UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________
Commission file number: 0-19960
Datawatch Corporation
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(Exact name of registrant as specified in its charter)
Delaware 02-0405716
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Tower III, 5th Floor, 900 Chelmsford Street, Lowell, MA 01851-8100
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(Address of principal executive offices) (Zip Code)
(978) 441-2200
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(Registrant's telephone number, including area code)
None
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(Former name, former address, former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that
the registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes __X__ No _____
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date:
Class Outstanding at August 10, 1999
- ------------------------------ ------------------------------
Common stock, $.01 par value 9,189,113
DATAWATCH CORPORATION AND SUBSIDIARIES
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TABLE OF CONTENTS
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PART I. FINANCIAL INFORMATION
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Item 1. Financial Statements Page #
------
a) Consolidated Condensed Balance Sheets:
June 30, 1999 and September 30, 1998 3
b) Consolidated Condensed Statements of Operations:
Three Months Ended June 30, 1999 and 1998
Nine Months Ended June 30, 1999 and 1998 4
c) Consolidated Condensed Statements of Cash Flows:
Nine Months Ended June 30, 1999 and 1998 5
d) Notes to Consolidated Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
Item 3. Quantitative and Qualitative Disclosures About Market Risk 17
PART II. OTHER INFORMATION
- ----------------------------
Item 1. Legal Proceedings *
Item 2. Changes in Securities *
Item 3. Default upon Senior Securities *
Item 4. Submission of Matters to a Vote of Security Holders *
Item 5. Other Information *
Item 6. Exhibits and Reports on Form 8-K 18
SIGNATURES
* No information provided due to inapplicability of item.
PART I.
Item 1. Financial Statements
--------------------
DATAWATCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(Unaudited)
JUNE 30, SEPTEMBER 30,
1999 1998
-----------------------------------
ASSETS
- ------
CURRENT ASSETS:
Cash and equivalents $ 2,091,023 $ 3,575,256
Short-term investments 1,751,448 3,395,410
Accounts receivable, net 6,945,145 6,401,965
Inventories 429,765 511,669
Prepaid expenses 1,090,736 1,270,671
--------------- --------------
Total current assets 12,308,117 15,154,971
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PROPERTY AND EQUIPMENT:
Property and equipment 4,086,979 4,280,100
Less accumulated depreciation
and amortization (2,583,661) (2,453,240)
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Net property and equipment 1,503,318 1,826,860
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OTHER ASSETS 858,891 625,293
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EXCESS OF COSTS OVER NET ASSETS
OF ACQUIRED COMPANIES 577,911 725,091
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TOTAL ASSETS $ 15,248,237 $ 18,332,215
=============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 3,055,507 $ 3,791,323
Accrued expenses 1,122,643 1,301,599
Borrowings under credit lines 1,500,000 250,000
Deferred revenue 1,324,954 1,161,556
Current portion of long-term debt 55,466 147,065
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Total current liabilities 7,058,570 6,651,543
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LONG-TERM DEBT 5,213 44,190
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TOTAL LIABILITIES 7,063,783 6,695,733
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COMMITMENTS AND CONTINGENCIES (NOTE 5)
SHAREHOLDERS' EQUITY:
- ---------------------
Common stock 92,178 91,803
Additional paid-in capital 19,864,329 19,823,887
Accumulated deficit (11,247,714) (7,829,554)
Accumulated other comprehensive loss (383,951) (309,266)
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8,324,842 11,776,870
Less treasury stock - at cost (140,388) (140,388)
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Total shareholders' equity 8,184,454 11,636,482
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TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 15,248,237 $ 18,332,215
================ ===============
See notes to consolidated condensed financial statements.
DATAWATCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Nine Months Ended
June 30, June 30,
1999 1998 1999 1998
------------------------- -------------------------
IBM-PC based products $ 6,687,263 $ 6,533,423 $20,371,451 $19,116,255
Macintosh-based products 172,254
----------- ----------- ----------- -----------
NET SALES 6,687,263 6,533,423 20,371,451 19,288,509
COSTS AND EXPENSES:
Cost of sales 1,545,817 1,263,342 4,768,722 3,987,016
Engineering and product
development 572,817 739,584 1,948,890 1,658,110
Selling, general and
administrative 4,979,108 6,280,434 16,878,061 18,298,650
Restructuring and
centralization costs 449,130 648,767 2,364,246
----------- ----------- ----------- -----------
LOSS FROM OPERATIONS (859,609) (1,749,937) (3,872,989) (7,019,513)
INTEREST EXPENSE (33,586) (13,178) (98,207) (45,514)
OTHER INCOME, primarily
interest 33,788 105,040 147,179 392,571
GAIN (LOSS) ON DISPOSITION
OF FIXED ASSETS (3,080) (5,210)
GAIN ON SALE OF PRODUCT
LINE 15,431,253
FOREIGN CURRENCY
TRANSACTION GAIN (LOSS) (1,870) (4,526) (563) (14,728)
----------- ----------- ----------- -----------
INCOME (LOSS) BEFORE
PROVISION (BENEFIT) FOR
INCOME TAX (864,357) (1,662,601) (3,829,790) 8,744,069
PROVISION (BENEFIT) FOR
INCOME TAX (411,630) (1,000,000) (411,630) 1,225,000
----------- ----------- ----------- -----------
NET INCOME (LOSS) $ (452,727) $ (662,601) $(3,418,160) $ 7,519,069
=========== =========== ============ ===========
NET INCOME (LOSS) PER:
COMMON SHARE-Basic $ (.05) $ (.07) $ (.37) $ .82
=========== =========== =========== ===========
COMMON SHARE-Diluted $ (.05) $ (.07) $ (.37) $ .81
=========== =========== =========== ===========
WEIGHTED AVERAGE SHARES
OUTSTANDING - Basic 9,157,133 9,147,542 9,151,300 9,128,355
ADJUSTMENT FOR DILUTIVE
POTENTIAL COMMON STOCK 203,698
----------- ----------- ----------- -----------
WEIGHTED AVERAGE SHARES
OUTSTANDING - Diluted 9,157,133 9,147,542 9,151,300 9,332,053
=========== =========== =========== ===========
See notes to consolidated condensed financial statements.
DATAWATCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended June 30,
1999 1998
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (3,331,305) $ 7,519,068
Adjustment to reconcile net income to net cash:
Gain on sale of product line (15,431,253)
(Gain) loss on disposition of fixed assets 4,857 (12,383)
Depreciation and amortization 866,181 936,489
Interest accrued on short-term investments (5,660) (5,387)
Changes in current assets and liabilities:
Inventories 68,566 275,818
Prepaid expenses 511,424 (130,476)
Accounts receivable (784,933) 263,419
Accounts payable and accrued expenses (702,370) (2,146,585)
Deferred revenue 244,136 (129,713)
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Net cash used in operating activities (3,129,104) (8,861,003)
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CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to equipment and fixtures (264,018) (654,995)
Proceeds from maturity of short-term investments 6,906,947 4,879,482
Purchase of short-term investments (5,257,325) (8,649,764)
Proceeds from sale of product line to Dr Solomon's
Software, Inc. 16,750,000
Proceeds from disposition of fixed assets 8,849 18,400
Purchased software development (338,260)
Other assets (92,763) (53,680)
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Net cash provided by investing activities 963,430 12,289,443
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 40,817 86,567
Principal payments on long-term obligations (121,314) (206,185)
Principal payments on bank term-loan (1,500,000)
Borrowings under credit line, net 1,250,000
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Net cash provided by (used in) financing activities 1,169,503 (1,619,618)
------------ ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH: (488,062)
------------ ------------
NET INCREASE (DECREASE) IN CASH: (1,484,233) 1,808,822
CASH, BEGINNING OF PERIOD 3,575,256 1,586,875
------------ ------------
CASH, END OF PERIOD $ 2,091,023 $ 3,395,697
============ ============
See notes to consolidated condensed financial statements.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
1. Basis of Presentation: The accompanying unaudited condensed consolidated
financial statements include the accounts of Datawatch Corporation (the
"Company") and its wholly owned subsidiaries and have been prepared pursuant to
the rules and regulations of the Securities and Exchange Commission regarding
interim financial reporting. Accordingly, they do not include all of the
information and notes required by generally accepted accounting principles for
complete financial statements and should be read in conjunction with the audited
consolidated financial statements included in the Company's Annual Report on
Form 10-K for the year ended September 30, 1998.
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements have been prepared on the same basis as the
audited consolidated financial statements and include all adjustments necessary
for fair presentation of the results of the interim periods presented. The
operating results for the interim periods presented are not necessarily
indicative of the results expected for the full year.
2. Recent Accounting Pronouncements: The American Institute of Certified
Public Accountants ("AICPA") issued Statement of Position ("SOP") No. 97-2,
"Software Revenue Recognition," and interpretive guidance in SOP Nos. 98-4 and
98-9 which supersede SOP No. 91-1. The Company has adopted SOP No. 97-2 and the
successor SOPs effective October 1, 1998. SOP No. 97-2 generally requires
revenue earned on software arrangements involving multiple elements to be
allocated to each element based on the relative fair values of the elements. The
adoption of SOP No. 97-2 did not have a material effect on the Company's
operating results for either the three or nine months ended June 30, 1999.
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures About
Segments of an Enterprise and Related Information." SFAS No. 131 establishes
standards for the way that public business enterprises report information about
operating segments in annual financial statements and requires that those
enterprises report selected information about operating segments in interim
financial reports. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. SFAS No. 131 will
be adopted by the Company in its annual consolidated financial statements for
fiscal 1999. Such standard is a "disclosure standard" and will not impact the
Company's consolidated results of operations.
In March 1998, the AICPA released SOP 98-1, "Accounting for Costs of Computer
Software Developed or Obtained for Internal Use," which requires certain
expenditures made for internal use software to be capitalized. The Company is
currently studying the impact of SOP 98-1, which is required to be adopted by
the Company in October 1999.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," effective for fiscal years beginning after
June 15, 1999. The new standard requires that all companies record derivatives
on the balance sheet as assets or liabilities, measured at fair value. Gains or
losses resulting from changes in the values of those derivatives would be
accounted for depending on the use of the derivative and whether it qualifies
for hedge accounting. Management is currently assessing whether there will be
any impact of SFAS No. 133 on the Company's consolidated financial statements
upon adoption, which is required in October 1999.
3. Inventories: The Company accounts for its inventories using a standard
cost methodology. Inventories were comprised of the following:
June 30, 1999 September 30, 1998
------------------ ------------------
Materials $ 260,741 $ 303,426
Finished goods 169,024 208,243
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TOTAL $ 429,765 $ 511,669
================== ==================
4. Restructuring and Centralization Costs: During the fourth quarter of fiscal
1998, the Company approved and completed a restructuring plan to further
centralize its administrative infrastructure and its development efforts. These
charges, totaling approximately $315,000 have been paid. There were no changes
in these estimates in the nine months ended June 30, 1999.
During the first quarter of fiscal 1999, the Company approved and completed a
restructuring plan to centralize in the United States the quality assurance
efforts for its Quetzal/SC product. The restructuring plan consisted of charges
for severance benefits and related costs for 10 terminated employees. These
charges, totaling approximately $200,000, have been paid.
During the three months ended June 30, 1999, the Company approved and
completed a plan to further reduce costs and focus resources on key areas of the
business. The restructuring plan consisted of charges for severance benefits and
related costs for 21 employees. These charges, totaling approximately $449,000
were either paid ($354,000) or accrued ($95,000) in the third quarter of fiscal
1999. The accrued expenses will be paid in the fourth quarter of fiscal 1999.
5. Litigation: The Company is not a party to any litigation that management
believes will have a material adverse effect on the Company's consolidated
financial statements or its business.
6. Comprehensive Income: Effective October 1, 1998, the Company adopted the
provisions of SFAS No. 130, "Reporting Comprehensive Income." The following is
presented in accordance with this statement:
Nine Months Ended June 30,
1999 1998
------------ ------------
Net income (loss) $ (3,418,160) $ 7,519,069
Other comprehensive income, net of tax:
Foreign currency translation adjustments (74,685) 144,229
------------ ------------
Comprehensive income (loss) $ (3,492,845) $ 7,663,298
============ ============
Accumulated other comprehensive income (loss) reported in the condensed
consolidated balance sheets consists only of foreign currency translation
adjustments.
7. Financing Arrangement: On March 16, 1999 the Company amended its line of
credit with a bank. As amended, the line of credit expires on January 30, 2000
and provides for maximum borrowings up to the lesser of $1,500,000 or 50%-80%
of defined eligible accounts receivable. Borrowings under the line are
collateralized by substantially all assets of the Company. Outstanding
borrowings bear interest at the bank's prime rate plus 1% (8.75% at June 30,
1999). As of June 30, 1999, the Company had approximately $1,500,000 of
outstanding borrowings under the line of credit. The line of credit contains
customary covenants which require, among other items, a minimum level of
consolidated tangible net worth and the maintenance of a minimum liquidity
ratio, as defined. As of June 30, 1999, the Company was in default on its
covenant to maintain the minimum level of consolidated net worth. The default
on this covenant has been waived for the quarter ended June 30, 1999.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
---------------------------------------------------------------
GENERAL
Datawatch Corporation (the "Company" or "Datawatch") is a provider of
knowledge-based software solutions for the business enterprise.
Datawatch's principal products are: Monarch(T), a report mining application
that lets users extract and manipulate data from ASCII report files produced on
any mainframe, midrange, client/server or PC system; Monarch/ES(T), a
configurable enterprise reporting solution that lets organizations store and
deliver reports electronically via their local area network; Monarch/ES Web(T),
a Monarch/ES extension introduced in October 1998 that supports browser-based
report retrieval via the World Wide Web; Monarch/ES Report Publisher(T), a
Monarch/ES extension also introduced in October 1998 that supports automated
delivery of reports via MAPI-compliant email; Redwing(T) a plug-in for Adobe(R)
Acrobat(R) that lets users extract text and tables from Adobe PDF documents;
Monarch Data Pump(T), a data replication and migration tool that offers a
shortcut for populating and refreshing data marts and data warehouses; and
Quetzal/SC(T) an integrated help desk and asset management solution for multi-
user networked support centers.
RESULTS OF OPERATIONS
Three Months Ended June 30, 1999 and 1998
- -----------------------------------------
Net sales for the three months ended June 30, 1999 were $6,687,000 which
represents an increase of $154,000, or approximately 2% from net sales of
$6,533,000 for the three months ended June 30, 1998. This increase in net sales
results from an increase of the Company's Monarch/ES product sales and an
increase in third-party product sales. For the three months ended June 30, 1999,
the Monarch suite of products accounted for approximately 53% of net sales, the
Quetzal/SC product accounted for approximately 34% of net sales, and the
third-party product lines accounted for approximately 13% of net sales.
Cost of sales for the three months ended June 30, 1999 was $1,546,000 or
approximately 23% of net sales. Cost of sales for the three months ended
June 30, 1998 was $1,263,000 or approximately 19% of net sales. This increase
in cost of sales is due primarily to the increase in the Company's Monarch/ES
product sales and third-party product sales that bear a higher cost of sales
as a percentage of sales.
Engineering and product development expenses were $573,000 for the three
months ended June 30, 1999, a decrease of $167,000 or approximately 23% from
$740,000 for the three months ended June 30, 1998. This decrease is primarily
attributable to a reduction in the expenditures for development efforts
undertaken by developers under contract to the Company and a reduction in
quality assurance personnel for the Company's Quetzal/SC product resulting from
the restructuring which took place during the first quarter of fiscal 1999.
Selling, general and administrative expenses were $4,979,000 for the three
months ended June 30, 1999, a decrease of $1,301,000 or approximately 21% from
$6,280,000 for the three months ended June 30, 1998. This decrease is primarily
due to the reduction of personnel in the Company's worldwide operations pursuant
to a restructuring during the fourth quarter of fiscal 1998 and the third
quarter of fiscal 1999, as well as a decrease in promotional activities
associated with the Company's Monarch product.
During the three months ended June 30, 1999, the Company approved and
completed a plan to further reduce costs and focus resources on key areas of the
business. The restructuring plan consisted of charges for severance benefits and
related costs for 21 employees. These charges, totaling approximately $449,000
were either paid ($354,000) or accrued ($95,000) in the third quarter of fiscal
1999. The accrued expenses will be paid in the fourth quarter of fiscal 1999.
The Company recorded an income tax benefit of approximately $412,000 for the
three months ended June 30, 1999. This reflects the Company's current estimate
that it will not be in a taxable position at the end of the current year and
will be in a position to carry back certain net operating losses such estimates
are reviewed by management and are subject to change. The Company also recorded
an income tax benefit of approximately $1,000,000 for the three months ended
June 30, 1998 owing to management's change in estimate, at that time, of taxable
income for the year.
As a result of the foregoing, the loss from operations for the three months
ended June 30, 1999 was $860,000 which compares to a loss from operations of
$1,750,000 for the three months ended June 30, 1998. The net loss for the
three months ended June 30, 1999 was $453,000, which compares to a net loss of
$663,000 for the three months ended June 30, 1999.
Nine Months Ended June 30, 1999 and 1998
- ----------------------------------------
Net sales for the nine months ended June 30, 1999 were $20,371,000, which
represents an increase of $1,083,000 or approximately 6% from net sales of
$19,288,000 for the nine months ended June 30, 1998. This increase in net
sales results from an increase of the Company's Monarch/ES product sales and
approximately $420,000 of non-recurring revenue resulting from the reimbursement
by Adobe of engineering expenses paid to a third-party developer for
customization of the Company's Redwing product. Such an arrangement is unusual
in that customization work is usually undertaken and billed by a third-party.
For the nine months ended June 30, 1999, the Monarch suite of products accounted
for approximately 52% of net sales, Quetzal/SC accounted for approximately 35%,
and third-party product lines accounted for approximately 13% of net sales.
Cost of sales for the nine months ended June 30, 1999 was $4,769,000 or
approximately 23% of net sales. Cost of sales for the nine months ended
June 30, 1998 was $3,978,000 or approximately 21% of net sales. Included in the
cost of sales for the nine months ended June 30, 1999 were non-recurring
engineering expenses of approximately $420,000 paid to a third-party developer
on behalf of Adobe which has licensed certain technology from the Company's
Redwing product. Excluding these expenses from cost of sales and excluding the
reimbursement from Adobe from net sales, cost of sales for the nine months
ended June 30, 1999 would have been $4,349,000 or 22%, which is comparable to
cost of sales for the same period of fiscal 1998.
Engineering and product development expenses were $1,949,000 for the nine
months ended June 30, 1999, an increase of $291,000 or approximately 18% from
$1,658,000 for the nine months ended June 30, 1998. This increase is primarily
attributable to expenditures for development efforts undertaken by developers
under contract to the Company offset by a reduction in quality assurance
personnel for the Company's Quetzal/SC product resulting from the restructuring
which took place during the first quarter of fiscal 1999.
Selling, general and administrative expenses were $16,878,000 for the nine
months ended June 30, 1999, a decrease of $1,421,000 or approximately 8% from
$18,299,000 for the nine months ended June 30, 1998. Included in the expenses
for the nine months ended June 30, 1999 were approximately $631,000 of
non-recurring legal expenses associated with the Palms Technology litigation,
which has been settled. Included in the expenses for the nine months ended
June 30, 1998 were approximately $196,000 of one-time expenses associated with
the Company's restructuring subsequent to the sale of its Macintosh product
line to Dr Solomon's Software. Excluding these costs, selling, general and
administrative expenses would have been $16,247,000 for the nine months ended
June 30, 1999, a decrease of $1,856,000 or approximately 10% from $18,103,000
for the nine months ended June 30, 1998. This decrease is primarily due to the
reduction of personnel in the Company's worldwide operations pursuant to a
restructuring during the fourth quarter of fiscal 1998 and the third quarter
of fiscal 1999, as well as a decrease in promotional activities associated with
the Company's Monarch product.
During the nine months ended June 30, 1999, the Company approved and
completed a restructuring plan to centralize in the United States the quality
assurance efforts for its Quetzal/SC product. The restructuring plan consisted
of charges for severance benefits and related costs for 10 terminated employees.
These charges, totaling approximately $200,000, have been paid.
During the nine months ended June 30, 1999, the Company approved and
completed a plan to further reduce costs and focus resources on key areas of the
business. The restructuring plan consisted of charges for severance benefits and
related costs for 21 employees. These charges, totaling approximately $449,000
were either paid ($354,000) or accrued ($95,000) in the third quarter of fiscal
1999. The accrued expenses will be paid in the fourth quarter of fiscal 1999.
The Company recorded an income tax benefit of approximately $412,000 in the
nine months ended June 30, 1999. This reflects the Company's current estimate
that it will not be in a taxable position at the end of the current year and
will be in a position to carry back certain net operating losses. Such
estimates are reviewed by management and are subject to change. The Company
recorded a provision of approximately $1,225,000 for income taxes in the nine
months ended June 30, 1998 owing to management's estimate, at that time, of
taxable income for the year.
As a result of the foregoing, the loss from operations for the nine months
ended June 30, 1999 was $3,873,000 which compares to a loss from operations of
$7,020,000 for the nine months ended June 30, 1998. The net loss for the nine
months ended June 30, 1999 was $3,418,000, which compares to net income of
$7,519,000 for the nine months ended June 30, 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company's management believes that its currently anticipated capital
needs for future operations of the Company will be satisfied through at least
September 30, 1999 by funds currently available, funds generated from
operations and available borrowings. On March 16, 1999 the Company amended its
line of credit with a bank. The line of credit, as amended, expires on
January 30, 2000 and provides for maximum borrowings up to the lesser of
$1,500,000 or 50% to 80% of defined eligible accounts receivable. Borrowings
under the line are collateralized by substantially all assets of the Company.
Outstanding borrowings bear interest at the bank's prime rate plus 1% (8.75% at
June 30, 1999). As of June 30, 1999, the Company had approximately $1,500,000
of outstanding borrowings under the line of credit. As of June 30, 1999, the
Company was in default on its covenant to maintain the minimum level of
consolidated net worth. The default on this covenant has been waived for the
quarter ended June 30, 1999.
Working capital decreased by approximately $3,254,000 during the nine months
ended June 30, 1999 primarily as a result of unprofitable operations, cash flow
requirements of the Company's international subsidiaries, and legal expenses
associated with the Palms Technology litigation, which has been settled.
Management believes that the Company's current operations are not materially
impacted by the effects of inflation.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information." SFAS No. 131 establishes standards for the
way that public business enterprises report information about operating segments
in annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports. It
also establishes standards for related disclosures about products and services,
geographic areas and major customers. SFAS No. 131 will be adopted by the
Company in its annual consolidated financial statements for fiscal 1999. Such
standard is a "disclosure standard" and will not impact the Company's
consolidated results of operations.
In March 1998, the AICPA released SOP 98-1, "Accounting for Costs of Computer
Software Developed or Obtained for Internal Use," which requires certain
expenditures made for internal use software to be capitalized. The Company is
currently studying the impact of SOP 98-1, which is required to be adopted by
the Company in October 1999.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," effective for fiscal years beginning after
June 15, 1999. The new standard requires that all companies record derivatives
on the balance sheet as assets or liabilities, measured at fair value. Gains or
losses resulting from changes in the values of those derivatives would be
accounted for depending on the use of the derivative and whether it qualifies
for hedge accounting. Management is currently assessing whether there will be
any impact of SFAS No. 133 on the Company's consolidated financial statements
upon adoption, which is required in October 1999.
YEAR 2000 READINESS DISCLOSURE STATEMENT
General
The Company is aware of the global concerns related to what is known as the
Year 2000 issue and the potential for the associated system failures and
business interruptions that may result. The Year 2000 issue concerns three
main areas: the ambiguity that may result from processing and storing data
using 2-digit year formats; the recognition that the year 2000 is a leap year;
and the use of dates (most commonly 9/9/99) for special programming functions.
Any of these problems could result in a system failure or miscalculations
causing disruptions of operations, including, among other things, a temporary
inability to process transactions or engage in normal business activities for
both the Company and its customers who rely on its products.
Year 2000 Compliance Program
The Company has been aware of the Year 2000 issue for several years and has
been actively engaged in correcting Year 2000 deficiencies as they are
recognized, but has not yet completed reviewing, correcting and testing all
facets of the Year 2000 compliance issues facing it. The Company is
continuing to implement the Company's Year 2000 compliance program and takes
corrective action as Year 2000 issues are identified. The purpose of the
compliance program is to identify important internal systems that are not yet
Year 2000 compliant; to initiate replacement or remedial action to assure that
key systems and products will continue to operate in the Year 2000 and to test
the replaced or remediated systems and products; to identify and contact key
suppliers, vendors, customers and business partners to evaluate their ability
to maintain normal operations in the Year 2000; and to develop appropriate
contingency plans for dealing with foreseeable Year 2000 complications. The
Company has appointed a Year 2000 Readiness Coordinator who is responsible
for administering the Company's Year 2000 compliance program.
Internal Systems
The preliminary results of the Company's assessment of its internal use
hardware and software, including telephone systems and other facilities
equipment, determined that it was necessary to modify or replace some of its
internal use software and hardware. During 1998, a project was initiated at
the corporate offices in Wilmington, Massachusetts and at the Company's largest
subsidiary, Datawatch International, in Potters Bar, England to upgrade the
Company's accounting software to a Year 2000 compliant version. These
simultaneous projects were completed in September 1998. Although the Company
anticipates that the accounting systems at some of its other subsidiaries
will be replaced by the end of 1999, the accounting systems at these locations
are significantly less critical than at the locations already upgraded. The
Company currently believes that all other "mission critical" software is Year
2000 compliant. The Company also believes that all major internal use
hardware, including network servers and telephone systems, have been upgraded
or replaced so that they are now Year 2000 compliant. A complete assessment of
all desktop and laptop computers, with all major Year 2000 issues corrected as
identified, is now complete. The Company believes that all Year 2000 issues
related to internal use software and hardware have been identified and
corrective action will be complete by December 31, 1999. With the assessment
of internal use hardware and software now complete, the estimated cost to bring
internal operations into compliance has been reduced to $50,000.
The Company has begun contacting mission critical vendors concerning the
status of their Year 2000 readiness. All supplies used to market, sell or
produce the Company's products are readily available from many different
suppliers. Therefore, the Company intends to use only vendors who are
determined to be Year 2000 compliant for supplies after September 30, 1999.
Software Products
The Company has designed, tested and continues to test the most current
versions of its products for Year 2000 issues. With respect to certain of
those products, the Company has relied on testing and representations by its
third-party developers. Based on its internal testing and the testing done by
its third-party developers to date, the Company believes that the latest
versions of its products are substantially Year 2000 compliant and are not
likely to pose a significant Year 2000 liability issue for the Company or any
significant operational problems for its customers. In the event problems are
discovered, the Company intends to issue product updates to correct such
anomalies. The Company has requested and is waiting to receive Year 2000
compliance statements from vendors of certain widely-accepted database and
middleware tools which are used in the development of its products; in the
event such tools are not compliant, the Company believes achieving compliance
will require upgrades to newer versions of such tools.
The Company also has performed and continues to perform limited Year 2000
compliance assessments of certain older versions of its products, and where
problems are discovered, will determine the practicality of modifying older
versions. Where such modifications are deemed impractical, the Company will
discontinue the sale of such older versions. Certain of the Company's customers
use older 16-bit operating systems which are believed not to be Year 2000
compliant and the Company makes available to these customers older 16-bit
versions of its software, which in some cases are not Year 2000 compliant. The
Company believes it does not have material financial exposure to customers with
respect to older versions of its products.
The Company estimates the total cost for testing its products for Year 2000
compliance to be approximately $100,000 and estimates the cost associated with
customer communication to be approximately $50,000.
As the Year 2000 compliance assessment and/or testing of a product is
completed, the Company makes this information available to its customers via
the Company's web site. Information is also communicated to registered
customers in newsletters and other special mailings.
Risks Associated with Year 2000 Issue
The Company believes its Year 2000 compliance program will allow it to
identify and correct any material Year 2000 compliance deficiencies. This
assessment is subject to revision based on the results of the Company's on-going
Year 2000 compliance efforts. If unforeseen compliance efforts are required or
if present compliance efforts are not completed on time, or if the cost of any
required updating, modification or replacement of the Company's systems or
equipment exceeds the Company's estimates, the Year 2000 issue could result in
material costs and have a material adverse effect on the Company. However, the
Company believes that the risk is minimal.
The Company utilizes third-party vendors for product development and testing.
Should these vendors not be compliant in a timely manner, product releases
scheduled to take place after December 31, 1999 could be delayed. The Company
also utilizes third-party vendors for processing data and payments, e.g.
payroll services, 401(k) plan administration, check processing, medical benefits
processing, etc. Should these vendors not be compliant in a timely manner, the
Company may be required to process transactions manually or delay processing
until such time as the vendors are Year 2000 compliant. The Company has
warranted, to certain customers, that certain of its products are or will be
Year 2000 compliant. Non-compliance with these warranties may result in legal
action for breach of warranty.
Various statements in this discussion of Year 2000 are forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995 as discussed below under "Risk Factors". These statements include
statements of the Company's expectations, statements with regard to
schedules and expected completion dates and statements regarding expected Year
2000 compliance. These forward-looking statements are subject to various risk
factors which may materially affect the Company's efforts to achieve Year 2000
compliance. These risk factors include: the inability of the Company to
complete in a timely manner the plans and modifications that it has identified;
any inaccuracy in the assessment of the cost and financial exposure of the
Company with respect to current and older versions of the Company's products;
the failure of software vendors to deliver the upgrades and repairs to which
they have committed; the wide variety of information technology systems and
components, both hardware and software, that must be evaluated; and the large
number of vendors and customers with which the Company interacts. The Company's
assessments of the effects of Year 2000 on the Company are based, in part, upon
information received from third parties and the Company's reasonable reliance on
that information. Therefore, the risk that inaccurate information is supplied
by third parties upon which the Company reasonably relies must be considered as
a risk factor that might affect the Company's Year 2000 efforts. The Company
is attempting to reduce the risks by utilizing an organized approach, extensive
testing, and allowance of ample contingency time to address issues identified by
tests.
Contingency Plans
The Company has not established a specific Year 2000 contingency plan at
this time. The Company is in the process of developing a general corporate
contingency plan which it anticipates will be in place prior to December 31,
1999. The purpose of this plan will be to allow the Company to recognize system
failures, if any, and identify resources needed and available to restore
operations in a timely manner.
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 Form 10-Q
that are not historical facts (including, but not limited to statements
contained in "Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations" of Part I of this Report on Form 10-Q
relating to liquidity and capital resources) may constitute forward-looking
statements and are made under the safe harbor provisions of The Private
Securities Litigation Reform Act of 1995. The Company'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 Form 10-Q,
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.
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, delays in the introduction of products or
product enhancements and general market trends. Historically, the Company has
operated with little backlog of orders because its software products are
generally shipped as orders are received. As a result, net sales in any quarter
are substantially dependent on orders booked and shipped in that quarter.
Because the Company's staffing and operating expenses are based on anticipated
revenue levels and a high percentage of the Company's costs are fixed in the
short-term, small variations in the timing of revenues can cause significant
variations in operating results from quarter to quarter. Because of these
factors, the Company believes that period-to-period comparisons of its results
of operations are not necessarily meaningful and should not be relied upon as
indications of future performance. There can be no assurance that the Company
will not experience such variations in operating results in the future or that
such variations will not have a material adverse effect on the Company's
business, financial condition or results of operation.
Dependence on Principal Products
For the nine months ended June 30, 1999, the Monarch suite of products and
the Quetzal/SC product accounted for approximately 52% and 35%, respectively,
of the Company's net sales. The Company is highly dependent on Monarch and
Quetzal/SC. As a result, any factor adversely affecting sales of either of
these products could have a material adverse effect on the Company. The
Company's future financial performance will depend in part on the successful
introduction of its new and enhanced versions of these products and
development of new versions of these and other products and subsequent
acceptance of such new and enhanced products. In addition, competitive
pressures or other factors may result in significant price erosion that could
have a material adverse effect on the Company's business, financial condition
or results of operations.
International Sales
The Company anticipates that international sales will continue to account
for a significant percentage of its net sales. A significant portion of the
Company's net sales 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, 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
Although the Company has no current acquisition plans, it has addressed and
may continue to address the need to develop new products, in part, through the
acquisition of other companies. Acquisitions involve numerous risks including
difficulties in the assimilation of the operations, technologies and products
of the acquired companies, the diversion of management's attention from other
business concerns, risks of entering markets in which the Company has no or
limited direct prior experience and where competitors in such markets have
stronger market positions, and the potential loss of key employees of the
acquired Company. Achieving and maintaining the anticipated benefits of an
acquisition will depend in part upon whether the integration of the companies'
business is accomplished in an efficient and effective manner, and there can be
no assurance that this will occur. The successful combination of companies in
the high technology industry may be more difficult to accomplish than in other
industries.
Dependence on New Introductions; New Product Delays
Growth in the Company's business depends in substantial part on the
continuing introduction of new products. The length of product life cycles
depends in part on end-user demand for new or additional functionality in the
Company's products. If the Company fails to accurately anticipate the demand
for, or encounters any significant delays in developing or introducing, new
products or additional functionality on its products, there could be a material
adverse effect on the Company's business. Product life cycles can also be
affected by the introduction by suppliers of operating systems of comparable
functionality within their products. The failure of the Company to anticipate
the introduction of additional functionality in products developed by such
suppliers could have a material adverse effect on the Company's business. In
addition, the Company's competitors may introduce products with more features
and lower prices than the Company's products. Such increase in competition
could adversely affect the life cycles of the Company's products, which in turn
could have a material adverse effect on the Company's business.
Software products may contain undetected errors or failures when first
introduced or as new versions are released. There can be no assurance that,
despite testing by the Company and by current and potential end-users, errors
will not be found in new products after commencement of commercial shipments,
resulting in loss of or delay in market acceptance. Any failure by the Company
to anticipate or respond adequately to changes in technology and customer
preferences, or any significant delays in product development or introduction,
could have a material adverse effect on the Company's business.
Rapid Technological Change
The markets in which the Company competes have undergone, and can be expected
to continue to undergo, rapid and significant technological change. The ability
of the Company to grow will depend on its ability to successfully update and
improve its existing products and market and license new products to meet the
changing demands of the marketplace and that can compete successfully with the
existing and new products of the Company's competitors. There can be no
assurance that the Company will be able to successfully anticipate and satisfy
the changing demands of the personal computer software marketplace, that the
Company will be able to continue to enhance its product offerings, or that
technological changes in hardware platforms or software operating systems, or
the introduction of a new product by a competitor, will not render the Company's
products obsolete.
Year 2000 Issue
Although the Company does not expect that the Year 2000 issue will have a
material effect on the Company's results of operations or financial condition,
the Company is potentially exposed to Year 2000 issues with respect to internal
software and external product offerings. If the Company's internal systems or
its products fail to operate properly as a result of Year 2000, the Company's
results of operations and financial condition could be materially and adversely
impacted. The Company continues to evaluate the Year 2000 issue. See "Year 2000
Readiness Disclosure Statement," particularly the subsection headed "Risks
Associated with Year 2000 Issue," which appears immediately before this "Risk
Factors" section of this Report on Form 10-Q, for a discussion of the Company's
Year 2000 readiness and the risks associated with the Year 2000 issue.
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 IBM, Network Associates,
Inc., Remedy, and Actuate) have substantially greater financial, marketing and
technological resources than the Company. No assurance can be given that the
Company will have the resources required to compete successfully in the future.
Dependence on Proprietary Software Technology
The Company's success is dependent upon proprietary software technology.
Although the Company does not own any patents on any such technology, it does
hold exclusive licenses to such technology and relies principally on a
combination of trade secret, copyright and trademark laws, nondisclosure
and other contractual agreements and technical measures to protect its rights
to such proprietary technology. Despite such precautions, there can be no
assurance that such steps will be adequate to deter misappropriation of such
technology.
Reliance on Software License Agreements
Substantially all of the Company's products incorporate third-party
proprietary technology which is generally licensed to the Company on an
exclusive, worldwide basis. Failure by such third parties to continue to
develop technology for the Company and license such technology to the Company
could have a material adverse effect on the Company's business and results of
operations.
Indirect Distribution Channels
The Company sells 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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
----------------------------------------------------------
Derivative Financial Instruments, Other Financial Instruments, and Derivative
Commodity Instruments
At June 30, 1999 the Company did not participate in any derivative financial
instruments, or other financial and commodity instruments for which fair value
disclosure would be required under SFAS No. 107. The Company holds no
investment securities which would require disclosure of market risk.
Primary Market Risk Exposures
The Company's primary market risk exposures are in the areas of interest rate
risk and foreign currency exchange rate risk. The Company's exposure to
interest rate risk fluctuations has been and is expected to continue to be
modest. The Company utilizes U.S. dollar denominated borrowings to fund its
operational needs through a working capital line of credit pursuant to which the
Company is permitted to borrow up to a maximum of $1,500,000. The line of
credit, which currently bears an interest rate of prime plus 1% (8.75% at June
30, 1999), is subject to annual renewal and expires on January 30, 2000. Had
the interest rates under the line of credit been 10% greater or lesser than
actual rates, the impact on the Company's consolidated financial results for
the period ended June 30, 1999 would not have been material. As of June 30,
1999, the Company had approximately $1,500,000 of outstanding borrowings under
the line of credit.
The Company's exposure to currency exchange rate fluctuations has been and
is expected to continue to be modest due to the fact that the operations of
its international subsidiaries are almost exclusively conducted in their
respective local currencies. International subsidiary operating results are
translated into U.S. dollars and consolidated for reporting purposes. The
impact of currency exchange rate movements on intercompany transactions was
immaterial for the period ended June 30, 1999. Currently, the Company does not
engage in foreign currency hedging activities.
PART II.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
A. Exhibits
27 Financial Data Schedule (filed with SEC Edgar version only).
B. Reports on Form 8-K
No Current Report on Form 8-K was filed during the quarterly period ended
June 30, 1999.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized on August 16, 1999.
DATAWATCH CORPORATION
/s/ Betsy J. Hartwell
---------------------------------------------
Betsy J. Hartwell
Vice President of Finance and Chief Financial
Officer (Principal Financial Officer)
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