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

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 Annual Report on Form 10-K for the fiscal year ended September 30, 2008, as well as the accuracy of the Company’s internal estimates of revenue and operating expense levels. 

The Company is engaged in the design, development, manufacture, marketing, and support of business computer software primarily for the Enterprise Information Management market which incorporates business intelligence, enterprise content management and service management solutions to allow organizations to access and analyze information in a more meaningful fashion.

The Company’s principal product lines are Business Intelligence Solutions (including Monarch, Monarch Data Pump, Monarch RMS, Monarch BI Server, Datawatch ES, Datawatch Researcher, Visual Insight, iMergence and VorteXML), Content Management Solutions (including Datawatch BDS, Datawatch BDS Workflow and Datawatch MailManager) and Service Management Solutions (including Visual QSM and Visual HD). Included in the above categories are: Monarch, a desktop report mining and business intelligence application that lets users extract and manipulate data from ASCII report files, PDF files or HTML files produced on any mainframe, midrange, client/server or PC system; Monarch Data Pump, a data replication and migration tool that offers a shortcut for populating and refreshing data marts and data warehouses, for migrating legacy data into new applications and for providing automated delivery of reports in a variety of formats via email; Monarch RMS, a web-based report mining and analysis solution that integrates with any existing Enterprise Report Management document or content management archiving solution; Monarch BI Server, an out-of-the-box web-based Business Intelligence solution developed specifically for small to mid-sized businesses and departments; Datawatch ES, an enterprise business intelligence system that provides web-enabled report management, mining and distribution as well as data analysis and MS Excel integration; Datawatch Researcher, a development platform for building performance management, content and data aggregation and workflow solutions; Visual Insight, a performance management solution that provides web-based knowledge management and Key Performance Indicator reporting; iMergence, an enterprise report mining system; VorteXML, a data transformation product for the emerging XML market that easily and quickly converts structured text output from any system into valid XML for web services and more using any DTD or XDR schema without programming; Datawatch BDS, a system for high-volume document capture, archiving, and online presentation; Datawatch BDS Workflow, a web-enabled enterprise business process management solution that provides highly effective processing of document intensive business transactions; Datawatch MailManager, a highly scalable email management solution that provides complete lifecycle, compliance and storage management for Microsoft Exchange environments; 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.

The Company offers its enterprise products through perpetual licenses and subscription pricing models.

 

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Subscriptions automatically renew unless terminated with 90 days notice following the first year of the subscription term. The subscription arrangement includes software, maintenance and unspecified future upgrades including major version upgrades. The subscription renewal rate is the same as the initial subscription rate. During the three months ended March 31, 2009 and 2008, revenues under the subscription model were $120,000 and $149,000, respectively. During the six months ended March 31, 2009 and 2008, revenues under the subscription model were $256,000 and $293,000, respectively.

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

The Company has two types of software product offerings: Enterprise Software and Desktop and Server Software. Enterprise Software products are sold directly to end-users and through the use of value added resellers. The Company sells its Desktop and Server Software products directly to end-users and through distributors and resellers.  Sales to distributors and resellers accounted for approximately 36% and 40%, respectively, of total sales for the three months ended March 31, 2009 and 2008, and 39% and 40%, respectively, for the six months ended March 31, 2009 and 2008. Revenue from the license of all software products is generally recognized at the time of shipment, provided there are no uncertainties surrounding product acceptance, the fee is fixed and determinable, collection is considered probable, persuasive evidence of the arrangement exists and there are no significant obligations remaining.  Both types of the Company’s software product offerings are “off-the-shelf” as such term is defined by Statement of Position No. 97-2, “Software Revenue Recognition.” The Company’s software products can be installed and used by customers on their own with little or no customization required.  Multi-user licenses marketed by the Company are sold as a right to use the number of licenses and license fee revenue is recognized upon delivery of all software required to satisfy the number of licenses sold. Upon delivery, the licensing fee is payable without further delivery obligations of the Company.

Desktop and Server Software products are generally not sold in multiple element arrangements. Enterprise Software sales are generally multiple element arrangements which include software license deliverables, professional services and post-contract customer support, which primarily consists of maintenance. In such multiple element arrangements, the Company applies the residual method in determining revenue to be allocated to a software license. In applying the residual method, the Company deducts from the sale proceeds the vendor specific objective evidence (“VSOE”) of fair value of the services and post-contract customer support in determining the residual fair value of the software license. The VSOE of fair value of the services and post-contract customer support is based on the amounts charged for these elements when sold separately. Professional services include implementation, integration, training and consulting services with revenue recognized as the services are performed. These services are generally delivered on a time and materials basis, are billed on a current basis as the work is performed, and do not involve modification or customization of the software or any other unusual acceptance clauses or terms. Post-contract customer support is typically provided under a maintenance agreement which provides technical support and rights to unspecified software maintenance updates and bug fixes on a when-and-if available basis.  Revenue from post-contract customer support services is deferred and recognized ratably over the contract period (generally one year).  Such deferred amounts are recorded as part of deferred revenue in the Company’s condensed consolidated balance sheets included herein.

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

 

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customer site and available for use by the customer, and provided that all other criteria for revenue recognition are met, the deferred revenue amount is recognized ratably over the period the service is provided. The customer is then invoiced every 90 days and, in accordance with SOP 97-2, revenue is recognized ratably over the period the service is provided. The subscription arrangement includes software, maintenance and unspecified future upgrades including major version upgrades. The 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 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. Certain software products, including desktop versions of Monarch, Monarch Data Pump, Monarch BI Server and VorteXML licensed directly to end-users, include a guarantee under which such customers may return products within 30 days for a full refund. Additionally, the Company provides its distributors with stock-balancing rights and applies the guidance found in Statement of Financial Accounting Standards No. 48, “Revenue Recognition when Right of Return Exists” (“SFAS No. 48”).  Revenue from the license of software products to distributors and resellers is recognized at the time of shipment providing all other criteria for revenue recognition as stated above are met and (i) the distributor or reseller is unconditionally obligated to pay for the products, including no contingency as to product resale, (ii) the distributor or reseller has independent economic substance apart from the Company, (iii) the Company is not obligated for future performance to bring about product resale, and (iv) the amount of future returns can be reasonably estimated. The Company’s experience and history with its distributors and resellers allows for reasonable estimates of future returns. Among other things, estimates of potential future returns are made based on the inventory levels at the various distributors and resellers, which the Company monitors frequently. Once the estimates of potential future returns from all sources are made, the Company determines if it has adequate returns reserves to cover anticipated returns and the returns reserve is adjusted as required. Adjustments are recorded as increases or decreases in revenue in the period of adjustment. Actual returns have historically been within the range estimated by the Company. The Company’s returns reserves were $60,000 and $65,000 as of March 31, 2009 and September 30, 2008, respectively.

The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of customers to make required payments. The Company analyzes accounts receivable and the composition of the accounts receivable aging, historical bad debts, customer creditworthiness, current economic trends, foreign currency exchange rate fluctuations and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. Based upon the analysis and estimates of the collectibility of its accounts receivable, the Company records an increase in the allowance for doubtful accounts when the prospect of collecting a specific account receivable becomes doubtful. Actual results could differ from the allowances for doubtful accounts recorded, and this difference may have a material effect on the Company’s financial position and results of operations. The Company’s allowance for doubtful accounts was $154,000 and $171,000 as of March 31, 2009 and September 30, 2008, respectively.

Income Taxes

The Company has deferred tax assets related to net operating loss carryforwards and tax credits that expire at different times through and until 2028. 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 assets are more likely than not to be realized and a full valuation allowance continues to be provided. Management evaluates the realizability of the deferred tax assets quarterly and, if current economic conditions change or future results of operations are better than expected, future assessments may result in the Company concluding that it is more likely than not that all or a portion of the deferred tax assets are realizable. If this conclusion were reached, the valuation allowance against deferred tax assets would be reduced resulting in a tax benefit being recorded for financial reporting purposes. Total net deferred tax assets subject to the full valuation allowance were approximately $5.9 million as of March 31, 2009.

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 The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109” (“FIN 48”) on October 1, 2007. FIN 48 provides a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns.

Under FIN 48, the Company first determines whether a tax authority would “more likely than not” sustain its tax position if it were to audit the position with full knowledge of all the relevant facts and other information. For those tax positions that meet this threshold, the Company measures the amount of tax benefit based on the largest amount of tax benefit that the Company has a greater than 50% chance of realizing in a final settlement with the relevant authority. Those tax positions failing to qualify for initial recognition are recognized in the first interim period in which they meet the more likely than not standard, or are resolved through negotiation or litigation with the taxing authority, or upon expiration of the statute of limitations. The Company maintains a cumulative risk portfolio relating to all of its uncertainties in income taxes in order to perform this analysis, but the evaluation of the Company’s tax position in connection with FIN 48 requires significant judgment and estimation in part because, in certain cases, tax law is subject to varied interpretation, and whether a tax position will ultimately be sustained may be uncertain. The actual outcome of the Company’s tax positions, if significantly different from its estimates, could materially impact the financial statements.

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 or penalties as such amounts have been de minimis.

Capitalized Software Development Costs

The Company capitalizes certain software development costs as well as purchased software upon achieving technological feasibility of the related products. Software development costs incurred and software purchased prior to achieving technological feasibility are charged to research and development expense as incurred.  Commencing upon initial product release, capitalized costs are amortized to cost of software licenses using the straight-line method over the estimated life (which approximates the ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product), which is generally 18 to 36 months. The net amount of acquired and capitalized software was approximately $1.1 million and $664,000 at March 31, 2009 and September 30, 2008, respectively. During the six months ended March 31, 2009, the Company capitalized approximately $543,000 of software development costs related to new products in development. No amounts were capitalized during the six months ended March 31, 2008.

Goodwill, Other Intangible Assets and Other Long-Lived Assets

The Company performs an evaluation of whether goodwill is impaired annually or when events occur or circumstances change that would more likely than not reduce the fair value of the applicable reporting unit below its carrying amount. The annual impairment analysis is performed on May 31st of each applicable fiscal year. Fair value is determined using market comparables for similar businesses, current market valuations of the Company’s common stock, or forecasts of discounted future cash flows. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Factors the Company considers important that could trigger an impairment review include, but are not limited to, significant underperformance relative to historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for the Company’s overall business, significant negative industry or economic trends, a significant decline in the Company’s stock price for a sustained period, and decreases in the Company’s market capitalization below the recorded amount of its net assets for a sustained period.

Goodwill and one indefinite lived trademark were not subject to amortization and were tested annually, on May 31st, for impairment or more frequently if events and circumstances indicate that the asset might be impaired. Factors the Company believes could trigger interim impairment reviews include, but are not limited to, significant underperformance relative to historical or projected future operating results, significant changes in the manner of

 

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use of the acquired assets or the strategy for the Company’s overall business, significant negative industry or economic trends, a significant decline in the Company’s stock price for a sustained period, and significant decreases in the Company’s market capitalization for a sustained period.

The Company performed interim tests of impairment for its goodwill and its indefinite lived trademark at September 30, 2008, December 31, 2008 and again at March 31, 2009 in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets” due to uncertainties surrounding the global economy and the volatility in the Company’s stock price. The Company tests goodwill for impairment using a two-step approach. The first step is to compare the fair value of the reporting unit to its carrying amount, including goodwill. If the fair value of the reporting unit is greater than its carrying amount, goodwill is not considered impaired, but if the fair value of the reporting unit is less than its carrying amount, the amount of the impairment loss, if any, must be measured. An impairment loss is recognized to the extent that the carrying amount of the reporting unit exceeds the reporting unit’s fair value. The Company estimates its fair value using the best information available, including market information and discounted cash flow projections also referred to as the income approach. The income approach uses future estimated operating results and cash flows that are discounted using a weighted-average cost of capital that reflects current market conditions. These projections utilize management’s best estimates of economic and market conditions over the projected period, including growth rates in revenues, costs, estimates of future expected changes in operating margins and cash expenditures. Other significant estimates and assumptions include terminal value growth rates, future estimates of capital expenditures and changes in future working capital requirements. The Company validates its estimates of fair value under the income approach by comparing the values to fair value estimates using a market approach. A market approach estimates fair value by applying cash flow multiples to the reporting unit’s operating performance. The multiples are derived from comparable publicly traded companies with similar operating and investment characteristics of the reporting unit.

In conducting its most recent interim impairment analysis at March 31, 2009, management took into account the effects of the global economic recession, including among other factors, that Company revenues were lower than expected in the three months ended March 31, 2009. The results of the impairment analysis at March 31, 2009 indicated that the Company’s book value exceeded its estimated fair value. Further analysis indicated that the Company’s goodwill was fully impaired. Therefore, the Company recorded a non-cash impairment charge of approximately $6.1 million in the three months ended March 31, 2009.

The Company tests its indefinite lived intangible asset for impairment by comparing the fair value to the net book value of the asset. The Company estimates the fair value of its trademark using the relief-from-royalty method, which requires assumptions related to projected revenues and assumed royalty rates that could be payable if it did not own the trademark, as well as an estimated discount rate. The results of the Company’s valuation analysis at March 31, 2009 indicated that a trademark was fully impaired at March 31, 2009. Therefore, the Company recorded a non-cash impairment charge of approximately $285,000 in the three months ended March 31, 2009.

Accounting for Stock-Based Compensation

The Company recognizes stock-based compensation expense in accordance with Statement of Financial Accounting Standards No. 123 (revised 2004) (“SFAS 123(R)”), “Share-Based Payment.” SFAS 123(R) requires all share-based awards, including grants of employee stock options, to be recognized in the financial statements based on their fair value.

Under the provisions of SFAS No. 123(R), 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. For the three months ended March 31, 2009 and 2008, the Company recorded stock-based compensation expense of approximately $56,000 and $55,000, respectively. For the six months ended March 31, 2009 and 2008, the Company recorded stock-based compensation expense of approximately $114,000 and $106,000, respectively. In order to determine the fair value of stock options on the date of grant, the Company applies the Black-Scholes option-pricing model. Inherent in the determination of fair value of share-based awards are assumptions related to

 

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expected stock-price volatility, option life, risk-free interest rate, dividend yield and expected forfeitures. While the risk-free interest rate and dividend yield are less subjective assumptions, typically based on factual data derived from public sources, the expected stock-price volatility, option life and forfeiture assumptions require a greater level of judgment which makes them critical accounting estimates.

The Company uses an expected stock-price volatility assumption that represents historical volatilities of the underlying stock which are obtained from public data sources. The Company believes this approach results in a reasonable estimate of future volatility.

With regard to the weighted-average option life assumption, the Company considers the exercise behavior of past grants and models the pattern of aggregate historical 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.

With regard to the forfeiture rate assumption, the Company reviews historical voluntary turnover rates. 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.

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, 2008.

 

		Three Months Ended				Six Months Ended
		March 31,				March 31,
		2009		2008		2009		2008
REVENUE:
Software licenses and subscriptions		58.4%		53.7%		56.5%		54.3%
Maintenance and services		41.6%		46.3%		43.5%		45.7%
Total Revenue		100.0%		100.0%		100.0%		100.0%
COSTS AND EXPENSES:
Cost of software licenses and subscriptions		10.4%		9.4%		10.3%		9.4%
Cost of maintenance and services		16.4%		20.0%		16.6%		19.2%
Sales and marketing		36.4%		33.5%		34.1%		35.0%
Engineering and product development		11.5%		14.2%		12.6%		13.3%
General and administrative		20.0%		21.7%		21.2%		20.8%
Impairment of goodwill and other intangible assets		125.7%		—		62.2%		—
Total costs and expenses		220.4%		98.8%		157.0%		97.7%
INCOME (LOSS) FROM OPERATIONS		-120.4%		1.2%		-57.0%		2.3%
Interest income and other income (expense), net		-0.1%		0.8%		1.6%		1.2%
INCOME (LOSS) BEFORE INCOME TAXES		-120.5%		2.0%		-55.4%		3.5%
Provision (benefit) for income taxes		-5.6%		0.6%		-2.3%		0.7%
NET INCOME (LOSS)		-114.9%		1.4%		-53.1%		2.8%

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Three Months Ended March 31, 2009 Compared to Three Months Ended March 31, 2008

Total Revenues

The following table presents total revenue, total revenue decrease and percentage change in total revenue for the three months ended March 31, 2009 and 2008:

 

		Three Months Ended
		March 31,								Increase				Percentage
		2009				2008				(Decrease)				Change
		(In thousands)
Software licenses and subscriptions		$	2,973			$	3,155			$	(182	)			-5.8%
Maintenance and services			2,119				2,718				(599	)			-22.0%
Total revenue		$	5,092			$	5,873			$	(781	)			-13.3%

Software license and subscription revenue for the three months ended March 31, 2009 was $2,973,000 or approximately 58% of total revenue, as compared to $3,155,000 or approximately 54% of total revenue for the three months ended March 31, 2008. This represents a decrease of $182,000 or approximately 6% from the second quarter of fiscal 2008 to the second quarter of fiscal 2009. The overall net decrease in software license and subscription revenue for the three months ended March 31, 2009 consists of a $105,000 decrease in Business Intelligence Solutions (including Monarch, Monarch Data Pump, Monarch RMS, Monarch BI Server, Datawatch ES, Datawatch Researcher, Visual Insight, iMergence and VorteXML products), a $55,000 decrease in Service Management Solutions (including Visual QSM and Visual HD products) and a $22,000 decrease in Content Management Solutions (including Datawatch BDS, Datawatch BDS Workflow and Datawatch MailManager products). The $105,000 decrease in Business Intelligence Solutions relates primarily to a decrease in Monarch desktop license sales as compared to the same period in fiscal 2008.

Maintenance and services revenue for the three months ended March 31, 2009 was $2,119,000 or approximately 42% of total revenue, as compared to $2,718,000 or approximately 46% of total revenue for the three months ended March 31, 2008. This represents a decrease of $599,000 or approximately 22% from the second quarter of fiscal 2008 as compared to the second quarter of fiscal 2009. The decrease in maintenance and services revenue includes a $371,000 decrease in Service Management Solutions (including Visual QSM and Visual HD products), a $119,000 decrease in Content Management Solutions (including Datawatch BDS, Datawatch BDS Workflow and Datawatch MailManager products) and a $109,000 decrease in Business Intelligence Solutions (including Monarch, Monarch Data Pump, Monarch RMS, Monarch BI Server, Datawatch ES, Datawatch Researcher, Visual Insight, iMergence and VorteXML products).

Costs and Operating Expenses

The following table presents costs and operating expenses, increase/(decrease) in costs and operating expenses and percentage changes in costs and operating expenses for the three months ended March 31, 2009 and 2008:

 

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		Three Months Ended
		March 31,								Increase				Percentage
		2009				2008				(Decrease)				Change
		(In thousands)
Cost of software licenses and subscriptions		$	531			$	550			$	(19	)			-3.5%
Cost of maintenance and services			834				1,177				(343	)			-29.1%
Sales and marketing			1,854				1,968				(114	)			-5.8%
Engineering and product development			585				836				(251	)			-30.0%
General and administrative			1,018				1,273				(255	)			-20.0%
Impairment of goodwill and other intangible assets			6,401				—				6,401
Total costs and operating expenses		$	11,223			$	5,804			$	5,419				93.4%

 

Cost of software licenses and subscriptions for the three months ended March 31, 2009 was $531,000 or approximately 18% of software license and subscription revenue, as compared to $550,000 or approximately 17% of software license and subscription revenues for the three months ended March 31, 2008. The decrease in cost of software licenses and subscriptions is due to lower royalty costs related to revenue mix which was partly offset by higher amortization expense of capitalized software costs for new product releases.

Cost of maintenance and services for the three months ended March 31, 2009 was $834,000 or approximately 40% of maintenance and services revenue, as compared to $1,177,000 or approximately 43% of maintenance and services revenue for the three months ended March 31, 2008. The decrease in total cost of maintenance and services of $343,000 is primarily attributable to lower headcount and employee-related costs, travel-related expenses and decreased use of external consultants.

Sales and marketing expenses for the three months ended March 31, 2009 were $1,854,000, or 36% of total revenues as compared to $1,968,000 or 34% of total revenues for the three months ended March 31, 2008. The decrease in sales and marketing expenses of $114,000, or approximately 6%, is attributable to lower headcount and related expenses and lower external consulting costs as compared to the same period last year.

Engineering and product development expenses for the three months ended March 31, 2009 were $585,000, or 12% of total revenues as compared to $836,000, or 14% of total revenues for the three months ended March 31, 2008. The decrease in engineering and product development expenses of $251,000, or approximately 30%, is primarily attributable to costs capitalized related to new product releases.

General and administrative expenses for the three months ended March 31, 2009 were $1,018,000, or 20% of total revenues as compared to $1,273,000, or 22% of total revenues for the three months ended March 31, 2008. The decrease in general and administrative expenses of $255,000, or 20%, is primarily attributable to decreased accounting and legal fees, bad debt reserves and other external consulting services.   

Impairment of goodwill and other intangible assets of $6.4 million is attributable to the full impairment of the Company’s goodwill totaling $6,116,000 and an indefinite lived trademark totaling $285,000.

Interest income for the three months ended March 31, 2009 was $6,000 as compared to $31,000 for the three months ended March 31, 2008. The decrease in interest income was the result of lower interest rates available from banks in the United States and the United Kingdom. Gain (loss) on foreign currency transactions for the three months ended March 31, 2009 was a loss of $12,000 as compared to a gain of $18,000 for the three months ended March 31, 2008.

Income tax benefit for the three months ended March 31, 2009 was primarily attributable to the reversal of the Company’s deferred tax liability of $319,000 related to its tax-deductible goodwill from the IDARS acquisition, which was determined to be fully impaired for book purposes as of March 31, 2009. Income tax provision for the three months ended March 31, 2008 primarily represents deferred tax expense related to the

 

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difference between the tax and book basis of the tax-deductible goodwill generated by the Company’s acquisition of the business assets of IDARS. Deferred tax expense was recognized for financial reporting purposes equal to the tax rate on the excess of tax amortization over the amortization for financial reporting purposes.

Net loss for the three months ended March 31, 2009 was ($5,854,000). Excluding the effects of the goodwill and trademark impairment charge, net income for the three months ended March 31, 2009 would have been $228,000, or $0.04 per diluted share, as compared to $83,000, or $0.01 per diluted share, for the three months ended March 31, 2008.

Six months Ended March 31, 2009 Compared to Six Months Ended March 31, 2008

Total Revenues

 

The following table presents total revenue, total revenue decrease and percentage change in total revenue for the six months ended March 31, 2009 and 2008:

 

		Six Months Ended
		March 31,								Increase				Percentage
		2009				2008				(Decrease)				Change
		(In thousands)
Software licenses and subscriptions		$	5,813			$	6,488			$	(675	)			-10.4%
Maintenance and services			4,481				5,452				(971	)			-17.8%
Total revenue		$	10,294			$	11,940			$	(1,646	)			-13.8%

 

Software license and subscription revenue for the six months ended March 31, 2009 was $5,813,000 or approximately 57% of total revenue, as compared to $6,488,000 or approximately 54% of total revenue for the six months ended March 31, 2008. This represents a decrease of $675,000 or approximately 10% from the six months of fiscal 2008 to the six months of fiscal 2009. The overall net decrease in software license and subscription revenue for the six months ended March 31, 2009 consists of a $529,000 decrease in Business Intelligence Solutions (including Monarch, Monarch Data Pump, Monarch RMS, Monarch BI Server, Datawatch ES, Datawatch Researcher, Visual Insight, iMergence and VorteXML products), a $99,000 decrease in Service Management Solutions (including Visual QSM and Visual HD products) and an $47,000 decrease in Content Management Solutions (including Datawatch BDS, Datawatch BDS Workflow and Datawatch MailManager products). The $529,000 decrease in Business Intelligence Solutions relates primarily to a decrease in Monarch desktop product license sales as compared to the same period in fiscal 2008.

Maintenance and services revenue for the six months ended March 31, 2009 was $4,481,000 or approximately 43% of total revenue, as compared to $5,452,000 or approximately 46% of total revenue for the six months ended March 31, 2008. This represents a decrease of $971,000, or approximately 18%, from the first six months of fiscal 2008 as compared to the first six months of fiscal 2009. The decrease in maintenance and services revenue includes a $789,000 decrease in Service Management Solutions (including Visual QSM and Visual HD products), a $96,000 decrease in Business Intelligence Solutions (including Monarch, Monarch Data Pump, Monarch RMS, Monarch BI Server, Datawatch ES, Datawatch Researcher, Visual Insight, iMergence and VorteXML products) and an $86,000 decrease in Content Management Solutions (including Datawatch BDS, Datawatch BDS Workflow and Datawatch MailManager products).

Costs and Operating Expenses

The following table presents costs and operating expenses, increase (decrease) in costs and operating expenses and percentage changes in costs and operating expenses for the six months ended March 31, 2009 and 2008:

 

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		Six Months Ended
		March 31,								Increase				Percentage
		2009				2008				(Decrease)				Change
		(In thousands)
Cost of software licenses and subscriptions		$	1,061			$	1,122			$	(61	)			-5.4	%
Cost of maintenance and services			1,707				2,297				(590	)			-25.7	%
Sales and marketing			3,515				4,189				(674	)			-16.1	%
Engineering and product development			1,298				1,586				(288	)			-18.2	%
General and administrative			2,184				2,478				(294	)			-11.9	%
Impairment of goodwill and other intangible assets			6,401				—				6,401
Total costs and operating expenses		$	16,166			$	11,672			$	4,494				38.5	%

 

Cost of software licenses and subscriptions for the six months ended March 31, 2009 was $1,061,000 or approximately 18% of software license and subscription revenue, as compared to $1,122,000 or approximately 17% of software license and subscription revenues for the six months ended March 31, 2008. The decrease in cost of software licenses and subscriptions of $61,000 is due to lower royalty costs related to product royalty mix which was partially offset by higher amortization of capitalized software.

Cost of maintenance and services for the six months ended March 31, 2009 was $1,707,000 or approximately 38% of maintenance and services revenue, as compared to $2,297,000 or approximately 42% of maintenance and services revenue for the six months ended March 31, 2008. The decrease in cost of maintenance and services of $590,000 is primarily due to lower employee and travel-related expenses and lower international consulting costs.

Sales and marketing expenses for the six months ended March 31, 2009 were $3,515,000, or 34% of total revenues as compared to $4,189,000, or 35% of total revenues for the six months ended March 31, 2008.  The decrease in sales and marketing expenses of $674,000, or approximately 16%, is primarily attributable to a reduction of cost due to lower employee related expenses as well as lower consulting costs.

Engineering and product development expenses for the six months ended March 31, 2009 were $1,298,000, or 13% of total revenues as compared to $1,586,000, or 13% of total revenues, for the six months ended March 31, 2008. The decrease in engineering and product development expenses of $288,000, or approximately 18%, is primarily attributable to the capitalization of development costs for new software releases.

General and administrative expenses for the six months ended March 31, 2009 were $2,184,000, or 21% of total revenues, as compared to $2,478,000, or 21% of total revenues for the six months ended March 31, 2008. The decrease in general and administrative expenses of $294,000, or approximately 12%, is primarily attributable to decreases in professional services fees including accounting, legal and consulting.

Impairment of goodwill and other intangible assets of $6.4 million is attributable to the full impairment of the Company’s goodwill totaling $6,116,000 and an indefinite lived trademark totaling $285,000.

Interest income for the six months ended March 31, 2009 was $27,000 as compared to $71,000 for the six months ended March 31, 2008. The decrease in interest income was the result of lower interest rates available from banks in the United States and the United Kingdom. Gain on foreign currency transactions for the six months ended March 31, 2009 was $136,000 as compared to $75,000 for the six months ended March 31, 2008.

Income tax benefit for the six months ended March 31, 2009 of $240,000 was primarily attributable to the reversal of the Company’s deferred tax liability of $319,000 related to its goodwill from the IDARS acquisition which was determined to be fully impaired at March 31, 2009. Income tax provision for the six months ended March 31,

 

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2008 primarily represents deferred tax expense related to the tax-deductible goodwill generated by the Company’s acquisition of the business assets of IDARS. The goodwill resulting from this transaction was deductible for tax purposes and a deferred tax expense was recognized for financial reporting purposes equal to the tax rate on the excess of tax amortization over the amortization for financial reporting purposes.

Net loss for the six months ended March 31, 2009 was ($5,469,000). Excluding the effects of the goodwill and trademark impairment charge, net income for the six months ended March 31, 2009 would have been $614,000, or $0.10 per diluted share, as compared to $330,000, or $0.06 per diluted share, for the six months ended March 31, 2008.

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 2011. The lease agreements generally provide for the payment of minimum annual rentals, pro rata share of taxes, and maintenance expenses.  Rental expense for all operating leases was approximately $80,000 and $99,000 for the three months ended March 31, 2009 and 2008, respectively, and $163,000 and $249,000 for the six months ended March 31, 2009 and 2008, respectively.

As of March 31, 2009, contractual obligations include minimum rental commitments under non-cancelable operating leases as follows:

 

Contractual Obligations:		Total				Less than 1 Year				1-3 Years				3-5 Years				More than 5 Years
		(in thousands)
Operating Lease
Obligations		$	502			$	262			$	240			$	—			$	—
Other Liabilities		$	113			$	—			$	—			$	—			$	113

 

The Company is also obligated to pay royalties ranging from 7% to 50% on revenue generated by the sale of certain licensed software products. Royalty expense included in cost of software licenses was approximately $404,000 and $437,000, respectively, for the three months ended March 31, 2009 and 2008, and $795,000 and $894,000 for the six months ended March 31, 2009 and 2008, respectively. The Company is not obligated to pay any minimum amounts for royalties.

On August 11, 2004, the Company acquired 100% of the shares of Mergence Technologies Corporation. The purchase agreement includes a provision for quarterly cash payments to the former Mergence shareholders equal to 10% of revenue, as defined, of the Datawatch Researcher and Visual Insight products until September 30, 2010. The Company expensed approximately $5,000 and $1,000 for each of the three months and six months ended March 31, 2009 and 2008, respectively, which is included in cost of software licenses and subscriptions.

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. If necessary, the Company would provide for the estimated cost of warranties based on specific warranty claims and claim history. However, the Company has never incurred significant expense under its product or service warranties. As a result, the Company believes the estimated fair value of these warranty agreements is minimal. Accordingly, there are no liabilities recorded for warranty claims as of March 31, 2009.

The Company is required by a sublease agreement related to its Chelmsford, Massachusetts facility to provide a letter of credit in the amount of approximately $107,000 as a security deposit to the landlord of amounts due under the lease as of March 31, 2009. Cash on deposit providing security in the amount of this letter of credit is classified as restricted cash in the Company’s condensed consolidated balance sheets in the amount of $107,000 and $125,000 as of March 31, 2009 and September 30, 2008, respectively.

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The Company enters into indemnification agreements in the ordinary course of business. Pursuant to these agreements, the Company agrees to indemnify, hold harmless, and reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally its customers, in connection with any patent, copyright or other intellectual property infringement claim by any third party with respect to the Company’s products. The term of these indemnification agreements is generally perpetual. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited. The Company has never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the Company believes the estimated fair value of these agreements is minimal. Accordingly, the Company has no liabilities recorded for these agreements as of March 31, 2009.

Certain of the Company’s agreements also provide for the performance of services at customer sites. These agreements may contain indemnification clauses, whereby the Company will indemnify the customer from any and all damages, losses, judgments, costs and expenses for acts of its employees or subcontractors resulting in bodily injury or property damage. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company has general and umbrella insurance policies that would enable it to recover a portion of any amounts paid. The Company has never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the Company believes the estimated fair value of these agreements is minimal. Accordingly, the Company has no liabilities recorded for these agreements as of March 31, 2009.

As permitted under Delaware law, the Company has agreements with its directors whereby the Company will indemnify them for certain events or occurrences while the director is, or was, serving at the Company’s request in such capacity. The term of the director indemnification period is for the later of ten years after the date that the director ceases to serve in such capacity or the final termination of proceedings against the director as outlined in the indemnification agreement. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company’s director and officer insurance policy would enable it to recover a portion of any future amounts paid. As a result of its insurance policy coverage, the Company believes the estimated fair value of these indemnification agreements is minimal. The Company has no liabilities recorded for these agreements as of March 31, 2009.

LIQUIDITY AND CAPITAL RESOURCES

Management believes that its current cash balances and cash generated from operations will be sufficient to meet the Company’s cash needs for working capital and anticipated capital expenditures for at least the next twelve months. At March 31, 2009, the Company had $5,128,000 of cash and equivalents, an increase of $243,000 from September 30, 2008.

At March 31, 2009, the Company had working capital of approximately $1,402,000 as compared to working capital of $1,130,000 at September 30, 2008. The Company expects cash flows from operations to remain positive as it anticipates continued profitability during the fiscal year ended September 30, 2009. However, if the Company’s cash flow from operations were to decline significantly, it may need to consider further reductions to its operating expenses. The Company does not anticipate additional cash requirements to fund significant growth or the acquisition of complementary technology or businesses. However, if in the future, such expenditures are anticipated or required, the Company may need to seek additional financing by issuing equity or obtaining credit facilities to fund such requirements.

The Company had net loss of approximately ($5,469,000) for the six months ended March 31, 2009 which was the result of a non-cash charge of $6.4 million related to the impairment of goodwill and a trademark, as compared to net income of approximately $330,000 for the six months ended March 31, 2008. During the six months ended March 31, 2009 and 2008, approximately $1,399,000 and $282,000, respectively, of cash was provided by the Company’s operations. During the six months ended March 31, 2009, the main source of cash from operations was the adjustment to net loss adjusted for a non-cash charge of $6.4 million related to the impairment of goodwill and a trademark, depreciation and amortization as well as a decrease in accounts

 

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receivable offset by a decrease in current liabilities.

Net cash used in investing activities for the six months ended March 31, 2009 of $609,000 is primarily related to capitalization of software expense and the purchase of property and equipment.

The Mergence purchase agreement dated August 11, 2004 includes a provision for quarterly cash payments to the former Mergence shareholders equal to 10% of revenue, as defined, of the Datawatch Researcher product for a period of six years. As the cash payments are based on recognized revenue and no minimum payments are required, they are not expected to have a significant impact on the Company’s liquidity or cash flows. See the section titled “Off Balance Sheet Arrangements, Contractual Obligations and Contingent Liabilities and Commitments” included elsewhere herein for a more complete disclosure of the Company’s commitments and contingent liabilities.

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

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