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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2003

OR

For the transition period from ________________to_________________

COMMISSION FILE NUMBER: 000-25590

DATASTREAM SYSTEMS, INC.

Incorporated pursuant to the laws of the State of Delaware

Internal Revenue Service — Employer Identification No. 57-0813674

50 DATASTREAM PLAZA, GREENVILLE, SC 29605

(864) 422-5001

NOT APPLICABLE

(Former Name, Former Address, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ý    No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes ý    No o

APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:           November 11, 2003:   20,216,129 shares, $0.01 par value.

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Datastream Systems, Inc.

FORM 10-Q

Quarter ended September 30, 2003

Index

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“SAFE HARBOR” STATEMENT UNDER THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995

        From time to time, we make oral and written statements that may constitute “forward looking statements” (rather than historical facts) as defined in the Private Securities Litigation Reform Act of 1995 or by the Securities and Exchange Commission (the “SEC”) in its rules, regulations and releases, including Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We desire to take advantage of the “safe harbor” provisions in the Private Securities Litigation Reform Act of 1995 for forward looking statements made from time to time, including, but not limited to, the forward looking statements made in this Quarterly Report on Form 10-Q (the “Report”), as well as those made in other filings with the SEC.

        Forward looking statements can be identified by our use of forward looking terminology such as “may,” “will,” “expect,” “anticipate,” “estimate,” “believe,” “continue” or other similar words. Such forward looking statements are based on management’s current plans and expectations and are subject to risks, uncertainties and changes in plans that could cause actual results to differ materially from those described in the forward looking statements. In the preparation of this Report, where such forward looking statements appear, we have sought to accompany such statements with meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those described in the forward looking statements. Such factors include, but are not limited to: a highly competitive market; our ability to keep pace with rapid technological changes and demands in our markets; volatility of our quarterly results due to increasing sales cycles; solutions that require longer implementations and other professional services engagements; reduced profitability due to our hosting services strategy; our ability to generate revenue and profits from our electronic procurement solution; significant delays in product development and our ability to be an innovator in the industry; third party relationships on which our success is substantially dependent; third party technologies on which our future success is substantially dependent; our ability to detect software bugs or errors to avoid a correction to or delay in the release of our products; our ability to manage our international operations; deterioration of economic and political conditions; continued acceptance of the Internet for business transactions; recruiting and retaining key employees; our ability to adequately protect our proprietary rights; security risks and concerns that may deter use of the Internet for our applications; fluctuations in our stock price since our initial public offering; and our exposure to foreign exchange rate fluctuations. The preceding list of risks and uncertainties, however, is not intended to be exhaustive, and should be read in conjunction with other cautionary statements that we make herein including, but not limited to, the “Risk Factors” set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s Form 10-K for the fiscal year ended December 31, 2002, as well as other risks and uncertainties identified from time to time in our SEC reports, registration statements and public announcements.

        We do not have, and expressly disclaim, any obligation to release publicly any updates or any changes in our expectations or any changes in events, conditions or circumstances on which any forward-looking statement is based.

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ITEM 1. Consolidated Financial Statements

Datastream Systems, Inc. and Subsidiaries
Consolidated Balance Sheets
Assets
(unaudited)

See accompanying notes to consolidated financial statements.

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Datastream Systems, Inc. and Subsidiaries
Consolidated Balance Sheets (Continued)
Liabilities and Stockholders’ Equity
(unaudited)

See accompanying notes to consolidated financial statements.

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Datastream Systems, Inc. and Subsidiaries
Consolidated Statements of Operations
(unaudited)
Three months ended September 30, 2002 and 2003

See accompanying notes to consolidated financial statements.

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Datastream Systems, Inc. and Subsidiaries
Consolidated Statements of Operations
(unaudited)
Nine months ended September 30, 2002 and 2003

See accompanying notes to consolidated financial statements

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Datastream Systems, Inc. and Subsidiaries
Consolidated Statement of Stockholders’ Equity and Comprehensive Loss
(unaudited)
Nine months ended September 30, 2003

See accompanying notes to consolidated financial statements.

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Datastream Systems, Inc. and Subsidiaries

Consolidated Statements of Cash Flows
(unaudited)
Nine months ended September 30, 2002 and 2003

See accompanying notes to consolidated financial statements.

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Datastream Systems, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

1. Basis of Presentation

The interim financial information included herein is unaudited. Certain information and footnote disclosures normally included in the consolidated financial statements have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (SEC), although the Company believes that the disclosures made are adequate to make the information presented not misleading. In the opinion of management, such unaudited information reflects all adjustments, consisting only of normal recurring accruals and other adjustments as disclosed herein, necessary for a fair presentation of the unaudited information. These consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes contained in the Company’s Form 10-K for the year ended December 31, 2002 filed with the SEC on March 27, 2003. Other than as indicated herein, there have been no significant changes from the financial data published in those reports.

Results for interim periods are not necessarily indicative of results expected for the full year.

2. Segment and Geographic Information

The Company has identified one business segment for reporting purposes: Asset Performance Management. The Company manages the Asset Performance Management business over geographical regions. The principal areas of operation include the United States, Europe, Latin America and Asia. Financial information concerning the Company’s operations in different geographical regions is as follows:

For the three months ended September 30, 2002 and 2003:

For the nine months ended September 30, 2002 and 2003:

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The United States revenues include international revenues of approximately $502,000 and $703,000 for the third quarters of 2002 and 2003, respectively, and approximately $1,540,000 and $ 1,725,000 for the first nine months of 2002 and 2003, respectively.

3. Reconciliation of Basic and Diluted Net Income Per Share

Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding. Diluted net income per share is computed by dividing net income by the weighted average number of common and potential common shares outstanding. Diluted weighted average common shares include common shares and stock options using the treasury stock method, except when those potential common shares result in antidilution. The reconciliation of basic and diluted income per share as of September 30, 2002 and 2003 is as follows:

Antidilutive shares totaling 3,318,203 and 1,361,734 were excluded from the diluted net income per share calculations for the three months ended September 30, 2002 and 2003, respectively and antidilutive shares totaling 3,058,762 and 2,860,830 were excluded from the diluted net income per share calculations for the nine months ended September 30, 2002 and 2003, respectively.

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4. Stock Option Plans

The Company applies the intrinsic-value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, as amended, to account for its fixed-plan stock options. Under this method, compensation expense is measured on the date of grant only if the current market price of the underlying stock exceeds the exercise price. SFAS No. 123, Accounting for Stock-Based Compensation, established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted only the disclosure requirements of SFAS No. 123. The following table illustrates the effect on net income if the fair-value-based method had been applied for the three months and nine months ended September 30, 2002 and 2003.

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5. Recent Accounting Pronouncements

In December 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure, an amendment of FASB Statement No. 123. This Statement amends SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”) to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements. Certain of the disclosure modifications are required for fiscal years ending after December 15, 2002. See note 4.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (SFAS 149). This Statement amends and clarifies financial accounting and reporting for derivative instruments and for hedging activities under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”) to improve financial reporting by requiring that contracts with comparable characteristics be accounted for similarly. This Statement is generally effective for contracts entered into or modified after June 30, 2003. The adoption of SFAS 149 did not have a material effect on the Company’s consolidated financial statements.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability, or an asset in certain circumstances. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this Statement did not have a material effect on the Company’s consolidated financial statements.

In November 2002, the FASB issued Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34 (“FIN 45”). This Interpretation elaborates on the disclosures to be made by a guarantor about its obligations under guarantees issued. FIN 45 also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of FIN 45 are applicable to guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim and annual periods ending after December 31, 2002. The adoption of FIN 45 did not have a material effect on the Company’s consolidated financial statements.

In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51 (“FIN 46”). This Interpretation addresses the consolidation by business enterprises of variable interest entities as defined in the interpretation and sets forth additional disclosures about such interests. FIN 46 is effective for the Company’s fiscal year ending December 31, 2003. The adoption of FIN 46 is not expected to have a material effect on the Company’s consolidated financial statements.

In July 2003, the Emerging Issues Task Force (EITF) reached a consensus on EITF 03-5, Applicability of AICPA SOP 97-2 to Non-Software Deliverables. EITF 03-5 provides accounting guidance on whether non-software deliverables (e.g., non-software related equipment or services) included in an arrangement that contains software are within the scope of SOP 97-2. In general, any non-software deliverable is within the scope of 97-2 if the software deliverable is essential to its functionality. Companies are required to adopt this consensus in the first reporting period (annual or interim) beginning after ratification by the Financial Accounting Standard Board, which occurred on August 31, 2003. The Company believes the adoption of EITF 03-5 in the fourth quarter of 2003 will not have a material effect on the Company’s financial position or results of operations.

The EITF recently reached a consensus on EITF 00-21, Revenue Arrangements with Multiple Deliverables. EITF 00-21 provides accounting guidance for customer solutions where delivery or performance of products, services and/or performance may occur at different points in time or over different periods of time. Companies are required to adopt this consensus for fiscal periods beginning after June 15, 2003. The adoption of EITF 00-21 did not have a material impact on the Company’s financial position or results of operations

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6. Commitments and Contingencies

The Company is occasionally involved in claims arising out of its operations in the normal course of business. No such current claims are expected, individually or in the aggregate, to have a material adverse effect on the Company.

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This Report contains certain forward-looking statements with respect to the Company’s operations, industry, financial condition and liquidity. These statements reflect the Company’s assessment of a number of risks and uncertainties. The Company’s actual results could differ materially from the results anticipated in these forward-looking statements as a result of certain factors set forth in this Report. An additional statement made pursuant to the Private Securities Litigation Reform Act of 1995 and summarizing certain of the principal risks and uncertainties inherent in the Company’s business is included in Part I of this Report under the caption “‘Safe Harbor’ Statement Under the Private Securities Litigation Reform Act of 1995". Readers of this Report are encouraged to read such statement carefully.

Overview

For over seventeen years, Datastream has been a leading provider of asset management software and services to enterprises worldwide, including more than 65 percent of the Fortune 500. Datastream’s flagship product, Datastream 7i^™, delivers a complete Asset Performance Management infrastructure by combining an Internet architecture with broad enterprise asset management functionality, integrated procurement, advanced analytics and multi-site capability. Because Datastream 7i is completely designed and built around the flexibility, speed and reliability of the Internet, customers achieve organizational transparency of asset performance in a manner unique to the marketplace.

Results of Operations

        Total Revenues. Total revenues increased 2% to $22,389,065 in the third quarter of 2003 from $21,975,416 in the third quarter of 2002. Total revenues increased 3% to $68,561,856 for the first nine months of 2003 from $66,385,954 for the first nine months of 2002. For the three and nine month periods, the increase is due principally to the transition to Datastream 7i, which has a larger average deal size and greater market demand due to advanced functionality, an increase in support renewal contracts, and the increased number of hosted customers. International revenues were approximately $9,333,000 (42% of total revenues) in the third quarter of 2003 and approximately $8,778,000 (40% of total revenues) in the third quarter of 2002. International revenues were approximately $27,096,000 (40% of total revenues) for the first nine months of 2003 and approximately $25,782,000 (39% of total revenues) for the first nine months of 2002. See Note 2 to the consolidated financial statements.

        Software product revenues increased 3% to $6,210,698 (28% of total revenues) in the third quarter of 2003 from $6,040,013 (27% of total revenues) in the third quarter of 2002, as a result of the market success of Datastream 7i, which has a larger average deal size. Software product revenues increased 2% to $19,003,979 (28% of total revenues) for the first nine months of 2003 from $18,670,826 (28% of total revenues) for the first nine months of 2002.

        Services and support revenues increased 2% to $16,178,367 (72% of total revenues) in the third quarter of 2003 from $15,935,403 (73% of total revenues) in the third quarter of 2002. Services and support revenues increased 4% to $49,557,877 (72% of total revenues) for the first nine months of 2003 from $47,715,128 (72% of total revenues) for the first nine months of 2002. For both periods, support revenue increased due to increased software license deal size, an increase in average customer support renewal revenue, and an increase in the number of hosted customers. The increase in support revenue was partially offset by a decrease in service revenue due to general economic conditions and increased competition by third party service providers.

        Cost of Revenues. Cost of revenues decreased 10% to $7,490,607 (33% of total revenues) in the third quarter of 2003, as compared to $8,363,355 (38% of total revenues) in the third quarter of 2002. Cost of revenues decreased 6% to $23,202,692 (34% of total revenues) for the first nine months of 2003, as compared to $24,731,081 (37% of total revenues) for the first nine months of 2002. The decrease in cost of revenues for the three and nine month periods ending September 30, 2003 is due to decreased service revenues and overall reductions in internal and third party service costs.

        Sales and Marketing Expenses. Sales and marketing expenses decreased 16% to $7,005,412 (31% of total revenues) in the third quarter of 2003 from $8,347,083 (38% of total revenues) in the third quarter of 2002. Sales and marketing expenses decreased 12% to $22,231,766 (32% of total revenues) for the first nine months of 2003 from $25,193,322 (38% of total revenues) for the first nine months of 2002. The decrease in sales and marketing expenses is due to cost savings resulting from lower advertising and marketing expenditures and lower sales commissions.

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        Product Development Expenses. Total product development expenditures increased 27% to $3,360,052 (15% of total revenues) in the third quarter of 2003 from $2,647,870 (12% of total revenues) in the third quarter of 2002. Total product development expenditures increased 16% to $9,250,362 (13% of total revenues) for the first nine months of 2003 from $7,949,168 (12% of total revenues) for the first nine months of 2002. The increase in total product development expense is a result of increased investment in asset performance management functionality, mobile solutions, web services, and new database platforms for Datastream 7i.

        General and Administrative Expenses. General and administrative expenses increased 23% to $2,726,454 (12% of total revenues) in the third quarter of 2003 from $2,216,055 (10% of total revenues) in the third quarter of 2002 due primarily to increased write-offs of doubtful accounts during the third quarter of 2003 and a reduction in foreign currency gains on transactions denominated in a foreign currency due to fluctuating currency rates. General and administrative expenses increased 15% to $8,923,406 (13% of total revenues) for the first nine months of 2003 from $7,731,330 (12% of total revenues) for the first nine months of 2002. The increase for the nine month period ended September 30, 2003 compared to the nine month period ended September 30, 2002 is due to an increase in medical claims, the transition of personnel to administration and a reduction in foreign currency gains on transactions denominated in a foreign currency due to fluctuating currency rates.

        Other income (expense), net. Other income (expense), net decreased 32% to $83,713 in the third quarter of 2003 from $123,156 in the third quarter of 2002 due to lower yields on cash and cash eqivalents. Other income (expense), net changed significantly to ($1.2) million for the first nine months of 2003 from $268,043 for the first nine months of 2002. The decrease was due to a write down of the Company’s long-term investment in the second quarter of 2003 and lower yields on cash and cash equivalents.

        Tax Rate. The Company’s effective tax rate was 35% for the three months and nine months ended September 30, 2003 and September 30, 2002.

        Net income. Net income increased to $1.2 million (5% of total revenues) in the third quarter of 2003 from a net income of $340,733 (2% of total revenues) in the third quarter of 2002. Net income improved to $2.4 million (4% of total revenues) for the first nine months of 2003 from a net income of $683,728 (1% of total revenues) for the first nine months of 2002. The improvement for both periods is attributed to increased Datastream 7i revenues and decreased cost of services and sales and marketing expenditures.

Financial Condition

Consolidated total assets were $81.7 million at September 30, 2003, an increase of approximately $4.8 million, or 6% from $76.9 million at December 31, 2002. The increase was primarily due to a $7.7 million increase in cash and cash equivalents partially offset by a $2.0 million reduction in accounts receivable and unbilled revenue as a result of improved collections on customer accounts and a $1.5 million write-down in the carrying value of the Company’s long-term investment in the second quarter of 2003.

Consolidated total liabilities were $28.6 million at September 30, 2003, an increase of approximately $1.2 million, or 4% from $27.4 million at December 31, 2002. The increase was primarily due to a $1.5 million increase in unearned revenue as a result of increased support renewals and a $460,000 increase in income taxes payable due to a higher net income, offset by a decrease in other accrued liabilities primarily as a result of approximately $500,000 of accrued expenses for corporate building renovations at December 31, 2002, which has since been paid.

Cash and cash equivalents increased 31% to $42.5 million at September 30, 2003 compared to $32.4 million at September 30, 2002. Cash and cash equivalents increased 22% at September 30, 2003 compared to $34.7 million at December 31, 2002. Cash continues to improve as a result of increased sales, improved collections on accounts receivable, improved days sales outstanding and decreased operating expenses.

Cash provided by operations increased 1% to $9.6 million at September 30, 2003 from $9.5 million at September 30, 2002. The increase was primarily a result of decreased operating costs and increased collections on accounts receivable and unbilled revenue.

Net cash used in investing activities increased 121% to $3.1 million for the nine months ended September 30, 2003 compared to approximately $1.4 million for the nine months ended September 30, 2002. The increase was primarily due to building renovations at corporate headquarters during the first nine months of 2003 and the purchase of information technology for internal use.

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Liquidity and Capital Resources

The Company has funded its operating activities primarily with cash generated from operations. The Company ended its third quarter of 2003 with $42.5 million in cash and cash equivalents, which are defined as highly liquid securities with maturities of 90 days or less.

On August 15, 2003, the Company announced that its board of directors had authorized a plan to repurchase up to 1,000,000 shares of the Company’s outstanding common stock. This plan expires August 15, 2005. Subject to availability, the repurchases may be made from time to time in the open market or otherwise at prices that the Company deems appropriate. The repurchased shares are classified as treasury shares on the balance sheet and are reported at cost. The shares may be used, when needed, for general corporate purposes, including the grant of stock options. The Company repurchased 22,000 shares for $190,920 under the current plan during the third quarter of 2003. The aggregate number of shares repurchased under all prior and current plans was 1,176,400 as of September 30, 2003.

As of September 30, 2003, the Company had no long-term debt commitments and no material commitments for capital expenditures. The Company believes that its current cash balances and cash flows from operations will be sufficient to meet its working capital and capital expenditure needs for the next 12 months.

Critical Accounting Polices

Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions. The Company’s critical accounting policies include revenue recognition, income taxes, and allowance for doubtful accounts. For a detailed discussion on the application of these and other accounting policies, see the Company’s Form 10-K filed for the year ended December 31, 2002.

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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 the undersigned thereunto duly authorized.

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EXHIBIT INDEX

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