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Datawatch Corporation (NASDAQ:DWCH)

F3Q09 Earnings Call

August 4, 2009 2:00 pm ET

Executives

Dan Incropera - Controller

Ken Bero - President and CEO

John Kitchen - SVP and Chief Marketing Officer

Murray Fish - CFO and VP of Finance

Analysts

Jim Stone – PSK Advisors

Jim Lieberman - Wells Fargo

Operator

Welcome to the Datawatch third quarter 2009 earnings conference call. At this time, all participants are in listen-only mode. (Operator Instructions) It is now my pleasure to introduce your host, Mr. Dan Incropera. Thank you, Mr. Incropera, you may begin.

Dan Incropera

Thank you. Good afternoon, everyone. Thank you joining us today for the Datawatch Corporation third quarter fiscal year 2009 earnings conference call. I am Dan Incropera, Vice President and Controller at Datawatch. Joining me today is Ken Bero, our President and CEO; John Kitchen, Senior Vice President and Chief Marketing Office and Murray Fish, our Chief Financial Officer and Vice President of Finance.

You can obtain a copy of our earnings release which was distributed earlier today by e-mailing us at investor@datawatch.com. This release will also be posted on our website at www.datawatch.com.

Let me first outline for you this afternoon’s agenda. Following this introduction, Ken will provide some general comments on the business. Murray will then present a summary of our third quarter of fiscal year 2009 financial results, which will be followed by closing remarks from Ken. Upon conclusion of our prepared comments, we will open up the call for questions and answers.

Before we begin, I would like to review our Safe Harbor statement with you. While we do not share projections of our future performance, we do need to remind you that any statements we make that do not describe historical facts including, without limitation, statements concerning expected expense savings, market trends, product introductions, acquisitions and general market conditions, may constitute forward looking statements. Any such statements are based on our current expectations that are subject to a number of risks and uncertainties that may cause actual results to differ materially from current expectations.

For more information, I refer you to the descriptions of these risk factors found in our earnings release, as well as the company’s annual report on Form 10-K for the year ended September 30, 2008 and other publically available documents filed with the SEC. Any forward-looking statements should be considered in light of those factors.

I will now turn the call over to Ken for a discussion of business results.

Ken Bero

Thanks, Dan. Good afternoon, everyone. As mentioned, I will share some opening comments about our Q3 performance and following my remarks Murray Fish, our Chief Financial Officer, will provide more detailed information regarding our financials for the quarter. John Kitchen, our Chief Marketing Officer, is in attendance for the call and following Murray’s remarks, we will open the meeting up for discussion.

Revenues for the quarter were slightly below $4.8 million. As mentioned in the press release Q3 revenues were approximately 17% below results from a year ago. While revenue comparisons to a year ago are worthwhile, I think it is more important to understand the current revenue trends. The Q3 results were lower than revenues during the second quarter of this year although our actual Q3 results exceeded our own internal forecasts.

The worldwide recession continues to impact our business. Discretionary spending continues to be tight and actual expenditures continue to receive unprecedented levels of scrutiny and review. These factors had a significant impact on Datawatch’s Monarch business during the second quarter, particularly in the U.S. markets. While corporate software and other IT products remains controlled, the downward trend we experienced in Q2 regarding Monarch business in the U.S. leveled off and was flat in Q3 as compared to the previous quarter.

We were encouraged by this trend. Although Monarch sales in the U.S. remain stable versus Q2, we did see declines in Monarch sales in our international markets particularly in the U.K. and Europe. Overall we were pleased with the Monarch results for the quarter.

Our enterprise business was in line with our expectations. While the average deal size for Q3 enterprise solutions was lower than Q2 we actually closed more deals. In addition, we procured enterprise orders for all of our product lines; intelligence, archive and service management solutions.

In April we successfully launched QSM for the Web, a browser based offering for the service management market. QSM for the Web was introduced at the [SIT] Show in London and received excellent reviews from both existing and potential customers.

A web based version of our QSM service management offering has been something our customer base has been seeking for quite some time. We are very excited about its potential and during the quarter we had several existing customers take advantage of our introductory pricing and purchase QSM upgrades to their current installations. These purchases occurred in both the United Kingdom and Australia.

We also had stronger services quarter. Along with installations for BI and service management solutions, several BDS customers initiated upgrade projects moving their current versions of BDS to newer versions.

Income from operations for the quarter was solidly in the black. As mentioned in the press release, our income for the quarter exceeded year-ago results on less revenues. During the quarter we adjusted our headcount to meet expected revenues. Excluding the effects of last quarter’s non-cash write downs for goodwill and the trademark impairment charge, Datawatch has returned higher operating income year-to-date than last year on less revenue in a very difficult economy. In addition, we continue to build our cash position and have no debt on the balance sheet.

Overall, we were pleased with the quarter’s outcome. With the product investments we have made over the previous year our solutions offerings have never been stronger. The organization is solid and the sales team has proved its effectiveness in positioning how we can solve significant problems for our customers. We believe that our solutions position us well during this economic period and for continued growth as the economy turns around.

Murray will now provide some additional information regarding our financials.

Murray Fish

Thank you Ken. Good afternoon. For those of you who have not seen our results released earlier today, our total revenues for the third quarter fiscal year 2009 were $4.8 million as compared to $5.8 million for the third quarter fiscal 2008. Revenue decreased by $1 million or 17% quarter-over-quarter.

For the third quarter of fiscal 2009 revenues from licenses and subscriptions were $2.6 million as compared to $3.1 million for the third quarter fiscal year 2008. As a percentage of revenue software license and subscription sales accounted for 55% of revenues for the third quarter fiscal 2009 and 54% of revenue for the third quarter of fiscal 2008.

For the third quarter fiscal 2009 revenues from maintenance and services were $2.2 million compared to $2.7 million for the third quarter of fiscal 2008. As a percentage of revenue, maintenance and services accounted for 45% of revenue for the third quarter fiscal 2009 and 46% for the third quarter fiscal 2008.

Business intelligence solutions, content management solutions and service management solutions product revenues were 72%, 17% and 11% of total revenues for the third quarter of fiscal year 2009 as compared to 67%, 16% and 17% for the third quarter fiscal 2008. Domestic revenue and international revenue were 78% and 22% of revenue for the third quarter fiscal 2009 as compared to 70% and 30% for the third quarter of fiscal year 2008.

Gross margins on software licenses and subscriptions were 78% for the third quarter fiscal 2009 as compared to 82% for the third quarter fiscal year 2008. Gross margins for maintenance and services were 64% for the third quarter fiscal year 2009 and 61% for the third quarter of fiscal year 2008.

Overall, total gross margins were 72% for the third quarter fiscal 2009 as compared to 73% for the third quarter fiscal 2008. Sales and marketing expenses decreased by $645,000 or 30% in the third quarter of fiscal year 2009 over third quarter fiscal year 2008. Sales and marketing expenses as a percentage of revenue were 32% for the third quarter fiscal 2009 as compared to 37% for the third quarter fiscal year 2008. This decrease was primarily attributable to lower headcount and related costs such as commissions and travel.

Engineering and product development expenses decreased by $221,000 or 31% in the third quarter fiscal year 2009 over the third quarter fiscal 2008. Engineering and product development expenses as a percentage of revenues were 10% for the third quarter fiscal 2009 as compared to 12% for the third quarter of fiscal year 2008. The decrease in engineering and product development expenses is primarily due to capitalized development costs of new product releases.

General and administrative expenses decreased by $226,000 or 17% in the third quarter fiscal 2009 over the third quarter of fiscal 2008. General and administrative expenses as a percentage of revenues were 23% for both the third quarter fiscal year 2009 and the third quarter of fiscal year 2008. This decrease was primarily attributable to lower professional service fees.

There were no additional non-cash impairment charges for the third quarter ended June 30, 2009. Other income/expense decreased by $146,000 in the third quarter of fiscal year 2009 over the third quarter fiscal year 2008. The provision for income tax expense decreased by $17,000 in the third quarter fiscal 2009 over the third quarter fiscal 2008 due to the reversal of tax provisions related to goodwill which was written off as a result of the impairment in the second quarter of 2009.

Net income for the third quarter fiscal year 2009 was $275,000 or $0.05 per diluted share as compared to net income of $91,000 or $0.02 per diluted share for the third quarter fiscal year 2008.

For the year-to-date results, our total revenues for the first nine months fiscal 2009 were $15.1 million as compared to $17.7 million for the first nine months of fiscal year 2008. Revenue decreased by $2.7 million or 15% due to the worldwide recession and lower currency exchange rates.

For the first nine months of fiscal 2009 revenues from licenses and subscriptions were $8.4 million as compared to $9.6 million for the first nine months of fiscal year 2008. As a percentage of revenue, software license and subscription sales accounted for 56% of revenue for the first nine months of fiscal year 2009 and 54% of revenue for the first nine months of fiscal year 2008.

For the first nine months fiscal 2009 revenues from services were $6.6 million as compared to $8.1 million for the first nine months of fiscal 2008. As a percentage of revenue, maintenance and services accounted for 44% of revenues for the first nine months of fiscal year 2009 and 46% of revenues for the first nine months of fiscal year 2008.

Business intelligence solutions, content management solutions and service management solutions product revenues were 72%, 16% and 12% of total revenues for the first nine months of fiscal year 2009 as compared to 67%, 15% and 18% for the first nine months of fiscal year 2008. Domestic revenue and international revenue were 77% and 23% of total revenues for the first nine months of 2009 as compared to 69% and 31% for the first nine months of fiscal year 2008.

Gross margins for software licenses and subscriptions were 81% for the first nine months of fiscal year 2009 as compared to 83% for the first nine months of fiscal 2008. Gross margins for maintenance and services were 63% for the first nine months of fiscal year 2009 and 59% for the first nine months of fiscal 2008.

Overall, total gross margins were 73% for the first nine months of fiscal year 2009 as compared to 72% for the first nine months of fiscal year 2008.

Sales and marketing expenses decreased by $1,319,000 or 21% for the first nine months of fiscal year 2009 over the first nine months of fiscal year 2008. Sales and marketing expenses as a percentage of revenues were 33% for the first nine months of fiscal 2009 as compared to 36% for the first nine months of fiscal year 2008. This decrease was primarily attributable to lower headcount and related costs and lower consulting costs.

Engineering and product development expenses decreased by $510,000 or 22% in the first nine months of fiscal year 2009 over the first nine months of fiscal year 2008. Engineering and product development expenses as a percentage of revenues were 12% for the first nine months of fiscal year 2009 as compared to 13% for the first nine months of fiscal year 2008. The decrease in engineering and product development expenses was primarily attributable to capitalized development costs and new product releases.

General and administrative expenses decreased by $520,000 or 14% in the first nine months of fiscal year 2009 over the first nine months of fiscal year 2008. General and administrative expenses as a percentage of revenues were 22% for the first nine months of fiscal 2009 as compared to 21% for the first nine months of fiscal year 2008. This decrease was primarily attributable to lower professional service fees.

The company recorded a non-cash impairment charge in the quarter ended March 31, 2009 of approximately $6.4 million related to full impairment of its goodwill and indefinite [inaudible] trademark.

Other income/expense decreased by $128,000 or 53% in the first nine months of fiscal 2009 over the first nine months of fiscal year 2008. The provision benefit for income tax expense decreased by $432,000 in the first nine months of fiscal year 2009 over the first nine months of fiscal year 2008 due to the reversal of a tax provision related to goodwill which was written off as a result of the impairment in the second quarter of fiscal year 2009.

The net loss for the first nine months of fiscal year 2009 including the non-cash impairment charge was $5,194,000 or negative $0.88 per diluted share as compared to net income of $421,000 or $0.07 per diluted share for the first nine months of fiscal year 2008. Excluding the non-cash impairment charge and trademark impairment charge, net of tax, net income would have been $889,000 or $0.15 per diluted share for the first nine months of fiscal year 2009.

As of June 30, 2009 the company had $5,444,000 in net cash and cash equivalents, an increase of $998,000 or 22% compared to June 30, 2008.

Ken?

Ken Bero

Thanks Murray. Now what I would like to do is open the call for any questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Jim Stone – PSK Advisors.

Jim Stone – PSK Advisors

Could you give us some feeling of what actually was underneath the difference between Q2 and Q3? Was there a difference in old customers versus new customers, etc. so we can get a better feel for what is happening?

Ken Bero

I think the biggest change was, as I said, the U.S. Monarch revenues were about the same as Q2. So we were pleased with that. That was really very good. We did see a little bit of slippage in the international markets with regard to Monarch. The other place that causes us really to be below Q2 was we had in particular one very large, but we had several large enterprise deals, that happened in Q2 and I’m picking up one in particular that included services and was over $300,000. I think it was almost $350,000 by the time it was all implemented that we knew at the beginning of the quarter was not going to be repeated. We didn’t have anything that large in the pipeline for this quarter even though we did sell actually more enterprise deals than we did last quarter.

The international Monarch revenue we lost a little bit relative to Q2. Then the enterprise business, although I will tell you we actually were slightly ahead of our enterprise forecast in terms of total revenues for the quarter. So we were pretty happy with the enterprise outcome.

Jim Stone – PSK Advisors

What about old customers versus new customers?

Ken Bero

Well it is a mix particularly on the BI side of things. We have some solutions that just make a whole lot of sense with new customers. So we have made some inroads with our Data Pump ETL products with new customers. We have made some headwind with new ones. The implementations for service management, for example, were back into the existing customer base. The BDS solutions we sold were back into an existing base that picked up some more features from the product they wanted to take advantage of and the larger BI deals were also back into the existing base.

Jim Stone – PSK Advisors

I’m thinking more of the ratio of revenue from new customers versus revenue from old customers. Has that ratio changed much?

Ken Bero

I don’t think so. I think John would like to address this.

John Kitchen

I think a couple of things are happening here. What we are seeing here is especially in our Monarch business, as Ken said it leveled off. What we are seeing from a street level basis is that many of our large existing customers, as opposed to cutting back we are starting to see that business coming back now with new full copy sales. We also just beginning this last quarter are starting to see the emergence of new customers who are buying copies to evaluate moving forward.

The typical Monarch buying cycle for new customers is they will buy one or two copies, evaluate it and then will buy more copies down the road. We are starting to see some of those new customers starting to come across again. Last quarter that was an encouraging trend. New names are starting to pop up from the Monarch side.

On the enterprise side again what is encouraging is yes some of the enterprise business is to existing customers with upgrades but we are also starting to see new names cropping into the sales. So, without going into specific numbers the answer is yes, not only are existing customers starting to buy but we are starting to see some interest again from new customers.

Jim Stone – PSK Advisors

Can you give us any reasons or stories relative to why new guys are selecting you rather than the competition, etc.? Is that changing any or is that the same reason we have heard before?

John Kitchen

I think the answers are what we have been talking about for awhile now. The fact that we have low cost, high value solutions that make it easier for people to get answers without a lot of custom database work, without a lot of time consuming IT involvement to give people the answers they need. Again, I think people are recognizing they need to get answers. They need to get business answers to help do their jobs better. To help them cut costs. To help them manage their business better. To help operations. The people we are talking to, especially new people are saying well this is really a low cost, easy way for us to get those answers in this economy right now.

I think the same way we have been selling ourselves in the past, an easy way to get at the data, an easy way to get answers, a cost saving way for them to get the answers they need without a lot of expense, that message is resonating with our customer base and new customers are coming in when we talk to them.

Operator

The next question comes from the line of Jim Lieberman - Wells Fargo.

Jim Lieberman - Wells Fargo

This was a real demonstration of fabulous management through very challenging times. I keep focusing on the enterprise business as a segment that could really propel you to the next level. Do you think you are approaching that point where you could hit this inflection point where you could see significant growth irrespective of economic conditions?

Ken Bero

It really would be great. I think it is going to come from a couple of different directions. For one, the product line has never been stronger. We have invested in the product over the last year to 18 months and it is across all of the products. I think the launch of the service management product is going to re-invigorate that market and that customer base for us. It was interesting at the [SIT] Show, not only did the existing customers come in and they were excited about it, which we expected, but it also gave us an opportunity talk to essentially brand new customers which we have not done for quite some time as far as that offering. We are seeing the investment in the product we have made. I think that is going to come to fruition.

The other factor that goes along side that is the team itself, the sales team. They have been in place now for a fairly substantial period of time. A good portion of them particularly in the U.S. have been there over a year. They understand the product. They understand the value proposition. They understand where in the organization we effectively sit. So they are being far more effective in terms of taking the message into those accounts and yes the economy is still difficult and tough. There is no question about it. It just goes to spending controls, scrutiny and the rest of it.

As I said, we met our enterprise forecast. We closed all of the deals that we were working on. We feel pretty good about that. I think overall that piece of the business continues to get stronger. The pipelines continue to build. There are customers that are interested in our solutions because they work in the environment. We feel good about both pieces of the business.

Jim Lieberman - Wells Fargo

My observation is you really are seeing results and it is partly the value proposition, the quality of the product and also the way in which your marketing staff has begun to sort of improve its presentation and gaining more traction in the market place.

John Kitchen

I would add two comments to what Ken said. Thanks for those comments. Number one, just in case for those of you who don’t know what the [SIT] Show is, that was a help desk service management show that was in London in the spring time where we presented the visual QSM for the Web product for the first time. As Ken said, we have a lot of excitement among not only our existing base but also new customers.

The second comment I would like to make to your comment about our message being clearer than ever. In the market we have worked very hard at that. I think that our message of business intelligence made easy, our ability now to go to market and to get a hearing, we are finding potential customers and corporations are much more open to hearing our message now even at higher levels in terms of leveraging their existing infrastructure, BI that doesn’t involve the torture and has the advantage of being up and running, making yourself productive faster and getting answers faster. Those kinds of messages, which we have been sort of beating about for the past year, are really starting to resonate now in the market place and people are starting to listen to us. I think that does bode well for our chances in the future.

Operator

We have no further questions in the queue at this time.

Ken Bero

Let me kind of summarize then. I appreciate everybody being on the call. I would conclude with the economy continues to be pretty difficult and we were pleased with the Q3 performance. We continue to show that our solutions continue to provide meaningful value to the market and our customers. While the recession may be bottoming out, business still remains tough. We therefore continue to be proactive regarding expense management. While remaining prudent regarding the business we are also optimistic and have confidence that we will effectively weather this storm period. We are in a strong position to take advantage of the expected future opportunities. Thank you for your continued interest in Datawatch.

Operator

Ladies and gentlemen this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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