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, 2002
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 April 30, 2002:
Class Number of Shares
----- ----------------
Common Stock, no par value 5,082,402
DSET CORPORATION
TABLE OF CONTENTS
Page
----
PART I. FINANCIAL INFORMATION.................................................................... 1
Item 1. Condensed Consolidated Financial Statements...................................... 1
Condensed Consolidated Balance Sheets as of March 31, 2002 and
December 31, 2001............................................................ 2
Condensed Consolidated Statements of Loss
and Comprehensive Loss for the Three Months Ended March 31,
2002 and 2001................................................................ 3
Condensed Consolidated Statements of Cash Flows for the Three Months
Ended March 31, 2002 and 2001................................................ 4
Notes to Condensed Consolidated Financial Statements............................. 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations....................................................... 15
Results of Operations............................................................ 19
Liquidity and Capital Resources.................................................. 21
Item 3. Quantitative and Qualitative Disclosures About Market Risk....................... 24
PART II. OTHER INFORMATION........................................................................ 25
Item 2. Changes in Securities and Use of Proceeds........................................ 25
Item 4. Submission of Matters to a Vote of Security Holders.............................. 25
Item 5. Other Information................................................................ 25
Item 6. Exhibits and Reports on Form 8-K................................................. 25
SIGNATURES............................................................................................. 26
i
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
1
DSET Corporation and Subsidiaries
Condensed Consolidated Balance Sheets (Unaudited)
- --------------------------------------------------------------------------------
March 31, 2002 December 31, 2001
-------------- -----------------
Assets
Current assets:
Cash and cash equivalents $ 6,504,081 $12,958,074
Accounts receivable, net of allowance for doubtful accounts
of $7,697,383 at March 31, 2002 and December 31, 2001 629,230 823,793
Income taxes receivable 1,407,386 8,416
Prepaid licenses 916,416 935,000
Prepaid expenses and other current assets 373,831 329,864
----------- -----------
Total current assets 9,830,944 15,055,147
Fixed assets, net 2,261,868 2,173,139
Acquired technology, net 3,866,667 --
Goodwill, net 11,478,961 19,004
Loans to ISPsoft, Inc. -- 3,850,000
Merger and acquisition costs -- 1,042,985
Other assets, net 525,064 417,289
----------- -----------
Total assets $27,963,504 $22,557,564
=========== ===========
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable and accrued expenses $ 2,974,327 $ 2,459,972
Deferred revenues 1,964,794 2,293,214
Accrued restructuring expenses 1,034,211 1,177,154
Notes payable 800,000 493,786
Current portion of capital lease obligation 138,367 138,367
----------- -----------
Total current liabilities 6,911,699 6,562,493
Long term accrued restructuring expenses 970,907 1,021,344
Deferred rent 559,836 549,566
Capital lease obligation 245,439 282,494
Other liabilities 21,000 21,000
----------- -----------
Total liabilities 8,708,881 8,436,897
----------- -----------
Commitments and contingencies
Shareholders' equity:
Preferred stock, no par value; 5,000,000 shares authorized, no shares
issued or outstanding at March 31, 2002 and December 31, 2001 -- --
Series A Junior Participating Preferred stock, no par value; 5,000 shares
authorized, no shares issued or outstanding at March 31, 2002 or
December 31, 2001 -- --
Common stock, no par value; 10,000,000 shares authorized, 5,188,543
and 2,907,400 shares issued at March 31, 2002 and December 31, 2001,
respectively; 5,082,402 and 2,801,259 shares outstanding at
March 31, and December 31, 2001, respectively 57,043,533 50,138,022
Accumulated deficit (37,609,048) (35,837,420)
Other comprehensive loss (21,802) (21,875)
Treasury stock, at cost; 106,141 shares at March 31, 2002
and December 31, 2001 (158,060) (158,060)
----------- -----------
Total shareholders' equity 19,254,623 14,120,667
----------- -----------
Total liabilities and shareholders' equity $27,963,504 $22,557,564
=========== ===========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
DSET Corporation and Subsidiaries
Condensed Consolidated Statements of Loss and Comprehensive Loss (Unaudited)
- --------------------------------------------------------------------------------
Three Months Ended March 31,
-----------------------------
2002 2001
---- ----
Revenues:
License revenues $ 253,343 $ 1,521,160
Service revenues 1,248,012 1,894,280
----------- ------------
Total revenues 1,501,355 3,415,440
----------- ------------
Cost of revenues:
License revenues 202,473 501,826
Service revenues 1,034,367 1,990,663
----------- ------------
Total cost of revenues 1,236,840 2,492,489
----------- ------------
Gross profit 264,515 922,951
----------- ------------
Operating expenses:
Sales and marketing 735,502 2,529,592
Research and product development 986,665 3,909,534
General and administrative 1,219,097 1,852,265
Bad debt expense and other charges - 440,087
Amortization of goodwill - 100,117
Restructuring and impairment charges 463,781 3,428,918
----------- ------------
Total operating expenses 3,405,045 12,260,513
----------- ------------
Operating loss (3,140,530) (11,337,562)
Interest expense and other income (expense) (63,405) (46,928)
Interest income and realized gains and losses on marketable securities 45,919 490,265
----------- ------------
Loss before income taxes (3,158,016) (10,894,225)
Provision (benefit) for income taxes (1,386,388) 28,837
----------- ------------
Net loss $(1,771,628) $(10,923,062)
=========== ============
Other comprehensive income (loss), net of tax
Unrealized appreciation on investments - 56,941
Cumulative translation adjustment 73 1,669
----------- ------------
Comprehensive loss $(1,771,555) $(10,864,452)
=========== ============
Net loss applicable to common shares $(1,771,628) $(10,923,062)
=========== ============
Net loss per common share - basic and diluted $ (0.41) $ (3.76)
=========== ============
Weighted average number of common shares outstanding 4,296,675 2,907,199
=========== ============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
DSET Corporation and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
- --------------------------------------------------------------------------------
Three Months Ended March 31,
-----------------------------
2002 2001
---- ----
Cash flows from operating activities:
Net loss $(1,771,628) $(10,923,062)
Adjustments to reconcile net loss to net cash
(used in) operating activities, net of effects of acquisitions:
Stock based compensation charges - (9,227)
Realized (gain) on marketable securities - (131,087)
Depreciation 170,850 352,991
Amortization 133,333 421,964
Bad debt expense and other charges - 440,087
Asset impairments 147,099 2,895,825
Changes in operating assets and liabilities:
Accounts receivable 210,563 914,348
Income taxes (1,398,970) 122,804
Prepaid licenses 18,584 (88,001)
Prepaid expenses and other current assets (42,854) 679,992
Other assets (61,657) (192,895)
Accounts payable and accrued expenses 444,513 (2,678,345)
Deferred revenues (328,420) (23,916)
Accrued restructuring expenses (193,380) 529,375
Deferred rent 10,270 15,222
----------- ------------
Net cash (used in) operating activities (2,661,697) (7,673,925)
----------- ------------
Cash flows from investing activities:
Redemption of marketable securities - 8,214,905
Acquisition of business, less cash acquired (3,248,422) -
Purchase of acquired technology - (347,035)
Acquisition of fixed assets (19,106) (603,603)
----------- ------------
Net cash provided by (used in) investing activities (3,267,528) 7,264,267
----------- ------------
Cash flows from financing activities:
Repayments of notes payable (493,786) (500,000)
Repayments of capital lease obligation (37,055) (34,169)
Repayment from officers and shareholders 6,000 7,600
Proceeds from the exercise of stock options - 4,538
----------- ------------
Net cash (used in) financing activities (524,841) (522,031)
----------- ------------
Effect of foreign exchange rate changes on cash 73 1,669
----------- ------------
Net (decrease) in cash and cash equivalents (6,453,993) (930,020)
----------- ------------
Cash and cash equivalents, beginning of period 12,958,074 7,314,254
----------- ------------
Cash and cash equivalents, end of period $ 6,504,081 $ 6,384,234
=========== ============
Supplemental disclosure of cash flow information:
Cash (received) paid during the period for income taxes $ 12,582 $ (123,933)
Cash paid during the period for interest 14,293 36,528
Non-cash activities:
Accrued merger and acquisition costs 400,368 -
Issuance of common stock and options in business acquisition 6,905,511 -
Supplemental information of business acquired:
Fair value of assets acquired:
Cash 1,183 -
Current assets 23,113 -
Non-current assets 430,855 -
Acquired technology 4,000,000 -
Goodwill 11,459,957 -
Less liabilities assumed and non-cash consideration:
Current liabilities (268,695) -
Notes payable (800,000) -
Stock issued (6,378,077) -
Stock options issued (527,434) -
Accrued merger and acquisition costs (400,368) -
----------- ------------
Cash paid 7,540,534 -
Less, cash acquired (1,183) -
Net cash paid 7,539,351 -
Less, cash paid prior to December 31,2001 4,290,929 -
----------- ------------
Acquisition of business, less cash acquired $ 3,248,422 $ -
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
DSET Corporation and Subsidiaries
March 31, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
1. Basis of Presentation
The condensed consolidated financial information presented as of March 31,
2002 and for the three month periods ended March 31, 2002 and 2001 is
unaudited, but in the opinion of the management of DSET Corporation("DSET"
or the "Company"), 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 March 31, 2002, the
results of its operations and its cash flows for the three month periods
ended March 31, 2002 and 2001. The financial statements included herein
have been prepared in accordance with generally accepted accounting
principles and the instructions to Form 10-Q and Rule 10-01 of Regulation
S-X. Accordingly, certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted. These
financial statements should be read in conjunction with the Company's
audited financial statements 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, 2001. The December 31, 2001 balance sheet data contained in
this Form 10-Q was derived from audited financial statements, but does not
include all the 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.
On August 14, 2001 the Company announced a reverse stock split effective
on the close of business on August 21, 2001, pursuant to which one new
share of common stock of the Company was issued in exchange for each four
outstanding shares of common stock. The Board of Directors approved the
reverse split under New Jersey law and also authorized the reduction of
the Company's authorized common stock four-fold from 40,000,000 to
10,000,000 shares. The Company's common stock commenced trading at the
post-split price on August 22, 2001. All share and per share amounts in
this Form 10-Q have been adjusted retroactively to reflect the
one-for-four reverse stock split.
2. Going Concern
The condensed consolidated financial statements of DSET have been prepared
on the basis that DSET will continue as a going concern, which
contemplates the realization of assets and satisfaction of liabilities and
commitments in the normal course of business. At March 31, 2002 and
December 31, 2001, DSET had an accumulated deficit of $37.6 million and
$35.8 million and working capital of $2.9 million and $8.5 million,
respectively. DSET also incurred net losses of $1.8 million for the
quarter ended March 31, 2002 and $33.3 million for the year ended December
31, 2001. These factors raise substantial doubt about DSET's ability to
continue as a going concern. The losses and deficits resulted principally
from the lack of demand for DSET's products due to a
5
DSET Corporation and Subsidiaries
March 31, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
major downturn in the telecommunications industry which began in the
second half of 2000 (and continues to the present), having its most acute
impact on Competitve Service Providers ("CSPs"), the Company's primary
targeted customers. This downturn was brought about by the sudden
withdrawal of available financing to the CSPs from traditional sources.
Many of the Company's customers have declared bankruptcy, refused to pay
or delayed additional purchases. This has resulted in the impairment of
tangible and intangible assets, excess capacities and substantial bad
debts. The Company has taken action to mitigate these circumstances by
reducing headcount, subletting facilities and searching for additional
financing to enable it to fund its return to positive cash flow and
profitability.
In 2002 DSET received two non-compliance notifications from the Nasdaq
Stock Market, Inc. ("Nasdaq").
On February 14, 2002, the Company received notice from Nasdaq that for the
preceding 30 consecutive trading days, the Company's common stock had not
maintained the minimum Market Value of Publicly Held Shares ("MVPHS") of
$5,000,000 as required for continued inclusion by Marketplace Rule
4450(a)(2) (the "Rule") on the Nasdaq National Market. MVPHS equals the
closing bid price multiplied by that portion of a company's outstanding
shares which is in the hands of public investors (i.e., - shares not held
by company officers, directors, or investors who hold a controlling
interest in the company.) Therefore, in accordance with Marketplace Rule
4450(e)(1), the Company has 90 calendar days, or until May 15, 2002, to
regain compliance. If compliance with the Rule cannot be demonstrated by
May 15, 2002, the Company's securities will be delisted from the Nasdaq
National Market. The Company has applied to transfer the trading of its
common stock to the Nasdaq SmallCap Market and delisting is stayed
pending Nasdaq's ruling on this application.
On March 5, 2002, the Company received notice from Nasdaq that for the
previous 30 consecutive trading days, the price of the Company's common
stock had closed below the minimum $1.00 per share requirement for
continued inclusion under Marketplace Rule 4450(a)(5) (the "$1.00 Rule").
Therefore, in accordance with Marketplace Rule 4450(e)(2), the Company has
90 calendar days, or until June 3, 2002, to regain compliance. If
compliance with the $1.00 Rule cannot be demonstrated by June 3, 2002, the
Company's securities will be delisted from the Nasdaq National Market.
The Company has applied to transfer the trading of its common stock to
the Nasdaq SmallCap Market and delisting is stayed pending Nasdaq's
ruling on this application.
DSET's failure to meet the Nasdaq's maintenance criteria in the future
may result in the delisting of its common stock from the Nasdaq National
Market. In such event, trading, if any, of DSET's common stock may then
continue to be conducted in the Nasdaq SmallCap market, if DSET meets its
criteria or the over-the-counter market, in what is commonly referred to
as the electronic bulletin board or the "pink sheets". As a result, an
investor may find it more difficult to dispose of or obtain accurate
quotations as to the market value of DSET's common stock. In addition, in
the event DSET's common stock is delisted, broker-dealers would have
certain regulatory burdens imposed upon them, which may discourage them
from effecting transactions in DSET's common stock,
6
DSET Corporation and Subsidiaries
March 31, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
further limiting the liquidity thereof. This may have the effect of
limiting DSET's ability to raise additional financing.
DSET's ability to continue as a going concern is dependent upon its
ability to generate sufficient cash flows to meet its obligations as they
come due. DSET believes that the cost reductions from its restructurings
in 2001 (including work force reductions) and the merger with ISPsoft will
enhance its cash flows from operations. Additional financing may still be
required for DSET to fund its operating and capital requirements through
2002. If cash flows are insufficient, or the Company is unable to raise
funds on acceptable terms, there would be a material adverse effect on
DSET's financial position and operations and its ability to continue as a
going concern. This could force DSET to further reduce its capital
expenditures, reduce its workforce, sell certain assets or possibly
explore additional alternatives including seeking bankruptcy protection.
The consolidated financial statements do not include any adjustments
relating to the recoverability of the carrying amount of the recorded
assets or the amount of liabilities that might result from the outcome
of these uncertainties. The Company cannot be certain that additional
debt or equity financing will be available when required or, if available,
that it can secure it on terms satisfactory to the Company.
3. Summary of Significant Accounting Policies
Consolidation
The condensed 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; and DSET Canada, Inc. ("Canada"). All significant
intercompany transactions have been eliminated in consolidation.
Goodwill
Goodwill represents the excess of the purchase price of an acquistion over
the fair value of the net tangible and intangible assets acquired. In
accordance with Statement of Financial Accounting Standards ("SFAS") 142
"Goodwill and Other Intangible Assets", the Company ceased amortizing
goodwill effective January 1, 2002. In 2001 the Company amortized
goodwill using a straight-line method over an estimated useful life of
five years. The Company periodically assesses the realizability of
goodwill based on estimated future cash flows. Accumulated amortization
was $162,000 as of March 31, 2002 and December 31, 2001. On January 31,
2002 the Company merged with ISPsoft, Inc. In accordance with SFAS 141,
"Business Combinations", the merger was accounted for as a purchase
resulting in the recording of approximately $11.5 million in goodwill.
(See Note 7)
7
DSET Corporation and Subsidiaries
March 31, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
Acquired Technology
Acquired technology represents the costs of feasible technology acquired
from external sources. 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. The acquired technology,
resulting from the Company's merger with ISPsoft, Inc., was valued at $4.0
million. It was determined that the technology had a finite life of five
years from the time of purchase. In the first quarter of 2002,
amortization expense of $133,000 was recognized as cost of revenues. (See
Note 7)
Research and Product Development
Research and product development costs are charged to expense as incurred.
However, the costs incurred 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
In August 2001, SFAS 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets", was issued, replacing SFAS 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of" and portions of APB Opinion 30, "Reporting the Results of Operations".
SFAS 144 provides a single accounting model for long-lived assets to be
disposed of and changes the criteria to be met to classify an asset as
held-for-sale. SFAS 144 retains the requirement of APB Opinion 30 to
report discontinued operations separately from continuing operations and
extends that reporting to a component of an entity that either has been
disposed of or is classified as held-for-sale. The Company adopted SFAS
144 effective January 1, 2002 and there was no impact on the condensed
consolidated financial statements for the quarter ended March 31, 2002.
Treasury Stock
The Company's purchases of shares of its common stock are recorded, at
cost, as Treasury Stock and results in a reduction of stockholders'
equity. When treasury shares are reissued, the Company uses a first-in,
first-out method and the difference between the repurchase cost and the
reissuance price is treated as an adjustment to common stock.
Revenue Recognition
License revenues are comprised of one time license fees for
electronic-bonding gateways, application development tools, Local Number
Portability ("LNP") solutions and repetitive license royalty fees for
application development tools that are sold on a multiple-use basis.
Revenue for the one time license fees is recognized when there is
persuasive evidence that an arrangement exists, delivery has occurred, the
fee is fixed and determinable and collection is probable. Royalty revenue
for the multiple-use licenses is recognized when the customer sells a
product within which is
8
DSET Corporation and Subsidiaries
March 31, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
embedded libraries of the application development tools. The contracts for
multiple-use licenses do not call for any minimum royalties.
Service revenues are comprised of postcontract customer support service
fees, gateway rental fees, professional service fees which include
training, consulting, installation, implementation, and charges for
reimbursable expenses and custom product development fees. Revenues for
postcontract customer support services and gateway rental fees are
recognized ratably over the period in which the services are provided.
Revenues for training in the Company's products are recognized when the
training has been completed. Revenues for consulting services are
recognized in the period in which the consulting services are provided.
Revenues for product installation and implementation services are
recognized when contractually agreed upon milestones have been achieved.
It is not necessary for the Company to provide implementation services.
Outside third parties are available to perform integration of the
Company's software with the customer's systems or the customer can choose
to install the software. Revenues for reimbursable expenses are recognized
as the expenses are incurred. Revenues for custom product development are
recognized under the contract method of accounting in accordance with
AICPA Statement of Position 81-1, "Accounting for Performance of
Construction-Type and Certain Production-Type Contracts" since they
generally require significant production, modification or customization of
the Company's products. Revenue for custom product development is
recognized as a percentage of the contract completed based upon the ratio
of direct labor costs incurred to the estimated total direct labor costs
required for the project. Any revenue for custom product development that
is recognized in excess of amounts invoiced to the customer for progress
billings is recorded as unbilled accounts receivable.
Some customer contracts provide for multiple elements to be delivered (for
example, electronic-bonding gateway product, postcontract customer
support, training, custom product development, etc.). In those contracts
that include multiple elements, the contract fee is allocated to the
various elements based on vendor-specific objective evidence ("VSOE") of
fair value. VSOE of fair value is the price charged when the same element
is sold separately, or for an element not yet being sold separately, the
price established by the Company's product management department.
In 2001, the Company began a new gateway rental program which provides
existing and prospective customers the ability to rent electronic-bonding
gateways on a month-to-month basis, with a 90-day cancellation provision.
The program includes the use of the software, technical support, software
upgrades and change management services for a monthly fee. Revenue under
this program is recognized pro rata as customers use the Company's
software and services.
Income Taxes
9
DSET Corporation and Subsidiaries
March 31, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
The Company utilizes an asset and liability approach for financial
reporting for income taxes. Deferred income tax assets and liabilities are
computed 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 more likely than not to be realized.
For certain stock options, the Company receives a tax deduction for the
difference between the fair value at the date of exercise of the stock
option and the exercise price. To the extent the amount deducted for
income taxes exceeds the amount charged to operations for financial
statement purposes, the related tax benefits are credited to shareholders'
equity.
The tax benefit in the first quarter of 2002 relates to the Job Creation
and Worker Assistance Act ("JCWAA") signed into law in March 2002, which
allows an extension to the general net operating loss carry-back period to
five years (from two years).
Reclassifications
Certain amounts in 2001 have been reclassified to conform to the current
period presentation.
New Accounting Standards
In August 2001, the Financial Accounting Standards Board issued SFAS 143,
"Accounting for Asset Retirement Obligations", which addresses financial
accounting and reporting obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. The
Statement applies to legal obligations associated with the retirement of
long-lived assets that result from the acquisition, construction,
development, and (or) the normal operation of a long-lived asset, except
for certain obligations of lessees. The effective date for SFAS 143 is for
financial statements issued for fiscal years beginning after June 15,
2002. The Company does not expect that the adoption of the provisions of
SFAS 143 will have a material impact on its results of operations or
financial position.
4. Revenue Concentration
10
DSET Corporation and Subsidiaries
March 31, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
The Company had three customers accounting for 13%, 12%, and 10% of
revenues, respectively, for the quarter ended March 31, 2002 and one
customer that accounted for 37% of revenues for the quarter ended March
31, 2001.
5. Earnings Per Share
The Company computes, presents and discloses earnings per share in
accordance with SFAS No. 128 "Earnings Per Share" ("EPS") which specifies
the computation, presentation and disclosure requirements for earnings per
share of entities with publicly held common stock or potential common
stock. The statement defines two earnings per share calculations, basic
and assuming dilution. The objective of basic EPS is to measure the
performance of an entity over the reporting period by dividing income
available to common stock by the weighted average shares outstanding. The
objective of diluted EPS is consistent with that of basic EPS, that is to
measure the performance of an entity over the reporting period, while
giving effect to all dilutive potential common shares that were
outstanding during the period. The calculation of diluted EPS is similar
to basic EPS except both the numerator and denominator are increased for
the conversion of potential common shares. Due to the Company's net loss
for the three month periods ended March 31, 2002 and 2001, all outstanding
stock options are considered to be anti-dilutive.
At March 31, 2002, the exercise prices of all outstanding stock options
exceeded the market price of the Company's common stock. All outstanding
options to purchase 1,148,974 shares of common stock are antidilutive and
excluded from the computation of diluted loss per share for the three
months ended March 31, 2002.
6. Restructuring and Impairment Charges
In the first quarter of 2002, the Company decided to close its San Ramon,
California office and reduce the sales and marketing workforce.
The approximate restructuring and impairment charges recorded in the first
quarter 2002 are summarized as follows:
Fixed asset impairments $147,000
Employee severance 285,000
Other 32,000
--------
$464,000
========
In the first quarter of 2001, the Company decided to reduce the workforce
in the United States and to close its Canadian subsidiary due to the
changing and unpredictable conditions in the marketplace, and the
discontinuance of product lines in an effort to conserve cash. The
approximate restructuring charges recorded in the first quarter 2001 are
summarized as follows:
11
DSET Corporation and Subsidiaries
March 31, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
Software license asset impairment $2,174,000
U.S. and Canadian employee severance 378,000
U.S. and Canadian fixed asset impairments
and future non-refundable lease payments 847,000
Other 30,000
-----------
$3,429,000
===========
The total remaining restructuring accrual inclusive of termination
benefits and non-refundable lease payments at March 31, 2002 is
approximately $2.0 million as summarized as follows:
Short-term Long-term
---------- ---------
Severance $ 256,000 $ -
Rent 336,000 732,000
Equipment leases 378,000 239,000
Other 64,000 -
---------- ----------
Total accrued restructuring expenses at March 31, 2002 $1,034,000 $ 971,000
========== ==========
Reconciliation of Accrued restructuring expenses
Balance, December 31, 2001 $2,198,000
Additions 317,000
Payments (510,000)
----------
Balance, March 31, 2002 $2,005,000
==========
7. Merger with ISPsoft Inc.
In June 2001, the Company announced an agreement to merge with ISPsoft,
which closed on January 31, 2002. The merger was accounted for under the
purchase method in accordance with SFAS 141. ISPsoft has developed
Internet Protocol provisioning and activation software which has achieved
technological feasibility. At closing, ISPsoft security holders received
an aggregate of 2,281,143 shares of DSET common stock, $1,000,000 in
cash, issuance of an aggregate of $800,000 of DSET notes payable and
payment of $544,519 in cash in exchange for certain debts payable by
ISPsoft to certain ISPsoft security holders and/or affiliates, and are
entitled to receive up to $500,000 in cash and/or unregistered shares of
DSET common stock in potential milestone payments (if revenues from
ISPsoft products are $4.0 million by June 30, 2002) in exchange for their
ISPsoft securities in the
12
DSET Corporation and Subsidiaries
March 31, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
merger. In addition, the Company loaned ISPsoft $4.4 million through the
consummation of the transaction. DSET also assumed the ISPsoft 2000 Stock
Plan and granted the holders of 2,781,010 issued and outstanding options
to purchase shares of ISPsoft common stock the right to purchase up to
241,483 shares of DSET common stock. The results of operations of ISPsoft
are included in the accompanying Condensed Consolidated Statements of Loss
and Comprehensive Loss beginning February 1, 2002.
In conjunction with the merger with ISPsoft, the Company issued two
$400,000 notes on January 31, 2002 to Signal Lake Venture Fund, L.P. and
Lucent Technologies, Inc. The principal of these notes accrue interest at
8% per year and are due and payable on the earlier of (a) January 31,
2003; (b) the consummation by DSET of at least $10,000,000 in equity
financing; or (c) the receipt by the Company of at least $5,000,000
in cash from sales agreements for the sale of ISPsoft's products, provided
such agreements were executed prior to January 31, 2002.
Consideration and Purchase Price Allocation
The following is a summary of the consideration paid for ISPsoft and
related purchase price allocation:
DSET common stock equity consideration $ 6,378,077
Fair value of DSET's options in exchange for ISPsoft options 527,434
Cash consideration to shareholders of ISPsoft 1,544,519
Loans to ISPsoft prior to consummation 4,400,000
Assumption of notes payable 800,000
Merger and acquisition costs 1,996,383
-----------
Total Consideration $15,646,413
===========
Allocation of consideration:
Net tangible assets of ISPsoft $ 186,456
Acquired technology 4,000,000
Goodwill 11,459,957
-----------
$15,646,413
===========
Common stock consideration has been calculated based on Emerging Issues
Task Force Issue ("EITF") 99-12, "Accounting for Formula Arrangements
under EITF 95-19". For this calculation, DSET used the average market
price for a few days before and after the merger was agreed to and
announced, June 26, 2001 ($2.796 per common share).
13
DSET Corporation and Subsidiaries
March 31, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
Fair value of ISPsoft's options exchanged for the Company's options has
been calculated based on FASB Interpretation No. 44, "Accounting for
Certain Transactions Involving Stock Compensation - an interpretation of
APB Opinion No. 2511 and EITF 00-23, "Issues Related to the Accounting for
Stock Compensation Under APB 25 and FIN44." DSET used the average market
price for the few days before and after the merger was agreed to (as
explained above) for the vested portion of the options issued, and the
market price on the consummation date, January 31, 2002, for the unvested
portion.
Selected Pro Forma Financial Information
The Company has prepared a pro forma loss statement in accordance with
SFAS 141, for the first quarter of 2002 and 2001 as if ISPsoft were part
of DSET as of January 1, 2002 and 2001, respectively. In the period ended
January 31, 2002, ISPsoft recorded a non-recurring item which decreased
the provision for income taxes expense by $227,000 for the sale of
ISPsoft tax credits, which is included below in the selected pro forma
information.
The following pro forma statement of loss presents the consolidated
results had DSET and ISPsoft been combined at the beginning of the
respective periods:
Three Months Ended March 31,
------------------------------------
2002 2001
---- ----
Revenues: $ 1,501,355 $ 3,415,440
Cost of revenues: 1,370,173 2,892,489
----------- ------------
Gross Profit: 131,182 522,951
----------- ------------
Operating expenses: 4,104,084 13,701,840
----------- ------------
Operating loss: (3,972,902) (13,178,889)
Loss before income taxes (3,997,255) (12,809,975)
Provision (benefit) for income taxes (1,613,992) 28,837
----------- ------------
Net loss applicable to common shares $(2,383,263) $(12,838,812)
=========== ============
Net loss per common share - basic and diluted $ (0.47) $ (2.47)
Weighted average number of common shares outstanding 5,082,402 5,188,342
14
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
General
DSET develops and markets service-provisioning and electronic-bonding
solutions for use by telecommunications providers around the world. Our
Universal Provisioning eXchange ("UPX") software platform, acquired in our
merger with ISPsoft in January 2002, enables a service provider to
provision, activate, and manage services such as Internet Protocol ("IP")
based virtual private networks ("VPNs") in complex multi-vendor network
environments. We also offer a family of software solutions for competitive
service providers ("CSPs") that enables them to exchange information with
other telecommunications service providers to reduce the time necessary to
provision new voice and data services for their customers.
1999 and 2000 were years of unprecedented demand for all types of
communications products and services. Companies in the telecommunications
industry had access to and utilized abundant sources of investment capital.
However, the downturn in the industry, which began in the second half of
2000, reduced our revenues significantly beginning in the third quarter of
2000 and through the first quarter of 2002. This downturn was brought about
by the sudden withdrawal of available financing from almost all of the
traditional financing sources (vendors, lenders, private equity/venture
capital sources, public equity markets and large corporate partners) to our
current and potential customers. Prior to this downturn, the new CSPs were
successfully and regularly obtaining large capital commitments allowing
them to increase the size and the pace of their infrastructure spending.
This funding crisis also affected our collection efforts since many
customers either declared bankruptcy or concluded that they did not have
sufficient available cash to pay their obligations to DSET. We believe that
we have adequately reserved for doubtful accounts, although no assurance
can be made that additional customers will not go bankrupt or have
financial difficulties.
Our policy to assess the probability of collection consists of
reviewing public and private sources of financial information for all
potential customers (e.g., financial statements, periodic filings and press
releases), inquiring of management of the potential customer how they
intend to pay for their purchase, reviewing available information from
credit rating agencies, and if available, contacting funding sources,
reviewing recent announcements regarding completed and proposed financing
and discussing the potential customer's credit worthiness with other
suppliers.
In the second half of 2000 and continuing through the first quarter of
2002, the business models of many service providers came into doubt. The
industry continues to see a dramatic decline in the availability of
capital and spending by service providers. 2001 can be characterized as a
year of survival and retrenchment for the industry, with the contraction
of the CSPs severely impacting hardware and software vendors that had
previously experienced substantial growth in revenues and profits.
Virtually every company that remained in business, including DSET, had to
reorganize. In 2001, we incurred substantial losses, and accordingly
reduced headcount and expenses in an effort to conserve cash and
ultimately return to profitability. We have utilized cash previously
invested in marketable securities to finance the
15
losses brought about by the downturn. In the first quarter of 2002, we
continue to see turmoil in the industry as additional customers have either
commenced or declared their intent to commence formal reorganization
proceedings.
We currently offer two additional sales models, in addition to the
traditional perpetual license and services arrangement, to our customers to
acquire our products and services: a transaction based payment plan ("Pay
as You Grow") and a rental program with little cash due up front ("Gateway
Rental Program"). Prior to the inclusion of these alternative programs, our
license revenues were derived from the sale of electronic-bonding gateways
to CSPs under contracts that provided for perpetual licenses and
corresponding fees, with the total price of a license sale to a customer
depending on the number of licensed products, the number of trading
partners and amount of additional services acquired.
In the second quarter of 2001 we began marketing a "Pay as You Grow"
pricing option to provide an alternative to CSPs that are constrained by
lack of funding. The "Pay As You Grow" model is a run time royalty model
with a minimum monthly payment requirement. The contractual minimum payment
amounts are determined based on estimated monthly usage by the customer at
the beginning of the contract. The customer is charged monthly based on the
actual usage of the software or the minimum contract amount, whichever is
greater. Usage is defined as completed transactions for provisioning
services between a CSP and a trading partner. Therefore, revenue will be
recognized on a periodic basis as it becomes due in accordance with SOP
97-2. The pricing model has the effect of spreading our normal license
revenue over two to three years depending on customer usage. This program
has been offered to certain potential customers beginning in the second
quarter of 2001. Although no contracts have yet to be consummated with this
pricing model and no revenue has been recognized to date on this basis, it
is this model, together with the traditional long-term license that we
intend to use in marketing our UPX platform and solutions.
In the fourth quarter of 2001, again in an effort to find the right
financial model to encourage CSPs to once again start buying
electronic-bonding gateways, we announced our Gateway Rental Program, which
provides existing and prospective customers the ability to rent
electronic-bonding gateways on a month-to-month basis, with a 90-day
cancellation provision. The program includes the use of the software,
technical support, software upgrades and change management services for a
monthly charge that is roughly equivalent to what they had been paying for
the maintenance services only. Service revenue is recognized in the month
in which customers use our software and services.
Our service revenues are comprised of fees derived from custom program
development, implementation, installation, training fees and maintenance.
Our custom program 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 custom program
development services are generally recognized on a percentage of completion
basis calculated as direct labor costs are incurred in relation to
estimated total direct labor costs at completion for each project. The
impact of revisions in percentage of
16
completion estimates is reflected in the period in which the revisions are
made. Maintenance services, for which we typically charge annually between
15% and 30% of the price of the products licensed by the customer
annually, may be purchased at the customer's option. Maintenance fees are
recognized as service revenue over the term of the maintenance period.
Our cost of license revenues consists primarily of royalties paid to
third-party software companies and the amortization of acquired technology
and capitalized software development costs. We generally are 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 charged to operations as such costs are
incurred. Our 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.
For the quarters ended March 31, 2002 and 2001, we derived
approximately 16.9% and 44.5%, respectively, of our total revenues from
license revenues and approximately 83.1% and 55.5%, respectively, of our
total revenues from service revenues. During the first quarter of 2002,
revenues generated from CSPs were approximately $1.3 million and revenues
generated from network equipment vendors for LNP solutions, application
development tools and related services were approximately $184,000. During
the first quarter of 2001, revenues generated from CSPs were $2.8 million
and revenues generated from network equipment vendors were approximately
$600,000.
We had three customers accounting for 13%, 12%, and 10% of revenues,
respectively, for the quarter ended March 31, 2002 and one customer that
accounted for 37% of revenues for the quarter ended March 31, 2001. We
derive a portion of our revenues from international sales, which
constituted 0% of our total revenues in the first quarter of 2002 and
1.3% in the first quarter of 2001. Our international sales have been United
States dollar-denominated. As a result, an increase in the value of the
United States dollar relative to foreign currencies could make our
products and services less competitive in international markets.
The merger with ISPsoft was completed on January 31, 2002. ISPsoft
has developed what we believe to be a technically advanced version of IP
provisioning software. The market for next generation software-based
provisioning systems is expected to grow from approximately $800 million
in 2001 to almost $1.6 billion in 2004, according to a report by the
research and consulting firm IDC. At closing, ISPsoft security holders
received an aggregate of 2,281,143 shares of DSET common stock, $1,000,000
in cash, issuance of an aggregate of $800,000 of DSET Notes Payable and
payment of $544,519 in cash in exchange for certain debts payable by
ISPsoft to certain ISPsoft security holders and/or affiliates and are
entitled to receive up to $500,000 in cash and/or
17
unregistered shares of DSET common stock in potential milestone payments
(if revenues from ISPsoft products are $4.0 million by June 30, 2002) in
exchange for their ISPsoft securities in the merger. In addition, we
loaned ISPsoft $4.4 million through the consummation of the transaction.
We also assumed the ISPsoft 2000 Stock Plan and granted the holders of
2,781,010 issued and outstanding options to purchase shares of ISPsoft
common stock the right to purchase up to 241,483 shares of DSET common
stock. Effective February 1, 2002 ISPsoft's staff became our employees
including three administrative, three sales and marketing, and 37 research
and development employees. In the quarter ended March 31, 2002, these
new departments contributed $200,000, $300,000, and $1,000,000 in
operating expenses, respectively.
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) our ability to continue as a going concern; (ii)
risks associated with the integration of ISPsoft with us following our
recent acquisition of ISPsoft and the potential acquisition of other
businesses by us, including risks relating to unanticipated liabilities or
expenses, lower than expected revenues and the commercialization of
acquired technology or products; (iii) the need for substantial financing
to continue operations; (iv) the risk that our application for transfer
trading of our common stock to the Nasdaq Small Cap Market may not be
approved and/or that our common stock may be delisted from the Nasdaq
National Market; (v) our dependence on the market for advanced
telecommunications products and services; (vi) rapid technological change
in our industry; (vii) our lack of an operating history in providing
Internet Protocol (IP) based provisioning and management applications and
services; (viii) the failure to protect proprietary rights or enforce
licensing rights; and (ix) the loss of third-party software we utilize in
our products. The success of the Company depends to a large degree upon
increased demand by telecom service providers for its products and
services, and the market for IP provisioning software. 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 Company's actual results may
differ materially from the results discussed in or implied by the
forward-looking statements contained herein.
Critical Accounting Estimates and Judgements
Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
us to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate our estimates, including
those related to bad debts, investments, recoverability of long-lived assets,
income taxes, restructuring charges, post-contract customer support agreements,
and contingencies and litigation. We base our estimates on historical experience
and on various other assumptions that we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.
As more fully described in Note 3 to our consolidated financial statements, we
believe the following critical accounting policies affect our more significant
judgments and estimates used in the preparation of our consolidated financial
statements.
o We recognize both product and service revenue.
o We do not recognize revenue if, in our judgment, the revenue does
not meet the requirements of AICPA Statement of Position ("SOP")
97-2, `Software Revenue Recognition' (i.e., persuasive evidence
that an arrangement exists, delivery has occurred, the customer's
fee is fixed and determinable and collectibility is probable).
o On long-term, fixed price contracts, we recognize revenue using
the percentage-of-completion method in accordance with SOP 81-1,
"Accounting for Performance of Construction-Type and Certain
Production-Type Contracts." As work progresses, we rely on
estimates of total expected contract revenue and costs. We follow
this method since reasonably dependable estimates of the revenue
and costs applicable to various stages of a contract can be made.
Recognized revenues and profit are subject to revisions as the
contract progresses to completion. Revisions in profit estimates
are credited to income in the period in which the facts that give
rise to the revision become known.
o We maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our customers to make required
payments. If the financial condition of our customers deteriorates,
resulting in an impairment of their ability to make payments,
additional allowances may be required.
18
o We make a determination as to the carrying value of intangibles,
long-lived assets and related good will that may not be recoverable
based upon the existence of indicators of impairment and measure any
impairment in accordance with the provisions of SFAS 142, based on a
projected discounted cash flow method using a discount rate
determined by management to be commensurate with the risk inherent in
our current business model. We currently do not expect to record an
impairment charge, however, there can be no assurance that at the
time of future review that a material impairment charge will not be
recorded.
o Contraction of the telecommunications industry commencing in the
latter half of 2000 and continuing through the first quarter of 2002
has led us to re-examine all facets of our business. In the face of
declining revenues and certain customers' unwillingness or inability
to honor their commitments, it became necessary for us to take steps
to reorganize to a level commensurate with the expected reduced
revenue levels. These steps included recognizing asset impairments on
many of our long-lived intangible and tangible assets, closing
facilities, reducing and consolidating the workforce, seeking sublet
tenants for portions of facilities covered by long term operating
leases, and recognizing charges against earnings in the current
period for future fixed asset and facility lease payments that will
not benefit future periods. Considerable management judgment is
necessary to estimate the charges for asset impairments and
restructuring. Restructuring charges derived from our plans of
closing facilities and discontinuing certain product lines are
recognized pursuant to Emerging Issues Task Force ("EITF") No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (Including Certain Costs Incurred in
a Restructuring)" and Staff Accounting Bulletin ("SAB") 100,
"Restructuring and Impairment Charges".
o We record a valuation allowance to reduce our deferred tax assets to
the amount that is more likely than not to be realized. While we have
considered future taxable income and ongoing prudent and feasible tax
planning strategies in assessing the need for the valuation
allowance, in the event we were to determine that we would be able to
realize our deferred tax assets in the future in excess of our net
recorded amount (zero at December 31, 2001), an adjustment to the
deferred tax asset would increase income in the period such
determination was made.
Results of Operations
Three Months Ended March 31, 2002 Compared to the Three Months Ended March
31, 2001
Revenues. Total revenues decreased by 56.0% to $1.5 million in the
first quarter of 2002 from $3.4 million in the first quarter of 2001.
License revenues decreased by 83.3% to $253,000 in the
19
first quarter of 2002 from $1.5 million in the first quarter of 2001. This
decrease was attributable to a downturn in the telecom industry, especially
in our market niche, resulting in a reduction in orders by prospective
customers due to poor operating results of the CSPs, and the absence of
available funding from capital markets to these prospective customers.
Service revenues decreased 34.1% to $1.2 million in the first quarter of
2002 from $1.9 million in the first quarter of 2001. This decrease was
attributable to a $523,000 decrease in revenue for network solutions, a
$81,000 decrease in gateway solutions service revenue and a $41,000
decrease in LNP solutions revenue.
Gross profit. The Company's gross profit decreased 71.3% to $265,000
in the first quarter of 2002 from $923,000 in the first quarter of 2001.
Gross profit percentage for license revenues decreased to 20.0% in the
first quarter of 2002 from 67.0% in the first quarter of 2001. The
decrease was due to one large contract signed in the first quarter of 2001,
for which there was a significant gross profit. Gross profit percentage
for service revenues increased to 17.1% in the first quarter of 2002 from
-5.1% in the first quarter of 2001. The increase was due to a decrease in
operating expenses for the department.
Sales and marketing expenses. Sales and marketing expenses decreased
70.9% to $736,000 in the first quarter of 2002 from $2.5 million in the
first quarter of 2001. The decrease in sales and marketing expenses was
mainly attributable to a $1.0 million decrease in personnel related
expenses, a $300,000 decrease in travel, a $300,000 decrease in occupancy
costs and depreciation, a $100,000 decrease in commissions (due to reduced
sales), and a $100,000 reduction in miscellaneous other expenses. The
decrease was mainly due to a drop in average headcount for these
departments to eleven in the first quarter of 2002 as compared to 48 for
the first quarter of 2001.
Research and product development expenses. Research and product
development expenses decreased 74.8% to $1.0 million in the first quarter
of 2002 from $3.9 million in the first quarter of 2001. Personnel related
expenses decreased by $2.0 million, depreciation and occupancy and related
costs decreased by $400,000, contract labor decreased by $250,000, travel
and telephone expense decreased by $100,000, and hardware and software
maintenance decreased by $100,000. The decrease was mainly due to a drop in
average headcount for this department which was 21 in the first quarter of
2002 as compared to 134 for the first quarter of 2001.
General and administrative expenses. General and administrative
expenses decreased 34.2% to $1.2 million in the first quarter of 2002 from
$1.9 million in the first quarter of 2001. The decrease in general and
administrative expenses was mainly due to a $200,000 decrease in relocation
expenses, a decrease of $200,000 in occupancy and depreciation costs, a
$200,000 decrease in miscellaneous other expenses, and a $100,000 decrease
in recruiting costs.
Bad debt expense. Bad debt expense was zero in the first quarter of
2002 as compared to $440,000 in the first quarter of 2001.
The Company's bad debt expense recorded in the first quarter of 2001
corresponded to $302,000 of revenue recognized in 1999 and $138,000 of
revenue recognized in the second and third quarters of 2000.
20
Amortization of goodwill and other intangibles. Amortization expense
was zero in the first quarter of 2002 compared to $100,000 in the first
quarter of 2001. The reduction is due to the asset impairments for goodwill
and other intangible assets and the effect of SFAS 142 which was adopted on
January 1, 2002 whereby goodwill amortization ceased.
Restructuring and other charges. Restructuring and other charges in the
first quarter of 2002 were $464,000 which included a severance charge of
$285,000 for the reorganization in the sales and marketing departments,
$147,000 for the impairment of fixed assets and $32,000 for legal, moving,
and rent charges associated with the closed office in San Ramon,
California. In the first quarter of 2001, a $3.4 million dollar charge was
taken, which included an impairment charge of $2.2 million for the carrying
value of certain licenses related to the Canadian market, $400,000 in
charges related to severances in March 2001 and $850,000 in charges related
to the facility closure in Canada and fixed asset impairments in both
Canada and the United States.
Interest expense and other income (expense). Interest expense and other
income and expense increased to $63,000 for the first quarter of 2002 from
an expense of $47,000 for the first quarter of 2001. The difference was due
to the accruing of interest on a note payable to Konark, which was paid in
full in March 2002.
Interest income and realized gains and losses on marketable securities.
Interest income decreased to $46,000 in the first quarter of 2002 as
compared to approximately $490,000 in the first quarter of 2001. This
decrease was due to lower principal balances in 2002 due to the funding of
operations and reduced interest rates due to the current economic climate
as well as lower realized gains from redemptions of marketable securities
and interest received on federal income tax refunds.
Income taxes. We recognized a tax benefit of $1.4 million for the
first quarter of 2002 as compared to a tax provision of $29,000 in the
first quarter of 2001. The tax benefit in the first quarter of 2002
relates to the Job Creation and Worker Assistance Act ("JCWAA") signed into
law in March 2002, which allows an extension to the general net operating
loss carry-back period to five years (from two years). The 2002 and 2001
rates differ substantially from the statutory rate due to our losses.
Liquidity and Capital Resources
Our consolidated financial statements have been prepared on the basis
that we will continue as a going concern, which contemplates the
realization of assets and satisfaction of liabilities and commitments in
the normal course of business. At March 31, 2002, our cash and cash
equivalents aggregated approximately $6.5 million. At December 31, 2001
our cash and cash equivalents totaled $13.0 million. Our working capital
was $2.9 million and $8.5 million at March 31, 2002 and December 31, 2001,
respectively.
At March 31, 2002, our principal sources of liquidity were our cash and
cash equivalents that totaled $6.5 million. In addition, we expect to
receive $1.4 million in cash
21
for the expected U.S. Federal Income Tax refund due to the new tax
carry-back provisions of the JCWAA by the end of the third quarter of 2002.
Our operating activities used cash of $2.7 million and $7.7 million
for the quarters ended March 31, 2002 and 2001, respectively. Cash used by
operations in the first quarter of 2002 was primarily attributable to a net
loss adjusted for the non-cash charges for depreciation and restructuring,
as well as an increase in income taxes receivable and accounts payable and
accruals, offset by decreases in accounts receivable and deferred revenues.
Cash provided by (used in) investing activities in the quarters ended
March 31, 2002, and 2001 was ($3.3) million and $7.3 million, respectively.
Cash used in investing activities in the first quarter of 2002 was
primarily attributable to the merger with ISPsoft, Inc. We expect minimal
capital equipment and leasehold improvement expenditures to be made in
2002.
We used approximately $525,000 and $522,000 in cash in financing
activities in the quarters ended March 31, 2002, and 2001, respectively. We
paid approximately $500,000 in note obligations in connection with a
previous acquisition during each of the quarters ended March 31, 2002 and
2001.
In addition, in 2002 DSET has received two non-compliance notifications
from the Nasdaq Stock Market, Inc. ("Nasdaq").
On February 14, 2002, we received notice from the Nasdaq Stock Market,
Inc. ("Nasdaq") that for the preceding 30 consecutive trading days, our
common stock had not maintained the minimum Market Value of Publicly Held
Shares ("MVPHS") of $5,000,000 as required for continued inclusion by
Marketplace Rule 4450(a)(2) (the "Rule") on the Nasdaq National Market.
MVPHS equals the closing bid price multiplied by that portion of a
company's outstanding shares which is in the hands of public investors
(i.e., - shares not held by company officers, directors, or investors who
hold a controlling interest in the company.) Therefore, in accordance
with Marketplace Rule 4450(e)(1), we have 90 calendar days, or until May
15, 2002, to regain compliance. If compliance with the Rule cannot be
demonstrated by May 15, 2002, our securities will be delisted from the
Nasdaq National Market. We have applied to transfer the trading of
DSET's common stock to the Nasdaq Small Cap Market and delisting is stayed
pending Nasdaq's ruling on our application.
On March 5, 2002, we received notice from Nasdaq that for the previous
30 consecutive trading days, the price of our common stock had closed
below the minimum $1.00 per share requirement for continued inclusion
under Marketplace Rule 4450(a)(5) (the "$1.00 Rule"). Therefore, in
accordance with Marketplace Rule 4450(e)(2), we have 90 calendar days, or
until June 3, 2002, to regain compliance. If compliance with the $1.00
Rule cannot be demonstrated by June 3, 2002, our securities will be
delisted from the Nasdaq National Market. We have applied to transfer the
trading of DSET's common stock to the Nasdaq Small Cap Market and delisting
is stayed pending Nasdaq's ruling on our application.
22
Our failure to meet the Nasdaq's maintenance criteria in the future
may result in the delisting of our common stock from the Nasdaq National
Market. In such event, trading, if any, of DSET's common stock may then
continue to be conducted in the Nasdaq SmallCap market, if we meet its
criteria or the over-the-counter market, in what is commonly referred to as
the electronic bulletin board or the "pink sheets". As a result, an
investor may find it more difficult to dispose of or obtain accurate
quotations as to the market value of DSET's common stock. In addition, in
the event DSET's common stock is delisted, broker-dealers would have
certain regulatory burdens imposed upon them, which may discourage them
from effecting transactions in DSET's common stock, further limiting the
liquidity thereof. This may have the effect of limiting our ability to
raise additional financing.
Our ability to continue as a going concern is dependent upon our
ability to generate sufficient cash flows to meet our obligations as they
come due. We believe that the cost reductions from our restructurings in
2001 (including work force reductions) and the merger with ISPsoft will
enhance our cash flows from operations. Additional financing may still be
required for us to fund our operating and capital requirements through
2002. If cashflows are insufficient or we are unable to raise funds on
acceptable terms there would be a material adverse effect on our financial
position and operations and our ability to continue as a going concern.
This could force us to further reduce our capital expenditures, reduce our
workforce, sell certain assets or possibly explore additional alternatives
including seeking bankruptcy protection. The consolidated financial
statements do not include any adjustments relating to the recoverability of
the carrying amount of the recorded assets or the amount of liabilities
that might result from the outcome of these uncertainties. We cannot be
certain that additional debt or equity financing will be available when
required or, if available, that we can secure it on terms satisfactory
to us.
Accounts receivable, net, decreased to $629,000 at March 31, 2002 from
$824,000 at December 31, 2001, primarily as a result of decreased sales and
the collection of outstanding receivables. Included in accounts receivable
at March 31, 2002 was $7.5 million for trade receivables and $800,000 for
unbilled project revenue as compared to $7.4 million for trade receivables
and $1.1 million for unbilled project revenue at December 31, 2001. The
allowance for doubtful accounts was $7.7 million at March 31, 2002 and
December 31, 2001. 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.
23
Contractual obligations including interest on these obligations are as
follows:
Payments Due by Period
April 1, 2002 April 1, 2003 April 1, 2005
through through through After
March 31, March 31, March 31, March 31,
Contractual Obligations Total 2003 2005 2007 2007
Notes payable $ 864,000 $ 864,000 $ 0 $ 0 $ 0
Capitalized lease obligations 421,260 180,540 240,720 0 0
Operating leases (equipment)* 1,391,637 984,574 356,144 50,919 0
Rental lease obligations* 12,899,486 2,365,175 4,578,600 2,882,929 3,072,782
NJTC Venture Fund commitment 800,000 200,000 600,000 0 0
----------- ----------- ----------- ---------- ----------
Total contractual cash obligations $16,376,383 $ 4,594,289 $ 5,775,464 $2,933,848 $3,072,782
Sublessor agreements* (2,735,946) (1,124,256) (1,611,690) 0 0
----------- ----------- ----------- ---------- ----------
Net $13,640,437 $ 3,470,033 $ 4,163,774 $2,933,848 $3,072,782
=========== =========== =========== ========== ==========
* A total of $1.7 million is included in accrued restructuring expenses in the
condensed consolidated financial statements as of March 31, 2002.
We may seek additional funding through collaborative arrangements,
borrowing money and by the sale of additional equity securities. Any sales
of additional equity securities are likely to result in further dilution to
our then existing shareholders. Further, if we issue additional equity
securities, the new equity securities may have rights, preferences or
privileges senior to those of existing holders of DSET's common stock.
Alternatively, we may borrow money from conventional lenders, possibly at
high interest rates, which may affect the value of our shareholders'
holdings. Despite our efforts, funding may not be available at all or
only on terms that are unacceptable. We also could be required to seek
funds through arrangements with collaborative partners or others that may
require us to relinquish rights to certain of our technologies, product
candidates or products which we would otherwise pursue on our own.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
We believe that we are not subject to a material impact to our
financial position or results of operations relating to market risk
associated with foreign currency rates or derivative securities.
24
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds.
Recent Sales of Unregistered Securities
The following information relates to all securities sold by us within the
first quarter of 2002 which were not registered under the securities laws at
the time of grant, issuance and/or sale:
1. During the first quarter of 2002, we granted stock options pursuant to
our 1998 Stock Plan, as amended, which were not registered under the
Securities Act of 1933, as amended. The following table sets forth
certain information regarding such grants during the quarter.
<Table>
<Caption>
Number Exercise
of Shares Price
--------- -----
474,786 $0.923
</Table>
2. During the first quarter of 2002, we assumed stock options in connection
with our merger with ISPsoft Inc. which were not registered under the
Securities Act of 1933, as amended. The following table sets forth
certain information regarding such options during the quarter.
<Table>
<Caption>
Number Exercise
of Shares Price
--------- -----
241,483 $1.97
</Table>
We did not employ an underwriter in connection with the issuance of the
securities described above. We believe that the issuance of the foregoing
securities was exempt from registration under either (i) section 4(2) of
the Securities Act of 1933, as amended, as transactions not involving any
offering and such securities having been acquired for investment and not
with a view to distributionm, or (ii) Rule 701 under the Securities Act of
1933, as amended, as transactions made pursuant to a written compensatory
benefit plan or pursuant to a written contract relating to compensation.
All recipients had adequate access to information about DSET.
On April 23, 2002, we filed a registration statement on Form S-8 with the
Securities and Exchange Commission with respect to the foregoing securities.
Item 4. Submission of Matters to a Vote of Security Holders.
In connection with our merger with ISPsoft Inc., on January 31, 2002, we
held a Special Meeting of Shareholders.
There were present at the Special Meeting in person or by proxy
stockholders holding an aggregate of 1,582,652 shares of our common stock.
A vote of the shareholders was taken at such Special Meeting with respect
to the proposal to approve the merger with ISPsoft, the merger agreement,
as amended, and the proposed issuance of up to 2,519,735 shares of our
common stock and such other shares of common stock and consideration to
the security holders of ISPsoft in connection with the merger all as
described in the Joint Proxy Statement/Prospectus mailed to shareholders.
1,119,702 shares voted in favor of such proposal, 460,655 shares were
voted against such proposal and 2,295 shares abstained from voting.
A vote of the shareholders was taken at such Special Meeting with respect
to the proposed amendment to our Amended and Restated Certificate of
Incorporation to provide for the classification of our Board of Directors
into three classes of directors with staggered terms of office as
described in the Joint Proxy Statement/Prospectus mailed to shareholders.
1,109,110 shares voted in favor of such proposal, 471,047 shares were
voted against such proposal and 2,495 shares abstained from voting.
In addition, a vote of the shareholders was taken at the Special Meeting
with respect to the proposed amendments to our 1998 Stock Plan to increase
the maximum aggregate number of shares of our common stock available for
issuance under the 1998 Stock Plan from 875,000 shares to 1,125,000 shares
and to ensure compliance with section 162(m) of the Internal Revenue Code
as described in the Joint Proxy Statement/Prospectus mailed to
shareholders by approving the continuance of the 1998 Stock Plan, limiting
the maximum number of shares of our common stock with respect to which
awards may be granted to any person under the 1998 Stock Plan to 250,000
per calendar year, and making certain other conforming amendments.
1,099,540 shares voted in favor of such proposal, 477,642 shares were
voted against such proposal and 5,470 shares abstained from voting.
Item 5. Annual Meeting of Shareholders
We held our last annual meeting of shareholders on June 13, 2001. Our
Board of Directors has not yet selected a definitive date for the annual meeting
shareholders for 2002. We will provide appropriate notice to shareholders
in connection with such meeting.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
None.
(b) Reports on Form 8-K.
On February 7, 2002 the Company filed a current report on
Form 8-K with the Securities and Exchange Commission with
respect to the Company's merger with ISPsoft Inc. on
January 31, 2002.
25
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, 2002 By: /s/ William P. McHale, Jr.
---------------------------------
William P. McHale, Jr.,
Chief Executive Officer
(Principal Executive Officer)
DATE: May 15, 2002 By: /s/ Bruce M. Crowell
---------------------------------
Bruce M. Crowell
Vice President and Chief
Financial Officer
(Principal Financial and
Accounting Officer)
26