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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2004 OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
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)
TELEPHONE NUMBER: (978) 441-2200
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK $0.01 PAR VALUE
(TITLE OF CLASS)
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [_] No [X]
Aggregate market value of voting stock held by non-affiliates: $17,987,405
(based on the closing price of the registrant's Common Stock of $5.15 per share
on December 22, 2004 as reported by the NASDAQ SmallCap Market).
Number of shares of common stock outstanding at December 22, 2004: 5,303,344
DOCUMENTS INCORPORATED BY REFERENCE
Registrant intends to file a definitive Proxy Statement pursuant to Regulation
14A within 120 days of the end of the fiscal year ended September 30, 2004.
Portions of such Proxy Statement are incorporated by reference in Part III of
this report.
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PART I
ITEM 1. BUSINESS
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GENERAL
Datawatch Corporation (the "Company" or "Datawatch"), founded in 1985, is
a provider of enterprise reporting, business intelligence, report mining, data
transformation and service center software products that help organizations
increase productivity, reduce costs and gain competitive advantages. Datawatch
products are used in more than 20,000 companies, institutions and government
agencies worldwide.
On August 11, 2004, the Company acquired 100% of the outstanding shares of
Mergence Technologies Corporation ("Mergence") for an acquisition cost of
$2,598,691 comprised of $2,500,000 in cash and direct costs of $98,691. The
Mergence purchase agreement also includes a provision for quarterly cash
payments to the former Mergence shareholders equal to 10% of the revenues, as
defined, of Mergence's Researcher product for a period of six years. Payment
amounts will be expensed as a cost of revenue as the Researcher product is sold.
Coincident with the acquisition, the Company renamed the acquired subsidiary
Datawatch Technologies Corporation ("DTC") and consolidated the general and
administrative functions into its headquarters in Lowell, but retained the DTC
sales and support office in Rutherford, NJ to provide services to customers in
the metropolitan NY area. DTC also has a software development and testing
faciltity in the Philippines. The acquistion adds an ongoing revenue stream from
the existing DTC products, principally iMergence iStore, and a new DTC product
which Datawatch will market as Datawatch|Researcher.
During the first quarter of fiscal 2004, the Company introduced a
subscription sales model for the sale of its enterprise products. The Company
continues to offer its enterprise products through the sale of perpetual
licenses and introduced the subscription pricing model to allows customers to
begin using the Company's products at a lower initial cost of software
acquisition. Subscription terms typically run 90 days or 24 months and
automatically renew unless terminated with 90 days notice. During fiscal 2004,
sales under the subscription model were not significant, however, customer
interest in the model and revenues resulting from sales under the model
increased through the fiscal year.
The Company is a Delaware corporation, with executive offices located at
175 Cabot Street, Lowell, Massachusetts 01854 and the Company's telephone number
is (978) 441-2200.
PRODUCTS
MONARCH - Datawatch is best known for its popular desktop report mining and
business intelligence application called Monarch. More than 400,000 copies of
Monarch have been sold, with localized versions in English, French, German and
Spanish. Monarch transforms structured text files (reports, statements, etc.)
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
Professional Edition lets users extract and work with data in HTML files,
databases, spreadsheets and ODBC sources as well as reports.
MONARCH DATA PUMP - Monarch Data Pump ("MDP") provides powerful information
delivery and data ETL (Extract, Transform, Load) capabilities in one automated
solution, without programming. Combining Datawatch's Monarch Report Mining/Data
Mining engine with the Microsoft .NET framework, MDP delivers a highly scalable
and easily administered enterprise solution to acquire, combine, and monitor
customized data, and deliver that data in a wide variety of formats, on an
automatic, scheduled basis.
MONARCH|RMS - Monarch|RMS (Report Mining Server) is a web-based report mining
and analysis solution that integrates with any existing COLD/ERM, document or
content management archiving solution. Monarch|RMS opens up the corporate data
locked in stored, static reports, enabling dynamic business-driven analysis of
information in users' web browsers or favorite productivity tools with no
programming.
DATAWATCH|ES - Datawatch|ES is a web-enabled business information portal,
providing complete report management, business intelligence and content
management, and the ability to analyze data within reports, all using just a web
browser. Datawatch|ES allows organizations to quickly and easily deliver
business intelligence and decision support, derived from existing reporting
systems and other database sources, with no new programming or report writing.
Datawatch|ES automatically archives report data and binary documents in an
enterprise report and document warehouse and provides users a unified point of
entry to view, analyze and share information over the Internet.
2
DATAWATCH|RESEARCHER - Datawatch|Researcher, acquired as part of the Mergence
Technologies Corporation acquisition during fiscal 2004, is a .NET based content
and data aggregation solution that searches inter-related data, documents, and
communications scattered over multiple and disparate repositories, then merges
and analyzes the results into comprehensive actionable case records for easier
compliance, auditing, accounting, and billing processes. Datawatch|Researcher
increases productivity, reduces errors, enhances collaboration in conjunction
with document management systems and business-process management software and
integrates all data and related documents into an integrated online library of
meaningful and accessible information.
VISUAL|QSM - Visual|QSM is a fully internet-enabled IT support solution that can
scale from a basic help desk system to a full service center solution that
incorporates workflow and network management capabilities and provides web
access to multiple databases while enabling customers to interact via a standard
browser. Visual|QSM, a market leader in Europe, also provides advanced service
level management capabilities, integrated change management features, business
process automation tools and one of the industry's easiest to learn and use
interfaces.
VISUAL|HELP DESK - Visual|Help Desk ("Visual|HD" ), leverages the IBM Lotus
Domino platform to provide a 100% web-based help desk and call center solution.
Cost effective and easy to deploy, Visual|HD is an enterprise-wide support
solution that supports an organization's existing IT infrastructure. Visual|HD
has the additional ability to utilize XML-based Web Services as well as the
ability to integrate directly with IBM enterprise applications.
VORTEXML - VorteXML software quickly and easily converts any structured text
output generated from any system into valid XML for web services and more using
any DTD or XDR schema without programming. VorteXML dramatically speeds up and
reduces the cost of enabling current applications for web services, implementing
enterprise XML solutions, putting legacy output on the web (including bill
presentment), and more. The VorteXML solution suite is comprised of two powerful
software products that work together: VORTEXML DESIGNER, a desktop tool that
provides users a visual interface that allows users to extract, transform and
map data from existing text documents into XML without programming; and VORTEXML
SERVER, a scalable, high-volume server that automates the extraction and
conversion of text documents into XML.
The Company also receives license royalties for its IMERGENCE ISTORE product
primarily from a provider of services to the financial services industry.
iMergence iStore, which was acquired as part of the acquisition of Mergence
Technologies Corporation during 2004, is a report management solution which
manages computer-generated reports, mines the data contained in them, and allows
users to interactively merge and transform them into new reports. This product
is not being actively marketed to new customers at this time.
PRICING
The Company's desktop products are sold under single and multi-user
licenses. A single user license for Monarch Standard Edition is priced at $635.
Multi-user licenses for Monarch Standard Edition are typically priced from $300
to $535 per user, depending upon the number of users. A single user license for
Monarch Professional Edition is priced at $765. Multi-user licenses for Monarch
Professional Edition are typically priced from $415 to $665 per user, depending
upon the number of users. A single user license for Monarch Data Pump Personal
Edition is priced at $2,495 and Monarch Data Pump Server is typically priced at
$7,999 per server. A single user license for VorteXML Designer is priced at $499
and VorteXML Server is typically priced at $7,999 per server.
The Company's report enterprise and service center products are primarily
sold under server-based licenses with named-user and concurrent-user client
licenses. An entry-level Monarch|RMS system is priced at $15,000, with typical
configurations priced in the $25,000 to $40,000 range. Entry-level Datawatch|ES
and Datawatch|Researcher systems are priced at approximately $30,000 and
$40,000, respectively. Typical configurations are priced in the range of $60,000
to $450,000. An entry-level Visual|QSM system is priced at approximately
$20,000. Typical configurations sell in the range of $35,000 to $200,000. An
entry-level Visual|HD system sells for less than $10,000, with typical
configurations priced in the $10,000 to $60,000 range. Maintenance agreements,
training and implementation services are sold separately.
The Company also sells its Enterprise Software using a subscription model.
Subscription terms typically run 90 days or 24 months and automatically renew
unless terminated with 90 days notice. The subscription pricing does not include
professional services beyond the installation of the software and such
professional services are invoiced separately. Prices for Datawatch|ES and
Datawatch|Researcher subscriptions typically range from approximately $1,750 to
$7,000 per month. Visual|QSM subscriptions typically range from approximately
$1,000 to $2,500 per month, and Visual|HD subscriptions typically range from
$500 to $1,200 per month.
3
MARKETING AND DISTRIBUTION
Datawatch markets its products through a variety of channels in order to
gain broad market exposure and to satisfy the needs of its customers. Datawatch
believes that some customers prefer to purchase products through
service-oriented resellers, while others buy on the basis of price, purchase
convenience, and/or immediate delivery.
The Company is engaged in active direct sales of its products to
end-users, including repeat and add-on sales to existing customers and sales to
new customers. Datawatch utilizes direct mail, the Internet, telemarketing and
direct personal selling to generate its sales.
Datawatch uses a variety of marketing programs to create demand for its
products. These programs include advertising, cooperative advertising with
reseller partners, direct mail, exhibitor participation in industry shows,
executive participation in press briefings, Internet-based marketing and
on-going communication with the trade press.
The Company offers certain of its resellers the ability to return obsolete
versions of its products and slow-moving products for credit. Based on its
historical experience relative to products sold to these distributors, the
Company believes that its exposure to such returns is minimal. It has provided a
provision for such estimated returns in the financial statements.
Datawatch warrants the physical disk media and printed documentation for
its products to be free of defects in material and workmanship for a period of
30 to 90 days from the date of purchase depending on the product. Datawatch also
offers a 30 day or 60 day money-back guarantee on certain of its products sold
directly to end-users. Under the guarantee, customers may return purchased
products within the 30 day or 60 day period for a full refund if they are not
completely satisfied. To date, the Company has not experienced any significant
product returns under its money-back guarantee.
During fiscal 2004, 2003 and 2002, one distributor, Ingram Micro Inc.,
represented approximately 20%, 19% and 18%, respectively, of the Company's total
revenue. No other customer accounted for more than 10% of the Company's total
revenue in fiscal 2004, 2003 or 2002. Datawatch's revenues from outside of the
U.S. are primarily the result of sales through the direct sales force of its
wholly owned subsidiary, Datawatch International Limited and its subsidiaries
("Datawatch International") and through international resellers. Such
international sales, not including export sales from domestic operations,
represented approximately 39%, 38% and 41% of the Company's total revenue for
fiscal 2004, 2003 and 2002, respectively. See Note 13 to the Consolidated
Financial Statements which appear elsewhere herein.
RESEARCH AND DEVELOPMENT
The Company believes that timely development of new products and
enhancements to its existing products is essential to maintain strong positions
in its markets. Datawatch intends to continue to invest significant amounts in
research and product development to ensure that its products meet the current
and future demands of its markets as well as to take advantage of evolving
technology trends.
Datawatch's product development efforts are conducted through in-house
software development engineers and by external developers. External developers
are compensated either through royalty or commission payments based on product
sales levels achieved or under contracts based on services provided. Datawatch
has established long-term relationships with several development engineering
firms, providing flexibility, stability and reliability in its development
process.
Datawatch's product managers work closely with developers, whether
independent or in-house, to define product specifications. The initial concept
for a product originates from this cooperative effort. The developer is
generally responsible for coding the development project. Datawatch's product
managers maintain close technical control over the products, giving the Company
the freedom to designate which modifications and enhancements are most important
and when they should be implemented. The product managers and their staff work
in parallel with the developers to produce printed documentation, on-line help
files, tutorials and installation software. In some cases, Datawatch may choose
to subcontract a portion of this work on a project basis to third-party
suppliers under contracts. Datawatch personnel also perform extensive quality
assurance testing for all products and coordinate external beta test programs.
Datawatch has a contractual agreement with the independent developer of
Monarch, Monarch Data Pump and VorteXML which requires that source code be
placed into escrow. The principal developer for these products is also bound by
contractual commitments which require the developer's continuing involvement in
product maintenance and enhancement. The Company has been granted exclusive
worldwide rights to Monarch, Monarch Data Pump and VorteXML with a stated term
expiring in the year 2009. On April 29, 2004, the Company, a subsidiary of the
Company and this developer entered into
4
an Option Purchase Agreement which gives Datawatch the right to purchase, in
exchange for $8 million, the intellectual property rights of software code owned
by the developer and used in Datawatch products Monarch, Monarch Data Pump,
VorteXML, as well as certain other software components used in the Company's
products. The Option Purchase Agreement can be exercised by the Company at any
time during the 2 years following execution of the agreement. Monarch and
Monarch Data Pump are trademarks of Datawatch Corporation and VorteXML is a
registered trademark of Datawatch Corporation.
Other Datawatch products have been developed through in-house software
development or by independent software engineers hired under contract. Datawatch
maintains source code and full product control for these products, which include
- -Datawatch|ES, Visual|QSM, and Visual|HD products. Datawatch|ES, Visual|QSM, and
Visual|HD are trademarks of Datawatch Corporation. Visual Help Desk is a
registered trademark of Auxilor, Inc. ("Auxilor"), a wholly-owned subsidiary of
Datawatch Corporation.
During fiscal 2004, the Company acquired Mergence Technologies Corporation
which has a branch software development and testing office in the Philippines.
Mergence, which was renamed Datawatch Technologies Corporation coincident with
the acquisition, developed the iMergence iStore and Datawatch|Researcher
products at its facilities in the United States and the Philippines prior to the
acquisition. The Company expects to use the Philippines development branch as an
alternative development facility for its other enterprise products. iMergence is
a registered trademark of Datawatch Technologies Corporation.
BACKLOG
The Company's software products are generally shipped within three
business days of receipt of an order. Accordingly, the Company does not believe
that backlog for its products is a meaningful indicator of future business. The
Company does maintain a backlog of services related to its Datawatch|ES,
Visual|QSM, and Visual|HD business. While this services backlog will provide
future revenue to the Company, the Company believes that it is not a meaningful
indicator of future business.
COMPETITION
The software industry is highly competitive and is characterized by
rapidly changing technology and evolving industry standards. Datawatch competes
with a number of companies including BMC Software, Actuate Corporation, Mobius
Management Systems, Inc. and others that have substantially greater financial,
marketing and technological resources than the Company. Competition in the
industry is likely to intensify as current competitors expand their product
lines and as new competitors enter the market.
PRODUCT PROTECTION
Although Datawatch does not generally own patents on its software
technologies, it relies on a combination of trade secret, copyright and
trademark laws, nondisclosure and other contractual agreements, and technical
measures to protect its rights in its products. Despite these precautions,
unauthorized parties may attempt to copy aspects of Datawatch's products or to
obtain and use information that Datawatch regards as proprietary. Patent
protection is not considered crucial to Datawatch's success. Datawatch believes
that, because of the rapid pace of technological change in the software
industry, the legal protections for its products are less significant than the
knowledge, ability and experience of its employees and developers, the frequency
of product enhancements and the timeliness and quality of its support services.
Prior to its acquisition by Datawatch, Mergence started the process of obtaining
patents on certain technology used in the Datawatch|Researcher product.
Datawatch expects to continue the process of obtaining the patents on this
technology. Datawatch believes that none of its products, trademarks, patents,
and other proprietary rights infringe on the proprietary rights of third
parties, but there can be no assurance that third parties will not assert
infringement claims against it or its developers in the future.
PRODUCTION
Production of Datawatch's products involves the duplication of compact and
floppy disks, and the printing of user manuals, packaging and other related
materials. High volume compact disk duplication is performed by non-affiliated
subcontractors, while low volume compact disk duplication is performed in-house.
Floppy disk duplication is performed in-house with high-capacity disk
duplication equipment. Printing work is also performed by non-affiliated
subcontractors. To date, Datawatch has not experienced any material difficulties
or delays in production of its software and related documentation and believes
that, if necessary, alternative production sources could be secured at a
commercially reasonable cost.
5
EMPLOYEES
As of December 10, 2004, Datawatch had 112 full-time and 9 contract,
temporary or part-time employees, including 48 engaged in marketing, sales, and
customer service; 32 engaged in product consulting, training and technical
support; 16 engaged in product management, development and quality assurance; 22
providing general, administrative, accounting, and IT functions; and 3 engaged
in software production and warehousing.
ITEM 2. PROPERTIES
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The Company is currently headquartered in 20,492 square feet of leased
office space in Lowell, Massachusetts. The lease expires in January 2006. The
Company's Datawatch Technologies subsidiary is headquartered in New Jersey and
leases serviced offices on an annual basis. The Company also maintains
international sales and administrative offices in the United Kingdom and
Australia, sales offices in France and Germany, and a software development and
testing facility in the Philippines.
ITEM 3. LEGAL PROCEEDINGS
- --------------------------
In May 2004, the Company was served with a charge of discrimination filed
with the Massachusetts Commission Against Discrimination (MCAD) by a current
employee. In addition to the Company, the employee has named an executive of the
Company as well as the employee's former supervisor as defendants. The employee
alleges that her former supervisor engaged in sexually harassing conduct. The
employee accuses the executive of engaging in retaliation upon learning of the
employee's complaint. The complaint was withdrawn from the MCAD in August 2004,
with the stated intent of pursuing the claim in Superior Court in the state of
Massachusetts. To date, the Company has not been notified of any further filing.
Given the early stage and current status of the claim, the Company is unable to
predict the ultimate outcome. The Company intends to vigorously defend the
claims.
The Company is not party to any other litigation that management believes
will have a material adverse effect on the Company's consolidated financial
condition, results of operations, or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
No matters were submitted to a vote of the Registrant's security holders
during the last quarter of the fiscal year covered by this report.
EXECUTIVE OFFICERS OF THE REGISTRANT
The names, ages and titles of the executive officers of the Company as of
December 10, 2004 are as follows:
Robert W. Hagger 56 President, Chief Executive Officer and Director
John H. Kitchen, III 49 Senior Vice President of Desktop & Server Solutions
and Secretary
Alan R. MacDougall 56 Senior Vice President of Finance, Chief Financial
Officer, Treasurer and Assistant Secretary
H. Calvin G. MacKay 60 Senior Vice President for Enterprise Software
Officers are elected by, and serve at the discretion of, the Board of Directors.
ROBERT W. HAGGER, President, Chief Executive Officer and Director. Mr.
Hagger assumed the positions of President, Chief Executive Officer and Director
on July 9, 2001. Prior thereto, and since November 1, 1997, Mr. Hagger was
Senior Vice President of International Operations of the Company. Prior to that
and since March 1997, Mr. Hagger was Managing Director of the Company's
wholly-owned subsidiary Datawatch International Limited. Prior to joining
Datawatch, from 1993 to March 1997, Mr. Hagger was founder and Managing Director
of Insight Strategy Management Ltd. Prior to that he was Managing Director of
Byrne Fleming Ltd.
JOHN H. KITCHEN, III, Senior Vice President of Desktop & Server Solutions
and Secretary. Mr. Kitchen assumed the position of Senior Vice President of
Desktop & Server Solutions on July 9, 2001. Prior thereto, and since July 2000,
Mr.
6
Kitchen was the Company's Vice President of Marketing. Prior to July 2000, and
since March 1998, Mr. Kitchen was the Company's Director of Marketing. Prior to
that, Mr. Kitchen was a marketing consultant to the Company.
ALAN R. MACDOUGALL, Senior Vice President of Finance, Chief Financial
Officer, Treasurer and Assistant Secretary. Mr. MacDougall assumed the position
of Senior Vice President of Finance on October 22, 2003. Prior thereto, and
since December 16, 2000, Mr. MacDougall held the position of Vice President of
Finance. Mr. MacDougall assumed the positions of Chief Financial Officer,
Treasurer and Assistant Secretary on December 16, 2000. Prior thereto, and since
October 1997, Mr. MacDougall was the Company's Corporate Controller. Prior to
October 1997, and since June 1994, Mr. MacDougall was the Company's Director of
Operations.
H. CALVIN G. MACKAY, Senior Vice President for Enterprise Software. Mr.
MacKay assumed the position of Senior Vice President for Enterprise Software on
July 9, 2001 and was elected an executive officer of the Company on December 1,
2001. Prior thereto, and since January 2001, Mr. MacKay was a marketing and
sales consultant to the Company's wholly-owned subsidiary, Datawatch
International Limited. Prior to January 2001, and since December 1998, Mr.
MacKay acted as an advisor and consultant to several technology companies. From
June 1996 to October 1998, Mr. MacKay served as Principal of Renoir and
Rembrandt Consulting Ltd., a management consulting firm, and as the Chief
Executive Officer of the firm's South East Asia operations.
7
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
- --------------------------------------------------------------------------
MATTERS
- -------
The Registrant's common stock is listed and traded on the Nasdaq SmallCap
Market under the symbol DWCH. The range of high and low closing prices during
each fiscal quarter for the last two fiscal years is set forth below:
For the Year Ended Common Stock
September 30, 2004 High Low
-------------------------------------------------------
4th Quarter 4.690 3.010
3rd Quarter 6.875 3.910
2nd Quarter 5.905 2.815
1st Quarter 4.210 2.600
For the Year Ended Common Stock
September 30, 2003 High Low
-------------------------------------------------------
4th Quarter 4.370 1.375
3rd Quarter 1.500 1.240
2nd Quarter 1.625 1.360
1st Quarter 1.820 1.435
There are approximately 140 shareholders of record as of December 22,
2004. The Company believes that the number of beneficial holders of common stock
exceeds 2,000. The last reported sale of the Company's common stock on December
22, 2004 was at $5.15.
The Company has not paid any cash dividends and it is anticipated that
none will be declared in the foreseeable future. The Company intends to retain
future earnings, if any, to provide funds for the operation, development and
expansion of its business.
The information set forth under the caption "Equity Compensation Plans"
appearing in the Company's definitive Proxy Statement for the Annual Meeting of
Shareholders for the fiscal year ended September 30, 2004 is incorporated herein
by reference.
ITEM 6. SELECTED FINANCIAL DATA
- --------------------------------
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
of approximately $763,000 for severance benefits and related costs for 42
terminated employees. Of these charges, $377,000 was paid during fiscal 2001
with the balance of $386,000 accrued as of September 30, 2001. Additional
amounts of $12,000, $153,000 and $217,000, were paid during fiscal 2004, fiscal
2003 and fiscal 2002, respectively, leaving a balance of $4,000 accrued as of
September 30, 2004. The total balance is expected to be fully paid by January
2005. During the second quarter of fiscal 2002, the Company approved and
completed an additional restructuring 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 four
terminated employees. These charges were fully paid during fiscal 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 Statement of Financial Accounting Standards
("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 five 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. At September 30, 2004 there was
an additional accrued severance amount of approximately $1,000, which was not
related to restructuring activities.
8
The following table summarizes the restructuring activity related to the
Company's restructurings:
Fiscal 2001 Restructuring Charge $ 763,000
Cash Payments - Fiscal 2001 (377,000)
----------
Restructuring Reserve as of September 30, 2001 386,000
Fiscal 2002 Restructuring Charge 88,000
Cash Payments - Fiscal 2002 (305,000)
----------
Restructuring Reserve as of September 30, 2002 169,000
Fiscal 2003 Restructuring Charge 181,000
Cash Payments - Fiscal 2003 (334,000)
----------
Restructuring Reserve as of September 30, 2003 16,000
Cash Payments - Fiscal 2004 (12,000)
----------
Restructuring Reserve as of September 30, 2004 $ 4,000
==========
The following table sets forth selected consolidated financial data of the
Company for the periods indicated. The selected consolidated financial data for
and as of the end of the years in the five-year period ended September 30, 2004
are derived from the Consolidated Financial Statements of the Company. The
information set forth below should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Consolidated Financial Statements and notes which appears elsewhere in this
Annual Report on Form 10-K.
Statements of Operations Data
Years Ended September 30, 2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Revenue $ 19,335,146 $ 17,712,206 $ 19,440,743 $ 18,321,251 $ 22,368,637
Costs and Expenses 18,410,460 16,886,018 18,499,009 23,638,923 23,329,304
------------ ------------ ------------ ------------ ------------
Income (Loss) from Operations 924,686 826,188 941,734 (5,317,672) (960,667)
Income (Loss) from
Continuing Operations 1,084,776 846,545 846,379 (5,385,051) (1,002,097)
Discontinued Operations
Income (Loss) from Guildsoft
operations, net -- -- -- (143,856) 12,468
Gain on sale of Guildsoft -- -- 17,096 413,013 --
------------ ------------ ------------ ------------ ------------
Income from Discontinued
Operations -- -- 17,096 269,157 12,468
Net Income (Loss) $ 1,084,776 $ 846,545 $ 863,475 $ (5,115,894) $ (989,629)
============ ============ ============ ============ ============
Net Income (Loss) from Continuing Operations
per Common Share:
Basic $0.21 $0.16 $0.17 $(1.12) $(0.24)
Diluted $0.19 $0.16 $0.16 $(1.12) $(0.24)
Net Income (Loss) per Common Share:
Basic $0.21 $0.16 $0.17 $(1.07) $(0.24)
Diluted $0.19 $0.16 $0.16 $(1.07) $(0.24)
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Balance Sheet Data
September 30, 2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Total Assets $ 12,628,794 $ 10,503,942 $ 9,454,466 $ 9,423,894 $ 13,572,817
Working Capital 2,547,879 3,407,639 2,022,702 596,136 4,339,237
Long-Term Obligations 125,373 3,115 12,795 126,121 --
Shareholders' Equity 6,435,929 5,138,115 4,060,212 2,985,289 6,866,891
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
- -------------
The following discussion and analysis is qualified by reference to, and
should be read in conjunction with, the Consolidated Financial Statements of
Datawatch and its subsidiaries which appear elsewhere in this Annual Report on
Form 10-K.
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,
data replication, service management and help desk markets.
Datawatch's principal products are: Monarch, a desktop report mining and
business intelligence application that lets users extract and manipulate data
from ASCII report files or HTML files produced on any mainframe, midrange,
client/server or PC system; Monarch Data Pump, a data replication and migration
tool that offers a shortcut for populating and refreshing data marts and data
warehouses, for migrating legacy data into new applications and for providing
automated delivery of reports in a variety of formats via email; Monarch|RMS, a
web-based report mining and analysis solution that integrates with any existing
COLD/ERM, document or content management archiving solution; Datawatch|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|Researcher, a .NET based content and data
aggregation solution that searches inter-related data, documents, and
communications scattered over multiple and disparate repositories, then merges
and analyzes the results into comprehensive actionable case records; Visual|QSM,
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 or Visual|HD, a web-based help desk and
call center solution operating on 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 August 11, 2004, Datawatch acquired 100% of the shares of Mergence
Technologies Corporation in exchange for $2.5 million in cash. The purchase
agreement also included a provision for quarterly cash payments to the former
Mergence shareholders equal to 10% of revenue, as defined, of the
Datawatch|Researcher product for a period of six years. The activities of
Mergence from August 11, 2004 are consolidated into the Company's consolidated
financial statements. See Note 2 to the Consolidated Financial Statements which
appear elsewhere herein for more detailed financial information on the
acquisition of Mergence.
On October 16, 2002, Datawatch acquired 100% of the shares of Auxilor,
Inc., in exchange for $127,000 in cash and 29,528 shares of Datawatch common
stock valued at approximately $50,000. The 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 activities of Auxilor from October 1, 2002
to October 16, 2002 are not consolidated into the Company's consolidated
financial statements and are not significant. See Note 2 to the Consolidated
Financial Statements which appear elsewhere herein for more detailed financial
information on the acquisition of Auxilor.
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. The Company's accounting policies are set forth in the Notes to the
Consolidated
10
Financial Statements, which are included in Item 15. Certain of those policies
are comparatively more important to the Company's financial results and
condition than others. The policies that the Company believes are most important
for a reader's understanding of the financial information are described below.
Revenue Recognition, Allowance for Doubtful Accounts and Returns Reserve
The Company has two types of software product offerings: Enterprise
Software and Desktop and Server Software. Enterprise Software products are
generally sold directly to end-users. The Company sells its Desktop and Server
Software products directly to end-users and through distributors and resellers.
Sales to distributors and resellers accounted for approximately 29%, 29% and
27%, respectively, of total sales for the fiscal years ended September 30, 2004,
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 or 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." The Company's 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 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 herein.
The Company also sells its Enterprise Software using a subscription model.
At the time a customer enters into a binding agreement to purchase a
subscription, the customer is invoiced for an initial term of the subscription
(generally ninety days) and an account receivable and deferred revenue are
recorded. Beginning on the date the software is installed at the customer site
and available for use by the customer, the deferred revenue amount is recognized
ratably over the initial term of the agreement provided all other criteria for
revenue recognition are met. Following the initial term, the customer is
invoiced for each subsequent term (generally ninety days), once again resulting
in an account receivable and deferred revenue being recorded. The deferred
revenue is then recognized ratably over such subsequent term.
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, and VorteXML 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 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
11
adjustment. Actual returns have historically been within the range estimated by
the Company. For the fiscal years ended September 30, 2004, 2003 and 2002
changes to and ending balances of the returns reserve were approximately as
follows:
2004 2003 2002
Returns Reserve Balance - Beginning of Year $ 213,000 $ 285,000 $ 245,000
Amounts Accrued for the Returns Reserve 165,000 379,000 255,000
Returns Applied Against the Returns Reserve 192,000 451,000 215,000
---------- ---------- ----------
Returns Reserve Balance - End of Year $ 186,000 $ 213,000 $ 285,000
========== ========== ==========
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 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 the
Company's financial position and results of operations. For the fiscal years
ended September 30, 2004, 2003 and 2002, changes to and ending balances of the
allowance for doubtful accounts were approximately as follows:
2004 2003 2002
Allowance for Doubtful Accounts Balance - Beginning of Year $ 230,000 $ 260,000 $ 317,000
Additions to the Allowance of Doubtful Accounts 105,000 120,000 48,000
Amounts Applied Against the Allowance for Doubtful Accounts 105,000 150,000 105,000
---------- ---------- ----------
Allowance for Doubtful Accounts Balance - End of Year $ 230,000 $ 230,000 $ 260,000
========== ========== ==========
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 and subscriptions 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 24 to 72 months.
For the fiscal years ended September 30, 2004, 2003 and 2002 amounts related to
capitalized software development costs and purchased software were approximately
as follows:
2004 2003 2002
Capitalized Software Balance - Beginning of Year $ 697,000 $ 962,000 $1,084,000
Capitalized Software Development Costs 191,000 109,000 272,000
Capitalized Purchased Software 520,000 124,000 --
Amortization of Capitalized Software Development
Costs and Purchased Software 471,000 498,000 394,000
---------- ---------- ----------
Capitalized Software Balance - End of Year $ 937,000 $ 697,000 $ 962,000
========== ========== ==========
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 the fiscal
years ended September 30, 2004 and 2003, the accumulated foreign currency
translation loss totaled approximately $318,000 and $403,000, respectively. The
Company does not currently engage in foreign currency hedging activities.
12
Income Taxes
The Company has deferred tax assets related to net operating loss
carryforwards and tax credits that 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 the
Company's deferred tax assets will be recoverable are considered in making these
determinations. The Company's domestic operations have been profitable during
the past three years while international operations have continued to generate
operating losses. During fiscal 2004, the Company increased sales and marketing
expense by approximately 24% and introduced a subscription sales model, both of
which could have an adverse effect on profitability in the near term.
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
FISCAL YEAR ENDED SEPTEMBER 30, 2004 AS COMPARED TO
---------------------------------------------------
FISCAL YEAR ENDED SEPTEMBER 30, 2003
------------------------------------
Revenue from continuing operations for the fiscal year ended September 30,
2004 was $19,335,000, which represents an increase of $1,623,000 or
approximately 9% from revenue of $17,712,000 for the fiscal year ended September
30, 2003. For fiscal 2004 Monarch (including Monarch Data Pump and VorteXMLand
Redwing), Visual|QSM and Visual|HD, and Datawatch|ES (including Monarch|RMS and
iMergence iStore) sales accounted for 56%, 30% and 14% of total revenue,
respectively, as compared to 59%, 29% and 12%, respectively, for fiscal 2003.
Software license and subscription revenue for the fiscal year ended
September 30, 2004 was $12,442,000 or approximately 64% of total revenue, as
compared to $12,210,000 or approximately 69% of total revenue for the fiscal
year ended September 30, 2003. This represents an increase of $232,000 or
approximately 2% from fiscal 2003 to fiscal 2004. In fiscal 2004, Datawatch|ES
license and subscription revenue increased by $276,000 ($58,000 was iMergence
iStore revenue resulting from the Mergence acquisition for the period August 11,
2004 through September 30, 2004) and Monarch license revenue (including Monarch
Data Pump and VorteXML) increased by $241,000, when compared to fiscal 2003.
These increases were partially offset by a decrease in Visual|QSM and Visual|HD
license revenue of $285,000 (Visual|QSM license and subscription revenue
decreased by $276,000 and Visual|HD license and subscription revenue decreased
by $9,000). The Company attributes the increases in Datawatch|ES and Monarch
software license and subscription revenue to increased capital spending in
fiscal 2004 resulting from an improved domestic economic outlook and the
decrease in Visual|QSM and Visual|HD software license and subscription revenue
to increased competitive pressure to reduce product pricing for products in that
mature market.
Maintenance and services revenue for the fiscal year ended September 30,
2004 was $6,893,000 or approximately 36% of total revenue, as compared to
$5,502,000 or approximately 31% of total revenue for the fiscal year ended
September 30, 2003. This represents an increase of $1,391,000 or approximately
25% from fiscal 2003 to fiscal 2004. This increase is primarily attributable to
increases in Visual|QSM and Visual|HD maintenance and services revenue of
$1,012,000, Datawatch|ES (including Monarch|RMS and iMergence iStore)
maintenance and services revenue of $320,000 and Monarch maintenance and
services revenue of $58,000. The increase in Visual|QSM and Visual|HD
maintenance and services revenue is the result of increases in both professional
services (increase of $843,000) and maintenance (increase of $169,000) revenues.
The increase in Datawatch|ES maintenance and services revenue is also the result
of increases in both professional services (increase of $215,000) and
maintenance (increase of $105,000) revenues. The Company attributes the
increases in maintenance and services revenue to continued customer loyalty
resulting in increased demand for professional services due to upgrades and
expanded use of the Company's products and a high percentage of maintenance
renewals. Additionally, the Datawatch|ES revenue includes iMergence iStore
services revenue of $116,000 resulting from the Mergence acquisition
(professional services revenue of $110,000 and maintenance revenue of $6,000)
for the period from August 11, 2004 to September 30, 2004.
13
Cost of software licenses and subscriptions for the fiscal year ended
September 30, 2004 was $2,583,000 or approximately 21% of software license and
subscription revenues, as compared to $2,563,000 or approximately 21% of
software license revenues for the fiscal year ended September 30, 2003.
Cost of maintenance and services for the fiscal year ended September 30,
2004 was $2,710,000 or approximately 39% of maintenance and service revenues, as
compared to $2,369,000 or approximately 43% of maintenance and service revenues,
for the fiscal year ended September 30, 2003. While gross margins on maintenance
and services improved in fiscal 2004 when compared to fiscal 2003, overall costs
increased primarily due to the use of third-party consultants to supplement the
Company's internal consulting and training staff in revenue-generating
activities (increase of $217,000) and increased technical support staff salaries
and related expenses (increase of $133,000).
Sales and marketing expenses were $7,629,000 for the fiscal year ended
September 30, 2004, which represents an increase of $1,500,000, or approximately
24%, from $6,129,000 for the fiscal year ended September 30, 2003. This increase
is primarily attributable to increased sales staff salaries and related expenses
(increase of $1,409,000) and increased marketing expenses for lead generation
(increase of $168,000), trade show expense (increase of $49,000) and web site
development (increase of $44,000), partially offset by a decrease in advertising
expenses (decrease of $166,000).
Engineering and product development expenses were $1,452,000 for the
fiscal year ended September 30, 2004, which represents a decrease of $55,000 or
approximately 4% from $1,507,000 for the fiscal year ended September 30, 2003.
This decrease is attributable to reduced engineering and development expenses
related to the Visual|HD product (decrease of $128,000) and decreased costs for
employee severance payments (decrease of $90,000), partially offset by increased
development costs outsourced to third party developers (increase of $172,000).
During fiscal 2004, the Company capitalized $191,000 in software development
costs. This compares to $109,000 capitalized during fiscal 2003. This increase
in capitalized costs is primarily due to increased capitalized costs associated
with development projects to increase the functionality and improve the
performance of the Company's enterprise products.
General and administrative expenses were $4,037,000 for the fiscal year
ended September 30, 2004, which represents a decrease of $100,000 or
approximately 2% from $4,137,000 for the fiscal year ended September 30, 2003.
This decrease is primarily attributable to reductions in international general
and administrative expenses (decrease of $118,000).
As a result of the foregoing, income before income taxes for the year
ended September 30, 2004 was $958,000, which compares to income before taxes of
$852,000 for the year ended September 30, 2003. In 2004, the Company recorded a
benefit for income taxes of approximately $126,650 which included the
recognition of a $148,000 reduction in the valuation allowance as a result of
realizing the tax benefit of certain of the Company's deferred tax assets due to
deferred tax liabilities associated with the Mergence acquisition, partially
offset by the recording of a provision for income taxes primarily due to an
estimated federal tax liability for alternative minimum tax due. In fiscal 2003,
the Company recorded a provision for income taxes of $5,500, primarily due to an
estimated federal tax liability for alternative minimum tax due. No tax benefits
or provisions were recorded in either fiscal 2004 or fiscal 2003 in any other
jurisdiction due to the Company's current estimate that it will not be in a
significant taxable position in any other jurisdiction owing primarily to the
availability of loss carryforwards for which valuation allowances had previously
been provided. At September 30, 2004, the Company had federal tax loss
carryforwards available to offset future taxable income of approximately $5
million (plus approximately $2 million in state tax loss carryforwards and $6
million in tax loss carryforwards in foreign jurisdictions); 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 and the Company has determined that
it is not more likely than not that future taxable income will be sufficient to
realize a tax benefit from its loss carryforwards.
Net income for the year ended September 30, 2004 was $1,085,000, which
compares to net income of $847,000 for the year ended September 30, 2003.
FISCAL YEAR ENDED SEPTEMBER 30, 2003 AS COMPARED TO
---------------------------------------------------
FISCAL YEAR ENDED SEPTEMBER 30, 2002
------------------------------------
Revenue from continuing operations for the fiscal year ended September 30,
2003 was $17,712,000, which represents a decrease of $1,729,000 or approximately
9% from revenue of $19,441,000 for the fiscal year ended September 30, 2002. For
fiscal 2003 Monarch, Visual|QSM and Visual|HD, and Datawatch|ES sales accounted
for 59%, 29% and 12% of total revenue, respectively, as compared to 59%, 26% and
15%, respectively, for fiscal 2002.
14
Software license and subscription revenue for the fiscal year ended
September 30, 2003 was $12,210,000 or approximately 69% of total revenue, as
compared to $13,814,000 or approximately 71% of total revenue for the fiscal
year ended September 30, 2002. This represents a decrease of $1,604,000 or
approximately 12% from fiscal 2002 to fiscal 2003. In fiscal 2003, Datawatch|ES
license revenue decreased by $911,000 and Monarch license revenue (including
Monarch Data Pump, VorteXML and Redwing) decreased by $909,000 when compared to
fiscal 2002. These decreases were partially offset by an increase in Visual|QSM
and Visual|HD license revenue of $216,000 (Visual|HD license revenue increased
by $232,000 and Visual|QSM license revenue decreased by $16,000). The Company
attributes the decreases in software license and subscription 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 fiscal year ended September 30,
2003 was $5,502,000 or approximately 31% of total revenue, as compared to
$5,627,000 or approximately 29% of total revenue for the fiscal year ended
September 30, 2002. This represents a decrease of $125,000 or approximately 2%
from fiscal 2002 to fiscal 2003. This decrease is primarily attributable to a
net decrease for Visual|QSM maintenance and services revenue of $386,000 and a
net decrease in Monarch maintenance and services revenue of $101,000. This was
partially offset by Visual|HD and Datawatch|ES maintenance and services revenue
increases of $219,000 and $143,000, respectively. The decrease in Visual|QSM
maintenance and services revenue is the result of reduced revenue from the
Company's Visual|QSM professional services (decrease of $570,000), partially
offset by increased Visual|QSM maintenance revenue (increase of $184,000 for
fiscal 2003). The increase in Datawatch|ES maintenance and services revenue is
the result of increased revenue from Datawatch|ES maintenance (increase of
$228,000) partially offset by reduced revenue from Datawatch|ES professional
services (decrease of $85,000). 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 fiscal year ended September 30, 2003 was
$2,563,000 or approximately 21% of software license revenues, as compared to
$2,795,000 or approximately 20% of software license revenues for the fiscal year
ended September 30, 2002. This decrease of $232,000 is primarily attributable to
decreased software license sales during fiscal 2003 as compared to fiscal 2002,
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 fiscal year ended September 30,
2003 was $2,369,000 or approximately 43% of maintenance and service revenues, as
compared to $2,679,000 or approximately 48% of maintenance and service revenues,
for the fiscal year ended September 30, 2002. This decrease of $310,000 is
primarily attributable to reductions in services headcount and related expenses.
Sales and marketing expenses were $6,129,000 for the fiscal year ended
September 30, 2003, which represents a decrease of $768,000, or approximately
11%, from $6,897,000 for the fiscal year ended September 30, 2002. This decrease
is primarily attributable to decreases in marketing expenses for direct mail
(decrease of $395,000), lead generation (decrease of $250,000) and advertising
(decrease of $152,000), partially offset by an increase in show expense
(increase of $28,000).
Engineering and product development expenses were $1,507,000 for the
fiscal year ended September 30, 2003, which represents an increase of $231,000
or approximately 18% from $1,276,000 for the fiscal year ended September 30,
2002. This increase is attributable to engineering and development expenses of
$167,000 related to the Visual|HD product acquired in the Auxilor purchase
during fiscal 2003 and increased severance charges for product development
personnel totaling $90,000. During fiscal 2003, the Company capitalized $233,000
in purchased software and software development costs. This compares to $272,000
capitalized during fiscal 2002. This decrease in capitalized costs is due to
reduced capitalized costs associated with a development project for a new
version of Visual|QSM which was completed during the Company's fiscal 2003
second quarter.
General and administrative expenses were $4,137,000 for the fiscal year
ended September 30, 2003, which represents a decrease of $627,000 or
approximately 13% from $4,764,000 for the fiscal year ended September 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 year ended September 30, 2003 was $847,000, which compares to income from
continuing operations of $846,000 for the year ended September 30, 2002. The
Company recorded a provision for income taxes of $5,500 in fiscal 2003 primarily
due to an estimated federal tax liability for alternative minimum tax due, while
in fiscal 2002, no benefit or provision for income taxes was recorded. No
further tax benefits or provisions were recorded in either fiscal 2003 or fiscal
2002 due to the Company's current estimate that it will not be in a
15
significant taxable position in any jurisdiction owing primarily to the
availability of loss carryforwards for which valuation allowances had previously
been provided. At September 30, 2003, the Company had federal tax loss
carryforwards available to offset future taxable income of approximately $7
million (plus approximately $8 million in state tax loss carryforwards and $5
million in tax loss carryforwards in foreign jurisdictions); 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 Consolidated
Statement of Operations for fiscal 2002 included elsewhere herein.
Net income for the year ended September 30, 2003 was $847,000, which
compares to net income of $863,000 for the year ended September 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 $679,000, $766,000 and $810,000 for the
years ended September 30, 2004, 2003 and 2002, respectively.
As of September 30, 2004, minimum rental commitments under noncancelable
operating leases are as follows:
YEAR ENDING SEPTEMBER 30
2005 $ 575,991
2006 183,723
2007 21,105
2008 8,794
2009 --
Thereafter --
----------
Total minimum lease payments $ 789,613
==========
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 and subscriptions was
approximately $1,677,000, $1,584,000 and $1,802,000 for the years ended
September 30, 2004, 2003 and 2002, respectively. The Company is not obligated to
pay any minimum royalty amounts.
On August 11, 2004, the Company acquired 100% of the shares of Mergence
Technologies Corporation. The purchase agreement includes a provision for
quarterly cash payments to the former Mergence shareholders equal to 10% of
revenue, as defined, of the Datawatch|Researcher product until September 30,
2010. There were no sales of the Datawatch|Researcher product from the date of
acquisition to September 30, 2004. Accordingly, the Company expensed no such
amounts during fiscal 2004. See Note 2 to the Consolidated Financial Statements
which appear elsewhere herein for more detailed financial information on the
acquisition of Mergence.
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 September 30, 2004 and 2004.
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 provide credit support for payment to the landlord of amounts due
under the lease. Cash on deposit providing security in the amount of this letter
of credit is classified as part of restricted cash in the Company's consolidated
balance sheets at September 30, 2004 and 2003. No amount has ever been drawn
against the letter of credit by
16
the landlord to provide rent payments 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 September 30, 2004 and 2003. See
Note 7 to the Consolidated Financial Statements included elsewhere herein for
disclosure of minimum rental commitments under noncancelable operating leases.
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.
No warranty claims were made by the purchaser and 50% of the funds were released
to Datawatch in September 2002 and the remaining 50% in September 2004. As there
were no claims made against the warranties, no contingent liability was recorded
by the Company for these warranties at September 30, 2004 and 2003.
In the August 2004 Stock Purchase Agreement for the acquisition of
Mergence, the Company made certain warranties regarding, among other things, its
legal authority to enter into the agreement consummating the acquisition and its
ability to continue in its business. The Company further agreed to indemnify the
sellers of Mergence and hold them harmless for any damages incurred of suffered
arising out of any misrepresentation or breach of such warranties made by the
Company in the agreement. The Company believes that no such misrepresentations
or breaches of warranty exist, or are likely to exist in the future, and,
accordingly, has recorded no liabilities related to such indemnification.
The Company enters into indemnification agreements in the ordinary course
of business. Pursuant to these agreements, the Company agrees to indemnify, hold
harmless, and to reimburse the indemnified party for losses suffered or incurred
by the indemnified party, generally its customers, in connection with any
patent, copyright or other intellectual property infringement claim by any third
party with respect to the Company's products. The term of these indemnification
agreements is generally perpetual and 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
September 30, 2004 and 2003.
Certain of the Company's agreements also provide for the performance of
services at customer sites. These agreements may contain indemnification
clauses, whereby the Company will indemnify the customer from any and all
damages, losses, judgments, costs and expenses for acts of its employees or
subcontractors resulting in bodily injury or property damage. The maximum
potential amount of future payments the Company could be required to make under
these indemnification agreements is unlimited; however, the Company has general
and umbrella insurance policies that would enable it to recover a portion of any
amounts paid. The Company has never incurred costs to defend lawsuits or settle
claims related to these indemnification agreements. As a result, the Company
believes the estimated fair value of these agreements is minimal. Accordingly,
the Company has no liabilities recorded for these agreements as of September 30,
2004 and 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 the Company's request in
such capacity. The term of the director indemnification period is for the later
of ten years after the date that the director ceases to serve in such capacity
or the final termination of proceedings against the director as outlined in the
indemnification agreement. The maximum potential amount of future payments the
Company could be required to make under these indemnification agreements is
unlimited; however, the Company's director and officer insurance policy limits
the Company's exposure and enables it to recover a portion of any future amounts
paid. As a result of its insurance policy coverage, the Company believes the
estimated fair value of these indemnification agreements is minimal. The Company
has no liabilities recorded for these agreements as of September 30, 2004 and
2003.
LIQUIDITY AND CAPITAL RESOURCES
The Company had net income of $1,085,000 for the year ended September 30,
2004 as compared to net income of $847,000 and $863,000 in fiscal 2003 and 2002,
respectively. Working capital decreased by $860,000 during fiscal 2004. During
fiscal 2004, approximately $1,665,000 of cash was provided by the Company's
operations as compared to approximately $1,747,000 of cash provided by
operations during fiscal 2003. During fiscal 2001, 2002 and 2003,
17
management took a series of steps to reduce operating expenses and to
restructure operations. See Note 4 to the Consolidated 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. These restructurings significantly reduced the Company's operating
expenses allowing the Company to generate previously noted operating income for
fiscal 2004, 2003 and 2002. The Company continues to closely monitor its
operating expenses and capital expenditures, as exhibited by its slightly
decreased engineering and product development and general and administrative
expenses in fiscal 2004 as compared to fiscal 2003. In an effort to increase
revenue, the Company increased its sales and marketing expenditures by
approximately 24% in fiscal 2004 as compared to fiscal 2003. The Company expects
to continue the increases in sales and marketing expenses during fiscal 2005,
but will continue to closely monitor its operating expenses and capital
expenditures against anticipated revenue.
Net cash provided by operating activities for fiscal 2004 of $1,665,000 is
primarily the result of profitable operations and an increase in accrued
expenses and accounts payable ($597,000), offset by an increase in accounts
receivable ($347,000) and a decrease in deferred revenue ($222,000). The
increase in accrued expenses is primarily the result of increased accruals for
employee bonuses and sales commission (increase of $277,000 compared to
September 30, 2003), outside professional services (increase of $125,000
compared to September 30, 2003), employee benefits principally for accrued
vacation and sick time (increase of $86,000 compared to September 30, 2003), and
royalties due to outside developers (increase of $56,000 compared to September
30, 2003). The increase in accounts payable is primarily due to increased
expense levels in the fourth quarter of fiscal 2004 compared to the same period
of fiscal 2003. The increase in accounts receivable is primarily the result of
increased sales in the fourth quarter of fiscal 2004 compared to the same period
of fiscal 2003, while the decrease in deferred revenue is primarily the result
of decreased maintenance deferrals for the Company's international subsidiaries,
partially offset by an increase in maintenance deferrals for the Company's
domestic operations.
Net cash used in investing activities for fiscal 2004 of $2,774,000 is
primarily the result of the acquisition of Mergence Technologies (net cash used
of $2,515,000); the purchase of fixed assets, primarily computer equipment and
software ($217,000) and the investment in capitalized software development
($191,000), partially offset by a decrease in other assets ($108,000), primarily
from changes in restricted cash and rent deposits.
Net cash provided by financing activities for fiscal 2004 of $125,000 is
primarily the result of the cash received from the exercise of employee stock
options.
On October 29, 2003, the Company's bank line of credit, which provided for
maximum borrowings of the lesser of $1,500,000 or 70% of defined eligible
receivables and was collateralized by substantially all the assets of the
Company, expired. The Company was offered the option to renew its bank line of
credit but decided, based on its positive cash flow during the past two fiscal
years and the current level of its cash holdings, that it was in the Company's
best interest to forego the expense required to continue the line of credit and,
therefore, did not renew the line of credit.
During fiscal 2004, the Company introduced a subscription sales model for
the sale of its enterprise products. This new pricing model allows customers to
begin using the Company's products at a lower initial cost of software
acquisition when compared to the more traditional perpetual license sale. While
this initiative is designed to increase the number of enterprise solutions sold
and also reduce dependency on short-term sales by building a recurring revenue
stream, it introduces increased risks for the Company primarily associated with
the timing of revenue recognition and reduced cash flows. The subscription model
delays revenue recognition when compared to the typical perpetual license sale
and also, as the Company allows termination of certain subscriptions with 90
days notice, could result in decreased revenue for solutions sold under the
model if the Company experiences a high percentage of subscription cancellations
during the first two years of the subscription. Further, as amounts due from
customers are invoiced over the life of the subscription, there are delayed cash
flows from subscription sales when compared to perpetual license sales.
The Mergence purchase agreement includes a provision for quarterly cash
payments to the former Mergence shareholders equal to 10% of revenue, as
defined, of the Datawatch|Researcher product for a period of six years. As the
cash payments are based on recognized revenue and no minimum payments are
required, they are not expected to have a significant impact on the Company's
liquidity or cash flows. See the section titled OFF BALANCE SHEET ARRANGEMENTS,
CONTRACTUAL OBLIGATIONS AND CONTINGENT LIABILITIES AND COMMITMENTS included
elsewhere herein for a more complete disclosure of the Company's commitments and
contingent liabilities.
Management believes based on its current cash position and by continuing
to closely monitor operating expenses and capital expenditures, the Company will
have sufficient liquidity through at least September 30, 2005 to fund its cash
requirements.
18
Management believes that the Company's current operations have not been
materially impacted by the effects of inflation.
RECENT ACCOUNTING PRONOUCEMENTS
On December 16, 2004, the Financial Accounting Standards Board (the
"FASB") issued a revision to SFAS No. 123, "Accounting for Stock-Based
Compensation," which is titled "Share-Based Payment." This revision requires
that all share-based payments to employees, including grants of employee stock
options, be recognized in the consolidated statement of operations based on
their fair values. The revision will be effective for public companies for
fiscal periods beginning after June 15, 2005. The standard offers the Company
alternative methods of adopting the proposed final rule. The Company has not yet
determined which alternative method it will use.
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
Annual Report on Form 10-K 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 Annual
Report on Form 10-K relating to liquidity and capital resources) may constitute
forward looking statements and are made under the safe harbor provisions of The
Private Securities Litigation Reform Act of 1995. The Company cautions readers
not to place undue reliance on any such forward looking-statements, which speak
only as of the date they are made. The Company disclaims any obligation, except
as specifically required by law and the rules of the Securities and Exchange
Commission, to publicly update or revise any such statements to reflect any
change in the Company's expectations or in events, conditions or circumstances
on which any such statements may be based, or that may affect the likelihood
that actual results will differ from those set forth in the forward-looking
statements. The Company's actual results of operations and financial condition
have varied and may in the future vary significantly from those stated in any
forward looking statements. Factors that may cause such differences include,
without limitation, the risks, uncertainties and other information discussed
below and within this Annual Report on Form 10-K, as well as the accuracy of the
Company's internal estimates of revenue and operating expense levels. 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.
Subscription Sales Model Risk
During fiscal 2004, the Company introduced a subscription sales model for
the sale of its enterprise products. This new pricing model allows customers to
begin using the Company's products at a lower initial cost of software
acquisition when compared to the more traditional perpetual license sale. While
this initiative is designed to increase the number of enterprise solutions sold
and also reduce dependency on short-term sales by building a recurring revenue
stream, it introduces increased risks for the Company primarily associated with
the timing of revenue recognition and reduced cash flows. The subscription model
delays revenue recognition when compared to the typical perpetual license sale
and also, as the Company allows termination of certain subscriptions with 90
days notice, could result in decreased revenue for solutions sold under the
model if the Company experiences a high percentage of subscription cancellations
during the first two years of the subscription. Further, as amounts due from
customers are invoiced over the life of the subscription, there are delayed cash
flows from subscription sales when compared to perpetual license sales.
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. Further, the Company's introduction of the subscription sales model
could result in decreased revenues over the short term. 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.
19
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 and reduced profitability. In addition,
terrorist attacks against the United States, and the United States military
response to these attacks have added to economic and political uncertainty which
may adversely affect worldwide demand for computer software and services and
result in significant fluctuations in the value of foreign currencies. In a
weakened economy, the Company cannot be assured that it will be able to
effectively promote future growth in its software and services revenues or
maintain profitability.
Dependence on Principal Products
In fiscal 2004, Monarch, Visual|QSM and Visual|HD, and Datawatch|ES
accounted for approximately 56%, 30% and 14%, respectively, of the Company's
total revenue. The Company is wholly dependent on the Monarch, Visual|QSM,
Visual|HD, Datawatch|ES and the recently acquired Datawatch|Researcher 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, results of operations, or cash flows.
International Sales
In fiscal 2004, 2003 and 2002, international sales, including export sales
from domestic operations, accounted for approximately 41%, 39% and 42%,
respectively, of the Company's total revenue. The Company anticipates that
international sales will continue to account for a significant percentage of its
total revenue. A significant portion of the Company's total revenue will
therefore be subject to risks associated with international sales, including
unexpected changes in legal and regulatory requirements, changes in tariffs,
exchange rates and other barriers, political and economic instability, possible
effects of war and acts of terrorism, difficulties in account receivable
collection, difficulties in managing distributors or representatives,
difficulties in staffing and managing international operations, difficulties in
protecting the Company's intellectual property overseas, seasonality of sales
and potentially adverse tax consequences.
Acquisition Strategy
As evidenced by its August 2004 acquisition of Mergence Technologies
Corporation and 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
20
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, Mobius Management Systems, 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.
The Company's success depends, in large part, upon its 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. The Company's failure
to attract and retain the highly trained technical personnel that are integral
to the Company's 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 the Company's 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
21
retain additional qualified resellers or that any such resellers will be able to
effectively sell the Company's products. The Company seeks to select and retain
resellers on the basis of their business credentials and their ability to add
value through expertise in specific vertical markets or application programming
expertise. In addition, the Company relies on resellers to provide post-sales
service and support, and any deficiencies in such service and support could
adversely affect the Company's business.
Volatility of Stock Price
As is frequently the case with the stocks of high technology companies,
the market price of the Company's common stock has been, and may continue to be,
volatile. Factors such as quarterly fluctuations in results of operations,
increased competition, the introduction of new products by the Company or its
competitors, expenses or other difficulties associated with assimilating
companies acquired by the Company, changes in the mix of sales channels, the
timing of significant customer orders, and macroeconomic conditions generally,
may have a significant impact on the market price of the stock of the Company.
Any shortfall in revenue or earnings from the levels anticipated by securities
analysts could have an immediate and significant adverse effect on the market
price of the Company's common stock in any given period. In addition, the stock
market has from time to time experienced extreme price and volume fluctuations,
which have particularly affected the market price for many high technology
companies and which, on occasion, have appeared to be unrelated to the operating
performance of such companies.
ITEM 7(A). QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ----------------------------------------------------------------------
Derivative Financial Instruments, Other Financial Instruments, and Derivative
Commodity Instruments
At September 30, 2004, the Company did not participate in any derivative
financial instruments, or other financial and commodity instruments. The Company
holds no investment securities that possess significant market risk.
Primary Market Risk Exposures
The Company's primary market risk exposure is currency exchange rate risk.
International revenues and expenses are generally translated by the Company's
foreign subsidiaries in their respective countries and are denominated in local
currency. Approximately 39%, 38% and 41% of the Company's revenues for 2004,
2003 and 2002, respectively, were from foreign subsidiaries. In addition,
approximately 37%, 36% and 40% of the Company's expenses for fiscal 2004, 2003
and 2002, respectively, were from foreign subsidiaries.
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, when realized , 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.
22
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- -----------------------------------------------------
The following consolidated financial statements and the related notes
thereto of Datawatch Corporation and the Report of Independent Registered Public
Accounting Firm thereon are filed as part of this Annual Report on Form 10-K.
PAGE
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 24
CONSOLIDATED FINANCIAL STATEMENTS AS OF SEPTEMBER 30, 2004 and 2003
AND FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED SEPTEMBER 30, 2004:
Consolidated Balance Sheets 25
Consolidated Statements of Operations 26
Consolidated Statements of Shareholders' Equity 27
Consolidated Statements of Cash Flows 28
Notes to Consolidated Financial Statements 29
23
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Datawatch Corporation
Lowell, Massachusetts
We have audited the accompanying consolidated balance sheets of Datawatch
Corporation and subsidiaries as of September 30, 2004 and 2003 and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the three years in the period ended September 30, 2004. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Datawatch Corporation and
subsidiaries as of September 30, 2004 and 2003, and the results of their
operations and their cash flows for each of the three years in the period ended
September 30, 2004 in conformity with accounting principles generally accepted
in the United States of America.
/s/ Deloitte & Touche LLP
Boston, Massachusetts
December 27, 2004
24
DATAWATCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2004 AND 2003
- -----------------------------------------------------------------------------------------------
ASSETS 2004 2003
CURRENT ASSETS:
Cash and equivalents $ 4,260,632 $ 5,070,850
Accounts receivable, less allowances for doubtful accounts
and sales returns of approximately $416,000 in 2004
and $443,000 in 2003 3,672,218 3,041,322
Inventories 67,955 105,258
Prepaid expenses 614,566 552,921
------------ ------------
Total current assets 8,615,371 8,770,351
------------ ------------
PROPERTY AND EQUIPMENT:
Office furniture and equipment 1,711,772 1,685,132
Manufacturing and engineering equipment 204,799 164,201
------------ ------------
1,916,571 1,849,333
Less accumulated depreciation and amortization (1,483,004) (1,388,427)
------------ ------------
Net property and equipment 433,567 460,906
------------ ------------
OTHER ASSETS:
Goodwill 1,632,646 --
Amortizing intangible assets, net 1,305,355 696,861
Trademarks 345,152 285,152
Restricted cash 268,299 226,514
Other 28,404 64,158
------------ ------------
Total other assets 3,579,856 1,272,685
------------ ------------
TOTAL $ 12,628,794 $ 10,503,942
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,137,539 $ 918,734
Accrued expenses 2,026,830 1,503,621
Deferred revenue 2,903,123 2,940,357
------------ ------------
Total current liabilities 6,067,492 5,362,712
------------ ------------
ESCROW FOR MERGENCE SHAREHOLDERS 125,373 --
ACCRUED SEVERANCE, less current portion -- 3,115
------------ ------------
COMMITMENTS AND CONTINGENCIES (Notes 1, 2, 7 and 8)
SHAREHOLDERS' EQUITY:
Preferred stock, par value $.01- authorized,
1,000,000 shares; none issued -- --
Common stock, par value $.01- authorized,
20,000,000 shares; issued, 5,315,108 shares and
5,244,328 shares in 2004 and 2003, respectively;
outstanding, 5,300,862 shares and 5,230,082
shares in 2004 and 2003, respectively 53,151 52,443
Additional paid-in capital 21,828,621 21,701,297
Accumulated deficit (14,987,462) (16,072,238)
Accumulated other comprehensive loss (317,993) (402,999)
------------ ------------
6,576,317 5,278,503
Less treasury stock, at cost - 14,246 shares (140,388) (140,388)
------------ ------------
Total shareholders' equity 6,435,929 5,138,115
------------ ------------
TOTAL $ 12,628,794 $ 10,503,942
============ ============
See notes to consolidated financial statements.
25
DATAWATCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------------------------
2004 2003 2002
REVENUE:
Software licenses and subscriptions $ 12,441,667 $ 12,209,857 $ 13,814,192
Maintenance and services 6,893,479 5,502,349 5,626,551
------------ ------------ ------------
Total Revenue 19,335,146 17,712,206 19,440,743
------------ ------------ ------------
COSTS AND EXPENSES:
Cost of software licenses and subscriptions 2,582,627 2,563,400 2,795,110
Cost of maintenance and services 2,710,562 2,368,556 2,679,379
Sales and marketing 7,629,058 6,128,640 6,897,176
Engineering and product development 1,451,533 1,507,223 1,275,997
General and administrative 4,036,680 4,136,740 4,763,696
Restructuring and centralization costs -- 181,459 87,651
------------ ------------ ------------
Total costs and expenses 18,410,460 16,886,018 18,499,009
------------ ------------ ------------
INCOME FROM OPERATIONS 924,686 826,188 941,734
INTEREST EXPENSE (622) (7,243) (120,953)
INTEREST INCOME 61,062 40,568 22,761
FOREIGN CURRENCY TRANSACTION (LOSSES) GAINS (27,000) (7,468) 2,837
------------ ------------ ------------
INCOME FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES 958,126 852,045 846,379
(BENEFIT) PROVISION FOR INCOME TAXES (126,650) 5,500 --
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INCOME FROM CONTINUING OPERATIONS 1,084,776 846,545 846,379
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DISCONTINUED OPERATIONS -
Gain on sale of Guildsoft -- -- 17,096
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NET INCOME 1,084,776 846,545 863,475
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NET INCOME PER COMMON SHARE-Basic:
Continuing operations $ 0.21 $ 0.16 $ 0.17
Discontinued operations -- -- 0.00
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NET INCOME PER COMMON SHARE - Basic $ 0.21 $ 0.16 $ 0.17
============ ============ ============
WEIGHTED-AVERAGE NUMBER OF
SHARES OUTSTANDING - Basic 5,267,520 5,196,824 5,127,670
============ ============ ============
NET INCOME PER COMMON SHARE - Diluted:
Continuing operations $ 0.19 $ 0.16 $ 0.16
Discontinued operations -- -- 0.00