**SECURITIES AND EXCHANGE COMMISSION**

 

**Washington, D.C. 20549**

 

**FORM 10-QSB**

 

|                                | **ý** |                                               | **QUARTERLY  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------------------------------------|------------|----------------------------------------------------|----------------------------------------------------------------------------------------|
|                                |       |                                               |
|                                |       | **FOR THE QUARTERLY PERIOD ENDED MARCH 31,  2004** |
|                                |       |                                               |
| **or**                              |
|                                |       |                                               |
|                                | **o**      |                                               | **TRANSITION  REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT**                   |
|                                |       |                                               |
| **COMMISSION FILE NUMBER: 0-11933** |

 

**AXCESS INTERNATIONAL INC.**

(Exact name of small business issuer asspecified in its charter)

 
| **Delaware**                                                                         |   | **85-0294536**                       |
|--------------------------------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of incorporation or organization)                       |   | (I.R.S. Employer Identification No.) |
|                                                                                 |   |                                 |
| **3208 Commander DriveCarrollton, Texas 75006  (972) 407-6080**                      |
| (Address, including telephone number and area code, of principal  executive offices) |

 

Check whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) of theExchange Act during the past 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

Yes ýNo o

 

Number of shares of commonstock outstanding on May 10, 2004: **23,975,373**

 

Transitional Small BusinessDisclosure Format: Yes oNo ý

 

 

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**AXCESS INC.INDEX**

 
| **PART I. FINANCIAL INFORMATION** |                                                                    |
|-----------------------------------|-------------------------------------------------------------------------|
|                              |                                                                    |   |   |
|                              | Item 1. Financial Statements:                                           |   |
|                              |                                                                    |   |   |
|                              |                                                                    | Balance Sheets at March 31, 2004 and  December 31, 2003 |   |
|                              |                                                                    |   |   |
|                              |                                                                    | Statements of Operations for the Three Months  ended March 31, 2004 and 2003 |   |
|                              |                                                                    |   |   |
|                              |                                                                    | Statements of Cash Flows for the Three  Months ended March 31, 2004 and 2003 |   |
|                              |                                                                    |   |   |
|                              |                                                                    | Notes to Financial Statements |   |
|                              |                                                                    |   |   |
|                              | Item 2. Management’s Discussion and  Analysis or Plan of Operation |   |
|                              |                                                                    |   |   |
|                              | Item 3. Controls and Procedures                                         |   |
|                              |                                                                    |   |   |
| **PART II. OTHER INFORMATION**    |                                                                    |
|                              |                                                                    |   |   |
|                              | Item 1. Legal Proceedings                                               |   |
|                              |                                                                    |   |   |
|                              | Item 2. Changes in Securities                                           |   |
|                              |                                                                    |   |   |
|                              | Item 3. Defaults Upon Senior Securities                                 |   |
|                              |                                                                    |   |   |
|                              | Item 4. Submission of Matters to a Vote of  Security Holders            |   |
|                              |                                                                    |   |   |
|                              | Item 5. Other Information                                               |   |
|                              |                                                                    |   |   |
|                              | Item 6. Exhibits and Reports on Form 8-K                                |   |
|                              |                                                                    |   |   |
| **SIGNATURES**                    |                                                                    |

 

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**PART 1. FINANCIAL INFORMATION**

**Item 1. Financial Statements**

 

**AXCESS INTERNATIONAL INC.CONSOLIDATED BALANCE SHEETS**

 
|                                                                                                                                                                                  |   | **(Unaudited)  March 31,  2004** |      | **December  31,  2003** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|-----------|-------------------------|--------|
| ASSETS                                                                                                                                                                                |   |                             |      |                    |   |
|                                                                                                                                                                                  |   |                             |      |                    |   |
| Current assets:                                                                                                                                                                       |   |                             |      |                    |   |
| Cash and cash equivalents                                                                                                                                                             |   | $                                | 1,393,789 |                    | $      | 2,163,977 |   |
| Accounts receivable - trade, net of  allowance for doubtful accounts                                                                                                                  |   | 95,032                           |      | 85,248                  |   |
| Inventory                                                                                                                                                                             |   | 151,076                          |      | 131,515                 |   |
| Prepaid expenses and other                                                                                                                                                            |   | 99,911                           |      | 148,490                 |   |
|                                                                                                                                                                                  |   |                             |      |                    |   |
| Total current assets                                                                                                                                                                  |   | 1,739,808                        |      | 2,529,230               |   |
|                                                                                                                                                                                  |   |                             |      |                    |   |
| Property, plant and equipment, net                                                                                                                                                    |   | 49,564                           |      | 61,756                  |   |
| Intellectual property, net                                                                                                                                                            |   | 75,318                           |      | 149,704                 |   |
| Deferred debt issuance costs                                                                                                                                                          |   | 633,611                          |      | 675,852                 |   |
| Other assets                                                                                                                                                                          |   | 595                              |      | 595                     |   |
|                                                                                                                                                                                  |   |                             |      |                    |   |
| Total assets                                                                                                                                                                          |   | $                                | 2,498,896 |                    | $      | 3,417,137 |   |
|                                                                                                                                                                                  |   |                             |      |                    |   |
| LIABILITIES AND STOCKHOLDERS’ DEFICIT                                                                                                                                            |   |                             |      |                    |   |
|                                                                                                                                                                                  |   |                             |      |                    |   |
| Current liabilities:                                                                                                                                                                  |   |                             |      |                    |   |
| Accounts payable                                                                                                                                                                      |   | $                                | 625,798   |                    | $      | 813,976 |   |
| Other accrued liabilities                                                                                                                                                             |   | 771,220                          |      | 802,355                 |   |
| Dividends payable                                                                                                                                                                     |   | 82,102                           |      | 125,999                 |   |
| Total current liabilities                                                                                                                                                             |   | 1,479,120                        |      | 1,742,330               |   |
|                                                                                                                                                                                  |   |                             |      |                    |   |
| Note payable to stockholder                                                                                                                                                           |   | 4,058,956                        |      | 4,058,956               |   |
| Convertible notes payable (includes  $120,000 with related party in 2004 and 2003)                                                                                                    |   | 1,081,667                        |      | 1,288,333               |   |
| Discount on convertible debt                                                                                                                                                          |   | (471,504                         | )         | (680,457                | )      |
|                                                                                                                                                                                  |   |                             |      |                    |   |
| Total liabilities                                                                                                                                                                     |   | 6,148,239                        |      | 6,409,162               |   |
|                                                                                                                                                                                  |   |                             |      |                    |   |
| Stockholders’ deficit:                                                                                                                                                           |   |                             |      |                    |   |
| Convertible preferred stock, 7,000,000  shares authorized                                                                                                                             |   |                             |      |                    |   |
| With liquidation preference; 54 shares  issued and outstanding in 2003                                                                                                                |   | —                           |      | 536,623                 |   |
| Without liquidation preference; $0.01 par  value, 1,790,000 shares issued and outstanding in 2003 and 2004, respectively                                                              |   | 17,900                           |      | 17,900                  |   |
| Common stock, $0.01 par value, 50,000,000  shares authorized in 2004 and 2003; 23,975,373 shares issued and outstanding  in 2004 and 19,446,028 shares issued and outstanding in 2003 |   | 239,754                          |      | 194,461                 |   |
| Shares of common stock to be issued,  425,800 shares in 2004 and 4,529,345 shares in 2003                                                                                             |   | 4,258                            |      | 45,293                  |   |
| Non-voting convertible common stock, $0.01  par value, 2,250,000 shares authorized; no shares issued and outstanding in  2004 or 2003                                                 |   | —                           |      | —                  |   |
| Additional paid-in capital                                                                                                                                                            |   | 147,164,629                      |      | 146,246,094             |   |
| Accumulated deficit                                                                                                                                                                   |   | (151,075,884                     | )         | (150,032,396            | )      |
|                                                                                                                                                                                  |   |                             |      |                    |   |
| Total stockholders’ deficit                                                                                                                                                      |   | (3,649,343                       | )         | (2,992,025              | )      |
|                                                                                                                                                                                  |   |                             |      |                    |   |
| Total liabilities and stockholders’ deficit                                                                                                                                      |   | $                                | 2,498,896 |                    | $      | 3,417,137 |   |

 

See accompanying notes to unaudited financial statements.

 

1

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**AXCESS INTERNATIONALINC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

 
|                                                 |   | **Three  Months Ended  March 31,** |       |
|------------------------------------------------------|--------|------------------------------------|------------|
|                                                 |   | **2004**                           |       | **2003** |   |
|                                                 |   |                               |       |   |   |
| Sales                                                |   | $                                  | 206,678    |   | $ | 290,564 |   |
| Cost of sales                                        |   | 98,886                             |       | 174,712 |   |
|                                                 |   |                               |       |   |   |
| Gross profit                                         |   | 107,792                            |       | 115,852 |   |
| Expenses:                                            |   |                               |       |   |   |
| Research and development                             |   | 185,359                            |       | 136,393 |   |
| General and administrative                           |   | 404,215                            |       | 258,567 |   |
| Selling and marketing                                |   | 174,583                            |       | 88,597 |   |
| Depreciation and amortization                        |   | 93,632                             |       | 119,162 |   |
|                                                 |   |                               |       |   |   |
| Operating expenses                                   |   | 857,789                            |       | 602,719 |   |
|                                                 |   |                               |       |   |   |
| Loss from operations                                 |   | (749,997                           | )          | (486,867 | ) |
|                                                 |   |                               |       |   |   |
| Other income (expense):                              |   |                               |       |   |   |
| Interest expense, net                                |   | (322,723                           | )          | (219,640 | ) |
| Gain in vendor settlements                           |   | 88,243                             |       | 2,792 |   |
| Other                                                |   | 6,509                              |       | — |   |
|                                                 |   |                               |       |   |   |
| Other expense, net                                   |   | (227,971                           | )          | (216,848 | ) |
|                                                 |   |                               |       |   |   |
| Net loss                                             |   | (977,968                           | )          | (703,715 | ) |
|                                                 |   |                               |       |   |   |
| Preferred stock dividend requirements                |   | (65,520                            | )          | (99,196 | ) |
|                                                 |   |                               |       |   |   |
| Net loss applicable to common  stock                 |   | $                                  | (1,043,488 | ) | $ | (802,911 | ) |
|                                                 |   |                               |       |   |   |
| Basic and diluted net loss per share                 |   | $                                  | (0.05      | ) | $ | (0.05 | ) |
|                                                 |   |                               |       |   |   |
| Weighted average shares of common stock  outstanding |   | 21,594,791                         |       | 16,744,787 |   |

 

See accompanying notes to unaudited financial statements.

 

2

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**AXCESS INTERNATIONALINC.CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)**

 
|                                                                         |   | **Three  Months Ended  March 31,** |      |
|------------------------------------------------------------------------------|--------|------------------------------------|-----------|
|                                                                         |   | **2004**                           |      | **2003** |   |
| Cash flows from operating activities:                                        |   |                               |      |   |   |
| Net loss                                                                     |   | $                                  | (977,968  | ) | $ | (703,715 | ) |
| Adjustments to reconcile net loss to net  cash used by operating activities: |   |                               |      |   |   |
| Depreciation and amortization                                                |   | 93,632                             |      | 119,161 |   |
| Amortization of financing discount and  issuance costs                       |   | 251,195                            |      | 61,311 |   |
| Gain on vendor settlements                                                   |   | (88,243                            | )         | — |   |
| Changes in operating assets and  liabilities:                                |   |                               |      |   |   |
| Accounts receivable                                                          |   | (9,784                             | )         | (40,920 | ) |
| Inventory                                                                    |   | (19,561                            | )         | 17,563 |   |
| Prepaid expenses and other                                                   |   | 48,579                             |      | 21,744 |   |
| Other assets                                                                 |   | —                             |      | 29,384 |   |
| Accounts payable                                                             |   | (60,984                            | )         | 3,336 |   |
| Other liabilities                                                            |   | —                             |      | 8,324 |   |
| Net cash used by operating activities                                        |   | (763,134                           | )         | (483,812 | ) |
|                                                                         |   |                               |      |   |   |
| Cash flow from investing activities:                                         |   |                               |      |   |   |
| Capital expenditures                                                         |   | (7,054                             | )         | — |   |
| Change in restricted cash                                                    |   | —                             |      | 140,000 |   |
| Net cash provided (used) by investing  activities                            |   | (7,054                             | )         | 140,000 |   |
|                                                                         |   |                               |      |   |   |
| Cash flow from financing activities:                                         |   |                               |      |   |   |
| Borrowings under financing agreements                                        |   | —                             |      | 354,000 |   |
| Principal payments on financing agreements                                   |   | —                             |      | (28,155 | ) |
| Net cash provided by financing activities                                    |   | —                             |      | 325,845 |   |
|                                                                         |   |                               |      |   |   |
| Net decrease in cash and cash equivalents                                    |   | (770,188                           | )         | (17,967 | ) |
| Cash and cash equivalents, beginning of  period                              |   | 2,163,977                          |      | 33,249 |   |
| Cash and cash equivalents, end of period                                     |   | $                                  | 1,393,789 |   | 15,282 |   |
|                                                                         |   |                               |      |   |   |
| Supplemental information:                                                    |   |                               |      |   |   |
| Cash paid during the period for interest                                     |   | $                                  | —    |   | $ | 217 |   |
|                                                                         |   |                               |      |   |   |
| Supplemental Disclosure of Non-Cash  Investing and Financing Activities:     |   |                               |      |   |   |
| Conversions of notes payable into common  stock                              |   | $                                  | 206,667   |   | — |   |
| Conversions of accrued interest into common  stock                           |   | 70,086                             |      | — |   |
| Conversions of preferred stock into common  stock                            |   | 536,623                            |      | — |   |
| Conversion of accrued dividends into common  stock                           |   | 109,417                            |      | — |   |
| Preferred stock dividends accrued                                            |   | 65,520                             |      | 99,196 |   |

 

See accompanying notes to unaudited financial statements.

 

3

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**AXCESSNOTES TO FINANCIAL STATEMENTS(Unaudited)**

 

**(1) Summary of Significant AccountingPolicies**

 

**(a) Description ofBusiness**

 

The Companyprovides advanced security and asset management systems, which locate,identify, track, monitor and protect assets. The main applications of theCompany’s systems are security video through closed circuit television (calledCCTV), personnel and vehicle access control, and automatic asset tracking andprotection. The Company provides solutions in the recently identified homelandsecurity markets such as air and ground transportation, water treatmentfacilities, oil and gas, power plants, as well as in the markets for datacenters, retail / convenience stores, education, healthcare, and corporateoffices. AXCESS utilizes two patented and integrated technologies:network-based radio frequency identification (RFID) and tagging and streamingvideo. Both application and browser-based software options deliver criticalreal-time information tailored to each end user via the enterprise network orInternet, also providing custom alerts in the form of streaming video, e-mail,or messages delivered to wireless devices.

 

The Company’s business plan for 2004 is predicated principally upon thesuccessful marketing of its RFID and digital video products. During the firstquarter of 2004, operating activities utilized approximately $0.8 million ofcash. During 2003 and the second quarter of 2004 we raised a net of $4.4million and $1.2 million, respectively, for additional working capital throughthree exempt Preferred Stock offering.

 

The future results of operations and financial condition of the Companywill be impacted by the following factors, among others: changes fromanticipated levels of sales, access to capital, future national or regionaleconomic and competitive conditions, changes in relationships with customers,difficulties in developing and marketing new products, marketing existingproducts, customer acceptance of existing and new products, validity ofpatents, technological change, dependence on key personnel, availability of keycomponent parts, dependence on third party manufacturers, vendors, contractors,product liability, casualty to or other disruption of the productionfacilities, delays and disruptions in the shipment of the Company’s products,and the ability of the Company to meet its stated business goals.

 

Ifthe Company’s losses or lack of operating capital continue, the Company willhave to obtain funds to meet its cash requirements through business alliances,such as strategic or financial transactions with third parties, the sale ofsecurities or other financing arrangements, or the Company may be required tocurtail its operations, seek a merger partner, or seek protection under federalbankruptcy laws. Any of the foregoing may be on terms that are unfavorable tothe Company or disadvantageous to existing stockholders. In addition, noassurance may be given that the Company will be successful in raisingadditional funds or entering into business alliances.

 

**(b) CompanyOrganization and Basis of Presentation**

 

Theaccompanying consolidated financial statements include the accounts of theCompany and its majority-owned subsidiaries. All significant intercompanyaccounts and transactions have been eliminated in consolidation.

 

The Company has received working capital in various forms from AmphionVentures, L. P. and affiliates of Amphion Ventures, L. P. including AmphionPartners, Amphion Investments LLC, Antiope Partners, VennWorks LLC (formerlyincuVest LLC), Amphion Capital Management, and NVW, LLC (collectively, the“Amphion Group”). Following the conversion of the 2003 preferred stock held bythe Amphion Group into common stock in 2003, the Amphion Group ownsapproximately 69% of the outstanding voting stock of the Company.

 

**(c) Inventory**

 

Inventory isvalued at the lower of cost or market using the first-in, first-out method.Inventory was comprised of the following at March 31, 2004 and December 31,2003:

 

|            |   | **March 31,  2004** |    | **December  31,  2003** |   |
|-----------------|--------|---------------------|---------|-------------------------|--------|
| Raw materials   |   | $                   | 52,553  |                    | $      | 36,682 |   |
| Work-in-process |   | —              |    | 10,513                  |   |
| Finished goods  |   | 98,523              |    | 84,320                  |   |
|            |   | $                   | 151,076 |                    | $      | 131,515 |   |

 

4

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**(d) Stock Options**

 

The Company accounts for its stock-based compensation plan underAccounting Principles Board (“ABP”) Opinion No. 25, Accounting for Stock Issuedto Employees. The pro forma information below is based on provisions ofStatement of Financial Accounting Standard (“FAS”) No. 123, Accounting forStock-Based Compensation, as amended by FAS 148, Accounting for Stock-BasedCompensation—Transition and Disclosure, issued in December 2002.

 

The Company does not have a history of paying cash dividends and nonehave been assumed in estimating the fair value of its options.

 

The Black-Scholes option valuation model was developed for use inestimating the fair value of traded options, which have no vesting restrictionsand are fully transferable. In addition, option valuation models require theinput of highly subjective assumptions including expected stock pricevolatility. Because, among other things, changes in the subjective inputassumptions can materially affect the fair value estimate, in management’sopinion, the existing models do not necessarily provide a reliable measure ofthe fair value of its employee stock options. For purposes of pro forma disclosures,the estimated fair value of the options is amortized to expense over theoptions’ vesting periods. 
|                                                       |   | **Three  Months Ended  March 31,** |       |
|------------------------------------------------------------|--------|------------------------------------|------------|
|                                                       |   | **2004**                           |       | **2003** |   |
| **Pro forma impact of fair value method (FAS  148)**       |   |                               |       |   |   |
| Reported net loss attributed to common stock               |   | $                                  | (1,043,488 | ) | $ | (802,911 | ) |
| Less: fair value of employee stock  compensation           |   | (80,424                            | )          | (119,421 | ) |
| Pro forma net loss attributed to common  stock             |   | (1,123,912                         | )          | (922,332 | ) |
|                                                       |   |                               |       |   |   |
| **Loss per common share**                                  |   |                               |       |   |   |
| Basic and diluted net loss per share – as reported    |   | $                                  | (0.05      | ) | $ | (0.05 | ) |
| Basic and diluted net loss per share – pro  forma     |   | $                                  | (0.05      | ) | $ | (0.06 | ) |
|                                                       |   |                               |       |   |   |
| **Weighted average Black-Scholes fair value  assumptions** |   |                               |       |   |   |
| Risk free interest rate                                    |   | 4.25%                              |       | 5.00% |   |
| Expected life                                              |   | 2 years                            |       | 5 years |   |
| Expected volatility                                        |   | 175%                               |       | 88% - 92% |   |
| Expected dividend yield                                    |   | 0.0%                               |       | 0.0% |   |

 

**(e) Recent AccountingPronouncements**

 

In January 2003, the FASB issued Interpretation No. 46, *Consolidation of Variable Interest Entities, anInterpretation of ARB No. 51* (“FIN 46”), which was revised andsuperceded by FASB Interpretation No. 46R in December 2003 (FIN 46R).   FIN 46R requires the consolidation ofcertain variable interest entities, as defined.  FIN 46R is effectiveimmediately for special purpose entities and variable interest entities createdafter December 31, 2003, and must be applied to other variable interestentities no later than December 31, 2004. The Company believes it has no suchvariable interest entities and as a result FIN No. 46R will have no impact onits results of operations, financial position or cash flows.

 

**(2) Contingencies**

 

Axcess is engaged in a number of lawsuitswith approximately thirteen vendors who claim they are owed amounts from $500to $45,000, which aggregates in total $223,885. We are currently defending orseeking to settle each of the vendor’s claims. At March 31, 2004, we had accrued the delinquent amounts we expect to beliable for, for the claims described in this paragraph.

 

5

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**(3) Preferred Stock**

 

The Company has authorized 7,000,000 shares of convertible preferredstock, of which shares designated in five series have been issued. Informationwith respect to the series of preferred stock outstanding at each balance sheetdate is summarized below.

 
|                                                                    |   | **Series I**                          |   | **Series J**                           |   | **2003B  Series**                     |   |
|-------------------------------------------------------------------------|--------|---------------------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
| Number of  shares authorized                                            |   | 2,500                                 |   | 2,500                                  |   | 2,750,000                             |   |
|                                                                    |   |                                  |   |                                   |   |                                  |   |
| Stated value                                                            |   | $                                     | 10,000 |                                   | $      | 10,000                                |   | $ | 0.01 |   |
|                                                                    |   |                                  |   |                                   |   |                                  |   |
| Number of  shares issued and outstanding:                               |   |                                  |   |                                   |   |                                  |   |
| December 31, 2003                                                       |   | 52                                    |   | 2                                      |   | 1,790,000                             |   |
| March 31, 2004                                                          |   | —                                |   | —                                 |   | 1,790,000                             |   |
|                                                                    |   |                                  |   |                                   |   |                                  |   |
| Conversion ratio (or conversion price) of  preferred shares into common |   | $ 2.51 into  voting  common  stock    |   | $ 2.51 into  non-voting  common  stock |   | 1 to 1 into  voting  common  stock    |   |
|                                                                    |   |                                  |   |                                   |   |                                  |   |
| Liquidation  preference                                                 |   | Stated value  plus accrued  dividends |   | Stated value  plus accrued  dividends  |   | Stated value  plus accrued  dividends |   |
|                                                                    |   |                                  |   |                                   |   |                                  |   |
| Dividend  rights                                                        |   | 8% per  annum,  cumulative            |   | 8% per  annum,  cumulative             |   | 7% per  annum,  cumulative            |   |
|                                                                         |        |                                       |        |                                        |        |                                       |        |  |  |  |

 

*(a)            SeriesI and Series J Preferred Stock*

 

The holders of Series I Preferred Stock and Series J Preferred Stockare entitled to receive semi-annual dividends on each such share at the annualrate of 8% of the original issue price of each share payable in arrears, when,as and if declared by the Company’s board of directors, in cash or additionalshares of preferred stock.   Shares ofSeries I Preferred Stock and Series J Preferred Stock are convertible intoshares of common stock at a conversion price of $2.51 per share.  During the three months ended March 31, 2004there were $10,441 and $411 of dividends accrued for Series I Preferred Stockand Series J Preferred Stock, respectively.  Dividends payable were $0 and $95,182 for Series I Preferred Stock atMarch 31, 2004 and December 31, 2003, respectively. Dividends payable were $0and $3,384 of dividends payable for Series J Preferred Stock at March 31, 2004and December 31, 2003, respectively.

 

The holder of the Series I converted $516,299 of Preferred Series I and$105,623 of accrued dividends into 248,769 shares of common stock of Axcess.The holder of the Series J converted $20,324 of Preferred Series J and $3,795of accrued dividends into 9,648 shares of common stock of Axcess.   During the first quarter of 2003 all sharesof the Series of Series I and Series J preferred stock were retired orconverted and there are currently no shares outstanding.

 

*(b)            Series2003B Preferred Stock*

 

The Company completed a $3,132,500 exempt Preferred Stock Offeringduring the fourth quarter of 2003. The Preferred Stock is designated as 2003BPreferred and each $70,000 unit consisted of 40,000 shares of Preferred Stockbearing a 7% dividend, approximately 2,000 shares of common stock and 40,000warrants to purchase the Company’s common stock exercisable for two years at$2.75 per share. The offering also included an automatic conversion into CommonStock on a one for one basis if the closing twenty-day average stock price isover $3.75. The Company has also accrued $27,433 of dividends payable forSeries 2003B Preferred Stock at December 31, 2003. As of December 31, 2003, theCompany had 1,790,000 shares of Series 2003B Preferred shares outstanding.

 

In connection with the issuance of the 2003B Preferred Stock, theCompany recorded preferred stock dividend requirements of $1,782,831 that willbe reflected as preferred stock dividends as the underlying preferred stockconverts to common stock.  As ofDecember 31, 2003 that amount is reflected in accumulated deficit on thebalance sheet.

 

6

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**(4) Convertible Notes Payable**

 

On July 30, 2002, theCompany entered into a bridge financing agreement with ten accredited investorsfor the sale and issuance of 10 “units” to the investors for an aggregatepurchase price of $1,000,000. Each unit consists of a convertible promissorynote in the amount of $100,000 and 25,000 shares of the Company’s commonstock.  Each investor has agreed to notsell more than one-third of the common stock comprising the units during anycalendar month. The convertible promissory notes comprising the units bearinterest at an annual rate of 7% and mature on July 30, 2005. On each of July30, 2003, July 30, 2004 and July 30, 2005, the investors have the option toconvert one-third of the principal amount of the notes into common stock of theCompany. The conversion price of the notes is initially 65% of the averageclosing price of a share of the Company’s common stock for the 20 trading dayspreceding the given anniversary date of the notes. The maximum conversion priceshall be $4.00 per share and the minimum conversion price shall be $1.00 pershare. The conversion price will be subject to adjustment from time to time toreflect any reorganization, recapitalization, reclassification, stock dividend,stock split, reverse stock split or similar change in the Company’s shares ofcommon stock. The Company without premium or penalty may prepay the notes inwhole or in part.

 

During the three monthsended March 31, 2004, two holders elected to convert $200,000 of their notesplus $67,785 of accrued interest into 160,959 shares of Axcess common stock,which should be issued during the second quarter of 2004.  In connection with this conversion,the Company recorded $117,739 of additional debt discount amortization.

 

On January 17,2003, Axcess entered into a bridge financing agreement with ten accreditedinvestors for the sale and issuance of 3.05 “units” to the investors for anaggregate purchase price of  $305,000.  Each unit consists of a convertiblepromissory note in the amount of $100,000 and 50,000 shares of our commonstock.  By agreement, each investor maynot sell more than one-third of the common stock comprising the units duringany calendar month. The convertible promissory notes comprising the units bearinterest at an annual rate of 7% and mature on January 31, 2006. On each ofJanuary 31, 2004, January 31, 2005 and January 31, 2006, the investors have theoption to convert one-third of the principal amount of the notes into commonstock of Axcess. The conversion price of the notes is initially 65% of theaverage closing price of a share of our common stock for the twenty (20)trading days preceding the given anniversary date of the notes. The maximumconversion price shall be $2.00 per share and the minimum conversion priceshall be $0.50 per share. The conversion price will be subject to adjustmentfrom time to time to reflect any reorganization, recapitalization,reclassification, stock dividend, stock split, reverse stock split or similarchange in our shares of common stock. The notes may be prepaid in whole or inpart by us without premium or penalty.

 

During the three monthsended March 31, 2004, one holder elected to convert $6,667 of their note plus$2,301 of accrued interest into 6,546 shares of Axcess common stock, whichshould be issued during the second quarter of 2004.  In connection with this conversion, the Company recorded$4,212 of additional debt discount amortization.

 

**(5)Significant Customers**

 

During the three months ended March 31, 2004 the Company had twocustomers that accounted for 40% of the overall revenue, two customersaccounted for 45% of the digital video product sales and three customersaccounted for 57% of the RFID product sales. During the three months ended March 31, 2003 the Company had twocustomers that accounted for 44% of the overall revenue, two customersaccounted for 78% of the digital video product sales and three customersaccounted for 42% of the RFID product sales.

 

**Item 2. Management’s Discussion and Analysisor Plan of Operation**.

 

**Forward-LookingStatements**

 

This quarterly report on Form 10-QSB includes “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of 1933, asamended (the “Securities Act”), and Section 21E of the Securities Exchange Actof 1934, as amended, which can be identified by the use of forward-lookingterminology such as, “may,” “expect,” “could,” “plan,” “seek,” “anticipate,”“estimate,” or “continue” or the negative thereof or other variations thereonor comparable terminology.

 

These forward-looking statements are subject to various risks anduncertainties that could cause actual results to differ materially from thosereferred to in the forward-looking statements and are made pursuant to the“safe-harbor” provisions of the Private Securities Litigation Reform Act of1995.  These statements are made basedon management’s current expectations or beliefs as well as assumptions made by,and information currently available to, management.

 

A variety of factors could cause actual results to differ materiallyfrom those anticipated in the Company’s forward-looking statements, includingthe following factors: changes fromanticipated levels of sales, access to capital, future national or regionaleconomic and competitive conditions, changes in relationships with customers,difficulties in developing and marketing new products, marketing existingproducts, customer acceptance of existing and new products, validity ofpatents, technological change, dependence on key personnel, availability of keycomponent parts, dependence on third party manufacturers, vendors, contractors,product liability, casualty to or other disruption of the productionfacilities, delays and disruptions in the shipment of

 

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the Company’s product, and theability of the Company to meet its stated business goals.  For a detailed discussion ofthese and other cautionary statements and factors that could cause actualresults to differ from the Company’s forward-looking statements, please referto the Company’s filings with the Securities and Exchange Commission,especially  “Item 1. Description ofBusiness” (including the “Risk Factors” section of Item 1) and “Item 6. Management’sDiscussion and Analysis or Plan of Operation” of the Company’s 2003 AnnualReport on Form 10-KSB.

 

Readers are cautioned not to place undue reliance on theseforward-looking statements, which reflect management’s analysis only as of thedate hereof. The Company does not undertake any obligation to publicly revisethese forward-looking statements to reflect events or circumstances that ariseafter the date hereof. Readers should carefully review the risk factorsdescribed in other documents the Company files from time to time with the Securitiesand Exchange Commission.

 

##### **RecentDevelopments:  Going Concern andLiquidity Problems**

##### ** **

Our auditors have included an explanatoryparagraph in their audit opinion with respect to our consolidated financialstatements at December 31, 2003. The paragraph states that our recurring lossesfrom operations and resulting continued dependence on access to externalfinancing raise substantial doubts about our ability to continue as a goingconcern. Furthermore, the factors leading to and the existence of theexplanatory paragraph may adversely affect our relationship with customers andsuppliers and have an adverse effect on our ability to obtain financing.

 

We do not have sufficient working capital tosustain our operations.  We have beenunable to generate sufficient revenues to sustain our operations. We will haveto obtain funds to meet our cash requirements through business alliances, suchas strategic or financial transactions with third parties, the sale ofsecurities or other financing arrangements, or we may be required to curtailour operations, seek a merger partner, or seek protection under federalbankruptcy laws. Any of the foregoing may be on terms that are unfavorable tous or disadvantageous to existing stockholders. In addition, no assurance maybe given that we will be successful in raising additional funds or enteringinto business alliances.

 

##### **Liquidityand Capital Resources**

 

Since inception, we have utilized theproceeds from a number of public and private sales of our equity securities, theexercise of options and warrants and more recently, convertible debt,short-term bridge loans from stockholders and preferred equity offerings tomeet our working capital requirements. At March 31, 2004, we had workingcapital of $260,687.

 

Our operations generated losses in 2003 andcontinue to generate losses in 2004. Our cash decreased $770,188 during thethree months ended March 31, 2004 with operating activities using $763,134 ofcash. We funded operations primarily through cash on hand from borrowings andequity offerings over the last two years. No assurance can be given that such activities will continue to beavailable to provide funding to us.  Ourbusiness plan for 2004 is predicated principally upon the successful marketingof our RFID and digital video products. We anticipate that our existing workingcapital resources and revenues from operations will not be adequate to satisfyour funding requirements in 2004.

 

Our working capital requirements will dependupon many factors, including the extent and timing of our product sales, ouroperating results, the status of competitive products, and actual expendituresand revenues compared to our business plan. We are currently experiencingdeclining liquidity, losses from operations and negative cash flows, whichmakes it difficult for us to meet our current cash requirements, includingpayments to vendors, and may jeopardize our ability to continue as a goingconcern. We intend to address our liquidity problems by controlling costs,seeking additional funding (through capital raising transactions and businessalliances) and maintaining focus on revenues and collections.

 

If our losses continue, we will have toobtain funds to meet our cash requirements through business alliances, such asstrategic or financial transactions with third parties, the sale of securitiesor other financing arrangements, or we may be required to curtail ouroperations, seek a merger partner, or seek protection under federal bankruptcylaws. Any of the foregoing may be on terms that are unfavorable to us ordisadvantageous to existing stockholders. In addition, no assurance may begiven that we will be successful in raising additional funds or entering intobusiness alliances.

 

##### **2004Preferred Equity Offering**

##### ** **

During the second quarter of 2004 we raised anet of  $1,200,000 of additional workingcapital through an exempt Preferred Stock offering.  The Preferred Stock is designated as 2004 Preferred and consistedof 625,000 shares of Preferred Stock bearing a 7% dividend and 357,142 warrantsto purchase our common stock exercisable for two years at $3.20 per share.  The offering also includes anautomatic conversion into Common Stock on a one for one basis if the closingtwenty-day average stock price is over $4.00 or when we achieve a full quarterof profitability.

 

In connectionwith the issuance of the 2004 Preferred Stock, we will record preferred stockdividend requirements of approximately $1,000,000 that will be reflected aspreferred stock dividends as the underlying preferred stock converts to commonstock.

 

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##### **Sales and Marketing Initiatives**

##### ** **

In the past our sales volume has not been sufficientto sustain our operations. During the quarter ended March 31, 2004 we wereable, through the recent financing, to initiate a new marketing emphasis, whichis intended by us to build sales, primarily of our RFID products. Our marketingteam has implemented the following sales strategies:

 

1.               A marketing communications program to createbrand awareness in the security systems integration space;

2.               The hiring of two additional sales personneland one marketing administrative assistant;

3.               An assessment of the non-security market foractive RFID.

 

While there can be no assurance that our efforts will be successful, webelieve that these strategies will assist us in our goal of becomingprofitable.

 

**Results of Operations**

 

##### **ThreeMonths Ended March 31, 2004 Compared to Three Months Ended March 31, 2003**

 

*Sales and GrossProfit*. Sales for the three months ended March 31,2004 were $206,678 and for the three months ended March 31, 2003 were$290,564.  Cost of sales for the threemonths ended March 31, 2004 were $98,886 and for the three months ended March31, 2003 were $174,712. The gross profit for the three months ended March 31,2004 was $107,792 and $115,852 for the three months ended March 31, 2003. Thedecrease in sales was due to a large order for the video product in 2003 thatwas not duplicated in 2004.  The marginimprovement is driven by a shift in the product mix and continued improvementin margins based on the shift to contract manufacturers.

 

Radio frequency identification (RFID) product sales were $174,307 forthe three months ended March 31, 2004 and $126,312 for the three months endedMarch 31, 2003. Cost of sales was $85,497 for the three months ended March 31,2004 and $80,935 for the three months ended March 31, 2003. As a result, grossprofits from RFID products were $88,810 for the three months ended March 31,2004 and $45,377 for the three months ended March 31, 2003.  Sales are continuing to increase based onthe increased exposure in the marketplace. The margin improvement is a result of the product mix shift andcontinued improvement based on the shift to contract manufacturers.

 

Digital videoproduct sales were $32,371 for the three months ended March 31, 2004 and$164,252 for the three months ended March 31, 2003.  Cost of sales was $13,387 for the three months ended March 31,2004 and $93,776 for the three months ended March 31, 2003.  As a result, gross profits from digitalvideo products were $18,984 for the three months ended March 31, 2004 and$70,476 for the three months ended March 31, 2003.  The decrease in sales is a result of one large order during 2003that was not duplicated in 2004.  Themargin improvement is a result of the product mix shift and continuedimprovement based on the shift to contract manufacturers.

 

*Operating Expenses*.Operating expenses were $857,789 for the three months ended March 31, 2004 and$602,719 for the three months ended March 31, 2003.  This increase was due to increased salaries, increasedadvertising, additional research and development, higher insurance and thehiring of outside professional services companies.

 

Research anddevelopment expenses were $185,359 for the three months ended March 31, 2004and $136,393 for the three months ended March 31, 2003.  The increase is a result of increasedsalaries from the recession of the pay reduction implemented during 2003 andsome additional development relating to certain RFID products offset by thedownsizing of the California facility.

 

Corporate general and administrative expenses were $404,215 for thethree months ended March 31, 2004 and $258,567 for the three months ended March31, 2003.  The increase is a result ofincreased salaries from the recession of the pay reduction implemented during2003, increased spending on an investor relations firms, increased director’sand officer’s insurance and an increase in professional services expensesrelating to the filing of a registration statement.  However, we were able to offset some of that increase with areduction in bad debt expense.

 

Selling and marketing expenses were $174,583 for the three months endedMarch 31, 2004 and $88,597 for the three months ended March 31, 2003.  The increase is a result of increasedsalaries from the recession of the pay reduction implemented during 2003,increased headcount and an increase in advertising.  We attended several trade shows during the first quarter as wellas placed several advertisements.  Weare attempting to reestablish our place in the market.

 

Depreciation and amortization expenses were $93,632 for the threemonths ended March 31, 2004 and $119,162 for the three months ended March 31,2003.  The decrease is related to lowerdepreciation expense as a result of the age of the equipment, the closing ofthe Georgia facility and the downsizing of the California facility.

 

*Other expenses, net*.Other expenses, net, were $227,971 for the three months ended March 31, 2004and $216,848 for the three months ended March 31, 2003. Interest expense was$103,083 higher during the three months ended March 31, 2004, compared to thethree months ended March 31, 2003, reflecting an increase in the amortization ofthe debt discount related to the convertible notes that converted during thequarter.  We also were able to settlesome accounts payable issues relating to prior periods at a discount from theaccrued amounts, which resulted in an $88,243 income.  As a result of the downsizing of the Texas facility we soldcertain furniture and fixtures that we no longer needed for $6,509.

 

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*Net Loss*.Net loss was $977,968 for the three months ended March 31, 2004, compared to aloss of $703,715 for the three months ended March 31, 2003.  The increase is mainly relating to theincreased salary expense, increased marketing activity and the hiring ofcertain professional service firms.

 

*Preferred Stockdividend requirements. *PreferredStock dividend requirements were $65,520 for the three months ended March 31,2004 and $99,196 for the three months ended March 31, 2003. This decrease wasdue to fewer preferred shares outstanding.

 

##### **Other**

##### ** **

*Inflation*.Inflation has not had, and is not expected to have, a material impact on theoperations and financial condition of the Company.

 

**Item 3. Controls and Procedures**

 

##### **Controlsand Procedures**

##### ** **

(a)           Evaluation of Disclosure Controlsand Procedures.  Based on theirevaluation as of the end of the period covered by this Quarterly Report on Form10-QSB, the Company’s principal executive officer and principal financialofficer have concluded that the Company’s disclosure controls and procedures(as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Actof 1934 (the “Exchange Act”)) are effective to ensure that information requiredto be disclosed by the Company in reports that it files or submits under theExchange Act is recorded, processed, summarized and reported within the timeperiods specified in the rules and forms of the Securities and ExchangeCommission.

 

(b)           Changes in Internal Controls.  During the period covered by this report,there were no significant changes in the Company’s internal controls or inother factors that could significantly affect these controls subsequent to thedate of their evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 

**PARTII. OTHER INFORMATION**

 

**Item1. Legal Proceedings**

 

Axcess is engaged in a number of lawsuitswith approximately thirteen vendors who claim they are owed amounts from $500to $45,000, which aggregates in total $223,885. We are currently defending orseeking to settle each of the vendor’s claims. At March 31, 2004, we had accrued the delinquent amounts we expect to beliable for, for the claims described in this paragraph.

 

**Item 2. Changes in Securities**.

 

During the three months ended March 31, 2004, the Company issuedunregistered securities in connection with the transactions described below.The issuance of stock was exempt from the registration requirements of theSecurities Act, as amended by virtue of Section 4(2) thereof, as transactionsnot involving a public offering and an appropriate restrictive legend was affixedto the stock certificates.

 

***ConvertibleNote***

 

During the three months ended March 31, 2004 two of the holders of theJuly 2002 Convertible debt elected to convert $200,000 of their $600,000 noteplus $67,785 of accrued interest into 160,859 of unregistered commonstock.  We reissued the notes for$400,000.  The shares will be issuedduring the second quarter.

 

During the three months ended March 31, 2004 one of the holder of theJanuary 2003 Convertible debt elected to convert $6,667 of his $20,000 noteplus $2,301 of accrued interest into 6,546 of unregistered common stock.  We reissued the note for $13,333.  The shares will be issued during the secondquarter.

 

***Ardinger.***

 

Ardingerconverted $516,299 of Preferred Series I and $105,623 of accrued dividends into248,769 shares of common stock of Axcess. Ardinger also converted $20,324 ofPreferred Series J and $3,795 of accrued dividends into 9,648 shares of commonstock of Axcess. The shares will be issued during the second quarter.

 

***2004 Preferred Equity Offering***

 

During the second quarter of 2004 the Companyraised a net of approximately $1,200,000 of additional working capital throughan exempt Preferred Stock offering.  ThePreferred Stock is designated as 2004 Preferred and consists of 625,000 sharesof Preferred Stock bearing a 7% dividend and 357,142 warrants to purchase theCompany’s common stock exercisable for two years at $3.20 per share. The offering also included an automaticconversion into common stock on a one for one basis if the closing twenty-dayaverage stock price is over $4.00 per share.

 

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##### **Item 3. Defaults Upon SeniorSecurities**

 

None

 

##### **Item 4. Submission ofMatters to a Vote of Security Holders**

 

None

 

##### **Item 5. Other Information**

 

***NVW L.L.C.***

 

In January 2004, Axcess entered into a one year Advisory Agreement withNVW L.L.C. (“NVW”).  NVW agreed workcooperatively with us to assist in our growth as set forth.  NVW may provide Axcess: (i) Identify,evaluate, and advise on a variety of options for Axcess’ to undertake toenhance its current capital structure including business model, financialoperations, operational, managerial, strategic, CRM, and strategic technologypartnering,  (ii) Prepare or coordinatewith Axcess and others in the development of business plans, investorpresentations, and financial models, when appropriate; (iii) Advise and assistAxcess with strategies relating to asset development, asset enhancement andmaximization of asset utilization, including those associated with anyintellectual property assets, (iv) Advise and assist Axcess in connection withthe preparation of any registration statements, periodic or other SEC reportsor proxies, and  (v) Coordinate with,and advise on with the activities of outside professionals, including withoutlimitation attorneys, accountants, market professionals.   In return Axcess has agreed to pay NVW$5,000 per month in advance.

 

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

 

(a) Exhibits:

 
|   | **Exhibit No.** |   | **Description**                                                                                                                                                                            |
|--------|-----------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 10.1            |   | Stock Purchase agreement for the 2004 Preferred Equity Offering from May 2004 *                                                                                                            |
|   | 10.2            |   | Letter dated April 14, 2004, from Ardinger regarding conversion  Series I Preferred Stock and accrued dividends.  *                                                                   |
|   | 10.3            |   | Letter dated April 14, 2004, from Ardinger regarding conversion  Series J Preferred Stock and accrued dividends.  *                                                                   |
|   | 10.4            |   | Advisory agreement between NVW LLC and Axcess.  Incorporated by reference to Exhibit 10.39  to the Company’s Annual Report on Form 10-KSB for the year ended December 31,  2003. |
|   | 31.1            |   | Certification  of our President, Chief Executive Officer and Principal Executive Officer,  under Section 302 of the Sarbanes-Oxley Act of 2002. *                                          |
|   | 31.2            |   | Certification  of our Vice President, Chief Financial Officer, Secretary and Principal  Accounting and Financial Officer, under Section 302 of the Sarbanes-Oxley Act  of 2002. *          |
|   | 32.1            |   | Certification  of our President, Chief Executive Officer and Principal Executive Officer,  under Section 906 of the Sarbanes-Oxley Act of 2002. *                                          |
|   | 32.2            |   | Certification  of our Vice President, Chief Financial Officer, Secretary and Principal  Accounting and Financial Officer, under Section 906 of the Sarbanes-Oxley Act  of 2002. *          |

 

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* Filedherewith

 

(b) Reports onForm 8-K:

 
| **Date**          |   | **Description**                                                                               |
|-------------------|--------|-----------------------------------------------------------------------------------------------|
| February 12, 2004 |   | Amended 8-K disclosing the Pro Forma financial statements of the balance sheet restructuring. |

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|         | AXCESS  INTERNATIONAL INC.,  Registrant                |
|--------------|--------------------------------------------------------|
|         |                                                   |
|         | /s/ ALLAN  GRIEBENOW                                   |
|         | Allan  Griebenow Director, President and               |
|         | Chief  Executive Officer (Principal Executive Officer) |
|         |                                                   |
|         | /s/ ALLAN L.  FRANK                                    |
|         | Allan L.  Frank                                        |
|         | Chief  Financial Officer and Secretary                 |
|         | (Principal  Accounting and Financial Officer)          |
|         |                                                   |
| May 14, 2004 |                                                   |

 

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