10-Q 1 a33731.txt DSET CORPORATION 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

i PART I. FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements 1 DSET Corporation and Subsidiaries Condensed Consolidated Balance Sheets (Unaudited) --------------------------------------------------------------------------------

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) --------------------------------------------------------------------------------

*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) --------------------------------------------------------------------------------

*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) --------------------------------------------------------------------------------

*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:

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:

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:

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 ------------------------ The trademark symbol shall be expressed as............................. 'TM' The section symbol shall be expressed as............................... 'SS'

DSET CORP 10-Q