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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Conformed
Washington, D.C. 20549
FORM 10-K
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 0-26494
GSE Systems, Inc.
(Exact name of registrant as specified in its charter)
Delaware 52-1868008
(State of incorporation) (I.R.S. Employer Identification Number)
9189 Red Branch Road, Columbia, Maryland 21045
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (410) 772-3500
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Common Stock, $.01 par value
(Title of each class)
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy
or information statements incorporated by reference in Part III of
this Form 10-K or any amendment to this Form 10-K. [ ]
The aggregate market value of Common Stock held by non-affiliates as of March
15, 2000 was $40,170,164 based on closing price of such stock on that date.
Number of shares of Common Stock outstanding as of March 15, 2000: 5,183,247
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates certain information by reference from the
Registrant's definitive proxy statement to be filed for its 2000 Annual Meeting
of Shareholders.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1999
TABLE OF CONTENTS
PART I Page
Item 1. Business.............................................................. 3
Item 2. Properties............................................................12
Item 3. Legal Proceedings.................................................... 13
Item 4. Submission of Matters to a Vote of Security Holders.................. 13
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters................................................. 14
Item 6. Selected Financial Data.............................................. 15
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................... 16
Item 7A Quantitative and Qualitative Disclosures About Market Risk........... 22
Item 8. Financial Statements and Supplementary Data.......................... 23
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure.............................. 24
PART III
Item 10. Directors and Executive Officers of the Company*.................... 25
Item 11. Executive Compensation*............................................. 25
Item 12. Security Ownership of Certain Beneficial Owners
and Management*..................................................... 25
Item 13. Certain Relationships and Related Transactions*..................... 25
PART IV
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K................................................. 26
SIGNATURES................................................................... 26
Exhibits Index............................................................... 28
* to be incorporated by reference from the Proxy Statement for the
registrant's 2000 Annual Meeting of Shareholders.
Cautionary Statement Regarding Forward-Looking Statements. This Form 10-K
contains certain forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended, which are subject to the safe harbors created
by those Acts. These statements include the plans and objectives of management
for future operations, including plans and objectives relating to the
development of the Company's business in the domestic and international
marketplace. All forward-looking statements involve risks and uncertainties,
including, without limitation, risks relating to the Company's ability to
enhance existing software products and to introduce new products in a timely and
cost-effective manner, reduced development of nuclear power plants that may
utilize the Company's products, a long pay-back cycle from the investment in
software development, uncertainties regarding the ability of the Company to grow
its revenues and successfully integrate operations through expansion of its
existing business and strategic acquisitions, the ability of the Company to
respond adequately to rapid technological changes in the markets for process
control and simulation software and systems, significant quarter-to-quarter
volatility in revenues and earnings as a result of customer purchasing cycles
and other factors, dependence upon key personnel, and general market conditions
and competition. See "Risk Factors", in Part I. The forward-looking statements
included herein are based on current expectations that involve numerous risks
and uncertainties as set forth herein, the failure of any one of which could
materially adversely affect the operations of the Company. The Company's plans
and objectives are also based on the assumptions that market conditions and
competitive conditions within the Company's business areas will not change
materially or adversely and that there will be no material adverse change in the
Company's operations or business. Assumptions relating to the foregoing involve
judgments with respect, among other things, to future economic, competitive and
market conditions and future business decisions, all of which are difficult or
impossible to predict accurately and many of which are beyond the control of the
Company. Although the Company believes that the assumptions underlying the
forward-looking statements are reasonable, any of the assumptions could be
inaccurate and there can, therefore, be no assurance that the forward-looking
statements included in this Form 10-K will prove to be accurate. In light of the
significant uncertainties inherent in the forward-looking statements included
herein, the inclusion of such information should not be regarded as a
representation by the Company or any other person that the objectives and plans
of the Company will be achieved.
PART I
ITEM 1. BUSINESS.
GSE Systems, Inc. ("GSE Systems", "GSE" or the "Company") develops and
delivers business and technology solutions by applying process control,
simulation software, systems and services to the energy, process and
manufacturing industries worldwide. The Company's solutions and services assist
customers in reducing the time-to-market for new product development; improving
chemistry for producing products; improving quality, safety and throughput;
reducing operating expenses; and enhancing overall productivity. The Company's
products are used in over 500 applications, representing over 200 customers in
30 countries, in the following industries: specialty chemical, food & beverage,
pharmaceutical, and fossil and nuclear power generation.
Recent Developments.
Following the scale back of the Company to its core business units in 1998,
Power Systems and Process Solutions, GSE developed a business strategy in 1999
that leverages the strengths of these core businesses, simulation and
automation. In May, 1999 the Company introduced its new business and marketing
strategy VirtualPlant. VirtualPlant combines the benefits of real-time
simulation with control systems to create a "living", learning real-time
representation of an operating plant. VirtualPlant also allows a customer to
create an environment for simulation-enhanced experimentation, thereby reducing
the amount of physical experimentation necessary to achieve an optimal design
result for a new process product. Based on sophisticated simulation technologies
and expert knowledge of processing realities, VirtualPlant is a fully
integrated, comprehensive strategy including software, consulting services and
training that energy and process manufacturing companies can use to dramatically
reduce new product time-to-market, minimize development costs, achieve greater
optimization and improve overall profitability. Several significant events have
occurred in the last year that reflect the development of the Company's
strategy:
o In April, 1999 the Company purchased certain assets and employed the
associates of BatchCAD Limited, a United Kingdom-based supplier of batch
process development and design consulting services and simulation software
tools. The BatchCAD software tools provide simulation-based solutions that
enable chemical, food, and pharmaceutical companies to achieve optimal
configurations of chemistry, equipment, control system and other
charcteristics necessary to technically describe enough parameters to
successfully design and transfer to manufacturing a chemical product. In
doing so, the product helps achieve a faster time-to-market and enables
more product ideas to reach the full manufacturing stage.
o In April, 1999 the Company purchased certain assets and contracts of
Mitech, a Massachusetts-based supplier of neural network and artificial
intelligence software.
o In February, 2000 the Company participated in the founding of Avantium
Technologies, a high technology company that employs high speed
experimentation and simulation ("HSE&S") technologies in contract research
and development in the area of new product development and process
chemistry. GSE is an equity shareholder along with Shell International
Chemical, SmithKline Beecham, W.R. Grace, three Dutch universities
(Technical University of Delft, Technical University of Eindhoven, and
Twente University) and three venture capital firms (Alpinvest, The Generics
Group, and S.R.One, the SmithKline Beecham venture funding company).
Avantium Technologies will deploy HSE&S techniques to rapidly discover and
optimize new processes and products of interest to the petrochemicals, fine
chemicals and pharmaceutical industries. GSE will provide the basis for the
informatics system that will automate and maximize Avantium's lab
environment, and the Company will utilize its core simulation technologies
to assist in the optimization of experimentation as well as analysis of the
resulting data. The Company's undiluted holdings in Avantium Technologies
will be approximately 10%; after taking into consideration the expected
dilutive effect of stock option plans, the Company's diluted ownership
percentage is anticipated to be approximately 5%.
o The Company will have exclusive distribution and marketing rights to the
technology developed with Avantium Technologies (including but not limited
to the informatics solution set, the laboratory equipment/solution and
associated equipment/sensor technology, the management services associated
with the laboratory technology, the technology contributed by any of the
current or future partners in Avantium) and will provide engineering and
development services on a contract basis to Avantium for the completion of
this technology.
o The Company initiated a market development program designed to bring the
benefits of VirtualPlant, plus the products and services associated with
its affiliation with Avantium Technologies, to major customers around the
world. Additionally, the Company will directly, but non-exclusively, market
the R&D capabilities of Avantium Technologies.
Background.
GSE Systems was formed on April 13, 1994, by ManTech International
Corporation ("ManTech"), GP Strategies Corporation ("GP Strategies") and its
affiliates, General Physics Corporation and SGLG, Inc.; and Vattenfall AB to
consolidate the simulation and related businesses of their affiliates, GSE Power
Systems, Inc. ("Power Systems" and formerly known as "Simulation, Systems &
Services Technologies Company" or "S3 Technologies"), GP International
Engineering & Simulation, Inc. ("GPI") and GSE Power Systems AB ("Power Systems
AB" and formerly known as "EuroSim AB"). On December 30, 1994, GSE Systems
expanded into the process control automation and supply chain management
consulting industry through its acquisition of the process systems division of
Texas Instruments Incorporated, which the Company operates as GSE Process
Solutions, Inc. ("Process Solutions").
In April 1996, the Company aligned its operating groups into three
strategic business units ("BUs") to better serve its then primary vertical
markets - Power, Process and Oil & Gas. The realignment allowed the
Company to focus on providing all of its technologies to these markets,
while addressing the specific needs of each market and delivering industry
specific solutions. In May 1996, the Company acquired Erudite Software &
Consulting, Inc. "Erudite"), a regional provider of client/server
technology, custom application software development, training services,
hardware/software sales, and network design and implementation services.
The acquisition was made to facilitate the Company's efforts to enter the
client/server information technology solutions market. Erudite was
subsequently combined with a small pre-existing consulting group within the
Company to form the Company's Business Systems BU.
In December 1997, the Company acquired 100% of the outstanding common
stock of J.L.Ryan,Inc.,("Ryan"), a provider of engineering modifications
and upgrade services to the power plant simulation market. The combination
of the Compan's pre-existing technology with the technical staff of the
acquired Ryan business positioned the Company to be more competitive for
modifications and upgrade services projects within the nuclear
simulation market.
After incurring substantial losses in 1997, management decided to divest
the Company's unprofitable BU's and concentrate its resources on its core
businesses, Power Systems and Process Solutions. Accordingly, in April 1998, the
Company sold substantially all of the assets of Erudite to Keane, Inc. and in
November 1998, the Company divested certain assets of the Oil & Gas BU to Valmet
Automation (USA), Inc. See Note 3, Acquisitions and dispositions, in the"Notes
to Consolidated Financial Statements," for a discussion of these
transactions.
As discussed in the "Recent Developments" Section above, in April
1999 the Company acquired certain assets and employed the associates of BatchCAD
Limited. With this acquisition, the Company gained a presence in the United
Kingdom, with an office in Hexham, England, that will provide the baseline for
future expansion in the region. The BatchCAD product is a key element in the
Company's VirtualPlant strategy.
Business Strategy.
GSE Systems combines real-time control automation, real-time simulation and
application engineering for true problem solving techniques and solutions.
The Company believes this provides a technological advantage which, when
combined with its focused efforts on targeted industry markets and defined
application solution approach, allows its staff to assess, define, develop,
and apply innovative solutions that meet the current and future
industry-specific needs of its customers.
Users in the markets served by the Company want to focus their resources on
their own customers and wish to spend less resources on managing areas such
as control and simulation systems, the core strengths of GSE. Its products
and services are designed to help its customers solve problems and create
opportunity within these areas.
Within the targeted industry segments, the Company seeks customers who
will make investments based primarily on one of the following six
basic goals:
o Reduction in time-to-market for new product development
o Improvement in chemistry for producing products
o Increase in yield or efficiency
o Improvement in quality
o Solution to an environmental concern
o Solution to a safety concern
All of these directly or indirectly impact the profitability of a
particular customer. GSE Systems utilizes its expertise within real-time control
automation, real-time simulation and application engineering to provide
solutions to its customers in those areas.
The Company believes that GSE Systems can partner with customers to help
provide them with cost-effective solutions for problems associated with
simulation and control, which would allow its customers to focus their resources
on their own strengths.
The Company has enhanced its ability to develop strategic
opportunities with the formation of a Business Development group. This
group will focus on identifying industry trends and creating new
opportunities for the Company to leverage its core capabilities of
resources and products.
As a result of this strategy, the Company has recently developed
an informatics strategy that provides an integrated system for the
management and implementation of advanced lab environments to assist
companies in the development of new products and to improve the
chemistry necessary to produce products under the most optimum
conditions.
Services and Products.
GSE Systems has developed its knowledge and expertise in process control
and simulation systems that are utilized to improve, control and model
processes. This expertise is concentrated heavily in the process industries,
including the chemicals, food & beverage, and pharmaceuticals fields, as well as
in the power generation industry, where the Company is a world leader in nuclear
power plant simulation.
As the Microsoft Windows NT operating environment continues to evolve, the
Company has continued the migration of its products to this platform in such a
way as to assure current customers' legacy applications will function properly
while at the same time offering the advantages of the new technology. Although
the Company uses open standards for its products, the Company's standard system
configurations are based on the proprietary technology and know-how, which are
necessary to meet the requirements of its customers in the controls and
simulation markets.
The Company's business model is based on software licensing and value-added
services, as well as hardware sales. Because this model is based primarily on
software and value-added services, the Company believes it can maintain its
business model in an environment of rapidly decreasing hardware costs.
In the Process Business Unit, the flagship product is a Distributed Control
System ("DCS") product, known as the D/3 DCS that is highly flexible and open.
This product is a real-time system, which uses multiple process control modules
to monitor, measure, and automatically control variables in both continuous and
complex batch processes, as well as form the platform for plant-wide information
for use by operators, engineers and management.
Other products include the following:
o VPbatch (formerly FlexBatch) , a flexible batch manufacturing system
used to facilitate the rapid creation of various batch production
processes;
o TotalVision, which is a graphical system that provides a
client/server-based human-machine interface for real-time process and plant
information;
o VPtv, a web enabled version of the TotalVision package; and
o SABL, which is a sophisticated batch and sequential manufacturing
software language that permits the scheduling and tracking of raw materials
and finished products, data collection and emergency shutdown procedures.
The Company's proprietary technology also includes real-time dynamic
simulation tools and products that are used to develop high fidelity simulations
for use in petroleum refineries, chemical processing plants and other industrial
plants. The most prominent set of products and tools is known as SimSuite Pro,
which facilitates design verification, process optimization and operator
training.
The Power Business Unit focuses on developing high fidelity, real-time,
dynamic simulators for nuclear and fossil power plants for use in both operator
training and plant optimization. GSE's SimSuite Power set of auto-code
generators provides state of the art simulation of flow processes, logic and
control systems and electrical distribution systems within a power plant. This
technology is both licensed by the Company to its customers as well as used by
the Company to develop simulators for its customers.
In addition, other products include:
o SimExec, a Windows NT based real-time simulation executive system that
controls all simulation activities and allows for off-line software
development environment in parallel with the training environment.
o RACS, a fully integrated Access Control and Intrusion Detection System
ideally suited for nuclear power plant security applications, and other
large, multi-access facilities.
o Simon, a computer workstation system used for monitoring stability of
boiling water reactor plants. SIMON assists the operator in determining
potential instability events, enabling corrective action to be taken to
prevent unnecessary plant shutdowns.
The Company also provides value-added services to help users plan, design,
implement, and manage/support simulation and control systems. Services
include application engineering, project management, training,
site services, maintenance contracts and repair.
Customers.
The Company has provided over 500 simulation and process control systems to
an installed base of over 200 customers worldwide. In 1999, approximately 38% of
the Company's worldwide revenue was generated from end users outside the United
States.
The Companys customers include, among others, Archer Daniels Midland
Company, Bethlehem Steel Corporation, BASF Corporation, Cargill Incorporated,
Carolina Power and Light Company, Commonwealth Edison Company, Eastman Company,
Eskom South Africa, Karnaraft Sakerhet & Utbildning AB, Merck & Co., Inc.,
Miller Brewing Company, Nationalina Elecktrischecka Kompania, Orgrez SC, Pacific
Northwest National Laboratory, and Westinghouse Savannah River Company.
For the year ended December 31, 1999, one customer accounted for
approximately 13% of the Company's revenues.
Strategic Alliances.
In recent years, a high portion of the Company's international business has
come from major contracts in Europe, the republics of the former Soviet Union,
and the Pacific Rim. In order to acquire and perform these contracts, the
Company entered into strategic alliances or partnerships with various entities
including Automation Systems Co. Inc., a subsidiary of ManTech China Systems
Corporation; Siemens AG (Europe); All Russian Research Institute for Nuclear
Power Plant Operation (Russia); Kurchatov Institute (Russia); Samsung
Electronics (Korea); Toyo Engineering Corporation (Japan); and Institute for
Information Industry (Taiwan). These alliances have enabled the Company to
penetrate these regions by combining its technological expertise with the
regional or local presence and knowledge of its partners.
Also, the Company continues to believe that it must have strong solutions
partners as well as strong technology partners in order to address the myriad of
systems needs of its customers in the various geographical areas in which they
do business.
Sales and Marketing.
The Company markets its products and services through a network of direct
sales staff, agents and representatives, systems integrators and strategic
alliance partners. The Company also employs personnel that support corporate
advertising, literature development and exhibit/conference participation.
GSE Systems employs a direct sales force in the continental United States
that is regionally based, market focused and trained on its product and service
offerings. Market-oriented business and customer development teams define and
implement specific campaigns to pursue opportunities in the power, process and
manufacturing marketplaces. This effort is supported by an extensive,
regionally-based support organization focused on the current customer installed
base. The Company's ability to support its multi-facility, international and/or
multinational clients, is facilitated by its network of offices throughout the
U.S. and overseas. Within the U.S., the Company maintains offices in: Alabama,
Georgia, Louisiana, Maryland, North and South Carolina, Pennsylvania and Texas.
Outside the U.S., the Company has offices in Sweden, Belgium, Japan, Taiwan and
the United Kingdom. In addition to its offices located overseas, the Company's
ability to conduct international business is enhanced by its multilingual and
multicultural work force.
The Company has recently enhanced the sales and marketing function by
establishing a VirtualPlant customer and marketing development team. This group
focuses on the executive level relationship between GSE and potential customer
partners. This group will also be responsible for handling the new customer
growth as a result of the Avantium venture.
Strategic alliance partners, systems integrators and agents represent the
Company's interests in Russia, Germany, Switzerland, Spain, Czech Republic,
Slovakia, United Arab Emirates, India, South Africa, Venezuela, Mexico,
Argentina, and the People's Republic of China.
Product Development.
The Company continued to invest in the conversion of its D/3 DCS (Version
10.0 was released in October, 1999), VPbatch, and SimSuite Pro products to the
Microsoft Windows NT platform. For the years ended December 31, 1999, 1998 and
1997, gross research and product development expenditures for the Company were
$5.4 million, $4.3 million, and $5.1 million, respectively. Capitalized software
development costs totaled $2.5 million, $2.3 million and $3.5 million for the
years ended December 31, 1999, 1998 and 1997. See Note 2, Summary of significant
accounting policies, in the "Notes to Consolidated Financial Statements", for a
discussion of the Company's policy regarding capitalization of software
development costs.
Industries Served.
The following chart illustrates the approximate percentage of the Company's
1999, 1998 and 1997 revenues, respectively, attributable to each of the major
industries served by the Company:
1999 1998 1997
------ ------ ------
Power 48 % 42 % 31 %
Process 52 % 49 % 46 %
Other 0 % 9 % 23 %
------ ------ ------
Total 100 % 100 % 100 %
====== ====== ======
Contract Backlog.
The Company does not reflect an order in backlog until it has received a
contract that specifies the terms and milestone delivery dates. As of December
31, 1999, the Company's aggregate contract backlog totaled approximately $40
million.
Employees.
As of December 31, 1999, the Company had 406 employees, a 9% increase from
December 1998.
Segment Information.
See Note 17, Segment information, in the "Notes to Consolidated Financial
Statements", for discussion of the Company's segments.
RISK FACTORS.
Fluctuations in Quarterly Operating Results.
The Company's operating results have fluctuated in the past and may
fluctuate significantly in the future as a result of a variety of factors,
including purchasing patterns, timing of new products and enhancements by the
Company and its competitors, and fluctuating foreign economic conditions. Since
the Company's expense levels are based in part on its expectations as to future
revenues, the Company may be unable to adjust spending in a timely manner to
compensate for any revenue shortfall and such revenue shortfalls would likely
have a disproportionate adverse effect on net income. The Company believes that
these factors may cause the market price for its common stock to fluctuate,
perhaps significantly. In addition, in recent years the stock market in general,
and the shares of technology companies in particular, have experienced extreme
price fluctuations. The Company's common stock has also experienced a relatively
low trading volume, making it further susceptible to extreme price fluctuations.
International Sales and Operations.
Sales of products and the provision of services to end users outside the
United States accounted for approximately 38% of the Companys consolidated
revenues in 1999. The Company anticipates that international sales and services
will continue to account for a significant portion of its revenues in the
foreseeable future. As a result, the Company may be subject to certain risks,
including risks associated with the application and imposition of protective
legislation and regulations relating to import or export (including export of
high technology products) or otherwise resulting from trade or foreign policy
and risks associated with exchange rate fluctuations. Additional risks include
potentially adverse tax consequences, tariffs, quotas and other barriers,
potential difficulties involving the Company's strategic alliances and managing
foreign sales agents or representatives and potential difficulties in accounts
receivable collection. The Company currently sells products and provides
services to customers in emerging market economies such as Russia, Ukraine,
Bulgaria, and the Czech Republic, as well as to customers in countries whose
economies have suffered in the recent Asian financial crisis. The Company has
taken steps designed to reduce the additional risks associated with doing
business in these countries, but the Company believes that such risks may still
exist and include, among others, general political and economic instability,
lack of currency convertibility, as well as uncertainty with respect to the
efficacy of applicable legal systems. There can be no assurance that these and
other factors will not have a material adverse effect on the Company's business,
financial condition or results of operations. Furthermore, the Company's ability
to expand its business into certain emerging international markets is dependent,
in part, on the ability of its customers to obtain financing.
Revenues in the Nuclear Power Industry.
The Company will continue to derive a significant portion of its revenues
from customers in the nuclear power industry, particularly the international
nuclear power industry, for the foreseeable future. The Company's ability to
supply nuclear power plant simulators and related products and services is
dependent on the continued operation of nuclear power plants and, to a lesser
extent, on the construction of new nuclear power plants. A wide range of factors
affect the continued operation and construction of nuclear power plants,
including the political and regulatory environment, the availability and cost of
alternative means of power generation, the occurrence of future nuclear
incidents, general economic conditions and the ability of customers to obtain
adequate financing.
Revenues in the Chemicals Industry.
The Company derives a portion of its revenues from companies in the
chemicals industry. Accordingly, the Company's future performance is dependent
to a certain extent upon the demand for the Company's products by customers in
the chemical industry. The Company's revenues may be subject to period-to-period
fluctuations as a consequence of industry cycles, as well as general domestic
and foreign economic conditions and other factors affecting spending by
companies in the Company's target process industries. There can be no assurance
that such factors will not have a material adverse effect on the Company's
business, operating results and financial condition.
Product Development and Technological Change.
The Company believes that its success will depend in large part on its
ability to maintain and enhance its current product line, develop new products,
maintain technological competitiveness and meet an expanding range of customer
needs. The Company's product development activities are aimed at the development
and expansion of its library of software modeling tools, the improvement of its
display systems and workstation technologies, and the advancement and upgrading
of its simulation and process control technologies. The life cycles for software
modeling tools, display system software, process control and simulation
technologies are variable and largely determined by competitive pressures.
Consequently, the Company will need to continue to make significant investments
in research and development to enhance and expand its capabilities in these
areas and to maintain its competitive advantage.
The Company's products are offered in markets affected by technological
change and emerging standards that are influenced by customer preferences. The
Company has expended significant resources in developing versions of its core
products that operate in the increasingly popular Windows NT environment;
however, there can be no assurance of customer acceptance of these Windows
NT-based products or that these products will be competitive with products
offered by the Company's competitors. Although the Company believes that no
significant trends to migrate to other operating platforms currently affect the
markets for the Company's products, there can be no assurance that customers
will not require compatibility with such other operating platforms in the
future.
Intellectual Property Rights.
Although the Company believes that factors such as the technological and
creative skills of its personnel, new product developments, frequent product
enhancements and reliable product maintenance are important to establishing and
maintaining a technological leadership position, the Company's business depends,
in part, on its intellectual property rights in its proprietary technology and
information. The Company relies upon a combination of trade secret, copyright,
patent and trademark law, contractual arrangements and technical means to
protect its intellectual property rights. The Company generally enters into
confidentiality agreements with its employees, consultants, joint venture and
alliance partners, customers and other third parties that are granted access to
its proprietary information, and generally limits access to and distribution of
its proprietary information. There can be no assurance, however, that the
Company has protected or will be able to protect its proprietary technology and
information adequately, that the unauthorized disclosure or use of the Company's
proprietary information will be prevented, that others have not or will not
develop similar technology or information independently, or, to the extent the
Company owns patents, that others have not or will not be able to design around
those patents. Furthermore, the laws of certain countries in which the Company's
products are sold do not protect the Company's products and intellectual
property rights to the same extent as the laws of the United States.
Competition.
The Company's businesses operate in highly competitive environments with
both domestic and foreign competitors, many of whom have substantially greater
financial, marketing and other resources than the Company. The principal factors
affecting competition include price, technological proficiency, ease of system
configuration, product reliability, applications expertise, engineering support,
local presence and financial stability. The Company believes that competition in
the simulation and process automation fields may further intensify in the future
as a result of advances in technology, consolidations and/or strategic alliances
among competitors, increased costs required to develop new technology and the
increasing importance of software content in systems and products. The Company
believes that its technology leadership, experience, ability to provide a wide
variety of solutions, product support and related services, open architecture
and international alliances will allow it to compete effectively in these
markets. As the Company's business has a significant international component,
changes in the value of the dollar could adversely affect the Company's ability
to compete internationally.
Additionally, GSE Systems' operations are dependent on the efforts of its
technical personnel and its senior management. Thus, recruiting and retaining
capable personnel, particularly engineers, computer scientists and other
personnel with expertise in computer software and hardware, as well as
particular customer processes, are critical to the future performance of the
Company. Competition for qualified technical and management personnel is
substantial.
Legal Liability.
The Company's business could expose it to third party claims with respect
to product, environmental and other similar liabilities. Although the Company
has sought to protect itself from these potential liabilities through a variety
of legal and contractual provisions as well as through liability insurance, the
effectiveness of such protections has not been fully tested. The failure or
malfunction of one of the Company's systems or devices could create potential
liability for substantial monetary damages and environmental cleanup costs. Such
damages or claims could exceed the applicable coverage of the Company's
insurance. Although management has no knowledge of material liability claims
against the Company to date, such potential future claims could have a material
adverse effect on the business or financial condition of the Company. Certain of
the Company's products and services are used by the nuclear power industry. The
Company believes that it does not have significant liability exposure associated
with such use, as nearly all such products and services relate to training.
Although the Company's contracts for such products and services typically
contain provisions designed to protect the Company from potential liabilities
associated with such use, there can be no assurance that the Company would not
be materially adversely affected by claims or actions which may potentially
arise.
Influence of Affiliate Stockholders.
As of the date of this report, certain directors, executive officers and
other parties that are affiliates of the Company beneficially own approximately
45% of the common stock of the Company. If these stockholders vote together as a
group, they will be able to exert significant influence on the business and
affairs of the Company, including the election of individuals to the Company's
Board of Directors, and the outcome of actions that require stockholder
approval.
ITEM 2. PROPERTIES.
In early 1998, the Company entered into agreements whereby the lease for
its then-existing Columbia facility was terminated. The operations that occupied
this facility were relocated into two separate facilities during the second
quarter of 1998. One of these facilities is in Columbia, Maryland (approximately
53,000 square feet) and is occupied by the operations of Power Systems, as well
the Company's corporate headquarters offices and support functions; the other
facility is in Baltimore, Maryland (approximately 39,000 square feet) and is
occupied by the operations of Process Solutions. Each of the leases for these
smaller facilities has a term of ten years.
In addition, the Company leases office space domestically in Alabama,
Georgia, Louisiana, Texas, Pennsylvania, North and South Carolina, and
internationally in Belgium, Japan, Sweden, Taiwan, and the United Kingdom. The
Company leases these facilities for terms ending between 2000 and 2002. During
1999, as part of the wind down of the Oil & Gas BU, the Company's facilities in
Singapore and Korea were shut down.
ITEM 3. LEGAL PROCEEDINGS.
The Company is from time to time involved in legal proceedings incidental
to the conduct of its business. The Company currently is not a party to legal
proceedings which, in the opinion of management, are likely to have a material
adverse effect on the Company's business, financial condition or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matter was submitted to a vote of security holders during the quarter
ended December 31, 1999.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The following table sets forth, for the periods indicated, the high and low
sale prices for the Company's common stock reported by the American Stock
Exchange.
1999
Quarter High Low
First $5 $2 1/2
Second $6 3/4 $4 1/8
Third $6 1/4 $3 3/4
Fourth $4 1/4 $3
1998
Quarter High Low
First $3 1/2 $2
Second $5 $2 1/4
Third $3 11/16 $1
Fourth $3 1/2 $2 1/4
In January 1999, the Company's common stock was approved for listing on the
American Stock Exchange, where it now trades under the symbol "GVP". Previously,
the Company's common stock had traded on the NASDAQ National Market System under
the symbol "GSES".
There were approximately 37 holders of record of the common stock as of
March 15, 2000. Based upon information available to it, the Company believes
there are approximately 700 beneficial holders of the common stock. The Company
has never declared or paid a cash dividend on its common stock. The Company
currently intends to retain future earnings to finance the growth and
development of its business, and therefore does not anticipate paying any cash
dividends in the foreseeable future.
The Company believes factors such as quarterly fluctuations in results of
operations and announcements of new products by the Company or by its
competitors may cause the market price of the common stock to fluctuate, perhaps
significantly. In addition, in recent years the stock market in general, and the
shares of technology companies in particular, have experienced extreme price
fluctuations. The Company's common stock has also experienced a relatively low
trading volume, making it further susceptible to extreme price fluctuations.
These factors may adversely affect the market price of the Company's common
stock.
ITEM 6. SELECTED FINANCIAL DATA.
Historical consolidated results of operations and balance sheet data
presented below, have been derived from the historical financial statements of
the Company. Erudite was acquired on May 22, 1996 through a merger accounted for
by using the pooling of interests method. Accordingly, the Company's financial
statements have been restated to include, on a historical cost basis, the
accounts and operations of Erudite for all periods presented. The Company
disposed of substantially all of the assets of Erudite as of April 30, 1998. In
November 1998, the Company completed the sale of certain assets related to
activities of its Oil & Gas business unit ("O&G"), effective as of October 30,
1998. The balance sheet data of the Company as of December 31, 1997 includes the
operations of Ryan which was acquired by Power Systems as of December 1, 1997.
The statement of operations data for the year ended December 31, 1997 includes
the activity of Ryan from the date of its acquisition.
For information and disclosures regarding the Compan's business segments,
see Note 17, Segment Information, in the "Notes to Consolidated Financial
Statements".
Year ended December 31,
(in thousands, except per share data)
1995 1996 1997 1998 1999
Contract revenue $ 96,060 $ 96,033 $ 79,711 $73,818 $66,699
Cost of revenue 65,592 63,679 58,326 49,814 41,629
Gross profit 30,468 32,354 21,385 24,004 25,070
Operating expenses:
Selling, general and administrative 21,815 24,192 27,320 20,345 22,646
Depreciation and amortization 2,341 2,111 2,368 1,768 1,680
Business combination costs - 1,206 - - -
Employee severance and termination costs - - 1,124 - -
Total operating expenses 24,156 27,509 30,812 22,113 24,326
Operating income (loss) 6,312 4,845 (9,427) 1,891 744
Gain on sale of assets - - - 550 -
Interest expense, net (983) (387) (765) (350) (450)
Other income (expense) 364 394 (1,228) 326 40
Income (loss) before income taxes 5,693 4,852 (11,420) 2,417 334
Provision for (benefit from) income taxes 2,017 709 (2,717) 1,020 233
Net income (loss) $ 3,676 $ 4,143 $ (8,703) $ 1,397 $ 101
Earnings (loss) per common share -Basic $ 0.91 $ 0.82 $ (1.72) $ 0.28 $ 0.02
-Diluted $ 0.91 $ 0.82 $ (1.72) $ 0.27 $ 0.02
===============--==============--============--============--============
Weighted average common shares outstanding
-Basic 4,049 5,066 5,066 5,066 5,066
==============--==============--==============--============--============
==============--==============--==============--============--============
-Diluted 4,059 5,073 5,066 5,107 5,351
==============--==============--==============--============--============
==============--==============--==============--============--============
As of December 31,
1995 1996 1997 1998 1999
Working capital $ 16,077 $ 13,867 $ 1,646 $ 4,058 $ 8,665
Total assets 54,688 51,006 48,362 48,743 43,027
Long-term liabilities 6,055 2,580 2,369 3,350 9,083
Stockholders' equity 20,532 24,693 15,924 17,089 17,170
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
Results of Operations.
The following table sets forth the results of operations for the periods
presented expressed in thousands of dollars and as a percentage of revenues.
Year ended December 31,
1999 % 1998 % 1997 %
Contract revenue 66,699 100.0% 73,818 100.0% 79,711 100.0%
Cost of revenue 41,629 62.4% 49,814 67.5% 58,326 73.2%
Gross profit 25,070 37.6% 24,004 32.5% 21,385 26.8%
Operating expenses:
Selling, general and administrative 22,646 34.0% 20,345 27.6% 27,320 34.3%
Depreciation and amortization 1,680 2.5% 1,768 2.4% 2,368 3.0%
Employee severance and termination costs - - - - 1,124 1.4%
Total operating expenses 24,326 36.5% 22,113 30.0% 30,812 38.7%
Operating income (loss) 744 1.1% 1,891 2.6% (9,427) -11.8%
Gain on sale of assets - 0.0% 550 0.7% - -
Interest expense, net (450) -0.7% (350) -0.5% (765) -1.0%
Other income (expense) 40 0.1% 326 0.4% (1,228) -1.5%
Income (loss) before income taxes 334 0.5% 2,417 3.3% (11,420) -14.3%
Provision for (benefit from) taxes 233 0.3% 1,020 1.4% (2,717) -3.4%
Net income (loss) $ 101 0.2% $ 1,397 1.9% (8,703) -10.9%
==========--===========-===========--==========--==========--========
==========--===========-===========--==========--==========--========
Comparison of 1999 to 1998.
Contract Revenue. Total contract revenue was $66.7 million and $73.8
million for the years ended December 31, 1999 and 1998, respectively. As
previously disclosed, the assets of the Company's Erudite subsidiary and Oil &
Gas business unit were divested in 1998. Included in 1998 revenue was $5.3
million from Erudite and $1.1 million from the Oil & Gas BU. After excluding
these revenues from 1998 results, total revenues decreased $0.7 million from
1998, or 1.0%.
The Power business unit increased revenue by $1.2 million, or 3.9%, to
$32.1 million in 1999 from $30.9 million in 1998, primarily due to higher
domestic simulator upgrade projects and service contracts. The Process business
unit's revenues decreased by $1.9 million, or 5.2%, to $34.6 million in 1999
from $36.5 million in 1998. During the second half of 1999, the Process Business
Unit experienced an order slowdown as customers postponed additional investments
in their process control systems, pending the resolution of Y2K date issue
concerns.
Gross Profit. Despite the lower revenues in 1999, gross profit increased to
$25.1 million in 1999 (37.6% of revenue) from $24.0 million in 1998 (32.5% of
revenue). The increase in gross profit as a percentage of revenues reflects a
higher component of upgrade projects in the Process business unit in 1999 than
in 1998, mainly due to customer concerns about Year 2000 date calculations in
their existing process control software. Such upgrades typically have fewer
hardware and instrumentation components and more license fees and application
engineering work, which tend to generate better margins. In addition, the 1998
margins were impacted slightly by low margins on revenues generated by Erudite
and the Oil & Gas business unit prior to the divestiture of their assets.
Excluding the margins on the revenues of these divested businesses, 1998 gross
profit as a percentage of revenue would have been 33.1%.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses totaled $22.6 million in 1999 (34.0% of revenues), an
11.3% increase from 1998 expenses of $20.3 million (27.6% of revenues). Other
than changes in research and development costs which increased $900,000 and are
discussed below, the increase reflects additional sales and marketing personnel
in the Process business unit, increased advertising and promotions related to
the Company's VirtualPlant suite of products and services, higher legal fees
related to the Company's new credit facility, and internal Y2K compliance
programs.
Gross research and product development expenditures were $5.4 million (8.1%
of revenue) and $4.3 million (5.8% of revenue) for the years ended December 31,
1999 and 1998, respectively. Of these expenditures, $2.5 million in 1999 and
$2.3 million in 1998 were capitalized. Thus, net research and development costs
included in selling, general and administrative expenses were $2.9 million and
$2.1 million during the years ended December 31, 1999 and 1998, respectively.
The Company continued to invest in the conversion of its D/3 DCS (Version 10.0
was released in October, 1999), VPBatch, and SimSuite Pro products to the
Microsoft Windows NT platform.
Depreciation and Amortization. Depreciation expense amounted to $1.3
million and $1.2 million during the years ended December 31, 1999 and 1998,
respectively.
Amortization of goodwill was $388,000 and $365,000 during the years ended
December 31, 1999 and 1998, respectively.
Operating Income (Loss). Operating income amounted to $744,000 (1.1% of
revenue) versus $1.9 million, (2.6% of revenue), for the years ended December
31, 1999 and 1998, respectively. The decrease in operating income reflects the
lower revenues in 1999 coupled with higher selling, general and administrative
costs, as discussed above.
Gain on Sale of Assets. The gain on sale of assets in 1998 reflects the net
pre-tax gain realized on the disposition of the Erudite and the Oil & Gas
business unit assets. During the second quarter of 1998, the Company recorded a
gain of $5.6 million on the sale of the Erudite assets. In the third quarter of
1998, the Company recognized a ($5.0) million pre-tax loss on the disposition of
the Oil & Gas business unit assets. These sales and related gains and losses are
described more fully under Note 3, Acquisitions and dispositions, in the "Notes
to Consolidated Financial Statements".
Interest Expense. Interest expense increased to $450,000 in 1999 from
$350,000 in 1998. This increase is attributable primarily to an increase in the
Company's borrowings under its lines of credit made during the period to fund
working capital requirements.
Other Income (Expense). Other income amounted to $40,000 in 1999 versus
$326,000 in 1998, resulting from recognized foreign currency transaction gains.
Provision for (Benefit from) Income Taxes. The Company's effective tax rate
was 69.8% in 1999 versus 42.2% in 1998. The difference between the statutory
U.S. tax rate and the Company's effective rate for 1999 is primarily the effect
of foreign operations taxed at different rates, state taxes and adjustments to
the prior year tax provision based on the final 1998 tax returns.
Comparison of 1998 to 1997.
Contract Revenue. Total contract revenue was $73.8 million and $79.7
million for the years ended December 31, 1998 and 1997, respectively. This $5.9
million (7.4%) decrease in revenue was primarily attributable to the disposition
of substantially all of the assets of GSE's wholly owned subsidiary, Erudite,
and the disposition of certain assets related to activities of the Oil & Gas BU,
as previously disclosed. Revenue of $5.3 million and $18.0 million from Erudite
were included in 1998 and 1997, respectively, and revenue of $1.1 million and
$2.3 million from the Oil & Gas BU were included in 1998 and 1997, respectively.
Revenue from the Company's two core businesses, operated through the
Process and Power business units, increased in 1998. The Process business unit
increased revenue by $1.7 million to $36.5 million in 1998 from $34.8 million in
1997, or 4.9%, due to increases in customer orders. The Power business unit
increased revenue by $6.4 million to $30.9 million in 1998 from $24.5 million in
1997, or 26.1%, primarily due to revenues generated by its domestic service
contracts resulting from the acquisition of Ryan, as previously disclosed, and
increases in customer orders.
Gross Profit. Gross profit increased to $24.0 million in 1998 from $21.4
million in 1997, or 12.2%, primarily due to increased customer orders and
improved margins in the core businesses, and the disposition of unprofitable
businesses. Gross profit percentage was 32.5% in 1998 compared to 26.8% in 1997,
reflecting improved margins in the core businesses and the disposition of
unprofitable businesses.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased to $20.3 million, or 27.6% of revenue, during
the year ended December 31, 1998 from $27.3 million, or 34.3% of revenue, during
the corresponding period in 1997. The decrease in these expenses in 1998 was
attributable to the disposition of unprofitable businesses, reduced facilities
costs in 1998 due to the relocation of the primary offices of the Company, and
ongoing cost containment efforts. 1997 expenses reflected one-time costs for a
$600,000 reserve recorded to reduce certain Korean receivables to their
estimated realizable value as a result of the Asian financial crisis,
professional services related to a lawsuit, and costs of $852,000 associated
primarily with the future lease commitments on the unused portion of the former
Columbia, Maryland leased facility for which the Company would derive no future
benefit.
Gross research and product development expenditures were $4.3 million and
$5.1 million for the years ended December 31, 1998 and 1997, respectively.
Capitalized software development costs totaled $2.3 million and $3.5
million, during the years ended December 31, 1998 and 1997, respectively.
Net research and development costs included in selling, general and
administrative expenses were $2.1 million and $1.6 million during the years
ended December 31, 1998 and 1997, respectively. The Company continued
investing in the conversion of its D/3 DCS product to the Microsoft Windows
NT platform and the productization of its SimSuite software tools.
Employee Severance and Termination Costs. The Company recorded a net charge
for severance and other employee obligations of $1.1 million in 1997 in
connection with cost reduction efforts initiated to offset the impact of a
decrease in contract revenues. Of this charge, $976,000 was expended as of
December 31, 1997 and the remaining balance was expended in 1998.
Depreciation and Amortization. Depreciation expense amounted to $1.2
million and $2.1 million during the years ended December 31, 1998 and 1997,
respectively. This decrease was primarily attributable to the disposition of
assets included in the Erudite and the Oil & Gas BU sales.
Amortization of goodwill and intangibles was $365,000 and $219,000 during
the years ended December 31, 1998 and 1997, respectively. This increase
primarily resulted from the amortization of certain intangible assets acquired
as a result of the acquisition of Ryan in December of 1997.
Operating Income (Loss). Operating income amounted to $1.9 million, or 2.6%
of revenues, and operating loss amounted to ($9.4) million, or (11.8%) of
revenues, during the years ended December 31, 1998 and 1997, respectively. This
significant increase in operating income reflected the disposition of
unprofitable businesses, increases in customer orders, improved margins and
reduced selling, general and administrative expenses in 1998 as compared to
1997.
Gain on Sale of Assets. Gain on sale of assets reflected the net pre-tax
gain realized on the disposition of the Erudite and the Oil & Gas BU assets, as
previously disclosed. In the third quarter of 1998, the Company recognized a
($5.0) million pre-tax loss on the disposition of the Oil & Gas BU assets.
During the second quarter, the Company recorded a gain of $5.6 million on the
sale of the Erudite assets. These sales and related gains and losses are
described more fully under Note 3, Acquisitions and dispositions, in the "Notes
to Consolidated Financial Statements".
Interest Expense. Interest expense decreased to $350,000 in 1998 from
$765,000 in 1997. This decrease is attributable primarily to a significant
decrease in the Company's borrowings under its lines of credit made during the
period to fund working capital requirements.
Other Income (Expense). Other income amounted to $326,000 in 1998, and
other expenses amounted to $1.2 million in 1997, resulting almost exclusively
from recognized foreign exchange gains in 1998 and recognized foreign exchange
losses in 1997 from the Company's Asian operations.
Provision for (Benefit from) Income Taxes. The Company's effective tax rate
amounted to 42.2% in 1998. The difference between the statutory U.S. tax rate
and the Company's effective tax rate for 1998 is primarily the result of the
effects of foreign operations at different tax rates, state income taxes, and
other non-deductible expenses reflected in the calculation of the 1998 tax
provision. Due to the loss experienced in 1997, the Company recognized a tax
benefit of $2.7 million.
Liquidity and Capital Resources.
Operating Activities. Net cash provided by operating activities was $2.6
million during 1999, as reported on the Consolidated Statements of Cash Flows.
Significant changes in the Company's assets and liabilities included a $4.4
million reduction in contract receivables partially due to improvements in
internal collection processes; a $1.9 million reduction in accounts payable and
accrued expenses; and a $3.3 million reduction in billings in excess of
revenues.
Investing Activities. Net cash used in investing activities was $4.1
million in 1999, including $1.4 million of capital expenditures, $2.5 million of
capitalized software development costs, and $930,000 in cash payments for
acquired businesses ($300,000 for the Mitech acquisition in 1999, $530,000 for
contingent considerations for prior year acquisitions, and $100,000 for notes
payable related to a prior year acquisition). The Company received $731,000 from
Keane, Inc. as final payment on the 1998 Erudite sale. In 1998, the Company's
investing activities generated $5.3 million in cash, made up primarily of $9.7
million from the sale of assets (see Note 3, Acquisitions and dispositions, in
the "Notes to Consolidated Financial Statements") offset by $2.1 million of
capital expenditures and $2.3 million of capitalized software development costs.
In 1997, the Company used $4.4 million in investing activities, mainly for
capital expenditures and capitalized software development costs.
Financing Activities. In 1999, the Company generated $2.0 million net cash
from financing activities. The assignment of two long-term customer lease
contracts to a finance company generated $3.4 million cash, which was partially
offset by the paydown of the Company's credit lines ($.5 million), repayments
under capital lease obligations ($143,000) and the deposit of $735,000 into a
bank account for which the balance is being used to collateralize two of the
Company's outstanding letters of credit. In 1998, the Company's financing
activities used cash of approximately $2.6 million, consisting primarily of $2.3
million in repayments under the Companys lines of credit. In 1997, the Company
generated $6.2 million of net cash mainly through increases in its lines of
credit.
Credit Facilities. On June 4, 1999, the Company entered into a loan and
security agreement with a financial institution for a new credit facility with a
maturity date of May 31, 2002. Borrowings from this facility were used to pay
off the existing debt under the Company's previous credit facility. The new
agreement established two lines of bank credit, through the Company's
subsidiaries, which were cross-collateralized, and provided for borrowings up to
a total of $9.0 million to support working capital needs and foreign letters of
credit.
The first line, for $6.0 million, used by the Power business unit, was 90%
guaranteed by the Export-Import Bank of the United States ("EX-IM") through
March 31, 2000, was collateralized by substantially all of Power's assets, and
provided for borrowings up to 90% of eligible receivables and 60% of unbilled
receivables. The second line, for $3.0 million, used by the Process business
unit, was collateralized by substantially all of Process' assets, and provided
for borrowing up to 85% of eligible receivables and 20% of eligible inventory up
to a maximum of $600,000 . Both lines were guaranteed by the Company and
collateralized by substantially all of the Company's assets. In addition, GP
Strategies Corporation ("GP Strategies") and ManTech International Corporation
("ManTech"), both of which are shareholders of the Company, provided limited
guarantees for these lines totaling $1.8 million from each company.
The credit lines required the Company to comply with certain financial
ratios and precluded the Company from paying dividends and making acquisitions
beyond certain limits without the bank's consent. At December 31, 1999, the
Company was not in compliance with its minimum EBITDA and minimum tangible net
worth covenants; however, the bank has provided a written waiver for these
covenants.
As noted above, the EX-IM guarantee was scheduled to expire on March 31,
2000. EX-IM Bank's Working Capital Guarantee Program is designed to facilitate
the expansion of U.S. exports by helping small and medium-sized businesses that
have exporting potential but need funds to buy or produce goods or provide
services for export. The program is intended to help businesses for a limited
time, until the businesses have grown their export trade enough to finance them
without the EX-IM guarantees. The Company has benefited from this program since
the Company's inception in 1994. However, when the EX-IM guarantee was renewed
in 1999, GSE was informed by EX-IM that the Company was expected to graduate
from the program when the current guarantee expired in 2000. An agreement could
not be worked out with the Company's bank to allow GSE to continue its credit
facility without the EX-IM guarantee, so the Company negotiated a new loan and
security agreement with another financial institution, which was entered into on
March 23, 2000. Borrowings from this facility were used to pay off the existing
debt under the Company's previous credit facility.
The new agreement established a $10 million line of bank credit for the
Company and its subsidiaries, GSE Process Solutions, Inc. and GSE Power Systems,
Inc., jointly and severally as co-borrowers. The credit facility has a maturity
date of March 23, 2003 and provides for borrowings to support working capital
needs and foreign letters of credit ($2 million sublimit). The line is
collateralized by substantially all of the Company's assets and provides for
borrowings up to 85% of eligible accounts receivable, 50% of eligible unbilled
receivables and 40% of eligible inventory up to a maximum of $1.2 million. In
addition, ManTech has provided a one-year $900,000 standby letter of credit to
the bank as additional collateral for the Company's credit facility. GSE is
allowed to borrow up to 100% of the letter of credit value. GP Strategies
provided a limited guarantee totaling $1.8 million; ManTech has provided a
limited guarantee totaling $900,000.
The loan and security agreement requires the Company to comply with certain
financial ratios and precludes the Company from paying dividends and making
acquisitions beyond certain limits without the bank's consent. Management
believes that these covenants are attainable for the foreseeable future, based
on existing budgets and forecasts.
In 1998, in connection with the Company's then existing credit facility,
the Company had arranged for certain guarantees to be provided on its behalf by
GP Strategies and ManTech. In consideration for these guarantees, the Company
granted each of ManTech and GP Strategies warrants to purchase shares of the
Company's common stock; each of such warrants provides the right to purchase
150,000 shares of the Company's common stock at $2.375 per share. In 1998, the
Company recorded $300,000 as the estimated fair value of such warrants in the
consolidated financial statements and amortized such value over the life of the
initial guarantee, which expired in June 1999. During 1999, the Company
recognized $120,000 of expense related to these warrants; in 1998 the Company
recognized $180,000 of expense. The fair value of the warrants was determined
using the Black-Scholes valuation model. Assumptions used in the calculation
were as follows: dividend yield of 0%, expected volatility of 61%, risk-free
interest rates of 5.6% and expected terms of 2.5 years.
As of December 31, 1999, the Company was contingently liable for three
letters of credit totaling $765,000. Two of the letters of credit represent
payment bonds on contracts, while the remaining one was issued to the landlord
of the Company's previous facility (whose lease was terminated in 1998). Of the
total amount of letters of credit, approximately $735,000 was issued in 1998
through the Company's bank at the time and was supported by the Company's credit
facility. These letters of credit could not be reissued by the Company's new
financial institution, and in June 1999, the Company was required to deposit
funds with the issuing institution as collateral against the letters of credit.
On January 27, 2000, the Company issued 116,959 shares of its common stock,
at fair market value less discount, to ManTech for $500,000. The proceeds of the
stock issuance were used for working capital.
Management believes that the Company has sufficient liquidity and working
capital resources necessary in 2000 for planned business operations, debt
service requirements, planned investments and capital expenditures.
Year 2000.
As previously reported, beginning in 1998, GSE developed and implemented a
plan to address the anticipated impacts of the Year 2000 problem on the
Company's products and installed base and on its financial and administrative
information technology systems. The Company also surveyed selected third parties
to determine the status of their Year 2000 compliance programs. In addition,
contingency plans were developed specifying what the Company would do if it or
important third parties experienced disruptions to critical business activities
as a result of the Year 2000 problem. GSE's Year 2000 plan was completed in all
material respects prior to the anticipated Year 2000 failure dates. As of March
30, 2000, the Company has not experienced any materially important business
disruptions or system failures as a result of Year 2000 issues. However, Year
2000 compliance has many elements and potential consequences, some of which may
not be foreseeable or may be realized in future periods. Consequently, there can
be no assurance that unforeseen circumstances may not arise, or that the Company
will not in the future identify equipment or systems that are not Year 2000
compliant.
The Company estimates that the aggregate costs to address the Year 2000
issue totaled approximately $1.7 million in 1999. The Company believes that most
of the customer related costs associated with the Year 2000 issue would have
occurred as part of its normal operations. The Company did not track these costs
separately. In 1999, the Company spent approximately $238,000, incremental to
normal operating costs, on upgrades to its internal systems and outside
consultant fees. The Company's policy is to expense as incurred information
system maintenance costs and to capitalize the cost of new software and hardware
and amortize or depreciate it over the assets' useful lives.
Foreign Exchange.
A portion of the Company's international sales revenue has been and may be
received in a currency other than the currency in which the expenses relating to
such revenue are paid. When necessary, the Company manages its foreign currency
exposure primarily by entering into foreign currency exchange agreements and
purchasing foreign currency options.
Other Matters.
To date, management believes inflation has not had a material impact on the
Company's operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company's market risk is principally confined to changes in foreign
currency exchange rates and potentially adverse effects of differing tax
structures. The Company's exposure to foreign exchange rate fluctuations arises
in part from inter-company accounts in which costs incurred in one entity are
charged to other entities in different foreign jurisdictions. The Company is
also exposed to foreign exchange rate fluctuations as the financial results of
all foreign subsidiaries are translated into U.S. dollars in consolidation. As
exchange rates vary, those results when translated may vary from expectations
and adversely impact overall expected profitability.
The Company is also subject to market risk related to the interest rates on
its existing line of credit. As of March 30, 2000, such interest rates are based
on the prime rate.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. Page
INDEX TO FINANCIAL STATEMENTS
GSE Systems, Inc. and Subsidiaries
Report of Independent Accountants........................................... F-1
Consolidated Balance Sheets as of December 31,1999 and 1998................. F-2
Consolidated Statements of Operations for the years ended
December 31, 1999, 1998 and 1997............................................ F-3
Consolidated Statements of Comprehensive Income (Loss) for the years ended
December 31, 1999, 1998 and 1997............................................ F-4
Consolidated Statements of Changes in Stockholders' Equity for the years ended
December 31, 1999, 1998 and 1997.............................................F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1999, 1998 and 1997.............................................F-6
Notes to Consolidated Financial Statements...................................F-7
REPORT OF INDEPENDENT ACCOUNTANTS
To The Board of Directors
and Stockholders of GSE Systems, Inc.
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, comprehensive income (loss),
changes in stockholders' equity and cash flows present fairly, in all
material respects, the financial position of GSE Systems, Inc. and
subsidiaries as of December 31, 1999 and 1998, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 1999, in conformity with accounting principles generally
accepted in the United States. These financial statements are the
responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with auditing
standards generally accepted in the United States, which require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
McLean, Virginia
February 29, 2000, except for Note 19, as to which the date is March 23,
2000
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
ASSETS
December 31,
1999 1998
Current assets:
Cash and cash equivalents $ 2,695 $ 2,240
Restricted cash 255 -
Contract receivables 16,881 24,426
Note receivable - 1,000
Inventories 3,255 2,892
Prepaid expenses and other current assets 2,207 1,654
Deferred income taxes 146 150
Total current assets 25,439 32,362
Property and equipment, net 3,094 2,714
Software development costs, net 5,395 4,715
Goodwill, net 2,949 2,781
Deferred income taxes 3,251 3,366
Restricted cash 480 -
Other assets 2,419 2,805
Total assets $ 43,027 $ 48,743
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Lines of credit $ - $ 6,746
Accounts payable 5,024 8,407
Accrued expenses 3,965 3,140
Accrued compensation an payroll taxes 1,539 1,204
Billings in excess of revenue earned 3,077 6,359
Accrued warranty reserves 620 846
Income taxes payable 30 151
Other current liabilities 2,519 1,451
Total current liabilities 16,774 28,304
Line of credit 6,233 -
Note payable to related party 131 148
Accrued warranty reserves 680 596
Other liabilities 2,039 2,606
Total liabilities 25,857 31,654
Stockholders' equity:
Common stock $.01 par value, 8,000,000 shares authorized,
5,065,688 shares issued and outstanding 50 50
Additional paid-in capital 21,691 21,678
Retained earnings (deficit) - at formation (5,112) (5,112)
Retained earnings - since formation 1,259 1,158
Accumulated other comprehensive loss (718) (685)
Total stockholders' equity 17,170 17,089
Total liabilities & stockholders' equity $ 43,027 $ 48,743
==================-----================--
==================-----================--
The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Years ended December 31,
1999 1998 1997
Contract revenue $ 66,699 $ 73,818 $ 79,711
Cost of revenue 41,629 49,814 58,326
Gross profit 25,070 24,004 21,385
Operating expenses
Selling, general and administrative 22,646 20,345 27,320
Depreciation and amortization 1,680 1,768 2,368
Employee severance and termination costs - - 1,124
Total operating expenses 24,326 22,113 30,812
Operating income (loss) 744 1,891 (9,427)
Gain on sale of assets - 550 -
Interest expense, net (450) (350) (765)
Other income (expense) 40 326 (1,228)
Income (loss) before income taxes 334 2,417 (11,420)
Provision for (benefit from) income taxes 233 1,020 (2,717)
Net income (loss) $ 101 $ 1,397 $ (8,703)
Basic earnings (loss) per common share $ 0.02 $ 0.28 $ (1.72)
Diluted earnings (loss) per common share $ 0.02 $ 0.27 $ (1.72)
The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
Years ended December 31,
1999 1998 1997
Net income (loss) $ 101 $ 1,397 $ (8,703)
Foreign currency translation adjustment (33) (532) (66)
Comprehensive income (loss) $ 68 $ 865 $ (8,769)
============--=============--============
============--=============--============
The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC, AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands)
Retained Earnings Accumulated
Common Additional (Deficit) Other
Stock Paid-in At Since Comprehensive
Shares Amount Capital Formation Formation Loss Total
Balance, January 1, 1997 5,066 $ 50 $ 21,378 $ (5,112) $ 8,464 $ (87) $ 24,693
Foreign currency translation adjustment - - - - - (66) (66)
Net loss - - - - (8,703) (8,703)
Balance, December 31, 1997 5,066 50 21,378 (5,112) (239) (153) 15,924
Foreign currency translation adjustment - - - - - (532) (532)
Fair value of warrants issued to non-employees - - 300 - - - 300
Net income - - - - 1,397 - 1,397
Balance, December 31, 1998 5,066 50 21,678 (5,112) 1,158 (685) 17,089
Foreign currency translation adjustment - - - - - (33) (33)
Fair value of warrants issued to non-employees - - 13 - - - 13
Net income - - - - 101 - 101
Balance, December 31, 1999 5,066 $ 50 $ 21,691 $ (5,112) $ 1,259 $ (718) $ 17,170
The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years ended December 31,
1999 1998 1997
Cash flows from operating activities:
Net income (loss) $ 101 $ 1,397 $ (8,703)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 3,481 3,492 3,492
Provision (credit) for doubtful contract receivables - (255) 723
Foreign currency transaction (gain) loss (40) (326) 1,275
Fair value of warrants issued to non-employees 133 180 -
Deferred income taxes 119 301 (2,277)
Gain on sale of assets - (550) -
Changes in assets and liabilities:
Contract receivables 4,382 (2,344) 1,464
Inventories (363) (185) 727
Prepaid expenses and other assets (563) (1,381) 819
Accounts payable, accrued compensation and accrued expenses (1,888) (2,600) (1,152)
Billings in excess of revenues earned (3,282) 83 644
Accrued warranty reserves (142) 102 (710)
Other liabilities 744 1,428 198
Income taxes payable (121) (114) (315)
Net cash provided by (used in) operating activities 2,561 (772) (3,815)
Cash flows from investing activities:
Proceeds from sale of assets 731 9,697 -
Net cash paid for acquisition of businesses (930) - (578)
Capital expenditures (1,398) (2,061) (918)
Capitalization of software development costs (2,460) (2,304) (3,474)
Proceeds from sale/leaseback transaction - - 521
Net cash provided by (used in) investing activities (4,057) 5,332 (4,449)
Cash flows from financing activities:
Proceeds from assignment of sales-type leases 3,432 - -
Restricted cash (735) - -
(Decrease) increase in lines of credit with banks (513) (2,287) 6,450
Repayments under capital lease obligations (143) (265) (266)
Decrease in note payable to related party (17) (12) (17)
Net cash provided by (used in) financing activities 2,024 (2,564) 6,167
Effect of exchange rate changes on cash (73) (90) (19)
Net increase (decrease) in cash and cash equivalents 455 1,906 (2,116)
Cash and cash equivalents at beginning of period 2,240 334 2,450
Cash and cash equivalents at end of period $2,695 $ 2,240 $ 334
The accompanying notes are an integral part of these consolidated financial statements.
GSE Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 1999
1. Business
GSE Systems, Inc. ("GSE Systems", "GSE" or the "Company") develops and
delivers business and technology solutions by applying process control,
simulation software, systems and services to the energy, process and
manufacturing industries worldwide. The Company's solutions and services assist
customers in reducing the time-to-market for new product development; improving
chemistry for producing products; improving quality, safety and throughput;
reducing operating expenses; and enhancing overall productivity.
The Company's operations are subject to certain risks and uncertainties
including, among others, rapid technological changes, success of the Company's
product development, marketing and distribution strategies, the need to manage
growth, the need to retain key personnel and protect intellectual property, and
the availability of additional financing on terms acceptable to the Company.
2. Summary of significant accounting policies
Principles of consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries. The results of operations of GSE
Erudite Software, Inc. ("Erudite") are included through April 30, 1998. All
intercompany balances and transactions have been eliminated.
Revenue recognition
Revenue under fixed-price contracts generally is accounted for on the
percentage-of-completion method, based on contract costs incurred to date and
estimated costs to complete. Estimated contract earnings are reviewed and
revised periodically as the work progresses, and the cumulative effect of any
change is recognized in the period in which the change is determined. The effect
of changes in estimates of contract earnings was to increase gross profit by
approximately $353,000 during the year ended December 31, 1999 and decrease
gross profit by approximately $45,000 and $410,000 during the years ended
December 31, 1998 and 1997, respectively. Estimated losses are charged against
earnings in the period such losses are identified. The remaining liability for
contract costs to be incurred in excess of contract revenue is reflected as
accrued contract reserves in the Company's consolidated balance sheets. Revenue
from certain consulting or training contracts are recognized on a time and
material basis. For time-and-material type contracts, revenue is recognized
based on hours incurred at a contracted labor rate plus expenses.
Accounting estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and cash equivalents
Cash and cash equivalents consist of cash on hand and highly liquid
investments with maturities of three (3) months or less at the date of purchase.
Inventories
Inventories are stated at the lower of cost, as determined by the average
cost method, or market. Obsolete or unsaleable inventory is reflected at its
estimated net realizable value. Inventory costs include raw materials and
purchased parts.
Property and equipment
Property and equipment are recorded at cost and depreciated using the
straight-line method with estimated useful lives ranging from three to ten
years. Leasehold improvements are amortized over the life of the lease or the
estimated useful life, whichever is shorter, using the straight-line method.
Upon sale or retirement, the cost and related amortization are eliminated from
the respective accounts and any resulting gain or loss is included in
operations. Maintenance and repairs are charged to expense as incurred.
Software development costs
Certain computer software development costs are capitalized in the
accompanying consolidated balance sheets. Capitalization of computer software
development costs begins upon the establishment of technological feasibility.
Capitalization ceases and amortization of capitalized costs begins when the
software product is commercially available for general release to customers.
Amortization of capitalized computer software development costs is included in
cost of revenue and is provided using the straight-line method over the
remaining estimated economic life of the product, not to exceed five years.
Goodwill
Goodwill represents the excess of purchase price for acquired businesses
over the fair value of net tangible and intangible assets acquired. These
amounts are amortized on a straight-line basis over periods ranging from seven
to fifteen years.
Research and development
Development expenditures incurred to meet customer specifications under
contracts accounted for under the percentage of completion method are charged to
contract costs. Company sponsored research and development expenditures are
charged to operations as incurred and are included in selling, general and
administrative expenses. The amounts incurred for Company sponsored research and
development activities relating to the development of new products and services
or the improvement of existing products and services, exclusive of amounts
capitalized, were approximately $2,915000, $2,051,000, and $1,580,000 for the
years ended December 31, 1999, 1998 and 1997, respectively.
Asset impairment
The Company periodically evaluates the recoverability of its long-lived
assets by comparing the carrying value of the intangible with the assets'
expected future cash flows, undiscounted and without interest costs. Estimates
of expected future cash flows represent management's best estimate based on
reasonable and supportable assumptions and projections. Impairments are
recognized in operating results to the extent that the carrying value exceeds
fair value. No impairment losses were recognized in 1999, 1998 or 1997.
Foreign currency translation
Balance sheet accounts for foreign operations are translated at the
exchange rate at the balance sheet date, and income statement accounts are
translated at the average exchange rate for the period. The resulting
translation adjustments are included in accumulated other comprehensive income
(loss) in stockholders' equity. Transaction gains and losses, resulting from
changes in exchange rates, are included in other income (expense) in the
Consolidated Statement of Operations in the period in which they occur. For the
years ended December 31, 1999 and 1998, foreign currency transaction gains were
approximately $40,000 and $326,000, respectively. In 1997, the Company
experienced a foreign currency loss of approximately $1,275,000, resulting
primarily from intercompany transactions which were negatively impacted by the
poor financial condition of Asian markets.
Warranties
As the Company recognizes revenue under the percentage-of-completion
method, it provides an accrual for estimated future warranty costs based on
historical and projected claims experience.
Income taxes
Deferred income taxes are provided under the asset and liability method.
Under this method, deferred income taxes are determined based on the differences
between the financial statement and tax bases of assets and liabilities using
enacted tax rates in effect for the year in which the differences are expected
to reverse. Valuation allowances are established when necessary to reduce
deferred tax assets to the amounts expected to be realized. Provision is made
for the Company's current liability for federal, state and foreign income taxes
and the change in the Company's deferred income tax assets and liabilities. No
provision has been made for the undistributed earnings of the Company's foreign
subsidiaries as they are considered permanently invested. Amounts of
undistributed earnings are not material to the overall consolidated financial
statements.
Earnings per share
Basic earnings per share is computed based on the weighted average number
of outstanding common shares for the period. Diluted earnings per share adjusts
such weighted average for the potential dilution that could occur if stock
options, warrants or other convertible securities were exercised or converted
into common stock. Diluted earnings per share is the same as basic earnings per
share for the year ended December 31, 1997 because the effects of such items
were anti-dilutive.
The number of common shares and common share equivalents used in the
determination of basic and diluted earnings (loss) per share was as follows:
Year ended December 31,
1999 1998 1997
Weighted average shares outstanding - Basic 5,065,688 5,065,688 5,065,688
Weighted average shares outstanding - Diluted 5,351,474 5,107,428 5,065,688
The difference between the amounts in 1999 and 1998 represents dilutive
options and warrants to purchase shares of common stock computed under the
treasury stock method, using the average market price during the related
periods.
Reclassifications
Certain reclassifications have been made to prior year amounts to conform
with current year presentation. Additionally, certain reclassifications have
been made to the December 31, 1997 financial statements to conform with the
reporting requirements of FAS No. 130,Reporting Comprehensive Income.
New Accounting Standards
In June 1998, the Financial Accounting Standards Board issued FAS No. 133,
Accounting for Derivative Instruments and Hedging Activities This statement
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. In June 1999, FAS 137, Accounting for Derivative Instruments and
Hedging Activities Deferral of the Effective Date of FASB Statement No. 133 -
an amendment of FASB Statement No. 133 was issued. The Company will be required
to adopt this new accounting standard by March 31, 2001. Management does not
anticipate early adoption. The Company does not believe that the effect of the
adoption of FAS No. 133 will be material.
In December 1999, the SEC released Staff Accounting Bulletin No. 101,
Revenue Recognition in Financial Statements. This bulletin establishes more
clearly defined revenue recognition criteria than previously existing accounting
pronouncements. This bulletin will become effective for the Company for the
quarter ended March 31, 2000. The Company is currently evaluating the full
impact of this bulletin to determine the impact on its financial position and
results of operations.
Concentration of credit risk
The Company is subject to concentration of credit risk with respect to
contract receivables. Credit risk on contract receivables is mitigated by the
nature of the Company's worldwide customer base and its credit policies. The
Company's customers are not concentrated in any specific geographic region, but
are concentrated in the energy and manufacturing industries. For the year ended
December 31, 1999, one customer accounted for approximately 13% of the Company's
revenues. No single customer accounted for a significant (greater than 10%)
amount of the Company's revenue during the years ended December 31, 1998 and
1997, and there were no significant contract receivables from a single customer
at December 31, 1999 or 1998.
Fair values of financial instruments
The carrying amounts of current assets and current liabilities reported in
the Consolidated Balance Sheets approximate fair value.
Off balance sheet risk and foreign exchange contracts
When necessary, the Company enters into forward exchange contracts, options
and swaps as hedges against certain foreign currency commitments. The Company
also enters into letters of credit and performance guarantees in the ordinary
course of business as required by certain contracts and proposal requirements.
The Company does not hold any derivative financial instruments for trading
purposes. Gains and losses on foreign exchange contracts and swaps are
recognized as part of the cost of the underlying transactions being hedged in
the period in which the exchange rates changed. Foreign exchange contracts have
an element of risk that the counterparty may not be able to meet the terms of
the agreement. However, the Company minimizes such risk exposure by limiting
counterparties to nationally recognized financial institutions. Foreign exchange
options contracts permit but do not require the Company to exchange foreign
currencies at a future date with counterparties at a contracted exchange rate.
Costs associated with such contracts are amortized over the life of the contract
matching the underlying receipts.
3. Acquisitions and dispositions
Acquisitions
In April, 1999, the Company completed two acquisitions for the Process
business unit using the purchase method of accounting. On April 20, the Company
purchased certain assets and employed the associates of BatchCAD Limited, a
United Kingdom-based supplier of batch process development and design consulting
services and simulation software tools. The purchase price was approximately
$548,000 payable in cash in three equal installments on January 1, 2000, 2001
and 2002 and was allocated as follows (in thousands):
Purchased software (property and equipment) $481
Trade receivables 45
Property and equipment 22
-----------
Total purchase price $548
===========
On April 30, 1999 the Company acquired all proprietary technology and
software assets from, and assumed substantially all customer contracts
of, Mitech Corporation, a Massachusetts-based supplier of neural network
and artificial intelligence software. The purchase price was $350,000
(consisting of $300,000 in cash and $50,000 payable one year from the closing)
and was allocated 100% to property and equipment as purchased software.
On December 1, 1997, the Company acquired 100% of the outstanding common
stock of J.L. Ryan, Inc. ("Ryan") for an initial purchase price of $1,000,000
and contingent consideration based on the performance of the business from 1998
to 2002; a minimum of $250,000 of such earnings payments for each of 1998 and
1999 has been guaranteed by the Company. The Company paid $600,000 in cash upon
the closing of the transaction and entered into a promissory note payable in
four annual installments of $100,000 each beginning on January 2, 1999. This
acquisition was accounted for under the purchase method. The financial results
of Ryan have been included in the results of operations from the date of
acquisition. The acquisition resulted in total goodwill of $1,133,976, which is
being amortized over seven years. For 1999 and 1998, the contingent
consideration in excess of the minimum guaranteed amount was approximately
$411,000 and $166,000, respectively, which the Company has recorded as additions
to goodwill.
Dispositions
On November 10, 1998, the Company completed the sale of certain assets
related to activities of its Oil & Gas business unit ("O&G"), to Valmet
Automation (USA), Inc. ("Valmet"), pursuant to an Asset Purchase Agreement,
effective as of October 30, 1998, by and between the Company and Valmet. The
Company recognized a loss before income taxes on this transaction of $5.0
million, including the write-off of approximately $2.9 million in capitalized
software development costs, since all operations that would support the
recoverability of these capitalized costs were sold. The Company received
approximately $742,000 in cash, subject to certain adjustments, and Valmet
assumed certain identified liabilities. Included in the Consolidated Statement
of Operations for the year ended December 31, 1998, are revenues of $1.1 million
and operating losses of $721,000 attributable to O&G prior to the sale to
Valmet. See Note 17, Segment Information, for historical revenues and business
unit contribution provided by O&G during 1997.
On May 1, 1998, the Company completed the sale of substantially all of the
assets of Erudite to Keane, Inc. ("Keane"), pursuant to an Asset Purchase
Agreement, dated as of April 30, 1998, by and among the Company, Erudite and
Keane. The aggregate purchase price for the Erudite assets was approximately
$9.9 million (consisting of $8.9 million in cash and $1.0 million in the form of
an uncollateralized promissory note due on April 30, 1999, subject to certain
adjustments described in the next paragraph). In connection with the
transaction, Keane purchased certain assets with a book value of $4.4 million
and assumed certain operating liabilities totaling approximately $2.2 million.
The Company recognized a gain before income taxes on this transaction of $5.6
million. In connection with the sale of these assets, the Company wrote off
approximately $800,000 in capitalized software development costs, as well as
$321,000 of purchased software, since all operations that would support the
recoverability of these costs were sold. The write-off of these costs is
reflected in the calculation of the gain on the sale. Included in the
Consolidated Statement of Operations for the year ended December 31, 1998, are
revenues of $5.3 million and operating losses of $64,000 attributable to Erudite
prior to the sale to Keane. See Note 17, Segment Information, for historical
revenues and business unit contribution provided by Erudite during 1997.
As noted above, the purchase price for the sale of Erudite Software was
subject to post-closing adjustments based upon a balance sheet as of the closing
date (the "Closing Balance Sheet"). Due to certain differences in valuation
amounts of the Closing Balance Sheet, the purchase price was reduced by
$269,000, which had been provided for in 1998. Accordingly, of the $1.0 million
promissory note due to the Company on April 30, 1999, the Company received
$731,000, plus $60,000 interest income.
4. Contract receivables
Contract receivables represent balances due from a broad base of both
domestic and international customers. All contract receivables are considered to
be collectible within twelve months. Recoverable costs and accrued profit not
billed, represent costs incurred and associated profit accrued on contracts that
will become billable upon future milestones or completion of contracts.
The components of contract receivables are as follows (in thousands):
December 31,
1999 1998
Billed receivables $ 9,797 $16,469
Recoverable costs and accrued profit not billed 7,593 8,839
Allowance for doubtful accounts (509) (882)
Total contract receivables $16,881 $24,426
5. Inventories
Inventories consist of the following (in thousands):
December 31,
1999 1998
Raw materials $ 2,536 $ 1,873
Service parts 719 1,019
Total inventories $ 3,255 $ 2,892
6. Prepaid expenses and other current assets
Prepaid expenses and other current assets consist of the following (in
thousands):
1999 1998
Investment in sales-type lease - current portion $ 1,137 $ 560
Prepaid expenses 641 889
Employee advances 98 159
Other current assets 331 46
Total $ 2,207 $ 1,654
7. Property and equipment
Property and equipment consist of the following (in thousands):
December 31,
1999 1998
Computer equipment $ 7,820 $ 7,300
Leasehold improvements 817 657
Furniture and fixtures 2,944 2,205
11,581 10,162
Accumulated depreciation and amortization (8,487) (7,448)
Property and equipment, net $ 3,094 $ 2,714
Depreciation and amortization expense was approximately $1,292,000,
$1,218,000 and $2,149,000 for the years ended December 31, 1999, 1998 and 1997,
respectively.
The Company has approximately $404,000 in assets held under capital lease
as of December 31, 1999 and 1998. Accumulated amortization on these assets,
included in accumulated depreciation and amortization above, was approximately
$386,000 and $142,000 as of December 31, 1999 and 1998, respectively.
8. Software development costs
Software development costs, net, consist of the following (in thousands):
December 31,
1999 1998
Capitalized software development costs $9,888 $ 7,407
Accumulated amortization (4,493) (2,692)
Software development costs, net $ 5,395 $ 4,715
Software development costs capitalized were approximately $2,460,000,
$2,304,000 and $3,474,000 for the years ended December 31, 1999, 1998 and 1997,
respectively. Amortization of software development costs capitalized, excluding
write-offs in connection with asset dispositions, was approximately $1,801,000,
$1,909,000 and $1,124,000 for the years ended December 31, 1999, 1998 and 1997,
respectively, and are included in cost of revenue.
9. Goodwill
Goodwill consists of the following (in thousands):
December 31,
1999 1998
Goodwill, at cost $ 4,287 $ 3,731
Accumulated amortization (1,338) (950)
Goodwill, net $ 2,949 $ 2,781
Amortization expense for goodwill was approximately $388,000, $365,000 and
$219,000 for the years ended December 31, 1999, 1998 and 1997, respectively.
10. Notes payable and financing arrangements
Notes payable and financing arrangements consist of the following (in
thousands):
December 31,
1999 1998
Lines of credit with bank $ 6,233 $ 6,746
Obligations under sales-type lease 2,465 1,680
Notes payable, other 1,485 1,760
Note payable to related party 149 174
Capital lease obligations 10 153
Total notes payable and financing arrangements 10,342 10,513
Less amounts payable within one year (1,938) (8,530)
Long-term portion $ 8,404 $ 1,983
Lines of Credit
On June 4, 1999, the Company entered into a loan and security agreement
with a financial institution for a new credit facility with a maturity date of
May 31, 2002. Borrowings from this facility were used to pay off the existing
debt under the Company's previous credit facility. The new agreement established
two lines of bank credit, through the Company's subsidiaries, which were
cross-collateralized, and provided for borrowings up to a total of $9.0 million
to support working capital needs and foreign letters of credit. The interest
rate on these lines of credit was based on the bank's prime rate plus 1 1/2%
(10% as of December 31, 1999), with interest only payments due monthly.
The first line, for $6.0 million, used by the Power business unit, was 90%
guaranteed by the Export-Import Bank of the United States "EX-IM") through
March 31, 2000, was collateralized by substantially all of Power's assets, and
provided for borrowings up to 90% of eligible receivables and 60% of unbilled
receivables. The second line, for $3.0 million, used by the Process business
unit, was collateralized by substantially all of Process' assets, and provided
for borrowing up to 85% of eligible receivables and 20% of eligible inventory
(up to a maximum of $600,000). Both lines were guaranteed by the Company and
collateralized by substantially all of the Company's assets. In addition, GP
Strategies Corporation ("GP Strategies") and ManTech International Corporation
("ManTech"), both of which are shareholders of the Company, provided limited
guarantees for these lines totaling $1.8 million from each company.
The credit lines required the Company to comply with certain financial
ratios and precluded the Company from paying dividends and making acquisitions
beyond certain limits without the bank's consent. At December 31, 1999, the
Company was not in compliance with its minimum EBITDA and minimum tangible net
worth covenants; however, the bank has provided a written waiver for these
covenants.
As noted above, the EX-IM guarantee was scheduled to expire on March 31,
2000. EX-IM Bank's Working Capital Guarantee Program is designed to facilitate
the expansion of U.S. exports by helping small and medium-sized businesses that
have exporting potential but need funds to buy or produce goods or provide
services for export. The program is intended to help businesses for a limited
time, until the businesses have grown their export trade enough to finance them
without the EX-IM guarantees. The Company has benefited from this program since
the Company's inception in 1994. However, when the EX-IM guarantee was renewed
in 1999, GSE was informed by EX-IM that the Company was expected to graduate
from the program when the current guarantee expired in 2000. An agreement could
not be worked out with the Company's bank to allow GSE to continue its credit
facility without the EX-IM guarantee, so the Company has negotiated a new loan
and security agreement with another financial institution. See Note 19,
Subsequent events, for information regarding the new loan and security
agreement.
In 1998, in connection with the Company's then existing credit facility,
the Company had arranged for certain guarantees to be provided on its behalf by
GP Strategies and ManTech. In consideration for these guarantees, the Company
granted each of ManTech and GP Strategies warrants to purchase shares of the
Company's common stock; each of such warrants provides the right to purchase
150,000 shares of the Company's common stock at $2.375 per share. In 1998, the
Company recorded $300,000 as the estimated fair value of such warrants in the
consolidated financial statements and amortized such value over the life of the
initial guarantee, which expired in June 1999. During 1999, the Company
recognized $120,000 of expense related to these warrants; in 1998 the Company
recognized $180,000 of expense. The fair value of the warrants was determined
using the Black-Scholes valuation model. Assumptions used in the calculation
were as follows: dividend yield of 0%, expected volatility of 61%, risk-free
interest rates of 5.6% and expected terms of 2.5 years.
Obligations under sales-type lease
In March 1999 and December 1998, the Company entered into two separate
contracts with a customer for the lease of certain hardware and software under
two 36-month leases. The Company has accounted for the leases as sales-type
leases. During 1999, the Company assigned the payments due under the sales-type
leases to a third party financing company and received proceeds of $3,432,000.
Since the Company remains contingently liable for amounts due to the third party
financing company, the remaining investment in and obligation under the
sales-type leases are reflected in the Company's balance sheets as follows (in
thousands):
1999 1998
Net investment in sales-type lease
Prepaid expense and other assets $1,137 $ 560
Other assets 1,328 1,120
$2,465 $1,680
Obligation under sales-type lease
Other current liabilities $1,137 $ 560
Other liabilities 1,328 1,120
$2,465 $1,680
As of December 31, 1999, the components of the net investment in the
sales-type leases are as follows (in thousands):
Minimum rentals receivable $ 2,834
Less: unearned interest income (369)
Net investment in sales-type leases $ 2,465
Minimum rentals receivable under this lease at December 31, 1999 are as
follows (in thousands):
2000 $ 1,420
2001 1,414
Total $ 2,834
Notes payable, other
Notes payable, other is comprised of the following (in thousands):
December 31,
1999 1998
Acquisitions $ 1,148 $ 1,323
Insurance and other 337 437
Total notes payable, other $ 1,485 $ 1,760
Less amounts payable within one year (773) (1,035)
Long-term portion $ 712 $ 725
Capital lease obligations
The Company entered into capital lease agreements for furniture and
equipment, totaling $58,000, and $102,000 during the years ended December 31,
1998 and 1997, respectively. These obligations bear interest between 9% and 11%
per annum and expire during 2000.
Debt maturities
Aggregate maturities of debt as of December 31, 1999 are as follows:
2000 $1,938
2001 1,585
2002 6,725
2003 18
2004 18
2005 and thereafter 58
Total $10,342
11. Income taxes
The consolidated income (loss) before income taxes, by domestic and foreign
sources, is as follows (in thousands):
Years ended December 31,
1999 1998 1997
Domestic $ (1,386) $ 1,379 $ (8,850)
Foreign 1,720 1,038 (2,570)
$ 334 $ 2,417 $(11,420)
The provision for (benefit from) income taxes is as follows (in thousands):
December 31,
1999 1998 1997
Current:
Federal $ - $ - $ (27)
State 30 157 -
Foreign 84 257 (413)
114 414 (440)
Deferred:
Federal (88) 556 (2,388)
State - - (229)
Foreign 207 50 340
119 606 (2,277)
Total $ 233 $ 1,020 $ (2,717)
The (benefit from) provision for income taxes varies from the amount of income
tax determined by applying the applicable U.S. statutory rate to pre-tax (loss)
income as a result of the following:
Effective tax rate percentage (%)
Years ended December 31,
1999 1998 1997
Statutory U.S. tax rate 34.0 % 34.0 % (34.0)%
State income tax, net of federal tax benefit 2.7 2.7 (2.7)
Effect of foreign operations 7.1 (2.2) 3.8
Gain on debt forgiveness of foreign entities (115.4) - -
Change in valuation allowance - (0.8) 7.8
Adjustments to prior year provision based on
actual 1998 tax return amounts 97.6 - -
Other, principally permanent differences 43.8 8.5 1.3
Effective tax rate 69.8 % 42.2 % (23.8)%
At December 31, 1999, the Company had available $11,196,000 and $1,650,000
of domestic and foreign net operating loss carryforwards, respectively, which
expire between 2007 and 2019. In addition, the Company had $362,000 of foreign
tax credit carryforwards which expire between 2000 and 2004. These carryforwards
will be utilized to reduce taxable income in subsequent years. A portion of the
net operating losses were generated by certain of the Company's predecessors
prior to the formation of the Company and, as a result, there are limitations on
the amounts that can be utilized to offset taxable income in a given year.
Deferred income taxes arise from temporary differences between the tax
bases of assets and liabilities and their reported amounts in the financial
statements. A summary of the tax effect of the significant components of the
deferred income tax assets (liabilities) is as follows (in thousands)
Years ended December 31,
1999 1998
Net operating loss carryforwards $ 4,563 $ 4,945
Software development costs (1,980) (1,731)
Book reserves not deductible for tax purposes 1,165 876
Foreign tax credits 362 338
Property and equipment 326 340
Swedish tax deferral (299) (645)
Accrued expenses 109 164
Cash to accrual adjustment (29) (58)
Contract loss reserves - 48
Other 238 297
4,455 4,574
Valuation allowance (1,058) (1,058)
Total $ 3,397 $ 3,516
==============---================
The valuation allowance at December 31, 1999 and 1998 primarily relates to
the future utilization of net operating loss carryforwards and foreign tax
credits that the Company has determined are not realizable at this time.
Management believes that it is more likely than not that the net deferred tax
asset as of December 31, 1999 is realizable.
12. Capital stock
As of December 31, 1999, the Company had 10,000,000 total shares of capital
stock authorized, of which 8,000,000 are common stock and 2,000,000 are
preferred stock. As of December 31, 1999 and 1998, there are no shares of
preferred stock outstanding. The Board of Directors has the authority to
establish one or more classes of preferred stock and to determine, within any
class of preferred stock, the preferences, rights and other terms of such class
13. Stock options
Long term incentive plan
During 1995, the Company established the 1995 Long-Term Incentive Stock
Option Plan (the "Plan"), which includes all officers, key employees and
non-employee members of the Company's Board of Directors. All options to
purchase shares of the Company's common stock under the Plan expire ten years
from the date of grant and generally become exercisable in three installments
with 40% vesting on the first anniversary of the grant date and 30% vesting on
each of the second and third anniversaries of the grant date, subject to
acceleration under certain circumstances. Under the original terms of the Plan,
the Company had reserved 425,000 shares of common stock for issuance of stock
options, which amount was increased to 625,000 shares in 1996 by action of the
Company's directors and stockholders.
In 1997, the executive and compensation committees of the Company's Board
of Directors determined that the purposes of the Plan were no longer being met
with respect to those individuals holding nonstatutory stock options with
exercise prices greater than the then-current market value of the Company's
common stock. As a result, the Company offered certain employees and
non-management directors who were holders of outstanding options under the Plan
as of December 1, 1997 the opportunity to exchange such options for replacement
stock options at an exercise price of $3.875 per share, the fair market value of
the Company's common stock at the close of business on that date. Each option
holder accepting such offer was required to surrender his or her existing option
and enter into new stock option agreements whereby each option's three-phased
vesting period (40% vested as of the first anniversary of the date of grant, 70%
vested as of the second anniversary of the date of grant, and 100% vested as of
the third anniversary of the date of grant) would re-commence as of December 1,
1997, the new date of grant. A total of 84 individuals were eligible to
participate in this replacement of options, and those individuals' existing
options had an average exercise price of $13.26 per share prior to the
replacement. Of such individuals, 81 participated in the replacement of options,
representing a total of 295,837 options which are included in the stock option
activity table as new options granted and options cancelled.
In November 1998, the Company amended the Plan such that the term of any
future options granted would be seven years and that upon termination, the
option holder would have 90 days in which to exercise options. Prior to the
amendment, the term of options granted was ten years and there were no time
frames related to termination.
On April 5, 1999, the Company amended and restated the Plan. The amendment
increased the number of shares available for issuance under the Plan, from
625,000 shares to 1,175,000 shares and also increased the maximum number of
shares with respect to which awards may be granted in any one fiscal year to any
one person from 100,000 shares to 400,000 shares. The class of eligible
individuals was expanded to include consultants, and the Plan was modified to
permit the Company to grant phantom stock awards and performance-based awards.
The amendment eliminated the Independent Director Program previously provided
under the Plan. Under the Independent Director Program, each non-employee
director of the Company received a nonqualified stock option for 1,500 shares on
initial election or appointment to the Board and on each following December 31st
while serving as a member of the board of directors. Pursuant to the amendment,
all awards granted under the Plan, including those granted to non-employee
directors, are determined at the discretion of the board of directors or the
compensation committee of the board of directors. The amendment will not
adversely affect the rights or obligations of award holders with respect to any
of their awards granted prior to the amendment. In December 1999, the number of
shares available for issuance under Plan was further increased by the Company
pending shareholder approval.
Stock option activity under the Plan is as follows:
Stock option activity under the plan is as follows:
1999 1998 1997
Weigted Weigted Weigted
Average Average Average
Shares Exercise Price Shares Exercise Price Shares Exercise Price
Options outstanding, beginning of period 535,206 $ 5.93 595,015 $ 6.89 413,366 $ 13.61
Options canceled (45,601) (5.62) (246,009) (4.77) (306,044) (11.57)
Options granted 678,000 4.07 186,200 2.79 487,693 4.12
Options outstanding, end of period 1,167,605 4.93 535,206 5.93 595,015 6.89
The following table summarizes information relating to currently
outstanding and exercisable options at December 31, 1999:
Options Outstanding Options Exercisable
Weighted
Average
Remaining Weighted Weighted
Range of Options Contract Average Options Average
Exercise Prices Outstanding Life in Years Exercise Price Outstanding Exercise Price
- ---------------------------------------------------------------------------------------------------------------------------
$1.48-$2.95 162,800 6.2 $ 2.69 55,480 $ 2.68
$2.96-$4.43 858,364 6.8 3.98 180,292 3.82
$4.44-$5.90 20,000 6.5 5.88 - -
$5.91-$10.32 - - - - -
$10.33-11.80 200 6.6 11.25 200 11.25
$11.81-$13.27 - - - - -
$13.28-$14.75 126,241 5.7 14.11 126,241 14.11
- ---------------------------------------------------------------------------------------------------------------------------
1,167,605 6.6 4.93 362,213 7.24
================----------------------------------------------================---------------------
The Company accounts for grants under the Plan in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. Accordingly, no compensation expense
has been recognized as all options granted under the Plan have been granted at
an exercise price equal to the fair value of the underlying common stock on the
date of grant. Had compensation expense been determined based on the fair value
at the grant dates for awards under the Plan consistent with the recognition
method of FAS No. 123, "Accounting for Stock Based Compensation," the Compan's
pro forma net income (loss) and basic and diluted earnings (loss) per common
share would have been approximately ($615,000) and ($.12), respectively, in
1999; $900,000 and $.18, respectively, in 1998; and ($10,276,000) and ($2.03),
respectively, in 1997.
The fair value of each option is estimated on the date of grant using a
Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants during the years ended December 31, 1999, 1998, and
1997, respectively: expected volatility of 82%, 61% and 80%, dividend yield of
0%, risk-free interest rates ranging from 5.6% to 6.6%, and expected terms
ranging from 3 to 7 years.
At December 31, 1999, the Company had 7,395 shares of common stock reserved
for the future grants under the Plan. The weighted average fair value of options
granted during 1999, 1998 and 1997 was $2.82 per share, $2.79 per share and
$3.00 per share, respectively.
In 1997, the Company granted one of its senior executives a stock option to
acquire 25,000 shares of common stock at an exercise price of $11.25. This grant
was not made pursuant to the Plan. This option expires ten years from the date
of grant and was exercisable in three installments with 40% vesting on the first
anniversary of the date of grant and 30% vesting on each of the second and third
anniversaries of the date of grant. During 1999, the executive terminated
employment with the Company and was vested in 70% of the stock options at the
date of termination. In accordance with the provisions of the Plan, no further
vesting will occur.
14. Commitments and contingencies
Leases
The Company is obligated under certain noncancelable operating leases for
office facilities and equipment. Future minimum lease payments under
noncancelable operating leases as of December 31, 1999 are approximately as
follows (in thousands):
2000 $ 2,017
2001 1,759
2002 1,379
2003 1,305
2004 1,339
Thereafter 4,591
Total $12,390
The future minimum lease payments above include approximately $28,000 for
noncancelable leases entered into during the first quarter of 2000. Total rent
expense under operating leases was approximately $2,013,000, $2,134,000, and
$3,220,000 for the years ended December 31, 1999, 1998 and 1997, respectively.
In early 1998, the Company entered into agreements whereby the lease for
its then-existing Columbia facility was terminated. The operations that occupied
this facility were relocated into two separate facilities during the second
quarter of 1998. One of these facilities is in Columbia, Maryland (approximately
53,000 square feet) and is occupied by the operations of Power Systems, as well
the Company's corporate headquarters offices and support functions; the other
facility is in Baltimore, Maryland (approximately 39,000 square feet) and is
occupied by the operations of Process Solutions. Each of the leases for these
smaller facilities has a term of ten years.
In addition, the Company leases office space domestically in Alabama,
Georgia, Louisiana, Texas, Pennsylvania, North and South Carolina, and
internationally in Belgium, Japan, Sweden, Taiwan, and the United Kingdom. The
Company leases these facilities for terms ending between 2000 and 2002. During
1999, as part of the wind down of the Oil & Gas BU, the Company's facilities in
Singapore and Korea were shut down
Letters of credit and performance bonds
As of December 31, 1999, the Company was contingently liable for three
letters of credit totaling approximately $765,000. Two of the letters of credit
represent payment bonds on contracts, while the remaining one was issued to the
landlord of the Company's previous facility (whose lease was terminated in
1998). Of the total amount of letters of credit, approximately $735,000 was
issued in 1998 through the Company's bank at the time and was supported by the
Company's credit facility. These letters of credit could not be reissued by the
Company's new financial institution, and in June 1999, the Company was required
to deposit funds with the issuing institution as collateral against the letters
of credit. Restricted cash of $255,000 will be released by the bank in 2000 upon
the expiration of the related letters of credit.
During 1998, the Company placed approximately $332,000 in escrow as a
performance bond deposit in connection with a simulator contract in Taiwan. Of
this amount, approximately $221,000 will be held in escrow until April 30, 2000
and approximately $111,000 will be held in escrow until April 30, 2003. These
deposits are classified in other assets on the Consolidated Balance Sheet at
December 31, 1999
Contingencies
Various actions and proceedings are presently pending to which the Company
is a party. In the opinion of management, the aggregate liabilities, if any,
arising from such actions are not expected to have a material adverse effect on
the financial position, results of operations or cash flows of the Company.
15. Related party transactions
A subsidiary of the Company subleased office space to ManTech based on
square footage used through May 1998. For the years ended December 31, 1998 and
1997 , such charges amounted to $30,000 and $117,000, respectively.
During 1997, ManTech entered into arrangements for the consulting services
of a member of the Company's finance staff. Payments to the Company for such
services were $92,000 for the year ended December 31, 1997.
In 1997, a subsidiary of the Company entered into certain agreements
regarding the formation of a joint venture with a company organized in the
People's Republic of China. In connection with the initial capitalization of
this joint venture, each of ManTech and GP Strategies made advances of $126,000
on behalf of the Company. During 1998, ManTech assumed control of the joint
venture. The operations of the joint venture were immaterial during the years
ended December 31, 1998 and 1997.
16. Employee benefits
The Company has a qualified defined contribution plan that covers
substantially all U.S. employees under Section 401(k) of the Internal Revenue
Code. Under this plan, the Company's stipulated basic contribution matches a
portion of the participants' contributions based upon a defined schedule.
Contributions are invested by an independent investment company in one or more
of several investment alternatives. The choice of investment alternatives is at
the election of each participating employee. The Company's contributions to the
plan were approximately $359,000, $468,000 and $524,000 for the years ended
December 31, 1999, 1998 and 1997, respectively.
During 1997, the Company recorded a net charge for severance and other
employee obligations of $1.1 million in connection with cost reduction efforts
initiated to offset the impact of a decrease in contract revenues. Of this
charge, $976,000 was expended as of December 31, 1997, with the remainder
expended in 1998.
17. Segment information
In 1998, the Company adopted FAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which establishes standards for reporting
and disclosure requirements for operating segments. The prior years' segment
information has been restated to present GSE's two reportable segments, Process
and Power, its core business units.
The accounting policies of the segments are the same as those described in
the "Summary of Significant Accounting Policies". The Company is primarily
organized on the basis of these two business units. The Company has a wide range
of knowledge of control and simulation systems and the processes those systems
are intended to improve, control and model. The Company's knowledge is
concentrated heavily in the process industries, which include the chemicals,
food & beverage, and pharmaceuticals fields, as well as in the power generation
industry. The Process business unit is primarily engaged in process control and
simulation in a variety of commercial industries. Contracts typically range from
three to nine months. The Power business unit is primarily engaged in simulation
for the power generation industry, with the vast majority of customers being in
the nuclear power industry. Contracts typically range from 18 months to three
years.
GSE evaluates the performance of its business units utilizing "Business
Unit Contribution", which is substantially equivalent to earnings before
interest and taxes (EBIT) before allocating any corporate expenses. The segment
information regarding the two divested businesses is also included below (see
Note 3, Acquisitions and dispositions).
The table below presents information about reported segments:
(in thousands)
Years ended December 31,
1999
Process Power Total
Contract revenue $34,638 $32,061 $66,699
Business unit contribution $ 1,026 $ 5,093 $ 6,119
1998
- --------------------------------------------------------------------------------------------------------------------
Process Power Total
Contract revenue $36,484 $30,930 $67,414
Business unit contribution $ 3,444 $ 4,535 $ 7,979
1997
- --------------------------------------------------------------------------------------------------------------------
Process Power Total
Contract revenue $34,837 $24,552 $59,389
Business unit contribution $ 3,480 $ 718 $ 4,198
A reconciliation of segment revenue to consolidated revenue and segment
business unit contribution to consolidated income before taxes for the years
ended December 31, 1999, 1998 and 1997 is as follows:
(in thousands)
Years ended December 31,
1999 1998 1997
- ---------------------------------------------------------------------------------------------
Total segment contract revenue $66,699 $67,414 $59,389
Erudite - 5,267 17,999
Oil & Gas - 1,137 2,323
Consolidated contract revenue $66,699 $73,818 $79,711
===============--==============--===============
Segment business unit contribution $ 6,119 $ 7,979 $ 4,198
Erudite and Oil & Gas business unit losses - (491) (4,848)
Corporate expenses (5,335) (5,271) (8,881)
Severance cost - - (1,124)
Gain on disposition of assets - 550 -
Interest expense, net (450) (350) (765)
Consolidated income (loss) before taxes $ 334 $ 2,417 $(11,420)
===============--==============--===============
The Company designs, develops and delivers business and technology
solutions to the energy, process and manufacturing industries worldwide.
Revenue, operating income and identifiable assets for the Company's United
States, European and Asian operations are as follows (in thousands):
Year Ended December 31, 1999
--------------------------------------------------------------------------------
United States Europe Asia Eliminations Consolidated
Contract revenue $ 60,150 $6,549 $ - $ - $ 66,699
Transfers between geographic locations 832 223 - (1,055) -
------------- ---------- ------------- --------------- --------------
Total contract revenue $ 60,982 $6,772 $ - $ (1,055) $ 66,699
============== ========== ============= =============== ==============
Operating income (loss) $ 1,690 ($946) $ - $ - $ 744
============= ========== ============= =============== =============
Identifiable assets $ 47,002 $4,568 $ 414 $ (8,956) $ 43,027
============== ========== ============= =============== ==============
Year Ended December 31, 1998
--------------------------------------------------------------------------------
United States Europe Asia Eliminations Consolidated
Contract revenue $ 62,689 $8,241 $ 2,888 $ - $ 73,818
Transfers between geographic locations 1,761 423 (2,184) -
------------- ---------- ------------- --------------- --------------
Total contract revenue $ 64,450 $8,664 $ 2,888 $ (2,184) $ 73,818
============= ========== ============= =============== ==============
Operating income (loss) $ 1,571 $ 592 $ (272) $ - $ 1,891
============= ========== ============= =============== ===============
Identifiable assets $ 50,904 $5,836 $ 953 $ (8,950) $ 48,743
============= ========== ============= =============== ==============
Year Ended December 31, 1997
--------------------------------------------------------------------------------
United States Europe Asia Eliminations Consolidated
Contract revenue $ 70,580 $5,907 $ 3,224 $ - $ 79,711
Transfers between geographic locations 1,582 - 1,314 (2,896) -
---------------- ---------- ------------- --------------- --------------
Total contract revenue $ 72,162 $5,907 $ 4,538 $ (2,896) $ 79,711
================ ========== ============= =============== ==============
Operating income (loss) $ (6,930) $ (324) $ (2,173) $ - $ (9,427)
================ ========== ============= =============== ==============
Identifiable assets $ 50,296 $3,686 $ 2,111 $ (7,731) $ 48,362
================ ========== ============= =============== ==============
18. Supplemental disclosure of cash flow information
(in thousands)
Years ended December 31,
1999 1998 1997
- ---------------------------------------------------------------------------------------------
Non-cash investing & financing activities:
Obligations under capital leases $ - $ 58 $ 102
===========---==========----===========
Notes payable to related party for
investment in joint venture $ - $ - $ 252
===========---==========----===========
Asset acquisitions financed with debt to seller (see Note 3):
Notes payable issued $598 $250 $ 900
===========---==========----===========
Interest $481 $580 $ 741
===========---==========----===========
Income taxes $683 $426 $ 233
===========---==========----===========
19. Subsequent events
Lines of credit
On March 23, 2000, the Company entered into a new loan and security
agreement with a financial institution for a new credit facility with a maturity
date of March 23, 2003. Borrowings from this facility were used to pay off the
existing debt under the Company's previous credit facility.
The new agreement established a $10 million line of bank credit for the
Company and its subsidiaries, GSE Process Solutions, Inc. and GSE Power Systems,
Inc, jointly and severally as co-borrowers. The credit facility provides for
borrowings to support working capital needs and foreign letters of credit ($2
million sublimit). The line is collateralized by substantially all of the
Company's assets and provides for borrowings up to 85% of eligible accounts
receivable, 50% of eligible unbilled receivables and 40% of eligible inventory
(up to a maximum of $1.2 million). In addition, ManTech has provided a one-year
$900,000 standby letter of credit to the bank as additional collateral for the
Company's credit facility. GSE is allowed to borrow up to 100% of the letter of
credit value. GP Strategies provided a limited guarantee totaling $1.8 million
ManTech has provided a limited guarantee totaling $900,000. The interest rate on
this line of credit is based on the bank's prime rate (9% as of March 30, 2000),
with interest only payments due monthly.
The loan and security agreement requires the Company to comply with certain
financial ratios and precludes the Company from paying dividends and making
acquisitions beyond certain limits without the bank's consent.
Capital stock issued
On January 27, 2000, the Company issued 116,959 shares of its common stock,
at fair market value less discount, to ManTech for $500,000. The proceeds of the
stock issuance were used for working capital.
Investment (unaudited)
In February, 2000 the Company participated in the founding of Avantium
Technologies, a high technology company that will employ high speed
experimentation and simulation ("SE&S") technologies in contract research and
development in the area of new product development and process chemistry. GSE is
an equity shareholder along with Shell International Chemical, SmithKline
Beecham, W.R. Grace, three Dutch universities (Technical University of Delft,
Technical University of Eindhoven, and Twente University) and three venture
capital firms (Alpinvest, The Generics Group, and S.R.One, the SmithKline
Beecham venture funding company). Avantium Technologies will deploy HSE&S
techniques to rapidly discover and optimize new processes and products of
interest to the petrochemicals, fine chemicals and pharmaceutical industries.
GSE will provide the basis for the informatics system that will automate and
maximize Avantium's lab environment. Additionally, the Company will utilize its
core simulation technologies to assist in the optimization of experimentation as
well as analysis of the resulting data.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1999
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
On October 19, 1999, GSE Systems, Inc. ("Registrant") notified their
independent accountants PricewaterhouseCoopers LLP ("PwC") that PwC would
not be reappointed as the Registrant's independent accountants for the
fiscal year ending December 31, 2000.
The reports of PwC on the Registrant's financial statements for each of the
past three fiscal years contained no adverse opinions or disclaimers of
opinion and were not qualified or modified as to uncertainty, audit scope
or accounting principle.
In connection with its audits for the three most recent years, there have
been no disagreements between the Registrant and PwC on any matter of
accounting principle or practices, financial statement disclosure, or
auditing scope or procedure, which disagreements if not resolved to the
satisfaction of PwC, would have caused them to make reference thereto in
their report on financial statements for such fiscal years.
During the three most recent fiscal years, there have been no reportable
events (as defined in Regulation S-K Item 304 (a) (1) (v) ).
The Registrant has requested that PwC furnish it with a letter addressed to
the SEC stating whether or not it agrees with the above statements. A copy
of such letter, dated March 30, 2000, is filed as Exhibit 16.1 to this Form
10-K.
PART III
The information required in response to Items 10, 11, 12 and 13 is hereby
incorporated by reference to the information under the captions "Election
of Directors", "Principal Executive Officers of the Company Who Are Not
Also Directors", "Executive Compensation", "Voting Securities and Principal
Stockholders", "Security Ownership of Management", and "Certain Related
Transactions" in the Proxy Statement for the Company's 2000 Annual Meeting
of Shareholders.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a)(1) List of Financial Statements
The following financial statements are included in Item 8:
GSE Systems, Inc. and Subsidiaries
Report of Independent Accountants
Consolidated Balance Sheets as of December 31, 1999 and 1998
Consolidated Statements of Operations for the years ended December 31,
1999, 1998 and 1997
Consolidated Statements of Comprehensive Income (Loss) for the years ended
December 31, 1999, 1998 and 1997
Consolidated Statements of Changes in Stockholders' Equity for the years
ended December 31, 1999, 1998 and 1997
Consolidated Statements of Cash Flows for the years ended December 31, 1999
and 1998 and 1997
Notes to Consolidated Financial Statements
(a)(2) List of Schedules
All other schedules to the consolidated financial statements are
omitted as the required information is either inapplicable or presented in
the consolidated financial statements or related notes.
(a)(3) List of Exhibits
The Exhibits which are filed with this report or which are
incorporated by reference are set forth in the Exhibit Index hereto.
(b) Reports on Form 8-K:
No current report on Form 8-K was filed by the Registrant with the
Securities and Exchange Commission during the quarter ended December 31,
1999.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
GSE Systems, Inc.
By: /s/ Christopher M. Carnavos
Christopher M. Carnavos
Director, Chief Executive Officer and President
Pursuant to the requirements of the Securities Act, this report has
been signed by the following persons in the capacities and on the dates
indicated.
Date: March 30, 2000 /s/ CHRISTOPHER M. CARNAVOS
Christopher M. Carnavos, Director,
Chief Executive Officer and President
(Principal Executive Officer)
Date: March 30, 2000 /s/ JEFFERY G. HOUGH
Jeffery G. Hough, Senior Vice President
and Chief Financial Officer
Principal Financial and Accounting Officer)
Date: March 30, 2000
(Jerome I. Feldman, Chairman of the Board) By/s/JEFFERY G. HOUGH
(Scott N. Greenberg, Director) Jeffery G. Hough
(John A. Moore, Jr. Director) Attorney-in-Fact
(George J. Pedersen, Director)
A Power of Attorney, dated March 30, 2000, authorizing Jeffery G.
Hough to sign this Annual Report on Form 10-K for the fiscal year ended
December 31, 1999 on behalf of certain of the directors of the Registrant
is filed as Exhibit 24 to this Annual Report.