<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 March 31, 2000
Commission File Number 0-23611
DSET CORPORATION
------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
<TABLE>
<S> <C>
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)
</TABLE>
(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 May 1, 2000:
<TABLE>
<CAPTION>
Class Number of Shares
----- ----------------
<S> <C>
Common Stock, no par value 11,297,155
</TABLE>
<PAGE>
DSET CORPORATION
<TABLE>
<CAPTION>
TABLE OF CONTENTS
Page
----
<S> <C> <C>
PART I. FINANCIAL INFORMATION..................................................................... 1
Item 1. Financial Statements............................................................. 1
Consolidated Balance Sheets as of March 31, 2000 and December 31, 1999........... 2
Consolidated Statements of Income and Comprehensive Income for the
Three Months Ended March 31, 2000 and 1999 ................................... 3
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2000
and 1999 ..................................................................... 4
Notes to Consolidated Financial Statements....................................... 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations...................................................................... 13
Results of Operations............................................................ 16
Liquidity and Capital Resources.................................................. 17
Item 3. Quantitative and Qualitative Disclosures About Market Risk....................... 20
PART II. OTHER INFORMATION........................................................................ 21
Item 2. Use of Proceeds.................................................................. 21
Item 6. Exhibits and Reports on Form 8-K................................................ 21
SIGNATURES ....................................................................................... 22
</TABLE>
i
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
1
<PAGE>
DSET Corporation and Subsidiaries
March 31, 2000
Consolidated Balance Sheets
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
March 31, 2000 December 31, 1999*
-------------- ------------------
(unaudited) (audited)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 9,368,613 $ 2,212,759
Marketable securities 38,533,916 37,945,597
Accounts receivable, net of allowance for doubtful accounts
of $699,000 and $600,000 14,459,410 20,132,404
Income taxes receivable 1,345,726 -
Deferred income taxes 741,923 735,774
Prepaid licenses 815,000 25,000
Prepaid expenses and other current assets 2,350,459 1,963,944
----------------- ---------------
Total current assets 67,615,047 63,015,478
Acquired technology, net 4,271,674 4,343,313
Software development costs, net 532,577 564,854
Fixed assets, net 4,233,513 3,428,268
Goodwill, net 1,189,667 1,258,175
Other assets 860,412 885,290
----------------- ---------------
Total assets $ 78,702,890 $ 73,495,378
================= ===============
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable and accrued expenses $ 6,879,190 $ 6,144,874
Income taxes payable - 394,206
Deferred revenues 3,301,647 1,719,975
Current portion of notes payable 945,026 1,000,000
Current portion of lease obligation 130,417 130,415
----------------- ---------------
Total current liabilities 11,256,280 9,389,470
Deferred income taxes 624,997 710,765
Long-term notes payable 837,004 1,310,560
Capital lease obligation 519,476 561,670
----------------- ---------------
Total liabilities 13,237,757 11,972,465
----------------- ---------------
Commitments
Shareholders' equity:
Preferred stock, no par value; 5,000,000 shares authorized, no
shares issued or outstanding at March 31, 2000 and December 31, 1999 - -
Common stock, no par value; 40,000,000 shares authorized, 11,329,560
and 10,860,770 shares issued and outstanding at March 31, 2000
and December 31, 1999, respectively 48,527,067 45,635,959
Deferred stock compensation (163,832) (196,737)
Retained earnings 17,168,507 16,247,807
Accumulated other comprehensive income ( 66,609) (164,116)
----------------- ---------------
Total shareholders' equity 65,465,133 61,522,913
----------------- ---------------
Total liabilities and shareholders' equity $ 78,702,890 $ 73,495,378
================= ===============
</TABLE>
* Certain amounts have been reclassified for comparative purposes.
The accompanying notes are an integral part of these consolidated
financial statements.
2
<PAGE>
DSET Corporation and Subsidiaries
March 31, 2000
Consolidated Statements of Income and Comprehensive Income
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Three Months Ended March 31,
2000 1999*
---- -----
(unaudited) (unaudited)
<S> <C> <C>
Revenues:
License revenues $ 8,095,419 $ 4,153,146
Service revenues 3,502,994 3,323,140
------------- ------------
Total revenues 11,598,413 7,476,286
------------- ------------
Cost of revenues:
License revenues 799,219 283,109
Service revenues 2,235,645 1,266,948
------------- ------------
Total cost of revenues 3,034,864 1,550,057
------------- ------------
Gross profit 8,563,549 5,926,229
------------- ------------
Operating expenses:
Sales and marketing 2,710,003 2,394,654
Research and product development 3,418,351 2,345,898
General and administrative 1,294,500 810,313
Amortization of goodwill and other intangibles 103,284 9,502
------------- ------------
Total operating expenses 7,526,138 5,560,367
------------- ------------
Operating income 1,037,411 365,862
Interest expense and other income (expense) (55,299) (13,999)
Interest income 398,434 536,434
------------- ------------
Income before income taxes 1,380,546 888,297
Provision for income taxes 459,846 316,345
------------- ------------
Net income 920,700 571,952
Other comprehensive income, net of tax:
Unrealized appreciation/(depreciation)
on investments 97,507 (53,413)
------------- ------------
Comprehensive income $ 1,018,207 $ 518,539
============= ============
Net income applicable to common shares $ 920,700 $ 571,952
============= ============
Net income per common share $ .08 $ .06
============= ============
Weighted average number of common shares
outstanding 11,037,458 10,028,583
============= ============
Net income per common share assuming dilution $ .08 $ .05
============= ============
Weighted average number of common shares and
common equivalent shares outstanding 12,116,680 11,331,694
============= ============
</TABLE>
* Certain amounts have been reclassified for comparative purposes.
The accompanying notes are an integral part of these consolidated
financial statements.
3
<PAGE>
DSET Corporation and Subsidiaries
March 31, 2000
Consolidated Statements of Cash Flows
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Three Months Ended March 31,
2000 1999 *
---- ----
(unaudited) (unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net income $ 920,700 $ 571,952
Adjustments to reconcile net income to net cash
provided by operating activities:
Deferred income taxes (133,616) -
Tax benefit from exercise of stock options 1,775,415 589,819
Amortization of deferred stock compensation 32,905 63,889
Depreciation 233,181 184,009
Loss on disposal of assets 475 -
Amortization 207,199 9,502
Bad debt expense 99,000 15,900
Earnings from joint venture - (1,208)
Changes in assets and liabilities:
Accounts receivable 5,573,994 1,335,206
Prepaid licenses (790,000) -
Prepaid expenses and other current assets (186,515) (716,840)
Other assets (9,897) (117,640)
Accounts payable and accrued expenses 734,316 (541,114)
Income taxes receivable and payable (1,739,932) (377,048)
Deferred revenues 1,581,672 415,875
------------ -----------
Net cash provided by operating activities 8,298,897 1,432,302
------------ -----------
Cash flows from investing activities:
Purchases of marketable securities (10,427,655) (4,598,866)
Redemption of marketable securities 9,978,542 7,534,691
Acquisitions of businesses - (2,624,890)
Software development costs - (231,091)
Acquisition of fixed assets (1,038,901) (181,825)
------------ -----------
Net cash used in investing activities (1,488,014) (101,981)
------------ -----------
Cash flows from financing activities:
Loan to employee (200,000) -
Repayment of notes payable (528,530) (55,000)
Repayments capital lease obligation (42,192) -
Proceeds from the exercise of stock options 1,115,693 473,334
------------ -----------
Net cash provided by financing activities 344,971 418,334
------------ -----------
Net increase in cash and cash equivalents 7,155,854 1,748,655
Cash and cash equivalents, beginning of period 2,212,759 9,198,270
------------ -----------
Cash and cash equivalents, end of period $ 9,368,613 $10,946,925
============ ===========
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes $ 572,350 $ 99,400
Cash paid during the period for interest 18,464 1,396
</TABLE>
* Certain amounts have been reclassified for comparative purposes.
The accompanying notes are an integral part of these consolidated
financial statements.
4
<PAGE>
DSET Corporation and Subsidiaries
March 31, 2000
Notes to Consolidated Financial Statements (unaudited)
- -------------------------------------------------------------------------------
1. Basis of Presentation
The consolidated information presented as of March 31, 2000 and the
three-month periods ended March 31, 2000 and 1999 is unaudited, but in the
opinion of DSET Corporation's (the "Company") management, the accompanying
unaudited consolidated financial statements contain all adjustments
(consisting only of normal recurring adjustments) which the Company considers
necessary for the fair presentation of the Company's financial position as of
March 31, 2000 and the results of its operations and its cash flows for the
three-month periods ended March 31, 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. The consolidated entity
includes DSET Corporation and its wholly-owned subsidiaries, DSET Acquisition
Corp., a Delaware corporation; Konark Inc., a California corporation; PIC
Technologoies, Inc., a Delaware corporation; and Chengdu DSET Science &
Technology Co., Ltd. (China).
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
depreciation was $66,609 (net of deferred taxes of $41,699) at March 31,
2000. Cost is determined on specific identification basis.
5
<PAGE>
DSET Corporation and Subsidiaries
March 31, 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 its
estimated useful life of five years. The Company periodically assesses the
realizability of the asset based on estimated future cash flows. Accumulated
amortizaton was $211,305 as of March 31, 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 revenue, 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 bear 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 $864,325 as of March
31, 2000.
Acquired Technology
Acquired technology represents the costs of feasible technology acquired from
external sources. At December 31, 1999, acquired technology reflects the
purchase of certain assets of Network Programs LLC ("NPL") and Konark
Inc.("Konark"), as well as related costs to acquire such assets. Accumulated
amortization was $486,693 as of March 31, 2000. There was no accumulated
amortization at March 31, 1999. Amortization of acquired technology is the
greater of the amount computed using (a) the ratio that current gross
revenues for a product bear 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.
Research and Product Development
Research and 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.
6
<PAGE>
DSET Corporation and Subsidiaries
March 31, 2000
Notes to Consolidated Financial Statements (unaudited)
- -------------------------------------------------------------------------------
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 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.
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.
7
<PAGE>
DSET Corporation and Subsidiaries
March 31, 2000
Notes to Consolidated Financial Statements (unaudited)
- -------------------------------------------------------------------------------
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. 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, 1999 (January 1,
2000 for the Company). SFAS No. 133 requires that all derivative instruments
be recorded on the balance sheet at their fair value. Changes in the fair
value of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part
of a hedge transaction and, if it is, the type of hedge transaction.
Management of the Company anticipates that, due to its limited use of
derivative instruments, the adoption of SFAS No. 133 will not have a
significant effect on the Company's results of operations or its financial
position.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements,"
("SAB 101") which must be adopted by June 30, 2000. The Company is currently
evaluating the impact of SAB 101 on its results of operations.
Reclassifications
Certain amounts in the first quarter of 1999 have been reclassified to
conform to the first quarter of 2000 presentation.
8
<PAGE>
DSET Corporation and Subsidiaries
March 31, 2000
Notes to Consolidated Financial Statements (unaudited)
- -------------------------------------------------------------------------------
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 new 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>
March 31, 2000 December 31, 1999
-------------- -----------------
<S> <C> <C>
Furniture and fixtures $ 743,462 $ 743,462
Accumulated amortization (83,318) (51,550)
-------------- -----------------
$ 660,144 $ 691,912
-------------- -----------------
</TABLE>
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 (9.00% at March 31, 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 March 31, 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
On September 30, 1999, 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 approximately $28,000 for the three months ended March
31, 2000. The note is payable in five installments and matures on March 1,
2002.
9
<PAGE>
DSET Corporation and Subsidiaries
March 31, 2000
Notes to Consolidated Financial Statements (unaudited)
- -------------------------------------------------------------------------------
As of March 31, 2000, future payments under the notes are as follows:
<TABLE>
<CAPTION>
Principal
Year Ending December 31, Payments
----------------------- --------
<S> <C>
2000 $ 500,000
2001 1,000,000
2001 500,000
----------
2,000,000
Less: Unamortized interest $ (217,970)
----------
Present value of notes payable 1,782,030
Less: Current portion 945,026
----------
Long-term portion $ 837,004
----------
</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
$158,416.
The costs to acquire NPL are recorded as acquired technology and goodwill. In
addition, research and 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 expense was approximately $128,000 for the three months ended March 31,
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 and goodwill that will
be amortized over five years.
10
<PAGE>
DSET Corporation and Subsidiaries
March 31, 2000
Notes to Consolidated Financial Statements (unaudited)
- -------------------------------------------------------------------------------
The following is a summary of the purchase price allocation and
consideration:
<TABLE>
<CAPTION>
Purchase Price Allocation
-------------------------
<S> <C>
Acquired technology $ 2,195,507
Other assets 695,507
Goodwill 1,036,015
------------
$ 3,927,029
------------
<CAPTION>
Consideration
-------------
<S> <C>
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. 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. The following table is a reconciliation of the
numerator and denominator under each method:
<TABLE>
<CAPTION>
For the Three Months ended March 31, 2000
-----------------------------------------
Per Share
Net Income Shares Amount
<S> <C> <C> <C>
Basic EPS $920,700 11,037,458 $ 0.08
Assuming dilution:
Stock options - 1,036,207
Warrants - 43,015
-------- ----------
$920,700 12,116,680 $ 0.08
-------- ----------
</TABLE>
11
<PAGE>
DSET Corporation and Subsidiaries
March 31, 2000
Notes to Consolidated Financial Statements (unaudited)
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the Three Months ended March 31, 1999
-----------------------------------------
Per Share
Net Income Shares Amount
<S> <C> <C> <C>
Basic EPS $571,952 10,028,583 $ 0.06
Assuming dilution:
Stock options - 1,147,247
Warrants - 155,864
-------- ----------
$571,952 11,331,694 $ 0.05
-------- ----------
</TABLE>
12
<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 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 Data Local Exchange Carriers ("DLECs") 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 ("Telecom Act") encourages competition among
providers of local phone services by requiring incumbent local exchange carriers
("ILECs") to allow new Telecom Service Providers to lease portions of the
incumbents' networks and access their OSSs. 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 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. 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. However, the Company is actively moving
away from selling these application development tools.
The Company's continued success will depend on continued growth in the
market for advanced telecommunications products, OSS interconnection products
and services and LNP solutions.
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 March 31, 2000 and 1999, the Company derived
approximately 69.8% and 55.6%, respectively, of its total revenues from license
revenues and approximately 30.2% and 44.4%, respectively, of its total revenues
from service revenues. During the first quarter of 2000, revenues generated from
Telecom Service Providers were approximately $7.0 million. Revenues generated
from network equipment vendors for LNP solutions, application development tools
and related services were approximately $4.6 million in the first quarter of
2000. Revenues generated from Telecom Service Providers were $1.9 million in the
first quarter
13
<PAGE>
of 1999, and revenues generated from network equipment vendors were $5.6
million in the first quarter of 1999.
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 licenses of the Telecom Service Providers' solutions
and other applications range from $75,000 to $500,000, depending on the number
of licensed components. 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 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 customer accounting for 20% of revenues for the quarter
ended March 31, 2000 and no customer which accounted for more than 10% of
revenues for the quarter ended March 31,1999. The Company anticipates that its
results of operations in any given period will continue to depend to a
significant extent upon sales to a small number of customers. As a result of
this customer concentration, the Company's revenues from quarter to quarter and
14
<PAGE>
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 and the amortization of acquired technology
and capitalized software costs. 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 March 31, 2000, the remaining unamortized deferred stock compensation balance
was approximately $164,000.
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 6% and 10% of the Company's total revenues in
the first quarter of 2000 and 1999, respectively. International sales are
derived from 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.
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 (the "Exchange Act").
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
15
<PAGE>
industry, (iv) the limited number of customers for a significant portion of
the Company's revenue, (v) risks associated with market acceptance of the
Company's new OSS gateways interconnection and LNP products, (vi) risks
associated with intense competition in the industry, including competition for
qualified technical personnel and (vii) 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 March 31, 2000 Compared to the Three Months Ended March
31, 1999
Revenues. Total revenues increased 55.1% to $11.6 million in the first
quarter of 2000 from $7.5 million in the first quarter of 1999. License revenues
increased by 94.9% to $8.1 million in the first quarter of 2000 from $4.2
million in the first quarter of 1999. This increase was primarily attributable
to an increase in the sale of OSS gateway licenses to Telecom Service Providers.
Service revenues increased 5.4% to $3.5 million in the first quarter of 2000
from $3.3 million in the first quarter of 1999. This increase was attributable
primarily to custom application development projects for OSS interconnection and
LNP solutions, offset by a decrease in projects for network equipment vendors.
Revenues recorded using the percentage of completion method of contract
accounting amounted to $2.4 million in the first quarter of 2000 as compared to
$1.9 million in the first quarter of 1999.
Gross profit. The Company's gross profit increased 44.5% to $8.6 million in
the first quarter of 2000 from $5.9 million in the first quarter of 1999. Gross
profit percentage for license revenues decreased to 90.1% in the first quarter
of 2000 from 93.2% in the first quarter of 1999 due to an increase of third
party royalties and amortization of acquired technology and capitalized software
costs. Gross profit percentage for service revenues decreased to 36.2% in the
first quarter of 2000 from 61.9% in the first quarter of 1999. The decreases in
gross profit percentages were primarily attributable to higher implementation
costs arising from the use of third party resources, less application
development service revenue, other support costs associated with satisfying
customer requirements and the amortization of acquired technology and
capitalized software.
Sales and marketing expenses. Sales and marketing expenses increased 13.2%
to $2.7 million in the first quarter of 2000 from $2.4 million in the first
quarter of 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 sales force and provision for bad debt expense
16
<PAGE>
offset by a lower commission rate on in-house sales as compared to the
higher commission rate associated with higher agent sales in the previous year.
Research and product development expenses. Research and product development
expenses increased 45.7% to $3.4 million in the first quarter of 2000 from $2.3
million in the first quarter of 1999. The increase in research and product
development expenses was due primarily to an expansion in the number of new
products under development.
General and administrative expenses. General and administrative expenses
increased 59.8% to $1.3 million in the first quarter of 2000 from $810,000 in
the first quarter of 1999. The increase in general and administrative expenses
was due primarily to recruiting, personnel and related costs and professional
fees.
Amortization of goodwill. Amortization expense increased to approximately
$103,000 in the first quarter of 2000 as compared to $10,000 in the first
quarter of 1999. This increase was due primarily to amortization of goodwill
from the Konark and NPL acquisitions.
Interest expense and other income (expense). Interest expense and other
income and expense increased to $55,000 for the first quarter of 2000 from
$14,000 for the first quarter of 1999, reflecting higher interest cost incurred
with the capital lease agreement and other miscellaneous cost increases.
Interest Income. Interest income decreased to $398,000 in the first quarter
of 2000 as compared to $536,000 in the first quarter of 1999. This decrease was
due primarily to lower interest rates.
Income taxes. The Company's effective tax rate was 33.3% and 35.6% for the
first quarter of 2000 and 1999, respectively. In the first quarter of 2000, the
effective tax rate was lower than the statutory tax rates due to the increased
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 March 31, 2000, the Company's cash, cash
equivalents and marketable securities aggregated approximately $47.9 million, of
which cash and cash equivalents aggregated approximately $9.4 million and
marketable securities aggregated approximately $38.5 million. Marketable
securities at March 31, 2000 were comprised of fixed income government
securities and corporate bonds. The Company's working capital was $56.4 million
and $53.6 million at March 31, 2000 and December 31, 1999, respectively.
Accounts receivable, net decreased to $14.5 million at March 31, 2000 from
$20.1 million at December 31, 1999, primarily as a result of increased
collection efforts, more favorable contract terms and a lower sales base as
compared to the fourth quarter of 1999.
17
<PAGE>
Included in accounts receivable in the first quarter of 2000 was $12.2
million for trade receivables and $3.8 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. 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 March 31,
2000 includes approximately $467,000 from customers in this region.
The Company's capital expenditures were approximately $1.0 million and
$182,000 for the three months ended March 31, 2000 and 1999, respectively. The
increase in equipment and facilities-related expenditures are primarily the
result of increased computer hardware and software purchases to accommodate
current and future growth.
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 1997, the Company obtained an unsecured revolving credit facility
with a bank pursuant to which the Company may borrow up to a maximum of $3.0
million. Borrowings under this line of credit bear interest at the bank's prime
rate less 0.25% on 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 March 31,
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, 2000.
On March 18, 1998, the Company consummated an initial public offering of
3,500,000 shares of its Common Stock at a price to the public of $16.00 per
share of which 2,500,000 shares were issued and sold by the Company and
1,000,000 shares were sold by certain Selling Shareholders. The net proceeds to
the Company from the offering were approximately $36.1 million. On April 7,
1998, certain Selling Shareholders sold an additional 525,000 shares of the
Company's Common Stock at a price to the public of $16.00 per share upon the
consummation of the exercise of the Underwriters' over-allotment option. The
Company did not receive any of the proceeds from the sale of shares by the
Selling Shareholders.
18
<PAGE>
The net proceeds received by the Company upon the consummation of such
offering, pending specific application, are invested in short-term,
investment-grade, interest-bearing instruments.
The Company believes that its existing available cash, credit facility and
the cash flow expected to be generated from operations, together with the
proceeds from its initial public offering, will be adequate to satisfy its
current and planned operations for at least the next 12 months. There can be no
assurance, however, that the Company will not require additional financing prior
to such time to fund its operations or possible acquisitions.
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.
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.
19
<PAGE>
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.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements,"
("SAB 101") which must be adopted by June 30, 2000. The Company is currently
evaluating the impact of SAB 101 on its results of operations.
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.
20
<PAGE>
PART II. OTHER INFORMATION
Item 2. 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 March 31, 2000, all of the $36.1
million in net proceeds received by the Company upon consummation of such
offering, pending specific application, were invested in short-term,
investment-grade, interest-bearing instruments.
For working capital restrictions and limitations on the payment of
dividends, see "Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
Item 6. Exhibits and Reports on Form 8-K.
<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>
21
<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: May 15, 2000 By: /s/ William P. McHale, Jr.
--------------------------
William P. McHale, Jr., President
and Chief Executive Officer
(Principal Executive Officer)
DATE: May 15, 2000 By: /s/ Bruce M. Crowell
---------------------------
Bruce M. Crowell
Vice President and Chief Financial
Officer
(Principal Financial and Accounting
Officer)
22
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary information extracted from the unaudited
financial statements included in the registrant's Form 10-Q for the period ended
March 31, 2000 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> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<EXCHANGE-RATE> 1
<CASH> 9,369
<SECURITIES> 38,534
<RECEIVABLES> 15,158
<ALLOWANCES> (699)
<INVENTORY> 0
<CURRENT-ASSETS> 67,615
<PP&E> 6,614
<DEPRECIATION> (2,380)
<TOTAL-ASSETS> 78,703
<CURRENT-LIABILITIES> 11,257
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0
0
<COMMON> 48,527
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<CGS> 3,035
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<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>
