level management positions establishing direction and operational implementation for business, financial and engineering systems integration. From November 1996 through August 1999, Mr. Ban served as Director of Customer Integration for ABB Power T&D Inc.'s electricity metering group, where he was responsible for global systems integration for large-scale information management solutions. From June to November 1996, Mr. Ban served as Director of Re-Engineering Services for the Pinnacle Group, a consulting company, where he was instrumental in establishing a consulting business offering re-engineering process management focused on enterprise resource planning. Mr. Ban holds an M.B.A. from Duke University and a bachelor's degree in industrial management and an associate applied science degree in computer engineering from the Milwaukee School of Engineering.
Robert A. Bruggeworth was appointed to our Board of Advisors in June 2002. He is currently the Chief Executive Officer of RF Micro Devices, Inc. Previously, Mr. Bruggeworth served as the president of RF Micro Devices wireless products group. Before joining RF Micro Devices, Mr. Bruggeworth was employed by AMP, Inc., from July 1983 to June 1999, serving most recently as vice president of global computer and consumer electronics.
Stephen M. Finn was appointed to our Board of Directors on February 2, 2004. Mr. Finn currently serves as president of Solstice, a media production and technology consulting firm. He began a career as an award-winning professional photographer, extending his skills to the worlds of computer graphics and video production as these technologies evolved. Based on this experience, Mr. Finn founded Solstice in 1978 specializing in corporate theater, sales and marketing development, product introduction and branding. Solstice also focuses on translating technology advances into strategic product concepts.
Andrew L. Fox has been Summus’ Vice President - Sales and Business Development since February 2001. Mr. Fox is responsible for sales, business development and content acquisition activity for Summus and has been responsible for putting partnerships in place with Disney, ESPN, Fujifilm, The Associated Press and other high profile media brands. Before joining Summus, Mr. Fox was marketing director at RealNetworks, a provider of software products and services for Internet media delivery. At RealNetworks, he was part of the initial RealAudio and RealVideo launch teams, and also started and ran RealNetworks Enterprise Group. He also served as a Sales and Marketing Manager for IBM's Wireless Data Division and a Product Manager at IBM's Networking Hardware Division. Mr. Fox holds a master of business administration degree and an undergraduate degree in computer science and electrical engineering from Duke University.
Neil R. Guenther was appointed to our Board of Directors in February 2003. Dr. Guenther has been a shareholder of Anesthesiology Associates of Wisconsin since 1992 and has served as the President of its Board of Directors since January 2002. Dr. Guenther received his Bachelor of Science degree from the University of Wisconsin in 1977 and his medical degree from the Medical College of Wisconsin in 1983. Dr. Guenther is a member of the National Association of Corporate Directors.
J. Winder Hughes was appointed to our Board of Directors on December 22, 2003. Mr. Hughes is the founder of Hughes Capital Investors L.L.C., an investment group that he formed in 1995. He established the investor partnership, The Focus Fund L.P., in 1999, for which he serves as the managing general partner. Mr. Hughes, who received his Bachelor of Arts degree in economics from the University of North Carolina in 1980, brings more than 20 years of investment community experience to the Summus board.
Donald T. Locke joined Summus as a consultant in October 2001,and has served as its General Counsel. In March 2004, he was appointed as Summus’ Chief Financial Officer. Prior to Summus, Mr. Locke was Of Counsel to Kilpatrick Stockton LLP, a large southeastern law firm, where his practice focused on Securities and Exchange Commission, financing and merger and acquisition issues for public companies, with an emphasis on small- to medium-sized public companies. Mr. Locke received his bachelor’s degree from Furman University in 1980 and his M.B.A and Law degrees from the University of South Carolina in 1986 and 1987, respectively.
Leonard T. Mygatt, III has been our Executive Vice President -Technology, since our acquisition of Summus, Ltd.'s assets in February 2001. In this position Mr. Mygatt is responsible for technical development and strategy, maintaining technical and standards awareness, providing technical review of new and competitive technologies, managing and protecting the Company's intellectual property, and technical support for business development, contracts, and proposals. Mr. Mygatt began with Summus, Ltd. in December 1995 and held various management and technical roles in developing Summus, Ltd.'s technical capabilities and business. Prior to his association with Summus, Ltd., Mr. Mygatt was employed by Magnavox Electronic Systems Company, where he served as a project leader for the design, development and production of advanced tactical data link systems and as a project manager and leader for a research and development project investigating image and video compression. Mr. Mygatt received a bachelor's degree in electrical engineering from the University of California at San Diego in 1983.
Jiangying Zhou was appointed our Vice President-Development in May 2001. She had previously served as Director of Research and Development at Summus and, before that, at Summus, Ltd. Prior to joining Summus, Ltd. in March 1998, Dr. Zhou was a research scientist at Panasonic Information and Networking Technologies Laboratories, Princeton, New Jersey, where she conducted research in the areas of image analysis, information retrieval and document processing. Dr. Zhou received her Ph.D. in Electrical Engineering from the University of New York at Stony Brook in 1993. She received her M.S. degree (1985) and B.S. degree (1982), both in computer science, from Fudan University, Shanghai, China. Dr. Zhou has taught in the computer science department of Fudan University. She has published 30 papers in international journals and conferences and has given many talks at international conferences. She is also the owner of five U.S. patents. Dr. Zhou is currently the co-chair for the SPIE/IS&T Document Recognition Conference. She also served as session chair and as referee for several international conferences and journals, including the SPIE Document Recognition Conference, the Fifth International Conference on Document Analysis and Information Retrieval, IEEE Transaction on Pattern Recognition and Machine Intelligence, Journal of Computer Vision, Graphics, and Image Processing, and Journal of Electronic Imaging. Dr. Zhou's research interests include video/image analysis, pattern recognition, information retrieval, character recognition, and document processing.
Family Relationships
There are no family relationships between or among any of our directors and executive officers.
Board of Directors and Committees of the Board of Directors
Our Board of Directors is responsible for establishing broad corporate policies and for our overall performance. During the fiscal year ended December 31, 2003, the Board of Directors held 4 meetings. The Board of Directors has an Audit Committee, Compensation Committee, and Nominating Committee.
During the fiscal year ended December 31, 2003, the Company’s Audit Committee met 4 times. Its members during the last fiscal year were George H. Simmons and Neil R. Guenther. Dr. Simmons resigned from the Board of Directors of the Company on January 3, 2004. Our Board of Directors appointed J. Winder Hughes to the Audit Committee on March 26, 2004. The Audit Committee reviews the Company’s auditing, accounting, financial reporting, and internal control functions and makes recommendations to the Board of Directors for the selection of independent accountants. In addition, the Audit Committee monitors the quality of the Company’s accounting principles and financial reporting, as well as the independence of and the non-audit services provided by the Company’s independent accountants. The Audit Committee discusses with the auditors their independence and obtains at least annually the auditors’ written statement describing their independent status.
Neither of the members of the Audit Committee qualifies as an “Audit Committee Financial Expert”, as such term is defined in the rules and regulations of the Securities and Exchange Commission. However, the Board of Directors has determined that each Audit Committee member has sufficient knowledge in financial and auditing matters to serve on the Committee. The Board of Directors will consider adding a qualified member to the Board of Directors and the Audit Committee who will meet the requirements of an “Audit Committee Financial Expert”. Until that time, the Audit Committee has the authority to engage legal counsel or other experts or consultants as it deems appropriate to carry out its responsibilities.
During the fiscal year ended December 31, 2003, the Compensation Committee met 2 times. Its members during the last fiscal year were George H. Simmons and Neil R. Guenther. Dr. Simmons resigned from the Board of Directors of the Company on January 3, 2004. Our Board of Directors reconstituted the Compensation Committee and appointed J. Winder Hughes and Stephen M. Finn to such committee on March 26, 2004. The Compensation Committee determines, reviews, approves, and reports to the Board of Directors on all elements of the compensation for the Company’s executive officers including salaries, bonuses, stock options, benefits, and other compensation arrangements.
During the fiscal year ended December 31, 2003, the Nominating Committee met 2 times. Its members during the last fiscal year were George H. Simmons and Neil R. Guenther. Dr. Simmons resigned from the Board of Directors of the Company on January 3, 2004. The Nominating Committee shall consider candidates for the Board of Directors of the Corporation and shall make all nominations for Directors to the full Board of Directors.
During the last fiscal year, no Directors attended fewer than seventy-five percent (75%) of the aggregate of the total number of meetings of the Board of Directors held during the period they served as Directors and the total number of meetings held by the committees of the Board of Directors during the period that they served on any such committees of the Board of Directors.
Code of Ethics
We have adopted a Code of Ethics within the meaning of Item 405(b) of Regulation S-K of the Securities Exchange Act of 1934. This Code of Ethics applies to all Directors, officers and employees of Summus. A copy of this Code of Ethics is publicly available on our website at www.summus.com.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires Summus’ executive officers, Directors and persons who beneficially own more than 10% of Summus’ common stock to file reports of ownership and changes in ownership with the Securities and Exchange Commission and NASDAQ. Officers, Directors and beneficial owners of more than 10% of Summus’ common stock are required by the Commission regulations to furnish Summus with copies of all Section 16(a) forms that they file.
Based solely on review of the copies of such reports furnished to us, or written representations that no reports were required, we believe that for the period from January 1, 2003 through December 31, 2003, all executive officers, Directors and greater than 10% beneficial owners complied with all Section 16(a) filing requirements applicable to them, except that the Company was late in making the Form 3 filings for each of Jere A. Ayers and Stephen M. Finn.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Executive Compensation
The following table provides certain summary information concerning the compensation paid during the fiscal years ended 2003, 2002, and 2001 to (i) the Chief Executive Officer and (ii) to each of the four other most highly compensated executive officers of the Company (based on salary and bonus received during the last fiscal year) who were serving as executive officers of the Company at the end of the fiscal year ended December 31, 2003, and whose aggregate compensation exceeded $100,000 (the “Named Executive Officers”).
Summary Compensation Table (1)
______________
(1)
The aggregate amount of perquisites and other personal benefits, if any, did not exceed the lesser of $50,000 or 10% of the total amount of salary and bonus for any year for any of the Named Executive Officers and has therefore been omitted.
(2)
The options granted are without tandem stock appreciation rights, and we did not grant any stock appreciation rights to any of the Named Executive Officers.
(3)
Dr. Jawerth became Co-Chief Executive Officer on February 16, 2001, and Chief Executive Officer in November 2001. The Board of Directors did not renew Dr. Jawerth’s contract, which expired on February 16, 2004.
(4)
Mr. Ban became Chief Operating Officer on February 16, 2001. The Board of Directors elected Mr. Ban as Summus’ Chief Executive Officer on February 17, 2004.
(5)
Mr. Lowrey became Chief Financial Officer and Vice President of Finance on June 1, 2000. Mr. Lowrey resigned from all positions with Summus on November 14, 2003.
(6)
79,037 and 44,255 of these options received by Mr. Lowrey in 2003 and 2002, respectively, were granted pursuant to the Company’s Alternative Compensation Plan in lieu of cash compensation owed to him.
(7)
231,540 and 103,266 of these options received by Dr. Jawerth in 2003 and 2002, respectively, were granted pursuant to the Company’s Alternative Compensation Plan in lieu of cash compensation owed to him.
(8)
116,226 and 51,634 of these options received by Mr. Ban in 2003 and 2002, respectively, were granted pursuant to the Company’s Alternative Compensation Plan in lieu of cash compensation owed to him.
(9)
These amounts were paid to the Dr. Jawerth and Messrs. Ban, and Lowrey by the issuance of 29,988, 15,250, and 13,172 restricted shares, respectively, of the Company’s common stock in lieu of cash compensation for salary owed to them. The restrictions on these shares lapsed on April 25, 2003.
(10)
Mr. Mygatt became Executive Vice President - Technology on February 16, 2001.
(11)
In lieu of a $75,000 bonus to which Mr. Lowrey was contractually owed under the terms of his employment contract with Summus as of February 16, 2001, he received 75,000 shares of common stock and warrants to purchase 150,000 shares of Summus common stock. These warrants have an exercise price of $2.00 per share
(12)
$26,165 of the total amount of cash salary compensation paid to Dr. Jawerth in 2003 was for salary owed to him since 2000.
(13)
Mr. Locke was appointed as the Company’s Chief Financial Officer on March 26, 2004. Prior to this date Mr. Locke was a consultant serving as the Company’s General Counsel since October 2001.
(14)
All amounts paid to Mr. Locke in 2002 and 2003 were paid to him as a consultant to the Company.
(15)
Mr. Locke converted $200,000 owed to him for services rendered to the Company as a consultant from October 2001 until December 2002 into warrants to purchase 333,333 shares of Summus common stock with an exercise price of $0.60 per share.
(16)
$39,000 of the total amount of cash salary compensation paid to Mr. Ban in 2003 was for a bonus amount owed to Mr. Ban since February 16, 2001 pursuant to his employment agreement with Summus.
Option Grants During Last Fiscal Year
The following table sets forth information concerning options to purchase shares of common stock granted during the fiscal year ended December 31, 2003, to the Named Executive Officers.
_________________
(1)
All of these options are subject to the terms of the Company’s Amended and Restated Equity Compensation Plan. These options were granted to the Named Executive Officers in lieu of cash compensation owed to them pursuant to their employment agreements with the Company. All of these options were fully vested on their date of grant.
(2)
All options were granted at an exercise price equal to the fair market value of the Company’s common stock on the date of grant
(3)
The cumulative percent of total stock options granted to Dr. Jawerth, and Messrs. Ban and Lowrey in 2003, relative to all options granted by the Summus in 2003 were 17.6%, 8.8% and 6.0% respectively.
(4)
The values in this column have been prepared using the Black-Scholes model. The calculations made pursuant to this model assume (a) volatility ranging from 1.218 to 1.379, (b) a risk-free rate of return ranging from 2.75% to 3.46%, (c) a dividend yield of 0%, and (d) an expected option life of five years.
Aggregated Option Exercises and Fiscal Year-End Option Values
The following table sets forth information concerning the number and intrinsic value of stock options held by the Named Executive Officers on December 31, 2003. Year-end values are based on the fair market value of $0.20 per share as of December 31, 2003, as reported on the OTC Bulletin Board System. They do not reflect the actual amounts, if any, which may be realized upon the future exercise of remaining stock options and should not be considered indicative of future stock performance. No Named Executive Officer exercised any options during the 2003 fiscal year.
Employment Agreements
Employment Agreement with Bjorn D. Jawerth
On February 16, 2001, Summus entered into a three-year employment agreement with Bjorn D. Jawerth, our Chief Executive Officer. Dr. Jawerth’s employment agreement expired on February 16, 2004, and was not renewed by the Board of Directors. Under Dr. Jawerth’s expired employment agreement he received:
an initial base salary of $350,000, which was to be increased on an annual basis by at least 10%; however, Dr. Jawerth elected to defer any increase in cash compensation to this initial base salary. As of February 17, 2002 and February 17, 2003, Dr. Jawerth was to receive an annual salary of $385,000 and $423,500, respectively, pursuant to his agreement. Dr. Jawerth elected on July 31, 2002, to reduce his cash compensation temporarily to $262,500 on an annual basis to help lower the Company’s cash consumption. The difference between the original contract amount of $350,000 and the cash salary amount of $262,500 was paid to Dr. Jawerth on a bi-monthly basis in the form of options to buy common stock under the Company’s Alternative Compensation Plan. These options were priced at the closing market price of the Company’s common stock at the end of each bi-monthly pay period . The difference between the increased salary amounts of $385,000 for the period February 17, 2002 to February 16, 2003 and $423,500 for the period February 17, 2003 to February 16, 2004, respectively, owed to Dr. Jawerth and his original base salary of $350,000 in his employment agreement was being deferred and accrued by the Company until the Board of Directors and Dr. Jawerth determine when and how these deferred and accrued amounts may be paid;
performance bonuses and options as were generally available to other senior management and Board members (including awards under our Amended and Restated 2000 Equity Compensation Plan), as determined by the Compensation Committee of the Board;
health insurance, and other benefits.
In addition to the foregoing, Dr. Jawerth was to have been paid $500,000 in cash as compensation for his non-competition covenants (which have an 18-month term). In lieu of such cash payment, we issued to Dr. Jawerth options to purchase 166,667 shares of our common stock exercisable for $0.50 per share and options to purchase 333,333 shares of our common stock exercisable for $3.75 per share.
Under the terms of the Asset Purchase Agreement, Summus agreed to use reasonable commercial efforts to assist Dr. Jawerth in the private sale of up to 1,666,667 shares of Summus common stock held by him (representing $2.5 million in value) at a per share price of not less than $1.50 per share. In addition, under the terms of Dr. Jawerth’s employment agreement, Summus was obligated to issue him options, with an exercise price of $1.50 per share, exercisable for three times the number of shares of common stock sold in the private sale as described above. As of the date of this report, no shares subject to this agreement have been sold. The Board of Directors believes that it has no further obligations regarding this sale of shares.
Pursuant to the terms of his employment agreement and in accordance with corporate policy, all intellectual property developed by Dr. Jawerth in connection with his employment by the Company is the exclusive property of the Company. Without any impact on the Company’s ownership of the intellectual property, Dr. Jawerth’s employment agreement granted to him, personally, a non-exclusive, non-transferable, world-wide license, without right to sublicense, to make and use New Technology (as defined in the Inventions Award Plan) that were developed during the twelve months following the closing (the “Closing”) of the asset purchase agreement between Summus, Ltd. and High Speed Net Solutions, Inc. This license was to terminate on the later of the date twelve months from the Closing or such later date as may be set by the Board, excluding Dr. Jawerth. Pursuant to the terms of Dr. Jawerth’s employment agreement, the Board of Directors terminated Dr. Jawerth’s license on February 4, 2004.
Employment Agreements with Messrs. Ban and Lowrey
Summus entered into employment agreements with each of Gary E. Ban and Robert S. Lowrey on February 16, 2001. Mr. Lowrey resigned from Summus on November 14, 2003, and Mr. Ban’s employment agreement expired on February 16, 2004. The employment agreements named Mr. Ban as the Chief Operating Officer and Mr. Lowrey as Chief Financial Officer, at annual base salaries as follows:
Name of Executive
Annual Base Salary
Gary E. Ban
$175,000
Robert S. Lowrey
$150,000
Messrs. Ban and Lowrey elected on July 31, 2002 to reduce their cash compensation temporarily to help lower the Company’s cash consumption. From July 31, 2002 to December 1, 2003 in the case of Mr. Ban, and to November 14, 2003, in the case of Mr. Lowrey, Messrs. Ban and Lowrey cut their cash compensation to $131,250 and $112,500, respectively, on an annual basis. The difference between the contract amount identified in the table above for each of Messrs. Ban and Lowrey and their current cash salary amount was paid to them on a bi-monthly basis in the form of options to buy common stock of the Company under the Company’s Alternative Compensation Plan. These options had an exercise price based on the closing market price of the Company’s common stock at the end of each bi-monthly pay period.
Under their employment agreements executed in February 2001, each of Messrs. Ban and Lowrey also received a one-time bonus equal to 50 percent of his annual base salary, payable as mutually agreed between Summus and Mr. Ban and Mr. Lowrey, as applicable. This bonus was equal to $75,000 in Mr. Lowrey’s case and $87,500 in Mr. Ban’s case. Since the Company did not have available funds to pay Mr. Lowrey in cash, he entered into an amendment to his employment agreement with the Company in which he agreed to accept 75,000 restricted shares of the Company’s common stock and 150,000 warrants to purchase shares of common stock; these warrants have an exercise price of $2.00 per share. Mr. Ban entered into an amendment to his employment agreement in which he and the Company agreed to pay him his bonus amount in cash by within six-months of November 23, 2002, based on available funds. If funds were not available to pay Mr. Ban this amount as of such date, he had the option, in his sole discretion, of having Summus pay him this bonus amount or receiving restricted shares of Summus common stock and warrants, based on terms offered to third party investors of Summus, for the unpaid bonus amount owed to him. Mr. Ban was also owed $10,938 in back salary from 2003. In November 2003, the Company agreed to pay Mr. Ban all of his bonus amount and back salary owed to him in cash over a four-month period, plus $2,500 in interest. Mr. Ban received $77,000 of these owed amounts, and he subsequently agreed to receive 184,139 shares of Summus’ common stock for the remaining $23,938 owed to him.
Stock Option Plan
The following summary description of our Amended and Restated 2000 Equity Compensation Plan (the “Plan”) is not intended to be complete and is qualified by reference to the copy of the Plan, filed as Exhibit 10.8 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003.
The Plan, as adopted by the shareholders on January 27, 2000, and subsequently amended by the Board of Directors is intended to provide incentives:
to the officers and other employees of Summus and its subsidiaries by providing them with opportunities to purchase shares of common stock in Summus pursuant to options granted under the Plan which qualify as “incentive stock options” (“ISOs”) under Section 422(b) of the Internal Revenue Code of 1986, as amended (the “Code”);
to directors, officers, employees and consultants of Summus and its subsidiaries by providing them with opportunities to purchase shares of common stock in Summus pursuant to options granted under the Plan which do not qualify as ISOs (“non-qualified options”) (ISOs and non-qualified options being collectively referred to as “options”); and
to directors, officers, employees and consultants of Summus, and its subsidiaries by providing them with stock appreciation rights, awards of restricted stock or deferred stock, stock awards, performance shares or other stock-based awards.
The Compensation Committee (the “Committee”), consisting of two or more members of the Board of Directors, administers the Plan. The Committee has the exclusive right to interpret, construe and administer the Plan, to determine the individuals associated with Summus and its subsidiaries from among the class of individuals eligible to whom options, awards and authorizations to make purchases may be granted in accordance with the terms of the Plan, and to determine the number, form, terms, conditions and duration of any such grant.
ISOs. ISOs may be granted at any time through the tenth anniversary of the effective date of the Plan (which was January 31, 2000). The ISO exercise price is to be no less than 100% of the “Fair Market Value” (as defined in the Plan) of the common stock on the grant date. No ISO may be granted to an individual owning more than 10% of the total combined voting power of all classes of stock issued by Summus unless the purchase price of the underlying shares of common stock is at least 110% of the Fair Market Value of the shares issuable on exercise of the ISO determined as of the date the ISO is granted. ISOs granted under the Plan may have maximum terms of not more than ten years (five years in the case of an individual that owns more than 10% of the total combined voting power of all classes of Summus stock) or such shorter period as the Committee specifies in an individual award. Generally, ISOs granted under the Plan may remain outstanding and may be exercised at any time up to three months after the person to whom such ISO was granted is no longer employed. ISOs granted under the Plan are subject to the restriction that the aggregate Fair Market Value (determined as of the date of grant) of ISOs, which first become exercisable in any calendar year, cannot exceed $100,000.
Stock Appreciation Rights. Stock appreciation rights may be granted to eligible participants in tandem with an ISO or non-qualified option or may be granted independent of any related option. A tandem stock appreciation right entitles the holder of the option, within the period specified for exercise of such option, to surrender the unexercised option or a portion thereof and receive in exchange a payment in cash or shares of common stock having an aggregate value equal to the amount by which the Fair Market Value of each share of common stock underlying the option (or portion thereof) surrender exceeds the per share option exercise price, multiplied by the number of underlying shares of common stock surrendered. Each tandem stock appreciation right is subject to the same terms and conditions as the related option.
With respect to non-tandem stock appreciation rights, the Committee is to specify the number of shares of common stock covered by such right and the base price of a share of common stock (the “Base Price”), which is to be no less than 100% of the Fair Market Value of a share of common stock on the date of grant. Upon exercise of a non-tandem stock appreciation right, the participant is entitled to receive from Summus cash and/or common stock having an aggregate Fair Market Value equal to (i) the excess of (A) the Fair Market Value of one share of common stock at the time of exercise, over (B) the Base Price, multiplied by (ii) the number of shares of common stock covered by the non-tandem stock appreciation right. The Committee has the sole discretion to determine in each case whether the payment is to be made in the form of cash or shares of common stock.
Options and stock appreciation rights granted under the Plan are generally not transferable, except by will or the laws of descent and distribution, or under the terms of a qualified domestic relations order as defined by the Code or ERISA; however, non-qualified options (including a related tandem stock appreciation right) may be transferred to the extent determined by the Committee to be consistent with securities and other applicable laws and with our policy.
Restricted Stock. The Committee may make restricted stock awards to participants in the Plan as an incentive for the performance of future services that will contribute materially to the successful operation of Summus. Awards of restricted stock may be made alone or in addition to or in tandem with other awards made under the Plan. The Committee is to determine the purchase price, if any, to be paid for the restricted stock, the length of the restriction period, the nature of the restrictions (e.g., in terms of the participant’s service or performance), whether the restrictions are to lapse at the end of the restriction period as to any or all of the shares covered by the award, and whether dividends and other distributions on the restricted stock are to be paid currently to the participant or to Summus for the account of the participant.
Deferred Stock. The Committee may make deferred stock awards, together with cash dividend equivalents, to participants in the Plan, conditioned upon the attainment of specified performance goals or other factors or criteria as the Committee determines. Deferred stock awards may not be sold, transferred, pledged, assigned or encumbered during the deferral period, as specified by the Committee. At the expiration of the deferral period, share certificates are to be delivered to the participant in a number equal to the shares of common stock covered by the award. Upon termination of employment during the deferral period, the participant shall forfeit the deferred stock; however, the Committee may accelerate the vesting of the award in the event of termination of employment due to death, disability or retirement, or in the event of hardship or other special circumstances.
Stock Awards. Stock awards are to be granted only in payment of compensation that has been earned or as compensation to be earned. All shares of common stock subject to a stock award are to be valued at no less than 100% of the Fair Market Value of such shares on the date of the stock award’s grant. Shares of common stock subject to a stock award may be issued or transferred to the participant at the time of grant or at a subsequent time, or in installments, as the Committee determines. A stock award will be subject to the terms and conditions the Committee determines; however, upon issuance of the shares, the participant shall be entitled to receive dividends, exercise voting rights and exercise all other rights of a shareholder except as otherwise provided in the stock award.
Performance Shares. Performance shares may be awarded to participants as an incentive for the performance of future services to Summus. Awards of performance shares may be made either alone or in addition to or in tandem with other awards granted under the Plan. The Committee is to determine and designate those participants to whom performance shares are to be awarded, the performance period and/or performance objectives (e.g., minimum earnings per share or return on equity), and any adjustments to be made to such objectives, applicable to such awards, the form of settlement of performance shares, and the other terms and conditions of such awards.
Other Stock-Based Awards. The Committee may grant other awards that are valued in whole or in part by reference to, or are based on, the common stock, including convertible preferred stock, convertible debentures, exchangeable securities, phantom stock and stock awards or options valued by reference to book value or performance.
Administration. The Plan provides that the Committee may make equitable adjustments in the aggregate number of shares of common stock that may be awarded under the Plan, the number of shares and class of stock that may be subject to an award, the purchase price to be paid per share under outstanding options, and the terms, conditions or restrictions of any award in the event of any reorganization, recapitalization, reclassification, stock split, stock dividend, merger or consolidation or separation, including a spin-off, of Summus, the sale or other disposition of all or a portion of its assets and certain other transactions involving Summus; however, the Plan requires that all such adjustments shall be made such that ISOs granted under the Plan shall continue to constitute ISOs within the meaning of Section 422 of the Code.
Authorized but unissued shares of common stock of Summus, shares of common stock that are not delivered or purchased under the Plan, and shares reacquired by Summus, for reasons including a forfeiture, termination of employment, expiration or cancellation of an option, can be issued under the Plan. Under the Plan, 2,000,000 shares of common stock were initially reserved for issuance. On February 13, 2001, the Board adopted resolutions to amend the Plan to increase that number to 6,500,000 shares, and on May 23, 2002, the Board adopted resolutions to amend the Plan to increase that number to 8,500,000 shares. As of March 15, 2004, we have issued 6,993,202 options to purchase shares of common our stock; 6,574,807 of these options are currently vested.
Amendment of the Plan. The Plan provides that our Board of Directors may amend or terminate the Plan at any time, provided, however, that specific types of amendments require approval of our shareholders and no such action may be taken which adversely affects any award previously granted to a participant under the Plan without the written consent of the Participant.
Alternative Compensation Plan
In order to conserve the Company’s cash position, the Board of Directors adopted an Alternative Compensation Plan (the “Alternative Plan”) on August 1, 2002. Under the Alternative Plan, each officer of the Company could elect to receive any portion of their compensation in the form of fully vested non-qualified stock options. The options have an exercise price equal to the Fair Market Value of the Company’s common stock based on the closing price of the Company’s common stock at the end of each bi-monthly payroll period. All of the options granted under this plan are issued under the Amended and Restated 2002 Equity Compensation Plan.
Officers could elect a percentage starting at a minimum level of 15% of their cash compensation that they may receive under the Alternative Plan. The election could be terminated at the sole discretion of the Board of Directors. Dr. Jawerth and Messrs. Ban and Lowrey elected to receive 25% of their compensation under the Alternate Plan until February 15, 2004, December 1, 2003 and November 14, 2003, respectively.
Inventions Awards Plan
The following summary description of our Inventions Awards Plan is not intended to be complete and is qualified by reference to the copy of the Inventions Awards Plan, filed as Exhibit 10.16 to the Company’s annual report on Form 10-K for the fiscal year ended December 31, 2003. This plan was terminated by the Board of Directors effective March 26, 2004.
Summus established the Inventions Awards Plan, effective October 30, 2000, in connection with the then contemplated merger between Summus, Ltd. and High Speed Net Solutions, which closed on February 16, 2001, to provide incentives to eligible employees by providing them with opportunities to receive additional compensation as a result of their development of enhancements or new methods involving the business of Summus that would generate revenue for us (“New Technology”). New Technology is defined under the plan to exclude existing technology of ours or technology acquired from Summus, Ltd.
Under the plan, we were to set aside 5% of the gross revenues derived from the licensing or sale of New Technology (or products incorporating such technology) for distribution among eligible employees. Dr. Jawerth and a designee of the Board of Directors were, on a quarterly basis, to calculate the amount of funds to be set aside and the amounts to be received by eligible employees. If Summus sold the rights to New Technology, eligible employees were to be entitled to an award of 10% of the gross proceeds. If an eligible employee (other than Dr. Jawerth) ceased to be employed by Summus, for any reason, such employee’s right to awards under the plan were to cease.
All eligible employees execute our standard agreement concerning assignment to Summus of inventions developed by such employees while employed by us. Eligible employees could also apply to have technology that is not owned by Summus (defined as “Outside Technology”) commercialized by us. If we elect to commercialize such technology, the eligible employee(s) shall receive an award equal to 5% (10%, if two or more eligible employees submit the Outside Technology) of the gross revenues derived from the licensing or sale of such technology (or products incorporating such technology). No eligible employee made application for the commercialization of any Outside Technology prior to the termination of the Inventions Awards Plan.
Under the Inventions Awards Plan, Summus could, at its option, initiate a spin-off company to develop a New Technology or an accepted Outside Technology. In such event, eligible employees could be selected to join the spin-off company. If the eligible employee(s) were to accept a position in the spin-off company, his or her rights to awards under the plan were to be surrendered for 25% of the founders’ equity in the spin-off company. No spin-off company was initiated prior to the termination of the Inventions Awards Plan.
Dr. Jawerth sent correspondence to the Company on February 17, 2004, seeking payment for certain inventions. Management and the Board of Directors have evaluated these assertions and determined that no amounts are due Dr. Jawerth or other employees under the provisions of the Inventions Awards Plan. If litigation is pursued by Dr. Jawerth for any payments under the Inventions Awards Plan, Summus will vigorously defend against any such action. If Dr. Jawerth were to be successful in any such litigation, there may be a material adverse impact to the Company.
Compensation of Directors
The members of the Board of Directors who are not executive officers or employees of the Company receive:
a one-time grant of options to purchase 30,000 shares of our common stock upon their initial appointment;
an annual grant of options to purchase 40,000 shares of our common stock on April 1 of each year, or a pro rata portion if the Director’s service begins after April 1 of a particular year;
an annual grant of options to purchase 2,500 shares of common stock for each committee of the Board of Director’s on which he serves; and
the reimbursement of travel expenses for travel by members of the Board of Directors who reside outside of the local area.
Each of these grants to members of our Board of Directors as described above have an exercise price equal to the fair market value of our common stock on the date of grant; vest quarterly over a one-year period from the date of grant; and have a ten-year life.
During fiscal year 2003, the outside members of our Board of Directors were issued the following grants of options opposite their names.
____________________
(1)
Dr. Simmons resigned from the Board on January 3, 2004 and vested in only 33,750 of these options.
Compensation Committee Interlocks and Insider Participation
During the fiscal year ended December 31, 2003, George H. Simmons and Neil R. Guenther served as members of the Compensation Committee of the Company’s Board of Directors, none of which is or has been an officer or employee of the Company. Dr. Simmons resigned as a Director of the Company and as a member of the Compensation Committee as of January 3, 2004. The Compensation Committee currently consists of Mr. Hughes and Mr. Finn, neither of which is or has been an officer or employee of the Company. No interlocking relationship existed during the fiscal year ended December 31, 2003, between the Company’s Board of Directors or Compensation Committee and the board of directors or compensation committee of any other company.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
The following table sets forth, as of March 15, 2004, certain information regarding beneficial ownership of our common stock by: (i) each of our directors, (ii) each Named Executive Officer, as such term is defined in the regulations of the SEC, (ii) all directors and executive officers as a group and (iii) each person who is known by the Company to own beneficially more than 5% of the outstanding shares of our common stock. As of March 15, 2004, we had 71,277,220 shares of common stock issued and outstanding. As of that date, we also had 2,078 shares of Series A convertible preferred stock; 1,310 shares of Series C Stock; 2,525 shares of Series D Stock; and 130 shares of Series E Stock issued and outstanding. Each of Series A, C, D and E convertible preferred stock are non-voting, except in certain instances under Florida law.
Beneficial ownership is determined in accordance with rules of the Securities and Exchange Commission and includes generally voting power and/or investment power with respect to securities. Shares of common stock subject to options currently exercisable or exercisable within 60 days of March 15, 2004, are deemed outstanding for purposes of computing the percentage beneficially owned by the person holding the options but are not deemed outstanding for purposes of computing the percentage beneficially owned by any other person. The persons and entities named in the table have sole voting power and sole investment power of the shares reflected by their names, except as otherwise noted.
Unless otherwise specified, the address for each beneficial owner is c/o Summus, Inc. (USA), 434 Fayetteville Street, Suite 600, Raleigh, North Carolina 27601.
__________________
* Represents beneficial ownership of less than one percent (1%) of common stock.
(1) Based upon information supplied by officers and directors and filings under Section 16 of the Securities and Exchange Act of 1934, as amended (the "Exchange Act").
(2) Dr. Jawerth’s employment agreement expired on February 16, 2004, and was not renewed by the Board of Directors. Dr. Jawerth resigned as a Director effective March 5, 2004.
(3) Includes (i) 1,647,196 shares of common stock and 274,991 shares of common stock underlying warrants owned by Kerstin Jawerth with respect to which Dr. Jawerth has sole voting power and (ii) 1,757,053 shares of common stock underlying options that are exercisable within 60 days of March 15, 2004.
(4) Includes 400,000 shares of common stock underlying warrants and 38,946 shares of common stock underlying options that are exercisable within 60 days of March 15, 2004.
(5) Includes (i) 212,500 shares of common stock underlying warrants that are exercisable within 60 days of March 15, 2004 and (ii) 375,000 shares of common stock issuable upon conversion of the Company’s Series D Stock that are convertible within 60 days of March 15, 2004.
(6) Includes (i) 40,000 shares of common stock held in the names of Dr. Guenther’s children, (ii) 1,409,924 shares of common stock underlying warrants and 80,796 shares of common stock underlying options that are exercisable within 60 days of March 15, 2004, and (iii) 80,000 shares of common stock underlying warrants held in the names of Dr. Guenther’s children that are exercisable or convertible within 60 days of March 15, 2004.
(7) Includes 1,550,000 shares of common stock underlying warrants (750,000 of which are held in the name of The Focus Fund L.P., of which Mr. Hughes is the managing partner), (ii) 18,595 shares of common stock underlying options that are exercisable within 60 days of March 15, 2004 and (iii) 1,500,000 shares issuable upon conversion of the Company’s Series D Stock within 60 days of March 15, 2004, which are held in the name of the Focus Fund L.P., of which Mr. Hughes is the managing partner.
(8) Includes 619,137 shares of common stock underlying options and 12,546 shares of common stock underlying warrants that are exercisable within 60 days of March 15, 2004.
(9) Includes 544,844 shares of common stock underlying options that are exercisable within 60 days of March 15, 2004.
(10) Includes 68,167 shares of common stock underlying options and 333,333 shares of common stock underlying warrants that are exercisable within 60 days of March 15, 2004.
(11) Includes 339,249 shares of common stock underlying options and 16,728 shares of common stock underlying warrants that are exercisable within 60 days of March 15, 2004.
(12) Includes 7,500,000 shares of common stock issuable upon conversion of the Company’s Series D Stock and 3,750,000 shares of common stock underlying warrants that are exercisable within 60 days of March 15, 2004.
(13) Includes 2,000,000 shares of common stock issuable upon conversion of the Company’s Series C Stock and 3,214,286 shares of common stock underlying warrants that are exercisable within 60 days of March 15, 2004.
(14) Includes 2,000,000 shares of common stock issuable upon conversion of the Company’s Series C Stock and 2,000,000 shares of common stock underlying warrants that are exercisable within 60 days of March 15, 2004.
(15) Includes shares beneficially owned by all current directors and executive officers.
(16) Includes 1,709,734 shares of common stock underlying options, 4,015,031 shares underlying warrants, and 1,875,000 shares underlying Series D Stock that are exercisable or convertible within 60 days of March 15, 2004.
Securities Authorized for Issuance Under Equity Compensation Plans
The 2000 Amended and Restated Equity Compensation Plan was created in 2000 for the purpose of granting incentive or non-qualified stock options to employees of, or contractors for, or directors of the Company. A total of 2 million shares were initially authorized under the plan. Subsequently, the Board amended the plan two times to increase the authorized shares to 6.5 million and then to 8.5 million. Options granted under this plan were priced either at the fair market value of our common stock on the date of grant or at prices below the fair market value of our common stock and have a life of ten (10) years from their date of grant, subject to earlier termination as set forth in such plan. As of December 31, 2003, this plan is still in effect.
(1)
The 2000 Amended and Restated Equity Compensation Plan was originally approved by shareholders and authorized 2,000,000 shares for issuance. The plan was subsequently amended twice by the Board to increase the authorized number of shares to 8,500,000 and is therefore classified as a plan not approved by our shareholders.
(2)
These options were granted to Dr. Jawerth outside of the 2000 Amended and Restated Equity Compensation Plan since only a maximum of 500,000 options can be granted pursuant to such plan in any one fiscal year.
(3)
This column excludes securities reflected in column (a)
There are no equity compensation plans approved by shareholders at the present time.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Pursuant to a letter agreement between Summus and Hughes Capital Investors, L.L.C. dated August 26, 2003, Summus agreed that it would pay Hughes Capital commissions of (i) 3.0% in cash and (ii) 5% in warrants to purchase shares of Summus common stock, of all amounts raised by Hughes Capital and accepted by Summus in connection with its Series D and Series E convertible preferred stock, except for any amounts of the Series D and E convertible preferred stock purchased by affiliates or entities under common control with Hughes Capital. J. Winder Hughes, who became a Director of Summus on December 22, 2003, is the principal of Hughes Capital. We raised $4,000,000 from the sale of the Series D convertible preferred stock and $200,000 from the sale of the Series E convertible preferred stock. Hughes Capital received $117,000 in cash commissions and warrants to purchase 800,000 shares of Summus common stock. All warrants received by Hughes Capital have an exercise price of $0.35 per share and are exercisable for a period of three years from their date of issuance.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Audit Fees
The aggregate fees billed to the Company by Ernst & Young LLP for the audit of the Company’s annual financial statements and for the review of the financial statements included in its quarterly reports on Form 10-Q for the fiscal years ended December 31, 2003 and 2002 totaled $137,746 and $132,349, respectively.
Audit-Related Fees
The Company did not incur or pay any fees to Ernst & Young LLP, and Ernst & Young LLP did not provide any services related to audit-related fees in either of the last two fiscal years.
Tax Fees
The aggregate fees billed to the Company by Ernst & Young LLP for tax compliance, tax advice, and tax planning for the fiscal years ended December 31, 2003 and 2002 totaled $0 and $2,660, respectively.
All Other Fees
The aggregate fees billed to the Company by Ernst & Young LLP for products and services, other than those as reported above for Audit Fees, Audit-Related Fees and Tax Fees, for the fiscal years ended December 31, 2003 and 2002 totaled $0 and $0, respectively.
It is the audit committee’s policy to pre-approve all services provided by Ernst & Young LLP. All services provided by Ernst & Young LLP during the years ended December 31, 2002 and 2003 were pre-approved by the audit committee.
As of the date of this filing, the Company’s current policy is to not engage Ernst & Young LLP to provide, among other things, bookkeeping services, appraisal or valuation services, or internal audit services. The policy provides that the Company engage Ernst & Young LLP to provide audit, tax, and other assurance services, such as review of SEC reports or filings.
The Audit Committee considered and determined that the provision of the services other than the services described under “Audit Fees” is compatible with maintaining the independence of the independent auditors.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a)(1)
Financial Statements. See Index to Financial Statements on page.
(a)(2)
Financial Statement Schedules have been omitted because of the absence of conditions under which they would be required or because the required information has been included in the financial statements.
(a)(3)
The following Exhibits are filed as part of this annual report on Form 10-K. The Exhibits designated by (*) have been previously filed with the Securities and Exchange Commission and are incorporated by reference herein.
Exhibit
Number
Exhibit
Description
3(I).1*
Amended and Restated Articles of Incorporation, filed February 28, 2000 (incorporated by reference to Exhibit 3.1 to our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30 , 2003)
3(I).2*
Articles of Amendment and Statement of Rights and Preferences of the 8% Series A Convertible Preferred Stock, filed March 3, 2000 (incorporated by reference to Exhibit 3.2 to our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2003)
3(I).3*
Articles of Correction filed June 23, 2000 to Articles of Amendment, filed March 2, 2000 (incorporated by reference to Exhibit 3.3 to our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2003)
3(I).4*
Amendment to Amended and Restated Articles of Incorporation, filed February 27, 2002, changing our name to Summus, Inc. (USA) (incorporated by reference to Exhibit 3.4 to our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2003)
3(I).5*
Amendment to Amended and Restated Articles of Incorporation, filed February 27, 2002, increasing our authorized common stock, par value $.001, from 50,000,000 shares to 100,000,000 shares (incorporated by reference to Exhibit 3.5 to our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2003)
3(I).6*
Articles of Amendment and Statement of Rights and Preferences of the Series C Convertible Preferred Stock (incorporated by reference to Exhibit 3.6 to our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2003)
3(I).7*
Articles of Amendment and Statement of Rights and Preferences of the Series D Convertible Preferred Stock dated September 25, 2003 (incorporated by reference to Exhibit 3.7 to our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2003)
3(I)8*
Articles of Amendment and Statement of Rights and Preferences of the Series E Convertible Preferred Stock dated October 17, 2003 (incorporated by reference to Exhibit 3.8 to our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2003)
3(I)9
Amendment to Amended and Restated Articles of Incorporation, filed December 3, 2003, increasing our authorized common stock, par value $.001, from 100,000,000 shares to 185,000,000 shares
3(II).1*
Second Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 to our Form 10 filed on July 5, 2001)
4.1*
Specimen Common Stock Certificate (incorporated by reference to Exhibit 4.1 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2001)
4.2*
Form of Subscription Agreement for private placement sales of our common stock (incorporated by reference to Exhibit 4.2 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2001)
10.9*
Executive Employment Agreement, dated as of February 16, 2001, between Summus, Inc. and Bjorn Jawerth (incorporated by reference to Exhibit 10.06 to our Current Report on Form 8-K dated February 16, 2001)
10.10*
Amendment to Executive Employment Agreement of Bjorn D. Jawerth, dated as of February 28, 2001 (incorporated by reference to Exhibit 10.11 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2001)
10.11*
Executive Employment Agreement, dated as of February 16, 2001, between Summus, Inc. and Gary E. Ban (incorporated by reference to Exhibit 10.12 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2001)
10.12*
Executive Employment Agreement, dated as of February 16, 2001, between Summus, Inc. and Robert S. Lowrey (incorporated by reference to Exhibit 10.15 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2001)
10.13*
Lease Agreement, dated as of October 15, 1999, as modified on March 23, 2000 and June 9, 2000, between Phoenix Limited Partnership of Raleigh and Summus, Inc. (incorporated by reference to Exhibit 10.31 to our Form 10 filed on July 5, 2001)
10.14*
Lease Agreement, dated as of August 12, 1999, between Phoenix Limited Partnership of Raleigh and Summus, Ltd. (incorporated by reference to Exhibit 32 to our Form 10 filed on July 5, 2001)
10.15*
Lease Modification Agreement Number 1, dated as of December 22, 1999, between Phoenix Limited Partnership of Raleigh and Summus, Ltd. . (incorporated by reference to Exhibit 33 to our Form 10 filed on July 5, 2001)
10.16*
Summus, Inc. Invention Awards Plan, effective October 30, 2000 (incorporated by reference to Exhibit 10.40 to Amendment No. 1 to our Form 10 filed on September 28, 2001)
10.17*
Master Porting Agreement, dated July 27, 2001, between Summus, Inc. and Samsung Electronics America (incorporated by reference to Exhibit 10.41 to Amendment No. 2 to our Form 10 filed on October 31, 2001)
10.18*
Alternative Compensation Plan, adopted as of August 1, 2002 (incorporated by reference to Exhibit 10.19 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2002) .
14.1
Code of Ethics
21.1
Subsidiaries of Summus - None
23.1
Consent of Ernst & Young LLP
31.1
Rule 13a-14(a)/15(d)-14(a) Certificate of Gary E. Ban, Chief Executive Officer
31.2
Rule 13a-14(a)/15(d)-14(a) Certificate of Donald T. Locke, Chief Financial Officer
32.1
Section 1350 Certificate of Gary E. Ban, Chief Executive Officer
32.2
Section 1350 Certificate of Donald T. Locke, Chief Financial Officer
Report of Independent Auditors
The Board of Directors and Shareholders
Summus, Inc. (USA)
We have audited the accompanying consolidated balance sheets of Summus, Inc. (USA) as of December 31, 2003 and 2002, and the related consolidated statements of operations, shareholders’ equity (deficit) and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of Summus, Inc. (USA)’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Summus, Inc. (USA) at December 31, 2003 and 2002 and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States.
The accompanying financial statements have been prepared assuming that Summus, Inc. (USA) will continue as a going concern. As more fully described in Note 1, Summus, Inc. (USA) has incurred operating losses since inception. These conditions raise substantial doubt about Summus, Inc. (USA)’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
/s/ Ernst & Young LLP
Ernst & Young LLP
March 29, 2004
Raleigh, North Carolina
Summus, Inc. (USA)
Consolidated Balance Sheets
See accompanying notes.
Summus, Inc. (USA)
Consolidated Statements of Operations
* Selling, general and administrative expenses in 2003, 2002 and 2001 exclude $0.3 million, $1.3 million and $1.0 million, respectively, of non-cash compensation and consulting charges.
See accompanying notes.
Summus, Inc. (USA)
Consolidated Statements of Shareholders’ Equity (Deficit)
Summus, Inc. (USA)
Consolidated Statements of Shareholders’ Equity (Deficit)
(continued)
See accompanying notes.
Summus, Inc. (USA)
Consolidated Statements of Shareholders’ Equity (Deficit)
(continued)
Summus, Inc. (USA)
Consolidated Statements of Shareholders’ Equity (Deficit)
(continued)
Summus, Inc. (USA)
Consolidated Statements of Shareholders’ Equity (Deficit)
(continued)
See accompanying notes.
Summus, Inc. (USA)
Consolidated Statements of Shareholders’ Equity (Deficit)
(continued)
Summus, Inc. (USA)
Consolidated Statements of Cash Flows
See accompanying notes.
Summus, Inc. (USA)
Notes to Consolidated Financial Statements
December 31, 2003
1. Business, Organization and Basis of Presentation
Business
Summus, Inc. (USA) ("Summus” or the "Company"), formerly known as High Speed Net Solutions, Inc., is engaged primarily in the development of efficient information processing solutions for the mobile and wireless markets. Prior to the second quarter of 2002, Summus’ primary business activities included providing services under research and development contracts for governmental agencies in the areas of complex imaging and object recognition as well as the licensing to third parties its Photo ID and WI compression and decompression technology. Although the Company’s core business activities are now focused on the mobile and wireless market, Summus continues to evaluate business opportunities related to services and products that it had formerly provided as they become available, particularly opportunities that offer growth potential with the business objectives and mission of the Company’s BlueFuel platform. The core of the Company's business plan is to focus on the emerging wireless and mobile market. Summus has developed software, technology and applications to enable information processing and resource management to include, but not be limited to, the creation, transmission, playing and management of content over wireless networks. The Company's technology platform, which provides the foundation for its current and future products and services, is designed to address the bandwidth, power, memory, and usability constraints of existing wireless network infrastructure. This platform will enable more efficient use of existing and future bandwidth allocations, resulting in a perceived bandwidth increase by the mobile end-user. The platform’s objective is to create a superior mobile end-user experience, which will impact devices, wireless carrier infrastructure and mobile applications.
The Company has completed development of and has launched twenty-five (25) wireless applications. Eleven (11) wireless carriers in the United States and eight (8) international wireless carriers currently deploy at least one or a combination of the twenty-five (25) wireless applications that have been completed by the Company. It launched its first wireless application during the second quarter of 2002. These applications can be purchased by the end-user as a one-time purchase, or a monthly subscription, depending on content, product function, and/or carrier preferences.
The majority of the applications completed and deployed by the Company, as well as planned future applications, have been developed by the Company through a process that involves securing agreements with content providers and carriers, and developing and launching the applications. The Company outsources the infrastructure needed to host and deliver the transactions for its application end-users.
Organization
On February 16, 2001, High Speed Net Solutions, Inc. (“High Speed”) and Summus, Ltd. entered into a contract whereby, in legal form, High Speed acquired all the assets of Summus, Ltd. Although the legal form of the transaction was an acquisition of assets, in substance the transaction represented a Summus, Ltd. capital transaction accompanied by a recapitalization. Since the Summus, Ltd. shareholders were the majority owners of the entity after this transaction was completed, the transaction was accounted for as an issuance of stock by Summus, Ltd. in exchange for the net monetary assets of High Speed accompanied by a recapitalization of Summus, Ltd. The accounting for the transaction is essentially equivalent to that resulting from a reverse acquisition, except that no goodwill or other intangible assets are recorded.
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
1. Business, Organization and Basis of Presentation (continued)
Prior to this recapitalization transaction, High Speed was a publicly-traded entity and Summus, Ltd. was a privately-held company. Since the legal form of the transaction was an acquisition of Summus, Ltd. by High Speed, the legal entity, which represented the combined, recapitalized Summus, Ltd., continued to use the High Speed trade name and its stock continued to trade in the public markets under the High Speed name. As a result of the transaction, the historical financial statements of Summus, Ltd., for accounting purposes, are deemed to be those of the Company.
On February 27, 2002, the Company officially changed its legal name from High Speed Net Solutions, Inc. to Summus, Inc. (USA). Therefore, the financial statements presented herein and labeled as the financial statements of Summus, Inc. (USA) represent the historical financial statements of Summus, Ltd., now renamed Summus, Inc. (USA) and also referred to herein as “the Company.” References herein to “High Speed” refer to High Speed Net Solutions prior to the February 16, 2001 recapitalization transaction.
Basis of Presentation
The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the financial statements for the year ended December 31, 2003, the Company incurred a net loss of $3,877,301 and experienced negative cash flows from operations. The Company’s continuation as a going concern is dependent on its ability to generate sufficient cash flow to meet its obligations on a timely basis, to obtain additional financing, and ultimately to attain profitability. The Company is actively promoting and expanding its product line and pursuing additional equity financing from existing shareholders and other institutional investors. Management expects to be able to attract additional capital to continue to fund and expand operations and also expects that increased revenues will reduce its operating losses in future periods. However, there can be no assurance that management’s plan will be executed as anticipated.
The financial statements presented herein do not include any adjustments relating to the recoverability of assets and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.
2. Recapitalization
As previously noted, on February 16, 2001, High Speed and Summus, Ltd. entered into a merger transaction. The transaction was accounted for as a Summus, Ltd. capital transaction, accompanied by a recapitalization.
As a result of the transaction, the historical financial statements of Summus, Ltd., for accounting purposes, are deemed to be those of the Company. The equity accounts of Summus, Ltd. have been adjusted for a recapitalization to reflect the equity structure of High Speed, the legal acquirer. Specifically:
the historical shareholders’ equity of Summus, Ltd. prior to the transaction has been restated for the equivalent number of shares of High Speed common and Series B preferred stock, and other equity interests, received in the transaction after giving effect to any difference in par value of High Speed’s and Summus, Ltd.’s common stock, with an offset to additional paid-in capital;
the accumulated deficit of Summus, Ltd. has been carried forward after the transaction;
the loss per share for periods prior to the transaction have been restated to reflect the number of equivalent shares received by Summus, Ltd. in the transaction; and
the transaction resulted in the net issuance of 23.4 million shares of common stock, 2,000 shares each of Series A and Series B preferred stock and warrants to purchase 500 shares of Series B preferred stock.
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
3. Summary of Significant Accounting Policies
Principles of Consolidation
The 2001 consolidated financial statements include the accounts of the Company and its former wholly owned subsidiary, Douglas May & Company, Inc. Significant intercompany accounts and transactions have been eliminated in consolidation. The results of operations of Douglas May & Company, Inc. have been presented as discontinued operations for the year ended December 31, 2001.
Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Revenue Recognition and Related Costs
Change in Revenue Recognition Policy
After a careful review of the Company’s revenue recognition policies and giving consideration to guidance provided for in Emerging Issues Task Force No. 99-19 Reporting Revenue Gross as a Principal versus Net as an Agent (“EITF 99-19”), the Company has changed certain revenue recognition policies affecting revenues earned by wireless applications and contracts. Prior to 4th quarter 2003, the Company reported revenues earned by wireless applications and contracts and cost of revenues for wireless applications and contracts net of certain third-party costs in the statement of operations. These transactions have been reclassified to reflect a gross revenue presentation with no effect on gross profit or net loss. The amount by which revenues and costs of revenues have been reclassified for the year ended December 31, 2003 is $635,989. Revenues and costs of revenues for 2002 have not been reclassified due to immateriality.
Wireless applications and contracts
Commencing during the second quarter of 2002, our resources were dedicated to the development of solutions for the mobile and wireless markets. Revenues earned from wireless applications are recognized upon delivery and acceptance by the end-user either as a one-time purchase or a monthly subscription. For content delivery partner arrangements, whereby the Company remits a portion of the revenues earned through the sale of the Company’s applications, revenue is recorded on a gross basis in accordance with EITF 99-19. The Company recognizes the cost of payments to the content providers as a cost of revenues. Wireless applications and contracts cost of revenues includes all third-party hosting, testing and/or carrier distribution fees. These costs are incurred on a monthly basis and are primarily fixed in nature regardless of the revenue generated by the related applications.
During January of 2002, the Company entered into a strategic partnership agreement with a global leader in semiconductor, telecommunication and digital convergence technology, related to the mobile and wireless markets for which it received $100,000. Revenue earned under this agreement was recognized ratably over the twelve-month term of the agreement.
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
3. Summary of Significant Accounting Policies (continued)
Periodically, we enter into non-recurring engineering arrangements with our content partners. Generally, under the terms of these agreements, we receive funding upfront to complete projects. The funding we receive upfront is recorded as deferred revenue and is recognized as revenue under the terms of the individual arrangements. Deferred revenue represents amounts received for which the Company has not yet completed its contractual obligations.
Wireless License Fees
We recognize revenue from licensee fees for wireless software applications in accordance with the provisions of AICPA Statement of Position 97-2, “Software Revenue Recognition”, as amended by AICPA Statement of Position 98-9 “Modification of SOP No. 97-2 Software Revenue Recognition with Respect to Certain Transactions.” Revenue from software license fees is generally recognized upon delivery provided that a contract has been executed, the vendor fee is fixed or determinable, no significant vendor obligations or uncertainties surrounding customer acceptance remain, and collection of the resulting receivable is deemed probable.
There were no costs related to the wireless license fee revenue generated during the year ended December 31, 2003 as the license fee revenue related to technology that had been previously developed by the Company, and there were no costs for installation, delivery or customization, or other related costs.
Contracts and license fees
We derive certain revenues from research and development contracts for governmental agencies and the commercial licensing of our technology. We recognize revenue on these contracts at the time services are rendered based upon the terms of individual contracts. Regarding the commercial licensing of our technology, we follow the provisions of AICPA Statement of Position 97-2, “Software Revenue Recognition”, as amended by AICPA Statement of Position 98-9 “Modification of SOP No. 97-2 Software Revenue Recognition with Respect to Certain Transactions.” Revenue from software license fees is generally recognized upon delivery provided that a contract has been executed, the vendor fee is fixed or determinable, no significant vendor obligations or uncertainties surrounding customer acceptance remain, and collection of the resulting receivable is deemed probable.
Segments
Management has structured the Company’s internal organization as one business segment for which all operating decisions are made and all operating results are evaluated.
Equipment and Furniture
Equipment and furniture is stated at cost. Depreciation is computed over the estimated useful lives of the assets (generally three to seven years) using the straight-line method. Amortization of capital lease assets is included in depreciation expense.
Financial Instruments
The Company’s financial instruments that are exposed to a concentration of credit risk consist primarily of its trade accounts receivable, which are unsecured. Collateral is generally not required. Management provides an estimated
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
3. Summary of Significant Accounting Policies (continued)
allowance for doubtful accounts based on its assessment of the likelihood of future collections. No allowance has been recorded as of December 31, 2003 or 2002, as all amounts are deemed to be fully collectible. The carrying amount of cash, accounts receivable, accounts payable and debt approximate fair value for these financial instruments because of the short maturities of the instruments.
Significant Concentrations
For the year ended December 31, 2003, one customer accounted for 45% and 59% of the Company’s consolidated revenues and accounts receivable, respectively. This same customer accounted for 100% of the Company’s wireless revenues and accounts receivable for the year ended December 31, 2002. There were no other customers with revenues or accounts receivable in excess of 10 percent of the respective balances. Should this wireless carrier discontinue the deployment of the Company’s applications, the Company’s business would be adversely affected.
During 2003, 2002 and 2001, revenue from the U.S. Government and related entities represented 3%, 29% and 67%, of total revenue, respectively. Revenue from sources other than the U.S. Government and related entities in 2002 was generated by one customer that accounted for 25% and a second customer that accounted for 11% of the Company’s total revenue.
Software Development Costs
Capitalization of software development costs begins with the establishment of technological feasibility of new or enhanced software products. Technological feasibility of a computer software product is established when the Company has completed all planning, designing, coding and testing 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 software product are charged to research and development expense as incurred.
The Company amortizes capitalized software development costs on a product-by-product basis at the greater of the amount computed using (a) the ratio of current gross revenues for a product to the total of current and anticipated future gross 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. The Company capitalized $337,451 during 2001 of costs incurred related to product development that met these criteria for capitalization.
During the fourth quarter of 2001, the Company wrote off the $337,451 of software costs that were capitalized during the second and third quarters of 2001. During the fourth quarter of 2001, management changed its business model and its intended use of its software products and related technology. Based on an evaluation of the change in the business model and the associated projected cash flows, management determined that the software costs capitalized during 2001 were impaired and wrote the amount off as research and development costs. No capitalized software development costs were incurred in 2003 or 2002.
Income Taxes
Income taxes are accounted for using the liability method in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes.” Under SFAS 109, deferred tax assets or liabilities are computed based upon the difference between the financial statement and income tax basis of assets and liabilities using the enacted marginal tax rate applicable when the related asset or liability is expected to be realized or settled. Deferred income tax expenses or benefits are based on the changes in the asset or liability from period to period. If available evidence suggests that it is more likely than not that some portion or all of the deferred tax assets will not be realized, a valuation allowance is required to reduce the deferred tax assets to the amount that is more likely than not to be realized. Future changes in such valuation allowance would be included in the provision for deferred income taxes in the period of change.
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
3. Summary of Significant Accounting Policies (continued)
Stock-Based Compensation
The Company has stock-based compensation plans for employees, consultants and directors, which are described more fully in Note 13. The Company accounts for those plans under the intrinsic value method prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees and related interpretations. For options granted under those plans with an exercise price equal to the market value of the stock on the date of grant, no compensation cost is recognized in net operations as reported in the consolidated statement of operations. Compensation cost is recognized in net earnings/loss for awards granted under those plans with an exercise price less than the market value of the underlying common stock on the date of grant. Such costs are recognized ratably over the vesting period. The Company recorded non-cash compensation related to the issuance of fully-vested stock options with exercise prices below the fair market value of the underlying stock plus the amortization of deferred compensation arising from stock option issuances subject to vesting totaling $185,255, $364,000 and $956,321 in 2003, 2002 and 2001, respectively.
The following table illustrates the effect on net loss and net loss per share if the Company had applied the fair value recognition provision of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation. In accordance with SFAS 123, the fair value of each option grant was determined by using the Black-Scholes option pricing model with the following weighted average assumptions for the years ended December 31, 2003, 2002 and 2001: dividend yield of 0%; volatility ranging from 1.218 to 1.789; risk-free interest rate ranging from 2.75% to 5.34%, and expected option lives of 5 years for employees and 10 years for Board members. The weighted average grant-date fair value of options granted during 2003, 2002 and 2001 was $0.30, $0.62 and $2.90 per option, respectively.
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
3. Summary of Significant Accounting Policies (continued)
The Company accounts for stock-based compensation to non-employees of the Company, primarily consultants and advisors, at the fair value of the equity instrument in accordance with the provisions of SFAS No. 123. Non-cash consulting expense related to such stock based compensation for the years ended December 31, 2003 and 2002 was $119,630 and $887,992, respectively. There was no non-cash consulting expense related to stock based compensation for the year ended December 31, 2001.
Net Loss Per Share
Loss per share has been calculated in accordance with SFAS No. 128, “Earnings Per Share.” Basic loss per share was computed by dividing the net loss for each period presented by the weighted average number of shares of common stock outstanding for such period, as adjusted for the recapitalization. Although the Company has potential common stock equivalents related to its outstanding stock options, warrants and preferred stock, these potential common stock equivalents were not included in diluted loss per share for each period presented because the effect would have been antidilutive.
Common stock equivalents not included in diluted loss per share in 2003 consist of 7,709,629 outstanding stock options, 44,543,728 outstanding warrants, 161,246 Series A preferred shares and related accrued dividends, as converted, 5,240,000 Series C preferred shares, as converted, 14,500,000 Series D preferred shares, as converted, and 850,000 Series E shares, as converted.
New Accounting Pronouncements
In January 2003, the EITF published EITF Issue 00-21, "Revenue Arrangements with Multiple Deliverables," which requires companies to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. In applying EITF Issue 00-21, revenue arrangements with multiple deliverables should be divided into separate units of accounting if the deliverables in the arrangement meet certain criteria. Arrangement consideration should be allocated among the separate units of accounting based on their relative fair values. EITF Issue 00-21 is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of EITF Issue 00-21 is not expected to have a material impact on the Company's financial statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities", which addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. The Interpretation applies immediately to variable interests in variable interest entities created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. The adoption of this Interpretation did not have an impact on the Company's financial statements. The Interpretation becomes effective for entities created before February 1, 2003 as of the beginning of the first period after December 15, 2003. We do not anticipate the application of this provision of the Interpretation to have a material impact on the Company's financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity." SFAS No. 150 establishes standards for how an issuer of financial statements classifies and measures certain financial instruments that have characteristics of both liabilities and equity. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 did not have a material impact on the Company's financial statements.
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
4. Equipment and Furniture
Equipment, software and furniture consists of the following at December 31:
Depreciation expense totaled $259,025, $371,457 and $439,027 for the years ended December 31, 2003, 2002 and 2001, respectively.
5. Leases
The Company leases equipment and office space under long-term capital and operating lease agreements. Rental expense amounted to approximately $259,000, $347,000 and $498,000 for the years ended December 31, 2003, 2002 and 2001, respectively.
Minimum future lease payments under noncancellable leases at December 31, 2003 are as follows:
6. Income Taxes
No provision for income taxes has been recorded during the years presented due to the Company’s significant operating losses in each year.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax assets are as follows:
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
6. Income Taxes (continued)
Management has determined that a 100% valuation allowance for existing deferred tax assets is appropriate given the uncertainty regarding the ultimate realization of these assets.
The reasons for the difference between actual income tax benefit for the years ended December 31, 2003 and 2001 and the amount computed by applying the statutory federal income tax rate to losses before incomes taxes are as follows:
At December 31, 2003, the Company had federal and state net operating loss carryforwards of approximately $27 million for income tax purposes. The tax benefit of these carryforwards is reflected in the above table of deferred tax assets. If not used, these carryforwards begin to expire in 2020 for federal tax purposes and in 2015 for state tax purposes. U. S. tax rules impose limitations on the use of net operating losses following certain changes in ownership. If such a change occurs, the limitation would reduce the amount of these benefits that would be available to offset future taxable income each year, starting with the year of ownership change.
7. Related Party Transactions
During 2003, the Company paid commissions to a director of the Company in connection with the Series D and E convertible preferred stock offerings. The Company paid cash commissions of $117,000 and issued warrants to purchase 975,000 shares of unregistered common stock with an exercise price of $.35 per share and a contractual life of three years. The warrants were valued at $299,750, using the Black-Scholes option-pricing model. The value of the consideration paid to the director was recorded as a stock issuance cost.
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
8. Convertible Debentures
On July 19, 2002, the Company issued 6% convertible secured debentures, along with warrants to purchase 1,724,138 shares of common stock for aggregate gross proceeds of $500,000. The warrants are exercisable upon issuance, have a term of three years and have exercise prices ranging from $0.47 to $0.59 per share. The debentures had an initial life of five years and were convertible into common stock at a conversion rate of $0.29 per share. As of December 31, 2002, all of the convertible debentures plus accrued interest had been converted into 1,728,568 shares of common stock.
The accounting treatment for the debentures involved allocating the value of the principal amount of $500,000 between the debentures, the associated warrants and a beneficial conversion feature associated with the debentures. A beneficial conversion feature existed because the conversion rate of the debentures was below the traded value of the Company’s common stock on the date the debentures were issued. The beneficial conversion feature was valued at $189,655 and was recorded as a debt discount and additional paid-in-capital on the date the debentures were issued. Since the debentures were convertible into common stock immediately, the value of the beneficial conversion feature was charged to interest expense on the date of issuance.
Interest expense relating to the convertible debenture transaction totaled $420,250 for the year ended December 31, 2002 and consisted of the following:
$190,000, relating to the value, as determined by the Black-Scholes pricing model, of the 1,724,138 warrants issued to the debentures holders;
$189,655, relating to the value of the beneficial conversion feature associated with the convertible debentures;
$39,310, relating to placement agent fees, consisting of a cash commission of $30,000 and a warrant to purchase 51,724 shares of common stock that was valued at $9,310 using the Black-Scholes pricing model and;
$1,285, relating to interest expense incurred while the debentures remained outstanding based on the stated rate of 6% per annum. At the Company’s election, these interest costs were paid through the issuance of shares of common stock based on the conversion rate of $0.29, resulting in the issuance of 4,430 shares of common stock.
9. Notes Payable
On September 4, 2000, the Company entered into an agreement to obtain the rights to certain software technology. In exchange for these rights, the Company agreed to pay $200,000 in eight equal installments of $25,000 beginning in 2001 and continuing over the next two years. On July 19, 2002, the payment terms of this agreement were amended for an adjustment in the payment terms, whereby the Company issued 235,000 shares of unregistered common stock with registration rights to repay $87,500 of the outstanding balance. The remaining balance was scheduled to be repaid in 6 equal installments commencing July 19, 2003; however, no payments have been made on this balance subsequent to July 19, 2003, and therefore the agreement is in default. The outstanding principal balance of this note as of December 31, 2003 and 2002 is $77,500.
On May 23, 2003, the Company executed a settlement agreement with Holland & Knight LLP (“H&K”). The terms of the H&K agreement are more fully described in Note 15 below. Under the terms of the H&K agreement, the Company entered into a note payable agreement whereby it agreed to make payments totaling $325,000, consisting of monthly payments of $9,028 over a three year period commencing on June 1, 2003. Since the H&K agreement did not provide for an interest
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
9. Notes Payable (continued)
rate component pertaining to this payment plan, a rate of 20% per annum was used to present value the note, resulting in a net present value of $242,926. As of December 31, 2003, the current portion of this note totaled $67,994 and the non-current portion totaled $132,695.
On September 3, 2003, the Company negotiated a revised settlement agreement with Analysts International Corporation (“AIC”), a former service provider. The terms of the revised AIC settlement agreement are more fully described in Note 15 below. Under the terms of the revised AIC settlement agreement, the Company agreed to pay a monthly payment of $7,500 until the total indebtedness, including interest at 8%, is paid in full. As of December 31, 2003, the current portion of this note totaled $90,000 and the non-current portion totaled $59,437. Prior to the revised AIC settlement agreement on September 3, 2003, the amount due to AIC was recorded as a currently liability, included in Accounts Payable and Accrued Expenses, since the Company was in default under the terms of the initial settlement agreement.
On September 30, 2003, the Company executed a settlement agreement with Raytheon Company (“Raytheon”), regarding a note payable agreement that had previously been in default and had accrued interest at a rate of 18% per annum. The terms of the Raytheon agreement are more fully described in Note 15 below. Under the terms of the Raytheon agreement, the Company entered into a note payable agreement whereby it agreed to make payments totaling $87,516, consisting of an initial payment of $10,000; six (6) equal monthly installments of $3,000; fourteen (14) monthly installments of $4,000; and one final installment of $3,516. Since the Raytheon agreement did not provide for an interest rate component pertaining to this payment plan, a rate of 20% per annum was used to present value the note, resulting in a net present value of $74,305. As of December 31, 2003, the current portion of this note totaled $34,701 and the non-current portion totaled $23,800.
10. Profit Sharing Plan
The Company has established a 401(k) retirement plan for the benefit of employees who have attained the age of 21 years. The Company’s matching contribution to the plan is discretionary and is not limited to profits. For the years ended December 31, 2003, 2002 and 2001, the Company contributed $28,706, $26,166 and $37,176 to the plan, respectively.
11. Common Stock and Warrants
During 2003, the Company sold to private accredited investors in negotiated transactions 2,704,153 shares of its unregistered common stock, warrants to purchase an additional 316,000 shares of common stock, and re-priced 6,609,645 previously issued warrants. These transactions were in two forms. The first form involved purchases of common stock at prices which were above the trading value of the Company’s freely-tradable shares 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 the exercise price of previously issued warrants if the holder exercised those repriced warrants immediately. The original exercise prices of the repriced warrants ranged between $0.60 and $5.25, per share. The repriced exercise prices ranged between $0.20 and $1.69, per share. Total cash proceeds from the sale of the shares and issuance of the new warrants was $1,337,582.
During 2003, the Company issued 3,491,243 shares of unregistered common stock upon the exercise of warrants with exercise prices ranging from $0.20 to $0.50 per share. Of the 3,491,243 exercised warrants, 2,881,343 were exercised in connection with the repricing of the exercise price of the warrants as described in the previous paragraph. The initial exercise prices of the warrants ranged between $0.60 and $5.25. The repriced exercise prices ranged between $0.20 and $1.69. The exercise of these warrants generated gross proceeds of $928,675.
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
11. Common Stock and Warrants (continued)
During 2003, the Company issued to consultants 219,257 shares of unregistered common stock, 103,400 stock options, and 17,935 warrants for services provided to the Company for an aggregate value of $112,456. The shares of unregistered common stock were valued at $78,629 based on the negotiated terms of each contract and the options and warrants were valued at $29,888 and $3,939, respectively, using the Black-Scholes option-pricing model. Also during 2003, the Company granted 33,000 options to the sole member of its Advisory Board. These options vest quarterly over a one year period and have an exercise price equal to the traded per share value of the underlying common stock on the date of grant. The value of the vested portion of the option of $8,663 was determined using the Black-Scholes option-pricing model and was recorded as non-cash compensation expense for the year ended December 31, 2003.
During 2003, the Company issued 906,936 shares of its unregistered common stock valued at $308,355 to entities as payment on outstanding vendor balances.
During 2003, the Company issued 1,461,717 shares of its unregistered common stock valued at $517,504 to entities as settlement of outstanding obligations. During 2003, Summus issued 333,333 warrants to Donald T. Locke, a consultant who acts in the capacity of the general counsel to Summus, as payment for $200,000 of fees owed to Mr. Locke. The warrants have an exercise price of $0.60 per share and a contractual life of 5 years. The warrants were valued at $83,333 using the Black-Scholes option-pricing model. The settlement gain resulting from this transaction was $116,667 and was recorded in non-cash settlements for the year ended December 31, 2003. The settlements are more fully described in Note 15 below.
During 2002, the Company sold to investors 9,053,167 shares of its unregistered common stock (including 21,666 shares of unregistered common stock in the form of commissions) and warrants to purchase an additional 17,779,104 shares of unregistered common stock for net cash proceeds of $6,439,307. The warrants have exercise prices ranging from $0.48 to $4.00 per share, a term of five years and cannot be exercised within the first six months of the date of issuance. The estimated fair value of the unregistered shares issued as commissions for capital raising of $12,287 was deducted from the gross proceeds raised. During the year ended December 31, 2002, the Company paid one of its outside directors cash commissions of $110,139 relating to the sale of the Company’s unregistered common stock and warrants.
During 2002, the Company issued 177,885 shares of its unregistered common stock and warrants to purchase 150,000 shares of unregistered common stock to certain members of management in lieu of cash payment for unpaid salary amounts earned in 2001. These shares and warrants were valued at $177,895, based on the recorded value of the unpaid salary amounts as of December 31, 2001.
During 2002, the Company issued 234,254 shares of its unregistered common stock and 40,000 warrants to purchase unregistered common stock with an exercise price of $2.35 to consultants for services provided to the Company and 20,313 shares of its unregistered common stock in connection with the termination of a former employee as a severance payment. The unregistered common shares were valued at $85,958, based on the negotiated terms of each contract and the warrants were valued at $44,800 using the Black-Scholes option-pricing model. The costs of these services were included in non-cash consulting expense for the year ended December 31, 2002.
During January 2002, the Company entered into two separate agreements whereby it issued 115,000 shares of its unregistered common stock and 230,000 warrants to purchase the Company’s unregistered common stock with an exercise price of $2.50 per share to a shareholder as consideration for the conveyance by him of 115,000 shares of the Company’s common stock to: (1) an investment banking company for investment banking services and (2) an independent consultant for financial advisory services. The 115,000 shares were recorded at their estimated fair value of $157,376 by applying a discount to the traded value of the Company’s freely trading common stock on the date of each agreement. The 230,000 warrants were valued at approximately $297,600 using the Black-Scholes option-pricing model. The costs of these services were included in non-cash consulting expense for the year ended December 31, 2002.
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
11. Common Stock and Warrants (continued)
During February 2002, the Company issued 25,000 shares of its unregistered common stock and 12,500 warrants to purchase the Company’s unregistered common stock with an exercise price of $2.50 per share to an independent firm providing investor relation services. The 25,000 shares were recorded at their estimated fair value of $37,280 by applying a discount to the traded value of the Company’s freely trading Common Stock on the date of the agreement. The 12,500 warrants were recorded at their estimated fair value of $17,625 using the Black-Scholes option-pricing model. On June 19, 2002, the Company terminated this agreement and issued 10,000 warrants to purchase the Company’s unregistered common stock with an exercise price of $2.50 per share as a termination fee. These warrants were valued at $4,200 using the Black-Scholes option-pricing model. Additionally, prior to the termination of this agreement, the Company was committed to issue to the investor relations firm warrants to purchase shares of the Company’s unregistered common stock, if and when the traded value of the Company’s stock price achieved certain levels over a certain time period. These contingent warrants were valued at $30,000 and since this agreement was terminated before the any of the warrants could be earned, the $30,000 was charged to non-cash expense.
During 2002, the Company issued 235,000 shares of its unregistered common stock as a partial payment of $87,500 on a note payable, see Note 9. Also during 2002, the Company issued 20,000 shares of its unregistered common stock as a partial payment of $10,216 on an outstanding balance due to a former service provider to the Company. In each instance, the value of these shares was determined based on negotiations between the parties.
During 2002, the Company issued 189,624 shares of its unregistered common stock upon the exercise of outstanding warrants. The Company received $79,813 in proceeds from the exercise of these warrants.
During 2002, the Company deemed the $65,000 stock purchase receivable not collectible and wrote off the receivable against additional paid in capital.
Subsequent to the Company’s recapitalization (see Note 2), Summus, Inc. sold to investors during 2001, 2,978,390 shares of its unregistered common stock and warrants to purchase an additional 6,175,658 shares of unregistered common stock for gross cash proceeds of $6,371,912. During 2000 and through the closing of the Summus, Ltd. recapitalization transaction on February 16, 2001, the Company issued 1,997,564 and 428,234 warrants, respectively, to purchase shares of its unregistered common stock in connection with sales of its unregistered common stock for cash. The warrants have exercise prices ranging from $2.40 to $5.25 per share, a term of five years and cannot be exercised within five months of the date of issuance.
Also in connection with the Summus, Ltd. recapitalization transaction, the former Summus, Ltd. shareholders were issued warrants to purchase 500 shares of Series B preferred stock at an exercise price of $5,500 share. On February 27, 2002, these warrants were converted into 500,000 warrants exercisable over five years to purchase shares of unregistered common stock, with an exercise price of $5.50 per share. The warrants to purchase Series B preferred stock were issued as partial consideration in the Summus, Ltd. recapitalization transaction in order to preserve the Company’s common stock for other uses.
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
11. Common Stock and Warrants (continued)
The Company has reserved shares of its authorized 185,000,000 shares of common stock for future issuance as follows:
A summary of the Company’s outstanding warrants as of December 31, 2003 is as follows:
The warrants can be exercised at any time until their expiration dates, which are between July 25, 2005 and December 31, 2008.
12. Preferred Stock
Series A Convertible Preferred Stock
The Company has 2,078 and 2,328 shares of Series A convertible preferred stock (“Series A preferred stock”) outstanding as of December 31, 2003 and 2002, respectively. 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 preferred stock are entitled to receive cumulative cash dividends at a rate of 8% per annum of the initial liquidation preference of $1,000 per share. These dividends are accrued monthly. The Company, at its election, can provide for the payment of dividends on the Series A preferred stock through the issuance of additional shares of Series A preferred stock having an aggregate initial liquidation preference equal to the amount of cash dividends otherwise payable. Dividends are cumulative from the date of issuance and are payable, when, as and if declared by the Board of Directors, on March 31 and September 30 of each year. The Company is restricted from paying dividends on common stock until dividends are paid on Series A preferred in full. The Company recorded preferred stock dividends of $171,265 and $183,039 in 2003 and 2002, respectively. No dividends were paid in 2003.
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
12. Preferred Stock (continued)
In April 2002 and October 2002, the Company’s Board of Directors authorized the payment of the accrued Series A preferred stock dividends at March 31, 2002 and September 30, 2002, totaling $355,315 and $90,997, respectively. At the Company’s election, the payment of these dividends was made through the issuance of 446 new shares of Series A preferred stock. During 2003, a holder of the Series A preferred stock converted 250 shares of Series A preferred stock into 17,557 shares of the Company’s unregistered common stock. During 2002, a holder of Series A preferred stock converted 118 shares of Series A preferred stock into 8,287 shares of the Company’s unregistered common stock. As of December 31, 2003, the Company had recorded $218,143 in accrued dividends, which is reflected in current liabilities in the accompanying consolidated balance sheet.
The holders of the outstanding shares of Series A preferred stock are not entitled to vote on matters submitted to the Company’s shareholders for voting. However, approval of holders of a majority of the outstanding shares of Series A preferred stock is required prior to the issuance of a new series of preferred stock that ranks senior to the Series A preferred stock. Each share of the Series A preferred stock is convertible at the option of the holder, at any time after the date of issuance, into shares of common stock equal to the Liquidation Preference divided by the initial conversion price of $14.24. The conversion price is subject to adjustment in accordance with the Company’s articles of incorporation. At the Company’s election, it has the right to redeem any outstanding shares of the Series A preferred stock at the Liquidation Preference of $1,000 per share.
Series B Convertible Preferred Stock
During February 2001, the Company amended its bylaws to provide for the authorization of 6,500 shares of Series B convertible preferred stock (“Series B preferred stock”). The Company issued 6,000 shares of Series B preferred stock (2,000 of which were placed in escrow) in connection with the Summus, Ltd. recapitalization. Of these shares, 4,000 were issued to the former Summus, Ltd. shareholders in the first quarter of 2002.
On February 16, 2002, the escrow agreement that was established in connection with the recapitalization transaction between the Company and Summus, Ltd. was terminated. Initially, 2,000 Series B preferred shares were placed in escrow as security for any indemnification obligations of Summus, Ltd. and its shareholders under the recapitalization transaction. Prior to the termination of the escrow agreement, claims were made against the escrowed shares for liabilities of Summus, Ltd. that were identified and paid during the escrow period, but were not known at the closing of the recapitalization transaction on February 16, 2001. Of the total 2,000 Series B preferred shares placed in escrow, 329.660 shares were claimed for indemnification of Summus, Ltd.’s obligations, resulting in 1,670.339 Series B preferred shares available for distribution to the former Summus, Ltd. shareholders. As noted below, these shares were automatically converted into 1,670,339 unregistered common shares based on a conversion ratio of 1,000 to 1 and were subsequently distributed to the former Summus, Ltd. shareholders.
On February 27, 2002, a majority of the Company’s shareholders approved the increase in the number of authorized common shares from 50.0 million to 100.0 million. The increase in the number of authorized shares triggered the automatic conversion of all of the outstanding shares of the Series B preferred stock. On February 27, 2002, there were 6,000 shares of Series B preferred stock outstanding that converted into 6,000,000 shares of common stock. The 329.660 Series B preferred shares that were claimed for indemnification purposes were converted into 329,660 shares of common stock and were retired by the Company, resulting in a net issuance of 5,670,340 of common stock on the conversion date.
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
12. Preferred Stock (continued)
Series C Convertible Preferred Stock
In June 2003, the Company amended its articles of incorporation to establish its Series C convertible preferred stock (“Series C preferred stock”). The Series C preferred stock has an issued price of $1,000 per share and has the following rights and privileges:
no voting rights except with respect to (i) the amendment or alteration of the statement of rights and preferences applicable to the Series C preferred stock, and (ii) any matters for which voting rights are provided under Florida law;
shares of the Series C preferred stock shall rank on a parity with Summus’ Series A, Series D and Series E convertible preferred stock as to liquidation preference upon dissolution, liquidation or the winding up of Summus;
a liquidation preference, subject to adjustment for any combinations, consolidations, stock distributions or stock dividends with respect to the Series C preferred stock, of $1,000 per share payable in the event of any liquidation, dissolution or winding up of Summus, 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 the Series C preferred stockholder, after nine (9) months from the date of its issuance. Each share of Series C preferred stock shall be convertible into 4,000 fully paid and nonassessable shares of the Company’s common stock.
During 2003, the Company sold 1,310 shares of its Series C preferred stock and issued warrants in connection with such sale to purchase 5,240,000 shares of unregistered common stock with an exercise price of $0.75 per share for gross proceeds of $1,310,000. The value of the warrants issued in this offering, totaling $650,990, was determined utilizing the Black Scholes pricing model, limited to the pro-rata fair value of the Series C offering proceeds allocable to the warrants. Cash commissions of $35,263 were paid in connection with the Series C offering.
Series D Convertible Preferred Stock
In September 2003, the Company amended its articles of incorporation to establish its Series D convertible preferred stock (“Series D preferred stock”). The newly established Series D preferred stock has an issued price of $1,000 per share and has the following rights and privileges:
no voting rights except with respect to (i) the amendment or alteration of the statement of rights and preferences applicable to the Series D preferred stock, and (ii) any matters for which voting rights are provided under Florida law;
shares of the Series D preferred stock shall rank on a parity with Summus’ Series A, Series C and Series E preferred stock as to liquidation preference upon dissolution, liquidation or the winding up of Summus;
a liquidation preference, subject to adjustment for any combinations, consolidations, stock distributions or stock dividends with respect to the Series D preferred stock, of $1,000 per share payable in the event of any liquidation, dissolution or winding up of Summus, Inc.; and
the right to convert each share of Series D preferred stock into shares of our common stock at any time, at the option of the Series D preferred stockholder. Each share of Series D preferred stock shall be convertible into 5,000 fully paid and nonassessable shares of the Company’s common stock.
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
12. Preferred Stock (continued)
During 2003, the Company sold 4,000 shares of its Series D preferred stock and issued warrants in connection with such sale to purchase 10,000,000 shares of unregistered common stock with an exercise price of $0.35 per share for gross proceeds of $4,000,000. The value of the warrants issued in this offering, totaling $1,219,856, was determined utilizing the Black Scholes pricing model, limited to the pro-rata fair value of the Series D offering proceeds allocable to the warrants. Cash commissions of $111,000 were paid in connection with the Series D offering.
During 2003, holders of the Series D preferred stock converted 1,100 shares of Series D preferred stock into 5,500,000 shares of the Company’s unregistered common stock.
Series E Convertible Preferred Stock
In November 2003, the Company amended its articles of incorporation to establish its Series E convertible preferred stock (“Series E preferred stock”). The Series E preferred stock has an issued price of $1,000 per share and has the following rights and privileges:
no voting rights except with respect to (i) the amendment or alteration of the statement of rights and preferences applicable to the Series E preferred stock, and (ii) any matters for which voting rights are provided under Florida law;
shares of the Series E preferred stock shall rank on a parity with Summus’ Series A, Series C and Series D preferred stock as to liquidation preference upon dissolution, liquidation or the winding up of Summus;
a liquidation preference, subject to adjustment for any combinations, consolidations, stock distributions or stock dividends with respect to the Series E preferred stock, of $1,000 per share payable in the event of any liquidation, dissolution or winding up of Summus, 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 the Series E preferred stockholder. Each share of Series E preferred stock shall be convertible into 5,000 fully paid and nonassessable shares of the Company’s common stock.
During November 2003, the Company sold 200 shares of its Series E preferred stock and issued warrants in connection with such sale to purchase 500,000 shares of unregistered common stock with an exercise price of $0.35 per share for gross proceeds of $200,000. The value of the warrants issued in this offering, totaling $59,459, was determined utilizing the Black Scholes pricing model, limited to the pro-rata fair value of the Series E offering proceeds allocable to the warrants. Cash commissions of $6,000 were paid in connection with the Series E offering.
During 2003, a holder of Series E preferred stock converted 30 shares of Series E preferred stock into 150,000 shares of the Company’s unregistered common stock.
Summus, Inc. (USA) Notes to Consolidated Financial Statements (continued)
12. Preferred Stock (continued)
The accounting treatment for the Series C, D and E preferred stock (the “Preferred Stock”) involved allocating the value of the principal amount received from the Preferred Stock offerings between the Preferred Stock, the associated warrants and a beneficial conversion feature (“BCF”) associated with the Preferred Stock. A BCF existed because the effective conversion rate of the Preferred Stock was below the traded value of the Company’s common stock on the date the Preferred Stock was issued. The BCF for the Preferred Stock totaling $3,579,695 was recorded as a discount to the Preferred Stock and additional paid-in capital on the date the Preferred Stock was issued. Since the Series C preferred stock 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 C preferred stock BCF for the year ended December 31, 2003 was $365,566. Since the Series D and E preferred stock was convertible immediately, the value of its beneficial conversion feature totaling $2,920,685 was fully amortized to retained deficit on the date of issuance.
13. Stock Options
During 2000, the Company established a stock option plan to provide for the issuance of stock options to employees and directors. Options granted in connection with initial employment with the Company generally have a term of ten years and vest quarterly over a three-year term.
During 2000, all of the stock options were granted with an exercise price of $0.19 per share. This exercise price was below the fair value of the Company’s underlying common stock. Deferred compensation has been recorded for the difference in value between exercise price and the fair value of the underlying common stock and is being recognized over the vesting period of the stock options. Non-cash compensation expense relating to these grants was $176,592, $202,642 and $202,157 in 2003, 2002 and 2001, respectively. Additionally, during 2001, stock options exercisable for 615,879 shares of common stock were granted with exercise prices below the fair value of the underlying common stock, resulting in total compensation expense of $864,164, of which $110,000 was deferred at December 31, 2001 and is being amortized to non-cash compensation through 2004. Of the $864,164 compensation expense attributable to 2001 option grants, $541,688 related to options issued to Dr. Jawerth in connection with the recapitalization discussed in Note 2.
During 2002, the Company granted 397,531 fully vested stock options to an employee/director of the Company with exercise prices ranging between $ 0.31 and $1.24, in connection with capital raising activities. Of these options, 310,586 had exercise prices below the fair value of the underlying common stock resulting in non-cash compensation expense of $161,358 during the year ended December 31, 2002.
During 2002, the Company granted 33,000 stock options to each of the three new members of its Board of Advisors. These options vest quarterly over a twelve month term and have an exercise price equal to the traded per share value of the underlying common stock on the date of grant. The value of these options, as determined by the Black-Scholes option pricing model under the fair value method of accounting, was recorded as non-cash consulting expense of $97,515 during 2002. Also during 2002, the Company entered into an agreement with one of its Board of Advisors for consulting services. Under the terms of this agreement, 200,000 options with an exercise price of $0.35 were granted to this advisor. The vesting schedule of these options provided for 75,000 of these options to be fully vested on the date of grant, 50,000 to vest over the next three month period, and 15,000 to vest each quarterly period thereafter. The value of the vested options, as determined by the Black-Scholes option pricing model under the fair value method of accounting, was recorded as non-cash consulting expense of $25,000 during 2002. This agreement was terminated during the fourth quarter of 2002, upon which 75,000 options were forfeited.
During 2003, the Company granted 33,000 stock options to a member of its Board of Advisors. This option vests quarterly over a one year period and has an exercise price equal to the traded per share value of the underlying common stock on the date of grant. The value of the vested portion of the option of $8,663 was determined using the Black-Scholes option-pricing model and was recorded as non-cash compensation expense for the year ended December 31, 2003.
Summus, Inc. (USA) Notes to Consolidated Financial Statements (continued)
13. Stock Options (continued)
Commencing August 15, 2002, the Company adopted an alternative compensation arrangement for its executives. Under the terms of the new arrangement, electing executives may receive a portion of their annual cash compensation in the form of fully vested stock options. The stock options will have an exercise price equal to the fair market value of the Company’s’ common stock based on the closing prices of the common stock at the end of each respective payroll period. The amount of compensation to be received in stock options (the “target compensation”) is to be determined by the participating executive based on increments of 5% commencing with a minimum level of 15% of the participant’s annual compensation. The number of shares underlying each option will be determined by dividing the dollar value of the target compensation by the closing price at the end of each respective payroll period. Once this election is made, it will remain effective for a minimum of three months and can be terminated early at the full discretion of the Company. Beginning on August 15, 2002, five executives elected to participate in this alternative payment plan at reduced salary levels ranging between 25% and 35% of their respective annual compensation. During the years ended December 31, 2003 and 2002, the Company issued 490,292 and 241,431, respectively, fully vested stock options with exercise prices ranging between $0.23 and $0.51 per share under this plan.
The Company has entered into various consulting agreements that provide for the issuance of options to purchase unregistered shares of the Company’s common stock primarily on a monthly basis as services are performed. These options vest on a monthly basis as they are earned and have exercise prices that equal the traded per share value of the underlying common stock on the date of grant. For the years ended December 31, 2003 and 2002, the Company issued 103,400 and 146,032 options, respectively, under these consulting agreements. These options were valued at $29,888 and $81,788, respectively, using the Black-Scholes option-pricing model under the fair value method of accounting. The term of these agreements is generally twelve months, however the Company can immediately terminate them.
The Company’s Board of Directors authorized an amendment to Summus, Inc.’s Equity Compensation Plan (the “Plan”) in February 2001 to increase the aggregate number of shares of its common stock available for issuance of stock awards under the Plan to 6,500,000. The Plan provides for the issuance of stock options to employees, directors, advisors and consultants of the Company. Options granted generally have a ten-year term and vest over three years from the date of grant. Certain of the stock options granted under the Plan have been granted pursuant to various stock option agreements. Each stock option agreement contains specific terms. On May 23, 2002, the Company’s Board of Directors adopted resolutions to amend the Company’s Plan to increase the shares available under the Plan from 6,500,000 to 8,500,000.
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
13. Stock Options (continued)
A summary of the Company’s stock option activity is as follows:
The following table summarizes information about stock options outstanding at December 31, 2003:
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
13. Stock Options (continued)
During 2002, the Company issued 290,300 shares of its common stock upon the exercise of outstanding stock options. The Company received $12,750 in proceeds from the exercise of these stock options. There were no exercises of stock options in 2003.
14. Commitments and Contingencies
Dr. Bjorn Jawerth’s Employment Agreement
In connection with the recapitalization transaction on February 16, 2001 (see Note 1), the Company entered into a three-year employment agreement with Dr. Bjorn Jawerth. Dr. Jawerth’s employment agreement expired on February 16, 2004, and was not renewed by the Board of Directors. The employment agreement provided for an initial base salary of $350,000, which was to be increased on an annual basis by at least 10%; however, Dr. Jawerth elected to defer any increase in cash compensation to this initial base salary. As of February 16, 2003 and February 16, 2002, Dr. Jawerth was to receive an annual salary of $423,500 and $385,000, respectively, pursuant to his agreement; however, Dr. Jawerth elected on July 31, 2002, to reduce his cash compensation temporarily to $262,500 on an annual basis to help lower the Company’s cash consumption. The difference between the original contract amount of $350,000 and the current cash salary amount was paid to Dr. Jawerth on a bi-monthly basis in the form of options to buy common stock under the Company’s Alternative Compensation Plan. These options were priced at the closing market price of the Company’s common stock at the end of each bi-monthly pay period. The difference between the increased salary amounts of $423,500 and $385,000, respectively, owed to Dr. Jawerth and the original base salary of $350,000 in his employment agreement was deferred and accrued by the Company until the Board of Directors and Dr. Jawerth determine when and how these deferred and accrued amounts may be paid. The 10% annual increases provided for in Dr. Jawerth’s employment contract have been recorded as accrued salaries in the Company’s balance sheet as of December 31, 2003.
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 not less than $1.50 per share (representing $2.5 million in value). Under the terms of Dr. Jawerth's employment agreement, the Company was obligated to issue to Dr. Jawerth options, with an exercise price of $1.50 per share, exercisable for three times the number of shares of common stock sold in the private sale as describe above. No shares subject to this agreement have been sold. The Company believes it has no further obligations regarding this sale of shares.
Pursuant to the terms of his employment agreement and in accordance with corporate policy, all intellectual property developed by Dr. Jawerth in connection with his employment by the Company is the exclusive property of the Company. Without any impact on the Company’s ownership of the intellectual property, the employment agreement granted Dr. Jawerth, personally, a non-exclusive, non-transferable, world-wide license, without right to sublicense, to make and use New Technology (as defined in the Inventions Award Plan) that was developedduring the twelve months following the closing of the recapitalization transaction. This license was to terminate on the later of the date twelve months from the closing of the recapitalization transaction or such later date as may be set by the Board, excluding Dr. Jawerth. Pursuant to the terms of Dr. Jawerth’s employment agreement, the Company terminated Dr. Jawerth’s license on February 4, 2004.
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
14. Commitments and Contingencies (continued)
Cancellation of warrants
On July 19, 2002, the Company entered into an irrevocable common stock equity line that was intended to provide funding to the Company in amounts up to $10.0 million. The Company filed a registration statement on Form S-1 with the Securities and Exchange Commission (“SEC”) on July 31, 2002 relating to this common stock equity line agreement. Based on comments received from the Securities and Exchange Commission and related communications with the SEC, the Company understood that the terms of the equity line financing arrangement were such that it would not be able to resolve the staff’s comments in a timely manner and seek effectiveness of the registration statement in a timely manner. Due to these developments, the length of time involved in completing the transaction, and other factors, the Company determined that it was in its best interest to withdraw the registration statement and not proceed with the equity line. Accordingly, on September 17, 2002, the Company submitted to the SEC a request to withdraw the registration statement and cancelled all agreements associated with the common stock equity line. In connection with the cancellation of the agreements associated with the common stock equity line, Talisman, the intended purchaser under the equity line, indicated to the Company its intention to retain ownership of the warrants to purchase 500,000 shares of the Company’s unregistered common stock at an exercise price of $0.47 per share that were issued to Talisman upon the execution of the equity line agreements. It is management’s position, with the advice of legal counsel, that the cancellation of these warrants became effective with the cancellation of the equity line agreements and that no loss contingency exists. Therefore, the Company has not recorded the issuance of these 500,000 warrants in its consolidated financial statements nor disclosed them as part of outstanding warrants. The Company has sent correspondence to Talisman stating its position that the warrants have been cancelled. To date, the Company has not received correspondence back from Talisman indicating their concurrence.
Inventions Awards Plan
The Company established the Inventions Awards Plan (“the Plan”), effective October 30, 2000, to provide incentives to certain eligible employees by providing them with opportunities to receive additional compensation as a result of their development of enhancements or new methods that generate revenue for the Company.
Under the terms of the plan, the Company is obligated to reserve 5% of the gross revenues derived from the licensing or sale of “New Technology”, as defined in the agreement, for distribution among eligible employees. If the Company sells the rights to New Technology, eligible employees shall be entitled to an award of 10% of the gross proceeds.
In addition, the Company may, at its option, initiate a spin-off company to develop New Technology. If the eligible employee accepts a position in the spin-off company, his or her rights to awards under the plan are to be surrendered for 25% of the founders’ equity in the spin-off company.
Dr. Jawerth sent correspondence to the Company on February 17, 2004, seeking payment for certain inventions under the Plan. Management and the Board of Directors of the Company have evaluated these assertions and determined that no amounts are due Dr. Jawerth or other employees under the provisions of the Plan. If litigation is pursued by Dr. Jawerth for any payments under the Plan and he is successful in such litigation, there may be a material adverse impact to the Company.
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
15. Settlements of Contractual Disputes and Litigation
The Richdale Contractual Dispute
In June 2001, the Company entered into an agreement of settlement and compromise whereby it issued 250,000 shares of its registered common stock in full satisfaction of a $435,815 payable to entities affiliated with a related party.
The Dunavant Litigation
On June 29, 2001, the Company entered into a settlement agreement and voting agreement with William R. Dunavant and his counsel. Under the terms of such agreements:
the Company issued an aggregate of 475,000 shares of unregistered common stock to Mr. Dunavant and his counsel which were valued at $352,688. Such amount was determined by applying a discount to the traded value of the Company’s stock on the date of the revised settlement;
Mr. Dunavant agreed to certain resale restrictions with respect to all but 350,000 shares of common stock held by him (an aggregate of 2,275,000 shares), specifically, to limit his public resale of such shares to 30,000 shares per calendar month until February 15, 2002;
the Company agreed to prepare and proceed diligently to complete and file a registration statement with the SEC registering the resale of all of the shares held by Mr. Dunavant, his spouse and his counsel. The registration statement on Form S-1 was declared effective by the SEC on July 22, 2002.
Mr. Dunavant, his spouse and his counsel agreed, for a two-year period from the date of the agreements, to vote the shares held by them in favor of and for the election of Board nominees by the Company and to vote such shares in a manner consistent with the recommendation of the Board with respect to certain extraordinary transactions (such as a tender offer, an exchange offer, merger or other business combination); and
the Company, on the one hand, and Mr. Dunavant and his counsel, on the other, executed mutual general releases with respect to any and all claims against each other, except with respect to the obligations and liabilities under such agreements.
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
15. Settlements of Contractual Disputes and Litigation (continued)
The AIC Litigation
On March 30, 2001, Analysts International Corporation (“AIC”) filed a civil summons and complaint in General Court of Justice, District Court Division, County of Wake, North Carolina, against High Speed Net Solutions, Inc. The complaint alleged that the Company breached certain contracts with AIC, dated December 9, 1999, February 11, 2000, April 25, 2000, May 9, 2000, and May 23, 2000, under which AIC provided the Company with computer programming services.
The Company and AIC entered into a settlement agreement and release, dated August 7, 2001, under which the Company agreed to pay the sum of $358,426, plus interest accruing at the rate of 8% per annum from March 31, 2000 (the “Indebtedness”) according to the following payment schedule: (i) $20,000 upon execution of the settlement agreement, (ii) $5,000 per month for a period of nine months, commencing one month after execution of the settlement agreement, and (iii) $10,000 per month thereafter until the balance of the Indebtedness is paid in full. We ceased making payments under this settlement agreement on November 15, 2002 due to liquidity constraints, and therefore, we were in default under the terms of the initial agreement. The Company received notification of its default from AIC on July 9, 2003, and the 3-day cure period to which the Company was entitled under the terms of the settlement agreement expired, which would allow AIC to file a consent judgment against the Company. While negotiating to amend the settlement agreement in August 2003, Summus learned that AIC had filed the consent judgment on February 13, 2002, which Summus believes was in breach of the original settlement agreement. In September 2003, the parties negotiated a revised settlement agreement pursuant to which (i) the consent judgment remains filed and of record, (ii) AIC will file with the court a credit to the judgment reflecting all payments made by the Company; (iii) the payment terms have been revised to require payment by the Company of $60,000 by September 5, 2003, which has been made, and $7,500 per month thereafter until the full amount of the indebtedness, including accrued interest is paid, and (iv) AIC agrees to refrain from executing on the consent judgment as long as the Company makes the payments required by the revised settlement terms as identified in this paragraph. In the event that the Company fails to make a scheduled payment as set forth in this revised settlement agreement, AIC may execute on the consent judgment and seek to satisfy the judgment from the assets of the Company in accordance with the laws of the state of North Carolina.
The ENELF Litigation
On March 15, 2001, ENELF, LLC filed a civil lawsuit in the United States District Court for the Eastern District of Texas alleging patent infringement by Microsoft Corporation, Texas Instruments, Incorporated Aware, Inc. and the Company. ENELF alleged that certain modules of MaxxSystem and PhotoID SDK infringed upon ENELF’s U.S. Patent Number 4,599,567 entitled “Signal Representation Generator”. ENELF sought to enjoin the Company from making, selling, offering for sale, using, or importing its wavelet-based video and image processing technology. In addition, ENELF sought an unspecified amount of monetary damages. The Company has asserted counterclaims for a declaratory judgment of noninfringement, invalidity and unenforceability of the ENELF patent.
On December 12, 2001, the Company and ENELF entered into a settlement and release agreement to settle all matters raised in the lawsuit filed on March 15, 2001 to avoid further expenditure of time and resources relating to further litigation and uncertain outcome thereof. Under the terms of the settlement and release agreement, the Company issued to ENELF 75,000 shares of the Company’s unregistered common stock which were valued at $80,437.
The Company expensed the aggregate estimated fair value of these securities, resulting in a non-cash charge in the statement of operations for the year ended December 31, 2001.
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
15. Settlements of Contractual Disputes and Litigation (continued)
Settlement of Claims of Van Ernst Jakobs N.V.
On August 21, 2001, the Company commenced negotiations with Van Ernst Jakobs N.V. (“VEJ”) regarding the settlement of disputed amounts claimed by VEJ.
VEJ asserted a claim for services rendered in connection with fund raising activities it coordinated and for services as a “finder” in the Company’s recapitalization transaction. VEJ asserted that certain amounts were due and payable by the Company to VEJ, in the form of cash and equity securities of the Company. The Company’s management was of the view that payment of any amounts to VEJ (beyond consideration previously paid in connection with its capital-raising efforts on behalf of the Company, consisting of a cash payment of $100,000 and the issuance of 32,501 shares of the Company’s common stock) was conditioned on VEJ raising additional capital for the Company.
In October 2001, the Company and VEJ entered into a definitive settlement agreement and release, which provided for the Company’s issuance to VEJ:
(1)
80,000 shares of its unregistered common stock (in lieu of a cash payment of $143,415);
(2)
a warrant to purchase 250,000 shares of the Company’s unregistered common stock with an exercise price of $4.00 per share, valued using the Black-Scholes option pricing model, at approximately $400,000;
(3)
a warrant to purchase 150,000 of the Company’s unregistered common stock with an exercise price of $2.50 per share, valued, using the Black-Scholes option pricing model, at $256,500; and
(4)
a warrant to purchase 150,000 of the Company’s unregistered common stock with an exercise price of $4.50 per share, valued, using the Black-Scholes option pricing model, at $252,000.
The Company expensed the aggregate estimated fair value of these securities, resulting in a non-cash charge in the statement of operations of the year ended December 31, 2001 of $1,051,915.
The Alan Kleinmaier Litigation
On November 15, 2001, Alan Kleinmaier, a former employee and officer of Summus, Inc. and Summus, Ltd. filed a civil lawsuit in the General Court of Justice, Superior Court Division in Wake County, North Carolina, against the Company and the former officers and directors of Summus, Ltd. In this suit, Mr. Kleinmaier claims that he was entitled to three months severance pay of $32,350 when he was terminated from Summus, Ltd. The Company has filed an answer to Mr. Kleinmaier’s claims and has made several counterclaims against him. In May 2002, the Company and Mr. Kleinmaier mediated claims between them. Mr. Kleinmaier received 15,000 options to purchase shares of Summus, Inc.’s unregistered common stock at $0.50 per share and executed a release against all parties. These options were valued at $8,850 using the Black-Scholes option-pricing model.
The AT&T CORP. Litigation
On June 7, 2002, AT&T filed a civil lawsuit in the United States District Court for the Eastern District of North Carolina against Summus, Inc. (USA). In this suit, AT&T claims that it is entitled to payment in the amount of $238,783 for telephone calls and services rendered to the Company. In March 2003, the Company and AT&T settled the claim between them, whereby both parties agreed to reduce the total amount owed by the Company to AT&T to $120,000 and this reduced amount be repaid over an 18 month period commencing in March 2003. The settlement gain resulting from this transaction was $118,783. The balance as of December 31, 2003 was $53,456, which is included in accounts payable.
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
15. Settlements of Contractual Disputes and Litigation (continued)
The Porter Novelli Litigation
On December 12, 2002, Porter Novelli filed a civil summons in Wake County General District Court of Justice in the State of North Carolina, claiming that it is entitled payment in the amount of $18,886 for past services rendered to the Company. These amounts were paid in full in 2003.
Bowne Litigation
On February 25, 2003, Bowne of New York City, LLC (“Bowne”), a financial printing firm, filed a civil summons in the Supreme Court of County of New York in the State of New York, claiming that it is entitled payment in the amount of $276,374, plus accrued interest, for past services rendered to the Company. The Company disputes the total amount Bowne claims the Company owes. However, the Company has recorded a liability of $276,374 relating to this claim as of December 31, 2003 and 2002. The Company is in the process of attempting to negotiate a settlement to this claim.
The Holland and Knight LLP Litigation
On February 27, 2003, Holland & Knight LLP (“H&K”) filed a civil lawsuit in the Superior Court for the District of Columbia against Summus. In this suit, H&K claims that it was entitled to $867,268, plus interest, for services rendered to Summus. Summus and H&K entered into an agreement on May 23, 2003 settling this litigation, whereby both parties agreed to the following terms:
$217,268 of the total balance due was forgiven by H&K, resulting in a portion of the settlement gain of this transaction.
$325,000 of the total balance due will be paid over a three-year period with monthly installments of $9,028, commencing on June 1, 2003. The settlement agreement did not provide for an interest rate component pertaining to the three-year payment plan. Therefore, an interest rate of 20% per annum was used to present value the note, resulting in a net present value of $242,926. The difference between the face value of $325,000 and the net present value of $242,926, totaling $82,074, was recorded as a portion of the settlement gain. The 20% rate of interest was considered appropriate to fair value the note based on the Company’s financial condition, including its negative working capital and negative net worth position. In the event that the Company fails to make a scheduled payment as set forth in this settlement agreement, H&K may execute on a consent judgment and seek to satisfy the judgment from the assets of the Company in accordance with the laws of the State of North Carolina.
The remaining amount of the recorded liability due to H&K of $325,000 was satisfied through the issuance to H&K of 738,636 shares of the Company’s unregistered common stock, with registration rights. The fair value of the 738,636 shares of unregistered common stock was estimated at $273,295, based on the traded value of the Company’s common stock on the date the settlement agreement became effective. The difference between the estimated fair value of the 738,636 unregistered common shares and the recorded value of the liability of $325,000, totaling $51,705, was recorded as a portion of the settlement gain. The unregistered shares have since been registered, and H&K has contractually agreed to sell no more than 18,000 shares in any one (1) business day.
Therefore, the aggregate settlement gain resulting from this transaction totaled $351,047.
The settlement agreement also provided that if the Company raised $5.0 million or more in capital at one time, all remaining unpaid amounts owed under the $325,000 note agreement shall become immediately due and payable. This note is unsecured, and upon default of the terms of the agreement, the unpaid balance shall become
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
15. Settlements of Contractual Disputes and Litigation (continued)
immediately due and payable and such amount shall include pre-judgment interest in the amount of 6% accruing as of April 3, 2002 and post- judgment interest at a rate to be determined.
The Raytheon Company Litigation
During 1999, the Company entered into an agreement with Raytheon Company (“Raytheon”) to repurchase 1,533 shares of its common stock from Raytheon for an aggregate value of $268,373, of which $268,075 represented a termination fee for a development contract and $298 represented the fair value of the shares repurchased. In connection with this agreement, the Company entered into a promissory note with Raytheon whereby the Company agreed to pay approximately $10,000 per month over a 27-month period to fund this transaction. The Company did not make all required monthly installments and thus defaulted on the promissory note. Consequently, the note began accruing interest at 18% per annum. On September 30, 2003, the Company executed a settlement agreement with Raytheon whereby both parties agreed to the following terms.
$ 49,128 of the total balance due was forgiven by Raytheon, resulting in a portion of the settlement gain of this transaction.
$87,516 of the total balance due will be paid over a 22 month period, with an initial payment of $10,000; six (6) equal monthly installments of $3,000; fourteen (14) monthly installments of $4,000; and one final installment of $3,516. The settlement agreement did not provide for an interest rate component pertaining to the 22-month payment plan. Therefore, an interest rate of 20% per annum was used to present value the note, resulting in a net present value of $74,306. The difference between the face value of $87,516 and the net present value of $74,306, totaling $13,210 was recorded as a portion of the settlement gain. The 20% rate of interest was considered appropriate to fair value the note based on the Company’s financial condition, including its negative working capital and negative net worth position. In the event that the Company fails to make a scheduled payment as set forth in this settlement agreement, Raytheon may execute on a consent judgment and seek to satisfy the judgment from the assets of the Company in accordance with the laws of the State of North Carolina.
The remaining amount of the recorded liability due to Raytheon of $87,516 was satisfied through the issuance to Raytheon of 295,662 shares of the Company’s unregistered common stock, with registration rights. The fair value of the 295,662 shares of unregistered common stock was estimated at $94,613, based on the traded value of the Company’s common stock on the date the settlement agreement became effective. The difference between the estimated fair value of the 295,662 unregistered common shares and the recorded value of the liability of $87,516, totaling $7,097, was recorded as an offset to the settlement gain. Raytheon has contractually agreed to sell no more than 15,000 shares in any one (1) business day.
Therefore, the aggregate settlement gain resulting from this transaction totaled $55,241.
Other Settlements
On February 21, 2003, the Company signed and executed a mutual release of all claims with a former law firm that had provided legal services to the Company. Under the terms of this agreement, both parties agreed to a mutual release of any and all claims between the parties, as well as a cancellation of the unpaid fees owed by the Company to the law firm, totaling $886,557. The Company did not issue any cash or equity securities or enter into any other obligations in connection with this release. The settlement gain resulting from this transaction was $886,557.
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
15. Settlements of Contractual Disputes and Litigation (continued)
On June 5, 2003, the Company signed and executed an agreement pertaining to the payment of amounts owed to a current service provider. Under the terms of the agreement, the Company issued 427,419 shares of its unregistered common stock, with registration rights, for full payment of $132,500 owed to the service provider. The fair value of the 427,419 shares of unregistered common stock was estimated at $149,597, based on the traded value of the Company’s common stock on the date the settlement agreement became effective. The difference between the estimated fair value of the 427,419 unregistered common shares and the recorded value of the liability of $132,500 was recorded as a settlement loss of $17,097. The service provider has contractually agreed to sell no more than 5,000 shares in any one (1) business day.
During 2003, the Company issued warrants to purchase 333,333 shares of common stock to a consultant as payment for $200,000 of fees. The warrants were valued at $83,333 using the Black-Scholes option-pricing model. The non-cash settlement gain resulting from this transaction totaled $116,667.
On August 29, 2003, the Company signed and executed an agreement pertaining to past due amounts owed to a current service provider totaling $62,500. Under the terms of the agreement, the service provider agreed to forgive $14,500 of the total past due amounts. The remaining amount due of $48,000 is to be paid in twelve-monthly installments of $4,000 each. The non-cash settlement gain resulting from this transaction totaled $14,500.
The total aggregate settlement gains resulting from these transactions during the year ended December 31, 2003 were $1,525,698.
16. Discontinued Operations
Divestiture of “Rich Media Direct” (RMD) Business, including Douglas May & Co., Inc.
Upon the closing of the Company’s recapitalization transaction, management decided to focus the Company’s efforts on Summus, Ltd.’s business operations at the time of the transaction. Management chose to focus primarily on Summus, Ltd.’s business plan because of its perception that this business plan had the potential to create greater shareholder value compared to the scope of Summus, Inc.’s business operations. In addition, the Company did not expect to have the fund-raising capacity to continue to fund the business plans of both Summus, Ltd. and Summus, Inc., as previously envisioned. The Summus, Inc. business consisted primarily of the “rich media direct” business operated by Douglas May & Co., a wholly-owned subsidiary of Summus, Inc. Therefore, management undertook a review to determine the appropriate course of action for this portion of its business given the existing and anticipated funding constraints.
On September 19, 2001, the Company and Douglas May entered into a stock purchase agreement under which the Company sold and transferred to Mr. May all of the Company’s equity interest in Douglas May & Co. and related rich media direct assets. The date of the transaction represents the measurement date, as defined by Accounting Principles Board Opinion No. 30 (“APB 30”), for the disposition of the Company’s rich media direct business. The results of operations of Douglas May & Co. have been presented as discontinued operations in the Company’s statement of operations for the year ended December 31, 2001 in accordance with the guidance of APB 30. For the period February 16, 2001 through September 19, 2001, the operations of Douglas May & Co. reflected approximately $319,000 in revenues and a net loss of $135,798. The Company has recorded a loss of $215,500 on this disposition of the discontinued operations for the year ended December 31, 2001.
Under the terms of its acquisition agreement with Mr. May, the Company acquired all of the issued and outstanding shares of capital stock of Douglas May & Co. from Mr. May in September 2000. As partial consideration for the Company’s sale of Douglas May & Co. back to Mr. May, the Company has been released from its obligations with respect to two
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
16. Discontinued Operations (continued)
allotments of shares of the Company’s common stock issued to Mr. May under the terms of the September 2000 share acquisition agreement, specifically:
the obligation to repurchase one allotment of 87,498 shares of the Company’s common stock for $576,000; and
the commitment to issue to Mr. May additional shares of the Company’s common stock, which when combined with an original 50,000 share allotment, would provide a value of $500,000 as of the first anniversary of the date the Company acquired Douglas May & Co. This amount was initially recorded at the guaranteed value of $500,000. Therefore, if these shares had ultimately been issued, the only accounting implication would have been reclassification of the par value of the shares within the shareholders’ deficit.
The release of the Company from the above obligations was expressly made conditional upon the Company not filing (or having filed against it) a petition in bankruptcy for a period of one year from the closing of the sale of Douglas May & Co. to Mr. May. Since this release is conditional for one year, the Company reflected a liability of $576,000 on its balance sheet during the one-year time period. Since the Company did not file ( or have filed against it) a petition in bankruptcy during the one-year time period commencing September 30, 2001, the $576,000 liability was reclassified to permanent equity on September 19, 2002.
Under the terms of the stock purchase agreement, Mr. May retains his option, issued under his now terminated employment agreement with the Company, to purchase 150,000 shares of the Company’s unregistered common stock at an exercise price of $2.50 per share, such options being exercisable over a ten-year term.
In connection with the sale of the Company’s entire equity interest in Douglas May & Co., the Company transferred certain technology to Douglas May & Co., including specific applications of the Company’s MaxxSystem suite of software products developed in connection with the Company’s previously planned “rich media direct” service offering.
The Company also entered into a technology license agreement (and a related source code escrow agreement) with a newly formed corporation and wholly-owned subsidiary of Douglas May & Co. Under the technology license agreement, the Company has granted to this company a perpetual, non-exclusive, non-transferable license with respect to some of the Company’s core software technology for image, video compression and video streaming. The technology license agreement provides for the licensee’s payment to the Company of royalties, payable on a quarterly basis, equal to the greater of: (1) a percentage of the “net revenues” derived from the sale or license of end user products using or incorporating the licensed technology or (2) specified minimum amounts This royalty payment plan will remain in effect each year the agreement remains in effect. The agreement can be terminated by the licensee at any time following the first to occur: (1) payment of $400,000 in royalty payments to the Company or (2) ninety days prior to the second anniversary of the agreement, provided that $400,000 in royalty payments have been earned by the Company. The first specified minimum royalty payment of $100,000 was payable to the Company on December 31, 2001. The Company extended the payment of the $100,000 into various installments commencing on March 31, 2002. As of June 30, 2002, the Company did not receive the scheduled installments under the extended payment plan, and accordingly all agreements between the Company and Douglas May & Co., Inc. and it wholly owned subsidiary became null and void, except the obligations noted above which expired on September 19, 2002. All royalty payments received by the Company during 2002, totaling $30,000, were recorded as contracts and licensee fee revenue when the cash payments were collected due to the uncertainty of collection.
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
17. Selected Quarterly Financial Data (Unaudited)
Change in Revenue Recognition Policy
After a careful review of the Company’s revenue recognition policies and giving consideration to guidance provided for in Emerging Issues Task Force No. 99-19 Reporting Revenue Gross as a Principal versus Net as an Agent (“EITF 99-19”), the Company has changed certain revenue recognition policies affecting revenues earned by wireless applications and contracts. Prior to 4th quarter 2003, the Company reported revenues earned by wireless applications and contracts and cost of revenues for wireless applications and contracts net of certain third-party costs in the statement of operations. These transactions have been reclassified to reflect a gross revenue presentation with no effect on gross profit or net loss. The amount by which revenues and costs of revenues have been reclassified for the year ended December 31, 2003 is $635,989. Revenues and costs of revenues for 2002 have not been reclassified due to immateriality.
Selected quarterly financial data for the years ended December 31, 2003 and 2002 is as follows:
18. Subsequent Events
Conversion of preferred stock
Subsequent to December 31, 2003, holders of the Series D preferred stock converted 375 shares of Series D preferred stock into 1,875,000 shares of the Company’s unregistered common stock.
Subsequent to December 31, 2003, a holder of Series E preferred stock converted 170 shares of Series E preferred stock into 850,000 shares of the Company’s unregistered common stock.
Payment of accrued salaries
Subsequent to December 31, 2003, the Company made cash payments of approximately $180,000 towards accrued salaries and related costs that were incurred as of December 31, 2003. As a result of these payments, accrued unpaid salaries and related costs that were earned as of December 31, 2003 have been reduced from approximately $440,000 to $260,000. Included in accrued salaries and related costs is approximately $61,000 of earned and unpaid vacation.
Summus, Inc. (USA)
Notes to Consolidated Financial Statements (continued)
18. Subsequent Events (continued)
Settlement Agreement
Subsequent to December 31, 2003, the Company entered into a settlement agreement with a strategic partner regarding software development. Under the settlement agreement, the other party has agreed to make payments of $420,000 over a twelve-month period beginning in March 2004. As of March 29, 2004, the Company had received $35,000 under this agreement. The remaining payments will be recorded as revenues when and if received.
Expiration of Employment Agreement
On February 16, 2004, Dr. Jawerth’s employment agreement with the Company expired and was not renewed by the Board of Directors. Dr. Jawerth resigned from the Company’s Board of Directors on March 5, 2004.
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) Securities Exchange Act of 1934, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized.
Summus, Inc. (USA)
By: /s/ Gary E. Ban
Gary E. Ban
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Exhibit
Number
Exhibit
Description
3(I).1*
Amended and Restated Articles of Incorporation, filed February 28, 2000 (incorporated by reference to Exhibit 3.1 to our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30 , 2003)
3(I).2*
Articles of Amendment and Statement of Rights and Preferences of the 8% Series A Convertible Preferred Stock, filed March 3, 2000 (incorporated by reference to Exhibit 3.2 to our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2003)
3(I).3*
Articles of Correction filed June 23, 2000 to Articles of Amendment, filed March 2, 2000 (incorporated by reference to Exhibit 3.3 to our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2003)
3(I).4*
Amendment to Amended and Restated Articles of Incorporation, filed February 27, 2002, changing our name to Summus, Inc. (USA) (incorporated by reference to Exhibit 3.4 to our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2003)
3(I).5*
Amendment to Amended and Restated Articles of Incorporation, filed February 27, 2002, increasing our authorized common stock, par value $.001, from 50,000,000 shares to 100,000,000 shares (incorporated by reference to Exhibit 3.5 to our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2003)
3(I).6*
Articles of Amendment and Statement of Rights and Preferences of the Series C Convertible Preferred Stock (incorporated by reference to Exhibit 3.6 to our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2003)
3(I).7*
Articles of Amendment and Statement of Rights and Preferences of the Series D Convertible Preferred Stock dated September 25, 2003 (incorporated by reference to Exhibit 3.7 to our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2003)
3(I)8*
Articles of Amendment and Statement of Rights and Preferences of the Series E Convertible Preferred Stock dated October 17, 2003 (incorporated by reference to Exhibit 3.8 to our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2003)
3(I)9
Amendment to Amended and Restated Articles of Incorporation, filed December 3, 2003, increasing our authorized common stock, par value $.001, from 100,000,000 shares to 185,000,000 shares
3(II).1*
Second Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 to our Form 10 filed on July 5, 2001)
4.1*
Specimen Common Stock Certificate (incorporated by reference to Exhibit 4.1 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2001)
4.2*
Form of Subscription Agreement for private placement sales of our common stock (incorporated by reference to Exhibit 4.2 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2001)
10.9*
Executive Employment Agreement, dated as of February 16, 2001, between Summus, Inc. and Bjorn Jawerth (incorporated by reference to Exhibit 10.06 to our Current Report on Form 8-K dated February 16, 2001)
10.10*
Amendment to Executive Employment Agreement of Bjorn D. Jawerth, dated as of February 28, 2001 (incorporated by reference to Exhibit 10.11 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2001)
10.11*
Executive Employment Agreement, dated as of February 16, 2001, between Summus, Inc. and Gary E. Ban (incorporated by reference to Exhibit 10.12 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2001)
10.12*
Executive Employment Agreement, dated as of February 16, 2001, between Summus, Inc. and Robert S. Lowrey (incorporated by reference to Exhibit 10.15 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2001)
10.13*
Lease Agreement, dated as of October 15, 1999, as modified on March 23, 2000 and June 9, 2000, between Phoenix Limited Partnership of Raleigh and Summus, Inc. (incorporated by reference to Exhibit 10.31 to our Form 10 filed on July 5, 2001)
10.14*
Lease Agreement, dated as of August 12, 1999, between Phoenix Limited Partnership of Raleigh and Summus, Ltd. (incorporated by reference to Exhibit 32 to our Form 10 filed on July 5, 2001)
10.15*
Lease Modification Agreement Number 1, dated as of December 22, 1999, between Phoenix Limited Partnership of Raleigh and Summus, Ltd. . (incorporated by reference to Exhibit 33 to our Form 10 filed on July 5, 2001)
10.16*
Summus, Inc. Invention Awards Plan, effective October 30, 2000 (incorporated by reference to Exhibit 10.40 to Amendment No. 1 to our Form 10 filed on September 28, 2001)
10.17*
Master Porting Agreement, dated July 27, 2001, between Summus, Inc. and Samsung Electronics America (incorporated by reference to Exhibit 10.41 to Amendment No. 2 to our Form 10 filed on October 31, 2001)
10.18*
Alternative Compensation Plan, adopted as of August 1, 2002 (incorporated by reference to Exhibit 10.19 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2002) .
14.1
Code of Ethics
21.1
Subsidiaries of Summus - None
23.1
Consent of Ernst & Young LLP
31.1
Rule 13a-14(a)/15(d)-14(a) Certificate of Gary E. Ban, Chief Executive Officer
31.2
Rule 13a-14(a)/15(d)-14(a) Certificate of Donald T. Locke, Chief Financial Officer
32.1
Section 1350 Certificate of Gary E. Ban, Chief Executive Officer
32.2
Section 1350 Certificate of Donald T. Locke, Chief Financial Officer