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, 2007
                  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 x     No
        o
 
 Indicate
        by check mark if disclosure of delinquent filers pursuant to Item 405 of
        Regulation S-K is not contained herein, and will not be contained, to the
        best
        of registrant’s knowledge, in definitive proxy or information statements
        incorporated by reference in Part III of this Form 10-K or any
        amendment to this Form 10-K.    ý
 
 Indicate
        by check mark whether the registrant is a large accelerated filer, an
        accelerated filer or a non-accelerated filer.  See definitions of
“accelerated filer” and “large accelerated filer” in Rule 12b-2 of the
        Exchange Act.
  Large
                  accelerated filer o
              Accelerated
                  filer  o
              Non-accelerated
                  filer 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, 2007,
        the last business day of the Company’s most recently completed second fiscal
        quarter, as reported by the NASDAQ Capital Market was $12,418,946.
 
 The
        number of shares of the registrant’s common stock, $.01 par value, outstanding
        as of December 28, 2007 was 5,763,215.
 
 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,
        2007.  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
              12Item
                  3.
              Legal
                  Proceedings
              12Item
                  4.
              Submission
                  of Matters to a Vote of Security Holders
              12Part IIItem
                  5.
              Market
                  for Registrant’s Common Equity and Related Shareholder
                  Matters
              14Item
                  6.
              Selected
                  Consolidated Financial Data
              14Item
                  7.
              Management’s
                  Discussion and Analysis of Financial Condition and Results of
                  Operations
              15Item
                  7A.
              Quantitative
                  and Qualitative Disclosures about Market Risk
              29Item
                  8.
              Financial
                  Statements and Supplementary Data
              30Item
                  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 Enterprise Information
        Management (“EIM”), helps companies make better decisions and solve business
        problems by simplifying access to information. 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 20,000 organizations worldwide rely on 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 offers its enterprise products through the sale of perpetual licenses
        as
        well as a subscription pricing model that allows customers to begin using
        the
        Company’s products at a lower initial cost of software acquisition. Subscription
        terms typically run 12 months or 24 months and 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
        Company is a Delaware corporation with executive offices located at 271 Mill
        Road, Quorum Office Park, Chelmsford, MA 01824 and the Company’s telephone
        number is (978) 441-2200.  Periodic reports are made available to the
        public, free of charge, on the Company’s website, www.datawatch.com and
        through the SEC’s website, www.sec.gov as soon
        as reasonably practicable after they have been filed with the SEC.
 
 PRODUCTS
 
 Monarch
        - Datawatch is best
        known for its world-leading desktop report mining and business intelligence
        application called Monarch. More than 450,000 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 Open Data Base Connectivity (“ODBC”) sources
        as well as reports.  The Monarch product line represented
        approximately 54% of total revenues for the fiscal year 2007.
 
 Monarch
        Data Pump - Monarch
        Data Pump (“MDP”) provides powerful information delivery and data Extract,
        Transform and Load (“ETL”) capabilities in one automated solution, without
        programming. Combining Datawatch’s Monarch Report Mining/Data Mining engine with
        the Microsoft.NET framework, MDP delivers a highly scalable and easily
        administered solution to acquire, combine, and monitor customized data, and
        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 SQL Server 2005 Integration Services.
 
 Monarch|RMS
        - Monarch|RMS
        (Report Mining Server) is a web-based report mining and analysis solution
        that
        integrates with any existing Enterprise Record Management (“ERM”), document or
        content management archiving solution including Datawatch|BDS, IBM OnDemand
        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.
 
 Datawatch|ES–
        Datawatch|ES is an
        enterprise Business Intelligence (“BI”) 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,
  -
            3
            -
 with
        no
        new programming or report writing. Datawatch|ES automatically archives report
        data and binary documents in an enterprise report and document warehouse
        and
        provides users a unified point of entry to view, analyze and share information
        over the Internet.
 
 Datawatch|BDS–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. 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, and Monarch|RMS for web-enabled transformation of business documents
        into customized data for easy analysis.
 
 Datawatch|MailManager–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|Insight–Visual|Insightis
        a performance
        management solution that provides web based scorecarding, knowledge management
        and Key Performance Indicator (KPI) reporting. Built on the Datawatch|Researcher
        .NET platform, Visual|Insight not only allows for performance management,
        but
        can actually facilitate performance improvement. Highly customizable,
        Visual|Insight can access data from any and all organizational databases,
        as
        well as having the ability to take advantage of existing trusted data sources
        such as reports, for ease and speed of installation and a quick return on
        investment.
 
 Datawatch|Researcher–Datawatch|Researcher
        is a
        development platform for building performance management, content and data
        aggregation and workflow solutions. NET based, Datawatch|Researcher searches
        inter-related data, documents, and communications scattered over multiple
        and
        disparate repositories including databases, document and content management
        systems, email repositories, the Internet and more. It then merges and analyzes
        the results for uses in balanced scorecards, KPI reporting, problem management
        and business process management. It also can turn the results into comprehensive
        actionable case records for easier compliance, auditing, accounting, and
        billing
        processes.
 
 Visual|QSM
        - Visual|QSM is an
        Internet-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, a market leader in Europe, also provides
        advanced service level management capabilities, integrated change management
        features, business process automation tools and one of the industry’s easiest to
        learn and use interfaces.  The Visual|QSM product line represented
        approximately 18% of total revenues for fiscal year 2007.
 
 Visual|Help
        Desk - Visual|Help Desk
        (“Visual|HD”), leverages the IBM Lotus Domino platform to provide a 100%
        web-based help desk and call center solution. Cost effective and easy to
        deploy,
        Visual|HD is an enterprise-wide support solution that supports an organization’s
        existing IT infrastructure. Visual|HD has the additional ability to utilize
        XML-based Web Services as well as the ability to integrate directly with
        IBM
        enterprise applications.
 
 VorteXML
        - VorteXML software
        quickly and easily converts any structured text output generated from any
        system
        into valid XML for web services and more using any DTD or XDR schema without
        programming.  VorteXML dramatically speeds up and reduces the cost of
        enabling current applications for web services, implementing enterprise XML
        solutions, putting legacy output on the web (including bill presentment),
        and
        more.  The VorteXML solution suite is comprised of two software
        products that work together: VorteXML Designer, a
   -
            4
            -
 desktop
        tool that provides users a visual interface that allows users to extract,
        transform and map data from existing text documents into XML without
        programming; and VorteXML Server,a scalable, high-volume
        server that automates the extraction and conversion of text documents into
        XML.
 
 The
        Company also receives license royalties for its iMergence iStore product
        primarily from a provider of services to the financial services industry.
        iMergence iStore is a report management solution which manages
        computer-generated reports, mines the data contained in them, and allows
        users
        to interactively merge and transform them into new reports.
 
 PRICING
 
 The
        Company’s desktop products are sold under single and multi-user licenses. A
        single user license for Monarch Standard Edition is priced at $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 business
        service management products are primarily sold under server-based licenses
        with
        named-user and concurrent-user client licenses.  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 $20,000.
        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 can cost
        significantly more depending on the number of software modules, software
        server
        licenses and 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.
 
 The
        Company offers certain of its 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 2007, 2006 and 2005, one distributor, Ingram Micro Inc., represented
        approximately 15%, 16%
   -
            5
            -
 and
        19%,
        respectively, of the Company’s total revenue. During fiscal 2007, 2006 and 2005,
        another distributor, Tech Data Corporation, represented approximately 13%,
        13%,
        and 7%, respectively, of the Company’s total revenue. No other customer
        accounted for more than 10% of the Company’s total revenue in fiscal 2007, 2006
        or 2005. 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 31%, 32% and 36% of the
        Company’s total revenue for fiscal 2007, 2006 and 2005,
        respectively.  See Note 10 to the Company’s Consolidated Financial
        Statements for segment information.
 
 RESEARCH
        AND
        DEVELOPMENT
 
 The
        Company believes that timely development of new products and enhancements
        to its
        existing products is essential to maintain strong positions in its markets.
        Datawatch intends to continue to invest significant amounts in research and
        product development to ensure that its products meet the current and future
        demands of its markets as well as to take advantage of evolving technology
        trends.
 
 Datawatch’s
        product development efforts are conducted through in-house software development
        engineers and by external developers.  External developers are
        compensated 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.
 
 Other
        Datawatch products have been developed through in-house software development
        or
        by independent software engineers hired under contract. Datawatch maintains
        source code and full product control for these products, which include
        Datawatch|BDS, Datawatch|ES, Visual|QSM, and Visual|HD products. Datawatch|ES,
        Visual|QSM, and Visual|HD are trademarks of Datawatch Corporation. Visual|Help
        Desk is a registered trademark of Auxilor, Inc. (“Auxilor”), a wholly-owned
        subsidiary of Datawatch Corporation.
 
 During
        fiscal 2004, the Company acquired Mergence Technologies Corporation which
        had a
        branch software development and testing office in the Philippines. Mergence,
        which was renamed Datawatch Technologies Corporation (“DTC”) coincident with the
        acquisition, developed the iMergence iStore and Datawatch|Researcher products
        at
        its facilities in the United States and the Philippines prior to the
        acquisition. The Company has integrated the Philippines development branch
        as an
        alternative development facility for its other enterprise
  -
            6
            -
 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 $2,951,000, $2,094,000 and
        $2,031,000 for fiscal years 2007, 2006 and 2005, respectively.
 
 BACKLOG
 
 The
        Company’s software products are generally shipped within three business days of
        receipt of an order.  Accordingly, the Company does not believe that
        backlog for its products is a meaningful indicator of future business. The
        Company does maintain a backlog of services related to its Datawatch|BDS,
        Datawatch|ES, Visual|QSM, and Visual|HD business. While this services backlog
        will provide future revenue to the Company, the Company believes that it
        is not
        a meaningful indicator of future business.
 
 COMPETITION
 
 The
        software industry is highly competitive and is characterized by rapidly changing
        technology and evolving industry standards.  Datawatch competes with a
        number of companies including Actuate Corporation, IBM, 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.
 
 PRODUCTION
 
 Production
        of Datawatch’s products involves the duplication of compact disks and the
        printing of user manuals, packaging and other related materials. High volume
        compact disk duplication is performed by 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 21, 2007, Datawatch had 116 full-time and 5 contract, temporary or
        part-time employees, including 34 engaged in marketing, sales, and customer
        service; 35 engaged in product consulting, training and technical support;
        31
        engaged in product management, development and quality assurance; 19 providing
        general, administrative, accounting, and IT functions; and 2 engaged in software
        production and warehousing.
 
 -
            7
            -
 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.
 
 Fluctuations
        in Quarterly
        Operating Results
  The
        Company’s future operating results could vary substantially from
        quarter-to-quarter because of uncertainties and/or risks associated with
        such
        things as technological change, competition, and delays in the introduction
        of
        products or product enhancements and general market trends. Historically,
        the
        Company has operated with little backlog of orders because its software products
        are generally shipped as orders are received.  As a result, net sales
        in any quarter are substantially dependent on orders booked and shipped in
        that
        quarter.  Further, the Company’s increased sales under its
        subscription sales model could result in decreased revenues over the short
        term.
        Because the Company’s staffing and operating expenses are based on anticipated
        revenue levels and a high percentage of the Company’s costs are fixed in the
        short-term, small variations in the timing of revenues can cause significant
        variations in operating results from quarter-to-quarter. Because of these
        factors, the Company believes that period-to-period comparisons of its results
        of operations are not necessarily meaningful and should not be relied upon
        as
        indications of future performance. There can be no assurance that the Company
        will not experience such variations in operating results in the future or
        that
        such variations will not have a material adverse effect on the Company’s
        business, financial condition or results of operations.
 
 Weakening
        of World Wide
        Economic Conditions and the Computer Software Market May Result in Lower
        Revenue Growth Rates or Decreased Revenues
  The
        revenue growth and profitability of the Company’s business depends on the
        overall demand for computer software and services, particularly in the markets
        in which it competes. Because the Company’s sales are primarily to major
        corporate customers, its business also depends on general economic and business
        conditions.  A softening of demand for computer software and services
        caused by a weakening of the economy in the United States or abroad, may
        result
        in lower revenue growth rates, decreased revenues and reduced profitability.
        In
        addition, terrorist attacks against the United States, and the United States
        military response to these attacks have added to economic and political
        uncertainty which may adversely affect worldwide demand for computer software
        and services and result in significant fluctuations in the value of foreign
        currencies. In a weakened economy, the Company cannot be assured that it
        will be
        able to effectively promote future growth in its software and services revenues
        or maintain profitability.
 
 -
            8
            -
 Dependence
        on Principal
        Products
  In
        the
        year ended September 30, 2007, Monarch, Visual|QSM, Datawatch|BDS and
        Datawatch|ES accounted for approximately 54%, 18%, 14% and 8%, respectively,
        of
        the Company’s total revenue. The Company is primarily dependent on its Monarch,
        Visual|QSM, Datawatch|BDS 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.
 
 Dependence
        on New
        Introductions; New Product Delays
  Growth
        in
        the Company’s business depends in substantial part on the continuing
        introduction of new products. The length of product life cycles depends in
        part
        on end-user demand for new or additional functionality in the Company’s
        products. If the Company fails to accurately anticipate the demand for, or
        encounters any significant delays in developing or introducing, new products
        or
        additional functionality on its products, there could be a material adverse
        effect on the Company’s business. Product life cycles can also be affected by
        the introduction by suppliers of operating systems of comparable functionality
        within their products. The failure of the Company to anticipate the introduction
        of additional functionality in products developed by such suppliers could
        have a
        material adverse effect on the Company’s business. In addition, the Company’s
        competitors may introduce products with more features and lower prices than
        the
        Company’s products. Such increase in competition could adversely affect the life
        cycles of the Company’s products, which in turn could have a material adverse
        effect on the Company’s business.
 
 Software
        products may contain undetected errors or failures when first introduced
        or as
        new versions are released.  There can be no assurance that, despite
        testing by the Company and by current and potential end-users, errors will
        not
        be found in new products after commencement of commercial shipments, resulting
        in loss of or delay in market acceptance. Any failure by the Company to
        anticipate or respond adequately to changes in technology and customer
        preferences, or any significant delays in product development or introduction,
        could have a material adverse effect on the Company’s business.
 
 International
        Sales
  In
        the
        years ended September 30, 2007, 2006 and 2005, international
        sales accounted for approximately  31%, 32% and 36%,
        respectively, of the Company’s total revenue.  The Company anticipates
        that international sales will continue to account for a significant percentage
        of its total revenue.  A significant portion of the Company’s total
        revenue will therefore be subject to risks associated with international
        sales,
        including unexpected changes in legal and regulatory requirements, changes
        in
        tariffs, exchange rates and other barriers, political and economic instability,
        possible effects of war and acts of terrorism, difficulties in account
        receivable collection, difficulties in managing distributors or representatives,
        difficulties in staffing and managing international operations, difficulties
        in
        protecting the Company’s intellectual property overseas, seasonality of sales
        and potentially adverse tax consequences.
 
 Acquisition
        Strategy
  As
        evidenced by the May 2006 acquisition of the IDARS business from ClearStory
        Systems, Inc., the August 2004 acquisition of Mergence Technologies
        Corporation and the October 2002 acquisition of Auxilor Inc., the Company
        continues to address the need to develop new products, in part, through the
        acquisition of other companies. Acquisitions involve numerous risks including
        difficulties in the assimilation of the operations, technologies and products
        of
        the acquired companies, the diversion of management’s attention from other
        business concerns, risks of entering markets in which the Company has no
        or
        limited direct prior experience and where competitors in such markets have
        stronger market positions, and the potential loss of key employees of the
        acquired company.  Achieving and maintaining the anticipated benefits
        of an acquisition will depend in part upon whether the integration of the
        companies’ business is accomplished in an efficient and effective manner, and
        there
  -
            9
            -
 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 our 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 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 PC
        Software Industry
  The
        software market for personal computers is highly competitive and characterized
        by continual change and improvement in technology. Several of the Company’s
        existing and potential competitors, including BMC Software, Actuate Corporation,
        Hyperion, 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.
 
 -
            10
            -
 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, are creating
        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, 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 may 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 relies on distributors and resellers to provide post-sales
        service and support, and any deficiencies in such service and support could
        adversely affect the Company’s business.
 
 Subscription
        Sales Model
        Risk
  During
        fiscal 2004, the Company introduced a subscription sales model for the sale
        of
        its enterprise products.  This pricing model allows customers to begin
        using the Company’s products at a lower initial cost of software acquisition
        when compared to the more traditional perpetual license sale. While the
        subscription sales model is designed to increase the number of enterprise
        solutions sold and also reduce dependency on short-term sales by building
        a
        recurring revenue stream, it introduces increased risks for the Company
        primarily associated with the timing of revenue recognition and reduced cash
        flows. The subscription model delays revenue recognition when compared to
        the
        typical perpetual license sale and also, as the Company allows termination
        of
        certain subscriptions with 90 days notice, could result in decreased revenue
        for
        solutions sold under the model if the Company experiences a high percentage
        of
        subscription cancellations during the first 12 months or 24 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.
 
 -
            11
            -
 Volatility
        of Stock
        Price
  As
        is
        frequently the case with the stocks of high technology companies, the market
        price of the Company’s common stock has been, and may continue to be, volatile.
        Factors such as quarterly fluctuations in results of operations, increased
        competition, the introduction of new products by the Company or its competitors,
        expenses or other difficulties associated with assimilating companies acquired
        by the Company, changes in the mix of sales channels, the timing of significant
        customer orders, and macroeconomic conditions generally, may have a significant
        impact on the market price of the stock of the Company. Any shortfall in
        revenue
        or earnings from the levels anticipated by securities analysts could have
        an
        immediate and significant adverse effect on the market price of the Company’s
        common stock in any given period. In addition, the stock market has from
        time to
        time experienced extreme price and volume fluctuations, which have particularly
        affected the market price for many high technology companies and which, on
        occasion, have appeared to be unrelated to the operating performance of such
        companies.
 
 
 Item
        1B.  UNRESOLVED STAFF COMMENTS
 
 Not
        applicable.
 
 
 Item
        2.  PROPERTIES
 
 The
        Company is currently headquartered in 14,683 square feet of leased office
        space
        in Chelmsford, Massachusetts pursuant to a sublease agreement executed on
        September 28, 2005. The sublease expires in June 2011. The sublease contains
        annual rent escalations for each year of the sublease as well as an abatement
        of
        rent during the first twelve months of the sublease term. The aggregate rent
        for
        the remaining term of the sublease is approximately $623,000. 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 5, 2007 are as follows:
 
 -
            12
            -
  Robert
                  W. Hagger
              
              59
              
              President,
                  Chief Executive Officer and DirectorKenneth
                  P. Bero
              
              53
              
              Chief
                  Operating Officer, Senior Vice President of Sales and
                  DirectorJohn
                  H. Kitchen, III
              
              52
              
              Chief
                  Marketing Officer, Senior Vice President and SecretaryMurray
                  P. Fish
              
              56
              
              Chief
                  Financial Officer, Vice President of Finance, Treasurer andAssistant
                  SecretaryDaniel
                  F. Incropera
              
              43
              
              Corporate
                  Controller & Vice President
 
 Officers
        are elected by, and serve at the discretion of, the Board of
        Directors.
 
 ROBERT
        W. HAGGER, President, Chief
        Executive Officer and Director.  Mr. Hagger assumed the
        positions of President, Chief Executive Officer and Director on July 9,
        2001. Prior thereto, and since November 1, 1997, Mr. Hagger was Senior
        Vice President of International Operations of the Company. Prior to that
        and
        since March 1997, Mr. Hagger was Managing Director of the Company’s
        wholly-owned subsidiary Datawatch International Limited. Prior to joining
        Datawatch, from 1993 to March 1997, Mr. Hagger was founder and
        Managing Director of Insight Strategy Management Ltd. Prior to that, he was
        Managing Director of Byrne Fleming Ltd.  On October 19, 2007, the
        Company announced that Mr. Hagger would be retiring from his position as
        President and Chief Executive Officer effective January 1, 2008.  Mr.
        Hagger will remain a Director of the Company for at least twelve months
        following his resignation subject to successful re-election at the next
        shareholder meeting.
 
 KENNETH
        P. BERO, Chief Operating
        Officer, Senior Vice President of Sales and Director. Mr. Bero was
        appointed Chief Operating Officer & Senior Vice President of Sales effective
        April 1, 2007. Mr. Bero had most recently been Senior Vice President of
        Enterprise Solutions for the Company. 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, as
        Nasdaq listed software development and services company. On October 19, 2007,
        the Company announced the appointment of Mr. Bero as the Company’s new Chief
        Executive Officer effective January 1, 2008. Mr. Bero was also appointed
        a
        Director of the Company effective October 19, 2007.
 
 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.
 
 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 private business intelligence
        company.  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 publicly held company.
 
 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. which
        was
        a publicly traded software company providing network service management
        solutions.
 
 
 -
            13
            -
 PART II
 
 Item
        5.   MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED
        SHAREHOLDER MATTERS
 
 The
        Registrant’s common stock is listed and traded on the Nasdaq Capital Market
        (formerly the Nasdaq SmallCap Market) under the symbol DWCH.  The
        range of high and low closing prices during each fiscal quarter for the last
        two
        fiscal years is set forth below:
 
 For
                  the Year
                  Ended
              
              Common
                  StockSeptember 30,
                  2007
              
              High
                  ($)
              
              Low
                  ($)4th
                  Quarter
              
              6.20
              
              4.213rd
                  Quarter
              
              6.07
              
              2.852nd
                  Quarter
              
              3.10
              
              2.451st
                  Quarter
              
              2.93
              
              1.89
 
 For
                  the Year
                  Ended
              
              Common
                  StockSeptember 30,
                  2006
              
              High
                  ($)
              
              Low
                  ($)4th
                  Quarter
              
              3.68
              
              2.473rd
                  Quarter
              
              3.85
              
              3.362nd
                  Quarter
              
              5.38
              
              3.531st
                  Quarter
              
              4.85
              
              3.04
 
 There
        are
        approximately 100 shareholders of record as of December 5,
        2007.  The Company believes that the number of beneficial holders of
        common stock exceeds 2,000.  The last reported sale of the Company’s
        common stock on December 28, 2007 was at $5.93.
 
 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, 2007 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, 2007 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.
  -
            14
            -
 Statements
                    of Operations
                    Data:Years
                    Ended
                    September 30,
                
                2007
                
                
                2006
                
                
                2005
                
                
                2004
                
                
                2003(In
                    thousands, except per share
                    data)Revenue
                
                $
                25,259
                
                
                $
                20,811
                
                
                $
                21,511
                
                
                $
                19,335
                
                
                $
                17,712Costs
                    and Expenses
                
                
                23,524
                
                
                
                21,345
                
                
                
                20,823
                
                
                
                18,410
                
                
                
                16,886Income
                    (loss) from Operations
                
                
                1,735
                
                
                
                (534
                )
                
                
                688
                
                
                
                925
                
                
                
                826Net
                    Income (Loss)
                
                $
                1,669
                
                
                $
                (555
                )
                
                $
                800
                
                
                $
                1,085
                
                
                $
                847Earnings
                    (Loss) per Common Share:Basic
                
                $
                0.30
                
                
                $
                (0.10
                )
                
                $
                0.15
                
                
                $
                0.21
                
                
                $
                0.16Diluted
                
                $
                0.29
                
                
                $
                (0.10
                )
                
                $
                0.14
                
                
                $
                0.19
                
                
                $
                0.16Balance
                    Sheet
                    Data:September 30,
                
                2007
                
                
                2006
                
                
                2005
                
                
                2004
                
                
                2003(In
                    thousands)Total
                    Assets
                
                $
                18,337
                
                
                $
                16,025
                
                
                $
                13,412
                
                
                $
                12,629
                
                
                $
                10,504Working
                    Capital (Deficiency)
                
                
                (279
                )
                
                
                (2,465
                )
                
                
                3,487
                
                
                
                2,548
                
                
                
                3,408Long-Term
                    Obligations
                
                
                448
                
                
                
                266
                
                
                
                —
                
                
                
                125
                
                
                
                3Shareholders’
                    Equity
                
                
                9,020
                
                
                
                6,956
                
                
                
                7,306
                
                
                
                6,436
                
                
                
                5,138
 
 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 Enterprise Information Management
        market which incorporates business intelligence, enterprise content management,
        business service management, help desk and workflow to allow organizations
        to
        access and analyze information in a more meaningful fashion.
 
 Datawatch’s
        principal products are Business Intelligence Solutions (including Datawatch|ES,
        Monarch, Monarch Data Pump, Monarch|RMS, Datawatch|Researcher, Visual|Insight,
        iMergence and VorteXML), Content Management Solutions (including
        Datawatch|BDS and Datawatch|MailManager) and Business Service Management
        and Workflow Solutions (including BDS|Workflow, Visual|QSM and Visual|HD).
        Included in the above categories are:  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; ERAMS,
        a
        web-enabled compliance solution for educational and medical institutions
        receiving federal grant funding; Monarch, a desktop report mining and business
        intelligence application that lets users extract and manipulate data from
        ASCII
        report files, PDF files or HTML files produced on any mainframe, midrange,
        client/server or PC system; Monarch Data Pump, a data replication and migration
        tool that offers a shortcut for populating and refreshing data marts and
        data
        warehouses, for migrating legacy data into new applications and for providing
        automated delivery of reports in a variety of formats via email; Monarch|RMS,
        a
        web-based report mining and analysis solution that integrates with any existing
        Enterprise Report Management (“ERM”) document or content management archiving
        solution; Visual|Insight, a performance management solution that provides
        web-based knowledge management and Key Performance Indicator (“KPI”) reporting;
        VorteXML, a data transformation product for the emerging XML
  -
            15
            -
 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; Datawatch|Researcher,
        a
        development platform for building performance management, content and data
        aggregation and workflow solutions; BDS|Workflow, a web-enabled enterprise
        business process management solution that provides highly effective processing
        of document intensive business transactions; 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.
 
 On
        May 3,
        2006, Datawatch acquired certain assets of ClearStory Systems, Inc’s Integrated
        Document Archiving and Retrieval Systems (“IDARS”) business in exchange for
        $4,349,000 in cash and incurred $441,000 in direct costs. In accordance with
        the
        purchase and sale agreement, payments equal to 30% of revenue for a period
        of
        eighteen months from the closing date (May 3, 2006) of the Datawatch|BDS
        product, excluding the first $337,500 of revenue, net of any claims, commenced
        during the Company’s third and fourth quarters of fiscal year 2007 and the
        remaining payments are required to be made in the first quarter of fiscal
        year
        2008. These amounts will be charged to goodwill as additional purchase price,
        as
        incurred or accrued. At September 30, 2007 and 2006, the Company has accrued
        approximately $329,000 and $215,000, respectively, related to future earn
        out
        payments, net of any claims. The activities of the IDARS business from May
        3,
        2006 are included in the Company’s consolidated financial statements. See Note 2
        to the Consolidated Financial Statements for more detailed financial information
        on the acquisition of the IDARS business.
 
 During
        the first quarter of fiscal 2004, the Company introduced a subscription sales
        model for the sale of its enterprise products. The Company continues to offer
        its enterprise products through perpetual licenses and introduced the
        subscription pricing model to allow customers to begin using the Company’s
        products at a lower initial cost of software acquisition. Subscriptions
        automatically renew unless terminated with 90 days notice following the first
        year of the subscription term. The subscription arrangement includes software,
        maintenance and unspecified future upgrades including major version upgrades.
        The initial subscription rate is the same as the renewal rate. During fiscal
        2005, 2006 and 2007, customer interest in and acceptance of the subscription
        model has been increasing as evidenced by a 6% growth in subscription revenue,
        from approximately $615,000 to approximately $649,000, during fiscal 2007
        as
        compared to fiscal 2006.
 
 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
 
 The
        Company has two types of software product offerings: Enterprise Software
        and
        Desktop and Server Software. Enterprise Software products are generally sold
        directly to end-users. The Company licenses its Desktop and Server Software
        products directly to end-users and through distributors and
        resellers.  Sales to distributors and resellers accounted for
        approximately 32%, 33% and 31%, of total sales for fiscal years 2007, 2006
        and
        2005, respectively. Revenue from the license of all software products is
        generally recognized at the time of shipment, provided there are no
        uncertainties surrounding product acceptance, the fee is fixed or determinable,
        collection is considered probable, persuasive evidence of an arrangement
        exists
        and there are no significant obligations remaining.  Both types of the
        Company’s software product offerings are “off-the-shelf” as such term is defined
        by Statement of Position No. 97-2, “Software Revenue
        Recognition.” The Company’s software products
  -
            16
            -
 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
        Software products are generally not sold in multiple element arrangements.
        Enterprise and Server Software sales are generally multiple element arrangements
        which include software license deliverables, professional services and
        post-contract customer support. In such multiple element arrangements, the
        Company applies the residual method in determining revenue to be allocated
        to a
        software license. In applying the residual method, the Company deducts from
        the
        sale proceeds the vendor specific objective evidence (“VSOE”)
        of fair value of
        the services and post-contract customer support in determining the residual
        fair
        value of the software license. The VSOE of fair value of the services and
        post-contract customer support is based on the amounts charged for these
        elements when sold separately. Professional services include implementation,
        integration, training and consulting services with revenue recognized as
        the
        services are performed. These services are generally delivered on a time
        and
        materials basis, are billed on a current basis as the work is performed,
        and do
        not involve modification or customization of the software or any other unusual
        acceptance clauses or terms. Post-contract customer support is typically
        provided under a maintenance agreement which provides technical support and
        rights to unspecified software maintenance updates and bug fixes on a
        when-and-if available basis. Revenue from post-contract customer support
        services is deferred and recognized ratably over the contract period (generally
        one year).  Such deferred amounts are recorded as part of deferred
        revenue in the Company’s Consolidated Balance Sheets included elsewhere
        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, in accordance with SOP 97-2,
        revenue is recognized ratably over the period the service is provided. The
        subscription arrangement includes software, maintenance and unspecified future
        upgrades including major version upgrades. The initial subscription rate
        is the
        same as the renewal rate. Subscriptions can be cancelled by the customer
        at any
        time by providing 90 days written notice 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, 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
        and applies the guidance found in Statement of Financial Accounting Standards
        No. 48, “Revenue Recognition
        when Right of Return Exists” (“SFAS No. 48”). Revenue from the license of
        software products to distributors and resellers is recognized at the time
        of
        shipment providing all other criteria for revenue recognition as stated above
        are met and (i) the distributor or reseller is unconditionally obligated to
        pay for the products, including no contingency as to product resale,
        (ii) the distributor or reseller has independent economic substance apart
        from the Company, (iii) the Company is not obligated for future performance
        to bring about product resale, and (iv) the amount of future returns can be
        reasonably estimated. The Company’s experience and history with its distributors
        and resellers allows for reasonable estimates of future returns. Among other
        things, estimates of potential future returns are made based on the inventory
        levels at the various distributors and resellers, which the Company monitors
        frequently. Once the estimates of potential future returns from all sources
        are
        made, the Company determines if it has adequate returns reserves to cover
        anticipated returns and the returns reserve is adjusted as required. Adjustments
        are recorded as increases or decreases in revenue in the period of adjustment.
        Actual returns have historically been within the range estimated by the Company.
        The Company’s returns reserves were $80,000 and $79,000 as of September 30,
        2007 and 2006, respectively.
 
 The
        Company maintains allowances for doubtful accounts for estimated losses
        resulting from the inability of
  -
            17
            -
 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 $223,000 and $193,000 as of
        September 30, 2007 and 2006, respectively.
 
 Deferred
        Tax
        Assets
 
 The
        Company has deferred tax assets related to net operating loss carryforwards
        and
        tax credits that expire at different times through and until 2026. At September
        30, 2007, the Company had U.S. federal tax loss carryforwards of approximately
        $7.3 million, expiring at various dates through 2026, including $520,000
        resulting from the Mergence acquisition undertaken during 2004 which are
        subject
        to additional annual limitations as a result of the changes in Mergence’s
        ownership, and had approximately $2.1 million in state tax loss carryforwards,
        which also expire at various dates through 2026. An alternative minimum tax
        credit of approximately $157,000 is available to offset future regular federal
        taxes. Research and development credits of approximately $499,000 expire
        beginning in 2009. In addition, the Company has the following foreign net
        operating loss carryforwards: United Kingdom losses of $8.5 million with
        no
        expiration date, France losses of $93,000 with no expiration date, Germany
        losses of $708,000 with no expiration date and Australia losses of $2.9 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. For financial
        reporting purposes, the Company’s domestic operations have been profitable
        during the past three years while international operations have continued
        to
        generate operating losses. For tax return purposes, however, the Company
        has had
        marginal, if any, domestic taxable income the last three years as its UK
        subsidiaries are treated as branches on the domestic tax returns and,
        accordingly, the losses at such subsidiaries are recorded on the domestic
        tax
        returns. Accordingly, management does not believe the deferred tax assets
        are
        more likely than not to be realized and a full valuation allowance, previously
        provided against the deferred tax assets, continues to be provided. Management
        evaluates the realizability of the deferred tax assets quarterly and, if
        current
        economic conditions change or future results of operations are better than
        expected, future assessments may result in the Company concluding that it
        is
        more likely than not that all or a portion of the deferred tax assets are
        realizable. If this conclusion were reached, the valuation allowance against
        deferred tax assets would be reduced resulting in a tax benefit being recorded
        for financial reporting purposes. Total net deferred tax assets subject to
        a
        valuation allowance were approximately $5.9 million as of September 30,
        2007. In relation to the recent asset purchase of the IDARS business, the
        applicable goodwill associated with this purchase has an indefinite life
        for US
        GAAP purposes but is deductible over a 15 year life for tax reporting purposes.
        Accordingly, for each reporting period, the Company will record deferred
        tax
        expense and an offsetting deferred tax liability on this difference in tax
        amortization of intangibles with indefinite lives based on the Company’s
        effective tax rate for the period. The deferred tax expense recorded for
        the
        year ended September 30, 2007 was approximately $133,000.
 
 Capitalized
        Software
        Development Costs
 
 The
        Company capitalizes certain software development costs as well as purchased
        software upon achieving technological feasibility of the related products.
        Software development costs incurred and software purchased prior to achieving
        technological feasibility are charged to research and development expense
        as
        incurred.  Commencing upon initial product release, capitalized costs
        are amortized to the cost of software licenses using the straight-line method
        over the estimated life (which approximates the ratio that current gross
        revenues for a
   -
            18
            -
 product
        bear to the total of current and anticipated future gross revenues for that
        product) which is generally 24 to 72 months. The Company’s capitalized software
        was $395,000 and $473,000 at September 30, 2007 and 2006,
        respectively.
 
 Goodwill,
        Other Intangible
        Assets and Other Long-Lived Assets
 
 The
        Company performs an evaluation of whether goodwill is impaired annually or
        when
        events occur or circumstances change that would more likely than not reduce
        the
        fair value of the applicable reporting unit below its carrying amount. The
        annual impairment analysis is performed each May of the applicable fiscal
        year. Fair value is determined using market comparables for similar businesses,
        current market valuations of our common stock, or forecasts of discounted
        future
        cash flows. The Company also reviews other intangible assets and other
        long-lived assets when an indication of potential impairment exists, such
        as a
        significant reduction in cash flows associated with the assets. Should the
        fair
        value of the Company’s long-lived assets decline because of reduced operating
        performance, market declines, or other indicators of impairment, a charge
        to
        operations for impairment may be necessary. In fiscal 2007, the Company
        concluded there was a partial impairment of its iMergence trademark resulting
        in
        a $39,000 impairment charge to operations. This charge is reflected in general
        and administrative costs in the Company’s Consolidated Statements of Operations
        for the year ended September 30, 2007.  No other impairment charges
        were taken during fiscal 2007.
 
 Accounting
        for Stock-Based
        Compensation
 
 With
        the
        adoption of Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” (“SFAS
        No. 123(R)”) on October 1, 2005, the Company is required to record the grant
        date fair value of stock-based compensation awards as compensation costs.
        For
        the fiscal year ended September 30, 2007, the Company recorded stock-based
        compensation expense of approximately $132,000. 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 a combination
        of both current and historical implied volatilities of the underlying stock
        which are obtained from public data sources. The Company believes this approach
        results in a reasonable estimate of volatility. For stock option grants issued
        during the fiscal year ended September 30, 2007, the Company used a range
        of
        expected stock-price volatility rates from 76% to 83% based upon the implied
        volatility at the time of issuance.
 
 With
        regard to the weighted-average option life assumption, the Company considers
        the
        exercise behavior of past grants and models the pattern of aggregate historical
        exercises. Patterns are determined on specific criteria of the aggregate
        pool of
        optionees including the reaction to vesting, realizable value and
        short-time-to-maturity effect. For stock option grants issued during the
        year
        ended September 30, 2007, the Company used a weighted-average expected option
        life assumption of five 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, 2007, 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.
 
 
 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.
 
 -
            19
            -
 Year
                    Ended
                    September 30,2007
                
                
                2006
                
                
                2005REVENUE:Software
                    licenses and subscriptions
                
                
                58.8
                %
                
                
                63.2
                %
                
                
                66.2
                %Maintenance
                    and services
                
                
                41.2
                
                
                
                36.8
                
                
                
                33.8Total
                    Revenue
                
                
                100.0
                
                
                
                100.0
                
                
                
                100.0COSTS
                    AND EXPENSES:Cost
                    of software licenses and subscriptions
                
                
                9.8
                
                
                
                10.9
                
                
                
                11.7Cost
                    of maintenance and services
                
                
                15.6
                
                
                
                19.0
                
                
                
                16.0Sales
                    and marketing
                
                
                36.8
                
                
                
                43.9
                
                
                
                40.4Engineering
                    and product development
                
                
                11.7
                
                
                
                10.1
                
                
                
                9.4General
                    and administrative
                
                
                19.3
                
                
                
                18.7
                
                
                
                19.3Total
                    costs and expenses
                
                
                93.2
                
                
                
                102.6
                
                
                
                96.8INCOME
                    (LOSS) FROM OPERATIONS
                
                
                6.8
                
                
                
                (2.6
                )
                
                
                3.2Interest
                    expense
                
                
                (0.1
                )
                
                
                (0.1
                )
                
                
                —Interest
                    income and other income, net
                
                
                0.4
                
                
                
                0.2
                
                
                
                0.4INCOME
                    (LOSS) BEFORE INCOME TAXES
                
                
                7.1
                
                
                
                (2.5
                )
                
                
                3.6(Provision)
                    benefit for income taxes
                
                
                (0.5
                )
                
                
                (0.2
                )
                
                
                0.1NET
                    INCOME (LOSS)
                
                
                6.6
                
                
                
                (2.7
                )
                
                
                3.7
 
 Fiscal
        Year Ended
        September 30, 2007 as Compared to
 Fiscal
        Year Ended
        September 30, 2006
 
 Total
        Revenues
 
 The
        following table presents total revenue, total revenue increase (decrease)
        and
        percentage change in total revenue for the years ended September 30, 2007
        and 2006:
  Year
                    Ended
                    September 30,
                
                
                Increase
                
                
                Percentage2007
                
                
                2006
                
                
                (Decrease)
                
                
                Change(In
                    thousands)Software
                    licenses and subscriptions
                
                $
                14,852
                
                
                $
                13,145
                
                
                $
                1,707
                
                
                
                13.0%Maintenance
                    and services
                
                
                10,407
                
                
                
                7,666
                
                
                
                2,741
                
                
                
                35.8%Total
                    revenue
                
                $
                25,259
                
                
                $
                20,811
                
                
                $
                4,448
                
                
                
                21.4%
 Revenue
        for the fiscal year ended September 30, 2007 was $25,259,000, which
        represents an increase of $4,448,000 or approximately 21% from revenue of
        $20,811,000 for the fiscal year ended September 30, 2006. For fiscal 2007,
        Business Intelligence Solutions (including Monarch, Monarch Data Pump,
        Monarch|RMS, Datawatch|ES, Datawatch|Researcher, Visual|Insight,
        iMergence and VorteXML), Content Management Solutions (including
        Datawatch|BDS and Datawatch|MailManager) and Business Service Management
        and Workflow Solutions (including Visual|QSM and Visual|HD) revenue accounted
        for 67%, 14%, and 19% of total revenue, respectively, as compared to 73%,
        5%,
        and 22%, respectively, for fiscal 2006. The increase in software license
        revenue
        can be attributed primarily to the Monarch Version 9 upgrade that was released
        in February 2007.
 
 Software
        license and subscription revenue for the fiscal year ended September 30,
        2007 was $14,852,000 or approximately 59% of total revenue, as compared to
        $13,145,000 or approximately 63% of total revenue for the fiscal year ended
        September 30, 2006. This represents an increase of $1,707,000 or
        approximately 13% from fiscal 2006. The overall increase in software license
        and
        subscription revenue during fiscal 2007 includes a
   -
            20
            -
 $1,391,000
        increase in Business Intelligence Solutions (including Monarch, Monarch Data
        Pump, Monarch|RMS, Datawatch|ES, Datawatch|Researcher, Visual|Insight,
        iMergence and VorteXML products), a $230,000 increase in Content Management
        Solutions (including Datawatch|BDS and Datawatch|MailManager products) and
        an $85,000 increase in Business Service Management and Workflow Solutions
        (including Visual|QSM and Visual|HD products). Datawatch|BDS license revenues
        increased $230,000 which is attributable to a full year of BDS sales in fiscal
        2007. The BDS product was acquired in connection with the Company’s acquisition
        of the Integrated Document Archiving and Retrieval Systems (“IDARS”) business
        from ClearStory Systems, Inc. in May 2006. Monarch revenues increased $1,499,000
        in fiscal 2007 which is attributed to the release of version 9 during fiscal
        2007.
  Maintenance
        and services revenue for the fiscal year ended September 30, 2007 was
        $10,407,000 or approximately 41% of total revenue, as compared to $7,666,000
        or
        approximately 37% of total revenue for the fiscal year ended September 30,
        2006. This represents an increase of $2,741,000 or approximately 36% from
        fiscal
        2006. The increase in maintenance and services revenue includes a $2,343,000
        increase in Content Management Solutions (including Datawatch|BDS and
        Datawatch|MailManager products), a $225,000 increase in Business
        Intelligence Solutions (including Monarch, Monarch Data Pump, Monarch|RMS,
        Datawatch|ES, Datawatch|Researcher, Visual|Insight, iMergence and VorteXML
        products) and a $173,000 increase in Business Service Management and Workflow
        Solutions (including Visual|QSM and Visual|HD products). Datawatch|BDS services
        and maintenance revenues increased $2,343,000 which is attributable to a
        full
        year of revenues associated with the Company’s acquisition of the IDARS business
        in May 2006. Maintenance and services revenue for the Business Service
        Management and Workflow Solutions product line increased due to higher
        professional services which were offset by lower renewal rates of annual
        maintenance contracts from existing customers. Visual|QSM had a product
        upgrade release and new products were integrated with it during 2007. There
        was no new upgrade introduced for the Visual|Help Desk product line during
        fiscal year 2007. 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.
 
 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, 2007 and 2006:
  Year
                    Ended
                    September 30,
                
                
                Increase
                    /
                
                
                Percentage2007
                
                
                2006
                
                
                (Decrease)
                
                
                Change(in
                    thousands)Costs
                    of software licenses and subscriptions
                
                $
                2,468
                
                
                $
                2,268
                
                
                $
                200
                
                
                
                8.8%Costs
                    of maintenance and services
                
                
                3,943
                
                
                
                3,949
                
                
                
                (6
                )
                
                
                -0.1%Sales
                    and marketing expenses
                
                
                9,290
                
                
                
                9,136
                
                
                
                154
                
                
                
                1.7%Engineering
                    and product development expenses
                
                
                2,951
                
                
                
                2,094
                
                
                
                857
                
                
                
                40.9%General
                    and administrative expenses
                
                
                4,872
                
                
                
                3,898
                
                
                
                974
                
                
                
                25.0%Total
                    costs and operating expenses
                
                $
                23,524
                
                
                $
                21,345
                
                
                $
                2,179
                
                
                
                10.2%
 
 Cost
        of
        software licenses and subscriptions for the fiscal year ended September 30,
        2007 was $2,468,000 or approximately 17% of software license and subscription
        revenues, as compared to $2,268,000 or approximately 17% of software license
        revenues for the fiscal year ended September 30, 2006. Costs of software
        licenses and
   -
            21
            -
 subscriptions
        as a percentage of software licenses and subscription revenue have remained
        consistent year over year.
 
 Cost
        of
        maintenance and services for the fiscal year ended September 30, 2007 was
        $3,943,000 or approximately 38% of maintenance and service revenues, as compared
        to $3,949,000 or approximately 52% of maintenance and service revenues, for
        the
        fiscal year ended September 30, 2006. The slight decrease in total cost of
        maintenance and services was attributable to the net effect of (i) savings
        generated from the Company’s restructuring plan which was initiated and
        completed during the first quarter of fiscal 2007 and additional headcount
        attrition offset by (ii) increased costs attributable to additional headcount
        brought on from the acquisition of IDARS in the third quarter of fiscal
        2006.
 
 Sales
        and
        marketing expenses were $9,290,000 for the fiscal year ended September 30,
        2007, which represents an increase of $154,000 or approximately 2%, from
        $9,136,000 for the fiscal year ended September 30, 2006. This increase is
        primarily attributable to an increase in amortization expense for a full
        year in
        2007 related to the customer lists acquired in the IDARS acquisition in May
        2006
        as well as an increase in costs associated with the 2007 user conference
        (net of
        sales).  These increases were partially offset by cost savings
        resulting from the Company’s restructuring plan which was initiated and
        completed during the first quarter of fiscal year 2007.
 
 During
        the first quarter of fiscal 2007, the Company initiated and completed a
        restructuring plan in an effort to reduce costs and focus on key areas of
        the
        business. The restructuring plan was limited to one of the Company’s wholly
        owned subsidiaries, Datawatch International Limited and resulted in charges
        for
        severance benefits and related costs for nine terminated employees of
        approximately $128,000.  All of these costs were charged in the first
        quarter of fiscal 2007 and none were accrued or incurred in fiscal 2006.
        The
        Company anticipates annual sales and marketing expense savings from this
        restructuring to approximate $1.2 million.
 
 Engineering
        and product development expenses were $2,951,000 for the fiscal year ended
        September 30, 2007, which represents an increase of $857,000 or
        approximately 41% from $2,094,000 for the fiscal year ended September 30,
        2006. This increase is primarily attributable to the additional headcount
        resulting from the IDARS acquisition and increases in outsourced development
        activities. The Company will continue to use third-party development activities
        in conjunction with in-house development for the foreseeable
        future.
 
 General
        and administrative expenses were $4,872,000 for the fiscal year ended
        September 30, 2007, which represents an increase of $974,000 or
        approximately 25% from $3,898,000 for the fiscal year ended September 30,
        2006. This increase is primarily attributable to accruals related to the
        Company’s executive bonus plan, administrative costs related to personnel hired
        for revenue recognition expertise and increased consulting, audit and legal
        professional fees.
 
 Net
        income for the year ended September 30, 2007 was $1,669,000, which compares
        to net loss of $555,000 for the year ended September 30, 2006. Net income
        for fiscal year 2007 includes a tax provision of approximately $133,000 while
        net loss for fiscal year 2006 includes a tax provision of $36,000.
  Fiscal
        Year Ended
        September 30, 2006 as Compared to
 Fiscal
        Year Ended
        September 30, 2005
 
 Total
        Revenues
 
 The
        following table presents total revenue, change in total revenue and total
        revenue growth for the year ended September 30, 2006 and 2005:
 
 -
            22
            -
 Year
                    Ended
                    September 30,
                
                
                Increase
                
                
                Percentage2006
                
                
                2005
                
                
                (Decrease)
                
                
                Change(In
                    thousands)Software
                    licenses and subscriptions
                
                $
                13,145
                
                
                $
                14,233
                
                
                $
                (1,088
                )
                
                
                -7.6%Maintenance
                    and services
                
                
                7,666
                
                
                
                7,278
                
                
                
                388
                
                
                
                5.3%Total
                    revenue
                
                $
                20,811
                
                
                $
                21,511
                
                
                $
                (700
                )
                
                
                -3.3%
 Revenue
        for the fiscal year ended September 30, 2006 was $20,811,000, which
        represents a decrease of $700,000 or approximately 3% from revenue of
        $21,511,000 for the fiscal year ended September 30, 2005. For
        fiscal 2006, Business Intelligence Solutions
        (including Monarch, Monarch Data Pump, Monarch|RMS, Datawatch|ES,
        Datawatch|Researcher, Visual|Insight, iMergence and VorteXML), Content
        Management Solutions (including Datawatch|BDS and Datawatch|MailManager)
        and
        Business Service Management and Workflow Solutions
        (including  Visual|QSM and Visual|HD) revenue accounted for 73%,
        5%, and 22% of total revenue, respectively, as compared to 74%, 0% and
        26%, respectively, for fiscal 2005. The
        slight decrease in revenue can be attributed primarily to fewer license sales
        of
        Monarch due to fiscal 2006 being a non-upgrade release year for that
        product.
 
 Software
        license and subscription revenue for the fiscal year ended September 30,
        2006 was $13,145,000 or approximately 63% of total revenue, as compared to
        $14,233,000 or approximately 66% of total revenue for the fiscal year ended
        September 30, 2005. This represents a decrease of $1,088,000 or
        approximately 8% from fiscal 2005. The overall decrease in software license
        and
        subscription revenue during fiscal 2006 includes a $873,000
        decrease in Business Intelligence Solutions
        (including Monarch, Monarch Data Pump, Monarch|RMS, Datawatch|ES,
        Datawatch|Researcher, Visual|Insight, iMergence and VorteXML products), a
        $323,000 decrease in Business Service Management and Workflow Solutions
        (including  Visual|QSM and Visual|HD products) and a $108,000 increase
        in Content Management Solutions (including Datawatch|BDS and
        Datawatch|MailManager products). The
        Datawatch|BDS license revenue for fiscal 2006 is attributable to new products
        which were acquired in connection with the Company’s acquisition of the IDARS
        business in May 2006. The Company attributes the decrease in Monarch software
        license revenue to the lack of a new release during fiscal 2006 as well as
        reduced customer spending during the year. The Company’s most recent upgrade to
        Monarch V8 was released in March 2005.
 
 Maintenance
        and services revenue for the fiscal year ended September 30, 2006 was
        $7,666,000 or approximately 37% of total revenue, as compared to $7,278,000
        or
        approximately 34% of total revenue for the fiscal year ended September 30,
        2005. This represents an increase of $388,000 or approximately 5% from fiscal
        2005. The
        increase in maintenance and service revenue includes a $921,000 increase
        in
        Content Management Solutions (including Datawatch|BDS and Datawatch|MailManager
        products), a $691,000 decrease in Business Service Management and Workflow
        Solutions (including  Visual|QSM and Visual|HD products) and a
        $158,000 increase in Business Intelligence Solutions
        (including Monarch, Monarch Data Pump, Monarch|RMS, Datawatch|ES,
        Datawatch|Researcher, Visual|Insight, iMergence and VorteXML
        products). The
        BDS
        maintenance and service revenue for fiscal 2006 is related to the new products
        which were acquired in connection with the Company’s acquisition of the IDARS
        business in May 2006. The Company attributes the overall increases in
        maintenance and services revenue to continued customer loyalty, which has
        resulted in high renewal rates for annual maintenance service contracts and
        an
        increased demand for professional services from existing customers, which
        also
        includes upgrades and additional training. The decrease in maintenance revenue
        for the Business Service Management and Workflow Solution product line was
        the
        result of lower renewal rates of annual maintenance contracts from existing
        customers due to a mature market for the products. The decrease in Business
        Service Management and Workflow Solutions maintenance and services 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
        2006.
 
 -
            23
            -
 Costs
        and Operating
        Expenses
 
 The
        following table presents costs and operating expenses, changes in costs and
        operating expenses and costs and operating expenses growth for the year ended
        September 30, 2006 and 2005:
  Year
                    Ended
                    September 30,
                
                
                Increase
                    /
                
                
                Percentage2006
                
                
                2005
                
                
                (Decrease)
                
                
                Change(in
                    thousands)Costs
                    of software licenses and subscriptions
                
                $
                2,268
                
                
                $
                2,515
                
                
                $
                (247
                )
                
                
                -9.8%Costs
                    of maintenance and services
                
                
                3,949
                
                
                
                3,438
                
                
                
                511
                
                
                
                14.9%Sales
                    and marketing expenses
                
                
                9,136
                
                
                
                8,687
                
                
                
                449
                
                
                
                5.2%Engineering
                    and product development expenses
                
                
                2,094
                
                
                
                2,031
                
                
                
                63
                
                
                
                3.1%General
                    and administrative expenses
                
                
                3,898
                
                
                
                4,152
                
                
                
                (254
                )
                
                
                -6.1%Total
                    costs and operating expenses
                
                $
                21,345
                
                
                $
                20,823
                
                
                $
                522
                
                
                
                2.5%
 Cost
        of
        software licenses and subscriptions for the fiscal year ended September 30,
        2006 was $2,268,000 or approximately 17% of software license and subscription
        revenues, as compared to $2,515,000 or approximately 18% of software license
        revenues for the fiscal year ended September 30, 2005. Costs of software
        licenses and subscriptions as a percentage of software licenses and subscription
        revenue have remained consistent year over year.
 
 Cost
        of
        maintenance and services for the fiscal year ended September 30, 2006 was
        $3,949,000 or approximately 52% of maintenance and service revenues, as compared
        to $3,438,000 or approximately 47% of maintenance and service revenues, for
        the
        fiscal year ended September 30, 2005. This increase was primarily due to an
        increase in headcount of consulting and training staff. The IDARS acquisition
        added several individuals to the consulting staff headcount. The increase
        can
        also be attributed to the increasing subscription sales. As the Company
        continues to see a slight shift in selling more subscription term licenses,
        revenues are recognized over future periods rather than at the point of sale,
        while the associated professional services costs and systems installation
        costs
        are incurred during the period for the project work associated with the
        implementation of the systems for these customers.
 
 Sales
        and
        marketing expenses were $9,136,000 for the fiscal year ended September 30,
        2006, which represents an increase of $449,000 or approximately 5%, from
        $8,687,000 for the fiscal year ended September 30, 2005. This increase is
        primarily attributable to increased sales staff personnel, increased headcount
        from the IDARS acquisition, higher salaries and other related expenses,
        increased marketing expenses for lead generation, and trade show expense.
        During
        fiscal year 2004, the Company made a strategic decision for additional
        investments within the sales and marketing programs to improve upon the
        Company’s top-line revenue growth initiatives. This additional investment focus
        was continued throughout the 2005 and 2006 fiscal years.
 
 Engineering
        and product development expenses were $2,094,000 for the fiscal year ended
        September 30, 2006, which represents an increase of $63,000 or
        approximately 3% from $2,031,000 for the fiscal year ended September 30,
        2005. This increase is primarily attributable to the additional headcount
        resulting from the IDARS acquisition offset by cost savings attributable
        to the
        transitioning of previously outsourced development activities in-house. The
        Company will continue to use third-party development activities in conjunction
        with in-house development for the foreseeable future, but will rely more
        on the
        Company’s in-house engineering and product development
        capabilities.
 
 General
        and administrative expenses
        were $3,898,000 for the fiscal year ended September 30, 2006, which
        represents a decrease of $254,000 or approximately 6% from $4,152,000 for
        the
        fiscal year ended September 30,
   -
            24
            -
 2005.
        This decrease is primarily
        attributable to a reduction in overhead costs including a small reduction
        in
        headcount and the related wage and employee benefit savings totaling
        approximately $99,000. During fiscal 2006 there was an emphasis on managing
        administrative costs with certain reductions to lower investor relation costs
        and a reduction in the allowance for doubtful accounts, due to the improvement
        in overall collection efforts. In addition, the Company experienced savings
        attributable to lower management incentive bonuses of approximately $100,000
        due
        to the Company’s net loss for the fiscal year and lower accounting costs
        attributable to a delay in the Company’s implementation of Section 404 of the
        Sarbanes-Oxley Act as a result of the one year extension for compliance granted
        by the Securities and Exchange Commission.
 
 Net
        loss
        for the year ended September 30, 2006 was $555,000, which compares to net
        income of $800,000 for the year ended September 30, 2005. Net loss for
        fiscal year 2006 includes a tax provision of approximately $36,000 while
        net
        income for fiscal year 2005 includes a tax benefit of $22,000.
 
 
 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 $511,000, $632,000 and $664,000 for fiscal 2007, 2006 and 2005,
        respectively.
 
 As
        of
        September 30, 2007, contractual obligations include minimum rental
        commitments under noncancelable operating leases as follows (in
        thousands):
 
 Contractual
                  Obligations:
              
              Total
              
              Less
                  than 1
                  Year
              
              1-3
                  Years
              
              3-5
                  Years
              
              More
                  than 5
                  YearsOperating
                  Lease Obligations
              
              $
              1,054
              
              407
              
              506
              
              141
              
              —
 
 The
        Company is also obligated to pay royalties ranging from 7% to 50% on revenue
        generated by the sale of certain licensed software products. Royalty expense
        included in cost of software licenses was approximately $1,865,000, $1,602,000
        and $1,659,000 respectively, for the years ended September 30, 2007, 2006
        and 2005.  The Company is not obligated to pay any minimum amounts for
        royalties.
 
 On
        August
        11, 2004, the Company acquired 100% of the shares of Mergence Technologies
        Corporation. The purchase agreement includes a provision for quarterly cash
        payments to the former Mergence shareholders equal to 10% of revenue, as
        defined, of the Datawatch|Researcher product until September 30, 2010. The
        Company expensed approximately $17,000, $5,000 and $10,000 for the fiscal
        years
        ended September 30, 2007, 2006 and 2005, respectively, for royalty payments
        to
        Mergence.
 
 On
        May 3,
        2006, the Company acquired certain assets of ClearStory Systems, Inc’s. IDARS
        business. The initial acquisition cost for IDARS was approximately $4,790,000,
        consisting of $4,349,000 in cash and direct acquisition costs of approximately
        $441,000.  The acquisition also includes an 18-month earn-out payment
        equal to 30% of net revenues of products from the IDARS business excluding
        the
        first $337,500 of revenues. The earn-out payment will be considered additional
        purchase price and will be recorded as additional goodwill. At September
        30,
        2007 and September 30, 2006, the Company has accrued approximately $329,000
        and
        $215,000, respectively, related to such earn-out payments. In accordance
        with
        the asset purchase agreement, payments commenced during the Company’s third and
        fourth quarters of fiscal year 2007 and the remaining payments are required
        to
        be made in the first quarter of fiscal year 2008. During fiscal 2007, the
        Company made earn-out payments totaling approximately $671,000. On November
        29,
        2007, the Company made an additional earn-out payment totaling approximately
        $328,000. See Note 2 to the Consolidated Financial Statements for more detailed
        financial information on the acquisition of IDARS.
 
 -
            25
            -
 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, 2007.
 
 The
        Company is required by the new sublease agreement related to its Chelmsford,
        Massachusetts facility to provide a letter of credit in the amount of
        approximately $125,000 as a security deposit to the landlord of amounts due
        under the lease. 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, 2007 and 2006.
 
 The
        Company enters into indemnification agreements in the ordinary course of
        business. Pursuant to these agreements, the Company agrees to indemnify,
        hold
        harmless, and reimburse the indemnified party for losses suffered or incurred
        by
        the indemnified party, generally its customers, in connection with any patent,
        copyright or other intellectual property infringement claim by any third
        party
        with respect to the Company’s products. The term of these indemnification
        agreements is generally perpetual. The maximum potential amount of future
        payments the Company could be required to make under these indemnification
        agreements is unlimited. The Company has never incurred costs to defend lawsuits
        or settle claims related to these indemnification agreements. As a result,
        the
        Company believes the estimated fair value of these agreements is minimal.
        Accordingly, the Company has no liabilities recorded for these agreements
        as of
        September 30, 2007.
 
 Certain
        of the Company’s agreements also provide for the performance of services at
        customer sites. These agreements may contain indemnification clauses, whereby
        the Company will indemnify the customer from any and all damages, losses,
        judgments, costs and expenses for acts of its employees or subcontractors
        resulting in bodily injury or property damage. The maximum potential amount
        of
        future payments the Company could be required to make under these
        indemnification agreements is unlimited; however, the Company has general
        and
        umbrella insurance policies that would enable it to recover a portion of
        any
        amounts paid. The Company has never incurred costs to defend lawsuits or
        settle
        claims related to these indemnification agreements. As a result, the Company
        believes the estimated fair value of these agreements is minimal.
        Accordingly,the Company
        has no liabilities recorded for these agreements as of September 30,
        2007.
 
 As
        permitted under Delaware law, the Company has agreements with its directors
        whereby the Company will indemnify them for certain events or occurrences
        while
        the director is, or was, serving at the Company’s request in such capacity. The
        term of the director indemnification period is for the later of ten years
        after
        the date that the director ceases to serve in such capacity or the final
        termination of proceedings against the director as outlined in the
        indemnification agreement. The maximum potential amount of future payments
        the
        Company could be required to make under these indemnification agreements
        is
        unlimited; however, the Company’s director and officer insurance policy limits
        the Company’s exposure and enables it to recover a portion of any future amounts
        paid. As a result of its insurance policy coverage, the Company believes
        the
        estimated fair value of these indemnification agreements is minimal. The
        Company
        has no liabilities recorded for these agreements as of September 30,
        2007.
 
 
 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, 2007, the Company had $3,841,000 of cash and equivalents, an
        increase of $1,979,000 from September 30, 2006. This increase is principally
        attributable to increased profitability achieved during the year resulting
        from
        the release of Monarch Version 9 as well as revenues from the Datawatch|BDS
        product line which was acquired as part of the acquisition of IDARS in fiscal
        year 2006. The increase in cash and equivalents occurred despite the $1,000,000
        repayment on the Company’s line of credit during fiscal 2007. From
  -
            26
            -
 May
        2006
        through February 8, 2007, the Company had outstanding a line of credit of
        $1,000,000 which was subsequently repaid and terminated on February 9,
        2007.
 
 At
        September 30, 2007, the Company had a working capital deficit of $279,000
        as
        compared to a working capital deficit of $2,465,000 as of September 30, 2006.
        The working capital deficit at September 30, 2007 is primarily a result of
        deferred revenue of $4,486,000 as of September 30, 2007. The Company expects
        cash flows from operations to continue to improve as the Company anticipates
        increased sales for most of its main product offerings during the fiscal
        year
        ended September 30, 2008 while continuing to actively control costs. However,
        if
        the Company’s cash flow from operations were to decline significantly, it may
        need to consider further reductions to our operating expenses. The Company
        does
        not anticipate additional cash requirements to fund significant growth or
        the
        acquisition of complementary technology or businesses. However, if in the
        future, such expenditures are anticipated or required, the Company may need
        to
        seek additional financing by issuing equity or obtaining credit facilities
        to
        fund such requirements.
 
 The
        Company had net income of approximately $1,669,000 for the year ended September
        30, 2007 as compared to a net loss of approximately $(555,000) for the year
        ended September 30, 2006 and net income of approximately $800,000 for the
        year ended September 30, 2005. During the years ended September 30, 2007
        and 2006, approximately $3,521,000 and $975,000, respectively, of cash was
        provided by the Company’s operations. During fiscal year 2007, the main source
        of cash from operations was net income adjusted for depreciation and
        amortization as well as an increase in accounts payable and accrued
        expenses.
 
 Net
        cash
        used in investing activities for the year ended September 30, 2007 of
        $905,000 is primarily related to the purchase of fixed assets as well as
        costs
        associated with software development. Included in net cash used in investing
        activities was $671,000 of earn-out payments related to the IDARS acquisition,
        the purchase of fixed assets and costs associated with software
        development.
 
 Net
        cash
        used in financing activities for the year ended September 30, 2007 of
        $651,000 is primarily related to the repayment of the Company’s $1 million line
        of credit, net of proceeds from the exercise of stock options.
 
 On
        May 3,
        2006, the Company acquired certain assets of ClearStory Systems, Inc’s.
        Integrated Document Archiving and Retrieval Systems (“IDARS”) business. The
        acquisition of IDARS was consummated pursuant to an asset purchase agreement
        dated as of March 10, 2006 among the Company and Clearstory Systems, Inc.
        The
        purchase agreement includes a provision for payments over an 18 month period
        equal to 30% of net revenues of products from the IDARS business, excluding
        the
        first $337,500 of revenues, net of any claims. The earn-out payments will
        be
        considered additional purchase price and will be recorded as additional
        goodwill. At September 30, 2007, the Company had accrued approximately $329,000
        related to such earn-out payments. In accordance with the asset purchase
        agreement, payments commenced during the Company’s third and fourth quarters of
        fiscal year 2007 and the remaining payments are required to be made in the
        first
        quarter of fiscal year 2008. During fiscal 2007, the Company made earn-out
        payments totaling approximately $671,000. On November 29, 2007, the Company
        made
        an additional earn-out payment totaling approximately $328,000.
 
 The
        Mergence purchase agreement dated August 11, 2004 includes a provision for
        quarterly cash payments to the former Mergence shareholders equal to 10%
        of
        revenue, as defined, of the Datawatch|Researcher product for a period of
        six
        years.  As the cash payments are based on recognized revenue and no
        minimum payments are required, they are not expected to have a significant
        impact on the Company’s liquidity or cash flows. See the section titled
“Off Balance Sheet Arrangements, Contractual Obligations and Contingent
        Liabilities and Commitments” included elsewhere herein for a more complete
        disclosure of the Company’s commitments and contingent liabilities.
 
 An
        existing agreement between Datawatch and Math Strategies grants the Company
        exclusive worldwide rights to use and distribute certain intellectual property
        owned by Math Strategies and incorporated by the Company in its Monarch,
        Monarch
        Data Pump and certain other products. On April 29, 2004, the Company
        entered into a two year Option Purchase Agreement with Math Strategies giving
        the Company the option to purchase these intellectual property rights for
        $8
        million. This option, if exercised, would provide the Company with increased
        flexibility to utilize the purchased technology in the future. In February
        2006,
        the Company entered into an amendment to the original agreement with Math
        Strategies dated January 19, 1989.  Pursuant to
  -
            27
            -
 the
        amendment to the license agreement, the term of the license agreement was
        extended to April 30, 2015. In conjunction with the license amendment, the
        Company also entered into an amendment to the Option Purchase Agreement dated
        as
        of April 29, 2004. Under the option purchase amendment, the option has been
        extended until April 30, 2015. The option purchase amendment changes the
        purchase price for the option to a formula price based on a multiple of the
        aggregate royalties paid to Math Strategies by the Company for the four fiscal
        quarters preceding the exercise of the option.
 
 Management
        believes that the Company’s current operations have not been materially impacted
        by the effects of inflation.
 
 
 RECENT
        ACCOUNTING
        PRONOUNCEMENTS
 
 In
        June
        2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation
        No. 48, “Accounting for
        Uncertainty in Income Taxes – an Interpretation of FASB Statement No.
        109” (“FIN 48”).  FIN 48 clarifies the accounting for income
        taxes by prescribing the minimum recognition threshold a tax position is
        required to meet before being recognized in the financial statements. This
        interpretation also provides guidance on derecognition, measurement,
        classification, interest and penalties, accounting in interim periods,
        disclosure and transition. FIN 48 will require disclosure at the end of the
        annual reporting period of the nature of uncertain tax positions and related
        events if it is reasonably possible that those positions and events could
        change
        the associated recognized tax benefit within the next twelve months. This
        Interpretation is effective for fiscal years beginning after December 15,
        2006.  The Company will adopt FIN 48 effective October 1, 2007. The
        Company is currently in the process of evaluating the effect of adopting
        the
        provisions of FIN 48 and does not believe the cumulative effect of applying
        the
        provisions of FIN 48 will have a material impact on retained earnings as
        of
        October 1, 2007.
 
 In
        September 2006, the FASB issued Statement of Financial Accounting Standards
        No.
        157, “Fair Value
        Measurements” (“SFAS 157”), which establishes a framework for
        measuring fair value and expands disclosures about the use of fair value
        measurements and liabilities in interim and annual reporting periods subsequent
        to initial recognition.  Prior to SFAS 157, which emphasizes that fair
        value is a market-based measurement and not an entity-specific measurement,
        there were different definitions of fair value and limited definitions for
        applying those definitions in GAAP.  SFAS 157 is effective for the Company
        on a prospective basis for the reporting period beginning October 1, 2008. 
The effect of adoption on the Company’s financial position and results of
        operations have not been determined.
 
 In
        February 2007, the FASB issued Statement No. 159, “The Fair Value Option
        for Financial
        Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 expands
        opportunities to use fair value measurement in financial reporting and permits
        entities to choose to measure many financial instruments and certain other
        items
        at fair value. This Statement is effective for fiscal years beginning after
        November 15, 2007. The Company has not decided if it will early adopt SFAS
        159
        or if it will choose to measure any eligible financial assets and liabilities
        at
        fair value.
 
 In
        September 2006, the Securities and Exchange Commission staff published Staff
        Accounting Bulletin (“SAB”) 108, “Considering the Effects
        of Prior
        Year Misstatements when Quantifying Misstatements in Current Year Financial
        Statements” (“SAB 108”). SAB 108 provides interpretive guidance on how
        the effects of the carryover or reversal of prior year misstatements should
        be
        considered in quantifying a current year misstatement. The Company applied
        the
        provisions of SAB 108 in the year ended September 30, 2007. Application of
        SAB
        108 had no impact on the Company’s consolidated financial position, results of
        operations or cash flows.
 
 In
        December 2007, the FASB issued SFAS No. 141(R), “Business Combinations”(“SFAS 141(R)”), which replaces
        SFAS No. 141. SFAS No. 141(R) establishes
        principles and requirements for how an acquirer recognizes and measures in
        its
        financial statements the identifiable assets acquired, the liabilities assumed,
        any non-controlling interest in the acquiree and the goodwill acquired. The
        Statement also establishes disclosure requirements which will enable users
        to
        evaluate the nature and financial effects of the business
        combination.
  -
            28
            -
 SFAS
        141(R) is effective for fiscal years beginning after December 15, 2008. The
        adoption of SFAS 141(R) will have an impact on accounting for business
        combinations once adopted, but the effect is dependent upon acquisitions
        at that
        time.
 
 In
        December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests
        in
        Consolidated Financial Statements – an amendment of Accounting Research Bulletin
        No. 51”(“SFAS 160”), which establishes accounting and reporting
        standards for ownership interests in subsidiaries held by parties other than
        the
        parent, the amount of consolidated net income attributable to the parent
        and to
        the noncontrolling interest, changes in a parent’s ownership interest and the
        valuation of retained non-controlling equity investments when a subsidiary
        is
        deconsolidated. The Statement also establishes reporting requirements that
        provide sufficient disclosures that clearly identify and distinguish between
        the
        interests of the parent and the interests of the non-controlling owners.
        SFAS
        160 is effective for fiscal years beginning after December 15, 2008. The
        Company
        has not determined the effect that the application of SFAS 160 will have
        on its
        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, 2007, the Company did not hold any derivative financial
        instruments or commodity instruments.  The Company holds no investment
        securities that possess significant market risk.
 
 Primary
        Market Risk
        Exposures
  The
        Company’s primary market risk exposure is foreign currency exchange rate risk.
        International revenues and expenses are generally transacted by the Company’s
        foreign subsidiaries and are denominated in local currency. Approximately
        31%,
        32% and 36% of the Company’s revenues for 2007, 2006 and 2005, respectively,
        were from foreign subsidiaries. In addition, approximately 34%, 36% and 37%
        of
        the Company’s operating expenses for fiscal 2007, 2006 and 2005, respectively,
        were from foreign subsidiaries.
 
 The
        Company’s earnings exposure to currency exchange rate fluctuations has been and
        is expected to continue to be modest due to the fact that the operations
        of its
        international subsidiaries are almost exclusively conducted in their respective
        local currencies, and dollar advances to the Company’s international
        subsidiaries, if any, are considered to be of a long-term investment nature.
        Therefore, 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 other income (expense), net in the consolidated statements of operations.
        These have not been material in the past nor does management believe that
        they
        will be material in the future. Currently, the Company does not engage in
        foreign currency hedging activities.
 
 
 
 
 -
            29
            -
 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
              31Consolidated
                  Financial Statements as of September 30, 2007 and 2006 and foreach
                  of the Three Years in the Period Ended September 30, 2007:Consolidated
                  Balance Sheets
              32Consolidated
                  Statements of Operations
              33Consolidated
                  Statements of Shareholders’ Equity and Comprehensive Income
                  (Loss)
              34Consolidated
                  Statements of Cash Flows
              35Notes
                  to Consolidated Financial Statements
              36
          
 -
            30
            -
 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, 2007 and 2006, 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, 2007.  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, 2007 and 2006, and the results of their operations and their
        cash
        flows for each of the three years in the period ended September 30, 2007,
        in
        conformity with accounting principles generally accepted in the United States
        of
        America.
 
 /s/
        DELOITTE & TOUCHE LLP
 
 Boston,
        Massachusetts
 December 28,
        2007
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 -
            31
            -


DATAWATCH
      CORPORATION


CONSOLIDATED
      BALANCE
      SHEETS


(In
      thousands, except share and per
      share amounts)






September
                  30,
              
              
              September
                  30,2007
              
              
              2006ASSETSCURRENT
                  ASSETS:Cash
                  and equivalents
              
              $
              3,841
              
              
              $
              1,862Accounts
                  receivable, less allowance for doubtful accounts and sales returns
                  of
                  $303,000 in 2007 and $272,000 in 2006
              
              
              4,174
              
              
              
              3,786Inventories
              
              
              48
              
              
              
              37Prepaid
                  expenses
              
              
              527
              
              
              
              653Total
                  current assets
              
              
              8,590
              
              
              
              6,338Property
                  and equipment:Office
                  furniture and equipment
              
              
              2,090
              
              
              
              2,186Manufacturing
                  and engineering equipment
              
              
              288
              
              
              
              2702,378
              
              
              
              2,456Less
                  accumulated depreciation and amortization
              
              
              (1,522
              )
              
              
              (1,327
              )Net
                  property and equipment
              
              
              856
              
              
              
              1,129Goodwill
              
              
              6,020
              
              
              
              5,236Other
                  intangible assets, net
              
              
              2,676
              
              
              
              3,155Restricted
                  cash
              
              
              125
              
              
              
              125Other
                  long-term assets
              
              
              70
              
              
              
              42$
              18,337
              
              
              $
              16,025LIABILITIES
                  AND SHAREHOLDERS’
                  EQUITYCURRENT
                  LIABILITIES:Line
                  of credit
              
              $
              —
              
              
              $
              1,000Accounts
                  payable
              
              
              1,215
              
              
              
              1,302Accrued
                  expenses
              
              
              2,839
              
              
              
              1,818Deferred
                  revenue
              
              
              4,486
              
              
              
              4,468Accrued
                  cost of acquisition
              
              
              329
              
              
              
              215Total
                  current liabilities
              
              
              8,869
              
              
              
              8,803LONG-TERM
                  LIABILITIES:Deferred
                  rent
              
              
              179
              
              
              
              230Long-term
                  deferred revenue
              
              
              122
              
              
              
              —Deferred
                  tax liability
              
              
              147
              
              
              
              36Total
                  long-term liabilities
              
              
              448
              
              
              
              266COMMITMENTS
                  AND CONTINGENCIESSHAREHOLDERS’
                  EQUITY:Common
                  stock, par value $.01; 20,000,000 shares authorized; issued, 5,647,666
                  shares and 5,526,485 shares, respectively; outstanding, 5,633,420
                  shares
                  and 5,512,239 shares, respectively
              
              
              56
              
              
              
              55Additional
                  paid-in capital
              
              
              22,684
              
              
              
              22,204Accumulated
                  deficit
              
              
              (13,072
              )
              
              
              (14,741
              )Accumulated
                  other comprehensive loss
              
              
              (508
              )
              
              
              (422
              )9,160
              
              
              
              7,096Less
                  treasury stock, at cost, 14,246 shares
              
              
              (140
              )
              
              
              (140
              )Total
                  shareholders’ equity
              
              
              9,020
              
              
              
              6,956$
              18,337
              
              
              $
              16,025






See
      notes to consolidated financial
      statements.


-
          32
          -


DATAWATCH
      CORPORATION


CONSOLIDATED
      STATEMENTS OF
      OPERATIONS


(In
      thousands, except per share
      amounts)








Year
                  Ended September
                  30,2007
              
              
              2006
              
              
              2005REVENUE:Software
                  licenses and subscriptions
              
              $
              14,852
              
              
              $
              13,145
              
              
              $
              14,233Maintenance
                  and services
              
              
              10,407
              
              
              
              7,666
              
              
              
              7,278Total
                  Revenue
              
              
              25,259
              
              
              
              20,811
              
              
              
              21,511COSTS
                  AND EXPENSES:Cost
                  of software licenses and subscriptions
              
              
              2,468
              
              
              
              2,268
              
              
              
              2,515Cost
                  of maintenance and services
              
              
              3,943
              
              
              
              3,949
              
              
              
              3,438Sales
                  and marketing
              
              
              9,290
              
              
              
              9,136
              
              
              
              8,687Engineering
                  and product development
              
              
              2,951
              
              
              
              2,094
              
              
              
              2,031General
                  and administrative
              
              
              4,872
              
              
              
              3,898
              
              
              
              4,152Total
                  costs and expenses
              
              
              23,524
              
              
              
              21,345
              
              
              
              20,823INCOME
                  (LOSS) FROM OPERATIONS
              
              
              1,735
              
              
              
              (534
              )
              
              
              688Interest
                  expense
              
              
              (33
              )
              
              
              (18
              )
              
              
              (3
              )Interest
                  income
              
              
              107
              
              
              
              40
              
              
              
              85Foreign
                  currency transaction (losses) gains
              
              
              (7
              )
              
              
              (7
              )
              
              
              8INCOME
                  (LOSS) FROM OPERATIONS BEFORE INCOME TAXES
              
              
              1,802
              
              
              
              (519
              )
              
              
              778(PROVISION)
                  BENEFIT FOR INCOME TAXES
              
              
              (133
              )
              
              
              (36
              )
              
              
              22NET
                  INCOME (LOSS)
              
              $
              1,669
              
              
              $
              (555
              )
              
              $
              800Net
                  income (loss) per share - Basic:
              
              $
              0.30
              
              
              $
              (0.10
              )
              
              $
              0.15Net
                  income (loss) per share - Diluted:
              
              $
              0.29
              
              
              $
              (0.10
              )
              
              $
              0.14Weighted-Average
                  Shares Outstanding - Basic
              
              
              5,558
              
              
              
              5,481
              
              
              
              5,317Weighted-Average
                  Shares Outstanding - Diluted
              
              
              5,855
              
              
              
              5,481
              
              
              
              5,774











See
      notes to consolidated financial
      statements.


-
          33
          -


DATAWATCH
      CORPORATION


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


Years
      Ended September 30, 2007, 2006
      and 2005


(In
      thousands, except share
      amounts)







AccumulatedAdditional
              
              
              
              
              
              OtherCommon
                  Stock
              
              
              Paid-In
              
              
              Accumulated
              
              
              Comprehensive
              
              
              Comprehensive
              
              
              Treasury
                  StockShares
              
              
              Amount
              
              
              Capital
              
              
              Deficit
              
              
              Loss
              
              
              Income
                  (Loss)
              
              
              Shares
              
              
              Amount
              
              
              TotalBALANCE,
                  OCTOBER 1, 2004
              
              
              5,315,108
              
              
              $
              53
              
              
              $
              21,828
              
              
              $
              (14,986
              )
              
              $
              (318
              )
              
              
              
              
              
              (14,246
              )
              
              $
              (140
              )
              
              $
              6,437Stock
                  options exercised
              
              
              67,976
              
              
              
              1
              
              
              
              82
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              83Stock
                  option acceleration expense
              
              
              
              
              
              
              
              
              
              
              47
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              47Translation
                  adjustments
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (60
              )
              
              $
              (60
              )
              
              
              
              
              
              
              
              
              
              
              (60
              )Net
                  income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              800
              
              
              
              
              
              
              
              800
              
              
              
              
              
              
              
              
              
              
              
              800Total
                  comprehensive income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              740BALANCE,
                  SEPTEMBER 30, 2005
              
              
              5,383,084
              
              
              
              54
              
              
              
              21,957
              
              
              
              (14,186
              )
              
              
              (378
              )
              
              
              
              
              
              
              (14,246
              )
              
              
              (140
              )
              
              
              7,307Stock
                  options exercised
              
              
              143,401
              
              
              
              1
              
              
              
              180
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              181Stock-based
                  compensation expense
              
              
              
              
              
              
              
              
              
              
              67
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              67Comprehensive
                  income:Translation
                  adjustments
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (44
              )
              
              
              (44
              )
              
              
              
              
              
              
              
              
              
              
              (44
              )Net
                  loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (555
              )
              
              
              
              
              
              
              (555
              )
              
              
              
              
              
              
              
              
              
              
              (555
              )Total
                  comprehensive loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              (599
              )BALANCE,
                  SEPTEMBER 30, 2006
              
              
              5,526,485
              
              
              
              55
              
              
              
              22,204
              
              
              
              (14,741
              )
              
              
              (422
              )
              
              
              
              
              
              
              (14,246
              )
              
              
              (140
              )
              
              
              6,956Stock
                  options exercised
              
              
              121,181
              
              
              
              1
              
              
              
              348
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              349Stock-based
                  compensation expense
              
              
              
              
              
              
              
              
              
              
              132
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              132Comprehensive
                  income: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
              )
              
              $
              9,020










See
      notes to consolidated financial
      statements.


-
          34
          -


DATAWATCH
      CORPORATION


CONSOLIDATED
      STATEMENTS OF CASH
      FLOWS


(In
      thousands)





Year
                  Ended September
                  30,2007
              
              
              2006
              
              
              2005CASH
                  FLOWS FROM OPERATING ACTIVITIES:Net
                  income (loss)
              
              $
              1,669
              
              
              $
              (555
              )
              
              $
              800Adjustments
                  to reconcile net income (loss) to cash provided by operating
                  activities:Depreciation
                  and amortization
              
              
              928
              
              
              
              832
              
              
              
              697Impairment
                  of trademark
              
              
              39
              
              
              
              —
              
              
              
              —Provision
                  for doubtful accounts and sales returns
              
              
              25
              
              
              
              (149
              )
              
              
              3Loss
                  on disposal of equipment
              
              
              —
              
              
              
              8
              
              
              
              21Stock-based
                  compensation
              
              
              132
              
              
              
              67
              
              
              
              47Deferred
                  income taxes
              
              
              111
              
              
              
              36
              
              
              
              —Changes
                  in current assets and liabilities, net of effects of the acquisition
                  of
                  IDARS:Accounts
                  receivable
              
              
              (320
              )
              
              
              569
              
              
              
              (479
              )Inventories
              
              
              (10
              )
              
              
              22
              
              
              
              13Prepaid
                  expenses and other
              
              
              146
              
              
              
              95
              
              
              
              69Accounts
                  payable and accrued expenses
              
              
              797
              
              
              
              (197
              )
              
              
              (75
              )Deferred
                  revenue
              
              
              4
              
              
              
              247
              
              
              
              67Cash
                  provided by operating activities
              
              
              3,521
              
              
              
              975
              
              
              
              1,163CASH
                  FLOWS FROM INVESTING ACTIVITIES:Purchases
                  of equipment and fixtures
              
              
              (136
              )
              
              
              (912
              )
              
              
              (343
              )Proceeds
                  from sale of equipment
              
              
              8
              
              
              
              2
              
              
              
              4Purchase
                  of IDARS business, net of cash acquired
              
              
              (671
              )
              
              
              (4,575
              )
              
              
              —Capitalized
                  software development costs
              
              
              (81
              )
              
              
              —
              
              
              
              (43
              )Decrease
                  (increase) in restricted cash
              
              
              —
              
              
              
              268
              
              
              
              (122
              )Other
                  assets
              
              
              (25
              )
              
              
              (9
              )
              
              
              (19
              )Cash
                  used in investing activities
              
              
              (905
              )
              
              
              (5,226
              )
              
              
              (523
              )CASH
                  FLOWS FROM FINANCING ACTIVITIES:Proceeds
                  from exercise of stock options
              
              
              349
              
              
              
              181
              
              
              
              82(Repayments)
                  borrowings on line of credit
              
              
              (1,000
              )
              
              
              1,000
              
              
              
              —Cash
                  (used in) provided by financing activities
              
              
              (651
              )
              
              
              1,181
              
              
              
              82EFFECT
                  OF EXCHANGE RATE CHANGES ON CASH AND EQUIVALENTS
              
              
              14
              
              
              
              31
              
              
              
              (82
              )INCREASE
                  (DECREASE) IN CASH AND EQUIVALENTS
              
              
              1,979
              
              
              
              (3,039
              )
              
              
              640CASH
                  AND EQUIVALENTS, BEGINNING OF YEAR
              
              
              1,862
              
              
              
              4,901
              
              
              
              4,261CASH
                  AND EQUIVALENTS, END OF YEAR
              
              $
              3,841
              
              
              $
              1,862
              
              
              $
              4,901SUPPLEMENTAL
                  CASH FLOW INFORMATION:Interest
                  paid
              
              $
              42
              
              
              $
              31
              
              
              $
              3Income
                  taxes paid
              
              $
              4
              
              
              $
              6
              
              
              $
              —Income
                  tax refunds received
              
              $
              —
              
              
              $
              —
              
              
              $
              63





See
      notes
      to consolidated financial statements.


-
          35
          -


DATAWATCH
      CORPORATION


NOTES
      TO CONSOLIDATED FINANCIAL
      STATEMENTS








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





Nature
      of
      Business





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





Summary
      of Significant
      Accounting Policies





Principles
      of
      Consolidation




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.





Revenue
      Recognition




The
      Company follows the guidance as defined by the American Institute of Certified
      Public Accountants (“AICPA”) Statement of Position 97-2, “Software Revenue Recognition”
(“SOP 97-2”), as amended by
      Statement of Position 98-9, “Modification of SOP 97-2,
      Software
      Revenue Recognition, With Respect to Certain Transactions” (“SOP 98-9”)
      in recognizing revenue on software transactions. SOP 97-2 requires that revenue
      allocated to software products, specified upgrades and enhancements be
      recognized upon delivery of the related product, upgrades or
      enhancements.  Revenue allocated by vendor specific objective evidence
      (“VSOE”) of fair value to post contract customer support (primarily maintenance)
      is recognized ratably over the term of the support, and revenue allocated by
      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 in
      accordance with relevant sections of SOP 97-2 and (2) the difference between
      the
      total arrangement fee and the amount deferred for the undelivered elements
      is
      recognized as revenue related to the delivered elements.





The
      Company has two types of software product offerings: Enterprise Software and
      Desktop and Server Software. Enterprise Software products are sold directly
      to
      end-users and through value added resellers. The Company sells its Desktop
      and
      Server Software products directly to end-users and through distributors and
      resellers.  Sales to distributors accounted for approximately 32%, 33%
      and 31%, of total sales for the years ended




-
          36
          -


September
      30, 2007, 2006 and 2005, respectively. Revenue from the sale of all software
      products (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 defined by SOP 97-2.  The Company’s software products can be
      installed and used by customers on their own with little or no customization
      required. Multi-user licenses marketed by the Company are sold as a right to
      use
      the number of licenses and license fee revenue is recognized upon delivery
      of
      all software required to satisfy the number of licenses sold. Upon delivery,
      the
      licensing fee is payable without further delivery obligations to the
      Company.





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





The
      Company also sells its Enterprise Software using a subscription model. At the
      time a customer enters into a binding agreement to purchase a subscription,
      the
      customer is invoiced for an initial 90 day service period and an account
      receivable and deferred revenue are recorded. Beginning on the date the software
      is installed at the customer site and available for use by the customer, and
      provided that all other criteria for revenue recognition are met, the deferred
      revenue amount is recognized ratably over the period the service is provided.
      The customer is then invoiced every 90 days and, in accordance with the SOP
      97-2, revenue is recognized ratably over the period the service is
      provided.  The subscription arrangement includes software, maintenance
      and unspecified future upgrades including major version upgrades. The initial
      subscription rate is the same as the renewal rate. Subscriptions can be
      cancelled by the customer at any time by providing 90 days 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 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
      and applies the guidance found in Statement of Financial Accounting Standards
      No. 48, “Revenue Recognition
      when Right of Return Exists.” Revenue from the sale of software products
      to distributors and resellers is recognized at the time of shipment providing
      all other criteria for revenue recognition as stated above are met and (i)
      the
      distributor or reseller is unconditionally obligated to pay for the products,
      including no contingency as to product resale, (ii) the distributor or reseller
      has independent economic substance apart from the Company, (iii) the Company
      is
      not obligated for future performance to bring about product resale, and (iv)
      the
      amount of future returns can be reasonably estimated. The Company’s experience
      and history with its distributors and resellers allows for reasonable estimates
      of future returns. Among other things, estimates of potential future returns
      are
      made based on the inventory levels at the various distributors and resellers,
      which the Company monitors frequently.




-
          37
          -


Allowance
      for Doubtful
      Accounts




The
      Company maintains allowances for doubtful accounts for estimated losses
      resulting from the inability of customers to make required payments. The Company
      analyzes accounts receivable and the composition of the accounts receivable
      aging, historical bad debts, customer creditworthiness, current economic trends
      and changes in customer payment terms when evaluating the adequacy of the
      allowance for doubtful accounts. Based upon the analysis and estimates of the
      uncollectibility of its accounts receivable, the Company records an increase
      in
      the allowance for doubtful accounts when the prospect of collecting a specific
      account receivable becomes doubtful. Actual results could differ from the
      allowances for doubtful accounts recorded, and this difference may have a
      material effect on the Company’s financial position and results of
      operations.





For
      the
      fiscal years ended September 30, 2007, 2006 and 2005, changes to and ending
      balances of the allowance for doubtful accounts were approximately as
      follows:





2007
              
              
              2006
              
              
              2005(in
                  thousands)Allowance
                  for doubtful accounts balance - beginning of year
              
              $
              193
              
              
              $
              294
              
              
              $
              230Additions
                  to the allowance for doubtful accounts
              
              
              57
              
              
              
              11
              
              
              
              75Deductions
                  against the allowance for doubtful accounts
              
              
              (27
              )
              
              
              (112
              )
              
              
              (11
              )Allowance
                  for doubtful accounts balance - end of year
              
              $
              223
              
              
              $
              193
              
              
              $
              294





Sales
      Returns
      Reserve




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





For
      the
      fiscal years ended September 30, 2007, 2006 and 2005, changes to and ending
      balances of the sales returns reserve were approximately as
      follows:





2007
              
              
              2006
              
              
              2005(in
                  thousands)Sales
                  returns reserve balance - beginning of year
              
              $
              79
              
              
              $
              123
              
              
              $
              186Additions
                  to the sales returns reserve
              
              
              131
              
              
              
              82
              
              
              
              180Deductions
                  against the sales returns reserve
              
              
              (130
              )
              
              
              (126
              )
              
              
              (243
              )Sales
                  returns reserve balance - end of year
              
              $
              80
              
              
              $
              79
              
              
              $
              123





Capitalized
      Software Development
      Costs




The
      Company capitalizes certain software development costs as well as purchased
      software upon achieving technological feasibility of the related products.
      Software development costs incurred and software purchased prior to achieving
      technological feasibility are charged to research and development expense as
      incurred. Commencing upon initial product release, capitalized costs are
      amortized to cost of software licenses using the straight-line method over
      the
      estimated life (which approximates the ratio that current gross revenues for
      a
      product bear to the total of current and anticipated future gross revenues
      for
      that product), which is generally 24 to 72 months.





For
      the
      fiscal years ended September 30, 2007, 2006 and 2005, amounts related to
      capitalized and purchased software development costs and purchased software
      were
      approximately as follows:





-
          38
          -


2007
              
              
              2006
              
              
              2005(in
                  thousands)Capitalized
                  and purchased software balance - beginning of year
              
              $
              473
              
              
              $
              583
              
              
              $
              937Capitalized
                  software development costs
              
              
              81
              
              
              
              —
              
              
              
              42Capitalized
                  purchased software
              
              
              —
              
              
              
              180
              
              
              
              —Amortization
                  of capitalized software development costs and purchased
                  software
              
              
              (159
              )
              
              
              (290
              )
              
              
              (396
              )Capitalized
                  and purchased software balance - end of year
              
              $
              395
              
              
              $
              473
              
              
              $
              583


Cash
      and
      Equivalents




Cash
      and
      equivalents include cash on hand, cash deposited with banks and highly liquid
      securities including money market investments and short-term treasury deposits
      with original maturities of 90 days or less.





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.
      One customer, Ingram Micro Inc., individually accounted for 15%, 16% and 19%
      of
      total revenue in 2007, 2006 and 2005, respectively. Ingram Micro Inc. accounted
      for 15% and 12% of outstanding gross trade receivables as of September 30,
      2007
      and 2006, respectively. One other customer, Tech Data Product Management,
      individually accounted for approximately 13%, 13% and 7% of total revenue in
      2007, 2006 and 2005, respectively. Tech Data Product Management accounted for
      20% and 16% of outstanding gross trade receivables as of September 30, 2007
      and
      2006, respectively. The Company sells to Ingram Micro Inc. and Tech Data Product
      Management under distribution agreements, which automatically renew for
      successive one-year terms unless terminated. Other than these two customers,
      no
      other customer constitutes a significant portion (more than 10%) of sales or
      accounts receivable. The Company performs ongoing credit evaluations of its
      customers and generally does not require collateral. Allowances are provided
      for
      anticipated doubtful accounts and sales returns based on management’s review of
      receivables, inventory and historical trends.





Deferred
      Revenue




Deferred
      revenue consisted of the following at September 30:




2007
              
              
              2006(in
                  thousands)Maintenance
              
              $
              4,012
              
              
              $
              3,690Other
              
              
              596
              
              
              
              778Total
              
              
              4,608
              
              
              
              4,468Less:
                  Long-term portion of deferred maintenance
              
              
              (122
              )
              
              
              —Current
                  portion of deferred revenue
              
              $
              4,486
              
              
              $
              4,468


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





Other
      deferred revenue consists of deferred license, subscription and professional
      services revenue generated from arrangements that are invoiced in accordance
      with the terms and conditions of the arrangement but do not




-
          39
          -


meet
      all
      the criteria for revenue recognition, and are, therefore, deferred until all
      revenue recognition criteria are met.





Inventories




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





Property
      and
      Equipment




Purchased
      equipment and fixtures are recorded at cost. Leased equipment accounted for
      as
      capital leases is recorded at the present value of the minimum lease payments
      required during the lease terms. Depreciation and amortization are provided
      using the straight-line method over the estimated useful lives of the related
      assets or over the terms, if shorter, of the related leases. Useful lives and
      lease terms range from one to seven years. Depreciation and amortization expense
      related to property and equipment was $407,000, $363,000 and $235,000,
      respectively, for the years ended September 30, 2007, 2006 and 2005. There
      were
      no items under capital leases as of September 30, 2007 or 2006.





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





Goodwill
      and certain trademarks are not subject to amortization and are tested annually
      for impairment or more frequently if events and circumstances indicate that
      the
      asset might be impaired. Goodwill is tested for impairment using a two-step
      approach. The first step is to compare the fair value of the reporting unit
      to
      its carrying amount, including goodwill. If the fair value of the reporting
      unit
      is greater than its carrying amount, goodwill is not considered impaired, but
      if
      the fair value of the reporting unit is less than its carrying amount, the
      amount of the impairment loss, if any, must be measured. An impairment loss
      is
      recognized to the extent that the carrying amount exceeds the asset’s fair
      value. Changes in the carrying amounts of goodwill for the years ended September
      30, 2007 and 2006 are as follows (in thousands):





2007
            
            2006Balance
                at beginning of year
            
            $
            5,236
            
            $
            1,631Acquisition
                of IDARS business
            
            
            784
            
            
            3,605Balance
                at end of year
            
            $
            6,020
            
            $
            5,236




-
          40
          -


The
      Company has the following other intangible assets as of September 30, 2007
      and
      2006:





Weighted
              
              September
                  30,
                  2007
              
              September
                  30,
                  2006Average
              
              Gross
              
              
              
              
              
              GrossIdentified
                  Intangible
              
              Useful
                  Life
              
              Carrying
              
              Accumulated
              
              Net
                  Carrying
              
              Carrying
              
              Accumulated
              
              Net
                  CarryingAsset
              
              in
                  Years
              
              Amount
              
              Amortization
              
              Amount
              
              Amount
              
              Amortization
              
              Amount(in
                  thousands)Capitalized
                  software
              
              2
              
              $        1,747
              
              $            1,671
              
              $                76
              
              $       1,666
              
              $           1,648
              
              $                 18Purchased
                  software
              
              5
              
              700
              
              381
              
              319
              
              700
              
              245
              
              455Patents
              
              20
              
              160
              
              24
              
              136
              
              160
              
              16
              
              144Customer
                  lists
              
              10
              
              1,790
              
              337
              
              1,453
              
              1,790
              
              138
              
              1,652Non-compete
                  agreements
              
              4
              
              640
              
              254
              
              386
              
              640
              
              99
              
              541Trademark
              
              2
              
              21
              
              —
              
              21
              
              60
              
              —
              
              60Trademark
              
              indefinite
              
              285
              
              —
              
              285
              
              285
              
              —
              
              285Total
              
              8
                  Years
              
              $       5,343
              
              $          2,667
              
              $          2,676
              
              $       5,301
              
              $           2,146
              
              $           3,155




During
      fiscal 2007, the Company determined that a trademark with a carrying value
      of
      $60,000 no longer had an indefinite useful life and was impaired by $39,000.
      The
      remaining balance of $21,000 will be amortized over the remaining estimated
      useful life of two years.





The
      intangible asset amounts amortized to cost of software licenses and
      subscriptions totaled $167,000, $351,000 and $462,000 for fiscal 2007, 2006
      and
      2005, respectively.





As
      of
      September 30, 2007, the estimated future amortization expense related to
      amortizing intangible assets was as follows (in thousands):





Years
                  Ending September
                  30,2008
              
              $
              5132009
              
              
              4662010
              
              
              3532011
              
              
              1952012
              
              
              174Thereafter
              
              
              690Total
                  estimated future amortization expense
              
              $
              2,391





Restricted
      Cash




At
      September 30, 2007 and 2006, restricted cash consisted of a $125,000 security
      deposit in the form of an irrevocable letter of credit held in escrow for the
      landlord of the Company’s Chelmsford, MA corporate offices.





Fair
      Value
      Disclosure




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





Income
      Taxes




Deferred
      income taxes are provided for the tax effects of temporary differences between
      the carrying amounts of assets and liabilities for financial reporting purposes
      and the amounts used for income tax purposes




-
          41
          -


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 per share reflects the impact, when
      dilutive, of the exercise of options using the treasury-stock
      method.





The
      following table presents the options that were not included in the computation
      of diluted net income per share, because the exercise price of the
      options was greater than the average market price of the common stock for
      the years ended September 30, 2007, 2006 and 2005:





2007
            
            
            2006
            
            
            2005Quantity
                of option shares not included
            
            
            190,042
            
            
            
            255,753
            
            
            
            145,870Weighted-average
                exercise price
            
            $
            4.90
            
            
            $
            4.76
            
            
            $
            5.86





Foreign
      Currency Translations and
      Transactions




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





Advertising
      and Promotional
      Materials




Advertising
      costs are expensed as incurred and amounted to $311,000, $325,000 and $373,000
      in 2007, 2006 and 2005, respectively. Direct mail/direct response costs are
      expensed as the associated revenue is recognized. The amortization period is
      based on historical results of previous mailers (generally three to six months
      from the date of the mailing). Direct mail expense was $164,000, $33,000 and
      $112,000 in 2007, 2006 and 2005, respectively. At both September 30, 2007 and
      2006, deferred direct mail/direct response costs were $4,000 and are included
      under the caption “prepaid expenses and other” in the accompanying consolidated
      balance sheets.





Stock-Based
      Compensation




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





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





Under
      the
      provisions of SFAS No. 123(R), the Company recognizes the fair value of
      share-based awards over the requisite service period of the individual awards,
      which generally equals the vesting period. All of the Company’s share-based
      awards are accounted for initially as equity instruments. See additional
      Stock-Based Compensation disclosure in Note 8 to the Company’s consolidated
      financial statements.





On
      November 10, 2005, the Financial Accounting Standards Board (“FASB”) issued FASB
      Staff Position No. FAS 123(R)-3, “Transition Election Related
      to
      Accounting for Tax Effects of Share-Based Payment Awards.”






-
          42
          -


During
      the first quarter of fiscal 2007, the Company elected to adopt the alternative
      transition method provided in the FASB Staff Position for calculating the tax
      effects of stock-based compensation pursuant to SFAS 123(R). The alternative
      transition method includes simplified methods to establish the beginning balance
      of the additional paid-in capital (“APIC pool”) related to the tax effects of
      employee stock-based compensation, and to determine the subsequent impact on
      the
      APIC pool and Consolidated Statements of Cash Flows of the tax effects of
      employee stock-based compensation awards that are outstanding upon adoption
      of
      SFAS 123(R).





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 2007, 2006 and 2005 were $86,000, $44,000, and $60,000,
      respectively.





Segment
      Information




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





Guarantees
      and
      Indemnifications




The
      Company’s software products are sold under warranty against certain defects in
      material and workmanship for a period of 30 days from the date of purchase.
      The
      Company has never incurred significant expense under its product or service
      warranties. As a result, the Company believes the estimated fair value of these
      warranty agreements is minimal. Accordingly, there are no liabilities recorded
      for warranty claims as of September 30, 2007 and 2006.





The
      Company is required by the lease related to its Chelmsford, Massachusetts
      facility to provide a letter of credit in the amount of $125,000 as a security
      deposit to provide credit support for payment to the landlord of amounts due
      under the lease.  As previously disclosed, cash on deposit providing
      security in the amount of this letter of credit is classified as part of
      restricted cash in the Company’s consolidated balance sheets at September 30,
      2007. See Note 5 for disclosure of minimum rental commitments under
      non-cancelable operating leases.





In
      August
      2004, the Company entered into a Stock Purchase Agreement for the acquisition
      of
      Mergence in which the Company made certain warranties regarding, among other
      things, its legal authority to enter into the agreement consummating the
      acquisition and its ability to continue in its business.  The Company
      further agreed to indemnify the sellers of Mergence and hold them harmless
      for
      any damages incurred or suffered arising out of any misrepresentation or breach
      of such warranties made by the Company in the agreement. The Company believes
      that no such misrepresentations or breaches of warranty exist, or are likely
      to
      exist in the future, and, accordingly, has recorded no liabilities related
      to
      such indemnification as of September 30, 2007 and 2006.





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 agreements is minimal. Accordingly, the Company has no
      liabilities recorded for these agreements as of September 30, 2007 and
      2006.





Certain
      of the Company’s agreements also provide for the performance of services at
      customer sites. These agreements may contain indemnification clauses, whereby
      the Company will indemnify the customer from any




-
          43
          -


and
      all
      damages, losses, judgments, costs and expenses for acts of its employees or
      subcontractors resulting in bodily injury or property damage. The maximum
      potential amount of future payments the Company could be required to make under
      these indemnification agreements is unlimited; however, the Company has general
      and umbrella insurance policies that would enable it to recover a portion of
      any
      amounts paid. The Company has never incurred costs to defend lawsuits or settle
      claims related to these indemnification agreements. As a result, the Company
      believes the estimated fair value of these agreements is minimal. Accordingly,
      the Company has no liabilities recorded for these agreements as of September
      30,
      2007and
      2006.





As
      permitted under Delaware law, the Company has agreements with its directors
      whereby the Company will indemnify them for certain events or occurrences while
      the director is, or was, serving at the Company’s request in such capacity. The
      term of the director indemnification period is for the later of ten years after
      the date that the director ceases to serve in such capacity or the final
      termination of proceedings against the director as outlined in the
      indemnification agreement. The maximum potential amount of future payments
      the
      Company could be required to make under these indemnification agreements is
      unlimited; however, the Company’s director and officer insurance policy limits
      the Company’s exposure and enables it to recover a portion of any future amounts
      paid. As a result of its insurance policy coverage, the Company believes the
      estimated fair value of these indemnification agreements is minimal. The Company
      has no liabilities recorded for these agreements as of September 30, 2007 and
      2006.





Recent
      Accounting
      Pronouncements




In
      June
      2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty
      in
      Income Taxes – an Interpretation of FASB Statement No. 109” (“FIN
      48”).  FIN 48 clarifies the accounting for income taxes by prescribing
      the minimum recognition threshold a tax position is required to meet before
      being recognized in the financial statements. This interpretation also provides
      guidance on derecognition, measurement, classification, interest and penalties,
      accounting in interim periods, disclosure and transition. FIN 48 will require
      disclosure at the end of the annual reporting period of the nature of uncertain
      tax positions and related events if it is reasonably possible that those
      positions and events could change the associated recognized tax benefit within
      the next twelve months. This Interpretation is effective for fiscal years
      beginning after December 15, 2006.  The Company will adopt FIN 48
      effective October 1, 2007. The Company is currently in the process of evaluating
      the effect of adopting the provisions of FIN 48 and does not believe the
      cumulative effect of applying the provisions of FIN 48 will have a material
      impact on retained earnings as of October 1, 2007.





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





In
      February 2007, the FASB issued Statement No. 159, “The Fair Value Option for
      Financial
      Assets and Financial Liabilities” (“SFAS No. 159”). SFAS No. 159 expands
      opportunities to use fair value measurement in financial reporting and permits
      entities to choose to measure many financial instruments and certain other
      items
      at fair value. This Statement is effective for fiscal years beginning after
      November 15, 2007. The Company has not decided if it will early adopt SFAS
      159
      or if it will choose to measure any eligible financial assets and liabilities
      at
      fair value.





In
      September 2006, the Securities and Exchange Commission staff published Staff
      Accounting Bulletin (“SAB”) 108, “Considering the Effects
      of Prior
      Year Misstatements when Quantifying Misstatements in Current Year Financial
      Statements” (“SAB 108”). SAB 108 provides interpretive guidance on how
      the effects of the carryover or reversal of prior year misstatements should
      be
      considered in quantifying a current year misstatement.






-
          44
          -


The
      Company applied the provisions of SAB 108 in the year ended September 30, 2007.
      Application of SAB 108 had no impact on the Company’s consolidated financial
      position, results of operations or cash flows.




In
      December 2007, the FASB issued SFAS No. 141(R), “Business Combinations”(“SFAS 141(R)”), which replaces
      SFAS No. 141. SFAS No. 141(R) establishes
      principles and requirements for how an acquirer recognizes and measures in
      its
      financial statements the identifiable assets acquired, the liabilities assumed,
      any non-controlling interest in the acquiree and the goodwill acquired. The
      Statement also establishes disclosure requirements which will enable users
      to
      evaluate the nature and financial effects of the business combination. SFAS
      141(R) is effective for fiscal years beginning after December 15, 2008. The
      adoption of SFAS 141(R) will have an impact on accounting for business
      combinations once adopted, but the effect is dependent upon acquisitions at
      that
      time.





In
      December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests
      in
      Consolidated Financial Statements – an amendment of Accounting Research Bulletin
      No. 51”(“SFAS 160”), which establishes accounting and reporting
      standards for ownership interests in subsidiaries held by parties other than
      the
      parent, the amount of consolidated net income attributable to the parent and
      to
      the noncontrolling interest, changes in a parent’s ownership interest and the
      valuation of retained non-controlling equity investments when a subsidiary
      is
      deconsolidated. The Statement also establishes reporting requirements that
      provide sufficient disclosures that clearly identify and distinguish between
      the
      interests of the parent and the interests of the non-controlling owners. SFAS
      160 is effective for fiscal years beginning after December 15, 2008. The Company
      has not determined the effect that the application of SFAS 160 will have on
      its
      consolidated financial statements.








2.        ACQUISITION





On
      May 3,
      2006, the Company acquired certain assets and assumed certain liabilities of
      ClearStory Systems, Inc.’s Integrated Document Archiving and Retrieval Systems
      (“IDARS”) business. The acquisition of IDARS was consummated pursuant to an
      asset purchase agreement dated as of March 10, 2006 among the Company and
      ClearStory Systems, Inc. The acquisition cost for IDARS was approximately
      $4,790,000, consisting of $4,349,000 in cash and direct acquisition costs of
      approximately $441,000. Additional acquisition costs include an 18-month
      earn-out payment equal to 30% of net revenues of products from the IDARS
      business excluding the first $337,500 of revenues, net of any claims. The
      earn-out payments will be considered additional purchase price and will be
      recorded as additional goodwill when incurred. At September 30, 2007 and 2006,
      the Company accrued approximately $329,000 and $215,000, respectively, related
      to such earn-out payments. In accordance with the asset purchase agreement,
      payments commenced during the third and fourth quarters of fiscal 2007 and
      the
      remaining payments are required to be made in the first quarter of fiscal year
      2008. During fiscal 2007, the Company made earn-out payments totaling
      approximately $671,000. On November 29, 2007, the Company made an additional
      earn-out payment totaling approximately $329,000.





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





Current
                  assets
              
              $
              56Property
                  and equipment, net
              
              
              64Current
                  liabilities
              
              
              (125
              )Deferred
                  revenues
              
              
              (1,190
              )Goodwill
              
              
              3,605Acquired
                  intangible assets:Existing
                  technology
              
              
              180Customer
                  list
              
              
              1,660Non-compete
                  agreement
              
              
              540Total
                  purchase price
              
              $
              4,790




-
          45
          -


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





The
      intangible asset for existing technology is for technologies developed by
      IDARS.  The Company has estimated the life of these products as five
      years.  The IDARS customer list and non-compete agreements have
      estimated lives of ten years and four years, respectively. The fair values
      for
      the existing technology, customer list and non-compete agreements will be
      amortized over their estimated life, subject to appropriate asset impairment
      assessments. Amortization of the intangible assets acquired as part of the
      IDARS
      acquisition totaled $337,000 for fiscal year 2007 and $140,000 from the date
      of
      acquisition through September 30, 2006.





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








3.
            INVENTORIES





Inventories
      consisted of the following at September 30:




2007
              
              
              2006(in
                  thousands)Raw
                  materials
              
              $
              32
              
              
              $
              18Finished
                  goods
              
              
              16
              
              
              
              19Total
              
              $
              48
              
              
              $
              37








4.
            ACCRUED
                EXPENSES





Accrued
      expenses consisted of the following at September 30:





2007
              
              
              2006(in
                  thousands)Accrued
                  salaries and benefits
              
              $
              357
              
              
              $
              347Accrued
                  royalties and commissions
              
              
              1,542
              
              
              
              933Accrued
                  professional fees
              
              
              421
              
              
              
              255Other
              
              
              519
              
              
              
              283Total
              
              $
              2,839
              
              
              $
              1,818





5.        COMMITMENTS





Leases




The
      Company leases various facilities and equipment in the U.S. and overseas under
      non-cancelable operating leases which expire through 2011. The lease agreements
      generally provide for the payment of minimum annual rentals, pro-rata share
      of
      taxes, and maintenance expenses. Rental expense for all operating leases was
      $511,000, $632,000 and $664,000 for the years ended September 30, 2007, 2006
      and
      2005, respectively.  Certain






-
          46
          -


of
      the
      Company’s facility leases include options to renew.





As
      of
      September 30, 2007, minimum rental commitments under noncancelable operating
      leases are as follows (in thousands):




Years
                  Ending September
                  30,2008
              
              $
              4072009
              
              
              3102010
              
              
              1962011
              
              
              141Total
                  minimum lease payments
              
              $
              1,054





Royalties




The
      Company is committed to pay royalties ranging from 7% to 50% on revenue
      generated by the sale of certain licensed software products.  Royalty
      expense included in cost of software licenses and subscriptions was $1,865,000,
      $1,602,000 and $1,659,000 for the years ended September 30, 2007, 2006 and
      2005, respectively. The Company is not obligated to pay minimum royalty
      amounts.





ClearStory
      Systems
      Royalties




As
      a
      result of the acquisition of certain assets of the IDARS business on May 3,
      2006
      (see Note 2), the Company is required to make payments equal to 30% of net
      revenues of products from the IDARS business excluding the first $337,500 of
      this revenue, net of any claims, covering the 18 month earn-out period from
      May
      3, 2006 until November 3, 2007. In accordance with the purchase and sale
      agreement, payments commenced during the Company’s third and fourth quarters of
      fiscal year 2007 and the remaining payments are required to be made in the
      first
      quarter of fiscal year 2008.





Mergence
      Royalties




On
      August
      11, 2004, the Company acquired 100% of the shares of Mergence Technologies
      Corporation.  The purchase agreement includes a provision for
      quarterly cash payments to the former Mergence shareholders equal to 10% of
      revenue, as defined, of the Datawatch|Researcher product until September 30,
      2010. The Company expensed approximately $17,000, $5,000 and $10,000 for the
      years ended September 30, 2007, 2006 and 2005.





Contingencies




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








6.
            FINANCING
                ARRANGEMENTS





Borrowings




On
      April
      20, 2006, the Company entered into a one-year Loan and Security Agreement (“Loan
      Agreement”) with a bank.  The Loan Agreement established two revolving
      $1.5 million lines of credit, for a total of $3.0 million.  As of
      September 30, 2006, advances on the Company’s two credit lines amounted to
      $1,000,000. Under the terms of the Loan Agreement, the Company could borrow
      under the first line of credit based on a formula percentage based on the
      Company’s eligible accounts receivable balance. There was no borrowing base
      formula for the second line of credit. The first line of credit bore an interest
      rate equal to the prime rate plus 0.50% and the second line of credit bore
      an
      interest rate equal to the prime rate plus 1.00%. Amounts borrowed under the
      Loan Agreement were secured by all of the assets of the Company, including
      its
      intellectual property. The Loan Agreement required the Company to maintain
      certain specified cash flow and liquidity levels. In addition, the






-
          47
          -


Loan
      Agreement required that the Company maintain at all times unrestricted cash
      with
      the bank of not less than $500,000.





On
      February 9, 2007, the Company elected to repay its $1,000,000 advance under
      the
      line of credit. The Company did not renew the line of credit upon its expiration
      date of April 19, 2007.





Letter
      of
      Credit




The
      Company has an irrevocable standby letter of credit with a bank securing
      performance of a five-year property lease. The Company has provided a cash
      term
      deposit in the amount of $125,000 to secure the letter of credit. This amount
      is
      included as part of restricted cash in the Company’s consolidated balance sheets
      at September 30, 2007 and 2006.








7.
            INCOME
                TAXES





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




2007
              
              
              2006
              
              
              2005(in
                  thousands)Domestic
              
              $
              2,078
              
              
              $
              1,551
              
              
              $
              1,645Foreign
              
              
              (276
              )
              
              
              (2,070
              )
              
              
              (867
              )Total
              
              $
              1,802
              
              
              $
              (519
              )
              
              $
              778





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





2007
              
              
              2006
              
              
              2005(in
                  thousands)Current:Federal
              
              $
              12
              
              
              $
              —
              
              
              $
              (12
              )State
              
              
              9
              
              
              
              —
              
              
              
              (10
              )Foreign
              
              
              1
              
              
              
              —
              
              
              
              —22
              
              
              
              —
              
              
              
              (22
              )Deferred:Federal
              
              
              138
              
              
              
              (26
              )
              
              
              (18
              )State
              
              
              52
              
              
              
              10
              
              
              
              11Foreign
              
              
              —
              
              
              
              (32
              )
              
              
              —Change
                  in valuation allowance
              
              
              (79
              )
              
              
              84
              
              
              
              7111
              
              
              
              36
              
              
              
              —Total
                  provision (benefit)
              
              $
              133
              
              
              $
              36
              
              
              $
              (22
              )





At
      September 30, 2007, the Company had U.S. federal tax loss carryforwards of
      approximately $7.3 million, expiring at various dates through 2026, including
      $520,000 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 $2.1 million in state tax loss carryforwards,
      which also expire at various dates through 2026. An alternative minimum tax
      credit of approximately $157,000 is available to offset future regular federal
      taxes. Research and development credits of approximately $499,000 expire
      beginning in 2009. In addition, the Company has the following net operating
      loss
      carryforwards: United Kingdom losses of $8.5 million with no expiration date,
      France losses of $93,000 with no expiration date, Germany losses of $708,000
      with no expiration date




-
          48
          -


and
      Australia losses of $2.9 million with no expiration date.





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





2007
              
              
              2006(in
                  thousands)Deferred
                  tax liabilities:Goodwill
                  amortization
              
              $
              (147
              )
              
              $
              (36
              )Prepaid
                  expenses
              
              
              (71
              )
              
              
              (58
              )Acquired
                  intangibles
              
              
              (152
              )
              
              
              (356
              )(370
              )
              
              
              (450
              )Deferred
                  tax assets:Net
                  operating loss carryforwards
              
              
              3,931
              
              
              
              4,147Research
                  and development credits
              
              
              499
              
              
              
              418Accounts
                  and notes receivable reserves
              
              
              84
              
              
              
              144Alternative
                  minimum tax credits
              
              
              157
              
              
              
              148Depreciation
                  and amortization
              
              
              734
              
              
              
              182Deferred
                  rent
              
              
              92
              
              
              
              95Other
              
              
              311
              
              
              
              545,808
              
              
              
              5,188Total
              
              
              5,438
              
              
              
              4,738Valuation
                  allowance
              
              
              (5,585
              )
              
              
              (4,774
              )Deferred
                  tax liability, net
              
              $
              (147
              )
              
              $
              (36
              )






For
      financial reporting purposes, the Company had profitable domestic operations
      but
      continued to have operating losses from its significant international
      subsidiaries during the years ended September 30, 2007, 2006 and 2005. The
      Company has had marginal, if any domestic taxable income during this same period
      as the Company’s subsidiaries in the United Kingdom are treated as branches on
      the domestic tax returns and, accordingly, the losses at such subsidiaries
      are
      recorded on the domestic tax returns. Previous 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 $118,000 of state net operating loss
      carryforwards expired in fiscal 2006. 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.





SFAS
      No.
      109, “Accounting for Income
      Taxes,” requires recognition of deferred tax liabilities and deferred tax
      assets (and related valuation allowances, if necessary) for the excess of
      tax-deductible goodwill over goodwill for financial reporting purposes. The
      tax
      benefit for the excess tax-deductible goodwill is recognized when realized
      on
      the tax return. During fiscal year 2006, Datawatch acquired the business assets
      of IDARS that resulted in tax-deductible amortization being recognized as a
      deferred tax expense in 2006 and 2007. As the goodwill is deducted for tax
      purposes, a deferred tax expense will be recognized each year with a
      corresponding deferred tax liability equal to the excess of tax amortization
      over the amortization for financial reporting purposes.





The
      following table reconciles the Company’s tax provision based on its effective
      tax rate to its tax provision based on the federal statutory rate of 34% for
      the
      years ended September 30, 2007, 2006 and 2005 (in thousands):





-
          49
          -




2007
            
            
            2006
            
            
            2005Provision
                at federal statutory rate
            
            $
            613
            
            
            $
            (176
            )
            
            $
            265State,
                net of federal impact
            
            
            21
            
            
            
            6
            
            
            
            (7
            )Foreign
                income taxes
            
            
            (473
            )
            
            
            (76
            )
            
            
            (60
            )Valuation
                allowance increase (decrease)
            
            
            (79
            )
            
            
            350
            
            
            
            7Extra-territorial
                income exclusion
            
            
            —
            
            
            
            (72
            )
            
            
            (120
            )Other
            
            
            51
            
            
            
            4
            
            
            
            (107
            )Provision
                (benefit) for income taxes
            
            $
            133
            
            
            $
            36
            
            
            $
            (22
            )








8.
            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 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 (the “1996 International 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 (the “1996 Stock Plan”), which provides for the granting of both incentive
      stock options and nonqualified options, the award of Company common stock,
      and
      opportunities to make direct purchases of Company common stock (collectively,
      “Stock Rights”), as determined by a committee appointed by the Board of
      Directors. Options pursuant to this plan 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.





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





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





-
          50
          -


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





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





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




Year
                  EndedSeptember
                  30,2005(In
                  thousands)Net
                  income, as reported
              
              $
              800Add:Total
                  stock-based employee compensation expenseincluded in net
                  income
              
              
              47Less:Total
                  stock-based employee compensation expensedetermined under fair
                  value base method for all awards,net of taxes
              
              
              (590
              )Pro
                  forma net income
              
              $
              257Basic
                  net income per share:As
                  reported
              
              $
              0.15Pro
                  forma
              
              $
              0.05Diluted
                  net income per share:As
                  reported
              
              $
              0.14Pro
                  forma
              
              $
              0.04


Beginning
      with the 2006 fiscal year, with the adoption of SFAS 123(R), the Company
      recorded stock-based compensation expense for the fair value of stock options.
      Stock-based compensation expense for the fiscal years ended September 30, 2007
      and 2006 was $132,000 and $67,000, respectively, which was included in the
      following expense categories (in thousands):





Years
                Ended September
                30,2007
            
            
            2006(In
                thousands)Sales
                and marketing
            
            $
            51
            
            
            $
            25Engineering
                and product development
            
            
            11
            
            
            
            7General
                and administrative
            
            
            70
            
            
            
            35$
            132
            
            
            $
            67




-
          51
          -


The
      Company uses the Black-Scholes option-pricing model to calculate the fair value
      of options. The key assumptions for this valuation method include the expected
      life of the option, stock price volatility, risk-free interest rate, dividend
      yield, exercise price and forfeiture rate. The weighted-average fair values
      of
      the options granted under the stock options plans were $1.54, $3.10 and $2.98
      for the years ended September 30, 2007, 2006 and 2005, respectively. The total
      intrinsic value of options exercised during the years ended September 30, 2007,
      2006 and 2005 was approximately $190,000, $184,000 and $152,000, respectively.
      As of September 30, 2007, there was $236,000 of total unrecognized compensation
      cost related to nonvested stock option arrangements, which is expected to be
      recognized over a weighted-average period of 1.97 years.





Many
      of
      these assumptions are judgmental and highly sensitive in the determination
      of
      compensation expense. The table below indicates the key assumptions used in
      the
      option valuation calculations for options granted for the years ended September
      30, 2007 and 2006:




2007
              
              
              2006Expected
                  life
              
              5
                  years
              
              
              5
                  yearsExpected
                  volatility
              
              
              75.88%-83.34
              %
              
              
              95.91%-97.65
              %Weighted
                  average volatility
              
              77.63
              %
              
              96.69
              %Risk-free
                  interest rate
              
              
              4.48%-4.99
              %
              
              
              4.43%-5.03
              %Dividend
                  yield
              
              
              0.0
              %
              
              
              0.0
              %







The
      dividend yield of zero is based on the fact that the Company has never paid
      cash
      dividends and has no present intention to pay cash dividends. The Company uses
      an expected stock-price volatility assumption that is a combination of both
      historical and current implied volatilities of the underlying stock which are
      obtained from public data sources. The risk-free interest rate is the U.S.
      Treasury bill rate with constant maturities with a remaining term equal to
      the
      expected life of the option. The expected life is based on historical trends
      and
      data.  With regard to the weighted-average option life assumption, the
      Company considers the exercise behavior of past grants and models the pattern
      of
      aggregate exercises. Patterns are determined on specific criteria of the
      aggregate pool of optionees including the reaction to vesting, realizable value
      and short-time-to-maturity effect. Based on the Company’s historical voluntary
      turnover rates, an annualized estimated forfeiture rate of 10% has been used
      in
      calculating the estimated compensation 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, 2007, 600,000 shares were authorized and 489,166 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:





Weighted-
            
            Weighted
                -
                AverageNumber
                of
            
            
            Average
            
            Remaining
            
            AggregateOptions
            
            
            Exercise
            
            Contractual
            
            IntrinsicOutstanding
            
            
            Price
            
            Term
            
            Value
                $(000)Outstanding,
                October 1, 2004
            
            
            919,970
            
            
            $
            2.17Granted
            
            
            115,334
            
            
            
            3.78Canceled
            
            
            (55,286
            )
            
            
            3.06Exercised
            
            
            (67,976
            )
            
            
            1.21Outstanding,
                September 30, 2005
            
            
            912,042
            
            
            
            2.39Granted
            
            
            100,000
            
            
            
            4.14Canceled
            
            
            (16,325
            )
            
            
            6.89Exercised
            
            
            (143,401
            )
            
            
            1.26Outstanding,
                September 30, 2006
            
            
            852,316
            
            
            
            2.65Granted
            
            
            110,000
            
            
            
            2.67Canceled
            
            
            (31,592
            )
            
            
            4.38Exercised
            
            
            (121,181
            )
            
            
            2.88Outstanding,
                September 30, 2007
            
            
            809,543
            
            
            $
            2.55
            
            5.42
            
            $
            1,650Vested
                or expected
                to vest, September 30, 2007
            
            
            797,844
            
            
            $
            2.54
            
            5.19
            
            $
            1,636Exercisable,
                September 30, 2007
            
            
            685,828
            
            
            $
            2.43
            
            4.96
            
            $
            1,484Exercisable,
                September 30, 2006
            
            
            771,908
            
            
            $
            2.50




-
          52
          -


The
      following table presents weighted-average price and life information regarding
      options outstanding and exercisable at September 30, 2007:





Outstanding
            
            
            ExercisableWeighted-Average
            
            
            Weighted-
            
            
            
            
            
            Weighted-Remaining
            
            
            Average
            
            
            
            
            
            AverageExercise
            
            Number
                of
            
            
            Contractual
            
            
            Exercise
            
            
            
            
            
            ExercisePrices
            
            Shares
            
            
            Life
                (Years)
            
            
            Price
            
            
            Shares
            
            
            Price$0.74
              – $3.10
            
            
            
            544,602
            
            
            
            5.12
            
            
            $
            1.59
            
            
            
            479,618
            
            
            $
            1.48$3.11
              – $5.76
            
            
            
            250,713
            
            
            
            6.23
            
            
            
            4.35
            
            
            
            191,982
            
            
            
            4.43$7.59
            
            
            
            14,228
            
            
            
            2.49
            
            
            
            7.59
            
            
            
            14,228
            
            
            
            7.59809,543
            
            
            
            5.42
            
            
            $
            2.55
            
            
            
            685,828
            
            
            $
            2.43





Restricted
      Stock
      Units




On
      March
      9, 2007 and July 27, 2007, the Company granted awards of restricted stock units
      (“RSU”) to each of its six non-employee Directors. 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 such that when fully vested, each holder will receive
      2,500 shares of common stock, for a total of 15,000 shares of common stock.
      Each
      RSU vests at the rate of 33.33% on each of the first and second anniversaries
      of
      March 9, 2007 or July 27, 2007, with the balance to be vested on March 9, 2010
      or July 27, 2010. 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 value of the RSUs granted on March 9,
      2007
      and July 27, 2007 was $38,000 (or $3.02 fair value per share) and $15,000 (or
      $5.85 fair value per share), respectively. The Company recorded
      compensation related to the RSUs of $8,000 during the year ended September
      30,
      2007 which is included in the total stock-based compensation expense disclosed
      above. As of September 30, 2007, there was $44,000
      of total unrecognized compensation cost related to RSUs, which is expected
      to be
      recognized over a weighted average period of 2.56 years.








9.
            RETIREMENT
                SAVINGS
                PLAN





The
      Company has a 401(k) retirement savings plan covering substantially all of
      the
      Company’s full-time domestic employees. Under the provisions of the plan,
      employees may contribute a portion of their compensation within certain
      limitations. The Company, at the discretion of the Board of Directors, may
      make
      contributions on behalf of its employees under this plan. Such contributions,
      if
      any, become fully vested after five years of continuous service. The Company
      has
      not made any contributions during 2007, 2006 or 2005.








10.
            SEGMENT
                INFORMATION





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







-
          53
          -


2007
              
              2006
              
              2005Business
                  Intelligence Solutions (including Monarch,
                  Monarch
                  Data Pump, Monarch|RMS, Datawatch|ES, Datawatch|Researcher,
                  Visual|Insight, iMergence and VorteXML)
              67%
              
              73%
              
              74%Content
                  Management Solutions (including  Datawatch|BDS
                  and Datawatch|MailManager)
              14%
              
              5%
              
              0%Business
                  Service Management and Workflow Solutions (including Visual|QSM
                  and
                  Visual|HD)
              19%
              
              22%
              
              26%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:




International(Principally
              
              
              IntercompanyDomestic
              
              
              U.K.)
              
              
              Eliminations
              
              
              Total(in
                  thousands)Year
                  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
              
              
              
              —
              
              
              
              9,747Year
                  Ended September 30,
                  2006Total
                  revenue
              
              $
              15,110
              
              
              $
              6,676
              
              
              $
              (975
              )
              
              $
              20,811Operating
                  income (loss)
              
              
              565
              
              
              
              (1,099
              )
              
              
              —
              
              
              
              (534
              )Long-lived
                  assets
              
              
              8,806
              
              
              
              881
              
              
              
              —
              
              
              
              9,687Year
                  Ended September 30,
                  2005Total
                  revenue
              
              $
              14,727
              
              
              $
              7,848
              
              
              $
              (1,064
              )
              
              $
              21,511Operating
                  income (loss)
              
              
              1,640
              
              
              
              (952
              )
              
              
              —
              
              
              
              688Long-lived
                  assets
              
              
              3,456
              
              
              
              94
              
              
              
              —
              
              
              
              3,550


11.
            QUARTERLY
                RESULTS
                (UNAUDITED)





Supplementary
      Information:






-
          54
          -


First
              
              
              Second
              
              
              Third
              
              
              Fourth(in
                  thousands, except per share
                  amounts)Year
                  Ended September 30,
                  2007:Software
                  license and subscription revenue
              
              $
              3,438
              
              
              $
              3,257
              
              
              $
              4,091
              
              
              $
              4,066Maintenance
                  and service revenue
              
              
              2,338
              
              
              
              2,892
              
              
              
              2,392
              
              
              
              2,785Cost
                  of software licenses and subscriptions
              
              
              537
              
              
              
              560
              
              
              
              691
              
              
              
              680Cost
                  of maintenance and services
              
              
              1,032
              
              
              
              983
              
              
              
              922
              
              
              
              1,006Expenses
              
              
              4,117
              
              
              
              4,138
              
              
              
              4,470
              
              
              
              4,388Income
                  from operations
              
              
              90
              
              
              
              468
              
              
              
              400
              
              
              
              777Net
                  income
              
              
              34
              
              
              
              424
              
              
              
              382
              
              
              
              829Net
                  income per share - basic
              
              $
              0.01
              
              
              $
              0.08
              
              
              $
              0.07
              
              
              $
              0.15Net
                  income per share - diluted
              
              $
              0.01
              
              
              $
              0.07
              
              
              $
              0.06
              
              
              $
              0.14Year
                  Ended September 30,
                  2006:Software
                  license and subscription revenue
              
              $
              3,155
              
              
              $
              3,445
              
              
              $
              3,386
              
              
              $
              3,159Maintenance
                  and service revenue
              
              
              1,593
              
              
              
              1,949
              
              
              
              1,958
              
              
              
              2,166Cost
                  of software licenses and subscriptions
              
              
              573
              
              
              
              591
              
              
              
              580
              
              
              
              524Cost
                  of maintenance and services
              
              
              841
              
              
              
              964
              
              
              
              1,000
              
              
              
              1,144Expenses
              
              
              3,284
              
              
              
              3,631
              
              
              
              4,055
              
              
              
              4,158Income
                  (loss) from operations
              
              
              50
              
              
              
              208
              
              
              
              (291
              )
              
              
              (501
              )Net
                  income (loss)
              
              
              64
              
              
              
              227
              
              
              
              (315
              )
              
              
              (531
              )Net
                  income (loss) per share - basic
              
              $
              0.01
              
              
              $
              0.04
              
              
              $
              (0.06
              )
              
              $
              (0.09
              )Net
                  income (loss) per share - diluted
              
              $
              0.01
              
              
              $
              0.04
              
              
              $
              (0.06
              )
              
              $
              (0.09
              )








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.





-
          55
          -





(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, 2007 that have materially affected, or are reasonably likely
      to materially affect, our internal control over financial
      reporting.








Item
                9B.
            OTHER
                INFORMATION





None.
































-
          56
          -


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, 2007. 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, 2007 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, 2007 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, 2007 is incorporated herein by
      reference.








Item
      14.  PRINCIPAL ACCOUNTANT FEES AND
      SERVICES





The
      information set forth under the caption “Principal Accountant Fees and Services”
appearing in the Company’s definitive Proxy Statement for the Annual Meeting of
      Shareholders for the fiscal year ended September 30, 2007 is incorporated herein
      by reference.








-
          57
          -


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, 2007 and 2006


Consolidated
      Statements of Operations for the Years Ended September 30, 2007, 2006 and
      2005


Consolidated
      Statements of Shareholders’ Equity and Comprehensive Income (Loss) for the Years
      Ended September 30, 2007, 2006 and 2005


Consolidated
      Statements of Cash Flows for the Years Ended September 30, 2007, 2006 and
      2005


Notes
      to
      Consolidated Financial Statements





2.  Financial
      Statement
      Schedule





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





3.  List
      of
      Exhibits





Ex.
      No.                                                             Description





(1)
            
            3.1
            
            Restated
                Certificate of Incorporation of the Registrant (Exhibit
                3.2)(6)
            
            3.2
            
            Certificate
                of Amendment of Restated Certificate of Incorporation of the Registrant
                (Exhibit 3.2)(1)
            
            3.3
            
            By-Laws,
                as amended, of the Registrant (Exhibit 3.3)(1)
            
            4.1
            
            Specimen
                certificate representing the Common Stock (Exhibit 4.4)(4)
            
            4.2
            
            Warrant
                to Purchase Stock issued to Silicon Valley Bank, dated January 17,
                2001
                (Exhibit 4.1)(6)
            
            4.3
            
            Warrant
                to Purchase Stock issued to Silicon Valley Bank, dated October 30,
                2001
                (Exhibit 4.3)(1)
            
            10.1*
            
            1987
                Stock Plan (Exhibit 10.7)(11)
            
            10.2*
            
            Form
                of Incentive Stock Option Agreement of the Registrant (Exhibit
                10.2)(11)
            
            10.3*
            
            Form
                of Nonqualified Stock Option Agreement of the Registrant (Exhibit
                10.3)(1)
            
            10.4
            
            Software
                Development and Marketing Agreement by and between Personics Corporation
                and Raymond Huger, dated January 19, 1989 (Exhibit
                10.12)(9)
            
            10.5
            
            Option
                Purchase Agreement by and among Datawatch Corporation, Personics
                Corporation and Raymond J. Huger dated April 29, 2005. (Exhibit
                10.1)(8)
            
            10.6
            
            Distribution
                Agreement, dated December 10, 1992, by and between Datawatch Corporation
                and Ingram Micro Inc. (Exhibit 10.2)(2)
            
            10.7*
            
            1996
                Non-Employee Director Stock Option Plan, as amended on December 10,
                1996
                (Exhibit 10.30)(2)
            
            10.8*
            
            1996
                International Employee Non-Qualified Stock Option Plan (Exhibit
                10.31)(8)
            
            10.9*
            
            1996
                Stock Plan as amended as of March 7, 2003 (Exhibit
                10.1)(3)
            
            10.10
            
            Indemnification
                Agreement between Datawatch Corporation and James Wood, dated January
                12,
                2001 (Exhibit 10.1)(3)
            
            10.11
            
            Indemnification
                Agreement between Datawatch Corporation and Richard de J. Osborne,
                dated
                January 12, 2001 (Exhibit 10.2)(5)
            
            10.12
            
            Form
                of Indemnification Agreement between Datawatch Corporation and each
                of its
                Non-Employee Directors (Exhibit 10.1)(5)
            
            10.13*
            
            Advisory
                Agreement, dated April 5, 2001, by and between Datawatch Corporation
                and
                Richard de J. Osborne (Exhibit 10.2)(6)
            
            10.14*
            
            Executive
                Agreement, dated July 9, 2001, between the Company and Robert W.
                Hagger
                (Exhibit 10.24)(7)
            
            10.15*
            
            Executive
                Agreement, dated April 25, 2002, by and between Datawatch Corporation
                and
                John Kitchen (Exhibit 10.2)(7)
            
            10.16
            
            Professional
                Services Agreement, dated May 16, 2002, by and between Vested Development
                Inc. and Datawatch Corporation (Exhibit
                10.3)





-
          58
          -


(13)
            
            10.17*
            
            Severance
                Agreement between Datawatch Corporation and John Hulburt, dated November
                19, 2004. (Exhibit 10.19)(10)
            
            10.18
            
            Stock
                Purchase Agreement among Datawatch Corporation, Mergence Technologies
                Corporation and the Management Sellers, dated as of August 11, 2005
                (Exhibit 2.1).(10)
            
            10.19
            
            Form
                of Stock Purchase Agreement among Datawatch Corporation, Mergence
                Technologies Corporation and the Non-Management Sellers, dated as
                of
                August 11, 2005 (Exhibit 2.2)(11)
            
            10.20*
            
            Description
                of Fiscal Executive Sales Incentive Plan (Exhibit 10.4)(12)
            
            10.21*
            
            Form
                of Lock-up Agreement between Datawatch Corporation and each Executive
                Officer of Datawatch Corporation, dated September 26, 2005 (Exhibit
                99.1)(12)
            
            10.22
            
            Sublease
                Agreement, dated September 28, 2005, between Tellabs Operations,
                Inc., and
                Datawatch Corporation (Exhibit 99.2)(14)
            
            10.23
            
            February
                2006 Amendment to Software Development and Marketing Agreement, dated
                February 21, 2006 by and among the Company, Personics Corporation,
                Raymond
                J. Huger and Math Strategies (Exhibit 10.1)(14)
            
            10.24
            
            Amendment
                to Option Purchase Agreement, dated February 21, 2006 by and among
                the
                Company, Personics Corporation, Raymond J. Huger and Math Strategies
                (Exhibit 10.2)(15)
            
            10.25*
            
            2006
                Equity Compensation and Incentive Plan(20)
            
            10.26*
            
            Form
                of 2006 Non-Qualified Stock Option Agreement for Directors (Exhibit
                10.26)(20)
            
            10.27*
            
            Form
                of 2006 Non-Qualified Stock Option Agreement for Officers (Exhibit
                10.27)(20)
            
            10.28*
            
            Form
                of 2006 Incentive Stock Option Agreement for Officers (Exhibit
                10.28)(16)
            
            10.29
            
            Asset
                Purchase Agreement dated as of March 10, 2006 between Datawatch
                Corporation and ClearStory Systems, Inc. (Exhibit 10.1)(17)
            
            10.30
            
            Loan
                and Security Agreement dated April 20, 2006 between Silicon Valley
                Bank, Datawatch Corporation, and Datawatch Technologies Corporation
                (Exhibit 10.1)(18)
            
            10.31
            
            First
                Loan Modification Agreement dated August 2, 2006 between Silicon
                Valley
                Bank, Datawatch Corporation and Datawatch Technologies Corporation
                (Exhibit 10.1)(19)
            
            10.32
            
            Second
                Loan Modification Agreement dated November 27, 2006 between Silicon
                Valley
                Bank, Datawatch Corporation, and Datawatch Technologies Corporation
                (Exhibit 10.1)(21)
            
            10.33*
            
            Executive
                Agreement, dated March 26, 2007, between Datawatch Corporation and
                Murray
                Fish (Exhibit 10.1)(22)
            
            10.34*
            
            Form
                of Restricted Stock Unit Agreement for Directors (Exhibit
                10.1)(23)
            
            10.35*
            
            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.





(1)
            
            Previously
                filed as an exhibit to Registration Statement 33-46290 on Form S-1
                and
                incorporated herein by reference (the number given in parenthesis
                indicates the corresponding exhibit in such Form S-1).(2)
            
            Previously
                filed as an exhibit to Registrant’s Annual Report on Form 10-K for the
                fiscal year ended September 30, 1996 and incorporated herein by reference
                (the number given in parenthesis indicates the corresponding exhibit
                in
                such Form 10-K).(3)
            
            Previously
                filed as an exhibit to Registrant’s Current Report on Form 8-K dated
                February 2, 2001 and incorporated herein by reference (the number
                in
                parenthesis indicates the corresponding exhibit in such Form
                8-K).(4)
            
            Previously
                filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q for the
                quarter ended December 31, 2000 and incorporated herein by reference
                (the
                number given in parenthesis indicates the corresponding exhibit in
                such
                Form 10-Q).(5)
            
            Previously
                filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q for the
                quarter ended March 31, 2001 and incorporated herein by reference
                (the
                number given in parenthesis indicates the corresponding exhibit in
                such
                Form 10-Q).





-
          59
          -


(6)
            
            Previously
                filed as an exhibit to Registrant’s Annual Report on Form 10-K for the
                fiscal year ended September 30, 2001 and incorporated herein by reference
                (the number given in parenthesis indicates the corresponding exhibit
                in
                such Form 10-K).(7)
            
            Previously
                filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q for the
                quarter ended June 30, 2002 and incorporated herein by reference
                (the
                number given in parenthesis indicates the corresponding exhibit in
                such
                Form 10-Q).(8)
            
            Previously
                filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q for the
                quarter ended March 31, 2003 and incorporated herein by reference
                (the
                number given in parenthesis indicates the corresponding exhibit in
                such
                Form 10-Q).(9)
            
            Previously
                filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q for the
                quarter ended March 31, 2004 and incorporated herein by reference
                (the
                number given in parenthesis indicates the corresponding exhibit is
                such
                Form 10-Q).(10)
            
            Previously
                filed as an exhibit to Registrant’s Current Report on Form 8-K dated
                August 20, 2004 and incorporated herein by reference (the number
                in
                parenthesis indicates the corresponding exhibit in such Form
                8-K).(11)
            
            Previously
                filed as an exhibit to Registrant’s Current Report on Form 8-K dated
                November 2, 2004 and incorporated herein by reference (the number
                in
                parenthesis indicates the corresponding exhibit in such Form
                8-K).(12)
            
            Previously
                filed as an exhibit to Registrant’s Current Report on Form 8-K dated
                September 26, 2005 and incorporated herein by reference (the number
                in
                parenthesis indicates the corresponding exhibit in such Form
                8-K).(13)
            
            Previously
                filed as an exhibit to Registrant’s Annual Report on Form 10-K for the
                fiscal year ended September 30, 2005 and incorporated herein by reference
                (the number given in parenthesis indicates the corresponding exhibit
                in
                such Form 10-K).(14)
            
            Previously
                filed as an exhibit to Registrant’s Current Report on Form 8-K dated
                February 21, 2006 and incorporated herein by reference (the number
                in
                parenthesis indicates the corresponding exhibit in such Form
                8-K).(15)
            
            Previously
                filed as Appendix A to Registrant’s Definitive Proxy Statement dated
                January 30, 2006 and incorporated herein by reference.(16)
            
            Previously
                filed as an exhibit to Registrant’s Current Report on Form 8-K dated March
                10, 2006 and incorporated herein by reference (the number in parenthesis
                indicates the corresponding exhibit in such Form 8-K).(17)
            
            Previously
                filed as an exhibit to Registrant’s Current Report on Form 8-K dated April
                20, 2006 and incorporated herein by reference (the number in parenthesis
                indicates the corresponding exhibit in such Form 8-K).(18)
            
            Previously
                filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q for the
                quarter ended June 20, 2006 and incorporated herein by reference
                (the
                number in parenthesis indicates the corresponding exhibit in such
                Form
                10-Q).(19)
            
            Previously
                filed as an exhibit to Registrant’s Current Report on Form 8-K dated
                November 27, 2006 and incorporated herein by reference (the number
                in
                parenthesis indicates the corresponding exhibit in such Form
                8-K).(20)
            
            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
                (the number given in parenthesis indicates the corresponding exhibit
                in
                such Form 10-K).(21)
            
            Previously
                filed as an exhibit to Registrant’s Current Report on Form 8-K dated March
                26, 2007 and incorporated herein by reference (the number in parenthesis
                indicates the corresponding exhibit in such Form 8-K).(22)
            
            Previously
                filed as an exhibit to Registrant’s Current Report on Form 8-K dated
                August 2, 2007 and incorporated herein by reference (the number in
                parenthesis indicates the corresponding exhibit in such Form
                8-K).(23)
            
            Previously
                filed as an exhibit to Registrant’s Current Report on Form 8-K dated
                October 23, 2007 and incorporated herein by reference (the number
                in
                parenthesis indicates the corresponding exhibit in such Form
                8-K).




(b)  Exhibits





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




(c)  Financial
      Statement
      Schedules





Not
      applicable.








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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:
            December
                31, 2007
            By:
            /s/
                Robert W. HaggerRobert
                W. HaggerPresident,
                Chief Executive Officer
              and
                Director





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





SIGNATURE
            
            TITLE
            
            DATE/s/
                Robert W. Hagger
            
            President,
                Chief Executive Officer and Director
            
            December
                31, 2007Robert
                W. Hagger
            
            (Principal
                Executive Officer)/s/
                Murray P. Fish
            
            Vice
                President of Finance, Chief Financial Officer,
            
            December
                31, 2007Murray
                P. Fish
            
            Treasurer
                and Assistant Secretary(Principal
                Financial and Accounting Officer)/s/
                Richard de J. Osborne
            
            Chairman
                of the Board
            
            December
                31, 2007Richard
                de J. Osborne/s/
                Kenneth P. Bero
            
            Director
            
            December 31,
              2007Kenneth
                P. Bero/s/
                Thomas H. Kelly
            
            Director
            
            December
                31, 2007Thomas
                H. Kelly/s/
                Terry W. Potter
            
            Director
            
            December
                31, 2007Terry
                W. Potter/s/
                David T. Riddiford
            
            Director
            
            December
                31, 2007David
                T. Riddiford/s/
                William B. Simmons, Jr.
            
            Director
            
            December
                31, 2007William
                B. Simmons, Jr./s/
                James Wood
            
            Director
            
            December
                31, 2007James
                Wood






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