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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003
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 August 11, 2003
----- ------------------------------
Common Stock $0.01 par value 2,604,698
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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:
June 30, 2003 and September 30, 2002 3
b) Consolidated Condensed Statements of Operations:
Three Months and Nine Months Ended June 30, 2003 and 2002 4
c) Consolidated Condensed Statements of Cash Flows:
Nine Months Ended June 30, 2003 and 2002 5
d) Notes to Consolidated Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk 24
Item 4. Internal Controls and Procedures 24
PART II. OTHER INFORMATION
- ----------------------------
Item 1. Legal Proceedings *
Item 2. Changes in Securities and Use of Proceeds 25
Item 3. Defaults upon Senior Securities *
Item 4. Submission of Matters to a Vote of Security Holders *
Item 5. Other Information *
Item 6. Exhibits and Reports on Form 8-K 25
SIGNATURES 26
* No information provided due to inapplicability of item.
2
PART I.
Item 1. Unaudited Financial Statements
------------------------------
DATAWATCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
JUNE 30, SEPTEMBER 30,
2003 2002
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and equivalents $ 4,320,823 $ 3,605,044
Accounts receivable, net 3,576,286 3,057,356
Inventories 117,209 170,735
Prepaid expenses 547,043 571,026
------------ ------------
Total current assets 8,561,361 7,404,161
------------ ------------
PROPERTY AND EQUIPMENT:
Property and equipment 1,848,292 3,328,717
Less accumulated depreciation and amortization (1,354,032) (2,596,107)
------------ ------------
Net property and equipment 494,260 732,610
------------ ------------
OTHER ASSETS 1,357,552 1,317,695
------------ ------------
TOTAL ASSETS $ 10,413,173 $ 9,454,466
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 859,795 $ 1,156,966
Accrued expenses 1,840,580 1,996,554
Deferred revenue 2,828,214 2,227,939
------------ ------------
Total current liabilities 5,528,589 5,381,459
------------ ------------
ACCRUED SEVERANCE, less current portion 5,598 12,795
------------ ------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Common stock, $.01 par value, 20,000,000 shares authorized;
issued, 2,606,817 and 2,587,605, respectively; outstanding,
2,599,694 and 2,580,482, respectively 26,068 25,876
Additional paid-in capital 21,669,132 21,609,555
Accumulated deficit (16,253,865) (16,918,783)
Accumulated other comprehensive loss (421,961) (516,048)
------------ ------------
5,019,374 4,200,600
Less treasury stock, at cost, 7,123 shares (140,388) (140,388)
------------ ------------
Total shareholders' equity 4,878,986 4,060,212
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 10,413,173 $ 9,454,466
============ ============
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 JUNE 30, NINE MONTHS ENDED JUNE 30,
------------------------------ ------------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
REVENUE
Software licenses $ 3,603,543 $ 3,684,256 $ 9,523,645 $ 10,346,643
Maintenance and services 1,497,113 1,459,961 4,186,633 4,210,198
------------ ------------ ------------ ------------
TOTAL REVENUE 5,100,656 5,144,217 13,710,278 14,556,841
------------ ------------ ------------ ------------
COSTS AND EXPENSES:
Cost of software licenses 774,824 687,207 1,919,569 2,131,213
Cost of maintenance and services 563,485 686,925 1,793,728 2,102,943
Sales and marketing 1,663,566 1,862,439 4,625,571 4,977,243
Engineering and product development 390,283 310,822 1,205,536 972,136
General and administrative 1,012,626 1,287,763 3,320,834 3,563,177
Restructuring and centralization costs -- -- 181,459 87,651
------------ ------------ ------------ ------------
TOTAL COSTS AND EXPENSES 4,404,784 4,835,156 13,046,697 13,834,363
------------ ------------ ------------ ------------
INCOME FROM OPERATIONS 695,872 309,061 663,581 722,478
INTEREST EXPENSE (1,106) (24,584) (6,999) (98,359)
OTHER INCOME, primarily interest 9,773 4,351 24,804 15,219
FOREIGN CURRENCY TRANSACTION (LOSS) GAIN (5,866) 5,878 (15,968) 870
PROVISION FOR INCOME TAX (500) -- (500) --
------------ ------------ ------------ ------------
INCOME FROM CONTINUING OPERATIONS 698,173 294,706 664,918 640,208
------------ ------------ ------------ ------------
DISCONTINUED OPERATIONS
Gain on sale of Guildsoft -- -- -- 17,096
------------ ------------ ------------ ------------
NET INCOME $ 698,173 $ 294,706 $ 664,918 $ 657,304
============ ============ ============ ============
NET INCOME PER COMMON SHARE:
Continuing operations - basic $ 0.27 $ 0.11 $ 0.26 $ 0.25
------------ ------------ ------------ ------------
Continuing operations - diluted $ 0.26 $ 0.11 $ 0.25 $ 0.24
------------ ------------ ------------ ------------
Discontinued operations - basis and diluted -- -- -- $ 0.01
------------ ------------ ------------ ------------
NET INCOME PER SHARE - Basic $ 0.27 $ 0.11 $ 0.26 $ 0.26
============ ============ ============ ============
NET INCOME PER SHARE - Diluted $ 0.26 $ 0.11 $ 0.25 $ 0.25
============ ============ ============ ============
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic 2,599,694 2,571,868 2,596,413 2,558,225
============ ============ ============ ============
Diluted 2,665,295 2,684,209 2,673,489 2,670,566
============ ============ ============ ============
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
NINE MONTHS ENDED JUNE 30,
------------------------------
2003 2002
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 664,918 $ 657,304
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization 622,966 689,915
Gain on sale of Guildsoft -- (17,096)
Loss on disposition of equipment 108,436 848
Stock-based compensation 3,811 37,500
Changes in current assets and liabilities, net of acquisitions:
Accounts receivable (183,304) 738,175
Inventories 56,281 52,904
Prepaid expenses 39,701 131,704
Accounts payable and accrued expenses (772,527) (494,893)
Deferred revenue 440,492 115,176
------------ ------------
Net cash provided by operating activities 980,774 1,911,537
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of equipment and fixtures (104,177) (94,748)
Proceeds from sale of equipment - net 22,793 191
Proceeds from sale of Guildsoft -- 20,509
Purchase of Auxilor, Inc., including direct costs of $59,855 (172,150) --
Long term notes receivable 5,959 --
Capitalized software development costs (53,880) (174,042)
Other assets 56,183 8,268
------------ ------------
Net cash used in investing activities (245,272) (239,822)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options 5,957 --
Principal payments on long-term obligations (7,197) (107,652)
Payments under credit lines, net -- (635,000)
------------ ------------
Net cash used in financing activities (1,240) (742,652)
------------ ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (18,483) (696)
------------ ------------
NET INCREASE IN CASH AND EQUIVALENTS 715,779 928,367
CASH AND EQUIVALENTS, BEGINNING OF PERIOD 3,605,044 1,568,691
------------ ------------
CASH AND EQUIVALENTS, END OF PERIOD $ 4,320,823 $ 2,497,058
============ ============
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Director stock option acceleration $ 3,811 $ --
============ ============
Issuance of 15,312 shares of common stock for services $ -- $ 37,500
============ ============
Issuance of warrants $ -- $ 76,956
============ ============
See accompanying notes to consolidated condensed financial statements.
5
Item 1. 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,
2002.
In the opinion of management, the accompanying unaudited consolidated
condensed financial statements have been prepared on the same basis as the
audited consolidated financial statements, and include all adjustments necessary
for fair presentation of the results of the interim periods presented. The
operating results for the interim periods presented are not necessarily
indicative of the results expected for the full year. Certain amounts for the
periods ended June 30, 2002 have been reclassified to conform with the June 30,
2003 presentation.
2. Revenue Recognition: The Company has two software product offerings:
Enterprise Software and Desktop and Server 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 31% and 28%, respectively, of total sales during the three months
ended June 30, 2003 and 2002, and 27% and 24%, respectively, of total sales
during the nine months ended June 30, 2003 and 2002. 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. All 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 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).
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
6
Item 1. Unaudited Financial Statements (continued)
------------------------------
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.
3. Stock Options: The following table presents selected information regarding
the Company's stock option plans as of June 30, 2003:
SHARES
AUTHORIZED AVAILABLE FOR
FOR GRANT FUTURE GRANT
---------- ----------
1996 International Employee Non-Qualified
Stock Option Plan 44,444 9,765
Datawatch Corporation 1996 Stock Plan 624,000 167,887
---------- ----------
668,444 177,652
========== ==========
The following table is a summary of combined activity for all of the
Company's stock option plans for the nine months ended June 30, 2003:
OPTIONS WEIGHTED-AVERAGE
OUTSTANDING EXERCISE PRICE
---------- ----------
Outstanding, October 1, 2002 402,247 $ 4.56
Granted 60,167 3.13
Canceled (46,937) 5.03
Exercised (4,448) 1.34
---------- ----------
Outstanding, June 30, 2003 411,029 $ 4.33
==========
Exercisable, June 30, 2003 249,762 $ 5.67
==========
The following table presents weighted-average price and life information
regarding stock options outstanding and exercisable at June 30, 2003:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ------------------------------------------------------ --------------------
WEIGHTED-AVERAGE WEIGHTED- WEIGHTED-
REMAINING AVERAGE AVERAGE
EXERCISE NUMBER OF CONTRACTUAL EXERCISE EXERCISE
PRICES SHARES LIFE (YEARS) PRICE SHARES PRICE
- ------------- --------- -------------- --------- -------- ---------
$ 1.45 - 2.16 150,131 9 $ 1.52 69,947 $ 1.53
2.53 - 3.60 135,684 9 2.92 55,180 2.87
5.20 - 7.17 51,647 6 5.52 51,290 5.52
7.61 - 10.97 37,522 5 9.15 37,300 9.14
11.52 - 15.19 32,489 5 13.06 32,489 13.06
19.41 889 4 19.41 889 19.41
31.78 2,667 3 31.78 2,667 31.78
--------- -------------- --------- -------- ---------
411,029 8 $ 4.33 249,762 $ 5.67
========= ============== ========= ======== =========
7
Item 1. Unaudited Financial Statements (continued)
------------------------------
The Company uses the intrinsic 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 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 JUNE 30, NINE MONTHS ENDED JUNE 30,
------------------------------ ------------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Net income, as reported $ 698,173 $ 294,706 $ 664,918 $ 657,304
Add: Stock-based employee compensation
expense included in reported net income -- -- 3,811 --
Less: Total stock-based employee
compensation expense determined under
fair value based method for all awards (51,846) (75,392) (195,729) (202,353)
------------ ------------ ------------ ------------
Pro forma net income $ 646,327 $ 219,314 $ 473,000 $ 454,951
============ ============ ============ ============
Earnings per share:
Basic - as reported $ 0.27 $ 0.11 $ 0.26 $ 0.26
Basic - pro forma $ 0.25 $ 0.09 $ 0.18 $ 0.18
Diluted - as reported $ 0.26 $ 0.11 $ 0.25 $ 0.25
Diluted - pro forma $ 0.24 $ 0.08 $ 0.18 $ 0.17
The fair values used to compute pro forma net income and pro forma net
income per share were estimated on the grant date using the Black-Scholes option
pricing model with the following assumptions:
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
---------------- ----------------
2003 2002 2003 2002
------ ------ ------ ------
Risk-free interest rate n/a 4.2% 3.0% 4.7%
Expected life of option grants (years) n/a 3.0 4.0 3.0
Expected volatility of underlying stock n/a 113.2% 118.1% 114.9%
Expected dividend payment rate n/a 0.0% 0.0% 0.0%
Expected forfeiture rate n/a 0.0% 0.0% 0.0%
No stock options were granted during the three months ended June 30, 2003.
The weighted-average fair value of stock options granted was $2.63 for the three
months ended June 30, 2002, and $3.13 and $1.56, respectively, for the nine
months ended June 30, 2003 and 2002.
4. Concentration of Credit Risks and Major Customers: One customer, Ingram
Micro Inc., individually accounted for 26% and 20% of revenue for the three
months ended June 30, 2003 and June 30, 2002, respectively, and 20% and 17% of
revenue for the nine months ended June 30, 2003 and June 30, 2002, respectively.
Ingram Micro Inc. accounted for 31% and 23%, respectively, of outstanding trade
receivables as of June 30, 2003 and September 30, 2002. The Company sells to
Ingram Micro Inc. under a distribution agreement which automatically renews for
successive one (1) 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.
8
Item 1. Unaudited Financial Statements (continued)
------------------------------
5. Inventories: Inventories consisted of the following at June 30, 2003 and
September 30, 2002:
JUNE 30, SEPTEMBER 30,
2003 2002
------------ ------------
Materials $ 100,984 $ 105,814
Finished goods 16,225 64,921
------------ ------------
Total $ 117,209 $ 170,735
============ ============
6. Comprehensive Income: The following table sets forth the reconciliation of
net income to comprehensive income:
THREE MONTHS ENDED JUNE 30, NINE MONTHS ENDED JUNE 30,
----------------------------- -----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Net income $ 698,173 $ 294,706 $ 664,918 $ 657,304
Other comprehensive income, net of tax:
Foreign currency translation adjustments 92,076 96,380 94,087 77,203
------------ ------------ ------------ ------------
Comprehensive income $ 790,249 $ 391,086 $ 759,005 $ 734,507
============ ============ ============ ============
Accumulated other comprehensive loss reported in the consolidated condensed
balance sheets consists only of foreign currency translation adjustments.
7. Earnings per Share: Basic net income per common share is computed by
dividing net income by the weighted average number of common shares outstanding
during the period. Diluted net income per share reflects the impact, when
dilutive, of the exercise of options and warrants using the treasury stock
method.
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 JUNE 30, NINE MONTHS ENDED JUNE 30,
------------------------ ------------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Quantity of option shares not included 254,675 136,676 169,440 136,676
Weighted average exercise price $ 6.03 $ 9.60 $ 7.68 $ 9.60
8. 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 NINE MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Monarch 60 % 59 % 58 % 57 %
Datawatch|ES 12 15 12 15
Q|SM & Visual Help Desk 28 26 30 28
---------- ---------- ---------- ----------
100 % 100 % 100 % 100 %
========== ========== ========== ==========
9
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:
TOTAL REVENUE DOMESTIC INTERNATIONAL ELIMINATIONS TOTAL
------------- ----------- ----------- ----------- -----------
Three months ended 6/30/03 $ 3,591,253 $ 1,772,416 $ (263,013) $ 5,100,656
Three months ended 6/30/02 3,389,813 2,059,424 (305,020) 5,144,217
Nine months ended 6/30/03 $ 9,268,517 $ 5,246,532 $ (804,771) $13,710,278
Nine months ended 6/30/02 9,370,246 6,050,688 (864,093) 14,556,841
LONG-LIVED ASSETS DOMESTIC INTERNATIONAL ELIMINATIONS TOTAL
----------------- ----------- ----------- ----------- -----------
At June 30, 2003 $ 1,660,410 $ 191,402 $ -- $ 1,851,812
At September 30, 2002 1,571,978 436,171 -- 2,008,149
The reconciliation of total long-lived assets to the amounts contained in
our financial statements is as follows:
AT JUNE 30, 2003 AT SEPTEMBER 30, 2002
---------------- ---------------------
Property and equipment, net $ 494,260 $ 732,610
Capitalized software development costs, net * 780,255 962,312
Restricted cash * 226,089 221,729
Trademarks * 285,152 --
Long term notes receivable * 25,197 --
Deposits * 40,859 91,498
------------ ------------
Total Long-lived assets $ 1,851,812 $ 2,008,149
* Included in other assets in the accompanying consolidated financial
statements.
Export sales aggregated approximately $842,000 and $1,102,000,
respectively, for the three months ended June 30, 2003 and June 30, 2002, and
$2,610,000 and $3,270,000, respectively, for the nine months ended June 30, 2003
and June 30, 2002.
9. Line of Credit: On November 15, 2002, the Company renewed its domestic bank
line-of-credit for a period to expire on October 29, 2003. The Company also had
an international line-of-credit which expired on October 1, 2002. The renewed
domestic credit line, which bears interest at the bank's prime rate plus 3/4%
(5% at June 30, 2003), contains customary covenants which require, among other
items, that the Company maintain a minimum level of consolidated tangible net
worth. The renewed domestic credit line provides for maximum borrowings of the
lesser of $1,500,000 or 70% of defined eligible receivables. As of June 30,
2003, the Company had no outstanding borrowings under its bank line-of-credit
with approximately $1,000,000 in borrowings available under the line.
10. 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 June 30, 2003, the accrual related to this
restructuring totaled $23,000 (reflecting cash payments of approximately
$363,000 since September 30, 2001) of which the long-term portion is $6,000. The
charges are expected to be fully paid in January 2005.
During the second quarter of fiscal 2002, there was an additional
reorganization undertaken to further improve efficiencies and reduce costs,
which resulted in an additional restructuring charge of approximately $88,000
for severance benefits and related costs for 4 terminated employees. The charges
for this restructuring were fully paid in July 2002.
During the first quarter of fiscal 2003, the Company approved and completed
a restructuring undertaken to reduce costs related to its international
operations. 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
10
Item 1. Unaudited Financial Statements (continued)
------------------------------
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.
11. Acquisition: On October 16, 2002, the Company acquired 100% of the
outstanding shares of Auxilor, Inc. for a total consideration of approximately
$561,000 comprised of $127,000 in cash, 14,764 shares of Datawatch common stock
valued at approximately $50,000, direct costs of approximately $60,000, and
assumed liabilities totaling approximately $324,000. In exchange, the Company
received Auxilor tangible assets valued at approximately $152,000 resulting in
$409,000 to be allocated to intangible assets in accordance with SFAS No. 141
and SFAS No. 142. A valuation analysis subsequently allocated approximately
$285,000 and $124,000, respectively, to trademarks and acquired software. The
Auxilor purchase agreement also includes an earn-out clause, which provides for
a cash payout equal to 10% of the sales of Auxilor products in fiscal 2003. The
earn-out will be expensed as a cost of revenue as Auxilor products and services
are sold. The activities of Auxilor from October 1, 2002 to October 16, 2002 are
not consolidated into the Company's consolidated condensed financial statements
and are not significant.
11
Item 2. Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations
---------------------
GENERAL
Datawatch Corporation (the "Company" or "Datawatch") is engaged in the
design, development, manufacture, marketing, and support of business computer
software primarily for the Windows-based market. Its products address the
enterprise reporting, business intelligence, data replication and service
management markets.
Datawatch's principal products are: Monarch, a report mining and business
intelligence application that lets users extract and manipulate data from ASCII
report files or HTML files produced on any mainframe, midrange, client/server or
PC system; Monarch Data Pump, a data replication and migration tool that offers
a shortcut for populating and refreshing data marts and data warehouses, for
migrating legacy data into new applications and for providing automated delivery
of reports in a variety of formats via email; Datawatch|ES (formerly
Monarch|ES), a web-enabled business information portal that allows an
organization to quickly deliver business intelligence and decision support
derived from existing reporting systems with no new programming or report
writing; Q|Service Management ("Q|SM"), a fully internet-enabled IT support
solution that incorporates workflow and network management capabilities and
provides web access to multiple databases via a standard browser; Visual Help
Desk, a web-based help desk and call center solution operating on the IBM Lotus
Domino platform, acquired in the Auxilor, Inc. purchase; VorteXML, a data
transformation product for the emerging XML market that easily and quickly
converts structured text output from any system into valid XML for web services
and other uses using any DTD or XDR schema without programming; and Redwing, a
plug-in for Adobe Acrobat that lets users extract text and tables from Adobe PDF
documents.
CRITICAL ACCOUNTING POLICIES
In the preparation of financial statements and other financial data,
management applies certain accounting policies to transactions that, depending
on choices made by management, can result in various outcomes. In order for a
reader to understand the following information regarding the financial
performance and condition of the Company, an understanding of those accounting
policies is important. Certain of those policies are comparatively more
important to our financial results and condition than others. The policies that
we believe are most important for a reader's understanding of the financial
information provided in this report are described below.
Revenue Recognition, Allowance for Bad Debts and Returns Reserve
The Company has two software product offerings: Enterprise Software and
Desktop and Server 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 31% and 28%,
respectively, of total sales during the three months ended June 30, 2003 and
2002, and 27% and 24%, respectively, of total sales during the nine months ended
June 30, 2003 and 2002. 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. All 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
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
12
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).
The Company's software products are sold under warranty against certain
defects in material and workmanship for a period of 30 to 90 days from the date
of purchase. Certain software products, including desktop versions of Monarch,
Monarch Data Pump, VorteXML and Redwing sold directly to end-users, include a
guarantee under which such customers may return products within 30 to 60 days
for a full refund. Additionally, the Company provides its distributors with
stock-balancing rights and applies the guidance found in Statement of Financial
Accounting Standards 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 reasonable 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. During the three months ended June 30, 2003, changes to the returns
reserve were comprised of $262,000 accrued for the returns reserve and
approximately $43,000 in returns applied against the reserve. This compares to
$105,000 accrued for the returns reserve and approximately $16,000 in returns
applied against the returns reserve for the three months ended June 30, 2002.
During the nine months ended June 30, 2003, changes to the returns reserve were
comprised of $362,000 accrued for the returns reserve and approximately $288,000
in returns applied against the reserve. This compares to $205,000 accrued for
the returns reserve and approximately $138,000 in returns applied against the
returns reserve for the nine months ended June 30, 2002. At June 30, 2003,
approximately $359,000 was recorded for the returns reserve on the Company's
balance sheet, with 86% related to specific accounts, as compared to
approximately $285,000, with 70% related to specific accounts, at September 30,
2002.
The Company maintains allowances for doubtful accounts for estimated losses
resulting from the inability of customers to make required payments. The Company
analyzes accounts receivable and the composition of the accounts receivable
aging, historical bad debts, customer creditworthiness, current economic trends,
foreign currency exchange rate fluctuations, and changes in customer payment
terms when evaluating the adequacy of the allowance for doubtful accounts. Based
upon the analysis and estimates of the uncollectibility of its accounts
receivable, the Company records an increase in the allowance for doubtful
accounts when the prospect of collecting a specific account receivable becomes
doubtful. Actual results could differ from the allowances for doubtful accounts
recorded, and this difference may have a material effect on our financial
position and results of operations. The Company recorded in its statements of
operations, provisions for doubtful accounts of $6,000 and $13,000,
respectively, for the three months ended June 30, 2003 and 2002, and $16,000 and
$40,000, respectively, for the nine months ended June 30, 2003 and 2002. The
Company had write-offs against its allowances for doubtful accounts of $0 and
$1,000, respectively, during the three months ended June 30, 2003 and 2002, and
$29,000 and $111,000, respectively, for the nine months ended June 30, 2003 and
2002. The Company's balance sheets as of June 30, 2003 and September 30, 2002,
include allowances for doubtful accounts of $321,000 and $259,000, respectively.
Capitalized Software Development Costs
The Company capitalizes certain software development costs as well as
purchased software upon achieving technological feasibility of the related
products. For the three months ended June 30, 2003 and 2002, the Company
purchased and capitalized software amounting to $0 and $47,000, respectively,
and recorded no capitalized software development costs. Software development
costs incurred and software purchased prior to achieving technological
feasibility are charged to research and development expense as incurred.
Commencing upon initial product release, capitalized costs are amortized to cost
of software licenses using the straight-line method over the estimated life
(which approximates the ratio that current gross revenues for a product bear to
the total of current and anticipated future gross revenues for that product),
generally 12 to 36 months. For the three months ended June 30, 2003 and 2002,
amortization of these costs was approximately $142,000 and $90,000,
respectively. For the nine months ended June 30, 2003 and 2002, amortization of
these costs was approximately $360,000 and $295,000, respectively. The
unamortized balance of capitalized software, including approximately $77,000
relating to the acquisition of Auxilor (see Note 11 of the Consolidated
13
Condensed Financial Statements included elsewhere herein), was approximately
$780,000 at June 30, 2003. The unamortized balance of capitalized software at
September 30, 2002 was approximately $962,000.
Foreign Currency Translations
Assets and liabilities of foreign subsidiaries are translated into U.S.
dollars at rates in effect at each balance sheet date. Revenues, expenses and
cash flows are translated into U.S. dollars at average rates prevailing when
transactions occur. The related translation adjustments are reported as a
separate component of shareholders' equity under the heading "Accumulated Other
Comprehensive Income (Loss)." Accumulated other comprehensive loss reported in
the consolidated balance sheets consists only of foreign currency translation
adjustments. At June 30, 2003 and September 30, 2002, the accumulated foreign
currency translation loss totaled approximately $422,000 and $516,000,
respectively. Foreign currency translation gains arising during the three months
ended June 30, 2003 and 2002 were approximately $92,000 and $96,000,
respectively. The Company does not currently engage in foreign currency hedging
activities.
RESULTS OF OPERATIONS
Financial information for the three months and nine months ended June 30,
2002 has been reclassified to conform with the June 30, 2003 presentation and to
comply with the requirements of Emerging Issues Task Force No. 01-9, "Accounting
for Consideration Given by a Vendor to a Customer (Including a Reseller of the
Vendor's Products)," which requires that certain amounts paid by a vendor for
advertising and marketing to a customer be recorded as a reduction of revenue,
when certain conditions are met. The Company previously accounted for payments
of this type to certain distributors as marketing expenses. For the three months
and nine months ended June 30, 2002, the Company has reclassified payments
totaling $20,990 and $59,664, respectively, as a reduction of revenue.
Three Months Ended June 30, 2003 and 2002
- -----------------------------------------
Revenue from continuing operations for the three months ended June 30,
2003 was $5,101,000 which represents a decrease of $43,000, or approximately 1%,
from revenue of $5,144,000 for the three months ended June 30, 2002. For the
three months ended June 30, 2003, Monarch, Q|SM and Visual Help Desk, and
Datawatch|ES sales accounted for 60%, 28% and 12% of total revenue,
respectively, as compared to 59%, 26% and 15%, respectively, for the three
months ended June 30, 2002. Visual Help Desk revenues which are the result of
the recent Auxilor acquisition totaled approximately $115,000 for the three
months ended June 30, 2003.
Software license revenue for the three months ended June 30, 2003 was
$3,604,000 or approximately 71% of total revenue, as compared to $3,684,000 or
approximately 72% of total revenue for the three months ended June 30, 2002.
This represents a decrease of $80,000 or approximately 2% from fiscal 2002 to
fiscal 2003. For the three months ended June 30, 2003, Datawatch|ES license
revenue decreased by $152,000, Monarch license revenue (including Data Pump,
VorteXML and Redwing) increased by $56,000, and Q|SM and Visual Help Desk
license revenue increased by $16,000 (Visual Help Desk license revenue increased
by $40,000, while Q|SM license revenue decreased by $24,000) when compared to
the three months ended June 30, 2002. The Company attributes the decrease in
Datawatch|ES and Q|SM software license revenue 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.
Maintenance and services revenue for the three months ended June 30, 2003
was $1,497,000, or approximately 29% of total revenue, as compared to
$1,460,000, or approximately 28% of total revenue, for the three months ended
June 30, 2002. This represents an increase of $37,000 or approximately 3%. This
increase is primarily attributable to an increase for Q|SM and Visual Help Desk
maintenance and services revenue of $71,000 (Visual Help Desk services revenue
increased by $74,000 and Q|SM services revenue decreased by $3,000) and an
increase for Datawatch|ES maintenance and services revenue of $15,000, partially
offset by a decrease in Monarch maintenance and services revenue of
approximately $49,000. The increase in maintenance and services revenue is
primarily attributable to the increase in Visual Help Desk maintenance and
services revenue which was acquired as part of the Auxilor purchase. The
decrease in Monarch maintenance and services revenue is the result of decreased
Monarch training revenue (decrease of $57,000).
Cost of software licenses for the three months ended June 30, 2003 was
$775,000 or approximately 22% of software license revenues, as compared to
$687,000 or approximately 19% of software license revenues for the three months
ended June 30, 2002. This increase of $88,000 is primarily attributable to
increased amortization of capitalized development for Q|SM (increase of $36,000)
and increased royalty costs for Datawatch|ES and Monarch (increases of $29,000
and $26,000, respectively).
14
Cost of maintenance and services for the three months ended June 30, 2003
was $563,000 or approximately 38% of maintenance and service revenues, as
compared to $687,000 or approximately 47% of maintenance and service revenues,
for the three months ended June 30, 2002. This decrease of $124,000 is primarily
attributable to reductions in services headcount and related expenses.
Sales and marketing expenses were $1,664,000 for the three months ended
June 30, 2003, which represents a decrease of $198,000 from $1,862,000 for the
three months ended June 30, 2002. This decrease is primarily attributable to
decreases in employee salaries and related expenses and marketing expenses for
direct mail and lead generation, partially offset by an increase in trade show
expense. The decrease in employee salaries and related expenses totaled $97,000
and the decreases in direct mail expense and lead generation expense totaled
$93,000 and $81,000, respectively. The increase in trade show expense totaled
$93,000.
Engineering and product development expenses were $390,000 for the three
months ended June 30, 2003, which represents an increase of $79,000 or
approximately 26% from $311,000 for the three months ended June 30, 2002. This
increase is primarily attributable to severance charges for product development
personnel totaling approximately $68,000 and engineering and development
expenses of $14,000 related to the Visual Help Desk product acquired in the
Auxilor purchase. During the three months ended June 30, 2003, the Company did
not capitalize any purchased software or software development costs. This
compares to $47,000 capitalized in the three months ended June 30, 2002. This
decrease in capitalized costs in the third quarter of fiscal 2003, as compared
to the third quarter of fiscal 2002, is due to the completion of the development
project for a new version of Q|SM during the Company's fiscal 2003 second
quarter.
General and administrative expenses were $1,013,000 for the three months
ended June 30, 2003, which represents a decrease of $275,000 or approximately
21% from $1,288,000 for the three months ended June 30, 2002. This decrease is
primarily attributable to reductions in international general and administrative
expenses.
As a result of the foregoing, the income from continuing operations for the
three months ended June 30, 2003 was $698,000, which compares to income from
continuing operations of $295,000 for the three months ended June 30, 2002.
During the three months ended June 30, 2003 an expense of $500 was recorded for
prior year income taxes. No other provision for income taxes was recorded during
the three months ended June 30, 2003 or the three months ended June 30, 2002.
This is due to the Company's current estimate that it will not be in a
significant taxable position in any jurisdiction owing primarily to the
availability of loss carryforwards for which valuation allowances had previously
been provided. At June 30, 2003, the Company had federal tax loss carryforwards
available to offset future taxable income of approximately $5 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 June 30, 2003 was $698,000, which
compares to net income of $295,000 for the three months ended June 30, 2002.
Nine Months Ended June 30, 2003 and 2002
- ----------------------------------------
Revenue from continuing operations for the nine months ended June 30, 2003
was $13,710,000 which represents a decrease of $847,000, or approximately 6%,
from revenue of $14,557,000 for the nine months ended June 30, 2002. For the
nine months ended June 30, 2003, Monarch, Q|SM and Visual Help Desk, and
Datawatch|ES sales accounted for 58%, 30% and 12% of total revenue,
respectively, as compared to 57%, 28% and 15%, respectively, for the nine months
ended June 30, 2002. Visual Help Desk revenues which are the result of the
recent Auxilor acquisition totaled approximately $379,000 for the nine months
ended June 30, 2003.
Software license revenue for the nine months ended June 30, 2003 was
$9,524,000 or approximately 69% of total revenue, as compared to $10,347,000 or
approximately 71% of total revenue for the nine months ended June 30, 2002. This
represents a decrease of $823,000 or approximately 8% from fiscal 2002 to fiscal
2003. For the nine months ended June 30, 2003, Datawatch|ES license revenue
decreased by $663,000 and Monarch license revenue (including Data Pump, VorteXML
and Redwing) decreased by $349,000 when compared to the nine months ended June
30, 2002. These decreases were partially offset by an increase in Q|SM and
Visual Help Desk license revenue of $189,000 (Visual Help Desk license revenue
increased by $212,000 and Q|SM license revenue decreased by $23,000) when
compared to the same period of fiscal 2002. The Company attributes the decrease
in software license revenue to concerns regarding the possible effects of war
and terrorism on an uncertain worldwide economy and the resulting reduction in
15
corporate spending on software solutions and the timing of new product releases.
The Company released a new version of its Monarch product during the third
quarter of fiscal 2003.
Maintenance and services revenue for the nine months ended June 30, 2003
was $4,187,000, or approximately 31% of total revenue, as compared to
$4,210,000, or approximately 29% of total revenue, for the nine months ended
June 30, 2002. This represents a decrease of $23,000 or approximately 1%. This
decrease is primarily attributable to a net decrease for Q|SM maintenance and
services revenue of $280,000 and a net decrease in Monarch maintenance and
services revenue of $15,000. This was partially offset by Visual Help Desk and
Datawatch|ES maintenance and services revenue increases of $167,000 and
$105,000, respectively. The decrease in Q|SM maintenance and services revenue is
the result of reduced revenue from the Company's Q|SM professional services
(decrease of $484,000 for the nine months ended June 30, 2003), partially offset
by increased Q|SM maintenance revenue (increase of $204,000 for the nine months
ended June 30, 2003). The increase in Datawatch|ES maintenance and services
revenue is the result of increased revenue from Datawatch|ES maintenance
(increase of $175,000 for the nine months ended June 30, 2003) partially offset
by reduced revenue from Datawatch|ES professional services (decrease of $70,000
for the nine months ended June 30, 2003). The Company believes the lower
professional services revenues are the result of a reduced demand for such
services due to a weakened worldwide economy. The Company attributes the
increased maintenance revenues to increasing customer loyalty for its products,
resulting in a higher percentage of maintenance contract renewals.
Cost of software licenses for the nine months ended June 30, 2003 was
$1,920,000 or approximately 20% of software license revenues, as compared to
$2,131,000 or approximately 21% of software license revenues for the nine months
ended June 30, 2002. This decrease of $211,000 is primarily attributable to
decreased software license sales during the nine months ended June 30, 2003,
especially those for Datawatch|ES which has a substantially higher cost of
royalties than the Company's other products.
Cost of maintenance and services for the nine months ended June 30, 2003
was $1,794,000 or approximately 43% of maintenance and service revenues, as
compared to $2,103,000 or approximately 50% of maintenance and service revenues,
for the nine months ended June 30, 2002. This decrease of $309,000 is primarily
attributable to the reductions in services headcount and related expenses.
Sales and marketing expenses were $4,626,000 for the nine months ended June
30, 2003, which represents a decrease of $351,000 from $4,977,000 for the nine
months ended June 30, 2002. This decrease is primarily attributable to decreases
in marketing expenses for direct mail and lead generation, partially offset by
increases in sales and marketing expenses for services provided by outside
consultants and trade show expense. The decrease in direct mail expense totaled
$276,000 and the decrease in lead generation expense totaled $215,000. The
increase in expenses for services provided by outside consultants was $70,000
and the increase in trade show expenses was $36,000.
Engineering and product development expenses were $1,206,000 for the nine
months ended June 30, 2003, which represents an increase of $234,000 or
approximately 24% from $972,000 for the nine months ended June 30, 2002. This
increase is primarily attributable to engineering and development expenses of
$95,000 related to the Visual Help Desk product acquired in the Auxilor purchase
during this fiscal year and increased severance charges for product development
personnel totaling $90,000 and increased expense for development work performed
by outside consultants totaling $22,000. During the nine months ended June 30,
2003, the Company capitalized $54,000 in purchased software and software
development costs. This compares to $174,000 capitalized in the nine months
ended June 30, 2002. This decrease in capitalized costs during the nine months
ended June 30, 2003, as compared to the nine months ended June 30, 2002, is due
to reduced capitalized costs associated with a development project for a new
version of Q|SM which was completed during the Company's fiscal 2003 second
quarter.
General and administrative expenses were $3,321,000 for the nine months
ended June 30, 2003, which represents a decrease of $242,000 or approximately 7%
from $3,563,000 for the nine months ended June 30, 2002. This decrease is
attributable to reductions in international general and administrative expenses.
As a result of the foregoing, the income from continuing operations for the
nine months ended June 30, 2003 was $665,000, which compares to income from
continuing operations of $640,000 for the nine months ended June 30, 2002.
During the nine months ended June 30, 2003 an expense of $500 was recorded for
prior year income taxes. No other provision for income taxes was recorded during
the nine months ended June 30, 2003 or the nine months ended June 30, 2002. This
is due to the Company's current estimate that it will not be in a significant
taxable position in any jurisdiction owing primarily to the availability of loss
carryforwards for which valuation allowances had previously been provided. At
June 30, 2003, the Company had federal tax loss carryforwards available to
16
offset future taxable income of approximately $5 million; a full valuation
reserve has been established against these assets as uncertainty continues to
exist regarding the Company's ability to generate sufficient future taxable
income for the utilization of these losses.
In September 2001, Datawatch sold the operations of Guildsoft Limited, a
United Kingdom distribution subsidiary, to a third party. In December 2001 there
was a purchase price settlement between Datawatch and the purchaser of Guildsoft
Limited, resulting in an additional gain of $17,000 which is shown as a gain on
the sale of Guildsoft as part of discontinued operations on the accompanying
consolidated condensed statement of operations for the nine months ended June
30, 2002.
Net income for the nine months ended June 30, 2003 was $665,000, which
compares to net income of $657,000 for the nine months ended June 30, 2002.
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 $144,000 and $173,000 for the three
months ended June 30, 2003 and 2002, respectively, and approximately $467,000
and $505,000 for the nine months ended June 30, 2003 and 2002, respectively.
As of June 30, 2003, minimum rental commitments under noncancelable
operating leases are as follows:
Year Ending September 30,
2003 $ 177,398
2004 501,571
2005 391,567
2006 141,320
Thereafter 29,898
-----------
Total minimum lease payments $ 1,241,754
===========
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 $514,000 and
$457,000 for the three months ended June 30, 2003 and 2002, respectively, and
approximately $1,202,000 and $1,435,000 for the nine months ended June 30, 2003
and 2002, respectively. The Company is not obligated to pay any minimum royalty
amounts.
On October 16, 2002, the Company acquired 100% of the shares of Auxilor,
Inc. The purchase agreement includes an earn-out clause, which provides for a
cash payout equal to 10% of the sales of Auxilor products in fiscal 2003.
Accordingly, the Company expensed earn-out payments of approximately $11,000 and
$38,000, respectively, during the three months and nine months ended June 30,
2003.
LIQUIDITY AND CAPITAL RESOURCES
Working capital increased by approximately $1,010,000 during the nine
months ended June 30, 2003. During the nine months ended June 30, 2003,
approximately $981,000 of cash was provided by the Company's operations as
compared to approximately $1,912,000 of cash provided by operations for the nine
months ended June 30, 2002. During the three month periods ended September 30,
2001, June 30, 2002 and December 31, 2002, management took a series of steps to
reduce operating expenses and to restructure operations. See Note 10 to the
Consolidated Condensed Financial Statements included elsewhere herein for a
further discussion of the reductions in the workforce as well as other
restructuring actions taken to reduce operating expenses.
Net cash provided by operating activities for the nine months ended June
30, 2003 of $981,000 is primarily the result of profitable operations and an
increase in deferred revenue which is due to increased maintenance renewals and
product orders which can be invoiced but not recognized as revenue under the
Company's revenue recognition policies, partially offset by cash payments
required to reduce the assumed liabilities resulting from the purchase of
Auxilor, Inc., decreases in accounts payable and accrued expenses, and an
increase in accounts receivable. As discussed in Note 11 of the Consolidated
Condensed Financial Statements included elsewhere herein, the Company assumed
17
liabilities totaling approximately $324,000 as a result of the acquisition of
Auxilor. From the date of acquisition of Auxilor to June 30, 2003, approximately
$253,000 was used to reduce these assumed liabilities. The decrease in accounts
payable during the nine months ended June 30, 2003 was primarily the result of
reduced expense levels due to the restructuring which took place during the
quarter ended December 31, 2002. The decrease in accrued expenses which took
place during the same period was primarily the result of reductions in accrued
restructuring costs and accrued royalties due to outside developers. The
increase in accounts receivable is primarily due to the increased sales for the
quarter ended June 30, 2003 compared to the quarter ended September 30, 2002.
Net cash used in investing activities for the nine months ended June 30,
2003 of $245,000 is primarily the result of the acquisition of Auxilor, the
purchase of fixed assets (primarily computer equipment and software) and the
investment in acquired software and capitalized development, partially offset by
a decrease in other assets (primarily rent deposits).
On November 15, 2002, the Company renewed its domestic bank line-of-credit
for a period to expire on October 29, 2003. The renewed domestic line provides
for maximum borrowings of the lesser of $1,500,000 or 70% of defined eligible
receivables and is collateralized by substantially all assets of the Company.
The credit line contains customary covenants which require, among other items,
the Company maintain a minimum level of consolidated tangible net worth.
Borrowings under the credit line bore interest at the bank's prime rate plus
3/4%, or 5%, at June 30, 2003. The Company had no outstanding borrowings under
its bank line-of-credit, with approximately $1,000,000 in borrowings available
under the line, as of June 30, 2003.
Management believes that by continuing to control operating expenses and
capital expenditures and with the borrowings available under its line-of-credit,
the Company will have sufficient liquidity through at least September 30, 2004
to fund its cash requirements.
Management believes that the Company's current operations have not been
materially impacted by the effects of inflation.
RECENT ACCOUNTING PRONOUNCEMENTS
In April 2002, the Financial Standards Accounting Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 145, "Rescission of
FASB Statements SFAS Nos. 4, 44, and 64, Amendment of FASB Statement No. 13 and
Technical Corrections." SFAS No. 145 will impact how companies account for
sale-leaseback transactions and how gains or losses on debt extinguishments are
presented in financial statements. The Company adopted SFAS No. 145 on October
1, 2002. Adoption did not have a significant effect on the Company's
consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit and Disposal Activities." SFAS No. 146 will impact how
companies account for costs incurred with exit activities, such as employee
severance and facility closure costs. The Company adopted SFAS No. 146 on
October 1, 2002. Accordingly, the Company recorded $181,459 in restructuring and
centralization costs for severance benefits for 5 terminated employees and costs
resulting from the cancellation of leases and the disposal of fixed assets
related to a relocation to smaller facilities during the first quarter of fiscal
2003. (See Note 10 of the consolidated condensed financial statements elsewhere
herein.)
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure," which addresses financial accounting
and reporting for recording expenses for the fair value of stock options. SFAS
No. 148 provides alternative methods of transition for a voluntary change to a
fair value based method of accounting for stock-based employee compensation and
requires more prominent and more frequent disclosures in financial statements
about the effects of stock-based compensation. The Company adopted the
disclosure provisions for the interim periods ending March 31, 2003. The Company
will continue to account for its stock-based compensation under the intrinsic
value method prescribed under Accounting Principles Board Opinion No. 25. (See
Note 3 of the consolidated condensed financial statements elsewhere herein.)
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This statement amends and
clarifies financial reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities
under SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities." This statement is effective for contracts entered into or modified
after June 30, 2003, and for hedging relationships designated after June 30,
2003. The adoption of SFAS 149 is not expected to have a significant impact on
the Company's consolidated financial statements.
18
In May 2003, the FASB issued SFAS 150, "Accounting For Certain Financial
Instruments with Characteristics of both Liabilities and Equity," which
establishes standards for how an issuer of financial instruments classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances) if, at
inception, the monetary value of the obligation is based solely or predominantly
on a fixed monetary amount known at inception, has variations in something other
than the fair value of the issuer's equity shares or has variations inversely
related to changes in the fair value of the issuer's equity shares. SFAS No. 150
is effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. The adoption of SFAS 150 is not expected to have
a significant impact on the Company's consolidated financial statements.
In November 2002, the FASB issued Financial Interpretation No. 45 ("FIN
45"), "Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others." FIN 45 requires
certain guarantees to be recorded at fair value and requires a guarantor to make
significant new disclosures, even when the likelihood of making any payments
under the guarantee is remote. Generally, FIN 45 applies to certain types of
financial guarantees that contingently require the guarantor to make payments to
the guaranteed party based on changes in an underlying that is related to an
asset, liability, or an equity security of the guaranteed party; performance
guarantees involving contracts which require the guarantor to make payments to
the guaranteed party based on another entity's failure to perform under an
obligating agreement; indemnification agreements that contingently require the
guarantor to make payments to an indemnified party based on changes in an
underlying that is related to an asset, liability, or an equity security of the
indemnified party; or indirect guarantees of the indebtedness of others. The
disclosures required under FIN 45 follow below.
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, we would provide for the estimated cost of warranties
based on specific warranty claims and claim history. However, we have never
incurred significant expense under our product or service warranties. As a
result, we believe the estimated fair value of these warranty agreements is
minimal. Accordingly, we have no liabilities recorded for warranty claims as of
June 30, 2003.
The Company is required by the lease related to its Lowell, Massachusetts
facility to provide a Letter of Credit in the amount of $143,299 as a security
deposit to guarantee payment to the landlord of amounts due under the lease. The
amount of this Letter of Credit is recorded as part of Other Assets in the
Company's Consolidated Condensed Balance Sheets for September 30, 2002 and June
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 June 30, 2003. See the
section titled OFF BALANCE SHEET ARRANGEMENTS, CONTRACTUAL OBLIGATIONS AND
CONTINGENT LIABILITIES AND COMMITMENTS which is found elsewhere in this filing
for a full disclosure of minimum rental commitments under noncancelable
operating leases.
As a requirement of the Company's bank line-of-credit arrangement, its
United Kingdom subsidiaries, Datawatch International Limited and Datawatch
Europe Limited, have entered into unlimited guarantees that pledge their assets
as collateral against any default by the Company in the repayment of amounts
borrowed under the line-of-credit. Any amounts borrowed under the line-of-credit
are recorded as a liability by Company. No such amounts were recorded as of June
30, 2003. (See Note 9 of the consolidated condensed financial statements
elsewhere herein.)
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 $80,000, will remain in escrow until September 2004 under the
terms of the purchase and sale agreement and is recorded as part of Other Assets
in the Company's Consolidated Condensed Balance Sheets for September 30, 2002
and June 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 June 30, 2003.
19
We enter into standard indemnification agreements in our ordinary course of
business. Pursuant to these agreements, we indemnify, hold harmless, and agree
to 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 we could be
required to make under these indemnification agreements is unlimited. We have
never incurred costs to defend lawsuits or settle claims related to these
indemnification agreements. As a result, we believe the estimated fair value of
these agreements is minimal. Accordingly, we have no liabilities recorded for
these agreements as of June 30, 2003.
Certain of our agreements also provide for the performance of services at
customer sites. These agreements may contain indemnification clauses, whereby we
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 we could be
required to make under these indemnification agreements is unlimited; however,
we have general and umbrella insurance policies that would enable us to recover
a portion of any amounts paid. We have never incurred costs to defend lawsuits
or settle claims related to these indemnification agreements. As a result, we
believe the estimated fair value of these agreements is minimal. Accordingly, we
have no liabilities recorded for these agreements as of June 30, 2003.
As permitted under Delaware law, the Company has agreements with its
directors whereby we 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 we 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, we
believe the estimated fair value of these indemnification agreements is minimal.
All of these indemnification agreements were grandfathered under the provisions
of FIN No. 45 as they were in effect prior to December 31, 2002. Accordingly, we
have no liabilities recorded for these agreements as of June 30, 2003.
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. No additional disclosures are required under
FIN 46 for the quarter ended June 30, 2003.
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, 2002. The following discussion of
the Company's risk factors should be read in conjunction with the financial
statements contained herein and related notes thereto. Such factors, among
others, may have a material adverse effect upon the Company's business, results
of operations and financial condition.
20
Fluctuations in Quarterly Operating Results
The Company's future operating results could vary substantially from
quarter-to-quarter because of uncertainties and/or risks associated with such
things as technological change, competition, and delays in the introduction of
products or product enhancements and general market trends. Historically, the
Company has operated with little backlog of orders because its software products
are generally shipped as orders are received. As a result, net sales in any
quarter are substantially dependent on orders booked and shipped in that
quarter. Because the Company's staffing and operating expenses are based on
anticipated revenue levels and a high percentage of the Company's costs are
fixed in the short-term, small variations in the timing of revenues can cause
significant variations in operating results from quarter-to-quarter. Because of
these factors, the Company believes that period-to-period comparisons of its
results of operations are not necessarily meaningful and should not be relied
upon as indications of future performance. There can be no assurance that the
Company will not experience such variations in operating results in the future
or that such variations will not have a material adverse effect on the Company's
business, financial condition or results of operation.
Weakening of World Wide Economic Conditions and the Computer Software Market May
Result in Lower Revenue Growth Rates or Decreased Revenues
The revenue growth and profitability of the Company's business depends on
the overall demand for computer software and services, particularly in the
markets in which it competes. Because the Company's sales are primarily to major
corporate customers, its business also depends on general economic and business
conditions. A softening of demand for computer software and services, caused by
a weakening of the economy in the United States or abroad, may result in lower
revenue growth rates, decreased revenues or reduced profitability. In addition,
recent terrorist attacks against the United States, and the United States
military response to these attacks, 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 nine months ended June 30, 2003, Monarch, Q|SM and Visual Help Desk,
and Datawatch|ES accounted for approximately 58%, 30% and 12%, respectively, of
the Company's total revenue. The Company is wholly dependent on the Monarch,
Q|SM, Visual Help Desk and Datawatch|ES products. As a result, any factor
adversely affecting sales of any of these products could have a material adverse
effect on the Company. The Company's future financial performance will depend in
part on the successful introduction of its new and enhanced versions of these
products and development of new versions of these and other products and
subsequent acceptance of such new and enhanced products. In addition,
competitive pressures or other factors may result in significant price erosion
that could have a material adverse effect on the Company's business, financial
condition or results of operations.
International Sales
In the nine months ended June 30, 2003 and 2002, international sales,
including export sales from domestic operations, accounted for approximately 40%
and 43%, respectively, of the Company's total revenue. The Company anticipates
that international sales will continue to account for a significant percentage
of its total revenue. A significant portion of the Company's total revenue will
therefore be subject to risks associated with international sales, including
unexpected changes in legal and regulatory requirements, changes in tariffs,
exchange rates and other barriers, political and economic instability, possible
effects of war and acts of terrorism, difficulties in account receivable
collection, difficulties in managing distributors or representatives,
difficulties in staffing and managing international operations, difficulties in
protecting the Company's intellectual property overseas, seasonality of sales
and potentially adverse tax consequences.
Acquisition Strategy
As evidenced by its October 2002 acquisition of Auxilor, Inc., the Company
continues to address the need to develop new products, in part, through the
acquisition of other companies. Acquisitions involve numerous risks including
difficulties in the assimilation of the operations, technologies and products of
the acquired companies, the diversion of management's attention from other
business concerns, risks of entering markets in which the Company has no or
limited direct prior experience and where competitors in such markets have
stronger market positions, and 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.
21
Dependence on New Introductions; New Product Delays
Growth in the Company's business depends in substantial part on the
continuing introduction of new products. The length of product life cycles
depends in part on end-user demand for new or additional functionality in the
Company's products. If the Company fails to accurately anticipate the demand
for, or encounters any significant delays in developing or introducing, new
products or additional functionality on its products, there could be a material
adverse effect on the Company's business. Product life cycles can also be
affected by the introduction by suppliers of operating systems of comparable
functionality within their products. The failure of the Company to anticipate
the introduction of additional functionality in products developed by such
suppliers could have a material adverse effect on the Company's business. In
addition, the Company's competitors may introduce products with more features
and lower prices than the Company's products. Such increase in competition could
adversely affect the life cycles of the Company's products, which in turn could
have a material adverse effect on the Company's business.
Software products may contain undetected errors or failures when first
introduced or as new versions are released. There can be no assurance that,
despite testing by the Company and by current and potential end-users, errors
will not be found in new products after commencement of commercial shipments,
resulting in loss of or delay in market acceptance. Any failure by the Company
to anticipate or respond adequately to changes in technology and customer
preferences, or any significant delays in product development or introduction,
could have a material adverse effect on the Company's business.
Rapid Technological Change
The markets in which the Company competes have undergone, and can be
expected to continue to undergo, rapid and significant technological change. The
ability of the Company to grow will depend on its ability to successfully update
and improve its existing products and market and license new products to meet
the changing demands of the marketplace and that can compete successfully with
the existing and new products of the Company's competitors. There can be no
assurance that the Company will be able to successfully anticipate and satisfy
the changing demands of the personal computer software marketplace, that the
Company will be able to continue to enhance its product offerings, or that
technological changes in hardware platforms or software operating systems, or
the introduction of a new product by a competitor, will not render the Company's
products obsolete.
Competition in the PC Software Industry
The software market for personal computers is highly competitive and
characterized by continual change and improvement in technology. Several of the
Company's existing and potential competitors, including BMC Software, Actuate
Corporation, Quest Software Inc., and others, have substantially greater
financial, marketing and technological resources than the Company. No assurance
can be given that the Company will have the resources required to compete
successfully in the future.
Dependence on Proprietary Software Technology
The Company's success is dependent upon proprietary software technology.
Although the Company does not own any patents on any such technology, it does
hold exclusive licenses to such technology and relies principally on a
combination of trade secret, copyright and trademark laws, nondisclosure and
other contractual agreements and technical measures to protect its rights to
such proprietary technology. Despite such precautions, there can be no assurance
that such steps will be adequate to deter misappropriation of such technology.
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.
22
Indirect Distribution Channels
The Company sells a significant portion of its products through resellers,
none of which are under the direct control of the Company. The loss of major
resellers of the Company's products, or a significant decline in their sales,
could have a material adverse effect on the Company's operating results. There
can be no assurance that the Company will be able to attract or retain
additional qualified resellers or that any such resellers will be able to
effectively sell the Company's products. The Company seeks to select and retain
resellers on the basis of their business credentials and their ability to add
value through expertise in specific vertical markets or application programming
expertise. In addition, the Company relies on resellers to provide post-sales
service and support, and any deficiencies in such service and support could
adversely affect the Company's business.
Volatility of Stock Price
As is frequently the case with the stocks of high technology companies, the
market price of the Company's common stock has been, and may continue to be,
volatile. Factors such as quarterly fluctuations in results of operations,
increased competition, the introduction of new products by the Company or its
competitors, expenses or other difficulties associated with assimilating
companies acquired by the Company, changes in the mix of sales channels, the
timing of significant customer orders, and macroeconomic conditions generally,
may have a significant impact on the market price of the stock of the Company.
Any shortfall in revenue or earnings from the levels anticipated by securities
analysts could have an immediate and significant adverse effect on the market
price of the Company's common stock in any given period. In addition, the stock
market has from time to time experienced extreme price and volume fluctuations,
which have particularly affected the market price for many high technology
companies and which, on occasion, have appeared to be unrelated to the operating
performance of such companies.
Transfer of Common Stock Listing
On March 30, 2001 the Company announced that it had received a notice from
The Nasdaq Stock Market, Inc. that the Company's Common Stock failed to comply
with the $1.00 minimum bid price requirement for continued listing on The Nasdaq
National Market as set forth in marketplace Rule 4450(a)(5), and that the
Company's Common Stock was, therefore, subject to delisting from The Nasdaq
National Market. Management presented the Company's plan to regain compliance
with the minimum bid price requirement to the Nasdaq Listing Qualifications
Panel and, on May 30, 2001, the Listing Qualifications Panel's notified the
Company that it had determined to continue listing the Company's common stock on
the Nasdaq National Market, provided that on or before July 31, 2001, the
Company's Common Stock evidenced a closing bid price of at least $1.00 per share
and, immediately thereafter, a closing bid price of at least $1.00 for a minimum
of ten consecutive trading days and that the Company remained in compliance with
all other requirements for continued listing on The Nasdaq National Market.
Effective as of the close of business on July 23, 2001 the Company effected a
1-for-4.5 reverse stock split which resulted in compliance with the $1.00 per
share minimum bid price requirement for the Company's common stock.
In January 2002, the Company received a notice from the Nasdaq Stock
Market, Inc. that it was not in compliance with the $4 million net tangible
asset requirement for continued listing on The Nasdaq National Market and, in
response, the Company applied for listing of its Common Stock on The Nasdaq
SmallCap Market. In early February 2002, the Company was notified that its
application for listing on The Nasdaq SmallCap Market had been approved. The
listing of the Company's Common Stock was transferred to The Nasdaq SmallCap
Market at the opening of business on February 7, 2002.
There can be no assurance that the Company will remain in compliance with
the requirements for continued listing on The Nasdaq SmallCap Market. In
addition, the transfer of the Company's Common Stock listing to The Nasdaq
SmallCap Market may impair the ability of stockholders to buy and sell shares of
the Company's Common Stock and could adversely affect the market price of, and
the efficiency of the trading market for, the shares of Common Stock. Further,
the transfer of the Common Stock from The Nasdaq National Market could
significantly impair the Company's ability to raise capital in the public
markets should it desire to do so in the future.
23
Item 3. Quantitative and Qualitative Disclosures About Market Risk
- ---------------------------------------------------------------------
Derivative Financial Instruments, Other Financial Instruments, and Derivative
Commodity Instruments
At June 30, 2003, the Company did not participate in any derivative
financial instruments, or other financial and commodity instruments. The Company
holds no investment securities that possess significant market risk.
Primary Market Risk Exposures
The Company's primary market risk exposures are in the areas of interest
rate risk and foreign currency exchange rate risk. The Company may utilize U.S.
dollar denominated borrowings to fund its operational needs through its working
capital line-of-credit agreement. The line, which currently bears an interest
rate of prime plus 3/4%, or 5%, is subject to annual renewal. Had the interest
rate under the line-of-credit been 10% greater or lesser than actual rates, the
impact would not have been material in the Company's consolidated financial
statements for the three months ended June 30, 2003. As of June 30, 2003, the
Company had no outstanding borrowings under the working capital line.
The Company's exposure to currency exchange rate fluctuations has been and
is expected to continue to be modest due to the fact that the operations of its
international subsidiaries are almost exclusively conducted in their respective
local currencies, and dollar advances to the Company's international
subsidiaries, if any, are usually considered to be of a long-term investment
nature. Therefore, the majority of currency movements are reflected in the
Company's other comprehensive income. There are, however, certain situations
where the Company will invoice customers in currencies other than its own. Such
gains or losses, whether realized or unrealized, are reflected in income. These
have not been material in the past nor does management believe that they will be
material in the future. Currently the Company does not engage in foreign
currency hedging activities.
Item 4. 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.
24
PART II.
Item 2. Changes in Securities and Use of Proceeds
- ----------------------------------------------------
On October 16, 2002, the Company issued 14,764 shares of Common Stock
valued at approximately $50,000, to three individuals as part of the
consideration given for the purchase of 100% of the shares of Auxilor, Inc. No
underwriter was involved in the foregoing issuance of Common Stock. Such
issuance was made by the Company in reliance upon an exemption from the
registration provisions of the Securities Act of 1933 set forth in Section 4(2)
thereof as a transaction by an issuer not involving a public offering.
Item 6. Exhibits and Reports on Form 8-K
- -------------------------------------------
A. Exhibits
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 April 24, 2003,
furnishing a press release that announced its second quarter 2003
financial results. The Company filed a Current Report on Form 8-K on
July 24, 2003, furnishing a press release that announced its third
quarter 2003 financial results.
25
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 August 14, 2003.
DATAWATCH CORPORATION
/s/ Alan R. MacDougall
-----------------------------
Alan R. MacDougall
Vice President of Finance and
Chief Financial Officer
(Principal Financial Officer)
26