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 September 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 November 1, 2003, there were 8,531,053 shares of the Registrant's common
stock outstanding.
GSE SYSTEMS, INC.
QUARTERLY REPORT ON FORM 10-Q
INDEX
PAGE
PART I. FINANCIAL INFORMATION 3
Item 1. Financial Statements:
Consolidated Balance Sheets as of September 30, 2003 and December 31, 2002 3
Consolidated Statements of Operations for the Three and Nine Months Ended September 4
30, 2003 and September 30, 2002
Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months 5
Ended September 30, 2003 and September 30, 2002
Consolidated Statements of Cash Flows for the Three and Nine Months Ended September 6
30, 2003 and September 30, 2002
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 25
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
Unaudited
September 30, 2003 December 31, 2002
ASSETS
Current assets:
Cash and cash equivalents $ 2,633 $ 1,617
Restricted cash 462 608
Contract receivables 7,791 10,761
Inventories - 1,560
Prepaid expenses and other current assets 1,082 2,656
------------ ----------
Total current assets 11,968 17,202
Property and equipment, net 768 1,697
Software development costs, net 969 4,401
Goodwill, net 1,739 2,901
Restricted cash 29 139
Other assets 596 2,554
-------------- ---------
Total assets $ 16,069 $ 28,894
============== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 33 $ 1,905
Accounts payable 2,411 2,521
Accrued expenses 1,779 1,727
Accrued compensation and payroll taxes 1,347 1,401
Billings in excess of revenue earned 3,115 3,059
Accrued warranty reserves 179 491
Other current liabilities 109 62
-------------- ---------
Total current liabilities 8,973 11,166
Long-term debt 667 8,033
Billings in excess of revenue earned - 998
Accrued warranty reserves 395 586
Other liabilities 25 -
------------- --------
Total liabilities 10,060 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 28,106 27,841
Retained earnings (deficit) - at formation (5,112) (5,112)
Retained earnings (deficit) - since formation (16,011) (13,490)
Accumulated other comprehensive loss (1,034) (1,187)
---------- --------
Total stockholders' equity 6,009 8,111
---------- --------
Total liabilities and stockholders' equity $ 16,069 $ 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 Nine months ended
September 30, September 30,
2003 2002 2003 2002
---------- --------- --------- ---------
Contract revenue $ 6,112 $ 5,482 $ 16,537 $ 15,270
Cost of revenue 4,577 4,170 12,833 11,896
--------- -------- -------- ---------
Gross profit 1,535 1,312 3,704 3,374
-------- -------- --------- ---------
Operating expenses
Selling, general and administrative 1,201 1,339 3,228 4,213
Depreciation and amortization 95 90 292 290
------- ------- ------- ---------
Total operating expenses 1,296 1,429 3,520 4,503
------- ------- ------- --------
Operating income (loss) 239 (117) 184 (1,129)
Interest expense, net (116) (57) (303) (133)
Other income (expense), net (13) 4 (22) (10)
------- ------- ------- --------
Income (loss) from continuing operations before income taxes 110 (170) (141) (1,272)
Provision (benefit) for income taxes - (65) 22 (487)
------- ------- ------- --------
Net income (loss) from continuing operations 110 (105) (163) (785)
------- ------- -------- --------
Income (loss) from discontinued operations, net of income taxes (544) 23 (1,921) 1,258
Loss on sale of discontinued operations (262) - (262) -
------- -------- -------- -------
Income (loss) from discontinued operations (806) 23 (2,183) 1,258
------ -------- -------- -------
Net income (loss) (696) (82) (2,346) 473
Preferred stock dividends (59) (59) (175) (175)
------ -------- ------- ------
Net income (loss) attributed to common shareholders (755) $ (141) $ (2,521) $ 298
========= ========== ============ =========
Basic income (loss) per common share:
Continuing operations $ 0.01 $ (0.02) $ (0.06) $ (0.16)
Discontinued operations (0.13) - (0.36) 0.21
-------- ------- -------- --------
Net income (loss) $(0.12) $ (0.02) $ (0.42) $ 0.05
========= ======== ========= ========
Diluted income (loss) per common share:
Continuing operations $ 0.01 $ (0.02) $ (0.06) $ (0.16)
Discontinued operations (0.13) - (0.36) 0.21
----- ------- ------- --------
Net income (loss) $ (0.12) $ (0.02) $ (0.42) $ 0.05
======= =========== ========== ==========
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 Nine months
ended September 30, ended September 30,
2003 2002 2003 2002
------- ------- -------- -------
Net income (loss) $ (696) $ (82) $ (2,346) $ 473
Foreign currency translation adjustment 58 (10) 153 83
-------- ------- -------- ---------
Comprehensive income (loss) $ (638) $ (92) $ (2,193) $ 556
======== ======== ========== =========
The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
Nine months
ended September 30,
2003 2002
-------- --------
Cash flows from operating activities:
Net income (loss) $ (2,346) $ 473
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization 2,151 1,705
Write down of investment in Avantium International B.V. 115 -
Loss on sale of Process business 262
Changes in assets and liabilities:
Contract receivables (1,517) (1,699)
Inventories, prepaid expenses and other assets (584) 104
Accounts payable, accrued compensation and accrued expenses 864 (143)
Billings in excess of revenues earned 3,307 (1,620)
Accrued warranty reserves (207) (135)
Other liabilities (4) 276
------- --------
Net cash provided by (used in) operating activities 2,041 (1,039)
-------- --------
Cash flows from investing activities:
Proceeds from sale of Process business, net of transaction costs 5,245 -
Capital expenditures (57) (424)
Capitalized software development costs (1,086) (2,176)
-------- ---------
Net cash provided by (used in) investing activities 4,102 (2,600)
------- --------
Cash flows from financing activities:
Repayment of note payable to related party - (350)
Releases (restrictions) of cash as collateral under line of credit 256 (168)
Decrease in borrowings under line of credit (5,431) (1,333)
Proceeds from assignments of sales-type leases - 2,589
Proceeds from issuance of common stock, net of costs - 1,583
Other financing activities, net (21) (262)
------- ---------
Net cash provided by (used in) financing activities (5,196) 2,059
------- --------
Effect of exchange rate changes on cash 69 5
------- --------
Net increase (decrease) in cash and cash equivalents 1,016 (1,575)
Cash and cash equivalents at beginning of year 1,617 2,040
------- --------
Cash and cash equivalents at end of period $ 2,633 $ 465
======= =========
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Three and Nine Months ended September 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, which were $3.3 million and $4.0
million as of September 30, 2003 and December 31, 2002, respectively, are
typically billed within thirty days.
2. Basic and Diluted Income 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 Nine months
ended September 30, ended September 30,
2003 2002 2003 2002
Numerator:
Net income (loss) $ (696) $ (82) $ (2,346) $ 473
Preferred stock dividends (59) (59) (175) (175)
------ ------ ------- ------
Net income (loss) attributed to
common stockholders $ (755) $ (141) $ (2,521) $ 298
======= ======= ======= =======
Denominator:
Weighted-average shares outstanding
for basic earnings per share 6,019,138 5,869,138 5,974,083 5,861,111
Effect of dilutive securities:
Employee stock options, warrants and
options outside the plan - - - 332,694
------- -------- --------- ---------
Adjusted weighted-average shares outstanding
and assumed conversions for diluted
earnings per share 6,019,138 5,869,138 5,974,083 6,193,805
========= ========= ========= ==========
Shares related to dilutive securities
excluded because inclusion would be 3,230,856 2,676,906 3,230,856 2,652,600
anti-dilutive
Basic income (loss) per common share:
Continuing operations $ 0.01 $ (0.02) $ (0.06) $ (0.16)
Discontinued operations (0.13) 0.00 (0.36) 0.21
---------- -------- -------- --------
Net income (loss) $ (0.12) $ (0.02) $ (0.42) $ 0.05
========== ======== ======== ========
Diluted income (loss) per common share:
Continuing operations $ 0.01 $ (0.02) $ (0.06) $ (0.15)
Discontinued operations (0.13) 0.00 (0.36) 0.20
--------- -------- -------- --------
Net income (loss) $ (0.12) $ (0.02) $ (0.42) $ 0.05
========= ======== ======== ========
The difference between the basic and diluted number of weighted
average shares outstanding for the nine months ended September 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 nine months ended
September 30, 2003 and 2002 were reduced by preferred stock dividends
of $59,000 and $175,000, respectively, in calculating the per share
amounts. Conversion of the stock options, warrants and preferred stock
was not assumed for the three and nine months ended September 30, 2003
and the three months ended September 30, 2002 because the impact was
anti-dilutive.
3. Sale of Process Business
In September 2003, the Company completed the sale of substantially
all of the assets of GSE Process Solutions, Inc. (Process) to Novatech,
LLC. (Novatech) pursuant to an Asset Purchase Agreement, effective as of
September 25, 2003, by and between the Company, Process and Novatech.
The Company received $5.5 million in cash, subject to certain
adjustments. The Company recognized a loss on this transaction of
$262,000. In connection with the transaction, Novatech purchased certain
assets with a book value of $11.7 million and assumed certain operating
liabilities totaling approximately $6.8 million. The Company incurred
approximately $865,000 of closing costs associated with the transaction.
The operating results of the Company's Process business prior to the
sale have been classified as discontinued operations in the Consolidated
Statements of Operations.
A summary of the results of the Process Business for the three and
nine months ended September 30, 2003 and 2002 follows:
Three months ended Nine months ended
September 30, September 30,
2003 2002 2003 2002
Contract revenue $ 5,206 $ 5,130 $ 13,815 $ 18,747
Income (loss) before income taxes (806) 37 (2,183) 2,039
Net income (loss) (806) 23 (2,183) 1,258
4. 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) December 31,
2002
-----------------
Raw materials $ 1,203
Service parts 357
-----------------
Total inventories $ 1,560
=================
The Company's Process inventory was purchased by Novatech as part of
the September 2003 Asset Purchase Agreement discussed in Note 3.
5. 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 $85,000 and $113,000 for
the three months ended September 30, 2003 and 2002, respectively. Total
amortization expense included in continuing operations was $71,000 and
$48,000 for the quarters ended September 30, 2003 and 2002, respectively.
For the nine months ended September 30, 2003 and 2002, software development
costs capitalized were $464,000 and $357,000, respectively. Total
amortization expense included in continuing operations was $237,000 and
$208,000 for the nine months ended September 30, 2003 and 2002,
respectively. The increase in amortization expense from the prior year
reflects 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. JADE version 1.0 was released for sale on March 31, 2003.
6. Stock Compensation
The Company applies the intrinsic-value-based method of
accounting prescribed by Accounting Principles Board (APB) Opinion No.
25, Accounting for Stock issued to Employees, and related interpretations
including FASB Interpretation No. 44, Accounting for Certain Transactions
involving Stock Compensation, and interpretation of APB Opinion No. 25,
issued in March 2000, to account for its fixed-plan stock options. Under
this method, compensation expense is recorded on the date of grant only
if the current market price of the underlying stock exceeds the exercise
price. SFAS No. 123, Accounting for Stock-Based Compensation, established
accounting and disclosure requirements using a fair-value-based method of
accounting for stock based employee compensation plans. As allowed by
SFAS No. 123, the Company has elected to continue to apply the
intrinsic-value-based method of accounting 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 Nine months
ended September 30, ended September 30,
2003 2002 2003 2002
Net income (loss) attributed to
common stockholders, as reported $ (755) $ (141) $ (2,521) $ 298
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) (200) (317)
------- ------- ------- -------
Pro forma net income (loss) $ (822) $ (247) $ (2,721) $ (19)
======= ======= ======= =======
Net income (loss) per share, as reported:
Basic $ (0.12) $ (0.02) $ (0.42) $ 0.05
Diluted $ (0.12) $ (0.02) $ (0.42) $ 0.05
Net income (loss) per share, as adjusted:
Basic $ (0.14) $ (0.04) $ (0.46) $ (0.00)
Diluted $ (0.14) $ (0.04) $ (0.46) $ (0.00)
No employee stock options were issued in the first nine months of 2003
or 2002.
7. Long-term Debt
The Company's long-term debt consists of the following notes payable
and other financing arrangements:
(in thousands) September 30, December 31,
2003 2002
------------- ---------------
Line of credit with bank $ - $ 5,431
Obligations under financing leases - 3,784
Notes payable to related parties 650 650
Notes payable, other 50 73
------------- ---------------
Total notes payable and financing arrangements 700 9,938
Less amounts payable within one year 33 1,905
------------- ---------------
Long-term portion $ 667 $ 8,033
============= ===============
Line of Credit
The Company has a 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 and is collateralized by substantially all of
the Company's assets.
On September 25, 2003 in conjunction with the sale of the
Company's Process business assets to Novatech, the Company's existing
credit facility was amended as follows:
- The credit facility was extended to May 31, 2004 from the
scheduled expiration date of March 31, 2004. The lender has
requested that the Company find a new lender.
- The maximum commitment under the credit facility was reduced from
$6.5 million to $1.5 million as of September 25, 2003; with an
additional reduction to $1.0 million on April 1, 2004.
- The line provides for borrowings up to 85% of eligible accounts
receivable and 50% of eligible unbilled receivables (up to a
maximum of $250,000). Previously, there was no dollar maximum for
borrowings against the eligible unbilled receivables.
- The sublimit for foreign letters of credit was reduced from $2.0
million to $100,000, excluding the letters of credit which were
outstanding as of September 25, 2003.
- At March 31, 2003 and June 30, 2003 the Company was not in
compliance with certain financial ratios as required by the
credit facility. The Company received a written waiver from the
bank for noncompliance. Certain covenant modifications were made
to the credit facility to position the Company for future
compliance. At September 30, 2003, the Company was in compliance
with these modified covenants.
The interest rate on this line of credit is based on the bank's
prime rate plus 1.00% (5.00% as of September 30, 2003), with interest
only payments due monthly. At September 30, 2003, the Company's
available borrowing base was $1.5 million, none of which had been
utilized.
In March, 2003 GP Strategies, one of the Company's major
stockholders, extended their $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 issued 150,000 shares of its
common stock to GP Strategies. The number of shares was calculated based
upon a 10% fee divided by the closing price of GSE's common stock on
March 21, 2003.
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 September 30,
2003, there is $650,000 outstanding on the note.
Notes Payable,Other
The Company has an additional unsecured promissory note to a
former employee. The Company makes payments semi-monthly, and the final
payment will be made on April 14, 2005. The outstanding balance at
September 30, 2003 was $50,000.
Obligations under financing leases
As part of the sale of the Process business assets on September
25, 2003 to Novatech, Novatech assumed the obligations under the
Company's financing leases. The Company had five separate contracts with
a customer for the lease of certain hardware and software under 36-month
leases. Previous to the asset sale, the Company had 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 remained contingently liable for amounts
due to the third-party financing company prior to the asset sale, the
remaining investment in and obligation under the financing leases were
reflected in the Company's balance sheets as follows:
(in thousands) September 30, December 31,
2003 2002
------------------ -----------------
Net investment in sales-type leases:
Prepaid expense and other assets $ - $ 1,875
Other assets - 1,909
------------------ -----------------
Total net investment $ - $ 3,784
================== =================
Obligation under financing leases:
Current portion of long-term debts $ - $ 1,875
Long-term debts - 1,909
------------------ -----------------
Total obligations $ - $ 3,784
================== =================
8. 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 September 30, 2003 and December
31, 2002 the Company had accrued dividends payable of $351,000 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.
9. Letters of Credit
As of September 30, 2003, the Company was contingently liable for
five letters of credit totaling $491,000. 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.
In June 2003, the Company received a $6.6 million order from the
Mexican utility Comision Federal de Electricidad (CFE) 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 issued 100,000 warrants at an exercise price of $1.33 per share,
the closing price on July 8, 2003 and will 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.
10. Income Taxes
The Company's effective tax rate was 15% and 38.3% for the nine
months ended September 30, 2003 and September 30, 2002, respectively.
The 15% 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 nine months ended September 30, 2003.
11. Segment Information
With the sale of the Company's Process business assets, the
Company has only one reportable segment, Power Simulation. 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.
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.
14. Subsequent Events
On October 23, 2003 GP Strategies purchased all of the GSE common
stock held by ManTech International Corporation. As a result of this
transaction, GP Strategies will own approximately 58% of the total
outstanding common stock of GSE.
GSE SYSTEMS, INC. AND SUBSIDIARIES
FORM 10-Q
For the Three and Nine Months ended September 30, 2003 and 2002
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
In September 2003, the Company completed the sale of substantially all
of the assets of GSE Process Solutions, Inc. (Process) to Novatech, LLC.
(Novatech) pursuant to an Asset Purchase Agreement, effective as of September
25, 2003, by and between the Company, Process and Novatech. The Company received
$5.5 million in cash, subject to certain adjustments. The Company recognized a
loss on this transaction of $262,000. In connection with the transaction,
Novatech purchased certain assets with a book value of $11.7 million and assumed
certain operating liabilities totaling approximately $6.8 million. The Company
incurred approximately $865,000 of closing costs associated with the
transaction. The operating results of the Company's Process business prior to
the sale have been classified as discontinued operations in the Consolidated
Statements of Operations.
The Company has a $1.5 million credit facility with a bank which
matures on May 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 $1.0 million on April 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 is in the process of identifying a new
lender.
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 nine months of 2003 . The Company's
Power simulation business contract backlog has increased $13.6 million from
$19.0 million at December 31, 2002 to $32.6 million at September 30, 2003.
Cautionary Statement Regarding Forward-Looking Statements
This report contains certain forward-looking statements. Any statements
contained herein that are not statements of historical facts may be deemed
forward-looking statements. These statements are based on management's current
beliefs and expectations and are subject to numerous risks and uncertainties and
changes in circumstances. Actual results may differ materially from these
forward-looking statements due to changes in global, economic, business,
governmental, technical, competitive, market and regulatory factors.
General Business Environment
GSE Systems, Inc. ("GSE Systems", "GSE" or the "Company") is a world
leader in real-time power plant simulation. 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.
Prior to September 25, 2003, the Company also had a process automation
and control business. The automation products of this business unit optimized
batch and hybrid plant control for the specialty chemical, food and beverage,
and pharmaceutical industries. On September 25, 2003, the Company completed the
sale of substantially all of the assets of this Process automation business to
Novatech, LLC. (Novatech) pursuant to an Asset Purchase Agreement.
Accordingly, as of September 30, 2003, the Company has only one
business segment, Power simulation.
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.
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 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.
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 September 30, Nine months ended September 30,
2003 % 2002 % 2003 % 2002 %
Contract revenue $ 6,112 100.0 % $ 5,482 100.0 % $ 16,537 100.0 % $ 15,270 100.0 %
Cost of revenue 4,577 74.9 % 4,170 76.1 % 12,833 77.6 % 11,896 77.9 %
----- ----- ------- ----- ------- ------- ------- -------
Gross profit 1,535 25.1 % 1,312 23.9 % 3,704 22.4 % 3,374 22.1 %
----- ------ ------ ----- ------- ------ ------ -------
Operating expenses:
Selling, general and administrative 1,201 19.6 % 1,339 24.4 % 3,228 19.5 % 4,213 27.6 %
Depreciation and amortization 95 1.6 % 90 1.6 % 292 1.8 % 290 1.9 %
------ ------- ------ ------- ------ ------ ------- -------
Total operating expenses 1,296 21.2 % 1,429 26.0 % 3,520 21.3 % 4,503 29.5 %
Operating income (loss) 239 3.9 % (117) (2.1)% 184 1.1 % (1,129) (7.4)%
Interest expense, net (116) (1.9)% (57) (1.0)% (303) (1.8)% (133) (0.8)%
Other income (expense), net (13) (0.2)% 4 0.0 % (22) (0.2)% (10) (0.1)%
------ ------ -------- ------- ------- ------- ------- --------
Income (loss) from continuing
operations before income taxes 110 1.8 % (170) (3.1)% (141) 0.9)% (1,272) (8.3)%
Provision (benefit) for income taxes - 0.0 % (65) (1.2)% 22 0.1 % (487) (3.2)%
------ ------ -------- ------ ------- -------- ------- --------
Net income (loss) from continuing
operations 110 1.8% (105) (1.9)% (163) (1.0)% (785) (5.1)%
Income (loss) from discontinued
operations, net of income taxes (544) (8.9)% 23 0.4 % (1,921) (11.6)% 1,258 8.2 %
Loss on sale of discontinued
operations (262) (4.3)% - 0.0 % (262) (1.6)% - 0.0 %
------- -------- ------- -------- ------- -------- -------- ---------
Loss on discontinued operations (806) (13.2)% 23 0.4% (2,183) (13.2)% 1,258 8.2%
------- --------- ------- --------- -------- ------- --------- ---------
Net income (loss) $ (696) (11.4)% $ (82) (1.5)% $(2,346) (14.2)% $ 473 3.1 %
======== ======== ======= ========= ======== ======== ======== =========
Critical Accounting Policies and Estimates
In preparing the Company's financial statements, management makes
several estimates and assumptions that affect the Company's reported amounts of
assets, liabilities, revenues and expenses. Those accounting estimates that have
the most significant impact on the Company's operating results and place the
most significant demands on management's judgment are discussed below. For all
of these policies, management cautions that future events rarely develop exactly
as forecast, and the best estimates may require adjustment.
Revenue Recognition on Long-Term Contracts. The Company uses the
percentage-of-completion revenue recognition methodology to record revenue under
its long-term fixed-price contracts in accordance with the AICPA Statement of
Position 81-1, "Accounting for Performance of Construction-Type and Certain
Production-Type Contracts". This methodology recognizes income as work
progresses on the contract and is based on an estimate of the income earned to
date, less income recognized in earlier periods. The Company bases its estimate
of the degree of completion of the contract by reviewing the relationship of
costs incurred to date to the expected total costs that will be incurred on the
project. The Company's project managers are responsible for estimating the costs
to be incurred at the beginning of each project and are responsible for updating
the estimate 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 September 30,
2003, the Company has net capitalized software development costs of $1.0
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 September 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
September 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. Contract revenue increased 11.5% in the three months
ended September 30, 2003 as compared to the same period in the prior year, from
$5.5 million to $6.1 million. Revenue for the nine months ended September 30,
2003 was $16.5 million versus $15.3 million in the same period of 2002, an 8.3%
increase. The increases are mainly attributable to the start-up of three large
international training simulator projects in 2003.
Gross Profit. Gross profit totaled $1.5 million (25.1% of revenue) for
the quarter ended September 30, 2003, as compared with $1.3 million (23.9% of
revenue) for the quarter ended September 30, 2002. For the nine months ended
September 30, 2003 and 2002, gross profit increased from $3.4 million (22.1% of
revenue) to $3.7 million (22.4% of revenue). The increases in gross profit as a
percentage of revenue reflect the recovery of the Company's operating overhead
costs over a higher revenue base.
Selling, General and Administrative Expenses. Selling, general and
administrative ("SG&A") expenses totaled $1.2 million in the quarter ended
September 30, 2003, a 10.3% decrease from the $1.3 million for the same period
in 2002. SG&A expenses for the nine months ended September 30, 2003 decreased
23.4%, from $4.2 million to $3.2 million as compared to the same period in the
prior year. In 2002, SG&A costs included $205,000 of severance costs in the
third quarter, and $291,000 for the nine months ended September 30, 2002.
Included in SG&A is net research and product development expenditures
("R&D"), as discussed below.
Gross R&D totaled $142,000 in the third quarter of 2003, as compared
with $95,000 in the same period of 2002. Capitalized software development costs
totaled $85,000 and $113,000 for the third quarter of 2003 and 2002,
respectively. Accordingly, net R&D expensed and included in SG&A was $57,000 and
($18,000) for the third quarter of 2003 and 2002, respectively.
Gross R&D spending for the nine months ended September 30, 2003 and
2002 totaled $690,000 and $476,000, respectively. Capitalized software
development costs totaled $464,000 in the first nine months of 2003 versus
$357,000 in the same period of 2002; and net R&D expensed and included in SG&A
was $226,000 in the first nine months of 2003 versus $119,000 in 2002.
The Company's R&D expenditures in the first nine months of 2003 were
related to:
- 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 $95,000 and
$90,000 during the quarters ended September 30, 2003 and 2002, respectively. For
the nine months ended September 30, 2003 and 2002 depreciation expense totaled
$292,000 and $290,000, respectively.
Operating Income (Loss). The Company had operating income of $239,000
(3.9% of revenue) in the third quarter 2003, as compared with an operating loss
of $117,000 (2.1% of revenue) for the same period in 2002. For the nine months
ended September 30, 2003 and 2002, the Company had operating income of $184,000
(1.1% of revenue) and an operating loss of $1.1 million (7.4% of revenue),
respectively. The increase in operating results for both periods was due to the
factors outlined above.
Interest Expense, Net. Net interest expense increased 39.7% from
$57,000 in the quarter ended September 30, 2002 to $116,000 for the same quarter
in 2003. For the nine months ended September 30, 2003 and 2002, net interest
expense totaled $303,000 and $133,000, respectively. The increase in interest
expense mainly reflects an increase in commitment fees for the Company's credit
facility due to the renewal of the credit facility for one year in March 2003,
and the cost of the extension of the related bank guarantee provided by GP
Strategies. 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 nine months ended
September 30, 2003, other income (expense), net mainly reflects an equity loss
on the Company's investment in RedStorm Scientific LLC. Other income
(expense), net for the three and nine months ended September 30, 2002 reflects
recognized foreign currency transaction losses offset in part by royalty income.
Provision (Benefit) for Income Taxes. The Company's effective tax rate
was 15% and 38.3% for the nine months ended September 30, 2003 and September 30,
2002, respectively. The 15% 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 nine months ended September 30, 2003.
Income (Loss) from Discontinued Operations. In September 2003, the
Company completed the sale of substantially all of the assets of GSE Process
Solutions, Inc. (Process) to Novatech, LLC. (Novatech) pursuant to an Asset
Purchase Agreement, effective as of September 25, 2003, by and between the
Company, Process and Novatech. The operating results of the Company's Process
business prior to the sale have been classified as discontinued operations in
the Consolidated Statements of Operations.
For the three months ended September 30, 2003, the Process business
incurred a net loss of $544,000 versus net income of $23,000 for the same period
in 2002. For the nine months ended September 30, 2003, the Process business
incurred a net loss of $1.9 million, versus net income of $1.3 million in the
nine months ended September 30, 2002. The reduction in income was due
principally to lower revenues.
Loss on Sale of Discontinued Operations. The Company received $5.5
million in cash, subject to certain adjustments. The Company recognized a loss
on this transaction of $262,000. In connection with the transaction, Novatech
purchased certain assets with a book value of $11.7 million and assumed certain
operating liabilities totaling approximately $6.8 million. The Company incurred
approximately $865,000 of closing costs associated with the transaction.
Liquidity and Capital Resources
As of September 30, 2003, the Company's cash and cash equivalents
totaled $2.6 million, compared to $1.6 million at December 31, 2002.
Cash provided by (used in) operating activities. Net cash provided by
operating activities was $2.0 million for the nine months ended September 30,
2003. Significant changes in the Company's assets and liabilities in 2003
included:
- A $1.5 million reduction in the Company's contract receivables, mainly
reflecting the lower activity in 2003 of the Process business.
- A $3.3 million increase in the Company's billings in excess of revenues
earned. The Company had received an order from one Process customer in
the third quarter 2003 that allowed GSE to invoice the customer in full
prior to the work being completed. In addition, the Power business
entered into a contract with Comision Federal de Electricidad in Mexico
for a full scope simulator. Per the terms of the contract, the Company
invoiced CFE for 20% of the contract upon the receipt of the purchase
order as an advance payment.
Net cash used in operating activities was $1.0 million for the nine
months ended September 30, 2002. Significant changes in the Company's assets and
liabilities in 2002 included:
- a decrease in contract receivables of $1.6 million, largely related to
the collection of receivables for Westinghouse Savannah River Company
projects, and
- a $1.6 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 reflects the completion of a portion of these two
contracts during the first nine months of 2002.
Cash provided by (used in) investing activities. Net cash provided by
investing activities was $4.1 million in the nine months ended September 30,
2003. The Company received $5.2 million cash from the sale of the Process
business, net of transaction costs. The Company used $1.1 million for
capitalized software development costs and $57,000 for capital expenditures.
In the first nine months of 2002, net cash used in investing activities
was $2.6 million, consisting of $2.2 million of capitalized software development
costs and $424,000 for capital expenditures.
Cash provided by (used in) financing activities. During the nine months
ended September 30, 2003, the Company used $5.2 million in cash for financing
activities. The Company decreased its borrowings under its bank line of credit
by $5.4 million, using proceeds from the sale of the Process business to
completely pay down the outstanding balance. 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, and one additional
cash-collateralized standby letter of credit totaling $52,000 was issued in
2003.
During the nine months ended September 30, 2002, the Company generated
$2.1 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 $1.3 million to a total of $3.7 million, and decreased its
borrowings from ManTech International Corporation by $350,000 to a total of
$650,000. 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 $168,000 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 $1.5 million bank line of credit with a bank which
matures on May 31, 2004. The credit facility provides for borrowings up to a
total $1.5 million to support working capital needs and foreign letters of
credit. At September 30, 2003, the Company's available borrowing base was $1.5
million, of which none had been utilized. The lender has requested that the
Company find a new lender. The Company is in the process of locating a new
lender.
The maximum commitment under the credit facility will be reduced to
$1.0 million on April 1, 2004. The agreement prohibits the payment of all
dividends, including dividends due to ManTech on its outstanding preferred
stock. GP Strategies has provided a $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 issued 150,000 shares of its common
stock to GP Strategies. The number of shares was calculated based upon a 10% fee
divided by the closing price of GSE's common stock on March 21, 2003.
The credit facility requires the Company to comply with certain
financial ratios. At March 31, 2003 and June 30, 2003 the Company was not in
compliance with certain financial ratios. However, the Company has received a
written waiver from the bank for the noncompliance. Certain covenant
modifications were made to the credit facility to position the Company for
future compliance. At September 30, 2003, the Company was in compliance with
these modified covenants.
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 issued 100,000 warrants at an exercise price of $1.33 per share, the
closing price on July 8, 2003 and will 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 September 30, 2003, such interest
rates are based on the bank's prime rate plus 100 basis-points.
As of September 30, 2003, $650,000 of the Company's debt was subject to
variable interest rates. A 100 basis-point change in such rates during the three
and nine months ended September 30, 2003 would have changed the Company's
interest expense by approximately $12,000 and $37,000, 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 Nine Months ended September 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
None
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 July 16, 2003 regarding the press release
issued by the Company announcing the receipt of numerous contract
awards totaling over $11.0 million.
Form 8-K was filed by the Registrant with the Securities and
Exchange Commission on August 13, 2003 regarding the press release
issued by the Company announcing contract awards totaling over
$7.5 million.
Form 8-K was filed by the Registrant with the Securities and
Exchange Commission on August 14, 2003 regarding the press release
issued by the Company announcing the Company's second quarter 2003
operating results.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 14, 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)