Conformed
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the Quarterly Period Ended June 30, 2003.
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Transition Period from____________to________.
Commission File Number: 0-26494
GSE SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 52-1868008
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
9189 Red Branch Road, Columbia Maryland, 21045
(Address of principal executive office and zip code)
Registrant's telephone number, including area code: (410) 772-3500
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ X ] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [ X ]
As of August 1, 2003, there were 6,019,138 shares of the Registrant's common
stock outstanding.
GSE SYSTEMS, INC.
QUARTERLY REPORT ON FORM 10-Q
INDEX
PAGE
PART I. FINANCIAL INFORMATION 3
Item 1. Financial Statements:
Consolidated Balance Sheets as of June 30, 2003
and December 31, 2002 3
Consolidated Statements of Operations for the
Three and Six Months Ended June 30, 2003 and June 30, 2002 4
Consolidated Statements of Comprehensive Income (Loss)
for the Three and Six Months Ended June 30, 2003 and June 30, 2002 5
Consolidated Statements of Cash Flows for the Three and Six Months
Ended June 30, 2003 and June 30, 2002 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk 23
Item 4. Controls and Procedures 23
PART II. OTHER INFORMATION 24
Item 1. Legal Proceedings 24
Item 2. Changes in Securities and Use of Proceeds 24
Item 3. Defaults Upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 24
Item 6. Exhibits and Reports on Form 8-K 24
SIGNATURES 26
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
Unaudited
June 30, 2003 December 31,2002
ASSETS
Current assets:
Cash and cash equivalents $ 584 $ 1,617
Restricted cash 439 608
Contract receivables 10,263 10,761
Inventories 1,646 1,560
Prepaid expenses and other current assets 2,774 2,656
________ ________
Total current assets 15,706 17,202
Property and equipment, net 1,467 1,697
Software development costs, net 3,968 4,401
Goodwill, net 2,901 2,901
Restricted cash - 139
Other assets 1,619 2,554
________ ________
Total assets $ 25,661 $ 28,894
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 7,108 $ 1,905
Accounts payable 2,971 2,521
Accrued expenses 1,450 1,727
Accrued compensation and payroll taxes 1,301 1,401
Billings in excess of revenue earned 2,756 3,059
Accrued warranty reserves 459 491
Other current liabilities 61 62
________ ________
Total current liabilities 16,106 11,166
Long-term debt 1,749 8,033
Billings in excess of revenue earned 771 998
Accrued warranty reserves 416 586
_________ ________
Total liabilities 19,042 20,783
_________ ________
Commitments and contingencies
Stockholders' equity:
Series A Convertible preferred stock $.01 par value, 2,000,000 shares
authorized, shares issued and outstanding 39,000 in 2003 and in 2002 - -
Common stock $.01 par value, 18,000,000 shares authorized, shares issued
and outstanding 6,019,138 in 2003 and 5,869,138 in 2002 60 59
Additional paid-in capital 28,019 27,841
Retained earnings (deficit) - at formation (5,112) (5,112)
Retained earnings (deficit) - since formation (15,256) (13,490)
Accumulated other comprehensive loss (1,092) (1,187)
________ _________
Total stockholders' equity 6,619 8,111
________ _________
Total liabilities and stockholders' equity $ 25,661 $ 28,894
============ ===========
The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(Unaudited)
Three months ended Six months ended
ended June 30, ended June 30,
____________________ ____________________
2003 2002 2003 2002
_______ _______ _______ _________
Contract revenue $ 9,772 $ 12,131 $ 19,035 $ 23,405
Cost of revenue 7,493 8,382 14,398 16,173
_______ ________ ________ ________
Gross profit 2,279 3,749 4,637 7,232
Operating expenses
Selling, general and administrative 3,022 3,427 5,617 6,045
Depreciation and amortization 152 102 309 242
_______ ________ _______ ________
Total operating expenses 3,174 3,529 5,926 6,287
_______ ________ _______ ________
Operating income (loss) (895) 220 (1,289) 945
Interest expense, net (88) (63) (169) (135)
Other income (expense), net (164) 43 (170) 90
_______ ________ _______ ________
Income (loss) before income taxes (1,147) 200 (1,628) 900
Provision (benefit) for income taxes (15) 77 22 345
_______ _________ ________ ________
Net income (loss) (1,132) 123 (1,650) 555
Preferred stock dividends (58) (58) (116) (116)
_______ ________ _______ ________
Net income (loss) attributed to
common shareholders $ (1,190) $ 65 $ (1,766) $ 439
=========== ========= ========= =========
Basic earnings (loss) per common share $ (0.20) $ 0.01 $ (0.30) $ 0.07
=========== ========= ========== =========
Diluted earnings (loss) per common share $ (0.20) $ 0.01 $ (0.30) $ 0.07
=========== ========== =========== ==========
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 Six months
ended June 30, ended June 30,
_________________ __________________
2003 2002 2003 2002
_______ _______ ________ ________
Net income (loss) $(1,132) $ 123 $ (1,650) $ 555
Foreign currency translation adjustment 92 120 95 93
_______ _______ ________ ________
Comprehensive income (loss) $(1,040) $ 243 $ (1,555) $ 648
======== ======== ========= =========
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
Six months
ended June 30,
2003 2002
Cash flows from operating activities:
Net income (loss) $(1,650) $ 555
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization 1,493 1,146
Write down of investment in Avantium International B.V. 115 -
Changes in assets and liabilities:
Contract receivables 498 (944)
Inventories, prepaid expenses and other assets (302) 268
Accounts payable, accrued compensation and accrued expenses 180 (698)
Billings in excess of revenues earned (531) (1,380)
Accrued warranty reserves (203) 17
Other liabilities (15) 351
______ ______
Net cash used in operating activities (415) (685)
______ ______
Cash flows from investing activities:
Capital expenditures (95) (406)
Capitalized software development costs (751) (1,525)
______ ______
Net cash used in investing activities (846) (1,931)
______ ______
Cash flows from financing activities:
Repayment of note payable to related party - (300)
Releases (restrictions) of cash as collateral under line of credit 308 (150)
Decrease in borrowings under line of credit (368) (1,884)
Proceeds from assignments of sales-type leases - 2,589
Proceeds from issuance of common stock, net of costs - 1,583
Other financing activities, net 245 (227)
_______ ______
Net cash provided by financing activities 185 1,611
_______ ______
Effect of exchange rate changes on cash 43 6
_______ ______
Net decrease in cash and cash equivalents (1,033) (999)
Cash and cash equivalents at beginning of year 1,617 2,040
_______ ______
Cash and cash equivalents at end of period $ 584 $1,041
======= ======
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Three Months ended June 30, 2003 and 2002
(Unaudited)
1. Basis of Presentation and Revenue Recognition
The consolidated financial statements included herein have been
prepared by GSE Systems, Inc. (the "Company") without independent
audit. In the opinion of the Company's management, all adjustments and
reclassifications of a normal and recurring nature necessary to
present fairly the financial position, results of operations and cash
flows for the periods presented have been made. Certain information
and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted
in the United States have been condensed or omitted. These
consolidated financial statements should be read in conjunction with
the consolidated financial statements and notes thereto included in
the Company's Annual Report on Form 10-K for the period ended December
31, 2002 filed with the Securities and Exchange Commission on March
31, 2003.
The majority of the Company's revenue is derived through the sale
of uniquely designed systems containing hardware, software and other
materials under fixed-price contracts. In accordance with Statement of
Position 81-1 "Accounting for Performance of Construction-Type and
Certain Production-Type Contracts", the revenue under these
fixed-price contracts is accounted for on the percentage-of-completion
method, based on contract costs incurred to date and estimated costs
to complete. Estimated contract earnings are reviewed and revised
periodically as the work progresses, and the cumulative effect of any
change is recognized in the period in which the change is identified.
Estimated losses are charged against earnings in the period such
losses are identified.
As the Company recognizes revenue under the
percentage-of-completion method, it provides an accrual for estimated
future warranty costs based on historical and projected claims
experience. The Company's longer-term contracts generally provide for
a one-year warranty on parts, labor and any bug fixes as it relates to
software embedded in the systems.
The Company's system design contracts do not provide for "post
customer support service" (PCS) in terms of software upgrades,
software enhancements or telephone support. In order to obtain PCS,
the customers must purchase a separate contract at the date of system
installation. Such PCS arrangements are generally for a one-year
period renewable annually and include customer support, unspecified
software upgrades, maintenance releases, hardware support and spare
parts. The Company recognizes revenue from these contracts ratably
over the life of the agreements in accordance with Statement of
Position 97-2 "Software Revenue Recognition".
Revenues from certain consulting or training contracts are
recognized on a time-and-material basis. For time-and-material type
contracts, revenue is recognized based on hours incurred at a
contracted labor rate plus expenses.
Contract receivables unbilled of $5.2 million and $4.0 million as
of June 30, 2003 and December 31, 2002, respectively, are typically
billed within thirty days.
2. Basic and Diluted Earnings Per Common Share
Basic earnings per share is based on the weighted average number
of outstanding common shares for the period. Diluted earnings per
share adjusts the weighted average shares outstanding for the
potential dilution that could occur if stock options, warrants or
convertible preferred stock were exercised or converted into common
stock. The number of common shares and common share equivalents used
in the determination of basic and diluted earnings (loss) per share
were as follows:
(in thousands, except for per share amounts) Three months Six months
ended June 30, ended June 30,
___________________ _____________________
2003 2002 2003 2002
________ _______ __________ ________
Numerator:
Net income (loss) $(1,132) $ 123 $(1,650) $ 555
Preferred stock dividends (58) (58) (116) (116)
________ ________ _________ _______
Net income (loss) attributed to
common stockholders $(1,190) $ 65 $(1,766) $ 439
======= ======= ======= =======
Denominator:
Weighted-average shares outstanding for basic
earnings per share 6,019,138 5,869,138 5,951,182 5,857,030
Effect of dilutive securities:
Employee stock options, warrants and
options outside the plan - 416,303 - 402,635
________ __________ _________ __________
Adjusted weighted-average shares outstanding
and assumed conversions for diluted
earnings per share 6,019,138 6,285,441 5,951,182 6,259,665
========= ========== ========= ==========
Shares related to dilutive securities
excluded because inclusion would be
anti-dilutive: 3,538,956 2,290,100 3,538,956 2,290,100
========= ========= ========= =========
Basic $ (0.20) $ 0.01 $ (0.30) $ 0.07
Diluted $ (0.20) $ 0.01 $ (0.30) $ 0.07
The difference between the basic and diluted number of weighted
average shares outstanding for the three and six months ended June 30,
2002 represents dilutive stock options, warrants and convertible
preferred stock to purchase shares of common stock computed under the
treasury stock method, using the average market price during the
period. The net income (loss) for the three and six months ended June
30, 2003 and 2002 were decreased by preferred stock dividends of
$58,000 and $116,000, respectively, in calculating the per share
amounts. Conversion of the stock options, warrants and preferred stock
was not assumed for the three and six months ended June 30, 2003
because the impact was anti-dilutive.
3. Inventories
Inventories are stated at the lower of cost, as determined by the
average cost method, or market. Obsolete or unsaleable inventory is
reflected at its estimated net realizable value. Inventories consist
of the following:
(in thousands) June 30, December 31,
2003 2002
------------- ---------------
Raw materials $ 1,311 $ 1,203
Service parts 335 357
------------- ---------------
Total inventories $ 1,646 $ 1,560
============= ===============
4. Software Development Costs
Certain computer software development costs are capitalized in
the accompanying consolidated balance sheets. Capitalization of
computer software development costs begins upon the establishment of
technological feasibility. Capitalization ceases and amortization of
capitalized costs begins when the software product is commercially
available for general release to customers. Amortization of
capitalized computer software development costs is included in cost of
revenue and is determined using the straight-line method over the
remaining estimated economic life of the product, not to exceed five
years.
Software development costs capitalized were $343,000 and $1.0
million for the three months ended June 30, 2003 and 2002,
respectively. Total amortization expense was $610,000 and $455,000 for
the quarters ended June 30, 2003 and 2002, respectively. For the six
months ended June 30, 2003 and 2002, software development costs
capitalized were $751,000 and $1.5 million, respectively. Total
amortization expense was $1.2 million and $904,000 for the six months
ended June 30, 2003 and 2002, respectively. The decrease from the
prior year reflects the completion of the D/3 version 11.0 and D/3
Compact development projects; these new products were released in the
third quarter 2002.
5. Stock Compensation
The Company applies the intrinsic-value-based method of
accounting prescribe by Accounting Principles Board (APB) Opinion No.
25, Accounting for Stock issued to Employees, and related
interpretations including FASB Interpretation No. 44, Accounting for
Certain Transactions involving Stock Compensation, and interpretation
of APB Opinion No. 25, issued in March 2000, to account for its
fixed-plan stock options. Under this method, compensation expense is
recorded on the date of grant only if the current market price of the
underlying stock exceeds the exercise price. SFAS No. 123, Accounting
for Stock-Based Compensation, established accounting and disclosure
requirements using a fair-value-based method of accounting for stock
based employee compensation plans. As allowed by SFAS No. 123, the
Company has elected to continue to apply the intrinsic-value-based
method of accounting describe above, and has adopted only the
disclosure requirements of SFAS No. 123.
If the computed values of all the Company's stock based awards
were calculated and expensed (over the vesting period of the awards)
using the fair value method specified under SFAS 123, net income
(loss) would have been as follows:
(in thousands, except per share data) Three months Six months
ended June 30, ended June 30,
_______________________ _______________________
2003 2002 2003 2002
________ _________ ________ _________
Net income (loss) attributed to
common stockholders, as reported $ (1,190) $ 65 $ (1,766) $ 439
Add stock-based employee compensation expense
included in reported net income (loss), net of tax - - - -
Deduct total stock-based employee compensation
expense determined under fair-value-method
for all awards, net of tax (67) (106) (133) (211)
________ _________ ________ _________
Pro forma net income (loss) $ (1,257) $ (41) $ (1,899) $ 228
========== ========== ========== =========
Net income (loss) per share, as reported:
Basic $ (0.20) $ 0.01 $ (0.30) $ 0.07
Diluted $ (0.20) $ 0.01 $ (0.30) $ 0.07
Net income (loss) per share, as adjusted:
Basic $ (0.21) $ (0.01) $ (0.32) $ 0.04
Diluted $ (0.21) $ 0.00 $ (0.32) $ 0.05
No employee stock options were issued in the first six months of 2003 or
2002.
6. Long-term Debt
The Company's long-term debt consists of the following notes payable
and other financing arrangements:
(in thousands) June 30, December 31,
2003 2002
------------- ---------------
Line of credit with bank $ 5,063 $ 5,431
Obligations under financing leases 2,828 3,784
Notes payable to related parties 908 650
Notes payable, other 58 73
------------- ---------------
Total notes payable and financing arrangements 8,857 9,938
Less amounts payable within one year 7,108 1,905
------------- ---------------
Long-term portion $ 1,749 $ 8,033
============= ===============
Line of Credit
The Company has a $6.5 million bank line of credit under which
the Company and its subsidiaries, GSE Process Solutions, Inc. and GSE
Power Systems, Inc., are jointly and severally liable as co-borrowers.
The credit facility provides for borrowings to support working capital
needs and foreign letters of credit ($2.0 million sub limit). The line
is collateralized by substantially all of the Company's assets and
provides for borrowings up to 85% of eligible accounts receivable, 50%
of eligible unbilled receivables and 40% of eligible inventory (up to
a maximum of $1.2 million). The interest rate on this line of credit
is based on the bank's prime rate plus 1.00% (5.25% as of June 30,
2003), with interest only payments due monthly. At June 30, 2003, the
Company's available borrowing base was approximately $5.6 million, of
which approximately $5.1 million had been utilized. The credit
facility expires on March 31, 2004. The lender has requested that the
Company find a new lender.
The maximum commitment under the credit facility will be reduced
to $5.5 million on October 1, 2003 and to $5.0 million on January 1,
2004. The agreement prohibits the payment of all dividends, including
dividends due to ManTech on its outstanding preferred stock. GP
Strategies has provided $1.8 million limited guarantee of the
Company's bank facility through March 31, 2004. In consideration for
the extension of the guarantee, the Company will issue 150,000 shares
of its common stock to GP Strategies. The number of shares was
calculated based upon a 10% fee divided by the closing price of GSE's
common stock on March 21, 2003.
The credit facility requires the Company to comply with certain
financial ratios. At June 30, 2003, the Company was not in compliance
with its financial ratio covenants. The Company expects to receive a
written waiver from the bank for noncompliance.
Because the credit facility expires on March 31, 2004, the
Company has classified the borrowings under the line of credit as
current as of June 30, 2003. The lender has requested that the
Company find a new lender by March 31, 2004.
Notes Payable to Related Parties
On June 25, 2001, the Company issued an unsecured promissory note
to ManTech for $1.0 million at an interest rate of prime plus one
percent. The Company used the loan proceeds for working capital
purposes. The note is subordinated to the Company's credit facility.
During 2002, the Company repaid ManTech $350,000; as of June 30, 2003,
there is $650,000 outstanding on the note.
In December 1997, the Company acquired 100% of the outstanding
common stock of J.L.Ryan, Inc. for an initial purchase price of $1.0
million and contingent consideration based on the performance of the
business from 1998 to 2002. In April, 2003, the Company issued four
promissory notes to the former shareholders of J. L. Ryan (all of whom
are current GSE employees) totaling approximately $515,000 for the
2002 contingent consideration. The notes are payable in six monthly
installments and have an interest rate of prime plus two percent. In
the first quarter 2003, the Company paid $257,000; as of June 30, 2003
there is $258,000 outstanding on the notes.
Notes Payable Other
The Company has an additional unsecured promissory note to a
former employee for $58,000 which expires April 14, 2005.
Obligations under financing leases
As of June 30, 2003, the Company has seven separate contracts
with a customer for the lease of certain hardware and software under
36-month leases. The Company has accounted for the leases as
sales-type leases. The Company assigned the payments due under the
sales-type leases to a third-party financing company; for the year
ended December 31, 2002, the Company received approximately $2.2
million of proceeds. Since the Company remains contingently liable for
amounts due to the third-party financing company, the remaining
investment in and obligation under the financing leases are reflected
in the Company's balance sheets as follows:
(in thousands) June 30, December 31,
2003 2002
------------------ -----------------
Net investment in sales-type leases:
Prepaid expense and other assets $ 1,755 $ 1,875
Other assets 1,073 1,909
------------------ -----------------
Total net investment $ 2,828 $ 3,784
================== =================
Obligation under financing leases:
Current portion of long-term debts $ 1,755 $ 1,875
Long-term debts 1,073 1,909
------------------ -----------------
Total obligations $ 2,828 $ 3,784
================== =================
7. Series A Convertible Preferred Stock
The Series A convertible preferred stock has no voting rights and
bears dividends at the rate of 6% per annum payable quarterly.
Dividends will accumulate if not paid quarterly and compounded
interest will accrue on any unpaid dividends. As of June 30, 2003 and
December 31, 2002 the Company had accrued dividends payable of
$292,000 and $176,000, respectively. ManTech at its discretion has the
right to convert each share of Series A convertible preferred stock
into GSE common stock, but if not converted prior to December 2004,
the Series A convertible stock automatically converts into GSE common
stock at that time.
8. Letters of Credit
As of March 31, 2003, the Company was contingently liable for
five letters of credit totaling $439,000. All of these letters of
credit represent payment bonds on contracts and have been cash
collateralized and are classified as restricted cash in the
consolidated balance sheet.
9. Income Taxes
The Company's effective tax rate was 1.4% and 38.3% for the six
months ended June 30, 2003 and June 30, 2002, respectively. The 1.4%
effective tax rate is an average rate that consists of a zero
effective tax rate for the Company's US and China operations and a
10.4% effective tax rate for its Swedish operations. The decrease in
the effective tax rate is attributable to the Company recording no
federal or state income tax benefit for net operating losses generated
by its US and China operations for the six months ended June 30, 2003.
10. Segment Information
The Company's two reportable segments are its core business units
Process and Power. The Company is primarily organized on the basis of
these two business units. The Company has a wide range of knowledge of
control and simulation systems and the processes those systems are
intended to improve, control and model. The Company's knowledge is
concentrated heavily in the process industries, which include the
chemicals, food & beverage, and pharmaceuticals fields, as well as in
the power generation industry. The Process business unit is primarily
engaged in process control in a variety of commercial industries.
Contracts typically range from three to nine months. The Power
business unit is primarily engaged in simulation for the power
generation industry, with the vast majority of customers being in the
nuclear power industry. Contracts typically range from 18 months to
three years.
The Company evaluates the performance of its business units
utilizing "Business Unit Contribution", which is substantially
equivalent to earnings before interest and taxes before allocating any
corporate expenses.
The table below presents information about the reportable
segments:
(in thousands) Three months ended June 30, 2003 Six months ended June 30, 2003
____________________________________ _____________________________________
Process Power Consolidated Process Power Consolidated
_________ _________ _____________ _________ _________ ______________
Contract revenue $ 4,279 $ 5,493 $ 9,772 $ 8,610 $ 10,425 $ 19,035
============ =========== ============ ============ =========== ============
Business unit contribution $ (317) $ 289 $ (28) $ (321) $ 679 $ 358
============ =========== ============= =========== =========== =============
Three months ended June 30, 2002 Six months ended June 30, 2002
Process Power Consolidated Process Power Consolidated
_________ ________ ____________ ________ ________ ____________
Contract revenue $ 6,916 $ 5,215 $ 12,131 $ 13,617 $ 9,788 $ 23,405
============ =========== ============ ============ =========== ============
Business unit contribution $ 1,125 $ 40 $ 1,165 $ 2,777 $ (80) $ 2,697
============ =========== ============ ============ =========== ============
A reconciliation of segment business unit contribution to
consolidated income before taxes is as follows:
(in thousands) Three months Six months
ended June 30, ended June 30,
_____________________ ___________________
2003 2002 2003 2002
________ ________ ________ _______
Segment business unit contribution $ (28) $ 1,165 $ 358 $ 2,697
Corporate expenses (1,031) (902) (1,817) (1,662)
Interest expense, net (88) (63) (169) (135)
________ ________ ________ ________
Income (loss) before income taxes $ (1,147) $ 200 $ (1,628) $ 900
=========== ========= ========= =======
11. Recent Accounting Pronouncements
In October 2002, the Emerging Issues Task Force of the FASB
reached a consensus on the accounting for revenues in transactions
that involve multiple deliverables. The guidance governs how to
identify whether goods or services or both, that are to be delivered
separately in a bundled sales arrangement, should be accounted for
separately. This guidance will be effective July 1, 2003. The Company
has not yet determined the impact this consensus will have on its
consolidated financial statements.
12. Reclassifications
Certain prior year amounts have been reclassified to conform to
the current year presentation.
13. Guaranties
Except for warranties provided to customers in the normal course
of business and letters of credit issued to customers to insure the
Company's performance on certain uncompleted contracts, the Company
has no guarantees as defined in FIN 45.
GSE SYSTEMS, INC. AND SUBSIDIARIES
FORM 10-Q
For the Three and Six Months ended June 30, 2003 and 2002
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
The Company has a $6.5 million credit facility with a bank which
matures on March 31, 2004. The Company was informed by its bank in the
first quarter 2003 that the Company should search for a new financial
institution to provide for its future financing requirements. The
maximum commitment under the credit facility reduces to $5.5 million
on October 1, 2003 and to $5.0 million on January 1, 2004. Based upon
the Company's current forecasts of its cash flow in 2003, management
believes the reductions in the maximum commitment will not have an
impact on the Company's operations or liquidity. The Company has begun
the process of identifying a new lender.
In order to help improve the Company's liquidity and operating
results, management has undertaken actions to reduce its operating
expenses, including the sublease of 29,000 square feet of its 34,000
square foot Baltimore, Maryland facility effective May 1, 2003. During
the second quarter of 2003, the Company recorded charges of
approximately $313,000 related to the estimated loss on the sublease,
the broker's commission, moving expenses and severance costs.
The Company's 2003 profitability and liquidity projections
reflect several large full-scope simulator contracts in its Power
business unit which were awarded to the Company in the first six
months of 2003. The Company's contract backlog has increased $9.4
million from $29.9 million to $39.3 million as of December 31, 2002
and June 30, 2003, respectively.
Cautionary Statement Regarding Forward-Looking Statements
This report contains certain forward-looking statements. Any
statements contained herein that are not statements of historical
facts may be deemed forward-looking statements. These statements are
based on management's current beliefs and expectations and are subject
to numerous risks and uncertainties and changes in circumstances.
Actual results may differ materially from these forward-looking
statements due to changes in global, economic, business, governmental,
technical, competitive, market and regulatory factors.
General Business Environment
GSE Systems, Inc. ("GSE Systems", "GSE" or the "Company") is a
world leader in real-time power plant simulation and process
automation and control. The Company provides simulation solutions and
services to the nuclear and fossil electric utility industry, as well
as process industries such as the chemical and petrochemical
industries. In addition, the Company provides plant monitoring,
security access and control, and signal analysis monitoring and
optimization software primarily to the power industry. The Company's
process automation products optimize batch and hybrid plant control
for the specialty chemical, food and beverage, and pharmaceutical
industries. The Company operates through two business segments, Power
Simulation and Process Automation.
The Company's annual report on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K, and all amendments to those
reports will be made available free of charge through the Investor
Relations section of the Company's Internet website
(http://www.gses.com) as soon as practicable after such material is
electronically filed with, or furnished to, the Securities and
Exchange Commission.
* Power Simulation Business.
The Company's Power Simulation Business Unit ("Power") has
positioned itself to take advantage of emerging trends in the power
industry. The operating licenses for numerous US nuclear power plants
will expire over the next several years. The majority of these nuclear
power plants are in some stage of license renewal. Sixteen plants have
already completed the renewal license application, fourteen of which
are currently under NRC review, and twenty-seven have plans to file
for license extensions over the next three years. Many plants are also
planning significant upgrades to the physical equipment and control
room technology in conjunction with the license extensions. Both will
result in the need to modify or replace the existing plant control
room simulators. The Company, having the largest installed base of
existing simulators, is well positioned to capture the majority of
this business and received several upgrade contracts in the second
quarter 2003 as a result of this trend.
To address the varying levels of technology that exists across
the Company's installed base, the Company has developed a Java-based
graphical overlay technology called JADE (Java Application Development
Environment). JADE provides a common look and feel to the Company's
various simulation tools regardless of whether the underlying
technology is UNIX, LINUX or Microsoft Windows XP. JADE also works
with all of the Company's tools for building electrical, logic and
control, and flow system models for plants. Jade Version 1.0 was
released for sale on March 31, 2003.
Driven by the market's need for additional security of chemical
plant process control systems, the Company began development of its
GAARDS Validation and Authentication Server. This product will provide
an added layer of security to process control systems, verifying
operator identification through biometrics, and allowing customer
selected verification during key process functions. If desired, a
customer can require concurrence of the shift supervisor before an
operator makes a critical change to a process step, or batch recipe.
The server not only adds new security features, but enables the
Company to meet many of the verification and auditing requirements of
the Food and Drug Administrations requirements on electronic records
and electronic signatures. The GAARDS Validation and Authentication
Server will allow plants to also validate training and fitness for
duty checks, and tie access to the control room and controls systems
together. Remote access to control systems will become much more
secure through both biometric validation and built in "concurrence"
from on-site plant personnel. The Company sees a market for this type
of product in Chemical, Pharmaceutical and Food and Beverage
industries, as well as for use in energy market DCS and SCADA
applications.
* Process Control Business
To expand within its traditional customer base and gain new
customers, Process embarked upon a program in 2002 to develop a
lower-cost, next generation process controller using the latest
microprocessor technology. This new controller was part of the third
quarter 2002 D/3 product release that also included enhanced alarming
and improved security features. This new version of the D/3 product
allows the Company to bridge the cost gap between programmable logic
controllers (PLCs) and the distributed control systems while providing
the increased performance of a full-function distributed control
system. This more cost effective solution will enable existing
customers to apply automation to areas of their plants that could not
previously afford the benefits of a full-function distributed control
system. In the second quarter 2003, the Company continued to expand
its Distribution Channel Partnership program by adding an additional
System Integrator. Thus the Company has partnered with six
Manufacturer's Representative organizations and four Systems
Integrator companies. In addition, the Company entered into agreements
with strategic third party software providers to provide more
complete, integrated solutions for its customers. The new software
partners provide capabilities in neural network solutions as well as
multi-variable advanced process control.
The Company entered into a sublease agreement with Alpharma USPD
Inc. to sublease 29,000 square feet of its Baltimore, MD facility for
a five-year period commencing on May 1, 2003. The subtenant may
terminate the lease at the end of the second or third year of the
agreement provided a six month notice is given. The Company moved most
of the Process personnel that were using this facility to its
Columbia, Maryland facility in April 2003.
Results of Operations
The following table sets forth the results of operations for the
periods presented expressed in thousands of dollars and as a percentage of
revenue:
(in thousands) Three months ended June 30, Six months ended June 30,
______________________________________ ________________________-_____________
2003 % 2002 % 2003 % 2002 %
________ ________ ________ ________ ________ _______ ________ _________
Contract revenue $ 9,772 100.0 % $12,131 100.0 % 19,035 100.0 % $23,405 100.0 %
Cost of revenue 7,493 76.7 % 8,382 69.1 % 14,398 75.6 % 16,173 69.1 %
________ ________ ________ ________ ________ _______ ________ _________
Gross profit 2,279 23.3 % 3,749 30.9 % 4,637 24.4 % 7,232 30.9 %
________ ________ ________ ________ ________ _______ ________ _________
Operating expenses:
Selling, general and
administrative 3,022 30.9 % 3,427 28.2 % 5,617 29.6 % 6,045 25.8 %
Depreciation and amortization 152 1.6 % 102 0.9 % 309 1.6 % 242 1.1 %
________ ________ ________ ________ ________ _______ ________ _________
Total operating expenses 3,174 32.5 % 3,529 29.1 % 5,926 31.2 % 6,287 26.9 %
________ ________ ________ ________ ________ _______ ________ _________
Operating income (loss) (895) (9.2)% 220 1.8 % (1,289) (6.8)% 945 4.0 %
Interest expense, net (88) (0.9)% (63) (0.5)% (169) (0.9)% (135) (0.6)%
Other income (expense), net (163) (1.7)% 43 0.3 % (170) (0.9)% 90 0.4 %
________ ________ ________ ________ ________ _______ ________ _________
Income (loss) before income taxes (1,147) (11.8)% 200 1.6 % (1,628) (8.6)% 900 3.8 %
Provision (Benefit)for income taxes (15) (0.2)% 77 0.6 % 22 0.1 % 345 1.5 %
________ ________ ________ ________ _________ _______ _________ _________
Net income (loss) $(1,132) (11.6)% $ 123 1.0 % $(1,628) (8.7)% $ 555 2.3 %
========= ========= ======== ========= ========= ======== ========= ==========
Critical Accounting Policies and Estimates
In preparing the Company's financial statements, management makes several
estimates and assumptions that affect the Company's reported amounts of assets,
liabilities, revenues and expenses. Those accounting estimates that have the
most significant impact on the Company's operating results and place the most
significant demands on management's judgment are discussed below. For all of
these policies, management cautions that future events rarely develop exactly as
forecast, and the best estimates may require adjustment.
Revenue Recognition on Long-Term Contracts. The Company uses the
percentage-of-completion revenue recognition methodology to record revenue under
its long-term fixed-price contracts in accordance with the AICPA Statement of
Position 81-1, "Accounting for Performance of Construction-Type and Certain
Production-Type Contracts". This methodology recognizes income as work
progresses on the contract and is based on an estimate of the income earned to
date, less income recognized in earlier periods. The Company bases its estimate
of the degree of completion of the contract by reviewing the relationship of
costs incurred to date to the expected total costs that will be incurred on the
project. The Company's project managers are responsible for estimating the costs
to be incurred at the beginning of each project and are responsible for updating
the estimate as the project progresses. Management reviews the status of each
project periodically with the project managers and determines whether the cost
estimates are reasonable. If changes in the estimated costs to complete the
projects are required, the cumulative impact on the percentage of completion
revenue calculation is recognized in the period identified. Whenever evidence
indicates that the estimated total cost of a contract will exceed its total
contract value, the Company's operating results are charged for the full amount
of the estimated losses immediately. Uncertainties inherent in the performance
of contracts include labor availability and productivity, material costs, change
order scope and pricing, software modification issues and customer acceptance
issues. The reliability of these cost estimates is critical to the Company's
revenue recognition as a significant change in the estimates can cause the
Company's revenue and related margins to change significantly from the amounts
estimated in the early stages of the project.
Capitalization of Computer Software Development costs. In accordance with
Statement of Financial Accounting Standards (SFAS) No. 86 "Accounting for the
Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed", the
Company capitalizes computer software development costs incurred after
technological feasibility has been established, but prior to the release of the
software product for sale to customers. Once the product is available to be
sold, the Company begins to amortize the costs over the estimated useful life of
the product, which normally ranges from three to five years. At June 30, 2003,
the Company has net capitalized software development costs of $4.0 million. On
an annual basis, the Company assesses the recovery of the unamortized software
computer costs by estimating the net undiscounted cash flows expected to be
generated by the sale of the product. If the undiscounted cash flows are not
sufficient to recover the unamortized software costs the Company will write-down
the unamortized software development costs to net realizable value. The excess
of any unamortized computer software costs over the related net realizable value
is written down and charged to income. Significant changes in the sales
projections could result in an impairment with respect to the capitalized
software that is reported on the Company's balance sheet.
Deferred Income Tax Valuation Allowance. Deferred income taxes arise from
temporary differences between the tax bases of assets and liabilities and their
reported amounts in the financial statements. As required by SFAS No. 109
"Accounting for Income Taxes" management makes an annual assessment of the
realizability of the Company's deferred tax assets. In making this assessment,
management considers whether it is more likely than not that some or all of the
deferred tax assets will not be realized. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible. Management
considers the scheduled reversal of deferred tax liabilities and projected
future taxable income of the Company in making this assessment. A valuation
allowance is recorded to reduce the total deferred income tax assets to its
realizable value. At June 30, 2003, the Company's deferred tax assets related
primarily to a U.S. net operating loss carryforward of $15.1 million which can
be utilized over the next twenty years. The recovery of the remaining net
deferred tax asset could not be substantiated by currently available objective
evidence, and, accordingly, the Company has established a full valuation
allowance for the balance of its deferred tax asset of $7.7 million at June 30,
2003. If the Company is able to realize taxable income in the future, the
valuation allowance will be reduced.
Results of Operations
Contract Revenue. Total contract revenue for the three and six months ended
June 30, 2003 totaled $9.8 million and $19.0 million, respectively, as compared
with total contract revenue of $12.1 million and $23.4 million for the three and
six months ended June 30, 2002, respectively.
The Process business unit's revenue decreased 38.1% for the three months
ended June 30, 2003 as compared to the same period in the prior year, from $6.9
million to $4.3 million. Likewise, revenue for the six months ended June 30,
2003 fell to $8.6 million from $13.6 million for the same period in the prior
year, a 36.8% decrease. The decrease in Process' revenue is mainly attributable
to a reduction in orders received from Westinghouse Savannah River Company.
Revenue generated from work performed for Westinghouse Savannah River Company
totaled 28% of total Process revenue in the second quarter 2003 versus 59% in
the second quarter 2002, and 29% of total Process revenue for the six months
ended June 30, 2003 versus 54% in the same period 2002.
The Power business unit's revenue increased 5.3% in the three months ended
June 30, 2003 as compared to the same period in the prior year, from $5.2
million to $5.5 million. Revenue for the six months ended June 30, 2003 was
$10.4 versus $9.8 in the same period of 2002, a 6.5% increase. The increase is
mainly attributable to the start-up of two large international training
simulator projects in the first quarter, 2003.
Gross Profit. Gross profit totaled $2.3 million (23.3% of revenue) for the
quarter ended June 30, 2003, as compared with $3.7 million (30.9% of revenue)
for the quarter ended June 30, 2002. For the six months ended June 30, 2003 and
2002, gross profit decreased from $7.2 million (30.9% of revenue) to $4.6
million (24.4% of revenue). The decreases in gross profit as a percentage of
revenue are mainly attributable to increases in operations overhead and
amortization of capitalized software development costs in 2003.
Selling, General and Administrative Expenses. Selling, general and
administrative ("SG&A") expenses totaled $3.0 million in the quarter ended June
30, 2003, an 11.8% decrease from the $3.4 million for the same period in 2002.
SG&A expenses for the six months ended June 30, 2003 decreased 7.1%, from $6.0
million to $5.6 million as compared to the same period in the prior year. The
reduction in SG&A expense in 2003 mainly reflects lower Process sales
commissions and reduced marketing expenditures, offset in part by costs incurred
by the Process business unit in relocating its main headquarters offices. The
Company entered into a sublease agreement with Alpharma USPD Inc. to sublease
29,000 square feet of its Baltimore, Maryland facility for a five-year period
commencing on May 1, 2003. The subtenant may terminate the lease at the end of
the second or third year of the agreement provided a six-month notice is given.
The Company moved most of the Process personnel that had been using this office
to its Columbia, Maryland facility in April 2003. During the second quarter of
2003, the Company recorded charges of approximately $313,000 related to the
estimated loss on the sublease, the broker's commission, and moving expenses.
Included in SG&A is net research and product development expenditures
("R&D"), as discussed below.
Gross R&D totaled $630,000 in the second quarter of 2003, as compared with
$1.4 million in the same period of 2002. Capitalized software development costs
totaled $343,000 and $1.0 million for the second quarter of 2003 and 2002,
respectively. Accordingly, net R&D expensed and included in SG&A was $287,000
and $371,000 for the second quarter of 2003 and 2002, respectively.
Gross R&D spending for the six months ended June 30, 2003 and 2002 totaled
$1.3 million and $2.0 million, respectively. Capitalized software development
costs totaled $751,000 in the first half of 2003 versus $1.5 million in the same
period of 2002; and net R&D expensed and included in SG&A was $522,000 in the
first six months of 2003 versus $452,000 in 2002.
The decrease in gross R&D spending in 2003 as compared to the prior
year is mainly due to the completion of Version 11.0 of the Company's D/3
Distributed Control System which was released for sale in the third quarter
2002. The Company enhanced the capabilities of the D/3 through significant
investment in a lower-cost next generation process controller using the latest
microprocessor technology.
The Company's R&D expenditures in the first half of 2003 were related
to:
* Enhancements for the D/3 system including improved diagnostics, enhanced
display features, improved PCM redundancy and an Ethernet interface for
I/O.
* The completion of JADE 1.0 (Java Applications & Development Environment), a
Java-based application that provides a window into the simulation
instructor station and takes advantage of the web capabilities of Java,
allowing customers to access the simulator and run simulation scenarios
from anywhere they have access to the web. JADE version 1.0 was released
for sale on March 31, 2003.
* Additional enhancements to JADE that will be released in version 2.0,
including implementing XML file structure in JADE for pagination, adding
wireless PDA for JStation applications, multi-language support, and adding
a two phase object oriented flow network. JADE version 2.0 is expected to
be released at the end of 2003.
* The development of the GAARDS Validation and Authentication Server. This
product will provide an added layer of security to process control systems,
verifying operator identification through biometrics, and allowing
customer-selected verification during key process functions.
Depreciation and Amortization. Depreciation expense totaled $152,000 and
$102,000 during the quarters ended June 30, 2003 and 2002, respectively. For the
six months ended June 30, 2003 and 2002 depreciation expense totaled $309,000
and $242,000, respectively.
Operating Income (Loss). The Company had operating loss of $895,000 (9.2%
of revenue) in the second quarter 2003, as compared with operating income of
$220,000 (1.8% of revenue) for the same period in 2002. For the six months ended
June 30, 2003 and 2002, the Company had an operating loss of $1.3 million (6.8%
of revenue) and operating income of $945,000 (4.0% of revenue), respectively.
The decrease in operating results for both periods was due to the factors
outlined above.
Interest Expense, Net. Net interest expense increased 39.7% from $63,000 in
the quarter ended June 30, 2002 to $88,000 for the same quarter in 2003. For the
six months ended June 30, 2003 and 2002, net interest expense totaled $169,000
and $135,000, respectively. In 2002, the Company had received $23,000 of
interest income related to a Federal Income tax refund.
Other Income (Expense), Net. For the three and six months ended June 30,
2003, the Company incurred a $46,000 loss on the disposal of fixed assets in
conjunction with the relocation of Process to the Company's Columbia, Maryland
office. In addition, the Company wrote off the remaining balance of its
investment in Avantium International B.V. ($115,000) in the second quarter 2003.
Per the final term sheet of Avantium's pending private round of financing, GSE's
ownership will be diluted to .03%. Accordingly, the Company concluded that this
pending transaction was evidence of "an other than temporary decline" in the
fair value of its investment in Avantium. For the comparable periods in 2002,
other income mainly reflects recognized foreign currency transaction gains and
royalty income.
Provision (Benefit) for Income Taxes. The Company's effective tax rate was
1.4% and 38.3% for the three months ended June 30, 2003 and June 30, 2002,
respectively. The 1.4% effective tax rate is an average rate that consists of a
zero effective tax rate for the Company's US and China operations and a 10.4%
effective tax rate for its Swedish operations. The decrease in the effective tax
rate is attributable to the Company recording no federal or state income tax
benefit for net operating losses generated by its US and China operations for
the six months ended June 30, 2003.
Liquidity and Capital Resources
As of June 30, 2003, the Company's cash and cash equivalents totaled
$584,000, compared to $1,617,000 at December 31, 2002.
Cash used in operating activities. Net cash used in operating activities
was $415,000 for the six months ended June 30, 2003. The most significant change
in the Company's assets and liabilities in 2003 was a decrease of $531,000 in
billings in excess of revenues earned. The Company received an order for a
one-year maintenance contract in December 2002 that allowed GSE to invoice the
customer in full at the time of order receipt. The reduction in billings in
excess of revenue earned mainly reflects the recognition of revenue associated
with this maintenance contract.
Net cash used in operating activities was $685,000 for the six months
ended June 30, 2002. Significant changes in the Company's assets and liabilities
in 2002 included:
* an increase in contract receivables of $944,000 largely related to the
Westinghouse Savannah River Company projects, and
* a $1.4 million reduction in billings in excess of revenues earned. The
Company had received orders from two Process customers in the third quarter
2001 that allowed GSE to invoice the customer in full prior to the work
being completed. The reduction in billings in excess of revenues earned
mainly reflects the completion of a portion of these two contracts in the
first six months of 2002.
Cash used in investing activities. Net cash used in investing activities
was $846,000 in the six months ended June 30, 2003, consisting of $751,000 of
capitalized software development costs and $95,000 for capital expenditures.
In the first six months of 2002, net cash used in investing activities was
$1.9 million, consisting of $1.5 million of capitalized software development
costs and $406,000 for capital expenditures.
Cash provided by financing activities. During the six months ended June 30,
2003, the Company generated $185,000 cash from financing activities. The Company
decreased its borrowings under its bank line of credit by $368,000 to a total of
$5.1 million. In addition, two cash-collateralized standby letters of credit
totaling $308,000 issued by the Company prior to 2003 expired and the cash was
received.
During the six months ended June 30, 2002, the Company generated $1.6
million net cash through financing activities. The Company received $1.3 million
from its escrow agent in January 2002 from a fixed-price rights offering which
was completed on December 31, 2001 and received $262,000 from the exercise of
employee stock options. The Company decreased its borrowings under its bank line
of credit by $1.9 million to a total of $3.1 million, and decreased its
borrowings from ManTech International Corporation by $300,000 to a total of
$700,000. The Company entered into two contracts with a customer for the lease
of certain hardware and software under 36-month leases and assigned the payments
due under these sales-type leases to a third party financing company, receiving
proceeds of $2.6 million. In addition, the Company issued a $150,000 bid bond
that was cash collateralized. Bid bonds are issued by the Company in the
ordinary course of business through banks as required by certain contracts and
proposal requirements.
Credit Facilities
The Company has a $6.5 million bank line of credit with a bank which
matures on March 31, 2004. The credit facility provides for borrowings up to a
total $6.5 million to support working capital needs and foreign letters of
credit. At June 30, 2003, the Company's available borrowing base was $5.6
million, of which approximately $5.1 million had been utilized. The credit
facility expires on March 31, 2004. The lender has requested that the Company
find a new lender. The Company has initiated the process to locate a new lender.
The maximum commitment under the credit facility will be reduced to $5.5
million on October 1, 2003 and to $5.0 million on January 1, 2004. The agreement
prohibits the payment of all dividends, including dividends due to ManTech on
its outstanding preferred stock. GP Strategies has provided $1.8 million limited
guarantee of the Company's bank facility through March 31, 2004. In
consideration for the extension of the guarantee, the Company will issue 150,000
shares of its common stock to GP Strategies. The number of shares was calculated
based upon a 10% fee divided by the closing price of GSE's common stock on March
21, 2003.
The credit facility requires the Company to comply with certain financial
ratios. At June 30, 2003, the Company was not in compliance with its financial
ratio covenants. The Company expects to receive a written waiver from the bank
for noncompliance. As of June 30, 2003, the Company has classified the
borrowings under the line of credit as current. See Note 6, "Long-term Debt", in
the Notes to Consolidated Financial Statements" for additional details about
this line of credit.
On June 25, 2001, the Company issued an unsecured promissory note to
ManTech that allowed the Company to borrow up to $1.0 million at an interest
rate of prime plus one percent. The note is subordinated to the Company's credit
facility. In January 2002, the Company repaid ManTech $250,000 of the note from
the proceeds of a fixed-price rights offering that was completed in December
2001 and an additional $100,000 subsequent to January 2002.
Other
In June, 2003, the Company received a $6.6 million order from the Mexican
utility Comision Federal de Electricidad for a major simulator upgrade to the
Laguna Verde nuclear plant near Vera Cruz, Mexico. The contract required that
the Company issue an advance payment bond ($1.8 million) and a performance bond
($1.3 million) to CFE. On July 9, 2003, the Company entered into a Collateral
Agreement with ManTech International Corporation in which ManTech agreed to
issue two letters of credit on the Company's behalf to a Mexican surety company
as collateral for the bonds. One letter of credit will be outstanding for at
least 30 months or until the advance payment bond is released, whichever is
later, and the other letter of credit will be outstanding for at least 42 months
or until the performance bond is released, whichever is later. As consideration
for ManTech's issuance of the letters of credit, the Company will issue 100,000
warrants at an exercise price of $1.33 per share, the closing price on July 8,
2003 and pay ManTech a fee equal to 7% per annum on the total amount of the
then-existing value of the letters of credit, payable on a quarterly basis.
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 June 30, 2003, such interest rates are based
on the bank's prime rate plus 100 basis-points.
As of June 30, 2003, $5.7 million of the Company's debt was subject to
variable interest rates. A 100 basis-point change in such rates during the three
and six months ended June 30, 2003 would have changed the Company's interest
expense by approximately $13,000 and $25,000, respectively.
Item 4. Controls and Procedures
Within the 90-day period prior to the filing of this report, GSE
management, including the Chief Operating Officer and Chief Financial Officer,
conducted an evaluation of the effectiveness of the design and operation of the
company's disclosure controls and procedures as defined in Exchange Act Rule
13a-14(c). Based on that evaluation, the Chief Operating Officer and Chief
Financial Officer concluded that the company's disclosure controls and
procedures were effective as of the date of that evaluation. There have been no
significant changes in internal controls, or in factors that could significantly
affect internal controls, subsequent to the date the Chief Operating Officer and
Chief Financial Officer completed their evaluation.
GSE SYSTEMS, INC. AND SUBSIDIARIES
FORM 10-Q
For the Three and Six Months ended June 30, 2003 and 2002
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
In accordance with its conduct in the ordinary course of business, certain
actions and proceedings are pending to which the Company is a party. In the
opinion of management, the aggregate liabilities, if any, arising from such
actions are not expected to have a material adverse effect on the financial
condition of the Company.
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
Votes
Proposal For Against Abstain Withheld
------------- ---------------- ------------ ------------ -------------
1) Election of directors:
Scott N. Greenberg 4,537,346 - - 253,200
Joseph W. Lewis 4,537,346 - - 253,200
John A. Moore, Jr. 4,521,632 - - 268,914
2) Ratification of KPMG LLP as
the Company's independent
auditors for the current fiscal year 4,788,246 2,300 - -
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31.1 Certification Pursuant to Section 302 of Sarbanes-Oxley
Act of 2002
31.2 Certification Pursuant to Section 302 of Sarbanes-Oxley
Act of 2002
32.1 Certification Pursuant to Section 906 of Sarbanes-Oxley
Act of 2002
32.2 Certification Pursuant to Section 906 of Sarbanes-Oxley
Act of 2002
(b) Reports on Form 8-K
Form 8-K was filed by the Registrant with the Securities and Exchange
Commission on April 10, 2003 regarding the press release issued by the
Company announcing the receipt of simulation orders in excess of $4.0
million.
Form 8-K was filed by the Registrant with the Securities and Exchange
Commission on May 15, 2003 regarding the press release issued by the
Company announcing the net loss for the quarter ended March 31, 2003.
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: August 14, 2003 GSE SYSTEMS, INC.
/S/ CHIN-OUR JERRY JEN
Chin-Our Jerry Jen
Chief Operating Officer and President
(Principal Executive Officer)
/S/ JEFFERY G. HOUGH
Jeffery G. Hough
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)