<PAGE>
CONFORMED COPY
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
--------------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
Commission File Number 0-23611
DSET CORPORATION
----------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
New Jersey 22-3000022
----------------------------------- -------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
1160 U. S. Highway 22, Bridgewater, New Jersey 08807
--------------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
(908) 526-7500
------------------------------
(Registrant's Telephone Number,
Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes: X No:
------- ------
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of October 31, 2000:
<TABLE>
<CAPTION>
Class Number of Shares
----- ----------------
<S> <C>
Common Stock, no par value 11,532,565
</TABLE>
<PAGE>
DSET CORPORATION
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I. FINANCIAL INFORMATION................................................................. 1
Item 1. Financial Statements............................................................. 1
Consolidated Balance Sheets as of September 30, 2000 and December 31, 1999....... 2
Consolidated Statements of Net Income (Loss) and Comprehensive Income (Loss)
for the Three Months Ended September 30, 2000 and 1999........................ 3
Consolidated Statements of Net Income (Loss) and Comprehensive Income (Loss)
for the Nine Months Ended September 30, 2000 and 1999......................... 4
Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 2000 and 1999................................................... 5
Notes to Consolidated Financial Statements....................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.................................................................... 14
Results of Operations........................................................... 17
Liquidity and Capital Resources.................................................. 20
Item 3. Quantitative and Qualitative Disclosures About Market Risk....................... 23
PART II. OTHER INFORMATION..................................................................... 25
Item 4. Use of Proceeds.................................................................. 25
Item 5. Other Informaion................................................................. 25
Item 6. Exhibits and Reports on Form 8-K................................................. 25
SIGNATURES...................................................................................... 26
</TABLE>
i
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
1
<PAGE>
DSET CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000 DECEMBER 31, 1999*
------------------ -----------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 9,246,926 $ 2,212,759
Marketable securities 30,204,947 37,945,597
Accounts receivable, net of allowance for doubtful accounts
of $4,700,000 and $600,000 19,082,154 20,132,404
Income taxes receivable 1,598,843 -
Deferred income taxes 2,130,242 735,774
Prepaid licenses 466,750 25,000
Prepaid expenses and other current assets 2,478,126 1,963,944
----------- -----------
Total current assets 65,207,988 63,015,478
Acquired technology, net 4,924,334 4,343,313
Software licenses, net 2,619,995 -
Software development costs, net 468,023 564,854
Fixed assets, net 4,857,814 3,428,268
Goodwill, net 1,049,849 1,258,175
Other assets, net 809,489 885,290
----------- -----------
Total assets $79,937,492 $73,495,378
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 8,290,258 $ 6,067,174
Income taxes payable - 394,206
Deferred revenues 3,266,384 1,797,675
Current portion of notes payable 872,129 1,000,000
Current portion of lease obligation 138,367 130,415
----------- -----------
Total current liabilities 12,567,138 9,389,470
Deferred income taxes 455,311 710,765
Long-term notes payable 409,901 1,310,560
Capital lease obligation 456,879 561,670
----------- -----------
Total liabilities 13,889,229 11,972,465
----------- -----------
Commitments and contingencies
Shareholders' equity:
Preferred stock, no par value; 5,000,000 shares authorized, no
shares issued or outstanding at September 30, 2000 and December 31, 1999 - -
Common stock, no par value; 40,000,000 shares authorized, 11,521,130
and 10,860,770 shares issued and outstanding at September 30, 2000
and December 31, 1999, respectively 49,922,994 45,636,672
Deferred stock compensation (93,893) (196,737)
Retained earnings 16,089,294 16,247,807
Accumulated other comprehensive income 129,868 (164,829)
----------- -----------
Total shareholders' equity 66,048,263 61,522,913
----------- -----------
Total liabilities and shareholders' equity $79,937,492 $73,495,378
=========== ===========
</TABLE>
* Certain amounts have been reclassified for comparative purposes.
The accompanying notes are an integral part of these condensed
consolidated financial statements.
2
<PAGE>
DSET CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF NET INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS)
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
2000 1999*
---- ----
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
REVENUES:
License revenues $ 9,788,675 $ 6,558,838
Service revenues 4,078,053 6,350,351
----------- -----------
Total revenues 13,866,728 12,909,189
----------- -----------
COST OF REVENUES:
License revenues 1,552,806 622,169
Service revenues 3,332,995 2,078,658
----------- -----------
Total cost of revenues 4,885,801 2,700,827
----------- -----------
Gross profit 8,980,927 10,208,362
----------- -----------
OPERATING EXPENSES:
Sales and marketing 3,244,513 3,351,420
Research and product development 4,884,455 2,956,102
General and administrative 1,667,265 1,174,081
Bad debt expense and other charges 4,926,367 27,738
Amortization of goodwill and other intangibles 106,084 16,702
----------- -----------
Total operating expenses 14,828,684 7,526,043
----------- -----------
Operating income (loss) (5,847,757) 2,682,319
Interest expense and other income (expense) (43,303) (21,094)
Interest income 496,013 567,313
----------- -----------
Income (loss) before income taxes (5,395,047) 3,228,538
Provision (benefit) for income taxes (2,144,336) 1,093,326
------------ -----------
Net income (loss) (3,250,711) 2,135,212
OTHER COMPREHENSIVE INCOME, NET OF TAX
Unrealized appreciation/(depreciation)
on investments 111,783 (23,596)
Cumulative translation adjustment 273 (104)
----------- -----------
Comprehensive income (loss) $(3,138,655) $ 2,111,512
=========== ===========
Net income (loss) applicable to common shares $(3,250,711) $ 2,135,212
=========== ===========
Net income (loss) per common share $ (0.28) $ 0.20
=========== ===========
Weighted average number of common shares
outstanding 11,464,461 10,512,423
=========== ===========
Net income (loss) per common share assuming dilution $ (0.28) $ 0.19
=========== ===========
Weighted average number of common shares and
common equivalent shares outstanding 11,464,461 11,507,859
=========== ===========
</TABLE>
* Certain amounts have been reclassified for comparative purposes.
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
<PAGE>
DSET CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF NET INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS)
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2000 1999*
---- ----
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
REVENUES:
License revenues $30,089,662 $15,957,911
Service revenues 11,609,095 13,545,246
----------- -----------
Total revenues 41,698,757 29,503,157
----------- -----------
COST OF REVENUES:
License revenues 3,251,244 1,183,836
Service revenues 8,120,968 4,982,869
----------- -----------
Total cost of revenues 11,372,212 6,166,705
----------- -----------
Gross profit 30,326,545 23,336,452
----------- -----------
OPERATING EXPENSES:
Sales and marketing 9,501,862 8,477,551
Research and product development 12,490,877 7,766,042
General and administrative 4,302,998 3,121,304
Bad debt expense and other charges 5,792,561 316,519
Amortization of goodwill and other intangibles 312,652 103,546
----------- -----------
Total operating expenses 32,400,950 19,784,962
----------- -----------
Operating income (loss) (2,074,405) 3,551,490
Interest expense and other income (expense) (139,356) (96,473)
Interest income 1,477,293 1,674,523
----------- -----------
Income (loss) before income taxes (736,468) 5,129,540
Provision (benefit) for income taxes (577,955) 1,769,180
------------ -----------
Net income (loss) (158,513) 3,360,360
OTHER COMPREHENSIVE INCOME, NET OF TAX
Unrealized appreciation/(depreciation)
on investments 295,171 (151,271)
Cumulative translation adjustment (474) (323)
----------- -----------
Comprehensive income (loss) $ (136,184) $ 3,208,766
=========== ===========
Net income (loss) applicable to common shares $ (158,513) $ 3,360,360
=========== ===========
Net income (loss) per common share $ (0.01) $ 0.33
=========== ===========
Weighted average number of common shares
outstanding 11,305,117 10,314,884
=========== ===========
Net income (loss) per common share assuming dilution $ (0.01) $ 0.30
=========== ===========
Weighted average number of common shares and
common equivalent shares outstanding 11,305,117 11,347,781
=========== ===========
</TABLE>
* Certain amounts have been reclassified for comparative purposes.
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
<PAGE>
DSET CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2000 1999*
---- ----
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (158,513) $ 3,360,360
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Deferred income taxes (1,649,922) 367,409
Tax benefit from exercise of stock options 2,499,868 734,919
Amortization of deferred stock compensation 102,844 188,617
Depreciation 880,348 593,036
Loss from joint venture - 36,238
Loss on disposal of assets 413 4,535
Amortization 1,221,511 232,020
Bad debt expense and other charges 5,792,561 316,519
Changes in assets and liabilities:
Accounts receivable (4,742,311) (7,378,780)
Prepaid licenses (441,750) 25,000
Prepaid assets and other current assets (514,182) (884,513)
Other assets (28,525) (253,179)
Accounts payable and accrued expenses 2,194,556 1,625,335
Income taxes (1,993,049) 779,112
Deferred revenues 1,468,708 240,556
------------- -----------
Net cash provided by operating activities 4,632,557 (12,816)
------------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities (22,635,500) (14,780,411)
Redemption of marketable securities 30,671,321 13,553,935
Acquisitions of businesses - (3,778,416)
Purchase of Goodwill - (248,408)
Purchase of acquired technology (1,255,154) (326,896)
Software development costs - (661,686)
Acquisition of software licenses (2,757,890) -
Acquisition of fixed assets (2,311,831) (1,754,911)
Proceeds on disposition of fixed assets 1,525 -
------------- -----------
Net cash used in investing activities 1,712,471 (7,996,793)
-------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceed from capital sale/leaseback - 402,761
Repayment from officers and shareholders - (100,000)
Repayment of notes payable (1,000,000) (111,657)
Repayments capital lease obligation (96,841) (15,045)
Proceeds from the exercise of stock options and warrants 1,786,454 1,089,466
------------- -----------
Net cash provided by financing activities 689,613 1,265,525
------------- -----------
Effect of foreign exchange rate changes on cash (474) (323)
-------------- ------------
Net (decrease) increase in cash and cash equivalents 7,034,167 (6,744,407)
------------- ------------
Cash and cash equivalents, beginning of period 2,212,759 9,198,270
------------- ------------
Cash and cash equivalents, end of period $ 9,246,926 $ 2,453,863
============= ============
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes $ 731,967 $ 490,472
Cash paid during the period for interest $ 40,891 $ 55,560
Non-cash activities:
Lease of fixed assets $ - $ 340,702
Issuance of note payable in acquisition $ - $ 2,282,031
</TABLE>
* Certain amounts have been reclassified for comparative purposes.
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
<PAGE>
DSET CORPORATION AND SUBSIDIARIES
SEPTEMBER 30, 2000
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
--------------------------------------------------------------------------------
1. BASIS OF PRESENTATION
The condensed consolidated financial information presented as of September
30, 2000 and for the three-month and nine-month periods ended September
30, 2000 and 1999 is unaudited, but in the opinion of DSET Corporation's
(the "Company") management, contains all adjustments (consisting only of
normal recurring adjustments) which the Company considers necessary for
the fair presentation of the Company's financial position as of September
30, 2000 and the results of its operations for the three-month and
nine-month periods ended September 30, 2000 and 1999 and its cash flows
for the nine-month periods ended September 30, 2000 and 1999. The
financial statements included herein have been prepared in accordance
with generally accepted accounting principles and the instructions to Form
10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information
and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles
have been condensed or omitted. These financial statements should be
read in conjunction with the Company's 1999 audited financial statements
and accompanying notes and Management's Discussion and Analysis of
Financial Condition and Results of Operations contained in the Company's
Annual Report on Form 10-K for the year ended December 31, 1999. The
December 31, 1999 balance sheet data was derived from audited financial
statements, but does not include all disclosures required by generally
accepted accounting principles.
Results for the interim period are not necessarily indicative of results
that may be expected for the entire year.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION
The consolidated financial statements include all wholly-owned
subsidiaries from the respective dates of their acquisition or formation.
The consolidated entity includes DSET Corporation and its wholly-owned
subsidiaries, DSET Acquisition Corp., a Delaware corporation; Konark Inc.
("Konark"), a California corporation; PIC Technologies, Inc., a Delaware
corporation; Chengdu DSET Science & Technology Co., Ltd. (China); and
DSET Canada, Inc. (Canada). All intercompany transactions have been
eliminated in consolidation.
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 appreciation was $131,055 (net of deferred taxes of $82,043) at
September 30, 2000. Cost is determined on a specific identification basis.
6
<PAGE>
DSET CORPORATION AND SUBSIDIARIES
SEPTEMBER 30, 2000
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
--------------------------------------------------------------------------------
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 an
estimated useful life of five years. The Company periodically assesses the
realizability of the asset based on estimated future cash flows.
Accumulated amortizaton was $376,000 as of September 30, 2000.
SOFTWARE DEVELOPMENT COSTS
Capitalization of software development costs begins on establishment of
technological feasibility. Costs incurred prior to establishment of
technological feasibility are charged to research and product development
expense. The ongoing assessment of recoverability of capitalized costs
requires considerable judgement by management with respect to certain
factors, including the anticipated future gross revenues, estimated
economic life and changes in technology. These factors are considered on a
product-by-product basis. Amortization of software development costs is
the greater amount computed using (a) the ratio that current gross
revenues for a product bears to the total of current and anticipated
future gross revenues for that product or (b) the straight-line method
over the remaining estimated economic life ranging from three to five
years of the product including the period being reported on. Accumulated
amortization was $929,000 as of September 30, 2000.
ACQUIRED TECHNOLOGY
Acquired technology represents the costs of feasible technology acquired
from external sources. At September 30, 2000, acquired technology mainly
reflects the purchase of certain assets of Network Programs LLC ("NPL")
and Konark Inc., as well as related costs to acquire such assets.
Accumulated amortization was $1,024,000 as of September 30, 2000.
Amortization of acquired technology is the greater of the amount computed
using (a) the ratio that current gross revenues for a product bears to the
total of current and anticipated future gross revenues for that product or
(b) the straight-line method over the remaining estimated economic life
ranging from three to five years of the product including the period being
reported on.
SOFTWARE LICENSES
Software licenses represent the costs to acquire software licenses from
external sources, a number of which were purchased in 2000. Amortization
of software licenses is the greater of the amount computed using (a) the
ratio of current gross revenues for products generated from these licenses
to the total of current and anticipated future gross revenues for products
7
<PAGE>
DSET CORPORATION AND SUBSIDIARIES
SEPTEMBER 30, 2000
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
--------------------------------------------------------------------------------
related to these licenses or (b) the straight line method over the
remaining estimated economic life of five years from the date of the
license agreement. Accumulated amortizaton was $138,000 as of September
30, 2000.
RESEARCH AND PRODUCT DEVELOPMENT
Research and product development costs are charged to expense as incurred.
However, the costs incurrred for the development of computer software that
will be sold, leased, or otherwise marketed are capitalized when
technological feasibility has been established.
LONG-LIVED ASSETS
The Company reviews its long-lived assets for impairment whenever events
or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable.
REVENUE RECOGNITION
License revenues are recorded when the software has been shipped to the
Company's licensees and all significant obligations have been satisfied.
Any contract holdbacks or contingent charges are recognized as revenue
when they are satisfied. Revenues from run-time licenses are recognized as
equipment using the Company's software is deployed by the Company's
customers. Notification is typically received from customers pursuant to
quarterly reports or via purchase orders for individual licenses.
Custom application development and gateway 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 estimated
direct labor costs. When the engineering of a product is not yet
completed, revenue is recognized on orders for that product using the
percentage of completion method as defined above. Any revenue recognized
in excess of amounts invoiced to the customer for progress billings are
recorded as unbilled accounts receivable.
Service revenue from maintenance contracts is deferred and recognized over
the term of the respective contracts (typically twelve months).
Revenues under software arrangements involving multiple elements of a sale
are allocated to each element based on vendor specific objective evidence
of the elements.
INCOME TAXES
The Company utilizes an asset and liability approach for 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
8
<PAGE>
DSET CORPORATION AND SUBSIDIARIES
SEPTEMBER 30, 2000
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
--------------------------------------------------------------------------------
allowances are established, when necessary, to reduce the deferred tax
assets to the amount expected to be realized.
For certain stock options, the Company receives a tax deduction for the
difference between the fair market value of the Company's common stock 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, accounts payable and accrued expenses,
and notes payable 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. Estimates are used when accounting for certain items such as
the allowance for doubtful accounts, depreciation and amortization, and
income taxes. Additionally, the Company evaluates the useful lives of its
acquired technology and software development costs based upon changes in
technology and industry conditions.
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, 2000 (January 1, 2001 for the Company). SFAS No. 133 requires that all
derivative instruments be recorded on the balance sheet at their fair
value. Changes in the fair value of derivatives are recorded each period
in current earnings or other comprehensive income, depending on whether a
derivative is designated as part of a hedge transaction and, if it is, the
type of hedge transaction. Management of the Company anticipates that, due
to its limited use of derivative instruments, the adoption of SFAS No. 133
will not have a significant effect on the Company's results of operations
or its financial position.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements," ("SAB 101"). A second amendment to SAB 101 has been isssued
by the Securities and Exchange Commission which delays the implementation
date of SAB 101 to no later than the fourth fiscal quarter
9
<PAGE>
DSET CORPORATION AND SUBSIDIARIES
SEPTEMBER 30, 2000
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
--------------------------------------------------------------------------------
of fiscal years beginning after December 15, 1999. The Company is
currently evaluating the impact of SAB 101 on its results of operations.
RECLASSIFICATIONS
Certain prior period amounts have been reclassified to conform to the
current period presentation.
3. DEBT OBLIGATIONS
a) CAPITAL LEASE OBLIGATION
In June 1999, the Company entered into a five-year capital lease agreement
mainly for office furniture and fixtures in the Company's facilities in
Bridgewater, New Jersey and Plano, Texas at an annual rate of 8.21%.
Annual lease payments approximate $180,000. Assets recorded under this
lease are included in fixed assets as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000 DECEMBER 31, 1999
------------------ -----------------
<S> <C> <C>
Furniture and fixtures $ 743,462 $743,462
Accumulated amortization (136,295) (51,550)
--------- --------
$ 607,167 $691,912
========= ========
</TABLE>
b) LINES OF CREDIT
In August 2000, the Company renewed an unsecured revolving credit facility
with a bank increasing the line of credit to $5 million. Borrowings under
this line of credit bear interest at the bank's prime rate (9.50% at
September 30, 2000) 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 were outstanding at
September 30, 2000 or December 31, 1999. This credit facility contains,
among other provisions, a covenant which restricts the Company's ability
to pay cash dividends.
c) NOTES PAYABLE
As part of the acquisition of Konark, the Company paid $1.0 million in
cash and issued a $2.5 million non-interest bearing note payable which has
been discounted at 8.25%. Interest expense is accreted monthly and
totalled $114,000 at September 30, 2000. The note is payable in five
installments, and matures on March 1, 2002.
10
<PAGE>
DSET CORPORATION AND SUBSIDIARIES
SEPTEMBER 30, 2000
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
--------------------------------------------------------------------------------
As of September 30, 2000, future payments under the notes are as follows:
<TABLE>
<CAPTION>
Principal
Year Ending December 31, Payments
------------------------ --------
<S> <C>
2001 $1,000,000
2002 500,000
----------
1,500,000
Less: Unamortized interest (217,970)
----------
Present value of notes payable 1,282,030
Less: Current portion 872,129
----------
Long-term portion $ 409,901
==========
</TABLE>
4. ACQUISITIONS
On January 25, 1999, DSET Acquisition Corp., a wholly-owned subsidiary of
the Company consummated the acquisition of certain assets of NPL. The
purchase price consisted of $2,500,000 payable in cash to NPL and
professional fees of $158,000.
The costs to acquire NPL are recorded as acquired technology and goodwill.
In addition, research and product development costs associated with
bringing the acquired assets to market have been recorded as capitalized
software development costs. Amortization of these costs commenced with the
shipment of the product in the second quarter of 1999; amortization expense
related to this technology was approximately $123,000 for the three months
ended September 30, 2000.
The following is a summary of the purchase price allocation:
<TABLE>
<S> <C>
Acquired technology $2,458,416
Goodwill 200,000
----------
Total $2,658,416
==========
</TABLE>
On September 30, 1999, the Company purchased Konark and related
technologies for approximately $3.3 million in cash and certain deferred
payments plus professional fees and the related deferred tax liabilities.
The acquisition price, along with certain other acquisition costs and
associated deferred tax liabilities have been recorded as acquired
technology, other assets and goodwill that will be amortized over five
years.
11
<PAGE>
DSET CORPORATION AND SUBSIDIARIES
SEPTEMBER 30, 2000
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
--------------------------------------------------------------------------------
The following is a summary of the purchase price allocation and consideration:
<TABLE>
<S> <C>
Purchase Price Allocation
-------------------------
Acquired technology $ 2,195,507
Other assets 695,507
Goodwill 1,036,015
-----------
$ 3,927,029
===========
Consideration
-------------
Cash $(1,120,000)
Notes payable-current (971,470)
Long-term notes payable (1,310,559)
Deferred income taxes (525,000)
-----------
$(3,927,029)
===========
</TABLE>
5. REVENUE CONCENTRATION
The Company derives a portion of its revenues from international sales
which constituted approximately 16.0% and 4.7% of the Company's total
revenues in the third quarter of 2000 and 1999, respectively.
International sales are derived from Canada, Europe (primarily Italy and
Germany), and Asia (primarily Korea, China and Japan). 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.
6. EARNINGS PER SHARE
The Company calculates, presents and discloses earnings per share ("EPS")
in accordance with SFAS No. 128, "Earnings per Share". 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 net 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 the denominator
is increased for the conversion of potential common shares. No potential
dilutive common shares were outstanding because of the Company's net loss
for the three and nine month periods ending September 30, 2000. The
following table is a reconcilation of the numerator and denominator under
each method:
12
<PAGE>
DSET CORPORATION AND SUBSIDIARIES
SEPTEMBER 30, 2000
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED SEPTEMBER 30,
----------------------------------------
2000 1999
----------------------------------------- ------------------------------------------
Net Shares Per Share Net Shares Per Share
Loss ------ Amount Income ------ Amount
---- ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
BASIC EPS:
Net income (loss)
Applicable to
Common shares $(3,250,711) 11,464,461 $(0.28) $2,135,212 10,512,423 $0.20
ASSUMING DILUTION:
Warrants - - - 150,893
Stock options - - - 844,543
----------- ---------- ---------- ----------
$(3,250,711) 11,464,461 $(0.28) $2,135,212 11,507,859 $0.19
=========== ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
---------------------------------------
2000 1999
----------------------------------------- ------------------------------------------
Net Shares Per Share Net Shares Per Share
Loss ------ Amount Income ------ Amount
---- ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
BASIC EPS:
Net income (loss)
Applicable to
Common shares $(158,513) 11,305,117 $(0.01) $3,360,360 10,314,884 $0.33
ASSUMING DILUTION:
Warrants - - - 152,543
Stock options - - - 880,354
--------- ---------- ---------- ----------
$(158,513) 11,305,117 $(0.01) $3,360,360 11,347,781 $0.30
========= ========== ========== ==========
</TABLE>
13
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
GENERAL
DSET is a leading provider of business-to-business e-commerce
connectivity software solutions created specifically for the global
telecommunications marketplace. The DSET suite of electronic-bonding gateways
interconnects the operations support systems ("OSSs") of competing
telecommunications service providers ("Telecom Service Providers"), such as
Competitive Local Exchange Carriers ("CLECs") and Incumbent Local Exchange
Carriers ("ILECs") that must trade information and share network capabilities
to serve customers. In addition, DSET's local number portability ("LNP")
solutions play a key role in enabling customers to change Telecom Service
Providers without changing their local phone numbers. The Telecommunications
Act of 1996 encourages competition among providers of local phone services by
requiring ILECs to allow new Telecom Service Providers to access the incumbents'
OSSs and lease portions of their networks. Hundreds of Telecom Service
Providers are vying to win customers from the incumbents by offering better
pricing and service. With DSET solutions, Telecom Service Providers can complete
key tasks that assist "provisioning" or "service-fulfillment" of phone service
for new customers in days rather than weeks. In addition, DSET solutions help
Telecom Service Providers maintain a higher level quality of service for their
customers.
Historically, the Company 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. These applications are predominantly
sold to network equipment vendors, both domestically and internationally. Until
1999, substantially all the Company's revenues had been derived from application
development tools and applications or services based on Telecommunications
Management Network ("TMN") standards. The Company has announced its strategy to
move completely out of its product lines in application development tools and
local service management systems.
The Company's continued success will depend on continued growth in the
market for OSS interconnection products and services.
The Company's revenues are generated from two sources: license and
service revenues from Telecom Service Providers and license and service revenues
from network equipment vendors.
For the quarters ended September 30, 2000 and 1999, the Company derived
approximately 70.6% and 50.8%, respectively, of its total revenues from license
revenues and approximately 29.4% and 49.2%, respectively, of its total revenues
from service revenues. During the third quarter of 2000, revenues generated from
Telecom Service Providers were approximately $10.6 million and revenues
generated from network equipment vendors for LNP solutions, application
development tools and related services were approximately $3.3 million.
14
<PAGE>
During the third quarter of 1999 revenues generated from Telecom Service
Providers were $7.3 million and revenues generated from network equipment
vendors were approximately $5.6 million.
DSET's license revenues from Telecom Service Providers are derived from
the sale of electronic-bonding gateways to carriers under contracts that provide
for license fees. Prices for individual licenses of the Telecom Service
Providers' solutions and other applications range from $75,000 to $500,000.
License revenues are recorded when the software has been shipped to the customer
and all significant obligations have been satisfied. Any contract holdbacks or
contingent charges are recognized as revenue when they are satisfied.
License revenues derived from the sale of LNP solutions and
application development tools to customers under contracts generally provide for
license fees and run-time royalty fees. Prices for development licenses of the
Company's LNP solutions tool suites can range from approximately $150,000 to
$400,000 and prices for 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 for development tools also typically
provide for run-time royalty fees that are earned 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.
The Company's service revenues are comprised of fees derived from
custom application development products and services, maintenance fees,
installation and training fees and other revenues generated from customer
support 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 and effort 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 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 between 15% and
30% annually of the 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 customer accounting for more than 10% of revenues
for the quarter ended September 30, 2000 and no customer which accounted for
more than 10% of revenues for the quarter ended September 30, 1999. The Company
anticipates that its results of operations in any given period will continue to
depend to a significant extent upon sales to a
15
<PAGE>
small number of customers. In addition, the Company anticipates that its results
of operations in any given period will also continue to depend on its customers'
cash flow and ability to obtain external financing. As a result of this customer
concentration and the uncertainty in our customers' financing, the Company's
revenues from quarter to quarter, 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 and the amortization of acquired
technology and capitalized software development costs.
In June 2000, the Company signed a strategic alliance agreement with
Daleen Technologies, Inc. ("Daleen") under which DSET and Daleen will engage in
joint marketing, selling and other strategic activities. As part of the
strategic relationship, Daleen has granted DSET a license to certain of Daleen's
electronic bonding gateways optimized for the Canadian market and exclusive
distribution rights in Canada. The alliance allows DSET access to the Canadian
market with products matched to the technical standards existing in Canada.
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, costs associated with customer
satisfaction and quality 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. 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
$876,000 was recorded for options granted. This amount has been amortized to
compensation expense over the vesting period of the options (two to four years).
At September 30, 2000, the remaining unamortized deferred stock compensation
balance was approximately $94,000.
The Company primarily markets and sells its products and services
through a direct sales force in North America.
The Company derives a portion of its revenues from international sales
which constituted approximately 16.0% and 4.7% of the Company's total revenues
in the third quarter of 2000 and 1999, respectively. International sales are
derived from Canada, Europe (primarily Italy and Germany), and Asia (primarily
Korea, China and Japan). 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.
16
<PAGE>
FORWARD-LOOKING STATEMENTS
Statements contained in this Form 10-Q that are not based on historical fact are
"forward-looking statements" within the meaning of Section 21E of the Securities
Exchange Act of 1934, as amended. Forward-looking statements may be identified
by the use of forward-looking terminology such as "may," "will," "should,"
"expect," "estimate," "anticipate," "continue," or similar terms, variations of
such terms or the negative of those terms. Such forward-looking statements
involve risks and uncertainties, including, but not limited to: (i) the
substantial variability of the Company's quarterly operating results, (ii) the
Company's dependence on the rapidly evolving telecommunications industry,
(iii) rapid technological change in the Company's industry, (iv) uncertainty in
our customers' cash flows and external financing (v) the limited number of
customers for a significant portion of the Company's revenue, (vi) risks
associated with market acceptance of the Company's new OSS gateways
interconnection and LNP products, (vii) risks associated with intense
competition in the industry, including competition for qualified technical
personnel, (viii) the buying patterns of the telecommunications providers
(ix) the ongoing risk of that telecommunications providers will not get expected
funding to advance their business model and (x) 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. The success of the Company depends to a large degree upon
increased demand by Telecom Service Providers for its new OSS Interconnection
products and by network equipment vendors for its LNP products. 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.
RESULTS OF OPERATIONS
Three Months Ended September 30, 2000 Compared to the Three Months Ended
September 30, 1999
Revenues. Total revenues increased 7.4% to $13.9 million in the third
quarter of 2000 from $12.9 million in the third quarter of 1999. License
revenues increased by 49.2% to $9.8 million in the third quarter of 2000 from
$6.6 million in the third quarter of 1999. This increase was primarily
attributable to an increase in the sale of OSS gateway licenses to Telecom
Service Providers. Service revenues decreased 35.8% to $4.1 million in the third
quarter of 2000 from $6.4 million in the third quarter of 1999. This decrease
was primarily attributable to less percentage of completion revenue recorded for
custom carrier and network projects. Revenues recorded using the percentage of
completion method of contract accounting amounted to $1.8 million in the third
quarter of 2000 as compared to $4.5 million in the third quarter of 1999.
Gross profit. The Company's gross profit decreased 12.0% to $9.0
million in the third quarter of 2000 from $10.2 million in the third quarter of
1999. Gross profit percentage for license revenues decreased to 84.1% in the
third quarter of 2000 from 90.5% in the third quarter of 1999 due to a lower
sales volume, an increase of third party royalties and amortization of acquired
technology and capitalized software development costs. Gross profit percentage
for service revenues decreased to 18.3% in the third quarter of 2000 from 67.3%
in the third quarter of 1999. The decreased
17
<PAGE>
gross profit percentages were primarily attributable to higher implementation
costs arising from the use of third party contractors to provide interim
support, increase in personnel and related costs (internal resources), less
application development service revenue and support costs associated with
satisfying customer requirements.
Sales and marketing expenses. Sales and marketing expenses decreased
3.2% to $3.2 million in the third quarter of 2000 from $3.4 million in the third
quarter of 1999. The decrease in sales and marketing expenses was primarily
attributable to lower commission expense offset in part by expenses relating to
increased personnel and related costs resulting from the increase in the
Company's sales and marketing force.
Research and product development expenses. Research and product
development expenses increased 65.2% to $4.9 million in the third quarter of
2000 from $3.0 million in the third quarter of 1999. The increase in research
and product development expenses was due primarily to the expansion in the
number of new products under development, expenses relating to increase in
personnel and the hiring of additional outside consultants.
General and administrative expenses. General and administrative
expenses increased 42.0% to $1.7 million in the third quarter of 2000 from $1.2
million in the third quarter of 1999. The increase in general and administrative
expenses was due primarily to recruiting, personnel and related costs and
professional fees.
Bad debt expense and other charges. Bad debt expense and other charges
increased to approximately $4.9 million in the third quarter of 2000 from
approximately $28,000 in the third quarter of 1999. The increase was due in part
to the uncertainty in the cash flow and external financing for Telecom Service
Providers which continues to impact the Company's ability to collect its
receivables. Additionally, a major customer declared bankruptcy on September 28,
2000 with an accounts receivable balance of $1.9 million. Lastly, the Company
settled a dispute with a customer related to network products and wrote off
certain accounts receivable. In conjunction with the settlement the Company
recorded a reserve for future product credits that may be granted to the
customer.
Amortization of goodwill. Amortization expense increased to
approximately $106,000 in the third quarter of 2000 as compared to $17,000 in
the third quarter of 1999. This increase was due primarily to amortization of
goodwill from the Konark acquisition.
Interest expense and other income (expense). Interest expense and other
income and expense increased to $43,000 for the third quarter of 2000 from
$21,000 for the third quarter of 1999, due primarily to expenses resulting from
higher interest cost incurred with the capital lease obligations.
Interest income. Interest income decreased to approximately $496,000 in
the third quarter of 2000 as compared to approximately $567,000 in the third
quarter of 1999. This decrease was due primarily to lower cash balances to be
invested during the quarter and recognition of gains and losses on redemption.
18
<PAGE>
Income taxes. The Company's effective tax rate was 39.8% and 33.9% for
the third quarter of 2000 and 1999, respectively. In the third quarter of 2000,
the tax benefit on the current period loss reflects an effective tax rate higher
than the statutory tax rate due to the utilization of research and development
and foreign tax credits. The effective tax rate for third quarter 1999 was lower
than the statutory rate due to the utilization of research and development and
foreign tax credits.
Nine Months Ended September 30, 2000 Compared to the Nine Months Ended September
30, 1999
Revenues. Total revenues increased 41.3% to $41.7 million in the nine
months ended September 30, 2000 from $29.5 million in the nine months ended
September 30, 1999. License revenues increased by 88.6% to $30.1 million in the
nine months ended September 30, 2000 from $16.0 million in the nine months ended
September 30, 1999. This increase was primarily attributable to an increase in
the sale of OSS gateway licenses to Telecom Service Providers. Service revenues
decreased 14.3% to $11.6 million in the nine months ended September 30, 2000
from $13.5 million in the nine months ended September 30, 1999. This decrease
was attributable primarily to less custom application development projects for
OSS interconnection and LNP solutions. Revenues recorded using the percentage of
completion method of contract accounting amounted to $6.2 million in the nine
months ended September 30, 2000 as compared to $8.8 million in the nine months
ended September 30, 1999.
Gross profit. The Company's gross profit increased 30.0% to $30.3
million in the nine months ended September 30, 2000 from $23.3 million in the
nine months ended September 30, 1999. Gross profit percentage for license
revenues decreased to 89.2% in the nine months ended September 30, 2000 from
92.6% in the nine months ended September 30, 1999 due to a lower sales volume,
an increase of third party royalties and amortization of acquired technology and
capitalized software development costs. Gross profit percentage for service
revenues decreased to 30.0% in the nine months ended September 30, 2000 from
63.2% in the nine months ended September 30, 1999. The decreases in gross
profit percentages were primarily attributable to higher implementation costs
arising from the use of third party contractors to provide interim support,
increase in personnel and related costs (internal resources), less application
development service revenue, and other support costs associated with satisfying
customer requirements.
Sales and marketing expenses. Sales and marketing expenses increased
12.1% to $9.5 million in the nine months ended September 30, 2000 from $8.5
million in the nine months ended September 30, 1999. The increase in sales and
marketing expenses was primarily attributable to increased personnel and related
costs resulting from the increase in the Company's marketing department and the
use of outside consultants.
Research and product development expenses. Research and product
development expenses increased 60.8% to $12.5 million in the nine months ended
September 30, 2000 from $7.8 million in the nine months ended September 30,
1999. The increase in research and product
19
<PAGE>
development expenses was attributable to increased personnel and related costs
and the expansion of a number new products under development.
General and administrative expenses. General and administrative
expenses increased 37.9% to $4.3 million in the nine months ended September 30,
2000 from $3.1 million in the nine months ended September 30, 1999. The increase
in general and administrative expenses was due primarily to recruiting,
personnel and related costs and professional fees.
Bad debt expense and other charges. Bad debt expense and other charges
increased to approximately $5.8 million the nine months ended September 30, 2000
from approximately $317,000 in the nine months ended September 30, 1999. The
increase was due in part to the uncertainty in the cash flow and external
financing for Telecom Service Providers which continues to impact the
Company's ability to collect its receivables. Additionally, a major customer
declared bankruptcy on September 28, 2000 with an accounts receivable balance
of $1.9 million. Lastly, the company settled a dispute with a customer related
to network products and wrote off certain accounts receivable. In conjunction
with the settlement the Company recorded a reserve for future product credits
that may be granted to the customer.
Amortization of goodwill. Amortization expense increased to
approximately $312,000 in the nine months ending September 30, 2000 as compared
to $104,000 in the nine months ended September 30, 1999. This increase was due
primarily to amortization of goodwill from the Konark and the NPL acquisition.
Interest expense and other income (expense). Interest expense and other
income and expense increased to $139,000 for the nine months ended September 30,
2000 from $96,000 for the nine months ended September 30, 1999, reflecting
higher interest cost incurred with the capital lease obligations.
Interest Income. Interest income decreased to $1.5 million in the nine
months ended September 30, 2000 as compared to $1.7 million in the nine months
ended September 30, 1999. This decrease was due primarily to lower cash balances
during the period and recognition of gains and losses on redemptions.
Income taxes. The Company's effective tax rate was a benefit of 78.5%
for the nine months ended September 30, 2000 and a provision of 34.5% for the
nine months ended 1999. In the nine months ended September 30, 2000, the
effective tax rate was higher than the statutory tax rates due to the increase
of utilization of research and development and foreign tax credits. The
Company's effective tax rate for the nine months ended 1999 was lower than the
statutory rate due to the utilization of research and development and foreign
tax credits.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception in 1989, the Company has financed its operations
primarily through cash generated by operations and cash raised through its March
1998 initial public offering. At September 30, 2000, the Company's cash, cash
equivalents and marketable securities aggregated
20
<PAGE>
approximately $39.4 million, of which cash and cash equivalents aggregated
approximately $9.2 million and marketable securities aggregated approximately
$30.2 million. Marketable securities at September 30, 2000 were comprised of
fixed income government securities and corporate bonds. The Company's working
capital was $52.6 million and $53.6 million at September 30, 2000 and December
31, 1999, respectively.
Accounts receivable, net decreased to $19.1 million at September 30,
2000 from $20.1 million at December 31, 1999, primarily as a result of an
increase in allowance for doubtful accounts, increased collection efforts,
decreased quarterly sales and more favorable contract terms. Included in
accounts receivable in the third quarter of 2000 was $21.9 million for trade
receivables and $2.9 million for unbilled project revenue as compared to
$16.8 million for trade receivables and $4.8 million for unbilled project
revenue at December 31, 1999. The allowance for doubtful accounts was $4.7
million in the third quarter of 2000 as compared to $600,000 at December 31,
1999. Unbilled project revenue is the excess amount of revenue recognized
through percentage of completion that has not been billed to the customer.
Payment terms to customers are generally net zero to net ninety days.
The Company bills its foreign customers in U.S. dollars at agreed-upon
contractual terms. The Company has not experienced any significant negative
effects on its liquidity as a result of the volatility and devaluation trends
that have been experienced in certain Asian markets, although no assurance can
be made that the Company will not experience difficulty collecting accounts
receivable from such customers in the future. Accounts receivable at September
30, 2000 includes approximately $489,000 from customers in this region.
The Company's capital expenditures were approximately $721,000 and
$667,000 for the three months ended September 30, 2000 and 1999, respectively.
The increase in capital expenditures is due to the expansion of facilities in
California and Texas in 2000.
In June 1999, the Company entered into a five-year capital lease
agreement at an annual interest rate of 8.21% for equipment, furniture and
fixtures at its new office facilities. Assets recorded under this lease are
included in fixed assets. Annual lease payments approximate $180,000.
During August 2000, the Company renewed an unsecured revolving credit
facility with a bank pursuant to which the Company may borrow up to a maximum of
$5.0 million. Borrowings under this line of credit bear interest at the bank's
prime rate less 0.25% on aggregate principal amounts outstanding of less than
$1.0 million and at the bank's prime rate for aggregate principal amounts
exceeding $1.0 million. No borrowings under this line were outstanding as of
September 30, 2000. This credit facility contains, among other provisions,
covenants which: (i) mandate the amount of working capital the Company must
maintain at the end of each calendar quarter; and (ii) restrict the Company's
ability to pay cash dividends. The unsecured revolving credit facility expires
on August 5, 2004.
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
21
<PAGE>
shares were issued and sold by the Company and 1,000,000 shares were sold by
certain Selling Shareholders. The net proceeds to the Company from the offering
were approximately $36.1 million. On April 7, 1998, certain Selling Shareholders
sold an additional 525,000 shares of the Company's Common Stock at a price to
the public of $16.00 per share upon the consummation of the exercise of the
Underwriters' over-allotment option. The Company did not receive any of the
proceeds from the sale of shares by the Selling Shareholders.
The net proceeds received by the Company upon the consummation of such
offering, pending specific application, were invested in short-term,
investment-grade, interest-bearing instruments.
The Company believes that its existing available cash, its revolving
credit facility, the cash flow expected to be generated from operations,
together with the proceeds from its initial public offering, will be adequate to
satisfy its current and planned operations for at least the next 12 months.
There can be no assurance, however, that the Company will not require additional
financing prior to such time to fund its operations or possible acquisitions.
IMPACT OF THE YEAR 2000
Although the rollover has passed from December 31, 1999 to January 1,
2000, the Company still faces risks to the extent that suppliers of products,
services, and systems purchased by the Company or the suppliers of others with
whom the Company transacts business cannot timely provide products, components,
services, or systems that meet Year 2000 requirements. 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.
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.
In November 1998, we 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 also analyzed 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. 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.
To date, the Company has not been notified of any Year 2000 problems that have
occurred in these custom applications. However, a failure to properly implement
any correction, or problems with any correction, could cause errors in
customers' products which may materially impact the functionality of those
products.
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<PAGE>
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.
EUROPEAN MONETARY UNION
On January 1, 1999, eleven of the fifteen member countries of the
European Union set fixed conversion rates between their existing 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 euros and will redenominate outstanding sovereign debt. The
legacy currencies will continue to be used as legal tender through January 1,
2002, at which point 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 revenues 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 3. 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.
23
<PAGE>
The Company believes the market risk exposure with regard to marketable
securities held in the investment portfolio is limited to changes in quoted
market prices for such securities. Based upon the composition of the Company's
marketable securities at September 30, 2000, the Company does not believe an
adverse change in quoted market prices would be material to our results of
operations.
24
<PAGE>
PART II. OTHER INFORMATION
ITEM 4. USE OF PROCEEDS.
Use of Proceeds from Initial Public Offering
On March 12, 1998, the Commission declared effective the Company's
Registration Statement (Registration Statement No. 333-43827) as filed with the
Commission in connection with the Company's initial public offering of Common
Stock, which was managed by BT Alex. Brown Incorporated, BancAmerica Robertson
Stephens and SoundView Financial Group, Inc. Pursuant to such Registration
Statement, the Company registered and sold an aggregate of 2,500,000 shares of
its Common Stock, for a gross aggregate offering price of $40.0 million. The
Company incurred underwriting discounts and commissions of approximately $2.8
million. In connection with such offering, the Company incurred total expenses
of approximately $1.1 million. As of September 30, 2000, the remainder of the
$36.1 million in net proceeds received by the Company upon consummation of such
offering, pending specific application, were invested in short-term,
investment-grade, interest-bearing instruments.
On January 25, 1999, DSET Acquisition Corp., a wholly-owned subsidiary
of the Company consummated the acquisition of certain assets of NPL. The
purchase price consisted of $2.5 million payable in cash to NPL and professional
fees of $158,000. NPL provided specialized software to Telecom Service
Providers.
On September 30, 1999, the Company purchased Konark and related
technologies for approximately $3.3 million in cash and certain deferred
payments plus professional fees and the related deferred tax liabilities. Konark
provided software which enabled Telecom Service Providers to rapidly activate
new services for their customer.
For working capital restrictions and limitations on the payment of
dividends, see "Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
ITEM 5. OTHER INFORMATION.
On July 19, 2000 the Company announced that it had executed a strategic
alliance agreement with Daleen Technologies, Inc. ("Daleen") under which the
Company and Daleen will engage in joint marketing, selling and other strategic
activities targeting new and existing customers. As part of the strategic
relationship, Daleen has granted the Company the exclusive distribution rights
to license and resell certain Daleen's electronic bonding gateways optimized
for the Canadian market.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
<TABLE>
<S> <C>
(a) Exhibits.
27 - Financial Data Schedule.
(b) Reports on Form 8-K.
No Reports on Form 8-K were filed during the quarter for
which this report on Form 10-Q is filed.
</TABLE>
25
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DSET CORPORATION
DATE: November 14, 2000 By: /s/ William P. McHale, Jr.
---------------------------------
William P. McHale, Jr., President
and Chief Executive Officer
(Principal Executive Officer)
DATE: November 14, 2000 By: /s/ Bruce M. Crowell
---------------------------------
Bruce M. Crowell
Vice President and Chief
Financial Officer
(Principal Financial and
Accounting Officer)
26
