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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 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
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(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
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 978-441-2200
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [_] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Class Outstanding at February 10, 2004
----- --------------------------------
Common Stock $0.01 par value 2,618,500
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DATAWATCH CORPORATION AND SUBSIDIARIES
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TABLE OF CONTENTS
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PART I. FINANCIAL INFORMATION
- ------------------------------
Item 1. Unaudited Financial Statements Page #
a) Consolidated Condensed Balance Sheets:
December 31, 2003 and September 30, 2003 ..................... 3
b) Consolidated Condensed Statements of Operations:
Three Months Ended December 31, 2003 and 2002 ................ 4
c) Consolidated Condensed Statements of Cash Flows:
Three Months Ended December 31, 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 ...... 23
Item 4. Internal Controls and Procedures ................................ 23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ............................................... 24
Item 2. Changes in Securities and Use of Proceeds ....................... *
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 ................................ 24
SIGNATURES ............................................................... 25
* No information provided due to inapplicability of item.
2
PART I.
Item 1. Unaudited Financial Statements
- ---------------------------------------
DATAWATCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
DECEMBER 31, SEPTEMBER 30,
ASSETS 2003 2003
- ------ ------------ ------------
CURRENT ASSETS:
Cash and equivalents $ 5,793,417 $ 5,070,850
Accounts receivable, net 2,893,539 3,041,322
Inventories 86,873 105,258
Prepaid expenses 650,569 552,921
------------ ------------
Total current assets 9,424,398 8,770,351
------------ ------------
PROPERTY AND EQUIPMENT:
Property and equipment 1,683,191 1,849,333
Less accumulated depreciation and amortization (1,230,466) (1,388,427)
------------ ------------
Net property and equipment 452,725 460,906
------------ ------------
OTHER ASSETS:
Capitalized software development costs, net 556,518 696,861
Restricted cash 232,479 226,514
Trademarks 285,152 285,152
Other 40,846 64,158
------------ ------------
Total other assets 1,114,995 1,272,685
------------ ------------
TOTAL ASSETS $ 10,992,118 $ 10,503,942
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 699,728 $ 918,734
Accrued expenses 1,554,680 1,503,621
Deferred revenue 3,198,570 2,940,357
------------ ------------
Total current liabilities 5,452,978 5,362,712
------------ ------------
ACCRUED SEVERANCE, Less current portion 464 3,115
------------ ------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Common stock, par value $.01- 20,000,000 shares authorized;
issued, 2,622,834 shares and 2,622,164, respectively;
outstanding, 2,615,711 shares and 2,615,041, respectively 26,228 26,222
Additional paid-in capital 21,728,820 21,727,518
Accumulated deficit (15,748,713) (16,072,238)
Accumulated other comprehensive loss (327,271) (402,999)
------------ ------------
5,679,064 5,278,503
Less treasury stock, at cost - 7,123 shares (140,388) (140,388)
------------ ------------
Total shareholders' equity 5,538,676 5,138,115
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 10,992,118 $ 10,503,942
============ ============
See accompanying notes to consolidated condensed financial statements.
3
Item 1. Unaudited Financial Statements (continued)
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DATAWATCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED DECEMBER 31,
-----------------------------
2003 2002
------------ ------------
REVENUE:
Software licenses $ 2,950,329 $ 3,292,881
Maintenance and services 1,456,759 1,208,739
------------ ------------
Total Revenue 4,407,088 4,501,620
------------ ------------
COSTS AND EXPENSES:
Cost of software licenses 630,090 567,029
Cost of maintenance and services 611,680 614,357
Sales and marketing 1,538,951 1,524,210
Engineering and product development 279,644 341,992
General and administrative 1,035,901 1,250,510
Restructuring and centralization costs -- 181,459
------------ ------------
Total costs and expenses 4,096,266 4,479,557
------------ ------------
INCOME FROM OPERATIONS 310,822 22,063
INTEREST EXPENSE -- (1,672)
INTEREST INCOME AND OTHER 12,857 6,437
FOREIGN CURRENCY TRANSACTION
GAINS (LOSSES) 5,346 (9,793)
------------ ------------
INCOME BEFORE INCOME TAXES 329,025 17,035
PROVISION FOR INCOME TAXES 5,500 --
------------ ------------
NET INCOME $ 323,525 $ 17,035
============ ============
NET INCOME PER SHARE - Basic $ 0.12 $ 0.01
============ ============
WEIGHTED-AVERAGE NUMBER OF
SHARES OUTSTANDING - Basic 2,615,423 2,592,839
============ ============
NET INCOME PER SHARE - Diluted $ 0.11 $ 0.01
============ ============
WEIGHTED-AVERAGE NUMBER OF
SHARES OUTSTANDING - Diluted 2,855,418 2,684,044
============ ============
See accompanying notes to consolidated condensed financial statements.
4
Item 1. Unaudited Financial Statements (continued)
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DATAWATCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED DECEMBER 31,
------------------------------
2003 2002
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 323,525 $ 17,035
Adjustments to reconcile net income to cash used in
operating activities:
Depreciation and amortization 205,053 180,146
Allowances for doubtful accounts and sales returns 9,544 (27,006)
Loss on disposition of equipment -- 65,981
Changes in current assets and liabilities, net of
effects from acquisition of Auxilor:
Accounts receivable 217,761 497,294
Inventories 19,718 16,412
Prepaid expenses and other (77,018) 58,746
Accounts payable and accrued expenses (221,777) (657,821)
Deferred revenue 126,626 (347,694)
------------ ------------
Cash provided by (used in) operating activities 603,432 (196,907)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of equipment and fixtures (51,094) (31,851)
Proceeds from sale of equipment -- 4,662
Purchase of Auxilor, including direct costs of $59,855 -- (172,150)
Capitalized software development costs -- (26,930)
Other assets 25,832 477
------------ ------------
Cash used in investing activities (25,262) (225,792)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from exercise of stock options 1,308 --
Principal payments on long-term obligations (2,651) (2,399)
------------ ------------
Cash used in financing activities (1,343) (2,399)
------------ ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND EQUIVALENTS 145,740 23,107
------------ ------------
INCREASE (DECREASE) IN CASH AND EQUIVALENTS 722,567 (401,991)
CASH AND EQUIVALENTS, BEGINNING OF YEAR 5,070,850 3,605,044
------------ ------------
CASH AND EQUIVALENTS, END OF YEAR $ 5,793,417 $ 3,203,053
============ ============
SUPPLEMENTAL INFORMATION:
Interest paid $ -- $ 1,672
============ ============
NONCASH INVESTING AND FINANCING ACTIVITIES:
Issuance of common stock for acquisition of Auxilor $ -- $ 50,000
============ ============
See accompanying notes to consolidated condensed financial statements.
5
Item 1. Unaudited Financial Statements (continued)
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NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
1. Basis of Presentation: The accompanying unaudited consolidated condensed
financial statements include the accounts of Datawatch Corporation (the
"Company") and its wholly owned subsidiaries and have been prepared pursuant to
the rules and regulations of the Securities and Exchange Commission regarding
interim financial reporting. Accordingly, they do not include all of the
information and notes required by accounting principles generally accepted in
the United States of America for complete financial statements and should be
read in conjunction with the audited consolidated financial statements included
in the Company's Annual Report on Form 10-K for the year ended September 30,
2003.
In the opinion of management, the accompanying unaudited consolidated
condensed financial statements have been prepared on the same basis as the
audited consolidated financial statements, and include all adjustments necessary
for fair presentation of the results of the interim periods presented. The
operating results for the interim periods presented are not necessarily
indicative of the results expected for the full year. Certain amounts for the
periods ended December 31, 2002 have been reclassified to conform with the
December 31, 2003 presentation.
2. Revenue Recognition: The Company has two types of software product
offerings: Desktop and Server Software and Enterprise Software. The Company
sells its Desktop and Server Software products directly to end-users and through
distributors and resellers. Enterprise Software products are generally sold
directly to end-users. Sales to distributors and resellers accounted for
approximately 29% and 26%, respectively, of total sales during the three months
ended December 31, 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. Both types of the Company's
software product offerings are "off-the-shelf" as such term is defined by
Statement of Position No. 97-2 ("SOP 97-2"), "Software Revenue Recognition." Our
products are relatively straightforward and the software can be installed and
used by customers on their own with little or no customization required.
Multi-user licenses marketed by the Company are sold as a right to use the
number of licenses and license fee revenue is recognized upon delivery of all
software required to satisfy the number of licenses sold. Upon delivery, the
licensing fee is payable without further delivery obligations to the Company.
Desktop and Server Software products are generally not sold in multiple
element arrangements. Accordingly, the price paid by the customer is considered
the vendor specific objective evidence ("VSOE") of fair value for those
products.
Enterprise Software sales are generally multiple element arrangements which
include software license deliverables, professional services and post-contract
customer support. In such multiple element arrangements, the Company applies the
residual method in determining revenue to be allocated to a software license. In
applying the residual method, the Company deducts from the sale proceeds the
VSOE of fair value of the services and post-contract customer support in
determining the residual fair value of the software license. The VSOE of fair
value of the services and post-contract customer support is based on the amounts
charged for these elements when sold separately. Professional services include
implementation, integration, training and consulting services with revenue
recognized as the services are performed. These services are generally delivered
on a time and materials basis, are billed on a current basis as the work is
performed, and do not involve modification or customization of the software or
any other unusual acceptance clauses or terms. Post-contract customer support is
typically provided under a maintenance agreement which provides technical
support and rights to unspecified software maintenance updates and bug fixes on
a when-and-if available basis. Revenue from post-contract customer support
services is deferred and recognized ratably over the contract period (generally
one year).
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
6
Item 1. Unaudited Financial Statements (continued)
- ---------------------------------------------------
resellers allows for reasonable estimates of future returns. Among other things,
estimates of potential future returns are made based on the inventory levels at
the various resellers, which the Company monitors frequently. Once the estimates
of potential future returns are made, the Company determines if it has adequate
returns reserves to cover anticipated returns and the returns reserve is
adjusted as required. Adjustments are recorded as increases or decreases in
revenue in the period of adjustment. Actual returns have historically been
within the range estimated and amounts provided by management.
3. Stock Options: The following table presents selected information regarding
the Company's stock option plans as of December 31, 2003:
Shares Shares
Authorized Available for
for Grant Future Grant
------------ ------------
1996 International Employee Non-Qualified
Stock Option Plan 44,444 3,430
Datawatch Corporation 1996 Stock Plan 624,000 78,116
------------ ------------
668,444 81,546
============ ============
The following table is a summary of combined activity for all of the
Company's stock option plans for the three months ended December 31, 2003:
Options Weighted-Average
Outstanding Exercise Price
------------ ------------
Outstanding, October 1, 2003 473,731 $ 4.20
Granted 37,000 5.20
Canceled (18,943) 9.70
Exercised (670) 1.95
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Outstanding, December 31, 2003 491,118 $ 4.06
============ ============
Exercisable, December 31, 2003 266,702 $ 4.84
============ ============
The following table presents weighted-average price and life information
regarding stock options outstanding and exercisable at December 31, 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 - 2.16 144,682 8 $ 1.52 88,890 $ 1.52
2.53 - 3.60 210,507 8 3.10 80,717 2.92
5.20 - 7.17 80,363 7 5.43 41,529 5.60
7.61 - 10.97 30,856 4 9.43 30,856 9.43
11.52 - 15.19 21,154 5 13.85 21,154 13.85
19.41 889 3 19.41 889 19.41
31.78 2,667 2 31.78 2,667 31.78
--------- ---------------- -------- ------ --------
491,118 7 $ 4.06 266,702 $ 4.84
========= ================ ======== ======= ========
7
Item 1. Unaudited Financial Statements (continued)
- ---------------------------------------------------
The Company uses the intrinsic-value method of valuing its stock options
to measure compensation expense associated with grants of stock options to
employees and directors. As permitted under SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure," which amended SFAS No.
123 ("SFAS 123"), "Accounting for Stock-Based Compensation," the Company has
elected to continue to follow the intrinsic-value method in accounting for its
stock-based employee compensation arrangements as defined by Accounting
Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to
Employees," and related interpretations including Financial Accounting Standards
Board ("FASB") Interpretation No. 44, "Accounting for Certain Transactions
Involving Stock Compensation," an interpretation of APB No. 25. No stock-based
employee compensation cost is reflected in net income, as all options granted
under those plans had an exercise price equal to the market value of the
underlying common stock on the date of the grant. Had the Company recognized
compensation for its stock options and purchase plans based on the fair value
for awards under those plans, pro forma net income and pro forma net income per
share would have been as follows:
THREE MONTHS ENDED DECEMBER 31,
------------------------------
2003 2002
------------ ------------
Net income, as reported $ 323,525 $ 17,035
Add: Stock-based employee compensation
expense included in reported net income -- --
Less: Total stock-based employee
compensation expense determined under
fair value based method for all awards (53,756) (68,670)
------------ ------------
Pro forma net income (loss) $ 269,769 $ (51,635)
============ ============
Net income (loss) per share:
Basic - as reported $ 0.12 $ 0.01
Basic - pro forma $ 0.10 $ (0.02)
Diluted - as reported $ 0.11 $ 0.01
Diluted - pro forma $ 0.09 $ (0.02)
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 DECEMBER 31,
------------------------------
2003 2002
------------ ------------
Risk-free interest rate 3.2% 3.2%
Expected life of option grants (years) 4.0 4.0
Expected volatility of underlying stock 119.4% 118.7%
Expected dividend payment rate 0.0% 0.0%
Expected forfeiture rate 0.0% 0.0%
The weighted-average fair value of stock options granted was $4.06 and
$2.55 for the three months ended December 31, 2003 and 2002, respectively.
8
Item 1. Unaudited Financial Statements (continued)
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4. Concentration of Credit Risks and Major Customers: One customer, Ingram
Micro Inc., individually accounted for 17% and 15% of revenue for the three
months ended December 31, 2003 and 2002, respectively. Ingram Micro Inc.
accounted for 25% and 23%, respectively, of outstanding gross trade receivables
as of December 31, 2003 and September 30, 2003. The Company sells to Ingram
Micro Inc. under a distribution agreement which automatically renews for
successive one year terms unless terminated. Other than this customer, no other
customer constitutes a significant portion (more than 10%) of sales or accounts
receivable. The Company performs ongoing credit evaluations of its customers and
generally does not require collateral. Allowances are provided for anticipated
doubtful accounts and sales returns.
5. Inventories: Inventories consisted of the following at December 31, 2003 and
September 30, 2003:
DECEMBER 31, SEPTEMBER 30,
2003 2003
------------ ------------
Raw Materials $ 56,504 $ 77,127
Finished goods 30,369 28,131
------------ ------------
Total $ 86,873 $ 105,258
============ ============
6. Deferred Revenue: Deferred revenue consisted of the following at December
31, 2003 and September 30, 2003:
DECEMBER 31, SEPTEMBER 30,
2003 2003
------------ ------------
Maintenance $ 2,332,258 $ 2,456,296
Other 886,312 484,061
------------ ------------
Total $ 3,218,570 $ 2,940,357
============ ============
Maintenance consists of the unearned portion of post-contract customer
support services provided by the Company to customers who purchase maintenance
agreements for the Company's products. Maintenance revenues are recognized on a
straight-line basis over the term of the maintenance period, generally 12
months.
Other consists of deferred license or professional services revenue
generated from arrangements which are invoiced in accordance with the terms and
conditions of the arrangement but do not meet all the criteria of the Company's
revenue recognition policies, and are, therefore, deferred until all revenue
recognition criteria are met.
7. Comprehensive Income: The following table sets forth the reconciliation of
net income to comprehensive income:
THREE MONTHS ENDED DECEMBER 31,
------------------------------
2003 2002
------------ ------------
Net income $ 323,525 $ 17,035
Other comprehensive income, net of tax:
Foreign currency translation adjustments 75,728 23,758
------------ ------------
Comprehensive income $ 399,253 $ 40,793
============ ============
Accumulated other comprehensive loss reported in the consolidated condensed
balance sheets consists only of foreign currency translation adjustments.
9
Item 1. Unaudited Financial Statements (continued)
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8. Net Income 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 DECEMBER 31,
------------------------------
2003 2002
------------ ------------
Quantity of option shares not included 55,789 154,263
Weighted average exercise price $12.32 $8.85
9. Segment Information: The Company has determined that it has only one
reportable segment meeting the criteria established under SFAS No. 131. The
Company's chief operating decision maker, as defined, (determined to be the
Chief Executive Officer and the Board of Directors) does not manage any part of
the Company separately, and the allocation of resources and assessment of
performance is based solely on the Company's consolidated operations and
operating results.
The following table presents information about the Company's revenue by
product lines:
THREE MONTHS ENDED DECEMBER 31,
------------------------------
2003 2002
------------ ------------
Desktop (primarily Monarch) 62% 59%
Visual|QSM & Visual|HD 30% 30%
Datawatch|ES 8% 11%
------------ ------------
Total 100% 100%
============ ============
The Company's operations are conducted in the U.S. and internationally
(principally in the United Kingdom). The following tables present information
about the Company's geographic operations:
INTERNATIONAL
(PRINCIPALLY
DOMESTIC U.K.) ELIMINATIONS TOTAL
------------ ------------ ------------ ------------
Total Revenue
Three months ended December 31, 2003 $ 2,980,590 $ 1,672,829 $ (246,331) $ 4,407,088
Three months ended December 31, 2002 2,980,397 1,809,445 (288,222) 4,501,620
Long-lived Assets
At December 31, 2003 $ 1,369,968 $ 197,752 $ 1,567,720
At September 30, 2003 1,544,382 189,209 1,733,591
10
Item 1. Unaudited Financial Statements (continued)
- ---------------------------------------------------
The reconciliation of total long-lived assets to the amounts contained in
our financial statements is as follows:
DECEMBER 31, SEPTEMBER 30,
2003 2003
------------ ------------
Property and Equipment, net $ 452,725 $ 460,906
Capitalized software development costs, net 556,518 696,861
Restricted cash 232,479 226,514
Trademarks 285,152 285,152
Long-term notes receivable * -- 25,832
Deposits * 40,846 38,326
------------ ------------
Total long-lived assets $ 1,567,720 $ 1,733,591
============ ============
* Included in other assets in the accompanying consolidated condensed
financial statements
Export sales aggregated approximately $803,000 and $1,006,000,
respectively, for the three months ended December 31, 2003 and 2002.
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 September 30, 2003, the accrual related to this
restructuring totaled $16,000, of which the long-term portion was $3,000. During
the quarter ended December 31, 2003, $3,000 of these charges were paid, leaving
a balance of $13,000 at December 31, 2003 (reflecting cash payments of
approximately $373,000 since September 30, 2001), of which the long-term portion
is $0. The charges are expected to be fully paid in January 2005.
During the second quarter of fiscal 2002, there was an additional
reorganization undertaken to further improve efficiencies and reduce costs,
which resulted in an additional restructuring charge of approximately $88,000
for severance benefits and related costs for 4 terminated employees. The charges
for this restructuring were fully paid in July 2002.
During the first quarter of fiscal 2003, the Company approved and completed
a restructuring undertaken to reduce costs related to its international
operations. In accordance with SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," the Company recorded a restructuring charge
of approximately $181,000 for severance benefits for 5 terminated employees and
costs resulting from the cancellation of leases and the disposal of fixed assets
related to a relocation to smaller facilities. The charges for this
restructuring were fully paid in February 2003.
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. During
the quarter ended December 31, 2003, amortization of this acquired software
totaled approximately $15,000. The Auxilor purchase agreement also included an
earn-out clause, which provided for a cash payout equal to 10% of the sales of
Auxilor products in fiscal 2003. The earn-out was expensed as a cost of revenue
as Auxilor products and services were sold. No earn-out payments are required
for periods after September 30, 2003. The activities of Auxilor from October 1,
2002 to October 16, 2002 were not consolidated into the Company's consolidated
condensed financial statements and were not significant.
11
Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------
and Results of Operations
- -------------------------
GENERAL
Datawatch is engaged in the design, development, manufacture, marketing,
and support of business computer software primarily for the Windows-based
market. Its products address the enterprise reporting, business intelligence,
report mining, data transformation and service center software markets and are
used in more than 20,000 companies, institutions and government agencies
worldwide. The Company markets its software products by two means: (i) directly
to end-user customers through its direct sales force and (ii) through indirect
channels such as distributors, resellers and OEM partners. Revenues are
primarily derived from license fees for software products, and fees for services
relating to such products, including software maintenance and support,
consulting and training. Datawatch has significant international operations and
maintains offices in the United Kingdom, Australia, France and Germany.
Datawatch's principal products are: Monarch, a desktop report mining and
business intelligence application that allows users to transform data from
structured text files or HTML files, produced by any mainframe, midrange,
client/server or PC system, into a live database that users can sort, filter,
summarize, graph and export to other applications such as Microsoft
Corporation's Excel or Access; Monarch Data Pump, a data replication and
migration tool that offers a shortcut for populating and refreshing data marts
and data warehouses, for migrating legacy data into new applications and for
providing automated delivery of existing reports in a variety of formats,
including Excel, via email; Datawatch|ES, formerly known as Monarch|ES, a
web-enabled business information portal, providing complete report management,
business intelligence and content management, and the ability to analyze data
within reports derived from existing reporting systems with no new programming
or report writing; Datawatch|RMS, a report mining solution which adds powerful
web-based report access, transformation, analytics and forms capabilities to any
existing document/report management system; Visual|QSM, formerly known as
Q|Service Management or Q|SM, a fully internet-enabled ITIL Certified Service
Management solution that provides full Business Process Management (BPM) and
support capabilities; Visual|Help Desk ("Visual|HD"), a 100% web-based help desk
and call center solution which leverages the capabilities of the IBM Lotus
Domino platform; and VorteXML, a data transformation product for the emerging
XML market that easily and quickly converts structured text output from any
system into valid XML for web services and more using any DTD or XDR schema
without programming.
On October 16, 2002, Datawatch acquired 100% of the shares of Auxilor,
Inc., in exchange for $127,000 in cash and 14,764 shares of Datawatch common
stock valued at approximately $50,000. Auxilor was acquired to broaden and
expand the Company's product offerings in the service center software market by
the addition of the Visual|HD help desk and call center solution. Auxilor's
results were included with those of the Company from the date of acquisition.
The results of operations of Auxilor for periods prior to its acquisition by the
Company were not significant.
CRITICAL ACCOUNTING POLICIES
In the preparation of financial statements and other financial data,
management applies certain accounting policies to transactions that, depending
on choices made by management, can result in various outcomes. In order for a
reader to understand the following information regarding the financial
performance and condition of the Company, an understanding of those accounting
policies is important. Certain of those policies are comparatively more
important to our financial results and condition than others. The policies that
we believe are most important for a reader's understanding of the financial
information provided in this report are described below.
Revenue Recognition, Allowance for Bad Debts and Returns Reserve
The Company has two types of software product offerings: Desktop and Server
Software and Enterprise Software. The Company sells its Desktop and Server
Software products directly to end-users and through distributors and resellers.
Enterprise Software products are generally sold directly to end-users. Sales to
distributors and resellers accounted for approximately 29% and 26%,
respectively, of total sales during the three months ended December 31, 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. Both types of the Company's software product
offerings are "off-the-shelf" as such term is defined by Statement of Position
No. 97-2, "Software Revenue Recognition." Our products are relatively
straightforward and the software can be installed and used by customers on their
12
own with little or no customization required. Multi-user licenses marketed by
the Company are sold as a right to use the number of licenses and license fee
revenue is recognized upon delivery of all software required to satisfy the
number of licenses sold. Upon delivery, the licensing fee is payable without
further delivery obligations of the Company.
Desktop and Server Software products are generally not sold in multiple
element arrangements. Accordingly, the price paid by the customer is considered
the vendor specific objective evidence ("VSOE") of fair value for those
products.
Enterprise Software sales are generally multiple element arrangements which
include software license deliverables, professional services and post-contract
customer support. In such multiple element arrangements, the Company applies the
residual method in determining revenue to be allocated to a software license. In
applying the residual method, the Company deducts from the sale proceeds the
VSOE of fair value of the services and post-contract customer support in
determining the residual fair value of the software license. The VSOE of fair
value of the services and post-contract customer support is based on the amounts
charged for these elements when sold separately. Professional services include
implementation, integration, training and consulting services with revenue
recognized as the services are performed. These services are generally delivered
on a time and materials basis, are billed on a current basis as the work is
performed, and do not involve modification or customization of the software or
any other unusual acceptance clauses or terms. Post-contract customer support is
typically provided under a maintenance agreement which provides technical
support and rights to unspecified software maintenance updates and bug fixes on
a when-and-if available basis. Revenue from post-contract customer support
services is deferred and recognized ratably over the contract period (generally
one year). Such deferred amounts are recorded as part of deferred revenue in the
Company's Consolidated Balance Sheets included elsewhere in this filing.
The Company's software products are sold under warranty against certain
defects in material and workmanship for a period of 30 to 90 days from the date
of purchase. Certain software products, including desktop and server versions of
Monarch, Monarch Data Pump, and VorteXML, are sold directly to end-users,
include a guarantee under which such customers may return products within 30 or
60 days for a full refund. Historically, returns of products sold to end-users
with such refund rights have been minimal and no amounts have been specifically
provided for such returns. Additionally, the Company provides its distributors
with stock-balancing rights and applies the guidance found in SFAS No. 48,
"Revenue Recognition when Right of Return Exists." Revenue from the sale of
software products to distributors and resellers is recognized at the time of
shipment providing all other criteria for revenue recognition as stated above
are met and (i) the distributor or reseller is unconditionally obligated to pay
for the products, including no contingency as to product resale, (ii) the
distributor or reseller has independent economic substance apart from the
Company, (iii) the Company is not obligated for future performance to bring
about product resale, and (iv) the amount of future returns can be reasonably
estimated. The Company's experience and history with its distributors and
resellers allows for reasonable estimates of future returns. Among other things,
estimates of potential future returns are made based on the inventory levels at
the various distributors and resellers, which the Company monitors frequently.
Once the estimates of potential future returns from all sources are made, the
Company determines if it has adequate returns reserves to cover anticipated
returns and the returns reserve is adjusted as required. Adjustments are
recorded as increases or decreases in revenue in the period of adjustment.
Actual returns have historically been within the range estimated and amounts
provided by the Company.
For the three months ended December 31, 2003 and 2002, changes to the
returns reserve were approximately as follows:
THREE MONTHS ENDED DECEMBER 31,
---------------------------
2003 2002
------------ ------------
Returns Reserve Balance - Beginning of Period $ 213,000 $ 285,000
Amounts Accrued for the Returns Reserve 60,000 50,000
Returns Applied Against the Returns Reserve 65,000 101,000
------------ ------------
Returns Reserve Balance - End of Period $ 208,000 $ 234,000
============ ============
The Company maintains allowances for doubtful accounts for estimated losses
resulting from the inability of customers to make required payments. The Company
analyzes accounts receivable and the composition of the accounts receivable
aging, historical bad debts, customer creditworthiness, current economic trends,
foreign currency exchange rate fluctuations 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
13
accounts when the prospect of collecting a specific account receivable becomes
doubtful. Actual results could differ from the allowances for doubtful accounts
recorded, and this difference may have a material effect on our financial
position and results of operations.
For the three months ended December 31, 2003 and 2002, changes to the
allowance for doubtful accounts were approximately as follows:
THREE MONTHS ENDED DECEMBER 31,
-------------------------------
2003 2002
---------- ----------
Allowance for Doubtful Accounts Balance - Beginning of Period $ 230,000 $ 259,000
Additions to the Allowance of Doubtful Accounts 17,000 57,000
Amounts Applied Against the Allowance for Doubtful Accounts 1,000 1,000
---------- ----------
Allowance for Doubtful Accounts Balance - End of Period $ 246,000 $ 315,000
========== ==========
Capitalized Software Development Costs
The Company capitalizes certain software development costs as well as
purchased software upon achieving technological feasibility of the related
products. Software development costs incurred and software purchased prior to
achieving technological feasibility are charged to research and development
expense as incurred. Commencing upon initial product release, capitalized costs
are amortized to cost of software licenses using the straight-line method over
the estimated life (which approximates the ratio that current gross revenues for
a product bear to the total of current and anticipated future gross revenues for
that product), generally 12 to 36 months.
For the three months ended December 31, 2003 and 2002, amounts related to
capitalized software development costs and purchased software were approximately
as follows:
THREE MONTHS ENDED DECEMBER 31,
------------------------------
2003 2002
------------ ------------
Capitalized Software Development Costs -- $ 27,000
Capitalized Purchased Software -- $ 124,000
Amortization of Capitalized Software
Development Costs and Purchased Software $ 140,000 $ 86,000
Foreign Currency Translations
Assets and liabilities of the Company's foreign subsidiaries, which are
principally located in the UK and Australia, are translated into U.S. dollars at
rates in effect at each balance sheet date. Revenues, expenses and cash flows
are translated into U.S. dollars at average rates prevailing when transactions
occur. The related translation adjustments are reported as a separate component
of shareholders' equity under the heading "Accumulated Other Comprehensive
Loss." Accumulated other comprehensive loss reported in the consolidated balance
sheets consists only of foreign currency translation adjustments. At December
31, 2003 and September 30, 2003, the accumulated foreign currency translation
loss totaled approximately $327,000 and $403,000, respectively. Foreign currency
translation gains arising during the three months ended December 31, 2003 and
2002 were approximately $76,000 and $24,000, respectively. The Company does not
currently engage in foreign currency hedging activities.
14
Income Taxes
The Company has deferred tax assets related to net operating loss
carryforwards and tax credits, which expire at different times through and until
2020. Significant judgment is required in determining the Company's provision
for income taxes, the carrying value of deferred tax assets and liabilities and
the valuation allowance recorded against net deferred tax assets. Factors such
as future reversals of deferred tax assets and liabilities, projected future
taxable income, changes in enacted tax rates and the period over which our
deferred tax assets will be recoverable are considered in making these
determinations. The Company's domestic operations have been profitable during
the past two years while international operations have continued to generate
operating losses. Accordingly, management does not believe the deferred tax
assets are more likely than not to be realized and a full valuation allowance,
previously provided against the deferred tax assets, continues to be provided.
Management evaluates the realizability of the deferred tax assets quarterly and,
if current economic conditions change or future results of operations are better
than expected, future assessments may result in the Company concluding that it
is more likely than not that all or a portion of the deferred tax assets are
realizable. If this conclusion were reached, the valuation allowance against
deferred tax assets would be reduced resulting in a tax benefit being recorded
for financial reporting purposes.
RESULTS OF OPERATIONS
Three Months Ended December 31, 2003 and 2002
- ---------------------------------------------
Revenue for the three months ended December 31, 2003 was $4,407,000, which
represents a decrease of $95,000, or approximately 2%, from revenue of
$4,502,000 for the three months ended December 31, 2002. For the three months
ended December 31, 2003, Desktop (including Monarch, Monarch Data Pump and
VorteXML), Visual|QSM and Visual|HD, and Datawatch|ES (including Datawatch|RMS)
sales accounted for 62%, 30% and 8% of total revenue, respectively, as compared
to 59%, 30% and 11%, respectively, for the three months ended December 31, 2002.
Software license revenue for the three months ended December 31, 2003 was
$2,950,000 or approximately 67% of total revenue, as compared to $3,293,000 or
approximately 73% of total revenue for the three months ended December 31, 2002.
This represents a decrease of $343,000 or approximately 10% from fiscal 2002 to
fiscal 2003. For the three months ended December 31, 2003, Visual|QSM and
Visual|HD license revenue decreased by $259,000 (Visual|QSM license revenue
decreased by $255,000, while Visual|HD license revenue decreased by $4,000),
Datawatch|ES (including Datawatch|RMS) license revenue decreased by $159,000,
and Desktop (including Monarch, Monarch Data Pump, and VorteXML) license revenue
increased by $75,000, when compared to the three months ended December 31, 2002.
The Company attributes the decrease in Visual|QSM software license revenue to
continued reluctance of companies in the United Kingdom, where the product is
principally sold, to commit to expenditures for large ticket software solutions
in an uncertain economic climate. The decrease in Datawatch|ES software license
revenue is the result of increased deferred software license revenue for that
product when compared to the same period last year. Deferred software license
revenue is the result of contractual obligations or liabilities that delay the
recognition of revenue under the Company's revenue recognition policies. Such
deferred software license revenue can result in significant quarter-to-quarter
fluctuations in software license revenue.
Maintenance and services revenue for the three months ended December 31,
2003 was $1,457,000, or approximately 33% of total revenue, as compared to
$1,209,000, or approximately 27% of total revenue, for the three months ended
December 31, 2002. This represents an increase of $248,000 or approximately 21%.
This increase is attributable to an increase for Visual|QSM and Visual|HD
maintenance and services revenue of $211,000 (Visual|QSM services revenue
increased by $196,000 and Visual|HD services revenue increased by $15,000), an
increase in Desktop (including Monarch, Monarch Data Pump, and VorteXML)
maintenance and services revenue of approximately $20,000, and an increase for
Datawatch|ES maintenance and services revenue of $17,000. The increase in
maintenance and services revenue is primarily attributable to the increases in
Visual|QSM professional services revenue (increase of $175,000) and increased
maintenance revenue for all products (increase of $79,000). Management believes
the increases in Visual|QSM professional services revenue and maintenance
revenues are both the result of increasing customer loyalty for the Company's
products, resulting in a higher demand for professional services as users
upgrade or extend their use of the Company's products and a higher percentage of
maintenance contract renewals.
Cost of software licenses for the three months ended December 31, 2003 was
$630,000 or approximately 21% of software license revenues, as compared to
$567,000 or approximately 17% of software license revenues for the three months
ended December 31, 2002. This increase of $63,000 is primarily attributable to
15
increased amortization of capitalized software development costs and purchased
software (increase of $54,000). During the three months ended December 31, 2003,
the Company did not capitalize any purchased software or software development
costs.
Cost of maintenance and services for the three months ended December 31,
2003 was $612,000 or approximately 42% of maintenance and service revenues, as
compared to $614,000 or approximately 51% of maintenance and service revenues,
for the three months ended December 31, 2002. This decrease of $2,000 is not
significant and reflects that the Company's maintenance and services costs are
largely comprised of fixed personnel costs that may not change significantly
with short-term changes in maintenance and services revenues. Sales and
marketing expenses were $1,539,000 for the three months ended December 31, 2003,
which represents an increase of $15,000 or approximately 1% from $1,524,000 for
the three months ended December 31, 2002. This increase is not significant. The
Company expects sales and marketing expenses to increase during the remainder of
fiscal 2004, as the Company intends to hire additional sales personnel and
increase the marketing budget.
Engineering and product development expenses were $280,000 for the three
months ended December 31, 2003, which represents a decrease of $62,000 or
approximately 18% from $342,000 for the three months ended December 31, 2002.
This decrease is attributable to reduced engineering and product development
headcount and related expenses (decrease of $62,000). The Company expects that
engineering and product development expenses will increase during the remainder
of fiscal 2004, as the Company intends to add product development personnel and
increase the budget for outside development.
General and administrative expenses were $1,036,000 for the three months
ended December 31, 2003, which represents a decrease of $215,000 or
approximately 17% from $1,251,000 for the three months ended December 31, 2002.
This decrease is primarily attributable to reductions in international general
and administrative expenses (decrease of $203,000) resulting from the
restructuring which the Company completed during the first quarter of fiscal
2003. (See Note 10 to the Consolidated Condensed Financial Statements included
elsewhere in this filing for a further discussion of this restructuring.) The
Company expects a slight increase in general and administrative expenses during
the remainder of fiscal 2004.
As a result of the foregoing, income before income taxes for the three
months ended December 31, 2003 was $329,000, which compares to income before
income taxes of $17,000 for the three months ended December 31, 2002. During the
three months ended December 31, 2003 an expense of $5,500 was recorded for the
Company's estimate of the expected income tax rate for the year based on federal
alternative minimum taxes due. No other provision for income taxes was recorded
during the three months ended December 31, 2003 or the three months ended
December 31, 2002. The Company's current estimate is that it will not be in a
significant taxable position in any jurisdiction primarily as a result of the
availability of loss carryforwards for which valuation allowances had previously
been provided. At December 31, 2003, the Company had federal tax loss
carryforwards available to offset future taxable income of approximately $6
million; a full valuation reserve has been established against these assets as
uncertainty continues to exist regarding the Company's ability to generate
sufficient future taxable income for the utilization of these losses.
Net income for the three months ended December 31, 2003 was $324,000, which
compares to net income of $17,000 for the three months ended December 31, 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 $150,000 and $192,000 for the three
months ended December 31, 2003 and 2002, respectively.
16
As of December 31, 2003, minimum rental commitments under noncancelable
operating leases are as follows:
Year Ending September 30,
2004 $ 463,493
2005 419,658
2006 141,320
2007 21,105
2008 8,793
Thereafter --
-----------
Total minimum lease payments $ 1,054,369
===========
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 $393,000 and
$357,000 for the three months ended December 31, 2003 and 2002, respectively.
The Company is not obligated to pay any minimum royalty amounts.
The Company's software products are sold under warranty against certain
defects in material and workmanship for a period of 30 to 90 days from the date
of purchase. If necessary, the Company would provide for the estimated cost of
warranties based on specific warranty claims and claim history. However, the
Company has never incurred significant expense under its product or service
warranties. As a result, the Company believes the estimated fair value of these
warranty agreements is minimal. Accordingly, there are no liabilities recorded
for warranty claims as of December 31, 2003.
The Company is required by the lease related to its Lowell, Massachusetts
facility to provide a letter of credit in the amount of approximately $143,000
as a security deposit to guarantee payment to the landlord of amounts due under
the lease. Cash on deposit providing security in the amount of this letter of
credit is recorded as part of restricted cash in the Company's consolidated
balance sheets as of December 31, 2003 and September 30, 2003 found elsewhere in
this filing. No amount has ever been drawn against the letter of credit by the
landlord to guarantee payment and no such action is anticipated in the future.
As it is anticipated that this and any other lease arrangement will continue to
be paid in a timely manner, no contingent liability has been recorded by the
Company for such leases as of December 31, 2003.
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 $89,000 at December 31, 2003, will remain in escrow until
September 2004 under the terms of the purchase and sale agreement and is
recorded as part of restricted cash in the Company's consolidated balance sheets
as of December 31, 2003 and September 30, 2003 found elsewhere in this filing.
As there have been no claims to date against the warranties and the Company
believes the fair value of any such claims to be minimal and insignificant, no
contingent liability has been recorded by the Company for these warranties as of
December 31, 2003.
The Company enters into standard indemnification agreements in our ordinary
course of business. Pursuant to these agreements, the Company agrees to
indemnify, hold harmless, and reimburse the indemnified party for losses
suffered or incurred by the indemnified party, generally our customers, in
connection with any patent, copyright or other intellectual property
infringement claim by any third party with respect to our products. The term of
these indemnification agreements is generally perpetual. The maximum potential
amount of future payments the Company could be required to make under these
indemnification agreements is unlimited. The Company has never incurred costs to
defend lawsuits or settle claims related to these indemnification agreements. As
a result, the Company believes the estimated fair value of these agreements is
minimal. Accordingly, the Company has no liabilities recorded for these
agreements as of December 31, 2003.
17
Certain of our agreements also provide for the performance of services at
customer sites. These agreements may contain indemnification clauses, whereby
the Company will indemnify the customer from any and all damages, losses,
judgments, costs and expenses for acts of our employees or subcontractors
resulting in bodily injury or property damage. The maximum potential amount of
future payments the Company could be required to make under these
indemnification agreements is unlimited; however, the Company has general and
umbrella insurance policies that would enable us to recover a portion of any
amounts paid. The Company has never incurred costs to defend lawsuits or settle
claims related to these indemnification agreements. As a result, the Company
believes the estimated fair value of these agreements is minimal. Accordingly,
the Company has no liabilities recorded for these agreements as of December 31,
2003.
As permitted under Delaware law, the Company has agreements with its
directors whereby the Company will indemnify them for certain events or
occurrences while the director is, or was, serving at our request in such
capacity. The term of the director indemnification period is for the later of
ten years after the date that the director ceases to serve in such capacity or
the final termination of proceedings against the director as outlined in the
indemnification agreement. The maximum potential amount of future payments the
Company could be required to make under these indemnification agreements is
unlimited; however, our director and officer insurance policy limits our
exposure and enables us to recover a portion of any future amounts paid. As a
result of our insurance policy coverage, the Company believes the estimated fair
value of these indemnification agreements is minimal. All of these
indemnification agreements were grandfathered under the provisions of Financial
Interpretation No. 45 ("FIN 45") as they were in effect prior to December 31,
2002. Accordingly, the Company has no liabilities recorded for these agreements
as of December 31, 2003.
LIQUIDITY AND CAPITAL RESOURCES
Working capital increased by approximately $564,000 during the three months
ended December 31, 2003. During the three months ended December 31, 2003,
approximately $603,000 of cash was provided by the Company's operations as
compared to approximately $197,000 of cash used in operations for the three
months ended December 31, 2002. During the three month periods ended September
30, 2001, March 31, 2002 and December 31, 2002, management took a series of
steps to reduce operating expenses and to restructure operations. See Note 10 to
the Consolidated Condensed Financial Statements included elsewhere in this
filing for a further discussion of the reductions in the workforce as well as
other restructuring actions taken to reduce operating expenses.
Net cash provided by operating activities for the three months ended
December 31, 2003 of $603,000 is primarily the result of profitable operations,
a decrease in accounts receivable due primarily to the timing of collections 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 a decrease in
accounts payable and an increase in prepaid expenses. The decrease in accounts
payable during the three months ended December 31, 2003 was primarily the result
of continued cost controls resulting in reduced expense levels. The increase in
prepaid expenses during the same period was primarily the result of the
prepayment of insurances, software licenses, and certain expenses related to the
Company's 2004 User Conference which takes place in May 2004, partially offset
by a decrease in prepaid royalties.
Net cash used in investing activities for the three months ended December
31, 2003 of $25,000 is primarily the result of the purchase of fixed assets
(primarily computer equipment and software), partially offset by a decrease in
long term notes receivable.
On October 29, 2003, the Company's bank line of credit, which provided for
maximum borrowings of the lesser of $1,500,000 or 70% of defined eligible
receivables and was collateralized by substantially all the assets of the
Company, expired. The Company was offered the option to renew its bank line of
credit but decided, based on its positive cash flow during the past two fiscal
years and the current level of its cash holdings, that it was in the Company's
best interest to forego the expense required to continue the line of credit and,
therefore, did not renew the line of credit.
Management believes that its current cash balances and cash generated from
operations will be sufficient to meet the Company's cash needs for working
capital and anticipated capital expenditures for at least the next twelve
months. The Company's does not currently anticipate any cash requirements,
during that time, to fund significant capital expenditures or the acquisition of
complementary technology or businesses. However, if in the future, such
18
expenditures are anticipated or required, the Company may need to seek
additional financing by issuing equity or obtaining credit facilities to fund
such requirements.
Management believes that the Company's current operations have not been
materially impacted by the effects of inflation.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit and Disposal Activities." SFAS No. 146 impacts how
companies account for costs incurred with exit activities, such as employee
severance and facility closure costs. The Company adopted SFAS No. 146 on
October 1, 2002. Accordingly, the Company recorded approximately $181,000 in
restructuring and centralization costs for severance benefits for five
terminated employees and costs resulting from the cancellation of leases and the
disposal of fixed assets related to a relocation to smaller facilities during
the first quarter of fiscal 2003. (See Note 10 to the Consolidated Condensed
Financial Statements elsewhere in this filing.)
In May 2003, the FASB issued SFAS No. 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 Company adopted SFAS
No. 150 on July 1, 2003. Adoption did not have a significant impact on the
Company's consolidated financial statements.
In November 2002, the FASB issued FIN 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." FIN 45 requires certain guarantees to be recorded at
fair value and requires a guarantor to make significant new disclosures, even
when the likelihood of making any payments under the guarantee is remote.
Generally, FIN 45 applies to certain types of financial guarantees that
contingently require the guarantor to make payments to the guaranteed party
based on changes in an underlying that is related to an asset, liability, or an
equity security of the guaranteed party; performance guarantees involving
contracts which require the guarantor to make payments to the guaranteed party
based on another entity's failure to perform under an obligating agreement;
indemnification agreements that contingently require the guarantor to make
payments to an indemnified party based on changes in an underlying that is
related to an asset, liability, or an equity security of the indemnified party;
or indirect guarantees of the indebtedness of others. Adoption of FIN 45 did not
have a significant impact on the Company's financial position or results of
operations. The Company's disclosures required under FIN 45 are included in the
section titled OFF BALANCE SHEET ARRANGEMENTS, CONTRACTUAL OBLIGATIONS AND
CONTINGENT LIABILITIES AND COMMITMENTS found elsewhere in this filing.
In January 2003, the FASB issued Financial Interpretation No. 46 ("FIN
46"), "Consolidation of Variable Interest Entities," with the objective of
improving financial reporting by companies involved with variable interest
entities. The Company is not involved with any variable interest entities as
defined within this interpretation. Accordingly, no additional disclosures are
required under FIN 46 for the three months ended December 31, 2003 and 2002.
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
19
only as of the date they are made. The Company disclaims any obligation, except
as specifically required by law and the rules of the Securities and Exchange
Commission, to publicly update or revise any such statements to reflect any
change in the Company's expectations or in events, conditions or circumstances
on which any such statements may be based, or that may affect the likelihood
that actual results will differ from those set forth in the forward looking
statements. The Company's actual results of operations and financial condition
have varied in the past and may in the future vary significantly from those
stated in any forward looking statements. Factors that may cause such
differences include, without limitation, the risks, uncertainties and other
information discussed below and within this Quarterly Report on Form 10-Q, as
well as the accuracy of the Company's internal estimates of revenue and
operating expense levels. Further information on factors that could cause actual
results to differ from those anticipated is detailed in various filings made by
the Company from time to time with the Securities and Exchange Commission,
including but not limited to, those appearing under the caption "Risk Factors"
in our Annual Report on Form 10-K filed with the Securities and Exchange
Commission for the year ended September 30, 2003. The following discussion of
the Company's risk factors should be read in conjunction with the financial
statements contained herein and related notes thereto. Such factors, among
others, may have a material adverse effect upon the Company's business, results
of operations and financial condition.
Fluctuations in Quarterly Operating Results
The Company's future operating results could vary substantially from
quarter-to-quarter because of uncertainties and/or risks associated with such
things as technological change, competition, and delays in the introduction of
products or product enhancements and general market trends. Historically, the
Company has operated with little backlog of orders because its software products
are generally shipped as orders are received and revenue in any quarter is
substantially dependent on orders booked and shipped in that quarter.
Furthermore, several factors may require us, in accordance with accounting
principles generally accepted in the United States, to defer recognition of
license fee revenue for a significant period of time after entering into a
license agreement. Because the Company's staffing and operating expenses are
based on anticipated revenue levels and a high percentage of the Company's costs
are fixed in the short-term, small variations in the timing of revenues can
cause significant variations in operating results from quarter-to-quarter.
Because of these factors, the Company believes that period-to-period comparisons
of its results of operations are not necessarily meaningful and should not be
relied upon as indications of future performance. There can be no assurance that
the Company will not experience such variations in operating results in the
future or that such variations will not have a material adverse effect on the
Company's business, financial condition or results of operation.
Weakening of World Wide Economic Conditions and the Computer Software Market May
Result in Lower Revenue Growth Rates or Decreased Revenues
The revenue growth and profitability of the Company's business depends on
the overall demand for computer software and services, particularly in the
markets in which it competes. Because the Company's sales are primarily to major
corporate customers, its business also depends on general economic and business
conditions. A softening of demand for computer software and services, caused by
a weakening of the economy in the United States or abroad, may result in lower
revenue growth rates, decreased revenues or reduced profitability. In addition,
recent terrorist attacks against the United States, and the United States
military response to these attacks, as well as the worldwide reaction to SARS,
have added to economic and political uncertainty which may adversely affect
worldwide demand for computer software and services and result in significant
fluctuations in the value of foreign currencies. In a weakened economy, the
Company cannot be assured that it will be able to effectively promote future
growth in its software and services revenues or maintain profitability.
Dependence on Principal Products
In the three months ended December 31, 2003, Desktop Products (including
Monarch, Monarch Data Pump and VorteXML), Visual|SM and Visual|HD, and
Datawatch|ES (including Datawatch|RMS) accounted for approximately 62%, 30% and
8%, respectively, of the Company's total revenue. The Company is wholly
dependent on the Monarch, Monarch Data Pump, VorteXML, Visual|SM, Visual|HD,
Datawatch|ES and Datawatch|RMS products. As a result, any factor adversely
affecting sales of any of these products could have a material adverse effect on
the Company. The Company's future financial performance will depend in part on
the successful introduction of its new and enhanced versions of these products
and development of new versions of these and other products and subsequent
acceptance of such new and enhanced products. In addition, competitive pressures
or other factors may result in significant price erosion that could have a
material adverse effect on the Company's business, financial condition or
results of operations.
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International Sales
In the three months ended December 31, 2003 and 2002, international sales,
including export sales from domestic operations, accounted for approximately 40%
and 41%, 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.
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.
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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.
Dependence on the Ability to Hire and Retain Skilled Personnel
Qualified personnel are in great demand throughout the software industry.
Our success depends, in large part, upon our ability to attract, train, motivate
and retain highly skilled employees, particularly, technical personnel such and
product development and professional services personnel, sales and marketing
personnel and other senior personnel. Our failure to attract and retain the
highly trained technical personnel that are integral to our product development,
professional services and direct sales teams may limit the rate at which the
Company can generate sales and develop new products or product enhancements. A
change in key management could result in transition and attrition in the
affected department. This could have a material adverse effect on our business,
operating results and financial condition.
Indirect Distribution Channels
The Company sells a significant portion of its products through resellers,
none of which are under the direct control of the Company. The loss of major
resellers of the Company's products, or a significant decline in their sales,
could have a material adverse effect on the Company's operating results. There
can be no assurance that the Company will be able to attract or retain
additional qualified resellers or that any such resellers will be able to
effectively sell the Company's products. The Company seeks to select and retain
resellers on the basis of their business credentials and their ability to add
value through expertise in specific vertical markets or application programming
expertise. In addition, the Company relies on resellers to provide post-sales
service and support, and any deficiencies in such service and support could
adversely affect the Company's business.
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Volatility of Stock Price
As is frequently the case with the stocks of high technology companies, the
market price of the Company's common stock has been, and may continue to be,
volatile. Factors such as quarterly fluctuations in results of operations,
increased competition, the introduction of new products by the Company or its
competitors, expenses or other difficulties associated with assimilating
companies acquired by the Company, changes in the mix of sales channels, the
timing of significant customer orders, and macroeconomic conditions generally,
may have a significant impact on the market price of the stock of the Company.
Any shortfall in revenue or earnings from the levels anticipated by securities
analysts could have an immediate and significant adverse effect on the market
price of the Company's common stock in any given period. In addition, the stock
market has from time to time experienced extreme price and volume fluctuations,
which have particularly affected the market price for many high technology
companies and which, on occasion, have appeared to be unrelated to the operating
performance of such companies.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
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Derivative Financial Instruments, Other Financial Instruments, and Derivative
Commodity Instruments
At December 31, 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 exposure is in the area of foreign
currency exchange rate risk. The Company's exposure to currency exchange rate
fluctuations has been and is expected to continue to be modest due to the fact
that the 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.
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PART II.
Item 1. Legal Proceedings
- --------------------------
From time to time, the Company receives claims and may be party to actions
that arise in the normal course of business. The Company is not party to any
litigation that management believes will have a material adverse effect on the
Company's consolidated financial condition, results of operations, or cash
flows.
Item 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 November 20, 2003,
furnishing a press release that announced its fiscal 2003 financial
results. The Company filed a Current Report on Form 8-K on January 26,
2004, furnishing a press release that announced its fiscal 2004 first
quarter financial results.
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SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized on February 13, 2004.
DATAWATCH CORPORATION
/s/ Alan R. MacDougall
----------------------
Alan R. MacDougall
Sr. Vice President of Finance
and Chief Financial Officer
(Principal Financial Officer)
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