Conformed
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, 2000.
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: (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 ___
As of November 9, 2000, there were 5,193,527 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, 2000(unaudited)
and December 31, 1999 3
Consolidated Statements of Operations for the Three and
Nine Months Ended September 30, 2000 (unaudited) and
September 30, 1999 (unaudited) 4
Consolidated Statements of Comprehensive Income (Loss)
for the Three and Nine Months Ended September 30, 2000
(unaudited) and September 30, 1999 (unaudited) 5
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2000 (unaudited)
and September 30, 1999 (unaudited) 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Results of Operations
and Financial Condition 12
Item 3. Quantitative and Qualitative Disclosure About Market
Risk 16
PART II. OTHER INFORMATION 17
Item 1. Legal Proceedings 17
Item 2. Changes in Securities and Use of Proceeds 17
Item 3. Defaults Upon Senior Securities 17
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 18
SIGNATURES 19
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
ASSETS
Unaudited
September 30, 2000 December 31, 1999
------------- -----------------
Current assets:
Cash and cash equivalents $ 1,694 $ 2,695
Restricted cash 510 255
Contract receivables 14,833 16,881
Inventories 2,563 3,255
Prepaid expenses and other current assets 2,708 2,207
Deferred income taxes 146 146
--- ---
Total current assets 22,454 25,439
Investment in Avantium Technologies B.V. 2,895 -
Property and equipment, net 2,543 3,094
Software development costs, net 5,312 5,395
Goodwill, net 2,572 2,949
Deferred income taxes 3,887 3,251
Restricted cash - 480
Other assets 1,197 2,419
----- -----
Total assets $ 40,860 $ 43,027
=================== =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Line of credit $ 8,480 $ -
Accounts payable 6,126 5,024
Accrued expenses 3,294 5,504
Billings in excess of revenue earned 2,310 3,077
Accrued warranty reserves 625 620
Income taxes payable - 30
Other current liabilities 2,448 2,519
----- -----
Total current liabilities 23,283 16,774
Line of credit - 6,233
Accrued warranty reserves 796 680
Other liabilities 792 2,170
----- -----
Total liabilities 24,871 25,857
------ ------
Stockholders' equity:
Common stock $.01 par value, 8,000,000 shares
authorized, 5,193,527 shares issued and outstanding 52 50
Additional paid-in capital 22,230 21,691
Retained earnings (deficit) - at formation (5,112) (5,112)
Retained earnings - since formation 22 1,259
Accumulated other comprehensive loss (1,203) (718)
---- ----
Total stockholders' equity 15,989 17,170
------ ------
Total liabilities and stockholders' equity $ 40,860 $ 43,027
============== ================
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,
2000 1999 2000 1999
---- ---- ---- ----
Revenue:
Contract revenue $ 13,694 $ 15,587 $ 39,224 $ 51,152
Software licensing revenue - - 2,895 -
----- ----- ----- -----
Total revenue 13,694 15,587 42,119 51,152
Cost of revenue 10,022 10,289 29,460 31,651
------ ------ ------ ------
Gross profit 3,672 5,298 12,659 19,501
------ ------ ------ ------
Operating expenses:
Selling, general and administrative 4,517 5,909 12,915 16,745
Depreciation and amortization 404 400 1,273 1,102
--- --- --- ---
Total operating expenses 4,921 6,309 14,188 17,847
----- ----- ----- ------
Operating income (loss) (1,249) (1,011) (1,529) 1,654
Interest expense, net (203) (140) (523) (271)
Other income (expense) 83 (26) 105 27
-- -- -- --
Income (loss) before income taxes (1,369) (1,177) (1,947) 1,410
Provision for (benefit from) income taxes (500) (450) (710) 535
---- --- ---- ---
Net income (loss) $ (869) $ (727) $(1,237) $ 875
======= ====== ======= =======
Basic earnings (loss) per common share $ (0.17) $(0.14) $ (0.24) $ 0.17
======= ====== ======= =======
Diluted earnings (loss) per common share $ (0.17) $(0.14) $ (0.24) $ 0.17
======= ====== ======= =======
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,
2000 1999 2000 1999
---- ---- ---- ----
Net income (loss) $ (869) $ (727) $(1,237) $ 875
Foreign currency translation adjustment (344) 106 (485) 178
--- -- ---- --
Comprehensive income (loss) $(1,213) $ (621) $(1,722) $ 1,053
====== ===== ====== =======
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,
2000 1999
---- ----
Cash flows from operating activities:
Net income (loss) $ (1,237) $ 875
Adjustments to reconcile net income (loss) to net cash
(used in) provided by operating activities:
Depreciation and amortization 2,943 2,470
Fair value of warrants issued to non-employees - 120
Non-monetary consideration received for software licensed to
Avantium Technologies B.V. (2,895) -
Deferred income taxes (636) 335
Changes in assets and liabilities:
Contract receivables 2,048 6,123
Inventories, prepaid expenses and other assets 1,398 (1,528)
Accounts payable and accrued expenses (1,428) (1,458)
Billings in excess of revenues earned (767) (2,643)
Accrued warranty reserves 121 169
Other liabilities (855) 354
---- -----
Net cash (used in) provided by operating activities (1,308) 4,817
---- -----
Cash flows from investing activities:
Proceeds from sale of assets - 731
Capital expenditures (389) (1,517)
Capitalization of software development costs (1,580) (1,822)
------ ------
Net cash used in investing activities (1,969) (2,608)
------ ------
Cash flows from financing activities:
Proceeds from issuance of common stock 541 -
Increase (decrease) in line of credit with bank 2,247 228
Other (406) (886)
---- ----
Net cash provided by (used in) financing activities 2,382 (658)
----- ------
Effect of exchange rate changes on cash (106) (190)
--- ---
Net increase (decrease) in cash and cash equivalents (1,001) 1,361
Cash and cash equivalents at beginning of period 2,695 2,240
----- -----
Cash and cash equivalents at end of period $ 1,694 $ 3,601
======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2000
(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 generally accepted accounting principles 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, 1999 filed with the Securities and Exchange Commission.
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 or warrants 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 per share was as follows:
Three months ended Nine months ended
September 30, September 30,
2000 1999 2000 1999
---- ---- ---- ----
Weighted average shares outstanding - Basic 5,193,527 5,065,688 5,190,198 5,065,688
========= ========= ========= =========
Weighted average shares outstanding - Diluted 5,193,527 5,065,688 5,190,198 5,239,756
========= ========= ========= =========
For the three and nine months ended September 30, 2000, the number of weighted
average shares used for calculating diluted loss per share is the same as basic
because the effect of potential common shares is anti-dilutive given the net
loss during both periods. The difference between the basic and diluted number of
weighted average shares outstanding for the nine months ended September 30, 1999
represents dilutive stock options and warrants to purchase shares of common
stock computed under the treasury stock method.
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 (in thousands):
September 30, December 31,
2000 1999
----------------- ------------------
Raw materials $ 1,816 $ 2,536
Service parts 747 719
----------------- ------------------
Total $ 2,563 $ 3,255
================= ==================
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 approximately $564,000 and $790,000
for the three months ended September 30, 2000 and 1999, respectively. Total
amortization expense was approximately $589,000 and $469,000 for the three
months ended September 30, 2000 and 1999, respectively.
For the nine months ended September 30, 2000 and 1999, software development
costs capitalized were approximately $1.6 million and $1.8 million,
respectively. Total amortization expense was approximately $1.7 million and $1.4
million for the nine months ended September 30, 2000 and 1999, respectively.
5. Investment in Avantium Technologies B.V.
On February 24, 2000, the Company licensed certain of its simulation software
products to Avantium Technologies B.V. ("Avantium") in exchange for 251,501
shares of Avantium preferred stock, valued at $2.3 million, and 352,102 shares
of Avantium common stock, valued at $598,000. The software license, which is
perpetual in nature, gives Avantium the right to use the software in the
development of new software products. In the event new software products are
developed, the Company has the first right of refusal to be the sole and
exclusive distributors of these products in exchange for a 10% royalty. Each
share of preferred stock is convertible into common stock. Subject to certain
restrictions, in the event that Avantium has not conducted an initial public
offering (or been purchased) within five years, the Company and certain other
holders of preferred shares may, at their option, have their shares redeemed by
Avantium, for the greater of (i) the original purchase price plus 8% interest
compounded annually plus any accrued and unpaid dividends whether or not
declared, or (ii) the fair market value of the shares on an
as-if-converted-into-common-shares-basis plus any accrued and unpaid dividends.
Avantium was formed to develop high-speed experimentation and simulation
("HSE&S") technologies for application in new product and process development in
pharmaceutical, petrochemical, fine chemical, biotechnology and polymers
industries. Avantium expects to develop HSE&S technologies through in-house
development and contract research at leading universities, hardware developers
and informatics companies. Avantium has various investors, including Shell
International Chemical, SmithKline Beecham, W.R. Grace, three major European
universities and two venture capital firms.
During the nine months ended September 30, 2000, the Company recognized software
licensing revenue of $2.9 million based on the fair value of the consideration
received from Avantium. The fair value was established based on cash paid by
other investors for their respective preferred and common stock interests in
Avantium. The Company has delivered all elements of the software and has no
other obligations to Avantium, other than standard warranty. The Company will
account for its investment in Avantium using the cost method of accounting based
on management's conclusion that the Company does not have significant influence
with respect to the operations of Avantium. During the nine months ended
September 30, 2000, the Company also received an additional $2.9 million
contract from Avantium to make certain improvements and enhancements to the
software on a best efforts basis. The rates and margins in the contract are
comparable to those the Company earns performing services for its existing
customers.
6. Financing Arrangements
On March 23, 2000, the Company entered into a new loan and security agreement
with a financial institution for a new credit facility with a maturity date of
March 23, 2003. Borrowings from this facility were used to pay off the existing
debt under the Company's previous credit facility.
The new agreement established a $10.0 million line of credit (the "Credit
Facility") for the Company and its subsidiaries, GSE Process Solutions, Inc. and
GSE Power Systems, Inc, jointly and severally as co-borrowers. The Credit
Facility provides for borrowings to support working capital needs and foreign
letters of credit ($2.0 million sublimit). 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). In addition, ManTech
International Corporation ("ManTech") has provided two separate one-year
$900,000 standby letters of credit to the bank as additional collateral for the
Company's credit facility. GSE is allowed to borrow up to 100% of the letter of
credit value. GP Strategies Corporation has provided a limited guarantee
totaling $1.8 million. The interest rate on this line of credit is based on the
bank's prime rate (9.5% as of September 30, 2000), with interest only payments
due monthly. At September 30, 2000, the Company's available borrowing base was
approximately $9.6 million, of which approximately $8.5 million had been
utilized.
The loan and security agreement requires the Company to comply with certain
financial ratios and precludes the Company from paying dividends and making
acquisitions beyond certain limits without the bank's consent. At September 30,
2000, the Company was not in compliance with its minimum EBITDA (earnings before
interest, taxes, depreciation and amortization) covenant, its minimum working
capital covenant, and its tangible net worth covenant. Accordingly, the Company
has classified the borrowings under the Credit Facility as current. The Company
has requested a written waiver for these covenants. In the event such waivers
are not obtained, the bank could demand repayment of outstanding amounts.
Subsequent to September 30,2000, restricted cash of $480,000 previously held as
collateral against the letter of credit was released by the bank.
7. Capital Stock
In January 2000, the Company issued 116,959 shares of its common stock, at fair
value, to ManTech for $500,000. The proceeds of the stock issuance were used for
working capital.
8. Income Taxes
The Company's effective tax rate is based on the best current estimate of its
expected annual effective tax rate. The difference between the statutory U.S.
tax rate and the Company's effective tax rate for the three and nine months
ended September 30, 2000 and 1999 is primarily due to the effects of foreign
operations being taxed at different rates and state income taxes. As of
September 30, 2000 and December 31, 1999, the aggregate deferred tax assets are
recorded net of a valuation allowance of $1.1 million.
9. Segment Reporting
The Company is primarily organized on the basis of two business units, Process
and Power. The Company has a wide range of knowledge concerning 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 and beverage, and
pharmaceutical fields, as well as in the power generation industry. The Process
business unit is primarily engaged in process control and simulation 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.
GSE evaluates the performance of its business units utilizing "Business Unit
Contribution", which is substantially equivalent to earnings before interest and
taxes (EBIT) before allocating any corporate expenses.
The table below presents information about reported segments:
(In thousands) (In thousands)
Three months ended September 30, Nine months ended September 30,
--------------------------- -------------------------
2000 2000
---- ----
Process Power Total Process Power Total
------- ----- ----- ------- ----- -----
Revenue $ 6,694 $ 7,000 $ 13,694 $ 19,899 $ 22,220 $ 42,119
======== ======= ======== ======== ======== ========
Business unit contribution $ (974) $ 860 $ (114) $ (1,721) $ 3,646 $ 1,925
======== ======= ======== ======== ======== ========
1999 1999
---- ----
Process Power Total Process Power Total
------- ----- ----- ------- ----- -----
Revenue $ 8,151 $ 7,436 $ 15,587 $ 28,115 $ 23,037 $ 51,152
======== ======= ======= ======= ======= ========
Business unit contribution $ (462) $ 843 $ 381 $ 2,282 $ 3,453 $ 5,735
======== ======= ======= ======= ======= ========
Below is a reconciliation of consolidated business unit contribution to
consolidated income before taxes.
(In thousands) (In thousands)
Three months ended September 30, Nine months ended September 30,
2000 1999 2000 1999
Consolidated revenue $ 13,694 $ 15,587 $ 42,119 $ 51,152
Consolidated business unit contribution $ (114) $ 381 $ 1,925 $ 5,735
Corporate expenses (1,052) (1,418) (3,349) (4,054)
Interest expense, net (203) (140) (523) (271)
Consolidated income (loss) before income taxes $ (1,369) $ (1,177) $ (1,947) $ 1,410
10. Recent Pronouncements
In September 1998, the Financial Accounting Standards Board issued FAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This statement
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. In September 1999, FAS 137, "Accounting for Derivative
Instruments and Hedging Activities - Deferral of the Effective Date of FASB
Statement No. 133 - an amendment of FASB Statement No. 133" was issued. The
Company will be required to adopt this new accounting standard on January 1,
2001. The Company does not believe that the effect of the adoption of FAS No.
133 will be material.
11. Reclassifications
Certain reclassifications have been made to prior year amounts to conform with
current year presentation.
12. Subsequent Event
On November 14, 2000, the Company announced that it has signed a letter of
intent whereby Avantium will purchase and acquire certain assets of the
Company's VirtualPlant business, under an asset purchase agreement, in return
for an undisclosed amount of shares in Avantium, thereby rendering the Company
as Avantium's largest shareholder. The transaction is intended to be completed
by the end of 2000 and would include certain assets of the Company, intellectual
property and employment of certain personnel. The fair value of the shares
received from Avantium will exceed the carrying value of the net assets sold.
The Company became an equity shareholder in Avantium at its founding (see Note
5, Investment in Avantium Technologies, B.V.).
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
General Business Environment
- ----------------------------
GSE Systems, Inc. ("GSE Systems", "GSE" or the "Company") develops and delivers
business and technology solutions by applying process control, simulation
software, systems and services to the energy, process and manufacturing
industries worldwide. The Company's solutions and services assist customers in
reducing the time-to-market for new product development; improving chemistry for
producing products; improving quality, safety and throughput; reducing operating
expenses; and enhancing overall productivity.
The Power business unit results continue to be strong, as the Company maintains
its dominant market position in the nuclear power simulation industry. Utilizing
its technical and project management strengths, the business unit has expanded
its focus to include the fossil power market. In the third quarter, a
multi-million dollar order was received for a full scope fossil simulator in
India. The deregulation of the electric power industry has increased the
importance of efficient and reliable operations of power stations. The use of
simulation to address these issues has resulted in new opportunities for GSE to
improve the simulation fidelity of existing simulators and the supply of new
simulators around the world. While GSE simulators are primarily utilized for
power plant operator training, the uses are expanding to include engineering,
plant modification studies, and operating efficiency improvements for both
nuclear and fossil utilities.
The Company's Process business unit is beginning to see an upturn in the third
quarter with a 79% increase in orders as compared to the second quarter 2000,
and a 4% increase as compared to the third quarter 1999. After spending
extensively in 1998 and the first half of 1999 on upgrading their process
control systems to deal with the Y2K date issue concerns, customer spending on
additional investments in their process control systems remained depressed in
the first half of 2000. This trend appears to be affecting the entire process
control industry. Accordingly, the Company took steps at the end of the third
quarter to reduce costs in the Process business unit to ensure at least
breakeven results for the business unit for the remainder of 2000, including a
personnel reduction in August. The Company incurred a charge of $262,000 during
the third quarter with respect to these terminations. Despite these charges, the
increases in third quarter orders in combination with the cost reductions have
resulted in a return to profitability for the Process Control portion of the
business. Management currently believes the Process business unit's long-lived
assets can be recovered through undiscounted cash flows. However, in the event
that the Company is unable to improve the results of the Process business unit,
the Company will need to consider the write-down of such assets, through asset
impairment charges in future periods.
In 1999, the Company introduced its new business and marketing strategy
VirtualPlant(TM). VirtualPlant combines the benefits of real-time simulation
with control systems to create a "living", learning real-time representation of
an operating plant. VirtualPlant also allows a customer to create an environment
for simulation-enhanced experimentation, thereby reducing the amount of physical
experimentation necessary to achieve an optimal design result for a new process
product. Based on sophisticated simulation technologies and expert knowledge of
processing realities, VirtualPlant is a fully integrated, comprehensive strategy
including software, consulting services and training that energy and process
manufacturing companies can use to dramatically reduce new product
time-to-market, minimize development costs, achieve greater optimization and
improve overall profitability.
A significant step in implementing the VirtualPlant strategy was the Company's
participation in the February 2000 founding of Avantium Technologies B.V.
("Avantium"), a Netherlands-based high technology company that employs
high-speed experimentation and simulation ("HSE&S") technologies in contract
research and development in the area of new product development and process
chemistry. GSE is an equity shareholder along with Shell International Chemical,
SmithKline Beecham, W.R. Grace, three Dutch universities (Technical University
of Delft, Technical University of Eindhoven, and Twente University) and three
venture capital firms (Alpinvest, The Generics Group, and S.R.One, the
SmithKline Beecham venture funding company). Avantium Technologies will deploy
HSE&S techniques to rapidly discover and optimize new processes and products of
interest to the petrochemicals, fine chemicals and pharmaceutical industries.
The Company's undiluted holdings in Avantium Technologies B.V. are approximately
10%; after taking into consideration the expected dilutive effect of stock
option plans, the Company's diluted ownership percentage is anticipated to be
approximately 5%.
In the third quarter 2000, the Company continued to make extensive investments
in its VirtualPlant business, in both the product development and sales and
marketing efforts. These investments have contributed to the net losses reported
for the third quarter 2000 and year-to-date September 30, 2000.
On November 13, 2000, the Company announced that it has signed a letter of
intent whereby Avantium will purchase and acquire certain assets of the
Company's VirtualPlant business, under an asset purchase agreement, in return
for an undisclosed amount of shares in Avantium, thereby rendering the Company
as Avantium's largest shareholder. The transaction is intended to be completed
by the end of 2000 and would include certain assets of the Company, intellectual
property and employment of certain personnel. The fair value of the shares
received from Avantium will exceed the carrying value of the net assets sold.
The Company became an equity shareholder in Avantium at its founding (see Note
5, Investment in Avantium Technologies, B.V.).
Results of Operations
- ---------------------
The following table sets forth the results of operations for the periods
presented expressed as a percentage of revenue (in thousands).
Three months ended September 30, Nine months ended September 30,
--------------------------- -------------------------
2000 % 1999 % 2000 % 1999 %
---- - ---- - ---- - ---- -
Revenue $ 13,694 100.0% $15,587 100.0% $ 42,119 100.0% $ 51,152 100.0%
Cost of revenue 10,022 73.2% 10,289 66.0% 29,460 69.9% 31,651 61.9%
------ ---- ------ ---- ------ ---- ------ ----
Gross profit 3,672 26.8% 5,298 34.0% 12,659 30.1% 19,501 38.1%
----- ---- ----- ---- ----- ---- ------ ----
Operating expenses
Selling, general and administrative 4,517 33.0% 5,909 37.9% 12,915 30.7% 16,745 32.7%
Depreciation and amortization 404 3.0% 400 2.6% 1,273 3.0% 1,102 2.2%
--- --- --- --- --- --- --- ---
Total operating expenses 4,921 35.9% 6,309 40.5% 14,188 33.7% 17,847 34.9%
----- ---- ----- ---- ----- ---- ------ ----
Operating income (loss) (1,249) (9.1%) (1,011) (6.5%) (1,529) (3.6%) 1,654 3.2%
Interest expense, net (203) (1.5%) (140) (0.9%) (523) (1.2%) (271) (0.5%)
Other income (expense) 83 0.6% (26) (0.2%) 105 0.2% 27 0.1%
-- --- -- --- -- --- -- ---
Income before (loss) income taxes (1,369) (10.0%) (1,177) (7.6%) (1,947) (4.6%) 1,410 2.8%
Provision for (benefit from) income taxes (500) (3.7%) (450) (2.9%) (710) (1.7%) 535 1.0%
---- ---- --- --- ---- ---- --- ---
Net income (loss) $ (869) (6.3%) $ (727) (4.7%) $ (1,237) (2.9%) $ 875 1.7%
====== ==== ===== === ====== ==== ======= ===
Revenue. Revenue for the three and nine months ended September 30, 2000 amounted
to $13.7 million and $42.1 million, respectively, as compared with revenues of
$15.6 million and $51.2 million for the three and nine months ended September
30, 1999. Process business unit year-to-date 2000 revenues are 29.2% lower than
the same period in the prior year. After making significant investments in their
process control systems in 1998 and the first half of 1999, many customers have
opted to reduce or postpone additional investments. The Company's Process
business unit is beginning to see an upturn in the third quarter with a 79%
increase in orders as compared to the second quarter 2000, and 4% increase over
orders received in the third quarter 1999. Included in the Process business unit
revenue for the nine months ended September 30, 2000 was $2.9 million from the
sale of licenses for five of GSE's software products to Avantium Technologies
B.V. ("Avantium"), including the object and source codes, in exchange for an
equity interest in Avantium. See Note 5, Investment in Avantium Technologies
B.V. in the Notes to Consolidated Financial Statement, above, for a discussion
of this transaction. The Power business unit revenue for the three and nine
months ended September 30, 2000 was $7.0 million and $22.2 million,
respectively, as compared to $7.4 million and $23.0 million for the three and
nine months ended September 30, 1999.
Gross Profit. Gross profit decreased to $3.7 million (26.8% of revenue) for the
three months ended September 30, 2000 from $5.3 million (34.0% of revenue) for
the corresponding period in 1999. The decrease in gross profit is primarily
related to the results of the Process business unit. In 2000, much of the
Process business unit revenue has been generated through service-related
revenues, such as engineering services, contract maintenance, and spare parts
sales, as compared to higher margin upgrade projects in 1999, resulting from
customer concerns about Y2K date issue. Year-to-date 2000 gross profit
percentage was higher than that for the third quarter 2000 mainly due to the
sale of the licenses to Avantium earlier in the year.
Selling, General and Administrative Expenses. Selling, general and
administrative ("SG&A") expenses totaled $4.5 million in the three months ended
September 30, 2000, a 23.7% decrease from the corresponding period in 1999. This
decrease, excluding research and development costs which are discussed below, is
attributable to (1) lower sales and marketing personnel and travel costs in the
Process business unit caused by lower headcount, (2) lower sales commissions due
to lower Process business unit orders, and (3) reduced relocation expenses
related to new hires. These reductions have been offset in part by increased
marketing and selling expenses related to the implementation of the Company's
VirtualPlant business strategy. For the nine months ended September 30, 2000,
SG&A expenses were $3.8 million lower than the same period in 1999, due to the
same reasons sited above plus a Power business unit refund of approximately
$759,000 from the Swedish Government for a distribution of a surplus created
from strong investment returns on contributions made to the Social Security
Program in Sweden during the last several years.
Gross research and product development expenditures approximated $1.1 million
and $1.6 million for the quarters ended September 30, 2000 and September 30,
1999. Capitalized software development costs totaled $534,000 and $790,000 for
the third quarters of 2000 and 1999, respectively; accordingly, net research and
development costs expensed and included in SG&A were approximately $536,000 and
$810,000 for the three-month periods ended September 30,2000 and September 30,
1999 respectively. During the third quarter 2000, the Company completed the
development of its VPbatch (TM) product, the Windows NT version of its
FlexBatch(R) Recipe and Process Management software, and continued the
development of version 10.2 of the Company's D/3 Distributed Control System. In
addition, the Company continued development initiatives to improve product ease
of use of all of its process simulation products and tightly couple them into
the VirtualPlant architecture. For the nine months ended September 30, 2000,
gross research and product development expenditures, capitalized software
development costs, and net research and development costs expensed in SG&A were
$3.3 million, $1.6 million and $1.7 million, respectively, versus $4.0 million,
$1.8 million and $2.2, respectively for the comparable period in 1999.
Depreciation and Amortization. Depreciation expense amounted to $267,000 and
$314,000 during the three months ended September 30, 2000 and September 30,
1999, respectively. During the nine months ended September 30, 2000 and
September 30, 1999, depreciation expense was $888,000 and $822,000,
respectively.
Amortization of goodwill was $137,000 and $86,000 during the three months ended
September 30, 2000 and September 30, 1999, respectively. During the nine months
ended September 30, 2000 and September 30, 1999, amortization expense was
$394,000 and $280,000, respectively. The increase in amortization during the
quarter and the nine-month period ended September 30, 2000 reflects the increase
in goodwill due to payments made for contingent consideration for prior year
acquisitions.
Operating Income (Loss). Operating income (loss) for the three months ended
September 30, 2000 amounted to $(1.2) million or (9.1%) of revenue, versus
($1.0) million or 6.5% of revenue for the corresponding period in 1999. For the
nine months ended September 30, 2000 and September 30, 1999, operating income
(loss) was $(1.5) million or (3.6%) of revenue and $1.7 million or 3.2% of
revenue, respectively. The decrease for the quarter and nine-month period is the
result of the continuing order slowdown in the Process business unit offset by
lower selling, general and administrative costs. The Company began restructuring
the Process business unit in the third quarter 2000 to reduce costs and return
the business unit to profitability. Twenty-nine personnel were terminated and
severance costs of $262,000 were incurred in the third quarter 2000. In October
2000, the Company entered into an agreement to outsource the Process
manufacturing/assembly functions. Additional severance costs of approximately
$100,000 will be incurred in the fourth quarter 2000.
Interest Expense, Net. Net interest expense increased to $203,000 for the three
months ended September 30, 2000 from $140,000 for the corresponding period in
1999. This increase is attributable primarily to an increase in the Company's
borrowings under its line of credit made during the period to fund working
capital requirements and higher borrowing costs. For the nine months ended
September 30, 2000 and September 30, 1999, net interest expense totaled $523,000
and $271,000, respectively. Interest expense in 1999 was offset by $60,000
interest income related to a note receivable.
Other Income (Expense). Other income (expense) mainly reflects recognized
foreign currency transaction gains and losses.
Provision for Income Taxes. The Company's effective tax rate is based on the
best current estimate of its expected annual effective tax rate. The difference
between the statutory U.S. tax rate and the Company's effective tax rate for the
three and nine months ended September 30, 2000 and 1999 is primarily due to the
effects of foreign operations being taxed at different rates and state income
taxes. As of September 30, 2000 and December 31, 1999, the aggregate deferred
tax assets are recorded net of a valuation allowance of $1.1 million.
Liquidity and Capital Resources
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Net cash used by operating activities was $1.3 million for the nine months ended
September 30, 2000, as reported on the Consolidated Statements of Cash Flows.
The Company's $2.9 million investment in Avantium Technologies was a
non-monetary transaction and had no impact on the Company's operating cash flow.
Significant changes in the Company's assets and liabilities included a $2.0
million reduction in contract receivables, mainly due to the lower orders of the
Process business unit in during 2000, and a $1,4 million reduction in accounts
payable and accrued expenses.
Net cash used in investing activities for the first nine months of 2000 was $2.0
million and consisted of $1.6 million of capitalized software development costs
and $389,000 of capital expenditures.
During the nine months ended September 30, 2000, the Company generated $2.4
million of net cash from financing activities. In January 2000, the Company
issued 116,959 shares of its common stock, at fair value, to ManTech
International Corporation for $500,000. Cash generated from the common stock
issuance and utilization of the Company's line of credit was partially offset by
cash payments for contingent consideration for prior year acquisitions.
On March 23, 2000, the Company entered into a new loan and security agreement
with a financial institution for a new credit facility with a maturity date of
March 23, 2003. Borrowings from this facility were used to pay off the existing
debt under the Company's previous credit facility. The line of credit (the
"Credit Facility") provides for borrowings up to a total of $10.0 million to
support working capital needs and foreign letters of credit. At September 30,
2000, the Company's available borrowing base was approximately $9.6 million, of
which approximately $8.5 million had been utilized. See Note 6, Financing
Arrangements, in the Notes to Consolidated Financial Statements, above, for
additional details about this line of credit. When the Credit Facility was first
entered into, ManTech International Corporation ("ManTech") had provided a
one-year $900,000 standby letter of credit to the bank as additional collateral
for the Company's credit facility and a limited guarantee totaling $900,000. In
July, 2000, ManTech's guarantee was converted into a second one-year $900,000
standby letter of credit to the bank, which is also used as additional
collateral for the Company's credit facility. GSE is allowed to borrow up to
100% of the value of these two letters of credit.
This new credit line requires the Company to comply with certain financial
ratios. At September 30, 2000 the Company was not in compliance with its minimum
EBITDA (earnings before interest, taxes, depreciation and amortization)
covenant, its minimum working capital covenant, and its tangible net worth
covenant. Accordingly, the Company has classified the borrowings under the
Credit Facility as current. The Company has requested a written waiver for these
covenants. In the event such waivers are not obtained, the bank could demand
repayment of outstanding amounts.
Due mainly to the lower volume of the Process business unit over the last four
quarters, the Company is currently experiencing limited operating cash flows.
Cost reduction efforts, including employee terminations and reduction of selling
and administrative expenses, were made in August 2000. Additionally, in November
2000, the Company has outsourced its Process manufacturing/assembly operations
and made additional reductions in personnel. The Company is continuing to
investigate options to improve business profitability.
Subsequent to September 30, 2000, restricted cash of $480,000, previously held
as collateral against a letter of credit, was released by the bank.
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 rate on its
existing line of credit. Such interest rate is currently based on the prime
rate.
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
Forward-Looking Statements
This Form 10-Q contains certain forward-looking statements, within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, which are subject to the safe
harbors created by those Acts. These statements include the plans and objectives
of management for future operations, including plans and objectives relating to
the development of the Company's business in the domestic and international
marketplace. All forward-looking statements involve risks and uncertainties,
including, without limitation, risks relating to the Company's ability to
enhance existing software products and to introduce new products in a timely and
cost effective manner, reduced development of nuclear power plants that may
utilize the Company's products, a long pay-back cycle from the investment in
software development, uncertainties regarding the ability of the Company to grow
its revenues and successfully integrate operations through expansion of its
existing business and strategic acquisitions, the ability of the Company to
respond adequately to rapid technological changes in the markets for process
control and simulation software and systems, significant quarter-to-quarter
volatility in revenues and earnings as a result of customer purchasing cycles
and other factors, dependence upon key personnel, and general market conditions
and competition. The forward-looking statements included herein are based on
current expectations that involve numerous risks and uncertainties as set forth
herein, the failure of any one of which could materially adversely affect the
operations of the Company. The Company's plans and objectives are also based on
the assumptions that market conditions and competitive conditions within the
Company's business areas will not change materially or adversely and that there
will be no material adverse change in the Company's operations or business.
Assumptions relating to the foregoing involve judgments with respect to, among
other things, future economic, competitive and market conditions and future
business decisions, all of which are difficult or impossible to predict
accurately and many of which are beyond the control of the Company. Although the
Company believes that the assumptions underlying the forward-looking statements
are reasonable, any of the assumptions could be inaccurate and there can,
therefore, be no assurance that the forward-looking statements included in this
Form 10-Q will prove to be accurate. In light of the significant uncertainties
inherent in the forward-looking statements included herein, the inclusion of
such information should not be regarded as a representation by the Company or
any other person that the objectives and plans of the Company will be achieved.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
None
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 14, 2000 GSE SYSTEMS, INC.
/S/ Christopher M. Carnavos
Christopher M. Carnavos
Director, Chief Executive 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)