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| Financial Information | | |
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| | | Item 1. | | Financial Statements (Unaudited) | | | | | | | | | | Condensed Consolidated Balance Sheets — June 30, 2006 and December 31, 2005 | | 1 | | | March 31, 2006 and December 31, 2005
| | | | | Condensed Consolidated Statements of Operations — Three Months and Six Months Ended June 30, 2006 and 2005 | | 2 | | | Three Months Ended March 31, 2006 and 2005
| | | | | Condensed Consolidated Statement of Stockholders’ Equity — Six Months Ended June 30, 2006 | | 3 | | | Three Months Ended March 31, 2006
| | | | | Condensed Consolidated Statements of Cash Flows — Six Months Ended June 30, 2006 and 2005 | | 4 | | | Three Months Ended March 31, 2006 and 2005
| | | | | Notes to Condensed Consolidated Financial Statements | | 5 | | | | | | Item 2. | | Management’s Discussion and Analysis of Financial Condition and Results of Operations | | 18 | | | | | | Item 3. | | Quantitative and Qualitative Disclosure About Market Risk | | 27 | | | | | | Item 4. | | Controls and Procedures | | 27 | | | | | | Part II. |
| Other Information | | |
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| | | Item 1. | | Legal Proceedings | | 28 | | | | | | Item 1A. | | Risk Factors | | 28 | | | | | | Item 2. | | Unregistered Sales of Equity Securities and Use of Proceeds | | 28 | | | | | | Item 3. | | Defaults Upon Senior Securities | | 28 | | | | | | Item 4. | | Submission of Matters to a Vote of Security Holders | | 28 | | | | | | Item 5. | | Other Information | | 28 | | | | | | Item 6. | | Exhibits | | 28 | | | | | | Signatures | | | | 30 |
Part I. Financial Information Item 1. Financial Statements GP STRATEGIES CORPORATION AND SUBSIDIARIES Condensed Consolidated Balance Sheets (Dollars inIn thousands, except per share data)amounts) | | | June 30, | | | | | | | 2006 | | December 31, | | | | March 31, 2006 (Unaudited) | | December 31, 2005 | | | (Unaudited) | | 2005 | | Assets | | | | | | | | | | | Current assets: | | | | | | | | | | | Cash and cash equivalents | | $ | 1,074 | | $ | 18,118 | | | $ | 2,164 | | $ | 18,118 | | Accounts and other receivables, less allowance for doubtful accounts of $918 in 2006 and $1,166 in 2005 | | 23,862 | | 27,079 | | | Accounts and other receivables, less allowance for doubtful accounts of $632 in 2006 and $1,166 in 2005 | | | 23,703 | | 27,079 | | Costs and estimated earnings in excess of billings on uncompleted contracts | | 13,024 | | 11,487 | | | 13,109 | | 11,487 | | Prepaid expenses and other current assets | | 5,273 | | 5,936 | | | 5,719 | | 5,936 | | Total current assets | | 43,233 | | 62,620 | | | 44,695 | | 62,620 | | Property, plant and equipment | | 6,593 | | 6,619 | | | 6,864 | | 6,619 | | Accumulated depreciation | | (4,760 | ) | (4,762 | ) | | (5,007 | ) | (4,762 | ) | Property, plant and equipment, net | | 1,833 | | 1,857 | | | 1,857 | | 1,857 | | Goodwill | | 58,552 | | 57,483 | | | 58,435 | | 57,483 | | Other intangible assets, net | | 609 | | 647 | | | 746 | | 647 | | Deferred tax assets | | 10,181 | | 10,391 | | | 7,874 | | 10,391 | | Other assets | | 2,085 | | 1,643 | | | 1,613 | | 1,643 | | | | $ | 116,493 | | $ | 134,641 | | | $ | 115,220 | | $ | 134,641 | | Liabilities and Stockholders’ Equity | | | | | | | | | | | Current liabilities: | | | | | | | | | | | Current maturities of long-term debt | | $ | 79 | | $ | 71 | | | $ | 58 | | $ | 71 | | Short-term borrowings | | 1,732 | | — | | | Accounts payable and accrued expenses | | 20,337 | | 20,315 | | | 19,188 | | 20,315 | | Billings in excess of costs and estimated earnings on uncompleted contracts | | 6,077 | | 7,430 | | | 6,438 | | 7,430 | | Total current liabilities | | 28,225 | | 27,816 | | | 25,684 | | 27,816 | | Long-term debt less current maturities | | 11,444 | | 11,309 | | | 11,558 | | 11,309 | | Other noncurrent liabilities | | 1,179 | | 1,174 | | | 1,193 | | 1,174 | | Total liabilities | | 40,848 | | 40,299 | | | 38,435 | | 40,299 | | | | | | | | | Stockholders’ equity: | | | | | | | | | | | Common stock, par value $0.01 per share | | 178 | | 171 | | | 178 | | 171 | | Class B capital stock, par value $0.01 per share | | — | | 12 | | | — | | 12 | | Additional paid-in capital | | 161,901 | | 168,737 | | | 161,835 | | 168,737 | | Accumulated deficit | | (70,341 | ) | (71,710 | ) | | (68,596 | ) | (71,710 | ) | Unearned compensation | | — | | (1,133 | ) | | — | | (1,133 | ) | Accumulated other comprehensive loss | | (1,120 | ) | (1,087 | ) | | (954 | ) | (1,087 | ) | Note receivable from stockholder | | (124 | ) | (619 | ) | | (124 | ) | (619 | ) | Treasury stock at cost | | (14,849 | ) | (29 | ) | | (15,554 | ) | (29 | ) | Total stockholders’ equity | | 75,645 | | 94,342 | | | 76,785 | | 94,342 | | | | $ | 116,493 | | $ | 134,641 | | | $ | 115,220 | | $ | 134,641 | |
See accompanying notes to condensed consolidated financial statements. 1
GP STRATEGIES CORPORATION AND SUBSIDIARIES Condensed Consolidated Statements of Operations
(Unaudited) (Dollars inIn thousands, except per share data)amounts) | | | Three Months Ended | | Six Months Ended | | | | Three Months Ended March 31, | | | June 30, | | June 30, | | | | 2006 | | 2005 | | | 2006 | | 2005 | | 2006 | | 2005 | | Revenue | | $ | 43,528 | | $ | 43,560 | | | $ | 45,779 | | $ | 43,659 | | $ | 89,307 | | $ | 87,219 | | Cost of revenue | | 37,766 | | 38,016 | | | 38,822 | | 37,291 | | 76,588 | | 75,307 | | Gross profit | | 5,762 | | 5,544 | | | 6,957 | | 6,368 | | 12,719 | | 11,912 | | Selling, general and administrative expenses | | 3,372 | | 3,538 | | | 3,632 | | 3,398 | | 7,004 | | 6,936 | | Operating income | | 2,390 | | 2,006 | | | 3,325 | | 2,970 | | 5,715 | | 4,976 | | Interest expense | | 414 | | 363 | | | 443 | | 379 | | 857 | | 742 | | Other income (including interest income of $131 in 2006 and $44 in 2005) | | 404 | | 42 | | | Other income | | | 180 | | 12 | | 584 | | 54 | | Income from continuing operations before income tax expense | | 2,380 | | 1,685 | | | 3,062 | | 2,603 | | 5,442 | | 4,288 | | Income tax expense | | 1,011 | | 843 | | | 1,317 | | 1,162 | | 2,328 | | 2,005 | | Income from continuing operations | | 1,369 | | 842 | | | 1,745 | | 1,441 | | 3,114 | | 2,283 | | Loss from discontinued operations, net of income taxes | | — | | (374 | ) | | — | | (221 | ) | — | | (595 | ) | Net income | | $ | 1,369 | | $ | 468 | | | $ | 1,745 | | $ | 1,220 | | $ | 3,114 | | $ | 1,688 | | | | | | | | | | | | | Basic weighted average shares outstanding | | | 15,550 | | 18,141 | | 15,889 | | 18,029 | | Diluted weighted average shares outstanding | | | 16,461 | | 18,761 | | 16,795 | | 18,879 | | | | | | | | | | | | | | | | | Per common share data: | | | | | | | | | | | | | | | Basic | | | | | | | | | | | | | | | Income from continuing operations | | $ | 0.08 | | $ | 0.05 | | | $ | 0.11 | | $ | 0.08 | | $ | 0.20 | | $ | 0.12 | | Loss from discontinued operations | | — | | (0.02 | ) | | — | | (0.01 | ) | — | | (0.03 | ) | Net income | | $ | 0.08 | | $ | 0.03 | | | $ | 0.11 | | $ | 0.07 | | $ | 0.20 | | $ | 0.09 | | Diluted | | | | | | | | | | | | | | | Income from continuing operations | | $ | 0.08 | | $ | 0.04 | | | $ | 0.11 | | $ | 0.08 | | $ | 0.19 | | $ | 0.12 | | Loss from discontinued operations | | — | | (0.02 | ) | | — | | (0.01 | ) | — | | (0.03 | ) | Net income | | $ | 0.08 | | $ | 0.02 | | | $ | 0.11 | | $ | 0.07 | | $ | 0.19 | | $ | 0.09 | |
See accompanying notes to condensed consolidated financial statements. 2
GP STRATEGIES CORPORATION AND SUBSIDIARIES Condensed Consolidated Statement of Stockholders’ Equity
(Unaudited) Three(Unaudited)
Six months ended March 31,June 30, 2006 (Dollars inIn thousands, except for par value per share) | | Common stock ($0.01 par) | | Class B capital stock ($0.01 par) | | Additional paid-in capital | | Accumulated deficit | | Unearned compensation | | Accumulated other comprehensive loss | | Note receivable from stockholder | | Treasury stock at cost | | Total stockholders’ equity | | Balance at December 31, 2005 | | $ | 171 | | $ | 12 | | $ | 168,737 | | $ | (71,710 | ) | $ | (1,133 | ) | (1,087 | ) | $ | (619 | ) | $ | (29 | ) | $ | 94,342 | | Net income | | — | | — | | — | | 1,369 | | — | | — | | — | | — | | 1,369 | | Repurchase and exchange of common stock and Class B stock in capital stock restructuring | | 6 | | (12 | ) | (6,062 | ) | — | | — | | — | | — | | (14,758 | ) | (20,826 | ) | Repayment of note receivable from stockholder | | — | | — | | — | | — | | — | | — | | 495 | | — | | 495 | | Repurchases of common stock in the open market | | — | | — | | — | | — | | — | | — | | — | | (71 | ) | (71 | ) | Elimination of unearned compensation upon adoption of SFAS No. 123R | | — | | — | | (1,133 | ) | — | | 1,133 | | — | | — | | — | | — | | Stock-based compensation expense | | — | | — | | 147 | | — | | — | | — | | — | | 9 | | 156 | | Other comprehensive loss | | — | | — | | — | | — | | — | | (33 | ) | — | | — | | (33 | ) | Net issuances of common stock | | 1 | | — | | 212 | | — | | — | | — | | — | | — | | 213 | | Balance at March 31, 2006 | | $ | 178 | | $ | — | | $ | 161,901 | | $ | (70,341 | ) | $ | — | | (1,120 | ) | $ | (124 | ) | $ | (14,849 | ) | $ | 75,645 | |
| | | | Class B | | | | | | | | Accumulated | | Note | | | | | | | | Common | | capital | | Additional | | | | | | other | | receivable | | | | Total | | | | stock | | stock | | paid-in | | Accumulated | | Unearned | | comprehensive | | from | | Treasury | | stockholders’ | | | | ($0.01 par) | | ($0.01 par) | | capital | | deficit | | compensation | | loss | | stockholder | | stock at cost | | equity | | Balance at December 31, 2005 | | $ | 171 | | $ | 12 | | $ | 168,737 | | $ | (71,710 | ) | $ | (1,133 | ) | $ | (1,087 | ) | $ | (619 | ) | $ | (29 | ) | $ | 94,342 | | Net income | | — | | — | | — | | 3,114 | | — | | — | | — | | — | | 3,114 | | Repurchase and exchange of common stock and Class B stock in capital stock restructuring | | 6 | | (12 | ) | (6,062 | ) | — | | — | | — | | — | | (14,758 | ) | (20,826 | ) | Repayment of note receivable from stockholder | | — | | — | | — | | — | | — | | — | | 495 | | — | | 495 | | Repurchases of common stock in the open market | | — | | — | | — | | — | | — | | — | | — | | (1,662 | ) | (1,662 | ) | Elimination of unearned compensation upon adoption of SFAS No. 123R | | — | | — | | (1,133 | ) | — | | 1,133 | | — | | — | | — | | — | | Stock-based compensation expense | | — | | — | | 298 | | — | | — | | — | | — | | — | | 298 | | Other comprehensive income | | — | | — | | — | | — | | — | | 133 | | — | | — | | 133 | | Net issuances of stock primarily for stock option exercises and retirement savings plan | | 1 | | — | | (5 | ) | — | | — | | — | | — | | 895 | | 891 | | Balance at June 30, 2006 | | $ | 178 | | $ | — | | $ | 161,835 | | $ | (68,596 | ) | $ | — | | $ | (954 | ) | $ | (124 | ) | $ | (15,554 | ) | $ | 76,785 | |
See accompanying notes to condensed consolidated financial statements.
GP STRATEGIES CORPORATION AND SUBSIDIARIES Condensed Consolidated Statements of Cash Flows
Three Six months ended March 31,June 30, 2006 and 2005
(Unaudited) (Dollars inIn thousands) | | 2006 | | 2005 | | | 2006 | | 2005 | | Cash flows from operating activities: | | | | | | | | | | | Income from continuing operations | | $ | 1,369 | | $ | 842 | | | Loss from discontinued operations, net of income taxes | | — | | (374 | ) | | Net income | | 1,369 | | 468 | | | $ | 3,114 | | $ | 1,688 | | Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | | | | Depreciation and amortization | | 600 | | 732 | | | 1,293 | | 1,499 | | Collection of deposit in escrow, including interest | | — | | 13,798 | | | — | | 13,798 | | Issuance of stock for retirement savings plan and non-cash compensation expense (recovery) | | 438 | | 60 | | | Other non-cash charges, including deferred income taxes | | 794 | | 368 | | | Changes in other operating items, net of effect of acquisition | | (794 | ) | (7,228 | ) | | Deferred income taxes | | | 1,889 | | 1,524 | | Issuance of stock for retirement savings plan and non-cash compensation expense | | | 870 | | 517 | | Minority interest | | | — | | (622 | ) | Changes in other operating items, net of effect of acquisition: | | | | | | | Accounts and other receivables | | | 4,138 | | (6 | ) | Costs and estimated earnings in excess of billings on uncompleted contracts | | | (1,622 | ) | (663 | ) | Prepaid and other current assets | | | 470 | | (890 | ) | Accounts payable and accrued expenses | | | (1,837 | ) | (8,529 | ) | Billings in excess of costs and estimated earnings on uncompleted contracts | | | (1,646 | ) | (197 | ) | Other | | | — | | 35 | | Net cash provided by operating activities | | 2,407 | | 8,198 | | | 6,669 | | 8,154 | | Cash flows from investing activities: | | | | | | | | | | | Additions to property, plant and equipment | | (165 | ) | (404 | ) | | (447 | ) | (431 | ) | Acquisition, net of cash acquired | | (619 | ) | — | | | (619 | ) | — | | Other investing activities | | | 71 | | 14 | | Net cash used in investing activities | | (784 | ) | (404 | ) | | (995 | ) | (417 | ) | Cash flows from financing activities: | | | | | | | | | | | Proceeds from (repayment of) short-term borrowings | | 1,732 | | (5,368 | ) | | Repayment of short-term borrowings | | | — | | (5,393 | ) | Repurchase and exchange of common stock and Class B stock in capital stock restructuring | | (20,826 | ) | — | | | (20,826 | ) | — | | Proceeds from issuance of subordinated convertible note by GSE | | | — | | 1,500 | | Repayment of note receivable from stockholder | | 495 | | — | | | 495 | | — | | Repurchases of common stock in the open market | | (71 | ) | — | | | (1,662 | ) | — | | Proceeds from issuance of common stock | | 14 | | 391 | | | Proceeds from stock option exercises | | | 423 | | 931 | | Deferred financing costs | | | — | | (182 | ) | Payments on obligations under capital leases | | (28 | ) | (23 | ) | | (53 | ) | (47 | ) | Net cash used in financing activities | | (18,684 | ) | (5,000 | ) | | (21,623 | ) | (3,191 | ) | | | | | | | | Effect of exchange rate changes on cash and cash equivalents | | 17 | | 278 | | | (5 | ) | (62 | ) | Net increase (decrease) in cash and cash equivalents | | (17,044 | ) | 3,072 | | | (15,954 | ) | 4,484 | | Cash and cash equivalents at beginning of year | | 18,118 | | 2,417 | | | Cash and cash equivalents at end of year | | $ | 1,074 | | $ | 5,489 | | | Cash and cash equivalents at beginning of period | | | 18,118 | | 2,417 | | Cash and cash equivalents at end of period | | | $ | 2,164 | | $ | 6,901 | |
See accompanying notes to condensed consolidated financial statements. 4
GP STRATEGIES CORPORATION AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements
Three months ended March 31, June 30, 2006 and 2005 (Unaudited) (1) Basis of Presentation GP Strategies Corporation (the “Company”) was incorporated in Delaware in 1959. The Company’s business consists of its training, engineering, and consulting business operated by General Physics Corporation (“General Physics” or “GP”). General Physics is a workforce development company that seeks to improve the effectiveness of organizations by providing training and e-Learning solutions, management consulting, e-Learning solutions and engineering services that are customized to meet the specific needs of clients. On September 30, 2005, the Company completed a taxable spin-off of its 57% interest in GSE Systems, Inc. (“GSE”) through a dividend to the Company’s stockholders. GSE is a stand alone public company which provides simulation solutions and services to energy, process and manufacturing industries worldwide. On September 30, 2005, stockholders received in the spin-off 0.283075 shares of GSE common stock for each share of the Company’s Common Stock or Class B Capital Stock (“Class B Stock”) held on the record date of September 19, 2005. Following the spin-off, the Company ceased to have any ownership interest in GSE and the operations of GSE have been reclassified as discontinued in the Company’s condensed consolidated statementstatements of operations for the prior periodperiods presented. The Company continues to provide corporate support services to GSE pursuant to a management services agreement which extends through December 31, 2006 (see Note 10). The accompanying condensed consolidated balance sheet as of March 31,June 30, 2006, the condensed consolidated statements of operations for the three and six months ended June 30, 2006 and 2005, and the condensed consolidated statements of operations and cash flows for the threesix months ended March 31,June 30, 2006 and 2005 have not been audited, but have been prepared in conformity with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2005, as presented in our Annual Report on Form 10-K dated March 16, 2006. In the opinion of management, this interim information includes all material adjustments, which are of a normal and recurring nature, necessary for a fair presentation. The results for the 2006 interim period are not necessarily indicative of results to be expected for the entire year. During 2006, the Company reflected $0.3 million of equity in earnings of a joint venture within other income. Previously, this amount was presented in revenue. During 2005, $0.1 million was reflected in revenue related to this joint venture. Certain other amounts in 2005 have been reclassified to conform with the presentation for 2006. The condensed consolidated financial statements include the operations of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated.
(2)Earnings Per Share Basic earnings per common share (EPS) is based uponcomputed by dividing earnings by the weighted average number of common shares outstanding during the periods. Diluted earnings per share is based uponEPS reflects the weighted average number of common shares outstanding during the periods assuming the issuancepotential dilution of common stock for all potentialequivalent shares that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. The Company’s dilutive common stock equivalents outstanding.
Earnings per share for the three months ended March 31, 2006 and 2005 is as follows (in thousands, except per share data):
| | Three months ended March 31, | | | | 2006 | | 2005 | | Income used in computation: | | | | | | Income from continuing operations | | $ | 1,369 | | $ | 842 | | Loss from discontinued operations | | — | | (374 | ) | Net income | | $ | 1,369 | | $ | 468 | | Shares used in computation: | | | | | | Basic weighted average shares outstanding | | 16,232 | | 17,917 | | Dilutive impact of stock options, warrants and non-vested stock units | | 901 | | 1,081 | | Diluted weighted average shares outstanding | | 17,133 | | 18,998 | | Earnings per common share: | | | | | | Basic | | | | | | Income from continuing operations | | $ | 0.08 | | $ | 0.05 | | Loss from discontinued operations | | — | | (0.02 | ) | Net income | | $ | 0.08 | | $ | 0.03 | | Diluted | | | | | | Income from continuing operations | | $ | 0.08 | | $ | 0.04 | | Loss from discontinued operations | | — | | (0.02 | ) | Net income | | $ | 0.08 | | $ | 0.02 | |
For the three months ended March 31, 2006 and 2005, the dilutive effectequivalent shares consist of stock options, non-vested stock units, (2006 only), warrants, and convertible notes, which totaled 585,000 and 574,000, respectively, are not included since they are anti-dilutive.
The difference between the basic and diluted number of weighted average shares outstanding for the three months ended March 31, 2006 and 2005 represents dilutive stock options, non-vested stock units (2006 only) and warrants to purchase shares of common stock computed under the treasury stock method, using the average market price during the period. The following table presents instruments which were not dilutive and were excluded from the computation of diluted EPS in each period, as well as the dilutive common stock equivalent shares which were included in the computation of diluted EPS:
| | Three Months Ended | | Six Months Ended | | | | June 30, | | June 30, | | | | 2006 | | 2005 | | 2006 | | 2005 | | | | (In thousands) | | Non-dilutive instruments | | 574 | | 574 | | 579 | | 574 | | | | | | | | | | | | Dilutive common stock equivalents | | 911 | | 620 | | 906 | | 850 | |
(3)Stock-Based Compensation Accounting Standard Adopted In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 123R, Share-Based Payment (SFAS No. 123R), which revises SFAS No. 123, Accounting for Stock-Based Compensation (SFAS No. 123), and supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25), and requires companies to recognize compensation expense for all equity-based compensation awards issued to employees that are expected to vest. The Company adopted SFAS No. 123R on January 1, 2006, using the Modified Prospective Application method without restatement of prior periods. Under this method, the Company began to amortize compensation cost for the remaining portion of its outstanding awards for which the requisite service was not yet rendered as of January 1, 2006. Compensation cost is based on the fair value of those awards as previously disclosed on a pro forma basis under SFAS No. 123. The Company will determinedetermines the fair value of and accountaccounts for awards that are granted, modified, or settled after January 1, 2006 in accordance with SFAS No. 123R. The following table presents the impact of SFAS No. 123R on income from continuing operations before income tax expense, net income, cash flows from operating and financing activities, and basic and diluted earnings per share:
Three Months Ended March 31, 2006 | | As Reported Including SFAS No. 123R Adoption | | Pro-Forma Excluding SFAS No. 123R Adoption | | Impact | | | | (In thousands, except per share data) | | Income from continuing operations before income tax expense | | $ | 2,380 | | $ | 2,455 | | $ | (75 | ) | Net income | | 1,369 | | 1,414 | | (45 | ) | Net cash provided by operating activities | | 2,407 | | 2,407 | | — | | Net cash used in financing activities | | 18,684 | | 18,684 | | — | | Earnings per share - basic | | 0.08 | | 0.09 | | (0.01 | ) | Earnings per share - diluted | | 0.08 | | 0.08 | | — | | | | | | | | | | | | |
Stock-Based Compensation Plans Pursuant to the Company’s Non-Qualified Stock Option Plan, as amended (the “Non-Qualified Plan”), and 2003 Incentive Stock Plan (the “2003 Plan”), the Company may grant awards of non-qualified stock options, incentive stock options, restricted stock, stock units, performance shares, performance units and other incentives payable in cash or in shares of the Company’s Common Stock to officers, employees or members of the Board of Directors. The Company is authorized to grant an aggregate of
4,237,515 shares under the Non-Qualified Plan and an aggregate of 2,000,000 shares under the 2003 Plan. The Company
may issue new shares or use shares held in treasury to deliver shares to employees for its equity grants or upon exercise of non-qualified stock options. Under SFAS No. 123R, the Company recognizes compensation expense on a straight-line basis over the requisite service period for stock-based compensation awards with both graded and cliff vesting terms. The Company applies a forfeiture estimate to compensation expense recognized for awards that are expected to vest during the requisite service period, and revises that estimate if subsequent information indicates that the actual forfeitures will differ from the estimate. The Company recognizes the cumulative effect of a change in the number of awards expected to vest in compensation expense in the period of change. The Company does not capitalize any portion of its stock-based compensation. DuringThe following table summarizes the three months ended March 31, 2006, the Company recognized $150,000 of pre-tax stock-based compensation expense included in reported net income under the fair value method in accordance with SFAS No. 123R. This123R (in thousands):
| | Three months | | Six months | | | | ended June 30, | | ended June 30, | | | | 2006 | | 2006 | | Cost of revenue | | $ | 106 | | $ | 211 | | Selling, general and administrative expenses | | 42 | | 87 | | Total stock-based compensation expense (pre-tax) | | $ | 148 | | $ | 298 | |
Total compensation expense was comprised of $75,000$64,000 for stock options and $75,000$84,000 for non-vested stock units. Theunits for the three months ended June 30, 2006, and $139,000 for stock options and $159,000 for non-vested stock units for the six months ended June 30, 2006. During the three and six months ended June 30, 2006, the Company recognized a deferred income tax benefit of $60,000$59,000 and $119,000, respectively, associated with the compensation expense recognized for these awards. As of March 31,June 30, 2006, the Company had non-qualified stock options, restricted stock, and non-vested stock units outstanding under these plans as discussed below. Non-Qualified Stock Options Non-qualified stock options are granted with an exercise price not less than the fair market value of the Company’s Common Stock at the date of grant, vest over a period up to ten years, and expire at various terms up to ten years from the date of grant.
Summarized information for the Company’s non-qualified stock options is as follows: | | | | | | | Weighted | | | | | | | | | | | average | | | | | | | | | Weighted | | remaining | | Aggregate | | | | | Number of | | average | | contractual | | intrinsic | | Stock Options | | Number of options | | Weighted average exercise price | | Weighted average remaining years | | Aggregate intrinsic value | | | options | | exercise price | | term | | value | | Outstanding at December 31, 2005 | | 1,411,345 | | $ | 4.83 | | | | | | | 1,411,345 | | $ | 4.83 | | | | | | | | | | | | | | | | | Granted | | — | | | | | | | | | — | | | | | | | | Exercised | | (1,799 | ) | 4.46 | | | | | | | (88,016 | ) | 4.73 | | | | | | Cancelled/expired | | (13,241 | ) | 5.42 | | | | | | | Outstanding at March 31, 2006 | | 1,396,305 | | 4.82 | | 1.78 | | $ | 3,322,000 | | | Exercisable at March 31, 2006 | | 1,308,995 | | 4.80 | | 1.80 | | $ | 3,138,000 | | | | Forfeited/expired | | | (23,973 | ) | 5.47 | | | | | | Outstanding and expected to vest at June 30, 2006 | | | 1,299,356 | | $ | 4.83 | | 1.50 | | $ | 3,880,000 | | Exercisable at June 30, 2006 | | | 1,252,575 | | $ | 4.78 | | 1.50 | | $ | 3,798,000 | |
The total intrinsic value realized by participants on stock options exercised was $244,000 and $501,000 during the three months ended March 31,June 30, 2006 and 2005, was $5,000respectively, and $261,000,$249,000 and $762,000 for the six months ended June 30, 2006 and 2005, respectively. The Company did not realize a tax benefit related to these stock option exercises due to the existence of net operating loss carryforwards in these periods. In addition, the Company received cash of $8,000 and $292,000 for the exercise price associated with stock options exercised of $409,000 and $552,000 during the three months ended March 31,June 30, 2006 and 2005, respectively, and $417,000 and $844,000 during the six months ended June 30, 2006 and 2005, respectively. The total fair value of stock options that vested during the three months ended March 31, 2006 and 2005 was $38,000 and $88,000, respectively. As of March 31,June 30, 2006, the Company had $115,000
$48,000 of unrecognized compensation related to the unvested portion of outstanding stock options expected to be recognized through July 2007 (a weighted average remaining vesting period of less than one year). Restricted Stock and Stock Unit Awards The Company granted 268,000 restricted stock and non-vested stock units to certain Company officers and employees during 2005 with a weighted-average grant date fair value of $7.40 per share. Of the total stock awards granted, 76,000 represented shares of restricted stock which were fully vested upon grant because they were attributed to 2004 service, but have a restriction on sale until December 31, 2007. The remainder of the awards granted during 2005 represented 192,000 non-vested stock units which vest to the recipients at various dates, up to five years, based on fulfilling service requirements. Upon vesting, the stock units are settled in shares of the Company’s Common Stock. As of both December 31, 2005 and March 31,June 30, 2006, the Company had 182,000 non-vested stock units outstanding with a weighted average grant date fair value of $7.54. No shares of restricted stock or stock units were granted or vested during the first quarter ofsix months ended June 30, 2006. As of March 31,June 30, 2006, the Company had unrecognized compensation cost of $1,058,000$974,000 related to the unvested portion of its outstanding stock units expected to be recognized over a weighted average remaining service period of approximately four3.6 years.
Pro-Forma Information The following table presents the pro-forma effect on net income and earnings per share for all outstanding stock-based compensation awards for the three and six months ended March 31,June 30, 2005 in which the fair value provisions of SFAS No. 123R were not in effect (dollars in thousands, except per share data): | | | Three months | | Six months | | | | | ended June 30, | | ended June 30, | | | | Three months ended March 31, 2005 | | | 2005 | | 2005 | | Net income — as reported | | $ | 468 | | | $ | 1,220 | | $ | 1,688 | | | | | | | | | Add: stock-based compensation expense determined under intrinsic value method and included in reported net income, net of tax | | — | | | 35 | | 35 | | | | | | | | | Deduct: stock-based compensation expense determined under the fair-value-based method for all awards, net of tax | | (74 | ) | | (96 | ) | (170 | ) | Pro forma net income | | $ | 394 | | | $ | 1,159 | | $ | 1,553 | | | | | | | | | Net income per share: | | | | | | | | | Basic—as reported | | $ | 0.03 | | | Basic—pro forma | | $ | 0.02 | | | Diluted—as reported | | $ | 0.02 | | | Diluted—pro forma | | $ | 0.02 | | | Basic — as reported | | | $ | 0.07 | | $ | 0.09 | | Basic — pro forma | | | $ | 0.06 | | $ | 0.09 | | Diluted — as reported | | | $ | 0.07 | | $ | 0.09 | | Diluted — pro forma | | | $ | 0.06 | | $ | 0.08 | |
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The per share weighted average fair value of the Company’s stock options granted during the first quarter ofsix months ended June 30, 2005 was $3.35 on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: | | Three and |
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| June 30, 2005 | | Expected dividend yield | | — | % | Risk-free interest rate | | 3.56 | % | Expected volatility | | 53.51 | % | Expected lifeterm | | 4.0 years | |
The Company estimates the fair value of its stock options on the date of grant using the Black-Scholes option pricing model. The Company estimates the expected lifeterm of stock options granted taking into consideration historical data related to stock option exercises. The Company also uses historical data in order to estimate the volatility factor for a period equal to the duration of the expected life of stock options granted. The Company believes that the use of historical data to estimate these factors provides a reasonable basis for these assumptions. The risk-free interest rate for the periods within the expected life
of the option is based on the U.S. Treasury yield curve in effect at the time of grant. No stock options were granted during the threesix months ended March 31,June 30, 2006. (4)Short-Term Borrowings General Physics has a $25 million Financing and Security Agreement (the ”Credit“Credit Agreement”), as amended, with a bank that expires on August 12, 2007 with annual renewal options. The Credit Agreement is secured by certain assets of General Physics and provides for an unsecured guaranty from the Company. TheThe Company continued to guarantee GSE’s borrowings under the Credit Agreement (for which $1,500,000 was allocated for use by GSE) subsequent to the spin-off on September 30, 2005. In March 2006, GSE repaid its borrowings in full and ceased to be a borrower under the Credit Agreement. As a result, the Company’s guarantee of GSE’s borrowings was terminated. The interest rate on the Credit Agreement is at the daily LIBOR market index rate plus 3.0%. Based upon the financial performance of General Physics, the interest rate can be reduced. As of March 31,June 30, 2006, the rate was reduced to LIBOR plus 2.50% for General Physics,2.5%, which resulted in a rate of approximately 7.3%7.8%. The Credit Agreement contains covenants with respect to General Physics’ minimum tangible net worth, leverage ratio, interest coverage ratio and its ability to make capital expenditures. General Physics was in compliance with all loan covenants under the Credit Agreement as of March 31,June 30, 2006. The Credit Agreement also contains certain restrictive covenants regarding future acquisitions, incurrence of debt and the payment of dividends. General Physics is currently restricted from paying dividends or management fees to the Company in excess of $1,000,000 in any year, with the exception of a waiver by the lender which permits General Physics to provide cash to the Company to repurchase up to $5 million of additional shares of its outstanding Common Stock (see Note 7).
As of March 31,June 30, 2006, General Physics had $1,732,000 ofno outstanding borrowings under the Credit Agreement and there was approximately $18,241,000$19,012,000 of available borrowings based upon 80% of eligible accounts receivable and 80% of eligible unbilled receivables. As of December 31, 2005, General Physics had no amounts outstanding under the Credit Agreement. 10
(5) Long-Term Debt Long-term debt consists of the following (in thousands): | | | June 30, | | December 31, | | | | March 31, 2006 | | December 31, 2005 | | | 2006 | | 2005 | | 6% conditional subordinated notes due 2008 (a) | | $ | 7,500 | | $ | 7,500 | | | $ | 7,500 | | $ | 7,500 | | ManTech Note (b) | | 5,251 | | 5,251 | | | 5,251 | | 5,251 | | Capital lease obligations | | 117 | | 93 | | | 91 | | 93 | | | | 12,868 | | 12,844 | | | 12,842 | | 12,844 | | Less warrant related discount, net of accretion | | (1,345 | ) | (1,464 | ) | | (1,226 | ) | (1,464 | ) | | | 11,523 | | 11,380 | | | 11,616 | | 11,380 | | Less current maturities | | (79 | ) | (71 | ) | | (58 | ) | (71 | ) | | | $ | 11,444 | | $ | 11,309 | | | $ | 11,558 | | $ | 11,309 | |
(a) In August 2003, the Company issued and sold to four Gabelli Funds $7,500,000 aggregate principal amount of 6% Conditional Subordinated Notes due 2008 (the Gabelli Notes) and 937,500 warrants (GP Warrants), each entitling the holder thereof to purchase (subject to adjustment) one share of the Company’s Common Stock at an exercise price of $8.00. The aggregate purchase price for the Gabelli Notes and GP Warrants was $7,500,000. The Gabelli Notes bear interest at 6% per annum payable semi-annually commencing on December 31, 2003 and mature in August 2008. The Gabelli Notes are secured by a mortgage on the Company’s former property located in Pawling, New York which was distributed to National Patent Development Corporation (NPDC) in connection with its spin-off by the Company on November 24, 2004. In addition, at any time that less than $1,875,000 of the principal amount of the Gabelli Notes is outstanding, the Company may defease the obligations secured by the mortgage and obtain a release of the mortgage by depositing with an agent for the Noteholders bonds or government securities with an investment grade rating by a nationally recognized rating agency which, without reinvestment, will provide cash on the maturity date of the Gabelli Notes in an amount not less than the outstanding principal amount of the Gabelli Notes. Subsequent to the spin-off of NPDC and GSE and in accordance with the anti-dilution provisions of the warrant agreement for stock splits, reorganizations, mergers and similar transactions, the number of GP Warrants was adjusted to 984,116 and the exercise price was adjusted to $5.85 per share. The GP warrants are exercisable at any time until August 2008. The exercise price may be paid in cash, by delivery of the Gabelli Notes, or a combination of the two. The fair value of the GP Warrants at
the date of issuance was $2,389,000, which reduced long-term debt in the accompanying consolidated balance sheets and is being accreted as additional interest expense using the effective interest rate over the term of the Gabelli Notes. The Gabelli Notes have a yield to maturity of 15.436% based on the discounted value. Accretion charged as interest expense was
approximately $119,000 and $102,000$103,000 for the three months ended March 31,June 30, 2006 and 2005, respectively, and approximately $238,000 and $205,000 for the six months ended June 30, 2006 and 2005, respectively. (b) In October 2003, the Company issued a five-year 5% note due in full in October 2008 in the principal amount of $5,250,955 to ManTech International. Interest is payable quarterly. Each year during the term of the note, the holder of the note has the option to convert up to 20% of the original principal amount of the note into Common Stock of the Company at the then market price of the Company’s Common Stock, but only in the event that the Company’s Common Stock is trading at $10 per share or more. In the event that less than 20% of the principal amount of the note is not converted in any year, such amount not converted will be eligible for conversion in each subsequent year until converted or until the note is repaid in cash. (6)Comprehensive Income The following are the components of comprehensive income (in thousands): | | | Three months ended | | Six months ended | | | | Three months ended March 31, | | | June 30, | | June 30, | | | | 2006 | | 2005 | | | 2006 | | 2005 | | 2006 | | 2005 | | Net income | | $ | 1,369 | | $ | 468 | | | $ | 1,745 | | $ | 1,220 | | $ | 3,114 | | $ | 1,688 | | Other comprehensive income (loss), net of income taxes | | | | | | | Net unrealized gain on available-for-sale securities | | 3 | | 116 | | | | | | | | | | | | | | Other comprehensive income (loss), net of income taxes: | | | | | | | | | | | Net unrealized (gain) loss on available-for-sale securities | | | (2 | ) | (120 | ) | 1 | | (4 | ) | Foreign currency translation adjustment | | (36 | ) | 149 | | | 168 | | (240 | ) | 132 | | (91 | ) | | | (33 | ) | 265 | | | 166 | | (360 | ) | 133 | | (95 | ) | Comprehensive income, net of tax | | $ | 1,336 | | $ | 733 | | | $ | 1,911 | | $ | 860 | | $ | 3,247 | | $ | 1,593 | |
As of March 31,June 30, 2006 and December 31, 2005, accumulated other comprehensive loss, net of tax, was $1,120,000$954,000 and $1,087,000, respectively, and consisted primarily of foreign currency translation adjustments. (7)Capital Stock Restructuring On January 19, 2006, the Company completed a restructuring of its capital stock, which included the repurchase of 2,121,500 shares of its Common Stock at a price of $6.80 per share, the repurchase of 600,000 shares of its Class B Stock at a price of $8.30 per share, and the exchange of 600,000 shares of its Class B Stock for 600,000 shares of Common Stock and payment of a cash premium of $1.50 per exchanged share. The repurchase prices and exchange premium were based on a fairness opinion rendered by an independent third party valuation firm. The repurchase and exchange transactions were negotiated
and approved by a Special Committee of the Board of Directors and had the effect of eliminating all
outstanding shares of the Company’s Class B Stock. The repurchase and exchange was financed with approximately $20.3 million of cash on hand. Prior to the restructuring, the 1,200,000 outstanding shares of Class B Stock collectively represented approximately 41% of the aggregate voting power of the Company since the Class B Stock hashad ten votes per share. The repurchase of a total of 2,721,500 shares representsrepresented approximately 15% of the total outstanding shares of capital stock of the Company. Of the 600,000 Class B shares exchanged for common shares, 568,750 shares were owned by the Chairman of the Executive Committee of the Company. In connection with the repurchase and exchange transactions, the Board of Directors of the Company authorized the repurchase of up to $5 million of additional common shares from time to time in the open market, subject to prevailing business and market conditions and other factors. General Physics’ lender has permitted General Physics to utilize funds borrowed under the Credit Agreement to provide cash to the Company to repurchase up to $5 million of additional shares of the Company’s outstanding Common Stock (see Note 4). During the threesix months ended March 31,June 30, 2006, the Company repurchased 10,000238,000 shares of its Common Stock in the open market for a total cost of approximately $71,000. During April 2006, the Company repurchased 214,300 shares of its Common Stock in the open market for a total cost of approximately $1,486,000.$1,662,000. (8)Business Segments In 2005, theThe Company re-evaluated its reportable business segments under SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information(SFAS No. 131), as a result of a change in the Chief Operating Decision Maker (CODM) of the Company.Based on the information which the CODM reviews in order to assess the performance of the Company and make decisions regarding the allocation of resources, the Company determined that it has two reportable business segments: 1) Process, Energy & Government; and 2) Manufacturing & Business Process Outsourcing (BPO). The Company is organized by operating group primarily based upon the services performed and markets served by each group. The reportable business segments represent an aggregation of the Company’s operating segments in accordance with the aggregation criteria in SFAS No. 131. GSE ceased to be a reportable business segment effective with the spin-off on September 30, 2005131, Disclosures about Segments of an Enterprise and its results are reported in discontinued operations in the condensed consolidated statements of operations through the effective date of the spin-off. As a result of the change in its reportable business segments, all prior period segment information has been restated to conform to the current year’s presentation.Related Information.
The Process, Energy & Government segment provides engineering consulting, design and evaluation services regarding facilities, the environment, processes and systems, and staff augmentation, curriculum design and development, and training and technical services primarily to federal and state governmental agencies, large government contractors, petroleum and chemical refining companies, and electric power utilities. The Manufacturing & BPO segment provides training, curriculum design and development, staff augmentation, e-Learning services, system hosting, integration and help desk support, training and business process
and training outsourcing, and consulting and technical services to large companies in the automotive, pharmaceutical, electronics, and other industries as well as to governmental clients.
ForGSE ceased to be a reportable business segment effective with the spin-off on September 30, 2005 and its results are reported in discontinued operations in the condensed consolidated statements of operations through the effective date of the spin-off. The Company recorded revenues for services provided to GSE pursuant to a management services agreement (see Note 10) of $151,000 and $162,000 for the three months ended March 31,June 30, 2006 and 2005, respectively, and $301,000 and $329,000 for the six months ended June 30, 2006 and 2005, respectively. The revenues and expenses related to these services, which were intercompany transactions prior to the spin-off of GSE have been eliminated in the condensed
consolidated statements of operations for the three and six months ended June 30, 2005. For the six months ended June 30, 2006 and 2005, sales to the United States government and its agencies represented approximately 33%32% and 39%, respectively, of the Company’s revenue. Revenue from the Department of the Army, which is included in the Process, Energy & Government segment, accounted for approximately 16%14% and 24%21% of the Company’s revenue for the threesix months ended March 31,June 30, 2006 and 2005, respectively. No other customer accounted for greater than 10% of the Company’s revenue for the threesix months ended March 31,June 30, 2006. The Company does not allocate the following corporate items to the segments: other income and interest expense; selling, general and administrative expense; and income tax expense. Inter-segment revenue is eliminated in consolidation and is not significant. The following tables settable sets forth the revenue and operating income of each of the Company’s operating segments and includes a reconciliation of segment revenue to consolidated revenue and operating income to consolidated income from continuing operations before income tax expense (in thousands): | | | Three months ended | | Six months ended | | | | | June 30, | | June 30, | | | | Three months ended March 31, | | | 2006 | | 2005 | | 2006 | | 2005 | | Revenue: | | 2006 | | 2005 | | | | | | | | | | | Process, Energy & Government | | $ | 19,673 | | $ | 21,523 | | | $ | 19,238 | | $ | 20,597 | | $ | 38,911 | | $ | 42,120 | | Manufacturing & BPO | | 23,855 | | 22,037 | | | 26,541 | | 23,062 | | 50,396 | | 45,099 | | | | $ | 43,528 | | $ | 43,560 | | | $ | 45,779 | | $ | 43,659 | | $ | 89,307 | | $ | 87,219 | | Operating income: | | | | | | | | | | | | | | | Process, Energy & Government | | $ | 1,488 | | $ | 2,376 | | | $ | 1,907 | | $ | 2,605 | | $ | 3,395 | | $ | 4,981 | | Manufacturing & BPO | | 1,632 | | 432 | | | 1,858 | | 730 | | 3,490 | | 1,162 | | Corporate and other general and administrative expenses | | (730 | ) | (802 | ) | | (440 | ) | (365 | ) | (1,170 | ) | (1,167 | ) | | | 2,390 | | 2,006 | | | 3,325 | | 2,970 | | 5,715 | | 4,976 | | Interest expense | | (414 | ) | (363 | ) | | (443 | ) | (379 | ) | (857 | ) | (742 | ) | Other income | | 404 | | 42 | | | 180 | | 12 | | 584 | | 54 | | Income from continuing operations before income tax expense | | $ | 2,380 | | $ | 1,685 | | | $ | 3,062 | | $ | 2,603 | | $ | 5,442 | | $ | 4,288 | |
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(9) AcquisitionAcquisition On February 3, 2006, the Company completed the acquisition of Peters Management Consultancy Ltd. (PMC), a performance improvement and training company in the United Kingdom. The Company acquired 100% ownership of PMC for a purchase price of $1,331,000 in cash, subject to a post-closing adjustment based on actual net equity, plus contingent payments of up to $923,000 based upon the achievement of certain performance targets during the first year following completion of the acquisition. In connection with the acquisition and in accordance with SFAS No. 141, Business Combinations, the Company recorded $1,084,000$868,000 of goodwill, and intangible assets, representing the excess of the purchase price over the net assets acquired and $133,000 of third party acquisition costs.costs, and $200,000 of customer-related intangible assets. PMC is included in the Company’s Manufacturing & BPO segment and its results are included in the condensed consolidated financial statements since the date of acquisition. The Company believes that the pro-forma impact of the PMC acquisition is not material to itsthe Company’s results of operations for the three and six months ended March 31,June 30, 2006 and 2005. The Company’s preliminary purchase price allocation for the net assets acquired is as follows: Cash | | $ | 845 | | | $ | 845 | | Accounts receivable and other current assets | | 784 | | | 840 | | Net property, plant and equipment | | 136 | | | Goodwill and intangible assets | | 1,084 | | | Property, plant and equipment, net | | | 88 | | Goodwill | | | 868 | | Intangible assets | | | 200 | | Total assets | | 2,849 | | | 2,841 | | | | | | | Accounts payable, accrued expenses and other liabilities | | 724 | | | 723 | | Billings in excess of costs and estimated earnings on uncompleted contracts | | 661 | | | 654 | | Total liabilities assumed | | 1,385 | | | 1,377 | | | | | | | Net assets acquired | | $ | 1,464 | | | $ | 1,464 | |
(10)Related Party Transactions Loans As of March 31,June 30, 2006 and December 31, 2005, the Company had a note receivable from the Company’s Chairman of the Executive Committee and former Chief Executive Officer of approximately $124,000 and $619,000, respectively. The proceeds of the original note were used primarily to exercise options to purchase Class B Stock. The note bears interest at the prime rate and is secured by certain assets owned by him. All unpaid principal on the loans and accrued interest areon the note is due on May 31, 2007. In addition, as of December 31, 2005, the Company had other employee advances, unsecured loans and accrued interest receivable from him, totaling $353,000. On January 19, 2006, he repaid approximately $853,000 of $972,000 of total indebtedness (including principal and interest) owed by him to the Company
using the proceeds he received from the Class B exchange transaction (see Note 7). As of March 31,June 30, 2006, the aggregate amount of indebtedness (including principal and accrued interest) outstanding under the loansnote was $135,000.$150,000.
Management Services Agreement Between NPDC and the Company Prior to the spin-off, NPDC was a wholly-owned subsidiary of the Company. In connection with the spin-off, NPDC entered into a separate management agreement with the Company pursuant to which the Company provides certain general corporate services to NPDC. Corporate Tax, Legal Support, and Executive Management Consulting Services
The Company has three employees, including the Chief Executive Officer and Chief Legal Officer, who also provide services to NPDC under athe management services agreement, for which the Company is reimbursed for such services. Services under the agreement relate to executive financial services, corporate legal services, corporate secretarial administrative support, and executive management consulting. The term of the agreement extends for three years from the date of the spin-off, or through November 24, 2007, and may be terminated by either NPDC or the Company on or after July 30, 2006 with 180 days prior written notice, with the exception of feesthe portion of the management fee relating to compensation for NPDC’s Chief Executive Officer for which NPDC is liable through May 31, 2007 pursuant to his employment agreement. NPDC pays the Company an annual fee of $913,500$934,000 as compensation for these services, payable in equal monthly installments. For the three and six months ended March 31,June 30, 2006, the Company charged NPDC approximately $228,000$230,000 and $458,000, respectively, for services under the management agreement, which is included as a reduction of selling, general and administrative expense. Corporate Office Leaseexpenses in the condensed consolidated statements of operations.
NPDC continues to occupy a portion of corporate office space leased by the Company. Pursuant to the management services agreement, NPDC compensates the Company for use of this space. The Company’s lease extends through December 31, 2006. Management Services Agreement Between GSE and the Company Pursuant to a management services agreement, the Company provides corporate support services to GSE. GSE pays the Company an annual fee of $685,000 for these services and can terminate the agreement by providing sixty days written notice. The management services agreement can be renewed by GSE upon mutual agreement for successive one-year terms and was renewed through December 31, 2006. Subsequent to the spin-off of GSE effective September 30, 2005, the Company continues to provide GSE with corporate support services through December 31, 2006. For the three months ended March 31, 2006 and 2005, the Company recorded revenues for services provided to GSE of $150,000 and $167,000, respectively. The revenues and expenses related to these services, which were intercompany transactions prior to the spin-off of GSE have been eliminated in the condensed consolidated statement of operations for the three months ended March 31, 2005.
(11) Guarantees Subsequent to the spin-off of NPDC, the Company continues to guarantee certain obligations of NPDC’s subsidiaries, Five Star Products, Inc. (“Five Star”) and MXL Industries, Inc. (“MXL”). The Company guarantees certain operating leases for Five Star’s New Jersey and Connecticut warehouses, totaling approximately $1,589,000 per year through the first quarter of 2007. The Company also guarantees the repayment of two debt obligations of MXL, which are secured by property and certain equipment of MXL. The aggregate outstanding balance of these debt obligations as of March 31,June 30, 2006 was $1,305,000.$1,218,000. The Company’s guarantees expire upon the maturity of the debt obligations which are October 1, 2006 and
March 31, 2011. (12)Litigation In November 2005, the Company settled its remaining fraud claims against Electronic Data Systems Corporation (EDS) and Systemhouse in connection with the Company’s 1998 acquisition of Learning Technologies. Pursuant to the settlement, EDS made a cash payment to the Company in the amount of $9,000,000 in December 2005. The Company recognized a gain on the litigation settlement, net of legal fees and expenses, of approximately $5,552,000 in the fourth quarter of 2005. In accordance with a spin-off agreement with NPDC, the Company made an additional capital contribution to NPDC for approximately $1,201,000 of the settlement proceeds, which was accounted for as a component of the net assets distributed to NPDC in connection with the spin-off, through a reduction of additional paid-in capital in 2005. The Company did not transfer cash to NPDC for this additional capital contribution, but instead is offsetting the management fee charges receivable from NPDC against the payable to NPDC (see Note 10). As of March 31,June 30, 2006, the Company has a remaining payable to NPDC of $986,000$693,000 for this additional capital contribution, which is included in accounts payable and accrued expenses on the condensed consolidated balance sheet. The Company’s original fraud action included MCI Communications Corporation (MCI) as a defendant. The fraud action against MCI had been stayed as a result of MCI’s bankruptcy filing and the Company’s claims against MCI were not tried or settled with the claims against EDS and Systemhouse. On December 13, 2005, the Bankruptcy Court heard argument on a summary judgment motion that MCI had made before filing for bankruptcy. The motion has not yet been decided. The Company is not a party to any legal proceeding, the outcome of which is believed by management to have a reasonable likelihood of having a material adverse effect upon the financial condition and operating results of the Company. (13) Accounting Standard Issued In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109 (FIN 48). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition of a tax position taken or expected to be taken on a tax return. Under FIN 48, a tax benefit from an uncertain tax position may be recognized only if it is “more likely than not” that the position is sustainable upon examination, based on its technical merits. The tax benefit of a qualifying position under FIN 48 would equal the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority having full knowledge of all relevant information. FIN 48 will be effective as of January 1, 2007 for calendar-year companies. In applying the new accounting model prescribed by FIN 48, companies will need to determine and assess all material positions existing as of the adoption date, including all significant uncertain positions, in all tax years, that are still subject to assessment or challenge under relevant tax statutes. The Company is currently evaluating the impact of adopting this new accounting standard on its consolidated financial statements. 17
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Results of Operations General Overview
The Company’s business consists of its core operating subsidiary, General Physics, a global training, engineering, and consulting company that seeks to improve the effectiveness of organizations by providing training and e-Learning solutions, management consulting, e-Learning solutions and engineering services and products that are customized to meet the specific needs of clients. Clients include Fortune 5001000 companies and manufacturing, process and energy companies and other commercial and governmental customers. General Physics is a global leader in performance improvement, with four decades of experience in providing solutions to optimize workforce performance. In 2005, the Company re-evaluated its reportable business segments under Statement of Financial Accounting Standards (SFAS) No. 131, Disclosures about Segments of an Enterprise and Related Information (SFAS No. 131), as a result of a change in the Company’s Chief Operating Decision Maker (CODM). Based on the information which the CODM reviews in order to assess the performance of theThe Company and make decisions regarding the allocation of resources, the Company determined that it has two reportable business segments: 1) Process, Energy & Government; and 2) Manufacturing & Business Process Outsourcing (BPO). As a result of the change in the Company’s reportable business segments, all prior period segment information presented herein has been restated to conform to the current year’s presentation.:
The following is a description of the Company’s two reportable business segments:
· Process, Energy & Government — this segment provides engineering consulting, design and evaluation services regarding facilities, the environment, processes and systems, and staff augmentation, curriculum design and development, and training and technical services primarily to federal and state governmental agencies, large government contractors, petroleum and chemical refining companies, and electric power utilities. · Manufacturing & BPO —- this segment provides training, curriculum design and development, staff augmentation, e-Learning services, system hosting, integration and help desk support, training and business process and training outsourcing, and consulting and technical services to large companies in the automotive, steel, pharmaceutical, electronics, and other industries as well as to governmental clients. Significant Events of 2006
Capital Stock Restructuring On January 19, 2006, the Company completed a restructuring of its capital stock, which included the repurchase of 2,121,500 shares of its Common Stock at a price of $6.80 per share, the repurchase of 600,000 shares of its Class B Stock at a price of $8.30 per share, and the exchange of 600,000 shares of its Class B Stock for 600,000 shares of Common Stock and payment of a cash premium of $1.50 per exchanged share. The repurchase prices and exchange premium were based on a fairness opinion rendered by an independent third party valuation firm. The repurchase and exchange transactions were negotiated and approved by a Special Committee of the Board of Directors and had the effect of eliminating all outstanding shares of the Company’s Class B Stock. Prior to the restructuring, the 1,200,000 outstanding sharess hares of Class B Stock collectively represented approximately 41% of the aggregate voting power of the Company since the Class B Stock had ten votes per share. The repurchase of a total of 2,721,500 shares representsrepresented approximately 15% of the total outstanding
shares of capital stock of the Company. Approximately $20.3 million was required for the repurchase and exchange and was financed with cash on hand. See Note 7 to the accompanying condensed consolidated financial statements for further details regarding the repurchase and exchange transaction. Acquisition On February 14,3, 2006, the Company completed the acquisition of Peters Management Consultancy Ltd. (PMC), a performance improvement and training company in the United Kingdom. The Company acquired 100%
ownership of PMC for a purchase price of $1.3 million in cash, subject to a post-closing adjustment based on actual net equity, plus contingent payments of up to $0.9 million based upon the achievement of certain performance targets during the first year following completion of the acquisition. PMC is included in the Company’s Manufacturing & BPO segment and its results are included in the accompanying condensed consolidated financial statements since the date of acquisition. Operating Highlights Three Monthsmonths ended March 31,June 30, 2006 compared to the three Monthsmonths ended March 31,June 30, 2005 For the three monthsquarter ended March 31,June 30, 2006, the Company had net income from continuing operations before income tax expense of $2.4$1.7 million, or $0.11 per diluted share, compared to $1.7$1.2 million, or $0.07 per diluted share, for the three monthsquarter ended March 31,June 30, 2005. The improved results were primarily due to increased operating income of $0.4 million, resulting from an increase in gross profit and aincome from continuing operations, the components of which are discussed in detail below. In addition, the $0.04 per share increase in diluted earnings per share is partially attributable to the decrease in selling, generalcommon shares outstanding during the second quarter of 2006 compared to the second quarter of 2005 as a result of the capital stock restructuring discussed above, and administrative expenses, and an increaserepurchases of 228,000 common shares in other incomethe open market during the second quarter of $0.4 million.2006. Revenue (Dollars in thousands) | | Three months ended March 31, | | | Three months ended | | (Dollars in thousands) | | 2006 | | 2005 | | | | | | June 30, | | | | | 2006 | | 2005 | | Process, Energy & Government | | $ | 19,673 | | $ | 21,523 | | | $ | 19,238 | | $ | 20,597 | | Manufacturing & BPO | | 23,855 | | 22,037 | | | 26,541 | | 23,062 | | | | $ | 43,528 | | $ | 43,560 | | | $ | 45,779 | | $ | 43,659 | |
Process, Energy & Government revenue decreased $1.9$1.4 million or 8.6%6.6% during the firstsecond quarter of 2006 compared to the same period insecond quarter of 2005. The decrease in revenue is primarily due to a $10.0 million decline in government funding for the Domestic Preparedness Equipment Technical Assistance Program (DPETAP) which resulted in a decrease in revenue of $3.2$2.2 million during the firstsecond quarter of 2006. This2006 compared to the second quarter of 2005. In addition, a scheduling delay on an environmental engineering contract resulted in a decrease in revenue wasof $1.3 million during the second quarter of 2006 compared to the second quarter of 2005. These decreases in revenue were offset by an increase in hurricane recovery services revenue of $1.3$1.6 million and an increase in revenue of $0.5 million related to a liquefied natural gas (LNG) fueling station project during the firstsecond quarter of 2006 compared to the same period in 2005.second quarter of 2005. Manufacturing & BPO revenue increased $1.8$3.5 million or 8.2%15.1% during the firstsecond quarter of 2006 compared to the same period insecond quarter of 2005. The increase in revenue is due to net increasesthe following: a $2.1 million increase due to the expansion of $1.2 million for e-Learning content developmentbusiness process outsourcing services with new and system hosting services, an $0.8existing customers, a $1.0 million increase from our international operations an $0.8in the United Kingdom primarily resulting from the PMC acquisition in February 2006, a $0.9 million increase related to ain lean manufacturing contract award, andservices, a $0.4$0.5 million increase related tofor other technical services provided primarily to a pharmaceutical customer.customer, and a $0.4 million increase for e-Learning, content development and system hosting services. This net increase in revenue was offset by other decreases in revenue, primarily due to a change in contract scopes with a business process
outsourcing customer during 2005 which resulted in a decrease in revenue of $1.3$1.4 million during the three months ended March 31,second quarter of 2006 compared to the same period in 2005.second quarter of 2005.
Gross Profit | | Three months ended March 31, | | | | 2006 | | 2005 | | (Dollars in thousands) | | | | % Revenue | | | | % Revenue | | Process, Energy & Government | | $ | 2,708 | | 13.8 | % | $ | 3,690 | | 17.1 | % | Manufacturing & BPO | | 3,054 | | 12.8 | % | 1,854 | | 8.4 | % | | | $ | 5,762 | | 13.2 | % | $ | 5,544 | | 12.7 | % |
(Dollars in thousands) | | Three months ended | | | | June 30, | | | | 2006 | | 2005 | | | | | | % Revenue | | | | % Revenue | | Process, Energy & Government | | $3,262 | | 17.0 | % | $3,978 | | 19.3 | % | Manufacturing & BPO | | 3,695 | | 13.9 | % | 2,390 | | 10.4 | % | | | $6,957 | | 15.2 | % | $6,368 | | 14.6 | % |
Process, Energy & Government gross profit of $2.7$3.3 million or 13.8%17.0% of revenue for firstthe second quarter of 2006 decreased by $1.0$0.7 million or 26.6%18.0% when compared to gross profit of approximately $3.7$4.0 million or 17.1%19.3% of revenue for the firstsecond quarter of 2005. This decrease in gross profit wasis primarily driven byattributable to a decline in government funding for the DPETAP contract and the environmental engineering project delay discussed above, and a decline in enrollment on certain other training contracts, offset by an increase in gross profit related to an increase in revenue from hurricane recovery services during the firstsecond quarter of 2006 compared to the second quarter of 2005. Manufacturing & BPO gross profit of $3.1$3.7 million or 12.8%13.9% of revenue for the firstsecond quarter of 2006 increased by $1.2$1.3 million or 64.7%54.6% when compared to gross profit of approximately $1.9$2.4 million or 8.4%10.4% of revenue for the firstsecond quarter of 2005. This increase in gross profit wasis primarily driven byattributable to an increase in revenue from business process outsourcing, e-Learning, lean manufacturing and other technical services, as well as international growth during the firstsecond quarter of 2006 compared to 2005. A decrease in lower margin subcontractor utilization and an increase in higher margin internal labor utilization on several business process outsourcing contracts also contributed to an increase in gross profit as a percentage of revenue during the firstsecond quarter of 2006 compared to 2005. Additionally, infrastructure costs have not increased at the same rate as our revenue growth for this segment, resulting in increased profitability.profitability. Selling, General and Administrative ExpenseExpenses SG&A decreasedincreased $0.2 million or 4.7%6.9% from $3.5$3.4 million for the firstsecond quarter of 2005 to $3.4$3.6 million for the same period insecond quarter of 2006. This net decreaseThe increase is primarily due to decreases in the provision for doubtful accounts and legal expenses, offset by an increase in severance expense and labor costsa non-cash compensation credit of $0.2 million during the firstsecond quarter of 2006 compared2005 related to 2005.the GP Strategies Millennium Cell Stock Option Plan which did not recur in 2006. Interest Expense Interest expense was $0.4 million for both the firstsecond quarter of 2006 and 2005. Other Income Other income increased $0.4$0.2 million during the firstsecond quarter of 2006 compared to the same period in 2005. The increase issecond quarter of 2005 primarily due to increases in interestinvestment income. Other income and investment income.for the second quarter of 2006 includes $0.1 million of equity in earnings of a joint venture, for which an immaterial amount was included in revenue during the second quarter of 2005. Income TaxesTax Expense Income tax expense increased $0.2$0.1 million from $0.8$1.2 million for the firstsecond quarter of 2005 to $1.0$1.3 million for the same period insecond quarter of 2006. This increase is due to increased income from continuing operations before income tax expense for the firstsecond quarter of 2006 compared to the second quarter of 2005. Income tax expense for the quarterly
interim periods is based on
an estimated annual effective tax rate which includes the federal and state statutory rates, permanent differences, and other items that may have an impact on income tax expense. Six months ended June 30, 2006 compared to the six months ended June 30, 2005 For the six months ended June 30, 2006, the Company had net income of $3.1 million, or $0.19 per diluted share, compared to $1.7 million, or $0.09 per diluted share, for the same period in 2005. The improved results were primarily due to an increase in income from continuing operations, the components of which are discussed in detail below. In addition, the $0.10 per share increase in diluted earnings per share is partially attributable to the decrease in common shares outstanding during the six months ended June 30, 2006 compared to the same period in 2005 as a result of the capital stock restructuring discussed above, and repurchases of 238,000 common shares in the open market during the six months ended June 30, 2006. Revenue (Dollars in thousands) | | Six months ended | | | | June 30, | | | | 2006 | | 2005 | | | | | | | | Process, Energy & Government | | $ | 38,911 | | $ | 42,120 | | Manufacturing & BPO | | 50,396 | | 45,099 | | | | $ | 89,307 | | $ | 87,219 | |
Process, Energy & Government revenue decreased $3.2 million or 7.6% during the six months ended June 30, 2006 compared to the same period in 2005. The decrease in revenue is primarily due to a $10.0 million decline in government funding for the DPETAP contract which resulted in a decrease in revenue of $5.4 million during the six months ended June 30, 2006 compared to the same period in 2005. In addition, a scheduling delay on an environmental engineering contract resulted in a decrease in revenue of $3.0 million during the six months ended June 30, 2006 compared to the same period in 2005. These decreases in revenue were offset by an increase in hurricane recovery services revenue of $2.9 million, an increase in chemical demilitarization training support services of $1.0 million, an increase in revenue of $0.8 million related to a liquefied natural gas (LNG) fueling station project, and net increases in various energy and other government contracts of $0.5 million during the six months ended June 30, 2006 compared to the same period in 2005. Manufacturing & BPO revenue increased $5.3 million or 11.7% during the six months ended June 30, 2006 compared to the same period in 2005. The increase in revenue is due to the following: a $2.7 million increase due to the expansion of business process outsourcing services with new and existing customers, a $1.6 million increase for e-Learning, content development and system hosting services, a $1.9 million increase from our international operations in the United Kingdom primarily resulting from the PMC acquisition in February 2006 as well as growth on existing international contracts, a $1.6 million increase in lean manufacturing services, and a $0.8 million increase for other technical services provided primarily to a pharmaceutical customer. These net increases in revenue were offset by other decreases in revenue, primarily due to a change in contract scopes with a business process outsourcing customer during 2005 which resulted in a decrease in revenue of $2.7 million, as well as net decreases of $0.6 million in revenue for other technical training services during the six months ended June 30, 2006 compared to the same period in 2005.
Gross Profit (Dollars in thousands) | | Six months ended | | | | June 30, | | | | 2006 | | 2005 | | | | | | % Revenue | | | | % Revenue | | Process, Energy & Government | | $ | 5,970 | | 15.3 | % | $ | 7,668 | | 18.2 | % | Manufacturing & BPO | | 6,749 | | 13.4 | % | 4,244 | | 9.4 | % | | | $ | 12,719 | | 14.2 | % | $ | 11,912 | | 13.7 | % |
Process, Energy & Government gross profit of $6.0 million or 15.3% of revenue for the six months ended June 30, 2006 decreased by $1.7 million or 22.1% when compared to gross profit of approximately $7.7 million or 18.2% of revenue for the six months ended June 30, 2005. This decrease in gross profit is primarily attributable to a decline in government funding for the DPETAP contract and the environmental engineering project delay discussed above, offset by an increase in gross profit related to an increase in revenue from hurricane recovery services during the six months ended June 30, 2006 compared to the same period in 2005. Manufacturing & BPO gross profit of $6.7 million or 13.4% of revenue for the six months ended June 30, 2006 increased by $2.5 million or 59.0% when compared to gross profit of approximately $4.2 million or 9.4% of revenue for the same period of 2005. This increase in gross profit is primarily attributable to an increase in revenue from business process outsourcing, e-Learning, lean manufacturing and other technical services, as well as international growth during the six months ended June 30, 2006 compared to the same period of 2005. A decrease in lower margin subcontractor utilization and an increase in higher margin internal labor utilization on certain contracts also contributed to an increase in gross profit as a percentage of revenue during the six months ended June 30, 2006 compared to the same period of 2005. Additionally, infrastructure costs have not increased at the same rate as our revenue growth for this segment, resulting in increased profitability. Selling, General and Administrative Expenses SG&A increased $0.1 million or 1.0% from $6.9 million for the six months ended June 30, 2005 to $7.0 million for the same period in 2006. This net increase is primarily due to an increase in compensation and severance expense, offset by decreases in the provision for doubtful accounts and legal expenses during the six months ended June 30, 2006 compared to the same period in 2005. Interest Expense Interest expense was $0.9 million for the six months ended June 30, 2006 compared to $0.7 million for the same period in 2005. The increase is primarily due to higher short-term borrowing levels during the six months ended June 30, 2006 compared to the same period in 2005. Other Income Other income was $0.6 million for the six months ended June 30, 2006 compared to $0.1 million for the same period in 2005. The increase is primarily due to increases in interest income and investment income during the six months ended June 30, 2006 compared to the same period in 2005. Other income for the six months ended June 30, 2006 includes $0.3 million of equity in earnings of a joint venture, for which an immaterial amount was included in revenue during the same period in 2005. 22
Income Tax Expense Income tax expense increased $0.3 million from $2.0 million for the six months ended June 30, 2005 to $2.3 million for the same period in 2006. This increase is due to increased income from continuing operations before income tax expense for the six months ended June 30, 2006 compared to the same period in 2005. Income tax expense for interim periods is based on an estimated annual effective tax rate which includes the federal and state statutory rates, permanent differences, and other items that may have an impact on income tax expense. Liquidity and Capital ResourcesWorking Capital For the six months ended June 30, 2006, the Company’s working capital decreased $15.8 million from $34.8 million at December 31, 2005 to $19.0 million at June 30, 2006. The decrease is primarily due to the use of approximately $20.3 million of cash in January 2006 to complete the capital stock restructuring discussed below. The Company hadbelieves that cash generated from operations and cash equivalents totaling $1.1 million asborrowing availability under the Credit Agreement (described below), will be sufficient to fund the working capital and other requirements of March 31, 2006, compared to $18.1 million as of December 31, 2005. the Company for the foreseeable future. On January 19, 2006, the Company completed a restructuring of its capital stock in which it used approximately $20.3 million of cash on hand to repurchase 2,121,500 shares of its Common Stock and 600,000 shares of its Class B Stock, and to exchange 600,000 shares of its Class B Stock for 600,000 shares of Common Stock. In connection with the capital stock restructuring, the Company authorized the repurchase of up to $5 million of additional common shares from time to time in the open market, subject to prevailing business and market conditions and other factors. See Note 7 to the accompanying condensed consolidated financial statements for further details regarding the repurchase and exchange transaction. During the first quarter ofsix months ended June 30, 2006, the Company repurchased 10,000238,000 shares of its Common Stock in the open market for a total cost of approximately $71,000. During April 2006, the Company repurchased 214,300 shares of its Common Stock in the open market for a total cost of approximately $1,486,000.$1.7 million. On February 14,3, 2006, the Company completed the acquisition of PMC, a performance improvement and training company in the United Kingdom. The purchase price was $1.3 million in cash, subject to a post-closing adjustment based on actual net equity, plus contingent payments of up to $0.9 million based upon the achievement of certain performance targets during the first year following completion of the acquisition. The Company believes that cash generated from operations and borrowing availability under the Credit Agreement (described below), will be sufficient to fund the working capital and other requirements of the Company for the foreseeable future.
For the quarter ended March 31, 2006, the Company’s working capital decreased $19.8 million from $34.8 million at December 31, 2005 to $15.0 million at March 31, 2006. The decrease is primarily due to the use of approximately $20.3 million of cash in January 2006 to complete the capital stock restructuring discussed above.
Cash Flows ThreeSix months ended March 31,June 30, 2006 compared to the threesix months ended March 31,June 30, 2005
The Company’s cash balance decreased $17.0$15.9 million from $18.1 million as of December 31, 2005 to $1.1$2.2 million at March 31,June 30, 2006. The decrease in cash and cash equivalents during the first quarter ofsix months ended June 30, 2006 resulted from cash provided by operating activities of $2.4$6.7 million, offset by cash used in investing activities of $0.8$1.0 million and cash used in financing activities of $18.7$21.6 million. Cash flows from discontinued operations are combined with cash flows from continuing operations within the operating, investing, and financing activities categories in the accompanying consolidated statements of cash flows through the effective date of the spin-off of GSE. Cash provided by operating activities was $2.4$6.7 million for the first quarter ofsix months ended June 30, 2006 compared to $8.2 million for the same period ofin 2005. The decrease in cash provided by operating activities compared to the prior year period is primarily due to the receipt of proceeds from the EDS arbitration award of $13.8 million in
January 2005, (including post-award interest). Changesoffset by an increase in other operating items increasednet income of $1.4 million and increases in net working capital changes of $9.8 million during the first quarter ofsix months ended June 30, 2006 compared to the same period in 2005. During the six months ended June 30, 2005, primarily due to aworking capital changes included an $8.5 million decrease in accrued expenses during the first quarter of 2005which was primarily related to
the payout of $5$5.0 million of the EDS arbitration proceeds to NPDC pursuant to the spin-off agreement (see Note 12 to the accompanying condensed consolidated financial statements). The decreaseExcluding this item, net changes in cash provided by operating activities was offset by an increase in net incomeworking capital increased $4.8 million during the first quarter ofsix months ended June 30, 2006 compared to the same period in 2005. Cash used in investing activities was $0.8$1.0 million for the first quarter ofsix months ended June 30, 2006 compared to $0.4 million for the same period ofin 2005. The increase in cash used in investing activities is primarily due to $1.4$0.6 million of net cash paid in connection with the acquisition of PMC net(net of $0.8 million cash acquired, offset by a decrease in capital expenditures for property, plant and equipment of $0.2 million during the first quarter of 2006 compared to 2005.acquired). Cash used in financing activities was $18.7$21.6 million for the first quarter ofsix months ended June 30, 2006 compared to $5.0$3.2 million for the same period ofin 2005. The increase in cash used in financing activities is primarily due to $20.8 million of cash used in connection with the capital stock restructuring (including transaction costs) and $1.7 million of cash used for repurchases of common stock in the open market (see Note 7 to the accompanying condensed consolidated financial statements), offset by. In addition, cash proceeds of $1.7 million from short-term borrowingsused in 2006 compared toinvesting activities during the six months ended June 30, 2005 included net repayments of short-term borrowings of $5.4 million, offset by proceeds from the issuance of a convertible note by GSE of $1.5 million, which did not recur in 2005.2006. Short-term Borrowings and Long-term Debt General Physics has a $25 million Credit Agreement with a bank that expires on August 13, 2007, as amended, with annual renewal options, and is secured by certain assets of General Physics. The interest rate on borrowings under the Credit Agreement is at the daily LIBOR Market Index Rate plus 3.00%3.0%. Based upon the financial performance of General Physics, the interest rate can be reduced. As of March 31,June 30, 2006, the rate was reduced to LIBOR plus 2.50% for General Physics,2.5%, which resulted in a rate of approximately 7.3%7.8%. The Credit Agreement also contains certain restrictive covenants. General Physics is currently restricted from paying dividends and management fees to the Company in excess of $1.0 million in any fiscal year, with the exception of a waiver by the lender which permits General Physics to provide cash to the Company to repurchase up to $5 million of additional shares of its outstanding Common Stock (see Note 7 to the accompanying condensed consolidated financial statements). As of March 31,June 30, 2006, the Company had $1,732,000 ofno outstanding borrowings under the Credit Agreement and there was approximately $18,241,000$19,012,000 of available borrowings based upon 80% of eligible accounts receivable and 80% of eligible unbilled receivables. As of December 31, 2005, the Company had no amounts outstanding under the Credit Agreement. In August 2003, the Company issued and sold to four Gabelli funds $7.5 million aggregate principal amount of 6% Conditional Subordinated Notes due 2008 (Gabelli Notes) and 937,500 warrants (GP Warrants), each entitling the holder thereof to purchase (subject to adjustment) one share of the Company’s Common Stock at an exercise price of $8.00. The aggregate purchase price for the Gabelli Notes and GP Warrants was $7.5 million. The Gabelli Notes are secured by a mortgage on the Company’s former property located in Pawling, New York which was distributed to National Patent Development Corporation. In addition, at any time that less than $1,875,000 million principal amount of the Gabelli Notes is outstanding, the Company may defease the obligations secured by the mortgage and obtain a release of the mortgage. Subsequent to the spin-offs of NPDC and GSE and in accordance with the anti-dilution provisions of the warrant agreement, the number of GP Warrants was adjusted to 984,116 and the exercise price was adjusted to $5.85 per share. As of March 31,June 30, 2006, there were 983,116 warrants with an exercise price of $5.85 outstanding and exercisable. In October 2003, the Company issued a five-year 5% note due in full in October 2008 in the principal amount of $5,250,955
$5,250,955 to ManTech International (ManTech). Interest is payable quarterly. Each year during the term of the note, ManTech has the option to convert up to 20% of the original principal amount of the note into Common Stock of the Company at the then market price of the Company’s Common Stock, but only in the event that the Company’s Common Stock is trading at $10 per share or more. In the event that less than 20% of the principal
amount of the note is not converted in any year, such amount not converted will be eligible for conversion in each subsequent year until converted or until the note is repaid in cash. Accounting Standard Issued In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109 (FIN 48). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition of a tax position taken or expected to be taken on a tax return. Under FIN 48, a tax benefit from an uncertain tax position may be recognized only if it is “more likely than not” that the position is sustainable upon examination, based on its technical merits. The tax benefit of a qualifying position under FIN 48 would equal the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority having full knowledge of all relevant information. FIN 48 will be effective as of January 1, 2007 for calendar-year companies. In applying the new accounting model prescribed by FIN 48, companies will need to determine and assess all material positions existing as of the adoption date, including all significant uncertain positions, in all tax years, that are still subject to assessment or challenge under relevant tax statutes. The Company is currently evaluating the impact of adopting this new accounting standard on its consolidated financial statements. Accounting Standard Adopted In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123R, Share-Based Payment, which revises SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and requires companies to recognize compensation expense for all equity-based compensation awards issued to employees that are expected to vest. The Company adopted SFAS No. 123R on January 1, 2006, using the Modified Prospective Application method without restatement of prior periods. Under this method, the Company began to amortize compensation cost for the remaining portion of its outstanding awards for which the requisite service was not yet rendered as of January 1, 2006. Compensation cost for these awards is based on the fair value of those awards as previously disclosed on a pro forma basis under SFAS No. 123. The Company will determine the fair value of and account for awards that are granted, modified, or settled after January 1, 2006 in accordance with SFAS No. 123R. During the three and six months ended March 31,June 30, 2006, the Company recognized $150,000$148,000 and $298,000, respectively, of pre-tax stock-based compensation expense under the fair value method in accordance with SFAS No. 123R. This was comprised of $75,000 for stock optionsDuring the three and $75,000 for non-vested stock units. Thesix months ended June 30, 2006, the Company recognized a deferred income tax benefit of $60,000$59,000 and $119,000, respectively, associated with the compensation expense recognized for these awards. As of March 31,June 30, 2006, the Company had $115,000$48,000 of unrecognized compensation related to the unvested portion of outstanding stock options awards expected to be recognized through July 2007 (a weighted-average remaining vesting period of less than one year). As of March 31,June 30, 2006, the Company had unrecognized compensation cost of $1,058,000$974,000 related to the unvested portion of its outstanding stock units expected to be recognized over a weighted average remaining service period of approximately four3.6 years. The Company did not grant any stock-based compensation awards during the first quarter ofsix months ended June 30, 2006.
Forward-Looking Statements This report contains 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. The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward looking statements. Forward—lookingForward-looking statements are not statements of historical facts, but rather reflect our current expectations concerning future events and results. We use words such as “expects”, “intends”, “believes”, “may”, “will” and “anticipates” to indicate forward-looking statements. Because these forward-looking statements involve risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements, including, but not limited to, those factors set forth under Item 1A - Risk Factors of the Company’s 2005 Annual Report on Form 10-K and those other risks and uncertainties detailed in the Company’s periodic reports and registration statements filed with the Securities and Exchange Commission. We caution that these risk factors may not be exhaustive. We operate in a continually changing business environment, and new risk factors emerge from time to time. We cannot predict these new risk factors, nor can we assess the effect, if any, of the new risk factors on our business or the extent to which any factor or combination of factors may cause actual results to differ from those expressed or implied by these forward-looking statements. If any one or more of these expectations and assumptions proves incorrect, actual results will likely differ materially from those contemplated by the forward-looking statements. Even if all of the foregoing assumptions and expectations prove correct, actual results may still differ materially from those expressed in the forward-looking statements as a result of factors we may not anticipate or that may be beyond our control. While we cannot assess the future impact that any of these differences could have on our business, financial condition, results of operations and cash flows or the market price of shares of our common stock, the differences could be significant. We do not undertake to update any forward-looking statements made by us, whether as a result of new information, future events or otherwise. You are cautioned not to unduly rely on such forward-looking statements when evaluating the information presented in this report.
Item 3. Quantitative and Qualitative Disclosure About Market Risk The Company has no material changes to the disclosure on this matter made in its Annual Report on Form 10-K for the fiscal year ended December 31, 2005. Item 4. Controls and Procedures We carried out an evaluation, under the supervision and with the participation of our management including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13-15(b) of the Securities Exchange Act of 1934, as amended. Based upon that evaluation and the material weakness described below, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were not effective as of the date covered by this report. As discussed more fully in Item 9A of our Annual Report on Form 10-K dated March 16, 2006, for the year ended December 31, 2005, in connection with our audit of our consolidated financial statements for the fiscal year ended December 31, 2005, we determined that the Company’s account reconciliation and management review controls over the accounting for income taxes were not operating effectively because of the lack of adequate tax accounting expertise as of December 31, 2005.2005. As a result, there was a material misstatement in the Company’s income tax provision that was corrected prior to the issuance of the consolidated financial statements for the year ended December 31, 2005. Based on the material weakness described above, management concluded that the Company’s internal control over financial reporting was not effective as of December 31, 2005. This assessment is based on management’s conclusion that as of December 31, 2005, there was more than a remote likelihood that a material misstatement of the Company’s annual or interim financial statements would not be prevented or detected on a timely basis by Company employees in the normal course of performing their assigned functions. As a result, we implemented changes in certain of our internal controls over financial reporting during the threesix months ended March 31,June 30, 2006, as follows: · The Company has, subsequent to December 31, 2005, continued to revise its processes and procedures over the accounting for income taxes. · The Company hired a new Director of Tax on December 31, 2005 whichwho we believe will provide the Company with the necessary technical skills to perform, review and analyze complex tax accounting activities. We believe these improvements in our internal controls will enable us to remediate the material weakness; however, such determination will not occur until these additional controls have been in place for a period of time sufficient to demonstrate that the controls are operating effectively. We will continue to evaluate the effectiveness of our disclosure controls and procedures and our internal controls over financial reporting on an ongoing basis, and will take further action as appropriate. However, there can be no assurance that our controls and procedures will prevent or detect material misstatement of the Company’s annual or interim financial statements. 2527
PART II. OTHER INFORMATION Item 1. Legal Proceedings
None.
Item 1A. Risk Factors
The Company has no material changes to the disclosure on this matter made in its Annual Report on Form 10-K for the fiscal year ended December 31, 2005.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table provides information about the Company’s share repurchase activity for the three months ended March 31, 2006:
Month | | | | Total number of shares purchased | | Average price paid per share | | Total number of shares purchased as part of publicly announced program | | Approximate dollar value of shares that may yet be purchased under the program | | January 1-31, 2006 | | — | | — | | — | | — | | February 1-28, 2006 | | — | | — | | — | | — | | March 1-31, 2006 | | 10,000 | (1) | $ | 7.08 | | 10,000 | | $ | 4,929,200 | | | | | | | | | | | | | | | |
Item 1. |
| Legal Proceedings |
|
|
| |
| None. | |
| | Item 1A. |
| Risk Factors |
|
|
| | | The Company has no material changes to the disclosure on this matter made in its Annual Report on Form 10-K for the fiscal year ended December 31, 2005. | | | | Item 2. |
| Unregistered Sales of Equity Securities and Use of Proceeds |
|
|
| | | The following table provides information about the Company’s share repurchase activity for the three months ended June 30, 2006: | | | |
| | Issuer Purchases of Equity Securities | | | | | | | | Total number | | Approximate | | | | | | | | of shares | | dollar value of | | | | Total number | | Average | | purchased as | | shares that may yet | | | | of shares | | price paid | | part of publicly | | be purchased under | | Month | | purchased | | per share | | announced program | | the program | | April 1-30, 2006 | | 214,300 | (1) | $ | 6.88 | | 214,300 | | $ | 3,454,000 | | May 1-31, 2006 | | — | | — | | — | | — | | June 1-30, 2006 | | 13,700 | (1) | $ | 7.56 | | 13,700 | | $ | 3,350,000 | |
(1) Represents shares repurchased in the open market in connection with the Company’s share repurchase program under which the Company may repurchase up to $5 million ifof its common stock from time to time in the open market subject to prevailing business and market conditions and other factors. This program was authorized by the Company’s Board of Directors and was publicly announced on January 19, 2006. There is no expiration date for the repurchase program. Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits
31.1Item 3.
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| Defaults Upon Senior Securities |
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|
|
| | Certification of Chief Executive Officer of the Company dated May 9, 2006 pursuant to Securities and Exchange Act Rule 13d-14(a)/15(d-14(a), as adopted pursuant to Section 302 and 404 of the Sarbanes-Oxley Act of 2002.*None.
| 31.2
| | Certification
| Item 4. |
| Submission of Executive Vice President and Chief Financial OfficerMatters to a Vote of the Company dated May 9, 2006 pursuant to Securities and Exchange Act Rule 13d-14(a)/15(d-14(a), as adopted pursuant to Section 302 and 404 of the Sarbanes-Oxley Act of 2002.*Security Holders |
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| |
| None. | |
|
| Item 5. |
| Other Information |
|
|
| |
| None. | |
|
| Item 6. |
| Exhibits |
31.1Certification of Chief Executive Officer of the Company dated August 9, 2006 pursuant to Securities and Exchange Act Rule 13d-14(a)/15(d-14(a), as adopted pursuant to Section 302 and 404 of the Sarbanes-Oxley Act of 2002.* 31.2Certification of Executive Vice President and Chief Financial Officer of the Company dated August 9, 2006 pursuant to Securities and Exchange Act Rule 13d-14(a)/15(d-14(a), as adopted pursuant to Section 302 and 404 of the Sarbanes-Oxley Act of 2002.*
32.1
| | Certification of Chief Executive Officer and Chief Financial Officer of the Company dated May 9, 2006 pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
|
32.1Certification of Chief Executive Officer and Chief Financial Officer of the Company dated August 9, 2006 pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
* Filed herewith 27
29
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. | | GP STRATEGIES CORPORATION | May
| | | | | | August 9, 2006 | | /s/ SCOTTScott N. GREENBERGGreenberg | | | | Chief Executive Officer |
| | | | | | | | /s/ SHARON ESPOSITO-MAYERSharon Esposito-Mayer | | | | Executive Vice President and Chief Financial Officer |
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