**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

**FORM 10-Q**

**QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIESEXCHANGE ACT OF 1934**

| **For the quarter ended June 30, 2004** | ** ** | **Commission File Number** | ** ** | **1-13591** |
|----------------------------------------------|------------|----------------------------|------------|-------------|

 

**AXS-ONE INC.**(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)

Indicateby check mark whether the registrant:  (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.

| YES | x |   | NO | o |
|-----|---|--------|----|---|

 

Indicateby check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).

| YES | o |   | NO | x |
|-----|---|--------|----|---|

 

Numberof shares outstanding of the issuer’s common stock as of August 4, 2004
| ** **                               | **Class** | ** ** | ** ** | **Number of Shares Outstanding** | ** ** |
|------------------------------------------|-----------|------------|------------|-------------------------------------------------|------------|
| Common Stock, par  value $0.01 per share |      |       | 28,082,164 |                                            |       |
|                                          |           |            |            |                                                 |            |  |  |

 

 

 

----

 

**AXS-ONEINC.**

**INDEX**
|                  | ** ** | ** **                                                                                                                  | ** ** | **Page  Number** |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------|------------|------------------|
| **PART I**  | ** ** | **FINANCIAL  INFORMATION**                                                                                                  | ** ** | ** **       |
|             |       | Item 1. Financial  Statements                                                                                               |       |             |
|             |       | Consolidated Balance Sheets  June 30, 2004 (unaudited) and December 31, 2003                                      |       | 3                |
|             |       | Consolidated Statements of Operations  (unaudited)  Three and six months ended June 30, 2004 and 2003                  |       | 4                |
|             |       | Consolidated Statements of Comprehensive  Income (Loss) (unaudited)  Three and six months ended June 30, 2004 and 2003 |       | 5                |
|             |       | Consolidated Statements of Cash Flows  (unaudited)  Three and six months ended June 30, 2004 and 2003                  |       | 6                |
|             |       | Notes to Consolidated Interim Financial  Statements                                                                         |       | 7                |
|             |       | Item 2.   Management’s Discussion and Analysis of Financial Condition and  Results of Operations                  |       | 17               |
|             |       | Item 3. Quantitative and Qualitative  Disclosures About Market Risk                                                         |       | 29               |
|             |       | Item 4. Controls and Procedures                                                                                             |       | 29               |
| **PART II** | ** ** | **OTHER  INFORMATION**                                                                                                      |       |             |
|             |       | Item 1. Legal Proceedings                                                                                                   |       | 30               |
|             |       | Item 2. Changes in Securities and Use of  Proceeds                                                                          |       | 30               |
|             |       | Item 4. Submission of Matters to a Vote of  Security Holders                                                                |       | 31               |
|             |       | Item 6. Exhibits and Reports on Form 8-K                                                                               |       | 31               |
| **SIGNATURES**   |
|             |       | Signatures                                                                                                                  |       | 32               |
|                  |            |                                                                                                                             |            |                  |  |

 

2

----

**AXS-ONE INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS(In thousands, except per share data)**
| ** **                                                                                                                                                               | ** ** | **June 30,  2004** | ** ** | **December 31,   2003** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                                                                               | ** ** | **(Unaudited)**         | ** ** | ** **                        | ** ** |
| **ASSETS**                                                                                                                                                               |       |                    |       |                              |       |   |   |   |   |
| Current assets:                                                                                                                                                          |       |                    |       |                              |       |   |   |   |   |
| Cash and cash equivalents                                                                                                                                                |       |                    | $          | 9,163                             |       |   |   | $ | 2,946 |   |   |
| Restricted cash                                                                                                                                                          |       |                    | 53         |                              |       |   | 56 |   |   |
| Accounts receivable, net of allowance for doubtful  accounts of $282 and $200 at June 30, 2004 and December 31, 2003,  respectively.                           |       |                    | 7,549      |                              |       |   | 5,541 |   |   |
| Due from joint venture                                                                                                                                                   |       |                    | 96         |                              |       |   | 107 |   |   |
| Prepaid expenses and other current assets .                                                                                                                              |       |                    | 773        |                              |       |   | 603 |   |   |
| Total current assets                                                                                                                                                     |       |                    | 17,634     |                              |       |   | 9,253 |   |   |
| Equipment and leasehold  improvements, at cost:                                                                                                                          |       |                    |       |                              |       |   |   |   |   |
| Computer and office equipment                                                                                                                                            |       |                    | 11,278     |                              |       |   | 11,098 |   |   |
| Furniture and fixtures                                                                                                                                                   |       |                    | 915        |                              |       |   | 924 |   |   |
| Leasehold improvements .                                                                                                                                                 |       |                    | 877        |                              |       |   | 873 |   |   |
|                                                                                                                                                                     |       |                    | 13,070     |                              |       |   | 12,895 |   |   |
| Less—accumulated depreciation and amortization .                                                                                                                    |       |                    | 12,658     |                              |       |   | 12,559 |   |   |
|                                                                                                                                                                     |       |                    | 412        |                              |       |   | 336 |   |   |
| Capitalized  software development costs, net of accumulated amortization of $10,045 and  $9,487 at June 30, 2004 and December 31, 2003, respectively           |       |                    | 2,348      |                              |       |   | 2,364 |   |   |
| Other assets                                                                                                                                                             |       |                    | 199        |                              |       |   | 197 |   |   |
|                                                                                                                                                                     |       |                    | $          | 20,593                            |       |   |   | $ | 12,150 |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY (DEFICIT)**                                                                                                                 |       |                    |       |                              |       |   |   |   |   |
| Current liabilities:                                                                                                                                                     |       |                    |       |                              |       |   |   |   |   |
| Current portion of long-term debt.                                                                                                                                       |       |                    | $          | —                            |       |   |   | $ | 547 |   |   |
| Accounts payable .                                                                                                                                                       |       |                    | 1,861      |                              |       |   | 1,737 |   |   |
| Accrued expenses .                                                                                                                                                       |       |                    | 4,347      |                              |       |   | 3,111 |   |   |
| Due to joint venture                                                                                                                                                     |       |                    | 62         |                              |       |   | 4 |   |   |
| Deferred revenue                                                                                                                                                         |       |                    | 10,879     |                              |       |   | 8,946 |   |   |
| Total current liabilities                                                                                                                                                |       |                    | 17,149     |                              |       |   | 14,345 |   |   |
| Long-term liabilities:                                                                                                                                                   |       |                    |       |                              |       |   |   |   |   |
| Long-term deferred revenue                                                                                                                                               |       |                    | 915        |                              |       |   | 1,504 |   |   |
| Commitments and  contingencies                                                                                                                                           |       |                    |       |                              |       |   |   |   |   |
| Stockholders’  equity (deficit):                                                                                                                                    |       |                    |       |                              |       |   |   |   |   |
| Preferred stock, $.01 par value, authorized 5,000  shares, no shares issued and outstanding                                                                              |       |                    | —     |                              |       |   | — |   |   |
| Common stock, $.01 par value, authorized 50,000  shares; 28,064 and 25,026 shares issued and outstanding at June 30, 2004  and December 31, 2003, respectively |       |                    | 281        |                              |       |   | 250 |   |   |
| Additional paid-in capital                                                                                                                                               |       |                    | 80,179     |                              |       |   | 72,148 |   |   |
| Accumulated deficit .                                                                                                                                                    |       |                    | (78,280    | )                                 |       |   | (76,453 | ) |   |
| Accumulated other comprehensive income                                                                                                                                   |       |                    | 349        |                              |       |   | 356 |   |   |
| Total stockholders’ equity (deficit) .                                                                                                                              |       |                    | 2,529      |                              |       |   | (3,699 | ) |   |
|                                                                                                                                                                     |       |                    | $          | 20,593                            |       |   |   | $ | 12,150 |   |   |

 

**Theaccompanying notes are an integral part of these consolidated financialstatements.**

3

----

**AXS-ONE INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OFOPERATIONS(In thousands, except per share data)(Unaudited)**
| ** **                                          | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                          | ** ** | **June 30,  2004**          | ** ** | **June 30,  2003**        | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
| Revenues:                                           |       |                             |       |                           |       |   |   |   |   |
| License fees                                        |       | $                                | 1,004      |                           | $          | 1,354 |   | $ | 3,464 |   | $ | 2,595 |   |
| Services                                            |       | 8,451                            |       | 8,160                          |       | 16,862 |   | 16,249 |   |
| Other—related parties                          |       | 50                               |       | 74                             |       | 101 |   | 189 |   |
| Total revenues                                      |       | 9,505                            |       | 9,588                          |       | 20,427 |   | 19,033 |   |
| Operating  expenses:                                |       |                             |       |                           |       |   |   |   |   |
| Cost of license fees                                |       | 375                              |       | 378                            |       | 786 |   | 719 |   |
| Cost of services                                    |       | 4,528                            |       | 4,003                          |       | 8,797 |   | 7,967 |   |
| Sales and marketing                                 |       | 2,455                            |       | 2,124                          |       | 4,425 |   | 3,755 |   |
| Research and development                            |       | 2,037                            |       | 1,578                          |       | 3,936 |   | 3,252 |   |
| General and administrative                          |       | 1,530                            |       | 1,348                          |       | 3,097 |   | 2,663 |   |
| Restructuring and other costs                       |       | 1,103                            |       | —                         |       | 1,103 |   | — |   |
| Total operating expenses                            |       | 12,028                           |       | 9,431                          |       | 22,144 |   | 18,356 |   |
| Operating income  (loss)                            |       | (2,523                           | )          | 157                            |       | (1,717 | ) | 677 |   |
| Other income (expense):                             |       |                             |       |                           |       |   |   |   |   |
| Interest income                                     |       | 40                               |       | 20                             |       | 65 |   | 32 |   |
| Interest expense                                    |       | (2                               | )          | (46                            | )          | (14 | ) | (119 | ) |
| Gain on sale of subsidiary                          |       | —                           |       | —                         |       | — |   | 71 |   |
| Equity in income (losses) of joint venture          |       | (49                              | )          | 134                            |       | (82 | ) | 115 |   |
| Other expense, net                                  |       | (18                              | )          | (82                            | )          | (51 | ) | (166 | ) |
| Other income (expense), net                         |       | (29                              | )          | 26                             |       | (82 | ) | (67 | ) |
| Net income (loss)  before income taxes              |       | (2,552                           | )          | 183                            |       | (1,799 | ) | 610 |   |
| Income tax  expense                                 |       | (28                              | )          | (28                            | )          | (28 | ) | (28 | ) |
| Net income (loss)                                   |       | $                                | (2,580     | )                              | $          | 155 |   | $ | (1,827 | ) | $ | 582 |   |
| Basic net income (loss) per common share            |       | $                                | (0.09      | )                              | $          | 0.01 |   | $ | (0.07 | ) | $ | 0.02 |   |
| Weighted average  basic common shares outstanding   |       | 27,915                           |       | 24,960                         |       | 26,582 |   | 24,913 |   |
| Diluted net  income (loss)per  common share         |       | $                                | (0.09      | )                              | $          | 0.01 |   | $ | (0.07 | ) | $ | 0.02 |   |
| Weighted average diluted  common shares outstanding |       | 27,915                           |       | 25,462                         |       | 26,582 |   | 25,773 |   |

 

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

4

----

**AXS-ONE  INC.AND SUBSIDIARIESCONSOLIDATED STATEMENTS OFCOMPREHENSIVE INCOME (LOSS)(In thousands)(Unaudited)**
| ** **                               | ** ** | **Three Months  Ended  June 30,** | ** ** | **Six Months  Ended  June 30,** | ** ** |
|------------------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **                               | ** ** | **2004**                                    | ** ** | **2003**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income (loss)                        |       | $                                           | (2,580     | )                                         | $          | 155 |   | $ | (1,827 | ) | $ | 582 |   |
| Foreign currency  translation adjustment |       | 73                                          |       | (14                                       | )          | (7 | ) | 20 |   |
| Comprehensive  income (loss)             |       | $                                           | (2,507     | )                                         | $          | 141 |   | $ | (1,834 | ) | $ | 602 |   |

 

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

5

----

**AXS-ONE INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands)(Unaudited)**
| ** **                                                                                 | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2004**                                      | ** ** | **2003** | ** ** |
| Cash flows from  operating activities:                                                     |       |                                          |       |   |   |
| Net income (loss)                                                                          |       | $                                             | (1,827     | ) | $ | 582 |   |
| Adjustments to reconcile  net income (loss) to net cash flows used in operating activities |       |                                          |       |   |   |
| Increase in cash surrender value of officers’ life  insurance                         |       | (10                                           | )          | (14 | ) |
| Depreciation and amortization                                                              |       | 685                                           |       | 820 |   |
| Net provision (recovery) of doubtful accounts                                              |       | 88                                            |       | (132 | ) |
| Gain on sale of subsidiary                                                                 |       | —                                        |       | (71 | ) |
| Equity in (income) losses of joint ventures                                                |       | 82                                            |       | (115 | ) |
| Consulting services received in lieu of payment on ccounts  receivable                     |       | 67                                            |       | 45 |   |
| Changes in assets and  liabilities                                                         |       |                                          |       |   |   |
| Restricted cash                                                                            |       | —                                        |       | 27 |   |
| Accounts receivable                                                                        |       | (2,163                                        | )          | (333 | ) |
| Due from joint venture                                                                     |       | 11                                            |       | 217 |   |
| Prepaid expenses and other current assets                                                  |       | (169                                          | )          | 99 |   |
| Accounts payable and accrued expenses                                                      |       | 1,440                                         |       | (1,393 | ) |
| Deferred revenue                                                                           |       | 1,406                                         |       | 260 |   |
| Net cash flows  used in operating activities                                               |       | (390                                          | )          | (8 | ) |
| Cash flows from  investing activities:                                                     |       |                                          |       |   |   |
| Change in other assets                                                                     |       | 16                                            |       | 18 |   |
| Loan to joint venture                                                                      |       | (25                                           | )          | (82 | ) |
| Capitalized software development costs                                                     |       | (542                                          | )          | (654 | ) |
| Purchase of equipment and leasehold improvements                                           |       | (212                                          | )          | (103 | ) |
| Net cash flows  used in investing activities                                               |       | (763                                          | )          | (821 | ) |
| Cash flows from  financing activities:                                                     |       |                                          |       |   |   |
| Proceeds from exercise of stock options and warrants                                       |       | 370                                           |       | 54 |   |
| Net proceeds from the sale of common stock                                                 |       | 7,692                                         |       | — |   |
| Payments of long-term debt                                                                 |       | (547                                          | )          | (900 | ) |
| Net cash flows  provided by (used in) financing activities                                 |       | 7,515                                         |       | (846 | ) |
| Foreign currency  exchange rate effects on cash and cash equivalents                       |       | (145                                          | )          | 129 |   |
| Net increase  (decrease) in cash and cash equivalents                                      |       | 6,217                                         |       | (1,546 | ) |
| Cash and cash  equivalents, beginning of period                                            |       | 2,946                                         |       | 2,702 |   |
| Cash and cash  equivalents, end of period                                                  |       | $                                             | 9,163      |   | $ | 1,156 |   |
| Supplemental disclosures  of cash flow information:                                        |       |                                          |       |   |   |
| Cash paid during  the period for—                                                     |       |                                          |       |   |   |
| Interest                                                                                   |       | $                                             | 21         |   | $ | 134 |   |
| Income taxes                                                                               |       | $                                             | 16         |   | $ | 107 |   |

The accompanyingnotes are an integral part of these consolidated financial statements.

6

----

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

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

TheCompany designs, markets and supports n-tier, Internet-enabled client/server,e-business, financial, workflow, desktop data access and storage solutions andrecords compliance management solutions for global 2000 businesses, andscheduling and time and expense solutions for professional servicesorganizations. The Company also offers consulting, implementation, training andmaintenance services in support of its customers’ use of its software products.

(a)           *Basis of Presentation*

The accompanying consolidated financial statementsinclude the accounts of AXS-One Inc., its wholly owned subsidiaries located inAustralia, Singapore, South Africa, and the United Kingdom and its division locatedin Canada (collectively, the “*Company*”). Allsignificant intercompany transactions and balances have been eliminated. In December 2003,the Company dissolved the legal entity of the subsidiary located in Canada. TheCanadian operation is now a division of the U.S. operation and as suchcontinues to be included in the consolidated financial statements of theCompany.

The Company has a 49% ownership in one joint venturein its South African operation. All significant intercompany transactions andbalances have been eliminated. The joint venture is considered to be a variableinterest entity as defined in FASB Interpretation No. 46, “Consolidationof Variable Interest Entities” (FIN 46). Since it was determined that theCompany is not the primary beneficiary as defined in FIN 46, the Companycontinues to use the equity method of accounting for its joint venture wherebyinvestments are stated at cost plus or minus the Company’s equity inundistributed earnings or losses.

The unaudited consolidated interim financialstatements have been prepared by the Company in accordance with accountingprinciples generally accepted in the United States of America and, in theopinion of management, contain all adjustments, consisting only of those of anormal recurring nature, necessary for a fair presentation of theseconsolidated interim financial statements.

These consolidated interim financial statements shouldbe read in conjunction with the consolidated financial statements and relatednotes included in the Company’s 2003 Annual Report on Form 10-K filed withthe Securities and Exchange Commission.

Theresults of operations for the three and six months ended June 30, 2004 arenot necessarily indicative of results to be expected for the full year 2004 orany future periods.

(b)          *Revenue Recognition*

The Companyrecognizes revenue in accordance with Statement of Position 97-2, “SoftwareRevenue Recognition” (“SOP 97-2”), and Statement of Position 98-9, “Modificationof SOP 97-2, Software Revenue Recognition, With Respect to CertainTransactions.”  Revenue fromnon-cancelable software licenses, through both direct and indirect channels, isrecognized when the license agreement has been signed, delivery has occurred,the fee is fixed or determinable and collectibility 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 commonlydeferred element is initial maintenance, which is recognized on a straight-

7

----

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

line basis over theinitial maintenance term. The VSOE of maintenance is determined by using aconsistent percentage of maintenance fee to license fee based on renewal rates.Maintenance fees in subsequent years are recognized on a straight-line basisover the life of the applicable agreement. Maintenance contracts entitle thecustomer to hot-line support and all unspecified product upgrades releasedduring the term of the maintenance contract. Upgrades include any and allunspecified patches or releases related to a licensed software product. Maintenancedoes not include implementation services to install these upgrades.

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

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

The majority of the Company’s training and consultingservices are billed based on hourly rates. The Company generally recognizesrevenue as these services are performed when there is also evidence of anarrangement, the fee is fixed or determinable and collectibility is reasonablyassured. However, when the Company enters into an arrangement that requires itto perform significant work either to alter the underlying software or to buildadditional complex interfaces so that the software performs as the customerrequests, the Company recognizes the entire fee using the percentage ofcompletion method of accounting. This would apply to the Company’s customprogramming services which are generally contracted on a fixed fee basis. Anticipatedlosses, if any, are charged to operations in the period such losses aredetermined.

Revenues from the joint venture (included in Revenues:Other-Related Parties in the Company’s Consolidated Statements of Operations)includes consulting revenue for the joint venture’s use of the Company’s SouthAfrican subsidiary’s consultants and for management fees arising from theCompany’s South African subsidiary providing managerial, technical and otherrelated services, including director services, to the joint venture in accordancewith the joint venture agreement. Revenue is recognized upon performance of theservices.

The Company assesses assuredness of collection for itsrevenue transactions based on a number of factors, including past transactionhistory with the customer and the credit-worthiness of the customer. TheCompany does not request collateral from its customers. If the Companydetermines that collection of a fee is uncertain, it defers the fee andrecognizes revenue at the time the uncertainty is eliminated, which isgenerally upon receipt of cash.

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

8

----

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

(c)           *Variable Interest Entity*

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

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

As of June 30, 2004, AXS-One’s total exposure toloss as a result of its involvement in African Solutions is $34, representingthe Company’s net investment in African Solutions as of June 30, 2004.

Presentedbelow is selected financial data for African Solutions for the three and sixmonths ended June 30, 2004 and 2003, respectively.
| ** **     | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **     | ** ** | **2004**                                        | ** ** | **2003**                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| Total revenues |       | $                                               | 381        |                                          | $          | 320 |   | $ | 714 |   | $ | 853 |   |
| Operating loss |       | $                                               | (51        | )                                             | $          | (197 | ) | $ | (78 | ) | $ | (210 | ) |

 

Totalassets were $294 and $312 as of June 30, 2004 and 2003, respectively. Totalstockholders’ deficit was $(1,437) and $(723) as of June 2004 and 2003,respectively.

(d)          *Stock-Based Compensation*

In December 2002, the FASB issued Statement No. 148,“Accounting for Stock Based Compensation—Transition and Disclosure, anAmendment of FASB Statement No. 123” (“SFAS 148”). SFAS 148 amends FASBStatement No. 123, “Accounting for Stock-based Compensation” (“SFAS 123”),to provide alternative methods of transition for a voluntary change to the fairvalue method of accounting for stock-based compensation. However, it allows anentity to continue to measure compensation cost for those instruments using theintrinsic-value method of accounting prescribed by Accounting Principles BoardOpinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees,”provided it discloses the effect of SFAS 123, as amended by SFAS 148, in thefootnotes to the financial statements. On November 14, 2003, the FASBdecided to require stock-based employee compensation to be recorded as a chargeto earnings beginning in 2005. Until that time, the Company has chosen tocontinue to account for stock-based compensation using the intrinsic valuemethod. 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.

9

----

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

Hadthe Company, however, elected to recognize compensation cost based on fairvalue of the stock options at the date of grant under SFAS 123, as amended bySFAS 148, such costs would have been recognized ratably over the vesting periodof the underlying instruments and the Company’s net income (loss) and netincome (loss) per common share would have changed to the pro forma amountsindicated in the table below.
| ** **                                                                                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended ** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                               | ** ** | **June 30,**                | ** ** | **June 30,**                    | ** ** |
| ** **                                                                                               | ** ** | **  2004**   | ** ** | **  2003**       | ** ** | **  2004**   | ** ** | **  2003**   | ** ** |
| Net income (loss)  as reported                                                                           |       | $                                | (2,580     | )                                    | $          | 155 |   | $ | (1,827 | ) | $ | 582 |   |
| Deduct: Total  stock based employeecompensation determined under fair value based method  for all awards |       | 323                              |       | 334                                  |       | 560 |   | 722 |   |
| Pro forma net  loss                                                                                      |       | $                                | (2,903     | )                                    | $          | (179 | ) | $ | (2,387 | ) | $ | (140 | ) |
| Net income (loss)  per common share:                                                                     |       |                             |       |                                 |       |   |   |   |   |
| Basic—as reported                                                                                   |       | $                                | (0.09      | )                                    | $          | 0.01 |   | $ | (0.07 | ) | $ | 0.02 |   |
| Basic—pro forma                                                                                     |       | (0.11                            | )          | (0.01                                | )          | (0.09 | ) | (0.01 | ) |
| Diluted—as reported                                                                                 |       | $                                | (0.09      | )                                    | $          | 0.01 |   | $ | (0.07 | ) | $ | 0.02 |   |
| Diluted—pro forma                                                                                   |       | (0.11                            | )          | (0.01                                | )          | (0.09 | ) | (0.01 | ) |

 

TheCompany has used the Black-Scholes option-pricing model in calculating the fairvalue of options granted. The assumptions used and the weighted averageinformation for the three and six months ended June 30, 2004 and 2003 areas follows:
| ** **                                                                                                            | ** ** | **Three Months Ended   June 30,** | ** ** | **Six Months Ended   June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                            | ** ** | **2004**                                              | ** ** | **2003**                                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Risk-free  interest rate                                                                                              |       | 5.31                                                  | %          | 4.57                                                | %          | 5.25 | % | 4.57 | % |
| Expected dividend  yield                                                                                              |       | —                                                |       | —                                              |       | — |   | — |   |
| Expected lives                                                                                                        |       | 7 years                                               |       | 7 years                                             |       | 7 years |   | 7 years |   |
| Expected  volatility                                                                                                  |       | 90                                                    | %          | 64                                                  | %          | 89 | % | 64 | % |
| Weighted-average  grant date fair value of options granted during the period                                          |       | $4.06                                                 |       | $0.79                                               |       | $3.84 |   | $0.78 |   |
| Weighted-average  remaining contractual life of options outstanding                                                   |       | 6.5 years                                             |       | 6.8 years                                           |       | 6.5 years |   | 6.8 years |   |
| Weighted-average  exercise price of 4,038 and 3,758 options exercisable at June 30, 2004  and 2003, respectively |       | $1.79                                                 |       | $1.77                                               |       | $1.79 |   | $1.77 |   |

 

**(2)**   REVOLVINGLINE OF CREDIT AND LONG-TERM DEBT

On March 31, 1998, the Company entered into aLoan and Security Agreement that contained a revolving line of credit and aterm loan. The unpaid principal on the term loan at December 31, 2003 of$547 was fully paid as of March 31, 2004. The Loan and Security Agreementterminated on May 28, 2004 in accordance with Amendment No. 15. As ofJune 30, 2004, no amounts remain outstanding or available 

10

----

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

under this agreement. (Forfurther information see Note 3 to the Company’s 2003 Annual Report on Form 10-K.)

On August 11, 2004, the Company entered into atwo-year Loan and Security Agreement (“Agreement”) which contains a revolvingline of credit under which the Company has available the lesser of $4 millionor 80% of eligible accounts, as defined.

Borrowingsunder the revolving line of credit bear interest at prime rate plus one half ofone percent (0.5%). The Agreement provides for a non-refundable commitment feeof $30 per year and an unused revolving line facility fee of .25% per annum. Theunused revolving line facility fee can be reduced if the Company maintains cashin a non-interest bearing checking account with the lender during the term ofthe agreement. The Agreement is secured by substantially all domestic assets ofthe Company and contains certain financial restrictive covenants based onadjusted quick ratio, as defined, and earnings before interest, taxes anddepreciation and amortization (EBITDA).

**(3)**   BASICAND DILUTED NET INCOME (LOSS) PER COMMON SHARE

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

Basic net income (loss) per common share is based onthe weighted average number of shares of common stock outstanding during theperiod. Diluted net loss per common share for the three and six months ended June 30,2004 does not include the effects of outstanding options to purchase 6,320shares of common stock and outstanding warrants to purchase 616 shares ofcommon stock for each period as the effect of their inclusion is anti-dilutivefor the periods. Diluted net income per common share for the three and sixmonths ended June 30, 2003 does not include the effects of outstandingoptions to purchase 3,240 shares of common stock for both periods andoutstanding warrants to purchase, for both periods, 100 shares of common stockas the effect of their inclusion is anti-dilutive for the periods.

Thefollowing represents the calculations of the basic and diluted net income(loss) per common share for the three and six months ended June 30, 2004and 2003:
| ** **                                                             | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                             | ** ** | **2004**                                        | ** ** | **2003**                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income  (loss).                                                    |       | $                                               | (2,580     | )                                             | $          | 155 |   | $ | (1,827 | ) | $ | 582 |   |
| Weighted average  basic common shares outstanding during the periods   |       | 27,915                                          |       | 24,960                                        |       | 26,582 |   | 24,913 |   |
| Dilutive effect  of stock options and warrants.                        | * *   | *—*                                        |       | 502                                           |       | — |   | 860 |   |
| Weighted average  diluted common shares outstanding during the periods |       | 27,915                                          |       | 25,462                                        |       | 26,582 |   | 25,773 |   |
| Basic net income  (loss) per common share                              |       | $                                               | (0.09      | )                                             | $          | 0.01 |   | $ | (0.07 | ) | $ | 0.02 |   |
| Diluted net income  (loss) per common share                            |       | $                                               | (0.09      | )                                             | $          | 0.01 |   | $ | (0.07 | ) | $ | 0.02 |   |

 

11

----

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

**(4)**   OPERATINGSEGMENTS

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

a)     AXS-OneEnterprise Solutions provide Enterprise Solutions to global 2000 companies thatenable organizations to achieve process transparency throughout their valuechain. These include AXS-One’s Foundation products for which the Company has anextensive installed base of customers. It also includes Tivity Solutions, averticalized version of AXS-One Enterprise solutions that provide a full suiteof business solutions and services to organizations that primarily sellprofessionals’ time.

b)     AXSPointSolutions focus on identifying markets that need to rapidly leverage theInternet in communicating, exchanging or reconciling large volumes of knowledgewith their customers, suppliers and partners. The AXSPoint Solutions targetlarge information-centric organizations that can utilize self-serviceinformation systems to improve communications with their customers and improveaccess to business intelligence. AXSPoint technology is also an electronicbooks and records repository that not only delivers a powerful portal toinformation but can also eliminate many paper production and storage costs. Throughits Records Compliance Management solutions, AXSPoint provides the ability tomeet and manage compliance mandates and to leverage the corporate knowledgecontained within email, instant messaging, and other ancillary systems.

The Company evaluates the performance of its twoproduct lines based on revenues and operating income. Summarized financialinformation concerning the Company’s reportable segments is shown in thefollowing table. The Chief Executive Officer uses the information below in thisformat while making decisions about allocating resources to each product lineand assessing its performance.
| ** **                                      | ** ** | **AXS-One**    | ** ** | ** **    | ** ** | ** ** | ** ** |   |
|-------------------------------------------------|------------|----------------|------------|---------------|------------|------------|------------|--------|
| ** **                                      | ** ** | **Enterprise** | ** ** | **AXSPoint**  | ** ** | ** ** | ** ** |   |
| ** **                                      | ** ** | **Solutions**  | ** ** | **Solutions** | ** ** | **Total**  | ** ** |   |
| ***Three  Months Ended June 30, 2004***    |       |           |       |          |       |       |       |   |   |
| Revenues:                                       |       |           |       |          |       |       |       |   |   |
| License fees                                    |       | $              | 228        |          |       | $          | 776        |   |   | $ | 1,004 |   |
| Services                                        |       | 6,923          |       |          | 1,528      |       |       | 8,451  |   |
| Total Revenues, excluding related party revenue |       | 7,151          |       |          | 2,304      |       |       | 9,455  |   |
| Operating income (loss).                        |       | (644           | )          |          | 444        |       |       | (200   | ) |
| Total assets.                                   |       | 18,235         |       |          | 2,358      |       |       | 20,593 |   |
| Capital expenditures                            |       | 86             |       |          | 10         |       |       | 96     |   |
| Depreciation and  amortization                  |       | 345            |       |          | 7          |       |       | 352    |   |
|                                                 |            |                |            |               |            |            |            |        |  |  |  |  |  |  |  |  |  |  |

12

----

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

 
| ***Three  Months Ended June 30, 2003(1)(2)*** |   |   |   |   |   |   |   |   |   |
|----------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
| Revenues:                                          |   |   |   |   |   |   |   |   |   |
| License fees                                       |   | $      | 859    |   |   | $      | 495    |   |   | $ | 1,354 |   |
| Services                                           |   | 7,954  |   |   | 206    |   |   | 8,160  |   |
| Total Revenues, excluding related party revenue    |   | 8,813  |   |   | 701    |   |   | 9,514  |   |
| Operating income                                   |   | 695    |   |   | 974    |   |   | 1,669  |   |
| Total assets.                                      |   | 8,626  |   |   | 735    |   |   | 9,361  |   |
| Capital expenditures                               |   | 64     |   |   | 3      |   |   | 67     |   |
| Depreciation and amortization                      |   | 422    |   |   | 1      |   |   | 423    |   |
| ***Six  Months Ended June 30, 2004***         |   |   |   |   |   |   |   |   |   |
| Revenues:                                          |   |   |   |   |   |   |   |   |   |
| License fees                                       |   | $      | 868    |   |   | $      | 2,596  |   |   | $ | 3,464 |   |
| Services                                           |   | 14,136 |   |   | 2,726  |   |   | 16,862 |   |
| Total Revenues, excluding related party revenue    |   | 15,004 |   |   | 5,322  |   |   | 20,326 |   |
| Operating income                                   |   | 436    |   |   | 1,943  |   |   | 2,379  |   |
| Total assets.                                      |   | 18,235 |   |   | 2,358  |   |   | 20,593 |   |
| Capital expenditures                               |   | 190    |   |   | 22     |   |   | 212    |   |
| Depreciation and amortization                      |   | 672    |   |   | 13     |   |   | 685    |   |
| ***Six Months Ended June 30,  2003(1)(2)***   |   |   |   |   |   |   |   |   |   |
| Revenues:                                          |   |   |   |   |   |   |   |   |   |
| License fees                                       |   | $      | 1,974  |   |   | $      | 621    |   |   | $ | 2,595 |   |
| Services                                           |   | 13,956 |   |   | 2,293  |   |   | 16,249 |   |
| Total Revenues,  excluding related party revenue   |   | 15,930 |   |   | 2,914  |   |   | 18,844 |   |
| Operating income                                   |   | 2,244  |   |   | 1,387  |   |   | 3,631  |   |
| Total assets.                                      |   | 8,626  |   |   | 735    |   |   | 9,361  |   |
| Capital  expenditures                              |   | 95     |   |   | 8      |   |   | 103    |   |
| Depreciation and  amortization                     |   | 808    |   |   | 12     |   |   | 820    |   |

----

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

(2)   Certainamounts, previously reported in the AXSPoint product line, have beenreclassified to AXS-One Enterprise to conform to the current periodpresentation.

13

----

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

Reconciliationof total segment operating income (loss) to consolidated operating income(loss):
| ** **                                        | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                        | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                        | ** ** | **2004**                         | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| Operating income  (loss) from reportable segments |       | $                                | (200       | )                              | $          | 1,669 |   | $ | 2,379 |   | $ | 3,631 |   |
| Unallocated  revenue, other—related parties  |       | 50                               |       | 74                             |       | 101 |   | 189 |   |
| Unallocated  general and administrative expense   |       | (1,514                           | )          | (1,331                         | )          | (3,066 | ) | (2,642 | ) |
| Other corporate  unallocated expenses             |       | (859                             | )          | (255                           | )          | (1,131 | ) | (501 | ) |
| Total consolidated operating  income (loss)       |       | $                                | (2,523     | )                              | $          | 157 |   | $ | (1,717 | ) | $ | 677 |   |

 

**(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. The Company received consideration in the formof a promissory note of Buyer in the face 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 ofthe sale, offset by accrued expenses of $180, directly related to the sale,resulted in a deferred gain of approximately $253, which the Company recordedin accordance with the Securities and Exchange Commission’s Staff AccountingBulletin No. 81 (SAB 81), “Gain Recognition on the Sale of a Business orOperating Assets to a Highly Leveraged Entity.” Additional direct costs of the sale of $3 and $5 recorded during thethree months ended June 30, 2002 and December 31, 2002, respectively,reduced the total deferred gain to $245.

14

----

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

The Company recognized such gain as the note receivablewas paid or equivalent value for services was received, but only after $180 wasreceived. Through December 31, 2002, $430 had been received in eitherpayment to the Company or equivalent services provided by the Buyer to theCompany or to the Company’s joint venture. The Company recognized $219 of suchgain through December 31, 2002, which included a reversal of $45 relatedto the original $180 in accrued expenses recorded at the time of the sale. The$45 was recognized during the three months ended September 30, 2002 as aresult of the release of a past customer claim. The remaining gain of $71,reflected as Deferred revenue on the December 31, 2002 consolidatedbalance sheet, was recognized in February 2003 when the Company receivedpayment from the Company’s joint venture for services provided by the Buyer tothe joint venture. The following table shows the activity related to thepromissory note and related deferred gain and gain recognized:
| ** **                                                            | ** ** | **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 June 30, 2003 |       |           | —     |         |       |           | (71        | ) |   |   | 71 |   |   |
| Balance at June 30,  2003                                        |       |           | $          | —       |       |           |       | $ | — |   |   |   | $ | 290 |   |   |

 

**(6)**   CONTINGENCIES

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

**(7)**   PRIVATE PLACEMENT

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

Issuance of the common stock and warrants in theprivate placement was not registered under the Securities Act of 1933 (“the Act”)in reliance upon Section 4(2) of the Act based on the fact that theshares of common stock and the warrants were issued to a small number ofsophisticated investors who had extensive knowledge of the Company at the timeof the issuance.

15

----

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

On April 8, 2004, theCompany filed a Form 8-K with the SEC disclosing details of the privateplacement and issuance of warrants. On May 4, 2004, the Company filed a Form S-3registration statement with the SEC covering the resale of the securitiesissued and securities issuable upon exercise of the warrants. We expect thefiling to be declared effective during the third quarter of 2004.

**(8)**   RESTRUCTURING AND OTHER COSTS

On June 30, 2004, in order to streamline andreorganize the Company to better meet its long-term goals, the Companyeliminated 25 positions in the United States and 11 positions in its foreignoperations. The Company recorded a charge to operations in the second quartertotaling approximately $0.8 million related to involuntary termination benefitsto be paid to the terminated employees. The activity related to therestructuring is as follows:
| Involuntary  termination costs recorded in June 2004 |   | $      | 786    |   |
|-----------------------------------------------------------|--------|--------|--------|--------|
| Cash payments  through June 2004                     |   | — |   |
| Restructuring liability  at June 30, 2004            |   | $      | 786    |   |

 

In addition, the Company recognized approximately $0.3million related to a retirement agreement with the Company’s former CEO. TheCompany expects to pay the retirement benefits in the third quarter of 2004.

16

----

Item 2.   Management’s Discussion and Analysis ofFinancial Condition and Results of Operations

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

This Report containsstatements of a forward-looking nature within the meaning of the safe harborprovisions of Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended, relating to future eventsor the future financial performance of AXS-One. Investors are cautionedthat such statements are only predictions and that actual events or results maydiffer materially. In evaluating such statements, investors should specificallyconsider the various factors identified in this Report which could cause actualresults to differ materially from those indicated by such forward-lookingstatements, including the matters set forth in “Business—Risk Factors” in our2003 Annual Report on Form 10K.

**ExecutiveOverview**

We are a leading provider of records compliancemanagement (including email and instant messaging archival management),financial management, and workflow software designed to efficiently managecomplex business processes. We have implemented high-volume, interoperable,scalable and secure business solutions for global 2000 companies. Our WebServices-based technology has been critically acclaimed as best of class. OurRecords Compliance Management Solutions provide fast deployment ofemail/instant messaging archival solutions for regulatory compliance andoperational efficiency. See “Item 1. Business” in our 2003 Annual Reporton Form 10K.

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

We are based in Rutherford, New Jersey withapproximately 230 full-time employees, as of June 30, 2004, in officesworldwide, including Asia, Australia, Canada, South Africa, the United Kingdomand the United States. Our foreign offices generated approximately 34.7% and35.6% of our total revenues for the three and six months ended June 30,2004, respectively, as compared to 44.7% and 40.9%, respectively, for thecorresponding prior year periods. We expect that such revenues will continue torepresent a significant percentage of our total revenues in the future. Most ofour international license fees and services revenues are denominated in foreigncurrencies. Fluctuations in the value of foreign currencies relative to the USdollar in the future could result in fluctuations in our revenue.

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

We encounter competition for all of our products inall markets and compete primarily based on the quality of our products, ourprice, our customer service and our time to implement. The timing of therelease of new products is also important to our ability to generate sales. Duringthe second half of 2003, we released our new Email and Instant MessagingArchival, Supervision & Legal Discovery software in response to newregulatory requirements for financial institutions in the United States as wellas to address the need to reduce costs in the email management area. OurRecords Compliance Management software, including this new product, accountedfor approximately 79% of our total license fee revenues in the first half of2004. In early 2004, we increased our sales and services teams in order to meetthe needs of this growing market and capitalize on this opportunity. However,there is no assurance that these efforts will achieve the desired results.

17

----

Our future ability to grow revenue will be directlyaffected by increased price competition and our ability to sustain anincreasingly higher maintenance revenue base from which to grow. Our growthrate and total revenues depend significantly on future services for existingcustomers as well as our ability to expand our customer base and to respondsuccessfully to the pace of technological change. In order to expand ourcustomer base, we have been actively seeking partnerships with resellers tosupplement our direct sales force. These efforts recently resulted in thealliances announced with Sun Microsystems, Sector, Inc. and RedFile. SunMicrosystems will resell our Records Compliance Management software to itsexisting enterprise customers and new customers in targeted markets. Sector, Inc.,a leading managed services, communications and data distribution provider forthe financial services industry, offers the AXS-One Compliance Platformfor Email and Instant Messaging Archival, Supervision and Discovery in a hostedapplication service provider (ASP) or hybrid environment.  Redfile, a digital risk and informationmanagements solution provider, will work with us to collaboratively develop andoffer a comprehensive hosted archival solution designed to help corporationsmeet evolving regulations, expedite legal discovery and streamline recordsmanagement. If our maintenance renewal rate or pace of new customeracquisitions slows, our revenues and operating results would be adverselyaffected.

We have experienced, and may in the future experience,significant fluctuations in our quarterly and annual revenues, results ofoperations and cash flows. We believe that domestic and international operatingresults and cash flows will continue to fluctuate significantly in the futureas a result of a variety of factors. For a description of these factors thatmay affect our operating results, see  “Business—RiskFactors” in our 2003 Annual Report on Form 10K.

In April 2004, William P. Lyons joined AXS-One inthe position of President and Chief Executive Officer, and was appointedChairman of the Board on June 10, 2004. He replaced John A. Rade, who, aspreviously announced, retired from the position of President and CEO afterseven years with AXS-One, but who will remain with the company as anon-executive employee for a transition period. Mr. Lyons has over 20years experience in the software industry in various executive positionsincluding CEO. A Form 8-K was filed with the SEC on April 30,2004 describing the specifics of our agreement with Mr. Lyons.

On April 5, 2004, we completed a privateplacement of shares of common stock that resulted in net proceeds ofapproximately $7.7 million. We expect to use the proceeds from the privateplacement to strengthen our balance sheet and to develop and continue thebusiness activities of AXS-One. (See Part II, Item 2: “Changes inSecurities and Use of Proceeds.”)

On June 30, 2004, weeliminated 25 positions in our US operations and 11 positions in our foreignoperations in order to improve the organization’s competitive position byaligning its operations for future growth in the Records Compliance Management(RCM) market while servicing existing customers worldwide more effectively. Webelieve that the restructuring will provide working capital savings that willbe used to invest in the growth of our RCM solutions and support our goal oflong-term profitability. (See Note 8 to the Consolidated Interim FinancialStatements.)

18

----

**Results of Operations**

Thefollowing table sets forth for the periods indicated, certain operating data,and data as a percentage of total revenues:
| ** **                                 | ** ** | **Three Months Ended**     | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------|------------|--------------------------------------|------------|----------------------------------|------------|
| ** **                                 | ** ** | **June 30, 2004**          | ** ** | **June 30, 2003**      | ** ** |
| ** **                                 | ** ** | ** **                           | ** ** | **Data as a**          | ** ** | ** ** | ** ** | **Data as a** | ** ** |
| ** **                                 | ** ** | **As**                               | ** ** | **percent of**              | ** ** | **As** | ** ** | **percent of** | ** ** |
| ** **                                 | ** ** | **Reported**                         | ** ** | **revenue**                      | ** ** | **Reported** | ** ** | **revenue** | ** ** |
| ** **                                 | ** ** | **(Unaudited)**                      | ** ** | **(Unaudited)**                  | ** ** |
| ** **                                 | ** ** | **(dollars in thousands)** | ** ** |
| Revenues:                                  |       |                                 |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| License fees                               |       |                                 | $          | 1,004                            |       |   |   | 10.6 | % |   | $ | 1,354 |   |   | 14.1 | % |   |
| Services                                   |       |                                 | 8,451      |                             |       |   | 88.9 |   |   | 8,160 |   |   | 85.1 |   |   |
| Other—related parties                 |       |                                 | 50         |                             |       |   | 0.5 |   |   | 74 |   |   | 0.8 |   |   |
| Total revenues                             |       |                                 | 9,505      |                             |       |   | 100.0 |   |   | 9,588 |   |   | 100.0 |   |   |
| Operating expenses:                        |       |                                 |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Cost of license fees                       |       |                                 | 375        |                             |       |   | 4.0 |   |   | 378 |   |   | 3.9 |   |   |
| Cost of services                           |       |                                 | 4,528      |                             |       |   | 47.6 |   |   | 4,003 |   |   | 41.8 |   |   |
| Sales and marketing                        |       |                                 | 2,455      |                             |       |   | 25.8 |   |   | 2,124 |   |   | 22.1 |   |   |
| Research and development                   |       |                                 | 2,037      |                             |       |   | 21.4 |   |   | 1,578 |   |   | 16.5 |   |   |
| General and administrative                 |       |                                 | 1,530      |                             |       |   | 16.1 |   |   | 1,348 |   |   | 14.0 |   |   |
| Restructuring and other Costs              |       |                                 | 1,103      |                             |       |   | 11.6 |   |   | — |   |   | — |   |   |
| Total operating expenses                   |       |                                 | 12,028     |                             |       |   | 126.5 |   |   | 9,431 |   |   | 98.3 |   |   |
| Operating income  (loss)                   |       |                                 | (2,523     | )                                |       |   | (26.5 | ) |   | 157 |   |   | 1.7 |   |   |
| Other income (expense):                    |       |                                 |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Equity in income (losses) of joint venture |       |                                 | (49        | )                                |       |   | (0.5 | ) |   | 134 |   |   | 1.4 |   |   |
| Other income (expense), net                |       |                                 | 20         |                             |       |   | 0.2 |   |   | (108 | ) |   | (1.2 | ) |   |
| Other income (expense), net                |       |                                 | (29        | )                                |       |   | (0.3 | ) |   | 26 |   |   | 0.2 |   |   |
| Net income (loss)  before income taxes     |       |                                 | (2,552     | )                                |       |   | (26.8 | ) |   | 183 |   |   | 1.9 |   |   |
| Income tax  expense                        |       |                                 | (28        | )                                |       |   | (0.3 | ) |   | (28 | ) |   | (0.3 | ) |   |
| Net income (loss)                          |       |                                 | $          | (2,580                           | )          |   |   | (27.1 | )% |   | $ | 155 |   |   | 1.6 | % |   |

 

19

----

** **
| ** **                                 | ** ** | **Six Months Ended**       | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------|------------|--------------------------------------|------------|--------------------------------|------------|
| ** **                                 | ** ** | **June 30, 2004**          | ** ** | **June 30, 2003**    | ** ** |
| ** **                                 | ** ** | ** **                           | ** ** | **Data as a**        | ** ** | ** ** | ** ** | **Data as a** | ** ** |
| ** **                                 | ** ** | **As**                               | ** ** | **percent of**            | ** ** | **As** | ** ** | **percent of** | ** ** |
| ** **                                 | ** ** | **Reported**                         | ** ** | **revenue**                    | ** ** | **Reported** | ** ** | **revenue** | ** ** |
| ** **                                 | ** ** | **(Unaudited)**                      | ** ** | **(Unaudited)**                | ** ** |
| ** **                                 | ** ** | **(dollars in thousands)** | ** ** |
| Revenues:                                  |       |                                 |       |                           |       |   |   |   |   |   |   |   |   |
| License fees                               |       | $                                    | 3,464      |                           |       | 17.0 | % |   | $ | 2,595 |   |   | 13.6 | % |   |
| Services                                   |       | 16,862                               |       |                           | 82.5       |   |   | 16,249 |   |   | 85.4 |   |   |
| Other—related parties                 |       | 101                                  |       |                           | 0.5        |   |   | 189 |   |   | 1.0 |   |   |
| Total revenues                             |       | 20,427                               |       |                           | 100.0      |   |   | 19,033 |   |   | 100.0 |   |   |
| Operating expenses:                        |       |                                 |       |                           |       |   |   |   |   |   |   |   |   |
| Cost of license fees                       |       | 786                                  |       |                           | 3.8        |   |   | 719 |   |   | 3.8 |   |   |
| Cost of services                           |       | 8,797                                |       |                           | 43.1       |   |   | 7,967 |   |   | 41.8 |   |   |
| Sales and marketing                        |       | 4,425                                |       |                           | 21.7       |   |   | 3,755 |   |   | 19.7 |   |   |
| Research and development                   |       | 3,936                                |       |                           | 19.3       |   |   | 3,252 |   |   | 17.1 |   |   |
| General and administrative                 |       | 3,097                                |       |                           | 15.1       |   |   | 2,663 |   |   | 14.0 |   |   |
| Restructuring and other costs              |       | 1,103                                |       |                           | 5.4        |   |   | — |   |   | — |   |   |
| Total operating expenses                   |       | 22,144                               |       |                           | 108.4      |   |   | 18,356 |   |   | 96.4 |   |   |
| Operating income  (loss)                   |       | (1,717                               | )          |                           | (8.4       | ) |   | 677 |   |   | 3.6 |   |   |
| Other income (expense):                    |       |                                 |       |                           |       |   |   |   |   |   |   |   |   |
| Equity in income (losses) of joint venture |       | (82                                  | )          |                           | (0.4       | ) |   | 115 |   |   | 0.6 |   |   |
| Other expense, net                         |       | —                               |       |                           | —     |   |   | (182 | ) |   | (1.0 | ) |   |
| Other expense, net                         |       | (82                                  | )          |                           | (0.4       | ) |   | (67 | ) |   | (0.4 | ) |   |
| Net income (loss)  before taxes            |       | (1,799                               | )          |                           | (8.8       | ) |   | 610 |   |   | 3.2 |   |   |
| Income tax  expense                        |       | (28                                  | )          |                           | (0.1       | ) |   | (28 | ) |   | (0.1 | ) |   |
| Net income (loss)                          |       | $                                    | (1,827     | )                              |       | (8.9 | )% |   | $ | 582 |   |   | 3.1 | % |   |

 

**Comparison of Three Months Ended June 30, 2004 to2003**

*Revenues*

Total revenues decreased $0.1 million or 0.9% for thethree months ended June 30, 2004 as compared to the corresponding prioryear period due to a 25.8% decrease in license fees partially offset by a 3.6%increase in services revenues. The decrease in license fees is mainly theresult of a decrease of $0.7 million in our South African subsidiary partiallyoffset by an increase of $0.3 million in the U.S. operations due to continuedsales of our Records Compliance Management software. For the three months endedJune 30, 2003, there was a large license contract from one customer in ourSouth African subsidiary.  There was nosimilar contract for the same period in 2004.

For both periods, we had a concentration of total revenueswithin a few select customers. Total revenues for the three months ended June 30,2004 included approximately $1.9 million or 20.1% of total revenues from onecustomer. Total revenues for the three months ended June 30, 2003 includedapproximately $1.2 million or 13.0% and $1.7 million or 17.8%, respectively, oftotal revenues from two customers.

 

20

----

Thefollowing table sets forth, for the periods indicated, each major category ofour services revenues as a percent of total services revenues:
| ** **             | ** ** | **Three Months Ended   June 30,** | ** ** |
|------------------------|------------|-------------------------------------------------------|------------|
| ** **             | ** ** | **2004**                                              | ** ** | **2003** | ** ** |
| ** **             | ** ** | **Amount**                                            | ** ** | **% of  Total** | ** ** | **Amount** | ** ** | **% of  Total** | ** ** |
| ** **             | ** ** | **(dollars in thousands)**                  | ** ** |
| Maintenance            |       | $                                                     | 4,270      |   | 50.5 | % | $ | 4,102 |   | 50.3 | % |
| Consulting             |       | 4,090                                                 |       | 48.4 | % | 3,950 |   | 48.4 | % |
| Training               |       | 20                                                    |       | 0.2 | % | 28 |   | 0.3 | % |
| Custom  programming    |       | 71                                                    |       | 0.9 | % | 80 |   | 1.0 | % |
| Total services revenue |       | $                                                     | 8,451      |   | 100.0 | % | $ | 8,160 |   | 100.0 | % |

 

The increase in services revenues is mainly a resultof increases of $168 thousand in maintenance revenue resulting from new licenseagreements and customary annual increases for existing agreements and $140thousand in consulting revenue from implementation of software upgrades forexisting customers under maintenance agreements and implementation of newlicenses.

Other-RelatedParties revenues, as shown in the table below, include management/directors’fees and consulting revenue from African Solutions.
| ** **                       | ** ** | **Three Months Ended  June 30,** | ** ** |
|----------------------------------|------------|-------------------------------------------------|------------|
| ** **                       | ** ** | **2004**                                        | ** ** | **2003** | ** ** |
| ** **                       | ** ** | **(dollars in thousands)**            | ** ** |
| Management/Directors’  fees |       | $                                               | 9          |   | $ | 18 |   |
| Consulting  revenue              |       | 41                                              |       | 56 |   |
| Total revenues                   |       | $                                               | 50         |   | $ | 74 |   |

 

The decrease inmanagement/directors’ fee revenue for the three months ended June 30, 2004as compared to the same period in 2003 resulted from our decision in the secondquarter of 2003 to temporarily stop charging management fees until AfricanSolutions becomes profitable. However, directors’ fees were charged for bothperiods. The decrease in consulting revenue resulted from decreased use ofconsultants from African Solutions, choosing instead to utilize our owninternal staff.

*Expenses*

Cost of license fees consist primarily of amortizationof capitalized software development costs and amounts paid to third partieswith respect to products we resell in conjunction with the licensing of ourproducts. The elements can vary substantially from period to period as apercentage of license fees. Cost of license fees remained relatively flat forthe three months ended June 30, 2004, as compared to the correspondingprior year period. An increase of $89 thousand in third party royalties due toincreased sales of third party software used in conjunction with our softwarewas mostly offset by an $82 thousand decrease in amortization of capitalizedsoftware as a result of certain costs becoming fully amortized in 2003.

Cost of services consists primarily of personnel andthird party costs for product quality assurance, training, installation,consulting and customer support. Cost of services increased $0.5 million or13.1% for the three months ended June 30, 2004 as compared to thecorresponding prior year period. The increase for the three-month period ispartly due to an increase of $0.1 million in cost of third party services dueto increased use of independent consultants in the U.S. operations for newsoftware implementations. The 

21

----

remainder of the increaserelates mainly to people related costs including salaries, related benefits andtravel and living expenses due to increased headcount in the U.S. andAustralian operations.

Sales and marketing expenses consist primarily ofsalaries, commissions and bonuses related to sales and marketing personnel, aswell as travel and promotional expenses. Sales and marketing expenses increased$0.3 million or 15.6% for the three months ended June 30, 2004, ascompared to the corresponding prior year period. The increase is primarily theresult of increases of $0.3 million in people related expenses due to increasedheadcount, annual salary increases and related benefits, employee recruitmentfees and travel and living expenses; $0.3 million in variable compensation foraccrued annual bonuses; $0.1 million in increased advertising costs; and $0.1million in other miscellaneous expenses. This was partially offset by adecrease of $0.5 million in commissions. The three-month period ending June 30,2003 included a $0.5 million sales commission in our South African subsidiaryrepresenting the commission to African Solutions for a large license contractrecognized in the second quarter of 2003.

Research and development expenses consist primarily ofpersonnel costs, costs of equipment, facilities and third party softwaredevelopment costs. Research and development expenses are generally charged tooperations as incurred. However, certain software development costs arecapitalized in accordance with Statement of Financial Accounting Standards No. 86(“SFAS 86”).  Such capitalized softwaredevelopment costs are generally amortized to cost of license fees on astraight-line basis over periods not exceeding three years.

Research and development expenses (net of capitalizedsoftware development costs) increased $0.5 million or 29.1% for the threemonths ended June 30, 2004 as compared to the comparable prior year period.The increase is primarily the result of increases of $0.1 million in salariesand related benefits due to annual merit increases; $0.1 million in temps andconsultants for work on the Records Compliance Management software; $0.1 millionfor accrued annual bonuses; and a decrease of $0.2 million in capitalizedsoftware development costs. We capitalized $0.2 million in software developmentcosts in the second quarter of 2004 as compared to $0.4 million in the secondquarter of 2003. The rate of capitalization of software development costs mayfluctuate depending on the mix and stage of development of our productdevelopment and engineering projects.

General and administrative expenses consist primarilyof salaries for administrative, executive and financial personnel, and outsideprofessional fees. General and administrative expenses increased $0.2 millionor 13.5% for the three months ended June 30, 2004 as compared to thecorresponding prior year period. The increase for the three months is primarilyas a result of increases of $0.1 million in the provision for bad debt in theU.S. and South African operations and $40 thousand in professional feesresulting from increased use of outside attorneys. In addition, the 2003 periodincluded a credit of approximately $60 thousand for a settlement ofprofessional fees due to one vendor and there was no similar credit in the 2004period.

On June 30, 2004, in order to streamline andreorganize our operations to better meet our long-term goals, we eliminated 25positions in the United States and 11 positions in our foreign operations. Werecorded a charge to operations in the second quarter totaling approximately$0.8 million related to involuntary termination benefits to be paid to theterminated employees. The elimination of the 36 positions is expected to resultin annual savings of approximately $3.2 million that will be used to invest inthe growth of new business opportunities. At this time, no further reductionsof headcount are expected or planned throughout the remainder of the year. (SeeNote 8 to the Consolidated Interim Financial Statements.)

In addition, we recognizedapproximately $0.3 million related to a retirement agreement with our formerCEO. We expect to pay the retirement benefits in the third quarter of 2004.

22

----

*Operating Income(Loss)*

Operating income (loss)decreased $(2.7) million for the three months ended June 30, 2004 ascompared to the corresponding prior year period due mainly to $0.8 million inrestructuring charges, $0.3 million in retirement benefits and $1.5 million inincreased operating expenses.

*Other Income(Expense), Net*

Other income (expense),net decreased $55 thousand to a net expense of $29 thousand for the threemonths ended June 30, 2004, as compared to $26 thousand income in the sameperiod in 2003. The increased expense is primarily due to an increase of $0.2million of equity in losses of joint venture. For the three months ended June 30,2003, the joint venture generated net income due to commissions on one largecontract. There was no such contract during the three months ended June 30,2004. This expense was partially offset by a decrease of $44 thousand ininterest expense and $64 thousand in foreign exchange loss. There was noborrowing under the revolving line of credit in 2004 and the term loan wasfully paid as of March 31, 2004. (See Note 2 to the Consolidated InterimFinancial Statements.)

*Income Tax Expense*

Income tax expense of $28thousand for the three months ended June 30, 2004 represents taxes due onexpected earnings in our South African subsidiary.

**Comparison of Six Months Ended June 30, 2004 to2003**

*Revenues*

Total revenues increased $1.4 million or 7.3% for thesix months ended June 30, 2004, as compared to the corresponding prioryear period. The increase for the six-month period is mainly attributable to anincrease of $1.5 million and $0.6 million in license fees and servicesrevenues, respectively, in our U.S. operations partially offset by a $0.7million decrease in license fees in our foreign operations. The increase inlicense revenues in our U.S. operations is the result of licensing of ourRecords Compliance Management software to new and existing customers andlicensing of web add-ons and additional users to our existing customer base. Thedecrease in our foreign license revenues is in our South African location whichhad a large contract in the second quarter of 2003 and no similar contract inthe second quarter of 2004.

For both periods, we had a concentration of totalrevenues within a few select customers. Total revenues for the six months endedJune 30, 2004 included $3.8 million or 18.8% of total revenues from onecustomer. Total revenues for the six-month period ended June 30, 2003included $2.9 million or 15.2% and $3.4 million or 18.1%, respectively, oftotal revenues from two customers.

Thefollowing table sets forth, for the periods indicated, each major category ofour services revenues as a percent of total services revenues:
| ** **             | ** ** | **Six Months Ended   June 30,** | ** ** |
|------------------------|------------|-----------------------------------------------------|------------|
| ** **             | ** ** | **2004**                                            | ** ** | **2003** | ** ** |
| ** **             | ** ** | **Amount**                                          | ** ** | **% of  Total** | ** ** | **Amount** | ** ** | **% of  Total** | ** ** |
| ** **             | ** ** | **(dollars in thousands)**                | ** ** |
| Maintenance            |       | $                                                   | 8,590      |   | 50.9 | % | $ | 8,194 |   | 50.4 | % |
| Consulting             |       | 7,866                                               |       | 46.7 | % | 7,806 |   | 48.1 | % |
| Training               |       | 37                                                  |       | 0.2 | % | 54 |   | 0.3 | % |
| Custom  programming    |       | 369                                                 |       | 2.2 | % | 195 |   | 1.2 | % |
| Total services revenue |       | $                                                   | 16,862     |   | 100.0 | % | $ | 16,249 |   | 100.0 | % |

 

23

----

The increase in services revenues in the U.S.operations is due to increases of $0.4 million in maintenance revenues due tonew license agreements and customary annual increases for existing agreements,$0.1 million in consulting fees due to implementation services related toupgrades of existing customers, under maintenance agreements, to our latestsoftware version and implementation services for new licenses and $0.1 millionin custom programming due to a large agreement with one customer.

Thefollowing table sets forth, for the periods indicated, each category of otherrelated parties revenue:
| ** **                              | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------|------------|-----------------------------------------------|------------|
| ** **                              | ** ** | **2004**                                      | ** ** | **2003** | ** ** |
| ** **                              | ** ** | **(dollars in thousands)**          | ** ** |
| Management/Directors’  fee revenue |       | $                                             | 18         |   | $ | 51 |   |
| Consulting  revenue                     |       | 83                                            |       | 138 |   |
| Total revenues                          |       | $                                             | 101        |   | $ | 189 |   |

 

Other-related parties revenue for the six months endedJune 30, 2004 included decreases of $33 thousand and $55 thousand,respectively, in management/directors’ fee revenues and consulting revenue dueto the same reasons as those indicated above in the comparison of the quartersended June 30, 2004 and 2003.

*Expenses*

Cost of license fees increased $67 thousand for thesix months ended June 30, 2004, as compared to the corresponding prioryear period. An increase of $206 thousand in third party software royalty feesdue to increased sales of third party software used in conjunction with oursoftware was partially offset by a decrease of $126 thousand in amortization ofcapitalized software development costs as a result of certain costs becomingfully capitalized in 2003.

Cost of services increased $0.8 million or 10.4% forthe six months ended June 30, 2004 as compared to the corresponding prioryear period. The increase is partially due to an increase of $0.2 million intemps and consultants expense due to the use of temporary consultants tosupplement our internal employees on specific assignments related mostly to thedeployment of our newer software products. The increase is also the result ofincreases of $0.2 million in salaries and wages due to annual merit increasesand related benefits and $0.2 million in travel and living expenses.

Sales and marketing expenses increased $0.7 million or17.8% for the six months ended June 30, 2004 as compared to thecorresponding prior year period. The increase is primarily a result ofincreases of $0.5 million in salaries and related benefits due to annual meritincreases and new hires, $0.1 million in travel and living expenses, $0.1million in employee recruitment fees, $0.4 million due to increased commissionsand bonuses expense as a direct result of the increase in license fee revenueand $0.2 million in other miscellaneous expenses. These increases werepartially offset by a decrease of $0.6 million in commission expense in ourSouth African subsidiary as explained in the quarter-to-quarter comparisonabove.

Research and development expenses (net of capitalizedsoftware development costs) increased $0.7 million or 21.0% for the six monthsended June 30, 2004, as compared to the corresponding prior year period. Theincrease is primarily the result of an increase of $0.6 million in personnelrelated expenses due to annual salary increases and related benefits, increaseduse of temporaries and consultants for continued work on development of theRecords Compliance Management software and a decrease in capitalized softwaredevelopment costs. There was also a $0.1 million increase in variablecompensation due to accrued annual bonus compensation. We capitalized $0.5million in software development costs in the first half of 2004 as compared to$0.6 million in the first half of 2003. The rate of capitalization of softwaredevelopment costs may fluctuate depending on the mix and stage of developmentof our product development and engineering projects.

24

----

General and administrative expenses increased $0.4million or 16.3% for the six months ended June 30, 2004 as compared to thecorresponding prior year period. The increase is primarily the result ofapproximately $0.1 million in recruiting expenses incurred in connection withthe selection of our new CEO, $0.1 million in bad debt recovery that reducedgeneral and administration expenses in the first quarter of 2003 and no similarrecovery occurred in 2004 and an additional $0.1 million increase in the bad debtprovision in the second quarter of 2004. There is also an increase of $0.1million in professional fees as per the reasons stated above in thequarter-to-quarter comparison.

For a discussion of therestructuring and other charges see the quarter-to-quarter comparison above andNote 8 to the Consolidated Interim Financial Statements.

*Operating Income(Loss)*

Operating income (loss)decreased $(2.4) million for the six months ended June 30, 2004 ascompared to the same period in 2003 due mainly to $0.8 million in restructuring charges, $0.3 million in retirementbenefits and $2.7 million in increased operating expenses. The increasein expenses was partially offset by an increase of $1.4 million in totalrevenues.

*Other Income(Expense), Net*

Other expense, netincreased $15 thousand for the six months ended June 30, 2004 as comparedto the same period in 2004. An increase of $0.2 million of equity in losses ofjoint venture was mostly offset by decreases of $0.1 million in both interestexpense and foreign exchange gain/loss. Equity in income of joint venture forthe six months ended June 30, 2003 included the sales commissionrecognized by the South African joint venture related to a large licensecontract recognized during the second quarter of 2003. There was no similarcontract during the six months ended June 30, 2004. Interest expenserelated to the interest on the revolving line of credit and term loan that wasfully paid as of March 31, 2004. (See Note 2 to the Consolidated InterimFinancial Statements.)

***Income Tax Expense***

Income tax expense of $28 thousand for the six monthsended June 30, 2004 represents taxes due on expected earnings in our SouthAfrican subsidiary for the period.

**Liquidity and Capital Resources**

On April 5, 2004, we completed a privateplacement of shares of common stock that resulted in the receipt of netproceeds of approximately $7.7 million. Prior to that we had a Loan andSecurity Agreement (“Agreement”) that contained a revolving line of credit anda term loan (See Note 2 to the Consolidated Interim Financial Statements). Theterm loan was paid in full as of March 31, 2004, and no amounts remainoutstanding. The Agreement terminated on May 28, 2004 as per the agreement.On August 11, 2004, the Company entered into a two-year Loan and SecurityAgreement which contains a revolving line of credit under which the Company hasavailable the lesser of $4 million or 80% of eligible accounts, as defined (SeeNote 2 to the Consolidated Interim Financial Statements).

Our operating activities used cash of $0.4 million and$8 thousand for the six months ended June 30, 2004 and 2003, respectively.Net cash used by operating activities during the six months ended June 30,2004 is primarily the result of the net loss and an increase in accounts receivablepartially offset by non-cash depreciation and amortization and an increase indeferred revenue and accounts payable and accrued expenses. The increase indeferred revenue is mainly the result of new agreements executed in the firsthalf of 2004 as well as annual maintenance renewal increases. The increase inaccounts receivable is mainly the result of new license billings at the end ofthe second quarter and an increase in consulting billings related to theincrease in revenue. The increase in accounts payable and accrued expenses ismainly due to the accrual for the restructuring and other charges.

25

----

Net cash used in operating activities during the sixmonths ended June 30, 2003 was comprised of the net income, non-cashdepreciation and amortization, and an increase in deferred revenue offset by anincrease in accounts receivable and a decrease in accounts payable and accruedexpenses.

Our investing activities used cash of $0.8 million foreach of the six months ended June 30, 2004 and 2003. The uses of cash forboth periods was primarily for capitalized software development costs relatedto development of new products as well as significant enhancements to certainexisting products and for the purchase of computer equipment.

Cash provided by (used in) financing activities was$7.5 million and ($0.8) million for the six months ended June 30, 2004 and2003, respectively. For the six months ended June 30, 2004, cash wasprimarily provided by the net proceeds received from the private placement andthe exercise of stock options and warrants during the period. This waspartially offset by the payment of the remaining balance of the outstandingterm loan.  Cash used for the six monthsended June 30, 2003 was for repayment of the term loan.

We have no significantcapital commitments. Planned capital expenditures for the year 2004 totalapproximately $1.5 million, including any software development costs that mayqualify for capitalization under SFAS 86. Our aggregate minimum operating leasepayments for 2004 will be approximately $2.0 million. We generated net incomeof $2.3 million and $1.9 million for the years ended December 31, 2003 and2002, respectively, after experiencing a net loss of $4.7 million during theyear ended December 31, 2001. For the year ended December 31, 2003,we experienced an increase in license fee revenues that, along with servicesrevenues, had declined in each of the prior two years primarily as a result ofintense competition and rapid technological change together with a slowing of theeconomy. We have continued to increase license fee revenues during the firsthalf of 2004 and to show improvement in our recurring revenues. Management’sinitiatives over the last two years, including the recent restructuring, havebeen designed to improve operating results and liquidity and better positionAXS-One to compete under current market conditions. In addition, during themonth of October 2003, we extended our maintenance agreement with onecustomer through December 2005 and received an advance payment of $2.8million in cash. Due to these efforts, in addition to the private placement, weexpect that our current cash balance and operating cash flow will be sufficientto fund our working capital requirements through 2004 and beyond. We also havea new revolving line of credit under which the Company has available the lesserof $4 million or 80% of eligible accounts, as defined. Our ability to achievethe anticipated results is affected by the extent of cash generated fromoperations. There is also the risk that cash held by our foreign subsidiarieswill not be readily available for use in our U.S. operations to pay ourobligations as the transfer of funds issometimes delayed due to various foreign government restrictions. Accordingly,we may in the future be required to seek new sources of financing or futureaccommodations from financial institutions. No assurance can be given thatmanagement’s initiatives will be successful or that any such additional sourcesof financing or lender accommodations will be available.

**SegmentInformation**

For the three and six months ended June 30, 2004,AXS-One Enterprise Solutions had license fee revenues of $0.2 million and $0.9million, respectively, compared to $0.9 million and $2.0 million, respectively,for the comparable prior year period; service revenues of $6.9 million and$14.1 million, respectively, compared to $8.0 million and $14.0 million,respectively, for the comparable prior year period; and operating income (loss)of ($0.6) million and $0.4 million, respectively, compared to $0.7 million and$2.2 million, respectively, for the comparable prior year period. License feeswere higher for the three and six months ended June 30, 2003 mainly due toa $0.7 million sale to one customer in our South African operations. Also,there is less demand for our higher priced Foundation products while customerscontinue to license lower priced Web-based add-ons for their existing products.Services revenues, though lower for the second quarter of 2004 than 2003 have increasedfor the first half of 2004 

26

----

due to increased demandfor consulting services in the installed base as customers under maintenanceagreements upgrade to the latest version of our software. Operating incomedecreased primarily as a result of increases in sales and marketing expense,cost of services and research and development costs.

AXSPoint Solutions hadlicense fee revenues of $0.8 million and $2.6 million, respectively, for thethree and six months ended June 30, 2004, compared to $0.5 million and$0.6 million, respectively for the comparable prior year periods; servicesrevenue of $1.5 million and $2.7 million, respectively, compared to $0.2million and $2.3 million, respectively, for the comparable prior year periodsand operating income of $0.4 million and $1.9 million, respectively, ascompared to $1.0 million and $1.4 million, respectively, for the comparableprior year periods. The increase in license and services revenues is mainly dueto the sales and implementation of the email/instant messaging archivalsolutions of our Records Compliance Management software released late in thethird quarter of 2003. The increase in operating income was mainly the resultof the increase in license revenues which more than offset an increase inoperating expenses.

**Critical Accounting Policies**

Our critical accounting policies are as follows:

·       Revenuerecognition and

·       Capitalizedsoftware development costs.

***Revenue Recognition***

We derive our revenue primarily from two sources: (i) softwarelicenses, through both direct and indirect channels, and (ii) services andsupport revenue, which includes software maintenance, training, consulting andcustom programming revenue. We also derive a limited amount of management anddirectors’ fee revenue from the joint venture (less than 1% of total revenue in2003) entered into during 2001 by our South African subsidiary. As describedbelow, certain management judgments and estimates must be made and used inconnection with the revenue recognized in any accounting period. Materialdifferences may result in the amount and timing of our revenue for any periodif our management made different judgments or utilized different estimates. Ourpolicies and procedures are the same regardless of whether the license isthrough our direct sales force or through our resellers.

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

We recognize revenue in accordance with Statement ofPosition 97-2, “Software Revenue Recognition” (“SOP 97-2”), andStatement of Position 98-9, “Modification of SOP 97-2, SoftwareRevenue Recognition, With Respect to Certain Transactions.”  Revenue from non-cancelable softwarelicenses, through both direct and indirect channels, is recognized when thelicense agreement has been signed, delivery has occurred, the fee is fixed ordeterminable and collectibility is probable. In multiple element arrangements,we defer the vendor-specific objective evidence of fair value (“VSOE”) relatedto the undelivered elements and recognize revenue on the delivered elementsusing the residual method. The most commonly deferred element is initialmaintenance, which is recognized on a straight-line basis over the initialmaintenance term. The VSOE of maintenance is determined by using a consistentpercentage of maintenance fee to license fee based on renewal rates. Maintenancefees in subsequent years are 

27

----

recognized on astraight-line basis over the life of the applicable agreement. Maintenancecontracts entitle the customer to hot-line support and all unspecified productupgrades released during the term of the maintenance contract. Upgrades includeany and all unspecified patches or releases related to a licensed softwareproduct. Maintenance does not include implementation services to install theseupgrades.

Delivery of software generally occurs when the product(on CDs) is delivered to a common carrier. Occasionally, delivery occursthrough electronic means where the software is made available through oursecure FTP (File Transfer Protocol) site. We do not offer any customers orresellers a right of return.

For software license and maintenance revenue, weassess whether the fee is fixed and determinable and whether or not collectionis probable. We assess whether the fee is fixed and determinable based on thepayment terms associated with the transaction. If a significant portion of a feeis due after our normal payment terms, which are 30 to 90 days from invoicedate, we account for the fee as not being fixed and determinable. In thesecases, we recognize revenue as the fees become due.

The majority of our training and consulting servicesare billed based on hourly rates. We generally recognize revenue as theseservices are performed when there is also evidence of an arrangement, the feeis fixed or determinable and collectibility is reasonably assured. However,when we enter into an arrangement that requires us to perform significant workeither to alter the underlying software or to build additional complexinterfaces so that the software performs as the customer requests, we recognizethe entire fee using the percentage of completion method of accounting. Thiswould apply to our custom programming services, which are generally contractedon a fixed fee basis. Anticipated losses, if any, are charged to operations inthe period such losses are determined.

Revenues from the joint venture (included in Revenues:Other-Related Parties in our Consolidated Interim Statements of Operations)include consulting revenue for the joint ventures’ use of our South Africansubsidiary’s consultants and for management and directors’ fees for oursubsidiary providing managerial, technical and other related services,including director services, to the joint venture in accordance with the jointventure agreement. Revenue is recognized upon performance of the services.

We assess assuredness of collection for revenuetransactions based on a number of factors, including past transaction historywith the customer and the credit-worthiness of the customer. We do not requestcollateral from our customers. If we determine that collection of a fee isuncertain, we defer the fee and recognize revenue at the time the uncertainlyis eliminated, which is generally upon receipt of cash.

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

***Capitalized Software Development Costs***

Our policy is tocapitalize certain software development costs in accordance with SFAS 86. UnderSFAS 86, costs incurred to develop a computer software product are charged toresearch and development expense as incurred until technological feasibilityhas been established. We establish technological feasibility upon completion ofa detailed program design from which point all research and development costsfor that project are capitalized until the product is available for generalrelease to customers. The establishment of technological feasibility and theongoing assessment of recoverability of capitalized software development costsrequire considerable judgment by management with respect to certain externalfactors, including, but not limited to, anticipated future revenues, estimatedeconomic life and changes in technology. It is reasonably possible thatestimates of anticipated future revenues, the remaining estimated economic lifeof the products, or both will be reduced in the future due to competitivepressures. As a result, the carrying amount of the capitalized software costsmay be reduced in the near term. Upon the general release of the softwareproduct to customers, capitalization ceases and such costs are amortized 

28

----

(usingthe straight-line method) on a product-by-product basis over the estimatedlife, which is generally three years.

**Recently Issued Accounting Standards**

In December 2003, theFASB issued Interpretation No. 46, “Consolidation of Variable InterestEntities” (FIN 46) that addresses the consolidation of variable interestentities. FIN 46 provides guidance for determining when a primary beneficiaryshould consolidate a variable interest entity, or equivalent structure, thatfunctions to support the activities of the primary beneficiary. We adopted FIN46 on March 31, 2004. Based on our evaluation of this Interpretation webelieve that our 49% owned joint venture, AXS-One African Solutions(Proprietary) Limited (“African Solutions”), is a variable interest entity(VIE) as defined in FIN 46. However, we have concluded that we are not theprimary beneficiary of African Solutions. Therefore, the adoption of thisinterpretation did not have a material impact on our consolidated financialposition or results of operations.

**Item 3.**   Quantitativeand Qualitative Disclosures About Market Risk

In the normal course ofbusiness, we are exposed to fluctuations in interest rates and equity marketrisks as we seek debt and equity capital to sustain our operations. We are alsoexposed to fluctuations in foreign currency exchange rates as the financialresults and financial conditions of our foreign subsidiaries are translatedinto U.S. dollars in consolidation. We do not use derivative instruments orhedging to manage our exposures and do not currently hold any market risksensitive instruments for trading purposes.

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

See our 2003 Annual Reporton Form 10K for a discussion of risk factors.

**Item 4.**   Controlsand Procedures

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

Our chief executiveofficer and our chief financial officer, after evaluating the effectiveness ofour “disclosure controls and procedures” (as defined in the Securities ExchangeAct of 1934 Rule 13a-15(e)) as of June 30, 2004 (the “EvaluationDate”), have concluded that as of the Evaluation Date, our disclosure controlsand procedures were effective and designed to ensure that material informationrelating to us and our consolidated subsidiaries would be collected and madeknown to them by others within those entities as appropriate to allow timelydecisions regarding required disclosure of such information.

***Internal controls over financial reporting***

During the most recent fiscal quarter, there has notbeen any change in our internal control over financial reporting that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

29

----

PART IIOTHER INFORMATION

**Item 1.**   LegalProceedings

Historically, we have beeninvolved in disputes and/or litigation encountered in our normal course ofbusiness. We believe that the ultimate outcome of these proceedings will nothave a material adverse effect on our business, consolidated financialcondition, results of operations or cash flows.

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

On April 5, 2004, theCompany completed an offer and sale of 2,580,645 shares of common stock for$3.10 per share in a private placement for consideration of $8,000,000 (orapproximately $7.7 million net of direct costs) to the investors named below. TheCompany also issued, at the same time, warrants to purchase an aggregate of258,065 shares of common stock at $3.98 per share and warrants to purchase258,064 shares of common stock at $4.50 per share. These warrants areexercisable for a period of three years beginning April 5, 2004. Thisprivate placement and issuance of warrants were made pursuant to the terms of aUnit Subscription Agreement, dated as of April 1, 2004, among the Companyand several investors listed below.

*Investors*
| Ganot Corporation                        |   | Globis Overseas Fund Ltd.             |
|------------------------------------------|--------|---------------------------------------|
| Globis Capital Partners L.P.             |   | Richard Grossman                      |
| James Kardon                             |   | Anthony Altamura                      |
| The Hewlett Fund                         |   | Steven J. Seif                        |
| Madison Value Ventures I LLC             |   | Madison Value Ventures II LLC         |
| Madison Value Ventures G.P. III          |   | Madison Value Ventures G.P. IV        |
| WPG Select Technology Fund LP            |   | WPG Select Technology FQP Fund LP     |
| WPG Select Technology Overseas Fund Ltd. |   | Bonanza Master Fund Ltd.              |
| Emancipation Capital, LP                 |   | Potomac Capital Partners, L.P.        |
| Potomac Capital International Ltd.       |   | Pleiades Investment Partners-R, L.P.  |
| Jack M. Dodick                           |   | Steven W. Spira                       |
| Fame Associates                          |   | Cam Co                                |
| Anfel Trading Limited                    |   | Scott R. Griffith                     |
| Jesse B. Shelmire IV                     |   | Griffith Shelmire Partners, Inc. |
| Hayden Communications, Inc.         |   |                                  |

 

Issuance of the common stock and warrants in theprivate placement was not registered under the Act in reliance upon Section 4(2) ofthe Act based on the fact that the shares of common stock and the warrants wereissued to a small number of sophisticated investors who had extensive knowledgeof the Company at the time of the issuance.

The Company will use the net proceeds from the privateplacement and the net proceeds, if any, from the exercising of the warrants,for working capital and general corporate purposes, including withoutlimitation, to support the operations of each of the Company’s subsidiaries.

On April 8, 2004, theCompany filed a Form 8-K with the SEC disclosing details of theprivate placement and issuance of warrants. On May 4, 2004, the Companyfiled a Form S-3 registration statement with the SEC covering theresale of the securities issued and securities issuable upon exercise of thewarrants. We expect the filing to be declared effective during the thirdquarter of 2004.

30

----

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

At our Annual Meeting ofStockholders on June 9, 2004, the following directors were nominated andelected by the votes indicated:
| ** **        | ** ** | **Votes For** | ** ** | **Votes Withheld** | ** ** |
|-------------------|------------|--------------------|------------|-------------------------|------------|
| Elias Typaldos    |       | 17,861,297         |       |                    | 166,717    |   |   |
| William P. Lyons  |       | 17,928,911         |       |                    | 99,103     |   |   |
| Gennaro Vendome   |       | 17,929,901         |       |                    | 98,113     |   |   |
| Daniel H. Burch   |       | 17,929,910         |       |                    | 98,104     |   |   |
| Robert Migliorino |       | 17,929,910         |       |                    | 98,104     |   |   |
| William E. Vogel  |       | 17,929,910         |       |                    | 98,104     |   |   |
| Edwin T. Brondo   |       | 17,929,910         |       |                    | 98,104     |   |   |
| Allan Weingarten  |       | 17,929,910         |       |                    | 98,104     |   |   |

 

In addition, thestockholders ratified the appointment of KPMG LLP as the Company’s independentauditors for 2004 by the following vote:

| **Votes For** | ** ** | **Votes Against** | ** ** | **Abstentions** | ** ** |
|--------------------|------------|------------------------|------------|-----------------|------------|
| 17,996,125         |       |                   | 18,471     |            |       |   | 18,405 |   |   |
|                    |            |                        |            |                 |            |  |  |  |  |

 

The stockholders alsoapproved the enumerated amendments to the 1998 Stock Option Plan by thefollowing vote:

| **Votes For** | ** ** | **Votes Against** | ** ** | **Abstentions** | ** ** | **Broker Non-votes** | ** ** |
|--------------------|------------|------------------------|------------|-----------------|------------|---------------------------|------------|
| 2,929,125          |       |                   | 2,274,673  |            |       |                      | 40,229     |   |   |   | 12,788,974 |   |   |
|                    |            |                        |            |                 |            |                           |            |  |  |  |  |  |  |

 

**Item 6.**   Exhibits and Reports on Form 8-K

(a)    Exhibits—
| Exhibit 10.62 |   | Loan and Security Agreement with Silicon Valley Bank  dated August 11, 2004 |
|--------------------|--------|----------------------------------------------------------------------------------|
| Exhibit 31.1  |   | Rule 13a-14(a)/15d-14(a) Certifications—William  P. Lyons         |
| Exhibit 31.2  |   | Rule 13a-14(a)/15d-14(a) Certifications—William  G. Levering      |
| Exhibit 32    |   | Officer Certifications under 18 USC 1350                                         |

 

(b)   Reports on Form 8-K—

On April 8, 2004, the Company filed a Form 8-Kwith the SEC disclosing details of a private placement and issuance ofwarrants.

On April 29, 2004, the Company furnished a Form 8-Kreporting the issue of a press release disclosing material non-publicinformation regarding the Registrant’s results of operations for the quarterended March 31, 2004.

On April 30, 2004, the Company filed a Form 8-Kreporting the appointment of William P. Lyons to the position of President andChief Executive Officer, as well as a director, and the retirement of John A.Rade, the former President and Chief Financial Officer.

31

----

 

**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                                |   | AXS-ONE INC. |
|--------------------------------|--------|--------------|
| **Date:**August 13,  2004 |   | By:          |   | /s/ William P. Lyons |
|                           |   |         |   | William P. Lyons*Chief Executive Officer and  Chairman of the Board* |
|                           |   | By:          |   | /s/ William G. Levering III |
|                           |   |         |   | William G. Levering III*Vice President, Chief Financial Officer,  and Treasurer*  (Duly Authorized Officer and  Principal Financial Officer) |

 

32

----