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EX-32.2 - EXHIBIT 32.2 - DATAWATCH CORPv415488_ex32-2.htm
EX-32.1 - EXHIBIT 32.1 - DATAWATCH CORPv415488_ex32-1.htm
EX-31.1 - EXHIBIT 31.1 - DATAWATCH CORPv415488_ex31-1.htm
EX-31.2 - EXHIBIT 31.2 - DATAWATCH CORPv415488_ex31-2.htm

 

 

UNITED STATES 

SECURITIES AND EXCHANGE COMMISSION 

WASHINGTON, D.C. 20549 

  

 

FORM 10-Q

 

 

 

  x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2015

OR

 

  ¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

  

FOR THE TRANSITION PERIOD FROM                TO               

COMMISSION FILE NUMBER: 000-19960 

 

 

DATAWATCH CORPORATION 

(Exact name of registrant as specified in its charter)

 

 

 

DELAWARE   02-0405716
(State or Other Jurisdiction of   (I.R.S. Employer
Incorporation or Organization)   Identification No.)

 

271 MILL ROAD 

QUORUM OFFICE PARK 

CHELMSFORD, MASSACHUSETTS 01824 

(978) 441-2200 

(Address and telephone number of principal executive office) 

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

Common Stock $0.01 PAR VALUE   NASDAQ
(Title of Class)   (Name of Exchange on which Registered)

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE 

 

 

  

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x   No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x    No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  ¨ Accelerated filer x Non-accelerated filer   ¨ Smaller reporting company ¨
    (Do not check if a smaller reporting company)  

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes ¨ No x

 

 

The number of shares of the registrant’s common stock, $.01 par value, outstanding as of July 24, 2015 was 11,515,592.

 

 

 

 
 

 

DATAWATCH CORPORATION

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2015

 

TABLE OF CONTENTS

 

    Page
Part I: FINANCIAL INFORMATION 1
     
Item 1. Consolidated Financial Statements (unaudited) 1
  Consolidated Balance Sheets as of June 30, 2015 and September 30, 2014 1
  Consolidated Statements of Operations for the Three and Nine months ended June 30, 2015 and 2014 2
  Consolidated Statements of Comprehensive Loss for the Three and Nine months ended June 30, 2015 and 2014 3
  Consolidated Statements of Cash Flows for the Nine months ended June 30, 2015 and 2014 4
  Notes to Consolidated Financial Statements (unaudited) 5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures about Market Risk 24
Item 4. Controls and Procedures 25
     
Part II: OTHER INFORMATION 26
     
Item 1. Legal Proceedings 26
Item 1A. Risk Factors 26
Item 4. Mine Safety Disclosures 26
Item 6. Exhibits 26
     
SIGNATURES 27

 

 
 

 

PART I: FINANCIAL INFORMATION

ITEM 1: CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

DATAWATCH CORPORATION

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(In thousands, except share amounts)

 

   June 30,   September 30, 
   2015   2014 
ASSETS          
CURRENT ASSETS:          
Cash and cash equivalents  $36,319   $47,668 
Accounts receivable, net of allowance for doubtful accounts and sales returns of $44 and $63 as of June 30, 2015 and September 30, 2014, respectively   6,382    7,024 
Prepaid expenses and other current assets   2,013    1,633 
Total current assets   44,714    56,325 
           
Property and equipment, net   589    400 
Acquired intellectual property, net   4,476    11,057 
Other intangible assets, net   1,346    7,090 
Goodwill and indefinite-lived assets   6,685    28,383 
Deferred tax asset, net   2,114    239 
Other long-term assets   342    103 
Total assets  $60,266   $103,597 
           
LIABILITIES AND SHAREHOLDERS’ EQUITY          
CURRENT LIABILITIES:          
Accounts payable  $1,192   $925 
Accrued expenses   3,042    2,884 
Deferred revenue   7,132    7,401 
Deferred tax liability, current   239    239 
Total current liabilities   11,605    11,449 
           
LONG-TERM LIABILITIES:          
Deferred revenue, long-term   179    105 
Deferred tax liability, noncurrent   -    798 
Other long-term liabilities   342    335 
Total long-term liabilities   521    1,238 
Total liabilities   12,126    12,687 
           
COMMITMENTS AND CONTINGENCIES (Note 6)          
           
SHAREHOLDERS’ EQUITY:          
Common stock, par value $0.01; authorized: 20,000,000 shares; issued and outstanding: 11,731,752 shares and 11,500,512 shares, respectively, as of June 30, 2015 and 11,289,098 shares and 11,057,858 shares, respectively, as of September 30, 2014   116    114 
Additional paid-in capital   139,025    134,960 
Accumulated deficit   (89,212)   (42,404)
Accumulated other comprehensive loss   (1,649)   (1,620)
    48,280    91,050 
Less treasury stock, at cost, 14,246 shares   (140)   (140)
Total shareholders’ equity   48,140    90,910 
           
Total liabilities and shareholders’ equity  $60,266   $103,597 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

1
 

 

DATAWATCH CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(In thousands, except per share amounts)

 

   Three Months Ended   Nine Months Ended 
   June 30,   June 30, 
   2015   2014   2015   2014 
REVENUE:                    
Software licenses  $4,117   $5,580   $11,203   $15,387 
Maintenance   3,311    3,236    10,016    9,357 
Professional services   348    412    980    1,293 
Total revenues   7,776    9,228    22,199    26,037 
                     
COSTS AND EXPENSES:                    
Cost of software licenses   697    999    2,293    3,013 
Cost of maintenance and services  (1)   557    979    2,519    2,462 
Sales and marketing  (1)   6,513    8,241    21,303    23,198 
Engineering and product development  (1)   1,988    1,942    6,698    6,830 
General and administrative  (1)   2,204    2,185    6,779    7,000 
Impairment of goodwill and long-lived assets   -    -    32,009    - 
Total costs and expenses   11,959    14,346    71,601    42,503 
                     
LOSS FROM OPERATIONS   (4,183)   (5,118)   (49,402)   (16,466)
                     
Interest expense   -    -    -    (406)
Other income (expense)   -    4    9    (755)
Foreign currency transaction gain (loss)   (36)   10    (47)   (152)
                     
LOSS FROM OPERATIONS BEFORE INCOME TAXES   (4,219)   (5,104)   (49,440)   (17,779)
Income tax expense (benefit)   (96)   53    (2,632)   (270)
                     
NET LOSS  $(4,123)  $(5,157)  $(46,808)  $(17,509)
                     
Net loss per share – basic:  $(0.36)  $(0.48)  $(4.14)  $(1.81)
Net loss per share – diluted:  $(0.36)  $(0.48)  $(4.14)  $(1.81)
                     
Weighted-average shares outstanding – basic   11,448    10,826    11,307    9,654 
Weighted-average shares outstanding – diluted   11,448    10,826    11,307    9,654 
                     
(1) Includes share-based compensation as follows:                    
                     
Cost of maintenance and services  $17   $25   $47   $91 
Sales and marketing   946    1,204    2,506    3,731 
Engineering and product development   125    136    337    1,493 
General and administrative   398    321    1,135    1,190 
   $1,486   $1,686   $4,025   $6,505 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

2
 

 

DATAWATCH CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (UNAUDITED)

(In thousands)

 

   Three Months Ended   Nine Months Ended 
   June 30,   June 30, 
   2015   2014   2015   2014 
                 
Net loss  $(4,123)  $(5,157)  $(46,808)  $(17,509)
Other comprehensive (loss) income:                    
Foreign currency translation adjustments   76    (51)   (29)   26 
Comprehensive loss  $(4,047)  $(5,208)  $(46,837)  $(17,483)

 

The accompanying notes are an integral part of the consolidated financial statements.

 

3
 

 

DATAWATCH CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands) 

 

   Nine Months Ended 
   June 30, 
   2015   2014 
CASH FLOWS FROM OPERATING ACTIVITIES:          
Net loss  $(46,808)  $(17,509)
Adjustments to reconcile net loss to cash used in operating activities:          
Depreciation and amortization   2,221    3,189 
Share-based compensation expense   4,025    6,505 
Non-cash interest expense   -    187 
Loss on extinguishment of debt   -    795 
Deferred income taxes   (2,672)   (330)
Impairment of goodwill and long-lived assets   32,009    - 
Changes in operating assets and liabilities:          
Accounts receivable   568    (516)
Prepaid expenses and other assets   (669)   (108)
Accounts payable, accrued expenses and other liabilities   547    (851)
Deferred revenue   (135)   (10)
Cash used in operating activities   (10,914)   (8,648)
           
CASH FLOWS FROM INVESTING ACTIVITIES:          
Capitalized software development costs   -    (250)
Purchases of property and equipment   (400)   (162)
Cash used in investing activities   (400)   (412)
           
CASH FLOWS FROM FINANCING ACTIVITIES:          
Proceeds from issuance of common stock, net of issuance costs   -    53,629 
Proceeds from exercise of stock options   58    88 
Repayments of debt   -    (3,944)
Repayments of line of credit   -    (900)
Capitalized debt issuance costs   -    (5)
Cash provided by financing activities   58    48,868 
           
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS   (93)   48 
           
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS   (11,349)   39,856 
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD   47,668    10,312 
CASH AND CASH EQUIVALENTS, END OF PERIOD  $36,319   $50,168 
           
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:          
Interest paid  $-   $169 
           
Income taxes paid  $38   $98 

 

These notes are an integral part of the consolidated financial statements.

 

4
 

 

DATAWATCH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

NOTE 1. DESCRIPTION OF BUSINESS 

 

Datawatch Corporation (the “Company” or “Datawatch”) designs, develops, markets and distributes computer software products. The Company also provides services, including implementation and support of its software products, as well as training on their use and administration. The Company is subject to a number of risks including dependence on key individuals, competition from substitute products and larger companies and the need for successful ongoing development and marketing of products. 

 

NOTE 2. BASIS OF PRESENTATION 

 

The accompanying unaudited consolidated financial statements include the accounts of Datawatch and its wholly-owned subsidiaries and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) regarding interim financial reporting. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) for complete financial statements and should be read in conjunction with the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended September 30, 2014 filed with the SEC. All intercompany accounts and transactions have been eliminated in consolidation.

 

In the opinion of management, the accompanying consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements for the fiscal year ended September 30, 2014, and include all adjustments necessary for fair presentation of the results of the interim periods presented. The operating results for the interim periods presented are not necessarily indicative of the results expected for the full year. The Company considers events or transactions that occur after the balance sheet date but before the financial statements are issued to provide additional evidence relative to certain estimates or to identify matters that require additional disclosure.

 

Certain amounts in the prior period consolidated financial statements have been reclassified to conform to the current period presentation. These reclassifications had no effect on the reported net loss.

 

NOTE 3. FAIR VALUE MEASUREMENTS 

 

The Company’s financial instruments consist of cash and cash equivalents, accounts receivable and accounts payable. The estimated fair values have been determined through information obtained from market sources and management estimates.  The estimated fair value of certain financial instruments including cash and cash equivalents, accounts receivable and accounts payable, approximate the carrying value due to their short-term maturity.

 

The fair value of the Company’s financial assets and liabilities are measured using inputs from the three levels of fair value hierarchy which are as follows:

 

·  Level 1 — Quoted prices in active markets for identical assets or liabilities; 

 

·  Level 2 — Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and

 

5
 

 

·  Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. 

 

The Company classified its cash equivalents, which primarily include money market mutual funds, of $29.4 million and $38.9 million as of June 30, 2015 and September 30, 2014, respectively, within Level 2 of the fair value hierarchy.

 

As of June 30, 2015 and September 30, 2014, the Company’s assets that are measured on a recurring basis and whose carrying values approximate their respective fair values include the following (in thousands):

 

   June 30, 2015   September 30, 2014 
   Fair Value Measurement   Fair Value Measurement 
   Using Input Types   Using Input Types 
   Level 1   Level 2   Level 3   Level 1   Level 2   Level 3 
Assets:                              
Money market funds  $-   $29,372   $-   $-   $38,863   $- 
Total  $-   $29,372   $-   $-   $38,863   $- 

 

Non-financial assets such as goodwill and long-lived assets are also subject to non-recurring fair value measurements if they are deemed to be impaired. The impairment models used for nonfinancial assets depend on the type of asset and are accounted for in accordance with FASB’s guidance on fair value measurement. The fair value measurements for these non-financial assets were calculated using a discounted cash flow approach, which includes unobservable inputs classified as Level 3 within the fair value hierarchy. See Note 4 for additional discussion regarding the fair value methods used for these assets.  The amount and timing of future cash flows was based on the Company’s most recent operational forecasts.  The Company uses the assistance of an independent consulting firm to develop valuation assumptions. See Notes 4 and 5 for additional discussion regarding the impairment of goodwill and long-lived assets.

 

As of June 30, 2015 and September 30, 2014, the Company’s assets that are measured on a non-recurring basis include the following (in thousands):

 

   June 30, 2015   September 31, 2014 
   Fair Value Measurement   Fair Value Measurement 
   Using Input Types   Using Input Types 
   Level 1   Level 2   Level 3   Level 1   Level 2   Level 3 
Assets:                              
Acquired intellectual property, net  $-   $-   $4,476   $-   $-   $11,057 
Other intangible assets, net   -    -    1,346    -    -    7,090 
Goodwill and indefinite-lived assets   -    -    6,685    -    -    28,383 
Total  $-   $-   $12,507   $-   $-   $46,530 

 

6
 

 

NOTE 4: IMPAIRMENT OF GOODWILL AND INDEFINITE-LIVED ASSETS

 

Goodwill represents the excess of the purchase price over the fair value of identifiable net assets of acquired businesses. Indefinite-lived intangibles are intangible assets whose useful lives are indefinite in that their lives extend beyond the foreseeable horizon – that is there is no foreseeable limit on the period of time over which they are expected to contribute to the cash flows of the reporting entity. The Company accounts for these items in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 350 Intangibles – Goodwill and Other, which requires that impairment testing for goodwill is performed at least annually at the reporting unit level. A reporting unit is an operating segment or one level below an operating segment (also known as a component). The Company has determined that it is comprised of only one reporting unit. We perform our annual impairment test as of July 31st. Goodwill is also tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. Examples of these events or circumstances include:

 

·A significant adverse long term outlook;
·Unanticipated competition or the introduction of a disruptive technology;
·Failure of an anticipated product or product line;
·The testing for recoverability under the ASC 360-10 Impairment or Disposal of Long-Lived Assets of a significant asset group;
·A loss of key personnel; and
·An expectation that a significant portion of the Company will be sold or otherwise disposed of.

 

The impairment test for goodwill uses a two-step approach. Step one compares the fair value of the reporting unit to its carrying value including goodwill. If the carrying value exceeds the fair value, there is a potential impairment and step two must be performed. Step two compares the carrying value of the reporting unit's goodwill to its implied value (i.e., the fair value of the reporting unit less the fair value of the unit's assets and liabilities, including identifiable intangible assets). If the carrying value of goodwill exceeds its implied value, the excess is recorded as an impairment.

 

During the three months ended December 31, 2014, the Company identified several events, that when combined, were determined to require an interim impairment test. These events consisted of a material decrease in revenue compared to prior year and compared to the prior quarter which resulted in a decision to pre-release earnings information; necessary operational changes within the Sales Organization which drove a shift in our sales approach; and a sustained decrease in share price.

 

Under Step 1 of the impairment test the Company determined fair value based on discounted cash flows using an income approach with the multi-period excess earnings method which estimates the fair value of the asset by discounting the future projected excess earnings associated with the asset to present value as of the valuation date. Based on the analysis, it was determined that the carrying value of the Company including goodwill exceeded the fair value, requiring us to perform Step 2 of the goodwill impairment test to measure the amount of impairment loss, if any.

 

The Company then performed Step 2 of the impairment test, noting fair value of the long-lived assets (other than goodwill), of $3.0 million, was less than the carrying amount of those assets and, as a result, recorded a non-cash, pre-tax impairment charge of $10.3 million during the quarter ended December 31, 2014 (see Note 5). The Company then determined the implied value of goodwill was $6.7 million, which was less than its carrying value and, as a result, the Company recognized a non-cash, pre-tax charge of $21.7 million during the quarter ended December 31, 2014 and nine months ended June 30, 2015. These impairment charges are included under the caption "Impairment of goodwill and long-lived assets" in our consolidated statements of operations.

 

7
 

 

The valuation methods utilized to value the long-lived assets and the goodwill discussed above are based on the amount and timing of expected future cash flows and growth rates and include a determination of an appropriate discount rate. The cash flows utilized in the discounted cash flow analyses were based on financial forecasts developed internally by management. Estimating future cash flows requires significant judgment and projections may vary from the cash flows eventually realized. Determining the fair value using a discounted cash flow method requires significant estimates and assumptions, including market conditions, discount rates, and long-term projections of cash flows. The Company’s estimates are based upon historical experience, current market trends, projected future volumes and other information. The Company believes that the estimates and assumptions underlying the valuation methodology are reasonable; however, different estimates and assumptions could result in a different estimate of fair value. In estimating future cash flows, the Company relies on internally generated projections for a defined time period for revenue and operating profits, including capital expenditures, changes in net working capital, and adjustments for non-cash items to arrive at the free cash flow available to invested capital. Where applicable, a terminal value utilizing a constant growth rate of cash flows is used to calculate a terminal value after the explicit projection period. The future projected cash flows for the discrete projection period and the terminal value are discounted at a risk adjusted discount rate to determine the fair value of the reporting unit.

 

The following table presents the changes in the carrying amount of our goodwill for the nine months ended June 30, 2015 (in thousands):

 

Balance at September 30, 2014  $28,383 
Goodwill impairment   (21,698)
      
Balance at June 30, 2015  $6,685 

 

NOTE 5: LONG-LIVED ASSETS

 

Intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable and an impairment loss is recognized when it is probable that the estimated cash flows are less than the carrying amount of the asset.

 

During the three months ended December 31, 2014, as a result of an interim impairment test of goodwill and long-lived assets (see Note 4), the Company recorded an impairment charge of $4.3 million for the intellectual property acquired from Panopticon and $6.0 million for the customer lists acquired from Panopticon. During the three months ended March 31, 2015, the Company reclassified $0.6 million of the impairment charge between the acquired intellectual property and the customer lists. The overall impairment charge of $10.3 million remained unchanged and the total intangible values also remained unchanged between December 31, 2014 and June 30, 2015 as a result of the reclassification.

 

Acquired Intellectual Property

 

In fiscal 2013, the Company acquired intellectual property from Panopticon totaling $7.9 million. The acquired intellectual property assets are being amortized to cost of software licenses using the straight-line method over the estimated life of the asset of seven and a half years.

 

The following table presents the changes in the carrying amount of the intellectual property acquired from Panopticon, which is included under the caption “Acquired intellectual property, net” in our consolidated balance sheets, for the nine months ended June 30, 2015 (in thousands):

 

8
 

  

   Gross       Net 
   Carrying   Accumulated   Carrying 
   Amount   Amortization   Amount 
             
Balance at September 30, 2014  $7,900   $(1,142)  $6,758 
Impairment charge   (4,895)   -    (4,895)
Amortization expense   -    (393)   (393)
                
Balance at June 30, 2015  $3,005   $(1,535)  $1,470 

 

Other Intangible Assets

 

Other intangible assets consist of trade names, patents and customer lists acquired from Panopticon. The values allocated to these intangible assets are amortized using the straight-line method over the estimated useful life of the related asset.

 

Other intangible assets at June 30, 2015 and September 30, 2014 consist of the following (in thousands):

 

June 30, 2015
Identified  Weighted  Gross             
Intangible  Average  Carrying   Impairment   Accumulated   Net Carrying 
Asset  Useful Life  Amount   Charge   Amortization   Amount 
   (In years)                
                    
Patents  20  $160   $-   $(87)  $73 
Customer lists  14   8,990    (5,416)   (2,333)   1,241 
Trade names  3   120    -    (88)   32 
                        
Total     $9,270   $(5,416)  $(2,508)  $1,346 

 

September 30, 2014
Identified  Weighted  Gross             
Intangible  Average  Carrying   Impairment   Accumulated   Net Carrying 
Asset  Useful Life  Amount   Charge   Amortization   Amount 
   (In years)                
                    
Patents  20  $160   $-   $(81)  $79 
Customer lists  14   8,990    -    (2,047)   6,943 
Trade names  3   120    -    (52)   68 
                        
Total     $9,270   $-   $(2,180)  $7,090 

 

NOTE 6. COMMITMENTS AND CONTINGENCIES

 

Leases  

 

The Company leases various facilities and equipment in the U.S. and overseas under non-cancelable operating leases which expire at various dates through 2022. The lease agreements generally provide for the payment of minimum annual rentals and pro-rata share of taxes and maintenance expenses. Rental expense for all operating leases was $0.3 and $0.2 million for the three months ended June 30, 2015 and 2014, respectively, and $0.8 million and $0.7 million for the nine months ended June 30, 2015 and 2014, respectively. Certain of the Company's facility leases include options to renew. 

 

9
 

 

During the three months ended June 30, 2015, the Company entered into a facility lease in Bedford, MA for new corporate headquarters. The lease is for 20,360 square feet commencing November 1, 2015 and ending on October 31, 2022 with a monthly expense of $42,000. The Company anticipates moving into the new facility during the first quarter of fiscal 2016 and anticipates recording a $0.1 million charge, which represents the remaining lease obligation under the lease agreement for the current corporate headquarters in Chelmsford, MA, upon the cease-use date of the existing corporate headquarters. In conjunction with entering into the lease, the Company was required to deposit $0.2 million into a restricted cash account as collateral for a Letter of Credit, which is included under the caption “Other long-term assets” in our consolidated balance sheets, for the period ended June 30, 2015.

 

Royalties

 

Royalty expense included in cost of software licenses was $0.2 million and $0.1 million for the three months ended June 30, 2015 and 2014, respectively, and $0.4 million and $0.3 million for the nine months ended June 30, 2015 and 2014, respectively. Minimum royalty obligations were insignificant for the three and nine months ended June 30, 2015 and 2014.

 

Contingencies 

 

From time to time, the Company is subject to claims and may be party to actions that arise in the normal course of business. The Company is not party to any litigation that management believes will have a material adverse effect on the Company's consolidated financial condition or results of operations.

 

NOTE 7. RESTRUCTURING CHARGES

 

Plans initiated during the first fiscal quarter of 2015

 

During the three months ended December 31, 2014, the Company initiated a restructuring plan to lower expense structure by reducing the investment in legacy solutions and the realignment of international operations, primarily impacting engineering and product development.  The planned action began during the first fiscal quarter and continued during the second fiscal quarter when the remaining employees impacted by the plan were notified. The Company recorded restructuring charges related to workforce reductions including severance and related benefit costs of $0.4 million during the three months ended December 31, 2014, $0.3 million during the three months ended March 31, 2015, and an immaterial amount during the three months ended June 30, 2015.

 

Plans initiated during the second fiscal quarter of 2015

 

During the three months ended March 31, 2015, the Company initiated a restructuring plan to reduce the workforce by nearly 15% across all functional areas of the Company in an effort to rebalance investments to match the go-to-market model. The Company completed all restructuring actions associated with this plan during the three months ended March 31, 2015, and recorded restructuring charges of $0.9 million during the three months ended March 31, 2015 related to workforce reductions including severance and related benefit costs, and an additional $27,000 during the three months ended June 30, 2015. No additional amounts are expected to be incurred in future periods.

 

The following table presents the changes in the accrual for restructuring charges, which is included under the caption “Accrued expenses” in our consolidated balance sheets, as of June 30, 2015 (in thousands):

 

   Plan initiated during     
   Q1 FY15   Q2 FY15   Total 
             
Balance at September 30, 2014  $-   $-   $- 
Charges   763    877    1,640 
Payments   (628)   (633)   (1,261)
Balance at June 30, 2015  $135   $244   $379 

 

10
 

 

The following table presents restructuring charges included in our unaudited consolidated statements of operations for the three and nine months ended June 30, 2015 (in thousands): 

 

   Three Months Ended   Nine Months Ended 
   June 30, 2015   June 30, 2015 
   Plan initiated during       Plan initiated during     
   1st
Quarter
   2nd
Quarter
   Total   1st
Quarter
   2nd
Quarter
   Total 
                         
Cost of maintenance and services  $-   $(14)  $(14)  $160   $205   $365 
Sales and marketing   -    31    31    247    469    716 
Engineering and product development   2    9    11    268    55    323 
General and administrative   -    1    1    88    148    236 
   $2   $27   $29   $763   $877   $1,640 

 

NOTE 8. INCOME TAXES

 

During the three months ended June 30, 2015, the Company recorded a tax benefit of $0.1, primarily related to the change in the deferred tax asset in Sweden as a result of generating losses, estimated state taxes, return to provision adjustments, and accruing interest on uncertain tax positions. During the three months ended June 30, 2014, the Company recorded a tax expense of $0.1, primarily related to losses generated in Sweden, estimated state taxes, return to provision adjustments, and accrued interest and penalties on uncertain tax positions. During the nine months ended June 30, 2015, the Company recorded a tax benefit of $2.6 million, primarily related to the change in the deferred tax liability in Sweden as a result of impairing non-goodwill intangibles and amortization, estimated state taxes, return to provision adjustments, and accruing interest on uncertain tax positions. During the nine months ended June 30, 2014, the Company recorded a tax benefit of $0.3 million, primarily related to losses generated in Sweden, estimated state taxes, return to provision adjustments, and accrued interest and penalties on uncertain tax positions.

 

The Company’s deferred tax assets include net operating loss carry forwards and tax credits that expire at different times through and until 2034. 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. With the exception of Sweden, management does not believe the deferred tax assets are more likely than not to be realized and a full valuation allowance has been provided against the deferred tax assets in the U.S, U.K., Australia, Germany, and Singapore at June 30, 2015 and September 30, 2014.

 

11
 

 

At September 30, 2014, the Company had a cumulative tax liability of $0.3 million related to uncertain tax positions for Federal, state, and foreign tax exposure that could result in cash payments.  There were no significant changes to the Company’s uncertain tax positions during the nine months ended June 30, 2015. The Company does not expect its tax liability to change significantly during the next twelve months.

 

NOTE 9. CALCULATION OF EARNINGS PER SHARE

 

Basic net loss per share is computed by dividing net loss by the weighted-average number of common shares outstanding. Diluted earnings per share is computed by dividing net income or loss by the weighted-average number of common shares outstanding plus additional common shares that would have been outstanding if dilutive potential common shares had been issued. For the purposes of this calculation, stock options are considered common equivalents in periods in which they have a dilutive effect. Stock options that are anti-dilutive are excluded from the calculation.

 

The following table presents the computation basic and diluted net loss per share attributable to common shareholders (in thousands, except per share data):  

 

   Three Months Ended   Nine Months Ended 
   June 30,   June 30, 
   2015   2014   2015   2014 
                 
Net loss  $(4,123)  $(5,157)  $(46,808)  $(17,509)
Weighted-average number of common shares outstanding   11,448    10,826    11,307    9,654 
                     
Net loss per share   (0.36)   (0.48)   (4.14)   (1.81)

 

For the three and nine months ended June 30, 2015 and 2014 all common stock equivalents in the respective periods were anti-dilutive as a result of the Company’s net loss position. As such, 242,200 shares and 563,738 shares, have not been included in the calculation of basic or diluted net loss per share for the three months ended June 30, 2015 and 2014, respectively and 272,700 shares and 883,891 shares for the nine months ended June 30, 2015 and 2014, respectively.

 

NOTE 10. SHARE-BASED COMPENSATION 

 

The Company provides its employees, officers, consultants and directors with stock options, restricted stock units and other stock rights for common stock of the Company on a discretionary basis. All option and restricted stock unit grants are subject to the terms and conditions determined by the Compensation and Stock Committee of the Board of Directors, and generally vest over a three-year period beginning three months from the date of grant and expire either seven or ten years from the date of grant depending on the plan. All awards granted during the nine months ended June 30, 2015 were granted under our 2011 Plan. At June 30, 2015, there were 399,833 shares available for future issuance under the 2011 Plan.

 

Generally, options and other stock rights are granted at exercise prices not less than the fair market value at the date of grant. All of the Company’s share-based awards are accounted for as equity instruments and there have been no liability awards granted. Share-based compensation expense for all share-based payment awards is measured based on the grant-date fair value of the award and recognized on a straight-line basis over the requisite period of the award.

 

12
 

 

Stock Option Plans

 

The Company estimates the fair value of each share-based award (except restricted stock units, which are discussed below) using the Black-Scholes option valuation model. The Black-Scholes option valuation model incorporates assumptions as to stock price volatility, the expected life of options, a risk-free interest rate and dividend yield.

 

The following table is a summary of combined activity for all of the Company’s stock option plans:  

 

       Weighted-   Weighted-     
       Average   Average   Aggregate 
       Exercise   Remaining   Intrinsic 
   Number of
Options
   Price
Per Share
   Life
(In years)
   Value
(In thousands)
 
                 
Outstanding, September 30, 2014   320,500   $5.97    3.74   $1,572 
Granted   -    -    -    - 
Canceled/Forfeited   -    -    -    - 
Exercised   (18,000)   2.91    1.07    71 
Outstanding, June 30, 2015   302,500   $6.15    3.12   $696 
                     
Exercisable, June 30, 2015   277,492   $5.54    2.96   $696 
                     
Unvested awards expected to vest, June 30, 2015   22,507   $12.92    4.82   $- 

 

Restricted Stock Units

 

The following table presents nonvested RSU information for the nine months ended June 30, 2015:   

 

   Number of 
   RSUs 
   Outstanding 
      
Nonvested, September 30, 2014   740,011 
Granted   441,568 
Canceled/Forfeited   (198,177)
Vested   (207,660)
Nonvested, June 30, 2015   775,742 

 

NOTE 11. SEGMENT INFORMATION AND REVENUE BY GEOGRAPHIC LOCATION

 

The Company operates its business as one operating segment and has determined that it has only one reportable segment. The Company’s chief operating decision maker, its Chief Executive Officer, does not manage any part of the Company separately, and the allocation of resources and assessment of performance is based solely on the Company’s consolidated operations and operating results.

 

13
 

 

The Company conducts operations in the U.S. and internationally. The following table presents information about the Company’s geographic operations (in thousands):

 

           Intercompany     
   Domestic   International   Eliminations   Total 
                 
Total Revenue                    
                     
Three months ended June 30, 2015  $6,787   $1,593   $(604)  $7,776 
Three months ended June 30, 2014  $7,680   $2,507   $(959)  $9,228 
                     
Nine months ended June 30, 2015  $19,367   $4,712   $(1,880)  $22,199 
Nine months ended June 30, 2014  $22,342   $5,912   $(2,217)  $26,037 
                     
Total Operating Loss                    
                     
Three months ended June 30, 2015  $(2,751)  $(1,385)  $(47)  $(4,183)
Three months ended June 30, 2014  $(4,422)  $(684)  $(12)  $(5,118)
                     
Nine months ended June 30, 2015  $(44,017)  $(5,332)  $(53)  $(49,402)
Nine months ended June 30, 2014  $(12,577)  $(3,873)  $(16)  $(16,466)
                     
Total Long-Lived Assets                    
At June 30, 2015  $15,301   $19   $-   $15,320 
At September 30, 2014  $47,135   $137   $-   $47,272 

 

NOTE 12. RECENT ACCOUNTING PRONOUNCEMENTS

 

In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606). The ASU is the result of a joint project by the FASB and the International Accounting Standards Board (“IASB”) to clarify the principles for recognizing revenue and to develop a common revenue standard for GAAP and International Financial Reporting Standards (“IFRS”) that would: remove inconsistencies and weaknesses, provide a more robust framework for addressing revenue issues, improve comparability of revenue recognition practices across entities, jurisdictions, industries, and capital markets, improve disclosure requirements and resulting financial statements, and simplify the presentation of financial statements. The core principle of the new guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU is effective for annual reporting periods beginning after December 15, 2016. On July 9, 2015, the FASB voted to delay the effective date of the new revenue standard by one year, but to permit entities to choose to adopt the standard as of the original effective date. We are currently evaluating the effect that the updated standard will have on our consolidated financial statements and related disclosures.

 

The Company has considered all other recently issued accounting pronouncements and does not believe the adoption of such pronouncements will have a material impact on its consolidated financial statements.

 

14
 

 

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS  

 

General

 

We do not provide forecasts of our future financial performance. However, from time to time, information we provide or statements made by our employees may contain “forward looking” information that involves risks and uncertainties. In particular, statements contained in this Quarterly Report on Form 10-Q that are not historical facts may constitute forward looking statements and are made under the safe harbor provisions of The Private Securities Litigation Reform Act of 1995. We caution readers not to place undue reliance on any such forward looking statements, which speak only as of the date they are made. We disclaim 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 our 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. Our 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 in Item 1A of the our Annual Report on Form 10-K for the fiscal year ended September 30, 2014 as well as the accuracy of our internal estimates of revenue and operating expense levels. 

 

Introduction 

 

We are engaged in the design, development, marketing, distribution and support of business computer software primarily for the visual data discovery and self-service data preparation markets to allow organizations to access, analyze and visualize information in a more meaningful fashion. The Datawatch Managed Analytics Platform is an enterprise solution that bridges the gap between the ease-of-use and agility that business users demand together with the scalability, automation and governance needed by IT.

 

Our principal product line of Managed Analytics Platform solutions includes the following products:  

 

·Datawatch Designer — Visually Design, Discover and Explore New Insights

 

Datawatch Designer lets users quickly start asking questions to see hidden patterns, spot problems and identify missed opportunities without programming or scripting. Our in-memory analytics engine enables on-the-fly aggregations and intuitive navigation and integration of data from virtually any data source. With a simple drag-and-drop interface, users can set up hierarchies and filters in their dashboards to make it easier to spot outliers and to see how different subsets of data correlate with each other. Datawatch Designer provides a range of specialized visualizations designed specifically to make analyzing streaming data, time series data and historical data, more impactful. With integrated data preparation capabilities and pre-built connectors make it simple to access and combine information from any data source, including data streams from message brokers and complex event processing engines.

 

·Datawatch Monarch™ — Capture and Transform Data from Virtually Any Source

 

Datawatch Monarch is a self-service data preparation tool to explore, manipulate and merge new data sources. With Datawatch Monarch, users can bring all the data that is needed to manage the business to life, whether that information is stored in structured sources like databases, or in less conventional places like unstructured or semi-structured EDI streams, PDF files, reports, or text files.

 

·Datawatch Server™ — Securely Share, Visualize Throughout the Organization

 

To fully exploit the power of optimized information, organizations must ensure that all information is easily available to users of all types. Datawatch Server is used to automate, manage, store and visualize information from any data source that can be modeled via the Datawatch Designer or Datawatch Monarch products.

 

·Datawatch Report Mining Server™ — Unlocking the Power of Content

 

Datawatch’s Report Mining Server (“RMS”) is a web-based report analytics solution that integrates with any existing enterprise content management system such as Datawatch Report Manager On-Demand, IBM Content Manager On-Demand, Microsoft SharePoint, Hyland OnBase, ASG Mobius ViewDirect and others. Datawatch RMS opens up the corporate data locked in content management systems, static reports and business documents, enabling dynamic business-driven analysis of information using Datawatch Designer or other productivity tools with no user programming.

 

15
 

 

CRITICAL ACCOUNTING POLICIES

 

The Securities and Exchange Commission (“SEC”) issued disclosure guidance for “critical accounting policies.” The SEC defines “critical accounting policies” as those that require the application of management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods.

 

Our significant accounting policies are described in Note 1 to the consolidated financial statements for the fiscal year ended September 30, 2014 included in our previously filed Form 10-K. There have been no material changes to the accounting policies for the three and nine months ended June 30, 2015.

 

OVERVIEW

 

During the first quarter of fiscal 2015, we announced several new strategic initiatives including the transition of our business and sales approach to one that emphasizes what we view as the higher value differentiation of our complete managed analytics platform and places more focus on the potential offered by our Monarch customer base, investing more in a ‘high velocity’ inside selling model and shifting our partner program to a centralized global model. In order to achieve these strategic objectives, we initiated significant restructuring efforts during the three months ended December 31, 2014, which reduced our investment in legacy solutions, and realigned international operations. In addition, during the three months ended March 31, 2015, we initiated a second restructuring plan in an effort to rebalance our investments to match the go-to-market model. Under the second quarter plan, we further reduced the workforce during the three months ended March 31, 2015 by nearly 15%, across all functional areas of the company. These combined actions are expected to reduce our annualized total operating expenses by $6.5 million. During the three months ended June 30, 2015, we reduced our operating expenses by $1.9 million compared to March 31, 2015.

 

The disruptions caused by these strategic initiatives have negatively impacted our performance, however, we are beginning to see positive signs that we are improving our sales execution, expanding our market awareness and producing meaningful innovation to our product platform.

 

Sales execution

 

During the three months ended June 30, 2015, we increased our license revenue by $0.2 million, or 5%, compared to the prior quarter ended March 31, 2015. In addition, we increased our deferred revenue balance by $0.4 million, or 6%, compared to the quarter ended March 31, 2015, which was driven by license deferred revenue. The increase in deferred revenue was primarily the result of a shift in our pricing policy to a subscription based model for our smaller sized Monarch orders.

 

Market awareness

 

During the three months ended June 30, 2015, we expanded our partner channel with several new Original Equipment Manufacturer, or “OEM” agreements, which are a critical element of our long-term strategic growth plan. In April, Dell Software announced a partnership with Datawatch to OEM our visualization capabilities directly into its Statistica advanced analytics platform. We also closed new OEM deals with Lipper, Fincad and FlexTrade, and extended existing OEM deals with Bloomberg and NASDAQ. Most encouraging, our enhanced data preparation capabilities have reinvigorated existing partners and expanded our partner pipeline with prospects whose solutions require complementary data preparation

 

16
 

 

Innovation to product platform

 

On June 30, 2015, we released Monarch version 13. The new product release significantly extends the range of data sources that we address and provides a simple point-and-click interface built on top of what we believe is the world’s most powerful data preparation engine. This release allows a user to immediately visualize prepared data not just in Datawatch Designer, but in other popular BI and advanced analytic tools such as Dell Statistica, Tableau, Qlik, IBM Watson Analytics, Tibco Spotfire, SAS, SAP Lumira, Excel and many others.

 

RESULTS OF OPERATIONS

 

The following table sets forth certain statements of operations data as a percentage of total revenues for the periods indicated. The data has been derived from our accompanying consolidated financial statements. The operating results for any period should not be considered indicative of the results expected for any future period.

 

   Three Months Ended   Nine Months Ended 
   June 30,   June 30, 
   2015   2014   2015   2014 
REVENUE:                    
Software licenses   53%   60%   51%   59%
Maintenance   43    35    45    36 
Professional services   4    5    4    5 
Total revenues   100%   100%   100%   100%
                     
COSTS AND EXPENSES:                    
Cost of software licenses   9%   11%   10%   12%
Cost of maintenance and services   7    10    11    9 
Sales and marketing   84    89    96    89 
Engineering and product development   26    21    30    26 
General and administrative   28    24    31    27 
Impairment of goodwill and long-lived assets   -    -    144    - 
Total costs and expenses   154%   155%   322%   163%
                     
LOSS FROM OPERATIONS   (54)%   (55)%   (222)%   (63)%
                     
Interest expense   -%   -%   -%   (1)%
Other income (expense)   -    -    -    (3)
Foreign currency transaction gain (loss)   -    -    -    (1)
                     
LOSS FROM OPERATIONS BEFORE INCOME TAXES   (54)%   (55)%   (222)%   (68)%
Income tax expense (benefit)   (1)   1    (12)   (1)
                     
NET LOSS   (53)%   (56)%   (210)%   (67)%

 

17
 

 

Three Months Ended June 30, 2015 Compared to

Three Months Ended June 30, 2014

 

Total Revenues

 

   Three Months Ended         
   June 30,   Increase   Percentage 
   2015   2014   (Decrease)   Change 
Software licenses  $4,117   $5,580   $(1,463)   (26)%
Maintenance   3,311    3,236    75    2 
Professional services   348    412    (64)   (16)
Total revenue  $7,776   $9,228   $(1,452)   (16)%

 

Software license revenue. As noted in the first fiscal quarter, we transitioned our business and sales approach to one that emphasizes what we view as the higher value differentiation of our complete managed analytics platform and places more focus on the potential offered by our Monarch customer base, investing more in a ‘high velocity’ inside selling model and shifting our partner program to a centralized global model. We continued to integrate these changes into our operations during the quarter ended June 30, 2015, however, the disruption associated with such a realignment of our focus was the primary driver of the decrease in software license revenue for the three months ended June 30, 2015 as compared to three months ended June 30, 2014. Two important operational metrics indicative of the transformation are the number of six-figure license deals and the average deal size for license sales greater than $10,000. For the three months ended June 30, 2015 there were 7 six-figure deals while the average deal size was $56,000 as compared to 8 six-figure license deals and $62,000 average deal size for the three months ended June 30, 2014. In addition, we implemented a new pricing policy during the quarter, which requires a subscription based model for smaller sized Monarch orders. As a result of this policy change, we increased deferred revenue by $0.4 million.

 

Maintenance revenue. The increase in maintenance revenue is primarily driven by strong renewal bookings of both enterprise and desktop software from prior quarters. Renewal rates for both enterprise and desktop products continue at prior levels.

 

Professional services. Professional services revenue decreased $0.1 million, as a result of changes in selling approach which previously required professional services included on all Enterprise deals.

 

Total Costs and Expenses

 

   Three Months Ended         
   June 30,   Increase   Percentage 
   2015   2014   (Decrease)   Change 
Cost of software licenses  $697   $999   $(302)   (30)%
Cost of maintenance and services   557    979    (422)   (43)
Sales and marketing   6,513    8,241    (1,728)   (21)
Engineering and product development   1,988    1,942    46    2 
General and administrative   2,204    2,185    19    1 
Impairment of goodwill and long-lived assets   -    -    -    - 
Total costs and operating expenses  $11,959   $14,346   $(2,387)   (17)%

 

18
 

 

Cost of software licenses. The $0.3 million decrease is due to a $0.2 million decrease in amortization expense as a result of the impairment charge recorded for long-lived assets during the first fiscal quarter and a $0.1 million decrease in capitalized software.

 

Cost of maintenance and services. The decrease is mainly due to a decrease in employee related expense resulting from a 20 percent decrease in headcount compared to the prior quarter and compared to the same quarter last fiscal year, due to the restructuring efforts and a shift to a web enabled, on-line approach to the delivery of training.

 

Sales and marketing expenses. The decrease in sales and marketing expenses is comprised of an increase in sales expense of $38,000 and a decrease in marketing expense of $1.8 million. The change in sales expense is comprised of an increase in outside consultants offset by a decrease in employee related expenses, resulting from an 8 percent decrease in headcount compared to the prior quarter and a 15 percent decrease in headcount compared to the same quarter last fiscal year, due to the restructuring efforts that occurred during our last fiscal quarter, and a $0.1 million decrease in amortization of intangibles which resulted from the lower intangible asset value subsequent to the impairment charges recorded in the first fiscal quarter. The marketing decrease is primarily comprised of a $1.2 million decrease in marketing and promotional expenses compared to fiscal 2014 resulting from expenses incurred during 2014 in connection with the redesign of our website and a decrease in other marketing materials as we refocus our lead generation programs. While we decreased employee related expenses in marketing by $0.4 million, as a result of the restructuring efforts that occurred over the past two fiscal quarters, we realigned our investments and focus in this area, and as a result headcount remained flat. In addition, marketing expense related to outside consultants decreased by $0.2 million.

 

Engineering and product development expenses. While overall engineering and product development expenses remained relatively flat over the prior period, we experienced a decrease in employee related expenses resulting from a 9 percent decrease in headcount compared to the prior quarter, and a 15 percent decrease compared to the same quarter last fiscal year primarily related to areas focused on legacy products, due to the restructuring efforts that occurred during our last two fiscal quarters, which were offset by an increase in consulting expenses related to outside development services.

 

General and administrative expenses. General and administrative expenses remained relatively flat over the prior period.

 

Other income (expense)

 

   Three Months Ended         
   June 30,       Percentage 
   2015   2014   Increase   Change 
Interest expense  $-   $-   $-    -%
Other (expense) income  $-   $4   $(4)   100%
Foreign currency transaction loss  $(36)  $10   $(46)   460%

 

 Interest expense. There was no interest expense for both the three months ended June 30, 2015 and 2014.

 

Other income (expense). There was no other income expense for the three months ended June 30, 2015. Other expense for the three months ended June 30, 2014 was minimal.

 

Foreign currency transactions loss. The foreign currency loss for the three months ended June 30, 2015 and 2014 was primarily attributable to fluctuation of the British pound sterling, Swedish krona and other foreign currencies we transact in.

 

19
 

 

Provision (benefit) for income taxes

 

   Three Months Ended         
   June 30,       Percentage 
   2015   2014   Increase   Change 
Income tax expense (benefit)  $(96)  $53   $(149)   281%

 

During the three months ended June 30, 2015, the Company recorded a tax benefit of $0.1 million, primarily related to the change in the deferred tax asset in Sweden as a result of generating losses, estimated state taxes, return to provision adjustments, and accruing interest on uncertain tax positions. During the three months ended June 30, 2014, the Company recorded a tax expense of $0.1 million, primarily related to losses generated in Sweden, estimated state taxes, return to provision adjustments, and accrued interest and penalties on uncertain tax positions.

 

Nine Months Ended June 30, 2015 Compared to

Nine Months Ended June 30, 2014

 

Total Revenues

 

   Nine Months Ended         
   June 30,   Increase   Percentage 
   2015   2014   (Decrease)   Change 
Software licenses  $11,203   $15,387   $(4,184)   (27)%
Maintenance   10,016    9,357    659    7 
Professional services   980    1,293    (313)   (24)
Total revenue  $22,199   $26,037   $(3,838)   (15)%

 

Software license revenue. As noted in the first fiscal quarter, we transitioned our business and sales approach to one that emphasizes what we view as the higher value differentiation of our complete managed analytics platform and places more focus on the potential offered by our Monarch customer base, investing more in a ‘high velocity’ inside selling model and shifting our partner program to a centralized global model. We continued to integrate these changes into our operations during the quarter ended June 30, 2015, however, the disruption associated with such a realignment of our focus was the primary driver of the decrease in software license revenue for the nine months ended June 30, 2015 as compared to the nine months ended June 30, 2014. During the nine months ended June 30, 2015, we implemented a new pricing policy which requires a subscription based model for smaller sized Monarch orders. As a result of this policy change, we increased our license deferred revenue by $0.5 million over the nine months ended June 30, 2015.

 

Maintenance revenue. The increase in maintenance revenue is primarily driven by strong renewal bookings of both enterprise and desktop software from prior quarters. Renewal rates for both enterprise and desktop products continue at prior levels

 

Professional services. Professional services revenue decreased $0.3 million, as a result of changes in selling approach which previously required professional services included on all Enterprise deals.

 

20
 

 

Total Costs and Expenses

 

   Nine Months Ended         
   June 30,   Increase   Percentage 
   2015   2014   (Decrease)   Change 
Cost of software licenses  $2,293   $3,013   $(720)   (24)%
Cost of maintenance and services   2,519    2,462    57    2 
Sales and marketing   21,303    23,198    (1,895)   (8)
Engineering and product development   6,698    6,830    (132)   (2)
General and administrative   6,779    7,000    (221)   (3)
Impairment of goodwill and long-lived assets   32,009    -    32,009    100 
Total costs and operating expenses  $71,601   $42,503   $29,098    68%

 

Cost of software licenses. The $0.7 million decrease is primarily due to lower amortization expense. Our amortization of capitalized development costs pertaining to a prior release of our Datawatch Monarch and Datawatch Automator (formerly Data Pump) products which were fully amortized as of September 30, 2014 decreased $0.7 million. In addition, amortization of acquired intangibles decreased by $0.4 million due to the reduction in carrying value of the asset as a result of the impairment charge recorded during the first fiscal quarter. These decreases in amortization expense were offset by a $0.2 million increase in royalties.

 

Cost of maintenance and services. Costs of maintenance and services increased $0.1 million as a result of a $0.3 million decrease in employee related expenses resulting from a 46 percent decrease in headcount due to the restructuring efforts that occurred during our first and second fiscal quarters and a shift to a web enabled, on-line approach to the delivery of training, which were offset by a $0.4 million increase in restructuring charges.

 

Sales and marketing expenses. The decrease in sales and marketing expenses is comprised of an increase in sales expense of $0.4 million and a decrease in marketing expense of $2.3 million. The increased sales expense results from a $0.3 million increase in employee-related costs attributable to increased headcount and a $0.5 million increase in professional services when compared to last year, a $0.3 million increase in restructuring charges offset by decreased share-based compensation of $0.7 million, and a $0.2 million decrease in amortization which resulted from the reduction in the carrying value of intangibles due to the impairment charges recorded during the first fiscal quarter. The marketing decrease is primarily driven by the restructuring effort which resulted in (i) an increase of $0.3 million of restructuring charges offset by a $1.7 million decrease in marketing and promotional expenses compared to fiscal 2014 resulting from expenses incurred during 2014 in connection with the redesign of our website and a decrease in other marketing materials as we refocus our lead generation programs, (ii) a $0.5 million decrease in share-based compensation, and (iii) a $0.3 million decrease in other employee related costs. In addition, consulting costs decreased $0.2 million.

 

Engineering and product development expenses. The $0.1 million decrease is driven mainly by a $1.2 million decrease in share-based compensation resulting from headcount reductions associated with the restructuring efforts, which were offset by an increase of $0.3 million in restructuring costs. In addition, consulting costs increased $0.4 million and facility related expenses increased $0.3 million driven by an increased focus on product development to support ongoing development of our managed analytics platform.

 

General and administrative expenses. The $0.2 million decrease is mainly the result of a $0.7 million decrease in external consulting costs, offset by a $0.3 million increase in employee related costs as we phased out the use of consultants by hiring employees. In addition, we incurred charges resulting from the restructuring, which were offset by decreases in share-based compensation due to the reduced headcount.

 

Impairment of goodwill and long-lived assets. We recorded goodwill and long-lived assets impairment charges of $21.7 million and $10.3 million, respectively, as a result of performing an interim impairment review as required under Accounting Standards Codification (“ASC”) 350 Intangibles – Goodwill and Other. The write-down of the long-lived assets will have a favorable effect on the statements of operations from reduced future intangible amortization expense.

 

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Other income (expense)

 

   Nine Months Ended         
   June 30,       Percentage 
   2015   2014   Increase   Change 
Interest expense  $-   $(406)  $406    100%
Other (expense) income  $9   $(755)  $764    101%
Foreign currency transaction loss  $(47)  $(152)  $105    69%

 

Interest expense. There was no interest expense for the nine months ended June 30, 2015. Interest expense of $0.4 million for the nine months ended June 30, 2014 represents primarily interest expense related to our $4.0 million subordinated notes with a private investment company and borrowings under a $2.0 million revolving credit facility with a bank, each of which were paid off in full and terminated during the nine months ended June 30, 2014.

 

Other income (expense). There was a minimal amount of other income for the nine months ended June 30, 2015. Other expense for the nine months ended June 30, 2014 of $0.8 million represents primarily a loss on extinguishment of debt recorded as a result of paying down the $2.0 million subordinated note with a private investment company. The loss represented the unamortized debt discount on the subordinated note.

 

Foreign currency transactions loss. The foreign currency loss for the nine months ended June 30, 2015 and 2014 was primarily attributable to fluctuation of the British pound sterling and other foreign currencies we transact in.

 

Benefit for income taxes

 

   Nine Months Ended         
   June 30,       Percentage 
   2015   2014   Decrease   Change 
Income tax benefit  $(2,632)  $(270)  $(2,362)   (875)%

 

During the nine months ended June 30, 2015, we recorded a tax benefit of $2.6 million, primarily related to the change in the deferred tax liability in Sweden as a result of impairing non-goodwill intangibles and amortization, estimated state taxes, return to provision adjustments, and accruing interest on uncertain tax positions. During the nine months ended June 30, 2014, we recorded a tax benefit of $0.3 million, primarily related to losses generated in Sweden, estimated state taxes, return to provision adjustments, and accrued interest and penalties on uncertain tax positions.

 

OFF BALANCE SHEET ARRANGEMENTS, CONTRACTUAL OBLIGATIONS AND CONTINGENT LIABILITIES AND COMMITMENTS

 

We lease various facilities and equipment in the U.S. and overseas under non-cancelable operating leases which expire at various dates through 2022. The lease agreements generally provide for the payment of minimum annual rentals and pro-rata share of taxes and maintenance expenses. Rental expense for all operating leases was $0.3 million and $0.2 million for the three months ended June 30, 2015 and 2014, respectively, and $0.8 million and $0.7 million for the nine months ended June 30, 2015 and 2014, respectively. Certain of our facility leases include options to renew.

 

During the three months ended June 30, 2015, we entered into a facility lease in Bedford, MA for our new corporate headquarters. The lease is for 20,360 square feet commencing November 1, 2015 and ending on October 31, 2022 with a monthly expense of $42,000. We anticipate moving into the new facility during the first quarter of fiscal 2016 and expect to record a $0.1 million charge, which represents the remaining lease obligation under the lease agreement for the current corporate headquarters in Chelmsford, MA, upon the cease-use date of the existing corporate headquarters. In conjunction with entering into the lease, we were required to deposit $0.2 million into a restricted cash account as collateral for a Letter of Credit, which is included under the caption “Other long-term assets” in our consolidated balance sheets, for the period ended June 30, 2015.

 

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As of June 30, 2015, our contractual obligations include minimum rental commitments under non-cancelable operating leases and other long-term liabilities related to uncertain tax positions as follows (in thousands):

 

       Less than           More than 
Contractual Obligations:  Total   1 Year   1 – 2 Years   3 – 5 Years   5 Years 
Operating Lease Obligations  $4,766   $226   $891   $1,859   $1,790 
Other long-term liabilities  $342   $-   $-   $-   $342 

 

Royalty expense included in cost of software licenses was $0.2 million and $0.1 million for the three months ended June 30, 2015 and 2014, respectively, and $0.4 million and $0.3 million for the nine months ended June 30, 2015 and 2014, respectively.

 

Our software products are sold under warranty against certain defects in material and workmanship for a period of 30 to 90 days from the date of purchase. If necessary, we would provide for the estimated cost of warranties based on specific warranty claims and claim history. However, we have never incurred significant expense under our product or service warranties. As a result, we believe our exposure related to these warranty agreements is minimal. Accordingly, there are no liabilities recorded for warranty claims as of June 30, 2015.

 

We enter into indemnification agreements in the ordinary course of business. Pursuant to these agreements, we generally agree to indemnify, hold harmless, and reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally our customers, in connection with any patent, copyright or other intellectual property infringement claim by any third party with respect to our products. The term of these indemnification agreements is generally perpetual. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited. We have never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, we believe our exposure related to these agreements is minimal. Accordingly, we have no liabilities recorded for these potential obligations as of June 30, 2015.

 

Certain of our agreements also provide for the performance of services at customer sites. These agreements may contain indemnification clauses, whereby we will indemnify the customer from any and all damages, losses, judgments, costs and expenses for acts of our employees or subcontractors resulting in bodily injury or property damage. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have general and umbrella insurance policies that would enable us to recover a portion of any amounts paid. We have never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, we believe our exposure related to these agreements is minimal. Accordingly, we have no liabilities recorded for these potential obligations as of June 30, 2015.

 

As permitted under Delaware law, we have agreements with our directors whereby we will indemnify them for certain events or occurrences while the director is, or was, serving at our request in such capacity. The term of the director indemnification period is for the later of ten years after the date that the director ceases to serve in such capacity or the final termination of proceedings against the director as outlined in the indemnification agreement. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, our director and officer insurance policy would enable us to recover a portion of any future amounts paid. As a result of our insurance policy coverage, we believe our exposure related to these indemnification agreements is minimal. Accordingly, we have no liabilities recorded for these potential obligations as of June 30, 2015.

 

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LIQUIDITY AND CAPITAL RESOURCES

 

We believe that our current cash balances will be sufficient to meet our cash needs for working capital and anticipated capital expenditures for at least the next twelve months. At June 30, 2015, we had $36.3 million of cash and cash equivalents as compared $47.7 million as of September 30, 2014, a decrease of $11.4 million. $1.5 million of cash and cash equivalents at June 30, 2015 was located in foreign banks.

 

At June 30, 2015, we had working capital of $33.1 million as compared to $44.9 million as of September 30, 2014. We do not anticipate additional cash requirements to fund growth or the acquisition of additional complementary technology or businesses. However, if in the future, such expenditures are anticipated or required, we may seek additional financing by issuing equity or obtaining credit facilities to fund such requirements. There can be no assurance that we will be able to issue additional equity or obtain a new or expanded credit facility at attractive prices or rates, or at all.

 

We had a net loss of $46.8 million for the nine months ended June 30, 2015 as compared to net loss of $17.5 million for the nine months ended June 30, 2014. During the nine months ended June 30, 2015 and 2014, $11.0 million and $8.6 million of cash was used in our operations, respectively. During the nine months ended June 30, 2015, the main use of cash in operations was net loss adjusted for depreciation and amortization, share-based compensation expense, deferred income taxes and the impairment of goodwill and long-lived assets as well as the increases in accounts receivable and accounts payable offset by decreases in prepaid expenses and other assets and deferred revenue. During the nine months ended June 30, 2014, the main use of cash in operations was net loss adjusted for depreciation and amortization, share-based compensation expense, loss on extinguishment of debt as well as the decrease in accounts receivable and accounts payable.

 

Net cash used in investing activities for the nine months ended June 30, 2015 of $0.4 million is related to the purchase of property and equipment. Net cash used in investing activities for the nine months ended June 30, 2014 of $0.4 million is related to the capitalized software development costs and the purchase of property and equipment.

 

Net cash provided by financing activities for the nine months ended June 30, 2015 of $58,000 is related to the proceeds from the issuance of common stock. Net cash provided by financing activities for the nine months ended June 30, 2014 of $48.9 million was primarily attributable to a public offering offset by the repayment of debt. On February 19, 2014, we completed a public offering of 2,018,250 shares of common stock at a price to the public of $28.50 per share. The number of shares we sold includes the underwriters’ full exercise of their over-allotment option of 263,250 shares. Net proceeds from the offering, after underwriting discounts and expenses were $53.6 million.

 

We believe that our current operations have not been materially impacted by the effects of inflation.

 

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Derivative Financial Instruments, Other Financial Instruments, and Derivative Commodity Instruments

 

At June 30, 2015, we did not participate in or hold any derivative financial instruments or commodity instruments. We hold no investment securities that possess significant market risk.

 

Primary Market Risk Exposures

 

Our primary market risk exposure is foreign currency exchange rate risk. International revenues and expenses are generally transacted by our foreign subsidiaries and are denominated in local currency. 20% and 27% of our revenues for the three months ended June 30, 2015 and 2014, respectively, and 21% and 23% of our revenues for the nine months ended June 30, 2015 and 2014, respectively, were from our foreign subsidiaries. In addition, 25% and 22% of our operating expenses for the three months ended June 30, 2015 and 2014, respectively, and 14% and 23% of our operating expenses for the nine months ended June 30, 2015 and 2014, respectively, were from our foreign subsidiaries.

 

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We are exposed to foreign currency exchange rate risk inherent in conducting business globally in several currencies, of which the most significant to our operations has historically been the British Pound. Our exposure to currency exchange rate fluctuations has been and is expected to continue to be modest due to the fact that the operations of our international subsidiaries are almost exclusively conducted in their respective local currencies, and dollar advances to our international subsidiaries, if any, are usually considered to be of a long-term investment nature. Accordingly, the majority of currency movements are reflected in our other comprehensive (loss) income. Foreign currency translation gains arising during the three months ended June 30, 2015 were $0.1 million. Foreign currency translation losses arising during the three months ended June 30, 2014 were $0.1 million. Foreign currency translation losses arising during the nine months ended June 30, 2015 were $29,000. Foreign currency translation gains arising during the nine months ended June 30, 2014 were $26,000. There are, however, certain situations where we will invoice customers in currencies other than our own. Such gains or losses from operating activity, whether realized or unrealized, are reflected in “Foreign currency transaction gain (loss)” section of the accompanying consolidated statements of operations and were losses of $36,000 for the three months ended June 30, 2015 Gains from foreign currency transactions were $10,000 for the 2014 Losses from foreign currency transactions were $47,000 and $0.2 million for the nine months ended June 30, 2015 and 2014, respectively.

 

Item 4. CONTROLS AND PROCEDURES

 

Our management, including the principal executive officer and principal financial officer, have evaluated our disclosure controls and procedures as of the end of the period covered by this report and have concluded that our disclosure controls and procedures are effective. They also concluded that there were no changes in our internal control over financial reporting, which have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting as of the end of the period covered by this report.

 

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PART II. OTHER INFORMATION

 

Item 1. LEGAL PROCEEDINGS

 

We are occasionally involved in legal proceedings and other claims arising out of our operations in the normal course of business. We are not party to any litigation that we believe will have a material adverse effect on our consolidated financial condition, results of operations or cash flows.

 

Item 1A. RISK FACTORS

 

In addition to the other information set forth in this report, the reader should carefully consider the factors discussed in Part I, Item 1A under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended September 30, 2014, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing the Company. Additional risks and uncertainties not currently known or that it currently deems to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

 

Risks Relating to our Business

 

We have recently recorded substantial impairment charges. Any future impairments of our assets could negatively impact our results of operations.

 

Non-amortizing intangible assets, including goodwill, are tested for impairment annually or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. An impairment test is also required for other long-lived assets if events or changes in circumstances indicate that the carrying value may not be recoverable. Examples of events or changes in circumstances indicating that the carrying value of such intangible assets may not be recoverable could include a significant adverse long term outlook; unanticipated competition or the introduction of disruptive technology; failure of an anticipated product or product line; testing for recoverability under the Impairment or Disposal of Long-Lived Assets Subsections of Subtopic ASC 360-10; loss of key personnel; or a more-likely-than-not expectation that a significant portion of the company will be sold or otherwise disposed of. During the nine months ended June 30, 2015, the Company recorded an impairment of goodwill and long-lived assets in the amount of $32.0 million, related to assets obtained in the acquisition of Panopticon Software AB (“Panopticon”), as a result of revenue shortfalls, operational changes in the sales organization as well as a sustained decline in our share price. Any future impairment of goodwill or other intangible assets could have a negative impact on our profitability and financial results.

 

Item 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

Item 6. Exhibits

 

  31.1   Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
       
  31.2   Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
       
  32.1   Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
       
  32.2   Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
       
  101   The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2015 formatted in Extensible Business Reporting Language (XBRL).

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized on July 29, 2015.

 

  DATAWATCH CORPORATION
   
   
  /s/ Michael A. Morrison
  Michael A. Morrison
  President, Chief Executive Officer, and
  Director (Principal Executive Officer)
   
   
  /s/ James L. Eliason
  James L. Eliason
  Chief Financial Officer
  (Principal Financial Officer)

 

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