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 September 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
- ------------------------------- ------------------------------------
(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
---------------------------
(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:
------- -------
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of October 30, 1998:
Class Number of Shares
----- ----------------
Common Stock, no par value 9,749,555
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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 September 30,1998
(unaudited) and December 31, 1997........................ 2
Consolidated Statements of Income for the Three Months
Ended September 30, 1998 and 1997 (unaudited)............ 3
Consolidated Statements of Income for the Nine Months
Ended September 30, 1998 and 1997 (unaudited)............ 4
Consolidated Statements of Cash Flows for the Nine
Months Ended September 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..................... 10
Results of Operations...................................... 11
Liquidity and Capital Resources............................ 14
PART II. OTHER INFORMATION............................................ 17
Item 2.Changes in Securities and Use of Proceeds................. 17
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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<TABLE>
<CAPTION>
DSET Corporation
Consolidated Balance Sheets
September 30, 1998 December 31, 1997
------------------ -----------------
Assets (unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents ..................................... $ 4,533,340 $ 2,081,846
Marketable securities ......................................... 40,381,469 1,123,795
Accounts receivable, net of allowance for doubtful accounts
of $122,130 and $125,504 .................................... 6,872,642 7,564,442
Deferred income taxes ......................................... 158,681 158,681
Prepaid expenses and other current assets ..................... 70,229 243,883
------------ ------------
Total current assets ........................................ 52,016,361 11,172,647
Fixed assets, net ................................................ 1,684,099 1,560,948
Goodwill, net .................................................... 139,366 167,873
Other assets ..................................................... 433,611 413,760
------------ ------------
Total assets ................................................ $ 54,273,437 $ 13,315,228
============ ============
Liabilities, Cumulative Redeemable Convertible Preferred
Stock and Shareholders' Equity (Deficit)
Current liabilities:
Accounts payable and accrued expenses ......................... $ 3,345,679 $ 2,779,954
Note payable .................................................. 166,657 220,000
Income taxes payable .......................................... 600,250 --
Deferred revenues ............................................. 1,587,338 1,897,039
------------ ------------
Total current liabilities ................................... 5,699,924 4,896,993
Deferred income taxes ............................................ 103,714 103,714
Note payable ..................................................... -- 111,657
------------ ------------
Total liabilities ........................................... 5,803,638 5,112,364
------------ ------------
Commitments
Series A cumulative redeemable convertible preferred stock, no
par value; 750,000 shares authorized, no shares issued or
outstanding at September 30, 1998; 676,361 shares issued
and outstanding at December 31, 1997; cumulative accrued
and undeclared dividends of $1,680,859 at Dec. 31, 1997 ....... -- 11,603,996
------------ ------------
Shareholders' equity (deficit):
Preferred stock, no par value; 5,000,000 shares authorized,
none issued or outstanding at September 30, 1998 or
December 31, 1997 ............................................. -- --
Common stock, no par value; authorized 40,000,000 shares,
9,658,534 and 6,775,092 shares issued at September 30,
1998 and December 31, 1997, respectively ...................... 41,190,246 2,537,806
Deferred stock compensation ...................................... (629,633) (875,835)
Retained earnings ................................................ 7,823,568 4,936,894
Unrealized appreciation on investments ........................... 85,618 --
Treasury stock, no shares and 3,043,625 shares of common
stock at cost at September 30, 1998 and December 31, 1997,
respectively .................................................. -- (9,999,997)
------------ ------------
Total shareholders' equity (deficit) ........................ 48,469,799 (3,401,132)
------------ ------------
Total liabilities, cumulative redeemable convertible
preferred stock and shareholders' equity (deficit) ........ $ 54,273,437 $ 13,315,228
============ ============
The accompanying notes are an integral part of these financial statements.
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</TABLE>
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<TABLE>
<CAPTION>
DSET Corporation
Consolidated Statements of Income
(unaudited)
Three Months Ended September 30,
--------------------------------
1998 1997
----------- -----------
<S> <C> <C>
Revenues:
License revenues ................................ $ 3,706,650 $ 2,654,354
Service revenues ................................ 4,115,359 2,534,572
----------- -----------
Total revenues ............................... 7,822,009 5,188,926
----------- -----------
Cost of revenues:
License revenues ................................ 392,599 374,946
Service revenues ................................ 1,220,544 1,116,882
----------- -----------
Total cost of revenues ....................... 1,613,143 1,491,828
----------- -----------
Gross profit .................................. 6,208,866 3,697,098
----------- -----------
Operating expenses:
Sales and marketing ............................. 2,296,794 1,285,639
Research and product development ................ 1,496,261 754,205
General and administrative ...................... 600,391 706,988
----------- -----------
Total operating expenses ..................... 4,393,446 2,746,832
----------- -----------
Operating income .............................. 1,815,420 950,266
Interest income and other income/expenses, net ..... 577,902 33,893
----------- -----------
Income before income taxes ......................... 2,393,322 984,159
Provision for income taxes ......................... 849,399 323,909
----------- -----------
Net income ......................................... 1,543,923 660,250
Less: accrued preferred stock dividends ........... -- 214,889
----------- -----------
Net income applicable to common shares ............. $ 1,543,923 $ 445,361
=========== ===========
Net income per common share ........................ $ 0.16 $ 0.12
=========== ===========
Weighted average number of common shares ........... 9,556,439 3,611,117
outstanding ..................................... ========== ==========
Net income per common share assuming dilution ...... $ 0.13 $ 0.08
=========== ===========
Weighted average number of common shares and
common equivalent shares outstanding ............ 11,451,547 8,358,073
=========== ===========
The accompanying notes are an integral part of these financial statements.
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</TABLE>
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<TABLE>
<CAPTION>
DSET Corporation
Consolidated Statements of Income
(unaudited)
Nine Months Ended September 30,
-------------------------------
1998 1997
----------- -----------
<S> <C> <C>
Revenues:
License revenues ................................ $ 9,923,234 $ 6,659,852
Service revenues ................................ 10,161,077 6,761,345
----------- -----------
Total revenues ............................... 20,084,311 13,421,197
----------- -----------
Cost of revenues:
License revenues ................................ 1,147,305 964,259
Service revenues ................................ 2,854,423 2,632,319
----------- -----------
Total cost of revenues ....................... 4,001,728 3,596,578
----------- -----------
Gross profit .................................. 16,082,583 9,824,619
----------- -----------
Operating expenses:
Sales and marketing ............................. 6,392,672 3,261,130
Research and product development ................ 4,596,538 2,238,868
General and administrative ...................... 1,777,144 1,944,539
----------- -----------
Total operating expenses ..................... 12,766,354 7,444,537
----------- -----------
Operating income .............................. 3,316,229 2,380,082
Interest income and other income/expenses, net ..... 1,203,301 76,348
----------- -----------
Income before income taxes ......................... 4,519,530 2,456,430
Provision for income taxes ......................... 1,632,856 809,756
----------- -----------
Net income ......................................... 2,886,674 1,646,674
Less: accrued preferred stock dividends ........... -- 644,666
----------- -----------
Net income applicable to common shares ............. $ 2,886,674 $ 1,002,008
=========== ===========
Net income per common share ........................ $ 0.33 $ 0.28
=========== ===========
Weighted average number of common shares
outstanding ..................................... 8,757,044 3,517,993
=========== ===========
Net income per common share assuming dilution ...... $ 0.26 $ 0.20
=========== ===========
Weighted average number of common shares and
common equivalent shares outstanding ............ 10,912,984 8,121,713
=========== ===========
The accompanying notes are an integral part of these financial statements.
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</TABLE>
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<TABLE>
<CAPTION>
DSET Corporation
Consolidated Statements of Cash Flows
(unaudited)
Nine Months Ended September 30,
-------------------------------
1998 1997
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income ................................................. $ 2,886,674 $ 1,646,674
Adjustments to reconcile net income to net
cash provided by operating activities:
Tax benefit from exercise of stock options .............. 525,285 93,569
Depreciation ............................................ 350,062 289,944
Amortization ............................................ 28,507 112,274
Gain (loss) on disposal of assets ....................... (1,716) --
Deferred stock compensation ............................. 246,202 --
Loss from joint venture ................................. 18,892 --
Changes in assets and liabilities:
Accounts receivable ................................... 691,800 (2,263,149)
Other assets .......................................... (38,401) (86,079)
Accounts payable and accrued expenses ................. 565,724 1,552,204
Income taxes payable .................................. 673,565 (36,679)
Deferred revenues ..................................... (309,702) (8,222)
------------ ------------
Net cash provided by operating activities ............ 5,636,892 1,300,536
------------ ------------
Cash flows from investing activities:
Loan repayment by officers and shareholders ................ 100,000 (150,000)
Purchases of marketable securities ......................... (82,323,988) (1,080,768)
Redemption of marketable securities ........................ 43,151,932 716,267
Acquisition of fixed assets ................................ (474,556) (588,456)
Proceeds from disposition of fixed assets .............. 3,059 --
Note repayments ............................................ (165,000) (55,000)
Investment in joint venture ................................ -- (243,266)
------------ ------------
Net cash used in investing activities ................ (39,708,553) (1,401,223)
Cash flows from financing activities:
Proceeds from the issuance of common stock, net ............ 36,082,626 --
Proceeds from exercise of stock options .................... 440,529 214,542
------------ ------------
Net cash provided by financing activities............. 36,523,155 214,542
------------ ------------
Net increase in cash and cash equivalents ............ 2,451,494 113,855
Cash and cash equivalents, beginning of period ................ 2,081,846 784,086
------------ ------------
Cash and cash equivalents, end of period ...................... $ 4,533,340 $ 897,941
============ ============
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes ............... $ 499,394 $ 752,868
Cash paid during the period for interest ................... 10,378 7,604
Non-cash activities:
Accrued dividends on Series A preferred stock .............. $ -- $ 644,666
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.
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</TABLE>
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DSET CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 -- Basis of Presentation:
The information presented as of September 30, 1998 and 1997, and for the
three-month and nine-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 September 30, 1998 and
the results of its operations and its cash flows for the three-month and
nine-month periods ended September 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. Certain prior period amounts have been
reclassified for comparative purposes.
Note 2 -- Summary of Significant Accounting Policies:
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 short-term securities of grade A2 or better with maturities of two years or
less which are considered to be available for sale securities and are reported
at cost. Unrealized appreciation on investments was $85,618 at September 30,
1998 and none for 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
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development expense. The ongoing assessment of recoverability of capitalized
costs requires considerable judgment by management with respect to certain
factors including the anticipated 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 $104,637 for the nine months ended September 30, 1998 and
1997, respectively. Amortization expense for the three months ending September
30, 1998 and 1997 was approximately $-0- and $30,057, 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
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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.
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.
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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 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:
For the three months ended
September 30, 1998
-----------------------------------
Per Share
Income Shares Amount
----------- --------- ---------
Basic EPS:
Net income applicable to common shares .... $ 1,543,923 9,556,439 $0.16
Assuming dilution:
Net income applicable to common shares:
Warrants .............................. -- 154,634
Stock options ......................... -- 1,740,474
----------- -----------
$ 1,543,923 11,451,547 $0.13
=========== ===========
For the nine months ended
September 30, 1998
-----------------------------------
Per Share
Income Shares Amount
----------- --------- ---------
Basic EPS:
Net income applicable to common shares .... $ 2,886,674 8,757,044 $0.33
Assuming dilution:
Net income applicable to common shares:
Warrants .............................. -- 157,484
Stock options ......................... -- 1,998,456
----------- -----------
$ 2,886,674 10,912,984 $0.26
=========== ===========
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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 one customer which accounted for 18.3% of revenue for the
three months ended September 30, 1998 and three significant customers which
accounted for in the aggregate 41.9% of total revenues for the three months
ended September 30, 1997. For the nine months ended September 30, 1998, the
Company had one significant customer which accounted for 16.8% of revenues; and
for the nine months ended September 30, 1997, two significant customers
accounted for in the aggregate 26.7% of total revenues. 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 9.5% and 30.2% of the
Company's total revenues in the quarters ended September 30, 1998 and 1997,
respectively. For the nine months ended September 30, 1998 and 1997, foreign
sales accounted for 19.4% and 29.8% 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 (the "Exchange Act").
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. In particular, the Company's statements relating to the Year 2000
compliance of its products and internal systems are forward looking statements
intended to qualify for the safe harbor provided
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by the Exchange Act. 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, (iv) risks associated with the development and marketing of new
products, including carrier-to-carrier applications (e.g., LNP or OSS Gateways)
and (v) risks and variables, including engineering costs, associated with the
remediation of certain of the Company's products which are not Year 2000
compliant. 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 (e.g., LNP or OSS Gateways) 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 September 30, 1998 Compared to Three Months Ended
September 30, 1997
Revenues. Total revenues increased 50.7% to $7.8 million in the third
quarter of 1998 from $5.2 million in the third quarter of 1997. License revenues
increased 39.6% to $3.7 million in the third quarter of 1998 from $2.7 million
in the third quarter of 1997. This increase was primarily attributable to an
increased demand for the Company's TMN-based agent tools, recognition of
run-time royalties, and to a lesser extent, licenses associated with OSS Gateway
products. Service revenues increased 62.4% to $4.1 million in the third quarter
of 1998 from $2.5 million in the third quarter of 1997. This increase was
primarily attributable to custom application development projects, fees from
consulting services and training courses, and new customers purchasing the
Company's new GR-303 solution, which includes custom application development
work. In the quarters ended September 30, 1998 and 1997, the Company derived
approximately 47.4% and 51.2%, respectively, of its total revenues from license
revenues and approximately 52.6% and 48.8%, respectively, of its total revenues
from service revenues.
Gross profit. The Company's gross profit increased 67.9% to $6.2 million
in the third quarter of 1998 from $3.7 million in the third quarter of 1997.
Gross profit percentage increased to 79.4% of total revenues in the third
quarter of 1998 from 71.2% in the third quarter of 1997. Gross profit percentage
for license revenues increased to 89.4% for the third quarter of 1998 from 85.9%
for the comparable 1997 period due to less third party software as a component
of sales. Gross profit percentage for service revenue increased to 70.3% in the
third quarter of 1998 from 55.9% in the third quarter of 1997. This increase was
attributable to higher margins associated with consulting services, training
revenues, an increase in the average billing rate, higher utilization of
personnel resources and the new GR-303 solutions purchased by network equipment
vendors.
Sales and marketing expenses. Sales and marketing expenses increased 78.6%
to $2.3 million in the third quarter of 1998 from $1.3 million in the third
quarter of 1997, and
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increased to 29.3% of total revenues in the third quarter of 1998 from 24.8% of
total revenue inthe third 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 as well as higher variable expenses such as commissions
related to higher sales.
Research and product development expenses. Research and product
development expenses increased 98.4% to $1.5 million in the third quarter of
1998 from $754,000 in the third quarter of 1997, and increased to 19.1% from
14.5% 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 15.1% to $600,000 in the third quarter of 1998 from $707,000 in the
third quarter of 1997, and decreased to 7.7% from 13.6% of total revenues for
the respective periods. The decrease of general and administrative expenses in
the third quarter of 1998 as compared to the corresponding period in 1997 is due
to the transition of the Company's Chief Technical Officer from administrative
functions to technical functions, and significantly lower recruiting costs.
Interest income and other income/expenses, net. Net interest income and
other income/expenses increased to $578,000 for the third quarter of 1998
compared to $34,000 for the third 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 35.5% and 32.9% for
each of the quarters ended September 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 partially due to
the non-deductible nature of deferred stock compensation associated with the
issuance of stock options and the effect on tax rate associated with doing
business in Chengdu, China.
Nine Months Ended September 30, 1998 Compared to Nine Months Ended
September 30, 1997
Revenues. Total revenues increased 49.6% to $20.1 million for the nine
months ending September 30, 1998 from $13.4 million in the first nine months of
1997. License revenues increased 49.0% to $9.9 million for the nine months
ending September 30, 1998 from $6.7 million in the first nine months of 1997.
This increase was primarily attributable to an increased demand for the
Company's TMN-based agent tools and increased run-time royalties. Service
revenues increased 50.3% to $10.2 million for the nine months ending September
30, 1998 from $6.8 million in the first nine months 1997. This increase was
primarily attributable to professional services projects and an increase in fees
from consulting services and training courses. In the nine months ended
September 30, 1998 and 1997, the Company derived
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approximately 49.4% and 49.6%, respectively, of its total revenues from license
revenues and approximately 50.6% and 50.4%, respectively, of its total revenues
from service revenues.
Gross profit. The Company's gross profit increased 63.7% to $16.1 million
for the nine months ending September 30, 1998 from $9.8 million in the first
nine months of 1997. Gross profit percentage increased to 80.1% of total
revenues for the nine months ending September 30, 1998 from 73.2% in the first
nine months of 1997. Gross profit percentage for license revenues increased to
88.4% for the first nine months of 1998 from 85.5% for the comparable 1997
period. This 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 71.9% for the nine months
ended September 30, 1998 from 61.1% in the first nine 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 96.0%
to $6.4 million for the nine months ending September 30, 1998 from $3.3 million
in the first nine months of 1997, and increased to 31.8% of total revenues for
the nine months ending September 30, 1998 from 24.3% of total revenue in the
first nine 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 as well as higher variable costs,
such as commissions, associated with higher sales.
Research and product development expenses. Research and product
development expenses increased 105.3% to $4.6 million for the nine months ending
September 30, 1998 from $2.2 million in the first nine months of 1997, and
increased to 22.9% from 16.7% 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 8.6% to $1.8 million for the nine months ending September 30, 1998
from $1.9 million in the first nine months of 1997, and decreased to 8.8% from
14.5% of total revenues for the respective periods. The reduction of general and
administrative expenses for the nine months ending September 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 Company's 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 $1,203,000 for the first nine months of 1998
compared to $76,000 for the first nine 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.
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Income taxes. The Company's effective tax rate was 36.1% and 33.0% for each
of the nine months ended September 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.
Liquidity and Capital Resources
Since its inception in 1989, the Company has financed its operations
primarily through cash generated by operations and cash raised through its March
1998 initial public offering. At September 30, 1998, the Company's cash, cash
equivalents and marketable securities aggregated approximately $44.9 million, of
which cash and cash equivalents aggregated approximately $4.5 million. The
Company's working capital was $46.3 million at September 30, 1998.
Accounts receivable decreased to $6.9 million at September 30, 1998 from
$7.6 million at December 31, 1997 primarily as a result of increased collection
efforts on aged accounts and more aggressively negotiated progress payments on
services contracts.
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 September 30, 1998 includes approximately
$456,000 from customers in this region.
The Company's capital expenditures were approximately $475,000 and
$588,000 for the nine months ended September 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 September 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
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$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 consummationof 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.
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 the Year 2000 compliance of its tool suites and
internal computer and management information systems. In addition, the Company
continually reviews and monitors its products and custom application development
deliverables for 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.
In November 1998, the Company determined that certain custom applications
developed and delivered to approximately ten customers may not be Year 2000
compliant. All of these customers have been notified of the Year 2000 compliance
status. The Company will bear certain of the remediation expenses of such
compliance, pursuant to the warranty provisions of the applicable agreements.
The Company currently does not consider the costs associated with such
remediation to be material. The Company is continuing to analyze the extent to
which any of the affected project offerings were integrated by customers into
other products which may expose the Company to claims from its customers.
Failure of the Company or the affected 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.
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<PAGE>
Additionally, there can be no assurance 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.
Based upon its internal review and representations from its vendors, the
Company believes that its internal computer and management information systems
are Year 2000 compliant, and the Company does not believe that there will be
future significant costs related to maintaining such compliance.
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<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. During the third quarter of 1998, the Company granted stock options
pursuant to its 1998 Stock Plan which were not registered under the
Securities Act of 1933, as amended (the "Securities Act"). The
following table sets forth certain information regarding such grants
during the quarter:
Number Exercise
of shares Price
--------- --------
68,750 $ 14.188
1,250 $ 8.25
3,750 $ 10.25
750 $ 8.50
2. During the third quarter of 1998, the Company issued shares of
Common Stock pursuant to exercises of stock options granted under
its 1993 Stock Plan which were not registered under the Securities
Act. The following table sets forth certain information regarding
such issuances during the quarter:
Weighted
Average
Number Exercise
of shares Price
--------- ---------
206,484 $ 0.80
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 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 Securities Act as transactions made
pursuant to a written compensatory benefit plan or pursuant to a written
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<PAGE>
contract relating to compensation. All recipients had adequate access to
information about the Company.
Use of Proceeds from Initial Public Offering
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 September 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 securities
of grade A2 or better with maturities of two years or less.
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 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.
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<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: November 13, 1998 By: /s/ William P. McHale, Jr.
--------------------------
William P. McHale, Jr.
President and Chief Executive Officer
(Principal Executive Officer)
DATE: November 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
SEPTEMBER 30, 1998 AND IS QUALIFIED BY REFERENCE TO SUCH FORM 10-Q.
</LEGEND>
<CIK> 0001052196
<NAME> DSET Corporation
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