Conformed
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, 2000.
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 May 9, 2000, there were 5,192,427 shares of the Registrant's common stock
outstanding.
<PAGE>
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, 2000
and December 31, 1999 3
Consolidated Statements of Operations for the Three
Months Ended March 31, 2000 and March 31, 1999 4
Consolidated Statements of Comprehensive Income
for the Three Months Ended March 31, 2000 and
March 31, 1999 5
Consolidated Statements of Cash Flows for the Three Months
Ended March 31, 2000 and March 31, 1999 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition 12
Item 3. Quantitative and Qualitative Disclosure About Market Risk 15
PART II. OTHER INFORMATION 16
Item 1. Legal Proceedings 16
Item 2. Changes in Securities and Use of Proceeds 16
Item 3. Defaults Upon Senior Securities 16
Item 4. Submission of Matters to a Vote of Security Holders 16
Item 5. Other Information 16
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURES 18
<PAGE>
<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
ASSETS
<S> <C> <C>
Unaudited
March 31, 2000 December 31, 1999
Current assets:
Cash and cash equivalents $ 2,653 $ 2,695
Restricted cash 360 255
Contract receivables 14,331 16,881
Inventories 3,263 3,255
Prepaid expenses and other current assets 2,153 2,207
Deferred income taxes 146 146
--- ---
Total current assets 22,906 25,439
Investment in Avantium Technologies B.V. 2,895 -
Property and equipment, net 2,952 3,094
Software development costs, net 5,306 5,395
Goodwill, net 2,823 2,949
Deferred income taxes 2,947 3,251
Restricted cash 330 480
Other assets 1,588 2,419
----- -----
Total assets $ 41,747 $ 43,027
=============== =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Line of credit $ 6,426 $ -
Accounts payable 5,280 5,024
Accrued expenses 4,008 5,504
Billings in excess of revenue earned 2,935 3,077
Accrued warranty reserves 531 620
Income taxes payable 25 30
Other current liabilities 2,426 2,519
----- -----
Total current liabilities 21,631 16,774
Line of credit - 6,233
Accrued warranty reserves 716 680
Other liabilities 1,296 2,170
----- -----
Total liabilities 23,643 25,857
Stockholders' equity:
Common stock $.01 par value,
8,000,000 shares authorized,
5,186,327 shares issued and
outstanding 52 50
Additional paid-in capital 22,204 21,691
Retained earnings (deficit)-at formation (5,112) (5,112)
Retained earnings - since formation 1,797 1,259
Accumulated other comprehensive loss (837) (718)
---- ----
Total stockholders' equity 18,104 17,170
------ ------
Total liabilities and
stockholders' equity $ 41,747 $ 43,027
=============== =================
The accompanying notes are an integral part of these consolidated financial
statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
<S> <C> <C>
Three months ended
March 31,
2000 1999
---- ----
Revenue:
Contract revenue $ 12,229 $ 17,578
Software licensing revenue 2,895 -
----- ------
Total revenue 15,124 17,578
Cost of revenue 9,160 10,879
----- ------
Gross profit 5,964 6,699
Operating expenses:
Selling, general and administrative 4,388 4,880
Depreciation and amortization 441 350
--- ---
Total operating expenses 4,829 5,230
----- -----
Operating income 1,135 1,469
Interest expense, net (191) (114)
Other income (expense) (42) 33
Income before income taxes 902 1,388
Provision for income taxes 365 528
--- ---
Net income $ 537 $ 860
============== ==========
Basic earnings per common share $ 0.10 $ 0.17
============== ==========
Diluted earnings per common share $ 0.09 $ 0.17
============== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
<TABLE>
<CAPTION>
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)
<S> <C> <C>
Three months ended
March 31,
2000 1999
---- ----
Net income $ 537 $ 860
Foreign currency translation adjustment (119) (19)
---- ---
Comprehensive income $ 418 $ 841
======= ======
The accompanying notes are an integral part of these consolidated financial
statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Three months ended
March 31,
2000 1999
==== ====
<S> <C> <C>
Cash flows from operating activities:
Net income $ 537 $ 860
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 978 751
Provision (credit) for doubtful contract
receivables - (29)
Fair value of warrants issued to non-employees - 60
Non-monetary consideration received for software licensed
to Avantium Technologies B.V. (2,895) -
Deferred income taxes 304 405
Changes in assets and liabilities:
Contract receivables 2,550 1,844
Inventories, prepaid expenses and other
assets 887 (28)
Accounts payable and accrued expenses (1,437) (473)
Billings in excess of revenues earned (142) 1,082
Accrued warranty reserves (53) 14
Other liabilities (684) (752)
---- ----
Net cash provided by operating activities 45 3,734
-- -----
Cash flows from investing activities:
Capital expenditures (77) (440)
Capitalization of software development costs (447) (446)
---- ----
Net cash used in investing activities (524) (886)
---- ----
Cash flows from financing activities:
Proceeds from issuance of common stock 515 -
Increase (decrease) in lines of credit with
banks 193 (3,435)
Other (242) (54)
-- ---
Net cash provided by (used in) financing
activities 466 (3,489)
--- ------
Effect of exchange rate changes on cash (29) (15)
--- ---
Net decrease in cash and cash equivalents (42) (656)
--- ----
Cash and cash equivalents at beginning of period 2,695 2,240
----- -----
Cash and cash equivalents at end of period $ 2,653 $ 1,584
========= ========
The accompanying notes are an integral part of these consolidated financial
statements.
</TABLE>
<PAGE>
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2000
(Unaudited)
1. Basis of Presentation
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 generally accepted accounting principles have been
condensed or omitted. It is suggested that these 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, 1999 filed with the Securities and Exchange Commission
on March 31, 2000.
2. Basic and Diluted Earnings Per Common Share
Basic earnings per share is based on the weighted average number of
outstanding common shares for the period. Diluted earnings per share adjusts the
weighted average shares outstanding for the potential dilution that could occur
if stock options or warrants were exercised or converted into common stock.
The number of common shares and common share equivalents used in the
determination of basic and diluted earnings per share was as follows:
<TABLE>
<CAPTION>
March 31,
2000 1999
---- ----
<S> <C> <C>
Weighted average shares outstanding - Basic 5,186,327 5,065,688
========= =========
Weighted average shares outstanding - Diluted 5,783,381 5,167,936
========= =========
</TABLE>
The difference between the basic and diluted number of weighted average
shares outstanding for the three months ended March 31, 2000 and 1999 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.
<PAGE>
3. Inventories
Inventories are stated at the lower of cost, as determined by the average
cost method, or market. Obsolete or unsaleable inventory is reflected at its
estimated net realizable value.
Inventories consist of the following (in
thousands):
<TABLE>
<CAPTION>
<S> <C> <C>
March 31, December 31,
2000 1999
-------------- ------------------
Raw materials $ 2,431 $ 2,536
Service parts 832 719
-------------- ------------------
Total $ 3,263 $ 3,255
============== ==================
</TABLE>
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 $447,000 and $446,000 for the
three months ended March 31, 2000 and 1999, respectively. Total amortization
expense was $537,000 and $440,000 for the three months ended March 31, 2000 and
1999, respectively.
5. Investment in Avantium Technologies B.V.
On February 24, 2000, the Company licensed certain of its simulation
software products to Avantium Technologies B.V.("Avantium") in exchange for
251,501 shares of Avantium preferred stock, valued at $2.3 million and 352,102
shares of Avantium common stock, valued at $598,000. The software license, which
is perpetual in nature, gives Avantium the right to use the software in the
development of new software products. In the event new software products are
developed, the Company has the first right of refusal to be the sole and
exclusive distributors of these products in exchange for a 10% royalty. Each
share of preferred stock is convertible into common stock. Subject to certain
restrictions, in the event that Avantium has not conducted an initial public
offering (or been purchased) within five years, the Company and certain other
holders of preferred shares may, at their option, have their shares redeemed by
Avantium, for the greater of (i) the original purchase price plus 8% interest
compounded annually plus any accrued and unpaid dividends whether or not
declared, or (ii) the fair market value of the shares on an as if converted into
common shares basis plus any accrued and unpaid dividends.
Avantium was formed to develop high speed experimentation and simulation
technologies (HSE) for application in new product and process development in
pharmaceutical, petrochemical, fine chemical, biotechnology and polymers
industries. Avantium expects to develop HSE technologies through in-house
development and contract research at leading universities, hardware developers
and informatics companies. Avantium has various investors, including Shell
International Chemical, SmithKline Beecham, W.R. Grace, three major European
universities and two venture capital firms.
<PAGE>
During the three months ended March 31, 2000, the Company recognized
software licensing revenue of $2.9 million based on the fair value of the
consideration received from Avantium. The fair value was established based on
cash paid by other investors for their respective preferred and common stock
interests in Avantium. The Company has delivered all elements of the software
and has no other obligations to Avantium, other than standard warranty. The
Company will account for its investment in Avantium using the cost method of
accounting based on management's conclusion that the Company does not have
significant influence with respect to the operations of Avantium. During the
first quarter of 2000, the Company also received an additional $2.9 million
contract from Avantium to make certain improvements and enhancements to the
software on a best efforts basis. The rates and margins in the contract are
comparable to those the Company earns performing services for its existing
customers.
6. Financing Arrangements
On March 23, 2000, the Company entered into a new loan and security
agreement with a financial institution for a new credit facility with a maturity
date of March 23, 2003. Borrowings from this facility were used to pay off the
existing debt under the Company's previous credit facility.
The new agreement established a $10 million line of credit (the "Credit
Facility") for the Company and its subsidiaries, GSE Process Solutions, Inc. and
GSE Power Systems, Inc, jointly and severally as co-borrowers. The Credit
Facility provides for borrowings to support working capital needs and foreign
letters of credit ($2 million sublimit). The line is collateralized by
substantially all of the Company's assets and provides for borrowings up to 85%
of eligible accounts receivable, 50% of eligible unbilled receivables and 40% of
eligible inventory (up to a maximum of $1.2 million). In addition, ManTech
International Corporation ("ManTech") has provided a one-year $900,000 standby
letter of credit to the bank as additional collateral for the Company's credit
facility. GSE is allowed to borrow up to 100% of the letter of credit value. GP
Strategies Corporation provided a limited guarantee totaling $1.8 million;
ManTech has provided a limited guarantee totaling $900,000. The interest rate on
this line of credit is based on the bank's prime rate (9% as of March 30, 2000),
with interest only payments due monthly. At March 31, 2000, the Company's
available borrowing base was approximately $6.5, of which approximately $6.4
million had been utilized.
The loan and security agreement requires the Company to comply with certain
financial ratios and precludes the Company from paying dividends and making
acquisitions beyond certain limits without the bank's consent. At March 31,
2000, the Company was not in compliance with its minimum EBITDA (earnings before
interest, taxes, depreciation and amortization) covenant. The Company has
requested and expects to obtain a written waiver for this covenant. However, the
Company was in compliance with its tangible net worth, working capital and ratio
of total liabilities to tangible net worth covenants. Accordingly, the Company
has classified the borrowings under the Credit Facility as current.
As of March 31, 2000, the Company was contingently liable for three letters
of credit totaling approximately $690,000. Two of the letters of credit
represent payment bonds on contracts, while the remaining one was issued to the
landlord of the Company's previous facility (whose lease was terminated in
1998). Of the total amount of letters of credit, approximately $660,000 was
issued in 1998 through the Company's bank at the time and was supported by the
Company's credit facility. These letters of credit could not be reissued by the
Company's financial institution, and in June 1999, the Company was required to
deposit funds with the issuing institution as collateral against the letters of
credit. Of the total balance of restricted cash, $360,000 will be released by
the bank within a year, upon expiration of such letters of credit, and
therefore, has been classified as short-term on the consolidated balance sheets.
The remaining balance of $330,000 has been classified as long-term on the
consolidated balance sheets.
<PAGE>
7. Capital Stock
In January 2000, the Company issued 116,959 shares of its common stock, at
fair market value less discount, to ManTech for $500,000. The proceeds of the
stock issuance were used for working capital.
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, 2000 and 1999 is primarily due to the effects of foreign operations
being taxed at different rates and state income taxes. As of March 31, 2000 and
December 31, 1999, the aggregate deferred tax assets are recorded net of a
valuation allowance of $1.1 million.
<PAGE>
9. Segment Reporting
The Company is primarily organized on the basis of two business units,
Process and Power. The Company has a wide range of knowledge concerning control
and simulation systems and the processes those systems are intended to improve,
control and model. The Company's knowledge is concentrated heavily in the
process industries, which include the chemicals, food and beverage, and
pharmaceutical fields, as well as in the power generation industry. The Process
business unit is primarily engaged in process control and simulation in a
variety of commercial industries. Contracts typically range from three to nine
months. The Power business unit is primarily engaged in simulation for the power
generation industry, with the vast majority of customers being in the nuclear
power industry. Contracts typically range from 18 months to three years.
GSE evaluates the performance of its business units utilizing "Business
Unit Contribution", which is substantially equivalent to earnings before
interest and taxes (EBIT) before allocating any corporate expenses.
The table below presents information about reported segments:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
(In thousands)
Three months ended March 31,
2000
Process Power Total
Revenue $ 7,964 $ 7,160 $ 15,124
======= ======= ========
Business unit contribution $ 1,247 $ 910 $ 2,157
======= ======= ========
1999
Process Power Total
Revenue $ 10,216 $ 7,362 $ 17,578
======== ======= ========
Business unit contribution $ 1,601 $ 1,217 $ 2,818
======== ======= ========
</TABLE>
<PAGE>
Below is a reconciliation of consolidated business unit contribution to
consolidated income before taxes.
<TABLE>
<CAPTION>
<S> <C> <C>
(In thousands)
Three months ended March 31,
2000 1999
Consolidated revenue $ 15,124 $ 17,578
======== ========
Consolidated business unit contribution $ 2,157 $ 2,818
Corporate expenses (1,064) (1,316)
Interest expense, net (191) (114)
---- ----
Consolidated income before income taxes $ 902 $ 1,388
===== ========
</TABLE>
10. Recent Pronouncements
In June 1998, the Financial Accounting Standards Board issued FAS 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. In June 1999, FAS 137, "Accounting for Derivative Instruments and
Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133 -
an amendment of FASB Statement No. 133" was issued. The Company will be required
to adopt this new accounting standard on January 1, 2001. Management does not
anticipate early adoption. The Company does not believe that the effect of the
adoption of FAS No. 133 will be material.
In December 1999, the SEC released Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements." This bulletin establishes more
clearly defined revenue recognition criteria than previously existing accounting
pronouncements and became effective for the Company for the quarter ended March
31, 2000. This pronouncement had no material impact on the Company's revenue
recognition methods.
11. Reclassifications
Certain reclassifications have been made to prior year amounts to conform
with current year presentation.
<PAGE>
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
General Business Environment
GSE Systems, Inc. ("GSE Systems", "GSE" or the "Company") develops and
delivers business and technology solutions by applying process control,
simulation software, systems and services to the energy, process and
manufacturing industries worldwide. The Company's solutions and services assist
customers in reducing the time-to-market for new product development; improving
chemistry for producing products; improving quality, safety and throughput;
reducing operating expenses; and enhancing overall productivity.
In 1999, the Company introduced its new business and marketing strategy
VirtualPlant. VirtualPlant combines the benefits of real-time simulation with
control systems to create a "living", learning real-time representation of an
operating plant. VirtualPlant also allows a customer to create an environment
for simulation-enhanced experimentation, thereby reducing the amount of physical
experimentation necessary to achieve an optimal design result for a new process
product. Based on sophisticated simulation technologies and expert knowledge of
processing realities, VirtualPlant is a fully integrated, comprehensive strategy
including software, consulting services and training that energy and process
manufacturing companies can use to dramatically reduce new product
time-to-market, minimize development costs, achieve greater optimization and
improve overall profitability.
A significant step in implementing the VirtualPlant strategy was the
Company's participation in the February 2000 founding of Avantium Technologies
B.V. ("Avantium"), a Netherlands-based high technology company that employs high
speed experimentation and simulation ("HSE&S") technologies in contract research
and development in the area of new product development and process chemistry.
GSE is an equity shareholder along with Shell International Chemical, SmithKline
Beecham, W.R. Grace, three Dutch universities ( Technical University of Delft,
Technical University of Eindhoven, and Twente University) and three venture
capital firms (Alpinvest, The Generics Group, and S.R.One, the SmithKline
Beecham venture funding company). Avantium Technologies will deploy HSE&S
techniques to rapidly discover and optimize new processes and products of
interest to the petrochemicals, fine chemicals and pharmaceutical industries.
GSE will provide the basis for the informatics system that will automate and
maximize Avantium's lab environment, and the Company will utilize its core
simulation technologies to assist in the optimization of experimentation as well
as analysis of the resulting data. The Company's undiluted holdings in Avantium
Technologies will be approximately 10%; after taking into consideration the
expected dilutive effect of stock option plans, the Company's diluted ownership
percentage is anticipated to be approximately 5%.
The Company will have exclusive distribution and marketing rights to the
technology developed with Avantium (including but not limited to the informatics
solution set, the laboratory equipment/solution and associated equipment/sensor
technology, the management services associated with the laboratory technology,
the technology contributed by any of the current or future partners in Avantium)
and will provide engineering and development services on a contract basis to
Avantium for the completion of this technology.
The Company initiated a market development program designed to bring the
benefits of VirtualPlant, plus the products and services associated with its
affiliation with Avantium Technologies, to major customers around the world.
The order slow down that the Company's Process Business Unit experienced
during the second half of 1999 has continued through the first quarter of 2000.
Despite the resolution of the Y2K date issue concerns that had depressed orders
in 1999, customers are continuing to postpone or reduce spending on additional
investments in their process control systems. This trend appears to be affecting
the entire process control industry and is currently expected to continue into
the third quarter 2000. Based on current workload and backlog, results for the
second and third quarters 2000 are not expected to be as strong as those
reported in the first quarter.
<PAGE>
Results of Operations
The following table sets forth the results of operations for the periods
presented expressed as a percentage of revenue (in thousands).
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Three months ended March 31,
2000 % 1999 %
---- - ---- -
Revenue $ 15,124 100.0% $17,578 100.0%
Cost of revenue 9,160 60.6% 10,879 61.9%
----- ---- ------ ----
Gross profit 5,964 39.4% 6,699 38.1%
----- ---- ----- ----
Operating expenses
Selling, general and administrative 4,388 29.0% 4,880 27.8%
Depreciation and amortization 441 2.9% 350 2.0%
--- --- --- ---
Total operating expenses 4,829 31.9% 5,230 29.8%
----- ---- ----- ----
Operating income 1,135 7.5% 1,469 8.4%
Interest expense, net (191) (1.3%) (114) (0.6%)
Other income (expense) (42) (0.3%) 33 0.2%
--- ---- -- ---
Income before income taxes 902 6.0% 1,388 7.9%
Provision for income taxes 365 2.4% 528 3.0%
--- --- --- ---
Net income $ 537 3.6% $ 860 4.9%
========= === ====== ===
</TABLE>
Revenue. Revenue for the three months ended March 31, 2000 and 1999 totaled
$15.1 million and $17.6 million, respectively. The Process business unit is
still experiencing a significant slowdown in its orders, which began in the
third quarter 1999, causing a 22.0% decrease in first quarter 2000 revenues
as compared to the prior year. The increase in order activity that was
expected once the Y2K date issue had been addressed has not occurred. It
appears that Process business unit customers will continue to postpone
significant additional investments in their process control systems until
the third quarter 2000. Included in the first quarter 2000 Process business
unit revenues was $2.9 million from the sale of licenses for five of GSE's
software products to Avantium Technologies B.V. ("Avantium"), including the
object and source codes, in exchange for an equity interest in Avantium.
See Note 5, Investment in Avantium Technologies B.V. in the Notes to
Consolidated Financial Statements, above, for a discussion of this
transaction. The Power business unit revenues were essentially constant
between the two quarters ($7.2 million in 2000 versus $7.4 million in
1999).
Gross Profit. Due to the lower revenue in the first quarter 2000, gross profit
decreased to $6.0 million (39.4% of revenue) for the three months ended
March 31, 2000 from $6.7 million (38.1% of revenue) for the corresponding
period in 1999. The increase in gross margin as a percentage of revenue
reflects the impact of the license sales to Avantium in the first quarter
2000.
Selling, General and Administrative Expenses. Selling, general and
administrative ("SG&A") expenses totaled $4.4 million in the three months
ended March 31, 2000, a 10.1% decrease from the corresponding period in
1999. The decrease reflects reduced sales, marketing and corporate
administration headcount, lower sales commissions due to lower Process
business unit orders, and reduced relocation expenses related to new hires.
Gross research and product development expenditures approximated $1.1
million in each of the quarters ended March 31, 2000 and March 31, 1999.
Capitalized software development costs totaled $447,000 and $446,000 for
the first quarter of 2000 and 1999, respectively; accordingly, net research
and development costs expensed and included in SG&A were approximately
$700,000 for each of the three month periods ended March 31, 2000 and 1999.
The Company continued development of its VPbatch product during the first
quarter 2000, the Windows NT version of its FlexBatch Recipe and Process
Management software. In addition, the Company began development initiatives
to improve product ease of use of all of its process simulation products
and tightly couple them into the VirtualPlant architecture.
<PAGE>
Depreciation and Amortization. Depreciation expense amounted to $313,000 and
$258,000 during the three months ended March 31, 2000 and 1999,
respectively.
Amortization of goodwill was $128,000 and $92,000 during the three months
ended March 31, 2000 and 1999, respectively. The increase in amortization
in the first quarter 2000 reflects the increase in goodwill due to payments
made for contingent considerations for prior year acquisitions.
Operating Income. Operating income amounted to $1.1 million (7.5% of revenue)
versus $1.5 million (8.4% of revenue) for the three months ended March 31,
2000 and March 31, 1999, respectively. This decrease is the result of the
continuing order slowdown in the Process business unit offset by lower
selling, general and administrative costs
Interest Expense, Net. Net interest expense increased to $191,000 for the three
months ended March 31, 2000 from $114,000 for the corresponding period in
1999. This increase is attributable primarily to an increase in the
Company's borrowings under its line of credit made during the period to
fund working capital requirements.
Other Income (Expense). Other income (expense) mainly reflects recognized
foreign currency transaction gains and losses.
Provision for 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, 2000 and 1999 is primarily
due to the effects of foreign operations being taxed at different rates
and state income taxes. As of March 31, 2000 and December 31, 1999,
the aggregate deferred tax assets are recorded net of a valuation allowance
of $1.1 million.
Liquidity and Capital Resources. Net cash provided by operating activities was
$45,000 for the three months ended March 31, 2000, as reported on the
Consolidated Statements of Cash Flows. The Company's $2.9 million
investmentin Avantium Technologies was a non-monetary transaction and had
no impact on the Company's operating cash flow. Significant changes in the
Company's assets and liabilities included a $2.6 million reduction in
contract receivables, mainly due to the lower orders of the Process
business unit in the first quarter 2000, and a $1.5 million reduction in
accounts payable and accrued expenses.
Net cash used in investing activities was $524,000 in the first quarter
2000, including $447,000 of capitalized software development costs
and $77,000 of capital expenditures.
During the three months ended March 31, 2000, the Company generated
$466,000 net cash from financing activities. In January 2000, the Company
issued 116,959 shares of its common stock at fair market value less
discount to ManTech International Corporation for $500,000.
<PAGE>
On March 23, 2000, the Company entered into a new loan and security
agreement with a financial institution for a new credit facility with a
maturity date of March 23, 2003. Borrowings from this facility were used to
pay off the existing debt under the Company's previous credit facility. The
line of credit provides for borrowings up to a total of $10 million to
support working capital needs and foreign letters of credit. At March 31,
2000, the Company's available borrowing base was approximately $6.5
million, of which approximately $6.4 million had been utilized. See Note 6,
Financing Arrangements, in the Notes to Consolidated Financial Statements,
above, for additional details about this line of credit.
This new credit line requires the Company to comply with certain financial
ratios; at March 31, 2000 the Company was not in compliance with its
minimum EBITDA (earnings before interest, taxes, depreciation and
amortization) covenant. The Company has requested and expects to obtain a
written waiver for this covenant. However, the Company was in compliance
with its tangible net worth, working capital and ratio of total liabilities
to tangible net worth covenants. Accordingly, the Company has classified
the orrrowings undr the Credit Facility as current.
Due mainly to the lower volume of the Process business unit over the last
three quarters, the Company is currently experiencing limited operating
cash flows. Cost reduction efforts, including employee terminations and
reduction of selling and administrative expenses, have been made. The
Company is currently in discussions with its financial institution
regarding a possible term loan in excess of its current available borrowing
base. Discussions are also being held with one of the Company's major
shareholders in regards to additional equity financing.
In order to advance the Company's VirtualPlant business and marketing
strategy, and to leverage the business opportunities provided by the
Company's business relationship with Avantium Technologies, the Company is
seeking equity financing for internal research and development, and
potential business acquisitions and joint ventures. Discussions are in
progress with several venture capital firms.
As of March 31, 2000, the Company was contingently liable for three letters
of credit totaling approximately $690,000. These letters of credit could
not be reissued by the Company's new financial institution, and in June
1999, the Company was required to deposit funds with the issuing
institution as collateral against the letters of credit. Of the total
balance of restricted cash, $360,000 will be released by the bank within a
year, upon expiration of such letters of credit, and therefore, has been
classified as short-term on the consolidated balance sheets. The remaining
balance of $330,000 has been classified as long-term on the consolidated
balance sheets.
Item 3. Quantitative and Qualitative Disclosure about Market Risk.
The Company's market risk is principally confined to changes in foreign
currency exchange rates and potentially adverse effects of differing tax
structures. The Company's exposure to foreign exchange rate fluctuations
arises in part from inter-company accounts in which costs incurred in one
entity are charged to other entities in different foreign jurisdictions.
The Company is also exposed to foreign exchange rate fluctuations as the
financial results of all foreign subsidiaries are translated into U.S.
dollars in consolidation. As exchange rates vary, those results when
translated may vary from expectations and adversely impact overall expected
profitability.
The Company is also subject to market risk related to the interest rates on
its existing lines of credit. Such interest rates are currently based on
the prime rate.
<PAGE>
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
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' business in the domestic and
international marketplace. All forward-looking statements involve risks and
uncertainties, including, without limitation, risks relating to the Company's
ability to enhance existing software products and to introduce new products in a
timely and cost effective manner, reduced development of nuclear power plants
that may utilize the Company's products, a long pay-back cycle from the
investment in software development, uncertainties regarding the ability of the
Company to grow its revenues and successfully integrate operations through
expansion of its existing business and strategic acquisitions, the ability of
the Company to respond adequately to rapid technological changes in the markets
for process control and simulation software and systems, significant
quarter-to-quarter volatility in revenues and earnings as a result of customer
purchasing cycles and other factors, dependence upon key personnel, and general
market conditions and competition. The forward-looking statements included
herein are based on current expectations that involve numerous risks and
uncertainties as set forth herein, the failure of any one of which could
materially adversely affect the operations of the Company. The Company's plans
and objectives are also based on the assumptions that market conditions and
competitive conditions within the Company's business areas will not change
materially or adversely and that there will be no material adverse change in the
Company's operations or business. Assumptions relating to the foregoing involve
judgments with respect to, among other things, future economic, competitive and
market conditions and future business decisions, all of which are difficult or
impossible to predict accurately and many of which are beyond the control of the
Company. Although the Company believes that the assumptions underlying the
forward-looking statements are reasonable, any of the assumptions could be
inaccurate and there can, therefore, be no assurance that the forward-looking
statements included in this Form 10-Q will prove to be accurate. In light of the
significant uncertainties inherent in the forward-looking statements included
herein, the inclusion of such information should not be regarded as a
representation by the Company or any other person that the objectives and plans
of the Company will be achieved.
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
None
<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: May 15, 2000 GSE SYSTEMS, INC.
/S/ Christopher M. Carnavos
Christopher M. Carnavos
Director, Chief Executive Officer and President
(Principal Executive Officer)
/S/ Jeffery G. Hough
Jeffery G. Hough
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
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