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, 1998.
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Transition Period from ______ to ______.
Commission File Number: 0-26494
-------
GSE SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 52-1868008
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
9189 Red Branch Road, Columbia, Maryland, 21045
(Address of principal executive office and zip code)
Registrant's telephone number,
including area code: (410) 772-3500
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
--- ---
As of August 14, 1998, there were 5,065,688 shares of the Registrant's
common stock (par value $ .01 per share) outstanding.
<PAGE>
GSE SYSTEMS, INC.
QUARTERLY REPORT ON FORM 10-Q
INDEX
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets as of June 30, 1998
and December 31, 1997 4
Consolidated Statements of Operations for the Three
and Six Months Ended June 30, 1998 and 1997 5
Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 1998 and 1997 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Results of Operations
and Financial Condition 10
Item 3. Quantitative and Qualitative Disclosure about Market Risk 13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 13
Item 2. Changes in Securities and Use of Proceeds 13
Item 3. Defaults upon Senior Securities 13
Item 4. Submission of Matters to a Vote of Security Holders 13
Item 5. Other Information 14
Item 6. Exhibits and Reports on Form 8-K 14
<PAGE>
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
<TABLE>
<CAPTION>
(Unaudited)
June 30, December 31,
1998 1997
----------- ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 3,000 $ 334
Contract receivables 18,658 24,371
Note Receivable 1,000 -
Inventories 2,496 2,700
Prepaid expenses and other current assets 1,516 1,739
Deferred income taxes 41 2,570
----------- ------------
Total current assets 26,711 31,714
Property and equipment, net 2,535 3,864
Investment in joint venture 151 252
Software development costs, net 7,267 7,526
Goodwill and other intangible assets, net 2,854 2,974
Deferred income taxes 2,463 1,730
Other assets 682 302
----------- -----------
Total assets $ 42,663 $ 48,362
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Lines of credit $ 4,015 $ 9,032
Accounts payable 6,410 7,919
Accrued expenses 3,055 4,304
Obligations under capital lease 218 208
Accrued severance costs - 148
Billings in excess of revenue earned 6,769 6,719
Accrued contract reserves 146 287
Accrued warranty reserves 519 625
Other current liabilities 536 513
Income taxes payable 428 313
---------- -----------
Total current liabilities 22,096 30,068
Notes payable to related parties 173 185
Obligations under capital lease 93 234
Accrued contract and warranty reserves 513 675
Other liabilities 1,258 1,276
---------- -----------
Total liabilities 24,133 32,438
---------- -----------
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 21,378
Retained earnings (deficit) - at formation (5,112) (5,112)
Retained earnings (deficit) - since formation 2,072 (239)
Accumulated Comprehensive income (loss) - (Note 9) (158) (153)
---------- -----------
Total stockholders' equity 18,530 15,924
---------- -----------
Total liabilities and
stockholders' equity $ 42,663 $ 48,362
========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
<PAGE>
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
1998 1997 1998 1997
------------------ ----------------
<S> <C> <C> <C> <C>
Contract revenue $ 16,722 $ 20,630 $ 34,176 $ 39,957
Cost of revenue 12,074 14,535 24,317 28,298
-------- -------- -------- --------
Gross profit 4,648 6,095 9,859 11,659
Operating expenses
Selling, general and administrative 4,962 6,940 10,289 13,189
Depreciation and amortization 375 632 936 1,200
Employee severance and termination costs - - - 1,349
-------- -------- -------- --------
Total operating expenses 5,337 7,572 11,225 15,738
-------- -------- -------- --------
Operating income (loss) (689) (1,477) (1,366) (4,079)
Gain on sale of assets 5,575 - 5,575 -
Interest (expense) (144) (172) (309) (359)
Other (expense) income (84) 97 344 (113)
-------- -------- -------- --------
Income (loss) before income taxes 4,658 (1,552) 4,244 (4,551)
Provision for (benefit from) income taxes 1,893 (515) 1,933 (1,525)
-------- -------- -------- --------
Net income (loss) $ 2,765 (1,037) $ 2,311 $ (3,026)
======== ======== ======== ========
Basic earnings (loss) per common share $ 0.55 $ (0.20) $ 0.46 $ (0.60)
======== ======== ======== ========
Diluted earnings (loss) per common share $ 0.54 $ (0.20) $ 0.45 $ (0.60)
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
<PAGE>
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
For the six months ended
June 30,
1998 1997
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 2,311 $ (3,026)
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization 1,965 1,369
Accrued severance - 969
Provision for doubtful contract receivables (245) (71)
Fair value of warrants issued to non-employees 60 -
Deferred income taxes 1,839 (1,567)
Equity in loss of investee 101 -
Gain on sale of assets (5,575) -
Changes in assets and liabilities
Contract receivables 3,954 822
Inventories 203 324
Prepaid expenses and other current assets (400) 261
Other assets (394) (187)
Accounts payable and accrued expenses (2,032) (620)
Billings in excess of revenues earned 497 (905)
Accrued contract and warranty reserves (66) (876)
Other current liabilities (376) (23)
Income taxes payable 116 (74)
Other liabilities (1) (1)
-------- --------
Net cash provided by (used in) operating activities 1,957 (3,605)
-------- --------
Cash flows from investment activities:
Proceeds from sale of assets 8,855 -
Capital expenditures (1,283) (715)
Capitalization of software development costs (1,704) (2,084)
-------- --------
Net cash provided by (used in) investing activities 5,868 (2,799)
-------- --------
Cash flows from financing activities:
(Decrease)increase in lines of credit with banks (5,017) 5,126
Repayments under capital lease obligations (106) (373)
Principal payments under long term notes - (77)
Decrease in notes payable to related parties (12) (8)
-------- --------
Net cash provided by (used in) financing activities (5,135) 4,668
Effect of exchange rate changes on cash (24) 138
-------- --------
Net increase (decrease) in cash and cash equivalents 2,666 (1,598)
Cash and cash equivalents at beginning of period 334 2,450
======== ========
Cash and cash equivalents at end of period $ 3,000 $ 852
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
<PAGE>
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998
(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, 1997 filed with Securities and Exchange
Commission on March 31, 1998. The results of operations for the period
ended June 30, 1998 are not necessarily indicative of what the operating
results for the full year will be.
2. Sale of Assets
On May 1, 1998, the Company completed the sale of substantially all of
the assets of its wholly owned subsidiary, 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 uncollateralized promissory note due on April 30, 1999,
subject to certain adjustments described in the next paragraph). In
connection with the transaction, Keane purchased certain assets totaling
approximately $4.4 million and assumed certain operating liabilities
totaling approximately $2.2 million. The Company has recognized a gain
on this transaction of $5.6 million. In connection with the sale of
these assets, the Company has written 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 have been sold. The write-off of these costs is reflected in
the calculation of the gain on the sale.
As previously disclosed, the purchase price was subject to post-closing
adjustment based upon a balance sheet as of closing (the "Closing
Balance Sheet"). The Closing Balance Sheet indicated that if the "Net
Asset Value" (defined in the Asset Purchase Agreement, as an amount
equal to (a) the assets purchased by Keane minus (b) the assumed
liabilities), was greater than, or less than $2.2 million, the purchase
price would be increased or decreased by that positive or negative
difference (the "Closing Net Book Value Adjustment"). Keane informed the
Company, subsequent to closing, that, under the terms of the agreement,
the Closing Net Book Value Adjustment resulted in an additional amount
due Keane of approximately $186,000. The Company has engaged in
communications with Keane regarding certain differences in valuation
amounts. The Company has accrued $186,000 as a reduction to the gain on
the sale of the Erudite assets. With the proceeds from the sale of the
Erudite assets, the Company reduced its outstanding borrowings under
credit facilities by approximately $3.8 million, and is using the
remainder of the proceeds to pay for transaction expenses and for
general corporate purposes.
3. Basic and Diluted Loss Per Common Share
Effective December 31, 1997, the Company adopted Statement of Financial
Accounting Standards No. 128, "Earnings Per Share," which requires the
presentation of basic earnings per share and diluted earnings per 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 for the potential dilution that could occur
if stock options, warrants or other convertible securities were
exercised or converted into common stock. Diluted earnings per share is
the same as basic earnings per share for the three and six months ended
June 30, 1997 because the effects of such items were anti-dilutive. The
earnings per share computations have been restated for all periods
presented to conform to FAS 128.
The following is a reconciliation of the weighted average number of
outstanding common shares and potential common shares during each period
presented for purposes of computing basic and diluted earnings per
share.
<PAGE>
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
1998 1997 1998 1997
------------------ ----------------
<S> <C> <C> <C> <C>
Weighted average shares outstanding-basic 5,065,688 5,065,688 5,065,688 5,065,688
Potential common shares 66,163 - 32,181 -
---------- --------- --------- ---------
Weighted average common shares outstanding-diluted 5,131,851 5,065,688 5,097,869 5,065,688
========== ========= ========= =========
</TABLE>
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:
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
-------- ------------
(in thousands)
<S> <C> <C>
Raw materials $1,466 $ 1,610
Service parts 1,030 1,090
------ -------
Total $2,496 $ 2,700
====== =======
</TABLE>
5. Software Development Costs
Certain computer software development costs are capitalized in the
accompanying consolidated balance sheets. Capitalization of computer
software development costs begins upon the establishment of
technological feasibility. Capitalization ceases and amortization of
capitalized costs begins when the software product is commercially
available for general release to customers. Amortization of capitalized
computer software development costs is included in cost of revenues and
is provided at the greater of the amount computed using (a) the ratio of
current gross revenues for a product to the total of current and
anticipated future gross revenues or (b) the straight-line method over
the remaining estimated economic life of the product, not to exceed five
years. Software development costs capitalized were $1,027,000 and
$993,000 for the three months ended June 30, 1998 and 1997,
respectively, and $1,704,000 and $2,084,000 for the six months ended
June 30, 1998 and 1997, respectively. Total amortization expense was
$585,000 and $33,000 for the three months ended June 30, 1998 and 1997,
respectively, and $1,029,000 and $177,000 for the six months ended June
30, 1998 and 1997, respectively.
6. Financing Arrangements
The Company maintains, through it subsidiaries, two lines of credit that
provide for borrowings up to $10.0 million to support foreign letters of
credit, margin requirements on foreign exchange contracts and working
capital needs. The lines of credit expire December 31, 1998. At June 30,
1998, there were $4.0 million of borrowings under the lines of credit,
and letters of credit issued in the ordinary course of business amounted
to approximately $800,000.
As previously disclosed, the aforementioned lines of credit contain
certain restrictive convenants. The Company was in violation of the cash
flow coverage ratio as of June 30, 1998. The bank has waived such
covenant violations.
<PAGE>
With respect to the potential liquidity issues related to the maturity
date on the lines of credit, certain of the Company's principal
stockholders, ManTech International Corporation ("ManTech") and GP
Strategies Corporation ("GP Strategies"), have agreed to provide working
capital support to the Company through June 30, 1999, in the form of
credit enhancements or by taking actions that would result in additional
liquidity to the Company.
As previously disclosed, in consideration for the guaranties, the
Company has agreed to grant both of ManTech and GP Strategies warrants
to purchase shares of the Company's common stock. Although the exact
number of shares of common stock and certain other provisions for such
warrants have not been finalized as of the date of this report, both of
such warrants would provide the right to purchase at least 150,000
shares of common stock at an exercise price of $2.375 per share. The
Company has recorded $300,000 as the estimated fair value of such
warrants in the consolidated financial statements to be amortized over
the term of the guaranties. During the three months ended June 30, 1998,
the Company recognized $60,000 of amortization expense related to these
warrants. The Company will expense the remainder of the fair value over
the term of the guaranties. If the terms of the warrants change when
finalized, the Company will recognize the fair value of any such change
in the consolidated financial statements.
7. Contract Receivables
The components of contract receivables are as follows (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
-------- ------------
<S> <C> <C>
Billed receivables $ 10,843 $ 16,994
Recoverable costs and accrued profit not billed 8,591 8,398
Allowance for doubtful accounts (776) (1,021)
-------- --------
Total contract receivables $ 18,658 $ 24,371
======== ========
</TABLE>
Recoverable costs and accrued profit not billed represent costs incurred
and profit accrued on contracts that will become billable upon future
milestones or completion of contracts.
Revisions in estimated contract costs at completion are reflected in the
period during which facts and circumstances necessitating such a change
first become known. Revenue under long-term, fixed-price contracts
generally is accounted for on the percentage-of-completion method, based
on contract costs incurred to date and estimated costs to complete. The
effect of changes in estimates of contract profits for the 1998 and 1997
periods is immaterial.
8. Income Taxes
The Company's effective tax rate is based on the best current estimate
of its expected annual effective tax rate. The difference between the
statutory U.S. tax rate and the Company's effective tax rate for the
three and six months ended June 30, 1998 is primarily the result of a
valuation allowance against all of the net operating losses generated
during the three months and six months ended June 30, 1998, the effects
of foreign operations at different tax rates and state income taxes. For
the three and six months ended June 30, 1997, the Company recorded an
income tax benefit on the pre-tax losses incurred by the Company's
domestic operations.
<PAGE>
9. Accumulated Comprehensive Income
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" is effective for the six months ended June 30,
1998. SFAS No. 130 establishes standards for reporting comprehensive
income on an annual basis in a full set of general purpose financial
statements either in the statement of operations or in a separate
statement. For the three months ended June 30, 1998 and 1997, the
Company had comprehensive income of $2.9 million and a comprehensive
loss of $920,000, respectively. For the six months ended June 30, 1998
and 1997 the Company had comprehensive income of $2.3 million and a
comprehensive loss of $3.2 million, respectively. The difference between
the comprehensive loss and the net loss as reported in the statements of
operations is related to foreign currency translation adjustments.
10. Recent Pronouncements
The Financial Accounting Standards Board has issued Statement of
Financial Accounting Standard No. 131, "Disclosures about Segments of an
Enterprise and Related Information." SFAS No. 131 establishes standards
for reporting information about operating segments, including related
disclosures, and products, services, geographic areas and major
customers and is effective for the year ending December 31, 1998. The
Company will implement SFAS No. 131 as of December 31, 1998.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards 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, 2000. Management does not anticipate early
adoption. The Company believes that the effect of adoption of SFAS No.
133 will not be material.
Item 2. Management's Discussion And Analysis Of Results Of Operations And
Financial Condition
General Business Environment. The Company designs, develops and delivers
business 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; addressing environmental issues; and enhancing
overall productivity.
As previously disclosed, the Company has finalized senior management changes,
and has set a course to reduce costs and to return the Company's focus to its
core businesses of controls and simulation.
On May 1, 1998, the Company completed the sale of substantially all of the
assets of Erudite to Keane, pursuant to an Asset Purchase Agreement, dated as
of April 30, 1998, by and among the Company, Erudite and Keane. The Erudite
sale is part of the Company's continuing plan and effort to refocus and reduce
costs. As a result of the Erudite sale, the Company was able to reduce its
debt by approximately $3.8 million, while improving its cash position by
approximately $4.1 million. (Refer to Liquidity and Capital Resources, Item 5
of Part II, Other Information, Acquisition and Disposition of Assets, below,
and Note 2, Disposal of Assets - "Notes to Consolidated Financial Statements"
for a further discussion of the sale).
The results to date of the efforts to re-focus and reduce costs are evidenced
by the improvement in operating results for the three months and six months
ended June 30, 1998 as compared to the three months and six months ended June
30, 1997. This is reflected in the operating losses of $689,000 versus $1.5
million and $1.4 million versus $4.1 million, for the three and six month
periods ended June 30, 1998 and 1997, respectively. The operating results for
the first two quarters of 1998 reflect an improvement over each corresponding
quarter in 1997.
The Company believes these actions will result in an ongoing, viable
enterprise more closely focused on its core businesses.
<PAGE>
Results of Operations
The following table sets forth the results of operations for the periods
presented expressed as a percentage of revenues.
<TABLE>
<CAPTION>
Three months ended June 30, Six months ended June 30,
1998 % 1997 % 1998 % 1997 %
------------------------------------ ------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Contract revenue 16,722 100.0% 20,630 100.0% 34,176 100.0% 39,957 100.0%
Cost of revenue 12,074 72.2% 14,535 70.5% 24,317 71.2% 28,298 70.8%
------ ----- ------ ----- ------ ----- ------ -----
Gross profit 4,648 27.8% 6,095 29.5% 9,859 28.8% 11,659 29.2%
Operating Expenses:
Selling, general and administrative 4,962 29.7% 6,940 33.6% 10,289 30.1% 13,189 33.0%
Depreciation and amortization 375 2.2% 632 3.1% 936 2.7% 1,200 3.0%
Employee severance and termination costs - 0.0% - 0.0% - 0.0% 1,349 3.4%
------ ----- ------ ----- ------ ----- ------ -----
Total operating expenses 5,337 31.9% 7,572 36.7% 11,225 32.8% 15,738 39.4%
------ ----- ------ ----- ------ ----- ------ -----
Operating income (loss) (689) -4.1% (1,477) -7.2% (1,366) -4.0% (4,079) -10.2%
Gain on sale of assets 5,575 33.3% - 0.0% 5,575 16.3% - 0.0%
Interest (expense) (144) -0.8% (172) -0.8% (309) -0.9% (359) -0.9%
Other (expense) income (84) -0.5% 97 0.5% 344 1.0% (113) -0.3%
------ ----- ------- ----- ------ ----- ------ -----
Income (loss) before income taxes 4,658 27.9% (1,552) -7.5% 4,244 12.4% (4,551) -11.4%
Provision for (benefit from) taxes 1,893 11.3% (515) -2.5% 1,933 5.7% (1,525) -3.8%
------ ----- ------- ----- -------- ----- ------ -----
Net income (loss) 2,765 16.5% (1,037) -5.0% 2,311 6.7% (3,026) -7.6%
====== ===== ======= ====== ======== ===== ====== =====
</TABLE>
Revenues. Revenues for the three and six months ended June 30, 1998 amounted
to $16.7 million and $34.2 million, respectively, as compared with revenues of
$20.6 million and $40.0 million in the three and six months ended June 30,
1997, respectively. This decrease was mainly due to the disposal of the
Erudite assets. In the three and six months ended June 30, 1997, Erudite
accounted for $3.9 million and $8.0 million of revenue, respectively, compared
with $1.2 million and $5.3 million during the same periods in 1998. The
remaining decrease in revenue was mainly due to temporary delays in customer
orders.
Gross Profit. Gross profit decreased to $4.6 million, a gross margin of 27.8%,
in the three months ended June 30, 1998 from $6.1 million, a gross margin of
29.5%, in the corresponding period of 1997. Gross profit decreased to $9.9
million, a gross margin of 28.8%, in the six months ended June 30, 1998 from
$11.7 million, a gross margin of 29.2%, in the corresponding period of 1997.
The decrease in the gross profit amount is primarily attributable to lower
revenues resulting from the disposition of the Erudite assets.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased to $5.0 million, or 29.7% of revenues,
during the three months ended June 30, 1998 from $6.9 million, or 33.6% of
revenues, during the corresponding period in 1997. Selling, general and
administrative expenses decreased to $10.3 million, or 30.1% of revenue during
the six months ended June 30, 1998 from $13.1 million, or 33.0% of revenues,
during the corresponding period in 1997. The decrease in selling, general and
administrative expenses is primarily attributable to the disposition of the
Erudite assets and the Company's ongoing efforts to reduce costs.
Gross research and product development expenditures were $1.4 million and $1.5
million in the three months ended June 30, 1998 and 1997, respectively, and
$2.5 million and $2.8 million in the six months ended June 30, 1998 and 1997,
respectively. Capitalized software development costs totaled $1.0 million and
$1.1 million during the quarters ended June 30, 1998 and 1997, and $1.7
million and $2.1 million during the six months ended June 30, 1998 and 1997,
respectively. Net research and development costs expensed and included within
selling, general and administrative expenses were $349,000 and $392,000 during
the quarters ended June 30, 1998 and 1997, respectively, and $774,000 and
$752,000 during the six months ended June 30, 1998 and 1997, respectively. The
Company continued investing in the conversion of its DCS product to the
Windows NT platform, SCADA system enhancements to the Windows NT platform and
the productization of its SimSuite software tools.
Depreciation and Amortization. Depreciation expense amounted to $294,000 and
$530,000 during the three months ended June 30, 1998 and 1997, respectively.
Depreciation expense amounted to $772,000 and $1.0 million during the six
months ended June 30, 1998 and 1997, respectively. This decrease was
attributable to the sale of the Erudite assets, and lower depreciation expense
after the facilities move disclosed in the first quarter.
<PAGE>
Amortization of goodwill and intangibles was $81,000 and $102,000 during the
three months ended June 30, 1998 and 1997, respectively, and $164,000 and
$156,000 during the six months ended June 30, 1998 and 1997, respectively. The
increase for the six months was due to the acquisition of J. L. Ryan, Inc. in
December of 1997, as previously disclosed.
Employee Severance and Termination Costs. For the three and six months ending
June 30, 1998, there were no charges for severance. During the six months
ended June 30, 1997, there was a charge for severance and other employee
obligations of $1.3 million in connection with cost reduction efforts
initiated to offset the impact of a decrease in project revenues.
Operating (Loss) Income. Operating (loss) for the three months ended June 30,
1998, decreased to $(689,000), or (4.1%) of revenues,from $(1.5 million), or
(7.2%) of revenues, during the corresponding period of 1997. Operating (loss)
for the six months ended June 30, 1998, decreased to $(1.4) million, or (4.0%)
of revenues, from $(4.1) million, or (10.2%) of revenues, during the
corresponding period of 1997. The 1998 reduction in loss is attributable to
the decrease in Employee Severance and Termination Costs, as well as decreased
selling, general and administrative expenses. In 1997, Erudite accounted for
$(438,000) and $(730,000) of the loss, respectively.
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, Sale of
Assets - "Notes to Consolidated Financial Statements",
"Liquidity and Capital Resources", below and by the full text of the Asset
Purchase Agreement, which was included as Exhibit 2.3 to the Company's Form
10-Q for the quarter ended March 31, 1998 and is incorporated herein by
reference.
Interest (Expense). Interest (expense) decreased to $144,000 and $309,000
during the three and six months ended June 30, 1998, respectively, from
$172,000 and $359,000 during the three and six months ended June 30, 1997,
respectively. This decrease is due to a lower level of borrowings during the
period.
Other Income (Expense). Other income (expense) 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.
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, 1998 and 1997 is primarily the result of
a valuation allowance against all of the net operating losses generated during
the three and six months ended June 30, 1998, the effects of foreign
operations at different tax rates and state income taxes. For the three and
six months ended June 30, 1997, the Company recorded an income tax benefit on
the pre-tax losses incurred by the domestic operations.
Liquidity and Capital Resources
During the six months ended June 30, 1998, the Company's operations provided
$2.0 million of net cash. At June 30, 1997, net cash used by operations was
$3.6 million.
At June 30, 1998, the Company had cash and cash equivalents totaling
approximately $3.0 million.
The Company continues to maintain its lines of credit amounting to $10.0
million. At June 30, 1998, there were $4.0 million in borrowings under these
lines of credit, and letters of credit issued in the ordinary course of
business amounted to $800,000. The lines of credit expire December 31, 1998;
however, the Company anticipates that these lines will be extended or
replaced. For further discussion, see Note 6, Financing Arrangements - "Notes
to Consolidated Financial Statements."
On May 1, 1998, the Company completed the sale of substantially all of the
assets of Erudite to Keane, pursuant to an Asset Purchase Agreement, dated as
of April 30, 1998, by and among the Company, Erudite and Keane. The purchase
price for the Erudite assets was $9.9 million ($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) plus the assumption by Keane of certain
operating liabilities totaling approximately $2.2 million. Net cash proceeds
to be received in 1998 in connection with the sale of Erudite, including
transaction costs, is estimated at $4.1 million, after reducing outstanding
debt as described below. The foregoing description of the Asset Purchase
Agreement is qualified in its entirety by the full text of the Asset Purchase
Agreement, which was included as Exhibit 2.3 to the Company's Form 10-Q for
the quarter ended March 31, 1998 and is incorporated herein by reference.
Refer to Note 2, Disposal of Assets - "Notes to Consolidated Financial
Statements" for a further discussion of the sale.
<PAGE>
The Company intends to continue to seek to replace or renegotiate its credit
facilities, which expire on December 31, 1998. In addition to the
approximately $4.1 million of cash proceeds from the Erudite sale, certain of
the Company's principal stockholders, ManTech and GP Strategies, have agreed
to provide working capital support to the Company through June 30, 1999, in
the form of credit enhancements or by taking actions that would result in
additional liquidity to the Company.
As previously disclosed, in consideration for the guaranties, the Company has
agreed to grant both of ManTech and GP Strategies warrants to purchase shares
of the Company's common stock. Although the exact number of shares of common
stock and certain other provisions for such warrants have not been finalized
as of the date of this report, both of such warrants would provide the right
to purchase at least 150,000 shares of common stock at an exercise price of
$2.375 per share. The Company has recognized $300,000 as the fair value of
such warrants in the consolidated financial statements. During the three
months ended June 30, 1998, the Company recognized $60,000 of expense related
to these warrants. The Company will expense the remainder of the fair value
over the term of the guarantees. If the terms of the warrants change when
finalized, the Company will recognize the fair value of any such change in the
consolidated financial statements.
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.
The Company is in the process of assessing its computer applications to ensure
their functionality with respect to the year 2000 millennium change. At
present, the Company does not anticipate that material incremental costs will
be incurred in any single future year.
Item 3. Quantitative and Qualitative Disclosure about Market Risk.
Not Applicable
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company is not a party to any current litigation; various 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 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
The Annual Meeting of Stockholders was held on May 28, 1998. At the
meeting the following actions were taken:
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<S> <C> <C> <C> <C> <C>
Votes
Proposal For Against Abstain Withheld
1) Election of Directors
Jerome I. Feldman 4,235,436 297,953
George J. Pedersen 4,235,436 297,953
Christopher M. Carnavos 4,237,436 295,953
John A. Moore, Jr. 4,232,436 300,953
2) Ratification of
Coopers & Lybrand L.L.P. as
Independent Accountants 3,432,511 1,089,678 11,200 -
</TABLE>
<PAGE>
Item 5. Other Information
Stockholder Proposals
If the Company does not receive notice at its principal executive offices on
or before March 16, 1999 of a shareholder proposal for consideration at the
1999 annual meeting of shareholders, the proxies named by the Company's Board
of Directors with respect to the meeting shall have discretionary voting
authority with respect to such proposal.
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, data acquisition 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, among other things, to 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
None
(b) Reports on Form 8-K
The Company filed a report on Form 8-K (April 17, 1998)
regarding a letter of intent between the Company and Keane ,
Inc. with respect to Keane's intention to purchase the Company's
Erudite Software business. This report on Form 8-K included the
text of a press release dated April 14, 1998.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: August 14, 1998 GSE SYSTEMS, INC.
/S/ Christopher M. Carnavos
---------------------------
Christopher M. Carnavos
President and Director
(Principal Executive Officer)
095
/S/ Stephen J. Fogarty
---------------------------
Stephen J. Fogarty
Senior Vice President, Chief Financial Officer
and Treasurer
(Principal Financial & Accounting Officer)
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