UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

ý                                  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2006

OR

o                                  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
Incorporation or Organization)

 

(I.R.S. Employer
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 if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes
o   No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes
o   No x

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 o

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 a large accelerated filer, an accelerated filer or a non-accelerated filer. See definitions of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer   o    Accelerated filer   o    Non-accelerated filer x

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

The aggregate market value of voting stock held by non-affiliates of the registrant, based on the closing price of the registrant’s common stock on March 31, 2006, the last business day of the Company’s most recently completed second fiscal quarter, as reported by the NASDAQ SmallCap Market was $16,390,909.

The number of shares of the registrant’s common stock, $.01 par value, outstanding as of December 26, 2006 was 5,516,923.

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, 2006. Portions of such Proxy Statement are incorporated by reference in Part III of this report.

 




DATAWATCH CORPORATION

ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

Part I

 

 

 

 

 

Item 1.

Business

 

Item 1A.

Risk Factors

 

Item 1B.

Unresolved Staff Comments

 

Item 2.

Properties

 

Item 3.

Legal Proceedings

 

Item 4.

Submission of Matters to a Vote of Security Holders

 

 

 

 

Part II

 

 

 

 

 

Item 5.

Market for Registrant’s Common Equity and Related Shareholder Matters

 

Item 6.

Selected Consolidated Financial Data

 

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Item 7A.

Quantitative and Qualitative Disclosures about Market Risk

 

Item 8.

Financial Statements and Supplementary Data

 

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

Item 9A

Controls and Procedures

 

Item 9B.

Other Information

 

 

 

 

Part III

 

 

 

 

 

Item 10.

Directors and Executive Officers of the Registrant

 

Item 11.

Executive Compensation

 

Item 12.

Security Ownership of Certain Beneficial Owners and Management

 

Item 13.

Certain Relationships and Related Transactions

 

Item 14.

Principal Accounting Fees and Services

 

 

 

 

Part IV

 

 

 

 

 

Item 15.

Exhibits and Financial Statement Schedules

 

 

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PART I

Item 1.  BUSINESS

GENERAL

Datawatch Corporation (the “Company” or “Datawatch”), founded in 1985, is a leading vendor in the Enterprise Information Management market space. By providing solutions that build on a Service Oriented Architecture (“SOA”) framework and Monarch report mining technologies, Datawatch allows organizations to access, archive, enhance, analyze and deliver information from wherever it resides inside or outside the enterprise to solve business problems. The ability to maximize an organization’s investment in existing systems, databases, and content management archives allows Datawatch to rapidly implement business intelligence, performance management, report mining, Extract, Transform, Load (“ETL”) and business service management solutions with very high return on investment. Datawatch products are used in more than 20,000 companies, institutions and government agencies worldwide.

The Company offers its enterprise products through the sale of perpetual licenses as well as a subscription pricing model that 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. The subscription arrangement includes software, maintenance and unspecified future upgrades including major version upgrades. During fiscal 2006, sales under the subscription model increased by over 36% as general industry knowledge and acceptance of the model grew substantially in the fiscal year.

The Company is a Delaware corporation with executive offices located at 271 Mill Road, Quorum Office Park, Chelmsford, MA 01824 and the Company’s telephone number is (978) 441-2200.  Periodic reports are made available to the public, free of charge, on the Company’s website, www.datawatch.com and through the SEC’s website, www.sec.gov as soon as reasonably practicable after they have been filed with the SEC.

PRODUCTS

Monarch - Datawatch is best known for its popular desktop report mining and business intelligence application called Monarch. More than 450,000 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 PDF and HTML files, databases, spreadsheets and Open Data Base Connectivity (“ODBC”) sources as well as reports.  The Monarch product line represented approximately 56% of total revenues for the fiscal year 2006.

Monarch Data Pump - Monarch Data Pump (“MDP”) provides powerful information delivery and data ETL 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 Computer Output to Laser Disk/Enterprise Record Management (“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|BDS - Datawatch|BDS (Business Document Server) is a high speed, high volume document archive system, storing text as well as images, intelligent data streams and unstructured content, complete with file compression. Datawatch|BDS is capable of enabling thousands of end users to access and retrieve stored documents

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in a matter of seconds via the network or web. Datawatch|BDS also offers advanced business benefits, including optional automatic email notification to end users of newly archived documents (“e-Notify”), with rules-based options for email content, as well as optional web-enabled transformation of business documents into customized data for easy analysis.

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.

Datawatch|MailManager Datawatch|MailManager is a highly scalable e-mail management solution that provides complete lifecycle, compliance, and storage management for Microsoft Exchange environments. It is a compliance solution built specifically for the corporate enterprise, able to support even the most stringent regulatory requirements. Datawatch|MailManager automates the e-mail management lifecycle. It captures internal, outgoing and incoming email correspondence, indexing it and managing its retention based on an organization’s internal policies. In the case of audit or legal discovery, related e-mail can be instantly and accurately retrieved for rapid response.

Visual|Insight Visual|Insight is a performance management solution that provides web based scorecarding, knowledge management and Key Performance Indicator (KPI) reporting. Built on the Datawatch|Researcher .NET platform, Visual|Insight not only allows for performance management, but can actually facilitate performance improvement. Highly customizable, Visual|Insight can access data from any and all organizational databases, as well as having the ability to take advantage of existing trusted data sources such as reports, for ease and speed of installation and a quick return on investment.

Datawatch|Researcher Datawatch|Researcher is the tool kit for building performance management and workflow capabilities into Visual|Insight, Datawatch|ES and Visual|QSM. Datawatch|Researcher is a .NET based content and data aggregation platform that searches inter-related data, documents, and communications scattered over multiple and disparate repositories including databases, document and content management systems, email repositories, the Internet and more. It then merges and analyzes the results for uses in balanced scorecards, KPI reporting, problem management and business process management. It also can turn the results into comprehensive actionable case records for easier compliance, auditing, accounting, and billing processes.

Visual | QSM - Visual|QSM is a fully internet-enabled IT support solution that can scale from a basic help desk system to a full business management 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.  The Visual|QSM product line represented approximately 21% of total revenues for fiscal year 2006.

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

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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 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.

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 $659.  Multi-user licenses for Monarch Standard Edition are typically priced from $340 to $550 per user, depending upon the number of users. A single user license for Monarch Professional Edition is priced at $799.  Multi-user licenses for Monarch Professional Edition are typically priced from $450 to $685 per user, depending upon the number of users. Monarch Data Pump 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 enterprise report management and business 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 the majority of such sales priced in the $25,000 to $50,000 range depending on the number of software modules and user licenses sold. Entry-level Datawatch|BDS systems are priced at approximately $55,000. The majority of our sales of Datawatch|BDS systems are priced in the range of $100,000 to $250,000. Entry-level Datawatch|ES and Visual|Insight systems are priced at approximately $30,000 and $40,000, respectively. The majority of sales for these products are priced in the range of $60,000 to $200,000. Entry-level Datawatch|MailManager systems are priced at approximately $12,000 with the majority of such sales priced in the range of $18,000 to $250,000. An entry-level Visual|QSM system is priced at approximately $20,000 with the majority of such sales priced in the range of $35,000 to $200,000. An entry-level Visual|HD system sells for less than $10,000, with the majority of such sales 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 range from 90 days to 24 months and automatically renew unless terminated with 90 days notice. The subscription arrangement includes software, maintenance and unspecified future upgrades including major version upgrades. The subscription pricing does not include professional services. Such professional services are invoiced separately. Prices for Datawatch|BDS subscriptions typically range from approximately $4,500 to $11,500 per month. Prices for Datawatch|ES and Visual|Insight subscriptions typically range from approximately $2,000 to $9,000 per month. Prices for Datawatch|MailManager subscriptions typically range from approximately $850 to $11,500 per month. Visual|QSM subscriptions typically range from approximately $1,500 to $9,000 per month, and Visual|HD subscriptions typically range from $500 to $2,500 per month.

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

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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 2006, 2005 and 2004, one distributor, Ingram Micro Inc., represented approximately 15%, 19% and 20%, respectively, of the Company’s total revenue.  During fiscal 2006, another distributor, Tech Data, represented approximately 13% of the Company’s total revenue. No other customer accounted for more than 10% of the Company’s total revenue in fiscal 2006, 2005 or 2004. 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 (which are primarily in the UK), not including export sales from domestic operations, represented approximately 32%, 36% and 39% of the Company’s total revenue for fiscal 2006, 2005 and 2004, respectively.  See Note 10 to the Company’s Consolidated Financial Statements for segment information.

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.

An existing agreement between Datawatch and Math Strategies grants the Company exclusive worldwide rights to use and distribute certain intellectual property owned by Math Strategies and incorporated by the Company in its Monarch, Monarch Data Pump, VorteXML and certain other products. In February 2006, the Company extended its exclusive worldwide distribution rights with Math Strategies for the technology used in the development of Monarch products until April 30, 2015. In addition, an amendment to the purchase option contract

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with Math Strategies, originally signed on April 29, 2004, gives Datawatch the option to purchase the intellectual property rights to the software source code and any existing patents at any time before April 30, 2015. This option, if exercised, would provide the Company with increased flexibility to utilize the purchased technology in the future.

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|BDS, 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 (“DTC”) 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 has integrated the Philippines development branch as an alternative development facility for its other enterprise products.  iMergence is a registered trademark of Datawatch Technologies Corporation.

Research and development expense was $2,093,707, $2,031,280 and $1,451,533 for fiscal years 2006, 2005 and 2004, respectively.

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|BDS, 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 Hyperion, 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

In addition to having certain patents pending on its software technologies, Datawatch 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.  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.  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 disks and the printing of user manuals, packaging and other related materials. High volume compact disk duplication is performed by

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non-affiliated subcontractors, while low volume compact disk duplication is performed in-house. 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.

EMPLOYEES

As of December 27, 2006, Datawatch had 131 full-time and 5 contract, temporary or part-time employees, including 38 engaged in marketing, sales, and customer service; 41 engaged in product consulting, training and technical support; 38 engaged in product management, development and quality assurance; 17 providing general, administrative, accounting, and IT functions; and 2 engaged in software production and warehousing.

Item 1A.  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 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations” of Part II 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 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 the subscription sales model 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.

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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 operations.

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 the year ended September 30, 2006, Monarch, Visual|QSM and Visual|HD, Datawatch|ES and Datawatch|BDS accounted for approximately 58%, 22%, 15% and 5%, respectively, of the Company’s total revenue. The Company is wholly dependent on the Monarch, Datawatch|ES, Visual|QSM, Visual|HD, Datawatch|Researcher and Datawatch|BDS products, the latter of which was introduced during the fiscal year ended September 30, 2006 through the Company’s acquisition of certain assets of the Integrated Document Archiving and Retrieval Systems (“IDARS”) business of ClearStory Systems, Inc. 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 the years ended September 30, 2006, 2005 and 2004, international sales, including export sales from domestic operations, accounted for approximately 32%, 38% and 41%, respectively, of the Company’s total revenue.  The Company anticipates that international sales will continue to account for a significant percentage of its total revenue.  A significant portion of the Company’s total revenue will therefore be subject to risks associated with international sales, including unexpected changes in legal and regulatory requirements, changes in tariffs, exchange rates and other barriers, political and economic instability, possible effects of war and acts of terrorism, difficulties in account receivable collection, difficulties in managing distributors or representatives, difficulties in staffing and managing international operations, difficulties in protecting the Company’s intellectual property overseas, seasonality of sales and potentially adverse tax consequences.

Acquisition Strategy

As evidenced by the May 2006 acquisition of the IDARS business from ClearStory Systems, Inc., the August 2004 acquisition of Mergence Technologies Corporation and the October 2002 acquisition of Auxilor Inc., the Company continues to address the need to develop new products, in part, through the acquisition of other

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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.

Compliance with Financial Covenants and other Provisions of the Credit Agreement

The Company currently has a secured credit agreement with a bank (the “Bank”), which includes certain cash financial covenants that the Company must meet on a monthly basis.  At June 30, 2006 and September 30, 2006, the Company did not meet these covenants, but sought and received waivers from the Bank with respect to these covenants and modifications to the credit agreement intended to make future defaults less likely.  However, there can be no assurance that the Company will not violate these financial covenants in the future or that, if it does, the Bank will grant any further waivers or modifications.  This may result in the Company not being able to borrow any additional amounts under the credit agreement, the Company may have to pay back the entire principal amount outstanding plus accrued interest, or, or if the Company were unable to repay the outstanding amount, the Bank may seek to sell the Company’s assets, any of which may have a material impact on the Company.

Dependence on New Introductions; New Product Delays

Growth in the Company’s business depends in substantial part on the continuing introduction of new products. The length of product life cycles depends in part on end-user demand for new or additional functionality in the Company’s products. If the Company fails to accurately anticipate the demand for, or encounters any significant delays in developing or introducing, new products or additional functionality on its products, there could be a material adverse effect on the Company’s business. Product life cycles can also be affected by the introduction by suppliers of operating systems of comparable functionality within their products. The failure of the Company to anticipate the introduction of additional functionality in products developed by such suppliers could have a material adverse effect on the Company’s business. In addition, the Company’s competitors may introduce products with more features and lower prices than the Company’s products. Such increase in competition could adversely affect the life cycles of the Company’s products, which in turn could have a material adverse effect on the Company’s business.

Software products may contain undetected errors or failures when first introduced or as new versions are released.  There can be no assurance that, despite testing by the Company and by current and potential end-users, errors will not be found in new products after commencement of commercial shipments, resulting in loss of or delay in market acceptance. Any failure by the Company to anticipate or respond adequately to changes in technology and customer preferences, or any significant delays in product development or introduction, could have a material adverse effect on the Company’s business.

Rapid Technological Change

The markets in which the Company competes have undergone, and can be expected to continue to undergo, rapid and significant technological change. The ability of the Company to grow will depend on its ability to successfully update and improve its existing products and market and license new products to meet the changing demands of the marketplace and that can compete successfully with the existing and new products of the Company’s competitors.  There can be no assurance that the Company will be able to successfully anticipate and satisfy the changing demands of the personal computer software marketplace, that the Company will be able to continue to enhance its product offerings, or that technological changes in hardware platforms or software operating systems, or the introduction of a new product by a competitor, will not render the Company’s products obsolete.

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Competition in the PC Software Industry

The software market for personal computers is highly competitive and characterized by continual change and improvement in technology. Several of the Company’s existing and potential competitors, including BMC Software, Actuate Corporation, Hyperion, 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 all 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 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 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.

11




Item 1B.  UNRESOLVED STAFF COMMENTS

Not applicable.

Item 2.  PROPERTIES

The Company is currently headquartered in 14,683 square feet of leased office space in Chelmsford, Massachusetts pursuant to a sublease agreement executed on September 28, 2005. The sublease expires in June 2011. The sublease contains annual rent escalations for each year of the sublease as well as an abatement of rent during the first twelve months of the sublease term. The aggregate rent for the remaining term of the sublease is approximately $736,000. In addition to rent, the sublease requires the Company to pay certain taxes, insurance and operating costs related to the leased facility based on the Company’s pro-rata share of such costs. The Company is also responsible for the costs of certain tenant improvements associated with the new facility but will be entitled to reimbursement for certain of such costs from the sublessor.

The Company also maintains a lease on offices in Rutherford, New Jersey and maintains international sales and administrative offices in the United Kingdom and Australia. In addition, the Company maintains leases on offices in France and Germany, and a software development and testing facility in the Philippines.

Item 3.  LEGAL PROCEEDINGS

The Company is occasionally involved in legal proceedings and other claims arising out of our operations in the normal course of business. The Company is not party to any litigation that management believes will have a material adverse effect on the Company’s consolidated financial condition, results of operations, or cash flows.

Item 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 1, 2006 are as follows:

Robert W. Hagger

 

58

 

President, Chief Executive Officer and Director

John H. Kitchen, III

 

50

 

Senior Vice President of Desktop & Server Solutions and Secretary

John J. Hulburt

 

40

 

Vice President of Finance, Chief Financial Officer, Treasurer and Assistant Secretary

 

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

12




since July 2000, Mr. 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.

JOHN J. HULBURT, Vice President of Finance, Chief Financial Officer, Treasurer and Assistant Secretary.  Mr. Hulburt assumed the position of Vice President of Finance on January 11, 2005.  Prior to joining Datawatch, Mr. Hulburt was Director of Audit and SEC Compliance at Bruker Biosciences Corporation, a publicly traded medical device company, a position he held since July 2003. Mr. Hulburt served as Chief Financial Officer and Treasurer of Bruker Daltonics Inc. before its merger with Bruker AXS. Mr. Hulburt is a Certified Public Accountant and from 1994 to 2000 he began his career with the accounting firms Ernst & Young LLP and Arthur Andersen LLP. On November 1, 2006, Mr. Hulburt resigned from these positions at the Company effective January 31, 2007.

13




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 Capital Market (formerly 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, 2006

 

High

 

Low

 

 

 

 

 

 

 

4th Quarter

 

3.68

 

2.47

 

3rd Quarter

 

3.85

 

3.36

 

2nd Quarter

 

5.38

 

3.53

 

1st Quarter

 

4.85

 

3.04

 

 

For the Year Ended

 

Common Stock

 

September 30, 2005

 

High

 

Low

 

 

 

 

 

 

 

4th Quarter

 

4.31

 

3.51

 

3rd Quarter

 

5.12

 

3.53

 

2nd Quarter

 

5.28

 

4.10

 

1st Quarter

 

5.30

 

3.22

 

 

There are approximately 100 shareholders of record as of December 1, 2006.  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 26, 2006 was at $2.61.

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, 2006 is incorporated herein by reference.

Item 6.   SELECTED CONSOLIDATED FINANCIAL DATA

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, 2006 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.

14




 

Statements of Operations Data

 

 

 

 

 

 

 

 

 

 

 

Years Ended September 30,

 

2006

 

2005

 

2004

 

2003

 

2002

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

20,811,244

 

$

21,511,595

 

$

19,335,146

 

$

17,712,206

 

$

19,440,743

 

Costs and Expenses

 

21,345,480

 

20,823,225

 

18,410,460

 

16,886,018

 

18,499,009

 

(Loss) Income from Operations

 

(534,236

)

688,370

 

924,686

 

826,188

 

941,734

 

(Loss) Income from Continuing Operations

 

(554,553

)

800,414

 

1,084,776

 

846,545

 

846,379

 

Discontinued Operations Income Gain on Sale of Guildsoft Operations

 

 

 

 

 

17,096

 

Income from Discontinued Operations

 

 

 

 

 

17,096

 

Net (Loss) Income

 

$

(554,553

)

$

800,414

 

$

1,084,776

 

$

846,545

 

$

863,475

 

 

 

 

 

 

 

 

 

 

 

 

 

Net (Loss) Income from Continuing Operations per Common Share:

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.10

)

$

0.15

 

$

0.21

 

$

0.16

 

$

0.17

 

Diluted

 

$

(0.10

)

$

0.14

 

$

0.19

 

$

0.16

 

$

0.16

 

 

 

 

 

 

 

 

 

 

 

 

 

Net (Loss) Income per Common Share:

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.10

)

$

0.15

 

$

0.21

 

$

0.16

 

$

0.17

 

Diluted

 

$

(0.10

)

$

0.14

 

$

0.19

 

$

0.16

 

$

0.16

 

 

Balance Sheet Data
September 30,

 

2006

 

2005

 

2004

 

2003

 

2002

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Assets

 

$

16,025,094

 

$

13,412,256

 

$

12,628,794

 

$

10,503,942

 

$

9,454,466

 

Working Capital (Deficiency)

 

(2,466,168

)

3,487,484

 

2,547,879

 

3,407,639

 

2,022,702

 

Long-Term Obligations

 

265,365

 

 

125,373

 

3,115

 

12,795

 

Shareholders’ Equity

 

6,955,374

 

7,305,764

 

6,435,929

 

5,138,115

 

4,060,212

 

 

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

Introduction

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 content management and reporting, business intelligence, data replication, business service management and help desk markets.

Datawatch’s principal products included in Desktop and Server Software, Report Management and Business Service Management Solutions are:  Monarch, a desktop report mining and business intelligence application that lets users extract and manipulate data from ASCII report files, PDF files or HTML files produced on any mainframe, midrange, client/server or PC system; Monarch Data Pump, a data replication and migration tool that

15




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|MS, 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|BDS, a system for high-volume document capture, archiving, and online presentation; 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, which subsequently changed its name to Datawatch Technologies, in exchange for $2,500,000 in cash and incurred $96,691 in direct costs.  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, not all Mergence products are subject to royalties. The activities of Mergence from August 11, 2004 are included in 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 May 3, 2006, Datawatch acquired certain assets of ClearStory Systems, Inc’s Integrated Document Archiving and Retrieval Systems (“IDARS”) business in exchange for $4,349,000 in cash and incurred $441,000 in direct costs. The purchase agreement also included a provision for quarterly cash payments for a period of eighteen months equal to 30% of revenue, as defined, of the Datawatch|BDS product excluding the first $337,500 of revenue. These amounts will be charged to goodwill as additional purchase price, as incurred. At September 30, 2006, the Company has accrued approximately $215,000 related to future earn out payments. The activities of the IDARS business from May 3, 2006 are included in the Company’s consolidated financial statements.  See Note 2 to the Consolidated Financial Statements for more detailed financial information on the acquisition of the IDARS business.

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 allow customers to begin using the Company’s products at a lower initial cost of software acquisition. Subscriptions automatically renew unless terminated with 90 days notice.  The subscription arrangement includes software, maintenance and unspecified future upgrades including major version upgrades. The initial subscription rate is the same as the renewal rate. During fiscal 2004, 2005 and 2006, customer interest in and acceptance of the subscription model has been increasing as evidenced by a greater than 36% growth in subscription revenue, from approximately $451,000 to approximately $615,000, during fiscal 2006 as compared to fiscal 2005.

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 different outcomes. In order for a reader to understand the following information regarding the financial performance and condition of the Company, an understanding of those accounting policies is important. Certain of those policies are comparatively more important to 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 provided in this report are described below.

16




Revenue Recognition, Allowance for Bad Debts 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 33%, 31% and 29%, of total sales for fiscal years 2006, 2005 and 2004, respectively. 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 an 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 software products 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 90 day service period 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, and provided that all other criteria for revenue recognition are met, the deferred revenue amount is recognized ratably over the period the service is provided. The customer is then invoiced every 90 days and, in accordance with SOP 97-2, revenue is recognized ratably over the period the service is provided. The subscription arrangement includes software, maintenance and unspecified future upgrades including major version upgrades. The initial subscription rate is the same as the renewal rate. Subscriptions can be cancelled by the customer at any time by providing 90 days written notice.

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 Statement of Financial Accounting Standards No. 48, “ Revenue Recognition when Right of Return Exists ” (“SFAS No. 48”).

17




Revenue from the sale of software products to distributors and resellers is recognized at the time of shipment providing all other criteria for revenue recognition as stated above are met and (i) the distributor or reseller is unconditionally obligated to pay for the products, including no contingency as to product resale, (ii) the distributor or reseller has independent economic substance apart from the Company, (iii) the Company is not obligated for future performance to bring about product resale, and (iv) the amount of future returns can be reasonably estimated. The Company’s experience and history with its distributors and resellers allows for reasonable estimates of future returns. Among other things, estimates of potential future returns are made based on the inventory levels at the various distributors and resellers, which the Company monitors frequently. Once the estimates of potential future returns from all sources are made, the Company determines if it has adequate returns reserves to cover anticipated returns and the returns reserve is adjusted as required. Adjustments are recorded as increases or decreases in revenue in the period of adjustment. Actual returns have historically been within the range estimated by the Company. The Company’s returns reserves were $78,836 and $123,315 as of September 30, 2006 and 2005, respectively.

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 collectibility 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. The Company’s allowance for doubtful accounts was $193,426 and $293,943 as of September 30, 2006 and 2005, respectively.

Deferred Tax Assets

The Company has deferred tax assets related to net operating loss carryforwards and tax credits that expire at different times through and until 2021. At September 30, 2006, the Company had U.S. federal tax loss carryforwards of approximately $7.6 million, expiring at various dates through 2021, including $520,000 resulting from the Mergence acquisition undertaken during 2004 which are subject to additional annual limitations as a result of the changes in Mergence’s ownership, and had approximately $2.0 million in state tax loss carryforwards, which also expire at various dates through 2021. An alternative minimum tax credit of approximately $148,000 is available to offset future regular federal taxes. Research and development credits of approximately $418,000 expire beginning in 2011. In addition, the Company has the following foreign net operating loss carryforwards: United Kingdom losses of $8.0 million with no expiration date, France losses of $130,000 with no expiration date, Germany losses of $2.0 million with no expiration date and Australia losses of $2.0 million with no expiration date.

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 four years while international operations have continued to generate operating losses. Accordingly, management does not believe the deferred tax assets are more likely than not to be realized and a full valuation allowance, previously provided against the deferred tax assets, continues to be provided. Management evaluates the realizability of the deferred tax assets quarterly and, if current economic conditions change or future results of operations are better than expected, future assessments may result in the Company concluding that it is more likely than not that all or a portion of the deferred tax assets are realizable. If this conclusion were reached, the valuation allowance against deferred tax assets would be reduced resulting in a tax benefit being recorded for financial reporting purposes. Total net deferred tax assets subject to a valuation allowance were approximately $4.7 million as of September 30, 2006. In relation to the recent asset purchase of the IDARS business, the applicable goodwill associated with this purchase has an indefinite life for US GAAP purposes but is deductible

18




over a 15 year life for tax reporting purposes. Accordingly, for each reporting period, the Company will record deferred tax expense and an offsetting deferred tax liability on this difference in tax amortization of intangibles with indefinite lives based on the Company’s effective tax rate for the period. The deferred tax expense recorded for the year ended September 30, 2006 was $35,550 .

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 the cost of software licenses using the straight-line method over the estimated life (which approximates the ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product) which is generally 24 to 72 months. The Company’s capitalized software was $473,114 and $583,158 at September 30, 2006 and 2005, respectively.

Goodwill, Other Intangible Assets and Other Long-Lived Assets

The Company performs an evaluation of whether goodwill is impaired annually or when events occur or circumstances change that would more likely than not reduce the fair value of the applicable reporting unit below its carrying amount. The annual impairment analysis is performed each May of the applicable fiscal year.  Fair value is determined using market comparables for similar businesses, current market valuations of our common stock, or forecasts of discounted future cash flows. The Company also reviews other intangible assets and other long-lived assets when an indication of potential impairment exists, such as a significant reduction in cash flows associated with the assets. Should the fair value of the Company’s long-lived assets decline because of reduced operating performance, market declines, or other indicators of impairment, a charge to operations for impairment may be necessary.  No impairment charges were taken during fiscal 2006.

Accounting for stock-based compensation

With the adoption of Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”) on October 1, 2005, the Company is required to record the grant date fair value of stock-based compensation awards as compensation costs. For the fiscal year ended September 30, 2006, the Company recorded stock-based compensation expense of $67,137. In order to determine the fair value of stock options on the date of grant, the Company applies the Black-Scholes option-pricing model. Inherent in this model are assumptions related to expected stock-price volatility, option life, risk-free interest rate and dividend yield. While the risk-free interest rate and dividend yield are less subjective assumptions, typically based on factual data derived from public sources, the expected stock-price volatility and option life assumptions require a greater level of judgment which makes them critical accounting estimates.

The Company uses an expected stock-price volatility assumption that is a combination of both current and historical implied volatilities of the underlying stock which are obtained from public data sources. The Company believes this approach results in a reasonable estimate of volatility. For stock option grants issued during the fiscal year ended September 30, 2006, the Company used a weighted-average expected stock-price volatility of 96% based upon the implied volatility at the time of issuance.

With regard to the weighted-average option life assumption, the Company considers the exercise behavior of past grants and models the pattern of aggregate exercises. Patterns are determined on specific criteria of the aggregate pool of optionees including the reaction to vesting, realizable value and short-time-to-maturity effect. For stock option grants issued during the year ended September 30, 2006, the Company used a weighted-average expected option life assumption of 5 years.

19




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 the Company’s consolidated financial statements.  The operating results for any period should not be considered indicative of the results expected for any future period.

 

Year Ended September 30,

 

 

 

2006

 

2005

 

2004

 

REVENUE:

 

 

 

 

 

 

 

Software licenses and subscriptions

 

63.2

%

66.2

%

64.3

%

Maintenance and services

 

36.8

%

33.8

%

35.7

%

Total Revenue

 

100.0

%

100.0

%

100.0

%

 

 

 

 

 

 

 

 

COSTS AND EXPENSES:

 

 

 

 

 

 

 

Cost of software licenses and subscriptions

 

10.9

%

11.7

%

13.4

%

Cost of maintenance and services

 

19.0

%

16.0

%

14.0

%

Sales and marketing

 

43.9

%

40.4

%

39.5

%

Engineering and product development

 

10.1

%

9.4

%

7.5

%

General and administrative

 

18.7

%

19.3

%

20.9

%

Total costs and expenses

 

102.6

%

96.8

%

95.3

%

(LOSS) INCOME FROM OPERATIONS

 

(2.6

)%

3.2

%

4.7

%

Interest expense

 

(0.1

)%

0.0

%

0.0

%

Interest income and other income, net

 

0.2

%

0.4

%

0.2

%

(LOSS) INCOME BEFORE INCOME TAXES

 

(2.5

)%

3.6

%

4.9

%

(Provision) benefit for income taxes

 

(0.2

)%

0.1

%

0.7

%

NET (LOSS) INCOME

 

(2.7

)%

3.7

%

5.6

%

 

Fiscal Year Ended September 30, 2006 as Compared to

Fiscal Year Ended September 30, 2005

Total Revenues

The following table presents total revenue, total revenue increase (decrease) and percentage change in total revenue for the years ended September 30, 2006 and 2005:

 

Year Ended September 30,

 

Increase

 

Percentage

 

 

 

2006

 

2005

 

(Decrease)

 

Change

 

Software licenses and subscriptions

 

$

13,145,591

 

$

14,232,946

 

$

(1,087,355

)

(7.6

)%

Maintenance and services

 

7,665,653

 

7,278,649

 

387,004

 

5.3

%

 

 

 

 

 

 

 

 

 

 

Total revenue

 

$

20,811,244

 

$

21,511,595

 

$

(700,351

)

(3.3

)%

 

Revenue for the fiscal year ended September 30, 2006 was $20,811,244, which represents a decrease of $700,351 or approximately 3% from revenue of $21,511,595 for the fiscal year ended September 30, 2005. For fiscal 2006 Monarch (including Monarch Data Pump and VorteXML), Visual|QSM and Visual|HD, Datawatch|ES (including Monarch|RMS, Datawatch|Researcher and iMergence iStore) and Datawatch|BDS revenue accounted for 58%, 22%, 15% and 5% of total revenue, respectively, as compared to 59%, 26%, 15% and 0%, respectively, for fiscal 2005. The slight decrease in revenue can be attributed primarily to fewer license sales of Monarch due to fiscal 2006 being a non-upgrade release year for that product.

Software license and subscription revenue for the fiscal year ended September 30, 2006 was $13,145,591 or approximately 63% of total revenue, as compared to $14,232,946 or approximately 66% of total revenue for the fiscal year ended September 30, 2005. This represents a decrease of $1,087,355 or approximately 8% from fiscal 2005. The overall decrease in license revenue during fiscal 2006 includes a $770,000 decrease in Monarch license revenue (which also includes the Monarch Data Pump and VorteXML products), a $105,000 decrease in

20




the Report Management license and subscription revenue (which includes Datawatch|ES, Monarch|RMS, Datawatch|Researcher and iMergence iStore) and a $320,000 decrease in Business Service Management license and subscription revenue (which includes Visual|QSM and Visual|Help Desk), offset by a $108,000 increase in new Datawatch|BDS license revenues.  The Datawatch|BDS license revenue for fiscal 2006 is attributable to new products which were acquired in connection with the Company’s acquisition of the Integrated Document Archiving and Retrieval Systems (“IDARS”) business from ClearStory Systems, Inc. in May 2006. The Company attributes the decrease in Monarch software license revenue to the lack of a new release during fiscal 2006 as well as reduced customer spending during the year. The Company’s most recent upgrade to Monarch V8 was released in March 2005. The Company partially attributes the overall revenue decrease in Business Service Management license and subscription revenue to foreign exchange variances as the US dollar strengthened against most European currencies during most of the fiscal year ended September 30, 2006 as compared to the previous fiscal year.

Maintenance and services revenue for the fiscal year ended September 30, 2006 was $7,665,653 or approximately 37% of total revenue, as compared to $7,278,649 or approximately 34% of total revenue for the fiscal year ended September 30, 2005. This represents an increase of $387,004 or approximately 5% from fiscal 2005. The overall increase in maintenance and service revenue includes a $242,000 increase in Monarch revenue and a $921,000 increase in BDS revenue.  These increases were partially offset by decreases in Report Management maintenance and services revenues of $150,000 (which includes maintenance for Datawatch|ES, Monarch|RMS, Datawatch|Researcher and iMergence iStore) and Business Service Management maintenance and services revenues of $626,000 (which includes maintenance for Visual|QSM and Visual|Help Desk).  The BDS maintenance and service revenue for fiscal 2006 is related to the new products which were acquired in connection with the Company’s acquisition of the Integrated Document Archiving and Retrieval Systems (“IDARS”) business from ClearStory Systems, Inc. in May 2006. The Company attributes the overall increases in maintenance and services revenue to continued customer loyalty, which has resulted in high renewal rates for annual maintenance service contracts and an increased demand for professional services from existing customers, which also includes upgrades and additional training. The decrease in maintenance revenue for the Business Service Management product line was the result of lower renewal rates of annual maintenance contracts from existing customers due a mature market for the product. The decrease in Business Service Management maintenance and services also resulted in less demand for professional services work related to this product line.  No significant product upgrades were introduced within the Visual|QSM or Visual|Help Desk product lines during fiscal year 2006.

Costs and Operating Expenses

The following table presents costs and operating expenses, increase/(decrease) in costs and operating expenses and percentage changes in costs and operating expenses for the years ended September 30, 2006 and 2005:

 

Year Ended September 30,

 

Increase /

 

Percentage
Increase /

 

 

 

2006

 

2005

 

(Decrease)

 

(Decrease)

 

Costs of software licenses and subscriptions

 

$

2,268,458

 

$

2,515,060

 

$

(246,602

)

(9.8

)%

Costs of maintenance and services

 

3,949,314

 

3,438,319

 

510,995

 

14.7

%

Sales and marketing expenses

 

9,135,527

 

8,686,672

 

448,855

 

5.2

%

Engineering and product development expenses

 

2,093,707

 

2,031,280

 

62,427

 

3.1

%

General and administrative expenses

 

3,898,474

 

4,151,894

 

(253,420

)

(6.1

)%

 

 

 

 

 

 

 

 

 

 

Total costs and operating expenses

 

$

21,345,480

 

$

20,823,225

 

$

522,255

 

2.5

%

 

Cost of software licenses and subscriptions for the fiscal year ended September 30, 2006 was $2,268,458 or approximately 17% of software license and subscription revenues, as compared to $2,515,060 or approximately 18% of software license revenues for the fiscal year ended September 30, 2005. Costs of software licenses and subscriptions as a percentage of software licenses and subscription revenue have remained consistent year over year.

21




Cost of maintenance and services for the fiscal year ended September 30, 2006 was $3,949,314 or approximately 52% of maintenance and service revenues, as compared to $3,438,319 or approximately 47% of maintenance and service revenues, for the fiscal year ended September 30, 2005. This increase was primarily due to an increase in headcount of consulting and training staff. The IDARS acquisition added several individuals to the consulting staff headcount. The increase can also be attributed to the increasing subscription sales. As the Company continues to see a slight shift in selling more subscription term licenses, revenues are recognized over future periods rather than at the point of sale, while the associated professional services costs and systems installation costs are incurred during the period for the project work associated with the implementation of the systems for these customers.

Sales and marketing expenses were $9,135,527 for the fiscal year ended September 30, 2006, which represents an increase of $448,855 or approximately 5%, from $8,686,672 for the fiscal year ended September 30, 2005. This increase is primarily attributable to increased sales staff personnel, increased headcount from the IDARS acquisition, higher salaries and other related expenses, increased marketing expenses for lead generation, and trade show expense. During fiscal year 2004, the Company made a strategic decision for additional investments within the sales and marketing programs to improve upon the Company’s top-line revenue growth initiatives. This additional investment focus was continued throughout the 2005 and 2006 fiscal years.

During the first quarter of fiscal 2007, the Company initiated and completed a restructuring plan in an effort to reduce costs and focus on key areas of the business.  The restructuring plan was limited to one of the Company’s wholly owned subsidiaries, Datawatch International Limited (“DWI”) and resulted in charges for severance benefits and related costs for nine terminated employees of approximately $128,000.  All of these costs will be charged in the first quarter of fiscal 2007 and none were accrued or incurred in fiscal 2006. The Company anticipates annual sales and marketing expense savings from this restructuring to approximate $1.2 million.

Engineering and product development expenses were $2,093,707 for the fiscal year ended September 30, 2006, which represents an increase of $62,427 or approximately 3% from $2,031,280 for the fiscal year ended September 30, 2005. This increase is primarily attributable to the additional headcount resulting from the IDARS acquisition offset by cost savings attributable to the transitioning of previously outsourced development activities in-house. The Company will continue to use third-party development activities in conjunction with in-house development for the foreseeable future, but will rely more on the Company’s in-house engineering and product development capabilities.

General and administrative expenses were $3,898,474 for the fiscal year ended September 30, 2006, which represents a decrease of $253,420 or approximately 6% from $4,151,894 for the fiscal year ended September 30, 2005. This decrease is primarily attributable to a reduction in overhead costs including a small reduction in headcount and the related wage and employee benefit savings totaling approximately $99,000. During fiscal 2006 there was an emphasis on managing administrative costs with certain reductions to lower investor relation costs and a reduction in the allowance for doubtful accounts, due to the improvement in overall collection efforts. In addition, the Company experienced savings attributable to lower management incentive bonuses of approximately $100,000 due to the Company’s net loss for the fiscal year and lower accounting costs attributable to a delay in the Company’s implementation of Section 404 of the Sarbanes-Oxley Act as a result of the one year extension for compliance granted by the Securities and Exchange Commission.

Net loss for the year ended September 30, 2006 was $554,553, which compares to net income of $800,414 for the year ended September 30, 2005. Net loss for fiscal year 2006 includes a tax provision of approximately $36,000 while net income for fiscal year 2005 includes a tax benefit of $22,000.

22




Fiscal Year Ended September 30, 2005 as Compared to

Fiscal Year Ended September 30, 2004

Total Revenues

The following table presents total revenue, change in total revenue and total revenue growth for the year ended September 30, 2005 and 2004:

 

Year Ended September 30,

 

 

 

Percentage

 

 

 

2005

 

2004

 

Increase

 

Increase

 

Software licenses and subscriptions

 

$

14,232,946

 

$

12,441,667

 

1,791,279

 

14.4

%

Maintenance and services

 

7,278,649

 

6,893,479

 

385,170

 

5.6

%

 

 

 

 

 

 

 

 

 

 

Total revenue

 

$

21,511,595

 

$

19,335,146

 

$

2,176,449

 

11.3

%

 

Revenue for the fiscal year ended September 30, 2005 was $21,511,595, which represents an increase of $2,176,449 or approximately 11% from revenue of $19,335,146 for the fiscal year ended September 30, 2004.   For fiscal 2005 Monarch (including Monarch Data Pump and VorteXML and Redwing), Datawatch|ES (including Monarch|RMS, Datawatch|Researcher and iMergence iStore) and Visual|QSM and Visual|HD revenue accounted for 59%, 15% and 26% of total revenue, respectively, as compared to 56%, 14% and 30%, respectively, for fiscal 2004.

Software license and subscription revenue for the fiscal year ended September 30, 2005 was $14,232,946 or approximately 66% of total revenue, as compared to $12,441,667 or approximately 64% of total revenue for the fiscal year ended September 30, 2004.  This represents an increase of $1,791,279 or approximately 14% from fiscal 2004 to fiscal 2005.  The overall increase in license revenue during fiscal 2005 consists of a $1,421,000 increase in Monarch license revenue (which also includes the Monarch Data Pump and VorteXML products), a $324,000 increase in the Report Management license and subscription revenue (which includes Datawatch|ES, Monarch|RMS, Datawatch|Researcher and iMergence iStore), and a $46,000 increase in Business Service Management license and subscription revenue (which includes Visual|QSM and Visual|Help Desk).  The $324,000 net increase in the Report Management license and subscription revenue includes an increase of $532,000 from the Researcher and iMergence iStore products, which were new products from the Mergence acquisition.  This increase offsets a $208,000 decrease in revenues from Datawatch|ES.  The $46,000 net increase in Business Service Management license and subscription revenue consists of a $113,000 increase in Visual|QSM revenue, which offset a $67,000 decrease in Visual|HD revenue.  The Company attributes the increase in Monarch software license revenue to the release of a new version of Monarch V8 in March 2005, and also to customers who increased their capital spending as a result of a an improved domestic economic outlook.  The Company attributes the decrease in Visual|HD software license and subscription revenue to intensified competitive pressure to reduce pricing for a product in a mature market.

Maintenance and services revenue for the fiscal year ended September 30, 2005 was $7,278,649 or approximately 34% of total revenue, as compared to $6,893,479 or approximately 36% of total revenue for the fiscal year ended September 30, 2004.  This represents an increase of $385,170 or approximately 6% from fiscal 2004 to fiscal 2005. The overall increase in maintenance and service revenue consists of a $401,000 increase in Monarch revenue, and a $303,000 increase in Report Management revenue (which includes maintenance for Datawatch|ES, Monarch|RMS, Datawatch|Researcher and iMergence iStore).  These increases were partially offset by decreases in Business Service Management maintenance and services revenues of $319,000 (which includes maintenance for Visual|QSM and Visual|Help Desk). The $303,000 net increase in Report Management revenue includes both a $409,000 increase related to Researcher and iMergence iStore products, which were new products from the Mergence acquisition, offset by a $106,000 decrease in Datawatch|ES revenue.  The Company attributes the overall increases in maintenance and services revenue to continued customer loyalty, which has resulted in high renewal rates for annual maintenance service contracts and an increased demand for professional services from existing customers, which also includes upgrades and additional training. The decrease in maintenance revenue for the Business Service Management product line was the result of lower renewal rates of annual maintenance contracts from existing customers due a mature market for the product.  The decrease in Business Service Management maintenance and services also resulted in less demand for professional services work related to this product line. No significant product upgrades were introduced within the Visual product lines during fiscal year 2005.

23




Costs and Operating Expenses

The following table presents costs and operating expenses, changes in costs and operating expenses and costs and operating expenses growth for the year ended September 30, 2005 and 2004:

 

Year Ended September 30,

 

Increase /

 

Percentage
Increase /

 

 

 

2005

 

2004

 

(Decrease)

 

(Decrease)

 

Costs of software licenses and subscriptions

 

$

2,515,060

 

$

2,582,627

 

(67,567

)

(2.6

)%

Costs of maintenance and services

 

3,438,319

 

2,710,562

 

727,757

 

26.8

%

Sales and marketing expenses

 

8,686,672

 

7,629,058

 

1,057,614

 

13.9

%

Engineering and product development expenses

 

2,031,280

 

1,451,533

 

579,747

 

39.9

%

General and administrative expenses

 

4,151,894

 

4,036,680

 

115,214

 

2.9

%

 

 

 

 

 

 

 

 

 

 

Total costs and operating expenses

 

$

20,823,225

 

$

18,410,460

 

$

2,412,765

 

13.1

%

 

Cost of software licenses and subscriptions for the fiscal year ended September 30, 2005 was $2,515,060 or approximately 18% of software license and subscription revenues, as compared to $2,582,627 or approximately 21% of software license revenues for the fiscal year ended September 30, 2004.  The decrease in costs of software licenses and subscriptions as a percentage of software licenses and subscription revenue is due to the decreasing amortization expense of capitalized software costs and the increased sales of internally-developed products, which do not have any associated royalty expenses.

Cost of maintenance and services for the fiscal year ended September 30, 2005 was $3,438,319 or approximately 47% of maintenance and service revenues, as compared to $2,710,562 or approximately 39% of maintenance and service revenues, for the fiscal year ended September 30, 2004.  During fiscal 2005, gross margins on maintenance and services decreased and 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 and due to increased salaries for technical support staff.  During fiscal year 2005, the Company hired additional consulting staff and training the new staff resulted in lower utilization rates per person as compared to fiscal year 2004.

Sales and marketing expenses were $8,686,672 for the fiscal year ended September 30, 2005, which represents an increase of $1,057,614 or approximately 14%, from $7,629,058 for the fiscal year ended September 30, 2004.  This increase is primarily attributable to increased sales staff personnel, increased salaries and other related expenses, increased marketing expenses for lead generation, and trade show expense.  Mid-way through fiscal year 2004 the Company made a strategic decision for additional investments within the sales and marketing programs to improve upon the Company’s top-line revenue growth initiatives.  This additional investment focus was continued throughout the entire 2005 fiscal year.

Engineering and product development expenses were $2,031,280 for the fiscal year ended September 30, 2005, which represents an increase of $579,747 or approximately 40% from $1,451,533 for the fiscal year ended September 30, 2004.  This increase is primarily attributable to an increase of approximately $600,000 in product development expenses resulting from the acquisition of the Datawatch Technologies subsidiary.  The Company continues to transition some existing outsourced development activities in-house, but currently expects to continue to use third-party development activities, as well as in-house development, in the foreseeable future.

General and administrative expenses were $4,151,894 for the fiscal year ended September 30, 2005, which represents an increase of $115,214 or approximately 3% from $4,036,680 for the fiscal year ended September 30, 2004.  This increase is primarily attributable to overall growth in the business and certain costs incurred during the year in relation to the Company preparing for its Sarbanes-Oxley 404 Internal Control documentation and preparation (“SOX 404”) and acceleration of un-vested stock options.  The Company’s external SOX 404 costs were approximately $35,000.  In September 2005 the Company accelerated all un-vested stock options and

24




incurred a charge of approximately $47,000.  See Note 8 to the consolidated financial statements which appear elsewhere herein for more detailed information on the stock option acceleration.

Net income for the year ended September 30, 2005 was $800,414, which compares to net income of $1,084,776 for the year ended September 30, 2004.  Net income for fiscal year 2005 and fiscal year 2004 include a tax benefit of $22,000 and $126,650, respectively.

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

The Company leases various facilities and equipment in the U.S. and overseas under noncancelable operating leases that expire through 2011. 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 $631,899, $663,664 and $678,677 for fiscal 2006, 2005 and 2004, respectively.

As of September 30, 2006, contractual obligations include minimum rental commitments under noncancelable operating leases as follows:

Contractual Obligations:

 

Total

 

Less than 1 Year

 

1-3 Years

 

3-5 Years

 

More than 5 
Years

 

Operating Lease Obligations

 

$

1,152,602

 

388,712

 

429,175

 

334,715

 

 

 

The Company is also obligated to pay royalties ranging from 7% to 50% on revenue generated by the sale of certain licensed software products. Royalty expense included in cost of software licenses was approximately $1,601,757, $1,659,308 and $1,677,231 respectively, for the years ended September 30, 2006, 2005 and 2004.  The Company is not obligated to pay any minimum amounts for royalties.

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. Not all Mergence products are subject to royalties. The Company expensed approximately $5,075 and $10,400 for the years ended September 30, 2006 and 2005, respectively for royalty payments to Mergence.  See Note 2 to the Consolidated Financial Statements for more detailed financial information on the acquisition of Mergence.

On May 3, 2006, the Company acquired certain assets of ClearStory Systems, Inc’s. IDARS business. The initial acquisition cost for IDARS was approximately $4,790,000, consisting of $4,349,000 in cash and direct acquisition costs of approximately $441,000.  The acquisition also includes an 18-month earn-out payment equal to 30% of net revenues of products from the IDARS business excluding the first $337,500 of revenues. The earn-out payment will be considered additional purchase price and will be recorded as additional goodwill. At September 30, 2006, the Company has accrued approximately $215,000 related to such earn-out payments. In accordance with the asset purchase agreement, the initial earn-out payments are due in March 2007. See Note 2 to the Consolidated Financial Statements for more detailed financial information on the acquisition of IDARS.

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, 2006.

At September 30, 2006, restricted cash consisted of a $125,000 security deposit in the form of an irrevocable letter of credit held in escrow for the landlord of the Company’s Chelmsford, MA corporate offices. At September 30, 2005, restricted cash consisted of $268,299 for security deposits to provide credit support for rent payments to

25




the landlord of the Company’s former headquarters located in Lowell, MA, and $125,000 held in escrow for the sellers of Mergence (see Note 2).

The Company enters into indemnification agreements in the ordinary course of business. Pursuant to these agreements, the Company agrees to indemnify, hold harmless, and reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally its customers, in connection with any patent, copyright or other intellectual property infringement claim by any third party with respect to the Company’s products. The term of these indemnification agreements is generally perpetual. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited. The Company has never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the Company believes the estimated fair value of these agreements is minimal. Accordingly, the Company has no liabilities recorded for these agreements as of September 30, 2006.

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, 2006.

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, 2006.

LIQUIDITY AND CAPITAL RESOURCES

Management believes that its current cash balances, the short-term financing facility and cash generated from operations will be sufficient to meet the Company’s cash needs for working capital and anticipated capital expenditures for at least the next twelve months. At September 30, 2006, the Company had $1,861,000 of cash and equivalents, a decline of $3,039,214 from September 30, 2005.  This decline is principally attributable to the acquisition of IDARS of $4,575,392 offset by $1 million borrowing on the Company’s line of credit with a bank in connection with the IDARS acquisition. At September 30, 2006, the Company had a working capital deficit of $2,466,000 as compared to working capital of $3,487,000 as of September 30, 2005, which is primarily a result of deferred revenue of $4,468,000 as of September 30, 2006. The Company’s deferred revenue balance increased $1,546,000 principally as a result of the IDARS acquisition. The Company expects cash flows from operations to improve as the Company anticipates releasing new versions of all of its main product offerings during the fiscal year ended September 30, 2007 and cost savings expected from the first quarter restructuring. However, if the Company’s cash flow from operations does not improve, we may need to consider further reductions to our operating expenses. The Company does not anticipate additional cash requirements to fund significant growth or the acquisition of complementary technology or businesses. However, if in the future, such expenditures are anticipated or required, the Company may need to seek additional financing by issuing equity or obtaining credit facilities to fund such requirements.

26




The Company had a net loss of approximately $(555,000) for the year ended September 30, 2006 as compared to net income of approximately $800,000 and $1,085,000, respectively, for the years ended September 30, 2005 and 2004.  During the years ended September 30, 2006 and 2005, approximately $975,000 and $1,163,000, respectively, of cash was provided by the Company’s operations. During fiscal year 2006, the main source of cash from operations was a decrease in accounts receivable as a result of an increase in cash collections during the period and the main adjustment to reconcile net income to operating cash flows was depreciation and amortization. The Company also received proceeds of $139,489 from its landlord for tenant improvements related to its Chelmsford facility which is classified as cash provided by operations. Working capital as of September 30, 2006 was $(2,466,000) as compared to $3,756,000 as of September 30, 2005.  The negative working capital is primarily the result of deferred revenue of $4,468,000 at September 30, 2006.

Net cash used in investing activities for the year ended September 30, 2006 of $5,225,579 is primarily the result of the net cash investment in the acquisition of the IDARS business from ClearStory Systems, Inc. and the purchase of fixed assets which included leasehold improvements, furniture and fixtures and computer equipment and software related to the new US facility and upgrading its IT infrastructure.

Net cash provided by financing activities for the year ended September 30, 2006 of $1,181,192 is primarily related to cash received from a $1 million borrowing on the Company’s line of credit with a bank and cash received from the exercise of employee stock options.

On April 20, 2006, the Company entered into a one-year Loan and Security Agreement (“Loan Agreement”) with a bank, as amended on August 2, 2006. The Loan Agreement established two revolving $1.5 million lines of credit, for a total of $3.0 million. The Company can borrow under the first line of credit based on a formula percentage based on the Company’s eligible accounts receivable balance. There is no borrowing base formula for the second line of credit. The Loan Agreement requires the Company to maintain certain specified cash flow and liquidity levels.

At September 30, 2006, the Company was in default on its Loan Agreement covenant to maintain the minimum level of Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) less capital expenditures, as defined.  Under a Second Loan Modification Agreement (“Modification Agreement”) dated as of November 27, 2006, the bank has agreed to waive this covenant for the Company for the three month period ended September 30, 2006, suspend this covenant for the three month periods ended October 31, 2006 and November 30, 2006, and to reduce the required EBITDA from $500,000 to $250,000 for each of the three month periods ending January 31, 2007 and thereafter. Additionally, the Modification Agreement changes the interest rate applicable to borrowings under the first line of credit. Under this line of credit, from July 31, 2006 until November 27, 2006, the interest rate was equal to the prime rate plus 1.50%, which was reduced to the prime rate plus 1.00% until five days after the Company delivers its December 31, 2006 financial statements indicating it is in compliance with all financial covenants under the Loan Agreement. Thereafter, the interest rate is further reduced to prime rate plus 0.50% for the remainder of the Loan Agreement. The interest rate for the second line of credit remains unchanged. No additional borrowings from the June 30, 2006 borrowing level will be available to the Company until December 31, 2006.

On May 3, 2006, the Company acquired certain assets of ClearStory Systems, Inc’s. Integrated Document Archiving and Retrieval Systems (“IDARS”) business. The acquisition of IDARS was consummated pursuant to an asset purchase agreement dated as of March 10, 2006 among the Company and Clearstory Systems, Inc. The purchase agreement includes a provision for quarterly cash payments over an 18 month period equal to 30% of net revenues of products from the IDARS business excluding the first $337,500 of revenues. The earn-out payment will be considered additional purchase price and will be recorded as additional goodwill when incurred. At September 30, 2006, the Company accrued approximately $215,000 related to such earn-out payments with a corresponding increase in goodwill. In accordance with the asset purchase agreement, the initial earn-out payments are due in March 2007.

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

27




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.

An existing agreement between Datawatch and Math Strategies grants the Company exclusive worldwide rights to use and distribute certain intellectual property owned by Math Strategies and incorporated by the Company in its Monarch, Monarch Data Pump, VorteXML and certain other products. On April 29, 2004, the Company entered into a two year Option Purchase Agreement with Math Strategies giving the Company the option to purchase these intellectual property rights for $8 million. This option, if exercised, would provide the Company with increased flexibility to utilize the purchased technology in the future. In February 2006, the Company entered into an amendment to the original agreement with Math Strategies dated January 19, 1989.  Pursuant to the amendment to the license agreement, the term of the license agreement was extended to April 30, 2015. In conjunction with the license amendment, the Company also entered into an amendment to the Option Purchase Agreement dated as of April 29, 2004. Under the option purchase amendment, the option has been extended until April 30, 2015. The option purchase amendment changes the purchase price for the option to a formula price based on a multiple of the aggregate royalties paid to Math Strategies by the Company for the four fiscal quarters preceding the exercise of the option.

Management believes that the Company’s current operations have not been materially impacted by the effects of inflation.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes.” The interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken, in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties accounting in interim periods, disclosure and transition. The interpretation is effective for fiscal years beginning after December 15, 2006. The Company is in the process of determining the effects that adoption of FIN 48 will have on the Company’s financial position, cash flows and results of operations.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Market Measurements” (“SFAS 157”), which establishes a framework for measuring fair value and expands disclosures about the use of fair value measurements and liabilities in interim and annual reporting periods subsequent to initial recognition.  Prior to SFAS 157, which emphasizes that fair value is a market-based measurement and not an entity-specific measurement, there were different definitions of fair value and limited definitions for applying those definitions in GAAP.  SFAS 157 is effective for the Company on a prospective basis for the reporting period beginning January 1, 2008.  The effect of adoption on the Company’s financial position and results of operations have not been determined.

In September 2006, the Securities and Exchange Commission staff published Staff Accounting Bulletin (“SAB”) 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The SAB is effective for fiscal years ending after November 15, 2006. Application of this SAB is not expected to impact the Company’s financial position, results of operations or cash flows.

28




Item 7(A).  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

At September 30, 2006, the Company did not hold any derivative financial instruments or 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 foreign currency exchange rate risk. International revenues and expenses are generally transacted by the Company’s foreign subsidiaries and are denominated in local currency. Approximately 32%, 36% and 39% of the Company’s revenues for 2006, 2005 and 2004, respectively, were from foreign subsidiaries. In addition, approximately 36%, 37% and 37% of the Company’s expenses for fiscal 2006, 2005 and 2004, respectively, were from foreign subsidiaries.

The Company’s earnings 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 from operating activity, whether realized or unrealized, are reflected in other income (expense), net in our consolidated statements of operations. These have not been material in the past nor does management believe that they will be material in the future. Currently the Company does not engage in foreign currency hedging activities.

Item 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.

Report of Independent Registered Public Accounting Firm

 

 

 

Consolidated Financial Statements as of September 30, 2006 and 2005 and for Each of the Three Years in the Period Ended September 30, 2006:

 

 

 

Consolidated Balance Sheets

 

 

 

Consolidated Statements of Operations

 

 

 

Consolidated Statements of Shareholders’ Equity

 

 

 

Consolidated Statements of Cash Flows

 

 

 

Notes to Consolidated Financial Statements

 

29




REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of Datawatch Corporation
Chelmsford, Massachusetts

We have audited the accompanying consolidated balance sheets of Datawatch Corporation and subsidiaries (the “Company”) as of September 30, 2006 and 2005, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended September 30, 2006.  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. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2006, in conformity with accounting principles generally accepted in the United States of America.

/s/ Deloitte & Touche LLP

 

 

Boston, Massachusetts

December 29, 2006

30




DATAWATCH CORPORATION

CONSOLIDATED BALANCE SHEETS

 

 

September 30,

 

September 30,

 

 

 

2006

 

2005

 

ASSETS

 

 

 

 

 

CURRENT ASSETS:

 

 

 

 

 

Cash and equivalents

 

$

1,861,659

 

$

4,900,873

 

Restricted cash

 

 

268,299

 

Accounts receivable, less allowance for doubtful accounts and sales returns of $272,000 in 2006 and $417,000 in 2005

 

3,786,136

 

4,097,283

 

Inventories

 

37,088

 

54,712

 

Prepaid expenses

 

653,304

 

541,108

 

Total current assets

 

6,338,187

 

9,862,275

 

 

 

 

 

 

 

Property and Equipment:

 

 

 

 

 

Office furniture and equipment

 

2,186,139

 

1,569,875

 

Manufacturing and engineering equipment

 

270,105

 

205,595

 

 

 

2,456,244

 

1,775,470

 

Less accumulated depreciation and amortization

 

(1,327,121

)

(1,259,058

)

Net property and equipment

 

1,129,123

 

516,412

 

 

 

 

 

 

 

Goodwill

 

5,236,109

 

1,630,646

 

Other intangible assets, net

 

3,154,836

 

1,250,825

 

Restricted cash

 

125,000

 

125,000

 

Other

 

41,839

 

27,098

 

 

 

$

16,025,094

 

$

13,412,256

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

Line of credit

 

$

1,000,000

 

$

 

Accounts payable

 

1,302,000

 

1,042,755

 

Accrued expenses

 

1,818,930

 

2,013,994

 

Deferred revenue

 

4,468,116

 

2,921,519

 

Accrued acquisition costs – IDARS business

 

215,309

 

 

Escrow for Mergence shareholders

 

 

128,224

 

Total current liabilities

 

8,804,355

 

6,106,492

 

 

 

 

 

 

 

LONG-TERM LIABILITIES:

 

 

 

 

 

Deferred rent

 

229,815

 

 

Deferred tax liability

 

35,550

 

 

Total long-term liabilities

 

265,365

 

 

 

 

 

 

 

 

Commitments and Contingencies

 

 

 

 

 

SHAREHOLDERS’ EQUITY:

 

 

 

 

 

Common stock, par value $.01; 20,000,000 shares authorized; issued, 5,526,485 shares and 5,383,084 shares, respectively; outstanding, 5,512,239 shares and 5,368,838 shares, respectively

 

55,265

 

53,831

 

Additional paid-in capital

 

22,204,304

 

21,957,409

 

Accumulated deficit

 

(14,741,601

)

(14,187,048

)

Accumulated other comprehensive loss

 

(422,206

)

(378,040

)

 

 

7,095,762

 

7,446,152

 

Less treasury stock, at cost, 14,246 shares

 

(140,388

)

(140,388

)

Total shareholders’ equity

 

6,955,374

 

7,305,764

 

 

 

 

 

 

 

 

 

$

16,025,094

 

$

13,412,256

 

 

See notes to consolidated financial statements.

31




DATAWATCH CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

Year Ended September 30,

 

 

 

2006

 

2005

 

2004

 

REVENUE:

 

 

 

 

 

 

 

Software licenses and subscriptions

 

$

13,145,591

 

$

14,232,946

 

$

12,441,667

 

Maintenance and services

 

7,665,653

 

7,278,649

 

6,893,479

 

Total Revenue

 

20,811,244

 

21,511,595

 

19,335,146

 

COSTS AND EXPENSES:

 

 

 

 

 

 

 

Cost of software licenses and subscriptions

 

2,268,458

 

2,515,060

 

2,582,627

 

Cost of maintenance and services

 

3,949,314

 

3,438,319

 

2,710,562

 

Sales and marketing

 

9,135,527

 

8,686,672

 

7,629,058

 

Engineering and product development

 

2,093,707

 

2,031,280

 

1,451,533

 

General and administrative

 

3,898,474

 

4,151,894

 

4,036,680

 

Total costs and expenses

 

21,345,480

 

20,823,225

 

18,410,460

 

 

 

 

 

 

 

 

 

(LOSS) INCOME FROM OPERATIONS

 

(534,236

)

688,370

 

924,686

 

Interest expense

 

(18,114

)

(2,899

)

(622

)

Interest income

 

40,715

 

84,687

 

61,062

 

Foreign currency transaction (losses) gains

 

(6,912

)

8,256

 

(27,000

)

 

 

 

 

 

 

 

 

(LOSS) INCOME FROM OPERATIONS BEFORE INCOME TAXES

 

(518,547

)

778,414

 

958,126

 

(PROVISION) BENEFIT FOR INCOME TAXES

 

(36,006

)

22,000

 

126,650

 

 

 

 

 

 

 

 

 

NET (LOSS) INCOME

 

$

(554,553

)

$

800,414

 

$

1,084,776

 

 

 

 

 

 

 

 

 

Net (loss) income per share - Basic:

 

$

(0.10

)

$

0.15

 

$

0.21

 

Net (loss) income per share - Diluted:

 

$

(0.10

)

$

0.14

 

$

0.19

 

 

 

 

 

 

 

 

 

Weighted-Average Shares Outstanding - Basic

 

5,480,662

 

5,317,400

 

5,267,520

 

Weighted-Average Shares Outstanding - Diluted

 

5,480,662

 

5,773,585

 

5,753,433

 

 

See notes to consolidated financial statements.

32




DATAWATCH CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

Years Ended September 30, 2006, 2005 and 2004

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

Other

 

 

 

 

 

 

 

 

 

 

 

Common Stock

 

Paid-In

 

Accumulated

 

Comprehensive

 

Comprehensive

 

Treasury Stock

 

 

 

 

 

Shares

 

Amount

 

Capital

 

Deficit

 

Loss

 

Income (Loss)

 

Shares

 

Amount

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE, SEPTEMBER 30, 2003

 

5,244,328

 

$

52,443

 

$

21,701,297

 

$

(16,072,238

)

$

(402,999

)

 

 

(14,246

)

$

(140,388

)

$

5,138,115

 

Issuance of common stock for Auxilor acquisition

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options exercised

 

70,780

 

708

 

127,324

 

 

 

 

 

 

 

128,032

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Translation adjustments

 

 

 

 

 

85,006

 

$

85,006

 

 

 

85,006

 

Net income

 

 

 

 

1,084,776

 

 

1,084,776

 

 

 

1,084,776

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

$

1,169,782

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE, SEPTEMBER 30, 2004

 

5,315,108

 

53,151

 

21,828,621

 

(14,987,462

)

(317,993

)

 

 

(14,246

)

(140,388

)

6,435,929

 

Stock options exercised

 

67,976

 

680

 

81,788

 

 

 

 

 

 

 

82,468

 

Stock option acceleration expense

 

 

 

47,000

 

 

 

 

 

 

 

47,000

 

Translation adjustments

 

 

 

 

 

(60,047

)

$

(60,047

)

 

 

(60,047

)

Net income

 

 

 

 

800,414

 

 

800,414

 

 

 

800,414

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

$

740,367

 

 

 

 

 

 

 

BALANCE, SEPTEMBER 30, 2005

 

5,383,084

 

53,831

 

21,957,409

 

(14,187,048

)

(378,040

)

 

 

(14,246

)

(140,388

)

7,305,764

 

Stock options exercised

 

143,401

 

1,434

 

179,758

 

 

 

 

 

 

 

181,192

 

FAS 123(R) expense

 

 

 

 

 

67,137

 

 

 

 

 

 

 

 

 

 

 

67,137

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Translation adjustments

 

 

 

 

 

(44,166

)

$

(44,166

)

 

 

(44,166

)

Net loss

 

 

 

 

(554,553

)

 

(554,553

)

 

 

(554,553

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total comprehensive income (loss)

 

 

 

 

 

 

 

 

 

 

 

$

(598,719

)

 

 

 

 

 

 

BALANCE, SEPTEMBER 30, 2006

 

5,526,485

 

$

55,265

 

$

22,204,304

 

$

(14,741,601

)

$

(422,206

)

 

 

(14,246

)

$

(140,388

)

$

6,955,374

 

 

See notes to consolidated financial statements.

33




DATAWATCH CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

Year Ended September 30,

 

 

 

2006

 

2005

 

2004

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

 

 

Net (loss) income

 

$

(554,553

)

$

800,414

 

$

1,084,776

 

Adjustments to reconcile net (loss) income to cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

831,965

 

697,373

 

728,189

 

Allowances for doubtful accounts and sales returns

 

(149,713

)

3,404

 

(29,425

)

Loss (gain) on disposal of equipment

 

8,307

 

20,863

 

(9,862

)

Stock-based compensation

 

67,138

 

47,000

 

 

Deferred income taxes

 

35,550

 

 

(148,000

)

Changes in current assets and liabilities, net of effects of the acquisitions of Mergence Technologies and IDARS:

 

 

 

 

 

 

 

Accounts receivable

 

569,090

 

(479,533

)

(347,499

)

Inventories

 

22,262

 

12,592

 

38,852

 

Prepaid expenses and other

 

94,738

 

69,295

 

(27,568

)

Accounts payable and accrued expenses

 

(196,833

)

(74,766

)

596,922

 

Deferred revenue

 

246,553

 

66,535

 

(221,809

)

Cash provided by operating activities

 

974,504

 

1,163,177

 

1,664,576

 

 

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

 

Purchase of equipment and fixtures

 

(911,787

)

(343,309

)

(216,825

)

Proceeds from sale of equipment

 

2,337

 

4,364

 

15,188

 

Purchase of Mergence Technologies, net of cash acquired

 

 

 

(2,515,284

)

Purchase of IDARS business, net of cash acquired

 

(4,575,392

)

 

 

Capitalized software development costs

 

 

(42,775

)

(190,825

)

Decrease (increase) in restricted cash

 

268,299

 

(122,149

)

373

 

Other assets

 

(9,036

)

(19,212

)

133,829

 

Cash used in investing activities

 

(5,225,579

)

(523,081

)

(2,773,544

)

 

 

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

 

 

Net proceeds from exercise of stock options

 

181,192

 

82,468

 

128,032

 

Advances on line of credit

 

1,000,000

 

 

 

Principal payments on long-term obligations

 

 

 

(3,115

)

Cash provided by financing activities

 

1,181,192

 

82,468

 

124,917

 

 

 

 

 

 

 

 

 

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND EQUIVALENTS

 

30,669

 

(82,323

)

173,833

 

 

 

 

 

 

 

 

 

(DECREASE) INCREASE IN CASH AND EQUIVALENTS

 

(3,039,214

)

640,241

 

(810,218

)

CASH AND EQUIVALENTS, BEGINNING OF YEAR

 

4,900,873

 

4,260,632

 

5,070,850

 

CASH AND EQUIVALENTS, END OF YEAR

 

$

1,861,659

 

4,900,873

 

$

4,260,632

 

SUPPLEMENTAL CASH FLOW INFORMATION:

 

 

 

 

 

 

 

Interest paid

 

$

30,691

 

$

2,899

 

$

622

 

Income taxes paid

 

$

5,963

 

$

 

$

43,000

 

Income tax refunds received

 

$

 

$

63,226

 

$

1,500

 

 

See notes to consolidated financial statements.

34




DATAWATCH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1.   Nature of Business and Summary of Significant Accounting Policies

Nature of Business

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

Summary of Significant Accounting Policies

Principles of Consolidation

The consolidated financial statements include the accounts of Datawatch Corporation and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

Accounting Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and judgments, which are evaluated on an on-going basis, that affect the amounts and disclosures reported in the Company’s consolidated financial statements and accompanying notes. Management bases its estimates on historical experience and on various other assumptions that it believes are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates and judgments. In particular, significant estimates and judgments include those related to revenue recognition, allowance for doubtful accounts, sales returns reserve, useful lives of property and equipment and intangible assets, valuation of net deferred tax assets, business combinations, and valuation of goodwill and other intangible assets.

Revenue Recognition

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 33%, 31% and 29%, of total sales for the year ended September 30, 2006, 2005 and 2004, respectively. 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 the American Institute of Certified Public Accountant’s (AICPA) Statement of Position No. 97-2, “ Software Revenue Recognition ” (“SOP 97-2”).  The Company’s software products can be installed and used by customers on their own with little or no customization required. Multi-user licenses marketed by the Company are sold as a right to use the number of licenses and license fee revenue is recognized upon delivery of all software required to satisfy the number of licenses sold. Upon delivery, the licensing fee is payable without further delivery obligations to the Company.

Desktop and Server Software products are generally not sold in multiple element arrangements.  Accordingly, the price paid by the customer is considered the vendor specific objective evidence (“VSOE”) of fair value for those products. Enterprise Software sales are generally multiple element arrangements which include software license deliverables, professional services and post-contract customer support. In such multiple element arrangements, the Company applies the residual method in determining revenue to be allocated to a software

35




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 unusual acceptance clauses or terms. Post-contract customer support is typically provided under a maintenance agreement which provides technical support and rights to unspecified software maintenance updates and bug fixes on a when-and-if available basis. Revenue from post-contract customer support services is deferred and recognized ratably over the contract period (generally one year).

The Company 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 90 day service period 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, and provided that all other criteria for revenue recognition are met, the deferred revenue amount is recognized ratably over the period the service is provided. The customer is then invoiced every 90 days and, in accordance with the SOP 97-2, revenue is recognized ratably over the period the service is provided.  The subscription arrangement includes software, maintenance and unspecified future upgrades including major version upgrades. The initial subscription rate is the same as the renewal rate. Subscriptions can be cancelled by the customer at any time by providing 90 days written notice.

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 Statement of Financial Accounting Standards (“SFAS”) No. 48, “ Revenue Recognition when Right of Return Exists .” Revenue from the sale of software products to distributors and resellers is recognized at the time of shipment providing all other criteria for revenue recognition as stated above are met and (i) the distributor or reseller is unconditionally obligated to pay for the products, including no contingency as to product resale, (ii) the distributor or reseller has independent economic substance apart from the Company, (iii) the Company is not obligated for future performance to bring about product resale, and (iv) the amount of future returns can be reasonably estimated. The Company’s experience and history with its distributors and resellers allows for reasonable estimates of future returns. Among other things, estimates of potential future returns are made based on the inventory levels at the various distributors and resellers, which the Company monitors frequently.

Allowance for Doubtful Accounts

The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of customers to make required payments. The Company analyzes accounts receivable and the composition of the accounts receivable aging, historical bad debts, customer creditworthiness, current economic trends and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. 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, 2006, 2005 and 2004, changes to and ending balances of the allowance for doubtful accounts were approximately as follows:

36




 

 

2006

 

2005

 

2004

 

 

 

 

 

 

 

 

 

Allowance for Doubtful Accounts Balance - Beginning of Year

 

$

294,000

 

$

230,000

 

$

230,000

 

Additions to the Allowance of Doubtful Accounts

 

11,000

 

75,000

 

105,000

 

Deductions Against the Allowance for Doubtful Accounts

 

(112,000

)

(11,000

)

(105,000

)

Allowance for Doubtful Accounts Balance - End of Year

 

$

193,000

 

$

294,000

 

$

230,000

 

 

Sales Returns Reserve

The Company maintains reserves for potential future product returns.  The Company estimates future product returns based on its experience and history with the Company’s various distributors and resellers as well as by monitoring inventory levels at such companies. Once the estimates of potential future returns from all sources are made, the Company determines if it has adequate returns reserves to cover anticipated returns and the returns reserve is adjusted as required.  Adjustments are recorded as increases or decreases in revenue in the period of adjustment.  Actual returns have historically been within the range estimated by management. Actual results could differ from the reserve for sales returns 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, 2006, 2005 and 2004, changes to and ending balances of the sales returns reserve were approximately as follows:

 

2006

 

2005

 

2004

 

 

 

 

 

 

 

 

 

Sales Returns Reserve Balance - Beginning of Year

 

$

123,000

 

$

186,000

 

$

213,000

 

Additions to the Sales Returns Reserve

 

82,000

 

180,000

 

165,000

 

Deductions Against the Sales Returns Reserve

 

(126,000

)

(243,000

)

(192,000

)

Sales Returns Reserve Balance - End of Year

 

$

79,000

 

$

123,000

 

$

186,000

 

 

Capitalized Software Development Costs

The Company capitalizes certain software development costs 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, 2006, 2005 and 2004 amounts related to capitalized and purchased software development costs and purchased software were approximately as follows:

 

2006

 

2005

 

2004

 

 

 

 

 

 

 

 

 

Capitalized and Purchased Software Balance - Beginning of Year

 

$

583,000

 

$

937,000

 

$

697,000

 

Capitalized Software Development Costs

 

 

42,000

 

191,000

 

Capitalized Purchased Software

 

180,000

 

 

520,000

 

Amortization of Capitalized Software Development Costs and Purchased Software

 

(290,000

)

(396,000

)

(471,000

)

Capitalized and Purchased Software Balance - End of Year

 

$

473,000

 

$

583,000

 

$

937,000

 

 

Cash and Equivalents

Cash and equivalents include cash on hand, cash deposited with banks and highly liquid securities with original maturities of 90 days or less.

37




Concentration of Credit Risks and Major Customers

The Company sells its products and services to U.S. and non-U.S. dealers and other software distributors, as well as to end users, under customary and normal credit terms. One customer, Ingram Micro Inc., individually accounted for 15%, 19% and 20% of total revenue in 2006, 2005 and 2004, respectively. Ingram Micro Inc. accounted for 12% and 17% of outstanding gross trade receivables as of September 30, 2006 and 2005, respectively. One other customer, Tech Data Product Management, individually accounted for approximately 13% of total revenue in 2006. Tech Data Product Management accounted for 16% of outstanding gross trade receivables as of September 30, 2006. The Company sells to Ingram Micro Inc. and Tech Data Product Management under distribution agreements, which automatically renew for successive one-year terms unless terminated. Other than these two customers, no other customer constitutes a significant portion (more than 10%) of sales or accounts receivable. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. Allowances are provided for anticipated doubtful accounts and sales returns.

Deferred Revenue

Deferred revenue consisted of the following at September 30:

 

2006

 

2005

 

 

 

 

 

 

 

Maintenance

 

$

3,690,034

 

$

2,531,973

 

Other

 

778,082

 

389,546

 

 

 

 

 

 

 

Total

 

$

4,468,116

 

$

2,921,519

 

 

Maintenance deferred revenue consists of the unearned portion of post-contract customer support services provided by the Company to customers who either purchased maintenance agreements for the Company’s products or represents the assumed contracts from the IDARS acquisition. Maintenance revenues are recognized on a straight-line basis over the term of the maintenance period, generally 12 months.

Other deferred revenue consists of deferred license, subscription and professional services revenue generated from arrangements that are invoiced in accordance with the terms and conditions of the arrangement but do not meet all the criteria for revenue recognition, and are, therefore, deferred until all revenue recognition criteria are met.

Inventories

Inventories consist of software components, primarily software manuals, compact disks and retail packaging materials. Inventories are valued at the lower of cost (first-in, first-out) method or market.

Property and Equipment

 Purchased equipment and fixtures are recorded at cost. Leased equipment accounted for as capital leases is recorded at the present value of the minimum lease payments required during the lease terms. Depreciation and amortization are provided using the straight-line method over the estimated useful lives of the related assets or over the terms, if shorter, of the related leases. Useful lives and lease terms range from one to seven years. Depreciation and amortization expense related to property and equipment was $362,769, $234,620 and $255,634 respectively, for the years ended September 30, 2006, 2005 and 2004. There were no items under capital leases as of September 30, 2006 or 2005.

Long-Lived Assets

 The Company continually evaluates whether events or circumstances have occurred that indicate that the estimated remaining useful lives of long-lived assets and certain identifiable intangibles may warrant revision or that the carrying value of these assets may be impaired. To compute whether assets have been impaired, the estimated undiscounted future cash flows for the estimated remaining useful life of the respective assets are

38




compared to the carrying value. To the extent that the undiscounted future cash flows are less than the carrying value, the fair value of the asset is determined. If such fair value is less than the current carrying value, the asset is written down to its estimated fair value.

Goodwill and Other Intangible Assets

Other intangible assets consist of capitalized software costs, acquired technology, patents, customer relationships, trademarks, trade names and non-compete agreements acquired through business combinations.  The values allocated to capitalized and purchased software costs, acquired technology, patents, tradenames and trademarks are amortized using the straight-line method over the estimated useful life of the related asset and are recorded in cost of sales for software license and subscriptions. The values allocated to customer relationships and non-compete agreements are amortized using the straight-line method over the estimated useful life of the related asset and are recorded in sales and marketing expenses. 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.

Goodwill and certain trademarks are not subject to amortization and are tested annually for impairment or more frequently if events and circumstances indicate that the asset might be impaired. Goodwill is tested for impairment using a two-step approach. The first step is to compare the fair value of the reporting unit to its carrying amount, including goodwill. If the fair value of the reporting unit is greater than its carrying amount, goodwill is not considered impaired, but if the fair value of the reporting unit is less than its carrying amount, the amount of the impairment loss, if any, must be measured (Step 2). An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value.

The Company has the following intangible assets, as of September 30, 2006 and 2005:

 

Weighted

 

September 30, 2006

 

September 30, 2005

 

Identified Intangible Asset

 

Average
Useful Life
in Years

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net Carrying
Amount

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net Carrying
Amount

 

Capitalized software

 

2

 

1,665,895

 

$

1,648,058

 

$

17,837

 

$

1,665,895

 

$

(1,483,015

)

$

182,880

 

Purchased software

 

5

 

700,000

 

244,723

 

455,277

 

520,000

 

(119,722

)

400,278

 

Patents

 

20

 

159,967

 

16,417

 

143,550

 

159,967

 

(8,389

)

151,578

 

Customer lists

 

10

 

1,790,000

 

138,230

 

1,651,770

 

130,000

 

(36,563

)

93,437

 

Non-compete agreements

 

4

 

640,000

 

98,750

 

541,250

 

100,000

 

(22,500

)

77,500

 

Trademarks

 

indefinite

 

345,152

 

 

345,152

 

345,152

 

 

345,152

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

8 Years

 

$

5,301,014

 

$

2,146,178

 

$

3,154,836

 

$

2,921,014

 

$

(1,670,189

)

$

1,250,825

 

 

The intangible asset amounts amortized to cost of software licenses and subscriptions totaled $350,573, $462,424 and $472,331, for fiscal 2006, 2005 and 2004, respectively.

As of September 30, 2006, the estimated future amortization expense related to amortizing intangible assets was as follows:

Year Ending September 30,

 

 

 

 

 

 

 

2007

 

$

514,236

 

2008

 

458,204

 

2009

 

425,861

 

2010

 

352,113

 

2011

 

195,028

 

Thereafter

 

864,243

 

 

 

 

 

Total estimated future amortization expense

 

$

2,809,685

 

 

39




Restricted Cash

At September 30, 2006, restricted cash consisted of a $125,000 security deposit in the form of an irrevocable letter of credit held in escrow for the landlord of the Company’s Chelmsford, MA corporate offices. At September 30, 2005, restricted cash consisted of $268,299 for security deposits to provide credit support for rent payments to the landlord of the Company’s former corporate headquarters located in Lowell, MA, and $125,000 held in escrow for the sellers of Mergence (see Note 2).

Fair Value Disclosure

The carrying amounts of cash and equivalents, accounts receivable, accounts payable and accrued expenses approximate fair value because of their short-term nature.

Income Taxes

Deferred income taxes are provided for the tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes and operating loss carryforwards and credits. Valuation allowances are recorded to reduce the net deferred tax assets to amounts the Company believes are more likely than not to be realized.

Net Income Per Share

Basic net income per common share is computed by dividing net income by the weighted-average number of common shares outstanding during the period.  Diluted net income per share reflects the impact, when dilutive, of the exercise of options and warrants using the treasury-stock method.

The following table presents the options and warrants that were not included in the computation of diluted net income per share, because the exercise price of the options or warrants was greater than the average market price of the common stock for the years ended September 30, 2006, 2005 and 2004:

 

2006

 

2005

 

2004

 

 

 

 

 

 

 

 

 

Quantity of option shares and warrants not included

 

255,753

 

145,870

 

120,818

 

Weighted-average exercise price

 

$

4.76

 

$

5.86

 

$

6.24

 

 

Foreign Currency Translations and Transactions

Assets and liabilities of foreign subsidiaries are translated into U.S. dollars at rates in effect at each balance sheet date. Revenues, expenses and cash flows are translated into U.S. dollars at average rates prevailing when transactions occur. The related translation adjustments are reported as a separate component of shareholders’ equity under the heading “Accumulated Other Comprehensive Loss.” Gains and losses resulting from transactions that are denominated in currencies other than the applicable unit’s functional currency are included in the operating results of the Company and were not material.

Advertising and Promotional Materials

Advertising costs are expensed as incurred and amounted to $324,810, $372,813 and $254,001 in 2006, 2005 and 2004, respectively. Direct mail/direct response costs are expensed as the associated revenue is recognized. The amortization period is based on historical results of previous mailers (generally three to six months from the date of the mailing). Direct mail expense was $32,860, $112,480 and $130,289 in 2006, 2005 and 2004, respectively. At September 30, 2006 and 2005, deferred direct mail/direct response costs were $4,424 and $6,157, respectively, and are included under the caption “prepaid expenses and other” in the accompanying consolidated balance sheets.

Stock-Based Compensation

On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised

40




2004) (“SFAS 123(R)”), “Share-Based Payment,” which is a revision of SFAS 123, “ Accounting for Stock Based Compensation” and supersedes Accounting Principles Bulletin (“APB”) No. 25, “ Accounting for Stock Issued to Employees,” and amends SFAS 95, “Statement of Cash Flows.”   SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. SFAS 123(R) eliminates the alternative to use the intrinsic value method of accounting.

On October 1, 2005 (the first day of the Company’s 2006 fiscal year), the Company adopted SFAS 123(R). The Company adopted SFAS 123(R) using a modified prospective application method, as permitted under SFAS 123(R). Accordingly, prior period amounts have not been restated. Under this approach, the Company is required to record compensation cost for all share-based awards granted after the date of adoption and for the unvested portion of previously granted stock-based awards at the date of adoption. See additional Stock-Based Compensation disclosure in Note 8 to the Company’s Consolidated Financial Statements.

Comprehensive Income (Loss)

Currently, the only item other than net income (loss) that is included in comprehensive income (loss) is foreign currency translation adjustments. Foreign currency translation (losses) gains arising during 2006, 2005 and 2004 were ($44,166), ($60,047) and, $85,006 respectively.

Segment Information

The Company has determined that it has only one reportable segment meeting the criteria established under SFAS No. 131, “ Disclosures about Segments of an Enterprise and Related Information .” The Company’s chief operating decision maker, (determined to be the Chief Executive Officer), does not manage any part of the Company separately, and the allocation of resources and assessment of performance is based on the Company’s consolidated operating results. See Note 10 for information about the Company’s revenue by product lines and geographic operations.

Guarantees and Indemnifications

The Company’s software products are sold under warranty against certain defects in material and workmanship for a period of 30 to 90 days from the date of purchase. 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, 2006 and 2005.

The Company is required by the lease related to its Chelmsford, Massachusetts facility to provide a letter of credit in the amount of $125,000 as a security deposit to provide credit support for payment to the landlord of amounts due under the lease.  As previously disclosed, 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, 2006. See Note 5 for disclosure of minimum rental commitments under non-cancelable operating leases.

In August 2004, the Company entered into a Stock Purchase Agreement for the acquisition of Mergence in which 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 or 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 as of September 30, 2006 and 2005.

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

41




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, 2006 and 2005.

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, 2006 and 2005.

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, 2006 and 2005.

Recent Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes.” The interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken, in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties accounting in interim periods, disclosure and transition. The interpretation is effective for fiscal years beginning after December 15, 2006. The Company is in the process of determining the effects that adoption of FIN 48 will have on the Company’s financial position, cash flows and results of operations.

In September 2006, the FASB issued SFAS No. 157, “Fair Market Measurements” (“SFAS 157”), which establishes a framework for measuring fair value and expands disclosures about the use of fair value measurements and liabilities in interim and annual reporting periods subsequent to initial recognition.  Prior to SFAS 157, which emphasizes that fair value is a market-based measurement and not an entity-specific measurement, there were different definitions of fair value and limited definitions for applying those definitions in GAAP.  SFAS 157 is effective for the Company on a prospective basis for the reporting period beginning January 1, 2008.  The effect of adoption on the Company’s financial position and results of operations have not been determined.

In September 2006, the Securities and Exchange Commission staff published Staff Accounting Bulletin (“SAB”) 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The SAB is effective for fiscal years ending after November 15, 2006. Application of this SAB is not expected to impact the Company’s financial position, results of operations or cash flows.

42




2.  ACQUISITIONS

Integrated Document Archiving and Retrieval Systems Business

On May 3, 2006, the Company acquired certain assets and assumed certain liabilities of ClearStory Systems, Inc’s. Integrated Document Archiving and Retrieval Systems (“IDARS”) business. The acquisition of IDARS was consummated pursuant to an asset purchase agreement dated as of March 10, 2006 among the Company and Clearstory Systems, Inc. The acquisition cost for IDARS was approximately $4,790,000, consisting of $4,349,000 in cash and direct acquisition costs of approximately $441,000. Additional acquisition costs include an 18- month earn-out payment equal to 30% of net revenues of products from the IDARS business excluding the first $337,500 of revenues. The earn-out payment will be considered additional purchase price and will be recorded as additional goodwill when incurred. At September 30, 2006, the Company accrued approximately $215,000 related to such earn-out payments with a corresponding increase in goodwill. In accordance with the asset purchase agreement, the initial earn-out payments are due in March 2007. The Company borrowed $1 million from its existing line of credit prior to the May 3, 2006 closing to finance part of the acquisition price. IDARS’s results are included with those of the Company from the date of acquisition.

The following table presents the allocation of the purchase price paid for IDARS based on the estimated fair values of the acquired assets and assumed liabilities of IDARS as of May 3, 2006:

Current assets

 

$

56,000

 

Property and equipment, net

 

64,000

 

Current liabilities

 

(125,000

)

Deferred revenues

 

(1,190,000

)

Goodwill

 

3,605,000

 

Acquired intangible assets:

 

 

 

Existing technology

 

180,000

 

Customer list

 

1,660,000

 

Non-compete agreement

 

540,000

 

 

 

 

 

Total purchase price

 

$

4,790,000

 

 

The allocation of the purchase price was based on an evaluation of the fair value of assets acquired and liabilities assumed. The valuation method used to determine the intangible asset values was the income approach. The income approach presumes that the value of an asset can be estimated by the net economic benefit (i.e. cash flows) to be received over the life of the asset, discounted to present value. The discounting process uses a rate of return that accounts for both the time value of money and investment risk factors. The weighted-average discount rate (or rate of return) used to determine the value of the identifiable intangible assets was 32%.

The intangible asset for existing technology is for technologies developed by IDARS.  The Company has estimated the life of these products as five years.  The IDARS customer list and non-compete agreements have estimated lives of ten years and four years, respectively. The fair values for the existing technology, customer list and non-compete agreements will be amortized over their estimated life, subject to appropriate asset impairment assessments. Amortization of the intangible assets acquired as part of the IDARS acquisition totaled $140,417 from the date of acquisition through September 30, 2006.

The goodwill will be tested for impairment annually, or on an interim basis, if an event or circumstance indicates that it is more likely than not that an impairment loss has been incurred.  Goodwill associated with this acquisition is deductible for tax purposes and has a 15 year amortization period for tax purposes.

The following (unaudited) pro forma consolidated results of operations have been prepared as if the acquisition of IDARS had occurred on October 1, 2004:

43




 

 

Years Ended September 30,

 

 

 

2006

 

2005

 

 

 

 

 

 

 

Sales

 

$

23,348,000

 

$

28,409,000

 

Net income

 

$

316,000

 

$

2,899,000

 

 

 

 

 

 

 

Earnings per share - basic

 

$

0.06

 

$

0.55

 

Earnings per share - diluted

 

$

0.06

 

$

0.50

 

 


(a) Based on the historical statements of operations of Datawatch for the years ended September 30, 2006 and 2005, and the historical statements of operations of IDARS for the years ended March 31, 2006 and 2005.

The pro forma information is presented for informational purposes only and is not necessarily indicative of the results of operations that actually would have been achieved had the acquisition been consummated as of that time, nor is it intended to be a projection of future results.

Mergence Technologies Corporation

On August 11, 2004, the Company acquired 100% of the outstanding shares of Mergence Technologies Corporation for an acquisition cost of $2,596,691 comprised of $2,500,000 in cash and direct costs of $96,691. 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, not all Mergence products are subject to royalties. Such amounts were expensed as a cost of revenue as the Researcher products were sold. The Company expensed $5,075 and $10,400 for 2006 and 2005, respectively.

The Mergence purchase agreement included an amount of $125,000 to be held in escrow for the sellers of Mergence and was to be paid 55 days after September 30, 2005, unless the sellers owe any damages or unresolved claims to the buyer. The escrow amount was paid to the sellers of Mergence during fiscal 2006.

Mergence was acquired to broaden and expand the Company’s product offerings. Mergence’s results are included with those of the Company from the date of acquisition.

3.                     INVENTORIES

Inventories consisted of the following at September 30:

 

2006

 

2005

 

 

 

 

 

 

 

Raw materials

 

$

17,900

 

$

28,406

 

Finished goods

 

19,188

 

26,306

 

 

 

 

 

 

 

Total

 

$

37,088

 

$

54,712

 

 

4.                       ACCRUED EXPENSES

Accrued expenses consisted of the following at September 30:

 

2006

 

2005

 

 

 

 

 

 

 

Accrued salaries and benefits

 

$

347,144

 

$

280,136

 

Accrued royalties and commissions

 

932,890

 

1,095,758

 

Accrued professional fees

 

255,285

 

312,606

 

Other

 

283,611

 

325,494

 

 

 

 

 

 

 

Total

 

$

1,818,930

 

$

2,013,994

 

 

44




5.                       COMMITMENTS

Leases

The Company leases various facilities and equipment in the U.S. and overseas under non-cancelable operating leases which expire through 2011. 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 $631,899, $663,664 and $678,677 for the years ended September 30, 2006, 2005 and 2004, respectively.  Certain of the Company’s facility leases include options to renew.

As of September 30, 2006, minimum rental commitments under noncancelable operating leases are as follows:

Year Ending September 30,

 

 

 

 

 

 

 

2007

 

$

388,712

 

2008

 

237,222

 

2009

 

191,953

 

2010

 

195,458

 

2011

 

139,257

 

 

 

 

 

Total minimum lease payments

 

$

1,152,602

 

 

Royalties

The Company is 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 $1,601,757, $1,659,308 and $1,677,231 for the years ended September 30, 2006, 2005 and 2004, respectively. The Company is not obligated to pay minimum royalty amounts.

ClearStory Systems Royalties

As a result of the acquisition of certain assets of ClearStory Systems, Inc’s. Integrated Document Archiving and Retrieval Systems (“IDARS”) business (see Note 2), the Company is required to make quarterly cash payments equal to 30% of net revenues of products from the IDARS business excluding the first $337,500 of revenues through an 18 month earn-out period.

Mergence Royalties

As a result of the acquisition of Mergence (see Note 2), the Company is required to make quarterly cash payments equal to 10% of the revenues, as defined, of Mergence’s Researcher product for a period of six years, but not all Mergence products are subject to royalties. The Company is not required to pay any minimum amounts unless the Company ceases to compete in the markets, as defined, in which the Researcher product competes.  The Company fully intends to continue to compete in these markets.

Contingencies

The Company is occasionally involved in legal proceedings and other claims arising out of our operations in the normal course of business. The Company is not party to any litigation that management believes will have a material effect on the Company’s consolidated financial condition, results of operations, or cash flows.

6.                     FINANCING ARRANGEMENTS

Borrowings

On April 20, 2006, the Company entered into a one-year Loan and Security Agreement (“Loan Agreement”) with a bank.  The loan agreement establishes two revolving $1.5 million lines of credit, for a total of $3.0

45




million.  As of September 30, 2006, advances on the Company’s two credit lines amounted to $1,000,000. The Company can borrow under the first line of credit based on a formula percentage based on the Company’s eligible accounts receivable balance. There is no borrowing base formula for the second line of credit. The first line of credit bears an interest rate equal to the prime rate plus 0.50% and the second line of credit bears an interest rate equal to the prime rate plus 1.00%. Amounts borrowed under the Loan Agreement are secured by all of the assets of the Company, including its intellectual property. Additionally, the Loan Agreement requires the Company to maintain certain specified cash flow and liquidity levels. In addition, the Loan Agreement requires that the Company maintain at all times unrestricted cash with the bank of not less than $500,000.

As of September 30, 2006 the Company was in default on its covenant to maintain the minimum level of Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) less capital expenditures. Pursuant to a Loan Modification Agreement between the Company and the bank dated as of November 27, 2006, the Company agreed with the bank to waive this covenant until the period ended December 31, 2006 and to modify the minimum cash flow ratios during the next fiscal year. Pursuant to the Loan Modification Agreement, the interest rate on the first line of credit was amended to reflect a rate equal to the prime rate plus 1.50% for the period from July 31, 2006 through November 26, 2006, a rate equal to the prime rate plus 1.00% for the period from November 27, 2006 through approximately January 31, 2007, and a rate equal to the prime rate plus 0.50% thereafter.

Letter of Credit

The Company has an irrevocable standby letter of credit with a bank securing performance of a five-year property lease. The Company has provided a cash term deposit in the amount of $125,000 to secure the letter of credit. This amount is included as part of restricted cash in the Company’s consolidated balance sheets at September 30, 2006.

7.                     INCOME TAXES

Income (loss) from operations before income taxes consists of the following for the years ended September 30:

 

2006

 

2005

 

2004

 

 

 

 

 

 

 

 

 

Domestic

 

$

1,550,985

 

$

1,645,322

 

$

980,486

 

Foreign

 

(2,069,532

)

(866,908

)

(22,360

)

 

 

 

 

 

 

 

 

Total

 

$

(518,547

)

$

778,414

 

$

958,126

 

 

The provision (benefit) for income taxes consisted of the following for the years ended September 30:

 

2006

 

2005

 

2004

 

 

 

 

 

 

 

 

 

Current:

 

 

 

 

 

 

 

Federal

 

$

 

$

(12,000

)

$

21,350

 

State

 

456

 

(10,000

)

 

Foreign

 

 

 

 

 

 

 

 

 

 

 

 

 

 

456

 

(22,000

)

21,350

 

 

 

 

 

 

 

 

 

Deferred:

 

 

 

 

 

 

 

Federal

 

(26,300

)

(18,000

)

9,000

 

State

 

9,500

 

11,000

 

171,000

 

Foreign

 

(31,650

)

 

120,000

 

Change in valuation allowance

 

84,000

 

7,000

 

(448,000

)

 

 

 

 

 

 

 

 

 

 

35,550

 

 

(148,000

)

 

 

 

 

 

 

 

 

Total

 

$

36,006

 

$

(22,000

)

$

(126,650

)

 

46




At September 30, 2006, the Company had U.S. federal tax loss carryforwards of approximately $7.6 million, expiring at various dates through 2021, including $520,000 resulting from the Mergence acquisition undertaken during 2004 which are subject to additional annual limitations as a result of the changes in Mergence’s ownership, and had approximately $2.0 million in state tax loss carryforwards, which also expire at various dates through 2021. Net state tax carryforwards of approximately $118,000 expired during the year ended September 30, 2006. An alternative minimum tax credit of approximately $148,000 is available to offset future regular federal taxes. Research and development credits of approximately $418,000 expire beginning in 2011. In addition, the Company has the following net operating loss carryforwards: United Kingdom losses of $8.0 million with no expiration date, France losses of $130,000 with no expiration date, Germany losses of $2.0 million with no expiration date and Australia losses of $2.0 million with no expiration date.

The components of the Company’s net deferred tax assets are as follows at September 30:

 

2006

 

2005

 

Deferred tax liabilities:

 

 

 

 

 

Goodwill amortization

 

$

(35,500

)

$

 

Prepaid expenses

 

(58,000

)

(66,000

)

Acquired intangibles

 

(356,000

)

(356,000

)

 

 

 

 

 

 

 

 

(449,500

)

(422,000

)

Deferred tax assets:

 

 

 

 

 

Net operating loss carryforwards

 

4,147,000

 

4,062,000

 

Research and development credits

 

418,000

 

512,000

 

Accounts and notes receivable reserves

 

144,000

 

150,000

 

Alternative minimum tax credits

 

148,000

 

148,000

 

Depreciation and amortization

 

181,750

 

176,000

 

Deferred rent

 

95,000

 

 

Other

 

54,000

 

64,000

 

 

 

 

 

 

 

 

 

5,187,750

 

5,112,000

 

 

 

 

 

 

 

Total

 

4,738,250

 

4,690,000

 

 

 

 

 

 

 

Valuation allowance

 

(4,773,800

)

(4,690,000

)

 

 

 

 

 

 

Deferred tax liability, net

 

$

(35,550

)

$

 

 

The Company had profitable domestic operations but continued to have significant operating losses from international operations for the years ended September 30, 2006, 2005 and 2004. This followed significant losses from operations, both domestically and internationally, over several prior years. Accordingly, management does not believe the tax assets are more likely than not to be realized and a full valuation allowance has been provided.  The valuation allowance increased by approximately $87,000 in 2006 and increased by $7,000 in 2005 as the Company maintains a full valuation allowance against the tax assets and such assets increased or decreased primarily as a result of utilization or expiration of net operating loss carryforwards in each respective year.

SFAS No. 109, “ Accounting for Income Taxes ,” requires recognition of deferred tax liabilities and deferred tax assets (and related valuation allowances, if necessary) for the excess of tax-deductible goodwill over goodwill for financial reporting purposes. The tax benefit for the excess tax-deductible goodwill is recognized when realized on the tax return. During fiscal year 2006, Datawatch acquired the business assets of IDARS that resulted in tax-deductible amortization being recognized as a deferred tax expense in 2006. As the goodwill is deducted for tax purposes, a deferred tax expense will be recognized each year with a corresponding deferred tax liability equal to the excess of tax amortization over the amortization for financial reporting purposes.

The following table reconciles the Company’s tax provision based on its effective tax rate to its tax provision based on the federal statutory rate of 34% for the years ended September 30, 2006, 2005 and 2004:

47




 

 

2006

 

2005

 

2004

 

 

 

 

 

 

 

 

 

Provision at federal statutory rate

 

$

(176,300

)

$

265,000

 

$

326,000

 

State, net of federal impact

 

5,600

 

(7,000

)

113,000

 

Foreign taxes

 

(75,500

)

(60,000

)

(137,000

)

Valuation allowance increase (decrease)

 

349,800

 

7,000

 

(448,000

)

Extra-territorial income exclusion

 

(71,600

)

(120,000

)

 

Other

 

4,006

 

(107,000

)

19,350

 

 

 

 

 

 

 

 

 

Provision (benefit) for income taxes

 

$

36,006

 

$

(22,000

)

$

(126,650

)

 

8.                     SHAREHOLDERS’ EQUITY

Stock Option Plans

The Company provides its employees, officers, consultants, and directors stock options and other stock rights to purchase common stock of the Company on a discretionary basis pursuant to three stock compensation plans described more fully below. All option grants are subject to the terms and conditions determined by the Compensation Committee of the Board of Directors, and generally vest over a three-year period beginning three months from date of grant and expire seven to ten years from date of grant depending on the plan. Generally, options and other stock rights are granted at exercise prices not less than the fair market value at the date of grant.

On October 4, 1996, the Company established the 1996 International Employee Non-Qualified Stock Option Plan (the “1996 International Plan”). Pursuant to this plan, nonqualified options may be granted to any employee or consultant of any of the Company’s foreign subsidiaries through October 4, 2006.

On December 10, 1996, the Company established the Datawatch Corporation 1996 Stock Plan (the “1996 Stock Plan”), which provides for the granting of both incentive stock options and nonqualified options, the award of Company common stock, and opportunities to make direct purchases of Company common stock (collectively, “Stock Rights”), as determined by a committee appointed by the Board of Directors. Options pursuant to this plan may be granted through December 10, 2006 and shall vest as specified by this committee.

On January 20, 2006, the Company established the Datawatch Corporation 2006 Equity Compensation and Incentive Plan (the “2006 Plan”) which provides for the granting of both incentive stock options and non-qualified options, the award of Company common stock and opportunities to make direct purchase of Company common stock (collectively, “Stock Rights”), as determined by a committee appointed by the Board of Directors.  Options pursuant to this plan may be granted through March 10, 2016 and shall vest as specified by the committee.

On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS 123 (revised 2004) (“SFAS 123(R)”), “Share-Based Payment,” which is a revision of SFAS 123, “ Accounting for Stock Based Compensation” and supersedes Accounting Principles Bulletin (“APB”) No. 25, “ Accounting for Stock Issued to Employees,” and amends SFAS 95, “Statement of Cash Flows.”   SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. SFAS 123(R) eliminates the alternative to use the intrinsic value method of accounting that was provided in SFAS 123.

On October 1, 2005 (the first day of the Company’s 2006 fiscal year), the Company adopted SFAS 123(R). The Company adopted SFAS 123(R) using a modified prospective application method, as permitted under SFAS 123(R). Accordingly, prior period amounts have not been restated. Under this approach, the Company is required to record compensation cost for all share-based awards granted after the date of adoption and for the unvested portion of previously granted stock-based awards at the date of adoption.

48




In September 2005, prior to the adoption of SFAS 123(R), the Compensation Committee of the Board of Directors approved the full vesting of all outstanding options with vesting dates occurring after September 30, 2005. The vesting of approximately 169,040 options was accelerated, of which approximately 64,000 options had an exercise price greater than the closing stock price on the modification date. As the Company estimated that certain of these awards would not have vested absent the acceleration, the Company recognized stock-based compensation charge of approximately $47,000, which is included in the results for the year ended September 30, 2005. The purpose of this modification was to eliminate the future compensation expense of the outstanding awards.  As all outstanding awards were fully vested, the adoption of FAS123(R) did not have any impact on the financial statements from awards outstanding as of the date of adoption.

Under the provisions of SFAS No. 123(R), the Company recognizes the fair value of stock compensation cost over the requisite service period of the individual awards, which generally equals the vesting period. All of the Company’s stock compensation awards are accounted for as equity instruments and there have been no liability awards granted.

Prior to the adoption of SFAS 123(R), the Company applied APB 25 to account for stock-based awards.  The following table illustrates the effect on earnings and earnings per share had compensation cost for the employee stock-based awards been recorded for the years ended September 30, 2005 and 2004 based on the fair value method under SFAS 123:

Datawatch Corporation

Stock-Based Compensation Disclosures

Years Ended September 30, 2006, 2005 and 2004

 

 

Years Ended September 30,

 

 

 

2005

 

2004

 

 

 

 

 

 

 

Net income, as reported

 

$

800,414

 

$

1,084,776

 

Add:

 

 

 

 

 

Total stock-based employee compensation expense included in net income

 

47,000

 

 

Less:

 

 

 

 

 

Total stock-based employee compensation expense determined under fair value base method for all awards, net of taxes

 

(589,693

)

(231,242

)

Pro forma net income

 

$

257,721

 

$

853,534

 

 

 

 

 

 

 

Basic net income per share:

 

 

 

 

 

As reported

 

$

0.15

 

$

0.21

 

Pro forma

 

$

0.05

 

$

0.16

 

 

 

 

 

 

 

Diluted net income per share:

 

 

 

 

 

As reported

 

$

0.14

 

$

0.19

 

Pro forma

 

$

0.04

 

$

0.15

 

 

Beginning with the 2006 fiscal year, with the adoption of SFAS 123(R), the Company recorded stock-based compensation expense for the fair value of stock options. Stock-based compensation expense for the fiscal year ended September 30, 2006 was $67,137 which was included in the following expense categories:

Sales and marketing

 

$

25,074

 

Engineering and product development

 

7,015

 

General and administrative

 

35,048

 

 

 

 

 

 

 

$

67,137

 

 

The Company uses the Black-Scholes option-pricing model to calculate the fair value of options. The key assumptions for this valuation method include the expected life of the option, stock price volatility, risk-free interest rate, dividend yield, exercise price and forfeiture rate. The weighted-average fair values of the options granted under the stock options plans were $3.10, $2.98 and $2.57 for the years ended September 30, 2006, 2005 and 2004, respectively.

49




Many of these assumptions are judgmental and highly sensitive in the determination of compensation expense. The table below indicates the weighted-average key assumptions used in the option valuation calculations for options granted for the year ended September 30, 2006:

Expected life

 

5 years

 

Expected volatility

 

96.25

%

Risk-free interest rate

 

4.62

%

Dividend yield

 

0.0

%

Forfeiture rate

 

10

%

 

The dividend yield of zero is based on the fact that the Company has never paid cash dividends and has no present intention to pay cash dividends. The Company uses an expected stock-price volatility assumption that is a combination of both historical and current implied volatilities of the underlying stock which are obtained from public data sources. The risk-free interest rate is the U.S. Treasury bill rate with constant maturities with a remaining term equal to the expected life of the option. The expected life is based on historical trends and data.  With regard to the weighted-average option life assumption, the Company considers the exercise behavior of past grants and models the pattern of aggregate exercises. Patterns are determined on specific criteria of the aggregate pool of optionees including the reaction to vesting, realizable value and short-time-to-maturity effect. Based on the Company’s historical voluntary turnover rates, an annualized estimated forfeiture rate of 10% has been used in calculating the estimated cost. Additional expense will be recorded if the actual forfeiture rate is lower than estimated, and a recovery of prior expense will be recorded if the actual forfeiture is higher than estimated.

Selected information regarding the Company’s stock option plans as of and for the year ended September 30, 2006 is as follows:

 

Shares

 

 

 

Authorized

 

Reserved for

 

 

 

for Grant

 

Future Issuance

 

 

 

 

 

 

 

1996 International Employee Non-Qualified Stock Option Plan

 

88,888

 

1,042

 

Datawatch Corporation 1996 Stock Plan

 

1,248,000

 

10,818

 

Datawatch Corporation 2006 Equity Compensation and Incentive Plan

 

600,000

 

595,000

 

 

 

 

 

 

 

 

 

1,936,888

 

606,860

 

 

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

 

 

 

Weighted-

 

 

 

Number of

 

Average

 

 

 

Options

 

Exercise

 

 

 

Outstanding

 

Price

 

 

 

 

 

 

 

Outstanding, September 30, 2003

 

947,462

 

2.10

 

Granted

 

127,000

 

3.38

 

Canceled

 

(83,712

)

3.46

 

Exercised

 

(70,780

)

1.81

 

Outstanding, September 30, 2004

 

919,970

 

2.17

 

Granted

 

115,334

 

3.78

 

Canceled

 

(55,286

)

3.06

 

Exercised

 

(67,976

)

1.21

 

Outstanding, September 30, 2005

 

912,042

 

2.39

 

Granted

 

100,000

 

4.14

 

Canceled

 

(16,325

)

6.89

 

Exercised

 

(143,401

)

1.26

 

Outstanding, September 30, 2006

 

852,316

 

$

2.65

 

 

 

 

 

 

 

Exercisable, September 30, 2006

 

771,908

 

$

2.50

 

Exercisable, September 30, 2005

 

912,042

 

$

2.39

 

 

50




The following table presents weighted-average price and life information regarding options outstanding and exercisable at September 30, 2006:

Options Outstanding

 

Options Exercisable

 

 

 

 

 

 

Weighted-

 

Weighted-

 

 

 

Weighted-

 

 

 

Remaining

 

Average

 

Average

 

 

 

Average

 

Exercise

 

Number of

 

Contractual

 

Exercise

 

 

 

Exercise

 

Prices

 

Shares

 

Life (Years)

 

Price

 

Shares

 

Price

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$ 0.55-3.62

 

 

605,006

 

5.91

 

$

1.78

 

584,171

 

$

1.71

 

3.62-6.69

 

 

230,192

 

6.48

 

4.55

 

170,619

 

4.64

 

6.69-9.75

 

 

17,118

 

3.18

 

7.81

 

17,118

 

7.81

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

852,316

 

6.00

 

$

2.65

 

771,908

 

$

2.50

 

 

9.                     RETIREMENT SAVINGS PLAN

The Company has a 401(k) retirement savings plan covering substantially all of the Company’s full-time domestic employees. Under the provisions of the plan, employees may contribute a portion of their compensation within certain limitations. The Company, at the discretion of the Board of Directors, may make contributions on behalf of its employees under this plan. Such contributions, if any, become fully vested after five years of continuous service. The Company has not made any contributions during 2006, 2005 or 2004.

10.              SEGMENT INFORMATION

The following table presents information about the Company’s revenues by product line for the years ended September 30, 2006, 2005 and 2004:

 

2006

 

2005

 

2004

 

 

 

 

 

 

 

 

 

Desktop (primarily Monarch)

 

58

%

59

%

56

%

Visual|QSM and Visual|HD

 

22

 

26

 

30

 

Datawatch|ES (including Datawatch|RMS, Datawatch|Researcher & iMergence)

 

15

 

15

 

14

 

Datawatch|BDS

 

5

 

 

 

 

 

 

 

 

 

 

 

 

 

100

%

100

%

100

%

 

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

 

 

 

International

 

 

 

 

 

 

 

 

 

(Principally

 

 

 

 

 

 

 

Domestic

 

U.K.)

 

Eliminations

 

Total

 

 

 

 

 

 

 

 

 

 

 

Year Ended September 30, 2006

 

 

 

 

 

 

 

 

 

Total revenue

 

$

15,110,134

 

$

6,675,569

 

$

(974,459

)

$

20,811,244

 

Operating income (loss)

 

564,554

 

(1,098,790

)

 

(534,236

)

Non-current assets

 

8,806,029

 

880,878

 

 

9,686,907

 

 

 

 

 

 

 

 

 

 

 

Year Ended September 30, 2005

 

 

 

 

 

 

 

 

 

Total revenue

 

$

14,726,803

 

$

7,847,803

 

$

(1,063,011

)

$

21,511,595

 

Operating income (loss)

 

1,639,882

 

(951,512

)

 

688,370

 

Non-current assets

 

3,456,146

 

93,835

 

 

3,549,981

 

 

 

 

 

 

 

 

 

 

 

Year Ended September 30, 2004

 

 

 

 

 

 

 

 

 

Total revenue

 

$

12,782,198

 

$

7,573,558

 

$

(1,020,610

)

$

19,335,146

 

Operating income (loss)

 

1,166,971

 

(242,285

)

 

924,686

 

Non-current assets

 

3,896,946

 

116,477

 

 

4,013,423

 

 

51




The reconciliations of total long-lived assets to the amounts contained in the Company’s consolidated financial statements at September 30, 2006 and 2005 are as follows:

 

2006

 

2005

 

 

 

 

 

 

 

Property and equipment, net

 

$

1,129,123

 

$

516,412

 

Goodwill

 

5,236,109

 

1,630,646

 

Acquired software, net *

 

455,278

 

400,278

 

Trademarks *

 

345,152

 

345,152

 

Capitalized software development costs, net *

 

17,836

 

182,880

 

Patents, net *

 

143,549

 

151,578

 

Customer list *

 

1,651,771

 

93,437

 

Non -compete agreements *

 

541,250

 

77,500

 

Restricted cash

 

125,000

 

125,000

 

Deposits **

 

41,839

 

27,098

 

 

 

 

 

 

 

Total long-lived assets

 

$

9,686,907

 

$

3,549,981

 

 


*

 

Included in other intangible assets, net in the accompanying consolidated financial statements.

**

 

Included in other assets in the accompanying consolidated financial statements.

 

Export revenue totaled $2,529,210, $3,386,650 and $3,261,252 in 2006, 2005 and 2004, respectively.

11.              QUARTERLY RESULTS (UNAUDITED)

Supplementary Information:

 

 

First

 

Second

 

Third

 

Fourth

 

 

 

 

 

 

 

 

 

 

 

Year Ended September 30, 2006:

 

 

 

 

 

 

 

 

 

Software license and subscription revenue

 

$

3,154,717

 

$

3,444,402

 

3,385,560

 

3,160,912

 

Maintenance and service revenue

 

1,592,840

 

1,949,201

 

1,958,481

 

2,165,131

 

Cost of software licenses and subscriptions

 

572,890

 

590,975

 

579,990

 

524,603

 

Cost of maintenance and services

 

840,649

 

963,710

 

999,861

 

1,145,094

 

Expenses

 

3,284,333

 

3,630,821

 

4,055,621

 

4,156,933

 

Income (loss) from operations

 

49,685

 

208,097

 

(291,431

)

(500,587

)

Net income (loss)

 

64,140

 

226,635

 

(315,162

)

(530,166

)

 

 

 

 

 

 

 

 

 

 

Net income (loss) per share - basic

 

$

0.01

 

$

0.04

 

$

(0.06

)

$

(0.09

)

Net income (loss) per share - diluted

 

$

0.01

 

$

0.04

 

$

(0.06

)

$

(0.09

)

 

 

 

 

 

 

 

 

 

 

Year Ended September 30, 2005:

 

 

 

 

 

 

 

 

 

Software license and subscription revenue

 

$

3,216,938

 

$

3,307,340

 

$

3,757,458

 

$

3,951,210

 

Maintenance and service revenue

 

1,870,390

 

1,801,407

 

1,861,474

 

1,745,378

 

Cost of software licenses and subscriptions

 

593,915

 

566,311

 

698,675

 

656,159

 

Cost of maintenance and services

 

915,937

 

840,503

 

822,671

 

859,208

 

Expenses

 

3,757,437

 

3,718,117

 

3,777,879

 

3,616,413

 

Income (loss) from operations

 

(179,961

)

(16,184

)

319,707

 

564,808

 

Net income (loss)

 

(153,782

)

6,764

 

330,064

 

617,368

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) per share - basic

 

$

(0.03

)

$

0.00

 

$

0.06

 

$

0.12

 

Net income (loss) per share - diluted

 

$

(0.03

)

$

0.00

 

$

0.06

 

$

0.11

 

 

52




12.              SUBSEQUENT EVENT- RESTRUCTURING

In October 2006, the Company initiated and completed a restructuring plan in an effort to reduce costs and focus resources on key areas of the business.  The restructuring plan was limited to one of the Company’s wholly owned subsidiaries, Datawatch International Limited (“DWI”) and resulted in charges for severance benefits and related costs for nine terminated employees of approximately $128,000.  All of these costs will be charged in the first quarter of fiscal 2007.

Item 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not Applicable.

Item 9A. CONTROLS AND PROCEDURES

(a)     Evaluation of disclosure controls and procedures

The principal executive officer and principal financial officer, with the participation of the Company’s management, evaluated the effectiveness of the Company’s “disclosure controls and procedures” (as defined in Exchange Act Rule 13(a)-15(e)) as of the end of the period covered by this Annual Report on Form 10-K.  Based on our evaluation, we have determined that in the area of revenue recognition, we did not have adequate controls to provide reasonable assurance that non-standard revenue contracts were sufficiently evaluated including consideration of customer acceptance terms and documentation of vendor specific objective evidence of services. As a result of this material weakness, with respect to the fourth quarter of fiscal 2006, certain contracts were not initially recorded in accordance with generally accepted accounting principles resulting in material revenue-related post-closing adjustments to our books and records. These adjustments totaling approximately $200,000, which are reflected in our financial statements as of, and for the year ended, September 30, 2006 (as set forth in Item 8 of this Form 10-K), had the effect of decreasing revenue, accounts receivable and accrued expenses, and increasing deferred revenue. These adjustments did not affect the previously reported results for the first, second or third quarters of fiscal 2006.

In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and our management necessarily applied its judgment in evaluating the cost-benefit relationship of possible controls and procedures.  Based on this evaluation, our principal executive officer and principal financial officer concluded that, as of September 30, 2006, as a result of the material weakness in our internal controls over financial reporting described above, our disclosure controls and procedures were not effective.

The following initiatives are being taken to address the material weakness described above:

·                hiring of additional personnel with software revenue recognition experience;

·                initiate additional training of sales organization regarding revenue recognition rules and best practices;

·                formulate checklists to define revenue recognition criteria and to document related transactional information; and

·                implement a policy requiring quarterly certifications from all sales personnel, in order to assist management in detecting issues that may affect revenue recognition and the accuracy of our financial statements.

53




As we proceed in the implementation of these strategies, additional changes may be made to our internal controls and procedures.

(b)                Changes in internal controls

As discussed above, management identified a material weakness related to controls over revenue recognition for non-standard contracts during the quarter ended September 30, 2006. No other changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the quarter ended September 30, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Item 9B. OTHER INFORMATION

None.

54




PART III

Item 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information with respect to Directors may be found under the caption “Election of Directors” appearing in the Company’s definitive Proxy Statement for the Annual Meeting of Shareholders for the fiscal year ended September 30, 2006.  Such information is incorporated herein by reference. Information with respect to the Company’s executive officers may be found under the caption “Executive Officers of the Registrant” appearing in Part I of this Annual Report on Form 10-K.

Item 11.  EXECUTIVE COMPENSATION

The information set forth under the captions “Compensation and Other Information Concerning Directors and Officers” appearing in the Company’s definitive Proxy Statement for the Annual Meeting of Shareholders for the fiscal year ended September 30, 2006 is incorporated herein by reference.

Item 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information set forth under the caption “Principal Holders of Voting Securities” and “Equity Compensation Plans” appearing in the Company’s definitive Proxy Statement for the Annual Meeting of Shareholders for the fiscal year ended September 30, 2006 is incorporated herein by reference.

Item 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information set forth under the caption “Certain Transactions” appearing in the Company’s definitive Proxy Statement for the Annual Meeting of Shareholders for the fiscal year ended September 30, 2006 is incorporated herein by reference.

Item 14.  PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information set forth under the caption “Principal Accountant Fees and Services” appearing in the Company’s definitive Proxy Statement for the Annual Meeting of Shareholders for the fiscal year ended September 30, 2006 is incorporated herein by reference.

55




PART IV

Item 15.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

The following documents are filed as part of this report:

(a)   1.  Consolidated Financial Statements

 

Report of Independent Registered Public Accounting Firm

 

Consolidated Balance Sheets as of September 30, 2006 and 2005

 

Consolidated Statements of Operations for the Years Ended September 30, 2006, 2005 and 2004

 

Consolidated Statements of Shareholders’ Equity for the Years Ended September 30, 2006, 2005 and 2004

 

Consolidated Statements of Cash Flows for the Years Ended September 30, 2006, 2005 and 2004

 

Notes to Consolidated Financial Statements

 

2.  Financial Statement Schedule

All schedules are omitted as the required information is not applicable or is included in the financial statements or related notes.

3.  List of Exhibits

Ex. No.

 

Description

 

 

 

 

 

(1)

 

3.1

 

Restated Certificate of Incorporation of the Registrant (Exhibit 3.2)

(6)

 

3.2

 

Certificate of Amendment of Restated Certificate of Incorporation of the Registrant (Exhibit 3.2)

(1)

 

3.3

 

By-Laws, as amended, of the Registrant (Exhibit 3.3)

(1)

 

4.1

 

Specimen certificate representing the Common Stock (Exhibit 4.4)

(4)

 

4.2

 

Warrant to Purchase Stock issued to Silicon Valley Bank, dated January 17, 2001 (Exhibit 4.1)

(6)

 

4.3

 

Warrant to Purchase Stock issued to Silicon Valley Bank, dated October 30, 2001 (Exhibit 4.3)

(1)

 

10.1*

 

1987 Stock Plan (Exhibit 10.7)

(11)

 

10.2*

 

Form of Incentive Stock Option Agreement of the Registrant (Exhibit 10.2)

(11)

 

10.3*

 

Form of Nonqualified Stock Option Agreement of the Registrant (Exhibit 10.3)

(1)

 

10.4

 

Software Development and Marketing Agreement by and between Personics Corporation and Raymond Huger, dated January 19, 1989 (Exhibit 10.12)

(9)

 

10.5

 

Option Purchase Agreement by and among Datawatch Corporation, Personics Corporation and Raymond J. Huger dated April 29, 2005. (Exhibit 10.1)

(8)

 

10.6

 

Distribution Agreement, dated December 10, 1992, by and between Datawatch Corporation and Ingram Micro Inc. (Exhibit 10.2)

(2)

 

10.7*

 

1996 Non-Employee Director Stock Option Plan, as amended on December 10, 1996 (Exhibit 10.30)

(2)

 

10.8*

 

1996 International Employee Non-Qualified Stock Option Plan (Exhibit 10.31)

(8)

 

10.9*

 

1996 Stock Plan as amended as of March 7, 2003 (Exhibit 10.1)

(3)

 

10.10

 

Indemnification Agreement between Datawatch Corporation and James Wood, dated January 12, 2001 (Exhibit 10.1)

(3)

 

10.11

 

Indemnification Agreement between Datawatch Corporation and Richard de J. Osborne, dated January 12, 2001 (Exhibit 10.2)

(5)

 

10.12

 

Form of Indemnification Agreement between Datawatch Corporation and each of its Non-Employee Directors (Exhibit 10.1)

(5)

 

10.13*

 

Advisory Agreement, dated April 5, 2001, by and between Datawatch Corporation and Richard de J. Osborne (Exhibit 10.2)

(6)

 

10.14*

 

Executive Agreement, dated July 9, 2001, between the Company and Robert W. Hagger (Exhibit 10.24)

(7)

 

10.15*

 

Executive Agreement, dated April 25, 2002, by and between Datawatch Corporation and John Kitchen (Exhibit 10.2)

(7)

 

10.16

 

Professional Services Agreement, dated May 16, 2002, by and between Vested Development Inc. and Datawatch Corporation (Exhibit 10.3)

 

56




 

(13)

 

10.17*

 

Severance Agreement between Datawatch Corporation and John Hulburt, dated November 19, 2004. (Exhibit 10.19)

(10)

 

10.18

 

Stock Purchase Agreement among Datawatch Corporation, Mergence Technologies Corporation and the Management Sellers, dated as of August 11, 2005 (Exhibit 2.1).

(10)

 

10.19

 

Form of Stock Purchase Agreement among Datawatch Corporation, Mergence Technologies Corporation and the Non-Management Sellers, dated as of August 11, 2005 (Exhibit 2.2)

(11)

 

10.20*

 

Description of Fiscal Executive Sales Incentive Plan (Exhibit 10.4)

(12)

 

10.21*

 

Form of Lock-up Agreement between Datawatch Corporation and each Executive Officer of Datawatch Corporation, dated September 26, 2005 (Exhibit 99.1)

(12)

 

10.22

 

Sublease Agreement, dated September 28, 2005, between Tellabs Operations, Inc., and Datawatch Corporation (Exhibit 99.2)

(14)

 

10.23

 

February 2006 Amendment to Software Development and Marketing Agreement, dated February 21, 2006 by and among the Company, Personics Corporation, Raymond J. Huger and Math Strategies (Exhibit 10.1)

(14)

 

10.24

 

Amendment to Option Purchase Agreement, dated February 21, 2006 by and among the Company, Personics Corporation,   Raymond J. Huger and Math Strategies (Exhibit 10.2)

(15)

 

10.25*

 

2006 Equity Compensation and Incentive Plan

 

 

10.26*

 

Form of 2006 Non-Qualified Stock Option Agreement for Directors (filed herewith)

 

 

10.27*

 

Form of 2006 Non-Qualified Stock Option Agreement for Officers (filed herewith)

 

 

10.28*

 

Form of 2006 Incentive Stock Option Agreement for Officers (filed herewith)

(16)

 

10.29

 

Asset Purchase Agreement dated as of March 10, 2006 between Datawatch Corporation and ClearStory Systems, Inc. (Exhibit 10.1)

(17)

 

10.30

 

Loan and Security Agreement dated April 20, 2006 between Silicon Valley Bank, Datawatch Corporation, and Datawatch Technologies Corporation (Exhibit 10.1)

(18)

 

10.31

 

First Loan Modification Agreement dated August 2, 2006 between Silicon Valley Bank, Datawatch Corporation and Datawatch Technologies Corporation (Exhibit 10.1)

(19)

 

10.32

 

Second Loan Modification Agreement dated November 27, 2006 between Silicon Valley Bank, Datawatch Corporation, and Datawatch Technologies Corporation (Exhibit 10.1)

 

 

21.1

 

Subsidiaries of the Registrant (filed herewith)

 

 

23.1

 

Consent of Independent Registered Pubic Accounting Firm (filed herewith)

 

 

31.1

 

Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (filed herewith)

 

 

31.2

 

Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (filed herewith)

 

 

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. (furnished herewith)

 

 

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. (furnished herewith)

 


*                                          Indicates a management contract or compensatory plan or contract.

(1)

 

Previously filed as an exhibit to Registration Statement 33-46290 on Form S-1 and incorporated herein by reference (the number given in parenthesis indicates the corresponding exhibit in such Form S-1).

(2)

 

Previously filed as an exhibit to Registrant’s Annual Report on Form 10-K for the fiscal year ended September 30, 1996 and incorporated herein by reference (the number given in parenthesis indicates the corresponding exhibit in such Form 10-K).

(3)

 

Previously filed as an exhibit to Registrant’s Current Report on Form 8-K dated February 2, 2001 and incorporated herein by reference (the number in parenthesis indicates the corresponding exhibit in such Form 8-K).

(4)

 

Previously filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2000 and incorporated herein by reference (the number given in parenthesis indicates the corresponding exhibit in such Form 10-Q).

(5)

 

Previously filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2001 and incorporated herein by reference (the number given in parenthesis indicates the corresponding exhibit in such Form 10-Q).

(6)

 

Previously filed as an exhibit to Registrant’s Annual Report on Form 10-K for the fiscal year ended September 30, 2001 and incorporated herein by reference (the number given in parenthesis indicates the corresponding exhibit in such Form 10-K).

 

57




 

(7)

 

Previously filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2002 and incorporated herein by reference (the number given in parenthesis indicates the corresponding exhibit in such Form 10-Q).

(8)

 

Previously filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2003 and incorporated herein by reference (the number given in parenthesis indicates the corresponding exhibit in such Form 10-Q).

(9)

 

Previously filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2004 and incorporated herein by reference (the number given in parenthesis indicates the corresponding exhibit is such Form 10-Q).

(10)

 

Previously filed as an exhibit to Registrant’s Current Report on Form 8-K dated August 20, 2004 and incorporated herein by reference (the number in parenthesis indicates the corresponding exhibit in such Form 8-K).

(11)

 

Previously filed as an exhibit to Registrant’s Current Report on Form 8-K dated November 2, 2004 and incorporated herein by reference (the number in parenthesis indicates the corresponding exhibit in such Form 8-K).

(12)

 

Previously filed as an exhibit to Registrant’s Current Report on Form 8-K dated September 26, 2005 and incorporated herein by reference (the number in parenthesis indicates the corresponding exhibit in such Form 8-K).

(13)

 

Previously filed as an exhibit to Registrant’s Annual Report on Form 10-K for the fiscal year ended September 30, 2005 and incorporated herein by reference (the number given in parenthesis indicates the corresponding exhibit in such Form 10-K).

(14)

 

Previously filed as an exhibit to Registrant’s Current Report on Form 8-K dated February 21, 2006 and incorporated herein by reference (the number in parenthesis indicates the corresponding exhibit in such Form 8-K).

(15)

 

Previously filed as Appendix A to Registrant’s Definitive Proxy Statement dated January 30, 2006 and incorporated herein by reference.

(16)

 

Previously filed as an exhibit to Registrant’s Current Report on Form 8-K dated March 10, 2006 and incorporated herein by reference (the number in parenthesis indicates the corresponding exhibit in such Form 8-K).

(17)

 

Previously filed as an exhibit to Registrant’s Current Report on Form 8-K dated April 20, 2006 and incorporated herein by reference (the number in parenthesis indicates the corresponding exhibit in such Form 8-K).

(18)

 

Previously filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 20, 2006 and incorporated herein by reference (the number in parenthesis indicates the corresponding exhibit in such Form 10-Q).

(19)

 

Previously filed as an exhibit to Registrant’s Current Report on Form 8-K dated November 27, 2006 and incorporated herein by reference (the number in parenthesis indicates the corresponding exhibit in such Form 8-K).

 

(b)              Exhibits

The Company hereby files as exhibits to this Annual Report on Form 10-K those exhibits listed in Item 15(a)3 above.

(c)              Financial Statement Schedules

Not applicable.

58




SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

 

Datawatch Corporation

 

 

 

Date:

December 29, 2006

By:

/s/ Robert W. Hagger

 

 

 

 

Robert W. Hagger

 

 

 

President, Chief Executive Officer

 

 

 

and Director

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

SIGNATURE

 

TITLE

 

DATE

 

 

 

 

 

/s/ Robert W. Hagger

 

 

President, Chief Executive Officer and Director

 

December 29, 2006

Robert W. Hagger

 

(Principal Executive Officer)

 

 

 

 

 

 

 

/s/ John J. Hulburt

 

 

Vice President of Finance, Chief Financial Officer,

 

December 29, 2006

John J. Hulburt

 

Treasurer and Assistant Secretary

 

 

 

 

(Principal Financial and Accounting Officer)

 

 

 

 

 

 

 

/s/ Richard de J. Osborne

 

 

Chairman of the Board

 

December 29, 2006

Richard de J. Osborne

 

 

 

 

 

 

 

 

 

/s/ Thomas H. Kelly

 

Director

 

December 29, 2006

Thomas H. Kelly

 

 

 

 

 

 

 

 

 

/s/ Terry W. Potter

 

 

Director

 

December 29, 2006

Terry W. Potter

 

 

 

 

 

 

 

 

 

/s/ David T. Riddiford

 

 

Director

 

December 29, 2006

David T. Riddiford

 

 

 

 

 

 

 

 

 

/s/ James Wood

 

 

Director

 

December 29, 2006

James Wood

 

 

 

 

 

59



Exhibit 10.26

DATAWATCH CORPORATION

Non-Qualified Stock Option Agreement

Datawatch Corporation, a Delaware corporation (the “Company”), hereby grants as of [Date] to [ Director] (the “Optionee”), an option to purchase a maximum of [# of shares] shares (the “Option Shares”) of its Common Stock, $.01 par value (“Common Stock”), at the price of [Price] per share, on the following terms and conditions:

1.                                       Grant Under 2006 Equity Compensation and Incentive Plan .   This option is granted pursuant to and is governed by the Company’s 2006 Equity Compensation and Incentive Plan (the “Plan”) and, unless the context otherwise requires, terms used herein shall have the same meaning as in the Plan.  Determinations made in connection with this option pursuant to the Plan shall be governed by the Plan as it exists on this date.

2.                                       Grant as Non-Qualified Stock Option; Other Options .  This option shall be treated as a Non-Qualified Stock Option (rather than an incentive stock option under Section 422 of the Internal Revenue Code of 1986, as amended (the “Code”)).  This option is in addition to any other options heretofore or hereafter granted to the Optionee by the Company or any Related Corporation (as defined in the Plan), but a duplicate original of this instrument shall not effect the grant of another option.

3.                                       Extent of Option if Business Relationship Continues .  If the Optionee has continued to serve the Company or any Related Corporation in the capacity of an employee, officer, director or consultant (such service is described herein as maintaining or being involved in a “Business Relationship” with the Company) on the following dates, the Optionee may exercise this option for the number of shares of Common Stock set opposite the applicable date:

Prior to [Date ]

 

-

 

- 0 - shares

 

 

 

 

 

On [Date] and at
the end of each three month
period thereafter

 

-

 

an additional [  ] shares (or such
smaller number of shares at the end of
the last three month period so that the
total does not exceed [# of shares ]
shares)

 

In accordance with the foregoing schedule, a total of [# of shares] shares shall be vested and exercisable on the third anniversary of [Date] .  Notwithstanding the foregoing, in accordance with and subject to the provisions of the Plan, the Committee may, in its discretion, accelerate the date that any installment of this Option becomes exercisable.  The foregoing rights are cumulative and, while the Optionee continues to maintain a Business Relationship with the Company, may be exercised on or before the date which is seven years from the date this option is granted.  All the foregoing rights are subject to Sections 4 and 5, as appropriate, if the Optionee ceases to maintain a Business Relationship with the Company.

4.                                       Termination of Business Relationship .   If the Optionee ceases to maintain a Business Relationship with the Company, other than by reason of death or disability as defined in Section 5, no further installments of this option shall become exercisable, and this option shall terminate (and may no longer be exercised) (i) after the passage of twelve months from the date the Business Relationship ceases, but in no event later than the scheduled expiration date, if the Optionee has been involved in a Business Relationship with the Company as a Director on the Company’s Board of Directors for less than five years or (ii) after the passage of twenty-four months from the date the Business Relationship ceases, but in no event later than the scheduled expiration date, if the Optionee has been involved in a Business Relationship with the Company as a Director on

1




the Company’s Board of Directors for five years or more.  In such a case, the Optionee’s only rights hereunder shall be those which are properly exercised before the termination of this option.

5.                                       Death; Disability .   If the Optionee dies while involved in a Business Relationship with the Company, this option may be exercised, to the extent of the number of shares with respect to which the Optionee could have exercised it on the date of his or her death, by his or her estate, personal representative or beneficiary to whom this option has been assigned pursuant to Section 9, at any time within 180 days after the date of death, but not later than the scheduled expiration date.  If the Optionee’s Business Relationship with the Company is terminated by reason of his or her disability (as defined in the Plan), this option may be exercised, to the extent of the number of shares with respect to which the Optionee could have exercised it on the date the Business Relationship was terminated, at any time within 180 days after the date of such termination, but not later than the scheduled expiration date.  At the expiration of such 180-day period or the scheduled expiration date, whichever is the earlier, this option shall terminate and the only the rights hereunder shall be those as to which the option was properly exercised before such termination.

6.                                       Partial Exercise This option may be exercised in part at any time and from time to time within the above limits, except that this option may not be exercised for a fraction of a share unless such exercise is with respect to the final installment of stock subject to this option and cash in lieu of a fractional share must be paid, in accordance with Paragraph 13(G) of the Plan, to permit the Optionee to exercise completely such final installment.  Any fractional share with respect to which an installment of this option cannot be exercised because of the limitation contained in the preceding sentence shall remain subject to this option and shall be available for later purchase by the Optionee in accordance with the terms hereof.

7.                                       Payment of Price .  (a)  The option price shall be paid in the following manner:

(i)                                      in United States dollars in cash or by check;

(ii)                                   subject to Section 7(b) below, by delivery of shares of the Company’s Common Stock having a fair market value (as determined by the Committee) as of the date of the exercise equal to the cash exercise price of this option;

(iii)                                by delivery of an assignment satisfactory in form and substance to the Company of a sufficient amount of the proceeds from the sale of the Option Shares and an instruction to the broker or selling agent to pay that amount to the Company; or

(iv)                               by any combination of the foregoing.

(b)                                   Limitations on Payment by Delivery of Common Stock .   If the Optionee delivers Common Stock held by the Optionee (“Old Stock”) to the Company in full or partial payment of the option price, and the Old Stock so delivered is subject to restrictions or limitations imposed by agreement between the Optionee and the Company, an equivalent number of Option Shares shall be subject to all restrictions and limitations applicable to the Old Stock to the extent that the Optionee paid for the Option Shares by delivery of Old Stock, in addition to any restrictions or limitations imposed by this Agreement.  Notwithstanding the foregoing, the Optionee may not pay any part of the exercise price hereof by transferring Common Stock to the Company unless such Common Stock has been owned by the Optionee free of any substantial risk of forfeiture for at least six months.

8.                                       Method of Exercising Option Subject to the terms and conditions of this Agreement, this option may be exercised by written notice to the Company at its principal executive office,  or to such transfer agent as the Company shall designate.  Such notice shall state the election to exercise this option and the number of Option Shares for which it is being exercised and shall be signed by the person or persons so exercising this option.  Such notice shall be accompanied by payment of the full purchase price of such shares, and the Company shall deliver a certificate or certificates representing such shares as soon as practicable after the notice shall be received.  Such certificate or certificates shall be registered in the name of the person or persons so exercising this

2




option (or, if this option shall be exercised by the Optionee and if the Optionee shall so request in the notice exercising this option, shall be registered in the name of the Optionee and another person jointly, with right of survivorship). In the event this option shall be exercised, pursuant to Section 5 hereof, by any person or persons other than the Optionee, such notice shall be accompanied by appropriate proof of the right of such person or persons to exercise this option.

9.                                       Option Not Transferable This option is not transferable or assignable except by will or by the laws of descent and distribution.  During the Optionee’s lifetime only the Optionee can exercise this option.

10.                                No Obligation to Exercise Option The grant and acceptance of this option imposes no obligation on the Optionee to exercise it.

11.                                No Obligation to Continue Business Relationship Neither the Plan, this Agreement, nor the grant of this option imposes any obligation on the Company or any Related Corporation to continue to maintain a Business Relationship with the Optionee.

12.                                No Rights as Stockholder until Exercise The Optionee shall have no rights as a stockholder with respect to the Option Shares until such time as the Optionee has exercised this option by delivering a notice of exercise and has paid in full the purchase price for the shares so exercised in accordance with Section 8.  Except as is expressly provided in the Plan with respect to certain changes in the capitalization of the Company, no adjustment shall be made for dividends or similar rights for which the record date is prior to such date of exercise.

13.                                Capital Changes and Business Successions The Plan contains provisions covering the treatment of options in a number of contingencies such as stock splits and mergers.  Provisions in the Plan for adjustment with respect to stock subject to options and the related provisions with respect to successors to the business of the Company are hereby made applicable hereunder and are incorporated herein by reference.

14.                                Withholding Taxes .   If the Company or any Related Corporation in its discretion determines that it is obligated to withhold any tax in connection with the exercise of this option, or in connection with the transfer of, or the lapse of restrictions on, any Common Stock or other property acquired pursuant to this option, the Optionee hereby agrees that the Company or any Related Corporation may withhold from the Optionee’s wages or other remuneration the appropriate amount of tax.  At the discretion of the Company or Related Corporation, the amount required to be withheld may be withheld in cash from such wages or other remuneration or in kind from the Common Stock or other property otherwise deliverable to the Optionee on exercise of this option.  The Optionee further agrees that, if the Company or any Related Corporation does not withhold an amount from the Optionee’s wages or other remuneration sufficient to satisfy the withholding obligation of the Company or Related Corporation, the Optionee will make reimbursement on demand, in cash, for the amount underwithheld.

15.                                Provision of Documentation to Optionee .   By signing this Agreement the Optionee acknowledges receipt of a copy of this Agreement and a copy of the Plan.

16.                                Acceleration of Vesting upon Change in Control .   Notwithstanding Section 3 hereof, in the event of a Change in Control of the Company while this option is in effect, this option shall, immediately prior to the consummation of such Change in Control, become fully vested and all unexercised options shall be exercisable by the Optionee; provided , however , that the Board, in its sole discretion, may require that the Optionee’s rights under this Section 16 shall be conditioned on approval by the stockholders of the Company in accordance with Section 280G(b)5(B) of the Code and regulations thereunder.  For purposes of this Agreement, a “Change in Control” means the occurrence of any of the following events:

(a)                   The Company is merged or consolidated or reorganized into or with another corporation or other legal person, and as a result of such merger, consolidation or reorganization less than a majority of the combined voting power of the then-outstanding securities of such surviving, resulting or reorganized corporation or person immediately after such transaction is held in the aggregate by the holders of the then-outstanding

3




securities entitled to vote generally in the election of directors of the Company (“Voting Stock”) immediately prior to such transaction;

(b)                   The Company sells or otherwise transfers all or substantially all of its assets to any other corporation or other legal person, and as a result of such sale or transfer less than a majority of the combined voting power of the then-outstanding securities of such corporation or person immediately after such sale or transfer is held in the aggregate by the holders of Voting Stock of the Company immediately prior to such sale or transfer;

(c)                   There is a report filed on Schedule 13D or Schedule 14D-1 (or any successor schedule, form or report), each as promulgated pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), disclosing that any “person” (as such term is used in Section 13(d)(3) or Section 14(d)(2) of the Exchange Act) has become the “beneficial owner” (as such term is used in Rule 13d-3 under the Exchange Act) of securities representing 35% or more of the Voting Stock of the Company;

(d)                   The Company files a report or proxy statement with the Securities and Exchange Commission pursuant to the Exchange Act disclosing in response to Form 8-K or Schedule 14A (or any successor schedule, form or report or item therein) that a change in control of the Company has occurred; or

(e)                   If during any period of two consecutive years, individuals who at the beginning of any such period constitute the Board cease for any reason to constitute at least a majority thereof, unless the election, or the nomination for election by the Company’s stockholders, of each director of the Company first elected during such period was approved by a vote of at least a majority of the directors then still in office who were directors of the Company at the beginning of any such period;

provided , however , that a “Change in Control” shall not be deemed to have occurred for purposes of this Agreement solely because (x) the Company, (y) an entity in which the Company directly or indirectly beneficially owns 50% or more of the voting securities, or (z) any Company-sponsored employee stock ownership plan or any other employee benefit plan of the Company, either files or becomes obligated to file a report or a proxy statement under or in response to Schedule 13D, Schedule 14D-1, Form 8-K or Schedule 14A (or any successor schedule, form or report) under the Exchange Act, disclosing beneficial ownership by it of shares of Voting Stock or because the Company reports that a change in control of the Company has occurred by reason of such beneficial ownership.

17.                                Miscellaneous .

(a)                                   Notices .   All notices hereunder shall be in writing and shall be deemed given when sent by certified or registered mail, postage prepaid, return receipt requested, to the address set forth below.  The addresses for such notices may be changed from time to time by written notice given in the manner provided for herein.

(b)                                   Entire Agreement; Modification This Agreement constitutes the entire agreement between the parties relative to the subject matter hereof, and supersedes all proposals, written or oral, and all other communications between the parties relating to the subject matter of this Agreement.  This Agreement may be modified, amended or rescinded only by a written agreement executed by both parties.

(c)                                   Severability The invalidity, illegality or unenforceability of any provision of this Agreement shall in no way affect the validity, legality or enforceability of any other provision.

(d)                                   Successors and Assigns This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns, subject to the limitations set forth in Section 9 hereof.

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(e)                                   Governing Law .   This Agreement shall be governed by and interpreted in accordance with the laws of the Commonwealth of Massachusetts , without giving effect to the principles of the conflicts of laws thereof.

[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]

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IN WITNESS WHEREOF, the Company and the Optionee have caused this instrument to be executed as of the date first above written.

COMPANY:

 

 

 

DATAWATCH CORPORATION

 

Quorum Office Park

 

271 Mill Road

 

Chelmsford, MA 01824

 

 

 

 

 

By:

 

 

 

 

Robert W. Hagger,

 

 

President and Chief Executive Officer

 

 

 

 

 

OPTIONEE:

 

 

 

 

 

 

 

 

[Name]

 

 

 

 

 

 

Street Address

 

 

 

 

 

 

City

State

Zip Code

 

6



Exhibit 10.27

DATAWATCH CORPORATION

Non-Qualified Stock Option Agreement

Datawatch Corporation, a Delaware corporation (the “Company”), hereby grants as of [Date] to [Officer] (the “Optionee”), an option to purchase a maximum of [# of shares] shares (the “Option Shares”) of its Common Stock, $.01 par value (“Common Stock”), at the price of [Price] per share, on the following terms and conditions:

1.                                       Grant Under 2006 Equity Compensation and Incentive Plan .   This option is granted pursuant to and is governed by the Company’s 2006 Equity Compensation and Incentive Plan (the “Plan”) and, unless the context otherwise requires, terms used herein shall have the same meaning as in the Plan.  Determinations made in connection with this option pursuant to the Plan shall be governed by the Plan as it exists on this date.

2.                                       Grant as Non-Qualified Stock Option; Other Options .  This option shall be treated as a Non-Qualified Stock Option (rather than an incentive stock option under Section 422 of the Internal Revenue Code of 1986, as amended (the “Code”)).  This option is in addition to any other options heretofore or hereafter granted to the Optionee by the Company or any Related Corporation (as defined in the Plan), but a duplicate original of this instrument shall not effect the grant of another option.

3.                                       Extent of Option if Business Relationship Continues .  If the Optionee has continued to serve the Company or any Related Corporation in the capacity of an employee, officer, director or consultant (such service is described herein as maintaining or being involved in a “Business Relationship” with the Company) on the following dates, the Optionee may exercise this option for the number of shares of Common Stock set opposite the applicable date:

Prior to [Date]

 

 

 

-0- shares

 

 

 

 

 

On [Date] and at the end of each
three-month period thereafter

 

-

 

An additional [   ] shares (or such
number of shares at the end of the last
three month period so that the total
does not exceed [# of shares ] shares.

 

In accordance with the foregoing schedule, a total of [# of shares] shares shall be vested and exercisable on the third anniversary of [Date] .  Notwithstanding the foregoing, in accordance with and subject to the provisions of the Plan, the Committee may, in its discretion, accelerate the date that any installment of this Option becomes exercisable.  The foregoing rights are cumulative and, while the Optionee continues to maintain a Business Relationship with the Company, may be exercised on or before the date which is seven years from the date this option is granted.  All the foregoing rights are subject to Sections 4 and 5, as appropriate, if the Optionee ceases to maintain a Business Relationship with the Company.

4.                                       Termination of Business Relationship .   If the Optionee ceases to maintain a Business Relationship with the Company, other than by reason of death or disability as defined in Section 5, no further installments of this option shall become exercisable, and this option shall terminate after the passage of ninety (90) days from the date the Business Relationship ceases (the “Additional Exercise Period”), but in no event later than the scheduled expiration date; provided, however, that, immediately upon the Employee’s completion of his or her first full year of continuous employment with the Company the Additional Exercise Period shall increase to twelve months.  In such a case, the Optionee’s only rights hereunder shall be those which are properly exercised before the termination of this option.

5.                                       Death; Disability .   If the Optionee dies while involved in a Business Relationship with the Company, this option may be exercised, to the extent of the number of shares with respect to which the Optionee

1




could have exercised it on the date of his or her death, by his or her estate, personal representative or beneficiary to whom this option has been assigned pursuant to Section 9, at any time within 180 days after the date of death, but not later than the scheduled expiration date.  If the Optionee’s Business Relationship with the Company is terminated by reason of his or her disability (as defined in the Plan), this option may be exercised, to the extent of the number of shares with respect to which the Optionee could have exercised it on the date the Business Relationship was terminated, at any time within 180 days after the date of such termination, but not later than the scheduled expiration date.  At the expiration of such 180-day period or the scheduled expiration date, whichever is the earlier, this option shall terminate and the only the rights hereunder shall be those as to which the option was properly exercised before such termination.

6.                                       Partial Exercise This option may be exercised in part at any time and from time to time within the above limits, except that this option may not be exercised for a fraction of a share unless such exercise is with respect to the final installment of stock subject to this option and cash in lieu of a fractional share must be paid, in accordance with Paragraph 13(G) of the Plan, to permit the Optionee to exercise completely such final installment.  Any fractional share with respect to which an installment of this option cannot be exercised because of the limitation contained in the preceding sentence shall remain subject to this option and shall be available for later purchase by the Optionee in accordance with the terms hereof.

7.                                       Payment of Price .  (a)  The option price shall be paid in the following manner:

(i)                                      in United States dollars in cash or by check;

(ii)                                   subject to Section 7(b) below, by delivery of shares of the Company’s Common Stock having a fair market value (as determined by the Committee) as of the date of the exercise equal to the cash exercise price of this option;

(iii)                                by delivery of an assignment satisfactory in form and substance to the Company of a sufficient amount of the proceeds from the sale of the Option Shares and an instruction to the broker or selling agent to pay that amount to the Company; or

(iv)                               by any combination of the foregoing.

(b)                                   Limitations on Payment by Delivery of Common Stock .   If the Optionee delivers Common Stock held by the Optionee (“Old Stock”) to the Company in full or partial payment of the option price, and the Old Stock so delivered is subject to restrictions or limitations imposed by agreement between the Optionee and the Company, an equivalent number of Option Shares shall be subject to all restrictions and limitations applicable to the Old Stock to the extent that the Optionee paid for the Option Shares by delivery of Old Stock, in addition to any restrictions or limitations imposed by this Agreement.  Notwithstanding the foregoing, the Optionee may not pay any part of the exercise price hereof by transferring Common Stock to the Company unless such Common Stock has been owned by the Optionee free of any substantial risk of forfeiture for at least six months.

8.                                       Method of Exercising Option Subject to the terms and conditions of this Agreement, this option may be exercised by written notice to the Company at its principal executive office,  or to such transfer agent as the Company shall designate.  Such notice shall state the election to exercise this option and the number of Option Shares for which it is being exercised and shall be signed by the person or persons so exercising this option.  Such notice shall be accompanied by payment of the full purchase price of such shares, and the Company shall deliver a certificate or certificates representing such shares as soon as practicable after the notice shall be received.  Such certificate or certificates shall be registered in the name of the person or persons so exercising this option (or, if this option shall be exercised by the Optionee and if the Optionee shall so request in the notice exercising this option, shall be registered in the name of the Optionee and another person jointly, with right of survivorship). In the event this option shall be exercised, pursuant to Section 5 hereof, by any person or persons other than the Optionee, such notice shall be accompanied by appropriate proof of the right of such person or persons to exercise this option.

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9.                                       Option Not Transferable This option is not transferable or assignable except by will or by the laws of descent and distribution.  During the Optionee’s lifetime only the Optionee can exercise this option.

10.                                No Obligation to Exercise Option The grant and acceptance of this option imposes no obligation on the Optionee to exercise it.

11.                                No Obligation to Continue Business Relationship Neither the Plan, this Agreement, nor the grant of this option imposes any obligation on the Company or any Related Corporation to continue to maintain a Business Relationship with the Optionee.

12.                                No Rights as Stockholder until Exercise The Optionee shall have no rights as a stockholder with respect to the Option Shares until such time as the Optionee has exercised this option by delivering a notice of exercise and has paid in full the purchase price for the shares so exercised in accordance with Section 8.  Except as is expressly provided in the Plan with respect to certain changes in the capitalization of the Company, no adjustment shall be made for dividends or similar rights for which the record date is prior to such date of exercise.

13.                                Capital Changes and Business Successions The Plan contains provisions covering the treatment of options in a number of contingencies such as stock splits and mergers.  Provisions in the Plan for adjustment with respect to stock subject to options and the related provisions with respect to successors to the business of the Company are hereby made applicable hereunder and are incorporated herein by reference.

14.                                Withholding Taxes .   If the Company or any Related Corporation in its discretion determines that it is obligated to withhold any tax in connection with the exercise of this option, or in connection with the transfer of, or the lapse of restrictions on, any Common Stock or other property acquired pursuant to this option, the Optionee hereby agrees that the Company or any Related Corporation may withhold from the Optionee’s wages or other remuneration the appropriate amount of tax.  At the discretion of the Company or Related Corporation, the amount required to be withheld may be withheld in cash from such wages or other remuneration or in kind from the Common Stock or other property otherwise deliverable to the Optionee on exercise of this option.  The Optionee further agrees that, if the Company or any Related Corporation does not withhold an amount from the Optionee’s wages or other remuneration sufficient to satisfy the withholding obligation of the Company or Related Corporation, the Optionee will make reimbursement on demand, in cash, for the amount underwithheld.

15.                                Provision of Documentation to Optionee .   By signing this Agreement the Optionee acknowledges receipt of a copy of this Agreement and a copy of the Plan.

16.                                Acceleration of Vesting upon Change in Control.   Notwithstanding Section 3 hereof, in the event of a Change in Control of the Company while this option is in effect, this option shall, immediately prior to the consummation of such Change in Control, become fully vested and all unexercised options shall be exercisable by the Employee: provided, however, that the Board, in its sole discretion, may require that the Employee’s rights under this section shall be conditioned on approval by the stockholders of the Company in accordance with Section 280G(b)5(B) of the Code and regulations thereunder.  For purposes of this Agreement, a “Change in Control” means the occurrence of any of the following events:

(a)                                   The Company is merged or consolidated or reorganized into or with another corporation or other legal person, and as a result of such merger, consolidation or reorganization less than a majority of the combined voting power of the then-outstanding securities of such surviving, resulting or reorganized corporation or person immediately after such transaction is held in the aggregate by the holders of the then-outstanding securities entitled to vote generally in the election of directors of the Company (“Voting Stock”) immediately prior to such transaction:

(b)                                   The Company sell or otherwise transfers all or substantially all of its assets to any other corporation or other legal person, and as a result of such sales or transfer less than a majority of

3




the combined voting power of the then-outstanding securities of such corporation or person immediately after such sale or transfer is held in the aggregate by the holder of Voting Stock of the Company immediately prior to such sale or transfer;

(c)                                   There is a report filed on Schedule 13D or Schedule 14D-1 (or any successor schedule, form or report), each as promulgated pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), disclosing that any “person” (as such term is used in Section 13(d)(3) or Section 14(d)(2) of the Exchange Act) has become the “beneficial owner” (as such term is used in Rule 13d-3 under the Exchange Act) of securities representing 35% or more of the Voting Stock of the Company;

(d)                                   The Company files a report or proxy statement with the Securities and Exchange Commission pursuant to the Exchange Act disclosing in response to Form 8-K or Schedule 14A (or any successor schedule, form or report or item therein) that a change in control of the Company has occurred; or

(e)                                   If during any period of two consecutive years, individuals who at the beginning of any such period constitute the Board cease for any reason to constitute at least a majority thereof, unless the election, or the nomination for election by the Company’s stockholders, of each director of the Company first elected during such period was approved by a vote of at least a majority of the directors then still in office who were directors of the Company at the beginning of any such period;

Provided, however, that a “Change in Control” shall not be deemed to have occurred for purposes of this Agreement solely because (x) the Company, (y) an entity in which the Company directly or indirectly beneficially owns 50% or more of the voting securities, or (z) any Company-sponsored employee stock ownership plan or any other employee benefit plan of the Company, either files or becomes obligated to file a report or a proxy statement under or in response to Schedule 13D, Schedule 14D-1, Form 8-K or Schedule 14A (or any successor schedule, form or report) under the Exchange Act, disclosing beneficial ownership by it of shares of Voting Stock or because the Company reports that a change in control of the Company has occurred by reason of such beneficial ownership.

17.                                Miscellaneous .

(a)                                   Notices .   All notices hereunder shall be in writing and shall be deemed given when sent by certified or registered mail, postage prepaid, return receipt requested, to the address set forth below.  The addresses for such notices may be changed from time to time by written notice given in the manner provided for herein.

(b)                                   Entire Agreement; Modification This Agreement constitutes the entire agreement between the parties relative to the subject matter hereof, and supersedes all proposals, written or oral, and all other communications between the parties relating to the subject matter of this Agreement.  This Agreement may be modified, amended or rescinded only by a written agreement executed by both parties.

(c)                                   Severability The invalidity, illegality or unenforceability of any provision of this Agreement shall in no way affect the validity, legality or enforceability of any other provision.

(d)                                   Successors and Assigns This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns, subject to the limitations set forth in Section 9 hereof.

4




(e)                                   Governing Law .   This Agreement shall be governed by and interpreted in accordance with the laws of the Commonwealth of Massachusetts , without giving effect to the principles of the conflicts of laws thereof.

[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]

5




IN WITNESS WHEREOF, the Company and the Optionee have caused this instrument to be executed as of the date first above written.

 

COMPANY:

 

 

 

DATAWATCH CORPORATION

 

Quorum Office Park

 

 

271 Mill Road

 

 

Chelmsford, MA 01824

 

 

 

 

 

 

 

By:

 

 

 

 

Robert W. Hagger

 

 

President and CEO

 

 

 

 

 

OPTIONEE:

 

 

 

 

 

 

 

 

[Name]

 

 

 

 

 

 

 

 

Street Address

 

 

 

 

 

City

State

Zip Code

 

 

6



Exhibit 10.28

DATAWATCH CORPORATION

Incentive Stock Option Agreement

Datawatch Corporation, a Delaware corporation (the “Company”), hereby grants as of [Date]  to [Officer] (the “Employee”), an option to purchase a maximum of [# of shares] shares (the “Option Shares”) of its Common Stock, $.01 par value (“Common Stock”), at the price of [Price] per share, on the following terms and conditions:

1.                                       Grant Under 2006 Equity Compensation and Incentive Plan .   This option is granted pursuant to and is governed by the Company’s 2006 Equity Compensation and Incentive Plan (the “Plan”) and, unless the context otherwise requires, terms used herein shall have the same meaning as in the Plan.  Determinations made in connection with this option pursuant to the Plan shall be governed by the Plan as it exists on this date.

2.                                       Grant as Incentive Stock Option; Other Options .  This option is intended to qualify as an incentive stock option under Section 422 of the Internal Revenue Code of 1986, as amended (the “Code”).  This option is in addition to any other options heretofore or hereafter granted to the Employee by the Company or any Related Corporation (as defined in the Plan), but a duplicate original of this instrument shall not effect the grant of another option.

3.                                       Vesting of Option if Employment Continues .  If the Employee has continued to be employed by the Company or any Related Corporation on the following dates, the Employee may exercise this option for the number of shares of Common Stock set opposite the applicable date:

Prior to [Date]

 

 

 

-0- shares

 

 

 

 

 

On [Date] and at the end of each
three-month period thereafter

 

-

 

An additional [   ] shares (or such smaller number of shares at the end of the last three month period so that the total does not exceed [# of shares ] shares.

 

Notwithstanding the foregoing, in accordance with and subject to the provisions of the Plan, the Committee may, in its discretion, accelerate the date that any installment of this Option becomes exercisable.  The foregoing rights are cumulative and (subject to Sections 4 or 5 hereof if the Employee ceases to be employed by the Company and all Related Corporations) may be exercised on or before the date which is seven years from the date this option is granted.

4.                                       Termination of Employment .

(a)                                   Termination Other Than for Cause .  If the Employee ceases to be employed by the Company and all Related Corporations, other than by reason of death or disability as defined in Section 5 or termination for Cause as defined in Section 4(c), no further installments of this option shall become exercisable, and this option shall terminate (and may no longer be exercised) after the passage of three months from the Employee’s last day of employment (the “Additional Exercise Period”), but in no event later than the scheduled expiration date; provided, however, that, immediately upon the Employee’s completion of his or her first full year of continuous employment with the Company the Additional Exercise Period shall increase to twelve months.  Employee acknowledges that if Employee exercises this option to purchase Option Shares at any time after the passage of three months from the Employee’s last day of employment, the option will no longer qualify as an incentive stock option under Section 422 of

1




the Code and will be treated for all purposes as a non-qualified stock option.  The Employee’s only rights hereunder shall be those which are properly exercised before the termination of this option.

(b)                                   Termination for Cause If the employment of the Employee is terminated for Cause (as defined in Section 4(c)), this option shall terminate upon the Employee’s receipt of written notice of such termination and shall thereafter not be exercisable to any extent whatsoever.

(c)                                   Definition of Cause “Cause” shall mean conduct involving one or more of the following:  (i) the substantial and continuing failure of the Employee, after notice thereof, to render services to the Company or Related Corporation in accordance with the terms or requirements of his or her employment; (ii) disloyalty, gross negligence, willful misconduct, dishonesty or breach of fiduciary duty to the Company or Related Corporation; (iii) the commission of an act of embezzlement or fraud; (iv) deliberate disregard of the rules or policies of the Company or Related Corporation which results in direct or indirect loss, damage or injury to the Company or Related Corporation; (v) the unauthorized disclosure of any trade secret or confidential information of the Company or Related Corporation; or (vi) the commission of an act which constitutes unfair competition with the Company or Related Corporation or which induces any customer or supplier to breach a contract with the Company or Related Corporation.

5.                                       Death; Disability .

(a)                                   Death .   If the Employee dies while in the employ of the Company or any Related Corporation, this option may be exercised, to the extent otherwise exercisable on the date of his or her death, by the Employee’s estate, personal representative or beneficiary to whom this option has been assigned pursuant to Section 9, at any time within 180 days after the date of death, but not later than the scheduled expiration date.

(b)                                   Disability .   If the Employee ceases to be employed by the Company and all Related Corporations by reason of his or her disability (as defined in the Plan), this option may be exercised, to the extent otherwise exercisable on the date of the termination of his or her employment, at any time within 180 days after such termination, but not later than the scheduled expiration date.

(c)                                   Effect of Termination At the expiration of the 180-day period provided in paragraphs (a) or (b) of this Section 5 or the scheduled expiration date, whichever is the earlier, this option shall terminate (and shall no longer be exercisable) and the only rights hereunder shall be those as to which the option was properly exercised before such termination.

6.                                       Partial Exercise This option may be exercised in part at any time and from time to time within the above limits, except that this option may not be exercised for a fraction of a share unless such exercise is with respect to the final installment of stock subject to this option and cash in lieu of a fractional share must be paid, in accordance with Paragraph 13(G) of the Plan, to permit the Employee to exercise completely such final installment.  Any fractional share with respect to which an installment of this option cannot be exercised because of the limitation contained in the preceding sentence shall remain subject to this option and shall be available for later purchase by the Employee in accordance with the terms hereof.

7.                                       Payment of Price .  (a)  The option price shall be paid in the following manner:

(i)                                      in United States dollars in cash or by check;

(ii)                                   subject to Section 7(b) below, by delivery of shares of the Company’s Common Stock having a fair market value (as determined by the Committee) as of the date of the exercise equal to the cash exercise price of this option;

2




(iii)                                by delivery of an assignment satisfactory in form and substance to the Company of a sufficient amount of the proceeds from the sale of the Option Shares and an instruction to the broker or selling agent to pay that amount to the Company; or

(iv)                               by any combination of the foregoing.

(b)                                   Limitations on Payment by Delivery of Common Stock .   If the Employee delivers Common Stock held by the Employee (“Old Stock”) to the Company in full or partial payment of the option price, and the Old Stock so delivered is subject to restrictions or limitations imposed by agreement between the Employee and the Company, an equivalent number of Option Shares shall be subject to all restrictions and limitations applicable to the Old Stock to the extent that the Employee paid for the Option Shares by delivery of Old Stock, in addition to any restrictions or limitations imposed by this Agreement.  Notwithstanding the foregoing, the Employee may not pay any part of the exercise price hereof by transferring Common Stock to the Company unless such Common Stock has been owned by the Employee free of any substantial risk of forfeiture for at least six months.

8.                                       Method of Exercising Option Subject to the terms and conditions of this Agreement, this option may be exercised by written notice to the Company at its principal executive office,  or to such transfer agent as the Company shall designate.  Such notice shall state the election to exercise this option and the number of Option Shares for which it is being exercised and shall be signed by the person or persons so exercising this option.  Such notice shall be accompanied by payment of the full purchase price of such shares, and the Company shall deliver a certificate or certificates representing such shares as soon as practicable after the notice shall be received.  Such certificate or certificates shall be registered in the name of the person or persons so exercising this option (or, if this option shall be exercised by the Employee and if the Employee shall so request in the notice exercising this option, shall be registered in the name of the Employee and another person jointly, with right of survivorship). In the event this option shall be exercised, pursuant to Section 5 hereof, by any person or persons other than the Employee, such notice shall be accompanied by appropriate proof of the right of such person or persons to exercise this option.

9.                                       Option Not Transferable This option is not transferable or assignable except by will or by the laws of descent and distribution.  During the Employee’s lifetime only the Employee can exercise this option.

10.                                No Obligation to Exercise Option The grant and acceptance of this option imposes no obligation on the Employee to exercise it.

11.                                No Obligation to Continue Employment Neither the Plan, this Agreement, nor the grant of this option imposes any obligation on the Company or any Related Corporation to continue the Employee in employment.

12.                                No Rights as Stockholder until Exercise The Employee shall have no rights as a stockholder with respect to the Option Shares until such time as the Employee has exercised this option by delivering a notice of exercise and has paid in full the purchase price for the shares so exercised in accordance with Section 8.  Except as is expressly provided in the Plan with respect to certain changes in the capitalization of the Company, no adjustment shall be made for dividends or similar rights for which the record date is prior to such date of exercise.

13.                                Capital Changes and Business Successions The Plan contains provisions covering the treatment of options in a number of contingencies such as stock splits and mergers.  Provisions in the Plan for adjustment with respect to stock subject to options and the related provisions with respect to successors to the business of the Company are hereby made applicable hereunder and are incorporated herein by reference.

14.                                Early Disposition The Employee agrees to notify the Company in writing immediately after the Employee transfers any Option Shares, if such transfer occurs on or before the later of (a) the date two years after the date of this Agreement or (b) the date one year after the date the Employee acquired such Option Shares.  The

3




Employee also agrees to provide the Company with any information concerning any such transfer required by the Company for tax purposes.

15.                                Withholding Taxes .   If the Company or any Related Corporation in its discretion determines that it is obligated to withhold any tax in connection with the exercise of this option, or in connection with the transfer of, or the lapse of restrictions on, any Common Stock or other property acquired pursuant to this option, the Employee hereby agrees that the Company or any Related Corporation may withhold from the Employee’s wages or other remuneration the appropriate amount of tax.  At the discretion of the Company or Related Corporation, the amount required to be withheld may be withheld in cash from such wages or other remuneration or in kind from the Common Stock or other property otherwise deliverable to the Employee on exercise of this option.  The Employee further agrees that, if the Company or any Related Corporation does not withhold an amount from the Employee’s wages or other remuneration sufficient to satisfy the withholding obligation of the Company or Related Corporation, the Employee will make reimbursement on demand, in cash, for the amount underwithheld.

16.                                Provision of Documentation to Employee .   By signing this Agreement the Employee acknowledges receipt of a copy of this Agreement and a copy of the Plan.

17.                                Acceleration of Vesting upon Change in Control.   Notwithstanding Section 3 hereof, in the event of a Change in Control of the Company while this option is in effect, this option shall, immediately prior to the consummation of such Change in Control, become fully vested and all unexercised options shall be exercisable by the Employee: provided, however, that the Board, in its sole discretion, may require that the Employee’s rights under this section shall be conditioned on approval by the stockholders of the Company in accordance with Section 280G(b)5(B) of the Code and regulations thereunder.  For purposes of this Agreement, a “Change in Control” means the occurrence of any of the following events:

(f)                                     The Company is merged or consolidated or reorganized into or with another corporation or other legal person, and as a result of such merger, consolidation or reorganization less than a majority of the combined voting power of the then-outstanding securities of such surviving, resulting or reorganized corporation or person immediately after such transaction is held in the aggregate by the holders of the then-outstanding securities entitled to vote generally in the election of directors of the Company (“Voting Stock”) immediately prior to such transaction:

(g)                                  The Company sell or otherwise transfers all or substantially all of its assets to any other corporation or other legal person, and as a result of such sales or transfer less than a majority of the combined voting power of the then-outstanding securities of such corporation or person immediately after such sale or transfer is held in the aggregate by the holder of Voting Stock of the Company immediately prior to such sale or transfer;

(h)                                  There is a report filed on Schedule 13D or Schedule 14D-1 (or any successor schedule, form or report), each as promulgated pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), disclosing that any “person” (as such term is used in Section 13(d)(3) or Section 14(d)(2) of the Exchange Act) has become the “beneficial owner” (as such term is used in Rule 13d-3 under the Exchange Act) of securities representing 35% or more of the Voting Stock of the Company;

(i)                                     The Company files a report or proxy statement with the Securities and Exchange Commission pursuant to the Exchange Act disclosing in response to Form 8-K or Schedule 14A (or any successor schedule, form or report or item therein) that a change in control of the Company has occurred; or

(j)                                     If during any period of two consecutive years, individuals who at the beginning of any such period constitute the Board cease for any reason to constitute at least a majority thereof, unless the election, or the nomination for election by the Company’s stockholders, of each director of the Company first elected during such period was approved by a vote of at least a majority of the

4




directors then still in office who were directors of the Company at the beginning of any such period;

Provided, however, that a “Change in Control” shall not be deemed to have occurred for purposes of this Agreement solely because (x) the Company, (y) an entity in which the Company directly or indirectly beneficially owns 50% or more of the voting securities, or (z) any Company-sponsored employee stock ownership plan or any other employee benefit plan of the Company, either files or becomes obligated to file a report or a proxy statement under or in response to Schedule 13D, Schedule 14D-1, Form 8-K or Schedule 14A (or any successor schedule, form or report) under the Exchange Act, disclosing beneficial ownership by it of shares of Voting Stock or because the Company reports that a change in control of the Company has occurred by reason of such beneficial ownership.

18.                                Miscellaneous .

(a)                                   Notices .   All notices hereunder shall be in writing and shall be deemed given when sent by certified or registered mail, postage prepaid, return receipt requested, to the address set forth below.  The addresses for such notices may be changed from time to time by written notice given in the manner provided for herein.

(b)                                   Entire Agreement; Modification This Agreement constitutes the entire agreement between the parties relative to the subject matter hereof, and supersedes all proposals, written or oral, and all other communications between the parties relating to the subject matter of this Agreement.  This Agreement may be modified, amended or rescinded only by a written agreement executed by both parties.

(c)                                   Severability The invalidity, illegality or unenforceability of any provision of this Agreement shall in no way affect the validity, legality or enforceability of any other provision.

(d)                                   Successors and Assigns This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns, subject to the limitations set forth in Section 9 hereof.

(e)                                   Governing Law .   This Agreement shall be governed by and interpreted in accordance with the laws of the Commonwealth of Massachusetts , without giving effect to the principles of the conflicts of laws thereof.

[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]

5




IN WITNESS WHEREOF, the Company and the Employee have caused this instrument to be executed as of the date first above written.

 

DATAWATCH CORPORATION

 

Quorum Office Park

 

271 Mill Road

 

Chelmsford, MA 01824

 

 

 

By:

 

 

 

 

Robert W. Hagger,

 

 

President & CEO

 

 

 

 

 

By: Employee:

 

 

 

 

 

 

 

 

[Name]

 

 

 

 

 

 

 

 

 

 

Street Address

 

 

 

 

 

 

 

 

 

City

State

Zip Code

 

 

 

 

 

 

 

 

By:

 

 

 

 

Robert W. Hagger

 

 

President and CEO

 

 

 

 

 

OPTIONEE:

 

 

 

 

 

 

 

 

[Name]

 

 

 

 

 

 

 

 

Street Address

 

 

 

 

 

City

State

Zip Code

 

 

6



EXHIBIT 21.1

SUBSIDIARIES OF THE REGISTRANT

 

PLACE OF

 

 

SUBSIDIARY

 

INCORPORATION

 

D/B/A NAME

 

 

 

 

 

Personics Corporation

 

Delaware, USA

 

Personics Corporation

 

 

 

 

 

Datawatch Technologies

 

Delaware, USA

 

Datawatch Technologies

Corporation

 

 

 

Corporation

 

 

 

 

 

Auxilor, Inc.

 

Delaware, USA

 

Auxilor, Inc.

 

 

 

 

 

Datawatch International

 

England and Wales

 

Datawatch International

Limited

 

 

 

Limited

 

 

 

 

 

Datawatch GmbH*

 

Germany

 

Datawatch GmbH

 

 

 

 

 

Datawatch France SARL*

 

France

 

Datawatch France SARL

 

 

 

 

 

Datawatch Pty Ltd.*

 

Australia

 

Datawatch Pty Ltd.

 

 

 

 

 

Datawatch Europe Limited*

 

England and Wales

 

Datawatch Europe

 

 

 

 

Limited

 


*All of the shares of capital stock of Datawatch GmbH, Datawatch France SARL, Datawatch Pty Ltd. and Datawatch Europe Limited are owned by Datawatch International Limited.

1



Exhibit 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in Registration Statement No.’s 333-134291, 333-104011, 333-84312,
333-57244, 333-34312, 333-39627 on
Form S-8 of our report dated December 29, 2006, relating to the financial statements of Datawatch Corporation, appearing in this Annual Report on Form 10-K of Datawatch Corporation for the year ended September 30, 2006.

/s/ DELOITTE & TOUCHE LLP

 

 

Boston, Massachusetts

December 29, 2006

1



EXHIBIT 31.1

CERTIFICATIONS

I, Robert W. Hagger, certify that:

1.                   I have reviewed this annual report on Form 10-K of Datawatch Corporation;

2.                   Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.                   Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.                   The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a)             Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)            Paragraph omitted in accordance with SEC transition instructions contained in SEC Release 34-47986.

(c)             Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)            Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.                   The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)             All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b)            Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: December 29, 2006

/s/ Robert W. Hagger

 

 

Robert W. Hagger

 

President, Chief Executive Officer

 

and Director

 

1



EXHIBIT 31.2

CERTIFICATIONS

I, John J. Hulburt, certify that:

1.                   I have reviewed this annual report on Form 10-K of Datawatch Corporation;

2.                   Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.                   Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.                   The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a)             Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)            Paragraph omitted in accordance with SEC transition instructions contained in SEC Release 34-47986.

(c)             Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)            Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.                   The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)             All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b)            Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: December 29, 2006

/s/ John J. Hulburt

 

 

John J. Hulburt

 

Vice President of Finance, Chief Financial Officer

 

1



EXHIBIT 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Datawatch Corporation (the “Company”) on Form 10-K for the fiscal year ended September 30, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Robert W. Hagger, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that:

(1)             The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)             The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

  /s/ Robert W. Hagger

 

 

Robert W. Hagger

 

Chief Executive Officer

 

December 29, 2006

 

1



EXHIBIT 32.2

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Datawatch Corporation (the “Company”) on Form 10-K for the fiscal year ended September 30, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, John J. Hulburt, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that:

(1)             The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)             The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

  /s/ John J. Hulburt

 

 

John J. Hulburt

 

Chief Financial Officer

 

December 29, 2006

 

1