Back to GetFilings.com
Conformed
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
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, 2002
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:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
Common Stock, $.01 par value American Stock Exchange
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. [ X ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes [ ] No [ X ]
The aggregate market value of Common Stock held by non-affiliates as of
June 30, 2002 was $15,964,055 based on closing price of such stock on that date
of $2.72.
Number of shares of Common Stock outstanding as of March 11, 2003: 5,869,138
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates certain information by reference from the
Registrant's definitive proxy statement to be filed for its 2003 Annual Meeting
of Shareholders.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 2002
TABLE OF CONTENTS
PART I Page
----
Item 1. Business.......................................................3
Item 2. Properties....................................................29
Item 3. Legal Proceedings.............................................29
Item 4. Submission of Matters to a Vote of Security Holders..........29
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters.........................................30
Item 6. Selected Financial Data.......................................32
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................33
Item 7A. Quantitative and Qualitative Disclosures About Market Risk....48
Item 8. Financial Statements and Supplementary Data...................49
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure......................50
PART III
Item 10. Directors and Executive Officers of the Company*..............51
Item 11. Executive Compensation*.......................................51
Item 12. Security Ownership of Certain Beneficial Owners
and Management*.............................................51
Item 13. Certain Relationships and Related Transactions*...............51
Item 14. Controls and Procedures.......................................51
PART IV
Item 15. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K.........................................52
SIGNATURES....................................................53
302 CERTIFICATIONS............................................54
906 CERTIFICATIONS............................................56
Exhibits Index................................................57
* to be incorporated by reference from the Proxy Statement for the
registrant's 2003 Annual Meeting of Shareholders.
D/3(R), D/3 DCS(R), SABL(R), TotalVision(R), FlexBatch(R) and RETACT(R) are
registered trademarks and GFLOW+(TM), GLOGIC+(TM), GCONTROL+(TM), GPower+(TM),
SimSuite Power(TM), SimSuite Pro(TM), SimExec(TM), eXtreme I/S(TM), RACS(TM),
PEGASUS Plant Surveillance and Diagnosis System(TM), SIMONTM, BRUS(TM),
SensBase(TM), Vista PIN(TM), TotalWebVision(TM), Java Applications & Development
Environment (JADE)(TM) and GAARDS(TM) are trademarks of GSE Systems, Inc. All
other trademarks used in this document are the property of their respective
owners.
Cautionary Statement Regarding Forward-Looking Statements.
This report contains certain forward-looking statements. Any statements
contained herein that are not statements of historical facts may be deemed
forward-looking statements. These statements are based on management's current
beliefs and expectations and are subject to numerous risks and uncertainties and
changes in circumstances. Actual results may differ materially from these
forward-looking statements due to changes in global, economic, business,
governmental, technical, competitive, market and regulatory factors.
PART I
ITEM 1. BUSINESS.
GSE Systems, Inc. ("GSE Systems", "GSE" or the "Company") is a world
leader in real-time power plant simulation and process automation and control.
The Company provides simulation solutions and services to the nuclear and fossil
electric utility industry, as well as process industries such as the chemical
and petrochemical industries. In addition, the Company provides plant
monitoring, security access and control, and signal analysis monitoring and
optimization software primarily to the power industry. The Company's process
automation products optimize batch and hybrid plant control for the specialty
chemical, food and beverage, and pharmaceutical industries. The Company operates
through two business segments, Power Simulation and Process Automation.
In addition to these two core businesses, GSE has invested in the use of
simulation and control technologies to reduce the product development cycle for
the pharmaceutical and chemical industries through its participation in the
Netherlands-based company Avantium International BV.
The Company's annual report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and all amendments to those reports will be made
available free of charge through the Investor Relations section of the Company's
Internet website (http://www.gses.com) as soon as practicable after such
material is electronically filed with, or furnished to, the Securities and
Exchange Commission.
Recent Developments.
Power Simulation Business
The Company's Power Simulation Business was significantly impacted in 2002
by the delay of several international multi-million dollar projects. For various
reasons, the awarding of these contracts was delayed by the customers until late
2002 or 2003. The US upgrade market was much stronger in 2002 than in the prior
year, however, the strength in this market was not sufficient to ensure the
profitability of the business unit. In addition, Power began marketing its plant
access control and intrusion detection system in 2002 to nuclear power plants;
this technology had been acquired in a previous year but the Company had not
committed resources to its development until 2002. Due to the lower revenues,
the business unit reduced its on-going operating costs in 2002 by implementing
two personnel reductions, one in April and one in September. Power's total
employees decreased 13.1% to 119 at December 31, 2002.
The Company's Power Simulation Business Unit ("Power") is positioning
itself to take advantage of emerging trends in the power industry. The operating
licenses for numerous nuclear power plants will expire over the next several
years. Ten plants have already received license extensions, and twenty more have
applications pending. Many plants are also planning significant upgrades to the
physical equipment and control room technology in conjunction with the license
extensions. Both will result in the need to modify or replace the existing plant
control room simulators. The Company, having the largest installed base of
existing simulators, is well positioned to capture the majority of this
business.
To address the varying levels of technology that exists across the
Company's installed base, the Company has developed a Java-based graphical
overlay technology called JADE (Java Application Development Environment). JADE
provides a common look and feel to the Company's various simulation tools
regardless of whether the underlying technology is UNIX, LINUX or Microsoft
Windows XP. JADE also works with all of the Company's tools for building
electrical, logic and control, and flow system models for plants.
The Company continues to focus on the fossil power segment of the power
industry. Several fossil plant simulators were delivered in 2002 receiving broad
acclaim from customers. The G-Suite tools developed in 2000 have enabled the
Company to effectively compete in the fossil market segment. These tools have
also been converted and are included in the JADE product line. The Company also
entered into a licensing arrangement with the Russian Research Center "Kurchatov
Institute", allowing the Company to utilize and market Kurchatov's SIMPORT
technology. This robust, object-oriented technology gives the Company an
additional technology offering for the fossil market to meet a variety of market
demands.
While GSE simulators are primarily utilized for power plant operator
training, the uses are expanding to include engineering, plant modification
studies, and operation efficiency improvements for both nuclear and fossil
utilities. During plant construction, simulators are used to test control
strategies and ensure on-time start-up. After commissioning, the same tools can
be used to increase plant availability and optimize plant performance for the
life of the facility. In 2002, the Company developed a plant optimization scheme
using its simulation technology in a new and unique way. The Company is actively
seeking partners to help bring this new application to the marketplace.
In 2002, the Company continued to expand the sale of its plant
optimization tools based on advanced signal analysis technology. The Company's
Pegasus Plant Surveillance and Diagnosis System helps improve plant
availability, safety and economy. Pegasus is a software package for
semi-automatic plant surveillance and diagnostics and enables site engineers to
perform detailed analysis for specified component faults, allowing the
identification of degraded performance and replacement of components before they
fail. SensBase provides comprehensive sensor test services, thus ensuring that
changes in transmitters and other instruments do not jeopardize the function of
the nuclear plant protection systems. BRUS, a noise analysis program package, is
a collection of signal analysis tools which allow users to detect developing
abnormalities in the plant. The Company's worldwide reputation for boiling water
reactor stability training lead to an increase in sales of both stability
training courses, and the Company's SIMON Stability Monitoring equipment. The
Company has been very successful in selling this technology to European and
Asian customers and is investigating its viability in the US market.
In 2001, the Company entered into a strategic marketing alliance with
General Physics Corporation, which is expected to help expand the Power
business. General Physics Corporation is the leading supplier of operator
instructional training programs for the Power industry. Whereas GSE is the
leading manufacturer of operating training simulators for the Power industry,
the alliance with General Physics Corporation will allow a more encompassing
solution to both companies' client base and strengthen their respective product
lines. In addition to cooperating in marketing of individual products, the
companies will combine some of General Physics' extensive training materials and
programs with GSE's power plant simulation models to provide truly interactive
and adaptive total training solutions. GSE will also help sell and distribute
General Physics' GFE product to GSE's customer base. The companies are working
towards a unique web-enabled training capability offering the Company's
simulation technology.
In light of recent security concerns at nuclear plants and other sensitive
locations, the Company began to aggressively market its access control and
intrusion detection system to the nuclear and process industries, technology
that the Company had acquired several years ago but had not committed resources
to develop. In 2002, the Company hired technical and marketing staff to grow the
security business. As a result, the Company secured a contract in 2002 with a
major nuclear utility to upgrade the security system at one of its nuclear power
plants with GAARDS (GSE Alarm, Access, Reporting and Detection System), and to
provide licenses to extend the technology to each of the other nuclear plants
operated by the utility. GAARDS is targeted at highly regulated industries that
require a very robust and feature rich security system. The system is a command
and control center that integrates information card readers, retinal scanners,
closed circuit TV and other field devices used for intrusion detection and
personnel access control. The Company is also teaming with ManTech Security
Technologies Company, a subsidiary of one of its principle shareholders, and
other industry security experts to provide turnkey capabilities to the nuclear
industry. Services include threat and vulnerability assessments, risk mitigation
plans, cost/benefit analysis, security system design, implementation, testing
and training.
In 2002, the chemical industry embarked on a self regulated program to
assess vulnerability to physical and cyber security at chemical plants. Now that
many of those assessments are complete, the Company believes that these plants
will begin to upgrade their existing access control and intrusion detection
systems in 2003 and beyond. Accordingly, the Company launched several marketing
campaigns to promote GAARDS in anticipation of this emerging demand.
The Company also believes it is uniquely qualified to apply its plant
design and operations knowledge as well as simulation technology to help
customers analyze security threats and develop strategies to test plant recovery
strategies in the event of an incident.
The Company entered into an agreement with RedStorm Scientific Inc. in
2002 for the use of GSE software in the drug discovery process. RedStorm is a
privately held computational drug design company. Its technology (patents
pending), known as Fyrestar, utilizes bio-informatics and computer-aided
molecular design to create lead compounds that are developed into successful new
drugs. It greatly reduces the significant cost associated with screening
thousands of potential compounds common in the drug development process. Under
the terms of the agreement, GSE will utilize its eSMART simulation software and
graphical user interface to enable scientists to easily access and use the
Fyrestar technology, graphically displaying results as the calculations take
place. This will enable scientists to adjust their assumptions in real time, and
further improve results.
Process Automation Business
The Process Automation Business was profitable in 2002, however, their
revenues declined from 2001 mainly due to reduced spending from their largest
customer, Westinghouse Savannah River Corporation. Many of Process' customers
continue to delay capital expenditures due to the overall US economy and
continue to postpone significant upgrades to their process control systems.
After downsizing significantly in 2000 and limiting its marketing expenditures
for the last several years, Process increased its marketing efforts
significantly in 2002 to introduce new products, improve customer's awareness of
the Company and its products, and revamp its marketing collateral.
To expand within its traditional customer base and gain new customers,
Process embarked upon a program in 2002 to develop a lower-cost, next generation
process controller using the latest microprocessor technology. This new
controller was part of the third quarter 2002 D/3 product release that also
included enhanced alarming and improved security features. This new version of
the D/3 product will allow the Company to bridge the cost gap between
programmable logic controllers (PLCs) and the distributed control systems while
providing the increased performance of a full-function distributed control
system. This more cost effective solution will enable existing customers to
apply automation to areas of their plants that could not previously afford the
benefits of a full-function distributed control system. The Company has
initiated a program to expand its distribution channels for its new products,
particularly in smaller, batch applications where previously the power of the
D/3 could not be cost effectively applied. To this end the Company has partnered
with six Manufacturer's Representative organizations and two Systems Integrator
companies. This new Channel Partnership program has increased the number of
salespeople selling the D/3 by over fifty. The Company intends to add additional
partners as needed.
In support of the aggressive sales efforts, the Process business unit
also initiated a number of marketing activities in 2002 in an effort to improve
awareness of GSE Systems in the marketplace. Although the D/3 family of
technology products is superior to other offerings, many potential new customers
are not aware of the Company. Accordingly, Process created an integrated
marketing program to reach new customers which included:
* Designing and developing new corporate brochures, pamphlets and other
marketing literature,
* Developing a new web site that was released in August,
* Launching two direct mail campaigns--one for existing customers and the
other for prospects in the specialty chemical, pharmaceutical, and
food and beverage industries,
* Launching a public relations campaign in an effort to use the media for
awareness,
* Establishing a contract with ARC Advisory Group, a leading analyst firm
in the process manufacturing industry, and
* Launching a customer reference program in an effort to document
successes with our loyal customer base.
In October 2002, GSE purchased the stock of ManTech Automation Systems
(Beijing) Company Ltd, from ManTech International Corp. (ManTech is a principle
shareholder of the Company). The Chinese company, which has seven employees, was
renamed GSE Systems Engineering (Beijing) Company Ltd. This acquisition gave the
Company a much needed base in China to pursue and implement automation and
simulation projects in that emerging market. In order to compete in the world
market, many large manufacturing companies have moved or intend to move some of
their manufacturing plants to China to take advantage of low labor costs and to
be positioned to participate in the large Chinese market. GSE has been informed
of such plans by some of its existing customers; these customers have indicated
that they intend to install GSE's D/3 control systems for their automation
processes in these new facilities. In 2002, GSE received a contract in China for
delivering a D/3 system and process simulation software; this project was
implemented by our Chinese subsidiary successfully with minimum support from GSE
headquarters. The Company believes that its new Chinese operation will be able
to provide critical local services that will enable the Company to meet the
needs of the Chinese market. Access to low cost engineering labor will also
enable the Company to be more competitive in its worldwide operations.
Research and Development
Throughout the year, GSE continued to invest in its core products of D/3
Distributed Control System and Power simulation technology. As mentioned above,
the Company enhanced the capabilities of the D/3 through significant investment
in a lower-cost, next generation process controller using the latest
microprocessor technology. This new controller was part of the third quarter
2002 D/3 product release that also included enhanced alarming and improved
security features. GSE also invested in the development of additional
enhancements to its FlexBatch Recipe and Process Management software.
The Company also released several power plant simulation tools using Java
Technology in 2002. The Graphic User Interfaces (GUI) for the Power GSuite and
Topmeret tools were replaced with a Java-based GUI, thus providing platform
independence and internet enabling. These tools include JElectric, JFlow,
JDesigner, JLogic, JControl, JExec and JStation which are the software packages
of the JADE suite of tools.
Background.
GSE Systems was formed on March 30, 1994 to consolidate the simulation and
related businesses of S3 Technologies, General Physics International Engineering
& Simulation and EuroSim, each separately owned and operated by ManTech
International Corporation, GP Strategies Corporation and Vattenfall AB,
respectively. 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 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
Company's pre-existing technology with the technical staff of the acquired Ryan
business positioned the Company to be more competitive for modifications and
upgrade service projects within the nuclear simulation market.
In April 1999, the Company acquired certain assets and employed the
associates of BatchCAD Limited. The BatchCAD product was a key element in the
Company's VirtualPlant business and marketing strategy.
In early 2000, while implementing the VirtualPlant strategy, the Company
participated in the founding of Avantium International B.V. Avantium, a
Netherlands-based high technology company, employs high-speed experimentation
and simulation technologies in contract research and development in the area of
new product development and process chemistry. In connection with Avantium's
founding, the Company licensed certain of its simulation software and automation
system products in exchange for Avantium preferred and common stock. GSE was
subsequently hired by Avantium to provide software to automate and maximize
Avantium's lab environment. Avantium also hired the Company to make certain
improvements and enhancements to the software it licensed to Avantium.
In early 2000, GSE determined that outside investment was required to
support its VirtualPlant business, however, the Company was unsuccessful in
attracting the needed capital on acceptable terms. Accordingly, in March 2001,
the Company sold its VirtualPlant assets and technology, including its BatchCAD
product, to Avantium. GSE received 200,000 shares of Avantium preferred stock
and 280,000 shares of Avantium common stock. At December 31, 2002 the Company
owned 6.1% of Avantium.
During 2002, the Company invested in RedStorm Scientific Inc., an emerging
biotechnology company utilizing a proprietary (patent pending) computational
technology for protein analysis called Fyrestar. RedStorm Scientific Inc. needed
a software development and operating environment to optimize the Fyrestar code.
The Company customized its eSMART (engineering, Simulation, Management and
Real-Time) product. In addition to the potential growth of RedStorm Scientific
Inc., the Company proved that eSMART is a viable product to help companies,
laboratories and educational institutions optimize their large, complex and
often inefficient computer codes. At December 31, 2002 the Company owned 10.2%
of RedStorm.
In October 2002, GSE purchased the stock of ManTech Automation Systems
(Beijing) Company Ltd, from ManTech International Corp. The Chinese company,
which has seven employees, was renamed GSE Systems Engineering (Beijing) Company
Ltd. This acquisition gave the Company a much needed based in China to pursue
and implement automation and simulation projects in that emerging market.
Power Simulation Business.
The Company's Power Simulation Business is comprised of three
divisions: Power Simulation, Plant Security Systems, and Process Simulation.
Power Simulation.
Industry
The real-time simulation industry grew from the need to train people on
complex and potentially dangerous operations, without placing life or capital
assets at risk. Real-time simulation has been used for the training of plant
operators for the power industry, including both nuclear power plants and
conventional fossil fuel power plants (i.e., coal, oil, and natural gas), since
the early 1970s. Real-time simulation usage has traditionally centered on
initial training of operators and follow-on training of operators in emergency
conditions that can best be achieved through simulation replicating actual plant
operations.
In the nuclear power industry, use of a simulator that accurately reflects
the current actual plant design is mandated by the U.S. Nuclear Regulatory
Commission. This mandate resulted from the investigation of the accident at the
Three Mile Island nuclear plant in 1979, which was attributed, at least in part,
to operator error. The NRC requires nuclear plant operators to earn their
licenses through simulator testing. Each nuclear plant simulator must pass a
certification program to ensure that the initial plant design and all subsequent
changes made to the actual plant control room or plant operations are accurately
reflected in the simulator. Plant operating licenses are tied to simulator
certification.
Full scope power plant simulators are a physical representation of the
entire plant control room. The control panels are connected to an input/output
(I/O) system, which converts analog electrical signals to digital signals
understood by the simulation computer. The simulation computer houses the
mathematical models, which simulate the physical performance of the power
plant's systems such as the reactor core, steam boiler, cooling water, steam
turbine, electrical generator, plant system controls and electrical distribution
systems. Partial scope simulators can be viewed as a subset of a full scope
simulator. Instead of simulating the entire performance of the power plant, a
partial scope simulator might represent one or two critical systems such as the
steam turbine and/or electrical generator operation.
In the past, training simulators had to strike a delicate balance between
providing an accurate engineering representation of the plant, while still
operating in "real-time" in order to provide effective training. As computing
power has increased, so too has the capacity of simulators to provide more
accurate plant representations in real-time based upon simulation models
developed from engineering design codes.
Simulation also is used to validate proposed plant equipment changes to
confirm the results of such changes, prior to making the change in the plant,
which can save time and money, as well as reduce the risk of unsafe designs, for
the utility.
Demand for new simulators in the nuclear power industry shifted to the
international market in the 1990s, as the domestic market was limited to
upgrades and replacement of existing simulators. However, the Company believes
that the new National Energy Policy's emphasis on the importance of nuclear
power to the U.S. energy supply may result in the extension of the useful lives
of U.S. nuclear power plants. Any service life extension of a nuclear power
plant is likely to require major upgrades to the plant's equipment and
technology, including its simulator.
Fossil fuel plant simulators are not required by law or regulation, but
are justified as a cost-effective approach to train operators on new digital
control systems being implemented at many fossil fuel power plants. The size,
complexity and price of a fossil plant simulator are much lower than for
simulators used for nuclear plants. Fossil plant simulators have traditionally
used lower fidelity (less sophisticated) mathematical models to provide an
approximate representation of plant performance. The demand for highly accurate
models did not exist in the early market for fossil simulators since the main
use of the simulator was to train operators on the functionality of distributed
control systems for plant start-up activities.
The deregulation of the power industry has forced utilities to view their
assets differently. Power plants must now be profit centers, and gaining the
maximum efficiency from the plant to become, or remain, competitive is a
paramount issue. The mindset of the operator has shifted, as plant operators now
must perform within narrower and narrower performance margins while still
maintaining safe operations. GSE believes its fossil fuel plant customers are
now recognizing the benefits of high fidelity simulation models that provide
highly accurate representations of plant operations to help plant operators and
management determine optimal performance conditions.
Despite the recent down-turn in the domestic power plant development
market, the Company sees two trends which may indicate the need for more
simulation products and services. First, the license extension process in the
nuclear industry may result in significant changes in plant equipment and
control room technology. Based upon US Nuclear Regulatory Commission
regulations, each training simulator is required to reflect all changes that are
made in the actual plant, thus when changes in plant equipment and control room
technology are made, the nuclear power plants must either upgrade existing
simulators or purchase brand new simulators. Second, the aging of the nuclear
and fossil plant operator workforce will result in the need for simulation to
train the next generation of plant operators.
Therefore, the Company believes that these trends, if they come to
fruition in whole or even in part, represent a market opportunity for its
real-time simulation, plant optimization, asset management and condition
monitoring products and services.
GSE's solution
The Company's Power Simulation business is a leader in the development,
marketing and support of high fidelity, real-time, dynamic simulation software
for the electric utility industry. The Company has built or modified about 65 of
the approximately 75 full-scope simulators serving about 103 operating nuclear
power plants in the United States. Outside the United States, GSE has built or
modified about 73 of the approximately 167 full-scope simulators serving
approximately 329 operating nuclear power plants.
In addition to operator training, the Company's simulation products and
services permit plant owners and operators to simulate the effects of changes in
plant configuration and performance conditions to optimize plant operation.
These features allow the Company's customers to understand the cost implications
of replacing a piece of equipment, installing new technology or holding
out-of-service assets. GSE has also developed a suite of tools based on
sophisticated signal analysis and simulation techniques to help its customers
manage their assets by determining equipment degradation before it severely
impacts plant performance.
The Company has also focused on upgrading older technology used in power
plants to new technology upgrades for plant process computers, safety parameter
display systems, and plant access security systems. As nuclear plants in the
U.S. continue to age, the Company will seek more business in this upgrade
market.
GSE provides both turnkey solutions, including simulated hardware and
proprietary software, to match a specific plant, and discrete simulation
technology for specific uses throughout a plant. Its substantial investment in
simulation technology has led to the development of proprietary software tools.
These tools significantly reduce the cost and time to implement simulation
solutions and support long-term maintenance. The Company's high fidelity,
real-time simulation technology for power plant fluid, logic and control,
electrical systems and associated real time support software, JADE, is available
in UNIX, Linux, and Windows XP computer platforms. This technology is
specifically designed to provide user friendly graphic interfaces to the
Company's high fidelity simulator.
In addition to the simulator market, the Company offers products aimed at
improving performance of existing plants by reducing the number of unplanned
outages due to equipment failure. Using advanced signal analysis techniques, the
Company's tools can predict when certain plant equipment needs to be replaced.
Replacement of critical equipment prior to failure permits effective planning
and efficient use of maintenance time during scheduled off-line periods. In the
future, the Company will apply this technology to its process control systems to
help customers better manage plant assets.
Other products of the Power Simulation business include:
* Java Applications & Development Environment (JADE), a Java-based
application that provides a window into the simulation instructor station
and takes advantage of the web capabilities of Java, allowing customers to
access the simulator and run simulation scenarios from anywhere they have
access to the web. JADE includes the following software modeling tools:
* Jflow, a modeling tool that generates dynamic models for flow and
pressure networks.
* Jcontrol, a modeling tool that generates control logic models from
logic diagrams.
* Jlogic, a modeling tool that generates control logic models from
schematic diagrams.
* Jelectric, a modeling tool that generates electric system models from
schematic and one-line diagrams.
* Jtopmeret, a modeling tool that generates two phase network dynamic
models.
* Jdesigner, a JADE based intuitive graphic editor for all JADE tools.
* Jstation, a JADE based web-enabled Instructor Station.
* G_Suite, a suite of software modeling tools developed under the
Microsoft Windows environment. It includes:
* Gflow, a modeling tool that generates dynamic models for flow and
pressure networks.
* Gcontrol, a modeling tool that generates control logic models from
logic diagrams.
* Glogic, a modeling tool that generates control logic models from
schematic diagrams.
* Gelectric a modeling tool that generates electric
system models from schematic and one-line diagrams.
* SimExec, a Windows NT-based real-time simulation executive system that
controls all real-time simulation activities and allows for an off-line
software development environment in parallel with the training environment.
It runs on Microsoft Windows, UNIX and LINUX operating systems.
* SmartTutor, complementary software for instructor stations. It provides
new capabilities to help improve training methodologies and productivity.
Using Microsoft ActiveX controls, SmartTutor allows the control of the
simulator software directly from Microsoft Office products. The user can
run training scenarios directly from a Microsoft Word document, or he can
plot and show transients live within a Microsoft PowerPoint slide.
* eXtreme I/S, a Microsoft Windows based Instructor Station that allows
the use of Microsoft Word and PowerPoint to control the real-time
simulation environment. eXtreme I/S is a user-friendly tool for classroom
training and electronic report generation. It provides real-time plant
performance directly from the simulator during classroom training, which
drastically increases learning efficiency.
* Pegasus Surveillance and Diagnosis System, a software package for
semi-automatic plant surveillance and diagnostics, incorporates
sophisticated signal processing and simulation techniques to help operators
evaluate the condition and performance of plant components. Pegasus permits
plant management to identify degraded performance and replace components
before they fail.
* 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.
* Vista PIN, a PC-based plant information system, provides unparalleled
flexibility usefulness and ease of maintenance while decreasing the cost of
ownership. Vista PIN provides real-time display of process parameters,
trends, alarm status, and historical data archiving with on-line retrieval.
The Power Simulation business also provides consulting and engineering
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.
Strategy
The goal of the Power Simulation business is to expand its business on
three fronts. First, it intends to continue serving its traditional customer
base and to be prepared to meet increased demand if traditional simulation use
grows in relation to increased electric capacity in the United States. Second,
it intends to market its existing and upgraded simulation products and its newly
developed signal analysis products as plant optimization, asset management and
condition monitoring tools. And, third, it intends to leverage its existing
engineering staff to provide additional services to domestic and international
clients.
Traditional Simulation Market. Nuclear power currently accounts for about
20% of the electrical power grid capacity in the United States and this
percentage will likely remain the same even as total capacity increases. Any new
nuclear power plants will likely be of the advanced reactor designs created by
Westinghouse, General Electric and Siemens. These new designs require new
simulators and training programs, as they are different from the nuclear power
plant designs currently in operation. In addition to new power plants existing
nuclear power plants will likely be required to remain on-line for a longer
period than originally expected. In order to stay in operation, many plants will
require life extension modifications. Since all existing US nuclear power plants
went on-line before 1979, their designs and technology can also benefit from the
substantial advances in plant design and technology developed over the past 20
years. For example, several of the Company's U.S. utility customers are
considering replacing their existing hard panel control rooms with modern
distributed control systems (DCS) as are common in fossil fuel plants, and which
have been implemented in Europe for several years. Significant changes to
control room instrumentation and overall control strategy from hard panel to DCS
generally require modification or replacement of the plant simulator. With the
largest installed base of nuclear plant simulators in the world, the Company
believes it is uniquely positioned to serve this market segment with new
simulation products and services.
As plants extend their useful life, many plan to "up-rate" the existing
capacity to increase electrical yield. By changing the capacity of certain
equipment in a plant, the utility can gain upwards of a 10%-15% increase in
output. Again, any such changes must be reflected in the control room simulator,
and operators must be trained on the new equipment before implementation.
In addition to the United States markets, several emerging regions of the
world are expanding their electrical capacity with both nuclear and fossil fuel
power plants. The Company believes this expansion includes the need for
integrated simulation and training programs and has developed products that will
enable it to exploit the fossil fuel simulation marketplace. GSE is increasing
its marketing efforts in this area
Simulation Beyond Training. In addition to operator training, the
Company's simulation products can meet this increased need for efficiency by
assisting plant operators in understanding the cost implications of replacing
equipment, installing new technology and maintaining out-of-service assets. In
order to exploit this potential, the Company has increased the fidelity of its
simulation products and is marketing its services to increase the fidelity of
simulators that are already in operation.
As computing power and networking technologies improve, several of the
Company's customers have started to migrate simulation technology from the
training organization to the engineering organization. The same full scope
simulation software that drives the simulated control room panels in a simulator
can be used with graphical representations of the panels so engineers can test
design changes and see how the balance of the plant will react to such changes.
GSE has developed a Java-based application to allow customers easier access to,
and use of, the simulation capabilities across the organization through network
communication.
Optimize Existing Engineering Resources. GSE's Power domestic service
organization focuses on simulator upgrades and retrofits. This group employs
over 20 engineers, and in addition, the Company employs over 60 engineers at
the Columbia, Maryland headquarters capable of servicing the upgrade/retrofit
and new simulator market. In addition to domestic resources, GSE has developed a
network of trained engineers in Russia, Ukraine, Czech Republic, Bulgaria, India
and China. These foreign resources provide low cost engineering and software
development capabilities and are readily available to supplement the United
States engineering staff as necessary.
In addition, the Power Simulation business has grown through acquisitions
and will continue to pursue acquisitions and investment opportunities that will
create value and enhance cash flow. The Company targets acquisitions and
investments that provide:
* Cost savings opportunities
* Enhanced positioning in existing markets
* Entry into new geographic and industry markets
* Turnaround opportunities for under-performing businesses
Strategic Alliances
Power's strategic alliances have enabled the Company to penetrate regions
outside the United States by combining the Company's technological expertise
with the regional presence and knowledge of local market participants. These
strategic alliances have also permitted the reduction of research and
development and marketing costs by sharing such costs with other companies.
In recent years, an increasing amount of the Company's international
business has come from contracts in Eastern Europe, including the republics of
the former Soviet Union, the Pacific Rim and India. 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 Beijing Jihang Automation (China); All Russian Research Institute
for Nuclear Power Plant Operation (Russia); Kurchatov Institute (Russia); Macmet
Ltd. (India); PowerGen (England); Risk Engineering Ltd. (Bulgaria); Samsung
Electronics (Korea); Toyo Engineering Corporation (Japan); and the Institute for
Information Industry (Taiwan).
In addition to traditional partners, GSE has developed a marketing
cooperation arrangement with the Power Technology group of PowerGen, the UK's
largest power company. This relationship gives GSE access to the European fossil
simulation market, as well as the tools necessary to simulate the Siemens
Teleperm control system, one of the more popular control systems being offered
to U.S. nuclear power plants.
Competition
The Power Simulation business encounters intense competition. In the
nuclear simulation market, GSE competes directly with larger firms primarily
from Canada and Germany, such as Canadian Aerospace & Electronics (CAE), and STN
Atlas. The fossil simulation market is represented by smaller companies in the
U.S. and overseas. Several of the Company's competitors have greater capital and
other resources than it has, including, among other advantages, more personnel
and greater marketing, financial, technical and research and development
capabilities. Customer purchasing decisions are generally based upon price, the
quality of the technology, experience in related projects, and the financial
stability of the supplier.
Customers
The Power Simulation business has provided approximately 200 simulation
systems to an installed base of over 75 customers worldwide. In 2002,
approximately 57% of the Power Simulation revenue was generated from end users
outside the United States. Customers include, among others, Ameren, Arizona
Public Service, Carolina Power and Light Company, Commonwealth Edison Company,
Eskom South Africa, Karnaraft Sakerhet & Utbildning AB, Korean Electric Power
Company, Nationalina Elecktrischecka Kompania, Orgrez SC, Battelle's Pacific
Northwest National Laboratory, Taiwan Power Company, and West Bengal Development
Corp.
For the years ended December 31, 2002, 2001, and 2000 one Power Simulation
customer (Battelle's Pacific Northwest National Laboratory) accounted for
approximately 11%, 17%, and 22%, respectively, of GSE's consolidated revenues.
The Pacific Northwest National Laboratory is the purchasing agent for the
Department of Energy and the numerous projects GSE performs in Eastern and
Central Europe.
Sales and Marketing
The Company markets its Power Simulation products and services through a
network of direct sales staff, agents and representatives, systems integrators
and strategic alliance partners. A direct sales force is employed in the
continental United States. Market-oriented business and customer development
teams define and implement specific campaigns to pursue opportunities in the
power marketplace.
The Company's ability to support its multi-facility, international and/or
multinational Power Simulation clients is facilitated by its network of offices
and strategic partners in the U.S. and overseas. Power Simulation offices are
maintained in Maryland and Georgia, and outside the U.S., in Sweden and Japan.
In addition to the offices located overseas, the Company's ability to conduct
international business is enhanced by its multilingual and multicultural work
force. GSE has strategic relationships with systems integrators and agents
representing its interests in:
Russia South Africa
Germany Mexico
Bulgaria Brazil
Spain Taiwan
Czech Republic South Korea
India Japan
United Kingdom People's Republic of China
Ukraine
Plant Security Systems
Industry
The access control market is a $2 billion subset of the $15 billion
monitoring and identification security market according to Morgan-Keegan. Prior
to the events of September 11, 2001, the nuclear power plant security industry
was focused on upgrading existing security systems to new computing technology.
Each plant has an access control and intrusion detection system in compliance
with regulations promulgated by the Nuclear Regulatory Commission (NRC). The
market was focused on upgrading existing control systems with newer computing
hardware and more powerful database systems. The requirements included the
ability to interface to new field sensing devices such as CCTV, microwave
sensors, and more sophisticated biometric devices such as hand geometry and
retinal scanners. The market is very diverse, serviced by a number of vendors
without clear dominance.
After the events of September 11, 2001, concern over the vulnerability
of nuclear plants to terrorist attacks has heightened. The NRC has issued new
directives to increase plant security, and the industry is formulating its
strategy and response. Of significance is the NRC and industry re-evaluation of
the "design basis threat" for nuclear plants. New terrorist capabilities and
strategies must now be factored into plant protection, addressing both external
threats and potential internal threats.
In addition to nuclear power reactors, there are numerous research
reactors and nuclear waste storage and processing facilities throughout the
country. Concern also centers on reactors in Eastern Europe, and the Department
of Energy is currently developing its strategy regarding nuclear plant security
as it relates to US policy and national security. The Company plans to utilize
the channels to market it has developed in the international nuclear market to
pursue the international nuclear security segment.
In addition to nuclear power, the domestic chemical, pharmaceutical and
food and beverage industries are evaluating their vulnerability to terrorist
threats. The American Chemical Council is recommending that manufacturers of
chemical products step up their role in protecting America's homeland. There are
over 15,000 chemical plants in the U.S. that have large quantities of extremely
toxic or volatile chemicals. Unlike the nuclear power industry, there are no
common standards of security across plants in the chemical industry.
Cyber security, particularly regarding plant process control systems, is a
growing concern, and is also being addressed by the American Chemical Council
and other industry associations. A part of the vulnerability assessment
methodology addresses internal and external access to process control equipment,
especially in light of trends in the process control industry to make systems
more open and integrated with other plant information systems.
GSE's Solution
The GSE Alarm Access Reporting and Detection System (GAARDS), provides
access control and intrusion detection for large industrial applications such as
nuclear power plants that require personnel tracking. This system is redundant,
stable, and includes such standard features as: access control and intrusion
detection, CCTV integration, biometrics and on-line personnel photos, dynamic
map displays, advanced event processing, security communications, and systems
integration. Using its rich engineering talent, the Company specializes in
writing customer interfaces to third party field hardware such as door locks,
card readers, CCTV, etc. This capability allows customers to utilize their
legacy hardware, and thereby save considerable money when upgrading their
security systems.
The Company has also launched a research and development program to
utilize its GAARDS technology as an authentication/validation server for the
Company's and third party process control systems. Securely integrating the
physical site security system with process control cyber security will provide
the Company with a unique offering to the process industries.
In addition to plant access control systems, the Company believes the
plant design and operations knowledge it has gained through simulation gives it
the expertise to help utilities uncover and assess plant vulnerabilities. The
Company's simulation capability can be used to assist the industry in testing
threat scenarios and response time frames. The Company continues to work with
experts in vulnerability assessment methodologies to bring this unique
application of simulation to the market.
Strategy
GAARDS is focused on highly regulated markets such as nuclear power,
chemical processing, pharmaceutical development and food and beverage. These
industries either already require, or may soon require, the robust features
already designed into GAARDS. The Company will also focus on the upgrade market,
leveraging its ability to interface with existing customer hardware and thereby
providing an economic advantage to the Company's solution.
The Company will continue to differentiate itself through offering
services beyond just the access control system implementation. The Company is
teaming with ManTech Security Technologies Company to provide turnkey
capabilities to the nuclear industry. Services range from threat and
vulnerability assessments, risk mitigation plans, cost/benefit analysis,
security system design to implementation, testing and training.
Competition and Competitive Advantage
The nuclear plant access control and intrusion detection system market is
not dominated by any vendor. This market is best classified as an upgrade
market, and the Company believes that it is in a strong position to compete due
to its superior technology and ability to provide cost effective upgrade
solutions. The Company's experience and reputation as a reliable supplier to the
nuclear industry and as a systems integrator of complex real-time nuclear plant
computer systems (Simulators, Security Systems, Plant Process and Control
Computers) gives the Company unique access to the industry.
The chemical and pharmaceutical market segment is also served by a wide
variety of relatively small sized companies. The Company believes that emerging
security awareness in this segment will result in the demand for the more
sophisticated security solutions offered by the GAARDS product. In addition, the
use of GAARDS in combination with process control system security provides the
Company a unique advantage.
Sales and Marketing
The Company will market its plant access control systems in the nuclear
power and process markets through a combination of techniques including its
existing direct sales channel, sales agents, strategic alliance partners and
system integrators. The Company is building its Systems Integrator channel and
investing in the necessary support infrastructure to make this channel
successful.
Process Simulation.
Industry
Throughout the process industries there is continuing competitive pressure
and a reduction of technical resources, which is forcing process manufacturers
to turn to advanced technologies for real-time optimization, training, and
advanced process control. Operational efficiency is vital for companies to
remain competitive where many of the manufacturing industries operate on very
thin margins. There are only one or two advanced technology companies that offer
services fully across this spectrum, and GSE offers dynamic real-time simulation
capabilities for operator training into this segment.
GSE's Solution
The SimSuite Pro product was developed by GSE specifically for operator
training, and the GSE culture and expertise is one of customized project
execution and delivery. This marketplace places a high value on experience, both
company-wide and for the individuals on the project teams, so GSE promotes its
long history in training simulators, while also seeking new applications. The
SimSuite Pro package continues to be enhanced with features applicable not just
to the execution of professional training techniques, but also to the recording
and validating of process operator performance for potential certification.
Strategy
The core concepts of process simulation make the technology a basis for
other potential process improvement activities, such as Advanced Process Control
and Process Optimization, which is where some of the major GSE competition has
more business focus than for operator training. GSE will continue to emphasize
its operator training focus and strengths, as well as the application of the
process simulator for change management, where changes in the process, control
strategy, or operating procedures, can be evaluated in real time before they are
applied to the actual process units. On-stream time is an important economic
factor, and there is recognizable value in avoiding the risk of unplanned
process disturbances from invalidated changes.
Competition and Competitive Advantage
GSE's competitors are a varied group. There are major corporations
offering a wide range of products and services that include operator training
simulators. There are also companies focused on Process Technology and
manufacturing enhancement, such as ABB and Honeywell who are DCS distributors to
the refining industry and provide operator simulation as part of their DCS
offering. There is a collection of companies with specific industry niches that
lets them sometimes compete in operator training simulation, such as Invensys
and Aspentech. There are also the smaller training companies that compete at the
lower cost levels of CBT (Computer Based Training) or simple simulations close
to CBT.
The GSE company focus on training simulation is a business strength to
project, and its vendor independence, with the ability to integrate to different
vendor's process control systems, is also a value which is appreciated. GSE can
be seen as a best-of-breed type of supplier because it is not tied to a major
control system, nor is it providing simulation software for engineering and
business management with high annual license fees.
Sales and Marketing
The Company will market its Process Simulation technologies through a
combination of techniques including its existing direct sales channel, sales
agents, and strategic alliance partners.
Process Automation Business.
Industry
Process control systems automate manufacturing and other processes,
thereby reducing labor and other production costs and maximizing production
efficiency. According to the Automation Research Council (ARC), the worldwide
market for Automation Products and Services for Process Industries, over $44
billion in 2001, is expected to grow at the Compounded Annual Growth Rate (CAGR)
of just over 5 percent over the next five years, reaching close to $57 billion
in 2006. In addition, the ARC reports that roughly $65 billion worth of
installed process control systems that are rapidly approaching the end of their
useful life. These systems simply cannot deliver the level of functional
autonomy and coordination required to be competitive. In their quest for
operational excellence, process manufacturers face further challenges and the
need to maximize Return on Assets (ROA). Manufacturing assets represent 75% of
capital assets for most process manufacturers and most of these assets are
controlled by process automation.
The sales of process control systems have been driven by customer desires
to improve production efficiency and reliability, and thereby maximizing Return
on Assets. The capital-intensive and competitive nature of manufacturing
requires companies to focus on designing, monitoring, and modifying the
production processes in the most efficient and profitable manner. Process
control systems consist of rugged microprocessor-based hardware, which is
physically distributed throughout a plant and linked by digital communications
to control centers. These systems allow users to monitor and control various
functions. The graphic information and control displays utilized by these
systems enhance the customer's strategic production and emergency
decision-making capabilities.
Two parts of the industry, the batch and hybrid controls markets, are of
particular interest to GSE. The batch controls market focuses on products made
in batches versus a continuous process. The Company believes the need for
traceability and increased government requirements (e.g., EPA, FDA) is fueling
the growth of batch control systems in the United States. The hybrid controls
market focuses on the integration of manufacturing automation and business
systems. The Company believes that the growth in e-business and the need to
optimize performance of supply chains are increasing the need for real-time
plant and production information that can be met by hybrid control systems.
GSE's solution
The Process Automation business designs, develops and delivers process
control, data acquisition, client/server and business software, systems and
services. These products permit the Company's customers to maximize the use of
plant assets by making real-time process information more easily available,
thereby enabling faster and better informed operating decisions.
Process Automation products and services are targeted at the following
industries in which the Company's personnel have substantial experience:
* Specialty chemicals * Pharmaceutical
* Food and beverage * Metals
The flagship product in the Process Automation business is the D/3 DCS, a
distributed control system product that is highly flexible and designed to meet
open standards. D/3 DCS 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. D/3 DCS also forms the platform for
plant-wide information for operators, engineers and management.
Other products of the Process Automation business include the following:
* D/3 Compact, a compact packaging of D/3 DCS with full functionality
and the capability to be expanded to a regular D/3 system.
* FlexBatch, a flexible batch manufacturing system used to facilitate
the rapid creation of various batch production processes.
* TotalVision, a graphical system that provides a client/server-based
human-machine interface for real-time process and plant information.
* TotalWebVision, a web-enabled version of the TotalVision package.
* SABL, 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 Process Automation offerings also include real-time dynamic simulation
tools and products that are used to develop high fidelity simulations for
chemical processing and other industrial plants. The most prominent set of
simulation products and tools is called SimSuite Pro. SimSuite Pro facilitates
design verification, process optimization and operator training in various types
of manufacturing operations.
Strategy
The goal of the Process Automation business is to expand its leading
position as a provider of process automation solutions and services to its
target markets of batch and hybrid control for the specialty chemical, food and
beverage, and pharmaceutical industries. GSE's strategy has the following key
elements:
* Maintain Existing Customer Base. The D/3 system (including its early
releases) has been used for process automation by existing customers for
more than 20 years. Throughout the advancement of new technology, the
Company always provides an upgrade path for customers to utilize its
investment in application software such that the maximum ROI (Return of
Investment) will be achieved. Also, a customer-focused business approach
is the Company's operation philosophy which distinguishes the Company
from its large competitors.
* Improving technology. The D/3 DCS distributed control system is
designed as an open standard that can work with a customer's existing
software. In 2000, the Company expanded its open system software to
permit communication with third-party I/O and implemented additional
Microsoft technology such as Windows 2000 and Microsoft's OLE for process
control to permit layering of third-party applications on its system. In
addition, the Company implemented graphical utilities to increase the
ease of use of this powerful system. These new tools and interfaces allow
customers to use their existing equipment when they wish to upgrade their
process automation technology. In 2002, the Company completed modifying
its process control module (PCM) to increase its operating speed and
reduce its manufacturing costs. The Company expects that this will allow
it to bridge the cost gap between programmable logic controllers (PLCs)
and the distributed control systems while providing the increased
performance of a full-function distributed control system. The Company
will continue to provide value-added differentiation through plant
optimization and asset management technologies ported from the Company's
power simulation market applications.
* Expand its expertise to new industries. GSE has experience in the
specialty chemical, food and beverage, pharmaceutical, and metals
industries. The Company will continue to focus its efforts on these
industries, but will seek to apply the technical expertise that it has
developed to other industries.
* Leverage its expertise through sale of engineering consulting services.
The Process Automation group has developed a significant amount of
expertise in manufacturing processes. In the past, it has provided field
service to customers of its products pursuant to its warranty or an
extended service plan. The Company is currently expanding these services
to provide applications, hardware and systems engineering consulting
services to its customers to improve the integration and performance of
their process automation technology.
Competition
The process automation industry is a highly competitive environment that
has undergone considerable consolidation over the past few years. The industry
is populated with numerous large process control vendors, many of which have
substantially greater financial, marketing and other resources than GSE has.
Examples include such companies as Foxboro, Siemens, Honeywell and Emerson. The
principal factors affecting competition include price, technology, ease of use,
reliability, application experience and support programs, and the financial
stability of the supplier. The Company competes by employing a "focus" strategy
that ensures its new product development protects its customers' previous
investments in applications software and process I/O, thereby maintaining or
significantly increasing barriers to change.
Customers
The Company has provided over 300 process control systems to an installed
base of over 125 customers worldwide. In 2002, approximately 9% of worldwide
Process Automation revenue was generated from end users outside the United
States. The Company's customers include, among others, Archer Daniels Midland
Company, Aristech, Bethlehem Steel Corporation, Cargill Incorporated, Eastman
Chemical Company, Formosa Plastics Company, GE Plastics, Merck & Co., Inc.,
Miller Brewing Company, and Westinghouse Savannah River Company. For the years
ended December 31, 2002, 2001, and 2000 one Process Automation customer
(Westinghouse Savannah River Company) accounted for approximately 24%, 24%, and
11%, respectively, of the Company's consolidated revenues.
Sales and Marketing
Process Automation markets its products and services through a network of
direct sales staff, agents and representatives, systems integrators and
strategic alliance partners. It 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 a
regional 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 in the
U.S. and overseas. Process maintains U.S. offices in:
Louisiana Pennsylvania
Maryland South Carolina
North Carolina Texas
Process Automation has strategic relationships with systems integrators
and agents representing its interests in:
Virginia Taiwan
California People's Republic of China
Michigan Belgium
New Jersey South Korea
Minnesota The Netherlands
Texas
Illinois
Competitive Advantages.
The Company believes that it is in a strong position to compete in both
the Power Simulation and Process Automation markets based upon the following
strengths:
* Technical and Applications Expertise. GSE is a leading innovator and
developer of real-time software with more than 30 years of experience
producing high fidelity real-time simulators and over 25 years in
producing fully integrated computerized process control systems in more
than 25 countries. As a result, the Company has acquired substantial
applications expertise in the energy and industrial process industries.
The Company employs a highly educated and experienced multinational
workforce of more than 240 employees, including approximately 180
engineers and scientists. Approximately half of these engineers and
scientists have advanced science and technical degrees in fields such
as chemical, mechanical and electrical engineering, applied mathematics
and computer sciences.
* Proprietary Software Tools. GSE has developed a library of proprietary
software tools including auto-code generators and system models that
substantially facilitate and expedite the design, production and
integration, testing and modification of software and systems. These
tools are used to automatically generate the computer code and systems
models required for specific functions commonly used in simulation and
process control applications, thereby enabling it or its customers to
develop high fidelity real-time software quickly, accurately and at
lower costs.
* Open System Architecture. GSE's software products and tools are
executed on standard operating systems with third-party off-the-shelf
hardware. The hardware and operating system independence of its
software enhances the value of its products by permitting customers to
acquire less expensive hardware and operating systems. The Company's
products work in the increasingly popular Microsoft operating
environment, allowing full utilization and integration of numerous
off-the-shelf products for improved performance.
* International Strengths. Approximately 31% of the Company's 2002
revenue was derived from international sales of its products and
services. GSE has a multinational sales force with offices located in
Beijing, China, Nykoping, Sweden, and Tokyo, Japan and agents and
representatives in 22 other countries. To capitalize on international
opportunities and penetrate foreign markets, the Company has
established strategic alliances and partnerships with several foreign
entities.
Intellectual Property.
The Company depends upon its intellectual property rights in its
proprietary technology and information. GSE maintains a portfolio of patents,
trademarks (both registered and unregistered), copyrights (both registered and
unregistered), and licenses. While such patents, trademarks, copyrights and
licenses as a group are of material importance to the Company, it does not
consider any one patent, trademark, copyright, or license to be of such
importance that the loss or expiration thereof would materially effect any
segment or the Company as a whole. The Company relies upon a combination of
trade secrets, copyright, patent and trademark law, contractual arrangements and
technical means to protect its intellectual property rights. GSE distributes its
software products under software license agreements that grant customers
nonexclusive licenses for the use of its products, which are nontransferable.
Use of the licensed software is restricted to designated computers at specified
sites, unless the customer obtains a site license of its use of the software.
Software and hardware security measures are also employed to prevent
unauthorized use of the Company's software, and the licensed software is subject
to terms and conditions prohibiting unauthorized reproduction of the software.
The Company has several U.S. patents that were issued in the 1996
time frame, none of which (individually or collectively) have a significant role
in the Company's current business operations. In accordance with Title 35 U.S.
Code Section 154, these patents have a duration of 20 years from the filing date
of the application, subject to any statutory extension, provided they are
properly maintained. The Company believes that all of the Company's trademarks
(especially those that use the phrase "GSE Systems") are valid and will have an
unlimited duration as long as they are adequately protected and sufficiently
used. The Company's licenses are perpetual in nature and will have an unlimited
duration as long as they are adequately protected and the parties adhere to the
material terms and conditions.
GSE's registered U.S. trademarks include D/3, D/3 DCS, SABL, TotalVision,
Flexbatch and RETACT. Registration is pending or is being considered for other
relevant trademarks, including JADE, SmartTutor, eSmart, D/3 Compact and GAARDS.
Some of these trademarks have also been registered in foreign countries. The
Company also claims trademark rights to SimSuite Power, SimSuite Pro, SimExec,
eXtreme I/S, RACS, PEGASUS Plant Surveillance and Diagnosis System, SIMON, Vista
PIN, TotalWebVision and Flexbatch.
In addition, the Company maintains federal statutory copyright protection
with respect to its software programs and products, has registered copyrights
for some of the documentation and manuals related to these programs, and
maintains trade secret protection on its software products.
Despite these protections, the Company cannot be sure that it has
protected or will be able to protect its intellectual property adequately, that
the unauthorized disclosure or use of its intellectual property will be
prevented, that others have not or will not develop similar technology
independently, or, to the extent it 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 its products
and intellectual property rights to the same extent as the laws of the United
States.
Industries Served.
The following chart illustrates the approximate percentage of the
Company's 2002, 2001, and 2000 revenues attributable to each of the Company's
reporting segments:
Industries served
2002 2001 2000
------------- ---------- -----------
Process 53% 50% 45%
Power 47% 50% 55%
------------- ---------- -----------
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, 2002, the Company's aggregate contract backlog totaled approximately $29.9
million, with $19.0 million in contract backlog for the Power Simulation
business and $10.9 million in contract backlog for the Process Automation
business. Approximately $20.1 million or 67% of the backlog is expected to be
converted to revenue by December 31, 2003. As of December 31, 2001, the
Company's aggregate contract backlog totaled approximately $21.5 million, with
$10.8 million in contract backlog for the Power Simulation business and $10.7
million in contract backlog for the Process Automation business.
Employees.
As of December 31, 2002, the Company had 241 employees, a 6% decrease
from December 2001. The reductions were primarily associated with the downsizing
of the U.S Power business offset partially by the acquisition of GSE Systems
Engineering (Beijing) Company Ltd.
Segment Information.
See Note 19, Segment information, in the "Notes to Consolidated
Financial Statements" for a discussion of the Company's business segments.
RISK FACTORS.
The Company's expense levels are based upon its expectations as to future
revenues, so it may be unable to adjust spending to compensate for a revenue
shortfall. Accordingly, any revenue shortfall would likely have a
disproportionate effect on the Company's 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 operating results. 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.
Risk of International Sales and Operations.
Sales of products and the provision of services to end users outside
the United States accounted for approximately 31% of the Company's consolidated
revenues in 2002. 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. Although end users in the Ukraine accounted
for 10.7%, 17.6% and 7.8% of the Company's consolidated revenue in 2002, 2001
and 2000, respectively, GSE's customer for these projects was Battelle's Pacific
Northwest National Laboratory, which is the purchasing agent for the U.S.
Department of Energy. The DOE provides funding for various projects in Eastern
and Central Europe. Accordingly, the Company is not subject to the political and
financial risks that are normally faced when doing business in the Ukraine. 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.
The Company relies on two customers for a substantial portion of its revenues.
The loss of either of these customers would have a material adverse effect upon
the Company's revenues and results of operations.
For the years ended December 31, 2002, 2001, and 2000, one Power
Simulation customer (Battelle's Pacific Northwest National Laboratory) accounted
for approximately 11%, 17%, and 22%, respectively, of the Company's consolidated
revenues. The Pacific Northwest National Laboratory is the purchasing agent for
the Department of Energy and the numerous projects the Company performs in
Eastern and Central Europe. For the years ended December 31, 2002, 2001, and
2000, one Process Automation customer (Westinghouse Savannah River Company)
accounted for approximately 24%, 24%, and 11%, respectively, of the Company's
consolidated revenues. If the Company lost either of these customers, the
Company's revenue and results of operations would be materially and adversely
affected.
The Company's business is substantially dependent on sales to certain
industries. Any disruption in these industries would have a material adverse
effect upon the Company's revenues.
In 2002, 40% of GSE's revenue was from customers in the nuclear power
industry. The Company will continue to derive a significant portion of its
revenues from customers in the 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, and general economic conditions.
In 2002, 35% and 10% of the Company's revenue were from customers in
the chemicals industry and the food and beverage industry, respectively.
Accordingly, the Company's future performance is dependent to a certain extent
upon the demand for the Company's products by customers in those industries. 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.
The Company's substantial indebtedness could adversely affect its financial
condition.
The Company has substantial indebtedness. In addition, it may increase its
indebtedness in the future. The following are important statistics about the
Company and its indebtedness:
* On December 31, 2002, the Company had total interest bearing debt of
$6.2 million, representing 43% of its total capitalization.
* On December 31, 2002, the Company's available borrowing base was $6.9
million, of which approximately $5.4 million had been utilized.
* On March 23, 2003, the Company's existing credit facility was extended
until March 31, 2004. The agreement reduced the maximum commitment
under the credit facility from $10.0 million to $6.5 million as of
March 23, 2003, with an additional reduction to $5.5 million on
October 1, 2003; and a final reduction to $5.0 million on January 1, 2004.
* The Company has been informed by its bank that the Company should begin
to search for a new financial institution to provide for its future
financing requirements. To provide the Company with enough time to
perform this search, the bank agreed to provide the Company with a
one-year extension of its current credit facility. Accordingly, on
March 23, 2003 the Company's credit facility was extended until March
31, 2004. By March 31, 2004, the Company believes that the Company will
have transferred the credit facility to a new financial institution.
The Company's level of indebtedness could have important consequences to
the stockholders. For example, it could:
* Make the Company more vulnerable to economic downturns.
* Potentially limit the Company's ability to withstand competitive
pressures.
* Impair the Company's ability to obtain additional financing in the
future for working capital, capital expenditures, acquisitions or general
corporate purposes.
* Make the Company more susceptible to the above risks because borrowings
under the Company's credit facility will bear interest at fluctuating
rates.
If GSE is unable to generate sufficient cash flows from operations in
the future the Company may be unable to repay or refinance all or a portion of
its then existing debt or to obtain additional financing. The Company cannot be
sure that any such refinancing would be possible or that any additional
financing could be obtained on acceptable terms.
The Company's debt agreements impose significant operating and financial
restrictions, which may prevent it from capitalizing on business opportunities.
GSE's debt agreements impose significant operating and financial
restrictions. These restrictions affect, and in certain cases limit, among other
things, the Company's ability to:
* incur additional indebtedness and liens;
* make capital expenditures;
* make investments and acquisitions and sell assets;
* consolidate, merge or sell all or substantially all of its assets.
There can be no assurance that these restrictions will not adversely
affect the Company's ability to finance its future operations or capital needs
or to engage in other business activities that may be in the interest of
stockholders.
The Company is dependent on product innovation and research and development,
which costs are incurred prior to revenues for new products and improvements.
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 relies upon its intellectual property rights for the success of its
business; however, the steps it has taken to protect its intellectual property
may be inadequate.
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 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 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.
The industries in which GSE operates are highly competitive. This competition
may prevent the Company from raising prices at the same pace as its costs
increase.
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.
GSE will continue to pursue new acquisitions and joint ventures, and any of
these transactions could adversely affect its operating results or result in
increased costs or other problems.
The Company intends to continue to pursue new acquisitions and joint
ventures, a pursuit which will consume substantial time and resources.
Identifying appropriate acquisition candidates and negotiating and consummating
acquisitions can be a lengthy and costly process. The Company may also encounter
substantial unanticipated costs or other problems associated with the acquired
businesses. The risks inherent in this strategy could have an adverse impact on
the Company's results of operation or financial condition.
The chemicals and nuclear power industries, two of the Company's largest
customer groups, are associated with a number of hazards which could create
significant liabilities for the Company.
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 primarily in operator 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.
The Company is controlled by the Company's principal stockholders, whose
interests may not be aligned with those of the Company's other stockholders.
As of March 11, 2003, ManTech, GP Strategies, the Company's directors
and executive officers beneficially own approximately 44% of GSE's outstanding
common stock. In addition ManTech owns 39,000 shares of Series A preferred
stock, which convert into an aggregate of 1,474,480 shares of common stock. If
fully converted by ManTech, ManTech will beneficially own approximately 36% of
GSE's outstanding common stock, and GP Strategies will beneficially own
approximately 18% of GSE's outstanding common stock. ManTech and GP Strategies
disclaim beneficial ownership of all shares, including those subject to option,
that are owned by affiliated individuals. ManTech has granted GP Strategies an
option to acquire 19,500 shares of the Series A preferred stock from ManTech. If
ManTech exercises its option to convert the Series A preferred stock to common
stock, and GP Strategies exercises its option to acquire 50% of the Series A
preferred stock held by ManTech and also converts those shares to common stock,
ManTech will beneficially own approximately 25% and GP Strategies will
beneficially own approximately 28%, of GSE's outstanding common stock. If these
stockholders vote together as a group, they will be able to control the
Company's business and affairs, including the election of individuals to the
board of directors, and the outcome of actions that require stockholder approval
including mergers, sales of assets, and to prevent, or to cause, a change of
control of the Company.
ITEM 2. PROPERTIES.
The Company's Power Simulation business unit is headquartered in a
facility in Columbia, Maryland (approximately 53,000 square feet) which also
houses the Company's corporate headquarters offices and support functions. The
Process Automation business unit is located in a 34,000 square foot facility in
Baltimore, Maryland. The leases for both of these facilities expire in 2008.
The Company has entered into a sublease agreement with Alpharma USPD
Inc. to sublease 29,000 square feet of its Baltimore, MD facility for a five
year period commencing on May 1, 2003. The subtenant may terminate the lease at
the end of the second or third year of the agreement provided a six month notice
is given. The Company plans to move most of the Process personnel presently
using this facility to its Columbia, Maryland facility in April 2003.
In addition, the Company leases office space domestically in Georgia,
Louisiana, Texas, Pennsylvania, North and South Carolina, and internationally in
China, Japan, and Sweden. The Company leases these facilities for terms ending
between 2003 and 2007.
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 that, 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, 2002.
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:
2002
- --------------------------------------------------------
Quarter High Low
First $ 4 $ 3
Second $ 4 $ 2 5/7
Third $ 3 1/2 $ 2 1/9
Fourth $ 2 1/4 $6/7
2001
- --------------------------------------------------------
Quarter High Low
First $ 1 4/5 $ 1 1/5
Second $ 2 5/9 $ 1
Third $ 2 5/9 $ 1 3/5
Fourth $ 3 1/9 $ 1 5/8
The following table sets forth the equity compensation plan information
for the year ended December 31, 2002:
- ---------------------------------------------------------------------------------------------------------------------------------
Number of securities to Weighted average exercise Number of securities
be issued upon exercise price of outstanding remaining available for
Plan category of outstanding options, options, future issuance under equity
warrants and rights warrants and rights compensation plans
- ---------------------------------------------------------------------------------------------------------------------------------
Equity compensation plan 1,691,976 $4.15 808,024
approved by security
holders
Equity compensation plan -- -- --
not approved by security
holders
-------------- -------------- --------------
Total 1,691,976 $4.15 808,024
The Company's common stock is listed on the American Stock Exchange,
where it trades under the symbol "GVP".
There were approximately 33 holders of record of the common stock as of
March 11, 2003. 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 on its common stock. The Company has issued
39,000 shares of convertible preferred stock which accrue dividends at an annual
rate of 6% payable quarterly. The amendment to the Company's credit facility
that was effective March 23, 2003 restricts the Company from paying any
dividends on the preferred stock.
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. For information and disclosures regarding the Company's business
segments, see Note 19, Segment information, in the "Notes to Consolidated
Financial Statements".
Years ended December 31,
-------------------------------------------------------------------
(in thousands, except per share data) 2002 2001 2000 1999 1998
----------- ------------ ------------ ------------ ------------
Contract revenue $ 43,116 $50,331 $55,715 $66,699 $73,818
Cost of revenue 31,801 36,381 40,822 41,629 49,814
----------- ------------ ------------ ------------ ------------
Gross profit 11,315 13,950 14,893 25,070 24,004
----------- ------------ ------------ ------------ ------------
Operating expenses:
Selling, general and administrative 12,303 10,857 17,853 22,646 20,345
Depreciation and amortization 540 1,375 1,695 1,680 1,768
----------- ------------ ------------ ------------ ------------
Total operating expenses 12,843 12,232 19,548 24,326 22,113
----------- ------------ ------------ ------------ ------------
Operating income (loss) (1,528) 1,718 (4,655) 744 1,891
Gain (loss) on sales of assets - 3,273 (990) - 550
Write-down of investment
in Avantium International B.V. (2,783) (4,605) - - -
Interest expense, net (277) (886) (687) (450) (350)
Other income (expense), net 34 406 55 40 326
----------- ------------ ------------ ------------ ------------
Income (loss) before income taxes (4,554) (94) (6,277) 334 2,417
Provision for (benefit from) income taxes 1,389 (353) 2,537 233 1,020
----------- ------------ ------------ ------------ ------------
Net income (loss) $(5,943) $ 259 $ (8,814) $ 101 $ 1,397
=========== ============ ============ ============ ============
Earnings (loss) per common share: -Basic $ (1.05) $ 0.05 $ (1.70) $ 0.02 $ 0.28
=========== ============ ============ ============ ============
-Diluted $ (1.05) $ 0.05 $ (1.70) $ 0.02 $ 0.27
=========== ============ ============ ============ ============
Weighted average common shares outstanding:
-Basic 5,863 5,217 5,182 5,066 5,066
=========== ============ ============ ============ ============
-Diluted 5,863 5,259 5,182 5,351 5,107
=========== ============ ============ ============ ============
As of December 31,
-------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ------------ ------------ ------------ ------------
Working capital $6,036 $7,063 $5,522 $8,665 $4,058
Total assets 28,894 33,674 35,949 43,027 48,743
Long-term liabilities 9,617 7,263 12,390 9,083 3,350
Stockholders' equity 8,111 13,852 8,713 17,170 17,089
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
In 2002, the Company incurred a significant operating loss attributable
in large part to the performance of the Company's Power business unit. The Power
business unit's revenue and profitability were significantly impacted by the
completion of several large, multi-year projects in late 2001 and early 2002
coupled with the delay of several very large full-scope international simulator
orders. In addition to the operating loss, the Company wrote down its investment
in Avantium International B.V., recording a non-cash charge of $2.8 million and
recorded an income tax provision of $1.4 million resulting mainly from an
increase in the Company's valuation allowance to fully reserve the Company's net
deferred tax assets.
The Company has a $10.0 million credit facility with a bank which
matured on March 23, 2003. The Company has been informed by its bank that the
Company should begin to search for a new financial institution to provide for
its future financing requirements. To provide the Company with enough time to
perform this search, the bank agreed to provide the Company with a one-year
extension of its current credit facility. Accordingly, on March 23, 2003 the
Company's credit facility was extended until March 31, 2004. At the time of the
extension, the maximum commitment under the credit facility was reduced from
$10.0 million to $6.5 million as of March 23, 2003; with an additional reduction
to $5.5 million on October 1, 2003; and a final reduction to $5.0 million on
January 1, 2004. Based upon the Company's current forecasts of its cash flow in
2003, the reductions in the maximum commitment will not have an impact on the
Company's operations or liquidity. Management believes in order to help improve
the Company's liquidity and operating results, management has undertaken actions
to reduce its operating expenses, including the reduction in US Power employees
by 15 in 2002 and the sublease of 29,000 square feet of its 34,000 square foot
Rutherford, Baltimore, Maryland facility effective May 1, 2003.
However, the Company's 2003 profitability and liquidity projections
depend on several large full-scope simulator contracts in its Power business
unit, several that have been quoted and verbally accepted, but have not yet
formally been awarded by the customer. In the event that the Company does not
receive these contracts, or is unable to find replacements for these contracts,
it may need to seek additional debt or equity financing in 2003. There can be no
assurance that such debt or equity financing will be available when needed.
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.
Years ended December 31,
-------------------------------------------------------------------------------------
2002 % 2001 % 2000 %
------------ ----------- ------------ ------------ -------------- ---------
Contract revenue $ 43,116 100.0 % $50,331 100.0 % $ 55,715 100.0 %
Cost of revenue 31,801 73.7 % 36,381 72.3 % 40,822 73.3 %
------------ ----------- ------------ ------------ -------------- ---------
Gross profit 11,315 26.3 % 13,950 27.7 % 14,893 26.7 %
------------- ----------- ------------ ------------ -------------- ---------
Operating expenses:
Selling, general and administrative 12,303 28.5 % 10,857 21.6 % 17,853 32.1 %
Depreciation and amortization 540 1.3 % 1,375 2.7 % 1,695 3.0 %
------------ ----------- ------------ ------------ -------------- -----------
Total operating expenses 12,843 29.8 % 12,232 24.3 % 19,548 35.1 %
------------- ----------- ------------ ------------ -------------- ----------
Operating income (loss) (1,528) (3.5)% 1,718 3.4 % (4,655) (8.4)%
Gain (loss) on sales of assets - 0.0 % 3,273 6.5 % (990) (1.8)%
Write-down of investment
in Avantium International B.V. (2,783) (6.5)% (4,605) (9.1)% - 0.0 %
Interest expense, net (277) (0.6)% (886) (1.8)% (687) (1.2)%
Other income, net 34 0.1 % 406 0.8 % 55 0.1 %
------------- ----------- ------------ ------------ -------------- ---------
Income (loss) before income taxes (4,554) (10.6)% (94) (0.2)% (6,277) (11.3)%
Provision for (benefit from) income taxes 1,389 3.2 % (353) (0.7)% 2,537 4.5 %
------------- ----------- ------------ ------------ -------------- ---------
Net income (loss) $ (5,943) (13.8)% $ 259 0.5 % $ (8,814) (15.8)%
============= =========== ============ ============ ============== =========
Critical Accounting Policies and Estimates.
As further discussed in Note 2 to the consolidated financial
statements, in preparing the Company's financial statements, management makes
several estimates and assumptions that affect the Company's reported amounts of
assets, liabilities, revenues and expenses. Those accounting estimates that have
the most significant impact on the Company's operating results and place the
most significant demands on management's judgment are discussed below. For all
of these policies, management cautions that future events rarely develop exactly
as forecast, and the best estimates may require adjustment.
Revenue Recognition on Long-Term Contracts. The Company uses the
percentage-of-completion revenue recognition methodology to record revenue under
its long-term fixed-price contracts in accordance with the AICPA Statement of
Position 81-1, "Accounting for Performance of Construction-Type and Certain
Production-Type Contracts". This methodology recognizes income as work
progresses on the contract and is based on an estimate of the income earned to
date, less income recognized in earlier periods. The Company bases its estimate
of the degree of completion of the contract by reviewing the relationship of
costs incurred to date to the expected total costs that will be incurred on the
project. The Company's project managers are responsible for estimating the costs
to be incurred at the beginning of each project and are responsible for updating
the estimate as the project progresses. Management reviews the status of each
project periodically with the project managers and determines whether the cost
estimates are reasonable. If changes in the estimated costs to complete the
projects are required, the cumulative impact on the percentage of completion
revenue calculation is recognized in the period identified. Whenever evidence
indicates that the estimated total cost of a contract will exceed its total
contract value, the Company's operating results are charged for the full amount
of the estimated losses immediately. Uncertainties inherent in the performance
of contracts include labor availability and productivity, material costs, change
order scope and pricing, software modification issues and customer acceptance
issues. The reliability of these cost estimates is critical to the Company's
revenue recognition as a significant change in the estimates can cause the
Company's revenue and related margins to change significantly from the amounts
estimated in the early stages of the project.
Capitalization of Computer Software Development Costs. In accordance
with Statement of Financial Accounting Standards (SFAS) No. 86 "Accounting for
the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed," the
Company capitalizes computer software development costs incurred after
technological feasibility has been established, but prior to the release of the
software product for sale to customers. Once the product is available to be
sold, the Company begins to amortize the costs over the estimated useful life of
the product, which normally ranges from three to five years. At December 31,
2002, the Company has net capitalized software development costs of $4.4
million. On an annual basis, the Company assesses the recovery of the
unamortized software computer costs by estimating the net undiscounted cash
flows expected to be generated by the sale of the product. If the undiscounted
cash flows are not sufficient to recover the unamortized software costs the
Company will write-down the investment to its estimated fair value based on
future discounted cash flows. The excess of any unamortized computer software
costs over the related net realizable value is written down and charged to
income. Significant changes in the sales projections could result in an
impairment with respect to the capitalized software that is reported on the
Company's consolidated balance sheet.
Deferred Income Tax Valuation Allowance. Deferred income taxes arise
from temporary differences between the tax bases of assets and liabilities and
their reported amounts in the financial statements. As required by SFAS No. 109
"Accounting for Income Taxes", management makes an annual assessment of the
realizability of the Company's deferred tax assets. In making this assessment,
management considers whether it is more likely than not that some or all of the
deferred tax assets will not be realized. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible. Management
considers the scheduled reversal of deferred tax liabilities and projected
future taxable income of the Company in making this assessment. A valuation
allowance is recorded to reduce the total deferred income tax assets to its net
realizable value. At December 31, 2002, the Company's deferred tax assets
related primarily to a U.S. net operating loss carryforward of $15.1 million
which can be utilized over the next twenty years. The recovery of the remaining
net deferred tax asset could not be substantiated by currently available
objective evidence and, accordingly, the Company has established a full
valuation allowance for the balance of its deferred tax assets of $7.8 million.
If the Company is able to realize taxable income in the future the valuation
allowance will be reduced.
Comparison of 2002 to 2001.
Contract Revenue. Total contract revenue was $43.1 million and $50.3
million for the years ended December 31, 2002 and 2001, respectively.
The Process business unit's revenue was $22.9 million in 2002 compared
with $25.0 million in 2001. Included in the 2001 revenue was $507,000 related to
Process' VirtualPlant business, which was sold to Avantium International B.V. in
March 2001. The decrease in Process' continuing business revenue is mainly
attributable to a reduction in revenue from Process' largest customer,
Westinghouse Savannah River Corporation. In 2002, revenues generated from work
performed for Westinghouse Savannah River Corporation totaled 45% of total
Process revenue, versus 48% in 2001.
The Power business unit revenue decreased 20.2% in 2002, from $25.3
million in 2001 to $20.2 million in 2002. Although there was increased activity
in the U.S. upgrade market in 2002 as compared to the prior year, international
revenue decreased due to the completion of several large, multi-year projects.
In addition, there were several very large full scope international simulator
orders that were delayed throughout 2002 which negatively impacted the Company's
2002 revenue. One of these orders, a $9.1 million simulator for Unit 3 of the
Zaporizhya Nuclear Power Station in eastern Ukraine, was received by the Company
in late December 2002. The contract was awarded to GSE through Battelle's
Pacific Northwest National Laboratory and is part of the Department of Energy's
International Nuclear Safety Program.
Gross Profit. Gross profit totaled $11.3 million (26.3% of revenue) for
the year ended December 31, 2002, as compared with $14.0 million (27.7% of
revenue) for the year ended December 31, 2001. During 2002, the Power business
reduced operations personnel by 14 employees. Despite this reduction in the
Company's overhead costs, gross profit as a percentage of revenue decreased as
the overhead costs incurred were spread over a lower revenue base.
Selling, General and Administrative Expenses. Selling, general and
administrative ("SG&A") expenses totaled $12.3 million in 2002 (28.5% of
revenue), a 12.8% increase from the $10.9 million (21.6% of revenue) for 2001.
In the first quarter 2002, the Process business unit hired a new marketing
manager who was charged with developing the business unit's marketing strategy,
revitalizing the Company's marketing collateral, planning the Company's annual
user's conference, and the product introductions for the D/3 Version 11.0 and
the new D/3 Compact which occurred in October 2002. The Power business has
incurred higher bidding and proposal costs in the pursuit of new orders and from
the addition of two marketing personnel hired for its security business in the
beginning of 2002. In 2002 the Power business unit implemented two staff
reductions; SG&A expense reflects $291,000 of accrued severance, of which
$51,000 had not been paid at December 31, 2002. In addition, the Company
increased its net research and product development expenditures ("R&D"), as
discussed below.
Gross R&D, including software development costs, totaled $3.5 million
in 2002 versus $1.6 million in 2001; capitalized software development costs
totaled $2.5 million in 2002 versus $809,000 million in 2001; and net R&D,
expensed and included in SG&A, was $1.0 million in 2002 versus $827,000 million
in 2001.
The increase in the Company's capitalized software development expenditures was
related to:
* The development of Version 11.0 of its D/3 Process Automation System.
The major enhancements to the system include improved alarm handling
and advanced system diagnostics. In addition, the Company introduced
two new more cost effective process controllers based on the use of
modern PCI back plane technology with greater performance speed and
flexibility. The project was completed for commercial release as of
October 1, 2002.
* The development of the Process D/3Compact, a smaller, redesigned
version of the D/3 distributed control system which is aimed at smaller
automation applications. This entry-level offering will combine the low
cost found in Programmable Logic Controllers (PLC) solutions with the
high functionality of a distributed control system. The project was
completed for commercial release as of October 1, 2002.
* The replacement of the Graphic User Interfaces (GUI) for our Power
GSuite and Topmeret tools with a Java based GUI, which will provide
platform independence and internet enabling. Version 1.0 of the new
GUI, called JADE, is expected to be completed and ready for commercial
release by March 31, 2003.
In 2003, the Company expects to reduce its gross R&D spending to
approximately $2.4 million. The major focus of this R&D spending will be:
* Greater security capabilities in the D/3 control system that will
address changes in regulatory agency requirements for the
pharmaceutical industry and provide all customers the flexibility to
select portions of the increased security that will fit their business
needs.
* Improvements to the D/3 control system's Ethernet I/O functionality and
Foundation Fieldbus offerings.
* Additional enhancements to JADE Version 1.0 including connectivity to
plant information databases and new applications on primary side
modeling and executive system.
Depreciation and Amortization. Depreciation expense amounted to
$540,000 and $706,000 during the years ended December 31, 2002 and 2001,
respectively. The decrease in depreciation in 2002 as compared to 2001 is due to
certain assets becoming fully depreciated.
Due to the Company's adoption of SFAS No. 142 "Goodwill and Other
Intangible Assets" on January 1, 2002, goodwill is no longer amortized, but is
subject to an annual test of impairment. Thus, the company recognized $669,000
of goodwill amortization in 2001 versus none in 2002. See Footnote 9, "Goodwill"
in the Notes to Consolidated Financial Statements.
Operating (Loss) Income. The Company had an operating loss of $1.5
million (3.5% of revenue) for the year ended December 31, 2002 as compared with
operating income of $1.7 million (3.4% of revenue) for the year ended December
31, 2001.
Write-down of Investment in Avantium International B.V. On February 7,
2002, Avantium completed a private placement round of financing which resulted
in 20 million Euros in new capital and the conversion of 11 million Euros of
convertible debt. The equity issuance and debt conversion diluted GSE's
ownership in Avantium to 6.1%. The estimated fair market value of Avantium
following the financing was $47.4 million. Accordingly the Company concluded
that this transaction was evidence of "an other than temporary decline" in the
fair value of its investment in Avantium. Thus, in the fourth quarter 2001, the
Company wrote down its investment in Avantium to $2.9 million and recognized a
$4.6 million pre-tax charge.
In the first quarter, 2003, Avantium indicated that it was pursuing
another private placement round of financing. Based upon the Company's
discussions with Avantium, GSE believes that its ownership in Avantium will be
diluted to less than 1%. Accordingly the Company concluded that this pending
transaction was evidence of "an other than temporary decline" in the fair value
of its investment in Avantium. Thus, in the fourth quarter 2002, the Company
wrote down its investment in Avantium to $115,000 and recognized a $2.8 million
pre-tax charge.
While the Company believes that the carrying amount of its investment
in Avantium stock will be recovered in the future based upon Avantium's current
business plan, the Company will continue to evaluate the recovery of the
investment as the result of any dilution in the Company's ownership resulting
from Avantium's additional capital requirements.
Interest Expense, Net. Net interest expense decreased 68.7% from
$886,000 for the year ended December 31, 2001 to $277,000 in 2002. This decrease
is due to lower interest rates in 2002 versus 2001 (5.4% average and 7.4%
average, respectively), a reduction in the average bank debt outstanding ($4.3
million for the year ended December 31, 2002 versus $5.8 million average for the
prior year), and a reduction in the average balance outstanding on the Company's
subordinated debt to ManTech ($691,000 average for the year ended December 31,
2002 versus $3.6 million average for the prior year).
Other Income (Expense), Net. For the year ended December 31, 2002, the
Company incurred $34,000 of foreign currency gains.
For the year ended December 31, 2001, other income (expense), net
includes the receipt of a $147,000 equity distribution from the Company's
liquidated Joint Venture in China (this investment was written off in a prior
year) and foreign currency gains.
Provision for Income Taxes. The Company recorded an income tax
provision of $1.4 million in 2002. This provision is mainly the result of an
increase in the valuation allowance for the Company's deferred income tax
assets. The Company established a full valuation allowance since recovery of the
deferred tax asset could not be substantiated by currently available objective
evidence. The difference between the statutory U.S. tax rate and the Company's
effective rate for 2002 was primarily due to the change in the deferred tax
asset valuation reserve and foreign taxes.
The Company recorded an income tax benefit of $353,000 in 2001. This
benefit was mainly the result of a decrease in the valuation allowance for the
Company's deferred income tax assets. The allowance was decreased to adjust the
net deferred tax asset to an amount that management believed was more likely
than not be realized. The difference between the statutory U.S. tax rate and the
Company's effective rate for 2001 was primarily due to the change in the
deferred tax asset valuation reserve and foreign taxes.
Comparison of 2001 to 2000.
Contract Revenue. Total contract revenue was $50.3 million and $55.7
million for the years ended December 31, 2001 and 2000, respectively.
The Process business unit's revenue was $25.0 million in 2001 compared
with $25.2 million in 2000. Although the decrease was only .8%, the overall
composition of the revenues changed significantly. The Company sold its
unprofitable Belgian subsidiary, GSE Process Solutions N.V., on November 30,
2000 to Newton Beheer B.V. of the Netherlands, and sold its VirtualPlant
technology and assets on March 6, 2001 to Avantium International B.V.
("Avantium"). For the years ended December 31, 2001 and 2000, Process revenues
included $507,000 and $7.6 million, respectively, for these two divested
businesses. Included in the 2000 Process revenue was $2.9 million from the sale
of licenses for five of GSE's software products to Avantium in February,
including the object and source codes, in exchange for an equity interest in
Avantium. In addition, the Company recorded revenue of $1.3 million for time and
material work completed for Avantium. Excluding the revenue for these divested
businesses, the Process business unit's revenue increased $6.9 million, or 39%,
in 2001 as compared to 2000. The increase in Process' continuing business
revenue is mainly attributable to several significant orders received from
Westinghouse Savannah River Corporation. In 2001, revenues generated from work
performed for Westinghouse Savannah River Corporation totaled 48% of total
Process revenues, versus 25% in 2000.
The Power business unit revenue decreased 17.0% in 2001, from $30.5
million in 2000 to $25.3 million in 2001. The decrease in revenue is
attributable to the completion of several large international projects in 2001
and fewer upgrades for simulators in the United States in 2001 as compared to
2000.
Gross Profit. Gross profit totaled $14.0 million (27.7% of revenue) for
the year ended December 31, 2001, as compared with $14.9 million (26.7% of
revenue) for the year ended December 31, 2000. The gross profit and gross profit
margins for 2000 reflect the software licenses sold to Avantium in the first
quarter 2000. Excluding the gross profit from the sale of software licenses to
Avantium, the gross profit margin for 2000 was 22.7%. This increase in gross
profit margin in 2001 was due to the following:
* The restructuring of the Process business unit in 2000 and 2001,
including the sale of the Company's Belgian subsidiary in late 2000 and the
VirtualPlant assets and technology in the first quarter 2001,
* The outsourcing of the Process manufacturing/assembly operation, and
Personnel reductions.
In December 2000, a $710,000 provision was recorded for certain Process
inventory to adjust its carrying value to net realizable value.
Selling, General and Administrative Expenses. Selling, general and
administrative ("SG&A") expenses totaled $10.9 million in 2001 (21.6% of
revenue), a 39.1% decrease from the $17.9 million (32.1% of revenue) for 2000.
The decrease in SG&A reflects reduced sales, marketing and corporate
administration headcount, and lower net research and product development
expenditures ("R&D"), as discussed below.
Gross R&D, including software development costs, totaled $1.6 million
in 2001 versus $3.5 million in 2000; capitalized software development costs
totaled $809,000 in 2001 versus $1.9 million in 2000; and net R&D, expensed and
included in SG&A, was $827,000 in 2001 versus $1.7 million in 2000. The
Company's R&D expenditures were reduced significantly in 2001 due to the sale of
the VirtualPlant business in March 2001 ($1.0 million was spent on VirtualPlant
R&D in 2000) and the completion of three major development projects: VPbatch,
the Windows NT version of its FlexBatch Recipe and Process Management software;
initiatives to improve product ease of use of SimSuite Pro its process
simulation product; and the release of version 10.2 of the D/3 Distributed
Control System in December 2000. R&D expenditures in 2001 were mainly related to
improvements in the process control module for the Process D/3 system and the
development of a high availability server system.
Depreciation and Amortization. Depreciation expense amounted to
$706,000 and $1.2 million during the years ended December 31, 2001 and 2000,
respectively. The decrease in depreciation in 2001 is primarily due to disposals
of fixed assets as the Company restructured its operations and divested certain
businesses.
Amortization of goodwill was $669,000 and $528,000 during the years
ended December 31, 2001 and 2000, respectively. The increase in amortization in
2001 reflects the increase in goodwill due to payments made for contingent
consideration for prior year acquisitions.
Operating Income (Loss). The Company had operating income of $1.7
million (3.4% of revenue) for the year ended December 31, 2001, as compared with
an operating loss of $4.7 million (8.4% of revenue) for the year ended December
31, 2000.
Excluding the operating results of the divested businesses, the
Company's operating income for the year ended December 31, 2001 was $2.2 million
compared with a loss of $988,000 for the year ended December 31, 2000. The
Company attributes its business restructuring initiatives for the improvement in
operating income of its remaining businesses.
Gain (loss) on Sales of Assets. On March 6, 2001, the Company sold its
VirtualPlant business technology and assets to Avantium. GSE received 8% of
Avantium's stock, thus increasing its holdings in Avantium to approximately 19%,
and recognized a gain on the sale of $3.3 million, before income taxes. This
gain was determined based on the estimated fair market value of the Avantium
stock received, based on an independent appraisal, less the book value of the
assets sold, approximately $700,000 in severance costs payable to certain former
employees of VirtualPlant that were not hired by Avantium, and other transaction
expenses.
The loss on sale of assets in 2000 reflects the net pre-tax loss
realized on the disposition of GSE Process Solutions NV, the Company's Belgian
subsidiary. This sale and related loss is described more fully under Note 18,
Acquisitions and dispositions, in the "Notes to Consolidated Financial
Statements".
Write-down of Investment in Avantium International B.V. On February 7,
2002, Avantium completed a private placement round of financing which resulted
in 20 million Euros in new capital and the conversion of 11 million Euros of
convertible debt. The equity issuance and debt conversion diluted GSE's
ownership in Avantium to 6.1%. The estimated fair market value of Avantium
following the financing was $47.4 million. Accordingly the Company concluded
that this transaction was evidence of "an other than temporary decline" in the
fair value of its investment in Avantium. Thus, in the fourth quarter 2001, the
Company wrote down its investment in Avantium to $2.9 million and recognized a
$4.6 million pre-tax charge.
Interest Expense, Net. Net interest expense increased to $886,000 for
the year ended December 31, 2001, from $687,000 in 2000. A reduction in the
Company's bank debt interest expense due to the reduction in interest rates in
2001 (the Company's interest rate was 9.5% in December 2000 versus 5.5% in
December 2001) and a reduction in the average bank debt outstanding ($7.3
million average for the twelve months ended December 31, 2000 versus $5.3
million average for the twelve months ended December 30, 2001) was more than
offset by an increase in the interest expense incurred on the Company's
subordinated debt due to ManTech. The average subordinated debt outstanding
increased from $250,000 in 2000 to $3.5 million in 2001. In addition, interest
income earned by the Company's Swedish subsidiary decreased from $219,000 in
2000 to $78,000 in 2001.
Other Income (Expense), Net. For the year ended December 31, 2001,
other income (expense), net includes the receipt of a $147,000 equity
distribution from the Company's liquidated Joint Venture in China (this
investment was written off in a prior year) and foreign currency gains of
$253,000.
For the year ended December 31, 2000, the Company incurred $55,000 of
foreign currency gains.
Provision for Income Taxes. The Company recorded an income tax benefit
of $353,000 in 2001. This benefit is mainly the result of a decrease in the
valuation allowance for the Company's deferred income tax assets. The allowance
was decreased to adjust the net deferred tax asset to an amount that management
believed was more likely than not be realized. The difference between the
statutory U.S. tax rate and the Company's effective rate for 2001 was primarily
due to the change in the deferred tax asset valuation reserve and foreign taxes.
The Company recorded a tax provision of $2.5 million in 2000. This
provision is mainly the result of an increase in the valuation allowance for the
Company's deferred income tax assets. The allowance was increased to reduce the
total deferred tax asset to an amount that management believed was more likely
than not to be realized. The difference between the statutory U.S. tax rate and
the Company's effective rate for 2000 was primarily due to the change in the
deferred tax asset valuation reserve and foreign taxes.
Liquidity and Capital Resources.
As of December 31, 2002, GSE had cash and cash equivalents of $1.6
million versus $2.0 million in 2001.
Cash from operating activities. Net cash used in operating activities was
$1.2 million for the year ended December 31, 2002. In 2002, the $2.8 million
pre-tax loss on the write-down of the Company's investment in Avantium was a
non-cash transaction. Significant changes in the assets and liabilities of the
Company in 2002 included:
* an $846,000 reduction in contracts receivable offset by the assignment
of $2.6 million of sales-type lease receivables.
* a $602,000 decrease in billings in excess of revenues earned. The
decrease is mainly related to the Power business unit and reflects the
completion of work in 2002 on the full scope simulator at the
Gorskomatom Rivne 2 unit in the Ukraine.
Net cash provided by operating activities was $1.9 million for the year
ended December 31, 2001. In 2001, the $4.6 million pre-tax loss on the
write-down of the Company's investment in Avantium was a non-monetary
transaction as was the $3.3 million gain on the sale of VirtualPlant technology
and assets. Significant changes in the assets and liabilities of the Company in
2001 included:
* A $3.3 million increase in billings in excess of revenues earned. The
increase reflects significant orders received from two Process
customers in the third quarter 2001 that allowed GSE to invoice the
customer in full prior to the work being completed.
* A $5.1 million reduction in accounts payable, accrued compensation and
accrued expenses. Due to the Company's improved operating cash flow in
2001 and additional subordinated borrowings from ManTech, the Company
was able to reduce its outstanding payables and was current with its
vendors at December 31, 2001.
Net cash used in operating activities for the year ended December 31,
2000 was $4.5 million. The $2.9 million revenue from the licensing of software
to Avantium in the first quarter 2000 in exchange for an equity stake in
Avantium was a non-monetary transaction. Significant changes in the Company's
assets and liabilities in 2000 included:
* A $1.9 million reduction in contract receivables which was mainly
related to the decline in overall revenues.
* A $1.6 million reduction in inventories. In 1999, the Process stockroom
inventory increased approximately $650,000 principally due to purchases
of large supplies of various PC boards. In 2000, this inventory
decreased approximately $800,000 as the Company made a concerted effort
to reduce on-hand inventory. The balance of the decrease is due to a
$710,000 provision for excess and slow moving inventory.
* A $1.6 million reduction in billings in excess of revenues earned due
to the lower business volume in 2000.
Cash used in investing activities. Net cash used in investing
activities for the year ended December 31, 2002 was $3.0 million, including
$45,000 in cash payments for an acquired business, $457,000 of capital
expenditures, and $2.5 million of capitalized software development costs.
For 2001, net cash used in investing activities was $2.4 million,
including $1.1 million in cash payments for acquired businesses ($599,000 of
contingent consideration for a prior year acquisition and $491,000 for notes
payable related to two prior year acquisitions), $477,000 of capital
expenditures, and $809,000 of capitalized software development costs.
For 2000, net cash used in investing activities was $3.3 million,
including $658,000 in cash payments for acquired businesses ($598,000 of
contingent considerations for prior year acquisitions, and $60,000 for notes
payable related to a prior year acquisition), $472,000 of capital expenditures,
$1.9 million of capitalized software development costs, and $261,000 in
connection with the disposition of the Company's Belgium subsidiary.
Cash provided by financing activities. For the year ended December 31,
2002, the Company generated $3.8 million net cash through financing activities.
The Company received $1.3 million from its escrow agent in January 2002 from a
fixed-price rights offering which was completed on December 21, 2001 and
received $263,000 for the exercise of employee stock options. The Company
increased its borrowings under its bank line of credit by $443,000 to a total of
$5.4 million, and decreased its borrowings from ManTech International
Corporation by $350,000 to a total of $650,000. The Company entered into two
contracts with a customer for the lease of certain hardware and software under
36-month leases and assigned the payments due under these sales-type leases to a
third party financing company, receiving proceeds of $2.6 million. The Company
issued three cash-collateralized stand-by letters of credit totaling $243,000.
Standby letters of credit are issued by the Company in the ordinary course of
business through banks as required by certain contracts and proposal
requirements.
Cash provided by financing activities was $1.1 million for the year
ended December 31, 2001. GSE reduced its borrowings under its bank line of
credit in 2001 by $4.3 million to a total of $5.0 million. However, in 2001 the
Company amended its $1.8 million subordinated promissory note to ManTech to
increase the amount to $3.9 million, and issued a second subordinated promissory
note to ManTech for $1.0 million. Accordingly, the Company increased its
subordinated borrowings from ManTech by $3.4 million in 2001 to a total of $4.9
million. In December 2001 ManTech elected to covert the $3.9 million
subordinated promissory note into Series A preferred stock, as permitted by the
note. In 2001, the Company entered into three contracts with a customer for the
lease of certain hardware and software under 36-month leases and assigned the
payments due under these sales-type leases to a third party financing company,
receiving proceeds of $2.2 million. The Company also generated $33,000 from the
conversion of employee stock options. In 2001, $29,000 of cash collateralized
letters of credit expired, and the cash collateral was released.
Cash provided by financing activities was $6.6 million in the year
ended December 31, 2000. The Company increased its borrowings under its bank
line of credit in 2000 by $3.0 million to a total of $9.3 million. In addition,
the Company issued a subordinated promissory note to ManTech that allowed it to
borrow up to $1.8 million at an interest rate of prime plus one percent; at
December 31, 2000 the Company had borrowed $1.6 million. The Company entered
into two contracts with a customer for the lease of certain hardware and
software under 36-month leases; the Company received $1.1 million upon
assignment of the payments to a third party financing company. The Company also
generated $500,000 from the sale of stock to ManTech and an additional $42,000
from the exercise of employee stock options. In 2000, $202,000 of cash
collateralized letters of credit expired and the cash collateral was released.
Credit Facilities.
The Company has a $10.0 million credit facility with a bank which
matured on March 23, 2003. The Company has been informed by its bank that the
Company should begin to search for a new financial institution to provide for
its future financing requirements. To provide the Company with enough time to
perform this search, the bank agreed to provide the Company with a one-year
extension of its current credit facility. Accordingly, on March 23, 2003 the
Company's credit facility was extended until March 31, 2004. The credit facility
provides for borrowings up to a total of $10.0 million to support working
capital needs and foreign letters of credit. At December 31, 2002, the Company's
available borrowing base was $6.9 million, of which approximately $5.4 million
had been utilized. The credit facility 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. As of
December 31, 2002, the Company was not in compliance with its financial ratio
covenants, however, the Company has received a written waiver from the bank for
noncompliance.
The following amendments to the agreement were made at the time of the
extension:
* the maximum commitment under the credit facility was reduced from
$10.0 million to $6.5 million as of March 23, 2003; with an additional
reduction to $5.5 million on October 1, 2003; and a final reduction to
$5.0 million on January 1, 2004. Based upon the Company's current
forecasts of its cash flow in 2003, management believes the reductions
in the maximum commitment will not have an impact on the Company's
operations. The average debt outstanding in 2002 was $4.6 million, with
the highest debt balance of the year totaling $5.4 million at December
31, 2002.
* the interest rate charged was increased from the bank's prime rate plus
.75% to the bank's prime rate plus 1.00%.
* payment of all dividends is prohibited, including dividends due to
ManTech on its outstanding preferred stock.
* certain covenant modifications were made to position the Company for
future compliance
* GP Strategies extended their $1.8 million limited guarantee of the
Company's bank facility through March 31, 2004. In consideration for
the extension of the guarantee, the Company will issue 150,000 shares
of its common stock to GP Strategies. The number of shares was
calculated based upon a 10% fee divided by the closing price of GSE's
common stock on March 21, 2003.
See Note 10, Long-term debt, in the "Notes to Consolidated Financial Statements"
for additional details about the Company's line of credit.
In 2000, the Company issued a demand promissory note to ManTech that
allowed the Company to borrow up to $1.8 million at an interest rate of prime
plus one percent. In addition, ManTech provided $1.8 million in standby letters
of credit to the Company's bank as additional collateral for the Company's
credit facility. In April 2001, ManTech agreed to allow the Company's bank to
draw upon ManTech's $1.8 million letter of credit which supported the Company's
credit facility, thus paying down a portion of the Company's bank debt in
exchange for additional subordinated debt in the Company. Accordingly, the
Company's promissory note to ManTech was amended to increase the amount to $3.9
million. The amended note permitted ManTech to convert the principal amount of
the note into GSE Series A convertible preferred stock at a conversion rate of
$100 per share. The Company determined that the conversion of this debt did not
constitute a beneficial conversion.
ManTech elected to convert its subordinated debt on December 5, 2001.
The Series A convertible preferred stock has no voting rights and bears
dividends at the rate of 6% per annum payable quarterly. Dividends will
accumulate if not paid quarterly and compounded interest will accrue on any
unpaid dividends. ManTech at its discretion has the right to convert each share
of Series A convertible preferred stock into GSE common stock at a purchase
price of $2.645 per share at any time after a one-year holding period from the
date of issuance. At the end of the third year from the date of issuance, the
Series A convertible preferred stock automatically converts into GSE common
stock. Prior to ManTech's conversion of the Series A convertible stock to common
stock, GP Strategies has the option to acquire 50% of the Series A convertible
preferred stock for $1,950,000 from ManTech.
At a special shareholder's meeting on August 2, 2001, the Company's
shareholders approved an amendment to the Certificate of Incorporation
increasing GSE's authorized common stock by 10 million shares to a total of 18
million shares. With this new authorization of common stock, the Company intends
to reserve 1,474,480 shares for the conversion of the ManTech convertible
preferred stock discussed above. In addition, the Company issued 522,611 shares
on December 21, 2001 in conjunction with a fixed price rights offering described
below.
On June 25, 2001, the Company issued an additional unsecured promissory
note to ManTech that allowed the Company to borrow up to $1.0 million at an
interest rate of prime plus one percent. The Company used the loan proceeds for
working capital purposes. The note is subordinated to the Company's credit
facility. In 2002, the Company repaid ManTech $350,000, plus $247,000 of
interest.
On October 25, 2001, the Company filed a final registration statement
with the SEC for a fixed price rights offering which became effective on October
29, 2001. In early November, the Company distributed to non-affiliated holders
of its common stock, based on an October 26, 2001 record date, subscription
rights to purchase additional shares of common stock at a subscription price of
$2.53 per share. Each non-affiliated holder of its common stock received .711
subscription right for each share held as of the record date. Shareholders had
until the expiration date of December 21, 2001 to subscribe to the offering. Of
the total 2,219,701 shares available, 522,611 shares were subscribed. The
proceeds to GSE totaled $1.3 million prior to fees and expenses related to the
offering of approximately $139,000. The Company received the cash proceeds from
its escrow agent in January 2002. The proceeds were used for a partial repayment
of the $1 million loan from ManTech discussed above and working capital
requirements.
Other. The following summarizes the Company's contractual cash
obligations at December 31, 2002, and the effect these obligations are expected
to have on its liquidity and cash flow in future periods:
Payments Due by Period
(in thousands)
- -------------------------------------------------------------------------------------------------------
Contractual Cash Obligations Total Less than 1-3 Years 4-5 Years After 5 Years
1 year
- -------------------------------------------------------------------------------------------------------
Long Term Debt (1) $ 5,431 - $ 5,431 - -
- -------------------------------------------------------------------------------------------------------
Purchase Commitments $ 5,254 $ 3,309 $ 1,945 - -
- -------------------------------------------------------------------------------------------------------
Related Party Debt $ 723 $ 30 $ 693 - -
- -------------------------------------------------------------------------------------------------------
Operating Leases (2) $ 7,727 $ 1,740 $ 3,208 $2,493 $ 286
- -------------------------------------------------------------------------------------------------------
Total Contractual Cash Obligations (2) $19,135 $ 5,079 $11,277 $2,493 $ 286
- -------------------------------------------------------------------------------------------------------
(1) The Company's credit facility expires on March 23, 2003. However, as
the Company has signed an amendment to the loan and security
agreement that extends the facility until March 31, 2004, the debt
outstanding at December 31, 2002 has been classified in the 1-3 Years
category in the above table, and is presented as long-term debt on the
December 31, 2002 balance sheet.
(2) Amounts exclude obligations under financing-type leases. See Note 10
to the Consolidated Financial Statements.
The Company has entered into a sublease agreement with Alpharma USPD
Inc. to sublease 29,000 square feet of its Baltimore, MD facility for a five-
year period commencing on May 1, 2003. The subtenant may terminate the lease at
the end of the second or third year of the agreement provided a six month notice
is given. The Company plans to move most of the Process personnel presently
using this facility to its Columbia, Maryland facility in April 2003.
As of December 31, 2002, the Company was contingently liable for seven
letters of credit totaling $747,000. All of these letters of credit represent
payment bonds on contracts and have been cash collateralized.
Due to the Company's cash situation at the end of 2000, GSE experienced
some difficulties in procuring supplies from its vendors for business
operations. In January 2001, the Company entered into a purchasing arrangement
with ManTech whereby ManTech dealt directly with some of the Company's vendors,
ordered the supplies needed and had the products shipped per the Company's
instructions. Purchases under this agreement totaled $843,000 for the year ended
December 31, 2001. This purchasing arrangement terminated in June 2001, and the
Company has no outstanding obligations to ManTech, in connection with this
purchasing arrangement as of December 31, 2002.
The Company's cash flow has continued to be extremely tight in 2002,
but has been sufficient to meet the Company's operating needs. The Company's
cash flow is expected to improve during 2003 as the Power business unit returns
to profitability. However, the Company's liquidity can be affected by any of the
following significant risk factors:
* The Company's business is substantially dependent on sales to the
nuclear power industry (40% of revenue in 2002) and the chemicals
industry (35% of revenue in 2002). Spending by companies in these
targeted industries is subject to period-to-period fluctuations as a
consequence of industry cycles, economic conditions, political and
regulatory environments and other factors.
* The Company relies on two customers, Battelle's Pacific Northwest
National Laboratory (11% of revenue in 2002) and Westinghouse Savannah
River Company (24% of revenue in 2002), for a substantial portion of
its revenues. The loss of either of these customers would have a
material adverse effect upon the Company' liquidity.
* Sales of products and the provision of services to end users outside
the United States accounted for approximately 31% of the Company's
revenue in 2002. Thus, the Company is subject to risks associated with
the application and imposition of protective legislation and
regulations relating to import or export or otherwise resulting from
trade or foreign policy.
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 enters into forward
exchange contracts, options and swap agreements as hedges against certain
foreign currency commitments to hedge its foreign currency risk.
New Accounting Standards.
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 143, Accounting for
Asset Retirement Obligations. SFAS No. 143 requires the Company to record the
fair value of an asset retirement obligation as a liability in the period in
which it incurs a legal obligation associated with the retirement of tangible
long-lived assets that result from the acquisition, construction, development,
and/or normal use of the assets. The Company also records a corresponding asset
that is depreciated over the life of the asset. Subsequent to the initial
measurement of the asset retirement obligation, the obligation will be adjusted
at the end of each period to reflect the passage of time and changes in the
estimated future cash flows underlying the obligation. The Company is required
to adopt SFAS No. 143 on January 1, 2003. The adoption of SFAS No. 143 is not
expected to have a material effect on the Company's financial position or
results of operations.
In April 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 145, Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. SFAS No. 145 provides for the rescission of several previously
issued accounting standards, new accounting guidance for the accounting for
certain lease modifications and various technical corrections that are not
substantive in nature to existing pronouncements. The Company will adopt SFAS
No. 145 as of January 1, 2003, except for the provisions relating to the
amendment of SFAS No. 13, which were adopted for transactions occurring
subsequent to May 15, 2002. Adoption of SFAS No. 145 is not expected to have a
material impact on the consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. SFAS No. 146 requires that a
liability for a cost associated with the exit or disposal activity be recognized
when incurred at fair value. SFAS No. 146 eliminates the definition and
requirements of EITF Issue 94-3. SFAS No. 146 is effective for exit or disposal
activities that are initiated after December 31, 2002 and may have an effect on
the timing of future restructuring charges taken, if and when they occur.
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. FIN 45 addresses the disclosure
requirements of a guarantor in its interim and annual financial statements about
its obligations under certain guarantees that it has issued. FIN 45 also
requires a guarantor to recognize, at the inception of a guarantee, a liability
for the fair value of the obligation undertaken in issuing the guarantee. The
liability recognition requirements of FIN 45 will be applicable prospectively to
all guarantees issued or modified after December 31, 2002. The Company is
currently evaluating the impact FIN 45 will have on its consolidated financial
statements.
In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation - Transition and Disclosure, an amendment of FASB
Statement No. 123. This Statement amends FASB Statement No. 123, Accounting for
Stock-Based Compensation, to provide alternative methods of transition for an
entity that voluntarily changes to the fair value based method of accounting for
stock-based employee compensation. It also amends the disclosure provisions of
that Statement to require prominent disclosure about the effects on reported net
income of an entity's accounting policy decisions with respect to stock-based
employee compensation. Finally, this Statement amends APB Opinion No. 28,
"Interim Financial Reporting", to require disclosure about those effects in
interim financial information. The transition provisions of this statement are
effective for financial statements for 2002. The disclosure provisions of this
statement will be effective for financial reports containing condensed financial
statements for interim periods beginning in 2003. The Company plans to retain
the intrinsic method to value stock options and accordingly, SFAS 148 will only
impact the Company's future disclosure requirements.
In October 2002, the Emerging Issues Task Force of the FASB reached a
consensus on the accounting for revenues in transactions that involve multiple
deliverables. The guidance governs how to identify whether goods or services or
both, that are to be delivered separately in a bundled sales arrangement, should
be accounted for separately. This guidance will be effective July 1, 2003. The
Company has not yet determined the impact this consensus will have on its
consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46, Consolidation
of Variable Interest Entities, which requires the consolidation of certain types
of entities. The Interpretation applies immediately to variable interest
entities created or acquired after January 31, 2003. The Interpretation is
effective for interim periods beginning after June 15, 2003 for an enterprise
that has variable interest entities acquired prior to February 1, 2003. The
Company will adopt the new Interpretation, as required, but does not expect
adoption will have a material effect on its financial statements.
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. During the year ended December 31, 2002, 2% and 1% of
the Company's revenues were from contracts which permitted payments in a
currency other than U.S. Dollars, principally Swedish Krona and Japanese Yen,
respectively. In addition, during the year ended December 31, 2002, 5% of the
Company's expenses were incurred in Swedish Krona. 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 23, 2003, such interest rates
are based on the prime rate plus 100 basis-points.
As of December 31, 2002, $6.1 million of the Company's debt was subject
to variable interest rates. A 100 basis-point change in such rates during the
year ended December 31, 2002 would have increased the Company's annual interest
expense by approximately $51,000.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEX TO FINANCIAL STATEMENTS
Page
GSE Systems, Inc. and Subsidiaries
Independent Auditors' Report .............................................F-1
Consolidated Balance Sheets as of December 31, 2002 and 2001..............F-2
Consolidated Statements of Operations for the years ended
December 31, 2002, 2001, and 2000..................................F-3
Consolidated Statements of Comprehensive Loss
for the years ended December 31, 2002, 2001, and 2000..............F-4
Consolidated Statements of Changes in Stockholders' Equity for
the years ended December 31, 2002, 2001 and 2000...................F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001, and 2000......................................F-6
Notes to Consolidated Financial Statements..................................F-7
Independent Auditors' Report
The Board of Directors and Stockholders
GSE Systems, Inc.:
We have audited the accompanying consolidated balance sheets of GSE Systems,
Inc. and subsidiaries as of December 31, 2002 and 2001, and the related
consolidated statements of operations, comprehensive loss, changes in
stockholders' equity and cash flows for each of the years in the three-year
period ended December 31, 2002. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards 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. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of GSE Systems, Inc.
and subsidiaries as of December 31, 2002 and 2001, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2002, in conformity with accounting principles generally
accepted in the United States of America.
The Company adopted the provisions of SFAS No. 142, Goodwill and Other
Intangible Assets, on January 1, 2002.
/s/KPMG LLP
Baltimore, Maryland
March 21, 2003
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
December 31,
---------------------------
2002 2001
------------- ------------
ASSETS
Current assets:
Cash and cash equivalents $ 1,617 $ 2,040
Restricted cash 608 164
Contract receivables 10,761 11,608
Proceeds of rights offering held by escrow agent - 1,322
Inventories 1,560 1,566
Prepaid expenses and other current assets 2,656 2,922
------------- ------------
Total current assets 17,202 19,622
Investment in Avantium International B.V. 115 2,898
Property and equipment, net 1,697 1,762
Software development costs, net 4,401 3,806
Goodwill, net 2,901 2,386
Restricted cash 139 340
Other assets 2,439 2,860
------------- ------------
Total assets $ 28,894 $ 33,674
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 1,905 $ 2,284
Accounts payable 2,521 2,163
Accrued expenses 1,727 1,217
Accrued compensation and payroll taxes 1,401 1,676
Billings in excess of revenue earned 3,059 4,659
Accrued warranty reserves 491 415
Other current liabilities 62 145
------------- ------------
Total current liabilities 11,166 12,559
Long-term debt 8,033 6,690
Billings in excess of revenue earned 998 45
Accrued warranty reserves 586 528
------------- ------------
Total liabilities 20,783 19,822
------------- ------------
Commitments and contingencies
Stockholders' equity:
Series A convertible preferred stock $.01 par value, 2,000,000 shares authorized,
shares issued and outstanding 39,000 in 2002 and 2001 - -
Common stock $.01 par value, 18,000,000 shares authorized, shares issued and
outstanding 5,869,138 and 5,741,138 in 2002 and 2001, respectively 59 57
Additional paid-in capital 27,841 27,535
Accumulated deficit - at formation (5,112) (5,112)
Accumulated deficit - since formation (13,490) (7,313)
Accumulated other comprehensive loss- foreign currency translation (1,187) (1,315)
------------- ------------
Total stockholders' equity 8,111 13,852
------------- ------------
Total liabilities and stockholders' equity $ 28,894 $ 33,674
============= ============
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,
2002 2001 2000
------------ ------------- -------------
Contract revenue $ 43,116 $ 50,331 $ 55,715
Cost of revenue 31,801 36,381 40,822
------------ ------------- -------------
Gross profit 11,315 13,950 14,893
Operating expenses
Selling, general and administrative 12,303 10,857 17,853
Depreciation and amortization 540 1,375 1,695
------------ ------------- -------------
Total operating expenses 12,843 12,232 19,548
------------ ------------- -------------
Operating income (loss) (1,528) 1,718 (4,655)
Gain (loss) on sales of assets - 3,273 (990)
Write-down of investment
in Avantium International B.V. (2,783) (4,605) -
Interest expense, net (277) (886) (687)
Other income, net 34 406 55
------------ ------------- -------------
Loss before income taxes (4,554) (94) (6,277)
Provision for (benefit from) income taxes 1,389 (353) 2,537
------------ ------------- -------------
Net income (loss) (5,943) 259 (8,814)
Preferred stock dividends (234) (17) -
------------ ------------- -------------
Net income (loss) attributed to
common stockholders $(6,177) $ 242 $(8,814)
============ ============= =============
Basic earnings (loss) per common share $ (1.05) $ 0.05 $ (1.70)
============ ============= =============
Diluted earnings (loss) per common share $ (1.05) $ 0.05 $ (1.70)
============ ============= =============
The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)
Years ended December 31,
2002 2001 2000
------------ ------------- -------------
Net income (loss) $ (5,943) $ 259 $ (8,814)
Foreign currency translation adjustment 128 (413) (184)
------------ ------------- -------------
Comprehensive loss $ (5,815) $ (154) $ (8,998)
============ ============= =============
The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC, AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2002, 2001 and 2000
(in thousands)
Accumulated Accumulated
Common Preferred Additional Deficit Other
----------------
Stock Stock Paid-in At Since Comprehensive
Shares Amount Shares Amount Capital Formation Formation Loss Total
------- ------- ------ ------- -------- ---------- --------- ---------- ------
Balance, January 1, 2000 5,066 $ 50 - $ - $ 21,691 $(5,112) $ 1,259 $ (718) $17,170
Common stock issued
for options exercised 11 - - - 40 - - - 40
Common stock issued to ManTech Intl. Corp. 117 2 - - 499 - - - 501
Foreign currency translation adjustment - - - - - - - (184) (184)
Net loss - - - - - - (8,814) - (8,814)
------- ------ ---- ------ ------- --------- -------- --------- --------
Balance, December 31, 2000 5,194 52 - - 22,230 5,112) (7,555) (902) 8,713
Fair value of options/warrants issued
to non-employees - - - - 194 - - - 194
Common stock issued for options exercised 25 - - - 33 - - - 33
Conversion of subordinated debt to
preferred stock - - 39 - 3,900 - - - 3,900
Rights offering 523 5 - - 1,178 - - - 1,183
Preferred stock dividends declared and payable - - - - - - (17) - (17)
Foreign currency translation adjustment - - - - - - - (413) (413)
Net income - - - - - - 259 - 259
--------- ------- ------ ----- -------- ------- --------- --------- --------
Balance, December 31, 2001 5,742 57 39 - 27,535 (5,112) (7,313) (1,315) 13,852
Common stock issued for options exercised 128 2 - - 261 - - - 263
Stock option compensation - - - - 45 - - - 45
Preferred stock dividends declared and payable - - - - - - (234) - (234)
Foreign currency translation adjustment - - - - - - - 128 128
Net loss - - - - - - (5,943) - (5,943)
--------- -------- ------ ---- -------- ------ --------- ------- ---------
Balance, December 31, 2002 5,870 $59 39 $ - $27,841 $(5,112) $(13,490) $(1,187) $8,111
------- -------- ----- ---- ------- ------ --------- ------- ---------
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,
2002 2001 2000
------------ ------------- -------------
Cash flows from operating activities:
Net income (loss) $ (5,943) $ 259 $ (8,814)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 2,424 3,394 3,882
Foreign currency transaction gain (34) (253) (255)
Stock option compensation 45 - -
(Gain) loss on sales of assets - (3,273) 990
Write-down of investment in Avantium International B.V. 2,783 4,605 -
Non-monetary consideration received for software licensed to
Avantium International B.V. - - (2,895)
Deferred income taxes 1,600 (476) 2,273
Changes in assets and liabilities:
Contract receivables (1,743) 683 1,939
Inventories 6 21 1,554
Prepaid expenses and other assets 275 (363) (164)
Accounts payable, accrued compensation and accrued expenses (22) (5,154) (690)
Billings in excess of revenues earned (602) 3,293 (1,599)
Accrued warranty reserves 134 (69) (288)
Other liabilities (61) (689) (561)
Income taxes payable (67) (68) 141
------------ ------------- -------------
Net cash provided by (used in) operating activities (1,205) 1,910 (4,487)
------------ ------------- -------------
Cash flows from investing activities:
Cash paid for acquisition of businesses (45) (1,090) (658)
Cash sold in disposition of business - - (261)
Capital expenditures (457) (477) (472)
Capitalized software development costs (2,478) (809) (1,868)
------------ ------------- -------------
Net cash used in investing activities (2,980) (2,376) (3,259)
------------ ------------- -------------
Cash flows from financing activities:
Proceeds from issuance of common stock 1,583 33 542
Proceeds from issuance of notes payable to related party - 3,350 1,550
Proceeds from issuance of notes payable - - 458
Repayment on notes payable to related party (350) - -
(Restrictions) releases of cash as collateral under letters of credit, net (243) 29 202
Increase (decrease) in borrowings under lines of credit 443 (4,289) 3,044
Proceeds from assignments of sales-type leases 2,589 2,198 1,141
Other financing repayments (269) (269) (346)
------------ ------------- -------------
Net cash provided by financing activities 3,753 1,052 6,591
------------ ------------- -------------
Effect of exchange rate changes on cash 9 (11) (75)
------------ ------------- -------------
Net increase (decrease) in cash and cash equivalents (423) 575 (1,230)
Cash and cash equivalents at beginning of year 2,040 1,465 2,695
------------ ------------- -------------
Cash and cash equivalents at end of year $ 1,617 $ 2,040 $ 1,465
============ ============= =============
The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001, and 2000
1. Business and liquidity
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 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.
In 2002, the Company incurred a significant operating loss attributable
in large part to the performance of the Company's Power business unit. The Power
business unit's revenue and profitability were significantly impacted by the
completion of several large, multi-year projects in late 2001 and early 2002
coupled with the delay of several very large full-scope international simulator
orders. In addition to the operating loss, the Company wrote down its investment
in Avantium International B.V., recording a non-cash charge of $2.8 million and
recorded an income tax provision of $1.4 million resulting mainly from an
increase in the Company's valuation allowance to fully reserve the Company's net
deferred tax assets.
The Company has a $10.0 million credit facility with a bank which
matured on March 23, 2003. The Company has been informed by its bank that the
Company should begin to search for a new financial institution to provide for
its future financing requirements. To provide the Company with enough time to
perform this search, the bank agreed to provide the Company with a one-year
extension of its current credit facility. Accordingly, on March 23, 2003 the
Company's credit facility was extended until March 31, 2004. At the time of the
extension, the maximum commitment under the credit facility was reduced from
$10.0 million to $6.5 million as of March 23, 2003; with an additional reduction
to $5.5 million on October 1, 2003; and a final reduction to $5.0 million on
January 1, 2004. Based upon the Company's current forecasts of its cash flow in
2003, management believes the reductions in the maximum commitment will not have
an impact on the Company's operations or liquidity. In order to help improve the
Company's liquidity and operating results, management has undertaken actions to
reduce its operating expenses, including the reduction of US Power employees by
15 in 2002 and the sublease of 29,000 square feet if its 34,000 square
foot Rutherford, Baltimore, Maryland facility effective May 1, 2003.
However, the Company's 2003 profitability and liquidity projections
depend on several large full-scope simulator contracts in its Power business
unit, several that have been quoted and verbally accepted, but have not yet
formally been awarded by the customer. In the event that the Company does not
receive these contracts, or is unable to find replacements for these contracts,
it may need to seek additional debt or equity financing in 2003. There can be no
assurance that such debt or equity financing will be available when needed.
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. All intercompany balances and
transactions have been eliminated.
Accounting estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America 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.
Revenue recognition
The majority of the Company's revenue is derived through the sale of
uniquely designed systems containing hardware, software and other materials
under fixed-price contracts. In accordance with Statement of Position 81-1
"Accounting for Performance of Construction-Type and Certain Production-Type
Contracts", the revenue under these fixed-price contracts 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 identified. Estimated
losses are charged against earnings in the period such losses are identified.
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. The Company's longer-term contracts
generally provide for a one-year warranty on parts, labor and any bug fixes as
it relates to software embedded in the systems.
The Company's system design contracts do not provide for "post customer
support service" (PCS) in terms of software upgrades, software enhancements or
telephone support. In order to obtain PCS, the customers must purchase a
separate contract at the date of system installation. Such PCS arrangements are
generally for a one-year period renewable annually and include customer support,
unspecified software upgrades, maintenance releases, hardware support and spare
parts. The Company recognizes revenue from these contracts ratably over the life
of the agreements in accordance with Statement of Position 97-2 "Software
Revenue Recognition".
Revenues 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.
Cash and cash equivalents
Cash and cash equivalents consist of cash on hand and highly liquid
investments with maturities of three 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. Slow moving 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.
Research and development
Development expenditures incurred to meet customer specifications under
contracts 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 were approximately $1,038,000, $827,000, and $1,679,000, for the
years ended December 31, 2002, 2001 and 2000, respectively.
Asset impairment
The Company periodically evaluates the recoverability of its long-lived
assets by comparing the carrying value of the asset to management's best
estimate of the expected future cash flows to be generated by the asset,
undiscounted and without interest costs. Impairments are recognized in operating
results to the extent that the carrying value exceeds fair value. No impairment
losses were recognized in 2002, 2001 or 2000.
Goodwill
On January 1, 2002, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, which
requires that goodwill and intangible assets with indefinite useful lives no
longer be amortized, but instead tested for impairment at least annually. As of
the date of adoption of SFAS No. 142, the Company had unamortized goodwill in
the amount of $2.4 million which was subject to the transition provisions of
SFAS No. 142. During 2002, the Company completed its analysis pursuant to the
transitional provisions of SFAS No. 142 and determined that no impairment charge
was necessary. On December 31, 2002, the Company completed a further analysis of
goodwill and determined no impairment charge was necessary.
Net income and net income per share for the years ended December 31,
2001 and 2000, adjusted to eliminate historical amortization of goodwill and
related tax effects, are as follows:
(in thousands, except for per share amounts) December 31,
------------------------------------
2001 2000
----------------- -----------------
Net income (loss) attributed to
common stockholders; as reported $ 242 $ (8,814)
Add: goodwill amortization, net of tax 527 317
----------------- -----------------
Net income (loss), as adjusted $ 769 $ (8,497)
================= =================
Net income (loss) per share, as reported:
Basic $ 0.05 $ (1.70)
Diluted $ 0.05 $ (1.70)
Net income (loss) per share, as adjusted:
Basic $ 0.15 $ (1.64)
Diluted $ 0.15 $ (1.64)
Prior to the adoption of SFAS No. 142, goodwill was being amortized
over periods from three to fifteen years on a straight-line basis. At each
reporting date, the Company assessed the recoverability of goodwill by
determining whether the amortization of goodwill over its remaining useful life
could be recovered through undiscounted operating cash flows of the acquired
operations. The amount of goodwill impairment, if any, was measured based on
projected discounted future operating cash flows using a discount rate
reflecting the Company's average costs of funds.
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
loss in stockholders' equity. Transaction gains and losses, resulting from
changes in exchange rates, are included in other income (expense) in the
Consolidated Statements of Operations in the period in which they occur. For the
years ended December 31, 2002, 2001, and 2000, foreign currency transaction
gains were approximately $34,000, $253,000, and $255,000, respectively.
Warranties
As the Company recognizes revenue under the percentage-of-completion
method, it provides an accrual for estimated future warranty costs based on
historical experience and projected claims. The activity in the warranty
accounts is as follows:
Years ended
(in thousands) December 31,
------------------------------------------
2002 2001 2000
------------ ------------ ------------
Beginning balance $ 943 $ 1,012 $ 1,300
Current year provision 1,251 604 462
Current year claims (1,117) (673) (750)
------------ ------------ ------------
Ending balance $ 1,077 $ 943 $ 1,012
============ ============ ============
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.
Stock Compensation
The Company applies the intrinsic-value-based method of accounting
prescribe by Accounting Principles Board (APB) Opinion No. 25, Accounting for
stock issued to Employees, and related interpretations including FASB
Interpretation No. 44, Accounting for Certain Transactions involving Stock
Compensation, and interpretation of APB Opinion No. 25, issued in March 2000, to
account for its fixed-plan stock options. Under this method, compensation
expense is recorded on the date of grant only if the current market price of the
underlying stock exceeds the exercise price. SFAS No. 123, Accounting for
Stock-Based Compensation, established accounting and disclosure requirements
using a fair-value-based method of accounting for stock based employee
compensation plans. As allowed by SFAS No. 123, the Company has elected to
continue to apply the intrinsic-value-based method of accounting describe above,
and has adopted only the disclosure requirements of SFAS No. 123. The following
table illustrates the effect on net income if the fair-value-based method had
been applied to all outstanding and unvested awards in each period.
(in thousands, except per share data) Years ended
December 31,
---------------------------------------
2002 2001 2000
------------- ----------- ---------
Net income (loss) attributed to
common stockholders, as reported $ (6,177) $ 242 $(8,814)
Add stock-based employee compensation expense
included in reported net loss, net of tax 45 - -
Deduct total stock-based employee compensation
expense determined under fair-value-method
for all ewards, net of tax (422) (878) (1,657)
------------- ------------ --------
Pro forma net loss $ (6,554) $ (636) $(10,471)
============= ============ ==========
Net income (loss) per share, as reported:
Basic $ (1.05) $ 0.05 $ (1.70)
Diluted $ (1.05) $ 0.05 $ (1.70)
Proforma net loss per share:
Basic $ (1.12) $ (0.12) $ (2.02)
Diluted $ (1.12) $ (0.12) $ (2.02)
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, 2001, and 2000:
expected volatility of 110%; dividend yield of 0%; risk-free interest
rates ranging from 2.63% to 6.2%; and expected terms ranging from 1 to 7 years.
The weighted-average fair value of options granted during 2001 and 2000 was
$1.55 per share, and $3.93 per share, respectively. There were no options
granted during 2002.
Earnings (loss) per share
Basic earnings per share is based on the weighted average number of
outstanding common shares for the period. Diluted earnings per share adjusts the
weighted average shares outstanding for the potential dilution that could occur
if stock options, warrants, or convertible preferred stock were exercised or
converted into common stock. The number of common shares and common share
equivalents used in the determination of basic and diluted earnings (loss) per
share was as follows:
(in thousands, except share data) Years ended
December 31,
---------------------------------------------
2002 2001 2000
-------------- ------------- --------------
Numerator:
Net income (loss) $ (5,943) $ 259 $(8,814)
Preferred stock dividends (234) (17) -
-------------- ------------- --------------
Net income (loss) attributed to
common stockholders $ (6,177) $ 242 $ (8,814)
============== ============= ==============
Denominator:
Weighted-average shares outstanding for basic
earnings per share 5,863,134 5,217,453 5,181,972
Effect of dilutive securities:
Employee stock options, warrants and
options outside the plan - 41,563 -
-------------- ------------- --------------
Adjusted weighted-average shares outstanding
and assumed conversions for diluted
earnings per share 5,863,134 5,259,016 5,181,972
============== ============= ==============
Shares related to dilutive securities excluded
because inclusion would be anti-dilutive: 3,166,456 3,436,195 687,423
============== ============= ==============
The difference between the basic and diluted number of weighted average
shares outstanding for the year ended December 31, 2001 represents dilutive
stock options, warrants and convertible preferred stock to purchase shares of
common stock computed under the treasury stock method, using the average market
price during the period. The net income (loss) for the years ended December 31,
2002 and 2001 decreased by preferred stock dividends of $234,000 and $17,000,
respectively, in calculating the per share amounts. For the year ended December
31, 2000, there were no preferred stock dividends. Conversion of the preferred
stock was not assumed for the years ended December 31, 2002 and 2001 because the
impact was anti-dilutive.
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 years ended
December 31, 2002, 2001 and 2000, one customer accounted for approximately 11%,
17%, and 22%, respectively, of the Company's revenues. At December 31, 2002, the
contracts receivable balance related to this significant customer was
approximately $1.33 million, or 11.9% of contract receivables, of which $1.2
million was unbilled at year-end. In 2002, 2001 and 2000, another customer
accounted for approximately 24%, 24%, and 11%, respectively, of the Company's
revenues. At December 31, 2002, the contracts receivable balance related to this
significant customer was approximately $642,000, or 6.0% of the balance, of
which $123,000 was unbilled at year-end.
Fair values of financial instruments
The carrying amounts of current assets, current liabilities, and
long-term debt reported in the Consolidated Balance Sheets approximate fair
value.
Off balance sheet risk and foreign exchange contracts
The Company utilizes various derivative financial instruments to manage
market risks associated with the fluctuations in foreign currency exchange
rates. It is the Company's policy to use derivative financial instruments to
protect against market risk arising in the normal course of business. The
criteria the Company uses for designating an instrument as a hedge include the
instrument's effectiveness in risk reduction and one-to-one matching of
derivative instruments to underlying transactions. The Company monitors its
foreign currency exposures to maximize the overall effectiveness of its foreign
currency hedge positions. Principal currencies hedged include the Euro and the
Japanese yen. The Company's objectives for holding derivatives are to minimize
the risks using the most effective methods to reduce the impact of these
exposures. The Company minimizes credit exposure by limiting counterparties to
nationally recognized financial institutions.
Effective January 1, 2001, the Company adopted Statements of Financial
Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and
Hedging Activities," as amended by SFAS No. 138 which establishes accounting and
reporting standards for derivative instruments. The adoption of Statement No.
133 resulted in no cumulative adjustment to income or other comprehensive income
at January 1, 2001. All derivatives, whether designated as hedging relationships
or not, are required to be recorded on the balance sheet at fair value. If the
derivative is designated as a fair value hedge, the changes in the fair value of
the derivative and of the hedged item attributable to the hedged risk are
recognized in earnings. If the derivative is designated as a cash flow hedge,
the change in the fair value of the derivative and of the hedged item are
recognized as an element of other comprehensive income. The Company utilizes
forward exchange contracts, options and swaps, as defined by Statement No. 133,
to hedge certain foreign currency balance sheet exposures.
At December 31, 2002, the Company had contracts for the sale of
approximately $383,000 and $334,000 of Japanese Yen and Euros, respectively, at
fixed rates. The contracts expire on various dates through November 2003. The
Company has not designated the contracts as hedges and, accordingly, has
recorded the estimated fair value of the contracts of $11,000 at December 31,
2002 as other assets in the consolidated balance sheet and other income
(expense) in the consolidated statement of operations.
Reclassifications
Certain reclassifications have been made to prior year amounts to
conform with the current year presentation.
New Accounting Standards
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 143, Accounting for
Asset Retirement Obligations. SFAS No. 143 requires companies to record the fair
value of an asset retirement obligation as a liability in the period in which it
incurs a legal obligation associated with the retirement of tangible long-lived
assets that result from the acquisition, construction, development, and/or
normal use of the assets. A corresponding asset is also recorded that is
depreciated over the life of the asset. Subsequent to the initial measurement of
the asset retirement obligation, the obligation will be adjusted at the end of
each period to reflect the passage of time and changes in the estimated future
cash flows underlying the obligation. The Company is required to adopt SFAS No.
143 on January 1, 2003. The adoption of SFAS No. 143 is not expected to have a
material effect on the Company's financial position or results of operations.
In April 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 145, Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. SFAS No. 145 provides for the rescission of several previously
issued accounting standards, new accounting guidance for the accounting for
certain lease modifications and various technical corrections that are not
substantive in nature to existing pronouncements. The Company will adopt SFAS
No. 145 as of January 1, 2003, except for the provisions relating to the
amendment of SFAS No. 13, which were adopted for transactions occurring
subsequent to May 15, 2002. Adoption of SFAS No. 145 is not expected to have a
material impact on the consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. SFAS No. 146 requires that a
liability for a cost associated with the exit or disposal activity be recognized
when incurred at fair value. SFAS No. 146 eliminates the definition and
requirements of EITF Issue 94-3. SFAS No. 146 is effective for exit or disposal
activities that are initiated after December 31, 2002 and may have an effect on
the timing of future restructuring charges taken, if and when they occur.
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. FIN 45 addresses the disclosure
requirements of a guarantor in its interim and annual financial statements about
its obligations under certain guarantees that it has issued. FIN 45 also
requires a guarantor to recognize, at the inception of a guarantee, a liability
for the fair value of the obligation undertaken in issuing the guarantee. The
liability recognition requirements of FIN 45 will be applicable prospectively to
all guarantees issued or modified after December 31, 2002. The Company is
currently evaluating the impact FIN 45 will have on its consolidated financial
statements.
In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation - Transition and Disclosure, an amendment of FASB
Statement No. 123. This Statement amends FASB Statement No. 123, Accounting for
Stock-Based Compensation, to provide alternative methods of transition for an
entity that voluntarily changes to the fair value based method of accounting for
stock-based employee compensation. It also amends the disclosure provisions of
that Statement to require prominent disclosure about the effects on reported net
income of an entity's accounting policy decisions with respect to stock-based
employee compensation. Finally, this Statement amends APB Opinion No. 28,
"Interim Financial Reporting", to require disclosure about those effects in
interim financial information. The transition provisions of this statement are
effective for financial statements for 2002. The disclosure provisions of this
statement will be effective for financial reports containing condensed financial
statements for interim periods beginning in 2003. The Company plans to retain
the intrinsic method to value stock options and accordingly, SFAS 148 will only
impact the Company's future disclosure requirements.
In October 2002, the Emerging Issues Task Force of the FASB reached a
consensus on the accounting for revenues in transactions that involve multiple
deliverables. The guidance governs how to identify whether goods or services or
both, that are to be delivered separately in a bundled sales arrangement, should
be accounted for separately. This guidance will be effective July 1, 2003. The
Company has not yet determined the impact this consensus will have on its
consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities" which requires the consolidation of certain types
of entities. The Interpretation applies immediately to variable interest
entities created or acquired after January 31, 2003. The Interpretation is
effective for interim periods beginning after June 15, 2003 for an enterprise
that has variable interest entities acquired prior to February 1, 2003. The
Company will adopt the new Interpretation, as required, but does not expect
adoption will have a material effect on its financial statements.
3. Investment in Avantium International B.V.
On February 24, 2000, the Company licensed certain of its simulation
software products to Avantium International B.V. ("Avantium") in exchange for
251,501 shares of Avantium preferred stock, valued at $2.5 million, and 352,102
shares of Avantium common stock, valued at $349,000. The software license, which
is perpetual in nature, gives Avantium the right to use the software in the
development of new software products. Each share of preferred stock is
convertible into common stock.
Avantium was formed to develop high-speed experimentation and
simulation ("HSE&S") technologies for application in new product and process
development in pharmaceutical, petrochemical, fine chemical, biotechnology and
polymers industries. Avantium expects to develop HSE&S technologies through
in-house development and contract research at leading universities, hardware
developers and informatics companies. Avantium has various investors, including
Shell International Chemical, SmithKline Beecham, W.R. Grace, Akzo Nobel, three
major European universities and various venture capital firms.
During the year ended December 31, 2000, the Company recognized
software-licensing revenue of $2.9 million based on the fair value of the
consideration received from Avantium. The fair value was established based on
cash paid by other investors for their respective preferred and common stock
interests in Avantium. The Company has delivered all elements of the software
and has no other obligations to Avantium, other than standard warranty. The
Company accounted for its investment in Avantium using the cost method of
accounting based on management's conclusion that the Company did not have
significant influence with respect to the operations of Avantium. During the
year ended December 31, 2000, the Company also received an additional $2.9
million contract from Avantium to make certain improvements and enhancements to
the software on a best efforts basis. The rates and margins in the contract were
comparable to those the Company earns performing services for its other
customers.
As a result of the experience with Avantium in 2000, the Company
concluded that a combination of the relevant interests of the two companies
would significantly increase the potential of both organizations. In addition,
focusing the technical and marketing resources of Avantium and the GSE
VirtualPlant team would produce significant cost savings.
On March 6, 2001, the Company sold its VirtualPlant business technology
and assets to Avantium. GSE received 8% of Avantium's stock, thus increasing its
holdings in Avantium to approximately 19%, and recognized a gain on the sale of
$3.3 million, before income taxes. This gain was determined based on the
estimated fair market value of the Avantium stock received ($9.60 per share),
based on an independent appraisal, less the book value of the assets sold,
approximately $700,000 in severance costs payable to certain former employees of
VirtualPlant, that were not hired by Avantium, and other transaction expenses.
The appraised value of $9.60 per share was calculated using the
Discounted Cash Flow income valuation method. Under this method, the annual
debt-free cash flow and residual value are discounted and added together to
arrive at Avantium's Aggregate Market Value. Avantium's annual debt-free cash
flow was estimated for the next five years, using Avantium's forecasts of
revenue, operating expenses, working capital, and fixed asset investments, and
then discounted at a rate of 20%. The residual value, or capitalized cash flows
beyond the five-year forecast period, was calculated using a capitalization rate
of 15%. Since Avantium is a closely held company, a discount for illiquidity of
20% was applied to the Aggregate Market Value determined. This value was then
divided by the number of outstanding shares to arrive at the per share appraised
value.
The appraised value was significantly higher than Avantium's net
tangible book value as of the date of the VirtualPlant sale. As Avantium was a
start-up phase company at the March 6, 2001 valuation date, it had not begun
generating positive earnings or cash flow. As such, its book value was comprised
primarily of the initial investments made in the company, less accumulated
operating losses. Based upon the business plans provided by Avantium for
analysis, quantifiable future earnings generation was expected for the business,
and Avantium was on track with its business development plans. Thus, the Company
determined that the use of the income valuation method would provide a more
accurate estimate of the valuation of the stock than the net tangible book
value.
Although the Company retained one seat on the supervisory board of
Avantium, management concluded that such seat did not provide the Company with
significant influence. Accordingly, the Company continued to account for its
investment in Avantium using the cost method. The cost method requires that if a
decline in fair value below cost is judged by management to be other than
temporary, the cost basis must be written down to fair value as a new cost
basis, and the amount of the write-down is included in earnings as a realized
loss. Any new cost basis derived in this manner is not changed for subsequent
recoveries in fair value.
On February 7, 2002, Avantium completed a private placement round of
financing which resulted in 20 million Euros in new capital and the conversion
of 11 million Euros of convertible debt. The equity issuance and debt conversion
diluted GSE's ownership in Avantium to 6.1%. The estimated fair market value of
Avantium following the financing was $47.4 million. Accordingly, the Company
concluded that this transaction was evidence of "an other than temporary
decline" in the fair value of its investment in Avantium. Thus, in the fourth
quarter 2001, the Company wrote down its investment in Avantium to $2.9 million
and recognized a $4.6 million pre-tax charge.
In the first quarter, 2003, Avantium indicated that it was pursuing
another private placement round of financing. Based upon the Company's
discussions with Avantium, GSE believes that its ownership in Avantium will be
diluted to less than 1%. Accordingly, the Company concluded that this pending
transaction was evidence of "an other than temporary decline" in the fair value
of its investment in Avantium. Thus, in the fourth quarter 2002, the Company
wrote down its investment in Avantium and recognized a $2.8 million pre-tax
charge.
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,
---------------------------
2002 2001
------------ -------------
Billed receivables $ 6,909 $ 6,640
Recoverable costs and accrued profit not billed 4,014 5,009
Allowance for doubtful accounts (162) (41)
------------ -------------
Total contract receivables $ 10,761 $ 11,608
============ =============
5. Inventories
Inventories consist of the following:
(in thousands) December 31,
---------------------------
2002 2001
------------ ------------
Raw materials $ 1,203 $ 1,143
Service parts 357 423
------------ ------------
Total inventories $ 1,560 $ 1,566
============ ============
6. Prepaid expenses and other current assets
Prepaid expenses and other current assets consist of the following:
(in thousands) December 31,
---------------------------
2002 2001
------------- -------------
Investment in sales-type lease - current portion $ 1,875 $ 1,016
Prepaid expenses 449 742
Employee advances 86 84
Deferred income taxes - 587
Other current assets 246 493
------------- -------------
Total $ 2,656 $ 2,922
============= =============
7. Property and equipment
Property and equipment consist of the following:
(in thousands) December 31,
---------------------------
2002 2001
------------- ------------
Computer equipment $ 5,571 $ 4,730
Leasehold improvements 878 878
Furniture and fixtures 1,882 2,051
------------- ------------
8,331 7,659
Accumulated depreciation and amortization (6,634) (5,897)
------------- ------------
Property and equipment, net $ 1,697 $ 1,762
============= ============
Depreciation and amortization expense was approximately $540,000,
$706,000, and $1,163,000, for the years ended December 31, 2002, 2001, and 2000,
respectively.
8. Software development costs
Software development costs, net, consist of the following:
(in thousands) December 31,
---------------------------
2002 2001
------------- ------------
Capitalized software development costs $8,166 $7,725
Accumulated amortization (3,765) (3,919)
------------- ------------
Software development costs, net $ 4,401 $ 3,806
============= ============
Software development costs capitalized were approximately $2,478,000, $809,000,
and $1,869,000, for the years ended December 31, 2002, 2001 and 2000,
respectively. Amortization of software development costs capitalized was
approximately $1,883,000, $2,019,000, and $2,202,000, for the years ended
December 31, 2002, 2001 and 2000, respectively, and were included in cost of
revenue.
9. Goodwill
Goodwill consists of the following:
(in thousands) December 31,
---------------------------
2002 2001
------------- ------------
Goodwill, at cost $ 5,370 $ 4,855
Accumulated amortization (2,469) (2,469)
------------- ------------
Goodwill, net $ 2,901 $ 2,386
============= ============
10. Long-term Debt
The Company's long-term debt consists of the following notes payable and
other financing arrangements:
(in thousands) December 31,
---------------------------
2002 2001
------------ ------------
Line of credit with bank $ 5,431 $ 4,988
Notes payable to related parties (see Note 16) 650 1,100
Obligations under financing leases 3,784 2,645
Notes payable, other 73 241
------------ ------------
Total notes payable and financing arrangements 9,938 8,974
Less amounts payable within one year 1,905 2,284
------------ ------------
Long-term portion $ 8,033 $ 6,690
============ ============
Line of Credit
The Company has a $10.0 million bank line of credit under which the
Company and its subsidiaries, GSE Process Solutions, Inc. and GSE Power Systems,
Inc., are jointly and severally liable as co-borrowers. The credit facility
provides for borrowings to support working capital needs and foreign letters of
credit ($2.0 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). GP Strategies Corporation, one of
the Company's major stockholders, has provided a limited guarantee totaling $1.8
million. The interest rate on this line of credit is based on the bank's prime
rate plus 0.75% (5.00% as of December 31, 2002), with interest only payments due
monthly. At December 31, 2002, the Company's available borrowing base was
approximately $6.9 million, of which approximately $5.4 million had been
utilized. The credit facility expired on March 23, 2003, but the Company's bank
agreed to extend the credit facility until March 31, 2004. Accordingly, the
balance outstanding under this credit facility at December 31, 2002 has been
classified as long-term debt on the December 31, 2002 balance sheet.
The credit facility 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. As of December
31, 2002, the Company was not in compliance with its financial ratio covenants.
The Company has received a written waiver from the bank for noncompliance and
amendments to the required financial ratio covenants for 2003.
On March 23, 2003 the Company's existing credit facility was extended
until March 31, 2004, with the following amendments to the agreement:
* the maximum commitment under the credit facility was reduced from $10.0
million to $6.5 million as of March 23, 2003; with an additional
reduction to $5.5 million on October 1, 2003; and a final reduction to
$5.0 million on January 1, 2004
* the interest rate charged was increased from the bank's prime rate plus
.75% to the bank's prime rate plus 1.00%.
* payment of all dividends is prohibited, including dividends due to
ManTech on its outstanding preferred stock.
* certain covenant modifications were made to position the Company for
future compliance.
* GP Strategies extended their $1.8 million limited guarantee of the
Company's bank facility through March 31, 2004. In consideration for
the extension of the guarantee, the Company will issue 150,000 shares
of its common stock to GP Strategies. The number of shares was
calculated based upon a 10% fee divided by the closing price of GSE's
common stock on March 21, 2003.
Notes Payable to Related Parties
In 2000, the Company issued a demand promissory note to ManTech that
allowed the Company to borrow up to $1.8 million at an interest rate of prime
plus one percent. In addition, ManTech provided $1.8 million in standby letters
of credit to the Company's bank as additional collateral for the Company's
credit facility. In April 2001, ManTech agreed to allow the Company's bank to
draw upon ManTech's $1.8 million letter of credit which supported the Company's
credit facility, thus paying down a portion of the Company's bank debt in
exchange for additional subordinated debt in the Company. Accordingly, the
Company's promissory note to ManTech was amended to increase the amount to $3.9
million. The amended note permitted ManTech to convert the principal amount of
the note into GSE Series A convertible preferred stock at a conversion rate of
$100 per share. The Company determined that the conversion of this debt did not
constitute a beneficial conversion. ManTech elected to convert its subordinated
debt into equity on December 5, 2001 (see Note 13).
On June 25, 2001, the Company issued an additional unsecured promissory
note to ManTech for $1.0 million at an interest rate of prime plus one percent.
The Company used the loan proceeds for working capital purposes. The note is
subordinated to the Company's credit facility. During 2002, the Company repaid
ManTech $350,000, plus $247,000 of interest.
Obligations under financing leases
During 2000, 2001 and 2002 the Company entered into seven separate
contracts with a customer for the lease of certain hardware and software under
36-month leases. The Company has accounted for the leases as sales-type leases.
The Company assigned the payments due under the sales-type leases to a
third-party financing company and received proceeds of $2,589,000 in 2002 and
$2,198,000 in 2001. Since the Company remains contingently liable for amounts
due to the third-party financing company, the remaining investment in and
obligation under the financing leases are reflected in the Company's balance
sheets as follows:
(in thousands) December 31,
---------------------------
2002 2001
------------ ------------
Net investment in sales-type leases:
Prepaid expense and other assets $ 1,875 $ 1,016
Other assets - non current 1,909 1,629
------------ ------------
Total net investment $ 3,784 $ 2,645
============ ============
Obligation under financing leases:
Current portion of long-term debts $ 1,875 $ 1,016
Long-term debts 1,909 1,629
------------ ------------
Total obligations $ 3,784 $ 2,645
============ ============
Minimum rentals receivable under these leases at December 31, 2002
amount to $2,275,000 in 2003, $1,647,000 in 2004, and 435,000 in 2005. As of
December 31, 2002, the components of the net investment in the sales-type leases
are total minimum rentals receivable of $4,357,000, less unearned interest
income of $573,000.
Debt maturities
Aggregate maturities of debt outstanding at December 31, 2002 are as follows:
(in thousands)
2003 $ 1,905
2004 7,607
2005 426
------------
Total $ 9,938
============
11. Income taxes
The consolidated loss before income taxes, by domestic and
foreign sources, is as follows:
(in thousands) Years ended December 31,
-------------------------------------------
2002 2001 2000
------------- ------------- -------------
Domestic $ (3,866) $ (135) $ (6,295)
Foreign (688) 41 18
------------- ------------- -------------
Total $ (4,554) $ (94) $ (6,277)
============= ============= =============
The provision for (benefit from) income taxes is as follows:
(in thousands) Years ended December 31,
-------------------------------------------
2002 2001 2000
------------- ------------- -------------
Current:
Federal $ (112) $ 54 $ (177)
State (57) 26 75
Foreign (42) 43 366
------------- ------------- -------------
Subtotal (211) 123 264
------------- ------------- -------------
Deferred:
Federal and State 1,694 (448) 2,543
Foreign (94) (28) (270)
------------- ------------- -------------
Subtotal 1,600 (476) 2,273
------------- ------------- -------------
Total $ 1,389 $ (353) $ 2,537
============= ============= =============
The provision for (benefit from) 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,
---------------------------------------------
2002 2001 2000
------------- ------------- -------------
Statutory U.S. tax rate (34.0)% (34.0)% (34.0)%
State income tax, net of federal tax benefit (2.0) 31.0 0.8
Effect of foreign operations 0.9 6.2 1.5
Change in valuation allowance 61.8 (447.2) 68.4
Other 3.8 68.9 3.7
------------- ------------- -------------
Effective tax rate 30.5 % (375.1)% 40.4 %
============= ============= =============
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) December 31,
----------------------------
2002 2001
------------- -------------
Net operating loss carryforwards $ 6,246 $ 5,589
Software development costs (1,615) (1,263)
Expenses not currently deductible for tax purposes 878 974
Foreign tax credits 379 379
Property and equipment (90) (27)
Swedish tax deferral - (175)
Accrued expenses 243 269
Alternative minimum tax credit carryforwards 162 217
Investments 1,512 470
Other 60 97
------------- -------------
Subtotal 7,775 6,530
Valuation allowance (7,775) (4,930)
------------- -------------
Total $ - $ 1,600
============= =============
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some or all of the deferred
tax assets will not be realized. The ultimate realization of deferred tax assets
is dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management considers the
scheduled reversal of deferred tax liabilities and projected future income in
making this assessment. Since the management could not substantiate recovery of
the net deferred tax assets with currently available objective evidence, the
Company has established a full valuation allowance of $7,775,000 at December 31,
2002. If the Company is able to realize taxable income in the future, the
valuation allowance will be reduced. The net change in the valuation allowance
for deferred tax assets was an increase of $2,845,000 and reduction of $420,000
in 2002 and 2001, respectively.
At December 31, 2002, the Company had available $15,146,000 and
$2,402,000 of domestic and foreign net operating loss carryforwards,
respectively, which expire between 2012 and 2022. In addition, the Company had
$379,000 of foreign tax credit carryforwards, which expire between 2003 and
2005. These carryforwards will be utilized to reduce taxable income in
subsequent years.
12. Capital stock
The Company's Board of Directors has authorized 20,000,000 total shares
of capital stock, of which 18,000,000 are designated as common stock and
2,000,000 are designated as preferred stock. 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.
On March 6, 2001, with the completion of the sale of VirtualPlant to
Avantium (see Note 3), the Company granted warrants to purchase shares of the
Company's common stock to two non-employees. The warrants provide the right to
purchase 37,500 shares of the Company's common stock at $1.00 per share. In
2001, the Company recognized expense related to the warrants of $115,000.
On March 9, 2001, with the completion of the sale of VirtualPlant to
Avantium (see Note 3), the Company arranged a consulting agreement with a
terminated employee. In consideration of consulting services, the Company
granted fully vested options to purchase 53,000 shares of the Company's common
stock at $1.70 per share. In 2001, the Company recognized expense related to
these options based on their estimated fair value of $79,000.
As of December 21, 2001, the Company completed a rights offering
granting rights to shareholders to purchase additional shares of common stock
for a subscription price of $2.53 per share. The rights granted 0.711 for every
share of common stock held of record as of October 26, 2001. Each whole right
entitled the shareholder to purchase one share of common stock for $2.53 per
share. As of December 31, 2001, the Company had a rights offering receivable of
$1.3 million due from its escrow agent and accrued $139,000 of costs associated
with the completion of the rights offering. The Company received the cash
proceeds from its escrow agent in January 2002. The proceeds were used for a
partial repayment of a $1 million loan from ManTech and working capital
requirements.
As of December 31, 2002, the Company has reserved 3,613,956 shares of
common stock for issuance upon exercise of stock options and warrants and the
conversion of preferred stock.
13. Series A Convertible Preferred Stock
On December 5, 2001, ManTech elected to convert $3.9 million of
subordinated debt into Series A convertible preferred stock at a conversion rate
of $100 per share. The Company has determined that the conversion of this debt
into preferred stock did not constitute a beneficial conversion. The Series A
convertible preferred stock has no voting rights and bears dividends at the rate
of 6% per annum payable quarterly. Dividends will accumulate if not paid
quarterly and compounded interest will accrue on any unpaid dividends. As of
December 31, 2002 and 2001, the Company had accrued dividends payable of
$176,000 and $17,000, respectively.
In the event of liquidation or dissolution of the Company, payment of
available funds shall be made on the Series A convertible preferred stock
(including payment in satisfaction of dividend obligations) prior and in
preference to the common stock. ManTech at its discretion has the right to
convert each share of Series A convertible preferred stock into GSE common stock
at a purchase price of $2.645 per share at any time after a one-year holding
period from the date of issuance. At the end of the third year from the date of
issuance, the Series A convertible preferred stock automatically converts into
1,474,480 shares of GSE common stock. Prior to ManTech's conversion of the
Series A convertible stock to common stock, GP Strategies has the option to
acquire 50% of the Series A convertible preferred stock for $1,950,000.
14. 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 seven 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. At December 31, 2002, the Company had
808,024 shares of common stock reserved for the future grants under the Plan.
Stock option activity under the Plan is as follows:
Weighted
Average
Shares Exercise Price
--------------- --------------
Options outstanding, as of January 1, 2000 1,167,605 $ 4.93
Options exercised (10,880) (3.56)
Options canceled (14,620) (3.73)
Options granted 295,000 5.07
---------------
Options outstanding, as of December 31, 2000 1,437,105 $ 4.81
Options exercised (25,000) (1.33)
Options canceled (99,950) (4.59)
Options granted 547,000 1.95
---------------
Options outstanding, as of December 31, 2001 1,859,155 $ 4.03
Options exercised (128,000) (2.05)
Options canceled (39,179) (2.00)
Options granted - -
---------------
Options outstanding, as of December 31, 2002 1,691,976 $ 4.15
===============
ABLE>
The following table summarizes information relating to currently outstanding and
exercisable options at December 31, 2002:
Options Outstanding Options Exercisable
-------------------------------------------------- --------------------------------
Weighted
Average
Remaining Weighted Weighted
Range of Options Contract Average Options Average
Exercise Prices Outstanding Life in Years Exercise Price Exercisable Exercise Price
- ----------------------- ---------------- --------------- --------------- --------------- ---------------
$1.48 - $2.95 546,050 5.0 $ 2.16 294,650 $ 2.26
$2.96 - $4.43 789,485 3.8 3.67 389,485 3.83
$4.44 - $5.90 200,000 4.1 4.75 200,000 4.75
$5.91 - $7.38 10,000 4.3 6.38 10,000 6.38
$7.39 - $8.85 20,000 4.2 7.50 14,000 7.50
$8.86 - $11.80 200 3.6 11.25 200 11.25
$11.81 - $14.75 126,241 2.7 14.11 126,241 14.11
Total 1,691,976 4.1 $ 4.15 1,034,576 $ 4.89
================ ============
15. 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, 2002 are as follows:
(in thousands)
2003 $ 1,740
2004 1,624
2005 1,584
2006 1,378
2007 1,115
Thereafter 286
-------------
Total $ 7,727
-------------
Total rent expense under operating leases for the years ended December
31, 2002, 2001, and 2000 was approximately $1,842,000, $1,924,000, and
$2,101,000, respectively.
Letters of credit and performance bonds
As of December 31, 2002, the Company was contingently liable for
approximately $747,000 under seven letters of credit used as payment bonds on
contracts, all of which were secured by cash deposits classified as restricted
cash in the consolidated balance sheet. As of December 31, 2002, the Company was
contingently liable for approximately $149,000 under three performance bonds on
contracts, all of which were secured by letters of credit of the Company's
foreign subsidiary. In addition, the Company has $111,000 in escrow until April
30, 2003 as a performance bond deposit in connection with a simulator contract
in Taiwan. This deposit is classified as an other asset in the consolidated
balance sheets at December 31, 2002 and 2001.
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.
16. Other related party transactions
In January 2000, the Company issued 116,959 shares of its common stock to
ManTech for $500,000. The proceeds of the stock issuance were used for working
capital.
Due to the Company's liquidity situation at the end of 2000, GSE
experienced some difficulties in procuring supplies from its vendors for
business operations. In January 2001, the Company entered into a purchasing
arrangement with ManTech whereby ManTech dealt directly with some of the
Company's vendors, ordered the supplies needed and had the products shipped in
accordance with the Company's instructions. Purchases under this agreement
totaled $843,000 for the year ended December 31, 2001. This purchasing
arrangement terminated in June 2001, and the Company has no outstanding
obligations to ManTech, in connection with this purchasing arrangement as of
December 31, 2002. The supplies purchased through ManTech were at the same
prices at which the Company could have procured the supplies directly.
In September 2001, the Company entered into a sublease agreement with
ManTech, allowing ManTech to sublease 2,088 square feet of space at the
Company's Columbia, Maryland office through September 2002. Subsequent to
September 2002, the lease is on a month to month basis. For the years ended
December 31, 2002 and 2001, such sublease rentals amounted to $32,000 and
$13,000, respectively.
In September, 2001, the Company entered into an alliance with General
Physics Corporation, the leading supplier of operator instructional training
programs for the Power industry. In addition to cooperating in marketing of
individual products, the companies will combine some of General Physics'
extensive training materials and programs with GSE's power plant simulation
models to provide interactive and adaptive total training solutions. GSE will
also help sell and distribute General Physics' GFE product to GSE's customer
base.
On December 7, 2001, the Company agreed to make certain cash and
in-kind contributions to RedStorm Scientific, Inc. ("RedStorm") in exchange for
a 10.1% interest in RedStorm. RedStorm is a privately held computational drug
design company. Its technology (patents pending), known as Fyrestar, utilizes
bio-informatics and computer-aided molecular design to create lead compounds
that are developed into successful new drugs. It greatly reduces the significant
cost associated with screening thousands of potential compounds common in the
drug development process.
The Company paid $50,000 to RedStorm in the fourth quarter of 2001 and
made additional cash payments of $200,000 in the year ended December 31, 2002.
GSE's in-kind contribution consists of the development of a graphical user
interface that will allow scientists to easily access and use the Fyrestar
technology and the development of additional functionality to Fyrestar, allowing
results to be graphically displayed as the calculations take place. This will
allow scientists the opportunity to adjust their assumptions in real time and
further improve results. GSE will receive a perpetual, worldwide, royalty-free,
non-transferable exclusive license for RedStorm's software products solely in
the power and process control markets.
One of the Company's directors is also on RedStorm's Board of Directors
and another director owns approximately 0.5% of RedStorm. The Company has
accounted for its investment in RedStorm using the equity method of accounting
based on management's conclusion that the Company has significant influence with
respect to the operations of RedStorm. During 2002, the Company recorded a loss
of $59,000 on this investment.
In October 2002, the Company purchased a Chinese subsidiary of ManTech.
See the discussion of this transaction in Note 18. Acquisitions and
dispositions.
17. 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 $215,000, $293,000, and $340,000, for the years ended
December 31, 2002, 2001, and 2000, respectively.
18. Acquisitions and dispositions
Acquisitions
In October 2002, the Company completed an acquisition for the Process
business unit which was accounted for using the purchase method. The Company
purchased the stock of ManTech Automation Systems (Beijing) Company Ltd, from
ManTech International Corp. The Chinese company, which has seven employees, was
renamed GSE Systems Engineering (Beijing) Company Ltd. The purchase price was
$45,000 and was allocated 100% to certain assets and property and equipment.
In December 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 was 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. For the years ended
December 31, 2002 and 2000, the contingent consideration in excess of the
minimum guaranteed amount was approximately $515,000, and $549,000,
respectively, which the Company has recorded as additions to goodwill. For the
year ended December 31, 2001, there was no contingent consideration.
Dispositions
On November 30, 2000, the Company completed the sale of its GSE Process
Solutions N.V. subsidiary ("GSE Belgium") to Newton Beheer B.V., pursuant to a
stock purchase agreement, whereby Newton Beheer B.V. acquired all of the assets
and assumed all of the liabilities of GSE Belgium. The aggregate cash sales for
GSE Belgium was $1. The Company recognized a loss before income taxes on this
transaction of $990,000. Included in the Consolidated Statement of Operations
for the year ended December 31, 2000, are revenues of $1.5 million and operating
losses of $346,000 attributable to GSE Belgium prior to the sale to Newton
Beheer B.V.
19. Segment information
The Company's two reportable segments are its core business units
Process and Power. (The Company's VirtualPlant business is reported under the
Process segment.) The accounting policies of the segments are the same as those
described in Note 2, 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
specialty chemicals, food & beverage, and pharmaceuticals fields, as well as in
the power generation industry. The Process business unit is primarily engaged in
process control in a variety of commercial industries. Contracts typically range
from three to nine months. The Power business unit is primarily engaged in
simulation and plant security for the power generation industry and simulation
for the process industries, with the vast majority of customers being in the
nuclear power industry. Contracts typically range from 18 months to three years.
The Power business unit is comprised of three divisions: Power Simulation, Plant
Security Systems, and Process Simulation.
The Company evaluates the performance of its business units utilizing
"Business Unit Contribution", which is substantially equivalent to earnings
before interest and taxes before allocating any corporate expenses. The segment
information regarding the divested businesses is also included below (see, Note
3, Investment in Avantium International B.V. and Note 18, Acquisitions and
dispositions).
The table below presents information as of and for the years ended
December 31, 2002, 2001, and 2000 about the reportable segments:
(in thousands) 2002
------------------------------------------
Process Power Total
Contract revenue $ 22,941 $ 20,175 $ 43,116
============ ============ ============
Business unit contribution $ 2,574 $ (736) $ 1,838
============ ============ ============
Total assets $ 15,852 $ 12,569 $ 28,421
============ ============ ============
Additions to long-lived assets $ 2,299 $ 638 $ 2,937
============ ============ ============
2001
------------------------------------------
Process Power Total
Contract revenue $ 24,999 $ 25,332 $ 50,331
============ ============ ============
Business unit contribution $ 3,745 $ 1,672 $ 5,417
============ ============ ============
Total assets $ 16,833 $ 14,861 $ 31,694
============ ============ ============
Additions to long-lived assets $ 974 $ 372 $ 1,346
============ ============ ============
2000
------------------------------------------
Process Power Total
Contract revenue $ 25,208 $ 30,507 $ 55,715
============ ============ ============
Business unit contribution $ (4,053) $ 4,549 $ 496
============ ============ ============
Total assets $ 16,831 $ 17,719 $ 34,550
============ ============ ============
Additions to long-lived assets $ 1,913 $ 921 $ 2,834
============ ============ ============
Contract revenue for the Process segment includes revenue for the
Company's VirtualPlant and Belgian businesses of $7.6 million for the year ended
December 31, 2000. Business unit contribution for the Process segment includes
losses for VirtualPlant and Belgium of $3.7 million for the year ended December
31, 2000.
For the years ended December 31, 2002, 2001, and 2000, one Power
Simulation customer (Battelle's Pacific Northwest National Laboratory) accounted
for approximately 11%, 17%, and 22%, respectively, of the Company's consolidated
revenue. The Pacific Northwest National Laboratory is the purchasing agent for
the Department of Energy and the projects the Company performs in Eastern and
Central Europe. For the years ended December 31, 2002, 2001, and 2000, one
Process Automation customer (Westinghouse Savannah River Company) accounted for
approximately 24%, 24%, and 11%, respectively, of the Company's consolidated
revenue.
For the years ended December 31, 2002, 2001, and 2000, 35%, 37%, and
26% of the Company's consolidated revenue were from customers in the chemicals
industry, respectively, and 40%, 38%, and 55% of the Company's consolidated
revenue were from customers in the nuclear power industry, respectively.
A reconciliation of segment business unit contribution to consolidated
income before taxes for the years ended December 31, 2002, 2001, and 2000 is as
follows:
(in thousands) Years ended December 31,
------------------------------------------
2002 2001 2000
------------ ------------ ------------
Segment business unit contribution $ 1,838 $ 5,417 $ 496
Corporate expenses (3,332) (3,293) (5,096)
Gain (loss) on disposition of assets - 3,273 (990)
Write-down on investment of
Avantium International B.V. (2,783) (4,605) -
Interest expense, net (277) (886) (687)
------------ ------------ ------------
Loss before income taxes $ (4,554) $ (94) $ (6,277)
============ ============ ============
A reconciliation of segment total assets to total consolidated assets
as of the years ended December 31, 2002, 2001, and 2000 is as follows:
(in thousands) December 31,
------------------------------------------
2002 2001 2000
------------ ------------ ------------
Segment total assets $ 28,421 $ 31,694 $ 34,550
Other assets unallocated to segments 473 1,980 1,399
------------ ------------ ------------
Total consolidated assets $ 28,894 $ 33,674 $ 35,949
============ ============ ============
The Company designs, develops and delivers business and technology
solutions to the energy, process and manufacturing industries worldwide.
Revenue, operating income (loss) and identifiable assets for the Company's
United States, European, and Asian operations as of and for the years December
31, 2002, 2001, and 2000 are as follows:
(in thousands) 2002
-----------------------------------------------------------------------------------
United States Europe Asia Eliminations Consolidated
--------------- ---------------- ---------------- ---------------- -----------
Contract revenue $ 41,496 $ 1,575 $ 45 $ - $ 43,116
Transfers between geographic locations 92 38 - (130) -
--------------- ---------------- ---------------- ---------------- -----------
Total contract revenue $ 41,588 $ 1,613 $ 45 $ (130) $ 43,116
=============== ================ ================ ================ ===========
Operating loss $ (794) $ (716) $(18) $ - $ (1,528)
=============== ================ ================ ================ ===========
Identifiable assets, at December 31 $ 36,000 $ 1,363 $ 52 $(8,521) $ 28,894
=============== ================ ================ ================ ===========
2001
-----------------------------------------------------------------------------------
United States Europe Asia Eliminations Consolidated
--------------- ---------------- ---------------- ---------------- -----------
Contract revenue $ 47,004 $ 3,327 $ - $ - $ 50,331
Transfers between geographic locations 123 37 - (160) -
--------------- ---------------- ---------------- ---------------- -----------
Total contract revenue $ 47,127 $ 3,364 $ - $ (160) $ 50,331
=============== ================ ================ ================ ===========
Operating income (loss) $ 2,294 $ (647) $ 71 $ - $ 1,718
=============== ================ ================ ================ ===========
Identifiable assets, at December 31 $40,168 $ 1,921 $ 101 $ (8,516) $33,624
=============== ================ ================ ================ ===========
2000
-----------------------------------------------------------------------------------
United States Europe Asia Eliminations Consolidated
--------------- ---------------- ---------------- ---------------- -----------
Contract revenue $ 44,441 $ 11,274 $ - $ - $ 55,715
Transfers between geographic locations 490 610 - (1,100) -
--------------- ---------------- ---------------- ---------------- -----------
Total contract revenue $ 44,931 $ 11,884 $ - $ (1,100) $ 55,715
=============== ================ ================ ================ ===========
Operating loss $ (263) $ (4,326) $ (66) $ - $ (4,655)
=============== ================ ================ ================ ===========
Identifiable assets, at December 31 $44,688 $ 2,912 $ 199 $ (11,850) $ 35,949
=============== ================ ================ ================ ===========
20. Supplemental disclosure of cash flow information
(in thousands) Years ended December 31,
-----------------------------------------
2002 2001 2000
------------ ----------- -----------
Software product license sold in exchange for
stock of buyer (see Note 3) $ - $ - $2,895
============ =========== ===========
Issuance of options/warrants to
non-employees (see Note 12) $ - $ 194 $ -
============ =========== ===========
Conversion of related party note payable to
preferred stock (see Note 10) $ - $3,900 $ -
============ =========== ===========
Cash paid:
Interest $ 485 $ 845 $ 889
============ =========== ===========
Income taxes $ 385 $ 434 $ 271
============ =========== ===========
21. Quarterly financial data (unaudited)
The Company's quarterly financial information has not been audited but,
in management's opinion, includes all adjustments necessary for a fair
presentation.
(in thousands, except per share data) Year ended December 31, 2002 Quarterly Data
---------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------- ------------- ------------- -------------
Contract revenue $ 11,274 $ 12,131 $ 10,612 $ 9,099
Operating income (loss) 725 220 (72) (2,401)
Net income (loss) 432 123 (82) (6,416)
Earnings (loss) per common share:
Basic $ 0.06 $ 0.01 $ (0.02) $ (1.10)
Diluted $ 0.06 $ 0.01 $ (0.02) $ (1.10)
Year ended December 31, 2001 Quarterly Data
----------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------- ------------- ------------- -------------
Contract revenue $ 12,478 $ 11,845 $ 13,823 $ 12,185
Operating income (loss) (209) 464 1,154 309
Net income (loss) 1,714 468 601 (2,524)
Earnings (loss) per common share:
Basic $ 0.33 $ 0.09 $ 0.12 $ (0.49)
Diluted $ 0.33 $ 0.09 $ 0.11 $ (0.48)
The first quarter 2001 net income includes a $3.3 million gain before
income taxes on the sale of the Company's VirtualPlant technology and assets to
Avantium. The fourth quarter 2001 net income includes a $4.6 million pre-tax
write down of the Company's investment in Avantium (see Note 3, Investment in
Avantium International B.V.) and a $420,000 reduction of the Company's deferred
tax valuation allowance.
The fourth quarter 2002 net income includes a $2.8 million pre-tax
write down of the Company's investment in Avantium and a $2.8 million increase
in the Company's deferred tax valuation allowance.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 2001
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 2002
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 2003 Annual Meeting of
Shareholders.
ITEM 14. CONTROLS AND PROCEDURES.
- ---------------------------------------
Within the 90-day period prior to the filing of this report, GSE
management, including the Chief Operating Officer and Chief Financial Officer,
conducted an evaluation of the effectiveness of the design and operation of the
company's disclosure controls and procedures as defined in Exchange Act Rule
13a-14(c). Based on that evaluation, the Chief Operating Officer and Chief
Financial Officer concluded that the company's disclosure controls and
procedures were effective as of the date of that evaluation. There have been no
significant changes in internal controls, or in factors that could significantly
affect internal controls, subsequent to the date the Chief Operating Officer and
Chief Financial Officer completed their evaluation.
PART IV
ITEM 15. 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
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 2002 and 2001
Consolidated Statements of Operations for the years ended December 31,
2002, 2001, and 2000
Consolidated Statements of Comprehensive Loss for the years ended
December 31, 2002, 2001, and 2000
Consolidated Statements of Changes in Stockholders' Equity for the
years ended December 31, 2002, 2001, and 2000
Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001, and 2000
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:
Form 8-K was filed by the Registrant with the Securities and Exchange
Commission on November 15, 2002 regarding the revised financial projections for
2002 in a Conference Call to investors. Specifically, the Company revised (i)
yearly revenue to about $45 million, and (ii) earnings per share to around 10-12
cents.
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 / Chin-Our Jerry Jen
Chin-Our Jerry Jen
Chief Operating 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 31, 2003 / S / Chin-Our Jerry Jen
Chin-Our Jerry Jen, Chief Operating
Officer and President
(Principal Executive Officer)
Date: March 31, 2003 / S / JEFFERY G. HOUGH
Jeffery G. Hough, Senior Vice President
and Chief Financial Officer
(Principal Financial and Accounting
Officer)
Date: March 31, 2003
(Jerome I. Feldman, Chairman of the Board) By: / S / JEFFERY G. HOUGH
(Dr. Sheldon L. Glashow, Director ) Jeffery G. Hough
(Scott N. Greenberg, Director ) Attorney-in-Fact
(Dr. Roger Hagengruber, Director )
(Joseph W. Lewis, Director )
(John A. Moore, Jr., Director )
(George J. Pedersen, Director )
A Power of Attorney, dated February 11, 2003, authorizing Jeffery G.
Hough to sign this Annual Report on Form 10-K for the fiscal year ended December
31, 2002 on behalf of certain of the directors of the Registrant is filed as
Exhibit 24 to this Annual Report.
SECTION 302 CERTIFICATIONS
I, Chin-Our Jerry Jen, certify that:
1. I have reviewed this annual report on Form 10-K of GSE Systems, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 31, 2003
/S/ CHIN-OUR JERRY JEN
Chin-Our Jerry Jen
President and Chief Operating Officer
(Principal Executive Officer)
SECTION 302 CERTIFICATIONS
I, Jeffery G. Hough, certify that:
1. I have reviewed this annual report on Form 10-K of GSE Systems, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated
in this annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: March 31, 2003
/S/ JEFFERY G. HOUGH
Jeffery G. Hough
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
CERTIFICATIONS PURSUANT TO
18 U.S.C. SECTION 1350
ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
As required by 18 U.S.C. Section 1350, I, Chin-Our Jerry, President and
Chief Operating Officer, hereby certify that, to the best of my knowledge:
1. This Annual Report on Form 10-K for the period ended December 31,
2002 fully complies with the requirements of section 13(a) or 15(d) of the
Securities Exchange Act of 1934, and
2. The Information contained in this report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
Dated: March 31, 2003
/S/CHIN-OUR JERRY JEN
Chin-Our Jerry Jen
President and Chief Operating Officer
(Principal Executive Officer)
As required by 18 U.S.C. Section 1350, I, Jeffery G. Hough, Senior
Vice President and Chief financial Officer, hereby certify that to the best of
my knowledge:
1. This Annual Report on Form 10-K for the period ended December 31,
2002 fully complies with the requirements of section 13(a) or 15(d) of the
Securities Exchange Act of 1934, and
2. The information contained in this report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
Dated: March 31, 2003
/S/JEFFERY G. HOUGH
Jeffery G. Hough
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
A signed original of this written statement required by Section 906 has been
provided to GSE Systems, Inc. and will be retained by GSE Systems, Inc. and
furnished to the Securities and Exchange Commission or its staff upon request.
EXHIBIT INDEX
The following exhibits are either filed herewith or have been previously filed
with the Securities and Exchange Commission and are referred to and incorporated
by reference.
Exhibit
Number
Exhibit Description of Exhibit Page
- ------------- ------------------------------------------------------------ -----
3. Articles of Incorporation and Bylaws
a. Third Amended and Restated Certificate of Incorporation of the Company.
Previously filed in connection with the GSE Systems, Inc. Form 8-K as
filed with the Securities and Exchange Commission on October 24, 2001
and incorporated herein by reference.
b. Form of Amended and Restated Bylaws of the Company. Previously filed in
connection with Amendment No. 1 to the GSE Systems, Inc. Form S-1
Registration Statement as filed with the Securities and Exchange
Commission on June 14, 1995 and incorporated herein by reference.
4. Instruments Defining Rights of Security Holders, including Indenture.
a. Specimen Common Stock Certificate of the Company. Previously filed in
connection with Amendment No. 3 to the GSE Systems, Inc. Form S-1
Registration Statement as filed with the Securities and Exchange
Commission on July 24, 1995 and incorporated herein by reference.
4. Instruments Defining Rights of Security Holders, including Indenture.
a. Specimen Common Stock Certificate of the Company. Previously filed in
connection with Amendment No. 3 to the GSE Systems, Inc. Form S-1
Registration Statement as filed with the Securities and Exchange
Commission on July 24, 1995 and incorporated herein by reference.
10. Material Contracts
a. Agreement among ManTech International Corporation, National Patent
Development Corporation, GPS Technologies, Inc., General Physics
Corporation, Vattenfall Engineering AB and GSE Systems, Inc. (dated as
of April 13, 1994). Previously filed in connection with the GSE
Systems, Inc. Form S-1 Registration Statement as filed with the
Securities and Exchange Commission on April 24, 1995 and incorporated
herein by reference.
b. GSE Systems, Inc. 1995 Long-Term Incentive Plan, amended as of April 5,
1999. Previously filed in connection with the GSE Systems, Inc. Form
10-K as filed with the Securities and Exchange Commission on March 30,
1999 and incorporated herein by reference. *
Exhibit
Number
Exhibit Description of Exhibit Page
- ------------- -----------------------------------------------------------------
c. Form of Option Agreement Under the GSE Systems, Inc. 1995 Long-Term
Incentive Plan. Previously filed in connection with the GSE Systems,
Inc. Form 10-K as filed with the Securities and Exchange Commission on
March 22, 1996 and incorporated herein by reference. *
d. Office Lease Agreement between Sterling Rutherford Plaza, L.L.C. and
GSE Systems, Inc. (dated as of February 10, 1998). Previously filed in
connection with the GSE Systems, Inc. Form 10-K as filed with the
Securities and Exchange Commission on March 21, 1998 and incorporated
herein by reference.
e. Office Lease Agreement between Red Branch Road, L.L.C. and GSE Systems,
Inc. (dated February 10, 1998). Previously filed in connection with the
GSE Systems, Inc. Form 10-K as filed with the Securities and Exchange
Commission on March 21, 1998 and incorporated herein by reference.
f. Executive Employment Agreements between GSE Systems, Inc. and Directors
Jerome I. Feldman, George J. Pedersen, Scott N. Greenberg, and John A.
Moore, Jr. (dated January 1, 1999). Previously filed in connection with
the GSE Systems, Inc. Form 8-K as filed with the Securities and
Exchange Commission on August 1, 2001 and incorporated herein by
reference.*
g. Warrant Agreements with GP Strategies and ManTech International
Corporation (dated September 13, 1999). Previously filed in connection
with the GSE Systems, Inc. Form 8-K as filed with the Securities and
Exchange Commission on August 15, 2001 and incorporated herein by
reference.
h. Change of Control Agreements between GSE Systems, Inc. and Jerry Jen
and Jeffery G. Hough (dated March 10, 2000). Previously filed in
connection with the GSE Systems, Inc. Form 8-K as filed with the
Securities and Exchange Commission on August 1, 2001 and incorporated
herein by reference.*
i. Loan and Security Agreement among GSE Systems, Inc., GSE Process
Solutions, Inc., GSE Power Systems, Inc., and National Bank of Canada,
dated March 23, 2000. Previously filed in connection with the GSE
Systems, Inc. Form 10-K as filed with the Securities and Exchange
Commission on March 30, 2000 and incorporated herein by reference.
Exhibit
Number
Page
Exhibit Description of Exhibit
- -------- ---------------------------------------------------------------------
j. $10,000,000 Promissory Note dated March 23, 2000, from GSE Systems,
Inc., GSE Process Solutions, Inc., and GSE Power Systems, Inc. to
National Bank of Canada. Previously filed in connection with the GSE
Systems, Inc. Form 10-K as filed with the Securities and Exchange
Commission on March 30, 2000 and incorporated herein by reference.
k. GP Strategies, Inc. Guarantee to National Bank of Canada, dated March
23, 2000. Previously filed in connection with the GSE Systems, Inc.
Form 10-K as filed with the Securities and Exchange Commission on March
30, 2000 and incorporated herein by reference.
l. Subscription and Shareholders' Agreement by and among Avantium
International B.V., B.V. Licht en Kracht Maatschappij, SmithKline
Beecham PLC, S.R. One, Limited, GSE Systems, Inc. Delft University of
Technology, Universiteit Twente, Eindhoven University of Technology,
the Generics Group Limited, and Alpinvest Holding NV, dated February
24, 2000. Previously filed in connection with the GSE Systems, Inc.
Form 10-K as filed with the Securities and Exchange Commission on March
30, 2000 and incorporated herein by reference.
m. Asset Sale and Purchase Agreement between GSE Systems, Inc. and
Avantium International B.V. dated March 6, 2001. Previously filed in
connection with the GSE Systems, Inc. Form 8-K as filed with the
Securities and Exchange Commission on March 21, 2001 and incorporated
herein by reference.
n. Executive Compensation Plan for Jerry Jen (dated August 28, 2002).
Previously filed in connection with the GSE Systems, Inc. Form 8-K as
filed with the Securities and Exchange Commission on September 20 2002
and incorporated herein by reference.*
o. $1,000,000 promissory note dated June 25, 2001 to ManTech International
Corporation. Previously filed in connection with the GSE Systems, Inc.
Form 8-K as filed with the Securities and Exchange Commission on August
1, 2001 and incorporated herein by reference.
Exhibit
Number
Page
Exhibit Description of Exhibit
- ------- ----------------------------------------------------------------------
p. Preferred Stock Issuance Agreement by and between GSE Systems, Inc. and
ManTech International Corporation (dated December 5, 2001). Previously
filed in connection with the GSE Systems, Inc. Form 8-K as filed with
the Securities and Exchange Commission on December 12, 2001 and
incorporated herein by reference.
q. Fifth Modification Agreement dated March 21, 2003 to the Loan and
Security Agreement among GSE Systems, Inc., GSE Process Solutions,
Inc., GSE Power Systems, Inc. and National Bank of Canada dated March
23, 2000 which was transferred on or about January 15, 2002 to PNC
Bank, National Association. 99.1 X-99.1
21. Subsidiaries.
a. List of Subsidiaries of Registrant at December 31, 2002. 21.1 X-21.1-1
23. Consents of Experts and Counsel
a. Independent Auditors' Consent. 23.1 X-23.1-1
Exhibit
Number
Page
Exhibit Description of Exhibit
24. Power of Attorney
a. Power of Attorney for Directors' and Officers' Signatures on SEC Form
10-K. 24.1 X-24.1-1
99. Additional Exhibits
a. Form of Right of First Refusal Agreement. Previously filed in
connection with Amendment No. 3 to the GSE Systems, Inc. Form S-1
Registration Statement as filed with the Securities and Exchange
Commission on July 24, 1995 and incorporated herein by reference.
* Management contracts or compensatory plans required to be filed as exhibits
pursuant to Item 14 (c) of this report.