SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
Commission File Number 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 U. S. 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
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
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None
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
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(Title of Class)
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(Title of Class)
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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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
State the aggregate market value of the voting common stock held by
non-affiliates of the registrant: $95,738,005 at March 1, 1999 based on the last
sales price on that date.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of March 1, 1999:
Class Number of Shares
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Common Stock, no par value 10,248,403
The following documents are incorporated by reference into the Annual
Report on Form 10-K: Portions of the registrant's definitive Proxy Statement for
its 1999 Annual Meeting of Shareholders are incorporated by reference into Part
III of this Report.
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TABLE OF CONTENTS
Item Page
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PART I 1. Business........................................... 1
2. Properties......................................... 13
3. Legal Proceedings.................................. 13
4. Submission of Matters to a Vote of Security
Holders ....................................... 13
PART II 5. Market for the Company's Common Equity
and Related Stockholder Matters................ 14
6. Selected Financial Data............................ 16
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations............ 18
7A. Quantitative and Qualitative Disclosures About
Market Risk.................................... 26
8. Financial Statements and Supplementary Data........ 26
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure............ 26
PART III 10. Directors and Executive Officers of the Company.... 27
11. Executive Compensation............................. 27
12. Security Ownership of Certain Beneficial Owners
and Management................................. 27
13. Certain Relationships and Related Transactions..... 27
PART IV 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K.......................... 28
SIGNATURES............................................................ 29
EXHIBIT INDEX......................................................... 31
FINANCIAL DATA AND SCHEDULES.......................................... F-1
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PART I
ITEM 1. BUSINESS.
GENERAL
DSET designs, develops, markets and supports standards-based application
development tools, custom application development services, and Local Number
Portability Solutions ("LNP") and operational support systems ("OSS") gateway
products for the global telecommunications industry. Network equipment vendors
utilize the Company's application development tools to build applications which
manage network devices and provision new services such as voice, data and
Internet access. The Company also provides application development services for
those customers who cannot devote internal resources to quickly build network
management, number portability or OSS interconnection solutions. The Company's
LNP and OSS interconnection solutions are used by telecommunications carriers to
facilitate the flow of information between competing carriers' networks and
their respective OSSs. Most of DSET's solutions are based on the
Telecommunications Management Network ("TMN") standard, which defines the
functionality, application programming interfaces ("APIs") and communication
protocols required to ensure interoperability within and between carrier
networks that incorporate devices deployed from multiple vendors. The Company's
current customers include Allegiance Telecom, AT&T, BellSouth, Choice One,
Fujitsu, Hitachi, Lucent, MCI, Samsung, Tellabs and US Xchange.
Telecommunications carriers face an increasingly competitive and complex
market environment due to continued deregulation and privatization of the global
telecommunications industry. Consequently, telecommunications carriers worldwide
are investing aggressively in new technologies and equipment to enhance access
to their networks and expand systems capacity or bandwidth in order to provide
new and enhanced services. As a result, telecommunication equipment vendors are
delivering a variety of new technologies and equipment to address the carriers'
requirements, including SONET and SDH multiplexers, dense wavelength division
multiplexers ("DWDM"), ATM switches, next generation digital loop carrier
systems, wireless local loop systems and digital subscriber line products. The
proliferation of new technologies, equipment and services, and the pressure to
deploy and provide them rapidly, has placed increased demands on the operations,
administration and management of carrier networks. In addition, the
Telecommunications Act of 1996 mandated access to the incumbent carriers'
networks and OSSs in order to enable the flow-through of information and
services between new competitive carriers and the incumbents in order to
facilitate customer choice of carriers. As a result, carriers increasingly
require TMN-compliant applications to facilitate the operation, administration
and management of their networks and systems.
The Company's highly functional and scalable TMN-based solutions (i) enable
carriers to remotely manage large and complex telecommunication networks
comprised of thousands of network devices in a multi-vendor environment; (ii)
facilitate the rapid deployment of new
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technologies and network equipment and the rapid provisioning of
telecommunications services; and (iii) expedite the development of
carrier-to-carrier applications which enable carriers to quickly and
cost-effectively enter new markets.
DSET's objective is to become a leading provider of applications for the
telecommunications industry. Key elements of the Company's strategy include: (i)
delivering pre-built electronic bonding gateways that interconnect the OSSs of
competitive local exchange carriers ("CLECs") and the regional bell operating
companies, also known as the incumbent local exchange carriers ("ILECs"); (ii)
delivering pre-built network management applications to network equipment
vendors and CLECs; (iii) expanding distribution in Europe and Asia; (iv)
pursuing strategic acquisitions of complementary businesses or technologies; and
(v) continuing to invest in research and development projects to enhance
existing products and develop new products to support emerging technology
standards.
The Company was incorporated in New Jersey in 1989. The Company's executive
offices are located at 1011 US Highway 22, Bridgewater, New Jersey 08807, and
its telephone number is (908) 526-7500.
FORWARD-LOOKING STATEMENTS
Statements contained or incorporated by reference in this Annual Report on
Form 10-K 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 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, such as LNP or OSS gateways, (v)
risks associated with acquisitions of businesses by the Company, including risks
relating to unanticipated liabilities or expenses or lower than expected
revenues of such acquired businesses, and (vi) 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, such as LNP or OSS gateways, by telecommunications carriers and
network equipment vendors, and the buying patterns of CLECs. As a result of such
risks and others expressed from time to time in the Company's filings with the
Securities and Exchange Commission (the "Commission"), the Company's actual
results may differ materially from the results discussed in or implied by the
forward-looking statements contained herein.
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PRODUCTS AND SERVICES
The Company designs, develops, markets and supports an integrated suite of
object-oriented application development tools and provides custom application
development services, both of which facilitate the rapid development of network
management applications for the global telecommunications industry. The Company
also offers pre-built carrier-to-carrier applications which facilitate the flow
of business information between competing carriers. Telecommunications equipment
vendors utilize the Company's tools and development services to build a full
range of TMN agent, manager and LNP applications. CLECs utilize the Company's
pre-built electronic bonding gateways to interconnect their OSSs with the ILEC's
OSSs, such as an interface between order management systems.
APPLICATION DEVELOPMENT TOOLS
DSET's application development tools enable its customers to rapidly create
scalable solutions for the management of network devices within wireline or
wireless telecommunications networks. The Company offers two suites of
TMN-compliant application development tools, the TMN Agent Tool Suite and the
TMN Manager++ Tool Suite. Telecommunications equipment vendors utilize the
Company's TMN Agent Tool Suite to build agent applications that are embedded in
their network devices and subsequently sold to and deployed by carriers. Such
network devices include SONET multiplexers, DWDMs, digital loop carrier systems,
wireless base station controllers and ATM switches. Carriers utilize the TMN
Manager++ Tool Suite to build applications that assist in remotely managing
network devices from a specific vendor and facilitate the flow-through of
information within the carrier's network management infrastructure.
TMN Agent Tool Suite
TMN agent applications built with DSET tools are incorporated in network
devices and enable the remote management of the devices and the implementation
of new services, such as provisioning of new voice lines, Internet access, video
conferencing and advanced voice capabilities. This suite of agent tools
includes:
Visual Agent Builder GDMO Agent Toolkit
Visual Agent Tester CMIP Translator
CMIS/ROSE OODB Interfaces
Distributed Systems Generator Information Modeling Tools
ASN.C Compiler Cross Development Kits
GDMO Compiler OSI, RFC 1006, GR-303 Protocol Stacks
TMN Manager++ Tool Suite
The Company introduced the TMN Manager++ Tool Suite to customers on March
8, 1999. The TMN Manager++ Tool Suite includes the Company's original TMN
Manager Tool
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Suite, together with enhancements such as an integrated development environment,
which increases productivity in the development of applications. TMN manager
applications built with DSET tools generally reside on UNIX or Windows NT
workstations and interact with the agent applications to facilitate the
monitoring of network devices and to direct the flow-through of information to
higher level applications, such as fault management, configuration management,
performance and security within the network management infrastructure. This new
suite of manager tools, based on the NMF++ standard, includes the following
products:
Manager Tester OSI, RFC 1006, GR-303 Protocol Stacks
CMIS++/ROSE Manager Tool Kit
Distributed Systems Generator++ Visual Manager Builder
ASN.C++ Compiler Visual TMN Application Builder
GDMO++ Compiler
The OSI Stack and Information Modeling Tools are distributed by the Company
pursuant to distribution arrangements with ATOS, S.A. and Erisoft AB,
respectively. The Company's tools share a common software architecture enabling
a wide range of platform, operating system and communication protocol
independence. The development tools operate in UNIX and Windows NT operating
systems and are supported on platforms from Sun Microsystems, Hewlett Packard,
IBM and Digital Equipment Corporation. The Company also provides cross-platform
toolkits so that the agent applications can be ported to run under real time
operating systems. The Company's products operate with leading real time
operating systems, including pSOS, VxWorks and VRTX, and also support a variety
of communication protocols, including OSI, RFC 1006, TCP/IP and GR-303. This
cross-platform support enables DSET's customers, when switching platform
vendors, to preserve their investment in applications built with DSET's tools.
The Company licenses its tools on both a suite and individual component
basis. Prices for development licenses of the tool suites typically range from
approximately $150,000 to $250,000, depending on the number of licensed
components and users. The Company's license agreements also typically provide
for the payment of run-time royalty fees for applications built with DSET tools
when such applications are shipped to carriers by the licensee.
CUSTOM APPLICATION DEVELOPMENT SERVICES
DSET offers a broad range of value-added application development services
to its customers. DSET currently offers system design, information modeling,
complete "end-to-end" development, integrated testing and test plan simulations,
and design optimization services for rapid solution deployment. The Company has
assembled a team of application engineers with expertise in GDMO, ASN.1, CMIP,
OSI, TCP/IP and GR-303 (a Bellcore specification for local access) the key
technologies underlying TMN, as well as PCS and GSM, to provide application
development services to telecommunications equipment vendors and carriers
worldwide. DSET engineers utilize DSET's tools, their accumulated TMN expertise
and their knowledge of specific
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hardware environments to develop agent, manager and carrier-to-carrier
applications. The Company generally retains the right to rebuild similar
applications for other customers.
The Company's application development services projects are generally
individually negotiated and contracted for on a fixed price basis with
performance and payment milestones. Prices for such projects vary depending upon
the size and scope of the project and estimated time to completion. There can be
no assurance that the Company will be able to accurately estimate the resources
required for its fixed price projects or complete its contractual obligations in
a timely manner consistent with the project plans upon which such fixed price
projects are based.
CARRIER-TO-CARRIER APPLICATIONS
As a result of the Telecommunications Act of 1996, the FCC has required
local exchange carriers to support the implementation of LNP which enables
customers to move from their current telephone carrier to another, without a
change in telephone number. LNP applications require a significant amount of
information to be exchanged electronically between carriers and the seven
FCC-approved Number Portability Administration Centers ("NPACs") managed by an
independent third party company.
During 1998, DSET introduced new applications which address LNP. DSET has
built a local service management system ("LSMS") application, which provides the
required TMN interface between the telephone companies and the NPACs. A LSMS is
the "local database manager" for all numbers ported through NPACs. A carrier's
LSMS receives information from the NPAC about subscribers who are porting
telephone numbers from one carrier to another and then downloads information
about the ported numbers to the relevant network devices. The Company also
markets a product called the NPAC Simulator which helps carriers and equipment
vendors simulate the performance of the NPAC which shortens the interoperability
testing time necessary for certifying the TMN interface.
The Telecommunications Act of 1996 also stipulated that ILEC's unbundle or
decouple portions of their networks and make them available to the CLECs. Of the
thousands of CLECs today, approximately 100 to 200 are purchasing central office
switches. These facility-based CLECs then order from the ILEC the "local loop,"
also called the last mile, which connects the customer (business or consumer) to
the ILEC's central office switch. The ILEC must unbundle this local loop. The
CLEC requests to order an unbundled local loop have been predominantly handled
by fax transmissions which result in frequent communication inefficiencies.
Facsimile and overnight delivery services simply cannot accommodate the required
information flow between the competing carriers. An alternative is to utilize a
software application known as an electronic bonding gateway. These gateways
process orders electronically between two companies, in this case, between
competing telecommunications service providers.
The Company began shipping two electronic bonding gateways, the Local
Service Order Administration ("LSOA") gateway and the Local Service Request
("LSR") gateway, in the third and fourth quarters of 1998, respectively. The LSR
gateway enables the CLEC to send an order from its order management system to
the ILEC's order management system to request that the
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local loop be plugged into the CLEC's new central office switch. Once the CLEC
gets confirmation that it can get the local loop from the ILEC, it must notify
the NPAC. The LSOA gateway sends a message to the NPAC, alerting it to the fact
that a customer has switched from an ILEC to a CLEC. The message will in turn
trigger messages to be sent from the NPAC to each carrier's LSMS, which will
ensure that the new CLEC customer can keep their local telephone number. The
Company believes these two gateways are critical to reducing the time necessary
for a CLEC to turn on service for a new customer; the target is to reduce what
now takes four to six weeks to only one week.
The Company has announced four additional gateways for delivery in the
second quarter of 1999. The Access Service Request gateway (ASR) facilitates
ordering dedicated trunks from the ILEC, the Line Information Database (LIDB)
provides for calling card validation, the Calling Name Management (CNAM)
provides customer name verification for "caller ID" services and the E911
gateway addresses emergency services. All of these gateways assist CLECs in
ordering network capabilities from the ILEC, or updating the service bureaus
that support services such as caller ID or emergency services.
Individual gateways are licensed to carriers for fees ranging from $75,000
to $500,000, depending upon gateway type and complexity. All six gateways are
marketed under the name "ILEC in a Box" and CLECs can order between two and six
gateways. The price for this suite of gateways ranges from $150,000 to
$1,100,000. Maintenance, consulting services and custom integration to OSSs are
also available as optional services. ILEC interoperability interfaces built in
accordance with Joint Implementation Agreements between ILECs and CLECs are
available on a licensed or custom-built basis.
In an effort to continue to deliver new solutions to CLECs, in January
1999, the Company acquired certain assets of Network Programs, LLC ("NPL"), a
company specializing in software aimed at automatically comparing the services
offered by the ILEC to a catalog of services the CLEC has the ability to
provide. The results of the comparison are processed and subsequently produce a
"sales proposal" enabling the CLEC sales team to more efficiently compete with
other CLECs and ILECs. There can be no assurance that the Company will
successfully market these new applications to CLECs or that such new
applications will achieve market acceptance.
CUSTOMER SUPPORT SERVICES
The Company believes that its ability to provide a high level of customer
support is critical to achieving long term customer satisfaction. Accordingly,
the Company has increased its customer support staff and expanded its services
offerings.
Maintenance. The Company's maintenance services include problem
identification and notification, work-around solutions, temporary software
patches and bug fixes. Depending upon the complexity of the problem, the Company
provides technical support solutions via electronic mail, website access,
telephone or on-site support. Such services are offered to all licensees of the
Company's application development tools under maintenance contracts, for which
the Company typically charges 18% annually of the list price of the products
licensed by the
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customer. The Company utilizes a number of procedures to ensure prompt service,
including tracking all technical support issues in a computerized system to
ensure same-day acknowledgment of the customer report. Domestically, technical
support is provided directly by the Company's technical support engineers.
Internationally, local distributors, supported by the Company's regional
offices, provide first line technical support services. The Company's products
generally are covered by a 90-day warranty which covers defects in the media
provided to the customer, as well as a warranty for Year 2000 compliance. In
certain circumstances, the Company has provided a warranty that its products, as
delivered, will meet customer specifications.
Software Upgrades. In most cases, the Company provides its annual
maintenance customers with the option to receive product upgrades, including new
releases and product patches, for no additional fee. Software patches may be
downloaded by customers from the Company's website. Software upgrades may be
purchased for an additional fee by customers which have not contracted for
annual maintenance services.
Consulting Services. The Company provides a variety of consulting services
to its customers. Such consulting services include architectural reviews,
debugging customer applications, performance tuning, product porting and other
related services. The provision of consulting services often leads to sales of
application development tools.
Training. DSET provides a variety of training courses which educate
software developers on the use of its tools or end-users on the use of its
gateways. The courses are offered on a fee basis at the Company's headquarters
and at customer sites. The courses range from basic tool training to highly
advanced telecommunications standards and software topics. In addition, the
Company offers customized training to meet specific customer requests.
TECHNOLOGY
From its founding in 1989, the Company has focused on the creation of
applications that could be distributed among many processors in order to solve
highly complex problems in the network management arena. Additionally, the
Company has developed extensive knowledge of requirements for multi-protocol 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 TMN standard.
Through these efforts, the Company's engineers broadened their expertise in
GDMO, CMIP, ASN.1 and OSI, the key technologies underlying TMN, as well as a
variety of other emerging technologies.
The Company has leveraged its experience in distributed technologies to add
value to the TMN-based toolkits and to differentiate its application development
tools from those of its competitors. The Company's distributed technologies
allow for concurrency, or multi-threading, and scalability for the processing of
significant amounts of management information. The Company believes that the
multi-threading and scalability capabilities of its application development
tools are competitive advantages. Many competitive alternatives utilize
sequential
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processing which cannot take full advantage of the multi-processing capabilities
of high performance computing platforms.
The Company's innovative software technologies include sub-agent
capabilities, which, in conjunction with the Company's virtual management
information tree capability, enable the management of millions of objects. In
addition, DSET's products can support simultaneous synchronous/asynchronous and
connection-oriented/connection-less inter-process communications. This
capability, in addition to ensuring the high performance of applications, also
facilitates integration with third-party products. DSET has also simplified the
process of using these complex technologies by developing high level APIs and
GUIs.
CUSTOMERS
The Company's customers are primarily telecommunications network equipment
vendors and carriers. The following is a partial list of customers who purchased
products or services during 1998.
Accelerated Networks Lucent
Alcatel MaxComm Technologies
Allegiance Telecom MCI
Ameritech Net2000
AT&T Nortel Networks
BellSouth Ovation
Carrier Access Corp. Samsung
Choice One Siemens Canada Ltd.
Fujitsu Southwestern Bell Telephone Co.
Hitachi Tellabs
Italtel Tollbridge Technologies
Lockheed Martin IMS US Xchange
The Company had one significant customer in each of the three years ended
December 31, 1998. Sales to Hitachi accounted for approximately 18% of total
revenues in the year ended December 31, 1996. Sales to Samsung accounted for
approximately 12% of total revenues in the year ended December 31, 1997. Sales
to DSC Communications (now known as Alcatel) accounted for approximately 17% of
total revenues in the year ended December 31, 1998. 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. Other than
customer agreements which provide for minimum royalties for run-time licenses
and maintenance, none of the Company's customers has entered into an agreement
requiring minimum purchases from the Company. The Company's software development
services agreements with its customers generally can be terminated by either
party with limited or no advance notice, and without significant penalty. Many
of the Company's customers may also be competitors of the Company.
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SALES AND MARKETING
The Company markets its products and services through its direct sales
organization in North America and Asia and international distributors in South
America, Europe, Israel and Asia. As of December 31, 1998, the Company's direct
field sales force consisted of 14 sales people supported by 10 consulting
engineers based in its New Jersey, California and Texas offices.
The Company also markets its products and services through direct sales and
non-exclusive distributors in China, Taiwan, South Korea and Japan. Sales,
marketing and technical support is provided to the international distributors by
DSET personnel in the United States. The Company utilizes TMN Tools, S.A. ("TMN
Tools"), its joint venture created in May 1997 with ATOS, S.A., to distribute
DSET's products and services in Europe and Israel. TMN Tools has exclusive
rights to sell the Company's products in such territories pursuant to a two-year
contract ending on May 21, 1999.
In general, the non-exclusive distributor agreements require distributors
to use their best efforts to promote and solicit orders for the Company's
products and allow distributors to use the Company's trademarks and trade names
in advertising and promoting Company products. Typically, distributors receive a
commission of 30% of the sale price of the Company's products and 30% of any
maintenance and training sales. Commissions are payable only after the Company's
receipt of the total revenues for such sale. Customers purchasing products
through non-exclusive distributors are required to enter into license agreements
with the Company.
The Company has a lengthy sales cycle for application development tools and
custom application development services and believes that the period of time
between initial customer contact and execution of a license agreement or
development services contract typically ranges from four to nine months.
Telecommunications carriers and network equipment vendors typically conduct
extensive and lengthy product evaluations before purchasing software or
application development services. The sales cycle for CLECs is approximately
three to four months.
The Company has implemented marketing initiatives to support the sales and
distribution of its products and services. The objective of these efforts is to
inform customers of the capabilities and benefits of the Company's products and
services. Marketing programs include on-site customer seminars, participation in
industry trade shows and forums, distribution of marketing materials and
dissemination of information concerning products and services through the
Company's website.
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RESEARCH AND PRODUCT DEVELOPMENT
The Company believes that its future success depends on its ability to
develop and introduce applications that embrace new technologies and evolving
industry standards to meet the rapidly changing demands of customers and the
marketplace. The Company's research and product development objectives focus on
compatibility with new technologies and enhancement of products and services in
response to customer needs and industry and market trends. While the Company
expects that new applications will continue to be developed internally, the
Company may, based on timing and cost considerations, acquire or license
technologies, products or applications from third parties.
The Company is building several new products and allocates its research and
product development resources in response both to market research and customer
demands for additional features and products. The Company's product development
strategy involves rolling out initial versions of its products and adding
features over time. The Company regularly incorporates product feedback received
from customers into its product development process. The Company's research and
product development efforts are principally focused on (i) the enhancement of
existing products to support new features; (ii) the development of new
electronic bonding gateways and related applications; and (iii) new development
platforms/frameworks that will support emerging technology standards. The
Company recently began shipping several new products that support C++ APIs
endorsed by the Telemanagement Forum and is utilizing other technologies, such
as CORBA and Java.
The Company employs highly qualified engineers and utilizes its in-house
development capabilities to efficiently manage design processes and to shorten
product introduction lead times. The Company seeks to maximize the use of
existing technology to minimize time to market of its products and applications.
Most of the Company's research and development personnel hold engineering and
other advanced technical degrees. The Company's research and development team
consisted of 82 engineers and engineering services personnel as of December 31,
1998. The Company's research and development expenditures were approximately
$1.3 million, $3.3 million and $6.2 million in 1996, 1997 and 1998,
respectively.
COMPETITION
Competition in DSET's markets is intense and involves rapidly changing
technologies, evolving industry standards, frequent new product introductions
and rapid changes in customer requirements. To maintain and improve its
competitive position, DSET must continue to develop and introduce, on a timely
and cost-effective basis, new products, features and services that keep pace
with the evolving needs of its customers. The principal competitive factors
affecting the market for the Company's software tools are product reputation,
quality, performance, price, customer support and product features such as
adaptability, scalability, ability to integrate with other products,
functionality and ease of use. The Company believes that the principal
competitive factors in the market for application development services include
compliance with industry standards, quality of service and deliverables, speed
of development
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and implementation, price, project management capability and technical and
business expertise. The Company believes that the principal competitive factors
in the market for electronic bonding gateways include many of the same factors
as the market for application development services together with the ability of
such applications to support additional technologies to facilitate the
flow-through of information between carriers' networks and systems. While there
can be no assurance that the Company will be able to compete effectively based
upon such competitive factors, DSET believes that its capabilities in the
products it has built differentiates its products and services in the
marketplace.
The Company competes in the application development tools market with other
software tool providers. The Company's competitors in the markets for
application development services and electronic bonding gateways include the
in-house development staffs of telecommunications carriers, network equipment
vendors and systems integrators. In addition, there are new companies building
electronic bonding gateways which include other software vendors and companies
providing order management systems. Many of its competitors have longer
operating histories, greater name recognition, larger or captive customer bases
and significantly greater financial, technical, sales, customer support,
marketing and other resources. Furthermore, TMN, as an open systems
architecture, can lead to increased competition as third parties develop
competitive products and services. Competitors may be able to respond more
quickly to emerging technologies and changes in customer requirements.
INTELLECTUAL PROPERTY
The Company's success and its ability to compete effectively is dependent,
in part, upon its proprietary rights. The Company relies primarily on a
combination of copyright, trademark, patent and trade secret laws, as well as
confidentiality procedures and contractual restrictions, to establish and
protect its proprietary rights. Furthermore, the Company generally enters into
non-competition, non-disclosure and invention assignment agreements with its
employees and consultants, and into non-disclosure agreements with its customers
and distributors. There can be no assurance that such measures will be adequate
to protect the Company's proprietary rights.
Additionally, the Company may be subject to further risks as it enters into
transactions in countries where intellectual property laws are not well
developed or are difficult to enforce. Legal protections of the Company's
proprietary rights may be ineffective in such countries. Litigation may be
necessary to defend and enforce the Company's proprietary rights, which could
result in substantial costs and diversion of management resources and could have
a material adverse effect on the Company's business, financial condition and
results of operations, regardless of the final outcome of such litigation.
Despite the Company's efforts to safeguard and maintain its proprietary rights
both in the United States and abroad, there can be no assurance that the Company
will be successful in doing so or that the steps taken by the Company in this
regard will be adequate to deter misappropriation or independent third-party
development of the Company's technology or to prevent an unauthorized third
party from copying or otherwise obtaining and using the Company's products or
technology. Any of such events could have a material adverse effect on the
Company's business, financial condition and results of operations.
11
<PAGE>
The Company or its employees may become subject to claims of infringement
or misappropriation of the intellectual property rights of others. In its
licenses and software development and distribution agreements, the Company
agrees to indemnify its customers and distributors for any expenses and
liabilities resulting from claimed infringements of patents, trademarks,
copyrights or other proprietary rights of third parties. The Company attempts to
limit its liability to the value of the agreement, however, the amount of the
Company's indemnity obligations may be greater than the revenues the Company may
have received under such agreements. There can be no assurance that third
parties will not assert infringement or misappropriation claims against the
Company, its customers or distributors in the future with respect to its
employees or current or future products or services. Any claims or litigation,
with or without merit, could be time-consuming, result in costly litigation,
cause product shipment delays or require the Company to enter into royalty or
licensing arrangements. Such royalty or licensing arrangements, if required, may
not be available on terms acceptable to the Company, if at all, which could have
a material adverse effect on the Company's business, financial condition and
results of operations.
A portion of the Company's revenues is generated from run-time royalty fees
which generally become due upon the deployment by equipment vendors to
telecommunications carriers of network devices which have embedded applications
built with the Company's software. Such customers are contractually required to
periodically report their sales to the Company. The Company's sales contracts
typically provide for the Company's right to audit reported sales. There can be
no assurance, however, that such customers will accurately report such sales or
that the Company will be able to effectively monitor and enforce its contractual
rights with respect to such fees.
EMPLOYEES
As of December 31, 1998, the Company had a total of 170 employees. Of the
total, 82 were in engineering and product development, 18 were in professional
services, 31 were in sales and sales support, 20 were in administration, finance
and operations, 8 were in customer service, and 11 were in marketing. The
Company's future performance depends in significant part upon the continued
service of its management, key product and application engineers, and sales and
technical sales support personnel. Competition for such personnel is intense and
there can be no assurance that the Company will be successful in attracting or
retaining such personnel in the future. None of the Company's employees are
represented by a labor union or are subject to a collective bargaining
agreement. The Company has not experienced any work stoppages and considers its
relations with its employees to be good.
In connection with the acquisition of certain assets of NPL on January 25,
1999, the Company hired approximately 22 systems engineers formerly employed by
NPL.
12
<PAGE>
ITEM 2. PROPERTIES.
The Company's executive offices, research and product development, and
primary production operations are located in Bridgewater, New Jersey, where the
Company occupies approximately 19,755 square feet pursuant to a lease expiring
in 1999. The annual rent and maintenance for the facility is approximately
$328,000. In addition, the Company has entered into a short-term lease in
Branchburg, New Jersey for 10,000 square feet of additional office space which
lease expires on June 1, 1999. The rent for such facility is $15,000 per month.
Effective May 29, 1999, the Company will commence a ten-year lease of new
corporate offices in Bridgewater, New Jersey, which includes executive and
administrative, research and development, and operations offices, for
approximately 45,679 square feet with an annual rent of approximately $770,000
per year for the first three years. Thereafter certain rent escalation clauses
become effective. In addition, the Company leases 5,465 square feet of office
space for a professional services office in Richardson, Texas. The Company also
leases facilities in Campbell, California and Fremont, California, occupying
2,797 square feet and 3,275 square feet, respectively. In February 1999, the
Company moved employees to its Campbell office and closed its Fremont,
California office. Pursuant to the lease agreement for such location, the
Company remains obligated until December 2002 at an approximate annual rent of
$72,500. Management is actively pursuing sublease alternatives for this
location. The Company's subsidiary, Chengdu DSET Science and Technology Co.,
Ltd., leases approximately 2,100 square feet of office space in Chengdu, China.
See Note 11 of Notes to Financial Statements for information regarding the
Company's obligations under such leases. The Company believes that suitable
additional or alternative space will be available as needed on commercially
reasonably terms.
ITEM 3. LEGAL PROCEEDINGS.
The Company is not a party to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
13
<PAGE>
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
Prior to March 1998, there was no established market for shares of the
Company's Common Stock. Since March 13, 1998, the Common Stock has traded on the
Nasdaq National Market ("NNM") under the symbol "DSET." The initial public
offering price per share in the Company's initial public offering was $16.00 per
share.
The following table sets forth the high and low sales price information for
the Common Stock for each of the quarters in the period beginning March 13, 1998
as reported on the NNM. Such quotations reflect inter-dealer prices, without
retail mark-up, mark-down or commission and may not represent actual
transactions.
Quarter Ended High Low
---------------------------------------------------------------
March 31, 1998.............. $22.00 $17.00
June 30, 1998............... $21.875 $13.375
September 30, 1998.......... $19.875 $ 7.187
December 31, 1998........... $15.75 $ 6.187
As of March 1, 1999, the approximate number of holders of record of the
Common Stock was 100 and the approximate number of beneficial holders of the
Common Stock was 2,129.
The Company has never declared or paid any cash dividends on its capital
stock. The Company intends to retain any earnings to fund future growth and the
operation of its business and, therefore, does not anticipate paying any cash
dividends in the foreseeable future.
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:
14
<PAGE>
OPTION GRANTS
1. During the fourth 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"). All of such
option grants were granted at the then current fair market value of
the Common Stock. The following table sets forth certain information
regarding such grants during the quarter:
WEIGHTED
AVERAGE
NUMBER EXERCISE
OF SHARES PRICE
--------- -----
323,000 $ 8.68
COMMON STOCK ISSUANCES
2. During the fourth quarter of 1998, the Company issued shares of Common
Stock pursuant to exercises of stock options granted under its 1993
Stock Option 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
--------- -----
159,025 $ 2.04
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
contract relating to compensation. All recipients had adequate access to
information about the Company.
15
<PAGE>
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 December 31, 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.
On January 25, 1999, DSET Acquisition Corp., a wholly-owned subsidiary of
the Company, consummated the acquisition of certain assets of Network Programs
LLC, a Delaware limited liability company ("NPL"). The purchase price consisted
of $2,500,000 payable in cash to NPL. NPL provided specialized software to
CLECs.
ITEM 6. SELECTED FINANCIAL DATA.
The selected financial data set forth below with respect to the Company's
statement of income data for each of the years in the three-year period ended
December 31, 1998, and with respect to the balance sheet data at December 31,
1997 and 1998 are derived from and are qualified by reference to the audited
financial statements and the related notes thereto of the Company found at "Item
14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K." The
statement of income data for the years ended December 31, 1994 and December 31,
1995 and the balance sheet data as of December 31, 1994, 1995 and 1996 are
derived from audited financial statements not included in this Annual Report on
Form 10-K. The selected financial data set forth below should be read in
conjunction with and is qualified in its entirety by, the Company's audited
financial statements and related notes thereto found at "Item 14. Exhibits,
Financial Statement Schedules, and Reports on Form 8-K" and "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" which are included elsewhere in this Annual Report on Form 10-K.
16
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF INCOME DATA:
<S> <C> <C> <C> <C> <C>
Revenues:
License revenues................................... $2,838 $5,734 $7,005 $10,850 $16,338
Service revenues................................... 1,172 2,179 6,111 8,515 12,952
------ ------ ------ ------- -------
Total revenues.................................... 4,010 7,913 13,116 19,365 29,290
------ ------ ------ ------- -------
Cost of revenues:
License revenues................................... 17 74 133 1,274 1,775
Service revenues................................... 301 436 2,149 3,405 3,692
------ ------ ------ ------- -------
Total cost of revenues............................ 318 510 2,282 4,679 5,467
------ ------ ------ ------- -------
Gross profit......................................... 3,692 7,403 10,834 14,686 23,823
------ ------ ------ ------- -------
Operating expenses:
Sales and marketing................................ 1,444 2,588 4,255 4,986 9,193
Research and product development................... 517 865 1,328 3,299 6,237
General and administrative......................... 860 1,297 2,381 2,881 2,708
------ ------ ------ ------- -------
Total operating expenses.......................... 2,821 4,750 7,964 11,166 18,138
------ ------ ------ ------- -------
Operating income..................................... 871 2,653 2,870 3,520 5,685
------ ------ ------ ------- -------
Net income............................................. $ 572 $1,705 $2,013 $2,469 $ 4,794
====== ====== ======= ====== ======
Net income per common share............................ $ 0.10 $ 0.28 $ 0.37 $ 0.45 $ 0.53
Weighted average number of common shares outstanding... 5,760 6,003 3,309 3,567 9,012
Net income per common share assuming dilution.......... $ 0.10 $ 0.26 $ 0.27 $ 0.30 $ 0.43
Weighted average number of common shares and common
equivalent shares outstanding......................... 5,807 6,490 7,393 8,346 11,043
Pro forma:(1)
Net income per common share.......................... $ 0.37
Weighted average number of common shares outstanding. 6,610
Net income per common share assuming dilution........ $ 0.30
Weighted average number of common shares and common
equivalent shares outstanding....................... 8,346
DECEMBER 31,
-----------------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash, cash equivalents and marketable securities..... $ 312 $7,004 $1,778 $ 3,206 $45,023
Working capital...................................... 1,113 2,541 4,284 6,276 49,037
Total assets......................................... 2,651 10,424 7,445 13,315 56,854
Series A preferred stock............................. -- 9,943 10,744 11,604 --
Retained earnings.................................... 918 2,117 3,328 4,937 9,731
Total shareholders' equity (deficit)................. 1,641 (6,669) (5,410) (3,401) 51,189
(1) Gives effect to the automatic conversion of all issued and outstanding shares of Series A Preferred
Stock into 3,043,625 shares of Common Stock upon the consummation of the Company's initial public offering.
</TABLE>
17
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
OVERVIEW
GENERAL
DSET designs, develops, markets and supports standards-based application
development tools, custom application development services, and LNP and OSS
gateway products for the global telecommunications industry. From its founding
in 1989, the Company has focused on the creation of applications that could be
distributed among many processors in order to solve highly complex problems in
the network management arena. 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 TMN solutions. Substantially all of the Company's revenues to
date has been derived from application development tools and services based on
TMN standards. The Company's recently developed pre-built carrier-to-carrier
applications facilitate the flow of business information between competing
carriers and their respective OSSs. The Company's success will depend on
continued growth in the market for advanced telecommunications products and
services. In the years ended December 31, 1997 and 1998, the Company derived
approximately 56.0% and 55.8%, respectively, of its total revenues from license
revenues and approximately 44.0% and 44.2%, respectively, of its total revenues
from service revenues.
DSET's license revenues are derived from the sale of its application
development tools to customers under contracts which generally provide for
license fees and run-time royalty fees. The Company licenses its tools on both a
suite and individual component basis. Prices for development licenses of the
Company's tool suites typically range from approximately $150,000 to $250,000,
depending on the number of licensed components and development users. The
Company's license agreements also typically provide for the payment of
maintenance (recorded as service revenues) and run-time royalty fees at the time
of deployment by equipment vendors to telecommunications carriers of network
devices which have embedded applications built with the Company's software. A
run-time license permits an equipment vendor to incorporate applications
developed with the Company's software tools in such vendor's telecommunications
network devices. License revenues from development licenses are recognized at
the time the product is shipped to the customer. Run-time royalty fees are
recognized as the Company is notified of such deployment. Notification is
typically received from customers pursuant to quarterly reports or via purchase
orders for individual licenses. In addition, license revenues are derived from
the sale of electronic bonding gateways to carriers under contracts which
provide for license fees. Prices for licenses of the electronic bonding gateways
range from $150,000 to $1,100,000 depending on the number of licensed
components.
The Company's service revenues are comprised of fees derived from
application development services, maintenance fees, and other revenues generated
from customer support
18
<PAGE>
services. The Company's application development services are generally
individually negotiated and contracted for on a fixed price basis. Prices for
such projects vary depending upon the size and scope of the project and
estimated time to completion. Revenues from application development services are
generally recognized on a percentage of completion basis calculated as direct
labor costs are incurred in relation to estimated total costs at completion for
each project. The cumulative impact of revisions in percentage of completion
estimates is reflected in the period in which the revisions are made.
Maintenance services, for which the Company typically charges 18% annually of
the list price of the products licensed by the customer, may be purchased at the
customer's option. Maintenance fees are recognized as service revenue over the
term of the maintenance period, which is typically a 12-month term.
The Company had one significant customer in each of the three years ended
December 31, 1998. Sales to Hitachi accounted for approximately 18% of total
revenues in the year ended December 31, 1996. Sales to Samsung accounted for
approximately 12% of total revenues in the year ended December 31, 1997. Sales
to DSC Communications (now known as Alcatel) accounted for approximately 17% of
total revenues in the year ended December 31, 1998. 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's costs of license revenues consist primarily of royalties paid
to third party software companies. The Company generally is not contractually
obligated to make minimum royalty payments. Costs of service revenues include
primarily payroll, related benefit costs, personnel and other operating
expenses. Sales and marketing expenses consist of salaries, commissions and
bonuses paid to sales and marketing personnel, as well as travel and promotional
expenses. Research and product development expenses encompass primarily software
engineering personnel costs, costs of third-party equipment and software
utilized for development purposes. Research and product development expenses are
generally charged to operations as such costs are incurred. The Company's
research and development projects are evaluated for technological feasibility in
order to determine whether they meet capitalization requirements. The Company
has not capitalized any research and development expense in the last three
years. General and administrative expenses are comprised of personnel costs and
occupancy costs for administrative, executive and finance personnel. During the
year ended December 31, 1997, deferred stock compensation of $875,835 was
recorded for options granted during the year. This amount will be amortized to
compensation expense over the vesting period of the options (two to four years).
At December 31, 1998, the remaining unamortized deferred stock compensation
balance was $494,306. See Note 7 of Notes to Financial Statements.
The Company markets and sells its products and services through a direct
sales force in North America and Asia and directly and indirectly though
distributors in South America, Europe, Israel and Asia. Typically, distributors
receive a commission of 30% of the sale price of the Company's products and 30%
of any maintenance and training sales. Commissions are payable only after the
Company's receipt of the total revenues for such sale. In May 1997, the
19
<PAGE>
Company entered into a joint venture with ATOS, S.A. to form TMN Tools which
currently serves as the Company's exclusive sales and marketing arm in Europe
and Israel. The Company owns 49% of the outstanding equity securities of TMN
Tools.
The Company derives a portion of its revenues from international sales
which constituted approximately 15%, 27% and 38% of the Company's total revenues
in 1998, 1997 and 1996, 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.
On January 25, 1999, DSET Acquisition Corp., a wholly-owned subsidiary of
the Company, consummated the acquisition of certain assets of Network Programs
LLC, a Delaware limited liability company ("NPL"). The purchase price consisted
of $2,500,000 payable in cash to NPL. NPL provided specialized software to
CLECs. Management expects the NPL Acquisition to be accretive to earnings for
the fiscal year ending December 31, 1999.
RESULTS OF OPERATIONS
Years Ended December 31, 1998 and December 31, 1997
Revenues. Total revenues increased 51.3% to $29.3 million in 1998 from
$19.4 million in 1997. License revenues increased by 50.6% to $16.3 million in
1998 from $10.9 million in 1997. This increase was primarily attributable to an
increase in market acceptance of the Company's TMN-based agent tools,
recognition of run-time royalties, and licenses associated with OSS gateway
products. Service revenues increased 52.1% to $13.0 million in 1998 from $8.5
million in 1997. This increase was attributable primarily to custom application
development projects, fees from consulting services and training courses and new
customers purchasing the Company's GR-303 solutions, which include custom
application development work.
Gross profit. The Company's gross profit increased 62.2% to $23.8 million
in 1998 from $14.7 million in 1997. Gross profit percentage increased to 81.3%
of total revenues in 1998 from 75.8% in 1997. Gross profit percentage for
license revenues increased to 89.1% in 1998 from 88.3% in 1997 due to less third
party software as a component of sales. Gross profit percentage for service
revenues increased to 71.5% in 1998 from 60.0% in 1997. This increase was
attributable to higher margins associated with consulting services, training
revenues, an increase in the average billing rate and new GR-303 solutions
purchased by network equipment vendors.
Sales and marketing expenses. Sales and marketing expenses increased 84.4%
to $9.2 million in 1998 from $5.0 million in 1997 and increased to 31.4% from
25.7% of total revenues. The increase in sales and marketing expenses in
absolute dollars and as a percentage of total revenues 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 expenses such as travel and living costs and commissions
related to higher sales.
20
<PAGE>
Research and product development expenses. Research and product development
expenses increased 89.1% to $6.2 million in 1998 from $3.3 million in 1997, and
increased from 17.0% to 21.3% of total revenues. The increase in research and
product development expenses both in absolute dollars and as a percentage of
total revenues was due primarily to an increase in staffing and an expansion in
the number of new products under development.
General and administrative expenses. General and administrative expenses
decreased 6.0% to $2.7 million in 1998 from $2.9 million in 1997, and decreased
from 14.9% to 9.2% of total revenues. The decrease in general and administrative
expenses in absolute dollars and as a percentage of total revenues was due
primarily to the transition of the Company's Chief Technical Officer from
administrative functions to technical research and development functions, and
significantly lower recruiting costs.
Interest income and other income/expenses, net. Net interest income and
other income/expenses increased to $1.7 million in 1998 compared to $126,000 for
1997. This increase was primarily due to significantly 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 34.8% and 32.3% for each
of 1998 and 1997, respectively. The effective rate was higher than the statutory
tax rates in 1998 due to the non-deductibility of deferred stock compensation
associated with the issuance of stock options, offset by the utilization of
research and development tax credits. In 1997, the effective tax rate was lower
than the statutory tax rates due to the utilization of research and development
tax credits.
Years Ended December 31, 1997 and December 31, 1996
Revenues. Total revenues increased 47.6% to $19.4 million in 1997 from
$13.1 million in 1996. License revenues increased by 54.9% to $10.9 million in
1997 from $7.0 million in 1996. This increase was primarily attributable to an
increase in market acceptance of the Company's TMN-based tools and, to a lesser
extent, distribution by the Company of the Marben OSI Stack. Service revenues
increased 39.3% to $8.5 million in 1997 from $6.1 million in 1996. This increase
was attributable primarily to the initiation of several major projects in 1997,
including a $2.5 million contract with Samsung, which resulted in the
recognition of $2.2 million in revenues in 1997. Samsung accounted for
approximately 12% of total revenues in 1997.
Gross profit. The Company's gross profit increased 35.6% to $14.7 million
in 1997 from $10.8 million in 1996. Gross profit percentage decreased from 82.6%
of total revenues in 1996 to 75.8% in 1997. The decline in the gross profit
percentage for license revenues from 98.1% in 1996 to 88.3% in 1997 was due
primarily to the commencement of sales of third party software upon which
royalties must be paid. The decline in gross profit percentage for service
revenues from 64.8% of service revenues in 1996 to 60.0% in 1997 was
attributable primarily to higher personnel costs in 1997.
21
<PAGE>
Sales and marketing expenses. Sales and marketing expenses increased 17.2%
to $5.0 million in 1997 from $4.3 million in 1996, but decreased from 32.4% to
25.7% of total revenues. The increase in sales and marketing expenses in
absolute dollars was primarily attributable to increased personnel costs
partially offset by lower sales-related operating expenses.
Research and product development expenses. Research and product development
expenses increased 148.5% to $3.3 million in 1997 from $1.3 million in 1996, and
increased from 10.1% to 17.0% of total revenues. The increase in research and
product development expenses both in absolute dollars and as a percentage of
total revenues was due primarily to an increase in staffing which approximately
doubled period over period.
General and administrative expenses. General and administrative expenses
increased 21.0% to $2.9 million in 1997 from $2.4 million in 1996, but decreased
from 18.2% to 14.9% of total revenues. The increase in general and
administrative expenses in absolute dollars was due primarily to the addition of
key management personnel, the investment in additional administrative and
accounting operating systems, and the addition of support personnel.
Interest income and other income/expenses, net. Net interest income and
other income/expenses increased to $126,000 in 1997 compared to $99,000 for
1996. This increase was primarily due to investment income associated with
higher cash balances offset by amortization expense from the Marben Products,
Inc. acquisition in March 1997.
Income taxes. The Company's effective tax rate was 32.3% and 32.2% for each
of 1997 and 1996, respectively. Such effective tax rates were lower than the
statutory tax rates due primarily to research and development tax credits.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception in 1989, the Company has financed its operations
primarily through cash generated by operations. At December 31, 1998, the
Company's cash, cash equivalents and marketable securities aggregated
approximately $45.0 million, of which cash and cash equivalents aggregated
approximately $1.2 million and marketable securities aggregated approximately
$43.8 million. Marketable securities at December 31, 1998 were comprised of
fixed income government securities, corporate bonds, money market funds and
overnight commercial paper. The Company's working capital was $49.0 million and
$6.3 million at December 31, 1998 and 1997, respectively.
Accounts receivable increased to $9.1 million at December 31, 1998 from
$7.6 million at December 31, 1997 primarily as a result of the increase in
billings in the fourth quarter of 1998 as compared to the fourth quarter of
1997. The Company bills its maintenance contracts on an annual basis. A
significant portion of such billing occurs in the fourth quarter. One customer
comprised 25% of accounts receivable at December 31, 1998, and one customer
comprised an aggregate of 12% of accounts receivable at December 31, 1997.
22
<PAGE>
The Company bills its customers in U.S. dollars at agreed-upon contractual
terms. While the Company has customers in Asian countries, such as Korea and
Japan, 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 such Asian markets. Accounts receivable at December 31,
1998 includes approximately $460,000 from customers in this region.
The Company has an unsecured revolving credit facility with Manufacturers
and Traders Trust Company (the "Bank") pursuant to which it may borrow up to a
maximum of $3.0 million. Amounts outstanding under such facility bear interest
at the Bank's prime rate less 0.25% on aggregate principal amounts outstanding
of $1.0 million or less and at the Bank's prime rate to the extent aggregate
principal amounts exceed $1.0 million. The Company also has certain LIBOR
options. No borrowings under the revolving credit facility were outstanding as
of December 31, 1998. The credit facility contains, among other provisions, a
covenant which restricts the Company's ability to pay cash dividends.
The Company's capital expenditures were approximately $593,000 and $808,000
for the years ended December 31, 1998 and 1997, respectively. The Company
anticipates higher levels of equipment and facilities-related expenditures in
the foreseeable future as a result of moving and expanding corporate offices in
mid-1999.
The Company underwent an audit by the Internal Revenue Service for fiscal
years ending December 31, 1995 and 1996. No significant adjustments to
previously recorded tax liabilities resulted. In addition, the Company underwent
an audit by the NJ State Division of Taxation covering the fiscal years ending
December 31, 1992 through 1997. No material adjustments to previously recorded
liabilities resulted.
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 the Company's 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 ISSUES
Assessment. The Company believes that its exposure to Year 2000 problems
lies primarily in three areas: (i) its internal operating systems; (ii) Year
2000 compliance of its tool suites, custom applications and pre-built electronic
bonding gateways and network management applications; and (iii) non-compliance
of third parties with whom the Company has material relationships. The Company
has completed its assessment with respect to its internal operating systems and
tool suites. The Company continues to evaluate its exposure with respect to its
pre-built electronic bonding gateways, network management applications, certain
custom applications and its relationships with third parties.
23
<PAGE>
Internal Operating Systems. The Company believes its internal operating
computer systems and recently purchased management information system are
currently Year 2000 compliant, and the Company does not believe that there will
be future significant costs related to future maintenance of such compliance.
Tool Suites and Pre-Built Applications. The Company has conducted an
internal review and believes that its tool suites developed after May 27, 1997
have been tested and are Year 2000 complaint. These products include:
PRODUCT NAME VERSION
------------ -------
ASN.C/C++ 3.5.3
Agent Tester 2.0.1
CMIP Translator 1.0.1
Distributed Systems Generator 4.2.0
GDMO Agent Emulator 2.0.0
GDMO Agent Toolkit 2.0.0
LNP Test Extensions 2.0.0
Manager Code Generator 1.0.4
Marben OSIAM Stack 2.6f/2.6g
Visual Agent Builder 1.0.0
Testing of the Company's pre-built electronic bonding gateways and network
management applications for Year 2000 compliance are ongoing. In addition, the
Company continues to review and monitor all such products for Year 2000
compliance.
Custom Applications. In November 1998, the Company determined that certain
custom applications developed and delivered to approximately ten customers were
not Year 2000 compliant. All of these customers were notified of such Year 2000
compliance status in November 1998. The Company has agreed to assist each of
these customers with any and all remediation solutions required to achieve Year
2000 compliance with the Company's products. The Company does not believe such
remediation will be significant or will materially adversely affect the
Company's financial condition and results of operations. To date, the Company
has incurred certain remediation expenses related to such compliance, pursuant
to the warranty provisions of the applicable agreements. Presently, the Company
is continuing to analyze the extent to which any of the affected custom
applications were integrated by customers into other products which may expose
the Company to claims from its customers. A failure 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.
Third Party Relationships. The Company is dependent on various third party
software and hardware vendors and suppliers. The Company is also dependent on
third party service providers and partners such as telephone companies, banks,
insurance carriers, auditors and marketing partners. The failure of such third
parties to deliver Year 2000 compliant products or to remediate their internal
systems could jeopardize the Company's ability to meet its obligations
24
<PAGE>
to its customers. As a result, the Company is presently conducting inquiries of
its outside vendors, suppliers, service providers and marketing partners to
identify and resolve Year 2000 exposure from third parties. Upon completion of
the foregoing, the Company will be able to assess such exposure and financial
impact, if any, should such parties fail to be Year 2000 compliant.
Risks of Year 2000 Issues. The Company expects to identify and resolve all
Year 2000 problems that could materially adversely affect its business,
financial condition or results of operations. However, the Company believes that
it is not possible to determine with complete certainty that all Year 2000
problems affecting the Company have been identified or corrected. Further, the
Company cannot accurately predict how many failures related to the Year 2000
Problem will occur or the severity, duration or financial consequences of such
failures. The Company believes that the most reasonably likely worst case Year
2000 scenario would include a combination of some or all of the following:
o The Company's internal operating systems may fail or provide
erroneous information. Such failure could result in: reduced
utilization of technical or other personnel; the inability to timely
generate financial reports and statements; and improper billing and
record keeping;
o A number of system failures that may require significant efforts by
the Company or its customers to prevent or alleviate material
business disruptions; and
o Failure in HVAC, lighting, telephone, security and similar systems
on which the Company relies.
Additionally, the Company cannot guarantee that its 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.
Costs. Other than time spent by the Company's personnel, the costs
associated with remediating non-compliant custom applications and assessing Year
2000 compliance issues have not been significant to date. The Company believes
that the continued analysis of compliance of new releases of products and
evaluation of potential Year 2000 problems will result in aggregate expenditures
of less than $100,000.
Contingency Plans. The Company believes its plans for addressing the Year
2000 Problem are adequate. The Company does not believe it will incur a material
financial impact from system failures, or from the costs associated with
assessing the risks of failure, arising from the Year 2000 Problem.
Consequently, the Company does not intend to create a detailed contingency plan.
In the event that the Company does not adequately identify and resolve its Year
2000 issues, the absence of a detailed contingency plan may materially adversely
affect the Company's business, financial condition and results of operations.
25
<PAGE>
EUROPEAN MONETARY UNION
On January 1, 1999, eleven of the fifteen member countries of the European
Union set fixed conversion rates between their existing legacy currencies and
the euro. At such time, these participating countries adopted the euro as their
common legal currency. The eleven participating countries now issue sovereign
debt exclusively in euro and will redenominate outstanding sovereign debt. The
legacy currencies will continue to be used as legal tender through January 1,
2002, at which time the legacy currencies will be canceled and euro bills and
coins will be used for cash transactions in the participating countries.
The Company does not denominate its international licensing agreements in
foreign currencies. The Company currently does not believe that the euro
conversion will have a material impact on the Company's results of operations or
financial condition.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company believes that it is not subject to a material impact to its
financial position or results of operations relating to market risk associated
with derivative securities. See Note 2 of Notes to Financial Statements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements required to be filed pursuant to this Item 8 are
appended to this Annual Report on Form 10-K. A list of the financial statements
filed herewith is found at "Item 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K."
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
26
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.
The information relating to the Company's directors, nominees for election
as directors and executive officers under the headings "Election of Directors"
and "Executive Officers" in the Company's definitive proxy statement for the
1999 Annual Meeting of Shareholders is incorporated herein by reference to such
proxy statement.
ITEM 11. EXECUTIVE COMPENSATION.
The discussion under the heading "Executive Compensation" in the Company's
definitive proxy statement for the 1999 Annual Meeting of Shareholders is
incorporated herein by reference to such proxy statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The discussion under the heading "Security Ownership of Certain Beneficial
Owners and Management" in the Company's definitive proxy statement for the 1999
Annual Meeting of Shareholders is incorporated herein by reference to such proxy
statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The discussion under the heading "Certain Relationships and Related
Transactions" in the Company's definitive proxy statement for the 1999 Annual
Meeting of Shareholders is incorporated herein by reference to such proxy
statement.
27
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) (1) Financial Statements.
Reference is made to the Index to Financial Statements and Schedules
on Page F-1.
(2) Financial Statement Schedules.
Reference is made to the Index to Financial Statements and Schedules
on Page F-1.
(3) Exhibits.
Reference is made to the Index to Exhibits on Page 31.
(b) Reports on Form 8-K.
No Reports on Form 8-K were filed during the quarter ended December
31, 1998.
28
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 this 31st day of March,
1999.
DSET CORPORATION
By:/s/William P. McHale, Jr.
-----------------------------
William P. McHale, Jr., President
and Chief Executive Officer
29
<PAGE>
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
- --------------------------------- -------------------------- -----------------
/s/ William P. McHale, Jr. President, Chief Executive March 31, 1999
- -----------------------------
William P. McHale, Jr. Officer and Director
(Principal Executive
Officer)
/s/ Susan M. Boykas Acting Chief Financial March 31, 1999
- -----------------------------
Susan M. Boykas Officer (Principal
Financial and Accounting
Officer)
Chairman of the Board,
- -----------------------------
S. Daniel Shia Chief Technical Officer
and Director
/s/ Elizabeth K. Adams Director March 31, 1999
- -----------------------------
Elizabeth K. Adams
/s/ Bruce R. Evans Director March 31, 1999
- -----------------------------
Bruce R. Evans
/s/ John C. Thibault Director March 31, 1999
- -----------------------------
John C. Thibault
Director
- -----------------------------
Jacob J. Goldberg
30
<PAGE>
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION OF EXHIBIT
- ----------- ----------------------
3.1(a) Amended and Restated Certificate of Incorporation.
3.2(a) Amended and Restated Bylaws.
4.1(a) 1993 Stock Option Plan of the Company, as amended.
4.2(a) 1998 Stock Plan of the Company.
4.3(a) Form of Warrant Agreement, dated as of September 13, 1996 between
the Company and Summit Ventures IV, L.P. and Summit Investors II,
L.P.
4.4(a) Registration Rights Provisions granted to Summit Ventures IV,
L.P. and Summit Investors II, L.P.
10.1(a) Corporate Revolving and Term Loan Agreement between Manufacturers
and Traders Trust Company and the Company dated August 5, 1997.
10.2(a) Joint Venture Agreement dated as of May 21, 1997 between ATOS,
S.A. (formerly Sligos/Marben S.A.) and the Company.
10.3(a) Lease dated November 20, 1995 between Hocroft Associates and the
Company, as amended August 16, 1996 and April 7, 1997.
10.4(a)(b) Form of Indemnification Agreement executed by each of the
Company's directors and executive officers.
10.5(a)(b) Employment Agreement dated October 1, 1996 between the Company
and S. Daniel Shia.
10.6(a)(b) Employment Agreement dated January 1, 1998 between the Company
and William P. McHale, Jr.
10.7(a)(b) Letter agreements dated September 9, 1996 and April 28, 1997
between the Company and Paul A. Lipari.
10.8(a) DSET Corporation 401(k) Plan.
21 List of Subsidiaries.
27 Financial Data Schedule.
(a) Incorporated by reference to the Company's Registration Statement on Form
S-1 (File Number 333-43827) which became effective on March 12, 1998.
(b) A management contract or compensatory plan or arrangement required to be
filed as an exhibit pursuant to Item 14(c) of Form 10-K.
31
<PAGE>
DSET CORPORATION
INDEX TO FINANCIAL STATEMENTS
PAGE
----
Report of Independent Accountants...................................... F-2
Balance Sheets as of December 31, 1998 and 1997........................ F-3
Statements of Income for the Years Ended December 31, 1998, 1997
and 1996............................................................. F-4
Statements of Changes in Cumulative Redeemable Convertible
Preferred Stock and Shareholders' Equity (Deficit) for the
Years Ended December 31, 1998, 1997 and 1996......................... F-5
Statements of Cash Flows for the Years Ended December 31, 1998,
1997 and 1996........................................................ F-6
Notes to Financial Statements.......................................... F-7
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
DSET Corporation
In our opinion, the accompanying balance sheets and the related statements of
income, of changes in cumulative redeemable convertible preferred stock and
shareholders' equity (deficit) and of cash flows present fairly, in all material
respects, the financial position of DSET Corporation at December 31, 1998 and
1997, and the results of its operations and its cash flows for each of the three
years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audits to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
Florham Park, New Jersey
February 2, 1999
F-2
<PAGE>
DSET Corporation
December 31, 1998
Balance Sheets
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
DECEMBER 31,
1998 1997
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 1,159,070 $ 2,081,846
Marketable securities 43,863,980 1,123,795
Accounts receivable, net of allowance for doubtful accounts
of $175,979 and $125,504 9,108,059 7,564,442
Deferred income taxes 258,144 158,681
Prepaid expenses and other current assets 193,418 243,883
-------------- ------------
Total current assets 54,582,671 11,172,647
Fixed assets, net 1,592,114 1,560,948
Goodwill, net 129,864 167,873
Other assets 548,963 413,760
-------------- ------------
Total assets $ 56,853,612 $ 13,315,228
-------------- ------------
LIABILITIES, CUMULATIVE REDEEMABLE CONVERTIBLE
PREFERRED STOCK AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued expenses $ 3,560,994 $ 2,779,954
Income taxes payable 145,673 -
Deferred revenues 1,726,906 1,897,039
Note payable 111,657 220,000
-------------- ------------
Total current liabilities 5,545,230 4,896,993
Deferred income taxes 119,127 103,714
Note payable - 111,657
-------------- ------------
Total liabilities 5,664,357 5,112,364
-------------- ------------
Commitments (Notes 5 and 11)
Series A cumulative redeemable convertible preferred stock,
no par value; 750,000 shares authorized, no shares
issued or outstanding at December 31, 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,
no shares issued or outstanding at December 31, 1998;
no shares authorized, issued or outstanding at
December 31, 1997 - -
Common stock, no par value; 40,000,000 shares authorized,
11,636,245 and 6,775,092 shares issued and outstanding
at December 31, 1998 and 1997, respectively 41,912,361 2,537,806
Deferred stock compensation (494,306) (875,835)
Retained earnings 9,731,077 4,936,894
Unrealized appreciation in investments 40,123 -
Treasury stock, no shares and 3,043,625 shares of common
stock at cost - (9,999,997)
-------------- ------------
Total shareholders' equity (deficit) 51,189,255 (3,401,132)
Total liabilities, cumulative redeemable convertible
preferred stock and shareholders' equity (deficit) $ 56,853,612 $ 13,315,228
============== ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
DSET Corporation
December 31, 1998
Statements of Income
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1998 1997 1996
<S> <C> <C> <C>
Revenues:
License revenues $ 16,337,615 $ 10,850,275 $ 7,005,313
Service revenues 12,952,549 8,514,512 6,111,227
------------ ------------ ----------
Total revenues 29,290,164 19,364,787 13,116,540
------------ ------------ -----------
Cost of revenues:
License revenues 1,775,144 1,274,355 133,209
Service revenues 3,692,092 3,404,484 2,149,036
------------ ------------ -----------
Total cost of revenues 5,467,236 4,678,839 2,282,245
------------ ------------ -----------
Gross profit 23,822,928 14,685,948 10,834,295
------------ ------------ -----------
Operating expenses
Sales and marketing 9,192,593 4,986,286 4,255,455
Research and product development 6,237,484 3,299,337 1,327,682
General and administrative 2,707,856 2,880,804 2,380,679
------------ ------------ ----------
Total operating expenses 18,137,933 11,166,427 7,963,816
------------ ------------ -----------
Operating income 5,684,995 3,519,521 2,870,479
Amortization of goodwill (38,009) (22,172) -
Interest and other expense (120,160) (12,194) -
Interest and other income 1,827,830 160,847 99,004
------------ ------------ -----------
Income before income taxes 7,354,656 3,646,002 2,969,483
Provision for income taxes 2,560,473 1,177,396 956,889
------------ ------------ -----------
Net income 4,794,183 2,468,606 2,012,594
Less: accrued preferred stock dividends - 859,555 801,578
------------ ------------ -----------
Net income applicable to common shares $ 4,794,183 $ 1,609,051 $ 1,211,016
============ ============ ===========
Net income per common share $ 0.53 $ 0.45 $ 0.37
============ ============ ===========
Weighted average number of common shares
outstanding 9,012,019 3,566,764 3,308,763
============ ============ ===========
Net income per common share assuming dilution $ 0.43 $ 0.30 $ 0.27
============ ============ ===========
Weighted average number of common shares and
common equivalent shares outstanding 11,043,422 8,346,365 7,392,793
============ ============ ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
DSET Corporation
December 31, 1998
Statements of Changes in Cumulative Redeemable
Convertible Preferred Stock and Shareholders' Equity (Deficit)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Series A Convertible
Preferred Stock Common Stock Deferred Other
Number Number Stock Retained Treasury Comprehensive
of Shares Amount of Shares Amount Compensation Earnings Stock Income Total
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at
January 1, 1996 676,361 $ 9,942,863 6,339,546 $ 1,214,616 $ - $2,116,827 $(9,999,997) $ - $(6,668,554)
Exercise of
stock options - - 50,814 47,201 - - - - 47,201
Accrued dividends
on redeemable
convertible
preferred stock - 801,578 - - - (801,578) - - (801,578)
Net income - - - - - 2,012,594 - - 2,012,594
--------- ----------- ---------- ----------- -------- ---------- ----------- --------- -----------
Balance at
December 31, 1996 676,361 10,744,441 6,390,360 1,261,817 - 3,327,843 (9,999,997) - (5,410,337)
Exercise of stock
options - - 384,732 275,813 - - - - 275,813
Tax benefit from
exercise of stock
options - - - 124,341 - - - - 124,341
Accrued dividends
on redeemable
convertible
preferred stock - 859,555 - - - (859,555) - - (859,555)
Deferred stock
compensation - - - 875,835 (875,835) - - - -
Net income - - - - - 2,468,606 - - 2,468,606
--------- ----------- ---------- ----------- -------- ---------- ----------- --------- -----------
Balance at
December 31, 1997 676,361 11,603,996 6,775,092 2,537,806 (875,835) 4,936,894 (9,999,997) - (3,401,132)
Exercise of stock
options - - 2,361,153 1,307,790 - - - - 1,307,790
Tax benefit from
exercise of stock
options - - - 501,217 - - - - 501,217
Amortization of
deferred stock
compensation - - - (6,808) 298,620 - - - 291,812
Forfeitures of
55,571 shares of
stock options - - - (82,909) 82,909 - - - -
Sale - Issuance of
common stock - - 2,500,000 37,200,000 - - - - 37,200,000
Costs related to
issuance of
common stock - - - (1,148,734) - - - - (1,148,734)
Conversion of
series A cumulative
redeemable
convertible
preferred stock (676,361) (11,603,996) 3,043,625 11,603,996 - - - - 11,603,996
Retirement of
treasury stock - - (3,043,625) (9,999,997) - - 9,999,997 - -
Unrealized
appreciation on
investments - - - - - - - 40,123 40,123
Net income - - - - - 4,794,183 - - 4,794,183
--------- ----------- ---------- ----------- -------- ---------- ----------- --------- -----------
Balance at
December 31, 1998 - $ - 11,636,245 $41,912,361 $(494,306) $9,731,077 $ - $ 40,123 $51,189,255
========= =========== ========== =========== ========= ========== =========== ========= ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
DSET Corporation
December 31, 1998
Statements of Cash Flows
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1998 1997 1996
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,794,183 $ 2,468,606 $ 2,012,594
Adjustments to reconcile net income to net cash
provided by operating activities:
Deferred income taxes (84,050) (123,482) (47,300)
Tax benefit from exercise of stock options 501,217 124,341 --
Amortization of deferred stock compensation 291,812 -- --
Depreciation 559,954 399,035 257,815
Gain on disposal of assets (1,172) -- --
Amortization 38,009 121,776 149,170
Loss (earnings) from joint venture 79,914 (26,131) --
Changes in assets and liabilities:
Accounts receivable (1,543,617) (3,014,841) (1,916,125)
Other assets (264,652) (94,759) (16,379)
Accounts payable and accrued expenses 781,040 1,631,892 604,778
Income tax payable 145,673 (108,468) (682,609)
Deferred revenues (170,133) 887,386 166,914
------------ ------------ ------------
Net cash provided by operating activities 5,128,178 2,265,355 528,858
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities (85,851,994) (1,080,768) (1,829,932)
Redemption of marketable securities 43,151,932 1,150,000 1,640,626
Acquisition of fixed assets (593,007) (807,640) (707,750)
Proceeds on disposition of fixed assets 3,059 -- --
Investment in joint venture -- (245,000) --
------------ ------------ ------------
Net cash used in investing activities (43,290,010) (983,408) (897,056)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment by (loans to) officers and shareholders 100,000 (150,000) --
Loan repayments (220,000) (110,000) --
Proceeds from issuance of common stock, net 36,051,266 -- --
Purchases of treasury stock -- -- (5,094,008)
Proceeds from the exercise of stock options 1,307,790 275,813 47,201
------------ ------------ ------------
Net cash provided by (used in) financing activities 37,239,056 15,813 (5,046,807)
------------ ------------ ------------
Net (decrease) increase in cash and cash equivalents (922,776) 1,297,760 (5,415,005)
Cash and cash equivalents, beginning of period 2,081,846 784,086 6,199,091
------------ ------------ ------------
Cash and cash equivalents, end of period $ 1,159,070 $ $2,081,846 $ 784,086
============ ============ ============
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes $ 1,142,000 $ 1,157,868 $ 1,678,798
Cash paid during the period for interest 12,458 12,194 --
Non-cash activities:
Conversion of Series A preferred stock to common stock $ 11,603,996 $ -- $ --
Retirement of treasury stock 9,999,997 -- --
Accrued dividends on Series A preferred stock -- 859,555 801,578
Note issued for net assets of Marben Products Inc. -- 441,657 --
Forfeiture of stock options with deferred stock compensation 82,909 -- --
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
DSET Corporation
December 31, 1998
Notes to Financial Statements
- --------------------------------------------------------------------------------
1. NATURE OF BUSINESS
DSET Corporation (the "Company"), which was founded in 1989, designs,
develops, markets and supports an integrated suite of object-oriented
application development tools and provides custom application development
services. The Company also offers carrier-to-carrier applications. In
addition, the Company provides its customers with consulting, training and
technical services. Headquartered in Bridgewater, New Jersey, the Company
serves customers worldwide.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents.
MARKETABLE SECURITIES
The marketable securities portfolio held by the Company are considered to
be available-for-sale securities and are reported at fair value. Unrealized
holding gains and losses were $40,123 at December 31, 1998 and were not
significant at December 31, 1997.
FIXED ASSETS
Equipment, furniture and purchased software are stated at cost less
accumulated depreciation. Depreciation is calculated using a straight-line
method over estimated useful lives ranging from three to seven years.
Leasehold improvements are amortized over the lesser of the estimated
useful life or the lease term.
GOODWILL
The Company amortizes goodwill using a straight-line method over its
estimated useful life of five years. The Company periodically assesses the
realizability of the asset based on estimated future cash flows.
REVENUE RECOGNITION
License revenues are recorded when the software has been shipped 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. Custom
application development 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 bases 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.
F-7
<PAGE>
DSET Corporation
December 31, 1998
Notes to Financial Statements
- --------------------------------------------------------------------------------
For certain stock options, the Company receives a tax deduction for the
difference between the fair value at the date of exercise of the stock
option and the exercise price. To the extent the amount deducted for income
taxes exceeds the amount charged to operations for financial statement
purposes, the related tax benefits are credited to shareholders' equity.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts in the financial statements for cash and cash
equivalents, accounts receivable, and accounts payable and accrued expenses
approximate their market value because of the short maturity of those
instruments.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
RECENTLY ISSUED ACCOUNTING STANDARDS
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.
3. MARKETABLE SECURITIES
Marketable securities at December 31, 1998 and 1997 were comprised as
follows:
DECEMBER 31,
1998 1997
Government fixed income securities $ 26,174,048 $ -
Corporate bonds 9,650,732 100,000
Money market funds 3,575,868 1,023,795
Overnight investments 4,463,332 -
------------ -------------
Total $ 43,863,980 $ 1,123,795
============ =============
The Company's credit policy provides for all short-term securities of grade
A2 or better with maturities of two years or less. Interest income earned
related to market securities was $1,667,000 and $122,000 for the years
ended December 31, 1998 and 1997, respectively.
F-8
<PAGE>
DSET Corporation
December 31, 1998
Notes to Financial Statements
- --------------------------------------------------------------------------------
4. FIXED ASSETS
Fixed assets consist of the following:
DECEMBER 31,
1998 1997
Computer equipment $ 1,688,910 $ 1,574,171
Purchased software 839,668 540,315
Furniture, fixtures and office
equipment 451,452 304,678
Leasehold improvements 68,080 32,692
Transportation equipment 32,692 41,242
-------------- -------------
3,080,802 2,493,098
Less: accumulated depreciation (1,488,688) (932,150)
--------------- --------------
$ 1,592,114 $ 1,560,948
============== ==============
5. CUMULATIVE REDEEMABLE CONVERTIBLE PREFERRED STOCK
During December 1995, the Company issued 676,361 shares of cumulative,
convertible Series A Preferred Stock in exchange for $10,000,000. As an
integral part of the Agreement, the Company was required to use the
proceeds received upon the sale of the preferred stock to repurchase, on or
before January 31, 1996, an aggregate of 3,043,625 shares of common stock.
Shareholders of Series A Preferred Stock were entitled to votes equal to
the number of common shares into which the shares of preferred stock were
convertible. The Series A Preferred shareholders were also entitled to
receive cumulative annual dividends equal to the "Applicable Percentage
Rate" of 8%, as defined in the Agreement, of the original purchase price
paid per share. In the event of conversion of the preferred stock to Common
Stock, however, all accumulated and unpaid dividends on the preferred stock
were to be forgiven. The holders of the Series A Preferred stock also had
certain redemption and liquidation rights.
The holders of the Series A Preferred Stock had the option to convert, at
any time, their shares into fully-paid and nonassessable shares of common
stock at the "Applicable Conversion Rate," which was four and one-half
shares of Common Stock for each share of Series A Preferred Stock
converted. The Series A Preferred Stock was to be automatically converted
into Common Stock upon the closing of an initial public offering in which
net proceeds to the Company equaled or exceeded $15,000,000 and the price
paid by the public for such shares was at least three times the then
conversion value per share as defined by the Agreement. The shares of the
Series A Preferred Stock were automatically converted upon the consummation
of the Company's initial public offering.
In the event of the issuance of stock options to two specified executives
(one of which is no longer with the Company), the Series A Preferred
Shareholders were entitled to receive warrants to purchase a proportionate
number of shares with an identical exercise price per share. In September
1996, warrants to purchase 185,331 shares with an exercise price of $2.18
per share were issued for no consideration. Such warrants are or will be
exercisable to the extent of 25% on each of September 13, 1997, 1998, 1999
and 2000. At December 31, 1998, all warrants were still outstanding.
F-9
<PAGE>
DSET Corporation
December 31, 1998
Notes to Financial Statements
- --------------------------------------------------------------------------------
6. COMMON STOCK
On December 29, 1997, the Company amended its Certificate of Incorporation
to increase the number of authorized shares of Common Stock to 40,000,000
shares. On December 31, 1997, the Company effected a three-for-two stock
split of the Company's Common Stock. All references to common share
amounts, shares, per share data, and preferred stock conversion rights
included in the financial statements and notes have been adjusted to give
retroactive effect to the stock split for all periods presented. On
December 31, 1997, the Company's Board of Directors authorized the officers
of the Company to amend and restate the Company's Certificate of
Incorporation to reflect, among other things, the authorization of
5,000,000 shares of a new class of undesignated preferred stock. Such
amendment and restatement to the Certificate of Incorporation became
effective upon the effectiveness of the Company's registration statement
filed in connection with the Company's initial public offering of its
Common Stock.
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.
7. STOCK OPTIONS
The Company maintains a stock option plan (the "1993 Plan") covering
officers, employees, directors and consultants, pursuant to which options
may be granted to purchase shares of the Company's Common Stock. Options
granted under this 1993 Plan may be either incentive stock options or
nonqualified stock options, as designated at the time of grant and vest
over a period not to exceed four years. The 1993 Plan provides that the
option price shall not be less than the fair market value of the shares at
date of grant (as determined by the 1993 Plan's administrators), except for
a more than 10% voting shareholder, in which case it will not be less than
110% of the fair market value at date of grant. Incentive stock options are
exercisable for ten years from the date of grant ("10 Year Options"),
except for a more than 10% voting shareholder, in which case the option is
exercisable for five years ("5 Year Options"). Nonqualified stock options
are exercisable for five years from the date of grant.
The 1998 Stock Plan was adopted by the Board of Directors on December 31,
1997. The 1998 Stock Plan became effective on the date of the consummation
of the Company's initial public offering (March 18, 1998) and terminates
ten years from such date. Upon effectiveness of the 1998 Stock Plan, a
total of 1,800,000 shares were reserved for issuance upon the exercise of
option and/or stock purchase rights granted thereunder. Those eligible to
receive stock option grants or stock purchase rights under the 1998 Stock
Plan include employees, non-employee directors and
F-10
<PAGE>
DSET Corporation
December 31, 1998
Notes to Financial Statements
- --------------------------------------------------------------------------------
consultants. The 1998 Stock Plan is administered by the Compensation
Committee of the Board of Directors of the Company.
During the year ended December 31, 1997, deferred stock compensation of
$875,835 was recorded for options granted during the year. This amount will
be amortized to compensation expense over the vesting period of the options
(two to four years). At December 31, 1998, the remaining unamortized
deferred stock compensation balance was $494,306.
At December 31, 1998, options to purchase 1,208,344 shares of common stock
were exercisable under the Company's stock option plans at a weighted
average exercise price per share of $1.59.
A summary of option transactions during 1998, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
WEIGHTED
NUMBER OF AVERAGE
SHARES EXERCISE
---------------------------------------
10 YEAR 5 YEAR PRICE PER
OPTIONS OPTIONS TOTAL SHARE
<S> <C> <C> <C> <C>
Outstanding January 1, 1996 344,250 1,114,024 1,458,274 $ 0.67
Granted 633,000 202,886 835,886 $ 2.19
Forfeited - (4,482) (4,482) $ 0.85
Exercised - (50,814) (50,814) $ 0.93
--------- --------- ---------
Outstanding December 31, 1996 977,250 1,261,614 2,238,864 $ 1.23
Granted 827,400 392,359 1,219,759 $ 3.67
Forfeited (141,000) (84,398) (225,398) $ 2.67
Exercised (157,500) (227,232) (384,732) $ 0.72
--------- --------- ---------
Outstanding December 31, 1997 1,506,150 1,342,343 2,848,493 $ 2.23
Granted 602,500 229,500 832,000 $ 11.99
Forfeited (111,074) (126,724) (237,798) $ 6.38
Exercised (205,322) (337,145) (542,467) $ 1.56
--------- --------- ---------
Outstanding December 31, 1998 1,792,254 1,107,974 2,900,228 $ 4.79
========= ========= =========
</TABLE>
In October, 1995, the Financial Accounting Standards Board issued SFAS No.
123, "Accounting for Stock-Based Compensation," which establishes financial
accounting and reporting standards for stock-based employee compensation
plans. However, SFAS No. 123 also permits the measurement of compensation
costs using the intrinsic value based method of accounting prescribed by
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock
Issued to Employees." The Company has elected to account for its employee
stock compensation plans under the guidance prescribed by APB Opinion No.
25 and has made the required pro forma disclosures of net income and net
income per share as if the fair value based method of accounting defined in
SFAS No. 123 had been applied as indicated below:
F-11
<PAGE>
DSET Corporation
December 31, 1998
Notes to Financial Statements
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Years ended December 31,
1998 1997 1996
<S> <C> <C> <C>
NET INCOME APPLICABLE TO COMMON SHARES:
As reported $ 4,794,183 $ 1,609,051 $ 1,211,016
Pro forma effect of applying SFAS No. 123 3,639,098 950,593 1,089,641
NET INCOME PER COMMON SHARE:
As reported $ 0.53 $ 0.45 $ 0.37
Pro forma effect of applying SFAS No. 123 $ 0.40 $ 0.27 $ 0.33
NET INCOME PER COMMON SHARE ASSUMING DILUTION:
As reported $ 0.43 $ 0.30 $ 0.27
Pro forma effect of applying SFAS No. 123 $ 0.33 $ 0.22 $ 0.26
</TABLE>
The fair value for options issued prior to the Company's initial public
offering were estimated at the date of grant using the minimum value method
with the following weighted average assumptions for the years ended
December 31, 1996 and 1997: risk-free interest rates of 4.65% to 7.28%;
expected life of five to ten years, volatility 0% and dividend yields of
0.0%. The fair value of option grants subsequent to the initial public
offering were calculated using the absolute method with the following
assumptions for the year ended December 31, 1998: risk-free interest rates
of 4.65% to 5.49%; expected life of 4 years, volatility of 80% and dividend
yields of 0.0%. These methods require the input of highly subjective
assumptions. Changes in the subjective input assumptions can materially
affect the fair value estimate. In management's opinion, the existing
models do not necessarily provide a reliable single measure of the fair
value of its employee stock options.
8. INCOME TAXES
The provision (benefit) for federal, state and local and foreign taxes
consists of the following:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1998 1997 1996
<S> <C> <C> <C>
CURRENT:
Federal $ 2,262,893 $ 1,079,038 $ 714,202
State and local 259,780 149,584 90,189
Foreign 121,850 72,256 199,798
------------ ------------ -----------
2,644,523 1,300,878 1,004,189
------------ ------------ -----------
DEFERRED:
Federal (76,649) (111,830) (40,476)
State and local (7,401) (11,652) (6,824)
------------ ------------ -----------
(84,050) (123,482) (47,300)
------------ ------------ -----------
Provision for income taxes $ 2,560,473 $ 1,177,396 $ 956,889
============ ============ ===========
</TABLE>
F-12
<PAGE>
DSET Corporation
December 31, 1998
Notes to Financial Statements
- --------------------------------------------------------------------------------
The tax provision reconciles to the amount computed by multiplying income
before income taxes by the United States federal statutory rate of 34% as
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1998 1997 1996
<S> <C> <C> <C>
Provision of statutory rate 34.0% 34.0% 34.0%
State taxes, net of federal benefit 2.2 2.5 1.9
Research and development tax credits (3.3) (4.2) (3.8)
Deferred stock compensation 1.3 - -
Other 0.6 - 0.1
--------- ---------- ---------
34.8% 32.3% 32.2%
========= ========== =========
</TABLE>
Deferred tax assets (liabilities) are comprised of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
1998 1997
<S> <C> <C>
CURRENT:
Accrued vacation $ 127,656 $ 82,971
Bad debt reserve 65,939 47,390
Deferred maintenance revenue 36,446 -
Accrued bonus 28,103 28,320
------------- ---------------
Total $ 258,144 $ $158,681
============= ===============
NON-CURRENT:
Fixed assets (119,127) (103,714)
------------- ---------------
Total $ (119,127) $ (103,714)
============= ===============
</TABLE>
9. REVENUE AND RECEIVABLE CONCENTRATION
The Company had one significant customer for each of the years ended 1996,
1997 and 1998, which accounted for approximately 18%, 12% and 17% of total
revenues, respectively. No other customer accounted for more than 10% of
total revenues in any of the three years ended December 31, 1998. Revenues
from customers in the following geographic regions as a percentage of total
revenues are as follows:
F-13
<PAGE>
DSET Corporation
December 31, 1998
Notes to Financial Statements
- --------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
1998 1997 1996
North America 85% 73% 62%
Asia/Pacific Rim 9 22 35
Europe 6 5 3
--------- -------- --------
100% 100% 100%
========= ========= ========
At December 31, 1997 and 1998, one and one customer, respectively,
accounted for approximately 12% and 25%, respectively, of accounts
receivable.
10. EMPLOYEE BENEFIT PLAN
During 1994, the Company instituted a savings plan pursuant to Section
401(k) of the Internal Revenue Code (the "Code") covering all employees
meeting eligibility requirements. Subject to certain limits set forth in
the Code, employees are permitted to make contributions to the plan on a
pre-tax salary reduction basis, and the Company may make voluntary
contributions of up to 60% of employee contributions. The Company made
contributions approximating $64,000, $164,000, and $251,000 for the years
ended December 31, 1996, 1997 and 1998, respectively.
11. COMMITMENTS
A) LEASES
The Company has operating leases for its offices and certain equipment.
Generally, the leases carry renewal provisions and require the payment of
maintenance costs. Rental expense charged to operations for the years ended
December 31, 1996, 1997 and 1998 was approximately $277,000, $402,000 and
$786,000, respectively.
The future minimum rental payments under noncancellable operating leases
approximate the following:
YEAR ENDING DECEMBER 31,
1999 $ 1,086,000
2000 1,084,000
2001 986,000
2002 1,053,000
2003 894,000
For the years 2004 and beyond 3,904,000
-----------------
Total $ 9,007,000
=================
B) LINES OF CREDIT
In August 1997, the Company obtained an unsecured revolving credit facility
with a bank totaling $3 million. Borrowings under this line of credit bear
interest at the bank's prime rate (7.75% at December 31, 1998) less 0.25%
on amounts outstanding of less than $1 million and at the bank's prime rate
for aggregate principal amounts exceeding $1 million. No borrowings under
this line
F-14
<PAGE>
DSET Corporation
December 31, 1998
Notes to Financial Statements
- --------------------------------------------------------------------------------
were outstanding at December 31, 1997 or 1998. This credit facility
contains, among other provisions, a covenant which restricts the Company's
ability to pay cash dividends.
12. ACQUISITION OF MARBEN PRODUCTS, INC.
In March 1997, the Company acquired the net assets of Marben Products,
Inc., ("MPI") a software distribution company located in California. The
purchase price was $190,045. Included in the net assets acquired was a note
payable of $441,657 to MPI's parent company. The note bears interest at 5%
per annum and requires quarterly payment of interest and $55,000 of
principal. The Company has accounted for the acquisition using the purchase
method, and the results of operations of the acquired business are included
in the Company's operations since acquisition.
The following is a summary of the purchase price allocation:
Current assets and other tangible assets $ 426,615
Current liabilities assumed (175,003)
Note issued in acquisition (441,657)
Goodwill 190,045
The following unaudited pro forma summary represents the results of
operations of the Company as if the acquisition of the net assets of MPI
had occurred at the beginning of the period presented and does not purport
to be indicative of what would have occurred had the acquisition been made
as of those dates or the results which may occur in the future.
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
<S> <C> <C>
Pro forma net revenues $ 19,742,634 $16,733,775
Pro forma net income applicable to common shares 1,291,927 869,674
Pro forma net income per common share $ 0.36 $ 0.26
Pro forma net income per common share assuming dilution $ 0.26 $ 0.23
</TABLE>
The unaudited pro forma results include the historical operations of the
Company and MPI, adjusted to reflect the amortization of goodwill and
interest on the note payable assumed.
13. 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 common stock or
potential common stock. The statement defines two earnings per share
calculations, basic and assuming dilution. 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
F-15
<PAGE>
DSET Corporation
December 31, 1998
Notes to Financial Statements
- --------------------------------------------------------------------------------
increased for the conversion of potential common shares. As required, the
following table is a reconciliation of the numerator and denominator under
each method:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1996
PER SHARE
INCOME SHARES AMOUNT
<S> <C> <C> <C>
BASIC EPS:
Net income applicable to common shares $ 1,211,016 3,308,763 $ 0.37
ASSUMING DILUTION:
Net income applicable to common shares
Convertible preferred stock 801,578 3,043,625
Warrants - 7,435
Stock options - 1,032,970
------------ ------------
$ 2,012,594 7,392,793 $ 0.27
============ ============
FOR THE YEAR ENDED DECEMBER 31, 1997
PER SHARE
INCOME SHARES AMOUNT
BASIC EPS:
Net income applicable to common shares $ 1,609,051 3,566,764 $ 0.45
ASSUMING DILUTION:
Net income applicable to common shares
Convertible preferred stock 859,555 3,043,625
Warrants - 98,216
Stock options - 1,637,760
------------ ------------
$ 2,468,606 8,346,365 $ 0.30
============ ============
FOR THE YEAR ENDED DECEMBER 31, 1998
PER SHARE
INCOME SHARES AMOUNT
BASIC EPS:
Net income applicable to common shares $ 4,794,183 9,012,019 $ 0.53
ASSUMING DILUTION:
Net income applicable to common shares
Stock options - 1,875,759
Warrants - 155,644
------------ ------------
$ 4,794,183 11,043,422 $ 0.43
============ ============
</TABLE>
14. SUBSEQUENT EVENT
On January 25, 1999, DSET Acquisition Corp., a wholly owned subsidiary of
the Company, acquired certain assets of Network Programs, LLC (NPL) for
$2.5 million. NPL was a New Jersey-based company which specialized in
software aimed at reducing the time necessary for a competitive local
exchange carrier (CLEC) to provide prospective customers with sales
proposals
F-16
<PAGE>
DSET Corporation
December 31, 1998
Notes to Financial Statements
- --------------------------------------------------------------------------------
that clearly define the CLEC's offering vs. the incumbent local exchange
carrier's (ILEC) current service offering.
F-17
EXHIBIT 21
<PAGE>
EXHIBIT 21
Subsidiary Year of Formation
- ---------- -----------------
Chengdu DSET Science and Technology Co., Ltd., a corporation 1998
organized under the laws of the Republic of China.
DSET Acquisition Corp., a Delaware Corporation. 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
audited financial statements at December 31, 1998 which are included in the
Registrant's Form 10-K and is qualified in its entirety by reference to
such financial statements.
</LEGEND>
<CIK> 0001052196
<NAME> DSET Corporation
<MULTIPLIER> 1,000
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 12-mos
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 1,159
<SECURITIES> 43,864
<RECEIVABLES> 9,284
<ALLOWANCES> (176)
<INVENTORY> 0
<CURRENT-ASSETS> 54,583
<PP&E> 3,081
<DEPRECIATION> (1,489)
<TOTAL-ASSETS> 56,854
<CURRENT-LIABILITIES> 5,545
<BONDS> 0
0
0
<COMMON> 41,912
<OTHER-SE> 9,277
<TOTAL-LIABILITY-AND-EQUITY> 56,854
<SALES> 29,290
<TOTAL-REVENUES> 29,290
<CGS> 5,467
<TOTAL-COSTS> 18,138
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 12
<INCOME-PRETAX> 7,355
<INCOME-TAX> 2,561
<INCOME-CONTINUING> 4,794
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,794
<EPS-PRIMARY> .53 <F1>
<EPS-DILUTED> .43 <F2>
<FN>
<F1> This amount represents Basic Earnings per Share in accordance with the
requirements of Statement of Financial Accounting Standards No. 128 -
"Earnings per Share."
<F2> This amount represents Diluted Earnings per Share in accordance with
the requirements of Statement of Financial Accounting Standards No.
128 - "Earnings per Share."
</FN>
</TABLE>
