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, 1999.
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
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GSE SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 52-1868008
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
9189 Red Branch Road, Columbia, Maryland, 21045
(Address of principal executive office and zip code)
Registrant's telephone number,
including area code: (410) 772-3500
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
--- ---
As of August 6, 1999, there were 5,065,688 shares of the Registrant's
common stock (par value $ .01 per share) 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, 1999
and December 31, 1998 3
Consolidated Statements of Operations for the Three
and Six Months Ended June 30, 1999 and June 30, 1998 4
Consolidated Statements of Comprehensive Income for the
Three and Six Months Ended June 30, 999 and June 30, 1998 5
Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 1999 and June 30, 1998 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Results of Operations
and Financial Condition 11
Item 3. Quantitative and Qualitative Disclosure about Market Risk 15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 15
Item 2. Changes in Securities and Use of Proceeds 15
Item 3. Defaults upon Senior Securities 15
Item 4. Submission of Matters to a Vote of Security Holders 15
Item 5. Other Information 15
Item 6. Exhibits and Reports on Form 8-K 16
SIGNATURES 18
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
ASSETS
June 30, December 31,
1999 1998
(unaudited)
----------- ------------
Current assets:
Cash and cash equivalents $ 3,425 $ 2,240
Contract receivables 18,746 24,426
Note Receivable - 1,000
Inventories 3,208 2,892
Prepaid expenses and other current assets 2,820 1,654
Deferred income taxes 139 150
----------- ------------
Total current assets 28,338 32,362
Property and equipment, net 3,532 2,714
Software development costs, net 4,880 4,715
Goodwill and other intangible assets, net 2,657 2,781
Deferred income taxes 2,526 3,366
Other assets 3,519 2,805
----------- -----------
Total assets $ 45,452 $ 48,743
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Lines of credit $ 2,927 $ 6,746
Accounts payable 5,229 8,407
Accrued expenses 5,509 4,344
Obligations under capital lease 84 143
Billings in excess of revenue earned 6,189 6,359
Accrued contract and warranty reserves 861 846
Other current liabilities 2,513 1,308
Income taxes payable 35 151
---------- -----------
Total current liabilities 23,347 28,304
Notes payable to related parties 140 148
Obligations under capital lease - 10
Accrued contract and warranty reserves 628 596
Other liabilities 2,574 2,596
---------- -----------
Total liabilities 26,689 31,654
---------- -----------
Stockholders' equity:
Common stock $.01 par value,
8,000,000 shares authorized,
5,065,688 shares issued and outstanding 50 50
Additional paid-in capital 21,678 21,678
Retained earnings (deficit) - at formation (5,112) (5,112)
Retained earnings - since formation 2,760 1,158
Accumulated other comprehensive income (loss) (613) (685)
---------- ----------
Total stockholders' equity 18,763 17,089
---------- ----------
Total liabilities and
stockholders' equity $ 45,452 $ 48,743
========== ===========
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
June 30, June 30,
1999 1998 1999 1998
------------------ ----------------
Contract revenue $ 17,987 $ 16,722 $ 35,565 $ 34,176
Cost of revenue 10,483 12,074 21,362 24,317
-------- -------- -------- --------
Gross profit 7,504 4,648 14,203 9,859
Operating expenses
Selling, general and administrative 5,955 4,962 10,836 10,289
Depreciation and amortization 352 375 702 936
-------- -------- -------- --------
Total operating expenses 6,307 5,337 11,538 11,225
-------- -------- -------- --------
Operating income (loss) 1,197 (689) 2,665 (1,366)
Gain on sale of assets - 5,575 - 5,575
Interest expense, net (16) (144) (131) (309)
Other income (expense) 19 (84) 53 344
-------- -------- -------- --------
Income before income taxes 1,200 4,658 2,587 4,244
Provision for income taxes 457 1,893 985 1,933
-------- -------- -------- --------
Net income $ 743 $ 2,765 $ 1,602 $ 2,311
======== ======== ======== ========
Basic earnings per common share $ 0.15 $ 0.55 $ 0.32 $ 0.46
======== ======== ======== ========
Diluted earnings per common share $ 0.14 $ 0.54 $ 0.31 $ 0.45
======== ======== ======== ========
The accompanying notes are an integral part of these consolidated
financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
-------- -------- -------- --------
Net income $ 743 $ 2,765 $ 1,602 $ 2,311
Other comprehensive income (loss):
Foreign currency translation adjustment 91 169 72 (5)
-------- -------- -------- ---------
Comprehensive Income $ 834 $ 2,934 $ 1,674 $ 2,306
======== ======== ======== =========
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)
For the six months ended
June 30,
1999 1998
-------- --------
Cash flows from operating activities:
Net income $ 1,602 $ 2,311
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 1,601 1,965
Provision for doubtful contract receivables (557) (245)
Amortization of fair value of warrants issued to non-employees 120 60
Deferred income taxes 851 1,839
Equity in loss of investee - 101
Gain on sale of assets - (5,575)
Changes in assets and liabilities:
Contract receivables 6,446 3,954
Inventories (317) 203
Prepaid expenses and other assets (1,999) (794)
Accounts payable and accrued expenses (2,013) (2,032)
Billings in excess of revenues earned (170) 497
Accrued contract and warranty reserves 47 (66)
Other current liabilities 1,205 (376)
Income taxes payable (116) 116
Other liabilities (23) (1)
------- -------
Net cash provided by operating activities 6,677 1,957
------- -------
Cash flows from investment activities:
Proceeds from sale of assets 791 8,855
Payment for acquired assets (300)
Capital expenditures (1,020) (1,283)
Capitalization of software developent costs (1,032) (1,704)
------- -------
Net cash provided by (used in) investing activities (1,561) 5,868
------- -------
Cash flows from financing activities:
Decrease in lines of credit with bank (3,819) (5,017)
Repayments under capital lease obligations (69) (106)
Decrease in notes payable to related parties (8) (12)
------- -------
Net cash used in financing activities (3,896) (5,135)
Effect of exchange rate changes on cash (35) (24)
------- -------
Net increase in cash and cash equivalents 1,185 2,666
Cash and cash equivalents at beginning of period 2,240 334
Cash and cash equivalents at end of period $ 3,425 $ 3,000
======= =======
The accompanying notes are an integral part of these consolidated
financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
(Unaudited)
1. Basis of Presentation
The condensed consolidated financial statements included herein have
been prepared by the Company without independent audit. In the opinion
of the Company's management, all adjustments and reclassifications of a
normal and recurring nature necessary to present fairly the financial
position, results of operations and cash flows for the periods presented
have been made. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted. It is
suggested that these condensed consolidated financial statements 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, 1998 filed with the Securities and Exchange
Commission on March 31, 1999.
2. Acquisitions and Dispositions
Acquisitions
In April, 1999, the Company completed two acquisitions for the Process
business unit using the purchase method of accounting. On April 20, the
Company purchased certain assets and employed the associates of BatchCAD
Limited, a United Kingdom-based supplier of batch process development
and design consulting services and simulation software tools. The
purchase price was approximately $548,000 payable in three equal
installments on January 1, 2000, 2001 and 2002 and was allocated as
follows:
Property and Equipment $ 22,000
Trade Receivables 45,000
Purchased Software (Property and Equipment) 481,000
---------
$ 548,000
On April 30, the Company acquired all proprietary technology and
software assets from, and assumed substantially all customer contracts
of, Mitech Corporation, a Massachusetts company and supplier of event
and alarm management and reporting software tools. The purchase price
was $350,000 (consisting of $300,000 in cash and %50,000 payable one
year from the closing) and was allocated 100% to property and equipment
as purchased software.
Dispositions
On May 1, 1998, the Company completed the sale of substantially all of
the assets of GSE Erudite Software, Inc.("Erudite") to Keane, Inc.
("Keane"), pursuant to an Asset Purchase Agreement, dated as of April
30, 1998, by and among the Company, Erudite and Keane. The aggregate
purchase price for the Erudite assets was approximately $9.9 million
(consisting of $8.9 million in cash and $1.0 million in the form of an
unsecured promissory note due on April 30, 1999, subject to certain
adjustments). In connection with the transaction, Keane purchased
certain assets with a book value of $4.4 million and assumed certain
operating liabilities totaling approximately $2.2 million. The Company
recognized a gain before income taxes on this transaction of $5.6
million. In connection with the sale of these assets, the Company wrote
off approximately $800,000 in capitalized software development costs, as
well as $321,000 of purchased software, since all operations that would
support the recoverability of these costs were sold. The write-off of
these costs was reflected in the calculation of the gain on the sale.
3. Basic and Diluted Loss 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 other
convertible securities were exercised or converted into common stock.
The number of common shares and common share equivalents used in the
determination of basic and diluted earnings per share was as follows:
Three months ended Six months ended
June 30, June 30,
1999 1998 1999 1998
---------------------- ----------------------
Weighted average shares outstanding:
Basic 5,065,688 5,065,688 5,065,688 5,065,688
========== ========= ========= =========
Diluted 5,274,451 5,131,851 5,246,622 5,097,869
========== ========= ========= =========
The difference between the basic and diluted number of weighted average
shares outstanding for both periods represents dilutive options and
warrants to purchase shares of common stock computed under the treasury
stock method, using the average market price during the period.
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, net, consist of the following at:
(in thousands)
June 30, December 31,
1999 1998
-------- ------------
Raw materials $ 2,366 $ 1,873
Service parts 842 1,019
------- -------
Total $ 3,208 $ 2,892
======= =======
5. Financing Arrangements
On June 4, 1999, the Company entered into a loan and security agreement
with a financial institution for a new credit facility with a maturity
date of May 31, 2002. Borrowings from this facility were used to pay off
the existing debt under the Company's previous credit facility. The new
agreement established two lines of bank credit, through the Company's
subsidiaries, which are cross-collateralized, and provide for borrowings
up to a total of $9.0 million to support foreign letters of credit,
margin requirements of foreign exchange contracts and working capital
needs.
The first line, for $6.0 million, used by the Power business unit
("Power"), is 90% guaranteed by the Export-Import Bank of the United
States ("EXIM") through March 31, 2000, is collateralized by
substantially all of Power's assets, and provides for borrowings up to
90% of eligible receivables and 50% of unbilled receivables. The second
line, for $3.0 million, used by the Process business unit ("Process"),
is collateralized by substantially all of Process' assets, and provides
for borrowing up to 85% of eligible receivables. Both lines are
guaranteed by the Company and collateralized by substantially all of the
Company's assets.
The lines require the Company to comply with certain financial ratios
and preclude the Company from paying dividends and making acquisitions
beyond certain limits without the bank's consent. The Company was in
compliance with all covenants as of June 30, 1999.
In 1998, in connection with the Company's previous credit facility, the
Company had arranged for certain guarantees to be provided on its behalf
by GP Strategies Corporation ("GP Strategies") and ManTech International
Corporation ("ManTech"), both of which are shareholders of the Company.
(These guarantees have been reissued for the new credit facility.) In
consideration for these guarantees, the Company granted each of ManTech
and GP Strategies warrants to purchase shares of the Company's common
stock; each of such warrants provides the right to purchase at least
150,000 shares of the Company's common stock at an exercise price of
$2.375 per share. In 1998, the Company recorded $300,000 as the
estimated fair value of such warrants in the consolidated financial
statements and amortized such value over the life of the initial
guarantee, which expired in June, 1999. The Company has recognized
$60,000 and $120,000 of expense related to these warrants for the three
and six months ended June 30, 1999, respectively. The fair value of the
warrants was determined using the Black-Scholes valuation model.
Assumptions used in the calculation were as follows: dividend yield of
0%, expected volatility of 61%, risk-free interest rates of 5.6% and
expected terms of 2.5 years.
6. Income Taxes
The Company's effective tax rate is based on the best current estimate
of its expected annual effective tax rate. The difference between the
statutory U.S. tax rate and the Company's effective tax rate for the
three and six months ended June 30, 1999, is primarily due to the
effects of foreign operations being taxed at different rates and state
income taxes.
7. Segment reporting
The Company is primarily organized on the basis of two business units,
Process and Power. The Company has a wide range of knowledge concerning
control and simulation systems and the processes those systems are
intended to improve, control and model. The Company's knowledge is
concentrated heavily in the process industries, which include the
chemical, food and beverage, and pharmaceutical fields, as well as in
the power generation industry. The Process business unit is primarily
engaged in process control and simulation in a variety of commercial
industries. Contracts typically range from three to nine months. The
Power business unit is primarily engaged in simulation for the power
generation industry, with the vast majority of customers being in the
nuclear power industry. Contracts typically range from 18 months to
three years or longer.
GSE evaluates the performance of its business units utilizing "Business
Unit Contribution", which is substantially equivalent to earnings before
interest and taxes ("EBIT") before allocating any corporate expenses.
The segment information regarding two businesses divested during 1998 is
included in "All Other".
The table below presents information about reported segments:
(in thousands)
Three Months Ended June 30, Six Months Ended June 30,
-------------------------------------- --------------------------------------
1999 1999
-------------------------------------- --------------------------------------
Process Power Total Process Power Total
Contract revenue $ 9,748 $ 8,239 $ 17,987 $ 19,964 $ 15,601 $ 35,565
========== ========= ========= ========== ========= =========
Business unit contribution $ 1,141 $ 1,393 $ 2,534 $ 2,744 $ 2,610 $ 5,354
========== ========= ========= ========== ========= =========
1998 1998
-------------------------------------- --------------------------------------
Process Power Total Process Power Total
Contract revenue $ 7,563 $ 7,443 $ 15,006 $ 14,470 $ 13,302 $ 27,772
========== ========= ========= ========== ========= =========
Business unit contribution $ 128 $ 1,135 $ 1,263 $ 235 $ 2,042 $ 2,277
========== ========= ========= ========== ========= =========
Below is a reconciliation of segment revenue to consolidated contract revenue
and segment business unit contribution to consolidated income before taxes.
(in thousands)
Three Months Ended June 30, Six Months Ended June 30,
---------------------------- ----------------------------
1999 1998 1999 1998
---------- --------- ---------- ---------
Total segment revenue $ 17,987 $ 15,006 $ 35,565 $ 27,772
All other 0 1,716 0 6,404
---------- --------- ---------- ---------
Consolidated contract revenue $ 17,987 $ 16,722 $ 35,565 $ 34,176
========== ========= ========== =========
Segment business unit contribution $ 2,534 $ 1,263 $ 5,354 $ 2,277
All other business unit contribution (loss) 0 (618) 0 (491)
Corporate expenses (1,318) (1,418) (2,636) (2,808)
Gain on sale of assets 0 5,575 0 5,575
Interest expense, net (16) (144) (131) (309)
---------- --------- ---------- ---------
Consolidated income before taxes $ 1,200 $ 4,658 $ 2,587 $ 4,244
========== ========= ========== =========
8. Recent Pronouncements
In June, 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. The Company
will be required to adopt this new accounting standard by January 1, 2001.
Management does not anticipate early adoption. The Company believes that the
effect of adopting SFAS No. 133 will not be material.
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
General Business Environment
GSE Systems, Inc. (the "Company") designs, develops and delivers business and
technology solutions by applying high technology-related process control and
high fidelity simulation systems and services into applications for worldwide
industries, including energy and process manufacturing. The Company's
solutions and services assist customers in improving quality, safety and
throughput; reducing operating expenses; and enhancing overall productivity.
In 1998, the Company divested the assets of its Oil and Gas business unit and
of its wholly owned subsidiary GSE Erudite Software, Inc. and refocused its
attention on its two core business units, Power and Process. The Power
business unit primarily provides simulation systems and services to the power
generation industry, while the Process business unit focuses on providing
process control and simulation in various process industries. For a breakdown
of relevant financial information by segment, see Note 7 to the Condensed
Consolidated Financial Statements, above.
The Company has begun the pursuit of strategic growth opportunities that will
complement the Company's core businesses and can be effected without diverting
the focus of the Company. In April, 1999, the Company completed two asset
purchase transactions for the Process business unit. On April 20, the Company
purchased certain assets and employed the associates of BatchCAD Limited, a
United Kingdom based supplier of batch process development and design
consulting services and simulation software tools. With this acquisition, the
Company has gained a presence in the United Kingdom with an office in Hexham,
England, which will provide the baseline for future expansion in the region.
On April 30, the Company acquired all proprietary technology and software
assets from, and assumed substantially all customer contracts of, Mitech
Corporation, a Massachusetts company and supplier of event and alarm
management and reporting software tools. Both of these acquisitions have added
to the current customer base of GSE Systems, and offer new opportunities in
promoting the Company's existing products and services.
On May 24, 1999, the Company announced their new business and marketing
strategy called VirtualPlant(TM). VirtualPlant(TM) combines the benefits of
real-time simulation with control systems to create a living, learning
real-time representation of an operating plant. VirtualPlant(TM) also allows a
company to create an environment for simulation rather than experimentation.
Based on sophisticated simulation technologies and expert knowledge of
processing realities, VirtualPlant(TM)is a fully integrated, comprehensive
program of customizable software, consulting services and training that energy
and process manufacturing companies can use to dramatically reduce time to
market, minimize development costs, achieve greater optimization and improve
overall profitability.
Results of Operations
The following table sets forth the results of operations for the periods
presented expressed as a percentage of revenues (in thousands).
Three months ended June 30, Six months ended June 30,
------------------------------------ ------------------------------------
1999 % 1998 % 1999 % 1998 %
---------------- ----------------- ---------------- ----------------
Contract revenue $17,987 100.0% $16,722 100.0% $35,565 100.0% $34,176 100.0%
Cost of revenue 10,483 58.3% 12,074 72.2% 21,362 60.1% 24,317 71.2%
------ ------ ------ ------
Gross profit 7,504 41.7% 4,648 27.8% 14,203 39.9% 9,859 28.8%
Operating expenses:
Selling, general and administrative 5,955 33.1% 4,962 29.7% 10,836 30.5% 10,289 30.1%
Depreciation and amortization 352 2.0% 375 2.2% 702 2.0% 936 2.7%
------ ------ ------ ------
Total operating expenses 6,307 35.1% 5,337 31.9% 11,538 32.4% 11,225 32.8%
------ ------ ------ ------
Operating income (loss) 1,197 6.7% (689) -4.1% 2,665 7.5% (1,366) -4.0%
Gain on sale of assets - 0.0% 5,575 33.3% - 0.0% 5,575 16.3%
Interest expense, net (16) -0.1% (144) -0.8% (131) -0.4% (309) -0.9%
Other income(expense) 19 0.1% (84) -0.5% 53 0.1% 344 1.0%
------ ------ ------- ------
Income before income taxes 1,200 6.7% 4,658 27.9% 2,587 7.3% 4,244 12.4%
Provision for income taxes 457 2.5% 1,893 11.3% 985 2.8% 1,933 5.7%
------ ------- -------- ------
Net income $ 743 4.1% $ 2,765 16.5% $ 1,602 4.5% $2,311 6.8%
====== ======= ======== ======
Revenues. Revenues for the three and six months ended June 30, 1999 amounted
to $18.0 million and $35.6 million, respectively, as compared with revenues of
$16.7 million and $34.2 million in the three and six months ended June 30,
1998, respectively. Included in the June 30, 1998 results were revenues of
$1.3 (three month period) and $5.3 million (six month period) related to the
Company's Erudite subsidiary and $.4 million (three month period) and $1.1
million (six month period) of revenues related to its Oil and Gas business
unit. As previously disclosed, the assets of these businesses were divested in
1998. A 38% increase (year-to-date) in the Process business unit's revenues
and a 17% increase (year-to-date) in the Power business unit's revenues
resulting from increased orders off set the reduction in the Company's
revenues from these dispositions.
Gross Profit. Gross profit increased to $7.5 million, (41.7% of revenues) for
the three months ended June 30, 1999 from $4.6 million (27.8% of revenues )
for the corresponding period in 1998. This increase reflects a higher
component of upgrade projects in the Process business unit in 1999 than in
1998, mainly due to customer concerns about Year 2000 date calculations in
their existing process control software. Such upgrade projects typically have
less hardware and instumentation components and more license fees and
application engineering work. Gross profit for the six months ended June 30,
1999 as compared to the same period in the prior year, reflected similar
improvements.
Selling, General and Administrative Expenses. Selling, general and
administrative ("SG&A") expenses totaled $6.0 million in the three months
ended June 30, 1999, a 20% increase from the corresponding period in June,
1998. (Included in the 1998 costs was $796,000 related to Erudite and the Oil
and Gas business.) The increase reflects additional sales and marketing
personnel in the Process business unit, increased advertising and promotion
related to the Company's VirtualPlant (TM) suite of products and services,
acquisition costs of the BatchCAD assets, internal Y2K compliance programs,
and legal fees related to the Company's new credit facility. For the six
months ended June 30, 1999, SG&A expenses increased 5.3% as compared to the
six months ended June 30, 1998; however, after excluding the costs related to
Erudite and the Oil and Gas business in 1998 ($1,979), SG&A increased 30%.
This increase is due to the same reasons outlined for the three months ended
June 30, 1999.
Gross research and product development expenditures were $1.3 million in the
three months ended June 30, 1999 versus $1.4 million for the same period in
1998.Capitalized software development costs totaled $586,000 and $1.0 million
for the second quarter of 1999 and 1998, respectively; accordingly, net
research and development costs expensed and included in SG&A were $714,000 and
$400,000 for the three months ended June 30, 1999 and 1998, respectively. The
Company continues to invest in the conversion of its D/3 DCS, FlexBatch, and
SimSuite Pro products to the Microsoft Windows NT(R) platform and the
productization of its SimSuite software tools. For the six months ended June
30, 1999, gross research and development expenditures, capitalized development
costs, and net research and development costs expensed in SG&A were $2.4
million, $1.7 million and $.7 million, respectively, versus $2.5 million, $1.7
million and $.8 million, respectively, for the comparable period in 1998.
Depreciation and Amortization. Depreciation expense amounted to $250,000 and
$294,000 during the three months ended June 30, 1999 and June 30, 1998,
respectively. During the six months ended June 30, 1999 and June 30, 1998,
depreciation expense was $508,000 and $772,000, respectively. The decrease in
depreciation expense reflects the disposition of the Erudite and Oil and Gas
assets in 1998.
Amortization of goodwill was $102,000 and $81,000 during the three months
ended June 30, 1999 and June 30, 1998, respectively. During the six months
ended June 30, 1999 and 1998, goodwill amortization was $194,000 and $164,000,
respectively.
Operating Income (loss) . Operating income for the three months ended June 30,
1999, increased to $1.2 million, or 6.7% of revenues, from ($.7 million) loss,
or (4.1%) of revenues, during the corresponding period of 1998. For the six
months ended June 30, 1999, operating income increased to $2.7 million or 7.5%
of revenues from a loss of ($1.4 million) or (4.0%) of revenues for the six
months ended June 30, 1998. This significant increase in operating income
reflects the disposition of unprofitable businesses, increases in revenues in
the core business units, and improved contract margins.
Interest Expense, net. Net interest expense decreased to $16,000 during the
three months ended June 30, 1999, an 88% decrease from the corresponding
period in 1998. The decrease was due to lower levels of borrowing and the
receipt of $60,000 of interest income on the Keane note receivable. For the
six months ended June 30, 1999, net interest expense totaled $131,000 versus
$309,000 for the comparable period in 1998.
Gain on Sale of Assets. For the three and six months ended June 30, 1998, the
Company recognized a gain of $5.6 million on the sale of the Erudite assets.
The sale and related gain are described more fully under Note 2 to the
Condensed Consolidated Financial Statements, above.
Other Income. Other income fluctuated significantly during the periods
presented primarily due to the effect of gains and losses on foreign currency
transactions from the Company's Asian operations in 1998.
Income Taxes. The Company's effective tax rate is based on the best current
estimate of its expected annual effective tax rate. The difference between the
statutory U.S. tax rate and the Company's effective tax rate for the three
months and six months ended June 30, 1999 and June 30, 1998 is primarily the
result of the effects of foreign operations being taxed at different tax
rates, state income taxes, and a valuation allowance against all of the net
operating losses generated during the three and six months ended June 30,
1998.
Liquidity and Capital Resources
During the six months ended June 30, 1999, the Company's operations provided
$6.6 million of net cash, primarily resulting from collection of receivables.
At June 30, 1999, the Company had cash and cash equivalents totaling
approximately $3.4 million.
Cash used in investing activities during the first six months of 1999 of $1.6
million relates primarily to the Company's capitalization of software
development costs and normal capital expenditures off set by $791,000 of
proceeds from asset sales.
On June 4, 1999, the Company entered into a loan and security agreement with a
financial institution for a new credit facility with a maturity date of May
31, 2002. Borrowings from this facility were used to pay off the existing debt
under the Company's previous credit facility. These lines of credit, which are
cross-collateralized, provide for borrowings up to a total of $9.0 million to
support foreign letters of credit, margin requirements or foreign exchange
contracts and working capital needs. See Note 5 to the Condensed Consolidated
Financial Statements above, for complete details about these lines of credit.
Borrowings under the lines of credit were reduced by $3.8 million in the first
six months of 1999. At June 30, 1999, there were $2.9 million in borrowings
under these lines of credit.
Management believes the Company has sufficient liquidity and working capital
resources necessary for currently planned business operations, debt service
requirements, planned investments and capital expenditures.
Impact of the "Year 2000" Issue
The "Year 2000" issue, which arises in date calculations, is caused by
computer systems using two digits rather than four to define the applicable
year. After December 31, 1999, such systems may recognize "00" as 1900 rather
than 2000. This could result in a system failure or miscalculation causing
disruptions to operations, including, among other things, a temporary
inability to process data or engage in normal business operations and
activities.
To address these contingencies, the Company has instituted a compliance
program covering not only the Company's products, but also its internal
administrative and financial systems. The program is intended to minimize
significant detrimental effects on both the Company's operations and the
software products it develops and markets to its customers.
While the Company believes that it has identified substantially all of the
potential "Year 2000" problems which could affect current versions of its
products, it is not possible to determine with certainty that all such
problems have been identified or corrected, with either current products or
previous versions thereof, due both to the complexity of these products, and
the fact that they interact with products of third party vendors not under the
Company's control.
The Company also relies on various administrative and financial applications
of computer products and software, including processing of customer orders and
collection of customer accounts, which require correction to properly handle
"Year 2000" related dates. In the event that one or more of these systems is
not adequately corrected, the Company's ability to obtain customers, and
schedule and fulfill their demands, could be impaired. Further, if a
collection processing system, or a component thereof, were to fail, the
Company may not be able to properly determine and apply payments to customer
account balances or correctly determine cash balances. While these events are
possible, the Company anticipates that the breadth of its customer base and
its compliance programs and corrective measures taken will effectively
minimize the effects of such interruptions without significant adverse effect
on the Company. However, there can be no assurance that such events will not
have a material adverse effect on the Company's business, results of
operations, business prospects, or financial performance and condition.
The Company estimates that the aggregate cost to address the "Year 2000" issue
will not exceed approximately $1.9 million in 1999. The Company believes that
most of the customer related costs associated with the "Year 2000" issue would
have occurred as part of its normal operations. The Company does not track
these costs separately. Of the amount to be expended in 1999, the Company
believes that approximately $225,000, primarily related to upgrades to
internal systems, is incremental to normal operating costs. While the Company
believes its efforts will provide reasonable assurance that material
disruptions to its internal systems and installed products will not occur, the
potential for interruption still exits. There can be no assurance that the
cost estimates associated with the Company's "Year 2000" issue will prove to
be accurate or that the actual costs will not have a material adverse effect
on the Company's business, results of operation, or financial condition.
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 lines of credit. Such interest rates are currently based on the
prime rate plus three percent.
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
Christopher M. Carnavos 4,184,116 2,151
Sheldon L. Glashow 4,184,116 2,151
Scott N. Greenberg 4,184,116 2,151
2) To amend the Company's
1995 Long-Term Incentive 3,925,716 253,651 6,900 -
Plan
3) Ratification of
PricewaterhouseCoopers LLP
as Independent Accountants 4,167,116 2,151 17,000
Item 5. Other Information
Forward-Looking Statements
This Form 10-Q contains certain forward-looking statements, within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of
the Securities Exchange Act of 1934, as amended, which are subject to the safe
harbors created by those Acts. These statements include the plans and
objectives of management for future operations, including plans and objectives
relating to the development of the Company's business in the domestic and
international marketplace. All forward-looking statements involve risks and
uncertainties, including, without limitation, risks relating to the Company's
ability to enhance existing software products and to introduce new products in
a timely and cost effective manner, reduced development of nuclear power
plants that may utilize the Company's products, a long pay-back cycle from the
investment in software development, uncertainties regarding the ability of the
Company to grow its revenues and successfully integrate operations through
expansion of its existing business and strategic acquisitions, the ability of
the Company to respond adequately to rapid technological changes in the
markets for process control and simulation software and systems, significant
quarter-to-quarter volatility in revenues and earnings as a result of customer
purchasing cycles and other factors, dependence upon key personnel, and
general market conditions and competition. The forward-looking statements
included herein are based on current expectations that involve numerous risks
and uncertainties as set forth herein, the failure of any one of which could
materially adversely affect the operations of the Company. The Company's plans
and objectives are also based on the assumptions that market conditions and
competitive conditions within the Company's business areas will not change
materially or adversely and that there will be no material adverse change in
the Company's operations or business. Assumptions relating to the foregoing
involve judgments with respect to, among other things, future economic,
competitive and market conditions and future business decisions, all of which
are difficult or impossible to predict accurately and many of which are beyond
the control of the Company. Although the Company believes that the assumptions
underlying the forward-looking statements are reasonable, any of the
assumptions could be inaccurate and there can, therefore, be no assurance that
the forward-looking statements included in this Form 10-Q will prove to be
accurate. In light of the significant uncertainties inherent in the
forward-looking statements included herein, the inclusion of such information
should not be regarded as a representation by the Company or any other person
that the objectives and plans of the Company will be achieved.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit Index
The following exhibits are filed herewith.
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
10.22 Loan and Security Agreement among GSE Power Systems, Inc., GSE Process
Solutions, Inc., GSE Systems, Inc. MSHI, Inc., GP International
Engineering & Simulation, Inc., and Dime Commercial Corp., dated June 4,
1999.
10.23 Export-Import Bank of the United States Working Capital Guarantee Program
Borrower Agreement dated June 4, 1999 between the Export- Import Bank of
the United States and GSE Power Systems, Inc., and acknowledged by Dime
Commercial Corp.
10.24 $6,000,000 Promissory Note dated June 4, 1999, from GSE Process
Solutions, Inc., and GSE Power Systems, Inc. to Dime Commercial Corp.
10.25 $3,000,000 Promissory Note dated June 4, 1999, from GSE Process
Solutions, Inc., and GSE Power Systems, Inc. to Dime Commercial Corp.
10.26 ManTech International Corporation Guarantee to Dime Commercial Corp.
dated June 4, 1999.
10.27 GP Strategies, Inc. Guarantee to Dime Commercial Corp. dated June 4,
1999.
(b) Reports on Form 8-K
None
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: August 13, 1999 GSE SYSTEMS, INC.
/S/ Christopher M. Carnavos
---------------------------
Christopher M. Carnavos
President and Director
(Principal Executive Officer)
/S/ Jeffery G. Hough
---------------------------
Jeffery G. Hough
Senior Vice President, Chief Financial Officer
and Treasurer
(Principal Financial & Accounting Officer)