** **

**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

 

**FORM 10-Q**

 

 

**QUARTERLY REPORT PURSUANT TO SECTION13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarter ended September 30,2003**

** **

**Commission FileNumber  1-13591**

 

**AXS-ONEINC.**

(Exactname 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’stelephone number, including area code)

 

Indicate by check mark whether theregistrant:  (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 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 whether the registrantis an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 

YES o    NO ý

 

Number of shares outstanding of the issuer’s commonstock as of November 3, 2003

 

| **Class**                                |   | **Number of  Shares Outstanding** |   |
|------------------------------------------|--------|-----------------------------------|--------|
| Common Stock, par value  $0.01 per share |   | 24,964,992                        |   |

 

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**AXS-ONEINC.**

 

**INDEX**

** **
| **PART I**     |   | **FINANCIAL INFORMATION**                                                                                             |
|----------------|--------|-----------------------------------------------------------------------------------------------------------------------|
|           |   |                                                                                                                  |
|           |   | Item 1. Financial  Statements                                                                                         |
|           |   |                                                                                                                  |
|           |   | Consolidated Balance  Sheets  December 31, 2002 and September 30, 2003 (unaudited)                                    |
|           |   |                                                                                                                  |
|           |   | Consolidated  Statements of Operations (unaudited)  Three and nine months ended September 30, 2002 and 2003           |
|           |   |                                                                                                                  |
|           |   | Consolidated  Statements of Comprehensive Income (unaudited)  Three and nine months ended September 30, 2002 and 2003 |
|           |   |                                                                                                                  |
|           |   | Consolidated  Statements of Cash Flows (unaudited)  Nine months ended September 30, 2002 and 2003                     |
|           |   |                                                                                                                  |
|           |   | Notes  to Consolidated Interim Financial Statements                                                                   |
|           |   |                                                                                                                  |
|           |   | 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                                                                                                            |

 

 

2

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**AXS-ONEINC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

**(Inthousands, except per share data)**

**(Unaudited)**

 
|                                                                                                                                                               |   | **December  31,** |   | **September  30,** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|--------|--------------------|--------|
|                                                                                                                                                               |   | **2002**          |   | **2003**           |   |
| **ASSETS**                                                                                                                                                         |   |              |   |               |   |
| Current assets:                                                                                                                                                    |   |              |   |               |   |
| Cash and cash equivalents                                                                                                                                          |   | $                 | 2,702  |               | $      | 1,344 |   |
| Restricted cash                                                                                                                                                    |   | 67                |   | 49                 |   |
| Accounts receivable, net of allowance for doubtful accounts of$379 and $176 at December 31, 2002 and September  30, 2003, respectively                             |   | 3,866             |   | 4,517              |   |
| Due from joint venture                                                                                                                                             |   | 345               |   | 178                |   |
| Prepaid expenses and other current assets                                                                                                                          |   | 706               |   | 668                |   |
| Total current assets                                                                                                                                               |   | 7,686             |   | 6,756              |   |
| Equipment and leasehold improvements, at cost:                                                                                                                     |   |              |   |               |   |
| Computer and office equipment                                                                                                                                      |   | 10,687            |   | 10,917             |   |
| Furniture and fixtures                                                                                                                                             |   | 857               |   | 910                |   |
| Leasehold improvements                                                                                                                                             |   | 860               |   | 870                |   |
|                                                                                                                                                               |   | 12,404            |   | 12,697             |   |
| Less-accumulated depreciation and amortization                                                                                                                     |   | 12,035            |   | 12,374             |   |
|                                                                                                                                                               |   | 369               |   | 323                |   |
| Capitalized software development costs, net of accumulated amortizationof $8,177 and $9,186 at  December 31, 2002 and September 30, 2003, respectively             |   | 2,378             |   | 2,340              |   |
| Other assets                                                                                                                                                       |   | 166               |   | 196                |   |
|                                                                                                                                                               |   | $                 | 10,599 |               | $      | 9,615 |   |
|                                                                                                                                                               |   |              |   |               |   |
| **LIABILITIES  AND STOCKHOLDERS’ DEFICIT**                                                                                                                    |   |              |   |               |   |
| Current liabilities:                                                                                                                                               |   |              |   |               |   |
| Current portion of long-term debt                                                                                                                                  |   | $                 | 1,800  |               | $      | 997 |   |
| Accounts payable                                                                                                                                                   |   | 2,304             |   | 1,783              |   |
| Accrued expenses                                                                                                                                                   |   | 2,973             |   | 2,848              |   |
| Due to joint venture                                                                                                                                               |   | 179               |   | —             |   |
| Deferred revenue                                                                                                                                                   |   | 8,821             |   | 8,448              |   |
| Total current liabilities                                                                                                                                          |   | 16,077            |   | 14,076             |   |
| Long-term liabilities:                                                                                                                                             |   |              |   |               |   |
| Long-term debt, net of current portion                                                                                                                             |   | 547               |   | —             |   |
| 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; 24,849 and  24,964 sharesissued and outstanding at  December 31, 2002 and September 30, 2003, respectively |   | 248               |   | 250                |   |
| Additional paid-in capital                                                                                                                                         |   | 72,052            |   | 72,123             |   |
| Accumulated deficit                                                                                                                                                |   | (78,769           | )      | (77,269            | )      |
| Accumulated other comprehensive income                                                                                                                             |   | 444               |   | 435                |   |
| Total stockholders’ deficit                                                                                                                                   |   | (6,025            | )      | (4,461             | )      |
|                                                                                                                                                               |   | $                 | 10,599 |               | $      | 9,615 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

3

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**AXS-ONEINC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Inthousands, except per share data)**

**(Unaudited)**

 
|                                              |   | **Three  Months Ended** |   | **Nine  Months Ended** |   |
|---------------------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                              |   | **September  30,**      |   | **September  30,**     |   |
|                                              |   | **2002**                |   | **2003**               |   | **2002** |   | **2003** |   |
| Revenues:                                         |   |                    |   |                   |   |   |   |   |   |
| License fees                                      |   | $                       | 1,030  |                   | $      | 2,459 |   | $ | 2,954 |   | $ | 5,054 |   |
| Services                                          |   | 8,196                   |   | 7,681                  |   | 24,542 |   | 23,930 |   |
| Other-related parties                             |   | 101                     |   | 71                     |   | 290 |   | 260 |   |
| Total revenues                                    |   | 9,327                   |   | 10,211                 |   | 27,786 |   | 29,244 |   |
|                                              |   |                    |   |                   |   |   |   |   |   |
| Operating expenses:                               |   |                    |   |                   |   |   |   |   |   |
| Cost of license fees                              |   | 393                     |   | 371                    |   | 1,095 |   | 1,090 |   |
| Cost of services                                  |   | 3,838                   |   | 3,815                  |   | 11,533 |   | 11,782 |   |
| Sales and marketing                               |   | 1,379                   |   | 1,780                  |   | 4,815 |   | 5,535 |   |
| Research and development                          |   | 1,697                   |   | 1,697                  |   | 5,123 |   | 4,949 |   |
| General and administrative                        |   | 1,259                   |   | 1,483                  |   | 3,380 |   | 4,146 |   |
| Total operating expenses                          |   | 8,566                   |   | 9,146                  |   | 25,946 |   | 27,502 |   |
| Operating income                                  |   | 761                     |   | 1,065                  |   | 1,840 |   | 1,742 |   |
| Other income (expense):                           |   |                    |   |                   |   |   |   |   |   |
| Interest income                                   |   | 8                       |   | 17                     |   | 31 |   | 49 |   |
| Interest expense                                  |   | (100                    | )      | (48                    | )      | (275 | ) | (167 | ) |
| Gain on sale of subsidiary                        |   | 149                     |   | —                 |   | 219 |   | 71 |   |
| Equity in income (losses) of joint ventures       |   | (179                    | )      | (81                    | )      | (476 | ) | 34 |   |
| Other expense, net                                |   | (52                     | )      | (6                     | )      | (176 | ) | (172 | ) |
| Other expense, net                                |   | (174                    | )      | (118                   | )      | (677 | ) | (185 | ) |
| Net income before income taxes                    |   | $                       | 587    |                   | $      | 947 |   | $ | 1,163 |   | $ | 1,557 |   |
| Income tax expense                                |   | —                  |   | (29                    | )      | — |   | (57 | ) |
| Net income                                        |   | $                       | 587    |                   | $      | 918 |   | $ | 1,163 |   | $ | 1,500 |   |
|                                              |   |                    |   |                   |   |   |   |   |   |
| Basic net income per common share                 |   | $                       | 0.02   |                   | $      | 0.04 |   | $ | 0.05 |   | $ | 0.06 |   |
| Weighted average basiccommon shares outstanding   |   | 24,827                  |   | 24,960                 |   | 24,808 |   | 24,929 |   |
|                                              |   |                    |   |                   |   |   |   |   |   |
| Diluted net income per common share               |   | $                       | 0.02   |                   | $      | 0.04 |   | $ | 0.05 |   | $ | 0.06 |   |
| Weighted average dilutedcommon shares outstanding |   | 25,170                  |   | 26,228                 |   | 25,566 |   | 25,932 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

4

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**AXS-ONE INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME**

**(In thousands)**

**(Unaudited)**

 
|                                    |   | **Three  Months Ended** |   | **Nine  Months Ended** |   |
|-----------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                    |   | **September  30,**      |   | **September  30,**     |   |
|                                    |   | **2002**                |   | **2003**               |   | **2002** |   | **2003** |   |
| Net income                              |   | $                       | 587    |                   | $      | 918 |   | $ | 1,163 |   | $ | 1,500 |   |
| Foreign currency translation adjustment |   | (13                     | )      | (29                    | )      | 74 |   | (9 | ) |
| Comprehensive income                    |   | $                       | 574    |                   | $      | 889 |   | $ | 1,237 |   | $ | 1,491 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

5

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**AXS-ONE INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In thousands)**

**(Unaudited)**

 
|                                                                                             |   | **Nine  Months Ended** |   |
|--------------------------------------------------------------------------------------------------|--------|------------------------|--------|
|                                                                                             |   | **September  30,**     |   |
|                                                                                             |   | **2002**               |   | **2003** |   |
| Cash flows from operating activities:                                                            |   |                   |   |   |   |
| Net income                                                                                       |   | $                      | 1,163  |   | $ | 1,500 |   |
| Adjustments to reconcile net income to net cash flowsprovided by (used in) operating activities: |   |                   |   |   |   |
| Increase in cash surrender value of officers’ life insurance                                |   | (41                    | )      | (14 | ) |
| Depreciation and amortization                                                                    |   | 1,473                  |   | 1,214 |   |
| Net recovery of doubtful accounts                                                                |   | (63                    | )      | (132 | ) |
| Gain on sale of subsidiary                                                                       |   | (219                   | )      | (71 | ) |
| Equity in (income) losses of joint ventures                                                      |   | 476                    |   | (34 | ) |
| Consulting services received in lieu of paymenton note receivable                                |   | 136                    |   | — |   |
| Consulting services received in lieu of paymenton accounts receivable                            |   | —                 |   | 45 |   |
| Changes in current assets and liabilities                                                        |   |                   |   |   |   |
| Restricted cash                                                                                  |   | (32                    | )      | 27 |   |
| Accounts receivable                                                                              |   | (182                   | )      | (293 | ) |
| Due from joint venture                                                                           |   | (292                   | )      | 167 |   |
| Prepaid expenses and other current assets                                                        |   | (280                   | )      | 76 |   |
| Accounts payable and accrued expenses                                                            |   | (1,400                 | )      | (862 | ) |
| Deferred revenue                                                                                 |   | (1,191                 | )      | (570 | ) |
| Net cash flows provided by (used in) operating activities                                        |   | (452                   | )      | 1,053 |   |
|                                                                                             |   |                   |   |   |   |
| Cash flows from investing activities:                                                            |   |                   |   |   |   |
| Change in other assets                                                                           |   | (9                     | )      | 11 |   |
| Proceeds from sale of subsidiary                                                                 |   | 67                     |   | — |   |
| Loans to joint ventures                                                                          |   | (125                   | )      | (156 | ) |
| Capitalized software development costs                                                           |   | (526                   | )      | (971 | ) |
| Purchase of equipment and leasehold improvements                                                 |   | (169                   | )      | (154 | ) |
| Net cash flows used in investing activities                                                      |   | (762                   | )      | (1,270 | ) |
|                                                                                             |   |                   |   |   |   |
| Cash flows from financing activities:                                                            |   |                   |   |   |   |
| Proceeds from exercise of stock options                                                          |   | 20                     |   | 71 |   |
| Net borrowings from revolving line of credit                                                     |   | 1,482                  |   | — |   |
| Proceeds from issuance of long-term debt                                                         |   | 500                    |   | — |   |
| Payments of long term debt and capital lease obligations                                         |   | (1,350                 | )      | (1,350 | ) |
| Net cash flows provided by (used in) financing activities                                        |   | 652                    |   | (1,279 | ) |
| Foreign currency exchange rate effects on cash and cash equivalents                              |   | 159                    |   | 138 |   |
| Net decrease in cash and cash equivalents                                                        |   | (403                   | )      | (1,358 | ) |
| Cash and cash equivalents, beginning of period                                                   |   | 1,048                  |   | 2,702 |   |
| Cash and cash equivalents, end of period                                                         |   | $                      | 645    |   | $ | 1,344 |   |
|                                                                                             |   |                   |   |   |   |
| Supplemental disclosures of cash flow information:                                               |   |                   |   |   |   |
| Cash paid during the period for —                                                           |   |                   |   |   |   |
| Interest                                                                                         |   | $                      | 274    |   | $ | 180 |   |
| Income taxes                                                                                     |   | $                      | 15     |   | $ | 108 |   |
| Non-cash investing activities —                                                             |   |                   |   |   |   |
| Consulting services received in lieuof payment on note receivable                                |   | $                      | 136    |   | $ | — |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

6

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**AXS-ONE INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS**

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

**(Unaudited)**

 

**(1) OPERATIONS, BUSINESS CONDITIONS AND SIGNIFICANTACCOUNTING POLICIES**

 

The Company designs, markets and supports n-tier, Internet-enabled,client/server, e-business, financial, workflow, and desktop data access andstorage software solutions for global 2000 businesses, and scheduling and timeand expenses solutions for professional services organizations.  The Company also offers consulting,installation, training and maintenance services in support of its customers’ useof its software products.

 

(a) *Basisof Presentation*

 

The accompanying consolidated financialstatements include the accounts of AXS-One Inc. and its wholly ownedsubsidiaries located in Australia, Canada, Singapore, South Africa, and theUnited Kingdom (collectively, the *“Company*”).  All significant intercompany transactions and balances have beeneliminated.  During the first quarter of2001, the Company’s South Africa operations entered into two jointventures.  Ownership was 50% or less inboth entities until November 30, 2002, at which time the Company acquired, fora nominal amount, the remaining 50% of the common stock of one of the entities,Hospitality Warehouse, to make it a wholly-owned subsidiary.  All significant intercompany transactions andbalances have been eliminated.  The Companyuses the equity method of accounting for its joint venture that it owns between20 and 50%.  Under the equity method,investments are stated at cost plus or minus the Company’s equity inundistributed earnings or losses.

 

The unaudited consolidated financial statements have been prepared bythe Company in accordance with accounting principles generally accepted in theUnited States of America and, in the opinion of management, contain alladjustments, consisting only of those of a normal recurring nature, necessaryfor a fair presentation of these consolidated financial statements.

 

These consolidated financial statementsshould be read in conjunction with the consolidated financial statements andrelated notes included in the Company’s 2002 Annual Report on Form 10-K filedwith the Securities and Exchange Commission.

 

The results of operations for the three andnine months ended September 30, 2003 are not necessarily indicative of resultsto be expected for the full year 2003 or any future periods.

 

(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 elements and recognizesrevenue on the delivered elements using the residual method.  The most commonly deferred element isinitial maintenance, which is recognized on a straight-line basis over theinitial maintenance 

 

7

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term.  The VSOE of maintenanceis determined by using a consistent percentage of maintenance fee to licensefee based on renewal rates.  Maintenancefees in subsequent years are recognized on a straight-line basis over the lifeof the applicable agreement.  Deliveryof software generally occurs when the product (on CDs) is delivered to a commoncarrier.

 

For software license and maintenance revenue,the Company assesses whether the fee is fixed and determinable and whether ornot collection is probable.  The Companyassesses whether the fee is fixed and determinable based on the payment termsassociated with the transaction.  If asignificant portion of a fee is due after the Company’s normal payment terms,which range from 30 to 90 days from invoice date, it accounts for the fee asnot being fixed and determinable.  Inthese cases, the Company recognizes revenue as the fees become due.

 

The majority of the Company’s training and consulting services arebilled based on hourly rates.  TheCompany generally recognizes revenue as these services are performed.  However, when the Company enters into anarrangement that requires it to perform significant work either to alter theunderlying software or to build additional complex interfaces so that thesoftware performs as the customer requests, the Company recognizes the entirefee using contract accounting.  This wouldapply to the Company’s custom programming services which are generallycontracted on a fixed fee basis. Anticipated losses, if any, are charged to operations in the period suchlosses are determined.

 

Revenues from joint ventures (included inRevenues: Other-Related Parties in the Company’s Consolidated Statements ofOperations) includes consulting revenue for the joint venture’s use of theCompany’s South African subsidiary’s consultants (2003 only) and for managementand director’s fees arising from the Company’s South African subsidiary providingmanagerial, technical and other related services to the joint ventures (2002and 2003 periods) in accordance with the joint venture agreements.  Revenue is recognized upon performance ofthe services.

 

The Company assesses assuredness of collectionbased on a number of factors, including past transaction history with thecustomer and the credit-worthiness of the customer.  The Company does not request collateral from its customers.  If the Company determines that collection ofa fee is not probable, it defers the fee and recognizes revenue at the timecollection becomes probable, which is generally upon receipt of cash.

 

The Company adopted EITF Issue No. 01-14, “Income StatementCharacterization of Reimbursement Received for ‘Out of Pocket’ ExpensesIncurred” on January 1, 2002. Accordingly, reimbursements received for out-of-pocket expenses incurredare classified as revenue in the unaudited consolidated statements ofoperations.

 

(c) *Stock-BasedCompensation*

 

In December 2002, the FASB issued Statement No. 148, “Accounting forStock Based Compensation-Transition and Disclosure, an Amendment of FASBStatement No. 123” (“SFAS 148”).  SFAS148 amends FASB Statement No. 123, “Accounting for Stock-based Compensation”(“SFAS 123”), to provide alternative methods of transition for a voluntarychange to the fair value method of accounting 

 

8

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for stock-based compensation. However, it allows an entity to continue to measure compensation costfor those instruments using the intrinsic-value method of accounting prescribedby Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for StockIssued to Employees,” provided it discloses the effect of applying the fairmarket value of SFAS 123, as amended by SFAS 148, in footnotes to the financialstatements.  On April 22, 2003, the FASBdecided to require stock-based employee compensation to be recorded as a chargeto earnings beginning in 2004.  Untilthat time, the Company has chosen to continue to account for stock-basedcompensation using the intrinsic value method. Accordingly, no stock option related compensation expense has beenrecognized in the consolidated statements of operations, as all options grantedhad an exercise price equal to the market value of the underlying stock on thedate of grant.  The Company was requiredto adopt SFAS 148 for the year ended December 31, 2002.  The adoption of SFAS 148 did not have animpact on the 2002 consolidated results of operations or financial position ofthe Company and is not expected to have an impact on the consolidated resultsof operations or financial position of the Company through 2003 as the Companyexpects to continue to apply the intrinsic value method prescribed by APB 25until such time as the new standard is issued by the FASB.

 

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  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|--------------------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                                                                                                   |   | **2002**                               |   | **2003**                              |   | **2002** |   | **2003** |   |
| Net income as reported                                                                                 |   | $                                      | 587    |                                  | $      | 918 |   | $ | 1,163 |   | $ | 1,500 |   |
| Deduct: Total stock based employeecompensation  determined underfair value based method for all awards |   | 373                                    |   | 326                                   |   | 1,250 |   | 1,047 |   |
| Pro forma net income (loss)                                                                            |   | $                                      | 214    |                                  | $      | 592 |   | $ | (87 | ) | $ | 453 |   |
|                                                                                                   |   |                                   |   |                                  |   |   |   |   |   |
| Net income (loss) per common share:                                                                    |   |                                   |   |                                  |   |   |   |   |   |
| Basic - as reported                                                                                    |   | $                                      | 0.02   |                                  | $      | 0.04 |   | $ | 0.05 |   | $ | 0.06 |   |
| Basic - pro forma                                                                                      |   | 0.01                                   |   | 0.02                                  |   | — |   | 0.02 |   |
|                                                                                                   |   |                                   |   |                                  |   |   |   |   |   |
| Diluted- as reported                                                                                   |   | $                                      | 0.02   |                                  | $      | 0.04 |   | $ | 0.05 |   | $ | 0.06 |   |
| Diluted - pro forma                                                                                    |   | 0.01                                   |   | 0.02                                  |   | — |   | 0.02 |   |

 

 

9

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The Company has used the Black-Scholes option-pricing model incalculating the fair value of options granted. The assumptions used and the weighted average information for the threeand nine months ended September 30, 2002 and 2003 are as follows:

 
|                                                                                                                       |   | **Three  Months Ended** |   | **Nine  Months Ended** |   |
|----------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                                                                                                       |   | **September  30,**      |   | **September  30,**     |   |
|                                                                                                                       |   | **2002**                |   | **2003**               |   | **2002** |   | **2003** |   |
| Risk-free interest rate                                                                                                    |   | 4.78                    | %      | 4.88                   | %      | 4.78 | % | 4.64 | % |
| Expected dividend yield                                                                                                    |   | —                  |   | —                 |   | — |   | — |   |
| Expected lives                                                                                                             |   | 6.17  years             |   | 7  years               |   | 6.52  years |   | 7  years |   |
| Expected volatility                                                                                                        |   | 133                     | %      | 45                     | %      | 133 | % | 56 | % |
| Weighted-average grant date fair value ofoptions  granted during the period                                                |   | $                       | 0.46   |                   | $      | 0.95 |   | $ | 0.64 |   | $ | 0.81 |   |
| Weighted-average remaining contractuallife of  options outstanding                                                         |   | 7.0  years              |   | 6.5  years             |   | 7.0  years |   | 6.5  years |   |
| Weighted-average exercise price of 3,676and 3,913  options exercisable at  September 30,  2002 and 2003, respectively |   | $                       | 1.60   |                   | $      | 1.72 |   | $ | 1.60 |   | $ | 1.72 |   |

 

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

 

On March 31, 1998, the Company entered into a Loan and SecurityAgreement (“Agreement”) that contained a revolving line of credit and a termloan (the “Initial Term Loan”).

 

Borrowings under the revolving line of credit bear annual interest atprime rate plus 1.25% subject to a minimum interest rate of 8.0% perannum.  The Agreement provides foryearly fees as follows:  (i) $111 inyear one, $86 in years two and three, $77 in year four, $74 in years five andsix and (ii) an unused revolving line of credit fee of .375% per annum.  The Agreement is secured by substantiallyall domestic assets of the Company together with a pledge of 65% of the stockof its foreign subsidiaries, and contains certain restrictive financialcovenants.  Under the revolving line ofcredit the Company currently has available the lesser of $5 million or 85% ofeligible receivables, as defined.  Thenet available amount under the revolving line of credit at September 30, 2003was approximately $1.0 million of which no amounts were outstanding.

 

The Initial Term Loan provided for $5 million available in onedraw-down which the Company borrowed on the closing date in 1998.  Effective December 22, 1999, the Companyamended the Agreement (Amendment No. 7) in order to make available to theCompany a second term loan in the original principal amount of $1.3 million,which the Company borrowed on that date. The Initial Term Loan and the secondterm loan, collectively the “A Term Loan,” bore interest at the prime rate asdefined (4.00% 

 

 

10

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per annum at September 30, 2003) plus 1.5% subject to a minimuminterest rate of 8.0% per annum.  The A TermLoan was fully repaid in June 2002 and no amounts remain outstanding.

 

Amendment No. 7 also made available a thirdterm loan (the “B Term Loan”) in the original principal amount of $750, whichthe Company borrowed in full.  The BTerm Loan bears interest at the fixed rate of 12.0% per annum.

 

Subsequent amendments to the Agreement made available additional ‘B’term loans in the original principal amounts totaling up to $4.5 million, ofwhich the Company has borrowed $4.0 million, extended the termination date ofthe credit facility to March 31, 2004 and established restrictive financialcovenants (which are quarterly for 2003) based on cumulative EBITDA (earningsbefore interest, taxes and depreciation and amortization).  The Company was in compliance with thesecovenants through September 30, 2003. The amount available under the ‘B’ term loans at September 30, 2003 was$500.  (For further information see Note3 to the Company’s 2002 Annual Report on Form 10-K.)

 

The aggregate outstanding principal amount of the Term Loans isrepayable in monthly installments of $150 beginning September 2002 over theremaining term of the Agreement.  Anyunpaid principal and interest is due in full on March 31, 2004.  The outstanding principal amount atSeptember 30, 2003 was $997.

 

Amendment No. 12 provides a limitation that if the total outstandingbalance of the Term Loans exceeds at any time the lesser of (i) 40% of eligiblemaintenance revenues from August 8, 2002 through December 31, 2002, 25% ofeligible maintenance revenues from January 1, 2003 through March 31, 2004 and(ii) $4.5 million, then the Company is required to prepay the principal amountin an amount sufficient to cause the aggregate principal amount of the TermLoans to be less than or equal to the relevant limits set forth above.  As of September 30, 2003, eligiblemaintenance revenues as defined, totaled approximately $12.1 million.

 

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

 

Basic and diluted net income per common shareis presented in accordance with SFAS No. 128, “Earnings per Share” (“SFAS No.128”).

 

Basic net income per common share is based onthe weighted average number of shares of common stock outstanding during theperiod.  Diluted net income per commonshare is based on the weighted average number of shares outstanding includingthe dilutive effect of stock options and warrants.  Diluted net income per common share for the three and nine monthsended September 30, 2002 does not include the effects of outstanding options topurchase 4,342 and 3,538, respectively, shares of common stock and outstandingwarrants to purchase 476 shares of common stock for each period as the effectof their inclusion is anti-dilutive for the periods.  Diluted net income per common share for the three and nine monthsended September 30, 2003 does not include the effects of outstanding options topurchase 3,064 and 3,267 shares, respectively, of common stock and outstandingwarrants to purchase, for both periods, 100 shares of common stock as theeffect of their inclusion is anti-dilutive for the periods.

 

 

11

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The following represents the calculations of the basic and diluted netincome per common share for the three and nine months ended September 30, 2002and 2003.

 
|                                                                  |   | **Three  Months Ended** |   | **Nine  Months Ended** |   |
|-----------------------------------------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                                                  |   | **September  30,**      |   | **September  30,**     |   |
|                                                                  |   | **2002**                |   | **2003**               |   | **2002** |   | **2003** |   |
| Net income                                                            |   | $                       | 587    |                   | $      | 918 |   | $ | 1,163 |   | $ | 1,500 |   |
|                                                                  |   |                    |   |                   |   |   |   |   |   |
| Weighted average basic common shares outstanding during the periods   |   | 24,827                  |   | 24,960                 |   | 24,808 |   | 24,929 |   |
|                                                                  |   |                    |   |                   |   |   |   |   |   |
| Dilutive effect of stock options and warrants                         |   | 343                     |   | 1,268                  |   | 758 |   | 1,003 |   |
| Weighted average diluted common shares outstanding during the periods |   | 25,170                  |   | 26,228                 |   | 25,566 |   | 25,932 |   |
|                                                                  |   |                    |   |                   |   |   |   |   |   |
| Basic net income per common share                                     |   | $                       | 0.02   |                   | $      | 0.04 |   | $ | 0.05 |   | $ | 0.06 |   |
|                                                                  |   |                    |   |                   |   |   |   |   |   |
| Diluted net income per common share                                   |   | $                       | 0.02   |                   | $      | 0.04 |   | $ | 0.05 |   | $ | 0.06 |   |

 

**(4) OPERATING SEGMENTS**

 

The Company hasthree product lines that it offers to specific markets as part of its strategyto focus on market opportunities.  Thethree product lines are as follows:

 

a)              AXS-One®Enterprise 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.

 

b)             AXSPoint®Solutions focus on identifying markets that need to rapidly leverage theInternet in communicating, exchanging or reconciling large volumes of knowledgewith their customers, suppliers and partners. AXSPoint Solutions target large information-centric organizations thatcan utilize self-service information systems to improve communications withtheir customers and improve access to business intelligence.  Also included is an email compliancesolution designed to help the Company’s customers meet SEC and NationalAssociation of Securities Dealers (NASD) regulations.

 

c)              TivityTMSolutions, a verticalized version of AXS-One Enterprise solutions, provide afull suite of business solutions and services to organizations that primarilysell professionals’ time.

 

The Company evaluates the performance of itsproduct lines based on revenues and operating income.  Summarized financial information concerning the Company’s productlines is shown in the following table. The Chief Executive Officer uses the information below in this formatwhile making decisions about allocating resources to each product line andassessing its performance.

 

 

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|                                             |   | **AXS-One**    |   |          |   |          |   |      |   |
|--------------------------------------------------|--------|----------------|--------|---------------|--------|---------------|--------|-----------|--------|
|                                             |   | **Enterprise** |   | **AXSPoint**  |   | **Tivity**    |   |      |   |
|                                             |   | **Solutions**  |   | **Solutions** |   | **Solutions** |   | **Total** |   |
| **Three Months Ended September 30, 2002**        |   |           |   |          |   |          |   |      |   |
| Revenues:                                        |   |           |   |          |   |          |   |      |   |
| License fees                                     |   | $              | 180    |          | $      | 827           |   | $         | 23     |   | $ | 1,030 |   |
| Services                                         |   | 6,445          |   | 1,028         |   | 723           |   | 8,196     |   |
| Total Revenues, excluding related party revenue  |   | 6,625          |   | 1,855         |   | 746           |   | 9,226     |   |
| Operating income                                 |   | 741            |   | 1,202         |   | 171           |   | 2,114     |   |
| Total assets                                     |   | 7,844          |   | 1,208         |   | 722           |   | 9,774     |   |
| Capital expenditures                             |   | 103            |   | 10            |   | 10            |   | 123       |   |
| Depreciation and amortization                    |   | 436            |   | 9             |   | 9             |   | 454       |   |
|                                             |   |           |   |          |   |          |   |      |   |
| **Three Months Ended September 30, 2003**        |   |           |   |          |   |          |   |      |   |
| Revenues:                                        |   |           |   |          |   |          |   |      |   |
| License fees                                     |   | $              | 2,079  |          | $      | 380           |   | $         | — |   | $ | 2,459 |   |
| Services                                         |   | 6,038          |   | 1,137         |   | 506           |   | 7,681     |   |
| Total Revenues, excluding related party revenue. |   | 8,117          |   | 1,517         |   | 506           |   | 10,140    |   |
| Operating income                                 |   | 1,911          |   | 561           |   | 258           |   | 2,730     |   |
| Total assets                                     |   | 9,023          |   | 465           |   | 127           |   | 9,615     |   |
| Capital expenditures                             |   | 43             |   | 4             |   | 4             |   | 51        |   |
| Depreciation and amortization                    |   | 383            |   | 5             |   | 6             |   | 394       |   |
|                                             |   |           |   |          |   |          |   |      |   |
| **Nine Months Ended September 30, 2002**         |   |           |   |          |   |          |   |      |   |
| Revenues:                                        |   |           |   |          |   |          |   |      |   |
| License fees                                     |   | $              | 1,077  |          | $      | 1,591         |   | $         | 286    |   | $ | 2,954 |   |
| Services                                         |   | 19,406         |   | 3,178         |   | 1,958         |   | 24,542    |   |
| Total Revenues, excluding related party revenue  |   | 20,483         |   | 4,769         |   | 2,244         |   | 27,496    |   |
| Operating income                                 |   | 2,425          |   | 2,800         |   | 173           |   | 5,398     |   |
| Total assets                                     |   | 7,844          |   | 1,208         |   | 722           |   | 9,774     |   |
| Capital expenditures                             |   | 141            |   | 14            |   | 14            |   | 169       |   |
| Depreciation and amortization                    |   | 1,393          |   | 39            |   | 41            |   | 1,473     |   |
|                                             |   |           |   |          |   |          |   |      |   |
| **Nine Months Ended September 30, 2003**         |   |           |   |          |   |          |   |      |   |
| Revenues:                                        |   |           |   |          |   |          |   |      |   |
| License fees                                     |   | $              | 4,053  |          | $      | 1,001         |   | $         | — |   | $ | 5,054 |   |
| Services                                         |   | 18,958         |   | 3,430         |   | 1,542         |   | 23,930    |   |
| Total Revenues, excluding related party revenue  |   | 23,011         |   | 4,431         |   | 1,542         |   | 28,984    |   |
| Operating income                                 |   | 4,230          |   | 1,948         |   | 183           |   | 6,361     |   |
| Total assets                                     |   | 9,023          |   | 465           |   | 127           |   | 9,615     |   |
| Capital expenditures                             |   | 129            |   | 12            |   | 13            |   | 154       |   |
| Depreciation and amortization                    |   | 1,177          |   | 17            |   | 20            |   | 1,214     |   |

 

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Reconciliation of total segment operating income toconsolidated operating income:

 
|                                             |   | **Three  Months Ended** |   | **Nine  Months Ended** |   |
|--------------------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                             |   | **September  30,**      |   | **September  30,**     |   |
|                                             |   | **2002**                |   | **2003**               |   | **2002** |   | **2003** |   |
| Operating income from reportable segments        |   | $                       | 2,114  |                   | $      | 2,730 |   | $ | 5,398 |   | $ | 6,361 |   |
| Unallocated revenue, other —related parties |   | 101                     |   | 71                     |   | 290 |   | 260 |   |
| Unallocated general and administrative expense   |   | (1,242                  | )      | (1,471                 | )      | (3,326 | ) | (4,113 | ) |
| Other corporate unallocated expenses             |   | (212                    | )      | (265                   | )      | (522 | ) | (766 | ) |
| Total consolidated operating income              |   | $                       | 761    |                   | $      | 1,065 |   | $ | 1,840 |   | $ | 1,742 |   |

 

**(5) DIVESTITURE**

 

On September 20, 2001, theCompany sold its wholly-owned subsidiary located in Central and Eastern Europe(C.E.E.), including offices in Poland, Estonia and Bulgaria, to PorterfieldInternational Ltd. (“Buyer”), a company wholly-owned by the former managingdirector of C.E.E. and his wife.  TheCompany received consideration in the form of a promissory note of Buyer in theface amount of $430 which was paid as of December 31, 2002.  A net asset deficiency of the C.E.E.operations of $(3), at the time of the sale, offset by accrued expenses of$180, directly related to the sale, resulted in a deferred gain ofapproximately $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 gainas the note receivable was paid or equivalent value for services was received,but only after $180 was received. Through December 31, 2002, $430 had been received in either payment tothe Company or equivalent services provided by the Buyer to the Company or tothe Company’s joint venture.  TheCompany recognized $219 of such gain through December 31, 2002, which includeda reversal of $45 related to the original $180 in accrued expenses recorded atthe time of the sale.  The $45 wasrecognized during the three months ended September 30, 2002 as a result of therelease of a past customer claim.  Theremaining gain of $71, reflected as Deferred revenue on the accompanyingDecember 31, 2002 consolidated balance sheet, was recognized in February 2003when the Company received payment from the Company’s joint venture for servicesprovided by the Buyer to the joint venture. The followingtable shows the activity related to the promissory note and related deferredgain and gain recognized:

 

 

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|                                                                       |   | **Note**       |   | **Deferred** |   | **Gain**       |   |
|----------------------------------------------------------------------------|--------|----------------|--------|--------------|--------|----------------|--------|
|                                                                       |   | **Receivable** |   | **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 September 30,  2003 |   | —         |   | (71          | )      | 71             |   |
| Balance at September 30, 2003                                              |   | $              | — |         | $      | —         |   | $ | 290 |   |

 

**(6) CONTINGENCIES**

 

The Securities and Exchange Commission (SEC) performedan investigation of the Company and of certain former employees and officers ofthe Company relating to activities performed through 1996 while they wereemployees of the Company.  The Companyfiled a Form 8-K with the SEC on February 15, 2001 disclosing the SECinvestigation and its disposition with respect to the Company.  In mid August 2001, the Company was informedby counsel for its former employees and officers, whom the Company knew to bethe subject of the SEC investigation, that such counsel had been informed bythe SEC that the SEC was no longer pursuing its investigation of theirclients.  Under the Company’scertificate of incorporation, and Delaware law, the Company has anindemnification obligation to reimburse legal fees to former employees andofficers relating to actions taken against them for work performed while theywere employed by the Company. Approximately $0.8 million in such estimated legal fees were recorded ingeneral and administrative expenses for the year ended December 31, 2001.  During the second quarter of 2002,approximately $0.3 million of these charges were reversed due to favorablesettlements of outstanding billings with legal firms.  The Company does not anticipate any further costs relating tothis matter.

 

Historically, the Company has been involvedin other 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.

 

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

 

The following discussion should be read in conjunction with theConsolidated Interim Financial Statements and Notes thereto and is qualified inits entirety by reference 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 2002 Annual Report onForm 10K.

 

**Overview**

 

We are a provider of e-Business solutions forglobal 2000 companies, professional service organizations (PSOs) and financialmanagers who have implemented high-volume, scalable and secure businesssolutions for hundreds of customers across the globe.

 

We supply a suite of e-business solutionsbased upon our next generation n-tier Internet-architecture.  This family of products, e-Celleratorä products, isdesigned to meet the needs of organizations that wish to conduct businessacross the Internet.  e-Celleratorproducts are used to build two families of solutions, AXS-OneÒ Enterprisesolutions and AXSPointÒ solutions.  AXS-One Enterprise solutions are designed toenable businesses to conduct business transactions across the Internet.  AXSPoint solutions are designed to enableorganizations to exchange information and knowledge across the Internet.  This includes our new email compliancesoftware designed to help our customers meet SEC and NASD regulations.  See “Item 1.  Business” in our 2002 Annual Report on Form 10K.

 

We have experienced, and may in the futureexperience, significant fluctuations in our quarterly and annual revenues,results of operations and cash flows. We believe that domestic and international operating results and cashflows will continue to fluctuate significantly in the future as a result of avariety of factors, including the timing of revenue recognition related tosignificant license agreements, the lengthy sales cycle for our products, theproportion of revenues attributable to license fees versus services, theutilization of third parties to perform services, the amount of revenuegenerated by re-sales of third party software, changes in product mix, demandfor our products, the size and timing of individual license transactions, theintroduction of new products and product enhancements by us or our competitors,changes in customers’ budgets, competitive conditions in the industry andgeneral economic conditions.  For adescription of certain factors that may affect our operating results, see  “Business—Risk Factors” in our 2002 AnnualReport on Form 10K.

 

We incurred net losses of $0.3 million and$4.7 million in 2000 and 2001, respectively, and generated net income of $1.9million in 2002.  We incurred operatinglosses of $0.2 million and $4.1 million in 2000 and 2001, respectively, andgenerated operating income of $2.8 million in 2002.  Operating losses incurred by the Central and Eastern Europesubsidiary, which was sold in 2001 totaled $0.6 million and $0.3 million for2000 and 2001, respectively.  Wereported net income of $0.9 million and $1.5 million for the three and ninemonths ended September 30, 2003, respectively, and operating income of $1.1million and $1.7 million, respectively, for the same periods.

 

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**Recently Issued AccountingStandards**

 

In July 2002, the Financial Accounting StandardsBoard (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 146,“Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS146”). SFAS 146 nullifies Emerging Issues Task Force (“EITF”) Issue No. 94-3,“Liability Recognition for Certain Employee Termination Benefits and OtherCosts to Exit an Activity (including Certain Costs Incurred in aRestructuring)” (“EITF 94-3”) and requires that a liability for costsassociated with an exit or disposal activity be recognized and measuredinitially at fair value in the period in which the liability is incurred.  Under EITF 94-3, a liability for an exitcost was recognized at the date of an entity’s commitment to an exit plan.  Under SFAS 146 recognition for certain typesof costs are delayed as compared to the provisions of EITF 94-3.  SFAS 146 is effective for new exit ordisposal activities that are initiated after December 31, 2002 and will affectthe types and timing of costs included in future restructuring programs, ifany.  Its adoption on January 1, 2003did not have a material impact on our consolidated financial position orresults of operations.

 

In December 2002, the FASBissued SFAS No. 148, “Accounting for Stock-Based Compensation-Transition andDisclosure.”  This statement amends SFASNo. 123, “Accounting for Stock-based Compensation,” to provide alternativemethods of transition for an entity that voluntarily changes to the fair valuebased method of accounting for stock-based compensation.  It also amends the disclosure provisions ofSFAS 123 to require prominent disclosure about the effects on reported netincome of an entity’s accounting policy decisions with respect to stock-basedemployee compensation.  Finally, thisstatement amends APB Opinion No. 28, “Interim Financial Reporting,” to requiredisclosure about those effects in interim financial information.  SFAS No. 148 is effective for financialstatements for fiscal years ending after December 15, 2002.  On April 22, 2003, the FASB decided torequire stock-based employee compensation to be recorded as a charge toearnings beginning in 2004.  Until thattime, we have elected to continue to follow the disclosure-only provisions ofSFAS No. 123 which require disclosure of the pro forma effects on net income(loss) and basic and diluted net income (loss) per common share as if the fairvalue method of accounting prescribed by SFAS No. 123 had been adopted, as wellas certain other information (see Note 1(c) to the Consolidated InterimFinancial Statements).  We will continueto monitor the FASB’s progress on issuance of this standard as well as evaluateour position with respect to current guidance.

 

InNovember 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accountingand Disclosure requirements for Guarantees, Including Indirect Guarantees ofIndebtedness of Others”.  ThisInterpretation elaborates on the existing disclosure requirements for mostguarantees, including loan guarantees such as standby letters of credit.  It also clarifies that at the time a companyissues a guarantee, the company must recognize an initial liability for thefair value, or market value, of the obligations it assumes under that guaranteeand must disclose that information in its interim and annual financialstatements.  The initial recognition andinitial measurement provisions apply on a prospective basis to guaranteesissued or modified after December 31, 2002, regardless of the guarantor’sfiscal year-end.  The disclosurerequirements in the Interpretation are effective for financial statements ofinterim or annual periods ending after December 15, 2002.  The adoption of this Interpretation onDecember 31, 2002 did not have a material impact on our consolidated financialposition or results of operations.

 

In January 2003, theFASB 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.  FIN 46 iseffective after January 31, 2003 for newly created variable interest entities.  For variable interest entities createdbefore February 1, 2003, the implementation date has been postponed to effectfinancial statements issued for 

 

 

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the first interim orannual period ending after December 15, 2003 provided the reporting entity hasnot already issued financial statements in accordance with FIN 46.  We are currently evaluating what, if any,impact the adoption of this Interpretation will have on our consolidatedfinancial position or results of operations.

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for CertainFinancial Instruments with Characteristics of both Liabilities andEquity.”  This Statement requires thatcertain financial instruments, previously accounted for as equity, be classifiedas liabilities in statements of financial position.  SFAS 150 affects accounting for three types of freestandingfinancial instruments: 1) mandatorily redeemable shares, which the issuingcompany is obligated to buy back in exchange for cash or other assets, 2)instruments such as put options and forward purchase contracts, that do or mayrequire the issuer to buy back some of its shares in exchange for cash or otherassets and 3) obligations that can be settled with shares, the monetary valueof which is fixed, tied solely or predominately to a variable such as marketindex, or varies inversely with the value of the issuers’ shares.  This statement is effective for allfinancial instruments entered into or modified after May 31, 2003, andotherwise is effective at the beginning of the first interim period beginningafter June 15, 2003.  The adoption ofthis statement did not have a material impact on our consolidated financialposition or results of operations as we do not currently utilize these types offinancial instruments.

 

 

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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** |   | **Three  Months Ended** |   |
|---------------------------------------------|--------|-------------------------|--------|-------------------------|--------|
|                                        |   | **September  30, 2002** |   | **September  30, 2003** |   |
|                                        |   |                    |   | **Data as a**           |   |   |   | **Data as a** |   |
|                                        |   | **As**                  |   | **percent of**          |   | **As** |   | **percent of** |   |
| **(in  thousands)**                         |   | **Reported**            |   | **revenue**             |   | **Reported** |   | **revenue** |   |
|                                        |   | **(Unaudited)**         |   | **(Unaudited)**         |   |
| Revenues:                                   |   |                    |   |                    |   |   |   |   |   |
| License fees                                |   | $                       | 1,030  |                    | 11.0   | % | $ | 2,459 |   | 24.1 | % |
| Services                                    |   | 8,196                   |   | 87.9                    |   | 7,681 |   | 75.2 |   |
| Other-related parties                       |   | 101                     |   | 1.1                     |   | 71 |   | 0.7 |   |
| Total revenues                              |   | 9,327                   |   | 100.0                   |   | 10,211 |   | 100.0 |   |
|                                        |   |                    |   |                    |   |   |   |   |   |
| Operating expenses:                         |   |                    |   |                    |   |   |   |   |   |
| Cost of license fees                        |   | 393                     |   | 4.2                     |   | 371 |   | 3.7 |   |
| Cost of services                            |   | 3,838                   |   | 41.1                    |   | 3,815 |   | 37.4 |   |
| Sales and marketing                         |   | 1,379                   |   | 14.8                    |   | 1,780 |   | 17.4 |   |
| Research and development                    |   | 1,697                   |   | 18.2                    |   | 1,697 |   | 16.6 |   |
| General and administrative                  |   | 1,259                   |   | 13.5                    |   | 1,483 |   | 14.5 |   |
| Total operating expenses                    |   | 8,566                   |   | 91.8                    |   | 9,146 |   | 89.6 |   |
| Operating income                            |   | 761                     |   | 8.2                     |   | 1,065 |   | 10.4 |   |
| Other income (expense):                     |   |                    |   |                    |   |   |   |   |   |
| Equity in income (losses) of joint ventures |   | (179                    | )      | (1.9                    | )      | (81 | ) | (0.8 | ) |
| Other income (expense), net                 |   | 5                       |   | —                  |   | (37 | ) | (0.3 | ) |
| Other expense, net                          |   | (174                    | )      | (1.9                    | )      | (118 | ) | (1.1 | ) |
| Net income before income taxes              |   | 587                     |   | 6.3                     |   | 947 |   | 9.3 |   |
| Income tax expense                          |   | —                  |   | —                  |   | (29 | ) | (0.3 | ) |
| Net income                                  |   | $                       | 587    |                    | 6.3    | % | $ | 918 |   | 9.0 | % |

 

 

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|                                        |   | **Nine  Months Ended**  |   | **Nine  Months Ended**  |   |
|---------------------------------------------|--------|-------------------------|--------|-------------------------|--------|
|                                        |   | **September  30, 2002** |   | **September  30, 2003** |   |
|                                        |   |                    |   | **Data as a**           |   |   |   | **Data as a** |   |
|                                        |   | **As**                  |   | **percent of**          |   | **As** |   | **percent of** |   |
| **(in  thousands)**                         |   | **Reported**            |   | **revenue**             |   | **Reported** |   | **revenue** |   |
|                                        |   | **(Unaudited)**         |   | **(Unaudited)**         |   |
| Revenues:                                   |   |                    |   |                    |   |   |   |   |   |
| License fees                                |   | $                       | 2,954  |                    | 10.6   | % | $ | 5,054 |   | 17.3 | % |
| Services                                    |   | 24,542                  |   | 88.3                    |   | 23,930 |   | 81.8 |   |
| Other-related parties                       |   | 290                     |   | 1.1                     |   | 260 |   | 0.9 |   |
| Total revenues                              |   | 27,786                  |   | 100.0                   |   | 29,244 |   | 100.0 |   |
|                                        |   |                    |   |                    |   |   |   |   |   |
| Operating expenses:                         |   |                    |   |                    |   |   |   |   |   |
| Cost of license fees                        |   | 1,095                   |   | 4.0                     |   | 1,090 |   | 3.7 |   |
| Cost of services                            |   | 11,533                  |   | 41.5                    |   | 11,782 |   | 40.3 |   |
| Sales and marketing                         |   | 4,815                   |   | 17.3                    |   | 5,535 |   | 18.9 |   |
| Research and development                    |   | 5,123                   |   | 18.4                    |   | 4,949 |   | 16.9 |   |
| General and administrative                  |   | 3,380                   |   | 12.2                    |   | 4,146 |   | 14.2 |   |
| Total operating expenses                    |   | 25,946                  |   | 93.4                    |   | 27,502 |   | 94.0 |   |
| Operating income                            |   | 1,840                   |   | 6.6                     |   | 1,742 |   | 6.0 |   |
| Other income (expense):                     |   |                    |   |                    |   |   |   |   |   |
| Equity in income (losses) of joint ventures |   | (476                    | )      | (1.7                    | )      | 34 |   | 0.1 |   |
| Other expense, net                          |   | (201                    | )      | (0.7                    | )      | (219 | ) | (0.8 | ) |
| Other expense, net                          |   | (677                    | )      | (2.4                    | )      | (185 | ) | (0.7 | ) |
| Net income before taxes                     |   | 1,163                   |   | 4.2                     |   | 1,557 |   | 5.3 |   |
| Income tax expense                          |   | —                  |   | —                  |   | (57 | ) | (0.2 | ) |
| Net income                                  |   | $                       | 1,163  |                    | 4.2    | % | $ | 1,500 |   | 5.1 | % |

** **

**Total Revenues**

 

Total revenues increased $0.9 million or 9.5%and $1.5 million or 5.2% for the three and nine months ended September 30, 2003,respectively, as compared to the corresponding prior year periods.  The increase for the three month period ismainly the result of a $1.4 million increase in license fees which included a$1.1 million license fee from one customer in the U.S. operations, partiallyoffset by a $0.5 million decrease in U.S. service revenues.  The increase for the nine month period ismainly attributable to an increase of $2.1 million in license fees whichincluded a $1.1 million license fee from one customer in our U.S. operationsand a $0.7 million license fee from one customer in our South Africaoperations.  This increase was partiallyoffset by a $1.4 million decrease in service revenues from U.S. operations thatwas, in turn, partially offset by an increase of $0.8 million in servicerevenues from our foreign operations. The decrease in service revenues in our U.S. operations was primarilythe result of continued weak economic conditions which, we believe, haveresulted in customers delaying or limiting their technology spending, choosingto purchase lower cost point solutions rather than higher dollar projects.  We believe it was also the result ofuncertainties, especially during the first quarter, regarding the war in Iraq andthe continued threat of terrorist attacks in the U.S. and throughout the world.

 

Total revenues for the three months endedSeptember 30, 2003 included $2.5 million or 24.1% of total revenues from onecustomer.  Total revenues for the ninemonths ended September 30, 2003 included $3.9 million or 13.2% and $5.9 millionor 20.2% of total revenues from two customers, respectively.  For the three months ended September 30,2002, two customers represented $3.4 million or 12.3% and $4.3 million or17.5%, respectively, of total revenues. Total revenues for the nine months ended September 

 

 

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30, 2002 included $3.4 million or 12.3% and$4.3 million or 17.5% of total revenues from two customers, respectively.

 

We derived approximately $3.1 million and $10.9million, or 30.1% and 37.1%, of our total revenues from customers outside ofthe United States for the three and nine months ended September 30, 2003,respectively, compared to $2.9 million and $8.2 million, or 30.9% and 29.5%,respectively, for the corresponding prior year periods.  We expect that such revenues will continueto represent a significant percentage of our total revenues in the future.  Most of our international license fees andservice revenues are denominated in foreign currencies.  Though there are significant increases inthe revenue from our foreign subsidiaries during the nine months endedSeptember 30, 2003 due to increased license and consulting revenue theincreases are also the result of more favorable exchange rates during the currentperiod as compared to the same period in 2002. Future fluctuations in the value of foreign currencies relative to theU.S. dollar in the future could result in fluctuations in our revenue.

 

***License Fees***

 

License fees include revenues from software licenseagreements we entered into with our customers with respect to both our productsand, to a lesser degree, third party products resold by us.  Total license fees increased $1.4 million or138.7% and $2.1 million or 71.1% for the three and nine months ended September30, 2003, respectively, as compared to the corresponding prior yearperiods.  The increase for thenine-month period is mainly the result of licenses of new products to existingand new customers in the U.S. including licenses, in the third quarter, of ourrecently released email compliance software designed to help our customers meetSEC and NASD regulations.  The increasefor the nine month period is also the result of a large license contract fromone customer in our South African subsidiary.

 

***Service Revenues***

 

Service revenues include fees from softwaremaintenance agreements, training, consulting services, including installation,and custom programming.  Maintenancefees, including first year maintenance, which is allocated from the totallicense arrangements based on VSOE, are recognized ratably over the period ofthe maintenance agreement.  Training,consulting, and custom programming revenues are recognized as the services areperformed.

 

Service revenues decreased $0.5 million or 6.3% and $0.6 million or2.5% for the three and nine months ended September 30, 2003, respectively, ascompared to the corresponding prior year periods.  The decrease for the nine month period is primarily the result ofa $1.0 million decrease in consulting revenue, mostly in our U.S. and U.K.operations, resulting mainly from fewer demands for upgrade services in theinstalled base in the early part of the year pending the release of a newversion of our software at the end of the second quarter of 2003 as well ascustomers delaying projects until there is improvement in the economy.  Most customers tend to upgrade their systemswithin a twelve-month period following the release of a new version of thesoftware.  The decrease is partiallyoffset by a $0.4 million increase in total maintenance revenues for the ninemonths ended September 30, 2003.  Theincrease in maintenance revenues is mainly the result of new license agreementsand customary annual increases for existing agreements.

 

 

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The following table sets forth, for the periods indicated, each majorcategory of our service revenues as a percent of total service revenues:

 
|                   |   | **Three  Months Ended September 30,** |   | **Nine  Months Ended September 30,** |   |
|------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
| **(in  thousands)**    |   | **2002**                              |   | **2003**                             |   | **2002** |   | **2003** |   |
|                   |   |                                  |   | **% of**                             |   |   |   | **% of** |   |   |   | **% of** |   |   |   | **% of** |   |
|                   |   | **Amount**                            |   | **Total**                            |   | **Amount** |   | **Total** |   | **Amount** |   | **Total** |   | **Amount** |   | **Total** |   |
| Maintenance            |   | $                                     | 4,089  |                                 | 49.9   | % | $ | 4,087 |   | 53.2 | % | $ | 11,915 |   | 48.6 | % | $ | 12,281 |   | 51.3 | % |
| Consulting             |   | 3,945                                 |   | 48.1                                 | %      | 3,488 |   | 45.4 | % | 12,266 |   | 50.0 | % | 11,295 |   | 47.2 | % |
| Training               |   | 49                                    |   | 0.6                                  | %      | 32 |   | 0.4 | % | 105 |   | 0.4 | % | 85 |   | 0.4 | % |
| Custom programming     |   | 113                                   |   | 1.4                                  | %      | 74 |   | 1.0 | % | 256 |   | 1.0 | % | 269 |   | 1.1 | % |
| Total services revenue |   | $                                     | 8,196  |                                 | 100.0  | % | $ | 7,681 |   | 100.0 | % | $ | 24,542 |   | 100.0 | % | $ | 23,930 |   | 100.0 | % |
|                        |        |                                       |        |                                      |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Other —RelatedParties***

 

During January 2001, we entered into two South African joint ventures:AXS-One African Solutions (Pty) Ltd (“African Solutions”) and HospitalityWarehouse (Pty) Ltd (“Hospitality Warehouse”). African Solutions sells and services our suite of products.  Hospitality Warehouse uses our procurementsoftware and generates fees for purchases made by member companies primarily inthe hospitality industry.  Ownership was50% or less in both entities until November 30, 2002, at which time we acquired,for a nominal amount, the remaining 50% of the common stock of HospitalityWarehouse to make it a wholly-owned subsidiary.  We use the equity method of accounting for our investments in 20to 50 percent-owned companies.  Underthe equity method, investments are stated at cost plus or minus our equity inundistributed earnings or losses. Revenues for the three and nine months ended September 30, 2003 includedmanagement fee revenue of $8 thousand and $59 thousand, respectively, andconsulting revenue of $63 thousand and $201 thousand, respectively, solely fromAfrican Solutions.  Revenues for thethree and nine months ended September 30, 2002 from both joint venturesincluded management fee revenue of $95 thousand and $279 thousand, respectivelyand consulting revenue of $6 thousand and $11 thousand, respectively.

 

Management fees for the three and nine months ended September 30, 2003decreased from the corresponding periods in 2002 as a result of our decision totemporarily stop charging management fees until African Solutions becomesprofitable.  We continue to chargedirectors’ fees, which are included in total management fees for bothperiods.  The increase in consultingrevenue in the 2003 periods resulted from services of the internal consultingstaff hired in January 2003 to complement the services of third partyconsultants from African Solutions and elsewhere.

 

**Cost of License Fees**

 

Cost of license fees consist primarily ofamortization of capitalized software development costs and amounts paid tothird parties with respect to products we resold in conjunction with thelicensing of our products.  The elementscan vary substantially from period to period as a percentage of license fees.

 

Cost of license fees decreased slightly forthe three and nine months ended September 30, 2003 as compared to thecorresponding prior year periods.  Theamortization of software development costs and costs of third party royaltiesfor 2003 are consistent with the prior year costs for both periods presented.

 

 

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**Cost of Services**

 

Cost of services consists primarily ofpersonnel and third party costs for product quality assurances, training,installation, consulting and customer support.

 

Cost of services is approximately the samefor the three months ended September 30, 2002 and 2003.  An increase of $0.2 million in temps andconsultants in the 2003 period was offset by decreases of $0.1 million intravel and living expenses and $0.1 million in variable compensation.  Cost of services increased $0.2 million or2.2% for the nine months ended September 30, 2003 as compared to thecorresponding prior year period.  Theincrease for the nine month period is primarily due to an increase of $0.5million in temps and consultants expense mainly in our South African subsidiarydue to their continued use of consultants from the joint venture in 2003.  The increase for the nine-month period isalso due to a consolidated increase of $0.1 million in salaries and wagesoffset by a decrease of $0.2 million in travel and living expenses and a $0.1million combined decrease in facilities support and depreciation andamortization expense.

 

As a percentage of service revenues, cost ofservices increased from 46.8% and 47.0% for the three and nine months endedSeptember 30, 2002, respectively, to 49.7% and 49.2% for the three and ninemonths ended September 30, 2003, respectively. The decreased margins are due partly to increased revenue in South Africa,which currently has lower margins than the rest of the world due to their useof high priced third party consultants.

 

**Sales and Marketing**

 

Sales and marketing expenses consistprimarily of salaries, commissions and bonuses related to sales and marketingpersonnel, as well as travel and promotional expenses.

 

Sales and marketing expenses increased $0.4million and $0.7 million or 29.1% and 15.0% for the three and nine months endedSeptember 30, 2003, respectively, as compared to the corresponding prior yearperiods.  The increase for the ninemonth period is primarily as a result of an increase of $0.6 million in salescommissions in our South Africa subsidiary mainly representing the commissionto African Solutions for a large license contract recognized in the secondquarter.  It is also due to a $0.2million increase in salaries and wages and a $0.2 million increase in otherexpense partially offset by a $0.2 million decrease in marketing expenses dueprimarily to a decrease in trade show and user conference expenses.  For the three month period, the increase isprimarily due to a $0.2 million increase in people related expenses and a $0.2million increase in Hospitality Warehouse sales expense which was recorded inthe prior year in equity in losses of joint venture.

 

**Research and Development**

 

Research and development expenses consistprimarily of personnel costs, costs of equipment, facilities and third partysoftware development costs.  Researchand development expenses are generally charged to operations as incurred.  However, certain software development costsare capitalized in accordance with Statement of Financial Accounting StandardsNo. 86 (SFAS 86), “Accounting for the Costs of Computer Software to be Sold,Leased or Otherwise Marketed.”  Suchcapitalized software development costs are generally amortized to cost oflicense fees on a straight-line basis over periods not exceeding three years.

 

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Research and development expenses remainedthe same for the three months ended September 30, 2003 and decreased $0.2million or 3.4% for the nine months ended September 30, 2003 as compared to thecomparable prior year periods.  Wecapitalized $1.0 million in software development costs for the nine monthsended September 30, 2003 as compared to $0.5 million in the corresponding prioryear period.  The rate of capitalizationof software development costs may fluctuate depending on the mix and stage ofdevelopment of our product development and engineering projects.  The decrease in research and developmentcosts for the nine months ended September 30, 2003 is primarily the result of adecrease of $0.2 million in personnel related expenses due to the increase incapitalized software development costs partially offset by customary annualsalary increases and related benefits.

 

**General and Administrative**

 

General and administrative expenses consist primarily of salaries foradministrative, executive and financial personnel, and outside professionalfees.  General and administrativeexpenses increased $0.2 million and $0.8 million or 17.8% and 22.7% for thethree and nine months ended September 30, 2003, respectively, as compared tothe comparable prior year periods.  Theincrease for the nine months ended September 30, 2003 is primarily as a resultof an increase of $0.3 million in professional fees resulting from the absenceof credits that were received in the second quarter of 2002 (see below).  The increase for the nine-month period isalso the result of an increase of $0.1 million in insurance expense, $0.2million in rent expense and $0.2 million in salaries and wages due to customaryannual increases.  The increase for thethree month period is primarily the result of increases in variablecompensation, rent expense and professional fees.

 

The Securities and Exchange Commission (SEC) performedan investigation of AXS-One and of certain of our former employees and officersrelating to activities performed through 1996 while they were ouremployees.  We filed a Form 8-K with theSEC on February 15, 2001 disclosing the SEC investigation and its dispositionwith respect to AXS-One.  In mid August2001, we were informed by counsel for our former employees and officers, whomwe knew to be the subject of the SEC investigation, that such counsel had beeninformed by the SEC that the SEC was no longer pursuing its investigation oftheir clients.  Under our certificate ofincorporation, and Delaware law, we have an indemnification obligation toreimburse legal fees to former employees and officers relating to actions takenagainst them for work performed while they were our employees.  Approximately $0.8 million in such estimatedlegal fees were recorded during the year ended December 31, 2001.  During the second quarter of 2002approximately $0.3 million of these charges were reversed due to favorablesettlements of outstanding billings with legal firms.  The Company does not anticipate any further costs relating tothis matter.

 

**Other Expense, Net**

 

Other expense, net decreased $56 thousand and$0.5 million for the three and nine months ended September 30, 2003,respectively, as compared to the same periods in 2002.  The decreased expense is primarily due toincreases of $0.1 million and $0.5 million, respectively, of equity in income(losses) of joint ventures related to two joint ventures entered into duringthe first quarter of 2001 by our South Africa operations.  On November 30, 2002, we acquired, for anominal amount, the remaining 50% of the common stock of one of the entities,Hospitality Warehouse, to make it a wholly-owned subsidiary.  Equity in income of joint ventures for thenine months ended September 30, 2003 increased primarily due to the salescommission recognized by the joint venture related to the large licensecontract recognized during the second quarter. Interest expense relates to the interest on the revolving line of creditand term loan.  (See Note 2 to theConsolidated Interim Financial Statements.)

 

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**Income Tax Expense**

 

Income tax expenseof $29 thousand and $57 thousand for the three and nine months ended September30, 2003, respectively, represents taxes due on income earned in our SouthAfrica subsidiary for the periods. There is no provision for income tax expense in the U. S. or our otherforeign subsidiaries due to the availability of net operating loss carryforwards.

 

**Segment Information**

 

For the three and nine months ended September 30, 2003, AXS-OneEnterprise Solutions had license fee revenues of $2.1 million and $4.1 million,respectively, compared to $0.2 million and $1.1 million, respectively, for thecomparable prior year period; service revenues of $6.0 million and $19.0million, respectively, compared to $6.4 million and $19.4 million,respectively, for the comparable prior year period; and operating income of$1.9 million and $4.2 million, respectively, compared to $0.7 million and $2.4million, respectively, for the comparable prior year period.  License fees were higher for the three andnine months ended September 30, 2003 due to a large contract with one customerexpanding its use of already licensed systems and sales of our newer web basedproducts to existing customers.  Servicerevenues decreased due to fewer demands for upgrades in the installed base.

 

AXSPoint Solutions had license fee revenues of $0.4 million and $1.0million, respectively, for the three and nine months ended September 30, 2003,compared to $0.8 million and $1.6 million, respectively, for the comparableprior year period; services revenue of $1.1 million and $3.4 million,respectively, compared to $1.0 million and $3.2 million, respectively, for thecomparable prior year period and operating income of $0.6 million and $1.9million, respectively, as compared to $1.2 million and $2.8 million, respectively,for the comparable prior year period. The increase in service revenues was mainly due to an increase inmaintenance revenues due to customary annual increases and new contracts.

 

Tivity Solutions had no license fee revenues for the three or nine monthsended September 30, 2003, as compared to $23 thousand and $0.3 million,respectively, for the comparable prior year period; service revenues of $0.5million and $1.5 million, respectively, as compared to $0.7 million and $2.0million, respectively, for the comparable prior year period and operatingincome of $0.3 million and $0.2 million, respectively, as compared to $0.2million and $0.2 million, respectively, for the comparable prior yearperiod.  The decrease in license feerevenues for the nine months ended September 30, 2003 from the comparable prioryear period was due to lack of any sales to new or existing customers.  The decrease in service revenues for thethree and nine months ended September 30, 2003 as compared to the comparableprior year period is due to decreases in both consulting and maintenancerevenues from the installed base.

 

**Critical Accounting Policies**

 

Our critical accounting policies are asfollows:

 

•                    Revenue recognition and

 

•                    Capitalized softwaredevelopment costs.

*** ***

***RevenueRecognition***

 

We derive our revenue from primarily two sources: (i) software licensesand (ii) services and support revenue, which includes software maintenance,training, consulting and custom programming revenue.  We also derive a limited amount of management fee revenue fromjoint ventures (approximately 1% of 

 

25

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total revenue in 2002) entered into during 2001 by our South Africaoperations.  As described below,significant management judgments and estimates must be made and used inconnection with the revenue recognized in any accounting period.  Material differences may result in theamount and timing of our revenue for any period if our management made differentjudgments or utilized different estimates.

 

We license our software products on a perpetual basis.  Each license agreement generally includes aprovision for initial post-contract support (maintenance).  For all license sales we use a signedlicense agreement as evidence of an arrangement.  For maintenance fees, we use a maintenance agreement as evidenceof the arrangement.  We use aprofessional services agreement as evidence of an arrangement for our training,custom programming and consulting revenues. Management fee revenues from our joint ventures are evidenced by masteragreements governing the relationship.

 

We recognize revenue in accordance with Statement of Position 97-2,“Software Revenue Recognition” (“SOP 97-2”), and Statement of Position 98-9,“Modification of SOP 97-2, Software Revenue Recognition, With Respect 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, we defer the VSOE related to the undelivered elements andrecognize revenue on the delivered elements using the residual method.  The most commonly deferred element isinitial maintenance, which is recognized on a straight-line basis over theinitial maintenance term.  The VSOE ofmaintenance is determined by using a consistent percentage of maintenance feeto license fee based on renewal rates. Maintenance fees in subsequent years are recognized on a straight-linebasis over the life of the applicable agreement.  Delivery of software generally occurs when the product (on CDs)is delivered to a common carrier.

 

For software license and maintenance revenue, we assess whether the feeis fixed and determinable and whether or not collection is probable.  We assess whether the fee is fixed anddeterminable based on the payment terms associated with the transaction.  If a significant portion of a fee is dueafter our normal payment terms, which are 30 to 90 days from invoice date, we accountfor the fee as not being fixed and determinable.  In these cases, we recognize revenue as the fees become due.

 

The majority of our training and consulting services are billed basedon hourly rates.  We generally recognizerevenue as these services are performed. However, when we enter into an arrangement that requires us to performsignificant work either to alter the underlying software or to build additionalcomplex interfaces so that the software performs as the customer requests, werecognize the entire fee using contract accounting.  This would apply to our 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 joint ventures (included inRevenues: Other-Related Parties in the our Consolidated Statements ofOperations) includes consulting revenue for the joint venture’s use of ourSouth African subsidiary’s consultants (2003 only) and for management and director’sfees for our subsidiary providing managerial, technical and other relatedservices to the joint ventures (2002 and 2003 periods) in accordance with thejoint venture agreements.  Revenue isrecognized upon performance of the services.

 

We assess assuredness of collection based ona number of factors, including past transaction history with the customer andthe credit-worthiness of the customer. We do not request collateral from our customers.  If we determine that collection of a fee isnot probable, we defer the fee and recognize revenue at the time collectionbecomes probable, which is generally upon receipt of cash.

 

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Our arrangements do not usually include acceptance clauses.  However, if an arrangement includes anacceptance provision, acceptance generally occurs upon the earlier of receiptof a written customer acceptance or expiration of the acceptance period.

 

***CapitalizedSoftware Development Costs***

 

Our policy is to capitalize certain software development costs inaccordance with Statement of Financial Accounting Standards No. 86, “Accountingfor the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed”(“SFAS 86”).  Under SFAS 86, costsincurred to develop a computer software product are charged to research anddevelopment expense as incurred until technological feasibility has beenestablished.  We establish technologicalfeasibility upon completion of a detailed program design from which point allresearch and development costs for that project are capitalized until theproduct is available for general release to customers.  The establishment of technologicalfeasibility and the ongoing assessment of recoverability of capitalized softwaredevelopment costs require considerable judgment by management with respect tocertain external factors, including, but not limited to, anticipated futurerevenues, estimated economic life and changes in technology.  It is reasonably possible that estimates ofanticipated future revenues, the remaining estimated economic life of theproducts, or both will be reduced in the future due to competitivepressures.  As a result, the carryingamount of the capitalized software costs may be reduced in the near term.  Upon the general release of the softwareproduct to customers, capitalization ceases and such costs are amortized (usingthe straight-line method) on a product-by-product basis over the estimatedlife, which is generally three years.

 

**Liquidity and Capital Resources**

 

On March 31, 1998, we entered into a Loan andSecurity Agreement (“Agreement”) that contained a revolving line of credit anda term loan.  Subsequent amendments tothe Agreement since that date have made available additional term loans (SeeNote 2 to the Consolidated Interim Financial Statements).  The available amount under the revolvingline of credit at September 30, 2003 was approximately $1.0 million.  The available amount under the term loans atSeptember 30, 2003 was $0.5 million.

 

We are required to comply with quarterly andannual financial statement reporting requirements, as well as certainrestrictive financial and other covenants. The ability to continue to borrow under the Agreement is dependent uponfuture compliance with such covenants and available collateral.  Management believes that our projectedoperating results throughout 2003 will result in compliance under theAgreement, although there can be no assurances that such operating results willbe achieved.

 

Our operating activities provided (used) cashof $(0.5) million and $1.1 million for the nine months ended September 30, 2002and 2003, respectively.  Net cash usedby operating activities during the nine months ended September 30, 2002 wascomprised primarily of an increase in accounts receivable, a decrease inaccounts payable and accrued expenses and a decrease in deferred revenuepartially offset by the net income and depreciation and amortizationexpense.  Net cash provided by operatingactivities during the nine months ended September 30, 2003 was comprisedprimarily of the net income and depreciation and amortization expense partiallyoffset by decreases in accounts payable and accrued expenses and in deferredrevenue.

 

Our investing activities used cash of $0.8million and $1.3 million for the nine months ended September 30, 2002 and 2003,respectively.  For the nine months endedSeptember 30, 2002 uses of cash were primarily for capitalized softwaredevelopment costs, equipment purchases and loans to joint ventures, partiallyoffset by proceeds from sale of subsidiary. The principal uses during 2003 were for equipment purchases, capitalizedsoftware development costs and loans to the joint venture.

 

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Cash provided by (used in) financingactivities was $0.7 million and $(1.3) million for the nine months endedSeptember 30, 2002 and 2003, respectively. Cash provided by financing activities for the nine months endedSeptember 30, 2002 related mainly to proceeds from the issuance of debtpartially offset by repayments of debt. Cash used by financing activities for the nine months ended September30, 2003 was related to the repayment of debt.

 

Wehave no significant capital commitments. Planned capital expenditures for 2003 total approximately $1.4 million,including any software development costs that may qualify for capitalizationunder SFAS 86.  Our aggregate minimumoperating lease payments for 2003 will be approximately $1.8 million.  We generated net income of$1.9 million for the year ended December 31, 2002 after experiencing net lossesof $0.3 million and $4.7 million during the years ended December 31, 2000 and2001, respectively.  For the nine monthsended September 30, 2003, we have experienced an increase in license feerevenues which, along with service revenues, had declined in each of the threeyears ended December 31, 2002 as a result of intense competition and rapidtechnological change together with a slowing of the economy.  The increased license fee revenue along withmanagement’s initiatives over the last two years to improve operating resultsand liquidity and better position AXS-One to compete under current marketconditions have allowed us to generate net income during the last nine quartersending September 30, 2003.  In addition,during the month of October 2003, we extended our maintenance agreement withone customer through December 2005 and received $2.8 million in cash.  Due to these factors we expect that ouroperating cash flow and available financial resources will be sufficient tofund our working capital requirements through 2003.  However, our ability to achieve the anticipated results isaffected by the extent of cash generated from operations and the pace at whichwe utilize our available resources. 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 debt andother obligations as the transfer of funds is subject to various foreigngovernment restrictions.  Accordingly,we may in the future be required to seek additional sources of financing orfuture accommodations from our existing lender.  No assurance can be given that management’s initiatives will besuccessful or that any such additional sources of financing or lenderaccommodations will be available.

 

**Item 3.    Quantitativeand Qualitative 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 AffectFuture Results and Financial Condition and the Market Price of Securities**

 

See our 2002 Annual Report on Form 10K for adiscussion of risk factors.

 

**Item 4. Controls and Procedures**

 

***Evaluation ofdisclosure controls and procedures***

 

Our chief executive officer and our chieffinancial officer, after evaluating the effectiveness of our “disclosurecontrols and procedures” (as defined in the Securities Exchange Act of 1934Rule 13a-15(e)) as of September 30, 2003 (the “Evaluation Date”), haveconcluded that as of the Evaluation Date, our 

 

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disclosure controls and procedures wereeffective and designed to ensure that material information relating to us andour consolidated subsidiaries would be collected and made known to them byothers within those entities as appropriate to allow timely decisions regardingrequired disclosure of such information.

 

***Changes ininternal controls***

 

There were no significant changes in ourinternal controls over financial reporting or, to our knowledge, in otherfactors, that have materially affected or are reasonably likely to materiallyaffect our internal controls over financial reporting either during the thirdfiscal quarter or subsequent to the Evaluation Date.

 

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**AXS-ONEINC.**

Part II

Other Information

 

**Item 1.    Legal Proceedings**

 

Historically, we have been involved in disputes and/or litigationencountered in our normal course of business. We believe that the ultimate outcome of these proceedings will not havea material adverse effect on our business, consolidated financial condition,results of operations or cash flows.

 

**Item 2. Changes in Securities and Use of Proceeds**

 

On October 1, 2002, the Company entered intoan agreement with a South Carolina corporation to provide investor relationsservices to the Company, whereby upon expiration or termination of theagreement the Company would issue warrants to purchase the number of shares ofcommon stock of the Company which is 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 is (i) for the initial up to 60,000shares covered by the warrants, $0.41 per share, which represents the closingprice of the Company’s common stock on October 1, 2002 and (ii) for the remainingshares covered by the warrants, if any, the closing price of the Company’scommon stock on April 1, 2003, which was $0.59 per share.  The warrants are fully vested on the date oftheir 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 is September30, 2006.  As of September 30, 2003 nowarrants were exercised.

 

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 for the nine months ended September 30, 2003 wererecorded in sales and marketing expense on the consolidated interim financialstatements.  No further compensationcosts will be recognized related to these warrants since the warrants are fullyvested.

 

Issuance of the warrants was not registered underthe Securities Act of 1933, as amended (the “Act”) in reliance upon Section4(2) of the Act based on the fact that the warrants were issued to only onesophisticated investor who had extensive knowledge of the Company at the timeof the issuance.

 

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

 

(a)          Exhibits—

 
| Exhibit 4.5   |   | Form of Warrants (2003)                                       |
|---------------|--------|---------------------------------------------------------------|
| Exhibit 10.60 |   | Employment agreement  between the Company and Gennaro Vendome |
| Exhibit  31   |   | Rule  13a-14(a)/15d-14(a) Certifications                      |
| Exhibit  32   |   | Officer  Certifications under 18 USC 1350                     |

 

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(b)         Reports on Form8-K—

 

OnJuly 31, 2003, the Company furnished a Form 8-K reporting the issue of a pressrelease disclosing material non-public information regarding the Registrant’sresults of operations for the three and six months ended June 30, 2003.

 

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**AXS-ONE INC.**

 

SIGNATURES

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 
|                                   | AXS-ONE INC. |
|----------------------------------------|--------------|
|                                   |         |   |
| **Date:**  November 14, 2003 | By:          | /s/ John A. Rade |
|                                   |         | John A. Rade |
|                                   |         | 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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