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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the Quarterly Period Ended March 31, 2003. or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Transition Period from __________to _______.
Commission File Number: 0-26494
GSE SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 52-1868008
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
9189 Red Branch Road, Columbia Maryland, 21045
(Address of principal executive office and zip code)
Registrant's telephone number, including area code: (410) 772-3500
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [ X ]
As of May 6, 2003, there were 5,869,138 shares of the Registrant's common stock
outstanding.
GSE SYSTEMS, INC.
QUARTERLY REPORT ON FORM 10-Q
INDEX
PAGE
PART I. FINANCIAL INFORMATION 3
Item 1. Financial Statements:
Consolidated Balance Sheets as of March 31, 2003 3
and December 31, 2002
Consolidated Statements of Operations for the Three Months Ended 4
March 31, 2003 and March 31, 2002
Consolidated Statements of Comprehensive Income (Loss) for 5
the Three Months Ended March 31, 2003 and March 31, 2002
Consolidated Statements of Cash Flows for the Three Months Ended 6
March 31, 2003 and March 31, 2002
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of 15
Results of Operations and Financial Condition
Item 3. Quantitative and Qualitative Disclosures About Market Risk 22
Item 4. Controls and Procedures 22
PART II. OTHER INFORMATION 23
Item 1. Legal Proceedings 23
Item 2. Changes in Securities and Use of Proceeds 23
Item 3. Defaults Upon Senior Securities 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 5. Other Information 23
Item 6. Exhibits and Reports on Form 8-K 23
SIGNATURES 24
302 CERTIFICATIONS 25
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
March 31, 2003 December 31, 2002
------------------- -------------------
ASSETS Unaudited
Current assets:
Cash and cash equivalents $ 209 $ 1,617
Restricted cash 623 608
Contract receivables 9,898 10,761
Inventories 1,562 1,560
Prepaid expenses and other current assets 3,289 2,656
------------------- -------------------
Total current assets 15,581 17,202
Property and equipment, net 1,573 1,697
Software development costs, net 4,234 4,401
Goodwill, net 2,901 2,901
Restricted cash 139 139
Other assets 2,167 2,554
------------------- -------------------
Total assets $ 26,595 $ 28,894
=================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 5,510 $ 1,905
Accounts payable 3,035 2,521
Accrued expenses 2,050 1,727
Accrued compensation and payroll taxes 1,089 1,401
Billings in excess of revenue earned 3,269 3,059
Accrued contract and warranty reserves 386 491
Other current liabilities 72 62
------------------ -------------------
Total current liabilities 15,411 11,166
Long-term debt 2,170 8,033
Billings in excess of revenue earned 770 998
Accrued warranty reserves 527 586
------------------- -------------------
Total liabilities 18,878 20,783
------------------ -------------------
Commitments and contingencies
Stockholders' equity:
Series A Convertible preferred stock $.01 par value, 2,000,000 shares authorized,
shares issued and outstanding 39,000 in 2003 and in 2002 - -
Common stock $.01 par value, 18,000,000 shares authorized, shares issued
and outstanding 6,019,138 in 2003 and 2002, respectively. 60 59
Additional paid-in capital 28,019 27,841
Accumulated deficit - at formation (5,112) (5,112)
Accumulated deficit - since formation (14,066) (13,490)
Accumulated other comprehensive loss (1,184) (1,187)
------------------- -------------------
Total stockholders' equity 7,717 8,111
------------------- -------------------
Total liabilities and stockholders' equity $ 26,595 $ 28,894
=================== ===================
The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(Unaudited)
Three months
ended March 31,
-----------------------------
2003 2002
------------- -------------
Contract revenue $ 9,263 $ 11,274
Cost of revenue 6,905 7,791
------------- -------------
Gross profit 2,358 3,483
------------- -------------
Operating expenses
Selling, general and administrative 2,595 2,618
Depreciation and amortization 157 140
------------- -------------
Total operating expenses 2,752 2,758
------------- -------------
Operating income (loss) (394) 725
Interest expense, net (81) (72)
Other income (expense), net (6) 47
------------- -------------
Income (loss) before income taxes (481) 700
Provision for income taxes 37 268
------------- -------------
Net income (loss) (518) 432
Preferred stock dividends (58) (58)
------------- -------------
Net income (loss) attributed to
common stockholders $ (576) $ 374
============= =============
Basic earnings (loss) per common share $ (0.10) $ 0.06
============= =============
Diluted earnings (loss) per common share $ (0.10) $ 0.06
============= =============
The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
(Unaudited)
Three months
ended March 31,
----------------------------
2003 2002
------------- -------------
Net income (loss) $ (518) $ 432
Foreign currency translation adjustment 3 (27)
------------ -------------
Comprehensive income (loss) $ (515) $ 405
============= =============
The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
Three months
ended March 31,
-----------------------------
2003 2002
------------- -------------
Cash flows from operating activities:
Net income (loss) $ (518) $ 432
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation and amortization 732 589
Changes in assets and liabilities:
Contract receivables 864 (570)
Inventories, prepaid expenses and other assets (27) (124)
Accounts payable, accrued compensation and accrued expenses (14) (475)
Billings in excess of revenues earned (18) (962)
Accrued contract and warranty reserves (164) 44
Other liabilities (50) 165
------------- -------------
Net cash provided by (used in) operating activities 805 (901)
------------- -------------
Cash flows from investing activities:
Capital expenditures (19) (343)
Capitalized software development costs (408) (523)
------------- -------------
Net cash used in investing activities (427) (866)
------------- -------------
Cash flows from financing activities:
Repayment of note payable to related party - (250)
Restrictions of cash as collateral under line of credit (15) (150)
Decrease in borrowings under lines of credit (1,778) (68)
Proceeds from issuance of common stock, net of costs - 1,584
Other financing activities, net (7) (119)
------------- -------------
Net cash provided by (used in) financing activities (1,800) 997
------------- -------------
Effect of exchange rate changes on cash 14 -
------------- -------------
Net decrease in cash and cash equivalents (1,408) (770)
Cash and cash equivalents at beginning of year 1,617 2,040
------------- -------------
Cash and cash equivalents at end of period $ 209 $ 1,270
============= =============
The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Three Months ended March 31, 2003 and 2002
(Unaudited)
1. Basis of Presentation
The consolidated financial statements included herein have been
prepared by GSE Systems, Inc. (the "Company") without independent audit.
In the opinion of the Company's management, all adjustments and
reclassifications of a normal and recurring nature necessary to present
fairly the financial position, results of operations and cash flows for
the periods presented have been made. Certain information and footnote
disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United
States have been condensed or omitted. These consolidated financial
statements should be read in conjunction with the consolidated financial
statements and notes thereto included in the Company's Annual Report on
Form 10-K for the period ended December 31, 2002 filed with the
Securities and Exchange Commission on March 31, 2003.
The majority of the Company's revenue is derived through the sale of
uniquely designed systems containing hardware, software and other materials
under fixed-price contracts. In accordance with Statement of Position 81-1
"Accounting for Performance of Construction-Type and Certain
Production-Type Contracts", the revenue under these fixed-price contracts
is accounted for on the percentage-of-completion method, based on contract
costs incurred to date and estimated costs to complete. Estimated contract
earnings as reviewed and revised periodically as the work progresses, and
the cumulative effect of any change is recognized in the period in which
the change is identified. Estimated losses are charged against earnings in
the period such losses are identified.
As the company recognizes revenue under the percentage-of-completion
method, it provides an accrual for estimated future warranty costs based on
historical and projected claims experience. the Company's longer-term
contracts generally provide for a one-year warranty on parts, labor and any
bug fixes as it relates to software embedded in the systems.
The Company's system design contracts do not provide for "post
customer support service" (PCS) in terms of software upgrades, software
enhancements or telephone support. In order to obtain PCS, the customers
must purchase a separate contract at the date of system installation. Such
PCS arrangements are generally for a one-year period renewable annually and
include customer support, unspecified software upgrades, maintenance
releases, hardware support and spare parts. The Company recognizes revenue
from these contracts ratable over the life of the agreements in accordance
with Statement of Position 97-2 "Software Revenue Recognition".
Revenues from certain consulting or training contracts are recognized
on a time-and-material basis. For time-and-material type contracts, revenue
is recognized based on hours incurred at a contracted labor rate plus
expenses.
Contract receivables unbilled of $5.0 million and $4.0 million as of
March 31, 2003 and December 31, 2002, respectively, are typically billed
within thirty days.
2. Basic and Diluted Earnings Per Common Share
Basic earnings per share is based on the weighted average number of
outstanding common shares for the period. Diluted earnings per share
adjusts the weighted average shares outstanding for the potential
dilution that could occur if stock options, warrants or convertible
preferred stock were exercised or converted into common stock. The
number of common shares and common share equivalents used in the
determination of basic and diluted earnings (loss) per share were as
follows:
(in thousands, except share data) Three months
ended March 31,
------------------------------------
2003 2002
--------------- ----------------
Numerator:
Net income (loss) $ (518) $ 432
Preferred stock dividends (58) (58)
--------------- ----------------
Net income (loss) attributed to
common stockholders $ (576) $ 374
================ ================
Denominator:
Weighted-average shares outstanding for
basic earnings per share 5,869,138 5,844,788
Effect of dilutive securities:
Employee stock options, warrants, options outside
the plan and convertible preferred stock - 1,706,793
---------------- ----------------
Adjusted weighted-average shares outstanding
and assumed conversions for
diluted earnings per share 5,869,138 7,551,581
=============== ================
Shares related to dilutive securities excluded
because inclusion would be anti-dilutive 3,538,956 821,620
================ ================
The difference between the basic and diluted number of weighted
average shares outstanding for the quarter ended March 31, 2002
represents dilutive stock options, warrants and convertible preferred
stock to purchase shares of common stock computed under the treasury
stock method, using the average market price during the period. The net
income (loss) for the quarters ended March 31, 2003 and 2002 were
decreased by preferred stock dividends of $58,000 in calculating the per
share amounts. Conversion of the stock options, warrants and preferred
stock was not assumed for the three months ended March 31, 2003 because
the impact was anti-dilutive.
3. Inventories
Inventories are stated at the lower of cost, as determined by the
average cost method, or market. Obsolete or unsaleable inventory is
reflected at its estimated net realizable value. Inventories consist of
the following:
Note 3 - Inventories
(in thousands) March 31, December 31,
2003 2002
------------- ---------------
Raw materials $ 1,237 $ 1,203
Service parts 325 357
------------- ---------------
Total inventories $ 1,562 $ 1,560
============= ===============
4. Software Development Costs
Certain computer software development costs are capitalized in the
accompanying consolidated balance sheets. Capitalization of computer
software development costs begins upon the establishment of
technological feasibility. Capitalization ceases and amortization of
capitalized costs begins when the software product is commercially
available for general release to customers. Amortization of capitalized
computer software development costs is included in cost of revenue and
is determined using the straight-line method over the remaining
estimated economic life of the product, not to exceed five years.
Software development costs capitalized were $408,000 and $523,000
for the quarters ended March 31, 2003 and 2002, respectively. Total
amortization expense was $575,000 and $449,000 for the quarters ended
March 31, 2003 and 2002, respectively.
5. Stock Compensation
The Company applies the intrinsic-value-based method of
accounting prescribe by Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock issued to Employees, and related interpretations
including FASB Interpretation No. 44, Accounting for Certain Transactions
involving Stock Compensation, and interpretation of APB Opinion No. 25,
issued in March 2000, to account for its fixed-plan stock options. Under
this method, compensation expense is recorded on the date of grant only
if the current market price of the underlying stock exceeds the exercise
price. SFAS No. 123, Accounting for Stock-Based Compensation, established
accounting and disclosure requirements using a fair-value-based method of
accounting for stock based employee compensation plans. As allowed by
SFAS No. 123, the Company has elected to continue to apply the
intrinsic-value-based method of accounting describe above, and has
adopted only the disclosure requirements of SFAS No. 123.
If the computed values of all the Company's stock based awards were
calculated and expensed (over the vesting period of the awards) using the
fair value method specified under SFAS 123, net income (loss) would have
been as follows:
(in thousands, except per share data) Three months
ended March 31,
----------------------------
2003 2002
------------- ------------
Net income (loss) attributed to
common stockholders, as reported $ (576) $ 374
Add stock-based employee compensation expense
included in reported net imcome (loss), net of tax - -
Deduct total stock-based employee compensation
expense determined under fair-value-method
for all awards, net of tax (67) (106)
------------- ------------
Pro forma net income (loss) $ (643) $ 268
============= ============
Net income (loss) per share, as reported:
Basic $ (0.10) $ 0.06
Diluted $ (0.10) $ 0.06
Proforma net income (loss) per share:
Basic $ (0.11) $ 0.05
Diluted $ (0.11) $ 0.04
No employee stock options were issued in the first quarter of 2003 or
2002.
6. Long-term Debt
The Company's long-term debt consists of the following notes payable
and other financing arrangements:
Note 11 Notes and financing
(in thousands) March 31, December 31,
2003 2002
------------------ ------------------
Line of credit with bank $ 3,653 $ 5,431
Obligations under financing leases 3,312 3,784
Notes payable to related parties 650 650
Notes payable, other 65 73
------------------ ------------------
Total notes payable and financing arrangements 7,680 9,938
Less amounts payable within one year 5,510 1,905
------------------ ------------------
Long-term portion $ 2,170 $ 8,033
================== ==================
Line of Credit
The Company has a $6.5 million bank line of credit under which the
Company and its subsidiaries, GSE Process Solutions, Inc. and GSE Power
Systems, Inc., are jointly and severally liable as co-borrowers. The
credit facility provides for borrowings to support working capital needs
and foreign letters of credit ($2.0 million sub limit). The line is
collateralized by substantially all of the Company's assets and provides
for borrowings up to 85% of eligible accounts receivable, 50% of
eligible unbilled receivables and 40% of eligible inventory (up to a
maximum of $1.2 million). The interest rate on this line of credit is
based on the bank's prime rate plus 1.00% (5.25% as of March 31, 2003),
with interest only payments due monthly. At March 31, 2003, the
Company's available borrowing base was approximately $4.2 million, of
which approximately $3.7 million had been utilized. The credit facility
expires on March 31, 2004. The lender has requested that the Company
find a new lender.
The maximum commitment under the credit facility will be reduced
to $5.5 million on October 1, 2003 and to $5.0 million on January 1,
2004. The agreement prohibits the payment of all dividends, including
dividends due to ManTech on its outstanding preferred stock. GP
Strategies has provided $1.8 million limited guarantee of the Company's
bank facility through March 31, 2004. In consideration for the extension
of the guarantee, the Company will issue 150,000 shares of its common
stock to GP Strategies. The number of shares was calculated based upon a
10% fee divided by the closing price of GSE's common stock on March 21,
2003.
The credit facility requires the Company to comply with certain
financial rations. At March 31, 2003, the Company was not in
compliance with its financial ratio covenants. The Company expects to
receive a written waiver from the bank for noncompliance.
Because the credit facility expires on March 31, 2004, the Company
has classified the borrowings under the line of credit as current as of
March 31, 2003. The lender has requested that the Company find a new
lender by March 31, 2004.
Notes Payable to Related Parties
On June 25, 2001, the Company issued an unsecured promissory note
to ManTech for $1.0 million at an interest rate of prime plus one
percent. The Company used the loan proceeds for working capital
purposes. The note is subordinated to the Company's credit facility.
During 2002, the Company repaid ManTech $350,000; as of March 31, 2003,
there is $650,000 outstanding on the note. The Company has an additional
unsecured promissory note to a former employee for $65,000 which expires
April 14, 2005.
Obligations under financing leases
As of March 31, 2003, the Company has seven separate contracts
with a customer for the lease of certain hardware and software under
36-month leases. The Company has accounted for the leases as sales-type
leases. The Company assigned the payments due under the sales-type
leases to a third-party financing company; for the year ended December
31, 2002, the Company received approximately $2.2 million of proceeds.
Since the Company remains contingently liable for amounts due to the
third-party financing company, the remaining investment in and
obligation under the financing leases are reflected in the Company's
balance sheets as follows:
(in thousands) March 31, December 31,
2003 2002
------------------ -----------------
Net investment in sales-type leases:
Prepaid expense and other assets $ 1,826 $ 1,875
Other assets 1,486 1,909
------------------ -----------------
Total net investment $ 3,312 $ 3,784
================== =================
Obligation under financing leases:
Current portion of long-term debt $ 1,826 $ 1,875
Long-term debt 1,486 1,909
------------------ -----------------
Total obligations $ 3,312 $ 3,784
================== =================
7. Series A Convertible Preferred Stock
The Series A convertible preferred stock has no voting rights and
bears dividends at the rate of 6% per annum payable quarterly. Dividends
will accumulate if not paid quarterly and compounded interest will
accrue on any unpaid dividends. As of March 31, 2003 and December 31,
2002 the Company had accrued dividends payable of $234,000 and $176,000,
respectively. ManTech at its discretion has the right to convert each
share of Series A convertible preferred stock into GSE common stock, but
if not converted prior to December 2004, the Series A convertible stock
automatically converts into GSE common stock at that time.
8. Letters of Credit
As of March 31, 2003, the Company was contingently liable for seven
letters of credit totaling $762,000. All of these letters of credit
represent payment bonds on contracts and have been cash collateralized
and are classified as restricted cash in the consolidated balance sheet.
9. Income Taxes
The Company's effective tax rate was 7.7% and 38.3% for the three
months ended March 31, 2003 and March 31, 2002. The 7.7% effective tax
rate is an average rate that consists of a zero effective tax rate for
the Company's US and China operations and a 13.1% effective tax rate
for its Swedish operations. The decrease in the effective tax rate is
attributable to the Company recording no federal or state benefit for
net operation losses generated by its US and China operations as of
March 31, 2003.
10. Segment Information
The Company's two reportable segments are its core business units
Process and Power. The Company is primarily organized on the basis of
these two business units. The Company has a wide range of knowledge of
control and simulation systems and the processes those systems are
intended to improve, control and model. The Company's knowledge is
concentrated heavily in the process industries, which include the
chemicals, food & beverage, and pharmaceutical fields, as well as in
the power generation industry. The Process business unit is primarily
engaged in process control in a variety of commercial industries.
Contracts typically range from three to nine months. The Power business
unit is primarily engaged in simulation for the power generation
industry, with the vast majority of customers being in the nuclear power
industry. Contracts typically range from 18 months to three years.
The Company evaluates the performance of its business units
utilizing "Business Unit Contribution", which is substantially
equivalent to earnings before interest and taxes before allocating any
corporate expenses.
The table below presents information about the reportable segments:
(in thousands) Three months ended March 31, 2003
---------------------------------------------
Process Power Consolidated
Contract revenue $ 4,331 $ 4,932 $ 9,263
============ ============= ================
Business unit contribution $ (4) $ 390 $ 386
============ ============= ================
Three months ended March 31, 2002
--------------------------------------------
Process Power Consolidated
Contract revenue $ 6,701 $ 4,573 $ 11,274
============ ============= ================
Business unit contribution $ 1,652 $ (120) $ 1,532
=========== ============= ================
A reconciliation of segment business unit contribution to
consolidated income before taxes is as follows:
(in thousands) Three months
ended March 31,
-----------------------------
2003 2002
-------------- -------------
Segment business unit contribution $ 386 $ 1,532
Corporate expenses (786) (760)
Interest expense, net (81) (72)
-------------- -------------
Income before income taxes $ (481) $ 700
============== =============
11. Recent Accounting Pronouncements
In October 2002, the Emerging Issues Task Force of the FASB reached a
consensus on the accounting for revenues in transactions that involve
multiple deliverables. The guidance governs how to identify whether goods
or services or both, that are to be delivered separately in a bundled
sales arrangement, should be accounted for separately. This guidance will
be effective July 1, 2003. The Company has not yet determined the impact
this consensus will have on its consolidated financial statements.
12. Sublease
The Company has entered into a sublease agreement with Alpharma USPD
Inc. to sublease 29,000 square feet of its Baltimore, MD facility for a
five-year period commencing on May 1, 2003. The subtenant may terminate
the lease at the end of the second or third year of the agreement
provided a six month notice is given. The Company has moved most of the
Process personnel presently using this facility to its Columbia,
Maryland facility in April 2003. During the second quarter of 2003, the
Company will record a charge of approximately $100,000 related to the
estimated loss on the sublease and moving expenses.
13. Reclassifications
Certain prior year amounts have been reclassified to conform to the
current year presentation.
GSE SYSTEMS, INC. AND SUBSIDIARIES
FORM 10-Q
For the Three Months ended March 31, 2003 and 2002
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
The Company has a $6.5 million credit facility with a bank which
matures on March 31, 2004. The Company has been informed by its bank that the
Company should begin to search for a new financial institution to provide for
its future financing requirements. The maximum commitment under the credit
facility reduces to $5.5 million on October 1, 2003 and to $5.0 million on
January 1, 2004. Based upon the Company's current forecasts of its cash flow in
2003, management believes the reductions in the maximum commitment will not have
an impact on the Company's operations or liquidity. In order to help improve the
Company's liquidity and operating results, management has undertaken actions to
reduce its operating expenses, including the sublease of 29,000 square feet of
its 34,000 square foot Baltimore, Maryland facility effective May 1, 2003.
During the second quarter of 2003, the Company will record a charge of
approximately $100,000 related to the estimatedd loss on the sublease and moving
expenses.
The Company's 2003 profitability and liquidity projections depend on
several large full-scope simulator contracts in its Power business unit, several
of which were awarded to the Company during the quarter ended March 31, 2003.
The Company's contract backlog has increased $5.9 million from $29.9 million to
$35.8 million as of December 31, 2002 and March 31, 2003, respectively.
Approximately all but 28% of the $35.8 million backlog will be filled in 2003.
Cautionary Statement Regarding Forward-Looking Statements
This report contains certain forward-looking statements. Any statements
contained herein that are not statements of historical facts may be deemed
forward-looking statements. These statements are based on management's current
beliefs and expectations and are subject to numerous risks and uncertainties and
changes in circumstances. Actual results may differ materially from these
forward-looking statements due to changes in global, economic, business,
governmental, technical, competitive, market and regulatory factors.
General Business Environment
GSE Systems, Inc. ("GSE Systems", "GSE" or the "Company") is a world
leader in real-time power plant simulation and process automation and control.
The Company provides simulation solutions and services to the nuclear and fossil
electric utility industry, as well as process industries such as the chemical
and petrochemical industries. In addition, the Company provides plant
monitoring, security access and control, and signal analysis monitoring and
optimization software primarily to the power industry. The Company's process
automation products optimize batch and hybrid plant control for the specialty
chemical, food and beverage, and pharmaceutical industries. The Company operates
through two business segments, Power Simulation and Process Automation.
The Company's annual report on Form 10-K, quarterly reports on Form
10-Q, current reports on Form 8-K, and all amendments to those reports will be
made available free of charge through the Investor Relations section of the
Company's Internet website (http://www.gses.com) as soon as practicable after
such material is electronically filed with, or furnished to, the Securities and
Exchange Commission.
Power Simulation Business.
The Company's Power Simulation Business Unit ("Power") is positioning
itself to take advantage of emerging trends in the power industry. The operating
licenses for numerous nuclear power plants will expire over the next several
years. Ten plants have already received license extensions, and twenty more have
applications pending. Many plants are also planning significant upgrades to the
physical equipment and control room technology in conjunction with the license
extensions. Both will result in the need to modify or replace the existing plant
control room simulators. The Company, having the largest installed base of
existing simulators, is well positioned to capture the majority of this
business.
To address the varying levels of technology that exists across the
Company's installed base, the Company has developed a Java-based graphical
overlay technology called JADE (Java Application Development Environment). JADE
provides a common look and feel to the Company's various simulation tools
regardless of whether the underlying technology is UNIX, LINUX or Microsoft
Windows XP. JADE also works with all of the Company's tools for building
electrical, logic and control, and flow system models for plants. Jade Version
1.0 was released for sale on March 31, 2003.
Process Control Business
To expand within its traditional customer base and gain new customers,
Process embarked upon a program in 2002 to develop a lower-cost, next generation
process controller using the latest microprocessor technology. This new
controller was part of the third quarter 2002 D/3 product release that also
included enhanced alarming and improved security features. This new version of
the D/3 product will allow the Company to bridge the cost gap between
programmable logic controllers (PLCs) and the distributed control systems while
providing the increased performance of a full-function distributed control
system. This more cost effective solution will enable existing customers to
apply automation to areas of their plants that could not previously afford the
benefits of a full-function distributed control system. The Company has
initiated a program to expand its distribution channels for its new products,
particularly in smaller, batch applications where previously the power of the
D/3 could not be cost effectively applied. To this end the Company has partnered
with six Manufacturer's Representative organizations and two Systems Integrator
companies. This new Channel Partnership program has increased the number of
salespeople selling the D/3 by over fifty. The Company intends to add additional
partners as needed.
The Company has entered into a sublease agreement with Alpharma USPD
Inc. to sublease 29,000 square feet of its Baltimore, MD facility for a
five-year period commencing on May 1, 2003. The subtenant may terminate the
lease at the end of the second or third year of the agreement provided a six
month notice is given. The Company plans to move most of the Process personnel
presently using this facility to its Columbia, Maryland facility in April 2003.
Results of Operations
The following table sets forth the results of operations for the
periods presented expressed in thousands of dollars and as a percentage of
revenues:
(in thousands) Three months ended March 31,
-----------------------------------------------
2003 % 2002 %
----------- --------- ----------- ---------
Contract revenue $ 9,263 100.0 % $11,274 100.0 %
Cost of revenue 6,905 74.5 % 7,791 69.1 %
----------- --------- ----------- ---------
Gross profit 2,358 25.5 % 3,483 30.9 %
----------- --------- ----------- ---------
Operating expenses:
Selling, general and administrative 2,595 28.0 % 2,618 23.2 %
Depreciation and amortization 157 1.3 % 140 1.3 %
----------- --------- ----------- ---------
Total operating expenses 2,752 29.3 % 2,758 24.5 %
----------- --------- ----------- ---------
Operating income (loss) (394) (3.9)% 725 6.4 %
Interest expense, net (81) (0.9)% (72) (0.6)%
Other income (expense), net (6) (0.1)% 47 0.4 %
---------- --------- ----------- ---------
Income(loss)before income taxes (481) (5.2)% 700 6.2 %
Provision for income taxes 37 0.4 % 268 2.4 %
---------- --------- ----------- ---------
Net income (loss) $ (518) (5.6)% $ 432 3.8 %
=========== ========= =========== =========
Critical Accounting Policies and Estimates
In preparing the Company's financial statements, management makes
several estimates and assumptions that affect the Company's reported amounts of
assets, liabilities, revenues and expenses. Those accounting estimates that have
the most significant impact on the Company's operating results and place the
most significant demands on management's judgment are discussed below. For all
of these policies, management cautions that future events rarely develop exactly
as forecast, and the best estimates may require adjustment.
Revenue Recognition on Long-Term Contracts. The Company uses the
percentage-of-completion revenue recognition methodology to record revenue under
its long-term fixed-price contracts in accordance with the AICPA Statement of
Position 81-1, "Accounting for Performance of Construction-Type and Certain
Production-Type Contracts". This methodology recognizes income as work
progresses on the contract and is based on an estimate of the income earned to
date, less income recognized in earlier periods. The Company bases its estimate
of the degree of completion of the contract by reviewing the relationship of
costs incurred to date to the expected total costs that will be incurred on the
project. The Company's project managers are responsible for estimating the costs
to be incurred at the beginning of each project and are responsible for updating
the estimate as the project progresses. Management reviews the status of each
project periodically with the project managers and determines whether the cost
estimates are reasonable. If changes in the estimated costs to complete the
projects are required, the cumulative impact on the percentage of completion
revenue calculation is recognized in the period identified. Whenever evidence
indicates that the estimated total cost of a contract will exceed its total
contract value, the Company's operating results are charged for the full amount
of the estimated losses immediately. Uncertainties inherent in the performance
of contracts include labor availability and productivity, material costs, change
order scope and pricing, software modification issues and customer acceptance
issues. The reliability of these cost estimates is critical to the Company's
revenue recognition as a significant change in the estimates can cause the
Company's revenue and related margins to change significantly from the amounts
estimated in the early stages of the project.
Capitalization of Computer Software Development costs. In accordance
with Statement of Financial Accounting Standards (SFAS) No. 86 "Accounting for
the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed", the
Company capitalizes computer software development costs incurred after
technological feasibility has been established, but prior to the release of the
software product for sale to customers. Once the product is available to be
sold, the Company begins to amortize the costs over the estimated useful life of
the product, which normally ranges from three to five years. At March 31, 2003,
the Company has net capitalized software development costs of $4.2 million. On
an annual basis, the Company assesses the recovery of the unamortized software
computer costs by estimating the net undiscounted cash flows expected to be
generated by the sale of the product. If the undiscounted cash flows are not
sufficient to recover the unamortized software costs the Company will write-down
the unamortized software development costs to net realizable value. The excess
of any unamortized computer software costs over the related net realizable value
is written down and charged to income. Significant changes in the sales
projections could result in an impairment with respect to the capitalized
software that is reported on the Company's balance sheet.
Deferred Income Tax Valuation Allowance. Deferred income taxes arise
from temporary differences between the tax bases of assets and liabilities and
their reported amounts in the financial statements. As required by SFAS No. 109
"Accounting for Income Taxes", management makes an annual assessment of the
realizability of the Company's deferred tax assets. In making this assessment,
management considers whether it is more likely than not that some or all of the
deferred tax assets will not be realized. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible. Management
considers the scheduled reversal of deferred tax liabilities and projected
future taxable income of the Company in making this assessment. A valuation
allowance is recorded to reduce the total deferred income tax assets to its
realizable value. At March 31, 2003, the Company's deferred tax assets related
primarily to a U.S. net operating loss carryforward of $15.1 million which can
be utilized over the next twenty years. The recovery of the remaining net
deferred tax asset could not be substantiated by currently available objective
evidence, and, accordingly, the Company has established a full valuation
allowance for the balance of its deferred tax asset of $7.8 million at March 31,
2003. If the Company is able to realize taxable income in the future, the
valuation allowance will be reduced.
Results of Operations - Three Months ended March 31, 2003 versus Three Months
ended March 31, 2002.
Contract Revenue. Total contract revenue for the quarter ended March
31, 2003 totaled $9.3 million, which was 17.8% lower than the $11.3 million
total revenue for the quarter ended March 31, 2002.
The Process business unit's revenue was $4.3 million for the first
quarter 2003 compared with $6.7 million in the same period of 2002, a 35.4%
decrease. The decrease in Process' revenue is mainly attributable to a reduction
in orders received from Westinghouse Savannah River Corporation. In the first
quarter 2003, revenue generated from work performed for Westinghouse Savannah
River Corporation totaled 29.4% of total Process revenue, versus 49.3% in 4the
first quarter 2002.
The Power business unit revenue increased 7.9% in the three months
ended March 31, 2003 as compared to the same period in the prior year, from $4.6
million to $4.9 million. The increase is mainly attributable to the start-up of
two large international training simulator projects in the first quarter, 2003.
Gross Profit. Gross profit totaled $2.4 million (25.5% of revenue) for
the quarter ended March 31, 2003, as compared with $3.5 million (30.9% of
revenue) for the quarter ended March 31, 2002. The decrease in gross profit is
mainly attributable to increases in operations overhead and capitalized software
development amortization.
Selling, General and Administrative Expenses. Selling, general and
administrative ("SG&A") expenses totaled $2.6 million in the quarter ended March
31, 2003, which was essentially unchanged from the same period in 2002,
including the net research and product development expenditures ("R&D"), as
discussed below.
Gross R&D totaled $643,000 in the first quarter of 2003, as compared
with $626,000 in the same period of 2002. Capitalized software development costs
totaled $408,000 and $523,000 for the first quarter of 2003 and 2002,
respectively. Accordingly, net R&D expensed and included in SG&A was $235,000
and $102,000 for the first quarter of 2003 and 2002, respectively. The Company's
R&D expenditures in the first quarter 2003 were related to:
* Enhancements for the D/3 system including improved diagnostics,
enhanced display features, improved PCM redundancy and an Ethernet
interface for I/O.
* The completion of JADE 1.0 (Java Applications & Development
Environment), a Java-based application that provides a window into the
simulation instructor station and takes advantage of the web
capabilities of Java, allowing customers to access the simulator and
run simulation scenarios from anywhere they have access to the web.
* Additional enhancements to JADE that will be released in version 2.0,
including implementing XML in JADE for pagination, adding wireless PDA
for JStation applications, and adding a two phase object oriented flow
network.
Depreciation and Amortization. Depreciation expense totaled $147,000
and $140,000 during the quarters ended March 31, 2003 and 2002, respectively.
Operating Income (Loss). The Company had operating loss of $394,000
(3.9% of revenue) in the first quarter 2003, as compared with operating income
of $725,000 (6.4% of revenue) for the same period in 2002. The decrease was due
to the factors outlined above.
Interest Expense, Net. Net interest expense increased 12.5% from
$72,000 in the quarter ended March 31, 2002 to $81,000 for the same quarter in
2003.
Other Income (Expense), Net. For the three months ended March 31,
2003, other income (expense) mainly reflects the Company's proportionate share
of income of the Company's investment in RedStorm Scientific, Inc. In the same
period of 2002, other income (expense) mainly reflects recognized foreign
currency transaction gains.
Provision for Income Taxes. The Company's effective tax rate was 7.7%
and 38.3% for the three months ended March 31, 2003 and March 31, 2002. The 7.7%
effective tax rate is an average rate that consists of a zero effective tax rate
for the Company's US and China operations and a 13.1% effective tax rate for its
Swedish operations. The decrease in the effective tax rate is attributable to
the Company recording no federal or state benefit for net operating losses
generated by its US and China operations as of March 31, 2003.
Liquidity and Capital Resources
As of March 31, 2003, the Company's cash and cash equivalents totaled
$209,000, compared to $1,617,000 at December 31, 2002.
Cash provided by (used in) operating activities. Net cash provided by
operating activities was $805,000 for the quarter ended March 31, 2003. The only
significant change in the Company's assets and liabilities in 2003 was a
decrease in contract receivables of $864,000 due to the collection of a
significant receivable from one customer.
Net cash used in operating activities was ($901,000) for the quarter
ended March 31, 2002. Significant changes in the Company's assets and
liabilities in 2002 included:
* an increase in contract receivables of $570,000 largely related to the
Westinghouse Savannah River Corp. projects, and
* $962,000 reduction in billings in excess of revenues earned. The
Company had received orders from two Process customers in the third
quarter 2001 that allowed GSE to invoice the customer in full prior to
the work being completed. The reduction in billings in excess reflects
the completion of a portion of these two contracts in the first quarter
2002.
Cash used in investing activities. Net cash used in investing
activities was $427,000 in the first quarter 2003, including $408,000 of
capitalized software development costs and $19,000 for capital expenditures.
In the first quarter 2002, net cash used in investing activities was
$866,000, consisting of $523,000 of capitalized software development costs and
$343,000 for capital expenditures.
Cash provided by (used in) financing activities. During the quarter
ended March 31, 2003, the Company used $1.8 million net cash in financing
activities. The Company decreased its borrowings under its bank line of credit
by $1.8 million to a total of $3.7 million. In addition, the Company issued a
$15,000 bid bond that was cash collateralized. Bid bonds are issued by the
Company in the ordinary course of business through banks as required by certain
contracts and proposal requirements.
In the first quarter of 2002, the Company generated $997,000 net cash
through financing activities. The Company received $1.3 million from its escrow
agent in January 2002 from a fixed-price rights offering which was completed on
December 21, 2001 and received $262,000 from the exercise of employee stock
options. The Company decreased its borrowings under its bank line of credit by
$68,000 to a total of $4.9 million, and decreased its borrowings from ManTech
International Corporation by $250,000 to a total of $750,000. In addition, the
Company issued a $150,000 bid bond that was cash collateralized.
Credit Facilities
The Company has a $6.5 million bank line of credit with a bank which
matures on March 31, 2004. The credit facility provides for borrowings up to a
total $6.5 million to support working capital needs and foreign letters of
credit. At March 31, 2003, the Company's available borrowing base was $4.2
million, of which approximately $3.7 million had been utilized. The credit
facility expires on March 31, 2004. The lender has requested that the Company
find a new lender.
The maximum commitment under the credit facility will be reduced to
$5.5 million on October 1, 2003 and to $5.0 million on January 1, 2004. The
agreement prohibits the payment of all dividends, including dividends due to
ManTech on its outstanding preferred stock. GP Strategies has provided $1.8
million limited guarantee of the Company's bank facility through March 31, 2004.
In consideration for the extension of the guarantee, the Company will issue
150,000 shares of its common stock to GP Strategies. The number of shares was
calculated based upon a 10% fee divided by the closing price of GSE's common
stock on March 21, 2003.
The credit facility requires the Company to comply with certain
financial ratios. At March 31, 2003, the Company was not in compliance with its
financial ratio covenants. The Company has received a written waiver from the
bank for noncompliance and amendments to the required financial ratio covenants
for 2003. As of March 31, 2003, the Company has classified the borrowings under
the line of credit as current. See Note 6, "Long-term Debt", in the Notes to
Consolidated Financial Statements" for additional details about this line of
credit.
On June 25, 2001, the Company issued an unsecured promissory note to
ManTech that allowed the Company to borrow up to $1.0 million at an interest
rate of prime plus one percent. The note is subordinated to the Company's credit
facility. In January 2002, the Company repaid ManTech $250,000 of the note from
the proceeds of a fixed-price rights offering that was completed in December
2001 and an additional $100,000 subsequent to January 2002.
Item 3. Quantitative and Qualitative Disclosure about Market Risk
The Company's market risk is principally confined to changes in foreign
currency exchange rates and potentially adverse effects of differing tax
structures. The Company's exposure to foreign exchange rate fluctuations arises
in part from inter-company accounts in which costs incurred in one entity are
charged to other entities in different foreign jurisdictions. The Company is
also exposed to foreign exchange rate fluctuations as the financial results of
all foreign subsidiaries are translated into U.S. dollars in consolidation. As
exchange rates vary, those results when translated may vary from expectations
and adversely impact overall expected profitability.
The Company is also subject to market risk related to the interest
rates on its existing line of credit. As of March 31, 2003, such interest rates
are based on the bank's prime rate plus 100 basis-points.
As of March 31, 2003, $4.3 million of the Company's debt was subject to
variable interest rates. A 100 basis-point change in such rates during the
quarter ended March 31, 2003 would have changed the Company's interest expense
by approximately $12,000.
Item 4. Controls and Procedures
Within the 90-day period prior to the filing of this report, GSE
management, including the Chief Operating Officer and Chief Financial Officer,
conducted an evaluation of the effectiveness of the design and operation of the
company's disclosure controls and procedures as defined in Exchange Act Rule
13a-14(c). Based on that evaluation, the Chief Operating Officer and Chief
Financial Officer concluded that the company's disclosure controls and
procedures were effective as of the date of that evaluation. There have been no
significant changes in internal controls, or in factors that could significantly
affect internal controls, subsequent to the date the Chief Operating Officer and
Chief Financial Officer completed their evaluation.
GSE SYSTEMS, INC. AND SUBSIDIARIES
FORM 10-Q
For the Quarters ended March 31, 2003 and 2002
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
In accordance with its conduct in the ordinary course of business,
certain actions and proceedings are pending to which the Company is a party. In
the opinion of management, the aggregate liabilities, if any, arising from such
actions are not expected to have a material adverse effect on the financial
condition of the Company.
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
99.1 Certification Pursuant to Section 906 of Sarbanes-Oxley
Act of 2002
99.2 Certification Pursuant to Section 906 of Sarbanes-Oxley
Act of 2002
(b) Reports on Form 8-K
Form 8-K was filed by the Registrant with the Securities and
Exchange Commission on March 10, 2003 regarding the net loss for
the quarter ending December 31, 2002 and for the year ended
December 31, 2002.
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.
Date: May 15, 2003 GSE SYSTEMS, INC.
/S/ CHIN-OUR JERRY JEN
Chin-Our Jerry Jen
Chief Operating Officer and President
(Principal Executive Officer)
/S/ JEFFERY G. HOUGH
Jeffery G. Hough
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
SECTION 302 CERTIFICATIONS
I, Chin-Our Jerry Jen, certify that:
1.) I have reviewed this quarterly report on Form 10-Q of GSE Systems, Inc.
(the "Company");
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 period 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 Company as of, and for, the periods presented in this
quarterly report.
4.) The Company's other certifying officers 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 Company, 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 Company'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;
5.) The Company's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit
committee of the 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 Company's ability to record,
process, summarize and report financial data and have identified for the
Company'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 Company's internal controls;
and
6.) The Company's other certifying officers 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.
Date: May 15, 2003
/S/ CHIN-OUR JERRY JEN
Chin-Our Jerry Jen
President and Chief Operating Officer
(Principal Executive Officer)
SECTION 302 CERTIFICATIONS
I, Jeffery G. Hough, certify that:
1.) I have reviewed this quarterly report on Form 10-Q of GSE Systems, Inc.
(the "Company");
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 period 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 Company as of, and for, the periods presented in this
quarterly report.
4.) The Company's other certifying officers 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 Company, 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 Company'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;
5.) The Company's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit
committee of the 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 Company's ability to record,
process, summarize and report financial data and have identified for the
Company'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 Company's internal controls;
and
6.) The Company's other certifying officers 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.
Date: May 15, 2003
/S/ JEFFERY G. HOUGH
Jeffery G. Hough
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)