SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
Commission File No. 0-23611
DSET Corporation
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(Exact Name of Registrant as Specified in Its Charter)
New Jersey 22-3000022
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
1011 US Highway 22, Bridgewater, New Jersey 08807
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(Address of Principal Executive Offices) (Zip Code)
(908) 526-7500
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(Registrant's Telephone Number,
Including Area Code)
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:
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Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of July 31, 1998:
Class Number of Shares
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Common Stock, no par value 9,542,613
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DSET CORPORATION
TABLE OF CONTENTS
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Page
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PART I. FINANCIAL INFORMATION......................................... 1
Item 1. Financial Statements................................. 1
Consolidated Balance Sheets as of June 30,1998
(unaudited) and December 31, 1997......................... 2
Consolidated Statements of Income for the Three Months
Ended June 30, 1998 and 1997 (unaudited).................. 3
Consolidated Statements of Income for the Six Months
Ended June 30, 1998 and 1997 (unaudited).................. 4
Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 1998 and 1997 (unaudited).................. 5
Notes to Consolidated Financial Statements (unaudited)...... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................. 11
Results of Operations....................................... 12
Liquidity and Capital Resources............................. 15
PART II. OTHER INFORMATION............................................ 17
Item 2.Changes in Securities and Use of Proceeds............. 17
Item 5.Other Information..................................... 18
Item 6.Exhibits and Reports on Form 8-K...................... 18
SIGNATURES............................................................ 19
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
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<PAGE>
<TABLE>
<CAPTION>
DSET Corporation
Consolidated Balance Sheets
June 30, 1998 December 31, 1997
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(unaudited)
Assets
Current assets:
<S> <C> <C>
Cash and cash equivalents ................................ $ 3,040,545 $ 2,081,846
Marketable securities .................................... 39,388,237 1,123,795
Accounts receivable, net of allowance for
doubtful accounts of $89,836 and $125,504 .............. 6,998,919 7,564,442
Deferred income taxes .................................... 158,681 158,681
Prepaid expenses and other current assets ................ 58,285 243,883
------------ ------------
Total current assets ................................... 49,644,667 11,172,647
Fixed assets, net .......................................... 1,669,782 1,560,948
Goodwill, net .............................................. 148,868 167,873
Other assets ............................................... 390,625 413,760
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Total assets ........................................... $ 51,853,942 $ 13,315,228
============ ============
Liabilities, Cumulative Redeemable Convertible Preferred
Stock and Shareholders' Equity (Deficit)
Current liabilities:
Accounts payable and accrued expenses .................... $ 2,989,437 $ 2,779,954
Note payable ............................................. 221,657 220,000
Income taxes payable ..................................... 71,501 --
Deferred revenues ........................................ 2,019,903 1,897,039
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Total current liabilities .............................. 5,302,498 4,896,993
Deferred income taxes ...................................... 103,714 103,714
Note payable ............................................... -- 111,657
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Total liabilities ...................................... 5,406,212 5,112,364
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Commitments
Series A cumulative redeemable convertible
preferred stock, no par value; 750,000
shares authorized, no shares issued or
outstanding at June 30, 1998; 676,361 shares
issued and outstanding at December 31, 1997;
cumulative accrued and undeclared dividends
of $1,680,859 at December 31, 1997 ....................... -- 11,603,996
------------ ------------
Shareholders' equity (deficit):
Preferred stock, no par value; 5,000,000 shares
authorized, none issued or outstanding at
June 30, 1998 or December 31, 1997 ....................... -- --
Common stock, no par value; authorized
40,000,000 shares, issued 9,452,050 at June
30, 1998 and 6,775,092 shares at December 31,
1997, respectively ....................................... 41,053,525 2,537,806
Deferred stock compensation ................................ (711,701) (875,835)
Retained earnings .......................................... 6,105,906 4,936,894
Treasury stock, no shares and 3,043,625 shares
of common stock at cost at June 30, 1998 and
December 31, 1997, respectively .......................... -- (9,999,997)
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Total shareholders' equity (deficit) ................... 46,447,730 (3,401,132)
------------ ------------
Total liabilities, cumulative redeemable
convertible preferred stock and
shareholders' equity (deficit) ........................ $ 51,853,942 $ 13,315,228
============ ============
The accompanying notes are an integral part of these financial statements.
</TABLE>
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<TABLE>
<CAPTION>
DSET Corporation
Consolidated Statements of Income
(unaudited)
Three Months Ended June 30,
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1998 1997
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Revenues:
<S> <C> <C>
License revenues ................................ $ 3,579,949 $ 2,523,968
Service revenues ................................ 3,360,240 2,514,230
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Total revenues ............................... 6,940,189 5,038,198
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Cost of revenues:
License revenues ................................ 514,077 519,507
Service revenues ................................ 931,883 826,717
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Total cost of revenues ....................... 1,445,960 1,346,224
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Gross profit .................................. 5,494,229 3,691,974
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Operating expenses:
Sales and marketing ............................. 2,112,884 1,183,568
Research and product development ................ 1,605,378 775,488
General and administrative ...................... 647,052 588,752
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Total operating expenses ..................... 4,365,314 2,547,808
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Operating income .............................. 1,128,915 1,144,166
Interest income and other income/expenses, net ..... 559,396 22,250
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Income before income taxes ......................... 1,688,311 1,166,416
Provision for income taxes ......................... 636,762 384,918
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Net income ......................................... 1,051,549 781,498
Less: accrued preferred stock dividends ........... -- 214,889
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Net income applicable to common shares ............. $ 1,051,549 $ 566,609
=========== ===========
Net income per common share ........................ $ 0.11 $ 0.16
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Weighted average number of common shares
outstanding ...................................... 9,404,100 3,474,990
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Net income per common share assuming dilution ...... $ 0.09 $ 0.10
=========== ===========
Weighted average number of common shares and
common equivalent shares outstanding ............ 11,690,395 8,120,957
=========== ===========
The accompanying notes are an integral part of these financial statements.
</TABLE>
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<TABLE>
<CAPTION>
DSET Corporation
Consolidated Statements of Income
(unaudited)
Six Months Ended June 30,
---------------------------
1998 1997
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Revenues:
<S> <C> <C>
License revenues ................................... $ 6,216,584 $ 4,005,498
Service revenues ................................... 6,045,717 4,226,772
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Total revenues .................................. 12,262,301 8,232,270
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Cost of revenues:
License revenues ................................... 754,706 589,313
Service revenues ................................... 1,633,878 1,515,437
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Total cost of revenues .......................... 2,388,584 2,104,750
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Gross profit ..................................... 9,873,717 6,127,520
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Operating expenses:
Sales and marketing ................................ 4,095,878 1,975,491
Research and product development ................... 3,100,277 1,484,663
General and administrative ......................... 1,176,752 1,237,551
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Total operating expenses ........................ 8,372,907 4,697,705
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Operating income ................................. 1,500,810 1,429,815
Interest income and other income/expenses, net ........ 625,398 42,455
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Income before income taxes ............................ 2,126,208 1,472,270
Provision for income taxes ............................ 783,457 485,850
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Net income ............................................ 1,342,751 986,420
Less: accrued preferred stock dividends .............. -- 429,778
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Net income applicable to common shares ................ $ 1,342,751 $ 556,642
=========== ===========
Net income per common share ........................... $ 0.16 $ 0.16
=========== ===========
Weighted average number of common shares
outstanding ......................................... 8,357,346 3,471,431
=========== ===========
Net income per common share assuming dilution ......... $ 0.13 $ 0.12
=========== ===========
Weighted average number of common shares and
common equivalent shares outstanding ............... 10,643,675 8,003,598
=========== ===========
The accompanying notes are an integral part of these financial statements
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
DSET Corporation
Consolidated Statements of Cash Flows
(unaudited)
Six Months Ended June 30,
-------------------------
1998 1997
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Cash flows from operating activities:
<S> <C> <C>
Net income ................................................ $ 1,342,751 $ 986,420
Adjustments to reconcile net income to net cash provided
by operating activities:
Tax benefit from exercise of stock options ............ 329,320 62,170
Depreciation .......................................... 231,812 199,266
Amortization .......................................... 19,005 72,714
Deferred stock compensation ........................... 164,134 --
Loss from joint venture ............................... 39,655 --
Changes in assets and liabilities:
Accounts receivable ................................. 565,523 (1,838,486)
Other assets ........................................ 69,269 3,184
Accounts payable and accrued expenses ............... 209,483 819,167
Income taxes payable ................................ 71,501 161,171
Deferred revenues ................................... 122,863 664,279
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Net cash provided by operating activities ........ 3,165,316 1,129,885
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Cash flows from investing activities:
Loan repayment by officers and shareholders ............... 100,000 --
Purchases of marketable securities ........................ (41,795,442) (278,792)
Redemption of marketable securities ....................... 3,531,000 --
Acquisition of fixed assets ............................... (340,836) (449,130)
Note repayments ........................................... (110,000) --
Investment in joint venture ............................... -- (245,000)
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Net cash used in investing activities ............ (38,615,278) (972,922)
------------ ------------
Cash flows from financing activities:
Proceeds from the issuance of common stock, net ........... 36,050,825 --
Proceeds from exercise of stock options ................... 357,836 141,495
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Net cash provided by financing activities ........ 36,408,661 141,495
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Net increase in cash and cash equivalents ........ 958,699 298,458
Cash and cash equivalents, beginning of period ................. 2,081,846 784,086
------------ ------------
Cash and cash equivalents, end of period ....................... $ 3,040,545 $ 1,082,544
============ ============
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes .............. $ 391,512 $ 251,201
Cash paid during the period for interest .................. 7,604 --
Non-cash activities:
Accrued dividends on Series A preferred stock ............. $ -- $ 429,778
Conversion of Series A preferred stock to common stock .... 11,603,996 --
Note issued for purchase of net assets of Marben Products,
Inc ..................................................... -- 441,657
The accompanying notes are an integral part of these financial statements.
</TABLE>
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<PAGE>
DSET CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 -- Basis of Presentation:
- --------------------------------
The information presented as of June 30, 1998 and 1997, and for the
three-month and six-month periods then ended, is unaudited, but, in the opinion
of DSET Corporation's (the "Company") management, the accompanying unaudited
financial statements contain all adjustments (consisting only of normal
recurring adjustments) which the Company considers necessary for the fair
presentation of the Company's financial position as of June 30, 1998 and the
results of its operations and its cash flows for the three-month and six-month
periods ended June 30, 1998 and 1997. The financial statements included herein
have been prepared in accordance with generally accepted accounting principles
and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly,
certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. These financial statements should be read in
conjunction with the Company's audited financial statements for the year ended
December 31, 1997, which were included as part of the Company's Registration
Statement on Form S-1 (Registration No. 333-43827), as declared effective by the
Securities and Exchange Commission (the "Commission") on March 12, 1998.
Results for the interim period are not necessarily indicative of results
that may be expected for the entire year.
Note 2 -- Summary of Significant Accounting Policies:
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CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with a
maturity of three months or less to be cash equivalents.
MARKETABLE SECURITIES
The marketable securities portfolio held by the Company consists primarily
of money market funds which are considered to be available-for-sale securities
and are reported at fair value. Unrealized holding gains and losses were not
significant at June 30, 1998 and 1997.
CAPITALIZED SOFTWARE DEVELOPMENT COSTS
Capitalization of costs begins on establishment of technological
feasibility. Costs incurred prior to establishment of technological feasibility
are charged to research and product development expense. The ongoing assessment
of recoverability of capitalized costs requires considerable judgment by
management with respect to certain factors including the anticipated
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future gross revenue, estimated economic life and changes in technology. These
factors are considered on a product-by-product basis.
Amortization of capitalized software costs is calculated using a
straight-line method over the estimated useful life of the respective product
(five years). Amortization expense related to capitalized software costs was
approximately $-0- and $73,000 for the six months ended June 30, 1998 and 1997,
respectively. Amortization expense for the three months ending June 30, 1998 and
1997 was $-0- and $36,000, respectively.
REVENUE RECOGNITION
License revenues are recorded when the software has been delivered to the
Company's licensees and all significant obligations have been satisfied.
Revenues from run-time licenses are recognized as equipment using the Company's
software is deployed by the Company's customers. Service revenues are recognized
over the period in which the service is performed based on the percentage of
direct labor costs incurred to the total costs estimated. Revenues from
maintenance contracts are deferred and recognized over the term of the
respective contracts (typically twelve months).
INCOME TAXES
The Company utilizes an asset and liability approach to financial
reporting for income taxes. Deferred income tax assets and liabilities are
computed annually for differences between the financial statement and tax basis
of assets and liabilities that will result in taxable or deductible amounts in
the future, based on enacted tax laws and rates applicable to the period in
which the differences are expected to affect taxable income. Valuation
allowances are established, when necessary, to reduce the deferred tax assets to
the amount expected to be realized.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts in the financial statements for cash and cash
equivalents, marketable securities, accounts receivable, and accounts payable
and accrued expenses approximate their market value because of the short
maturity of those instruments.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued Statement
No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"). SFAS No. 130 applies
to all companies and is effective for fiscal years beginning after December 15,
1997. SFAS No. 130 establishes standards for the reporting and display of
comprehensive income in a set of financial statements. Comprehensive income is
defined as the change in net assets of a business enterprise during a period
from transactions generated from non-owner sources. It includes all changes in
equity during a period except those resulting from investments by owners and
distributions to owners. Management believes that the adoption of SFAS No. 130
has not had a material impact on the financial statements.
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<PAGE>
In June 1997, the Financial Accounting Standards Board issued Statement
No. 131 "Disclosures about Segments of an Enterprise and Related Information"
("SFAS No. 131"). SFAS No. 131 applies to all public companies and is effective
for fiscal years beginning after December 15, 1997. SFAS No. 131 requires that
business segment financial information be reported in the financial statements
utilizing the management approach. The management approach is defined as the
manner in which management organizes the segments within the enterprise for
making operating decisions and assessing performance. The Company has only one
operating segment - providing software products and services to the
telecommunications industry. Management believes the adoption of SFAS No. 131
has not had a material impact on the financial statements.
On June 15, 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133 "Accounting for Derivatives
and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 is effective for all
fiscal quarters of all fiscal years beginning after June 15, 1999 (January 1,
2000 for the Company). SFAS No. 133 requires that all derivative instruments be
recorded on the balance sheet at their fair value. Changes in the fair value of
derivatives are recorded each period in current earnings or other comprehensive
income, depending on whether a derivative is designated as part of a hedge
transaction and, if it is, the type of hedge transaction. Management of the
Company anticipates that, due to its limited use of derivative instruments, the
adoption of SFAS No. 133 will not have a significant effect on the Company's
results of operations or its financial position.
In October 1997, the American Institute of Certified Public Accountants
issued Statement of Position 97-2, "Software Revenue Recognition," which is
effective for transactions entered into in fiscal years beginning after December
15, 1997. The Statement of Position governs the recognition of revenue by
enterprises that license, sell, lease or otherwise market software, except where
software is incidental to the products or services being offered as a whole.
Application of this Statement of Position has not had a material impact on the
financial statements.
Note 3 -- Initial Public Offering:
- ----------------------------------
On March 18, 1998, the Company consummated an initial public offering of
3,500,000 shares of its Common Stock at a price to the public of $16.00 per
share, of which 2,500,000 shares were issued and sold by the Company and
1,000,000 shares were sold by certain shareholders of the Company (the "Selling
Shareholders"). The net proceeds to the Company from the offering were
approximately $36.1 million. On April 7, 1998, certain Selling Shareholders sold
an additional 525,000 shares of the Company's Common Stock at a price to the
public of $16.00 per share upon the consummation of the exercise of the
Underwriters' over-allotment option. The Company did not receive any of the
proceeds from the sale of shares by the Selling Shareholders.
The net proceeds received by the Company upon the consummation of such
offering, pending specific application, are invested in short-term,
investment-grade, interest-bearing
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instruments. See "Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
Note 4 -- Cumulative Redeemable Convertible Preferred Stock:
- ------------------------------------------------------------
In December 1995, the Company issued 676,361 shares of cumulative,
convertible Series A Preferred Stock. Upon consummation of the Company's initial
public offering, the shares of Series A Preferred Stock converted into an
aggregate of 3,043,625 shares of the Company's Common Stock.
Note 5 -- Earnings Per Share
- ----------------------------
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share"
(EPS), which specifies the computation, presentation and disclosure requirements
for earnings per share of entities with publicly held company stock or potential
common stock. The statement defines two earnings per share calculations, basic
and diluted. The objective of basic EPS is to measure the performance of an
entity over the reporting period by dividing income available to common stock by
the weighted average shares outstanding. The objective of diluted EPS is
consistent with that of basic EPS, that is to measure the performance of an
entity over the reporting period, while giving effect to all dilutive potential
common shares that were outstanding during the period. The calculation of
diluted EPS is similar to basic EPS except both the numerator and denominator
are increased for the conversion of potential common shares. The following table
is a reconciliation of the numerator and denominator under each method:
<TABLE>
<CAPTION>
For the three months ended June 30, 1998
-----------------------------------------
Per Share
Income Shares Amount
----------- ----------- ---------
BASIC EPS:
<S> <C> <C> <C>
Net income applicable to common shares ... $ 1,051,549 9,404,100 $ 0.11
ASSUMING DILUTION:
Net income applicable to common shares
Warrants ............................ -- 160,859
Stock options ....................... -- 2,125,436
----------- -----------
$ 1,051,549 11,690,395 $ 0.09
=========== ===========
For the six months ended June 30, 1998
-------------------------------------------
Per Share
Income Shares Amount
----------- ----------- ---------
BASIC EPS:
Net income applicable to common shares ... $ 1,342,751 8,357,346 $ 0.16
ASSUMING DILUTION:
Net income applicable to common shares
Warrants ............................ -- 158,909
Stock options ....................... -- 2,127,420
----------- ----------
$ 1,342,751 10,643,675 $ 0.13
=========== ==========
</TABLE>
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Note 6 - New Subsidiary
- -----------------------
On May 7, 1998 the Company's Board of Directors authorized the
establishment of a wholly-owned subsidiary in Chengdu, China. Initially, the
purpose of this subsidiary is for research and development. The name of the
subsidiary is Chengdu DSET Science and Technology Co., Ltd.
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<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
General
- -------
DSET designs, develops, markets and supports standards-based application
development tools, custom application development services, Local Number
Portability Solutions and OSS Gateway products for the global telecommunications
industry. From its founding in 1989, the Company has focused on distributed
concurrent object technology and the creation of applications that could be
distributed among many processors. Additionally, the Company developed extensive
knowledge of requirements for multiple protocols and multi-vendor communications
as well as real time operating systems. In the early 1990's, the Company made a
strategic decision to focus on creating suites of tools that facilitate the
development of solutions based upon the Telecommunications Management Network
("TMN") standard. Substantially all of the Company's revenues to date have been
derived from application development tools and services based on TMN standards.
The Company's success will depend on continued growth in the market for advanced
telecommunications products and services.
The Company had no customers which accounted for more than 10% of revenue
for the quarter ended June 30, 1998 and two significant customers which
accounted for 32.4% of total revenues for the three months ended June 30, 1997.
For the six months ended June 30, 1998 and 1997, the Company had one and two
significant customers which accounted for 15.9% and 26.6% of revenues,
respectively. The Company anticipates that its results of operations in any
given period will continue to depend to a significant extent upon sales to a
small number of customers. As a result of this customer concentration, the
Company's revenues from quarter to quarter and business, financial condition and
results of operations may be subject to substantial period-to-period
fluctuations.
The Company derives a significant portion of its revenues from
international sales which constituted approximately 21.2% and 36.2% of the
Company's total revenues in the quarters ended June 30, 1998 and 1997,
respectively. For the six months ended June 30, 1998 and 1997, foreign sales
accounted for 25.7% and 29.5% of revenues, respectively. The Company's
international sales currently are United States dollar-denominated. As a result,
an increase in the value of the United States dollar relative to foreign
currencies could make the Company's products and services less competitive in
international markets.
Statements contained in this Form 10-Q that are not based on historical
fact are "forward-looking statements" within the meaning of Section 21E of the
Securities Exchange Act of 1934, as amended. Forward-looking statements may be
identified by the use of forward-looking terminology such as "may," "will,"
"expect," "estimate," "anticipate," "continue," or similar terms, variations of
such terms or the negative of those terms. Such forward-looking statements
involve risks and uncertainties, including, but not limited to: (i) the
Company's dependence on the rapidly evolving telecommunications industry, (ii)
the Company's dependence on the TMN industry standard, (iii) rapid technological
change in the Company's industry and (iv) risks
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associated with the development and marketing of new products, including
carrier-to-carrier applications. The success of the Company depends to a large
degree upon increased utilization of its application development tools, custom
application development services and carrier-to-carrier applications by
telecommunications carriers and network equipment vendors. As a result of such
risks and others expressed from time to time in the Company's filings with the
Commission, the Company's actual results may differ materially from the results
discussed in or implied by the forward-looking statements contained herein.
Results of Operations
- ---------------------
THREE MONTHS ENDED JUNE 30, 1998 COMPARED TO THREE MONTHS ENDED JUNE 30, 1997
Revenues. Total revenues increased 37.7% to $6.9 million in the second
quarter of 1998 from $5.0 million in the second quarter of 1997. License
revenues increased 41.8% to $3.6 million in the second quarter of 1998 from $2.5
million in the second quarter of 1997. This increase was primarily attributable
to an increased demand for the Company's TMN-based agent tools and recognition
of run-time royalties. Service revenues increased 33.6% to $3.4 million in the
second quarter of 1998 from $2.5 million in the second quarter of 1997. This
increase was primarily attributable to professional services projects, fees from
consulting services and training courses, and new customers (equipment vendors)
purchasing the Company's new solutions (with project work for implementation)
for facilitating access to the central office switch from xDLS-based services.
In the quarters ended June 30, 1998 and 1997, the Company derived approximately
51.6% and 50.1%, respectively, of its total revenues from license revenues and
approximately 48.4% and 49.9%, respectively, of its total revenues from service
revenues.
Gross profit. The Company's gross profit increased 48.8% to $5.5 million
in the second quarter of 1998 from $3.7 million in the second quarter of 1997.
Gross profit percentage increased to 79.2% of total revenues in the second
quarter of 1998 from 73.3% in the second quarter of 1997. Gross profit
percentage for license revenues increased to 85.6% for the second quarter of
1998 from 79.4% for the comparable 1997 period due to less third party software
as a component of sales. Gross profit percentage for service revenue increased
to 72.3% in the second quarter of 1998 from 67.1% in the second quarter of 1997.
This increase was attributable to higher margins associated with consulting
services, training revenues, new customers (equipment vendors) purchasing the
Company's new solutions for facilitating access to the central office switch
from xDLS-based services and higher utilization of personnel resources.
Sales and marketing expenses. Sales and marketing expenses increased 78.5%
to $2.1 million in the second quarter of 1998 from $1.2 million in the second
quarter of 1997, and increased to 30.4% of total revenues in the second quarter
of 1998 from 23.5% of total revenue in the second quarter of 1997. This increase
as a percentage of sales is primarily attributable to increased personnel and
related costs resulting from the increase in the Company's sales force and an
expanded marketing department.
Research and product development expenses. Research and product
development expenses increased 107.0% to $1.6 million in the second quarter of
1998 from $775,000 in the
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second quarter of 1997, and increased to 23.1% from 15.4% of total revenues over
the respective periods. This increase in research and product development
expenses both in absolute dollars and as a percentage of revenues was due
primarily to additional personnel expenses attributable to an increase in
staffing and an expansion in the number of projects under development.
General and administrative expenses. General and administrative expenses
increased 9.9% to $647,000 in the second quarter of 1998 from $589,000 in the
second quarter of 1997, and decreased to 9.3% from 11.7% of total revenues for
the respective periods. The increase of general and administrative expenses in
the second quarter of 1998 as compared to the corresponding period in 1997 is
due to additional staffing in this area and costs associated with compliance
with statutory public company filing requirements.
Interest income and other income/expenses, net. Net interest income and
other income/expenses increased to $559,000 for the second quarter of 1998
compared to $22,000 for the second quarter of 1997. This increase was primarily
due to higher balances in cash and short-term investments as a result of the
Company's initial public offering of its Common Stock in March 1998.
Income taxes. The Company's effective tax rate was 37.7% and 33.0% for
each of the quarters ended June 30, 1998 and 1997, respectively. Such effective
tax rates were lower than the statutory tax rates due primarily to research and
development tax credits. The increase in 1998 is due to the non-deductible
nature of deferred stock compensation associated with the issuance of stock
options. As of June 30, 1998, the research and development tax credit has not
been renewed by Congress. If this provision in the tax code is not retroactively
renewed, the loss of this credit will result in a higher effective tax rate for
the Company in future periods.
SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO SIX MONTHS ENDED JUNE 30, 1997
Revenues. Total revenues increased 48.9% to $12.2 million for the six
months ending June 30, 1998 from $8.2 million in the first six months of 1997.
License revenues increased 55.2% to $6.2 million for the six months ending June
30, 1998 from $4.0 million in the first six months of 1997. This increase was
primarily attributable to an increased demand for the Company's TMN-based agent
tools. Service revenues increased 43.0% to $6.0 million for the six months
ending June 30, 1998 from $4.2 million in the first six months 1997. This
increase was primarily attributable to professional services projects and an
increase in fees from consulting services and training courses. In the six
months ended June 30, 1998 and 1997, the Company derived approximately 50.7% and
48.7%, respectively, of its total revenues from license revenues and
approximately 49.3% and 51.3%, respectively, of its total revenues from service
revenues.
Gross profit. The Company's gross profit increased 61.1% to $9.9 million
for the six months ending June 30, 1998 from $6.1 million in the first six
months of 1997. Gross profit percentage increased to 80.5% of total revenues for
the six months ending June 30, 1998 from 74.4% in the first six months of 1997.
Gross profit percentage for license revenues increased to 87.9% for the first
six months of 1998 from 85.3% for the comparable 1997 period. This
- 13 -
<PAGE>
increase was attributable to the slightly better margins on the sale of tools
due to less third party software as a component of sales. Gross profit
percentage for service revenue increased to 73.0% for the six months ended June
30, 1998 from 64.1% in the first six months of 1997. This increase was
attributable to higher margins and utilization of personnel associated with
consulting services, training revenues and maintenance.
Sales and marketing expenses. Sales and marketing expenses increased
107.3% to $4.1 million for the six months ending June 30, 1998 from $2.0 million
in the first six months of 1997, and increased to 33.4% of total revenues for
the six months ending June 30, 1998 from 24.0% of total revenue in the first six
months of 1997. This increase was primarily attributable to increased personnel
and related costs resulting from the increase in the Company's sales force and
an expanded marketing department.
Research and product development expenses. Research and product
development expenses increased 108.8% to $3.1 million for the six months ending
June 30, 1998 from $1.5 million in the first six months of 1997, and increased
to 25.3% from 18.0% of total revenues over the respective periods. This increase
in research and product development expenses both in absolute dollars and as a
percentage of revenues was due primarily to additional personnel expenses
attributable to an increase in staffing and an expansion in the number of
projects under development.
General and administrative expenses. General and administrative expenses
decreased 5% to $1.1 million for the six months ending June 30, 1998 from $1.2
million in the first six months of 1997, and decreased to 9.6% from 15.0% of
total revenues for the respective periods. The reduction of general and
administrative expenses for the six months ending June 30, 1998 as compared to
the corresponding period in 1997 was due to the non-recurring cost of hiring two
executives in 1997. Further reduction of these expenses is due to the transition
of the Chief Technical Officer from administrative functions to technical
functions.
Interest income and other income/expenses, net. Net interest income and
other income/expenses increased to $625,000 for the first six months of 1998
compared to $42,000 for the first six months of 1997. This increase was
primarily due to higher balances in cash and short-term investments as a result
of the Company's initial public offering of its Common Stock in March 1998.
Income taxes. The Company's effective tax rate was 36.8% and 33.0% for
each of the six months ended June 30, 1998 and 1997, respectively. Such
effective tax rates were lower than the statutory tax rates due primarily to
research and development tax credits. The rate is higher in 1998 due to the
non-deductibility of deferred stock compensation associated with the issuance of
stock options. As of June 30, 1998, the research and development tax credit has
not been renewed by Congress. If this provision in the tax code is not
retroactively renewed, the loss of this credit will result in a higher effective
tax rate for the Company in future periods.
- 14 -
<PAGE>
Liquidity and Capital Resources
- -------------------------------
Since its inception in 1989, the Company has financed its operations
primarily through cash generated by operations. At June 30, 1998, the Company's
cash, cash equivalents and marketable securities aggregated approximately $42.4
million, of which cash and cash equivalents aggregated approximately $3.0
million. The Company's working capital was $44.0 million at June 30, 1998.
Accounts receivable decreased to $7.0 million at June 30, 1998 from $7.6
million at December 31, 1997 primarily as a result of increased collection
efforts on aged accounts.
The Company bills its customers, several of which are based in Korea and
Japan, in U.S. dollars at agreed-upon contractual terms. The Company has not
experienced any significant negative effects on its liquidity as a result of the
volatility and devaluation trends that recently have been experienced in certain
Asian markets, although no assurance can be made that the Company will not
experience difficulty collecting accounts receivable from such customers in the
future. Accounts receivable at June 30, 1998 includes approximately $901,000
from customers in this region.
The Company's capital expenditures were approximately $341,000 and
$560,000 for the six months ended June 30, 1998 and 1997, respectively. Although
the Company anticipates higher levels of equipment and facilities-related
expenditures in the foreseeable future, such future expenditures are not
anticipated to be significantly higher as a percentage of total revenues as
compared to prior periods.
In August 1997, the Company obtained an unsecured revolving credit
facility with a bank pursuant to which the Company may borrow up to a maximum of
$3.0 million. Borrowings under this line of credit bear interest at the bank's
prime rate less 0.25% on amounts outstanding of less than $1.0 million and at
the bank's prime rate for aggregate principal amounts exceeding $1.0 million. No
borrowings under this line were outstanding as of June 30, 1998. This credit
facility contains, among other provisions, covenants which (i) mandate the
amount of working capital the Company must maintain at the end of each calendar
quarter and (ii) restrict the Company's ability to pay cash dividends.
On March 18, 1998, the Company consummated an initial public offering of
3,500,000 shares of its Common Stock at a price to the public of $16.00 per
share, of which 2,500,000 shares were issued and sold by the Company and
1,000,000 shares were sold by certain Selling Shareholders. The net proceeds to
the Company from the offering were approximately $36.1 million. On April 7,
1998, certain Selling Shareholders sold an additional 525,000 shares of the
Company's Common Stock at a price to the public of $16.00 per share upon the
consummation of the exercise of the Underwriters' over-allotment option. The
Company did not receive any of the proceeds from the sale of shares by the
Selling Shareholders.
The net proceeds received by the Company upon the consummation of such
offering, pending specific application, were invested in short-term,
investment-grade, interest-bearing instruments.
- 15 -
<PAGE>
The Company believes that its existing available cash, credit facility and
the cash flow expected to be generated from operations, together with the
proceeds from its initial public offering, will be adequate to satisfy its
current and planned operations for at least the next 12 months. There can be no
assurance, however, that the Company will not require additional financing prior
to such time to fund its operations or possible acquisitions.
Year 2000 Compliance
- --------------------
The Company believes that it has sufficiently assessed its state of
readiness with respect to its Year 2000 compliance. The Company generally
warrants and has represented to its customers that its products are free from
Year 2000 defects. In 1997, the Company conducted a Year 2000 compliance review
of its products and determined that one component of its tool suites (version
ASN.C sold prior to May 1997) was unable to interpret four digits, including the
year 2000 and beyond. The Company notified all of its customers of the problem
and in June 1997 made the correction available on its website, free of charge.
In addition, the Company provided annual maintenance customers with the
correction as part of a subsequent upgrade of the product. Failure of customers
to properly implement the correction, or problems with the correction, could
cause errors in customers' products which may materially impact the
functionality of those products. The cost associated with such correction was
not considered material and the Company anticipates limited future expenditures
to address Year 2000 issues. There can be no assurances, however, that the
Company's products will not be used by other companies, or its customers, to
build applications which might not be Year 2000 compliant, or that the Company's
products or applications built with the Company's products will not be
integrated by the Company or its customers or interact with non-compliant
software or other products which may expose the Company to claims from its
customers.
The Company's internal computer systems and recently purchased Management
Information System are Year 2000 compliant, and the Company does not believe
that there will be future significant costs related to maintaining such
compliance.
- 16 -
<PAGE>
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
Changes in Securities
- ---------------------
The following information relates to all securities of the Company sold by
the Company within the past quarter which were not registered under the
securities laws at the time of grant, issuance and/or sale:
1. The Company has, during the second quarter of 1998, granted stock
options pursuant to its 1998 Stock Plan which, at the time of grant,
had not yet been registered under the securities laws. The following
table sets forth certain information regarding such grants during
the quarter:
Number Exercise
of shares Price
--------- --------
16,750 $ 15.25
25,000 $ 15.375
The Company did not employ an underwriter in connection with the issuance
of the securities described above. The Company believes that the issuance of the
foregoing securities was exempt from registration under either (i) Section 4(2)
of the Securities Act of 1933, as amended (the "Act"), as transactions not
involving any public offering and such securities having been acquired for
investment and not with a view to distribution, or (ii) Rule 701 under the Act
as transactions made pursuant to a written compensatory benefit plan or pursuant
to a written contract relating to compensation. All recipients had adequate
access to information about the Company.
Use of Proceeds
- ---------------
On March 12, 1998, the Commission declared effective the Company's
Registration Statement (Registration Statement No. 333-43827) as filed with the
Commission in connection with the Company's initial public offering of Common
Stock, which was managed by BT Alex. Brown Incorporated, BancAmerica Robertson
Stephens and SoundView Financial Group, Inc. Pursuant to such Registration
Statement, the Company registered and sold an aggregate of 2,500,000 shares of
its Common Stock, for a gross aggregate offering price of $40.0 million. The
Company incurred underwriting discounts and commissions of approximately $2.8
million. In connection with such offering, the Company incurred total expenses
of approximately $1.1 million. As of June 30, 1998, all of the $36.1 million in
net proceeds received by the Company upon consummation of such offering, pending
specific application, were invested in short-term, investment-grade,
interest-bearing instruments.
- 17 -
<PAGE>
For working capital restrictions and limitations on the payment of
dividends, see "Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
Item 5. Other Information.
Initial Public Offering
- -----------------------
On March 18, 1998, the Company consummated an initial public offering of
3,500,000 shares of its Common Stock at a price to the public of $16.00 per
share, of which 2,500,000 shares were issued and sold by the Company and
1,000,000 shares were sold by certain Selling Shareholders. The net proceeds to
the Company from the offering were $36.1 million. On April 7, 1998, certain
Selling Shareholders sold an additional 525,000 shares of the Company's Common
Stock at a price to the public of $16.00 per share upon the consummation of the
exercise of the Underwriters' over-allotment option. The Company did not receive
any of the proceeds from the sale of shares by the Selling Shareholders.
The net proceeds received by the Company upon the consummation of such
offering, pending specific application, were invested in short-term,
investment-grade, interest-bearing instruments.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
27 Financial Data Schedule
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter for which
this report on Form 10-Q is filed.
- 18 -
<PAGE>
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.
DSET Corporation
DATE: August 13, 1998 By: /s/ William P. McHale, Jr.
-------------------------------
William P. McHale, Jr.
President and Chief Executive
Officer (Principal Executive Officer)
DATE: August 13, 1998 By: /s/ Paul A. Lipari
-------------------------------
Paul A. Lipari
Chief Financial Officer
(Principal Financial and Accounting
Officer)
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY INFORMATION EXTRACTED FROM THE UNAUDITED
FINANCIAL STATEMENTS INCLUDED IN THE REGISTRANT'S FORM 10-Q FOR THE PERIOD ENDED
JUNE 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FORM 10-Q.
</LEGEND>
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<NAME> DSET Corporation
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