UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549





FORM 10-K





ý
            ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2009
      OR





o
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM
                              
      TO





COMMISSION
FILE NUMBER: 000-19960





DATAWATCH
CORPORATION


(Exact
name of registrant as specified in its charter)





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





271
MILL ROAD


QUORUM
OFFICE PARK


CHELMSFORD,
MASSACHUSETTS 01824


(978)
441-2200


(Address
and telephone number of principal executive office)





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


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


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





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.  Yes o   No  ý





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





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 ý     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   o    No
  o





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.    ý





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 definitions 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  ý





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





The
aggregate market value of voting stock held by non-affiliates of the registrant,
based on the closing price of the registrant’s common stock on March 31, 2009,
the last business day of the Company’s most recently completed second fiscal
quarter, as reported by the NASDAQ Capital Market was $6,002,410.





The
number of shares of the registrant’s common stock, $.01 par value, outstanding
as of December 14, 2009 was 5,925,839.





Documents
Incorporated By Reference





Registrant
intends to file a definitive Proxy Statement pursuant to Regulation 14A within
120 days of the end of the fiscal year ended September 30,
2009.  Portions of such Proxy Statement are incorporated by reference
in Part III of this report.















DATAWATCH
CORPORATION


ANNUAL
REPORT ON FORM 10-K





TABLE
OF CONTENTS





Page


Part IItem
      1.
            Business
            3Item
      1A.
            Risk
      Factors
            8Item
      1B.
            Unresolved
      Staff Comments
            12Item
      2.
            Properties
            13Item
      3.
            Legal
      Proceedings
            13Item
      4.
            Submission
      of Matters to a Vote of Security Holders
            13Part IIItem
      5.
            Market
      for Registrant’s Common Equity and Related Shareholder
    Matters
            15Item
      6.
            Selected
      Consolidated Financial Data
            15Item
      7.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            16Item
      7A.
            Quantitative
      and Qualitative Disclosures about Market Risk
            30Item
      8.
            Financial
      Statements and Supplementary Data
            31Item
      9.
            Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
            55Item
      9A
            Controls
      and Procedures
            55Item
      9B.
            Other
      Information
            56Part IIIItem
      10.
            Directors
      and Executive Officers of the Registrant
            57Item
      11.
            Executive
      Compensation
            57Item
      12.
            Security
      Ownership of Certain Beneficial Owners and Management
            57Item
      13.
            Certain
      Relationships and Related Transactions
            57Item
      14.
            Principal
      Accounting Fees and Services
            57Part IVItem
      15.
            Exhibits
      and Financial Statement Schedules
            58




- 2
-


PART I





Item
1.  BUSINESS





GENERAL





Datawatch
Corporation (the “Company” or “Datawatch”), a leader in Business Intelligence
(“BI”) and Enterprise Information Management (“EIM”), helps companies make
better decisions and solve business problems by simplifying access to and
analysis of information. Unique among BI vendors, Datawatch transforms the
massive amounts of data and documents generated inside or outside a company into
actionable insight, without any changes needed to existing systems. Datawatch
customers benefit from the right information, in the right context, at the right
time. More than 40,000 organizations worldwide have purchased Datawatch products
including its market-leading Monarch report and data mining solutions. Founded
in 1985, Datawatch is based in Chelmsford, Massachusetts with offices in London,
Sydney and Manila.





The
Company is a Delaware corporation with executive offices located at 271 Mill
Road, Quorum Office Park, Chelmsford, MA 01824 and the Company’s telephone
number is (978) 441-2200.  Periodic reports, proxy statements and
other information are available to the public, free of charge, on the Company’s
website, www.datawatch.com, as
soon as reasonably practicable after they have been filed with the SEC and
through the SEC’s website, www.sec.gov. Such
reports, proxy statements and other information may be obtained by visiting the
Public Reference Room of the SEC at 100 F Street, N.E., Washington, DC 20549 or
by calling the SEC at 1-800-SEC-0330.





PRODUCTS





MonarchTM – Datawatch is best known for
its market-leading desktop report mining and business intelligence application
called Monarch. More than 400,000 copies of Monarch have been licensed, with
localized versions in English, French and German. Monarch transforms structured
text files (reports, statements, etc.) into a live database that users can sort,
filter, summarize, graph and export to other applications such as Microsoft
Corporation’s Excel or Access. Monarch Professional Edition lets users extract
and work with data in PDF and HTML files, databases, spreadsheets and ODBC and
OLE DB sources as well as reports.  The Monarch product line
represented approximately 51% of total revenues for the fiscal year
2009.





Monarch Data PumpTM – Monarch Data Pump provides
powerful information delivery and data extract, transform and load capabilities
in one automated solution, without programming. Combining Datawatch’s Monarch
Report Mining/Data Mining engine with the Microsoft.NET framework, Monarch Data
Pump delivers a highly scalable and easily administered solution to acquire,
combine, and segment customized data, and can deliver that data in a wide
variety of formats, on an automatic, scheduled basis. Monarch Data Pump
Professional Edition adds high-volume data production, remote web
administration, a web service interface and tight integration with Microsoft
SharePoint and Microsoft SQL Server 2005 Integration Services.





Monarch BI ServerTM – Monarch BI Server is an
out-of-the-box web-based BI solution developed specifically for small to medium
size businesses and individual departments of large businesses. By transforming
reports and other business documents stored in a central report warehouse on
demand into browser-based tables, summaries and charts or Excel spreadsheets,
Monarch BI Server allows organizations to fully leverage their investments in
existing reporting output and processes. Monarch BI Server delivers BI without
data marts or programming, little or no need for end user training and with
minimal support and administration requirements.





Monarch RMSTM – Monarch RMS (Report Mining
Server) is a web-based report mining and analysis solution that integrates with
any existing Enterprise Record Management document or content management
archiving solution including Datawatch BDS, IBM Content Manager OnDemand (CMOD)
and Hyland OnBase. Monarch RMS opens up the corporate data locked in stored,
static reports, enabling dynamic business-driven analysis of information in
users’ web browsers or favorite productivity tools with no
programming.





- 3
-


Datawatch ESTM– Datawatch ES (Enterprise
Server) is an enterprise Business Intelligence system that provides web-enabled
report management, mining and distribution as well as data analysis and MS Excel
integration, at a fraction of the complexity and cost of traditional BI
solutions. Datawatch ES allows organizations to quickly and easily deliver
business intelligence and decision support, derived from existing reporting
systems and other database sources, with no new programming or report writing.
Datawatch ES automatically stores report data in an enterprise report and
document warehouse and provides users a unified point of entry to view, analyze
and share information over the Internet. Designed to be scalable through
thousands of users, Datawatch ES offers powerful additional features including
dynamic on-line analytical process-type tools, XML forms generation,
collaboration and subscription capabilities, and live linking of report and
database information. The Datawatch ES product line represented approximately
10% of total revenues for fiscal year 2009.





Datawatch BDSTM–Datawatch BDS (Business
Document Server) is a high speed, high volume document archive system, storing
text as wellas
images, intelligent data streams and unstructured content, complete with file
compression and encryption. Datawatch BDS is capable of enabling thousands of
end users to access and retrieve stored documents in a matter of seconds via the
network or web. Datawatch BDS also offers optional advanced business modules
including e-Notify for automatic email notification to end users of newly
archived documents, Datawatch BDS Workflow for web-enabled enterprise business
process management, Monarch RMS for web-enabled transformation of business
documents into customized data for easy analysis and Datawatch BDS Records
Management for the ability to organize and process documents and other content
within a regulatory compliant plan. The Datawatch BDS product line represented
approximately 17% of total revenues for fiscal year 2009.





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





Visual InsightTM–Visual Insightis a highly customizable
performance management solution that can provide Key Performance Indicator
reporting, as well as workflow and knowledge base portals. Built on a .NET
platform, Visual Insight not only delivers performance management, but actually
facilitates performance improvement. Visual Insight is available as a web-based
business data and information management server Software Development
Kit.





Visual QSMTM – Visual QSM is a
Web-enabled IT service management system that scales from a basic help desk
system to a full business management solution that incorporates workflow and
network management capabilities and provides web access to multiple databases
while enabling customers to interact via a standard browser.  Visual
QSM also provides advanced service level management capabilities, integrated
change management features, business process automation tools and one of the
industry’s easiest to learn and use interfaces.  The Visual QSM
product line represented approximately 11% of total revenues for fiscal year
2009.





Visual Help DeskTM – Visual Help Desk
(“Visual HD”) leverages the IBM Lotus Domino platform to provide a 100%
web-based help desk and call center solution. Cost effective and easy to deploy,
Visual HD is an enterprise-wide support solution that supports an organization’s
existing IT infrastructure. Visual HD has the additional ability to utilize
XML-based Web Services as well as the ability to integrate directly with IBM
enterprise applications.





VorteXMLTM - VorteXML software
quickly and easily converts any structured text output generated from any system
into valid XML for web services and more using any DTD or XDR schema without
programming.  VorteXML dramatically speeds up and reduces the cost of
enabling current applications for web services, implementing enterprise XML
solutions, putting legacy output on the web (including bill presentment) and
more.





- 4
-


The
VorteXML solution suite is comprised of two software products that work
together: VorteXML Designer, a desktop tool that provides users a visual
interface that allows users to extract, transform and map data from existing
text documents into XML without programming; and VorteXML Server,a scalable, high-volume
server that automates the extraction and conversion of text documents into
XML.





Datawatch DashboardsTM -
Datawatch Dashboards is a fully interactive dashboard solution that gives all
levels of users a visual overview of operational performance as well as the
ability to monitor specific business processes and events. Utilizing information
from existing databases (in real time if so desired) and other sources of data
including Excel and reports, Datawatch Dashboards allows users to visualize data
in over 50 eye-catching graphical chart types in a web browser. Users from
senior level executives to operational staff can easily assess results, identify
trends, reveal issues and rapidly initiate appropriate actions with Datawatch
Dashboards.





The
Company also receives license royalties for its iMergence iStore product
primarily from a provider of services to the financial services industry.
iMergence iStore is a report management solution which manages
computer-generated reports, mines the data contained in them, and allows users
to interactively merge and transform them into new reports.





The
Company has determined that it has only one operating segment. See Note 8 to the
Company’s Consolidated Financial Statements for information about the Company’s
revenue by product line and geographic operations.





PRICING





The
Company’s desktop products are sold under single and multi-user licenses. A
single user license for Monarch Standard Edition is priced at $699. A single
user license for Monarch Professional Edition is priced at $849. Monarch Data
Pump is priced at $8,995 per server for the Standard Edition and $24,995 for the
Professional Edition. A single user license for VorteXML Designer is priced at
$499 and VorteXML Server is priced at $8,995 per server.





The
Company’s enterprise business intelligence, content management and service
management products are primarily sold under server-based licenses with
named-user and concurrent-user client licenses. The base prices for Datawatch
Dashboards and Monarch BI Server are $9,995 and $10,995, respectively.
Entry-level Datawatch ES and Datawatch BDS systems are priced at $30,000.
Entry-level Visual QSM and Visual Insight systems are priced at approximately
$25,000. An entry-level Monarch RMS system is priced at $15,000. An entry level
Datawatch MailManager system is priced at $12,000. An entry-level Visual HD
system is priced for less than $10,000. All of the above systems with the
exception of Monarch BI Server can cost significantly more depending on the
number of software modules, software server licenses and client end user
licenses sold and the amount of professional services and maintenance
included.





MARKETING
AND DISTRIBUTION





Datawatch
sells its products through a variety of channels including directly to customers
through its own internal and external sales force as well as through a variety
of value-added partners, system integrators, distributors and national resellers
in order to gain broad market exposure and to satisfy the needs of its
customers.





The
Company is engaged in active sales of its products to end-users, including
repeat and add-on sales to existing customers and sales to new
customers.  Datawatch utilizes direct mail, the Internet,
telemarketing and direct personal selling to generate its sales.





Datawatch
uses a variety of marketing programs to create demand for its products. These
programs include advertising, cooperative advertising with reseller partners,
direct mail, exhibitor participation in industry shows, executive participation
in press briefings, Internet-based marketing and on-going communication with the
trade press.





- 5
-


The
Company offers selected distributors the ability to return obsolete versions of
its products and slow-moving products for credit. Based on its historical
experience relative to products sold to these distributors, the Company believes
that its exposure to such returns is minimal. It has provided a provision for
such estimated returns in the financial statements.





Datawatch
warrants the physical disk media and printed documentation for its products to
be free of defects in material and workmanship for a period of 30 days from the
date of purchase depending on the product.  Datawatch also offers a 30
day money-back guarantee on certain of its products sold directly to end-users.
Under the guarantee, customers may return purchased products within the 30 day
period for a full refund if they are not completely satisfied. To date, the
Company has not experienced any significant product returns under its money-back
guarantee.





During
fiscal 2009, 2008 and 2007, one distributor, Ingram Micro Inc., represented
approximately 17%, 21% and 15%, respectively, of the Company’s total revenue.
During fiscal 2009, 2008 and 2007, another distributor, Tech Data Corporation,
represented approximately 7%, 8%, and 13%, respectively, of the Company’s total
revenue. No other customer accounted for more than 10% of the Company’s total
revenue in fiscal 2009, 2008 or 2007. Datawatch’s revenues from outside of the
U.S. are primarily the result of sales through the direct sales force of its
wholly-owned subsidiary, Datawatch International Limited and its subsidiaries
(“Datawatch International”) and through international resellers. Such
international sales (which are primarily in the UK) represented approximately
23%, 30% and 31% of the Company’s total revenue for fiscal 2009, 2008 and 2007,
respectively.





RESEARCH
AND DEVELOPMENT





The
Company believes that timely development of new products and enhancements to its
existing products is essential to maintain strong positions in its markets.
Datawatch intends to continue to invest significant amounts in research and
product development to ensure that its products meet the current and future
demands of its markets as well as to take advantage of evolving technology
trends.





Datawatch’s
product development efforts are conducted through in-house software development
engineers and by external developers. External developers are compensated
through royalty payments based on product sales levels achieved or under
contracts based on services provided. Datawatch has established long-term
relationships with several development engineering firms, providing flexibility,
stability and reliability in its development process.





Datawatch’s
product managers work closely with developers, whether independent or in-house,
to define product specifications.  The initial concept for a product
originates from this cooperative effort.  The developer is generally
responsible for coding the development project. Datawatch’s product managers
maintain close technical control over the products, giving the Company the
freedom to designate which modifications and enhancements are most important and
when they should be implemented.  The product managers and their staff
work in parallel with the developers to produce printed documentation, on-line
help files, tutorials and installation software. In some cases, Datawatch may
choose to subcontract a portion of this work on a project basis to third-party
suppliers under contracts. Datawatch personnel also perform extensive quality
assurance testing for all products and coordinate external beta test
programs.





An
existing agreement between Datawatch and Math Strategies grants the Company
exclusive worldwide rights to use and distribute certain intellectual property
owned by Math Strategies and incorporated by the Company in its Monarch, Monarch
Data Pump and certain other products. In February 2006, the Company extended its
exclusive worldwide distribution rights with Math Strategies for the technology
used in the development of Monarch products until April 30, 2015. In addition,
an amendment to the purchase option contract with Math Strategies, originally
signed on April 29, 2004, gives Datawatch the option to purchase the
intellectual property rights to the software source code and any existing
patents at any time before April 30, 2015. This option, if exercised, would
provide the Company with increased flexibility to utilize the purchased
technology in the future.





- 6
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Other
Datawatch products have been developed through in-house software development or
by independent software engineers hired under contract. Datawatch maintains
source code and full product control for these products, which include Datawatch
BDS, Datawatch ES, Monarch BI Server, Visual QSM, and Visual HD products.
Datawatch BDS, Datawatch ES, Monarch BI Server, Visual QSM, and Visual HD are
trademarks of Datawatch Corporation. Visual Help Desk is a registered trademark
of Auxilor, Inc. (“Auxilor”), a wholly-owned subsidiary of Datawatch
Corporation.





During
fiscal 2004, the Company acquired Mergence Technologies Corporation which had a
branch software development and testing office in the Philippines. Mergence,
which was renamed Datawatch Technologies Corporation coincident with the
acquisition, developed the iMergence iStore and Visual Insight products at its
facilities in the United States and the Philippines prior to the acquisition.
The Company has integrated the Philippines development branch as an alternative
development facility for its other enterprise products.  iMergence is
a registered trademark of Datawatch Corporation.





During
fiscal 2006, the Company acquired the Integrated Document Archiving and
Retrieval Systems (“IDARS”) business from ClearStory Systems, Inc., including
Radiant Business Document Server, which was renamed Datawatch BDS, and Radiant
MailManager which was renamed Datawatch MailManager.





The
Company’s total research and development expense was $2,433,000, $2,966,000 and
$2,951,000 for fiscal years 2009, 2008 and 2007, respectively.





BACKLOG





The
Company’s software products are generally shipped within three business days of
receipt of an order.  Accordingly, the Company does not believe that
backlog for its products is a meaningful indicator of future business. The
Company does maintain a backlog of services primarily related to its Datawatch
BDS, Datawatch ES, Visual QSM, and Visual HD business. While this services
backlog will provide future revenue to the Company, the Company believes that it
is not a meaningful indicator of future business.





COMPETITION





The
software industry is highly competitive and is characterized by rapidly changing
technology and evolving industry standards. Datawatch competes with a number of
companies including Actuate Corporation, IBM, Microsoft Corporation, ASG
Software Solutions and others that have substantially greater financial,
marketing and technological resources than the Company. Competition in the
industry is likely to intensify as current competitors expand their product
lines and as new competitors enter the market.





PRODUCT
PROTECTION





In
addition to having certain patents pending on its software technologies,
Datawatch relies on a combination of trade secret, copyright and trademark laws,
nondisclosure and other contractual agreements, and technical measures to
protect its rights in its products.  Despite these precautions,
unauthorized parties may attempt to copy aspects of Datawatch’s products or to
obtain and use information that Datawatch regards as
proprietary.  Datawatch believes that, because of the rapid pace of
technological change in the software industry, the legal protections for its
products are less significant than the knowledge, ability and experience of its
employees and developers, the frequency of product enhancements and the
timeliness and quality of its support services.  Datawatch believes
that none of its products, trademarks, patents, and other proprietary rights
infringes on the proprietary rights of third parties, but there can be no
assurance that third parties will not assert infringement claims against it or
its developers in the future or that products developed by third parties do not
infringe on other parties’ proprietary rights.





PRODUCTION





Production
of Datawatch’s products involves the duplication of compact disks and the
printing of user





- 7
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manuals,
packaging and other related materials. High volume compact disk duplication is
performed by non-affiliated subcontractors, while low volume compact disk
duplication is performed in-house. Printing work is also performed by
non-affiliated subcontractors. To date, Datawatch has not experienced any
material difficulties or delays in production of its software and related
documentation and believes that, if necessary, alternative production sources
could be secured at a commercially reasonable cost.





EMPLOYEES





As of
December 14, 2009, Datawatch had 98 full-time and 3 contract, temporary or
part-time employees, including 26 engaged in marketing, sales, and customer
service; 32 engaged in product consulting, training and technical support; 25
engaged in product management, development and quality assurance; and 18
providing general, administrative, accounting, IT and software production and
warehousing functions.






Item 1A.  RISK
FACTORS





The
Company does not provide forecasts of its future financial performance. However,
from time to time, information provided by the Company or statements made by its
employees may contain “forward looking” information that involves risks and
uncertainties. In particular, statements contained in this Annual Report on
Form 10-K that are not historical facts (including, but not limited to
statements contained in “Item 7.  Management’s Discussion and Analysis
of Financial Condition and Results of Operations” of Part II of this Annual
Report on Form 10-K relating to liquidity and capital resources) may
constitute forward looking statements and are made under the safe harbor
provisions of The Private Securities Litigation Reform Act of 1995. The Company
cautions readers not to place undue reliance on any such forward
looking-statements, which speak only as of the date they are made. The Company
disclaims any obligation, except as specifically required by law and the
rules of the Securities and Exchange Commission, to publicly update or
revise any such statements to reflect any change in the Company’s expectations
or in events, conditions or circumstances on which any such statements may be
based, or that may affect the likelihood that actual results will differ from
those set forth in the forward-looking statements. The Company’s actual results
of operations and financial condition have varied and may in the future vary
significantly from those stated in any forward looking
statements.  Factors that may cause such differences include, without
limitation, the risks, uncertainties and other information discussed below and
within this Annual Report on Form 10-K, as well as the accuracy of the
Company’s internal estimates of revenue and operating expense levels. The
following discussion of the Company’s risk factors should be read in conjunction
with the financial statements contained herein and related notes thereto. Such
factors, among others, may have a material adverse effect upon the Company’s
business, results of operations and financial condition.





World Wide Recession and
Softening in the Computer Software Market May Result in Decreased Revenues
or Lower Revenue Growth Rates




The
profitability of the Company’s business depends on the overall demand for
computer software and services, particularly in the financial services markets
and other markets in which it competes. The worldwide recession, resulting in
tighter credit and negative financial news may continue to have an adverse
affect on the market for computer software and result in significant
fluctuations in the value of foreign currencies. Because the Company’s sales are
primarily to major corporate customers, poor economic conditions may continue to
soften the demand for computer software and services which may result in
decreased revenues, lower revenue growth rates and reduced profitability. In
addition, a weak global economy may result in longer sales cycles, reduced,
deferred or cancelled orders, or greater than anticipated uncollectible accounts
receivables. In a weakened economy, the Company cannot be assured that it will
be able to effectively promote future growth in its software and services
revenues or maintain profitability.





Furthermore,
terrorist attacks against the United States, and the United States military
response to these attacks have added to economic and political uncertainty which
may adversely affect worldwide demand for computer software and
services.





- 8
-


Dependence on Principal
Products




In the
year ended September 30, 2009, Monarch, Datawatch BDS, Visual QSM, and
Datawatch ES accounted for approximately 51%, 17%, 11% and 10%, respectively, of
the Company’s total revenue. The Company is primarily dependent on its Monarch,
Datawatch BDS, Visual QSM and Datawatch ES products. As a result, any factor
adversely affecting sales of any of these products could have a material adverse
effect on the Company. The Company’s future financial performance will depend in
part on the successful introduction of its new and enhanced versions of these
products and development of new versions of these and other products and
subsequent acceptance of such new and enhanced products. In addition,
competitive pressures or other factors may result in significant price erosion
that could have a material adverse effect on the Company’s business, financial
condition, results of operations, or cash flows.





Fluctuations in Quarterly
Operating Results




The
Company’s future operating results could vary substantially from
quarter-to-quarter because of uncertainties and/or risks associated with such
things as current economic conditions, technological change, competition, delays
in the introduction of products or product enhancements and general market
trends. Historically, the Company has operated with minimal backlog of orders
because its software products are generally shipped as orders are received. As a
result, net sales in any quarter are substantially dependent on orders booked
and shipped in that quarter. Further, any increases in sales under the Company’s
subscription sales model could result in decreased revenues over the short term.
Because the Company’s staffing and operating expenses are based on anticipated
revenue levels and a high percentage of the Company’s costs are fixed in the
short-term, small variations in the timing of revenues can cause significant
variations in operating results from quarter-to-quarter. Because of these
factors, the Company believes that period-to-period comparisons of its results
of operations are not necessarily meaningful and should not be relied upon as
indications of future performance. The Company can give no assurance that it
will not experience such variations in operating results in the future or that
such variations will not have a material adverse effect on its business,
financial condition or results of operations.





Dependence on New
Introductions; New Product Delays




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





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





Volatility of Stock
Price




As seen
recently with the turmoil in the financial markets, and is frequently the case
with the stocks of high technology companies, the market price of the Company’s
common stock has been, and may continue to be, volatile. Factors such as
quarterly fluctuations in results of operations, increased competition, the
introduction of new products by the Company or its competitors, expenses or
other difficulties associated with assimilating





- 9
-


companies
acquired by the Company, changes in the mix of sales channels, the timing of
significant customer orders, and macroeconomic conditions generally, may have a
significant impact on the market price of the stock of the Company. Any
shortfall in revenue or earnings from the levels anticipated by securities
analysts could have an immediate and significant adverse effect on the market
price of the Company’s common stock in any given period. In addition, the stock
market has from time to time experienced extreme price and volume fluctuations,
which have particularly affected the market price for many high technology
companies and which, on occasion, have appeared to be unrelated to the operating
performance of such companies. Finally, to maintain its stock listing with
Nasdaq, the Company must be in compliance with Nasdaq Marketplace Rules,
including but not limited to, minimum bid price requirements. If it is not able
to maintain compliance with these rules, and if the Company’s common stock does
not qualify for, or is subsequently delisted from the Nasdaq Capital Market,
investors may have difficulty converting their investment into cash
efficiently. The price of the Company’s common stock and the ability of
holders to sell such stock would be adversely affected.





International
Sales




In the
years ended September 30, 2009, 2008 and 2007, international sales
accounted for approximately 23%, 30% and 31%, respectively, of the Company’s
total revenue. The Company anticipates that international sales will continue to
account for a significant percentage of its total revenue. A significant portion
of the Company’s total revenue will therefore be subject to risks associated
with international sales, including further deterioration of international
economic conditions, unexpected changes in legal and regulatory requirements,
changes in tariffs, currency exchange rates and other barriers, political and
economic instability, possible effects of war and acts of terrorism,
difficulties in account receivable collection, difficulties in managing
distributors or representatives, difficulties in staffing and managing
international operations, difficulties in protecting the Company’s intellectual
property overseas, seasonality of sales and potentially adverse foreign tax
consequences.





Acquisition
Strategy




The
Company continues to address the need to develop new products, in part, through
the acquisition of other companies including its May 2006 acquisition of the
IDARS business from ClearStory Systems, Inc., its August 2004 acquisition
of Mergence Technologies Corporation and its October 2002 acquisition of
Auxilor, Inc. Acquisitions involve numerous risks including difficulties in the
assimilation of the operations, technologies and products of the acquired
companies, the diversion of management’s attention from other business concerns,
risks of entering markets in which the Company has no or limited direct prior
experience and where competitors in such markets have stronger market positions,
and the potential loss of key employees of the acquired
company.  Achieving and maintaining the anticipated benefits of an
acquisition will depend in part upon whether the integration of the companies’
business is accomplished in an efficient and effective manner, and there can be
no assurance that this will occur. The successful combination of companies in
the high technology industry may be more difficult to accomplish than in other
industries.





Limitations on Effectiveness
of Controls




The
Company’s management, including the Chief Executive Officer and President and
the Chief Financial Officer, does not expect that its internal controls will
prevent all errors and intentional misrepresentations. A control system, no
matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further,
the design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no evaluation
of controls can provide absolute assurance that all control issues, if any,
within the Company have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty and that breakdowns
can occur because of simple error or mistake. Additionally, controls can be
circumvented by the individual acts of some persons, by collusion of two or more
people, or by management override of the control. The design of any system of
controls also is based in part upon certain assumptions about the likelihood of
future events, and no assurance can be given that any design will succeed in
achieving its stated goals under all potential future conditions; over time,
controls may become inadequate because of changes in conditions, or the degree
of compliance with the policies or procedures





- 10
-


may
deteriorate. Because of the inherent limitations in a cost-effective control
system, misstatements due to error or intentional conduct may occur and not be
detected.





Rapid Technological
Change




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





Competition in the Software
Industry




The
software market for personal computers is highly competitive and characterized
by continual change and improvement in technology. Several of the Company’s
existing and potential competitors, including Actuate Corporation, IBM,
Microsoft Corporation, ASG Software Solutions and others, have substantially
greater financial, marketing and technological resources than the
Company.  No assurance can be given that the Company will have the
resources required to compete successfully in the future.





Dependence on Proprietary
Software Technology




The
Company’s success is dependent upon proprietary software technology. Although
the Company does not own all patents on any such technology, it does hold
exclusive licenses to such technology and relies principally on a combination of
trade secret, copyright and trademark laws, nondisclosure and other contractual
agreements and technical measures to protect its rights to such proprietary
technology. Despite such precautions, there can be no assurance that such steps
will be adequate to deter misappropriation of such technology.





Reliance on Software License
Agreements




A
majority of the Company’s products incorporate third-party proprietary
technology which is generally licensed to the Company on an exclusive, worldwide
basis. Failure by such third-parties to continue to develop technology for the
Company and license such technology to the Company could have a material adverse
effect on the Company’s business and results of operations.





Dependence on the Ability to
Hire and Retain Skilled Personnel




Qualified
personnel are in great demand throughout the software industry. The Company’s
success depends, in large part, upon its ability to attract, train, motivate and
retain highly skilled employees, particularly technical personnel and product
development and professional services personnel, sales and marketing personnel
and other senior personnel. The Company’s failure to attract and retain the
highly trained technical personnel that are integral to the Company’s product
development, professional services and direct sales teams may limit the rate at
which the Company can generate sales and develop new products or product
enhancements. A change in key management could result in transition and
attrition in the affected department. This could have a material adverse effect
on the Company’s business, operating results and financial
condition.





Evolving Regulation of
Corporate Governance and Public Disclosure May Result in Additional Expenses and
Continuing Uncertainty




Changing
laws, regulations and standards relating to corporate governance and public
disclosure, including the Sarbanes-Oxley Act of 2002 and related SEC regulations
as well as the listing standards of the NASDAQ Stock Market, have created and
are continuing to create uncertainty for public companies. The Company
continually evaluates and monitors developments with respect to new and proposed
rules and cannot predict or estimate the amount of the additional costs incurred
or the timing of such costs. These new or changed laws,





- 11
-


regulations
and standards are subject to varying interpretations, in many cases due to their
lack of specificity, and as a result, their application in practice may evolve
over time as new guidance is provided by regulatory and governing bodies. This
could result in continuing uncertainty regarding compliance matters and higher
costs necessitated by ongoing revisions to disclosure and governance practices.
The Company is committed to maintaining high standards of corporate governance
and public disclosure. As a result, the Company has invested resources to comply
with evolving laws, regulations and standards. This investment has and may
continue to result in increased general and administrative expenses and a
diversion of management time and attention from revenue-generating activities to
compliance activities. If the Company’s efforts to comply with new or changed
laws, regulations and standards differ from the activities intended by
regulatory or governing bodies due to ambiguities related to practice,
regulatory authorities may initiate legal proceedings against the Company and it
may be harmed.





Indirect Distribution
Channels




The
Company sells a significant portion of its products through distributors and
resellers, none of which are under the direct control of the Company. The loss
of major distributors or resellers of the Company’s products, or a significant
decline in their sales, could have a material adverse effect on the Company’s
operating results. There can be no assurance that the Company will be able to
attract or retain additional qualified distributors or resellers or that any
such distributors or resellers will be able to effectively sell the Company’s
products. The Company seeks to select and retain distributors and resellers on
the basis of their business credentials and their ability to add value through
expertise in specific vertical markets or application programming expertise. In
addition, the Company may rely on resellers to provide post-sales service and
support, and any deficiencies in such service and support could adversely affect
the Company’s business.





Sales Returns
Reserve




Revenue
from the Company’s sale of all software products (when separately sold) is
generally recognized at the time of shipment. The Company estimates and
maintains reserves for potential future product returns based on its experience
and history with the Company’s various distributors and resellers as well as by
monitoring inventory levels at such companies. While actual returns have
historically been within the range estimated by management, future actual
results could differ from the reserve for sales returns recorded, and this
difference could have a material effect on the Company’s financial position and
results of operations.





Subscription Sales Model
Risk




The
Company sells its enterprise products through the sale of perpetual licenses and
through a subscription pricing model. The subscription pricing model allows
customers to begin using the Company’s products at a lower initial cost of
software acquisition when compared to the more traditional perpetual license
sale. Although the subscription sales model is designed to increase the number
of enterprise solutions sold and also reduce dependency on short-term sales by
building a recurring revenue stream, it introduces increased risks for the
Company primarily associated with the timing of revenue recognition and reduced
cash flows. The subscription model delays revenue recognition when compared to
the typical perpetual license sale and also, as the Company allows termination
of certain subscriptions with 90 days notice, could result in decreased revenue
for solutions sold under the model if the Company experiences a high percentage
of subscription cancellations following the first 12 months of the
subscription.  Further, as amounts due from customers are invoiced
over the life of the subscription, there are delayed cash flows from
subscription sales when compared to perpetual license sales.






Item
1B.  UNRESOLVED STAFF COMMENTS





Not
applicable.





- 12
-


Item
2.  PROPERTIES





The
Company is currently headquartered in 14,683 square feet of leased office space
in Chelmsford, Massachusetts pursuant to a sublease agreement executed on
September 28, 2005. The sublease expires in June 2011. The sublease contains
annual rent escalations for each year of the sublease as well as an abatement of
rent during the first twelve months of the sublease term. The aggregate rent for
the remaining term of the sublease is approximately $304,000. In addition to
rent, the sublease requires the Company to pay certain taxes, insurance and
operating costs related to the leased facility based on the Company’s pro-rata
share of such costs. The Company is also responsible for the costs of certain
tenant improvements associated with the new facility but will be entitled to
reimbursement for certain of such costs from the sublessor.





The
Company also maintains international sales and administrative offices in the
United Kingdom and Australia. In addition, the Company maintains a software
development and testing facility in the Philippines.








Item 3.  LEGAL
PROCEEDINGS





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








Item
4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS





No
matters were submitted to a vote of the Registrant’s security holders during the
last quarter of the fiscal year covered by this report.





Executive
Officers of the Registrant





The
names, ages and titles of the executive officers of the Company as of December
15, 2009 are as follows:





Kenneth
      P. Bero
            
            55
            
            President,
      Chief Executive Officer and DirectorMurray
      P. Fish
            
            58
            
            Chief
      Financial Officer, Vice President of Finance, Treasurer and
              Assistant
      SecretaryJohn
      H. Kitchen, III
            
            54
            
            Chief
      Marketing Officer, Senior Vice President and SecretaryHarvey
      C. Gross
            
            60
            
            Vice
      President, Product Management and DevelopmentRobert
      W. Clemens
            
            52
            
            Vice
      President, Worldwide SalesDaniel
      F. Incropera
            
            45
            
            Corporate
      Controller & Vice President





Officers
are elected by, and serve at the discretion of, the Board of
Directors.





KENNETH P. BERO, President, Chief
Executive Officer and Director. Mr. Bero was appointed President and
Chief Executive Officer of the Company effective January 1, 2008. Prior thereto,
and since April 1, 2007, Mr. Bero held the position of Chief Operating Officer
& Senior Vice President of Sales. Previously, Mr. Bero had been Senior Vice
President of Enterprise Solutions. In April 2006, Mr. Bero joined the Company as
Vice President of Enterprise Sales for North America. Prior to joining
Datawatch, Mr. Bero served as Vice President, North American Channel Sales at
Business Objects S.A., an international provider of business intelligence
software and services. Previous roles include the position of Chief Operating
Officer and Executive Vice President of Sales and Marketing at NAVIDEC, a Nasdaq
listed software development and services company. Mr. Bero was also appointed a
Director of the Company effective October 19, 2007.





MURRAY P. FISH, Chief Financial
Officer, Vice President of Finance, Treasurer and Assistant
Secretary.  Mr. Fish was appointed Chief Financial
Officer, Vice President of Finance, Treasurer and Assistant Secretary on March
26, 2007. Prior to joining Datawatch, Mr. Fish served as Chief Financial
Officer of Cymfony, Inc., a





- 13
-


marketing
business intelligence company owned by TNS-MI.  From 2003 until 2005,
Mr. Fish was the principal consultant at M.P. Fish Associates, where he provided
financial consulting services to large public and private organizations. From
1998 until 2003, Mr. Fish was the Chief Financial Officer and a Director at
Network-1 Security Solutions, Inc., a Nasdaq listed software development and
services company.





JOHN H. KITCHEN, III, Chief
Marketing Officer, Senior Vice President and Secretary. Mr. Kitchen
was appointed Chief Marketing Officer & Senior Vice President effective
April 1, 2007. Prior thereto, and since July 2001, Mr. Kitchen held the position
of Senior Vice President of Desktop & Server Solutions. From July 2000
until July 2001, Mr. Kitchen was the Company’s Vice President of Marketing.
Prior to July 2000, and since March 1998, Mr. Kitchen was the
Company’s Director of Marketing. Prior to that, Mr. Kitchen was a marketing
consultant to the Company.





HARVEY C. GROSS, Vice President,
Product Management and Development. Mr. Gross was appointed Vice
President, Product Management and Development on October 1, 2008. Mr. Gross
joined the Company in February 2007. Prior to joining Datawatch, Mr. Gross was
the principal consultant at HG & Associates, a content management consulting
company serving a variety of companies in business, technology and the federal
government, and was a principal consultant at eVisory, a leading industry
consulting group. Other roles included Chief Technology Officer for Lason, Inc.,
an international business process outsourcing firm, Senior Vice President at
Virtual Image Technologies, Inc., a regional document management service
company, and Senior Vice President of Product Development at 360 Services,
Inc.





ROBERT W. CLEMENS, Vice President,
Worldwide Sales. Mr. Clemens was appointed Vice President of Worldwide
Sales on January 1, 2008. Mr. Clemens served as Vice President of North American
sales from April 2007 until December 2007. Prior to joining Datawatch, Mr.
Clemens was the Director of Sales at Zantaz, Vice President, Worldwide Sales at
GaleForce Solutions and Director of North American Channel Sales at Business
Objects. Mr. Clemens also served in a variety of executive and senior level
sales positions at companies such as NeTpower, Ashton-Tate/Borland and
more.





DANIEL F. INCROPERA, Corporate
Controller & Vice President.  Mr. Incropera was appointed
Corporate Controller & Vice President on September 7, 2007.  Mr.
Incropera has served as the Company’s Controller since October 2006. From 2003
until joining the Company, Mr. Incropera served as Controller of Pennichuck
Corporation, a publicly traded company that operates several water utility and
real estate investment subsidiaries.  From 2002 until 2003, Mr.
Incropera was the Assistant Controller at Concord Communications, Inc., a Nasdaq
listed software company which provided network service management
solutions.







- 14
-


PART II





Item
5.   MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED
SHAREHOLDER MATTERS





The
Registrant’s common stock is listed and traded on the Nasdaq Capital Market
(formerly the Nasdaq SmallCap Market) under the symbol DWCH.  The
range of high and low closing prices during each fiscal quarter for the last two
fiscal years is set forth below:





For
      the Year Ended
            
            Common
      StockSeptember 30,
      2009
            
            
            High
      ($)
            
            Low
      ($)4th
      Quarter
            
            2.77
            
            1.433rd
      Quarter
            
            1.97
            
            1.262nd
      Quarter
            
            1.93
            
            0.841st
      Quarter
            
            1.79
            
            0.90





For
      the Year Ended
            
            Common
      StockSeptember 30,
      2008
            
            
            High
      ($)
            
            Low
      ($)4th
      Quarter
            
            2.62
            
            1.323rd
      Quarter
            
            4.35
            
            2.342nd
      Quarter
            
            7.22
            
            3.101st
      Quarter
            
            7.68
            
            4.57





There
were 92 shareholders of record as of December 4, 2009.  The
Company believes that the number of beneficial holders of common stock is
approximately 1,600. The last reported sale of the Company’s common stock on
December 15, 2009 was at $2.41.





The
Company has not paid any cash dividends and it is anticipated that none will be
declared in the foreseeable future. The Company intends to retain future
earnings, if any, to provide funds for the operation, development and expansion
of its business.





The
information set forth under the caption “Equity Compensation Plans” appearing in
the Company’s definitive Proxy Statement for the Annual Meeting of Shareholders
for the fiscal year ended September 30, 2009 is incorporated herein by
reference.








Item
6.   SELECTED CONSOLIDATED FINANCIAL DATA





The
following table sets forth selected consolidated financial data of the Company
for the periods indicated.  The selected consolidated financial data
for and as of the end of the years in the five-year period ended
September 30, 2009 are derived from the Consolidated Financial Statements
of the Company.  The information set forth below should be read in
conjunction with “Management’s Discussion and Analysis of Financial Condition
and Results of Operations” and the Consolidated Financial Statements and notes
which appear elsewhere in this Annual Report on Form 10-K.




- 15
-


Statements
      of Operations Data:Years
      Ended September 30,
              
              2009
              
              
              2008
              
              
              2007
              
              
              2006
              
              
              2005(In
      thousands, except per share data)Revenue
              
              $
              19,618
              
              
              $
              23,030
              
              
              $
              25,259
              
              
              $
              20,811
              
              
              $
              21,511Costs
      and Expenses
              
              
              24,912
              
              
              
              22,531
              
              
              
              23,524
              
              
              
              21,345
              
              
              
              20,823Income
      (loss) from Operations
              
              
              (5,294
              )
              
              
              499
              
              
              
              1,735
              
              
              
              (534
              )
              
              
              688Net
      Income (Loss) (1)
              
              $
              (4,940
              )
              
              $
              717
              
              
              $
              1,669
              
              
              $
              (555
              )
              
              $
              800Earnings
      (Loss) per Common Share:Basic
      (1)
              
              $
              (0.83
              )
              
              $
              0.12
              
              
              $
              0.30
              
              
              $
              (0.10
              )
              
              $
              0.15Diluted
      (1)
              
              $
              (0.83
              )
              
              $
              0.12
              
              
              $
              0.29
              
              
              $
              (0.10
              )
              
              $
              0.14Balance
      Sheet Data:September 30,
              
              
              2009
              
              
              
              2008
              
              
              
              2007
              
              
              
              2006
              
              
              
              2005(In
      thousands)Total
      Assets
              
              $
              12,043
              
              
              $
              18,169
              
              
              $
              18,337
              
              
              $
              16,025
              
              
              $
              13,412Working
      Capital (Deficiency)
              
              
              2,627
              
              
              
              1,130
              
              
              
              (279
              )
              
              
              (2,465
              )
              
              
              3,487Long-Term
      Obligations
              
              
              482
              
              
              
              627
              
              
              
              448
              
              
              
              266
              
              
              
              -Shareholders’
      Equity
              
              
              5,166
              
              
              
              10,082
              
              
              
              9,020
              
              
              
              6,956
              
              
              
              7,306
  (1)
                Net
      income (loss) and earnings (loss) per common share for 2009 include the
      impact of the full impairment of goodwill andan
      indefinite lived trademark totaling $6,401,000. See Note 1. Nature of Business and Summary
      of Significant Accounting Policies,of
      Notes to Consolidated Financial Statements in Part II, Item 8 of this
      Report.








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





The
following discussion and analysis is qualified by reference to, and should be
read in conjunction with, the Consolidated Financial Statements of Datawatch and
its subsidiaries which appear elsewhere in this Annual Report on
Form 10-K.





GENERAL





Introduction





Datawatch
is engaged in the design, development, manufacture, marketing, and support of
business computer software primarily for the Business Intelligence and
Enterprise Information Management markets which include 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 products are Business Intelligence Solutions (including
Monarch, Monarch Data Pump, Monarch RMS, Monarch BI Server, Datawatch ES,
Datawatch Dashboards, Datawatch Researcher, Visual Insight, iMergence and
VorteXML), Content Management Solutions (including Datawatch BDS 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





- 16
-


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 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; 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 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. 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 fiscal years 2009, 2008 and 2007
subscription revenues were approximately $489,000, $600,000 and $649,000,
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 generally 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 40%, 41% and 39%, of total sales for fiscal years 2009, 2008 and
2007, respectively. Revenue from the sale of all software products (when
separately sold) 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 customarily defined. 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 may include software licenses, professional services and
post-contract customer support. In such multiple element arrangements, the
Company applies the





- 17
-


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
vendor specific objective evidence (“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 do
not involve modification or customization of the software or any other unusual
acceptance clauses or terms. Post-contract customer support is typically
provided under a maintenance agreement which provides technical support and
rights to unspecified software maintenance updates and bug fixes on a
when-and-if available basis. Revenue from post-contract customer support
services is deferred and recognized ratably over the contract period (generally
one year). Such deferred amounts are recorded as part of deferred revenue in the
Company’s Consolidated Balance Sheets included 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 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 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, BI Server and VorteXML sold 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.
Revenue from the sale of software products to distributors and resellers is
recognized at the time of shipment providing all other criteria for revenue
recognition as stated above are met and (i) the distributor or reseller is
unconditionally obligated to pay for the products, including no contingency as
to product resale, (ii) the distributor or reseller has independent
economic substance apart from the Company, (iii) the Company is not
obligated for future performance to bring about product resale, and
(iv) the amount of future returns can be reasonably estimated. The
Company’s experience and history with its distributors and resellers allows for
reasonable estimates of future returns. Among other things, estimates of
potential future returns are made based on the inventory levels at the various
distributors and resellers, which the Company monitors frequently. Once the
estimates of potential future returns from all sources are made, the Company
determines if it has adequate returns reserves to cover anticipated returns and
the returns reserve is adjusted as required. Adjustments are recorded as
increases or decreases in revenue in the period of adjustment. Actual returns
have historically been within the range estimated by the Company. The Company’s
returns reserves were $55,000 and $65,000 as of September 30, 2009 and
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 $160,000 and $171,000 as of September 30, 2009 and
2008, respectively.





- 18
-


Income
Taxes





The
Company has deferred tax assets primarily related to net operating loss
carryforwards and tax credits that expire at different times through and until
2028. At September 30, 2009, the Company had U.S. federal tax loss carryforwards
of approximately $6.5 million, expiring at various dates through 2028, including
$366,000 resulting from the Mergence acquisition undertaken during 2004 which
are subject to additional annual limitations as a result of the changes in
Mergence’s ownership, and had approximately $867,000 in state tax loss
carryforwards, which also expire at various dates through 2028. An alternative
minimum tax credit of approximately $166,000 is available to offset future
regular federal taxes. Research and development credits of approximately
$525,000 expire beginning in 2011. In addition, the Company has the following
foreign net operating loss carryforwards: United Kingdom losses of $8.5 million
with no expiration date and Australian losses of $2.7 million with no expiration
date.





Significant judgment is required in
determining the Company’s provision for income taxes, the carrying value of
deferred tax assets and liabilities and the valuation allowance recorded against
net deferred tax assets.  Factors such as future reversals of deferred
tax assets and liabilities, projected future taxable income, changes in enacted
tax rates and the period over which the Company’s deferred tax assets will be
recoverable are considered in making these determinations. Management does not
believe the deferred tax assets are more likely than not to be realized and
therefore a full valuation allowance has been provided against the deferred tax
assets at September 30, 2009 and 2008. 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 $5.4 million as of September 30, 2009. In relation to the
Company’s asset purchase of the IDARS business, the applicable goodwill
associated with this purchase was determined to be fully impaired and written
off for book purposes under generally accepted accounting principles during
fiscal year 2009 but is deductible over a 15 year life for tax reporting
purposes. Accordingly, upon impairment, the Company recorded a deferred tax
asset, with a corresponding full valuation allowance, for the future tax benefit
of the goodwill based on the Company’s effective tax rate for the period. Prior
to the full impairment assessment and write off of this goodwill, the Company
was recording, for each reporting period, deferred tax expense and an offsetting
deferred tax liability on the difference in tax amortization of intangibles with
indefinite lives for US GAAP purposes based on the Company’s effective tax rate
for the period. Deferred tax benefit recorded for the fiscal year 2009 was
approximately $266,000. Deferred tax expense recorded for the fiscal years ended
September 30, 2008 and 2007 was approximately $115,000 and $111,000,
respectively.





The
Company adopted the new accounting requirements for uncertain tax positions on
October 1, 2007. The comprehensive model addresses the financial statement
recognition, measurement, presentation and disclosure of uncertain tax positions
taken or expected to be taken in income tax returns. In accordance with these
requirements, 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 positions 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.


Upon
adoption of the accounting requirements for uncertain tax positions, the Company
recorded a reduction of its deferred tax asset in the amount of $690,000 and a
corresponding reduction to the tax asset valuation reserve
 
 - 19
-
 of
$690,000 for all identified uncertain tax positions, for any years open under
the statute of limitations. At that time, the Company also recorded a $75,000
tax liability fully related to foreign tax exposure. During each of the fiscal
years ended September 30, 2008 and 2009, the Company increased its tax liability
by $25,000, resulting in a cumulative tax liability of $125,000 at September 30,
2009. These amounts have been recorded as an increase to other long-term
liabilities on the Company’s Consolidated Balance Sheets.





Capitalized Software
Development Costs





The
Company capitalizes certain software development costs as well as purchased
software upon achieving technological feasibility of the related products.
Software development costs incurred and software purchased prior to achieving
technological feasibility are charged to research and development expense as
incurred.  Commencing upon initial product release, capitalized costs
are amortized to the cost of software licenses using the straight-line method
over the estimated life 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 18 to 36
months. The net amount of capitalized software development costs and purchased
software was approximately $1,106,000 and $664,000 at September 30, 2009
and 2008, respectively. During fiscal 2009, the Company capitalized
approximately $831,000 of software development costs related to new products in
development.





Goodwill, Other Intangible
Assets and Other Long-Lived Assets





The
Company concluded based on an impairment analysis conducted at March 31, 2009
that its goodwill was fully impaired, as described below. The Company generally
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. To the extent
goodwill exists, the annual impairment analysis is performed on May 31’st of
each applicable fiscal year. Factors the Company considers important in
determining whether to conduct an interim 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 our market capitalization
below the recorded amount of our net assets for a sustained period.





Other
intangible assets consist of internally developed software costs, acquired
technology, patents, customer lists, trademarks, and non-compete agreements
acquired through business combinations. The values allocated to these intangible
assets are amortized using the straight-line method over the estimated useful
life of the related asset. The Company reviews other intangible assets and other
long-lived assets whenever an indication of potential impairment exists, such as
a significant reduction in cash flows associated with the assets. Should the
fair value of the Company’s long-lived assets decline because of reduced
operating performance, market declines, or other indicators of impairment, a
charge to operations for impairment may be necessary. No impairment charges were
taken for amortizing intangible assets during fiscal year 2009.





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 due to uncertainties surrounding the global economy and the
volatility in the Company’s stock price. The Company tested goodwill for
impairment using a two-step approach. The first step was to compare the fair
value of the Company (which consists of one 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 estimated 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 used
future estimated operating results and cash flows that were discounted using a
weighted-average cost of capital that reflected current market conditions. These
projections utilized 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





- 20
-


margins
and cash expenditures. Other significant estimates and assumptions included
terminal value growth rates, future estimates of capital expenditures and
changes in future working capital requirements. The Company validated its
estimates of fair value under the income approach by comparing the values to
fair value estimates using a market approach. The market approach estimated fair
value by applying cash flow multiples to the reporting unit’s operating
performance. The multiples were derived from comparable publicly traded
companies with similar operating and investment characteristics of the reporting
unit.





The
results of the Company’s 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 tested its indefinite lived intangible asset for impairment by comparing
the fair value to the net book value of the asset. The Company estimated the
fair value of its trademark using the relief-from-royalty method, which required
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 the 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 generally
accepted accounting principles which require that all share-based awards,
including grants of employee stock options, be recognized in the financial
statements based on their fair value.





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 fiscal year ended September 30, 2009, the Company recorded
stock-based compensation expense of approximately $213,000. In order to
determine the fair value of stock options on the date of grant, the Company
applies the Black-Scholes option-pricing model. Inherent in this model are
assumptions related to expected stock-price volatility, option life, risk-free
interest rate and dividend yield. While the risk-free interest rate and dividend
yield are less subjective assumptions, typically based on factual data derived
from public sources, the expected stock-price volatility and option life
assumptions require a greater level of judgment which makes them critical
accounting estimates.





The
Company uses an expected stock-price volatility assumption that is based on
historical volatilities of the underlying stock which are obtained from public
data sources. The Company believes this approach results in a reasonable
estimate of volatility. For stock option grants issued during the fiscal year
ended September 30, 2009, the Company used an expected stock-price volatility of
73% based upon the historical volatility at the time of issuance.





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. For stock option grants issued during the year ended September 30, 2009,
the Company used an expected option life assumption of 5 years.





With
regard to the forfeiture rate assumption, the Company reviews historical
voluntary turnover rates. For stock option grants issued during the fiscal year
ended September 30, 2009, the Company used an annual estimated forfeiture rate
of 10%. 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.




- 21
-


RESULTS
OF OPERATIONS





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




Year
      Ended September 30,2009
              
              
              2008
              
              
              2007REVENUE:Software
      licenses and subscriptions
              
              
              55.7
              %
              
              
              54.0
              %
              
              
              58.8
              %Maintenance
      and services
              
              
              44.3
              
              
              
              46.0
              
              
              
              41.2Total
      revenue
              
              
              100.0
              
              
              
              100.0
              
              
              
              100.0COSTS
      AND EXPENSES:Cost
      of software licenses and subscriptions
              
              
              11.5
              
              
              
              9.6
              
              
              
              9.8Cost
      of maintenance and services
              
              
              16.0
              
              
              
              18.5
              
              
              
              15.6Sales
      and marketing
              
              
              32.7
              
              
              
              35.4
              
              
              
              36.8Engineering
      and product development
              
              
              12.4
              
              
              
              12.9
              
              
              
              11.7General
      and administrative
              
              
              21.8
              
              
              
              21.4
              
              
              
              19.3Impairment
      of goodwill and other intangible assets
              
              
              32.6
              
              
              
              —
              
              
              
              —Total
      costs and expenses
              
              
              127.0
              
              
              
              97.8
              
              
              
              93.2INCOME
      (LOSS) FROM OPERATIONS
              
              
              (27.0
              )
              
              
              2.2
              
              
              
              6.8Interest
      expense
              
              
              —
              
              
              
              —
              
              
              
              (0.1
              )Interest
      income and other income (expense), net
              
              
              1.0
              
              
              
              1.6
              
              
              
              0.4INCOME
      (LOSS) BEFORE INCOME TAXES
              
              
              (26.0
              )
              
              
              3.8
              
              
              
              7.1Benefit
      (provision) for income taxes
              
              
              0.8
              
              
              
              (0.7
              )
              
              
              (0.5
              )NET
      INCOME (LOSS)
              
              
              (25.2
              )
              
              
              3.1
              
              
              
              6.6





Fiscal Year Ended
September 30, 2009 as Compared to


Fiscal Year Ended
September 30, 2008





Total
Revenues





The
following table presents total revenue, total revenue decrease and percentage
change in total revenue for the years ended September 30, 2009 and
2008:




Year
      Ended September 30,
              
              
              Increase
              
              
              Percentage2009
              
              
              2008
              
              
              (Decrease)
              
              
              Change(In
      thousands)Software
      licenses and subscriptions
              
              $
              10,931
              
              
              $
              12,435
              
              
              $
              (1,504
              )
              
              
              -12.1
              %Maintenance
      and services
              
              
              8,687
              
              
              
              10,595
              
              
              
              (1,908
              )
              
              
              -18.0
              %Total
      revenue
              
              $
              19,618
              
              
              $
              23,030
              
              
              $
              (3,412
              )
              
              
              -14.8
              %


Revenue
for the fiscal year ended September 30, 2009 was $19,618,000, which
represents a decrease of $3,412,000 or approximately 15% from revenue of
$23,030,000 for the fiscal year ended September 30, 2008. For fiscal 2009,
Business Intelligence Solutions (including Monarch, Monarch Data Pump, Monarch
RMS, Monarch BI Server, Datawatch ES, Datawatch Dashboards, Visual Insight,
iMergence and VorteXML), Content Management Solutions (including Datawatch BDS)
and Service Management Solutions (including Visual QSM and Visual HD) revenue
accounted for 71%, 17%, and 12% of total revenue, respectively, as compared to
67%, 16%, and 17%, respectively, for fiscal 2008.





- 22
-


Software
license and subscription revenue for the fiscal year ended September 30,
2009 was $10,931,000 or approximately 56% of total revenue, as compared to
$12,435,000 or approximately 54% of total revenue for the fiscal year ended
September 30, 2008. This represents a decrease of $1,504,000 or
approximately 12% from fiscal 2008. The overall decrease in software license and
subscription revenue consists of a $1,394,000 decrease in Business Intelligence
Solutions (including Monarch, Monarch Data Pump, Monarch RMS, Datawatch BI
Server, Datawatch ES, Datawatch Dashboards, Visual Insight, iMergence and
VorteXML products), a $185,000 decrease in Service Management Solutions
(including Visual QSM and Visual HD products) and a $75,000 increase in Content
Management Solutions (including Datawatch BDS). The Company attributes the
overall decrease in software licenses and subscription revenue to lower currency
exchange rates in 2009 for the British Pound as compared to the U.S. dollar,
softened demand for computer software due to the worldwide recession, and
customers’ redistributing licenses of laid off employees internally. The
decrease in Business Intelligence Solutions is primarily due to decreased
Monarch license sales as a result of the global recession as compared to fiscal
2008.





Maintenance
and services revenue for the fiscal year ended September 30, 2009 was
$8,687,000 or approximately 44% of total revenue, as compared to $10,595,000 or
approximately 46% of total revenue for the fiscal year ended September 30,
2008. This represents a decrease of $1,908,000 or approximately 18% from fiscal
2008. The decrease in maintenance and services revenue consists of a $1,309,000
decrease in Service Management Solutions (including Visual QSM and Visual HD
products), a $467,000 decrease in Content Management Solutions (including
Datawatch BDS) and a $132,000 decrease in Business Intelligence Solutions
(including Monarch, Monarch Data Pump, Monarch RMS, Monarch BI Server, Datawatch
ES, Datawatch Dashboards, Visual Insight, iMergence and VorteXML products). The
Company attributes the overall decreases in maintenance and services revenue to
lower currency exchange rates in 2009 for the British Pound as compared to the
U.S. Dollar, softened demand for computer software due to the worldwide
recession, and lower renewal rates of annual maintenance contracts from existing
customers. The decrease in Service Management Solutions revenue was also the
result of less demand for professional services work related to this product
line while customers waited for the release of the Company’s Visual QSM for the
Web product which was introduced in the third quarter of fiscal
2009.





Costs
and Operating Expenses





The
following table presents costs and operating expenses, increase (decrease) in
costs and operating expenses and percentage changes in costs and operating
expenses for the years ended September 30, 2009 and 2008:




Year
      Ended September 30,
              
              
              Increase
      /
              
              
              Percentage2009
              
              
              2008
              
              
              (Decrease)
              
              
              Change(in
      thousands)Cost
      of software licenses and subscriptions
              
              $
              2,248
              
              
              $
              2,218
              
              
              $
              30
              
              
              
              1.4
              %Cost
      of maintenance and services
              
              
              3,135
              
              
              
              4,271
              
              
              
              (1,136
              )
              
              
              -26.6
              %Sales
      and marketing
              
              
              6,423
              
              
              
              8,153
              
              
              
              (1,730
              )
              
              
              -21.2
              %Engineering
      and product development
              
              
              2,433
              
              
              
              2,966
              
              
              
              (533
              )
              
              
              -18.0
              %General
      and administrative
              
              
              4,272
              
              
              
              4,923
              
              
              
              (651
              )
              
              
              -13.2
              %Impairment
      of goodwill and other intangible assets
              
              
              6,401
              
              
              
              —
              
              
              
              6,401Total
      costs and operating expenses
              
              $
              24,912
              
              
              $
              22,531
              
              
              $
              2,381
              
              
              
              10.6
              %





Cost of
software licenses and subscriptions for the fiscal year ended September 30,
2009 was $2,248,000 or approximately 21% of software license and subscription
revenues, as compared to $2,218,000 or approximately 18% of software license and
subscription revenues for the fiscal year ended September 30, 2008. Cost of
software licenses and subscriptions as a percent of software license and
subscription revenue has remained relatively consistent year over year. The
dollar increase in cost of software licenses and subscriptions is primarily due
to higher software amortization costs associated with new products released
during fiscal 2009.





- 23
-


Cost of
maintenance and services for the fiscal year ended September 30, 2009 was
$3,135,000 or approximately 36% of maintenance and service revenue, as compared
to $4,271,000 or approximately 40% of maintenance and service revenue for the
fiscal year ended September 30, 2008. The decrease in the total cost of
maintenance and services is primarily due to lower headcount and
employee-related costs as well as lower use of external consultants in 2009 as
compared to fiscal 2008.





Sales and
marketing expenses for the fiscal year ended September 30, 2009 were $6,423,000,
or 33% of total revenue as compared to $8,153,000, or approximately 35% of total
revenue for fiscal 2008.  The decrease in sales and marketing expenses
of $1,730,000, or approximately 21%, is primarily due to lower headcount and
employee-related costs and commissions due to lower revenues. Additionally, the
Company incurred fewer promotional and travel-related expenses during the fiscal
year ended September 30, 2009 due to the worldwide recession.





Engineering
and product development expenses were $2,433,000, or 12% of total revenue for
the fiscal year ended September 30, 2009 as compared to $2,966,000, or 13%
of total revenue in fiscal 2008. The decrease in engineering and product
development expenses of $533,000, or approximately 18%, is primarily
attributable to higher capitalized software costs from new product development
as well as savings due to lower headcount and employee-related
costs.





General
and administrative expenses were $4,272,000, or 22% of total revenue for the
fiscal year ended September 30, 2009 as compared to $4,923,000 or 21% of
total revenue in fiscal 2008. The decrease in general and administrative
expenses of $651,000, or approximately 13%, is primarily attributable to lower
accounting and auditing fees, lower Sarbanes-Oxley compliance costs, and
decreased use of outside consultants.





Impairment
of goodwill and other intangible assets of $6,401,000 in fiscal 2009 is
attributable to the full impairment of the Company’s goodwill totaling
$6,116,000 and an indefinite lived trademark totaling $285,000 which were
recorded in the second quarter of fiscal 2009. In conducting its 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 and that the Company’s
goodwill was fully impaired, resulting in a non-cash impairment charge of
approximately $6,116,000. The results of the Company’s interim impairment
analysis of its indefinite lived trademark indicated that the trademark was
fully impaired at March 31, 2009 resulting in a non-cash impairment charge of
approximately $285,000.





Interest
income and other income (expense) for fiscal year 2009 includes primarily the
following two components: interest income; and miscellaneous income. Interest
income for the fiscal year ended September 30, 2009 was $29,000 as compared to
$130,000 for fiscal 2008. Interest income was lower due to lower interest rates
in 2009 due to the worldwide recession. Miscellaneous income for the fiscal year
ended September 30, 2009 was $26,000 as compared to $15,000 for fiscal 2008.
Interest income and other income (expense) for the fiscal year ended September
30, 2008 also included a $147,000 gain on the complete dissolution of the
Company’s French and German subsidiaries (Datawatch France SARL and Datawatch
GmbH). This amount represented the cumulative effect of translation adjustments
related to the consolidation of these subsidiaries which were previously
accumulated and reported in the shareholders’ equity section of the Company’s
consolidated balance sheets.





Gain on
foreign currency transactions for the fiscal year ended September 30, 2009 was
$138,000 as compared to $79,000 for the fiscal year ended September 30,
2008.





Income
tax benefit for the year ended September 30, 2009 was $161,000 as compared to
income tax expense of $153,000 for the year ended September 30, 2008. The income
tax benefit for 2009 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. The
income tax provision for fiscal 2008 primarily represents deferred tax expense
related to the tax-deductible goodwill generated by the Company’s





- 24
-


acquisition
of the business assets of IDARS. The goodwill resulting from this transaction
was deductible for tax purposes and, prior to the 2009 impairment, 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 year ended September 30, 2009 was $4,940,000 as compared to net
income of $717,000 for the year ended September 30, 2008. Net loss for
fiscal 2009 includes the impairment of goodwill and an indefinite lived
trademark of $6,401,000. Excluding the effects of the goodwill and trademark
impairment charge, non-GAAP net income for the year ended September 30, 2009
would have been $1,142,000, or $0.19 per diluted share, as compared to $717,000,
or $0.12 per diluted share, for the year ended September 30, 2008.








Fiscal Year Ended
September 30, 2008 as Compared to


Fiscal Year Ended
September 30, 2007





Total
Revenues





The
following table presents total revenue, total revenue increase (decrease) and
percentage change in total revenue for the years ended September 30, 2008
and 2007:




Year
      Ended September 30,
              
              
              Increase
              
              
              Percentage2008
              
              
              2007
              
              
              (Decrease)
              
              
              Change(In
      thousands)Software
      licenses and subscriptions
              
              $
              12,435
              
              
              $
              14,852
              
              
              $
              (2,417
              )
              
              
              -16.3
              %Maintenance
      and services
              
              
              10,595
              
              
              
              10,407
              
              
              
              188
              
              
              
              1.8
              %Total
      revenue
              
              $
              23,030
              
              
              $
              25,259
              
              
              $
              (2,229
              )
              
              
              -8.8
              %


Revenue
for the fiscal year ended September 30, 2008 was $23,030,000, which
represents a decrease of $2,229,000 or approximately 9% from revenue of
$25,259,000 for the fiscal year ended September 30, 2007. For fiscal 2008,
Business Intelligence Solutions (including Monarch, Monarch Data Pump, Monarch
RMS, Monarch BI Server, Datawatch ES, Visual Insight, iMergence and VorteXML),
Content Management Solutions (including Datawatch BDS) and Service Management
Solutions (including Visual QSM and Visual HD) revenue accounted for 67%, 16%,
and 17% of total revenue, respectively, as compared to 67%, 14%, and 19%,
respectively, for fiscal 2007.





Software
license and subscription revenue for the fiscal year ended September 30,
2008 was $12,435,000 or approximately 54% of total revenue, as compared to
$14,852,000 or approximately 59% of total revenue for the fiscal year ended
September 30, 2007. This represents a decrease of $2,417,000 or
approximately 16% from fiscal 2007. The overall decrease in software license and
subscription revenue consists of a $1,858,000 decrease in Business Intelligence
Solutions (including Monarch, Monarch Data Pump, Monarch RMS, Datawatch BI
Server, Datawatch ES, Visual Insight, iMergence and VorteXML products), a
$144,000 decrease in Content Management Solutions (including Datawatch BDS) and
a $415,000 decrease in Service Management Solutions (including Visual QSM and
Visual HD products). The decrease in Business Intelligence Solutions is
primarily due to decreased Monarch license sales as compared to fiscal 2007.
Sales from the Company’s Monarch product were significantly higher during fiscal
2007 following the release of upgrade version 9.0 in February 2007.





Maintenance
and services revenue for the fiscal year ended September 30, 2008 was
$10,595,000 or approximately 46% of total revenue, as compared to $10,407,000 or
approximately 41% of total revenue for the fiscal year ended September 30,
2007. This represents an increase of $188,000 or approximately 2% from fiscal
2007. The increase in maintenance and services revenue consists of a $554,000
increase in Business Intelligence Solutions





- 25
-


(including
Monarch, Monarch Data Pump, Monarch RMS, Monarch BI Server, Datawatch ES, Visual
Insight, iMergence and VorteXML products) and a $191,000 increase in Content
Management Solutions (including Datawatch BDS) which were partially offset by a
$557,000 decrease in Service Management Solutions (including Visual QSM and
Visual HD products). The Company attributes the overall increases in maintenance
and services revenue to continued customer loyalty, which has resulted in high
renewal rates for annual maintenance service contracts and an increased demand
for professional services from existing customers, which also includes upgrades
and additional training. The decrease in maintenance revenue for the Service
Management Solutions product line was the result of lower renewal rates of
annual maintenance contracts from existing customers. The decrease in Service
Management Solutions revenue was also the result of less demand for professional
services work related to this product line. No significant product upgrades were
introduced within the Visual QSM or Visual Help Desk product lines during fiscal
year 2008.





Costs
and Operating Expenses





The
following table presents costs and operating expenses, increase (decrease) in
costs and operating expenses and percentage changes in costs and operating
expenses for the years ended September 30, 2008 and 2007:




Year
      Ended September 30,
              
              
              Increase
      /
              
              
              Percentage2008
              
              
              2007
              
              
              (Decrease)
              
              
              Change(in
      thousands)Cost
      of software licenses and subscriptions
              
              $
              2,218
              
              
              $
              2,468
              
              
              $
              (250
              )
              
              
              -10.1
              %Cost
      of maintenance and services
              
              
              4,271
              
              
              
              3,943
              
              
              
              328
              
              
              
              8.3
              %Sales
      and marketing expenses
              
              
              8,153
              
              
              
              9,290
              
              
              
              (1,137
              )
              
              
              -12.2
              %Engineering
      and product development expenses
              
              
              2,966
              
              
              
              2,951
              
              
              
              15
              
              
              
              0.5
              %General
      and administrative expenses
              
              
              4,923
              
              
              
              4,872
              
              
              
              51
              
              
              
              1.0
              %Total
      costs and operating expenses
              
              $
              22,531
              
              
              $
              23,524
              
              
              $
              (993
              )
              
              
              -4.2
              %





Cost of
software licenses and subscriptions for the fiscal year ended September 30,
2008 was $2,218,000 or approximately 18% of software license and subscription
revenues, as compared to $2,468,000 or approximately 17% of software license and
subscription revenues for the fiscal year ended September 30, 2007. Cost of
software licenses and subscriptions as a percentage of software licenses and
subscription revenue have remained relatively consistent year over year. The
dollar decrease in cost of software licenses and subscriptions is primarily due
to lower royalty costs associated with lower sales of Monarch during fiscal
2008. As previously described, sales of the Company’s Monarch product were
significantly higher during fiscal 2007 due to the release of version 9.0 in
February 2007.





Cost of
maintenance and services for the fiscal year ended September 30, 2008 was
$4,271,000 or approximately 40% of maintenance and service revenue, as compared
to $3,943,000 or approximately 38% of maintenance and service revenue for the
fiscal year ended September 30, 2007. The increase in total cost of
maintenance and services is primarily due to higher employee-related costs due
to increased headcount and higher incentive compensation costs as compared to
fiscal 2007.





Sales and
marketing expenses for the fiscal year ended September 30, 2008 were $8,153,000,
or 35% of total revenue as compared to $9,290,000, or approximately 37% of total
revenue for fiscal 2007.  The decrease in sales and marketing expenses
of $1,137,000, or approximately 12%, is primarily attributable to cost savings
resulting from the Company’s restructuring plan which was initiated and
completed during the first quarter of fiscal year 2007 and resulted in lower
headcount. Additionally, the Company incurred fewer consulting and
travel-related expenses during the fiscal year ended September 30, 2008 as
compared to fiscal 2007.





Engineering
and product development expenses were $2,966,000, or 13% of total revenue for
the fiscal year ended September 30, 2008 as compared to $2,951,000, or 12%
of total revenue in fiscal 2007. The slight increase in engineering and product
development expenses of $15,000, or approximately 1%, is primarily attributable
to the increased use of external development consultants and employee-related
costs, net of capitalized software.





- 26
-


General
and administrative expenses were $4,923,000, or 21% of total revenue for the
fiscal year ended September 30, 2008 as compared to $4,872,000, or 19% of
total revenue in fiscal 2007. The increase in general and administrative
expenses of $51,000, or approximately 1%, is primarily attributable to higher
accounting and auditing fees and compliance costs associated with Section 404 of
the Sarbanes-Oxley Act.





Interest
expense for the fiscal year ended September 30, 2007 was $33,000 which resulted
from the Company’s $1 million borrowing under its line of credit in the third
quarter of fiscal 2006. There was no interest expense for the fiscal year ended
September 30, 2008 as the Company elected to repay its outstanding balance under
its line of credit in the second quarter of fiscal 2007.





Interest
income and other income (expense) includes primarily the following two
components: interest income; and a gain on the dissolution of the Company’s
French and German subsidiaries (Datawatch France SARL and Datawatch GmbH).
Interest income for the fiscal year ended September 30, 2008 was $130,000 as
compared to $40,000 for fiscal 2007. The increase in interest income was the
result of higher cash balances held in interest-bearing accounts. Additionally,
during fiscal 2008, there was a gain of $147,000 recorded upon the complete
dissolution of two of the Company’s foreign subsidiaries: Datawatch France SARL
and Datawatch GmbH. This amount represents the cumulative effect of translation
adjustments related to the consolidation of these subsidiaries which were
previously accumulated and reported in the shareholders’ equity section of the
Company’s consolidated balance sheets.





Gain
(loss) on foreign currency transactions for the fiscal year ended September 30,
2008 was a gain of $79,000 as compared to a loss of $7,000 for the fiscal year
ended September 30, 2007.





Income
tax expense for the year ended September 30, 2008 was $153,000 as compared to
$133,000 for the year ended September 30, 2007. Income tax expense for both
periods includes additional 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 is deductible for tax purposes and
a deferred tax expense is recognized for financial reporting purposes equal to
the tax rate on the excess of tax amortization over the amortization for
financial reporting purposes, which is zero unless there is an impairment. The
increase in income taxes of $20,000 is a result of additional deferred tax
expense related to the earn-out provisions of the IDARS acquisition and
uncertain tax positions relative to foreign taxes.





Net
income for the year ended September 30, 2008 was $717,000 as compared to
net income of $1,669,000 for the year ended September 30,
2007.





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





The
Company leases various facilities and equipment in the U.S. and overseas under
noncancelable operating leases that expire through 2011. The lease agreements
generally provide for the payment of minimum annual rentals, pro rata share of
taxes, and maintenance expenses. Rental expense for all operating leases was
approximately $318,000, $440,000 and $511,000 for fiscal years 2009, 2008 and
2007, respectively.





As of
September 30, 2009, contractual obligations include minimum rental
commitments under non-cancelable operating leases and long-term liabilities
related to uncertain tax positions as follows (in thousands):




Less
      than 1
              
              
              
              
              
              
              
              
              More
      thanContractual
      Obligations:
              
              Total
              
              
              Year
              
              
              1-3
      Years
              
              
              3-5
      Years
              
              
              5
      YearsOperating
      LeaseObligations
              
              $
              561
              
              
              $
              324
              
              
              $
              235
              
              
              $
              2
              
              
              $
              —Other
      Liabilities
              
              $
              125
              
              
              $
              —
              
              
              $
              —
              
              
              $
              —
              
              
              $
              125


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





- 27
-


$1,580,000,
$1,779,000 and $1,865,000 respectively, for the years ended September 30,
2009, 2008 and 2007.  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, $4,000 and $17,000 for the
fiscal years ended September 30, 2009, 2008 and 2007, respectively, for royalty
payments to Mergence.





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 September 30, 2009.





The
Company is required by a sublease agreement related to its Chelmsford,
Massachusetts facility to provide a letter of credit originally in the amount of
$125,000 as a security deposit to the landlord of amounts due under the lease.
In accordance with the terms of its sublease agreement, the Company was allowed
to reduce its letter of credit to $107,000 following the completion of the first
three years of its lease arrangement, which occurred during the first quarter of
fiscal year 2009. Cash on deposit providing security in the amount of this
letter of credit is classified as restricted cash in the Company’s consolidated
balance sheets as of September 30, 2009 and 2008.





The
Company enters into indemnification agreements in the ordinary course of
business. Pursuant to these agreements, the Company generally 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
potential obligations is minimal. Accordingly, the Company has no liabilities
recorded for these potential obligations as of September 30,
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 potential obligations is minimal.
Accordingly,the Company
has no liabilities recorded for these potential obligations as of
September 30, 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 potential obligations is minimal. The Company has no liabilities recorded
for these potential obligations as of September 30, 2009.





- 28
-


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
September 30, 2009, the Company had $5,649,000 of cash and equivalents, an
increase of $764,000 from September 30, 2008.





At
September 30, 2009, the Company had working capital of approximately $2,627,000
as compared to $1,130,000 as of September 30, 2008. The Company expects cash
flows from operations to remain positive as it anticipates profitability in the
future. 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. There can be no assurance that the
Company will be able to issue additional equity or obtain a new credit facility
at attractive prices or rates, or at all.





The
Company had a net loss of approximately $4,940,000 for the year ended September
30, 2009 which was the result of a non-cash impairment charge of $6.4 million
related to the impairment of goodwill and a trademark, as compared to net income
of approximately $717,000 for the year ended September 30, 2008 and net
income of approximately $1,669,000 for the year ended September 30, 2007. During
the years ended September 30, 2009 and 2008, approximately $1,968,000 and
$1,838,000, respectively, of cash was provided by the Company’s operations.
During fiscal year 2009, the main source of cash from operations was net income
adjusted for the impairment of goodwill and other intangible assets and adjusted
for depreciation and amortization as well as a decrease in accounts
receivable.





Net cash
used in investing activities for the year ended September 30, 2009 of
$909,000 is primarily related to capitalization of software development costs
and the purchase of property and equipment.





Net cash
provided by financing activities for the year ended September 30, 2009 of
$1,000 is related to proceeds from the exercise of stock options.





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 and Visual Insight products 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 through April 30, 2015 certain
intellectual property owned by Math Strategies and incorporated by the Company
in its Monarch, Monarch Data Pump, VorteXML and certain other products. The
Company has also entered into an Option Purchase Agreement with Math Strategies
giving the Company the option to purchase these intellectual property rights for
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. The option, if exercised, would provide the Company with increased
flexibility to utilize the purchased technology in the future.





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




- 29
-


RECENT
ACCOUNTING PRONOUNCEMENTS





In
December 2007, the Financial Accounting Standards Board (“FASB”) issued guidance
that established principles and requirements for determining how a company
recognizes and measures in its financial statements the fair value of certain
assets and liabilities acquired in a business combination, including
non-controlling interests, contingent consideration, and certain acquired
contingencies. The revised guidance on business combinations also requires
acquisition-related transaction expenses and restructuring costs be expensed as
incurred rather than capitalized. The guidance will be applied prospectively to
business combinations beginning in the year ending September 30,
2010.





In
February 2008, the FASB issued guidance that established principles and
disclosure requirements for fair value measurements and disclosures, that
delayed the effective date of fair value measurements accounting for all
non-financial assets and non-financial liabilities, except for items that are
recognized or disclosed at fair value in the financial statements on a recurring
basis (at least annually). The adoption of this update to non-financial assets
and liabilities became effective for the Company on October 1, 2009 and did not
have any impact on the Company’s consolidated financial statements.





In May
2009, the FASB issued guidance that establishes general standards of accounting
for and disclosure of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued. The guidance was
effective for fiscal years and interim periods ending after June 15, 2009. The
implementation of this standard did not have a material impact on the Company’s
consolidated financial statements.








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







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




At
September 30, 2009, the Company did not participate in any derivative
financial instruments or commodity instruments.  The Company holds no
investment securities that possess significant market risk.





Primary Market Risk
Exposures




The
Company’s primary market risk exposure is foreign currency exchange rate risk.
International revenues and expenses are generally transacted by the Company’s
foreign subsidiaries and are denominated in local currency. Approximately 23%,
30% and 31% of the Company’s revenues for 2009, 2008 and 2007, respectively,
were from foreign subsidiaries. In addition, approximately 18%, 31% and 34% of
the Company’s operating expenses for fiscal 2009, 2008 and 2007, respectively,
were from foreign subsidiaries.





The
Company is exposed to foreign currency exchange rate risk inherent in conducting
business globally in several currencies, of which the most significant to our
operations has historically been the British Pound. The Company’s exposure to
currency exchange rate fluctuations has historically been modest due to the fact
that the operations of its international subsidiaries are almost exclusively
conducted in their respective local currencies, and dollar advances to the
Company’s international subsidiaries, if any, are usually considered to be of a
long-term investment nature. Accordingly, the majority of currency movements are
reflected in the Company’s other comprehensive income (loss). There are,
however, certain situations where the Company will invoice customers in
currencies other than its own. Such gains or losses from operating activity,
whether realized or unrealized, are reflected in interest income and other
income (expense), net in the consolidated statements of operations. Due to the
worldwide recession and significant recent fluctuations in the currency markets,
the Company’s gain on foreign currency transactions was more significant in
fiscal year 2009 than it had been in previous years. Foreign currency
transaction gains for the fiscal years ended September 30, 2009 and 2008 were
$138,000 and $79,000, respectively. Foreign currency gains and losses were not
material in the year ended September 30, 2007. Currently, the Company does not
engage in foreign currency hedging activities.





- 30
-


Item
8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA





The
following consolidated financial statements and the related notes thereto of
Datawatch Corporation and the Report of Independent Registered Public Accounting
Firm thereon are filed as part of this Annual Report on Form 10-K.





REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
            32CONSOLIDATED
      FINANCIAL STATEMENTS AS OF SEPTEMBER 30, 2009 AND 2008 AND FOR EACH OF THE
      THREE YEARS IN THE PERIOD ENDED SEPTEMBER 30, 2009:Consolidated
      Balance Sheets
            33Consolidated
      Statements of Operations
            34Consolidated
      Statements of Shareholders’ Equity and Comprehensive Income
      (Loss)
            35Consolidated
      Statements of Cash Flows
            36Notes
      to Consolidated Financial Statements
            37










- 31
-


REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM








To the
Board of Directors and Shareholders of Datawatch Corporation


Chelmsford,
Massachusetts





We have
audited the accompanying consolidated balance sheets of Datawatch Corporation
and subsidiaries (the “Company”) as of September 30, 2009 and 2008, and the
related consolidated statements of operations, shareholders’ equity and
comprehensive income (loss), and cash flows for each of the three years in the
period ended September 30, 2009.  These financial statements are the
responsibility of the Company’s management. Our responsibility is to
express an opinion on these financial statements based on our
audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion.  An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation.  We believe that our audits
provide a reasonable basis for our opinion.





In our
opinion, such consolidated financial statements present fairly, in all material
respects, the financial position of Datawatch Corporation and subsidiaries as of
September 30, 2009 and 2008, and the results of their operations and their cash
flows for each of the three years in the period ended September 30, 2009, in
conformity with accounting principles generally accepted in the United States of
America.





As
discussed in Note 5 to the consolidated financial statements, on October 1,
2007, the Company changed its method of accounting for uncertain tax positions
to conform to new authoritative guidance issued by the Financial Accounting
Standards Board.





/s/
DELOITTE & TOUCHE LLP





Boston,
Massachusetts


December21,2009





























- 32
-


DATAWATCH
CORPORATION


CONSOLIDATED
BALANCE SHEETS


(In
thousands, except share and per share amounts)


September
      30,
              
              
              September
      30,2009
              
              
              2008ASSETSCURRENT
      ASSETS:Cash
      and equivalents
              
              $
              5,649
              
              
              $
              4,885Accounts
      receivable, less allowance for doubtful accounts and sales returnsof
      $215,000 in 2009 and $236,000 in 2008
              
              
              2,968
              
              
              
              3,287Inventories
              
              
              65
              
              
              
              57Prepaid
      expenses
              
              
              340
              
              
              
              361Total
      current assets
              
              
              9,022
              
              
              
              8,590Property
      and equipment:Office
      furniture and equipment
              
              
              1,136
              
              
              
              1,157Software
              
              
              464
              
              
              
              560Leasehold
      improvements
              
              
              509
              
              
              
              5092,109
              
              
              
              2,226Less
      accumulated depreciation and amortization
              
              
              (1,611
              )
              
              
              (1,489
              )Net
      property and equipment
              
              
              498
              
              
              
              737Goodwill
              
              
              —
              
              
              
              6,116Other
      intangible assets, net
              
              
              2,397
              
              
              
              2,577Restricted
      cash
              
              
              107
              
              
              
              125Other
      long-term assets
              
              
              19
              
              
              
              24Total
      assets
              
              $
              12,043
              
              
              $
              18,169LIABILITIES
      AND SHAREHOLDERS’ EQUITYCURRENT
      LIABILITIES:Accounts
      payable
              
              $
              761
              
              
              $
              1,028Accrued
      expenses
              
              
              1,915
              
              
              
              2,385Deferred
      revenue
              
              
              3,719
              
              
              
              4,047Total
      current liabilities
              
              
              6,395
              
              
              
              7,460LONG-TERM
      LIABILITIES:Deferred
      rent
              
              
              55
              
              
              
              120Deferred
      revenue - long-term
              
              
              302
              
              
              
              145Deferred
      tax liability
              
              
              —
              
              
              
              262Other
      liabilities
              
              
              125
              
              
              
              100Total
      long-term liabilities
              
              
              482
              
              
              
              627COMMITMENTS
      AND CONTINGENCIESSHAREHOLDERS’
      EQUITY:Common
      stock, par value $.01; 20,000,000 shares authorized; issued,
      5,940,085 shares and 5,928,604 shares, respectively; outstanding,
      5,925,839 shares and 5,914,358 shares,
      respectively
              
              
              59
              
              
              
              59Additional
      paid-in capital
              
              
              23,634
              
              
              
              23,421Accumulated
      deficit
              
              
              (17,370
              )
              
              
              (12,430
              )Accumulated
      other comprehensive loss
              
              
              (1,017
              )
              
              
              (828
              )5,306
              
              
              
              10,222Less
      treasury stock, at cost, 14,246 shares
              
              
              (140
              )
              
              
              (140
              )Total
      shareholders’ equity
              
              
              5,166
              
              
              
              10,082Total
      liabilities and shareholders' equity
              
              $
              12,043
              
              
              $
              18,169





See
notes to consolidated financial statements.





- 33
-


DATAWATCH
CORPORATION


CONSOLIDATED STATEMENTS OF
OPERATIONS


(In
thousands, except per share amounts)




Year
      Ended September 30,2009
              
              
              2008
              
              
              2007REVENUE:Software
      licenses and subscriptions
              
              $
              10,931
              
              
              $
              12,435
              
              
              $
              14,852Maintenance
      and services
              
              
              8,687
              
              
              
              10,595
              
              
              
              10,407Total
      revenue
              
              
              19,618
              
              
              
              23,030
              
              
              
              25,259COSTS
      AND EXPENSES:Cost
      of software licenses and subscriptions
              
              
              2,248
              
              
              
              2,218
              
              
              
              2,468Cost
      of maintenance and services
              
              
              3,135
              
              
              
              4,271
              
              
              
              3,943Sales
      and marketing
              
              
              6,423
              
              
              
              8,153
              
              
              
              9,290Engineering
      and product development
              
              
              2,433
              
              
              
              2,966
              
              
              
              2,951General
      and administrative
              
              
              4,272
              
              
              
              4,923
              
              
              
              4,872Impairment
      of goodwill and other intangible assets
              
              
              6,401
              
              
              
              —
              
              
              
              —Total
      costs and expenses
              
              
              24,912
              
              
              
              22,531
              
              
              
              23,524INCOME
      (LOSS) FROM OPERATIONS
              
              
              (5,294
              )
              
              
              499
              
              
              
              1,735Interest
      expense
              
              
              —
              
              
              
              —
              
              
              
              (33
              )Interest
      income and other income (expense), net
              
              
              55
              
              
              
              292
              
              
              
              107Foreign
      currency transaction gains (losses)
              
              
              138
              
              
              
              79
              
              
              
              (7
              )INCOME
      (LOSS) FROM OPERATIONS BEFORE INCOME TAXES
              
              
              (5,101
              )
              
              
              870
              
              
              
              1,802Benefit
      (provision) for income taxes
              
              
              161
              
              
              
              (153
              )
              
              
              (133
              )NET
      INCOME (LOSS)
              
              $
              (4,940
              )
              
              $
              717
              
              
              $
              1,669Net
      income (loss) per share - Basic:
              
              $
              (0.83
              )
              
              $
              0.12
              
              
              $
              0.30Net
      income (loss) per share - Diluted:
              
              $
              (0.83
              )
              
              $
              0.12
              
              
              $
              0.29Weighted-average
      shares outstanding - basic
              
              
              5,920
              
              
              
              5,835
              
              
              
              5,558Weighted-average
      shares outstanding - diluted
              
              
              5,920
              
              
              
              6,035
              
              
              
              5,855








See
notes to consolidated financial statements.





- 34
-


DATAWATCH
CORPORATION


CONSOLIDATED STATEMENTS OF
SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)





Years
Ended September 30, 2009, 2008 and 2007


(In
thousands, except share amounts)




AccumulatedAdditional
              
              
              
              
              
              Other
              
              
              ComprehensiveCommon
      Stock
              
              
              Paid-In
              
              
              Accumulated
              
              
              Comprehensive
              
              
              Income/
              
              
              Treasury
      StockShares
              
              
              Amount
              
              
              Capital
              
              
              Deficit
              
              
              Loss
              
              
              (Loss)
              
              
              Shares
              
              
              Amount
              
              
              TotalBALANCE,OCTOBER
      1, 2006
              
              
              5,526,485
              
              
              $
              55
              
              
              $
              22,204
              
              
              $
              (14,741
              )
              
              $
              (422
              )
              
              
              
              
              
              (14,246
              )
              
              $
              (140
              )
              
              $
              6,956Stock
      options exercised
              
              
              121,181
              
              
              
              1
              
              
              
              348
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              349Stock-based
      compensationexpense
              
              
              
              
              
              
              
              
              
              
              132
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              132Comprehensive
      income (loss):Translation
      adjustments
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (86
              )
              
              
              (86
              )
              
              
              
              
              
              
              
              
              
              
              (86
              )Net
      income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              1,669
              
              
              
              
              
              
              
              1,669
              
              
              
              
              
              
              
              
              
              
              
              1,669Total
      comprehensive income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              1,583BALANCE,SEPTEMBER
      30, 2007
              
              
              5,647,666
              
              
              
              56
              
              
              
              22,684
              
              
              
              (13,072
              )
              
              
              (508
              )
              
              
              
              
              
              
              (14,246
              )
              
              
              (140
              )
              
              
              9,020Cumulative
      effect of changein accounting for uncertain tax
      positions
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (75
              )
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (75
              )Stock
      options exercised
              
              
              280,938
              
              
              
              3
              
              
              
              512
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              515Stock-based
      compensationexpense
              
              
              
              
              
              
              
              
              
              
              225
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              225Comprehensive
      income (loss):Translation
      adjustments
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (320
              )
              
              
              (320
              )
              
              
              
              
              
              
              
              
              
              
              (320
              )Net
      income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              717
              
              
              
              
              
              
              
              717
              
              
              
              
              
              
              
              
              
              
              
              717Total
      comprehensive income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              397BALANCE,SEPTEMBER
      30, 2008
              
              
              5,928,604
              
              
              
              59
              
              
              
              23,421
              
              
              
              (12,430
              )
              
              
              (828
              )
              
              
              
              
              
              
              (14,246
              )
              
              
              (140
              )
              
              
              10,082Stock
      options exercised
              
              
              11,481
              
              
              
              —
              
              
              
              —
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              —Stock-based
      compensationexpense
              
              
              
              
              
              
              
              
              
              
              213
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              213Comprehensive
      income (loss):Translation
      adjustments
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (189
              )
              
              
              (189
              )
              
              
              
              
              
              
              
              
              
              
              (189
              )Net
      loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (4,940
              )
              
              
              
              
              
              
              (4,940
              )
              
              
              
              
              
              
              
              
              
              
              (4,940
              )Total
      comprehensive loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              (5,129
              )BALANCE,SEPTEMBER
      30, 2009
              
              
              5,940,085
              
              
              $
              59
              
              
              $
              23,634
              
              
              $
              (17,370
              )
              
              $
              (1,017
              )
              
              
              
              
              
              
              (14,246
              )
              
              $
              (140
              )
              
              $
              5,166





See
notes to consolidated financial statements.




- 35
-


DATAWATCH
CORPORATION


CONSOLIDATED STATEMENTS OF CASH
FLOWS


(In
thousands)




Year
      Ended September 30,2009
              
              
              2008
              
              
              2007CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income (loss)
              
              $
              (4,940
              )
              
              $
              717
              
              
              $
              1,669Adjustments
      to reconcile net income (loss) to cash provided by operating
      activities:Impairment
      of goodwill and other intangible assets
              
              
              6,401
              
              
              
              —
              
              
              
              39Depreciation
      and amortization
              
              
              1,058
              
              
              
              861
              
              
              
              928Provision
      for doubtful accounts and sales returns
              
              
              (12
              )
              
              
              (67
              )
              
              
              25Loss
      (gain) on disposal of equipment
              
              
              1
              
              
              
              (1
              )
              
              
              —Gain
      on disolution of foreign subsidiaries
              
              
              —
              
              
              
              (147
              )
              
              
              —Stock-based
      compensation
              
              
              213
              
              
              
              225
              
              
              
              132Deferred
      income taxes
              
              
              (262
              )
              
              
              115
              
              
              
              111Changes
      in current assets and liabilities, net of effects of the acquisition
      of IDARS:Accounts
      receivable
              
              
              185
              
              
              
              819
              
              
              
              (320
              )Inventories
              
              
              (9
              )
              
              
              (9
              )
              
              
              (10
              )Prepaid
      expenses and other assets
              
              
              14
              
              
              
              164
              
              
              
              146Accounts
      payable, accrued expenses and other liabilities
              
              
              (691
              )
              
              
              (590
              )
              
              
              797Deferred
      revenue
              
              
              10
              
              
              
              (249
              )
              
              
              4Cash
      provided by operating activities
              
              
              1,968
              
              
              
              1,838
              
              
              
              3,521CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchases
      of equipment and fixtures
              
              
              (99
              )
              
              
              (237
              )
              
              
              (136
              )Proceeds
      from sale of equipment
              
              
              —
              
              
              
              2
              
              
              
              8Purchase
      of IDARS business, net of cash acquired
              
              
              —
              
              
              
              (424
              )
              
              
              (671
              )Capitalized
      software development costs
              
              
              (831
              )
              
              
              (411
              )
              
              
              (81
              )Decrease
      in restricted cash
              
              
              18
              
              
              
              —
              
              
              
              —Decrease
      (increase) in other assets
              
              
              3
              
              
              
              40
              
              
              
              (25
              )Cash
      used in investing activities
              
              
              (909
              )
              
              
              (1,030
              )
              
              
              (905
              )CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from exercise of stock options
              
              
              1
              
              
              
              515
              
              
              
              349Repayments
      on line of credit
              
              
              —
              
              
              
              —
              
              
              
              (1,000
              )Cash
      provided by (used in) financing activities
              
              
              1
              
              
              
              515
              
              
              
              (651
              )EFFECT
      OF EXCHANGE RATE CHANGES ON CASH ANDEQUIVALENTS
              
              
              (296
              )
              
              
              (279
              )
              
              
              14INCREASE
      IN CASH AND EQUIVALENTS
              
              
              764
              
              
              
              1,044
              
              
              
              1,979CASH
      AND EQUIVALENTS, BEGINNING OF YEAR
              
              
              4,885
              
              
              
              3,841
              
              
              
              1,862CASH
      AND EQUIVALENTS, END OF YEAR
              
              $
              5,649
              
              
              $
              4,885
              
              
              $
              3,841SUPPLEMENTAL
      CASH FLOW INFORMATION:Interest
      paid
              
              $
              —
              
              
              $
              —
              
              
              $
              42Income
      taxes paid
              
              $
              12
              
              
              $
              23
              
              
              $
              4





See
notes to consolidated financial statements.





- 36
-


DATAWATCH
CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS








1.
            NATURE
      OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
  POLICIES





Nature
of Business





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





Summary of Significant
Accounting Policies





Principles of
Consolidation




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





Accounting
Estimates




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





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. Subsequent events have been evaluated through December 21,
2009, the date of issuance of these financial statements.




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 using 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 has two types of software product offerings: (1) Enterprise Software and
(2) Desktop and Server Software. Enterprise Software products are sold directly
to end-users and through value added resellers. The Company sells its Desktop
and Server Software products directly to end-users and through distributors and





- 37
-


resellers.
Sales to distributors and resellers accounted for approximately 40%, 41% and
39%, of total sales for the years ended September 30, 2009, 2008 and 2007,
respectively. Revenue from the sale of all software products (when separately
sold) is generally recognized at the time of shipment, provided there are no
uncertainties surrounding product acceptance, the fee is fixed or determinable,
collection is considered probable, persuasive evidence of the arrangement exists
and there are no significant obligations remaining. Both types of the Company’s
software product offerings are “off-the-shelf” as such term is customarily
defined. The Company’s software products can be installed and used by customers
on their own with little or no customization required. Multi-user licenses
marketed by the Company are sold as a right to use the number of licenses and
license fee revenue is recognized upon delivery of all software required to
satisfy the number of licenses sold. Upon delivery, the licensing fee is payable
without further delivery obligations to the Company.





Desktop
and Server Software products are generally not sold in multiple element
arrangements. Enterprise Software sales are generally 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 do not involve modification or
customization of the software or any unusual acceptance clauses or terms.
Post-contract customer support is typically provided under a maintenance
agreement which provides technical support and rights to unspecified software
maintenance updates and bug fixes on a when-and-if available basis. Revenue from
post-contract customer support services is deferred and recognized ratably over
the period of support (generally one year). Such deferred amounts are recorded
as part of deferred revenue in the Company’s consolidated balance
sheets.





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 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.
Certain software products, including desktop versions of Monarch, Monarch Data
Pump, BI Server and VorteXML sold 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.
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 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, resellers and end users 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.




- 38
-


Allowance for
Doubtful Accounts




The
Company maintains allowances for doubtful accounts for estimated losses
resulting from the inability of customers to make required payments. The Company
analyzes accounts receivable and the composition of the accounts receivable
aging, historical bad debts, customer creditworthiness, current economic trends
and changes in customer payment terms when evaluating the adequacy of the
allowance for doubtful accounts. Actual results could differ from the allowances
recorded, and this difference could have a material effect on the Company’s
financial position and results of operations.





For the
fiscal years ended September 30, 2009, 2008 and 2007, changes to and ending
balances of the allowance for doubtful accounts were approximately as
follows:




2009
              
              
              2008
              
              
              2007(in
      thousands)Allowance
      for doubtful accounts balance - beginning of year
              
              $
              171
              
              
              $
              223
              
              
              $
              193Additions
      to the allowance for doubtful accounts
              
              
              76
              
              
              
              62
              
              
              
              57Deductions
      against the allowance for doubtful accounts
              
              
              (87
              )
              
              
              (114
              )
              
              
              (27
              )Allowance
      for doubtful accounts balance - end of year
              
              $
              160
              
              
              $
              171
              
              
              $
              223
  Sales
Returns Reserve




The
Company maintains reserves for potential future product returns. The Company
estimates future product returns based on its experience and history with the
Company’s various distributors and resellers as well as by monitoring inventory
levels at such companies. Adjustments are recorded as increases or decreases in
revenue in the period of adjustment. Actual returns have historically been
within the range estimated by management. Actual results could differ from the
reserve for sales returns recorded, and this difference could have a material
effect on the Company’s financial position and results of
operations.





For the
fiscal years ended September 30, 2009, 2008 and 2007, changes to and ending
balances of the sales returns reserve were approximately as
follows:




2009
              
              
              2008
              
              
              2007(in
      thousands)Sales
      returns reserve balance - beginning of year
              
              $
              65
              
              
              $
              80
              
              
              $
              79Additions
      to the sales returns reserve
              
              
              45
              
              
              
              93
              
              
              
              131Deductions
      against the sales returns reserve
              
              
              (55
              )
              
              
              (108
              )
              
              
              (130
              )Sales
      returns reserve balance - end of year
              
              $
              55
              
              
              $
              65
              
              
              $
              80
  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 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 18 to 36 months.





For the
fiscal years ended September 30, 2009, 2008 and 2007, amounts related to
capitalized and purchased software development costs were approximately as
follows:




- 39
-




2009
              
              
              2008
              
              
              2007(in
      thousands)Capitalized
      and purchased software balance - beginning of year
              
              $
              664
              
              
              $
              395
              
              
              $
              473Capitalized
      software development costs
              
              
              831
              
              
              
              411
              
              
              
              81Amortization
      of capitalized software development costs andpurchased
      software
              
              
              (389
              )
              
              
              (142
              )
              
              
              (159
              )Capitalized
      and purchased software balance - end of year
              
              $
              1,106
              
              
              $
              664
              
              
              $
              395
  Cash
and Equivalents




Cash and
equivalents include cash on hand, cash deposited with banks and highly liquid
securities consisting of money market investments. The Company’s cash
equivalents are carried at fair value, which is defined as the price that would
be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. The Company
classifies the inputs used to measure fair value into the following
hierarchy:




·
            Level
      1 – Observable inputs such as quoted prices in active
    markets;


·
            Level
      2 – Inputs, other than the quoted prices in active markets, that are
      observable either directly or indirectly;
and


·
            Level
      3 – Unobservable inputs in which there is little or no market data, which
      require the reporting entity to develop its own
    assumptions.




The
following table represents information about the Company’s cash equivalents
measured at fair value on a recurring basis at September 30, 2009 (in
thousands):




Quoted
      Pricesin
      Active
              
              
              SignificantMarkets
      for
              
              
              Other
              
              
              SignificantIdentical
              
              
              Observable
              
              
              UnobservableAssets
              
              
              Inputs
              
              
              InputsTotal
              
              
              (Level
      1)
              
              
              (Level
      2)
              
              
              (Level
      3)Money
      market funds
              
              $
              2,232
              
              
              $
              2,232
              
              
              $
              —
              
              
              $
              —
  Concentration
of Credit Risks and Major Customers




The
Company sells its products and services to U.S. and non-U.S. dealers and other
software distributors, as well as to end users, under customary credit terms.
Two customers, Ingram Micro Inc. and Tech Data Product Management, individually
accounted for the following percentages of total revenue and accounts receivable
for the periods indicated:




Percentage
      of total revenue
              
              Percentage
      of totalfor
      the year ended
              
              accounts
      receivable atSeptember
      30,
              
              September
      30,2009
              
              2008
              
              2007
              
              2009
              
              2008Ingram
      Micro, Inc.
              
              17%
              
              21%
              
              15%
              
              24%
              
              26%Tech
      Data Product Management
              
              7%
              
              8%
              
              13%
              
              7%
              
              4%


The
Company sells to Ingram Micro Inc. and Tech Data Product Management under
separate distribution agreements, which automatically renew for successive
one-year terms unless terminated. Other than these two customers, no other
customer constitutes a significant portion (more than 10%) of revenues or
accounts receivable. The Company performs ongoing credit evaluations of its
customers and generally does not require collateral.




- 40
-


Deferred
Revenue




Deferred
revenue consisted of the following at September 30:


2009
              
              
              2008(in
      thousands)Maintenance
              
              $
              3,666
              
              
              $
              3,763Other
              
              
              355
              
              
              
              429Total
              
              
              4,021
              
              
              
              4,192Less:
      Long-term portion of deferred maintenance
              
              
              (302
              )
              
              
              (145
              )Current
      portion of deferred revenue
              
              $
              3,719
              
              
              $
              4,047





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





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





Inventories




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





Property
and Equipment




Property
and equipment consists of office equipment, furniture and fixtures, software and
leasehold improvements, all of which are recorded at cost. Depreciation and
amortization are provided using the straight-line method over the estimated
useful lives of the related assets or over the terms, if shorter, of the related
leases. Useful lives and lease terms range from three to seven years.
Depreciation and amortization expense related to property and equipment was
$332,000, $352,000 and $407,000, respectively, for the years ended September 30,
2009, 2008 and 2007.





Long-Lived
Assets




The
Company periodically evaluates whether events or circumstances have occurred
that indicate that the estimated remaining useful lives of long-lived assets and
certain identifiable intangibles may warrant revision or that the carrying value
of these assets may be impaired. To determine whether assets have been impaired,
the estimated undiscounted future cash flows for the estimated remaining useful
life of the respective assets are compared to the carrying value. To the extent
that the undiscounted future cash flows are less than the carrying value, the
fair value of the asset is determined and an impairment is recognized. If such
fair value is less than the current carrying value, the asset is written down to
its estimated fair value.





Goodwill
and Other Intangible Assets




Other
intangible assets consist of internally developed software costs, acquired
technology, patents, customer lists, trademarks and non-compete agreements
acquired through business combinations. The values allocated to the majority of
these intangible assetsare amortized using the
straight-line method over the estimated useful life of the related asset and are
recorded in cost of software licenses and subscriptions. The values allocated to
customer relationships and non-compete agreements are amortized using the
straight-line method over the





- 41
-


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





Goodwill
and one indefinite lived trademark were not subject to amortization and were
tested for impairment annually, on May 31st, or
more frequently if events and circumstances indicated 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 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 at March 31, 2009 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.


The
results of the Company’s 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 an impairment charge of approximately $6.1 million in the three months
ended March 31, 2009.





The
Company also tested its indefinite lived intangible asset for impairment by
comparing the fair value to the net book value of the asset. The results of the
Company’s valuation analysis at March 31, 2009 indicated that the trademark was
fully impaired at March 31, 2009. Therefore, the Company recorded an impairment
charge of approximately $285,000 in the three months ended March 31,
2009.





Changes
in the carrying amounts of goodwill for the years ended September 30, 2009 and
2008 are as follows (in thousands):





2009
            
            
            2008Balance
      at beginning of year
            
            $
            6,116
            
            
            $
            6,020Acquisition
      of IDARS business
            
            
            —
            
            
            
            96Impairment
      charge
            
            
            (6,116
            )
            
            
            —Balance
      at end of year
            
            $
            —
            
            
            $
            6,116





The
Company has the following other intangible assets as of September 30, 2009 and
2008:




Weighted
              
              
              September
      30, 2009
              
              
              September
      30, 2008Average
              
              
              Gross
              
              
              
              
              
              Net
              
              
              Gross
              
              
              
              
              
              NetIdentified
      Intangible
              
              Useful
      Life
              
              
              Carrying
              
              
              Accumulated
              
              
              Carrying
              
              
              Carrying
              
              
              Accumulated
              
              
              CarryingAsset
              
              in
      Years
              
              
              Amount
              
              
              Amortization
              
              
              Amount
              
              
              Amount
              
              
              Amortization
              
              
              Amount(in
      thousands)Capitalized
      software
              
              
              2
              
              
              $
              2,659
              
              
              $
              1,673
              
              
              $
              986
              
              
              $
              1,828
              
              
              $
              1,384
              
              
              $
              444Purchased
      software
              
              
              5
              
              
              
              700
              
              
              
              580
              
              
              
              120
              
              
              
              700
              
              
              
              480
              
              
              
              220Patents
              
              
              20
              
              
              
              160
              
              
              
              41
              
              
              
              119
              
              
              
              160
              
              
              
              33
              
              
              
              127Customer
      lists
              
              
              10
              
              
              
              1,790
              
              
              
              697
              
              
              
              1,093
              
              
              
              1,790
              
              
              
              531
              
              
              
              1,259Non-compete
      agreements
              
              
              4
              
              
              
              640
              
              
              
              561
              
              
              
              79
              
              
              
              640
              
              
              
              409
              
              
              
              231Trademark
              
              
              2
              
              
              
              21
              
              
              
              21
              
              
              
              —
              
              
              
              21
              
              
              
              10
              
              
              
              11Trademark
              
              indefinite
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              285
              
              
              
              —
              
              
              
              285Total
              
              
              
              
              
              $
              5,970
              
              
              $
              3,573
              
              
              $
              2,397
              
              
              $
              5,424
              
              
              $
              2,847
              
              
              $
              2,577




During
fiscal 2009, the Company determined that an indefinite lived trademark with a
carrying value of $285,000 was fully impaired.





During
fiscal 2008, the Company wrote-off approximately $329,000 of fully-amortized
capitalized software costs for technology no longer in use.





- 42
-


The
intangible asset amounts amortized to cost of software licenses and
subscriptions totaled $407,000, $160,000 and $167,000 for fiscal 2009, 2008 and
2007, respectively. Intangible asset amounts amortized to sales and marketing
expense totaled $319,000, $349,000 and $354,000, respectively.





As of
September 30, 2009, the estimated future amortization expense related to
amortizing intangible assets was as follows (in thousands):




Fiscal
      Years Ending September 30,2010
              
              
              $
              9372011
              
              
              
              5472012
              
              
              
              2242013
              
              
              
              1742014
              
              
              
              174Thereafter
              
              
              
              341Total
      estimated future amortization expense
              
              
              $
              2,397
  Restricted
Cash




At
September 30, 2008, restricted cash consisted of a $125,000 security deposit in
the form of an irrevocable letter of credit held in escrow for the landlord of
the Company’s Chelmsford, MA corporate offices. In accordance with the terms of
the Company’s sublease agreement, the Company was allowed to reduce its security
deposit by approximately $18,000 following the completion of the first three
years of its lease arrangement, which occurred during the first quarter of
fiscal year 2009. Accordingly, the restricted cash balance is $107,000 as of
September 30, 2009.





Financial
Instruments




The
Company’s financial instruments consist primarily of cash and equivalents,
accounts receivable and accounts payable and their carrying values approximate
fair value because of their short-term nature.





Income
Taxes




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





Net Income (Loss)
Per Share




Basic net
income (loss) per common share is computed by dividing net income (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 options using the treasury-stock method. Diluted net loss per share is the
same as basic net loss per share as the potentially dilutive securities are all
antidilutive.





The
following table presents the options that were not included in the computation
of diluted net income (loss) per share, because the effect was antidilutive for
the years ended September 30, 2009, 2008 and 2007:





2009
            
            
            2008
            
            
            2007Quantity
      of option shares not included
            
            
            548,800
            
            
            
            227,751
            
            
            
            190,042Weighted-average
      exercise price
            
            $
            3.05
            
            
            $
            5.00
            
            
            $
            4.90





Foreign Currency
Translations and Transactions




Assets
and liabilities of foreign subsidiaries are translated into U.S. dollars at
rates in effect at each balance sheet date. Revenues, expenses and cash flows
are translated into U.S. dollars at average rates prevailing when





- 43
-


transactions
occur. The related translation adjustments are reported as a separate component
of shareholders’ equity under the heading “Accumulated Other Comprehensive
Loss.” Gains and losses resulting from transactions that are denominated in
currencies other than the applicable unit’s functional currency are included in
the operating results of the Company and were $138,000 and $79,000 for the years
ended September 30, 2009 and 2008, respectively.  Foreign currency
gains and losses were not material in the year ended September 30,
2007.





Advertising and
Promotional Materials




Advertising
costs are expensed as incurred and amounted to $209,000, $281,000 and $311,000
in 2009, 2008 and 2007, respectively. Direct mail/direct response costs are
expensed over the period in which the associated revenue is recognized,
generally three to six months from the date of the mailing. Direct mail expense
was $164,000, $54,000 and $164,000 in 2009, 2008 and 2007, respectively. At
September 30, 2009, deferred direct mail/direct response costs were $3,000 and
were included under the caption “Prepaid Expenses” in the accompanying
consolidated balance sheets. There were no deferred direct mail/direct response
costs at September 30, 2008.





Stock-Based
Compensation




All
share-based awards, including grants of employee stock options, are recognized
in the financial statements based on their fair value.





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
stock-based compensation disclosure in Note 6 to the Company’s consolidated
financial statements.





Comprehensive Income (Loss)




The only
item other than net income (loss) that is included in comprehensive income
(loss) is foreign currency translation adjustments. Foreign currency translation
losses arising during 2009, 2008 and 2007 were $189,000, $320,000, and $86,000,
respectively.





In fiscal
2008, the Company recognized a $147,000 gain primarily consisting of cumulative
translation adjustments as a result of the complete liquidation of two of its
foreign subsidiaries: Datawatch France SARL and Datawatch GmbH, which is
included in “Interest income and other income (expense), net” in the
consolidated statements of operations for the year ended September 30,
2008.





Restructuring




In April
2009, in response to the existing business climate, the Company initiated and
completed a restructuring plan to reduce costs and reduced its workforce by
twelve employees. The restructuring plan resulted in charges for severance
benefits and related costs for the terminated employees of $96,000 in the fiscal
year ended September 30, 2009. These costs are included primarily within costs
of maintenance and services and sales and marketing expenses. All such
terminations were completed by June 30, 2009 and all amounts incurred were paid
in fiscal 2009.





Segment
Information




The
Company has determined that it has only one operating 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. See Note 8 for information about the Company’s revenue by
product lines and geographic operations.





Guarantees and
Indemnifications




The
Company’s software products are sold under warranty against certain defects in
material and





- 44
-


workmanship
for a period of 30 days from the date of purchase. The Company has never
incurred significant expense under its product or service warranties and does
not expect to do so in the future. As a result, the Company believes the
estimated fair value of these warranty agreements is minimal. Accordingly, there
are no liabilities recorded for warranty claims as of September 30, 2009 and
2008.





The
Company enters into indemnification agreements in the ordinary course of
business. Pursuant to these agreements, the Company agrees to indemnify, hold
harmless, and to reimburse the indemnified party for losses suffered or incurred
by the indemnified party, generally its customers, in connection with any
patent, copyright or other intellectual property infringement claim by any third
party with respect to the Company’s products. The term of these indemnification
agreements is generally perpetual and the maximum potential amount of future
payments the Company could be required to make under these indemnification
agreements is unlimited. The 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 potential obligations is
minimal. Accordingly, the Company has no liabilities recorded for these
potential obligations as of September 30, 2009 or 2008.





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 potential obligations is minimal.
Accordingly, the Company has no liabilities recorded for these potential
obligations as of September 30, 2009or
2008.





As
permitted under Delaware law, the Company has agreements with its directors
whereby the Company will indemnify them for certain events or occurrences while
the director is, or was, serving at the Company’s request in such capacity. The
term of the director indemnification period is for the later of ten years after
the date that the director ceases to serve in such capacity or the final
termination of proceedings against the director as outlined in the
indemnification agreement. The maximum potential amount of future payments the
Company could be required to make under these indemnification agreements is
unlimited; however, the Company’s director and officer insurance policy limits
the Company’s exposure and enables it to recover a portion of any future amounts
paid. As a result of its insurance policy coverage for directors, the Company
believes the estimated fair value of these potential obligations is minimal. The
Company has no liabilities recorded for these potential obligations as of
September 30, 2009 or 2008.





Recent
Accounting Pronouncements




In
December 2007, the Financial Accounting Standards Board (“FASB”) issued guidance
that established principles and requirements for determining how a company
recognizes and measures in its financial statements the fair value of certain
assets and liabilities acquired in a business combination, including
non-controlling interests, contingent consideration, and certain acquired
contingencies. The revised guidance on business combinations also requires
acquisition-related transaction expenses and restructuring costs to be expensed
as incurred rather than capitalized. The guidance will be applied prospectively
to business combinations beginning in the year ending September 30,
2010.





In
February 2008, the FASB issued guidance that established principles and
disclosure requirements for fair value measurements and disclosures, that
delayed the effective date of fair value measurements accounting for all
non-financial assets and non-financial liabilities, except for items that are
recognized or disclosed at fair value in the financial statements on a recurring
basis (at least annually). The adoption of this update to non-financial assets
and liabilities became effective for the Company on October 1, 2009 and did not
have any impact on the Company’s consolidated financial statements.





In May
2009, the FASB issued guidance that establishes general standards of accounting
for and disclosure of events that occur after the balance sheet date but before
financial statements are issued or are available to be





- 45
-


issued.
The guidance was effective for fiscal years and interim periods ending after
June 15, 2009. The implementation of this standard did not have a material
impact on the Company’s consolidated financial statements.





2.
            INVENTORIES





Inventories
consisted of the following at September 30:


2009
              
              
              2008(in
      thousands)Raw
      materials
              
              $
              34
              
              
              $
              44Finished
      goods
              
              
              31
              
              
              
              13Total
              
              $
              65
              
              
              $
              57





3.
            ACCRUED
      EXPENSES





Accrued
expenses consisted of the following at September 30:


2009
              
              
              2008(in
      thousands)Accrued
      salaries and benefits
              
              $
              190
              
              
              $
              412Accrued
      royalties and commissions
              
              
              1,119
              
              
              
              1,092Accrued
      professional fees
              
              
              235
              
              
              
              375Other
              
              
              371
              
              
              
              506Total
              
              $
              1,915
              
              
              $
              2,385


4.
            COMMITMENTS
      AND CONTINGENCIES





Leases




The
Company leases various facilities and equipment in the U.S. and overseas under
non-cancelable operating leases which expire through 2011. The lease agreements
generally provide for the payment of minimum annual rentals, pro-rata share of
taxes, and maintenance expenses. Rental expense for all operating leases was
$318,000, $440,000 and $511,000 for the years ended September 30, 2009, 2008 and
2007, respectively.  Certain of the Company’s facility leases include
options to renew.





As of
September 30, 2009, minimum rental commitments under noncancelable operating
leases are as follows (in thousands):




Years Ending September 30,2010
              
              $
              3242011
              
              
              2342012
              
              
              12013
              
              
              12014
              
              
              1Total
      future minimum lease payments
              
              $
              561
  Royalties




The
Company is 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 and subscriptions was approximately
$1,580,000, $1,779,000 and $1,865,000 for the years ended September 30,
2009, 2008 and 2007,





- 46
-


respectively.
The Company is not obligated to pay minimum royalty amounts.





On August
11, 2004, the Company acquired 100% of the shares of Mergence Technologies
Corporation.  The purchase agreement includes a provision for
quarterly cash payments to the former Mergence shareholders equal to 10% of
revenue, as defined, of the Datawatch Researcher product until September 30,
2010. The Company expensed approximately $5,000, $4,000 and $17,000,
respectively, for the years ended September 30, 2009, 2008 and
2007.





Contingencies




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





5.
            INCOME
      TAXES





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




2009
                
                
                2008
                
                
                2007(in
      thousands)Domestic
                
                $
                (5,336
                )
                
                $
                (2
                )
                
                $
                2,078Foreign
                
                
                235
                
                
                
                872
                
                
                
                (276
                )Total
                
                $
                (5,101
                )
                
                $
                870
                
                
                $
                1,802


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




2009
              
              
              2008
              
              
              2007(in
      thousands)Current:Federal
              
              $
              15
              
              
              $
              —
              
              
              $
              12State
              
              
              18
              
              
              
              13
              
              
              
              9Foreign
              
              
              72
              
              
              
              25
              
              
              
              1105
              
              
              
              38
              
              
              
              22Deferred:Federal
              
              
              (750
              )
              
              
              295
              
              
              
              138State
              
              
              (199
              )
              
              
              8
              
              
              
              52Change
      in valuation allowance
              
              
              683
              
              
              
              (188
              )
              
              
              (79
              )(266
              )
              
              
              115
              
              
              
              111Total
      provision (benefit)
              
              $
              (161
              )
              
              $
              153
              
              
              $
              133





At
September 30, 2009, the Company had U.S. federal tax loss carryforwards of
approximately $6.5 million, expiring at various dates through 2028, including
$366,000 resulting from the Mergence acquisition during 2004 which are subject
to additional annual limitations as a result of the changes in Mergence’s
ownership, and had approximately $867,000 in state tax loss carryforwards, which
also expire at various dates through 2028. An alternative minimum tax credit of
approximately $166,000 is available to offset future regular federal taxes.
Research and development credits of approximately $525,000 expire beginning in
2011. In addition, the Company has the following net operating loss
carryforwards: United Kingdom losses of $8.5 million with no expiration date and
Australia losses of $2.7 million with no expiration date.





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





- 47
-


2009
              
              
              2008
              
              
              2007(in
      thousands)Deferred
      tax liabilities:Goodwill
      amortization
              
              $
              —
              
              
              $
              (262
              )
              
              $
              (147
              )Prepaid
      expenses
              
              
              (39
              )
              
              
              (27
              )
              
              
              (71
              )Acquired
      intangibles
              
              
              (46
              )
              
              
              (84
              )
              
              
              (152
              )(85
              )
              
              
              (373
              )
              
              
              (370
              )Deferred
      tax assets:Net
      operating loss carryforwards
              
              
              4,850
              
              
              
              3,563
              
              
              
              3,931Research
      and development credits
              
              
              525
              
              
              
              397
              
              
              
              499Accounts
      and notes receivable reserves
              
              
              58
              
              
              
              69
              
              
              
              84Alternative
      minimum tax credits
              
              
              166
              
              
              
              157
              
              
              
              157Depreciation
      and amortization
              
              
              1,617
              
              
              
              349
              
              
              
              734Deferred
      rent
              
              
              46
              
              
              
              71
              
              
              
              92Other
              
              
              102
              
              
              
              184
              
              
              
              3117,364
              
              
              
              4,790
              
              
              
              5,808Total
              
              
              7,279
              
              
              
              4,417
              
              
              
              5,438Valuation
      allowance
              
              
              (7,279
              )
              
              
              (4,679
              )
              
              
              (5,585
              )Deferred
      tax liability, net
              
              $
              —
              
              
              $
              (262
              )
              
              $
              (147
              )





For
financial reporting purposes, the Company had profitable income from domestic
operations in 2007 but incurred losses from domestic operations in 2008 and
2009. The Company had operating losses from its significant international
subsidiaries during the year ended September 30, 2007. The Company had a
domestic taxable loss in 2008 and had marginal domestic taxable income in 2009
and 2007 as the Company’s subsidiaries in the United Kingdom are treated as
branches on the domestic tax returns and, accordingly, any losses at such
subsidiaries are recorded on the domestic income tax returns. Prior to the
results of the last three years, the Company experienced significant losses from
operations, both domestically and internationally, over several prior years. The
Company has also had a history of certain state net operating loss carryforwards
expiring. Approximately $341,000 and $6.8 million of state net operating loss
carryforwards expired in fiscal 2009 and 2008, respectively. Accordingly,
management does not believe the deferred tax assets are more likely than not to
be realized and a full valuation allowance has been provided.





The
Company recognized deferred tax liabilities for the excess of
tax-deductible goodwill over goodwill for financial reporting purposes. The tax
benefit for the excess tax-deductible goodwill is recognized when realized on
the tax return. During fiscal year 2006, Datawatch acquired the business assets
of IDARS that resulted in tax-deductible amortization being recognized as a
deferred tax expense in 2008 and 2007. As the goodwill was deducted for tax
purposes, a deferred tax expense was recognized each year with a corresponding
deferred tax liability equal to the excess of tax amortization over the
amortization for financial reporting purposes. During the fiscal years ended
September 30, 2008 and 2007, the Company recorded deferred tax expense of
approximately $115,000 and $111,000, respectively. During fiscal year 2009, the
applicable goodwill associated with this purchase was determined to be fully
impaired and written off for book purposes but continues to be deductible over a
15 year life for tax reporting purposes. Accordingly, upon impairment, the
Company recorded a deferred tax asset, with a corresponding full valuation
allowance, for the future tax benefit of the goodwill based on the Company’s
effective tax rate for the period. Deferred tax benefit recorded for the fiscal
year 2009 was approximately $266,000.





The
following table reconciles the Company’s tax (benefit) provision based on its
effective tax rate to its tax (benefit) provision based on the federal statutory
rate of 34% for the years ended September 30, 2009, 2008 and 2007 (in
thousands):





- 48
-




2009
            
            
            2008
            
            
            2007Provision
      at federal statutory rate
            
            $
            (1,734
            )
            
            $
            296
            
            
            $
            613State,
      net of federal impact
            
            
            (119
            )
            
            
            13
            
            
            
            21Foreign
      income taxes
            
            
            72
            
            
            
            25
            
            
            
            (473
            )Valuation
      allowance increase (decrease)
            
            
            683
            
            
            
            (188
            )
            
            
            (79
            )Goodwill
      impairment impact
            
            
            651
            
            
            
            —
            
            
            
            —Return
      to provision adjustments
            
            
            136
            
            
            
            —
            
            
            
            —Other
            
            
            150
            
            
            
            7
            
            
            
            51Provision
      for income taxes
            
            $
            (161
            )
            
            $
            153
            
            
            $
            133





Provision for Uncertain Tax
Positions


The
Company adopted the new accounting requirements for uncertain tax positions on
October 1, 2007 which provide 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.





In
accordance with these requirements, 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.





Upon
adoption of the accounting requirements for uncertain tax positions, the Company
recorded a reduction of its deferred tax asset in the amount of $690,000 and a
corresponding reduction to the valuation allowance of $690,000 for all
identified uncertain tax positions, for any years open under the statute of
limitations. At that time, the Company also recorded a $75,000 tax liability
related to foreign tax exposure. During each of the fiscal years ended September
30, 2009 and 2008, the Company increased its tax liability by $25,000, resulting
in a cumulative tax liability of $125,000 at September 30, 2009. These amounts
have been recorded as an increase to other long-term liabilities on the
Company’s consolidated balance sheets. The Company does not expect this
liability to change significantly during the next twelve months. The Company has
not accrued any interest and penalties associated with this liability as they
are immaterial. Also in fiscal 2008 and 2009, the Company recorded additional
uncertain tax positions of approximately $13,000 and $9,000, respectively, which
were recorded as a reduction of the Company’s deferred tax asset and a
corresponding reduction to its valuation allowance. 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.
 
 As of
October 1, 2008, the Company had approximately $759,000 of total gross
unrecognized tax benefits (before consideration of any valuation allowance).
These unrecognized tax benefits 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 in fiscal 2009 was as
follows:


Balance
      at October 1, 2007
            
            $
            721Additions
      for prior year tax positions
            
            38Balance
      at September 30, 2008
            
            759Additions
      for prior year tax positions
            
            34Balance
      at September 30, 2009
            
            $
            793


- 49
-
 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, 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, 2006 through September 30, 2008 are generally still open to examination in
the jurisdictions listed above.





6.
            SHAREHOLDERS’
      EQUITY





Stock
Option Plans




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





On
October 4, 1996, the Company established the 1996 International Employee
Non-Qualified Stock Option Plan. Pursuant to this plan, nonqualified options
were available to be granted to any employee or consultant of any of the
Company’s foreign subsidiaries through October 4, 2006. This plan expired on
October 4, 2006.





On
December 10, 1996, the Company established the Datawatch Corporation 1996 Stock
Plan, which provides for the granting of both incentive stock options and
nonqualified options, the award of Company common stock, and opportunities to
make direct purchases of Company common stock (collectively, “Stock Rights”), as
determined by a committee appointed by the Board of Directors. Options pursuant
to this plan were available to be granted through December 9, 2006 and shall
vest as specified by this committee. This plan expired on December 9,
2006.





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





The
Company recognizes stock-based compensation expense in accordance with generally
accepted accounting principles which require that all share-based awards,
including grants of employee stock options, be recognized in the financial
statements based on their fair value.





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 stock compensation awards are accounted for as
equity instruments and there have been no liability awards granted.





Stock-based
compensation expense for the fiscal years ended September 30, 2009, 2008 and
2007 was $213,000, $225,000 and $132,000, respectively, which was included in
the following expense categories:





- 50
-


Years
      Ended September 30,2009
              
              
              2008
              
              
              2007(in
      thousands)Sales
      and marketing
              
              $
              49
              
              
              $
              68
              
              
              $
              51Engineering
      and product development
              
              
              14
              
              
              
              16
              
              
              
              11General
      and administrative
              
              
              150
              
              
              
              141
              
              
              
              70Total
              
              $
              213
              
              
              $
              225
              
              
              $
              132





The
Company uses the Black-Scholes option-pricing model to calculate the fair value
of options. The key assumptions for this valuation method include the expected
life of the option, stock price volatility, risk-free interest rate and dividend
yield. The weighted-average fair values of the options granted under the stock
options plans were $0.97, $3.11 and $1.54 for the years ended September 30,
2009, 2008 and 2007, respectively. The total intrinsic value of options
exercised during the years ended September 30, 2009, 2008 and 2007 was
approximately $1,000, $1,156,000 and $190,000, respectively. Total cash received
from option exercises during the years ended September 30, 2009, 2008 and 2007
was $1,000, $515,000 and $349,000, respectively. The tax benefit realized from
stock options exercised was $1,000, $697,000 and $187,000, respectively. As of
September 30, 2009, there was $150,000 of total unrecognized compensation cost
related to nonvested stock option arrangements, which is expected to be
recognized over a weighted-average period of 1.39 years.





The table
below indicates the key assumptions used in the option valuation calculations
for options granted for the years ended September 30, 2009, 2008 and
2007:


2009
              
              2008
              
              2007Expected
      life
              5
      years
              
              5
      years
              
              5
      yearsExpected
      volatility
              73.42%
              
              70.11%
      - 73.26%
              
              75.88%
      - 83.34%Weighted-average
      volatility
              73.42%
              
              72.56%
              
              77.63%Risk-free
      interest rate
              1.88%
              
              2.87%
      - 4.03%
              
              4.48%
      - 4.99%Dividend
      yield
              0.0%
              
              0.0%
              
              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 dividend yield of zero is based on the fact that the Company
has never paid cash dividends and has no present intention to pay cash
dividends. Based on the Company’s historical voluntary turnover rates, an
annualized estimated forfeiture rate of 10% has been used in calculating the
estimated cost. Additional expense will be recorded if the actual forfeiture
rate is lower than estimated, and a recovery of prior expense will be recorded
if the actual forfeiture is higher than estimated.





At
September 30, 2009, 600,000 shares were authorized and 330,667 shares were
available for future issuance under the 2006 Plan.





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








- 51
-





Weighted-
            
            Weighted
      - AverageNumber
      of
            
            
            Average
            
            Remaining
            
            AggregateOptions
            
            
            Exercise
            
            Contractual
            
            IntrinsicOutstanding
            
            
            Price
            
            Term
            
            Value
      $(000)Outstanding,
      October 1, 2006
            
            
            852,316
            
            
            $
            2.65Granted
            
            
            110,000
            
            
            
            2.67Canceled
            
            
            (31,592
            )
            
            
            4.38Exercised
            
            
            (121,181
            )
            
            
            2.88Outstanding,
      September 30, 2007
            
            
            809,543
            
            
            
            2.55Granted
            
            
            98,000
            
            
            
            4.99Canceled
            
            
            (49,753
            )
            
            
            4.63Exercised
            
            
            (275,934
            )
            
            
            1.87Outstanding,
      September 30, 2008
            
            
            581,856
            
            
            
            3.10Granted
            
            
            26,500
            
            
            
            1.61Canceled
            
            
            (58,910
            )
            
            
            2.96Exercised
            
            
            (646
            )
            
            
            1.05Outstanding,
      September 30, 2009
            
            
            548,800
            
            
            $
            3.05
            
            4.16
            
            $
            239Vested
      or expected to vest, September 30, 2009
            
            
            541,276
            
            
            $
            3.04
            
            4.14
            
            $
            237Exercisable,
      September 30, 2009
            
            
            473,561
            
            
            $
            2.94
            
            3.96
            
            $
            221Exercisable,
      September 30, 2008
            
            
            451,174
            
            
            $
            2.80





The
following table presents weighted-average price and life information regarding
options outstanding and exercisable at September 30, 2009:





Outstanding
            
            ExercisableWeighted-Average
            
            Weighted-
            
            
            
            Weighted-Remaining
            
            Average
            
            
            
            AverageExercise
            
            Number
      of
            
            Contractual
            
            Exercise
            
            
            
            ExercisePrices
            
            Shares
            
            Life
      (Years)
            
            Price
            
            Shares
            
            Price$
      0.74 – $3.10
            
            
            298,685
            
            3.54
            
            $
            1.62
            
            265,902
            
            $
            1.59$3.11
      – $5.76
            
            
            226,333
            
            5.14
            
            4.48
            
            188,873
            
            4.39$5.77
      – $7.59
            
            
            23,782
            
            2.52
            
            7.44
            
            18,786
            
            7.49548,800
            
            4.16
            
            $
            3.05
            
            473,561
            
            $
            2.94





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 on a discretionary basis pursuant to its 2006 Plan. 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 September 30, 2009 was 39,494. Each RSU vests at the rate of
33.33% on each of the first through third anniversaries of the grant date with
final vesting scheduled to occur in March 2012. The fair value related to the
RSUs was calculated based 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 general and administrative expense. The fair values
of the RSUs granted in fiscal years 2009, 2008 and 2007, was approximately
$31,000 (or $1.27 weighted average fair value per share), $62,000 (or $3.53 fair
value per share) and $52,000 (or $3.49 weighted average fair value per share).
The Company recorded compensation related to the RSUs of $43,000, $29,000 and
$8,000 during the years ended September 30, 2009, 2008 and 2007, respectively,
which is included in the total stock-based compensation expense disclosed above.
As of September 30, 2009, there was $64,000 of total unrecognized compensation
cost related to RSUs, which is expected to be recognized over a weighted average
period of 1.7 years.





The
following table presents RSU information for the fiscal year ended September 30,
2009:




- 52
-





Number
      ofRSUsOutstandingOutstanding,
      October 1, 2007
            
            
            15,000Granted
            
            
            17,500Vested
            
            
            (5,004
            )Outstanding,
      September 30, 2008
            
            
            27,496Granted
            
            
            24,500Canceled
            
            
            (1,667
            )Vested
            
            
            (10,835
            )Outstanding,
      September 30, 2009
            
            
            39,494





7.
            RETIREMENT
      SAVINGS PLAN





The
Company has a 401(k) retirement savings plan covering substantially all of the
Company’s full-time domestic employees. Under the provisions of the plan,
employees may contribute a portion of their compensation within certain
limitations. The Company, at the discretion of the Board of Directors, may make
contributions on behalf of its employees under this plan. Such contributions, if
any, become fully vested after five years of continuous service. The Company did
not make any contributions to the 401(k) retirement savings plan in fiscal 2009,
2008 or 2007.





8.
            SEGMENT
      INFORMATION





The
Company has determined that it has only one operating segment. The following
table presents information about the Company’s revenues by product line for the
years ended September 30:




2009
              
              2008
              
              2007Business
      Intelligence Solutions (including Monarch, Monarch
      Data Pump, Monarch RMS, Monarch BI Server, Datawatch ES, Datawatch
      Dashboards, Datawatch Researcher, Visual Insight, iMergence and
      VorteXML)
              71%
              
              67%
              
              67%Content
      Management Solutions (including  Datawatch
      BDS)
              
              17%
              
              16%
              
              14%Service
      Management Solutions (including Visual QSM and
      Visual HD)
              
              12%
              
              17%
              
              19%100%
              
              100%
              
              100%





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




- 53
-


International(Principally
              
              
              IntercompanyDomestic
              
              
              U.K.)
              
              
              Eliminations
              
              
              Total(In
      thousands)Year
      Ended September 30, 2009Total
      revenue
              
              $
              15,967
              
              
              $
              4,558
              
              
              $
              (907
              )
              
              $
              19,618Operating
      income (loss)
              
              
              (5,347
              )
              
              
              53
              
              
              
              —
              
              
              
              (5,294
              )Long-lived
      assets
              
              
              2,981
              
              
              
              40
              
              
              
              —
              
              
              
              3,021Year
      Ended September 30, 2008Total
      revenue
              
              $
              17,476
              
              
              $
              6,875
              
              
              $
              (1,321
              )
              
              $
              23,030Operating
      income (loss)
              
              
              530
              
              
              
              (31
              )
              
              
              —
              
              
              
              499Long-lived
      assets
              
              
              9,515
              
              
              
              64
              
              
              
              —
              
              
              
              9,579Year
      Ended September 30, 2007Total
      revenue
              
              $
              18,521
              
              
              $
              7,800
              
              
              $
              (1,062
              )
              
              $
              25,259Operating
      income (loss)
              
              
              2,091
              
              
              
              (356
              )
              
              
              —
              
              
              
              1,735Long-lived
      assets
              
              
              9,632
              
              
              
              115
              
              
              
              —
              
              
              
              9,747


9.
            QUARTERLY
      RESULTS (UNAUDITED)





Supplementary
Information:




First
              
              
              Second
              
              
              Third
              
              
              Fourth(in
      thousands, except per share amounts)Year
      Ended September 30, 2009:Software
      license and subscription revenue
              
              $
              2,840
              
              
              $
              2,973
              
              
              $
              2,605
              
              
              $
              2,513Maintenance
      and service revenue
              
              
              2,362
              
              
              
              2,119
              
              
              
              2,160
              
              
              
              2,046Cost
      of software licenses and subscriptions
              
              
              530
              
              
              
              531
              
              
              
              574
              
              
              
              613Cost
      of maintenance and services
              
              
              873
              
              
              
              834
              
              
              
              783
              
              
              
              645Expenses
              
              
              3,540
              
              
              
              3,457
              
              
              
              3,077
              
              
              
              3,054Impairment
      of goodwill and other intangible assets
              
              
              —
              
              
              
              6,401
              
              
              
              —
              
              
              
              —Income
      (loss) from operations
              
              
              259
              
              
              
              (6,131
              )
              
              
              331
              
              
              
              247Net
      income (loss)
              
              
              385
              
              
              
              (5,854
              )
              
              
              275
              
              
              
              254Net
      income (loss) per share - basic
              
              $
              0.07
              
              
              $
              (0.99
              )
              
              $
              0.05
              
              
              $
              0.04Net
      income (loss) per share - diluted
              
              $
              0.06
              
              
              $
              (0.99
              )
              
              $
              0.05
              
              
              $
              0.04Year
      Ended September 30, 2008:Software
      license and subscription revenue
              
              $
              3,333
              
              
              $
              3,155
              
              
              $
              3,116
              
              
              $
              2,831Maintenance
      and service revenue
              
              
              2,734
              
              
              
              2,718
              
              
              
              2,659
              
              
              
              2,484Cost
      of software licenses and subscriptions
              
              
              572
              
              
              
              550
              
              
              
              556
              
              
              
              540Cost
      of maintenance and services
              
              
              1,120
              
              
              
              1,177
              
              
              
              1,031
              
              
              
              943Expenses
              
              
              4,175
              
              
              
              4,077
              
              
              
              4,170
              
              
              
              3,620Income
      from operations
              
              
              200
              
              
              
              69
              
              
              
              18
              
              
              
              212Net
      income
              
              
              247
              
              
              
              83
              
              
              
              91
              
              
              
              296Net
      income per share - basic
              
              $
              0.04
              
              
              $
              0.01
              
              
              $
              0.02
              
              
              $
              0.05Net
      income per share - diluted
              
              $
              0.04
              
              
              $
              0.01
              
              
              $
              0.02
              
              
              $
              0.05


- 54
-


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





Not
Applicable.








Item 9A. CONTROLS AND
PROCEDURES





(a)
            Evaluation
      of Disclosure Controls and
Procedures





The
principal executive officer and principal financial officer, with the
participation of the Company’s management, evaluated the effectiveness of the
Company’s disclosure controls and procedures as of the end of the period covered
by this Annual Report on Form 10-K.  The term “disclosure controls and
procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act,
means controls and other procedures of a company that are designed to ensure
that information required to be disclosed by a company in the reports that it
files or submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the SEC’s rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed by a
company in the reports that it files or submits under the Exchange Act is
accumulated and communicated to the company’s management, including its
principal executive and principal financial officers, as appropriate to allow
timely decisions regarding required disclosure. Management recognizes that any
system of controls and procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving their objectives. Based upon that
evaluation, the Company’s principal executive officer and principal financial
officer concluded that the Company’s disclosure controls and procedures are
effective in enabling the Company to record, process, summarize and report
information required to be included in the Company’s periodic SEC filings within
the required time period.





(b)
            Changes
      in Internal Controls





No
changes in our internal control over financial reporting (as defined in Rules
13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the quarter
ended September 30, 2009 that have materially affected, or are reasonably likely
to materially affect, our internal control over financial
reporting.




(c)
            Management’s
      Report on Internal Control over Financial
  Reporting





Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rule 13a-15(f) and 15d-15(f)
under the Exchange Act. Internal control over financial reporting is designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles (“GAAP”). Internal control over
financial reporting includes those policies and procedures that:





1)
            pertain
      to the maintenance of records that, in reasonable detail, accurately and
      fairly reflect the transactions and dispositions of the assets of the
      Company;


2)
            provide
      reasonable assurance that transactions are recorded as necessary to permit
      preparation of financial statements in accordance with GAAP, and that
      receipts and expenditures of the company are being made only in accordance
      with authorizations of management and directors of the Company;
      and


3)
            provide
      reasonable assurance regarding prevention or timely detection of
      unauthorized acquisition, use or disposition of the Company’s assets that
      could have a material effect on the financial
  statements.





Because
of its inherent limitations, a system of internal control over financial
reporting can provide only reasonable assurance and may not prevent or detect
misstatements. Projections of any evaluation of effectiveness to future periods
are subject to the risk that controls may become inadequate because of changes
in conditions, or that the degree of compliance with the policies or procedures
may deteriorate.





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Our
management assessed the effectiveness of our internal control over financial
reporting as of September 30, 2009. In making its assessment, management used
the criteria set forth in “Internal Control–Integrated
Framework” issued by the Committee of Sponsoring Organizations (“COSO”)
of the Treadway Commission. Based on this assessment, our management concluded
that our internal control over financial reporting is effective as of September
30, 2009.





This
annual report does not include an attestation report of the Company’s registered
public accounting firm regarding internal control over financial reporting.
Management’s report was not subject to attestation by the Company’s registered
public accounting firm pursuant to temporary rules of the Securities and
Exchange Commission that permit the Company to provide only management’s report
in this annual report.








Item 9B. OTHER
INFORMATION





None.




























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PART III








Item
10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE
REGISTRANT





Information
with respect to Directors may be found under the caption “Election of Directors”
appearing in the Company’s definitive Proxy Statement for the Annual Meeting of
Shareholders for the fiscal year ended September 30, 2009. Such information is
incorporated herein by reference. Information with respect to the Company’s
executive officers may be found under the caption “Executive Officers of the
Registrant” appearing in Part I of this Annual Report on Form 10-K.








Item
11.  EXECUTIVE COMPENSATION





The
information set forth under the captions “Compensation and Other Information
Concerning Directors and Officers” appearing in the Company’s definitive Proxy
Statement for the Annual Meeting of Shareholders for the fiscal year ended
September 30, 2009 is incorporated herein by reference.








Item 12.  SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT





The
information set forth under the caption “Principal Holders of Voting Securities”
and “Equity Compensation Plans” appearing in the Company’s definitive Proxy
Statement for the Annual Meeting of Shareholders for the fiscal year ended
September 30, 2009 is incorporated herein by reference.








Item 13.  CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS





The
information set forth under the caption “Certain Transactions” appearing in the
Company’s definitive Proxy Statement for the Annual Meeting of Shareholders for
the fiscal year ended September 30, 2009 is incorporated herein by
reference.








Item
14.  PRINCIPAL ACCOUNTING FEES AND SERVICES





The
information set forth under the caption “Principal Accountant Fees and Services”
appearing in the Company’s definitive Proxy Statement for the Annual Meeting of
Shareholders for the fiscal year ended September 30, 2009 is incorporated herein
by reference.











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PART
IV





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





The
following documents are filed as part of this report:





(a)
            1.  Consolidated
      Financial Statements





Report of
Independent Registered Public Accounting Firm


Consolidated
Balance Sheets as of September 30, 2009 and 2008


Consolidated
Statements of Operations for the Years Ended September 30, 2009, 2008 and
2007


Consolidated
Statements of Shareholders’ Equity and Comprehensive Income (Loss) for the Years
Ended September 30, 2009, 2008 and 2007


Consolidated
Statements of Cash Flows for the Years Ended September 30, 2009, 2008 and
2007


Notes to
Consolidated Financial Statements





2.  Financial
Statement Schedules





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





3.  List
of Exhibits











Ex.
    No.
            
            Description(1)
            
            3.1
            
            Restated
      Certificate of Incorporation of the Registrant (Exhibit
    3.2)(6)
            
            3.2
            
            Certificate
      of Amendment of Restated Certificate of Incorporation of the Registrant
      (Exhibit 3.2)(1)
            
            3.3
            
            By-Laws,
      as amended, of the Registrant (Exhibit 3.3)(1)
            
            4.1
            
            Specimen
      certificate representing the Common Stock (Exhibit 4.4)(4)
            
            4.2
            
            Warrant
      to Purchase Stock issued to Silicon Valley Bank, dated January 17, 2001
      (Exhibit 4.1)(11)
            
            10.2*
            
            Form
      of Incentive Stock Option Agreement of the Registrant (Exhibit
      10.2)(11)
            
            10.3*
            
            Form
      of Nonqualified Stock Option Agreement of the Registrant (Exhibit
      10.3)(1)
            
            10.4
            
            Software
      Development and Marketing Agreement by and between Personics Corporation
      and Raymond Huger, dated January 19, 1989 (Exhibit
  10.12)(9)
            
            10.5
            
            Option
      Purchase Agreement by and among Datawatch Corporation, Personics
      Corporation and Raymond J. Huger dated April 29, 2005. (Exhibit
      10.1)(8)
            
            10.6
            
            Distribution
      Agreement, dated December 10, 1992, by and between Datawatch Corporation
      and Ingram Micro Inc. (Exhibit 10.2)(2)
            
            10.7*
            
            1996
      Non-Employee Director Stock Option Plan, as amended on December 10, 1996
      (Exhibit 10.30)(2)
            
            10.8*
            
            1996
      International Employee Non-Qualified Stock Option Plan (Exhibit
      10.31)(8)
            
            10.9*
            
            1996
      Stock Plan as amended as of March 7, 2003 (Exhibit
10.1)(3)
            
            10.10
            
            Indemnification
      Agreement between Datawatch Corporation and James Wood, dated January 12,
      2001 (Exhibit 10.1)(3)
            
            10.11
            
            Indemnification
      Agreement between Datawatch Corporation and Richard de J. Osborne, dated
      January 12, 2001 (Exhibit 10.2)(5)
            
            10.12
            
            Form
      of Indemnification Agreement between Datawatch Corporation and each of its
      Non-Employee Directors (Exhibit 10.1)(5)
            
            10.13*
            
            Advisory
      Agreement, dated April 5, 2001, by and between Datawatch Corporation and
      Richard de J. Osborne (Exhibit 10.2)(7)
            
            10.14*
            
            Executive
      Agreement, dated April 25, 2002, by and between Datawatch Corporation and
      John Kitchen (Exhibit 10.2)(10)
            
            10.15
            
            Stock
      Purchase Agreement among Datawatch Corporation, Mergence Technologies
      Corporation and the Management Sellers, dated as of August 11, 2005
      (Exhibit 2.1).(10)
            
            10.16
            
            Form
      of Stock Purchase Agreement among Datawatch Corporation, Mergence
      Technologies Corporation and the Non-Management Sellers, dated as of
      August 11, 2005 (Exhibit 2.2)(12)
            
            10.17*
            
            Form
      of Lock-up Agreement between Datawatch Corporation and each Executive
      Officer of Datawatch  - 58
-
 Corporation,
      dated September 26, 2005 (Exhibit 99.1)(12)
              
              10.18
              
              Sublease
      Agreement, dated September 28, 2005, between Tellabs Operations, Inc., and
      Datawatch Corporation (Exhibit 99.2)(13)
              
              10.19
              
              February
      2006 Amendment to Software Development and Marketing Agreement, dated
      February 21, 2006 by and among the Company, Personics Corporation, Raymond
      J. Huger and Math Strategies (Exhibit 10.1)(13)
              
              10.20
              
              Amendment
      to Option Purchase Agreement, dated February 21, 2006 by and among the
      Company, Personics Corporation, Raymond J. Huger and Math Strategies
      (Exhibit 10.2)(14)
              
              10.21*
              
              2006
      Equity Compensation and Incentive Plan(15)
              
              10.22*
              
              Form
      of 2006 Non-Qualified Stock Option Agreement for Directors (Exhibit
      10.26)(15)
              
              10.23*
              
              Form
      of 2006 Non-Qualified Stock Option Agreement for Officers (Exhibit
      10.27)(15)
              
              10.24*
              
              Form
      of 2006 Incentive Stock Option Agreement for Officers (Exhibit
      10.28)(16)
              
              10.25
              
              Asset
      Purchase Agreement dated as of March 10, 2006 between Datawatch
      Corporation and ClearStory Systems, Inc. (Exhibit 10.1)(17)
              
              10.26*
              
              Executive
      Agreement, dated March 26, 2007, between Datawatch Corporation and Murray
      Fish (Exhibit 10.1)(18)
              
              10.27*
              
              Form
      of Restricted Stock Unit Agreement for Directors (Exhibit
      10.1)(19)
              
              10.28*
              
              Management
      Consulting Agreement dated October 22, 2007 by and between Robert W.
      Hagger and Datawatch Corporation (Exhibit 10.1)21.1
              
              Subsidiaries
      of the Registrant (filed herewith)23.1
              
              Consent
      of Independent Registered Pubic Accounting Firm (filed
      herewith)31.1
              
              Certification
      of the Chief Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002. (filed herewith)31.2
              
              Certification
      of the Chief Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002. (filed herewith)32.1
              
              Certification
      of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
      (furnished herewith)32.2
              
              Certification
      of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
      (furnished herewith)





*
            
            Indicates
      a management contract or compensatory plan or
  contract.





Note:  The
      number given in parenthesis next to each item listed above indicates the
      corresponding exhibit in each filing listed below.(1)
            
            Previously
      filed as an exhibit to Registration Statement 33-46290 on Form S-1 and
      incorporated herein by reference.(2)
            
            Previously
      filed as an exhibit to Registrant’s Annual Report on Form 10-K for the
      fiscal year ended September 30, 1996 and incorporated herein by
      reference.(3)
            
            Previously
      filed as an exhibit to Registrant’s Current Report on Form 8-K dated
      February 2, 2001 and incorporated herein by reference.(4)
            
            Previously
      filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q for the
      quarter ended December 31, 2000 and incorporated herein by
      reference.(5)
            
            Previously
      filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q for the
      quarter ended March 31, 2001 and incorporated herein by
      reference.(6)
            
            Previously
      filed as an exhibit to Registrant’s Annual Report on Form 10-K for the
      fiscal year ended September 30, 2001 and incorporated herein by
      reference.(7)
            
            Previously
      filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q for the
      quarter ended June 30, 2002 and incorporated herein by
      reference.(8)
            
            Previously
      filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q for the
      quarter ended March 31, 2003 and incorporated herein by
      reference.(9)
            
            Previously
      filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q for the
      quarter ended March 31, 2004 and incorporated herein by
      reference.(10)
            
            Previously
      filed as an exhibit to Registrant’s Current Report on Form 8-K dated
      August 20, 2004 and incorporated herein by reference.(11)
            
            Previously
      filed as an exhibit to Registrant’s Current Report on Form 8-K dated
      November 2, 2004 and incorporated herein by reference.(12)
            
            Previously
      filed as an exhibit to Registrant’s Current Report on Form 8-K dated
      September 26, 2005 and incorporated herein by
reference.(13)
            
            Previously
      filed as an exhibit to Registrant’s Current Report on Form 8-K dated
      February 21, 2006 and incorporated herein by
  reference.  - 59
-
 (14)
            
            Previously
      filed as Appendix A to Registrant’s Definitive Proxy Statement dated
      January 30, 2006 and incorporated herein by reference.(15)
            
            Previously
      filed as an exhibit to Registrant’s Annual Report on Form 10-K for the
      fiscal year ended September 30, 2006 and incorporated herein by
      reference.(16)
            
            Previously
      filed as an exhibit to Registrant’s Current Report on Form 8-K dated March
      10, 2006 and incorporated herein by reference.(17)
            
            Previously
      filed as an exhibit to Registrant’s Current Report on Form 8-K dated March
      26, 2007 and incorporated herein by reference.(18)
            
            Previously
      filed as an exhibit to Registrant’s Current Report on Form 8-K dated
      August 2, 2007 and incorporated herein by reference.(19)
            
            Previously
      filed as an exhibit to Registrant’s Current Report on Form 8-K dated
      October 23, 2007 and incorporated herein by
  reference.








(b)  Exhibits





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








(c)  Financial
Statement Schedules





Not
applicable.


























- 60
-





SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.





Datawatch
      CorporationDate:
            December21,2009
            By:
            /s/ Kenneth P. BeroKenneth
      P. BeroPresident,
      Chief Executive Officer
              and
      Director





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





SIGNATURE
            
            
            TITLE
            
            DATE/s/
      Kenneth P. Bero
            
            
            President,
      Chief Executive Officer and Director
            
            December21,2009Kenneth
      P. Bero
            
            
            (Principal
      Executive Officer)/s/
      Murray P. Fish
            
            
            Chief
      Financial Officer, Treasurer, Vice President of
            
            December21,
      2009Murray
      P. Fish
            
            
            Finance
      and Assistant Secretary(Principal
      Financial and Accounting Officer)/s/
      Richard de J. Osborne
            
            
            Chairman
      of the Board
            
            December21,2009Richard
      de J. Osborne/s/
      Thomas H. Kelly
            
            
            Director
            
            December21,2009Thomas
      H. Kelly/s/
      Terry W. Potter
            
            
            Director
            
            December21,2009Terry
      W. Potter/s/
      David T. Riddiford
            
            
            Director
            
            December21,2009David
      T. Riddiford/s/
      William B. Simmons, Jr.
            
            
            Director
            
            December21,2009William
      B. Simmons, Jr./s/
      James Wood
            
            
            Director
            
            December21,2009James
      Wood





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