**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

 

**Washington, D.C.  20549**

 

**FORM 10-Q**

 

**QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES**

**EXCHANGE ACT OF 1934**

 

**For the quarter endedMarch 31, 2004           Commission FileNumber 1-13591**

 

**AXS-ONE INC.**(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                    |   | **13-2966911**                       |
|-----------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer Identification No.) |
|                                                            |   |                                 |
| **301 Route 17 North  Rutherford, New Jersey**                  |   | **07070**                            |
| (Address of principal executive offices)                        |   | (Zip Code)                           |
|                                                            |   |                                 |
| **(201) 935-3400**                                              |
| (Registrant’s telephone number, including area code)       |

 

Indicate by check mark whetherthe registrant:  (1) has filed allreports required to be filed by Section 13 or 15 (d) of the Securities ExchangeAct of 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 

| YES |   | ý |   | NO |   | o |
|-----|--------|--------|--------|----|--------|---|

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).

 

| YES |   | o |   | NO |   | ý |
|-----|--------|---|--------|----|--------|--------|

 

Number of shares outstanding of the issuer’s common stock as of May 3,2004

 
| **Class**                               |   | **Number of Shares Outstanding** |
|-----------------------------------------|--------|----------------------------------|
| Common Stock, par value $0.01 per share |   | 27,984,564                       |

 

 

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**AXS-ONE INC.**

 

**INDEX**

 
| **PART I**     | **FINANCIAL INFORMATION** |                                                                                                     |
|----------------|---------------------------|----------------------------------------------------------------------------------------------------------|
|           |                      |                                                                                                     |   |
|           | Item 1.                   | Financial  Statements                                                                                    |   |
|           |                      |                                                                                                     |   |
|           |                      | Consolidated Balance Sheets  March 31, 2004 (unaudited) and December 31, 2003                            |   |
|           |                      | Consolidated Statements of Operations  (unaudited)  Three months ended March 31, 2004 and 2003           |   |
|           |                      | Consolidated Statements of Comprehensive  Income (unaudited)  Three months ended March 31, 2004 and 2003 |   |
|           |                      | Consolidated Statements of Cash Flows  (unaudited)  Three months ended March 31, 2004 and 2003           |   |
|           |                      | Notes to Consolidated Interim Financial  Statements (unaudited)                                          |   |
|           |                      |                                                                                                     |   |
|           | Item 2.                   | Management’s Discussion and Analysis of  Financial  Condition and Results of Operations             |   |
|           |                      |                                                                                                     |   |
|           | Item 3.                   | Quantitative and Qualitative Disclosures  About Market Risk                                              |   |
|           |                      |                                                                                                     |   |
|           | Item 4.                   | Controls and Procedures                                                                                  |   |
|           |                      |                                                                                                     |   |
| **PART II**    | **OTHER INFORMATION**     |                                                                                                     |
|           |                      |                                                                                                     |   |
|           | Item  1.                  | Legal  Proceedings                                                                                       |   |
|           |                      |                                                                                                     |   |
|           | Item 2.                   | Changes in Securities and Use of Proceeds                                                                |   |
|           |                      |                                                                                                     |   |
|           | Item 6.                   | Exhibits and Reports on Form 8-K                                                                         |   |
|           |                      |                                                                                                     |   |
| **SIGNATURES** |                      |                                                                                                     |
|           |                      |                                                                                                     |   |
|           | Signatures                |                                                                                                     |

 

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**AXS-ONE INC. AND SUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

**(In thousands, except per share data)**

 
|                                                                                                                                                            |   | **March 31,  2004** |   | **December  31,  2003** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|--------|-------------------------|--------|
|                                                                                                                                                            |   | **(Unaudited)**     |   |                    |   |
| **ASSETS**                                                                                                                                                      |   |                |   |                    |   |
| Current assets:                                                                                                                                                 |   |                |   |                    |   |
| Cash and cash equivalents                                                                                                                                       |   | $                   | 3,710  |                    | $      | 2,946 |   |
| Restricted cash                                                                                                                                                 |   | 57                  |   | 56                      |   |
| Accounts receivable, net of allowance for  doubtful accounts of $176 and $200 at March 31, 2004 and December 31, 2003,  respectively                            |   | 7,077               |   | 5,541                   |   |
| Due from joint venture                                                                                                                                          |   | 113                 |   | 107                     |   |
| Prepaid expenses and other current assets                                                                                                                       |   | 734                 |   | 603                     |   |
| Total current assets                                                                                                                                            |   | 11,691              |   | 9,253                   |   |
| Equipment and leasehold improvements, at cost:                                                                                                                  |   |                |   |                    |   |
| Computer and office equipment                                                                                                                                   |   | 11,244              |   | 11,098                  |   |
| Furniture and fixtures                                                                                                                                          |   | 928                 |   | 924                     |   |
| Leasehold improvements                                                                                                                                          |   | 879                 |   | 873                     |   |
|                                                                                                                                                            |   | 13,051              |   | 12,895                  |   |
| Less-accumulated depreciation and  amortization                                                                                                                 |   | 12,654              |   | 12,559                  |   |
|                                                                                                                                                            |   | 397                 |   | 336                     |   |
| Capitalized software  development costs, net of accumulated amortization of $9,761 and $9,487 at  March 31, 2004 and December 31, 2003, respectively            |   | 2,424               |   | 2,364                   |   |
| Other assets                                                                                                                                                    |   | 175                 |   | 197                     |   |
|                                                                                                                                                            |   | $                   | 14,687 |                    | $      | 12,150 |   |
|                                                                                                                                                            |   |                |   |                    |   |
| **LIABILITIES AND STOCKHOLDERS’ DEFICIT**                                                                                                                  |   |                |   |                    |   |
| Current liabilities:                                                                                                                                            |   |                |   |                    |   |
| Current portion of long-term debt                                                                                                                               |   | $                   | — |                    | $      | 547 |   |
| Accounts payable                                                                                                                                                |   | 1,895               |   | 1,737                   |   |
| Accrued expenses                                                                                                                                                |   | 3,019               |   | 3,111                   |   |
| Due to joint venture                                                                                                                                            |   | 32                  |   | 4                       |   |
| Deferred revenue                                                                                                                                                |   | 11,214              |   | 8,946                   |   |
| Total current liabilities                                                                                                                                       |   | 16,160              |   | 14,345                  |   |
| Long-term liabilities:                                                                                                                                          |   |                |   |                    |   |
| Long-term deferred revenue                                                                                                                                      |   | 1,289               |   | 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; 25,401 and 25,026 shares issued and outstanding at March 31,  2004 and December 31, 2003, respectively |   | 254                 |   | 250                     |   |
| Additional paid-in capital                                                                                                                                      |   | 72,408              |   | 72,148                  |   |
| Accumulated deficit                                                                                                                                             |   | (75,700             | )      | (76,453                 | )      |
| Accumulated other comprehensive income                                                                                                                          |   | 276                 |   | 356                     |   |
| Total stockholders’ deficit                                                                                                                                |   | (2,762              | )      | (3,699                  | )      |
|                                                                                                                                                            |   | $                   | 14,687 |                    | $      | 12,150 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

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**AXS-ONE INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

(Inthousands, except per share date)

(Unaudited)

 
|                                                |   | **Three  Months Ended March 31,** |   |
|-----------------------------------------------------|--------|-----------------------------------|--------|
|                                                |   | **2004**                          |   | **2003** |   |
| Revenues:                                           |   |                              |   |   |   |
| License fees                                        |   | $                                 | 2,460  |   | $ | 1,241 |   |
| Services                                            |   | 8,411                             |   | 8,089 |   |
| Other-related parties                               |   | 51                                |   | 115 |   |
| Total revenues                                      |   | 10,922                            |   | 9,445 |   |
|                                                |   |                              |   |   |   |
| Operating expenses:                                 |   |                              |   |   |   |
| Cost of license fees                                |   | 411                               |   | 341 |   |
| Cost of services                                    |   | 4,269                             |   | 3,964 |   |
| Sales and marketing                                 |   | 1,970                             |   | 1,631 |   |
| Research and development                            |   | 1,899                             |   | 1,674 |   |
| General and administrative                          |   | 1,567                             |   | 1,315 |   |
| Total operating expenses                            |   | 10,116                            |   | 8,925 |   |
| Operating income                                    |   | 806                               |   | 520 |   |
| Other income (expense):                             |   |                              |   |   |   |
| Interest income                                     |   | 25                                |   | 12 |   |
| Interest expense                                    |   | (12                               | )      | (73 | ) |
| Gain on sale of subsidiary                          |   | —                            |   | 71 |   |
| Equity in losses of joint ventures                  |   | (33                               | )      | (19 | ) |
| Other expense, net                                  |   | (33                               | )      | (84 | ) |
| Other expense, net                                  |   | (53                               | )      | (93 | ) |
| Net income                                          |   | $                                 | 753    |   | $ | 427 |   |
|                                                |   |                              |   |   |   |
| Basic and diluted net income per common  share      |   | $                                 | 0.03   |   | $ | 0.02 |   |
|                                                |   |                              |   |   |   |
| Weighted average basic  common shares outstanding   |   | 25,250                            |   | 24,865 |   |
|                                                |   |                              |   |   |   |
| Weighted average diluted  common shares outstanding |   | 28,782                            |   | 25,581 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

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**AXS-ONE INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME**

(Inthousands)

(Unaudited)

 
|                                    |   | **Three  Months Ended  March 31,** |   |
|-----------------------------------------|--------|------------------------------------|--------|
|                                    |   | **2004**                           |   | **2003** |   |
|                                    |   |                               |   |   |   |
| Net income                              |   | $                                  | 753    |   | $ | 427 |   |
| Foreign currency translation adjustment |   | (80                                | )      | 34 |   |
| Comprehensive income                    |   | $                                  | 673    |   | $ | 461 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

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**AXS-ONE INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS**(In thousands)(Unaudited)

 
|                                                                                     |   | **Three  Months Ended March 31,** |   |
|------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                                     |   | **2004**                          |   | **2003** |   |
| Cash flows from operating activities:                                                    |   |                              |   |   |   |
| Net income                                                                               |   | $                                 | 753    |   | $ | 427 |   |
| Adjustments to reconcile net income to net  cash flows provided by operating activities: |   |                              |   |   |   |
| Depreciation and amortization                                                            |   | 333                               |   | 397 |   |
| Net recovery of doubtful accounts                                                        |   | (19                               | )      | (121 | ) |
| Gain on sale of subsidiary                                                               |   | —                            |   | (71 | ) |
| Equity in losses of joint venture                                                        |   | 33                                |   | 19 |   |
| Consulting services received in lieu of  payment on accounts receivable                  |   | 8                                 |   | 25 |   |
| Changes in current assets and liabilities:                                               |   |                              |   |   |   |
| Restricted cash                                                                          |   | —                            |   | 23 |   |
| Accounts receivable                                                                      |   | (1,451                            | )      | (1,819 | ) |
| Due from joint venture                                                                   |   | (6                                | )      | 79 |   |
| Prepaid expenses and other current assets                                                |   | (125                              | )      | (196 | ) |
| Accounts payable and accrued expenses                                                    |   | 47                                |   | (545 | ) |
| Deferred revenue                                                                         |   | 1,996                             |   | 2,022 |   |
|                                                                                     |   |                              |   |   |   |
| Net cash flows provided by operating  activities                                         |   | 1,569                             |   | 240 |   |
|                                                                                     |   |                              |   |   |   |
| Cash flows from investing activities:                                                    |   |                              |   |   |   |
| Change in other assets                                                                   |   | 20                                |   | 4 |   |
| Loan to joint venture                                                                    |   | (6                                | )      | (21 | ) |
| Capitalized software development costs                                                   |   | (334                              | )      | (285 | ) |
| Purchase of equipment and leasehold  improvements                                        |   | (116                              | )      | (36 | ) |
| Net cash flows used in investing activities                                              |   | (436                              | )      | (338 | ) |
|                                                                                     |   |                              |   |   |   |
| Cash flows from financing activities:                                                    |   |                              |   |   |   |
| Proceeds from exercise of stock options and  warrants                                    |   | 264                               |   | 38 |   |
| Payments of long-term debt                                                               |   | (547                              | )      | (450 | ) |
| Net cash flows used in financing activities                                              |   | (283                              | )      | (412 | ) |
| Foreign currency exchange rate effects on  cash and cash equivalents                     |   | (86                               | )      | 61 |   |
| Net increase (decrease) in cash and cash  equivalents                                    |   | 764                               |   | (449 | ) |
| Cash and cash equivalents, beginning of  period                                          |   | 2,946                             |   | 2,702 |   |
| Cash and cash equivalents, end of period                                                 |   | $                                 | 3,710  |   | $ | 2,253 |   |
|                                                                                     |   |                              |   |   |   |
| Supplemental disclosures of cash flow  information:                                      |   |                              |   |   |   |
| Cash paid during the period for—                                                    |   |                              |   |   |   |
| Interest                                                                                 |   | $                                 | 17     |   | $ | 79 |   |
| Income taxes                                                                             |   | $                                 | 12     |   | $ | 2 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

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

 

**(1) OPERATIONS, BUSINESS CONDITIONS AND SIGNIFICANT ACCOUNTING POLICIES**

 

The Company designs, marketsand supports n-tier, Internet-enabled client/server, e-business, financial,workflow, desktop data access and storage solutions and email compliancesoftware for global 2000 businesses, and scheduling and time and expensesolutions for professional services organizations.  The Company also offers consulting, implementation, training andmaintenance services in support of its customers’ use of its software products.

 

(a) *Basis ofPresentation*

 

The accompanying consolidatedfinancial statements include the accounts of AXS-One Inc., its wholly ownedsubsidiaries located in Australia, Singapore, South Africa, and the UnitedKingdom and its division located in Canada (collectively, the *“Company*”).  All significant intercompany transactionsand balances have been eliminated.  InDecember 2003, the Company dissolved the legal entity of the subsidiary locatedin Canada.  The Canadian operation is nowa division of the U.S. operation and as such continues to be included in theconsolidated financial statements of the Company.

 

The Company has a 49% ownershipin one joint venture in its South African operation.  All significant intercompany transactions and balances have beeneliminated.  The joint venture isconsidered to be a variable interest entity as defined in FASB InterpretationNo. 46, “Consolidation of Variable Interest Entities” (FIN 46).  Since it was determined that the Company isnot the primary beneficiary as defined in FIN 46, the Company continues to usethe equity method of accounting for its joint venture whereby investments arestated at cost plus or minus the Company’s equity in undistributed earnings orlosses.

 

The unauditedconsolidated financial statements have been prepared by the Company inaccordance with accounting principles generally accepted in the United Statesof America and, in the opinion of management, contain all adjustments,consisting only of those of a normal recurring nature, necessary for a fairpresentation of these consolidated financial statements.

 

These consolidated financialstatements should be read in conjunction with the consolidated financialstatements and related notes included in the Company’s 2003 Annual Report onForm 10-K filed with the Securities and Exchange Commission.

 

The results ofoperations for the three-month period ended March 31, 2004 are not necessarilyindicative of results to be expected for the full year 2004 or any futureperiods.

 

(b) *Revenue Recognition*

 

The Company recognizes revenue in accordance with Statement of Position97-2, “Software Revenue Recognition” (“SOP 97-2”), and Statement of Position98-9, “Modification of SOP 97-2, Software Revenue Recognition, With Respect toCertain Transactions.”  Revenue fromnon-cancelable software licenses is recognized when the license agreement hasbeen signed, delivery has occurred, the fee is fixed or determinable andcollectibility is probable.  In multipleelement arrangements, the Company defers the vendor-specific objective evidenceof fair value (“VSOE”) related to the undelivered

 

7

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elements and recognizes revenue on the delivered elements using theresidual method.  The most commonly deferredelement is initial maintenance, which is recognized on a straight-line basisover the initial maintenance term.  TheVSOE of maintenance is determined by using a consistent percentage ofmaintenance fee to license fee based on renewal rates.  Maintenance fees in subsequent years arerecognized on a straight-line basis over the life of the applicableagreement.  Delivery of softwaregenerally occurs when the product (on CDs) is delivered to a common carrier.  Occasionally, delivery occurs through electronicmeans where the software is made available through the Company’s secure FTP(File Transfer Protocol) site.

 

For software license andmaintenance revenue, the Company assesses whether the fee is fixed anddeterminable and whether or not collection is probable.  The Company assesses whether the fee isfixed and determinable based on the payment terms associated with thetransaction.  If a significant portionof a fee is due after the Company’s normal payment terms, which are 30 to 90days from invoice date, it accounts for the fee as not being fixed anddeterminable.  In these cases, theCompany recognizes revenue as the fees become due.

 

The majority ofthe Company’s training and consulting services are billed based on hourlyrates.  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 Companyenters into an arrangement that requires it to perform significant work eitherto alter the underlying software or to build additional complex interfaces sothat the software performs as the customer requests, the Company recognizes theentire fee using contract accounting. This would apply to the Company’s custom programming services which aregenerally contracted on a fixed fee basis. Anticipated losses, if any, are charged to operations in the period suchlosses are determined.

 

Revenues from the joint venture(included in Revenues: Other-Related Parties in the Company’s ConsolidatedStatements of Operations) include consulting revenue for the joint venture’suse of the Company’s South African subsidiary’s consultants and for managementfees arising from the Company’s South African subsidiary providing managerial,technical and other related services, including director services, to the jointventure in accordance with the joint venture agreement.  Revenue is recognized upon performance ofthe 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.  TheCompany does not request collateral from its customers.  If the Company determines that collection ofa fee is uncertain, it defers the fee and recognizes revenue at the time theuncertainty is eliminated, which is generally upon receipt of cash.

 

In accordance withEITF Issue No. 01-14, “Income Statement Characterization of ReimbursementReceived for ‘Out of Pocket’ Expenses Incurred,” reimbursements received forout-of-pocket expenses incurred are classified as services revenue in theunaudited consolidated statements of operations.

 

8

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(c)*Variable Interest Entity*

 

We adopted FIN 46as required on March 31, 2004.  TheCompany’s 49% owned joint venture, African Solutions (Pty) Ltd (“AfricanSolutions”), is considered to be a variable interest entity as defined in FIN46.  Because it was determined that theCompany is not the primary beneficiary of African Solutions, the adoption ofFIN 46 did not have a material impact on the Company’s consolidated financialposition or results of operations.

 

African Solutionsis acting as an non-exclusive authorized third party service provider toprovide 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 software products, but isrequired to remain exclusively focused on the AXS-One product range.  African Solutions conducts businessthroughout the African continent where its target markets are the FinancialSector and Government Departments.

 

As of March 31, 2004, AXS-One’stotal exposure to loss as a result of its involvement in African Solutions is$81, representing the Company’s net investment in African Solutions as of March31, 2004.

 

Presented below is selectedfinancial data for African Solutions for the three months ended March 31, 2004and 2003.

 

|                             |   | **Three  Months Ended March 31,** |   |
|----------------------------------|--------|-----------------------------------|--------|
|                             |   | **2004**                          |   | **2003** |   |
| Total revenues                   |   | $                                 | 333    |   | $ | 533 |   |
| Operating income (loss)          |   | $                                 | (27    | ) | $ | (13 | ) |
| Total assets                     |   | $                                 | 356    |   | $ | 486 |   |
| Total stockholders’ deficit |   | $                                 | (1,311 | ) | $ | (946 | ) |

 

(d)*Stock-Based Compensation*

 

In December 2002,the FASB issued Statement No. 148, “Accounting for Stock BasedCompensation-Transition and Disclosure, an Amendment of FASB Statement No. 123”(“SFAS 148”).  SFAS 148 amends FASBStatement No. 123, “Accounting for Stock-based Compensation” (“SFAS 123”), toprovide alternative methods of transition for a voluntary change to the fairvalue method of accounting for stock-based compensation.  However, it allows an entity to continue tomeasure compensation cost for those instruments using the intrinsic-valuemethod of accounting prescribed by Accounting Principles Board Opinion No. 25(“APB 25”), “Accounting for Stock Issued to Employees,” provided it disclosesthe effect of SFAS 123, as amended by SFAS 148, in the footnotes to the financialstatements.  On November 14, 2003, theFASB decided to require stock-based employee compensation to be recorded as acharge to earnings beginning in 2005. Until that time, the Company has chosen to continue to account forstock-based compensation using the intrinsic value method.  Accordingly, no stock option related

 

9

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compensationexpense has been recognized in the consolidated statements of operations, asall options granted had an exercise price equal to the market value of theunderlying stock on the date of grant.

 

Had the Company, however,elected to recognize compensation cost based on fair value of the stock optionsat the date of grant under SFAS 123, as amended by SFAS 148, such costs wouldhave been recognized ratably over the vesting period of the underlyinginstruments and the Company’s net income and net income per common share wouldhave changed to the pro forma amounts indicated in the table below.

 
|                                                                                                             |   | **Three  Months Ended March 31,** |   |
|------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                                                             |   | **2004**                          |   | **2003** |   |
|                                                                                                             |   |                              |   |   |   |
| Net income as reported                                                                                           |   | $                                 | 753    |   | $ | 427 |   |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all awards |   | 180                               |   | 388 |   |
| Pro forma net income                                                                                             |   | $                                 | 573    |   | $ | 39 |   |
|                                                                                                             |   |                              |   |   |   |
| Net income per common share:                                                                                     |   |                              |   |   |   |
| Basic-as reported                                                                                                |   | $                                 | 0.03   |   | $ | 0.02 |   |
| Basic-pro forma                                                                                                  |   | $                                 | 0.02   |   | — |   |
|                                                                                                             |   |                              |   |   |   |
| Diluted-as reported                                                                                              |   | $                                 | 0.03   |   | $ | 0.02 |   |
| Diluted-pro forma                                                                                                |   | $                                 | 0.02   |   | — |   |

 

The Company has used the Black-Scholesoption-pricing model in calculating the fair value of options granted.  The assumptions used and the weightedaverage information for the three months ended March 31, 2004 and 2003 are asfollows:

 
|                                                                                                             |   | **Three Months Ended March 31,** |   |
|------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|--------|
|                                                                                                             |   | **2004**                         |   | **2003** |   |
| Risk-free interest rate                                                                                          |   | 4.78                             | %      | 4.84 | % |
| Expected dividend yield                                                                                          |   | —                           |   | — |   |
| Expected lives                                                                                                   |   | 7 years                          |   | 7 years |   |
| Expected volatility                                                                                              |   | 76                               | %      | 80 | % |
| Weighted-average grant date fair value of  options granted during the period                                     |   | $                                | 2.08   |   | $ | 0.64 |   |
| Weighted-average remaining contractual life  of options outstanding                                              |   | 6.14 years                       |   | 6.75 years |   |
| Weighted-average exercise price of 3,911  and 3,891 options exercisable at March 31, 2004 and 2003, respectively |   | $                                | 1.66   |   | $ | 1.58 |   |

 

10

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**(2) REVOLVING LINE OF CREDIT AND LONG-TERM DEBT**

 

On March 31, 1998,the Company entered into a Loan and Security Agreement (“Agreement”) thatcontained a revolving line of credit and a term loan (the “Initial Term Loan”).

 

Borrowings underthe revolving line of credit bear annual interest at prime rate plus 1.25%subject to a minimum interest rate of 8.0% per annum.  The Agreement provides for yearly fees as follows:  (i) $111 in year one, $86 in years two andthree, $77 in year four, $74 in years five and six and (ii) an unused revolvingline of credit fee of .375% per annum. The Agreement is secured by substantially all domestic assets of theCompany together with a pledge of 65% of the stock of its foreign subsidiaries,and contains certain restrictive financial covenants.  Under the revolving line of credit the Company currently hasavailable the lesser of $5 million or 85% of eligible receivables, asdefined.  The net available amount underthe revolving line of credit at March 31, 2004 was approximately $1.4 millionof which no amounts were outstanding.

 

The Initial TermLoan provided for $5 million available in one draw-down which the Companyborrowed on the closing date in 1998. Effective December 22, 1999, the Company amended the Agreement(Amendment No. 7) in order to make available to the Company a second term loanin the original principal amount of $1.3 million, which the Company borrowed onthat date.  The Initial Term Loan andthe second term loan, collectively the “A Term Loan,” bore interest at theprime rate as defined plus 1.5% subject to a minimum interest rate of 8.0% perannum.  The A Term Loan was fully repaidin June 2002 and no amounts remain outstanding.

 

Amendment No. 7 also madeavailable a third term loan (the “B Term Loan”) in the original principalamount of $750, which the Company borrowed in full.  The B Term Loan bore interest at the fixed rate of 12.0% perannum.

 

Subsequentamendments to the Agreement made available additional ‘B’ term loans in theoriginal principal amounts totaling up to $4.5 million, of which the Companyborrowed $4.0 million, extended the termination date of the credit facility toMarch 31, 2004 and established restrictive financial covenants based oncumulative EBITDA (earnings before interest, taxes and depreciation andamortization).  The Company was in compliancewith these covenants through March 31, 2004. (For further information see Note 3 to the Company’s 2003 Annual Reporton Form 10-K.)

 

The aggregateoutstanding principal amount of the Term Loans was repayable in monthlyinstallments of $150 beginning September 2002 over the remaining term of theAgreement.  Any unpaid principal andinterest was due in full and paid on March 31, 2004.  As of March 31, 2004 there were no amounts outstanding on theterm loan.

 

On March 26, 2004, the Companyfurther amended the Agreement (Amendment No. 15) to extend the termination datefrom March 31, 2004 to May 28, 2004.

 

11

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**(3) BASIC AND DILUTED NET INCOME PER COMMON SHARE**

 

Basic and diluted net incomeper common share is presented in accordance with SFAS No. 128, “Earnings perShare” (“SFAS No. 128”).

 

Basic net income per commonshare is based on the weighted average number of shares of common stockoutstanding during the period.  Dilutednet income per common share for the three months ended March 31, 2004 and 2003does not include the effects of outstanding options to purchase 654 and 4,115shares of common stock, respectively, and outstanding warrants to purchase zeroand 100 shares of common stock, respectively, as the effect of their inclusionis anti-dilutive for the periods.

 

The following represents thecalculations of the basic and diluted net income per common share for the threemonths ended March 31, 2004 and 2003.

 
|                                                                   |   | **Three  Months Ended March 31,** |   |
|------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                   |   | **2004**                          |   | **2003** |   |
|                                                                   |   |                              |   |   |   |
| Net income                                                             |   | $                                 | 753    |   | $ | 427 |   |
| Weighted average basic common shares  outstanding during the periods   |   | 25,250                            |   | 24,865 |   |
|                                                                   |   |                              |   |   |   |
| Dilutive effect of stock options and  warrants                         |   | 3,532                             |   | 716 |   |
|                                                                   |   |                              |   |   |   |
| Weighted average diluted common shares  outstanding during the periods |   | 28,782                            |   | 25,581 |   |
|                                                                   |   |                              |   |   |   |
| Basic net income per common share                                      |   | $                                 | 0.03   |   | $ | 0.02 |   |
|                                                                   |   |                              |   |   |   |
| Diluted net income per common share                                    |   | $                                 | 0.03   |   | $ | 0.02 |   |

 

**(4)  OPERATING SEGMENTS**

 

In the fourth quarter of2003 the Company consolidated the sales and marketing efforts of its threebusiness units in order to streamline the sales process and controlexpenses.  The Company now has only twoproduct lines that it offers to specific markets as part of its strategy tofocus on market opportunities.  The twoproduct lines are as follows:

 

a)              AXS-OneEnterprise Solutions provide Enterprise Solutions to global 2000 companies thatenable organizations to achieve process transparency throughout their valuechain.  These include AXS-One’sFoundation products for which the Company has an extensive installed base ofcustomers.  It also includes TivitySolutions, a verticalized version of AXS-One Enterprise solutions that providea full suite of business solutions and services to organizations that primarilysell professionals’ time.

 

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b)             AXSPointSolutions focus on identifying markets that need to rapidly leverage theInternet in communicating, exchanging or reconciling large volumes of knowledgewith their customers, suppliers and partners. The AXSPoint Solutions target large information-centric organizationsthat can utilize self-service information systems to improve communicationswith their customers and improve access to business intelligence.  AXSPoint technology is also an electronicbooks and records repository, and not only delivers a powerful portal toinformation but can also eliminate many paper production and storagecosts.  As an enterprise solution,AXSPoint provides the ability to meet and manage compliance mandates and toleverage the corporate knowledge contained within email, instant messaging, andother ancillary systems.

 

The Companyevaluates the performance of its two product lines based on revenues andoperating income.  Summarized financialinformation concerning the Company’s reportable segments is shown in thefollowing 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  Enterprise  Solutions** |   | **AXSPoint  Solutions** |   | **Total** |   |
|--------------------------------------------------|--------|------------------------------------|--------|-------------------------|--------|-----------|--------|
|                                             |   |                               |   |                    |   |      |   |
| **Three Months Ended March 31, 2004**            |   |                               |   |                    |   |      |   |
| Revenues:                                        |   |                               |   |                    |   |      |   |
| License fees                                     |   | $                                  | 640    |                    | $      | 1,820     |   | $ | 2,460 |   |
| Services                                         |   | 7,213                              |   | 1,198                   |   | 8,411     |   |
| Total revenues, excluding related party  revenue |   | 7,853                              |   | 3,018                   |   | 10,871    |   |
| Operating income                                 |   | 1,080                              |   | 1,499                   |   | 2,579     |   |
| Total assets.                                    |   | 12,347                             |   | 2,340                   |   | 14,687    |   |
| Capital expenditures                             |   | 104                                |   | 12                      |   | 116       |   |
| Depreciation and amortization                    |   | 327                                |   | 6                       |   | 333       |   |
|                                             |   |                               |   |                    |   |      |   |
| **Three Months Ended March 31, 2003 (1) (2)**    |   |                               |   |                    |   |      |   |
| Revenues:                                        |   |                               |   |                    |   |      |   |
| License fees                                     |   | $                                  | 1,115  |                    | $      | 126       |   | $ | 1,241 |   |
| Services                                         |   | 7,022                              |   | 1,067                   |   | 8,089     |   |
| Total revenues, excluding related party  revenue |   | 8,137                              |   | 1,193                   |   | 9,330     |   |
| Operating income                                 |   | 1,612                              |   | 350                     |   | 1,962     |   |
| Total assets                                     |   | 9,960                              |   | 2,238                   |   | 12,198    |   |
| Capital expenditures                             |   | 31                                 |   | 5                       |   | 36        |   |
| Depreciation and amortization                    |   | 386                                |   | 11                      |   | 397       |   |

 

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

(2) Certain amounts, previouslyreported in the AXSPoint product line, have been reclassified to AXS-OneEnterprise to conform to the current year presentation.

 

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Reconciliation of total segment operatingincome to consolidated operating income:

 
|                                             |   | **Three  Months Ended** |   |
|--------------------------------------------------|--------|-------------------------|--------|
|                                             |   | **March 31,  2004**     |   | **March 31,  2003** |   |
|                                             |   |                    |   |   |   |
| Operating income from reportable segments        |   | $                       | 2,579  |   | $ | 1,962 |   |
| Unallocated revenue, other-related parties       |   | 51                      |   | 115 |   |
| Unallocated general and administrative  expenses |   | (1,552                  | )      | (1,311 | ) |
| Other corporate unallocated expenses             |   | (272                    | )      | (246 | ) |
| Total consolidated operating income              |   | $                       | 806    |   | $ | 520 |   |

 

**(5)  DIVESTITURE**

 

On September 20, 2001, the Company sold its wholly-owned subsidiarylocated in Central and Eastern Europe (C.E.E.), including offices in Poland,Estonia and Bulgaria, to Porterfield International Ltd. (“Buyer”), a companywholly-owned by the former managing director of C.E.E. and his wife.  The Company received consideration in theform of a promissory note of Buyer in the face amount of $430 which was paid asof December 31, 2002.  A net assetdeficiency of the C.E.E. operations of $(3), at the time of the sale, offset byaccrued expenses of $180, directly related to the sale, resulted in a deferredgain of approximately $253, which the Company recorded in accordance with theSecurities and Exchange Commission’s Staff Accounting Bulletin No. 81 (SAB 81),“Gain Recognition on the Sale of a Business or Operating Assets to a HighlyLeveraged Entity.”  Additional directcosts of the sale of $3 and $5 recorded during the three months ended June 30,2002 and December 31, 2002, respectively, reduced the total deferred gain to$245.

 

The Company recognized such gain as the note receivable was paid orequivalent value for services was received, but only after $180 wasreceived.  Through December 31, 2002,$430 had been received in either payment to the Company or equivalent servicesprovided by the Buyer to the Company or to the Company’s joint venture.  The Company recognized $219 of such gainthrough December 31, 2002, which included a reversal of $45 related to theoriginal $180 in accrued expenses recorded at the time of the sale.  The $45 was recognized during the threemonths ended September 30, 2002 as a result of the release of a past customerclaim.  The remaining gain of $71,reflected as Deferred revenue on the December 31, 2002 consolidated balancesheet, was recognized in February 2003 when the Company received payment fromthe Company’s joint venture for services provided by the Buyer to the jointventure.  The following table shows the activity related to thepromissory note and related deferred gain and gain recognized:

 

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|                                                              |   | **Note  Receivable** |   | **Deferred  Gain** |   | **Gain  Recognized** |   |
|-------------------------------------------------------------------|--------|----------------------|--------|--------------------|--------|----------------------|--------|
| Balance at December 31, 2001                                      |   | $                    | 336    |               | $      | 253                  |   | $ | — |   |
| Direct expense incurred in June 2002                              |   | —               |   | (3                 | )      | —               |   |
| Cash payments and services received 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 received from joint venture  through March 31, 2003 |   | —               |   | (71                | )      | 71                   |   |
| Balance at March 31, 2003                                         |   | $                    | — |               | $      | —               |   | $ | 290 |   |

 

**(6) CONTINGENCIES**

 

Historically, the Company hasbeen involved in disputes and/or litigation encountered in its normal course ofbusiness.  The Company believes that theultimate outcome of these proceedings will not have a material adverse effecton the Company’s business, consolidated financial condition, results ofoperations or cash flows.

 

**(7) SUBSEQUENT EVENTS**

 

On April 5, 2004, the Companycompleted an offer and sale of 2,580 shares of common stock for $3.10 per sharein a private placement for consideration of $8,000 (or approximately $7.8million net of direct costs).  TheCompany also issued, at the same time, warrants to purchase an aggregate of 258shares of common stock at $3.98 per share and warrants to purchase 258 sharesof common stock at $4.50 per share. These warrants are exercisable for a period of three years beginningApril 5, 2004.  This private placementand issuance of warrants were made pursuant to the terms of a Unit SubscriptionAgreement, dated as of April 1, 2004, among the Company and several investors.

 

Issuance of the common stock and warrants in the private placement wasnot registered under the Securities Act of 1933 (“the Act”) in reliance uponSection 4(2) of the Act based on the fact that the shares of common stock andthe warrants were issued to a small number of sophisticated investors who hadextensive knowledge of the Company at the time of the issuance.

 

On April 8, 2004, the Companyfiled a Form 8-K with the SEC disclosing details of the private placement andissuance of warrants.  On May 4, 2004,the Company filed a Form S-3 registration statement with the SEC covering theresale of the securities issued and securities issuable upon exercise of thewarrants.

 

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**Item 2.  Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

The followingdiscussion should be read in conjunction with the Consolidated InterimFinancial Statements and Notes thereto and is qualified in its entirety byreference thereto.

 

This Report contains statements of a forward-lookingnature within the meaning of the safe harbor provisions of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the Securities ExchangeAct of 1934, as amended, relating to future events or the future financialperformance of AXS-One.  Investors arecautioned that such statements are only predictions and that actual events orresults may differ materially.  Inevaluating such statements, investors should specifically consider the variousfactors identified in this Report which could cause actual results to differmaterially from those indicated by such forward-looking statements, includingthe matters set forth in “Business—Risk Factors” in our 2003 Annual Report onForm 10K.

 

**Executive Overview**

 

We are a leading provider ofrecords management, email and instant messaging archival management, financialmanagement, and workflow software designed to efficiently manage complexbusiness processes.  We have implementedhigh-volume, interoperable, scalable and secure business solutions for global2000 companies.  Our Web Services-basedtechnology has been critically acclaimed as best of class.  Our Compliance Platform Solutions providefast deployment of email/instant messaging archival solutions for regulatorycompliance and operational efficiency. See “Item 1.  Business” in our2003 Annual Report on Form 10K.

 

Our revenues are derived mainlyfrom license fees from software license agreements entered into between AXS-Oneand our customers with respect to both our products and, to a lesser degree,third party products resold by AXS-One and services revenues from softwaremaintenance agreements, training, consulting services including installationand custom programming.

 

We are based in Rutherford, NewJersey with approximately 250 full-time employees in offices worldwide,including Asia, Australia, Canada, South Africa, the United Kingdom and theUnited States.  Our foreign officesgenerated approximately 36.4% and 37.0% of our total revenues for the threemonths ended March 31, 2004 and 2003, respectively.  We expect that such revenues will continue to represent asignificant percentage of our total revenues in the future.  Most of our international license fees andservice revenues are denominated in foreign currencies.  Fluctuations in the value of foreigncurrencies relative to the US dollar in the future could result in fluctuationsin our revenue.

 

We have a 49% ownership in onejoint venture in our South African operation, AXS-One African Solutions (Pty)Ltd (“African Solutions”).  AfricanSolutions sells and services our suite of products.  We use the equity method of accounting for our investmentwhereby, the investment is stated at cost plus or minus our equity inundistributed earnings or losses.

 

We encounter competition forall of our products in all markets and compete primarily based on the qualityof our products, our price, our customer service and our time toimplement.  The timing of the release ofnew products is also important to our ability to generate sales.  During the second half of 2003, we releasedour new Email and Instant Messaging Archival, Supervision & Legal Discovery(“Email Compliance”) software in response to new regulatory requirements forfinancial institutions in the United States as well as to address the need toreduce costs in the email management area. This new product alone accounted for approximately 49% of our totallicense fee revenues in the fourth quarter of 2003 and 38% in the first quarterof 2004.  In early 2004, we increasedour sales and services teams in order to

 

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meet the needs of this growingmarket and capitalize on this opportunity. However, there is no assurance that these efforts will achieve thedesired results.

 

Our future ability to growrevenue will be directly affected by increased price competition and anincreasingly higher maintenance revenue base from which to grow.  Our growth rate and total revenues dependsignificantly on future upgrades for existing customers as well as our abilityto expand our customer base and to respond successfully to the pace oftechnological change.  If our renewalrate or pace of new customer acquisitions slows, our revenues and operatingresults would be adversely affected.

 

We have experienced, and may inthe future experience, significant fluctuations in our quarterly and annualrevenues, results of operations and cash flows.  We believe that domestic and international operating results andcash flows will continue to fluctuate significantly in the future as a resultof a variety of factors.  For adescription of these factors that may affect our operating results, see  “Business—Risk Factors” in our 2003 AnnualReport on Form 10K.

 

In April 2004, William P. Lyonsjoined AXS-One in the position of President and Chief Executive Officer, aswell as a director.  He replaces John A.Rade, who, as previously announced, is retiring after seven years with AXS-One,but who will remain with the company as a non-executive employee for atransition period.  Mr. Lyons has over20 years experience in the software industry in various executive positionsincluding CEO.  A Form 8-K was filedwith the SEC on April 30, 2004 describing the specifics of our agreement withMr. Lyons.

 

On April 5, 2004, we completeda private placement of shares of common stock that resulted in an increase incash of approximately $7.8 million, net of related direct costs.  We expect to use the proceeds from theprivate placement to strengthen our balance sheet and to develop and continuethe business activities of AXS-One. (See Part II, Item 2: “Changes inSecurities and Use of Proceeds.”)

 

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**Results of Operations**

 

The following table sets forth for the periodsindicated, certain operating data, and data as a percentage of total revenues:

 
|                               |   | **Three  Months Ended  March 31, 2004** |   | **Three  Months Ended  March 31, 2003** |   |
|------------------------------------|--------|-----------------------------------------|--------|-----------------------------------------|--------|
| **(in thousands)**                 |   | **As  Reported**                        |   | **Data as a  percent of  revenue**      |   | **As  Reported** |   | **Data as a  percent of  revenue** |   |
|                               |   | **Unaudited**                           |   | **Unaudited**                           |   |
| Revenues:                          |   |                                    |   |                                    |   |   |   |   |   |
| License fees                       |   | $                                       | 2,460  |                                    | 22.5   | % | $ | 1,241 |   | 13.1 | % |
| Services                           |   | 8,411                                   |   | 77.0                                    |   | 8,089 |   | 85.7 |   |
| Other-related parties              |   | 51                                      |   | 0.5                                     |   | 115 |   | 1.2 |   |
| Total revenues                     |   | 10,922                                  |   | 100.0                                   |   | 9,445 |   | 100.0 |   |
|                               |   |                                    |   |                                    |   |   |   |   |   |
| Operating expenses:                |   |                                    |   |                                    |   |   |   |   |   |
| Cost of license fees               |   | 411                                     |   | 3.8                                     |   | 341 |   | 3.6 |   |
| Cost of services                   |   | 4,269                                   |   | 39.1                                    |   | 3,964 |   | 42.0 |   |
| Sales and marketing                |   | 1,970                                   |   | 18.0                                    |   | 1,631 |   | 17.3 |   |
| Research and development           |   | 1,899                                   |   | 17.4                                    |   | 1,674 |   | 17.7 |   |
| General and administrative         |   | 1,567                                   |   | 14.3                                    |   | 1,315 |   | 13.9 |   |
| Total operating expenses           |   | 10,116                                  |   | 92.6                                    |   | 8,925 |   | 94.5 |   |
| Operating income                   |   | 806                                     |   | 7.4                                     |   | 520 |   | 5.5 |   |
| Other income (expense):            |   |                                    |   |                                    |   |   |   |   |   |
| Equity in losses of joint ventures |   | (33                                     | )      | (0.3                                    | )      | (19 | ) | (0.2 | ) |
| Other expense, net                 |   | (20                                     | )      | (0.2                                    | )      | (74 | ) | (0.8 | ) |
| Other expense, net                 |   | (53                                     | )      | (0.5                                    | )      | (93 | ) | (1.0 | ) |
| Net income                         |   | $                                       | 753    |                                    | 6.9    | % | $ | 427 |   | 4.5 | % |

 

 

**Comparison of 2004 to 2003 First QuarterResults**

 

*Revenues*

 

Total revenuesincreased $1.5 million or 15.6% for the three months ended March 31, 2004, ascompared to the three months ended March 31, 2003 due to increases of 98.2% and4.0% in license fees and services revenues, respectively.  The increase in license fees was mainlyattributable to an increase of $1.2 million in our U.S. operations due mainlyto sales of our email management software, released in the second half of 2003,to three new customers and one existing customer.  Our license fee revenues also included licenses of our newere-Cellerator products to our existing customers and one new customer as well asthe license of additional users for previously licensed software.

 

The increase inservices revenues resulted mainly from increases of $0.2 million in maintenancerevenue resulting from new license agreements and customary annual increasesfor existing agreements and $0.2

 

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million in customprogramming due to a large agreement with one customer in the U.S.operation.  This was partially offset bya decrease of $0.1 million in consulting revenue in our Australian operations.

 

The followingtable sets forth for the periods indicated each major category of our servicerevenues as a percent of total service revenues:

 
|                   |   | **Three  Months Ended March 31,** |   |
|------------------------|--------|-----------------------------------|--------|
|                   |   | **2004**                          |   | **2003** |   |
| **(in thousands)**     |   | **Amount**                        |   | **% of Total** |   | **Amount** |   | **% of Total** |   |
| Maintenance            |   | $                                 | 4,320  |   | 51.4 | % | $ | 4,093 |   | 50.6 | % |
| Consulting             |   | 3,776                             |   | 44.9 | % | 3,856 |   | 47.7 | % |
| Training               |   | 17                                |   | 0.2 | % | 26 |   | 0.3 | % |
| Custom programming     |   | 298                               |   | 3.5 | % | 114 |   | 1.4 | % |
| Total services revenue |   | $                                 | 8,411  |   | 100.0 | % | $ | 8,089 |   | 100.0 | % |

 

Other-RelatedParty revenues include management/directors’ fee revenue and consulting revenuefrom African Solutions.  The decrease inmanagement/directors’ fee revenue for the three months ended March 31, 2004 ascompared to the same period in 2003 resulted from our decision in the secondquarter of 2003 to temporarily stop charging management fees until AfricanSolutions becomes profitable.  Wecontinued to charge directors’ fees for both periods.  The decrease in consulting revenue resulted from decreased use ofconsultants from African Solutions, choosing instead to utilize our owninternal staff.

 
|                                   |   | **Three  Months Ended March 31,** |   |
|----------------------------------------|--------|-----------------------------------|--------|
| **(in thousands)**                     |   | **2004**                          |   | **2003** | ** ** |
| Management/Directors’ fee revenue |   | $                                 | 9      |   | $ | 33 |   |
| Consulting revenue                     |   | 42                                |   | 82 |   |
| Total revenues                         |   | $                                 | 51     |   | $ | 115 |   |

 

For both periods,we had a concentration of total revenues within a few select customers.  For the three months ended March 31, 2004,total revenues included $1.9 million or 17.6% of total revenues from onecustomer.  Total revenues for the threemonths ended March 31, 2003 included $1.7 million each or 17.5% and 18.4% oftotal revenues from two customers, respectively.

 

*Expenses*

 

Cost of license fees consistprimarily of amortization of capitalized software development costs and amountspaid to third parties with respect to products we resold in conjunction withthe licensing of our products.  Theelements can vary substantially from period to period as a percentage oflicense fees.  Cost of license feesincreased $70 thousand or 20.5% for the three months ended March 31, 2004 ascompared to the same period in 2003.  A$113 thousand increase in third party royalties due to the increased sales ofthird party software used in conjunction with our software was partially offsetby a $43 thousand decrease in amortization of capitalized software costs as aresult of certain costs becoming fully amortized in 2003.

 

Cost of services consistsprimarily of personnel and third party costs for product quality assurance,training, installation, consulting and customer support.  Cost of services increased $0.3 million or7.7% for the three months ended March 31, 2004 as compared to the three monthsended March 31, 2003.  The increase isprimarily due to an increase of $0.2 million in temps and consultants expensedue to the use of

 

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temporary consultants tosupplement our internal employees on specific assignments related mostly to thedeployment of our newer software products. The increase is also the result of increases of $0.1 million in salariesand wages due to annual merit increases and $70 thousand in travel and livingexpenses.  These increases were partiallyoffset by decreases of $48 thousand in cost of third party services resultingfrom decreased use of third party consultants in our U.K subsidiary and $30thousand of billable expenses.

 

Sales and marketing expensesconsist primarily of salaries, commission and bonuses related to sales andmarketing personnel, as well as travel and promotional expenses.  Sales and marketing expenses increased $0.3million or 20.8% for the three months ended March 31, 2004 as compared to thethree months ended March 31, 2003.  Theincrease is primarily a result of increases of $0.2 million in salaries andwages due to annual merit increases and new hires, $0.1 million in travel andliving expenses and $0.1 million due to increased commission expense as adirect result of the increase in license fee revenue.  These increases were partially offset by a decrease of $0.1million in commission expense in our South African subsidiary.

 

Research and developmentexpenses consist primarily of personnel costs, costs of equipment, facilitiesand third party software development costs. Research and development expenses are generally charged to operations asincurred.  However, certain softwaredevelopment costs are capitalized in accordance with Statement of FinancialAccounting Standards No. 86.  Suchcapitalized software development costs are generally amortized to cost oflicense fees on a straight-line basis over periods not exceeding three years.

 

Research and developmentexpenses (net of capitalized software development costs) increased $0.2 millionor 13.4% for the three months ended March 31, 2004 as compared to the sameperiod in 2003.  The increase isprimarily the result of increases of $0.1 million in salaries and wages due toannual merit increases and new hires and $0.1 million in temps and consultantsfor continued work on development of the Email Compliance software.  We capitalized $0.3 million in softwaredevelopment costs in both periods.  Therate of capitalization of software development costs may fluctuate depending onthe mix and stage of development of our product development and engineeringprojects.

 

General andadministrative expenses consist primarily of salaries for administrative,executive and financial personnel, and outside professional fees.  General and administrative expensesincreased $0.3 million or 19.2% for the three months ended March 31, 2004, ascompared to the three months ended March 31, 2003.  The increase is primarily the result of approximately $150 thousandin recruiting expenses incurred in connection with the selection of our new CEOand $113 thousand in bad debt recovery that reduced general and administrationexpenses in the 2003 period and no similar recovery occurred in 2004.

 

*Operating Income*

 

Operating income increased $0.3million or 55.0% for the three months ended March 31, 2004 as compared to thesame period in 2003 due to the increase in total revenues that more than offsetthe related increase in operating expenses.

 

*Other Expense, Net*

 

Other expense, net decreased$40 thousand for the three months ended March 31, 2004 as compared to the threemonths ended March 31, 2003 as a result of decreases of $61 thousand ininterest expense, $61 thousand in foreign exchange gain/loss and an increase of$13 thousand in interest income partially offset

 

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by a $14 thousand increase inequity in losses of joint ventures.  Wedid not use the revolving line of credit in the first quarter of 2004 and paidthe total remaining balance due on the term loan prior to quarter end, whichreduced our interest expense for the period (See Note 2 to the ConsolidatedInterim Financial Statements.)  For the2003 period we also recorded a gain on the sale of subsidiary of $71 thousandthat was zero for the 2004 period.

 

*Results of Operations*

 

As aconsequence of the above, net income increased $0.3 million or 76% from thequarter ended March 31, 2003 to the quarter ended March 31, 2004.

 

**Liquidity and Capital Resources**

 

On March 31, 1998, we enteredinto a Loan and Security Agreement (“Agreement”) that contained a revolvingline of credit and a term loan. Subsequent amendments to the Agreement since that date made availableadditional term loans (See Note 2 to the Consolidated Interim FinancialStatements). The available amount under the revolving line of credit at March31, 2004 was approximately $1.4 million of which no amounts wereoutstanding.  As of March 31, 2004, theterm loan was paid in full and no amounts remain outstanding.

 

On March 26, 2004, we amended theAgreement to extend the termination date from March 31, 2004 to May 28,2004.  We are currently in discussionswith our existing lender and other financial institutions for possible futurefinancing arrangements.  However, noassurance can be given that we can obtain such future financing arrangements oncommercially acceptable terms.

 

Our operating activitiesprovided cash of $1.6 million and $0.2 million for the three months ended March31, 2004 and 2003, respectively.  Netcash provided by operating activities during the three months ended March 31,2004 is primarily the result of the net income, non-cash depreciation andamortization and an increase in deferred revenue partially offset by anincrease in accounts receivable.  Theincrease in deferred revenue is mainly the result of new agreements executed inthe first quarter as well as annual renewal increases.  The increase in accounts receivable ismainly the result of new license billings at the end of the quarter.

 

Net cash provided by operatingactivities during the three months ended March 31, 2003 was comprised of thenet income, an increase in deferred revenue partially offset by an increase inaccounts receivable and a decrease in accounts payable and accrued expenses.

 

Our investing activities usedcash of $0.4 million and $0.3 million for the three months ended March 31, 2004and 2003, respectively.  The uses ofcash for the three months ended March 31, 2004 were primarily for capitalizedsoftware development costs related to development of new products as well assignificant enhancements to certain existing products and for the purchase ofcomputer equipment.  Cash used forinvesting activities in the 2003 period was mainly for capitalized software developmentcosts related to development of the new email management product as well asother new and existing products.

 

Cash used by financingactivities was $0.3 million and $0.4 million for the three months ended March31, 2004 and 2003, respectively.  Forthe 2004 period, cash was primarily used to pay the remaining balance of theoutstanding term loan.  This waspartially offset by proceeds received from the exercise of stock options andwarrants during the period.  Cash usedfor the 2003 period was for repayment of the term loan.

 

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We have no significant capitalcommitments.  Planned capitalexpenditures for 2004 total approximately $1.5 million, including any softwaredevelopment costs that may qualify for capitalization under SFAS 86.  Our aggregate minimum operating leasepayments for 2004 will be approximately $2.0 million.  We generated net income of $2.3 million and $1.9 million for theyears ended December 31, 2003 and 2002, respectively, after experiencing a netloss of $4.7 million during the year ended December 31, 2001.  For the year ended December 31, 2003, weexperienced an increase in license fee revenues that, along with servicesrevenues, had declined in each of the prior two years primarily as a result ofintense competition and rapid technological change together with a slowing ofthe economy.  The increased license feerevenues along with management’s initiatives over the last two years to improveoperating results and liquidity and better position AXS-One to compete undercurrent market conditions have allowed us to generate net income during everyquarter from September 30, 2001 to the present.  In addition, during the month of October 2003, we extended ourmaintenance agreement with one customer through December 2005 and received anadvance payment of $2.8 million in cash and on April 5, 2004, we completed aprivate placement of shares of common stock that resulted in an increase incash of approximately $7.8 million, net of related direct costs.  Due to these efforts we expect that ourcurrent cash balance and operating cash flow will be sufficient to fund ourworking capital requirements through 2004 and beyond.  Our ability to achieve the anticipated results is affected by theextent of cash generated from operations. There is also the risk that cash held by our foreign subsidiaries willnot be readily available for use in our U.S. operations to pay our obligations as the transfer of funds is sometimes delayeddue to various foreign government restrictions.  Accordingly, we may in the future be required to seek new sourcesof financing or future accommodations from our existing lender or otherfinancial institutions.  Our existinglender has extended the maturity date of the loan agreement from March 31, 2004until May 28, 2004 to give both parties sufficient time to potentially enterinto a new debt agreement.  No assurancecan be given that management’s initiatives will be successful or that any suchadditional sources of financing or lender accommodations will be available.

 

**Segment Information**

 

For the threemonths ended March 31, 2004, AXS-One Enterprise Solutions had license feerevenues of $0.6 million compared to $1.1 million for the comparable prior yearperiod; services revenue of $7.2 million compared to $7.0 million for thecomparable prior year period; and operating income of $1.1 million compared to$1.6 million for the comparable prior year period.  License fees were lower for the three months ended March 31, 2004due to less demand for our higher priced Foundation products while customerspurchased lower cost Web based add-on products.  Service revenues increased due to increased demand for consultingservices in the installed base as customers upgrade to the latest version ofour software.  Operating income for thethree months ended March 31, 2004 decreased $0.5 million from the correspondingprior year period primarily as a result of the decrease in license fee revenueand increases in both cost of services and sales expense.

 

AXSPoint Solutionshad license fee revenues of $1.8 million for the three months ended March 31,2004 compared to $0.1 million for the comparable prior year period; servicerevenues of $1.2 million compared to $1.1 million for the comparable prior yearperiod; and operating income of $1.5 million compared to $0.4 million for thecomparable prior year period.  Theincrease in license revenues was primarily due to sales of our email managementproduct which represented approximately 50% of total AXSPoint license fees forthe quarter.  The increase in servicerevenues was primarily due to increased demand for consulting services toimplement products sold in the fourth quarter of 2003 and early 2004.  The increase in operating income was mainlythe result of the increase in license fee revenue for the three months endedMarch 31, 2004 as compared to the prior year period.

 

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**Critical Accounting Policies**

 

Our critical accountingpolicies are as follows:

 

• Revenue recognition and

 

• Capitalized software developmentcosts.

 

***RevenueRecognition***

 

We derive our revenueprimarily from two sources: (i) software licenses and (ii) services and supportrevenue, which includes software maintenance, training, consulting and customprogramming revenue.  We also derive alimited amount of management and directors’ fee revenue from the joint venture(less than 1% of total revenue in 2003) entered into during 2001 by our SouthAfrican subsidiary.  As described below,certain management judgments and estimates must be made and used in connectionwith the revenue recognized in any accounting period.  Material differences may result in the amount and timing of ourrevenue for any period if our management made different judgments or utilizeddifferent estimates.

 

We normally license oursoftware products on a perpetual basis. Each license agreement generally includes a provision for initialpost-contract support (maintenance). For the majority of license sales we use a signed license agreement asevidence of an arrangement. Occasionally, where a master license agreement with a customer alreadyexists, we accept the customer’s purchase order as evidence of anarrangement.  For maintenance fees, weuse a maintenance agreement as evidence of the arrangement.  We generally use a professional servicesagreement as evidence of an arrangement for our training, custom programmingand consulting revenues.  Management anddirectors’ fee revenues from our joint ventures are evidenced by masteragreements governing the relationship.

 

We recognize revenue inaccordance with Statement of Position 97-2, “Software Revenue Recognition”(“SOP 97-2”), and Statement of Position 98-9, “Modification of SOP 97-2,Software Revenue Recognition, With Respect to Certain Transactions.”  Revenue from non-cancelable softwarelicenses is recognized when the license agreement has been signed, delivery hasoccurred, the fee is fixed or determinable and collectibility is probable.  In multiple element arrangements, we deferthe vendor-specific objective evidence of fair value (“VSOE”) related to theundelivered elements and recognize revenue on the delivered elements using theresidual method.  The most commonlydeferred element is initial maintenance, which is recognized on a straight-linebasis over the initial maintenance term. The VSOE of maintenance is determined by using a consistent percentageof maintenance fee to license fee based on renewal rates.  Maintenance fees in subsequent years arerecognized on a straight-line basis over the life of the applicableagreement.  Delivery of softwaregenerally occurs when the product (on CDs) is delivered to a commoncarrier.  Occasionally, delivery occursthrough electronic means where the software is made available through oursecure FTP (File Transfer Protocol) site.

 

For software license andmaintenance revenue, we assess whether the fee is fixed and determinable andwhether or not collection is probable. We assess whether the fee is fixed and determinable based on the paymentterms associated with the transaction. If a significant portion of a fee is due after our normal payment terms,which are 30 to 90 days from invoice date, we account for the fee as not beingfixed and determinable.  In these cases,we recognize revenue as the fees become due.

 

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The majority of ourtraining and consulting services are billed based on hourly rates.  We generally recognize revenue as theseservices are performed when there is also evidence of an arrangement, the feeis fixed or determinable and collectibility is reasonably assured.  However, when we enter into an arrangementthat requires us to perform significant work either to alter the underlyingsoftware or to build additional complex interfaces so that the softwareperforms as the customer requests, we recognize the entire fee using contractaccounting.  This would apply to ourcustom programming services, which are generally contracted on a fixed feebasis.  Anticipated losses, if any, arecharged to operations in the period such losses are determined.

 

Revenues from the jointventure (included in Revenues: Other-Related Parties in our ConsolidatedInterim Statements of Operations) include consulting revenue for the jointventures’ use of our South African subsidiary’s consultants and for managementand directors’ fees for our subsidiary providing managerial, technical andother related services, including director services, to the joint venture inaccordance with the joint venture agreements. Revenue is recognized upon performance of the services.

 

We assess assuredness ofcollection for revenue transactions based on a number of factors, includingpast transaction history with the customer and the credit-worthiness of thecustomer.  We do not request collateralfrom our customers.  If we determinethat collection of a fee is uncertain, we defer the fee and recognize revenueat the time the uncertainly is eliminated, which is generally upon receipt ofcash.

 

Our arrangements do notgenerally include acceptance clauses. However, if an arrangement includes an acceptance provision, acceptanceoccurs upon the earliest of receipt of a written customer acceptance,expiration of the acceptance period or productive use of the software by thecustomer.

 

***CapitalizedSoftware Development Costs***

 

Our policy is tocapitalize certain software development costs in accordance with Statement ofFinancial Accounting Standards No. 86, “Accounting for the Costs of ComputerSoftware to Be Sold, Leased, or Otherwise Marketed” (“SFAS 86”).  Under SFAS 86, costs incurred to develop acomputer software product are charged to research and development expense asincurred until technological feasibility has been established.  We establish technological feasibility uponcompletion of a detailed program design from which point all research anddevelopment costs for that project are capitalized until the product isavailable for general release to customers. The establishment of technological feasibility and the ongoingassessment of recoverability of capitalized software development costs requireconsiderable judgment by management with respect to certain external factors,including, but not limited to, anticipated future revenues, estimated economiclife and changes in technology.  It isreasonably possible that estimates of anticipated future revenues, theremaining estimated economic life of the products, or both will be reduced inthe future due to competitive pressures. As a result, the carrying amount of the capitalized software costs maybe reduced in the near term.  Upon thegeneral release of the software product to customers, capitalization ceases andsuch costs are amortized (using the straight-line method) on aproduct-by-product basis over the estimated life, which is generally threeyears.

 

**Recently Issued Accounting Standards**

 

In December 2003,the FASB issued Interpretation No. 46, “Consolidation of Variable InterestEntities” (FIN 46) that addresses the consolidation of variable interestentities.  FIN 46 provides guidance fordetermining when a primary beneficiary should consolidate a variable interestentity, or equivalent structure, that functions to support the activities ofthe primary beneficiary.  We adopted FIN46 on March 31, 2004.  Based on ourevaluation of this Interpretation we believe that our 49% owned joint venture,AXS-One African Solutions (Proprietary) Limited (“African Solutions”), is avariable interest

 

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entity (VIE) asdefined in FIN 46.  However, we haveconcluded that we are not the primary beneficiary of African Solutions.  Therefore, the adoption of thisinterpretation did not have a material impact on our consolidated financialposition or results of operations.

 

**Item 3. Quantitative andQualitative Disclosures About Market Risk**

 

In the normal course of business, we are exposed tofluctuations in interest rates and equity market risks as we seek debt andequity capital to sustain our operations. We are also exposed to fluctuations in foreign currency exchange ratesas the financial results and financial conditions of our foreign subsidiariesare translated into U.S. dollars in consolidation.  We do not use derivative instruments or hedging to manage ourexposures and do not currently hold any market risk sensitive instruments fortrading purposes.

 

**Certain Factors That May Affect FutureResults and Financial Condition and the Market Price of Securities**

 

See our 2003 Annual Report onForm 10K for a discussion of risk factors.

 

**Item 4.  Controls andProcedures**

 

***Evaluationof disclosure controls and procedures***

 

Our chiefexecutive officer and our chief financial officer, after evaluating theeffectiveness of our “disclosure controls and procedures” (as defined in theSecurities Exchange Act of 1934 Rule 13a-15(e)) as of March 31, 2004 (the“Evaluation Date”), have concluded that as of the Evaluation Date, ourdisclosure controls and procedures were effective and designed to ensure thatmaterial information relating to us and our consolidated subsidiaries would becollected and made known to them by others within those entities as appropriateto allow timely decisions regarding required disclosure of such information.

 

***Internalcontrols over financial reporting***

 

During the mostrecent fiscal quarter, there has not been any change in our internal controlover financial reporting that has materially affected, or is reasonably likelyto materially affect, our internal control over financial reporting.

 

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Part II

Other Information

 

**Item 1.  Legal Proceedings**

 

Historically, wehave been involved in disputes and/or litigation encountered in our normalcourse of business.  We believe that theultimate outcome of these proceedings will not have a material adverse effecton our business, consolidated financial condition, results of operations orcash flows.

 

**Item 2.  Changesin Securities and Use of Proceeds**

 

On October 1, 2002, the Companyentered into an agreement with a South Carolina corporation to provide investorrelations services to the Company, whereby upon expiration or termination ofthe agreement the Company would issue warrants to purchase the number of sharesof common stock of the Company which was equal to the product of 10,000 sharesmultiplied by the number of whole months during the actual term of theagreement to a maximum of 120,000 shares. The exercise price for the warrants was (i) for the initial up to 60,000shares covered by the warrants, $0.41 per share, which represented the closingprice of the Company’s common stock on October 1, 2002 and (ii) for theremaining shares covered by the warrants, if any, the closing price of theCompany’s common stock on April 1, 2003, which was $0.59 per share.  The warrants were fully vested on the dateof their issuance by the Company.

 

On September 30, 2003, theCompany issued two (2) warrants, each to purchase 60,000 shares of the CommonStock of AXS-One, one with an exercise price of $0.41 per share and one with anexercise price of $0.59 per share in accordance with the agreement.  The expiration date of both warrants isSeptember 30, 2006.  On January 21, 2004all 120,000 warrants were exercised for total proceeds remitted to the Companyof $60,000.

 

The accounting for thesewarrants was determined in accordance with EITF Issue No. 96-18, “Accountingfor Equity Instruments that are Issued to Other than Employees for Acquiring,or in Conjunction with Selling Goods or Services,” and, as a result, the fairvalue of the warrants was being recognized as an expense over the vestingperiod using variable accounting.  Totalexpenses of $34 thousand were recorded in sales and marketing expense for theyear ended December 31, 2003.  Nofurther compensation costs will be recognized related to these warrants sincethe warrants are fully vested.

 

Issuance of thewarrants was not registered under the Securities Act of 1933, as amended (the“Act”) in reliance 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 April 5, 2004, the Companycompleted an offer and sale of 2,580,645 shares of common stock for $3.10 pershare in a private placement for consideration of $8,000,000 (or approximately$7.8 million net of direct costs) to the investors named below.  The Company also issued, at the same time,warrants to purchase an aggregate of 258,065 shares of common stock at $3.98per share and warrants to purchase 258,064 shares of common stock at $4.50 pershare.  These warrants are exercisablefor a period of three years beginning April 5, 2004.  This private placement and issuance of warrants were madepursuant to the terms of a Unit Subscription Agreement, dated as of April 1,2004, among the Company and several investors.

 

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*Investors*

 

Ganot Corporation

Globis Capital Partners L.P.

James Kardon

The Hewlett Fund

Madison Value Ventures I LLC

Madison Value Ventures G.P. III

WPG Select Technology Fund LP

WPG Select Technology OverseasFund Ltd.

Emancipation Capital, LP

Potomac Capital InternationalLtd.

Jack M. Dodick

Fame Associates

Anfel Trading Limited

Jesse B. Shelmire IV

Hayden Communications, Inc.

Globis Overseas Fund Ltd.

Richard Grossman

Anthony Altamura

Steven J. Seif

Madison Value Ventures II LLC

Madison Value Ventures G.P. IV

WPG Select Technology FQP FundLP

Bonanza Master Fund Ltd.

Potomac Capital Partners, L.P.

Pleiades Investment Partners-R,L.P.

Steven W. Spira

Cam Co

Scott R. Griffith

Griffith Shelmire Partners,Inc.

 

Issuance of the common stock and warrants in the private placement wasnot registered under 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.

 

The Company will use the netproceeds from the private placement and the net proceeds, if any, from theexercising of the warrants for working capital and general corporate purposes,including without limitation, to support the operations of each of theCompany’s subsidiaries.

 

On April 8, 2004, the Companyfiled a Form 8-K with the SEC disclosing details of the private placement andissuance of warrants.  On May 4, 2004,the Company filed a Form S-3 registration statement with the SEC covering theresale of the securities issued and securities issuable upon exercise of thewarrants.

 

**Item 6.  Exhibitsand Reports on Form 8-K**

 
| (a) Exhibits  –       |
|----------------------------|
|                       |
|                       | Exhibit 31.1 |   | Rule  13a-14(a)/15d-14(a) Certifications – William P. Lyons |
|                       | Exhibit 31.2 |   | Rule  13a-14(a)/15d-14(a) Certifications – William G. Levering III |
|                       | Exhibit 32 |   | Officer Certifications  under 18 USC 1350 |
|                       |
| (b) Reports  on Form 8-K - |

 

On January 29, 2004, the Companyfurnished a Form 8-K reporting the issue of a press release disclosing materialnon-public information regarding the Registrant’s results of operations for thequarter and year ended December 31, 2003.

 

On February 10, 2004, theCompany filed a Form 8-K announcing the pending retirement of its President andChief Executive Officer, John A. Rade, on or about the end of 2004 and theCompany’s succession plans regarding his position.

 

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SIGNATURES

 

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

 

 
|                               | AXS-ONE INC. |
|------------------------------------|--------------|
|                               |         |
|                               |         |
| **Date:  **May  14, 2004 | By:          | /s/  William P. Lyons |   |
|                               |         | William P.  Lyons |
|                               |         | Chief  Executive Officer, |
|                               |         | President  and Director |
|                               |         |
|                               |         |
|                               | By:          | /s/  William G. Levering III |   |
|                               |         |  William  G. Levering III |
|                               |         |  Vice  President, Chief Financial Officer, |
|                               |         | and  Treasurer |
|                               |         | (Duly  Authorized Officer and |
|                               |         |   Principal  Financial Officer) |
|                                    |              |  |  |  |

 

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