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 March 31, 2001.
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 ___
As of May 10, 2001, 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 March 31, 2001
and December 31, 2000 3
Consolidated Statements of Operations for the
Three Months Ended March 31, 2001 and March 31, 2000 4
Consolidated Statements of Comprehensive Income
for the Three Months Ended March 31, 2001 and March 31, 2000 5
Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2001 and March 31, 2000 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition 13
Item 3. Quantitative and Qualitative Disclosure About Market Risk 17
PART II. OTHER INFORMATION 18
Item 1. Legal Proceedings 18
Item 2. Changes in Securities and Use of Proceeds 18
Item 3. Defaults Upon Senior Securities 18
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 5. Other Information 18
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)
Unaudited
March 31, 2001 December 31, 2000
ASSETS
Current assets:
Cash and cash equivalents ................................................ $ 612 $ 1,465
Restricted cash .......................................................... 533 30
Contract receivables ..................................................... 13,139 14,489
Inventories .............................................................. 1,537 1,587
Prepaid expenses and other current assets ................................ 2,313 2,520
Deferred income taxes .................................................... 277 277
Total current assets ................................................. 18,411 20,368
Investment in Avantium International B.V ...................................... 7,503 2,895
Property and equipment, net ................................................... 1,823 2,299
Software development costs, net ............................................... 4,642 5,067
Goodwill, net ................................................................. 2,885 2,996
Deferred income taxes ......................................................... 847 847
Restricted cash ............................................................... -- 503
Other assets .................................................................. 785 974
Total assets ......................................................... $ 36,896 $ 35,949
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt ........................................ $ 2,066 $ 2,347
Accounts payable ......................................................... 3,926 5,669
Accrued expenses ......................................................... 2,328 2,115
Accrued compensation and payroll taxes ................................... 2,596 1,940
Billings in excess of revenue earned ..................................... 1,867 1,366
Accrued warranty reserves ................................................ 503 462
Other current liabilities ................................................ 1,993 947
Total current liabilities ............................................ 15,279 14,846
Long-term debt ................................................................ 10,622 11,840
Accrued warranty reserves ..................................................... 516 550
Total liabilities .................................................... 26,417 27,236
Commitments and contingencies
Stockholders' equity:
Common stock $.01 par value, 8,000,000 shares authorized, shares issued
and outstanding 5,193,527 in 2001 and in 2000 ........................ 52 52
Additional paid-in capital ............................................... 22,424 22,230
Retained earnings (deficit) - at formation ............................... (5,112) (5,112)
Retained earnings (deficit) - since formation ............................ (5,841) (7,555)
Accumulated other comprehensive loss ..................................... (1,044) (902)
Total stockholders' equity ........................................... 10,479 8,713
Total liabilities and stockholders' equity ........................... $ 36,896 $ 35,949
The accompanying notes are an integral part of these consolidated financial
statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(Unaudited)
Three months
ended March 31,
2001 2000
Contract revenue $ 12,478 $ 15,124
Cost of revenue 9,506 9,160
Gross profit 2,972 5,964
Operating expenses
Selling, general and administrative 2,820 4,388
Depreciation and amortization 361 441
Total operating expenses 3,181 4,829
Operating income (loss) (209) 1,135
Gain on sale of assets 3,273 -
Interest expense, net (232) (191)
Other income (expense), net 24 (42)
Income before income taxes 2,856 902
Provision for income taxes 1,142 365
Net income $ 1,714 $ 537
Basic earnings per common share $ 0.33 $ 0.10
Diluted earnings per common share $ 0.33 $ 0.09
The accompanying notes are an integral part of these consolidated financial
statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
(Unaudited)
Three months
ended March 31,
2001 2000
Net income $ 1,714 $ 537
Foreign currency translation adjustment (142) (119)
Comprehensive income $ 1,572 $ 418
The accompanying notes are an integral part of these consolidated financial
statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
Three months
ended March 31,
2001 2000
Cash flows from operating activities:
Net income ......................................................... $ 1,714 $ 537
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ................................. 887 978
Gain on sale of assets ........................................ (3,273) --
Non-monetary consideration received for software licensed to
Avantium International B.V ................................... -- (2,895)
Changes in assets and liabilities:
Contract receivables ........................................ 1,350 2,550
Inventories, prepaid expenses and other assets .............. (62) 887
Accounts payable, accrued compensation and accrued expenses (1,680) (1,437)
Billings in excess of revenues earned ....................... 501 (142)
Accrued warranty reserves ................................... 7 (53)
Other liabilities ........................................... 989 (380)
Net cash provided by operating activities .......................... 433 45
Cash flows from investing activities:
Capital expenditures .......................................... (41) (77)
Capitalized software development costs ........................ (152) (447)
Net cash used in investing activities .............................. (193) (524)
Cash flows from financing activities:
Proceeds from issuance of note payable to related party ....... 550 --
Increase (decrease) in borrowings under lines of credit ....... (1,411) 193
Proceeds from issuance of common stock ........................ -- 515
Other financing activities, net ............................... (220) (242)
Net cash provided by (used in) financing activities ................ (1,081) 466
Effect of exchange rate changes on cash ............................ (12) (29)
Net decrease in cash and cash equivalents .......................... (853) (42)
Cash and cash equivalents at beginning of year ..................... 1,465 2,695
Cash and cash equivalents at end of period ......................... $ 612 $ 2,653
The accompanying notes are an integral part of these consolidated financial
statements.
- -
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Three Months ended March 31, 2001 and 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 accounting principles generally accepted in the United
States of America 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, 2000 filed with
the Securities and Exchange Commission on April 2, 2001.
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 were as follows:
Three months
ended March 31,
2001 2000
Weighted average shares outstanding - Basic 5,193,527 5,149,822
Weighted average shares outstanding - Diluted 5,201,387 5,802,403
The difference between the basic and diluted number of weighted
average shares outstanding for the quarters ended March 31, 2001 and
2000 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.
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) March 31, December 31,
2001 2000
Raw materials $ 1,052 $ 1,084
Service parts 485 503
------------- ---------------
Total inventories $ 1,537 $ 1,587
============= ===============
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 $152,000 and $447,000
for the quarters ended March 31, 2001 and 2000, respectively. Total
amortization expense was $526,000 and $537,000 for the quarters ended
March 31, 2001 and 2000, respectively.
5. Investment in Avantium International B.V.
On February 24, 2000, the Company licensed certain of its simulation
software products to Avantium International B.V. ("Avantium") in
exchange for 251,501 shares of Avantium preferred stock, valued at $2.5
million, and 352,102 shares of Avantium common stock, valued at
$349,000. The software license, which is perpetual in nature, gives
Avantium the right to use the software in the development of new
software products. 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 year ended December 31, 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 year ended December
31, 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
were comparable to those the Company earns performing services for its
existing customers.
As a result of the experience with Avantium in 2000, the Company
concluded that a combination of the relevant interests of the two
companies would significantly increase the potential of both
organizations. In addition, focusing the technical and marketing
resources of Avantium and the GSE VirtualPlant team would produce
significant cost savings. Accordingly, On March 6, 2001, the Company
sold its VirtualPlant business to Avantium. Avantium purchased certain
fixed assets and intellectual property (including BatchCAD and
BatchWizard software products), obtained perpetual licenses to certain
GSE Process software products, and employed certain personnel in both
the US and the UK. GSE received 8% of Avantium's stock, thus increasing
its holdings in Avantium to approximately 19%. Avantium and GSE will
continue to work together in the marketplace and in product development
so that common clients will be able to use Avantium's VirtualPlant
technology to develop scalable products that will be compatible at the
manufacturing level with GSE's process control and simulation products.
However, GSE is not obligated to provide any further support to
Avantium.
The Company recognized a gain on the sale of its
VirtualPlant business of $3.3 million, before income taxes. This gain
was determined based on the estimated fair value of the Avantium stock
received, based on an independent appraisal, less the book value of
the assets sold, approximately $700,000 in severance costs payable to
certain former employees of VirtualPlant that were not hired by
Avantium (these amounts will be paid during the balance of 2001), and
other transaction expenses. GSE retains one seat on the supervisory
board of Avantium. However, management has concluded that such seat
does not provide the Company with significant influence. Accordingly,
the Company will report its investment in Avantium at its cost basis.
If a decline in fair value below cost is judged by management to be
other than temporary, the cost basis of the stock will be written
down to fair value as a new cost basis and the amount of the write-down
will be included in earnings as a realized loss. Any new cost basis
derived in this manner will not be changed for subsequent
recoveries in fair value.
6. Long-term Debt
The Company has a $10.0 million bank line of credit (the "Credit
Facility") under which the Company and its subsidiaries, GSE Process
Solutions, Inc. and GSE Power Systems, Inc., are jointly and severally
liable as co-borrowers. The Credit Facility provides for borrowings to
support working capital needs and foreign letters of credit ($2.0
million 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 Corp. ("ManTech") provided $1.8 million in standby
letters of credit to the bank as additional collateral for the Company's
Credit Facility (see Note 12). The Company 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 plus .75%
(8.75% as of March 31, 2001), with interest only payments due monthly.
At March 31, 2001, the Company's available borrowing base was
approximately $7.9 million, of which all was utilized.
The Credit Facility 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
March 31, 2001, the Company was in compliance with its covenants
In the fourth quarter of 2000, the Company had issued a demand
promissory note to ManTech that allowed the Company to borrow up to $1.8
million at an interest rate of prime plus one percent of which $1.6 million
was borrowed at December 31, 2000. The promissory note was secured by the
Company's pledge of its equity interest in Avantium, but such security
interest was subordinate to the first lien thereon by the Company's bank.
In the first quarter of 2001, the Company borrowed an additional $550,000
from ManTech and the promissory note was amended to increase the principal
amount to $2.1 million. Subsequently, in the first quarter of 2001, and
with ManTech's approval, the Company issued a replacement promissory note
in the amount of $2.1 million to ManTech pursuant to which the Company's
obligations to ManTech became unsecured and the principal is payable over a
two year period, in equal installments, commencing April 1, 2004, with
interest payments to commence monthly on July 1, 2001.
7. Letters of Credit
As of March 31, 2001, the Company was contingently liable for
approximately $533,000 under five letters of credit used as payment
bonds on contracts, all of which were secured by cash deposits
classified as restricted cash in the consolidated balance sheet.
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 quarters ended March 31, 2001 and 2000 is primarily due to the
effects of foreign operations being taxed at different rates and state
income taxes. As of March 31, 2001 and December 31, 2000, the aggregate
deferred tax assets are recorded net of a valuation allowance of $5.4
million.
9. Segment Information
The Company's two reportable segments are its core business units
Process and Power. (The Company's VirtualPlant business is reported under
the Process segment.) The Company is primarily organized on the basis of
these two business units. The Company has a wide range of knowledge of
control and simulation systems and the processes those systems are intended
to improve, control and model. The Company's knowledge is concentrated
heavily in the process industries, which include the chemicals, food &
beverage, and pharmaceuticals 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.
The Company evaluates the performance of its business units utilizing
"Business Unit Contribution", which is substantially equivalent to earnings
before interest and taxes before allocating any corporate expenses. The
segment information regarding the divested businesses is also included
below (see Note 5, Investment in Avantium International B.V.).
The table below presents information about the reportable segments:
(in thousands) Three months ended March 31, 2001
Process Power Consolidated
Contract revenue $ 5,314 $ 7,164 $ 12,478
Business unit contribution $ (157) $ 1,024 $ 867
Three months ended March 31, 2000
Process Power Consolidated
Contract revenue $ 7,964 $ 7,160 $ 15,124
Business unit contribution $ 1,247 $ 910 $ 2,157
The Company sold its Belgian business in November 2000 and its
VirtualPlant business in March 2001 (see Note 5, Investment in Avantium
International B.V.). Contract revenues for the Process segment includes
revenues for the Company's VirtualPlant business of $507,000 for the
quarter ended March 31, 2001 and revenues for the Company's VirtualPlant
and Belgian businesses of $3.4 million for the quarter ended March 31,
2000. The 2000 revenues include $2.9 million from a software license
sold to Avantium (see Note 5, Investment in Avantium International
B.V.). Business unit contribution for the Process segment includes a
loss for VirtualPlant of $471,000 for the quarter ended March 31, 2001
and earnings related to the VirtualPlant and Belgian businesses of $2.2
million for the quarter ended March 31, 2000.
A reconciliation of segment business unit contribution to
consolidated income before taxes is as follows:
(in thousands) Three months
ended March 31,
2001 2000
Segment business unit contribution $ 867 $ 2,157
Corporate expenses (1,052) (1,064)
Gain (loss) on disposition of assets 3,273 --
Interest expense, net (232) (191)
Income (loss) before income taxes $ 2,856 $ 902
10. New Accounting Standards
Effective January 1, 2001, the Company adopted Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities," and No. 138 "Accounting for Certain Derivative Instruments
and Certain Hedging Activities." These statements require that an entity
recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair
value. The adoption of these standards, including the valuation of
derivative instruments outstanding on the effective date, had no
impact on the Company's consolidated financial statements as the Company
had no derivative instruments at January 1 or March 31, 2001.
11. Reclassifications
Certain prior year amounts have been reclassified to conform
to the current year presentation.
12. Subsequent Events
On April 6, 2001, ManTech agreed to allow the Company's bank to draw
upon ManTech's $1.8 million letter of credit which supported the Company's
credit facility, thus paying down a portion of the Company's bank debt in
exchange for additional subordinated debt in the Company. Accordingly, the
Company's promissory note to ManTech was amended to increase the amount to
$3.9 million. As permitted by the note, ManTech has elected to convert its
debt into equity in the form of convertible preferred stock at the
conversion rate of $100 per share. Thus, pending shareholder approval at
the Shareholders Annual Meeting being held on May 30, 2001, the Company
will issue 39,000 shares of preferred stock to ManTech. The convertible
preferred stock will bear dividends at the rate of 6% per annum payable
quarterly. Dividends will accumulate if not paid quarterly and compounded
dividends will accrue on any unpaid dividends. ManTech at its discretion
shall have the right to convert each share of convertible preferred stock
into GSE common stock at a purchase price of $1.6215 per share at any time
within three years from the date of issuance. Upon the expiration of the
three-year conversion period, the convertible preferred stock automatically
converts into GSE common stock. Prior to ManTech's conversion of the
convertible preferred stock to common stock, GP Strategies has the option
to acquire 50% of the convertible preferred stock for $1,950,000. If the
Company's stock price is greater than $1.6215 per share on May 30, 2001,the
Company will determine the value of the beneficial conversion feature and
amortize such amount over the life of the preferred stock in determining
income attributable to common shareholders.
GSE SYSTEMS, INC. AND SUBSIDIARIES
FORM 10-Q
For the Three Months ended March 31, 2001 and 2000
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Cautionary Statement Regarding 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, the ability
of the Company to meet bank financial covenants and manage cash needs, and
general market conditions and competition. See "Risk Factors," in Part I of the
Company's Form 10-K for the year-ended December 31, 2000. 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 forward-looking
statements, any such information included herein 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.
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 improving quality, safety and throughput; reducing operating
expenses; and enhancing overall productivity.
Power Simulation Business
The Company's Power Simulation Business Unit ("Power") is continuing
its efforts to expand its leadership in nuclear simulation technology to the
fossil simulation marketplace. In the past year, GSE has released its "G-Suite"
software tools which target fossil simulation applications. These new tools
elevate the level of simulation beyond traditional training to allow the
operator to optimize plant performance. Following a concerted global marketing
effort, GSE has been awarded over $9 million of new orders for six fossil
simulators in the United States and India in the last twelve months, including a
recent award from American Electric Power for two full-scope fossil training
simulators. In addition, 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 operation efficiency improvements
for both nuclear and fossil utilities. During plant construction simulators are
used to test control strategies and ensure on-time start-up. After
commissioning, the same tools can be used to increase plant availability and
optimize plant performance for the life of the facility.
Process Control Business
In order to return the Company's Process Control Business Unit ("Process")
to profitability, the Company implemented a restructuring plan in 2000 that
included personnel reductions, the outsourcing of Process' manufacturing and
assembly operations, and the November 2000 sale of Process' unprofitable
European operations based in Belgium. The restructuring was completed in the
first quarter 2001. In addition, in March 2001, the Company sold the Business
Unit's VirtualPlant technology and assets to Avantium International B.V.
("Avantium") in exchange for Avantium stock. Avantium and GSE will continue to
work together in the marketplace and in product development so that common
clients will be able to use Avantium's VirtualPlant technology to develop
scalable products that will be compatible at the manufacturing level with GSE's
process control and simulation products, thus speeding up market introduction
and reducing the overall life cycle costs.
Process released the latest version, 10.2, of its D/3 Distributed
Control System(TM) software in December 2000. The new release furthers GSE's
strategy of providing an open system able to seamlessly communicate with a
variety of third-party hardware and software. By allowing maximum flexibility in
selection of Input-Output systems, customers can take advantage of the latest
control technology without costly replacement of their plant hardware.
Results of Operations
The following table sets forth the results of operations for the
periods presented expressed in thousands of dollars and as a percentage of
revenues:
(in thousands) Three months ended March 31,
2001 % 2000 %
Contract revenue $12,478 100.0 % $15,124 100.0 %
Cost of revenue 9,506 76.2 % 9,160 60.6 %
Gross profit 2,972 23.8 % 5,964 39.4 %
Operating expenses:
Selling, general and administrative 2,820 22.6 % 4,388 29.0 %
Depreciation and amortization 361 2.9 % 441 2.9 %
Total operating expenses 3,181 25.5 % 4,829 31.9 %
Operating income (loss) (209) (1.7)% 1,135 7.5 %
Gain on sale of assets 3,273 26.2 % - 0.0 %
Interest expense, net (232) (1.9)% (191) (1.3)%
Other income (expense), net 24 0.2 % (42) (0.3)%
Income before income taxes 2,856 22.9 % 902 6.0 %
Provision for income taxes 1,142 9.2 % 365 2.4 %
Net income $ 1,714 13.7 % $ 537 3.6 %
Contract Revenue. Revenue for the quarters ended March 31, 2001 and 2000
totaled $12.5 million and $15.1 million, respectively.
The Process business unit's revenue was $5.3 million for the first
quarter 2001, compared with $7.9 million for the first quarter 2000. Included in
the first quarter 2000 revenues was $2.9 million from the sale of licenses for
five of GSE's software products to Avantium International B.V., in exchange for
an equity interest in Avantium (see Note 5, Investment in Avantium International
B.V. in the Notes to Consolidated Financial Statements). The Company divested
its unprofitable Belgian subsidiary, GSE Process Solutions N.V., on November 30,
2000 to Newton Integrated Services B.V. of the Netherlands, and sold its
VirtualPlant technology and assets on March 6, 2001 to Avantium. For the three
months ended March 31, 2001 and 2000, Process revenues included $507,000 and
$3.4 million, respectively, for these two divested businesses. Excluding the
revenues for these divested businesses, the Process business unit's revenues
increased $206,000, or 4.5%, in the first quarter 2001 as compared with the
prior year.
The Power business unit revenues were constant, totaling $7.2 million
in both the first quarter of 2001 and 2000.
Gross Profit. Gross profit totaled $3.0 million (23.8% of revenue) for
the quarter ended March 31, 2001, as compared with $6.0 million (39.4% of
revenue) for the same period in 2000. The decrease in gross profit and gross
margin as a percentage of revenue is largely due to the impact of the software
licenses sold to Avantium in the first quarter 2000.
Selling, General and Administrative Expenses. Selling, general and
administrative ("SG&A") expenses totaled $2.8 million in the quarter ended March
31, 2001, a 35.7% decrease from the $4.4 million for the same period in 2000.
The decrease in SG&A reflects reduced sales, marketing and corporate
administration headcount, and lower net research and product development
expenditures ("R&D"), as discussed below.
Gross R&D totaled $368,000 in the first quarter of 2001, as compared
with $1.1 million in the same period of 2000. Capitalized software development
costs totaled $152,000 and $447,000 for the first quarter of 2001 and 2000,
respectively. Accordingly, net R&D expense included in SG&A was $216,000
and $670,000 for the first quarter of 2001 and 2000, respectively. The Company's
R&D expenditures were reduced significantly due to the completion of three major
development projects: VPbatch(TM), the Windows NT version of its FlexBatch(R)
Recipe and Process Management software; initiatives to improve product ease of
use of SimSuite Pro(TM), its process simulation product; and the release
of version 10.2 of the D/3 Distributed Control System in December 2000.
Depreciation and Amortization. Depreciation expense totaled $192,000
and $313,000 during the quarters ended March 31, 2001 and 2000, respectively.
The decrease in depreciation in the first quarter 2001 is primarily due to
disposals of fixed assets as the Company restructured its operations and
divested certain businesses.
Amortization of goodwill was $169,000 and $128,000 during the quarters
ended March 31, 2001 and 2000, respectively. The increase in amortization in the
first quarter 2001 reflects the increase in goodwill due to payments made for
contingent considerations for prior year acquisitions.
Operating Income (Loss). The Company incurred an operating loss of $209,000
(1.7% of revenues) in the first quarter 2001, compared with operating income of
$1.1 million (7.5% of revenue) for the same period in 2000. The 2000 results
reflect the impact of the $2.9 million license sale to Avantium. Excluding the
operating results of the divested businesses, the Company had operating income
of approximately $262,000 in the first quarter of 2001, compared with an
operating loss of approximately $1.1 million for the same period in the prior
year. The Company believes its business restructuring initiatives and sale of
VirtualPlant business contributed to the improvement in operating profits of its
core businesses.
Interest Expense, Net. Net interest expense increased 21.5%, to
$232,000 for the quarter ended March 31, 2001, from $191,000 for the same period
in 2000. This increase is primarily attributable to an increase in the Company's
average debt outstanding during the 2001 period in order to fund working capital
requirements.
Other Income (Expense), Net. 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 quarters ended March 31, 2001 and 2000 is primarily due to the
effects of foreign operations being taxed at different rates and state income
taxes. As of March 31, 2001 and December 31, 2000, the aggregate deferred tax
assets are recorded net of a valuation allowance of $5.4 million.
Liquidity and Capital Resources
Net cash provided by operating activities was $433,000 and $45,000 for
the quarters ended March 31, 2001 and 2000, respectively. The gain on the
Company's sale of its VirtualPlant technology and assets to Avantium
International B.V. ($3.3 million) was a non-monetary asset exchange that had no
impact on the Company's operating cash flow in 2001. Likewise, the Company's
$2.9 million licensing of software to Avantium in the first quarter 2000 for an
equity stake in Avantium was also a non-monetary transaction. Significant
changes in the Company's assets and liabilities in 2001 included a reduction in
contract receivables of $1.4 million and a $1.7 million reduction in accounts
payable and accrued expenses.
Net cash used in investing activities was $193,000 in the first quarter
2001, including $152,000 of capitalized software development costs and $41,000
for capital expenditures.
During the quarter ended March 31, 2001, the Company utilized $1.1 million
net cash in financing activities. The Company decreased its borrowings under its
bank line of credit by $1.4 million, but increased its borrowings from ManTech
International Corporation ("ManTech") by $550,000 to a total of $2.1 million. In
the fourth quarter of 2000, the Company had issued a demand promissory note to
ManTech that allowed the Company to borrow up to $1.8 million at an interest
rate of prime plus one percent of which $1.6 million was outstanding at December
31, 2000. The promissory note was secured by the Company's pledge of its equity
interest in Avantium, but such security interest was subordinate to the first
lien thereon by the Company's bank. In the first quarter of 2001, the Company
borrowed an additional $550,000 from ManTech and the promissory note was amended
to increase the principal amount to $2.1 million. Subsequently, in the first
quarter of 2001, and with ManTech's approval, the Company issued a replacement
promissory note in the amount of $2.1 million to ManTech pursuant to which the
Company's obligations to ManTech became unsecured and the principal is payable
over a two year period, in equal installments, commencing April 1, 2004, with
interest payments to commence monthly on July 1, 2001.
The Company has a $10.0 million bank line of credit (the "Credit
Facility") under which the Company and its subsidiaries, GSE Process Solutions,
Inc. and GSE Power Systems, Inc., are jointly and severally liable as
co-borrowers. The Credit Facility provides for borrowings to support working
capital needs and foreign letters of credit ($2.0 million 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 Corp. ("ManTech") provided $1.8 million in
standby letters of credit to the bank as additional collateral for the Company's
Credit Facility. The Company was 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 plus .75% (8.75% as of March 31, 2001), with interest only
payments due monthly. At March 31, 2001, the Company's available borrowing base
was approximately $7.9 million, of which approximately $7.9 million had been
utilized.
The Credit Facility 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 March 31,
2001, the Company was in compliance with the bank covenants.
On April 6, 2001, ManTech agreed to allow the Company's bank to draw upon
ManTech's $1.8 million letter of credit which supported the Company's credit
facility, thus paying down a portion of the Company's bank debt in exchange for
additional subordinated debt in the Company. Accordingly, the Company's
promissory note to ManTech was amended to increase the amount to $3.9 million.
As permitted by the note, ManTech has elected to convert its debt into equity in
the form of convertible preferred stock at the conversion rate of $100 per
share. Thus, pending shareholder approval at the Shareholders Annual Meeting
being held on May 30, 2001, the Company will issue 39,000 shares of preferred
stock to ManTech. The convertible preferred stock will bear dividends at the
rate of 6% per annum payable quarterly. Dividends will accumulate if not paid
quarterly and compounded dividends will accrue on any unpaid dividends. ManTech
at its discretion shall have the right to convert each share of convertible
preferred stock into GSE common stock at a purchase price of $1.6215 per share
at any time within three years from the date of issuance. Upon the expiration of
the three-year conversion period, the convertible preferred stock automatically
converts into GSE common stock. Prior to ManTech's conversion of the convertible
preferred stock to common stock, GP Strategies has the option to acquire 50% of
the convertible preferred stock for $1,950,000. If the Company's stock price is
greater than $1.6215 per share on May 30, 2001, the Company will determine the
value of the beneficial conversion feature and amortize such amount over the
life of the preferred stock in determining income attributable to common
shareholders.
The Company has undertaken a number of initiatives during 2000 and 2001
to improve operating results and cash flows. Management believes the initiatives
undertaken will enable the Company to maintain compliance with the bank
financial covenants as well as provide sufficient cash flow to meet the
Company's obligations as they become due.
Item 3. Quantitative and Qualitative Disclosure about Market Risk
The Company's market risk is principally confined to changes in foreign
currency exchange rates and potentially adverse effects of differing tax
structures. The Company's exposure to foreign exchange rate fluctuations arises
in part from inter-company accounts in which costs incurred in one entity are
charged to other entities in different foreign jurisdictions. The Company is
also exposed to foreign exchange rate fluctuations as the financial results of
all foreign subsidiaries are translated into U.S. dollars in consolidation. As
exchange rates vary, those results when translated may vary from expectations
and adversely impact overall expected profitability.
The Company is also subject to market risk related to the interest
rates on its existing line of credit. As of March 31, 2001, such interest rates
are based on the bank's prime rate plus 75 basis-points.
As of March 31, 2001, $10.0 million of the Company's debt was subject
to variable interest rates. A 100 basis-point change in such rates during the
quarter ended March 31, 2001 would have changed the Company's interest expense
by approximately $24,000.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
In accordance with its conduct in the ordinary course of business,
certain actions and proceedings are pending to which the Company is a party. In
the opinion of management, the aggregate liabilities, if any, arising from such
actions are not expected to have a material adverse effect on the financial
condition of the Company.
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
The Company filed a report on Form 8-K effective March 21, 2001
regarding the sale of certain assets relating to GSE's
VirtualPlant business under an asset purchase agreement in return
for GSE becoming a significant shareholder in Avantium
International B.V. ("Avantium"). This report on Form 8-K included
the text of a press release dated March 12, 2001, the UK Asset
Sale and Purchase Agreement, and the Avantium Asset Sale and
Purchase Agreement filed as exhibits.
GSE SYSTEMS, INC. AND SUBSIDIARIES
FORM 10-Q
For the Quarters ended March 31, 2001 and 2000
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: May 15, 2001 GSE SYSTEMS, INC.
/S/ CHIN-OUR JERRY JEN
Chin-Our Jerry Jen
Chief Operating Officer and President
(Principal Executive Officer)
/S/ JEFFERY G. HOUGH
Jeffery G. Hough
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)