-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AreacTP3dpqpO0os4n0HS6I/f2Kq0rZuDCw53zvo/3OUAEr2ADSpW4yW/9MybMxF slm9FGmbfPwCAK8svFa7UA== 0000944480-04-000031.txt : 20040517 0000944480-04-000031.hdr.sgml : 20040517 20040517160010 ACCESSION NUMBER: 0000944480-04-000031 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20040331 FILED AS OF DATE: 20040517 FILER: COMPANY DATA: COMPANY CONFORMED NAME: GSE SYSTEMS INC CENTRAL INDEX KEY: 0000944480 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 521868008 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-14785 FILM NUMBER: 04812425 BUSINESS ADDRESS: STREET 1: 9189 RED BRANCH ROAD CITY: COLUMBIA STATE: MD ZIP: 21045 BUSINESS PHONE: 4107723500 MAIL ADDRESS: STREET 1: 9189 RED BRANCH ROAD STREET 2: 9189 RED BRANCH ROAD CITY: COLUMBIA STATE: MD ZIP: 21045 10-Q 1 f10q_033104.txt 10Q FOR PERIOD ENDING 033104 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 March 31, 2004. 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 May 1, 2004, there were 8,949,706 shares of the Registrant's common stock outstanding. GSE SYSTEMS, INC. QUARTERLY REPORT ON FORM 10-Q INDEX PAGE PART I. FINANCIAL INFORMATION 3 Item 1. Financial Statements: Consolidated Balance Sheets as of March 31, 2004 3 and December 31, 2003 Consolidated Statements of Operations for the 4 Three Months Ended March 31, 2004 and March 31, 2003 Consolidated Statements of Comprehensive Income (Loss) 5 for the Three Months Ended March 31, 2004 and March 31, 2003 Consolidated Statements of Cash Flows for the 6 Three Months Ended March 31, 2004 and March 31, 2003 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Results of Operations 15 and Financial Condition Item 3. Quantitative and Qualitative Disclosures About Market Risk 22 Item 4. Controls and Procedures 22 PART II. OTHER INFORMATION 23 Item 1. Legal Proceedings 23 Item 2. Changes in Securities and Use of Proceeds 23 Item 3. Defaults Upon Senior Securities 23 Item 4. Submission of Matters to a Vote of Security Holders 23 Item 5. Other Information 23 Item 6. Exhibits and Reports on Form 8-K 23 SIGNATURES 24 PART I - FINANCIAL INFORMATION Item 1. Financial Statements GSE SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands, except share data) Unaudited March 31, 2004 December 31, 2003 ASSETS Current assets: Cash and cash equivalents $ 1,062 $ 1,388 Restricted cash 512 473 Contract receivables 9,209 9,457 Prepaid expenses and other current assets 1,545 1,635 ------------ ------------- Total current assets 12,328 12,953 Equipment and leasehold improvements, net 584 643 Software development costs, net 958 946 Goodwill, net 1,739 1,739 Other assets 142 255 ------------ ------------- Total assets $ 15,751 $ 16,536 ============ ============= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term debt $ 34 $ 33 Accounts payable 2,976 2,946 Accrued expenses 1,408 1,518 Accrued compensation and payroll taxes 1,989 1,752 Billings in excess of revenue earned 2,947 3,927 Other current liabilities 236 240 ------------ ------------ Total current liabilities 9,590 10,416 Long-term debt - 9 Accrued warranty reserves 434 407 Other liabilities 25 25 ------------ ------------ Total liabilities 10,049 10,857 ------------ ------------ Commitments and contingencies Stockholders' equity: Series A Convertible preferred stock $.01 par value, 2,000,000 shares authorized, no shares issued and outstanding - - Common stock $.01 par value, 18,000,000 shares authorized, shares issued and outstanding 8,949,706 in 2004 and 2003 89 89 Additional paid-in capital 30,815 30,815 Retained earnings (deficit) - at formation (5,112) (5,112) Retained earnings (deficit) - since formation (19,098) (19,162) Accumulated other comprehensive loss (992) (951) ------------ ------------ Total stockholders' equity 5,702 5,679 ------------ ------------- Total liabilities and stockholders' equity $ 15,751 $ 16,536 ============ ============ The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data) (Unaudited) Three months ended March 31, ------------------------------- 2004 2003 ------------- -------------- Contract revenue $ 7,561 $ 4,975 Cost of revenue 5,784 3,794 ------------- -------------- Gross profit 1,777 1,181 ------------- -------------- Operating expenses Selling, general and administrative 1,238 1,237 Administrative charges from GP Strategies 246 - Depreciation and amortization 69 101 ------------- -------------- Total operating expenses 1,553 1,338 ------------- -------------- Operating income (loss) 224 (157) Interest expense, net (143) (51) Other income (expense), net - (5) ------------- -------------- Income (loss) from continuing operations before income taxes 81 (213) Provision for income taxes 17 37 ------------- -------------- Income (loss) from continuing operations 64 (250) Loss from discontinued operations - (268) ------------- --------------- Net income (loss) 64 (518) Preferred stock dividends - (58) ------------- --------------- Net income (loss) attributed to common shareholders $ 64 $ (576) ============== =============== Basic earnings (loss) per common share: Continuing operations $ 0.01 $ (0.05) Discontinued operations - (0.05) ------------- ---------------- Net income (loss) $ 0.01 $ (0.10) ============= ================ Diluted earnings (loss) per common share Continuing operations $ 0.01 $ (0.05) Discontinued operations - (0.05) ------------- --------------- Net income (loss) $ 0.01 $ (0.10) ============== =============== The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (in thousands) (Unaudited) Three months ended March 31, ------------------------------ 2004 2003 ------------- ------------- Net income (loss) $ 64 $ (518) Foreign currency translation adjustment (41) 3 ------------ -------------- Comprehensive income (loss) $ 23 $ (515) The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (Unaudited) Three months ended March 31, -------------------------- 2004 2003 ----------- ------------ Cash flows from operating activities: Net income (loss) $ 64 $ (518) Loss from discontinued operations - (268) ---------- ----------- Income (loss) from continuing operations 64 (250) Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 154 167 Changes in assets and liabilities: Contract receivables 248 (597) Prepaid expenses and other assets 203 27 Accounts payable, accrued compensation and accrued expenses 130 280 Billings in excess of revenues earned (980) (63) Accrued warranty reserves 51 (26) Other liabilities (28) (24) ----------- ------------- Net cash used in continuing operations (158) (486) Net cash provided by discontinued operations - 1,291 ----------- ------------- Net cash provided by (used in) operating activities (158) 805 ----------- ------------- Cash flows from investing activities: Capital expenditures (16) (13) Capitalized software development costs (97) (209) Restrictions of cash as collateral under line of credit (39) (15) Other cash used in discontinued operations, net - (205) ------------ ------------- Net cash used in investing activities (152) (442) ------------ ------------- Cash flows from financing activities: Decrease in borrowings under lines of credit - (1,778) Other financing activities, net (8) (7) ------------ ------------ Net cash used in financing activities (8) (1,785) ----------- ----------- Effect of exchange rate changes on cash (8) 14 ----------- ----------- Net decrease in cash and cash equivalents (326) (1,408) Cash and cash equivalents at beginning of year 1,388 1,617 ---------- ----------- Cash and cash equivalents at end of period $ 1,062 $ 209 ========== =========== The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the Three Months ended March 31, 2004 and 2003 (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, 2003 filed with the Securities and Exchange Commission on April 14, 2004. With the sale of the Company's Process business, the Company has only one reportable segment. The Company has a wide range of knowledge of simulation systems and the processes those systems are intended to control and model. The Company's knowledge is concentrated heavily in the power generation industry. The Company is primarily engaged in simulation for the power generation industry and simulation for the process industries, with the vast majority of customers being in the nuclear power industry. Contracts typically range from 18 months to three years. The Power business is comprised of three divisions: Power Simulation, Process Simulation and Emergency Management Simulation. At March 31, 2004 GP Strategies Corporation ("GP Strategies") owned 58% of the Company's common stock. 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. 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. 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 long-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. Such PCS arrangements are generally for a one-year period renewable annually and include customer support, unspecified software upgrades, and maintenance releases. The Company recognizes revenue from these contracts ratably over the life of the agreements in accordance with Statement of Position 97-2 "Software Revenue Recognition". Revenues from certain consulting or training contracts are recognized on a time-and-material basis. For time-and-material type contracts, revenue is recognized based on hours incurred at a contracted labor rate plus expenses. Contract receivables unbilled of $5.5 million and $4.4 million as of March 31, 2004 and December 31, 2003, respectively, are typically billed within sixty days. In April, the Company billed $1.2 million of the unbilled amounts. 2. Basic and Diluted Earnings (loss) Per Common Share Basic earnings (loss) per share is based on the weighted average number of outstanding common shares for the period. Diluted earnings (loss) 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 ended March 31, ------------------------ 2004 2003 ----------- ---------- Numerator: Net income (loss) $ 64 $ (518) Preferred stock dividends - (58) ---------- ----------- Net income (loss) attributed to common stockholders $ 64 $ (576) =========== =========== Denominator: Weighted-average shares outstanding for basic earnings per share 8,949,706 5,880,805 Effect of dilutive securities: Employee stock options, warrants and options outside the plan 67,399 - --------- ------------ Adjusted weighted-average shares outstanding and assumed conversions for diluted earnings per share 9,017,105 5,880,805 ========= ========= Shares related to dilutive securities excluded because inclusion would be anti-dilutive: 1,728,276 3,538,956 ========== =========
The difference between the basic and diluted number of weighted average shares outstanding for the quarter ended March 31, 2004 represents dilutive stock options and warrants to purchase shares of common stock computed under the treasury stock method, using the average market price during the period. The net loss for the quarter ended March 31, 2003 was increased by preferred stock dividends of $58,000 in calculating the per share amounts. Conversion of the stock options, warrants and convertible preferred stock was not assumed for the three months ended March 31, 2003 because the impact was anti-dilutive. 3. 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 Company received $5.5 million in cash, subject to certain adjustments. The Company recognized a loss on this transaction of $262,000. In conjunction 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. Results of operations for the three months ended March 31, 2003 have been restated to classify the net loss, assets and liabilities of the Process business as discontinued operations. For the three months ended March 31, 2003, contract revenue and net loss for the discontinued Process business was $4.3 million and $268,000, respectively. 4. Software Development Costs Certain computer software development costs are capitalized in the accompanying consolidated balance sheets. Capitalization of computer software development costs begins upon the establishment of technological feasibility. Capitalization ceases and amortization of capitalized costs begins when the software product is commercially available for general release to customers. Amortization of capitalized computer software development costs is included in cost of revenue and is determined using the straight-line method over the remaining estimated economic life of the product, not to exceed five years. Software development costs capitalized were $97,000 and $208,000 for the quarters ended March 31, 2004 and 2003, respectively. Total amortization expense was $86,000 and $66,000 for the quarters ended March 31, 2004 and 2003, respectively. 5. Stock Compensation The Company applies the intrinsic-value-based method of accounting prescribe by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock issued to Employees, and related interpretations including FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, and interpretation of APB Opinion No. 25, issued in March 2000, to account for its fixed-plan stock options. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price. SFAS No. 123, Accounting for Stock-Based Compensation, established accounting and disclosure requirements using a fair-value-based method of accounting for stock based employee compensation plans. As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic-value-based method of accounting describe above, and has adopted only the disclosure requirements of SFAS No. 123. If the computed values of all the Company's stock based awards were calculated and expensed (over the vesting period of the awards) using the fair value method specified under SFAS 123, net income (loss) would have been as follows: (in thousands, except per share data) Three months ended March 31, ------------------------------ 2004 2003 ----------- ------------ Net income (loss) attributed to common stockholders, as reported $ 64 $ (576) Add stock-based employee compensation expense included in reported net loss, net of tax - - Deduct total stock-based employee compensation expense determined under fair-value-method for all awards, net of tax (15) (67) ------------ ------------- Pro forma net income (loss) $ 49 $ (643) ============ =========== Net income (loss) per share, as reported: Basic $ 0.01 $ (0.10) Diluted $ 0.01 $ (0.10) Net loss per share, as adjusted: Basic $ 0.01 $ (0.11) Diluted $ 0.01 $ (0.11)
No employee stock options were issued in the first quarter of 2004 or 2003. 6. Long-term Debt The Company's long-term debt consists of the following notes payable and other financing arrangements: (in thousands) March 31, December 31, 2004 2003 ------------ --------------- Line of credit with bank $ - $ - Note payable, other 34 42 ------------ --------------- Total notes payable and financing arrangements 34 42 Less amounts payable within one year 34 33 ------------ --------------- Long-term portion $ - $ 9 ============ ===============
Line of Credit General Physics Corporation is a wholly owned subsidiary of GP Strategies. On March 30, 2004, the Company was added as an additional borrower under the Financing and Security Agreement between General Physics Corporation and a financial institution. Under the terms of the agreement, $1.5 million of General Physics' available credit facility has been carved out for use by GSE. The line is collateralized by substantially all of the Company's assets and provides for borrowings up to 80% of eligible accounts receivable and 80% of eligible unbilled receivables. The interest rate on this line of credit is based upon the LIBOR Market Index Rate plus 3% (4.09% as of March 31, 2004), with interest only payments due monthly. At March 31, 2004, the Company's available borrowing base was $1.5 million, none of which had been utilized. The credit facility expires on August 23, 2005. The credit facility requires the Company to comply with certain financial ratios. At March 31, 2004, the Company was in compliance with its financial ratio covenants. In March, 2003, GP Strategies extended their $1.8 million limited guarantee of the Company's bank facility. 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 Company recorded the value of $180,000 as deferred financing cost with a corresponding credit to common stock and additional paid-in capital. The deferred costs were amortized over the one-year life of the guarantee. Notes Payable, other The Company has an unsecured promissory note to a former employee with a remaining balance of $34,000 which expires March 31, 2005. 7. Series A Convertible Preferred Stock The Series A convertible preferred stock has no voting rights and bears dividends at the rate of 6% per annum payable quarterly. Dividends will accumulate if not paid quarterly and compounded interest will accrue on any unpaid dividends. On October 23, 2003, ManTech International Corp. elected to convert all of its 39,000 shares of preferred stock to common stock in conjunction with the sale of its ownership in the Company to GP Strategies. Thus, as of March 31, 2004 and December 31, 2003 there are no shares of preferred stock outstanding. The Company had accrued dividends payable of $366,000 as of March 31, 2004 and December 31, 2003. 8. Letters of Credit and Performance Bonds. As of March 31, 2004, the Company was contingently liable for six letters of credit totaling approximately $541,000. 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 addition, the Company was contingently liable at March 31, 2004 for approximately $61,000 under a performance bond on one contract, which was secured by a bank guarantee of the Company's foreign subsidiary. 9. Income Taxes The Company's effective tax rate was 21.0% and 7.7% for the three months ended March 31, 2004 and March 31, 2003, respectively. The increase in the effective tax rate is attributable primarily to taxes on income earned by the Company's Swedish subsidiary. For 2004, the Company's combined U.S. Federal and State effective tax rate is projected to be 5% and the Swedish effective tax rate is projected to be 28%. 10. Administrative Charges from GP Strategies On January 1, 2004, the Company entered into a Management Services Agreement with GP Strategies Corporation in which GP Strategies agreed to provide corporate support services to GSE, including accounting, finance, human resources, legal, network support and tax. GSE will pay an annual fee of $685,000 ($171,250 per quarter) for these services. The term of the agreement is one year, subject to earlier termination only upon the mutual consent of the parties to the agreement. The agreement can be renewed for successive one-year terms. In December 2003, GSE's Board of Directors elected John Moran, a GP Strategies executive with experience in the power industry and simulation technology, as Chief Executive Officer. Mr. Moran will continue as a GP Strategies employee, however, Mr. Moran will devote 100% of his time to the performance of his duties as CEO of GSE. For 2004, GSE will reimburse GP Strategies $300,000 ($75,000 per quarter) for his compensation and benefits. 11. New Accounting Standards In December 2003, the FASB issued Interpretation No. 46R, Consolidation of Variable Interest Entities, which requires the consolidation of entities meeting certain criteria. The Company does not participate in any variable interest entities. GSE SYSTEMS, INC. AND SUBSIDIARIES FORM 10-Q For the Three Months ended March 31, 2004 and 2003 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, 3004, by and between the Company, Process and Novatech. The Company received $5.5 million in cash, subject to certain adjustments. The operating results of the Company's Process business have been classified as discontinued operations in the Consolidated Statements of Operations for the three months ended March 31, 2003. Following the sale of Process, the Company operates only in the Power business. On January 1, 2004, the Company entered into a Management Services Agreement with GP Strategies Corporation in which GP Strategies agreed to provide corporate support services to GSE, including accounting, finance, human resources, legal, network support and tax. GSE will pay an annual fee of $685,000 ($171,250 per quarter) for these services. The term of the agreement is one year, subject to earlier termination only upon the mutual consent of the parties to the agreement. The agreement can be renewed for successive one-year terms. 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 the chemical and petrochemical industries. In addition, the Company provides plant monitoring and signal analysis monitoring and optimization software primarily to the power industry. Effective January 1, 2004, the Company reorganized, creating a dedicated worldwide business development organization under the direction of one manager, and consolidating all of its operations in Columbia, Maryland, St. Mary's, Georgia and Nykoping, Sweden under another manager. The Company entered into a Management Services Agreement with GP Strategies effective January 1, 2004 in which the Company outsourced most of its corporate functions (accounting, human resources, etc.) and terminated most of its corporate staff at the end of 2003. The Company's Power Simulation Business Unit ("Power") is positioning itself to take advantage of emerging trends in the power industry. The operating licenses for numerous nuclear power plants will expire over the next several years. Fourteen plants have already received license extensions, and sixteen more have applications pending. 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. In 2004, the Company is working on embedding its full scope simulator software into classroom training materials. This will provide dynamic training and feedback to the student, versus just static text. The Company is segmenting its simulation software into "pieces" so that the software can be utilized to teach specific skills in operating the nuclear electric utilities without the need for control room panels. The Company is completing the modification of its simulation technology to simulate the operation of Emergency Operations Centers (EOC) run by municipal and state governments. REMITS is a Real-time Emergency Management Interactive Training System designed to simulate emergency situations and enable EOC staff to train without requiring human participation in the field. REMITS enables the EOC staff to stay current with the technology and enables instructors to introduce new problems and challenges during the exercise to test the EOC staff response to changing situations. As the Federal Government spends billions of dollars in first responder training, management believes the Company's REMITS product will be useful in training for disaster recovery and terrorist threat response. Results of Operations The following table sets forth the results of operations for the periods presented expressed in thousands of dollars and as a percentage of revenues: (in thousands) Three months ended March 31, ----------------------------------------------------- 2004 % 2003 % -------- --------- --------- ---------- Contract revenue $ 7,561 100.0 % $ 4,975 100.0 % Cost of revenue 5,784 76.5 % 3,794 76.3 % -------- --------- --------- ---------- Gross profit 1,777 23.5 % 1,181 23.7 % -------- --------- --------- ---------- Operating expenses: Selling, general and administrative 1,238 16.4 % 1,237 24.9 % Administrative charges from GP Strategies 246 3.2 % - 0.0 % Depreciation and amortization 69 0.9 % 101 2.0 % -------- --------- --------- ---------- Total operating expenses 1,553 20.5 % 1,338 26.9 % -------- --------- --------- ----------- Operating income (loss) 224 3.0 % (157) (3.2)% Interest expense, net (143) (1.9)% (51) (1.0)% Other income (expense), net - 0.0 % (5) (0.1)% -------- --------- --------- ----------- Income (loss) from continuing operations before income taxes 81 1.1 % (213) (4.3)% Provision for income taxes 17 0.3 % 37 0.7 % -------- --------- --------- ----------- Income (loss) from continuing operations 64 0.8 % (250) (5.0)% Loss from discontinued operations - 0.0 % (268) (5.4)% -------- --------- --------- ----------- Net income (loss) $ 64 0.8 % $(518) (10.4)% ======== ========= ========= ===========
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 March 31, 2004, the Company has net capitalized software development costs of $958,000. 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 investment to its estimated fair value based on future discounted cash flows. 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 a regular 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 asset to its realizable value. At March 31, 2004, the Company's deferred tax assets related primarily to a U.S. net operating loss carryforward of $15.9 million which expire in various amounts over the next twenty years. The amount of loss carryforward which can be used by the Company may be limited to approximately $500,000 annually. 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 $8.6 million at March 31, 2004. If the Company is able to realize taxable income in the future, the valuation allowance will be reduced. Results of Operations - Three Months ended March 31, 2004 versus Three Months ended March 31, 2003. Contract Revenue. Total contract revenue for the quarter ended March 31, 2004 totaled $7.6 million, which was 52.0% higher than the $5.0 million total revenue for the quarter ended March 31, 2003. The increase reflects the significant order volume logged in 2003. Total orders in 2003 exceeded $35 million, a 26% increase over 2002, and backlog had increased 59% to $30.4 million at December 31, 2003. At March 31, 2004, the Company's backlog was $26.8 million. Gross Profit. Gross profit totaled $1.8 million (23.5% of revenue) for the quarter ended March 31, 2004, as compared with $1.2 million (23.7% of revenue) for the quarter ended March 31, 2004. The slight decrease in gross profit percentage is mainly attributable to an increase in the amortization of capitalized software development costs. Selling, General and Administrative Expenses. Selling, general and administrative ("SG&A") expenses totaled $1.2 million in the quarter ended March 31, 2004, which was essentially unchanged from the same period in 2003, however the components of the SG&A varied between the quarters. Business development costs increased from $410,000 in the first quarter 2003 to $572,000 in the first quarter 2004. This reflects the Company's renewed focus on business development in 2004 and the reassignment of four operating personnel into the business development function on January 1, 2004. The Company's corporate and G&A expenses decreased from $752,000 to $664,000 reflecting the outsourcing of the Company's corporate function to GP Strategies on January 1, 2004. Finally, the Company's net research and product development expenditures ("R&D") have decreased as discussed below. Gross R&D totaled $97,000 in the first quarter of 2004, as compared with $283,000 in the same period of 2003. Capitalized software development costs totaled $97,000 and $208,000 for the first quarter of 2004 and 2003, respectively. Accordingly, net R&D expensed and included in SG&A was $0 and $75,000 for the first quarter of 2004 and 2003, respectively. The Company's R&D expenditures in the first quarter 2004 were related to: * The development of new functionality for the Company's Jtools software modeling tools. * The modification of the Company's simulation technology to simulate the operation of Emergency Operations Centers (EOC) run by municipal and state governments. * The embedding of the Company's full scope simulator software into classroom training materials by segmenting its simulation software into "pieces" so that the software can be utilized to teach specific skills in operating the nuclear electric utilities without the need for control room panels. Administrative Charges from GP Strategies. On January 1, 2004, the Company entered into a Management Services Agreement with GP Strategies Corporation in which GP Strategies agreed to provide corporate support services to GSE, including accounting, finance, human resources, legal, network support and tax. GSE will pay an annual fee of $685,000 ($171,250 per quarter) for these services. The term of the agreement is one year, subject to earlier termination only upon the mutual consent of the parties to the agreement. The agreement can be renewed for successive one-year terms. In December 2003, GSE's Board of Directors elected John Moran, a GP Strategies executive with experience in the power industry and simulation technology, as Chief Executive Officer. Mr. Moran will continue as a GP Strategies employee, however, Mr. Moran will devote 100% of his time to the performance of his duties as CEO of GSE. For 2004, GSE will reimburse GP Strategies $300,000 ($75,000 per quarter) for his compensation and benefits. Depreciation and Amortization. Depreciation expense totaled $69,000 and $101,000 during the quarters ended March 31, 2004 and 2003, respectively. The reduction reflects certain assets becoming fully depreciated. Operating Income (Loss). The Company had operating income of $224,000 (3.0% of revenue) in the first quarter 2004, as compared with operating loss of $157,000 (3.2% of revenue) for the same period in 2003. The increase was due to the factors outlined above. Interest Expense, Net. Net interest expense increased from $51,000 in the quarter ended March 31, 2003 to $143,000 for the same quarter in 2004. In March 2003, GP Strategies extended their $1.8 million limited guarantee of the Company's bank facility for a one-year period. 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 shares on March 21, 2003. The cost of the guarantee was amortized over the one year period; GSE recognized $45,000 of interest expense in the first quarter 2004 which completed the amortization of these costs. The fees paid to the Company's financial institution as consideration for the extension of the Company's credit facility for a one-year period beginning March 23, 2003 were amortized over the one year extension. In the first quarter 2004, the Company recognized $94,000 of interest expense which completed the amortization of these costs. Other Income (Expense), Net. For the three months ended March 31, 2003, other income (expense) mainly reflects the Company's proportionate share of the income of the Company's investment in RedStorm Scientific, Inc. Provision for Income Taxes. The Company's effective tax rate was 21.0% and 7.7% for the three months ended March 31, 2004 and March 31, 2003, respectively. The increase in the effective tax rate is attributable primarily to taxes on income earned by the Company's Swedish subsidiary. For 2004, the Company's combined U.S. Federal and State effective tax rate is projected to be 5% and the Swedish effective tax rate is projected to be 28%. Liquidity and Capital Resources As of March 31, 2004, the Company's cash and cash equivalents totaled $1.1 million compared to $1.4 million at December 31, 2003. Cash provided by (used in) operating activities. Net cash used in operating activities was $158,000 for the three months ended March 31, 2004. The only significant change in the Company's assets and liabilities during these three months was the decrease of billings in excess of revenues earned by $980,000. In 2003, the Company had entered into a $6.0 million contract with a Mexican customer for a full scope simulator that allowed the Company to invoice the customer for 20% of the contract upon the receipt of the purchase order as an advance payment. The reduction in billings in excess of revenues earned mainly reflects the completion of work which has reduced the Company's liability to the customer for the advance payment. Net cash provided by operating activities was $805,000 for the quarter ended March 31, 2003; $486,000 was used by continuing operations and $1.3 million was provided by discontinued operations. The only significant change in the Company's assets and liabilities in the first quarter 2003 was an increase in contract receivables of $597,000. The Company's unbilled receivables increased during the quarter due to the timing of contract-specified milestone billings. Cash used in investing activities. Net cash used in investing activities was $152,000 for the three months ended March 31, 2004, consisting of $97,000 of capitalized software development costs, $16,000 of capital expenditures and the reduction of a reserve against a cash-collateralized letter of credit of $39,000. The letter of credit expired on March 31, 2004 and the Company received the full cash collateral in April. Net cash used in investing activities was $442,000 in the first quarter 2003; $237,000 was used by continuing operations and $205,000 was used by discontinued operations. The $237,000 used by continuing operations included $209,000 of capitalized software development costs, $13,000 for capital expenditures, and the issuance of a $15,000 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. Cash used in financing activities. In the three months ended March 31, 2004, the Company used $8,000 in financing activitiesrelated to the pay down of a note payable. During the quarter ended March 31, 2003, the Company used $1.8 million net cash in financing activities. The Company decreased its borrowings under its bank line of credit by $1.8 million to a total of $3.7 million. Additionally, the Company paid down a note payable by $7,000. Credit Facilities General Physics Corporation is a wholly owned subsidiary of GP Strategies. On March 30, 2004, the Company was added as an additional borrower under the Financing and Security Agreement between General Physics Corporation and a financial institution. Under the terms of the agreement, $1.5 million of General Physics' available credit facility has been carved out for use by GSE. The line is collateralized by substantially all of the Company's assets and provides for borrowings up to 80% of eligible accounts receivable and 80% of eligible unbilled receivables. The interest rate on this line of credit is based upon the LIBOR Market Index Rate plus 3% (4.09% as of March 31, 2004), with interest only payments due monthly. At March 31, 2004, the Company's available borrowing base was $1.5 million, none of which had been utilized. The credit facility expires on August 23, 2005. The credit facility requires the Company to comply with certain financial ratios. At March 31, 2004, the Company was in compliance with its financial ratio covenants. Item 3. Quantitative and Qualitative Disclosure about Market Risk The Company's market risk is principally confined to changes in foreign currency exchange rates and potentially adverse effects of differing tax structures. The Company's exposure to foreign exchange rate fluctuations arises in part from inter-company accounts in which costs incurred in one entity are charged to other entities in different foreign jurisdictions. The Company is also exposed to foreign exchange rate fluctuations as the financial results of all foreign subsidiaries are translated into U.S. dollars in consolidation. As exchange rates vary, those results when translated may vary from expectations and adversely impact overall expected profitability. The Company is also subject to market risk related to the interest rate on its existing line of credit. As of March 31, 2004, such interest rate is based on the Libor Market Index Rate plus 300 basis-points. As of March 31, 2004, the Company did not have any outstanding debt that was subject to variable interest rates. Item 4. Controls and Procedures Within the 90-day period prior to the filing of this report, GSE management, including the Chief Executive 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 Executive 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 Executive Officer and Chief Financial Officer completed their evaluation. GSE SYSTEMS, INC. AND SUBSIDIARIES FORM 10-Q For the Quarters ended March 31, 2004 and 2003 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 of the Chief Executive Officer pursuant to Section 302 of the Sarbanes- Oxley Act of 2002. 31.2 Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (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: May 17, 2004 GSE SYSTEMS, INC. /S/ JOHN V. MORAN John V. Moran Chief Executive Officer (Principal Executive Officer) /S/ JEFFERY G. HOUGH Jeffery G. Hough Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) EX-31 2 exh31_033104.txt JOHN MORAN Exhibit 31.1 SECTION 302 CERTIFICATIONS I, John Moran, certify that: 1. I have reviewed this quarterly report on Form 10-Q of GSE Systems, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4.The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's first fiscal quarter in the case of an quarterly report) that has materially affected, or is reasonable likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 17, 2004 /s/ John V. Moran ______________________ John V. Moran Chief Executive Officer (Principal Executive Officer) EX-31 3 exh312_033104.txt JEFF HOUGH Exhibit 31.2 SECTION 302 CERTIFICATIONS I, Jeffery G. Hough, certify that: 1. I have reviewed this quarterly report on Form 10-Q of GSE Systems, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's first fiscal quarter in the case of an quarterly report) that has materially affected, or is reasonable likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 17, 2004 /s/ Jeffery G. Hough _______________________________ Jeffery G. Hough Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) EX-32 4 exh32_033104.txt EXHIBIT 32.1 906 CERTIFICATION WRITTEN STATEMENT OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 The undersigned, the Chief Executive Officer and the Chief Financial Officer of GSE Systems, Inc. (the "Company"), each hereby certifies that, to his knowledge, on the date hereof: (a) the Quarterly Report on Form 10-Q of the Company for three months ended March 31, 2004 filed on the date hereof with the Securities and Exchange Commission (the "Quarterly Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (b) the information contained in the Quarterly Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/John V. Moran _______________________ John V. Moran Chief Executive Officer Date: May 17, 2004 /s/ Jeffery G. Hough ________________________ Jeffery G. Hough Senior Vice President and Chief Financial Officer Date: May 17, 2004 -----END PRIVACY-ENHANCED MESSAGE-----