| Nature of Business and Summary of Significant Accounting Policies | NOTE 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
Datawatch Corporation (the “Company” or “Datawatch”) designs, develops, markets and distributes business computer software products. The Company also provides services, including implementation and support of its software products, as well as training on their use and administration. The Company is subject to a number of risks including dependence on key individuals, competition from substitute products and larger companies and the need for successful ongoing development and marketing of products.
Summary of Significant Accounting Policies
Basis of Presentation and Principles of Consolidation
These consolidated financial statements include the accounts of Datawatch and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.
Accounting Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and judgments, which are evaluated on an on-going basis, that affect the amounts and disclosures reported in the Company’s consolidated financial statements and accompanying notes. Management bases its estimates on historical experience and on various other assumptions that it believes are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The most significant estimates and judgments include those related to revenue recognition, the allowance for doubtful accounts, sales returns reserve, valuation of share-based compensation awards, useful lives of property and equipment and intangibles, and the valuation of long term assets including goodwill, intellectual property and intangibles, and deferred tax assets. Actual results could differ from those estimates and judgments.
Business Combinations
We allocate the fair value of purchase consideration to Angoss’ tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. When determining the fair values of assets acquired and liabilities assumed, management makes significant estimates and assumptions, especially with respect to intangible assets.
Critical estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from customer relationships and acquired developed technology and discount rates. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ materially from estimates. Other estimates associated with the accounting for acquisitions may change as additional information becomes available regarding the assets acquired and liabilities assumed.
Revenue Recognition
Datawatch software products are generally sold in multiple element arrangements which may include software licenses, professional services and post-contract customer support (“PCS”). The Company licenses its software products directly to end-users and indirectly to end-users through value added resellers and distributors. Sales to indirect distribution channels accounted for 37% , 36% and 35% of total sales for the years ended September 30, 2018 , 2017 and 2016 , respectively. The Company’s software product offerings do not require customization and can be installed and used by customers on their own with little or no configuration required. Multi-user licenses marketed by the Company are sold as a right to use the number of licenses, and the license fee revenue is recognized upon delivery of the software.
Revenue typically consists of software licenses, PCS and professional services. Revenue from the sale of software products is generally recognized at the time of delivery, provided there are no uncertainties surrounding product acceptance, the fee is fixed or determinable, collectability is reasonably assured, persuasive evidence of the arrangement exists and there are no significant obligations remaining. PCS 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 PCS agreements is deferred and recognized ratably over the term of the agreements, typically one year. Professional services include advanced modeling, application design, implementation and configuration and process optimization with revenue recognized as the services are performed. These services are generally delivered on a time and materials basis, billed on a current basis as the work is performed, and generally do not involve modification or customization of the software or any unusual acceptance clauses or provisions.
For multiple element arrangements, total fees are allocated to each of the undelivered elements based upon vendor specific objective evidence (“VSOE”) of their fair values, with the residual amount recognized as revenue for the delivered elements. The residual method of revenue recognition is used for multi-element arrangements when the VSOE of the fair value does not exist for one of the delivered elements, generally the software license. Under the residual method, the arrangement fee is recognized as follows: (1) the total fair value of the undelivered elements, as supported by VSOE, is deferred and subsequently recognized as such items are delivered or completed and (2) the difference between the total arrangement fee and the amount allocated to the undelivered elements is recognized as revenue related to the delivered elements. The Company has established VSOE of fair value of PCS from either contractually stated renewal rates or using the bell-shaped curve method. Additionally, VSOE of fair value of the professional services is based on the amounts charged for these elements when sold separately.
Certain deals related to Angoss products contain unbilled receivables, fixed price services and multi-year contract term licenses with significant and incremental discounts. We do not have VSOE in software bundled arrangements involving fixed price services, which results in revenue being deferred and recognized ratably over the longest contractual period. Additionally, we may enter into multi-year contracts with customers that include a discount on future renewal options that is significant and incremental to the initial arrangement. A portion of the fee is deferred as a result of the significant and incremental discount and is recognized as revenue proportionally as future renewals are delivered or as the discount expires.
The Company also licenses its enterprise software using a subscription model. At the time a customer enters into a binding agreement to purchase a subscription, the customer is invoiced annually in advance and an account receivable and deferred revenue are recorded. Beginning on the date the software is delivered and available for use by the customer, and provided that all other criteria for revenue recognition are met, the deferred revenue amount is recognized ratably over the period the service is provided. The subscription arrangement includes software, maintenance and unspecified future upgrades including major version upgrades on a when-and-if available basis.
The Company’s software products are sold under warranty against certain defects in material and workmanship for a period of 30 days from the date of purchase. Revenue from the sale of software products to distributors and resellers is recognized at the time of shipment providing all other revenue recognition criteria 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.
Allowance for Doubtful Accounts
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 and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. Actual results could differ from the allowances recorded, and this difference could have a material effect on the Company’s financial position and results of operations. Receivables are written off against these allowances in the period they are determined to be uncollectible.
For the fiscal years ended September 30, 2018 , 2017 and 2016 , changes to and ending balances of the allowance for doubtful accounts were as follows:
September 30,
2018
2017
2016
(In thousands)
Allowance for doubtful accounts balance - beginning of year
$ 60
$ 28
$ 106
Additions to the allowance for doubtful accounts
117
113
51
Deductions against the allowance for doubtful accounts
(84)
(81)
(129)
Allowance for doubtful accounts balance - end of year
$ 93
$ 60
$ 28
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, cash deposited with banks and highly liquid securities consisting of money market investments with original maturities of 90 days or less.
Concentration of Credit Risks and Major Customers
Financial instruments, which potentially expose the Company to concentrations of credit risk consist primarily of cash, cash equivalents, and accounts receivable. The Company’s cash is maintained with what management believes to be a high-credit quality financial institution. At times, deposits held at this bank may exceed the federally insured limits. Management believes that the financial institutions that hold the Company’s deposits are financially sound and have minimal credit risk. Risks associated with cash and cash equivalents are mitigated by the Company’s investment policy, which limits the Company’s investing of excess cash into only money market mutual funds.
The Company licenses its products and services directly to end-users and indirectly to end-users through U.S. and non-U.S. distributors and other software resellers, under customary credit terms. No partners or customers accounted for more than 10% of total revenue for the years ended September 30, 2018 and 2016. One partner accounted for 12% of total revenue for the year ended September 30, 2017. No partner or customer constituted a significant portion (more than 10%) of accounts receivable for the years ended September 30, 2018 and 2017 . The Company performs ongoing credit evaluations of its customers and generally does not require collateral.
Deferred Revenue
Deferred revenue consisted of the following at September 30 :
September 30,
2018
2017
(In thousands)
Maintenance
$ 10,336
$ 8,632
Software licenses
9,561
2,853
Professional services
372
120
Total
20,269
11,605
Less: Long-term portion of deferred revenue
(2,078)
(302)
Current portion of deferred revenue
$ 18,191
$ 11,303
Deferred maintenance revenue consists primarily of the unearned portion of customer support services provided by the Company to customers who purchased 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. Deferred license revenue consists primarily of the unearned portion of revenue from subscription sales and are recognized on a straight-line basis over the term of the subscription period. The increase in the long-term portion of deferred revenue is attributable to Angoss multi-year contracts . W e may enter into multi-year contracts with customers that include a discount on future renewal options that is significant and incremental to the initial arrangement. A portion of the fee is deferred as a result of the significant and incremental discount and is recognized as revenue proportionally as future renewals are delivered or as the discount expires.
Deferred professional services revenue is generated from arrangements that are invoiced in accordance with the terms and conditions of the arrangement but do not meet all the criteria for revenue recognition and are, therefore, deferred until all revenue recognition criteria are met.
Property and Equipment
Property and equipment consists of office equipment, furniture and fixtures, software and leasehold improvements, all of which are recorded at cost. Depreciation and amortization are provided using the straight-line method over the lesser of the estimated useful lives of the related assets or term of the related leases. Useful lives and lease terms range from three to seven years. Depreciation and amortization expense related to property and equipment was $0.4 million for each of the years ended September 30, 2018 , 2017 , and 2016 .
Long-Lived Assets
Intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable and an impairment loss is recognized when it is probable that the estimated cash flows are less than the carrying amount of the asset.
Long-Lived Assets: Acquired Intellectual Property
Acquired intellectual property consists of software source code acquired through business combinations. The acquired intellectual property assets are being amortized to cost of software licenses using the straight-line method over the estimated life of the asset.
Acquired intellectual property, net, were comprised of the following at September 30, 2018 and 2017 (in thousands):
September 30, 2018
Identified
Weighted
Gross
Intangible
Average
Carrying
Accumulated
Net Carrying
Asset
Useful Life
Amount
Amortization
Amount
(In years)
Intellectual property
8
$ 15,021
$ (11,278)
$ 3,743
September 30, 2017
Identified
Weighted
Gross
Intangible
Average
Carrying
Accumulated
Net Carrying
Asset
Useful Life
Amount
Amortization
Amount
(In years)
Intellectual property
8
$ 11,621
$ (10,734)
$ 887
Amortization expense related to the acquired intellectual property assets charged to cost of software licenses for the years ended September 30, 2018 , 2017 and 2016 , was $0.5 million, $1.1 million and $2.0 million, respectively.
The future amortization expense related to the acquired intellectual property is as follows (in thousands):
Fiscal Years Ending September 30,
2019
$ 685
2020
685
2021
533
2022
425
2023
425
Thereafter
990
Total future amortization expense
$ 3,743
Long-Lived Assets: Other Intangible Assets
Other intangible assets consist of trade names, patents and customer lists acquired through business combinations. The values allocated to these intangible assets are amortized using the straight-line method over the estimated useful life of the related asset.
Other intangible assets, net, were comprised of the following at September 30, 2018 and 2017 (in thousands):
September 30, 2018
Identified
Weighted
Gross
Intangible
Average
Carrying
Accumulated
Net Carrying
Asset
Useful Life
Amount
Amortization
Amount
(In years)
Patents
20
$ 160
$ (113)
$ 47
Customer lists
8
8,075
(3,347)
4,728
Trade names
0
120
(120)
-
Total
$ 8,355
$ (3,580)
$ 4,775
September 30, 2017
Identified
Weighted
Gross
Intangible
Average
Carrying
Accumulated
Net Carrying
Asset
Useful Life
Amount
Amortization
Amount
(In years)
Patents
20
$ 160
$ (105)
$ 55
Customer lists
14
3,574
(2,660)
914
Trade names
3
120
(120)
-
Total
$ 3,854
$ (2,885)
$ 969
Amortization expense related to other intangible assets charged to sales and marketing totaled $0.7 million, $0.1 million and $0.2 million for fiscal 2018, 2017 and 2016, respectively. There was no amortization expense related to other intangible assets charged to general and administrative expense in fiscal years 2018 and 2017. Amortization expense related to other intangible assets charged to general and administrative expense totaled $20,000 for fiscal 2016.
The future amortization expense related to amortizing other intangible assets is as follows (in thousands):
Fiscal Years Ending September 30,
2019
$ 992
2020
992
2021
992
2022
992
2023
389
Thereafter
418
Total future amortization expense
$ 4,775
Goodwill and Indefinite-Lived Assets
Goodwill represents the excess of the purchase price over the fair value of identifiable net assets of acquired businesses. Indefinite-lived intangibles are intangible assets whose useful lives are indefinite in that their lives extend beyond the foreseeable horizon – that is there is no foreseeable limit on the period of time over which they are expected to contribute to the cash flows of the reporting entity. The Company accounts for these items in accordance with FASB’s ASC 350 Intangibles – Goodwill and Other . This requires that goodwill and intangible assets having indefinite lives are not amortized but instead are reviewed annually, or more frequently as a result of an event or change in circumstances, for possible impairment with impaired assets written down to fair value. Goodwill, assembled workforce and Angoss trade names are considered indefinite-lived intangibles. The Company conducts its annual impairment test for goodwill and indefinite-lived intangible assets during the fourth quarter of each fiscal year.
The following table presents the changes in the carrying amount of goodwill and indefinite lived intangibles (in thousands):
Amount
Balance as of September 30, 2017
$ 6,685
Goodwill acquired from the Angoss Acquisition 11,633
Indefinite lived trade names acquired from the Angoss Acquisition 3,200
Balance as of September 30, 2018
$ 21,518
Fair Value Measurements
The Company’s financial instruments consist of cash and cash equivalents, accounts receivable and accounts payable. The estimated fair values have been determined through information obtained from market sources and management estimates. The estimated fair value of certain financial instruments including cash equivalents, accounts receivable and account payable, approximate the carrying value due to their short-term maturity.
The fair value of the Company’s financial assets and liabilities are measured using inputs from the three levels of fair value hierarchy which are as follows:
Level 1 — Quoted prices in active markets for identical assets or liabilities;
Level 2 — Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and
Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The Company classified its cash equivalents, which primarily include money market mutual funds, of $16.5 million as of September 30, 2017 within Level 2 of the fair value hierarchy. The Company held no money market mutual funds as of September 30, 2018
As of September 30, 2017 , the Company’s assets that are measured on a recurring basis include the following (in thousands):
September 30, 2017
Fair Value Measurement
Using Input Types
Level 1
Level 2
Level 3
Assets:
Money market funds
$
-
$ 16,470
$
-
Total
$
-
$ 16,470
$
-
Non-financial assets such as goodwill and long-lived assets are also subject to fair value measurements. Goodwill is subject to recurring fair value measurements to determine whether impairment exists. Long-lived assets are subject to non-recurring fair value measurements if they are deemed to be impaired. The impairment models used for nonfinancial assets depend on the type of asset and are accounted for in accordance with the FASB guidance on fair value measurement.
Income Taxes
The provision for income taxes is based on the earnings or losses reported in the consolidated financial statements. The Company recognizes deferred tax liabilities and assets for the expected future tax consequences of events that have been recognized in the Company’s financial statements or tax returns. Deferred tax liabilities and assets are determined based on the difference between the financial statement carrying amounts and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. The Company provides a valuation allowance against deferred tax assets if it is more likely than not that some or all of the deferred tax assets will not be realized.
The Company follows the accounting guidance for uncertain tax positions. This guidance clarifies the accounting for income taxes by prescribing the minimum threshold a tax position is required to meet before being recognized in the financial statements. It also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition.
Net Loss Per Share
Basic net loss per common share is computed by dividing net loss by the weighted-average number of common shares outstanding during the period.
The following table details the derivation of weighted-average shares outstanding used in the calculation of basic and diluted net loss for each period (in thousands, except share data):
Years Ended
September 30,
2018
2017
2016
Net loss
$ (9,252)
$ (3,993)
$ (14,632)
Weighted-average number of common shares outstanding
12,521
12,073
11,758
Net loss per share
$ (0.74)
$ (0.33)
$ (1.24)
As the Company was in a net loss position in fiscal 2018 , 2017 and 2016 , all common stock equivalents (vested stock options and unvested RSUs) in the respective periods were anti-dilutive. As a result of being anti-dilutive, 184,738 shares, 220,729 shares and 384,312 shares for the years ended September 30, 2018 , 2017 and 2016 , respectively, were excluded in the calculation above.
Foreign Currency Translations and Transactions
The Company’s foreign subsidiaries functional currency is their local currency. As a result, assets and liabilities of foreign subsidiaries are translated into U.S. dollars at rates in effect at each balance sheet date. Revenues, expenses and cash flows are translated into U.S. dollars at average rates prevailing during the respective period. The related translation adjustments are reported as a separate component of shareholders’ equity under the heading “Accumulated Other Comprehensive Loss.” Included in comprehensive loss are the foreign currency translation adjustments. During fiscal years 2018 , 2017 , and 2016 there were foreign currency translation losses of $0.1 million, losses of $34,000 and gains of $0.1 million, respectively.
Gains and losses resulting from transactions that are denominated in currencies other than the applicable unit’s functional currency are included in the operating results of the Company. For fiscal years 2018, 2017 and 2016 there were gains of $0.2 million, losses of $49,000 and losses of $0.1 million, respectively.
Advertising and Promotional Materials
Advertising and promotional costs are expensed as incurred and amounted to $0.2 million, $0.1 million and $0.6 million in fiscal years 2018 , 2017 and 2016 , respectively.
Share-Based Compensation
The Company recognizes the fair value of share-based awards over the requisite service period of the individual awards, which generally equals the vesting period. All of the Company’s share-based awards are accounted for as equity instruments and there have been no liability awards granted. See additional share-based compensation disclosure in Note 5.
Segment Information and Revenue by Geographic Location
The Company has determined that it has only one reportable segment. The Company’s chief operating decision maker, its Chief Executive Officer, 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. See Note 9 for information about the Company’s revenue by geographic operations.
Guarantees and Indemnifications
The Company’s software products are sold under warranty against certain defects in material and workmanship for a period of 30 days from the date of purchase. The Company has never incurred significant expense under its product or service warranties and does not expect to do so in the future. As a result, the Company believes its exposure related to these warranty agreements is minimal. Accordingly, there are no liabilities recorded for warranty claims as of September 30, 2018 or 2017 .
The Company enters into indemnification agreements in the ordinary course of business. Pursuant to these agreements, the Company agrees to indemnify, hold harmless, and to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally its customers, in connection with any patent, copyright or other intellectual property infringement claim by any third party with respect to the Company’s 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 its exposure related to these agreements is minimal. Accordingly, the Company has no liabilities recorded for these potential obligations as of September 30, 2018 or 2017 .
Certain of the Company’s 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 its 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 it 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 its exposure related to these agreements is minimal. Accordingly, the Company has no liabilities recorded for these potential obligations as of September 30, 2018 or 2017 .
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 the Company’s 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, the Company’s director and officer insurance policy limits the Company’s exposure and would enable it to recover a portion of any future amounts paid. As a result of its insurance policy coverage for directors, the Company believes its exposure related to these indemnification agreements is minimal. The Company has no liabilities recorded for these potential obligations as September 30, 2018 or 2017 .
Research and Development Costs
Research and development costs are expensed as incurred to the extent the costs do not meet the capitalization requirements. Capitalization of computer software developed for resale begins upon the establishment of technological feasibility, generally demonstrated by a working model or an operative version of the computer software product. Such costs have not been material to date as technological feasibility is established within a short time frame from the software’s general availability and, as a result, no costs were capitalized in fiscal years 2018 , 2017 , or 2016 .
Recent Accounting Pronouncements
In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill And Other (Topic 350): Simplifying The Test For Goodwill Impairment , in an effort to simplify the subsequent measurement of goodwill and the associated procedures to determine fair value. The guidance eliminates Step 2 from the goodwill impairment test. Instead, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of the reporting unit with its carrying amount, and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, not to exceed the total amount of goodwill allocated to the reporting unit. This guidance is effective for fiscal years beginning after December 15, 2019, including interim periods within that reporting period. The adoption of this guidance is not expected to have a material impact on our financial statements, unless we have an impairment.
In June 2016, the FASB issued ASU 2016-13 , Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which requires entities to estimate all expected credit losses for certain types of financial instruments, including trade receivables, held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. The updated guidance also expands the disclosure requirements to enable users of financial statements to understand the entity’s assumptions, models and methods for estimating expected credit losses. This guidance is effective for fiscal years beginning after December 15, 2019, including interim periods within that reporting period. Early adoption is permitted. The Company is in the process of evaluating the potential impacts of this new guidance on the Company’s consolidated financial statements and related disclosures.
In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting , which is intended to simplify various aspects of how share-based payments are accounted for and presented in financial statements. The standard is effective prospectively for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017, with early adoption permitted. The Company elected to adopt the pronouncement on a prospective basis starting from the first quarter of the fiscal year ended September 30, 2018. As a result of the adoption of ASU 2016-09, we recognize the impact of forfeitures when they occur with no adjustment for estimated forfeitures and recognize excess tax benefits as a reduction of income tax expense regardless of whether the benefit reduces income taxes payable. At September 30, 2017, the Company had approximately $7.6 million of Federal and state net operating loss carryovers related to excess stock compensation. The Company has increased its net operating loss deferred tax asset with a corresponding increase to its valuation allowance.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842 ) , which requires lessees to recognize, on the balance sheet, leases with a lease terms of greater than twelve months as a right-of-use asset and a lease liability. The standard is effective for fiscal years beginning after December 15, 2018. The Company is currently evaluating the effect that the standard will have on the Company’s consolidated financial statements and related disclosures.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) . The ASU is the result of a joint project by the FASB and the International Accounting Standards Board (“IASB”) to clarify the principles for recognizing revenue and to develop a common revenue standard for GAAP and International Financial Reporting Standards (“IFRS”) that would: re |
