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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 September 30, 2004.
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 November 1, 2004, there were 8,949,706 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 September 30, 2004 and 3
December 31, 2003
Consolidated Statements of Operations for the Three 4
and Nine Months Ended September 30, 2004
and September 30, 2003
Consolidated Statements of Comprehensive Income (Loss) 5
for the Three and Nine Months Ended September 30, 2004
and September 30, 2003
Consolidated Statements of Cash Flows for the 6
Nine Months Ended September 30, 2004 and September 30, 2003
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Results of 13
Operations and Financial Condition
Item 3. Quantitative and Qualitative Disclosures About Market Risk 21
Item 4. Controls and Procedures 21
22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 22
Item 2. Changes in Securities and Use of Proceeds 22
Item 3. Defaults Upon Senior Securities 22
Item 4. Submission of Matters to a Vote of Security Holders 22
Item 5. Other Information 22
Item 6. Exhibits 22
SIGNATURES 23
- -----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
Unaudited
September 30, 2004 December 31, 2003
------------------ -----------------
ASSETS
Current assets:
Cash and cash equivalents $ 1,025 $ 1,388
Restricted cash 94 473
Contract receivables 9,479 9,457
Prepaid expenses and other current assets 1,031 1,635
--------------- --------------
Total current assets 11,629 12,953
Equipment and leasehold improvements, net 580 643
Software development costs, net 982 946
Goodwill, net 1,739 1,739
Other assets 121 255
-------------- -------------
Total assets $ 15,051 $ 16,536
============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 18 $ 33
Accounts payable 3,466 2,946
Due to GP Strategies Corporation 427 100
Accrued expenses 1,457 1,418
Accrued compensation and payroll taxes 1,575 1,752
Billings in excess of revenue earned 1,375 3,927
Other current liabilities 193 240
-------------- -------------
Total current liabilities 8,511 10,416
Long-term debt - 9
Accrued warranty reserves 655 407
Other liabilities 6 25
-------------- -------------
Total liabilities 9,172 10,857
Commitments and contingencies
Stockholders' equity:
Series A convertible preferred stock $.01 par value, 2,000,000 shares
authorized, no shares issued and outstanding - -
Common stock $.01 par value, 18,000,000 shares authorized, shares issued
and outstanding 8,949,706 in 2004 and 2003 89 89
Additional paid-in capital 30,815 30,815
Retained earnings (deficit) - at formation (5,112) (5,112)
Retained earnings (deficit) - since formation (18,959) (19,162)
Accumulated other comprehensive loss (954) (951)
-------------- -------------
Total stockholders' equity 5,879 5,679
-------------- -------------
Total liabilities and stockholders' equity $ 15,051 $ 16,536
============== =============
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 Nine months ended
September 30, September 30,
--------------------- -----------------------
2004 2003 2004 2003
--------- ---------- --------- --------
Contract revenue $ 7,340 $ 6,139 $ 22,498 $ 16,660
Cost of revenue 5,835 4,654 17,379 12,980
--------- ---------- --------- ---------
Gross profit 1,505 1,485 5,119 3,680
--------- ---------- --------- ---------
Operating expenses
Selling, general and administrative 1,449 1,588 3,871 4,140
Administrative charges from GP Strategies 247 - 739 -
Depreciation and amortization 64 95 207 295
--------- ----------- -------- ----------
Total operating expenses 1,760 1,683 4,817 4,435
--------- ----------- -------- ----------
Operating income (loss) (255) (198) 302 (755)
Interest expense, net (5) (101) (164) (246)
Other income (expense), net 19 (14) 35 (22)
--------- ----------- -------- ----------
Income (loss) from continuing operations
before income taxes (241) (313) 173 (1,023)
Provision (benefit) for income taxes (44) - 30 22
--------- ----------- -------- ----------
Income (loss) from continuing operations (197) (313) 143 (1,045)
Loss from discontinued operations - (121) - (1,039)
Income (loss) on sale of discontinued operations 60 (262) 60 (262)
--------- ---------- -------- -----------
Net income (loss) (137) (696) 203 (2,346)
Preferred stock dividends - (59) - (175)
---------- ----------- ---------- ----------
Net income (loss) attributed to
common shareholders $ (137) $ (755) $ 203 $ (2,521)
========== =========== ========== ==========
Basic earnings (loss) per common share:
Continuing operations $ (0.02) $ (0.06) $ 0.02 $ (0.20)
Discontinued operations - (0.07) - (0.23)
---------- ---------- ---------- -----------
Net income (loss) $ (0.02) $ (0.13) $ 0.02 $ (0.43)
========== ========== ========== ===========
Diluted earnings (loss) per common share:
Continuing operations $ (0.02) $ (0.06) $ 0.02 $ (0.20)
Discontinued operations - (0.07) - (0.23)
--------- --------- ---------- -----------
Net income (loss) $ (0.02) $ (0.13) $ 0.02 $ (0.43)
========== ========== ========== ==========
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 Nine months ended
September 30, September 30,
------------------------ -------------------------
2004 2003 2004 2003
---------- --------- ----------- ------------
Net income (loss) $ (137) $ (696) $ 203 $ (2,346)
Foreign currency translation adjustment 51 58 (3) 153
--------- ---------- ----------- -------------
Comprehensive income (loss) $ (86) $ (638) $ 200 $ (2,193)
======== ========= ========== ===========
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)
Nine months ended
September 30,
---------------------------
2004 2003
------------ --------------
Cash flows from operating activities:
Net income (loss) $ 203 $ (2,346)
Loss from discontinued operations - (1,039)
Income (loss) on sale of discontinued operations 60 (262)
----------- ------------
Income (loss) from continuing operations 143 (1,045)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 490 535
Changes in assets and liabilities:
Contract receivables (22) (1,344)
Prepaid expenses and other assets 709 (430)
Accounts payable, accrued compensation and accrued expenses 406 1,261
Due to GP Strategies Corporation 327 -
Billings in excess of revenues earned (2,552) 2,523
Accrued warranty reserves 320 (193)
Other liabilities (44) (3)
------------ ------------
Net cash provided by (used in) continuing operations (223) 1,304
Net cash provided by (used in) discontinued operations (60) 1,253
------------ -------------
Net cash provided by (used in) operating activities (283) 2,557
------------ -------------
Cash flows from investing activities:
Proceeds from sale of Process business, net of transaction costs - 5,245
Net cash paid for acquisition of businesses - (515)
Capital expenditures (144) (173)
Capitalized software development costs (319) (464)
Releases of cash as collateral under letters of credit 408 256
Other cash used in discontinued operations, net - (506)
------------ -------------
Net cash provided by (used in) investing activities (55) 3,843
------------ --------------
Cash flows from financing activities:
Decrease in borrowings under line of credit - (5,431)
Other financing activities, net (24) (22)
------------ -------------
Net cash used in financing activities (24) (5,453)
------------ -------------
Effect of exchange rate changes on cash (1) 69
------------ -------------
Net increase (decrease) in cash and cash equivalents (363) 1,016
Cash and cash equivalents at beginning of year 1,388 1,617
------------ -------------
Cash and cash equivalents at end of period $ 1,025 $ 2,633
============ =============
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 and Nine Months ended September 30, 2004 and 2003
(Unaudited)
1. Basis of Presentation and Revenue Recognition
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, 2003 filed with the Securities
and Exchange Commission on April 14, 2004.
With the sale of the Company's Process Automation business in 2003,
the Company has only one reportable segment. The Company has a wide range
of knowledge of simulation systems and the processes those systems are
intended to control and model. The Company's knowledge is concentrated
heavily in simulation technology and model development. The Company is
primarily engaged in simulation for the power generation industry, the
process industries, and the US Government. The Company has a commanding
competitive position in the nuclear power industry with an installed
capacity over two times all other competitors combined. Contracts typically
range from 18 months to three years. At September 30, 2004 GP Strategies
Corporation ("GP Strategies") owned 58% of the Company's common stock.
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. 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. Estimated contract earnings are
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 long-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. Such PCS arrangements are generally for
a one-year period renewable annually and include customer support,
unspecified software upgrades, and maintenance releases. The Company
recognizes revenue from these contracts ratably 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 $5.5 million and $4.4 million as of
September 30, 2004 and December 31, 2003, respectively, are typically
billed within sixty days. In October, the Company billed $1.3 million of
the unbilled amounts.
During the three months ended September 30, 2004, the Company
increased the estimated costs to complete several contracts which reduced
the Company's revenue and gross profit by $288,000.
2. Basic and Diluted Earnings (Loss) Per Common Share
Basic earnings (loss) per share is based on the weighted average
number of outstanding common shares for the period. Diluted earnings (loss)
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 for per share) Three months ended Nine months ended
September 30, September 30,
------------------------ --------------------------
2004 2003 2004 2003
----------- ---------- ------------ ------------
Numerator:
Net income (loss) $ (137) $ (696) $203 $ (2,346)
Preferred stock dividends - (59) - (175)
---------- ---------- ------------ ------------
Net income (loss) attributed to
common stockholders $ (137) $ (755) $ 203 $ (2,521)
=========== =========== ============ ============
Denominator:
Weighted-average shares outstanding
for basic earnings per share 8,949,706 6,019,138 8,949,706 5,974,083
Effect of dilutive securities:
Employee stock options, warrants and
options outside the plan - - 43,767 -
----------- ----------- ------------ -----------
Adjusted weighted-average shares outstanding
and assumed conversions for diluted
earnings per share 8,949,706 6,019,138 8,993,473 5,974,083
=========== =========== ============ ============
Shares related to dilutive securities excluded
because inclusion would be anti-dilutive 1,429,383 2,676,906 1,297,826 2,652,600
=========== =========== ============ ============
The difference between the basic and diluted number of weighted
average shares outstanding for the nine months ended September
30, 2004 represents dilutive stock options and warrants to purchase shares
of common stock computed under the treasury stock method, using the average
market price during the period. The net loss for the three and nine months
ended September 30, 2003 was increased by preferred stock dividends of
$59,000 and $175,000, respectively, in calculating the per share amounts.
Conversion of the stock options, warrants and convertible preferred stock
was not assumed for the three and nine months ended September 30, 2003 and
the three months ended September 30, 2004 because the impact was
anti-dilutive.
3. Discontinued Operations
In September 2003, the Company completed the sale of substantially all
of the assets of GSE Process Solutions, Inc. (Process) to Novatech, LLC
(Novatech) pursuant to an Asset Purchase Agreement, effective as of
September 25, 2003, by and between the Company, Process and Novatech. The
Company received $5.5 million in cash, subject to certain adjustments. The
Company recognized a loss on this transaction of $262,000. In conjunction
with the transaction, Novatech purchased certain assets with a book value
of $11.7 million and assumed certain operating liabilities totaling
approximately $6.8 million. The Company incurred approximately $865,000 of
closing costs associated with the transaction. Results of operations for
the three and nine months ended September 30, 2003 have been restated to
classify the operating results of the Process business as discontinued
operations.
As part of the closing costs of the Process sale, the Company had
established a $100,000 accrual for possible post-closing claims from
Novatech in the twelve months following the sale, as outlined in the
provisions of the Asset Purchase Agreement. In the third quarter 2004 the
Company reduced the accrual by $66,000 to management's best estimate of the
Company's exposure to loss.
For the three and nine months ended September 30, 2003, contract
revenue for the discontinued Process business was $5.2 million and $13.7
million, respectively. Net loss for the discontinued Process business for
the same periods was $121,000 and $1.0 million, respectively.
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 $80,000 and $85,000 for
the quarters ended September 30, 2004 and 2003, respectively. Total
amortization expense was $111,000 and $71,000 for the quarters ended
September 30, 2004 and 2003, respectively. For the nine months ended
September 30, 2004 and 2003, software development costs capitalized were
$319,000 and $464,000, respectively. Total amortization expense was
$283,000 and $237,000 for the nine months ended September 30, 2004 and
2003, respectively.
5. Stock Compensation
The Company applies the intrinsic-value-based method of accounting
prescribed 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 described 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 Nine months ended
September 30, September 30,
-------------------------- ------------------------
2004 2003 2004 2003
-------- --------- -------- ----------
Net income (loss) attributed to
common stockholders, as reported $ (137) $ (755) $203 $ (2,521)
Add stock-based employee compensation expense
included in reported net income (loss) - - - -
Deduct total stock-based employee compensation
expense determined under fair-value-method
for all awards (15) (67) (45) (200)
-------- --------- --------- ----------
Pro forma net income (loss) $ (152) $ (822) $158 $ (2,721)
======== ========= ========= ===========
Net income (loss) per share, as reported:
Basic $ (0.02) $ (0.13) $ 0.02 $ (0.43)
Diluted $ (0.02) $ (0.13) $ 0.02 $ (0.43)
Net income (loss) per share, as adjusted:
Basic $ (0.02) $ (0.14) $ 0.02 $ (0.46)
Diluted $ (0.02) $ (0.14) $ 0.02 $ (0.46)
No employee stock options were issued in the first nine months of
2004 or 2003.
6. Long-term Debt
The Company's long-term debt consists of an unsecured promissory note
to a former employee with a remaining balance of $18,000 at September 30,
2004 which is due March 31, 2005.
General Physics Corporation is a wholly owned subsidiary of GP
Strategies. On March 30, 2004, the Company was added as an additional
borrower under the Financing and Security Agreement between General Physics
Corporation and a financial institution. Under the terms of the agreement,
$1.5 million of General Physics' available credit facility has been carved
out for use by GSE. The line is collateralized by substantially all of the
Company's assets and provides for borrowings up to 80% of eligible accounts
receivable and 80% of eligible unbilled receivables. The interest rate on
this line of credit is based upon the LIBOR Market Index Rate plus 3%
(4.84% as of September 30, 2004), with interest only payments due monthly.
At September 30, 2004, the Company's available borrowing base was $1.5
million, none of which had been utilized. The credit facility expires on
August 12, 2006.
The credit facility requires the Company to comply with certain
financial ratios. At September 30, 2004, the Company was in compliance with
its financial ratio covenants.
7. Series A Convertible Preferred Stock
The Series A convertible preferred stock had no voting rights and
required dividends at the rate of 6% per annum payable quarterly. Dividends
accumulated if not paid quarterly and compounded interest accrued on any
unpaid dividends. On October 23, 2003, ManTech International Corp. elected
to convert all of its 39,000 shares of preferred stock to common stock in
conjunction with the sale of its ownership in the Company to GP Strategies.
Thus, as of September 30, 2004 and December 31, 2003, there are no shares
of preferred stock outstanding. The Company had accrued dividends payable
of $366,000 as of September 30, 2004 and December 31, 2003. Such amount
accrues interest at the rate of 6% until paid.
8. Letters of Credit and Performance Bonds.
As of September 30, 2004, the Company was contingently liable for one
letter of credit totaling approximately $29,000. This letter of credit
represents a payment bond on a contract and has been cash collateralized
and is classified as restricted cash in the consolidated balance sheet. In
addition, the Company was contingently liable at September 30, 2004 for
approximately $65,000 under a performance bond on one contract which was
secured by a cash-collateralized bank guarantee of the Company's foreign
subsidiary.
9. Income Taxes
The Company's effective tax rate was 15.1% and .9% for the nine months
ended September 30, 2004 and September 30, 2003, respectively. The increase
in the effective tax rate is attributable primarily to higher taxable
income in Sweden and the impact of the alternative minimum tax in the
United States. For 2004 the Company's combined U.S. federal and state
effective tax rate is projected to be 10% and the Swedish effective tax
rate is projected to be 35%.
10. Administrative Charges from GP Strategies and Other Related Party
Transactions
On January 1, 2004, the Company entered into a Management Services
Agreement with GP Strategies Corporation in which GP Strategies agreed to
provide corporate support services to GSE, including accounting, finance,
human resources, legal, network support and tax. GSE will pay an annual fee
of $685,000 ($171,250 per quarter) for these services. The term of the
agreement is one year, subject to earlier termination only upon the mutual
consent of the parties to the agreement. The agreement can be renewed for
successive one-year terms.
In December 2003, GSE's Board of Directors elected John Moran, a GP
Strategies executive with experience in the power industry and simulation
technology, as Chief Executive Officer. Mr. Moran will continue as a GP
Strategies employee, however, Mr. Moran will devote 100% of his time to the
performance of his duties as CEO of GSE. For 2004, GSE will reimburse GP
Strategies $300,000 ($75,000 per quarter) for his compensation and
benefits.
In March, 2003, GP Strategies extended their $1.8 million limited
guarantee of the Company's previous bank facility. In consideration for the
extension of the guarantee, the Company issued 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 Company recorded the value of $180,000 as deferred financing cost
with a corresponding credit to common stock and additional paid-in capital.
The deferred costs were amortized over the one-year life of the guarantee.
11. Commitments and Contingencies
In conjunction with the move of its Process Automation business to its
Columbia, Maryland facility in May 2003, the Company subleased most of its
vacated facility in Baltimore, Maryland to Alpharma USPD Inc. for a
five-year period, although Alpharma could terminate the lease at the end of
the second year provided a six-month notice was given. In October, 2004,
Alpharma notified the Company that they will terminate the sublease on
April 30, 2005. The Company's broker is actively seeking another subtenant,
and management believes that a subtenant will be found prior to the end of
Alpharma's sublease. However, if a subtenant is not found or the terms of a
new subtenant lease arrangement are not consistent with those of the
Alpharma lease, the Company may be required to record an additional charge
related to the lease for the vacated facility. The Company's lease expires
in July 2008; the annual rent is approximately $550,000, of which the
Company currently has a loss accrual of $181,000.
12. New Accounting Standards
In December 2003, the FASB issued Interpretation No. 46R,
Consolidation of Variable Interest Entities, which requires the
consolidation of entities meeting certain criteria. The Company does not
participate in any variable interest entities.
GSE SYSTEMS, INC. AND SUBSIDIARIES
FORM 10-Q
For the Three and Nine Months ended September 30, 2004 and 2003
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
GSE Systems, Inc. ("GSE Systems", "GSE" or the "Company") is a world leader
in real-time high fidelity simulation technology and model development. The
Company provides simulation solutions and services to the power generation
industry, the process industries, and the US Government sector. In addition, the
Company provides plant monitoring and signal analysis monitoring and
optimization software primarily to the power industry, and develops specialized
software applications for emerging technologies.
In September 2003, the Company completed the sale of substantially all of
the assets of GSE Process Solutions, Inc. (Process) to Novatech, LLC (Novatech)
pursuant to an Asset Purchase Agreement, effective as of September 25, 2003, by
and between the Company, Process and Novatech. The Company received $5.5 million
in cash, subject to certain adjustments. The operating results of the Company's
Process business have been classified as discontinued operations in the
Consolidated Statements of Operations for the three and nine months ended
September 30, 2003. Following the sale of Process, the Company operates only in
the Simulation business.
In October 2003, as a result of the acquisition by GP Strategies Corp. of
ManTech International Corp.'s interest in the Company, along with certain other
transactions, GSE became a 58%-owned subsidiary of GP Strategies.
General Physics Corporation is a wholly owned subsidiary of GP Strategies.
On March 30, 2004, the Company was added as an additional borrower under the
Financing and Security Agreement between General Physics Corporation and a
financial institution. Under the terms of the agreement, $1.5 million of General
Physics' available credit facility has been carved out for use by GSE.
On January 1, 2004, the Company entered into a Management Services
Agreement with GP Strategies Corporation in which GP Strategies agreed to
provide corporate support services to GSE, including accounting, finance, human
resources, legal, network support and tax. GSE will pay an annual fee of
$685,000 ($171,250 per quarter) for these services. The term of the agreement is
one year, subject to earlier termination only upon the mutual consent of the
parties to the agreement. The agreement can be renewed for successive one-year
terms.
In conjunction with the move of its Process Automation business to its
Columbia, Maryland facility in May 2003, the Company subleased most of its
vacated facility in Baltimore, Maryland to Alpharma USPD Inc. for a five-year
period, although Alpharma could terminate the lease at the end of the second
year provided a six-month notice was given. In October, 2004, Alpharma notified
the Company that they will terminate the sublease on April 30, 2005. The
Company's broker is actively seeking another subtenant, and management believes
that a subtenant will be found prior to the end of Alpharma's sublease. However,
if a subtenant is not found or the terms of a new subtenant lease arrangement
are not consistent with those of the Alpharma lease, the Company may be required
to record an additional charge related to the lease for the vacated facility.
The Company's lease expires in July 2008; the annual rent is approximately
$550,000, of which the Company currently has a loss accrual of $181,000.
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
Effective January 1, 2004, the Company reorganized, creating a dedicated
worldwide business development organization under the direction of one manager,
and consolidating all of its operations in Columbia, Maryland, St. Mary's,
Georgia and Nykoping, Sweden under another manager. The Company entered into a
Management Services Agreement with GP Strategies effective January 1, 2004 in
which the Company outsourced most of its corporate functions (accounting, human
resources, etc.) and terminated most of its corporate staff at the end of 2003.
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. Thirty plants have already received license extensions, and sixteen 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. Installation of new control room technology is also
driving increased simulator business in the fossil power market.
In 2004, the Company is working on embedding its full scope simulator
software into classroom training materials. Utilizing the drastically increased
computing power of personal computers, the Company is able to house the entire
simulator software on a single PC running in real time. This enables dynamic
training and feedback to the student, versus just static text, in the training
environment. The Company is segmenting its simulation software into "pieces"
with respect to individual plant systems and equipment so that the software can
be utilized to teach specific skills in operating the nuclear electric utilities
without the need for control room panels.
The Company is expanding its presence in the US Government sector. The
Company is teaming with other established military simulation, training and
support services contractors and is actively submitting proposals to secure
contracts where its expertise and team strengths coupled with team partner
capability, provides a compelling competitive advantage. The Company is also
exploring opportunities in the Homeland Security Sector of the Government, and
is completing technology to simulate the operation of Emergency Operations
Centers (EOC) run by municipal and state governments. REMITS is a Real-time
Emergency Management Interactive Training System designed to simulate emergency
situations and enable EOC staff to train without requiring human participation
in the field. REMITS enables the EOC staff to stay current with the technology
and enables instructors to introduce new problems and challenges during the
exercise to test the EOC staff response to changing situations. As the Federal
Government spends billions of dollars in first responder training, management
believes the Company's REMITS product will be useful in training for disaster
recovery and terrorist threat response. The Company expects to release the
REMITS product for sale in the fourth quarter 2004.
In Emerging Technologies, the Company is completing the launch of
PRISM(TM), a hand held, wireless application designed for physicians and health
care professionals. Within a hand held, wireless device, PRISM stores electronic
patient records which can be quickly retrieved and updated at the point of
care--in essence simulating a physician's home office in real time. It also
records dictation, provides patient history, lab and consult reports, allergies
and insurance information. With PRISM physicians can also order prescriptions,
medical supplies, lab tests, consultations and create clinical reminders, among
many other features. The Company has developed PRISM in concert with MD Offices,
Inc., a start up company whose mission is to develop and commercialize the PRISM
technology. PRISM is in beta phase testing with a commercial launch scheduled
for the fourth quarter of 2004.
There is no certainty that either REMITS or PRISM will have a materially
positive impact upon the Company's future performance.
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 September 30, Nine months ended September 30,
2004 % 2003 % 2004 % 2003 %
------ ------ ------ ------ ------- ------- ------- -------
Contract revenue $ 7,340 100.0 % $ 6,139 100.0 % $ 22,498 100.0% $ 16,660 100.0%
Cost of revenue 5,835 79.5 % 4,654 75.8 % 17,379 77.2% 12,980 77.9%
------ ------ ------- ------ ------- ------- ------- -------
Gross profit 1,505 20.5 % 1,485 24.2 % 5,119 22.8% 3,680 22.1%
------ ------ ------- ------ ------- ------- ------- -------
Operating expenses:
Selling, general and administrative 1,449 19.7 % 1,588 25.9 % 3,871 17.2% 4,140 24.8%
Administrative charges from GP Strategies 247 3.4 % - 0.0 % 739 3.4% - 0.0%
Depreciation and amortization 64 0.9 % 95 1.5 % 207 0.9% 295 1.8%
------ ------ ------- ------ ------ ------ ------- ------
Total operating expenses 1,760 24.0 % 1,683 27.4 % 4,817 21.5% 4,435 26.6%
------ ------ ------- ------ ------ ------ ------- ------
Operating income (loss) (255) (3.5)% (198) (3.2)% 302 1.3% (755) (4.5)%
Interest expense, net (5) (0.1)% (101) (1.7)% (164) (0.7)% (246) (1.5)%
Other income (expense), net 19 0.3 % (14) (0.2)% 35 0.2 % (22) (0.1)%
----- ------ ------- ------ ------ ------ -------- ------
Income (loss) from continuing operations
before income taxes (241) (3.3)% (313) (5.1)% 173 0.8 % (1,023) (6.1)%
Provision (benefit) for income taxes (44) (0.6)% - 0.0 % 30 0.2 % 22 0.2 %
----- ------ ------ ------ ------- ------ -------- -------
Income (loss) from continuing operations (197) (2.7)% (313) (5.1)% 143 0.6 % (1,045) (6.3)%
Loss from discontinued operations - 0.0% (121) (2.0)% - 0.0% (1,039) (6.2)%
Income (loss) on sale of discontinued 60 0.8% (262) (4.2)% 60 0.3% (262) (1.6)%
operations ------ ------ ------ ------ ------- ------- -------- -------
Net income (loss) $ (137) (1.9%) $ (696) (11.3)% $ 203 0.9% $ (2,346) (14.1)%
======= ====== ====== ======= ======= ======= ======== =======
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 monthly as the project progresses. Management reviews the status of
each project monthly 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 September 30,
2004, the Company has net capitalized software development costs of $982,000. On
an annual basis, and more frequently as conditions indicate, 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 investment to its
estimated fair value based on future discounted cash flows. 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 a regular 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 asset to its
realizable value. At September 30, 2004, the Company's largest deferred tax
asset related to a U.S. net operating loss carryforward of $15.9 million which
expires in various amounts over the next twenty years. The amount of loss
carryforward which can be used by the Company may be limited to approximately
$500,000 annually. The recovery of the Company's 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 $8.6 million at September 30, 2004. If the
Company is able to realize taxable income in the future, the valuation allowance
will be reduced.
Results of Operations - Three and Nine Months ended September 30, 2004 versus
Three and Nine Months ended September 30, 2003.
Contract Revenue. Total contract revenue for the quarter ended September
30, 2004 totaled $7.3 million, which was 19.6% higher than the $6.1 million
total revenue for the quarter ended September 30, 2003. Revenue for the nine
months ended September 30, 2004 was $22.5 million versus $16.7 million in the
same period of 2003, a 35.0% increase. The increases reflect the significant
order volume logged in 2003. At September 30, 2004, the Company's backlog was
$19.5 million of which approximately $6.7 million will be recognized as revenue
in the next three months.
Gross Profit. Gross profit totaled $1.5 million for both the quarter ended
September 30, 2004, as well as the quarter ended September 30, 2003; however, as
a percentage of revenue, gross profit decreased from 24.2% for the three months
ended September 30, 2003 to 20.5 % for the three months ended September 30,
2004. In the third quarter 2004, the Company made adjustments to the estimated
costs to complete several of its long-term contracts which resulted in a net
reduction of the project-to-date revenue and gross profit recognized on the
projects of approximately $288,000.
For the nine months ended September 30, 2004, gross profit increased from
$3.7 million (22.1% of revenue) for the nine months ended September 30, 2003 to
$5.1 million (22.8% of revenue). The increase in gross profit percentage is
mainly attributable to a 13% decrease in the Company's overhead costs in 2004
together with a higher revenue base to recover the Company's relatively fixed
overhead costs.
Selling, General and Administrative Expenses. Selling, general and
administrative ("SG&A") expenses totaled $1.4 million in the quarter ended
September 30, 2004, an 8.8% decrease from the $1.6 million for the same period
in 2003. SG&A expenses for the nine months ended September 30, 2004 decreased
6.5%, from $4.1 million for the nine months ended September 30, 2003 to $3.9
million. Business development costs increased from $443,000 in the third quarter
2003 to $803,000 in the third quarter 2004 and increased from $1.2 million for
the nine months ended September 30, 2003 to $2.0 million in the same period of
2004. This reflects the Company's renewed focus on business development in 2004
and the reassignment of four operating personnel into the business development
function on January 1, 2004. The Company's corporate and G&A expenses decreased
from $1.1 million in the third quarter 2003 to $590,000 in the third quarter
2004 reflecting the outsourcing of the Company's corporate function to GP
Strategies on January 1, 2004. Likewise, for the nine months ended September 30,
2004, corporate and G&A expenses decreased from $2.7 million for the first nine
months of 2003 to $1.9 million in 2004. Gross spending on software product
development ("development") totaled $134,000 in the quarter ended September 30,
2004 as compared to $142,000 in the same period of 2003. For the nine months
ended September 30, 2004 and 2003, gross development spending totaled $373,000
and $690,000, respectively. The reduction in gross development spending mainly
reflects the release of JADE version 2.0 at the end of 2003. JADE is 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. The Company anticipates that its gross development spending
in 2005 will approximate the same level as 2004.
The Company capitalized $80,000 of development expenditures in the three
months ended September 30, 2004 as compared to $85,000 in the same period of
2003. For the nine months ended September 30, 2004 and 2003, the Company
capitalized $319,000 and $464,000, respectively. The Company's development
expenditures in 2004 were related to:
* The development of new functionality for the Company's Jtools software
modeling tools.
* The modification of the Company's simulation technology to simulate
the operation of Emergency Operations Centers (EOC) run by municipal
and state governments.
* The development of a software product that will allow doctors to
create digital patient records through the use of a personal
digital assistant (PDA) instead of manually recording patient
information.
* The embedding of the Company's full scope simulator software into
classroom training materials by segmenting its simulation software
into "pieces" so that the software can be utilized to teach
specific skills in operating the nuclear electric utilities
without the need for control room panels.
Administrative Charges from GP Strategies. On January 1, 2004, the Company
entered into a Management Services Agreement with GP Strategies Corporation in
which GP Strategies agreed to provide corporate support services to GSE,
including accounting, finance, human resources, legal, network support and tax.
GSE will pay an annual fee of $685,000 ($171,250 per quarter) for these
services. The term of the agreement is one year, subject to earlier termination
only upon the mutual consent of the parties to the agreement. The agreement can
be renewed for successive one-year terms.
In December 2003, GSE's Board of Directors elected John Moran, a GP
Strategies executive with experience in the power industry and simulation
technology, as Chief Executive Officer. Mr. Moran will continue as a GP
Strategies employee, however, Mr. Moran will devote 100% of his time to the
performance of his duties as CEO of GSE. For 2004, GSE will reimburse GP
Strategies $300,000 ($75,000 per quarter) for his compensation and benefits.
Depreciation and Amortization. Depreciation expense totaled $64,000 and
$95,000 during the quarters ended September 30, 2004 and 2003, respectively. For
the nine months ended September 30, 2004 and 2003 depreciation expense totaled
$207,000 and $295,000, respectively. The reduction reflects certain assets
becoming fully depreciated.
Operating Income (Loss). The Company had an operating loss of $255,000
(3.5% of revenue) in the third quarter 2004, as compared with operating loss of
$198,000 (3.2% of revenue) for the same period in 2003. For the nine months
ended September 30, 2004 and 2003, the Company had operating income of $302,000
(1.3% of revenue) and operating loss of $755,000 (4.5% of revenue),
respectively. The variances were due to the factors outlined above.
Interest Expense, Net. Net interest expense decreased from $101,000 in the
quarter ended September 30, 2003 to $5,000 for the same quarter in 2004. For the
nine months ended September 30, 2004 and 2003, net interest expense totaled
$164,000 and $246,000, respectively. In March 2003, GP Strategies extended their
$1.8 million limited guarantee of the Company's bank facility for a one-year
period. In consideration for the extension of the guarantee, the Company issued
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
shares on March 21, 2003. The cost of the guarantee was amortized over the
one-year period; GSE recognized $45,000 of interest expense in the first quarter
2004 which completed the amortization of these costs.
The fees paid to the Company's financial institution as consideration for
the extension of the Company's credit facility for a one-year period beginning
March 23, 2003 were amortized over the one year extension. In the first quarter
2004, the Company recognized $94,000 of interest expense which completed the
amortization of these costs.
Provision for Income Taxes. The Company's effective tax rate was 15.1% and
..9% for the nine months ended September 30, 2004 and September 30, 2003,
respectively. The increase in the effective tax rate is attributable primarily
to higher taxable income in Sweden and the impact of the alternative minimum tax
in the United States. For 2004 the Company's combined U.S. federal and state
effective tax rate is projected to be 10% and the Swedish effective tax rate is
projected to be 35%.
Income (Loss) from Discontinued Operations. In September 2003, the Company
completed the sale of substantially all of the assets of GSE Process Solutions,
Inc. (Process) to Novatech, LLC. (Novatech) pursuant to an Asset Purchase
Agreement, effective as of September 25, 2003, by and between the Company,
Process and Novatech. The operating results of the Company's Process business
prior to the sale have been classified as discontinued operations in the
Consolidated Statements of Operations.
For the three and nine months ended September 30, 2003, contract revenue
for the discontinued Process business was $5.2 million and $13.7 million,
respectively. Net loss for the discontinued Process business for the same
periods was $121,000 and $1.0 million, respectively.
Loss on Sale of Discontinued Operations. In conjunction with the Company's
sale of its Process business in September 2003, the Company received $5.5
million in cash, subject to certain adjustments. The Company recognized a loss
on this transaction of $262,000. In connection with the transaction, Novatech
purchased certain assets with a book value of $11.7 million and assumed certain
operating liabilities totaling approximately $6.8 million. The Company incurred
approximately $865,000 of closing costs associated with the transaction,
including a $100,000 accrual for possible post-closing claims from Novatech in
the twelve months following the sale, as outlined in various provisions of the
Asset Purchase Agreement. In the third quarter 2004, the Company reduced the
accrual by $66,000 to management's best estimate of the Company's exposure to
loss.
Liquidity and Capital Resources
As of September 30, 2004, the Company's cash and cash equivalents totaled
$1.0 million compared to $1.4 million at December 31, 2003.
Cash provided by (used in) operating activities. For the nine months ended
September 30, 2004, net cash used in operating activities was $283,000; $223,000
was used by continuing operations and $60,000 was used by discontinued
operations. Significant changes in the Company's assets and liabilities in 2004
included:
* a $709,000 reduction in prepaid expenses and other assets. The
reduction reflects (1) lower prepaid insurance expense due to the
participation of the Company in some of GP Strategies' insurance
programs, (2) the collection from Novatech of expenses paid by the
Company on behalf of Novatech after the sale of the Process business
in 2003 and (3) a reduction in capitalized bank commitment fees.
* an increase in accounts payable, accrued compensation and accrued
expenses of $406,000. The increase reflects the increase in project
activity in 2004 as compared to the prior year and the related
increase in obligations to the Company's subcontractors that are
working on projects located in Mexico and Eastern Europe.
* a decrease in billings in excess of revenues earned by $2.6 million.
In 2003, the Company had entered into a $6.6 million contract with a
Mexican customer for a full scope simulator that allowed the Company
to invoice the customer for 20% of the contract upon the receipt of
the purchase order as an advance payment. The reduction in billings in
excess of revenues earned largely reflects the completion of work
which has reduced the Company's liability to the customer for the
advance payment.
Net cash provided by operating activities was $2.6 million for the nine
months ended September 30, 2003; $1.3 million was provided by continuing
operations and $1.3 million was provided by discontinued operations. Significant
changes in the Company's assets and liabilities in the third quarter 2003
included:
* a $1.3 million increase in contract receivables mainly due to the
receipt of a $6.6 million contract with a Mexican customer for a full
scope simulator. At September 30, 2003, the Company had outstanding
invoices with this customer of approximately $1.0 million.
* an increase in accounts payable, accrued compensation and accrued
expenses of $1.3 million. The increase reflects (1) an increase in
preferred stock dividends payable to ManTech, (2) the accrual of
various Process sale-related liabilities and (3) and an increase in
obligations due to the Company's subcontractors, mainly related to the
$6.6 million Mexican contract.
* a $2.5 million increase in billings in excess of revenues earned. The
contract with the Mexican customer mentioned above allowed the Company
to invoice the customer for 20% of the contract upon the receipt of the
purchase order as an advance payment.
Cash used in investing activities. Net cash used in investing activities
was $55,000 for the nine months ended September 30, 2004, consisting of $319,000
of capitalized software development costs and $144,000 of capital expenditures,
offset by the expiration of stand-by letters of credit for which the $408,000 of
cash collateral was released. Standby letters of credit are issued by the
Company in the ordinary course of business through banks as required by certain
contracts and proposal requirements.
Net cash used in investing activities was $3.8 million in the nine months
ended September 30, 2003; $4.3 million was provided by continuing operations and
$506,000 was used by discontinued operations. The $4.3 million provided by
continuing operations included $5.2 million proceeds from the sale of the
Process business unit, net of transaction costs, offset by $515,000 in cash
payments of contingent consideration for a prior year acquisition, $173,000 of
capital expenditures, and $464,000 of capitalized software development costs.
Additionally, several stand-by letters of credit expired, and $256,000 of cash
collateral was released.
Cash used in financing activities. In the nine months ended September 30,
2004, the Company used $24,000 in financing activities related to the pay down
of a note payable.
The Company used $5.5 million net cash in financing activities in the nine
months ended September 30, 2003, all of which was used in the continuing
operations. The Company decreased the borrowings under its bank line of credit
by $5.4 million and had no outstanding bank debt at September 30, 2003. In
addition, the Company paid down a note payable by $22,000.
Credit Facilities
General Physics Corporation is a wholly owned subsidiary of GP Strategies.
On March 30, 2004, the Company was added as an additional borrower under the
Financing and Security Agreement between General Physics Corporation and a
financial institution. Under the terms of the agreement, $1.5 million of General
Physics' available credit facility has been carved out for use by GSE. The line
is collateralized by substantially all of the Company's assets and provides for
borrowings up to 80% of eligible accounts receivable and 80% of eligible
unbilled receivables. The interest rate on this line of credit is based upon the
LIBOR Market Index Rate plus 3% (4.84% as of September 30, 2004), with interest
only payments due monthly. At September 30, 2004, the Company's available
borrowing base was $1.5 million, none of which had been utilized. The credit
facility expires on August 12, 2006.
The credit facility requires the Company to comply with certain financial
ratios. At September 30, 2004, the Company was in compliance with its financial
ratio covenants.
Item 3. Quantitative and Qualitative Disclosure about Market Risk
The Company's most significant market risk is changes in foreign currency
exchange rates. 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 rate on
its existing line of credit. As of September 30, 2004, such interest rate is
based on the Libor Market Index Rate plus 300 basis-points. However, the Company
had no loans outstanding at that date or for the nine months
ended September 30, 2004 that were subject to variable interest rates.
Item 4. Controls and Procedures
As of the end of the period covered by this report, GSE management,
including the Chief Executive 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-15(e).
Based on that evaluation, the Chief Executive 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 Executive Officer and Chief
Financial Officer completed their evaluation.
GSE SYSTEMS, INC. AND SUBSIDIARIES
FORM 10-Q
For the Three and Nine Months ended September 30, 2004 and 2003
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
10.1 Third Amendment dated July 30, 2004 to the Financing and Security
Agreement among General Physics Corporation, Skillright, Inc.,
GSE Systems Inc., GSE Power Systems, Inc. and MSHI, Inc. and
Wachovia Bank National Association.
31.1 Certification of the Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
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: November 12, 2004 GSE SYSTEMS, INC.
/S/ JOHN V. MORAN
___________________
John V. Moran
Chief Executive Officer
(Principal Executive Officer)
/S/ JEFFERY G. HOUGH
_____________________
Jeffery G. Hough
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)