================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2002
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBER: 000-19960
DATAWATCH CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 02-0405716
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
175 CABOT STREET
SUITE 503
LOWELL, MASSACHUSETTS 01854
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 978-441-2200
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 [X] No [_]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes [_] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Class Outstanding at February 12, 2003
----- --------------------------------
Common Stock $0.01 par value 2,595,990
================================================================================
DATAWATCH CORPORATION AND SUBSIDIARIES
--------------------------------------
TABLE OF CONTENTS
-----------------
PART I. FINANCIAL INFORMATION
- ------------------------------
Item 1. Unaudited Financial Statements Page #
a) Consolidated Condensed Balance Sheets:
December 31, and September 30, 2002 3
b) Consolidated Condensed Statements of Operations:
Three Months Ended December 31, 2002 and 2001 4
c) Consolidated Condensed Statements of Cash Flows:
Three Months Ended December 31, 2002 and 2001 5
d) Notes to Consolidated Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk 20
Item 4. Controls and Procedures 20
PART II. OTHER INFORMATION
- --------------------------
Item 1. Legal Proceedings *
Item 2. Changes in Securities and Use of Proceeds 21
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 21
SIGNATURES 22
CERTIFICATIONS 23
* No information provided due to inapplicability of item.
PART I.
Item 1. Financial Statements
--------------------
DATAWATCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(Unaudited)
December 31, September 30,
2002 2002
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and equivalents $ 3,203,053 $ 3,605,044
Accounts receivable, net 2,742,205 3,057,356
Inventories 155,930 170,735
Prepaid expenses 519,326 571,026
------------ ------------
Total current assets 6,620,514 7,404,161
------------ ------------
PROPERTY AND EQUIPMENT:
Property and equipment 1,869,308 3,328,717
Less accumulated depreciation and amortization (1,231,931) (2,596,107)
------------ ------------
Net property and equipment 637,377 732,610
------------ ------------
OTHER ASSETS 1,673,697 1,317,695
------------ ------------
TOTAL ASSETS $ 8,931,588 $ 9,454,466
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,155,317 $ 1,156,966
Accrued expenses 1,630,169 1,996,554
Deferred revenue 1,984,701 2,227,939
------------ ------------
Total current liabilities 4,770,187 5,381,459
------------ ------------
ACCRUED SEVERANCE, less current portion 10,396 12,795
------------ ------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Common stock 26,024 25,876
Additional paid-in capital 21,659,407 21,609,555
Accumulated deficit (16,901,748) (16,918,783)
Accumulated other comprehensive loss (492,290) (516,048)
------------ ------------
4,291,393 4,200,600
Less treasury stock - at cost (140,388) (140,388)
------------ ------------
Total shareholders' equity 4,151,005 4,060,212
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 8,931,588 $ 9,454,466
============ ============
See accompanying notes to consolidated condensed financial statements.
3
Item 1. Financial Statements (continued)
--------------------
DATAWATCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended
December 31,
2002 2001
----------- -----------
REVENUE
Software licenses $ 3,292,881 $ 3,266,349
Maintenance and services 1,208,739 1,334,394
----------- -----------
TOTAL REVENUE 4,501,620 4,600,743
COSTS AND EXPENSES:
Cost of software licenses 567,029 732,236
Cost of maintenance and services 614,357 670,002
Sales and marketing 1,524,210 1,523,447
Engineering and product development 341,992 323,484
General and administrative 1,250,510 1,199,332
Restructuring and centralization costs 181,459 --
----------- -----------
TOTAL COSTS AND EXPENSES 4,479,557 4,448,501
----------- -----------
INCOME FROM OPERATIONS 22,063 152,242
INTEREST EXPENSE (1,672) (46,983)
OTHER INCOME, primarily interest 6,437 4,828
FOREIGN CURRENCY TRANSACTION GAIN (LOSS) (9,793) (1,476)
----------- -----------
INCOME FROM CONTINUING OPERATIONS 17,035 108,611
----------- -----------
DISCONTINUED OPERATIONS:
Gain on sale of Guildsoft -- 17,096
----------- -----------
INCOME FROM DISCONTINUED OPERATIONS -- 17,096
----------- -----------
NET INCOME $ 17,035 $ 125,707
=========== ===========
NET INCOME PER COMMON SHARE-Basic and diluted:
Continuing operations $ 0.01 $ 0.04
Discontinued operations -- 0.01
----------- -----------
NET INCOME PER SHARE - Basic and diluted $ 0.01 $ 0.05
=========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING - Basic 2,592,839 2,546,922
=========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING - Diluted 2,684,044 2,550,333
=========== ===========
See accompanying notes to consolidated condensed financial statements.
4
Item 1. Financial Statements (continued)
--------------------
DATAWATCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
December 31,
2002 2001
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 17,035 $ 125,707
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization 180,146 242,820
Gain on sale of Guildsoft -- (17,096)
Loss on disposition of equipment 65,981 --
Stock-based compensation -- 37,500
Changes in current assets and liabilities, net of acquisitions:
Accounts receivable 470,288 767,464
Inventories 16,412 22,019
Prepaid expenses 58,746 82,409
Accounts payable and accrued expenses (657,821) (530,495)
Deferred revenue (347,694) (178,892)
----------- -----------
Net cash (used in) provided by operating activities (196,907) 551,436
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of equipment and fixtures (31,851) (8,928)
Proceeds from sale of equipment - net 4,662 --
Proceeds from sale of Guildsoft -- 20,509
Purchase of Auxilor, Inc., includes direct costs of $59,855 (172,150) --
Long term notes receivable (589) --
Capitalized software development costs (26,930) (62,750)
Other assets 1,066 4,522
----------- -----------
Net cash used in investing activities (225,792) (46,647)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on long-term obligations (2,399) (35,886)
Payments under credit lines, net -- (405,942)
----------- -----------
Net cash used in financing activities (2,399) (441,828)
----------- -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH 23,107 (12,516)
----------- -----------
NET (DECREASE) INCREASE IN CASH AND EQUIVALENTS (401,991) 50,445
CASH AND EQUIVALENTS, BEGINNING OF PERIOD 3,605,044 1,568,691
----------- -----------
CASH AND EQUIVALENTS, END OF PERIOD $ 3,203,053 $ 1,619,136
=========== ===========
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Issuance or 15,312 shares of common stock for services -- $ 37,500
=========== ===========
Issuance of warrants -- $ 76,956
=========== ===========
See accompanying notes to consolidated condensed financial statements.
5
Item 1. Financial Statements (continued)
--------------------
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
1. Basis of Presentation: The accompanying unaudited consolidated condensed
financial statements include the accounts of Datawatch Corporation (the
"Company") and its wholly owned subsidiaries and have been prepared pursuant to
the rules and regulations of the Securities and Exchange Commission regarding
interim financial reporting. Accordingly, they do not include all of the
information and notes required by accounting principles generally accepted in
the United States of America for complete financial statements and should be
read in conjunction with the audited consolidated financial statements included
in the Company's Annual Report on Form 10-K for the year ended September 30,
2002.
In the opinion of management, the accompanying unaudited consolidated
condensed financial statements have been prepared on the same basis as the
audited consolidated financial statements, and include all adjustments necessary
for fair presentation of the results of the interim periods presented. The
operating results for the interim periods presented are not necessarily
indicative of the results expected for the full year. Certain amounts for the
period ended December 31, 2001 have been reclassified to conform with the
December 31, 2002 presentation.
2. Recent Accounting Pronouncements: In April 2002, the Financial
Accounting Standards Board ("FASB") issued SFAS No. 145, "Rescission of FASB
Statements SFAS Nos. 4, 44, and 64, Amendment of FASB Statement No. 13 and
Technical Corrections." SFAS No. 145 will impact how companies account for
sale-leaseback transactions and how gains or losses on debt extinguishments are
presented in financial statements. The Company adopted SFAS No. 145 during the
three months ended December 31, 2002. Adoption did not have a significant effect
on the Company's consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit and Disposal Activities." SFAS No. 146 will impact how
companies account for costs incurred with exit activities, such as employee
severance and facility closure costs. The Company adopted SFAS No. 146 during
the three months ended December 31, 2002. Accordingly, the Company recorded
$181,459 in restructuring and centralization costs during the three months ended
December 31, 2002. (See note 11.)
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure" which addresses financial
accounting and reporting for recording expenses for the fair value of stock
options. SFAS No. 148 provides alternative methods of transition for a voluntary
change to a fair value based method of accounting for stock-based employee
compensation. Additionally, SFAS No. 148 requires more prominent and more
frequent disclosures in financial statements about the effects of stock-based
compensation. The provisions of this Statement are effective for fiscal years
ending after December 15, 2002, with early application permitted in certain
circumstances. The interim disclosure provisions are effective for financial
reports containing financial statements for interim periods beginning after
December 15, 2002. The Company will continue to account for its stock-based
compensation under the intrinsic value method prescribed under Accounting
Principles Board Opinion No. 25.
In November 2002, the Financial Accounting Standards Board ("FASB")
issued Financial Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." FIN 45 requires certain guarantees to be recorded at
fair value and requires a guarantor to make significant new disclosures, even
when the likelihood of making any payments under the guarantee is remote.
Generally, FIN 45 applies to certain types of financial guarantees that
contingently require the guarantor to make payments to the guaranteed party
based on changes in an underlying that is related to an asset, liability, or an
equity security of the guaranteed party; performance guarantees involving
contracts which require the guarantor to make payments to the guaranteed party
based on another entity's failure to perform under an obligating agreement;
indemnification agreements that contingently require the guarantor to make
payments to an indemnified party based on changes in an underlying that is
related to an asset, liability, or an equity security of the indemnified party;
or indirect guarantees of the indebtedness of others. The initial recognition
and initial measurement provisions of FIN 45
6
Item 1. Financial Statements (continued)
--------------------
are applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. Disclosure requirements under FIN 45 are effective for
financial statements ending after December 15, 2002 and are applicable to all
guarantees issued by the guarantor subject to FIN 45's scope, including
guarantees issued prior to FIN 45. Special disclosures for product warranties
under FIN 45 include disclosures on the guarantor's accounting and methodology
used in determining its liability and a tabular reconciliation of the changes in
the guarantor's product warranty liability for the reporting period. No
additional disclosures are required under FIN 45 for the quarter ended December
31, 2002. The Company's policies with regard to warranty are disclosed in the
Company's Annual Report on Form 10-K for the year ended September 30, 2002. The
Company has no accrued warranty costs. Adoption of FIN 45 is not expected to
have a material effect on the Company's financial condition, results of
operations or cash flows.
In January 2003, the FASB issued Financial Interpretation No. 46 ("FIN
46"), "Consolidation of Variable Interest Entities" with the objective of
improving financial reporting by companies involved with variable interest
entities. A variable interest entity is a corporation, partnership, trust, or
any other legal structure used for business purposes that either (a) does not
have equity investors with voting rights, or (b) has equity investors that do
not provide sufficient financial resources for the entity to support its
activities. Historically, entities generally were not consolidated unless the
entity was controlled through voting interests. FIN 46 changes that by requiring
a variable interest entity to be consolidated by a company if that company is
subject to a majority of the risk of loss from the variable interest entity's
activities or entitled to receive a majority of the entity's residual returns or
both. A company that consolidates a variable interest entity is called the
"primary beneficiary" of that entity. FIN 46 also requires disclosures about
variable interest entities that a company is not required to consolidate but in
which it has a significant variable interest. The consolidation requirements of
FIN 46 apply immediately to variable interest entities created after January 31,
2003. The consolidation requirements of FIN 46 apply to existing entities in the
first fiscal year or interim period beginning after June 15, 2003. Also, certain
disclosure requirements apply to all financial statements issued after January
31, 2003, regardless of when the variable interest entity was established. The
Company is currently evaluating the provisions of the interpretation and does
not expect any material impact to the financial statements as a result of
adopting this interpretation.
3. Discontinued Operations: On September 20, 2001, the Company sold the
operations of Guildsoft Limited, a United Kingdom distribution subsidiary, to a
third party, as part of a restructuring plan (Note 11). In December 2001, there
was a purchase price settlement between Datawatch and the purchaser of Guildsoft
Limited, resulting in a gain of $17,000 which is shown as a gain on the sale of
Guildsoft as part of discontinued operations on the accompanying consolidated
condensed statement of operations for the three months ended December 31, 2001.
4. Concentration of Credit Risks and Major Customers: The Company sells its
products and services to U.S. and non-U.S. dealers and other software
distributors, as well as to end users under normal credit terms. One customer
individually accounted for 15% of revenue for both the three months ended
December 31, 2002 and the three months ended December 31, 2001. This same
customer accounted for 19% and 23% of outstanding trade receivables as of
December 31, 2002 and September 30, 2002, respectively. Other than this
customer, no other customer constitutes a significant portion (more than 10%) of
sales or accounts receivable. The Company performs ongoing credit evaluations of
its customers and generally does not require collateral. Allowances are provided
for anticipated doubtful accounts and sales returns.
5. Inventories: Inventories consisted of the following at December 31, 2002
and September 30, 2002:
December 31, September 30,
2002 2002
-------- --------
Materials $114,937 $105,814
Finished goods 40,993 64,921
-------- --------
TOTAL $155,930 $170,735
======== ========
7
Item 1. Financial Statements (continued)
--------------------
6. Comprehensive Income: The following table sets forth the reconciliation
of net income to comprehensive income:
Three Months Ended
December 31,
2002 2001
-------- --------
Net income $ 17,035 $125,707
Other comprehensive income,
net of tax:
Foreign currency translation
adjustments 23,758 2,476
-------- --------
Comprehensive income $ 40,793 $128,183
======== ========
Accumulated other comprehensive loss reported in the consolidated
condensed balance sheets consists only of foreign currency translation
adjustments.
7. Earnings per Share: Basic net income per common share is computed by
dividing net income by the weighted average number of common shares outstanding
during the period. Diluted net income per share reflects the impact, when
dilutive, of the exercise of options and warrants using the treasury stock
method.
8. Line of Credit: On October 30, 2001 and December 19, 2001, respectively,
the Company entered into amended and restated domestic and international credit
lines for a period to expire on October 1, 2002. As part of the agreement to
enter into these credit lines, warrants to purchase 49,669 shares of the
Company's common stock were issued to the bank at an exercise price of $1.51.
The fair market value of the warrants (determined by the Black-Scholes pricing
model and the following assumptions: 134% volatility, 7 year estimated life and
4.8% risk-free interest rate) was determined to be $76,956 which was recorded in
prepaid interest (being recognized as a component of interest expense during the
term of the amended agreement period) with a corresponding increase in
additional paid in capital. On May 3, 2002, the Company issued 24,498 shares of
it common stock to the bank pursuant to the cashless exercise of this warrant
and another existing Warrant to Purchase Stock dated January 17, 2001. As a
result of this cashless exercise using a conversion right allowed under the
terms of both Warrants to Purchase Stock, the bank has no further rights to
acquire the Company's common stock under these warrants.
On November 15, 2002, the Company renewed the domestic bank
line-of-credit for a period to expire on October 29, 2003. The renewed domestic
credit line, which bears interest at the bank's prime rate plus 3/4% (5% at
December 31, 2002), contains customary covenants which require, among other
items, that the Company maintain a minimum level of consolidated tangible net
worth. The Company has no plans to renew or extend its international
line-of-credit which expired on October 1, 2002. The renewed domestic credit
line provides for maximum borrowings of the lesser of $1,500,000 or 70% of
defined eligible receivables. As of December 31, 2002, the Company had no
outstanding borrowings under its bank line-of-credit with approximately $599,000
in borrowings available under the line.
9. Non-cash issuance of Common Stock: In November 2001, the Company issued
15,312 shares of common stock with an aggregate fair value of $37,500 to a
director for services. The fair value of the stock issued to the director was
expensed as the services were provided.
8
Item 1. Financial Statements (continued)
--------------------
10. Segment Information: The Company has determined that it has only one
reportable segment meeting the criteria established under SFAS No. 131. The
Company's chief operating decision maker, as defined, (determined to be the
Chief Executive Officer and the Board of Directors) does not manage any part of
the Company separately, and the allocation of resources and assessment of
performance is based solely on the Company's consolidated operations and
operating results.
The following table presents information about the Company's revenue by
product lines:
Three Months Ended
December 31,
2002 2001
----- -----
Monarch 59% 55%
Monarch|ES 11 16
Q|SM & Visual Help Desk 30 29
----- -----
100% 100%
===== =====
The Company's operations are conducted in the U.S. and internationally
(principally in the United Kingdom). The following tables present information
about the Company's geographic operations:
Total Revenue
-------------
Domestic International Eliminations Total
---------- ---------- ---------- ----------
Three months ended 12/31/02 $2,980,397 $1,809,445 $ (288,222) $4,501,620
Three months ended 12/31/01 2,914,331 1,982,457 (296,045) 4,600,743
Long-lived Assets
-----------------
Domestic International Eliminations Total
---------- ---------- ---------- ----------
At December 31, 2002 $1,977,560 $ 333,514 $ -- $2,311,074
At September 30, 2002 1,571,978 436,171 -- 2,008,149
Export sales aggregated approximately $1,006,000 and $1,056,000,
respectively, for the three months ended December 31, 2002 and December 31,
2001.
11. Restructuring and Centralized Operations: During the fourth quarter of
fiscal 2001, the Company approved and completed a corporate-wide restructuring
plan in an effort to reduce costs and centralize administrative operations. The
restructuring plan resulted in charges for severance benefits and related costs
for 42 terminated employees. On December 31, 2002, the accrual related to this
restructuring totaled $95,000 (reflecting cash payments of approximately
$291,000 since September 30, 2001) of which the long-term portion is $10,000.
The charges are expected to be fully paid in January 2005.
During the second quarter of fiscal 2002, there was an additional
reorganization undertaken to further improve efficiencies and reduce costs,
which resulted in an additional restructuring charge of approximately $88,000
for severance benefits and related costs for 4 terminated employees. The charges
for this restructuring were fully paid in July 2002.
During the first quarter of fiscal 2003, the Company approved and
completed a restructuring undertaken to reduce costs related to its
international operations, which resulted in an additional restructuring charge
of approximately $181,000 for severance benefits for 5 terminated employees and
costs resulting from the cancellation of leases and the disposal of fixed assets
related to a relocation to smaller facilities. Of these charges, $141,000 was
paid during the first quarter with $40,000 accrued as of December 31, 2002. The
charges for this restructuring are expected to be fully paid in March 2003.
9
Item 1. Financial Statements (continued)
--------------------
12. Acquisition: On October 16, 2002, the Company acquired 100% of the
outstanding shares of Auxilor, Inc. for a total consideration of approximately
$561,000 comprised of $127,000 in cash, 14,764 shares of Datawatch common stock
valued at approximately $50,000, direct costs of approximately $60,000, and
assumed liabilities totaling approximately $324,000. In exchange, the Company
received Auxilor tangible assets valued at approximately $152,000 resulting in
$409,000 to be allocated to intangible assets in accordance with SFAS No. 141
and SFAS No. 142. A valuation analysis subsequently allocated approximately
$285,000 and $124,000, respectively, to trademarks and acquired software. The
Auxilor purchase agreement also includes an earn-out clause, which provides for
a cash payout equal to 10% of the sales of Auxilor products in fiscal 2003. The
earn-out will be expensed as a cost of revenue as Auxilor products and services
are sold. The activities of Auxilor from October 1, 2002 to October 16, 2002 are
not consolidated into the Company's consolidated condensed financial statements
and are not significant.
13. Commitments: The Company leases various facilities, equipment and
automobiles in the U.S. and overseas under noncancelable operating leases which
expire through 2006. The lease agreements generally provide for the payment of
minimum annual rentals, pro rata share of taxes, and maintenance expenses.
Rental expense for all operating leases was approximately $192,000 and $165,000
for the three months ended December 31, 2002 and 2001, respectively.
As of December 31, 2002, minimum rental commitments under noncancelable
operating leases are as follows:
Year Ending September 30,
2003 $ 523,753
2004 475,727
2005 368,446
2006 119,784
Thereafter --
----------
Total minimum lease payments $1,487,710
==========
The Company is also committed to pay royalties ranging from 7% to 50%
on revenue generated by the sale of certain licensed software products. Royalty
expense included in cost of software licenses was approximately $309,000 and
$441,000 for the three months ended December 31, 2002 and 2001, respectively.
The Company is not obligated to pay any minimum royalty amounts.
On October 16, 2002, the Company acquired 100% of the shares of
Auxilor, Inc. The purchase agreement includes an earn-out clause, which provides
for a cash payout equal to 10% of the sales of Auxilor products in fiscal 2003.
10
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
of Operations
-------------
GENERAL
Datawatch Corporation (the "Company" or "Datawatch") is engaged in the
design, development, manufacture, marketing, and support of business computer
software primarily for the Windows-based market. Its products address the
enterprise reporting, business intelligence, data replication and service
management markets.
Datawatch's principal products are: Monarch, a report mining and
business intelligence application that lets users extract and manipulate data
from ASCII report files or HTML files produced on any mainframe, midrange,
client/server or PC system; Monarch Data Pump, a data replication and migration
tool that offers a shortcut for populating and refreshing data marts and data
warehouses, for migrating legacy data into new applications and for providing
automated delivery of reports in a variety of formats via email; Monarch|ES, a
web-enabled business information portal that allows an organization to quickly
deliver business intelligence and decision support derived from existing
reporting systems with no new programming or report writing; Q|Service
Management ("Q|SM"), a fully internet-enabled IT support solution that
incorporates workflow and network management capabilities and provides web
access to multiple databases via a standard browser; Visual Help Desk, a
web-based help desk and call center solution operating on the IBM Lotus Domino
platform, acquired in the Auxilor, Inc. purchase; VorteXML, a data
transformation product for the emerging XML market that easily and quickly
converts structured text output from any system into valid XML for web services
and other uses using any DTD or XDR schema without programming; and Redwing, a
plug-in for Adobe Acrobat that lets users extract text and tables from Adobe PDF
documents.
CRITICAL ACCOUNTING POLICIES
In the preparation of financial statements and other financial data,
management applies certain accounting policies to transactions that, depending
on choices made by management, can result in various outcomes. In order for a
reader to understand the following information regarding the financial
performance and condition of the Company, an understanding of those accounting
policies is important. Certain of those policies are comparatively more
important to our financial results and condition than others. The policies that
we believe are most important for a reader's understanding of the financial
information provided in this report are described below.
Revenue Recognition, Allowance for Bad Debts and Returns Reserve
Datawatch generally recognizes revenue from the sale of software
products at the time of shipment, providing there are no uncertainties
surrounding product acceptance, the fee is fixed and determinable, collection is
considered probable, persuasive evidence of the arrangement exists and there are
no significant obligations remaining. For enterprise solutions products, the
Company applies the residual method in determining revenue from license sales.
Revenue from implementation, integration, training and consulting services is
recognized as the services are performed. Revenue from post-contract customer
support services is deferred and recognized ratably over the contract period
(generally one year). Post-contract customer support includes technical support
and rights to unspecified software upgrades and enhancements on a when-and-if
available basis.
The Company's software products are sold under warranty against certain
defects in material and workmanship for a period of 30 to 90 days from the date
of purchase. Certain software products, including desktop versions of Monarch,
Monarch Data Pump, VorteXML and Redwing sold directly to end-users, include a
guarantee under which such customers may return products within 30 to 60 days
for a full refund. The Company offers its distributors the ability to return
obsolete versions of its products and slow-moving products for refund or credit.
Reserves are provided for potential returns under these arrangements based upon
historical experience and anticipated exposures. Returns reserves are primarily
calculated by accruing a fixed amount each period, assessing the level of the
reserve at the end of the period against anticipated returns and adjusting the
reserve as needed. During the three months ended December 31, 2002, changes to
the returns reserve were comprised of $50,000 accrued for the returns reserve
and approximately $102,000 in returns applied against the reserve. This compares
to $50,000 accrued for the returns reserve and approximately $50,000 in returns
applied against the returns reserve for the three months ended December 31,
2001. At December 31, 2002, approximately $234,000 was recorded for the returns
reserve on the Company's balance sheet, with 82% related to specific accounts,
as compared to approximately $285,000, with 70% related to specific accounts, at
September 30, 2002.
11
The Company maintains allowances for doubtful accounts for estimated
losses resulting from the inability of customers to make required payments. The
Company analyzes accounts receivable and the composition of the accounts
receivable aging, historical bad debts, customer creditworthiness, current
economic trends, foreign currency exchange rate fluctuations, and changes in
customer payment terms when evaluating the adequacy of the allowance for
doubtful accounts. Based upon the analysis and estimates of the uncollectibility
of its accounts receivable, the Company records an increase in the allowance for
doubtful accounts when the prospect of collecting a specific account receivable
becomes doubtful. Actual results could differ from the allowances for doubtful
accounts recorded, and this difference may have a material effect on our
financial position and results of operations. The Company recorded in its
statements of operations, provisions for doubtful accounts of $5,000 and $17,000
for the three months ended December 31, 2002 and 2001, respectively. The
Company's balance sheets as of December 31, 2002 and September 30, 2002, include
allowances for bad debts of $315,000 and $259,000, respectively.
Capitalized Software Development Costs
The Company capitalizes certain software development costs as well as
purchased software upon achieving technological feasibility of the related
products. For the three months ended December 31, 2002 and 2001, the Company
capitalized software development costs and purchased software totaling $27,000
and $63,000, respectively. For the three months ended December 31, 2002 and
2001, the Company capitalized $27,000 and $12,000 of software development costs,
respectively, and the Company purchased and capitalized software amounting to $0
and $51,000, respectively. Software development costs incurred and software
purchased prior to achieving technological feasibility are charged to research
and development expense as incurred. Commencing upon initial product release,
capitalized costs are amortized to cost of software licenses using the
straight-line method over the estimated life (which approximates the ratio that
current gross revenues for a product bear to the total of current and
anticipated future gross revenues for that product), generally 12 to 36 months.
For the three months ended December 31, 2002 and 2001, amortization of these
costs was approximately $86,000 and $115,000, respectively. The unamortized
balance of capitalized software, including approximately $124,000 relating to
the acquisition of Auxilor (see Note 12 of the Consolidated Condensed Financial
Statements included elsewhere herein), was approximately $1,027,000 at December
31, 2002. The unamortized balance of capitalized software at September 30, 2002
was approximately $962,000.
Foreign Currency Translations
Assets and liabilities of foreign subsidiaries are translated into U.S.
dollars at rates in effect at each balance sheet date. Revenues, expenses and
cash flows are translated into U.S. dollars at average rates prevailing when
transactions occur. The related translation adjustments are reported as a
separate component of shareholders' equity under the heading "Accumulated Other
Comprehensive Income (Loss)." Accumulated other comprehensive loss reported in
the consolidated balance sheets consists only of foreign currency translation
adjustments. At December 31, 2002 and September 30, 2002, the accumulated
foreign currency translation loss totaled approximately $492,000 and $516,000,
respectively. Foreign currency translation gains arising during the three months
ended December 31, 2002 and December 31, 2001 were approximately $24,000 and
$2,000, respectively. The Company does not currently engage in foreign currency
hedging activities.
RESULTS OF OPERATIONS
Financial information for the three months ended December 31, 2001 has been
reclassified to conform with the December 31, 2002 presentation and to comply
with the requirements of EITF 01-9 which requires that certain amounts paid by a
vendor for advertising and marketing to a customer be recorded as a reduction of
revenue, when certain conditions are met. The Company previously accounted for
payments of this type to certain distributors as marketing expenses. For the
three months ended December 31, 2001, the Company has reclassified payments
totaling $20,328 as a reduction of revenue.
12
Three Months Ended December 31, 2002 and 2001
- ---------------------------------------------
Revenue from continuing operations for the three months ended December
31, 2002 was $4,502,000 which represents a decrease of $99,000, or approximately
2%, from revenue of $4,601,000 for the three months ended December 31, 2001. For
three months ended December 31, 2002, Monarch, Q|SM and Visual Help Desk, and
Monarch|ES sales accounted for 59%, 30% and 11% of total revenue, respectively,
as compared to 55%, 29% and 16%, respectively, for the three months ended
December 31, 2001.
Software license revenue for the three months ended December 31, 2002
was $3,293,000 or approximately 73% of total revenue, as compared to $3,266,000
or approximately 71% of total revenue for the three months ended December 31,
2001. This represents an increase of $27,000 or approximately 1% from fiscal
2001 to fiscal 2002. For the three months ended December 31, 2002, Q|SM and
Visual Help Desk license revenue increased by $217,000 (Visual Help Desk license
revenue accounted for $72,000 of this increase) and Monarch license revenue
(including Data Pump, VorteXML and Redwing but excluding Monarch|ES) increased
by $100,000 when compared to the three months ended December 31, 2001. Together
these increases account for an increase of approximately 10% in total software
license revenue. These increases were partially offset by a decrease in
Monarch|ES license revenue of $291,000, or 58%, when compared to the same period
of fiscal 2001. This decrease accounts for a decrease in total software license
revenue of approximately 9%. The Company attributes the decrease in Monarch|ES
license revenue to a reduction in corporate spending on high-ticket software
solutions due to an uncertain worldwide economy and continuing reactions to the
events of September 11, 2001 and ongoing concerns regarding the possible effects
of war and terrorism.
Maintenance and services revenue for the three months ended December
31, 2002 was $1,209,000, or approximately 27% of total revenue, as compared to
$1,334,000, or approximately 29% of total revenue, for the three months ended
December 31, 2001. This represents a decrease of $125,000 or approximately 9%.
This decrease is primarily attributable to a net decrease for Q|SM maintenance
and services revenue of $225,000, which accounts for a decrease of approximately
17% in total maintenance and services revenue. This was partially offset by
Visual Help Desk, Monarch|ES and Monarch maintenance and services revenue
increases of $42,000, $38,000 and $20,000, respectively, which account for an
increase of 8% in total maintenance and services revenue. The decrease in Q|SM
maintenance and services revenue is the result of reduced revenue from the
Company's Q|SM professional services which the Company believes is the result of
a declining demand for such services due to a weakened economy in the United
Kingdom where they are primarily sold.
Cost of software licenses for the three months ended December 31, 2002
was $567,000 or approximately 17% of software license revenues, as compared to
$732,000 or approximately 22% of software license revenues for the three months
ended December 31, 2001. This decrease of $165,000 is primarily attributable to
decreased software licenses revenues for Monarch|ES which has a substantially
higher cost of royalties than the Company's other products.
Cost of maintenance and services for the three months ended December
31, 2002 was $614,000 or approximately 51% of maintenance and service revenues,
as compared to $670,000 or approximately 50% of maintenance and service
revenues, for the three months ended December 31, 2001. This decrease of $56,000
is attributable to the reductions in services headcount and related expenses.
The realized cost savings from the reduction in headcount and related expenses
was $60,000.
Sales and marketing expenses were $1,524,000 for the three months ended
December 31, 2002, which represents an increase of $1,000 from $1,523,000 for
the three months ended December 31, 2001.
Engineering and product development expenses were $342,000 for the
three months ended December 31, 2002, which represents an increase of $19,000 or
approximately 6% from $323,000 for the three months ended December 31, 2001.
This increase is primarily attributable to engineering and development expenses
related to the Visual Help Desk product acquired in the Auxilor purchase. During
the three months ended December 31, 2002, the Company capitalized $27,000 in
purchased software and software development costs. This compares to $63,000
capitalized in the three months ended December 31, 2001. This decrease in
capitalized costs in the first quarter of fiscal 2003, as compared to the first
quarter of fiscal 2002, is due to reduced capitalized costs associated with a
development project for a new version of Q|SM which was nearing completion in
the three months ended December 31, 2002.
General and administrative expenses were $1,251,000 for the three
months ended December 31, 2002, which represents an increase of $52,000 or
approximately 4% from $1,199,000 for the three months ended December 31,
13
2001. This increase is primarily attributable to general and administrative
expenses related to the Company's newly acquired Auxilor subsidiary.
As a result of the foregoing, the income from continuing operations for
the three months ended December 31, 2002 was $17,000, which compares to income
from continuing operations of $109,000 for the three months ended December 31,
2001. During the three months ended December 31, 2002 and 2001, no benefit or
provision for income taxes was recorded due to the availability of loss
carryforwards for which valuation allowances had previously been provided. At
December 31, 2002, the Company had federal tax loss carryforwards available to
offset future taxable income of approximately $7 million; a full valuation
reserve has been established against these assets as uncertainty continues to
exist regarding the Company's ability to generate sufficient future taxable
income for the utilization of these losses.
In September 2001, Datawatch sold the operations of Guildsoft Limited,
a United Kingdom distribution subsidiary, to a third party. In December 2001
there was a purchase price settlement between Datawatch and the purchaser of
Guildsoft Limited, resulting in a gain of $17,000 which is shown as a gain on
the sale of Guildsoft as part of discontinued operations on the accompanying
consolidated condensed statement of operations for the three months ended
December 31, 2001.
Net income for the three months ended December 31, 2002 was $17,000,
which compares to net income of $126,000 for the three months ended December 31,
2001.
OFF BALANCE SHEET ARRANGEMENTS, CONTRACTUAL OBLIGATIONS AND CONTINGENT
LIABILITIES AND COMMITMENTS
The Company leases various facilities, equipment and automobiles in the
U.S. and overseas under noncancelable operating leases which expire through
2006. The lease agreements generally provide for the payment of minimum annual
rentals, pro rata share of taxes, and maintenance expenses. Rental expense for
all operating leases was approximately $192,000 and $165,000 for the three
months ended December 31, 2002 and 2001, respectively.
As of December 31, 2002, minimum rental commitments under noncancelable
operating leases are as follows:
Year Ending September 30,
2003 $ 523,753
2004 475,727
2005 368,446
2006 119,784
Thereafter --
----------
Total minimum lease payments $1,487,710
==========
The Company is also committed to pay royalties ranging from 7% to 50%
on revenue generated by the sale of certain licensed software products. Royalty
expense included in cost of software licenses was approximately $309,000 and
$441,000 for the three months ended December 31, 2002 and 2001, respectively.
The Company is not obligated to pay any minimum royalty amounts.
On October 16, 2002, the Company acquired 100% of the shares of
Auxilor, Inc. The purchase agreement includes an earn-out clause, which provides
for a cash payout equal to 10% of the sales of Auxilor products in fiscal 2003.
LIQUIDITY AND CAPITAL RESOURCES
Working capital decreased by approximately $172,000 primarily as a
result of the Company's acquisition of Auxilor, Inc. During the three months
ended December 31, 2002, approximately $197,000 of cash was used by the
Company's operations as compared to approximately $551,000 of cash provided by
operations for the three months ended December 31, 2001. During the three month
periods ended September 30, 2001, April 30, 2002 and December 31, 2002,
management took a series of steps to reduce operating expenses and to
restructure operations. See Note 11 to the Consolidated Condensed Financial
Statements included elsewhere herein for a further discussion of the reductions
in the workforce as well as other restructuring actions taken to reduce
operating expenses.
14
On November 15, 2002, the Company renewed its domestic bank
line-of-credit for a period to expire on October 29, 2003. The renewed domestic
line provides for maximum borrowings of the lesser of $1,500,000 or 70% of
defined eligible receivables and is collateralized by substantially all assets
of the Company. The credit line contains customary covenants which require,
among other items, the Company maintain a minimum level of consolidated tangible
net worth. Borrowings under the credit line bore interest at the bank's prime
rate plus 3/4%, or 5%, at December 31, 2002. The Company had no outstanding
borrowings under its bank line-of-credit, with approximately $599,000 in
borrowings available under the line, as of December 31, 2002.
Management believes that by continuing to control operating expenses
and capital expenditures and with the borrowings available under its
line-of-credit, the Company will have sufficient liquidity through at least
September 30, 2003 to fund its cash requirements.
Management believes that the Company's current operations have not been
materially impacted by the effects of inflation.
RECENT ACCOUNTING PRONOUNCEMENTS
In April 2002, the Financial Standards Accounting Board ("FASB") issued
SFAS No. 145, "Rescission of FASB Statements SFAS Nos. 4, 44, and 64, Amendment
of FASB Statement No. 13 and Technical Corrections." SFAS No. 145 will impact
how companies account for sale-leaseback transactions and how gains or losses on
debt extinguishments are presented in financial statements. The Company adopted
SFAS No. 145 during the three months ended December 31, 2002. Adoption did not
have a significant effect on the Company's consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit and Disposal Activities." SFAS No. 146 will impact how
companies account for costs incurred with exit activities, such as employee
severance and facility closure costs. The Company adopted SFAS No. 146 during
the three months ended December 31, 2002. Accordingly, during the three months
ended December 31, 2002, the Company recorded $181,459 in restructuring and
centralization costs for severance benefits for 5 terminated employees and costs
resulting from the cancellation of leases and the disposal of fixed assets
related to a relocation to smaller facilities.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure" which addresses financial
accounting and reporting for recording expenses for the fair value of stock
options. SFAS No. 148 provides alternative methods of transition for a voluntary
change to a fair value based method of accounting for stock-based employee
compensation. Additionally, SFAS No. 148 requires more prominent and more
frequent disclosures in financial statements about the effects of stock-based
compensation. The provisions of this Statement are effective for fiscal years
ending after December 15, 2002, with early application permitted in certain
circumstances. The interim disclosure provisions are effective for financial
reports containing financial statements for interim periods beginning after
December 15, 2002. The Company will continue to account for its stock-based
compensation under the intrinsic value method prescribed under Accounting
Principles Board Opinion No. 25.
In November 2002, the Financial Accounting Standards Board ("FASB")
issued Financial Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." FIN 45 requires certain guarantees to be recorded at
fair value and requires a guarantor to make significant new disclosures, even
when the likelihood of making any payments under the guarantee is remote.
Generally, FIN 45 applies to certain types of financial guarantees that
contingently require the guarantor to make payments to the guaranteed party
based on changes in an underlying that is related to an asset, liability, or an
equity security of the guaranteed party; performance guarantees involving
contracts which require the guarantor to make payments to the guaranteed party
based on another entity's failure to perform under an obligating agreement;
indemnification agreements that contingently require the guarantor to make
payments to an indemnified party based on changes in an underlying that is
related to an asset, liability, or an equity security of the indemnified party;
or indirect guarantees of the indebtedness of others. The initial recognition
and initial measurement provisions of FIN 45 are applicable on a prospective
basis to guarantees issued or modified after December 31, 2002. Disclosure
requirements under FIN 45 are effective for financial statements ending after
December 15, 2002 and are applicable to all guarantees issued by the guarantor
subject to FIN 45's scope, including guarantees issued prior to FIN 45. Special
disclosures for product warranties under FIN 45 include disclosures on the
guarantor's accounting and methodology
15
used in determining its liability and a tabular reconciliation of the changes in
the guarantor's product warranty liability for the reporting period. No
additional disclosures are required under FIN 45 for the quarter ended December
31, 2002. The Company's policies with regard to warranty are disclosed in the
Company's Annual Report on Form 10-K for the year ended September 30, 2002. The
Company has no accrued warranty costs. Adoption of FIN 45 is not expected to
have a material effect on the Company's financial condition, results of
operations or cash flows.
In January 2003, the FASB issued Financial Interpretation No. 46 ("FIN
46"), "Consolidation of Variable Interest Entities" with the objective of
improving financial reporting by companies involved with variable interest
entities. A variable interest entity is a corporation, partnership, trust, or
any other legal structure used for business purposes that either (a) does not
have equity investors with voting rights, or (b) has equity investors that do
not provide sufficient financial resources for the entity to support its
activities. Historically, entities generally were not consolidated unless the
entity was controlled through voting interests. FIN 46 changes that by requiring
a variable interest entity to be consolidated by a company if that company is
subject to a majority of the risk of loss from the variable interest entity's
activities or entitled to receive a majority of the entity's residual returns or
both. A company that consolidates a variable interest entity is called the
"primary beneficiary" of that entity. FIN 46 also requires disclosures about
variable interest entities that a company is not required to consolidate but in
which it has a significant variable interest. The consolidation requirements of
FIN 46 apply immediately to variable interest entities created after January 31,
2003. The consolidation requirements of FIN 46 apply to existing entities in the
first fiscal year or interim period beginning after June 15, 2003. Also, certain
disclosure requirements apply to all financial statements issued after January
31, 2003, regardless of when the variable interest entity was established. The
Company is currently evaluating the provisions of the interpretation and does
not expect any material impact to the financial statements as a result of
adopting this interpretation.
RISK FACTORS
The Company does not provide forecasts of its future financial
performance. However, from time to time, information provided by the Company or
statements made by its employees may contain "forward looking" information that
involves risks and uncertainties. In particular, statements contained in this
Quarterly Report on Form 10-Q that are not historical facts (including, but not
limited to statements contained in "Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations" of Part I of this Quarterly
Report on Form 10-Q relating to liquidity and capital resources) may constitute
forward looking statements and are made under the safe harbor provisions of The
Private Securities Litigation Reform Act of 1995. The Company cautions readers
not to place undue reliance on any such forward looking statements, which speak
only as of the date they are made. The Company disclaims any obligation, except
as specifically required by law and the rules of the Securities and Exchange
Commission, to publicly update or revise any such statements to reflect any
change in the Company's expectations or in events, conditions or circumstances
on which any such statements may be based, or that may affect the likelihood
that actual results will differ from those set forth in the forward looking
statements. The Company's actual results of operations and financial condition
have varied and may in the future vary significantly from those stated in any
forward looking statements. Factors that may cause such differences include,
without limitation, the risks, uncertainties and other information discussed
below and within this Quarterly Report on Form 10-Q, as well as the accuracy of
the Company's internal estimates of revenue and operating expense levels.
Further information on factors that could cause actual results to differ from
those anticipated is detailed in various filings made by the Company from time
to time with the Securities and Exchange Commission, including but not limited
to, those appearing under the caption "Risk Factors" in our Annual Report on
Form 10-K filed with the Securities and Exchange Commission for the year ended
September 30, 2002. The following discussion of the Company's risk factors
should be read in conjunction with the financial statements contained herein and
related notes thereto. Such factors, among others, may have a material adverse
effect upon the Company's business, results of operations and financial
condition.
16
Fluctuations in Quarterly Operating Results
The Company's future operating results could vary substantially from
quarter to quarter because of uncertainties and/or risks associated with such
things as technological change, competition, and delays in the introduction of
products or product enhancements and general market trends. Historically, the
Company has operated with little backlog of orders because its software products
are generally shipped as orders are received. As a result, net sales in any
quarter are substantially dependent on orders booked and shipped in that
quarter. Because the Company's staffing and operating expenses are based on
anticipated revenue levels and a high percentage of the Company's costs are
fixed in the short-term, small variations in the timing of revenues can cause
significant variations in operating results from quarter to quarter. Because of
these factors, the Company believes that period-to-period comparisons of its
results of operations are not necessarily meaningful and should not be relied
upon as indications of future performance. There can be no assurance that the
Company will not experience such variations in operating results in the future
or that such variations will not have a material adverse effect on the Company's
business, financial condition or results of operation.
Weakening of World Wide Economic Conditions and the Computer Software Market May
Result in Lower Revenue Growth Rates or Decreased Revenues
The revenue growth and profitability of the Company's business depends
on the overall demand for computer software and services, particularly in the
markets in which it competes. Because the Company's sales are primarily to major
corporate customers, its business also depends on general economic and business
conditions. A softening of demand for computer software and services, caused by
a weakening of the economy in the United States or abroad, may result in lower
revenue growth rates, decreased revenues or reduced profitability. In addition,
recent terrorist attacks against the United States, and the United States
military response to these attacks, have added to economic and political
uncertainty which may adversely affect worldwide demand for computer software
and services and result in significant fluctuations in the value of foreign
currencies. In a weakened economy, the Company cannot be assured that it will be
able to effectively promote future growth in its software and services revenues
or maintain profitability.
Dependence on Principal Products
In the three months ended December 31, 2002, Monarch, Q|SM and Visual
Help Desk, and Monarch|ES accounted for approximately 59%, 30% and 11%,
respectively, of the Company's total revenue. The Company is wholly dependent on
the Monarch, Q|SM, Visual Help Desk and Monarch|ES products. As a result, any
factor adversely affecting sales of any of these products could have a material
adverse effect on the Company. The Company's future financial performance will
depend in part on the successful introduction of its new and enhanced versions
of these products and development of new versions of these and other products
and subsequent acceptance of such new and enhanced products. In addition,
competitive pressures or other factors may result in significant price erosion
that could have a material adverse effect on the Company's business, financial
condition or results of operations.
International Sales
In the three months ended December 31, 2002 and 2001, international
sales accounted for approximately 41% and 44%, respectively, of the Company's
total revenue. The Company anticipates that international sales will continue to
account for a significant percentage of its total revenue. A significant portion
of the Company's total revenue will therefore be subject to risks associated
with international sales, including unexpected changes in legal and regulatory
requirements, changes in tariffs, exchange rates and other barriers, political
and economic instability, possible effects of war and acts of terrorism,
difficulties in account receivable collection, difficulties in managing
distributors or representatives, difficulties in staffing and managing
international operations, difficulties in protecting the Company's intellectual
property overseas, seasonality of sales and potentially adverse tax
consequences.
Acquisition Strategy
As evidenced by its October 2002 acquisition of Auxilor, Inc., the
Company continues to address the need to develop new products, in part, through
the acquisition of other companies. Acquisitions involve numerous risks
including difficulties in the assimilation of the operations, technologies and
products of the acquired companies, the diversion of management's attention from
other business concerns, risks of entering markets in which the Company has no
or limited direct prior experience and where competitors in such markets have
stronger market positions, and
17
the potential loss of key employees of the acquired company. Achieving and
maintaining the anticipated benefits of an acquisition will depend in part upon
whether the integration of the companies' business is accomplished in an
efficient and effective manner, and there can be no assurance that this will
occur. The successful combination of companies in the high technology industry
may be more difficult to accomplish than in other industries.
Dependence on New Introductions; New Product Delays
Growth in the Company's business depends in substantial part on the
continuing introduction of new products. The length of product life cycles
depends in part on end-user demand for new or additional functionality in the
Company's products. If the Company fails to accurately anticipate the demand
for, or encounters any significant delays in developing or introducing, new
products or additional functionality on its products, there could be a material
adverse effect on the Company's business. Product life cycles can also be
affected by the introduction by suppliers of operating systems of comparable
functionality within their products. The failure of the Company to anticipate
the introduction of additional functionality in products developed by such
suppliers could have a material adverse effect on the Company's business. In
addition, the Company's competitors may introduce products with more features
and lower prices than the Company's products. Such increase in competition could
adversely affect the life cycles of the Company's products, which in turn could
have a material adverse effect on the Company's business.
Software products may contain undetected errors or failures when first
introduced or as new versions are released. There can be no assurance that,
despite testing by the Company and by current and potential end-users, errors
will not be found in new products after commencement of commercial shipments,
resulting in loss of or delay in market acceptance. Any failure by the Company
to anticipate or respond adequately to changes in technology and customer
preferences, or any significant delays in product development or introduction,
could have a material adverse effect on the Company's business.
Rapid Technological Change
The markets in which the Company competes have undergone, and can be
expected to continue to undergo, rapid and significant technological change. The
ability of the Company to grow will depend on its ability to successfully update
and improve its existing products and market and license new products to meet
the changing demands of the marketplace and that can compete successfully with
the existing and new products of the Company's competitors. There can be no
assurance that the Company will be able to successfully anticipate and satisfy
the changing demands of the personal computer software marketplace, that the
Company will be able to continue to enhance its product offerings, or that
technological changes in hardware platforms or software operating systems, or
the introduction of a new product by a competitor, will not render the Company's
products obsolete.
Competition in the PC Software Industry
The software market for personal computers is highly competitive and
characterized by continual change and improvement in technology. Several of the
Company's existing and potential competitors, including BMC Software, Actuate
Corporation, Quest Software Inc., and others, have substantially greater
financial, marketing and technological resources than the Company. No assurance
can be given that the Company will have the resources required to compete
successfully in the future.
Dependence on Proprietary Software Technology
The Company's success is dependent upon proprietary software
technology. Although the Company does not own any patents on any such
technology, it does hold exclusive licenses to such technology and relies
principally on a combination of trade secret, copyright and trademark laws,
nondisclosure and other contractual agreements and technical measures to protect
its rights to such proprietary technology. Despite such precautions, there can
be no assurance that such steps will be adequate to deter misappropriation of
such technology.
18
Reliance on Software License Agreements
Substantially all of the Company's products incorporate third-party
proprietary technology which is generally licensed to the Company on an
exclusive, worldwide basis. Failure by such third-parties to continue to develop
technology for the Company and license such technology to the Company could have
a material adverse effect on the Company's business and results of operations.
Indirect Distribution Channels
The Company sells a significant portion of its products through
resellers, none of which are under the direct control of the Company. The loss
of major resellers of the Company's products, or a significant decline in their
sales, could have a material adverse effect on the Company's operating results.
There can be no assurance that the Company will be able to attract or retain
additional qualified resellers or that any such resellers will be able to
effectively sell the Company's products. The Company seeks to select and retain
resellers on the basis of their business credentials and their ability to add
value through expertise in specific vertical markets or application programming
expertise. In addition, the Company relies on resellers to provide post-sales
service and support, and any deficiencies in such service and support could
adversely affect the Company's business.
Volatility of Stock Price
As is frequently the case with the stocks of high technology companies,
the market price of the Company's common stock has been, and may continue to be,
volatile. Factors such as quarterly fluctuations in results of operations,
increased competition, the introduction of new products by the Company or its
competitors, expenses or other difficulties associated with assimilating
companies acquired by the Company, changes in the mix of sales channels, the
timing of significant customer orders, and macroeconomic conditions generally,
may have a significant impact on the market price of the stock of the Company.
Any shortfall in revenue or earnings from the levels anticipated by securities
analysts could have an immediate and significant adverse effect on the market
price of the Company's common stock in any given period. In addition, the stock
market has from time to time experienced extreme price and volume fluctuations,
which have particularly affected the market price for many high technology
companies and which, on occasion, have appeared to be unrelated to the operating
performance of such companies.
Transfer of Common Stock Listing
On March 30, 2001 the Company announced that it had received a notice
from The Nasdaq Stock Market, Inc. that the Company's Common Stock failed to
comply with the $1.00 minimum bid price requirement for continued listing on The
Nasdaq National Market as set forth in marketplace Rule 4450(a)(5), and that the
Company's Common Stock was, therefore, subject to delisting from The Nasdaq
National Market. Management presented the Company's plan to regain compliance
with the minimum bid price requirement to the Nasdaq Listing Qualifications
Panel and, on May 30, 2001, the Listing Qualifications Panel's notified the
Company that it had determined to continue listing the Company's common stock on
the Nasdaq National Market, provided that on or before July 31, 2001, the
Company's Common Stock evidenced a closing bid price of at least $1.00 per share
and, immediately thereafter, a closing bid price of at least $1.00 for a minimum
of ten consecutive trading days and that the Company remained in compliance with
all other requirements for continued listing on The Nasdaq National Market.
Effective as of the close of business on July 23, 2001 the Company effected a
1-for-4.5 reverse stock split which resulted in compliance with the $1.00 per
share minimum bid price requirement for the Company's common stock.
In January 2002, the Company received a notice from the Nasdaq Stock
Market, Inc. that it was not in compliance with the $4 million net tangible
asset requirement for continued listing on The Nasdaq National Market and, in
response, the Company applied for listing of its Common Stock on The Nasdaq
SmallCap Market. In early February 2002, the Company was notified that its
application for listing on The Nasdaq SmallCap Market had been approved. The
listing of the Company's Common Stock was transferred to The Nasdaq SmallCap
Market at the opening of business on February 7, 2002.
There can be no assurance that the Company will remain in compliance
with the requirements for continued listing on The Nasdaq SmallCap Market. In
addition, the transfer of the Company's Common Stock listing to The Nasdaq
SmallCap Market may impair the ability of stockholders to buy and sell shares of
the Company's Common Stock and could adversely affect the market price of, and
the efficiency of the trading market for, the shares of Common Stock.
19
Further, the transfer of the Common Stock from The Nasdaq National Market could
significantly impair the Company's ability to raise capital in the public
markets should it desire to do so in the future.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
----------------------------------------------------------
Derivative Financial Instruments, Other Financial Instruments, and Derivative
Commodity Instruments
At December 31, 2002, the Company did not participate in any derivative
financial instruments, or other financial and commodity instruments. The Company
holds no investment securities that possess significant market risk.
Primary Market Risk Exposures
The Company's primary market risk exposures are in the areas of
interest rate risk and foreign currency exchange rate risk. The Company utilizes
U.S. dollar denominated borrowings to fund its operational needs through its
working capital line of credit agreement. The line, which currently bears an
interest rate of prime plus 3/4%, or 5%, is subject to annual renewal. Had the
interest rate under the line of credit been 10% greater or lesser than actual
rates, the impact would not have been material in the Company's consolidated
financial statements for the three months ended December 31, 2002. As of
December 31, 2002, the Company had no outstanding borrowings under the working
capital line.
The Company's exposure to currency exchange rate fluctuations has been
and is expected to continue to be modest due to the fact that the operations of
its international subsidiaries are almost exclusively conducted in their
respective local currencies, and dollar advances to the Company's international
subsidiaries, if any, are usually considered to be of a long-term investment
nature. Therefore, the majority of currency movements are reflected in the
Company's other comprehensive income. There are, however, certain situations
where the Company will invoice customers in currencies other than its own. Such
gains or losses, whether realized or unrealized, are reflected in income. These
have not been material in the past nor does management believe that they will be
material in the future. Currently the Company does not engage in foreign
currency hedging activities.
Item 4. Controls and Procedures
-----------------------
(a) Evaluation of disclosure controls and procedures.
------------------------------------------------
As of a date (the "Evaluation Date") within ninety days prior to the
filing date of this Quarterly Report on Form 10-Q, the Company, under the
supervision and with the participation of the Company's management, including
the Company's Chief Executive Officer and Chief Financial Officer, evaluated the
effectiveness of the design and operation of the Company's disclosure controls
and procedures pursuant to Rules 13a-15 and 15d-15 promulgated under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). Based upon
that evaluation, the Company's Chief Executive Officer and Chief Financial
Officer concluded that, as of the Evaluation Date, the Company's disclosure
controls and procedures are effective in ensuring that material information
relating to the Company (including its consolidated subsidiaries) required to be
disclosed by the Company in the reports that it files or submits under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms,
including ensuring that such material information is accumulated and
communicated to the Company's management, including the Company's Chief
Executive Officer and Chief Financial Officer, as appropriate to allow timely
decisions regarding required disclosure.
(b) Changes in internal controls.
----------------------------
There were no significant changes in the Company's internal controls
or, to the knowledge of the Company, in other factors that could significantly
affect the Company's internal controls subsequent to the date of their
evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.
20
PART II.
Item 2. Changes in Securities and Use of Proceeds
-----------------------------------------
On October 16, 2002, the Company issued 14,764 shares of Common Stock
valued at approximately $50,000, to three individuals as part of the
consideration given for the purchase of 100% of the shares of Auxilor, Inc. No
underwriter was involved in the foregoing issuance of Common Stock. Such
issuance was made by the Company in reliance upon an exemption from the
registration provisions of the Securities Act of 1933 set forth in Section 4(2)
thereof as a transaction by an issuer not involving a public offering.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
A. Exhibits
99.1 CEO Certification Pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.*
99.2 CFO Certification Pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.*
* The Company has the originally signed certificate and will provide it
to the Securities and Exchange Commission upon request.
B. Reports on Form 8-K
No Current Report on Form 8-K was filed during the quarterly period
ended December 31, 2002.
21
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 on February 14, 2003.
DATAWATCH CORPORATION
/s/ Alan R. MacDougall
----------------------------------
Alan R. MacDougall
Vice President of Finance and
Chief Financial Officer
(Principal Financial Officer)
22
CERTIFICATIONS
I, Robert W. Hagger, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Datawatch Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data and
have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: February 14, 2003
/s/ Robert W. Hagger
----------------------------------------
Robert W. Hagger
President, Chief Executive Officer and
Director
23
I, Alan R. MacDougall, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Datawatch Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data and
have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: February 14, 2003
/s/ Alan R. MacDougall
----------------------------------------
Alan R. MacDougall
Vice President Finance, Chief Financial
Officer, Treasurer and
Assistant Secretary
24