SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
-------------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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)
661 Shrewsbury Avenue, Shrewsbury, New Jersey 07702
- --------------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
(732) 945-6000
-------------------------------
(Registrant's Telephone Number,
Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes: |X| No: |_|
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of October 31, 2002:
Class Number of Shares
----- ----------------
Common Stock, no par value 5,147,182
DSET CORPORATION
TABLE OF CONTENTS
Page
----
PART I. FINANCIAL INFORMATION....................................................................
Item 1. Condensed Consolidated Financial Statements.............................................. 1
Condensed Consolidated Balance Sheets as of September 30, 2002 and December 31, 2001..... 2
Condensed Consolidated Statements of Loss and Comprehensive Loss for the Three
Months Ended September 30, 2002 and 2001............................................... 3
Condensed Consolidated Statements of Loss and Comprehensive Loss for the Nine Months
Ended September 30, 2002 and 2001...................................................... 4
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30,
2002 and 2001.......................................................................... 5
Notes to Condensed Consolidated Financial Statements..................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.... 20
Results of Operations.................................................................... 26
Liquidity and Capital Resources.......................................................... 31
Item 3. Quantitative and Qualitative Disclosures About Market Risk............................... 34
Item 4. Controls and Procedures.................................................................. 34
PART II. OTHER INFORMATION........................................................................ 35
Item 5. Other Information........................................................................ 35
Item 6. Exhibits and Reports on Form 8-K......................................................... 35
SIGNATURES ......................................................................................... 37
CERTIFICATIONS ..................................................................................... 38
i
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
1
DSET Corporation and Subsidiaries
Condensed Consolidated Balance Sheets (Unaudited)
- --------------------------------------------------------------------------------
September 30, 2002 December 31, 2001
------------------ -----------------
Assets
Current assets:
Cash and cash equivalents $ 1,554,646 $ 12,958,074
Accounts receivable, net of allowance for doubtful accounts of $1,216,105
at September 30, 2002 and $7,697,383 at December 31, 2001 559,728 823,793
Income taxes receivable 461,262 8,416
Prepaid licenses 920,167 935,000
Prepaid expenses and other current assets 387,378 329,864
------------ ------------
Total current assets 3,883,181 15,055,147
Fixed assets, net 1,549,792 2,173,139
Acquired technology, net 3,466,667 --
Goodwill, net -- 19,004
Loans to ISPsoft Inc. -- 3,850,000
Merger and acquisition costs -- 1,042,985
Other assets, net 172,694 417,289
------------ ------------
Total assets $ 9,072,334 $ 22,557,564
============ ============
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable and accrued expenses $ 1,555,850 $ 2,459,972
Deferred revenues 1,397,649 2,293,214
Accrued restructuring expenses 1,499,014 1,177,154
Notes payable 819,556 493,786
Current portion of capital lease obligation 162,020 138,367
------------ ------------
Total current liabilities 5,434,089 6,562,493
Long term accrued restructuring expenses 460,222 1,021,344
Deferred rent 100,394 549,566
Capital lease obligation 145,132 282,494
Other liabilities -- 21,000
------------ ------------
Total liabilities 6,139,837 8,436,897
------------ ------------
Commitments and contingencies
Shareholders' equity:
Preferred stock, no par value; 5,000,000 shares authorized, no shares issued
or outstanding at September 30, 2002 and December 31, 2001 -- --
Series A Junior Participating Preferred stock, no par value; 5,000 shares
authorized, no shares issued authorized, no shares issued or outstanding
at September 30, 2002 and December 31, 2001 -- --
Common stock, no par value; 10,000,000 shares authorized, 5,175,255 and
2,907,400 shares issued at September 30, 2002 and December 31, 2001,
respectively; 5,147,182 and 2,801,259 shares outstanding at September
30, 2002 and December 31, 2001, respectively 56,946,302 50,138,022
Accumulated deficit (53,948,118) (35,837,420)
Other comprehensive loss (22,032) (21,875)
Treasury stock, at cost; (28,073 and 106,141 shares at September 30, 2002
and December 31, 2001, respectively) (43,655) (158,060)
------------ ------------
Total shareholders' equity 2,932,497 14,120,667
------------ ------------
Total liabilities and shareholders' equity $ 9,072,334 $ 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 September 30,
--------------------------------
2002 2001*
---- ----
Revenues:
License revenues $ 153,674 $ 229,680
Service revenues 1,244,054 1,785,179
----------- -----------
Total revenues 1,397,728 2,014,859
----------- -----------
Cost of revenues:
License revenues 200,000 130,984
Service revenues 795,693 1,083,147
----------- -----------
Total cost of revenues 995,693 1,214,131
----------- -----------
Gross profit 402,035 800,728
----------- -----------
Operating expenses:
Sales and marketing 308,830 1,302,747
Research and product development 754,575 1,691,766
General and administrative 703,159 1,114,735
Bad debt expense and other charges -- 1,433
Amortization of goodwill -- 70,181
Restructuring and other charges -- 4,269,102
Impairment of goodwill -- 310,837
----------- -----------
Total operating expenses 1,766,564 8,760,801
----------- -----------
Operating loss (1,364,529) (7,960,073)
Interest expense and other income (expense) (212,558) 51,546
Interest income and realized gains and losses on marketable securities 17,041 468,648
----------- -----------
Loss before income taxes (1,560,046) (7,439,879)
Provision for income taxes -- 125,047
----------- -----------
Net loss $(1,560,046) $(7,564,926)
=========== ===========
Other comprehensive income (loss), net of tax
Unrealized (depreciation) appreciation on investments -- (145,746)
Translation adjustment 1,612 (40,729)
----------- -----------
Comprehensive loss $(1,558,434) $(7,751,401)
=========== ===========
Net loss applicable to common shares $(1,560,046) $(7,564,926)
=========== ===========
Net loss per common share - basic and diluted $ (0.30) $ (2.61)
=========== ===========
Weighted average number of common shares outstanding 5,147,182 2,895,173
=========== ===========
*Certain amounts have been reclassified for comparative purposes.
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
DSET Corporation and Subsidiaries
Condensed Consolidated Statements of Loss and Comprehensive Loss (Unaudited)
- --------------------------------------------------------------------------------
Nine Months Ended September 30,
-------------------------------
2002 2001*
---- ----
Revenues:
License revenues $ 530,539 $ 2,337,019
Service revenues 3,569,642 5,709,521
------------ ------------
Total revenues 4,100,181 8,046,540
------------ ------------
Cost of revenues:
License revenues 535,761 1,156,874
Service revenues 2,710,470 4,638,762
------------ ------------
Total cost of revenues 3,246,231 5,795,636
------------ ------------
Gross profit 853,950 2,250,904
------------ ------------
Operating expenses:
Sales and marketing 1,539,415 5,951,936
Research and product development 2,832,834 8,595,005
General and administrative 2,835,075 4,383,867
Bad debt expense (benefit) and other charges (307,468) 986,708
Amortization of goodwill -- 273,581
Restructuring and other charges 2,250,078 14,058,635
Impairments of goodwill 11,443,763 730,379
------------ ------------
Total operating expenses 20,593,697 34,980,111
------------ ------------
Operating loss (19,739,747) (32,729,207)
Interest expense and other income (expense) (289,234) (26,043)
Interest income and realized gains and losses on marketable securities 83,292 1,363,045
------------ ------------
Loss before income taxes (19,945,689) (31,392,205)
Provision (benefit) for income taxes (1,834,991) 252,200
------------ ------------
Net loss $(18,110,698) $(31,644,405)
============ ============
Other comprehensive income (loss), net of tax
Unrealized (depreciation) appreciation on investments -- (144,611)
Translation adjustment (157) (19,670)
------------ ------------
Comprehensive loss $(18,110,855) $(31,808,686)
============ ============
Net loss applicable to common shares $(18,110,698) $(31,644,405)
============ ============
Net loss per common share - basic and diluted $ (3.74) $ (10.90)
============ ============
Weighted average number of common shares outstanding 4,845,202 2,903,228
============ ============
*Certain amounts have been reclassified for comparative purposes.
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
DSET Corporation and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
- --------------------------------------------------------------------------------
Nine Months Ended September 30,
-------------------------------
Cash flows from operating activities: 2002 2001*
---- ----
Net loss $(18,110,698) $(31,644,405)
Adjustments to reconcile net loss to net cash
(used in) operating activities, net of effects of acquisitions:
Stock based compensation charges 2,575 18,038
Realized (gain) on marketable securities -- (469,594)
Depreciation 428,802 1,028,140
Amortization 533,333 871,180
Loss on disposal of assets -- 9,308
Restructuring and other charges 918,548 9,937,508
Bad debt expense (benefit) and other charges (307,468) 986,708
Impairment of goodwill 11,443,763 695,603
Changes in operating assets and liabilities:
Accounts receivable 587,533 4,422,586
Income taxes receivable (452,846) 3,164,350
Prepaid licenses 14,833 (517,614)
Prepaid expenses and other current assets (95,297) 668,461
Other assets 110,814 57,597
Accounts payable and accrued expenses (570,761) (3,174,798)
Deferred revenues (895,565) (57,743)
Accrued restructuring expenses (239,262) 1,817,585
Deferred rent (449,172) 33,349
Other liabilities (21,000) --
------------ ------------
Net cash (used in) operating activities (7,101,868) (12,153,741)
------------ ------------
Cash flows from investing activities:
Redemption of marketable securities -- 27,014,466
Acquisition of business, less cash acquired (3,613,592) --
Purchase of acquired technology -- (667,035)
Acquisition of fixed assets (159,367) (713,189)
Proceeds from disposition of fixed assets -- 41,717
Loans to ISPsoft Inc. -- (2,250,000)
------------ ------------
Net cash provided by (used in) investing activities (3,772,959) 23,425,959
------------ ------------
Cash flows from financing activities:
Loan proceeds from financing insurance 68,444 --
Purchases of treasury stock -- (190,923)
Reissuance of treasury stock 14,599 --
Repayments of notes payable (542,674) (1,000,000)
Repayments of capital lease obligation (113,709) (104,717)
Repayment from officers and shareholders 44,896 17,452
Proceeds from the exercise of stock options -- 4,538
------------ ------------
Net cash (used in) financing activities (528,444) (1,273,650)
------------ ------------
Effect of foreign exchange rate changes on cash (157) (18,462)
------------ ------------
Net increase (decrease) in cash and cash equivalents (11,403,428) 9,980,106
------------ ------------
Cash and cash equivalents, beginning of period 12,958,074 7,314,254
------------ ------------
Cash and cash equivalents, end of period $ 1,554,646 $ 17,294,360
============ ============
Supplemental disclosure of cash flow information:
Cash received during the period for income taxes $ (1,382,145) $ (3,133,050)
Cash paid during the period for interest 30,023 101,211
Non-cash activities:
Issuance of common stock and options in business acquisition $ 6,905,511 $ --
Supplemental information of business acquired:
Fair value of assets acquired:
Cash 1,182 --
Current assets 23,113 --
Non-current assets 430,855 --
Acquired technology 4,000,000 --
Goodwill 11,424,759 --
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) --
------------ ------------
Cash paid 7,905,703 --
Less, cash acquired (1,182) --
Net cash paid 7,904,521 --
Less, cash paid prior to December 31, 2001 4,290,929 --
------------ ------------
Acquisition of business, less cash acquired $ 3,613,592 $ --
============ ============
*Certain amounts have been reclassified for comparative purposes
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
DSET Corporation and Subsidiaries
September 30, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
1. Basis of Presentation
The condensed consolidated financial information presented as of September 30,
2002 and for the three month and nine month periods ended September 30, 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 September 30, 2002, the
results of its operations for the three and nine month periods ended and its
cash flows for the nine month periods ended September 30, 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 as
amended. The December 31, 2001 balance sheet data contained in this Form 10-Q
was derived from audited financial statements, but does not include all of 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.
On November 8, 2002, the Company announced that it had entered into a definitive
Agreement of Merger under which all outstanding shares of the Company will be
acquired by a newly formed subsidiary of NE Technologies, Inc. at $0.30 per
share (see note 9).
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 September 30, 2002 and December 31, 2001, DSET had
an accumulated deficit of $53.9 million and $35.8 million and
6
DSET Corporation and Subsidiaries
September 30, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
working capital (deficit) of ($1.6) million and $8.5 million, respectively. DSET
also incurred net losses of $1.6 million and $18.1 million for the three and
nine month periods ended September 30, 2002, respectively, 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. Additionally, the Company's cash
and cash equivalents have decreased from approximately $13.0 million as of
December 31, 2001 to $1.6 million as of September 30, 2002. The losses and
deficits resulted principally from the lack of demand for DSET's products due
to a 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 Competitive Service Providers ("CSPs"). 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, substantial
bad debts and partially contributed to the decline in the Company's cash and
cash equivalents. 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 four 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) 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 had 90 calendar days, or until May 15,
2002, to regain compliance. Effective May 29, 2002 the Company transferred
the trading of its Common Stock to the Nasdaq SmallCap Market.
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) on the Nasdaq National Market. Therefore, in
accordance with Marketplace Rule 4450(e)(2), the Company had 90 calendar days,
or until June 3, 2002, to regain compliance. If compliance with this rule could
not be demonstrated by June 3, 2002, the Company's securities would have been
delisted from the Nasdaq National Market. Effective May 29, 2002 the Company
transferred the trading of its common stock to the Nasdaq SmallCap Market.
On July 17, 2002, the Company received notice from Nasdaq that for the previous
30 consecutive trading days, the price of the Company's common stock had not
maintained a minimum market value of publicly held shares of $1,000,000 as
required for continued inclusion by Marketplace Rule 4310(c)(7) on the
Nasdaq SmallCap Market. Therefore, in accordance with Marketplace
Rule 4310(c)(8)(B), the Company had 90
7
DSET Corporation and Subsidiaries
September 30, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
calendar days, or until October 15, 2002, to regain compliance. If compliance
with Rule 4310(c)(7) could not be demonstrated by October 15, 2002, Nasdaq
informed the Company that it would receive written notification from Nasdaq that
the Company's securities would be delisted from the Nasdaq SmallCap Market.
On September 5, 2002, the Company received notice from Nasdaq that the Company
had not regained compliance in accordance with Marketplace Rule 4310(c)(8)(D)
and that its securities would be delisted from the Nasdaq SmallCap Market at the
opening of business on September 13, 2002. The Company requested a hearing to
appeal the Nasdaq Staff's determination pursuant to the procedures set forth in
the Nasdaq Marketplace Rule 4800 Series. Such hearing was held October 24, 2002.
As of the date hereof, the determination of this hearing has not been
communicated by Nasdaq to the Company.
If the Company's common stock is delisted from the Nasdaq SmallCap Market,
trading, if any, of DSET's common stock may then continue to be conducted in the
over-the-counter market, on the over-the-counter bulletin board or other
electronic quotation services. 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
from the Nasdaq SmallCap Market, 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 DSET's ability to raise additional financing.
If DSET's pending merger with NE Technologies is not consummated, the Company
may likely be unable to meet its obligations as they come due. DSET would then
have to seek additional financing or other merger opportunities to fund its
operating and capital requirements through 2003. 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 would 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;
8
DSET Corporation and Subsidiaries
September 30, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
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
tests goodwill for impairment by comparing its carrying amount to the fair value
of goodwill. Accumulated amortization was zero and $162,000 as of September 30,
2002 and December 31, 2001, respectively. 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 $11.4 million in goodwill.
In the second quarter of 2002, the Company recognized a $11.4 million write-down
of goodwill due to the significant decline in the valuation of the Company's
stock due to the negative industry and economic trends affecting both the
Company's current operations and expected future sales as well as the general
decline of telecommunications valuations. In accordance with SFAS 142, the
Company performed an assessment of the carrying value of its goodwill and other
intangible assets recorded in connection with the Company's various
acquisitions. The fair value of goodwill was determined based on the market
value of the Company (see Note 8).
In the third quarter of 2001, the Company recognized a $311,000 write-down of
goodwill based upon management's decision to reduce operations due to the
continuing deterioration of market conditions for DSET's gateway products.
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 third quarter
of 2002, amortization expense of $200,000 was recognized as cost of revenues. In
the nine months ended September 30, 2002, amortization expense of $533,333 was
recognized as cost of revenues. Based upon management's current plans, the
remaining balance of acquired technology is expected to be recovered from the
sale of related products (see Note 7).
9
DSET Corporation and Subsidiaries
September 30, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
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 at adoption.
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 shareholders' 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 software products
released for general availability, royalties from third party licensees, and
repetitive license royalty fees for applications 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 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
10
DSET Corporation and Subsidiaries
September 30, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
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
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 of $1.4 million recorded in the first quarter of 2002 related 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). An additional tax benefit of $449,000 was
recorded in the second quarter of 2002 related to the research and
11
DSET Corporation and Subsidiaries
September 30, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
development tax credit and the foreign tax credit released as a result of the
carry-back related to the JCWAA. This benefit was recorded in the second quarter
as a result of further clarification of this new legislation.
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 ("FASB") 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.
In April 2002, the FASB issued SFAS 145, "Rescission of FASB Statements No. 4,
44 and 64, Amendment to FASB Statement No. 13, and Technical Corrections". SFAS
145 eliminates the requirement (in SFAS No. 4) that gains and losses from the
extinguishments of debt be aggregated and classified as extraordinary items, net
of the related income tax. In addition, SFAS No. 145 requires sales-lease back
treatment for certain modifications of a capital lease that result in the lease
being classified as an operating lease. The rescission of SFAS No. 4 is
effective for fiscal years beginning after May 15, 2002, which for the Company
would be the fiscal year ended December 31, 2003. Earlier application is
encouraged. Any gain or loss on extinguishment of debt that was previously
classified as an extraordinary item would be reclassified to other income
(expense). The remainder of the statement is generally effective for
transactions occurring after May 15, 2002. The Company does not expect that the
adoption of SFAS No. 145 will have a material impact on the Company's financial
condition, cash flows and results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities". SFAS 146 requires recording costs associated
with exit or disposal activities at their fair values when a liability has been
incurred. Under previous guidance, certain exit costs were accrued upon
management's commitment to an exit plan, which is generally before an actual
liability has been incurred. Adoption of SFAS 146 is required with the beginning
of fiscal year 2003.
12
DSET Corporation and Subsidiaries
September 30, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
4. Revenue Concentration
The Company had three customers accounting for 19%, 12%, and 10% of revenues,
respectively, for the quarter ended September 30, 2002 and three customers that
accounted for 12%, 11% , and 10% of revenues, repectively, for the quarter ended
September 30, 2001. The Company had two customers accounting for 12% and 11% of
revenues, respectively, for the nine months ended September 30, 2002 and one
customer that accounted for 22% of revenues for the nine months ended September
30, 2001.
5. Earnings Per Share
The Company computes, presents and discloses earnings per share in accordance
with SFAS 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
the denominator is increased for the conversion of potential common shares. Due
to the Company's net loss for the three month and nine month periods ended
September 30, 2002 and 2001, all outstanding stock options are considered to be
anti-dilutive.
At September 30, 2002, the exercise prices of all outstanding stock options
exceeded the market price of the Company's common stock. All outstanding options
to purchase 578,087 shares of common stock are antidilutive and excluded from
the computation of diluted loss per share for the three and nine month periods
ended September 30, 2002.
6. Restructuring and Other Charges
In the first quarter of 2002, the Company decided to close its San Ramon,
California office and reduce the sales and marketing workforce by a total of
five employees.
The approximate restructuring and other 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
========
13
DSET Corporation and Subsidiaries
September 30, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
In the second quarter of 2002, the Company decided to further reduce its
workforce by a total of 34 employees. As a result, the Company closed its
Bridgewater, New Jersey facility and consolidated those operations into the
Company's Shrewsbury, New Jersey office. As part of the restructuring, the
Company recorded a reserve to the outstanding loan balance of the former Chief
Executive Officer based on his severance agreement.
The approximate restructuring and other charges recorded in the second quarter
of 2002 are summarized as follows:
Employee severance $ 949,000
Fixed asset impairments 594,000
Officers loan reserve 177,000
Other 66,000
----------
$1,786,000
==========
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 and other charges recorded in the first quarter of
2001 are summarized as follows:
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
==========
In June 2001, the Company further reduced its workforce in the United States by
approximately seventy-one employees due to the continued changing and
unpredictable conditions in the marketplace and discontinuing certain product
lines in an effort to conserve cash. The employees terminated mainly supported
the ezSubscribe, ez911, CNAM/LIDB and PIC gateways.
The approximate restructuring charges recorded in the second quarter of 2001 are
summarized as follows:
14
DSET Corporation and Subsidiaries
September 30, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
Intangible asset impairment $4,101,000
Workforce reduction 969,000
Fixed asset impairments and future non-refundable
lease payments 1,290,000
----------
$6,360,000
==========
During the quarter ended September 30, 2001, the Company recorded a pre-tax
restructuring charge of approximately $4.6 million for fixed asset write-offs,
prepaid license write-offs, lease write-downs, consolidation of office space and
impairment of certain intangible assets based upon management's decision to
reduce operations due to the continuing deterioration of market conditions for
DSET's gateway products. In addition, a headcount reduction of sixty employees
was put into effect on October 2, 2001. Associated severance costs of employees
of approximately $700,000 was expensed in the quarter ending December 31, 2001
in accordance with standards established by the Financial Accounting Standards
Board's Emerging Issues Task Force ("EITF"), Issue No. 94-3.
The approximate restructuring charges recorded in the third quarter of 2001 are
summarized as follows:
Fixed asset impairments and future non-refundable
lease payments $1,523,000
Acquired technology asset impairment 772,000
Covenant not to compete asset impairment 417,000
Future rent payments for Plano, Texas facility 1,147,000
Prepaid software license impairment 360,000
Other 50,000
----------
$4,269,000
==========
The total remaining restructuring accrual inclusive of termination benefits and
non-refundable lease payments at September 30, 2002 is approximately $2.0
million as summarized as follows:
Short-term Long-term
---------- ----------
Severance $ 366,000 $ --
Rent 767,000 392,000
Equipment leases 366,000 68,000
---------- ----------
Total accrued restructuring expenses at September 30, 2002 $1,499,000 $ 460,000
========== ==========
15
DSET Corporation and Subsidiaries
September 30, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
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
Additions 1,015,000
Deferred rent 455,000
Payments (681,000)
-----------
Balance, June 30, 2002 2,794,000
Payments (835,000)
-----------
Balance, September 30, 2002 $ 1,959,000
===========
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 of accounting in accordance with SFAS 141. ISPsoft has developed Internet
Protocol provisioning and activation software which has achieved technological
feasibility in the second half of 2001. 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 were 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 were $4.0 million by June
30, 2002) in exchange for their ISPsoft securities in the merger. The milestone
payments were not required. 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
promissory notes on January 31, 2002 one to each of 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
16
DSET Corporation and Subsidiaries
September 30, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
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 1,961,185
-----------
Total consideration $15,611,215
===========
Allocation of consideration:
Net tangible assets of ISPsoft $ 186,456
Acquired Technology 4,000,000
Goodwill 11,424,759
-----------
$15,611,215
===========
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).
The fair value of ISPsoft's options exchanged for the Company's options has been
calculated based upon FASB Interpretation No. 44, "Accounting for Certain
Transactions Involving Stock Compensation - an interpretation of APB Opinion No.
25" and EITF 00-23, "Issues Related to the Accounting for Stock Compensation
Under APB 25 and FIN 44." DSET used the average market price for a 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 three and nine month periods ended September 30, 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.
17
DSET Corporation and Subsidiaries
September 30, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
The following pro forma statement of loss presents the consolidated results had
DSET and ISPsoft been combined at the beginning of the respective periods:
Quarter ended September 30, Nine Months ended September 30,
----------------------------- -----------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
Revenues: $ 1,397,728 $ 2,014,859 $ 4,100,181 $ 8,046,540
Cost of revenues: 995,693 1,414,131 3,312,898 6,395,636
------------ ------------ ------------ ------------
Gross profit: 402,035 600,728 787,283 1,650,904
------------ ------------ ------------ ------------
Operating expenses: 1,766,564 10,267,705 21,292,737 39,316,355
------------ ------------ ------------ ------------
Operating loss: (1,364,529) (9,666,977) (20,505,454) (37,665,451)
Loss before income taxes (1,560,046) (9,242,139) (20,716,779) (36,531,939)
Provision (benefit) for income taxes -- 60,223 (2,046,214) 135,276
------------ ------------ ------------ ------------
Net loss applicable to common shares $ (1,560,046) $ (9,302,362) $(18,670,565) $(36,667,215)
============ ============ ============ ============
Net loss per common share - basic and diluted $ (0.30) $ (1.80) $ (3.85) $ (7.07)
Weighted average number of common shares
outstanding 5,147,182 5,176,316 4,845,202 5,184,371
8. Impairment of Goodwill
In June 2002, the Company recorded a charge for the impairment of goodwill of
$11.4 million relating to DSET's merger with ISPsoft Inc. in January 2002. The
amount of impairment reflects both the further decline in the Company's stock
price and resulting market valuation from January 31, 2002 to June 30, 2002 and
a reassessment of the market outlook for capital equipment and software
purchases in the telecommunications industry. Under SFAS 142, an impairment of
goodwill is deemed to exist if the net book value of a reporting unit exceeds
its estimated fair value. The fair value was determined based on the recent
market value of the Company's shares. This charge is non-operational in nature
and does not affect cash flows.
18
DSET Corporation and Subsidiaries
September 30, 2002
Notes to Condensed Consolidated Financial Statements (Unaudited)
9. Subsequent Events
On November 8, 2002, the Company announced that it had entered into a definitive
Agreement of Merger under which all outstanding shares of the Company will be
acquired by a newly formed subsidiary of NE Technologies, Inc. at $0.30 per
share. The transaction is subject to approval by the Company's shareholders.
Certain significant shareholders of the Company have agreed to vote in favor
of the transaction. Completion of the merger is also subject to certain
customary closing conditions. It is expected that the Company's shareholders
will be asked to vote on the proposed merger at a meeting expected to be held
during the fourth quarter of 2002 or the first quarter of 2003. The Company
will file with the Securities and Exchange Commission and mail to its
shareholders a Proxy Statement in connection with the transaction.
In November 2002, DSET signed an agreement with the lessor and sublease lessee
of the Bridgewater facility whereby a final payment of $270,000 was made to
eliminate all obligations as of October 31, 2002. As such, the net lease
obligations will be reduced by approximately $7 million from November 2002
to May 2009.
19
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
IPSource'TM' 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.
On November 8, 2002, we announced that we had entered into a definitive
Agreement of Merger under which all outstanding shares of the Company will be
acquired by a newly formed subsidiary of NE Technologies, Inc. at $0.30 per
share. The transaction is subject to approval by our shareholders. Certain
significant shareholders of DSET have agreed to vote in favor of the
transaction. Completion of the merger is also subject to certain customary
closing conditions. It is expected that our shareholders will be asked to vote
on the proposed merger at a meeting expected to be held during the fourth
quarter of 2002 or the first quarter of 2003. We will file with the Securities
and Exchange Commission and mail to our shareholders a Proxy Statement in
connection with the transaction.
Prospective customers for our IPSource'TM' products are offered the basic
platform under a perpetual license and the right to establish services on a
usage basis similar to the "pay as you grow" model for gateways. This allows
prospective customers to only pay for those services or device drivers that they
need to provision and activate their customers' services.
Presently, we are in the process of conducting trials of the IPSource'TM'
software with certain major network providers and plan to initiate trials with
additional prospective customers in the near future. These trials are generally
required by prospects prior to purchasing software similar to IPSource'TM'.
Based upon management's current plans, the remaining balance of acquired
technology is expected to be recovered from the sale of related products.
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 third 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
20
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 third 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. We have utilized cash previously invested in marketable
securities to finance the losses brought about by the downturn. Through the
third 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.
For our electronic-bonding gateway products, we currently offer two 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 fourth quarter of 2001, 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,
21
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 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 September 30, 2002 and 2001, we derived
approximately 11.0% and 11.4%, respectively, of our total revenues from license
revenues and approximately 89.0% and 88.6%, respectively, of our total revenues
from service revenues. During the third quarter of 2002, revenues generated from
CSPs were approximately $1.2 million and revenues generated from network
equipment vendors for LNP solutions, application development tools and related
services were approximately $156,000. During the third quarter of 2001, revenues
generated from CSPs were $1.8 million and revenues generated from network
equipment vendors were approximately $230,000.
22
We had three customers accounting for 19%, 12%, and 10% of revenues,
respectively, for the quarter ended September 30, 2002 and three customers that
accounted for 12%, 11% and 10% of revenues, respectively, for the quarter ended
September 30, 2001. Revenues from international sales are currently
insignificant.
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 global market for next generation IP based service
activation and configuration management solutions is expected to grow from
approximately $800 million in 2001 to almost $1.4 billion in 2005, according to
data compiled by the Yankee Group. 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 promissory 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 were 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 were $4.0
million by June 30, 2002) in exchange for their ISPsoft securities in the
merger. The milestone payments were not required. 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.
In June 2002, the Company recorded a charge for the impairment of goodwill
of $11.4 million relating to DSET's merger with ISPsoft Inc. in January 2002.
The amount of impairment reflects both the further decline in the Company's
stock price and resulting market valuation in recent months and a reassessment
of the market outlook for capital equipment and software purchases in the
telecommunications industry. Under SFAS 142, a goodwill impairment is deemed to
exist if the net book value of a reporting unit exceeds its estimated fair
value. The fair value was determined based on the recent market value of the
Company's shares. This charge is non-operational in nature and does not affect
cash flows.
Effective with the May 2002 restructuring, DSET's corporate headquarters
changed from Bridgewater, New Jersey to Shrewsbury, New Jersey and Mr. Binay
Sugla replaced Mr. William McHale as Chief Executive Officer. Mr. McHale
separated from the Company effective May 24, 2002, but remains on the Board of
Directors.
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
23
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) the risk that the proposed merger with NE Technologies,
Inc. may not be consummated; (iii) 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; (iv) the need for substantial financing to
continue operations; (v) the risk that our common stock may be delisted from the
Nasdaq SmallCap Market; (vi) our dependence on the market for advanced
telecommunications products and services; (vii) rapid technological change in
our industry; (viii) our lack of an operating history in providing Internet
Protocol (IP) based provisioning and management applications and services; (ix)
the failure to protect proprietary rights or enforce licensing rights; and (x)
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 our products and services, and the market for IP provisioning
software. As a result of such risks and others expressed from time to time in
our filings with the Securities and Exchange Commission, our actual results may
differ materially from the results discussed in or implied by the
forward-looking statements contained herein.
Critical Accounting Estimates and Judgments
Our discussion and analysis of our financial condition and results of
operations are based upon our condensed 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.
24
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.
o We make a determination as to the carrying value of intangibles, long-lived
assets such as acquired technology and related goodwill 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 and
SFAS 144, based on applying the appropriate fair value methodology.
o Contraction of the telecommunications industry commencing in the latter
half of 2000 and continuing through the third 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
25
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 September 30, 2002 and December 31, 2001), an adjustment to the
deferred tax asset would increase income in the period such determination
was made.
o The condensed 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. The condensed consolidated financial
statements do not include any adjustments relating to the recoverability
of the carrying amount of the recorded assets and liabilities that might
result from the outcome of this uncertainty.
Results of Operations
Three Months Ended September 30, 2002 Compared to the Three Months Ended
September 30, 2001
Revenues. Total revenues decreased by 30.6% to $1.4 million in the third
quarter of 2002 from $2.0 million in the third quarter of 2001. License revenues
decreased by 33.1% to $154,000 in the third quarter of 2002 from $230,000 in the
third quarter of 2001. This decrease was attributable to the continued 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 30.3% to $1.2 million in the
third quarter of 2002 from $1.8 million in the third quarter of 2001. This
decrease reflects a $400,000 decrease in gateway solutions service revenue and a
$200,000 decrease in network solutions service revenue.
Gross profit. The Company's gross profit decreased 49.8% to $402,000 in the
third quarter of 2002 from $801,000 in the third quarter of 2001. Gross profit
(loss) percentage for license revenues decreased to (30.1%) in the third quarter
of 2002 from 43.0% in the third quarter of 2001. The decrease is primarily due
to the amortization of acquired technology related to our IPSource'TM' product
in the amount of $200,000 for the current quarter that was not present in the
third quarter of 2001. Gross profit percentage for service revenues decreased to
36.0% in the third quarter of 2002 from 39.3% in the third quarter of 2001.
26
Sales and marketing expenses. Sales and marketing expenses decreased 76.3%
to $309,000 in the third quarter of 2002 from $1.3 million in the third quarter
of 2001. The decrease in sales and marketing expenses reflects a $600,000
decrease in personnel related expenses, a $300,000 decrease in occupancy costs
and depreciation, and a $100,000 decrease in travel. The decrease was mainly due
to a drop in average headcount in applicable departments to three in the third
quarter of 2002 as compared to 25 for the third quarter of 2001.
Research and product development expenses. Research and product development
expenses decreased 55.4% to $755,000 in the third quarter of 2002 from $1.7
million in the third quarter of 2001. Personnel related expenses decreased by
$700,000, depreciation and occupancy and related costs decreased by $200,000,
and other expenses decreased by a net amount of $100,000. The decrease was
mainly due to a drop in average headcount in this department to 21 in the third
quarter of 2002 as compared to 38 for the third quarter of 2001.
General and administrative expenses. General and administrative expenses
decreased 36.9% to $703,000 in the third quarter of 2002 from $1.1 million in
the third quarter of 2001. The decrease in general and administrative expenses
was mainly due to a decrease of $200,000 in occupancy and depreciation costs,
and a $200,000 decrease in personnel and related expenses. The decrease was
mainly due to a drop in average headcount in this department to 12 in the third
quarter of 2002 as compared to 22 for the third quarter of 2001.
Bad debt expense. Bad debt expense was zero in the third quarter of 2002
compared to $1,000 in the third quarter of 2001.
Amortization of goodwill and other intangibles. Amortization expense was
zero in the third quarter of 2002 compared to $70,000 in the third quarter of
2001. The reduction is due to 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
third quarter of 2002 were zero. In the third quarter of 2001, a $4.3 million
charge was taken which included $1.2 million in asset impairments of intangible
assets, $1.4 million in surplus fixed assets, $1.1 million in charges related to
the rent in the Plano, Texas office, $360,000 in impaired prepaid licenses,
$150,000 in impaired leasehold improvements, and $50,000 in other expenses.
Impairment of goodwill. Impairment of goodwill in the third quarter of 2002
was zero. In the third quarter of 2001, a $311,000 charge was taken for the
impairment of goodwill related to DSET's electronic-bonding gateway business.
Interest expense and other income (expense). Interest expense and other
income and expense decreased to an expense of $213,000 for the third quarter of
2002 from an income of $52,000 for the third quarter of 2001. In 2002, the
balance included an expense of $200,000 as a reserve against the value of our
investment in the New Jersey Technology Council Venture Fund. In 2001, the
balance included rental income of $67,000 for the sublet of the third floor of
the Bridgewater office.
27
Interest income and realized gains and losses on marketable securities.
Interest income decreased to $17,000 in the third quarter of 2002 as compared to
approximately $469,000 in the third 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. The tax provision for the third quarter of 2002 was zero as
compared to a tax provision of $125,000 in the third quarter of 2001. The tax
provision in the third quarter of 2001 related to the realized gains from
redemptions of marketable securities and a change in estimate for 2000's income
taxes. The 2002 and 2001 rates differ substantially from the statutory rate due
to our losses and the change in estimate.
Nine Months Ended September 30, 2002 Compared to the Nine Months Ended September
30, 2001
Revenues. Total revenues decreased by 49.0% to $4.1 million in the nine
months ended September 30, 2002 from $8.0 million in the nine months ended
September 30, 2001. License revenues decreased by 77.3% to $531,000 in the nine
months ended September 30, 2002 from $2.3 million in the nine months ended
September 30, 2001. This decrease reflects the continued 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 37.5% to $3.6 million in the nine months ended
September 30, 2002 from $5.7 million in the nine months ended September 30,
2001. This decrease was attributable to a $1.0 million decrease in service
revenues for network solutions, a $1.0 million decrease in gateway solutions
service revenues and a $100,000 decrease in LNP solutions revenues.
Gross profit. The Company's gross profit decreased 62.1% to $854,000 in the
nine months ended September 30, 2002 from $2.3 million in the nine months ended
September 30, 2001. Gross profit (loss) percentage for license revenues
decreased to (1.0%) in the nine months ended September 30, 2002 from 50.5% in
the nine months ended September 30, 2001. The decrease was due to one large
contract signed in the nine months ended September 30, 2001, for which there was
a significant gross profit, and the amortization of acquired technology of
$533,000 during the nine months ending September 30, 2002. Gross profit
percentage for service revenues increased to 24.1% in the nine months ended
September 30, 2002 from 18.8% in the nine months ended September 30, 2001. The
increase in service gross profit percentage was mainly due to the decrease in
average headcount for this department; 16 employees as compared to 26 employees.
Sales and marketing expenses. Sales and marketing expenses decreased 74.1%
to $1.5 million in the nine months ended September 30, 2002 from $6.0 million in
the
28
nine months ended September 30, 2001. The decrease in sales and marketing
expenses reflects a $2.9 million decrease in personnel related expenses, a
$800,000 decrease in occupancy costs and depreciation, a $500,000 decrease in
travel expenses, a $100,000 decrease in trade shows and sales meetings expenses,
a $100,000 decrease in telephone expenses, and a net $100,000 decrease in other
sales and marketing expenses. The decrease was mainly due to an 80% decrease in
average headcount for these departments; 7 employees as compared to 35
employees.
Research and product development expenses. Research and product development
expenses decreased 67.0% to $2.8 million in the nine months ended September 30,
2002 from $8.6 million in the nine months ended September 30, 2001. Personnel
related expenses decreased by $4.1 million, depreciation and occupancy and
related costs decreased by $1.0 million, contract labor decreased by $300,000,
travel and telephone expense decreased by $200,000, hardware and software
maintenance decreased by $100,000, and a net $100,000 decrease in other research
and product development expenses. The decrease was mainly due to a 64% decrease
in average headcount for this department; 27 employees as compared to 74
employees.
General and administrative expenses. General and administrative expenses
decreased 35.3% to $2.8 million in the nine months ended September 30, 2002 from
$4.4 million in the nine months ended September 30, 2001. The decrease in
general and administrative expenses reflects a decrease of $600,000 in occupancy
and depreciation costs, a $400,000 decrease in personnel related expenses, a
$300,000 decrease in relocation expenses, a $200,000 decrease in recruiting
expenses, a $200,000 decrease in contract labor costs, and a net $100,000
decrease in miscellaneous other expenses, offset by a $100,000 increase in
insurance expense and a $100,000 increase in directors fees. The average
headcount for this department decreased to 18 for the nine months ended
September 30, 2002 as compared to 28 in the nine months ended September 30,
2001.
Bad debt expense. Bad debt expense was a credit of $307,000 in the nine
months ended September 30, 2002 due to the collection of previously reserved
accounts. Bad debt expense was $987,000 in the nine months ended September 30,
2001. The Company's bad debt expense recorded for the nine months ended
September 30, 2001 corresponded to $609,000 of revenue recognized in 1999,
$356,000 of revenue recognized in 2000, and $20,000 of revenue recognized in the
first quarter of 2001.
Amortization of goodwill and other intangibles. Amortization expense was
zero in the nine months ended September 30, 2002 compared to $274,000 in the
nine months ended September 30, 2001. The reduction is due to 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
nine months ended September 30, 2002 were $2.3 million which included a
severance charge of $1.2 million for the reorganization in the sales and
marketing departments, $775,000 for the impairment of fixed assets, a $177,000
addition to the officer's loan
29
reserve, and $64,000 for legal, moving, and rent charges associated with
the closing of the offices in San Ramon, California and Bridgewater, New Jersey.
In the nine months ended September 30, 2001, a $14.1 million dollar charge was
taken, which included asset impairments of $7.5 million for the carrying value
of certain licenses related to acquired technology, $4.9 million for fixed asset
impairment and non-refundable future lease payments, and $1.7 million in
severance charges related to the March and June 2001 staffing reductions.
Impairment of goodwill. Charges for the impairment of goodwill in the nine
months ended September 30, 2002 of $11.4 million were related to DSET's merger
with ISPsoft Inc. in January 2002. The amount of impairment reflects both the
further decline in the Company's stock price and resulting market valuation in
recent months and a reassessment of the market outlook for capital equipment and
software purchases in the telecommunications industry. Under SFAS 142, a
goodwill impairment is deemed to exist if the net book value of a reporting unit
exceeds its estimated fair value. The fair value was determined based on the
recent market value of the Company's shares. In the nine-month period ended
September 30, 2001 charges for the impairment of goodwill were $730,000 related
to DSET's electronic-bonding gateway business.
Interest expense and other income (expense). Interest expense and other
income and expense increased to $289,000 for the nine months ended September 30,
2002 from an expense of $26,000 for the nine months ended September 30, 2001.
In 2002, the balance includes an expense of $200,000 as a reserve against the
value of our investment in the New Jersey Technology Council Venture Fund. In
2001, the balance included rental income of $67,000 for the sublet of the third
floor of the Bridgewater office.
Interest income and realized gains and losses on marketable securities.
Interest income decreased to $83,000 in the nine months ended September 30, 2002
as compared to approximately $1.4 million in the nine months ended September 30,
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 $1.8 million for the nine
months ended September 30, 2002 as compared to a tax provision of $252,200 in
the nine months ended September 30, 2001. The tax benefit in 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 tax provision for the nine months ended
September 30 2001 related to the realized gains from redemptions of marketable
securities and a change in estimate for 2000's income taxes. The 2002 and 2001
rates differ substantially from the statutory rate due to our losses and the
change in estimate.
30
Liquidity and Capital Resources
Our condensed 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 September 30, 2002, our cash and cash equivalents
aggregated approximately $1.6 million. At December 31, 2001 our cash and cash
equivalents totaled $13.0 million. Our working capital (deficit) was ($1.6)
million and $8.5 million at September 30, 2002 and December 31, 2001,
respectively.
At September 30, 2002, our principal sources of liquidity were our cash and
cash equivalents that totaled $1.6 million. In addition, we expect to receive
$449,000 in cash for the U.S. Federal Income Tax refund due to the amended tax
return to claim the research and development tax credit and foreign tax credit
which is released as a result of an NOL carry-back from 2001 to 1996 which
released the 1996 research and development tax credit and the foreign tax credit
due to the new tax carry-back provisions of the JCWAA. We expect to receive this
refund in the fourth quarter of 2002.
Our operating activities used cash of $7.1 million and $12.2 million for
the nine months ended September 30, 2002 and 2001, respectively. Cash used by
operations in the nine months ended September 30, 2002 was primarily
attributable to a net loss adjusted for the non-cash charges for impairment of
goodwill, amortization, depreciation and restructuring, as well as an increase
in income taxes receivable, offset by decreases in deferred revenues, deferred
rent, accounts payable and accrued expenses.
Cash provided by (used in) investing activities in the nine months ended
September 30, 2002, and 2001 was ($3.8) million and $23.4 million, respectively.
Cash used in investing activities in the nine months ended September 30, 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 $528,000 and $1.3 million in cash in financing
activities in the nine months ended September 30, 2002, and 2001, respectively,
relating mainly to the repayment of loans.
In addition, in 2002 DSET has received four 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) 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
31
controlling interest in the company.) Therefore, in accordance with
Marketplace Rule 4450(e)(1), we had 90 calendar days, or until May 15, 2002, to
regain compliance. Effective May 29, 2002, the Company transferred the trading
of its common stock to the Nasdaq SmallCap Market and no further action was
taken by Nasdaq.
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) on the Nasdaq National Market. Therefore, in accordance with
Marketplace Rule 4450(e)(2), we had 90 calendar days, or until June 3, 2002,
to regain compliance. If compliance with this Rule could not be demonstrated
by June 3, 2002, our securities would have been delisted from the Nasdaq
National Market. Effective May 29, 2002 the Company transferred the trading of
its common stock to the Nasdaq SmallCap Market.
On July 17, 2002, we received notice from Nasdaq that for the previous 30
consecutive trading days, the price of the our common stock had not maintained a
minimum market value of publicly held shares of $1,000,000 as required for
continued inclusion by Marketplace Rule 4310(c)(7) on the Nasdaq SmallCap
Market. Therefore, in accordance with Marketplace Rule 4310(c)(8)(B), we had
90 calendar days, or until October 15, 2002, to regain compliance. If compliance
with Rule 4310(c)(7) could not be demonstrated by October 15, 2002, Nasdaq
informed us that we would receive a written notification from the Nasdaq that
the Company's securities would be delisted from the Nasdaq SmallCap Market.
On September 5, 2002, we received notice from Nasdaq that the
Company had not regained compliance in accordance with Marketplace Rule
4310(c)(8)(D) and that its securities would be delisted from the Nasdaq SmallCap
Market at the opening of business on September 13, 2002. The Company has
requested a hearing to appeal the Nasdaq Staff's determination pursuant to the
procedures set forth in the Nasdaq Marketplace Rule 4800 Series. Such hearing
was held October 24, 2002. As of the date hereof, the determination of this
hearing has not been communicated by Nasdaq to the Company.
If our common stock is delisted from the Nasdaq SmallCap Market, trading,
if any, of DSET's common stock may then continue to be conducted in the
over-the-counter market, on the over-the-counter bulletin board or other
electronic quotation services. 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.
If our pending merger with NE Technologies is not consummated, we may
likely be unable to meet our obligations as they come due. We would then
have to seek additional financing or other merger opportunities to fund our
operating and capital requirements through 2003. If cashflows are insufficient
or we are unable to raise funds on acceptable terms, there would be a material
adverse effect on our
32
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 work force, sell certain assets, or possibly explore other alternatives
including seeking bankruptcy protection. The condensed 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 $560,000 at September 30, 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
September 30, 2002 was $1.0 million for trade receivables and $750,000 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 $1.2 million and $7.7 million at September 30, 2002
and December 31, 2001, respectively. 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.
Contractual obligations including interest on these obligations are as
follows:
Payments Due by Period
October 1, 2002 October 1, 2003 October 1, 2005
through through through After
September 30, September 30, September 30, September 30,
Contractual Obligations Total 2003 2005 2007 2007
Notes payable $ 884,027 $ 884,027 $ 0 $ 0 $ 0
Capitalized lease obligations* 330,990 180,540 150,450 0 0
Operating leases (equipment)* 817,838 597,631 197,062 23,145 0
Rental lease obligations* (A) 11,954,456 2,412,180 4,501,291 2,574,120 2,466,865
NJTC Venture Fund commitment (B) 800,000 200,000 600,000 0 0
------------ ------------ ------------ ------------ ------------
Total contractual cash
obligations $ 14,787,311 $ 4,274,378 $ 5,448,803 $ 2,597,265 $ 2,466,865
Sublessor agreements* (A) (2,265,855) (1,148,848) (1,117,007) 0 0
------------ ------------ ------------ ------------ ------------
Net $ 12,521,456 $ 3,125,530 $ 4,331,796 $ 2,597,265 $ 2,466,865
============ ============ ============ ============ ============
33
* A total of $1.6 million is included in accrued restructuring expenses in the
condensed consolidated financial statements for the period as of September 30,
2002.
(A) In November 2002, DSET signed an agreement with the lessor and the sublease
lessee of the Bridgewater facility whereby a final payment of $270,000 was made
to eliminate all obligations as of October 31, 2002. As such, the net lease
obligations will be reduced by approximately $7 million from those noted above.
(B) Related to the New Jersey Technology Council Venture Fund, DSET was in
default on a capital call for $100,000 due by October 11, 2002. As a result,
DSET may not be eligible for future capital contributions to the fund.
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.
Item 4. Controls and Procedures.
a. Evaluation of Disclosure Controls and Procedures
Based upon their evaluation of the Company's disclosure controls and
procedures conducted within 90 days of the date of filing this report on Form
10-Q the Company's Chief Executive Officer and the Chief Financial Officer have
concluded that the Company's disclosure controls and procedures (as defined in
Rules 13a-14(c) and 15d-14(c) promulgated under the Securities Act of 1934) are
effective to ensure that information required to be disclosed by the Company in
reports that it files or submits under the Securities Act of 1934 is recorded,
processed, summarized, and reported within the time periods specified in
Securities and Exchange rules and forms.
b. Changes in Internal Controls
There were no significant changes in the Company's internal controls or in
other factors that could significantly affect these controls subsequent to the
date of their evaluation. There were no deficiencies or material weaknesses,
and, therefore, there were no corrective actions taken.
34
PART II -- OTHER INFORMATION
Item 5. Other Information.
On November 8, 2002, the Company announced that it had entered into a
definitive Agreement of Merger under which all outstanding shares of the
Company will be acquired by a newly formed subsidiary of NE Technologies, Inc.
at $0.30 per share. The transaction is subject to approval by the Company's
shareholders. Certain significant shareholders of DSET have agreed to vote
in favor of the transaction. Completion of the merger is also subject
to certain customary closing conditions. It is expected that the Company's
shareholders will be asked to vote on the proposed merger at a meeting
expected to be held during the fourth quarter of 2002 or the first quarter
of 2003. The Company will file with the Securities and Exchange Commission
and mail to its shareholders a Proxy Statement in connection with the
transaction.
On September 5, 2002, the Company received notice from Nasdaq that the
Company had not regained compliance in accordance with Marketplace Rule
4310(c)(8)(D) and that its securities would be delisted from the Nasdaq SmallCap
Market at the opening of business on September 13, 2002. The Company requested a
hearing to appeal the Nasdaq Staff's determination pursuant to the procedures
set forth in the Nasdaq Marketplace Rule 4800 Series. Such hearing was held on
October 24, 2002. As of the date hereof, the determination of this hearing has
not been communicated by Nasdaq to the Company.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit 99.1. Certification pursuant to 18 U.S.C. Section 1350
(b) Reports on Form 8-K.
On September 13, 2002 the Company filed a current report on Form 8-K
with the Securities and Exchange Commission with respect to the
Company's request for hearing before the Nasdaq Listing Qualifications
Panel to appeal Nasdaq's delisting ruling.
On November 1, 2002 the Company filed a current report on Form 8-K
with the Securities and Exchange Commission with respect to the first
amendment to the
35
January 30, 2002 employment agreement between the Company and its
President, Dr. Binay Sugla.
On November 8, 2002 the Company filed a current report on Form 8-K
with the Securities and Exchange Commission with respect to the
definitive Agreement of Merger under which all outstanding shares of
DSET Corporation will be acquired by a newly formed subsidiary of NE
Technologies, Inc.
36
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DSET CORPORATION
DATE: November 14, 2002 By: /s/ Dr. Binay Sugla
-------------------------------------
Dr. Binay Sugla,
Chief Executive Officer
DATE: November 14, 2002 By: /s/ Bruce M. Crowell
-------------------------------------
Bruce M. Crowell
Vice President and Chief Financial
Officer
37
CERTIFICATION
I, Dr. Binay Sugla, certify that:
1. I have reviewed this quarterly report on Form 10-Q of DSET Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the periods covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
38
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
/s/ Dr. Binay Sugla
------------------------------------------
Dated: November 14, 2002 Dr. Binay Sugla,
President and Chief Executive Officer
(Principal Executive Officer)
39
CERTIFICATION
I, Bruce M. Crowell, certify that:
1. I have reviewed this quarterly report on Form 10-Q of DSET Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the periods covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent
40
evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.
/s/ Bruce M. Crowell
----------------------------------------
Dated: November 14, 2002 Bruce M. Crowell,
Vice President and Chief Financial
Officer (Principal Financial Officer and
Principal Accounting Officer)
41
STATEMENT OF DIFFERENCES
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The trademark symbol shall be expressed as............................. 'TM'
The section symbol shall be expressed as............................... 'SS'