**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

**Annual Report Pursuant to Section 13 or15(d) of the Securities Exchange Act of 1934**

**Forthe fiscal year ended December 31, 2004**

**CommissionFile Number: 1-13591**

**AXS-ONE INC.**

(Exact name of registrantas specified in its charter)

| **Delaware**                                                     | **13-2966911**                     |
|------------------------------------------------------------------|------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) | (IRS Employer  Identification No.) |
| **301 Route 17 North, Rutherford, New Jersey**                   | **07070**                          |
| (Address of  principal executive offices)                        | (Zip Code)                         |

 

**201-935-3400**

(Registrant’s telephonenumber, including area code)

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

|                                  | **Title of each class**      | ** ** | ** ** | **Name of each exchange  on which registered** | ** ** |
|----------------------------------|------------------------------|------------|------------|------------------------------------------------|------------|
| **Common  Stock $.0l par value** | **American  Stock Exchange** |

 

Securities Registered Pursuant to Section 12(g) ofthe Act:

**None**

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 (the “Act”) during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes x No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405**ofRegulation S-K is not contained herein, and will not be contained, to the bestof Registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. o

Indicate by check markwhether the Registrant is an accelerated filer (as defined in Rule 12b-2under the Act). Yes o  No x

The aggregate market valueof the voting and non-voting common equity held by non-affiliates of theRegistrant, based upon the closing sale price of Common Stock on June 30,2004 (the last business day of the Registrant’s most recently completed secondfiscal quarter) as reported on the American Stock Exchange, was approximately $68.3million. Shares of Common Stock held by each officer and director of theoutstanding Common Stock have been excluded in that such persons may be deemedto be affiliates. This determination of affiliate status is not necessarily aconclusive determination for other purposes.

As of March 15, 2005,Registrant had outstanding 28,563,566 shares of Common Stock.

**DOCUMENTSINCORPORATED BY REFERENCE**

**Items 10, 11, 12, 13 and 14 of Part III areincorporated by reference from a portion of the Registrant’s definitive proxystatement to be furnished to stockholders in connection with the 2005 AnnualMeeting of Stockholders.**

 

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**Item 1.**                        Business

This Report containsstatements of a forward-looking nature within the meaning of the safe harborprovisions of Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended, relating to future eventsor future financial results of the Company. Investors are cautioned that suchstatements are only predictions and that actual events or results may differmaterially. In evaluating such statements, investors should specifically considerthe various factors identified in this Report which could cause actual eventsor results to differ materially from those indicated by such forward-lookingstatements, including the matters set forth in “Business—Risk Factors” below.

**General**

AXS-One Inc. (“AXS-One” or the “Company”) is asoftware company providing robust, secure business solutions that allow anorganization to reduce the inherent risks associated with retaining andmanaging corporate records as well as to achieve efficiency in its businessprocesses and to extend those efficiencies to its customers, suppliers, andbusiness partners. AXS-One has a proven track record in developing flexible,high-performance, scalable, secure and effective business solutions for global2000 organizations. AXS-One’s ability to quickly identify emerging marketopportunities and to build high-quality, innovative solutions has wonmany awards over the years. The Company has devoted significant resources todeveloping new products which serve the Content Archival, Records Management,Compliance Management, and Information Management Markets.

AXS-One believes that changes in the scope andcomplexity of the corporate regulatory and legal environment, and the risksarising from corporate malfeasance have significantly altered how organizationsare doing, and are required to do, business. Organizations are re-evaluatingtheir software requirements to invest in solutions that ensure operationalefficiency and competitive advantage while enabling them to address and satisfytheir requirements for corporate governance, regulatory compliance, legaldiscovery and privacy of information. AXS-One’s approach allows organizationsto meet these requirements by leveraging investments in existing systems toextend them with collaborative web services and business components thatautomate business processes across corporate boundaries. This results inmanageable investments, quick implementation schedules and a more rapid returnon investment.

AXS-One has two main product lines:

**FinancialManagement**—**AXS-One® EnterpriseFinancials**—a comprehensive suite of financial management solutionsfor a broad range of industries designed to address accounting, time andexpense management, financial reporting, performance management and corporategovernance.

**Records ComplianceManagement—AXS-One Compliance PlatformTM**—an integratedsolution that enables organizations to securely capture, index, archive,search, supervise, share and manage the retention and disposition of electronicrecords, including e-mail and Instant Messages, images, voice, officedocuments, ERP-generated data such as SAP and electronic print reports. Theseproducts have been developed and optimized to address global issues ofregulatory compliance, corporate governance, supervision, legal discovery andprivacy as they relate to the retention and disposition of electronic records.

**Distribution**

AXS-One markets itsproducts worldwide through a direct sales force located in the United States,the United Kingdom, South Africa, Australia, Singapore, Hong Kong, Malaysia****and Taiwan. During 2004, the Company announced a number ofpartnerships, establishing an indirect sales channel through global partnershipand local reseller agreements. For fiscal year 2004, AXS-One did not generatesignificant revenues from its distributors. For further information, see “StrategicAlliances and Business Development 

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Programs”.Information specific to the two product lines are presented in Note 10 to theConsolidated Financial Statements.

**Products**

***AXS-One Enterprise Financials***

AXS-One Enterprise Financials provide a comprehensivesuite of financial management products designed to address accounting,financial reporting, time and expense management, performance management andcorporate governance requirements across the enterprise. With the advent of theSarbanes-Oxley Act of 2002 in the United States, the degree of success orfailure of these processes is measured in terms of accuracy, control andaccountability as well as speed and efficiency. AXS-One Enterprise Financialsenable organizations to effectively manage and audit entire process lifecycleswith proven transactional applications and templated and automated processworkflow. By leveraging AXS-One’s Web Services architecture, solutionscan be rapidly deployed and integrated. They can also be deployed andintegrated with other third party applications. For instance, AXS-OneEnterprise Financials have been successfully deployed within hosted Internetsolutions such as those provided by an Internet-based property managementsolution in Australia.

AXS-One’s Enterprise Financials continue to be one ofthe primary back office applications of world-class organizationsincluding customers in Financial Services, Life Sciences and State and LocalGovernment.

The Company continues to enhance this solution suiteto ensure continued compatibility with and optimization of current technology,to respond to customer enhancement requests and to ensure continued competitivedifferentiation. During 2004, AXS-One pre-announced Enterprise 9.0—ComplianceEdition to its customers. General Availability of Version 9.0 is currentlyscheduled for the first half of 2005.

As well as includingcustomer-requested enhancements to existing components, Enterprise 9.0—ComplianceEdition includes new functionality designed to help customers more easilycomply with the requirements of Sarbanes-Oxley, including sections 404, 103 and802. The “duty to preserve” requirements of Sections 103 and 802 have beenaddressed by integrating the AXS-One Enterprise Financials products with theAXS-One Compliance Platform solution, enabling output generated by any of theEnterprise 9.0—Compliance Edition components to be automatically andsecurely stored and retained in AXS-One® Central, AXS-One’s digitalarchive solution. This functionality can then be expanded by implementingadditional components of the AXS-One Compliance Platform including e-mailmanagement, Instant Messaging management, electronic records management, legaldiscovery and legal case management. AXS-One believes that integration of itstwo product lines to address customers’ critical business issues will not onlyaddress customer satisfaction and customer retention issues for its EnterpriseFinancial solutions but provide an enhanced platform to generate future salesopportunities within its current customer base for its Records ComplianceManagement product suite.

*AXS-One EnterpriseFinancials Architecture*

AXS-One’s e-CelleratorTM architecture includestechnology such as Web Services, Simple Object Access Protocol (SOAP),eXtensible Markup Language (XML), Hyper Text Transfer Protocol (HTTP) and otherstandards. The architecture is designed to deliver a highly scalable, flexibleenvironment that runs on industry standard platforms and database systems. As aresult, AXS-One’s architecture delivers an adaptable suite of interoperabilitychoices, creating flexibility in integration and business process managementstrategies.

Customers can usepre-packaged AXS-One solutions, customize AXS-One solutions to meet specificbusiness requirements, connect existing systems with AXS-One, or buildcompletely new solutions 

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in-house,supported by AXS-One products. Interoperability choices include real-time andbatch Web services interfaces, XML documents, reports, e-mail, faxes, images,relational database systems and even websites.

*AXS-One EnterpriseFinancials Products*

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

***AXS-One Records Compliance Management Solutions***

The AXS-One Compliance Platform is an integratedsolution that enables organizations to securely capture, index, archive, share,search, supervise and manage the retention and disposition of all electronicrecords, including e-mail and Instant Messages, images, voice, officedocuments, ERP-generated data such as SAP and electronic print reports. Theseproducts have been developed and optimized to address global issues ofregulatory compliance, corporate governance, supervision, legal discovery andprivacy as they relate to the retention and disposition of electronic records.

The basis for this solution is AXS-One Central, aComputer Output to Laser Disk (“COLD”) archiving solution that provides acentralized and highly scalable repository and digital archive designed forlong term secure storage and management of massive volumes (terabytes) of data.Originally launched in 1993 as “COOLTM”, AXS-One Central has been implemented byglobal financial institutions, including four of the world’s largest financialinstitutions, for the long term archival of their financial books and recordsin compliance with SEC Rule 17a-4 under the Securities Exchange Act.In addition to eliminating paper production, distribution and storage costs,the solutions provide fast, secure online access to relevant information via apowerful portal that can deliver significant productivity gains toorganizations.

Applications built on AXS-One’s set of archiving andworkflow products have been deployed as electronic bill presentment anddocument delivery 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 typically implementedin weeks, thus providing a rapid time-to-value.

During 2004, AXS-One completed significant developmenton the AXS-One Compliance Platform, launching Version 3.0 at the end of theyear that included a number of key enhancements as well as new integratedfunctionally—AXS-One Retention ManagerTM. AXS-One believes that the architectureand functionality of the AXS-One Compliance Platform provides it with acompetitive advantage, and means that the Company can offer its customers andprospective customers a broad suite of solutions that enable them to addresstheir current enterprise needs and to scale to meet their future requirements.

Development also focused on optimizing the AXS-OneCompliance Platform to ensure that it could be sold through a channel salesmodel. Additionally during 2004, AXS-One completed significant scalability andperformance testing with Sun Microsystems to test and optimize the AXS-OneCompliance Platform solution for the Sun platform. This not only tested thatthe AXS-One solution could take advantage of and optimize the Sun Solarisarchitecture but also proved the scalability of the AXS-One solution for theSolaris platform. (See “Strategic Alliances and Business Development Programs.”)

AXS-One believes that theCompany’s ability to focus on real business requirements as they relate totechnology continues to differentiate the Company from its competitors. As acomponent of the AXS-One Compliance Platform, AXS-One Retention Manager helpsensure that organizations can continue to protect the trustworthiness andaccessibility of electronic records over time by providing a full “processchain of custody” audit trail for every record within the system. This solutionautomatically records 

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programor human interaction with records so that, in the case of legal action, arecord can be proven to be trustworthy and admissible.

*AXS-One RecordsCompliance Management Architecture*

The AXS-One Records Compliance Management solutionsuite is based on a single, scalable archive. This architecture provides theability for organizations to capture, store, manage and reproduce “states-of-time”on demand: to reproduce, via a single platform, records such as e-mail, instantmessage, desktop/office document (such as a Microsoft Word document orMicrosoft Excel spreadsheet), electronic report and more, based upon request byinternal parties, or for satisfaction of external regulatory audit or legaldiscovery requests. This architecture also provides system level assurance ofdata and process integrity by delivering full process chain of custody recordsfor the managed data, as well as enabling organizations to recognizeoperational efficiencies.

AXS-One has focused its architectural requirements onenterprise scalability and on the ability to handle large, complex requirementsfor integration within large corporate infrastructures (which can then beeasily applied to meet the requirements of strategic hosting and applicationservice providers (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 truly pervasive withinan organization, and of applications that deliver significant value—e-delivery,e-mail and IM archiving, supervision, legal discovery and legal case hold, SAParchiving and records management.

In 2004, AXS-One announced the certification of itsAXS-Link for SAP solution on the SAP/R3 platform to perform SAP document anddata archival. The Company’s competitive position in this market is highlydifferentiated because its end-to-end managed solution delivers the ability tomanage retention, disposition and risk associated with records across manysystems, including SAP, in combination with the data stored within the AXS-OneCentral archive.

In 2004, AXS-One completedscalability and performance testing of the AXS-One Compliance Platform with SunMicrosystems (See ***AXS-One Records Compliance ManagementSolutions*****above*).*AXS-Onebelieves that the ability of its products to support and exploit UNIX operatingsystems, such as Sun’s Solaris operating system, as well as Windowsenvironments and to support the heterogeneous environments in which customershave already invested is a competitive differentiator.

*AXS-One RecordsCompliance Management Products*

Integrated productcomponents are available for: COLD archiving; electronic presentment; e-mailarchival and management for Microsoft Exchange, Lotus Notes, Bloomberg Mail andother message types; Instant Messaging archival, with specific connectors forproducts from FaceTime and IMlogic; SAP archival; supervision; electronicrecords management; legal discovery and active case management.

**Client Services**

The Company considers its Client Services to be amajor asset and key differentiator from other vendors. With its 24 x 7 clientsupport, “Implementation Certainty” methodology, standard and customizedtraining and 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, 2004,the Company had 104 employees worldwide providing customer support, consultingand training services. To maintain a high standard of service, the Companyrequests customer evaluations of client support personnel on a quarterly basis.The Company’s services are described below.

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*Client Support*

Support for domestic U.S. clients is based out of theCompany’s corporate headquarters in Rutherford, New Jersey. Client supportcenters are also based in Johannesburg, London, Singapore, and Sydney. Theglobal support center infrastructure has been optimized to allow for aneffective and efficient “follow the sun” 24 x 7 customer support strategy. Annualmaintenance contracts are generally required for the first year of a customer’suse of the Company’s products, and are renewable on an annual basis. Maintenancecontracts entitle the customer to hot-line support and all unspecified productupgrades released during the term of the maintenance contract. Upgrades includeany and all unspecified patches or releases related to a licensed softwareproduct. Maintenance is offered at three levels of hot-line supportavailability, Platinum, Gold and Silver. Maintenance fees vary depending on thehours of hot-line support requested by the customer and typically range between18% and 25% of license fees.

The Company also providesmanagement overview and product information bulletins on an ongoing basis aswell as a customer-accessible knowledge base and periodic informational updatesabout installed products. The bulletins generally answer “commonly askedquestions” and provide information about new product features. The Company alsoprovides services for the development of customized documentation about thecustomer’s system to reflect, among other things, user-defined modificationsand specific business logic and processes.

*Technical Services*

The Company offersassistance in developing 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 mission criticalsystems. The Company also provides network troubleshooting and assists itscustomers in deploying Internet systems, relational database management systems(RDBMS) software and operating systems.

*Consulting Services*

The Company’s consultingservices organization provides project assurance, business systems review,technical design, functional design, business modeling, system tailoring,system certification, change management and ongoing project support inconnection with a customer’s implementation of the Company’s products. Similarservices are also provided for upgrades to later versions of the software andmigrations to different operating platforms. The Company frequently works withthird-party consultants and system integrators to provide customers with a fullrange of installation, customization and project management services.

*Education Services*

The Company provideseducation services worldwide through its Knowledge Transfer organization. Thisgroup is responsible for the development and delivery of training coursesdesigned to familiarize users with the Company’s products, and to train AXS-Onestaff and partners in product installation, implementation and technicalsupport. In addition to scheduled classroom training, this group deliversstandard courses at customer locations as well as working with customers tocreate classes tailored to their specific requirements. Training courses varyin length from one to five days

**StrategicAlliances and Business Development Programs**

AXS-One’s mission is to be a leading provider ofRecords Compliance Management solutions, leveraging its expertise in archiving,workflow and compliance gained and maintained by its strong presence in theEnterprise Financials market. The solutions offered by the Company’s productlines address the requirements of global enterprises across differentindustries. In order to gain market share, 

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establish new geographicalmarkets and leverage best in breed technology, the Company realizes that itmust leverage not only its own key resources but also those of otherorganizations.

Since its inception in 1978, the Company hasestablished strategic alliances and relationships with a number oforganizations as an integral component of its go-to-market strategy. TheCompany believes these relationships are important to the development, sales,marketing, integration, and support of its products. During 2004, the Companystated its intentions to significantly develop its channel sales model by establishingrelationships with leading organizations around the world.

During 2004, AXS-One announced several partnershipsand began to recognize revenues from some of these. These include Sector, amanaged services provider to the financial services community, whose customersare utilizing the AXS-One Compliance Platform to address SEC Rule 17a-4and NASD Rule 3010 requirements. In July 2004, AXS-One announced areseller agreement with Sun Microsystems in North America for its entireAXS-One Compliance Platform products suite. At the end of 2004, AXS-Oneand Sun concluded negotiations to significantly expand the terms of theirrelationship. As a result, the two organizations have entered into a TechnologyDevelopment and License Agreement. Under the terms of the agreement, Sun ismarketing, licensing, implementing and supporting the entire AXS-One CompliancePlatform product suite worldwide as well as marketing and supporting this suitethrough Sun’s iForce partners - its global reseller network. As a result, in January 2005,Sun announced a new solution—the Sun Compliance and Content Management Solution—anintegrated and tested solution that includes the AXS-One Compliance Platformwith Sun servers, Sun storage and Sun middleware. Furthermore, Sun has agreed toreplace its current e-mail archival product—Infinite Mailbox—and to facilitatethe migration of Infinite Mailbox customers to the newly announced solution.

At the end of 2004, AXS-One closed its first jointsale with StorageTek, a leading provider of enterprise information lifecyclemanagement and storage solutions. By the end of January 2005, AXS-One hadcompleted the interoperability testing with StorageTek that is required toqualify for StorageTek TekAlliance Partner status. AXS-One and StorageTek areactively engaged in joint sales and marketing opportunities.

During 2005, AXS-Oneexpects to finalize official partnerships with additional organizations and,believes that these partnerships, as well as partnerships finalized in 2004,will drive revenue opportunities for the Company. See “Business—Risk Factors.”

**Product Development**

The Company has a dedicated product development andengineering organization and periodically releases new products andenhancements to existing products. Product development efforts are directed atincreasing product functionality, improving product performance, providingsupport to existing products, expanding the capabilities of the products tointer-operate with third-party software and hardware, developing new products andintegrating new technologies. In particular, the Company has from time to timedevoted substantial resources to develop additional modules for its productsand the capability to support additional platforms, databases, graphical userinterfaces (GUIs), toolsets and emerging technologies. While the Companyanticipates that certain new products and enhancements will be developedinternally, the Company has in the past and may continue to acquire or licensetechnology or software from third parties when appropriate. See “Business—RiskFactors.”

As of December 31,2004, the Company had 64 employees engaged in product development andengineering.

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**Competition**

The software markets inwhich AXS-One is engaged are intensely competitive and rapidly changing. Anumber of companies offer products similar to AXS-One’s and target the samecustomers. The Company believes its ability to compete depends upon manyfactors within and outside its control, including the timing and marketacceptance of new products and enhancements developed by the Company and itscompetitors, product functionality, performance, price, reliability, customerservice and support, sales and marketing efforts and product distribution. TheCompany’s AXS-One Enterprise Financials are positioned in a highly dynamicmarket, with competition from traditional ERP vendors such as the financialapplications software offered by SAP, Oracle Corporation (who recently acquiredPeopleSoft and SSA Global), and others. In light of the current market focus onregulatory compliance, many organizations are trying to position themselves asvendors of “compliance” solutions. This includes traditional competitors forthe Company’s AXS-One Central product such as IBM and Mobius. It also includescompetition from vendors of point solutions (Legato, KVS, and IXOS) that arerapidly being acquired by larger vendors—EMC, Veritas and OpenText. AXS-Onebelieves that it is currently the largest independent software vendor in therecords management and compliance market. See “Business—Risk Factors.”

**Intellectual Property**

The Company’s success is heavily dependent upon itsproprietary technologies as well as products from third parties, softwarevendors, hardware vendors, etc. The Company regards its software asproprietary, and relies primarily on a combination of contractual provisionsand trade secrets, copyright and trademark law to protect its proprietaryrights. As of December 31, 2004, the Company had no patents or patentapplications pending, and existing trade secrets and copyright laws afford onlylimited protection.

The Company has obtainedFederal registrations for its trademarks “AXS One®,” the distinctive AXS-Onelogo, “Access Tomorrow Today®,” “AXSPoint®,” “TransAXS®,” and “Computron®.” In addition, the Company hascertain U.S. common law rights, and rights under foreign laws in relation toits trademarks, service marks and product names. See “Business—Risk Factors.”

**Employees**

As of December 31,2004, the Company had 249 full-time employees, 164 within the United States and85 outside the United States, including 64 in product development andengineering, 104 in customer service and support, 51 in sales and marketing,and 30 in finance, administration and executive management. The Company’semployees are not covered by any collective bargaining agreements. The Companybelieves that its relations with its employees are good.

**Business—RiskFactors**

*We have a previoushistory of net losses.*

AXS-One incurred a net loss of $5.2 million for 2004 afterhaving generated net income of $2.3 million and $1.9 million during the yearsended December 31, 2003 and 2002, respectively. Although AXS-Onegenerated revenues and reduced costs sufficient to be profitable in 2003 and2002, we were not able to sustain profitability in 2004 and may not be able toon a quarterly or annual basis in the future. As of December 31, 2004, wehad an accumulated deficit of $81.7 million.

AXS-One’s revenueand operating results have fluctuated and may continue to fluctuate significantlyfrom quarter to quarter in the future, causing our common stock price to bequite volatile and may cause the market price to fall. A variety of factors,many of which are not in our control, cause these fluctuations and include,among others:

·       theproportion of revenues we earn from license fees versus fees for the serviceswe provide,

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·       thenumber of third parties we use to perform services,

·       theamount of revenues we generate from our sale of third party software,

·       changesin our product mix,

·       demandfor our products,

·       thesize and timing of individual license transactions,

·       theproducts and enhancements that we, or our competitors, introduce,

·       changesin our customers’ budgets,

·       potentialcustomers’ unwillingness to undertake major expenditures with us due to ourpast operating results,

·       competitiveconditions in the industry and general economic conditions and

·       unrestin the Middle East or other world events.

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

·       ourclients must commit a significant amount of capital, and

·       frequently,a license purchase must be authorized through the multiple channels within aclient’s organization.

Because of these reasons, as well as others, ourproducts’ sales cycles are typically lengthy and subject to a number ofsignificant risks over which we often have little or no control which include acustomer’s budgetary constraints and internal authorization reviews.

Historically, AXS-One has operated with a smalllicense backlog, since products are generally shipped as we receive orders. Becauseour license fees in any quarter substantially depend on orders booked andshipped in the last month, and often during the last week, of a given quarterour revenues have been back end loaded and subject to fluctuation.

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

·       ahigh percentage of our operating expenses are relatively fixed, and

·       onlya small percentage of our operating expenses vary with our revenues.

Because of these factors, we believe thatperiod-to-period comparisons of our operating results are not necessarilymeaningful and one should not rely on quarter-to-quartercomparisons of our operating results to be indicative of our futureperformance.

Additionally, ourbusiness has experienced, and we expect to continue to experience, significantseasonality, due, in part, to our customers’ buying patterns, caused primarilyby:

·       ourcustomers’ budgeting and purchasing patterns, and

·       oursales commission policies. Generally, we compensate our sales personnel basedon quarterly and annual performance quotas.

We expect that these patterns will likely continue inthe future.

As a result of thesefactors, in future quarters, our operating results may be significantly lowerthan the estimates of public market analysts and investors. Any discrepancycould cause the price of our 

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commonstock to be volatile and to decline significantly. We can give no assurancethat we will be profitable in any future quarter.

*The markets inwhich we compete are intensely competitive.*

AXS-One can give noassurance that we will be able to compete successfully against current orfuture competitors or that competitive pressures will not have a materialadverse effect on our business, operating results and financial condition. Ourmarkets are intensely competitive and changing rapidly. A number of companiesoffer products similar to ours and target the same customers. We believe thatour ability to compete depends upon many factors, many of which are not in ourcontrol, including, among others,

·       timingand market acceptance of new products and enhancements developed by us, as wellas by our competitors,

·       whetherour products are reliable, how they function, perform, and are priced,

·       ourcustomer service and support,

·       oursales and marketing efforts, and

·       ourproduct distribution.

AXS-One solutions are positioned in a highly dynamicmarket, with competition from traditional ERP vendors such as the financialapplications software offered by SAP, Oracle Corporation (which recentlyacquired PeopleSoft and SSA Global) and others. Additionally, many traditionalenterprise resource planning software providers have entered into the e-businessmarketplace. Traditional competitors for our COLD solution are IBM, Systemware,Mobius and others. The principal competitors in the area of statementpresentment include Mobius, Bluegill, Alysis and others. The Company’scompetitors for records and compliance management products include IBM, HP, EMC(Legato), iLumin, OpenText (IXOS) and Veritas (KVS).

Most of our competitors are substantially larger thanus, and have significantly greater financial, technical and marketingresources, and extensive direct and indirect distribution channels. As aresult, our competitors may be able to respond more quickly to new or emergingtechnologies and changes in customer requirements or to devote greaterresources to developing, promoting and selling their products than we can. Ourproducts also compete with those offered by other vendors and with proprietarysoftware developed by third-party professional service organizations, as wellas by potential customers’ management information systems departments.

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. We expect thatcompetition will also increase as the software industry consolidates. During2004, a number of our competitors in the records and compliance managementmarket were acquired by large companies with significantly greater financialand marketing resources than us. Furthermore, we cannot assure anyone that anyof the companies with whom we currently have relationships, many of which mayhave significantly greater financial and marketing resources than we do, willnot, in the future, develop or market software products that compete with ourproducts, or discontinue their relationship or support of us.

Additionally, ourcurrent and potential competitors have established, or may establish in thefuture, cooperative relationships among themselves or with third parties toincrease their products’ ability to address the needs of our prospectivecustomers. Therefore, new competitors or alliances among competitors couldemerge and rapidly acquire a significant market share. Increased competition islikely to result in

·       reducingthe price of our products,

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·       reducingour gross margins, and

·       losingour market share.

Any of these factors wouldadversely affect our business, our operating results and financial condition.

*AXS-One depends ona few principal products for its revenues.*

Substantially allof our revenues are derived from licensing and fees from related services of:

·       AXS-OneEnterprise Financials; and

·       AXS-OneCompliance Platform Solutions.

We expect thatthese products and services will continue to account for substantially all ofour revenues during 2005. Accordingly, our future operating results willdepend, in part, on:

·       achievingbroader market acceptance of our products and services,

·       maintainingour customer base, as well as

·       enhancingthese products and services to meet our customers’ evolving needs.

During 2004, certain customers did not renew theirannual maintenance, primarily due to our customers being acquired or mergedwith companies using other software. We can give no assurance that this trendwill not continue or that we will be able to maintain our existing customers.

Additionally,during 2005, our AXS-One Compliance Platform Solutions need to gain greatermarket acceptance. If:

·       demandin the market for our type of software is reduced,

·       competitionincreases, or

·       salesof such products or services decline,

any of these factors could have a material adverseaffect on our business, operating results and financial condition.

*AXS-One has aconcentration of revenues from certain customers*

During the last three years, AXS-One has generated asignificant amount of revenues from a select number of customers. Because ofthe size of certain of our customers, it is likely that they will continue togenerate a significant portion of our revenues especially in our servicesrevenue area. If any of these customers should discontinue their business withus it could have a material adverse affect on our business, operating resultsand financial condition. There is no assurance that we would be able to replacethese lost revenues with revenues from new or other existing customers.

For the year ended December 31, 2004, twocustomers, Pfizer Inc. and AIG Insurance, represented 14.6% and 10.1%,respectively, of total revenues. For the year ended December 31, 2003, twocustomers, Pfizer, Inc. and AIG Insurance, represented 18.7% and 12.1%,respectively, of total revenues. For the year ended December 31, 2002, twocustomers, Pfizer, Inc. and AIG Insurance, represented 16.1 % and 12.0%,respectively, of total revenues. No one customer represented more than 10% oflicense revenues for the year ended December 31, 2004. License revenuesincluded 29.5% (or 18.2% and 11.3% individually) of revenue from two customersin 2003 and 14.7% from one customer in 2002. Services revenues included 27.2%(or 16.1% and 11.1% individually), 31.9% (or 19.0% and 12.9% individually) and30.7% (or 18.2% and 12.5% individually) of revenue from the same two customersin 2004, 2003 and 2002, respectively.

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*AXS-One’s market ischaracterized by new products frequently being introduced, rapid technologychanges, product defect risks, and development delays.*

If AXS-One is unable, for technological, financial orother reasons, whether or not within its control, to timely develop andintroduce new products or enhancements to respond to changing customerrequirements, technological change or emerging industry standards, ourbusiness, operating results and financial condition could suffer.

Our softwareperformance, customization, reporting capabilities, or other businessobjectives may or may not be affected by these changes and may or may notrender us incapable of meeting future customer software demands. Introducingproducts embodying new technologies and emerging new industry standards canrender existing products obsolete and unmarketable. Accordingly, it isdifficult to estimate our products’ life cycles. Our future success will dependin part on our ability to maintain our AXS-One Enterprise products and to developand introduce new AXS-One Compliance Platform products that respond to evolvingcustomer requirements and keep pace with technological development and emergingindustry standards, such as new:

·       operatingsystems,

·       hardwareplatforms,

·       interfaces,and

·       thirdparty application software.

We can give noassurance that:

·       wewill be successful in developing and marketing product enhancements or newproducts that respond to:

·        technologicalchange,

·        changesin customer requirements, or

·        emergingindustry standards.

·       wewill not experience difficulties that could delay or prevent our successfullydeveloping, introducing and marketing new products and enhancements, or

·       anynew products or enhancements that we may introduce will be accepted by ourtargeted market.

Software productsas complex as those we offer often encounter development delays and, whenintroduced or when new versions are released, may contain undetected errors ormay simply fail. These delays, errors or failures create a risk that the softwarewill not operate correctly and could cause our future operating results to fallshort of expectations published by certain public market financial analysts orothers. From time to time, we develop products that are intended to becompatible with various new computer operating systems, although we make noassurances that we will successfully develop software products that will becompatible with additional operating systems or that will perform as we intend.Additionally, our products, technologies and our business in general rely uponthird-party products from various sources including, among others:

·       hardwareand software vendors,

·       relationaldatabase management systems vendors,

·       reportingsoftware vendors, or

·       e-mailsystem vendors.

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In the future, it isunclear whether our dependence upon these third-party products will affect ourability to support or make our products readily available. In the past, we haveexperienced delays by third parties who develop software that our productsdepend upon. These holdups have resulted in delays in developing and shippingour products. Despite testing by our current and potential customers, as wellas by us, errors may be found in new products or enhancements after we shipthem that can delay or adversely affect market acceptance. We cannot assureanyone that any of these problems would not adversely affect our business,operating results and financial condition.

*We risk beingde-listed from the American Stock Exchange, which could reduce our ability toraise funds.*

Although we are currently in compliance with thecontinued listing requirements of the American Stock Exchange, that has notalways been true in the past, and no assurances can be made that we willcontinue to be in compliance with those requirements in the future. In theevent that we were to cease being in compliance with those requirements at sometime in the future, the American Stock Exchange could choose to de-list ourstock from trading on that Exchange. If our common stock were to be de-listedby the American Stock Exchange, we might be unable to list our common stockwith another stock exchange. In that event, trading of our common stock mightbe limited to the OTC Bulletin Board or similar quotation system.

Inclusion of our commonstock on the OTC Bulletin Board or similar quotation system could adverselyaffect the liquidity and price of our common stock and make it more difficultfor AXS-One to raise additional capital on favorable terms, if at all. Inaddition, de-listing by the American Stock Exchange might negatively impactAXS-One’s reputation and, as a consequence, its business.

*In the future,AXS-One may not have sufficient capital resources to fully carry out itsbusiness plans.*

Our ability to carry out our future business plans andachieve the anticipated results will be affected by the amount of cashgenerated from operations. There is also the risk that cash held by our foreignsubsidiaries will not be readily available for use in our U.S. operations asthe transfer of funds is sometimes delayed due to various foreign governmentrestrictions. Accordingly, we may in the future be required to seek new sourcesof financing or future accommodations from our existing lender or otherfinancial institutions, or we may seek equity infusions from private investors.We may also be required to further reduce operating costs in order to meet ourobligations.

On April 5, 2004, we completed an offer and saleof 2,580,645 shares of common stock in a private placement for totalconsideration of $8,000,000. Upon closing, we received net proceeds ofapproximately $7,700,000. We also issued, at the same time, warrants topurchase an aggregate of 258,065 shares of common stock at $3.98 per share andwarrants to purchase 258,064 shares of common stock at $4.50 per share. Thesewarrants are exercisable for a period of three years beginning April 5,2004.

On August 11, 2004, we entered into a two-yearLoan and Security Agreement (“Agreement”) with a financial institution whichcontains a revolving line of credit under which we can borrow the lesser of $4 millionor 80% of eligible accounts, as defined in the Agreement (see Note 3 to theConsolidated Financial Statements). The available amount under the revolvingline of credit at December 31, 2004 was approximately $3.9 million ofwhich no amounts were outstanding. The Agreement contains certain restrictivefinancial covenants.

On January 27, 2005, we amended the Loan andSecurity Agreement (First Loan Modification) to revise the financial covenantbased on earnings before interest, taxes and depreciation and amortization(EBITDA) for the six months ended December 31, 2004. We were in compliancewith this revised covenant and all other covenants as of December 31,2004.

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However, no assurance canbe given that management’s initiatives will be successful or that anyadditional necessary sources of financing, lender accommodations or equityinfusions will be available. As a result our business, operating results andfinancial condition could be adversely impacted.

*AXS-One dependsupon its proprietary technology and if we were unable to protect ourtechnology, our competitive position would be adversely affected.*

We believe that our success greatly depends on ourproprietary technology and software. We rely primarily on a combination oftrademark and copyright law, trade secret protection and contractual agreementswith our employees, customers, partners and others to protect our proprietaryrights. Despite our efforts to protect our proprietary rights, unauthorized thirdparties may attempt to copy all or part of our products or reverse engineer orobtain and use information that we regard as proprietary. We make our sourcecode available to certain of our customers, which may increase the likelihoodof misappropriation or other misuse of our software. Additionally, the laws ofsome foreign countries do not protect our proprietary rights to the same extentas do the laws of the United States. We cannot assure anyone that the steps wetake to protect our proprietary rights will be adequate or that our competitorswill not independently develop technologies that are substantially equivalentor superior to ours.

Although we believe thatthe trademarks and service marks we use are distinct, there can be no assurancethat we will be able to register or protect such trademarks and service marks.

*Our products maybecome subject to infringement claims.*

We believe that none ofour products, trademarks, or service marks, technologies or other proprietaryrights infringe upon the proprietary rights of any third parties. However, asthe number of software products in our industry increases and the functionalityof these products further overlap, we believe that software developers like usmay become increasingly subject to infringement claims. Additionally, the e-businessfield has seen an increase in the number of “business method” patents issued,and infringement claims asserted, based on these issued patents. Any claimsasserted, regardless of their merit, can be time consuming and expensive todefend, could cause delays in shipping our products or require us to enter intoroyalty or licensing agreements that may not be available on terms acceptableto us. Any of these factors would significantly impact our operating resultsand financial conditions or materially disrupt the conduct of our business. Wecannot assure anyone that third parties will not assert infringement claimsagainst us in the future with respect to our current or future products orservices.

*A security breachcould harm our business.*

Our products providesecurity features designed to protect its users’ data from being retrieved ormodified without being authorized. While AXS-One continues to review andenhance the security features in its products, we can make no assurancesconcerning the successful implementation of security features and theireffectiveness within a customer’s operating environment. If an actual securitybreach were to occur, our business, operating results and financial conditioncould suffer.

*A variety of risksassociated with AXS-One’s international operations could adversely affect ourbusiness.*

Risks inherent in international revenue include theimpact of longer payment cycles, greater difficulty in accounts receivablecollection, unexpected changes in regulatory requirements, tariffs and othertrade barriers, and difficulties in staffing and managing foreign operations. Inaddition, most of our international license fees and services revenues aredenominated in foreign currencies which can have an impact on our consolidatedrevenues as exchange rates fluctuate. Currently, we do not hedge againstforeign currency exchange risks but in the future we may commence hedgingagainst specific foreign currency transaction risks. We may be unable to hedgeall of our exchange rate exposure economically and exchange rate 

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fluctuations may have anegative effect on our ability to meet our obligations. With respect to ourinternational sales that are U.S. dollar denominated, decreases in the value offoreign currencies relative to the U.S. dollar could make our products lessprice competitive. These factors may have a material adverse effect on ourfuture international revenue.

We believe that our continued growth and profitabilitywill require AXS-One to expand its sales in international markets, whichrequire significant management attention and financial resources. As a result,we expect that revenues from customers outside the United States will continueto represent a significant percentage of our total revenues in the future. Wecannot assure anyone, however, that we will be able to maintain or increaseinternational market demand for our products and services.

In2004, 2003 and 2002 the Company’s total revenues from customers outside theUnited States were as follows:
| **Year** | ** ** | ** ** | ** **   | **$ Amount** | ** ** | **Percentage of  Total Revenues** | ** ** |
|----------|------------|------------|--------------|-------------------|------------|---------------------------------------------|------------|
| 2004     |       | $          | 13.6 million |              |       | 35.3                                        | %          |   |
| 2003     |       | $          | 15.0 million |              |       | 37.7                                        | %          |   |
| 2002     |       | $          | 11.5 million |              |       | 30.8                                        | %          |   |

 

AXS-One is subjectto additional risks related to operating in foreign countries. These risks generallyinclude:

·       unexpectedchanges in tariffs, trade barriers and regulatory requirements,

·       costsof localizing products for foreign countries,

·       lackof acceptance of localized products in foreign markets,

·       longeraccounts receivable payment cycles,

·       difficultiesmanaging international operations,

·       potentiallyadverse tax consequences,

·       restrictionson repatriation of earnings,

·       reducedlegal protection of our intellectual property, and

·       theburden of complying with a wide variety of foreign laws.

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

*We rely on certainthird-party relationships.*

Our business,product development, operating results and financial condition could beadversely impacted if we fail to maintain our existing relationships orestablish new relationships, in the future, with third parties because ofdiverging interests, one or more of these third parties is acquired, or for anyother reason, whether or not within our control. We rely on third-partyrelationships with a number of consultants, systems integrators and softwarevendors to:

·       enhanceour product development and marketing and sales efforts,

·       implementour software products, and

·       supportour customers.

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These relationships assist our product developmentprocess and assist us in marketing, servicing and implementing our products. Anumber of these relationships are not memorialized in formal written agreements.

Our products alsoincorporate software that we license from third parties. These licenses expirefrom time to time and generally, we do not have access to the source code forthe software that a third party will license to us. Certain of these third partiesare small companies without extensive financial resources. If any of thesecompanies terminate relationships with us, cease doing business, or stopsupporting their products, we may be forced to expend a significant amount oftime and development resources to try to replace the licensed software. We mayalso find that replacement is not possible or commercially feasible. If thatwere to occur, our business, operating results and financial condition could beadversely impacted.

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

This stockownership may prevent or discourage tender offers for our common stock unlessthese controlling stockholders approve the terms of any such offers. As of March 15,2005, AXS-One’s executive officers, directors and affiliates togetherbeneficially own approximately 26.1% of our outstanding common stock. As aresult, these stockholders are able to exercise control over matters requiringstockholder approval including:

·       electingdirectors, and

·       mergers, consolidations,and sale of all or substantially all of our assets.

*AXS-One relies onits key personnel and may have difficulty attracting and retaining the skilledemployees it needs to operate successfully.*

AXS-One’s future success will depend, in large part,on the continued service of its key executives, and if we fail to attract andmaintain those executives, the quality of our products, our business, financialcondition and operating results could suffer. AXS-One has experienced turnoverof its key executives in the past particularly in the position of VicePresident of Sales. On April 30, 2004, John A. Rade retired as thePresident and Chief Executive Officer of the Company and was replaced byWilliam P. Lyons, who is now our Chairman of the Board and Chief ExecutiveOfficer. In October 2004, Matt Suffoletto joined the Company as SeniorVice President North America Sales and Professional Services. The previousSenior Vice President of Sales, North America had been with the Company foreighteen months prior to his resignation in October 2004. At the end of2004, William G. Levering III left the position of Chief Financial Officer ofthe Company and was replaced by Joseph P. Dwyer. We cannot assure anyone thatturnover of our key executives will not continue, and that such turnover wouldnot adversely affect our business, operating results and financial condition.

We also believe that ourfuture success will depend, in large part, on our ability to attract, retainand motivate highly skilled employees, and, particularly, technical,management, sales and marketing personnel. Competition for qualified employeesin our industry is intense. AXS-One has from time to time in the pastexperienced, and expects to continue experiencing, difficulty in hiring andretaining employees with appropriate qualifications. We cannot assure anyonethat we will be able to retain our employees or attract or retain highlyqualified employees to develop, market, service and support our products and conductour operations.

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*AXS-One’s commonstock’s trading price may be volatile for reasons over which it may have littleor no control.*

AXS-One’s commonstock’s trading price has, from time to time, experienced, and is likely tocontinue to experience, significant price and volume fluctuations, oftenresponding to, among other factors:

·       quarterlyvariations in our operating results,

·       thegain or loss of significant contracts,

·       changesin earnings estimates by securities analysts,

·       announcementsof technological innovations by us or our competitors,

·       announcementsof new products or services by us or our competitors,

·       generalconditions in the software and computer industries, and

·       generaleconomic and market conditions.

Additionally, the stockmarket, in general, frequently experiences extreme price and volumefluctuations. In particular, the market prices of the securities of companiessuch as ours 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 common stock maybe adversely affected by these market fluctuations. Also, the low market priceof our common stock may make it prohibitive to obtain additional equity funding.

*AXS-One has neverpaid or declared dividends and does not expect to in the foreseeable future.*

AXS-One has never paid ordeclared any cash dividends and we do not expect to pay any cash dividends inthe foreseeable future. We currently intend that future earnings, if any, willbe retained for business use.

*Changes in laws and regulations that affect the governance of publiccompanies have increased our operating expenses and will continue to do so.*

Changesin the laws and regulations affecting public companies included in theSarbanes-Oxley Act of 2002 have imposed new duties on us and on our executives,directors, attorneys and independent registered public accounting firm. Inorder to comply with these new rules, we hired a consulting advisory firm to assistus in the process and we also expect to use additional services of our outsidelegal counsel, both of which will increase our operating expenses. Inparticular, we expect to incur additional administrative expenses as weimplement Section 404 of the Sarbanes-Oxley Act, which requires managementto report on, and our Independent Registered Public Accounting Firm to attestto, our internal 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. Managementtime associated with these compliance efforts necessarily reduces timeavailable for other operating activities, which could adversely affectoperating results. If we are unable to achieve full and timely compliance withthese regulatory requirements, we could be required to incur additional costs,expend additional management time on remedial efforts and make related publicdisclosures that could adversely affect our stock price.

**Available Information**

Our annual report on Form 10K,quarterly reports on Form 10-Q, current reports on Form 8-Kand amendments to those reports are available, without charge, on the SEC website, *www.sec.gov*, as soon as reasonably practicalafter they are electronically filed with, or furnished to, the SEC. Theinvestor section 

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of ourweb site, *www.axsone.com*, provides a direct linkto AXS-One filings with the SEC. Copies are also available, without charge,from AXS-One Inc., Investor Relations, 301 Route 17 North, Rutherford, NJ 07070.

**Directors,Executive Officers and Key Management Employees**

Thecurrent directors, executive officers and key management employees of theCompany as of March 15, 2005, are as follows:
| **Name**                | ** ** | ** ** | ** ** | **Age**                                                                | ** ** | **Position** |
|-------------------------|------------|------------|------------|------------------------------------------------------------------------|------------|--------------|
| William P. Lyons        |       | 60         |       | Chairman of the Board and Chief Executive Officer                      |
| Elias Typaldos          |       | 54         |       | Executive Vice President, Technology and Director                      |
| Gennaro Vendome         |       | 58         |       | Executive Vice President, Business Development, and  Director          |
| Richard Dym             |       | 57         |       | Executive Vice President, Chief Marketing Officer                      |
| Joseph Dwyer            |       | 49         |       | Executive Vice President, Chief Financial Officer  and Treasurer       |
| Matt Suffoletto         |       | 57         |       | Senior Vice President, Sales and Professional  Services, North America |
| Paul Abel               |       | 51         |       | Vice President, Secretary and General Counsel                          |
| Daniel H. Burch(1)      |       | 53         |       | Director                                                               |
| Robert Migliorino(2)    |       | 55         |       | Director                                                               |
| William E. Vogel(1)(3)  |       | 67         |       | Director                                                               |
| Edwin T. Brondo(2)(3)   |       | 57         |       | Director                                                               |
| Allan  Weingarten(1)(3) |       | 67         |       | Director                                                               |

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(1)          Member of the AuditCommittee

(2)          Member of theCompensation Committee

(3)          Member of the NominatingCommittee

**William P. Lyons**joinedthe Company as President and Chief Executive Officer in April 2004 and wasappointed 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 energy industry from July 2002until April 2003 when it was sold to SunGard Data Systems, Inc. From April 2003until April 2004, Mr. Lyons served as a consultant for variouspre-public software companies on strategic issues. From January 2001 untilJuly 2002, when it was sold to Rational Software, Mr. Lyons wasPresident & Chief Executive Officer of NeuVis, a technology providerof N-tier application development software. From 1998 to 2001, Mr. Lyonswas President and Chief Executive Officer of Finjan Software, a privately heldvendor of security software solutions. Mr. Lyons was a director of FileNetCorporation, a software provider for Enterprise Content Management (ECM) untilhe resigned in November 2004.

**Elias Typaldos,**a founder of theCompany, has been Senior Vice President, Research and Development (1978 – 2002)and Executive Vice President, 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 until June 2004.

**Gennaro Vendome,**a founder ofthe Company, has been a Vice President and director since the Company’sformation in 1978, with the exception that Mr. Vendome served as ExecutiveVice President of Sales, Marketing and Consulting for North America from April 2002until August 2004. Mr. Vendome was Treasurer of the Company from 1981until 1991 and Secretary of the Company from 1982 until 1991.

**Richard Dym**joined the Companyin June 2004 as the Executive Vice President and Chief MarketingOfficer. Prior to joining the Company, from September 2002 through July 2004,Mr. Dym held the position of Chief Marketing Officer at OpSource, Inc.,a venture funded IT infrastructure outsourcing company. 

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From February 2001through May 2002, Mr. Dym served as Senior Vice President ofMarketing for Metromedia Fiber Networks (now Abovenet). From January 2000to February 2001 he served as Vice President Marketing for SiteSmith, Inc.,which was sold to Metromedia Fiber Networks. Prior positions included SeniorVice President of Marketing and Vice president of International Operations atParcPlace; General Manager of the Multimedia Division at Autodesk; andDirector, Graphics and Decision Support products for Ashton-Tate, all softwarevendors.

**Joseph Dwyer**joined the Companyas 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 and marketing ofenterprise asset management and mobile workforce software to utilities,municipalities and asset intensive industries. From 2001 to 2003, Mr. Dwyerserved as Executive Vice President and Chief Financial Officer of CaminusCorporation, a publicly traded provider of integrated enterprise softwareapplications to the global energy industry, and from 2000 to 2001 he served asExecutive Vice President and Chief Financial Officer of ACTV, Inc., apublicly traded digital media company. Prior to ACTV, from 1994 to 2000, Mr. Dwyerserved as Senior Vice President of Finance for Winstar Communications, Inc.,a publicly traded global telecommunications provider.

**Matt Suffoletto**joined theCompany in October 2004 as the Senior Vice President of Sales andProfessional Services, North America. Prior to joining the Company, from November 2001through September 2004, Mr. Suffoletto was President and CEO of IXOSSoftware, Inc., a wholly owned subsidiary of SAP archiving softwarevendor, IXOS Software AG (acquired by Open Text in October 2003). From November 2000to November 2001, Mr. Suffoletto served as CEO of TechTrader, anInternet infrastructure software company. Previously, he spent six yearsleading sales and marketing, as Senior Vice President and General Manager,with a project management software company, Primavera Systems Inc.

**Paul Abel**joined the Company in April 1997as Secretary and Corporate Counsel and was promoted to Vice President,Secretary and General Counsel in June 1998. From October 1996 to March 1997,Mr. Abel served as Project Manager for Charles River Computers, an ITsystems integrator. From 1983 to September 1996, Mr. Abel was anattorney with Matsushita Electric Corporation of America, an electronicproducts manufacturer/distributor.

**Daniel H. Burch**has been a director since October 1999.Mr. Burch is the Chairman of the Board, Chief Executive Officer andfounder of MacKenzie Partners, Inc., a proxy solicitation and mergers andacquisitions firm. From January 1990 to the founding of MacKenzie Partnersin February 1992, Mr. Burch was Executive Vice President at DeweRogerson & Company, an investor and public relations firm.

**Robert Migliorino**has been adirector since 1991. Since January 1, 2002, Mr. Migliorino has been aManaging Director and founding partner of W Capital Management LLC, a privateequity investment firm. Prior to W Capital, he was a founding partner of theventure capital partnership Canaan Partners, which, through its affiliates,was, until early 2000, a principal stockholder of the Company. Prior toestablishing Canaan Partners in 1987, he spent 15 years with General ElectricCo. in their Drive Systems, Industrial Control, Power Delivery, InformationServices and Venture Capital businesses.

**William E. Vogel**has been adirector since August 1996. Mr. Vogel is currently retired. From 1971to October 2002, Mr. Vogel was Chief Executive Officer of CentennialFinancial Group, Inc., which is in the health insurance business. He wasalso the Chief Executive Officer of W.S. Vogel Agency, Inc., a lifeinsurance brokerage general agency, from 1961 until October 2002. From November 2000to October 2002, Mr. Vogel was an employee and Executive SalesManager for Benefitmall.com which is in the employee benefits business.

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**Edwin T. Brondo**has been adirector since May 1997. Mr. Brondo is currently retired. From August 1998to August 2000 he was Executive Vice President and Chief Financial Officerof e-Vantage Solutions, Inc. (formerly called Elligent Consulting Group, Inc.),a technology consulting company. e-Vantage Solutions may be deemed to bean affiliate of the Company by virtue of the relationship of e-VantageSolutions with a major stockholder of the Company. Mr. Brondo was ChiefAdministrative Officer and Senior Vice President of First Albany Companies, Inc.,an investment banking firm, from June 1993 until December 1997.

**Allan Weingarten**has been adirector since October 2000. On December 31, 2003, Mr. Weingartenretired from Jacuzzi Brands, Inc. (formerly U.S. Industries, Inc.), amanufacturer of home and building products, where, since January 2001, hewas the Senior Vice President and Chief Financial Officer. He continues hiswork as a private investor and independent business consultant that he began in1995. He is also a director of Programmers Paradise, Inc.

Each of the Directors willbe subject to re-election at the 2005 Annual Stockholders meeting.

**Item 2.**                        Properties

**Facilities**

The Company’s corporateheadquarters are located in Rutherford, New Jersey in leased facilitiesconsisting of 48,800 square feet of office space occupied under a lease expiringin December 2012 with an option to renew the lease for one additionalfive-year period. AXS-One has the right to cancel the lease in 2007 withoutpenalty. The Company leases additional facilities and offices, includingfacilities located in Rockwall and Colleyville, Texas and Shelton, Connecticut.The Company also leases sales and support offices outside of North America inAustralia, Singapore, South Africa and the United Kingdom. While the Companybelieves that its facilities are adequate for its present needs, the Companyperiodically reviews its needs. The Company believes that additional space, ifneeded, would be available on commercially reasonable terms.

**Item 3.**                        LegalProceedings

Historically, the Companyhas been involved in disputes and/or litigation encountered in its normalcourse of business. The Company believes that the ultimate outcome of theseproceedings will not have a material adverse effect on the Company’s business,financial condition and results of operations or cash flows.

**Item 4.**                        Submissionof Matters to a Vote of Security Holders

No matters were submitted to a vote of securityholders during the fourth quarter of 2004.

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**PART II**

**Item 5*.****                       *Marketfor the Registrant’s Common Equity and Related Stockholder Matters

The Company’s Common Stock currently trades on theAmerican Stock Exchange under the symbol “AXO.”

Thefollowing table lists the high and low sales prices for the periods set forthbelow:
| **Period**     | ** ** | ** **  | ** ** | **High**    | ** ** | **Low** | ** ** |
|----------------|------------|-------------|------------|-------------|------------|---------|------------|
| **2004**       | ** ** | ** **  | ** ** | ** **  | ** ** |
| First quarter  |       | $ 4.24 |       | $ 1.80 |       |
| Second quarter |       | 4.70        |       | 2.58        |       |
| Third quarter  |       | 2.89        |       | 1.70        |       |
| Fourth quarter |       | 3.12        |       | 2.05        |       |
| **2003**       | ** ** | ** **  | ** ** | ** **  | ** ** |
| First quarter  |       | $ 0.80 |       | $ 0.52 |       |
| Second quarter |       | 0.98        |       | 0.59        |       |
| Third quarter  |       | 1.31        |       | 0.76        |       |
| Fourth quarter |       | 2.18        |       | 1.10        |       |

 

As of March 15, 2005 the approximate number ofrecord holders of the Company’s Common Stock was 705.

The Company has never paidcash dividends on its capital stock. The Company currently intends to retainany earnings for use in its business and does not anticipate paying any cashdividends in the foreseeable future.

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**Item 6.**                        SelectedConsolidated Financial Data

Theselected consolidated financial data set forth below for the years ended December 31,2004, 2003, 2002, 2001, and 2000 have been derived from the auditedconsolidated financial statements of the Company. The consolidated statement ofoperations data for the years ended December 31, 2004, 2003, and 2002 andthe consolidated balance sheet data as of December 31, 2004 and 2003 arederived from the audited consolidated financial statements and the relatednotes thereto included elsewhere in this report. The selected consolidatedfinancial data set forth below should be read in conjunction with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andthe consolidated financial statements of the Company and related notes theretoincluded elsewhere in this report.
| ** **                                                           | ** ** | **Years Ended December 31,**                        | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                           | ** ** | **2004**                                                           | ** ** | **2003** | ** ** | **2002** | ** ** | **      2001      ** | ** ** | **2000** | ** ** |
| ** **                                                           | ** ** | **(In thousands, except per share data)** | ** ** |
| **Statement of Operations  Data:(1)**                                |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |
| Revenues:                                                            |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |
| License fees                                                         |       | $ 6,781                                                       |       | $ 6,443 |   | $ 3,917 |   |   | $ 5,421 |   |   | $ 8,765 |   |
| Services(2)                                                     |       | 31,446                                                             |       | 32,948 |   | 33,030 |   |   | 35,272 |   |   | 41,787 |   |
| Other—related parties                                           |       | 209                                                                |       | 300 |   | 405 |   |   | 542 |   |   | — |   |
| Total revenues                                                       |       | 38,436                                                             |       | 39,691 |   | 37,352 |   |   | 41,235 |   |   | 50,552 |   |
| Operating  expenses:                                                 |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |
| Cost of license fees                                                 |       | 1,923                                                              |       | 1,524 |   | 1,482 |   |   | 1,355 |   |   | 1,245 |   |
| Cost of services(2)                                             |       | 17,086                                                             |       | 15,832 |   | 15,479 |   |   | 18,393 |   |   | 22,781 |   |
| Sales and marketing                                                  |       | 9,565                                                              |       | 7,297 |   | 6,364 |   |   | 9,504 |   |   | 10,546 |   |
| Research and development                                             |       | 7,999                                                              |       | 6,832 |   | 6,704 |   |   | 7,029 |   |   | 6,926 |   |
| General and administrative                                           |       | 6,411                                                              |       | 5,634 |   | 4,559 |   |   | 8,303 |   |   | 9,242 |   |
| Restructuring and other costs                                        |       | 1,020                                                              |       | — |   | — |   |   | 797 |   |   | — |   |
| Total operating expenses                                             |       | 44,004                                                             |       | 37,119 |   | 34,588 |   |   | 45,381 |   |   | 50,740 |   |
| Operating income  (loss)                                             |       | (5,568                                                             | )          | 2,572 |   | 2,764 |   |   | (4,146 | ) |   | (188 | ) |
| Other income  (expense):                                             |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |
| Equity in losses of joint ventures                                   |       | (162                                                               | )          | (114 | ) | (525 | ) |   | (121 | ) |   | — |   |
| Other, net                                                           |       | 301                                                                |       | (241 | ) | (375 | ) |   | (570 | ) |   | (415 | ) |
| Total other income (expense), net                                    |       | 139                                                                |       | (355 | ) | (900 | ) |   | (691 | ) |   | (415 | ) |
| Income (loss)  before income tax benefit, net and extraordinary item |       | (5,429                                                             | )          | 2,217 |   | 1,864 |   |   | (4,837 | ) |   | (603 | ) |
| Income tax  benefit, net                                             |       | 217                                                                |       | 99 |   | 60 |   |   | 182 |   |   | 304 |   |
| Net income (loss)                                                    |       | $ (5,212                                                      | )          | $ 2,316 |   | $ 1,924 |   |   | $ (4,655 | ) |   | $   (299 | ) |
| Basic and diluted net income (loss) per common share                 |       | $ (0.19                                                       | )          | $   0.09 |   | $   0.08 |   |   | $ (0.19 | ) |   | $  (0.01 | ) |
| Weighted average  basic common shares outstanding                    |       | 27,395                                                             |       | 24,945 |   | 24,818 |   |   | 24,785 |   |   | 24,624 |   |
| Weighted average  diluted common shares outstanding                  |       | 27,395                                                             |       | 26,264 |   | 25,511 |   |   | 24,785 |   |   | 24,624 |   |

 

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| ** **                                                                  | ** ** | **As of December 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                  | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                                                  | ** ** | **(In thousands)**          | ** ** |
| **Balance Sheet Data:(1)**                                                  |       |                        |       |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents, short-term investments and restricted cash |       | $ 4,871                |       | $ 3,002 |   | $ 2,769 |   | $   1,092 |   | $ 2,257 |   |
| Working capital  deficiency                                                 |       | (3,258                      | )          | (5,092 | ) | (8,391 | ) | (10,705 | ) | (6,990 | ) |
| Total assets                                                                |       | 14,781                      |       | 12,150 |   | 10,599 |   | 10,060 |   | 15,184 |   |
| Deferred revenue                                                            |       | 9,786                       |       | 8,946 |   | 8,821 |   | 8,782 |   | 7,496 |   |
| Total long-term  debt                                                       |       | —                      |       | — |   | 547 |   | 1,347 |   | 1,222 |   |
| Total stockholders’  deficit                                           |       | (1,024                      | )          | (3,699 | ) | (6,025 | ) | (8,180 | ) | (3,808 | ) |

----

(1)          For the periods 2001 and2000, the data above included the subsidiary in Central and Eastern Europe thatwas sold during 2001.

(2)          For the 2001 and 2000periods, reimbursed “out of pocket” expenses of $1,216 and $1,776,respectively, have been reclassifed as revenue from a reduction of cost ofservices to conform with the 2004, 2003 and 2002 presentations.

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**Item 7.**                        Management’s Discussion and Analysis of Consolidated Financial Conditionand Results of Operations

The following discussion should be read in conjunctionwith the Consolidated Financial Statements and Notes thereto and is qualifiedin its entirety by reference thereto.

This Report containsstatements of a forward-looking nature within the meaning of the safe harborprovisions of Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended, relating to future eventsor the future financial performance of AXS-One. Investors are cautionedthat such statements are only predictions and that actual events or results maydiffer materially. In evaluating such statements, investors should specificallyconsider the various factors identified in this Report which could cause actualresults to differ materially from those indicated by such forward-lookingstatements, including the matters set forth in “Business—Risk Factors.”

**Executive Overview**

We are a leading provider of Records ComplianceManagement and Financial Management software solutions designed to reduce theinherent risks associated with retaining and managing corporate records as wellas to efficiently manage complex business processes. We have implementedhigh-volume, interoperable, scalable and secure business solutions for global2000 companies. Our Web Services-based technology has been critically acclaimedas best of class. Our Records Compliance Management solutions deliver anintegrated platform providing content management-based solutions for disparateelectronic record types. This includes e-mail and instant messaging, SAP,electronic print report (Books and Records) archival and records management, aswell as supervision and legal discovery functionality, for regulatorycompliance and corporate governance, as well as for operational efficiency. See“Item 1. Business”.

Our revenues are derived mainly from license fees fromsoftware license agreements entered into between AXS-One and our customers withrespect to both our products and, to a lesser degree, third party productsresold by AXS-One and services revenues from software maintenance agreements,training, consulting services including installation and custom programming.

We are based in Rutherford, New Jersey withapproximately 249 full-time employees, as of December 31, 2004, in officesworldwide, including Australia, Singapore, South Africa, the United Kingdom andthe United States. Our foreign offices generated approximately 35.3% of ourtotal revenues for the twelve months ended December 31, 2004. We expectthat such revenues will continue to represent a significant percentage of ourtotal revenues in the future. Most of our international license fees andservices revenues are denominated in foreign currencies. Fluctuations in thevalue of foreign currencies relative to the U.S. dollar in the future couldresult in fluctuations in our revenue.

We have a 49% ownership in a joint venture in ourSouth African operation, AXS-One African Solutions (Pty) Ltd (“AfricanSolutions”). African Solutions sells and services our suite of products. We usethe equity method of accounting for our investment whereby the investment,including loans to the joint venture, is stated at cost plus or minus ourequity in undistributed earnings or losses.

We encounter competition for all of our products inall markets and compete primarily based on the quality of our products, ourprice, our customer service and our time to implement. The timing of the releaseof new products is also important to our ability to generate sales. During thesecond half of 2003, we launched our Records Compliance Management solution fore-mail and Instant Messaging Archival, Supervision, and Legal Discovery inresponse to new regulatory requirements for financial institutions in theUnited States as well as to address the need to reduce costs in the emailmanagement area. Our Records Compliance Management software, including this newsolution, accounted for approximately 67% of our total license fee revenues forthe year ended December 31, 2004. During the past nine months, we 

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have increased ourresearch and development, sales and services teams in this area in order tomeet the needs of this growing market and capitalize on this opportunity. However,there is no assurance that these efforts will achieve the desired results.

Our future ability to grow revenue will be directlyaffected by continued price competition and our ability to sustain anincreasingly higher maintenance revenue base from which to grow. Our growthrate and total revenues depend significantly on future services for existingcustomers as well as our ability to expand our customer base and to respondsuccessfully to the pace of technological change. In order to expand ourcustomer base, we have been actively seeking partnerships with resellers tosupplement our direct sales force. These efforts recently resulted in allianceswith Sun Microsystems, Sector, Inc., and NuTech. Sun Microsystems willsell a new integrated and tested solution that includes our Compliance Platformsoftware with their servers, storage and middleware to Sun’s existingenterprise customers and new customers in targeted markets. Sector, Inc.,a leading managed services, communications and data distribution provider forthe financial services industry, offers the AXS-One Compliance Platform forEmail and Instant Messaging Archival, Supervision and Discovery in a hostedapplication service provider (ASP) or hybrid environment. NuTech, a leading systemsintegrator of enterprise level messaging solutions, will resell our AXS-OneCompliance Platform to its existing enterprise customers and new customers. Ifour maintenance renewal rate or pace of new customer acquisitions slows, ourrevenues and operating results would be adversely affected.

We have experienced, and may in the future experience,significant fluctuations in our quarterly and annual revenues, results ofoperations and cash flows. We believe that domestic and international operatingresults and cash flows will continue to fluctuate significantly in the futureas a result of a variety of factors. For a description of the factors that mayaffect our operating results see “Business—Risk Factors”.

During 2004, AXS-One saw renewedinterest in our AXS-One Central data archive product from both existing and newcustomers. One of the key business drivers for this appears to be extendedpressure for financial services organizations to be in compliance with Rule 17a-4of the U.S. Securities and Exchange Commission promulgated under the SecuritiesExchange Act (SEC 17a-4) as well as interest across all industries in theSarbanes-Oxley Act of 2002 in the United States and the requirement fororganizations to manage and provide evidence of the trustworthiness of theirfinancial statements. The ability of our COLD technology to reproduce “statesof time” on demand—i.e., to reproduce any single transaction, as well as allcorresponding documents 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 records retentionin the future.

In September 2004, weannounced that the four largest UK-based tour operators (Thomas Cook, MyTravel,First Choice and TUI) had signed three year subscription agreements withAXS-One for our e-delivery service—based on the AXS-One Central archive—whichhas been endorsed by the CAA, the UK-based Civil Aviation Authority. The samemonth, we also signed a similar agreement with one of the largest Europeanferry companies. We expect to recognize revenue for these deals commencing inthe second quarter of 2005. As of February 15, 2005, AXS-One estimatedthat approximately 30% of all invoices generated by tour operators in the UKwere under contract to be delivered by our e-delivery service. During 2005, wewill be seeking to sign contracts for this e-delivery service with otherleading European-based travel operators.

At the end of 2004, we announcedour first sales of our AXS-LinkTM for SAP solution to eight new customers,including our first ever order in Taiwan. These customers include:Mantrack, a privately owned bureau for SAP Human Resources/Payroll servicesbased in Australia and New Zealand; and Tenaga Nasional Berhad, Malaysia’slargest electric utility company, serving more than six million customers inthe region. The AXS-Link for SAP solution was shipped in the fourth quarter of2004 into what was then a 

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new market for the Company.We are encouraged by these early results as well as by anticipated demand forthis product.

We continue to make progress growing our customer basefor our e-mail archival and electronic retention management-based solutions. Thisincludes both extending opportunities within existing customers as well asacquiring new customers. During 2004, we grew our customer base for our e-mailarchival solution, in terms of number of customers, by more than 500%.

In December 2004,Joseph Dwyer joined AXS-One in the position of Executive Vice President andChief Financial Officer. Prior to joining AXS-One, Mr. Dwyer served asChief Financial Officer of Synergen, Inc., a company engaged in thedevelopment and marketing of enterprise asset management and mobile workforcesoftware to utilities, municipalities and asset intensive industries. Previouspositions held by Mr. Dwyer include: Executive Vice President and ChiefFinancial Officer of Caminus Corporation, a publicly traded provider ofintegrated enterprise software applications to the global energy industry whichwas sold to SunGard Data Systems in April 2003; Executive Vice Presidentand Chief Financial Officer of ACTV, Inc., a publicly traded digital mediacompany; Senior Vice President of Finance for Winstar Communications, Inc.,a publicly traded global telecommunications provider; and Chief FinancialOfficer for Legal Software Solutions, Inc. Mr. Dwyer replaced WilliamG. Levering III, Vice President and Chief Financial Officer, who left to pursueother business interests. Mr. Levering was available to assist Mr. Dwyerduring the transition.

**Results of Operations**

Thefollowing tables set forth for the periods indicated, certain operating data,and data as a percentage of total revenues.
| ** **                               | ** ** | **Year Ended  December 31, 2004** | ** ** | **Year Ended  December 31, 2003**  | ** ** |
|------------------------------------------|------------|--------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                               | ** ** | **Total  Consolidated**                          | ** ** | **Data as a  percent of  revenue** | ** ** | **Total  Consolidated** | ** ** | **Data as a  percent of  revenue** | ** ** |
| ** **                               | ** ** | **(in millions)**                                | ** ** |
| Revenues:                                |       |                                             |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| License fees                             |       |                                             | $          | 6.8                                               |       |   |   | 17.7 | % |   |   | $ | 6.4 |   |   |   | 16.2 | % |   |
| Services                                 |       |                                             | 31.4       |                                              |       |   | 81.8 |   |   |   | 32.9 |   |   |   | 83.0 |   |   |
| Other—related parties               |       |                                             | 0.2        |                                              |       |   | 0.5 |   |   |   | 0.3 |   |   |   | 0.8 |   |   |
| Total revenues                           |       |                                             | 38.4       |                                              |       |   | 100.0 |   |   |   | 39.6 |   |   |   | 100.0 |   |   |
| Operating expenses:                      |       |                                             |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of license fees                     |       |                                             | 1.9        |                                              |       |   | 4.9 |   |   |   | 1.5 |   |   |   | 3.8 |   |   |
| Cost of services                         |       |                                             | 17.1       |                                              |       |   | 44.5 |   |   |   | 15.8 |   |   |   | 39.9 |   |   |
| Sales and marketing                      |       |                                             | 9.6        |                                              |       |   | 25.0 |   |   |   | 7.3 |   |   |   | 18.4 |   |   |
| Research and development                 |       |                                             | 8.0        |                                              |       |   | 20.8 |   |   |   | 6.8 |   |   |   | 17.2 |   |   |
| General and administrative               |       |                                             | 6.4        |                                              |       |   | 16.7 |   |   |   | 5.6 |   |   |   | 14.2 |   |   |
| Restructuring and other costs            |       |                                             | 1.0        |                                              |       |   | 2.6 |   |   |   | — |   |   |   | — |   |   |
| Total operating expenses                 |       |                                             | 44.0       |                                              |       |   | 114.5 |   |   |   | 37.0 |   |   |   | 93.5 |   |   |
| Operating income  (loss)                 |       |                                             | (5.6       | )                                                 |       |   | (14.5 | ) |   |   | 2.6 |   |   |   | 6.5 |   |   |
| Other income (expense):                  |       |                                             |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Equity in losses of joint ventures       |       |                                             | (0.2       | )                                                 |       |   | (0.5 | ) |   |   | (0.1 | ) |   |   | (0.3 | ) |   |
| Other income (expense), net              |       |                                             | 0.4        |                                              |       |   | 1.0 |   |   |   | (0.3 | ) |   |   | (0.6 | ) |   |
| Other income (expense), net              |       |                                             | 0.2        |                                              |       |   | 0.5 |   |   |   | (0.4 | ) |   |   | (0.9 | ) |   |
| Income (loss)  before income tax benefit |       |                                             | (5.4       | )                                                 |       |   | (14.0 | ) |   |   | 2.2 |   |   |   | 5.6 |   |   |
| Income tax  benefit                      |       |                                             | 0.2        |                                              |       |   | 0.5 |   |   |   | 0.1 |   |   |   | 0.2 |   |   |
| Net income (loss)                        |       |                                             | $          | (5.2                                              | )          |   |   | (13.5 | )% |   |   | $ | 2.3 |   |   |   | 5.8 | % |   |

 

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| ** **                         | ** ** | **Year Ended  December 31, 2002** | ** ** |
|------------------------------------|------------|----------------------------------------|------------|
| ** **                         | ** ** | **Total  Consolidated**                | ** ** | **Data as a  percent  of revenue** | ** ** |
| Revenues:                          |       |                                   |       |   |   |   |   |   |   |
| License fees                       |       |                                   | $          | 3.9 |   |   |   | 10.4 | % |   |
| Services                           |       |                                   | 33.0       |   |   |   | 88.5 |   |   |
| Other—related parties         |       |                                   | 0.4        |   |   |   | 1.1 |   |   |
| Total revenues                     |       |                                   | 37.3       |   |   |   | 100.0 |   |   |
| Operating expenses:                |       |                                   |       |   |   |   |   |   |   |
| Cost of license fees               |       |                                   | 1.4        |   |   |   | 3.8 |   |   |
| Cost of services                   |       |                                   | 15.5       |   |   |   | 41.5 |   |   |
| Sales and marketing                |       |                                   | 6.4        |   |   |   | 17.2 |   |   |
| Research and development           |       |                                   | 6.7        |   |   |   | 18.0 |   |   |
| General and administrative         |       |                                   | 4.6        |   |   |   | 12.3 |   |   |
| Total operating expenses           |       |                                   | 34.6       |   |   |   | 92.8 |   |   |
| Operating income                   |       |                                   | 2.7        |   |   |   | 7.2 |   |   |
| Other expense:                     |       |                                   |       |   |   |   |   |   |   |
| Equity in losses of joint ventures |       |                                   | (0.5       | ) |   |   | (1.3 | ) |   |
| Other expense, net                 |       |                                   | (0.4       | ) |   |   | (1.1 | ) |   |
| Other expense, net                 |       |                                   | (0.9       | ) |   |   | (2.4 | ) |   |
| Income before  income tax benefit  |       |                                   | 1.8        |   |   |   | 4.8 |   |   |
| Income tax benefit                 |       |                                   | 0.1        |   |   |   | 0.3 |   |   |
| Net income                         |       |                                   | $          | 1.9 |   |   |   | 5.1 | % |   |

 

**2004 Compared to2003**

*Revenues*

Total revenues decreased3.2% from 2003 to 2004 due to a 4.6% decrease in services revenues partiallyoffset by a 5.2% increase in license fee revenues. The increase in license feerevenues was mainly due to increases of $0.9 million in our U.S. operations,primarily resulting from licenses of our new Email Compliance software, and$0.4 million in our Southeast Asia operations resulting from licenses ofadditional products to existing customers. This increase was partially offsetby a decrease of $0.9 million in our South African subsidiary which had a largecontract in the second quarter of 2003 and no similar contract in 2004. Approximately67% of our 2004 license fee revenues came from licenses of our RecordsCompliance Management (RCM) software as compared to approximately 32% in 2003,a reflection of our new strategy market during the past year. Our license feerevenues also included licenses of our newer web-based products to our existingcustomers as well as the license of additional users for previously licensedsoftware.

The decrease in servicesrevenues resulted mainly from a decrease in consulting revenues partiallyoffset by an increase in maintenance fees. The decrease in services revenueswas primarily in the U.S. and Australian operations resulting from fewer ordersfor consulting services related to software upgrades in the installed base andfrom our strategic shift during the past year to RCM products. The decrease inthe U.S. operations was also the result of the completion in mid 2004 ofseveral large enterprise implementation projects and no new similar projectscommenced in late 2004. The increase in maintenance fees is mainly the resultof new license agreements and customary annual increases for existingagreements. The increase in custom programming was mainly the result of a largecontract with one customer.

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Thefollowing table sets forth for the periods indicated each major category of ourservices revenues as a percent of services revenues.
| ** **              | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------|------------|---------------------------------------------|------------|
| ** **              | ** ** | **2004**                                    | ** ** | **2003** | ** ** |
| ** **              | ** ** | **Amount**                                  | ** ** | **% of   Total** | ** ** | **Amount** | ** ** | **% of   Total** | ** ** |
| ** **              | ** ** | **(in thousands)**                     | ** ** |
| 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 both management feerevenue and consulting revenue. The decrease in management fees, inclusive ofdirector’s fees charged to African Solutions, was as a result of our decisionin the fourth quarter of 2004 to temporarily stop charging director’s feesuntil the African Solutions joint venture becomes profitable. The decrease inconsulting revenue resulted from decreased use of consultants from AfricanSolutions.

Thefollowing table sets forth the breakdown of other-related parties revenue:
| ** **              | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------|------------|---------------------------------------------|------------|
| ** **              | ** ** | **2004(a)**                                 | ** ** | **2003(a)** | ** ** |
| ** **              | ** ** | **(in thousands)**                     | ** ** |
| Management fee  revenue |       |                                        | $ 27  |   |   |   | $ 68 |   |   |
| Consulting  revenue     |       |                                        | 182        |   |   |   | 232 |   |   |
| Total revenues          |       |                                        | $ 209 |   |   |   | $ 300 |   |   |

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(a)           Includesrevenues from African Solutions only

*Operating Expenses*

Cost of license fees consist primarily of amortizationof capitalized software development costs and amounts paid to third partieswith respect to products resold by AXS-One in conjunction with the licensing ofour products. The elements can vary substantially from period to period as apercentage of license fees. Cost of license fees increased 26.2% from 2003 to2004 primarily as a result of a $0.6 million increase in third party royaltiesdue to increased sales of third party software used in conjunction with oursoftware. This was partially offset by a $0.2 million decrease in amortizationof capitalized software development costs as a result of certain costs becomingfully amortized in 2003.

Cost of services consists primarily of personnel andthird party costs for product quality assurance, training, installation,consulting and customer support. Total services costs increased 7.9% from 2003to 2004 primarily due to a $0.7 million increase in temporary employee andconsultants expense due to the use of temporary consultants to supplement ourinternal employees on specific assignments related mostly to the deployment ofour newer software products. The increase also resulted from an increase of$0.1 million in travel and living expenses mostly due to a decrease in expensesof that type that we could bill to our customers and $0.3 million in otheremployee related expenses.

Sales and marketing expenses consist primarily ofsalaries, commissions and bonuses related to sales and marketing personnel aswell as travel and promotional expenses. Sales and marketing expenses increased31.1% from 2003 to 2004 primarily due to employee related costs resulting fromour commitment to enhance the sales and marketing functions related to our RCMproduct strategy. There were increases of $1.4 million in salaries and relatedbenefits due to annual merit increases and new hires, $0.2 million in relatedemployee recruitment fees, $0.3 million in travel and living expenses, $0.1million in 

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marketing program expensesand $0.4 million in other miscellaneous expenses. The increase also included anincrease of $0.4 million in variable compensation in the U.S. operations due toa revision in the commission plans for 2004 that provided added incentives for thesales employees resulting in higher commissions. These increases were partiallyoffset by a decrease of $0.6 million in commission expense in our South Africansubsidiary which had a large license contract in the second quarter of 2003 andno similar contract in 2004.

Research and development expenses consist primarily ofpersonnel costs, and costs of equipment and facilities. Research anddevelopment expenses are generally charged to operations as incurred. However,certain software development costs are capitalized in accordance with Statementof Financial Accounting Standards No. 86. Such capitalized softwaredevelopment costs are amortized to cost of license fees on a straight-linebasis over periods not exceeding three years.

Research and development expenses (net of capitalizedsoftware development costs) increased 17.1% from 2003 to 2004 due primarily toan increase of $0.2 million in salaries and wages and related benefits duemainly to customary annual salary increases and $0.3 million in temporaries andconsultants working on the development of the new RCM products. The increasewas also the result of a decrease in capitalized software development costs of$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 ofsoftware development costs may fluctuate depending on the mix and stage ofdevelopment of our research and development projects. The decrease incapitalized costs during 2004 was mainly the result of the completion andgeneral release of projects that we had been capitalizing from prior periodsand from a change in the nature of our development efforts. The nature of ourcurrent development is generally such that we can measure technological feasibilitymost effectively using the working model method where the time betweenestablishment of a working model and general availability is of short durationwhich results in very little or no costs that qualify for capitalization. Thiswill result in less capitalized costs in the future.

General and administrative expenses consist primarilyof salaries of administrative, executive and financial personnel and outsideprofessional fees. General and administrative expenses increased 13.8% from2003 to 2004 primarily as a result of increases of $0.3 million in salaries andwages as a result of management changes during the year and $0.1 million in baddebt recovery that reduced general and administration expenses in the firstquarter of 2003 and no similar recovery occurred in 2004 and an additional $0.4million increase in the bad debt provision for the 2004 period in our foreignlocations.

Restructuring and othercosts:   On June 30, 2004, in order to streamline and reorganize ouroperations to better meet our long-term goals, we eliminated 25 positions inthe United States and 11 positions in our foreign operations. We recorded acharge to operations in the second quarter totaling approximately $0.8 millionrelated to involuntary termination benefits to be paid to the terminatedemployees. In the third quarter, we reduced the restructuring charge byapproximately $0.1 million mainly resulting from our decision to retain twopeople in our foreign operations. The elimination of the net 34 positions wasexpected to result in annual savings of approximately $3.2 million that isbeing used to enhance the sales, marketing and research and developmentfunctions related to our RCM product strategy. (See Note 12 to the ConsolidatedFinancial Statements.) In addition to the restructuring charges, we recognizedapproximately $0.3 million in expenses related to a retirement agreement withour former CEO. The retirement benefit was paid in January 2005.

*Operating Income(Loss)*

Operating income (loss)decreased from income of $2.6 million for 2003 to a loss of ($5.6) million for2004 due to a $6.9 million increase in operating expenses, as described above,which includes restructuring and other costs of $1.0 million, and a decrease inrevenue of $1.3 million.

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*Other Income(Expense), Net*

Other income (expense),net was $0.1 million in 2004 as compared to ($0.4) million in 2003 mainly as aresult of an increase of $0.1 million in interest income due to higher cashbalances during 2004, a decrease of $0.2 million in interest expense and aforeign exchange gain of $0.2 million in 2004 as compared to a loss of ($0.2)million in 2003. Interest expense related to the interest on the revolving lineof credit and term loan that was fully paid as of March 31, 2004. (SeeNote 3 to the Consolidated Financial Statements.)

*Income Tax Benefit*

We recorded an income taxbenefit of $194,000 and $142,000 in 2004 and 2003, respectively, from the salesto third parties of certain expiring New Jersey State Tax net operating losscarry-forwards and research and development credits. We cannot be certain thatthe State of New Jersey will continue to allow such sales in the future or, ifit did, that sales to third parties could be consummated. For 2004 there was anadditional tax benefit of $23,000 in one foreign location. The 2003 sale of NewJersey State Tax net operating loss carry-forwards was partially offset by a$43,000 provision for income taxes for one foreign location.

*Results ofOperations*

As a consequence of theabove, we generated a net loss of $5.2 million in 2004 as compared to netincome of $2.3 million in 2003.

**2003 Compared to 2002**

*Revenues*

Total revenues increased 6.3% from 2002 to 2003 due toa 64.5% increase in license fee revenues partially offset by a 0.2% decrease inservices revenues. The increase in license fee revenues was mainly due toincreases of $1.0 million in our U.S. operations, primarily resulting fromlicenses of our Email Compliance software, and $1.5 million in our foreignoperations primarily resulting from licenses of existing products to two newcustomers, one in Australia and one in South Africa. Our license fee revenuesalso included licenses of our newer web-based products to our existingcustomers as well as the license of additional users for previously licensedsoftware.

The decrease in services revenues resulted mainly froma decrease in consulting revenues mostly offset by an increase in maintenancefees. The decrease in services revenues was primarily in the U.S. operationsresulting from fewer orders for upgrade services in the installed base in theearly part of the year pending the release of a new version of our software atthe end of the second quarter as well as customers delaying projects untilthere was improvement in the economy. Approximately half of our customers tendto upgrade their systems within a twelve-month period following the release ofa new version. The decrease in U.S. revenues was partially offset by anincrease in consulting revenue in our South Africa operations resulting fromservices of the internal consulting staff hired in 2003 to complement theservices of third party consultants from our joint venture and elsewhere. It isalso a result of services revenues from Hospitality Warehouse that became aconsolidated subsidiary at the end of 2002 (see Note 5 to the ConsolidatedFinancial Statements). The increase in maintenance fees is mainly the result ofnew license agreements and customary annual increases for existing agreements.

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Thefollowing table sets forth for the periods indicated each major category of ourservices revenues as a percent of services revenues.
| ** **              | ** ** | **2003**                | ** ** | **2002**             | ** ** |
|-------------------------|------------|-------------------------|------------|----------------------|------------|
| ** **              | ** ** | **Amount**              | ** ** | **% of  Total** | ** ** | **Amount** | ** ** | **% of  Total** | ** ** |
| ** **              | ** ** | **(in thousands)** | ** ** |
| Maintenance             |       | $ 16,961           |       | 52                   | %          | $ 16,077 |   | 49 | % |
| Consulting              |       | 15,486                  |       | 47                   |       | 16,374 |   | 50 |   |
| Training                |       | 113                     |       | —               |       | 160 |   | — |   |
| Custom  programming     |       | 388                     |       | 1                    |       | 419 |   | 1 |   |
| Total services revenues |       | $ 32,948           |       | 100                  | %          | $ 33,030 |   | 100 | % |

 

Other-Related Parties revenue for 2003 includedmanagement fee revenue and consulting revenue from African Solutions only whilethe 2002 period included revenues from two joint ventures. The decrease inrelated party revenue from 2002 to 2003 resulted from a decrease of $319,000 inmanagement fee revenue partially offset by an increase of $214,000 inconsulting revenue. The decrease in management fees was as a result of ourdecision in 2003 to temporarily stop charging management fees to AfricanSolutions until that entity becomes profitable. We continued to chargedirectors’ fees in 2003, which are included in total management fees for bothperiods. The increase in consulting revenue resulted from services of theinternal consulting staff hired in January 2003 to complement the servicesof third party consultants from African Solutions and elsewhere.

Thefollowing table sets forth the breakdown of other-related parties revenue:
| ** **              | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------|------------|---------------------------------------------|------------|
| ** **              | ** ** | **2003(a)**                                 | ** ** | **2002(b)** | ** ** |
| ** **              | ** ** | **(in thousands)**                     | ** ** |
| Management fee  revenue |       |                                        | $ 68  |   |   |   | $ 387 |   |   |
| Consulting  revenue     |       |                                        | 232        |   |   |   | 18 |   |   |
| Total revenues          |       |                                        | $ 300 |   |   |   | $ 405 |   |   |

----

(a)           Includes revenues fromAfrican Solutions only

(b)          Includesrevenues from African Solutions for the entire year and Hospitality Warehousethrough November only

*Operating Expenses*

Cost of license fees for 2003 remained relativelyconsistent with 2002. A $99,000 increase in third party royalties due toincreased sales of third party software used in conjunction with our softwarewas mostly offset by a $79,000 decrease in amortization of capitalized softwaredevelopment costs as a result of certain costs becoming fully amortized in2003.

Cost of services increased 2.3% from 2002 to 2003primarily due to a $0.7 million increase in temporary employees and consultantsexpense mainly in our South Africa subsidiary due to their continued use ofconsultants from the African Solutions joint venture and other third partyconsultants in addition to their own internal staff. The increase also resultedfrom an increase in salaries and related benefits and employee recruitmentcosts totaling $0.2 million. These increases were mostly offset by a $0.2million decrease in variable compensation based on revenue related bonus plansin the U.S. and U.K. operations related to the decrease in service revenues anda $0.3 million decrease in billable expenses.

Sales and marketing expenses increased 14.7% from 2002to 2003 primarily due to a $0.6 million increase in sales commissions in ourSouth Africa subsidiary representing the commission to African 

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Solutions for a largelicense contract recognized in the second quarter. The increase is also due toan increase of $0.3 million in salaries due to annual merit increases and newhires, $0.2 million in employee recruitment fees for the hiring of new salesmenin the U.S. and Australia operations and $0.2 million in sales expense forHospitality Warehouse which became a consolidated subsidiary at the end of 2002.These increases were partially offset by a decrease of $0.3 million inmarketing expenses due primarily to a decrease in trade show and userconference expenses and a decrease of $0.1 million in cost of third partyservices expense in our South Africa subsidiary. Sales and marketing as apercentage of license fees decreased from 2002 to 2003 due to the increase inlicense fee revenues.

Research and development expenses (net of capitalizedsoftware development costs) increased 1.9% from 2002 to 2003 due primarily toan increase of $0.2 million in bonuses, $0.3 million in customary annual salaryincreases and related benefits and $0.1 million in temps and consultantsworking on the development of the new Email Compliance software. Theseincreases were partially offset by an increase in capitalized softwaredevelopment costs of $0.5 million. We capitalized software development costs of$1.3 million and $0.8 million in 2003 and 2002, respectively. The rate ofcapitalization of software development costs may fluctuate depending on the mixand stage of development of our research and development projects.

General and administrative expenses increased 23.6%from 2002 to 2003 due primarily to increases of $0.4 million in professionalfees resulting mainly from the absence of credits that were received in thesecond quarter of 2002 (see below), $0.3 million in rent expense mostly relatedto the start of a new lease in the U.S. operations in January 2003, $0.2million due mainly to customary annual salary increases, $0.1 million in bonusexpense, $0.1 million in insurance expense and $0.2 million in other expensepartially as a result of our decision to compensate the outside Board membersin 2003. These increases were partially offset by decreases of $0.2 million indepreciation and amortization expense due to the aging of our assets andlimited new purchases in 2003 and $0.1 million in repairs and maintenanceexpense.

During 2002 and 2001, theSecurities and Exchange Commission (SEC) performed an investigation of AXS-Oneand of certain of our former employees and officers relating to activitiesperformed through 1996 while they were our employees. We filed a Form 8-Kwith the SEC on February 15, 2001 disclosing the SEC investigation and itsdisposition with respect to AXS-One. In mid August 2001, we were informedby counsel for our former employees and officers, whom we knew to be thesubject of the SEC investigation, that such counsel had been informed by the SECthat the SEC was no longer pursuing its investigation of their clients. Underour certificate of incorporation, and Delaware law, we have an indemnificationobligation to reimburse legal fees to former employees and officers relating toactions taken against them for work performed while they were our employees. Approximately$0.8 million in such legal fees related to our indemnification obligation wererecorded during the year ended December 31, 2001. During the secondquarter of 2002 approximately $0.3 million of these charges were reversed dueto favorable settlements of outstanding billings with legal firms. We do notanticipate any further costs relating to this matter.

*Operating Income*

Operating income for 2003as compared to 2002 decreased 6.9% due to the increase in operating expenses,as described above, which more than offset the increase in revenues. Inaddition, our share of losses incurred by Hospitality Warehouse were recordedbelow operating income for eleven months in 2002 in equity in losses of jointventures. As stated previously, Hospitality Warehouse became a 100% ownedsubsidiary at the end of 2002 and its results were fully reflected in operatingincome in 2003.

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*Other Expense, Net*

Other expense, netdecreased 60.6% from 2002 to 2003 mainly as a result of decreases of $0.2million in interest expense due to decreased use of the revolving line ofcredit and our continued repayment of the term loan (see Note 3 to theConsolidated Financial Statements) and $0.4 million in equity in losses ofjoint ventures.

*Income Tax Benefit*

We recorded an income taxbenefit of $142,000 and $198,000 in 2003 and 2002, respectively, from the salesto third parties of certain expiring New Jersey State Tax net operating losscarry-forwards and research and development credits. The 2003 sale waspartially offset by a $43,000 provision for income taxes for one foreignlocation. The 2002 sale was partially offset by a $138,000 provision for incometaxes in two of our foreign locations.

*Results ofOperations*

As a consequence of theabove, net income increased by 20.4% from 2002 to 2003.

**Related Party Transactions**

AXS-One has certain business relationships with anentity that was founded by the former President and Chief Executive Officer whoowns a majority beneficial equity interest in such entity. During the yearsended December 31, 2004, 2003 and 2002 we recorded as cost of license feesapproximately $1,000, $36,000 and $32,000, respectively, from this relatedparty. These costs, related to royalty and maintenance fees on licensedproducts, have been generally decreasing as customers upgrade to newer versionsof our software that no longer require this related party software.

In August 2003, we entered into a businessrelationship with an entity that is owned by a former chairman and principalstockholder. This entity was providing consulting services related to thedevelopment of our instant messaging product. For the years ended December 31,2004 and 2003, we recorded $84,000 and $75,000, respectively, as research anddevelopment expense from this related party. We discontinued use of this entity’sservices in June 2004.

As of December 31, 2004, the investment in theAfrican Solutions joint venture, net of cumulative equity in losses, was($29,000) reflected as “Due to joint venture” on the accompanying consolidatedbalance sheet. As of December 31, 2003, the investment in AfricanSolutions, net of cumulative equity in losses, was ($4,000). As of December 31,2002, the investment in African Solutions, net of cumulative equity in losses,was $179,000. In December 2002, we purchased, for a nominal amount, theremaining 50% of common stock of Hospitality Warehouse to make it awholly-owned subsidiary. At the time of the acquisition our investment in thejoint venture was $112,000. Equity in losses in 2002 for Hospitality Warehouse,prior to the acquisition, was $120,000.

Pursuant to AccountingPrinciples Board Opinion No. 18, “The Equity Method of Accounting forInvestments in Common Stock,” we evaluated our investment in African Solutionsand adjusted down the carrying value by $61,000 as of December 31, 2003due to an other than temporary decline in value. No adjustment was made in2004.

**Liquidity and Capital Resources**

At December 31, 2004, we had cash and cashequivalents of $4.8 million and a working capital deficit of $3.3 million whichincluded $9.8 million of deferred revenue. The reduction of the working capitaldeficit from $5.1 million at December 31, 2003 is primarily the result ofan increase in cash from our $7.7 

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million private placement(see below) partially offset by cash used to fund operating and investingactivities during 2004.

On April 5, 2004, we completed a privateplacement of shares of common stock that resulted in the receipt of netproceeds of approximately $7.7 million. Prior to that we had a Loan andSecurity Agreement (“Agreement”) that contained a revolving line of credit anda term loan (See Note 3 to the Consolidated Financial Statements). The termloan was paid in full as of March 31, 2004, and no amounts remainoutstanding. The Agreement terminated on May 28, 2004 as per its terms. OnAugust 11, 2004, we entered into a two-year Loan and Security Agreementwith a different institution which contains a revolving line of credit underwhich we have available the lesser of $4 million or 80% of eligible accounts,as defined (See Note 3 to the Consolidated Financial Statements). The availableamount under the revolving line of credit at December 31, 2004 wasapproximately $3.9 million of which no amounts were outstanding.

On January 27, 2005, we amended the Loan andSecurity Agreement (First LoanModification) to revise the financial covenant based on EBITDA for the sixmonths ended December 31, 2004. We were in compliance with this revisedcovenant and all other covenants as of December 31, 2004.

On March 28, 2005, we furtheramended the Agreement (Second Loan Modification)in order to set the EBITDA and adjusted quick ratio quarterly covenants for2005.

Wehave no significant capital commitments. Planned capital expenditures for 2005total approximately $0.5 million, including any software development costs thatmay qualify for capitalization under SFAS No. 86. Our aggregate minimumoperating lease payments for 2005 will be approximately $2.0 million. Weexpect to fund these commitments from cash generated by operating activities,but it may be necessary to seek other sources of financing should we fail togenerate sufficient cash.

Future payments dueunder lease obligations as of December 31, 2004 are as follows:
| ** ** | ** ** | **Non-Cancelable  Operating Leases** | ** **   |
|------------|------------|-------------------------------------------|--------------|
| ** ** | ** ** | **(in thousands)**                   | ** **   |
| 2005       |       |                                      | $ 1,923 |   |   |
| 2006       |       |                                      | 1,793        |   |   |
| 2007       |       |                                      | 1,467        |   |   |
| 2008       |       |                                      | 42           |   |   |
| 2009       |       |                                      | 19           |   |   |
| Total      |       |                                      | $ 5,244 |   |   |

 

Our operating activities used cash of $4.5 million in2004 and provided cash of $3.6 million and $3.3 million in 2003 and 2002,respectively. Net cash used by operating activities in 2004 is primarily theresult of the net loss, an increase in accounts receivable and prepaid expensesand other current assets and a decrease in deferred revenue partially offset bynon-cash depreciation and amortization charges, the net provision for doubtfulaccounts and by an increase in accounts payable and accrued expenses. Theincrease in accounts receivable is mainly the result of new license billings atthe end of the year. The increase in prepaid expenses and other current assetsis mainly the result of expenses related to a services agreement in one foreignlocation that is being accounted for on a percentage-of-completion basiswhereby expenses are deferred until the related revenue is recognized. Thedecrease in deferred revenue is mainly the result of the amortization in 2004of a two-year maintenance commitment from one of our customers resulting in anadditional $1.4 million in deferred maintenance revenue as of December 31,2003. This was partially offset by an increase in deferred revenue related tothe services agreement mentioned above. The increase in the net provision fordoubtful accounts results mainly from one customer in one foreign location. Theincrease in accounts payable and accrued expenses is mainly the result of theincreased operating expenses in 2004 mainly in our U.S. operations and includesthe accrual for $0.3 million related to a retirement agreement with our formerCEO. (See Note 12 to the Consolidated Financial Statements.)

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Net cash provided by operating activities in 2003 wasprimarily the result of the net income, non-cash depreciation and amortizationcharges and an increase in deferred revenue partially offset by a decrease inaccounts payable and accrued expenses and an increase in accounts receivable. Theincrease in deferred revenue was mainly the result of the two-year maintenancecommitment mentioned above. The decrease in accounts payable and accruedexpenses was mainly the result of our ability to pay vendors on a more timelybasis from available cash. The increase in accounts receivable was mainly theresult of new license billings at the end of the year. 

Net cash provided by operating activities in 2002 wasprimarily the result of the net income, non-cash depreciation and amortizationcharges and a decrease in accounts receivable partially offset by a decrease inaccounts payable and accrued expenses and an increase in receivables due fromthe joint venture. The decrease in accounts receivable was mainly due to an increasein collections in December 2002 versus December 2001. The decrease inaccounts payable and accrued expenses was mainly due to payments and reversalsof non-recurring legal fees related to favorable settlements. 

Our investing activities used cash of $1.1 million,$1.8 million and $1.1 million in 2004, 2003 and 2002, respectively, principallyfor purchases of equipment and leasehold improvements and for capitalizedsoftware development costs. The decrease in cash used in investing activitiesfrom 2003 to 2004 was mainly the result of a decrease in capitalized softwaredevelopment costs partially offset by an increase in the purchase of equipmentand leasehold improvements. The increase in cash used in investing activitiesfrom 2002 to 2003 resulted mainly from an increase in capitalized softwaredevelopment costs related primarily to development of the new Email Compliancesoftware. 

Our financing activities provided cash of $7.7 millionin 2004 and used cash of $1.7 million and $0.8 million in 2003 and 2002,respectively. Cash provided by financing activities in 2004 was primarily theresult of the net proceeds received from the private placement and the exerciseof stock options and warrants during the period. This was partially offset bythe payment of the remaining balance of the outstanding term loan. Cash used infinancing activities for 2003 resulted mainly from repayments on the term loanin accordance with the loan agreement. In 2002, cash used in financingactivities resulted from $1.8 million in payments against the term loanpartially offset by proceeds from the issuance of new term loan debt of $1.0million which was used to fund our operating activities.                 

We generated a net loss of$5.2 million for the year ended December 31, 2004 after generating netincome of $2.3 million and $1.9 million for the years ended December 31,2003 and 2002, respectively. For the year ended December 31, 2004, weexperienced a decline in revenue as our business has shifted to focus moreheavily on the records compliance management business. Management’s initiativesover the last two years, including the recent restructuring and the April 2004private placement of common stock, have been designed to improve operatingresults and liquidity and better position AXS-One to compete under currentmarket conditions. As a result of these efforts, we expect that our currentcash balance, availability of borrowing capacity under our bank line of creditand operating cash flow will be sufficient to fund our working capital requirementsthrough 2005. Our ability to fund our operations for the next twelve months isheavily dependent on the growth of our revenues over 2004 levels. Additionally,there is a risk that cash held by our foreign subsidiaries may not be readilyavailable for use in our U.S. operations to pay our obligations as the transferof funds is sometimes delayed due to various foreign government restrictions. Accordingly,we may in the future be required to seek new sources of financing or futureaccommodations from our existing lender or other financial institutions, or wemay seek equity infusions from private investors. We may also be required tofurther reduce operating costs in order to meet our obligations. No assurancecan be given that management’s initiatives will be successful or that any suchadditional sources of financing, lender accommodations or equity infusions willbe available. (See “Business—Risk Factors.”)

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**Critical Accounting Policies**

Our criticalaccounting policies are as follows: 

·       Revenuerecognition and

·       Capitalized softwaredevelopment costs.

***RevenueRecognition***

We derive our revenue primarily from two sources: (i) softwarelicenses and (ii) services and support revenue, which includes softwaremaintenance, training, consulting and custom programming revenue. We alsoderive a limited amount of management fee revenue from the joint venture (lessthan 1% of total revenue in 2004 and 2003 and approximately 1% in 2002) enteredinto during 2001 by our South Africa subsidiary. As described below,significant management judgments and estimates must be made and used inconnection with the revenue recognized in any accounting period. Materialdifferences may result in the amount and timing of our revenue for any periodif our management made different judgments or utilized different estimates.

We normally license our software products on aperpetual basis. Each license agreement generally includes a provision forinitial post-contract support (maintenance). For the majority of license saleswe use a signed license agreement as evidence of an arrangement. Formaintenance fees, we use a maintenance agreement as evidence of the arrangement.We use a professional services agreement as evidence of an arrangement for ourtraining, custom programming and consulting revenues. Occasionally, where amaster license or services agreement with a customer already exists, we acceptthe customer’s purchase order as evidence of an arrangement. Management feerevenues from our joint ventures are evidenced by master agreements governingthe relationship.

We recognize revenue in accordance with Statement ofPosition 97-2, “Software Revenue Recognition” (“SOP 97-2”), and Statement ofPosition 98-9, “Modification of SOP 97-2, Software Revenue Recognition, WithRespect to Certain Transactions.” Revenue from non-cancelable software licensesis recognized when the license agreement has been signed, delivery hasoccurred, the fee is fixed or determinable and collectibility is probable. Revenuesfrom resellers, generated using the sell through method whereby we recognizerevenue when the software has been sold to the end user, is recognized aspreviously stated in accordance with SOP 97-2. In multiple elementarrangements, we defer the vendor-specific objective evidence of fair value(“VSOE”) related to the undelivered elements and recognize revenue on thedelivered elements using the residual method. The most commonly deferredelement is initial maintenance, which is recognized on a straight-line basisover the initial maintenance term. The VSOE of maintenance is determined byusing a consistent percentage of maintenance fee to license fee based onrenewal rates. Maintenance fees in subsequent years are recognized on astraight-line basis over the life of the applicable agreement. Maintenancecontracts entitle the customer to hot-line support and all unspecified productupgrades released during the term of the maintenance contract. Upgrades includeany and all unspecified patches or releases related to a licensed softwareproduct. Maintenance does not include implementation services to install theseupgrades.

Delivery of software generally occurs when the product(on CDs) is delivered to a common carrier. Occasionally, delivery occursthrough electronic means where the software is made available through oursecure FTP (File Transfer Protocol) site. The Company does not offer anycustomers or resellers a right of return.

For software license and maintenance revenue, weassess whether the fee is fixed and determinable and whether or not collectionis probable. We assess whether the fee is fixed and determinable based on thepayment terms associated with the transaction. If a significant portion of afee is due after our normal 

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payment terms, which are30 to 90 days from invoice date, we account for the fee as not being fixed anddeterminable. In these cases, we recognize revenue as the fees become due.

The majority of our training and consulting servicesare billed based on hourly rates. We generally recognize revenue as theseservices are performed. However, when we enter into an arrangement thatrequires us to perform significant work either to alter the underlying softwareor to build additional complex interfaces so that the software performs as thecustomer requests, we recognize the entire fee using the percentage ofcompletion method of accounting. This would apply to our custom programmingservices, which are generally contracted on a fixed fee basis. Anticipatedlosses, if any, are charged to operations in the period such losses aredetermined.

Revenues from joint ventures (included in Revenues:Other-Related Parties in our Consolidated Statements of Operations) includesconsulting revenue for the joint ventures’ use of our South African subsidiary’sconsultants and for management fees for our subsidiary providing managerial,technical and other related services to the joint ventures (2002 period only)in accordance with the joint venture agreements. Revenue is recognized uponperformance of the services.

We assess assuredness of collection based on a numberof factors, including past transaction history with the customer and thecredit-worthiness of the customer. We do not request collateral from ourcustomers. If we determine that collection of a fee is not probable, we deferthe fee and recognize revenue at the time collection becomes probable, which isgenerally upon receipt of cash.

Our arrangements do notgenerally include acceptance clauses. However, if an arrangement includes anacceptance provision, acceptance occurs upon the earliest of receipt of awritten customer acceptance, expiration of the acceptance period or productiveuse of the software by the customer.

***CapitalizedSoftware Development Costs***

Our policy is tocapitalize certain software development costs in accordance with Statement ofFinancial Accounting Standards No. 86, “Accounting for the Costs ofComputer Software to Be Sold, Leased, or Otherwise Marketed” (“SFAS 86”). UnderSFAS 86, costs incurred to develop or significantly enhance computer softwareproducts are charged to research and development expense as incurred untiltechnological feasibility has been established. We establish technologicalfeasibility upon completion of a working model or completion of a detailedprogram design. Generally costs related to projects that reach technologicalfeasibility upon completion of a working model are not capitalized as the timeperiod between establishment of the working model and general availability isof short duration. For projects that meet technological feasibility uponcompletion of a detailed program design, all research and development costs forthat project are capitalized from that point until the product is available forgeneral release to customers. The establishment of technological feasibilityand the ongoing assessment of recoverability of capitalized softwaredevelopment costs require considerable judgment by management with respect tocertain external factors, including, but not limited to, anticipated futurerevenues, estimated economic life and changes in technology. It is reasonablypossible that estimates of anticipated future revenues, the remaining estimatedeconomic life of the products, or both will be reduced in the future due tocompetitive pressures. As a result, the carrying amount of the capitalizedsoftware costs may be reduced through a charge to operations in the near term. Uponthe general release of the software product to customers, capitalization ceasesand such costs are amortized (using the straight-line method) over theestimated life, which is generally three years.

**RecentlyIssued Accounting Standards**

In December 2004, the FASB issued SFAS No. 123(revised 2004), “Share-Based Payment” (SFAS No. 123R), which replaces SFASNo. 123 and supersedes APB Opinion No. 25. SFAS No. 123R addressesthe accounting for transactions in which an enterprise receives employeeservices in exchange for (a) equity 

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instruments of theenterprise or (b) liabilities that are based on the fair value of theenterprise’s equity instruments or that may be settled by the issuance of suchequity instruments. SFAS No. 123R requires all share-based payments toemployees, including grants of employee stock options and restrictive stockgrants, to be recognized as a compensation cost based on their fair values. Thepro forma disclosures previously permitted under SFAS No. 123 no longerwill be an alternative to financial statement recognition. We are required toadopt SFAS No. 123R no later than July 1, 2005. Under SFAS No. 123R,we must determine the appropriate fair value model to be used for valuingshare-based payments, the amortization method for compensation cost and thetransition method to be used at date of adoption. The transition methodsinclude prospective and retroactive adoption options. Under the retroactiveoption, prior periods may be restated either as of the beginning of the year ofadoption or for all periods presented. The prospective method requires thatcompensation expense be recorded for all unvested stock options and restrictedstock at the beginning of the first quarter of adoption of SFAS No. 123R,while the retroactive methods would record compensation expense for allunvested stock options and restricted stock beginning with the first periodrestated. We are evaluating the requirements of SFAS No. 123R and expectthat the adoption of SFAS No. 123R will have a material impact on ourconsolidated results of operations and earnings per share. We have not yetdetermined the method of adoption or the effect of adopting SFAS No. 123R,and have not determined whether the adoption will result in amounts that aresimilar to the current pro forma disclosures under SFAS No. 123 includedin Note 1*(m*)* *tothe Consolidated Financial Statements.

On December 16, 2004, the FASB issued Statement No. 153,“Exchanges of Non-monetary Assets,” an amendment of APB Opinion No. 29. Statement153 addresses the measurement of exchanges of non-monetary assets andredefines the scope of transactions that should be measured based on the fairvalue of the assets exchanged. The Statement is effective for non-monetaryasset exchanges occurring in fiscal periods beginning after June 15, 2005.We do not believe adoption of Statement 153 will have a material effect on ourconsolidated financial position, results of operations or cash flows.

On December 21, 2004,the FASB issued FASB Staff Position No. FAS 109-2 (FAS 109-2), “Accountingand Disclosure Guidance for the Foreign Earnings Repatriation Provision withinthe American Jobs Creation Act of 2004.” The American Jobs Creation Actintroduces a special one-time dividends received deduction on the repatriationof certain foreign earnings to a U.S. taxpayer (repatriation provision),provided certain criteria are met. FAS 109-2 provides accounting and disclosureguidance for the repatriation provision. FAS 109-2 is effective immediately,though the Treasury Department or Congress is expected to provide additionalclarifying language on key elements of the repatriation provision. We do notbelieve adoption of FAS 109-2 will have a material effect on our consolidatedfinancial position, results of operations or cash flows as we do not currentlyhave foreign earnings available for repatriation.

**Item 7A.**                Quantitative andQualitative Disclosures about Market Risk

In the normal course ofbusiness, we are exposed to fluctuations in interest rates and equity marketrisks as we seek debt and equity capital to sustain our operations. We are alsoexposed to fluctuations 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 to manage ourexposures and do not currently hold any market risk sensitive instruments fortrading purposes.

**Item 8.**                        ConsolidatedFinancial Statements and Supplementary Data

The information requiredby this Item is incorporated by reference herein from Part IV Item 14(a) (1) and(2).

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**Item 9.**                        Changes inand Disagreements with Accountants on Accounting and Financial Disclosure*.*

Not applicable.

**Item 9A.**                Controls andProcedures

***Evaluation of disclosure controls and procedures***

Our chief executiveofficer and our chief financial officer, after evaluating the effectiveness ofour “disclosure controls and procedures” (as defined in the Securities ExchangeAct of 1934 Rule 13a-15(e)) as of December 31, 2004 (the “EvaluationDate”), have concluded that as of the Evaluation Date, our disclosure controlsand procedures were effective and designed to ensure that material informationrelating to us and our consolidated subsidiaries would be collected and madeknown to them by others within those entities as appropriate to allow timelydecisions regarding required disclosure of such information.

***Internal controls over financial reporting***

During the most recentfiscal quarter, there has not been any change in our internal control overfinancial reporting that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

**Item 9B**                  OtherInformation

Not applicable.

**PART III**

**Item 10.**                 Directors andExecutive Officers of the Registrant

The Company incorporates herein by reference theinformation concerning directors and executive officers in its Notice of AnnualStockholders’ Meeting and Proxy Statement to be filed within 120 days after theend of the Company’s fiscal year (the “2005 Proxy Statement”).

The Company’s codeof business conduct and ethics, which applies to all Company employees,including its chief executive officer, chief financial officer and controller,is available, without charge, by written request to:

AXS-One Inc.

Corporate Secretary

301 Route 17 North

Rutherford, NJ 07070

**Item 11.**                 ExecutiveCompensation

The Company incorporatesherein by reference the information concerning executive compensation containedin the 2005 Proxy Statement.

**Item 12.**                 SecurityOwnership of Certain Beneficial Owners and Management

The Company incorporatesherein by reference the information concerning security ownership of certainbeneficial owners and management contained in the 2005 Proxy Statement.

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**Item 13.**                 CertainRelationships and Related Transactions

The Company incorporatesherein by reference the information concerning certain relationships andrelated transactions contained in the 2005 Proxy Statement.

**Item 14.**                 PrincipalAccountant Fees and Services

The Company incorporatesherein by reference the information concerning principal accountant fees andservices contained in the 2005 Proxy Statement.

**PART IV**

**Item 15.**                 Exhibits,Consolidated Financial Statements, Schedules, and Reports on Form 8-K

**(a) (1)****           ConsolidatedFinancial Statements:**
|                                                                                                                                                              | ** ** | **Page No.** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|
| Report of Independent  Registered Public Accounting Firm                                                                                                     |       |              | 43 |   |
| Consolidated Balance Sheets at  December 31, 2004 and 2003                                                                                              |       |              | 44 |   |
| Consolidated Statements of  Operations for the years ended December 31, 2004, 2003 and 2002                                                             |       |              | 45 |   |
| Consolidated Statements of  Comprehensive Income (Loss) for the years ended December 31, 2004, 2003 and  2002        |       |              | 46 |   |
| Consolidated Statements of  Stockholders’ Deficit for the years ended  December 31, 2004, 2003 and 2002                                       |       |              | 47 |   |
| Consolidated Statements of  Cash Flows for the years ended December 31, 2004, 2003 and 2002                                                             |       |              | 48 |   |
| Notes to Consolidated  Financial Statements                                                                                                                  |       |              | 49 |   |

 

**(a) (2)****           ConsolidatedFinancial Statement Schedules:**
| Report of Independent  Registered Public Accounting Firm on Consolidated Financial Statement Schedule                      |   |   | 71 |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|----|--------|
| Schedule II—Valuation  and Qualifying Accounts for the years ended December 31, 2004, 2003 and  2002        |   |   | 72 |   |

 

**(a) (3)****           Exhibits.**
| 3.1(a)   |   | Fourth Amended and Restated Certificate of  Incorporation                                                                                                         |
|----------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.2(a)   |   | Amended and Restated Bylaws of the Company                                                                                                                        |
| 4.1(a)   |   | Specimen Common Stock Certificate                                                                                                                                 |
| 4.2      |   | See Exhibits 3.1 and 3.2 for provisions of the  Certificate of Incorporation and Bylaws of the Company defining rights of  holders of Common Stock of the Company |
| 4.4(f)   |   | Form of Warrant (2001)                                                                                                                                       |
| 4.5(j)   |   | Form of Warrants (2003)                                                                                                                                      |
| 10.3(a)  |   | Employment Agreement between the Company and Elias  Typaldos, as amended                                                                                          |
| 10.6(a)  |   | 1995 Stock Option Plan                                                                                                                                            |
| 10.9(a)  |   | License Agreement between the Company and  Pfizer, Inc., as amended                                                                                          |
| 10.13(a) |   | Program License Contract between the Company and  Deutsche Bank AG                                                                                                |
| 10.19(c) |   | 1995 Stock Option Plan, as amended                                                                                                                                |
| 10.20(b) |   | Securities Purchase Agreement                                                                                                                                     |
| 10.21(c) |   | Employment Agreement between the Company and John  Rade                                                                                                           |
| 10.24(c) |   | Amendment to Securities Purchase Agreement                                                                                                                        |
| 10.27(d) |   | 1998 Stock Option Plan                                                                                                                                            |

40

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| 10.32(e) |   | Amendment to the Employment Agreement between the  Company and John Rade                                                                                                |
|----------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.47(f) |   | Investment Banking Services Agreement between the  Company and Stonegate Securities, Inc. dated November 2, 2000, and  Amendment dated January 24, 2001. |
| 10.48(f) |   | Employment Agreement between the Company and William  Levering                                                                                                          |
| 10.50(g) |   | Stock Purchase Agreement, dated as of  September 1, 2001, between the Company and Porterfield Ltd. relating to  the sale of all shares of AXS-One Sp. z.o.o.       |
| 10.51(g) |   | Promissory Note of Porterfield International Ltd.  Issued to the Company                                                                                                |
| 10.54(h) |   | Lease Agreement between the Company and CIN Meadows  L.L.C.                                                                                                             |
| 10.56(i) |   | Investor Relations Services Agreement between the  Company and Hayden Communications, Inc.                                                                         |
| 10.60(j) |   | Employment agreement between the Company and Gennaro  Vendome                                                                                                           |
| 10.61(k) |   | Employment agreement between the Company and Paul  Abel                                                                                                                 |
| 10.62(l) |   | Loan and Security Agreement with Silicon Valley Bank  dated August 11, 2004                                                                                        |
| 10.63(m) |   | Employment Agreement between the Company and William  P. Lyons                                                                                                          |
| 10.64**  |   | Employment Agreement between the Company and Joseph  P. Dwyer                                                                                                           |
| 10.65**  |   | Employment Agreement between the Company and Richard  Dym                                                                                                               |
| 10.66**  |   | Employment Agreement between the Company and Matthew  Suffoletto                                                                                                        |
| 10.67**  |   | First Loan Modification to the Loan &  Security Agreement dated January 27, 2005                                                                          |
| 10.68**  |   | Second Loan Modification  to the Loan & Security Agreement dated March 28, 2005                                                                                     |
| 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**   |   | Rule 13a-14(a)/15d-14(a) certifications—Joseph  Dwyer                                                                                                    |
| 32**     |   | Officer Certifications under 18 USC 1350                                                                                                                                |

----

(a)           Incorporatedby reference to the Exhibits filed with the Company’s Registration Statement onForm S-l, File No. 33-93990.

(b)          Incorporated byreference to the Exhibits filed with the Company’s Form 8-K filed onJanuary 8, 1998

(c)           Incorporated byreference to the Exhibits filed with the Company’s 1997 Form 10-K

(d)          Incorporated byreference to the Exhibits filed with the Company’s March 31, 1998Form 10-Q

(e)           Incorporated byreference to the Exhibits filed with the Company’s 1998 Form 10-K

(f)             Incorporated byreference to the Exhibits filed with the Company’s 2000 Form 10-K

(g)           Incorporated byreference to the Exhibits filed with the Company’s Form 8-K filed onOctober 5, 2001

(h)          Incorporated byreference to the Exhibits filed with the Company’s 2001 Form 10-K

(i)             Incorporated byreference to the Exhibits filed with the Company’s 2002 Form 10-K

(j)              Incorporated byreference to the Exhibits filed with the Company’s September 30, 2003 10-Q

(k)          Incorporated byreference to the Exhibits filed with the Company’s 2003 Form 10-K

(l)             Incorporated byreference to the Exhibits filed with the Company’s June 30, 2004 10-Q

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

**             Filed herewith

by

41

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
|        | AXS-ONE INC.               |
|--------|----------------------------|
|   | By:                        | /s/ WILLIAM P. LYONS |   |
|   |                       | William P. Lyons, |
|   |                       | *Chairman  of the Board and Chief Executive Officer* |
|   | Date: March 31,  2005 |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the Registrant, and inthe capacities indicated, on March 31, 2005.
|                        | **Signature** | ** **                                                       | ** ** | ** ** | **Title(s)** | ** ** |
|------------------------|---------------|------------------------------------------------------------------|------------|------------|--------------|------------|
| /s/  WILLIAM P. LYONS  |          | Chairman of the Board and Chief Executive Officer                |
| (William P.  Lyons)    |          | (Principal Executive Officer)                                    |
| /s/  JOSEPH DWYER      |          | Executive Vice  President, Chief Financial Officer and Treasurer |
| (Joseph Dwyer)         |          | (Principal Financial and Accounting Officer)                     |
| /s/  ELIAS TYPALDOS    |          | Executive Vice President  Technology and Director                |
| (Elias Typaldos)       |          |                                                             |
| /s/  GENNARO VENDOME   |          | Executive Vice President  Business Development and Director      |
| (Gennaro Vendome)      |          |                                                             |
| /s/  DANIEL H. BURCH   |          | Director                                                         |
| (Daniel H. Burch)      |          |                                                             |
| /s/  ROBERT MIGLIORINO |          | Director                                                         |
| (Robert  Migliorino)   |          |                                                             |
| /s/  WILLIAM VOGEL     |          | Director                                                         |
| (William E.  Vogel)    |          |                                                             |
| /s/  EDWIN T. BRONDO   |          | Director                                                         |
| (Edwin T. Brondo)      |          |                                                             |
| /s/  ALLAN WEINGARTEN  |          | Director                                                         |
| (Allan  Weingarten)    |          |                                                             |

 

 

42

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**Report of Independent Registered Public AccountingFirm**

The Board of Directors andStockholdersAXS-One Inc.:

We have audited the accompanying consolidated balancesheets of AXS-One Inc. and subsidiaries as of December 31, 2004 and 2003,and the related consolidated statements of operations, comprehensive income(loss), stockholders’ deficit, and cash flows for each of the years in thethree-year period ended December 31, 2004. These consolidated financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these consolidated financialstatements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of AXS-One Inc. andsubsidiaries as of December 31, 2004 and 2003, and the results of theiroperations and their cash flows for each of the years in the three-year periodended December 31, 2004, in conformity with U.S. generally acceptedaccounting principles.
| /s/ KPMG LLP            |
|-------------------------|
| Short Hills, New Jersey |
| March 30, 2005     |

 

43

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**AXS-ONE INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS(In thousands, except per share data)**
| ** **                                                                                                                                                 | ** ** | **December 31,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                                 | ** ** |                        | ** ** | ** **                  |       |   | ** ** | ** ** |   |
| Current assets:                                                                                                                                            |       |                        |       | ** **                  |       |   |   | ** ** |   |
| Cash and cash  equivalents                                                                                                                                 |       |                        | $          | 4,809                       | ** ** |   |   | $ | 2,946 | ** ** |   |
| Restricted cash                                                                                                                                            |       |                        | 62         | ** **                  |       |   | 56 | ** ** |   |
| Accounts receivable, net  of allowance for doubtful accounts of $577 and $200 at December 31, 2004  and 2003, respectively                            |       |                        | 6,084      | ** **                  |       |   | 5,541 | ** ** |   |
| Due from joint venture                                                                                                                                     |       |                        | 68         | ** **                  |       |   | 107 | ** ** |   |
| Prepaid expenses and  other current assets                                                                                                                 |       |                        | 1,221      | ** **                  |       |   | 603 | ** ** |   |
| Total current assets                                                                                                                                       |       |                        | 12,244     | ** **                  |       |   | 9,253 | ** ** |   |
| Equipment and leasehold improvements, at cost:                                                                                                             |       |                        |       | ** **                  |       |   |   | ** ** |   |
| Computer and office  equipment                                                                                                                             |       |                        | 11,606     | ** **                  |       |   | 11,098 | ** ** |   |
| Furniture and fixtures                                                                                                                                     |       |                        | 943        | ** **                  |       |   | 924 | ** ** |   |
| Leasehold improvements                                                                                                                                     |       |                        | 865        | ** **                  |       |   | 873 | ** ** |   |
|                                                                                                                                                       |       |                        | 13,414     | ** **                  |       |   | 12,895 | ** ** |   |
| Less-accumulated  depreciation and amortization                                                                                                            |       |                        | 12,905     | ** **                  |       |   | 12,559 | ** ** |   |
|                                                                                                                                                       |       |                        | 509        | ** **                  |       |   | 336 | ** ** |   |
| Capitalized software  development costs, net of accumulated amortization of $10,566 and $9,487 at  December 31, 2004 and 2003, respectively           |       |                        | 1,886      | ** **                  |       |   | 2,364 | ** ** |   |
| Other assets                                                                                                                                               |       |                        | 142        | ** **                  |       |   | 197 | ** ** |   |
|                                                                                                                                                       |       |                        | $          | 14,781                      | ** ** |   |   | $ | 12,150 | ** ** |   |
| **LIABILITIES AND STOCKHOLDERS’  DEFICIT**                                                                                                            | ** ** |                        | ** ** | ** **                  |       |   | ** ** | ** ** |   |
| Current liabilities:                                                                                                                                       |       |                        |       | ** **                  |       |   |   | ** ** |   |
| Current portion of  long-term debt                                                                                                                         |       |                        | $          | —                      | ** ** |   |   | $ | 547 | ** ** |   |
| Accounts payable                                                                                                                                           |       |                        | 1,901      | ** **                  |       |   | 1,737 | ** ** |   |
| Accrued expenses.                                                                                                                                          |       |                        | 3,786      | ** **                  |       |   | 3,111 | ** ** |   |
| Due to joint venture                                                                                                                                       |       |                        | 29         | ** **                  |       |   | 4 | ** ** |   |
| Deferred revenue                                                                                                                                           |       |                        | 9,786      | ** **                  |       |   | 8,946 | ** ** |   |
| Total current  liabilities                                                                                                                                 |       |                        | 15,502     | ** **                  |       |   | 14,345 | ** ** |   |
| Long-term liabilities:                                                                                                                                     |       |                        |       | ** **                  |       |   |   | ** ** |   |
| Long-term deferred  revenue                                                                                                                                |       |                        | 303        | ** **                  |       |   | 1,504 | ** ** |   |
| Commitments and contingencies                                                                                                                              |       |                        |       | ** **                  |       |   |   | ** ** |   |
| Stockholders’ deficit:                                                                                                                                |       |                        |       | ** **                  |       |   |   | ** ** |   |
| Preferred stock, $.01  par value, authorized 5,000 shares, no shares issued and outstanding                                                                |       |                        | —     | ** **                  |       |   | — | ** ** |   |
| Common stock, $.01 par  value, authorized 50,000 shares; 28,341 and 25,026 shares issued and  outstanding at December 31, 2004 and 2003, respectively |       |                        | 283        | ** **                  |       |   | 250 | ** ** |   |
| Additional paid-in  capital                                                                                                                                |       |                        | 80,339     | ** **                  |       |   | 72,148 | ** ** |   |
| Accumulated deficit                                                                                                                                        |       |                        | (81,665    | **)**                       |       |   | (76,453 | **)** |   |
| Accumulated other  comprehensive income                                                                                                                    |       |                        | 19         | ** **                  |       |   | 356 | ** ** |   |
| Total stockholders’  deficit                                                                                                                          |       |                        | (1,024     | **)**                       |       |   | (3,699 | **)** |   |
|                                                                                                                                                       |       |                        | $          | 14,781                      | ** ** |   |   | $ | 12,150 | ** ** |   |

 

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

44

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**AXS-ONE INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OFOPERATIONS(In thousands, except per share data)**
| ** **                                           | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                           | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Revenues:                                            |       |                                        |       |   |   |   |   |
| License fees                                         |       | $                                           | 6,781      |   | $ | 6,443 |   | $ | 3,917 |   |
| Services                                             |       | 31,446                                      |       | 32,948 |   | 33,030 |   |
| Other—related parties                           |       | 209                                         |       | 300 |   | 405 |   |
| Total revenues                                       |       | 38,436                                      |       | 39,691 |   | 37,352 |   |
| Operating expenses:                                  |       |                                        |       |   |   |   |   |
| Cost of license fees                                 |       | 1,923                                       |       | 1,524 |   | 1,482 |   |
| Cost of services                                     |       | 17,086                                      |       | 15,832 |   | 15,479 |   |
| Sales and marketing                                  |       | 9,565                                       |       | 7,297 |   | 6,364 |   |
| Research and development                             |       | 7,999                                       |       | 6,832 |   | 6,704 |   |
| General and administrative                           |       | 6,411                                       |       | 5,634 |   | 4,559 |   |
| Restructuring and other costs                        |       | 1,020                                       |       | — |   | — |   |
| Total operating expenses                             |       | 44,004                                      |       | 37,119 |   | 34,588 |   |
| Operating income  (loss)                             |       | (5,568                                      | )          | 2,572 |   | 2,764 |   |
| Other income (expense):                              |       |                                        |       |   |   |   |   |
| Interest income                                      |       | 144                                         |       | 73 |   | 38 |   |
| Interest expense                                     |       | (14                                         | )          | (197 | ) | (364 | ) |
| Gain on sale of subsidiary                           |       | —                                      |       | 71 |   | 219 |   |
| Equity in losses of joint ventures                   |       | (162                                        | )          | (114 | ) | (525 | ) |
| Other income (expense), net                          |       | 171                                         |       | (188 | ) | (268 | ) |
| Other income (expense), net                          |       | 139                                         |       | (355 | ) | (900 | ) |
| Income (loss)  before income tax benefit, net        |       | (5,429                                      | )          | 2,217 |   | 1,864 |   |
| Income tax  benefit, net                             |       | 217                                         |       | 99 |   | 60 |   |
| Net income (loss)                                    |       | $                                           | (5,212     | ) | $ | 2,316 |   | $ | 1,924 |   |
| Basic and diluted net income (loss) per common share |       | $                                           | (0.19      | ) | $ | 0.09 |   | $ | 0.08 |   |
| Weighted average basic common shares outstanding     |       | 27,395                                      |       | 24,945 |   | 24,818 |   |
| Weighted average  diluted common shares outstanding  |       | 27,395                                      |       | 26,264 |   | 25,511 |   |

 

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

45

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**AXS-ONE INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OFCOMPREHENSIVE INCOME (LOSS)(In thousands)**
| ** **                               | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------|------------|---------------------------------------------|------------|
| ** **                               | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net income (loss)                        |       | $                                           | (5,212     | ) | $ | 2,316 |   | $ | 1,924 |   |
| Foreign currency  translation adjustment |       | (337                                        | )          | (88 | ) | 211 |   |
| Comprehensive  income (loss)             |       | $                                           | (5,549     | ) | $ | 2,228 |   | $ | 2,135 |   |

 

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

46

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**AXS-ONE INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’DEFICIT(In thousands)**
| ** **                                     | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **      | ** ** | ** **        | ** ** | **Accumulated**        | ** ** | ** **  | ** ** |
|------------------------------------------------|------------|------------|------------|----------------------------|------------|-----------------|------------|-------------------|------------|------------------------|------------|-------------|------------|
| ** **                                     | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **      | ** ** | ** **        | ** ** | **Other**              | ** ** | ** **  | ** ** |
| ** **                                     | ** ** | **Common** | ** ** | ** Additional ** | ** ** | ** **      | ** ** | **Comprehensive** | ** ** | **Total**              | ** ** |
| ** **                                     | ** ** | **Stock**  | ** ** | **Paid-in**                | ** ** | **Accumulated** | ** ** | **Income**        | ** ** | **Stockholders’** | ** ** |
| ** **                                     | ** ** | **Shares** | ** ** | **Amount**                 | ** ** | **Capital**     | ** ** | **Deficit**       | ** ** | **(Loss)**             | ** ** | **Deficit** | ** ** |
| **Balance—December 31, 2001**   |       | 24,785     |       |                       | $          | 248             |       |              |       | $                      | 72,032     |        |       |   | $ | (80,693 | ) |   |   | $ | 233 |   |   |   | $ | (8,180 | ) |   |
| Net income                                     |       | —     |       |                       | —     |            |       |              | —     |                   |       |        | 1,924      |   |   |   | — |   |   |   | 1,924 |   |   |
| Foreign currency  translation adjustment       |       | —     |       |                       | —     |            |       |              | —     |                   |       |        | —     |   |   |   | 211 |   |   |   | 211 |   |   |
| Exercise of stock  options                     |       | 64         |       |                       | —     |            |       |              | 20         |                   |       |        | —     |   |   |   | — |   |   |   | 20 |   |   |
| **Balance—December 31, 2002**   |       | 24,849     |       |                       | 248        |            |       |              | 72,052     |                   |       |        | (78,769    | ) |   |   | 444 |   |   |   | (6,025 | ) |   |
| Net income                                     |       | —     |       |                       | —     |            |       |              | —     |                   |       |        | 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  translation adjustment       |       | —     |       |                       | —     |            |       |              | —     |                   |       |        | —     |   |   |   | (337 | ) |   |   | (337 | ) |   |
| Sale of Common  Stock                          |       | 2,581      |       |                       | 26         |            |       |              | 7,666      |                   |       |        | —     |   |   |   | — |   |   |   | 7,692 |   |   |
| Exercise of stock  options and warrants        |       | 734        |       |                       | 7          |            |       |              | 525        |                   |       |        | —     |   |   |   | — |   |   |   | 532 |   |   |
| **Balance—December 31,  2004**  |       | 28,341     |       |                       | $          | 283             |       |              |       | $                      | 80,339     |        |       |   | $ | (81,665 | ) |   |   | $ | 19 |   |   |   | $ | (1,024 | ) |   |

 

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

47

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**AXS-ONE INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OFCASH FLOWS(In thousands)**
| ** **                                                                                                                                                                                                                                                                                                                                                              | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                                              | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Cash flows from operating activities:                                                                                                                                                                                                                                                                                                                                   |       |                                        |       |   |   |   |   |
| Net income (loss)                                                                                                                                                                                                                                                                                                                                                       |       | $                                           | (5,212     | ) | $ | 2,316 |   | $ | 1,924 |   |
| Adjustments to reconcile net income (loss) to net  cash flows provided by (used in) operating activities:                                                                                                                                                                                                                                                               |       |                                        |       |   |   |   |   |
| Increase in cash  surrender value of officers’ life insurance                                                                                                                                                                                                                                                                                                      |       | (15                                         | )          | (20 | ) | (41 | ) |
| Depreciation and  amortization                                                                                                                                                                                                                                                                                                                                          |       | 1,348                                       |       | 1,570 |   | 1,946 |   |
| Net provision for  (recovery of) doubtful accounts                                                                                                                                                                                                                                                                                                                      |       | 465                                         |       | (108 | ) | (131 | ) |
| Gain on sale of  subsidiary                                                                                                                                                                                                                                                                                                                                             |       | —                                      |       | (71 | ) | (219 | ) |
| Equity in losses  of joint ventures                                                                                                                                                                                                                                                                                                                                     |       | 162                                         |       | 114 |   | 525 |   |
| Non-cash revenue  related to investment in joint ventures                                                                                                                                                                                                                                                                                                               |       | —                                      |       | — |   | (34 | ) |
| Consulting  services received in lieu of cash payment on note receivable                                                                                                                                                                                                                                                                                                |       | —                                      |       | — |   | 195 |   |
| Consulting  services received in lieu of cash payment on accounts receivable                                                                                                                                                                                                                                                                                            |       | 299                                         |       | 45 |   | — |   |
| Changes in current assets and liabilities:                                                                                                                                                                                                                                                                                                                              |       |                                        |       |   |   |   |   |
| Restricted cash                                                                                                                                                                                                                                                                                                                                                         |       | (3                                          | )          | 25 |   | (18 | ) |
| Accounts  receivable                                                                                                                                                                                                                                                                                                                                                    |       | (1,148                                      | )          | (973 | ) | 1,358 |   |
| Due from joint  venture                                                                                                                                                                                                                                                                                                                                                 |       | (36                                         | )          | 60 |   | (429 | ) |
| Prepaid expenses  and other current assets                                                                                                                                                                                                                                                                                                                              |       | (566                                        | )          | 149 |   | (188 | ) |
| Accounts payable  and accrued expenses                                                                                                                                                                                                                                                                                                                                  |       | 698                                         |       | (828 | ) | (1,411 | ) |
| Deferred revenue                                                                                                                                                                                                                                                                                                                                                        |       | (529                                        | )          | 1,310 |   | (172 | ) |
| Net cash flows  provided by (used in) operating activities                                                                                                                                                                                                                                                                                                              |       | (4,537                                      | )          | 3,589 |   | 3,305 |   |
| Cash flows from investing activities:                                                                                                                                                                                                                                                                                                                                   |       |                                        |       |   |   |   |   |
| Change in other  assets                                                                                                                                                                                                                                                                                                                                                 |       | 86                                          |       | 8 |   | 26 |   |
| Investment in  joint venture                                                                                                                                                                                                                                                                                                                                            |       | —                                      |       | — |   | (138 | ) |
| Loan to joint  venture                                                                                                                                                                                                                                                                                                                                                  |       | (115                                        | )          | (288 | ) | (102 | ) |
| Proceeds from sale  of subsidiary                                                                                                                                                                                                                                                                                                                                       |       | —                                      |       | — |   | 67 |   |
| Capitalized  software development costs                                                                                                                                                                                                                                                                                                                                 |       | (601                                        | )          | (1,296 | ) | (777 | ) |
| Cash paid for  acquisition, net of cash acquired                                                                                                                                                                                                                                                                                                                        |       | —                                      |       | — |   | 14 |   |
| Purchase of  equipment and leasehold improvements                                                                                                                                                                                                                                                                                                                       |       | (426                                        | )          | (214 | ) | (197 | ) |
| Net cash flows  used in investing activities                                                                                                                                                                                                                                                                                                                            |       | (1,056                                      | )          | (1,790 | ) | (1,107 | ) |
| Cash flows from financing activities:                                                                                                                                                                                                                                                                                                                                   |       |                                        |       |   |   |   |   |
| Proceeds from  exercise of stock options and warrants                                                                                                                                                                                                                                                                                                                   |       | 532                                         |       | 98 |   | 20 |   |
| Net proceeds from  sale of common stock                                                                                                                                                                                                                                                                                                                                 |       | 7,692                                       |       | — |   | — |   |
| Proceeds from  issuance of long term debt                                                                                                                                                                                                                                                                                                                               |       | —                                      |       | — |   | 1,000 |   |
| Payments of  long-term debt                                                                                                                                                                                                                                                                                                                                             |       | (547                                        | )          | (1,800 | ) | (1,800 | ) |
| Net cash flows  provided by (used in) financing activities                                                                                                                                                                                                                                                                                                              |       | 7,677                                       |       | (1,702 | ) | (780 | ) |
| Foreign currency  exchange rate effects on cash and cash equivalents                                                                                                                                                                                                                                                                                                    |       | (221                                        | )          | 147 |   | 236 |   |
| Net increase in cash and  cash equivalents                                                                                                                                                                                                                                                                                                                              |       | 1,863                                       |       | 244 |   | 1,654 |   |
| Cash and cash  equivalents, beginning of year                                                                                                                                                                                                                                                                                                                           |       | 2,946                                       |       | 2,702 |   | 1,048 |   |
| Cash and cash  equivalents, end of year                                                                                                                                                                                                                                                                                                                                 |       | $                                           | 4,809      |   | $ | 2,946 |   | $ | 2,702 |   |
| Supplemental disclosures  of cash flow information:                                                                                                                                                                                                                                                                                                                     |       |                                        |       |   |   |   |   |
| Cash paid during the year  for—                                                                                                                                                                                                                                                                                                                                    |       |                                        |       |   |   |   |   |
| Interest                                                                                                                                                                                                                                                                                                                                                                |       | $                                           | 21         |   | $ | 219 |   | $ | 370 |   |
| Income taxes                                                                                                                                                                                                                                                                                                                                                            |       | 20                                          |       | 112 |   | 21 |   |
| In  December 2002, the Company purchased, for a nominal amount, the  remaining 50% of common stock of one of its joint ventures to make it a  wholly owned subsidiary. At the time of acquisition the Company’s investment  in the joint venture was $112. In conjunction with the acquisition, net  assets acquired and liabilities assumed were as follows: |       |                                        |       |   |   |   |   |
| Fair value of assets  acquired                                                                                                                                                                                                                                                                                                                                          |       | $                                           | —     |   | $ | — |   | $ | 191 |   |
| Liabilities assumed                                                                                                                                                                                                                                                                                                                                                     |       | $                                           | —     |   | $ | — |   | $ | 84 |   |

 

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

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**AXS-ONE INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share data)**

**(1)**   Operations, Business Conditions,Liquidity and Significant Accounting Policies

The Company was incorporated under the laws of theState of Delaware in September 1978. The name of the Company was changedto AXS-One Inc. in November 2000. The Company designs, markets andsupports records compliance management solutions that include digitalarchiving, business process management, electronic document delivery andintegrated records disposition and discovery for e-mail, instant messaging,images, SAP and other corporate records, as well as financial managementapplications for global 2000 businesses, and scheduling and time and expensesolutions for professional services organizations. The Company also offersconsulting, implementation, training, technical support and maintenanceservices in support of its customers’ use of its software products.

The Company generated anet loss of $5.2 million for the year ended December 31, 2004 aftergenerating net income of $2.3 million and $1.9 million for the years ended December 31,2003 and 2002, respectively. For the year ended December 31, 2004, theCompany experienced a second year of increased license fee revenues that, alongwith services revenues, had declined in 2002 and prior as a result of intensecompetition and rapid technological change together with a slowing of theeconomy. Management’s initiatives over the last two years, including the recentrestructuring and the April 2004 private placement of common stock (seeNote 7), have been designed to improve operating results and liquidity andbetter position the Company to compete under current market conditions. Due tothese efforts the Company expects that its current cash balance, availabilityof borrowing capacity under the bank line of credit and operating cash flowwill be sufficient to fund its working capital requirements through 2005. TheCompany’s ability to achieve the anticipated results is affected by the extentof cash generated from operations. There is also the risk that cash held by theCompany’s foreign subsidiaries may not be readily available for use in its U.S.operations to pay its obligations as the transfer of funds is sometimes delayeddue to various foreign government restrictions. Accordingly, the Company may inthe future be required to seek new sources of financing or futureaccommodations from financial institutions. No assurance can be given thatmanagement’s initiatives will be successful or that any such additional sourcesof financing or lender accommodations will be available.

*(a) Principles ofConsolidation*

The consolidated financialstatements include the accounts of AXS-One Inc.; its wholly owned subsidiarieslocated in Australia, Singapore, South Africa and the United Kingdom(collectively, the *“Company”)*. In December 2003,the Company dissolved the legal entity of the subsidiary located in Canada. TheCanadian operation is now a division of the U.S. operation and as suchcontinues to be included in the consolidated financial statements of theCompany. The Company has a 49% ownership in a joint venture in its SouthAfrican operation. All significant intercompany transactions and balances havebeen eliminated. The joint venture is considered to be a variable interestentity as defined in FASB Interpretation No. 46R, “Consolidation ofVariable Interest Entities” (FIN 46R). However, the Company has determined thatit is not the primary beneficiary. Accordingly, the Company uses the equitymethod of accounting for its joint venture whereby investments, including loansto the joint venture, are stated at cost plus or minus the Company’s equity inundistributed earnings or losses.

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**AXS-ONE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

*(b) RevenueRecognition*

The Company recognizes revenue in accordance withStatement of Position 97-2, “Software Revenue Recognition” (“SOP 97-2”), andStatement of Position 98-9, “Modification of SOP 97-2, Software RevenueRecognition, With Respect to Certain Transactions.” Revenue from non-cancelablesoftware licenses, through both direct and indirect channels, is recognizedwhen the license agreement has been signed or the customer purchase order hasbeen received, delivery has occurred, the fee is fixed or determinable andcollectibility is probable. For the majority of license sales the Company usesa signed license agreement as evidence of an arrangement. For maintenance fees,the Company uses a maintenance agreement as evidence of the arrangement. TheCompany uses a professional services agreement as evidence of an arrangementfor training, custom programming and consulting revenues. Occasionally, where amaster license or services agreement with a customer already exists, theCompany accepts the customer’s purchase order as evidence of an arrangement. Managementfee revenue from the joint venture is evidenced by a master agreement governingthe relationship.

Revenues from resellers, generated using the sellthrough method whereby the Company recognizes revenue when the software hasbeen sold to the end user, is recognized as previously stated in accordancewith SOP 97-2. In multiple element arrangements, the Company defers thevendor-specific objective evidence of fair value (“VSOE”) related to theundelivered elements and recognizes revenue on the delivered elements using theresidual method. The most commonly deferred element is initial maintenance,which is recognized on a straight-line basis over the initial maintenance term.The VSOE of maintenance is determined by using a consistent percentage ofmaintenance fee to license fee based on renewal rates. Maintenance fees insubsequent years are recognized on a straight-line basis over the life of theapplicable agreement. Maintenance contracts entitle the customer to hot-linesupport and all unspecified product upgrades released during the term of themaintenance contract. Upgrades include any and all unspecified patches orreleases related to a licensed software product. Maintenance does not includeimplementation services to install these upgrades.

Delivery of software generally occurs when the product(on CDs) is delivered to a common carrier. Occasionally, delivery occursthrough electronic means where the software is made available through theCompany’s secure FTP (File Transfer Protocol) site. The Company does not offerany customers or resellers a right of return.

For software license and maintenance revenue, theCompany assesses whether the fee is fixed and determinable and whether or notcollection is probable. The Company assesses whether the fee is fixed anddeterminable based on the payment terms associated with the transaction. If asignificant portion of a fee is due after the Company’s normal payment terms,which are 30 to 90 days from invoice date, the fee is not considered to befixed and determinable. In these cases, the Company recognizes revenue as thefees become due.

The majority of the Company’s training and consultingservices are billed based on hourly rates. The Company generally recognizesrevenue as these services are performed when there is also evidence of anarrangement, the fee is fixed or determinable and collectibility is reasonablyassured. However, when the Company enters into an arrangement that requires itto perform significant work either to alter the underlying software or to buildadditional complex interfaces so that the software performs as the customerrequests, the Company recognizes the entire fee using the percentage ofcompletion method of 

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**AXS-ONE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

accounting. This wouldapply to the Company’s custom programming services which are generallycontracted on a fixed fee basis. Anticipated losses, if any, are charged tooperations in the period such losses are determined.

Revenues from joint ventures (included in Revenues:Other-Related Parties in the Consolidated Statements of Operations) includesconsulting revenue for the joint ventures’ use of the Company’s South Africansubsidiary’s consultants and for management fees for the Company’s subsidiaryproviding managerial, technical and other related services to the jointventures (2002 period only) in accordance with the joint venture agreements. Revenueis recognized upon performance of the services.

The Company assessesassuredness of collection for its revenue transactions based on a number offactors, including past transaction history with the customer and thecredit-worthiness of the customer. The Company does not request collateral fromits customers. If the Company determines that collection of a fee is uncertain,it defers the fee and recognizes revenue at the time the uncertainty iseliminated, which is generally upon receipt of cash.

*(c) VariableInterest Entity*

The Company adopted FIN 46R as required on March 31,2004. The Company’s 49% owned joint venture, African Solutions (Pty) Ltd (“AfricanSolutions”), is considered to be a variable interest entity as defined in FIN46R. However, the Company has determined that the majority owner, AfricanLegends Technology, absorbs the majority of the expected losses and therefore,African Legends Technology, is the primary beneficiary. Due to the fact thatthe Company is not the primary beneficiary of African Solutions, the adoptionof FIN 46R did not have an impact on the Company’s consolidated financialposition or results of operations.

African Solutions is acting as a non-exclusiveauthorized third party service provider to provide consulting andimplementation services, and as a non-exclusive representative in providingmarketing and promotional services directly to the end users in regard to,among other things, AXS-One’s software products. African Solutions conductsbusiness throughout the African continent where its target markets are theFinancial Sector and Government Departments.

As of December 31, 2004, AXS-One’s total exposureto loss as a result of its involvement in African Solutions is $39,representing the Company’s net investment in African Solutions as of December 31,2004.

Presentedbelow is selected financial data for African Solutions for the years ended December 31,2004, 2003 and 2002.
| ** **     | ** ** | **Twelve Months Ended December 31,**             | ** ** |
|----------------|------------|----------------------------------------------------------------------|------------|
| ** **     | ** ** | **     2004     ** | ** ** | **     2003     ** | ** ** | **     2002     ** | ** ** |
| Total revenues |       |                                                                 | $          | 1,309 |   |   |   | $ | 1,755 |   |   |   | $ | 1,165 |   |   |
| Operating loss |       |                                                                 | $          | (135 | ) |   |   | $ | (40 | ) |   |   | $ | (191 | ) |   |

 

Total assets were $535 and$224 as of December 31, 2004 and 2003, respectively. Total stockholders’deficit was $(1,765) and $(614) as of December 31, 2004 and 2003,respectively.

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**AXS-ONE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

*(d) Use of ManagementEstimates*

The preparation ofconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe consolidated financial statements and the reported amounts of revenues andexpenses during the periods presented. Actual results could differ from thoseestimates. Some of the significant estimates involve allowance for doubtfulaccounts, recoverability of capitalized software development costs, accruedexpenses, provision for income taxes in foreign jurisdictions, assessment ofcontingencies, and pro forma compensation expense pursuant to SFAS No. 123.

*(e) Cash and CashEquivalents and Restricted Cash*

Cash equivalents arestated at cost, which approximates market, and consist of short-term, highlyliquid investments with original maturities of less than three months. Restrictedcash at December 31, 2004 and 2003 represents amounts on deposit forpayments of lease obligations by the Australia subsidiary.

*(f) Allowance forDoubtful Accounts*

The Company evaluates thecollectibility of accounts receivable based on a combination of factors. Incases where the Company is aware of circumstances that may impair a specificcustomer’s ability to meet its financial obligations, the Company records aspecific allowance against amounts due, and thereby reduces the net receivableto the amount management believes is probable of collection. For all othercustomers, the Company recognizes allowances for doubtful accounts based on thelength of time the receivables are outstanding, the current businessenvironment and historical experience.

*(g) Equipment andLeasehold Improvements*

Equipment and leaseholdimprovements are stated at cost, less accumulated depreciation and amortization.Depreciation expense is computed using the straight-line method over theestimated useful lives of the assets (two to five years). Leaseholdimprovements are amortized using the straight-line method over the lesser ofthe remaining term of the lease or their estimated useful lives.

*(h) SoftwareDevelopment Costs*

The Company’s policy is to capitalize certain softwaredevelopment costs in accordance with Statement of Financial AccountingStandards No. 86, “Accounting for the Costs of Computer Software to BeSold, Leased, or Otherwise Marketed” (“SFAS 86”). Under SFAS 86, costs incurredto develop or significantly enhance computer software products are charged toresearch and development expense as incurred until technological feasibilityhas been established. The Company establishes technological feasibility uponcompletion of a working model or completion of a detailed program design. Generallycosts related to projects that reach technological feasibility upon completionof a working model are not capitalized as the time period between establishmentof the working model and general availability is of short duration. Forprojects that meet technological feasibility upon completion of a detailedprogram design, all research and development costs for that project arecapitalized from that point until the product is available for general releaseto customers. The establishment of technological feasibility and the ongoing 

52

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**AXS-ONE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

assessment ofrecoverability of capitalized software development costs require considerablejudgment by management with respect to certain external factors, including, butnot limited to, anticipated future revenues, estimated economic life andchanges in technology. It is reasonably possible that estimates of anticipatedfuture revenues, the remaining estimated economic life of the products, or bothwill be reduced in the future due to competitive pressures. As a result, thecarrying amount of the capitalized software costs may be reduced through acharge to operations in the near term. Upon the general release of the softwareproduct to customers, capitalization ceases and such costs are amortized (usingthe straight-line method) over the estimated life, which is generally threeyears.

During 2004, 2003 and 2002capitalized software development costs amounted to $601, $1,296 and $777,respectively. Annual amortization of software development costs of $1,079,$1,310 and $1,361 for 2004, 2003 and 2002, respectively, was recorded using thestraight-line method over three years, the estimated economic life of theproducts.

*(i) Impairment orDisposal of Long-Lived Assets*

In accordance withStatement of Financial Accounting Standards (“SFAS”) No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets,” which was adopted on January 1,2002, the Company monitors events or changes in circumstances that may indicatecarrying amounts of its long-lived assets may not be recoverable. When suchevents or changes in circumstances are present, the Company assesses therecoverability of its assets by determining whether the carrying amount of itsassets will be recovered through undiscounted, expected future cash flows. Shouldthe Company determine that the carrying values of specific long-lived assetsare not recoverable, the Company would record a charge to operations to reducethe carrying value of such assets to their fair values. The Company considersvarious valuation factors, principally discounted cash flows, to assess thefair values of long-lived assets.

*(j) Income Taxes*

Income taxes are accountedfor under the asset and liability method. The asset and liability methodrequires that deferred tax assets be reduced by a valuation allowance if, basedon the weight of available evidence, it is more likely than not that someportion or all of such assets will not be realized. Deferred tax assets andliabilities are recognized for the future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities, and their respective tax bases and operating loss and taxcredit carryforwards. Deferred tax assets and liabilities are measured usingenacted tax rates expected to apply to taxable income in the years in whichthose temporary differences are expected to be recovered or settled. The effecton deferred tax assets and liabilities of a change in tax rates is recognizedin operations in the period that includes the enactment date.

*(k) Concentrationof Credit Risk*

SFAS No. 105, “Disclosure of Information aboutFinancial Instruments with Off-Balance Sheet Risk and Financial Instrumentswith Concentration of Credit Risk,”**requiresdisclosure of any significant off-balance sheet and credit risk concentrations.The Company has no significant off-balance sheet concentration of credit risksuch as foreign exchange contracts, option contracts or other foreign hedgingarrangements. The Company maintains the majority of cash balances with fourfinancial institutions and its accounts receivable credit risk is notconcentrated within any geographic area. The Company’s revenues 

53

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**AXS-ONE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

are concentrated in thecomputer software industry, which is highly competitive and rapidly changing. Significanttechnological changes in the industry or customer requirements, or theemergence of competitive products with new capabilities or technologies, couldadversely affect operating results.

As of December 31,2004, no one customer represented more than 10% of total gross receivables. Asof December 31, 2003, three customers represented 33.1% of total grossreceivables (or 10.5%, 10.7% and 11.9% individually). As of December 31,2002, two customers represented 25.7% of total gross receivables (or 15.3% and10.4% individually). For the year ended December 31, 2004, two customers,Pfizer Inc. and AIG Insurance, represented 14.6% and 10.1%, respectively, oftotal revenues. For the year ended December 31, 2003, two customers,Pfizer, Inc. and AIG Insurance, represented 18.7% and 12.1%, respectively,of total revenues. For the year ended December 31, 2002, two customers,Pfizer, Inc. and AIG Insurance, represented 16.1% and 12.0%, respectively,of total revenues. No one customer represented more than 10% of licenserevenues for the year ended December 31, 2004. License revenues included29.5% (or 18.2% and 11.3% individually) of revenue from two customers in 2003and 14.7% from one customer in 2002. Services revenues included 27.2% (or 16.1%and 11.1% individually), 31.9% (or 19.0% and 12.9% individually) and 30.7% (or18.2% and 12.5% individually) of revenue from the same two customers in 2004,2003 and 2002, respectively.

*(l) ForeignCurrency Translation*

The functional currencyfor foreign subsidiaries is the local currency. The results of operations forthese foreign subsidiaries are translated from local currencies into U.S.dollars using the average exchange rates during each period. Assets andliabilities are translated using exchange rates at the end of the period withtranslation adjustments accumulated in stockholders’ deficit. Intercompanyloans are denominated in U.S. currency. Foreign currency transaction gains andlosses, related to short-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, “ForeignCurrency Translation,” whereby foreign currency transaction gains and lossesare recorded in cumulative foreign currency translation adjustment, a componentof stockholders’ deficit. As of December 31, 2004 and 2002, no loans wereconsidered long-term in nature. During 2003, intercompany loans to one foreignsubsidiary were considered long-term in nature.

*(m) Stock-BasedCompensation*

FASB Statement No. 148, “Accountingfor Stock Based Compensation-Transition and Disclosure, an Amendment of FASBStatement No. 123” (“SFAS 148”) provides alternative methods of transitionfor a voluntary change to the fair value method of accounting for stock-basedcompensation. However, it allows an entity to continue to measure compensationcost for stock instruments granted to employees using the intrinsic-valuemethod of accounting prescribed by Accounting Principles Board Opinion No. 25(“APB 25”), “Accounting for Stock Issued to Employees,” provided itdiscloses the effect of SFAS 123, as amended by SFAS 148, in the footnotes tothe financial statements. On November 14, 2003, the FASB decided torequire stock-based employee compensation to be recorded as a charge toearnings beginning in 2005. In December 2004, the FASB issued SFAS123 (revised 2004), “Share-Based Payment” (SFAS 123R), which replaces SFAS123 and supercedes APB Opinion No. 25. SFAS 123R requires all share-based paymentsto employees, including grants of employee stock options and restrictive stock 

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**AXS-ONE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

grants, to be recognizedas a compensation cost based on their fair values. The pro forma disclosurespreviously permitted under SFAS 123 no longer will be an alternative tofinancial statement recognition. The Company is required to adopt SFAS 123R nolater than July 1, 2005. Until thattime, the Company has chosen to continue to account for stock-basedcompensation using the intrinsic-value method. Accordingly, no stock optionrelated compensation expense has been recognized in the consolidated statementsof operations, as all options granted had an exercise price equal to the marketvalue of the underlying stock on the date of grant.

Had the Company, however, elected to recognizecompensation cost based on fair value of the stock options at the date of grantunder SFAS 123, as amended by SFAS 148 and SFAS 123R, such costs would havebeen recognized ratably over the vesting period of the underlying instrumentsand the Company’s net income (loss) and net income (loss) per common sharewould have changed to the pro forma amounts indicated in the table below.
| ** **                                                                                                        | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                        | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net income (loss)  as reported                                                                                    |       | $                                           | (5,212     | ) | $ | 2,316 |   | $ | 1,924 |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  method for all awards |       | (1,434                                      | )          | (1,348 | ) | (1,659 | ) |
| Pro forma net income (loss)                                                                                       |       | $                                           | (6,646     | ) | $ | 968 |   | $ | 265 |   |
| Net income (loss)  per common share:                                                                              |       |                                        |       |   |   |   |   |
| Basic—as  reported                                                                                           |       | $                                           | (0.19      | ) | $ | 0.09 |   | $ | 0.08 |   |
| Basic—pro  forma                                                                                             |       | $                                           | (0.24      | ) | $ | 0.04 |   | $ | 0.01 |   |
| Diluted—as  reported                                                                                         |       | $                                           | (0.19      | ) | $ | 0.09 |   | $ | 0.08 |   |
| Diluted—pro  forma                                                                                           |       | $                                           | (0.24      | ) | $ | 0.04 |   | $ | 0.01 |   |

 

TheCompany has used the Black-Scholes option-pricing model in calculating the fairvalue of options granted. The assumptions used and the weighted averageinformation for the years ended December 31, 2004, 2003 and 2002 are asfollows:
| ** **                                                                                                                             | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                             | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Risk-free  interest rates                                                                                                              |       | 5.02                                        | %          | 4.70 | % | 4.78 | % |
| Expected dividend  yield                                                                                                               |       | —                                      |       | — |   | — |   |
| Expected lives                                                                                                                         |       | 5 years                                     |       | 7 years |   | 7 years |   |
| Expected  volatility                                                                                                                   |       | 103                                         | %          | 110 | % | 103 | % |
| Weighted-average  grant date fair value of options granted during the period                                                           |       | $                                           | 2.30       |   | $ | 0.86 |   | $ | 0.57 |   |
| Weighted-average  remaining contractual life of options outstanding                                                                    |       | 6.84 years                                  |       | 6.29 years |   | 6.31 years |   |
| Weighted-average  exercise price of 4,091, 4,026 and 3,868 options exercisable at  December 31, 2004, 2003 and 2002, respectively |       | $                                           | 1.67       |   | $ | 1.63 |   | $ | 1.55 |   |

 

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**AXS-ONE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

*(n) Basic andDiluted Net Income (Loss) per Common Share*

Basic and diluted net income (loss) per common shareis presented in accordance with SFAS No. 128, “Earnings per Share” (“SFAS No. 128”).Basic net income (loss) per common share is based on the weighted-averagenumber of shares of common stock outstanding during the period. Diluted netloss per common share was the same as basic net loss per common share for theyear ended December 31, 2004 since the effect of stock options andwarrants was anti-dilutive for this period. Diluted net income per common sharefor the periods ended December 31, 2003 and 2002 do not include theeffects of outstanding options to purchase 3,010 and 3,941 shares of commonstock, respectively, and outstanding warrants to purchase 100 and 130 shares ofcommon stock, respectively, as the effect of their inclusion is anti-dilutivefor the periods presented. As of December 31, 2004, there were outstandingoptions to purchase 7,453 shares of common stock and outstanding warrants topurchase 516 shares of common stock.

Thefollowing represents the calculations of the basic and diluted net income(loss) per common share for the years ended December 31, 2004, 2003 and2002.
| ** **                                                          | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                          | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net income (loss)                                                   |       | $                                           | (5,212     | ) | $ | 2,316 |   | $ | 1,924 |   |
| Weighted average basic common shares outstanding  during the year   |       | 27,395                                      |       | 24,945 |   | 24,818 |   |
| Dilutive effect of stock options and warrants                       |       | —                                      |       | 1,319 |   | 693 |   |
| Weighted average diluted common shares outstanding  during the year |       | 27,395                                      |       | 26,264 |   | 25,511 |   |
| Basic and diluted  net income (loss) per common share               |       | $                                           | (0.19      | ) | $ | 0.09 |   | $ | 0.08 |   |

 

*(o) Fair Value ofFinancial Instruments*

Cash and cash equivalents,restricted cash, accounts receivable, accounts payable, accrued expenses, othercurrent liabilities and debt reported in the consolidated balance sheets equalor approximate fair values.

*(p) DeferredRevenue*

Deferred revenuesprimarily relate to customer software maintenance agreements that have beenpaid for by customers prior to the performance of those services and, to alesser extent, prepaid consulting and deferred license fees.

*(q) Accounting forGuarantees*

The Company warrants that each version of its softwarewill substantially conform to the latest edition of the documentationapplicable to that version. Such warranties are accounted for in accordancewith SFAS No. 5, “Accounting for Contingencies.” To date the Company hasnot incurred significant costs related to warranty obligations.

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**AXS-ONE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

The Company’s product license and services agreementsinclude a limited indemnification provision for claims from third partiesrelating to the Company’s intellectual property. Such indemnificationprovisions are accounted for in accordance with SFAS No. 5. Theindemnification is generally limited to the amount paid by the customer. Todate, claims under such indemnification provisions 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 maintaining operations ina certain locality or to secure leases or other operating obligations of asubsidiary. The maximum exposure on these guarantees is not significant, eitherindividually or in the aggregate.

**(2)   Divestiture**

On September 20, 2001, theCompany sold its wholly-owned subsidiary located in Central and Eastern Europe(C.E.E.), including offices in Poland, Estonia and Bulgaria, to PorterfieldInternational Ltd. (“Buyer”), a company wholly-owned by the former managingdirector of C.E.E. and his wife established by them in 2001 specifically toacquire ownership of C.E.E. The Company received consideration in the form of apromissory note of Buyer in the face amount of $430. The note was payableeither in cash or, if the Company requested, an equivalent dollar amount ofprofessional services, in 15 monthly installments ending on December 1,2002 and bore interest at the fixed rate of 6.75% per year. A net assetdeficiency of the C.E.E. operations of $(3) at the time of the sale,offset by accrued expenses of $180 directly related to the sale, resulted in adeferred gain of approximately $253, which the Company recorded in accordancewith the Securities and Exchange Commission’s Staff Accounting Bulletin No. 81(SAB 81), “Gain Recognition on the Sale of a Business or Operating Assets to aHighly Leveraged Entity.” Additional direct costs of the sale of $3 and $5recorded during the three months ended June 30, 2002 and December 31,2002, respectively, reduced the total deferred gain to $245.

The Company recognized such gainas the note receivable was paid or equivalent value for services was received,but only after $180 was received. Through December 31, 2002, $235 had beenreceived in cash payment to the Company and $195 had been received inequivalent services provided by the Buyer to the Company or to the Company’sAfrican Solutions joint venture. The remaining $3 net difference is a foreigncurrency translation effect. Porterfield provided consulting services to theCompany’s end users in the U.K. and South Africa and to certain end users ofAfrican Solutions, the Company’s 49%-owned joint venture, at hourly ratessimilar to those charged to the Company by other third party service providersutilized in those regions. Porterfield is unrelated to the entities to whichthese services were provided.

The Company recognized $219 ofsuch gain through December 31, 2002, which included a reversal of $45related to the original $180 in accrued expenses recorded at the time of thesale. The $45 was recognized during the three months ended September 30,2002 as a result of the release of a past customer claim. The remaining gain of$71, reflected as Deferred revenue on the accompanying December 31, 2002consolidated balance sheet was recognized in the first quarter of 2003 afterpayment was received from the Company’s joint venture for services provided bythe Buyer to the joint venture.

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**AXS-ONE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

Thefollowing table shows the activity related to the promissory note and relateddeferred gain and gain:
| ** **                                                          | ** ** | **Note**       | ** ** | **Deferred** | ** ** | **Gain**       | ** ** |
|---------------------------------------------------------------------|------------|----------------|------------|--------------|------------|----------------|------------|
| ** **                                                          | ** ** | **Receivable** | ** ** | **Gain**     | ** ** | **Recognized** | ** ** |
| September 20,  2001                                            |       |           | $          | 430          |       |           |       | $ | 253 |   |   |   | $ | — |   |   |
| Cash payments and  services provided through December 31, 2001 |       |           | (94        | )            |       |           | —     |   |   |   | — |   |   |
| Balance at  December 31, 2001                                  |       |           | 336        |         |       |           | 253        |   |   |   | — |   |   |
| Direct expense  incurred in June 2002                          |       |           | —     |         |       |           | (3         | ) |   |   | — |   |   |
| Cash payments and  services provided through December 31, 2002 |       |           | (336       | )            |       |           | (174       | ) |   |   | 174 |   |   |
| Reversal of  accrued expense in September 2002                 |       |           | —     |         |       |           | —     |   |   |   | 45 |   |   |
| Direct expense  incurred in October 2002                       |       |           | —     |         |       |           | (5         | ) |   |   | — |   |   |
| Balance at  December 31, 2002                                  |       |           | —     |         |       |           | 71         |   |   |   | 219 |   |   |
| Cash payments and  services provided through December 31, 2003 |       |           | —     |         |       |           | (71        | ) |   |   | 71 |   |   |
| Balance at December 31,  2003                                  |       |           | $          | —       |       |           |       | $ | — |   |   |   | $ | 290 |   |   |

 

**(3)   Long-TermDebt**

TheCompany’s long-term debt consists of the following:
| ** **                              | ** ** | **December 31,** | ** ** |
|-----------------------------------------|------------|-----------------------|------------|
| ** **                              | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Term loan                               |       | $                     | —     |   | $ | 547 |   |
| Less: current  portion                  |       | —                |       | 547 |   |
| Long-term debt, net of  current portion |       | $                     | —     |   | $ | — |   |

 

On March 31, 1998, theCompany entered into a Loan and Security Agreement that contained a revolvingline of credit and a term loan. The unpaid principal on the term loan at December 31,2003 of $547 was fully paid as of March 31, 2004. The Loan and SecurityAgreement terminated on May 28, 2004 in accordance with Amendment No. 15.As of December 31, 2004, no amounts remain outstanding or available underthis agreement.

On August 11, 2004, the Company entered into atwo-year Loan and Security Agreement (“Agreement”) which contains a revolvingline of credit under which the Company has available the lesser of $4 millionor 80% of eligible accounts, as defined. The available amount under therevolving line of credit at December 31, 2004 was approximately $3.9million of which no amounts were outstanding.

Borrowings under the revolving line of credit bearinterest at prime rate plus one half of one percent (0.5%). The Agreementprovides for a non-refundable commitment fee of $30 per year and an unusedrevolving line facility fee of .25% per annum. The unused revolving linefacility fee can be reduced if the Company maintains cash in a non-interestbearing checking account with the lender during the term of the agreement. TheAgreement is secured by substantially all domestic assets of the Company andcontains 

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**AXS-ONE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

certain financialrestrictive covenants based on adjusted quick ratio, as defined, and earningsbefore interest, taxes and depreciation and amortization (EBITDA).

On January 27, 2005, the Company amended the Agreement(First Loan Modification) to revise the financial covenant based on EBITDA forthe six months ended December 31, 2004. The Company was in compliance withthis revised covenant and all other covenants as of December 31, 2004.

On March28, 2005, the Company further amended the Agreement (Second Loan Modification)in order to set the EBITDA and adjusted quick ratio quarterly covenants for2005.

**(4)   LeaseObligations**

The Company leases office space and equipment undernon-cancelable operating leases. Rent expense charged to operations in theaccompanying consolidated statements of operations for office space, vehiclesand equipment under operating leases was $2,154, $2,021 and $1,736 for theyears ended December 31, 2004, 2003 and 2002, respectively.

Scheduledfuture minimum payments required for all non-cancelable operating leases are asfollows:
| **Years Ending December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------------------|------------|------------|------------|------------|------------|
| 2005                                         |       | $          | 1,923      |       |
| 2006                                         |       | 1,793      |       |
| 2007                                         |       | 1,467      |       |
| 2008                                         |       | 42         |       |
| 2009/Thereafter                              |       | 19         |       |
| Total                                        |       | $          | 5,244      |       |

 

**(5)   RelatedParty Transactions**

The Company has certain business relationships with anentity that was founded by the former President and Chief Executive Officer whoowns a majority beneficial equity interest in such entity. During the yearsended December 31, 2004, 2003 and 2002 the Company recorded as cost oflicense fees approximately $1, $36 and $32, respectively, from this relatedparty. These costs, related to royalty and maintenance fees on licensedproducts, have been generally decreasing as customers upgrade to newer versionsof the Company’s software that no longer require this related party software.

In August 2003, the Company entered into abusiness relationship with an entity that is owned by the Company’s formerchairman and principal stockholder. This entity was providing consultingservices related to the development of the Company’s instant messagingarchiving product. For the years ended December 31, 2004 and 2003, theCompany recorded $84 and $75, respectively, as research and development expensefrom this related party. The Company discontinued use of this entity’s servicesin June 2004.

During January 2001, the Company entered into twoSouth African joint ventures: AXS-One African Solutions (Pty) Ltd (“AfricanSolutions”) and Hospitality Warehouse (Pty) Ltd (“Hospitality Warehouse”). AfricanSolutions is acting as a non-exclusive authorized third party service providerto provide consulting and implementation services, and as a non-exclusiverepresentative in providing marketing and promotional services directly to theend users in regard to, among other things AXS-One’s 

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**AXS-ONE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

software products. AfricanSolutions conducts business throughout the African continent where its targetmarkets are the Financial Sector and Government Departments. African Solutionsis considered to be a variable interest entity as defined in FIN 46R (See Notes1(a) and 1(c) for further information).

Hospitality Warehouse uses AXS-One’s procurementsoftware and generates fees for purchases made by member companies in the hospitalityindustry. In December 2002, the Company purchased, for a nominal amount,the remaining 50% of common stock of Hospitality Warehouse to make it awholly-owned subsidiary. At the time of the acquisition the investment in thejoint venture was $112, net of equity in losses of $120. Pro-forma results asif Hospitality Warehouse had been acquired on January 1, 2002 are notsignificantly different than the reported 2002 consolidated results.

Revenues from African Solutions during 2004 and 2003include management fee revenue of $27 and $68, respectively, and consultingrevenue of $182 and $232, respectively. Revenues from both joint venturesduring 2002 include management fee revenue of $387 and consulting revenue of$18.

As of December 31, 2004 and 2003, the equityinvestment in African Solutions was $(29) and ($4), respectively, reflected as “Dueto joint venture” on the accompanying December 31, 2004 and 2003consolidated balance sheets, net of accumulated equity in losses. As of December 31,2004 and 2003, amounts due from African Solutions related to the billing forrevenues were $68 and $107, respectively, bringing the net investment to $39and $103, respectively.

Pursuant to AccountingPrinciples Board Opinion No. 18, “The Equity Method of Accounting forInvestments in Common Stock,” the Company evaluated the investment in AfricanSolutions and adjusted down the carrying value by $61 as of December 31,2003, due to an other than temporary decline in value. No similar adjustmentwas made in 2004.

**(6)   IncomeTaxes**

Thecomponents of income (loss) before income tax benefit, net are as follows:
| ** ** | ** ** | **Years Ended December 31,** | ** ** |
|------------|------------|---------------------------------------------|------------|
| ** ** | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Domestic   |       | $                                           | (1,503     | ) | $ | (4,127 | ) | $ | (546 | ) |
| Foreign    |       | (3,926                                      | )          | 6,344 |   | 2,410 |   |
| Total      |       | $                                           | (5,429     | ) | $ | 2,217 |   | $ | 1,864 |   |

 

Incometax (provision) benefit is as follows:
| ** ** | ** ** | **Years Ended December 31,** | ** ** |
|------------|------------|---------------------------------------------|------------|
| ** ** | ** ** | **  2004  **            | ** ** | ** 2003 ** | ** ** | **  2002  ** | ** ** |
| State      |       | $                                           | 194        |   | $ | 142 |   | $ | 198 |   |
| Foreign    |       | 23                                          |       | (43 | ) | (138 | ) |
| Total      |       | $                                           | 217        |   | $ | 99 |   | $ | 60 |   |

 

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**AXS-ONE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

Areconciliation of Federal income tax (expense) benefit at the statutory rate of34% to income tax benefit, net reflected in the accompanying consolidatedstatements of operations is as follows:
| ** **                                                                                                               | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                               | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Federal income  tax (expense) benefit at 34%                                                                             |       | $                                           | 1,846      |   | $ | (754 | ) | $ | (634 | ) |
| State income tax  (expense) benefit, net of Federal tax (expense) benefit                                                |       | 213                                         |       | 382 |   | 220 |   |
| Change in  valuation allowance, net of change in valuation allowance related to stock options  and sales of subsidiaries |       | (2,511                                      | )          | 1,593 |   | 1,289 |   |
| Foreign tax rate  differential and change in foreign NOLs                                                                |       | 868                                         |       | (972 | ) | (650 | ) |
| Reduction of  state NOLs due to sale of New Jersey NOLs, net of federal benefit                                          |       | (149                                        | )          | (108 | ) | (158 | ) |
| Other, net                                                                                                               |       | (50                                         | )          | (42 | ) | (7 | ) |
|                                                                                                                     |       | $                                           | 217        |   | $ | 99 |   | $ | 60 |   |

 

Theprincipal components of the Company’s deferred taxes are as follows:
| ** **                                     | ** ** | **December 31,** | ** ** |
|------------------------------------------------|------------|-----------------------|------------|
| ** **                                     | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Deferred tax  assets:                          |       |                  |       |   |   |
| Non-deductible accruals and other              |       | $                     | 238        |   | 151 |   |
| Allowance for doubtful accounts                |       | 53                    |       | 55 |   |
| Purchased research and development             |       | 658                   |       | 770 |   |
| Research and development credit carry-forwards |       | 2,895                 |       | 2,895 |   |
| Net operating loss carry-forwards              |       | 21,508                |       | 19,833 |   |
| Deferred tax assets                            |       | 25,352                |       | 23,704 |   |
| Less valuation  allowance                      |       | 24,543                |       | 22,759 |   |
| Net deferred tax assets                        |       | 809                   |       | 945 |   |
| Deferred tax  liabilities:                     |       |                  |       |   |   |
| Software development costs                     |       | 809                   |       | 945 |   |
| Net deferred taxes                             |       | $                     | —     |   | $ | — |   |
|                                                |            |                       |            |  |  |  |  |

 

At December 31, 2004, the Company had UnitedStates net operating loss carry-forwards of approximately $50,700 which areavailable to offset future Federal taxable income, if any, and which begin toexpire in 2007. In addition, foreign net operating loss carry-forwardsaggregated approximately $8,526 at December 31, 2004, which are notsubject to expiration.

The Company has recorded a valuationallowance for its net deferred tax assets and will continue to monitor therealizability of such assets. Approximately $1,917 and $1,250 of the Company’sdeferred tax asset pertaining to NOLs and the corresponding valuation allowanceat December 31, 2004 and 2003, respectively, relates to tax deductions arisingfrom the exercise 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.

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**AXS-ONE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

For the year ended December 31, 2003, there was areduction in the foreign NOL in the amount of $3,364. Most of that reduction isattributable to the intercompany debt that was eliminated as part of theclosing of the Canadian subsidiary and the corresponding debt forgiveness bythe United States parent.

Foreign subsidiaries have paid, and are expected tocontinue to pay, appropriate taxes, if and when due, to their respective taxingauthorities. It is the intention of the Company to reinvest the earnings of itsnon-U.S. subsidiaries, if any, in those operations. Accordingly, no Federaltaxes have been provided on undistributed foreign earnings and no deferred taxliability for temporary differences related to the Company’s foreignsubsidiaries and foreign joint ventures has been established as the determinationof the amounts is not practical.

During state fiscal years2002 through 2005, AXS-One was authorized by the New Jersey EconomicDevelopment Authority (“NJEDA”) in conjunction with the New Jersey Division ofTaxation to sell a portion of its New Jersey net operating losses and researchand development credits for consideration that is to be used to fund itsresearch activities in the State of New Jersey. For the State’s fiscal year2005 (July 1, 2004 to June 30, 2005), AXS-One was authorized to sell$226 of its available tax benefit of $226. AXS-One sold the entire authorizedamount for consideration of $194, net of broker commissions. For the State’sfiscal year 2004 (July 1, 2003 to June 30, 2004), AXS-One wasauthorized to sell $165 of its available tax benefit of $165. AXS-One sold theentire authorized amount for consideration of $142, net of broker commissions. Forthe State’s fiscal year 2003 (July 1, 2002 to June 30, 2003) AXS-Onewas authorized to sell an available tax benefit of $239 relating to tax yearsthrough December 31, 2000. AXS-One sold the entire authorized amount forconsideration of $198, net of broker commissions. Approximately 66% of the taxbenefits sold is reflected as reduction of state NOLs due to sales of NewJersey NOLs, net of federal benefit in the income tax rate reconciliation tableabove. As of December 31, 2004, the remaining New Jersey tax benefitin the amount of $74 is available to sell if the program is extended by theNJEDA or will be available to offset future New Jersey income taxes.

**(7)   Stockholders’Deficit**

*(a) Warrants*

On October 1, 2002, the Company entered into anagreement with a South Carolina corporation to provide investor relationsservices to the Company for a term of twelve months, whereby upon expiration ortermination of the agreement the Company would issue warrants to purchase thenumber of shares of common stock of the Company which was equal to the productof 10 shares multiplied by the number of whole months during the actual term ofthe agreement to a maximum of 120 shares. The exercise price for the warrantswas (i) for the initial 60 shares covered by the warrants, $0.41 pershare, which represented the closing price of the Company’s common stock on October 1,2002 and (ii) for the remaining shares covered by the warrants, if any,the closing price of the Company’s common stock on April 1, 2003, whichwas $0.59 per share. The warrants were fully vested on the date of theirissuance by the Company.

On September 30, 2003, the Company issued two (2) warrantsunder this agreement, each to purchase 60 shares of the Common Stock ofAXS-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. The expiration dateof both warrants was September 30, 2006. On January 21, 2004, thewarrants were exercised and proceeds in the amount of 

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**AXS-ONE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

$60 were remitted to theCompany. No warrants remain outstanding under this agreement as of December 31,2004.

The accounting for these warrants was determined inaccordance with EITF Issue No. 96-18, “Accounting for EquityInstruments that are Issued to Other than Employees for Acquiring, or inConjunction with Selling Goods or Services,” and, as a result, the fair valueof the warrants was being recognized as an expense over the term of theagreement. Total expenses of $34 were recorded in sales and marketing expenseon the 2003 consolidated financial statements related to these warrants. Nofurther compensation costs will be recognized related to these warrants sinceno further services are being provided under the agreement which expired on September 30,2003.

Shares of common stock underlying the warrants werenot registered under the Securities Act of 1933, as amended (the “Act”) inreliance upon Section 4(2) of the Act based on the fact that thewarrants were issued to only one sophisticated investor who had extensiveknowledge of the Company at the time of the issuance.

On November 2, 2000, the Company issued warrantsto a Dallas corporation for the purchase of 200 shares of Common Stock inexchange for services to be rendered as the Company’s non-exclusive financialadvisor and for certain investment-banking services. The warrants areexercisable at $1.875 per share, subject to adjustment, until January 24,2006 and were to vest in two separate tranches of 100 each on February 28,2001 and May 31, 2001. By written notice dated May 25, 2001, 100warrants that were to be vested on May 31, 2001 were cancelled inconnection with the cancellation of the services agreement. As permitted by theWarrant Agreement, the Dallas corporation exercised the remaining warrants infull on September 24, 2004, surrendering back to the Company some of theshares of AXS-One Common Stock acquired through such exercise as paymentof the option exercise price in accordance with the original terms (knownas a “cashless exercise”). No warrants remain outstanding under this agreementas of December 31, 2004.

The fair value of these warrants was determined inaccordance with EITF Issue No. 96-18 and was being recognized asexpense over 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.

Shares of common stock underlying the warrants werenot registered under the Securities Act of 1933, as amended (the “Act”) inreliance upon Section 4(2) of the Act based on the fact that thewarrants were issued to only one sophisticated investor who had extensiveknowledge of the Company at the time of the issuance.

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**AXS-ONE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

On April 5, 2004, the Company completed an offerand sale of 2,581 shares of common stock for $3.10 per share in a privateplacement for total consideration of $8,000. Upon closing, the Company receivednet proceeds of approximately $7,700. The Company also issued, at the sametime, warrants to purchase an aggregate of 258 shares of common stock at $3.98per share and warrants to purchase 258 shares of common stock at $4.50 pershare. These warrants are exercisable for a period of three years beginning April 5,2004. This private placement and issuance of warrants were made pursuant to theterms of a Unit Subscription Agreement, dated as of April 1, 2004, amongthe Company and several investors.

Issuance of the common stock andwarrants in the private placement was not registered under the Securities Actof 1933 (“the Act”) in reliance upon Section 4(2) of the Act based onthe fact that the shares of common stock and the warrants were issued to asmall number of sophisticated investors who had extensive knowledge of theCompany at the time of the issuance.

On April 8, 2004, the Company filed a Form 8-Kwith the SEC disclosing details of the private placement and issuance ofwarrants. On May 4, 2004, the Company filed a registration statement on Form S-3with the SEC covering the resale of the securities issued and securitiesissuable upon exercise of the warrants. The Form S-3 registrationstatement, as amended, was declared effective by the SEC on September 28,2004.

Asummary of warrant activity is as follows:
| ** **                                                                                 | ** ** | **Number  of Shares** | ** ** | **Exercise Price  Per Share** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Weighted Average  Remaining Life  (Years)** | ** **  |
|--------------------------------------------------------------------------------------------|------------|----------------------------|------------|-----------------------------------------|------------|------------------------------------------------|------------|---------------------------------------------------------|-------------|
| Balance,  December 31, 2002                                                           |       |                       | 130        |                                    |       | $ 0.41 - 1.875                  |       |                                                    | $ 1.54 |   |   |   | 3.04 |   |   |
| Granted                                                                                    |       |                       | 90         |                                    |       | 0.41 - 0.59                          |       |                                                    | $ 0.50 |   |   |   | — |   |   |
| Balance,  December 31, 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  (all of which are exercisable at December 31, 2004) |       |                       | 516        |                                    |       | $  3.98 - 4.50             |       |                                                    | $ 4.24 |   |   |   | 2.25 |   |   |

 

*(b) StockOption Plans*

Pursuant to the 1995 Stock Option Plan, as amended(the 1995 Plan), the Company may grant statutory and non-statutory options topurchase an aggregate of up to 4,500 shares of Common Stock. The Company hasspecifically reserved such shares. Options may be granted under thediscretionary option program to employees, consultants, independent advisorsand non-employee directors. Prior to adoption of the 1998 Plan discussed below,options were automatically granted to non-employee directors under theautomatic option grant programs. Options granted under the discretionary grantprogram have an exercise price of not less than 85% of the fair market value ofthe Common Stock on the grant date. Options granted under the automatic grantprogram have an exercise price of 100% of the fair market value on the grantdate.

In April 1998, the Company adopted the 1998 StockOption Plan (the 1998 Plan). Pursuant to the 1998 Plan, the Company may grantstock options or stock appreciation rights to purchase an aggregate of 

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**AXS-ONE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

up to 5,000 shares ofCommon Stock (inclusive of 2,000 and 1,500 shares added to the 1998 Plan by thestockholders in June 2004 and 2001, respectively). In accordance with a June 2004amendment, up to 300 shares of the total shares may be used for restrictedstock awards. Options may be granted under the discretionary option program (asamended in June 2004) to employees and consultants of the Company not toexceed 500 shares per person during any calendar year except that in the firstyear of employment, the maximum grant will not exceed 1,000 shares per person. Non-employeedirectors receive an automatic grant of stock options to purchase 20 shares ofCommon Stock upon date of commencement of service as a non-employee directorand thereafter, 10 shares on the date of each annual meeting of stockholders,provided that on, and as of, such date, such individual has been a non-employeedirector for the previous 12-month period. No option may have an exercise priceless than the fair market value of the Common Stock at the time of grant.

All options granted under the Plans expire ten yearsfrom the date of grant (or five years for statutory options granted to 10%stockholders), unless terminated earlier. Options generally vest over afour-year period. However, as of December 31, 2004, options to purchaseapproximately 517 shares of common stock had been granted with a two-yearvesting period, options to purchase approximately 115 shares of common stockvest upon the earlier of the occurrence of certain events or four years andoptions to purchase approximately 15 shares of common stock had been grantedwith a vesting period of three-years and eleven months.

Asummary of stock option activity under the Plans is as follows:
| ** **                               | ** ** | **Number of** | ** ** | **Exercise Price** | ** ** | **Weighted Average**     | ** ** |
|------------------------------------------|------------|--------------------|------------|-------------------------|------------|-------------------------------|------------|
| ** **                               | ** ** | **Shares**         | ** ** | **Per Share**      | ** ** | **Exercise Price**       | ** ** |
| **Balance,  December 31, 2001**     |       |               | 5,829      |                    |       | $ 0.21 - 13.00 |       |   | $ 2.01 |   |   |
| Granted                                  |       |               | 982        |                    |       | 0.41 - 1.14                   |       |   | 0.58 |   |   |
| Exercised                                |       |               | (64        | )                       |       | 0.30 - 0.72                   |       |   | 0.32 |   |   |
| Cancelled                                |       |               | (470       | )                       |       | 0.30 - 6.25                   |       |   | 1.04 |   |   |
| **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 |   |   |
| **Exercisable,  December 31, 2004** |       |               | 4,091      |                    |       |                          |       |   | $ 1.67 |   |   |

 

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**AXS-ONE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

A summary of stock options outstanding and exercisableas of December 31, 2004, follows:
| **Options Outstanding**            | ** ** | **Options Exercisable** | ** ** |
|-----------------------------------------|------------|------------------------------|------------|
| **Range of  exercise prices** | ** ** | ** **                   | ** ** | **Number  outstanding** | ** ** | **Weighted average  remaining life(years)** | ** ** | **Weighted average  exercise price** | ** ** | **Number  exercisable** | ** ** | **Weighted average  exercise price** | ** ** |
| $  0.21  - 1.00               |       |                         | 3,090      |   |   |   | 6.80 |   |   |   | $ 0.67 |   |   |   | 2,588 |   |   |   | $ 0.67 |   |   |
| $  1.06  - 3.78               |       |                         | 2,912      |   |   |   | 6.47 |   |   |   | $ 2.15 |   |   |   | 952 |   |   |   | $ 1.84 |   |   |
| $  4.21                       |       |                         | 900        |   |   |   | 9.32 |   |   |   | $ 4.21 |   |   |   | — |   |   |   | $     — |   |   |
| $  6.00  - 7.63               |       |                         | 548        |   |   |   | 6.26 |   |   |   | $ 6.03 |   |   |   | 548 |   |   |   | $ 6.03 |   |   |
| $13.00                                  |       |                         | 3          |   |   |   | 1.58 |   |   |   | $ 13.00 |   |   |   | 3 |   |   |   | $ 13.00 |   |   |
|                                    |       |                         | 7453       |   |   |   |   |   |   |   |   |   |   |   | 4,091 |   |   |   |   |   |   |

 

**(8)   Employee401(k) Plan**

The Company’s 401(k) Plan (the Plan) is a definedcontribution plan. All employees with three months of service and who are atleast 21 years of age are eligible to become participants in the Plan and tomake voluntary contributions based on a percentage of their compensation withincertain Plan limitations.

The Plan falls under the provisions of Section 401(k) ofthe Internal Revenue Code. Employees may elect to contribute a percentage oftheir pretax salary, subject to statutory limitations, as well as certainpercentages of their after-tax salary, to the Plan. By approval of the Board ofDirectors, the Company may elect to match a pre-determined percentage of theemployees’ contribution. In addition, the Company may make additional contributionsat the discretion of the Board of Directors, which would be allocated among allparticipants in proportion to each participant’s compensation, as defined. Duringthe years ended December 31, 2004, 2003 and 2002, no additionalcontributions were made under the Plan.

Beginning in 2002, all contributions by the Companyare on a discretionary basis only as approved by the Board of Directors. Forthe year ended December 31, 2004, the Company contributed 50% of theemployees’ first 6% of pretax salary contribution. For the year 2003, theCompany contributed 25% of the employees’ first 6% of pretax salarycontribution. No contributions were approved or made for the year 2002.

The Company’scontributions charged to operations in the accompanying consolidated statementsof operations were approximately $308, $96, and none for the years ended December 31,2004, 2003 and 2002, respectively.

**(9)   FinancialInformation by Geographic Area**

SFAS No. 131, “Disclosure about Segments of anEnterprise and Related Information,” establishes standards for the way publicbusiness enterprises report information about operating segments in annualfinancial statements and requires that those enterprises report selectedinformation about reporting segments in interim financial reports issued toshareholders. It also establishes standards for related disclosures aboutproducts and services, geographic areas and major customers.

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**AXS-ONE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

Revenuesand long-lived assets for the Company’s United States, United Kingdom,Australia and Southeast Asia and other international operations are as follows:
| ** **        | ** ** | ** **    | ** ** | ** **              | ** **   | **Australia and** | ** ** | ** ** | ** **   | ** **       | ** ** |
|-------------------|------------|---------------|------------|-------------------------|--------------|------------------------|------------|------------|--------------|------------------|------------|
| ** **        | ** ** | **United**    | ** ** | **United**              | ** **   | **Southeast**          | ** ** | **South**  | ** **   | ** **       | ** ** |
| ** **        | ** ** | **States**    | ** ** | ** Kingdom ** | ** **   | **Asia**               | ** ** | **Africa** | ** **   | **Consolidated** | ** ** |
| ***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 |   |   |
| ***2002***        |       |          |       |                    |         |                   |       |       |         |             |       |   |   |   |   |   |   |
| Revenues(1)       |       | $ 26,826 |       |                    | $ 5,473 |                   |       |       | $ 4,091 |             |       | $  962 |   |   | $ 37,352 |   |   |
| Long-lived assets |       | 2,485         |       |                    | 112          |                   |       |       | 74           |             |       | 76 |   |   | 2,747 |   |   |

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(1)          Revenuesare attributed to geographic area based on location of sales office.

**(10)   OperatingSegments**

In the fourthquarter of 2003, the Company consolidated the sales and marketing efforts ofits three business units in order to streamline the sales process and controlexpenses. The Company now has only two product lines that it offers to specificmarkets as part of its strategy to focus on market opportunities. The twoproduct lines are as follows:

a)               AXS-One EnterpriseFinancials provide an integrated suite of internet-enabled financial managementand accounting applications to global 2000 organizations, enabling them toachieve process transparency while maintaining secure access required to meetreporting, control and governance requirements. AXS-One has an extensiveinstalled customer base for its core financial management products as well asfor its Time and Billing components, a full suite of business solutions andservices optimized to address the requirements of organizations that primarilysell professionals’ time.

b)              AXS-One RecordsCompliance Platform Solutions enable organizations to utilize documents anddata generated by their corporate applications as an asset while reducingcorporate risk and operational overheads and addressing requirements for corporategovernance, legal discovery and industry regulations associated with howcorporate records are managed and retained. Utilizing the AXS-One CompliancePlatform Solutions, organizations can capture, archive, manage, search,supervise, integrate, share and audit their electronic records, regardless oforiginating platform. Disparate document and data types can be managedincluding e-mail, instant messages, images, voice and video, office documents,ERP-generated data such as SAP, and electronic print reports generated by hostsystems. AXS-One Compliance Platform solutions target large information-centricorganizations that can utilize self-service information systems to reducecosts, increase efficiency, improve communications with their customers and improveaccess to business intelligence.

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**AXS-ONE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

TheCompany evaluates the performance of its two product lines based on revenuesand operating income. Summarized financial information concerning the Company’sreportable segments is shown in the following table. The Chief ExecutiveOfficer uses the information below in this format while making decisions aboutallocating resources to each product line and assessing its performance.
| ** **                                       | ** ** | **AXS-One**                | ** **   | **AXS-One**                | ** ** | ** ** | ** **   |
|--------------------------------------------------|------------|----------------------------|--------------|----------------------------|------------|------------|--------------|
| ** **                                       | ** ** | ** Enterprise ** | ** **   | ** Compliance ** | ** ** | ** ** | ** **   |
| ** **                                       | ** ** | **Financials**             | ** **   | **Solutions**              | ** ** | **Total**  | ** **   |
| ***Year  Ended December 31, 2004***         |       |                       |         |                       |       |       |         |   |   |   |   |
| Revenues:                                        |       |                       |         |                       |       |       |         |   |   |   |   |
| License fees                                     |       |                       | $ 2,419 |                       |       |       | $ 4,362 |   |   | $ 6,781 |   |
| Services                                         |       |                       | 25,704       |                       |       |       | 5,742        |   |   | 31,446 |   |
| Total revenue,  excluding related party revenue  |       |                       | 28,123       |                       |       |       | 10,104       |   |   | 38,227 |   |
| Operating income                                 |       |                       | 53           |                       |       |       | 2,801        |   |   | 2,854 |   |
| Total assets                                     |       |                       | 12,274       |                       |       |       | 2,507        |   |   | 14,781 |   |
| Capital  expenditures                            |       |                       | 380          |                       |       |       | 46           |   |   | 426 |   |
| Depreciation and  amortization                   |       |                       | 1,319        |                       |       |       | 29           |   |   | 1,348 |   |
| ***Year Ended December 31,  2003***         |       |                       |         |                       |       |       |         |   |   |   |   |
| Revenues:                                        |       |                       |         |                       |       |       |         |   |   |   |   |
| License fees                                     |       |                       | $ 4,371 |                       |       |       | $ 2,072 |   |   | $ 6,443 |   |
| Services                                         |       |                       | 28,064       |                       |       |       | 4,884        |   |   | 32,948 |   |
| Total revenue,  excluding related party revenue  |       |                       | 32,435       |                       |       |       | 6,956        |   |   | 39,391 |   |
| Operating income                                 |       |                       | 5,687        |                       |       |       | 3,214        |   |   | 8,901 |   |
| Total assets                                     |       |                       | 10,572       |                       |       |       | 1,578        |   |   | 12,150 |   |
| Capital  expenditures                            |       |                       | 196          |                       |       |       | 18           |   |   | 214 |   |
| Depreciation and  amortization                   |       |                       | 1,548        |                       |       |       | 22           |   |   | 1,570 |   |
| ***Year Ended December 31,  2002(1)***      |       |                       |         |                       |       |       |         |   |   |   |   |
| Revenues:                                        |       |                       |         |                       |       |       |         |   |   |   |   |
| License fees                                     |       |                       | $ 1,548 |                       |       |       | $ 2,369 |   |   | $ 3,917 |   |
| Services                                         |       |                       | 28,782       |                       |       |       | 4,248        |   |   | 33,030 |   |
| Total revenues,  excluding related party revenue |       |                       | 30,330       |                       |       |       | 6,617        |   |   | 36,947 |   |
| Operating income                                 |       |                       | 3,914        |                       |       |       | 4,075        |   |   | 7,989 |   |
| Total assets                                     |       |                       | 9,284        |                       |       |       | 1,315        |   |   | 10,599 |   |
| Capital  expenditures                            |       |                       | 182          |                       |       |       | 15           |   |   | 197 |   |
| Depreciation and  amortization                   |       |                       | 1,899        |                       |       |       | 46           |   |   | 1,945 |   |

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(1)          Tivity Solutions,previously reported as a separate unit, has been consolidated with AXS-OneEnterprise Financials to reflect the new two-product line structure.

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**AXS-ONE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

Reconciliation of segment operating income toconsolidated operating income (loss) is as follows:
| ** **                                       | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                       | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| Operating income from reportable segments        |       | $ 2,854                               |       | $ 8,901 |   | $ 7,989 |   |
| Unallocated  revenue, Other—related parties |       | 209                                        |       | 300 |   | 405 |   |
| Unallocated  general and administrative expenses |       | (6,367                                     | )          | (5,599 | ) | (4,492 | ) |
| Other corporate unallocated expenses             |       | (2,264                                     | )          | (1,030 | ) | (1,138 | ) |
| Total consolidated  operating income (loss)      |       | $ (5,568                              | )          | $ 2,572 |   | $ 2,764 |   |

 

**(11)   QuarterlyFinancial Data (Unaudited)**

Summarizedquarterly financial data for 2004 and 2003 is as follows (in thousands exceptper share data):
| ** **                                     | ** ** | **Quarter** | ** ** |
|------------------------------------------------|------------|-------------|------------|
| **2004**                                       | ** ** | ** **  | ** ** | **First** | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| Total revenues                                 |       | 10,922      |       | 9,505 |   | 9,145 |   | 8,864 |   |
| Gross profit                                   |       | 6,242       |       | 4,602 |   | 4,323 |   | 3,842 |   |
| Net income (loss)                              |       | 753         |       | (2,580 | ) | (1,659 | ) | (1,726 | ) |
| Basic net income  (loss) per common share(1)   |       | 0.03        |       | (0.09 | ) | (0.06 | ) | (0.06 | ) |
| Diluted net  income (loss) per common share(1) |       | 0.03        |       | (0.09 | ) | (0.06 | ) | (0.06 | ) |
|                                                |            |             |            |  |  |  |  |  |  |  |  |

 
| ** **                              | ** ** | **Quarter** | ** ** |
|-----------------------------------------|------------|-------------|------------|
| **2003**                                | ** ** | ** **  | ** ** | **First** | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| Total revenues                          |       | 9,445       |       | 9,588 |   | 10,211 |   | 10,447 |   |
| Gross profit                            |       | 5,140       |       | 5,207 |   | 6,025 |   | 984 |   |
| Net income                              |       | 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 |   |
|                                         |            |             |            |  |  |  |  |  |  |  |  |

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(1)          Basicand diluted net income (loss) per common share are computed independently foreach quarter. Therefore, the sum of the quarters will not necessarily equal thebasic and diluted net income (loss) per common share for the full year.

**(12)   RestructuringCosts**

On June 30, 2004, in orderto streamline and reorganize the Company to better meet its long-term goals,the Company eliminated 25 positions in the United States and 11 positions inits foreign operations. The Company recorded a charge to operations in thesecond quarter totaling approximately $0.8 million related to involuntarytermination benefits to be paid to the terminated employees. The severanceaccrual was adjusted down by approximately $0.1 million in the third quartermainly due to the re-assignment of two people previously scheduled fortermination.

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**AXS-ONE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

The activity related to the restructuring is as follows:
| Involuntary termination costs recorded in June 2004        |   | $ 786                |   |
|-----------------------------------------------------------------|--------|---------------------------|--------|
| Cash payments through June 2004                            |   | —                    |   |
| Restructuring liability at June 30, 2004                   |   | 786                       |   |
| Cash payments through September 30, 2004                   |   | (657                      | )      |
| Adjustment to severance accrual through September 30, 2004 |   | (83                       | )      |
| Restructuring liability at September 30, 2004              |   | 46                        |   |
| Cash payments through December 31, 2004                    |   | (46                       | )      |
| Restructuring  liability at December 31, 2004              |   | $   — |   |

 

In addition, in June 2004,the Company recognized an expense of approximately $0.3 million related to aretirement agreement with the Company’s former CEO. The liability for theretirement agreement is included in accrued expenses on the accompanying December 31,2004 Consolidated Balance Sheet. The Company paid the retirement benefits in January 2005.

**(13)   Contingencies**

Historically, the Company has been involved indisputes and/or litigation encountered in its normal course of business. TheCompany believes that the ultimate outcome of these proceedings will not have amaterial adverse effect on the Company’s business, consolidated financialcondition, results of operations or cash flows.

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**Reportof Independent Registered Public Accounting Firm**

TheBoard of Directors and Stockholders

AXS-One Inc.:

Under date of March 30, 2005, we reported on theconsolidated balance sheets of AXS-One Inc. and subsidiaries as of December 31,2004 and 2003, and the related consolidated statements of operations,comprehensive income (loss), stockholders’ deficit, and cash flows for each ofthe years in the three-year period ended December 31, 2004, which isincluded in the 2004 annual report on Form 10-K. In connection withour audits of the aforementioned consolidated financial statements, we alsoaudited the accompanying related consolidated financial statement schedule. Thisconsolidated financial statement schedule is the responsibility of the Company’smanagement. Our responsibility is to express an opinion on this consolidatedfinancial statement schedule based on our audits.

In our opinion, suchconsolidated financial statement schedule, when considered in relation to thebasic consolidated financial statements taken as a whole, presents fairly, inall material respects, the information set forth therein.
| /s/ KPMG LLP            |
|-------------------------|
| Short Hills, New Jersey |
| March 30, 2005     |

 

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**SCHEDULE II**

**AXS-ONE INC.VALUATION AND QUALIFYING ACCOUNTSYears Ended December 31, 2004, 2003 and 2002(in thousands)**
| ** **                                          | ** ** | ** **          | ** ** | **Charged**            | ** ** | ** **                | ** ** | ** **      | ** ** |
|-----------------------------------------------------|------------|---------------------|------------|------------------------|------------|---------------------------|------------|-----------------|------------|
| ** **                                          | ** ** | **Balance at** | ** ** | **(Credited) to** | ** ** | **Amounts**               | ** ** | **Balance**     | ** ** |
| ** **                                          | ** ** | **Beginning**       | ** ** | **Costs and**     | ** ** | **Written**               | ** ** | **at End** | ** ** |
| **Allowance For Doubtful Accounts:** | ** ** | ** **          | ** ** | **of Year**       | ** ** | **Expenses, net(a)** | ** ** | **Off**         | ** ** | **of Year** | ** ** |
| **Year  ended December 31, 2004**              |       |                | $          | 200                    |       |                      |       | $               | 465        |   |   |   | $ | (88 | ) |   |   | $ | 577 |   |   |
| **Year ended December 31, 2003**               |       |                | $          | 379                    |       |                      |       | $               | (108       | ) |   |   | $ | (71 | ) |   |   | $ | 200 |   |   |
| **Year  ended December 31, 2002**              |       |                | $          | 657                    |       |                      |       | $               | (131       | ) |   |   | $ | (147 | ) |   |   | $ | 379 |   |   |
|                                                     |            |                     |            |                        |            |                           |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(a)           Creditsto costs and expenses reflect recoveries of amounts previously written off orrevisions to previous estimates.

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