SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A (Amendment #1)
[X]Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Quarterly Period Ended March 31, 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)
8930 Stanford Boulevard, Columbia, Maryland, 21045
(Address of principal executive office and zip code)
Registrant's telephone number,
including area code: (410) 312-3700
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 May 7, 1998, there were 5,065,688 shares of the Registrant's common
stock (par value $ .01 per share) outstanding.
This amended filing is being submitted due to typographical errors in Part I,
Item 1, Financial Statements and Part II, Item 5, Other Information.
In the opinion of Management, none of the changes made in this amended 10 Q
constitute a material difference in information previously submitted.
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, 1998
(Unaudited) and December 31, 1997 3
Unaudited Consolidated Statements of Operations
for the Three Months Ended March 31, 1998 and 1997 4
Unaudited Consolidated Statements of Cash Flows
for the Three Months Ended March 31, 1998 and 1997 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Results
of Operations and Financial Condition 9
PART II. OTHER INFORMATION 12
Item 5. Other Information 13
SIGNATURES 20
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
ASSETS
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
---- ----
(unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 754 $ 334
Contract receivables 22,944 24,371
Inventories 2,898 2,700
Prepaid expenses and other current assets 2,161 1,739
Deferred income taxes 2,570 2,570
------ ------
Total current assets 31,327 31,714
Property and equipment, net 3,290 3,864
Investment in joint venture 188 252
Software development costs, net 7,638 7,526
Goodwill and other intangible assets, net 2,888 2,974
Deferred income taxes 1,730 1,730
Other assets 322 302
------ ------
Total assets $ 47,383 $ 48,362
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Lines of credit $ 8,939 $ 9,032
Accounts payable 7,755 7,919
Accrued expenses 4,686 4,304
Obligations under capital lease 67 208
Accrued severance costs 60 148
Billings in excess of revenue earned 7,223 6,719
Accrued contract reserves 155 287
Accrued warranty reserves 675 625
Other current liabilities 211 513
Income taxes payable 305 313
------ ------
Total current liabilities 30,076 30,068
Notes payable to related parties 181 185
Obligations under capital lease 183 234
Accrued contract and warranty reserves 649 675
Other liabilities 1,270 1,276
------ ------
Total liabilities 32,359 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 21,378 21,378
Retained earnings (deficit) - at formation (5,112) (5,112)
Retained earnings (deficit) - since formation (965) (239)
Cumulative translation adjustment (327) (153)
------ ------
Total stockholders' equity 15,024 15,924
------ ------
Total liabilities & stockholders' equity $ 47,383 $ 48,362
====== ======
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three months Three months
ended ended
March 31, March 31,
1998 1997
---- ----
<S> <C> <C>
Contract revenue $ 17,454 $ 19,327
Cost of revenue 12,243 13,763
------ ------
Gross profit 5,211 5,564
Operating expenses:
Selling, general and administrative 5,327 6,249
Depreciation and amortization 561 568
Employee severance and termination costs - 1,349
------ ------
Total operating expenses 5,888 8,166
------ ------
Operating income (loss) (677) (2,602)
Interest expense 165 187
Other expense (income) (428) 210
------ ------
Income (loss) before income taxes (414) (2,999)
------ ------
Provision for (benefit from) income taxes 40 (1,010)
------ ------
Net (loss) $ (454) $ (1,989)
====== ======
Basic and diluted (loss) per common share $ (.09) $ (0.39)
====== ======
Weighted average common shares outstanding 5,065,688 5,065,688
</TABLE>
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)
<TABLE>
<CAPTION>
Three months Three months
ended ended
March 31, 1998 March 31, 1997
-------------- --------------
<S> <C> <C>
Cash Flows From Operating Activities:
Net (loss) $ (454) $ (1,989)
Adjustments made to reconcile net income
(loss) to net cash (used in) provided
by operating activities:
Depreciation and amortization 1,170 712
Accrued severance -- 1,349
Deferred income taxes -- (390)
Changes in assets and liabilities:
Contract receivables 1,671 1,520
Inventories (138) 438
Prepaid expenses and other current assets (398) (307)
Other assets 123 83
Accounts payable and accrued expenses (984) (2,050)
Billings in excess of revenue earned 1,233 (1,371)
Accrued contract and warranty reserves (166) (328)
Other current liabilities (622) (584)
Income taxes payable (14) (532)
Other liabilities -- (1)
------ ------
Net cash (used in) operating activities 1,421 (3,450)
------ ------
Cash Flows From Investing Activities:
Capital expenditures (25) (340)
Capitalization of software development costs (722) (993)
------ ------
Net cash (used in) investing activities (747) (1,333)
------ ------
Cash Flows From Financing Activities:
Increase in lines of credit with bank (93) 4,056
Repayments under capital lease obligations (188) (285)
Principal payments under term-note 4 (23)
Decrease in borrowings from related parties (4) (4)
------ ------
Net cash (used in) provided by financing activities(281) 3,744
Effect of exchange rate changes on cash 17 (204)
------ ------
Net increase (decrease) in cash
and cash equivalents 410 (1,243)
Cash and cash equivalents at beginning of period 344 2,450
------ ------
Cash and cash equivalents at end of period $ 754 $ 1,207
====== ======
</TABLE>
The accompanying notes are in integral part of these
condensed consolidated financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 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 March 31, 1998 are not necessarily indicative
of what the operating results for the full year will be.
2. Subsequent Event - Disposal 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 $9.86
million (consisting of $8.86 million in cash and $1.0 million in the form of
an unsecured promissory note due on April 30, 1999, subject to certain
adjustments). In connection with the transaction, Keane purchased certain
assets of approximately $4.4 million and assumed certain operating
liabilities of Erudite totaling approximately $2.2 million. The Company
anticipates recognizing a gain on this transaction in excess of $5.0 million.
In connection with the sale of these assets, the Company has written off
approximately $800,000 in capitalized software development costs, 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
expected gain on the sale.
The purchase price is subject to post-closing adjustment based upon a balance
sheet as of closing (the "Closing Balance Sheet"). If the Closing Balance
Sheet indicates that the "Net Asset Value" (defined in the Asset Purchase
Agreement), which is an amount equal to (a) the assets purchased by Keane
minus (b) the assumed liabilities, is greater than, or less than $2.2
million, the purchase price will be increased or decreased by that positive
or negative difference (the "Closing Net Book Value Adjustment"), respectively.
With the proceeds from the sale of the Erudite assets, the Company reduced its
outstanding bank debt by approximately $3.8 million, and will use the remainder
of the proceeds to pay for transaction expenses and for general corporate
purposes.
The Company acquired Erudite on May 22, 1996. This acquisition, which was
accounted for as a pooling of interests, was made to facilitate the Company's
efforts to enter the client/server IT solutions market. As previously
disclosed, as a result of the Company's decision to re-focus its strategy on
its core businesses, the Company decided to divest itself of Erudite.
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 months ended March 31, 1998 and 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.
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>
March 31, December 31,
1998 1997
---- ----
<S> <C> <C>
(in thousands)
Raw materials $1,784 $1,610
Service parts 1,114 1,090
------ ------
Total $2,898 $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 $700,000 and $1.0 million
for the three months ended March 31, 1998 and 1997. Total amortization
expense was $609,000 and $144,000 for the three months ended March 31, 1998
and 1997.
6. Financing Arrangements
----------------------
The Company maintained, through its subsidiaries, two lines of credit with
its bank that provided for borrowings up to $14.0 million to support foreign
letters of credit, margin requirements on foreign exchange contracts and
working capital needs, which were due to expire June 30, 1998. At March 31,
1998, the Company had approximately $8.9 million of borrowings under the
lines of credit with its bank. Concurrent with the sale of the Erudite
assets described in Note 2, the line of credit for Process Solutions was
reduced from $7.0 million to $3.0 million, reducing the two lines of credit
to $10.0 million with the same maturity date of June 30, 1998. The Company
reduced its bank debt by $3.8 million after the Erudite closing. Letters of
credit issued from its bank amounted to approximately $850,000 at March 31,
1998.
As previously disclosed, the aforementioned lines of credit contain certain
restrictive covenants. The Company was in violation of the cash flow
coverage ratio as of March 31, 1998. As of March 6, 1998, the bank has
waived such covenant violations at March 31, 1998. Should a violation of any
loan covenant occur at any future measurement date, the bank would have the
right to declare an event of default, and the loans would be payable on demand.
With respect to the potential liquidity issues related to the June 30, 1998
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 March 31, 1999, in the form of credit enhancements or
by taking actions that would result in additional liquidity to the Company.
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. The number of shares of common stock and other provisions for such
warrants have not been finalized as of the date of this report. When the
terms of the warrants become finalized, including the number of shares of
common stock into which the warrants will be exercisable and the related
exercise price, the Company will recognize the fair value of such warrants in
the consolidated financial statements.
7. Contract Receivables
--------------------
The components of contract receivables are as follows:
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
---- ----
<S> <C> <C>
(in thousands)
Billed receivables $ 16,403 $ 16,994
Recoverable costs and accrued profit
not billed 7,321 8,398
Allowance for doubtful accounts (780) (1,021)
------ ------
Total contract receivables $ 22,944 $ 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 was to increase gross profit by $139,523 and
$237,000 during the three months ended March 31, 1998.
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 months ended
March 31, 1998 and 1997 is primarily the result of a valuation allowance
against all of the net operating losses generated during the three months
ended March 31, 1998, the effects of foreign operations at different tax
rates and state income taxes. For the three months ended March 31, 1997, the
Company recorded an income tax benefit on the pre-tax losses incurred by the
Company's domestic operations.
9. Comprehensive Income
--------------------
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" is effective for the three months ended March 31, 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
March 31, 1998 and 1997, the Company had a comprehensive loss of $788,000 and
$2,279,000, respectively. The difference between the comprehensive loss and
the net loss as reported in the statements of operations 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.
Item 2. Management's Discussion and Analysis of Results of Operations
and Financial Condition
-------------------------------------------------------------
General Business Environment
- ----------------------------
GSE 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 is finalizing the 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. Additionally, the
Company has completed the sale of Erudite to Keane.
The results to date of the efforts to re-focus and reduce costs are evidenced by
the improvement in operating results from the first quarter of 1997 to the
first quarter of 1998, reflected in the operating losses of $677,000 versus
$2.6 million, respectively. The operating results for the first quarter of
1998 were a substantial improvement over each quarter in 1997.
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, Subsequent Events - Disposal of Assets - "Notes
to the Condensed Consolidated Financial Statements" for a further discussion
of the sale).
The Company believes these actions will result in an ongoing, viable
enterprise more closely focused on its core businesses.
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 Three months ended
March 31, 1998 March 31, 1997
-------------- --------------
<S> <C> <C>
Contract revenue $17,454 100.0% $19,327 100.0%
Cost of revenue 12,243 70.1 13,763 71.2
------ ----- ------ -----
Gross profit 5,211 29.9 5,564 28.8
Operating expenses:
Selling, general and
administrative 5,327 30.6 6,249 32.3
Depreciation and amortization 561 3.2 568 3.0
Employee severance and termination
costs -- 0.0 1,349 7.0
------ ----- ------ -----
Total operating expenses 5,888 33.8 8,166 42.3
------ ----- ------ -----
Operating income (loss) (677) (3.9) (2,602) (13.5)
Interest expense 165 1.0 187 1.0
Other expense (income) (428) (2.5) 210 1.1
------ ----- ------ -----
Income (loss) before income
taxes (414) (2.4) (2,999) (15.5)
Provision for income taxes 40 (0.3) (1,010) (5.2)
------ ----- ------ -----
Net income $ (454) (2.6)% $ (1,989) (10.3)%
====== ===== ====== =====
</TABLE>
Revenues. Revenues for the three months ended March 31, 1998 amounted to
$17.5 million, as compared with revenues of $19.3 million in the three months
ended March 31, 1997, respectively. This decrease was mainly due to
temporary delays in customer orders.
Gross Profit. Gross profit decreased to $5.2 million in the three months
ended March 31, 1998 from $5.6 million in the corresponding period of 1997.
The decrease in the gross profit amount is primarily attributable to lower
revenues.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased to $5.3 million, or 30.6% of revenues,
during the three months ended March 31, 1998, from $6.2 million, or 32.3% of
revenues, during the corresponding period of 1997, due to the Company's
outgoing efforts to reduce costs.
Total research and product development expenditures were $1.1 million and
$1.4 million in the three months ended March 31, 1998 and 1997, respectively.
Capitalized software development costs totaled $0.7 and $1.0 million during
the quarters ended March 31, 1998 and 1997, respectively. Net research and
development costs expensed and included within selling, general and
administrative expenses were $425,000 and $360,000 during the quarters ended
March 31, 1998 and 1997, respectively. The Company continued investing in
the conversion of its DCS product to the Windows NT(r) platform, SCADA system
enhancements for the Windows NT(r) platform and the productization of its
SimSuite(tm) software tools.
Depreciation and Amortization. Depreciation expense amounted to $478,000
and $514,000 during the three months ended March 31, 1998 and 1997,
respectively.
Amortization of goodwill and intangibles was $83,000 and $54,000 during the
three months ended March 31, 1998 and 1997, respectively. This increase is
attributable to the acquisition of J. L. Ryan, Inc. in December of 1997, as
previously disclosed.
Operating (Loss). Operating results improved to a loss of $(677,000), or
(3.9%) of revenues, during the three months ended March 31, 1998, from a loss
of $(2.6) million, or (13.5%) 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, which partially offset the reduction in revenues and
gross profit.
Interest Expense. Interest expense decreased to $165,000 during the three
months ended March 31, 1998, respectively, from $187,000 during the three
months ended March 31, 1997, respectively.
Other (Income) Expense. Other (income) expense increased for the three
months ended March 31, 1998 compared to the same period of 1997, from an
expense of $ 210,000 to income of $ 428,000 primarily due to gains 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 ended March 31, 1998 and 1997 is primarily the result of a
valuation allowance against all of the net operating losses generated during
the three months ended March 31, 1998, the effects of foreign operations at
different tax rates and state income taxes. For the three months ended March
31, 1997, the Company recorded an income tax benefit on the pre-tax losses
incurred by the domestic operations.
Liquidity and Capital Resources
- -------------------------------
During the three months ended March 31, 1998, the Company's operations provided
$1.4 million of net cash, primarily resulting from collections of receivables.
At March 31, 1998, the Company had cash and cash equivalents totaling
approximately $754,000 compared with $334,000 at December 31, 1997.
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 $9.86 million ($8.86 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 is filed as
Exhibit 2.3 to this report and is incorporated herein by reference.
Refer to Item 5 of Part II, Other Information, Acquisition and Disposition of
Assets, below, and Note 2, Subsequent Event - Disposal of Assets - "Notes to
the Condensed Consolidated Financial Statements" for a further discussion of
the sale.
The Company maintained, through its subsidiaries, two lines of credit with
its bank that provided for borrowings up to $14.0 million to support foreign
letters of credit, margin requirements on foreign exchange contracts and
working capital needs, which are due to expire June 30, 1998. At
March 31, 1998, the Company had approximately $8.9 million of borrowings
under the lines of credit with its bank. Concurrent with the sale of the
Erudite assets described in Notes 2, the line of credit for Process Solutions
was reduced from $7.0 million to $3.0 million using approximately $3.8
million of the proceeds from the Erudite transaction. Available borrowings
under the two lines of credit now total $10.0 million with the same
maturity date of June 30, 1998.
The Company intends to continue to seek to replace or renegotiate its expiring
credit facilities. 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 March 31, 1999, in the form of credit
enhancements or by taking actions that would result in additional liquidity
to the Company.
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. The number of shares of common stock and other provisions for such
warrants have not been finalized as of the date of this report. When the
terms of the warrants become finalized, including the number of shares of
common stock into which the warrants will be exercisable and the related
exercise price, the Company will recognize the fair value of such warrants in
the consolidated financial statements.
The aforementioned lines of credit also contain certain restrictive
covenants. The Company was in violation of the cash flow coverage ratio and
the tangible net worth covenants as of March 31, 1998. The bank has waived
such covenant violations at March 31, 1998. Should a violation of any loan
covenant occur at any future measurement date, the bank would have the right
to declare an event of default, and the loans would be payable on demand. For
further discussion, see Note 6 of "Notes to Condensed 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.
PART II - OTHER INFORMATION
- ---------------------------
Item 5. Other Information
Acquisition or Disposition of Assets
- ------------------------------------
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 approximately $9.86 million ($8.86 million
in cash and $1.0 million in the form of an unsecured promissory note due on
April 30, 1999, subject to certain adjustments). In connection with the
transaction, Keane purchased certain assets of approximately $4.4 million and
assumed certain operating liabilities totaling approximately $2.2 million
(Refer to Item 2, Management's Discussion and Analysis of the Results of
Operations and Financial Condition, General Business Environment and
Liquidity and Capital Resources, above, and Note 2, Subsequent Event -
Disposal of Assets - "Notes to the Condensed Consolidated Financial
Statements" for a further discussion of the sale).
The purchase price is subject to post-closing adjustment based upon a balance
sheet as of the closing date (the "Closing Balance Sheet"). If the Closing
Balance Sheet indicates that the "Net Asset Value" (defined in the Asset
Purchase Agreement), which is an amount equal to (a) the assets purchased by
Keane minus (b) the assumed liabilities, is greater than, or less than
approximately $2.2 million, then the purchase price will be increased or
decreased by that positive or negative difference (the "Closing Net Book
Value Adjustment"), respectively.
With the proceeds from the Sale of the Erudite, the Company reduced its
outstanding bank debt by approximately $3.8 million, and will use the
remainder of the proceeds to pay for transaction expenses and for general
corporate purposes.
The foregoing description of the Asset Purchase Agreement is qualified in its
entirety by the full text of the Asset Purchase Agreement, which is included
as Exhibit 2.3 to this report and is incorporated herein by reference.
The Company expects to report a pre-tax gain on the sale of Erudite in excess
of $5.0 million in the second quarter of 1998.
Pro Forma Financial Statements
- ------------------------------
The following unaudited Pro Forma Balance Sheet as of March 31, 1998 and the
unaudited Pro Forma Statements of Operations for the three months ended
March 31, 1998 and the year ended December 31, 1997, are presented to give
effect to the sale of Erudite.
Historical financial data used to prepare the pro forma financial statements
were derived from the audited consolidated financial statements included in
the Company's Annual Report on Form 10-K for the year ended December 31, 1997
and the unaudited condensed consolidated financial statements included in the
Company's Quarterly Report on Form 10-Q herein for the period ended
March 31, 1998. These pro forma financial statements should be read in
conjunction with such historical financial statements and notes thereto.
The pro forma adjustments reflected herein are based on available information
and certain assumptions that the Company's management believes are reasonable.
Pro forma adjustments made in the unaudited Pro Forma Balance Sheet assume that
the Sale of the Erudite was consummated on March 31, 1998, and do not reflect
the impact of Erudite's operating results or changes in balance sheet amounts
subsequent to March 31, 1998. The pro forma adjustments to the unaudited Pro
Forma Statements of Operations assume that the Sale of Erudite was
consummated on January 1, 1998 and January 1, 1997 in the unaudited Pro Forma
Statements of Operations for the three months ended March 31, 1998 and for
the year ended December 31, 1997, respectively.
The Pro Forma Balance Sheet and Pro Forma Statements of Operations are based
on assumptions and approximations and, therefore, do not reflect the impact
of the transaction on the historical financial statements. In addition, such
pro forma financial statements should not be used as a basis for forecasting
the future operations of the Company.
<TABLE>
<CAPTION>
GSE SYSTEMS, INC.
PRO FORMA CONSOLIDATED BALANCE SHEET
As of March 31, 1998
(In thousands, unaudited)
Less:
Erudite net Pro forma
Historical assets sold adjustments Pro Forma
---------- ----------- ----------- ---------
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents $ 754 4,105(A)$ 4,859
Contract receivables 22,944 (2,456) 20,488
Inventories 2,898 2,898
Prepaid expenses and
other current assets 2,161 (705) 1,456
Deferred income taxes 2,570 (2,505)(C) 65
------ ------ ------ ------
Total current assets 31,327 (3,161) 1,600 29,766
------ ------ ------ ------
Property and equipment, net 3,290 (1,195) 2,095
Investment in joint venture 188 188
Software development
costs, net 7,638 (815)(D) 6,823
Goodwill and other
intangible assets, net 2,888 2,888
Deferred income taxes 1,730 (27)(C) 1,703
Other assets 322 (35) 1,000 (B) 1,287
------ ------ ------ ------
Total assets $47,383 $(4,391) $1,758 $44,750
====== ====== ===== ======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Lines of credit $ 8,939 $(3,800)(E) 5,139
Accounts payable 7,755 $ (705) 7,050
Accrued expenses 4,686 (762) 3,924
Obligations under capital
lease 67 67
Accrued severence costs 60 60
Billing in excess of
revenue earned 7,223 (586) 6,637
Accrued contract reserves 155 155
Accrued warranty reserves 675 675
Other current liabilities 211 (50) 161
Income taxes payable 305 305
------ ----- ------- ------
Total current liabilities 30,076 (2,103) (3,800) 24,173
------ ----- ------- ------
Notes payable to related
parties 181 181
Obligations under capital
lease 183 (88) 95
Accrued contract and
warranty reserves 649 649
Other liabilities 1,270 1,270
------ ----- ------- ------
Total liabilities 32,359 (2,191) (3,800) 26,368
------ ----- ------- ------
Total stockholders' equity15,024 (2,200) 5,558 (F) 18,382
------ ----- ------- ------
Total liabilities &
stockholders' equity $47,383 $(4,391) $ 1,758 44,750
====== ===== ======= ======
</TABLE>
GSE SYSTEMS, INC.
PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
For the three months ended March 31, 1998
(In thousand, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Less Pro forma
Historical Erudite adjustments Pro Forma
---------- ------- ----------- ---------
<S> <C> <C> <C> <C>
Contract revenue $ 17,454 $ 4,032 $ 13,422
Cost of revenue 12,243 2,731 9,512
------- ------- ------- -------
Gross profit 5,211 1,301 3,910
------- ------- ------- -------
Operating expenses:
Selling, general and
administrative 5,327 937 4,390
Depreciation and
amortization 561 122 439
------- ------- ------- -------
Total operating expenses 5,888 1,059 4,829
------- ------- ------- -------
Operating (loss) income (677) 242 (919)
Interest expense, net 165 $ (65) (G) 100
Other (income) expense (428) - (428)
------- ------- ------- -------
(Loss) income before
income taxes (414) 242 65 (591)
(Benefit from) provision for
income taxes 40 40
------- ------- ------- -------
Net (loss) income $ (454) $ 242 $ 65 $ (631)
======= ======= ======= =======
Basic and diluted (loss)
per common share $ (0.09) $ 0.04 $ 0.01 $ (0.12)
</TABLE>
GSE SYSTEMS, INC.
PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
For the year ended December 31, 1997
(In thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Less Pro forma
Historical Erudite adjustments Pro Forma
---------- ------- ----------- ---------
<S> <C> <C> <C> <C>
Contract revenue $ 79,711 $ 17,999 $ 61,712
Cost of revenue 58,326 15,148 43,178
-------- -------- ---------- --------
Gross profit 21,385 2,851 18,534
-------- -------- ---------- --------
Operating expenses:
Selling, general and
administrative 27,320 5,199 22,121
Depreciation and amortization 2,368 334 2,034
Employee severance and
termination costs 1,124 1,124
-------- -------- ---------- --------
Total operating expenses 30,812 5,533 25,279
-------- -------- ---------- --------
Operating (loss) (9,427) (2,682) (6,745)
Interest expense, net 765 $ (290)(G) 475
Other (income) expense 1,228 (23) 1,251
-------- -------- ---------- --------
(Loss) income before
income taxes (11,420) (2,659) 290 (8,471)
(Benefit from) provision for
income taxes (2,717) (1,272) (1,445)
-------- -------- ---------- --------
Net (loss) $(8,703) $(1,387) $ 290 $ (7,026)
======== ======== ========== ========
Basic and diluted (loss) per
common share $ (1.72) $ 0.27 $ 0.01 $ (1.44)
</TABLE>
GSE SYSTEMS, INC.
NOTES TO PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Historical
----------
The historical balances represent the financial position as of March 31, 1998
and the results of operations for the three months ended March 31, 1998 and
for the year ended December 31, 1997 as reported in the historical consolidated
financial statements of GSE Systems, Inc. (the Company), by reference to the
Annual Report on Form 10-K of GSE Systems, Inc. for the year ended December 31,
1997.
2. Sale of the Net Assets of Erudite
---------------------------------
The Company has sold substantially all the net assets of Erudite. The Company
acquired Erudite on May 22, 1996 in a transaction accounted for under the
pooling-of-interests method. The net assets of Erudite sold to Keane, as set
forth in this column, have been excluded from the historical consolidated
balance sheet of the Company in the unaudited pro forma consolidated balance
sheet as of March 31, 1998. The operations of Erudite, as set forth in this
column, have been excluded from the historical statements of operations of the
Company in the unaudited pro forma consolidated statements of operations for
the three months ended March 31, 1998 and the year ended December 31, 1997,
respectively.
The following pro forma adjustments for the sale of the net assets of Erudite
are reflected as of March 31, 1998 in the case of the pro forma consolidated
balance sheet, or as of January 1, 1998 or January 1, 1997, respectively, in
the case of the pro forma consolidated statements of operations for the three
months ended March 31, 1998 and for the year ended December 31, 1997,
respectively.
(A) Net cash proceeds to be received in connection with the sale of the net
assets of Erudite, including transaction costs, is estimated at $4,105 and is
determined as follows:
<TABLE>
<CAPTION>
<S> <C>
Gross proceeds from sale $8,855
Estimated expenses related to sale (950)
Net proceeds 7,905
Less: required paydown of line of credit (3,800)
------
Net increase in cash $4,105
======
</TABLE>
(B) Amount represents an unsecured promissory note issued to the Company in
connection with the sale of the net assets of Erudite. The promissory note
is receivable April 30, 1999.
(C) Amount represents reduction of deferred taxes resulting from estimated
income tax liability related to the gain on the sale of the net assets of
Erudite. The Company's existing net operating loss carryforwards will be
used to offset the taxable gain on this transaction.
(D) Amount represents the write-off of capitalized software development costs
that were not acquired by Keane. Since all operations that would support the
recoverability of these costs have been sold to Keane, the write-off of the
costs is reflected in the calculation of the expected gain on the sale.
(E) Amount represents paydown of the line of credit using proceeds from the
sale of the net assets of Erudite. Such paydown was required pursuant to the
Company's negotiations for extension of its lines of credit.
(F) The net change in stockholders' equity is determined as follows:
<TABLE>
<CAPTION>
<S> <C>
Gross proceeds from sale $8,855
Estimated expenses related to sale (950)
------
Net proceeds 7,905
Add: Promissory note receivable (B) 1,000
Less: Write-off of assets acquired costs (D) ( 815)
Estimated income taxes (C) (2,532)
------
Net increase in stockholders' equity $5,558
======
</TABLE>
(G) Amount represents the reduction of interest expense incurred by the Company
during the three months ended March 31, 1998 and the year ended December 31,
1997 attributable to the borrowings under the bank line of credit that were
repaid with the proceeds from the sale of the net assets of Erudite.
Forward-Looking Statements
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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.
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 15, 1998 GSE SYSTEMS, INC.
/S/ Christopher M. Carnavos
----------------------------
Christopher M. Carnavos
President and Director
(Principal Executive Officer)
/S/ Robert W. Stroup
---------------------
Robert W. Stroup
Executive Vice President and Treasurer
