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, 2006

OR

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

COMMISSION FILE NUMBER:      000-19960

 

DATAWATCH CORPORATION

(Exact name of registrant as specified in its charter)

 

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

 

271 MILL ROAD
QUORUM OFFICE PARK
CHELMSFORD, MASSACHUSETTS 01824
(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 o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated o         Accelerated o         Non-accelerated x

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

 

DATAWATCH CORPORATION

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2006

TABLE OF CONTENTS

PART I.  FINANCIAL INFORMATION

					Page #
Item 1.			Consolidated Condensed Financial Statements (unaudited)
a)			Consolidated Condensed Balance Sheets:
			March 31, 2006 and September 30, 2005		3
b)			Consolidated Condensed Statements of Operations:
			Three and Six Months Ended March 31, 2006 and 2005		4
c)			Consolidated Condensed Statements of Cash Flows:
			Six Months Ended March 31, 2006 and 2005		5
d)			Notes to Consolidated Condensed Financial Statements		6
Item 2.			Management’s Discussion and Analysis of Financial Condition and Results of Operations		16
Item 3.			Quantitative and Qualitative Disclosures About Market Risk		27
Item 4.			Controls and Procedures		27
PART II. OTHER INFORMATION
Item 1.			Legal Proceedings		28
Item 1A.			Risk Factors		28
Item 4.			Submission of Matters to a Vote of Security Holders		28
Item 6.			Exhibits		29
SIGNATURES					30

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PART I. — Financial Information

Item 1:  Financial Statements

DATAWATCH CORPORATION
CONSOLIDATED CONDENSED BALANCE SHEETS
(Unaudited)

 

		March 31,			September 30,
		2006			2005
ASSETS
CURRENT ASSETS:
Cash and equivalents		$	5,122,086		$	4,900,873
Restricted cash		—			268,299
Accounts receivable, net		3,657,919			4,097,283
Inventories		36,130			54,712
Prepaid expenses		559,533			541,108
Total current assets		9,375,668			9,862,275
Property and equipment, net		1,163,879			516,412
Goodwill		1,630,646			1,630,646
Other intangible assets, net		1,040,074			1,250,825
Other long term assets		153,414			152,098
		$	13,363,681		$	13,412,256
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable		$	1,059,373		$	1,042,755
Accrued expenses		1,848,581			2,013,994
Deferred revenue		2,712,138			2,921,519
Escrow for Mergence shareholders		—			128,224
Total current liabilities		5,620,092			6,106,492
COMMITMENTS AND CONTINGENCIES (Note 7)
SHAREHOLDERS’ EQUITY:
Common stock, par value $.01— 20,000,000 shares authorized;
issued, 5,512,153 shares and 5,383,084 shares, respectively;
outstanding, 5,497,907 shares and 5,368,838 shares, respectively		55,122			53,831
Additional paid-in capital		22,127,070			21,957,409
Accumulated deficit		(13,896,273		)	(14,187,048		)
Accumulated other comprehensive loss		(401,942		)	(378,040		)
		7,883,977			7,446,152
Less treasury stock, at cost — 14,246 shares		(140,388		)	(140,388		)
Total shareholders’ equity		7,743,589			7,305,764
		$	13,363,681		$	13,412,256

 

The accompanying notes are an integral part of these consolidated condensed financial statements.

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DATAWATCH CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(unaudited)

 

		Three Months Ended March 31,						Six Months Ended March 31,
		2006			2005			2006			2005
REVENUE:
Software licenses and subscriptions		$	3,444,402		$	3,307,340		$	6,599,119		$	6,524,278
Maintenance and services		1,949,201			1,801,407			3,542,041			3,671,797
Total Revenue		5,393,603			5,108,747			10,141,160			10,196,075
COSTS AND EXPENSES:
Cost of software licenses and subscriptions		590,975			566,311			1,163,865			1,160,226
Cost of maintenance and services		963,710			840,503			1,804,359			1,756,440
Sales and marketing		2,180,804			2,183,138			4,149,189			4,361,538
Engineering and product development		427,617			548,143			855,370			1,098,106
General and administrative		1,022,400			986,836			1,910,595			2,015,910
Total costs and expenses		5,185,506			5,124,931			9,883,378			10,392,220
INCOME (LOSS) FROM OPERATIONS		208,097			(16,184		)	257,782			(196,145		)
Interest expense		(422		)	(752		)	(943		)	(1,465		)
Interest income and other income (expense), net		18,960			23,700			33,936			50,592
INCOME (LOSS) BEFORE INCOME TAXES		226,635			6,764			290,775			(147,018		)
Provision for income taxes		—			—			—			—
NET INCOME (LOSS)		$	226,635		$	6,764		$	290,775		$	(147,018	)
Net income (loss) per share — Basic		$	0.04		$	0.00		$	0.05		$	(0.03	)
Net income (loss) per share — Diluted		$	0.04		$	0.00		$	0.05		$	(0.03	)
Weighted-Average
Shares Outstanding — Basic		5,491,529			5,306,869			5,451,114			5,304,309
Weighted-Average
Shares Outstanding — Diluted		5,834,482			5,847,500			5,809,270			5,304,309

 

The accompanying notes are an integral part of these consolidated condensed financial statements.

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DATAWATCH CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(unaudited)

 

		Six Months Ended March 31,
		2006			2005
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)		$	290,775		$	(147,018	)
Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities:
Depreciation and amortization		390,166			329,604
Allowances for doubtful accounts and sales returns		(133,564		)	(33,673		)
Stock-based compensation expense		21,695			—
Loss on disposition of equipment		6,935			20,502
Changes in current assets and liabilities:
Accounts receivable		576,161			(405,600		)
Inventories		18,341			(12,848		)
Prepaid expenses and other		(44,895		)	(150,124		)
Proceeds from tenant improvements, offset against deferred rent		139,489			—
Accounts payable and accrued expenses		(320,085		)	(329,844		)
Deferred revenue		(187,074		)	90,646
Cash provided by (used in) operating activities		757,944			(638,355		)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment		(791,450		)	(146,110		)
Proceeds from sale of equipment		2,085			2,831
Restricted cash		140,075			1,417
Capitalized software development costs		—			(9,040		)
Other assets		(1,595		)	(2,179		)
Cash used in investing activities		(650,885		)	(153,081		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from exercise of stock options		149,255			10,323
Cash provided by financing activities		149,255			10,323
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND EQUIVALENTS		(35,101		)	60,745
INCREASE (DECREASE) IN CASH AND EQUIVALENTS		221,213			(720,368		)
CASH AND EQUIVALENTS, BEGINNING OF PERIOD		4,900,873			4,260,632
CASH AND EQUIVALENTS, END OF PERIOD		$	5,122,086		$	3,540,264
SUPPLEMENTAL INFORMATION:
Interest paid		$	943		$	1,465

 

The accompanying notes are an integral part of these consolidated condensed financial statements.

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DATAWATCH CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited)

Note 1. Summary of Significant Accounting Policies

Basis of Presentation and Principles of Consolidation

The accompanying 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 accounting principles generally accepted in the United States of America 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, 2005 filed with the Securities and Exchange Commission (the “SEC”). All significant intercompany accounts and transactions have been eliminated.

In the opinion of management, the accompanying consolidated condensed 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.

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

Revenue Recognition

The Company has two types of software product offerings: Enterprise Software and Desktop and Server Software. Enterprise Software products are generally sold directly to end-users. The Company sells its Desktop and Server Software products directly to end-users and through distributors and resellers. Sales to distributors and resellers accounted for approximately 32% and 31%, respectively, of total sales for the three months ended March 31, 2006 and 2005, and 33% and 31%, respectively, of total sales for the six months ended March 31, 2006 and 2005. Revenue from the sale of all software products is generally recognized at the time of shipment, provided there are no uncertainties surrounding product acceptance, the fee is fixed or determinable, collection is considered probable, persuasive evidence of the arrangement exists and there are no significant obligations remaining. Both types of the Company’s software product offerings are “off-the-shelf” as such term is defined by Statement of Position No. 97-2, “Software Revenue Recognition.”  The Company’s software products can be installed and used by customers on their own with little or no customization required. Multi-user licenses marketed by the Company are sold as a right to use the number of licenses and license fee revenue is recognized upon delivery of all software required to satisfy the number of licenses sold. Upon delivery, the licensing fee is payable without further delivery obligations to the Company.

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

The Company also sells its Enterprise Software using a subscription model. At the time a customer enters into a binding agreement to purchase a subscription, the customer is invoiced for an initial 90 day service period and an account receivable and deferred revenue are recorded. Beginning on the date the software is installed at the customer site and available for use by the customer, and provided that all other criteria for revenue recognition are met, the deferred revenue amount is recognized ratably over the period the service is provided. The customer is then invoiced every 90 days and revenue is recognized ratably over the period the service is provided. The subscription arrangement includes software, maintenance and unspecified future upgrades including major version upgrades. The initial subscription rate is the same as the renewal rate. Subscriptions can be cancelled by the customer at any time by providing 90 days written notice.

The Company’s software products are sold under warranty against certain defects in material and workmanship for a period of 30 to 90 days from the date of purchase. Certain software products, including desktop versions of Monarch, Monarch Data Pump and VorteXML sold directly to end-users, include a guarantee under which such customers may return products within 30 to 60 days for a full refund. Additionally, the Company provides its distributors with stock-balancing rights and applies the guidance found in Statement of Financial Accounting Standards (“SFAS”) No. 48, “Revenue Recognition when Right of Return Exists.” Revenue from the sale of software products to distributors and resellers is recognized at the time of shipment providing all other criteria for revenue recognition as stated above are met and (i) the distributor or reseller is unconditionally obligated to pay for the products, including no contingency as to product resale, (ii) the distributor or reseller has independent economic substance apart from the Company, (iii) the Company is not obligated for future performance to bring about product resale, and (iv) the amount of future returns can be reasonably estimated. The Company’s experience and history with its distributors and resellers allows for reasonable estimates of future returns. Among other things, estimates of potential future returns are made based on the inventory levels at the various distributors and resellers, which the Company monitors frequently. Once the estimates of potential future returns from all sources are made, the Company determines if it has adequate returns reserves to cover anticipated returns and the returns reserve is adjusted as required. Adjustments are recorded as increases or decreases in revenue in the period of adjustment. Actual returns have historically been within the range estimated by management. The Company’s returns reserve was $89,376 and $123,315 as of March 31, 2006 and September 30, 2005, respectively.

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Stock-Based Compensation

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

In November 2005, the FASB issued FASB Staff Position No. FAS 123(R)-3 “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards.” The Company is considering whether to adopt the alternative transition method provided in the FASB Staff Position (“FSP”) for calculating the tax effects of stock-based compensation pursuant to SFAS 123(R). The alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (“APIC pool”) related to the excess tax benefits available to absorb tax deficiencies recognized subsequent to the adoption of SFAS 123(R). The Company is currently evaluating which transition method it will use for calculating its APIC Pool. An entity may take up to one year from the later of its initial adoption of SFAS 123(R) or the effective date of this FSP to evaluate its available transition alternatives and make its one-time election. Until and unless the Company elects the transition method described in the FSP, the transition method provided in FAS123(R) is being followed. The Company expects to complete its evaluation by September 30, 2006.

On October 1, 2005 (the first day of the Company’s 2006 fiscal year), the Company adopted SFAS 123(R). The Company adopted SFAS 123(R) using a modified prospective application method, as permitted under SFAS 123(R). Accordingly, prior period amounts have not been restated. Under this approach, the Company is required to record compensation cost for all share-based awards granted after the date of adoption and for the unvested portion of previously granted stock-based awards at the date of adoption.

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

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

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Prior to the adoption of SFAS 123(R), the Company applied APB 25 to account for stock-based awards. The following table illustrates the effect on earnings and earnings per share had compensation cost for the employee stock-based awards been recorded in the three and six months ended March 31, 2005 based on the fair value method under SFAS 123(R):

		Three Months Ended			Six Months Ended
		March 31, 2005			March 31, 2005
		(unaudited)			(unaudited)
Net loss, as reported		$	6,764		$	(147,018	)
Add: Total stock-based employee compensation expense included in net income		—			—
Less: Total stock-based employee compensation expense determined under fair value based method for all awards		(74,327		)	(141,540		)
Pro forma net loss		$	(67,563	)	$	(288,558	)
Net loss per share:
Basic - as reported		$	0.00		$	(0.03	)
Basic - pro forma		$	(0.01	)	$	(0.05	)
Diluted - as reported		$	0.00		$	(0.03	)
Diluted - pro forma		$	(0.01	)	$	(0.05	)

 

Beginning with the 2006 fiscal year, with the adoption of SFAS 123(R), the Company recorded stock-based compensation expense for the fair value of stock options. Stock-based compensation expense for the three and six months ended March 31, 2006 was $14,719 and $21,696, respectively, included in the following expense categories:

		Three Months Ended			Six Months Ended
		March 31, 2006			March 31, 2006
		(unaudited)			(unaudited)
Sales and marketing		$	4,909		$	7,446
Engineering and product development		$	1,963		$	2,978
General and administrative		7,847			11,271
		$	14,719		$	21,695

 

The Company’s stock compensation plans provide for the granting of restricted shares and either incentive or nonqualified stock options to employees and non-employee directors. Options are subject to terms and conditions determined by the Compensation Committee of the Board of Directors, and generally vest over a three year period beginning three months from date of grant and expire ten years from date of grant.

The Company uses the Black-Scholes option-pricing model to calculate the fair value of options. The key assumptions for this valuation method include the expected life of the option, stock price volatility, risk-free interest rate, dividend yield, exercise price and forfeiture rate. The weighted-average fair values of the options granted under the stock options plans for the three and six months ended March 31, 2006 were $2.70 and $3.15, respectively.

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Many of these assumptions are judgmental and highly sensitive in the determination of compensation expense. The table below indicates the weighted-average key assumptions used in the option valuation calculations for options granted for the six months ended March 31, 2006:

 

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

The following table summarizes information about the Company’s stock option plans for the six months ended March 31, 2006.

		Options		Weighted-Average
		Outstanding		Exercise Price
Outstanding, October 1, 2005		912,042		$	2.39
Granted		80,000		4.22
Canceled		(4,323	)	5.80
Exercised		(129,069	)	1.16
Outstanding, March 31, 2006		858,650		$	2.73
Exercisable, March 31, 2006		783,237		$	2.59

 

Concentration of Credit Risks and Major Customers

The Company sells its products and services to U.S. and non-U.S. dealers and other software distributors, as well as to end users, under customary credit terms. Two customers, Ingram Micro Inc. and Tech Data Product Management, individually accounted for 15% and 12%, respectively, of total revenue for the three months ended March 31, 2006 and 20% and 7%, respectively, of total revenue for the three months ended March 31, 2005.  Ingram Micro Inc. and Tech Data Product Management, individually accounted for 15% and 12%, respectively, of total revenue for the six months ended March 31, 2006 and 21% and 6%, respectively, of total revenue for the six months ended March 31, 2005. Ingram Micro Inc. and Tech Data Product Management accounted for 16% and 13%, respectively, of outstanding gross trade receivables as of March 31, 2006 and 17% and 13%, respectively, of outstanding gross trade receivables as of September 30, 2005. The Company sells to Ingram Micro Inc. and Tech Data Product Management under a distribution agreement, which automatically renews for successive one-year terms unless terminated. Other than these two customers, no other customer constitutes a significant portion (more than 10%) of sales or accounts receivable. The Company performs ongoing credit

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evaluations of its customers and generally does not require collateral. Allowances are provided for anticipated doubtful accounts and sales returns.

Goodwill and Other Intangible Assets

Other intangible assets consist of capitalized software cost, acquired technology, patents, customer relationships, trademarks and trade names acquired through business combinations. The values allocated to these intangible assets are amortized using the straight-line method over the estimated useful life of the related asset and are recorded in cost of sales for software license and subscriptions. Intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable and an impairment loss is recognized when it is probable that the estimated cash flows are less than the carrying amount of the asset.

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

Note 2.   Goodwill and Other Intangible Assets, Net

Other intangible assets, net were comprised of the following as of March 31, 2006 (unaudited) and September 30, 2005:

 

						March 31, 2006									September 30, 2005
Identified Intangible Asset				Weighted Average Useful Life in Years		Gross Carrying Amount			Accumulated Amortization			Net Carrying Amount			Gross Carrying Amount			Accumulated Amortization			Net Carrying Amount
Capitalized software				3		$	1,665,895		$	(1,608,503	)	$	57,392		$	1,665,895		$	(1,483,015	)	$	182,880
Purchased software				5		520,000			(174,722		)	345,278			520,000			(119,722		)	400,278
Patents				20		159,967			(12,403		)	147,564			159,967			(8,389		)	151,578
Customer lists				4		130,000			(52,812		)	77,188			130,000			(36,563		)	93,437
Non-compete agreements				5		100,000			(32,500		)	67,500			100,000			(22,500		)	77,500
Trademarks				indefinite		345,152			—			345,152			345,152			—			345,152
Total						$	2,921,014		$	(1,880,940	)	$	1,040,074		$	2,921,014		$	(1,670,189	)	$	1,250,825

 

For the three months ended March 31, 2006 and 2005, amortization expense related to identified intangible assets was $97,252 and $114,552, respectively, and $210,751 and $229,993 for the six months ended March 31, 2006 and 2005, respectively.

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The estimated future amortization expense related to other intangible assets as of March 31, 2006 was as follows:

 

 

The carrying amount of goodwill as of March 31, 2006 was $1,630,646.

Note 3.   Inventories

Inventories consisted of the following at March 31, 2006 and September 30, 2005:

 

 

Note 4.   Deferred Revenue

Deferred revenue consisted of the following at March 31, 2006 and September 30, 2005:

 

 

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

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

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Note 5. Comprehensive Income (Loss)

The following table sets forth the reconciliation of net income (loss) to comprehensive income (loss):

 

Accumulated other comprehensive loss reported in the consolidated condensed balance sheets consists only of foreign currency translation adjustments.

Note 6.   Basic and Diluted Net Income (Loss) Per Share

Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding during the quarter. Diluted net income (loss) per share reflects the impact, when dilutive, of the exercise of options and warrants using the treasury stock method.

Potential dilutive common stock options aggregating 197,608 and 105,870 shares for the three months ended March 31, 2006 and 2005, respectively, and 207,608 and 659,533 shares for the six months ended March 31, 2006 and 2005, respectively, have been excluded from the computation of diluted net income (loss) per share because their inclusion would be antidilutive.

Note 7.   Commitments and Contingencies

In May 2004, the Company was served with a charge of discrimination filed with the Massachusetts Commission Against Discrimination (MCAD) by a then current employee. In addition to the Company, the employee named an executive of the Company as well as the employee’s former supervisor as defendants. The employee alleged that her former supervisor engaged in sexually harassing conduct. The employee accused the executive of engaging in retaliation upon learning of the employee’s complaint. The complaint was withdrawn from the MCAD in August 2004, with the stated intent of pursuing the claim in Superior Court in the state of Massachusetts. To date, the Company has not been notified of any further filing. Given the current status of the claim, the Company is unable to predict the ultimate outcome. The Company intends to vigorously defend the claims.

From time to time, the Company receives other claims and may be party to other actions that arise in the normal course of business. The Company does not believe the eventual outcome of any pending matters will have a material effect on the Company’s consolidated financial condition or results of operations.

Note 8.   Segment Information

The Company has determined that it has only one reportable segment. The Company’s chief operating decision maker, as defined, (determined to be the Chief Executive Officer) does not manage any part of the Company separately, and the allocation of resources and assessment of performance is based solely on the Company’s consolidated operations and operating results.

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The following table presents information about the Company’s revenue by product lines:

		Three Months				Six Months
		Ended March 31,				Ended March 31,
		2006		2005		2006		2005
Desktop and Server Software (primarily Monarch)		58	%	56	%	59	%	56	%
Report Management Solutions (including Datawatch|ES & iMergence)		18	%	15	%	16	%	15	%
Service Management Solutions (including Visual|QSM & Visual|HD)		24	%	29	%	25	%	29	%
Total		100	%	100	%	100	%	100	%

 

The Company’s operations are conducted in the U.S. and internationally (principally in the United Kingdom). The following tables present information about the Company’s geographic operations:

					International
					(Principally			Intercompany
		Domestic			U.K.)			Eliminations			Total
Total Revenue
Three months ended March 31, 2006		$	3,827,608		$	1,793,708		$	(227,713	)	$	5,393,603
Three months ended March 31, 2005		3,426,496			1,964,140			(281,889		)	5,108,747
Six months ended March 31, 2006		$	7,158,060		$	3,464,721		$	(481,621	)	$	10,141,160
Six months ended March 31, 2005		6,578,567			4,158,330			(540,822		)	10,196,075
Total Operating Income (Loss)
Three months ended March 31, 2006		$	564,877		$	(356,780	)				$	208,097
Three months ended March 31, 2005		201,131			(217,315		)				(16,184		)
Six months ended March 31, 2006		$	909,895		$	(652,113	)				$	257,782
Six months ended March 31, 2005		141,721			(337,866		)				(196,145		)
Non-current Assets
At March 31, 2006		$	3,899,705		$	88,308		$	—		$	3,988,013
At September 30, 2005		3,456,146			93,835			—			3,549,981

 

Note 9.   Subsequent Events

On March 10, 2006, the Company entered into an agreement to purchase certain assets from ClearStory Systems, Inc. (the “Seller”), which comprise of the Seller’s Integrated Document Archiving and Retrieval Systems (“IDARS”) business. Under the terms of the asset purchase agreement the Company will purchase the IDARS products and other intellectual property, be assigned certain customer contracts, and assume certain liabilities related to Seller’s IDARS business. The Company will pay a cash consideration of approximately $4.3 million and an estimate of direct costs of $200,000, plus an 18-month earn-out calculated by multiplying the net revenues derived from the IDARS product sales by 30%. The transaction currently is expected to be completed in May 2006 and will be accounted for using the purchase method of accounting.

On April 20, 2006, the Company entered into a one-year Loan and Security Agreement (“Loan Agreement”) with a Bank. The loan agreement establishes two revolving $1.5 million lines of credit, for a total of $3.0 million. The Company can borrow under the first line of credit based on a formula percentage of the Company’s accounts receivable balance. There is no borrowing base formula for the second

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line of credit. The first line of credit bears an interest rate equal to the prime rate plus 0.50% and the second line of credit bears an interest rate equal to the prime rate plus 1.00%. Amounts borrowed under the loan agreement are secured by all of the assets of the Company, including their intellectual property. Additionally, the loan agreement requires the Company to maintain certain specified cash flow and liquidity ratios.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

GENERAL

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 Quarterly Report on Form 10-Q that are not historical facts may constitute forward looking statements and are made under the safe harbor provisions of The Private Securities Litigation Reform Act of 1995. The Company cautions readers not to place undue reliance on any such forward looking-statements, which speak only as of the date they are made. The Company disclaims any obligation, except as specifically required by law and the rules of the Securities and Exchange Commission, to publicly update or revise any such statements to reflect any change in the Company’s expectations or in events, conditions or circumstances on which any such statements may be based, or that may affect the likelihood that actual results will differ from those set forth in the forward-looking statements. The Company’s actual results of operations and financial condition have varied and may in the future vary significantly from those stated in any forward looking statements. Factors that may cause such differences include, without limitation, the risks, uncertainties and other information discussed in Part II, Item 1A and within this Quarterly 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.

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 content management and reporting, business intelligence, data replication, service management and help desk markets.

Datawatch’s principal products included in Desktop and Server Software, Report Management and Business Service Management Solutions are:  Monarch, a desktop report mining and business intelligence application that lets users extract and manipulate data from ASCII report files, PDF files or HTML files produced on any mainframe, midrange, client/server or PC system; Monarch Data Pump, a data replication and migration tool that offers a shortcut for populating and refreshing data marts and data warehouses, for migrating legacy data into new applications and for providing automated delivery of reports in a variety of formats via email; Monarch|RMS, a web-based report mining and analysis solution that integrates with any existing COLD/ERM, document or content management archiving solution; Datawatch|ES, a web-enabled business information portal, providing complete report management, business intelligence and content management, and the ability to analyze data within reports derived from existing reporting systems with no new programming or report writing; Datawatch|Researcher, a .NET based content and data aggregation solution that searches inter-related data, documents, and communications scattered over multiple and disparate repositories, then merges and analyzes the results into comprehensive actionable case records; Visual|QSM, a fully internet-enabled IT support solution that incorporates workflow and network management capabilities and provides web access to multiple databases via a standard browser; Visual|Help Desk or Visual|HD, a web-based help desk and call center solution operating on the IBM Lotus Domino platform; and VorteXML, a data transformation product for the emerging XML market that easily and quickly converts structured text output from any system into valid XML for web services and more using any DTD or XDR schema without programming.

The Company uses both a subscription sales model and a perpetual sales model for the sale of its enterprise products. The Company continues to offer its enterprise products through the sale of perpetual licenses and introduced the subscription pricing model to allow customers to begin using the Company’s products at a lower initial cost of software acquisition. Subscriptions automatically renew unless terminated with 90 days notice. During fiscal 2004, 2005 and the six months ended March 31, 2006, revenues under the subscription model were not significant, however, customer interest in the model and sales under the model have been increasing.

CRITICAL ACCOUNTING POLICIES

In the preparation of financial statements and other financial data, management applies certain accounting policies to transactions that, depending on choices made by management, can result in different outcomes. In order for a reader to understand the following information regarding the financial performance and condition of the Company, an understanding

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of those accounting policies is important. Certain of those policies are comparatively more important to the Company’s financial results and condition than others. The policies that the Company believes are most important for a reader’s understanding of the financial information provided in this report are described below.

Revenue Recognition, Allowance for Bad Debts and Returns Reserve

The Company has two types of software product offerings: Enterprise Software and Desktop and Server Software. Enterprise Software products are generally sold directly to end-users. The Company sells its Desktop and Server Software products directly to end-users and through distributors and resellers. Sales to distributors and resellers accounted for approximately 32% and 31%, respectively, of total sales for the three months ended March 31, 2006 and 2005, and 33% and 31%, respectively, of total sales for the six months ended March 31, 2006 and 2005. Revenue from the sale of all software products is generally recognized at the time of shipment, provided there are no uncertainties surrounding product acceptance, the fee is fixed or determinable, collection is considered probable, persuasive evidence of the arrangement exists and there are no significant obligations remaining. Both types of the Company’s software product offerings are “off-the-shelf” as such term is defined by Statement of Position No. 97-2, “Software Revenue Recognition.”  The Company’s software products can be installed and used by customers on their own with little or no customization required. Multi-user licenses marketed by the Company are sold as a right to use the number of licenses and license fee revenue is recognized upon delivery of all software required to satisfy the number of licenses sold. Upon delivery, the licensing fee is payable without further delivery obligations of the Company.

Desktop and Server Software products are generally not sold in multiple element arrangements. Accordingly, the price paid by the customer is considered the vendor specific objective evidence (“VSOE”) of fair value for those products.

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

The Company also sells its Enterprise Software using a subscription model. At the time a customer enters into a binding agreement to purchase a subscription, the customer is invoiced for an initial 90 day service period and an account receivable and deferred revenue are recorded. Beginning on the date the software is installed at the customer site and available for use by the customer, and provided that all other criteria for revenue recognition are met, the deferred revenue amount is recognized ratably over the period the service is provided. The customer is then invoiced every 90 days and revenue is recognized ratably over the period the service is provided. The subscription arrangement includes software, maintenance and unspecified future upgrades including major version upgrades. The initial subscription rate is the same as the renewal rate. Subscriptions can be cancelled by the customer at any time by providing 90 days written notice.

The Company’s software products are sold under warranty against certain defects in material and workmanship for a period of 30 to 90 days from the date of purchase. Certain software products, including desktop versions of Monarch, Monarch Data Pump, and VorteXML sold directly to end-users, include a guarantee under which such customers may return products within 30 to 60 days for a full refund. Additionally, the Company provides its distributors with stock-balancing rights and applies the guidance found in SFAS No. 48, “Revenue Recognition when Right of Return Exists.”  Revenue from the sale of software products to distributors and resellers is recognized at the time of shipment providing all other criteria for revenue recognition as stated above are met and (i) the distributor or reseller is unconditionally obligated to pay for the products, including no contingency as to product resale, (ii) the distributor or reseller has independent economic substance

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apart from the Company, (iii) the Company is not obligated for future performance to bring about product resale, and (iv) the amount of future returns can be reasonably estimated. The Company’s experience and history with its distributors and resellers allows for reasonable estimates of future returns. Among other things, estimates of potential future returns are made based on the inventory levels at the various distributors and resellers, which the Company monitors frequently. Once the estimates of potential future returns from all sources are made, the Company determines if it has adequate returns reserves to cover anticipated returns and the returns reserve is adjusted as required. Adjustments are recorded as increases or decreases in revenue in the period of adjustment. Actual returns have historically been within the range estimated by the Company. The Company’s returns reserve was $89,376 and $123,315 as of March 31, 2006 and September 30, 2005, respectively.

The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of customers to make required payments. The Company analyzes accounts receivable and the composition of the accounts receivable aging, historical bad debts, customer creditworthiness, current economic trends, foreign currency exchange rate fluctuations and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. Based upon the analysis and estimates of the uncollectibility of its accounts receivable, the Company records an increase in the allowance for doubtful accounts when the prospect of collecting a specific account receivable becomes doubtful. Actual results could differ from the allowances for doubtful accounts recorded, and this difference may have a material effect on the Company’s financial position and results of operations. The Company’s allowance for doubtful accounts was $193,389 and $293,943 as of March 31, 2006 and September 30, 2005, respectively.

Deferred Tax Assets

The Company has deferred tax assets related to net operating loss carryforwards and tax credits that expire at different times through and until 2020. Significant judgment is required in determining the Company’s provision for income taxes, the carrying value of deferred tax assets and liabilities and the valuation allowance recorded against net deferred tax assets. Factors such as future reversals of deferred tax assets and liabilities, projected future taxable income, changes in enacted tax rates and the period over which the Company’s deferred tax assets will be recoverable are considered in making these determinations. The Company’s domestic operations have been profitable during the past four years while international operations have continued to generate operating losses. Accordingly, management does not believe the deferred tax assets are more likely than not to be realized and a full valuation allowance, previously provided against the deferred tax assets, continues to be provided. Management evaluates the realizability of the deferred tax assets quarterly and, if current economic conditions change or future results of operations are better than expected, future assessments may result in the Company concluding that it is more likely than not that all or a portion of the deferred tax assets are realizable. If this conclusion were reached, the valuation allowance against deferred tax assets would be reduced resulting in a tax benefit being recorded for financial reporting purposes. Total net deferred tax assets subject to a valuation allowance was approximately $4.7 million as of March 31, 2006.

Capitalized Software Development Costs

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

Goodwill, Other Intangible Assets and Other Long-Lived Assets

The Company performs an evaluation of whether goodwill is impaired annually or when events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Fair value is determined using market comparables for similar businesses or forecasts of discounted future cash flows. The Company also reviews other intangible assets and other long-lived assets when indication of potential impairment exists, such as a significant reduction in cash flows associated with the assets. Should the fair value of the Company’s long-lived assets decline because of reduced operating performance, market declines, or other indicators of impairment, a charge to operations for impairment may be necessary.

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Accounting for stock-based compensation

With the adoption of SFAS No. 123(R) on October 1, 2005, the Company is required to record the grant date fair value of stock-based compensation awards as compensation costs. In order to determine the fair value of stock options on the date of grant, the Company applies the Black-Scholes option-pricing model. Inherent in this model are assumptions related to expected stock-price volatility, option life, risk-free interest rate and dividend yield. While the risk-free interest rate and dividend yield are less subjective assumptions, typically based on factual data derived from public sources, the expected stock-price volatility and option life assumptions require a greater level of judgment which makes them critical accounting estimates.

The Company uses an expected stock-price volatility assumption that is a combination of both current and historical implied volatilities of the underlying stock which are obtained from public data sources. The Company believes this approach results in a reasonable estimate of volatility. For stock option grants issued during the three ended March 31, 2006, The Company used a weighted-average expected stock-price volatility of 96% based upon the implied volatility at the time of issuance.

With regard to the weighted-average option life assumption, The Company considers the exercise behavior of past grants and models the pattern of aggregate exercises. Patterns are determined on specific criteria of the aggregate pool of optionees including the reaction to vesting, realizable value and short-time-to-maturity effect. For stock option grants issued during the three months ended March 31, 2006, The Company used a weighted-average expected option life assumption of 5 years.

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RESULTS OF OPERATIONS

Three and Six Months Ended March 31, 2006 and 2005

The following table sets forth certain statements of operations data as a percentage of total revenues for the periods indicated. The data has been derived from the unaudited consolidated condensed financial statements contained in this Quarterly Report on Form 10-Q. The operating results for any period should not be considered indicative of the results expected for any future period. This information should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2005.

		Three Months Ended March 31,				Six Months Ended March 31,
		2006		2005		2006		2005
REVENUE:
Software licenses and subscriptions		63.9	%	64.7	%	65.1	%	64.0	%
Maintenance and services		36.1	%	35.3	%	34.9	%	36.0	%
Total Revenue		100.0	%	100.0	%	100.0	%	100.0	%
COSTS AND EXPENSES:
Cost of software licenses and subscriptions		11.0	%	11.1	%	11.5	%	11.4	%
Cost of maintenance and services		17.9	%	16.5	%	17.8	%	17.2	%
Sales and marketing		40.4	%	42.7	%	40.9	%	42.8	%
Engineering and product development		7.9	%	10.7	%	8.4	%	10.8	%
General and administrative		19.0	%	19.3	%	18.8	%	19.8	%
Total costs and expenses		96.2	%	100.3	%	97.4	%	102.0	%
INCOME (LOSS) FROM OPERATIONS		3.8	%	(0.3	)%	2.6	%	(2.0	)%
Interest expense		0.0	%	0.0	%	0.0	%	0.0	%
Interest income and other income (expense), net		0.3	%	0.4	%	0.3	%	0.5	%
INCOME (LOSS) BEFORE INCOME TAXES		4.1	%	0.1	%	2.9	%	(1.5	)%
Provision for income taxes		0.0	%	0.0	%	0.0	%	0.0	%
NET INCOME (LOSS)		4.1	%	0.1	%	2.9	%	(1.5	)%

 

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Comparison of the Three Months Ended March 31, 2006 and March 31, 2005

Total Revenues

The following table presents total revenue, change in total revenue and total revenue growth for the three months ended March 31, 2006 and 2005:

 

Software license and subscription revenue for the three months ended March 31, 2006 was $3,444,402 or approximately 64% of total revenue, as compared to $3,307,340 or approximately 65% of total revenue for the three months ended March 31, 2005. This represents an increase of $137,062 or approximately 4% from fiscal 2005 to fiscal 2006. The overall increase in license revenue for the three months ended March 31, 2006 consists of a $218,000 increase in Desktop and server license revenue, a $90,000 increase in the Report Management license and subscription revenue, offset by a $(170,000) decrease in Business Service Management license revenue. The Company also attributes the overall decrease in Business Service Management license revenue to foreign exchange variances as the US dollar continued to strengthen against most European currencies, as compared to the same period in the prior year.

Maintenance and services revenue for the three months ended March 31, 2006 was $1,949,201 or approximately 36% of total revenue, as compared to $1,801,407 or approximately 35% of total revenue for the three months ended March 31, 2005. This represents an increase of $147,794 or approximately 8% from fiscal 2005 to fiscal 2006. The overall increase in maintenance and service revenue consists of a $58,000 increase in Desktop and server revenue, a $97,000 increase in Report Management revenue (which includes maintenance for Datawatch|ES, Monarch|RMS, Datawatch|Researcher and iMergence iStore) and a decrease in Business Service Management maintenance and services revenues of $(7,000). The increase in maintenance and services revenue was the result of an improvement in billable hours for consultant services for work performed during the quarter. Overall service revenue increased approximately $144,000. The Company also attributes the overall revenue increase was offset by unfavorable exchange rates during the quarter as the US dollar continued to strengthen against most European currencies, as compared to the same period in the prior year.

Costs and Operating Expenses

The following table presents costs and operating expenses, changes in costs and operating expenses and costs and operating expenses growth for the three months ended March 31, 2006 and 2005:

 

Cost of software licenses and subscriptions for the three months ended March 31, 2006 was $590,975 or

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approximately 17% of software license and subscription revenues, as compared to $566,311 or approximately 17% of software license revenues for the three months ended March 31, 2005. Costs of software licenses and subscriptions as a percentage of software licenses and subscription revenue remained consistent quarter over quarter.

Cost of maintenance and services for the three months ended March 31, 2006 was $963,710 or approximately 49% of maintenance and service revenues, as compared to $840,503 or approximately 47% of maintenance and service revenues, for the three months ended March 31, 2005. For the three months ended March 31, 2006, gross margins on maintenance and services decreased as compared the three months ended March 31, 2005, primarily due to the increase in turnover within the professional services group during the quarter ended March 31, 2005. The headcount of the professional services group for the quarter ended March 31, 2006 increased approximately 23% as compared to the headcount as of March 31, 2005.

Sales and marketing expenses were $2,180,804 for the three months ended March 31, 2006, which is relatively consistent with $2,183,138 for the three months ended March 31, 2005. For the remainder of fiscal 2006, the Company will continue to pursue additional investments within the sales and marketing programs to improve upon the Company’s top-line revenue growth initiatives.

Engineering and product development expenses were $427,617 for the three months ended March 31, 2006, which represents a decrease of $(120,526) or approximately 22% from $548,143 for the three months ended March 31, 2005. This decrease is primarily attributable to the continued transitioning of existing outsourced development activities in-house. The Company will continue to use third-party development activities, in conjunction with its own in-house development team in the foreseeable future, but will rely more on the Company’s in-house engineering and product development capabilities, which will translate to an increase in product development output at a reduction in overall costs.

General and administrative expenses were $1,022,400 for the three months ended March 31, 2006, which is relatively consistent as compared to $986,836 for the three months ended March 31, 2005.

Net income for the three months ended March 31, 2006 was $226,635 as compared to a net income of $6,764 for the three months ended March 31, 2005.

Comparison of the Six Months Ended March 31, 2006 and March 31, 2005

Total Revenues

The following table presents total revenue, change in total revenue and total revenue growth for the six months ended March 31, 2006 and 2005:

 

Software license and subscription revenue for the six months ended March 31, 2006 increased by $74,841 or 1% as compared to the six months ended March 31, 2005. The overall increase in license revenue for the six months ended March 31, 2006 consists of a $211,000 increase in Desktop and server license revenue, a $9,000 increase in the Report Management license and subscription revenue, offset by a $(144,000) decrease in Business Service Management license revenue. The Company also attributes this overall revenue decrease in Business Service Management license and subscription revenue to foreign exchange variances as the US dollar continued to strengthen against most European currencies, as compared to the same period in prior year.

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