**U.S. SECURITIES AND EXCHANGECOMMISSION**

 

**Washington, D.C.20549**

 

**FORM 10-KSB**

 

| **ý** |   | **ANNUAL  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|--------|-------------------------------------------------------------------------------------|
|       |   |                                                                                |
|       |   | **FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002**                                     |
|       |   |                                                                                |
| **or**     |
|       |   |                                                                                |
| **o**      |   | **TRANSITION  REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT**                |

 

**COMMISSIONFILE NUMBER: 0-11933**

 

| **AXCESS  INTERNATIONAL INC.(formerly AXCESS Inc.)**               |
|--------------------------------------------------------------------|
| (Exact name of small business  issuer as specified in its charter) |

 

| **Delaware**                                                    |   | **85-0294536**                       |
|-----------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer Identification No.) |
|                                                            |   |                                 |
| **3208 Commander Drive  Carrollton, Texas**                     |   | **75006**                            |
| (Address of principal executive offices)                        |   | (Zip Code)                           |
|                                                            |   |                                 |
| **(972) 407-6080**                                              |   |                                 |
| (Issuer’s Telephone Number)                                |   |                                 |
|                                                            |   |                                 |

 

Securities registered pursuant to Section12(b) of the Exchange Act:  **NONE**

Securities registered pursuant to Section12(g) of the Exchange Act:  

 

| **Title  of Class:**                           |   | **Name  of exchange on which registered:** |
|------------------------------------------------|--------|--------------------------------------------|
| Voting Common Stock, par value $.01 per  share |   | Over-The-Counter Bulletin Board            |

 
| **16,566,148**                                            |
|-----------------------------------------------------------|
| (Number of Shares Outstanding as of: **March 14,  2003**) |

 

 

Check whether the issuer (1) filed allreports required to be filed by Section 13 or 15(d) of the Securities ExchangeAct during the past 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yesý     Noo

 

Check if there is no disclosure of delinquentfilers in response to Item 405 of Regulation S-B contained in this form, and nodisclosure will be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in PartIII of this Form 10-KSB or any amendment to this Form 10-KSB. o

 

The issuer’s revenues for the fiscal year endedDecember 31, 2002 were $1,596,221.

 

On March 14, 2003, the aggregate market valueof voting and non-voting common equity held by non-affiliates of the registrantwas approximately $2,181,738. This amount was calculated by reducing the totalnumber of shares of the registrant’s common stock outstanding by the totalnumber of shares of common stock held by officers and directors, andstockholders owning in excess of 5% of the registrant’s common stock, andmultiplying the remainder by the average of the bid and asked price for theregistrant’s common stock on March 14, 2003, as reported on theOver-The-Counter Bulletin Board Market. The information provided shall in noway be construed as an admission that any officer, director or more than 5%stockholder of the issuer may be deemed an affiliate of the issuer or that suchperson is the beneficial owner of shares reported as being held by such person,and any such inference is hereby disclaimed.

 

Documents Incorporated by Reference:  Portions of the registrant’s Proxy Statement for the 2003 Annual Meeting of Stockholders, to be held on June 24, 2003, are incorporated by reference into Part III.

 

Transitional Small BusinessDisclosure Format: Yes o     No ý

 

 

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**AXCESSINTERNATIONAL INC.**

**INDEX**

 
| **PART I**         |
|--------------------|
|               | **Item 1. DESCRIPTION OF BUSINESS** |
|               |   | **Risk Factors** |
|               |   |
|               | **Item 2. DESCRIPTION OF PROPERTIES** |
|               |   |
|               | **Item 3. LEGAL PROCEEDINGS** |
|               |   |
|               | **Item 4. SUBMISSION OF MATTERS TO A VOTE OF  SECURITY HOLDERS** |
|               |   |
| **PART II**        |
|               | **Item 5. MARKET FOR COMMON EQUITY AND  RELATED STOCKHOLDERS MATTERS** |
|               |   |
|               | **Item 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION  AND RESULTS OF OPERATIONS** |
|               |   |
|               | **Item 7. FINANCIAL STATEMENTS** |
|               |   |
|               | **Item 8. CHANGES IN AND DISAGREEMENTS WITH  ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE** |
|               |   |
| **PART III**       |
|               | **Item 9. DIRECTORS, EXECUTIVE OFFICERS,  PROMOTERS AND CONTROL PERSONS;** |
|               |   |
|               | **Item 10. EXECUTIVE COMPENSATION** |
|               |   |
|               | **Item 11. SECURITY OWNERSHIP OF CERTAIN  BENEFICIAL OWNERS AND MANAGEMENT** |
|               |   |
|               | **Item 12. CERTAIN RELATIONSHIPS AND RELATED  TRANSACTIONS** |
|               |   |
|               | **Item 13. EXHIBITS AND REPORTS ON FORM 8-K** |
|               |   |
|               | **Item 14. CONTROLS AND PROCEDURES** |
|               |   |
| **SIGNATURES**     |
|               |   |
| **CERTIFICATIONS** |
|               |   |
|               |   |
| FINANCIAL SECTION  |
|               | REPORT OF INDEPENDENT AUDITORS |
|               |   |
|               | Consolidated Balance Sheet |
|               |   |
|               | Consolidated Statements of Operations |
|               |   |
|               | Consolidated Statements of Stockholders’  Equity (Deficit) |
|               |   |
|               | Consolidated Statements of Cash Flows |
|               |   |
|               | Notes to Consolidated Financial Statements |
|               |   |
|               |   |
| **SIGNATURES**     |
|               |   |
| **CERTIFICATIONS** |
|                    |  |  |  |

 

2

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**PART I**

 

**Forward LookingStatements**

 

This annual report on Form 10-KSB includes“forward-looking statements” within the meaning of Section 27A of theSecurities Act of 1933, as amended (the “Securities Act”), and Section 21E ofthe Securities Exchange Act of 1934, as amended (the “Exchange Act”), which canbe identified by the use of forward-looking terminology such as “may,” “can,”“believe,” “expect,” “intend,” “plan,” “seek,” “anticipate,” “estimate,”“will,” or “continue” or the negative thereof or other variations thereon orcomparable terminology.  All statementsother than statements of historical fact included in this annual report on Form10-KSB, including without limitation, the statements under “Item 1. Descriptionof Business” and “Item 6. Management’s Discussion and Analysis or Plan ofOperation” and located elsewhere herein regarding the financial position andliquidity of the Company (defined below) are forward-looking statements.  Although the Company believes that the expectationsreflected in such forward-looking statements are reasonable, it can give noassurance that such expectations will prove to have been correct. Importantfactors with respect to any such forward-looking statements, including certainrisks and uncertainties that could cause actual results to differ materiallyfrom the Company’s expectations (“Cautionary Statements”), are disclosed inthis annual report on Form 10-KSB, including, without limitation, inconjunction with the forward-looking statements and under the caption “RiskFactors.” In addition, important factors that could cause actual results todiffer materially from those in the forward-looking statements included hereininclude, but are not limited to, inability to continue as a going concern,limited working capital, limited access to capital, changes from anticipatedlevels of sales, future national or regional economic and competitiveconditions, changes in relationships with customers, access to capital,difficulties in developing and marketing new products, marketing existing products,customer acceptance of existing and new products, validity of patents,technological change, dependence on key personnel, availability of keycomponent parts, dependence on third party manufacturers, vendors, contractors,product liability, casualty to or other disruption of the productionfacilities, delays and disruptions in the shipment of the Company’s products,and the ability of the Company to meet its stated business goals. Allsubsequent written and oral forward-looking statements attributable to theCompany or persons acting on its behalf are expressly qualified in theirentirety by the Cautionary Statements.

 

As used herein, references to the “Company”are to AXCESS International, Inc., a Delaware corporation (“AXCESS”) and itssubsidiaries (formerly Axcess Inc.).

 

##### **Item 1. DESCRIPTION OF BUSINESS**

##### ** **

##### **Recent Developments: GoingConcern and Liquidity Problems**

 

Our auditors have included an explanatoryparagraph in their audit opinion with respect to our consolidated financialstatements at December 31, 2002. The paragraph states that our recurring lossesfrom operations and resulting continued dependence on access to externalfinancing raise substantial doubts about our ability to continue as a goingconcern. Furthermore, the factors leading to and the existence of theexplanatory paragraph may adversely affect our relationship with customers andsuppliers and have an adverse effect on our ability to obtain financing.

 

We do not have sufficient working capital tosustain our operations.  We have been unableto generate sufficient revenues to sustain our operations. We will have toobtain funds to meet our cash requirements through business alliances, such asstrategic or financial transactions with third parties, the sale of securitiesor other financing arrangements, or we may be required to curtail ouroperations, seek a merger partner, or seek protection under federal bankruptcylaws. Any of the foregoing may be on terms that are unfavorable to us ordisadvantageous to existing stockholders. In addition, no assurance may begiven that the Company will be successful in raising additional funds orentering into business alliances.

 

See “Risk Factors” and “Management’sDiscussion and Analysis of Financial Condition and Results of Operations.”

##### ** **

##### **The Company**

 

AXCESS provides advanced security surveillance and asset managementsystems that automatically locate, identify, track, monitor, count, and protectpeople, assets, and vehicles.  Itssystems provide application solutions to reduce loss and liability, boostproductivity, and extend traditional security system coverage through the useof the Company’s proprietary technologies and networking.  AXCESS utilizes two patented and integratedtechnologies: battery-powered wireless tagging (commonly referred to asActive-Radio Frequency Identification or RFID) and network-based, streamingdigital video.  A particular focus is onautomatic incident detection, recording, and notification, all of whichincrease a security system’s efficiency, scope, and effectiveness.  The main applications are network-basedsecurity video recording and surveillance (CCTV), automatic personnel andvehicle access control, and automatic asset tracking and protection.  Bothapplication and browser-based software options deliver critical real-timeinformation tailored to each end user via the enterprise network or Internet,also providing custom alerts in the form of streaming video, e-mail, ormessages delivered to wireless devices. The Company provides solutions in enterprise vertical marketssuch as data centers, retail and convenience stores, education, and corporateoffices as well as the recently identified homeland security markets such asair and ground transportation, water treatment facilities, oil and gas, powerplants, and the Department of Defense.  The Company’s principal offices are locatedat 3208 Commander Drive, Carrollton, Texas, 75006, and its telephone number is972-407-6080.

 

3

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**Company Evolution**

 

The Company was formed in November 1982 asLasertechnics, Inc. Prior to 1999, the Company, through two subsidiaries, soldhigh-end dye-sublimation card printers and high-speed laser marking equipment.During 1998, the Company determined that it could not be consistently profitableselling these products. Accordingly, in October 1998, the Company discontinuedthe operations of its 96% owned subsidiary, Sandia Imaging Systems Corporation,which was engaged in distributing and reselling high-end dye-sublimation cardprinters and consumables. The Company sold this business in December 1998. Asecond subsidiary, Lasertechnics Marking Corporation, was engaged infabricating, distributing and selling high-speed laser marking equipment. InApril 1999, the Company sold Lasertechnics Marking Corporation to affiliates ofAmphion Ventures, L.P., a major stockholder of the Company. See also “Item 12.Certain Relationships and Related Transactions.”

 

The Company then made a concerted effort toenter into the high technology security products marketplace, and identifiedRFID as its initial target. In September 1998, the Company consummated theacquisition of the RFID based intellectual property assets of ASGI, Inc. andNauta, Inc., unaffiliated entities to AXCESS. The intellectual property assetsincluded a patent, trade secret rights, software, hardware, product designs andall other technical information necessary for the Company to manufacture andmarket RFID products to the access control and asset management markets.

 

In July 1999, the Company acquired anothercompany in the security technology marketplace in the digital video or CCTVarea. The Company acquired substantially all of the assets, including thenetwork video technology, of Prism Video, Inc. Prism Video, Inc. was engaged inthe development, design, manufacture and marketing of video security technologyand video storage products. The Company then hired new senior managementexperienced in the packaging, sales, and marketing of high technology securityproducts.

 

The Company further developed the RFID andnetwork-based streaming video technologies throughout 2001 and 2002. It alsosecured key reference accounts and established branding for its product linesduring the period. In November 2001, the Company acquired all of the assets ofIVEX Corporation relating to its VSA 1200 Project. The VSA 1200 project was anembedded processor-based multimedia streaming network appliance that pushesadvanced video and audio processing directly onto the corporate or Internetbackbone, then to any point on the network, including handheld devices. TheCompany believes that IVEX’s unique architecture offers a strategic platform onwhich to build value adding video filtering and detection software, which theCompany expects to improve the effectiveness of the IVEX product line as wellas provide a competitive advantage to the Company. Throughout 2001 and 2002,the Company used its reference customers and its brand awareness to secure keymarketing channel partners. These partners are important to the future revenuegrowth of the Company’s business due to their market presence. The Companybelieves that by integrating its systems into the systems of these channelpartners, adoption of the Company’s technologies and products will accelerate.The Company has completed its integration efforts with certain channel partnersand is in the process of integrating others.

 

In April 2003, the Company changed its namefrom Axcess, Inc. to Axcess International, Inc.

 

##### **Sales Channels**

 

AXCESS utilizes an indirect sales modelfocused primarily on system integrators as marketing channel partners capableof selling and installing network-based CCTV and asset management applications.Other outlets include distributors, specialty dealers, catalog salesorganizations, and OEMs (original equipment manufacturers). The Company iscontinuing channel development in the security industry, by focusing on largesystem integrators that have significant sales in which the Company hopes toparticipate. The system integrators and dealers are responsible for theinstallation in almost all cases. AXCESS has two salesmen that supportindividual sales as needed. Using established channels to gain widespreadexposure and sales leverage is a well-utilized model in the industry.

 

The indirect sales model allows the Companyto address multiple industry segments generically, including manufacturing,wholesale / distribution, retail, services, government, education and finance.The indirect sales model fits the characteristics of the Company’s product portfoliowith other products, which become system solutions that require custom siteplanning and installation. Sales generally have multiple locations with theaverage revenue per system location in the tens of thousands, and are based ona new technology and its application to traditional security problems. Byworking directly with established marketing channel partners, this indirectmodel also gives the Company the flexibility to introduce new products andapplication as they are developed.

 

For certain focused large system salesopportunities, the Company works more directly with end users. This approachenables the Company to prospect directly for selected larger transactions andreference accounts in a prudent, “opportunity driven” fashion. The eventual installationis still accomplished through an established channel partner.

##### ** **

4

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##### **Partnering**

 

The Company believes that the securityintegration business will continue to go through consolidations and grow by acquisition,and that each of the large integrators are working to develop full-productportfolios to provide the widest range of solutions for their customers. TheCompany also believes that its products can play a key role as strategicelements of these portfolios, and that the integrators bring to AXCESS broadproduct and corporate exposure and sales capabilities. Combined integratorrevenues were over $2 billion in 2001, according to a Security Distributing andMarketing (SDM) Magazine report. The largest global integrators that providesecurity technology solutions include Honeywell, Tyco, Siemens, Group 4 andGeneral Electric.

 

The Company has signed partnering agreementswith several integrators. In general, these agreements provide for theintegrators to sell and market the Company’s products, favorably price theCompany’s products based on the volume of the Company’s products sold, providecustomer service support for the Company’s products sold by the integrators,and integrate the Company’s products into the integrator’s system.  The Company believes this integrationstrategy has advantages over its prior partnership arrangements and will offeran increased opportunity for rapid sales growth.

 

*Honeywell.* In January 2000, the Company signed a product developmentand marketing agreement with Honeywell. Honeywell has bid and sold the Company’s RFID products to support theUnited States Department of Defense procurements in asset management and theCompany believes that some of the resulting programs may be awarded in 2003.

 

*Sonitrol (Tyco)*. In January 2000, the Company signed a strategicpartnership agreement with Sonitrol. In early 2002, Sonitrol finished theintegration of the Company’s software into the security-monitoring platform ofSonitrol.  The solution provides videocapability for their security monitoring franchises.

 

*Software House,Sensormatic, and ADT (Tyco).* In September 2001, the Company was selected bySoftware House as the preferred provider of RFID solutions for assetmanagement. Since September 2001, the Company’s ActiveTag products have beenintegrated into the C-Cure 800 access control system. Sensormatic and ADT alsohave the capability to sell the Axcess system integrated into C-Cure.

 

##### **Other Integrator Partners**

 

In the second half of 2001, AXCESS signedpartnership agreements with Anixter, Samsung USA, and Loronix (Comverse). TheAXCESS system has since been integrated into the systems provided by Samsung,Iteras, and Loronix, totaling four integrators who have the AXCESS system embeddedinto the solutions they sell.

 

##### **Products and Technology**

 

Under the ActiveTag(TM) label, the Companysupplies active RFID system solutions that connect directly into standardsecurity systems or utilize the enterprise networks or the Internet. ActiveTag(TM)is a multi-use, single-system solution scaleable for small, medium, and largeenterprises. This versatile technology has two patents awarded withapplications for thirteen additional patents pending. The system supports avariety of automatic monitoring and tracking applications, including electronicasset protection and asset management, and automatic personnel and vehicleaccess control.

 

ActiveTag(TM) uses small, battery-poweredtags that, when automatically activated at control points throughout a facility,transmit a wireless message to palm-size receivers networked on an existingcorporate local area network (commonly referred to as LAN). Tag identificationand location information is instantly forwarded to a local security controlpanel or transmitted over the network to a host computer. ActiveTrac(TM) is anapplication software program that logs and displays the information from thetag to provide a comprehensive picture of the person, asset or vehicle beingtracked. In addition, the Company is continuing to develop OnlineSupervisor(TM)software, which has a browser-based display and provides real-time managementsolutions through reporting, display, and decision and control functions.

 

ActiveTag(TM) tracks assets as the assetsenter, exit and move within a facility to monitor their whereabouts, detecttheft and prevent loss. ActiveTag(TM) software can link assets and personneltogether to provide a non-invasive, hands-free access control and assetprotection solution at perimeter doors and other controlled entry and exitpoints. Personnel tags include a panic button for increased personal safety andpeace of mind. This software can track vehicle and equipment movements toprovide real-time, paperless logistics data and automated gate control. Not onlycan pallets, containers or boxes be tracked in real-time, but a beaconingfeature (where the tag transmits on a fixed time interval) allows the user toautomatically count and monitor all inventory, even while stationary. Oneversion of the RFID tag includes an embedded temperature sensor inside tomonitor and transmit measurement of ambient temperature or to signal when thetemperature moves outside of a defined range. This sensor capability isutilized today for helping with the early detection of computer server failurein data centers. Another version of the RFID tag has external sensors so thetag can act as a low-cost wireless transmitter.

 

5

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AXCESS’ Prism Video products offer a fullynetworked, digital video system for enterprises providing remote and localsecurity video (CCTV) as well as digital video recording. Enterprises use thissystem to transmit and view video to detect security incidents. The Companyoffers both standards-based compression, currently H.323 and JPEG, andproprietary VSLE video compression, supported by 12 patents with applicationsfor three more patents pending. The advanced compression technology allowsvideo to be viewed live over traditional phone lines or on any network computer,and recorded and efficiently stored for analysis at a later time. A full arrayof Prism Products, including cameras, transmitters and recorders, providescustomers with low cost, enterprise-wide digital video solutions over thenetwork. Cameras and transmitters can utilize any transmission facilityincluding phone lines, ISDN, LAN, Internet or other facility. High speed,real-time video and audio provides visibility into operations to improve lifesafety, improve efficiency, observe sales programs, reduce theft, and monitorcompliance with both legal and corporate guidelines.

 

The LANconnect(TM) product line is comprisedof advanced multimedia streaming network appliances that acquire video at thesource, then provide advanced video and audio processing over the network todigital recorders and on to the other points of the network. The combination ofhighly-integrated embedded processing power and programmability allows digitalvideo processing to be distributed at the analog source, freeing up valuablenetwork bandwidth, reducing video storage requirements, eliminating singlepoint of failure and enabling the user to select the quality of the video. TheLANconnect system also stores video digitally, which allows fully distributedstorage. These storage possibilities make the video network efficient bytransmitting needed video only, yet making all of the video available ondemand. Only needed, “exception-based” video is transmitted either on alarm oron-demand.

 

The LANcam(TM) network camera transmitsdigitized CCTV video directly over an enterprise LAN at low bandwidths. Eachcamera is independently controllable, including the control for the amount ofnetwork capacity or bandwidth the camera utilizes, which prevents performanceimpacts on other applications.

 

Network-based digital video recording can bewidely distributed geographically using LANcorders(TM) to provide easy accessto recorded video along with live video on-demand. AXCESS’ specializedimplementation includes a software only videocassette recorder, or time-lapserecorder, utilizing standard computers on the existing network for recordingrather than dedicated hardware recorders. This architecture includesdistributed video recording along with playback and live viewing over anexisting computer network. The Company believes that this inherently low costand flexible architecture establishes a foundation upon which the Company maycompete today and in the future.

 

The Prism Video line includes a suite ofsoftware products for viewing live and recorded video. These products rangefrom dedicated security software applications, to web page viewing for casualuse. The products also permit a user to view video on wireless devices such ashandheld computers connected to a standard wireless LAN system.

 

The Onlinesupervisor(TM) system integratesthe presentation of RFID data and digital video to a standard web browser.Through a display customized to each end user, real-time status is integratedwith live and recorded digital video. Events that can be shown involve premisessecurity, physical asset protection, personnel staffing, and operationsperformance. Up to the minute personnel and asset inventory counts areprovided. Live streaming video is available of each site via the networkconnection. Each monitored event is linked to the database of recorded videofiles to enable the viewing of tagged events such as personnel activity at doorentrances and exits, access to controlled areas, and asset movements. Thesystem is available as a standalone enterprise solution or as a portal-basedsolution hosted by AXCESS. The Company believes that the system is unique inits ability to link information read from a tag with video clips and picturesfrom the scene surrounding the tag.

 

Typical Applications of the Company’sproducts include:

 

•                  “Hands-free”automatic personnel identification and access control - Doors can beautomatically opened as the accredited employee approaches the door, enablingrapid and easy entrance without presenting a card to be swiped. Multiplelogical control zones can be set up within a facility making key areasautomatically more secure as non-authorized people are quickly identified. Theidentification can be linked to tagged assets to improve asset managementaccountability.

 

•                  “Hands-free”automatic vehicle identification and access control - Vehicles automaticallyenter a controlled or gated area with a validated tag placed in the vehicle.The tag is recognized as it approaches the gate, allowing, “rolling access” andfacilitating entrance and exit speed. For industrial applications, driver tagsand inventory tags can be matched to ensure integrity of the shipment.

 

•                  Electronicasset protection and tracking - Assets, such as computers and medicalequipment, are automatically tracked as they move throughout the facility andprotected if they approach a perimeter door without authorization. Linking tocustodian tags provides accountability and instant authorized movement.

•                  Electronicfixed asset inventory and protection - Static assets such as desktop computerscan be tagged and automatically inventoried at periodic intervals. Should theassets be moved, their location is identified and automatically tracked.

 

6

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•      Electronic inventory control and tracking- Inventory items, such as pallets, crates, barrels and vessels, can beautomatically located, identified, and tracked as they move and protectedagainst unauthorized removal.

 

•                  CorporateCCTV digital video recording - Traditional security video recording can be donedigitally, apart from the source camera to ensure efficiency, quality,performance, and availability.

 

•                  RemoteCCTV surveillance - Traditional security surveillance is provided via telephoneline or over the network to give remote viewing for security central monitoringand for operations review. In retail stores this provides life safety as wellas improved monitoring of operations. In schools, student monitoring isimproved with live, on-campus video available to the police. In homelanddefense, live video of an incident is available to authorities, includingmobile professionals.

 

•                  Automaticpersonnel accounting (mustering) - In cases of catastrophic disaster involvingbuildings, tags on people are used to identify who exited safely.

 

 

##### **Markets**

 

AXCESS’ operates in the electronic securityproducts and systems markets. Its products have been designed, built andintroduced with general purpose, broad applications in mind, cutting acrossmany industries. Some examples of product solutions in selected markets areprovided below.

 

*Retail CCTV* - Management and security station personnel canuse AXCESS products to remotely supervise facilities such as retail stores,convenience stores, and fast food stores from the desktop using videotransmitted over an enterprise WAN, the Internet, or modem. Retail personnelcan also use remote video systems in retail are used for life safety and toreduce employee theft. The Company has many notable customers in this market.

 

*Education* - Various schools and universities areimplementing tagging to protect data center assets, schools, and universitiesare also using networked video for life safety reasons. Many schools anduniversities already have built-out networks, so RFID tagging and networkedvideo may be added for the incremental cost of this equipment. Built-outnetworks also offer additional flexibility to move video remotely and sharevideo data with school administrators and authorities. A federal programentitled “Safe Schools, Healthy Schools” is scheduled to fund additionalsecurity equipment in kindergarten through twelfth grade over the next severalyears, and AXCESS intends to market its products to schools taking advantage ofthis program.

 

*CorporateAccess Control and Asset Management* - Employees may gain access to company premisesusing automatic hands-free personnel RFID tags that may also be placed oncorporate assets, such as laptops, to track movements and prevent loss. AXCESS,through its control-point architecture, believes that it has a unique solutionto address this market by tagging laptops and implementing control zones.

 

*CorporateSecurity CCTV*- The Company believes that security CCTV is the fastest growing segment forsecurity products and systems. Management personnel can use security CCTV toview live motion video over the network and access stored video clips on-demandof operations activity, personnel corporate compliance, and security. Manyexisting security systems are analog, limiting video availability to cablednetworks and videocassette recorder tape. AXCESS’ products provide a bridgefrom analog systems to digital networks. Networked video enables viewing fromdesktops and wireless handhelds by multiple departments. Recorded video may bemade available to numerous locations on the corporate LAN or via the Internet.

 

*AirportSecurity and Homeland Defense* - AXCESS can provide hands-free premise accesscontrol to employees and authorized vehicles needing easy, secure access to theterminal and tarmac. The Company’s products can provide controlled access forfuel trucks at the fuel depot. Courtesy vehicles can use access control foradded gate security. Networked video and recording may be added to the networkinfrastructure to extend security visibility throughout the terminal andgrounds.

 

*Data CenterAsset Management* - AXCESS products locate and protect computer servers, centralprocessing units and other equipment using RFID tagging. Tagged servers canalso be monitored with temperature sensor tags that not only protect againstloss and misplacement, but also provide an early indication of potentialfailure. AXCESS’ products provide security and visibility from the entrances tothe server and cage level. Many legacy data centers and computer rooms have thesame characteristics. In addition to tagging the computers, users of AXCESSproducts can tag authorized personnel to facilitate easy movement of the assetsand to restrict access to sensitive areas. Video complements the assetmanagement application by providing live viewing capability into theco-location cage or cabinet area. Archived video is also available toinvestigate asset-based activity alarms.

 

*HealthcareResource Management* - Company products have been designed to tag personnel and equipment toprovide better utilization of clinical devices, to locate patients, and tostage devices in order to speed up procedures. Users of the Company’s RFIDtagging products may reduce equipment and personnel costs associated withpatients moving within the facility. The Company’s equipment may enablehealthcare facilities to increase revenues from more efficient billing ofequipment usage.

 

7

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*Inventory andTransportation Management* - Cartons, pallets, containers and even missiles may be tagged so theycan be located, tracked and monitored to facilitate movement, rapid orderpicking and inventory verification. Bar coding is common in source productlabeling at the start of the supply chain. Once products are packaged in largercontainers for shipping and warehousing, RFID tagging complements bar codingand the warehouse system by enabling automatic long-range identification andlocation of products. In production applications, the tag can be a wirelesssensor for a production line, transmit information about the buildspecifications for a product, and send notifications from the finished goodsarea after production is completed.

** **

**Patents andProprietary Technology**

 

The Company relies on a combination ofpatents, trade secrets, technology licenses, and other intellectual propertyrights.  In total, the Company hasreceived 13 U.S. patents with international coverage around the globe. TheCompany has 14 patents in various stages of prosecution with foreign patentauthorities and several additional patents being prepared for filing. Theperiod covered by the Company’s issued patents ranges from 7 to 17 years. TheCompany intends to protect and enforce its intellectual property rights and topreserve its rights relating to its key product technologies to the extentcommercially reasonable. The Company has registered a number of trade andservice marks, including AXCESS Inc.(TM), the AXCESS Inc. (logo)(TM), LANcam,ActiveTag(TM), onlineaccess.com(TM), Prism Video(TM) and LANcorder (TM).

 

##### **Engineering and Development**

 

The Prism Video(TM) product line providesflexible capture and placement of video on a network for recording and displayover the network. During 2002 the Company completed the majority of integrationtasks for the Prism Video (TM) line with the transmitter products the Companyacquired from IVEX Corporation. The IVEX products included a networktransmitter capable of serving up to eight simultaneous viewers, and a combinedtransmitter and recorder, which allow recording to be done and retained, nearthe camera. The IVEX products are being integrated into the Company’s coresoftware platforms to offer customers an increased range of feature andfunction options. During 2002, the Company completed development of specific featureand function enhancements to its Prism Video (TM) product line that theCompany’s integrators requested. The Company is developing advanced videoprocessing algorithms and will continue to focus on these algorithms toincrease the intelligence of the Company’s video appliances. Examples of thesealgorithms include advanced motion detection, motion tracking, speed anddirection measurement, object addition and subtraction detection, facialrecognition, and people counting.

 

During 2002, the Company developed a new,smaller key-fob size form factor for the RFID tags. The Company expects thatthis tag will reduce the cost of a personnel tag compared to previous formfactor. The Company continues to look at the development of new semiconductorsfor integrating RFID functions into smaller, less costly devices. The Companyintends to work toward the inclusion of various sensors, such as motion,humidity and power, to enable the tagging system to more fully address marketneeds in the data center and logistics markets. The Company anticipates thatthird party improvements to battery technology and manufacturing methods willenable size reduction.

 

Onlinesupervisor development continues to addadditional data sources that can be delivered over the same platform, makingthe product expandable beyond RFID data on an industry specific basis intoareas including condition monitoring and data mining.

 

##### **Competition**

 

The market for the Company’s products andservices is intensely competitive and is characterized by rapidly changingtechnology, evolving user needs and the frequent introduction of new products.

 

A number of the Company’s competitors aremore established, benefit from greater name recognition and have substantiallygreater financial, technical and marketing resources. The Company’s managementbelieves that the principal factors affecting competition in the Company’smarkets include product functionality, performance, flexibility and features,use of open standards technology, quality of service and support, companyreputation, price and overall costs of ownership. In order to compete, theCompany seeks to provide products that are technologically superior, and thatdeliver better value. The Company believes that the following factors helpdistinguish the Company’s products from those of its competitors:

 

The ActiveTag(TM) RFID automaticidentification system benefits from low cost, long-range tag activation andtransmission, which have a small form factor, long-term battery life, and alsoa platform for adding sensor capabilities. The activation of tags occurs at aseparate low frequency, a patented approach which the Company believes giveAXCESS an advantage among active RFID companies in the ability to establishphysical control points, such as doorways, and virtual control points, such ashallways. The receiver system is designed as a low cost infrastructure thatconnects directly into legacy systems and also runs on a standard Ethernetnetwork backbone. The system is flexible enough to support multiple applicationsfor people, physical assets, and vehicles. Finally, the tag data is integratedwith live and recorded streaming video on a multi-user browser display platformfor both casual viewing and industrial requirements.

 

8

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Flexibility comes from the use of dualfrequencies for wake-up and transmission: low frequency on wake-up and UHF fortransmission. Tag transmission at UHF penetrates all materials except metal,enabling reliable tag transmission. This also enables long range tag readsusing omni-directional antennas so that no line of sight is required. A simpletransmission protocol allows multiple tags to be read simultaneously. Theadvanced battery management design provides battery life of three to five yearsunder normal operating conditions, and five to seven years with an enhancedbattery. Control point activation, combined with the ability for tags totransmit on set time intervals or be queried individually enables the ActiveTagline to meet the major user requirements, including dynamic tracking, statictracking, multiple simultaneous tag reads, “authorized” movement of taggedassets, and a long read range for tag transmission, which the Company believesgives it an advantage. The Company believes that these features enable thesystem to outperform passive systems, relative location positioning systems,and infrared and combo infrared/RFID systems from competitors.

 

The Prism Video(TM) is a complete end-to-endsystem, which includes video transmitters, streaming video cameras, softwaredigital recording, web display, and wireless handheld display are allintegrated in an open architecture fashion on the network using the LAN andInternet.  The solution reduces the needfor special camera cabling, also enabling network-based video recording to beplaced in geographically optimal positions. With the video on the network, all video is viewable from anywhere inthe world the network provides authorized access.  The all-digital solution focuses on event-based security breachdetection, alarming, and evidence recording and notification.  It makes a video security system moreeconomic, have a greater geographical reach and operate more effectively.  Personnel are able to focus on preventionand response rather than on evidence processing.  Its efficiency is derived in part from advanced video compressionperformance, giving users the choice of standards-based H.323 and JPEG, orproprietary VSLE. Whether the video is compressed in the LANcam(TM) camera, theLANconnect(TM) network appliance products, or in a MicroMole video transmitter,the compression will use between two and 30 times less bandwidth thanuncompressed systems. This means more cameras can be used on a given network,and if only standard modem links are available, the video performance willstill be adequate. Even the fast performance proprietary scheme, VSLE, can beconverted to the Windows standard .avi frame format for software-only recordingand live display. The network appliances under the LANconnect product familyare programmable, ready for upgrades in compression types and advanced videoprocessing, which allows automated detection of security breaches. AXCESSbelieves that its solutions provide an inherent parts cost advantage over competitor’sdigital video devices due to the simplicity of the compression code whenimplemented in an embedded system such as the LANcam. Similarly, because ofthis compression efficiency stored video will take up less capacity on a harddrive, or other type of storage media than other digital video recorders. Allcamera, transmitter, and storage products are network enabled. The PrismVideo(TM) line includes over 30 interfaces to peripheral control equipment suchas pan, tilt, zoom, and multiplexers making it compatible with legacy CCTVequipment and requirements.

 

##### **Manufacturing and Suppliers**

 

The Company outsources the manufacturing ofits products and consequently depends on outside manufacturers to supplyfinished product. A large number of manufacturers in the U.S. have thecapability to produce the Company’s products. The Company periodically seeksbids for manufacturing and has multiple manufacturing sources for each of itsproducts.

 

Although the Company depends on a number ofoutside suppliers for components of its products, the Company has designed itscurrent line of products so that it is not dependent on a single source for anyof its products’ components. Although the Company has generally been able tosecure adequate suppliers, the inability of the Company in the future to obtainsufficient suppliers of component parts could have a material adverse effect onthe Company’s results of operations.

 

There are currently no long-term agreementsbetween the Company and its manufacturers or suppliers.

##### ** **

##### **Research and Development**

 

If the Company has sufficient working capitalthe Company plans to continually develop new products utilizing its existingtechnology and plans to bring new products to market throughout 2003. During2002 the assimilation of the IVEX video products was largely completed. Newproducts in both video and RFID will be built upon the core platforms now inplace. In RFID, the Company believes that a new tag with a key-fob form factorwill offer a lower cost and smaller version of the existing personnel accesscontrol tag. The company believes this new tag will also be used for protectingassets from theft. In video, the Company believes that the architectureacquired from IVEX will lead to products with advanced detection software forautomatically detecting security incidents. The new products should takeadvantage of the ability to record and store security video at the cameralocation and transmit both live and recorded security video via multiplesimultaneous connections to critical users. There can be no assurance that the Company will have sufficient workingcapital to undertake these activities.

 

During 2002 and 2001, the Company spent$1,632,385 and $2,355,269, respectively, for research and development and plansto continue spending similar amounts in fiscal year 2003 to develop products tosupport the Company’s continued revenue growth.

 

9

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##### **Employees**

 

As of December 31, 2002, the Company had 17full-time employees.  The Companyfurloughed all of its employees on October 16, 2002 and recalled 13 full-timeemployees during January 2003.

 

**Government Regulation**

 

Government regulations have not had, nor arethey expected to have, a material effect on the Company’s financial condition,results of operations or competitive position. FCC approval is required forsome of the Company’s principal products.

##### ** **

##### **Environmental Factors**

 

There has been, and it is anticipated thatthere will continue to be, no material effect upon the Company’s capitalexpenditures, earnings, or competitive position due to compliance with existingprovisions of federal, state and local laws regulating the discharge ofmaterial into, or otherwise relating to the protection of, the environment.

 

10

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**Risk Factors**

 

We operate in a changing environment thatinvolves numerous risks, some of which are beyond our control. The followinghighlights some of these risks.

 

##### **Ability to Continue as a GoingConcern**

 

Our auditors have included an explanatoryparagraph in their audit opinion with respect to our consolidated financialstatements at December 31, 2002. The paragraph states that our recurring lossesfrom operations and resulting continued dependence on access to externalfinancing raise substantial doubts about our ability to continue as a goingconcern. Furthermore, the factors leading to and the existence of theexplanatory paragraph may adversely affect our relationship with customers andsuppliers and have an adverse effect on our ability to obtain financing.

 

The Company’s business plan for 2003 ispredicated principally upon the successful marketing of its RFID products andthe digital video products. The Company anticipates that its existing workingcapital resources and revenues from operations will not be adequate to satisfyits funding requirements in 2003.

##### ** **

##### **Liquidity Problems; Need forAdditional Financing**

 

We do not have sufficient working capital tosustain our operations.  We have beenunable to generate sufficient revenues to sustain our operations.  Failure to obtain additional capital couldcause delay or abandonment of our business plans. The Company anticipates thatit will depend on outside sources of capital to fund operating losses for asignificant portion of the next twelve months. Additional capital may also berequired for a variety of other reasons, including unforeseen delays,unanticipated expenses, increased capital requirements, engineering designchanges and other technology risks or other corporate purposes. Theseadditional funds may not be available. Even if those funds are available, wemay not be able to obtain them on a timely basis, or on terms acceptable to us.Failure to obtain additional funds could result in the delay or abandonment ofour development and expansion plans and we may be unable to fund our ongoingoperations. Furthermore, the Company has substantial indebtedness in the formof demand notes and does not have the financial ability to satisfy a demand ifmade.

 

##### **History of Losses and Expectationof Future Losses; Uncertainty of Future Profitability; Limits on Operations**

 

From our incorporation in 1982 throughDecember 31, 2002, we have incurred an accumulated loss of approximately $136.8million and have been profitable in only one fiscal year during that time.There can be no assurance that we will generate sufficient revenues to achieveprofitability in the future. If the Company is unable to generate sufficientrevenues, the valuation of purchased intellectual property may be affected. Recoverabilityof assets to be held and used is measured by a comparison of the carryingamount of an asset to future net cash flows expected to be generated by theasset. If such assets are considered to be impaired, the impairment to berecognized is measured by the amount by which the carrying amount of the assetexceeds the fair value of the asset. Continued slow revenue growth andoperating losses by the Company may indicate circumstances requiring animpairment to be recorded.

 

If our losses continue, we will have toobtain funds to meet our cash requirements through business alliances, such asstrategic or financial transactions with third parties, the sale of securitiesor other financing arrangements, or we may be required to curtail ouroperations, seek a merger partner, or seek protection under federal bankruptcylaws. Any of the foregoing may be on terms that are unfavorable to us ordisadvantageous to existing stockholders. In addition, no assurance may begiven that the Company will be successful in raising additional funds orentering into business alliances.

 

11

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##### **Future Development of Products**

 

Introducing new technology involves, withoutlimitation, risks of “bugs”, prior release compatibility, customermodifications affecting standard interfaces, and unanticipated applicationenvironment anomalies. Although we use rigorous testing procedures andprotocols, delays in product introductions or shipments could have a materialadverse effect on our results of operations.

 

Much of our ability to compete depends ontrade secrets, know-how and proprietary technical knowledge that areunprotected by patents. Although we continue to implement protective measuresand intend to defend our proprietary rights vigorously when appropriate, therecan be no assurance that these efforts will be successful. Such protections maynot preclude competitors from developing products similar to ours. In addition,the laws of certain foreign countries do not protect intellectual propertyrights to the same extent, as do the laws of the United States. There can alsobe no assurance that third parties will not assert intellectual propertyinfringement claims against us. Any such infringement claim could result inprotracted and costly litigation and could have a material adverse effect onour results of operation regardless of the outcome.

 

##### **Obsolete Technology**

 

The technology we use may become obsolete orlimit our ability to compete effectively within the wireless, automatic identificationand multi-media applicable industries. These industries are characterized byrapidly changing technology, evolving industry standards and frequent newproduct introductions. The introduction of products embodying new technologiesor the emergence of industry standards can render existing products obsoleteand unmarketable. Our success will depend on our ability to enhance ourexisting products. Our success will also depend on our ability to develop andintroduce, on a timely and cost-effective basis, new products that keep pacewith technological developments and emerging industry standards and thataddress increasingly sophisticated customer requirements.

 

Our business would be adversely affected ifwe were to incur difficulties or delays in developing new products orenhancements or if those products or enhancements did not gain marketacceptance. Specifically:

 

•                  wemay not be successful in identifying, developing and marketing productenhancements or new products that respond to technological change or evolvingindustry standards;

 

•                  wemay experience difficulties that could delay or prevent the successfuldevelopment, introduction and marketing of these products; and

 

•                  ournew products and enhanced products may not adequately meet the requirements ofthe marketplace and achieve market acceptance or may not keep pace withadvances made by our competitors.

 

12

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##### **Outsourcing; Dependence onManufacturers and Suppliers to Produce Systems**

 

Because we outsource portions of ourbusiness, particularly for manufacturing, we depend heavily on third-partyvendors, suppliers, and contractors. The failure by any of our vendors,suppliers, or contractors to fulfill their contractual obligations to us couldadversely affect our operations. If we are unable to obtain sufficientcomponents and manufacturers for the products, or develop alternative sources,delays in product introductions or shipments could occur and could have amaterial adverse effect on our results of operations.

 

##### **OTC Bulletin Board** Listing

 

Trading of our shares is conducted in theover-the-counter market on the National Association of Securities Dealers’ OTCBulletin Board and/or on the pink sheets of the National Quotation Bureau. As aresult, an investor may find it more difficult to dispose of, or to obtainaccurate quotations as to the price of our common stock than when it was tradedon the NASDAQ SmallCap Market. In addition, our common stock is subjected torules promulgated under the Exchange Act applicable to penny stocks. TheCommission has adopted regulations that generally define a “penny stock” to bean equity security that has a market price (as determined pursuant toregulations adopted by the Commission) or exercise price of less than $5.00 pershare, subject to certain exceptions. Our securities are now subject to thepenny stock rules that impose additional sales practice requirements onbroker-dealers who sell penny stocks to persons other than establishedcustomers and accredited investors. Consequently, the penny stock rules mayadversely affect the ability of broker-dealers to sell our common stock and mayaffect the ability of purchasers of our common stock to sell such securities inthe secondary market.

##### ** **

##### **Small Trading Volume and Volatilityof Stock Price**

 

The weekly trading volume of our common stockin the over-the-counter market during 2002 varied from a hundred shares to22,500 shares, which may tend to increase the volatility of the price. FromJanuary 2002 through December 31, 2002, the closing bid price of our commonstock in the over-the-counter market has varied from a low of $0.25 to a highof $4.15 per share. There can be no assurance that the price volatility willnot continue in the future.

 

##### **Dependence on Key Personnel**

 

We believe that our ability to successfullyimplement our business strategy is highly dependent on our management andproduct development team. The loss of services of one or more of theseindividuals might hinder the achievement of our development objectives. Wecannot give any assurance that we will continue to be able to hire and retainthe qualified personnel needed for our business. The loss of the services of orthe failure to recruit key technical personnel could adversely affect ourbusiness, operating results and financial condition.

** **

**PotentialAdverse Effect of Shares Eligible for Future Sale; Outstanding ConvertibleSecurities and Warrants**

 

Future sales of our common stock in thepublic market by existing stockholders warrant holders and holders ofconvertible securities subsequent to the date hereof could adversely affect themarket price of our common stock. At March 15, 2003, 16,566,148 shares ofcommon stock were issued and outstanding with approximately 1,800,000 sharesfreely tradable without restriction under the Securities Act. If exercised, theconvertible debt, convertible securities, warrants and options outstanding atMarch 15, 2003, would result in over 8,000,000 additional shares of commonstock issued and outstanding. See Notes 10, 11, and 13 in Notes to ConsolidatedFinancial Statements.

 

##### **Voting Control of the CompanyHeld by the Amphion Group**

 

As of March 15, 2003, Amphion Ventures, L.P.and affiliates of Amphion Ventures, L.P. including Amphion Partners, AmphionInvestments, Antiope Partners, XL Vision, Inc. and VennWorks LLC (formerlyincuVest LLC) (collectively, the “Amphion Group”) owned approximately 81% ofour outstanding voting stock. This level of ownership provides the AmphionGroup with the power to determine the outcome of almost any matter submittedfor the vote or consent of our stockholders. Additionally, two of our fivedirectors are affiliates of the Amphion Group.

 

13

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**Item 2. DESCRIPTION OF PROPERTIES.**

 

The Company leases a 6,509 square footfacility in Carrollton, Texas used for administrative, engineering and salesoffices. This facility is rented under a month-to-month agreement. The monthlyrent is $5,000. The Company leases 3,171 square feet in Tustin, California usedfor engineering space. This lease will terminate in September 2005. The monthlyrent is $5,951. The Company’s facilities are suitable and adequate toaccommodate the Company’s operations. The Company’s management considers eachof these facilities to be in good condition and is of the opinion that thefacilities are adequately covered by insurance.

 

**Item 3. LEGAL PROCEEDINGS.**

 

In Charles Martin v. AXCESS, Inc., JAMSArbitration filed on or about October 2001, Charles Martin, a former employeeof the Company, asserted that he had good cause to terminate his employmentunder his employment agreement and is owed $300,000 in contractual severancepay. The arbitrator ruled in November 2002, that Mr. Martin had no basis forhis claim and the Company owed him no additional amounts.

 

In Stephen L. Briggs v. AXCESS, Inc., JAMSArbitration filed on October 2, 2001, Stephen Briggs, a former employee of theCompany, asserted that he had good cause to terminate his employment under hisemployment agreement and is owed $300,000 in severance pay.   In January 2002, Mr. Briggs signed arelease and dropped his request for arbitration and the Company owed him nopayment.

 

Barth Technologies Incorporated (“BTI”),filed a lawsuit against the Company in state district court in Tarrant County,Texas on October 18, 2001. BTI was a vendor to the Company and seeks damages of$263,655 for non-payment for services and supplies provided. During the firstquarter of 2003, the Company reached a tentative settlement in this case and shouldbecome final during the second quarter of 2003.

 

Pioneer Standard Electronics, Incorporated("Pioneer"), filed a lawsuit against the Company in the county courtin Dallas County, Texas on September 28, 2001. Pioneer was a vendor to the Company and seeks damages of $81,533 fornon-payment for services provided. During the first quarter of 2003, Pioneer was granted a judgment for theentire amount.  The Company isattempting to settle this claim, but has limited resources to do.  Other similar cases have been filed againstthe Company with claims aggregating $196,493. At December 31, 2002, the Company has accrued the deliquent amountspayable for the claims described in this paragraph.

 

**Item 4. SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS.**

 

None.

 

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**PART II**

** **

**Item 5. MARKET FOR COMMON EQUITY AND RELATEDSTOCKHOLDER MATTERS.**

 

The Company’s common shares trade on theover-the-counter bulletin board under the symbol AXSI.BB.  Prior to September 2002 the Company’s commonstock traded on the NASDAQ SmallCap Market tier of the NASDAQ Stock Marketunder the symbol AXSI. The Company was notified in September of 2002 that it nolonger qualified for the Nasdaq SmallCap minimum listing requirements.  The table below sets forth high and lowclosing prices for the common stock during each of the periods indicated, asreported by NASDAQ. Such price quotations represent inter-dealer prices withoutretail markup, markdown or commission and may not necessarily represent actualtransactions.

 
|              |   | **2002** |   | **2001** |   |
|-------------------|--------|----------|--------|----------|--------|
| **QUARTER ENDED** |   | **LOW**  |   | **HIGH** |   | **LOW** |   | **HIGH** |   |
| March 31          |   | $        | 2.20   |     | $      | 4.36 |   | $ | 3.19 |   | $ | 5.50 |   |
| June 30           |   | 0.93     |   | 2.50     |   | 3.52 |   | 5.75 |   |
| September 30      |   | 1.00     |   | 1.98     |   | 3.25 |   | 6.10 |   |
| December 31       |   | 0.25     |   | 1.01     |   | 3.50 |   | 8.45 |   |
|                   |        |          |        |          |        |  |  |  |  |  |  |  |  |

 

As of March 12, 2003, the Company had 1,159holders of record of voting common stock and one holder of record of non-votingcommon stock.

 

The Company has not paid dividends on itscommon stock and does not anticipate the payment of cash dividends in theforeseeable future as it contemplates retaining all earnings to finance thecontinued growth of the Company’s business.

##### ** **

##### **Equity Compensation Plans**

##### ** **

##### **Information concerning the 2001Equity Incentive Plan and the 1998 Directors Compensation Plan is presented inthe table that follows.  See “Item13.  Stock Options and Warrants” in thenotes to the financial statements.**

 
| **Plan Category**                                           |   | **Number of  securities to be  issued upon exercise of  outstanding options,  warrants and rights** |   | **Weighted-average  exercise price of  outstanding options,  warrants and rights** |   | **Number of  securities  remaining available  for future issuance  under equity  compensation plans** |    |
|-------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------|---------|
| Equity compensation plans approved by  security holders     |   | 2,175,999                                                                                           |   | $                                                                                  | 3.20   |                                                                                                  | 974,001 |   |
| Equity compensation plans not approved by  security holders |   | —                                                                                              |   | —                                                                             |   | —                                                                                                |    |
| Total                                                       |   | 2,175,999                                                                                           |   | $                                                                                  | 3.20   |                                                                                                  | 974,001 |   |

 

##### **Recent Sale of UnregisteredSecurities**

 

During 2002 the Company issued unregisteredsecurities in connection with each of the transactions described below. Theissuance of the preferred stock, common stock and promissory notes were exemptfrom the registration requirements of the Securities Act by virtue of Section4(2) thereof as a transaction not involving a public offering and anappropriate restrictive legend was affixed to the stock certificates andwarrants.  Information regarding salesin 2001 is provided to support disclosures contained elsewhere in this Form10-KSB.

##### ** **

##### **VennWorks**

 

On January 12, 2001, the Company entered intoa 9.0% convertible demand note (“9% Demand Note”) with VennWorks. The principaloutstanding under this note may be converted into securities of the Company atthe option of VennWorks. The borrowings are unsecured and are due and payableon demand by VennWorks.  On March 30,2001, VennWorks elected to convert $2,000,000 of demand note borrowings into200 shares of Series 2000 non-voting Preferred Stock, leaving a balance of$16,106 under the 9% Demand Note outstanding at March 31, 2001. During thethree months ended June 30, 2001, the Company borrowed an additional $1,070,000under the 9% Demand Note. On June 29, 2001, VennWorks elected to convert$1,080,000 of the principal balance and $80,000 of accrued interest payable onthis note into 116 shares of Series 2000 non-voting Preferred Stock, leaving abalance of $6,106 under this note outstanding at June 30, 2001. During thethree months ended September 30, 2001, the Company borrowed an additional$600,000 under the 9% Demand Note. On September 28, 2001, VennWorks elected toconvert $600,000 of the principal balance on this note into 60 shares of Series2000 non-voting Preferred Stock, leaving a balance of $6,106 under this noteoutstanding at September 30, 2001. During the three months ended December 31,2001, the Company borrowed an additional $797,149 under this note, leaving abalance of $803,255 under this note outstanding at December 31, 2001.  No borrowings were made under this noteduring 2002.  On December 31, 2002 therewas an outstanding balance of $803,255 on this note.

 

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The Company entered into a 6.75% convertible note with VennWorks LLCdated February 14, 2002. During 2002 the Company borrowed $814,000 under thisnote. The principal outstanding under this note may be converted intosecurities of the Company at the option of VennWorks on terms yet to bespecified. The borrowings are unsecured and are due and payable on demand byVennWorks.

** **

**Amphion Ventures, L.P**

 

On June 29, 2001, Amphion Ventures, L.P.elected to convert $580,000 of the outstanding principal balance and $140,000of accrued interest of a 10% note payable, dated April 30, 1998, issued by theCompany to Amphion Ventures, L.P. The borrowings and interest payable wereconverted into 72 shares of the Company’s Series 2000 Non-Voting PreferredStock.

 

On September 28, 2001, the Amphion Groupelected to convert (a) 306.25 shares of Series 2000 Non-Voting Preferred Stockwith an issue price of $10,000 per share and a conversion price of $3.50 pershare, into 875,000 shares of the Company’s common stock, (b) 214 shares ofSeries J Preferred Stock with an issue price of $10,000 per share and aconversion price of $4.00 per share, into 535,000 shares of the Company’scommon stock, and (c) 556.55 shares of Series I Preferred Stock with an issue priceof $10,000 per share and a conversion price of $4.00 per share, into 1,391,374shares of the Company’s common stock.

 

On December 31, 2001, the Amphion Groupelected to convert (a) 1,497.04 shares of Series 2000 Non-Voting PreferredStock with an issue price of $10,000 per share and a conversion price of $3.50per share, into 4,277,264 shares of the Company’s common stock, (b) 1,783.34shares of Series J Preferred Stock with an issue price of $10,000 per share anda conversion price of $4.00 per share, into 5,095,254 shares of the Company’scommon stock, (c) 70,356 shares of Series A Preferred Stock with an issue priceof $26 per share and a conversion price of $1.00 per share into 70,356 sharesof the Company’s common stock, (d) 64,410 shares of Series B Preferred Stockwith an issue price of $28.40 per share and a conversion price of $1.00 pershare, into 64,410 shares of the Company’s common stock and (e) 31,087 sharesof Series C Preferred Stock with an issue price of $30.20 per share and aconversion price of $1.00 per share, into 31,087 shares of the Company’s commonstock.

 

On November 14, 2001, the Company enteredinto a 4.5% convertible demand note with Amphion Ventures, L.P. During thethree months ended December 31, 2001, the Company borrowed $300,000 under thisnote, leaving a balance of $300,000 outstanding at December 31, 2001. Theprincipal outstanding under this note may be converted into securities of theCompany at the option of Amphion Ventures, L.P. The borrowings are unsecuredand are due and payable on demand by Amphion Ventures, L.P.

 

The Company entered into a 6.75% convertible note with Amphion VenturesL.P. (“Amphion Ventures”), dated February 28, 2002. During 2002 the Companyborrowed $1,255,000 under this note. The principal outstanding under this notemay be converted into securities of the Company at the option of AmphionVentures on terms yet to be specified. The borrowings are unsecured and are dueand payable on demand by Amphion Ventures.

 

**Amphion Investment,LLC**

 

The Company entered into a 6.75% convertible note with AmphionInvestments LLC dated January 25, 2002. During the nine months ended September30, 2002, the Company borrowed $355,000 under this note. The principaloutstanding under this note may be converted into securities of the Company atthe option of Amphion Investments on terms yet to be specified. The borrowingsare unsecured and are due and payable on demand by Amphion Investments.

 

##### **IVEX Asset Purchase**

 

Effective November 30, 2001, the Companycompleted its acquisition of certain of the assets of IVEX Corporation(“IVEX”), a privately held corporation engaged in the design, manufacture andmarketing of video security technology and video storage products. The purchaseprice for the assets included 148,000 shares of the Company’s common stock.

##### ** **

##### **Dividends**

 

The holders of the Company’s Series APreferred Stock, Series B Preferred Stock, and Series C Preferred Stock areentitled to receive quarterly dividends on each such share held at the annualrate of 10% of the original issue price of each share payable in arrears, when,as and if declared by the Company’s board of directors, in cash or additionalshares of preferred stock. The holders of Series I Preferred Stock, Series JPreferred Stock, Series 1999 Voting Preferred Stock, and Series 2000 Non-VotingPreferred Stock are entitled to receive semi-annual dividends on each suchshare at the annual rate of 8% of the original issue price of each sharepayable in arrears, when, as and if declared by the Company’s board ofdirectors, in cash or additional shares of preferred stock.

 

In 2002, the Company issued no preferredstock in lieu of dividends.

 

16

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##### **Preferred Stock ConversionTerms**

 

Series A, B and C Preferred Stock. Each shareof Series A, B, and C Convertible Preferred Stock is convertible at the optionof the holders into voting common stock on a share-for-share basis. The Companymay redeem the Series A, B and C Convertible Preferred Stock at any time at the$26.00, $28.40 and $30.20 stated value, respectively, plus accrued dividends,subject to the stock holder’s right to convert to voting common stock for 10business days following receipt of the Company’s notice of redemption. As ofDecember 31, 2002, no shares of Series A and B Convertible Preferred Stock wereoutstanding.

 

Series I and J Preferred Stock. Each Share ofSeries I Preferred Stock and Series J Preferred Stock is convertible in wholeor in part at any time at the option of the holder into shares of voting ornon-voting common stock of the Company, respectively, equal to the quotient of(a) the aggregate original issue price of $10,000 per share divided by (b) theconversion price of $2.51 per share. The Series I Preferred Stock and theSeries J Preferred Stock are both subject to the optional redemption at anytime by the Company, in whole or in part, at a redemption price per share equalto the $10,000 stated value, plus any accrued, but unpaid dividends thereon.The Company’s optional right of redemption is subject to each Series IPreferred Stock or Series J Preferred Stock holder’s right to convert suchpreferred stock into voting or non-voting common stock, as the case may be,within 10 business days after the Company’s notice of redemption.  The Series I Preferred Stock and the SeriesJ Preferred Stock are also subject to the mandatory conversion by the Companyinto shares of the Company’s voting or non-voting common stock, as the case maybe, if the closing bid price of the Company’s common stock on the NASDAQSmallCap Market is at least $10.00 per share for a period of at least 90consecutive trading days.

 

Series 1999 Preferred Stock and Series 2000Preferred Stock. Each share of Series 1999 and Series 2000 Preferred Stock isconvertible in whole or in part at any time at the option of the holder into anumber of shares of voting or non-voting common stock of the Company, as thecase may be, equal to the quotient of (a) the aggregate original issue price of$10,000 per share divided by (b) the conversion price of $2.50 or $3.50,respectively.  The Series 1999 PreferredStock and the Series 2000 Preferred Stock are both subject to the optionalredemption at any time by the Company, in whole or in part, at a redemptionprice per share equal to the $10,000 stated value, plus any accrued, but unpaiddividends thereon. The Company’s optional right of redemption is subject toeach Series 1999 Preferred Stock or Series 2000 Preferred Stock holder’s rightto convert such preferred stock into voting or non-voting common stock, as thecase may be, within 10 business days after the Company’s notice ofredemption.   The Series 1999 PreferredStock and the Series 2000 Preferred Stock are also subject to the mandatoryconversion by the Company into shares of the Company’s voting or non-votingcommon stock, as the case may be, if (a) the closing bid price of the Company’scommon stock on the NASDAQ SmallCap Market is at least $7.50 per share for aperiod of at least 20 consecutive trading days and (b) the trading volume ofthe common stock on the NASDAQ SmallCap Market is at least 50,000 shares perday as measured by NASDAQ during each of such 20 consecutive trading days.  As of December 31, 2002 there were no Series2000 Preferred shares outstanding.

 

**Item 6. MANAGEMENT’S DISCUSSION**AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

** **

**Recent Developments:  Going Concern and Liquidity Problems**

 

Our auditors have included an explanatoryparagraph in their audit opinion with respect to our consolidated financialstatements at December 31, 2002. The paragraph states that our recurring lossesfrom operations and resulting continued dependence on access to externalfinancing raise substantial doubts about our ability to continue as a goingconcern. Furthermore, the factors leading to and the existence of theexplanatory paragraph may adversely affect our relationship with customers andsuppliers and have an adverse effect on our ability to obtain financing.

 

We do not have sufficient working capital tosustain our operations.  We have beenunable to generate sufficient revenues to sustain our operations. We will haveto obtain funds to meet our cash requirements through business alliances, suchas strategic or financial transactions with third parties, the sale of securitiesor other financing arrangements, or we may be required to curtail ouroperations, seek a merger partner, or seek protection under federal bankruptcylaws. Any of the foregoing may be on terms that are unfavorable to us ordisadvantageous to existing stockholders. In addition, no assurance may begiven that the Company will be successful in raising additional funds orentering into business alliances.

 

See “Risk Factors.”

##### ** **

17

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##### **Results of Operations**

* *

*Sales and GrossProfit.* Sales forthe year ending December 31, 2002 and 2001 were $1,596,221 and $2,696,404,respectively. The Company realized gross profits of $383,220 in 2002 and$383,232 in 2001. Four customers accounted for 49% of the total revenue in 2002and one customer in the convenience store market accounted for 49% of the totalsales for 2001.

 

RFID product sales were $641,810 and $756,506for 2002 and 2001, respectively. Cost of sales were $498,352 in 2002. Cost ofsales were $690,872 in 2001. The Company realized gross profits of $143,458 and$65,634 in 2002 and 2001, respectively. The increase in gross margin percent is mainly related to a reduction ofproduction and warranty expenses.

 

Digital video product sales were $954,411 and$1,939,898 for 2002 and 2001, respectively. Cost of sales were $714,649 in 2002and $1,622,300 in 2001. As a result gross profits from digital video productswere $239,762 in 2002 and $317,598 in 2001. The decrease in revenue wasprimarily due to a video system sales to a single customer in theretail/convenience store market, which accounted for 68% of video system salesin 2001. The increase margin percent was primarily due to the decrease inproduction and warranty expense and the decrease in sales of lower margin productto the above mentioned customer.  Twocustomers accounted for 56% of the video sales during 2002.

* *

*OperatingExpenses.*Operating expenses were $4,840,043 and $11,524,438, in 2002 and 2001,respectively. The Company was able to lower its research and development,general and administrative, selling and marketing and depreciation andamortization expenses.

 

Research and development expenses were$1,632,385 in 2002 and $2,355,269 in 2001. The decrease was due to a thirtythree percent reduction of staffing and a significant reduction in the usage ofcontract labor.

 

Acquired in-process research and developmentcosts in 2001 consisted of costs allocated to intellectual property rightsacquired from IVEX. The cost of acquiring the intellectual property rights of$336,029 was expensed at the date of the acquisition because the acquiredresearch and development had no alternative future uses and had not reachedtechnological feasibility based on the status of design and developmentactivities that required further refinement and testing before it can beincorporated into future releases of the Company’s digital video products. TheCompany completed the development and integration of the initial application ofthis technology in its products in 2002.

 

Corporate general and administrative expenseswere $1,568,969 and $2,043,914 in 2002 and 2001, respectively. The decrease isattributable to a reduction in employee headcount by approximately twentypercent during 2002, a reduction of an investor relations campaign and reducedlegal expenses, offset by an increase in the directors and liability insurance.

 

Selling and marketing expenses were$1,072,425 and $2,432,105 in 2002 and 2001, respectively. The Company decreasedits advertising, marketing and selling expenses to concentrate on developingits indirect sales channel.

 

Depreciation and amortization expenses were$566,264 for 2002 compared to $4,357,121 for 2001.  The decrease is primarily a result of a $2,797,063 impairment ofintangible assets recorded in 2001. See Note 1 of the Notes to FinancialStatements.

* *

*Other income(expense),* net was$(1,144,311) and $(1,055,559) in 2002 and 2001, respectively. Interest expensewas $1,152,898 and $1,382,163 in 2002 and 2001, respectively. This decrease ininterest expense reflects a reduced discount amount relating to the Prism Noteand the maturity of the Amphion Convertible Note. Interest income was $0 and$327,037 in 2002 and 2001, respectively. This decrease was a result of adecrease in interest earned due to the default of the Amphion Note Receivable.

 

Net loss was $5,601,134 and $12,196,765 in2002 and 2001, respectively. The decrease of $6,595,631 in net loss of 2002 canbe attributed to the decrease in depreciation, amortization and impairmentcharge relating to the intangible assets and lower operating expenses as aresult of headcount reductions.

 

##### **Liquidity and CapitalResources**

 

Since inception, the Company has utilized theproceeds from a number of public and private sales of its equity securities,the exercise of options and warrants and more recently, convertible debt andshort-term bridge loans from stockholders to meet its working capitalrequirements. At December 31, 2002, the Company had a working capital deficitof $13,387,952.

 

The Company’s operations continued togenerate losses in 2002. The Company’s cash increased $33,249 during 2002 withoperating activities using $3,233,158 of cash. The Company funded operationsprimarily through borrowings from the Amphion Group with financing activitiesproviding net cash of $3,397,739. No assurance can be given that suchaffiliates will continue to provide funding to the Company.  The Company’s business plan for 2003 ispredicated principally upon the successful marketing of its RFID and digitalvideo products. The Company anticipates that its existing working capitalresources and revenues from operations will not be adequate to satisfy itsfunding requirements in 2003.

 

The Company’s working capital requirementswill depend upon many factors, including the extent and timing of the Company’sproduct sales, the Company’s operating results, the status of competitiveproducts, and actual expenditures and revenues compared to its business plan.The Company is currently experiencing declining liquidity, including negativeworking capital balances, losses from operations and negative cash flows, whichmakes it difficult for the Company to meet its current

 

18

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cash requirements, including payments tovendors, and may jeopardize the Company’s ability to continue as a goingconcern. The Company intends to address its liquidity problems by controllingcosts, seeking additional funding (through capital raising transactions andbusiness alliances) and maintaining focus on revenues and collections.

 

Our auditors have included an explanatoryparagraph in their audit opinion with respect to our consolidated financialstatements at December 31, 2002. The paragraph states that our recurring lossesfrom operations and resulting continued dependence on access to externalfinancing raise substantial doubts about our ability to continue as a goingconcern. Furthermore, the factors leading to and the existence of theexplanatory paragraph may adversely affect our relationship with customers andsuppliers and have an adverse effect on our ability to obtain financing.

 

The Company’s business plan for 2003 ispredicated principally upon the successful marketing of its RFID products andthe digital video products. The Company anticipates that its existing workingcapital resources and revenues from operations will not be adequate to satisfyits funding requirements in 2003.

 

If the Company’s losses continue, the Companywill have to obtain funds to meet its cash requirements through business alliances,such as strategic or financial transactions with third parties, the sale ofsecurities or other financing arrangements, or the Company may be required tocurtail its operations, seek a merger partner, or seek protection under federalbankruptcy laws. Any of the foregoing may be on terms that are unfavorable tothe Company or disadvantageous to existing stockholders. In addition, noassurance may be given that the Company will be successful in raisingadditional funds or entering into business alliances.

 

During the first quarter of 2003 the Companyhas closed an additional $305,000 from accredited investors under a convertiblenote agreement similar to the one it closed in July 2002.

 

The Company is the holder of a note due fromthe Amphion Group in the principal amount of $3,902,375, plus accrued interestin the amount of $809,540. In 2001, the Amphion Group converted shares ofvarious series of non-voting preferred stock of the Company into voting commonstock. See “Item 5. Market for Common Equity and Related Stockholder Matters —Recent Sale of Unregistered Securities.” As a result of the Amphion Group’sconversions, the Amphion Group’s ownership of outstanding voting stock of theCompany increased from 40.1% to 82.6%. As of December 31, 2002 the AmphionGroup ownership percent is 81%.  Inaddition, the Amphion Group made no principal payments on this note in 2001 or2002 and there is uncertainty regarding when the note will be paid.Consequently, the Company reclassified the note on the Company’s balance sheetfrom assets to stockholders’ equity. This reclassification reduced theCompany’s total assets, as stated on the December 31, 2001 balance sheet, from$7,485,546 to $2,773,631 and increased total stockholders’ deficit from$3,213,583 to $7,925,498.  This note wasto have matured on September 30, 2002; the note is currently in default.

 

##### **Recent AccountingPronouncements**

 

In June 2001, the Financial AccountingStandards Board (“FASB”) issued Statements of Financial Accounting StandardsNo. 141, Business Combinations, and No. 142, Goodwill and Other IntangibleAssets, (“FAS 142”), effective for fiscal years beginning after December 15,2001. Under the new rules, goodwill and intangible assets deemed to haveindefinite lives will no longer be amortized, but will be subject to annualimpairment tests in accordance with the Statements. Other intangible assetswill continue to be amortized over their useful lives. The Company began toapply the new rules on accounting for other intangible assets beginning in thefirst quarter of 2002. The Company’s intangible assets at December 31, 2002will continue to be amortized under FAS 142. Accordingly, adopting FAS 142 didnot have a material effect on the Company’s financial condition or results ofoperation.

 

The FASB has also recently issued FAS No.144, Accounting for the Impairment or Disposal of Long-Lived Assets (“FAS144”), which we adopted January 1, 2002. The FASB’s new rules on assetimpairment supersede FAS No. 121, Accounting for the Impairment of Long-LivedAssets and for Long-Lived Assets to Be Disposed Of (“FAS 121”). FAS 144 retainsthe requirements of FAS 121 to (a) recognize an impairment loss only if thecarrying amount of a long-lived asset is not recoverable from its undiscountedcash flows and (b) measure an impairment loss as the difference between thecarrying amount and fair value of the asset, but removes goodwill from itsscope. This aspect of FAS 144 will primarily impact the accounting forintangible assets subject to amortization and property and equipment. Theadoption of FAS 144 did not have a significant impact on the Company’sfinancial condition or results of operations

 

In July 2002, the FASB issued Statement of Financial AccountingStandards No. 146, *Accounting for CostsAssociated with Exit or Disposal Activities* (SFAS No. 146). SFAS 146nullifies FASB Emerging Issues Task Force (EITF) Issue No. 94-3, “LiabilityRecognition for Certain Employee Termination Benefits and Other Costs to Exitan Activity (including Certain Costs Incurred in a Restructuring)”. It requiresthat a liability be recognized for those costs only when the liability isincurred, that is, when it meets the definition of a liability in the FASB’sconceptual framework. SFAS No. 146 also establishes fair value as the objectivefor initial measurement of liabilities related to exit or disposal activities.SFAS 146 is effective for exit or disposal activities that are initiated afterDecember 31, 2002, with earlier adoption encouraged. The Company does notexpect that the adoption of SFAS 146 will have a material impact on itsfinancial position or results from operations.

 

19

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In December 2002, the FASB issued Statementof Financial Accounting Standards 148, *Accountingfor Stock-Based Compensation - Transition and Disclosure - an amendment of FASBStatement 123* (“SFAS 148”). For entities that change their accounting for stock-based compensationfrom the intrinsic method to the fair value method under SFAS 123, the fair valuemethod is to be applied prospectively to those awards granted after thebeginning of the period of adoption (the prospective method).  The amendment permits two additionaltransition methods for adoption of the fair value method.  In addition to the prospective method, theentity can choose to either (i) restate all periods presented (retroactiverestatement method) or (ii) recognize compensation cost from the beginning ofthe fiscal year of adoption as if the fair value method had been used toaccount for awards (modified prospective method).  For fiscal years beginning after December 15, 2003, theprospective method will no longer be allowed. The Company currently accounts for its stock-based compensation usingthe intrinsic value method as proscribed by APB No. 25, Accounting for StockIssued to Employees, and plans to continue using this method to account forstock options.  Therefore, it does notintend to adopt the transition requirements as specified in SFAS 148.

##### ** **

##### **Critical Accounting Policies**

 

In preparing our consolidated financialstatements in conformity with accounting principles generally accepted in theUnited States, we must make a variety of estimates that affect the reportedamounts and related disclosures. The following accounting policies arecurrently considered most critical to the preparation of our financialstatements. If actual results differ significantly from management’s estimatesand projections, there could be a material effect on our financial statements.

** **

**Allowance forDoubtful Accounts**

 

The Company continually evaluates thecreditworthiness of its customers’ financial condition and generally does notrequire collateral. The Company evaluates the collectability of its accountsbased on a combination of factors. In circumstances where the Company is awareof a specific customer’s inability to meet its financial obligations to us, theCompany records a specific reserve for bad debts against amounts due. TheCompany has not experienced significant losses on uncollectible accounts receivable.

** **

**InventoryValuation**

 

Inventories are stated at the lower ofstandard cost, which approximates actual cost determined on a first-in,first-out basis, or estimated realized value. Adjustments to reduce inventoriesto estimated realizable value, including allowances for excess and obsoleteinventories, are determined quarterly by comparing inventory levels ofindividual materials and parts to historical usage rates, current backlog andestimated future sales. Actual amounts realized upon the sale of inventoriesmay differ from estimates used to determine inventory valuation allowances dueto changes in customer demand, technology changes and other factors.

** **

**Impairment ofLong-Lived Assets and Long-Lived Assets to Be Disposed Of**

 

Long-lived assets and identifiable intangibleassets are reviewed for impairment whenever events or changes in circumstancesindicate that the carrying amount of an asset may not be recoverable.Recoverability of assets to be held and used is measured by a comparison of thecarrying amount of an asset to future net cash flows expected to be generatedby the asset. If such assets are considered to be impaired, the impairment tobe recognized is measured by the amount by which the carrying amount of theasset exceeds the fair value of the assets based on estimated future cashflows. Assets to be disposed of are reported at the lower of the carryingamount or fair value less costs to sell. Revenues from the sale of productsutilizing the Company’s purchased technologies have grown slowly and theCompany recorded an impairment charge of $2,797,063 in the fourth quarter of2001, representing the amount by which the carrying amount of the intangibleassets exceeded their estimated fair values. The Company believes thatassumptions made in projecting future cash flows for this evaluation arereasonable. However, if future actual results do not meet our expectation, theCompany may be required to record an additional impairment charge, the amountof which could be material to the results of its operations and financialposition.

 

**RevenueRecognition and Warranty Costs**

 

The Company recognizes revenue on sales ofits products when the products are shipped from the Company. Company policydoes not allow customers to return products for credit. The Company currentlyprovides a one-year warranty on all products. Provision is made at the time therelated revenue is recognized for estimated product repair costs.

** **

**Deferral TaxValuation Allowance**

 

Deferred tax assets and liabilities arerecognized for the future tax consequences attributable to differences betweenthe financial statements carrying amounts of existing assets and liabilitiesand their respective tax bases. Deferred tax assets and liabilities aremeasured using enacted tax rates expected to apply to taxable income in theyears in which those temporary differences are expected to be recovered orsettled. Valuation allowances are established when necessary to reduce deferredtax assets to the amount more likely than not to be realized. Income taxexpense is the total of tax payable for the period and the change during theperiod in deferred tax assets and liabilities.

 

20

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##### **Other**

* *

*Inflation.* Inflation has not had and is not expected tohave a material impact on the operations and financial condition of theCompany.

* *

*Seasonality.* Seasonality has not had and is not expected tohave a material impact on the operations and financial condition of theCompany.

 

**Item 7. FINANCIAL STATEMENTS.**

 
| Report of Hein + Associates LLP,  Independent Auditors                                                |
|-------------------------------------------------------------------------------------------------------|
| Report of Ernst & Young LLP,  Independent Auditors                                                |
|                                                                                                  |
| Consolidated Financial Statements:                                                                    |
|                                                                                                  |
| Consolidated Balance Sheets at December 31, 2002 and 2001                                             |
| Consolidated Statements of Operations for  the Years Ended December 31, 2002 and 2001                 |
| Consolidated Statements of Stockholders’  Deficit for the Years Ended December 31, 2002 and 2001 |
| Consolidated Statements of Cash Flows for  the Years Ended December 31, 2002 and 2001                 |
| Notes to Financial Statements                                                                         |

 

**Item 8. CHANGES IN AND DISAGREEMENTS**WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

 

At a meeting held on October 10, 2002, the Board of Directors of theCompany approved the engagement of Hein + Associates LLP as its independentauditors for the fiscal year ending December 31, 2002 to replace the firm ofErnst & Young LLP, who resigned as auditors of the Company effectiveOctober 10, 2002. The audit committee of the Board of Directors approved thechange in auditors on October 10, 2002 subject to approval of shareholders.

 

The reports of Ernst & Young LLP on the Company’s financialstatements for the past two fiscal years did not contain an adverse opinion ora disclaimer of opinion and were not qualified or modified as to uncertainty,audit scope, or accounting principles, except that the reports of the financialstatements as of and for the year ended December 31, 2001 and 2000 included anexplanatory paragraph expressing substantial doubt regarding the Company’sability to continue as a going concern.

 

In connection with the audits of the Company’s financial statements foreach of the two fiscal years ended December 31, 2001 and 2000, and in thesubsequent interim periods, there were no disagreements with Ernst & YoungLLP on any matters of accounting principles or practices, financial statementdisclosure, or auditing scope and procedures which, if not resolved to thesatisfaction of Ernst & Young LLP would have caused Ernst & Young LLPto make reference to the matter in their report.   The Company requested Ernst & Young LLP to furnish it a letteraddressed to the Commission stating whether it agrees with the abovestatements. A copy of that letter, dated October 10, 2002 was filed as Exhibit1 to the Form 8-K filed by the Company on October 15, 2002.

 

There were no reportable events of the type described in Item304(a)(1)(iv) of Regulation S-B.

 

21

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**PART III**

 

**Item9****. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.**

 

The information regarding Directors,Executive Officers, Promoters and Control Persons is incorporated by referencein this Form 10-KSB to the sections entitled “Principal Shareholders,”“Management,” and “General” in the Company’s Proxy Statement to be filed withthe Commission in connection with the Annual Meeting of Stockholders to be heldon June 24, 2003.

 

**Item 10**.EXECUTIVE COMPENSATION.

 

The information required by this item isincorporated by reference in this Form 10-KSB to the section entitled“Management” in the Company’s Proxy Statement.

 

**Item 11**.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

 

The information required by this item isincorporated by reference in this Form 10-KSB to the sections entitled“Principal Shareholders” and “Management” in the Company’s Proxy Statement.

 

**Item 12.** CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS.

 

The information required by this item isincorporated by reference in this Form 10-KSB to the section entitled“Management” in the Company’s Proxy Statement.

 

22

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**Item13****. EXHIBITS AND REPORTS ON FORM 8-K.**

 

(a) Exhibits

 
| **Exhibit  Number** |   | **Description**                                                                                                                                                                                                                                                                              |
|---------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                                                                                                                                                         |
| 3.1                 |   | —Certificate of Incorporation of the  Company. Incorporated herein by reference to Exhibit 3.1 to the Company’s  Registration Statement on Form S-1 (Registration No. 2-80946).                                                                                                    |
|                |   |                                                                                                                                                                                                                                                                                         |
| 3.2                 |   | —By-laws of the Company. Incorporated  herein by reference to Exhibit 3.2 to the Company’s Registration Statement on  Form S-1 (Registration No. 2-80946).                                                                                                                         |
|                |   |                                                                                                                                                                                                                                                                                         |
| 3.3                 |   | —First Amendment to Certificate of  Incorporation of the Company dated June 6, 1986. Incorporated herein by  reference to Exhibit 3.3 to the Company’s Annual Report on Form 10-KSB for  the year ended December 31, 1987.                                                         |
|                |   |                                                                                                                                                                                                                                                                                         |
| 3.4                 |   | —Second Amendment to Certificate of  Incorporation of the Company dated May 27, 1987. Incorporated herein by  reference to Exhibit 3.4 to the Company’s Annual Report on Form 10-KSB for  the year ended December 31, 1987.                                                        |
|                |   |                                                                                                                                                                                                                                                                                         |
| 3.5                 |   | —Third Amendment to Certificate of  Incorporation of the Company dated November 11, 1994. Incorporated herein by  reference to Exhibit 4.4 to the Company’s Registration Statement on Form S-3  (Registration No. 333-10665).                                                      |
|                |   |                                                                                                                                                                                                                                                                                         |
| 3.6                 |   | —Fourth Amendment to Certificate of  Incorporation of the Company dated July 28, 1995. Incorporated herein by  reference to Exhibit 4.5 to the Company’s Registration Statement on Form S-3  (Registration No. 333-10665).                                                         |
|                |   |                                                                                                                                                                                                                                                                                         |
| 3.7                 |   | —Fifth Amendment to Certificate of  Incorporation of the Company dated June 25, 1997. Incorporated herein by  reference to Exhibit 4.6 to the Company’s Registration Statement on Form S-3  (Registration No. 333-10665).                                                          |
|                |   |                                                                                                                                                                                                                                                                                         |
| 3.8                 |   | —Sixth Amendment to Certificate of  Incorporation of the Company dated March 31, 1998. Incorporated herein by  reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K dated  April 13, 1998.                                                                        |
|                |   |                                                                                                                                                                                                                                                                                         |
| 3.9                 |   | —Seventh Amendment to Certificate of  Incorporation of the Company dated March 31, 1998. Incorporated herein by  reference to Exhibit 99.2 to the Company’s Current Report on Form 8-K dated  April 13, 1998.                                                                      |
|                |   |                                                                                                                                                                                                                                                                                         |
| 3.10                |   | —Eighth Amendment to Certificate of  Incorporation of the Company dated April 9, 1998. Incorporated herein by  reference to Exhibit 99.3 to the Company’s Current Report on Form 8-K dated  April 13, 1998.                                                                        |
|                |   |                                                                                                                                                                                                                                                                                         |
| 3.11                |   | —Ninth Amendment to Certificate of  Incorporation of the Company dated June 9, 1999. Incorporated herein by  reference to Exhibit 3.11 to the Company’s Annual Report on Form 10-KSB for  the year ended December 31, 1999.                                                        |
|                |   |                                                                                                                                                                                                                                                                                         |
| 3.12                |   | —Certificate of Amendment of Certificate of  Incorporation of the Company dated June 6, 2000. Incorporated herein by  reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-QSB for  the period ended June 30, 2000.                                               |
|                |   |                                                                                                                                                                                                                                                                                         |
| 3.13                |   | —Certificate for Renewal and Revival of  Charter dated April 10, 2003.*                                                                                                                                                                                                                 |
|                |   |                                                                                                                                                                                                                                                                                         |
| 4.1                 |   | —Certificate of Designation of the  Company’s Series A, B and C Preferred Stock, dated December 27, 1995.  Incorporated herein by reference to Exhibit 4.7 to the Company’s Registration  Statement on Form S-3 (Registration No. 333-10665).                                 |
|                |   |                                                                                                                                                                                                                                                                                         |
| 4.2                 |   | —Certificate of Designation of the  Company’s Series I Preferred Stock. Incorporated herein by reference to  Exhibit 4.2 to the Company’s Annual Report on Form 10-KSB for the year ended  December 31, 1998.                                                                 |
|                |   |                                                                                                                                                                                                                                                                                         |
| 4.3                 |   | —Certificate of Designation of the  Company’s Series J Preferred Stock. Incorporated herein by reference to  Exhibit 4.3 to the Company’s Annual Report on Form 10-KSB for the year ended  December 31, 1998.                                                                 |
|                |   |                                                                                                                                                                                                                                                                                         |
| 4.4                 |   | —Certificate of Designation of the  Company’s Series 1999 Preferred Stock. Incorporated herein by reference to  Exhibit 4.4 to the Company’s Quarterly Report on Form 10-QSB for the period  ended June 30, 1999.                                                             |
|                |   |                                                                                                                                                                                                                                                                                         |
| 4.5                 |   | —Certificate of Designation of the  Company’s Series 1999 Non-Voting Preferred Stock. Incorporated herein by  reference to Exhibit 4.5 to the Company’s Quarterly Report on Form 10-QSB for  the period ended June 30, 1999.                                                  |
|                |   |                                                                                                                                                                                                                                                                                         |
| 4.6                 |   | —Certificate of Designation of the  Company’s Series 2000 Non-Voting Preferred Stock. Incorporated herein by  reference to Exhibit 4.6 to the Company’s Annual Report on Form 10-KSB for  the year ended December 31, 1999.                                                   |
|                |   |                                                                                                                                                                                                                                                                                         |
| 10.1                |   | —1991 Incentive Stock Option Plan, dated  August 14, 1991. Incorporated herein by reference to Exhibit 10.10 to  Lasertechnics’ Annual Report on Form 10-KSB for the year ended December 31,  1991. +                                                                              |
|                |   |                                                                                                                                                                                                                                                                                         |
| 10.2                |   | —Purchase of common stock and Convertible  Note Agreement between the Company and J. P. Morgan Investment Corporation,  dated July 8, 1994. Incorporated herein by reference to Exhibit 10.19 to the  Company’s Annual Report on Form 10-KSB for the year ended December 31, 1994. |

 

23

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| 10.3   |   | —Note Purchase Agreement dated June 25,  1997, by and among the Company, J. P. Morgan Investment Corporation and  Wolfensohn Associates L.P. Incorporated by reference to Exhibit 10.15 to the  Company’s Quarterly Report on Form 10-QSB for the period ended September 30,  1997.                                              |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.4   |   | —Amendment to Notes and Note Purchase  Agreement dated December 31, 1998, by and among the Company, Antiope Partners  L.L.C. and J. P. Morgan Investment Corporation. Incorporated herein by  reference to Exhibit 10.16 to Amendment No. 1 to the Company’s Annual Report  on Form 10-KSB for the year ended December 31, 1997. |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.5   |   | —Series H Preferred Stock Purchase  Agreement dated December 29, 1997, by and among the Company and Amphion  Ventures L.P. Incorporated herein by reference to Exhibit 10.17 to Amendment  No. 1 to the Company’s Annual Report on Form 10-KSB for the 10.1 year ended  December 31, 1997.                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.6   |   | —Preferred Stock Purchase Agreement dated  October 21, 1998 by and between the Company and Amphion Ventures L.P.  Incorporated herein by reference to Exhibit 10.8 to the Company’s Annual  Report on Form 10-KSB for the year ended December 31, 1998.                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.7   |   | —Form of Warrant to purchase shares of the  Company’s common stock issued to Antiope Partners L.L.C. and Amphion Ventures  L.P. Incorporated herein by reference to Exhibit 10.20 to Amendment No. 1 to  the Company’s Annual Report on Form 10-KSB for the year ended December 31,  1997.                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.8   |   | —Settlement Agreement dated as of April 21,  1998, by and between the Company and Xerox Corporation. Incorporated herein  by reference to Exhibit 10.21 to Amendment No. 1 to the Company’s Annual  Report on Form 10-KSB for the year ended December 31, 1997.                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.9   |   | —Note Payable Conversion Agreement dated  December 31, 1998, by and between the Company and Amphion Ventures L.P.  Incorporated herein by reference to Exhibit 10.12 to the Company’s Annual  Report on Form 10-KSB for the year ended December 31, 1998.                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.10  |   | —Note Payable Conversion Agreement dated  December 31, 1998, by and between the Company and Antiope Partners L.L.C.  Incorporated herein by reference to Exhibit 10.13 to the Company’s Annual  Report on Form 10-KSB for the year ended December 31, 1998.                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.11  |   | —Note Payable Conversion Agreement dated  December 31, 1998, by and between the Company and J. P. Morgan Investment  Corporation. Incorporated herein by reference to Exhibit 10.14 to the  Company’s Annual Report on Form 10-KSB for the year ended December 31, 1998.                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.12  |   | —Stock and Asset Purchase Agreement dated  March 30, 1999, by and between the Company and Amphion Ventures L.P.  Incorporated herein by reference to Exhibit 10.15 to the Company’s Annual  Report on Form 10-KSB for the year ended December 31, 1998.                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.13  |   | —Asset Purchase Agreement dated July 15,  1999, by and between the Company and Prism Video, Inc. Incorporated herein by  reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K dated  July 28, 1999.                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.14  |   | —Convertible Note Payable dated September  30, 1999, executed by the Company payable to Amphion Ventures L.P. in the  stated principal amount of up to $6,000,000. Incorporated herein by reference  to Exhibit 10.12 to the Company’s Quarterly Report Form 10-QSB for the period  ended September 30, 1999.                    |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.15  |   | —Form of Dividend Conversion Agreement by  and between the Company and Amphion Ventures L.P. and Jackson Hole Management  Co. Incorporated herein by reference to Exhibit 10.13 to the Company’s  Quarterly Report on Form 10-QSB for the period ended September 30, 1999.                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.16  |   | —Registration Rights Agreement dated  September 30, 1999 by and between the Company and Amphion Ventures L.P.  Incorporated herein by reference to Exhibit 10.14 to the Company’s Quarterly  Report on Form 10-QSB for the period ended September 30, 1999.                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.17  |   | —Letter Agreement dated December 30, 1999,  by and between the Company and Amphion Ventures L.P. regarding the  Convertible Note Payable dated September 30, 1999. Incorporated herein by  reference to Exhibit 10.17 to the Company’s Annual Report on Form 10-KSB for  the year ended December 31, 1999.                       |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.18  |   | —Non-Voting Common Stock Purchase Warrant  dated September 30, 1999, to purchase 180,362 shares of the Company’s  non-voting common stock, issued to Amphion Ventures L.P. Incorporated herein  by reference to Exhibit 10.18 to the Company’s Annual Report on Form 10-KSB  for the year ended December 31, 1999.          |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.19  |   | —Employment Agreement dated July 16, 1999,  by and between the Company and Allan Griebenow. Incorporated herein by  reference to Exhibit 10.19 to the Company’s Annual Report on Form 10-KSB for  the year ended December 31, 1999. +                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.20  |   | —AXCESS Inc. Stock Option Plan.  Incorporated herein by reference to Exhibit 4.1 to the Company’s Registration  Statement on Form S-8 (Registration No. 333-80857). +                                                                                                                                                       |

 

24

----

 
| 10.21  |   | —AXCESS Inc. Director Compensation Plan.  Incorporated herein by reference to Exhibit 4.1 to the Company’s Registration  Statement on Form S-8 (Registration No. 333-80843). +                                                                                                                                                                                                           |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.22  |   | —Stock Purchase Agreement dated March 29,  2000, by and between the Company and incuVest LLC. Incorporated herein by  reference to Exhibit 10.22 to the Company’s Annual Report on Form 10-KSB for  the year ended December 31, 1999.                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.23  |   | —AXCESS Inc. Non-Employee Directors’ Stock  Option Plan. Incorporated herein by reference to Exhibit 4. (a) to the  Company’s Registration Statement on Form S-8 (Registration No. 333-98160). +                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.24  |   | —Amendment No. 1 to the AXCESS Inc. 1991  Incentive Stock Option Plan dated April 26, 2000. Incorporated herein by  reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-QSB  for the period ended June 30, 2000. +                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.25  |   | —Commitment letter dated August 16, 2000,  from incuVest LLC regarding the purchase of 500 shares of Series 2000A  Preferred Stock. Incorporated herein by reference to Exhibit 10.2 to the  Company’s Quarterly Report on Form 10-QSB for the period ended September 30,  2000.                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.26  |   | —Demand Note dated as of September 14,  2000, executed by the Company payable to incuVest LLC in the principal amount  of $400,000. Incorporated herein by reference to Exhibit 10.1 to the  Company’s Quarterly Report on Form 10-QSB for the period ended September 30,  2000.                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.27  |   | —Senior Promissory Note dated December 14,  2000, executed by the Company payable to J.P. Morgan Investment Corporation,  in the principal amount of $400,000. Incorporated herein by reference to  Exhibit 10.27 to the Company’s Annual Report on Form 10-KSB for the year  ended December 31, 2000.                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.28  |   | —Voting Common Stock Purchase Warrant dated  December 14, 2000, to purchase 8,000 shares of the Company’s voting common  stock, issued to J.P. Morgan Investment Corporation. Incorporated herein by  reference to Exhibit 10.28 to the Company’s Annual Report on Form 10-KSB for  the year ended December 31, 2000.                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.29  |   | —Letter dated December 26, 2000, from  incuVest LLC regarding conversion of the Demand Note dated September 14,  2000, executed by the Company payable to incuVest LLC. in the principal  amount of $400,000. Incorporated herein by reference to Exhibit 10.29 to the  Company’s Annual Report on Form 10-KSB for the year ended December 31, 2000.                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.30  |   | —Letter dated December 29, 2000, from  Amphion Ventures, LP to the Company regarding Series A, B, and C Preferred  Stock Dividends. Incorporated herein by reference to Exhibit 10.30 to the  Company’s Annual Report on Form 10-KSB for the year ended December 31, 2000.                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.31  |   | —Letter dated December 29, 2000, from  Jackson Hole Management Co. to the Company regarding Series C Preferred Stock  Dividends. Incorporated herein by reference to Exhibit 10.31 to the Company’s  Annual Report on Form 10-KSB for the year ended December 31, 2000.                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.32  |   | —Demand Note dated as of January 12, 2001, executed  by the Company payable to incuVest LLC in the principal amount of $264,000.  Incorporated herein by reference to Exhibit 10.32 to the Company’s Annual  Report on Form 10-KSB for the year ended December 31, 2000.                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.33  |   | —Amended Schedule of Advances to the Demand  Note dated as of January 12, 2001, executed by the Company payable to  incuVest LLC in the principal amount of $264,000.                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.34  |   | —Subordinated Promissory Note dated April  30, 1999 executed by Amphion Ventures L.P. payable to the Company, in the  principal amount of $4,000,000. Incorporated herein by reference to Exhibit  10.33 to the Company’s Annual Report on Form 10-KSB for the year ended  December 31, 2000.                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.35  |   | —Security Agreement dated April 30, 1999 by  Amphion Ventures L.P. in favor of the Company regarding the Stock and Asset  Purchase Agreement dated March 30, 1999 by and among Amphion Ventures L.P.,  Antiope Partners, L.L.C. and the Company. Incorporated herein by reference to  Exhibit 10.34 to the Company’s Annual Report on Form 10-KSB for the year  ended December 31, 2000. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.36  |   | —Notice of Assignment dated July 28, 1999  from the Company to Amphion Ventures, L.P. regarding the April 30, 1999  Purchase Note executed by Amphion Ventures L.P. Incorporated herein by  reference to Exhibit 10.35 to the Company’s Annual Report on Form 10-KSB for  the year ended December 31, 2000.                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.37  |   | —Security Agreement dated July 28, 1999  among the Company and Prism Video, Inc. regarding the Subordinated Promissory  Note dated as of April 30, 1999 executed by Amphion Ventures L.P. payable to  the Company. Incorporated herein by reference to Exhibit 10.36 to the  Company’s Annual Report on Form 10-KSB for the year ended December 31, 2000.                                |

 

25

----

 
| 10.38  |   | —Purchase Note dated July 28, 1999 executed  by the Company payable to Prism Video, Inc. and BIL Far East Holdings  Limited, in the principal amount of $4,000,000. Incorporated herein by  reference to Exhibit 10.37 to the Company’s Annual Report on Form 10-KSB for  the year ended December 31, 2000.                                                             |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.39  |   | —Demand Note dated as of November 14, 2001,  executed by the Company payable to Amphion Ventures, L.P. in the principal  amount of $200,000.                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.40  |   | —Amended Schedule of Advances to the Demand  Note dated as of November 14, 2001, executed by the Company payable to  Amphion Ventures, L.P. in the principal amount of $200,000.                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.41  |   | —AXCESS Inc. 2001 Incentive Plan.  Incorporated herein by reference to Exhibit 10.2 to the Company’s Quarterly  Report on Form 10-QSB for the quarter ended June 30, 2001.                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.42  |   | —Demand note dated as of January 25, 2002,  executed by the Company payable to Amphion Investments, LLC in the principal  amount of $200,000 (plus additional amounts shown on the schedule of advances  to the note).  Incorporated herein by  reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-QSB  for the quarter ended June 30, 2002.   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.43  |   | —Demand note dated as of February 14, 2002,  executed by the Company payable to VennWorks, LLC in the principal amount of  $150,000 (plus additional amounts shown on the schedule of advances to the  note).  Incorporated herein by  reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-QSB for  the quarter ended June 30, 2002.            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.44  |   | —Demand note dated as of February 28, 2002,  executed by the Company payable to Amphion Ventures, LP in the principal  amount of $150,000 (plus additional amounts shown on the schedule of advances  to the note).  Incorporated herein by  reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-QSB  for the quarter ended September 30, 2002. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.45  |   | —Form of Bridge Financing Agreement, dated  as of July 30, 2002, between the Company and certain investors.  Incorporated herein by reference to  Exhibit 10.4 to the Company’s Quarterly Report on Form 10-QSB for the quarter  ended June 30, 2002.                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.46  |   | —Voting Common Stock Purchase Warrant,  Dated July 5, 2002, issued to J.P. Morgan Investment Corporation, for the  purchase of 10,000 Shares of voting common stock.  Incorporated herein by reference to Exhibit 10.5 to the  Company’s Quarterly Report on Form 10-QSB for the quarter ended June 30,  2002.                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.47  |   | —Senior Promissory Note, dated April 12,  2002, executed by the Company payable to J.P. Morgan Investment Corporation  in the principal amount of $400,000.   Incorporated herein by reference to Exhibit 10.6 to the Company’s  Quarterly Report on Form 10-QSB for the quarter ended June 30, 2002.                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 13.3   |   | —Certificate for Renewal and Revival of  Corporate Charter dated April 10, 2003.*                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 21.1   |   | —Subsidiaries of the Company.*                                                                                                                                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 23.1   |   | —Consent of Hein & Associates LLP.*                                                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 23.2   |   | —Consent of Ernst & Young LLP.*                                                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 99.1   |   | —906 Certification                                                                                                                                                                                                                                                                                                                                                           |

 

----

*                                 Filed herewith

+                                 Denotes management contract or compensatory plan.

 

(b) Reports on Form 8-K. None.

 

26

----

 

**Item 14. CONTROLS AND PROCEDURES**

 

**Controls and Procedures**

 

(a)           Evaluation ofDisclosure Controls and Procedures. Based on their evaluation as of a date within 90 days of the filing dateof this Annual Report on Form 10-KSB, the Company’s principal executive officerand principal financial officer have concluded that the Company’s disclosurecontrols and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under theSecurities Exchange Act of 1934 (the “Exchange Act”)) are effective to ensurethat information required to be disclosed by the Company in reports that itfiles or submits under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the rules and forms of theSecurities and Exchange Commission.

 

(b)           Changes inInternal Controls.  There were nosignificant changes in the Company’s internal controls or in other factors thatcould significantly affect these controls subsequent to the date of theirevaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

27

----

 

**SIGNATURES**

 

In accordance with Section 13 or 15(d) of theExchange Act, the registrant has caused this report to be signed on its behalfby the undersigned, thereunto duly authorized, on the 15th day of April 2003.

 

 
|   | AXCESS INTERNATIONAL INC.                   |
|--------|---------------------------------------------|
|   |                                        |
|   |                                        |
|   | By:                                         | /s/ Richard C.E. Morgan |   |
|   | Richard C.E.  Morgan, Chairman of the Board |

 

In accordance with the Exchange Act, thisreport has been signed by the following persons on behalf of the registrant andin the capacities indicated, on the      th day ofMarch 2003.

 
| **Signature**            |   | **Capacity**                                  |
|--------------------------|--------|-----------------------------------------------|
|                     |   |                                          |
| /s/ Richard C.E. Morgan  |   |                                          | Chairman of the Board |
| Richard C.E.  Morgan     |   |                                          |
|                     |   |                                          |
| /s/ Allan Griebenow      |   |                                          | Director, President and Chief Executive  Officer |
| Allan  Griebenow         |   | (Principal Executive Officer)                 |
|                     |   |                                          |
| /s/ Allan L. Frank       |   |                                          | Chief Financial Officer |
| Allan L. Frank           |   | (Principal Accounting and Financial  Officer) |
|                     |   |                                          |
| /s/ Paul J. Coleman, Jr. |   |                                          | Director |
| Paul J.  Coleman, Jr.    |   |                                          |
|                     |   |                                          |
| /s/ Robert J. Bertoldi   |   |                                          | Director |
| Robert J.  Bertoldi      |   |                                          |
|                     |   |                                          |
| /s/ Robert F. Hussey     |   |                                          | Director |
| Robert F.  Hussey        |   |                                          |

 

28

----

 

CERTIFICATIONS

 

I, Allan Griebenow, certify that:

 

1.               I have reviewed this annual report on Form 10-KSB of Axcess International Inc.;

2.               Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.               Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.               The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rule 13a-14 and 15d-14) for the registrant and we have:

a)              designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidating subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report was prepared;

b)             evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report  (the  “Evaluation Date”); and

c)              presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on the required evaluation as of the Evaluation Date;

5.               The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the   registrant’s auditors and the audit committee of registrant’s board of directors  (or persons performing the equivalent function):

a)              all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b)             any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.               The registrant’s other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 
| Date:  | April 15, 2003                                         |
|--------|--------------------------------------------------------|
|   |                                                   |
|   |                                                   |
|   | /s/ ALLAN GRIEBENOW                                    |   |
|   | Allan Griebenow, President and Chief Executive Officer |
|   | (Principal Executive Officer)                          |

 

29

----

 

**CERTIFICATIONS**

 

I, Allan Frank, certify that:

 

1.               I have reviewed this annual report on Form 10-KSB of Axcess International Inc.;

2.               Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.               Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.               The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rule 13a-14 and 15d-14) for the registrant and we have:

a)              designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidating subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report was prepared;

b)             evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report  (the  “Evaluation Date”); and

c)              presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on the required evaluation as of the Evaluation Date;

5.               The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the   registrant’s auditors and the audit committee of registrant’s board of directors  (or persons performing the equivalent function):

a)              all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b)             any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.               The registrant’s other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 
| Date:  | April 15, 2003                                                        |
|--------|-----------------------------------------------------------------------|
|   |                                                                  |
|   |                                                                  |
|   | /s/ ALLAN L. FRANK                                                    |   |
|   | Allan L. Frank, Vice President, Chief Financial Officer and Secretary |
|   | (Principal Accounting and Financial Officer)                          |

 

30

----

 

FINANCIAL SECTION OF THE 2002 FORM 10-KSB

 

31

----

 

REPORT OF HEIN + ASSOCIATES LLP, INDEPENDENT AUDITORS

 

The Board of Directors and StockholdersAXCESS Inc.

 

We have audited the accompanying consolidatedbalance sheet of AXCESS Inc. (the Company) as of December 31, 2002 and therelated consolidated statements of operations, stockholders’ equity (deficit)and cash flows for the year then ended. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audit.

 

We conducted our audit in accordance withauditing standards generally accepted in the United States of America. Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, the financial statementsreferred to above present fairly, in all material respects, the financialposition of AXCESS Inc., at December 31, 2002, and the results of itsoperations and cash flows for the year then ended in conformity with accountingprinciples generally accepted in the United States of America.

 

The accompanying consolidated financialstatements have been prepared assuming that the Company will continue as agoing concern. As discussed in Note 2 to the consolidated financial statements,the Company’s working capital deficiency and recurring losses from operationsand resulting continued dependence upon access to additional external financingraise substantial doubt about its ability to continue as a going concern.  If the Company is unable to generateprofitable operations or raise additional capital it may be forced to seekprotection under federal bankruptcy laws. Management’s plans in regard to these matters are also described in Note2. The consolidated financial statements do not include any adjustments thatmight result from the outcome of this uncertainty.

 

 
| /s/ HEIN + ASSOCIATES LLP |   |
|---------------------------|--------|
|                      |
| March 6, 2003             |
| Dallas, Texas             |

 

F-1

----

 

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

 

The Board of Directors and StockholdersAXCESS Inc.

 

We have audited the accompanying consolidatedbalance sheet of AXCESS Inc. (the Company) as of December 31, 2001, and therelated consolidated statements of operations, stockholders’ equity and cashflows for the year then ended. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audit.

 

We conducted our audit in accordance withauditing standards generally accepted in the United States. Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audit provides a reasonable basis for our opinion.

 

In our opinion, the financial statementsreferred to above present fairly, in all material respects, the financialposition of AXCESS Inc., at December 31, 2001, and the results of itsoperations and cash flows for the year then ended in conformity with accountingprinciples generally accepted in the United States.

 

The accompanying consolidated financialstatements have been prepared assuming that the Company will continue as agoing concern. As discussed in Note 2 to the consolidated financial statements,the Company’s working capital deficiency and recurring losses from operationsand resulting continued dependence upon access to additional external financingraise substantial doubt about its ability to continue as a going concern.Management’s plans in regard to these matters are also described in Note 2. Theconsolidated financial statements do not include any adjustments that mightresult from the outcome of this uncertainty.

 

 
|                          | /s/ ERNST & YOUNG LLP |
|-------------------------------|---------------------------|
|                          |
| April 10, 2002  Dallas, Texas |

 

F-2

----

 

**AXCESS INC.CONSOLIDATED BALANCE SHEETSDECEMBER 31, 2002 AND 2001**

 
|                                                                                                                                                                                                     |   | **2002**     |       | **2001**     |       |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------|------------|--------------|------------|
| ASSETS                                                                                                                                                                                                   |   |         | ** ** |         | ** ** |
|                                                                                                                                                                                                     |   |         |       |         |       |
| Current assets:                                                                                                                                                                                          |   |         |       |         |       |
| Cash and cash equivalents                                                                                                                                                                                |   | $            | 33,249     |         | $          | — |   |
| Restricted cash                                                                                                                                                                                          |   | 140,000      |       | —       |       |
| Accounts receivable - trade, net of  allowance for doubtful accounts of $67,908 and $21,678, respectively.                                                                                               |   | 85,379       |       | 158,279      |       |
| Inventory                                                                                                                                                                                                |   | 231,619      |       | 699,058      |       |
| Prepaid expenses and other                                                                                                                                                                               |   | 93,944       |       | 623,224      |       |
|                                                                                                                                                                                                     |   |         |       |         |       |
| Total current assets                                                                                                                                                                                     |   | 584,191      |       | 1,480,561    |       |
|                                                                                                                                                                                                     |   |         |       |         |       |
| Property, plant and equipment, net                                                                                                                                                                       |   | 213,794      |       | 519,049      |       |
| Intellectual property, net                                                                                                                                                                               |   | 447,245      |       | 744,787      |       |
| Other assets                                                                                                                                                                                             |   | 29,384       |       | 29,234       |       |
|                                                                                                                                                                                                     |   |         |       |         |       |
| Total assets                                                                                                                                                                                             |   | $            | 1,274,614  |         | $          | 2,773,631 |   |
|                                                                                                                                                                                                     |   |         |       |         |       |
| LIABILITIES AND STOCKHOLDERS’ DEFICIT                                                                                                                                                               |   |         |       |         |       |
|                                                                                                                                                                                                     |   |         |       |         |       |
| Current liabilities:                                                                                                                                                                                     |   |         |       |         |       |
| Accounts payable                                                                                                                                                                                         |   | $            | 1,404,060  |         | $          | 1,850,596 |   |
| Accrued liabilities                                                                                                                                                                                      |   | 1,501,727    |       | 863,768      |       |
| Restricted cash for future funding                                                                                                                                                                       |   | 140,000      |       | —       |       |
| Notes payable:                                                                                                                                                                                           |   |         |       |         |       |
| Stockholders, including $2,477,979 in  default                                                                                                                                                           |   | 10,405,227   |       | 7,912,378    |       |
| Other                                                                                                                                                                                                    |   | 65,844       |       | 47,105       |       |
| Dividends payable                                                                                                                                                                                        |   | 455,285      |       | 25,282       |       |
| Total current liabilities                                                                                                                                                                                |   | 13,972,143   |       | 10,699,129   |       |
|                                                                                                                                                                                                     |   |         |       |         |       |
| Note payable to stockholder                                                                                                                                                                              |   | 1,000,000    |       | —       |       |
| Discount on convertible debt                                                                                                                                                                             |   | (956,148     | )          | —       |       |
|                                                                                                                                                                                                     |   |         |       |         |       |
| Total liabilities                                                                                                                                                                                        |   | 14,015,995   |       | 10,699,129   |       |
|                                                                                                                                                                                                     |   |         |       |         |       |
| Commitments and  contingencies (Notes 2, 6, 9 and 14)                                                                                                                                                    |   |         |       |         |       |
|                                                                                                                                                                                                     |   |         |       |         |       |
| Stockholders’ deficit:                                                                                                                                                                              |   |         |       |         |       |
| Convertible preferred stock, 7,000,000  shares authorized; 11,976 shares issued and outstanding in 2002 and 12,028 in  2001; $4,872,847 aggregate liquidation preference in 2002 and $5,392,847 in  2001 |   | 4,872,847    |       | 5,392,847    |       |
| Common stock, $.01 par value, 50,000,000  shares authorized in 2002 and 2001; 16,566,148 shares issued and outstanding  in 2002 and 15,848,179 shares issued and outstanding in 2001                     |   | 165,662      |       | 158,482      |       |
| Non-voting convertible common stock, $.01  par value, 2,250,000 shares authorized; 112,492 shares issued and outstanding  in 2001, convertible into common stock on a one for one share basis            |   | —       |       | 1,125        |       |
| Additional paid-in capital                                                                                                                                                                               |   | 123,768,261  |       | 121,447,062  |       |
| Shares of common stock issuable pursuant to  asset purchase agreement                                                                                                                                    |   | —       |       | 592,000      |       |
| Note receivable and accrued interest due  from stockholder, in default                                                                                                                                   |   | (4,711,915   | )          | (4,711,915   | )          |
| Accumulated deficit                                                                                                                                                                                      |   | (136,836,236 | )          | (130,805,099 | )          |
|                                                                                                                                                                                                     |   |         |       |         |       |
| Total stockholders’ deficit                                                                                                                                                                         |   | (12,741,381  | )          | (7,925,498   | )          |
|                                                                                                                                                                                                     |   |         |       |         |       |
| Total liabilities and stockholders’ deficit                                                                                                                                                         |   | $            | 1,274,614  |         | $          | 2,773,631 |   |

See accompanying notes.

 

F-3

----

 

**AXCESS INC.CONSOLIDATED STATEMENTS OFOPERATIONSYEARS ENDED DECEMBER 31, 2002 and 2001**

 
|                                                 |   | **2002**   |       | **2001**    |   |
|------------------------------------------------------|--------|------------|------------|-------------|--------|
|                                                 |   |       |       |        |   |
| Sales                                                |   | $          | 1,596,221  |        | $      | 2,696,404 |   |
| Cost of sales                                        |   | 1,213,001  |       | 2,313,172   |   |
|                                                 |   |       |       |        |   |
| Gross profit                                         |   | 383,220    |       | 383,232     |   |
| Expenses:                                            |   |       |       |        |   |
| Research and development                             |   | 1,632,385  |       | 2,355,269   |   |
| Acquired in-process research and  development        |   | —     |       | 336,029     |   |
| General and administrative                           |   | 1,568,969  |       | 2,043,914   |   |
| Selling and marketing                                |   | 1,072,425  |       | 2,432,105   |   |
| Depreciation, amortization and impairment            |   | 566,264    |       | 4,357,121   |   |
|                                                 |   |       |       |        |   |
| Operating expenses                                   |   | 4,840,043  |       | 11,524,438  |   |
|                                                 |   |       |       |        |   |
| Loss from operations                                 |   | (4,456,823 | )          | (11,141,206 | )      |
|                                                 |   |       |       |        |   |
| Other income (expense):                              |   |       |       |        |   |
| Interest expense                                     |   | (1,152,898 | )          | (1,382,163  | )      |
| Interest income                                      |   | —     |       | 327,037     |   |
| Other                                                |   | 8,587      |       | (433        | )      |
|                                                 |   |       |       |        |   |
| Other expense, net                                   |   | (1,144,311 | )          | (1,055,559  | )      |
|                                                 |   |       |       |        |   |
| Net loss                                             |   | (5,601,134 | )          | (12,196,765 | )      |
|                                                 |   |       |       |        |   |
| Preferred stock dividend requirements                |   | (430,003   | )          | (7,016,234  | )      |
|                                                 |   |       |       |        |   |
| Net loss applicable to common stock                  |   | $          | (6,031,137 | )           | $      | (19,212,999 | ) |
|                                                 |   |       |       |        |   |
| Basic and diluted net loss per share                 |   | $          | (0.37      | )           | $      | (4.57 | ) |
|                                                 |   |       |       |        |   |
| Weighted average shares of common stock  outstanding |   | 16,132,374 |       | 4,201,253   |   |

 

See accompanying notes.

 

F-4

----

 

**AXCESS INC.CONSOLIDATED STATEMENTS OFSTOCKHOLDERS’ EQUITY (DEFICIT)**

**YEARSENDED DECEMBER 31, 2002 and 2001**

 
|                                                                                           |   | **CONVERTIBLE  PREFERRED STOCK** |   | **COMMON STOCK** |       | **NON-VOTING  CONVERTIBLE  COMMON STOCK** |       |           |   |
|------------------------------------------------------------------------------------------------|--------|----------------------------------|--------|------------------|------------|-------------------------------------------|------------|----------------|--------|
|                                                                                           |   | **NUMBER OF  SHARES**            |   | **PAR  VALUE**   |       | **NUMBER OF  SHARES**                     |       | **PAR  VALUE** |   | **NUMBER OF  SHARES** |   | **PAR  VALUE** |   | **ADDITIONAL  PAID-IN  CAPITAL** |   |
|                                                                                           |   |                             |   |             |       |                                      |       |           |   |   |   |   |   |   |   |
| Balance at  December 31, 2000                                                                  |   | 165,187                          |   | $                | 45,233,025 |                                      | 3,466,486  |           | $      | 34,665 |   | 112,492 |   | $ | 1,125 |   | $ | 69,490,368 |   |
|                                                                                           |   |                             |   |             |       |                                      |       |           |   |   |   |   |   |   |   |
| Issuance of  Series A, Series B and Series C Preferred stock for dividends payable             |   | 16,263                           |   | 452,167          |       | —                                    |       | —         |   | — |   | — |   | — |   |
| Issuance of  Series I and Series J Preferred stock for dividends Payable                       |   | 211                              |   | 2,093,809        |       | —                                    |       | —         |   | — |   | — |   | — |   |
| Issuance of  Series 1999 and 2000 Preferred stock for dividends Payable                        |   | 131                              |   | 1,302,992        |       | —                                    |       | —         |   | — |   | — |   | — |   |
| Issuance of  Series 2000 Preferred stock for 10% note payable and interest due to  stockholder |   | 376                              |   | 3,760,000        |       | —                                    |       | —         |   | — |   | — |   | — |   |
| Issuance of  Series 2000 Preferred stock for 10% note payable and interest due stockholder     |   | 72                               |   | 720,000          |       | —                                    |       | —         |   | — |   | — |   | — |   |
| Conversion of  preferred stock into common stock                                               |   | (170,212                         | )      | (48,169,146      | )          | 12,339,745                                |       | 123,398        |   | — |   | — |   | 48,045,748 |   |
| Warrants  issued with convertible debt                                                         |   | —                           |   | —           |       | —                                    |       | —         |   | — |   | — |   | 656,254 |   |
| Common stock  issuable pursuant to asset purchase agreement with IVEX                          |   | —                           |   | —           |       | —                                    |       | —         |   | — |   | — |   | — |   |
| Reclassification  of note receivable and accrued interest due from stockholder                 |   | —                           |   | —           |       | —                                    |       | —         |   | — |   | — |   | — |   |
| Interest on  note receivable due from stockholder                                              |   | —                           |   | —           |       | —                                    |       | —         |   | — |   | — |   | — |   |
| Issuance of  common stock exercise of stock options                                            |   | —                           |   | —           |       | 41,948                                    |       | 419            |   | — |   | — |   | 109,027 |   |
| Preferred  stock dividends                                                                     |   | —                           |   | —           |       | —                                    |       | —         |   | — |   | — |   | 3,145,665 |   |
| Net loss                                                                                       |   | —                           |   | —           |       | —                                    |       | —         |   | — |   | — |   | — |   |
|                                                                                           |   |                             |   |             |       |                                      |       |           |   |   |   |   |   |   |   |
| Balance at  December 31, 2001                                                                  |   | 12,028                           |   | 5,392,847        |       | 15,848,179                                |       | 158,482        |   | 112,492 |   | 1,125 |   | 121,447,062 |   |
|                                                                                           |   |                             |   |             |       |                                      |       |           |   |   |   |   |   |   |   |
| Conversion of  Preferred Series I                                                              |   | (52                              | )      | (520,000         | )          | 207,477                                   |       | 2,075          |   | — |   | — |   | 517,925 |   |
| Conversion of  Non-Voting Convertible Common Stock                                             |   | —                           |   | —           |       | 112,492                                   |       | 1,125          |   | (112,492 | ) | (1,125 | ) | — |   |
| Common Stock  issued pursuant to asset Purchase of IVEX                                        |   | —                           |   | —           |       | 148,000                                   |       | 1,480          |   | — |   | — |   | 590,520 |   |
| Shares issued  in conjunction with convertible debt offering                                   |   | —                           |   | —           |       | 250,000                                   |       | 2,500          |   | — |   | — |   | — |   |
| Debt discount  in conjunction with convertible debt offering                                   |   | —                           |   | —           |       | —                                    |       | —         |   | — |   | — |   | 952,500 |   |
| Capital  contribution of employees salaries for the fourth quarter of 2002                     |   | —                           |   | —           |       | —                                    |       | —         |   | — |   | — |   | 251,054 |   |
| Warrants  issued for extension of debt                                                         |   | —                           |   | —           |       | —                                    |       | —         |   | — |   | — |   | 9,200 |   |
| Preferred  stock dividends                                                                     |   | —                           |   | —           |       | —                                    |       | —         |   | — |   | — |   | — |   |
| Net Loss                                                                                       |   | —                           |   | —           |       | —                                    |       | —         |   | — |   | — |   | — |   |
|                                                                                           |   |                             |   |             |       |                                      |       |           |   |   |   |   |   |   |   |
| Balance at  December 31, 2002                                                                  |   | 11,976                           |   | $                | 4,872,847  |                                      | 16,566,148 |           | $      | 165,662 |   | — |   | $ | — |   | $ | 123,768,261 |   |

 

F-5

----

 
|                                                                                           |   | **COMMON STOCK  ISSUABLE** |   | **DUE FROM  STOCKHOLDERS** |   | **ACCUMULATED  DEFICIT** |   | **TOTAL STOCKHOLDERS’  EQUITY (DEFICIT)** |         |
|------------------------------------------------------------------------------------------------|--------|----------------------------|--------|----------------------------|--------|--------------------------|--------|------------------------------------------------|--------------|
|                                                                                           |   |                       |   |                       |   |                     |   |                                           |         |
| Balance at  December 31, 2000                                                                  |   | $                          | — |                       | $      | —                   |   | $                                              | (111,592,100 | ) | $ | 3,167,083 |   |
|                                                                                           |   |                       |   |                       |   |                     |   |                                           |         |
| Issuance of  Series A, Series B and Series C Preferred stock for dividends payable             |   | —                     |   | —                     |   | —                   |   | 452,167                                        |         |
| Issuance of  Series I and Series J Preferred stock for dividends payable                       |   | —                     |   | —                     |   | —                   |   | 2,093,809                                      |         |
| Issuance of  Series 1999 and 2000 Preferred stock for dividends payable                        |   | —                     |   | —                     |   | —                   |   | 1,302,992                                      |         |
| Issuance of  Series 2000 Preferred Stock for 10% note payable and interest due to  stockholder |   | —                     |   | —                     |   | —                   |   | 3,760,000                                      |         |
| Issuance of  Series 2000 Preferred Stock for 10% note payable and interest due stockholder     |   | —                     |   | —                     |   | —                   |   | 720,000                                        |         |
| Conversion of  preferred stock into common stock                                               |   | —                     |   | —                     |   | —                   |   | —                                         |         |
| Warrants  issued with convertible debt                                                         |   | —                     |   | —                     |   | —                   |   | 656,254                                        |         |
| Common stock  issuable pursuant to asset purchase agreement with IVEX                          |   | 592,000                    |   | —                     |   | —                   |   | 592,000                                        |         |
| Reclassification  of note receivable and accrued interest due from stockholder                 |   | —                     |   | (4,388,359                 | )      | —                   |   | (4,388,359                                     | )            |
| Interest on  note receivable due from stockholder                                              |   | —                     |   | (323,556                   | )      | —                   |   | (323,556                                       | )            |
| Issuance of  common stock exercise of Stock options                                            |   | —                     |   | —                     |   | —                   |   | 109,446                                        |         |
| Preferred stock  dividends                                                                     |   | —                     |   | —                     |   | (7,016,234               | )      | (3,870,569                                     | )            |
| Net loss                                                                                       |   | —                     |   | —                     |   | (12,196,765              | )      | (12,196,765                                    | )            |
|                                                                                           |   |                       |   |                       |   |                     |   |                                           |         |
| Balance at  December 31, 2001                                                                  |   | 592,000                    |   | (4,711,915                 | )      | (130,805,099             | )      | (7,925,498                                     | )            |
|                                                                                           |   |                       |   |                       |   |                     |   |                                           |         |
| Conversion of  Preferred Series I                                                              |   | —                     |   | —                     |   | —                   |   | —                                         |         |
| Conversion of  Non-Voting Convertible Common Stock                                             |   | —                     |   | —                     |   | —                   |   | —                                         |         |
| Common Stock  issued pursuant to asset Purchase of IVEX                                        |   | (592,000                   | )      | —                     |   | —                   |   | —                                         |         |
| Shares issued  in conjunction with convertible debt offering                                   |   | —                     |   | —                     |   | —                   |   | 2,500                                          |         |
| Debt discount  in conjunction with convertible debt offering                                   |   | —                     |   | —                     |   | —                   |   | 952,500                                        |         |
| Capital  contribution of employees salaries for the fourth quarter of 2002                     |   | —                     |   | —                     |   | —                   |   | 251,054                                        |         |
| Warrants  issued for extension of debt                                                         |   |                       |   |                       |   |                     |   | 9,200                                          |         |
| Preferred  stock dividends                                                                     |   | —                     |   | —                     |   | (430,003                 | )      | (430,003                                       | )            |
| Net loss                                                                                       |   | —                     |   | —                     |   | (5,601,134               | )      | (5,601,134                                     | )            |
|                                                                                           |   |                       |   |                       |   |                     |   |                                           |         |
| Balance at  December 31, 2002                                                                  |   | $                          | — |                       | $      | (4,711,915               | )      | $                                              | (136,836,236 | ) | $ | (12,741,381 | ) |

 

See accompanying notes

 

F-6

----

 

**AXCESS, INC.CONSOLIDATED STATEMENT OF CASH FLOWSYEARS ENDED DECEMBER 31, 2002 and 2001**

 

 
|                                                                         |   | **2002**   |       | **2001**   |   |
|------------------------------------------------------------------------------|--------|------------|------------|------------|--------|
|                                                                         |   |       |       |       |   |
| Cash flows from operating activities:                                        |   |       |       |       |   |
| Net loss                                                                     |   | $          | (5,601,134 | )          | $      | (12,196,765 | ) |
| Adjustments to reconcile net loss to net  cash used by operating activities: |   |       |       |       |   |
| Depreciation, amortization and impairment                                    |   | 566,264    |       | 4,357,121  |   |
| Acquired in-process research and  development                                |   | —     |       | 336,029    |   |
| Amortization of financing discount and  issuance costs                       |   | 608,809    |       | 330,854    |   |
| Capital contributions of employees’  salaries                           |   | 251,054    |       | —     |   |
| Loss on sale of assets                                                       |   | 26,202     |       | —     |   |
| Changes in operating assets and  liabilities:                                |   |       |       |       |   |
| Accounts receivable                                                          |   | 72,900     |       | 51,514     |   |
| Inventory                                                                    |   | 467,439    |       | 614,364    |   |
| Prepaid expenses and other                                                   |   | 44,035     |       | 389,024    |   |
| Other assets                                                                 |   | (150       | )          | 5,482      |   |
| Accounts payable                                                             |   | (446,536   | )          | 761,442    |   |
| Other liabilities                                                            |   | 777,959    |       | 259,481    |   |
| Net cash used by operating activities                                        |   | (3,233,158 | )          | (5,091,454 | )      |
|                                                                         |   |       |       |       |   |
| Cash flow from investing activities:                                         |   |       |       |       |   |
| Proceeds from asset sales                                                    |   | 11,016     |       | —     |   |
| Capital expenditures                                                         |   | (2,348     | )          | (111,878   | )      |
| Increase in restricted cash                                                  |   | (140,000   | )          | —     |   |
| Net cash used by investing activities                                        |   | (131,332   | )          | (111,878   | )      |
|                                                                         |   |       |       |       |   |
| Cash flow from financing activities:                                         |   |       |       |       |   |
| Borrowings under financing agreements                                        |   | 3,518,810  |       | 4,692,149  |   |
| Principal payments on financing agreements                                   |   | (121,071   | )          | (52,638    | )      |
| Net proceeds from issuance of common and  preferred stock                    |   | —     |       | 109,447    |   |
| Net cash provided by financing activities                                    |   | 3,397,739  |       | 4,748,958  |   |
|                                                                         |   |       |       |       |   |
| Net increase (decrease) in cash and cash  equivalents                        |   | 33,249     |       | (454,374   | )      |
| Cash and cash equivalents, beginning of  year                                |   | —     |       | 454,374    |   |
| Cash and cash equivalents, end of year                                       |   | $          | 33,249     |       | $      | — |   |
|                                                                         |   |       |       |       |   |
| Supplemental information:                                                    |   |       |       |       |   |
| Cash paid during the year for interest                                       |   | $          | 3,328      |       | $      | 1,771 |   |

 

See accompanying notes.

 

F-7

----

 

**AXCESSNOTES TO FINANCIAL STATEMENTS**

 

 

**(1) Summary ofSignificant Accounting Policies**

 

**(a)Description of Business**

 

The Company provides advanced security andasset management systems, which locate, identify, track, monitor and protectassets. The main applications of the Company’s systems are security videothrough closed circuit television (called CCTV), personnel and vehicle accesscontrol, and automatic asset tracking and protection. The Company providessolutions in the recently identified homeland security markets such as air andground transportation, water treatment facilities, oil and gas, power plants,as well as in the markets for data centers, retail / convenience stores,education, healthcare, and corporate offices. AXCESS utilizes two patented andintegrated technologies: network-based radio frequency identification (RFID)and tagging and streaming video.  Both applicationand browser-based software options deliver critical real-time informationtailored to each end user via the enterprise network or Internet, alsoproviding custom alerts in the form of streaming video, e-mail, or messagesdelivered to wireless devices.

 

From October 16, 2002 through January 15,2003, AXCESS Inc. (“AXCESS” or the “Company”) furloughed all of its employeesdue to a lack of operating capital. Nearly all of the Company’s furloughed employees volunteered to continueto work, without any compensation for that period.  That allowed the Company to continue to ship its products andmaintain customer support.  DuringJanuary 2003, the Company recalled 13 full time employees.

 

The Company’s business plan for 2003 ispredicated principally upon the successful marketing of its RFID and digitalvideo products. During 2002, operating activities utilized approximately $3.2million of cash.  During the firstquarter of 2003 the Company raised $305,000 for additional working capital.  However, the Company anticipates that itsexisting working capital resources and revenues from operations will not beadequate to satisfy its funding requirements in 2003.

 

The future results of operations and financial condition of the Companywill be impacted by the following factors, among others: changes fromanticipated levels of sales, access to capital, future national or regionaleconomic and competitive conditions, changes in relationships with customers,difficulties in developing and marketing new products, marketing existingproducts, customer acceptance of existing and new products, validity ofpatents, technological change, dependence on key personnel, availability of keycomponent parts, dependence on third party manufacturers, vendors, contractors,product liability, casualty to or other disruption of the productionfacilities, delays and disruptions in the shipment of the Company’s products,and the ability of the Company to meet its stated business goals.

 

If the Company’s losses or lack of operatingcapital continue, the Company will have to obtain funds to meet its cashrequirements through business alliances, such as strategic or financialtransactions with third parties, the sale of securities or other financingarrangements, or the Company may be required to curtail its operations, seek a mergerpartner, or seek protection under federal bankruptcy laws. Any of the foregoingmay be on terms that are unfavorable to the Company or disadvantageous toexisting stockholders. In addition, no assurance may be given that the Companywill be successful in raising additional funds or entering into businessalliances.

 

**(b)Company Organization and Basis of Presentation**

 

The accompanying consolidated financial statements include the accountsof the Company and its majority-owned subsidiaries. All significantintercompany accounts and transactions have been eliminated in consolidation.

 

The Company has received working capital invarious forms from Amphion Ventures, L. P. and affiliates of Amphion Ventures,L. P. including Amphion Partners, Amphion Investments LLC, Antiope Partners,and VennWorks LLC (formerly incuVest LLC) (collectively, the “Amphion Group”).Following the conversion of preferred stock held by the Amphion Group intocommon stock in 2001, the Amphion Group owns approximately 81% of the outstandingvoting stock of the Company.  TheCompany also received working capital in July 2002 through a bridge financingfrom several accredited investors.

 

**(c)Use of Estimates**

 

The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesrequires management to make estimates and assumptions that effect the amountsreported in the financial statements and accompanying notes. As discussedbelow, the Company makes significant assumptions in recording its allowance fordoubtful accounts, inventory valuation, impairment of long-lived assets,warranty costs and the valuation allowance for deferred tax assets. Actualresults could differ from those estimates, and the differences may besignificant.

 

F-8

----

 

**(d)Cash and Cash Equivalents**

 

The Company considers all highly liquid debtinstruments with original maturities of three months or less to be cashequivalents.

 

**(e)Inventory**

 

Inventory is valued at the lower of cost or market using the first-in,first-out method. Inventory was comprised of the following at December 31, 2002and December 31, 2001:

 

|            |   | **December  31,  2002** |    | **December  31,  2001** |   |
|-----------------|--------|-------------------------|---------|-------------------------|--------|
| Raw materials   |   | $                       | 162,806 |                    | $      | 300,133 |   |
| Work-in-process |   | 3,370                   |    | 12,928                  |   |
| Finished goods  |   | 65,443                  |    | 385,997                 |   |
|            |   | $                       | 231,619 |                    | $      | 699,058 |   |

 

**(f) Property andEquipment**

 

Property and equipment are recorded at costand depreciated using the straight-line method over the estimated useful livesof the assets. The Company capitalizes costs associated with software developedor obtained for internal use when both the preliminary project stage iscompleted and management has authorized further funding for the project, whichit deems completion to be probable, and that the project will be used toperform the function intended. Capitalization of such costs ceases no laterthan the point at which the project is substantially complete and ready for itsintended use.  The Company currently hasno capitalized software development on its books.

** **

**(g) IntangibleAssets**

 

Intangible assets, which consist primarily ofpatents and developed technologies, have been recorded as the result ofacquisitions of business and developed technologies and are being amortized onthe straight-line basis over five years.

** **

**(h) Impairmentof Long-Lived Assets-and Long-Lived Assets to Be Disposed Of**

 

Long-lived assets and identifiable intangibleassets are reviewed for impairment whenever events or changes in circumstancesindicate that the carrying amount of an asset may not be recoverable.Recoverability of assets to be held and used is measured by a comparison of thecarrying amount of an asset to future net cash flows expected to begenerated-by the asset. If such assets are considered to be impaired, theimpairment to be recognized is measured by the amount by which the carryingamount of the asset exceeds the fair value of the assets based on estimatedfuture cash flows. Assets to be disposed of are reported at the lower of-thecarrying amount or fair value less costs to sell. Revenues from the sale ofproducts utilizing the Company’s purchased technologies have grown slowly andthe Company has experienced operating losses since the respective dates ofacquisition. As a result, the Company recorded an impairment charge of$2,797,063 in the fourth quarter of 2001 representing the amount by which thecarrying amount of the intangible assets exceeded their estimated fair values.The Company believes that assumptions made in projecting future cash flows forthis evaluation are reasonable. However, if future actual results do not meetexpectations, the Company may be required to record an additional impairmentcharge, the amount of which could be material to the results of its operationsand financial position.  During the twelvemonths ended December 31, 2002 the Company recorded no impairment charges.

** **

**(i) FinancialInstruments**

 

Financial instruments that potentiallysubject the Company to concentrations of credit risk consists primarily oftrade accounts receivable and notes receivable. Products are sold to customers,including distributors and integrators, located principally in the UnitedStates. The Company continually evaluates the creditworthiness of itscustomers’ financial condition and generally does not require collateral. TheCompany evaluates the collectability of its accounts receivable based on acombination of factors. In circumstances where the Company is aware of aspecific customer’s inability to meet its financial obligations to us, theCompany records a specific reserve for bad debts against amounts due. TheCompany has not experienced significant losses on uncollectible accountsreceivable.

 

The carrying amounts of cash equivalents,accounts receivable, accounts payable, accrued liabilities and notes payableapproximate fair value because of the short-term maturity of these instruments.

 

F-9

----

 

**(j) RevenueRecognition**

 

The Company recognizes revenue on sales ofits products when the products are shipped from the Company. Company policydoes not allow customers to return products for credit. The Company currentlyprovides a one-year warranty on all products. Provision is made at the time therelated revenue is recognized for estimated product repair costs. In 2001, 49%of total revenues were related to one customer, QuickTrip.

 

The components of cost of sales at December31, 2002 and 2001, are summarized as follows:

 
|             |   | **Year ended December 31,** |      |
|------------------|--------|-----------------------------|-----------|
|             |   | **2002**                    |      | **2001** |   |
| Product Cost     |   | $                           | 1,185,688 |   | $ | 2,233,169 |   |
| Warranty Expense |   | 27,313                      |      | 80,003 |   |
| Cost of sales    |   | $                           | 1,213,001 |   | $ | 2,313,172 |   |

 

**(k) Research andDevelopment Costs**

 

Research and development costs are expensedas incurred. The Company capitalizes certain costs incurred during aninternal-use software development project, including costs related toapplications, infrastructure and graphics developments. Capitalizable costsconsist of (a) certain external direct cost of materials and services incurredin developing or obtaining internal-use computer software, (b) payroll andpayroll-related costs for employees who are directly associated with and whodevote time to the project and (c) interest cost incurred. Costs that areconsidered to be related to research and development activities are incurredduring the preliminary project stage, or for data conversion activities,training, maintenance and general administrative or overhead costs are expensedas incurred. Costs that cannot be separated between maintenance of, andrelatively minor upgrades and enhancements to, the Company’s internallydeveloped software are also expensed as incurred.

 

**(l) AdvertisingCosts**

 

Advertising costs are expensed as incurredand totaled approximately $12,443 and $270,698 during 2002 and 2001,respectively.

 

**(m) Depreciationand Amortization**

 

Depreciation of property and equipment isrecorded using the straight-line method over the estimated useful lives of therespective assets. Internally developed software and purchased technologies(Note 6) are amortized over the estimated useful lives of the respectivetechnology.

 

**(n) Stock-BasedCompensation**

 

The Company has elected to follow AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued to Employees,” inthe primary financial statements and has provided supplemental disclosuresrequired by Statement of Financial Accounting Standards No. 123, “Accountingfor Stock-Based Compensation”.

 

**(o) SeveranceCosts**

 

Severance costs are recognized at the date inwhich the employees are notified of their termination. The Company recognized$57,666 in severance charges in 2001 relating to staff reduction of 15 people,which represented 45% of the total employees of the Company. As of December 31,2001, all of the severance charges were paid. During 2002 the Company had one staff reduction of 7 people, whichreflected 33% of the total employees of the Company.  The Company paid no severance during 2002.

** **

**(p) Income Taxes**

 

Deferred tax assets andliabilities are recognized for the future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases. Deferred tax assets andliabilities are measured using enacted tax rates expected to apply to taxableincome in the years in which those temporary differences are expected to berecovered or settled. Valuation allowances are established when necessary toreduce deferred tax assets to the amount more likely than not to be realized.Income tax expense is the total of tax payable for the period and the changeduring the period in deferred tax assets and liabilities.

** **

**(q) Net Loss PerCommon Share**

 

Basic loss per share data is computed bydividing the net loss applicable to common stock by the weighted average numberof common shares outstanding during the year. Diluted earnings per share, whichincludes the dilutive effect of the conversion of convertible preferred stockand the convertible debt and exercise of options and warrants has not beenpresented because, due to the net losses recorded by the Company for allperiods presented, their inclusion would be antidilutive. Conversion ofconvertible preferred stock, convertible debt and the exercise of options andwarrants would result in 23,339,121 and 22,204,177 common shares outstanding atDecember 31, 2002 and 2001, respectively.

 

F-10

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**(r) SegmentReporting**

 

The Company operates in one-industry segmentselling two primary product lines, digital video and RFID. Sales, cost of salesand gross profits for each product line are as follows:

 

 
|          |   | **Digital Video** |    | **RFID**  |   |
|---------------|--------|-------------------|---------|-----------|--------|
|          |   | **2002**          |    | **2001**  |   | **2002** |   | **2001** |   |
| Sales         |   | $                 | 954,411 |      | $      | 1,939,898 |   | $ | 641,810 |   | $ | 756,506 |   |
| Cost of sales |   | 714,649           |    | 1,622,300 |   | 498,352 |   | 690,872 |   |
| Gross profit  |   | $                 | 239,762 |      | $      | 317,598 |   | $ | 143,458 |   | $ | 65,634 |   |

 

**(s) Significant Customers**

 

During the 2002 the Company had four customers that accounted for 49%of the overall revenue, two customers accounted for 56% of the digital videoproduct sales and four customers accounted for 44% of the RFID product sales.  During 2001, the Company had one customerthat accounted for 49% of the Company’s overall revenue and 92% of the digitalvideo product sales and four customers accounted for 51% of the RFID productsales.

 

**(t)Recent Accounting Pronouncements**

 

In June 2001, the Financial Accounting Standards Board (“FASB”) issuedStatements of Financial Accounting Standards No. 141, Business Combinations,and No. 142, Goodwill and Other Intangible Assets, (“FAS 142”), effective forfiscal years beginning after December 15, 2001. Under the new rules, goodwilland intangible assets deemed to have indefinite lives will no longer beamortized, but will be subject to annual impairment tests in accordance withthe Statements. Other intangible assets will continue to be amortized overtheir useful lives. The Company began to apply the new rules on accounting forother intangible assets in the first quarter of 2002. The Company’s intangibleassets at December 31, 2002 will continue to be amortized under FAS 142.Accordingly, adopting FAS 142 did not have a material effect on the Company’sfinancial condition or results of operation.

 

The FASB has also recently issued FAS No. 144, Accounting for theImpairment or Disposal of Long-Lived Assets (“FAS 144”), which the Companyadopted on January 1, 2002. The FASB’s new rules on asset impairment supersedeFAS No. 121, Accounting for the Impairment of Long-Lived Assets and forLong-Lived Assets to Be Disposed Of (“FAS 121”). FAS 144 retains therequirements of FAS 121 to (a) recognize an impairment loss only if thecarrying amount of a long-lived asset is not recoverable from its undiscountedcash flows and (b) measure an impairment loss as the difference between thecarrying amount and fair value of the asset, but removes goodwill from its scope.This aspect of FAS 144 will primarily impact the accounting for intangibleassets subject to amortization and property and equipment. The Company’sadoption of FAS 144 did not have a significant impact on its financialcondition or results of operations.

 

In July 2002, the FASB issued Statement of Financial AccountingStandards No. 146, *Accounting for CostsAssociated with Exit or Disposal Activities* (SFAS No. 146). SFAS 146nullifies FASB Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognitionfor Certain Employee Termination Benefits and Other Costs to Exit an Activity(including Certain Costs Incurred in a Restructuring)”. It requires that aliability be recognized for those costs only when the liability is incurred,that is, when it meets the definition of a liability in the FASB’s conceptualframework. SFAS No. 146 also establishes fair value as the objective forinitial measurement of liabilities related to exit or disposal activities. SFAS146 is effective for exit or disposal activities that are initiated afterDecember 31, 2002, with earlier adoption encouraged. The Company does notexpect that the adoption of SFAS 146 will have a material impact on itsfinancial position or results from operations.

 

In December 2002, the FASB issued Statementof Financial Accounting Standards 148, *Accountingfor Stock-Based Compensation - Transition and Disclosure - an amendment of FASBStatement 123* (“SFAS 148”). For entities that change their accounting for stock-based compensationfrom the intrinsic method to the fair value method under SFAS 123, the fairvalue method is to be applied prospectively to those awards granted after thebeginning of the period of adoption (the prospective method).  The amendment permits two additionaltransition methods for adoption of the fair value method.  In addition to the prospective method, theentity can choose to either (i) restate all periods presented (retroactiverestatement method) or (ii) recognize compensation cost from the beginning ofthe fiscal year of adoption as if the fair value method had been used toaccount for awards (modified prospective method).  For fiscal years beginning after December 15, 2003, theprospective method will no longer be allowed. The Company currently accounts for its stock-based compensation usingthe intrinsic value method as proscribed by APB No. 25, Accounting for StockIssued to Employees, and plans to continue using this method to account forstock options.  Therefore, it does notintend to adopt the transition requirements as specified in SFAS 148.

 

F-11

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**(2) Operations,Liquidity and Going Concern**

 

The Company’s operations in 2002 and 2001generated operating losses of $5.6 million and $12.2 million, respectively. Inaddition, at December 31, 2002 the Company had a working capital deficit of$13.4 million. Although the Company raised gross proceeds of approximately $3.5million and $4.7 million during 2002 and 2001, through equity and debtfinancing transactions, the Company’s operations, capital expenditures and debtservice requirements have utilized all of such proceeds. These factors raisesubstantial doubt about the Company’s ability to continue as a going concern.

 

The Company’s business plan for 2003 ispredicated principally upon the successful marketing of its RFID and digitalvideo products. During 2002, operating activities utilized approximately $3.2million of cash. The Company anticipates that its existing working capitalresources and revenues from operations will not be adequate to satisfy itsfunding requirements in 2003.

 

The Company’s working capital requirementswill depend upon many factors, including the extent and timing of the Company’sproduct sales, the Company’s operating results, the status of competitiveproducts, and actual expenditures and revenues compared to its business plan.The Company is currently experiencing declining liquidity, including negativeworking capital balances, losses from operations and negative cash flows, whichmakes it difficult for the Company to meet its current cash requirements,including payments to vendors, and may jeopardize the Company’s ability tocontinue as a going concern. The Company intends to address its liquidityproblems by controlling costs, seeking additional funding through capitalraising transactions and business alliances and maintaining focus on revenuesand collections.

 

If the Company’s losses continue, the Companywill have to obtain funds to meet its cash requirements through businessalliances, such as strategic or financial transactions with third parties, thesale of securities or other financing arrangements, or the Company may berequired to curtail its operations, seek a merger partner, or seek protectionunder federal bankruptcy laws. Any of the foregoing may be on terms that areunfavorable to the Company or disadvantageous to existing stockholders. Inaddition, no assurance may be given that the Company will be successful inraising additional funds or entering into business alliances.

 

During the first quarter of 2003 the Companyhas borrowed an additional $305,000 from a group of accredited investors undera convertible debt financing similar to the deal completed in July of 2002.

 

**(3) Acquisition ofIVEX Assets and In-Process Research and Development**

 

Effective November 30, 2001 the Companyacquired certain property and equipment and the rights to certain digital videointellectual property rights from IVEX, Inc., an investee of the Amphion Group,in exchange for 148,000 shares of the Company’s common stock. The aggregatedpurchase price of $592,000 was allocated to the property and equipment acquiredand to in-process research and development as follows:

 
| Property and equipment               |   | $       | 197,552 |   |
|--------------------------------------|--------|---------|---------|--------|
| In-process  research and development |   | 336,029 |    |
| Inventory                            |   | 68,419  |    |
| Accounts  payable                    |   | (10,000 | )       |
|                                 |   | $       | 592,000 |   |

 

The cost of acquiring the intellectualproperty rights of $336,029 was expensed at the date of the acquisition becausethe acquired research and development had no alternative future uses and hadnot reached technological feasibility based on the status of design anddevelopment activities that required further refinement and testing before itcan be incorporated into future releases of the Company’s digital videoproducts. The Company completed the development and integration of the initialapplication of this technology in its products in 2002.

 

**(4) Prepaid Expensesand Other Current Assets**

 

Prepaid expenses and other consists of thefollowing at December 31:

 
|              |   | **2002** |   | **2001** |   |
|-------------------|--------|----------|--------|----------|--------|
| Prepaid insurance |   | $        | 87,811 |     | $      | 55,580 |   |
| Prepaid  interest |   | 6,133    |   | 493,041  |   |
| Prepaid other     |   | —   |   | 74,603   |   |
|              |   | $        | 93,944 |     | $      | 623,224 |   |

 

Prepaid interest results from the warrantsissued in connection with the 10% convertible note payable to the Amphion Groupand a warrant issued in connection with the extension of the J.P. Morgan notepayable. See Note 10.

 

F-12

----

 

**(5) Property, Plantand Equipment**

 

Property, plant and equipment consists of the following at December 31:

 
|                                       |   | **2002**   |    | **2001**   |   | **Amortization/  Depreciation  Period** |   |
|--------------------------------------------|--------|------------|---------|------------|--------|-----------------------------------------|--------|
| Leasehold  improvements                    |   | $          | 80,775  |       | $      | 80,775                                  |   | Lease term |   |
| Machinery and  equipment                   |   | 1,742,463  |    | 1,535,444  |   | 5 years                                 |   |
| Furniture and  fixtures                    |   | 147,800    |    | 138,734    |   | 5 to 10 years                           |   |
|                                       |   | 1,971,038  |    | 1,754,953  |   |                                    |   |
| Accumulated  depreciation and amortization |   | (1,757,244 | )       | (1,235,904 | )      |                                    |   |
| Property,  plant and equipment, net        |   | $          | 213,794 |       | $      | 519,049                                 |   |   |   |

 

Depreciation totaled $268,723 and $240,113 during 2002 and 2001,respectively.

 

**(6) Intellectualproperty**

 

Intellectual property consists of the following at December 31:

 
|                                     |   | **2002**   |      | **2001**   |   | **Useful  Lives** |   | **Weighted Average  Remaining Useful  Lives at  December 31,  2002** |   |
|------------------------------------------|--------|------------|-----------|------------|--------|-------------------|--------|----------------------------------------------------------------------|--------|
| Purchased RFID  technology               |   | $          | 1,714,449 |       | $      | 1,714,449         |   | 5 years                                                              |   | — |   |
| Purchased  video technology              |   | 5,087,483  |      | 5,087,483  |   | 5 years           |   | 1.5 years                                                            |   |
| Internally  developed software           |   | 350,337    |      | 350,337    |   | 5 years           |   | —                                                               |   |
|                                     |   | 7,152,269  |      | 7,152,269  |   |              |   |                                                                 |   |
| Accumulated  amortization and impairment |   | (6,705,024 | )         | (6,407,482 | )      |              |   |                                                                 |   |
| Intellectual  property, net              |   | $          | 447,245   |       | $      | 744,787           |   |                                                                 |   |   |   |

 

The following table sets forth the estimated amortization expense onthe intellectual property for the fiscal years ended December 31:

 

| 2003  |   | $       | 298,260 |   |
|-------|--------|---------|---------|--------|
| 2004  |   | 148,985 |    |
| Total |   | $       | 447,245 |   |

 

The video technology was acquired in 1999 andconsists of proprietary digital video compression technology used in video andCCTV products as well as the related U.S. and international patent rights.

 

The RFID technology was acquired in 1998 andincludes a patent, trade secret rights software, hardware, product designs andall other technical information necessary for the Company to manufacture andmarket radio frequency identification products in the areas of access controland asset management. Up to an aggregate of an additional $6,000,000 is payableby the Company to the sellers of the RFID technology only if certain netoperating profit targets are realized during each of the five years followingthe acquisition date. Such payments would be treated as additional cost of theRFID technology, if and when paid, and amortized over the remaining economiclife of the technology. At December 31, 2001 and December 31, 2002, noadditional consideration was due to the sellers.

 

Internally developed software costs werecapitalized once the technological feasibility was achieved. These costs arereviewed for recoverability based on the expected future cash flows to begenerated.

 

Amortization expense of intellectual propertytotaled $297,542 and $1,319,945 during 2002 and 2001, respectively. Inaddition, the Company recorded an impairment charge of $2,797,063 in the fourthquarter of 2001, representing the amount by which the carrying amount of theintangible assets exceeded their estimated fair value. See Note 1.

 

F-13

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**(7) AccruedLiabilities**

 

Accrued liabilities consist of the followingat December 31:

 
|                                                   |   | **2002** |      | **2001** |   |
|--------------------------------------------------------|--------|----------|-----------|----------|--------|
| Accrued  vacation                                      |   | $        | 147,044   |     | $      | 200,154 |   |
| Accrued  interest payable                              |   | 963,827  |      | 443,177  |   |
| Accrued legal  costs, litigation settlements and other |   | 390,856  |      | 220,437  |   |
|                                                   |   | $        | 1,501,727 |     | $      | 863,768 |   |

 

**(8) Note Receivableand Accrued Interest due from Stockholder**

 

The note receivable and related accruedinterest is due from Amphion Ventures L.P. (“Amphion Ventures”), interest isdue at 8% per annum, payable quarterly. The Company has assigned all paymentsof principal under this note receivable to Prism Video, Inc. (“Prism”) untilthe balance of the note receivable is paid in full or until the balance dueunder the note payable to Prism (Note 10) is paid in full, whichever occursfirst. Amphion Ventures did not make its required payments under this noteduring 2001 or 2002. Accordingly, the note receivable and accrued interest wasreclassified in the accompanying balance sheets at December 31, 2001 andDecember 31, 2002 as a reduction of stockholders’ equity due to the AmphionGroup’s controlling voting interest in the Company (Note 1) and the uncertaintyas to the timing of repayment.  The notewas due March 31, 2002 and has not been paid. The Company stopped accruing interest income in 2002.

 

**(9) Lease Obligations**

 

The Company leases its officespace and certain equipment under operating leases. The rental expense recordedfor operating leases was $259,676 and $251,038 for the years ended December 31,2002 and 2001, respectively. At December 31, 2002, future minimum leasepayments on operating leases were as follows:

 
| 2003   |   | $      | 74,613  |   |
|--------|--------|--------|---------|--------|
| 2004   |   | 74,613 |    |
| 2005   |   | 49,742 |    |
|   |   | $      | 199,968 |   |

 

**(10) Notes Payable toStockholders**

 

Notes payable consist of the following atDecember 31:

 
|                                                                    |   | **2002**   |      | **2001**  |   |
|-------------------------------------------------------------------------|--------|------------|-----------|-----------|--------|
| Due to  stockholders:                                                   |   |       |      |      |   |
| Amphion  Convertible Note                                               |   | $          | 2,477,979 |      | $      | 2,477,979 |   |
| Non interest  bearing note, due December 31, 2002, discounted at 10.00% |   | 4,000,000  |      | 3,931,144 |   |
| Note Purchase  Agreement                                                |   | 400,000    |      | 400,000   |   |
| 9.00% demand  note payable to VennWorks                                 |   | 803,255    |      | 803,255   |   |
| 7.00%  convertible debt                                                 |   | 1,000,000  |      | —    |   |
| Discount  relating to 7.00% convertible debt                            |   | (956,148   | )         | —    |   |
| 6.75% demand  note payable to Amphion Ventures                          |   | 1,255,000  |      | —    |   |
| 6.75% demand  note payable to Amphion Investment                        |   | 355,000    |      | —    |   |
| 6.75% demand  note payable to VennWorks                                 |   | 814,000    |      | —    |   |
| 4.50% demand  note payable to Amphion Ventures                          |   | 300,000    |      | 300,000   |   |
| Other  miscellaneous                                                    |   | (7         | )         | —    |   |
|                                                                    |   | 10,449,079 |      | 7,912,378 |   |
| Less current  maturities                                                |   | 10,405,227 |      | 7,912,378 |   |
| Non-current  notes payable to stockholders                              |   | $          | 43,852    |      | $      | — |   |
|                                                                    |   |       |      |      |   |
| Other current  notes payable                                            |   | $          | 65,844    |      | $      | 47,105 |   |

 

On September 30, 1999, theCompany signed a 10% convertible note maturing September 30, 2002 (“AmphionConvertible Note”), under which the Company could borrow up to $6,000,000 fromAmphion Ventures. Amphion Ventures may convert all or any portion of theindebtedness into Series 1999 Non-Voting Preferred Stock of the Company. Inconsideration for the financing arrangement, the Company issued warrants toacquire 180,362 shares in 1999 and 117,999 shares in 2000 and 2001 of theCompany’s non-voting common stock at an exercise price of $2.10 per share. Thefair value of the warrants are recorded as prepaid interest when issued andamortized over 12 months. No additional borrowings were available to theCompany under the Amphion Convertible Note at December 31, 2001 and December31, 2002.  The balance of theindebtedness under the 10%

 

F-14

----

 

 

convertible note issued was duein full by the Company on September 30, 2002 and, as of December 31, 2002, thisnote is in default. The Company is negotiating with Amphion Ventures to extendthe term of the notes.

 

On July 28, 1999, the Company acquired substantiallyall of the assets of Prism Video, Inc. (“Prism”), a privately held corporation,and agreed to pay $4,000,000 to “Prism” on December 31, 2002. The balance ofthe indebtedness under the Prism note issued was due in full by the Company onDecember 31, 2002, this note is in default. The Company is negotiating withPrism to extend the term of the notes. The note payable has a face amount of$4,000,000 and is collateralized by the Company’s $3,902,375 note receivablefrom Amphion Ventures, L.P. (“Amphion Ventures”) (Note 8). Pursuant to theAsset Purchase Agreement between AXCESS and Prism, AXCESS assigned Prism allpayments of principal to be made by Amphion Ventures under the note receivableuntil the balance of the note receivable is paid in full or the balance dueunder the note payable to Prism is paid in full, whichever occurs first. Inaddition, the shares of common stock which Prism may acquire upon conversion ofpreferred stock or by exercise of the warrant are subject to a three-yearlockup from the date of the closing, which may be reduced to two years upon theoccurrence of certain events. The warrant is exercisable on or before July 28,2004.

 

On June 27, 2002, J.P. Morgan Investment Corporation, a stockholder ofthe Company, agreed with the Company to extend the maturity of the $400,000balance remaining under a note purchase agreement originally due December 31,1999 until December 31, 2003.  This notewas given to J.P. Morgan Investment Corporation in extension and partialrenewal of the original note issued pursuant to the note purchaseagreement.  The Company may prepay thisnote at any time at its option.  If theCompany or any of its subsidiaries completes (i) an equity or long-term debtfinancing, (ii) a sale of assets outside the ordinary course of business, (iii)a sale-leaseback or similar financing, or (iv) a joint venture or otherstrategic partnership, and such transaction results in cash proceeds to theCompany in excess of $5 million, then a portion of the amount of such proceedsin excess of $5 million shall be applied to prepay the note.  During 2002, the Company issued warrants toJ.P. Morgan Investment Corporation to purchase 10,000 shares of Common Stockfor $3.00 per share in consideration for extending the term of this indebtedness.  Using the Black Scholes option-pricing modelcalculation, the warrants are valued at $9,200, which will be amortized tointerest expense over the term of the loan. The warrants are exercisable at any time on or prior to December 31,2003.  The number of shares of CommonStock and the exercise price are subject to adjustment as provided in thewarrants. J.P. Morgan Investment Corporation may transfer the warrants at itsoption.

 

On July 30, 2002, the Company entered into a bridge financing agreementwith ten accredited investors for the sale and issuance of 10 “units” to theinvestors for an aggregate purchase price of $1,000,000.  Each unit consists of a convertiblepromissory note in the amount of $100,000 and 25,000 unregistered shares of theCompany’s common stock.

 

Pursuant to the bridge financing agreement, the Company is required touse reasonable efforts to register the shares of common stock comprising theunits within 60 days after the execution of the bridge financing agreement, oras soon as practicable thereafter.  TheCompany has not registered these shares of common stock yet.  Upon registration of the common stock, eachinvestor may not sell more than one-third of the common stock comprising theunits during any calendar month.  The convertiblepromissory notes comprising the units bear interest at an annual rate of 7% andmature on July 30, 2005.  On each ofJuly 30, 2003, July 30, 2004 and July 30, 2005, the investors have the optionto convert one-third of the principal amount of the notes into common stock ofthe Company.  The conversion price ofthe notes is initially 65% of the average closing price of a share of theCompany’s common stock for the 20 trading days preceding the given anniversarydate of the notes.  The maximum conversionprice shall be $4.00 per share and the minimum conversion price shall be $1.00per share.  The conversion price will besubject to adjustment from time to time to reflect any reorganization,recapitalization, reclassification, stock dividend, stock split, reverse stocksplit or similar change in the Company’s shares of common stock.  The notes may be prepaid in whole or in partby the Company without premium or penalty.

 

In connection with this bridge financing, the Company recorded a$1,000,000 debt discount due to the value of the equity consideration andbeneficial conversion of the financing, pursuant to the guidance issued by theEmerging Issues Task Force.  The debtdiscount will be amortized using the effective interest method over the three-yearlife of the agreement.

 

On January 12, 2001, the Company entered intoa 9.0% convertible demand note (“9% Demand Note”) with VennWorks. During theyear ended December 31, 2001, the Company borrowed $4,392,149 under this note.The principal outstanding under this note may be converted into securities ofthe Company at the option of VennWorks. The borrowings are unsecured and aredue and payable on demand by VennWorks. During 2001, VennWorks converted$3,680,000 of the principal balance of the 9% Demand Note and $80,000 ofaccrued interest on the demand notes due to VennWorks into 376 shares of Series2000 Preferred Stock, leaving a balance of $803,255 outstanding under the 9%Demand Note at December 31, 2001 and December 31, 2002.

 

The Company entered into a 6.75% convertiblenote with Amphion Ventures L.P. (“Amphion Ventures”), dated February 28, 2002.During the twelve months ended December 31, 2002, the Company borrowed$1,255,000 under this note. The principal outstanding under this note may beconverted into securities of the Company at the option of Amphion Ventures. Theborrowings are unsecured and are due and payable on demand by Amphion Ventures.

 

F-15

----

 

 

The Company entered into a 6.75% convertible note with AmphionInvestments LLC dated January 25, 2002. During the twelve months ended December31, 2002, the Company borrowed $355,000 under this note. The principaloutstanding under this note may be converted into securities of the Company atthe option of Amphion Investments. The borrowings are unsecured and are due andpayable on demand by Amphion Investments.

 

The Company entered into a 6.75% convertible note with VennWorks LLCdated February 14, 2002. During the twelve months ended December 31, 2002, theCompany borrowed $814,000 under this note. The principal outstanding under thisnote may be converted into securities of the Company at the option ofVennWorks. The borrowings are unsecured and are due and payable on demand byVennWorks.

 

On November 14, 2001, the Company enteredinto a 4.5% convertible demand note with Amphion Ventures. During 2001, theCompany borrowed $300,000 under this note, leaving a balance of $300,000outstanding at December 31, 2001 and December 31, 2002. The principal outstandingunder this note may be converted into securities of the Company at the optionof Amphion Ventures. The borrowings are unsecured and are due and payable ondemand by Amphion Ventures.

 

On June 29, 2001, Amphion Ventures, L.P.elected to convert $580,000 of the outstanding principal balance and $140,000of accrued interest of a 10% note payable, dated April 30, 1998, issued by theCompany to Amphion Ventures, L.P. into 72 shares of the Company’s Series 2000Non-Voting Preferred Stock, par value $.01 per share (the “Series 2000Preferred Stock”).

 

**(11) Preferred Stock**

 

The Company has authorized 7,000,000 shares of convertible preferredstock, of which shares designated in four series have been issued. Informationwith respect to the series of preferred stock outstanding at each balance sheetdate is summarized below.

 
|                                                                    |              | **Series C**                        |   | **Series I**                         |   | **Series J**                             |   | **Series 1999**                      |   |
|-------------------------------------------------------------------------|-------------------|-------------------------------------|--------|--------------------------------------|--------|------------------------------------------|--------|--------------------------------------|--------|
| Number of shares authorized                                             |              | 1,500,000                           |   | 2,500                                |   | 2,500                                    |   | 2,500                                |   |
|                                                                    |              |                                |   |                                 |   |                                     |   |                                 |   |
| Stated value                                                            |              | $                                   | 30.20  |                                 | $      | 10,000                                   |   | $                                    | 10,000 |   | $ | 10,000 |   |
|                                                                    |              |                                |   |                                 |   |                                     |   |                                 |   |
| Number of shares issued and outstanding:                                |              |                                |   |                                 |   |                                     |   |                                 |   |
|                                                                    | December 31, 2001 |                                | 11,522 |                                 | 177    |                                     | 177    |                                 | 152    |   |
|                                                                    | December 31, 2002 |                                | 11,522 |                                 | 125    |                                     | 177    |                                 | 152    |   |
|                                                                    |              |                                |   |                                 |   |                                     |   |                                 |   |
| Conversion ratio (or conversion price) of  preferred shares into common |              | 1 to 1 into voting common stock     |   | $ 2.51 into voting common stock |   | $ 2.51 into non-voting common stock |   | $ 2.51 into voting common stock |   |
|                                                                    |              |                                |   |                                 |   |                                     |   |                                 |   |
| Liquidation preference                                                  |              | Stated value plus accrued dividends |   | Stated value plus accrued dividends  |   | Stated value plus accrued dividends      |   | Stated value plus accrued dividends  |   |
|                                                                    |              |                                |   |                                 |   |                                     |   |                                 |   |
| Dividend rights                                                         |              | 10% per annum, cumulative           |   | 8% per annum, cumulative             |   | 8% per annum, cumulative                 |   | 8% per annum, cumulative             |   |
|                                                                         |                   |                                     |        |                                      |        |                                          |        |                                      |        |  |  |  |  |  |

 

*(a) Series A, Series B and Series C Convertible Preferred Stock*

 

As of December 31, 2001 and December 31, 2002, the Company had noSeries A or Series B Convertible Preferred shares outstanding.  The holders of the Company’s Series CPreferred Stock are entitled to receive quarterly dividends on each such shareheld at the annual rate of 10% of the original issue price of each sharepayable in arrears, when, as and if declared by the Company’s board ofdirectors, in cash or additional shares of preferred stock at the option of theholder.

 

During 2002 and 2001, the Company issued (a)0 and 6,664 shares, respectively, of Series A Preferred Stock to holdersthereof as payment in full for $0 and $173,288, respectively, of accrued, butunpaid dividends on the Series A Preferred Stock, (b) 0 and 6,102 shares, respectively,of Series B Preferred Stock to the holders thereof for $0 and $173,288,respectively, of accrued but unpaid dividends of the Series B Preferred Stockand (c) 0 and 3,497 shares, respectively, of Series C Preferred Stock to theholders thereof for $0 and $105,591, respectively, of accrued, but unpaiddividends on the Series C Preferred Stock. Dividends payable of $ 53,051 and$17,781 for Series C Preferred Stock were accrued at December 31, 2002 andDecember 31, 2001, respectively.

 

F-16

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During 2001, the Amphion Group converted70,356 shares of Series A, 64,410 shares of Series B, 31,087 shares of SeriesC, 557 shares of Series I, 1,998 shares of Series J, and 1,804 shares of Series2000 Preferred Stock into an aggregate of 12,339,745 shares of the Company’scommon stock.

 

*(b) Series Iand J Convertible Preferred Stock*

 

Each Share of Series I Preferred Stock andSeries J Preferred Stock are convertible in whole or in part at any time at theoption of the holder into a number of shares of voting or non-voting commonstock of the Company, respectively, equal to the quotient of (a) the aggregateoriginal issue price of $10,000 per share divided by (b) the conversion priceof $2.51 per share. The Series I Preferred Stock and the Series J PreferredStock are both subject to the optional redemption at any time by the Company,in whole or in part, at a redemption price per share equal to the stated value,plus any accrued, but unpaid dividends thereon. The Company’s optional right ofredemption is subject to each Series I. Preferred Stock or Series J PreferredStockholder’s right to convert such Series I Preferred Stock or Series JPreferred Stock into voting or non-voting common stock, as the case may be, withinten business days after the Company’s notice of redemption.

 

The Series I Preferred Stock and the Series JPreferred Stock are also subject to the mandatory conversion by the Companyinto shares of the Company’s voting or non-voting common stock, as the case maybe, if the closing bid price of the Company’s common stock on the NASDAQSmallCap Market is at least $10.00 per share for a period of at least ninety(90) consecutive trading days. Although the Company’s non-voting common stockmay be converted to common stock at any time by a holder thereof, AmphionVentures has agreed not to convert any shares of non-voting common stock tovoting common stock without the prior consent of the Company.

 

The dividends on the Series I Preferred Stockand the Series J Preferred Stock are payable semi-annually in cash oradditional shares of preferred stock at the Company’s option. During 2002 and2001, the Company issued (a) 0 and 47 shares, respectively, of Series IPreferred Stock to holders thereof as payment in full for $0 and $461,147,respectively, of accrued but unpaid dividends on the Series Preferred Stock and(b) 0 and 164 shares, respectively, of Series J Preferred Stock to holdersthereof as payment in full for $0 and $1,632,662, respectively, of accrued, butunpaid dividends on the Series J Preferred Stock. As the shares of the Series Iand Series J granted were converted into shares of common stock at a price lessthan the fair market value of the common stock on the date of issue, theCompany recorded additional preferred stock dividends of $568,086 in 2001.Dividends payable of $271,810 and $7,501 for Series I and J Preferred Stockwere accrued at December 31, 2002 and 2001, respectively.

 

The holders of Series I Preferred Stock, Series J Preferred Stock, andSeries 1999 Voting Preferred Stock are entitled to receive semi-annualdividends on each such share at the annual rate of 8% of the original issueprice of each share payable in arrears, when, as and if declared by theCompany’s board of directors, in cash or additional shares of preferredstock.   Shares of Series I PreferredStock, Series J Preferred Stock and Series 1999 Preferred Stock are convertibleinto shares of common stock at a conversion price of $2.51 per share.

 

On July 25, 2002 the Company received notice from J.P. MorganInvestment Corporation, a current stockholder of the Company, to convert 52shares of Series I Preferred Stock into a 207,477 fully paid and non-assessableshares of voting Common Stock of the Company. The 52 shares had a stated value of $10,000 per share and were convertedat $2.51 per share.

 

*(c) Series 1999and 2000 Preferred Stock*

 

In connection with the purchase of the Prismvideo assets during 1999, the Company issued 125 shares of Series 1999Preferred Stock (“Series 1999 Preferred Stock”). Dividends arepayable-semi-annually in cash or in additional shares of Series 1999 PreferredStock at the option of the Company.

 

The shares of common stock which Prism mayacquire upon conversion of the Series 1999 Preferred Stock are subject to athree-year lockup from the date of the closing, which maybe reduced to twoyears upon the occurrence of certain events

 

During 2001, VennWorks elected to convert$3,760,000 of borrowings and interest (Note 10) into 376 shares of the Company’sSeries 2000 Preferred Stock. As the shares of 2000 Preferred Stock granted wereconvertible into shares of common stock at a price less than the fair marketvalue of the common stock at the respective issuance dates, the Companyrecorded additional preferred stock dividends of $1,744,000 in 2001.

 

On June 29, 2001, Amphion Ventures, L.P.elected to convert $580,000 of the outstanding principal balance and $140,000of accrued interest of a 10% note payable, dated April 30, 1998, issued by theCompany to Amphion Ventures, L.P. into 72 shares of the Company’s Series 2000Non-Voting Preferred Stock. As the shares of Series 2000 Preferred Stock issuedwere convertible into shares of common stock at a price less than the fairmarket value of the common stock on the date of issuance, the Company recordedadditional preferred stock dividends of $185,143.

 

F-17

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During 2001, the Company issued 12 shares and119 shares of Series 1999 and Series 2000 Preferred Stock, respectively, to itspreferred stockholders for payment of accrued dividends totaling $1,302,992. Asthe shares of Series 1999 and 2000 Preferred Stock issued were convertible intoshares of common stock at a price less than the fair market value of the commonstock on the date of issuance, the Company recorded additional preferred stockdividends of $648,436.

 

In addition, 2,500 shares of Series 1999Non-Voting Preferred Stock were authorized in 1999 in connection with theAmphion convertible note. Through December 31, 2002, no shares had been issued.

 

During 2001, all of the shares of theCompany’s Series 2000 Preferred Stock were converted into common shares.  As of December 31, 2002 there are nooutstanding shares of the Series 2000 Preferred stock.

 

During 2001, all but 152 shares of theCompany’s Series 1999 Preferred Stock were converted into common stock.  As of December 31, 2002 there were 152shares outstanding.  The Company hasaccrued $122,922 of dividends for the Series 1999 Preferred Shares.

 

All series of preferred stock rank senior inright of payment to the Company’s common stock and on a parity with all seriesof preferred stock as to dividends or upon a liquidation or dissolution of theCompany.

 

**(12) Employee BenefitPlans**

 

The Company sponsors a 401(k) retirementplan. The Company, at its discretion, matches a portion of the participant’scontribution. Participants are vested in the Company’s matching contributionafter 4 years of full time service and may join the plan January or July ofeach year. Matching contribution expense was $13,000 in 2001. The Companysuspended its matching contribution on February 28, 2001.

** **

**(13) Stock Optionsand Warrants**

 

*(a) StockOption Plans.*

 

Under the Company’s 2001Equity IncentivePlan, the Company may grant up to 2,000,000 shares of common stock to itsemployees. The exercise price of each option is not less than the market priceof the Company’s stock on the date of grant and an option’s maximum term is tenyears. Options granted vest over a four-year period. The Company has issuedstock options to various members of the Board of Directors and officers of theCompany under this plan. Options are generally granted each year and havevarious vesting requirements. During 2002 and 2001, the Company made grants of200,000 and 0 options, respectively, as an inducement for the employment ofcertain officers of the Company, which do not reduce the 2,000,000 optionsavailable for grant under the stock option plan.

 

In 1998, the Company adopted a director compensationplan pursuant to which it pays each director who is not employed by the Companyand who does not beneficially own more than 5% of the shares of common stockoutstanding an annual grant of 5,000 options to acquire common stock of theCompany at an exercise price equal to the fair market value per share of thecommon stock at the time the option is granted (the “Annual Grant”). The AnnualGrant customarily occurs on the date of the Company’s annual meeting. Thedirector compensation plan also provided for an one-time initial grant of15,000 to each director of the Company as of July 21, 1998, the date thedirector compensation plan was approved by the Company’s stockholders (the“Initial Grant”). The Company has authorized 150,000 shares for issuance underthis plan.

 

Stock option transactions for the years endedDecember 31, 2002 and 2001 are summarized below:

 
|                                                |   | **2002**    |   | **2001**                               |   |
|-----------------------------------------------------|--------|-------------|--------|----------------------------------------|--------|
|                                                |   | **OPTIONS** |   | **WEIGHTED  AVERAGE  EXERCISE  PRICE** |   | **OPTIONS** |   | **WEIGHTED  AVERAGE  EXERCISE  PRICE** |   |
| Options  outstanding at beginning of year           |   | 2,060,537   |   | $                                      | 3.81   |   | 1,702,238 |   | $ | 3.79 |   |
| Options  granted                                    |   | 1,031,000   |   | 2.03                                   |   | 612,224 |   | 3.78 |   |
| Options  exercised                                  |   | —      |   | —                                 |   | (41,948 | ) | 2.67 |   |
| Options  forfeited                                  |   | (915,538    | )      | 3.26                                   |   | (211,977 | ) | 3.61 |   |
|                                                |   |        |   |                                   |   |   |   |   |   |
| Options  outstanding at end of year                 |   | 2,175,999   |   | 3.20                                   |   | 2,060,537 |   | 3.81 |   |
|                                                |   |        |   |                                   |   |   |   |   |   |
| Options  exercisable at end of year                 |   | 688,272     |   | 3.09                                   |   | 524,311 |   | 3.12 |   |
|                                                |   |        |   |                                   |   |   |   |   |   |
| Options  available for grant at the end of the year |   | 974,001     |   |                                   |   | 839,463 |   |   |   |
|                                                     |        |             |        |                                        |        |  |  |  |  |  |  |

 

The options outstanding at December 31, 2002have exercise prices as indicated in the table below.
| **Option Price** |   | **Number of Options** |   | **Weighted Average  Remaining Life** |   |
|------------------|--------|-----------------------|--------|--------------------------------------|--------|
| $1.70 - $3.00    |   | 1,517,627             |   | 7.72                                 |   |
| $3.01 - $4.50    |   | 254,656               |   | 8.00                                 |   |
| $4.51 - $6.25    |   | 403,716               |   | 7.50                                 |   |
| Total            |   | 2,175,999             |   | 7.73                                 |   |

 

 

F-18

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(b) Statement of Financial AccountingStandard No. 123 (“FAS 123”)

 

FAS 123 requires disclosure of pro forma netearnings and net earnings per common share information computed as if theCompany had accounted for its employee stock options under the fair valuemethod set forth in FAS 123. The fair value of the Company’s outstanding stockoptions was estimated at the date of grant using a Black-Scholes option-pricingmodel with the following weighted average assumptions:

 
|                           |   | **YEARS ENDED DECEMBER 31,** |   |
|--------------------------------|--------|------------------------------|--------|
|                           |   | **2002**                     |   | **2001** |   |
| Expected  option life in years |   | 5.00                         |   | 5.00 |   |
| Risk-free  interest rate       |   | 5.00                         | %      | 4.65 | % |
| Volatility  factor             |   | 91                           | %      | 84 | % |

 

The Company does not have a history of payingcash dividends and none have been assumed in estimating the fair value of itsoptions.

 

The Black-Scholes option valuation model wasdeveloped for use in estimating the fair value of traded options, which have novesting restrictions and are fully transferable. In addition, option valuationmodels require the input of highly subjective assumptions including expectedstock price volatility. Because, among other things, changes in the subjectiveinput assumptions can materially affect the fair value estimate, inmanagement’s opinion, the existing models do not necessarily provide a reliablemeasure of the fair value of its employee stock options. For purposes of proforma disclosures, the estimated fair value of the options is amortized toexpense over the options’ vesting periods.

 
|                                                            |   | **YEARS ENDED DECEMBER 31,** |   |
|-----------------------------------------------------------------|--------|------------------------------|--------|
|                                                            |   | **2002**                     |   | **2001** |   |
| Pro forma net  loss applicable to common stock                  |   | (6,349,826                   | )      | $ | (20,343,302 | ) |
|                                                            |   |                         |   |   |   |
| Pro forma  basic and diluted net loss per share                 |   | $                            | (0.39  | ) | $ | (4.84 | ) |
|                                                            |   |                         |   |   |   |
| Weighted  average fair value of options granted during the year |   | $                            | 1.81   |   | $ | 2.60 |   |

 

The Company has issued warrants to purchasecommon stock in connection with issuance of notes payable to stockholders,convertible debentures, and preferred stock. The following table summarizeswarrants outstanding at December 31:

 
| **2002**     |   | **2001**           |   |
|--------------|--------|--------------------|--------|
| **WARRANTS** |   | **EXERCISE PRICE** |   | **EXPIRATION** |   | **WARRANTS** |   | **EXERCISE PRICE** |   | **EXPIRATION** |   |
| 1,261,358    |   | $2.10 - 10.00      |   | 07/04 - 09/06 |   | 1,181,358 |   | $2.10 - 10.00 |   | 07/04 - 09/06 |   |
|         |   |               |   |   |   | 47,481 |   | 10.01 - 20.00 |   | 07/02 - 12/02 |   |
| 1,228,839    |   |               |   |   |   | 1,228,839 |   |   |   |   |   |

 

**(14) Contingencies**

 

In Charles Martin v. AXCESS, Inc., JAMSArbitration filed on or about October 2001, Charles Martin, a former employeeof the Company, asserted that he had good cause to terminate his employmentunder his employment agreement and is owed $300,000 in contractual severancepay. The arbitrator ruled in November 2002, that Mr. Martin had no basis forhis claim and the Company owed him no additional amounts.  In Stephen L. Briggs v. AXCESS, Inc., JAMSArbitration filed on October 2, 2001, Stephen Briggs, a former employee of theCompany, asserted that he had good cause to terminate his employment under hisemployment agreement and is owed $300,000 in severance pay.   In January 2002, Mr. Briggs signed arelease and dropped his request for arbitration and the Company owed him nopayment.

 

Barth Technologies Incorporated (“BTI”),filed a lawsuit against the Company in state district court in Tarrant County,Texas on October 18, 2001. BTI was a vendor to the Company and seeks damages of$263,655 for non-payment for services and supplies provided. During the firstquarter of 2003, the Company reached a tentative settlement in this case andshould become final during the second quarter of 2003.

 

Pioneer Standard Electronics, Incorporated("Pioneer"), filed a lawsuit against the Company in the county courtin Dallas County, Texas on September 28, 2001. Pioneer was a vendor to the Company and seeks damages of $81,533 fornon-payment for services provided. During the first quarter of 2003, Pioneer was granted a judgment for theentire amount.  The Company isattempting to settle this claim, but has limited resources to do.  Other similar cases have been filed againstthe Company with claims aggregating $196,493. At December 31, 2002, the Company has accrued the deliquent amountspayable for the claims described in this paragraph.

 

F-19

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**(15) Income Taxes**

 

Due to the Company’s losses, no income taxexpense was recorded for the years ended December 31, 2002 and 2001. AtDecember 31, 2002 and 2001, the Company had a net operating loss carryforwardof approximately $38,600,000 and $33,700,000, respectively for U.S. federalincome tax purposes. The net operating loss will begin expiring in 2003. OnDecember 31, 2002 and 2001 the tax benefit of the Company’s federal netoperating loss carryforwards (approximately $13,500,000 and $11,800,000,respectively) and certain other deferred tax assets (approximately $1,700,000and $1,500,000, respectively), have been fully offset by a valuation allowance,because the Company cannot currently conclude that it is more likely than notthat the benefits will be realized. The valuation allowance increased byapproximately $1,900,000 and $1,400,000 during 2002 and 2001, respectively. Achange in ownership, as defined for purposes of the Internal Revenue Code,occurred in 1996 and the Company believes that a subsequent ownership changeoccurred during 1998, each of which limit the annual utilization of the U.S.federal net operating loss carryforward under the applicable Internal RevenueService.

 

F-20

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#### **Exhibit Index**

 
| **Exhibit No.** |   | **Description**                                |
|-----------------|--------|------------------------------------------------|
| 13.3            |   | Certificate for Renewal and Revival of Charter |
| 21.1            |   | —Subsidiaries of the Company.*            |
| 23.1            |   | Consent of Hein & Associates LLP.          |
| 23.2            |   | Consent of Ernst & Young LLP.*             |

 

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* Filed herewith.

 

F-21

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