Datawatch Corporation
DATAWATCH CORP (Form: 10-Q, Received: 08/14/2013 17:55:34)



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C .  20549
 
FORM 10-Q

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

For the Quarterly Period Ended June 30, 2013

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)

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    þ      No    o

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer   o     Accelerated filer o
Non-accelerated filer    o (Do not check if a smaller reporting company)
Smaller reporting company   þ

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

The number of shares of the registrant’s common stock, $.01 par value, outstanding as of August 8, 2013 was 6,551,503.
 


 
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DATAWATCH CORPORATION
QUARTERLY REPORT ON FORM 10-Q
For the Quarterly Period Ended June 30, 2013
 
TABLE OF CONTENTS
       
      Page #
FINANCIAL INFORMATION  
       
   
       
 
3
       
 
4
       
 
5
       
 
6
       
 
7
       
 
18
       
 
27
       
  Controls and Procedures
27
       
PART II.    
       
 
28
 
28
 
28
       
SIGNATURES
29
       
CERTIFICATIONS
30

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PART I. FINANCIAL INFORMATION
Item 1:   FINANCIAL STATEMENTS

DATAWATCH CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except share and per share amounts)
             
   
June 30,
   
September 30,
 
   
2013
   
2012
 
ASSETS
           
CURRENT ASSETS:
           
Cash and equivalents
  $ 10,424     $ 8,722  
Accounts receivable, less allowances for doubtful accounts and sales
    5,085       4,391  
returns of $112 and $212, respectively
               
Inventories
    55       59  
Prepaid expenses
    803       532  
Total current assets
    16,367       13,704  
                 
Property and equipment, net
    286       281  
Acquired intellectual property, net
    6,453       7,745  
Other intangible assets, net
    852       792  
Other long-term assets
    228       283  
Total assets
  $ 24,186     $ 22,805  
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
CURRENT LIABILITIES:
               
Revolving line of credit
  $ 900     $ 900  
Current portion of note payable
    267       -  
Accounts payable
    1,183       676  
Accrued expenses
    2,107       1,792  
Deferred revenue
    6,283       6,295  
Total current liabilities
    10,740       9,663  
                 
LONG-TERM LIABILITIES:
               
Note payable, net of unamortized debt discount of $899 and
               
$1,017, respectively
    2,834       2,983  
Deferred revenue
    203       265  
Other liabilities
    213       200  
Total long-term liabilities
    3,250       3,448  
                 
COMMITMENTS AND CONTINGENCIES
               
                 
SHAREHOLDERS’ EQUITY:
               
Common stock, par value $.01; 20,000,000 shares authorized;
    65       64  
issued, 6,543,918 shares and 6,372,465 shares, respectively;
               
outstanding, 6,529,672 shares and 6,358,219 shares, respectively
               
Additional paid-in capital
    28,772       26,710  
Accumulated deficit
    (17,338 )     (15,824 )
Accumulated other comprehensive loss
    (1,163 )     (1,116 )
      10,336       9,834  
Less treasury stock, at cost, 14,246 shares
    (140 )     (140 )
Total shareholders’ equity
    10,196       9,694  
                 
Total liabilities and shareholders equity
  $ 24,186     $ 22,805  
 
See notes to condensed consolidated financial statements.
 
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DATAWATCH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share amounts)
 
   
Three Months Ended June 30,
   
Nine Months Ended June 30,
 
   
2013
   
2012
   
2013
   
2012
 
REVENUE:
                       
Software licenses
  $ 5,007     $ 4,699     $ 13,634     $ 13,182  
Maintenance
    2,409       2,106       7,042       5,683  
Professional services
    411       368       803       1,126  
Total revenue
    7,827       7,173       21,479       19,991  
                                 
COSTS AND EXPENSES:
                               
Cost of software licenses
    549       509       1,602       1,743  
Cost of maintenance and services
    602       668       1,697       2,019  
Sales and marketing
    4,398       3,244       12,391       9,041  
Engineering and product development
    759       730       2,361       2,048  
General and administrative
    2,038       1,289       4,475       3,469  
Total costs and expenses
    8,346       6,440       22,526       18,320  
                                 
INCOME (LOSS) FROM OPERATIONS
    (519 )     733       (1,047 )     1,671  
                                 
Interest expense and other income (expense), net
    (148 )     (176 )     (465 )     (285 )
                                 
INCOME (LOSS) BEFORE INCOME TAXES
    (667 )     557       (1,512 )     1,386  
Provision (benefit) for income taxes
    (1 )     9       2       75  
                                 
NET INCOME (LOSS)
  $ (666 )   $ 548     $ (1,514 )   $ 1,311  
                                 
Net income (loss) per share—Basic
  $ (0.10 )   $ 0.09     $ (0.24 )   $ 0.21  
                                 
Net income (loss) per share—Diluted
  $ (0.10 )   $ 0.08     $ (0.24 )   $ 0.20  
                                 
Weighted-Average Shares Outstanding—Basic
    6,495       6,288       6,434       6,224  
                                 
Weighted-Average Shares Outstanding—Diluted
    6,495       6,775       6,434       6,653  
 
See notes to condensed consolidated financial statements.
 
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DATAWATCH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF
COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
 (In thousands)
                         
   
Three Months Ended June 30,
   
Nine Months Ended June 30,
 
   
2013
   
2012
   
2013
   
2012
 
                         
Net Income (Loss)
  $ (666 )   $ 548     $ (1,514 )   $ 1,311  
                                 
Other Comprehensive Income (Loss):
                               
                                 
Foreign currency translation adjustments
    (29 )     18       (47 )     108  
                                 
Comprehensive income (Loss)
  $ (695 )   $ 566     $ (1,561 )   $ 1,419  
 
See notes to condensed consolidated financial statements.
 
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DATAWATCH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 (In thousands)
             
   
Nine Months Ended
 
   
June 30,
 
   
2013
   
2012
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income (loss)
  $ (1,514 )   $ 1,311  
Adjustments to reconcile net income (loss) to cash provided by
               
operating activities:
               
Depreciation and amortization
    1,590       698  
Provision for (recovery of) doubtful accounts and sales returns
    (99 )     26  
Loss on disposition of fixed assets
    2       1  
Share-based compensation
    1,922       560  
Non-cash interest expense on warrants
    117       40  
Amortization of debt issuance costs
    24       -  
Changes in operating assets and liabilities:
               
Accounts receivable
    (632 )     (1,995 )
Inventories
    4       (2 )
Prepaid expenses and other assets
    (221 )     (185 )
Accounts payable, accrued expenses and other liabilities
    868       333  
Deferred revenue
    (8 )     1,705  
Cash provided by operating activities
    2,053       2,492  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Purchases of equipment and fixtures
    (114 )     (117 )
Proceeds from sale of equipment
    -       1  
Purchase of intellectual property
    -       (8,616 )
Capitalized software development costs
    (278 )     (54 )
Increase in other assets
    -       (4 )
Cash used in investing activities
    (392 )     (8,790 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Proceeds from exercise of stock options
    142       235  
Advances on line of credit
    -       1,500  
Proceeds from issuance of long-term debt
    -       4,000  
Debt issuance costs
    -       (80 )
Cash provided by financing activities
    142       5,655  
                 
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND EQUIVALENTS
    (101 )     95  
                 
INCREASE (DECREASE) IN CASH AND EQUIVALENTS
    1,702       (548 )
CASH AND EQUIVALENTS, BEGINNING OF PERIOD
    8,722       8,384  
CASH AND EQUIVALENTS, END OF PERIOD
  $ 10,424     $ 7,836  
                 
SUPPLEMENTAL INFORMATION:
               
Income taxes paid
  $ 9     $ 51  
Interest paid
  $ 334     $ 120  
 
See notes to condensed consolidated financial statements.
 
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DATAWATCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
Note 1 - Summary of Significant Accounting Policies

Basis of Presentation and Principles of Consolidation
 
The accompanying 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 (the “SEC”) regarding interim financial reporting.  Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America (“GAAP”) for complete financial statements and should be read in conjunction with the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended September 30, 2012 filed with the SEC. All intercompany accounts and transactions have been eliminated.

In the opinion of management, the accompanying condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements for the fiscal year ended September 30, 2012, and include all adjustments necessary for fair presentation of the results of the interim periods presented. The operating results for the interim periods presented are not necessarily indicative of the results expected for the full year. The Company considers events or transactions that occur after the balance sheet date but before the financial statements are issued to provide additional evidence relative to certain estimates or to identify matters that require additional disclosure.

The preparation of financial statements in conformity with GAAP 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 condensed 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, the allowance for doubtful accounts, sales returns reserve, useful lives of property and equipment, and the valuation of net deferred tax assets, acquired intellectual property, other intangible assets and share-based awards.

Revenue Recognition
 
Revenue allocated to software products, specified upgrades and enhancements is recognized upon delivery of the related product, upgrades or enhancements. Revenue is allocated by vendor specific objective evidence (“VSOE”) of fair value to post-contract customer support (primarily maintenance) and is recognized ratably over the term of the support, and revenue allocated using VSOE to service elements (primarily training and consulting) is recognized as the services are performed. The residual method of revenue recognition is used for multi-element arrangements when the VSOE of the fair value does not exist for one of the delivered elements. Under the residual method, the arrangement fee is recognized as follows: (1) the total fair value of the undelivered elements, as supported by VSOE, is deferred and subsequently recognized as such items are delivered or completed and (2) the difference between the total arrangement fee and the amount allocated to the undelivered elements is recognized as revenue related to the delivered elements.

The Company licenses its software products directly to end-users, through value added resellers and through distributors. Sales to distributors and resellers accounted for approximately 37% and 34%, respectively, of total sales for the three months ended June 30, 2013 and 2012, and 32% and 31%, respectively, of total sales for the nine months ended June 30, 2013 and 2012. 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, collectability is reasonably assured, persuasive evidence of the arrangement exists and
 
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there are no significant obligations remaining. All of the Company’s software product offerings are considered to be “off-the-shelf” as such term is customarily defined. The Company’s software products can be installed and used by customers on their own with little or no configuration required. Multi-user licenses marketed by the Company are sold as a right to use the number of licenses, and the 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 by the Company.

Datawatch software products are generally sold in multiple element arrangements which may include software licenses, 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 the software license. In applying the residual method, the Company deducts from the sale proceeds the VSOE of fair value of the professional 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 generally do not involve modification or customization of the software or any unusual acceptance clauses or terms. The Company has established VSOE of fair value for the majority of its professional services using the bell-shaped curve method. 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 period of support (generally one year). Such deferred amounts are recorded as part of deferred revenue in the Company’s condensed consolidated balance sheets. The Company has established VSOE of fair value for the majority of its post-contract customer support based on stated renewal rates only if the rate is determined to be substantive and falls within the Company’s customary pricing practices. VSOE of fair value for post-contract customer support through the Company’s distribution channel was established using the bell-shaped curve method. VSOE calculations are updated and reviewed quarterly.

The Company also licenses 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 revenue is recognized ratably over the period of the subscription. The subscription arrangement includes software, maintenance and unspecified future upgrades on a when and if available basis including major version upgrades. The subscription renewal rate is the same as the initial subscription rate. Subscriptions can be cancelled by the customer at any time by providing 90 days prior written notice following the first year of the subscription term.

The Company’s software products are sold under warranty against certain defects in material and workmanship for a period of 30 days from the date of purchase. The Company also offers a 30 day money-back guarantee on its Monarch product sold directly to end-users. Additionally, the Company provides its distributors with stock-balancing rights. 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, and the returns history with, the various distributors and resellers, which the Company monitors frequently.
 
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Share-Based Compensation
 
All share-based awards, including grants of employee stock options and restricted stock units, are recognized in the financial statements based on their fair value at date of grant.

The Company recognizes the fair value of share-based awards over the requisite service period of the individual awards, which generally equals the vesting period. All of the Company’s share-based awards are accounted for as equity instruments and there have been no liability awards granted. See additional share-based compensation disclosure in Note 6 to the Company’s condensed consolidated financial statements.

Concentration of Credit Risks and Major Customers
 
The Company licenses its products and services to U.S. and non-U.S. distributors and other software resellers, as well as to end users, under customary credit terms. Three customers, Lifeboat Distribution, ASG and Unysis Belgium, individually accounted for the following percentages of total revenue and accounts receivable for the periods indicated:
 
   
Percentage of total
   
Percentage of total
             
   
revenue for the three
   
revenue for the nine
   
Percentage of total
 
   
months ended
   
months ended
   
accounts receivable at
 
   
June 30,
   
June 30,
   
June 30,
   
September 30,
 
   
2013
   
2012
   
2013
   
2012
   
2013
   
2012
 
                                     
Lifeboat Distribution
    24 %     22 %     22 %     13 %     30 %     19 %
                                                 
ASG
    10 %       *       *       *     12 %       *
                                                 
Unisys Belgium
            *       *       *       *     24 %
 

* - Amounts represent less than 10% for indicated periods.
 
The Company licenses to Lifeboat Distribution under a distribution agreement which automatically renews for successive one-year terms unless terminated. Other than these customers, no other customer constitutes a significant portion (more than 10%) of revenues or accounts receivable for the periods presented. 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 based on management’s review of receivables, inventory and historical trends.

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 engineering and product development expense as incurred. Commencing upon initial product release, capitalized costs are amortized to cost of software licenses using the straight-line method over the estimated life of the product (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 12 to 24 months. The net amount of capitalized software development costs was approximately $244,000 and $30,000 at June 30, 2013 and September 30, 2012, respectively. The Company capitalized approximately $278,000 and $54,000 of software development costs related to new products in development during the nine months ended June 30, 2013 and June 30, 2012, respectively.

Intangible Asset – Intellectual Property
 
On March 30, 2012, the Company acquired intellectual property which consisted primarily of the source code underlying its Monarch Professional and Datawatch Data Pump products for a purchase price of $8,541,000. Additionally, the Company capitalized approximately $75,000 in closing costs and adjustments related to the acquisition. The intellectual property assets are being amortized to cost of software licenses using the straight-line method over the estimated life of the asset, which is five years. Amortization expense related to the intellectual
 
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property assets was $431,000 and $1,292,000, respectively, for the three and nine months ended June 30, 2013. Amortization expense related to the intellectual property assets was $431,000 and $440,000, respectively, for the three and nine months ended June 30, 2012. The estimated future amortization expense related to the intellectual property is as follows (in thousands):
 
Fiscal Years Ended September 30,
       
         
Remainder of fiscal 2013
  $ 431  
2014
    1,723  
2015
    1,723  
2016
    1,723  
2017
    853  
         
Total estimated future amortization expense
  $ 6,453  
 
Other Intangible Assets, Net
 
Other intangible assets consist of internally developed software, patents and customer lists acquired through business combinations. The values allocated to the majority of these intangible assets are amortized using the straight-line method over the estimated useful life of the related asset and are recorded in cost of software licenses. The values allocated to customer relationships are amortized using the straight-line method over the estimated useful life of the related asset and are recorded in sales and marketing expenses. The values allocated to loan acquisition costs are amortized using the straight-line method over the estimated useful life of the related asset and are recorded in interest expense and other income (expense), net. 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.

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.

The Company follows the accounting guidance for uncertain tax positions. This guidance clarifies the accounting for income taxes by prescribing the minimum threshold a tax position is required to meet before being recognized in the financial statements. It also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition.

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

Fair Value Measurements
 
Fair value is the price that would be received for an asset or the amount paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company is required to classify certain assets and liabilities based on the following fair value hierarchy. 

 
·
Level 1 – Quoted prices in active markets that are unadjusted and accessible at the measurement date for identical, unrestricted assets or liabilities; 
 
·
Level 2 – Quoted prices for identical assets and liabilities in markets that are not active, quoted prices for similar assets and liabilities in active markets or financial instruments for which significant inputs are observable, either directly or indirectly; and 
 
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Level 3 – Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable. 
 
The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis at June 30, 2013 and September 30, 2012 (in thousands): 
                                                 
    June 30, 2013     September 30, 2012  
                     
Estimated
                     
Estimated
 
   
Fair Value Measurement
   
Fair
   
Fair Value Measurement
   
Fair
 
   
Using Input Types
   
Value
   
Using Input Types
   
Value
 
   
Level 1
   
Level 2
   
Level 3
   
Total
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Assets:
                                               
Money market funds
  $ 2,234     $ -     $ -     $ 2,234     $ 2,234     $ -     $ -     $ 2,234  
Total assets at fair value
  $ 2,234     $ -     $ -     $ 2,234     $ 2,234     $ -     $ -     $ 2,234  
                                                                 
Liablities:
                                                               
Line of credit
  $ 900     $ -     $ -     $ 900     $ 900     $ -     $ -     $ 900  
Note payable
    4,000       -       -       4,000       4,000       -       -       4,000  
Debt discount
    -       (899 )     -       (899 )     -       (1,017 )     -       (1,017 )
Total liabilities at fair value
  $ 4,900     $ (899 )   $ -     $ 4,001     $ 4,900     $ (1,017 )   $ -     $ 3,883  
 
Recent Accounting Pronouncements
 
In June 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income” (“ASU 2011-05”). ASU 2011-05 eliminates the option to report other comprehensive income and its components in the statement of changes in equity. Under this standard, an entity can elect to present items of net income and other comprehensive income in one continuous statement of comprehensive income or in two separate but consecutive statements. The Company adopted this standard in its fiscal quarter ended December 31, 2012 by including a new separate consolidated statement of comprehensive income (loss).
 
In December 2011, the FASB issued ASU No. 2011-12, “Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05” (“ASU 2011-12”). ASU 2011-12 supersedes certain paragraphs in ASU 2011-05 which pertain to how, when and where reclassification adjustments out of accumulated other comprehensive income are presented. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company adopted this guidance in its fiscal quarter ended December 31, 2012.
 

Note 2 – Acquisition

 
On June 14, 2013, the Company entered into a Stock Purchase Agreement under which it has agreed to acquire Panopticon Software AB, a privately-held Swedish company specializing in the delivery of real-time data visualization solutions (“Panopticon”). Pursuant to this agreement, the Company plans to acquire all outstanding shares of Panopticon in an all-stock transaction. Completion of the transaction is subject to the approval of the Company’s shareholders, which is expected to occur during its fourth fiscal quarter ending September 30, 2013. 
 
Note 3 – Other Intangible Assets, Net
 
Other intangible assets, net, were comprised of the following as of June 30, 2013 and September 30, 2012:
                   
   
Weighted
    June 30, 2013     September 30, 2012  
   
Average
   
Gross
               
Gross
             
Identified Intangible
 
Useful Life
   
Carrying
   
Accumulated
   
Net Carrying
   
Carrying
   
Accumulated
   
Net Carrying
 
Asset
 
in Years
   
Amount
   
Amortization
   
Amount
   
Amount
   
Amortization
   
Amount
 
                     
(in thousands)
             
                                     
Capitalized software
    1     $ 1,468     $ 1,224     $ 244     $ 1,190     $ 1,160     $ 30  
Patents
    20       160       71       89       160       65       95  
Customer lists
    10       1,790       1,320       470       1,790       1,195       595  
Loan acquisition costs
    4       88       39       49       88       16       72  
                                                         
Total
          $ 3,506     $ 2,654     $ 852     $ 3,228     $ 2,436     $ 792  
 
11
 

 

 
For the three months ended June 30, 2013 and 2012, amortization expense related to intangible assets was $87,000 and $52,000, respectively. For the nine months ended June 30, 2013 and 2012, amortization expense related to intangible assets was $218,000 and $167,000, respectively.
 
The estimated future amortization expense related to amortizing intangible assets as of June 30, 2013 is as follows (in thousands):
         
Fiscal Years Ending September 30,
       
       
Remainder of fiscal 2013
  $ 107  
2014
    380  
2015
    179  
2016
    110  
2017
    13  
2018
    13  
Thereafter
    50  
         
Total estimated future amortization expense
  $ 852  
 
Note 4 – Financing Arrangements
 
Revolving Line of Credit
 
In connection with the acquisition of intellectual property disclosed in Note 1 to the Company’s condensed consolidated financial statements, on March 30, 2012, the Company entered into a $2.0 million revolving credit facility with Silicon Valley Bank (“SVB”), pursuant to a Loan and Security Agreement with SVB. On March 30, 2012, the Company borrowed $1.5 million under this revolving credit facility. The Company repaid $600,000 under the line of credit in September 2012. The revolving line of credit under the SVB facility terminates on March 29, 2014. On that date, the principal amount of all advances then outstanding under the revolving line and all unpaid interest thereon will become due and payable. The principal amount outstanding under the revolving line accrues interest at a floating rate per annum equal to 1.5% above the prime rate, with the prime rate having a floor under the SVB agreement of 3.25%. The Company can borrow under the SVB revolving line of credit based on a formula percentage of its accounts receivable balance. Additionally, the SVB facility requires that the Company maintain certain net asset and net income ratios. The Company was in compliance with the covenants under its Loan and Security Agreement at June 30, 2013. The Company’s obligations under the SVB facility are secured by substantially all of the Company’s assets other than intellectual property. The principal amount outstanding under the revolving line of credit at June 30, 2013 was $900,000.
 
Note Payable
 
Also in connection with the intellectual property acquisition, on March 30, 2012, the Company entered into a Note and Warrant Purchase Agreement with Massachusetts Capital Resource Company (“MCRC”), the terms of which include a $4.0 million subordinated note and warrants for 185,000 shares of the Company’s common stock. The subordinated note issued to MCRC has a maturity date of February 28, 2019, with interest due monthly on the unpaid principal amount of the note at the rate of 10% per annum in arrears. The subordinated note also contains interest rate premiums on any optional redemption of principal payments during the first three years of the note agreement. The Company is also required under the MCRC agreement to maintain certain interest coverage and leverage ratios. The Company was in compliance with the covenants under its Note and Warrant Purchase Agreement at June 30, 2013.
 
12
 

 

 
Future principal payments related to the subordinated note are as follows (in thousands):
         
Fiscal Years Ended September 30,
       
         
Remainder of fiscal 2013
  $ -  
2014
    467  
2015
    800  
2016
    800  
2017
    800  
2018
    800  
Thereafter
    333  
         
Total future principal payments
  $ 4,000  
 
The warrants issued to MCRC are exercisable at any time prior to the later of the repayment in full of the MCRC note or February 28, 2019 at a purchase price per share of $11.54, which is equal to the average closing price of the Company’s common stock for the 45 trading days prior to the issuance of the warrants on March 30, 2012. The number of shares issuable upon exercise of the warrants is subject to adjustment in connection with stock splits and other events impacting the Company’s common stock generally, however, the warrants do not provide the holder with any anti-dilution protection.
 
The Company accounted for the borrowing under the Note and Warrant Purchase Agreement in accordance with the guidance prescribed in the FASB Accounting Standard Codification Topic 470-20, “Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants” (“ASC 470-20”). In accordance with ASC 470-20, the value of the stock purchase warrants is considered an Original Issue Discount (“OID”) which is required to be amortized over the life of the note as interest expense with a corresponding credit to note payable.  The fair value of the warrants on March 30, 2012, as determined under the Accounting Standard Codification Topic 820, “Fair Value Measurements and Disclosures” (“ASC 820”) was approximately $1.1 million which is included in Additional Paid-in Capital in the Company’s condensed consolidated balance sheets at June 30, 2013. The Company used the Black-Scholes pricing model to calculate the fair value of the warrants which included the following key assumptions: the contractual life of the warrants (7 years), stock price volatility (68.18%), risk-free interest rate (1.61%) and dividend yield (0%).
 
The unamortized debt discount at June 30, 2013 was $899,000 which will be amortized to interest expense over the life of the subordinated note which is seven years. Interest expense related to the warrants during the three and nine months ended June 30, 2013 was $39,000 and $117,000, respectively. Interest expense related to the warrants during the three and nine months ended June 30, 2012 was approximately $39,000 and $40,000, respectively.
 
Note 5 – Income Taxes
 
During the three months ended June 30, 2013, the Company recorded a tax benefit of $1,000 primarily related to adjustments to estimated federal alternative minimum taxes and estimated state taxes. During the nine months ended June 30, 2013, the Company recorded $2,000 in tax expense related to uncertain tax positions relative to foreign taxes net of these adjustments. During the three and nine months ended June 30, 2012, the Company recorded $9,000 and $75,000, respectively, related to estimated federal alternative minimum taxes, estimated state taxes and uncertain tax positions relative to foreign taxes.
 
Deferred Tax Assets
 
The Company’s deferred tax assets include net operating loss carry forwards and tax credits that expire at different times through and until 2031. 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. Management does not believe the deferred tax
 
13
 

 

 
assets are more likely than not to be realized and a full valuation allowance has been provided against the deferred tax assets at June 30, 2013 and September 30, 2012. 
 
Provision for Uncertain Tax Positions
 
At September 30, 2012, the Company had a cumulative tax liability of $200,000 related to foreign tax exposure that could result in cash payments, of which approximately $6,000 and $19,000, respectively, were recorded during the three and nine months ended June 30, 2012. The Company increased its tax liability by $6,000 during each of the three month periods ended December 31, 2012 and March 31, 2013. During the nine months ended June 30, 2013, the Company released a portion of its reserve for uncertain tax positions and recorded a benefit of $4,000. The Company does not expect its tax liability to change significantly during the next twelve months. The Company’s policy is to recognize interest and penalties related to uncertain tax positions as a component of income tax expense in its consolidated statements of operations. To date, the Company has not accrued any amounts for interest and penalties associated with this liability as such amounts have been de minimis.
 
The Company’s unrecognized tax benefits (before consideration of any valuation allowance) represent differences between tax positions taken by the Company in its various consolidated and separate worldwide tax returns and the benefits recognized and measured for uncertain tax positions. This amount also represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in any future periods. The change in the unrecognized tax benefits during the nine months ended June 30, 2013 was as follows (in thousands):
         
Balance at October 1, 2012
 
$
866
 
Additions for prior year tax positions
 
8
 
Balance at June 30, 2013
 
$
874
 
 
In the normal course of business, the Company is subject to examination by taxing authorities throughout the world, including such jurisdictions as the United Kingdom, Germany, Singapore, Australia and the United States, and as a result, files numerous consolidated and separate income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. The fiscal years ended September 30, 2010 through September 30, 2012 are generally still open to examination in the jurisdictions listed above.
 
Note 6 – Shareholders’ Equity
 
Share-based compensation expense for the three months ended June 30, 2013 and 2012 was $760,000 and $227,000, respectively, and $1,922,000 and $560,000 for the nine months ended June 30, 2013 and 2012, respectively, as included in the following expense categories:
                                 
    Three months Ended     Nine months Ended  
    June 30,     June 30,  
   
2013
   
2012
   
2013
   
2012
 
   
(In thousands)
 
       
Sales and marketing
  $ 523     $ 118     $ 1,451     $ 317  
Engineering and product development
    21       20       64       29  
General and administrative
    216       89       407       214  
    $ 760     $ 227     $ 1,922     $ 560  
 
The Company’s stock compensation plans provide for the granting of restricted stock units and either incentive or non-qualified stock options to employees and non-employee directors. Options and restricted stock units are subject to terms and conditions determined by the Compensation and Stock Committee of the Board of Directors. Options generally vest over a three year period beginning three months from the date of grant and expire either seven or ten years from the date of grant. Restricted stock units vest annually over a three year period.
 
14
 

 

 
Stock Options
 
The Company uses the Black-Scholes option-pricing model to calculate the fair value of options on the date of grant. The key assumptions for this valuation method include the expected life of the option, stock price volatility, risk-free interest rate and dividend yield. The weighted-average fair value of options granted under the stock option plans for the three and nine months ended June 30, 2013 was $7.61 per share. No options were granted under the stock option plans for the three or nine months ended June 30, 2012. The total intrinsic value of options exercised during the three months ended June 30, 2013 and 2012 was approximately $51,000 and $61,000, respectively. The total intrinsic value of options exercised during the nine months ended June 30, 2013 and 2012 was approximately $612,000 and $670,000, respectively. Total cash received from option exercises during the three and nine months ended June 30, 2013 was $9,000 and $142,000, respectively. As of June 30, 2013, there was $648,000 of total unrecognized compensation cost related to non-vested stock option arrangements, which is expected to be recognized over a weighted-average period of 2.63 years.
 
Many of the assumptions used in the determination of share-based compensation expense are judgmental and highly volatile. The table below indicates the key assumptions used in the option valuation calculations for options granted in the nine months ended June 30, 2013:
       
   
2013
 
Expected life
 
5 Years
 
Expected volatility
    72.95 %
Weighted-average volatility
    72.95 %
Risk-free interest rate
    0.71 %
Dividend yield
    0.0 %
 
The expected option life is based on historical trends and data. With regard to the expected 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. The Company uses an expected stock-price volatility assumption that is based on historical volatilities of the underlying stock which are obtained from public data sources. The risk-free interest rate is equal to the historical U.S. Treasury zero-coupon bond rate with a remaining term equal to the expected life of the option. The Company uses a dividend yield of zero which is based on the fact that the Company has never paid cash dividends and has no present intention to pay cash dividends. 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 rate is higher than estimated.
 
The following table summarizes information about the Company’s stock option plans for the nine months ended June 30, 2013.
                         
               
Weighted -
       
         
Weighted-
   
Average
       
   
Number of
   
Average
   
Remaining
   
Aggregate
 
   
Options
   
Exercise
   
Contractual
   
Intrinsic
 
   
Outstanding
   
Price
   
Term
   
Value $(000)
 
                             
Outstanding, October 1, 2012
    355,334     $ 3.71              
                             
Granted
    75,000       12.92              
Canceled
    -       -              
Exercised
    (49,000 )     2.87              
Outstanding, June 30, 2013
    381,334     $ 5.63       4.41     $ 4,732  
                                 
Vested or expected to vest, June 30, 2013
    367,898     $ 5.51       4.33     $ 4,611  
                                 
Exercisable, June 30, 2013
    246,975     $ 3.80       3.57     $ 3,516  
 
15
 

 


Restricted Stock Units
 
The Company periodically grants awards of restricted stock units (“RSU”) to each of its non-employee directors and some of its management team and employees on a discretionary basis pursuant to its stock compensation plans. Each RSU entitles the holder to receive, at the end of each vesting period, a specified number of shares of the Company’s common stock. The total number of RSUs unvested at June 30, 2013 was 660,630. Each RSU vests at the rate of 33.33% on each of the first through third anniversaries of the grant date with final vesting of the most recent grants scheduled to occur in May 2016. Included in the total number of RSUs unvested at June 30, 2013 are certain RSUs that are subject to a further vesting condition that the Company’s common stock must trade at a price greater than the following market prices per share on a national securities exchange for a period of twenty consecutive days on or prior to certain anniversaries of the grant date as follows:
         
     
Number of
 
     
Unvested RSUs
 
         
$10.00 per share prior to the fifth anniversary of the grant date *     103,513  
$10.00 per share prior to the fourth anniversary of the grant date *     189,273  
$17.50 per share prior to the fifth anniversary of the grant date
      30,000  
$17.50 per share prior to the fourth anniversary of the grant date *     112,171  
$17.50 per share prior to the third anniversary of the grant date
      166,500  
$20.00 per share prior to the fourth anniversary of the grant date
      8,500  
$22.50 per share prior to the fourth anniversary of the grant date
      19,000  
No vesting condition
      31,673  
           
Unvested RSUs, June 30, 2013
      660,630  
 
The Company’s common stock has satisfied both the $10 per share market price vesting condition and the $17.50 per share market price vesting condition for the grants denoted with an asterisk above totaling 404,957 RSUs. For all of the RSUs containing a market price vesting condition, the Company performed fair value analysis using the Monte Carlo option-pricing model. The fair value related to the RSUs was calculated based primarily on the average stock price of the Company’s common stock on the date of the grant and is being amortized evenly on a pro-rata basis over the vesting period to sales and marketing, engineering and product development and general and administrative expense. The fair values of the RSUs granted in the nine months ended June 30, 2013 and 2012, respectively, were approximately $4,619,795 (or $14.77 weighted-average fair value per share) and $1,198,000 (or $6.77 weighted-average fair value per share). The Company recorded compensation expense related to RSUs of approximately $683,000 and $185,000 for the three months ended June 30, 2013 and 2012, respectively, and $1,765,000 and $431,000 for the nine months ended June 30, 2013 and 2012, respectively. These amounts are included in the total share-based compensation expense disclosed above. As of June 30, 2013, there was approximately $7.0 million of total unrecognized compensation cost related to RSUs, which is expected to be recognized over a weighted average period of 2.31 years.
 
The following table presents RSU information for the nine months ended June 30, 2013:
       
   
Number of
 
   
RSUs
 
   
Outstanding
 
       
Outstanding, October 1, 2012
    464,584  
Granted
    339,000  
Canceled
    (6,667 )
Vested
    (136,287 )
         
Outstanding, June 30, 2013
    660,630  
 
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Note 7 - Basic and Diluted Net Income (Loss) Per Share
 
Basic net income (loss) per common share is computed by dividing net income or loss by the weighted-average number of common shares outstanding during the period. Diluted net income (loss) per share reflects the impact, when dilutive, of the exercise of stock options and the vesting of restricted stock units using the treasury stock method. Diluted net loss per share for the nine months ended June 30, 2013 is the same as basic net loss per share as the potentially dilutive securities are all anti-dilutive.
 
There were no potentially dilutive common stock options for either the three or nine months ended June 30, 2013 or the three or nine months ended June 30, 2012. Potentially dilutive restricted stock units aggregating 228,336 shares and 225,743 shares for the three and nine months ended June 30, 2013, respectively, have been excluded from the computation of diluted net income (loss) per share because their inclusion would be anti-dilutive. Potentially dilutive restricted stock units aggregating 25,599 shares and 9,560 shares for the three and nine months ended June 30, 2012, respectively, have been excluded from the computation of diluted net income (loss) per share because their inclusion would be anti-dilutive. There were no potentially dilutive warrants for the three or nine months ended June 30, 2013. There were no potentially dilutive warrants for the three months ended June 30, 2012. Potentially dilutive warrants aggregating 62,792 shares for the nine months ended June 30, 2012 have been excluded from the computation of diluted net income per share because their inclusion would be anti-dilutive.
 
Note 8 - Commitments and Contingencies
 
Prior to the acquisition of intellectual property on March 30, 2012, as disclosed in Note 1 to these condensed consolidated financial statements, the Company was obligated to pay royalties ranging from 7% to 50% on revenue generated by the sale of certain licensed software products. Additionally, the Company pays royalties under arrangements with vendors related to sales of its Datawatch Report Manager on Demand and Datawatch Dashboards products. Royalty expense included in cost of software licenses was approximately $35,000 and $21,000, respectively, for the three months ended June 30, 2013 and 2012 and $102,000 and $1,116,000, respectively, for the nine months ended June 30, 2013 and 2012. The Company is not obligated to pay any minimum amounts for royalties. As a result of the acquisition of the intellectual property, the Company is no longer required to pay royalties related to its Monarch Professional and Datawatch Data Pump products.
 
From time to time, the Company is subject to claims and may be party to actions that arise in the normal course of business. The Company is not party to any litigation that management believes will have a material adverse effect on the Company’s condensed consolidated financial condition or results of operations.
 
Note 9 - Segment Information
 
The Company has determined that it has only one reportable segment. The Company’s chief operating decision maker, its Chief Executive Officer, does not manage any part of the Company separately, and the allocation of resources and assessment of performance is based solely on the Company’s consolidated operations and operating results.
 
17
 

 

 
The following table presents information about the Company’s revenue by product lines:
             
   
Three Months Ended
   
Nine Months Ended
 
   
June 30,
   
June 30,
 
   
2013
   
2012
   
2013
   
2012
 
Information Optimization Solutions (including Monarch Professional, Datawatch Data Pump, Datawatch Enterprise Server, Datawatch Enterprise Server - Cloud, Datawatch RMS, Datawatch Report Manager on Demand, Datawatch Dashboards and iMergence) 
    97 %     96 %     97 %     95 %
                                 
Business Service Management Solutions (including Visual QSM and Visual HD)
    3 %     4 %     3 %     5 %
                                 
Total
    100 %     100 %     100 %     100 %
 
The Company conducts operations in the U.S. and internationally. The following table presents information about the Company’s geographic operations:
                         
               
Intercompany
       
   
Domestic
   
International
   
Eliminations
   
Total
 
    (In thousands)  
Total Revenue
                       
Three months ended June 30, 2013
  $ 7,054     $ 984     $ (211 )   $ 7,827  
Three months ended June 30, 2012
  $ 6,491     $ 869     $ (187 )   $ 7,173  
                                 
Nine months ended June 30, 2013
  $ 19,130     $ 2,996     $ (647 )   $ 21,479  
Nine months ended June 30, 2012
  $ 17,728     $ 2,881     $ (618 )   $ 19,991  
                                 
Total Operating Income (Loss)
                               
Three months ended June 30, 2013
  $ 2     $ (521 )   $ -     $ (519 )
Three months ended June 30, 2012
  $ 1,030     $ (297 )   $ -     $ 733  
                                 
Nine months ended June 30, 2013
  $ 377     $ (1,424 )   $ -     $ (1,047 )
Nine months ended June 30, 2012
  $ 2,231     $ (560 )   $ -     $ 1,671  
                                 
Non-current Assets
                               
At June 30, 2013
  $ 7,747     $ 72     $ -     $ 7,819  
At September 30, 2012
  $ 9,018     $ 83     $ -     $ 9,101  
 
 
GENERAL
 
The Company does not provide forecasts of its future financial performance. However, from time to time, information provided by the Company or statements made by its employees may contain “forward looking” information that involves risks and uncertainties. In particular, statements contained in this Quarterly Report on Form 10-Q that are not historical facts 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 in Item 1A of the Company’s
 
18
 

 

 
Annual Report on Form 10-K for the fiscal year ended September 30, 2012 and in the Company’s definitive proxy statement filed with the Securities and Exchange Commission on August 5, 2013, as well as the accuracy of the Company’s internal estimates of revenue and operating expense levels. 
 
Datawatch is engaged in the design, development, manufacture, marketing, and support of business computer software primarily by providing information optimization products and software solutions that allow organizations to deliver an extensive variety of data into their big data and business analytic applications.
 
The Company’s principal product lines are Information Optimization Solutions (including Monarch Professional, Datawatch Data Pump, Datawatch Enterprise Server, Datawatch Enterprise Server – Cloud, Datawatch RMS, Datawatch Report Manager on Demand, Datawatch Dashboards, and iMergence) and Business Service Management Solutions (including Visual QSM and Visual HD). Included in the above categories are:
 
 
Monarch Professional , a desktop reporting and data analysis 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;
 
Datawatch Data Pump , a data replication and migration tool that offers a shortcut for populating and refreshing data marts and data warehouses, for migrating legacy data into new applications and for providing automated delivery of reports in a variety of formats, such as Excel, via email;
 
Datawatch Enterprise Server , an enterprise solution that provides web-enabled report storage, transformation and distribution including data analysis, visualization and MS Excel integration for easy to use and cost effective self-serve reporting and analytics;
 
Datawatch Enterprise Server – Cloud , a cloud-based application that provides the same functionality as Datawatch Enterprise Server and which allows faster deployment with less expense and overhead;
 
Datawatch RMS , a web-based report analysis solution that integrates with any existing enterprise report management or content management archiving solution;
 
Datawatch Report Manager on Demand , a system for high-volume document capture, archiving, and online presentation;
 
Datawatch Dashboards , an interactive dashboard solution that provides a visual overview of operational performance as well as the ability to monitor specific business processes and events;
 
iMergence , an enterprise report mining system;
 
Visual QSM , a fully internet-enabled IT service management solution that incorporates workflow and network management capabilities and provides web access to multiple databases via a standard browser; and
 
Visual Help Desk or Visual HD , a web-based help desk and call center solution operating on the IBM Lotus Domino platform.
 
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.
 
 
Revenue Recognition, Allowance for Bad Debts and Returns Reserve
 
Income Taxes
 
Capitalized Software Development Costs
 
Valuation of Intangible Assets and Other Long-Lived Assets
 
Accounting for Share-Based Compensation
 
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During the nine months ended June 30, 2013, there were no significant changes in the Company’s critical accounting policies. See Note 1 to the Company’s condensed consolidated financial statements included in this Quarterly Report on Form 10-Q and in its Annual Report on Form 10-K for the year ended September 30, 2012 for additional information about these critical accounting policies, as well as a description of the Company’s other significant accounting policies.
 
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 unaudited condensed consolidated financial statements contained in this Quarterly Report on Form 10-Q. The operating results for any period should not be considered indicative of the results expected for any future period. This information should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2012.
             
   
Three Months Ended
   
Nine Months Ended
 
   
June 30,
   
June 30,
 
   
2013
   
2012
   
2013
   
2012
 
REVENUE:
                       
Software licenses
    64%       66%       63%       66%  
Maintenance
    31%       29%       33%       28%  
Professional services
    5%       5%       4%       6%  
Total revenue
    100%       100%       100%       100%  
                                 
COSTS AND EXPENSES:
                               
Cost of software licenses
    7%       7%       7%       9%  
Cost of maintenance and services
    8%       10%       8%       10%  
Sales and marketing
    56%       45%       58%       45%  
Engineering and product development
    10%       10%       11%       10%  
General and administrative
    26%       18%       21%       18%  
Total costs and expenses
    107%       90%       105%       92%  
INCOME (LOSS) FROM OPERATIONS
    -7%       10%       -5%       8%  
Interest expense and other income (expense), net
    -2%       -2%       -2%       -1%  
INCOME (LOSS) BEFORE INCOME TAXES
    -9%       8%       -7%       7%  
Provision (benefit) for income taxes
    0%       0%       0%       0%  
NET INCOME (LOSS)
    -9%       8%       -7%       7%  
 
Three Months Ended June 30, 2013 Compared to
Three Months Ended June 30, 2012
 
Total Revenues
 
The following table presents total revenue, revenue increase and percentage change in revenue for the three months ended June 30, 2013 and 2012:
                   
   
Three Months Ended
             
   
June 30,
         
Percentage
 
   
2013
   
2012
   
Increase
   
Change
 
    (In thousands)  
Software licenses
  $ 5,007     $ 4,699     $ 308       7 %
Maintenance
    2,409       2,106       303       14 %
Professional Services
    411       368       43       12 %
Total revenue
  $ 7,827     $ 7,173     $ 654       9 %
 
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Software license revenue for the three months ended June 30, 2013 was $5,007,000 or approximately 64% of total revenue, as compared to $4,699,000, or approximately 66% of total revenue for the three months ended June 30, 2012. The increase in software license revenue of $308,000 for the three months ended June 30, 2013 consists of a $317,000 increase in Information Optimization Solutions (including Monarch Professional, Datawatch Data Pump, Datawatch Enterprise Server, Datawatch Enterprise Server – Cloud, Datawatch RMS, Datawatch Report Manager on Demand, Datawatch Dashboards, and iMergence products) offset by a $9,000 decrease in Business Service Management Solutions (including Visual QSM and Visual HD products). Included in software license revenue for the three months ended June 30, 2013 was $600,000 related to a royalty payment from one customer.

Maintenance revenue for the three months ended June 30, 2013 was $2,409,000 or approximately 31% of total revenue, as compared to $2,106,000, or approximately 29% of total revenue for the three months ended June 30, 2012. The increase in maintenance revenue of $303,000 consists of a $356,000 increase in Information Optimization Solutions offset by a $53,000 decrease in Business Service Management Solutions. The Company attributes the increase in maintenance revenue to higher overall sales and higher renewal rates of Monarch Professional.

Professional services revenue for the three months ended June 30, 2013 was $411,000 or approximately 5% of total revenue, as compared to $368,000, or approximately 5% of total revenue for the three months ended June 30, 2012. The increase in professional services revenue of $43,000 consists of a $33,000 increase in Information Optimization Solutions and a $10,000 increase in Business Service Management Solutions.

Costs and Operating Expenses
 
The following table presents costs of sales and operating expenses, increase (decrease) in costs of sales and operating expenses and percentage changes in costs of sales and operating expenses for the three months ended June 30, 2013 and 2012:
                         
 
Three Months Ended
June 30,
  Increase     Percentage  
 
2013
 
2012
 
(Decrease)
   
Change
 
     
(In thousands)
           
                   
Cost of software licenses
  $ 549     $ 509     $ 40       8 %
Cost of maintenance and services
    602       668       (66 )     -10 %
Sales and marketing
    4,398       3,244       1,154       36 %
Engineering and product development
    759       730       29       4 %
General and administrative
    2,038       1,289       749       58 %
Total costs and operating expenses
  $ 8,346     $ 6,440     $ 1,906       30 %
 
The increase in cost of software licenses of $40,000, or approximately 8%, is primarily due to increased software amortization costs pertaining to development costs capitalized in fiscal year 2013 as well as increased royalty costs related to the Company’s Report Manager on Demand product.
 
The decrease in cost of maintenance and services of $66,000, or approximately 10%, is primarily due to lower commissions due to decreased consulting sales and decreased other employee-related costs as compared to the same period last year.

The increase in sales and marketing expenses of $1,154,000, or approximately 36%, is due to higher wages and employee-related costs, including share-based compensation, attributable to increased headcount and increased promotional and lead generation costs as compared to the same period last year. These increases reflect the Company’s significant investment in a new sales and marketing team during the last several quarters to accelerate revenue generation. The Company does not expect increases of this magnitude to continue beyond fiscal year 2013.
 
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The increase in engineering and product development expenses of $29,000, or approximately 4%, is primarily attributable to higher wages and other employee-related costs due to increased headcount offset by lower external consulting costs.

The increase in general and administrative expenses of $749,000, or 58%, is primarily attributable to acquisition costs incurred during the quarter in connection with the Company’s planned acquisition of a privately-held software company as well as higher external consulting costs and higher share-based compensation costs as compared to the same period last year. In June 2013, the Company announced the signing of a definitive agreement under which it has agreed to acquire Panopticon Software AB (“Panopticon”), a privately-held Swedish company specializing in the delivery of real-time data visualization solutions. Pursuant to this agreement, the Company plans to acquire all outstanding shares of Panopticon in an all-stock transaction. Completion of this transaction is subject to the approval of the Company’s shareholders, which is expected to occur during its fourth fiscal quarter of 2013. Total acquisition-related costs in the three months ended June 30, 2013 were approximately $563,000.

Interest expense and other income (expense), net for the three months ended June 30, 2013 was $148,000 which included $158,000 of interest expense related to both the Company’s $4.0 million subordinated note with a private investment company and borrowings under a $2.0 million revolving credit facility with a bank, offset by a gain on foreign currency transactions of $10,000. Both of these debt financings were issued in connection with the Company’s acquisition of the intellectual property underlying its Monarch Professional and Datawatch Data Pump product offerings. Interest expense and other income (expense), net for the three months ended June 30, 2012 was $176,000, which included $165,000 of interest expense related to the Company’s debt financings and a loss on foreign currency transactions of approximately $11,000.

Income tax benefit for the three months ended June 30, 2013 was $1,000 as compared to income tax expense of $9,000 for the three months ended June 30, 2012. The income tax benefit is primarily related to adjustments to estimated federal alternative minimum taxes offset by minimum state taxes. Income tax expense for the three months ended June 30, 2012 includes $10,000 related to estimated federal alternative minimum taxes and a $6,000 provision for uncertain tax positions relative to foreign taxes, offset by $7,000 in estimated state tax adjustments. At June 30, 2013, the Company had U.S. federal tax loss carryforwards of approximately $7.1 million which expire at various dates through and until 2031 as well as significant state and foreign net operating loss carryforwards.

Net loss for the three months ended June 30, 2013 was $666,000 as compared to net income of $548,000 for the three months ended June 30, 2012.

Nine months Ended June 30, 2013 Compared to
Nine months Ended June 30, 2012

Total Revenues
 
The following table presents total revenue, revenue increase (decrease) and percentage change in revenue for the nine months ended June 30, 2013 and 2012:
                                 
   
Nine Months Ended
             
   
June 30,
    Increase    
Percentage
 
   
2013
   
2012
   
(Decrease)
   
Change
 
           
( In thousands)
             
                           
Software licenses
  $ 13,634     $ 13,182     $ 452       3 %
Maintenance
    7,042       5,683       1,359       24 %
Professional Services
    803       1,126       (323 )     -29 %
Total revenue
  $ 21,479     $ 19,991     $ 1,488       7 %
 
22
 

 


Software license revenue for the nine months ended June 30, 2013 was $13,634,000 or approximately 63% of total revenue, as compared to $13,182,000, or approximately 66% of total revenue for the nine months ended June 30, 2012. The increase in software license revenue of $452,000 for the nine months ended June 30, 2013 consists of a $585,000 increase in Information Optimization Solutions offset by a $133,000 decrease in Business Service Management Solutions. Included in software license revenue for the nine months ended June 30, 2013 was $600,000 related to a royalty payment from one customer.

Maintenance revenue for the nine months ended June 30, 2013 was $7,042,000 or approximately 33% of total revenue, as compared to $5,683,000, or approximately 28% of total revenue for the nine months ended June 30, 2012. The increase in maintenance revenue of $1,359,000 consists of a $1,469,000 increase in Information Optimization Solutions offset by a $110,000 decrease in Business Service Management Solutions. The increase in maintenance revenue is due to higher overall sales and increased renewal rates of Monarch Professional.

Professional services revenue for the nine months ended June 30, 2013 was $803,000 or approximately 4% of total revenue, as compared to $1,126,000, or approximately 6% of total revenue for the nine months ended June 30, 2012. The decrease in professional services revenue of $323,000 consists of a $249,000 decrease in Information Optimization Solutions and a $74,000 decrease in Business Service Management Solutions. This decrease is due to lower consulting services primarily related to the Company’s Report Manager on Demand and Visual QSM product offerings.

Costs and Operating Expenses

The following table presents costs of sales and operating expenses, increase (decrease) in costs of sales and operating expenses and percentage changes in costs of sales and operating expenses for the nine months ended June 30, 2013 and 2012:
                         
   
Nine Months Ended
             
   
June 30,
   
Increase
   
Percentage
 
   
2013
   
2012
   
(Decrease)
   
Change
 
   
(In thousands)                         
 
                         
Cost of software licenses
  $ 1,602     $ 1,743     $ (141 )     -8 %
Cost of maintenance and services
    1,697       2,019       (322 )     -16 %
Sales and marketing
    12,391       9,041       3,350       37 %
Engineering and product development
    2,361       2,048       313       15 %
General and administrative
    4,475       3,469       1,006       29 %
Total costs and operating expenses
  $ 22,526     $ 18,320     $ 4,206       23 %
 
The decrease in cost of software licenses of $141,000, or approximately 8%, is primarily due to a decrease in royalty expense attributable to the acquisition of intellectual property underlying the Company’s Monarch Professional and Datawatch Data Pump products on March 30, 2012 which was partially offset by higher software amortization costs. As a result of this acquisition, the Company is no longer incurring royalty expense related to these products to cost of software licenses but is amortizing the purchase price of the intellectual property to cost of software licenses.

The decrease in cost of maintenance and services of $322,000, or approximately 16%, is primarily due to lower commissions resulting from decreased consulting sales and lower travel expenses and other employee-related costs.

The increase in sales and marketing expenses of $3,350,000, or approximately 37%, is attributable to higher wages and employee-related costs, including share-based compensation, due to increased headcount, higher travel expenses and increased consulting, promotional and lead generation costs as compared to the same period last
 
23
 

 

 
year. These increases reflect the Company’s significant investment in a new sales and marketing team during the last several quarters to accelerate revenue generation. The Company does not expect increases of this magnitude to continue beyond fiscal year 2013.

The increase in engineering and product development expenses of $313,000, or approximately 15%, is primarily due to higher wages and other employee-related costs offset by lower consulting costs as compared to the same period last year.

The increase in general and administrative expenses of $1,006,000, or approximately 29%, is primarily attributable to acquisition costs incurred during the three months ended June 30, 2013 in connection with the Company’s planned acquisition of a privately-held software company as well as higher external consulting costs and higher share-based compensation costs as compared to the same period last year. In June 2013, the Company announced the signing of a definitive agreement under which it has agreed to acquire Panopticon Software AB (“Panopticon”), a privately-held Swedish company specializing in the delivery of real-time data visualization solutions. Pursuant to this agreement, the Company plans to acquire all outstanding shares of Panopticon in an all-stock transaction. Completion of this transaction is subject to the approval of the Company’s shareholders, which is expected to occur during its fourth fiscal quarter of 2013. Total acquisition-related costs in the nine months ended June 30, 2013 were approximately $563,000.

Interest expense and other income (expense), net for the nine months ended June 30, 2013 was $465,000 which includes $474,000 of interest expense related to both the Company’s $4.0 million subordinated note with a private investment company and borrowings under a $2.0 million revolving credit facility with a bank; offset by a gain on foreign currency transactions of $9,000. Both of these debt financings were issued in connection the Company’s acquisition of the intellectual property underlying its Monarch Professional and Datawatch Data Pump product offerings. Interest expense and other income (expense), net for the nine months ended June 30, 2012 was $285,000 which included $167,000 of interest expense related to the Company’s debt financings and a loss on foreign currency transactions of approximately $118,000. The foreign currency loss for the nine months ended June 30, 2012 was attributable to the settlement of intercompany account balances due to the dissolution of one of the Company’s foreign subsidiaries and the repatriation of international funds to the US required by the Company’s line of credit facility which was entered into on March 30, 2012. Additionally, the foreign currency loss for the nine months ended June 30, 2012 was partially due to the repayment of intercompany loans between the Australian and UK subsidiaries.

Income tax expense for the nine months ended June 30, 2013 was $2,000 as compared to $75,000 for the nine months ended June 30, 2012. Income tax expense for the nine months ended June 30, 2013 includes a $13,000 provision related to uncertain tax positions relative to foreign taxes offset by adjustments to estimated federal alternative minimum taxes and estimated state taxes totaling $11,000. Income tax expense for the nine months ended June 30, 2012 includes $30,000 related to estimated federal alternative minimum taxes, $26,000 related to estimated state taxes and $19,000 related to uncertain tax positions relative to foreign taxes.

Net loss for the nine months ended June 30, 2013 was $1,514,000 as compared to net income of $1,311,000 for the nine months ended June 30, 2012.

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 non-cancelable operating leases that expire through 2016. 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 $128,000 and $105,000 for the three months ended June 30, 2013 and 2012, respectively, and $397,000 and $327,000 for the nine months ended June 30, 2013 and 2012, respectively.
 
24
 

 


As of June 30, 2013, the Company’s contractual obligations include minimum rental commitments under non-cancelable operating leases, long-term debt obligations and other liabilities related to uncertain tax positions as follows (in thousands):
                               
         
Less than 1
               
More than
 
Contractual Obligations:
 
Total
   
Year
   
1-3 Years
   
3-5 Years
   
5 Years
 
Operating Lease Obligations
  $ 701     $ 339     $ 362     $ -     $ -  
Long-term Debt Obligations
  $ 4,000     $ 267     $ 1,600     $ 1,600     $ 533  
Other Liabilities
  $ 213     $ -     $ -     $ -     $ 213  

Prior to the acquisition of intellectual property on March 30, 2012, as disclosed in Note 1 to the condensed consolidated financial statements, the Company was obligated to pay royalties ranging from 7% to 50% on revenue generated by the sale of certain licensed software products. Additionally, the Company pays royalties under arrangements with vendors related to sales of its Datawatch Report Manager on Demand and Datawatch Dashboards products. Royalty expense included in cost of software licenses was approximately $35,000 and $21,000 for the three months ended June 30, 2013 and 2012, respectively, and $102,000 and $1,116,000 for the nine months ended June 30, 2013 and 2012, respectively. The Company is not obligated to pay any minimum amounts for royalties. As a result of the acquisition of the intellectual property, the Company is no longer required to pay royalties related to its Monarch Professional and Datawatch Data Pump products.