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, 1996
                          -------------------
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: (508) 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: $49,129,167
(computed  by reference to the last sales price of such common stock on December
20,  1996  as  reported  in  the  National   Association  of  Security   Dealers
consolidated trading index).

Number of shares of common stock outstanding at December 20, 1996 : 9,100,113




                                       1





                       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,  1996.
Portions of such Proxy  Statement are  incorporated  by reference in Part III of
this report.




                                       2



                                     PART I
ITEM 1.  BUSINESS
-----------------

GENERAL

         From its founding in 1985 until  December 1991,  DATAWATCH  Corporation
("DATAWATCH"  or the "Company")  was engaged solely in the design,  manufacture,
test and marketing of IBM-compatible computer workstations and peripherals which
conformed to the U.S.  government's  TEMPEST  security  standard for  processing
classified  information.  However, with the ending of the Cold War, the break-up
of the  U.S.S.R.  and the  consequent  uncertainties  in the  future  market for
TEMPEST  products,  during  1991  management  developed a strategy to expand via
acquisition  into the business of PC software,  thereby  utilizing  its computer
expertise and lessening its reliance on the TEMPEST hardware market.

         Consistent  with this  strategy,  and further  prompted by a subsequent
precipitous  decline in the TEMPEST market, the Company completely  transitioned
its business  from  computer  hardware to computer  software  via the  following
transactions:

*   December 1991 - Acquisition of Personics Corporation.

*   October 1992 - Acquisition of the Utilities Product Group of Microcom.
    
*   May 1993 - Sale of the TEMPEST hardware division to Secure Systems Group.
   
*   May 1994 - Agreement as exclusive  North American  publisher and marketer of
    the Q-Support( line of software owned by UK-based  WorkGroup Systems Limited
    ("WorkGroup").

*   April  1995  -  Agreement  as  exclusive  U.S.  publisher  and  marketer  of
    netOctopus TM, a network management  software product owned by Pole Position
    Software GmbH ("Pole Position").

*   October 1995 - Acquisition of Pole Position.

*   March 1996 - Acquisition of WorkGroup.

*   July 1996 - Agreement as exclusive U.S. publisher and marketer of VET(TM), a
    PC based anti-virus software owned by Cybec Pty Ltd.


         DATAWATCH's  principal products are:  Monarch(TM),  which provides data
access,  translation  and  reporting  capabilities  to users of networked  PC's;
Virex(R)  and VET(TM)  for the PC,  which  detect,  repair and monitor for virus
infections for both the Apple Macintosh and IBM compatible  PC's,  respectively;
Quetzal (internationally) or Q-Support(TM) for Windows (in the United States), a
complete help desk and asset management  system; and  netOctopus(TM),  a network
management and administration system.



                                       3




         The Company's  executive offices are located at 234 Ballardvale Street,
Wilmington,  Massachusetts  01887 and the  Company's  telephone  number is (508)
988-9700.



                                       4







PRINCIPAL PRODUCTS

Monarch
-------

         Introduced in 1991,  Monarch is one of DATAWATCH's  principal  products
and represented approximately 41% of the Company's net sales in fiscal 1996, 46%
of net sales for fiscal 1995 and 38% for fiscal 1994. Monarch is a PC compatible
business intelligence software tool which allows users to access, manipulate and
translate  data held in report files.  Monarch is a  multi-function  data access
tool that uses  computer-generated  legacy reports as a source for data. Monarch
accepts a report file as input,  extracts  the data,  and  delivers  the data to
users in a variety of formats. Monarch is marketed as "an electronic alternative
to hard copy printouts."

         Corporate and  government  MIS  departments  have invested  substantial
resources in designing  reports and  delivering  them into the hands of managers
and their  staffs.  With Monarch,  users can gain instant  access to the reports
used in their  workplace.  When the chosen  report  appears  on screen,  Monarch
offers the user a variety of tools for rapid  lookup and  navigation.  Users can
view a full report,  or apply filters to view only  information that is relevant
to their needs.  With Monarch,  users can create custom  reports and  summaries,
produce  local  hard  copy,   create  graphs  and  export  data  to  popular  PC
applications  such as Lotus 1-2-3 or Excel. With the September 1996 introduction
of Monarch  Version  3.0 users are now able to create a Portable  Report  Format
(PRF) which  enables  electronic  distribution  of reports via the intranet thus
reducing hardcopy print and delivery costs.

         The use of  existing  reports as the  source  for data in  Monarch  has
several important advantages:

         *  Data is instantly available. Every computer-generated report used in
            the customer's organization  represents a ready-made,  pre-processed
            database that Monarch can exploit.

         *  Compatibility is achieved across computing environments. Because the
            computer  industry  has  adopted a standard  convention  for sending
            characters to printers,  Monarch can read report files  generated in
            nearly all computing environments,  including IBM, DEC, Unisys, ICL,
            NCR, Wang, Hewlett Packard, and many others.

         *  Users are immediately productive. Because users are already familiar
            with  computer-generated  reports,  they  are  quickly  able  to use
            Monarch. A report is perceived by most users as a physical, tangible
            object with information arranged for human consumption.

         *  Data security is maintained.  Since Monarch reads computer  reports,
            not the  computer  database,  the  computer's  data stays secure and
            out-of-reach.



                                       5





         *  Costs are reduced. Since Monarch takes the report off of the desktop
            and  puts  it  in  the  PC,  the  cost  of  report   generation  and
            distribution are significantly lowered.


Virex
-----

         Virex  was  introduced  in  1988  as the  first  commercial  anti-virus
software  product for the  Macintosh.  Virex has an installed  base of more than
800,000 users and  represented  approximately  15% of the Company's net sales in
fiscal  1996,  17% of net sales for fiscal  1995 and 20% of net sales for fiscal
1994.  Virex detects and repairs known Macintosh  viruses and then,  through the
Virex INIT,  a memory  resident  companion  program,  continuously  monitors the
system to prevent future infection by viruses.

         Virex is a leader in Macintosh virus  protection,  delivering  complete
protection  from both known and unknown  viruses  faster than any other product,
with its patented SpeedScan(TM) technology. Scan-At-Download - a Virex exclusive
-  automatically  protects  you from  viruses in files  downloaded  from on-line
services,  the Internet or any other network.  Other powerful  features  include
scheduled scanning, extensive network protection, instant updating, native Power
Macintosh  support  and  compressed  file  scanning,   supporting   Stuffit(TM),
CompactPro(TM), Disk Doubler, and more.

         Virex is the  only  Macintosh  anti-virus  product  that  automatically
detects and repairs ALL infected  documents as they are opened by Microsoft Word
or Excel, preventing wide-spread infection or data loss.

VET
---
         VET(TM) is a virus protection tool for business, government,  education
and consumer  users  introduced in the U.S. by the Company in September of 1996.
VET delivers fast and thorough virus protection  against viruses,  trojan horses
and Macro viruses for DOS,  Windows,  Windows 95, Windows NT and Novell Netware.
With VET, files are scanned  automatically so no manual checking is required. It
provides maximum  protection  against viruses  downloaded from the Internet,  in
e-mail attachments or copied from a diskette or network server.

         Comprehensive  on-screen help and detailed virus  information is always
available at the click of a mouse.  VET is  certified  by the National  Security
Computer  Association,  Novell accredited,  non-intrusive,  fully compatible and
easy to use.

Help Desk Products
------------------
Q-Support (U.S.)/Quetzal (Internationally)
         Q-Support,  marketed  internationally  under  the  name  Quetzal,  is a
Windows-based,  comprehensive help desk automation and asset management software
package.   Q-Support/Quetzal  ("Q-Support")  is  one  of  DATAWATCH's  principal
products and represented  approximately 39% of the Company's net sales in fiscal
1996,  33% for fiscal  1995 and 32% for




                                       6





fiscal 1994. The program provides IS support centers with a wide-range set of PC
software tools for use in a multi-user, networked environment.

         Featuring an easy-to-use  graphical  user  interface,  Q-Support  logs,
routes and tracks calls from initiation through  resolution.  With Q-Support you
have inventory control,  the ability to monitor  performance  levels,  access to
third-party  knowledge  providers,  e-mail and  extensive  management  reporting
options. Flexibility is built in-system administrators can customize the program
to suit organizational needs.

                  Q-Support  automates  four  key  functions  for the  corporate
support center:

         *  Asset  Management - addresses the increasing  needs by  corporations
            for  microcomputer  asset management by providing an accurate record
            of every item of equipment or service, tracing of equipment movement
            and change, and full maintenance and warranty information.

         *  Help Call  Management - automates  the  receiving  and  resolving of
            problem calls from the end-user by providing a fast logging process,
            allocation to groups or individuals, and monitoring screens to track
            progress, priority and status.

         *  Support   Facilities  -  provides  the  database  of  resources  and
            reference sources that are required to find the solution to end-user
            problems.

         *  Management  Analysis - satisfies the  Information  Center  manager's
            need to provide accurate  management reports on the status of either
            the inventory of equipment or the amount of support  activity taking
            place.

         Consulting   services   from   experienced   DATAWATCH    professionals
complements  the  Q-Support  package by providing  valuable  assistance  for all
phases of  implementation.  Q-Support  offers  all the tools you need to satisfy
end-users, lower support costs and optimize asset utilization.


netOctopus
----------

         netOctopus(TM)  from DATAWATCH is a  comprehensive  systems and network
administration  solution that allows  administrators to manage an entire network
of Macintosh and IBM-compatible  PC's from the convenience of their own desktop.
netOctopus can obtain  complete  hardware and software  inventory  detailing the
configuration  of each  computer  on a  network  in  real-time.  Any  number  of
workstations can be queried simultaneously without interrupting the work flow of
the computer users.

         Administrators  can  install  and  upgrade  software  of any  computer,
troubleshoot,  correct and prevent system  problems,  and monitor software usage
all from their desktop. For file distribution, use File Scripter to effortlessly
create  scripts  



                                       7





that accomplish  lengthy  installations of large and complex  software  programs
like  Microsoft  Office.  Additional  features  include  advanced  and  flexible
administrator  security,  remote  virus  scanning,  and  data  storage  for easy
integration into other programs.  netOctopus is fully customized and expandable.
All netOctopus features can be configured to operate  automatically.  netOctopus
operates  over LAN,  WAN, and dial-up  links for easy  administration  of remote
sites.

PRICING

         The  Company's  products are sold as  individual  units or under LAN or
site  licenses  for  multiple  users.  Monarch  licenses  list  for  $499 for an
individual  unit with LAN  licenses  listing  for a  minimum  of  $2,000.  Virex
licenses list for $99.95 per individual  copy and a minimum LAN price of $1,750.
VET  licenses  list for $59.95 per  individual  copy and a minimum  LAN price of
$1,250. A minimum three user license for Q-Support is $6,900.  The per seat list
price for netOctopus is $69.

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  end-user
customers,  no matter what their buying  behavior.  DATAWATCH  has observed 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-user customers,  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.

         During fiscal 1996, one distributor  represented  approximately  13% of
DATAWATCH's  net  sales.  No  other  customer  accounted  for  more  than 10% of
DATAWATCH's net sales in 1996.  DATAWATCH sells its products outside of the U.S.
directly through  WorkGroup's sales force and through  international  resellers.
Such  international  sales  represented   approximately  47%,  45%  and  49%  of
DATAWATCH'S net sales for fiscal 1996, 1995 and 1994, respectively.  See Note 11
to Consolidated  Financial  Statements which appears elsewhere in this Report on
Form 10-K.

         The  Company  offers  its  resellers  the  ability  to return  obsolete
versions of its products and slow-moving  products for credit 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;  however,  as
significant  new product  introductions  occur,  the  Company  has  periodically
exchanged re-seller inventories of older versions of the Company's products with
these new versions of its products.



                                       8





         A variety of marketing  programs are used by DATAWATCH 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.

         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.

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 through royalty payments based on product sales levels achieved.

         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's  Q-Support,  Virex and  netOctopus  products are developed,
enhanced  and  maintained  by its  software  development  engineers.  Monarch is
developed, maintained and enhanced by a contractual arrangement with an external
developer.  The tradenames  associated with each product,  as well as copyrights
for printed documentation, are held by DATAWATCH or its subsidiaries.

         DATAWATCH has a contractual agreement with the independent developer of
Monarch  which  requires  that source code be placed into escrow.  The principal
developer  for that  product  is also  bound by  contractual  commitments  which
require its continuing involvement in product maintenance and enhancement. Under
the agreement,  the Company has been granted manufacturing,  marketing and sales
rights under license  agreements which provide for royalty payments based on net
revenues and exclusive  worldwide rights with a stated term expiring in the year
2009.

BACKLOG



                                       9





         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.




                                       10






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,  Microsoft,  Symantec  Corp.,  McAfee
Associates,  Inc.,  Remedy,  Astea,  Applix 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 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 commercially reasonable cost.

EMPLOYEES

         As of  September  30,  1996,  DATAWATCH  had 211  full-time  employees,
including 4 executive officers, 68 engaged in marketing and sales, 44 engaged in
product management,  development and quality assurance,  55 engaged in providing
administrative,  accounting and production functions and 40 in technical support
services.




                                       11





         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 May 1999,  with an
option to renew for an additional five years. The Company uses approximately 60%
of this facility and the other 40% is subleased to Secure Systems Group.

         The Company also leases  approximately 6,200 square feet in Potter Bar,
Hertsfordshire,  England,  which  expires in January 2005,  approximately  3,500
square feet in Raleigh,  North  Carolina,  which  expires in January  1998,  and
maintains small offices in Germany, France and Australia.


         The Company believes its facilities are suitable for its current needs.

ITEM 3.  LEGAL PROCEEDINGS
--------------------------

         At the current time,  the  Registrant  does not have any material legal
proceedings.


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:

         Thomas R. Foley   56   President, Chief Executive Officer and Director
         Bruce R. Gardner  53   Executive Vice  President,  Chief  Financial  
                                Officer, Treasurer and Director
         Andrew W. Mathews 54   Vice President of Sales
         Marco D. Peterson 41   Vice President of Marketing and Product 
                                Development

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



                                       12





         THOMAS R. FOLEY,  President,  Chief Executive Officer and Director. Mr.
Foley,  a founder and director of  DATAWATCH,  has been its  President and Chief
Executive Officer since the Company was founded in 1985.

         BRUCE R. GARDNER,  Executive Vice President,  Chief Financial  Officer,
Treasurer and Director.  Mr. Gardner,  a founder and director of DATAWATCH,  has
been the Chief Financial  Officer and Treasurer since the Company was founded in
1985.  Mr.  Gardner was a Senior Vice  President  until June 1993 when he became
Executive Vice President.

         ANDREW W. MATHEWS, Vice President of Sales. Mr. Mathews has been a Vice
President  since  March  1986  serving  in  various  capacities  in the areas of
marketing, sales and as a division general manager.


         MARCO D. PETERSON, Vice President of Marketing and Product Development.
Mr.  Peterson was the founder of PERSONICS 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.



                                       13








                                     Part II

ITEM 5.  MARKET  FOR THE  REGISTRANT'S  COMMON  EQUITY AND  RELATED  SHAREHOLDER
--------------------------------------------------------------------------------
MATTERS
-------

The Registrant's common stock is listed and traded on the Nasdaq 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, 1996             High                      Low 
           ------------------            ---------------------------------

           4th Quarter                       11  5/8               6  3/8
           3rd Quarter                       11  5/8               4  3/4
           2nd Quarter                       5   1/4               3  3/8
           1st Quarter                       5   7/8               3  3/4

           For the Year Ended
           September 30, 1995
           ------------------

           4th Quarter                       6                     3  1/8
           3rd Quarter                       4  3/16               1  3/4
           2nd Quarter                       2  11/16              1  1/4
           1st Quarter                       1  11/16              1

     There are approximately 195 shareholders of record as of December 10, 1996.
The Registrant's common stock purchase warrants  previously  outstanding expired
in accordance with their terms on May 28, 1996.

    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.





                                       14








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, 1996
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>
<CAPTION>

Statements of Operations Data
Years Ended September 30,                           1996            1995            1994            1993            1992
                                                -------------- --------------- --------------- --------------- ---------------

<S>                                               <C>             <C>             <C>             <C>              <C>       
Net Sales                                         $30,022,122     $23,359,981     $16,882,142     $13,941,902      $7,888,053
Costs and Expenses                                 28,894,600      23,678,935      19,956,576      17,883,679       8,135,003
Income (Loss) Continuing Operations                 1,127,522       (318,954)     (3,074,434)     (3,941,777)       (246,216)
Income (Loss) from Discontinued                             -               -               -       (741,145)         463,216
  Operation
Loss on Disposal of Discontinued                            -               -               -     (1,478,082)
  Operation
Net Income (Loss)                                  $1,125,360      ($331,423)    ($3,042,767)    ($6,125,104)        $320,783




Income (Loss) from Continuing
  Operations per Common Share                           $0.13         ($0.04)         ($0.41)         ($0.54)         ($0.04)
Income (Loss) from Discontinued
  Operation                                              0.00            0.00            0.00          (0.10)            0.08
Loss on Disposal of Discontinued
  Operation                                              0.00            0.00            0.00          (0.20)            0.00
Net Income (Loss) per Common
  Share                                                 $0.13         ($0.04)         ($0.41)         ($0.84)           $0.05


Balance Sheet Data September 30,                     1996           1995            1994            1993            1992
                                                --------------- -------------- --------------- --------------- ---------------

Total Assets                                       $15,240,571    $12,358,132      $9,646,324     $12,108,270     $16,217.070
Working Capital                                      5,210,457      2,631,759       1,547,706       3,920,512       9,084,750
Long-Term Obligations                                  209,824        163,868         137,324         152,484          67,085
Shareholders' Equity                                $8,238,886     $6,062,170      $5,266,588      $8,086,154     $13,019,301

</TABLE>

    Data  for  all  years  has  been  retroactively   adjusted  to  reflect  the
    acquisition of WorkGroup which was accounted for as a pooling of interests.


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.

GENERAL




                                       15





         DATAWATCH CORPORATION (the "Company" or "DATAWATCH"), is engaged in the
design, development,  manufacture, marketing, consulting services and support of
personal computer software.

         On March 12, 1996, the Company acquired all of the outstanding  capital
stock  of  WorkGroup  Systems  Limited  ("WorkGroup"),  a United  Kingdom  based
provider of help-desk and asset management  software,  in exchange for 1,437,000
shares of the Company's common stock. This acquisition has been accounted for as
a pooling of  interests.  As a result,  DATAWATCH's  operating  results  for the
fiscal years ended September 30, 1996,  1995 and 1994, as discussed  herein have
been adjusted to include WorkGroup's operating results.

         On November 7, 1996 the Company acquired all the outstanding  shares of
capital stock of Guildsoft Limited ("Guildsoft"),  located in Plymouth, England,
which provides  software  companies with  multi-lingual  telesales,  support and
fulfillment  services  throughout  Europe,  in exchange  for  125,000  shares of
DATAWATCH common stock. This acquisition will be accounted for as a purchase.

         DATAWATCH's  principal products are:  Monarch(TM),  which provides data
access,  translation,  and  reporting  capability  to  users of  networked  PCs;
VIREX(R)  and VET( for the PC,  which  detect,  repair  and  monitor  for  virus
infections   for  Apple   Macintosh  and  IBM  compatible   PCs,   respectively;
Q-Support(TM)   for   Windows   (in   the   United   States),   or   Quetzal(TM)
(internationally)  or a  complete  help desk and asset  management  system;  and
netOctopus(TM), a network management and administration system.

RESULTS OF OPERATIONS

               FISCAL YEAR ENDED SEPTEMBER 30, 1996 AS COMPARED TO
               ---------------------------------------------------
                      FISCAL YEAR ENDED SEPTEMBER 30, 1995
                      ------------------------------------

         Net sales for the fiscal year ended September 30, 1996 were $30,022,000
which  represents  an  increase  of  $6,662,000  or 29%  from  the net  sales of
$23,360,000 for the fiscal year ended September 30, 1995. This increase  results
from growth in sales of all of DATAWATCH's products.  Monarch, which amounted to
approximately  41% of sales,  increased  by 14%;  Q-Support,  which  amounted to
approximately  39%  of  sales,  increased  by  51%;  Virex,  which  amounted  to
approximately 15% of sales, increased by 14%; and netOctopus,  which amounted to
approximately  4% of  sales,  increased  by  143%.  For the  fiscal  year  ended
September 30, 1996,  the Company's  products for the IBM compatible PC accounted
for  approximately  80% of sales while the  Company's  products for the Apple PC
accounted for approximately 20%. Revenues were reduced by approximately $400,000
for  the  fourth  quarter,  and  consequently  for  the  year,  as a  result  of
consultancy  revenue deferrals.  See Note 1 (Revenue  Recognition - Services and
Other) to Notes to Consolidated  Financial  Statements which appear elsewhere in
this Report on Form 10-K.

The  Company's  cost of sales for the fiscal year ended  September 30, 1996 were
$4,516,000 or approximately  15% of net sales. Cost of sales for the fiscal year
ended  September  30, 1995 were  $3,809,000 or  approximately  16% of net sales.
These costs  remained  reasonably  constant as a percentage of net sales for the
two periods.

    Engineering and product development  expenses were $2,339,000 for the fiscal
year ended September 30, 1996,  which increased by $119,000 or  approximately 5%
from  $2,220,000 for the fiscal year ended  September 30, 1995. This increase is
primarily  attributable to the increase in personnel  costs  associated with the
development and quality assurance for its products.

    Selling,  general and  administrative  expenses were  $22,039,000 for fiscal
year ended  September 30, 1996.  Included in these  expenses were  non-





                                       16





recurring  expenses  associated with the  acquisition of WorkGroup  amounting to
$450,000.   Excluding  these  non-recurring  expenses,   selling,   general  and
administrative  expenses were  $21,589,000 for the 1996 fiscal year resulting in
an increase of $3,939,000 or  approximately  22% from $17,650,000 for the fiscal
year ended  September  30,  1996.  This  increase is primarily  attributable  to
increases  in  personnel  within the sales and  marketing  organizations  and in
promotional expenses principally for Q-Support and Monarch.

    As a result of the  foregoing,  the net  income  for the  fiscal  year ended
September 30, 1996 was  $1,125,000,  an increase of $1,457,000  when compared to
the net loss of  $331,000  for the fiscal year ended  September  30,  1995.  The
Company  recorded  only  de  minimis  tax  provisions,   both  domestically  and
internationally,  during the  period  because  of its  ability  to  utilize  net
operating loss carryforwards.

               FISCAL YEAR ENDED SEPTEMBER 30, 1995 AS COMPARED TO
               ---------------------------------------------------
                      FISCAL YEAR ENDED SEPTEMBER 30, 1994
                      ------------------------------------

    Net sales for the fiscal  year ended  September  30,  1995 were  $23,360,000
which  represents  an  increase  of  $6,478,000  or 38%  from  the net  sales of
$16,882,000 for the fiscal year ended September 30, 1994. This increase  results
from sales growth in all of  DATAWATCH's  products.  Monarch,  which amounted to
approximately  46% of sales,  increased  by 66%;  Q-Support,  which  amounted to
approximately  33%  of  sales,  increased  by  41%;  Virex,  which  amounted  to
approximately 17% of sales, increased by 16%; and netOctopus,  which amounted to
approximately 2% of sales, increased by 26%. For the fiscal year ended September
30, 1995,  the  Company's  products  for the IBM  compatible  PC  accounted  for
approximately  80% of  sales  while  the  Company's  products  for the  Apple PC
accounted for approximately 20%.

    The  Company's  cost of sales for the fiscal year ended  September  30, 1995
were $3,809,000 or approximately  16% of net sales. Cost of sales for the fiscal
year ended September 30, 1994 were $3,253,000 or approximately 19% of net sales.
The decrease in cost of sales,  as a  percentage  of net sales,  is  principally
attributable to the higher volume of sales allowing for increased  absorption of
manufacturing overheads.

    Engineering and product development  expenses were $2,220,000 for the fiscal
year ended September 30, 1995 and $2,125,000 for the fiscal year ended September
30, 1994. Fiscal 1995 engineering and product development  expenses increased by
approximately  $95,000 or 4%. This  increase is  primarily  attributable  to the
increase  in  personnel  costs  associated  with  the  development  and  quality
assurance for its products.

    Selling,  general and  administrative  expenses were  $17,650,000 for fiscal
year ended  September 30, 1995.  These  expenses  increased by $3,071,000 or 21%
over the  $14,579,000 of selling,  general and  administrative  expenses for the
fiscal year ended September 30, 1994. Included in the 1994 expenses were certain
non-recurring   asset   write-offs,   relocation   costs   associated  with  the
consolidation  of certain of the Company's  operations into its headquarters and
non-recurring   product  marketing  expenses,  in  the  aggregate  amounting  to
approximately  $1,420,000.  Excluding these non-recurring expenses, the selling,
general and administrative expenses for the fiscal year ended September 30, 1995
increased by $4,491,000  or 34%.  This  increase can be attributed  primarily to
increased   promotional   costs,   principally  for  Monarch,   and  to  product
introduction  and selling expenses  associated with DATAWATCH's  newer products,
Q-Support and netOctopus.

    As a  result  of the  foregoing,  the net  loss for the  fiscal  year  ended
September 30, 1995 was $331,000  compared to the net loss of $3,043,000  for the
fiscal year ended September 30, 1994.


LIQUIDITY AND CAPITAL RESOURCES






                                       17







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, 1997 by funds currently  available and its unused  $1,500,000 bank
line of credit.  WorkGroup has an overdraft facility in place which allows it to
draw up to  approximately  $640,000.  The  facility  was  fully  utilized  as of
September 30, 1996. Working capital increased by approximately $2,579,000 during
fiscal  1996  primarily  as a result  of  profitable  operations  and cash  flow
generated  by  exercise  of the  Company's  outstanding  common  stock  purchase
warrants.  The Company  used its common  stock as  consideration  for its recent
acquisitions and, therefore,  completion of these acquisitions did not adversely
impact working capital.

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

CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS

         The  Company  does  not  provide  forecasts  of  its  future  financial
performance.  However,  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)  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 1996, Monarch,  Q-Support, Virex and netOctopus accounted for
approximately 41% and 39%, 15% and 4%, respectively, of the Company's net sales.
As a result, any factor adversely affecting sales of any of these products could
have a material  adverse effect on the Company.  The Company's  future financial
performance  




                                       18






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  results of
operations.

INTERNATIONAL SALES

         In 1996, 1995 and 1994, international sales accounted for approximately
47%,45%  and  49%,  respectively,  of  the  Company's  net  sales.  The  Company
anticipates that international  sales will continue to account for a significant
percentage  of its revenues.  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

         The Company has addressed  the need to develop new  products,  in part,
through the acquisition of other companies. Acquisitions such as WorkGroup, Pole
Position and Guildsoft  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. The combination of
such companies will require, among other things, coordination of their sales and
marketing  and  research  and  development  efforts.  The  difficulties  of such
integration  may be increased by the  necessity of  coordinating  geographically
separated  organizations.  The coordination of certain  operations  following an
acquisition  will  require  the  dedication  of  management  resources  that may
temporarily  distract attention from the day-to-day business of the Company. The
inability of management to  successfully  coordinate and integrate on an ongoing
basis the  operations  of  WorkGroup,  Pole  Position or  Guildsoft or any other
company which it may  subsequently  acquire could have a material adverse effect
on the business and results of operations of the Company.

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




                                       19





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  offering,  or that
technological  changes in hardware platforms or software  operating systems,  or
the introduction of a new product by a competitor, will not render the Company's
products obsolete.

COMPETITION IN THE PC SOFTWARE INDUSTRY

     The  software  market for  personal  computers  is highly  competitive  and
characterized by continual change and improvement in technology.  Several of the
Company's  existing  and  potential  competitors   (including  IBM  Corporation,
Microsoft,  McAfee  Associates, Inc., Remedy, Astea, Applix, Symantec Corp.  and
Ziff-Davis,   Inc.)  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.

INDIRECT DISTRIBUTION CHANNELS

    During 1996, 1995 and 1994, the Company derived  approximately  17%, 19% and
19%, respectivley,  of its net sales through resellers,  none of which are under
the direct




                                       20





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  13%, 10%, and 10% of the Company's  1996,  1995 and 1994 net
sales,  respectively,  no reseller or other customer accounted for more than 10%
of the Company's revenues in 1996, 1995 and 1994. 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 macroeconomics  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 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 Schedules" as a part of this report.

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,
1996. 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, 1996 is incorporated herein by reference.




                                       21






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, 1996 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, 1996 is incorporated herein
by reference.




                                       22





                                     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, 1996 and 1995

         Consolidated Statements of Operations for the Years Ended September 30,
         1996, 1995 and 1994.

         Consolidated  Statements  of  Changes in  Shareholders'  Equity for the
         Years Ended September 30, 1996, 1995 and 1994.

         Consolidated Statements of Cash Flows for the Years Ended September 30,
         1996, 1995 and 1994.

         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.    EXHIBITS

         The exhibits  listed in the Exhibit  Index  immediately  preceding  the
         Exhibits are filed as a part of this Annual Report on Form 10-K.

(b)      REPORTS ON FORM 8-K

         No current  report on Form 8-K was filed  during the  quarterly  period
ended September 30, 1996.




                                       23



<TABLE>
<CAPTION>


(C)                                EXHIBIT INDEX

<S>            <C> 
(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       Form of Warrant Agreement by and between the Registrant and Warrant Agent 
                (Exhibit 4.1)
(1)   4.2       Specimen certificate representing the Common Stock Purchase Warrants 
                (Exhibit 4.2)
(1)   4.3       Form of Representative's Warrant (Exhibit 4.3)
(1)   4.4       Specimen certificate representing the Common Stock (Exhibit 4.4)
(1)  10.1       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)
(2)  10.5       Software  Development and License  Agreement by and between Walter J. Biess
                and HJC Software,  Inc., dated as of May 25, 1989, as amended (Exhibit 10.2)
(2)  10.6       License  Agreement by and between Ross Greenberg and Microcom,  Inc., dated as
                of September 30, 1992 (Exhibit 10.3)
(2)  10.7       Asset Purchase  Agreement by and among Microcom,  Inc. and Microcom  Systems 
                and the Registrant,  dated as of September 30, 1992 (Exhibit 2.1)
(2)  10.8       Letter  Agreement by and between the Registrant and Microcom,  Inc.,  dated as 
                of September 30, 1992 (Exhibit 10.4)
(2)  10.9       Amended  and  Restated  Registration  Rights  Agreement,  dated as of  
                September  30,  1992 by and  among the Registrant and the parties listed therein 
                (Exhibit 10.5)
(1)  10.10      Software  Development and Marketing  Agreement by and between PERSONICS CORPORATION 
                and Raymond Huger, dated January  19, 1989 (Exhibit 10.12)
(1)  10.11      License  Agreement by and between  International  Business  Machines  
                Corporation and PERSONICS  CORPORATION, dated December 31, 1991 (Exhibit 10.16)
(1)  10.12      Software  Distribution  Agreement by and between  PERSONICS  CORPORATION and Librex 
                Computer  Systems,  Inc., dated March 12, 1991 (Exhibit 10.17)
(1)  10.13      Software License Agreement by an between M&H Consulting, dated June 1, 1987
                (Exhibit 10.13)
(4)  10.14      Software  Distribution  Agreement  by and  between  PERSONICS  CORPORATION  and
                Toshiba  America  Information Systems, Inc., dated March 19, 1993, as amended 
                (Exhibit 10.19)
(3)  10.15      Asset Purchase  Agreement by and between the  Registrant  and Secure Systems 
                Group,  dated as of May 14, 1993 (Exhibit 2.1)
(3)  10.16      Promissory  Note of Secure  Systems  Group to the  Registrant in the original
                principal  amount of $968,782, dated May 14, 1993 (Exhibit 10.1)
(3)  10.17      Promissory  Note of Secure  Systems Group to the Registrant in the original 
                principal  amount of $1,821,018, dated May 14, 1993 (Exhibit 10.2)
(3)  10.18      Security  Agreement  dated as of May 14, 1993 between  Secure  Systems Group 
                as debtor and the  Registrant as secured party (Exhibit 10.3)
(3)  10.19      Sublease  dated as of May 14,  1993  between  the  Registrant  as  sublandlord 
                and Secure  Systems  Group as subtenant (Exhibit 10.4)
(5)  10.20      Marketing  Agreement  dated May 1, 1994 between  WorkGroup  Systems Ltd. and 
                DATAWATCH  CORPORATION  (Exhibit 10.1)
(6)  10.21      Letter  Agreement  dated  November  1,  1994 by and among Silicon  Valley Bank,  
                Silicon  Valley Bank doing business under  the  name  Silicon  Valley  East,  
                DATAWATCH   CORPORATION  and PERSONICS CORPORATION (Exhibit 10.22)
(6)  10.22      Commercial  Security  Agreement  between  DATAWATCH  CORPORATION  and Silicon  Valley
                Bank doing  business as Silicon Valley East dated November 1, 1994 (Exhibit 10.23)



                                       24





(6)  10.23      Commercial  Security  Agreement  between  PERSONICS  CORPORATION  and Silicon  Valley
                Bank doing  business as Silicon Valley East dated November 1, 1994 (Exhibit 10.24)
(7)  10.24      Loan Modification Agreement dated November 1, 1995 between DATAWATCH  Corporation, 
                Personics Corporation and Silicon Valley Bank (Exhibit 10.24)
(8)  10.25      Executive Agreement between the Company and Andrew W. Mathews dated April       
                11, 1996 (Exhibit 10.1)
(8)  10.26      Executive Agreement between the Company and Marco D. Peterson dated April 11, 1996 
                (Exhibit 10.2)
(8)  10.27      Executive Agreement between the Company and Bruce R. Gardner dated April 11, 1996
                (Exhibit 10.3)
(8)  10.28      Executive Agreement between the Company and Thomas R. Foley dated April 11, 1996 
                (Exhibit 10.4)

     10.29      Loan Modification  Agreement dated October 31, 1996 between Datawatch  Corporation, 
                Personics  Corporation  and  Silicon  Valley  Bank (filed herewith).
     10.30      1996 Non-Employee Director Stock Option Plan, as amended on December 10, 1996 
                (filed herewith).
     10.31      1996 International Employee Non-Qualified Stock Option Plan (filed herewith).
     11.1       Statement re: computation of per share earnings (filed herewith)
     21.1       Subsidiaries of the Registrant (filed herewith)
     23.1       Consent of Independent Auditors (filed herewith)
     27         Financial Data Schedule (filed with EDGAR Submission only)
</TABLE>

------------------------------
(1)      Previously filed as exhibits 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 exhibits to Registrant's Current Report on Form 8-K
         dated  September  30,  1992,  filed  October 14, 1992 and  incorporated
         herein by reference  (the number  given in  parenthesis  indicates  the
         corresponding exhibit in such Form 8-K).

(3)      Previously filed as exhibits to Registrant's Current Report on Form 8-K
         dated May 14,  1993,  filed  May 28,  1993 and  incorporated  herein by
         reference (the number given in parenthesis  indicates the corresponding
         exhibit in such Form 8-K).

(4)      Previously  filed as an exhibit to  Registrant's  Annual Report on Form
         10-K for the Fiscal  Year ended  September  30,  1993 and  incorporated
         herein by reference  (the number  given in  parenthesis  indicates  the
         corresponding exhibit in such Form 10-K).

(5)      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).

(6)      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).

(7)      Previously  filed as an exhibit to  Registrant's  Annual Report on Form
         10-K for the Fiscal  Year ended  September  30,  1995 and  incorporated
         herein by reference  (the number  given in  parenthesis  indicates  the
         corresponding exhibit in such Form 10-K).

(8)      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).




                                       25





(D)      FINANCIAL STATEMENT SCHEDULES

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







                                       26






                                   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 26, 1996               By:  /s/Thomas R. Foley
       --------------------                 ----------------------------------
                                            Thomas R. Foley
                                            President, Chief Executive Officer 
                                            and Director
                                            (Principal Executive Officer)

         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.

<TABLE>
<CAPTION>

Signature                                            Title                      Date
---------                                            -----                      ----

<S>                                       <C>                                 <C> 
/s/Thomas R. Foley                          President, Chief Executive          December 26, 1996
------------------------------------
Thomas R. Foley                             Officer and Director


/s/Bruce R. Gardner                         Executive Vice President            December 26, 1996
------------------------------------
Bruce R. Gardner                            and Treasurer, and Director
(Principal Financial
 and Accounting Officer)


/s/John A. Blaeser                          Director                            December 26, 1996
------------------------------------
John A. Blaeser


/s/Jerome Jacobson                          Director                            December 26, 1996
------------------------------------
Jerome Jacobson


/s/David Riddiford                          Director                            December 26, 1996
------------------------------------
David Riddiford


</TABLE>



                                       27






--------------------------------------------------------------------------------
DATAWATCH CORPORATION 
AND SUBSIDIARIES

Consolidated  Balance Sheets as of September 30, 1996 and 1995 and  Consolidated
Statements of Operations,  Changes in Shareholders'  Equity,  and Cash Flows for
the Years Ended  September  30, 1996,  1995 and 1994 and  Independent  Auditors'
Report







DATAWATCH CORPORATION AND SUBSIDIARIES

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


                                                                      PAGE

INDEPENDENT AUDITORS' REPORT                                            1

CONSOLIDATED FINANCIAL STATEMENTS AS OF SEPTEMBER 30, 1996
   AND 1995 AND FOR THE THREE YEARS IN THE PERIOD ENDED
   SEPTEMBER 30, 1996:

   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                         6-15








INDEPENDENT AUDITORS' REPORT


Board of Directors and Shareholders
Datawatch Corporation
Wilmington, Massachusetts

We have  audited  the  accompanying  consolidated  balance  sheets of  Datawatch
Corporation and  subsidiaries as of September 30, 1996 and 1995, 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, 1996.  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,  1996 and  1995,  and the  results  of their
operations  and their cash flows for each of the three years in the period ended
September 30, 1996, 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.

As  described  in  Note  2  to  the  consolidated   financial  statements,   the
consolidated  financial statements have been restated to give retroactive effect
to the March 12, 1996 merger of  Datawatch  Corporation  and  WorkGroup  Systems
Limited, which has been accounted for as a pooling-of-interests.


                                                  /s/ Deloitte & Touche LLP

November 25, 1996




                                      -1-




<TABLE>
<CAPTION>


DATAWATCH CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 1996 AND 1995
------------------------------------------------------------------------------------


ASSETS                                                    1996            1995      

<S>                                                    <C>           <C>
CURRENT ASSETS:                                                                     
  Cash and equivalents                                $   1,696,349   $     876,802 
  Short-term investments                                    792,665         885,659 
  Accounts receivable, less allowance for doubtful                                  
   accounts and sales returns of $73,000 in 1996                                    
   and $83,000 in 1995                                    7,767,748       5,230,685  
  Inventories                                               480,758         262,528
  Prepaid advertising and other expenses                  1,264,798       1,508,179  
                                                          ---------       ---------

           Total current assets                          12,002,318       8,763,853  
                                                          ---------       ---------

PROPERTY AND EQUIPMENT:                                                             
  Office furniture and equipment                          3,174,964       2,490,719
  Manufacturing and engineering equipment                   359,795         246,247 
                                                          ---------       ---------

                                                          3,534,759       2,736,966  
  Less accumulated depreciation                                                     
    and amortization                                     (1,737,733)     (1,197,419)  
                                                          ---------       ---------
                                                                                    
           Net property and equipment                     1,797,026       1,539,547  
                                                          ---------       ---------
OTHER ASSETS                                                400,062         596,990
                                                          ---------       ---------
                                                                                    
EXCESS OF COST OVER NET ASSETS OF
  ACQUIRED COMPANIES - Less accumulated
    amortization of $1,877,461 in 1996 and
    $1,452,990 in 1995                                    1,041,165       1,457,742
                                                          ---------       ---------

                                                     $   15,240,571  $   12,358,132    
                                                     ==============  ==============    

</TABLE>

<TABLE>
<CAPTION>



---------------------------------------------------------------------------------     
                                                                                      
                                                                                      
  LIABILITIES AND SHAREHOLDERS' EQUITY                1996            1995            
                                                                                      
  CURRENT LIABILITIES:                                                                
<S>                                                <C>             <C>                
    Accounts payable                               $     2,914,952 $     2,718,825    
    Accrued expenses                                     1,063,129       1,815,419   
    Deferred revenue                                     1,946,473       1,314,655   
    Borrowings under credit lines                          636,806          81,847 
    Current portion of long-term obligations               230,501         201,348  
                                                         ---------       ---------   

             Total current liabilities                   6,791,861       6,132,094   
                                                         ---------       ---------   
                                                                                      
  LONG-TERM OBLIGATIONS                                    209,824         163,868  
                                                         ---------       ---------   
                                                                                      
  COMMITMENTS                                                                         
                                                                                      
  SHAREHOLDERS' EQUITY:                                                               
    Common stock, par value $.01; authorized,                                         
    20,000,000 shares; issued and                                                     
    outstanding, 8,965,988 shares in 1996                                             
    and 8,629,135 shares in 1995                           89,659           86,291   
    Additional paid-in capital                         18,665,402       17,614,360    
    Accumulated deficit                               (10,538,117)     (11,663,477)   
    Cumulative translation adjustment                      21,942           24,996 
                                                         ---------       ---------   
                                                                                       
            Total shareholders' equity                  8,238,886        6,062,170   
                                                                                      
                                                                                      
                                                                                      
                                                         ---------       ---------   
                                                                                      
                                                                                      
                                                   $   15,240,571   $   12,358,132     
                                                   ==============   ==============     
                                                                                      
</TABLE>
                                                                                
                                                                                
 See notes to consolidated financial statements.                               



                                      -2-





<TABLE>
<CAPTION>

DATAWATCH CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED SEPTEMBER 30, 1996, 1995 AND 1994
------------------------------------------------------------------------------------------------------------------------


                                                                         1996               1995                1994

<S>                                                              <C>                 <C>                <C>      
NET SALES                                                          $  30,022,122       $  23,359,981      $  16,882,142

COSTS AND EXPENSES:
  Cost of sales                                                        4,516,456           3,808,995          3,253,036
  Engineering and product development                                  2,338,724           2,219,930          2,124,655
  Selling, general and administrative                                 22,039,420          17,650,010         14,578,885
                                                                   -------------       -------------      -------------

INCOME (LOSS) FROM OPERATIONS                                          1,127,522            (318,954)        (3,074,434)

INTEREST EXPENSE                                                         (96,184)            (75,449)           (19,914)

OTHER INCOME - Primarily interest                                         49,162              67,688             65,178

FOREIGN CURRENCY TRANSACTION GAINS                                        11,860              23,292             17,403

BENEFIT (PROVISION ) FOR INCOME TAXES                                     33,000             (28,000)           (31,000)
                                                                   -------------       -------------      -------------

NET INCOME (LOSS)                                                 $    1,125,360      $     (331,423)     $  (3,042,767)
                                                                  ==============      ==============      ============= 

NET INCOME (LOSS) PER SHARE                                       $         0.13      $        (0.04)     $       (0.41)
                                                                  ==============      ==============      ============= 

WEIGHTED AVERAGE NUMBER OF
  COMMON AND COMMON EQUIVALENT
  SHARES OUTSTANDING                                                   8,943,862           8,204,502          7,372,946
                                                                  ==============      ==============      ============= 

See notes to consolidated financial statements.

</TABLE>



                                      -3-





<TABLE>
<CAPTION>

DATAWATCH CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
YEARS ENDED SEPTEMBER 30, 1996, 1995 AND 1994
-----------------------------------------------------------------------------------------------------------------------------------

                                                                                 Additional                  Cumulative
                                                             Common Stock         Paid-in    Accumulated     Translation
                                                          Shares       Amount     Capital      Deficit       Adjustments      Total


<S>                                                   <C>        <C>         <C>          <C>             <C>         <C>        
BALANCE, OCTOBER 1, 1993, As previously reported        5,919,670  $   59,197  $16,316,478  $ (8,652,605)   $ (3,050)   $ 7,720,020

  Adjustment for pooling-of-interest of  WorkGroup      1,437,000      14,370      147,348       204,397          19        366,134
                                                        ---------  ----------  -----------  ------------    --------    -----------

BALANCE, OCTOBER 1, 1993, As restated                   7,356,670      73,567   16,463,826    (8,448,208)     (3,031)     8,086,154

  Common stock options exercised                           22,086         220       14,585                                   14,805

  Translation adjustment                                                                                      49,475         49,475

  Adjustment to change fiscal year of WorkGroup                                                  158,921                    158,921

  Net loss                                                                                    (3,042,767)                (3,042,767)
                                                        ---------  ----------  -----------  ------------    --------    -----------

BALANCE, SEPTEMBER 30, 1994                             7,378,756      73,787   16,478,411   (11,332,054)     46,444      5,266,588

  Common stock options exercised                           97,039         970       71,123                                   72,093

  Warrants exercised, net of offering costs             1,153,340      11,534    1,064,826                                1,076,360

  Translation adjustment                                                                                     (21,448)       (21,448)

  Net loss                                                                                      (331,423)                  (331,423)
                                                        ---------  ----------  -----------  ------------    --------    -----------

BALANCE, SEPTEMBER 30, 1995                             8,629,135      86,291   17,614,360   (11,663,477)     24,996      6,062,170

  Common 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
                                                        =========  ==========  ===========  ============     =======    ===========


See notes to consolidated financial statements.


</TABLE>



                                      -4-


<TABLE>
<CAPTION>



DATAWATCH CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED SEPTEMBER 30, 1996, 1995 AND 1994
-------------------------------------------------------------------------------------------------------------------------

                                                                                    1996            1995            1994

CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                                         <C>             <C>           <C>            
  Net income (loss)                                                         $     1,125,360 $    (331,423)$   (3,042,767)
  Adjustments to reconcile net income (loss) to net cash used in
    operating activities:
      Adjustment to change fiscal year of WorkGroup                                               158,921
      Depreciation and amortization                                               1,223,162       975,254        936,817
      Write-off of assets under contractual obligation                                                         1,104,961
      Changes in current assets and liabilities:
        Inventories                                                                (218,230)      (20,900)       101,409
        Prepaid advertising and other expenses                                      243,381      (641,303)       364,189
        Accounts receivable                                                      (2,537,062)   (1,819,261)      (746,605)
        Accounts payable and accrued expenses                                      (567,112)      914,894        869,708
        Deferred revenue                                                            631,818       581,524       (244,071)
                                                                             -------------- -------------   ------------

           Net cash used in operating activities                                    (98,683)     (182,294)      (656,359)
                                                                             -------------- -------------   ------------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Additions to equipment and fixtures - net                                        (564,129)     (381,298)      (247,063)
  Payment received on asset held under contractual obligation                                                    123,131
  Proceeds from sale of short-term investments                                    2,312,478       676,733      3,977,694
  Purchase of short-term investments                                             (2,219,484)   (1,562,392)    (1,984,033)
  Other assets                                                                       25,571      (393,006)      (193,442)
                                                                             -------------- -------------   ------------

           Net cash (used in) provided by investing activities                     (445,564)   (1,659,963)     1,676,287
                                                                             -------------- -------------   ------------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Net proceeds from issuance of common stock                                      1,054,410     1,148,453         14,805
  Principal payments on long-term obligations                                      (245,575)     (136,833)      (332,418)
  Borrowings under credit lines - net                                               554,959        81,847
  Proceeds from equipment financing agreement                                                                     64,636
                                                                             -------------- -------------   ------------

           Net cash provided by (used in) financing activities                    1,363,794     1,093,467       (252,977)
                                                                             -------------- -------------   ------------

NET INCREASE (DECREASE)  IN CASH AND EQUIVALENTS                                    819,547      (748,790)       766,951

CASH AND EQUIVALENTS, BEGINNING OF YEAR                                             876,802     1,625,592        858,641
                                                                             -------------- -------------   ------------

CASH AND EQUIVALENTS, END OF YEAR                                            $    1,696,349 $     876,802   $  1,625,592
                                                                             -------------- -------------   ------------

SUPPLEMENTAL INFORMATION:
  Interest paid                                                              $       96,184 $      75,449   $     19,914
                                                                             -------------- -------------   ------------

  Income taxes paid                                                          $       78,922 $           0   $          0
                                                                             -------------- -------------   ------------

NONCASH INVESTING AND FINANCING ACTIVITIES - Equipment
  acquired under capital lease agreements                                    $      320,684 $     259,713   $    168,202
                                                                             -------------- -------------   ------------

See notes to consolidated financial statements.

</TABLE>


                                      -5-








DATAWATCH CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 1996, 1995 AND 1994
--------------------------------------------------------------------------------

1.    NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

      NATURE  OF  BUSINESS  -  Datawatch   Corporation   and  its  wholly  owned
      subsidiaries,  Personics Corporation ("Personics"), Pole Position Software
      GmbH  ("Pole  Position")  and  WorkGroup  Systems  Limited   ("WorkGroup")
      (collectively,  the "Company")  develop,  market and  distribute  personal
      computer  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 financial statements are consolidated to
      include  the  accounts  of  Datawatch  Corporation  and its  wholly  owned
      subsidiaries.  All significant intercompany balances and transactions have
      been eliminated in consolidation.  The accompanying consolidated financial
      statements  have  been  restated  to  give   retroactive   effect  to  the
      pooling-of-interests of WorkGroup on March 12, 1996 (see Note 2). The term
      "Datawatch,"  as used  herein,  refers to  Datawatch  Corporation  and its
      wholly owned subsidiaries prior to the  pooling-of-interests of WorkGroup.
      WorkGroup's  fiscal year end had historically  ended on December 31, while
      Datawatch's  fiscal year had ended on September 30.  Effective  January 1,
      1995,  WorkGroup changed its fiscal year end from December 31 to September
      30. Accordingly,  the accompanying  consolidated  financial statements for
      the  fiscal  year  ended  September  30,  1994  combine   information  for
      Datawatch's  fiscal year ended September 30, 1994 with WorkGroup's  fiscal
      year ended December 31, 1994.

      Due to the  different  fiscal  year ends of the  combined  companies,  the
      results of WorkGroup  for the three months ended  December 31, 1994,  have
      been included in the consolidated  statements of operations for both years
      ended  September  30, 1995 and 1994.  WorkGroup's  net sales for the three
      months ended December 31, 1994 were approximately $1,471,000.  WorkGroup's
      net loss for the three  months ended  December 31, 1994 was  approximately
      $159,000  and has  been  included  as an  adjustment  in the  consolidated
      statement of changes in shareholders' equity.

      REVENUE  RECOGNITION - Software - Revenues from sales of software products
      are  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 30-60 days from the date of  purchase.  Software  products
      sold directly to end-users  include a guarantee under which such customers
      may return products  within 60 days for a full refund.  During each of the
      three years in the period ended  September  30, 1996,  returns under these
      warranty and guarantee arrangements were not material.

      REVENUE  RECOGNITION  -  Services  and Other -  Revenues  from the sale of
      annual  subscription  agreements  to provide  upgrades  for minor  product
      improvements  and new virus  protection  are deferred at the time of sale.
      Revenues from the sale of separate consulting  agreements to provide field
      service  support  are  also  deferred  at the time of  sale.  The  Company
      recognizes  its revenue on these  agreements  ratably over a  twelve-month
      period.



                                      -6-






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

      REVENUE  RECOGNITION  - Services  and Other  (Continued)  - Revenues  from
      consulting  services  performed  in  connection  with the sale of  bundled
      products and services  (principally at the Company's WorkGroup subsidiary)
      are  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) and the
      cost of such  services  are  estimable.  If  consulting  services  are not
      expected to be provided  within a short  period of time after the shipment
      of the related  product,  such  revenues are deferred  and  recognized  as
      revenue as the services are  provided.  Prior to July 1996,  substantially
      all of the Company's bundled consulting  services were expected to be, and
      were,  provided  within a short  period of time after the  shipment of the
      related  product.  For shipments  made in and subsequent to July 1996, the
      Company has determined that, due to changes in the volume of the Company's
      sales,  as well as the increased  complexity  in the  Company's  products,
      bundled  consulting  services may not be provided within a short period of
      time after the shipment of the related product and, accordingly,  revenues
      from such consulting services are being deferred and recognized as revenue
      as the services are provided.

      CASH AND  EQUIVALENTS - Cash and  equivalents  includes cash on hand, cash
      deposited  with banks and highly  liquid debt  securities  with  remaining
      maturities of 90 days or less when purchased.

      SHORT-TERM  INVESTMENTS - Short-term  investments consist of United States
      Treasury  Bills  with  relatively  short-term  maturities  for  which  the
      carrying value approximates market.

      OTHER  ASSETS - At  September  30, 1996 and 1995,  other  assets  included
      approximately   $21,000  and   $81,000,   respectively,   of   unamortized
      capitalized software products resulting from acquisitions. Amortization is
      provided over estimated  lives of 1 to 5 years on a  straight-line  basis.
      Amortization  was  approximately  $60,000 in 1996 and 1995 and $177,000 in
      1994.

      Copyright-related  costs  accounted  for  the  majority  of the  remaining
      balance.  These costs are being  amortized on a basis  consistent with the
      capitalized software products mentioned above.

      ADVERTISING AND PROMOTIONAL  MATERIALS - Advertising costs are expensed as
      incurred  and amounted to  approximately  $917,000 in 1996 and $640,000 in
      1995 and  $1,170,000  in  1994.  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  3 to 4
      months  from  the  date  of  the   mailing).   Direct  mail   expense  was
      approximately  $3,970,000 in 1996,  $4,000,000  in 1995 and  $2,680,000 in
      1994.

      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 13% of net sales in 1996 and 10% of
      net sales in both 1995 and 1994.  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 or market.  Cost is  determined  using the
      first-in, first-out method.




                                      -7-







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

      PROPERTY AND EQUIPMENT - Purchased  equipment and fixtures are recorded at
      cost.  Leased  equipment  is recorded at the present  value of the minimum
      lease  payments   required  during  the  lease  term.   Depreciation   and
      amortization  are  provided  using  the  straight-line   method  over  the
      estimated  useful  lives of the  related  assets  and over the  terms,  if
      shorter, of the related leases.  Useful lives and lease terms range from 3
      to 7 years.

      INCOME  TAXES - The Company  adopted  Statement  of  Financial  Accounting
      Standards  ("SFAS")  No. 109,  "Accounting  for Income  Taxes,"  effective
      October  1,  1993.  There  was no  cumulative  effect  adjustment  for the
      adoption of the new statement and prior financial statements have not been
      restated.  Prior to this  time,  the  Company  accounted  for taxes  under
      Accounting Principles Board ("APB") No. 11.

      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 income (defined
      as operating cash flow less  depreciation and  amortization)  from related
      operations  will be less than the  carrying  amount of the  excess of cost
      over net assets of acquired companies.

      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
      financial  statements  and the  reported  amounts of revenue and  expenses
      during the  reporting  period.  Actual  results  could  differ  from those
      estimates.

      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 amount of the Company's
      current and long-term obligations approximate fair value.

      POOLING-OF-INTERESTS   -  All  share   and  per   share   data  have  been
      retroactively adjusted to reflect the pooling-of-interests of WorkGroup.

      NET INCOME PER COMMON SHARE - Net income per common share is computed upon
      the  weighted  average  number  of common  and  common  equivalent  shares
      outstanding during each period presented after retroactive  adjustment for
      the  pooling-of-interests.  Common stock  equivalents  consist of dilutive
      stock options and common stock warrants.

      FOREIGN   CURRENCY   TRANSACTIONS  -  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.

      FOREIGN  CURRENCY  TRANSLATIONS  - 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.

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



                                      -8-







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

      ACCOUNTING  FOR  LONG-LIVED  ASSETS - The Financial  Accounting  Standards
      Board ("FASB") has issued SFAS No. 121,  "Accounting for the Impairment of
      Long-Lived  Assets  and for  Long-Lived  Assets to Be  Disposed  Of." This
      statement   establishes   accounting   standards  for  the  impairment  of
      long-lived assets, certain identifiable intangibles,  and goodwill related
      to those assets to be held and used and for long-lived  assets and certain
      identifiable  intangibles  to be  disposed  of. The Company  adopted  this
      standard in fiscal 1996.  The  adoption did not have a material  effect on
      the Company's consolidated financial position or results of operations.

      ACCOUNTING FOR STOCK-BASED COMPENSATION - In October 1995, the FASB issued
      SFAS  No.  123,  "Accounting  for  Stock-Based   Compensation,"  which  is
      effective  for the  Company's  fiscal year 1997.  This  standard  requires
      expanded  disclosures  of  stock-based   compensation   arrangements  with
      employees and encourages (but does not require)  compensation  costs to be
      measured based on the fair value of stock options awarded. The Company has
      evaluated this standard and, as permitted  under SFAS No. 123, has decided
      that it will not adopt the fair value method and will  continue to use APB
      No.  25 for  the  measurement  and  recognition  of  employee  stock-based
      transactions.  As a result,  compliance  with this standard  during fiscal
      1997  will have no impact on the  Company's  1997  consolidated  financial
      statements other than the required additional  disclosure of the pro forma
      effect of SFAS No. 123 on net income and earnings per share.

2.    POOLING-OF-INTERESTS

      On March 12, 1996, the Company  acquired all of the outstanding  shares of
      capital  stock of  WorkGroup  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  has been
      accounted for as a pooling-of-interests and, accordingly, the consolidated
      financial  statements  have been  restated  to include  the  accounts  and
      operations  of WorkGroup for all periods  presented.  Costs related to the
      pooling-of-interests of $450,000 were expensed during fiscal 1996.

      Net sales and net income  (loss) of the separate  companies  for the years
      ended September 30 were as follows:





<TABLE>
<CAPTION>

                                        1996                1995               1994
Net sales:
<S>                            <C>                  <C>                <C>          
  Datawatch                    $   20,008,921       $  16,633,288      $  11,521,444
  WorkGroup                        10,389,664           7,034,639          5,412,058
  Eliminations                       (376,463)           (307,946)           (51,360)
                               --------------       -------------      ------------- 

Combined                       $   30,022,122       $  23,359,981      $  16,882,142
                               ==============       =============      =============

Net income (loss):
  Datawatch                    $    1,461,556       $     818,345      $  (3,285,562)
  WorkGroup                          (327,463)         (1,075,482)           277,967
  Eliminations                         (8,733)            (74,286)           (35,172)
                               --------------       -------------      ------------- 

Combined                       $    1,125,360       $    (331,423)     $  (3,042,767)
                               ==============       =============      ============= 

</TABLE>


                                      -9-








2.    POOLING-OF-INTERESTS (CONTINUED)

      On November 21, 1996,  the Company  redeemed  32,052 shares of the 143,698
      escrowed  shares in connection  with the  settlement of certain  WorkGroup
      contingent liabilities.

      As of September 30, 1995,  the Company  acquired Pole  Position,  a German
      software developer, in exchange for 300,000 shares of the Company's common
      stock.  The acquisition has been accounted for as a  pooling-of-interests.
      Costs related to the  pooling-of-interests of $70,208 were expensed during
      fiscal 1995.

3.    INVENTORIES

      Inventories consisted of the following at September 30:


                                               1996            1995

Raw materials                              $  218,615      $  198,917
Work in process                                 2,458           2,974
Finished goods                                259,685          60,637
                                              -------          ------

Total                                      $  480,758      $  262,528
                                           ==========      ==========



4.    ACCRUED EXPENSES

      Accrued expenses consisted of the following at September 30:


                                                  1996              1995
                                                  ----              ----
Accrued salaries and benefits             $     222,921     $     600,707
Accrued royalties and commissions               491,960           489,778
Accrued legal and accounting                    142,758           200,145
Accrued rent and property taxes                  80,487           124,373
Other                                           125,003           400,416
                                                -------           -------

Total                                     $   1,063,129     $   1,815,419
                                          =============     =============


5.    COMMITMENTS AND OBLIGATIONS

      Leases  -  The  Company  leases  various  facilities  under  noncancelable
      operating leases which expire through 2000. 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 certain  facilities for an additional five years  commencing
      in  2000.  Rental  expense  for all  operating  leases  was  approximately
      $851,000,  $714,000 and $650,000 for the years ended  September  30, 1996,
      1995 and 1994, respectively.





                                      -10-







5.    COMMITMENTS AND OBLIGATIONS (CONTINUED)

      As of September 30, 1996,  minimum  rental  commitments  under capital and
      noncancelable operating leases are as follows:


YEAR ENDING                                            CAPITAL         OPERATING
SEPTEMBER 30                                            LEASES            LEASES
 
1997                                                $  263,950      $    913,379
1998                                                   174,496           812,949
1999                                                    69,692           609,443
2000                                                                     449,155
                                                    ----------      ------------
Total minimum lease payments                           508,138      $  2,784,926
                                                                    ============
Less amount representing interest                       67,813
                                                    ----------
Present value of minimum lease payments                440,325

Less current portion                                   230,501
                                                    ----------
Long-term obligations                               $  209,824
                                                    ==========



      The cost and the related  accumulated  amortization  of  equipment  leased
      under capital lease agreements was approximately  $958,000 and $448,000 at
      September 30, 1996,  respectively,  and $640,000 and $225,000 at September
      30, 1995,  respectively.  Amortization expense was $224,000,  $142,000 and
      $104,000  for  the  years  ended   September  30,  1996,  1995  and  1994,
      respectively.

      ROYALTIES - The Company is also committed to pay royalties relating to the
      sales of software products.  Royalty expense was approximately $1,900,000,
      $1,630,000 and $1,300,000 for the years ended September 30, 1996, 1995 and
      1994, respectively.

6.    LINE OF CREDIT

      The  Company's  line of credit with a bank expired on October 31, 1996 and
      was extended to October 30, 1997. The extended line of credit was modified
      to  provide  for  maximum  borrowings  up to the lesser of  $1,500,000  or
      50%-75% of defined eligible accounts receivable. Borrowings under the line
      are collateralized by substantially all assets of the Company. Outstanding
      borrowings  will bear  interest  at the bank's  prime rate plus 1.0%.  The
      agreement  requires  compliance with certain financial and other covenants
      which  specify,  among  other  things,   dividend  restrictions,   certain
      quarterly  profitability  levels,  a  minimum  tangible  capital  base (as
      defined),  and minimum leverage and liquidity  levels. As of September 30,
      1996, there were no outstanding borrowings under the line of credit.

      The Company has an  additional  line of credit  facility  with a U.K. bank
      which provides for borrowings up to  approximately  $640,000.  Outstanding
      borrowings  are payable on demand and bear interest at the prime rate plus
      3.0% on  borrowings  up to  $160,000  and at prime  plus 6% on any  excess
      borrowings.  The agreement requires  compliance with certain financial and
      other  covenants.  Amounts  due  to  the  bank  under  this  facility  are
      approximately  $637,000  and  $82,000  at  September  30,  1996 and  1995,
      respectively.




                                      -11-







7.    INCOME TAXES

      INCOME  TAXES  -  At  September  30,  1996,   the  Company  had  available
      approximately $6,000,000 of regular tax loss carryforwards for federal and
      state  purposes  (approximately  $2,000,000  of which  may be  subject  to
      limitations under certain federal and state income tax regulations)  which
      commence  expiring in 2007. An alternative  minimum tax credit of $119,000
      at  September  30, 1996 is available  for offset  against  future  regular
      federal taxes.  Research and development  credits of $196,000 at September
      30, 1996 expire in 2005.

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

<TABLE>
<CAPTION>

                                                              1996               1995
<S>                                                  <C>                 <C>           
Deferred tax liabilities:
   Depreciation and amortization                     $        28,174     $      112,946
   Other                                                      20,041              7,987
                                                          ----------         ---------- 

                                                              48,215            120,933
Deferred tax assets:
   Inventory reserves                                         69,947             71,856
   Accounts and notes receivable reserves                    184,063            112,421
   Net operating loss carryforwards                        2,430,356          3,364,401
   Research and development credits                          195,817            195,817
   Alternative minimum tax credits                           119,000             89,000
                                                          ----------         ---------- 

                                                           2,950,968          3,712,562

Valuation allowance                                       (2,950,968)        (3,712,562)
                                                          ----------         ---------- 

Deferred taxes, net                                  $             0     $            0
                                                     ===============     ==============

</TABLE>

      The Company has experienced  significant losses prior to fiscal year 1996.
      Accordingly,  management  believes  the tax  benefits  do not  satisfy the
      realization  criteria  set  forth  in SFAS  No.  109 and  has  recorded  a
      valuation  allowance for the entire net tax asset. The valuation allowance
      decreased  by  approximately  $762,000  and  $185,000  in 1996  and  1995,
      respectively.

      The following  reconciles the Company's  effective tax rate to the federal
      statutory  rate of 34% for the years ended  September  30, 1996,  1995 and
      1994:

<TABLE>
<CAPTION>
                                                                  1996            1995                 1994

<S>                                                           <C>              <C>               <C>          
Taxes (benefit) at federal statutory rate                     $  372,000       $ (103,000)       $ (1,024,000)
Utilization of net operating loss carryforwards                 (507,000)        (287,000)           (105,000)
Net operating loss carryforwards not recognized                  133,000          365,000           1,117,000
Other                                                            (61,000)          28,000              43,000
Alternative minimum tax                                           30,000           25,000
                                                                  ------           ------           ---------
Provision (benefit) for income taxes                          $  (33,000)      $   28,000        $     31,000
                                                              ==========       ==========        ============

</TABLE>


                                      -12-







8.    SHAREHOLDERS' EQUITY

      STOCK  OPTIONS  - Under  the  Company's  1987  Stock  Plan  (the  "Plan"),
      nonqualified  and  incentive  stock options to purchase up to a maximum of
      790,791  shares  of common  stock may be  granted  to  certain  employees,
      officers, consultants and directors, at exercise prices not less than fair
      market  value at the date of the  grant.  Options  become  exercisable  as
      specified  at the date of grant and  generally  expire  ten years from the
      date of grant.

      The Company has also adopted the 1996  Non-Employee  Director Stock Option
      Plan that provides for the award of up to 72,000 shares.

      The following table summarizes option activity:


                                                                 Exercise
                                                                   Price
                                                    Shares       Per Share

Outstanding, October 1, 1993                       467,826     $0.44 - 4.00
    Granted                                        300,250      1.00 - 1.50
    Canceled                                      (296,500)     0.73 - 4.00
    Exercised                                      (22,086)     0.44 - 0.73
                                                 ----------

Outstanding, September 30, 1994                    449,490      0.73 - 2.75
    Granted                                          9,000      2.47 - 3.44
    Canceled                                       (41,832)     1.00 - 2.75
    Exercised                                      (97,039)     0.73 - 1.00
                                                 ----------

Outstanding, September 30, 1995                    319,619      0.73 - 3.44
    Granted                                        181,000      4.63 - 10.13
    Canceled                                        (7,667)     3.44 - 5.00
    Exercised                                     (217,411)     0.73 - 3.44
                                                 ----------
Outstanding, September 30, 1996                    275,541      1.00 - 10.13
                                                 ==========
Exercisable, September 30, 1996                     13,626
                                                 ==========




      The Company has reserved  292,201 shares of common stock for issuance upon
      exercise of stock options and stock purchase warrants (see Note 9).

      PREFERRED STOCK - The Company is authorized to issue  1,000,000  shares of
      preferred stock with a par value of $.01 per share. No shares of preferred
      stock were outstanding at September 30, 1996 and 1995.



                                      -13-







9.    STOCK PURCHASE WARRANTS

      In connection with its initial public offering in 1992, the Company issued
      warrants to purchase shares of common stock (the "Warrants"), expiring May
      28, 1996,  subject to earlier  redemption  by the Company,  at an exercise
      price of $7.50 per share.

      In June 1994, the Company's  Board of Directors  (the "Board")  approved a
      proposal to reduce the exercise price of each Warrant exercised during the
      period from October 3, 1994 to December  12,  1994.  On December 12, 1994,
      the Board  extended  the period to  February  10,  1995.  Pursuant to this
      offer,  1,066,540  Warrants had been  exercised as of September  30, 1995,
      providing a net aggregate of $1,076,360 cash  consideration.  During 1996,
      119,442  Warrants  were  exercised,  providing a net aggregate of $848,972
      cash consideration, and 64,019 Warrants expired. As of September 30, 1996,
      all Warrants have either been exercised or have expired.

10.   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
      1996, 1995 or 1994.

11.   SEGMENT INFORMATION

      Summarized  information about the Company's  operations by geographic area
      is as follows:

<TABLE>
<CAPTION>

                                                                   United
                                              Domestic             Kingdom         Eliminations          Total

<S>                                      <C>                  <C>                <C>              <C>
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


YEAR ENDED SEPTEMBER 30, 1995
Net sales                                      16,425,189           7,242,738          (307,946)        23,359,981
Income (loss) from operations                     945,860          (1,190,528)          (74,286)          (318,954)
Identifiable assets                             9,918,844           2,551,838          (112,550)        12,358,132


YEAR ENDED SEPTEMBER 30, 1994
Net sales                                      11,124,226           5,809,276           (51,360)        16,882,142
Income (loss) from operations                  (3,292,851)            253,589           (35,172)        (3,074,434)
Identifiable assets                             7,354,952           2,317,965           (26,593)         9,646,324


</TABLE>

      WorkGroup's  revenue and loss from  operations  for the three months ended
      December 31, 1994 of $1,471,000 and  ($159,000),  respectively,  have been
      included  in the  United  Kingdom  amounts  above  for  both  years  ended
      September 30, 1995 and 1994 (see Note 1).

      Export  sales   aggregated   approximately   $4,105,000,   $3,496,000  and
      $2,433,000 in 1996, 1995 and 1994, respectively.



                                      -14-







12.   SUBSEQUENT EVENT

      On November 7, 1996, the Company  acquired all of the outstanding  capital
      stock of Guildsoft Holdings Limited  ("Guildsoft"),  a U.K.-based software
      distributor,  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  will be accounted for as an
      asset  purchase.  On an unaudited pro forma basis,  if the acquisition had
      taken place on October 1, 1995,  net sales for fiscal 1996 would have been
      approximately  $31,900,000  and net income for fiscal  1996 would not have
      been materially different from the amount previously reported.

                                   * * * * * *




                                      -15-






<TABLE>
<CAPTION>

                                                             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
                                            Period                   Costs &                     Reserves
                                                                     Expenses(a) Other

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

<S>                                            <C>                    <C>            <C>           <C>                  <C>    
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   $0       ($52,268)                    $73,145
                                                 ==============================================================================


Year Ended September 30, 1995
-----------------------------
Allowance-doubtful accounts
  and sales returns                               $68,590               $74,550            ($60,076)(b)(c)              $83,064
                                                 ------------------------------------------------------------------------------
TOTAL                                             $68,590               $74,550   $0       ($60,076)                    $83,064
                                                 ==============================================================================


Year ended September 30, 1994
-----------------------------
Allowance-doubtful accounts
  and sales return                               $198,649               $92,562            ($222,621)(b)(c)             $68,590
Allowance-assets held
  under contractual
  obligation                                    1,401,840             1,208,395           (2,610,235)(b)
                                               ---------------------------------------------------------------------------------
TOTAL                                          $1,600,489            $1,300,957   $0     ($2,832,856)                   $68,590
                                               =================================================================================

(a) Current year provision
(b) Doubtful accounts written off
(c) Product returns


</TABLE>