UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549
                                    FORM 10-K
               [x]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended September 30, 1998
Commission file number  0-19960
                                            DATAWATCH CORPORATION
                  (Exact name of registrant as specified in its charter)
         Delaware                                                  02-0405716
(State of other jurisdiction of                       (I.R.S. Employer
incorporation or organization)                        Identification number)

234 Ballardvale St., Wilmington, Massachusetts                  01887
(Address of principal executive office)                       (Zip Code)

Registrant's telephone number, including area code: (978) 988-9700
Securities registered pursuant to Section 12 (b) of the Act:
                                                      None
Securities registered pursuant to Section 12 (g) of the Act:
                           Title of Class:     Common Stock $.01 par value
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed  by  Section  13 or 15 (d) of the  Securities  Exchange  Act of 1934
during the preceding 12 months (or for such shorter  period that the  Registrant
was  required  to file such  reports),  and (2) has been  subject to such filing
requirements for the past 90 days:
                                             Yes X               No

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation S-K  (Sec.229.405  of this chapter) 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 [X]

Aggregate  market  value of voting  stock  held by  non-affiliates:  $11,866,275
(computed  by reference to the last sales price of such common stock on December
15,  1998  as  reported  in  the  National   Association  of  Security   Dealers
consolidated trading index).

Number of shares of common stock outstanding at December 15, 1998: 9,148,312

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,  1998.
Portions of such Proxy  Statement are  incorporated  by reference in Part III of
this report.


<PAGE>



                                     PART I
Item 1.   BUSINESS

GENERAL

      DATAWATCH  CORPORATION  (the  "Company" or  "Datawatch")  is a provider of
Enterprise  Reporting,  Report Mining and Service Center software  products that
help  organizations  increase  productivity,  reduce costs and gain  competitive
advantages.   DATAWATCH  products  are  used  in  more  than  20,000  companies,
institutions and government agencies worldwide.

      The Company was founded in 1985 to design, manufacture and market computer
workstations  and  peripherals  that  conform to the U.S.  government's  TEMPEST
security standard. With the end of the Cold War and subsequent decline in demand
for defense-oriented products, the Company exited the TEMPEST market in 1993 and
focused its attention on commercial software.  Through a series of acquisitions,
the Company  assembled a diverse  portfolio  of popular  software  applications,
including Monarch(TM),  netOctopus(TM),  VIREX(R) and Q-Support(TM)/Quetzal(TM).
In October 1997,  DATAWATCH  divested its Apple  Macintosh  software  (VIREX and
netOctopus) in order to concentrate on the Windows/Intel platform.

      The Company is a Delaware corporation,  with executive offices located at 
234 Ballardvale Street, Wilmington,  Massachusetts 01887 and the Company's 
telephone number is (978) 988-9700.

PRODUCTS

      DATAWATCH is best known for its popular report mining  application  called
Monarch.  More than  200,000  copies of Monarch have been sold,  with  localized
versions in English, French, German and Japanese. Monarch lets users extract and
manipulate  data from ASCII report files  produced on any  mainframe,  midrange,
client/server or PC system.  The Company's  Redwing(TM)  product,  introduced in
1997, lets users extract text and tables from Adobe PDF documents.

      DATAWATCH  recently  completed a series of strategic  product  initiatives
that  position  the Company as a leader in the  emerging  market for  enterprise
reporting software. Monarch/ES(TM),  introduced in March 1998, is a configurable
enterprise   reporting   solution  that  lets   organizations   deliver  reports
electronically  via their  local area  network.  Reports  are stored in a secure
repository and brought to life on screen to support queries and analyses.

      Monarch/ES Web,  introduced in October 1998, extends the system to support
browser-based   report  retrieval  via  the  Worldwide  Web.  Monarch/ES  Report
Publisher,  also  introduced in October  1998,  supports  automated  delivery of
reports via MAPI-compliant email.

      In August  1998,  DATAWATCH  entered the market for data  replication  and
migration tools with the  introduction of Monarch Data Pump. This product offers
a shortcut for populating and refreshing data marts and data warehouses, and for
migrating legacy data into new applications.

      DATAWATCH also participates in the market for service center software. The
Company's  Quetzal/Q-Support help desk and asset management software is a market
leader in Europe, with the largest installed base among products that compete in
the  internal  help desk  market.  Customers  include the  British  Broadcasting
Corporation, Her Majesty's Customs and Excise Service and Toronto Dominion Bank.
Quetzal/Q-Support  is  recognized  for its  advanced  service  level  management
capabilities, integrated change management features, business process automation
tools and unique user-interface that promotes ease-of-use and ease-of-learning.

      Quetzal/SC,  introduced  in December  1998,  is a major new release of the
Company's Quetzal/Q-Support  software.  Quetzal/SC's advanced architecture gives
it strong performance and scalability.  The product was designed to handle up to
50,000 calls per hour,  and can be scaled to support as few as two users running
on an xBASE file server, hundreds of users running on an NT server, or thousands
of users running on powerful Unix servers.  Quetzal/SC  integrates  with popular
network management tools such as CA-Unicenter, Tivoli Management Edition and BMC
Patrol,  and employs  Monarch to provide  extensive  data analysis and reporting
capabilities.

PRICING

      The  Company's  desktop  products  are sold under  single  and  multi-user
licenses.  A single  user  license  for  Monarch  is priced at $499.  Multi-user
licenses  are  priced at $150 to $250 per  user,  depending  upon the  number of
users.  A single user license for Redwing is priced at $695. A five user license
is priced at $1,995.

      The  Company's   enterprise   products  are  sold  under   named-user  and
concurrent-user   licenses.  An  entry-level  Monarch/ES  system  is  priced  at
approximately $20,000. Typical configurations are priced in the range of $40,000
to $250,000. Monarch Data Pump is priced at approximately $20,000 per server. An
entry-level Quetzal/Q-Support systems is priced at approximately $8,000. Typical
configurations sell in the range of $15,000 to $125,000.  Maintenance agreements
and implementation services are sold separately.

MARKETING AND DISTRIBUTION

      DATAWATCH  markets its products  through a variety of channels in order to
gain broad market exposure and to satisfy the needs of its customers.  DATAWATCH
believes   that   some   customers   prefer   to   purchase   products   through
service-oriented  resellers,  while  others buy on the basis of price,  purchase
convenience, and/or immediate delivery.

      The  Company  is  engaged  in  active  direct  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, 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 and on-going  communication with the
trade press.

      The Company offers its resellers the ability to return  obsolete  versions
of its  products and  slow-moving  products for credit which can be used against
purchases of other DATAWATCH products on a  dollar-for-dollar  basis.  Defective
products may also be returned for credit or  exchange.  Based on its  historical
experience, the Company believes that its exposure to such returns is minimal.

      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
90 days from the date of purchase.  DATAWATCH also offers a 30-60 day money-back
guarantee  on certain of its  products  sold  directly to  end-users.  Under the
guarantee, customers may return purchased products within the 60 days 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 1998,  one  distributor  represented  approximately  12% of
DATAWATCH's  net  sales.  No  other  customer  accounted  for  more  than 10% of
DATAWATCH's net sales in 1998.  DATAWATCH sells its products outside of the U.S.
directly  through  the sales  force of its wholly  owned  subsidiary,  Datawatch
International   Limited   (formerly   WorkGroup   Systems    Limited)("Datawatch
International") and through  international  resellers.  Such international sales
represented  approximately  56%, 47% and 47% of DATAWATCH'S net sales for fiscal
1998,  1997  and  1996,  respectively.  See  Note 14 to  Consolidated  Financial
Statements which appear elsewhere in this Report on Form 10-K.

RESEARCH AND DEVELOPMENT

      The Company's product strategy  necessitates the timely development of new
products. DATAWATCH's product development efforts are conducted through in-house
software development  engineers or by external  developers,  who are compensated
either through royalty  payments based on product sales levels achieved or under
contracts based on services provided.

      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. 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.

      DATAWATCH has contractual  agreements  with the independent  developers of
Monarch and  Monarch/ES  which  require that source codes be placed into escrow.
The  principal  developers  for the  products  are  also  bound  by  contractual
commitments  which require their continuing  involvement in product  maintenance
and   enhancement.   Under  the   agreements,   the  Company  has  been  granted
manufacturing, marketing and sales rights under license agreements which provide
for royalty  payments  based on net sales.  The  Company  has also been  granted
exclusive  worldwide  rights to Monarch with a stated term  expiring in the year
2009,  and to  Monarch/ES  with a stated  term  expiring  in the year 2001.  The
Monarch/ES  license  automatically  renews for successive  annual periods unless
terminated for cause by either party prior to the regular termination date.

BACKLOG

      The Company's software products are generally shipped within seven days of
receipt of an order. Accordingly,  the Company does not believe that backlog for
its products is 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 IBM, Network Associates,  Remedy,  Actuate,
and others which have substantially greater research and development,  marketing
and financial resources than DATAWATCH. Competition in the industry is likely to
intensify  as  current  competitors  expand  their  product  lines  and  as  new
competitors enter the market.

PRODUCT PROTECTION

      Although  DATAWATCH  does  not  generally  own  patents  on  its  software
technologies,  it  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.  Patent
protection is not considered crucial to DATAWATCH's success.  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 and other proprietary
rights infringe on the proprietary rights of third parties, but an allegation of
misappropriation  of trade secrets has been made against the Company by a former
independent  developer.  (See Item 3 of this Report on Form 10-K), and 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 master
disks and the printing of user manuals,  packaging and other related  materials.
Disk  duplication  is performed  in-house with  high-capacity  disk  duplication
equipment, and is occasionally  supplemented with duplication services performed
by   non-affiliated   subcontractors.   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 September 30, 1998, DATAWATCH had 216 full-time employees, including
79 engaged in  marketing,  sales,  and customer  service;  27 engaged in product
consulting, 30 engaged in product management, development and quality assurance,
29 in technical support, 42 providing general,  administrative,  accounting, and
IT functions and 9 in software production and warehousing.

      The Company  believes that its future success may depend on its ability to
continue  to  attract  and  retain  highly-skilled   technical,   marketing  and
management personnel, who are in great demand. The Company currently has written
agreements  with each of its employees  prohibiting  disclosure of  confidential
information  to anyone  outside of the Company,  both during and  subsequent  to
employment.  These  agreements also require  disclosure to the Company of ideas,
discoveries or inventions  relating to or resulting from the employee's work for
the Company,  and  assignment to the Company of all  proprietary  rights to such
matters.

Item 2.  PROPERTIES

      The  Company is  currently  headquartered  in a 51,650  square foot leased
facility in Wilmington,  Massachusetts. The lease expires in April 1999, with an
option to renew for an additional five years. The Company uses approximately 65%
of this facility and the remaining 35% is sublet to Secure  Systems  Group.  The
Company also maintains small offices in California, Georgia, and Illinois.

      The Company  also leases  approximately  6,200 square feet in Potters Bar,
Hertfordshire,  England,  which  expires in January 2005,  approximately  16,000
square feet in Plymouth,  Devon,  England,  which expires in December  2017, and
maintains small offices in Germany, France and Australia.

      The Company is currently reevaluating its facilities needs.

Item 3.   LEGAL PROCEEDINGS

      On November 12, 1998,  the Company  brought a lawsuit in Superior Court of
Massachusetts for Middlesex County,  against Palms Technology U.S., Inc. and its
Chairman,  Jesse E. Torres, III (collectively,  "Palms"),  alleging, among other
things,  misrepresentation,  unfair or deceptive trade practices,  and breach of
contract,  including breach of a Development  Agreement dated as of December 19,
1997, for Palms' failure to complete and deliver  certain  software it was hired
to develop.  Also,  on November  12, 1998,  Palms  brought a lawsuit in the same
court  against  the  Company  and two of its  officers  (the  "Palms  lawsuit"),
claiming  that the Company  misappropriated  Palms'  trade  secrets and breached
contracts  between the parties.  On November 16, 1998, the Company was granted a
Temporary Restraining Order preventing Palms and Torres from dissipating certain
assets to avoid judgment,  and from damaging  certain  software and source code.
Management  believes that the Palms lawsuit has no merit, and Datawatch  intends
to vigorously  defend itself against Palms'  allegations.  Datawatch  intends to
pursue its claims against Palms aggressively.  However,  the ultimate outcome of
these matters cannot yet be determined. No provision for any liability regarding
these  lawsuits has been  recognized in the  Consolidated  Financial  Statements
included in Item 8.

      From time to time the Company is also involved in litigation matters which
arise in the ordinary  course of business,  including one current action brought
by a former employee.  The Company does not believe that the ultimate resolution
of this matter will have a material adverse effect on its 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 are 
      as follows:

Bruce R. Gardner    55   President,  Chief Executive Officer and Director
Marco D. Peterson   43   Senior Vice President of North American Operations
Robert Hagger       50   Senior Vice President  of International Operations,
                         Managing Director of Datawatch International Limited
Betsy J. Hartwell   51   Vice President of Finance, Chief Financial Officer
                         and Treasurer
Scott Crenshaw      33   Vice President of Product Development
John Loring         48   Vice President of Information Technology

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

      BRUCE R. GARDNER,  President,  Chief Executive  Officer and Director.  Mr.
Gardner,  a founder and director of DATAWATCH, was theChief  Financial  Officer 
and Treasurer  since the Company was founded in 1985 until  November 1, 1997. 
Mr. Gardner was a Senior Vice President until June 1993 when he became Executive
Vice President.  Mr. Gardner assumed his current position on November 1, 1997.

      MARCO D. PETERSON,  Senior Vice President of North American  Operations.
Mr.Peterson was the founder of Personics Corporation and has been its President 
since its founding in 1984.  Mr. Peterson took on the additional role of Vice 
President of Marketing and Product Development of the Company in October 1994 
until he became Senior Vice President on November 1, 1997.

      ROBERT  HAGGER, Senior Vice President of  International Operations, 
Managing Director of Datawatch International.  Mr. Hagger joined DATAWATCH as 
Managing  Director of Datawatch  International on March 4, 1997 and assumed the
title of Senior Vice President of International Operations on November 1, 1997. 
Mr. Hagger, since 1993, was founder and Managing Director of Insight Strategy
Management Ltd.  Prior to that he was Managing Director of Byrne Fleming Ltd.

      BETSY J. HARTWELL, Vice President of Finance, Chief Financial Officer and 
Treasurer.  Ms. Hartwell assumed the positions of Vice President of Finance,  
Chief Financial Officer and Treasurer on November 1, 1997.  Prior to that and 
since July, 1990, Ms. Hartwell was DATAWATCH's Corporate Controller.

      SCOTT  CRENSHAW,  Vice  President  of Product  Development.  Mr.  Crenshaw
assumed the  position of Vice  President of Product  Development  on November 1,
1997.  Prior to that and since joining  DATAWATCH in 1992, Mr. Crenshaw has held
various management positions,  most recently as Director of Business Development
and  International  Marketing and prior to that as Business  Segment Manager and
Director of Product Development.

      JOHN LORING, Vice President of Information Technology. Mr. Loring assumed 
the position of Vice President of Information Technology on November 1, 1997.  
Prior thereto and since November, 1993, Mr. Loring was the Company's Director of
Business Development/Information Systems. Prior to that, Mr. Loring was
 DATAWATCH's Manager of Systems Engineering.

                                     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
National  Market under the symbol DWCH.  The range of high and low prices during
each fiscal quarter for the last two fiscal years is set forth below:

                For the Year Ended           Common Stock
                September 30, 1998         High        Low

                4th Quarter               2 1/16        1 1/16
                3rd Quarter               2 7/8         1 7/8
                2nd Quarter               3 1/2         1 13/16
                1st Quarter               4 1/16        1 15/16


                For the Year Ended           Common Stock
                September 30, 1997         High        Low

                4th Quarter               2 7/8        1 7/16
                3rd Quarter               4 5/16       1 5/8
                2nd Quarter               6 5/8        3 5/8
                1st Quarter               8 3/4        5


         There are  approximately  206 shareholders of record as of December 15,
1998. The Company believes that the number of beneficial holders of common stock
exceeds 2,000.

      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.



<PAGE>



Item 6.   SELECTED 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, 1998
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  appearing  elsewhere in this
report.
<TABLE>

Statements of Operations Data
Years Ended September 30,     1998        1997         1996         1995         1994
<S>     <C>    <C>    <C>    <C>    <C>    <C>
                           ----------------------------------------------------------
Sales
 PC-based Products        $25,123,468  $25,995,197  $24,216,794  $18,839,265  $13,027,232
 Macintosh-based Products     172,254    6,052,298    5,805,328    4,520,716    3,854,910
                           --------------------------------------------------------------
Net Sales                  25,295,722   32,047,495   30,022,122   23,359,981   16,882,142
Costs and Expenses         35,800,154   33,929,460   28,894,600   23,678,935   19,956,576
Income (Loss) from
 Operations               (10,504,432)  (1,881,965)   1,127,522     (318,954)  (3,074,434)
Gain on Sale
 of Product Line           15,431,253
Net Income (Loss)          $4,703,996  ($1,995,433)  $1,125,360    ($331,423) ($3,042,767)
Net Income (Loss)
 per Common Share - Basic        $.52        ($.22)       $0.13      ($0.04)      ($0.41)
Net Income (Loss)
 per Common Share - Diluted      $.51        ($.22)       $0.13      ($0.04)      ($0.41)

Balance Sheet Data
 September 30,               1998         1997         1996          1995        1994
                        -------------------------------------------------------------


Total Assets            $18,332,215   $16,146,645   $15,240,571   $12,358,132  $9,646,324
Working Capital           8,503,428     4,451,821     5,210,457     2,631,759   1,547,706
Long-Term Obligations        44,190     1,399,089       209,824       163,868     137,324
Shareholders' Equity    $11,636,482    $6,924,849    $8,238,886   $ 6,062,170  $5,266,588
</TABLE>


<PAGE>




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 Report on FORM
10-K.

GENERAL

      DATAWATCH  CORPORATION (the "Company" or  "DATAWATCH"),  is engaged in the
design, development,  manufacture, marketing, consulting services and support of
business computer  software.  Its products  specifically  address the enterprise
reporting, business intelligence, and help desk markets. Until October 1997, the
Company developed, sold, and supported both PC and Macintosh-based products.

      On October 9, 1997, the Company sold its  Macintosh-based  product line to
Dr Solomon's  Software,  Inc. ("Dr  Solomon's")  for  $16,750,000 in cash.  This
resulted in a pre-tax gain of approximately $15,431,000.  Note 2 to Consolidated
Financial Statements of DATAWATCH and its subsidiaries  contains a more detailed
discussion of this transaction.

      DATAWATCH's  principal  products are: Monarch, a report mining application
that lets users extract and manipulate  data from ASCII report files produced on
any mainframe, midrange,  client/server or PC system; Monarch/ES, a configurable
enterprise   reporting   solution  that  lets   organizations   deliver  reports
electronically  via their  local area  network;  Monarch/ES  Web,  a  Monarch/ES
extension that supports  browser-based  report  retrieval via the Worldwide Web;
Monarch/ES  Report  Publisher,  a Monarch/ES  extension that supports  automatic
delivery  of reports  via  MAPI-compliant  email;  Redwing,  a plug-in for Adobe
Acrobat  that lets  users  extract  text and tables  from  Adobe PDF  documents;
Monarch Data Pump, a data  replication and migration tool that offers a shortcut
for populating and refreshing data marts and data warehouses,  and for migrating
legacy data into new applications;  Q-Support (in the United States) and Quetzal
(internationally),  an integrated  help desk and asset  management  solution for
multi-user,  networked support centers;  and Quetzal/SC,  a major new release of
the Company's Quetzal/Q-Support software, introduced in December 1998.

RESULTS OF OPERATIONS

               Fiscal Year Ended September 30, 1998 as Compared to
                      Fiscal Year Ended September 30, 1997

      Net sales for the fiscal year ended  September  30, 1998 were  $25,296,000
which  represents  a  decrease  of  $6,752,000  or 21%  from  the net  sales  of
$32,047,000  for the  fiscal  year ended  September  30,  1997.  Sales have been
segregated  on the  statements of operations so as to highlight the product line
which remains after the disposition of the Macintosh-based product line (sold to
Dr  Solomon's  Software on October 9, 1997).  Excluding  sales of the  Company's
Macintosh-based  products,  net sales for  fiscal  1998 were  $25,123,000  which
represents a decrease of $872,000 or 3% from net sales of $25,995,000 for fiscal
1997.  The  decline  in  sales is  principally  attributable  to lower  sales of
Q-Support/Quetzal  as customers  awaited the introduction of the next generation
product,  Quetzal/SC,  subsequently  released in December  1998. In fiscal 1998,
Monarch  accounted  for  approximately  51%  of  net  sales;   Q-Support/Quetzal
accounted  for  approximately  37% of net sales;  and  Guildsoft  accounted  for
approximately  11% of net sales.  For the fiscal year ended  September 30, 1998,
the Company's  PC-based  products  accounted for  approximately 99% of net sales
while the Company's Macintosh-based products accounted for approximately 1%.

      The Company's  cost of sales for the fiscal year ended  September 30, 1998
were $5,213,000 or approximately  21% of net sales. Cost of sales for the fiscal
year ended September 30, 1997 were $5,900,000 or approximately 18% of net sales.
Excluding the sales and costs of sales related to the Company's  Macintosh-based
products,  costs of sales for fiscal  1997 would  have been  approximately  20%.
Without the influence of the  Company's  Macintosh-based  products  (sold to Dr.
Solomon's in October, 1997) margins remained relatively comparable.

      Engineering and product  development  expenses include those  expenditures
attributable  to both  internal  development  efforts and efforts  undertaken by
third-party developers.  Fiscal 1998 external development expense included costs
incurred for parallel  development  efforts  undertaken for the next  generation
Q-Support/Quetzal   product.   Expenditures  of  approximately  $1,080,000  were
directly  related to the terminated  Palms Technology  development  project.  In
addition,  external costs of approximately  $543,000 attributable to maintenance
of  Q-Support/Quetzal,  the  next  generation  help  desk  product,  Quetzal/SC,
released in December 1998, and certain  enterprise  solutions products were also
recorded.  Internal engineering and product development expenses were $1,760,000
for the fiscal year ended  September  30, 1998, a decrease of  $1,044,000 or 37%
from  $2,804,000 for the fiscal year ended September 30, 1997. This decrease was
due to both the discontinuance of certain internal  development  efforts and the
non-recurrence  of  development  costs  incurred in fiscal 1997  relating to the
Macintosh based- product line (sold to Dr Solomon's in October, 1997).

      Selling,  general and  administrative  expenses were  $24,525,000  for the
fiscal year ended September 30, 1998, a decrease of $700,000 or approximately 3%
from  $25,225,000 for the fiscal year ended September 30, 1997.  Included in the
costs for fiscal 1998 were approximately $196,000 of one-time expenses primarily
associated  with leased  space no longer  required as a result of the  Company's
restructuring  subsequent to the sale of its Macintosh-based product line in the
first  quarter of 1998,  and  $91,000 of  administrative  and  consulting  costs
associated with the Company's second  restructuring during the fourth quarter of
fiscal 1998.  Included in the expenses for the fiscal year ended  September  30,
1997  were   $608,000  of  one-time   expenses   principally   associated   with
organizational  changes within the Company's  European  subsidiaries.  Excluding
these expenses, the decrease would have been $379,000 or 2% which is principally
attributable to selling expenses  associated with the Company's  Macintosh-based
product line.

      In October 1997, the Company sold its  Macintosh-based  product line to Dr
Solomon's  Software for $16,750,000 in cash. The Company realized a pre-tax gain
on the sale of  approximately  $15,431,000.  After the sale of this product line
the Company initiated a corporate-wide  restructuring  effort so as to allow the
Company to centralize both its administrative infrastructure and the development
efforts of its remaining  products.  The total amount  charged to operations for
the quarter  ended  December  31, 1997 was  approximately  $2,364,000.  The plan
included charges for salaries and wages and the related  severance  benefits for
terminated  personnel.  These charges totaling  approximately  $1,884,000,  were
either paid ($1,549,000) or accrued ($335,000) in the first fiscal quarter.  The
plan also included special payments made to outside  developers  associated with
the centralization of the Company's development efforts. These charges, totaling
$433,000, were either paid ($339,000) or accrued ($94,000) in the first quarter.
Those benefits or payments accrued were paid in the second quarter of 1998.

      During  the  fourth  quarter  of  fiscal  1998 the  Company  approved  and
completed  a second  restructuring  plan to  further  centralize  the  Company's
administrative  infrastructure  and its development  efforts.  The restructuring
plan  consisted  of charges  for  severance  benefits  and costs for  terminated
employees.  These  charges  totaling  approximately  $315,000  were  either paid
($134,000)  or  accrued  ($181,000)  as  of  September  30,  1998.  The  Company
anticipates  those  benefits and payments  accrued will be paid during the first
and second quarters of fiscal 1999.

      As a result of the foregoing,  the net loss from operations for the fiscal
year ended  September 30, 1998 was  $10,504,000,  which compares to the net loss
from  operations of $1,882,000 for the fiscal year ended September 30, 1997. Net
income for the fiscal  year  ended  September  30,  1998 was  $4,704,000,  which
compares to the net loss of  $1,995,000  for the prior fiscal year.  The Company
has recorded a tax provision in the amount of $600,000 for the fiscal year ended
September  30,  1998.  The Company  recorded a de minimis tax  provision  during
fiscal year ended September 30, 1997 because of its ability to utilize  domestic
net operating loss  carryforwards  (NOL) and foreign losses.  The Company's 1998
effective tax rate of 11% is primarily the result of utilizing  domestic NOL and
certain credit  carryforwards.  Such carryforwards have been exhausted in the US
although  the  foreign   operations  still  maintain   substantial   amounts  in
carryforwards (all currently reserved for).

               Fiscal Year Ended September 30, 1997 as Compared to
                      Fiscal Year Ended September 30, 1996

      Net sales for the fiscal year ended  September  30, 1997 were  $32,047,000
which  represents  an  increase  of  $2,025,000  or 7%  from  the net  sales  of
$30,022,000  for the  fiscal  year ended  September  30,  1996.  Sales have been
segregated on the  statements of operations so as to highlight the product lines
which remain after the disposal of the  Macintosh-based  product line. In fiscal
1997 Monarch,  which amounted to  approximately  40% of sales,  increased by 5%;
Q-Support/Quetzal,  which amounted to approximately  34% of sales,  decreased by
6%; Virex,  which amounted to approximately  15% of sales and netOctopus,  which
amounted to  approximately  4% of sales, did not change as a percentage of sales
from fiscal year ended September 30, 1996. Guildsoft, acquired in November 1996,
had net sales for fiscal 1997 which  amounted to  $1,876,000  or 6% of total net
sales.  For the fiscal year ended  September 30, 1997,  the  Company's  PC-based
products   accounted  for   approximately  81%  of  sales  while  the  Company's
Macintosh-based products accounted for approximately 19%.

      The Company's  cost of sales for the fiscal year ended  September 30, 1997
were $5,900,000 or approximately  18% of net sales. Cost of sales for the fiscal
year ended September 30, 1996 were $4,516,000 or approximately 15% of net sales.
The increase in cost of sales,  as a percentage  of net sales,  results from the
inclusion of  Guildsoft's  product sales which bear lower gross margins than the
Company's  other  products.  Cost of sales, as a percentage of net sales for the
fiscal year ended September 30, 1997, excluding Guildsoft,  would have been 16%,
which is relatively consistent with the prior period.

      Engineering  and product  development  expenses  were  $2,804,000  for the
fiscal year ended  September 30, 1997, an increase of $465,000 or  approximately
20% from  $2,339,000 for the fiscal year ended September 30, 1996. This increase
(net  of  approximately  $80,000  of  expenses  associated  with  organizational
changes)  is  primarily  attributable  to the  increase in  personnel  costs and
expenses necessary for continued  development of the  Q-Support/Quetzal  product
and quality assurance for the Monarch product. Product development costs related
to the Virex and netOctopus  products were approximately  $1,296,000 in 1997 and
$1,104,000 in 1996.

      Selling,  general and administrative  expenses were $25,225,000 for fiscal
year ended  September 30, 1997, an increase of $3,186,000 or  approximately  14%
from  $22,039,000 for the fiscal year ended September 30, 1996.  Included in the
expenses  were  $608,000  of  one-time  expenses  principally   associated  with
organizational  changes within Datawatch  International  during the third fiscal
quarter.  Included in the expenses for the fiscal year ended  September 30, 1996
were  $450,000  of  expenses   associated  with  the  acquisition  of  Datawatch
International in March,  1996.  Excluding these expenses,  selling,  general and
administrative  expenses  were  $24,617,000  for the 1997  fiscal  year and were
$21,589,000  for the 1996 fiscal year  resulting in an increase of $3,028,000 or
approximately  14%.  This  increase is  primarily  attributable  to increases in
personnel  within  the  sales  and  marketing  organizations,   principally  for
Q-Support/Quetzal and Monarch, and the inclusion of Guildsoft operating expenses
amounting to approximately  $912,000 for the period or approximately  30% of the
increase.

      As a result of the foregoing,  the net loss from operations for the fiscal
year ended September 30, 1997 was  $1,995,000,  which compares to the net income
of $1,125,000 for the fiscal year ended September 30, 1996. The Company recorded
a de minimis tax provision,  both domestically and  internationally,  during the
periods because of its ability to utilize NOL  carryforwards  during fiscal 1996
and because of its ability to utilize  domestic  NOL  carryforwards  and foreign
losses during fiscal 1997.

LIQUIDITY AND CAPITAL RESOURCES

      In  October  1997,  the  Company  received  $16,750,000  in  cash  from Dr
Solomon's  Software for its Virex and netOctopus  product lines,  resulting in a
pre-tax gain of approximately $15,431,000. This sale provided working capital in
the current year to accomplish  internal  restructuring  plans and fund on-going
operations.

      The Company's  management believes that its currently  anticipated capital
needs for future  operations  of the Company will be satisfied  through at least
September 30, 1999 by funds  currently  available from the above  mentioned sale
and funds generated from  operations.  The Company also has a $1,500,000 line of
credit pursuant to a letter agreement with a bank. Currently,  advances from the
line of credit amount to  $1,150,000.  Beginning as of September  30, 1998,  the
Company was not in compliance with one of the financial  covenants  contained in
the letter  agreement  with the bank.  The bank has  effectively  waived through
maturity  (January 29,  1999) a default  under the line of credit as a result of
the Company's  non-compliance with this financial  covenant,  but has restricted
the Company from further  advances above the $1,150,000  currently  outstanding.
The Company is  currently  negotiating  the renewal of the line of credit  which
expires in January 1999.

         Working capital  increased by  approximately  $4,052,000  during fiscal
1998 primarily as a result of the above mentioned divestiture offset by outflows
for  operating  activities,  costs  associated  with the  restructurings  of the
Company, and discontinued development efforts.

      Management   believes  that  the  Company's  current  operations  are  not
materially impacted by the effects of inflation.

RECENT ACCOUNTING PRONOUNCEMENTS

      In June 1997,  the FASB  issued  SFAS No.  130,  "Reporting  Comprehensive
Income," and SFAS No. 131,  "Disclosures  About  Segments of an  Enterprise  and
Related  Information."  SFAS No. 130  establishes  standards  for  reporting and
displaying  comprehensive income and its components (revenues,  expenses,  gains
and losses) in a full set of general purpose financial statements.  SFAS No. 131
establishes  standards  for the way  that  public  business  enterprises  report
information about operating segments in annual financial statements and requires
that those enterprises  report selected  information about operating segments in
interim financial reports. It also establishes standards for related disclosures
about products and services,  geographic areas and major customers. SFAS No. 130
will be adopted by the Company during the first quarter of fiscal 1999. SFAS No.
131  will  be  adopted  by the  Company  in its  annual  consolidated  financial
statements for fiscal 1999. Such standards are  "disclosure  standards" and will
not impact the Company's consolidated results of operations.

      In March of 1998,  the AICPA released SOP 98-1,  "Accounting  for Costs of
Computer  Software  Developed  or Obtained  for  Internal  Use," which  requires
certain  expenditures  made for  internal use  software to be  capitalized.  The
Company is currently  studying  the impact of SOP 98-1,  which is required to be
adopted by the Company in October 1999.

      In June 1998,  the FASB issued SFAS No. 133,  "Accounting  for  Derivative
Instruments and Hedging Activities,"  effective for fiscal years beginning after
June 15, 1999. The new standard  requires that all companies record  derivatives
on the balance sheet as assets or liabilities,  measured at fair value. Gains or
losses  resulting  from  changes  in the  values of those  derivatives  would be
accounted  for depending on the use of the  derivative  and whether it qualifies
for hedge  accounting.  Management is currently  assessing whether there will be
any impact of SFAS No. 133 on the Company's  consolidated  financial  statements
upon adoption, which is required in October 1999.

YEAR 2000 READINESS DISCLOSURE STATEMENT

General

      The  Company is aware of the global  concerns  related to what is known as
the Year 2000 issue and the potential  for the  associated  system  failures and
business  interruptions that may result. The Year 2000 issue concerns three main
areas:  the  ambiguity  that may result from  processing  and storing data using
2-digit year formats; the recognition that the year 2000 is a leap year; and the
use of dates (most commonly 9/9/99) for special  programming  functions.  Any of
these  problems  could  result in a system  failure or  miscalculations  causing
disruptions of operations,  including, among other things, a temporary inability
to process  transactions  or engage in normal  business  activities for both the
Company and its customers who rely on its products.

Year 2000 Compliance Program

      The Company  has been aware of the Year 2000 issue for  several  years and
has been  actively  engaged in  correcting  Year 2000  deficiencies  as they are
recognized,  but has not yet  completed  reviewing,  correcting  and testing all
facets of the Year 2000 compliance issues facing it. The Company is currently in
the process of developing a Year 2000 compliance  program,  the purpose of which
will be:  to  identify  important  internal  systems  that are not yet Year 2000
compliant; to initiate replacement or remedial action to assure that key systems
and products  will continue to operate in the Year 2000 and to test the replaced
or  remediated  systems and  products;  to identify  and contact key  suppliers,
vendors,  customers and business  partners to evaluate their ability to maintain
normal operations in the Year 2000; and to develop appropriate contingency plans
for dealing with foreseeable Year 2000 complications.  The Company has appointed
a  Year  2000  Readiness  Coordinator  who is  responsible  for  developing  and
administering the Company's Year 2000 compliance program. The Company expects to
complete  its  Year  2000  compliance  plan  by the  end  of  January  1999  and
substantially implement the plan by the end of 1999.

Internal Systems

      Based  on the  preliminary  results  of the  Company's  assessment  of its
internal  use  hardware  and  software,  including  telephone  systems and other
facilities  equipment,  the Company has  determined  that it may be necessary to
modify or replace some of its internal use software and hardware. During 1998, a
project was initiated at the corporate offices in Wilmington,  Massachusetts and
at the Company's largest subsidiary,  Datawatch  International,  in Potters Bar,
England to upgrade the Company's  accounting  software to a Year 2000  compliant
version.  These  simultaneous  projects were  completed in September  1998.  The
Company   anticipates  that  the  accounting   systems  at  some  of  its  other
subsidiaries  will be  replaced  by the end of  1999,  however,  the  accounting
systems at these locations are significantly less critical than at the locations
already  upgraded.  The  Company  currently  believes  that all  other  "mission
critical" software is Year 2000 compliant.  The Company anticipates completing a
full review of all internal software and hardware by April 30, 1999. The cost to
bring  internal  operations  into  compliance  is estimated to be  approximately
$100,000.

         In early 1999, the Company will begin contacting vendors concerning the
status of their  Year 2000  readiness.  All  supplies  used to  market,  sell or
produce  the  Company's  products  are  readily  available  from many  different
suppliers;  Therefore,  the Company intends that only vendors who are determined
to be Year 2000 compliant will be used for supplies after September 30, 1999.


Software Products

      The Company has  designed,  tested and  continues to test the most current
versions of its  products for Year 2000 issues.  The Company  believes  that the
latest  versions of its products are  substantially  Year 2000 compliant and are
not likely to pose a significant  Year 2000  liability  issue for the Company or
any significant operational problems for its customers. The Company continues to
test the current versions of its products for Year 2000  compliance,  and in the
event problems are  discovered,  the Company intends to issue product updates to
correct such anomalies. The Company has requested and is waiting to receive Year
2000 compliance statements from vendors of certain widely-accepted  database and
middleware tools which are used in the development of its products; in the event
such tools are not compliant,  the Company  believes  achieving  compliance will
require upgrades to newer versions of such tools.

      The Company also has performed and continues to perform  limited Year 2000
compliance  assessments  of certain older  versions of its  products,  and where
problems are  discovered,  will determine the  practicality  of modifying  older
versions.  Certain of the Company's customers use older 16-bit operating systems
which are believed not to be Year 2000 compliant; the Company makes available to
these customers  older 16-bit versions of its software,  which in some cases are
not Year  2000  compliant.  The  Company  believes  it does  not  have  material
financial exposure to customers with respect to older version of its products.

      The Company estimates testing costs for its products to be approximately  
$100,000 and an additional $50,000 for vendor compliance and customer 
communication.

      As the Year 2000  compliance  assessment  and/or  testing  of a product is
complete,  the Company will make available  information to its customers via the
Company's web site.  This  information  may also be  communicated  to registered
customers in news letters or other special mailings.

Risks Associated with Year 2000 Issue

      The  Company  believes  it will have an  effective  Year  2000  compliance
program in place  prior to the end of 1999 which will allow it to  identify  and
correct any Year 2000  compliance  deficiencies.  This  assessment is subject to
revision  based on the results of the Company's  on-going  Year 2000  compliance
efforts. If unforeseen  compliance efforts are required or if present compliance
efforts are not  completed  on time,  or if the cost of any  required  updating,
modification  or replacement of the Company's  systems or equipment  exceeds the
Company's estimates, the Year 2000 issue could result in material costs and have
a material adverse effect on the Company. However, the Company believes that the
risk is minimal.

      The Company  utilizes  third-party  vendors for  product  development  and
testing.  Should  these  vendors not be compliant  in a timely  manner,  product
releases  scheduled to take place after December 31, 1999 could be delayed.  The
Company also utilizes third-party vendors for processing data and payments, e.g.
payroll services, 401(k) plan administration, check processing, medical benefits
processing,  etc. Should these vendors not be compliant in a timely manner,  the
Company  may be required to process  transactions  manually or delay  processing
until  such  time as the  vendors  are Year  2000  compliant.  The  Company  has
warranted,  to certain  customers,  that  certain of its products are or will be
Year 2000 compliant.  Non-compliance  with these  warranties may result in legal
action for breach of warranty.

      Various  statements in this  discussion  of Year 2000 are  forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995  as  discussed  below  under  "Risk  Factors".   These  statements  include
statements of the Company's  expectations,  statements  with regard to schedules
and  expected  completion  dates and  statements  regarding  expected  Year 2000
compliance. These forward-looking statements are subject to various risk factors
which  may  materially  affect  the  Company's  efforts  to  achieve  Year  2000
compliance. These risk factors include: the inability of the Company to complete
in a timely  manner  the plans and  modifications  that it has  identified;  any
inaccuracy in the  assessment of the cost and financial  exposure of the Company
with  respect to current  and older  versions  of the  Company's  products;  the
failure of software  vendors to deliver the  upgrades  and repairs to which they
have  committed;   the  wide  variety  of  information  technology  systems  and
components,  both hardware and software,  that must be evaluated;  and the large
number  vendors and customers  with which the Company  interacts.  The Company's
assessments of the effects of Year 2000 on the Company are based,  in part, upon
information received from third parties and the Company's reasonable reliance on
that information. Therefore, the risk that inaccurate information is supplied by
third parties upon which the Company  reasonably  relies must be considered as a
risk factor that might affect the Company's  Year 2000  efforts.  The Company is
attempting  to reduce the risks by utilizing an  organized  approach,  extensive
testing, and allowance of ample contingency time to address issues identified by
tests.

Contingency Plans

      The Company has not established a specific  contingency plan at this time.
The Company is in the process of developing a general corporate contingency plan
which it anticipates will be in place prior to December 31, 1999. The purpose of
this plan is to allow the Company to  recognize  system  failures,  if any,  and
identify  resources  needed  and  available  to restore  operations  in a timely
manner.  If the need for an additional  Year 2000 specific  contingency  plan is
recognized, such plan will be developed.

RISK FACTORS

      The  Company  does  not  provide   forecasts   of  its  future   financial
performance.  However, from time to time, information provided by the Company or
statements made by its employees may contain "forward looking"  information that
involves risks and uncertainties.  In particular,  statements  contained in this
Form  10-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" relating to liquidity and capital
resources) may constitute forward looking statements and are made under the safe
harbor provisions of The Private  Securities  Litigation Reform Act of 1995. The
Company's  actual results of operations and financial  condition have varied and
may in the future vary  significantly  from those stated in any forward  looking
statements. Factors that may cause such differences include, without limitation,
the risks,  uncertainties and other information  discussed below and within this
Form 10-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 and
related notes thereto.  Such factors,  among others, may have a material adverse
effect  upon  the  Company's  business,  results  of  operations  and  financial
condition.

Fluctuations in Quarterly Operating Results

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

Dependence on Principal Products

      In fiscal 1998, Monarch and Q-Support/Quetzal  accounted for approximately
51% and 37%, respectively,  of the Company's net sales. With the disposal of the
Virex and netOctopus  products,  the Company is wholly  dependent on Monarch and
Q-Support/Quetzal.  As a result, any factor adversely  affecting sales of either
of these  products  could have a material  adverse  effect on the  Company.  The
Company's  future  financial  performance  will depend in part on the successful
introduction of its new and enhanced  versions of these products and development
of new versions of these and other  products and  subsequent  acceptance of such
new and enhanced products.  In addition,  competitive pressures or other factors
may result in  significant  price  erosion  that  could have a material  adverse
effect on the Company's business, financial condition or results of operations.

International Sales

      In 1998, 1997 and 1996,  international  sales accounted for  approximately
56%,  47% and  47%,  respectively,  of the  Company's  net  sales.  The  Company
anticipates that international  sales will continue to account for a significant
percentage of its net sales.  A  significant  portion of the Company's net sales
will  therefore  be  subject  to  risks  associated  with  international  sales,
including  unexpected changes in legal and regulatory  requirements,  changes in
tariffs, exchange rates and other barriers,  political and economic instability,
difficulties  in  account  receivable   collection,   difficulties  in  managing
distributors   or   representatives,   difficulties  in  staffing  and  managing
international operations,  difficulties in protecting the Company's intellectual
property   overseas,   seasonality   of  sales  and   potentially   adverse  tax
consequences.

Acquisition Strategy

      Although the Company has no current  acquisition  plans,  it has addressed
and may continue to address the need to develop new products,  in part,  through
the  acquisition  of  other  companies.   Acquisitions  involve  numerous  risks
including  difficulties in the assimilation of the operations,  technologies and
products of the acquired companies, the diversion of management's attention from
other business  concerns,  risks of entering markets in which the Company has no
or limited direct prior  experience  and where  competitors in such markets have
stronger  market  positions,  and the  potential  loss of key  employees  of the
acquired  company.  Achieving and  maintaining  the  anticipated  benefits of an
acquisition  will depend in part upon whether the  integration of the companies'
business is accomplished in an efficient and effective manner,  and there can be
no assurance that this will occur.  The  successful  combination of companies in
the high  technology  industry may be more difficult to accomplish than in other
industries.

Dependence on New Introductions; New Product Delays

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

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

Rapid Technological Change

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

Year 2000 Issue

         Although the Company does not expect that the Year 2000 issue will have
a material effect on the Company's results of operations or financial condition,
the Company is potentially  exposed to Year 2000 issues with respect to internal
software and external product  offerings.  If the Company's  internal systems or
its products  fail to operate  properly as a result of Year 2000,  the Company's
results of operations and financial  condition could be materially and adversely
impacted.  The Company continues to evaluate the Year 2000 issue. See "Year 2000
Readiness  Disclosure  Statement."  particularly  the  subsection  headed "Risks
Associated  with Year 2000 Issue" which  appears  immediately  before this "Risk
Factors"  section of this Report on Form 10-K, for a discussion of the Company's
Year 2000 readiness and the risks associated with the Year 2000 issue.

Competition in the PC Software Industry

      The software  market for  personal  computers  is highly  competitive  and
characterized by continual change and improvement in technology.  Several of the
Company's existing and potential competitors (including IBM, Network Associates,
Inc., Remedy, and Actuate) have substantially  greater financial,  marketing and
technological  resources  than the Company.  No assurance  can be given that the
Company will have the resources required to compete successfully in the future.

Dependence on Proprietary Software Technology

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

Reliance on Software License Agreements

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

Litigation

         The  Company  is  currently   engaged  in  litigation   with  a  former
independent software developer. See Item 3, Legal Proceedings, of this Report on
Form 10-K.  Although the Company  believes that the  developer's  claims have no
merit,  an unexpected  adverse result in this  litigation  could have a material
adverse effect on the Company's results of operations or financial condition. In
addition, the legal costs for this litigation may be substantial.

Indirect Distribution Channels

      During 1998, 1997 and 1996, the Company derived approximately 22%, 20% and
17%, respectively,  of its net sales through resellers,  none of which are under
the direct control of the Company.  The loss of major resellers of the Company's
products, or a significant decline in their sales, could have a material adverse
effect on the Company's  operating results.  Other than Ingram Micro Inc., which
accounted for  approximately  12%, 14%, and 13% of the Company's  1998, 1997 and
1996 net sales,  respectively,  no reseller or other customer accounted for more
than 10% of the  Company's  revenues  in 1998,  1997 or  1996.  There  can be no
assurance  that  the  Company  will be  able to  attract  or  retain  additional
qualified  resellers or that any such resellers will be able to effectively sell
the Company's products.  The Company seeks to select and retain resellers on the
basis of their  business  credentials  and their  ability  to add value  through
expertise in specific vertical markets or application  programming expertise. In
addition,  the Company  relies on  resellers to provide  post-sales  service and
support, and any deficiencies in such service and support could adversely affect
the Company's business.

Volatility of Stock Price

      As is frequently  the case with the stocks of high  technology  companies,
the market price of the Company's common stock has been, and may continue to be,
volatile.  Factors  such as  quarterly  fluctuations  in results of  operations,
increased  competition,  the  introduction of new products by the Company or its
competitors,   expenses  or  other  difficulties  associated  with  assimilating
companies  acquired by the Company,  changes in the mix of sales  channels,  the
timing of significant customer orders, and macroeconomic  conditions  generally,
may have a  significant  impact on the market price of the stock of the Company.
Any shortfall in revenue or earnings from the levels  anticipated  by securities
analysts  could have an immediate and  significant  adverse effect on the market
price of the Company's common stock in any given period. In addition,  the stock
market has from time to time experienced extreme price and volume  fluctuations,
which  have  particularly  affected  the market  price for many high  technology
companies and which, on occasion, have appeared to be unrelated to the operating
performance of such companies.

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

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

      At September 30, 1998,  the Company did not  participate in any derivative
financial  instruments,  or other financial and commodity  instruments for which
fair value disclosure would be required under SFAS No. 107. The Company holds no
investment securities which would require disclosure of market risk.

Primary Market Risk Exposures.

      The Company's  primary  market risk exposures are in the areas of interest
rate risk and foreign  currency  exchange rate risk.  The Company  utilizes U.S.
dollar  denominated  borrowings  to  fund  its  operational  needs  through  its
$1,500,000  working  capital line. The line,  which  currently bears an interest
rate of prime plus .75%  (9.25% at  September  30,  1998),  is subject to annual
renewal.  Had the  interest  rates  under the line of credit been 10% greater or
lesser  than  actual  rates,  the  impact  would not have been  material  in the
Company's  consolidated  financial  statements for the year ended  September 30,
1998.  As of September  30, 1998,  the Company had $250,000  outstanding  on its
working capital line.

         The Company's  exposure to currency exchange rate fluctuations has been
and is expected to continue to be modest due to the fact that the  operations of
its  international  subsidiaries  are  almost  exclusively  conducted  in  their
respective local  currencies.  International  subsidiary  operating  results are
translated into U.S. dollars and consolidated for reporting purposes. The impact
of currency exchange rate movements on intercompany  transactions was immaterial
for fiscal  1998.  Currently  the  Company  does not engage in foreign  currency
hedging activities.

Item 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

      The information required by this item is set forth in Item 14(a) under the
captions  "Consolidated   Financial  Statements"  and  "Consolidated   Financial
Statement Schedule" as a part of this Report on Form 10-K.

Item  9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND 
          FINANCIAL DISCLOSURE
     
       Not Applicable.

                                    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,
1998. 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  caption  "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, 1998 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" appearing in the Company's definitive Proxy Statement for the Annual
Meeting  of  Shareholders  for the  fiscal  year  ended  September  30,  1998 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, 1998 is incorporated herein
by reference.


<PAGE>



                                     PART IV

Item 14.  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

           Independent Auditors' Report
           Consolidated Balance Sheets as of September 30, 1998 and
           1997  Consolidated  Statements  of  Operations  for the  Years  Ended
           September 30, 1998, 1997 and 1996. Consolidated Statements of Changes
           in Shareholders'  Equity for the Years Ended September 30, 1998, 1997
           and 1996.  Consolidated  Statements of Cash Flows for the Years Ended
           September 30, 1998, 1997 and 1996.  Notes to  Consolidated  Financial
           Statements

         2.  Consolidated Financial Statement Schedule

          Schedule VIII Valuation and Qualifying Accounts
          All other  schedules  are omitted as the required  information  is not
          applicable  or is  included  in the  financial  statements  or related
          notes. The Independent Auditors' Report included with the Consolidated
          Financial  Statements under Item 14(a)1 above contains the Independent
          Auditors' Report on the Consolidated Financial Statement Schedule.

         3. List of Exhibits
 Ex.No                                 Description

(5) 2.1  Asset Purchase  Agreement,  dated October 9, 1997,  among DATAWATCH
         CORPORATION,  Pole Position  Software  GmbH and Dr Solomon's  Software,
         Inc. (Exhibit 2.1)
(5) 2.2  Escrow Agreement, dated October 9, 1997, among DATAWATCH CORPORATION, 
         Dr Solomon's Software, Inc. and State Street Bank and Trust Company.
         (Exhibit 2.2)
(1) 3.1 Restated Certificate of Incorporation of the Registrant (Exhibit 3.2)
(1) 3.2 By-Laws, as amended, of the Registrant (Exhibit 3.3) 
(1) 4.1 Specimen certificate representing the Common Stock (Exhibit 4.4) 
        Lease by and between the Registrant and CBOB Fund Corp., as Trustee of 
        Ballardvale Building D Nominee Trust, dated February 17, 1992 
        (Exhibit 10.2)
(1)10.2* 1987 Stock Plan (Exhibit 10.7) (1)10.3* Form of Incentive  Stock Option
         Agreement of the Registrant  (Exhibit 10.8) 
(1)10.4* Form of Nonqualified  Stock Option Agreement of the Registrant 
         (Exhibit 10.9)  
         Software Development and Marketing Agreement by and between PERSONICS 
         CORPORATION and Raymond Huger, dated January 19, 1989 (Exhibit 10.12)
(2)10.6  Marketing Agreement dated May 1, 1994 between WorkGroup Systems Ltd. 
         and DATAWATCH CORPORATION (Exhibit 10.1)
(3)10.7  Commercial Security Agreement between DATAWATCH CORPORATION and Silicon
         Valley  Bank doing  business as Silicon  Valley East dated  November 1,
         1994 (Exhibit 10.23)
(3)10.8  Commercial Security Agreement between PERSONICS CORPORATION and Silicon
         Valley  Bank doing  business as Silicon  Valley East dated  November 1,
         1994 (Exhibit 10.24)
(4)10.9* Executive Agreement between the Company and Marco D. Peterson dated 
         April 11, 1996 (Exhibit 10.2)
(4)10.10*Executive Agreement between the Company and Bruce R. Gardner dated 
         April 11, 1996 (Exhibit 10.3)
(6)10.11 Loan Modification Agreement dated October 31, 1996 between DATAWATCH 
         CORPORATION, Personics Corporation and Silicon Valley Bank 
         (Exhibit 10.29)
(6)10.12*1996 Non-Employee Director Stock Option Plan, as amended on 
         December 10, 1996 (Exhibit 10.30)
(6)10.13*1996 International Employee Non-Qualified Stock Option Plan 
         (Exhibit 10.31)
(7)10.14 Amended and Restated Letter Agreement, dated February 12, 1997, by and
         between DATAWATCH CORPORATION, Personics Corporation and Silicon Valley
         Bank (Exhibit 10.1) 
(7)10.15 Promissory Note, dated February 12, 1997, by and between DATAWATCH 
         CORPORATION, Personics Corporation and Silicon Valley Bank 
         (Exhibit 10.2).
(8)10.16 Loan Modification Agreement, dated October 30, 1997, by and between 
         DATAWATCH CORPORATION, Personics Corporation and Silicon Valley Bank 
         (Exhibit 10.23)
(9)10.17*1996 Stock Plan (Appendix A)
(10)10.18 Loan Modification Agreement, dated January 30, 1998, by and between 
          DATAWATCHCORPORATION, Personics Corporation and Silicon Valley Bank 
         (Exhibit 10.1)
    10.19 Loan Modification Agreement, dated December 18,1998, by and between 
          DATAWATCH CORPORATION, Personics Corporation and Silicon Valley Bank 
          (filed herewith)
     21.1 Subsidiaries of the Registrant (filed  herewith)
     23.1 Consent of Independent Auditors (filed  herewith) 
     27   Financial Data Schedule (filed 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  Quarterly  Report on Form
     10-Q for the  quarter  ended  June  30,  1994 and  incorporated  herein  by
     reference  (the number given in  parenthesis  indicates  the  corresponding
     exhibit in such Form 10-Q).
(3)  Previously  filed as an exhibit to Registrant's  Annual Report on Form 10-K
     for the Fiscal Year ended  September  30, 1994 and  incorporated  herein by
     reference  (the number given in  parenthesis  indicates  the  corresponding
     exhibit in such Form 10-K).
(4)  Previously  filed as an exhibit to  Registrant's  Quarterly  Report on Form
     10-Q for the  quarter  ended  June  30,  1996 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  Current Report on Form 8-K
     dated  October 9, 1997 and  incorporated  herein by  reference  (the number
     given in parenthesis indicates the corresponding exhibit in such Form 8-K).
(6)  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 for 10-K).
(7)  Previously  filed as an exhibit to  Registrant's  Quarterly  Report on Form
     10-Q for the  quarter  ended  March  31,  1997 and  incorporated  herein by
     reference (the number in parenthesis indicates the corresponding exhibit in
     such Form 10-Q).
(8)  Previously  filed as an exhibit to Registrant's  Annual Report on Form 10-K
     for the Fiscal Year ended  September  30, 1997 and  Incorporated  herein by
     reference  (the number given in  parenthesis  indicates  the  corresponding
     exhibit in such for 10-K).
(9)  Previously filed as Appendix A to the Company's  definitive Proxy Statement
     for  the  Annual  Meeting  of  Shareholders  held on  March  19,  1997  and
     incorporated herein by reference (the number given in parenthesis indicates
     the corresponding Appendix in such definitive Proxy Statement).
(10) Previously  filed as an exhibit to  Registrant's  Quarterly  Report on form
     10-Q for the  quarter  ended  March  31,  1998 and  incorporated  herein by
     reference (the number in parenthesis
     indicates the corresponding exhibit in such Form 10-Q.

(b)  Reports on Form 8-K

     No current  report on Form 8-K was filed during the quarterly  period ended
     September 30, 1998.

(c)  Exhibits
     The Company  hereby  files as  exhibits  to this Annual  Report on Form 
     10-K those exhibits listed in Item 14(a)3 above.

(d)  Financial Statement Schedules

     The Company  hereby files as financial  statement  schedules to this Annual
     Report on Form 10-K the Consolidated  Financial  Statement Schedules listed
     in Item 14(a)2 above which are attached hereto.



<PAGE>





                              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 CORPORATION

Date:    December 29, 1998        By:  /s/ Bruce R. Gardner
                                  Bruce R. Gardner
                                  President, 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/ Bruce R. Gardner        President, Chief Executive   December 29, 1998
Bruce R. Gardner            Officer and Director
                            (Principal Executive Officer)

/s/ Betsy J. Hartwell       Vice President Finance,      December 29, 1998
Betsy J. Hartwell           Chief Financial Officer
                            and Treasurer
                            (Principal Financial
                            and Accounting Officer)


/s/ Jerome Jacobson         Director                     December 29, 1998
Jerome Jacobson

/s/ David T. Riddiford      Director                     December 29, 1998
-------------------------
David T. Riddiford

/s/ Terry W. Potter         Director                     December 29, 1998
-------------------------
Terry W. Potter

/s/ Don M. Lyle             Director                     December 29, 1998
----------------------
Don M. Lyle


<PAGE>

















-------------------------------------------------------------------------------
    Datawatch Corporation and Subsidiaries
    Consolidated   Balance  Sheets  as  of  September  30,  1998  and  1997  and
    Consolidated Statements of Operations,  Changes in Shareholders' Equity, and
    Cash  Flows  for the  Years  Ended  September  30,  1998,  1997 and 1996 and
    Independent Auditors' Report



<PAGE>





DATAWATCH CORPORATION AND SUBSIDIARIES

TABLE OF CONTENTS
--------------------------------------------------------------------------------


                        

INDEPENDENT AUDITORS' REPORT                                                1   

CONSOLIDATED FINANCIAL  STATEMENTS AS OF SEPTEMBER 30, 1998 AND 1997 AND FOR THE
   THREE YEARS IN THE PERIOD ENDED SEPTEMBER 30, 1998:

   Consolidated Balance Sheets                                              2   

   Consolidated Statements of Operations                                    3  

   Consolidated Statements of Changes in Shareholders' Equity               4  

   Consolidated Statements of Cash Flows                                    5

   Notes to Consolidated Financial Statements                              6-20

<PAGE>














INDEPENDENT AUDITORS' REPORT


To the Board of Directors and Shareholders
Datawatch Corporation
Wilmington, Massachusetts

We have  audited  the  accompanying  consolidated  balance  sheets of  Datawatch
Corporation  (the "Company") and subsidiaries as of September 30, 1998 and 1997,
and the related consolidated statements of operations,  changes in shareholders'
equity, and cash flows for each of the three years in the period ended September
30, 1998. Our audits also included the consolidated financial statement schedule
listed in Item 14(a)2.  These financial  statements and the financial  statement
schedule are the responsibility of the Company's management.  Our responsibility
is to  express  an  opinion  on these  financial  statements  and the  financial
statement schedule based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
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,  1998 and  1997,  and the  results  of their
operations  and their cash flows for each of the three years in the period ended
September 30, 1998, in conformity with generally accepted accounting principles.
Also, in our opinion,  such  consolidated  financial  statement  schedule,  when
considered in relation to the basic consolidated financial statements taken as a
whole,  presents  fairly,  in all material  respects,  the information set forth
therein.

/s/ Deloitte & Touche LLP

November 24, 1998

<TABLE>
DATAWATCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 1998 AND 1997
------------------------------------------------------------------------------------------


ASSETS                                                          1998              1997
<S>                                                              <C>              <C>

CURRENT ASSETS:
  Cash and equivalents                                     $  3,575,256    $ 1,586,875
  Short-term investments                                      3,395,410              -
  Accounts receivable, less allowance for doubtful
   accounts of $353,000 in 1998
   and $228,000 in 1997                                       6,401,965      7,810,169
  Inventories                                                   511,669        876,767
  Prepaid advertising and other expenses                      1,270,671      2,000,717

           Total current assets                              15,154,971     12,274,528

PROPERTY AND EQUIPMENT:
  Office furniture and equipment                              4,120,118      3,748,022
  Manufacturing and engineering equipment                       159,982        450,063

                                                              4,280,100      4,198,085

  Less accumulated depreciation
    and amortization                                         (2,453,240)    (2,304,705)

           Net property and equipment                         1,826,860      1,893,380


OTHER ASSETS                                                    625,293        551,639

EXCESS OF COST OVER NET ASSETS OF
  ACQUIRED COMPANIES - Less accumulated
    amortization of $2,189,512 in 1998 and
    $2,424,263 in 1997                                          725,091      1,427,098




                                                            $18,332,215    $16,146,645





------------------------------------------------------------------------------------------



LIABILITIES AND SHAREHOLDERS' EQUITY                             1998           1997

CURRENT LIABILITIES:
  Accounts payable                                          $ 3,791,323    $ 3,837,376
  Accrued expenses                                            1,301,599      1,340,995
  Deferred revenue                                            1,161,556      2,143,203
  Borrowings under credit lines                                 250,000           -
  Current portion of long-term obligations                      147,065        501,133



           Total current liabilities                           6,651,543     7,822,707

LONG-TERM OBLIGATIONS                                             44,190     1,399,089

COMMITMENTS AND CONTINGENCIES (Notes 8 and 9)

SHAREHOLDERS' EQUITY:
  Preferred stock, par value $.01- authorized,
    1,000,000 shares; no shares issued                             -             -
  Common stock, par value $.01- authorized,
    20,000,000 shares; issued,  9,180,364 and 9,116,113 shares in 1998 and 1997,
    respectively; outstanding, 9,148,312 and 9,084,061 shares in
    1998 and 1997, respectively                                  91,803        91,160
  Additional paid-in capital                                 19,823,887    19,737,963
  Accumulated deficit                                        (7,829,554)  (12,533,550)
  Cumulative translation adjustment                            (309,266)     (230,336)

                                                             11,776,870     7,065,237
  Less treasury stock, at cost - 32,052 shares                 (140,388)     (140,388)

          Total shareholders' equity                         11,636,482     6,924,849

                                                           $ 18,332,215    $16,146,645
</TABLE>

See notes to consolidated financial statements.

<TABLE>
DATAWATCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
------------------------------------------------------------------------------------------------------------------------


                                                                1998               1997                1996
<S>                                                              <C>                <C>                <C>

NET SALES:
  PC-based  products                                       $ 25,123,468        $ 25,995,197      $ 24,216,794
  Macintosh-based products                                      172,254           6,052,298         5,805,328

          Net sales                                          25,295,722          32,047,495        30,022,122

COSTS AND EXPENSES:
  Cost of sales                                               5,212,595           5,899,849         4,516,456
  Engineering and product development                         3,383,260           2,804,434         2,338,724
  Selling, general and administrative                         24,524,839         25,225,177        22,039,420
  Restructuring and centralization costs                       2,679,460               -                 -

INCOME (LOSS) FROM OPERATIONS                                (10,504,432)        (1,881,965)        1,127,522

INTEREST EXPENSE                                                 (62,306)          (167,871)         (96,184)

INTEREST INCOME AND OTHER                                        470,367             54,503           49,162

GAIN ON SALE OF PRODUCT LINE                                  15,431,253               -                -

FOREIGN CURRENCY TRANSACTION
  GAINS (LOSSES)                                                 (30,886)              (100)          11,860

(PROVISION) BENEFIT FOR INCOME TAXES                            (600,000)              -              33,000

NET INCOME (LOSS)                                          $   4,703,996       $ (1,995,433)    $  1,125,360

NET INCOME (LOSS) PER SHARE - Basic                        $        0.52       $      (0.22)    $       0.13

NET INCOME (LOSS) PER SHARE - Diluted                      $        0.51       $      (0.22)    $       0.13

WEIGHTED-AVERAGE NUMBER OF
  SHARES OUTSTANDING - Basic                                   9,133,385          9,060,612        8,705,172

ADJUSTMENT FOR POTENTIAL COMMON
  STOCK                                                          176,868               -             243,040

WEIGHTED-AVERAGE NUMBER
  OF SHARES OUTSTANDING - Diluted                              9,310,253          9,060,612        8,948,212

</TABLE>

See notes to consolidated financial statements.


<TABLE>
DATAWATCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
------------------------------------------------------------------------------------------------------------------------------------
                                                           Additional                                    Cumulative
                                        Common Stock        Paid-in    Treasury Stock      Accumulated   Translation
                                       Shares   Amount      Capital   Shares    Amount       Deficit     Adjustments    Total
<S>                                      <C>     <C>          <C>       <C>      <C>           <C>           <C>         <C>

BALANCE, OCTOBER 1, 1995             8,629,135  $86,291  $17,614,360     -     $     -     $(11,663,477) $ 24,996    $ 6,062,170

  Stock options exercised              217,411    2,174      203,264     -           -             -         -           205,438

  Warrants exercised,
    net of offering costs              119,442    1,194      847,778     -           -             -         -           848,972

  Translation adjustment                  -        -            -        -           -             -       (3,054)        (3,054)

  Net income                              -        -            -        -           -        1,125,360      -         1,125,360

BALANCE, SEPTEMBER 30, 1996          8,965,988   89,659   18,665,402     -           -      (10,538,117)   21,942      8,238,886
  Stock issued pursuant to
    acquisition of Guildsoft           125,000    1,250      905,000     -           -             -         -           906,250

  Stock options exercised               25,125      251       27,173     -           -             -         -            27,424

  Escrowed shares
  returned to treasury                    -        -         140,388  (32,052)   (140,388)         -         -              -

  Translation adjustment                  -        -            -        -           -             -     (252,278)      (252,278)

  Net loss                                -        -            -        -           -       (1,995,433)     -        (1,995,433)

BALANCE, SEPTEMBER 30, 1997          9,116,113   91,160   19,737,963  (32,052)   (140,388)  (12,533,550) (230,336)     6,924,849

  Stock options exercised               64,251      643       85,924     -           -             -         -            86,567

  Translation adjustment                  -        -            -        -           -             -      (78,930)       (78,930)

  Net income                              -        -            -        -           -        4,703,996      -         4,703,996

BALANCE, SEPTEMBER 30, 1998          9,180,364  $91,803  $19,823,887  (32,052) $ (140,388) $ (7,829,554) $(309,266)  $11,636,482

</TABLE>

See notes to consolidated financial statements.


<TABLE>
DATAWATCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
-----------------------------------------------------------------------------------------------------------------------------------

                                                                                       1998              1997              1996
<S>                                                                                    <C>                <C>               <C>

CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income (loss)                                                                    $ 4,703,996   $ (1,995,433)     $ 1,125,360
  Adjustments to reconcile net income (loss) to net cash used in
    operating activities:
      Depreciation and amortization                                                      1,300,813      1,522,877        1,223,162
      Amortization of interest on short-term investments                                  (176,034)          -                -
      Gain on sale of product lines                                                    (15,431,253)          -                -
      Gain on disposition of equipment                                                      (8,537)          -                -
      Changes in current assets and liabilities, net of acquisitions:
        Accounts receivable                                                              1,036,395        353,381       (2,537,062)
        Inventories                                                                        275,884       (175,144)        (218,230)
        Prepaid advertising and other expenses                                             482,255       (672,054)         243,381
        Accounts payable and accrued expenses                                           (1,030,528)       132,358         (567,112)
        Deferred revenue                                                                  (143,020)       196,730          631,818

           Net cash used in operating activities                                        (8,990,029)      (637,285)         (98,683)

CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchase of equipment and fixtures                                                      (818,143)      (647,888)        (564,129)
  Proceeds from sale of equipment - net                                                     18,862         91,233             -
  Proceeds from sale of short-term investments                                           6,245,000      2,069,065        2,312,478
  Purchase of short-term investments                                                    (9,464,376)    (1,276,400)      (2,219,484)
  Proceeds from sale of product lines                                                   16,750,000
  Acquisition of Guildsoft Holdings, Ltd., net of working capital acquired                    -            19,833             -
  Other assets                                                                            (346,731)      (314,608)          25,571

           Net cash provided by (used in) investing activities                          12,384,612        (58,765)        (445,564)

CASH FLOWS FROM FINANCING ACTIVITIES:
  Net proceeds from issuance of common stock                                                86,567         27,424        1,054,410
  Principal payments on long-term obligations                                             (242,769)      (307,380)        (245,575)
  (Payments) borrowings under credit lines - net                                           250,000       (633,468)         554,959
  Proceeds from bank term loan                                                                -         1,500,000             -
  Payments of bank term loan                                                            (1,500,000)          -                -

           Net cash (used in) provided by financing activities                          (1,406,202)       586,576        1,363,794

NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS                                          1,988,381       (109,474)        819,547

CASH AND EQUIVALENTS, BEGINNING OF YEAR                                                  1,586,875      1,696,349         876,803

CASH AND EQUIVALENTS, END OF YEAR                                                      $ 3,575,256    $ 1,586,875     $ 1,696,350

SUPPLEMENTAL INFORMATION:
  Interest paid                                                                        $    62,306    $   159,954     $    96,184

  Income taxes paid                                                                    $ 1,175,000    $   167,490     $    78,922

NONCASH INVESTING AND FINANCING ACTIVITIES:
  Equipment acquired under capital lease agreements                                    $    77,311    $   267,277     $   320,684

  Escrowed shares returned to treasury                                                 $      -       $   140,388     $      -
</TABLE>

See notes to consolidated financial statements.



DATAWATCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
--------------------------------------------------------------------------------


1.    NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

      Nature of  Business -  Datawatch  Corporation  (the  "Company")  develops,
      markets and distributes  commercial  software  products.  The Company also
      provides   a  wide   range  of   consulting   services   surrounding   the
      implementation and support of its software products.

      Principles  of  Consolidation  -  The  consolidated  financial  statements
      include  the  accounts  of  Datawatch  Corporation  and its  wholly  owned
      subsidiaries.  All significant intercompany balances and transactions have
      been eliminated in consolidation.

      Accounting  Estimates  - The  preparation  of the  Company's  consolidated
      financial  statements in conformity  with  generally  accepted  accounting
      principles   necessarily   requires   management  to  make  estimates  and
      assumptions that affect the reported amounts of assets and liabilities and
      disclosure  of  contingent  assets  and  liabilities  at the  date  of the
      consolidated  financial statements and the reported amounts of revenue and
      expenses  during the reporting  period.  Actual  results could differ from
      those estimates.

      Revenue   Recognition  -  Revenue  from  sales  of  software  products  is
      recognized at the time of shipment when no significant  obligations remain
      and  collectibility is probable.  The Company's software products are sold
      under warranty  against  certain defects in material and workmanship for a
      period  of  thirty  to sixty  days  from the  date of  purchase.  Software
      products sold  directly to end users include a guarantee  under which such
      customers  may  return  products  within  thirty to sixty  days for a full
      refund.  The Company  offers its resellers the ability to return  obsolete
      versions of its products and slow-moving  products for credit which can be
      used against  purchases of other Company  products on a  dollar-for-dollar
      basis.  During each of the three years in the period ended  September  30,
      1998,  returns under these  warranty and guarantee  arrangements  were not
      material.

      Revenue from the sale of separate  consulting  agreements to provide field
      service  support is deferred at the time of sale.  The Company  recognizes
      its  revenue  on  these   agreements   ratably  over  their   twelve-month
      contractual  periods.   Revenue  from  the  sale  of  annual  subscription
      agreements  to provide  upgrades for minor  product  improvements  and new
      virus protection (with respect to the Company's Macintosh software product
      lines, see Note 2) was deferred at the time of sale and recognized ratably
      over their twelve-month contractual periods.

      Revenue from consulting  services performed in connection with the sale of
      bundled products and services is recognized at the time of the shipment of
      software if the consulting  services are expected to be provided  within a
      short  period of time after the  shipment  of the related  product  (i.e.,
      within  a  few  weeks),  the  cost  of  the  services  and  the  Company's
      obligations  are not  significant,  and the  cost  of  such  services  are
      estimable. If consulting services do not meet these criteria, such revenue
      is deferred and recognized as revenue as the services are provided.



<PAGE>


1.    NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES 
     (CONTINUED)

      Revenue Recognition (Continued) - The American Institute of Certified 
      Public Accountants ("AICPA") issued Statement of Position ("SOP")
      No. 97-2, "Software Revenue Recognition," and interpretive guidance in 
      SOP Nos. 98-4 and 98-9 which supersede SOP No. 91-1.  The Company has 
      adopted SOP No. 97-2 and the successor SOPs effective October 1, 1998.  
      SOP No. 97-2 generally requires revenue earned on software arrangements
      involving multiple elements to be allocated to each element based on the
      relative fair values of the elements.  The Company's management believes
      that the adoption of SOP No. 97-2 will not have a material effect on the
      Company's annual consolidated revenues and operating results.

      Cash and  Equivalents - Cash and  equivalents  includes cash on hand, cash
      deposited  with banks and highly  liquid debt  securities  with  remaining
      maturities of ninety days or less when purchased.

      Short-Term  Investments - Short-term  investments consist of United States
      Treasury Bills and commercial paper with relatively  short-term maturities
      (less  than one year from the date of  purchase)  for  which the  carrying
      value approximates market value.

      Other Assets - Pursuant to Statement  of  Financial  Accounting  Standards
      ("SFAS")  No. 86,  "Accounting  for the Costs of  Computer  Software to be
      Sold, Leased, or Otherwise  Marketed," issued by the Financial  Accounting
      Standards  Board ("FASB"),  the Company is required to capitalize  certain
      software  development and production costs once technological  feasibility
      has been achieved.  The cost of purchased  software is also required to be
      capitalized  when related to a product  which has  achieved  technological
      feasibility  or that has an  alternative  future use.  For the years ended
      September  30, 1998,  1997 and 1996,  the Company did not  capitalize  any
      internal  software  development  costs.  For the years ended September 30,
      1998,  1997 and 1996,  the  Company  purchased  and  capitalized  software
      amounting to $487,000, $315,000 and $0, respectively. Software development
      costs incurred prior to achieving technological feasibility are charged to
      research and development expense as incurred.

      Capitalized software development and purchased software costs are reported
      at the lower of unamortized cost or net realizable value.  Commencing upon
      initial product release, these costs are amortized using the straight-line
      method over the estimated life,  generally twelve to thirty-six months for
      purchased software. For the years ended September 30, 1998, 1997 and 1996,
      amortization   was   approximately   $125,000,    $22,000   and   $60,000,
      respectively.

      Advertising and Promotional  Materials - Advertising costs are expensed as
      incurred and amounted to approximately $339,000,  $721,000 and $917,000 in
      1998, 1997 and 1996,  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
      four  months  from the  date of the  mailing).  Direct  mail  expense  was
      approximately  $2,979,000,  $3,152,000  and  $3,970,000 in 1998,  1997 and
      1996,  respectively.  At  September  30,  1998 and 1997,  deferred  direct
      mail/direct  response costs were  approximately  $725,000 and  $1,291,000,
      respectively.



<PAGE>


1.    NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
     (CONTINUED)

      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  normal  credit  terms.  One
      customer individually accounted for 12%, 14% and 13% of net sales in 1998,
      1997 and 1996, respectively.  This same customer accounted for 16% and 26%
      of  outstanding  trade  receivables  as of  September  30,  1998 and 1997,
      respectively.  Other  than  this  customer,  no base of  customers  in one
      geographic area  constitutes a significant  portion of sales.  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.

      Inventories  -  Inventories  consist of  software  components  - primarily
      software manuals,  diskettes 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 three to seven  years.  The cost and the  related  accumulated
      amortization  of equipment  leased under  capital  lease  agreements  were
      approximately  $914,000 and $690,000 at September 30, 1998,  respectively,
      and  $1,043,000   and  $577,000  at  September  30,  1997,   respectively.
      Amortization  expense was  $232,000,  $296,000  and $224,000 for the years
      ended September 30, 1998, 1997 and 1996, respectively.

      Income Taxes - The Company  accounts for income taxes in  accordance  with
      SFAS No. 109,  "Accounting  for Income Taxes." This statement  requires an
      asset and liability approach to accounting for income taxes based upon the
      future  expected  values of the related assets and  liabilities.  Deferred
      income  taxes are  provided  for items which are  recognized  in different
      years for tax and financial reporting purposes.

      Excess of Cost Over Net Assets of Acquired  Companies - The excess of cost
      over  net  assets  of  acquired   companies   is  being   amortized  on  a
      straight-line basis over seven years. In addition, the net carrying amount
      of the excess of cost over net assets of acquired  companies is reduced if
      it is probable that the estimated  undiscounted operating cash flow before
      depreciation  and amortization  from related  operations will be less than
      the  carrying  amount of the  excess of cost over net  assets of  acquired
      companies.

      The  Company  also  evaluates  other  long-lived  assets  using  the  same
      methodology  in  accordance  with  SFAS  No.  121,   "Accounting  for  the
      Impairment of Long-Lived  Assets and for Long-Lived  Assets to Be Disposed
      Of."

      Fair Value of Financial  Instruments  - The  carrying  amounts of cash and
      equivalents,   short-term  investments,   accounts  receivable,   accounts
      payable,  accrued  expenses and deferred  revenue  approximate  fair value
      because of their short-term  nature. The carrying amounts of the Company's
      current and long-term obligations approximate fair value.



<PAGE>


1.    NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
      (CONTINUED)

      Earnings  (Loss)  Per Share - In the first  quarter of 1998,  the  Company
      adopted the provisions of SFAS No. 128,  "Earnings per Share." The Company
      therefore  changed  the  method  used to  compute  earnings  per share and
      restated all prior periods in accordance with SFAS No. 128. Basic earnings
      (loss)  per share  reflect  the  weighed-average  number of common  shares
      outstanding during each period.  Diluted earnings (loss) per share reflect
      the impact of potential common shares from options and warrants, using the
      treasury-stock  method. The Company's only dilutive potential common stock
      in 1998 and 1996 are  stock  options.  The  Company's  stock  options  are
      antidilutive in 1997 due to the recorded net loss.  Approximately  164,000
      potential  common  shares would have been included in the  calculation  in
      1997 had they not been antidilutive.

      Foreign Currency Translations and Transactions - The financial statements 
      of foreign subsidiaries are translated into U.S. dollars in accordance 
      with SFAS No. 52.  The related translation adjustments are reported as a
      separate component of shareholders' equity.  Gains and losses resulting 
      from transactions and related accounts that are denominated in currencies 
      other than the U.S. dollar are included in the net operating results of 
      the Company in accordance with SFAS No. 52.

      Reclassifications  - Certain prior year amounts have been  reclassified to
      conform with the current financial statement presentation.

      Stock-Based   Compensation   -  The  Company   accounts  for   stock-based
      compensation  using the  intrinsic-  value method in  accordance  with APB
      Opinion  No.  25.  The  difference   between  accounting  for  stock-based
      compensation  under APB  Opinion No. 25 and SFAS No. 123 is  disclosed  in
      Note 12.

      Recent Accounting  Pronouncements - In June 1997, the FASB issued SFAS No.
      130,  "Reporting  Comprehensive  Income,"  and SFAS No. 131,  "Disclosures
      About  Segments of an Enterprise  and Related  Information."  SFAS No. 130
      establishes  standards for reporting and displaying  comprehensive  income
      and its components (revenues, expenses, gains and losses) in a full set of
      general purpose financial  statements.  SFAS No. 131 establishes standards
      for the way that public  business  enterprises  report  information  about
      operating segments in annual financial  statements and requires that those
      enterprises  report  selected  information  about  operating  segments  in
      interim  financial  reports.  It also  establishes  standards  for related
      disclosures  about  products  and  services,  geographic  areas  and major
      customers.  SFAS No. 130 will be adopted by the  Company  during the first
      quarter of fiscal 1999. SFAS No. 131 will be adopted by the Company in its
      annual consolidated  financial  statements for fiscal 1999. Such standards
      are "disclosure  standards" and will not impact the Company's consolidated
      results of operations.

      In March of 1998,  the AICPA released SOP 98-1,  "Accounting  for Costs of
      Computer Software  Developed or Obtained for Internal Use," which requires
      certain expenditures made for internal use software to be capitalized. The
      Company is currently studying the impact of SOP 98-1, which is required to
      be adopted by the Company in October 1999.

      In June 1998,  the FASB issued SFAS No. 133,  "Accounting  for  Derivative
      Instruments and Hedging Activities,"  effective for fiscal years beginning
      after June 15, 1999. The new standard  requires that all companies  record
      derivatives  on the balance  sheet as assets or  liabilities,  measured at
      fair value.  Gains or losses resulting from changes in the values of those
      derivatives  would be accounted for depending on the use of the derivative
      and whether it qualifies  for hedge  accounting.  Management  is currently
      assessing  whether  there  will  be any  impact  of  SFAS  No.  133 on the
      Company's  consolidated  financial  statements  upon  adoption,  which  is
      required in October 1999.

2.     DIVESTITURE

      On October 9, 1997, the Company sold its Macintosh  software product lines
      for  $16,750,000  in cash,  resulting  in a pretax  gain of  approximately
      $15,431,000.  The assets sold consisted  primarily of inventory,  property
      and equipment,  trademarks and the  technological  rights related to these
      product lines.  In connection with the sale, the Company wrote off certain
      assets  and  liabilities  related to the  product  lines  sold,  including
      approximately  $286,000  representing the unamortized  balance of goodwill
      initially recorded in a prior acquisition of a business.

3.     RESTRUCTURING AND CENTRALIZATION COSTS

      Subsequent  to the  sale of its  Macintosh  software  product  lines,  the
      Company  undertook  a  corporate-  wide  restructuring  effort  so  as  to
      centralize  both its  administrative  infrastructure  and its  development
      efforts for its remaining products. The plan was approved and completed in
      the first  quarter of 1998.  The total  amount  charged  to first  quarter
      operations was  approximately  $2,364,000.  The plan included  charges for
      salaries  and wages and the related  severance  benefits  for  twenty-five
      terminated employees. These charges, totaling $1,884,000, were either paid
      ($1,549,000)  or accrued  ($335,000) in the first  quarter.  The plan also
      included special one-time payments made to outside  developers  associated
      with  the  centralization  of the  Company's  development  efforts.  These
      charges,  totaling  $433,000,  were  either  paid  ($339,000)  or  accrued
      ($94,000) in the first quarter.  Those  benefits or payments  accrued were
      paid in the second quarter of 1998.

      In August 1998,  management  approved,  and in September 1998,  management
      completed, a second restructuring plan to further centralize the Company's
      administrative   infrastructure   and   its   development   efforts.   The
      restructuring plan consisted of charges for severance benefits and related
      costs  for  thirteen  terminated   employees.   These  charges,   totaling
      approximately  $315,000, were either paid ($134,000) or accrued ($181,000)
      as of September 30, 1998.

4.    POOLING OF INTERESTS

      On March 12, 1996, the Company  acquired all of the outstanding  shares of
      capital  stock of  Datawatch  International  Limited  (formerly  Workgroup
      Systems Limited) ("Datawatch  International") in exchange for an aggregate
      of 1,437,000  shares of the Company's  common stock,  with 143,698 of such
      issued shares held in escrow for contingent  liabilities.  The acquisition
      was  accounted  for  as a  pooling  of  interests,  and  accordingly,  the
      Company's  consolidated  financial statements for the periods prior to the
      merger were  restated to include the accounts of Datawatch  International.
      Costs related to the pooling of interests of $450,000 were expensed during
      1996.  On November 21, 1996,  the Company  recovered  32,052 shares of the
      143,698  escrowed  shares in  connection  with the  settlement  of certain
      Datawatch International contingent liabilities. These liabilities had been
      previously recorded in the 1996 financial statements.

5.    PURCHASE ACQUISITION

      On November 7, 1996, the Company  acquired all of the outstanding  capital
      stock of Datawatch Europe Limited  (formerly  Guildsoft  Holdings Limited)
      ("Datawatch Europe") in exchange for an aggregate of 125,000 shares of the
      Company's  common stock,  with 12,500 of such issued shares held in escrow
      for  contingent  liabilities.  The  acquisition  was  accounted  for  as a
      purchase.  Accordingly,  all operating  activity of Datawatch  Europe from
      November  7,  1996  has  been  included  in  the  Company's   consolidated
      statements  of  operations.  On an  unaudited  pro  forma  basis,  if  the
      acquisition  had taken place on October 1, 1995,  net sales for 1996 would
      have been approximately $31,900,000 and net income for 1996 would not have
      been materially different from the amount previously reported.



5.    PURCHASE ACQUISITION (CONTINUED)



      The total purchase price of $1,719,000  (including  liabilities assumed of
      $812,000) was allocated to the assets acquired based upon their respective
      fair  values.  The  excess  of  cost  over  net  assets  acquired  totaled
      approximately $934,000.

6.    INVENTORIES
<TABLE>

      Inventories consisted of the following at September 30:

                                                    1998              1997
<S>                                                  <C>               <C>

Materials                                        $ 303,426          $ 340,385
Finished goods                                     208,243            536,382

Total                                            $ 511,669          $ 876,767
</TABLE>


7.    ACCRUED EXPENSES
<TABLE>

      Accrued expenses consisted of the following at September 30:

                                                   1998               1997
<S>                                                 <C>               <C>

Accrued salaries and benefits                  $   155,694        $   567,745
Accrued royalties and commissions                  491,300            406,536
Accrued professional fees                          136,716             19,802
Accrued rent and property taxes                     33,993             54,364
Accrued restructuring costs (Note 3)               181,344               -
Other                                              302,552            292,548

Total                                          $ 1,301,599        $ 1,340,995
</TABLE>




8.    COMMITMENTS

      Leases - The Company  leases  various  facilities in the U.S. and overseas
      under noncancelable  operating leases which expire through 2017. The lease
      agreements  provide  for the  payment  of  minimum  annual  rentals  and a
      pro-rata share of real estate taxes and maintenance expenses.  The Company
      has an option to renew the lease for its U.S. facilities for an additional
      five years commencing in 1999. Rental expense for all operating leases was
      approximately  $631,000,   $803,000  and  $851,000  for  the  years  ended
      September 30, 1998, 1997 and 1996, respectively.



<PAGE>


8.    COMMITMENTS (CONTINUED)
<TABLE>

      As of September 30, 1998, minimum rental  commitments under  noncancelable
operating leases are as follows:

Year Ending
September 30
<S>                                                                       <C>

1999                                                               $   720,318
2000                                                                   329,967
2001                                                                   195,719
2002                                                                   180,736
2003                                                                   180,736
Thereafter                                                           1,284,144

Total minimum lease payments                                       $ 2,891,620
</TABLE>



      Royalties - The Company is also committed to pay royalties relating to the
      sales of certain  software  products.  Royalty expense included in cost of
      sales was  approximately  $1,380,000,  $1,867,000  and  $1,533,000 for the
      years ended September 30, 1998, 1997 and 1996, respectively.

      Software Development  Agreement - In August 1998, the Company entered into
      a  software  development   agreement  whereby,   upon  completion  of  the
      development  and acceptance by the Company,  the Company will issue to the
      developer a number of shares of its common stock as would be determined by
      dividing  $160,000 by the average of the closing price of its stock during
      the period from the date of the  agreement  through the date of acceptance
      of the software.

9.     LITIGATION

      The Company has been named as a defendant in  litigation  arising from its
      normal business  activities.  The Company is not a party to any litigation
      that  management  believes  will  have a  material  adverse  effect on the
      Company's consolidated financial statements or its business.

10.   FINANCING ARRANGEMENTS

      Line of Credit - The Company  maintains a line of credit which will expire
      on January 29, 1999. The line of credit provides for maximum borrowings up
      to the  lesser of  $1,500,000  or 50%-80%  of  defined  eligible  accounts
      receivable.  Borrowings under the line are collateralized by substantially
      all assets of the Company.  Outstanding  borrowings  bear  interest at the
      bank's prime rate plus .75% (9.25% at September 30, 1998). As of September
      30,  1998  and  1997,  there  were  $250,000  and  $0,  respectively,   of
      outstanding  borrowings  under  the line of  credit.  The  line of  credit
      contains customary  covenants which require,  among other items, a minimum
      level of consolidated  tangible net worth and the maintenance of a minimum
      liquidity ratio, as defined.  As of September 30, 1998, the Company was in
      default on its covenant to maintain the minimum level of consolidated  net
      worth.  The bank  subsequently  waived  this  default  through  the line's
      maturity date and limited borrowings to $1,150,000.



<PAGE>


10.   FINANCING ARRANGEMENTS (CONTINUED)

      Term Loan - On February 12, 1997,  the Company  obtained an equipment line
      of credit with a bank. The line of credit provides for maximum  borrowings
      up to  $1,500,000.  Payments of interest only were required from March 12,
      1997 through  February 12, 1998, at which time the  equipment  line was to
      convert  to a term loan  payable.  The  Company  fully  repaid the loan on
      October 16, 1997.

      Capital Lease Obligations - The Company leases certain office and computer
      equipment  under capital leases with lease terms ranging from one to three
      years.


      Future  minimum  lease  payments  under the  noncancelable  capital  lease
obligation at September 30,1998 follows:

1999                                                                 $ 170,211
2000                                                                    50,583
2001 and thereafter                                                        422

Total minimum lease payments                                           221,216

Amounts representing interest                                          (29,961)

Present value of minimum lease commitments                             191,255

Current portion                                                       (147,065)

Long-term portion                                                    $  44,190




<PAGE>


11.   INCOME TAXES

      The provision  (benefit)  for income taxes  consisted of the following for
the years ended September 30:
                                        1998           1997             1996

Current:
  Federal                            $ 580,000     $    -            $(28,000)
  State                                 10,000          -              (5,000)
  Foreign                               10,000          -                -

                                       600,000          -             (33,000)


Deferred:
  Federal                            1,663,000      (797,000)         647,700
  State                                688,000      (141,000)         114,300
  Foreign                           (1,621,000)         -                -
  Change in valuation allowance       (730,000)      938,000         (762,000)

                                                        -                -

Total                                $ 600,000      $   -            $(33,000)



      At September 30, 1998, the Company has fully utilized the federal tax loss
      carryforwards   and  has   approximately   $358,000   in  state  tax  loss
      carryforwards, which commence expiring in 2007. An alternative minimum tax
      credit of $132,000 is available for offset against future regular  federal
      taxes.  Research and  development  credits of $75,000  expire in 2013.  In
      addition,  tax loss carryforwards in certain foreign  jurisdictions  total
      approximately $6,322,000.

      Deferred income taxes reflect the net tax effects of temporary differences
      between  the  carrying  amounts of assets and  liabilities  for  financial
      reporting  purposes  and the  amounts  used for  income tax  purposes  and
      operating loss carryforwards and credits.



<PAGE>


11.   INCOME TAXES (CONTINUED)

      The tax effects of significant items comprising the Company's net deferred
      tax position as of September 30 were as follows:

                                                         1998            1997
Deferred tax liabilities:
   Depreciation and amortization                     $ (60,000)      $ (92,000)

   Prepaid expenses                                   (309,000)           -

                                                      (369,000)        (92,000)
Deferred tax assets:
  Goodwill                                             362,000            -
  Inventory-related items                              100,000         197,000
  Accounts and notes receivable reserves               239,000         269,000
  Net operating loss carryforwards                   2,563,000       3,166,000
  Research and development credits                      75,000         205,000
  Alternative minimum tax credits                      132,000         144,000
  Other                                                 57,000            -

                                                     3,528,000       3,981,000

Total                                                3,159,000       3,889,000

Valuation allowance                                 (3,159,000)     (3,889,000)

Deferred taxes, net                                 $    -          $     -

      The Company has  experienced  significant  losses from  operations  either
      domestically or internationally over the past several years.  Accordingly,
      management  does  not  believe  the tax  assets  satisfy  the  realization
      criteria  set  forth in SFAS No.  109 and has thus  recorded  a  valuation
      allowance for the entire net tax asset. The valuation  allowance decreased
      by approximately $730,000 in 1998, primarily because of the utilization of
      net operating loss carryforwards.

<TABLE>

      The following  table  reconciles  the Company's  effective tax rate to the
      federal statutory rate of 34% for the years ended September 30, 1998, 1997
      and 1996:
                                                                 1998           1997            1996
<S>                                                               <C>            <C>             <C>

Taxes (benefit) at federal statutory rate                   $ 1,803,000     $ (678,000)      $ 372,000
Reversal of valuation allowances against
  net operating loss carryforwards                           (2,066,000)      (371,000)       (507,000)
Provision of valuation allowance against currently
  generated net operating loss carryforwards                    962,000      1,049,000         133,000
Benefit of research credits                                    (280,000)          -               -
Nondeductible goodwill                                           96,000           -               -
Other                                                            85,000           -            (31,000)

Provision (benefit) for income taxes                        $   600,000      $    -          $ (33,000)
</TABLE>




<PAGE>


12.   SHAREHOLDERS' EQUITY

      Stock Option Plans - The Company's four stock option plans described below
      provide for granting of options and other stock rights to purchase  common
      stock of the Company to employees, officers, consultants and directors who
      are not  otherwise  employees.  The  options  granted are  exercisable  as
      specified at the date of grant and generally expire five to ten years from
      the date of grant.  Generally,  options and other stock rights are granted
      at  exercise  prices  not less than fair  market  value at the date of the
      grant.

      The  Company's  1987  Stock  Option  Plan  provided  for the  issuance  of
      nonqualified   or  incentive   stock  options  to   employees,   officers,
      consultants,  and  directors.  As of February 25, 1997, the Company may no
      longer issue stock  options  under the 1987 Stock Option Plan  pursuant to
      terms of the plan.

      On June 1, 1996, the Company  established the 1996  Non-employee  Director
      Stock Option Plan (the "1996  Director  Plan") which was amended  December
      10, 1996.  The 1996  Director  Plan,  as amended,  provides for an initial
      grant of 12,000 options to each non-employee  director elected as a member
      of the Board of Directors and for the subsequent automatic annual grant of
      4,000  options (at the then current  fair market  value) to each member so
      long as that member  remains on the Board of  Directors.  Options  granted
      pursuant to this plan vest 8.33% during each three-month period subsequent
      to date of grant, so as to be fully vested three years from date of grant.
      Options may be granted under this plan through June 1, 2006.

      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 may be granted to any employee
      or consultant of any of the Company's foreign subsidiaries through 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 may be granted through December 10, 2006, and shall vest as specified
      by the Committee.

      Selected information  regarding the above stock option plans as of and for
      the year ended September 30, 1998 is as follows:

                                                Authorized      Available for
                                                 for Grant       Future Grant

1987 Stock Option Plan                            790,791             -
1996 Director Plan                                 72,000           20,000
1996 International Plan                           200,000           13,000
1996 Stock Plan                                 1,000,000          423,298

                                                2,062,791          456,298






<PAGE>


12.   SHAREHOLDERS' EQUITY (CONTINUED)

      Stock  Option  Plans  (Continued)  - The  following  table is a summary of
      activity for all of the Company's stock option plans:

                                    Weighted-
                                     Average
                                                     Options        Exercise
                                                   Outstanding       Price

Outstanding, October 1, 1995                         319,619       $ 0.99

    Granted                                          181,000         5.01
    Canceled                                          (7,667)        4.46
    Exercised                                       (217,411)        0.95


Outstanding, September 30, 1996                      275,541         3.56

    Granted                                          719,820         1.98
    Canceled                                        (198,527)        4.53
    Exercised                                        (25,125)        1.09

Outstanding, September 30, 1997                      771,709         1.92

    Granted                                          388,200         2.30
    Canceled                                        (181,499)        2.19
    Exercised                                        (64,251)        1.35

Outstanding, September 30, 1998                      914,159       $ 2.06

Exercisable, September 30, 1998                      272,360       $ 2.05

Exercisable, September 30, 1997                      158,204       $ 1.76




<PAGE>


12.   SHAREHOLDERS' EQUITY (CONTINUED)
<TABLE>

      Stock  Option  Plans   (Continued)  -  The  following   table  sets  forth
      information regarding options outstanding at September 30, 1998:
                        Options Outstanding                                  Options Exercisable
--------------------------------------------------------------------    -------------------------------
                                Weighted-Average  Weighted-                             Weighted-
                                   Remaining       Average                               Average
  Exercise       Number of        Contractual      Exercise                             Exercise
   Prices          Shares         Life (Years)      Price                     Shares      Price
    <S>            <C>                 <C>            <C>                      <C>        <C>

 $ 1.00            40,791               1          $ 1.00                     40,791     $ 1.00
1.59-2.28         598,701               8            1.75                    164,801       1.72
2.38-2.56         242,667              10            2.54                     45,760       2.54
4.31-4.87          20,000               5            4.65                     13,008       4.70
   7.06            12,000               8            7.06                      8,000       7.06

                  914,159               8          $ 2.06                    272,360     $ 2.05
</TABLE>
<TABLE>

      Pro  Forma  Disclosure  - As  described  in Note 1, the  Company  uses the
      intrinsic  method of valuing its stock options in accordance  with ABP No.
      25 to measure compensation expense associated with grants of stock options
      to employees and directors.  Had the Company  recognized  compensation for
      its stock  options and  purchase  plans based on the fair value for awards
      under those plans after October 1, 1995, in accordance  with SFAS No. 123,
      "Accounting for Stock Based Compensation," pro forma net income (loss) and
      pro forma net income (loss) per share would have been as follows:
                                                        
------------------------------------------------------------------------------------------------------
                                                       Years Ended September 30,
------------------------------------------------------------------------------------------------------
                                                         <S>              <C>              <C>   

------------------------------------------------------------------------------------------------------
                                                         1998             1997             1996
------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------

------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------
Pro forma net income (loss)                             $ 4,410,742      $ (2,263,219)    $ 1,062,506
------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------
Pro forma net income (loss)
------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------
  per share:
------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------
    Basic                                                    $ 0.48      $      (0.25)    $      0.12
------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------
    Diluted                                                    0.47             (0.25)           0.12
------------------------------------------------------------------------------------------------------

</TABLE>



<PAGE>


12.   SHAREHOLDERS' EQUITY (CONTINUED)

<TABLE>

      Pro Forma  Disclosure  (Continued)  - The fair  values used to compute pro
      forma net income (loss) and net income (loss) per share were  estimated on
      the grant  date  using the  Black-Scholes  option-pricing  model  with the
      following weighted-average assumptions:
-----------------------------------------------------------------------------------------------------------------------
                                                                              Years Ended September 30,
-----------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------------
<S>                                                                             <C>             <C>           <C>

                                                                               1998            1997           1996
-----------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------------

-----------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------------
Risk-free interest rate                                                        5.8 %           6.7 %          6.1 %
-----------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------------
Expected life of option grants (years)                                         5.0             5.0            5.0
-----------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------------
Expected volatility of underlying stock                                       92.8 %          87.2 %         52.1 %
-----------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------------
Expected dividend payment rate                                                 0.0 %           0.0 %          0.0 %
-----------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------------
Expected forfeiture rate                                                       0.0 %           0.0 %          0.0 %
-----------------------------------------------------------------------------------------------------------------------
</TABLE>

      The weighted-average fair value of stock options granted, was $1.71, $1.26
      and $3.41  during  the years  ended  September  30,  1998,  1997 and 1996,
      respectively.

      The option  pricing  model was designed to value readily  tradeable  stock
      options with relatively  short lives. The options granted to employees are
      not tradeable and have  contractual  lives of five to ten years.  However,
      management  believes  that the  assumptions  used and the model applied to
      value the awards  yields a  reasonable  estimate  of the fair value of the
      grants made under the circumstances.

13.   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
      1998, 1997 or 1996.



<PAGE>


14.   SEGMENT INFORMATION
<TABLE>

      Summarized  information,  determined  under the provisions of SFAS No. 14,
      about the Company's operations by geographic area is as follows:

                                                                          Europe
                                                                       (Principally
                                                     Domestic              U.K.)       Eliminations         Total
<S>                                                     <C>                  <C>            <C>                <C>  

Year Ended September 30, 1998

Net sales                                           $11,635,959       $14,058,471       $ (398,708)      $25,295,722
Income (loss) from operations                        (7,038,903)       (3,346,808)        (118,721)      (10,504,432)
Identifiable assets                                  21,672,565         6,549,965       (9,890,315)       18,332,215


Year Ended September 30, 1997

Net sales                                           $20,502,363       $12,398,815       $ (853,683)     $ 32,047,495
Income (loss) from operations                           986,866        (2,800,009)         (68,822)       (1,881,965)
Identifiable assets                                  16,782,249         5,089,501       (5,725,105)       16,146,645


Year Ended September 30, 1996

Net sales                                          $ 19,980,505      $ 10,418,080       $ (376,463)     $ 30,022,122
Income (loss) from operations                         1,802,456          (666,201)          (8,733)        1,127,522
Identifiable assets                                  12,329,945         4,658,682       (1,748,056)       15,240,571



Export sales aggregated approximately  $3,132,000,  $3,484,000 and $4,105,000 in
1998, 1997 and 1996, respectively.
</TABLE>

                                  Schedule VIII
                      DATAWATCH CORPORATION & SUBSIDIARIES
                        VALUATION AND QUALIFIED ACCOUNTS

------------------------------------------------------------------------------
COLUMN A           COLUMN B        COLUMN C            COLUMN D     COLUMN E
------------------------------------------------------------------------------
Description        Balance at      Additions           Deductions   Balance at
                   Beginning       Charged To          from         End of
                   Period     -----------------------  Reserves     Period
                             Costs & Expenses(a) Other
-----------------------------------------------------------------------------
Year Ended September 30, 1998
-----------------------------
Allowance-doubtful
 accounts and
 sales returns     $227,913   $322,128  $74,540 (e)  ($272,064)(b)(c) $352,517
                   -----------------------------------------------------------
TOTAL              $227,913   $322,128  $74,540      ($272,064)       $352,517
                   ===========================================================

Year Ended September 30, 1997
-----------------------------
Allowance-doubtful
 accounts and
 sales returns     $73,145   $177,334  $54,138 (d)(e)  ($76,704)(b)   $227,913
                   -----------------------------------------------------------
TOTAL              $73,145   $177,334  $54,138         ($76,704)      $227,913
                   ===========================================================

Year Ended September 30, 1996
-----------------------------
Allowance-doubtful
 accounts and
 sales returns     $83,064    $42,349                 ($52,268)(b)(c)  $73,145
                   -----------------------------------------------------------
TOTAL              $83,064    $42,349                 ($52,268)        $73,145
                   ===========================================================



(a)  Current year provision
(b)  Doubtful accounts written off
(c)  Product returns
(d)  Allowance acquired through purchase of Datawatch Europe Ltd.
(e)  Bad debt recoveries


                                  EXHIBIT INDEX
(5) 2.1  Asset Purchase  Agreement,  dated October 9, 1997,  among DATAWATCH
         CORPORATION,  Pole Position  Software  GmbH and Dr Solomon's  Software,
         Inc. (Exhibit 2.1)
(5) 2.2  Escrow Agreement, dated October 9, 1997, among DATAWATCH CORPORATION, 
         Dr Solomon's Software, Inc. and State Street Bank and Trust Company.
         (Exhibit 2.2)
(1) 3.1 Restated Certificate of Incorporation of the Registrant (Exhibit 3.2)
(1) 3.2 By-Laws, as amended, of the Registrant (Exhibit 3.3) 
(1) 4.1 Specimen certificate representing the Common Stock (Exhibit 4.4) 
        Lease by and between the Registrant and CBOB Fund Corp., as Trustee of 
        Ballardvale Building D Nominee Trust, dated February 17, 1992 
        (Exhibit 10.2)
(1)10.2* 1987 Stock Plan (Exhibit 10.7) (1)10.3* Form of Incentive  Stock Option
         Agreement of the Registrant  (Exhibit 10.8) 
(1)10.4* Form of Nonqualified  Stock Option Agreement of the Registrant 
         (Exhibit 10.9)  
         Software Development and Marketing Agreement by and between PERSONICS 
         CORPORATION and Raymond Huger, dated January 19, 1989 (Exhibit 10.12)
(2)10.6  Marketing Agreement dated May 1, 1994 between WorkGroup Systems Ltd. 
         and DATAWATCH CORPORATION (Exhibit 10.1)
(3)10.7  Commercial Security Agreement between DATAWATCH CORPORATION and Silicon
         Valley  Bank doing  business as Silicon  Valley East dated  November 1,
         1994 (Exhibit 10.23)
(3)10.8  Commercial Security Agreement between PERSONICS CORPORATION and Silicon
         Valley  Bank doing  business as Silicon  Valley East dated  November 1,
         1994 (Exhibit 10.24)
(4)10.9* Executive Agreement between the Company and Marco D. Peterson dated 
         April 11, 1996 (Exhibit 10.2)
(4)10.10*Executive Agreement between the Company and Bruce R. Gardner dated 
         April 11, 1996 (Exhibit 10.3)
(6)10.11 Loan Modification Agreement dated October 31, 1996 between DATAWATCH 
         CORPORATION, Personics Corporation and Silicon Valley Bank 
         (Exhibit 10.29)
(6)10.12*1996 Non-Employee Director Stock Option Plan, as amended on 
         December 10, 1996 (Exhibit 10.30)
(6)10.13*1996 International Employee Non-Qualified Stock Option Plan 
         (Exhibit 10.31)
(7)10.14 Amended and Restated Letter Agreement, dated February 12, 1997, by and
         between DATAWATCH CORPORATION, Personics Corporation and Silicon Valley
         Bank (Exhibit 10.1) 
(7)10.15 Promissory Note, dated February 12, 1997, by and between DATAWATCH 
         CORPORATION, Personics Corporation and Silicon Valley Bank 
         (Exhibit 10.2).
(8)10.16 Loan Modification Agreement, dated October 30, 1997, by and between 
         DATAWATCH CORPORATION, Personics Corporation and Silicon Valley Bank 
         (Exhibit 10.23)
(9)10.17*1996 Stock Plan (Appendix A)
(10)10.18 Loan Modification Agreement, dated January 30, 1998, by and between 
          DATAWATCHCORPORATION, Personics Corporation and Silicon Valley Bank 
         (Exhibit 10.1)
    10.19 Loan Modification Agreement, dated December 18,1998, by and between 
          DATAWATCH CORPORATION, Personics Corporation and Silicon Valley Bank 
          (filed herewith)
     21.1 Subsidiaries of the Registrant (filed  herewith)
     23.1 Consent of Independent Auditors (filed  herewith) 
     27   Financial Data Schedule (filed 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  Quarterly  Report on Form
     10-Q for the  quarter  ended  June  30,  1994 and  incorporated  herein  by
     reference  (the number given in  parenthesis  indicates  the  corresponding
     exhibit in such Form 10-Q).
(3)  Previously  filed as an exhibit to Registrant's  Annual Report on Form 10-K
     for the Fiscal Year ended  September  30, 1994 and  incorporated  herein by
     reference  (the number given in  parenthesis  indicates  the  corresponding
     exhibit in such Form 10-K).
(4)  Previously  filed as an exhibit to  Registrant's  Quarterly  Report on Form
     10-Q for the  quarter  ended  June  30,  1996 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  Current Report on Form 8-K
     dated  October 9, 1997 and  incorporated  herein by  reference  (the number
     given in parenthesis indicates the corresponding exhibit in such Form 8-K).
(6)  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 for 10-K).
(7)  Previously  filed as an exhibit to  Registrant's  Quarterly  Report on Form
     10-Q for the  quarter  ended  March  31,  1997 and  incorporated  herein by
     reference (the number in parenthesis indicates the corresponding exhibit in
     such Form 10-Q).
(8)  Previously  filed as an exhibit to Registrant's  Annual Report on Form 10-K
     for the Fiscal Year ended  September  30, 1997 and  Incorporated  herein by
     reference  (the number given in  parenthesis  indicates  the  corresponding
     exhibit in such for 10-K).
(9)  Previously filed as Appendix A to the Company's  definitive Proxy Statement
     for  the  Annual  Meeting  of  Shareholders  held on  March  19,  1997  and
     incorporated herein by reference (the number given in parenthesis indicates
     the corresponding Appendix in such definitive Proxy Statement).
(10) Previously  filed as an exhibit to  Registrant's  Quarterly  Report on form
     10-Q for the  quarter  ended  March  31,  1998 and  incorporated  herein by
     reference (the number in parenthesis
     indicates the corresponding exhibit in such Form 10-Q.




                                  EXHIBIT 10.19
                           LOAN MODIFICATION AGREEMENT

         This Loan  Modification  Agreement  is entered  into as of December 18,
1998, by and between Datawatch  Corporation and Personics  Corporation  (jointly
and  severally,  the  "Borrower"  and sometimes  referred to as  "Company")  and
Silicon  Valley Bank, a  California-chartered  bank  ("Lender"),  doing business
under the name "Silicon Valley East".

1. DESCRIPTION OF EXISTING  INDEBTEDNESS:  Among other indebtedness which may be
owing by Borrower to Lender,  Borrower is indebted to Lender  pursuant to, among
other  documents,  a  Promissory  Note,  dated  November 1, 1994 in the original
principal  amount of One  Million  Five  Hundred  Thousand  and  00/100  Dollars
($1,500,000.00),  as may have been modified from time to time (the "Note").  The
Note,  together with other promissory notes from Borrower to Lender, is governed
by the terms of an Amended and Restated  Letter  Agreement,  dated  February 12,
1997, between Borrower and Lender, as such agreement may be amended from time to
time (the "Loan Agreement"). Defined terms used but not otherwise defined herein
shall have the same meaning as in the Loan Agreement.

Hereinafter, all indebtedness owing by Borrower to Lender shall be referred to 
as the "Indebtedness."

2.  DESCRIPTION OF COLLATERAL:  Repayment of the  Indebtedness is secured by two
(2)  Commercial  Security  Agreements,  each dated  November 1, 1994 (each,  the
"Security Agreement"),  and two (2) Collateral  Assignment,  Patent Mortgage and
Security Agreements, each dated November 1, 1994 (each, the "Patent Agreement").

Hereinafter,  the above-described  security  documents,  together with all other
documents  securing  payment of the  Indebtedness  shall be  referred  to as the
"Security  Documents".  Hereinafter,  the Security Documents,  together with all
other documents  evidencing or securing the Indebtedness shall be referred to as
the "Existing Loan Documents."

3.       DESCRIPTION OF CHANGE IN TERMS.

         A.       Modification(s) to Note.

                  1.       The  paragraph  entitled  "Line of  Credit" is hereby
                           deleted.   Borrower  shall  not  be  allowed  further
                           advances under the Note.

         B.       Modification(s) to Loan Agreement.

                  1.       The  "Tangible   Capital  Base"  financial   covenant
                           requirement,   as  described   in  the   "Affirmative
                           Covenants" Section, is hereby deleted.

         C.       Waiver of Financial Covenant Default.

                  1.       Lender  hereby  waives  Borrower's  existing  default
                           under the Loan  Agreement  by  virtue  of  Borrower's
                           failure to comply with the  Tangible  Capital Base as
                           of months ended September 30, 1998,  October 31, 1998
                           and November 30, 1998.  Lender's waiver of Borrower's
                           compliance of this  covenant  shall apply only to the
                           foregoing periods.

                           Lender's  agreement  to  waive  the   above-described
                           default (1) in no way shall be deemed an agreement by
                           the Lender to waive  Borrower's  compliance  with the
                           above-described  covenant  as of all other  dates and
                           (2) shall not limit or impair the  Lender's  right to
                           demand strict  performance of this covenant as of all
                           other  dates and (3)  shall  not limit or impair  the
                           Lender's  right to demand strict  performance  of all
                           other covenants as of any date.

4.  PAYMENT OF LOAN FEE.  Borrower  shall pay Lender a fee in the amount of Two
Thousand  Five Hundred and 00/100  Dollars ($2,500.00) plus all out-of-pocket 
expenses (the "Loan Fee").

5. CONSISTENT  CHANGES.  The Existing Loan Documents are hereby amended wherever
necessary to reflect the changes described above.

6. NO DEFENSES OF BORROWER.  Borrower  agrees that,  as of this date,  it has no
defenses against the obligations to pay any amounts under the Indebtedness.

7. CONTINUING  VALIDITY.  Borrower  understands and agrees that in modifying the
existing  Indebtedness,  Lender  is  relying  upon  Borrower's  representations,
warranties,  and agreement, as set forth in the Existing Loan Documents.  Except
as expressly modified pursuant to this Loan Modification Agreement, the terms of
Existing Loan Documents remain unchanged and in full force and effect.  Lender's
agreement to  modifications to the existing  Indebtedness  pursuant to this Loan
Modification  Agreement  in no way  shall  obligate  Lender  to make any  future
modifications to the Indebtedness.  Nothing in this Loan Modification  Agreement
shall  constitute a  satisfaction  of the  Indebtedness.  It is the intention of
Lender and  Borrower  to retain as liable  parties all makers and  endorsers  of
Existing  Loan  Documents,  unless the party is expressly  released by Lender in
writing.  No maker,  endorser,  or guarantor  will be released by virtue of this
Loan Modification Agreement.  The terms of this Paragraph apply not only to this
Loan  Modification  Agreement,  but  also to all  subsequent  loan  modification
agreements.

8.  JURISDICTION/VENUE.  Borrower  accepts for itself and in connection with its
properties,  unconditionally,  the  non-exclusive  jurisdiction  of any state or
federal court of competent  jurisdiction in the Commonwealth of Massachusetts in
any action, suit, or proceeding of any kind against it which arises out of or by
reason of this Loan Modification Agreement;  provided,  however, that if for any
reason  Lender  cannot  avail  itself  of  the  courts  of the  Commonwealth  of
Massachusetts, then venue shall lie in Santa Clara County, California.

9.  COUNTERSIGNATURE.  This Loan  Modification  Agreement shall become effective
only when it shall have been executed by Borrower and Lender (provide,  however,
in no event shall this Loan Modification Agreement become effective until signed
by an officer of Lender in California).

10.  CONDITIONS.  The  effectiveness  of this  Loan  Modification  Agreement  is
conditioned upon payment of the Loan Fee.



<PAGE>



                              This Loan Modification Agreement is executed as of
the date first written above.

BORROWER:

DATAWATCH CORPORATION

By: /s/ Betsy J. Hartwell

Name: Betsy J. Hartwell

Title: CFO / VP Finance

PERSONICS CORPORATION

By: /s/ Betsy J. Hartwell

Name: Betsy J. Hartwell

Title: Assist. Treasurer

LENDER:

SILICON VALLEY BANK, doing business as
SILICON VALLEY EAST

By: /s/ J. C. Maynard

Name: J. C. Maynard

Title: SVP

SILICON VALLEY BANK

By: /s/ Amy Young

Name: Amy Young

Title: VP
(Signed at Santa Clara County, CA)

                                  EXHIBIT 21.1
                         SUBSIDIARIES OF THE REGISTRANT


Subsidiary                   Place of Incorporation  D/B/A Name

Personics Corporation        Delaware, USA           Personics Corporation

WorkGroup GmbH               Germany                 WorkGroup GmbH

Pole Position Software GmbH* Germany                 Pole Position Software GmbH

Datawatch International Ltd  England & Wales         Datawatch International Ltd

Datawatch GmbH**             Germany                 Datawatch GmbH

Datawatch France SARL**      France                  Datawatch France SARL

Datawatch Pty Ltd.**         Australia               Datawatch Pty Ltd.

Datawatch Europe Limited**   England & Wales         Datawatch Europe Limited

Guildsoft Limited ***        England & Wales         Guildsoft Limited

*    All of the shares of capital stock of Pole Position Software GmbH are owned
     by WorkGroup GmbH.

**   All of the shares of capital stock of WorkGroup Systems GmbH, WorkGroup 
     Systems France SARL, Datawatch Pty Ltd. and Datawatch Europe Limited are 
     owned by Datawatch International Limited.

***  All of the  shares  of  capital  stock of  Guildsoft  Limited  are owned by
     Datawatch Europe Limited.

                                  EXHIBIT 23.1

INDEPENDENT AUDITORS' CONSENT

We consent to the  incorporation  by reference  in  Registration  Statement  No.
333-39627 and No.  33-65786 of Datawatch  Corporation on Forms S-8 of our report
dated  November  24,  1998  appearing  in this  Annual  Report  on Form  10-K of
Datawatch Corporation for the year ended September 30, 1998.


/s/Deloitte & Touche LLP

Boston, Massachusetts
December 28, 1998



<PAGE>