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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 MARCH 31, 2004
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 May 7, 2004
----- --------------------------
Common Stock $.01 par value 5,295,160
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DATAWATCH CORPORATION AND SUBSIDIARIES
--------------------------------------
TABLE OF CONTENTS
-----------------
PART I. FINANCIAL INFORMATION
- -------------------------------
Item 1. Unaudited Financial Statements Page #
a) Consolidated Condensed Balance Sheets:
March 31, 2004 and September 30, 2003 .......................... 3
b) Consolidated Condensed Statements of Operations:
Three Months and Six Months Ended March 31, 2004 and 2003 ...... 4
c) Consolidated Condensed Statements of Cash Flows:
Six Months Ended March 31, 2004 and 2003 ....................... 5
d) Notes to Consolidated Condensed Financial Statements ........... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ......................................... 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk ........ 26
Item 4. Internal Controls and Procedures .................................. 26
PART II. OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings ................................................. 27
Item 2. Changes in Securities and Use of Proceeds ......................... 27
Item 3. Defaults upon Senior Securities ................................... *
Item 4. Submission of Matters to a Vote of Security Holders ............... 27
Item 5. Other Information ................................................. *
Item 6. Exhibits and Reports on Form 8-K .................................. 28
SIGNATURES .................................................................. 29
* No information provided due to inapplicability of item.
2
PART I.
Item 1. Unaudited Financial Statements
DATAWATCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
MARCH 31, SEPTEMBER 30,
ASSETS 2004 2003
------------ ------------
CURRENT ASSETS:
Cash and equivalents $ 6,105,906 $ 5,070,850
Accounts receivable, net 3,692,615 3,041,322
Inventories, net 92,084 105,258
Prepaid expenses 651,649 552,921
------------ ------------
Total current assets 10,542,254 8,770,351
------------ ------------
PROPERTY AND EQUIPMENT:
Property and equipment 1,721,241 1,849,333
Less accumulated depreciation and amortization (1,290,154) (1,388,427)
------------ ------------
Net property and equipment 431,087 460,906
------------ ------------
OTHER ASSETS:
Capitalized software development costs, net 449,756 696,861
Restricted cash 235,484 226,514
Trademarks 285,152 285,152
Other 34,289 64,158
------------ ------------
Total other assets 1,004,681 1,272,685
------------ ------------
TOTAL ASSETS $ 11,978,022 $ 10,503,942
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 990,777 $ 918,734
Accrued expenses 1,893,754 1,503,621
Deferred revenue 3,027,487 2,940,357
------------ ------------
Total current liabilities 5,912,018 5,362,712
------------ ------------
ACCRUED SEVERANCE, Less current portion -- 3,115
------------ ------------
COMMITMENTS AND CONTINGENCIES (Note 13)
SHAREHOLDERS' EQUITY:
Common stock, par value $.01 - 20,000,000 shares authorized;
issued, 5,293,634 shares and 5,244,328, respectively;
outstanding, 5,279,388 shares and 5,230,082, respectively 52,936 52,443
Additional paid-in capital 21,803,430 21,701,297
Accumulated deficit (15,353,150) (16,072,238)
Accumulated other comprehensive loss (296,824) (402,999)
------------ ------------
6,206,392 5,278,503
Less treasury stock, at cost - 14,246 shares (140,388) (140,388)
------------ ------------
Total shareholders' equity 6,066,004 5,138,115
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 11,978,022 $ 10,503,942
============ ============
See accompanying notes to consolidated condensed financial statements.
3
Item 1. Unaudited Financial Statements (continued)
------------------------------
DATAWATCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, SIX MONTHS ENDED MARCH 31,
------------------------------ ------------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
REVENUE:
Software licenses $ 3,480,205 $ 2,627,221 $ 6,430,534 $ 5,920,102
Maintenance and services 1,714,398 1,480,781 3,171,157 2,689,520
------------ ------------ ------------ ------------
Total Revenue 5,194,603 4,108,002 9,601,691 8,609,622
------------ ------------ ------------ ------------
COSTS AND EXPENSES:
Cost of software licenses 760,285 577,716 1,390,375 1,144,745
Cost of maintenance and services 661,193 615,886 1,272,873 1,230,243
Sales and marketing 1,954,977 1,437,795 3,493,928 2,962,005
Engineering and product development 341,481 473,261 621,125 815,253
General and administrative 1,066,726 1,057,698 2,102,627 2,308,208
Restructuring and centralization costs -- -- -- 181,459
------------ ------------ ------------ ------------
Total costs and expenses 4,784,662 4,162,356 8,880,928 8,641,913
------------ ------------ ------------ ------------
INCOME (LOSS) FROM OPERATIONS 409,941 (54,354) 720,763 (32,291)
INTEREST EXPENSE -- (4,221) -- (5,893)
INTEREST INCOME AND OTHER 10,715 8,594 23,572 15,031
FOREIGN CURRENCY TRANSACTION LOSSES (25,093) (309) (19,747) (10,102)
------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES 395,563 (50,290) 724,588 (33,255)
PROVISION FOR INCOME TAXES -- -- 5,500 --
------------ ------------ ------------ ------------
NET INCOME (LOSS) $ 395,563 $ (50,290) $ 719,088 $ (33,255)
============ ============ ============ ============
NET INCOME (LOSS) PER SHARE - Basic $ 0.08 $ (0.01) $ 0.14 $ (0.01)
============ ============ ============ ============
WEIGHTED-AVERAGE NUMBER OF SHARES
OUTSTANDING - Basic 5,244,305 5,193,494 5,237,539 5,189,542
============ ============ ============ ============
NET INCOME (LOSS) PER SHARE - Diluted $ 0.07 $ (0.01) $ 0.13 $ (0.01)
============ ============ ============ ============
WEIGHTED-AVERAGE NUMBER OF SHARES
OUTSTANDING - Diluted 5,779,465 5,193,494 5,738,526 5,189,542
============ ============ ============ ============
See accompanying notes to consolidated condensed financial statements.
4
Item 1. Unaudited Financial Statements (continued)
------------------------------
DATAWATCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED MARCH 31,
------------------------------
2004 2003
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 719,088 $ (33,255)
Adjustments to reconcile net income to cash used in operating
activities:
Depreciation and amortization 393,493 362,513
Allowances for doubtful accounts and sales returns 119,035 (133,398)
(Gain) loss on disposition of equipment (737) 105,903
Stock-based compensation -- 3,811
Changes in current assets and liabilities, net of effects
from acquisition of Auxilor:
Accounts receivable (676,140) 12,382
Inventories 14,970 45,342
Prepaid expenses and other (65,556) (24,332)
Accounts payable and accrued expenses 365,357 (882,252)
Deferred revenue (120,689) 278,370
------------ ------------
Cash provided by (used in) operating activities 748,821 (264,916)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of equipment and fixtures (89,920) (93,845)
Proceeds from sale of equipment 737 22,260
Purchase of Auxilor, including direct costs of $59,855 -- (172,150)
Capitalized software development costs (19,096) (53,880)
Other assets 33,278 89,551
------------ ------------
Cash used in investing activities (75,001) (208,064)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from exercise of stock options 102,626 5,957
Principal payments on long-term obligations (3,115) (4,798)
------------ ------------
Cash provided by financing activities 99,511 1,159
------------ ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND EQUIVALENTS 261,725 (91,678)
------------ ------------
INCREASE (DECREASE) IN CASH AND EQUIVALENTS 1,035,056 (563,499)
CASH AND EQUIVALENTS, BEGINNING OF PERIOD 5,070,850 3,605,044
------------ ------------
CASH AND EQUIVALENTS, END OF PERIOD $ 6,105,906 $ 3,041,545
============ ============
SUPPLEMENTAL INFORMATION:
Interest paid $ -- $ 5,893
============ ============
NONCASH INVESTING AND FINANCING ACTIVITIES:
Issuance of common stock for acquisition of Auxilor $ -- $ 50,000
============ ============
See accompanying notes to consolidated condensed financial statements.
5
Item 1. Unaudited 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,
2003.
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. Presentation of certain
amounts for the periods ended March 31, 2003 have been changed to conform to the
March 31, 2004 presentation.
2. Stock Split: On March 4, 2004, the Board of Directors approved a
two-for-one split of the Company's common shares. The stock split entitled each
shareholder of record at the close of business on March 19, 2004 (record date)
to receive one additional share for every share of Datawatch common stock held
on that date. Shares resulting from the split were distributed by the transfer
agent on April 8, 2004 (payment date). All share and per share amounts, for all
periods presented, have been retroactively restated to reflect the effect of the
stock split.
3. Revenue Recognition: The Company has two types of software product
offerings: Desktop and Server Software and Enterprise Software. The Company
sells its Desktop and Server Software products directly to end-users and through
distributors and resellers. Enterprise Software products are generally sold
directly to end-users. Sales to distributors and resellers accounted for
approximately 27% and 29%, respectively, of total sales during the three months
ended March 31, 2004 and 2003, and 28% and 27%, respectively, of total sales
during the six months ended March 31, 2004 and 2003. Revenue from the sale of
all software products is generally recognized at the time of shipment, provided
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. Both
types of the Company's software product offerings are "off-the-shelf" as such
term is defined by Statement of Position No. 97-2 ("SOP 97-2"), "Software
Revenue Recognition." Our products are relatively straightforward and the
software can be installed and used by customers on their own with little or no
customization required. Multi-user licenses marketed by the Company are sold as
a right to use the number of licenses and license fee revenue is recognized upon
delivery of all software required to satisfy the number of licenses sold. Upon
delivery, the licensing fee is payable without further delivery obligations to
the Company.
Desktop and Server Software products are generally not sold in multiple
element arrangements. Accordingly, the price paid by the customer is considered
the vendor specific objective evidence ("VSOE") of fair value for those
products.
Enterprise Software sales are generally multiple element arrangements which
include software license deliverables, professional services and post-contract
customer support. In such multiple element arrangements, the Company applies the
residual method in determining revenue to be allocated to a software license. In
applying the residual method, the Company deducts from the sale proceeds the
VSOE of fair value of the services and post-contract customer support in
determining the residual fair value of the software license. The VSOE of fair
value of the services and post-contract customer support is based on the amounts
charged for these elements when sold separately. Professional services include
implementation, integration, training and consulting services with revenue
recognized as the services are performed. These services are generally delivered
on a time and materials basis, are billed on a current basis as the work is
performed, and do not involve modification or customization of the software or
any other unusual acceptance clauses or terms. Post-contract customer support is
typically provided under a maintenance agreement which provides technical
support and rights to unspecified software maintenance updates and bug fixes on
a when-and-if available basis. Revenue from post-contract customer support
services is deferred and recognized ratably over the contract period (generally
one year).
6
Item 1. Unaudited Financial Statements (continued)
------------------------------
The Company provides its distributors with stock-balancing rights and
applies the guidance found in Statement of Financial Accounting Standards
("SFAS") No. 48, "Revenue Recognition when Right of Return Exists." Revenue from
the sale of software products to distributors and resellers is recognized at the
time of shipment providing all other criteria for revenue recognition as stated
above are met and (i) the distributor or reseller is unconditionally obligated
to pay for the products, including no contingency as to product resale, (ii) the
distributor or reseller has independent economic substance apart from the
Company, (iii) the Company is not obligated for future performance to bring
about product resale, and (iv) the amount of future returns can be reasonably
estimated. The Company's experience and history with its distributors and
resellers allows for reasonable estimates of future returns. Among other things,
estimates of potential future returns are made based on the inventory levels at
the various resellers, which the Company monitors frequently. Once the estimates
of potential future returns are made, the Company determines if it has adequate
returns reserves to cover anticipated returns and the returns reserve is
adjusted as required. Adjustments are recorded as increases or decreases in
revenue in the period of adjustment. Actual returns have historically been
within the range estimated and amounts provided by management.
4. Stock Options: The following table presents selected information regarding
the Company's stock option plans as of March 31, 2004:
SHARES SHARES
AUTHORIZED AVAILABLE FOR
FOR GRANT FUTURE GRANT
------------ ------------
1996 International Employee Non-Qualified
Stock Option Plan 88,888 6,172
Datawatch Corporation 1996 Stock Plan 1,248,000 137,582
------------ ------------
1,336,888 143,754
============ ============
The following table is a summary of combined activity for all of the
Company's stock option plans for the six months ended March 31, 2004:
OPTIONS WEIGHTED-AVERAGE
OUTSTANDING EXERCISE PRICE
------------ ------------
Outstanding, October 1, 2003 947,462 $ 2.10
Granted 115,000 3.41
Canceled (59,550) 3.74
Exercised (49,306) 2.08
------------ ------------
Outstanding, March 31, 2004 953,606 $ 2.15
============
Exercisable, March 31, 2004 548,128 $ 2.32
============
7
Item 1. Unaudited Financial Statements (continued)
------------------------------
The following table presents weighted-average price and life information
regarding stock options outstanding and exercisable at March 31, 2004:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ---------------------------------------------------- -------------------
WEIGHTED-AVERAGE WEIGHTED- WEIGHTED-
REMAINING AVERAGE AVERAGE
EXERCISE NUMBER OF CONTRACTUAL EXERCISE EXERCISE
PRICES SHARES LIFE (YEARS) PRICE SHARES PRICE
- ------------ --------- ---------------- --------- -------- ---------
$0.73 - 1.08 284,610 8 $ 0.76 197,978 $ 0.76
1.27 - 1.80 379,036 8 1.55 169,028 1.47
2.60 - 3.38 139,384 7 2.67 71,546 2.73
3.80 - 5.49 101,156 6 4.79 60,156 4.74
5.76 - 7.59 42,308 5 6.93 42,308 6.93
9.70 1,778 3 9.70 1,778 9.70
15.89 5,334 2 15.89 5,334 15.89
- ------------ --------- ---------------- --------- -------- ---------
953,606 8 $ 2.15 548,128 $ 2.32
========= ================ ========= ======== =========
The Company uses the intrinsic-value method of valuing its stock options to
measure compensation expense associated with grants of stock options to
employees and directors. As permitted under SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure," which amended SFAS No.
123 ("SFAS 123"), "Accounting for Stock-Based Compensation," the Company has
elected to continue to follow the intrinsic-value method in accounting for its
stock-based employee compensation arrangements as defined by Accounting
Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to
Employees," and related interpretations including Financial Accounting Standards
Board ("FASB") Interpretation No. 44, "Accounting for Certain Transactions
Involving Stock Compensation," an interpretation of APB No. 25. No stock-based
employee compensation cost is reflected in net income, as all options granted
under those plans had an exercise price equal to the market value of the
underlying common stock on the date of the grant. Had the Company recognized
compensation for its stock options and purchase plans based on the fair value
for awards under those plans, pro forma net income and pro forma net income per
share would have been as follows:
THREE MONTHS ENDED MARCH 31, SIX MONTHS ENDED MARCH 31,
------------------------------ ------------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net income (loss), as reported $ 395,563 $ (50,290) $ 719,088 $ (33,255)
Add: Stock-based employee compensation
expense included in reported net income -- -- -- --
Less: Total stock-based employee
compensation expense determined under
fair value based method for all awards (53,445) (71,402) (107,201) (140,072)
------------ ------------ ------------ ------------
Pro forma net income (loss) $ 342,118 $ (121,692) $ 611,887 $ (173,327)
============ ============ ============ ============
Net income (loss) per share:
Basic - as reported $ 0.08 $ (0.01) $ 0.14 $ (0.01)
Basic - pro forma $ 0.07 $ (0.02) $ 0.12 $ (0.03)
Diluted - as reported $ 0.07 $ (0.01) $ 0.13 $ (0.01)
Diluted - pro forma $ 0.06 $ (0.02) $ 0.11 $ (0.03)
8
Item 1. Unaudited Financial Statements (continued)
------------------------------
The fair values used to compute pro forma net income (loss) and pro forma
net income (loss) per share were estimated on the grant date using the
Black-Scholes option pricing model with the following assumptions:
THREE MONTHS ENDED MARCH 31, SIX MONTHS ENDED MARCH 31,
-------------------------- --------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
Risk-free interest rate 2.8% 2.7% 3.0% 3.0%
Expected life of option grants (years) 4.0 4.0 4.0 4.0
Expected volatility of underlying stock 107.2% 116.6% 115.0% 118.1%
Expected dividend payment rate 0.0% 0.0% 0.0% 0.0%
Expected forfeiture rate 0.0% 0.0% 0.0% 0.0%
The weighted-average fair value of stock options granted was $3.57 and
$1.06, respectively, for the three months ended March 31, 2004 and 2003, and
$2.58 and $1.22, respectively, for the six months ended March 31, 2004 and 2003.
5. Concentration of Credit Risks and Major Customers: One customer, Ingram
Micro Inc., individually accounted for 21% and 19%, respectively, of revenue for
the three months ended March 31, 2004 and 2003, and 19% and 17%, respectively,
of revenue for the six months ended March 31, 2004 and 2003. Ingram Micro Inc.
accounted for 25% and 23%, respectively, of outstanding gross trade receivables
as of March 31, 2004 and September 30, 2003. The Company sells to Ingram Micro
Inc. under a distribution agreement which automatically renews for successive
one-year terms unless terminated. 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.
6. Inventories: Inventories consisted of the following at March 31, 2004 and
September 30, 2003:
MARCH 31, SEPTEMBER 30,
2004 2003
---------- ----------
Raw Materials $ 66,893 $ 77,127
Finished goods 25,191 28,131
---------- ----------
Total $ 92,084 $ 105,258
========== ==========
7. Deferred Revenue: Deferred revenue consisted of the following at March 31,
2004 and September 30, 2003:
MARCH 31, SEPTEMBER 30,
2004 2003
---------- ----------
Maintenance $2,433,447 $2,456,296
Other 594,040 484,061
---------- ----------
Total $3,027,487 $2,940,357
========== ==========
Maintenance consists of the unearned portion of post-contract customer
support services provided by the Company to customers who purchase maintenance
agreements for the Company's products. Maintenance revenues are recognized on a
straight-line basis over the term of the maintenance period, generally 12
months.
Other consists of deferred license or professional services revenue
generated from arrangements which are invoiced in accordance with the terms and
conditions of the arrangement but do not meet all the criteria of the Company's
revenue recognition policies, and are, therefore, deferred until all revenue
recognition criteria are met.
9
Item 1. Unaudited Financial Statements (continued)
------------------------------
8. Comprehensive Income (Loss): The following table sets forth the
reconciliation of net income (loss) to comprehensive income (loss):
THREE MONTHS ENDED MARCH 31, SIX MONTHS ENDED MARCH 31,
2004 2003 2004 2003
---------- ---------- ---------- ----------
Net income (loss) $ 395,563 $ (50,290) $ 719,088 $ (33,255)
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments 30,447 (21,747) 106,175 2,011
---------- ---------- ---------- ----------
Comprehensive income (loss) $ 426,010 $ (72,037) $ 825,263 $ (31,244)
========== ========== ========== ==========
Accumulated other comprehensive loss reported in the consolidated condensed
balance sheets consists only of foreign currency translation adjustments.
9. Net Income (Loss) Per Share: Basic net income (loss) per common share is
computed by dividing net income (loss) by the weighted-average number of common
shares outstanding during the period. Diluted net income (loss) per share
reflects the impact, when dilutive, of the exercise of options and warrants
using the treasury stock method.
The following table presents the options that were not included in the
computation of diluted net income per share, because the exercise price of the
options was greater than the average market price of the common stock for the
period:
THREE MONTHS ENDED MARCH 31, SIX MONTHS ENDED MARCH 31,
------------------------ ------------------------
2004 2003 2004 2003
------- ------- ------- -------
Quantity of option shares not included 128,650 374,768 150,576 374,768
Weighted-average exercise price $ 6.19 $ 3.88 $ 5.84 $ 3.88
During periods of net loss, diluted net loss per share does not differ from
basic net loss per share since potential shares of common stock from stock
options and warrants are antidilutive and, therefore, are excluded from the
computation. As there was a net loss for both the three and six month periods
ended March 31, 2003, additional options totaling 148,172 and 166,100,
respectively, with an exercise price less than the average market price of the
common stock, were also excluded from the computation.
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 MARCH 31, SIX MONTHS ENDED MARCH 31,
-------------------------- --------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
Desktop (primarily Monarch) 52% 56% 57% 57%
Visual|QSM & Visual|HD 31% 32% 30% 31%
Datawatch|ES 17% 12% 13% 12%
---------- ---------- ---------- ----------
Total 100% 100% 100% 100%
========== ========== ========== ==========
10
Item 1. Unaudited Financial Statements (continued)
------------------------------
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:
INTERNATIONAL
(PRINCIPALLY
DOMESTIC U.K.) ELIMINATIONS TOTAL
----------- ----------- ----------- -----------
TOTAL REVENUE
- -------------
Three months ended March 31, 2004 $ 3,450,998 $ 2,025,553 $ (281,948) $ 5,194,603
Three months ended March 31, 2003 2,696,867 1,664,671 (253,536) 4,108,002
Six months ended March 31, 2004 $ 6,431,588 $ 3,698,382 $ (528,279) $ 9,601,691
Six months ended March 31, 2003 5,677,264 3,474,116 (541,758) 8,609,622
LONG-LIVED ASSETS
- -----------------
At March 31, 2004 $ 1,241,182 $ 194,586 $ 1,435,768
At September 30, 2003 1,544,382 189,209 1,733,591
The reconciliation of total long-lived assets to the amounts contained in
our financial statements is as follows:
MARCH 31, SEPTEMBER 30,
2004 2003
----------- -----------
Property and Equipment, net $ 431,087 $ 460,906
Capitalized software development costs, net 449,756 696,861
Restricted cash 235,484 226,514
Trademarks 285,152 285,152
Long-term notes receivable * -- 25,832
Deposits * 34,289 38,326
----------- -----------
Total long-lived assets $ 1,435,768 $ 1,733,591
=========== ===========
* Included in other assets in the accompanying consolidated condensed financial
statements
Export sales aggregated approximately $876,000 and $762,000, respectively,
for the three months ended March 31, 2004 and 2003, and approximately $1,679,000
and $1,768,000, respectively, for the six months ended March 31, 2004 and 2003.
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 September 30, 2003, the accrual related to this
restructuring totaled $16,000, of which the long-term portion was $3,000. During
the six months ended March 31, 2004, $5,000 of these charges were paid, leaving
a balance of $11,000 at March 31, 2004 (reflecting cash payments of
approximately $375,000 since September 30, 2001), of which the long-term portion
is $0. 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.
11
Item 1. Unaudited Financial Statements (continued)
------------------------------
During the first quarter of fiscal 2003, the Company approved and completed
a restructuring undertaken to reduce costs related to its international
operations. In accordance with SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," the Company recorded a 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. The charges for this
restructuring were fully paid in February 2003.
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. During
the six months ended March 31, 2004, amortization of this acquired software
totaled approximately $31,000. The Auxilor purchase agreement also included an
earn-out clause, which provided for a cash payout equal to 10% of the sales of
Auxilor products in fiscal 2003. The earn-out was expensed as a cost of revenue
as Auxilor products and services were sold. No earn-out payments are required
for periods after September 30, 2003. The activities of Auxilor from October 1,
2002 to October 16, 2002 were not consolidated into the Company's consolidated
financial statements and were not significant.
13. Subsequent Event: In May 2004, the Company was served with a charge of
discrimination filed with the Massachusetts Commission Against Discrimination
(MCAD) by a current employee. In addition to the Company, the employee has named
an executive of the Company as well as the employee's former supervisor as
defendants. The employee alleges that her former supervisor engaged in sexually
harassing conduct. The employee accuses the executive of engaging in retaliation
upon learning of the employee's complaint. Given the early stage and current
status of the litigation, the Company is unable to express an opinion as to the
likely outcome or an estimate of the possible loss or range of loss if there
were an unfavorable result. The Company intends to vigorously defend the claims.
12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
of Operations
--------------
GENERAL
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,
report mining, data transformation and service center software markets and are
used in more than 20,000 companies, institutions and government agencies
worldwide. The Company markets its software products by two means: (i) directly
to end-user customers through its direct sales force and (ii) through indirect
channels such as distributors, resellers and OEM partners. Revenues are
primarily derived from license fees for software products, and fees for services
relating to such products, including software maintenance and support,
consulting and training. Datawatch has significant international operations and
maintains offices in the United Kingdom, Australia, France and Germany.
Datawatch's principal products are: Monarch, a desktop report mining and
business intelligence application that allows users to transform data from
structured text files or HTML files, produced by any mainframe, midrange,
client/server or PC system, into a live database that users can sort, filter,
summarize, graph and export to other applications such as Microsoft
Corporation's Excel or Access; 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 existing reports in a variety of formats,
including Excel, via email; Datawatch|ES, formerly known as Monarch|ES, a
web-enabled business information portal, providing complete report management,
business intelligence and content management, and the ability to analyze data
within reports derived from existing reporting systems with no new programming
or report writing; Datawatch|RMS, a report mining solution which adds powerful
web-based report access, transformation, analytics and forms capabilities to any
existing document/report management system; Visual|QSM, formerly known as
Q|Service Management or Q|SM, a fully internet-enabled ITIL Certified Service
Management solution that provides full Business Process Management (BPM) and
support capabilities; Visual|Help Desk ("Visual|HD"), a 100% web-based help desk
and call center solution which leverages the capabilities of the IBM Lotus
Domino platform; and 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 more using any DTD or XDR schema
without programming.
On October 16, 2002, Datawatch acquired 100% of the shares of Auxilor,
Inc., in exchange for $127,000 in cash and 14,764 shares of Datawatch common
stock valued at approximately $50,000. Auxilor was acquired to broaden and
expand the Company's product offerings in the service center software market by
the addition of the Visual|HD help desk and call center solution. Auxilor's
results were included with those of the Company from the date of acquisition.
The results of operations of Auxilor for periods prior to its acquisition by the
Company were not significant.
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
The Company has two types of software product offerings: Desktop and
Server Software and Enterprise Software. The Company sells its Desktop and
Server Software products directly to end-users and through distributors and
resellers. Enterprise Software products are generally sold directly to
end-users. Sales to distributors and resellers accounted for approximately 27%
and 29%, respectively, of total sales during the three months ended March 31,
2004 and 2003, and 28% and 27%, respectively, of total sales during the six
months ended March 31, 2004 and 2003. Revenue from the sale of all software
products is generally recognized at the time of shipment, provided 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. Both types of the Company's
software product offerings are "off-the-shelf" as such term is defined by
Statement of Position No. 97-2, "Software Revenue Recognition." Our products are
13
relatively straightforward and the software can be installed and used by
customers on their own with little or no customization required. Multi-user
licenses marketed by the Company are sold as a right to use the number of
licenses and license fee revenue is recognized upon delivery of all software
required to satisfy the number of licenses sold. Upon delivery, the licensing
fee is payable without further delivery obligations of the Company.
Desktop and Server Software products are generally not sold in multiple
element arrangements. Accordingly, the price paid by the customer is considered
the vendor specific objective evidence ("VSOE") of fair value for those
products.
Enterprise Software sales are generally multiple element arrangements
which include software license deliverables, professional services and
post-contract customer support. In such multiple element arrangements, the
Company applies the residual method in determining revenue to be allocated to a
software license. In applying the residual method, the Company deducts from the
sale proceeds the VSOE of fair value of the services and post-contract customer
support in determining the residual fair value of the software license. The VSOE
of fair value of the services and post-contract customer support is based on the
amounts charged for these elements when sold separately. Professional services
include implementation, integration, training and consulting services with
revenue recognized as the services are performed. These services are generally
delivered on a time and materials basis, are billed on a current basis as the
work is performed, and do not involve modification or customization of the
software or any other unusual acceptance clauses or terms. Post-contract
customer support is typically provided under a maintenance agreement which
provides technical support and rights to unspecified software maintenance
updates and bug fixes on a when-and-if available basis. Revenue from
post-contract customer support services is deferred and recognized ratably over
the contract period (generally one year). Such deferred amounts are recorded as
part of deferred revenue in the Company's Consolidated Condensed Balance Sheets
included elsewhere in this filing.
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 and server versions of
Monarch, Monarch Data Pump, and VorteXML, are sold directly to end-users,
include a guarantee under which such customers may return products within 30 or
60 days for a full refund. Historically, returns of products sold to end-users
with such refund rights have been minimal and no amounts have been specifically
provided for such returns. Additionally, the Company provides its distributors
with stock-balancing rights and applies the guidance found in SFAS No. 48,
"Revenue Recognition when Right of Return Exists." Revenue from the sale of
software products to distributors and resellers is recognized at the time of
shipment providing all other criteria for revenue recognition as stated above
are met and (i) the distributor or reseller is unconditionally obligated to pay
for the products, including no contingency as to product resale, (ii) the
distributor or reseller has independent economic substance apart from the
Company, (iii) the Company is not obligated for future performance to bring
about product resale, and (iv) the amount of future returns can be reasonably
estimated. The Company's experience and history with its distributors and
resellers allows for reasonable estimates of future returns. Among other things,
estimates of potential future returns are made based on the inventory levels at
the various distributors and resellers, which the Company monitors frequently.
Once the estimates of potential future returns from all sources are made, the
Company determines if it has adequate returns reserves to cover anticipated
returns and the returns reserve is adjusted as required. Adjustments are
recorded as increases or decreases in revenue in the period of adjustment.
Actual returns have historically been within the range estimated and amounts
provided by the Company.
For the three months and six months ended March 31, 2004 and 2003, changes
to the returns reserve were approximately as follows:
Three Months Ended March 31, Six Months Ended March 31,
2004 2003 2004 2003
-------- -------- -------- --------
Returns Reserve Balance - Beginning of Period $208,000 $234,000 $213,000 $285,000
Amounts Accrued for the Returns Reserve 118,000 50,000 178,000 100,000
Returns Applied Against the Returns Reserve 18,000 144,000 83,000 245,000
-------- -------- -------- --------
Returns Reserve Balance - End of Period $308,000 $140,000 $308,000 $140,000
======== ======== ======== ========
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
14
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.
For the three months and six months ended March 31, 2004 and 2003, changes
to the allowance for doubtful accounts were approximately as follows:
Three Months Ended March 31, Six Months Ended March 31,
2004 2003 2004 2003
-------- -------- -------- --------
Allowance for Doubtful Accounts Balance - Beginning of Period $246,000 $315,000 $230,000 $259,000
Additions to the Allowance of Doubtful Accounts 27,000 14,000 44,000 71,000
Amounts Applied Against the Allowance for Doubtful Accounts 15,000 28,000 16,000 29,000
-------- -------- -------- --------
Allowance for Doubtful Accounts Balance - End of Period $258,000 $301,000 $258,000 $301,000
======== ======== ======== ========
Capitalized Software Development Costs
The Company capitalizes certain software development costs as well as
purchased software upon achieving technological feasibility of the related
products. 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 and six months ended March 31, 2004 and 2003, amounts
related to capitalized software development costs and purchased software were
approximately as follows:
Three Months Ended March 31, Six Months Ended March 31,
2004 2003 2004 2003
-------- -------- -------- --------
Capitalized Software Balance - Beginning of Period $557,000 $1,027,000 $697,000 $962,000
Capitalized Software Development Costs 19,000 27,000 19,000 54,000
Capitalized Purchased Software -- -- -- 124,000
Amortization of Capitalized Software Development
Costs and Purchased Software 126,000 132,000 266,000 218,000
-------- -------- -------- --------
Capitalized Software Balance - End of Period $450,000 $922,000 $450,000 $922,000
======== ======== ======== ========
Foreign Currency Translations
Assets and liabilities of the Company's foreign subsidiaries, which are
principally located in the UK and Australia, 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
Loss." Accumulated other comprehensive loss reported in the consolidated balance
sheets consists only of foreign currency translation adjustments. At March 31,
2004 and September 30, 2003, the accumulated foreign currency translation loss
totaled approximately $297,000 and $403,000, respectively. The foreign currency
translation gain arising during the three months ended March 31, 2004 was
approximately $30,000 compared to a loss of approximately $22,000 during the
three months ended March 31, 2003, while foreign currency translation gains
arising during the six months ended March 31, 2004 and 2003 were approximately
$106,000 and $2,000, respectively. The Company does not currently engage in
foreign currency hedging activities.
15
Income Taxes
The Company has deferred tax assets related to net operating loss
carryforwards and tax credits, which expire at different times through and until
2020. Significant judgment is required in determining the Company's provision
for income taxes, the carrying value of deferred tax assets and liabilities and
the valuation allowance recorded against net deferred tax assets. Factors such
as future reversals of deferred tax assets and liabilities, projected future
taxable income, changes in enacted tax rates and the period over which our
deferred tax assets will be recoverable are considered in making these
determinations. The Company's domestic operations have been profitable during
the past two years while international operations have continued to generate
operating losses. Accordingly, management does not believe the deferred tax
assets are more likely than not to be realized and a full valuation allowance,
previously provided against the deferred tax assets, continues to be provided.
Management evaluates the realizability of the deferred tax assets quarterly and,
if current economic conditions change or future results of operations are better
than expected, future assessments may result in the Company concluding that it
is more likely than not that all or a portion of the deferred tax assets are
realizable. If this conclusion were reached, the valuation allowance against
deferred tax assets would be reduced resulting in a tax benefit being recorded
for financial reporting purposes.
RESULTS OF OPERATIONS
Three Months Ended March 31, 2004 and 2003
- ------------------------------------------
Revenue for the three months ended March 31, 2004 was $5,195,000, which
represents an increase of $1,087,000, or approximately 26%, from revenue of
$4,108,000 for the three months ended March 31, 2003. For the three months ended
March 31, 2004, Desktop (including Monarch, Monarch Data Pump and VorteXML),
Visual|QSM and Visual|HD, and Datawatch|ES (including Datawatch|RMS) sales
accounted for 52%, 31% and 17% of total revenue, respectively, as compared to
56%, 32% and 12%, respectively, for the three months ended March 31, 2003.
Software license revenue for the three months ended March 31, 2004 was
$3,480,000 or approximately 67% of total revenue, as compared to $2,627,000 or
approximately 64% of total revenue for the three months ended March 31, 2003.
This represents an increase of $853,000 or approximately 32% from fiscal 2003 to
fiscal 2004. For the three months ended March 31, 2004, Datawatch|ES (including
Datawatch|RMS) license revenue increased by $443,000, Desktop (including
Monarch, Monarch Data Pump, and VorteXML) license revenue increased by $407,000,
and Visual|QSM and Visual|HD license revenue increased by $3,000 (Visual|QSM
license revenue increased by $82,000, while Visual|HD license revenue decreased
by $79,000), when compared to the three months ended March 31, 2003. The three
months ended March 31, 2003 was a difficult quarter for the Company with
decreased software license sales which the Company attributed to concerns
regarding the possible effects of war and terrorism on an uncertain worldwide
economy and the resulting reduction in corporate spending on software solutions.
The Company attributes the increase in software license sales for the three
months ended March 31, 2004 to a lessening in this uncertainty and increased
corporate capital budget expenditures. Additionally, the increase in
Datawatch|ES software license revenue is the result of the recognition of
approximately $348,000 of previously deferred domestic software license revenue
for that product during the quarter ended March 31, 2004. Deferred software
license revenue is the result of contractual obligations or liabilities that
delay the recognition of revenue under the Company's revenue recognition
policies. Such deferred software license revenue can result in significant
quarter-to-quarter fluctuations in software license revenue.
Maintenance and services revenue for the three months ended March 31, 2004
was $1,714,000, or approximately 33% of total revenue, as compared to
$1,481,000, or approximately 36% of total revenue, for the three months ended
March 31, 2003. This represents an increase of $233,000 or approximately 16%.
This increase is attributable to an increase for Visual|QSM and Visual|HD
maintenance and services revenue of $256,000 (Visual|QSM services revenue
increased by $229,000 and Visual|HD services revenue increased by $27,000), an
increase in Desktop (including Monarch, Monarch Data Pump, and VorteXML)
maintenance and services revenue of approximately $13,000, and a decrease for
Datawatch|ES maintenance and services revenue of $36,000. The increase in
maintenance and services revenue is primarily attributable to the increases in
Visual|QSM professional services revenue (increase of $205,000) and increased
maintenance revenue for all products (increase of $110,000), partially offset by
decrease in Datawatch|ES professional services revenue (decrease of $85,000).
Management believes the increases in Visual|QSM professional services revenue
and maintenance revenue are both the result of increasing customer loyalty for
the Company's products, resulting in a higher demand for professional services
as users upgrade or extend their use of the Company's products and a higher
percentage of maintenance contract
16
renewals. The Company attributes the decrease in Datawatch|ES professional
services to customer delays in scheduling previously ordered professional
services during the quarter ended March 31, 2004.
Cost of software licenses for the three months ended March 31, 2004 was
$760,000 or approximately 22% of software license revenues, as compared to
$578,000 or approximately 22% of software license revenues for the three months
ended March 31, 2003. This increase of $182,000 is primarily attributable to
increased royalties paid to third-party software developers (increase of
$163,000).
Cost of maintenance and services for the three months ended March 31, 2004
was $661,000 or approximately 39% of maintenance and service revenues, as
compared to $616,000 or approximately 42% of maintenance and service revenues,
for the three months ended March 31, 2003. This increase of $45,000 is
attributable to the Company's use of third-party consultants to supplement our
internal consulting and training staff in revenue generating activities
(increase of $61,000).
Sales and marketing expenses were $1,955,000 for the three months ended
March 31, 2004, which represents an increase of $517,000 or approximately 36%
from $1,438,000 for the three months ended March 31, 2003. This increase is
primarily attributable to increased sales headcount and related expenses
(increase of $433,000) and increases in marketing expenses for lead generation
(increase of $25,000), web site development (increase of $19,000) and trade show
expense (increase of $19,000). The Company expects sales and marketing expenses
to increase in the third quarter of fiscal 2004, as the Company intends to hire
additional sales personnel and increase the marketing budget.
Engineering and product development expenses were $341,000 for the three
months ended March 31, 2004, which represents a decrease of $132,000 or
approximately 28% from $473,000 for the three months ended March 31, 2003. This
decrease is primarily attributable to reduced engineering and product
development headcount and related expenses (decrease of $151,000), partially
offset by an increase in outsourced development expense (increase of $20,000).
The Company expects that engineering and product development expenses will
increase during the third quarter of fiscal 2004, as the Company intends to add
product development personnel and increase the budget for outsourced
development.
General and administrative expenses were $1,067,000 for the three months
ended March 31, 2004, which represents an increase of $9,000 or approximately 1%
from $1,058,000 for the three months ended March 31, 2003. This increase of
$9,000 is not significant. The Company expects a slight increase in general and
administrative expenses during the third quarter of fiscal 2004.
As a result of the foregoing, income before income taxes for the three
months ended March 31, 2004 was $396,000, which compares to a loss before income
taxes of $50,000 for the three months ended March 31, 2003. No provision for or
benefit from income taxes was recorded during the three months ended March 31,
2004 or the three months ended March 31, 2003. The Company's current estimate is
that it will not be in a significant taxable position in any jurisdiction
primarily as a result of the availability of loss carryforwards for which
valuation allowances had previously been provided. At March 31, 2004, the
Company had federal tax loss carryforwards available to offset future taxable
income of approximately $6 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.
Net income for the three months ended March 31, 2004 was $396,000, which
compares to a net loss of $50,000 for the three months ended March 31, 2003.
Six Months Ended March 31, 2004 and 2003
- ----------------------------------------
Revenue for the six months ended March 31, 2004 was $9,602,000, which
represents an increase of $992,000, or approximately 12%, from revenue of
$8,610,000 for the six months ended March 31, 2003. For the six months ended
March 31, 2004, Desktop (including Monarch, Monarch Data Pump and VorteXML),
Visual|QSM and Visual|HD, and Datawatch|ES (including Datawatch|RMS) sales
accounted for 57%, 30% and 13% of total revenue, respectively, as compared to
57%, 31% and 12%, respectively, for the six months ended March 31, 2003.
Software license revenue for the six months ended March 31, 2004 was
$6,431,000 or approximately 67% of total revenue, as compared to $5,920,000 or
approximately 69% of total revenue for the six months ended March 31, 2003. This
represents an increase of $511,000 or approximately 9% from fiscal 2003 to
fiscal 2004. For the six months ended March
17
31, 2004, Desktop (including Monarch, Monarch Data Pump, and VorteXML) license
revenue increased by $483,000, Datawatch|ES (including Datawatch|RMS) license
revenue increased by $284,000, and Visual|QSM and Visual|HD license revenue
decreased by $256,000 (Visual|QSM license revenue decreased by $173,000 and
Visual|HD license revenue decreased by $83,000), when compared to the six months
ended March 31, 2003. The Company attributes the increases in Desktop and
Datawatch|ES software license revenue to an improved outlook for the domestic
economy compared to last year, resulting in increased capital budget
expenditures. The Company attributes the decrease in Visual|QSM software license
revenue to reluctance of companies in the United Kingdom, where the product is
principally sold, to commit to expenditures for large ticket software solutions
during the first quarter of fiscal 2004. In the second quarter of fiscal 2004,
there was an increase in Visual|QSM software license sales in the United
Kingdom, which the Company attributes to generally increasing budgets for such
software solutions.
Maintenance and services revenue for the six months ended March 31, 2004
was $3,171,000, or approximately 33% of total revenue, as compared to
$2,690,000, or approximately 31% of total revenue, for the six months ended
March 31, 2003. This represents an increase of $481,000 or approximately 18%.
This increase is attributable to an increase for Visual|QSM and Visual|HD
maintenance and services revenue of $468,000 (Visual|QSM services revenue
increased by $425,000 and Visual|HD services revenue increased by $43,000), an
increase in Desktop (including Monarch, Monarch Data Pump, and VorteXML)
maintenance and services revenue of approximately $33,000, partially offset by a
decrease for Datawatch|ES maintenance and services revenue of $20,000. The
increase in maintenance and services revenue is primarily attributable to the
increases in Visual|QSM professional services revenue (increase of $379,000) and
increased maintenance revenue for all products (increase of $189,000), partially
offset by a decrease in Datawatch|ES professional services revenue (decrease of
$93,000). Management believes the increases in Visual|QSM professional services
revenue and maintenance revenue are both the result of increasing customer
loyalty for the Company's products, resulting in a higher demand for
professional services as users upgrade or extend their use of the Company's
products and a higher percentage of maintenance contract renewals. The Company
attributes the decrease in Datawatch|ES professional services to customer delays
in scheduling previously ordered professional services during the second quarter
of fiscal 2004.
Cost of software licenses for the six months ended March 31, 2004 was
$1,390,000 or approximately 22% of software license revenues, as compared to
$1,145,000 or approximately 19% of software license revenues for the six months
ended March 31, 2003. This increase of $245,000 is primarily attributable to
increased royalties paid to third-party software developers (increase of
$199,000), and increased amortization of capitalized software development costs
and purchased software (increase of $48,000). During the six months ended March
31, 2004, the Company capitalized $19,000 of software development costs.
Cost of maintenance and services for the six months ended March 31, 2004
was $1,273,000 or approximately 40% of maintenance and service revenues, as
compared to $1,230,000 or approximately 46% of maintenance and service revenues,
for the six months ended March 31, 2003. This increase of $43,000 is primarily
attributable to the Company's use of third-party consultants to supplement our
internal consulting and training staff in revenue generating activities
(increase of $81,000), partially offset by a decrease in consulting, training
and support headcount and related expenses (decrease of $35,000).
Sales and marketing expenses were $3,494,000 for the six months ended
March 31, 2004, which represents an increase of $532,000 or approximately 18%
from $2,962,000 for the six months ended March 31, 2003. This increase is
primarily attributable to increased sales headcount and related expenses
(increase of $599,000) and increases in marketing expenses for direct mail
campaigns (increase of $54,000) and lead generation (increase of $38,000),
partially offset by a decrease in advertising expense (decrease of $115,000) and
third-party sales consultant expense (decrease of $49,000). The Company expects
sales and marketing expenses to increase in the third quarter of fiscal 2004, as
the Company intends to hire additional sales personnel and increase the
marketing budget.
Engineering and product development expenses were $621,000 for the six
months ended March 31, 2004, which represents a decrease of $194,000 or
approximately 24% from $815,000 for the six months ended March 31, 2003. This
decrease is attributable to reduced engineering and product development
headcount and related expenses (decrease of $238,000), partially offset by an
increase in outsourced development expenses (increase of $44,000). The Company
expects that engineering and product development expenses will increase during
the third quarter of fiscal 2004, as the Company intends to add product
development personnel and increase the budget for outside development.
18
General and administrative expenses were $2,103,000 for the six months
ended March 31, 2004, which represents a decrease of $205,000 or approximately
9% from $2,308,000 for the six months ended March 31, 2003. This decrease is
primarily attributable to reductions in international general and administrative
expenses (decrease of $197,000) resulting from the restructuring which the
Company recorded during the first quarter of fiscal 2003. (See Note 11 to the
Consolidated Condensed Financial Statements included elsewhere in this filing
for a further discussion of this restructuring.) The Company expects a slight
increase in general and administrative expenses during the third quarter of
fiscal 2004.
As a result of the foregoing, income before income taxes for the six
months ended March 31, 2004 was $725,000, which compares to a loss before income
taxes of $33,000 for the six months ended March 31, 2003. During the six months
ended March 31, 2004 an expense of $5,500 was recorded for the Company's
estimate of the expected income tax rate for the year based on federal
alternative minimum taxes due. No other provision for income taxes was recorded
during the six months ended March 31, 2004 or the six months ended March 31,
2003. The Company's current estimate is that it will not be in a significant
taxable position in any jurisdiction primarily as a result of the availability
of loss carryforwards for which valuation allowances had previously been
provided. At March 31, 2004, the Company had federal tax loss carryforwards
available to offset future taxable income of approximately $6 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.
Net income for the six months ended March 31, 2004 was $719,000, which
compares to a net loss of $33,000 for the six months ended March 31, 2003.
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
2008. 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 $152,000 and $131,000 for the three
months ended March 31, 2004 and 2003, respectively, and approximately $301,000
and $323,000 for the six months ended March 31, 2004 and 2003, respectively.
As of March 31, 2004, minimum rental commitments under noncancelable
operating leases are as follows:
Year Ending September 30,
2004 $ 311,649
2005 420,752
2006 141,320
2007 21,105
2008 8,793
Thereafter --
---------
Total minimum lease payments $ 903,619
=========
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 $495,000 and
$332,000, respectively, for the three months ended March 31, 2004 and 2003, and
approximately $888,000 and $689,000, respectively, for the six months ended
March 31, 2004 and 2003. The Company is not obligated to pay any minimum royalty
amounts.
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. If necessary, the Company would provide for the estimated cost of
warranties based on specific warranty claims and claim history. However, the
Company has never incurred significant expense under its product or service
warranties. As a result, the Company believes the estimated fair value of these
warranty agreements is minimal. Accordingly, there are no liabilities recorded
for warranty claims as of March 31, 2004.
19
The Company is required by the lease related to its Lowell, Massachusetts
facility to provide a letter of credit in the amount of approximately $143,000
as a security deposit to guarantee payment to the landlord of amounts due under
the lease. Cash on deposit providing security in the amount of this letter of
credit is recorded as part of restricted cash in the Company's consolidated
balance sheets as of March 31, 2004 and September 30, 2003 found elsewhere in
this filing. No amount has ever been drawn against the letter of credit by the
landlord to guarantee payment and no such action is anticipated in the future.
As it is anticipated that this and any other lease arrangement will continue to
be paid in a timely manner, no contingent liability has been recorded by the
Company for such leases as of March 31, 2004.
As a result of the sale of the Company's former subsidiary Guildsoft
Limited in September 2001, the Company made certain warranties to the purchaser
regarding, among other things, the financial condition and accuracy of the
records of Guildsoft at the time of the sale and against future claims against
Guildsoft related to periods prior to the purchase and sale. As a guarantee of
payment for any such claims or inaccuracies, the equivalent of approximately
$160,000 was placed in escrow in a joint account controlled by both the
Company's and purchaser's United Kingdom attorneys. Under the terms of the
purchase and sale agreement, 50% of the escrow amount was to be released to the
Company on the one year anniversary of the sale and 50% released on the third
anniversary of the sale, if there were no warranty claims made by the purchaser.
To date, no warranty claims have been made by the purchaser and 50% of the funds
were released to Datawatch in September 2002. The balance, or the equivalent of
approximately $92,000 at March 31, 2004, will remain in escrow until September
2004 under the terms of the purchase and sale agreement and is recorded as part
of restricted cash in the Company's consolidated balance sheets as of March 31,
2004 and September 30, 2003 found elsewhere in this filing. As there have been
no claims to date against the warranties and the Company believes the fair value
of any such claims to be minimal and insignificant, no contingent liability has
been recorded by the Company for these warranties as of March 31, 2004.
The Company enters into standard indemnification agreements in our
ordinary course of business. Pursuant to these agreements, the Company agrees to
indemnify, hold harmless, and reimburse the indemnified party for losses
suffered or incurred by the indemnified party, generally our customers, in
connection with any patent, copyright or other intellectual property
infringement claim by any third party with respect to our products. The term of
these indemnification agreements is generally perpetual. The maximum potential
amount of future payments the Company could be required to make under these
indemnification agreements is unlimited. The Company has never incurred costs to
defend lawsuits or settle claims related to these indemnification agreements. As
a result, the Company believes the estimated fair value of these agreements is
minimal. Accordingly, the Company has no liabilities recorded for these
agreements as of March 31, 2004.
Certain of our agreements also provide for the performance of services at
customer sites. These agreements may contain indemnification clauses, whereby
the Company will indemnify the customer from any and all damages, losses,
judgments, costs and expenses for acts of our employees or subcontractors
resulting in bodily injury or property damage. The maximum potential amount of
future payments the Company could be required to make under these
indemnification agreements is unlimited; however, the Company has general and
umbrella insurance policies that would enable us to recover a portion of any
amounts paid. The Company has never incurred costs to defend lawsuits or settle
claims related to these indemnification agreements. As a result, the Company
believes the estimated fair value of these agreements is minimal. Accordingly,
the Company has no liabilities recorded for these agreements as of March 31,
2004.
As permitted under Delaware law, the Company has agreements with its
directors whereby the Company will indemnify them for certain events or
occurrences while the director is, or was, serving at our request in such
capacity. The term of the director indemnification period is for the later of
ten years after the date that the director ceases to serve in such capacity or
the final termination of proceedings against the director as outlined in the
indemnification agreement. The maximum potential amount of future payments the
Company could be required to make under these indemnification agreements is
unlimited; however, our director and officer insurance policy limits our
exposure and enables us to recover a portion of any future amounts paid. As a
result of our insurance policy coverage, the Company believes the estimated fair
value of these indemnification agreements is minimal. All of these
indemnification agreements were grandfathered under the provisions of Financial
Interpretation No. 45 ("FIN 45") as they were in effect prior to December 31,
2002. Accordingly, the Company has no liabilities recorded for these agreements
as of March 31, 2004.
20
LIQUIDITY AND CAPITAL RESOURCES
Working capital increased by approximately $1,223,000 during the six
months ended March 31, 2004. During the six months ended March 31, 2004,
approximately $749,000 of cash was provided by the Company's operations as
compared to approximately $265,000 of cash used in operations for the six months
ended March 31, 2003. During the three month periods ended September 30, 2001,
March 31, 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 in this filing
for a further discussion of the reductions in the workforce as well as other
restructuring actions taken to reduce operating expenses.
Net cash provided by operating activities for the six months ended March
31, 2004 of $749,000 is primarily the result of net income of $719,000,
including non-cash charges for depreciation and amortization of $393,000, an
increase in accounts payable and accruals and an increase in the allowances for
doubtful accounts and sales returns, partially offset by an increase in accounts
receivable, a decrease in deferred revenue (net of the effect of foreign
currency translation) and an increase in prepaid expenses. The increase in
accounts payable and accruals during the six months ended March 31, 2004 was
primarily the result of increased sales commission and bonus accruals. The
increase in the allowances for doubtful accounts and sales returns was primarily
the result of an increased allowance for potential returns from distributors and
resellers. The increase in accounts receivable was the result of increased
sales, while the decrease in deferred revenue was the result of revenue
recognized from previously deferred domestic maintenance and product revenue.
The increase in prepaid expenses during the same period was primarily the result
of the prepayment of software licenses and certain expenses related to the
Company's 2004 User Conference which takes place in May 2004, partially offset
by a decrease in prepaid royalties.
Net cash used in investing activities for the six months ended March 31,
2004 of $75,000 is primarily the result of the purchase of fixed assets
(primarily computer equipment and software) and the capitalization of software
development costs, partially offset by a decrease in long term notes receivable.
Net cash provided by financing activities for the six months ended March 31,
2004 of $100,000 is primarily the result of proceeds received from the exercise
of stock options.
On October 29, 2003, the Company's bank line of credit, which provided for
maximum borrowings of the lesser of $1,500,000 or 70% of defined eligible
receivables and was collateralized by substantially all the assets of the
Company, expired. The Company was offered the option to renew its bank line of
credit but decided, based on its positive cash flow during the past two fiscal
years and the current level of its cash holdings, that it was in the Company's
best interest to forego the expense required to continue the line of credit and,
therefore, did not renew the line of credit.
An existing agreement between Datawatch and Math Strategies grants the
Company exclusive worldwide rights to use and distribute certain intellectual
property owned by Math Strategies and incorporated by the Company in its
Monarch, VorteXML and certain other products. In April 2004, the Company entered
into an Option Purchase Agreement with Math Strategies giving the Company the
option to purchase these intellectual property rights for $8,000,000. This
option, if exercised, would provide the Company with increased flexibility to
utilize the purchased technology in the future. The option can be exercised by
Datawatch at any time during the two years following the effective date of the
Option Purchase Agreement.
Management believes that its current cash balances and cash generated from
operations will be sufficient to meet the Company's cash needs for working
capital and anticipated capital expenditures for at least the next twelve
months. The Company's does not currently anticipate any cash requirements,
during that time, to fund significant capital expenditures or the acquisition of
complementary technology or businesses. However, if in the future, such
expenditures are anticipated or required, the Company may need to seek
additional financing by issuing equity or obtaining credit facilities to fund
such requirements.
Management believes that the Company's current operations have not been
materially impacted by the effects of inflation.
21
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit and Disposal Activities." SFAS No. 146 impacts how
companies account for costs incurred with exit activities, such as employee
severance and facility closure costs. The Company adopted SFAS No. 146 on
October 1, 2002. Accordingly, the Company recorded approximately $181,000 in
restructuring and centralization costs for severance benefits for five
terminated employees and costs resulting from the cancellation of leases and the
disposal of fixed assets related to a relocation to smaller facilities during
the first quarter of fiscal 2003. (See Note 11 to the Consolidated Condensed
Financial Statements elsewhere in this filing.)
In November 2002, the FASB issued 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. Adoption of FIN 45 did not
have a significant impact on the Company's financial position or results of
operations. The Company's disclosures required under FIN 45 are included in the
section titled OFF BALANCE SHEET ARRANGEMENTS, CONTRACTUAL OBLIGATIONS AND
CONTINGENT LIABILITIES AND COMMITMENTS found elsewhere in this filing.
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. The Company is not involved with any variable interest entities as
defined within this interpretation. Accordingly, no additional disclosures are
required under FIN 46 for the three month and six month periods ended March 31,
2004 and 2003.
In December 2003, the Securities Exchange Commission ("SEC") issued Staff
Accounting Bulletin 104, "Revenue Recognition" ("SAB 104"). SAB 104 updates
existing Staff Accounting Bulletin Topic 13, "Revenue Recognition" to be
consistent with recently issued guidance, primarily Emerging Issues Task Force
Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables." The adoption
of SAB 104 did not have a significant impact on the Company's consolidated
financial statements.
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 in the past 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, 2003. The following discussion of
the Company's risk factors should be read in
22
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.
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 and revenue in any quarter is
substantially dependent on orders booked and shipped in that quarter.
Furthermore, several factors may require us, in accordance with accounting
principles generally accepted in the United States, to defer recognition of
license fee revenue for a significant period of time after entering into a
license agreement. 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, as well as the worldwide reaction to SARS,
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 six months ended March 31, 2004, Desktop Products (including
Monarch, Monarch Data Pump and VorteXML), Visual|QSM and Visual|HD, and
Datawatch|ES (including Datawatch|RMS) accounted for approximately 57%, 30% and
13%, respectively, of the Company's total revenue. The Company is wholly
dependent on the Monarch, Monarch Data Pump, VorteXML, Visual|QSM, Visual|HD,
Datawatch|ES and Datawatch|RMS 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 six months ended March 31, 2004 and 2003, international sales,
including export sales from domestic operations, accounted for approximately 40%
and 42%, 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.
23
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 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
24
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.
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.
Dependence on the Ability to Hire and Retain Skilled Personnel
Qualified personnel are in great demand throughout the software industry.
Our success depends, in large part, upon our ability to attract, train, motivate
and retain highly skilled employees, particularly, technical personnel such and
product development and professional services personnel, sales and marketing
personnel and other senior personnel. Our failure to attract and retain the
highly trained technical personnel that are integral to our product development,
professional services and direct sales teams may limit the rate at which the
Company can generate sales and develop new products or product enhancements. A
change in key management could result in transition and attrition in the
affected department. This could have a material adverse effect on our business,
operating results and financial condition.
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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
----------------------------------------------------------
Derivative Financial Instruments, Other Financial Instruments, and Derivative
Commodity Instruments
At March 31, 2004, 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 exposure is in the area of foreign
currency exchange rate risk. 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
25
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. Internal Controls and Procedures
--------------------------------
The principal executive officer and principal financial officer, with the
participation of the Company's management, evaluated the effectiveness of the
Company's "disclosure controls and procedures" (as defined in Exchange Act Rule
13(a)-15(e)) as of the end of the period covered by this Quarterly Report on
Form 10-Q. Based on this evaluation, they have concluded that, as of the end of
the period covered by this Quarterly Report on Form 10-Q, the Company's
disclosure controls and procedures are operating in an effective manner and are
designed to ensure that information required to be disclosed in the Company's
filings and submissions under the Securities and Exchange Act of 1934 is
accumulated and communicated to management, including the Company's principal
executive officer and principal financial officer, as appropriate to allow
timely decisions regarding required disclosure, and is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms. It should be noted that any system of controls is designed to provide
reasonable, but not absolute, assurances that the system will achieve its stated
goals under all reasonably foreseeable circumstances. The Company's principal
executive officer and principal financial officer have concluded that the
Company's disclosure controls and procedures are effective at a level that
provides such reasonable assurances.
There were no changes in the Company's internal controls over financial
reporting, or in other factors that could significantly affect these controls,
during the fiscal quarter to which this report relates that materially affected,
or are reasonably likely to materially affect, the Company's internal controls
over financial reporting.
26
PART II.
Item 1. Legal Proceedings
-----------------
In May 2004, the Company was served with a charge of discrimination filed
with the Massachusetts Commission Against Discrimination (MCAD) by a current
employee. In addition to the Company, the employee has named an executive of the
Company as well as the employee's former supervisor as defendants. The employee
alleges that her former supervisor engaged in sexually harassing conduct. The
employee accuses the executive of engaging in retaliation upon learning of the
employee's complaint. Given the early stage and current status of the
litigation, the Company is unable to express an opinion as to the likely outcome
or an estimate of the possible loss or range of loss if there were an
unfavorable result. The Company intends to vigorously defend the claims.
From time to time, the Company receives claims and may be party to actions
that arise in the normal course of business. The Company is not party to any
litigation that management believes will have a material adverse effect on the
Company's consolidated financial condition, results of operations, or cash
flows.
Item 2. Changes in Securities and Use of Proceeds
-----------------------------------------
On March 4, 2004, the Board of Directors approved a two-for-one split of
the Company's common shares. The stock split entitled each shareholder of record
at the close of business on March 19, 2004 (record date) to receive one
additional share for every share of Datawatch common stock held on that date. No
proceeds were generated by the stock split.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
A. The Annual Meeting of Stockholders of Datawatch Corporation was held on
March 5, 2004.
B. The directors elected at the meeting are Robert W. Hagger, Kevin R.
Morano, Richard de J. Osborne, Terry W. Potter, David T. Riddiford and
James Wood, which constitute all of the directors of the Company.
C. A vote was proposed to elect the following nominees to the Board of
Directors to serve for the ensuing year or until their respective
successors are duly elected and qualified:
Nominee Total Votes For Total Votes Against
------- --------------- -------------------
Robert W. Hagger 4,847,598 156,920
Kevin R. Morano 4,847,598 156,920
Richard de J. Osborne 4,847,598 156,920
Terry W. Potter 4,847,598 156,920
David T. Riddiford 4,847,598 156,920
James Wood 4,847,598 156,920
Total Votes For and Total Votes Against amounts have been adjusted to
reflect the effect of the two-for-one stock split which took place on
March 19, 2004 (record date).
D. No information provided due to inapplicability of item.
27
Item 6. Exhibits and Reports on Form 8-K
A. Exhibits
10.1 Option Purchase Agreement by and among Datawatch Corporation,
Personics Corporation and Raymond J. Huger dated April 29,
2004.
31.1 Certification of the Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
B. Reports on Form 8-K
The Company filed a Current Report on Form 8-K on January 26, 2004,
furnishing a press release that announced its fiscal 2004 first quarter
financial results. The Company filed a Current Report on Form 8-K on
April 22, 2004, furnishing a press release that announced its fiscal
2004 second quarter financial results.
28
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 May 12, 2004.
DATAWATCH CORPORATION
/s/ Alan R. MacDougall
-----------------------------------------
Alan R. MacDougall
Sr. Vice President of Finance and
Chief Financial Officer
(Principal Financial Officer)
29