-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, RVTd0ldlWgefxmBFIGNQq5k0jsNrdgi/oDJmuT9X50KETlHpyzru9NYYXjbpvnvr V5382OSDJxlhPXwhcbNmHw== 0001072613-02-000813.txt : 20020515 0001072613-02-000813.hdr.sgml : 20020515 20020515105747 ACCESSION NUMBER: 0001072613-02-000813 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20020331 FILED AS OF DATE: 20020515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DATAWATCH CORP CENTRAL INDEX KEY: 0000792130 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 020405716 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-19960 FILM NUMBER: 02648971 BUSINESS ADDRESS: STREET 1: TOWER 3, 5TH FLOOR STREET 2: 900 CHELMSFORD STREET CITY: LOWELL STATE: MA ZIP: 01851-8100 BUSINESS PHONE: 978-441-2200 10-Q 1 form10-q_11230.txt DATAWATCH CORPORATION FORM 10-Q 03/31/2002 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO ________ COMMISSION FILE NUMBER: 000-19960 DATAWATCH CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 02-0405716 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 175 CABOT STREET SUITE 503 LOWELL, MASSACHUSETTS 01854 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 978-441-2200 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Class Outstanding at May 9, 2002 ----- --------------------------- Common Stock $0.01 par value 2,580,482 ================================================================================ DATAWATCH CORPORATION AND SUBSIDIARIES -------------------------------------- TABLE OF CONTENTS ----------------- PART I. FINANCIAL INFORMATION - ----------------------------- Item 1. Financial Statements Page # a) Consolidated Condensed Balance Sheets: March 31, 2002 and September 30, 2001 3 b) Consolidated Condensed Statements of Operations: Three and Six Months Ended March 31, 2002 and 2001 4 c) Consolidated Condensed Statements of Cash Flows: Six Months Ended March 31, 2002 and 2001 5 d) Notes to Consolidated Condensed Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Item 3. Quantitative and Qualitative Disclosures About Market Risk 20 PART II. OTHER INFORMATION - -------------------------- Item 1. Legal Proceedings * Item 2. Changes in Securities and Use of Proceeds * Item 3. Defaults upon Senior Securities * Item 4. Submission of Matters to a Vote of Security Holders 21 Item 5. Other Information * Item 6. Exhibits and Reports on Form 8-K 21 SIGNATURES 22 * No information provided due to inapplicability of item. 2 PART I. ITEM 1. FINANCIAL STATEMENTS -------------------- DATAWATCH CORPORATION AND SUBSIDIARIES CONSOLIDATED CONDENSED BALANCE SHEETS (Unaudited) March 31, September 30, 2002 2001 -------------- -------------- ASSETS CURRENT ASSETS: Cash and equivalents $ 1,808,818 $ 1,568,691 Accounts receivable, net 3,991,810 4,255,809 Inventories 205,647 230,878 Prepaid expenses 861,212 853,332 -------------- -------------- Total current assets 6,867,487 6,908,710 -------------- -------------- PROPERTY AND EQUIPMENT: Property and equipment 3,231,540 3,516,765 Less accumulated depreciation and amortization (2,412,071) (2,491,996) -------------- -------------- Net property and equipment 819,469 1,024,769 -------------- -------------- OTHER ASSETS 1,399,382 1,490,505 -------------- -------------- TOTAL ASSETS $ 9,086,338 $ 9,423,984 ============== ============== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 1,217,317 $ 1,556,286 Accrued expenses 1,806,939 1,965,911 Borrowings under credit lines 231,621 635,000 Deferred revenue 2,332,942 2,155,377 -------------- -------------- Total current liabilities 5,588,819 6,312,574 -------------- -------------- ACCRUED SEVERANCE, less current portion 54,353 126,121 -------------- -------------- COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY: Common stock 25,631 25,478 Additional paid-in capital 21,609,800 21,495,497 Accumulated deficit (17,419,660) (17,782,258) Accumulated other comprehensive loss (632,217) (613,040) -------------- -------------- 3,583,554 3,125,677 Less treasury stock - at cost (140,388) (140,388) -------------- -------------- Total shareholders' equity 3,443,166 2,985,289 -------------- -------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 9,086,338 $ 9,423,984 ============== ============== See accompanying notes to consolidated condensed financial statements 3 ITEM 1. FINANCIAL STATEMENTS (CONTINUED) -------------------- DATAWATCH CORPORATION AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (Unaudited)
Three Months Ended Six Months Ended March 31, March 31, 2002 2001 2002 2001 ------------------------------- ------------------------------- NET SALES: License $ 3,414,384 $ 3,231,101 $ 6,701,061 $ 6,847,745 Services 1,415,843 1,361,864 2,750,237 2,804,132 -------------- -------------- -------------- -------------- Net Sales 4,830,227 4,592,965 9,451,298 9,651,877 COSTS AND EXPENSES: Cost of sales 832,022 798,354 1,637,560 1,537,562 Engineering & product development 337,830 523,816 661,314 943,101 Selling, general & administrative 3,311,549 4,443,100 6,651,356 8,776,722 Restructuring 87,651 - 87,651 - -------------- -------------- -------------- -------------- Total Costs and Expenses 4,569,052 5,765,270 9,037,881 11,257,385 INCOME (LOSS) FROM OPERATIONS 261,175 (1,172,305) 413,417 (1,605,508) INTEREST EXPENSE (26,792) (30,313) (73,775) (52,339) OTHER INCOME, primarily interest 6,040 12,770 10,868 24,254 FOREIGN CURRENCY GAIN (LOSS) (3,532) 605 (5,008) 4,330 -------------- -------------- -------------- -------------- INCOME (LOSS) FROM CONTINUING OPERATIONS $ 236,891 $ (1,189,243) $ 345,502 $ (1,629,263) DISCONTINUED OPERATIONS: Loss from Guildsoft Operations - (26,507) - (60,184) Gain on sale of Guildsoft - - 17,096 - -------------- -------------- -------------- -------------- INCOME (LOSS) FROM DISCONTINUED OPERATIONS - (26,507) 17,096 (60,184) -------------- -------------- -------------- -------------- NET INCOME (LOSS) $ 236,891 $ (1,215,750) $ 362,598 $ (1,689,447) -------------- -------------- -------------- -------------- INCOME (LOSS) PER COMMON SHARE-Basic & diluted: Continuing Operations-Basic $ .09 $ (.49) $ .14 $ (.72) -------------- -------------- -------------- -------------- Continuing Operations-Diluted $ .09 $ (.49) $ .13 $ (.72) -------------- -------------- -------------- -------------- Discontinued Operations $ .00 $ (.01) $ .01 $ (.03) -------------- -------------- -------------- -------------- NET INCOME (LOSS) PER SHARE-Basic & Diluted $ .09 $ (.50) $ .14 $ (.74) ============== ============== ============== ============== WEIGHTED AVERAGE SHARES OUTSTANDING: Basic 2,555,984 2,433,495 2,551,403 2,273,474 ADJUSTMENT FOR DILUTIVE POTENTIAL COMMON STOCK 96,783 - 96,783 - -------------- -------------- -------------- -------------- WEIGHTED AVERAGE SHARES OUTSTANDING: Diluted 2,652,767 2,433,495 2,648,186 2,273,474 ============== ============== ============== ==============
See notes to consolidated condensed financial statements. 4 ITEM 1. FINANCIAL STATEMENTS (CONTINUED) -------------------- DATAWATCH CORPORATION AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (Unaudited)
Six Months Ended March 31, 2002 2001 ------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ 362,598 $ (1,689,447) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 462,981 492,711 Gain on sale of Guildsoft (17,096) - Loss on disposition of equipment 848 22,182 Stock-based compensation 37,500 - Changes in current assets and liabilities, net of acquisitions: Accounts receivable 234,486 2,091,600 Inventories 23,087 97,842 Prepaid expenses 17,075 (401,892) Accounts payable and accrued expenses (455,505) (216,964) Deferred revenue 223,485 (143,113) -------------- -------------- Net cash provided by operating activities 889,459 252,919 -------------- -------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of equipment and fixtures (21,081) (303,040) Proceeds from sale of equipment - net 184 4,086 Proceeds from sale of short-term investments - 348,121 Proceeds from sale of Guildsoft 20,509 - Capitalized software development costs (127,542) (444,139) Other assets 5,193 46,013 -------------- -------------- Net cash used in investing activities (122,737) (348,959) -------------- -------------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock - 1,083,351 Principal payments on long-term obligations (71,768) (311) Borrowings (Payments) under credit lines, net (403,379) - -------------- -------------- Net cash provided by (used in) financing activities (475,147) 1,083,040 -------------- -------------- EFFECT OF EXCHANGE RATE CHANGES ON CASH (51,448) 26,323 NET INCREASE IN CASH AND EQUIVALENTS 240,127 1,013,323 CASH AND EQUIVALENTS, BEGINNING OF PERIOD 1,568,691 1,695,832 -------------- -------------- CASH AND EQUIVALENTS, END OF PERIOD $ 1,808,818 $ 2,709,155 ============== ==============
See accompanying notes to consolidated condensed financial statements. 5 ITEM 1. FINANCIAL STATEMENTS (CONTINUED) -------------------- NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS 1. Basis of Presentation: The accompanying unaudited consolidated condensed financial statements include the accounts of Datawatch Corporation (the "Company") and its wholly owned subsidiaries and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the audited consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended September 30, 2001. In the opinion of management, the accompanying unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements, and include all adjustments necessary for fair presentation of the results of the interim periods presented. The operating results for the interim periods presented are not necessarily indicative of the results expected for the full year. 2. Recent Accounting Pronouncements: In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." These pronouncements provide guidance on how to account for the acquisition of businesses and intangible assets, including goodwill, which arise from such activities. SFAS No. 141 affirms that only one method of accounting may be applied to a business combination, the purchase method. SFAS No. 141 also provides guidance on the allocation of purchase price to the assets acquired. SFAS No. 142 provides that goodwill resulting from business combinations no longer be amortized to expense, but rather requires an annual assessment of impairment and, if necessary, adjustments to the carrying value of goodwill. Adoption of these pronouncements is not expected to have a significant effect on the Company's consolidated financial statements. In August 2001, FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and the accounting and reporting provisions relating to the disposal of a component of a business of Accounting Principles Board Opinion ("APB") No. 30. In the fourth quarter of fiscal 2001, the Company elected to adopt the provisions of SFAS No. 144. In accordance with the provisions of SFAS No. 144, Guildsoft Limited, a UK distribution subsidiary sold in September 2001, is considered a discontinued operation, and prior years' financial statements have been reclassified to present Guildsoft Limited on that basis. 3. 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 18% and 17% of net sales for the three months ended March 31, 2002 and March 31, 2001, respectively, and 16% and 14% of the net sales for the six months ended March 31, 2002 and March 31, 2001, respectively. This same customer accounted for 16% and 21% of outstanding trade receivables as of March 31, 2002 and September 30, 2001, respectively. Other than this customer, no other customer constitutes a significant portion (more than 10%) of sales or accounts receivable. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. Allowances are provided for anticipated doubtful accounts and sales returns. 6 ITEM 1. FINANCIAL STATEMENTS (CONTINUED) -------------------- 4. Inventories: Inventories consisted of the following at March 31, 2002 and September 30, 2001: March 31, September 30, 2002 2001 -------------- -------------- Materials $ 157,611 $ 222,976 Finished goods 48,036 7,902 -------------- -------------- TOTAL $ 205,647 $ 230,878 ============== ============== 5. Comprehensive Income: The following table sets forth the reconciliation of net income (loss) to comprehensive income (loss):
Three Months Ended Six Months Ended March 31, March 31, 2002 2001 2002 2001 ------------------------------- ------------------------------- Net income (loss) $ 236,891 $ (1,215,750) $ 362,598 $ (1,689,447) Other comprehensive income (loss), net of tax: Foreign currency translation adjustments (21,653) (34,025) (19,177) 8,976 -------------- -------------- -------------- -------------- Comprehensive income (loss) $ 215,238 $ (1,249,775) $ 343,421 $ (1,680,471) ============== ============== ============== ==============
Accumulated other comprehensive loss reported in the condensed consolidated balance sheets consists only of foreign currency translation adjustments. 6. Earnings (Loss) per Share: Basic net income (loss) per common share is computed by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share reflects the impact, when dilutive, of the exercise of options and warrants using the treasury stock method. For the three and six month periods ended March 31, 2001, 10,586 and 10,586 potential shares were excluded from the calculation, respectively, as the effect would be antidilutive. 7. Line of Credit: On October 30, 2001 and December 19, 2001, respectively, the Company entered into amended and restated domestic and international credit lines for a period to expire on October 1, 2002. As part of the agreement to enter into these credit lines, warrants to purchase 49,669 shares of the Company's common stock were issued to the bank at an exercise price of $1.51. These warrants expire on October 30, 2008. The fair market value of the warrants (determined by the Black-Scholes pricing model and the following assumptions: 134% volatility, 7 year estimated life and 4.8% risk-free interest rate) was determined to be $76,956 which was recorded in prepaid interest (being recognized as a component of interest expense during the term of the amended agreement period) with a corresponding increase in additional paid in capital. The amended and restated domestic credit line provides for maximum borrowings of the lesser of $1,000,000 or 70% of defined eligible receivables and the amended and restated international credit line provides for maximum borrowings of the lesser of $500,000 or 80% of defined eligible receivables. As of March 31, 2002, the Company had approximately $232,000 of outstanding borrowings with approximately $262,000 in additional borrowings available under the lines. 7 ITEM 1. FINANCIAL STATEMENTS (CONTINUED) -------------------- 8. Non-cash issuance of Common Stock: In November 2001, the Company issued 15,312 shares of common stock with an aggregate fair value of $37,500 to a director for services. The fair value of the stock issued to the director was expensed as the services were provided. 9. Segment Information: The Company has determined that it has only one reportable segment meeting the criteria established under SFAS No. 131. The Company's chief operating decision maker, as defined, (determined to be the Chief Executive Officer and the Board of Directors) does not manage any part of the Company separately, and the allocation of resources and assessment of performance is based solely on the Company's consolidated operations and operating results. The following table presents information about the Company's sales by product lines: Three Months Ended Six Months Ended March 31, March 31, 2002 2001 2002 2001 ---------------------- ---------------------- Monarch and Monarch|ES 72% 69% 72% 69% Q|Service Management 28 31 28 31 ---------- ---------- ---------- ---------- 100% 100% 100% 100% ========== ========== ========== ========== The Company's operations are conducted in the U.S. and in Europe (principally in the United Kingdom). The following tables present information about the Company's geographic operations:
Net Sales Domestic Europe Eliminations Total --------- -------- ------ ------------ ----- Three Months ended 3/31/02 $3,084,448 $2,008,807 $(263,028) $4,830,227 Three Months ended 3/31/01 2,802,100 2,061,643 (270,778) 4,592,965 Six Months ended 3/31/02 $6,019,107 $3,991,264 $(559,073) $9,451,298 Six Months ended 3/31/01 5,800,503 4,378,490 (527,116) 9,651,877 Long-lived Assets Domestic Europe Eliminations Total ----------------- -------- ------ ------------ ----- At March 31, 2002 $1,744,335 $ 463,016 $ - $2,207,351 At September 30, 2001 1,943,505 559,769 - 2,503,274
Export sales aggregated approximately $1,112,000 and $1,162,000, respectively, for the three months ended March 31, 2002 and March 31, 2001, and $2,168,000 and $2,576,000, respectively, for the six months ended March 31, 2002 and March 31, 2001. 10. Discontinued Operations: On September 20, 2001, the Company sold the operations of Guildsoft Limited, a United Kingdom distribution subsidiary, to a third party, as part of a restructuring plan (Note 11). The sale resulted in gross proceeds of $1,179,000 and a gain of approximately $413,000. The operations of Guildsoft Limited have been reflected as a discontinued operation in all periods presented. For the three months and six months ended March 31, 2001, Guildsoft Limited had net sales of $958,380 and $1,951,511, respectively, and a loss before taxes of $26,507 and $60,184, respectively. These losses are shown on the accompanying consolidated condensed statements of operations for those periods as a loss from Guildsoft operations as part of discontinued operations. In December 2001 there was a purchase price settlement between Datawatch and the purchaser of Guildsoft Limited, resulting in a gain of $17,096 which is shown as a gain on the sale of Guildsoft as part of discontinued operations on the accompanying consolidated condensed statement of operations for the six months ended March 31, 2002. 8 ITEM 1. FINANCIAL STATEMENTS (CONTINUED) -------------------- 11. Restructuring and Centralized Operations: During the fourth quarter of fiscal 2001, the Company approved and completed a corporate-wide restructuring plan in an effort to reduce costs and centralize administrative operations. The restructuring plan resulted in charges for severance benefits and related costs for 42 terminated employees. Of these charges, totaling approximately $763,000, $377,000 was paid in fiscal 2001 and $386,000 accrued as of September 30, 2001. On March 31, 2002, the accrual related to this restructuring totaled $203,000 (reflecting cash payments of approximately $183,000 since September 30, 2001) of which the long-term portion is $54,000. The charges are expected to be fully paid in January 2005. During the second quarter of fiscal 2002, there was an additional reorganization undertaken to further improve efficiencies and reduce costs, which resulted in an additional restructuring charge of approximately $88,000 for severance benefits and related costs for 4 terminated employees. Of these charges, $36,000 was paid during the second quarter and $52,000 accrued as of March 31, 2002. The charges for this restructuring are expected to be fully paid in July 2002. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS ----------------------------------------------------------------------- OF OPERATIONS ------------- GENERAL Datawatch Corporation (the "Company" or "Datawatch") is engaged in the design, development, manufacture, marketing, and support of business computer software primarily for the Windows-based market. Its products address the enterprise reporting, business intelligence, data replication and service management markets. Datawatch's principal products are: Monarch, a report mining and business intelligence application that lets users extract and manipulate data from ASCII report files or HTML files produced on any mainframe, midrange, client/server or PC system; Monarch|ES, a web-enabled business information portal that allows an organization to quickly deliver business intelligence and decision support derived from existing reporting systems with no new programming or report writing; Monarch Data Pump, a data replication and migration tool that offers a shortcut for populating and refreshing data marts and data warehouses, for migrating legacy data into new applications and for providing automated delivery of reports in a variety of formats via email; Q|Service Management ("Q|SM"), an integrated service management and information technology support software package with integrated change management features, business process automation tools and a unique user-interface that promotes ease-of-use and ease-of-learning; VorteXML, a new data transformation product for the emerging XML market which converts existing, structured ASCII/ANSI text documents or HTML into valid XML on an ad hoc, programming-free basis; and Redwing, a plug-in for Adobe Acrobat that lets users extract text and tables from Adobe PDF documents. CRITICAL ACCOUNTING POLICIES Revenue Recognition and Returns Reserve Datawatch generally recognizes revenue from the sale of software products at the time of shipment, providing there are no uncertainties surrounding product acceptance, the fee is fixed and determinable, collection is considered probable, persuasive evidence of the arrangement exists and there are no significant obligations remaining. For enterprise solutions products, the Company applies the residual method in determining revenue from license sales. Revenue from implementation, integration, training and consulting services is recognized as the services are performed. Revenue from post-contract customer support services is deferred and recognized ratably over the contract period (generally one year). Post-contract customer support includes technical support and rights to unspecified software upgrades and enhancements on a when-and-if available basis. The Company's software products are sold under warranty against certain defects in material and workmanship for a period of 30 to 60 days from the date of purchase. Certain software products, including desktop versions of Monarch, Monarch Data Pump, VorteXML and Redwing sold directly to end-users, include a guarantee under which such customers may return products within 30 to 60 days for a full refund. The Company offers its distributors the ability to return obsolete versions of its products and slow-moving products for refund or credit. Reserves are provided for potential returns under these arrangements based upon historical experience and anticipated exposures. Returns reserves are primarily calculated by accruing a fixed amount each period, assessing the level of the reserve at the end of the period against anticipated returns and adjusting the reserve as needed. During the quarter ended March 31, 2002, $50,000 was accrued for the returns reserve and approximately $72,000 in returns were applied against the reserve. This compares to $50,000 accrued for the returns reserve and approximately $17,000 in returns applied against the returns reserve for the quarter ended March 31, 10 2001. During the six months ended March 31, 2002, $100,000 was accrued for the returns reserve and approximately $122,000 in returns were applied against the reserve. This compares to $100,000 accrued for the returns reserve and approximately $268,000 in returns applied against the returns reserve for the six months ended March 31, 2001. At March 31, 2002, the returns reserve was approximately $223,000, with 73% related to specific accounts, as compared to approximately $246,000, with 62% related to specific accounts, at September 30, 2001. Capitalized Software Development Costs The Company capitalizes certain software development costs as well as purchased software upon achieving technological feasibility of the related products. For the three months ended March 31, 2002 and 2001, the Company capitalized approximately $16,000 and $119,000, respectively, of software development costs and $49,000 and $51,000, respectively, of purchased software. Software development costs incurred and software purchased prior to achieving technological feasibility are charged to research and development expense as incurred. Commencing upon initial product release, capitalized costs are amortized to cost of sales using the straight-line method over the estimated life (which approximates the ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product), generally 12 to 36 months. For the three months ended March 31, 2002 and 2001, amortization of these costs was approximately $90,000 and $74,000, respectively. The unamortized balance of capitalized software is approximately $1,007,000 and $1,085,000 as of March 31, 2002 and September 30, 2001, respectively. Foreign Currency Translations Datawatch translates the financial statements of foreign subsidiaries into U.S. dollars in accordance with SFAS No. 52, "Foreign Currency Translation." The related translation adjustments are reported as a separate component of shareholders' equity under the heading "Accumulated Other Comprehensive Loss." Accumulated other comprehensive loss reported in the accompanying consolidated condensed balance sheets consists only of foreign currency translation adjustments. At March 31, 2002 and September 30, 2001, the accumulated foreign currency translation loss totaled approximately $632,000 and $613,000, respectively. Foreign currency translation losses arising during the quarters ended March 31, 2002 and March 31, 2001 were approximately $22,000 and $34,000, respectively. Currently the Company does not engage in foreign currency hedging activities. RESULTS OF OPERATIONS Financial information for the three months ended March 31, 2001 has been reclassified to conform to the presentation of Guildsoft Limited as a discontinued operation. See Note 10 to the consolidated condensed financial statements. Three Months Ended March 31, 2002 and 2001. - ------------------------------------------- Net sales for the three months ended March 31, 2002 totaled $4,830,000 which represents an increase of $237,000 or approximately 5% from net sales of $4,593,000 for the three months ended March 31, 2001. Revenue from the sale of licenses was approximately $3,414,000 and $3,231,000 in the quarters ended March 31, 2002 and March 31, 2001, respectively. Revenue from the sale of services was approximately $1,416,000 and $1,362,000 for the quarters ended March 31, 2002 and March 31, 2001, respectively. For the three months ended March 31, 2002, revenue from the sale of licenses accounted for 71% of total sales and revenue from the sale of services accounted for 29% of total sales, as compared to 70% from license sales and 30% from services sales for the three months ended March 31, 2001. For 11 the second quarter of fiscal 2002, Monarch and Monarch|ES accounted for approximately 72% of net sales (as compared to 69% of net sales for the second quarter of fiscal 2001) and Q|SM accounted for approximately 28% of net sales (as compared to 31% of net sales for the second quarter of fiscal 2001). The increase in net sales in the second quarter of fiscal 2002 as compared to the second quarter of fiscal 2001 is attributable to an increases in both license and services sales for Monarch products. Monarch family sales increased by $294,000 or 9% and Q|SM family sales decreased by $57,000 or 4% in the three months ended March 31, 2002 as compared to the three months ended March 31, 2001. Datawatch attributes the increase in Monarch family sales to strong sales of the latest version of the Monarch product and the decrease in the Q|SM family sales to a reduction in corporate spending on high ticket software solutions due to an uncertain worldwide economy and reaction to the events of September 11, 2002. Cost of sales for the three months ended March 31, 2002 was $832,000 or approximately 17% of net sales as compared to cost of sales of $798,000 or approximately 17% of net sales for the three months ended March 31, 2001. For this period there was an increase in cost of sales for Monarch|ES, which is the result of higher costs from royalties and amortization of acquired software and development for the current version as compared to previous versions. This increase was partially offset by a decrease in cost of sales for Q|SM, which is the result of reduced costs from amortization of acquired software and development for the current version as compared to the previous version. Cost of sales for Monarch|ES was $194,000 or 30% of Monarch|ES sales for the three months ended March 31, 2002 as compared to $126,000 or 24% of Monarch|ES sales for the three months ended March 31, 2001. Cost of sales for Q|SM was $61,000 or 4% of Q|SM sales for the three months ended March 31, 2002 as compared to $111,000 or 8% of Q|SM sales for the three months ended March 31, 2001. Engineering and product development expenses were $338,000 for the three months ended March 31, 2002, a decrease of $186,000 or approximately 35% from $524,000 for the three months ended March 31, 2001. This decrease is primarily attributable to reduced expenses for maintenance of the older versions of the Company's help desk and asset management products by external developers and reduced expenses resulting from the restructurings which took place in the fourth quarter of fiscal 2001 and the second quarter of fiscal 2002. The realized cost savings from the reduction in expenses for the maintenance of the help desk and asset management products was $102,000, or 55% of the decrease, and $63,000, or 34% of the decrease, was from a reduction in employee compensation and benefits directly related to the Company's restructurings. Selling, general and administrative expenses were $3,312,000 for the three months ended March 31, 2002, a decrease of $1,131,000 or approximately 25% from $4,443,000 for the three months ended March 31, 2001. This decrease in primarily attributable to reduced expenses related to the cost reduction and restructuring plan which was implemented during the fourth quarter of fiscal 2002. The cost savings from this plan were fully realized in the first quarter of fiscal 2002. The approximate distribution of the realized cost savings when comparing the quarters ended March 31, 2002 to March 31, 2001 is as follows: o $483,000 or 43% from savings in employee compensation and benefits o $354,000 or 31% from savings in professional services expenses provided by non-related companies o $165,000 or 15% from savings in marketing expenses primarily from reduced expenses for direct mail and trade shows o $35,000 or 3% from savings in facilities rent expenses o $25,000 or 2% from savings in equipment and software expenses o $20,000 or 2% from savings in travel and entertainment expenses o $49,000 or 4% from savings in all other expense types 12 Income from continuing operations for the three months ended March 31, 2002 was approximately $237,000 which compares to a loss from continuing operations of approximately $1,189,000 for the three months ended March 31, 2001. The Company has not recorded any benefit for income taxes in either period owing to the Company's conclusion that the realization of net operating loss carryforwards was not more likely than not and based upon the expected effective tax rates for the full years being 0% in both periods. The net income for the three months ended March 31, 2002 was $237,000 which compares to a net loss of $1,216,000 for the three months ended March 31, 2001. Six Months Ended March 31, 2002 and 2001. - ----------------------------------------- Net sales for the six months ended March 31, 2002 totaled $9,451,000 which represents a decrease of $201,000 or approximately 2% from net sales of $9,652,000 for the six months ended March 31, 2001. Revenue from the sale of licenses was approximately $6,701,000 and $6,848,000 in the six months ended March 31, 2002 and March 31, 2001, respectively. Revenue from the sale of services was approximately $2,750,000 and $2,804,000 for the six months ended March 31, 2002 and March 31, 2001, respectively. In both periods revenue from the sale of licenses accounted for 71% of total sales and revenue from the sale of services accounted for 29% of total sales. For the first six months of fiscal 2002, Monarch and Monarch|ES accounted for approximately 72% of net sales (as compared to 69% of net sales for the first six months of fiscal 2001) and Q|SM accounted for approximately 28% of net sales (as compared to 31% of net sales for the first six months of fiscal 2001). The decrease in net sales in the first six months of fiscal 2002 as compared to the first six months of fiscal 2001 is attributable to a decrease in revenue for the Q|SM product line. Q|SM family sales decreased by $263,000 or 9%, while Monarch family sales increased by $63,000 or 1% in the six months ended March 31, 2002 as compared to the six months ended March 31, 2001. Datawatch attributes these decreases in sales to a reduction in corporate spending on high ticket software solutions due to an uncertain worldwide economy and reaction to the events of September 11, 2002. Cost of sales for the six months ended March 31, 2002 was $1,638,000 or approximately 17% of net sales as compared to cost of sales of $1,538,000 or approximately 16% of net sales for the six months ended March 31, 2001. The increase in cost of sales is primarily attributable to the cost of sales of the latest version of the Monarch|ES product, which has higher costs from royalties and amortization of acquired software and development than previous versions. This increase was partially offset by a decrease in cost of sales for Q|SM, which is the result of reduced costs from amortization of acquired software and development for the current version as compared to the previous version. Cost of sales for Monarch|ES was $427,000 or 30% of Monarch|ES sales for the six months ended March 31, 2002 as compared to $181,000 or 14% of Monarch|ES sales for the six months ended March 31, 2001. Cost of sales for Q|SM was $126,000 or 5% of Q|SM sales for the six months ended March 31, 2002 as compared to $227,000 or 8% of Q|SM sales for the six months ended March 31, 2001. Engineering and product development expenses were $661,000 for the six months ended March 31, 2002, a decrease of $282,000 or approximately 30% from $943,000 for the six months ended March 31, 2001. This decrease is primarily attributable to reduced expenses for maintenance of the older versions of the Company's help desk and asset management products by external developers and reduced expenses resulting from the restructurings which took place in the fourth quarter of fiscal 2001 and the second quarter of fiscal 2002. The realized cost savings from the reduction in expenses for the maintenance of the help desk and asset management products was $201,000, or 71% of the decrease, and $81,000, or 29% of the decrease, was from a reduction in employee compensation and benefits directly related to the restructurings. 13 Selling, general and administrative expenses were $6,651,000 for the six months ended March 31, 2002, a decrease of $2,125,000 or approximately 24% from $8,776,000 for the six months ended March 31, 2001. This decrease in primarily attributable to reduced expenses related to the cost reduction and restructuring plan which was implemented during the fourth quarter of fiscal 2002. The cost savings from this plan were fully realized in the first quarter of fiscal 2002. The approximate distribution of the realized cost savings when comparing the quarters ended March 31, 2002 to March 31, 2001 is as follows: o $854,000 or 40% from savings in employee compensation and benefits o $521,000 or 25% from savings in professional services expenses provided by non-related companies o $470,000 or 22% from savings in marketing expenses primarily from reduced expenses for direct mail and trade shows o $92,000 or 4% from savings in travel and entertainment expenses o $68,000 or 3% from savings in facilities rent expenses o $54,000 or 3% from savings in equipment and software expenses o $66,000 or 3% from savings in all other expense types Income from continuing operations for the six months ended March 31, 2002 was approximately $346,000, which compares to a loss from continuing operations of approximately $1,629,000 for the six months ended March 31, 2001. The Company has not recorded any benefit for income taxes in either period owing to the Company's conclusion that the realization of net operating loss carryforwards was not more likely than not and based upon the expected effective tax rates for the full years being 0% in both periods. The net income for the six months ended March 31, 2002 was $363,000, which compares to a net loss of $1,689,000 for the six months ended March 31, 2001. In December 2001 there was a purchase price settlement between Datawatch and the purchaser of Guildsoft Limited, resulting in a gain of $17,096 which is shown as a gain on the sale of Guildsoft as part of discontinued operations on the accompanying consolidated condensed statement of operations for the six months ended March 31, 2002. LIQUIDITY AND CAPITAL RESOURCES Working capital increased by approximately $683,000 during the six months ended March 31, 2002 primarily as a result of profitable operations. The net cash provided by operating activities totaled $889,000 for the six months ended March 31, 2002 (as compared to $253,000 for the six months ended March 31, 2001). The primary sources of cash during the first six months of fiscal 2002 were profitable operations, collection of accounts receivable and collections from sales that have deferred revenue, offset by accounts payable and accrued expenses. Cash used in investing activities (primarily in capitalized software) was $123,000 for the six months ended March 31, 2002 and $349,000 for the six months ended March 31, 2001. Cash used in financing activities was $475,000 for the six months ended March 31, 2002 primarily as a result of a $403,000 reduction in the Company's borrowings under its credit lines and a reduction of long-term obligations of $72,000. In the six months ended March 31, 2001, there was $1,083,000 provided by financing activities. This increase is primarily attributable to the Company's issuance of 1,875,000 shares of common stock in a private placement to investors for an aggregate of $1,162,500. 14 Management believes that the currently anticipated capital requirements of the Company will be satisfied through at least September 30, 2002 by cash flow from operations and funds available under the Company's line of credit agreements. On October 30, 2001 and December 19, 2001, respectively, the Company entered into amended and restated domestic and international credit lines for a period to expire on October 1, 2002. The amended and restated domestic credit line provides for maximum borrowings of the lesser of $1,000,000 or 70% of defined eligible receivables and the amended and restated international credit line provides for maximum borrowings of the lessor of $500,000 or 80% of defined eligible receivables. As of March 31, 2002, the Company had approximately $232,000 of outstanding borrowings under these lines with approximately $262,000 in additional borrowings available under the lines. Management believes that the Company's current operations are not materially impacted by the effects of inflation. RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, the FASB issued SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." These pronouncements provide guidance on how to account for the acquisition of businesses and intangible assets, including goodwill, which arise from such activities. SFAS No.141 affirms that only one method of accounting may be applied to a business combination, the purchase method. SFAS No. 141 also provides guidance on the allocation of purchase price to the assets acquired. SFAS No. 142 provides that goodwill resulting from business combinations no longer be amortized to expense, but rather requires an annual assessment of impairment and, if necessary, adjustments to the carrying value of goodwill. Adoption of these pronouncements is not expected to have a significant effect on the Company's consolidated financial statements. RISK FACTORS The Company does not provide forecasts of its future financial performance. However, from time to time, information provided by the Company or statements made by its employees may contain "forward looking" information that involves risks and uncertainties. In particular, statements contained in this Report on Form 10-Q that are not historical facts (including, but not limited to statements contained in "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" of Part I of this Report on Form 10-Q relating to liquidity and capital resources) may constitute forward looking statements and are made under the safe harbor provisions of The Private Securities Litigation Reform Act of 1995. The Company's actual results of operations and financial condition have varied and may in the future vary significantly from those stated in any forward looking statements. Factors that may cause such differences include, without limitation, the risks, uncertainties and other information discussed below and within this Report on Form 10-Q, as well as the accuracy of the Company's internal estimates of revenue and operating expense levels. The following discussion of the Company's risk factors should be read in conjunction with the financial statements contained herein and related notes thereto. Such factors, among others, may have a material adverse effect upon the Company's business, results of operations and financial condition. Fluctuations in Quarterly Operating Results The Company's future operating results could vary substantially from quarter to quarter because of uncertainties and/or risks associated with such things as technological change, competition, and delays in the introduction of products or 15 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. Weakening of World Wide Economic Conditions and the Computer Software Market May Result in Lower Revenue Growth Rates or Decreased Revenues The revenue growth and profitability of the Company's business depends on the overall demand for computer software and services, particularly in the markets in which it competes. Because the Company's sales are primarily to major corporate customers, its business also depends on general economic and business conditions. A softening of demand for computer software and services, caused by a weakening of the economy in the United States or abroad, may result in lower revenue growth rates, decreased revenues or reduced profitability. In addition, recent terrorist attacks against the United States, and the United States military response to these attacks, have added to economic and political uncertainty which may adversely affect worldwide demand for computer software and services and result in significant fluctuations in the value of foreign currencies. In a weakened economy, the Company cannot be assured that it will be able to effectively promote future growth in its software and services revenues or restore profitability. Dependence on Principal Products For the six months ended March 31, 2002, Monarch and Monarch|ES products and Q|Service Management products accounted for approximately 72% and 28%, respectively, of the Company's net sales. The Company is wholly dependent on Monarch, Monarch|ES and Q|Service Management products. As a result, any factor adversely affecting sales of either of these products could have a material adverse effect on the Company. The Company's future financial performance will depend in part on the successful introduction of its new and enhanced versions of these products and development of new versions of these and other products and subsequent acceptance of such new and enhanced products. In addition, competitive pressures or other factors may result in significant price erosion that could have a material adverse effect on the Company's business, financial condition or results of operations. International Sales In the six months ended March 31, 2002, international sales accounted for approximately 44% of the Company's net sales. The Company anticipates that international sales will continue to account for a significant percentage of its net sales. A significant portion of the Company's net sales will therefore be subject to risks associated with international sales, including unexpected changes in legal and regulatory requirements, changes in tariffs, exchange rates and other barriers, political and economic instability, possible effects of war and acts of terrorism, difficulties in account receivable collection, difficulties in managing distributors or representatives, difficulties in staffing and managing international operations, difficulties in protecting the Company's intellectual property overseas, seasonality of sales and potentially adverse tax consequences. 16 Acquisition Strategy Although the Company has no current acquisition agreements, it has addressed and may continue to address the need to develop new products, in part, through the acquisition of other companies. Acquisitions involve numerous risks including difficulties in the assimilation of the operations, technologies and products of the acquired companies, the diversion of management's attention from other business concerns, risks of entering markets in which the Company has no or limited direct prior experience and where competitors in such markets have stronger market positions, and the potential loss of key employees of the acquired company. Achieving and maintaining the anticipated benefits of an acquisition will depend in part upon whether the integration of the companies' business is accomplished in an efficient and effective manner, and there can be no assurance that this will occur. The successful combination of companies in the high technology industry may be more difficult to accomplish than in other industries. Dependence on New Introductions; New Product Delays Growth in the Company's business depends in substantial part on the continuing introduction of new products. The length of product life cycles depends in part on end-user demand for new or additional functionality in the Company's products. If the Company fails to accurately anticipate the demand for, or encounters any significant delays in developing or introducing, new products or additional functionality on its products, there could be a material adverse effect on the Company's business. Product life cycles can also be affected by the introduction by suppliers of operating systems of comparable functionality within their products. The failure of the Company to anticipate the introduction of additional functionality in products developed by such suppliers could have a material adverse effect on the Company's business. In addition, the Company's competitors may introduce products with more features and lower prices than the Company's products. Such increase in competition could adversely affect the life cycles of the Company's products, which in turn could have a material adverse effect on the Company's business. Software products may contain undetected errors or failures when first introduced or as new versions are released. There can be no assurance that, despite testing by the Company and by current and potential end-users, errors will not be found in new products after commencement of commercial shipments, resulting in loss of or delay in market acceptance. Any failure by the Company to anticipate or respond adequately to changes in technology and customer preferences, or any significant delays in product development or introduction, could have a material adverse effect on the Company's business. Rapid Technological Change The markets in which the Company competes have undergone, and can be expected to continue to undergo, rapid and significant technological change. The ability of the Company to grow will depend on its ability to successfully update and improve its existing products and market and license new products to meet the changing demands of the marketplace and that can compete successfully with the existing and new products of the Company's competitors. There can be no assurance that the Company will be able to successfully anticipate and satisfy the changing demands of the personal computer software marketplace, that the Company will be able to continue to enhance its product offerings, or that technological changes in hardware platforms or software operating systems, or the introduction of a new product by a competitor, will not render the Company's products obsolete. 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 17 Company's existing and potential competitors, including Peregrine, Actuate, Quest, and others, have substantially greater financial, marketing and technological resources than the Company. No assurance can be given that the Company will have the resources required to compete successfully in the future. Dependence on Proprietary Software Technology The Company's success is dependent upon proprietary software technology. Although the Company does not own 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 The Company sells a significant portion of its products through resellers, none of which are under the direct control of the Company. The loss of major resellers of the Company's products, or a significant decline in their sales, could have a material adverse effect on the Company's operating results. There can be no assurance that the Company will be able to attract or retain additional qualified resellers or that any such resellers will be able to effectively sell the Company's products. The Company seeks to select and retain resellers on the basis of their business credentials and their ability to add value through expertise in specific vertical markets or application programming expertise. In addition, the Company relies on resellers to provide post-sales service and support, and any deficiencies in such service and support could adversely affect the Company's business. Volatility of Stock Price As is frequently the case with the stocks of high technology companies, the market price of the Company's common stock has been, and may continue to be, volatile. Factors such as quarterly fluctuations in results of operations, increased competition, the introduction of new products by the Company or its competitors, expenses or other difficulties associated with assimilating companies acquired by the Company, changes in the mix of sales channels, the timing of significant customer orders, and macroeconomic conditions generally, may have a significant impact on the market price of the stock of the Company. Any shortfall in revenue or earnings from the levels anticipated by securities analysts could have an immediate and significant adverse effect on the market price of the Company's common stock in any given period. In addition, the stock market has from time to time experienced extreme price and volume fluctuations, which have particularly affected the market price for many high technology companies and which, on occasion, have appeared to be unrelated to the operating performance of such companies. Transfer of Common Stock Listing In March 2001 the Company announced that it had received a notice from The Nasdaq Stock Market, Inc. that the Company's Common Stock failed to comply with the $1.00 minimum bid price requirement for continued listing on The Nasdaq 18 National Market as set forth in marketplace Rule 4450(a)(5), and that the Company's Common Stock was, therefore, subject to delisting from The Nasdaq National Market. Management presented the Company's plan to regain compliance with the minimum bid price requirement to the Nasdaq Listing Qualifications Panel and, in May 2001, the Listing Qualifications Panel notified the Company that it had determined to continue listing the Company's Common Stock on the Nasdaq National Market, provided that on or before July 31, 2001, the Company's Common Stock evidenced a closing bid price of at least $1.00 per share and, immediately thereafter, a closing bid price of at least $1.00 for a minimum of ten consecutive trading days and that the Company remained in compliance with all other requirements for continued listing on The Nasdaq National Market. Effective as of the close of business on July 23, 2001 the Company effected a 1-for-4.5 reverse stock split. Since July 24, 2001, the Company's Common Stock has evidenced a closing bid price in excess of $1.00 per share, demonstrating compliance with the minimum bid price requirement. However, the Company has not maintained compliance with the continued listing requirement for market value of public float of $5 million. In response to the extraordinary market conditions that resulted from the tragedies of September 11, 2001, Nasdaq declared an emergency moratorium on the enforcement of the minimum bid price and market value of public float requirements which expired on January 2, 2002. In January 2002 the Company received a notice from The Nasdaq Stock Market, Inc. that the Company had failed to comply with the $4 million net tangible asset requirement for continued listing on The Nasdaq National Market and, in response, the Company applied for listing of its Common Stock on The Nasdaq SmallCap Market. In early February 2002, the Company was notified that its application for such listing had been approved and that the listing of the Company's Common Stock would be transferred to The Nasdaq SmallCap Market at the opening of business on February 7, 2002. There can be no assurance that the Company will remain in compliance with the requirements for continued listing on The Nasdaq SmallCap Market. In addition, the transfer of the Company's Common Stock listing to the Nasdaq SmallCap Market may impair the ability of stockholders to buy and sell shares of the Company's Common Stock and could adversely affect the market price of, and the efficiency of the trading market for, the shares of Common Stock. Further, the transfer of the Common Stock from the Nasdaq National Market could significantly impair the Company's ability to raise capital in the public markets should it desire to do so in the future. 19 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ---------------------------------------------------------- Derivative Financial Instruments, Other Financial Instruments, and Derivative Commodity Instruments. At March 31, 2002, the Company did not participate in any derivative financial instruments, or other financial and commodity instruments. The Company holds no investment securities. Primary Market Risk Exposures The Company's primary market risk exposures are in the areas of interest rate risk and foreign currency exchange rate risk. The Company utilizes U.S. dollar denominated borrowings to fund its operational needs through its $1,500,000 working capital line of credit agreements. The lines, which currently bear an interest rate of prime plus 2% (6.75% at March 31, 2002), are subject to annual renewal. Had the interest rates under the lines of credit been 10% greater or lesser than actual rates, the impact would not have been material in the Company's consolidated financial statements for the period ended March 31, 2002. As of March 31, 2002, the Company had approximately $232,000 in outstanding borrowings under its working capital lines. The Company's exposure to currency exchange rate fluctuations has been and is expected to continue to be immaterial due to the fact that the operations of its international subsidiaries are almost exclusively conducted in their respective local currencies. As a result, foreign exchange fluctuations can impact the Company's consolidated results while having no impact on cash flows. Dollar advances to the Company's international subsidiaries, if any, are usually considered to be of a long-term investment nature. Therefore, the majority of currency movements are reflected in the Company's other comprehensive income. There are, however, certain situations where the Company will invoice customers in currencies other than its own. Such gains or losses, whether realized or unrealized, are reflected in income. These have not been material in the past nor does management believe that they will be material in the future. Currently the Company does not engage in foreign currency hedging activities. 20 PART II. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS --------------------------------------------------- A. The Annual Meeting of Stockholders of Datawatch Corporation was held on March 8, 2002. B. The directors elected at the meeting are Robert W. Hagger, Jerome Jacobson, Richard de J. Osborne, Terry W. Potter, David T. Riddiford and James Wood, which constitute all of the directors of the Company. C. A vote was proposed to elect the following nominees to the Board of Directors to serve for the ensuing year or until their respective successors are duly elected and qualified: Nominee Total Votes For Total Votes Against ------- --------------- ------------------- Robert W. Hagger 2,268,357 66,106 Jerome Jacobson 2,268,357 66,106 Richard de J. Osborne 2,268,357 66,106 Terry W. Potter 2,268,357 66,106 David T. Riddiford 2,268,357 66,106 James Wood 2,268,357 66,106 A proposal to approve an increase in the number of shares of Common Stock, $.01 par value, available for issuance under the Datawatch 1996 Stock Plan (the "1996 Stock Plan") from 366,667 to 494,400 shares, was approved and adopted with 2,213,913 shares voting in favor, 115,513 voting against, and 5,037 abstaining. D. No information provided due to inapplicability of item. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K -------------------------------- A. Exhibits 10.1 Executive Agreement dated December 1, 2001 by and between Datawatch Corporation and Calvin MacKay (filed herewith). 10.2 Severance Agreement and Release dated January 31, 2002 by and between Datawatch Corporation and Linda Lammi (filed herewith). 10.3 1996 Stock Plan as amended as of March 8, 2002 (filed herewith). B. Reports on Form 8-K No Current Report on Form 8-K was filed during the quarterly period ended March 31, 2002. 21 SIGNATURES Pursuant to the requirements 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 on May 15, 2002. DATAWATCH CORPORATION /s/ Alan R. MacDougall ----------------------------------- Alan R. MacDougall Vice President of Finance and Chief Financial Officer (Principal Financial Officer) 22 EX-10.1 3 ex10-1_11230.txt EXHIBIT 10.1 ------------ December 1, 2001 Calvin MacKay 521 Salem Street North Andover, MA 01845 Dear Calvin: The purpose of this letter is to memorialize the terms of your eligibility for severance with Datawatch Corporation ("the Company") in the event that you are involuntarily terminated by the Company without Cause (as defined in Paragraph 3) or if you terminate your employment for Good Reason (as defined in Paragraph 2) prior to July 31, 2004. 1. Your at-will employment with the Company began on December 1, 2001, as Senior Vice President of Enterprise Software. As an at-will employee, either you or the Company may terminate your employment at any time for any or no reason with or without notice. Neither this letter nor its terms constitute a contract for continued employment or a contract for a specific term of employment. Instead, this letter sets forth the terms of our agreement with respect to your eligibility for severance. 2. In the event that you voluntarily terminate your employment with the Company at your own election and without Good Reason, you shall be entitled to no severance. For the purpose of this Agreement, "Good Reason" is defined as a material diminution in the nature or scope of your responsibilities, duties or authority; provided, however, that the transfer of certain job responsibilities, or the assignment to others of your duties and responsibilities while you are out of work due to a disability or on a leave of absence for any reason, shall not constitute a material diminution in the nature or scope of the your responsibilities, duties or authority as set forth in this Section. 3. In the event that the Company terminates your employment for "Cause," you shall be entitled to no severance. Termination by the Company shall constitute a termination for Cause under this Paragraph 3 if such termination is for one or more of the following reasons: (a) the willful and continuing failure or refusal by you to render services to the Company in accordance with your obligations to the Company; (b) gross negligence, dishonesty, breach of fiduciary duty or breach of the terms of any other agreements executed in connection herewith; (c) the commission by you of an act of fraud, embezzlement or substantial disregard of the rules or policies of the Company; (d) acts which, in the judgment of the Board of Directors, would tend to generate significant adverse publicity toward the Company; (e) the commission, or plea of nolo contendere, by you of a felony; or (f) a breach by you of the terms of the Proprietary Information and Inventions Agreement executed by you. 4. In the event that the Company terminates your employment prior to July 31, 2004 for any reason other than those stated in Paragraph 3 above or if you terminate your employment prior to July 31, 2004 for Good Reason as defined in Paragraph 2, and you sign a comprehensive release in the form, and of a scope, acceptable to the Company (the "Release"), the Company will pay you severance payments in equal monthly installments at your then monthly base salary for six months following your termination (the "Severance Period"). Such payments shall be made in accordance with the Company's customary payroll practices and shall be subject to all applicable federal and state withholding, payroll and other taxes. If you breach your post-employment obligations under your Proprietary Information and Inventions Agreement, the Company may immediately cease payment of all severance and/or benefits described in this Agreement. This cessation of severance and/or benefits shall be in addition to, and not as an alternative to, any other remedies in law or in equity available to the Company, including the right to seek specific performance or an injunction. 5. The terms of this agreement constitute the entire understanding relating to your employment and supersede and cancel all agreements, written or oral, made prior to the date hereof between you and the Company relating to your employment with the Company; provided, however, that nothing herein shall be deemed to limit or terminate the provisions of Proprietary Information and Inventions Agreement executed by you or in any manner alter the terms of any stock option entered into between you and the Company. 6. This Agreement, the employment relationship contemplated herein and any claim arising from such relationship, whether or not arising under this Agreement, shall be governed by and construed in accordance with the internal laws of Massachusetts, without giving effect to the principles of choice of law or conflicts of law of Massachusetts and this Agreement shall be deemed to be performable in Massachusetts. Any claims or legal actions by one party against the other arising out of the relationship between the parties contemplated herein (whether or not arising under this Agreement) shall be commenced or maintained in any state or federal court located in Massachusetts, and Executive hereby submits to the jurisdiction and venue of any such court. 7. No waiver by either party of any breach by the other or any provision hereof shall be deemed to be a waiver of any later or other breach thereof or as a waiver of any other provision of this Agreement. This Agreement and its terms may not be waived, changed, discharged or terminated orally or by any course of dealing between the parties, but only by an instrument in writing signed by the party against whom any waiver, change, discharge or termination is sought. No modification or waiver by the Company shall be effective without the consent of the Board of Directors then in office at the time of such modification or waiver. 8. You acknowledge that the services to be rendered by you to the Company are unique and personal in nature. Accordingly, you may not assign any of your rights or delegate any of your duties or obligations under this Agreement. The rights and obligations of the Company under this Agreement may be assigned by the Company and shall inure to the benefit of, and shall be binding upon, the successors and assigns of the Company. If this letter correctly states the understanding we have reached, please indicate your acceptance by countersigning the enclosed copy and returning it to me. Very truly yours, DATAWATCH CORPORATION /s/ Robert Hagger ------------------------------------- Robert Hagger President and Chief Executive Officer YOU REPRESENT THAT YOU HAVE READ THE FOREGOING AGREEMENT, THAT YOU FULLY UNDERSTAND THE TERMS AND CONDITIONS OF SUCH AGREEMENT AND THAT YOU ARE VOLUNTARILY EXECUTING THE SAME. ACCEPTED: /s/ Calvin Mackay - ------------------------------------- Calvin Mackay EX-10.2 4 ex10-2_11230.txt EXHIBIT 10.2 ------------ January 31, 2002 VIA HAND DELIVERY - ----------------- Ms. Linda Lammi 10 Anglewood Lane N. Reading, MA 01864 Re: Severance Agreement and Release Dear Linda: This letter summarizes the terms of your separation from employment with Datawatch Corporation (the "Company") and the severance agreement and release between you and the Company (the "Agreement"). The purpose of this Agreement is to establish an amicable arrangement for ending your employment relationship, to release the Company from any claims and to permit you to receive severance pay and related benefits. With these understandings and in exchange for the promises of you and the Company as set forth below, you and the Company agree as follows. 1. EMPLOYMENT STATUS AND FINAL PAYMENTS: (a) Your termination from employment with the Company will be effective as of January 31, 2002 (the "Termination Date"). As of the Termination Date, your salary will cease, and any entitlement you have or might have under a Company-provided benefit plan, program, contract or practice will terminate, except as required by federal or state law, or as otherwise described below. (b) You hereby acknowledge that as of the Termination Date, you have been paid all wages earned but unpaid and have been paid for all vacation time accrued but unused as of the Termination Date. (c) The Termination Date shall be the date of the "qualifying event" under the Consolidated Omnibus Budget Reconciliation Act of 1985 ("COBRA") and the Company will present you with information on COBRA under separate cover. 2. CONSIDERATION: In exchange for, and in consideration of, your full execution of this Agreement and after the seven-day revocation period set forth in Section 11 has expired, the Company agrees as follows: (a) Severance Pay: The Company will pay you severance payments for a period of six (6) months following the Termination Date at your current gross semi-monthly salary rate of Five Thousand Six Hundred and Twenty-five Dollars ($5,625) in accordance with the Company's standard payroll practices less applicable taxes. (b) Health Insurance: If you elect to continue medical and dental insurance coverage after the Termination Date in accordance with the provisions of COBRA, the Company shall pay your monthly premium payments until the earlier of: (i) July 31, 2002; (ii) the date you obtain other employment; or (iii) the date your COBRA continuation coverage would terminate in accordance with the provisions of COBRA. Thereafter, medical and dental insurance coverage shall be continued only to the extent required by COBRA and only to the extent you timely pay the premium payments yourself. (c) Payments: The payments set forth in this Section 2 shall be subject to all applicable federal, state and/or local withholding and/or payroll taxes. 3. STOCK OPTION: As set forth in the Datawatch Corporation Stock Option and Incentive Plan and your Stock Option Agreement with the Company ("Stock Option Agreement"), your options to purchase stock in the Company will cease vesting on the Termination Date. All of your rights and obligations to stock options, including without limitation vesting, exercise and expiration, are governed by the terms and conditions of the Datawatch Corporation Stock Plan and the Stock Option Agreement. 4. RELEASE: In exchange for the amounts described in Section 2, which are in addition to anything of value to which you are entitled to receive, and other good and valuable consideration, the sufficiency of which is hereby acknowledged, you and your representatives, agents, estate, heirs, successors and assigns, absolutely and unconditionally hereby release, remise, discharge, indemnify and hold harmless the Company Releasees (defined to include the Company and/or any of its parents, subsidiaries or affiliates, predecessors, successors or assigns, and its and their respective current and/or former partners, directors, shareholders/stockholders, officers, employees, attorneys and/or agents, all both individually and in their official capacities), from any and all actions or causes of action, suits, claims, complaints, contracts, liabilities, agreements, promises, contracts, torts, debts, damages, controversies, judgments, rights and demands, whether existing or contingent, known or unknown, suspected or unsuspected, which arise out of your employment with, change in employment status with, and/or separation of employment from, the Company. This release is intended by you to be all encompassing and to act as a full and total release of any claims, whether specifically enumerated herein or not, that you may have or have had against the Company Releasees arising from conduct occurring up to and through the date of this Agreement, including, but not limited to, any claims arising from any federal, state or local law, regulation or constitution dealing with either employment, employment benefits or employment discrimination such as those laws or regulations concerning discrimination on the basis of race, color, creed, religion, age, sex, sex harassment, sexual orientation, national origin, ancestry, genetic carrier status, handicap or disability, veteran status, any military service or application for military service, or any other category protected under federal or state law; any contract, whether oral or written, express or implied; any tort; any claim for equity or other benefits; or any other statutory and/or common law claim. 2 5. ACCORD AND SATISFACTION: The amounts set forth above in Sections 1 and 2 shall be complete and unconditional payment, settlement, accord and/or satisfaction with respect to all obligations and liabilities of the Company Releasees to you, including, without limitation, all claims for back wages, salary, vacation pay, draws, incentive pay, bonuses, stock and stock options, commissions, severance pay, reimbursement of expenses, any and all other forms of compensation or benefits, attorney's fees, or other costs or sums. 6. WAIVER OF RIGHTS AND CLAIMS UNDER THE AGE DISCRIMINATION IN EMPLOYMENT ACT OF 1967: Since you are 40 years of age or older, you are being informed that you have or may have specific rights and/or claims under the Age Discrimination in Employment Act of 1967 (ADEA) and you agree that: (a) in consideration for the amounts described in Section 2 of this Agreement, which you are not otherwise entitled to receive, you specifically and voluntarily waive such rights and/or claims under the ADEA you might have against the Company Releasees to the extent such rights and/or claims arose prior to the date this Agreement was executed; (b) you understand that rights or claims under the ADEA which may arise after the date this Agreement is executed are not waived by you; (c) you are advised to consider the terms of this Agreement carefully and consult with or seek advice from an attorney of your choice or any other person of your choosing prior to executing this Agreement; (d) you have carefully read and fully understand all of the provisions of this Agreement, and you knowingly and voluntarily agree to all of the terms set forth in this Agreement; and (e) in entering into this Agreement you are not relying on any representation, promise or inducement made by the Company or its attorneys with the exception of those promises described in this document. 7. PERIOD FOR REVIEW AND CONSIDERATION OF AGREEMENT: (a) You acknowledge that you were informed and understand that you have twenty-one days to review this Agreement and consider its terms before signing it. (b) The 21-day review period will not be affected or extended by any revisions, whether material or immaterial, that might be made to this Agreement. 8. COMPANY FILES, DOCUMENTS AND OTHER PROPERTY: You agree that on or before the Termination Date you will return to the Company all Company property and materials, including but not limited to, (if applicable) personal computers, laptops, fax machines, 3 scanners, copiers, cellular phones, Company credit cards and telephone charge cards, manuals, building keys and passes, courtesy parking passes, diskettes, intangible information stored on diskettes, software programs and data compiled with the use of those programs, software passwords or codes, tangible copies of trade secrets and confidential information, sales forecasts, names and addresses of Company customers and potential customers, customer lists, customer contacts, sales information, sales forecasts, memoranda, sales brochures, business or marketing plans, reports, projections, and any and all other information or property previously or currently held or used by you that is or was related to your employment with the Company ("Company Property"). You agree that in the event that you discover any other Company Property in your possession after the Termination Date of this Agreement you will immediately return such materials to the Company. 9. FUTURE CONDUCT: (a) Nondisparagement: You agree not to make disparaging, critical or otherwise detrimental comments to any person or entity concerning the Company, its officers, directors or employees; the products, services or programs provided or to be provided by the Company; the business affairs, operation, management or the financial condition of the Company; or the circumstances surrounding your employment and/or separation of employment from the Company. (b) Confidentiality of this Agreement: You agree that you shall not disclose, divulge or publish, directly or indirectly, any information regarding the substance, terms or existence of this Agreement and/or any discussion or negotiations relating to this Agreement, to any person or organization other than your immediate family and accountants or attorneys when such disclosure is necessary for the accountants or attorneys to render professional services. Prior to any such disclosure that you may make, you shall secure from your attorney or accountant their agreement to maintain the confidentiality of such matters. (c) Disclosures: Nothing herein shall prohibit or bar you from providing truthful testimony in any legal proceeding or in communicating with any governmental agency or representative or from making any truthful disclosure required, authorized or permitted under law; provided, however, that in providing such testimony or making such disclosures or communications, you will use your best efforts to ensure that this Section is complied with to the maximum extent possible. Notwithstanding the foregoing, nothing in this Agreement shall bar or prohibit you from contacting, seeking assistance from or participating in any proceeding before any federal or state administrative agency to the extent permitted by applicable federal, state and/or local law. However, you nevertheless will be prohibited to the fullest extent authorized by law from obtaining monetary damages in any agency proceeding in which you do so participate. 10. REPRESENTATIONS AND GOVERNING LAW: (a) This Agreement sets forth the complete and sole agreement between the parties and supersedes any and all other agreements or understandings, whether oral or written, except the Proprietary Information and Inventions Agreement between you and the Company and the Stock Option Agreement, each of which shall remain in full force and effect in 4 accordance with their respective terms. This Agreement may not be changed, amended, modified, altered or rescinded except upon the express written consent of both the President of the Company and you. (b) If any provision of this Agreement, or part thereof, is held invalid, void or voidable as against public policy or otherwise, the invalidity shall not affect other provisions, or parts thereof, which may be given effect without the invalid provision or part. To this extent, the provisions and parts thereof of this Agreement are declared to be severable. Any waiver of any provision of this Agreement shall not constitute a waiver of any other provision of this Agreement unless expressly so indicated otherwise. The language of all parts of this Agreement shall in all cases be construed according to its fair meaning and not strictly for or against either of the parties. (c) This Agreement and any claims arising out of this Agreement (or any other claims arising out of the relationship between the parties) shall be governed by and construed in accordance with the laws of the Commonwealth of Massachusetts and shall in all respects be interpreted, enforced and governed under the internal and domestic laws of Massachusetts, without giving effect to the principles of conflicts of laws of such state. Any claims or legal actions by one party against the other shall be commenced and maintained in state or federal court located in Massachusetts, and you hereby submit to the jurisdiction and venue of any such court. (d) You may not assign any of your rights or delegate any of your duties under this Agreement. The rights and obligations of the Company shall inure to the benefit of the Company's successors and assigns. 11. EFFECTIVE DATE: After signing this letter, you may revoke this Agreement for a period of seven (7) days following said execution. The Agreement shall not become effective or enforceable and no payments will be made until this revocation period has expired ("Effective Date"). 5 If this letter correctly states the agreement and understanding we have reached, please indicate your acceptance by countersigning the enclosed copy and returning it to me. Very truly yours, DATAWATCH CORPORATION /s/ Robert W. Hagger ------------------------------------- Robert W. Hagger, President I REPRESENT THAT I HAVE READ THE FOREGOING AGREEMENT, THAT I FULLY UNDERSTAND THE TERMS AND CONDITIONS OF SUCH AGREEMENT AND THAT I AM KNOWINGLY AND VOLUNTARILY EXECUTING THE SAME. IN ENTERING INTO THIS AGREEMENT, I DO NOT RELY ON ANY REPRESENTATION, PROMISE OR INDUCEMENT MADE BY THE COMPANY OR ITS REPRESENTATIVES WITH THE EXCEPTION OF THE CONSIDERATION DESCRIBED IN THIS DOCUMENT. Accepted and Agreed to: /s/ Linda Lammi - ------------------------------------- LINDA LAMMI Date: February 5, 2002 ------------------------------- 6 IF YOU DO NOT WISH TO USE THE 21-DAY PERIOD, PLEASE CAREFULLY REVIEW AND SIGN THIS DOCUMENT ---------------------------------------------- I, Linda Lammi, acknowledge that I was informed and understand that I have 21-days within which to consider the attached Severance Agreement and Release, have been advised of my right to consult with an attorney regarding such Agreement and have considered carefully every provision of the Agreement, and that after having engaged in those actions, I prefer to and have requested that I enter into the Agreement prior to the expiration of the 21-day period. Dated: February 5, 2002 /s/ Linda Lammi ------------------------ ------------------------------------ Linda Lammi Dated: February 5, 2002 /s/ Carol A. Beauchamp ------------------------ ------------------------------------ Witness: Carol A. Beauchamp 7 EX-10.3 5 ex10-3_11230.txt EXHIBIT 10.3 ------------ DATAWATCH CORPORATION 1996 STOCK PLAN 1. PURPOSE. The purpose of the Datawatch Corporation 1996 Stock Plan (the "Plan") is to encourage key employees of Datawatch Corporation (the "Company") and of any present or future parent or subsidiary of the Company (collectively, "Related Corporations") and other individuals who render services to the Company or a Related Corporation, by providing opportunities to participate in the ownership of the Company and its future growth through (a) the grant of options which qualify as "incentive stock options" ("ISOs") under Section 422(b) of the Internal Revenue Code of 1986, as amended (the "Code"); (b) the grant of options which do not qualify as ISOs ("Non-Qualified Options"); (c) awards of stock in the Company ("Awards"); and (d) opportunities to make direct purchases of stock in the Company ("Purchases"). Both ISOs and Non-Qualified Options are referred to hereafter individually as an "Option" and collectively as "Options." Options, Awards and authorizations to make Purchases are referred to hereafter collectively as "Stock Rights." As used herein, the terms "parent" and "subsidiary" mean "parent corporation" and "subsidiary corporation," respectively, as those terms are defined in Section 424 of the Code. 2. ADMINISTRATION OF THE PLAN. A. BOARD OR COMMITTEE ADMINISTRATION. The Plan shall (be administered by the Board of Directors of the Company (the "Board") or, subject to paragraph 2(D) (relating to compliance with Section 162(m) of the Code), by a committee appointed by the Board (the "Committee"). Hereinafter, all references in this Plan to the "Committee" shall mean the Board if no Committee has been appointed. Subject to ratification of the grant or authorization of each Stock Right by the Board (if so required by applicable state law), and subject to the terms of the Plan, the Committee shall have the authority to (i) determine to whom (from among the class of employees eligible under paragraph 3 to receive ISOs) ISOs shall be granted, and to whom (from among the class of individuals and entities eligible under paragraph 3 to receive Non-Qualified Options and Awards and to make Purchases) Non-Qualified Options, Awards and authorizations to make Purchases may be granted; (ii) determine the time or times at which Options or Awards shall be granted or Purchases made; (iii) determine the purchase price of shares subject to each Option or Purchase, which prices shall not be less than the minimum price specified in paragraph 6; (iv) determine whether each Option granted shall be an ISO or a Non-Qualified Option; (v) determine (subject to paragraph 7) the time or times when each Option shall become exercisable and the duration of the exercise period; (vi) extend the period during which outstanding Options may be exercised; (vii) determine whether restrictions such as repurchase options are to be imposed on shares subject to Options, Awards and Purchases and the nature of such restrictions, if any, and (viii) interpret the Plan and -2- prescribe and rescind rules and regulations relating to it. If the Committee determines to issue a Non-Qualified Option, it shall take whatever actions it deems necessary, under Section 422 of the Code and the regulations promulgated thereunder, to ensure that such Option is not treated as an ISO. The interpretation and construction by the Committee of any provisions of the Plan or of any Stock Right granted under it shall be final unless otherwise determined by the Board. The Committee may from time to time adopt such rules and regulations for carrying out the Plan as it may deem advisable. No member of the Board or the Committee shall be liable for any action or determination made in good faith with respect to the Plan or any Stock Right granted under it. B. COMMITTEE ACTIONS. The Committee may select one of its members as its chairman, and shall hold meetings at such time and places as it may determine. A majority of the Committee shall constitute a quorum and acts of a majority of the members of the Committee at a meeting at which a quorum is present, or acts reduced to or approved in writing by all the members of the Committee (if consistent with applicable state law), shall be the valid acts of the Committee. From time to time the Board may increase the size of the Committee and appoint additional members thereof, remove members (with or without cause) and appoint new members in substitution therefor, fill vacancies however caused, or remove all members of the Committee and thereafter directly administer the Plan. C. GRANT OF STOCK RIGHTS TO BOARD MEMBERS. Stock Rights may be granted to members of the Board. All grants of Stock Rights to members of the Board shall in all respects be made in accordance with the provisions of this Plan applicable to other eligible persons. Members of the Board who either (i) are eligible to receive grants of Stock Rights pursuant to the Plan or (ii) have been granted Stock Rights may vote on any matters affecting the administration of the Plan or the grant of any Stock Rights pursuant to the Plan, except that no such member shall act upon the granting to himself or herself of Stock Rights, but any such member may be counted in determining the existence of a quorum at any meeting of the Board during which action is taken with respect to the granting to such member of Stock Rights. D. PERFORMANCE-BASED COMPENSATION. The Board, in its discretion, may take such action as may be necessary to ensure that Stock Rights granted under the Plan qualify as "qualified performance-based compensation" within the meaning of Section 162(m) of the Code and applicable regulations promulgated thereunder ("Performance-Based Compensation"). Such action may include, in the Board's discretion, some or all of the following (i) if the Board determines that Stock Rights granted under the Plan generally shall constitute Performance-Based Compensation, the Plan shall be administered, to the extent required for such Stock Rights to constitute Performance-Based Compensation, by a Committee consisting solely of two or more "outside directors" (as defined in applicable -3- regulations promulgated under Section 162(m) of the Code), (ii) if any Non-Qualified Options with an exercise price less than the fair market value per share of Common Stock are granted under the Plan and the Board determines that such Options should constitute Performance-Based Compensation, such options shall be made exercisable only upon the attainment of a pre-established, objective performance goal established by the Committee, and such grant shall be submitted for, and shall be contingent upon shareholder approval and (iii) Stock Rights granted under the Plan may be subject to such other terms and conditions as are necessary for compensation recognized in connection with the exercise or disposition of such Stock Right or the disposition of Common Stock acquired pursuant to such Stock Right, to constitute Performance-Based Compensation. 3. ELIGIBLE EMPLOYEES AND OTHERS. ISOs may be granted only to employees of the Company or any Related Corporation. Non-Qualified Options, Awards and authorizations to make Purchases may be granted to any employee, officer or director (whether or not also an employee) or consultant of the Company or any Related Corporation. The Committee may take into consideration a recipient's individual circumstances in determining whether to grant a Stock Right. The granting of any Stock Right to any individual or entity shall neither entitle that individual or entity to, nor disqualify such individual or entity from, participation in any other grant of Stock Rights. 4. STOCK. The stock subject to Stock Rights shall be authorized but unissued shares of Common Stock of the Company, par value $.01 per share (the "Common Stock"), or shares of Common Stock reacquired by the Company in any manner. The aggregate number of shares which may be issued pursuant to the Plan is 494,4001, subject to adjustment as provided in paragraph 13. If any Option granted under the Plan shall expire or terminate for any reason without having been exercised in full or shall cease for any reason to be exercisable in whole or in part or shall be repurchased by the Company, the unpurchased shares of Common Stock subject to such Option shall again be available for grants of Stock Rights under the Plan. No employee of the Company or any Related Corporation may be granted Options to acquire, in the aggregate, more than 155,556 shares of Common Stock under the Plan during any fiscal year of the Company. If any Option granted under the Plan shall expire or terminate for any reason without having been exercised in full or shall cease for any reason to be exercisable in whole or in part or shall be repurchased by the Company, the shares subject to such Option shall be included in the determination of the aggregate number of shares of Common Stock deemed to have been granted to such employee under the Plan. 5. GRANTING OF STOCK RIGHTS. Stock Rights may be granted under the Plan at any time on or after December 10, 1996 and prior to December 10, 2006. The date of grant of a Stock Right under the Plan will be the date specified by the Committee at the time it grants the - -------- 1 An amendment increasing the number of shares available for issuance under the Plan from 366,667 to 494,400 was approved by the Board of Directors pursuant to a Meeting of the Board of Directors held on January 29, 2002 and was approved by the stockholders at the Annual Meeting of Stockholders held on March 8, 2002. -4- Stock Right; provided, however, that such date shall not be prior to the date on which the Committee acts to approve the grant. 6. MINIMUM OPTION PRICE; ISO LIMITATIONS. A. PRICE FOR NON-QUALIFIED OPTIONS, AWARDS AND PURCHASES. Subject to paragraph 2(D) (relating to compliance with Section 162(m) of the Code), the exercise price per share specified in the agreement relating to each Non-Qualified Option granted, and the purchase price per share of stock granted in any Award or authorized as a Purchase, under the Plan may be less than the fair market value of the Common Stock of the Company on the date of grant; provided that, in no event shall such exercise price or such purchase price be less than the minimum legal consideration required therefor under the laws of any jurisdiction in which the Company or its successors in interest may be organized. B. PRICE FOR ISOS. The exercise price per share specified in the agreement relating to each ISO granted under the Plan shall not be less than the fair market value per share of Common Stock on the date of such grant. In the case of an ISO to be granted to an employee owning stock possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Company or any Related Corporation, the price per share specified in the agreement relating to such ISO shall not be less than one hundred ten percent (110%) of the fair market value per share of Common Stock on the date of grant. For purposes of determining stock ownership under this paragraph, the rules of Section 424(d) of the Code shall apply. C. $100,000 ANNUAL LIMITATION ON ISO VESTING. Each eligible employee may be granted Options treated as ISOs only to the extent that, in the aggregate under this Plan and all incentive stock option plans of the Company and any Related Corporation, ISOs do not become exercisable for the first time by such employee during any calendar year with respect to stock having a fair market value (determined at the time the ISOs were granted) in excess of $100,000. The Company intends to designate any Options granted in excess of such limitation as Non-Qualified Options, and the Company shall issue separate certificates to the optionee with respect to Options that are Non-Qualified Options and Options that are ISOs. D. DETERMINATION OF FAIR MARKET VALUE. If, at the time an Option is granted under the Plan, the Company's Common Stock is publicly traded, "fair market value" shall be determined as of the date of grant or, if the prices or quotes discussed in this sentence are unavailable for such date, the last business day for which such prices or quotes are available prior to the date of grant and shall mean (i) the average (on that date) of the high and low prices of the Common Stock on the principal national securities exchange on which the Common Stock is traded, if the Common Stock is then traded on a national securities exchange; or (ii) the -5- last reported sale price (on that date) of the Common Stock on the Nasdaq National Market, if the Common Stock is not then traded on a national securities exchange; or (iii) the closing bid price (or average of bid prices) last quoted (on that date) by an established quotation service for over-the-counter securities, if the Common Stock is not reported on the Nasdaq National Market. If the Common Stock is not publicly traded at the time an Option is granted under the Plan, "fair market value" shall mean the fair value of the Common Stock as determined by the Committee after taking into consideration all factors which it deems appropriate, including, without limitation, recent sale and offer prices of the Common Stock in private transactions negotiated at arm's length. 7. OPTION DURATION. Subject to earlier termination as provided in paragraphs 9 and 10 or in the agreement relating to such Option, each Option shall expire on the date specified by the Committee, but not more than (i) ten years from the date of grant in the case of Options generally and (ii) five years from the date of grant in the case of ISOs granted to an employee owning stock possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Company or any Related Corporation, as determined under paragraph 6(B). Subject to earlier termination as provided in paragraphs 9 and 10, the term of each ISO shall be the term set forth in the original instrument granting such ISO, except with respect to any part of such ISO that is converted into a Non-Qualified Option pursuant to paragraph 16. 8. EXERCISE OF OPTION. Subject to the provisions of paragraphs 9 through 12, each Option granted under the Plan shall be exercisable as follows: A. VESTING. The Option shall either be fully exercisable on the date of grant or shall become exercisable thereafter in such installments as the Committee may specify. B. FULL VESTING OF INSTALLMENTS. Once an installment becomes exercisable, it shall remain exercisable until expiration or termination of the Option, unless otherwise specified by the Committee. C. PARTIAL EXERCISE. Each Option or installment may be exercised at any time or from time to time, in whole or in part, for up to the total number of shares with respect to which it is then exercisable. D. ACCELERATION OF VESTING. The Committee shall have the right to accelerate the date that any installment of any Option becomes exercisable; provided that the Committee shall not, without the consent of an optionee, accelerate the permitted exercise date of any installment of any Option granted to any employee as an ISO (and not previously converted into a Non-Qualified Option pursuant to paragraph 16) if such acceleration would violate the annual vesting limitation contained in Section 422(d) of the Code, as described in paragraph 6(C). -6- 9. TERMINATION OF EMPLOYMENT. Unless otherwise specified in the agreement relating to such ISO, if an ISO optionee ceases to be employed by the Company and all Related Corporations other than by reason of death or disability as defined in paragraph 10, no further installments of his or her ISOs shall become exercisable, and his or her ISOs shall terminate on the earlier of (a) three months after the date of termination of his or her employment, or (b) their specified expiration dates, except to the extent that such ISOs (or unexercised installments thereof) have been converted into Non-Qualified Options pursuant to paragraph 16. For purposes of this paragraph 9, employment shall be considered as continuing uninterrupted during any bona fide leave of absence (such as those attributable to illness, military obligations or governmental service) provided that the period of such leave does not exceed 90 days or, if longer, any period during which such optionee's right to reemployment is guaranteed by statute or by contract. A bona fide leave of absence with the written approval of the Committee shall not be considered an interruption of employment under this paragraph 9, provided that such written approval contractually obligates the Company or any Related Corporation to continue the employment of the optionee after the approved period of absence. ISOs granted under the Plan shall not be affected by any change of employment within or among the Company and Related Corporations, so long as the optionee continues to be an employee of the Company or any Related Corporation. Nothing in the Plan shall be deemed to give any grantee of any Stock Right the right to be retained in employment or other service by the Company or any Related Corporation for any period of time. 10. DEATH; DISABILITY. A. DEATH. If an ISO optionee ceases to be employed by the Company and all Related Corporations by reason of his or her death, any ISO owned by such optionee may be exercised, to the extent otherwise exercisable on the date of death, by the estate, personal representative or beneficiary who has acquired the ISO by will or by the laws of descent and distribution, until the earlier of (i) the specified expiration date of the ISO or (ii) 180 days from the date of the optionee's death. B. DISABILITY. If an ISO optionee ceases to be employed by the Company and all Related Corporations by reason of his or her disability, such optionee shall have the right to exercise any ISO held by him or her on the date of termination of employment, for the number of shares for which he or she could have exercised it on that date, until the earlier of (i) the specified expiration date of the ISO or (ii) 180 days from the date of the termination of the optionee's employment. For the purposes of the Plan, the term "disability" shall mean "permanent and total disability" as defined in Section 22(e)(3) of the Code or any successor statute. 11. ASSIGNABILITY. No ISO shall be assignable or transferable by the optionee except by will or by the laws of descent and distribution, and during the lifetime of the optionee shall be -7- exercisable only by such optionee. Stock Rights other than ISOs shall be transferable to the extent set forth in the agreement relating to such Stock Right. 12. TERMS AND CONDITIONS OF OPTIONS. Options shall be evidenced by instruments (which need not be identical) in such forms as the Committee may from time to time approve. Such instruments shall conform to the terms and conditions set forth in paragraphs 6 through 11 hereof and may contain such other provisions as the Committee deems advisable which are not inconsistent with the Plan, including restrictions applicable to shares of Common Stock issuable upon exercise of Options. The Committee may specify that any Non-Qualified Option shall be subject to the restrictions set forth herein with respect to ISOs, or to such other termination and cancellation provisions as the Committee may determine. The Committee may from time to time confer authority and responsibility on one or more of its own members and/or one or more officers of the Company to execute and deliver such instruments. The proper officers of the Company are authorized and directed to take any and all action necessary or advisable from time to time to carry out the terms of such instruments. 13. ADJUSTMENTS. Upon the occurrence of any of the following events, an optionee's rights with respect to Options granted to such optionee hereunder shall be adjusted as hereinafter provided, unless otherwise specifically provided in the written agreement between the optionee and the Company relating to such Option: A. STOCK DIVIDENDS AND STOCK SPLITS. If the shares of Common Stock shall be subdivided or combined into a greater or smaller number of shares or if the Company shall issue any shares of Common Stock as a stock dividend on its outstanding Common Stock, the number of shares of Common Stock deliverable upon the exercise of Options shall be appropriately increased or decreased proportionately, and appropriate adjustments shall be made in the purchase price per share to reflect such subdivision, combination or stock dividend. B. CONSOLIDATIONS OR MERGERS. If the Company is to be consolidated with or acquired by another entity in a merger or other reorganization in which the holders of the outstanding voting stock of the Company immediately preceding the consummation of such event, shall, immediately following such event, hold, as a group, less than a majority of the voting securities of the surviving or successor entity, or in the event of a sale of all or substantially all of the Company's assets or otherwise (each, an "Acquisition"), the Committee or the board of directors of any entity assuming the obligations of the Company hereunder (the "Successor Board"), shall, as to outstanding Options, either (i) make appropriate provision for the continuation of such Options by substituting on an equitable basis for the shares then subject to such Options either (a) the consideration payable with respect to the outstanding shares of Common Stock in connection with the Acquisition, (b) shares of stock of the surviving or successor corporation or (c) such other securities as the Successor Board deems appropriate, the fair market value of which shall not materially exceed the fair market value of the shares of -8- Common Stock subject to such Options immediately preceding the Acquisition; or (ii) upon written notice to the optionees, provide that all Options must be exercised, to the extent then exercisable or to be exercisable as a result of the Acquisition, within a specified number of days of the date of such notice, at the end of which period the Options shall terminate; or (iii) terminate all Options in exchange for a cash payment equal to the excess of the fair market value of the shares subject to such Options (to the extent then exercisable or to be exercisable as a result of the Acquisition) over the exercise price thereof. C. RECAPITALIZATION OR REORGANIZATION. In the event of a recapitalization or reorganization of the Company (other than a transaction described in subparagraph B above) pursuant to which securities of the Company or of another corporation are issued with respect to the outstanding shares of Common Stock, an optionee upon exercising an Option shall be entitled to receive for the purchase price paid upon such exercise the securities he or she would have received if he or she had exercised such Option prior to such recapitalization or reorganization. D. MODIFICATION OF ISOS. Notwithstanding the foregoing, any adjustments made pursuant to subparagraphs A, B or C with respect to ISOs shall be made only after the Committee, after consulting with counsel for the Company, determines whether such adjustments would constitute a "modification" of such ISOs (as that term is defined in Section 424 of the Code) or would cause any adverse tax consequences for the holders of such ISOs. If the Committee determines that such adjustments made with respect to ISOs would constitute a modification of such ISOs or would cause adverse tax consequences to the holders, it may refrain from making such adjustments. E. DISSOLUTION OR LIQUIDATION. In the event of the proposed dissolution or liquidation of the Company, each Option will terminate immediately prior to the consummation of such proposed action or at such other time and subject to such other conditions as shall be determined by the Committee. F. ISSUANCES OF SECURITIES. Except as expressly provided herein, no issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares subject to Options. No adjustments shall be made for dividends paid in cash or in property other than securities of the Company. G. FRACTIONAL SHARES. No fractional shares shall be issued under the Plan and the optionee shall receive from the Company cash in lieu of such fractional shares. -9- H. ADJUSTMENTS. Upon the happening of any of the events described in subparagraphs A, B or C above, the class and aggregate number of shares set forth in paragraph 4 hereof that are subject to Stock Rights which previously have been or subsequently may be granted under the Plan shall also be appropriately adjusted to reflect the events described in such subparagraphs. The Committee or the Successor Board shall determine the specific adjustments to be made under this paragraph 13 and, subject to paragraph 2, its determination shall be conclusive. 14. MEANS OF EXERCISING OPTIONS. An Option (or any part or installment thereof) shall be exercised by giving written notice to the Company at its principal office address, or to such transfer agent as the Company shall designate. Such notice shall identify the Option being exercised and specify the number of shares as to which such Option is being exercised, accompanied by full payment of the purchase price therefor either (a) in United States dollars in cash or by check, (b) at the discretion of the Committee, through delivery of shares of Common Stock having a fair market value equal as of the date of the exercise to the cash exercise price of the Option, (c) at the discretion of the Committee, by delivery of the grantee's personal recourse note bearing interest payable not less than annually at no less than 100% of the lowest applicable Federal rate, as defined in Section 1274(d) of the Code, (d) at the discretion of the Committee and consistent with applicable law, through the delivery of an assignment to the Company of a sufficient amount of the proceeds from the sale of the Common Stock acquired upon exercise of the Option and an authorization to the broker or selling agent to pay that amount to the Company, which sale shall be at the participant's direction at the time of exercise, or (e) at the discretion of the Committee, by any combination of (a), (b), (c) and (d) above. If the Committee exercises its discretion to permit payment of the exercise price of an ISO by means of the methods set forth in clauses (b), (c), (d) or (e) of the preceding sentence, such discretion shall be exercised in writing at the time of the grant of the ISO in question. The holder of an Option shall not have the rights of a shareholder with respect to the shares covered by such Option until the date of issuance of a stock certificate to such holder for such shares. Except as expressly provided above in paragraph 13 with respect to changes in capitalization and stock dividends, no adjustment shall be made for dividends or similar rights for which the record date is before the date such stock certificate is issued. 15. TERM AND AMENDMENT OF PLAN. This Plan was adopted by the Board on December 10, 1996, subject, with respect to the validation of ISOs granted under the Plan, to approval of the Plan by the stockholders of the Company at the next Meeting of Stockholders or, in lieu thereof, by written consent. If the approval of stockholders is not obtained prior to December 10, 1997, any grants of ISOs under the Plan made prior to that date will be rescinded. The Plan shall expire at the end of the day on December 9, 2006 (except as to Options outstanding on that date). Subject to the provisions of paragraph 5 above, Options may be granted under the Plan prior to the date of stockholder approval of the Plan. The Board may terminate or amend the Plan in any respect at any time, except that, without the approval of the stockholders obtained within 12 months before or after the Board adopts a resolution authorizing any of the following actions: (a) the total number of shares that may be issued under the Plan -10- may not be increased (except by adjustment pursuant to paragraph 13); (b) the provisions of paragraph 3 regarding eligibility for grants of ISOs may not be modified; (c) the provisions of paragraph 6(B) regarding the exercise price at which shares may be offered pursuant to ISOs may not be modified (except by adjustment pursuant to paragraph 13); and (d) the expiration date of the Plan may not be extended. Except as otherwise provided in this paragraph 15, in no event may action of the Board or stockholders alter or impair the rights of a grantee, without such grantee's consent, under any Stock Right previously granted to such grantee. 16. MODIFICATIONS OF ISOS; CONVERSION OF ISOS INTO NON-QUALIFIED OPTIONS. Subject to paragraph 13(D), without the prior written consent of the holder of an ISO, the Committee shall not alter the terms of such ISO (including the means of exercising such ISO) if such alteration would constitute a modification (within the meaning of Section 424(h)(3) of the Code). The Committee, at the written request or with the written consent of any optionee, may in its discretion take such actions as may be necessary to convert such optionee's ISOs (or any installments or portions of installments thereof) that have not been exercised on the date of conversion into Non-Qualified Options at any time prior to the expiration of such ISOs, regardless of whether the optionee is an employee of the Company or a Related Corporation at the time of such conversion. Such actions may include, but shall not be limited to, extending the exercise period or reducing the exercise price of the appropriate installments of such ISOs. At the time of such conversion, the Committee (with the consent of the optionee) may impose such conditions on the exercise of the resulting Non-Qualified Options as the Committee in its discretion may determine, provided that such conditions shall not be inconsistent with this Plan. Nothing in the Plan shall be deemed to give any optionee the right to have such optionee's ISOs converted into Non-Qualified Options, and no such conversion shall occur until and unless the Committee takes appropriate action. Upon the taking of such action, the Company shall issue separate certificates to the optionee with respect to Options that are Non-Qualified Options and Options that are ISOs. 17. APPLICATION OF FUNDS. The proceeds received by the Company from the sale of shares pursuant to Options granted and Purchases authorized under the Plan shall be used for general corporate purposes. 18. NOTICE TO COMPANY OF DISQUALIFYING DISPOSITION. By accepting an ISO granted under the Plan, each optionee agrees to notify the Company in writing immediately after such optionee makes a Disqualifying Disposition (as described in Sections 421, 422 and 424 of the Code and regulations thereunder) of any stock acquired pursuant to the exercise of ISOs granted under the Plan. A Disqualifying Disposition is generally any disposition occurring on or before the later of (a) the date two years following the date the ISO was granted or (b) the date one year following the date the ISO was exercised. 19. WITHHOLDING OF ADDITIONAL INCOME TAXES. Upon the exercise of a Non-Qualified Option, the transfer of a Non-Qualified Stock Option pursuant to an arm's-length transaction, the grant of an Award, the making of a Purchase of Common Stock for less than its fair market value, the making of a Disqualifying Disposition (as defined in paragraph 18), the vesting or transfer of restricted stock or securities acquired on the exercise of an Option -11- hereunder, or the making of a distribution or other payment with respect to such stock or securities, the Company may withhold taxes in respect of amounts that constitute compensation includible in gross income. The Committee in its discretion may condition (i) the exercise of an Option, (ii) the transfer of a Non-Qualified Stock Option, (iii) the grant of an Award, (iv) the making of a Purchase of Common Stock for less than its fair market value, or (v) the vesting or transferability of restricted stock or securities acquired by exercising an Option, on the grantee's making satisfactory arrangement for such withholding. Such arrangement may include payment by the grantee in cash or by check of the amount of the withholding taxes or, at the discretion of the Committee, by the grantee's delivery of previously held shares of Common Stock or the withholding from the shares of Common Stock otherwise deliverable upon exercise of a Option shares having an aggregate fair market value equal to the amount of such withholding taxes. 20. GOVERNMENTAL REGULATION. The Company's obligation to sell and deliver shares of the Common Stock under this Plan is subject to the approval of any governmental authority required in connection with the authorization, issuance or sale of such shares. Government regulations may impose reporting or other obligations on the Company with respect to the Plan. For example, the Company may be required to send tax information statements to employees and former employees that exercise ISOs under the Plan, and the Company may be required to file tax information returns reporting the income received by grantees of Options in connection with the Plan. 21. GOVERNING LAW. The validity and construction of the Plan and the instruments evidencing Stock Rights shall be governed by the laws of the State of Delaware, or the laws of any jurisdiction in which the Company or its successors in interest may be organized. -----END PRIVACY-ENHANCED MESSAGE-----