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UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K

Annual Report Pursuant to Section 13 or 15(d) of the SecuritiesExchange Act of 1934For the fiscal year ended December31,  2005

Commission File Number: 1-13591

AXS-ONE INC.

(Exact name ofregistrant as specified in its charter)

|                                                               |  |                                  |  |        |  |  |  |  |  |  |
|---------------------------------------------------------------|--|----------------------------------|--|--------|--|--|--|--|--|--|
| Delaware                                                      |  | 13-2966911                       |  |   |
| (Stateor other jurisdiction of incorporation or organization) |  | (IRSEmployer Identification No.) |  |   |
| 301 Route 17 North,Rutherford, New Jersey                     |  | 07070                            |  |   |
| (Address of principal executiveoffices)                       |  | (ZipCode)                        |  |   |
|                                                               |

201-935-3400(Registrant'stelephone number, including area code)

Securities RegisteredPursuant to Section 12(b) of the Act:

|                            |  |                                          |  |  |  |  |
|----------------------------|--|------------------------------------------|--|--|--|--|
| Title of each class        |  | Name of eachexchange on which registered |
| Common Stock$.0l par value |  | American StockExchange                   |
|                            |

Securities Registered Pursuant toSection 12(g) of the Act:None

Indicate bycheck mark if the Registrant is a well-known seasoned issuer, asdefined in Rule 405 of the Securities Act.

YES    NO 

Indicate by check markif the Registrant is not required to file reports pursuant to Section13 or Section 15(d) of the Act. 

YES    NO 

Indicate by check markwhether the Registrant: (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the Registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

YES    NO 

Indicate by check markif disclosure of delinquent filers pursuant to Item 405 of RegulationS-K is not contained herein, and will not be contained, to the best ofRegistrant's knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K orany amendment to this Form 10-K. 

Indicate by check mark whether the Registrant is anaccelerated filer (as defined in Exchange Act Rule 12b-2).

YES     NO 

Indicate by check mark whether the Registrant is ashell company as defined in Rule 12b-2 of the Exchange Act).

YES     NO 

The aggregate market value of the voting andnon-voting common equity held by non-affiliates of the Registrant,based upon the closing sale price of Common Stock on June30,  2005 (the last business day of the Registrant’s mostrecently completed second fiscal quarter) as reported on the AmericanStock Exchange, was approximately $53.1  million. Shares of CommonStock held by each officer and director of the outstanding Common Stockhave been excluded in that such persons may be deemed to be affiliates.This determination of affiliate status is not necessarily a conclusivedetermination for other purposes.

As of March  7,2006, Registrant had outstanding 34,347,152 shares of CommonStock.

DOCUMENTS INCORPORATED BY REFERENCE

Items 10, 11, 12, 13 and 14 of Part III are incorporatedby reference from a portion of the Registrant's definitive proxystatement to be furnished to stockholders in connection with the 2006Annual Meeting of Stockholders.

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PART I

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| Item 1.  | Business |

This Report containsstatements of a forward-looking nature within the meaning of the safeharbor provisions of Section 27A of the Securities Act of 1933, asamended, and Section 21E of the Securities Exchange Act of 1934, asamended, relating to future events or future financial results of theCompany. Investors are cautioned that such statements are onlypredictions and that actual events or results may differ materially. Inevaluating such statements, investors should specifically consider thevarious factors identified in this Report which could cause actualevents or results to differ materially from those indicated by suchforward-looking statements, including the matters set forth in‘‘Risk Factors’’ below.

General

AXS-One Inc. (‘‘AXS-One’’ or the‘‘Company’’) is a software company providingrobust, secure business solutions that allow an organization to reducethe inherent risks associated with retaining and managing corporaterecords as well as to achieve efficiency in its business processes andto extend those efficiencies to its customers, suppliers, and businesspartners. AXS-One has a proven track record in developing flexible,high-performance, scalable, secure and effective business solutions forGlobal 2000 organizations. AXS-One’s ability to quickly identifyemerging market opportunities and to build high-quality, innovativesolutions has won many awards over the years. The Company has devotedsignificant resources to developing new products which serve theContent Archival, Records Management, Compliance Management,E-Discovery, and Information Management Markets.

AXS-Onebelieves that changes in the scope and complexity of the corporateregulatory, governance, privacy and legal environment havesignificantly altered how organizations are doing, and are required todo, business. Organizations are re-evaluating their softwarerequirements to invest in solutions that ensure operational efficiencyand competitive advantage while enabling them to address and satisfytheir requirements for corporate governance, regulatory compliance,legal discovery and privacy of information. AXS-One’s approachallows organizations to meet these requirements by leveraginginvestments in existing systems to extend them with collaborative webservices and business components that automate business processesacross corporate boundaries. This results in manageable investments,quick implementation schedules and a more rapid return oninvestment.

AXS-One has two main product lines:

Records Compliance Management – AXS-OneCompliance PlatformTM — an integrated solution thatenables organizations to manage growing volumes of disparate electronicrecords, including e-mail and instant messages, images, voice, officedocuments, ERP-generated data such as SAP and electronic print reports.All records are archived and managed according to corporate recordspolicies from initial capture and indexing through archival, search andultimate destruction. These products have been developed and optimizedto address global issues of regulatory compliance, corporategovernance, supervision and privacy as they relate to the retention anddisposition of electronic records, as well as to significantly reduceinfrastructure costs (primarily storage and associated managementcosts). Patent-pending search technology enables organizations torespond quickly and accurately to the growing pressures of e-discoveryand litigation support.

FinancialManagement – AXS-One® Enterprise Financials — acomprehensive suite of financial management solutions for a broad rangeof industries designed to address accounting, time and expensemanagement, financial reporting, performance management and corporategovernance.

Distribution

AXS-One markets its productsworldwide through a direct sales force located in the United States,the United Kingdom, South Africa, Australia, Singapore, Hong Kong andTaiwan. During 2005, the Company announced a number of partnerships,establishing an indirect sales channel through global partnership andlocal reseller agreements. For fiscal year 2005, AXS-One generated$1.4  million or 25.6% of license revenues from itsdistributors. For further information, see ‘‘StrategicAlliances and Business Development Programs’’. Informationspecific to the two product lines are presented in Note 10 to theConsolidated Financial Statements.

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Products

AXS-One RecordsCompliance Management Solutions

The AXS-One CompliancePlatform is an integrated solution that enables organizations tosecurely capture, index, archive, share, search, supervise and managethe retention and disposition of electronic records, including e-mailand instant messages, images, voice, office documents, ERP-generateddata such as SAP and electronic print reports. These products have beendeveloped and optimized to address global issues of regulatorycompliance, corporate governance, supervision, legal discovery andprivacy as they relate to the retention and disposition of electronicrecords.

The basis for this solution is AXS-One Central, adigital archiving solution that provides a centralized and highlyscalable repository designed for long term secure storage andmanagement of massive volumes (terabytes) of disparate data. Originallylaunched in 1993 as ‘‘COOLTM’’, AXS-OneCentral has been implemented by global financial institutions,including four of the world’s largest financial institutions,for the long term archival of their financial books and records incompliance with SEC Rule 17a-4 under the Securities Exchange Act.Integrated workflow ensures full record integrity by providing a fullaudit trail – ‘‘process chain ofcustody’’ to deliver documented evidence of all interactionduring the life of the record and confirmation that records have notbeen modified. In addition to eliminating paper production,distribution and storage costs, the solutions provide fast, secureonline access to relevant information via a powerful portal that candeliver significant productivity gains to organizations.

Applications built on AXS-One’s set of archiving and workflowproducts have been deployed as electronic bill presentment and documentdelivery solutions (e-delivery), self-service information systems,Internet report publishing and distribution solutions, customer servicesolutions, Internet-enabled information reconciliation solutions, andtransaction confirmation solutions. These solutions are typicallyimplemented in a timely manner, thus providing a rapid time-to-value.During 2005 AXS-One E-Delivery Service, developed for the Europeantravel industry, went live. At the end of 2005, 50 tour operators hadsubscribed to the E-Delivery Service.

During 2005, AXS-Oneannounced further significant development on the AXS-One CompliancePlatform, focusing primarily on performance-based enhancements. Version3.5, featuring Rapid-AXS, was launched in May, and introducedprovisional patent-pending search functionality. Rapid-AXS takesadvantage of grid computing architecture and leverages commodityhardware to deliver what AXS-One believes to be an unmatchedprice-performance ratio. Version 3.5 also introduced a Search Wizard,reducing the potential complexity of searches for non-IT staff andensuring error-proof search capabilities for legal discovery. Finallyin 2005 AXS-One announced AXS-Link for Desktop, a desktop archivingproduct available both as an integrated component of the AXS-OneCompliance Platform, as well as a stand-alone solution.

AXS-Onebelieves that the performance enhancements and additional functionalitymade to the AXS-One Compliance Platform through 2005 continues toprovide it with further competitive advantage, and means that theCompany can offer its customers and prospective customers a broad suiteof solutions that enable them to address their current enterprise needsand to scale to meet their future requirements.

During the year,AXS-One announced a significant number of new customer wins for its RCMtechnology around the world. The contracts were across multipleindustries, including financial services, healthcare, pharmaceutical,manufacturing, retail and government, and represented both competitivewins as well as the initial success of AXS-One’s channelstrategy. (See ‘‘Strategic Alliances and BusinessDevelopment Programs.’’) AXS-One believes that theCompany’s ability to deliver a single, integrated platformcapable of managing large and growing volumes of disparate electronicrecords throughout their lifecycle, as well as its focus on realbusiness requirements as they relate to technology continues todifferentiate the Company from its competitors.

AXS-OneRecords Compliance Management Architecture

The AXS-OneRecords Compliance Management solution suite is based on a single,scalable archive. This architecture provides the ability fororganizations to capture, store, manage and reproduce 

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‘‘states-of-time’’ ondemand: to reproduce, via a single platform, records such as e-mail,instant message, desktop/office document (Microsoft Word document orMicrosoft Excel spreadsheet), electronic reports and more, based uponrequest by internal parties, or for satisfaction of external regulatoryaudit or legal discovery requests. This architecture also providessystem level assurance of data and process integrity by delivering fullprocess chain of custody records for the managed data, as well asenabling organizations to recognize operational efficiencies.

AXS-One has focused its architectural requirements on enterprisescalability and performance, and on the ability to handle large,complex requirements for integration within large corporateinfrastructures (which can then be easily applied to meet therequirements of strategic subscription and application serviceproviders (ASP) partners). The Company continues to extend the value ofthe archive with the addition and continued improvements of our WebServices/XML capabilities, that allow our platform to be trulypervasive within an organization, and of applications that deliversignificant value – e-delivery, e-mail and IM archiving,supervision, legal discovery and legal case hold, SAP archiving andrecords management.

In 2005, AXS-One announced a series ofperformance-related enhancements (See AXS-One Records ComplianceManagement Solutions above) which focused on improving theperformance of the AXS-One Compliance Platform to address increasinglycritical processes (ingestion, search and retrieval). AXS-One believesthat scalability and performance, in addition to low total cost ofownership, are increasingly competitive differentiators for its directand indirect (channel) sales opportunities.

AXS-OneRecords Compliance Management Products

Integrated productcomponents are available for: digital archiving; electronicpresentment; e-mail archival and management for Microsoft Exchange,Lotus Notes, Bloomberg Mail and other message types; instant messagingarchival, with specific connectors for products from FaceTime andIMlogic; SAP archival; desktop archiving for content such as wordprocessing and spreadsheet documents; supervision; electronic recordsmanagement; legal discovery and case management.

AXS-OneEnterprise Financials

AXS-One Enterprise Financialsprovide a comprehensive suite of financial management products designedto address accounting, financial reporting, time and expensemanagement, performance management and corporate governancerequirements across the enterprise. With the advent of theSarbanes-Oxley Act of 2002 in the United States, the degree of successor failure of these processes is measured in terms of accuracy, controland accountability as well as speed and efficiency. AXS-One EnterpriseFinancials enable organizations to effectively manage and audit entireprocess lifecycles with proven transactional applications and templatedand automated process workflow. By leveraging AXS-One’s WebServices architecture, solutions can be rapidly deployed andintegrated. They can also be deployed and integrated with other thirdparty applications.

AXS-One’s Enterprise Financialscontinue to be one of the primary back office applications ofworld-class organizations including customers in financial services,life sciences and state and local government.

The Companycontinues to enhance this solution suite to ensure continuedcompatibility with and optimization of current technology, to respondto customer enhancement requests and to ensure continued competitivedifferentiation. During 2005, AXS-One delivered or made availableEnterprise 9.0  − Compliance Edition to its customers.

As well as including customer-requested enhancements to existingcomponents, Enterprise 9.0  – Compliance Editionincludes new functionality designed to help customers more easilycomply with the requirements of Sarbanes-Oxley, including sections 404,103 and 802. The ‘‘duty to preserve’’requirements of Sections 103 and 802 have been addressed by integratingthe AXS-One Enterprise Financials products with the AXS-One CompliancePlatform solution, enabling output generated by any of the Enterprise9.0  – Compliance Edition components to be automatically andsecurely stored and retained in AXS-One Central, AXS-One’sdigital archive solution. This functionality can then be expanded byimplementing 

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additional components of the AXS-OneCompliance Platform including e-mail management, instant messagingmanagement, electronic records management, legal discovery and legalcase management. AXS-One believes that integration of its two productlines to address customers’ critical business issues will notonly address customer satisfaction and customer retention issues forits Enterprise Financial solutions but provide an enhanced platform togenerate future sales opportunities within its current customer basefor its Records Compliance Management product suite.

AXS-OneEnterprise Financials Architecture

AXS-One’se-CelleratorTM architecture includes technology such as WebServices, Simple Object Access Protocol (SOAP), eXtensible MarkupLanguage (XML), Hyper Text Transfer Protocol (HTTP) and otherstandards. The architecture is designed to deliver a highly scalable,flexible environment that runs on industry standard platforms anddatabase systems. As a result, AXS-One’s architecture deliversan adaptable suite of interoperability choices, creating flexibility inintegration and business process management strategies.

Customers can use pre-packaged AXS-One solutions, customize AXS-Onesolutions to meet specific business requirements, connect existingsystems with AXS-One, or build completely new solutions in-house,supported by AXS-One products. Interoperability choices include batchand real-time Web services interfaces, XML documents, reports, e-mail,faxes, images, relational database systems and even websites.

AXS-One Enterprise Financials Products

Integrated productcomponents are available for: General Ledger, Accounts Payable,Accounts Receivable, Purchasing, Fixed Assets, Time and Billing,Encumbrance Accounting and Workflow.

During 2005, AXS-Oneshipped Version 9 – The Compliance Edition of its EnterpriseFinancials suite. Key new functionality included full integration withAXS-One Central specifically to address new data retention requirementsintroduced in the Sarbanes-Oxley Act, a new XML Interface, enhancedreporting with the integration of Crystal Reports and otherenhancements to the Cycle Management product. As well as providingcustomers with additional functionality, the new release enables themto meet their corporate governance needs and regulatory deadlines for2006. A number of customers have already successfully migrated to thisnew release.

Client Services

The Company considers itsClient Services to be a major asset and key differentiator from othervendors. With its 24 x 7 client support, ‘‘ImplementationCertainty’’ methodology, standard and customized trainingand product certification, AXS-One has created a client servicesprogram to handle the needs of its customers and to support its channelpartners.

As of December  31,  2005, the Company had84 employees worldwide providing customer support, consulting andtraining services. To maintain a high standard of service, the Companyrequests customer evaluations of client support personnel on aquarterly basis. The Company's services are described below.

Client Support

Support for domestic U.S. clients isbased out of the Company's corporate headquarters in Rutherford,New Jersey. Client support centers are also based in Johannesburg,London, Singapore, and Sydney. The global support center infrastructurehas been optimized to allow for an effective and efficient‘‘follow the sun’’ 24 x 7 customer supportstrategy. Annual maintenance contracts are generally required for thefirst year of a customer's use of the Company's products, andare renewable on an annual basis. Maintenance contracts entitle thecustomer to hot-line support and all product upgrades released duringthe term of the maintenance contract. Upgrades include any and allpatches or releases related to a licensed software product. Maintenanceis offered at three levels of hot-line support, Platinum, Gold andSilver. Maintenance fees vary depending on the hours of hot-linesupport requested by the customer and typically range between18% and 25% of license fees.

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The Company also provides productmanagement overview and product information bulletins on an ongoingbasis as well as a customer-accessible knowledge base and periodicinformational updates about installed products. The bulletins generallyanswer ‘‘commonly asked questions’’ and provideinformation about new product features. The Company also providesservices for the development of customized documentation about thecustomer's system to reflect, among other things, user-definedmodifications and specific business logic and processes.

Technical Services

The Company offers assistance indeveloping interfaces with third party software or legacy systems.These services are designed to enable the development of additionalclient-specific functionality and to integrate with other missioncritical systems. The Company also provides network troubleshooting andassists its customers in deploying Internet systems, relationaldatabase management systems (RDBMS) software and operating systems.

Consulting Services

The Company's consultingservices organization provides project assurance, business systemsreview, technical design, functional design, business modeling, systemtailoring, system certification, change management and ongoing projectsupport in connection with a customer’s implementation of theCompany's products. Similar services are also provided forupgrades to later versions of the software and migrations to differentoperating platforms. The Company frequently works with third-partyconsultants and system integrators to provide customers with a fullrange of installation, customization and project managementservices.

Education Services

The Companyprovides education services worldwide through its Knowledge Transferorganization. This group is responsible for the development anddelivery of training courses designed to familiarize users with theCompany's products, and to train AXS-One staff and partners inproduct installation, implementation and technical support. In additionto scheduled classroom training, this group delivers standard coursesat customer locations as well as working with customers to createclasses tailored to their specific requirements. Training courses varyin length from one to ten days

Strategic Alliances and BusinessDevelopment Programs

AXS-One’s mission is to be aleading provider of Records Compliance Management solutions, leveragingits expertise in archiving, workflow and compliance gained andmaintained by its strong presence in the Enterprise Financials market.The solutions offered by the Company’s product lines address therequirements of global enterprises across different industries. Inorder to gain market share, further penetrate new and existing marketsectors, establish new geographical markets and leverage best in breedtechnology, the Company realizes that it must leverage not only its ownkey resources but also those of other organizations.

Since itsinception, the Company has established strategic alliances andrelationships with a number of organizations as an integral componentof its go-to-market strategy. The Company believes these relationshipsare important to the development, sales, marketing, integration, andsupport of its products. During 2005, the Company executed against its2004 stated intention to significantly develop its channel sales modelby establishing relationships with leading organizations around theworld.

During 2005, AXS-One announced several partnerships andbegan to recognize revenues from some of these. The most significant ofthese was an announcement in January  2005 with Sun Microsystemswhereby the two organizations entered into a Technology Development andLicense Agreement. Under the terms of the agreement, Sun is marketing,licensing, implementing and supporting the entire AXS-One CompliancePlatform product suite worldwide as well as marketing and supportingthis suite through Sun’s global reseller network. Sun marketsthe AXS-One Compliance Platform as the core component of the SunCompliance and Content Management Solution – an integrated andtested solution 

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that may also include Sun servers, Sun storageand Sun middleware. In September  2005 the AXS-One products, as acomponent of the Sun Compliance and Content Management Solution, wereofficially added as part numbered items to Sun’s own price listand formally announced to the Sun organization. At the end of 2005,AXS-One issued a Sun-endorsed announcement that development work hadbeen completed to replace Sun’s current e-mail archival product– Infinite Mailbox – and to facilitate the migration ofInfinite Mailbox customers to the AXS-One solution. Throughout 2005,Sun and Storagetek closed a number of contracts around the world forthe Sun Compliance and Content Management Solution including apublicized sale at North Fork Bank in the US.

In addition toformalizing and expanding its global relationship with SunMicrosystems, AXS-One has developed relationships around the world withSun resellers and expects to continue this strategy throughout 2006.Initial successes have been recorded in Australia and the US.

Throughout 2005, AXS-One continued to expand its reseller network inAsia, announcing partnerships with organizations in Hong Kong, China,India, Malaysia, the Philippines and Thailand. All resellers have beenfully trained and are fully productive with new sales closed orpending.

Going into 2006, the Company has some 30 resellers in20 countries worldwide including Sun Microsystems, Fujitsu, Siemens andBT.

In response to the growing demand for hosted archivingsolutions and Software as a Service, AXS-One continues to expand itschannel strategy, entering into partnerships in 2005 with BT worldwideand Amerivault in the US. AXS-One expects its 2006 channel strategy toinclude partnership development into this expanding market. See‘‘Risk Factors.’’

ProductDevelopment

The Company has a dedicated product developmentand engineering organization and periodically releases new products andenhancements to existing products. Product development efforts aredirected at increasing product functionality, improving productperformance, providing support to existing products, expanding thecapabilities of the products to inter-operate with third-party softwareand hardware, developing new products and integrating new technologies.In particular, the Company has from time to time devoted substantialresources to develop additional modules for its products and thecapability to support additional platforms, databases, graphical userinterfaces (GUIs), toolsets and emerging technologies. While theCompany anticipates that certain new products and enhancements will bedeveloped internally, the Company has in the past and may continue toacquire or license technology or software from third parties whenappropriate. See ‘‘Risk Factors.’’

As ofDecember  31,  2005, the Company had 58 employees engaged inproduct development and engineering.

Competition

The software markets in which AXS-One is engaged are intenselycompetitive and rapidly changing. A number of companies offer productssimilar to AXS-One’s and target the same customers. The Companybelieves its ability to compete depends upon many factors within andoutside its control, including the timing and market acceptance of newproducts and enhancements developed by the Company and its competitors,product functionality, performance, price, reliability, customerservice and support, sales and marketing efforts and productdistribution. The Company’s AXS-One Enterprise Financials arepositioned in a highly dynamic market, with competition fromtraditional ERP vendors such as the financial applications softwareoffered by SAP, Oracle Corporation (which recently acquired PeopleSoft)Lawson and SSA Global, and others. In light of the current market focuson regulatory compliance, governance and legal discovery, manyorganizations are trying to position themselves as vendors of‘‘compliance’’ solutions. This includestraditional competitors for the Company's AXS-One Central productsuch as IBM and Mobius. It also includes competition from vendors ofpoint solutions (Legato, KVS, iLumin, and IXOS) that have been acquiredby larger vendors – EMC, Veritas (then acquired by Symantec) andOpenText. See ‘‘Risk Factors.’’

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Intellectual Property

TheCompany's success is heavily dependent upon its proprietarytechnologies as well as products from third parties, software vendorsand hardware vendors. The Company regards its software as proprietary,and relies primarily on a combination of contractual provisions andtrade secrets, copyright and trademark law to protect its proprietaryrights. As of December  31,  2005, the Company had no patentsand has one provisional patent application pending. Existing tradesecrets and copyright laws afford only limited protection.

TheCompany has obtained Federal registrations for its trademarks‘‘AXS One®,’’ the distinctive AXS-Onelogo, ‘‘Access Tomorrow Today®,’’‘‘AXSPoint®,’’‘‘TransAXS®,’’ and‘‘Computron®.’’ In addition, the Companyhas certain U.S. common law rights, and rights under foreign laws inrelation to its trademarks, service marks and product names. See‘‘Risk Factors.’’

Employees

Asof December  31,  2005, the Company had 209 full-timeemployees, 132 within the United States and 77 outside the UnitedStates, including 58 in product development and engineering, 84 incustomer service and support, 42 in sales and marketing, and 25 infinance, administration and executive management. The Company'semployees are not covered by any collective bargaining agreements. TheCompany believes that its relations with its employees are good.

Available Information

Our annual report on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K andamendments to those reports are available, without charge, on the SECweb site, www.sec.gov, as soon as reasonably practical afterthey are electronically filed with, or furnished to, the SEC. Theinvestor section of our web site, www.axsone.com, provides adirect link to AXS-One filings with the SEC. Copies are also available,without charge, from AXS-One Inc., Investor Relations, 301 Route 17North, Rutherford, NJ  07070.

Directors, ExecutiveOfficers and Key Management Employees

The currentdirectors, executive officers and key management employees of theCompany as of February  28,  2006, are as follows:

|                           |  |        |    |          |  |                                                                |  |  |  |  |
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| Name                      |  | Age    |    | Position |
| William P. Lyons          |  |   | 61 |     |  | Chairman of the Boardand Chief Executive Officer               |
| Elias Typaldos            |  |   | 55 |     |  | Executive Vice President, Technology andDirector               |
| Joseph Dwyer              |  |   | 50 |     |  | Executive Vice President, Chief Financial Officer andTreasurer |
| Rob Milks                 |  |   | 44 |     |  | SeniorVice President — Sales, Americas                   |
| GennaroVendome            |  |   | 59 |     |  | Director                                                       |
| Daniel H.Burch (1)        |  |   | 54 |     |  | Director                                                       |
| Robert Migliorino (2)     |  |   | 56 |     |  | Director                                                       |
| Allan Weingarten(1)(2)(3) |  |   | 68 |     |  | Director                                                       |
| Anthony Bloom (3)         |  |   | 67 |     |  | Director                                                       |
| HaroldCopperman(1)(2)(3)  |  |   | 58 |     |  | Director                                                       |
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| (1) | Memberof the Audit Committee |

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| (2) | Member of theCompensation Committee |

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| (3) | Member of theNominating Committee |

William P. Lyons joined theCompany as President and Chief Executive Officer in April  2004and was appointed Chairman of the Board on June  10,  2004.Prior to joining the Company, Mr.  Lyons was President and ChiefExecutive Officer of Caminus Corporation, a publicly traded provider ofintegrated enterprise software applications to the global energyindustry from July  2002 until April  2003 when it was

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sold to SunGard Data Systems, Inc. FromApril  2003 until April  2004, Mr.  Lyons served as aconsultant for various pre-public software companies on strategicissues. From January  2001 until July  2002, when it was soldto Rational Software, Mr.  Lyons was President & ChiefExecutive Officer of NeuVis, a technology provider of N-tierapplication development software. From 1998 to 2001, Mr.  Lyonswas President and Chief Executive Officer of Finjan Software, aprivately held vendor of security software solutions. Mr.  Lyonsalso has been CEO of Park Place Systems, an object-oriented toolscompany and Ashton-Tate Inc., a PC database company. He also spent 18years at IBM in a variety of sales and marketing positions mostrecently as VP Software for the PC division.

EliasTypaldos, a founder of the Company, has been Senior Vice President,Research and Development (1978 – 2002) and Executive VicePresident, Technology (2002 – present) of the Company. Mr.Typaldos has also been a director since the Company's formation in1978, and served as Chairman of the Board from March  1997 untilJune  2004.

Gennaro Vendome, a founder of theCompany, had been a Vice President and director since theCompany's formation in 1978. Mr.  Vendome served in variousexecutive positions with AXS-One from 1978 until June  2005,including as Executive Vice President of Sales, Marketing andConsulting for North America from April  2002 until August2004 and Executive Vice President of Business Development untilJune  2005. Mr.  Vendome was Treasurer of the Company from1981 until 1991 and Secretary of the Company from 1982 until 1991.Mr.  Vendome terminated from the Company in June  2005 as anexecutive officer but remains a director of the Company.

Joseph Dwyer joined the Company as Executive Vice President,Chief Financial Officer and Treasurer in December  2004. In 2004,prior to joining the Company, Mr.  Dwyer served as Chief FinancialOfficer of Synergen, Inc, a company engaged in the development andmarketing of enterprise asset management and mobile workforce softwareto utilities, municipalities and asset intensive industries. From 2001to 2003, Mr.  Dwyer served as Executive Vice President and ChiefFinancial Officer of Caminus Corporation, a publicly traded provider ofintegrated enterprise software applications to the global energyindustry, and from 2000 to 2001 he served as Executive Vice Presidentand Chief Financial Officer of ACTV, Inc., a publicly traded digitalmedia company. Prior to ACTV, from 1994 to 2000, Mr.  Dwyer servedas Senior Vice President of Finance for Winstar Communications, Inc., apublicly traded global telecommunications provider.

RobMilks was promoted to Senior Vice President of Sales,America’s in January  2006. Mr.  Milks joined thecompany in October  2005 as Regional Vice President of EasternSales. Mr.  Milks brings over 24 years of successful experiencebuilding and managing multi-million dollar enterprise software salesorganizations. Prior to joining AXS-One, Rob held executive salesmanagement positions at both public and private software companiesincluding BlueRoads Corporation, Selectica, Inc., Intertech InformationManagement, Inc., Shannon Data Systems, Inc. and MicroComputerCorp.

Daniel H. Burch has been a director sinceOctober  1999. Mr.  Burch is the Chairman of the Board, ChiefExecutive Officer and founder of MacKenzie Partners, Inc., a proxysolicitation and mergers and acquisitions firm.

RobertMigliorino has been a director since 1991. Since January1,  2002, Mr.  Migliorino has been a Managing Director andfounding partner of W Capital Management LLC, a private equityinvestment firm. Prior to W Capital, he was a founding partner of theventure capital partnership Canaan Partners, which, through itsaffiliates, was, until early 2000, a principal stockholder of theCompany. Prior to establishing Canaan Partners in 1987, he spent 15years with General Electric Co. in their Drive Systems, IndustrialControl, Power Delivery, Information Services and Venture Capitalbusinesses.

Allan Weingarten has been a director sinceOctober  2000. On December  31,  2003, Mr. Weingartenretired from Jacuzzi Brands, Inc. (formerly U.S. Industries, Inc.), amanufacturer of home and building products, where, since January2001, he was the Senior Vice President and Chief Financial Officer. Hecontinues his work as a private investor and independent businessconsultant that he began in 1995. He is also a director of ProgrammersParadise, Inc.

Anthony Bloom has been a director sinceJune  2005. Mr.  Bloom is an international investor now basedin London. Prior to his relocation to London in July  1988, helived in South Africa where he was 

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the Chairman and Chief Executive Officer ofThe Premier Group, a multi-billion dollar conglomerate involved inagribusiness, retail and consumer products, and a member of the boardsof directors of Barclays Bank in South Africa, Liberty Life Assuranceand South African Breweries. After moving to the United Kingdom in 1988he served as a member of the board of directors of RIT Capital Partnersplc, the publicly traded, London-based investment company chaired byLord Rothschild, and as Deputy Chairman of Sketchley plc. He iscurrently a director of Xantrex Technology Inc., CherokeeInternational, Cortiva Inc., Rio Narcea Limited, and is Chairman ofCineworld UK.

Harold Copperman has been a director sinceSeptember  2005. Mr.  Copperman is currently President andCEO of HDC Ventures, a management and investment group focusing onenterprise systems, software and services. From 1993 to 1999, Mr.Copperman served as Senior Vice President and Group Executive at theDigital Equipment Corp. Mr.  Copperman has also served asPresident and CEO of JWP Information Systems, President and COO ofCommodore Computers, and Vice President and General Manager at AppleComputer. He also spent 20 years at IBM, where he held a variety ofengineering, sales, marketing and executive management positions.Mr.  Copperman is currently on the board of Epicor Software,Avocent Corporation, Metastorm Inc., and WBT Systems.

Each ofthe Directors will be subject to re-election at the 2006 AnnualStockholders meeting.

|                |             |
|----------------|-------------|
| Item 1A.  | RiskFactors |

We have a previous history of net losses.

AXS-One incurred a net loss of $9.0 and $5.2  million for 2005and 2004, respectively, after having generated net income of $2.3million during the year ended December  31,  2003. AlthoughAXS-One generated revenues and reduced costs sufficient to beprofitable in 2003, we were not able to sustain profitability in 2005or 2004 and may not be able to on a quarterly or annual basis in thefuture. As of December  31,  2005, we had an accumulateddeficit of $90.7  million.

AXS-One’s revenue andoperating results have fluctuated and may continue to fluctuatesignificantly from quarter to quarter in the future, causing our commonstock price to be quite volatile and may cause the market price tofall. A variety of factors, many of which are not in our control, causethese fluctuations and include, among others:

|  |              |                                                                                              |
|--|--------------|----------------------------------------------------------------------------------------------|
|  | •  | the proportion of revenues weearn from license fees versus fees for the services we provide, |

|  |              |                                                                                      |
|--|--------------|--------------------------------------------------------------------------------------|
|  | •  | the number of partners sellingour products and their continued willingness to do so, |

|  |              |                                                        |
|--|--------------|--------------------------------------------------------|
|  | •  | the number of third parties weuse to perform services, |

|  |              |                                                                         |
|--|--------------|-------------------------------------------------------------------------|
|  | •  | theamount of revenues we generate from our sale of third partysoftware, |

|  |              |                            |
|--|--------------|----------------------------|
|  | •  | changes in ourproduct mix, |

|  |              |                         |
|--|--------------|-------------------------|
|  | •  | demand for ourproducts, |

|  |              |                                                        |
|--|--------------|--------------------------------------------------------|
|  | •  | the size and timingof individual license transactions, |

|  |              |                                                                      |
|--|--------------|----------------------------------------------------------------------|
|  | •  | the products and enhancementsthat we, or our competitors, introduce, |

|  |              |                                         |
|--|--------------|-----------------------------------------|
|  | •  | changes in our customers’budgets, |

|  |              |                                                                                                                   |
|--|--------------|-------------------------------------------------------------------------------------------------------------------|
|  | •  | potentialcustomers’ unwillingness to undertake major expenditures with usdue to our past operating results, |

|  |              |                                                                           |
|--|--------------|---------------------------------------------------------------------------|
|  | •  | competitive conditions in theindustry and general economic conditions and |

|  |              |                                                 |
|--|--------------|-------------------------------------------------|
|  | •  | unrest in the Middle East orother world events. |

Additionally, clients’licensing of our products is often delayed because:

|  |              |                                                         |
|--|--------------|---------------------------------------------------------|
|  | •  | our clients must commit asignificant amount of capital, |

|  |              |                                                                                                                         |
|--|--------------|-------------------------------------------------------------------------------------------------------------------------|
|  | •  | frequently, a license purchasemust be authorized through the multiple channels within aclient’s organization and, |

10

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|  |              |                                                                                              |
|--|--------------|----------------------------------------------------------------------------------------------|
|  | •  | salesare increasingly driven through our partners, reducing our control overthe sales cycle. |

Because of these reasons, as well as others,our products’ sales cycles are typically lengthy and subject toa number of significant risks over which we often have little or nocontrol which include a customer’s budgetary constraints andinternal authorization reviews.

Historically, AXS-One hasoperated with a small license backlog, since products are generallyshipped as we receive orders. Because our license fees in any quartersubstantially depend on orders booked and shipped in the last month,and often during the last week, of a given quarter our revenues havebeen back end loaded and subject to fluctuation.

Delays in thetiming of when we recognize specific revenues may adversely anddisproportionately affect our operating results because:

|  |              |                                                                      |
|--|--------------|----------------------------------------------------------------------|
|  | •  | a high percentage of ouroperating expenses are relatively fixed, and |

|  |              |                                                                          |
|--|--------------|--------------------------------------------------------------------------|
|  | •  | only a small percentage of ouroperating expenses vary with our revenues. |

Because of thesefactors, we believe that period-to-period comparisons of our operatingresults are not necessarily meaningful and one should not rely onquarter-to-quarter comparisons of our operating results to beindicative of our future performance.

Additionally, our businesshas experienced, and we expect to continue to experience, significantseasonality, due, in part, to our customers’ buying patterns,caused primarily by:

|  |              |                                                            |
|--|--------------|------------------------------------------------------------|
|  | •  | ourcustomers’ budgeting and purchasing patterns, and |

|  |              |                                                                                                                             |
|--|--------------|-----------------------------------------------------------------------------------------------------------------------------|
|  | •  | our sales commission policies.Generally, we compensate our sales personnel based on quarterly andannual performance quotas. |

We expect that these patternswill likely continue in the future.

As a result of thesefactors, in future quarters, our operating results may be significantlylower than the estimates of public market analysts and investors. Anydiscrepancy could cause the price of our common stock to be volatileand to decline significantly. We can give no assurance that we will beprofitable in any future quarter.

The markets in which wecompete are intensely competitive.

AXS-One can give noassurance that we will be able to compete successfully against currentor future competitors or that competitive pressures will not have amaterial adverse effect on our business, operating results andfinancial condition. Our markets are intensely competitive and changingrapidly. A number of companies offer products similar to ours andtarget the same customers. We believe that our ability to competedepends upon many factors, many of which are not in our control,including, among others,

|  |              |                                                                                                             |
|--|--------------|-------------------------------------------------------------------------------------------------------------|
|  | •  | timing and market acceptance ofnew products and enhancements developed by us, as well as by ourcompetitors, |

|  |              |                                                                               |
|--|--------------|-------------------------------------------------------------------------------|
|  | •  | whether ourproducts are reliable, how they function, perform, and are priced, |

|  |              |                                  |
|--|--------------|----------------------------------|
|  | •  | our customer service andsupport, |

|  |              |                                     |
|--|--------------|-------------------------------------|
|  | •  | our sales andmarketing efforts, and |

|  |              |                          |
|--|--------------|--------------------------|
|  | •  | ourproduct distribution. |

AXS-One solutions are positioned in ahighly dynamic market, with competition from traditional ERP vendorssuch as the financial applications software offered by SAP, OracleCorporation (which recently acquired PeopleSoft) SSA Global and others.Additionally, many traditional enterprise resource planning softwareproviders have entered into the e-business marketplace. Traditionalcompetitors for our digital solution are IBM, Systemware, Mobius andothers. The principal competitors in the area of statement presentmentinclude Mobius, and others. The Company’s competitors forrecords and compliance management products include IBM, HP, EMC(Legato), CA (iLumin), OpenText (IXOS), Zantaz and Symantec (KVS).There are also a growing number of smaller, niche vendors targetingspecific areas of this market worldwide.

11

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Most of our competitors are substantiallylarger than us, and have significantly greater financial, technical andmarketing resources, and extensive direct and indirect distributionchannels. As a result, our competitors may be able to respond morequickly to new or emerging technologies and changes in customerrequirements or to devote greater resources to developing, promotingand selling their products than we can. Our products also compete withthose offered by other vendors and with proprietary software developedby third-party professional service organizations, as well as bypotential customers’ management information systemsdepartments.

As our markets continue to develop and expand, weexpect established and emerging companies to compete with us due to therelatively low barriers necessary to enter the software market. Weexpect that competition will also increase as the software industryconsolidates. During 2005, we saw the acquisition trend continue withcompetitors in the records and compliance management market acquired bylarge companies with significantly greater financial and marketingresources than us. Furthermore, we cannot assure anyone that any of thecompanies with whom we currently have relationships, most of which mayhave significantly greater financial and marketing resources than wedo, will not, in the future, develop or market software products thatcompete with our products, or discontinue their relationship or supportof us.

Additionally, our current and potential competitors haveestablished, or may establish in the future, cooperative relationshipsamong themselves or with third parties to increase theirproducts’ ability to address the needs of our prospectivecustomers. Therefore, new competitors or alliances among competitorscould emerge and rapidly acquire a significant market share. Increasedcompetition is likely to result in

|  |              |                                    |
|--|--------------|------------------------------------|
|  | •  | reducing the price of ourproducts, |

|  |              |                                |
|--|--------------|--------------------------------|
|  | •  | reducing our grossmargins, and |

|  |              |                         |
|--|--------------|-------------------------|
|  | •  | losing ourmarket share. |

Any of these factors would adversely affectour business, our operating results and financial condition.

AXS-One depends on a few principal products for itsrevenues.

Substantially all of our revenues are derivedfrom licensing and fees from related services of:

|  |              |                                           |
|--|--------------|-------------------------------------------|
|  | •  | AXS-One Compliance Platformsolutions; and |

|  |              |                              |
|--|--------------|------------------------------|
|  | •  | AXS-OneEnterprise Financials |

We expect that these products and serviceswill continue to account for substantially all of our revenues during2006. Accordingly, our future operating results will depend, in part,on:

|  |              |                                                                  |
|--|--------------|------------------------------------------------------------------|
|  | •  | achieving broader marketacceptance of our products and services, |

|  |              |                                                                                                                                   |
|--|--------------|-----------------------------------------------------------------------------------------------------------------------------------|
|  | •  | expanding our relationships withvendors in the emerging subscription market as well as our Value-AddedReseller network worldwide, |

|  |              |                                                      |
|--|--------------|------------------------------------------------------|
|  | •  | expanding our relationships withsystems integrators, |

|  |              |                                          |
|--|--------------|------------------------------------------|
|  | •  | maintaining our customer base, aswell as |

|  |              |                                                                                   |
|--|--------------|-----------------------------------------------------------------------------------|
|  | •  | enhancing theseproducts and services to meet our customers’ evolving needs. |

During 2005, certain Enterprise Financials customers did not renewtheir annual maintenance, primarily due to our customers being acquiredor merged with companies using other software. We can give no assurancethat this trend will not continue or that we will be able to maintainour existing customers.

Additionally, during 2006, our AXS-OneCompliance Platform solutions need to gain greater market acceptance.If:

|  |              |                                                          |
|--|--------------|----------------------------------------------------------|
|  | •  | demand in the market forour type of software is reduced, |

|  |              |                           |
|--|--------------|---------------------------|
|  | •  | competition increases, or |

12

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|  |              |                                            |
|--|--------------|--------------------------------------------|
|  | •  | salesof such products or services decline, |

any of thesefactors could have a material adverse affect on our business, operatingresults and financial condition.

AXS-One has aconcentration of revenues from certain customers

During thelast three years, AXS-One has generated a significant amount ofrevenues from a select number of customers. Because of the size ofcertain of our customers, it is likely that they will continue togenerate a significant portion of our revenues especially in ourservices revenue area. If any of these customers should discontinuetheir business with us it could have a material adverse affect on ourbusiness, operating results and financial condition. There is noassurance that we would be able to replace these lost revenues withrevenues from new or other existing customers.

For the yearended December  31,  2005, no one customer represented morethan 10% of total revenues. For the year ended December31,  2004, two customers represented 14.6% and10.1%, individually, of total revenues. For the year endedDecember  31,  2003, two customers represented 18.7%and 12.1%, individually, of total revenues. For the year endedDecember  31,  2005, two customers represented 20.2%and 12.2%, individually, of license revenue. No one customerrepresented more than 10% of license revenues for the year endedDecember  31,  2004. License revenues included 29.5%(or 18.2% and 11.3% individually) of revenue from twocustomers in 2003. No one customer represented more than 10% ofservice revenues for the year ended December  31,  2005.Services revenues included 27.2% (or 16.1% and11.1% individually) and 31.9% (or 19.0% and12.9% individually) of revenue from the same two customers in2004 and 2003, respectively.

AXS-One’s marketis characterized by new products frequently being introduced, rapidtechnology changes, product defect risks, and developmentdelays.

If AXS-One is unable, for technological, financialor other reasons, whether or not within its control, to timely developand introduce new products or enhancements to respond to changingcustomer requirements, technological change or emerging industrystandards, our business, operating results and financial conditioncould suffer.

Our software performance, customization, reportingcapabilities, or other business objectives may or may not be affectedby these changes and may or may not render us incapable of meetingfuture customer software demands. Introducing products embodying newtechnologies and emerging new industry standards can render existingproducts obsolete and unmarketable. Accordingly, it is difficult toestimate our products’ life cycles. Our future success willdepend in part on our ability to maintain our AXS-One Enterpriseproducts and to develop and introduce new AXS-One Compliance Platformproducts that respond to evolving customer requirements and keep pacewith technological development and emerging industry standards, such asnew:

|  |              |                    |
|--|--------------|--------------------|
|  | •  | operating systems, |

|  |              |                     |
|--|--------------|---------------------|
|  | •  | hardware platforms, |

|  |              |                                                         |
|--|--------------|---------------------------------------------------------|
|  | •  | new environments such assubscription and ASP providers, |

|  |              |                 |
|--|--------------|-----------------|
|  | •  | interfaces, and |

|  |              |                                               |
|--|--------------|-----------------------------------------------|
|  | •  | third party hardware andapplication software. |

We can give no assurance that:

|  |              |                                                                                                       |
|--|--------------|-------------------------------------------------------------------------------------------------------|
|  | •  | we will be successful indeveloping and marketing product enhancements or new products thatrespond to: |

|  |              |                      |
|--|--------------|----------------------|
|  | •  | technologicalchange, |

|  |              |                                     |
|--|--------------|-------------------------------------|
|  | •  | changes in customerrequirements, or |

|  |              |                             |
|--|--------------|-----------------------------|
|  | •  | emergingindustry standards. |

13

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|  |              |                                                                                                                                                       |
|--|--------------|-------------------------------------------------------------------------------------------------------------------------------------------------------|
|  | •  | wewill not experience difficulties that could delay or prevent oursuccessfully developing, introducing and marketing new products andenhancements, or |

|  |              |                                                                                               |
|--|--------------|-----------------------------------------------------------------------------------------------|
|  | •  | any newproducts or enhancements that we may introduce will be accepted by ourtargeted market. |

Software products as complex as those we offeroften encounter development delays and, when introduced or when newversions are released, may contain undetected errors or may simplyfail. These delays, errors or failures create a risk that the softwarewill not operate correctly and could cause our future operating resultsto fall short of expectations published by certain public marketfinancial analysts or others. From time to time, we develop productsthat are intended to be compatible with various new computer operatingsystems, although we make no assurances that we will successfullydevelop software products that will be compatible with additionaloperating systems or that will perform as we intend. Additionally, ourproducts, technologies and our business in general rely uponthird-party products from various sources including, among others:

|  |              |                               |
|--|--------------|-------------------------------|
|  | •  | hardware and softwarevendors, |

|  |              |                                                |
|--|--------------|------------------------------------------------|
|  | •  | relational databasemanagement systems vendors, |

|  |              |                      |
|--|--------------|----------------------|
|  | •  | ERP software vendors |

|  |              |                            |
|--|--------------|----------------------------|
|  | •  | reporting software vendors |

|  |              |                         |
|--|--------------|-------------------------|
|  | •  | IM software vendors, or |

|  |              |                        |
|--|--------------|------------------------|
|  | •  | e-mail system vendors. |

Inthe future, it is unclear whether our dependence upon these third-partyproducts will affect our ability to support or make our productsreadily available. In the past, we have experienced delays by thirdparties who develop software that our products depend upon. Theseholdups have resulted in delays in developing and shipping ourproducts. Despite testing by our current and potential customers, aswell as by us, errors may be found in new products or enhancementsafter we ship them that can delay or adversely affect marketacceptance. We cannot assure anyone that any of these problems wouldnot adversely affect our business, operating results and financialcondition.

We risk being de-listed from the American StockExchange, which could reduce our ability to raise funds.

Although we are currently in compliance with the continued listingrequirements of the American Stock Exchange, that has not always beentrue in the past, and no assurances can be made that we will continueto be in compliance with those requirements in the future. In the eventthat we were to cease being in compliance with those requirements atsome time in the future, the American Stock Exchange could choose tode-list our stock from trading on that Exchange. If our common stockwere to be de-listed by the American Stock Exchange, we might be unableto list our common stock with another stock exchange. In that event,trading of our common stock might be limited to the OTC Bulletin Boardor similar quotation system.

Inclusion of our common stock onthe OTC Bulletin Board or similar quotation system could adverselyaffect the liquidity and price of our common stock and make it moredifficult for AXS-One to raise additional capital on favorable terms,if at all. In addition, de-listing by the American Stock Exchange mightnegatively impact AXS-One’s reputation and, as a consequence,its business.

In the future, AXS-One may not have sufficientcapital resources to fully carry out its business plans.

Our ability to carry out our future business plans and achieve theanticipated results will be affected by the amount of cash generatedfrom operations. There is also the risk that cash held by our foreignsubsidiaries will not be readily available for use in our U.S.operations as the transfer of funds is sometimes delayed due to variousforeign government restrictions. Accordingly, we may in the future berequired to seek new sources of financing or future accommodations fromour existing lender or other financial institutions, or we may seekequity infusions from private investors. We may also be required tofurther reduce operating costs in order to meet our obligations.

14

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On June  17,  2005, the Companyentered into a definitive agreement with a number of investors as wellas members of AXS-One Management and Board members to sell 4,534,461shares of its common stock for total consideration of $6.8million. On June  21,  2005, the initial closing date, theCompany received net proceeds of approximately $5.8  million fromthe investors and issued 4,081,015 shares of common stock. Thisexcluded amounts due from members of the Company’s managementand Board members which together represented 10% of theinvestment. The closing with respect to the shares being offered tomembers of the Company’s management and Board members wassubject to shareholder approval. The Company also issued, at the sametime, warrants to purchase an aggregate of 408,103 shares of commonstock at $1.90 per share and warrants to purchase 408,095 shares ofcommon stock at $2.15 per share. These warrants are exercisable for aperiod of three years beginning June  21,  2005. Warrants topurchase an additional 45,347 shares of common stock at $1.90 per shareand 45,342 shares of common stock at $2.15 per share were issuable tomembers of the Company’s management and Board member investorsupon approval of the shareholders.

On September  20,2005, the shareholders approved the above sale of the Company’scommon stock and warrants to members of the Company’s managementand Board members. On September  21,  2005, the closing date,the Company received net proceeds of $0.6  million, issued 453,446shares of common stock and warrants to purchase 45,347 shares of commonstock at $1.90 per share and 45,342 shares of common stock at $2.15 pershare.

On August  11,  2004, we entered into atwo-year Loan and Security Agreement(‘‘Agreement’’) with a financial institutionwhich contains a revolving line of credit under which we can borrow thelesser of $4  million or 80% of eligible accounts, asdefined in the Agreement (see Note 2 to the Consolidated FinancialStatements). The Agreement contains certain restrictive financialcovenants. On January  27, March  28 and September13,  2005 we amended the Loan and Security Agreement in order torevise certain terms of the Agreement.

As of September30,  2005, the Company was in compliance with all covenants withthe exception of a monthly ‘‘transition event’’covenant which requires the Company to maintain an adjusted quick ratiogreater than or equal to 1.6 to 1.0. The Company’s adjustedquick ratio at September  30,  2005 was 1.592 to 1.0. OnNovember  7,  2005, the bank granted a waiver on thetransition event covenant as of September  30,  2005 andtherefore did not require the Company to transition to thehigher-interest debt facility. The waiver was for the September30,  2005 date only.

As of December  31,  2005,the Company was in compliance with the adjusted quick ratio covenant of1.35 to 1.0 and transition event covenant, but was not in compliancewith the quarterly earnings before interest, taxes, depreciation,amortization and stock compensation expense(‘‘EBITDAS’’) covenant, which requires theCompany to achieve EBITDAS of the lesser of $1 better than theimmediate preceding quarter EBITDAS or $1. Additionally, as ofNovember  30,  2005, the Company did not achieve its monthly‘‘transition event’’ covenant which requiresthe Company to maintain an adjusted quick ratio greater than or equalto of 1.6 to 1.0. The Company’s adjusted quick ratio atNovember  30,  2005 was 1.44 to 1.0. On February6,  2006, the bank granted a waiver on the quarterly EBITDAScovenant and the November transition event covenant. The EBITDAScovenant waiver was for the quarter ended December  31,  2005only. The transition event waiver was for the November  30,2005 date only.

On March  14,  2006, the Company andthe Bank agreed to extend the loan to February 15,  2007. Allother terms of the loan remain the same.

In each of June2005 and 2004 we initiated cost reduction efforts designed to reduceour operating costs and reduce our need for additional capital. In the future, if we are unsuccessful with increasing revenues andoperating cash flow, we may be required to further reduce our operatingcosts.  We believe we can successfully reduce theCompany’s cost structure in the event of a shortage of capital;however, there can be no assurance that we will be able to reduceoperating costs quickly enough or in amounts sufficient to avoid theneed to find additional sources of financing.  

Noassurance can be given that management’s initiatives to generateprofitable operations will be successful or that any additionalnecessary sources of financing, lender accommodations or equityinfusions will be available. As a result our business, operatingresults and financial condition could be adversely impacted.

15

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AXS-One depends upon its proprietarytechnology and if we were unable to protect our technology, ourcompetitive position would be adversely affected.

Webelieve that our success greatly depends on our proprietary technologyand software. We rely primarily on a combination of trademark andcopyright law, trade secret protection and contractual agreements withour employees, customers, partners and others to protect ourproprietary rights. Despite our efforts to protect our proprietaryrights, unauthorized third parties may attempt to copy all or part ofour products or reverse engineer or obtain and use information that weregard as proprietary. We make our source code available to certain ofour customers, which may increase the likelihood of misappropriation orother misuse of our software. Additionally, the laws of some foreigncountries do not protect our proprietary rights to the same extent asdo the laws of the United States. We cannot assure anyone that thesteps we take to protect our proprietary rights will be adequate orthat our competitors will not independently develop technologies thatare substantially equivalent or superior to ours.

Although webelieve that the trademarks and service marks we use are distinct,there can be no assurance that we will be able to register or protectsuch trademarks and service marks.

Our products may becomesubject to infringement claims.

We believe that none of ourproducts, trademarks, or service marks, technologies or otherproprietary rights infringe upon the proprietary rights of any thirdparties. However, as the number of software products in our industryincreases and the functionality of these products further overlap, webelieve that software developers like us may become increasinglysubject to infringement claims. Additionally, the market in which wecompete has seen an increase in the number of ‘‘businessmethod’’ patents issued, and infringement claims asserted,based on these issued patents. Any claims asserted, regardless of theirmerit, can be time consuming and expensive to defend, could causedelays in shipping our products or require us to enter into royalty orlicensing agreements that may not be available on terms acceptable tous. Any of these factors would significantly impact our operatingresults and financial conditions or materially disrupt the conduct ofour business. We cannot assure anyone that third parties will notassert infringement claims against us in the future with respect to ourcurrent or future products or services.

A security breachcould harm our business.

Our products provide securityfeatures designed to protect its users’ data from beingretrieved or modified without being authorized. While AXS-One continuesto review and enhance the security features in its products, we canmake no assurances concerning the successful implementation of securityfeatures and their effectiveness within a customer’s operatingenvironment. If an actual security breach were to occur, our business,operating results and financial condition could suffer.

Avariety of risks associated with AXS-One’s internationaloperations could adversely affect our business.

Risksinherent in international revenue include the impact of longer paymentcycles, greater difficulty in accounts receivable collection,unexpected changes in regulatory requirements, tariffs and other tradebarriers, and difficulties in staffing and managing foreign operations.In addition, most of our international license fees and servicesrevenues are denominated in foreign currencies which can have an impacton our consolidated revenues as exchange rates fluctuate. Currently, wedo not hedge against foreign currency exchange risks but in the futurewe may commence hedging against specific foreign currency transactionrisks. We may be unable to hedge all of our exchange rate exposureeconomically and exchange rate fluctuations may have a negative effecton our ability to meet our obligations. With respect to ourinternational sales that are U.S. dollar denominated, decreases in thevalue of foreign currencies relative to the U.S. dollar could make ourproducts less price competitive. These factors may have a materialadverse effect on our future international revenue.

We believethat our continued growth and profitability will require AXS-One toexpand its sales in international markets, which require significantmanagement attention and financial resources. As a 

16

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result, we expect that revenues fromcustomers outside the United States will continue to represent asignificant percentage of our total revenues in the future. We cannotassure anyone, however, that we will be able to maintain or increaseinternational market demand for our products and services.

In2005, 2004 and 2003 the Company's total revenues generated by theCompany’s foreign offices were as follows:

|      |  |         |                   |                              |  |        |      |         |  |  |
|------|--|---------|-------------------|------------------------------|--|--------|------|---------|--|--|
| Year |  | $Amount |                   | Percentage of Total Revenues |
| 2005 |  | $       | 11.5 million |                         |  |   | 35.1 | %  |
| 2004 |  | $       | 13.6 million |                         |  |   | 35.3 | %  |
| 2003 |  | $       | 15.0 million |                         |  |   | 37.7 | %  |
|      |

AXS-One is subject toadditional risks related to operating in foreign countries. These risksgenerally include:

|  |              |                                                                           |
|--|--------------|---------------------------------------------------------------------------|
|  | •  | unexpectedchanges in tariffs, trade barriers and regulatory requirements, |

|  |              |                                                    |
|--|--------------|----------------------------------------------------|
|  | •  | costs of localizing products forforeign countries, |

|  |              |                                                             |
|--|--------------|-------------------------------------------------------------|
|  | •  | lack ofacceptance of localized products in foreign markets, |

|  |              |                                           |
|--|--------------|-------------------------------------------|
|  | •  | longer accounts receivablepayment cycles, |

|  |              |                                                |
|--|--------------|------------------------------------------------|
|  | •  | difficultiesmanaging international operations, |

|  |              |                                      |
|--|--------------|--------------------------------------|
|  | •  | potentially adverse taxconsequences, |

|  |              |                                          |
|--|--------------|------------------------------------------|
|  | •  | restrictions onrepatriation of earnings, |

|  |              |                                                           |
|--|--------------|-----------------------------------------------------------|
|  | •  | reduced legal protection of ourintellectual property, and |

|  |              |                                                             |
|--|--------------|-------------------------------------------------------------|
|  | •  | the burden of complying with awide variety of foreign laws. |

Any of these factors, orothers, could adversely affect our future international revenues and,consequently, our business, operating results and financialcondition.

We rely on certain third-partyrelationships.

Our business, product development, operatingresults and financial condition could be adversely impacted if we failto maintain our existing relationships or establish new relationships,in the future, with third parties because of diverging interests, oneor more of these third parties is acquired, or for any other reason,whether or not within our control. We rely on third-party relationshipswith a number of consultants, systems integrators and software vendorsto:

|  |              |                                 |
|--|--------------|---------------------------------|
|  | •  | enhance our productdevelopment, |

|  |              |                              |
|--|--------------|------------------------------|
|  | •  | market and sellour products, |

|  |              |                                     |
|--|--------------|-------------------------------------|
|  | •  | implement oursoftware products, and |

|  |              |                        |
|--|--------------|------------------------|
|  | •  | support our customers. |

These relationships assist our product development processand assist us in marketing, servicing and implementing our products. Anumber of these relationships are not memorialized in formal writtenagreements.

Our products also incorporate software that welicense from third parties. These licenses expire from time to time andgenerally, we do not have access to the source code for the softwarethat a third party will license to us. Certain of these third partiesare small companies without extensive financial resources. If any ofthese companies terminate relationships with us, cease doing business,or stop supporting their products, we may be forced to expend asignificant amount of time and development resources to try to replacethe licensed software. We may also find that replacement is notpossible or commercially feasible. If that were to occur, our business,operating results and financial condition could be adverselyimpacted.

17

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We rely on strategic partners andresellers for a large portion of our new license revenue.

Our strategy has shifted over the past several years to reliance onstrategic partners such as Sun Microsystems and other resellers aroundthe world. A loss of a strategic partner or the inability to maintainproductive reseller relationships could have a significant negativeeffect on our ability to generate new license and related servicerevenue.

AXS-One’s executive officers,directors and affiliates own a significant amount of its commonstock.

This stock ownership may prevent or discourage tenderoffers for our common stock unless these controlling stockholdersapprove the terms of any such offers. As of March  6,  2006,AXS-One’s executive officers, directors and affiliates togetherbeneficially own approximately 20% of our outstanding commonstock. As a result, these stockholders are able to exercise significantinfluence over matters requiring stockholder approval including:

|  |              |                         |
|--|--------------|-------------------------|
|  | •  | electing directors, and |

|  |              |                                                                             |
|--|--------------|-----------------------------------------------------------------------------|
|  | •  | mergers, consolidations, and saleof all or substantially all of our assets. |

AXS-One relies onits key personnel and may have difficulty attracting and retaining theskilled employees it needs to operate successfully.

AXS-One’s future success will depend, in large part, on thecontinued service of its key executives, and if we fail to attract andmaintain those executives, the quality of our products, our business,financial condition and operating results could suffer. We cannotprovide assurances that turnover of our key executives will notcontinue, and that such turnover would not adversely affect ourbusiness, operating results and financial condition.

We alsobelieve that our future success will depend, in large part, on ourability to attract, retain and motivate highly skilled employees, and,particularly, technical, management, sales and marketing personnel.Competition for qualified employees in our industry is intense. AXS-Onehas from time to time in the past experienced, and expects to continueexperiencing, difficulty in hiring and retaining employees withappropriate qualifications. We cannot assure anyone that we will beable to retain our employees or attract or retain highly qualifiedemployees to develop, market, service and support our products andconduct our operations.

AXS-One’s common stocktrading price may be volatile for reasons over which it may have littleor no control.

AXS-One’s common stock trading pricehas, from time to time, experienced, and is likely to continue toexperience, significant price and volume fluctuations, often respondingto, among other factors:

|  |              |                                               |
|--|--------------|-----------------------------------------------|
|  | •  | quarterly variations in ouroperating results, |

|  |              |                                           |
|--|--------------|-------------------------------------------|
|  | •  | the gainor loss of significant contracts, |

|  |              |                                                      |
|--|--------------|------------------------------------------------------|
|  | •  | changes in earnings estimates bysecurities analysts, |

|  |              |                                                                     |
|--|--------------|---------------------------------------------------------------------|
|  | •  | announcements of technologicalinnovations by us or our competitors, |

|  |              |                                                                    |
|--|--------------|--------------------------------------------------------------------|
|  | •  | announcements of new products orservices by us or our competitors, |

|  |              |                                                                |
|--|--------------|----------------------------------------------------------------|
|  | •  | general conditions in thesoftware and computer industries, and |

|  |              |                                        |
|--|--------------|----------------------------------------|
|  | •  | general economic and marketconditions. |

Additionally, the stock market, in general,frequently experiences extreme price and volume fluctuations. Inparticular, the market prices of the securities of companies such asours have been especially volatile recently, and often thesefluctuations have been unrelated or disproportionate to the operatingperformance of the affected companies. The market price of our commonstock may be adversely affected by these market fluctuations. Also, thelow market price of our common stock may make it prohibitive to obtainadditional equity funding.

18

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AXS-One has never paid or declareddividends and does not expect to in the foreseeable future.

AXS-One has never paid or declared any cash dividends and we do notexpect to pay any cash dividends in the foreseeable future. Wecurrently intend that future earnings, if any, will be retained forbusiness use.

Changes in laws and regulations that affectthe governance of public companies have increased our operatingexpenses and will continue to do so.

Changes in the lawsand regulations affecting public companies included in theSarbanes-Oxley Act of 2002 have imposed new duties on us and on ourexecutives, directors, attorneys and independent registered publicaccounting firm. In order to comply with these new rules, we hired aconsulting advisory firm to assist us in the process and we also expectto use additional services of our outside legal counsel, both of whichwill increase our operating expenses. In particular, we expect to incuradditional administrative expenses as we implement Section 404 of theSarbanes-Oxley Act, which requires management to report on, and ourIndependent Registered Public Accounting Firm to attest to, ourinternal controls. For example, we expect to incur significant expensesin connection with the implementation, documentation and testing of ourexisting control systems and possible establishment of new controls.Management time associated with these compliance efforts necessarilyreduces time available for other operating activities, which couldadversely affect operating results. If we are unable to achieve fulland timely compliance with these regulatory requirements, we could berequired to incur additional costs, expend additional management timeon remedial efforts and make related public disclosures that couldadversely affect our stock price.

|               |                           |
|---------------|---------------------------|
| Item1B.  | Unresolved Staff Comments |

None.

|               |            |
|---------------|------------|
| Item 2.  | Properties |

Facilities

The Company's corporate headquarters are located in Rutherford,New Jersey in leased facilities consisting of 48,800 square feet ofoffice space occupied under a lease expiring in December  2007with an option to renew the lease for one additional five-year period.AXS-One has the right to cancel the lease in 2007 without penalty. TheCompany leases additional facilities and offices, including facilitieslocated in Rockwall, Texas and Shelton, Connecticut. The Company alsoleases sales and support offices outside of North America in Australia,Singapore, South Africa and the United Kingdom. While the Companybelieves that its facilities are adequate for its present needs, theCompany periodically reviews its needs. The Company believes thatadditional space, if needed, would be available on commerciallyreasonable terms.

|               |                  |
|---------------|------------------|
| Item 3.  | LegalProceedings |

Historically, the Company has been involved indisputes and/or litigation encountered in its normal course ofbusiness. The Company believes that the ultimate outcome of theseproceedings will not have a material adverse effect on theCompany's business, financial condition and results of operationsor cash flows.

|               |                                                    |
|---------------|----------------------------------------------------|
| Item 4.  | Submission of Mattersto a Vote of Security Holders |

No matters were submitted to avote of security holders during the fourth quarter of2005.

19

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PART II

|               |                                                                                                            |
|---------------|------------------------------------------------------------------------------------------------------------|
| Item 5.  | Market for Registrant's CommonEquity, Related Stockholder Matters and Issuer Purchases of EquitySecurities |

The Company's Common Stock currently trades onthe American Stock Exchange under the symbol‘‘AXO.’’

The following tablelists the high and low sales prices for the periods set forthbelow:

|                |  |        |        |        |  |        |        |        |  |  |
|----------------|--|--------|--------|--------|--|--------|--------|--------|--|--|
| Period         |  | High   |        | Low    |
| 2005           |  |   |   |   |  |   |   |   |
| Firstquarter   |  | $      | 3.87   |   |  | $      | 2.45   |   |
| Secondquarter  |  |   | 3.35   |   |  |   | 1.35   |   |
| Third quarter  |  |   | 1.90   |   |  |   | 1.21   |   |
| Fourth quarter |  |   | 2.39   |   |  |   | 1.50   |   |
| 2004           |  |   |   |   |  |   |   |   |
| Firstquarter   |  | $      | 4.24   |   |  | $      | 1.80   |   |
| Secondquarter  |  |   | 4.70   |   |  |   | 2.58   |   |
| Third quarter  |  |   | 2.89   |   |  |   | 1.70   |   |
| Fourth quarter |  |   | 3.12   |   |  |   | 2.05   |   |
|                |

As of March7,  2006 the approximate number of record holders of theCompany’s Common Stock was 715.

The Company has never paidcash dividends on its capital stock. The Company currently intends toretain any earnings for use in its business and does not anticipatepaying any cash dividends in the foreseeable future.

|              |                         |
|--------------|-------------------------|
| Item6.  | Selected Financial Data |

The selectedconsolidated financial data set forth below for the years endedDecember  31,  2005, 2004, 2003, 2002, and 2001 have beenderived from the audited consolidated financial statements of theCompany. The consolidated statement of operations data for the yearsended December  31,  2005, 2004, and 2003 and theconsolidated balance sheet data as of December  31,  2005 and2004 are derived from the audited consolidated financial statements andthe related notes thereto included elsewhere in this report. Theselected consolidated financial data set forth below should be read inconjunction with "Management's Discussion andAnalysis of Financial Condition and Results of Operations’’and the consolidated financial statements of the Company and relatednotes thereto included elsewhere in this report.

20

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|                                                    |  |                                       |        |         |  |        |        |         |  |        |         |         |  |        |         |         |  |        |        |         |  |  |
|----------------------------------------------------|--|---------------------------------------|--------|---------|--|--------|--------|---------|--|--------|---------|---------|--|--------|---------|---------|--|--------|--------|---------|--|--|
|                                               |  | Years Ended December31,               |
|                                               |  | 2005                                  |        | 2004    |  | 2003   |        | 2002    |  | 2001   |
|                                               |  | (In thousands, except per share data) |
| Statement of Operations Data:(1)                   |  |                                  |   |    |  |   |   |    |  |   |    |    |  |   |    |    |  |   |   |    |
| Revenues:                                          |  |                                  |   |    |  |   |   |    |  |   |    |    |  |   |    |    |  |   |   |    |
| Licensefees                                        |  | $                                     | 5,546  |    |  | $      | 6,781  |    |  | $      | 6,443   |    |  | $      | 3,917   |    |  | $      | 5,421  |    |
| Services(2)                                        |  |                                  | 27,154 |    |  |   | 31,446 |    |  |   | 32,948  |    |  |   | 33,030  |    |  |   | 35,272 |    |
| Other - relatedparties                             |  |                                  | 108    |    |  |   | 209    |    |  |   | 300     |    |  |   | 405     |    |  |   | 542    |    |
| Total revenues                                     |  |                                  | 32,808 |    |  |   | 38,436 |    |  |   | 39,691  |    |  |   | 37,352  |    |  |   | 41,235 |    |
| Operatingexpenses:                                 |  |                                  |   |    |  |   |   |    |  |   |    |    |  |   |    |    |  |   |   |    |
| Cost oflicense fees                                |  |                                  | 1,585  |    |  |   | 1,923  |    |  |   | 1,524   |    |  |   | 1,482   |    |  |   | 1,355  |    |
| Cost of services(2)                                |  |                                  | 16,223 |    |  |   | 17,086 |    |  |   | 15,832  |    |  |   | 15,479  |    |  |   | 18,393 |    |
| Sales andmarketing                                 |  |                                  | 9,743  |    |  |   | 9,565  |    |  |   | 7,297   |    |  |   | 6,364   |    |  |   | 9,504  |    |
| Research anddevelopment                            |  |                                  | 7,828  |    |  |   | 7,999  |    |  |   | 6,832   |    |  |   | 6,704   |    |  |   | 7,029  |    |
| General andadministrative                          |  |                                  | 5,129  |    |  |   | 6,411  |    |  |   | 5,634   |    |  |   | 4,559   |    |  |   | 8,303  |    |
| Restructuring andother costs                       |  |                                  | 863    |    |  |   | 1,020  |    |  |   | — |    |  |   | — |    |  |   | 797    |    |
| Total operating expenses                           |  |                                  | 41,371 |    |  |   | 44,004 |    |  |   | 37,119  |    |  |   | 34,588  |    |  |   | 45,381 |    |
| Operating income (loss)                            |  |                                  | (8,563 | )  |  |   | (5,568 | )  |  |   | 2,572   |    |  |   | 2,764   |    |  |   | (4,146 | )  |
| Other income(expense):                             |  |                                  |   |    |  |   |   |    |  |   |    |    |  |   |    |    |  |   |   |    |
| Equity inlosses of joint ventures                  |  |                                  | (89    | )  |  |   | (162   | )  |  |   | (114    | )  |  |   | (525    | )  |  |   | (121   | )  |
| Other, net                                         |  |                                  | (371   | )  |  |   | 301    |    |  |   | (241    | )  |  |   | (375    | )  |  |   | (570   | )  |
| Total other income (expense), net                  |  |                                  | (460   | )  |  |   | 139    |    |  |   | (355    | )  |  |   | (900    | )  |  |   | (691   | )  |
| Income (loss) beforeincome tax benefit             |  |                                  | (9,023 | )  |  |   | (5,429 | )  |  |   | 2,217   |    |  |   | 1,864   |    |  |   | (4,837 | )  |
| Incometax benefit                                  |  |                                  | 25     |    |  |   | 217    |    |  |   | 99      |    |  |   | 60      |    |  |   | 182    |    |
| Net income (loss)                                  |  | $                                     | (8,998 | )  |  | $      | (5,212 | )  |  | $      | 2,316   |    |  | $      | 1,924   |    |  | $      | (4,655 | )  |
| Basicand diluted net income (loss)per common share |  | $                                     | (0.28  | )  |  | $      | (0.19  | )  |  | $      | 0.09    |    |  | $      | 0.08    |    |  | $      | (0.19  | )  |
| Weightedaverage basic commonshares outstanding     |  |                                  | 31,629 |    |  |   | 27,395 |    |  |   | 24,945  |    |  |   | 24,818  |    |  |   | 24,785 |    |
| Weightedaverage diluted commonshares outstanding   |  |                                  | 31,629 |    |  |   | 27,395 |    |  |   | 26,264  |    |  |   | 25,511  |    |  |   | 24,785 |    |
|                                                    |

|                                                                      |  |                    |         |         |  |        |         |         |  |        |         |         |  |        |         |         |  |        |         |         |  |  |
|----------------------------------------------------------------------|--|--------------------|---------|---------|--|--------|---------|---------|--|--------|---------|---------|--|--------|---------|---------|--|--------|---------|---------|--|--|
|                                                                 |  | As of December 31, |
|                                                                 |  | 2005               |         | 2004    |  | 2003   |         | 2002    |  | 2001   |
|                                                                 |  | (Inthousands)      |
| Balance Sheet Data:(1)                                               |  |               |    |    |  |   |    |    |  |   |    |    |  |   |    |    |  |   |    |    |
| Cash andcash equivalents, short-term investments and restricted cash |  | $                  | 3,670   |    |  | $      | 4,871   |    |  | $      | 3,002   |    |  | $      | 2,769   |    |  | $      | 1,902   |    |
| Working capital deficiency                                           |  |               | (3,578  | )  |  |   | (3,258  | )  |  |   | (5,092  | )  |  |   | (8,391  | )  |  |   | (10,705 | )  |
| Total assets                                                         |  |               | 11,066  |    |  |   | 14,781  |    |  |   | 12,150  |    |  |   | 10,599  |    |  |   | 10,060  |    |
| Deferred revenue, current                                            |  |               | 8,224   |    |  |   | 9,786   |    |  |   | 8,946   |    |  |   | 8,821   |    |  |   | 8,782   |    |
| Deferred revenue, long-term                                          |  |               | 63      |    |  |   | 303     |    |  |   | 1,504   |    |  |   | — |    |  |   | — |    |
| Total long-term debt                                                 |  |               | — |    |  |   | — |    |  |   | — |    |  |   | 547     |    |  |   | 1,347   |    |
| Total stockholders' deficit                                          |  |               | (2,116  | )  |  |   | (1,024  | )  |  |   | (3,699  | )  |  |   | (6,025  | )  |  |   | (8,180  | )  |
|                                                                      |

|  |
|--|
|  |  |
|  |

|     |                                                                                                       |
|-----|-------------------------------------------------------------------------------------------------------|
| (1) | For2001, the data above included a subsidiary in Central and EasternEurope that was sold during 2001. |

|     |                                                                                                                                                                                                |
|-----|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | For 2001 period,reimbursed "out of pocket" expenses of$1,216, have been reclasssied as revenue from a reduction of cost ofservices to conform with the 2005, 2004, 2003 and 2002presentations. |

21

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|              |                                                                                      |
|--------------|--------------------------------------------------------------------------------------|
| Item7.  | Management's Discussion and Analysis ofFinancial Condition and Results of Operations |

The followingdiscussion should be read in conjunction with the ConsolidatedFinancial Statements and Notes thereto and is qualified in its entiretyby reference thereto.

This Report contains statements of aforward-looking nature within the meaning of the safe harbor provisionsof Section 27A of the Securities Act of 1933, as amended, and Section21E of the Securities Exchange Act of 1934, as amended, relating tofuture events or the future financial performance of AXS-One. Investorsare cautioned that such statements are only predictions and that actualevents or results may differ materially. In evaluating such statements,investors should specifically consider the various factors identifiedin this Report which could cause actual results to differ materiallyfrom those indicated by such forward-looking statements, including thematters set forth in ‘‘Risk Factors.’’

Executive Overview

We are a leading provider of RecordsCompliance Management and Financial Management software solutionsdesigned to reduce the inherent risks associated with retaining andmanaging corporate records as well as to efficiently manage complexbusiness processes. We have implemented high-volume, interoperable,scalable and secure business solutions for Global 2000 companies. OurWeb Services-based technology has been critically acclaimed as best ofclass. Our Records Compliance Management solutions deliver anintegrated solution that enables organizations to manage growingvolumes of disparate electronic records, including e-mail and InstantMessages, images, voice, office documents, ERP - generateddata such as SAP and electronic print reports. All records are archivedand managed according to corporate records policies from initialcapture and indexing through archival, search and ultimate destruction.These products have been developed and optimized to address globalissues of regulatory compliance, corporate governance, supervision andprivacy as they relate to the retention and disposition of electronicrecords, as well as to significantly reduce infrastructure costs(primarily storage and associated management costs). Patent-pendingsearch technology enables organizations to respond quickly andaccurately to the growing pressures of e-discovery and litigationsupport. See ‘‘Item 1. Business’’.

Ourrevenues are derived mainly from license fees from software licenseagreements entered into between AXS-One and our customers and resellerswith respect to both our products and, to a lesser degree, third partyproducts resold by AXS-One and services revenues from softwaremaintenance agreements, training, consulting services includinginstallation and custom programming.

We are based in Rutherford,New Jersey with 209 full-time employees, as of December  31,2005, in offices worldwide, including Australia, Singapore, SouthAfrica, the United Kingdom and the United  States. Our foreignoffices generated approximately 35.1% of our total revenues forthe twelve months ended December  31,  2005. We expect thatsuch revenues will continue to represent a significant percentage ofour total revenues in the future. Most of our international licensefees and services revenues are denominated in foreign currencies.Fluctuations in the value of foreign currencies relative to the U.S.dollar in the future could result in fluctuations in our revenue.

We have a 49% ownership in a joint venture in our SouthAfrican operation, AXS-One African Solutions (Pty) Ltd(‘‘African Solutions’’). African Solutionssells and services our suite of products. We use the equity method ofaccounting for our investment whereby the investment, including loansto the joint venture, is stated at cost plus or minus our equity inundistributed earnings or losses.

We encounter competition forall of our products in all markets and compete primarily based on thequality of our products, our price, our customer service and our timeto implement. The timing of the release of new products is alsoimportant to our ability to generate sales. During the second half of2003, we launched our Records Compliance Management solution for e-mailand Instant Messaging Archival, Supervision, and Legal Discovery inresponse to new regulatory requirements for financial institutions inthe United States as well as to address the need to reduce costs in theemail management area. During 2005, AXS-One announced furthersignificant development on the AXS-One Compliance Platform, focusingprimarily on performance-based enhancements. Version 3.5, featuringRapid-AXS, was launched in May, and introduced patent-pending searchfunctionality. Rapid-AXS takes advantage of grid 

22

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computing architecture and leveragescommodity hardware to deliver what AXS-One believes to be an unmatchedprice-performance ratio. Version 3.5 also introduced a Search Wizard,reducing the potential complexity of searches for non-IT staff andensuring error-proof search capabilities for legal discovery. Finallyin 2005 AXS-One announced AXS-Link for Desktop, a desktop archivingproduct available both as an integrated component of the AXS-OneCompliance Platform, as well as a stand-alone solution. Our RecordsCompliance Management software, including this new solution, accountedfor approximately 74% of our total license fee revenues for theyear ended December  31,  2005.

Our future ability togrow revenue will be directly affected by continued price competitionand our ability to sustain a high maintenance revenue base from whichto grow. Our growth rate and total revenues depend significantly onfuture services for existing customers as well as our ability to expandour customer base and to respond successfully to the pace oftechnological change. In order to expand our customer base, we havebeen actively seeking partnerships with resellers to supplement ourdirect sales force. During 2005, AXS-One announced several partnershipsand began to recognize revenues from some of these. The mostsignificant of these was an announcement in January  2005 with SunMicrosystems whereby the two organizations entered into a TechnologyDevelopment and License Agreement. Under the terms of the agreement,Sun is marketing, licensing, implementing and supporting the entireAXS-One Compliance Platform product suite worldwide as well asmarketing and supporting this suite through Sun’s iForce partners- its global reseller network. In addition to formalizing and expandingits global relationship with Sun Microsystems, AXS-One has developedrelationships around the world with Sun iForce resellers and expects tocontinue this strategy throughout 2006. Initial successes have beenrecorded in Australia and the US. Throughout 2005, AXS-One continued toexpand its reseller network in Asia, announcing partnerships withorganizations in Hong Kong, China, India, Malaysia, the Philippines andThailand. All resellers have been fully trained to sell the productwith new sales closed or pending. In response to the growing demand forhosted archiving solutions and Software as a Service, AXS-One continuesto expand its channel strategy, entering into partnerships in 2005 withBT worldwide and Amerivault in the US. AXS-One expects its 2006 channelstrategy to include partnership development into this expanding market.If our maintenance renewal rate or pace of new customer acquisitionsslows, our revenues and operating results would be adversely affected.See ‘‘Risk Factors’’.

We haveexperienced, and may in the future experience, significant fluctuationsin our quarterly and annual revenues, results of operations and cashflows. We believe that domestic and international operating results andcash flows will continue to fluctuate significantly in the future as aresult of a variety of factors. For a description of the factors thatmay affect our operating results see ‘‘RiskFactors’’.

During 2005, AXS-One saw renewed interestin our AXS-One Central data archive product from both existing and newcustomers. One of the key business drivers for this appears to beextended pressure for financial services organizations to be incompliance with Rule 17a-4 of the U.S. Securities and ExchangeCommission promulgated under the Securities Exchange Act (SEC 17a-4) aswell as interest across all industries in the Sarbanes-Oxley Act of2002 in the United States and the requirement for organizations tomanage and provide evidence of the trustworthiness of their financialstatements. The ability of our digital technology to reproduce‘‘states of time’’ on demand – i.e., toreproduce any single transaction, as well as all correspondingdocuments and data – is enabling customers to maintain theircompliance with SEC 17a-4 as well as to address the requirements ofSarbanes-Oxley or other regulations and policies that address recordsretention in the future.

In September  2004, we announcedthat the four largest UK-based tour operators (Thomas Cook, MyTravel,First Choice and TUI) had signed three year subscription agreementswith AXS-One for our e-delivery service – based on the AXS-OneCentral archive – which has been endorsed by the CAA, theUK-based Civil Aviation Authority. The same month, we also signed asimilar agreement with one of the largest European ferry companies.During 2005 AXS-One E-Delivery Service, developed for the Europeantravel industry, went live. At the end of 2005, 50 tour operators hadsubscribed to the E-Delivery Service.

We continue to makeprogress growing our customer base for our e-mail archival andelectronic retention management-based solutions. This includes bothextending opportunities within existing customers as well as acquiringnew customers.

23

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Results of Operations

Thefollowing tables set forth for the periods indicated, certain operatingdata, and data as a percentage of total revenues.

(dollars in millions)

|                                   |  |                            |         |                             |  |                    |         |                             |  |        |        |         |  |        |        |          |  |  |
|-----------------------------------|--|----------------------------|---------|-----------------------------|--|--------------------|---------|-----------------------------|--|--------|--------|---------|--|--------|--------|----------|--|--|
|                              |  | Year EndedDecember 31,2005 |         | Year EndedDecember 31, 2004 |
|                              |  | Total Consolidated         |         | Dataas apercent of revenue  |  | Total Consolidated |         | Data as apercent of revenue |
| Revenues:                         |  |                       |    |                        |  |               |    |                        |  |   |   |    |  |   |   |     |
| Licensefees                       |  | $                          | 5.5     |                        |  |               | 16.8    | %                      |  | $      | 6.8    |    |  |   | 17.7   | %   |
| Services                          |  |                       | 27.2    |                        |  |               | 82.9    |                        |  |   | 31.4   |    |  |   | 81.8   |     |
| Other -related parties            |  |                       | 0.1     |                        |  |               | 0.3     |                        |  |   | 0.2    |    |  |   | 0.5    |     |
| Total revenues                    |  |                       | 32.8    |                        |  |               | 100.0   |                        |  |   | 38.4   |    |  |   | 100.0  |     |
| Operatingexpenses:                |  |                       |    |                        |  |               |    |                        |  |   |   |    |  |   |   |     |
| Cost of licensefees               |  |                       | 1.6     |                        |  |               | 4.9     |                        |  |   | 1.9    |    |  |   | 4.9    |     |
| Cost of services                  |  |                       | 16.2    |                        |  |               | 49.4    |                        |  |   | 17.1   |    |  |   | 44.5   |     |
| Sales and marketing               |  |                       | 9.8     |                        |  |               | 29.9    |                        |  |   | 9.6    |    |  |   | 25.0   |     |
| Research and development          |  |                       | 7.8     |                        |  |               | 23.8    |                        |  |   | 8.0    |    |  |   | 20.8   |     |
| General andadministrative         |  |                       | 5.1     |                        |  |               | 15.5    |                        |  |   | 6.4    |    |  |   | 16.7   |     |
| Restructuring and other costs     |  |                       | 0.9     |                        |  |               | 2.7     |                        |  |   | 1.0    |    |  |   | 2.6    |     |
| Total operating expenses          |  |                       | 41.4    |                        |  |               | 126.2   |                        |  |   | 44.0   |    |  |   | 114.5  |     |
| Operating loss                    |  |                       | (8.6    | )                      |  |               | (26.2   | )                      |  |   | (5.6   | )  |  |   | (14.5  | )   |
| Other income(expense):            |  |                       |    |                        |  |               |    |                        |  |   |   |    |  |   |   |     |
| Equity inlosses of joint ventures |  |                       | (0.1    | )                      |  |               | (0.3    | )                      |  |   | (0.2   | )  |  |   | (0.5   | )   |
| Other income(expense), net        |  |                       | (0.3    | )                      |  |               | (0.9    | )                      |  |   | 0.4    |    |  |   | 1.0    |     |
| Other income (expense),net        |  |                       | (0.4    | )                      |  |               | (1.2    | )                      |  |   | 0.2    |    |  |   | 0.5    |     |
| Loss before income tax benefit    |  |                       | (9.0    | )                      |  |               | (27.4   | )                      |  |   | (5.4   | )  |  |   | (14.0  | )   |
| Income tax benefit                |  |                       | — |                        |  |               | — |                        |  |   | 0.2    |    |  |   | 0.5    |     |
| Net Loss                          |  | $                          | (9.0    | )                      |  |               | (27.4   | )%                     |  | $      | (5.2   | )  |  |   | (13.5  | )%  |
|                                   |

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|                                   |  |                             |        |                              |  |        |        |         |  |  |
|-----------------------------------|--|-----------------------------|--------|------------------------------|--|--------|--------|---------|--|--|
|                              |  | Year Ended December 31,2003 |
|                              |  | TotalConsolidated           |        | Data as a percent of revenue |
| Revenues:                         |  |                        |   |                         |  |   |   |    |
| Licensefees                       |  | $                           | 6.4    |                         |  |   | 16.2   | %  |
| Services                          |  |                        | 32.9   |                         |  |   | 83.0   |    |
| Other - related parties           |  |                        | 0.3    |                         |  |   | 0.8    |    |
| Total revenues                    |  |                        | 39.6   |                         |  |   | 100.0  |    |
| Operatingexpenses:                |  |                        |   |                         |  |   |   |    |
| Cost of license fees              |  |                        | 1.5    |                         |  |   | 3.8    |    |
| Cost of services                  |  |                        | 15.8   |                         |  |   | 39.9   |    |
| Sales andmarketing                |  |                        | 7.3    |                         |  |   | 18.4   |    |
| Researchand development           |  |                        | 6.8    |                         |  |   | 17.2   |    |
| General and administrative        |  |                        | 5.6    |                         |  |   | 14.2   |    |
| Total operating expenses          |  |                        | 37.0   |                         |  |   | 93.5   |    |
| Operating income                  |  |                        | 2.6    |                         |  |   | 6.5    |    |
| Otherexpense:                     |  |                        |   |                         |  |   |   |    |
| Equity in losses of jointventures |  |                        | (0.1   | )                       |  |   | (0.3   | )  |
| Otherexpense, net                 |  |                        | (0.3   | )                       |  |   | (0.6   | )  |
| Other expense, net                |  |                        | (0.4   | )                       |  |   | (0.9   | )  |
| Incomebefore income tax benefit   |  |                        | 2.2    |                         |  |   | 5.6    |    |
| Income tax benefit                |  |                        | 0.1    |                         |  |   | 0.2    |    |
| Net income                        |  | $                           | 2.3    |                         |  |   | 5.8    | %  |
|                                   |

2005 Compared to 2004

Revenues

Total revenues decreased 14.6% from 2004 to2005 due to an 18.2% decrease in license revenue and a13.6% decrease in service revenue. The decrease in licenserevenue was mainly attributable to a $1.0  million decrease inenterprise financials software. The decrease in services revenue ismainly attributable to a $5.7  million decrease in service revenuefor our enterprise financials software primarily the result of lowerlicense sales resulting in lower implementation consulting revenue andcustomer release upgrade cycles, partially offset by a $1.4million increase in service revenue for our records compliancemanagement software. Approximately 74% of our 2005 license feerevenues came from licenses of our Records Compliance Management (RCM)software as compared to approximately 67% in 2004, a reflectionof our market strategy during the past two years.

The followingtable sets forth for the periods indicated each major category of ourservices revenues as a percent of services revenues.

|                         |  |                         |        |          |  |        |     |           |  |        |        |        |  |        |     |         |  |  |
|-------------------------|--|-------------------------|--------|----------|--|--------|-----|-----------|--|--------|--------|--------|--|--------|-----|---------|--|--|
|                    |  | Years Ended December31, |
|                    |  | 2005                    |        | 2004     |
| (inthousands)           |  | Amount                  |        | %ofTotal |  | Amount |     | % ofTotal |
| Maintenance             |  | $                       | 16,600 |     |  |   | 61  | %    |  | $      | 17,129 |   |  |   | 54  | %  |
| Consulting              |  |                    | 9,764  |     |  |   | 36  |      |  |   | 13,440 |   |  |   | 43  |    |
| Custom programming      |  |                    | 240    |     |  |   | 1   |      |  |   | 574    |   |  |   | 2   |    |
| Subscription revenue    |  |                    | 550    |     |  |   | 2   |      |  |   | 303    |   |  |   | 1   |    |
| Total services revenues |  | $                       | 27,154 |     |  |   | 100 | %    |  | $      | 31,446 |   |  |   | 100 | %  |
|                         |

The decrease inOther-Related Parties revenue resulted from decreases in bothmanagement fee revenue and consulting revenue. The decrease inmanagement fees, inclusive of director’s fees charged to

25

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African Solutions, was as a result of ourdecision in the fourth quarter of 2004 to temporarily stop chargingdirector’s fees until the African Solutions joint venturebecomes profitable. The decrease in consulting revenue resulted fromdecreased use of our consultants by African Solutions.

Operating Expenses

Cost of license fees consist primarilyof amortization of capitalized software development costs and royaltiesrelated to third party software resold by AXS-One in conjunction withthe licensing of our products. The elements can vary substantially fromperiod to period as a percentage of license fees. Cost of license feesdecreased $0.3  million or 17.6% from 2004 to 2005primarily as a result of a decrease of $0.2  million inamortization of capitalized software development costs and a decreaseof $0.1  million in third party software royalty fees.

Costof services consists primarily of personnel and third party costs forproduct quality assurance, training, installation, consulting andcustomer support. Cost of services decreased $0.9  million or5.1% from 2004 to 2005 partially due to a decrease of personnelrelated expenses of $0.9  million, a decrease of $0.2million in variable compensation resulting from a decrease in revenue,and a decrease in billable expense of $0.2  million. Thesedecreases were partially offset by an increase of $0.3  million inthird party consultants costs due to the use of these resources tosupplement our internal employees on a large project in our SouthAfrican operations.

Sales and marketing expenses consistprimarily of salaries, commissions and bonuses related to sales andmarketing personnel as well as travel and promotional expenses. Salesand marketing expenses increased $0.2  million or 1.9% from2004 to 2005 primarily due to an increase of $0.4  million ofemployee related costs due to the hiring of more highly qualified salesand marketing personnel during the period, $0.2  million inmarketing programs, offset partially by $0.2  million of lowervariable compensation and $0.2  million of other miscellaneousexpenses.

Research and development expenses consist primarily ofpersonnel costs, costs of equipment, facilities and third partysoftware development cost. Research and development expenses aregenerally charged to operations as incurred. However, certain softwaredevelopment costs are capitalized in accordance with Statement ofFinancial Accounting Standards No. 86. Such capitalized softwaredevelopment costs are amortized to cost of license fees on astraight-line basis over periods not exceeding three years. Researchand development expenses (net of capitalized software developmentcosts) decreased $0.2  million or 2.1% from 2004 to 2005due primarily to a decrease in personnel related expense of $0.6million resulting from lower headcount and a reduction of $0.2million of outside consultants expenses offset partially by lowercapitalized software development costs which were $0.6  million in2004 and only $18  thousand in 2005. The rate of capitalization ofsoftware development costs may fluctuate depending on the mix and stageof development of our research and development projects. The decreasein capitalized costs during 2005 was mainly from a change in the natureof our development efforts for RCM products versus the historicalenterprise financial products. The nature of our current developmentfor RCM products is generally such that we can measure technologicalfeasibility most effectively using the working model method where thetime between establishment of a working model and general availabilityis of short duration which results in very little or no costs thatqualify for capitalization. We historically used a detailed programdesign model to measure technological feasibility for our enterprisefinancial products. This shift in development of our product lines willresult in lower capitalized costs in the future.

General andadministrative expenses consist primarily of salaries ofadministrative, executive and financial personnel and outsideprofessional fees. General and administrative expenses decreased$1.3  million or 20% from 2004 to 2005 primarily as aresult of a decrease of $0.4  million in the provision for baddebt in our foreign locations of which $0.3  million recognized in2004 related to one customer in our South African operations, adecrease of $0.2  million in professional fees, a decrease of$0.2  million in employee related expenses, a decrease of$0.2  million of variable compensation expense and a decrease of$0.2  million of other miscellaneous expenses.

OnJune  30,  2005, in order to reduce operating costs to betterposition ourselves in the current market, we eliminated 22 positions inthe United States and 6 positions in our foreign operations. We

26

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recorded a charge to operations in the secondquarter totaling $0.9  million related to involuntary terminationbenefits to be paid to the terminated employees. Approximately$0.6  million of these restructuring costs have been paid during2005. The remaining liability at December  31,  2005 is$0.3  million and is expected to be paid in 2006. The eliminationof the net 28 positions was expected to result in annual savings ofapproximately $4.0  million. Additionally, the executivemanagement team reduced their base salaries by 10% and the Boardof Directors waived all cash compensation for the second half of 2005,resulting in a savings of $0.1  million. Such salary and Board feereductions were reinstated in 2006. On June  30,  2004, weeliminated 25 positions in the United States and 9 positions in ourforeign operations and recorded a charge to operations totalingapproximately $0.7  million related to involuntary terminationbenefits which were subsequently paid to the terminated employees. (SeeNote 12 to the Consolidated Financial Statements.) In addition, in thesecond quarter, we expensed approximately $0.3  million related toa retirement agreement with our former CEO. The retirement benefitswere paid in the first quarter of 2005.

Operating Loss

Operating loss increased from of $5.6  million for 2004 to$8.6  million for 2005 due to a decrease of $5.6  million intotal revenues offset partially by a decrease of $2.6  million inoperating expenses.

Other Income (Expense), Net

Otherincome (expense), net was $0.5  million expense in 2005 ascompared to $0.1  million income in 2004 mainly as a result offoreign exchange transaction losses of $0.5  million in 2005 ascompared to transaction gains of $0.2  million in 2004.

Income Tax Benefit

We recorded an income tax benefit of$25,000 in 2005 from one foreign entity. We recorded an income taxbenefit of $0.2  million in 2004 from the sale to third parties ofcertain expiring New Jersey State Tax net operating loss carry-forwardsand research and development credits. We cannot be certain that theState of New Jersey will continue to allow such sales in the future or,if it did, that sales to third parties could be consummated. For 2004there was an additional tax benefit of $23,000 in one foreignentity.

Results of Operations

As a consequence of theabove, we generated a net loss of $9.0  million in 2005 ascompared to a net loss of $5.2  million in 2004.

2004Compared to 2003

Revenues

Total revenues decreased3.2% from 2003 to 2004 due to a 4.6% decrease in servicesrevenues partially offset by a 5.2% increase in license feerevenues. The increase in license fee revenues was mainly due toincreases of $0.9  million in our U.S. operations, primarilyresulting from licenses of our new Email Compliance software, and$0.4  million in our Southeast Asia operations resulting fromlicenses of additional products to existing customers. This increasewas partially offset by a decrease of $0.9  million in our SouthAfrican subsidiary which had a large contract in the second quarter of2003 and no similar contract in 2004. Approximately 67% of our2004 license fee revenues came from licenses of our Records ComplianceManagement (RCM) software as compared to approximately 32% in2003, a reflection of our new market strategy during the past year. Ourlicense fee revenues also included licenses of our newer web-basedproducts to our existing customers as well as the license of additionalusers for previously licensed software.

The decrease in servicesrevenues resulted mainly from a decrease in consulting revenuespartially offset by an increase in maintenance fees. The decrease inservices revenues was primarily in the U.S. and 

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Australian operations resulting from fewerorders for consulting services related to software upgrades in theinstalled base and from our strategic shift during the past year to RCMproducts. The decrease in the U.S. operations was also the result ofthe completion in mid 2004 of several large enterprise implementationprojects and no new similar projects commenced in late 2004. Theincrease in maintenance fees is mainly the result of new licenseagreements and customary annual increases for existing agreements. Theincrease in custom programming was mainly the result of a largecontract with one customer.

The following table sets forth forthe periods indicated each major category of our services revenues as apercent of services revenues.

|                         |  |                         |        |          |  |        |         |           |  |        |        |        |  |        |         |         |  |  |
|-------------------------|--|-------------------------|--------|----------|--|--------|---------|-----------|--|--------|--------|--------|--|--------|---------|---------|--|--|
|                    |  | Years Ended December31, |
|                    |  | 2004                    |        | 2003     |
| (inthousands)           |  | Amount                  |        | %ofTotal |  | Amount |         | % ofTotal |
| Maintenance             |  | $                       | 17,129 |     |  |   | 54      | %    |  | $      | 16,961 |   |  |   | 52      | %  |
| Consulting              |  |                    | 13,679 |     |  |   | 44      |      |  |   | 15,486 |   |  |   | 47      |    |
| Training                |  |                    | 64     |     |  |   | — |      |  |   | 113    |   |  |   | — |    |
| Custom programming      |  |                    | 574    |     |  |   | 2       |      |  |   | 388    |   |  |   | 1       |    |
| Total services revenues |  | $                       | 31,446 |     |  |   | 100     | %    |  | $      | 32,948 |   |  |   | 100     | %  |
|                         |

The decrease inOther-Related Parties revenue resulted from decreases in bothmanagement fee revenue and consulting revenue. The decrease inmanagement fees, inclusive of director’s fees charged to AfricanSolutions, was as a result of our decision in the fourth quarter of2004 to temporarily stop charging director’s fees until theAfrican Solutions joint venture becomes profitable. The decrease inconsulting revenue resulted from decreased use of our consultants byAfrican Solutions.

The following table sets forth the breakdownof other-related parties revenue:

|                        |  |                         |     |        |  |        |     |        |  |  |
|------------------------|--|-------------------------|-----|--------|--|--------|-----|--------|--|--|
|                   |  | Years Ended December31, |
| (inthousands)          |  | 2004                    |     | 2003   |
| Management fee revenue |  | $                       | 27  |   |  | $      | 68  |   |
| Consulting revenue     |  |                    | 182 |   |  |   | 232 |   |
| Totalrevenues          |  | $                       | 209 |   |  | $      | 300 |   |
|                        |

Operating Expenses

Cost oflicense fees consist primarily of amortization of capitalized softwaredevelopment costs and amounts paid to third parties with respect toproducts resold by AXS-One in conjunction with the licensing of ourproducts. The elements can vary substantially from period to period asa percentage of license fees. Cost of license fees increased26.2% from 2003 to 2004 primarily as a result of a $0.6million increase in third party royalties due to increased sales ofthird party software used in conjunction with our software. This waspartially offset by a $0.2  million decrease in amortization ofcapitalized software development costs as a result of certain costsbecoming fully amortized in 2003.

Cost of services consistsprimarily of personnel and third party costs for product qualityassurance, training, installation, consulting and customer support.Total services costs increased 7.9% from 2003 to 2004 primarilydue to a $0.7  million increase in temporary employee andconsultants expense due to the use of temporary consultants tosupplement our internal employees on specific assignments relatedmostly to the deployment of our newer software products. The increasealso resulted from an increase of $0.1  million in travel andliving expenses mostly due to a decrease in expenses of that type thatwe could bill to our customers and $0.3  million in other employeerelated expenses.

Sales and marketing expenses consist primarilyof salaries, commissions and bonuses related to sales and marketingpersonnel as well as travel and promotional expenses. Sales andmarketing expenses increased 31.1% from 2003 to 2004 primarilydue to employee related costs resulting from our commitment to enhancethe sales and marketing functions related to our RCM product strategy.There were increases of $1.4  million in salaries and relatedbenefits due to annual merit increases and new hires, 

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$0.2  million in related employeerecruitment fees, $0.3  million in travel and living expenses,$0.1  million in marketing program expenses and $0.4  millionin other miscellaneous expenses. The increase also included an increaseof $0.4  million in variable compensation in the U.S. operationsdue to a revision in the commission plans for 2004 that provided addedincentives for the sales employees resulting in higher commissions.These increases were partially offset by a decrease of $0.6million in commission expense in our South African subsidiary which hada large license contract in the second quarter of 2003 and no similarcontract in 2004.

Research and development expenses consistprimarily of personnel costs, and costs of equipment and facilities.Research and development expenses are generally charged to operationsas incurred. However, certain software development costs arecapitalized in accordance with Statement of Financial AccountingStandards No. 86. Such capitalized software development costs areamortized to cost of license fees on a straight-line basis over periodsnot exceeding three years. Research and development expenses (net ofcapitalized software development costs) increased 17.1% from2003 to 2004 due primarily to an increase of $0.2  million insalaries and wages and related benefits due mainly to customary annualsalary increases and $0.3  million in temporaries and consultantsworking on the development of the new RCM products. The increase wasalso the result of a decrease in capitalized software development costsof $0.7  million. We capitalized software development costs of$0.6  million and $1.3  million in 2004 and 2003,respectively. The rate of capitalization of software development costsmay fluctuate depending on the mix and stage of development of ourresearch and development projects. The decrease in capitalized costsduring 2004 was mainly the result of the completion and general releaseof projects that we had been capitalizing from prior periods and from achange in the nature of our development efforts for RCM products versusthe historical enterprise financial products. The nature of our currentdevelopment for RCM products is generally such that we can measuretechnological feasibility most effectively using the working modelmethod where the time between establishment of a working model andgeneral availability is of short duration which results in very littleor no costs that qualify for capitalization. We historically used adetailed program design model to measure technological feasibility forour enterprise financial products. This shift in development of ourproduct lines will result in lower capitalized costs in the future.

General and administrative expenses consist primarily of salaries ofadministrative, executive and financial personnel and outsideprofessional fees. General and administrative expenses increased13.8% from 2003 to 2004 primarily as a result of increases of$0.3  million in salaries and wages as a result of managementchanges during the year and $0.1  million in bad debt recoverythat reduced general and administration expenses in the first quarterof 2003 and no similar recovery occurred in 2004 and an additional$0.4  million increase in the bad debt provision for the 2004period in our foreign locations.

Restructuring and other costs:On June  30,  2004, in order to streamline and reorganize ouroperations to better meet our long-term goals, we eliminated 25positions in the United States and 11 positions in our foreignoperations. We recorded a charge to operations in the second quarter of2004 totaling approximately $0.8  million related to involuntarytermination benefits to be paid to the terminated employees. In thethird quarter of 2004, we reduced the restructuring charge byapproximately $0.1  million mainly resulting from our decision toretain two people in our foreign operations. The elimination of the net34 positions was expected to result in annual savings of approximately$3.2  million that is being used to enhance the sales, marketingand research and development functions related to our RCM productstrategy. (See Note 12 to the Consolidated Financial Statements.) Inaddition to the restructuring charges, we recognized approximately$0.3  million in expenses related to a retirement agreement withour former CEO. The retirement benefit was paid in January2005.

Operating Income (Loss)

Operating income (loss)decreased from income of $2.6  million for 2003 to a loss of($5.6) million for 2004 due to a $6.9  million increase inoperating expenses, as described above, which includes restructuringand other costs of $1.0  million, and a decrease in revenue of$1.3  million.

Other Income (Expense), Net

Otherincome (expense), net was $0.1  million in 2004 as compared to($0.4) million in 2003 mainly as a result of an increase of $0.1million in interest income due to higher cash balances during 2004, a

29

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decrease of $0.2  million in interestexpense and a foreign exchange gain of $0.2  million in 2004 ascompared to a loss of ($0.2) million in 2003. Interest expense relatedto the interest on the revolving line of credit and term loan that wasfully paid as of March  31,  2004. (See Note 2 to theConsolidated Financial Statements.)

Income Tax Benefit

We recorded an income tax benefit of $0.2  million and$0.1  million in 2004 and 2003, respectively, from the sales tothird parties of certain expiring New Jersey State Tax net operatingloss carry-forwards and research and development credits. We cannot becertain that the State of New Jersey will continue to allow such salesin the future or, if it did, that sales to third parties could beconsummated. For 2004 there was an additional tax benefit of $23,000 inone foreign location. The 2003 sale of New Jersey State Tax netoperating loss carry-forwards was partially offset by a $43,000provision for income taxes for one foreign location.

Results ofOperations

As a consequence of the above, we generated a netloss of $5.2  million in 2004 as compared to net income of$2.3  million in 2003.

Liquidity and CapitalResources

At December  31,  2005, we had cash andcash equivalents of $3.6  million and a working capital deficit of$3.6  million which included $8.2  million of deferredrevenue. The increase of the working capital deficit from $3.3million at December  31,  2004 is primarily the result of adecrease in cash and decreased accounts receivable offset partially bya decrease in deferred revenue.

On June  21,  2005 andSeptember  21,  2005 we completed a private placement ofshares of common stock and warrants that resulted in the receipt of netproceeds of approximately $5.8  million and $0.6  million,respectively. On April  5,  2004, we completed a privateplacement of shares of common stock and warrants that resulted in thereceipt of net proceeds of approximately $7.7  million.

OnMarch  31,  1998, the Company entered into a Loan andSecurity Agreement that contained a revolving line of credit and a termloan. The unpaid principal on the term loan at December  31,2003 of $0.5  million was fully paid as of March  31,2004. The Loan and Security Agreement terminated on May  28,2004 in accordance with Amendment No. 15 (See Note 2 to theConsolidated Financial Statements).

On August  11,2004, we entered into a two-year Loan and Security Agreement with adifferent institution which contains a revolving line of credit underwhich we have available the lesser of $4  million or 80% ofeligible accounts, as defined (See Note 2 to the Consolidated FinancialStatements).

On January  27,  2005, we amended theLoan and Security Agreement (First Loan Modification) to revise thefinancial covenant based on EBITDA for the six months endedDecember  31,  2004. We were in compliance with this revisedcovenant and all other covenants as of December  31,  2004.On March  28,  2005, we further amended the Agreement (SecondLoan Modification) in order to set the EBITDA and adjusted quick ratioquarterly covenants for 2005. We were not in compliance with the EBITDAcovenant as of June  30,  2005.

On September13,  2005, we entered into an Amended and Restated Loan andSecurity Agreement (‘‘Amended Agreement’’) inorder to revise certain terms of the Agreement including the loan fees,interest on the loan and the financial covenants. The Amended Agreementincluded a waiver of the June  30,  2005 EBITDA covenantdefault under the Second Loan Modification.

As ofSeptember  30,  2005, the Company was in compliance with allcovenants with the exception of a monthly ‘‘transitionevent’’ covenant which requires the Company to maintain anadjusted quick ratio greater than or equal to of 1.6 to 1.0. TheCompany’s adjusted quick ratio at September  30,  2005was 1.592 to 1.0. On November  7,  2005, the bank granted awaiver on the transition event covenant as of September  30,2005 and therefore did not require the Company to transition to thehigher-interest debt facility. The waiver was for the September30,  2005 date only.

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As of December  31,  2005, theCompany was in compliance with the monthly adjusted quick ratiocovenant of 1.35 to 1.0 and the transition event covenant, but was notin compliance with the quarterly EBITDAS covenant, which requires theCompany to achieve EBITDAS of the lesser of $1 better than theimmediate preceding quarter EBITDAS or $1  dollar. Additionally,as of November  30,  2005, the Company did not achieve itsmonthly ‘‘transition event’’ covenant whichrequires the Company to maintain an adjusted quick ratio of greaterthan or equal to of 1.6 to 1.0. The Company’s adjusted quickratio at November  30,  2005 was 1.44 to 1.0. OnFebruary  6,  2006, the bank granted a waiver on thequarterly EBITDAS covenant and the November transition event covenant.The EBITDAS covenant waiver was for the quarter ended December31,  2005 date only. The transition event waiver was for theNovember  30,  2005 date only.

As of December31,  2005, there were no amounts outstanding under the AmendedAgreement and availability under the Amended Agreement was $4.0million, based on the lesser of $4.0  million or 80% ofeligible accounts receivable. On March  14,  2006, theCompany and the Bank agreed to extend the loan to February15,  2007. All other terms of the loan remain the same.

Wehave no significant capital commitments. Planned capital expendituresfor 2006 total approximately $0.4  million, including any softwaredevelopment costs that may qualify for capitalization under SFAS No.86. Our aggregate minimum operating lease payments for 2006 will beapproximately $1.9  million. Our aggregate minimum royaltiespayable for third party software used in conjunction with our softwareis approximately $0.5  million for 2006. We expect to fund thesecommitments from cash on hand and cash generated by operatingactivities, but it may be necessary to seek other sources of financingshould we fail to generate sufficient cash.

Future payments dueunder lease obligations and third party software providers as ofDecember  31,  2005 are as follows:

|                       |  |                               |         |                              |  |        |         |        |  |        |         |        |  |  |
|-----------------------|--|-------------------------------|---------|------------------------------|--|--------|---------|--------|--|--------|---------|--------|--|--|
| (in thousands)        |  | Non-CancelableOperatingLeases |         | Third-PartySoftwareProviders |  | Total  |
| 2006                  |  | $                             | 1,875   |                         |  | $      | 475     |   |  | $      | 2,350   |   |
| 2007                  |  |                          | 1,656   |                         |  |   | 150     |   |  |   | 1,806   |   |
| 2008                  |  |                          | 92      |                         |  |   | 75      |   |  |   | 167     |   |
| 2009                  |  |                          | 46      |                         |  |   | 75      |   |  |   | 121     |   |
| 2010 & thereafter |  |                          | — |                         |  |   | — |   |  |   | — |   |
| Total                 |  | $                             | 3,669   |                         |  | $      | 775     |   |  | $      | 4,444   |   |
|                       |

Our operating activities used cash of$8.7  million and $4.5  million in 2005 and 2004respectively, and provided cash of $3.6  million in 2003. Net cashused by operating activities in 2005 is primarily the result of the netloss, a decrease in deferred revenue and decreased accounts payable andaccrued expenses partially offset by non-cash depreciation andamortization charges and by a decrease in accounts receivable. Thedecrease in deferred revenue is mainly the result of a decrease inlong-term deferred revenue as twelve months of a two year pre-paidmaintenance agreement with one large customer have now beensubstantially recognized as revenue. The decrease in accounts payableand accrued expenses in 2005 is mainly due to timing of payments andlower bonus accruals. The decrease in accounts receivable in 2005,mainly in US operations, is due to lower revenue during the currentyear as well as better collections from customers in 2005 compared to2004.

Net cash used by operating activities in 2004 is primarilythe result of the net loss, an increase in accounts receivable andprepaid expenses and other current assets and a decrease in deferredrevenue partially offset by non-cash depreciation and amortizationcharges, the net provision for doubtful accounts and an increase inaccounts payable and accrued expenses. Net cash provided by operatingactivities in 2003 was primarily the result of the net income, non-cashdepreciation and amortization charges and an increase in deferredrevenue partially offset by a decrease in accounts payable and accruedexpenses and an increase in accounts receivable.

Our investingactivities used cash of $0.2  million, $1.1  million and$1.8  million in 2005, 2004 and 2003, respectively, principallyfor purchases of equipment and leasehold improvements and forcapitalized 

31

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software development costs. The decrease incash used in investing activities from 2005 to 2004 was mainly theresult of a decrease in capitalized software development costs and by adecrease in the purchase of equipment. The decrease in cash used ininvesting activities from 2003 to 2004 was mainly the result of adecrease in capitalized software development costs partially offset byan increase in the purchase of equipment and leasehold improvements.The increase in cash used in investing activities from 2002 to 2003resulted mainly from an increase in capitalized software developmentcosts related primarily to development of the new Email Compliancesoftware.

Our financing activities provided cash of $7.3million and $7.7  million in 2005 and 2004 respectively, and usedcash of $1.7  million in 2003. Cash provided by financingactivities in 2005 and 2004 was primarily the result of the netproceeds received from the private placements and the exercise of stockoptions and warrants during the period. This was partially offset in2004 by the payment of the remaining balance of the outstanding termloan. Cash used in financing activities for 2003 resulted mainly fromrepayments on the term loan in accordance with the loan agreement

As of March  16,  2006, the Company has approximately$7.5  million in cash, including $1.4  million held by ourforeign subsidiaries. The increase from year end is due to theprepayment of maintenance fees, specifically by one large customer. Theprepayment of maintenance fees by the one large customer will berecorded as service revenue over a three year time period starting inthe first quarter of 2006.

We generated a net loss of $9.0million and $5.2  million for the years ended December31,  2005 and 2004, respectively, after generating net income of$2.3  million for the year ended December  31,  2003.For the years ended December  31,  2005 and 2004, weexperienced a decline in revenue as our business has shifted to focusmore heavily on the records compliance management business.Management’s initiatives over the last two years, including theJune  2005 and 2004 restructurings and the April  2004 andJune  2005 private placements of common stock have been designedto improve operating results and liquidity and better position AXS-Oneto compete under current market conditions. As a result of theseefforts, we expect that our current cash balance, availability ofborrowing capacity under our bank line of credit and operating cashflow should be sufficient to meet the short-term requirements of thebusiness. Our ability to fund our operations for the next twelve monthsis heavily dependent on the growth of our revenues over 2005 levels.Additionally, there is a risk that cash held by our foreignsubsidiaries may not be readily available for use in our U.S.operations to pay our obligations as the transfer of funds is sometimesdelayed due to various foreign government restrictions. Accordingly, wemay in the future be required to seek new sources of financing orfuture accommodations from our existing lender or other financialinstitutions, or we may seek equity infusions from private investors.We may also be required to further reduce operating costs in order tomeet our obligations. We have successfully reduced costs in prior yearsand believe that we would be successful if additional costs reductionswere necessary to help fund our operations. No assurance can be giventhat management’s initiatives will be successful or that any suchadditional sources of financing, lender accommodations or equityinfusions will be available. (See ‘‘RiskFactors.’’)

Critical Accounting Policies

Our critical accounting policies are as follows:

|  |              |                         |
|--|--------------|-------------------------|
|  | •  | Revenue recognition and |

|  |              |                                        |
|--|--------------|----------------------------------------|
|  | •  | Capitalized software developmentcosts. |

Revenue Recognition

We derive our revenueprimarily from two sources: (i) software licenses and (ii) services andsupport revenue, which includes software maintenance, subscriptionservices, training, consulting and custom programming revenue. We alsoderive a limited amount of consulting revenue and directors’ feesfrom the related party joint venture in South Africa (less than1% of total revenue in 2005, 2004 and 2003). As described below,significant management judgments and estimates must be made and used inconnection with the revenue recognized in any accounting period.Material differences may result in the amount and timing of our revenuefor any period if our management made different judgments or utilizeddifferent estimates.

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We normally license our software productson a perpetual basis. Each license agreement generally includes aprovision for initial post-contract support (maintenance). For themajority of license sales we use a signed license agreement as evidenceof an arrangement. For maintenance fees, we use a maintenance agreementas evidence of the arrangement. We use a professional servicesagreement as evidence of an arrangement for our training, subscription,custom programming and consulting revenues. Occasionally, where amaster license or services agreement with a customer already exists, weaccept the customer’s purchase order as evidence of anarrangement. Director fee revenues from our joint venture are evidencedby a master agreement governing the relationship.

We recognizerevenue in accordance with Statement of Position 97-2,‘‘Software Revenue Recognition’’(‘‘SOP 97-2’’), and Statement of Position 98-9,‘‘Modification of SOP 97-2, Software Revenue Recognition,With Respect to Certain Transactions.’’ Revenue fromnon-cancelable software licenses is recognized when the licenseagreement has been signed, delivery has occurred, the fee is fixed ordeterminable and collectibility is probable. The Company recognizesrevenue from resellers when an end user has placed an order with thereseller and the above revenue recognition criteria have been met withrespect to the reseller. In multiple element arrangements, we defer thevendor-specific objective evidence of fair value(‘‘VSOE’’) related to the undelivered elementsand recognize revenue on the delivered elements using the residualmethod. The most commonly deferred elements are initial maintenance andconsulting services. Initial maintenance is recognized on astraight-line basis over the initial maintenance term. The VSOE ofmaintenance is determined by using a consistent percentage ofmaintenance fee to license fee based on renewal rates. Maintenance feesin subsequent years are recognized on a straight-line basis over thelife of the applicable agreement. Maintenance contracts entitle thecustomer to hot-line support and all unspecified product upgradesreleased during the term of the maintenance contract. Upgrades includeany and all unspecified patches or releases related to a licensedsoftware product. Maintenance does not include implementation servicesto install these upgrades. The VSOE of services is determined by usingan average consulting rate per hour for consulting services soldseparately multiplied by the estimate of hours required to complete theconsulting engagement.

Delivery of software generally occurswhen the product (on CDs) is delivered to a common carrier.Occasionally, delivery occurs through electronic means where thesoftware is made available through our secure FTP (File TransferProtocol) site. The Company does not offer any customers or resellers aright of return.

For software license, services and maintenancerevenue, we assess whether the fee is fixed and determinable andwhether or not collection is probable. We assess whether the fee isfixed and determinable based on the payment terms associated with thetransaction. If a significant portion of a fee is due after our normalpayment terms, which are 30 to 90 days from invoice date, we accountfor the fee as not being fixed and determinable. In these cases, werecognize revenue as the fees become due.

The majority of ourtraining and consulting services are billed based on hourly rates. Wegenerally recognize revenue as these services are performed. However,when we enter into an arrangement that is based on a fixed fee orrequires us to perform significant work either to alter the underlyingsoftware or to build additional complex interfaces so that the softwareperforms as the customer requests, we recognize the related revenueusing the percentage of completion method of accounting. This wouldapply to our custom programming services, which are generallycontracted on a fixed fee basis. Anticipated losses, if any, arecharged to operations in the period such losses are determined to beprobable.

Revenues from transaction fees associated with oursubscription arrangements, billable on a per transaction basis andincluded in services revenue on the Consolidated Statements ofOperations, are recognized based on the actual number of transactionsprocessed during the period.

Revenues from joint ventures(included in Revenues: Other-Related Parties in our ConsolidatedStatements of Operations) includes consulting revenue for the jointventures’ use of our South African subsidiary’s consultantsand directors’ fees (during the 2004 period only) in accordancewith the joint venture agreement. Revenue is recognized uponperformance of the services.

We assess assuredness of collectionbased on a number of factors, including past transaction history withthe customer and the credit-worthiness of the customer. We do notrequest collateral from our 

33

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customers. If we determine that collectionof a fee is not probable, we defer the fee and recognize revenue at thetime collection becomes probable, which is generally upon receipt ofcash.

Our arrangements do not generally include acceptanceclauses. However, if an arrangement includes an acceptance provision,acceptance occurs upon the earliest of receipt of a written customeracceptance or expiration of the acceptance period.

Capitalized Software Development Costs

Our policy isto capitalize certain software development costs in accordance withStatement of Financial Accounting Standards No. 86,‘‘Accounting for the Costs of Computer Software to Be Sold,Leased, or Otherwise Marketed’’ (‘‘SFAS86’’). Under SFAS 86, costs incurred to develop orsignificantly enhance computer software products are charged toresearch and development expense as incurred until technologicalfeasibility has been established. We establish technologicalfeasibility upon completion of a working model or completion of adetailed program design. Generally costs related to projects that reachtechnological feasibility upon completion of a working model are notcapitalized as the time period between establishment of the workingmodel and general availability is of short duration. For projects thatmeet technological feasibility upon completion of a detailed programdesign, all research and development costs for that project arecapitalized from that point until the product is available for generalrelease to customers. The nature of our current development for RCMproducts is generally such that we can measure technologicalfeasibility most effectively using the working model method where thetime between establishment of a working model and general availabilityis of short duration which results in very little or no costs thatqualify for capitalization. We historically used a detailed programdesign model to measure technological feasibility for our enterprisefinancial products. This shift in development of our product lines willresult in lower capitalized costs in the future. The establishment oftechnological feasibility and the ongoing assessment of recoverabilityof capitalized software development costs require considerable judgmentby management with respect to certain external factors, including, butnot limited to, anticipated future revenues, estimated economic lifeand changes in technology. It is reasonably possible that estimates ofanticipated future revenues, the remaining estimated economic life ofthe products, or both will be reduced in the future due to competitivepressures. As a result, the carrying amount of the capitalized softwarecosts may be reduced through a charge to operations in the near term.Upon the general release of the software product to customers,capitalization ceases and such costs are amortized (using thestraight-line method) over the estimated life, which is generally threeyears.

Recently Issued Accounting Standards

InDecember  2004, the FASB issued SFAS No. 123 (revised 2004),‘‘Share-Based Payment’’ (SFAS No. 123R), whichreplaces SFAS No. 123 and supersedes APB Opinion No. 25. SFAS No. 123Raddresses the accounting for transactions in which an enterprisereceives employee services in exchange for (a)  equity instrumentsof the enterprise or (b) liabilities that are based on the fair valueof the enterprise's equity instruments or that may be settled bythe issuance of such equity instruments. SFAS No. 123R requires allshare-based payments to employees, including grants of employee stockoptions and non-vested stock grants, to be recognized as a compensationcost based on their fair values. The pro forma disclosures previouslypermitted under SFAS No. 123 no longer will be an alternative tofinancial statement recognition. We are required to adopt SFAS No. 123Rno later than January  1,  2006. Under SFAS No. 123R, we mustdetermine the appropriate fair value model to be used for valuingshare-based payments, the amortization method for compensation cost andthe transition method to be used at date of adoption. The Companyexpects to adopt the modified prospective method of transition, whichrequires that compensation expense be recorded for all unvested stockoptions and non-vested stock at the beginning of the first quarter ofadoption of SFAS No. 123R based on the fair value of the awardsdetermined at the date of grant. On October  26,  2005, theBoard of Directors of the Company approved the acceleration of vestingof all unvested ‘‘out-of-the money’’ stockoptions previously awarded to current employees and directors under theCompany’s stock option plans. The accelerated options hadexercise prices ranging from $2.15 to $6.25 with a weighted averageexercise price of $2.99. Options to purchase approximately 2.2million shares became exercisable immediately as a result of thevesting acceleration. To avoid any unintended personal benefits, theCompany also imposed a holding period on 

34

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the shares underlying the acceleratedoptions in the form of a Resale Restriction Agreement. This agreementrequires all optionees to refrain from selling any shares acquired uponthe exercise of the accelerated options until the earlier of the datesuch shares would have vested under the options’ original vestingterms or the date of the employee’s or director’stermination from the Company. As a result of this acceleration, theCompany expects to reduce the stock compensation expense it otherwisewould have been required to record beginning in January  2006 uponadoption of SFAS 123R by approximately $4.1  million overapproximately 2.5 years. In making the decision to accelerate theseoptions, the Board of Directors considered the interests of theCompany’s stockholders as this acceleration will reducecompensation expense in future periods. The Company expects expense ofapproximately $0.2  million for the year ended December31,  2006 related to the adoption of SFAS 123R based on theunvested options outstanding at December  31,  2005. TheCompany anticipates it will grant additional employee stock optionsand/or non-vested stock units in 2006. The fair value of these grantsis not included in the amount above, as the impact of these grantscannot be predicted at this time because it will depend on the numberof share-based payments granted and the then current fair values.

On December  16,  2004, the FASB issued Statement No. 153,‘‘Exchanges of Non-monetary Assets,’’ anamendment of APB Opinion No. 29. Statement No. 153 addresses themeasurement of exchanges of non-monetary assets and redefines the scopeof transactions that should be measured based on the fair value of theassets exchanged. The Statement is effective for non-monetary assetexchanges occurring in fiscal years beginning after June15,  2005. We do not believe adoption of Statement No. 153 willhave a material effect on our consolidated financial position, resultsof operations or cash flows.

On December  21,  2004,the FASB issued FASB Staff Position No. FAS 109-2 (FAS 109-2),‘‘Accounting and Disclosure Guidance for the ForeignEarnings Repatriation Provision within the American Jobs Creation Actof 2004.’’ The American Jobs Creation Act introduces aspecial one-time dividends received deduction on the repatriation ofcertain foreign earnings to a U.S. taxpayer (repatriation provision),provided certain criteria are met. FAS 109-2 provides accounting anddisclosure guidance for the repatriation provision. FAS 109-2 iseffective immediately, though the Treasury Department or Congress isexpected to provide additional clarifying language on key elements ofthe repatriation provision. The adoption of FAS 109-2 did not have amaterial effect on our consolidated financial position, results ofoperations or cash flows as we do not currently have foreign earningsavailable for repatriation.

On May  5,  2005, the FASBissued SFAS No. 154, ‘‘Accounting Changes and ErrorCorrections’’ (‘‘SFAS No. 154’’),which replaces Accounting Principles Board(‘‘APB’’) Opinion No. 20‘‘Accounting Changes,’’ and SFAS No. 3‘‘Reporting Accounting Changes in Interim FinancialStatements.’’ SFAS No. 154 changes the requirements for theaccounting and reporting of a change in accounting principle, andapplies to all voluntary changes in accounting principles, as well aschanges required by an accounting pronouncement in the unusual instancethat it does not include specific transition provisions. Specifically,SFAS No. 154 requires retrospective application to prior periods'financial statements unless it is impracticable to determine the periodspecific effects or the cumulative effect of the change. SFAS No. 154does not change the transition provisions of any existingpronouncement. SFAS No. 154 is effective for the Company for allaccounting changes and corrections of errors made beginningJanuary  1,  2006.

|               |                                                           |
|---------------|-----------------------------------------------------------|
| Item7A.  | Quantitative and Qualitative Disclosures AboutMarket Risk |

In the normal course of business, we are exposed tofluctuations in interest rates and equity market risks as we seek debtand equity capital to sustain our operations. We are also exposed tofluctuations in foreign currency exchange rates as the financialresults of our foreign subsidiaries are translated into U.S. dollars inconsolidation. We do not use derivative instruments or hedging tomanage our exposures and do not currently hold any market risksensitive instruments for trading purposes.

|              |                                             |
|--------------|---------------------------------------------|
| Item8.  | Financial Statements and Supplementary Data |

The information required by this Item is incorporated by referenceherein from Part IV Item 15(a)  (1) and (2).

|              |                                                                                      |
|--------------|--------------------------------------------------------------------------------------|
| Item9.  | Changes in and Disagreements with Accountants onAccounting and Financial Disclosure. |

Not applicable.

35

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|                |                        |
|----------------|------------------------|
| Item 9A.  | Controls andProcedures |

Evaluation of disclosure controls andprocedures

Our chief executive officer and our chieffinancial officer, after evaluating the effectiveness of our‘‘disclosure controls and procedures’’ (asdefined in the Securities Exchange Act of 1934 Rule 13a-15(e)) as ofDecember  31,  2005 (the ‘‘EvaluationDate’’), have concluded that as of the Evaluation Date, ourdisclosure controls and procedures were effective and designed toensure that material information relating to us and our consolidatedsubsidiaries would be collected and made known to them by others withinthose entities as appropriate to allow timely decisions regardingrequired disclosure of such information.

Internal controlsover financial reporting

During the most recent fiscalquarter, there has not been any change in our internal control overfinancial reporting that has materially affected, or is reasonablylikely to materially affect, our internal control over financialreporting.

|                |                   |
|----------------|-------------------|
| Item 9B.  | Other Information |

On March  14,  2006, the Company and Silicon Valley Bankagreed to extend the term of the loan agreement. The term of the loanwas scheduled to expire on August  6,  2006 and has beenextended to February  15,  2007. All other terms of the loanremain the same.

PART III

|               |                                                   |
|---------------|---------------------------------------------------|
| Item10.  | Directors and Executive Officers of theRegistrant |

The Company incorporates herein by reference theinformation required by Items 401, 405 and 406 of Regulation S-K to beset forth in its Notice of Annual Stockholders' Meeting and ProxyStatement to be filed within 120 days after the end of theCompany's fiscal year (the ‘‘2006 ProxyStatement’’).

|                |                       |
|----------------|-----------------------|
| Item 11.  | ExecutiveCompensation |

The Company incorporates herein by reference theinformation required by Item 402 of Regulation S-K to be set forth inthe 2006 Proxy Statement.

|                |                                                                                              |
|----------------|----------------------------------------------------------------------------------------------|
| Item 12.  | SecurityOwnership of Certain Beneficial Owners and Management and RelatedStockholder Matters |

The Company incorporates herein byreference the information required by Items 201(d) and 403 ofRegulation S-K to be set forth in the 2006 Proxy Statement.

|                |                                               |
|----------------|-----------------------------------------------|
| Item 13.  | Certain Relationships and RelatedTransactions |

The Company incorporates herein by reference theinformation required by Item 404 of Regulation S-K to be set forth inthe 2006 Proxy Statement.

|                |                                       |
|----------------|---------------------------------------|
| Item 14.  | PrincipalAccountant Fees and Services |

The Company incorporates herein byreference the information required by Item 9(e) of Schedule 14A to beset forth in the 2006 Proxy Statement.

36

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PART IV

|               |                                            |
|---------------|--------------------------------------------|
| Item15.  | Exhibits and Financial Statement Schedules |

(a) (1)    Consolidated Financial Statements:

|                                                                                                            |  |          |  |  |  |  |
|------------------------------------------------------------------------------------------------------------|--|----------|--|--|--|--|
|                                                                                                       |  | Page No. |
| Report of Independent Registered Public AccountingFirm                                                     |  | 41       |
| Consolidated Balance Sheets at December  31,  2005and 2004                                                 |  | 42       |
| Consolidated Statements ofOperations for the years ended December  31,  2005,2004and 2003                  |  | 43       |
| Consolidated Statements ofComprehensive Income (Loss) for the years ended December31,  2005, 2004 and 2003 |  | 44       |
| Consolidated Statements of Stockholders' Deficit for theyears ended December  31,  2005, 2004 and 2003     |  | 45       |
| Consolidated Statements of Cash Flows forthe years ended December  31,  2005,2004 and 2003                 |  | 46       |
| Notes to Consolidated FinancialStatements                                                                  |  | 47       |
| (a) (2)Consolidated Financial StatementSchedules:                                                          |  |     |
| Report of Independent RegisteredPublic Accounting Firm on Consolidated Financial StatementSchedule         |  | 68       |
| Schedule II — Valuationand Qualifying Accounts for the years ended December  31,2005, 2004 and 2003  |  | 69       |
|                                                                                                            |

(a)(3)    Exhibits.

|          |
|----------|
|          |  |  |  |  |  |  |
| 3.1(a)   |  | Fourth Amended and Restated Certificate of Incorporation |
| 3.2(a)   |  | Amended and Restated Bylawsof the Company |
| 4.1(a)   |  | Specimen Common Stock Certificate |
| 4.2      |  | See Exhibits 3.1 and 3.2 for provisions ofthe Certificate of Incorporation and Bylaws of the Company definingrights of holders of Common Stock of the Company |
| 4.4(f)   |  | Form of Warrant(2001) |
| 4.5(j)   |  | Form ofWarrants (2003) |
| 10.3(a)  |  | Employment Agreement between the Company and Elias Typaldos, asamended |
| 10.6(a)  |  | 1995Stock Option Plan |
| 10.9(a)  |  | License Agreement between the Company and Pfizer, Inc., asamended |
| 10.13(a) |  | ProgramLicense Contract between the Company and Deutsche Bank AG |
| 10.19(c) |  | 1995 Stock Option Plan, asamended |
| 10.20(b) |  | Securities Purchase Agreement |
| 10.21(c) |  | Employment Agreementbetween the Company and John  Rade |
| 10.24(c) |  | Amendment to SecuritiesPurchase Agreement |
| 10.27(d) |  | 1998 Stock Option Plan |
| 10.32(e) |  | Amendment to the EmploymentAgreement between the Company and John Rade |
| 10.47(f) |  | Investment Banking ServicesAgreement between the Company and Stonegate Securities, Inc. datedNovember  2,  2000, and Amendment dated January24,  2001. |
| 10.48(f) |  | Employment Agreement between the Company and WilliamLevering |
| 10.50(g) |  | StockPurchase Agreement, dated as of September  1,  2001, betweenthe Company and Porterfield Ltd. relating to the sale of all shares ofAXS-One Sp. z.o.o. |
|          |

37

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|          |
|----------|
|          |  |  |  |  |  |  |
| 10.51(g) |  | Promissory Note of Porterfield International Ltd. Issued to theCompany |
| 10.54(h) |  | LeaseAgreement between the Company and CIN Meadows L.L.C. |
| 10.56(i) |  | Investor Relations ServicesAgreement between the Company and Hayden Communications,Inc. |
| 10.60(j) |  | Employmentagreement between the Company and Gennaro Vendome |
| 10.61(k) |  | Employment agreementbetween the Company and Paul Abel |
| 10.62(l) |  | Loan and Security Agreementwith Silicon Valley Bank dated August  11,  2004 |
| 10.63(m) |  | Employment Agreementbetween the Company and William P. Lyons |
| 10.64(n) |  | Employment Agreementbetween the Company and Joseph P. Dwyer |
| 10.65(n) |  | Employment Agreementbetween the Company and Richard Dym |
| 10.66(n) |  | Employment Agreementbetween the Company and Matthew Suffoletto |
| 10.67(n) |  | First Loan Modification tothe Loan & Security Agreement dated January  27,2005 |
| 10.68(o) |  | Unitsubscription agreement dated April  1,  2004, Class AWarrants, Class B  Warrants, and Investor Rights Agreements datedApril  5,  2004 |
| 10.69(p) |  | 2005 Stock IncentivePlan |
| 10.70(q) |  | Unitsubscription agreement dated June  17,  2005, Class CWarrants, Class D  Warrants, and Investor Rights Agreements datedJune  17,  2005 |
| 10.71(r) |  | Agreement and GeneralRelease between the Company and Richard Dym dated July  19,2005 |
| 10.72(s) |  | Amended andRestated Loan and Security Agreement dated September  13,2005 |
| 10.73(t) |  | Agreementand General Release between the Company and Gennaro Vendome datedOctober  13,  2005 |
| 10.74(u) |  | Form of Resale RestrictionAgreement for accelerated Stock Options dated October  26,2005 |
| 10.75**  |  | Modification of loanarrangement dated March  14,  2006 |
| 21.1**   |  | List of Subsidiaries |
| 23.1**   |  | Consent of KPMG LLP |
| 31.1**   |  | Rule 13a-14(a)/15d-14(a) certifications– William P. Lyons |
| 31.2**   |  | Rule13a-14(a)/15d-14(a) certifications – Joseph Dwyer |
| 32**     |  | Officer Certifications under 18 USC1350 |
|          |

|  |
|--|
|  |  |
|  |

|     |                                                                                                                         |
|-----|-------------------------------------------------------------------------------------------------------------------------|
| (a) | Incorporatedby reference to the Exhibits filed with the Company's RegistrationStatement on Form S-l, File No. 33-93990. |

|     |                                                                                                      |
|-----|------------------------------------------------------------------------------------------------------|
| (b) | Incorporated by reference tothe Exhibits filed with the Company's Form 8-K filed onJanuary  8,  1998 |

|     |                                                                                  |
|-----|----------------------------------------------------------------------------------|
| (c) | Incorporated by reference tothe Exhibits filed with the Company's 1997 Form 10-K |

|     |                                                                                             |
|-----|---------------------------------------------------------------------------------------------|
| (d) | Incorporated by reference tothe Exhibits filed with the Company's March  31,  1998Form 10-Q |

|     |                                                                                  |
|-----|----------------------------------------------------------------------------------|
| (e) | Incorporated by reference tothe Exhibits filed with the Company's 1998 Form 10-K |

|     |                                                                                        |
|-----|----------------------------------------------------------------------------------------|
| (f) | Incorporated by reference tothe Exhibits filed with the Company’s 2000 Form 10-K |

|     |                                                                                                            |
|-----|------------------------------------------------------------------------------------------------------------|
| (g) | Incorporated by reference tothe Exhibits filed with the Company’s Form 8-K filed onOctober  5,  2001 |

|     |                                                                                        |
|-----|----------------------------------------------------------------------------------------|
| (h) | Incorporated by reference tothe Exhibits filed with the Company’s 2001 Form 10-K |

|     |                                                                                        |
|-----|----------------------------------------------------------------------------------------|
| (i) | Incorporated by reference tothe Exhibits filed with the Company’s 2002 Form 10-K |

|     |                                                                                                 |
|-----|-------------------------------------------------------------------------------------------------|
| (j) | Incorporated by reference tothe Exhibits filed with the Company’s September  30,2003 10-Q |

|     |                                                                                        |
|-----|----------------------------------------------------------------------------------------|
| (k) | Incorporated by reference tothe Exhibits filed with the Company’s 2003 Form 10-K |

38

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|     |                                                                                            |
|-----|--------------------------------------------------------------------------------------------|
| (l) | Incorporatedby reference to the Exhibits filed with the Company’s June30,  2004 10-Q |

|     |                                                                                                           |
|-----|-----------------------------------------------------------------------------------------------------------|
| (m) | Incorporated by reference tothe Exhibits filed with the Company’s Form 8-K filed onApril  30,  2004 |

|     |                                                                                        |
|-----|----------------------------------------------------------------------------------------|
| (n) | Incorporated by reference tothe Exhibits filed with the Company’s 2004 Form 10-K |

|     |                                                                                                          |
|-----|----------------------------------------------------------------------------------------------------------|
| (o) | Incorporated by reference tothe Exhibits filed with the Company’s Form 8-K filed onApril  8,  2004 |

|     |                                                                                                        |
|-----|--------------------------------------------------------------------------------------------------------|
| (p) | Incorporated by reference tothe Exhibits filed with the Company’s Form 8-K filed on May27,  2005 |

|     |                                                                                                          |
|-----|----------------------------------------------------------------------------------------------------------|
| (q) | Incorporated by reference tothe Exhibits filed with the Company’s Form 8-K filed onJune  23,  2005 |

|     |                                                                                                          |
|-----|----------------------------------------------------------------------------------------------------------|
| (r) | Incorporated by reference tothe Exhibits filed with the Company’s Form 8-K filed onJuly  19,  2005 |

|     |                                                                                                               |
|-----|---------------------------------------------------------------------------------------------------------------|
| (s) | Incorporated by reference tothe Exhibits filed with the Company’s Form 8-K filed onSeptember  19,  2005 |

|     |                                                                                                             |
|-----|-------------------------------------------------------------------------------------------------------------|
| (t) | Incorporated by reference tothe Exhibits filed with the Company’s Form 8-K filed onOctober  24,  2005 |

|     |                                                                                                             |
|-----|-------------------------------------------------------------------------------------------------------------|
| (u) | Incorporated by reference tothe Exhibits filed with the Company’s Form 8-K filed onNovember  1,  2005 |

|    |                |
|----|----------------|
| ** | Filed herewith |

by

39

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of theSecurities Exchange Act of 1934, the Registrant has duly caused thisreport to be signed on its behalf by the undersigned, thereunto dulyauthorized.

|              |  |                                                                  |  |  |  |  |
|--------------|--|------------------------------------------------------------------|--|--|--|--|
| AXS-ONE INC. |
| By:          |  | /s/William P. Lyons                                              |
|         |  | William P. Lyons,Chairmanof the Board and Chief ExecutiveOfficer |
|              |

Date: March  23,2006

Pursuant to the requirements of the Securities Exchange Actof 1934, this report has been signed below by the following persons onbehalf of the Registrant and in the capacities indicated, onMarch  20,2006.

|                      |  |                                                                                                           |
|----------------------|--|-----------------------------------------------------------------------------------------------------------|
| Signature            |  | Title(s)                                                                                                  |
|                      |
| /s/ William P.Lyons  |  | Chairman ofthe Board and Chief Executive Officer (Principal ExecutiveOfficer)                             |
|                      |
| (William P. Lyons)   |
|                      |
| /s/ JosephDwyer      |  | Executive VicePresident, Chief Financial Officer and Treasurer(PrincipalFinancial and Accounting Officer) |
|                      |
| (Joseph Dwyer)       |
|                      |
| /s/ EliasTypaldos    |  | ExecutiveVice President Technology and Director                                                           |
|                      |
| (Elias Typaldos)     |
|                      |
| /s/Gennaro Vendome   |  | Director                                                                                                  |
|                      |
| (Gennaro Vendome)    |
|                      |
| /s/ Daniel H.Burch   |  | Director                                                                                                  |
|                      |
| (Daniel H. Burch)    |
|                      |
| /s/ RobertMigliorino |  | Director                                                                                                  |
|                      |
| (Robert Migliorino)  |
|                      |
| /s/ AnthonyBloom     |  | Director                                                                                                  |
|                      |
| (Anthony Bloom)      |
|                      |
| /s/ HaroldCopperman  |  | Director                                                                                                  |
|                      |
| (Harold Copperman)   |
|                      |
| /s/ AllanWeingarten  |  | Director                                                                                                  |
|                      |
| (Allan Weingarten)   |
|                      |

40

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Report ofIndependent Registered Public Accounting Firm

The Board of Directors and StockholdersAXS-OneInc.:

We have audited the accompanying consolidatedbalance sheets of AXS-One Inc. and subsidiaries as of December31,  2005 and 2004, and the related consolidated statements ofoperations, comprehensive income (loss), stockholders' deficit,and cash flows for each of the years in the three-year period endedDecember  31,  2005. These consolidated financial statementsare the responsibility of the Company's management. Ourresponsibility is to express an opinion on these consolidated financialstatements based on our audits.

We conducted our auditsin accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we planand perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amountsand disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates madeby management, as well as evaluating the overall financial statementpresentation. We believe that our audits provide a reasonable basis forour opinion.

In our opinion, the consolidated financialstatements referred to above present fairly, in all material respects,the financial position of AXS-One Inc. and subsidiaries as ofDecember  31,  2005 and 2004, and the results of theiroperations and their cash flows for each of the years in the three-yearperiod ended December  31,  2005, in conformity with U.S.generally accepted accounting principles.

/s/KPMG LLP

Short Hills, New JerseyMarch23,  2006

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AXS-ONE INC. ANDSUBSIDIARIESCONSOLIDATED BALANCE SHEETS(In thousands, exceptper share data)

|                                                                                                                                                                   |  |                   |         |                   |  |        |         |         |  |  |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|--|-------------------|---------|-------------------|--|--------|---------|---------|--|--|
|                                                                                                                                                              |  | December 31, 2005 |         | December 31, 2004 |
| ASSETS                                                                                                                                                            |  |              |         |              |
| Currentassets:                                                                                                                                                    |  |              |    |              |  |   |    |    |
| Cash and cashequivalents                                                                                                                                          |  | $                 | 3,613   |              |  | $      | 4,809   |    |
| Restricted cash                                                                                                                                                   |  |              | 57      |              |  |   | 62      |    |
| Accounts receivable, net of allowance for doubtfulaccounts of $167 and $577 at December  31,  2005 andDecember  31,  2004, respectively                           |  |              | 5,153   |              |  |   | 6,084   |    |
| Due from joint venture                                                                                                                                            |  |              | — |              |  |   | 68      |    |
| Prepaid expensesand other current assets                                                                                                                          |  |              | 718     |              |  |   | 1,221   |    |
| Total current assets                                                                                                                                              |  |              | 9,541   |              |  |   | 12,244  |    |
| Equipment and leasehold improvements, atcost:                                                                                                                     |  |              |    |              |  |   |    |    |
| Computer and office equipment                                                                                                                                     |  |              | 10,967  |              |  |   | 11,606  |    |
| Furniture andfixtures                                                                                                                                             |  |              | 924     |              |  |   | 943     |    |
| Leaseholdimprovements                                                                                                                                             |  |              | 865     |              |  |   | 865     |    |
|                                                                                                                                                              |  |              | 12,756  |              |  |   | 13,414  |    |
| Less— accumulated depreciation and amortization                                                                                                             |  |              | 12,361  |              |  |   | 12,905  |    |
|                                                                                                                                                              |  |              | 395     |              |  |   | 509     |    |
| Capitalized software development costs, net of accumulatedamortization of $11,432 and $10,566 at December  31,  2005and December  31,  2004, respectively         |  |              | 1,038   |              |  |   | 1,886   |    |
| Other assets                                                                                                                                                      |  |              | 92      |              |  |   | 142     |    |
|                                                                                                                                                              |  | $                 | 11,066  |              |  | $      | 14,781  |    |
| LIABILITIESAND STOCKHOLDERS'DEFICIT                                                                                                                               |  |              |    |              |  |   |    |    |
| Currentliabilities:                                                                                                                                               |  |              |    |              |  |   |    |    |
| Accounts payable                                                                                                                                                  |  | $                 | 1,576   |              |  | $      | 1,901   |    |
| Accruedexpenses                                                                                                                                                   |  |              | 3,267   |              |  |   | 3,786   |    |
| Due tojoint venture                                                                                                                                               |  |              | 52      |              |  |   | 29      |    |
| Deferred revenue                                                                                                                                                  |  |              | 8,224   |              |  |   | 9,786   |    |
| Total current liabilities                                                                                                                                         |  |              | 13,119  |              |  |   | 15,502  |    |
| Long-termliabilities:                                                                                                                                             |  |              |    |              |  |   |    |    |
| Long-term deferredrevenue                                                                                                                                         |  |              | 63      |              |  |   | 303     |    |
| Commitments andcontingencies                                                                                                                                      |  |              |    |              |  |   |    |    |
| Stockholders'deficit:                                                                                                                                             |  |              |    |              |  |   |    |    |
| Preferred stock, $.01 parvalue, authorized 5,000 shares, no shares issued and outstanding                                                                         |  |              | — |              |  |   | — |    |
| Common stock,$.01 par value, authorized 50,000 shares; 34,316 and 28,341 sharesissued and outstanding at December  31,  2005 andDecember  31,  2004, respectively |  |              | 343     |              |  |   | 283     |    |
| Additional paid-in capital                                                                                                                                        |  |              | 87,884  |              |  |   | 80,339  |    |
| Accumulateddeficit                                                                                                                                                |  |              | (90,663 | )            |  |   | (81,665 | )  |
| Accumulated other comprehensive income                                                                                                                            |  |              | 497     |              |  |   | 19      |    |
| Unearned stock compensation                                                                                                                                       |  |              | (177    | )            |  |   | — |    |
| Total stockholders' deficit                                                                                                                                       |  |              | (2,116  | )            |  |   | (1,024  | )  |
|                                                                                                                                                              |  | $                 | 11,066  |              |  | $      | 14,781  |    |
|                                                                                                                                                                   |

The accompanying notes are anintegral part of these consolidated financial statements.

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AXS-ONE INC. ANDSUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS(in thousands,except per share data)

|                                                     |  |                         |         |         |  |        |         |         |  |        |         |         |  |  |
|-----------------------------------------------------|--|-------------------------|---------|---------|--|--------|---------|---------|--|--------|---------|---------|--|--|
|                                                |  | Years Ended December31, |
|                                                |  | 2005                    |         | 2004    |  | 2003   |
| Revenues:                                           |  |                    |    |    |  |   |    |    |  |   |    |    |
| Licensefees                                         |  | $                       | 5,546   |    |  | $      | 6,781   |    |  | $      | 6,443   |    |
| Services                                            |  |                    | 27,154  |    |  |   | 31,446  |    |  |   | 32,948  |    |
| Other - related parties                             |  |                    | 108     |    |  |   | 209     |    |  |   | 300     |    |
| Total revenues                                      |  |                    | 32,808  |    |  |   | 38,436  |    |  |   | 39,691  |    |
| Operatingexpenses:                                  |  |                    |    |    |  |   |    |    |  |   |    |    |
| Cost of license fees                                |  |                    | 1,585   |    |  |   | 1,923   |    |  |   | 1,524   |    |
| Cost of services                                    |  |                    | 16,223  |    |  |   | 17,086  |    |  |   | 15,832  |    |
| Sales and marketing                                 |  |                    | 9,743   |    |  |   | 9,565   |    |  |   | 7,297   |    |
| Research and development                            |  |                    | 7,828   |    |  |   | 7,999   |    |  |   | 6,832   |    |
| General andadministrative                           |  |                    | 5,129   |    |  |   | 6,411   |    |  |   | 5,634   |    |
| Restructuring and other costs                       |  |                    | 863     |    |  |   | 1,020   |    |  |   | — |    |
| Total operating expenses                            |  |                    | 41,371  |    |  |   | 44,004  |    |  |   | 37,119  |    |
| Operating income (loss)                             |  |                    | (8,563  | )  |  |   | (5,568  | )  |  |   | 2,572   |    |
| Other income(expense):                              |  |                    |    |    |  |   |    |    |  |   |    |    |
| Interest income                                     |  |                    | 156     |    |  |   | 144     |    |  |   | 73      |    |
| Interest expense                                    |  |                    | (44     | )  |  |   | (14     | )  |  |   | (197    | )  |
| Gain on sale of subsidiary                          |  |                    | — |    |  |   | — |    |  |   | 71      |    |
| Equity in losses of joint venture                   |  |                    | (89     | )  |  |   | (162    | )  |  |   | (114    | )  |
| Other income(expense), net                          |  |                    | (483    | )  |  |   | 171     |    |  |   | (188    | )  |
| Other income (expense), net                         |  |                    | (460    | )  |  |   | 139     |    |  |   | (355    | )  |
| Income (loss) before income tax benefit             |  |                    | (9,023  | )  |  |   | (5,429  | )  |  |   | 2,217   |    |
| Income tax benefit                                  |  |                    | 25      |    |  |   | 217     |    |  |   | 99      |    |
| Net income (loss)                                   |  | $                       | (8,998  | )  |  | $      | (5,212  | )  |  | $      | 2,316   |    |
| Basic and diluted netincome (loss) per common share |  | $                       | (0.28   | )  |  | $      | (0.19   | )  |  | $      | 0.09    |    |
| Weighted average basic common sharesoutstanding     |  |                    | 31,629  |    |  |   | 27,395  |    |  |   | 24,945  |    |
| Weighted average diluted common sharesoutstanding   |  |                    | 31,629  |    |  |   | 27,395  |    |  |   | 26,264  |    |
|                                                     |

The accompanying notes are anintegral part of these consolidated financial statements.

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AXS-ONE INC. ANDSUBSIDIARIESCONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME(LOSS)(In thousands)

|                                         |  |                         |        |         |  |        |        |         |  |        |       |         |  |  |
|-----------------------------------------|--|-------------------------|--------|---------|--|--------|--------|---------|--|--------|-------|---------|--|--|
|                                    |  | Years Ended December31, |
|                                    |  | 2005                    |        | 2004    |  | 2003   |
| Net income (loss)                       |  | $                       | (8,998 | )  |  | $      | (5,212 | )  |  | $      | 2,316 |    |
| Foreign currency translation adjustment |  |                    | 478    |    |  |   | (337   | )  |  |   | (88   | )  |
| Comprehensive income (loss)             |  | $                       | (8,520 | )  |  | $      | (5,549 | )  |  | $      | 2,228 |    |
|                                         |

The accompanying notes are anintegral part of these consolidated financial statements.

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AXS-ONE INC. ANDSUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS'DEFICIT(In thousands)

|                                                    |  |             |         |                          |  |                    |         |                           |  |                                           |         |                           |  |        |         |         |  |        |         |         |  |        |         |         |  |        |         |         |  |  |
|----------------------------------------------------|--|-------------|---------|--------------------------|--|--------------------|---------|---------------------------|--|-------------------------------------------|---------|---------------------------|--|--------|---------|---------|--|--------|---------|---------|--|--------|---------|---------|--|--------|---------|---------|--|--|
|                                               |  | CommonStock |         | AdditionalPaid-inCapital |  | AccumulatedDeficit |         | UnearnedStockCompensation |  | AccumulatedOtherComprehensiveIncome(Loss) |         | TotalStockholders'Deficit |
|                                               |  | Shares      |         | Amount                   |
| Balance – December  31, 2002                 |  |        | 24,849  |                     |  | $                  | 248     |                      |  | $                                         | 72,052  |                      |  | $      | (78,769 | )  |  | $      | — |    |  | $      | 444     |    |  | $      | (6,025  | )  |
| Netincome                                          |  |        | — |                     |  |               | — |                      |  |                                      | — |                      |  |   | 2,316   |    |  |   | — |    |  |   | — |    |  |   | 2,316   |    |
| Foreign currency translation adjustment            |  |        | — |                     |  |               | — |                      |  |                                      | — |                      |  |   | — |    |  |   | — |    |  |   | (88     | )  |  |   | (88     | )  |
| Exercise of stock options                          |  |        | 177     |                     |  |               | 2       |                      |  |                                      | 96      |                      |  |   | — |    |  |   | — |    |  |   | — |    |  |   | 98      |    |
| Balance – December  31, 2003                 |  |        | 25,026  |                     |  |               | 250     |                      |  |                                      | 72,148  |                      |  |   | (76,453 | )  |  |   | — |    |  |   | 356     |    |  |   | (3,699  | )  |
| Net loss                                           |  |        | — |                     |  |               | — |                      |  |                                      | — |                      |  |   | (5,212  | )  |  |   | — |    |  |   | — |    |  |   | (5,212  | )  |
| Foreign currency translationadjustment             |  |        | — |                     |  |               | — |                      |  |                                      | — |                      |  |   | — |    |  |   | — |    |  |   | (337    | )  |  |   | (337    | )  |
| Sale of common stock and warrants                  |  |        | 2,581   |                     |  |               | 26      |                      |  |                                      | 7,666   |                      |  |   | — |    |  |   | — |    |  |   | — |    |  |   | 7,692   |    |
| Exercise of stockoptions and warrants              |  |        | 734     |                     |  |               | 7       |                      |  |                                      | 525     |                      |  |   | — |    |  |   | — |    |  |   | — |    |  |   | 532     |    |
| Balance – December  31,2004                  |  |        | 28,341  |                     |  |               | 283     |                      |  |                                      | 80,339  |                      |  |   | (81,665 | )  |  |   | — |    |  |   | 19      |    |  |   | (1,024  | )  |
| Net loss                                           |  |        | — |                     |  |               | — |                      |  |                                      | — |                      |  |   | (8,998  | )  |  |   | — |    |  |   | — |    |  |   | (8,998  | )  |
| Foreign currency translationadjustment             |  |        | — |                     |  |               | — |                      |  |                                      | — |                      |  |   | — |    |  |   | — |    |  |   | 478     |    |  |   | 478     |    |
| Issuance of non-vested stock, net of cancellations |  |        | 95      |                     |  |               | 1       |                      |  |                                      | 204     |                      |  |   | — |    |  |   | (205    | )  |  |   | — |    |  |   | — |    |
| Stock basedcompensation expense                    |  |        | — |                     |  |               | — |                      |  |                                      | 9       |                      |  |   | — |    |  |   | 28      |    |  |   | — |    |  |   | 37      |    |
| Sale of common stock and warrants                  |  |        | 4,535   |                     |  |               | 45      |                      |  |                                      | 6,317   |                      |  |   | — |    |  |   | — |    |  |   | — |    |  |   | 6,362   |    |
| Exercise of stockoptions                           |  |        | 1,345   |                     |  |               | 14      |                      |  |                                      | 1,015   |                      |  |   | — |    |  |   | — |    |  |   | — |    |  |   | 1,029   |    |
| Balance – December31, 2005                   |  |        | 34,316  |                     |  | $                  | 343     |                      |  | $                                         | 87,884  |                      |  | $      | (90,663 | )  |  | $      | (177    | )  |  | $      | 497     |    |  | $      | (2,116  | )  |
|                                                    |

The accompanying notes are anintegral part of these consolidated financial statements.

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AXS-ONE INC. ANDSUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(Inthousands)

|                                                                                                        |  |                         |         |         |  |        |         |         |  |        |         |         |  |  |
|--------------------------------------------------------------------------------------------------------|--|-------------------------|---------|---------|--|--------|---------|---------|--|--------|---------|---------|--|--|
|                                                                                                   |  | Years Ended December31, |
|                                                                                                   |  | 2005                    |         | 2004    |  | 2003   |
| Cash flows fromoperating activities:                                                                   |  |                    |    |    |  |   |    |    |  |   |    |    |
| Net (loss)income                                                                                       |  | $                       | (8,998  | )  |  | $      | (5,212  | )  |  | $      | 2,316   |    |
| Adjustments to reconcile net (loss) income to netcash flows provided by (used in) operatingactivities: |  |                    |    |    |  |   |    |    |  |   |    |    |
| Increase in cashsurrender value of officers' life insurance                                            |  |                    | (6      | )  |  |   | (15     | )  |  |   | (20     | )  |
| Depreciation andamortization                                                                           |  |                    | 1,153   |    |  |   | 1,348   |    |  |   | 1,570   |    |
| Net (recovery of) provision for doubtful accounts                                                      |  |                    | 11      |    |  |   | 465     |    |  |   | (108    | )  |
| Gainon sale of subsidiary                                                                              |  |                    | — |    |  |   | — |    |  |   | (71     | )  |
| Equity in losses of jointventures                                                                      |  |                    | 89      |    |  |   | 162     |    |  |   | 114     |    |
| Non-cash stock compensation expense                                                                    |  |                    | 37      |    |  |   | — |    |  |   | — |    |
| Consultingservices received in lieu of cash payment on accounts receivable                             |  |                    | — |    |  |   | 299     |    |  |   | 45      |    |
| Changes in assets andliabilities                                                                       |  |                    |    |    |  |   |    |    |  |   |    |    |
| Restricted cash                                                                                        |  |                    | 2       |    |  |   | (3      | )  |  |   | 25      |    |
| Accountsreceivable                                                                                     |  |                    | 813     |    |  |   | (1,148  | )  |  |   | (973    | )  |
| Due to (from) joint venture                                                                            |  |                    | (3      | )  |  |   | (36     | )  |  |   | 60      |    |
| Prepaid expenses andother current assets                                                               |  |                    | 526     |    |  |   | (566    | )  |  |   | 149     |    |
| Accounts payable and accrued expenses                                                                  |  |                    | (670    | )  |  |   | 698     |    |  |   | (828    | )  |
| Deferred revenue                                                                                       |  |                    | (1,615  | )  |  |   | (529    | )  |  |   | 1,310   |    |
| Net cash flows provided by (used in)operating activities                                               |  |                    | (8,661  | )  |  |   | (4,537  | )  |  |   | 3,589   |    |
| Cash flowsfrom investingactivities:                                                                    |  |                    |    |    |  |   |    |    |  |   |    |    |
| Change in otherassets                                                                                  |  |                    | 46      |    |  |   | 86      |    |  |   | 8       |    |
| Loan to joint venture                                                                                  |  |                    | — |    |  |   | (115    | )  |  |   | (288    | )  |
| Capitalized softwaredevelopment costs                                                                  |  |                    | (18     | )  |  |   | (601    | )  |  |   | (1,296  | )  |
| Purchase of equipment andleasehold improvements                                                        |  |                    | (196    | )  |  |   | (426    | )  |  |   | (214    | )  |
| Net cash flows used ininvesting activities                                                             |  |                    | (168    | )  |  |   | (1,056  | )  |  |   | (1,790  | )  |
| Cash flowsfrom financingactivities:                                                                    |  |                    |    |    |  |   |    |    |  |   |    |    |
| Proceeds fromexercise of stock options and warrants                                                    |  |                    | 1,029   |    |  |   | 532     |    |  |   | 98      |    |
| Net proceeds from sales of commonstock                                                                 |  |                    | 6,362   |    |  |   | 7,692   |    |  |   | — |    |
| Payment of debt issuance costs                                                                         |  |                    | (71     | )  |  |   | — |    |  |   | — |    |
| Borrowing underrevolving line-of-credit                                                                |  |                    | 1,500   |    |  |   | — |    |  |   | — |    |
| Repayment of revolvingline-of-credit                                                                   |  |                    | (1,500  | )  |  |   | — |    |  |   | — |    |
| Repayments of long-term debt                                                                           |  |                    | — |    |  |   | (547    | )  |  |   | (1,800  | )  |
| Net cash flows provided by (used in)financing activities                                               |  |                    | 7,320   |    |  |   | 7,677   |    |  |   | (1,702  | )  |
| Foreign currencyexchange rate effects on cash and cash equivalents                                     |  |                    | 313     |    |  |   | (221    | )  |  |   | 147     |    |
| Net (decrease) increase in cash and cashequivalents                                                    |  |                    | (1,196  | )  |  |   | 1,863   |    |  |   | 244     |    |
| Cash and cash equivalents, beginning of year                                                           |  |                    | 4,809   |    |  |   | 2,946   |    |  |   | 2,702   |    |
| Cash and cash equivalents, end of year                                                                 |  | $                       | 3,613   |    |  | $      | 4,809   |    |  | $      | 2,946   |    |
| Supplemental disclosures ofcash flow information:                                                      |  |                    |    |    |  |   |    |    |  |   |    |    |
| Cashpaid during the year for—                                                                    |  |                    |    |    |  |   |    |    |  |   |    |    |
| Interest                                                                                               |  | $                       | 6       |    |  | $      | 21      |    |  | $      | 219     |    |
| Incometaxes                                                                                            |  |                    | — |    |  |   | 20      |    |  |   | 112     |    |
|                                                                                                        |

The accompanying notes are anintegral part of these consolidated financialstatements.

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AXS-ONEINC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS(In thousands, except per sharedata)

(1)    Operations, BusinessConditions, Liquidity and Significant Accounting Policies

TheCompany was incorporated under the laws of the State of Delaware inSeptember  1978. The name of the Company was changed to AXS-OneInc. in November  2000. The Company designs, markets and supportsrecords compliance management solutions that include digital archiving,business process management, electronic document delivery andintegrated records disposition and discovery for e-mail, instantmessaging, images, SAP and other corporate records, as well asfinancial management applications for Global 2000 businesses, andscheduling and time and expense solutions for professional servicesorganizations. The Company also offers consulting, implementation,training, technical support, subscription and maintenance services insupport of its customers’ use of its software products.

The Company generated a net loss of $9,000 and $5,200 for the yearsended December  31,  2005 and 2004 respectively, aftergenerating net income of $2,300 for the year ended December31,  2003. Management’s initiatives over the last twoyears, including the restructurings in 2005 and 2004, and the privateplacements of common stock in 2005 and 2004 (see Note 7), have beendesigned to improve operating results and liquidity and better positionthe Company to compete under current market conditions. Due to theseefforts the Company expects that its current cash balance, availabilityof borrowing capacity under the bank line of credit and operating cashflow will be sufficient to fund its short-term requirements of thebusiness. The Company’s ability to achieve the anticipatedresults is affected by the extent of cash generated from operations.There is also the risk that cash held by the Company’s foreignsubsidiaries may not be readily available for use in its U.S.operations to pay its obligations as the transfer of funds is sometimesdelayed due to various foreign government restrictions. Accordingly,the Company may in the future be required to seek new sources offinancing or accommodations from financial institutions. The Companymay also be required to further reduce operating costs in order to meetits obligations. The Company has successfully reduced costs in prioryears and management believes that the Company would be successful ifadditional cost reductions were necessary to help fund its operations.No assurance can be given that management’s initiatives will besuccessful or that any such additional sources of financing or lenderaccommodations will be available.

(a) Principles ofConsolidation

The consolidated financial statements include theaccounts of AXS-One Inc.; its wholly owned subsidiaries located inAustralia, Singapore, South Africa and the United Kingdom(collectively, the ‘‘Company’’). InDecember  2003, the Company dissolved the legal entity of itssubsidiary located in Canada. The Canadian operation is now part of theU.S. operation and as such continues to be included in the consolidatedfinancial statements of the Company. All intercompany transactions andbalances have been eliminated. The Company has a 49% ownershipin a joint venture in its South African operation. The joint venture isconsidered to be a variable interest entity as defined in FASBInterpretation No. 46R, ‘‘Consolidation of VariableInterest Entities’’ (FIN 46R). However, the Company hasdetermined that it is not the primary beneficiary. Accordingly, theCompany uses the equity method of accounting for its joint venturewhereby investments, including loans to the joint venture, are statedat cost plus or minus the Company’s equity in undistributedearnings or losses.

47

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AXS-ONEINC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (continued)(In thousands, except per sharedata)

(b) Revenue Recognition

TheCompany recognizes revenue in accordance with Statement of Position97-2, ‘‘Software Revenue Recognition’’(‘‘SOP 97-2’’), and Statement of Position 98-9,‘‘Modification of SOP 97-2, Software Revenue Recognition,With Respect to Certain Transactions.’’ Revenue fromnon-cancelable software licenses is recognized when the licenseagreement has been signed, delivery has occurred, the fee is fixed ordeterminable and collectibility is probable. The Company recognizeslicense revenue from resellers when an end user has placed an orderwith the reseller and the above revenue recognition criteria have beenmet with respect to the reseller. In multiple element arrangements, theCompany defers the vendor-specific objective evidence of fair value(‘‘VSOE’’) related to the undelivered elementsand recognizes revenue on the delivered elements using the residualmethod. The most commonly deferred elements are initial maintenance andconsulting services. Initial maintenance is recognized on astraight-line basis over the initial maintenance term. The VSOE ofmaintenance is determined by using a consistent percentage ofmaintenance fee to license fee based on renewal rates. Maintenance feesin subsequent years are recognized on a straight-line basis over thelife of the applicable agreement. Maintenance contracts entitle thecustomer to hot-line support and all unspecified product upgradesreleased during the term of the maintenance contract. Upgrades includeany and all unspecified patches or releases related to a licensedsoftware product. Maintenance does not include implementation servicesto install these upgrades. The VSOE of services is determined by usingan average consulting rate per hour for consulting services soldseparately multiplied by the estimate of hours required to complete theconsulting engagement.

Delivery of software generally occurswhen the product (on CDs) is delivered to a common carrier.Occasionally, delivery occurs through electronic means where thesoftware is made available through our secure FTP (File TransferProtocol) site. The Company does not offer any customers or resellers aright of return.

For software license, services and maintenancerevenue, the Company assesses whether the fee is fixed and determinableand whether or not collection is probable. The Company assesses whetherthe fee is fixed and determinable based on the payment terms associatedwith the transaction. If a significant portion of a fee is due afterour normal payment terms, which are 30 to 90 days from invoice date,the fee is considered not fixed and determinable. In these cases, theCompany recognizes revenue as the fees become due.

The Companyassesses assuredness of collection based on a number of factors,including past transaction history with the customer and thecredit-worthiness of the customer. Collateral is not requested fromcustomers. If it is determined that collection of a fee is notprobable, the fee is deferred and revenue is recognized at the timecollection becomes probable, which is generally upon receipt ofcash.

The Company’s arrangements do not generally includeacceptance clauses. However, if an arrangement includes an acceptanceprovision, acceptance occurs upon the earliest of receipt of a writtencustomer acceptance or expiration of the acceptance period.

Themajority of our training and consulting services are billed based onhourly rates. The Company generally recognizes revenue as theseservices are performed. However, when there is an arrangement that isbased on a fixed fee or requires significant work either to alter theunderlying software or to build additional complex interfaces so thatthe software performs as the customer requests, the Company recognizesthe related revenue using the percentage of completion method ofaccounting. This would apply to our custom programming services, whichare generally contracted on a fixed fee basis. Anticipated losses, ifany, are charged to operations in the period such losses are determinedto be probable.

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NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (continued)(In thousands, except per sharedata)

Revenues from transaction fees associatedwith subscription arrangements, billable on a per transaction basis andincluded in services revenue on the Consolidated Statements ofOperations, are recognized based on the actual number of transactionsprocessed during the period.

Revenues from joint ventures(included in Revenues: Other-Related Parties in the ConsolidatedStatements of Operations) includes consulting revenue for the jointventures’ use of the South African subsidiary’sconsultants and directors’ fees (during the 2004 period only) inaccordance with the joint venture agreement. Revenue is recognized uponperformance of the services.

In accordance with EITF Issue No.01-14, "Income Statement Characterization of ReimbursementReceived for 'Out of Pocket' ExpensesIncurred," reimbursements received for out-of-pocketexpenses incurred are classified as services revenue in theConsolidated Statements of Operations.

(c) Variable InterestEntity

The Company adopted FIN 46R as required on March31,  2004. The Company’s 49% owned joint venture,African Solutions (Pty) Ltd (‘‘AfricanSolutions’’), is considered to be a variable interestentity as defined in FIN 46R. However, the Company has determined thatthe majority owner, African Legends Technology, absorbs the majority ofthe expected losses and therefore, African Legends Technology, is theprimary beneficiary. Due to the fact that the Company is not theprimary beneficiary of African Solutions, the results of AfricanSolutions are not consolidated, but instead the Company accounts forits interest using the equity method of accounting.

AfricanSolutions is acting as a non-exclusive authorized third party serviceprovider to provide consulting and implementation services, and as anon-exclusive representative in providing marketing and promotionalservices directly to end users in regard to, among other things,AXS-One’s software products. African Solutions conducts businessthroughout the African continent where its target markets are theFinancial Sector and Government Departments.

As ofDecember  31,  2005 and 2004, AXS-One had a liability toAfrican Solutions of $52 and $29, respectively, representing amountsdue for services rendered by African Solutions to the Company. As ofDecember  31,  2005 and 2004, the investment in AfricanSolutions including the equity method investment as well as amounts duefrom African Solutions for services rendered was $0 and $68respectively, bringing the net investment to ($52) and $39,respectively, net of accumulated equity in losses.

Presentedbelow is selected financial data for African Solutions for the yearsended December  31,  2005, 2004 and 2003.

|                        |  |                                 |      |         |  |      |       |         |  |   |       |         |  |  |
|------------------------|--|---------------------------------|------|---------|--|------|-------|---------|--|---|-------|---------|--|--|
|                   |  | Twelve Months Ended December31, |
|                   |  | 2005                            |      | 2004    |  | 2003 |
| Total revenues         |  | $                               | 980  |    |  | $    | 1,309 |    |  | $ | 1,755 |    |
| Operatingincome (loss) |  | $                               | 27   |    |  | $    | (135  | )  |  | $ | (40   | )  |
| Net loss               |  | $                               | (181 | )  |  | $    | (331  | )  |  | $ | (233  | )  |
|                        |

Total assets were $252 and $535 as ofDecember  31,  2005 and 2004, respectively. Totalstockholders’ deficit was $(1,752) and $(1,765) as ofDecember  31,  2005 and 2004, respectively.

Pursuantto Accounting Principles Board Opinion No. 18, ‘‘The EquityMethod of Accounting for Investments in Common Stock,’’ theCompany evaluated the investment in African Solutions and adjusted downthe carrying value by $61 as of December  31,  2003, due toan other than temporary decline in value. No similar adjustment wasmade in 2005 or 2004.

(d) Use of Management Estimates

The preparation of consolidated financial statements in conformitywith accounting principles generally accepted in the United States ofAmerica requires management to make estimates and 

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NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (continued)(In thousands, except per sharedata)

assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets andliabilities at the date of the consolidated financial statements andthe reported amounts of revenues and expenses during the periodspresented. Actual results could differ from those estimates. Some ofthe significant estimates involve allowance for doubtful accounts,recoverability of capitalized software development costs, accruedexpenses, provision for income taxes in foreign jurisdictions,assessment of contingencies, revenue recognition, valuation of deferredtax assets, and pro forma compensation expense pursuant to SFAS No.123.

(e) Cash and Cash Equivalents and Restricted Cash

Cash equivalents are stated at cost, which approximates market, andconsist of short-term, highly liquid investments with originalmaturities of less than three months. Restricted cash atDecember  31,  2005 and 2004 represents amounts on depositfor payments of lease obligations by the Australia subsidiary.

(f) Allowance for Doubtful Accounts

The Company evaluatesthe collectibility of accounts receivable based on a combination offactors. In cases where the Company is aware of circumstances that mayimpair a specific customer’s ability to meet its financialobligations, the Company records a specific allowance against amountsdue, and thereby reduces the net receivable to the amount managementbelieves is probable of collection. For all other customers, theCompany recognizes allowances for doubtful accounts based on the lengthof time the receivables are outstanding, the current businessenvironment and historical experience.

(g) Equipment andLeasehold Improvements

Equipment and leasehold improvements arestated at cost, less accumulated depreciation and amortization.Depreciation expense is computed using the straight-line method overthe estimated useful lives of the assets (two to five years). Leaseholdimprovements are amortized using the straight-line method over thelesser of the remaining term of the lease or their estimated usefullives.

(h) Software Development Costs

TheCompany’s policy is to capitalize certain software developmentcosts in accordance with Statement of Financial Accounting StandardsNo. 86, ‘‘Accounting for the Costs of Computer Software toBe Sold, Leased, or Otherwise Marketed’’(‘‘SFAS 86’’). Under SFAS 86, costs incurred todevelop or significantly enhance computer software products are chargedto research and development expense as incurred until technologicalfeasibility has been established. The Company establishes technologicalfeasibility upon completion of a working model or completion of adetailed program design. Generally costs related to projects that reachtechnological feasibility upon completion of a working model are notcapitalized as the time period between establishment of the workingmodel and general availability is of short duration. For projects thatmeet technological feasibility upon completion of a detailed programdesign, all research and development costs for that project arecapitalized from that point until the product is available for generalrelease to customers. The nature of the Company's currentdevelopment for RCM products is generally such that we can measuretechnological feasibility most effectively using the working modelmethod where the time between establishment of a working model andgeneral availability is of short duration which results in very littleor no costs that qualify for capitalization. The Company historicallyused a detailed program design model to measure technologicalfeasibility for its enterprise financial products. This shift indevelopment of the Company's product lines will result in lowercapitalized costs in the future. The establishment of technologicalfeasibility and the ongoing assessment of recoverability of capitalizedsoftware development costs require considerable judgment by managementwith respect to certain external factors, including, but not limitedto, anticipated future revenues, 

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NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (continued)(In thousands, except per sharedata)

estimated economic life and changes intechnology. It is reasonably possible that estimates of anticipatedfuture revenues, the remaining estimated economic life of the products,or both will be reduced in the future due to competitive pressures. Asa result, the carrying amount of the capitalized software costs may bereduced through a charge to operations in the near term. Upon thegeneral release of the software product to customers, capitalizationceases and such costs are amortized (using the straight-line method)over the estimated life, which is generally three years.

During2005, 2004 and 2003 capitalized software development costs amounted to$18, $601 and $1,296, respectively. Annual amortization of softwaredevelopment costs of $866, $1,079 and $1,310 for 2005, 2004 and 2003,respectively, was recorded using the straight-line method over threeyears, the estimated economic life of the products.

(i)Impairment or Disposal of Long-Lived Assets

In accordance withStatement of Financial Accounting Standards(‘‘SFAS’’) No. 144, ‘‘Accountingfor the Impairment or Disposal of Long-Lived Assets,’’ theCompany monitors events or changes in circumstances that may indicatecarrying amounts of its long-lived assets may not be recoverable. Whensuch events or changes in circumstances are present, the Companyassesses the recoverability of its assets by determining whether thecarrying amount of its assets will be recovered through undiscounted,expected future cash flows. Should the Company determine that thecarrying values of specific long-lived assets are not recoverable, theCompany would record a charge to operations to reduce the carryingvalue of such assets to their fair values. The Company considersvarious valuation factors, principally discounted cash flows, to assessthe fair values of long-lived assets.

(j) Income Taxes

Income taxes are accounted for under the asset and liability method.The asset and liability method requires that deferred tax assets bereduced by a valuation allowance if, based on the weight of availableevidence, it is more likely than not that some portion or all of suchassets will not be realized. Deferred tax assets and liabilities arerecognized for the future tax consequences attributable to differencesbetween the financial statement carrying amounts of existing assets andliabilities, and their respective tax bases and operating loss and taxcredit carryforwards. Deferred tax assets and liabilities are measuredusing enacted tax rates expected to apply to taxable income in theyears in which those temporary differences are expected to be recoveredor settled. The effect on deferred tax assets and liabilities of achange in tax rates is recognized in operations in the period thatincludes the enactment date.

(k) Concentration of CreditRisk

SFAS No. 105, ‘‘Disclosure of Informationabout Financial Instruments with Off-Balance Sheet Risk and FinancialInstruments with Concentration of Credit Risk,’’ requiresdisclosure of any significant off-balance sheet and credit riskconcentrations. The Company has no off-balance sheet concentration ofcredit risk such as foreign exchange contracts, option contracts orother foreign hedging arrangements. The Company maintains the majorityof cash balances with four financial institutions and its accountsreceivable credit risk is not concentrated within any geographic area.The Company’s revenues are concentrated in the computer softwareindustry, which is highly competitive and rapidly changing. Significanttechnological changes in the industry or customer requirements, or theemergence of competitive products with new capabilities ortechnologies, could adversely affect operating results.

As ofDecember  31,  2005, three customers represented45.6% of total gross receivables (17.1%, 16.8% and11.7%, individually). As of December  31,  2004, noone customer represented more than 10% of total grossreceivables. As of December  31,  2003, three customersrepresented 33.1% of total gross receivables (or 10.5%,10.7% and 11.9% individually). For the year endedDecember  31,  2005, no one customer 

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NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (continued)(In thousands, except per sharedata)

represented more than 10% of totalrevenues. For the year ended December  31,  2004, twocustomers represented 14.6% and 10.1%, individually, oftotal revenues. For the year ended December  31,  2003, twocustomers represented 18.7% and 12.1%, individually, oftotal revenues. For the year ended December  31,  2005, twocustomers represented 20.2% and 12.2%, individually, oflicense revenue. No one customer represented more than 10% oflicense revenues for the year ended December  31,  2004.License revenues included 29.5% (or 18.2% and11.3% individually) of revenue from two customers in 2003. Noone customer represented more than 10% of service revenues forthe year ended December  31,  2005. Services revenuesincluded 27.2% (or 16.1% and 11.1% individually)and 31.9% (or 19.0% and 12.9% individually) ofrevenue from the same two customers in 2004 and 2003, respectively.

(l) Foreign Currency Translation

The functional currencyfor foreign subsidiaries is the local currency. The results ofoperations for these foreign subsidiaries are translated from localcurrencies into U.S. dollars using the average exchange rates duringeach period. Assets and liabilities are translated using exchange ratesat the end of the period with translation adjustments accumulated instockholders' deficit. Intercompany loans are denominated in U.S.currency. Foreign currency transaction gains and losses, related toshort-term intercompany loans, are recorded in the consolidatedstatements of operations as incurred. Intercompany loans that are of along-term nature are accounted for in accordance with SFAS 52,‘‘Foreign Currency Translation,’’ wherebyforeign currency transaction gains and losses are recorded incumulative foreign currency translation adjustment, a component ofstockholders’ deficit. As of December  31,  2005 and2004, no loans were considered long-term in nature. During 2003,intercompany loans to one foreign subsidiary were considered long-termin nature.

(m) Stock-Based Compensation

FASB StatementNo. 148, ‘‘Accounting for Stock BasedCompensation-Transition and Disclosure, an Amendment of FASB StatementNo. 123’’ (‘‘SFAS 148’’) providesalternative methods of transition for a voluntary change to the fairvalue method of accounting for stock-based compensation. However, itallows an entity to continue to measure compensation cost for stockinstruments granted to employees using the intrinsic-value method ofaccounting prescribed by Accounting Principles Board Opinion No. 25(‘‘APB 25’’), ‘‘Accounting forStock Issued to Employees,’’ provided it discloses theeffect of SFAS 123, as amended by SFAS 148, in the footnotes to thefinancial statements. In December  2004, the FASB issued SFAS 123(revised 2004), ‘‘Share-Based Payment’’ (SFAS123R), which replaces SFAS 123 and supercedes APB Opinion No. 25. SFAS123R requires all share-based payments to employees, including grantsof employee stock options and non-vested stock grants, to be recognizedas a compensation cost based on their fair values. The pro formadisclosures previously permitted under SFAS 123 no longer will be analternative to financial statement recognition. The Company is requiredto adopt SFAS 123R no later than January  1,  2006. ThroughDecember  31,  2005, the Company has chosen to continue toaccount for stock-based compensation using the intrinsic-value method.Accordingly, no stock option related compensation expense has beenrecognized in the consolidated statements of operations as all optionsgranted had an exercise price equal to the market value of theunderlying stock on the date of grant.

On January3,  2005 and November  17,  2005 respectively, theCompany issued 75 and 45 shares of non-vested stock, respectively, tocertain employees with a vesting term of five years subject toacceleration in accordance with the grant stipulations. The fair valueof the non-vested stock awards on the date of grant was $193 and $76,respectively, which was recorded as Unearned Stock Compensation, acomponent of stockholder’s deficit, and is being amortized overthe vesting period of the grants, subject to acceleration based onCompany performance. On June  30,  2005, 25 shares wereforfeited and the related unearned stock compensation in the amount of$64 was reversed. Previously recognized compensation expense related tothe forfeitures of these shares was immaterial. For the twelve months

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NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (continued)(In thousands, except per sharedata)

ended December  31,  2005, theCompany recognized $28 as compensation expense related to non-vestedstock awards leaving a net balance of deferred compensation of $177 asof December  31,  2005. The Company recognized $9 of stockcompensation expense related to a modification of a director’sstock option in 2005.

On October  26,  2005,the Board of Directors of the Company approved the acceleration ofvesting of all unvested ‘‘out-of-the money’’stock options previously awarded to current employees and directorsunder the Company’s stock option plans. The accelerated optionshad exercise prices ranging from $2.15 to $6.25 with a weighted averageexercise price of $2.99. Options to purchase approximately 2,200 sharesbecame exercisable immediately as a result of the vesting acceleration.To avoid any unintended personal benefits, the Company also imposed aholding period on the shares underlying the accelerated options in theform of a Resale Restriction Agreement. This agreement requires alloptionees to refrain from selling any shares acquired upon the exerciseof the accelerated options until the earlier of the date such shareswould have vested under the options’ original vesting terms orthe date of the employee’s or director’s termination fromthe Company. As a result of this acceleration, the Company expects toreduce the stock compensation expense it otherwise would have beenrequired to record beginning in January  2006 upon adoption ofSFAS 123R by approximately $4,100 over approximately 2.5 years. Inmaking the decision to accelerate these options, the Board of Directorsconsidered the interests of the Company’s stockholders as thisacceleration will reduce compensation expense in future periods. TheCompany expects to use the modified prospective transition method whenadopting SFAS 123R. The Company expects expense of approximately $200for the year ended December  31,  2006 related to theadoption of SFAS 123R based on the unvested options outstanding atDecember  31,  2005. The Company anticipates it will grantadditional employee stock options and/or non-vested stock units in2006. The fair value of these grants is not included in the amountabove, as the impact of these grants cannot be predicted at this timebecause it will depend on the number of share-based payments grantedand the then current fair values.

Had the Company, however,elected to recognize compensation cost based on the fair value of thestock options at the date of grant under SFAS 123, as amended by SFAS148 and SFAS 123R, such costs would have been recognized ratably overthe vesting period of the underlying instruments and theCompany’s net income (loss) and net income (loss) per commonshare would have changed to the pro forma amounts indicated in thetable below.

|                                                                                                               |  |                         |         |         |  |        |         |         |  |        |         |         |  |  |
|---------------------------------------------------------------------------------------------------------------|--|-------------------------|---------|---------|--|--------|---------|---------|--|--------|---------|---------|--|--|
|                                                                                                          |  | Years Ended December31, |
|                                                                                                          |  | 2005                    |         | 2004    |  | 2003   |
| Net income (loss) asreported                                                                                  |  | $                       | (8,998  | )  |  | $      | (5,212  | )  |  | $      | 2,316   |    |
| Add: Stock based compensation expense                                                                         |  |                    | 37      |    |  |   | — |    |  |   | — |    |
| Deduct: Totalstock-based employee compensation expense determined under fair valuebased method for all awards |  |                    | (5,633  | )  |  |   | (1,434  | )  |  |   | (1,348  | )  |
| Pro forma net income(loss)                                                                                    |  | $                       | (14,594 | )  |  | $      | (6,646  | )  |  | $      | 968     |    |
| Net income (loss) per commonshare:                                                                            |  |                    |    |    |  |   |    |    |  |   |    |    |
| Basic and diluted -as reported                                                                                |  | $                       | (0.28   | )  |  | $      | (0.19   | )  |  | $      | 0.09    |    |
| Basic and diluted - pro forma                                                                                 |  | $                       | (0.46   | )  |  | $      | (0.24   | )  |  | $      | 0.04    |    |
|                                                                                                               |

The Company has used the Black-Scholesoption-pricing model in calculating the fair value of options granted.The assumptions used and the weighted average information for the yearsended December  31,  2005, 2004 and 2003 are asfollows:

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NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (continued)(In thousands, except per sharedata)

|                                                                                                                                |  |                          |         |            |  |           |         |         |  |        |         |         |  |  |
|--------------------------------------------------------------------------------------------------------------------------------|--|--------------------------|---------|------------|--|-----------|---------|---------|--|--------|---------|---------|--|--|
|                                                                                                                           |  | Years Ended December 31, |
|                                                                                                                           |  | 2005                     |         | 2004       |  | 2003      |
| Risk-free interest rates                                                                                                       |  |                     | 4.60    | %     |  |      | 5.02    | %  |  |   | 4.70    | %  |
| Expected dividend yield                                                                                                        |  |                     | — |       |  |      | — |    |  |   | — |    |
| Expected lives                                                                                                                 |  | 5 years                  |         | 5 years    |  | 7years    |
| Expected volatility                                                                                                            |  |                     | 99      | %     |  |      | 103     | %  |  |   | 110     | %  |
| Weighted-average grant date fair value of options grantedduring the period                                                     |  | $                        | 1.59    |       |  | $         | 2.30    |    |  | $      | 0.86    |    |
| Weighted-average remaining contractuallife of options outstanding                                                              |  | 6.73 years               |         | 6.84 years |  | 6.29years |
| Weighted-average exercise price of5,572, 4,091 and 4,026 options exercisable at December  31,2005, 2004 and 2003, respectively |  | $                        | 2.44    |       |  | $         | 1.67    |    |  | $      | 1.63    |    |
|                                                                                                                                |

(n) Basic and Diluted Net Income (Loss)per Common Share

Basic and diluted net income (loss) per commonshare is presented in accordance with SFAS No. 128,‘‘Earnings per Share’’ (‘‘SFAS No.128’’). Basic net income (loss) per common share is basedon the weighted-average number of shares of common stock outstandingduring the period. Diluted net income (loss) per share is computedusing the weighted average number of common and dilutive potentialcommon shares outstanding during the period. Potential common sharesconsist of stock options, non-vested stock and warrants. Diluted netloss per common share was the same as basic net loss per common sharefor the years ended December  31,  2005 and 2004 since theeffect of stock options, non-vested stock and warrants wasanti-dilutive for both years. Diluted net income per common share forthe year ended December  31,  2003 does not include theeffects of outstanding options to purchase 3,010 shares of common stockand outstanding warrants to purchase 100 shares of common stock, as theeffect of their inclusion was anti-dilutive. As of December31,  2005 and 2004, there were outstanding options to purchase6,370 and 7,453 shares of common stock and outstanding warrants topurchase 1,423 and 516 shares of common stock. As of December 31, 2005and 2004 there were 95 and 0 shares of non-vested stockoutstanding.

The following represents the calculations of thebasic and diluted net income (loss) per common share for the yearsended December  31,  2005, 2004 and 2003.

|                                                                   |  |                         |         |         |  |        |         |         |  |        |        |        |  |  |
|-------------------------------------------------------------------|--|-------------------------|---------|---------|--|--------|---------|---------|--|--------|--------|--------|--|--|
|                                                              |  | Years Ended December31, |
|                                                              |  | 2005                    |         | 2004    |  | 2003   |
| Net income (loss)                                                 |  | $                       | (8,998  | )  |  | $      | (5,212  | )  |  | $      | 2,316  |   |
| Weighted average basic commonshares outstanding during the year   |  |                    | 31,629  |    |  |   | 27,395  |    |  |   | 24,945 |   |
| Dilutive effect of stockoptions and warrants                      |  |                    | — |    |  |   | — |    |  |   | 1,319  |   |
| Weighted average diluted commonshares outstanding during the year |  |                    | 31,629  |    |  |   | 27,395  |    |  |   | 26,264 |   |
| Basic and diluted net income (loss) percommon share               |  | $                       | (0.28   | )  |  | $      | (0.19   | )  |  | $      | 0.09   |   |
|                                                                   |

(o) Fair Value ofFinancial Instruments

Cash and cash equivalents, restrictedcash, accounts receivable, accounts payable, accrued expenses, othercurrent liabilities and debt reported in the consolidated balancesheets equal or approximate fair values.

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NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (continued)(In thousands, except per sharedata)

(p) Deferred Revenue

Deferredrevenues primarily relate to customer software maintenance agreementsthat have been paid for by customers prior to the performance of thoseservices and, to a lesser extent, prepaid consulting and deferredlicense fees.

(q) Accounting for Guarantees

The Companywarrants that each version of its software will substantially conformto the latest edition of the documentation applicable to that version.Such warranties are accounted for in accordance with SFAS No. 5,‘‘Accounting for Contingencies.’’ To date theCompany has not incurred significant costs related to warrantyobligations.

The Company’s product license and servicesagreements include a limited indemnification provision for claims fromthird parties relating to the Company’s intellectual property.Such indemnification provisions are accounted for in accordance withSFAS No. 5. The indemnification is generally limited to theamount paid by the customer. To date, claims under such indemnificationprovisions have not been significant.

From time to time, theCompany may provide guarantees to third parties on behalf of a foreignsubsidiary. These guarantees are generally related to maintainingoperations in a certain locality or to secure leases or other operatingobligations of a subsidiary. The maximum exposure on these guaranteesis not significant, either individually or in the aggregate.

(2)    Revolving Line of Credit and Long-Term Debt

TheCompany had no outstanding debt as of December  31,  2005or 2004.

On March  31,  1998, the Company enteredinto a Loan and Security Agreement that contained a revolving line ofcredit and a term loan. The unpaid principal on the term loan atDecember  31,  2003 of $547 was fully paid as ofMarch  31,  2004. The Loan and Security Agreementterminated on May  28,  2004. 

On August11,  2004, the Company entered into a two-year Loan and SecurityAgreement (‘‘Agreement’’) which contained arevolving line of credit under which the Company had available thelesser of $4,000 or 80% of eligible accounts, as defined.

Borrowings under the revolving line of credit bore interest at primerate plus one half of one percent (0.5%). The Agreement providedfor a non-refundable commitment fee of $30 per year and an unusedrevolving line facility fee of .25% per annum. The Agreement issecured by substantially all domestic assets of the Company andcontained certain financial restrictive covenants based on adjustedquick ratio, as defined, and earnings before interest, taxes anddepreciation and amortization (EBITDA).

On January27,  2005, the Company amended the Agreement (First LoanModification) to revise the financial covenant based on EBITDA for thesix months ended December  31,  2004. The Company was incompliance with this revised covenant and all other covenants as ofDecember  31,  2004.

On March  28,2005, the Company further amended the Agreement (Second LoanModification) in order to set the quarterly EBITDA and adjusted quickratio covenants for 2005. The Company was not in compliance with theEBITDA covenant as of June  30,  2005.

OnSeptember  13,  2005, the Company entered into an Amendedand Restated Loan and Security Agreement (‘‘AmendedAgreement’’) in order to revise certain terms of theAgreement including the loan fees, interest on the loan and thefinancial covenants. The Amended Agreement included a waiver of theJune  30,  2005 EBITDA covenant default under the SecondLoan Modification.

Borrowings under the revolving line ofcredit, per the Amended Agreement, bear interest at prime rate plus oneand one half percent (1.5%). Should, however, the Company failto meet certain of the 

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AXS-ONEINC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (continued)(In thousands, except per sharedata)

financial covenants set forth in the AmendedAgreement, the interest rate will increase to the prime rate plus twoand one half percent (2.5%). The Agreement provided for anon-refundable commitment fee of $30 per year and an unused revolvingline facility fee of .25% per annum. The Amended Agreementincreased the second year commitment fee to $40 and the unused line feeto 0.375% per annum. The Amended Agreement includes a warrantwaiver fee of $20 and upon the occurrence of certain events, minimummonthly interest of $8 and an additional $20 warrant waiver fee. Anyborrowing under the Amended Agreement was secured by substantially alldomestic assets of the Company. The maturity date of the AmendedAgreement is August  9,  2006. Any loans outstanding aresubject to acceleration upon breach of: (i) a covenant tested monthlyregarding the ratio of unrestricted cash and net billed accountsreceivable to current liabilities minus deferred revenue which is to beno less than 1.35 to 1.0 (‘‘adjusted quick ratiocovenant’’), (ii) a covenant tested quarterly regarding theCompany's EBITDAS (earnings before interest expense (excludinginterest income), taxes, depreciation, amortization and stockcompensation expense in accordance with GAAP), and (iii) othercustomary non-financial covenants. There is also a monthly transitionevent covenant which requires the Company to maintain an adjusted quickratio greater than or equal to of 1.6 to 1.0.

As ofSeptember  30,  2005, the Company was in compliance withall covenants with the exception of the transition event covenant. TheCompany’s adjusted quick ratio at September  30,2005 was 1.592 to 1.0. On November  7,  2005, the bankgranted a waiver on the transition event covenant as ofSeptember  30,  2005 and therefore did not require theCompany to transition to the higher-interest debt facility. The waiverwas for the September  30,  2005 date only.

As ofDecember  31,  2005, the Company was in compliance with themonthly adjusted quick ratio covenant and the transition eventcovenant, but was not in compliance with the quarterly EBITDAScovenant, which requires the Company to achieve EBITDAS of the lesserof $1 better than the immediate preceding quarter EBITDAS or $1.Additionally, as of November  30,  2005, the Company didnot achieve its transition event covenant. The Company’sadjusted quick ratio at November  30,  2005 was 1.44 to1.0. On February  6,  2006, the bank granted a waiver onthe quarterly EBITDAS covenant and the November transition eventcovenant. The EBITDAS covenant waiver was for the quarter endedDecember  31,  2005 date only. The transition event waiverwas for the November  30,  2005 date only.

As ofDecember  31,  2005, there were no amounts outstandingunder the Amended Agreement and availability under the AmendedAgreement was $4,000, based on the lesser of $4,000 or 80% ofeligble accounts receivable. On March  14,  2006, theCompany and the Bank agreed to extend the loan to February15,  2007. All other terms of the loan remain the same.

(3)    Lease Obligations

The Company leases office spaceand equipment under non-cancelable operating leases. Rent expensecharged to operations in the accompanying consolidated statements ofoperations for office space, vehicles and equipment under operatingleases was $2,019, $2,154 and $2,021 for the years endedDecember  31,  2005, 2004 and 2003, respectively.

56

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AXS-ONEINC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (continued)(In thousands, except per sharedata)

Scheduled future minimum paymentsrequired for all non-cancelable operating leases are as follows:

|                          |  |        |         |        |  |  |
|--------------------------|--|--------|---------|--------|--|--|
| Years Ending December31, |  |   |
| 2006                     |  | $      | 1,875   |   |
| 2007                     |  |   | 1,656   |   |
| 2008                     |  |   | 92      |   |
| 2009                     |  |   | 46      |   |
| 2010/Thereafter          |  |   | — |   |
| Total                    |  | $      | 3,669   |   |
|                          |

(4)    RelatedParty Transactions

The Company has certain businessrelationships with an entity that was founded by the former Presidentand Chief Executive Officer who owns a majority beneficial equityinterest in such entity. During the years ended December  31,2004and 2003 the Company recorded as cost of license fees approximately $1and $36, respectively, from this related party. No costs were recordedin 2005. These costs, related to royalty and maintenance fees onlicensed products, have been generally decreasing as customers upgradeto newer versions of the Company’s software that no longerrequire this related party software.

In August  2003, theCompany entered into a business relationship with an entity that isowned by the Company's former chairman and principal stockholder.This entity was providing consulting services related to thedevelopment of the Company’s instant messaging archivingproduct. For the years ended December  31,  2004 and 2003,the Company recorded $84 and $75, respectively, as research anddevelopment expense from this related party. The Company discontinueduse of this entity’s services in June  2004.

DuringJanuary  2001, the Company entered into two South African jointventures: AXS-One African Solutions (Pty) Ltd (‘‘AfricanSolutions’’) and Hospitality Warehouse (Pty) Ltd(‘‘Hospitality Warehouse’’). African Solutionsis acting as a non-exclusive authorized third party service provider toprovide consulting and implementation services, and as a non-exclusiverepresentative in providing marketing and promotional services directlyto the end users in regard to, among other things, AXS-One’ssoftware products. African Solutions conducts business throughout theAfrican continent where its target markets are the Financial Sector andGovernment Departments. African Solutions is considered to be avariable interest entity as defined in FIN 46R (See Notes 1(a) and 1(c)for further information).

Hospitality Warehouse usesAXS-One’s procurement software and generates fees for purchasesmade by member companies in the hospitality industry. InDecember  2002, the Company purchased, for a nominal amount, theremaining 50% of common stock of Hospitality Warehouse to makeit a wholly-owned subsidiary. At the time of the acquisition theinvestment in the joint venture was $112, net of equity in losses of$120. Pro-forma results as if Hospitality Warehouse had been acquiredon January  1,  2002 are not significantly different thanthe reported 2002 consolidated results.

Revenues from AfricanSolutions during 2005 and 2004 include management fee revenue of $0 and$27, respectively, and consulting revenue of $108 and $182,respectively. Revenues from both joint ventures during 2003 includemanagement fee revenue of $68 and consulting revenue of $232.

57

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AXS-ONEINC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (continued)(In thousands, except per sharedata)

(5)    Income Taxes

Thecomponents of income (loss) before income tax benefit, net are asfollows:

|          |  |                         |        |         |  |        |        |         |  |        |        |         |  |  |
|----------|--|-------------------------|--------|---------|--|--------|--------|---------|--|--------|--------|---------|--|--|
|     |  | Years Ended December31, |
|     |  | 2005                    |        | 2004    |  | 2003   |
| Domestic |  | $                       | (3,488 | )  |  | $      | (1,503 | )  |  | $      | (4,127 | )  |
| Foreign  |  |                    | (5,535 | )  |  |   | (3,926 | )  |  |   | 6,344  |    |
| Total    |  | $                       | (9,023 | )  |  | $      | (5,429 | )  |  | $      | 2,217  |    |
|          |

Income tax (provision) benefit is asfollows:

|         |  |                         |    |        |  |        |     |        |  |        |     |         |  |  |
|---------|--|-------------------------|----|--------|--|--------|-----|--------|--|--------|-----|---------|--|--|
|    |  | Years Ended December31, |
|    |  | 2005                    |    | 2004   |  | 2003   |
| State   |  | $                       | 0  |   |  | $      | 194 |   |  | $      | 142 |    |
| Foreign |  |                    | 25 |   |  |   | 23  |   |  |   | (43 | )  |
| Total   |  | $                       | 25 |   |  | $      | 217 |   |  | $      | 99  |    |
|         |

A reconciliation of Federalincome tax (expense) benefit at the statutory rate of 34% toincome tax benefit reflected in the accompanying consolidatedstatements of operations is as follows:

|                                                                                                                      |  |                         |         |         |  |        |        |         |  |        |       |         |  |  |
|----------------------------------------------------------------------------------------------------------------------|--|-------------------------|---------|---------|--|--------|--------|---------|--|--------|-------|---------|--|--|
|                                                                                                                 |  | Years Ended December31, |
|                                                                                                                 |  | 2005                    |         | 2004    |  | 2003   |
| Federal income tax (expense)benefit at 34%                                                                           |  | $                       | 3,068   |    |  | $      | 1,846  |    |  | $      | (754  | )  |
| State income tax (expense) benefit,net of Federal tax (expense) benefit                                              |  |                    | 206     |    |  |   | 213    |    |  |   | 382   |    |
| Change in valuation allowance, net ofchange in valuation allowance related to stock options and salesof subsidiaries |  |                    | (3,260  | )  |  |   | (2,511 | )  |  |   | 1,593 |    |
| Foreign tax rate differential and changein foreign NOLs                                                              |  |                    | (5      | )  |  |   | 868    |    |  |   | (972  | )  |
| Reduction of state NOLs due to sale of New Jersey NOLs,net of federal benefit                                        |  |                    | — |    |  |   | (149   | )  |  |   | (108  | )  |
| Other, net                                                                                                           |  |                    | 16      |    |  |   | (50    | )  |  |   | (42   | )  |
|                                                                                                                 |  | $                       | 25      |    |  | $      | 217    |    |  | $      | 99    |    |
|                                                                                                                      |

58

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AXS-ONEINC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (continued)(In thousands, except per sharedata)

The principal components of theCompany's deferred taxes are as follows:

|                                                |  |             |         |        |  |        |         |        |  |  |
|------------------------------------------------|--|-------------|---------|--------|--|--------|---------|--------|--|--|
|                                           |  | December31, |
|                                           |  | 2005        |         | 2004   |
| Deferred taxassets:                            |  |        |    |   |  |   |    |   |
| Non-deductible accrualsand other               |  | $           | 295     |   |  | $      | 238     |   |
| Allowance for doubtful accounts                |  |        | 50      |   |  |   | 53      |   |
| Depreciation                                   |  |        | 426     |   |  |   | — |   |
| Purchasedresearch and development              |  |        | — |   |  |   | 658     |   |
| Research and development credit carry-forwards |  |        | 2,895   |   |  |   | 2,895   |   |
| Net operating losscarry-forwards               |  |        | 24,755  |   |  |   | 21,508  |   |
| Deferred tax assets                            |  |        | 28,421  |   |  |   | 25,352  |   |
| Less valuationallowance                        |  |        | 28,004  |   |  |   | 24,543  |   |
| Net deferred tax assets                        |  |        | 417     |   |  |   | 809     |   |
| Deferred taxliabilities:                       |  |        |    |   |  |   |    |   |
| Software developmentcosts                      |  |        | 417     |   |  |   | 809     |   |
| Net deferred taxes                             |  | $           | — |   |  | $      | — |   |
|                                                |

At December  31,  2005,the Company had United States net operating loss carry-forwards ofapproximately $54,849 which are available to offset future Federaltaxable income, if any, and which begin to expire in 2007. In addition,foreign net operating loss carry-forwards aggregated approximately$13,293 at December  31,  2005, which are not subject toexpiration.

The Company has recorded a valuation allowance forits net deferred tax assets and will continue to monitor therealizability of such assets. Approximately $2,360 and $1,917 of theCompany’s deferred tax asset pertaining to NOLs and thecorresponding valuation allowance at December  31,  2005and 2004, respectively, relates to tax deductions arising from theexercise of stock options and/or subsequent sales of the underlyingstock. For book purposes, the tax benefits related to such stock optiontransactions are recorded through equity when realized.

For theyear ended December  31,  2003, there was a reduction inthe foreign NOL in the amount of $3,364. Most of that reduction isattributable to the intercompany debt that was eliminated as part ofthe closing of the Canadian subsidiary and the corresponding debtforgiveness by the United States parent. 

Foreign subsidiarieshave paid, and are expected to continue to pay, appropriate taxes, ifand when due, to their respective taxing authorities. It is theintention of the Company to reinvest the earnings of its non-U.S.subsidiaries, if any, in those operations. Accordingly, no Federaltaxes have been provided on undistributed foreign earnings and nodeferred tax liability for temporary differences related to theCompany’s foreign subsidiaries and foreign joint ventures havebeen established as the determination of the amounts is notpractical.

During state fiscal years 2002 through 2005, AXS-Onewas authorized by the New Jersey Economic Development Authority(‘‘NJEDA’’) in conjunction with the New JerseyDivision of Taxation to sell a portion of its New Jersey net operatinglosses and research and development credits for consideration that isto be used to fund its research activities in the State of New Jersey.For the State’s fiscal year 2005 (July 1, 2004 to June30,  2005), AXS-One was authorized to sell $226 of its availabletax benefit of $226. AXS-One sold the entire authorized amount forconsideration of $194, net of broker commissions. For theState’s fiscal year 2004 (July 1, 2003 to June  30,2004), AXS-One was authorized to sell $165 of its available tax benefitof $165. AXS-One sold the entire authorized amount for consideration of$142, net of broker commissions. Approximately 66% of the taxbenefits sold is reflected as reduction of state NOLs due to sales ofNew Jersey NOLs, net of federal benefit in the income tax ratereconciliation table above. As of December  31,  2005, theremaining New Jersey tax benefit in the amount of $270 is available tosell if the program is extended by the NJEDA or will be available tooffset future New Jersey income taxes. No New Jersey Net operatinglosses were sold in 2005.

59

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AXS-ONEINC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (continued)(In thousands, except per sharedata)

(7)    Stockholders'Deficit

(a) Warrants

On November  2,2000, the Company issued warrants to a Dallas corporation for thepurchase of 200 shares of Common Stock in exchange for services to berendered as the Company’s non-exclusive financial advisor andfor certain investment-banking services. The warrants are exercisableat $1.875 per share, subject to adjustment, until January24,  2006 and were to vest in two separate tranches of 100 eachon February  28,  2001 and May  31,  2001. Bywritten notice dated May  25,  2001, 100 warrants that wereto be vested on May  31,  2001 were cancelled in connectionwith the cancellation of the services agreement. As permitted by theWarrant Agreement, the Dallas corporation exercised the remainingwarrants in full on September  24,  2004, surrendering backto the Company some of the shares of AXS-One Common Stock acquiredthrough such exercise as payment of the option exercise price inaccordance with the original terms (known as a ‘‘cashlessexercise’’). No warrants remain outstanding under thisagreement as of December  31,  2005.

The fair valueof these warrants was determined in accordance with EITF Issue No.96-18 ‘‘Accounting for Equity Instruments that are Issuedto Other than Employees for Acquiring, or in Conjunction with SellingGoods or Services,’’ and was being recognized as expenseover the service period. No further compensation costs will berecognized related to these warrants since services are no longer beingprovided. The expense related to this matter was nominal.

Sharesof common stock underlying the warrants were not registered under theSecurities Act of 1933, as amended (the‘‘Act’’) in reliance upon Section 4(2) of theAct based on the fact that the warrants were issued to only onesophisticated investor who had extensive knowledge of the Company atthe time of the issuance.

On October  1,  2002, theCompany entered into an agreement with a South Carolina corporation toprovide investor relations services to the Company for a term of twelvemonths, whereby upon expiration or termination of the agreement theCompany would issue warrants to purchase the number of shares of commonstock of the Company which was equal to the product of 10 sharesmultiplied by the number of whole months during the actual term of theagreement to a maximum of 120 shares. The exercise price for thewarrants was (i) for the initial 60 shares covered by the warrants,$0.41 per share, which represented the closing price of theCompany’s common stock on October  1,  2002 and (ii)for the remaining shares covered by the warrants, if any, the closingprice of the Company’s common stock on April  1,2003, which was $0.59 per share. The warrants were fully vested on thedate of their issuance by the Company.

On September30,  2003, the Company issued two (2) warrants under thisagreement, each to purchase 60 shares of the Common Stock of AXS-One,one with an exercise price of $0.41 per share and one with an exerciseprice of $0.59 per share in accordance with the agreement. Theexpiration date of both warrants was September  30,  2006.On January  21,  2004, the warrants were exercised andproceeds in the amount of $60 were remitted to the Company. No warrantsremain outstanding under this agreement as of December31,  2005.

The accounting for these warrants wasdetermined in accordance with EITF Issue No. 96-18, and, as a result,the fair value of the warrants was being recognized as an expense overthe term of the agreement. Total expenses of $34 were recorded in salesand marketing expense on the 2003 consolidated financial statementsrelated to these warrants. No further compensation costs will berecognized related to these warrants since no further services arebeing provided under the agreement which expired on September30,  2003.

60

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AXS-ONEINC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (continued)(In thousands, except per sharedata)

Shares of common stock underlying thewarrants were not registered under the Securities Act of 1933, asamended (the ‘‘Act’’) in reliance upon Section4(2) of the Act based on the fact that the warrants were issued to onlyone sophisticated investor who had extensive knowledge of the Companyat the time of the issuance.

On April  5,  2004, theCompany completed an offer and sale of 2,581 shares of common stock for$3.10 per share in a private placement for total consideration of$8,000. Upon closing, the Company received net proceeds ofapproximately $7,700. The Company also issued, at the same time,warrants to purchase an aggregate of 258 shares of common stock at$3.98 per share and warrants to purchase 258 shares of common stock at$4.50 per share. These warrants are exercisable for a period of threeyears beginning April  5,  2004. This private placement andissuance of warrants were made pursuant to the terms of a UnitSubscription Agreement, dated as of April  1,  2004, amongthe Company and several investors.

On June  17,2005, the Company entered into a definitive agreement with a number ofinvestors as well as certain members of AXS-One Management and Boardmembers to sell 4,534 shares of its common stock for totalconsideration of $6,750. On June  21,  2005, the initialclosing date, the Company received net proceeds of approximately $5,775from the investors and issued 4,081 shares of common stock. Thisexcluded amounts due from members of the Company’s managementand Board members which together represented 10% of theinvestment. The closing with respect to the shares being offered tomembers of the Company’s management and Board members wassubject to shareholder approval. The Company also issued, at the sametime, warrants to purchase an aggregate of 408 shares of common stockat $1.90 per share and warrants to purchase 408 shares of common stockat $2.15 per share. These warrants are exercisable for a period ofthree years beginning June  21,  2005. The warrants wereclassified within permanent equity in accordance with EITF 00-19,‘‘Accounting for Derivative Financial Instruments Indexedto and Potentially Settled in, a Company’s OwnStock.’’ Warrants to purchase an additional 45 shares ofcommon stock at $1.90 per share and 45 shares of common stock at $2.15per share were issuable to members of the Company’s managementand Board member investors upon approval of the shareholders. Thisprivate placement and issuance of warrants was made pursuant to theterms of a Unit Subscription Agreement, dated as of June17,  2005, among the Company and several investors.

OnSeptember  20,  2005, the shareholders approved the abovesale of the Company’s common stock and warrants to certainmembers of the Company’s management and Board members. OnSeptember  21,  2005, the closing date, the Companyreceived net proceeds of $587, issued 453 shares of common stock andwarrants to purchase 46 shares of common stock at $1.90 per share and45 shares of common stock at $2.15 per share.

A summary ofwarrant activity is as follows:

|                                                    |  |                 |         |                          |  |                               |            |                                      |  |        |         |        |  |        |         |        |  |  |
|----------------------------------------------------|--|-----------------|---------|--------------------------|--|-------------------------------|------------|--------------------------------------|--|--------|---------|--------|--|--------|---------|--------|--|--|
|                                               |  | Number ofShares |         | Exercise Price Per Share |  | WeightedAverageExercise Price |            | Weighted AverageRemainingLife(Years) |
| Balance, December31,  2003                         |  |            | 220     |                     |  | $                             | 0.41-1.875 |                                 |  | $      | 1.13    |   |  |   | 2.20    |   |
| Granted                                            |  |            | 516     |                     |  |                          | 3.98-4.50  |                                 |  | $      | 4.24    |   |  |   | — |   |
| Exercised                                          |  |            | 220     |                     |  |                          | 0.41-1.875 |                                 |  | $      | 1.13    |   |  |   | — |   |
| Balance, December  31,  2004                       |  |            | 516     |                     |  |                          | 3.98-4.50  |                                 |  | $      | 4.24    |   |  |   | 2.25    |   |
| Granted                                            |  |            | 907     |                     |  |                          | 1.90-2.15  |                                 |  | $      | 2.03    |   |  |   |    |   |
| Exercised                                          |  |            | — |                     |  |                          | —    |                                 |  |   | — |   |  |   |    |   |
| Balance, December31,  2005                         |  |            | 1,423   |                     |  | $                             | 1.90-4.50  |                                 |  | $      | 2.83    |   |  |   | 2.04    |   |
| (all of which are exercisable atDecember  31,2005) |  |            |    |                     |  |                          |       |                                 |  |   |    |   |  |   |    |   |
|                                                    |

61

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AXS-ONEINC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (continued)(In thousands, except per sharedata)

(b) Stock Option Plans

Pursuantto the 1995 Stock Option Plan, as amended (the 1995 Plan), the Companymay grant statutory and non-statutory options to purchase an aggregateof up to 4,500 shares of Common Stock. The Company has specificallyreserved such shares. Options may be granted under the discretionaryoption program to employees, consultants, independent advisors andnon-employee directors. Prior to adoption of the 1998 Plan discussedbelow, options were automatically granted to non-employee directorsunder the automatic option grant programs. Options granted under thediscretionary grant program have an exercise price of not less than85% of the fair market value of the Common Stock on the grantdate. Options granted under the automatic grant program have anexercise price of 100% of the fair market value on the grantdate. The 1995 plan has expired and no further options can be issuedunder this plan. Outstanding options under this plan will continue tovest.

In April  1998, the Company adopted the 1998 StockOption Plan (the 1998 Plan). Pursuant to the 1998 Plan, the Company maygrant stock options or stock appreciation rights to purchase anaggregate of up to 5,000 shares of Common Stock (inclusive of 2,000 and1,500 shares added to the 1998 Plan by the stockholders in June2004 and 2001, respectively). In accordance with a June  2004amendment, up to 300 shares of the total shares may be used fornon-vested stock awards. Options may be granted under the discretionaryoption program (as amended in June  2004) to employees andconsultants of the Company not to exceed 500 shares per person duringany calendar year except that in the first year of employment, themaximum grant will not exceed 1,000 shares per person. Non-employeedirectors receive an automatic grant of stock options to purchase 20shares of Common Stock upon date of commencement of service as anon-employee director and thereafter, 10 shares on the date of eachannual meeting of stockholders, provided that on, and as of, such date,such individual has been a non-employee director for the previous12-month period. No option may have an exercise price less than thefair market value of the Common Stock at the time of grant.

Alloptions granted under the Plans expire ten years from the date of grant(or five years for statutory options granted to 10%stockholders), unless terminated earlier. Substantially all optionsvest over a four-year period.

On April  13,  2005the Company approved the AXS-One Inc. 2005 Stock Incentive Plan (the2005 Plan). The Plan was approved by the Company's stockholders atthe 2005 Annual Meeting of Stockholders on May  25,  2005.All employees and consultants of the Company and its affiliates areeligible to receive stock options, stock appreciation rights andnon-vested stock under the Plan, as determined by the committee (asdescribed below) in its sole discretion. Non-employee directors of theCompany automatically receive grants of stock options under the Planand are also eligible to receive discretionary grants of stock options.A maximum of 1,500 shares of the Company's common stock areavailable for awards under the Plan, of which 375 are available fornon-vested stock (in each case subject to adjustment as provided in thePlan). The maximum number of shares subject to awards intended to be‘‘performance-based’’ compensation within themeaning of Section 162(m) of the Internal Revenue Code that may begranted to any employee during any calendar year will not exceed 500shares, except for the calendar year in which such individual commenceshis or her employment, the maximum grant will not exceed 1,000 shares(in each case subject to adjustment as provided in the Plan). The Planis administered by a committee of the Board of Directors (currently theCompensation Committee) consisting of two or more non-employeedirectors, each of whom is intended to be (to the extent required byapplicable law) a non-employee director as defined in Rule 16b-3 of theSecurities Exchange Act of 1934, an outside director as defined underSection 162(m) and an ‘‘independent director’’as defined under American Stock Exchange Rule 121A. With regard tooptions granted under the Plan to non-employee directors, the Board ofDirectors administers the Plan. All options granted under the Plansexpire ten years from the date of grant (or five years for statutoryoptions granted to 10% stockholders), unless terminated earlier.Options generally vest over a four-year period.

62

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AXS-ONEINC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (continued)(In thousands, except per sharedata)

A summary of stock option activity underthe Plans is as follows:

|                                |  |                 |        |                         |  |                               |            |        |  |        |      |        |  |  |
|--------------------------------|--|-----------------|--------|-------------------------|--|-------------------------------|------------|--------|--|--------|------|--------|--|--|
|                           |  | Number ofShares |        | Exercise Price PerShare |  | Weighted AverageExercisePrice |
| Balance, December  31,2002     |  |            | 6,277  |                    |  | $                             | 0.21-13.00 |   |  | $      | 1.54 |   |
| Granted                        |  |            | 326    |                    |  |                          | 0.65-2.17  |   |  |   | 0.55 |   |
| Exercised                      |  |            | (177   | )                  |  |                          | 0.21-1.38  |   |  |   | 0.36 |   |
| Cancelled                      |  |            | (775   | )                  |  |                          | 0.32-6.25  |   |  |   | 1.54 |   |
| Balance,December  31,  2003    |  |            | 5,651  |                    |  | $                             | 0.21-13.00 |   |  | $      | 1.54 |   |
| Granted                        |  |            | 2,770  |                    |  |                          | 2.00-4.21  |   |  |   | 2.95 |   |
| Exercised                      |  |            | (588   | )                  |  |                          | 0.21-3.44  |   |  |   | 0.94 |   |
| Cancelled                      |  |            | (380   | )                  |  |                          | 0.21-6.25  |   |  |   | 2.32 |   |
| Balance, December  31,2004     |  |            | 7,453  |                    |  | $                             | 0.21-13.00 |   |  | $      | 2.07 |   |
| Granted                        |  |            | 861    |                    |  |                          | 1.52-3.32  |   |  |   | 2.12 |   |
| Exercised                      |  |            | (1,345 | )                  |  |                          | 0.21-2.38  |   |  |   | 0.76 |   |
| Cancelled                      |  |            | (599   | )                  |  |                          | 0.21-13.00 |   |  |   | 2.50 |   |
| Balance, December  31,2005     |  |            | 6,370  |                    |  | $                             | 0.21-6.25  |   |  |   | 2.31 |   |
| Exercisable, December31,  2005 |  |            | 5,572  |                    |  |                          |       |   |  |   | 2.44 |   |
|                                |

A summary of stock optionsoutstanding and exercisable as of December  31,  2005,follows:

|                         |  |                     |       |                                         |  |                                |        |                    |  |                                 |        |        |  |        |       |        |  |        |        |        |  |  |
|-------------------------|--|---------------------|-------|-----------------------------------------|--|--------------------------------|--------|--------------------|--|---------------------------------|--------|--------|--|--------|-------|--------|--|--------|--------|--------|--|--|
| Options Outstanding     |  | Options Exercisable |
| Range of exerciseprices |  | Number outstanding  |       | Weighted average remaining life (years) |  | Weightedaverage exercise price |        | Number exercisable |  | Weighted average exercise price |
| $0.21-1.00              |  |                | 1,750 |                                    |  |                           | 5.65   |               |  | $                               | 0.63   |   |  |   | 1,516 |   |  | $      | 0.62   |   |
| $1.06-2.24              |  |                | 2,016 |                                    |  |                           | 6.94   |               |  | $                               | 1.85   |   |  |   | 1,452 |   |  | $      | 1.92   |   |
| $2.36-4.21              |  |                | 2,120 |                                    |  |                           | 7.96   |               |  | $                               | 3.27   |   |  |   | 2,120 |   |  | $      | 3.27   |   |
| $6.00-6.25              |  |                | 484   |                                    |  |                           | 4.26   |               |  | $                               | 6.02   |   |  |   | 484   |   |  | $      | 6.02   |   |
|                    |  |                | 6,370 |                                    |  |                           |   |               |  |                            |   |   |  |   | 5,572 |   |  |   |   |   |
|                         |

(8)    Employee401(k) Plan

The Company's 401(k) Plan (the Plan) is adefined contribution plan. All employees who are at least 21 years ofage are eligible on the first day in the month following their date ofhire to become participants in the Plan and to make voluntarycontributions based on a percentage of their compensation withincertain Plan limitations.

The Plan falls under the provisions ofSection 401(k) of the Internal Revenue Code. Employees may elect tocontribute a percentage of their pretax salary, subject to statutorylimitations, as well as certain percentages of their after-tax salary,to the Plan. By approval of the Board of Directors, the Company mayelect to match a pre-determined percentage of the employees’contribution. In addition, the Company may make additionalcontributions at the discretion of the Board of Directors, which wouldbe allocated among all participants in proportion to eachparticipant's compensation, as defined. During the years endedDecember  31,  2005, 2004 and 2003, no additionalcontributions were made under the Plan.

Beginning in 2002, allcontributions by the Company are on a discretionary basis only asapproved by the Board of Directors. For the year ended December31,  2005 and 2004, the Company contributed 

63

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AXS-ONEINC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (continued)(In thousands, except per sharedata)

50% of the employees’ first6% of pretax salary contribution. For the year 2003, the Companycontributed 25% of the employees’ first 6% ofpretax salary contribution.

The Company's contributionscharged to operations in the accompanying consolidated statements ofoperations were approximately $272, $308, and $96 for the years endedDecember  31,  2005, 2004 and 2003, respectively.

(9)    Financial Information by Geographic Area

SFAS No.131, ‘‘Disclosure about Segments of an Enterprise andRelated Information,’’ established standards for the waypublic business enterprises report information about operating segmentsin annual financial statements and requires that those enterprisesreport selected information about reporting segments in interimfinancial reports issued to shareholders. It also established standardsfor related disclosures about products and services, geographic areasand major customers.

Revenues and long-lived assets for theCompany's United States, United Kingdom, Australia and SoutheastAsia and other international operations are as follows:

|                   |  |               |        |               |  |                            |        |              |  |              |        |        |  |        |        |        |  |        |        |        |  |  |
|-------------------|--|---------------|--------|---------------|--|----------------------------|--------|--------------|--|--------------|--------|--------|--|--------|--------|--------|--|--------|--------|--------|--|--|
|              |  | United States |        | UnitedKingdom |  | Australia andSoutheastAsia |        | South Africa |  | Consolidated |
| 2005              |  |          |   |          |  |                       |   |         |  |         |   |   |  |   |   |   |  |   |   |   |
| Revenues(1)       |  | $             | 21,283 |          |  | $                          | 4,221  |         |  | $            | 3,801  |   |  | $      | 3,503  |   |  | $      | 32,808 |   |
| Long-lived assets |  |          | 1,184  |          |  |                       | 75     |         |  |         | 151    |   |  |   | 23     |   |  |   | 1,433  |   |
| 2004              |  |          |   |          |  |                       |   |         |  |         |   |   |  |   |   |   |  |   |   |   |
| Revenues(1)       |  | $             | 26,585 |          |  | $                          | 4,573  |         |  | $            | 4,683  |   |  | $      | 2,595  |   |  | $      | 38,436 |   |
| Long-lived assets |  |          | 2,094  |          |  |                       | 87     |         |  |         | 185    |   |  |   | 29     |   |  |   | 2,395  |   |
| 2003              |  |          |   |          |  |                       |   |         |  |         |   |   |  |   |   |   |  |   |   |   |
| Revenues(1)       |  | $             | 25,940 |          |  | $                          | 4,851  |         |  | $            | 5,354  |   |  | $      | 3,546  |   |  | $      | 39,691 |   |
| Long-lived assets |  |          | 2,465  |          |  |                       | 54     |         |  |         | 123    |   |  |   | 58     |   |  |   | 2,700  |   |
|                   |

|  |
|--|
|  |  |
|  |

|  |                                                                                                        |
|--|--------------------------------------------------------------------------------------------------------|
|  | (1)    Revenuesare attributed to geographic area based on location of salesoffice. |

(10)    Operating Segments

In thefourth quarter of 2003, the Company consolidated the sales andmarketing efforts of its three business units in order to streamlinethe sales process and control expenses. The Company now has only twoproduct lines that it offers to specific markets as part of itsstrategy to focus on market opportunities. The two product lines are asfollows:

|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|----------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| a)  | AXS-One EnterpriseFinancials provide an integrated suite of internet-enabled financialmanagement and accounting applications to global 2000 organizations,enabling them to achieve process transparency while maintaining secureaccess required to meet reporting, control and governance requirements.AXS-One has an extensive installed customer base for its core financialmanagement products as well as for its Time and Billing components, afull suite of business solutions and services optimized to address therequirements of organizations that primarily sell professionals’time. |

|          |                                                                                                                                                                                                                                                                                        |
|----------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| b)  | AXS-One Records ComplianceManagement Solutions enable organizations to utilize documents and datagenerated by their corporate applications as an asset while reducingcorporate risk and operational overheads and addressing requirementsfor corporate governance, legal discovery and |

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AXS-ONEINC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (continued)(In thousands, except per sharedata)

|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | industry regulations associated with howcorporate records are managed and retained. Utilizing the AXS-OneCompliance Management Solution, organizations can capture, archive,manage, search, supervise, integrate, share and audit their electronicrecords, regardless of originating platform. Disparate document anddata types can be managed including e-mail, instant messages, images,voice and video, office documents, ERP-generated data such as SAP, andelectronic print reports generated by host systems. AXS-One ComplianceManagement Solutions target large information-centric organizationsthat can utilize self-service information systems to reduce costs,increase efficiency, improve communications with their customers andimprove access to business intelligence. |

The Company evaluatesthe performance of its two product lines based on revenues andoperating income. Summarized financial information concerning theCompany’s reportable segments is shown in the following table.The Chief Executive Officer uses the information below in this formatwhile making decisions about allocating resources to each product lineand assessing its performance.

|                                               |  |                             |        |                            |  |        |        |         |  |        |        |         |  |  |
|-----------------------------------------------|--|-----------------------------|--------|----------------------------|--|--------|--------|---------|--|--------|--------|---------|--|--|
|                                          |  | AXS-OneEnterpriseFinancials |        | AXS-OneComplianceSolutions |  | Total  |
| Year Ended December 31,2005                   |  |                        |   |                       |  |   |   |    |  |   |   |    |
| Revenues:                                     |  |                        |   |                       |  |   |   |    |  |   |   |    |
| Licensefees                                   |  | $                           | 1,437  |                       |  | $      | 4,109  |    |  | $      | 5,546  |    |
| Services                                      |  |                        | 19,986 |                       |  |   | 7,168  |    |  |   | 27,154 |    |
| Total revenue, excludingrelated party revenue |  |                        | 21,423 |                       |  |   | 11,277 |    |  |   | 32,700 |    |
| Operating income (loss)                       |  |                        | 7,452  |                       |  |   | (8,716 | )  |  |   | (1,264 | )  |
| Totalassets                                   |  |                        | 3,646  |                       |  |   | 7,420  |    |  |   | 11,066 |    |
| Capital expenditures                          |  |                        | 172    |                       |  |   | 24     |    |  |   | 196    |    |
| Depreciation and amortization                 |  |                        | 729    |                       |  |   | 424    |    |  |   | 1,153  |    |
| Year Ended December31,2004                    |  |                        |   |                       |  |   |   |    |  |   |   |    |
| Revenues:                                     |  |                        |   |                       |  |   |   |    |  |   |   |    |
| Licensefees                                   |  | $                           | 2,419  |                       |  | $      | 4,362  |    |  | $      | 6,781  |    |
| Services                                      |  |                        | 25,704 |                       |  |   | 5,742  |    |  |   | 31,446 |    |
| Total revenue, excludingrelated party revenue |  |                        | 28,123 |                       |  |   | 10,104 |    |  |   | 38,227 |    |
| Operating income                              |  |                        | 53     |                       |  |   | 2,801  |    |  |   | 2,854  |    |
| Total assets                                  |  |                        | 12,274 |                       |  |   | 2,507  |    |  |   | 14,781 |    |
| Capitalexpenditures                           |  |                        | 380    |                       |  |   | 46     |    |  |   | 426    |    |
| Depreciation and amortization                 |  |                        | 1,319  |                       |  |   | 29     |    |  |   | 1,348  |    |
| YearEnded December  31,2003                   |  |                        |   |                       |  |   |   |    |  |   |   |    |
| Revenues:                                     |  |                        |   |                       |  |   |   |    |  |   |   |    |
| Licensefees                                   |  | $                           | 4,371  |                       |  | $      | 2,072  |    |  | $      | 6,443  |    |
| Services                                      |  |                        | 28,064 |                       |  |   | 4,884  |    |  |   | 32,948 |    |
| Total revenue, excludingrelated party revenue |  |                        | 32,435 |                       |  |   | 6,956  |    |  |   | 39,391 |    |
| Operating income                              |  |                        | 5,687  |                       |  |   | 3,214  |    |  |   | 8,901  |    |
| Total assets                                  |  |                        | 10,572 |                       |  |   | 1,578  |    |  |   | 12,150 |    |
| Capitalexpenditures                           |  |                        | 196    |                       |  |   | 18     |    |  |   | 214    |    |
| Depreciation and amortization                 |  |                        | 1,548  |                       |  |   | 22     |    |  |   | 1,570  |    |
|                                               |

65

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AXS-ONEINC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (continued)(In thousands, except per sharedata)

Reconciliation of segmentoperating income (loss) to consolidated operating income (loss) is asfollows:

|                                                   |  |                                                |        |         |  |        |        |         |  |        |        |         |  |  |
|---------------------------------------------------|--|------------------------------------------------|--------|---------|--|--------|--------|---------|--|--------|--------|---------|--|--|
|                                              |  | Year Ended December31,     |
|                                              |  | 2005                                           |        | 2004    |  | 2003   |
| Operating income (loss) fromreportable segments   |  | $                                              | (1,264 | )  |  | $      | 2,854  |    |  | $      | 8,901  |    |
| Unallocated revenue, Other –related parties |  |                                           | 108    |    |  |   | 209    |    |  |   | 300    |    |
| Unallocated general and administrative expenses   |  |                                           | (5,129 | )  |  |   | (6,367 | )  |  |   | (5,599 | )  |
| Othercorporate unallocated expenses               |  |                                           | (2,278 | )  |  |   | (2,264 | )  |  |   | (1,030 | )  |
| Total consolidated operating income(loss)         |  | $                                              | (8,563 | )  |  | $      | (5,568 | )  |  | $      | 2,572  |    |
|                                                   |

(11)    Quarterly Financial Data(Unaudited)

Summarized quarterly financial data for2005, 2004 and 2003 is as follows (in thousands except per sharedata):

|                                               |  |         |        |         |  |        |        |         |  |        |       |        |  |        |        |         |  |  |
|-----------------------------------------------|--|---------|--------|---------|--|--------|--------|---------|--|--------|-------|--------|--|--------|--------|---------|--|--|
|                                          |  | Quarter |
| 2005                                          |  | First   |        | Second  |  | Third  |        | Fourth  |
| Totalrevenues                                 |  |    | 8,058  |    |  |   | 7,479  |    |  |   | 9,357 |   |  |   | 7,914  |    |
| Gross profit                                  |  |    | 3,035  |    |  |   | 2,690  |    |  |   | 5,322 |   |  |   | 3,953  |    |
| Net income(loss)                              |  |    | (3,169 | )  |  |   | (4,359 | )  |  |   | 177   |   |  |   | (1,647 | )  |
| Basic net income (loss) per commonshare (1)   |  |    | (0.11  | )  |  |   | (0.15  | )  |  |   | 0.01  |   |  |   | (0.05  | )  |
| Diluted net income (loss) per commonshare (1) |  |    | (0.11  | )  |  |   | (0.15  | )  |  |   | 0.01  |   |  |   | (0.05  | )  |
|                                               |

|                                               |  |         |        |        |  |        |        |         |  |        |        |         |  |        |        |         |  |  |
|-----------------------------------------------|--|---------|--------|--------|--|--------|--------|---------|--|--------|--------|---------|--|--------|--------|---------|--|--|
|                                          |  | Quarter |
| 2004                                          |  | First   |        | Second |  | Third  |        | Fourth  |
| Totalrevenues                                 |  |    | 10,922 |   |  |   | 9,505  |    |  |   | 9,145  |    |  |   | 8,864  |    |
| Gross profit .                                |  |    | 6,242  |   |  |   | 4,602  |    |  |   | 4,323  |    |  |   | 4,260  |    |
| Net income(loss)                              |  |    | 753    |   |  |   | (2,580 | )  |  |   | (1,659 | )  |  |   | (1,726 | )  |
| Basic net income (loss) per commonshare (1)   |  |    | 0.03   |   |  |   | (0.09  | )  |  |   | (0.06  | )  |  |   | (0.06  | )  |
| Diluted net income (loss) per commonshare (1) |  |    | 0.03   |   |  |   | (0.09  | )  |  |   | (0.06  | )  |  |   | (0.06  | )  |
|                                               |

|                                         |  |         |       |        |  |        |       |        |  |        |        |        |  |        |        |        |  |  |
|-----------------------------------------|--|---------|-------|--------|--|--------|-------|--------|--|--------|--------|--------|--|--------|--------|--------|--|--|
|                                    |  | Quarter |
| 2003                                    |  | First   |       | Second |  | Third  |       | Fourth |
| Totalrevenues                           |  |    | 9,445 |   |  |   | 9,588 |   |  |   | 10,211 |   |  |   | 10,447 |   |
| Gross profit                            |  |    | 5,140 |   |  |   | 5,207 |   |  |   | 6,025  |   |  |   | 984    |   |
| Netincome                               |  |    | 427   |   |  |   | 155   |   |  |   | 918    |   |  |   | 816    |   |
| Basic net income per common share (1)   |  |    | 0.02  |   |  |   | 0.01  |   |  |   | 0.04   |   |  |   | 0.03   |   |
| Diluted net income per common share (1) |  |    | 0.02  |   |  |   | 0.01  |   |  |   | 0.04   |   |  |   | 0.03   |   |
|                                         |

|  |
|--|
|  |  |
|  |

|  |                                                                                                                                                                                                                                             |
|--|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|  | (1)Basic and diluted net income (loss) per common share are computedindependently for each quarter. Therefore, the sum of the quarters willnot necessarily equal the basic and diluted net income (loss) percommon share for the full year. |

(12)    RestructuringCosts

On June  30,  2004, in order to streamlineand reorganize the Company to better meet its long-term goals, theCompany eliminated 25 positions in the United States and 11 positionsin its foreign operations. The Company recorded a charge to operationsin the second quarter totaling approximately $786 related toinvoluntary termination benefits to be paid to the terminatedemployees. The severance accrual was adjusted down by approximately $83in the third quarter mainly due to the re-assignment of two peoplepreviously scheduled for termination. All amounts related to thisrestructuring had been paid as of December  31,  2004.

66

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AXS-ONEINC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (continued)(In thousands, except per sharedata)

In addition, in June  2004, theCompany recognized an expense of approximately $317 related to aretirement agreement with the Company’s former CEO. Theliability for the retirement agreement is included in accrued expenseson the accompanying December  31,  2004 ConsolidatedBalance Sheet. The Company paid the retirement benefits inJanuary  2005.

On June  30,  2005 the Companyeliminated 22 positions in the United States and 6 positions in itsforeign operations in order to further streamline the organization. TheCompany recorded a charge to operations in the second quarter totalingapproximately $863 related to involuntary termination benefits to bepaid to the terminated employees. The remaining restructuring liabilityis recorded as accrued expenses on the December  31,  2005balance sheet.

The activities related to the restructurings areas follows:

|                                       |  |        |         |         |  |        |         |         |  |  |
|---------------------------------------|--|--------|---------|---------|--|--------|---------|---------|--|--|
|                                  |  | 2005   |         | 2004    |
| Restructuring liability at January  1 |  | $      | — |    |  | $      | — |    |
| Involuntarytermination costs          |  |   | 863     |    |  |   | 786     |    |
| Cashpayments                          |  |   | (544    | )  |  |   | (703    | )  |
| Adjustmentto severance accrual        |  |   | — |    |  |   | (83     | )  |
| Restructuring liability at December31 |  | $      | 319     |    |  | $      | — |    |
|                                       |

(13)    Contingencies

Historically, the Company has been involved in disputes and/orlitigation encountered in its normal course of business. The Companybelieves that the ultimate outcome of these proceedings will not have amaterial adverse effect on the Company's business, consolidatedfinancial condition, results of operations or cashflows.

67

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Report ofIndependent Registered Public Accounting Firm

The Board of Directors and StockholdersAXS-OneInc.:

Under date of March  23,  2006,we reported on the consolidated balance sheets of AXS-One Inc. andsubsidiaries as of December  31,  2005 and 2004, and therelated consolidated statements of operations, comprehensive income(loss), stockholders' deficit, and cash flows for each of theyears in the three-year period ended December  31,  2005,which are included in the 2005 annual report on Form 10-K. Inconnection with our audits of the aforementioned consolidated financialstatements, we also audited the accompanying related consolidatedfinancial statement schedule. This consolidated financial statementschedule is the responsibility of the Company's management. Ourresponsibility is to express an opinion on this consolidated financialstatement schedule based on our audits.

In ouropinion, such consolidated financial statement schedule, whenconsidered in relation to the basic consolidated financial statementstaken as a whole, presents fairly, in all material respects, theinformation set forth therein.

/s/ KPMG LLP

Short Hills, New JerseyMarch  23,2006

68

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SCHEDULE II

AXS-ONE INC.VALUATION AND QUALIFYING ACCOUNTSYearsEnded December  31,  2005, 2004 and 2003

(inthousands)

|                                 |  |                           |     |                                               |  |                   |      |                      |  |   |      |         |  |   |     |        |  |  |
|---------------------------------|--|---------------------------|-----|-----------------------------------------------|--|-------------------|------|----------------------|--|---|------|---------|--|---|-----|--------|--|--|
| AllowanceFor Doubtful Accounts: |  | BalanceatBeginningof Year |     | Charged(Credited) toCostsandExpenses, net (a) |  | AmountsWrittenOff |      | Balanceat Endof Year |
| Year endedDecember  31,  2005   |  | $                         | 577 |                                          |  | $                 | 11   |                 |  | $ | (421 | )  |  | $ | 167 |   |
| Year endedDecember  31,  2004   |  | $                         | 200 |                                          |  | $                 | 465  |                 |  | $ | (88  | )  |  | $ | 577 |   |
| Year endedDecember  31,  2003   |  | $                         | 379 |                                          |  | $                 | (108 | )               |  | $ | (71  | )  |  | $ | 200 |   |
|                                 |

|  |
|--|
|  |  |
|  |

|     |                                                                                                                     |
|-----|---------------------------------------------------------------------------------------------------------------------|
| (a) | Creditsto costs and expenses reflect recoveries of amounts previously writtenoff or revisions to previousestimates. |

69

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