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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, 2003
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, 2003 was $9,931,577 based on the closing price of such stock on that
date of $1.65.
Number of shares of Common Stock outstanding as of March 1, 2004: 8,949,706
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates certain information by reference from the
Registrant's definitive proxy statement to be filed for its 2004 Annual Meeting
of Shareholders.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 2003
TABLE OF CONTENTS
PART I Page
Item 1. Business..................................................... 3
Item 2. Properties................................................... 22
Item 3. Legal Proceedings............................................ 22
Item 4. Submission of Matters to a Vote of Security Holders......... 22
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters........................................ 23
Item 6. Selected Financial Data...................................... 24
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................. 26
Item 7A. Quantitative and Qualitative Disclosures About Market Risk... 39
Item 8. Financial Statements and Supplementary Data.................. 40
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure..................... 50
Item 9A. Controls and Procedures...................................... 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. Principal Accountant Fees and Services*...................... 51
PART IV
Item 15. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K........................................ 52
SIGNATURES................................................... 53
Exhibits Index............................................... 54
* to be incorporated by reference from the Proxy Statement for the
registrant's 2004 Annual Meeting of Shareholders.
RETACT(R) is a registered trademark and GFLOW+TM, GLOGIC+TM, GCONTROL+TM,
GPower+TM, SimSuite PowerTM, SimSuite ProTM, SimExecTM, eXtreme I/STM, RACSTM,
PEGASUS Plant Surveillance and Diagnosis SystemTM, SIMONTM, BRUSTM,
SensBaseTM, Vista PINTM, Java Applications & Development Environment (JADE)TM
and GAARDSTM 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. The Company provides simulation
solutions and services to the nuclear and fossil electric utility industry, as
well 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 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.
In September 2003, the Company completed the sale of substantially all of
the assets of GSE Process Solutions, Inc. (Process) to Novatech, LLC (Novatech)
pursuant to an Asset Purchase Agreement, effective as of September 25, 2003, by
and between the Company, Process and Novatech. The Company received $5.5 million
in cash, subject to certain adjustments. The operating results of the Company's
Process business have been classified as discontinued operations in the
Consolidated Statements of Operations for all periods presented. With the sale
of the Process business, the Company now has only one reportable segment, Power
Simulation.
On October 23, 2003, ManTech International Corp. (ManTech) converted its
preferred stock to common stock and sold all of its GSE common stock and its
$650,000 unsecured subordinated promissory note to GP Strategies Corporation.
The terms of the subordinated note were amended to allow the conversion of the
subordinated debt by GP Strategies to GSE common stock. As a result of these
transactions, GP Strategies currently owns approximately 58% of GSE. In December
2003, John Moran, a GP Strategies executive with experience in both the power
industry and simulation technology, was elected Chief Executive Officer of GSE
by the Company's Board of Directors.
Power Simulation Business
The Company's Power Simulation Business had a strong order year, with the
receipt of several significant international simulation projects. Additionally,
the US upgrade market was stronger in 2003 than in the prior year, with the
Company receiving several multi-million dollar upgrade or simulator replacement
contracts. Total orders for the year exceeded $35 million, a 26% increase over
2002, and backlog increased 59% to $30.4 million. Although the Company's 2003
revenue increased 23.7% over the prior year and gross profit increased from
17.6% in 2002 to 23.4% in 2003, the Company still incurred an operating loss of
$1.0 million for the year ended December 31, 2003. Thus, in conjunction with the
divestiture of the Process Automation business at the end of the third quarter,
the Company restructured its Power Simulation Business in order to reduce
expenses and focus on business development. Several operating personnel were
terminated in the fourth quarter, and the Company entered into a Management
Services Agreement with GP Strategies effective January 1, 2004 in which the
Company outsourced most of its corporate functions (accounting, human resources,
etc.) and terminated most of its corporate staff. The Company recognized
$256,000 of severance expense in the fourth quarter 2003. The Company
reorganized, creating a dedicated worldwide business development organization
under the direction of one manager, and consolidating all of its operations in
Columbia, Maryland, St. Mary's, Georgia and Nykoping, Sweden under another
manager. To maintain its capability to fulfill customer orders, the Company
strengthened and expanded its relationships with international partners to
provide the necessary workforce augmentation.
The Company 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. Fourteen plants have already received
license extensions, and sixteen 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 simulator projects were awarded in 2003,
expanding the Company's presence in the market and establishing key strategic
relationships with power industry DCS providers. The Company expects continued
growth in this market segment and is focusing on second time simulation buyers
that now demand the more sophisticated and realistic simulation models offered
by the Company. Sales and marketing resources have been expanded for the fossil
power industry.
While GSE simulators are primarily utilized for power plant operator
training, the uses are expanding to include engineering analysis, 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 2003, the Company demonstrated its ability to link its
simulation models to plant optimization tools of third parties to provide a
unique and broad based optimization solution. The Company and its partners will
be bringing these new products to market in 2004.
The Company has targeted the Process simulation business as an area with a
significant potential for growth. The process industries, particularly oil and
gas and chemical, are expanding worldwide and are faced with the challenges of
performance improvement at existing facilities and training of personnel to
staff new and upgraded facilities. The Company's SimSuite Pro product and
experience in the process industries provide the Company with excellent
capabilities to service these needs. Dedicated sales and marketing resources
have been assigned to Process simulation to facilitate this initiative.
In 2003, 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.
The acquisition by GP Strategies of controlling interest in GSE has led to
further cooperation between the companies. In addition to cooperating in the
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. Cooperative marketing activities between General Physics and GSE will
enable the Company to extend simulation capabilities into industries beyond
Power and Process and to expand the range of products and services offered to
customers.
In 2003, the Company began to aggressively market its access control and
intrusion detection system to the nuclear and process industries, however, the
market has been slow to develop. The nuclear industry security focus has been on
investing in technology to detect the approach of intruders farther away from
the plant perimeter. As a result, much of the anticipated sales of the Company's
GAARDS system have failed to materialize. At the end of 2003, the Company made
the decision to reduce its investment in this market segment until the market
rebounds.
In lieu of pursuing physical security system projects, the Company has
turned its attention to opportunities for simulation in disaster recovery and
terrorist threat response. In 2003, the Company modified its simulation
technology to simulate the operation of Emergency Operations Centers (EOC) run
by municipal and state governments. REMITS is a Real-time Emergency Management
Interactive Training System designed to simulate emergency situations and enable
EOC staffs to train without requiring human participation in the field. REMITS
enables the EOC staff to stay current with the technology and enables
instructors to introduce new problems and challenges during the exercise to test
the EOC staff response to changing situations. As the Federal Government spends
billions in emergency response training, the Company believes its REMITS product
will find a large market in the developing field of training for disaster
recovery and terrorist threat response.
Research and Development
The Company's R&D expenditures in 2003 were related to:
* The completion of JADE 1.0 (Java Applications & Development
Environment), 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 version 1.0 was released for sale on March 31, 2003.
* Additional enhancements to JADE that were released in version 2.0,
including implementing XML file structure in JADE for pagination,
adding wireless PDA for JStation applications, multi-language support,
and adding a two phase object oriented flow network. JADE version 2.0
was released at the end of 2003.
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 operated as GSE Process Solutions, Inc. ("Process").
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.
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, 2003 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 base in China to pursue and
implement simulation projects in that emerging market.
In September 2003, the Company completed the sale of substantially all of
the assets of GSE Process Solutions, Inc. to Novatech, LLC (Novatech)
pursuant to an Asset Purchase Agreement, effective as of September 25, 2003, by
and between the Company, Process and Novatech. The Company received $5.5 million
in cash, subject to certain adjustments.
Simulation Business.
The Company is comprised of three divisions: Power Simulation, Process
Simulation and Emergency Management 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 economics and 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
for use primarily on UNIX and Linux computer platforms. The Company's eXtreme
tools were designed for the Windows environment. Both technologies were
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.
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.
- --eXtreme Tools is a suite of software modeling tools developed under the
Microsoft Windows environment. It includes:
* XtremeFlow, a modeling tool that generates dynamic models for flow and
pressure networks.
* XtremetControl, a modeling tool that generates control logic models
from logic diagrams.
* XtremeLogic, a modeling tool that generates control logic models from
schematic diagrams.
* Xtreme Electric, a modeling tool that generates electric
system models from schematic and one-line diagrams.
- --SimExec, and OpenSim are real-time simulation executive systems that control
all real-time simulation activities and allows for an off-line software
development environment in parallel with the training environment. OpenSim is
targeted for users of Microsoft Windows operating systems, while SimExec is
targeted for users of 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
Emerson-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 U.S.
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.
Classroom Simulation. In recent years the Company has upgraded numerous
training simulators to utilize standard PC technology. As an extension of the
PC-based simulator technology, the Company has developed tools which will allow
the training simulator to be used in a classroom setting, replacing the actual
control room panels with "soft-panel" graphics.
Increased training requirements and demands for performance improvement
have resulted in simulator training time becoming scarce. By providing the
actual training simulator models in a classroom setting, the value of the
simulator is increased by allowing more personnel the training advantages of
interactive, dynamic real time simulation.
The Company pioneered the technology to run a simulator on a PC several
years ago. However, the technology remains complex, which prevented wide
deployment of the simulator in classrooms. The Company has developed unique
software which allows simulator-based training lessons to be easily developed
and deployed in a classroom setting. The Company is currently engaged in a
cooperative effort with a major U.S. utility to refine this capability. It is
expected that this technology will become commercially available in 2004.
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 2003,
approximately 70% of the Company's 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, 2003, 2002, and 2001 one Power Simulation
customer (Battelle's Pacific Northwest National Laboratory) accounted for
approximately 29%, 23%, and 33%, respectively, of GSE's consolidated revenue.
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, China 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
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. Combining the training expertise
in chemical process and manufacturing industries from General Physics, the
Company will have access to more potential customers to offer a Total Training
Solution which includes both a simulator from GSE and a training program from
General Physics.
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
enables them to 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 Computer Based Training (CBT) or simple simulations close
to CBT.
The GSE focus on training simulation is a business strength, and its vendor
independence, with the ability to integrate to different vendor's process
control systems, is also a value which is appreciated by customers. 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. Sales and marketing resources for
Process Simulation have been increased for 2004.
Emergency Management Simulation
Industry
With the increasing demand to improve Homeland Security, all levels of
government and civil emergency management personnel need to be trained in
responding to manmade or natural disasters. Since an Emergency Operations Center
(EOC) is not permanently staffed, there is a significant loss of proficiency
between disasters. When a disaster happens, the staff must assimilate many
streams of data at once and make decisions based upon the facts presented to
them.
Today, training is accomplished in one of two ways. First is the tabletop
exercise, where the EOC staff sits around a table and a scenario is presented to
them and they must think through the steps to take and articulate a response.
Experts are there to record the exercise and provide after action analysis. The
second is a very costly exercise utilizing civil authorities and support
organizations such as fire, police, civil works, hospitals, National Guard etc.
These are extremely expensive and time consuming exercises in terms of manpower
resources and after action analysis.
The US Government is expected to request funding of $3.5 billion in 2004
for First Responders. There are EOC facilities at the municipal, state and
federal level.
GSE's Solution
GSE has utilized its over 30 years of experience in real-time simulation
modeling and operations personnel training to produce the Real-time Emergency
Management Interactive Training System (REMITS). REMITS is a PC-based real-time
simulation software for training EOC staff for emergency response. It is modular
in design, versatile and scalable to the specific training objectives. It can
interface with emergency management software such that the REMITS training
environment will be identical to the actual EOC, thus allowing the emergency
staff to use and train on the actual systems they will use in the event of a
disaster. This provides the same level of stress and intensity as experienced in
a real emergency scenario. REMITS can perform Individual Skills Training in the
familiarization of EOC equipment and procedures for different emergency
scenarios. Leadership training can be accomplished to teach effective command
and control over available assets. Finally, Team Collaboration Training enables
the staff to train on effective communications, moving resources and working
with constrained equipments and assets.
Strategy
GSE is working closely with General Physics to develop new business in the
Homeland Security industry. General Physics has over 12 years of experience in
training corporate and public sector HAZMAT First Responders nationwide, 20
years of operations/training support to the Army's Chemical Weapons Disposal
Program, 15 years performing environmental compliance and biological/chemical
remediation and five years support to the Department of Homeland Security (DHS),
Office of Domestic Preparedness (ODP) Equipment and Training Programs. Combining
the Homeland Security related expertise of General Physics and GSE's EOC
simulator product REMITS, the Company is aggressively pursuing business in the
government sector, local, state and federal.
Competition
GSE's competitors are unclear at this time. There are similar products
being developed for the market but most of them are either designed for
military usage or do not provide the extensive training features for civilian
emergency response training exercises.
Sales and Marketing
GSE will market its product in the US Homeland Security industry through
the existing sales channels of General Physics and foreign markets through
existing power simulation partners and agents.
Competitive Advantages.
The Company believes that it is in a strong position to compete in the
Simulation 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. 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 146 employees, including approximately 84
engineers and scientists. Approximately 60% 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 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 70% of the Company's 2003 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 affect 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
timeframe, 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 has one registered U.S. trademark: RETACT. Registration is pending or
is being considered for other relevant trademarks, including JADE, SmartTutor,
eSmart, 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, and Vista PIN.
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 2003, 2002, and 2001 revenues by industries served:
2003 2002 2001
------------- ---------- -----------
Nuclear power industry 89% 86% 76%
Fossil power industry 9% 12% 22%
Other 2% 2% 2%
------------ ---------- -----------
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, 2003, the Company's aggregate contract backlog totaled approximately $30.4
million. Approximately $19.5 million or 64.1% of the backlog is expected to be
converted to revenue by December 31, 2004. As of December 31, 2002, the
Company's aggregate contract backlog totaled approximately $19.1 million.
Employees.
As of December 31, 2003, the Company had 146 employees, a 39% decrease
from December 2002. The reductions were primarily associated with the sale of
the Process business and the outsourcing of the corporate functions to General
Physics Corporation, a wholly owned subsidiary of GP Strategies.
Segment Information.
Following the disposition of the Process business, the Company operates in
one business segment.
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 70% of the Company's consolidated
revenue in 2003. The Company anticipates that international sales and services
will continue to account for a significant portion of its revenue 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 28.7%, 22.8% and 33.2% of the Company's consolidated revenue in 2003, 2002
and 2001, 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 one customer for a substantial portion of its revenue.
The loss of this customer would have a material adverse effect upon the
Company's revenues and results of operations.
For the years ended December 31, 2003, 2002, and 2001, one Power
Simulation customer (Battelle's Pacific Northwest National Laboratory) accounted
for approximately 28.7%, 22.8%, and 33.2%, respectively, of the Company's
consolidated revenue. 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. If the Company lost this
customer, the Company's revenue and results of operations would be materially
and adversely affected.
The Company's business is substantially dependent on sales to the nuclear power
industry. Any disruption in this industry would have a material adverse
effect upon the Company's revenue.
In 2003, 89% of GSE's revenue was from customers in the nuclear power
industry. The Company will continue to derive a significant portion of its
revenue 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.
The Company's debt agreement imposes significant operating and financial
restrictions, which may prevent it from capitalizing on business opportunities.
GSE's debt agreement imposes 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 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 could 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 nuclear power industry, the Company's largest customer group, is 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. 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 stockholder, whose
interests may not be aligned with those of the Company's other stockholders.
As of March 1, 2004, GP Strategies Corporation, owns approximately 58% of
GSE's outstanding common stock. Accordingly, GP Strategies controls 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.
On January 1, 2004, the Company entered into a Management Services
Agreement with GP Strategies Corporation in which GP Strategies agreed to
provide corporate support services to GSE, including accounting, finance, human
resources, legal, network support and tax. In addition, GSE will use General
Physics' financial system. GSE will pay an annual fee to General Physics of
$685,000. The term of the agreement is one year, subject to earlier termination
only upon the mutual consent of the parties to the agreement. The agreement can
be renewed for successive one-year terms.
ITEM 2. PROPERTIES.
The Company is headquartered in a facility in Columbia, Maryland
(approximately 53,000 square feet). The lease for this facility expires in 2008.
In addition, the Company leases office space domestically in Georgia and
internationally in China, Japan, and Sweden. The Company leases these facilities
for terms ending between 2004 and 2007.
In September 2001, the Company entered into a sublease agreement with
ManTech International, Inc. in which ManTech subleases 1,432 sq. feet of space
in the Columbia, Maryland facility. The sublease is currently on a month to
month basis.
In September 2001, the Company entered into a sublease agreement with MECx
in which MECx subleases 2,088 sq. feet of space in the Columbia, Maryland
facility. The sublease is currently on a month to month basis.
In May, 2003, the Company moved its Process Automation business to its
Columbia, Maryland facility from the 34,000 square foot facility in Baltimore,
Maryland where this business had been headquartered. The lease of this facility
terminates in July, 2008. The Company entered into a sublease agreement with
Alpharma USPD Inc. to sublease 29,000 square feet of this 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.
In conjunction with the sale of the Process business to Novatech LLC in
September 2003, the Company entered into a sublease agreement with Novatech to
sublease a portion of the Columbia, Maryland facility for a one-year period.
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, 2003.
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:
2003
-------------------------------------
Quarter High Low
--------- ------- -------
First $1.62 $1.05
Second $1.71 $1.05
Third $2.13 $1.25
Fourth $2.08 $1.57
2002
-------------------------------------
Quarter High Low
--------- ------- -------
First $4.00 $3.00
Second $4.00 $ 2 5/7
Third $ 3 1/2 $ 2 1/9
Fourth $ 2 1/4 $6/7
The following table sets forth the equity compensation plan information
for the year ended December 31, 2003:
Number of securities to Weighted average exercise Number of securities
be issued upon exercise price of outstanding remaining available for
of outstanding options, options, warrants and future issuance under
Plan category warrants and rights rights equity compensation plans
Equity compensation plan 1,656,476 $4.19 679,644
approved by security holders
Equity compensation plan not -- -- 0
approved by security holders
------------ ------------- ------------
Total 1,656,476 $4.19 679,644
The Company's common stock is listed on the American Stock Exchange, where
it trades under the symbol "GVP".
There were approximately 34 holders of record of the common stock as of
March 1, 2004. 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. In December 2001, the
Company issued to ManTech International Corp. 39,000 shares of convertible
preferred stock which accrued dividends at an annual rate of 6% payable
quarterly. ManTech elected to convert the preferred stock to common stock in
October 2003. The Company's credit facility restricts the Company from paying
any dividends on the preferred stock, so accordingly, at December 31, 2003, the
Company had accrued dividends payable to ManTech of $366,000.
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. This information should be read in connection with the Company's
consolidated financial statements.
Years ended December 31,
-------------------------------------------------
(in thousands, except per share data) 2003 2002 2001 2000 1999
--------- ---------- -------- -------- ---------
Contract revenue $ 25,019 $ 20,220 $ 25,509 $ 30,507 $ 32,061
Cost of revenue 19,175 16,660 19,744 21,708 21,513
--------- ---------- -------- -------- ---------
Gross profit 5,844 3,560 5,765 8,799 10,548
--------- ---------- -------- -------- ---------
Operating expenses:
Selling, general and administrative 6,443 6,506 6,036 7,981 9,101
Depreciation and amortization 392 395 1,098 872 866
--------- ---------- -------- -------- ---------
Total operating expenses 6,835 6,901 7,134 8,853 9,967
--------- ---------- -------- -------- ---------
Operating income (loss) (991) (3,341) (1,369) (54) 581
Interest expense, net (504) (55) (469) (174) 10
Other income (expense), net (273) 37 442 55 (37)
--------- ---------- -------- -------- ---------
Income (loss) from continuing operations
before income taxes (1,768) (3,359) (1,396) (173) 554
Provision (benefit) for income taxes 93 891 (153) 541 330
--------- ---------- -------- -------- ---------
Income loss from continuing (1,861) (4,250) (1,243) (714) 224
operations --------- ---------- -------- -------- ---------
Income (loss) from discontinued operations,
net of income taxes (1,409) (1,693) 1,502 (8,100) (123)
Loss on sale of discontinued (262) - - - -
operations --------- ---------- -------- ------------------
Income (loss) from discontinued (1,671) (1,693) 1,502 (8,100) (123)
operations --------- ---------- -------- -------- ---------
Net income (loss) $ (3,532) $ (5,943) $ 259 $ (8,814) $ 101
========= ========== ======== ======== =========
Basic income (loss) per common share:
Continuing operations $ (0.61) $ (0.76) $ (0.24) $ (0.14) $ 0.04
Discontinued operations (0.26) (0.29) 0.29 (1.56) (0.02)
--------- ---------- -------- -------- ---------
Net income (loss) $ (0.87) $ (1.05) $ 0.05 $ (1.70) $ 0.02
========= ========== ======== ======== =========
Diluted income (loss) per common share:
Continuing operations $ (0.61) $ (0.76) $ (0.24) $ (0.14) $ 0.04
Discontinued operations (0.26) (0.29) 0.29 (1.56) (0.02)
--------- ---------- -------- -------- ---------
Net income (loss) $ (0.87) $ (1.05) $ 0.05 $ (1.70) $ 0.02
========= ========== ======== ======== =========
Weighted average common shares outstanding:
-Basic 6,542 5,863 5,217 5,182 5,066
========= ========== ======== ======== =========
-Diluted 6,542 5,863 5,259 5,182 5,351
========= ========== ======== ======== =========
As of December 31,
-------------------------------------------------
2003 2002 2001 2000 1999
--------- ---------- -------- -------- ---------
Working capital $ 2,537 $ 6,036 $ 7,063 $ 5,522 $ 8,665
Total assets 16,536 28,894 33,674 35,949 43,027
Long-term liabilities 441 9,617 7,263 12,390 9,083
Stockholders' equity 5,679 8,111 13,852 8,713 17,170
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
In September 2003, the Company completed the sale of substantially all of
the assets of GSE Process Solutions, Inc. (Process) to Novatech, LLC (Novatech)
pursuant to an Asset Purchase Agreement, effective as of September 25, 2003, by
and between the Company, Process and Novatech. The Company received $5.5 million
in cash, subject to certain adjustments. The operating results of the Company's
Process business have been classified as discontinued operations in the
Consolidated Statements of Operations for all periods presented. Following the
sale of Process, the Company operates only in the Power business.
On September 29, 2003 the Company amended the ManTech Preferred Stock
issuance agreement to revise the conversion rate from $2.645 per share to
$1.5526 per share. The change in conversion rate increased the number of common
shares available upon conversion from 1,474,480 to 2,511,915. On October 23,
2003 ManTech elected to convert all of its preferred stock to common stock and
sold all of its GSE common stock and subordinated debt to GP Strategies. The
additional common shares that ManTech received in the conversion due to the
change in conversion rate have been recorded as a beneficial conversion premium,
valued at $1,950,000 based upon the closing market price per share ($1.88) as
of October 23, 2003, and a reduction in income attributable to common
stockholders. The terms of the $650,000 subordinated note were amended by the
Company to allow the conversion of the subordinated debt to GSE common stock at
a rate of $1.5526 which was below the market rate ($1.88) on the date the
amendment was adopted. Accordingly, the Company recognized additional interest
expense of $137,000 reflecting the beneficial conversion premium. GP Strategies
elected to convert the note on October 23, 2003 and received 418,653 shares of
GSE common stock. As a result of these transactions, GP Strategies owns
approximately 58% of the total outstanding common stock of GSE at December 31,
2003.
The Company enters 2004 with no bank debt, only $42,000 of other notes
payable, and backlog that is at a five year high. The Company expects to return
to profitability in 2004 and the Company's cash flow is expected to be
sufficient for its operating needs during 2004. 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 (89% of revenue in 2003). Spending by companies in this
targeted industry 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 one customer, Battelle's Pacific Northwest National
Laboratory (29% of revenue in 2003) for a substantial portion of its
revenues. The loss of this customer 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 70% of the Company's revenue in
2003. 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.
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 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,
2003, the Company has net capitalized software development costs of $946,000. 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 a periodic 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, 2003, the Company's deferred tax assets
related primarily to a U.S. net operating loss carryforward of $15.9 million
which expire in various amounts over the next twenty years. The amount of loss
carryforward which can be used by the Company may be limitied to approximately
$500,000 annually. The recovery of the 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 $8.6 million. If the Company is able to realize taxable
income in the future the valuation allowance will be reduced.
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,
------------------------------------------------------------------------------
2003 % 2002 % 2001 %
----------- ----------- ----------- ---------- ----------- ---------
Contract revenue $ 25,019 100.0 % $ 20,220 100.0 % $ 25,509 100.0 %
Cost of revenue 19,175 76.6 % 16,660 82.4 % 19,744 77.4 %
----------- ----------- ----------- ---------- ----------- ---------
Gross profit 5,844 23.4 % 3,560 17.6 % 5,765 22.6 %
----------- ----------- ----------- ---------- ----------- ---------
Operating expenses:
Selling, general and administrative 6,443 25.8 % 6,506 32.2 % 6,036 23.7 %
Depreciation and amortization 392 1.6 % 395 1.9 % 1,098 4.3 %
----------- ----------- ----------- ---------- ----------- ---------
Total operating expenses 6,835 27.4 % 6,901 34.1 % 7,134 28.0 %
----------- ----------- ----------- ---------- ----------- ---------
Operating loss (991) (4.0)% (3,341) (16.5)% (1,369) (5.4)%
Interest expense, net (504) (2.0)% (55) (0.3)% (469) (1.8)%
Other income (expense), net (273) (1.1)% 37 0.2 % 442 1.7 %
----------- ----------- ----------- ---------- ----------- ---------
Loss from continuing operations
before income taxes (1,768) (7.1)% (3,359) (16.6)% (1,396) (5.5)%
Provision (benefit) for income taxes 93 0.3 % 891 4.4 % (153) (0.6)%
----------- ----------- ----------- ---------- ----------- ---------
Loss from continuing operations (1,861) (7.4)% (4,250) (21.0)% (1,243) (4.9)%
----------- ----------- ----------- ---------- ----------- ---------
Income (loss) from discontinued operations,
net of income taxes (1,409) (5.6)% (1,693) (8.4)% 1,502 5.9%
Loss on sale of discontinued operations (262) (1.1)% - 0.0 % - 0.0%
----------- ----------- ----------- ---------- ----------- ---------
Income (loss) from discontinued operations (1,671) (6.7)% (1,693) (8.4)% 1,502 5.9%
----------- ----------- ----------- ---------- ----------- ---------
Net income (loss) $ (3,532) (14.1)% $ (5,943) (29.4)% $ 259 1.0%
=========== =========== =========== ========== =========== =========
Comparison of 2003 to 2002.
Contract Revenue. Total contract revenue increased 23.7% as compared to
the prior year, from $20.2 million for the year ended December 31, 2002 to $25.0
million for the year ended December 31, 2003. The increase reflects the receipt
of several large international simulator contracts in 2003 which had been
delayed in 2002. The Company's backlog increased from $19.1 million at December
31, 2002 to $30.4. million at December 31, 2003.
$9.1 million of the December 31, 2002 backlog related to one project which was
logged in late December 2002.
Gross Profit. Gross profit totaled $5.8 million (23.4% of revenue) for the
year ended December 31, 2003, as compared with $3.6 million (17.6% of revenue)
for the year ended December 31, 2002. The increase in gross margin reflects
higher margins on the Company's fossil utility training simulator projects in
2003 and a higher volume of license sales.
Selling, General and Administrative Expenses. Selling, general and
administrative ("SG&A") expenses totaled $6.4 million in 2003 (25.8% of
revenue), a slight decrease from the $6.5 million (32.2% of revenue) for 2002.
The Company reduced its bidding and proposal costs in 2003 as compared to the
prior year. Included in 2003 SG&A was $264,000 of severance, of which $213,000
had not yet been paid at December 31, 2003 while $291,000 of severance expense
was included in 2002 SG&A. The Company increased its net research and product
development expenditures ("R&D") in 2003, as discussed below.
Gross R&D, including software development costs, totaled $856,000 in 2003
versus $763,000 in 2002; capitalized software development costs totaled $542,000
in 2003 versus $555,000 in 2002; and net R&D, expensed and included in SG&A, was
$314,000 in 2003 versus $208,000 in 2002.
The increase in the Company's capitalized software development expenditures was
related to:
--The completion of JADE 1.0 (Java Applications & Development Environment), 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 version 1.0 was released for sale on March
31, 2003.
--Additional enhancements to JADE that were released in version 2.0,
including implementing XML file structure in JADE for pagination, adding
wireless PDA for JStation applications, multi-language support, and adding a
two phase object oriented flow network. JADE version 2.0 was release at the
end of 2003.
In 2004, the Company expects to reduce its gross R&D spending to
approximately $600,000. The Company's research and development efforts will
focus on the release of JADE 3.0 to incorporate requested enhancements to the
Java-based simulation tools. In addition, the Company will enhance its Xtreme
tools to include more sophisticated modeling tools for Microsoft Windows
customers. With the closer working relationship with General Physics, the
Company will be integrating its simulation capability into the various training
programs offered by General Physics to create a unique interactive classroom
training solution. Refinements will also be made to the Emergency Operations
Center simulator platform REMITS to integrate more third party emergency
management software packages. Finally, the Company will continue to integrate
its simulation platform with third party thermal performance optimization tools
to create a plant-wide optimization tool for the power industry.
Depreciation and Amortization. Depreciation expense amounted to $392,000
and $395,000 during the years ended December 31, 2003 and 2002, respectively.
Operating Loss from Continuing Operations. The Company had an operating
loss from continuing operations of $1.0 million (4.0% of revenue) for the year
ended December 31, 2003 as compared with operating loss of $3.3 million (16.5%
of revenue) for the year ended December 31, 2002.
Interest Expense, Net. Net interest expense increased 816% from $55,000
for the year ended December 31, 2002 to $504,000 in 2003.
In September 2003, the Company paid off its outstanding bank debt from the
cash proceeds of the sale of the Process business. The interest expense incurred
on the outstanding bank debt in 2003 prior to the pay down and in 2002 has been
included in the costs of the discontinued business.
In March, 2003, GP Strategies extended their $1.8 million limited
guarantee of the Company's bank facility for a one-year period. In consideration
for the extension of the guarantee, the Company issued 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 shares on March 21, 2003.
The cost of the guarantee is being amortized over the one year period; GSE
recognized $135,000 of interest expense in 2003.
The fees paid to the Company's financial institution as consideration for
the extension of the Company's credit facility are being amortized over the life
of the credit facility. In 2003, the Company recognized $81,000 of interest
expense.
On October 23, 2003, ManTech sold their subordinated promissory note to GP
Strategies. The terms of the subordinated note were amended to allow the
conversion of the subordinated debt to GSE common stock at a rate of $1.5526
which was below the market rate ($1.88) on the date the amendment was adopted.
The Company recognized additional interest expense of $137,000 reflecting the
beneficial conversion premium.
In 2002, the Company had received $23,000 of interest income related to a
Federal income tax refund.
Other Income (Expense), Net. In 2003, the Company wrote off the balance of
its investment in RedStorm Scientific Inc. ($279,000) as the Company deemed the
decline in the estimated fair value to be other than temporary. In 2002 the
Company had recognized an equity loss of $59,000 on its investment in RedStorm.
These losses were offset by foreign currency gains in both years, and royalty
income in 2002.
Provision for Income Taxes. In 2003, the Company recorded an income tax
provision of $93,000. The provision is comprised of foreign and state income
taxes. The Company has a full valuation allowance on its deferred income tax
assets. The difference between the statutory U.S. tax rate and the Company's
effective rate for 2003 was primarily due to an increase in the deferred tax
asset valuation reserve and foreign taxes.
The Company recorded an income tax provision of $891,000 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.
Loss from Discontinued Operations. For the year ended December 31 2003,
the Company had an operating loss from discontinued operations of $1.7 million.
The Company's Process business was sold on September 25, 2003. For the nine
months ended September 30, 2003, the Process business had a 27% decrease in
revenue as compared to the same period in the prior year ($13.7 million vs $18.7
million, respectively). The decrease was mainly attributable to a reduction in
orders received from the business' major customer, Westinghouse Savannah River
Company. Included in the 2003 operating loss was a $262,000 loss on the sale of
the Process business and a $115,000 write down of the Company's investment in
Avantium International BV.
For the year ended December 31, 2002, the Company had an operating loss
from discontinued operations of $1.7 million. Included in this loss was $2.8
million from the write down of the Company's investment in Avantium
International BV.
Comparison of 2002 to 2001.
Contract Revenue. Total contract revenue was $20.2 million and $25.5
million for the years ended December 31, 2002 and 2001, respectively.
Although there was increased activity in the U.S. simulator 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 $3.6 million (17.6% of revenue) for the
year ended December 31, 2002, as compared with $5.8 million (22.6% 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 $6.5 million in 2002 (32.2% of
revenue), a 7.8% increase from the $6.0 million (23.7% of revenue) for 2001. The
Company had 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 addition there were two staff reductions
in 2002; SG&A expense reflected $291,000 of severance expense, of which $51,000
had not been paid at December 31, 2002. The Company decreased its net research
and product development expenditures ("R&D"), as discussed below.
Gross R&D, including software development costs, totaled $763,000 in 2002
versus $605,000 in 2001; capitalized software development costs totaled $555,000
in 2002 versus $140,000 in 2001; and net R&D, expensed and included in SG&A, was
$208,000 in 2002 versus $465,000 in 2001.
The increase in the Company's capitalized software development expenditures was
related to:
--The replacement of the Graphic User Interfaces (GUI) for the Power GSuite
and Topmeret tools with a Java based GUI, which provides platform
independence and internet enabling. Version 1.0 of the new GUI, called JADE,
was released for sale on March 31, 2003.
Depreciation and Amortization. Depreciation expense amounted to $395,000
and $574,000 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 $524,000
of goodwill amortization in 2001 versus none in 2002.
Operating Loss from Continuing Operations. The Company had an operating
loss from continuing operations of $3.3 million (16.5% of revenue) for the year
ended December 31, 2002 as compared with an operating loss of $1.4 million (5.4%
of revenue) for the year ended December 31, 2001.
Interest Expense, Net. Net interest expense decreased 88.3% from $469,000
for the year ended December 31, 2001 to $55,000 in 2002. This decrease is due to
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) plus the pay down of various notes
payable in 2001.
Other Income (Expense), Net. The Company had foreign currency gains
($68,000) and royalty income ($28,000) in 2002, which were partially offset by
the recognition of a $59,000 equity loss on the Company's investment in RedStorm
Scientific Inc.
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), foreign currency gains of $253,000, and royalty income of $42,000.
Provision for Income Taxes. The Company recorded an income tax provision
of $891,000 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 $153,000 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 to 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.
Loss from Discontinued Operations. For the year ended December 31, 2002,
the Company had an operating loss from discontinued operations of $1.7 million.
The Process business unit's revenue was $22.9 million in 2002 compared with
$25.0 million in 2001. The decrease in Process' revenue was mainly attributable
to a reduction in revenue from Process' largest customer, Westinghouse Savannah
River Corp. Included in this loss was a $2.8 million write down of the Company's
investment in Avantium International BV. For the year ended December 31, 2001,
the Company had operating income from discontinued operations of $1.5 million.
Included in this operating income was a gain of $3.3 million from the sale of
the Company's VirtualPlant business technology and assets to Avantium and a loss
of $4.6 million from the write down of the Company's investment in Avantium.
Liquidity and Capital Resources.
As of December 31, 2003, GSE had cash and cash equivalents of $1.4 million
versus $1.6 million at December 31, 2002.
Cash from operating activities. Net cash provided by operating activities
was $1.4 million for the year ended December 31, 2003; $506,000 was provided by
continuing operations and $883,000 by discontinued operations. Significant
changes in the assets and liabilities of the Company in 2003 included:
--A $3.0 million increase in contracts receivable. This increase reflects the
higher revenue and backlog in 2003 and the completion of significant billing
milestones at year-end. The Company's receivables continue to be collected
on a timely basis without the need of significant reserves.
--A $624,000 increase in prepaid expenses and other assets. The increase
reflects an advance payment to a subcontractor by the Company on one of its
projects and fees incurred in the issuance of project advance payment and
performance bonds.
--A $2.2 million increase in accounts payable, accrued compensation and
accrued expenses. Due to the increased project activity in 2003, purchases
of materials and subcontractor labor are at a higher level.
--A $3.3 million increase in billings in excess of revenue earned. The
increase reflects the receipt of an advance payment of $1.3 million on one
project in 2003 and the timing of milestone billings on several other
projects.
Net cash used in operating activities was $1.2 million for the year ended
December 31, 2002; $1.1 million was used in continuing operations and $110,000
was used in discontinued operations. The $1.6 million adjustment of the
Company's deferred tax asset valuation allowance was a non-cash item.
Significant changes in the assets and liabilities of the Company in 2002
included:
--A $1.2 million reduction in contracts receivables, reflecting the lower
project activity in 2002.
--A $674,000 decrease in billings in excess of revenue earned. The decrease
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; $693,000 was used in continuing operations and $2.6
million was provided by discontinued operations. Significant changes in the
assets and liabilities of the Company in 2001 included:
--A $3.4 million decrease in contracts receivable which was mainly related to
the decline in overall revenues.
--A $3.1 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.
Cash provided by investing activities. Net cash used in investing
activities for the year ended December 31, 2003 was $3.7 million; $4.2 million
provided by continuing operations and $506,000 used by discontinued operations.
The $3.7 million provided by continuing operations included $5.2 million
proceeds from the sale of the Process business unit, net of transaction costs,
offset by $515,000 in cash payments of contingent consideration for a prior year
acquisition, $191,000 of capital expenditures, and $542,000 of capitalized
software development costs. Additionally, $245,000 of cash collateralized
stand-by letters of credit expired, and the cash collateral was released.
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.
For 2002, net cash used in investing activities for the year ended
December 31, 2002 was $3.2 million; $1.2 million used in continuing operations
and $2.0 million used in discontinued operations. The $983,000 used in
continuing operations included $45,000 in cash payments for an acquired
business, $170,000 of capital expenditures, and $768,000 of capitalized software
development costs. In addition, the Company issued three cash-collateralized
stand-by letters of credit totaling $243,000.
For 2001, net cash used in investing activities was $2.3 million; $2.3
million used in continuing operations and $27,000 used in discontinued
operations. The $2.3 million used in continuing operations included $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), $591,000 of capital expenditures, and $668,000 of
capitalized software development costs. In 2001, $29,000 of cash collateralized
letters of credit expired, and the cash collateral was released.
Cash provided by financing activities. Cash used in financing activities
was $5.5 million, all of which was used in the continuing operations. The
Company decreased its borrowings under its bank line of credit by $5.4 million,
and had no outstanding bank debt at December 31, 2003.
For the year ended December 31, 2002, the Company generated $4.0 million
net cash through financing activities; $1.4 million was provided by continuing
operations and $2.6 million was provided by discontinued operations. 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.
Cash provided by financing activities was $1.0 million for the year ended
December 31, 2001; $1.2 million was used in continuing operations and $2.2 was
provided by discontinued operations. 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 convert the $3.9 million
subordinated promissory note into Series A preferred stock, as permitted by the
note. The Company also generated $33,000 from the conversion of employee stock
options.
Credit Facilities.
The Company has a $1.5 million bank line of credit. The credit facility
provides for borrowings to support working capital needs and foreign letters of
credit. The line is collateralized by substantially all of the Company's assets
and provides for borrowings up to 85% of eligible accounts receivable and 50% of
eligible unbilled receivables (up to a maximum of $250,000). The interest rate
on this line of credit is based on the bank's prime rate plus 1.00% (5.00% as of
December 31, 2003), with interest only payments due monthly. At December 31,
2003, the Company's available borrowing base was $1.5 million, none of which had
been utilized. The current credit facility was scheduled to expire on May 31,
2004; but on March 30, 2004, the Company has entered into a new loan and
security agreement with another financial institution.
In March, 2003, GP Strategies extended their $1.8 million limited
guarantee of the Company's bank facility. In consideration for the extension of
the guarantee, the Company issued 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.
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 preferred equity on December 5, 2001. The Series A convertible
preferred stock had no voting rights and bore dividends at the rate of 6% per
annum payable quarterly. Dividends accumulated if not paid quarterly and
compounded interest accrued on any unpaid dividends. ManTech at its discretion
had 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 would
automatically convert into GSE common stock
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 was
subordinated to the Company's credit facility. During 2002, the Company repaid
ManTech $350,000, plus $247,000 of interest. In 2003, the Company paid $35,000
of interest.
On September 29, 2003 the Company amended the ManTech Preferred Stock
issuance agreement to revise the conversion rate from $2.645 per share to
$1.5526 per share. The change in conversion rate increased the number of common
shares available upon conversion from 1,474,480 to 2,511,915. On October 23,
2003 ManTech elected to convert all of its preferred stock to common stock and
sold all of its GSE common stock and subordinated debt to GP Strategies. The
additional common shares that ManTech received in the conversion due to the
change in conversion rate have been recorded as a beneficial conversion premium,
valued at $1,950,000 based upon the closing market price per share ($1.88) as of
October 23, 2003, and a reduction in income attributable to common stockholders.
The terms of the $650,000 subordinated note were amended by the
Company to allow the conversion of the subordinated debt to GSE common stock at
a rate of $1.5526 which was below the market rate ($1.88) on the date the
amendment was adopted. Accordingly, the Company recognized additional interest
expense of $137,000 reflecting the beneficial conversion premium. GP Strategies
elected to convert the note on October 23, 2003 and received 418,653 shares of
GSE common stock. As a result of these transactions, GP Strategies owns
approximately 58% of the total outstanding common stock of GSE at December 31,
2003.
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, 2003, 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 year 1-3 Years 4-5 Years After 5 Years
Long Term Debt $ - $ - $ - $ - $ -
Related Party Long Term Debt $ 42 $ 33 $ 9 $ - $ -
Purchase Commitments $ 6,466 $ 5,294 $ 1,172 $ - $ -
Net future minimum lease payments $ 5,616 $ 827 $ 2,784 $ 2,005 $ -
--------- --------- --------- --------- ---------
Total Contractual Cash Obligations $12,124 $ 6,154 $ 3,965 $ 2,005 $ -
The Company 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's lease for the space expires in July 2008.
In conjunction with the sale of the Process business to Novatech LLC in
September, 2003, the Company entered into a sublease agreement with Novatech to
sublease a portion of the Columbia, Maryland facility for a one-year period.
As of December 31, 2003, the Company was contingently liable for six
letters of credit totaling $502,000. All of these letters of credit represent
payment bonds on contracts and have been cash collateralized. In addition, the
Company was contingently liable at December 31, 2003 for approximately $65,000
under a performance bond on one contract which was secured by a bank guarantee
of the Company's foreign subsidiary.
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.
Recent Developments.
General Physics Corporation is a wholly owned subsidiary of GP
Strategies. On March 30, 2004, the Company was added as an additional borrower
under the Financing and Security Agreement between General Physics Corporation
and a financial institution. Under the terms of the agreement, $1.5 million of
General Physics' available credit facility has been carved out for use by GSE.
The line is collateralized by substantially all of the Company's assets and
provides for borrowings up to 80% of eligible accounts receivable and 80% of
eligible unbilled receivables. The interest rate on this line of credit is based
upon the LIBOR Market Index Rate plus 3%, with interest only payments due
monthly. The credit facility expires on August 23, 2005.
On January 1, 2004, the Company entered into a Management Services
Agreement with GP Strategies Corporation in which GP Strategies agreed to
provide corporate support services to GSE, including accounting, finance, human
resources, legal, network support and tax. In addition, GSE will use General
Physics' financial system. GSE will pay an annual fee to General Physics of
$685,000. The term of the agreement is one year, subject to earlier termination
only upon the mutual consent of the parties to the agreement. The agreement can
be renewed for successive one-year terms.
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.
Off-balance Sheet Obligations.
The Company has no off-balance sheet obligations as of December 31, 2003.
New Accounting Standards.
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. The
Company implemented SFAS No. 146 on January 1, 2003. Adoption had no material
impact on results for the year ended December 31, 2003.
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 has not
issued any such guarantees other than product warranties.
In December 2003, the FASB issued Interpretation No. 46R, Consolidation of
Variable Interest Entities, which requires the consolidation of certain types of
entities. The Company does not participate in any variable interest entities.
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, 2003, 4% and 11% of
the Company's revenue was from contracts which permitted payments in a
currency other than U.S. Dollars, principally Swedish Krona and Japanese Yen,
respectively. For the year ended December 31, 2002, 5% of the Company's revenue
was in Swedish Krona, 3% was in Japanese Yen. In addition, during the years
ended December 31, 2003 and 2002, 13% and 9%, respectively, 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 30, 2004, such interest rates are
based on the prime rate plus 100 basis-points.
As of December 31, 2003, the Company did not have any outstanding debt
that was subject to variable interest rates. However, for the debt that was
outstanding earlier in 2003, a 100 basis-point change in such rates during the
year ended December 31, 2003 would have increased the Company's annual interest
expense by approximately $37,000.
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, 2003 and 2002........... F-2
Consolidated Statements of Operations for the years ended
December 31, 2003, 2002, and 2001................................ F-3
Consolidated Statements of Comprehensive Loss for the years ended
December 31, 2003, 2002, and 2001.................................... F-4
Consolidated Statements of Changes in Stockholders' Equity for
the years ended December 31, 2003, 2002, and 2001................... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 2003, 2002, and 2001.................................... 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, 2003 and 2002, 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, 2003. 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 audits.
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, 2003 and 2002, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2003 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 30, 2004
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
December 31,
---------------------------
2003 2002
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 1,388 $ 1,617
Restricted cash 473 608
Contract receivables 9,457 6,449
Prepaid expenses and other current assets 1,635 741
Current assets held for sale - 7,787
------------ ------------
Total current assets 12,953 17,202
Equipment and leasehold improvements, net 643 933
Software development costs, net 946 742
Goodwill, net 1,739 1,739
Other assets 255 667
Non-current assets held for sale - 7,611
------------ ------------
Total assets $ 16,536 $ 28,894
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 33 $ 30
Accounts payable 2,946 2,282
Accrued expenses 1,518 1,239
Accrued compensation and payroll taxes 1,752 997
Billings in excess of revenue earned 3,927 592
Other current liabilities 240 141
Other current liabilities held for sale - 5,885
------------ ------------
Total current liabilities 10,416 11,166
Long-term debt 9 6,123
Accrued warranty reserves 407 586
Other liabilities 25 2
Non-current liabilities held for sale - 2,906
------------ ------------
Total liabilities 10,857 20,783
------------ ------------
Commitments and contingencies
Stockholders' equity:
Preferred stock $.01 par value, 2,000,000 shares authorized, shares issued and
outstanding 39,000 in 2002 - -
Common stock $.01 par value, 18,000,000 shares authorized, shares issued and
outstanding 8,949,706 and 5,869,138 in 2003 and 2002, respectively 89 59
Additional paid-in capital 30,815 27,841
Accumulated deficit - at formation (5,112) (5,112)
Accumulated deficit - since formation (19,162) (13,490)
Accumulated other comprehensive loss (951) (1,187)
------------ ------------
Total stockholders' equity 5,679 8,111
------------ ------------
Total liabilities and stockholders' equity $ 16,536 $ 28,894
============ ============
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,
2003 2002 2001
------------ ------------- ------------
Contract revenue $ 25,019 $ 20,220 $ 25,509
Cost of revenue 19,175 16,660 19,744
------------ ------------- ------------
Gross profit 5,844 3,560 5,765
------------ ------------- ------------
Operating expenses
Selling, general and administrative 6,443 6,506 6,036
Depreciation and amortization 392 395 1,098
------------ ------------- ------------
------------ ------------- ------------
Total operating expenses 6,835 6,901 7,134
------------ ------------- ------------
Operating loss (991) (3,341) (1,369)
Interest expense, net (504) (55) (469)
Other income (expense), net (273) 37 442
------------ ------------- ------------
Loss from continuing operations before income taxes (1,768) (3,359) (1,396)
Provision (benefit) for income taxes 93 891 (153)
------------ ------------- ------------
Loss from continuing operations (1,861) (4,250) (1,243)
------------ ------------- ------------
Income (loss) from discontinued operations, net of income taxes (1,409) (1,693) 1,502
Loss on sale of discontinued operations (262) - -
------------ ------------- ------------
Income (loss) from discontinued operations (1,671) (1,693) 1,502
------------ ------------- ------------
Net income (loss) (3,532) (5,943) 259
Preferred stock dividends and beneficial conversion premium (2,140) (234) (17)
------------ ------------- ------------
Net income (loss) attributed to common shareholders $ (5,672) $ (6,177) $ 242
============ ============= ============
Basic earnings (loss) per common share:
Continuing operations $ (0.61) $ (0.76) $ (0.24)
Discontinued operations (0.26) (0.29) 0.29
------------ ------------- ------------
Net income (loss) $ (0.87) $ (1.05) $ 0.05
============ ============= ============
Diluted earnings (loss) per common share
Continuing operations $ (0.61) $ (0.76) $ (0.24)
Discontinued operations (0.26) (0.29) 0.29
------------ ------------- ------------
Net income (loss) $ (0.87) $ (1.05) $ 0.05
============ ============= ============
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,
-------------------------------------------
2003 2002 2001
------------- ------------ -------------
Net income (loss) $ (3,532) $ (5,943) $ 259
Foreign currency translation adjustment 236 128 (413)
------------- ------------ -------------
Comprehensive loss $ (3,296) $ (5,815) $ (154)
============= ============ =============
The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC, AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands)
Retained Earnings Accumulated
Common Preferred Additional (Deficit) Other
Stock Stock Paid-in At Since Comprehensive
Shares Amount Shares Amount Capital Formation Formation Loss Total
--------- ------------------ ------------------- ------------------------------------ ----------
Balance, January 1, 2001 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
Common stock issued to GP
Strategies Corporation 150 1 - - 179 - - - 180
Fair value of warrants issued
to non-employees - - - - 86 - - - 86
Preferred stock dividends
declared and payable - - - - - - (190) - (190)
Stock dividend issued due to
change in preferred stock
conversion price 1,037 10 - - 1,940 - (1,950) - -
Conversion of preferred stock to
common stock 1,474 15 (39) - (14) - - - 1
Conversion of subordinated debt
to common stock 419 4 783 787
Foreign currency translation
adjustment - - - - - - - 236 236
Net loss - - - - - - (3,532) - (3,532)
--------- -------- -------- ------- ----------- ---------- ---------- ------------ ----------
Balance, December 31, 2003 8,950 $ 89 - $ - $ 30,815 $(5,112) $ (19,162) $ (951) $ 5,679
========= ======== ======== ======= =========== ========== ========== ============ ==========
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,
-------------------------------------------
2003 2002 2001
------------- ------------ -------------
Cash flows from operating activities:
Net income (loss) $ (3,532) $ (5,943) $ 259
Income (loss) from discontinued operations (1,409) (1,693) 1,502
Loss on sale of discontinued operations (262) - -
------------- ------------ -------------
Loss from continuing operations (1,861) (4,250) (1,243)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 731 653 1,537
Foreign currency transaction gain (5) (34) (253)
Stock option compensation - 45 -
Deferred income taxes - 1,600 (476)
Changes in assets and liabilities:
Contract receivables (3,010) 1,248 3,407
Prepaid expenses and other assets (624) 272 (464)
Accounts payable, accrued compensation and accrued expenses 2,160 230 (3,125)
Billings in excess of revenue earned 3,335 (674) 297
Accrued warranty reserves (158) (60) 85
Other liabilities (26) (61) (390)
Income taxes payable (36) (64) (68)
------------- ------------ -------------
Net cash provided by (used in) continuing operations 506 (1,095) (693)
Net cash provided by discontinued operations 883 (110) 2,603
------------- ------------ -------------
Net cash provided by (used in) operating activities 1,389 (1,205) 1,910
------------- ------------ -------------
Cash flows from investing activities:
Proceeds from sale of Process business, net of transaction costs 5,245 - -
Net cash paid for acquisition of businesses (515) (45) (1,090)
Capital expenditures (191) (170) (591)
Capitalized software development costs (542) (768) (668)
Releases (restrictions) of cash as collateral under letters of credit, net 245 (243) 29
Other cash used in discontinued operations, net (506) (1,997) (27)
------------- ------------ -------------
Net cash provided by (used in) investing activities 3,736 (3,223) (2,347)
------------- ------------ -------------
Cash flows from financing activities:
Proceeds from issuance of common stock - 1,583 33
Proceeds from issuance of notes payable to related party - - 3,350
Repayment on note payable to related party - (350) -
(Decrease) increase in borrowings under line of credit (5,431) 443 (4,289)
Other financing repayments (30) (269) (269)
Other cash provided by discontinued operations, net - 2,589 2,198
------------- ------------ -------------
Net cash provided by (used in) financing activities (5,461) 3,996 1,023
------------- ------------ -------------
Effect of exchange rate changes on cash 107 9 (11)
------------- ------------ -------------
Net increase (decrease) in cash and cash equivalents (229) (423) 575
Cash and cash equivalents at beginning of year 1,617 2,040 1,465
------------- ------------ -------------
Cash and cash equivalents at end of year $ 1,388 $ 1,617 $ 2,040
============= ============ =============
The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002, and 2001
1. Business and liquidity
GSE Systems, Inc. ("GSE Systems", "GSE" or the "Company") develops and
delivers business and technology solutions by applying simulation software,
systems and services to the energy industry 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 September 2003, the Company completed the sale of substantially all of
the assets of GSE Process Solutions, Inc. (Process) to Novatech, LLC (Novatech)
pursuant to an Asset Purchase Agreement, effective as of September 25, 2003, by
and between the Company, Process, and Novatech. The Company received $5.5
million in cash, subject to certain adjustments. The operating results of the
Company's Process business have been classified as discontinued operations in
the Consolidated Statements of Operations for all periods presented.
On September 29, 2003 the Company amended the ManTech Preferred Stock
issuance agreement to revise the conversion rate from $2.645 per share to
$1.5526 per share. The change in conversion rate increased the number of common
shares available upon conversion from 1,474,480 to 2,511,915. On October 23,
2003 ManTech elected to convert all of its preferred stock to common stock and
sold all of its GSE common stock and subordinated debt to GP Strategies. The
additional common shares that ManTech received in the conversion due to the
change in conversion rate have been recorded as a beneficial conversion premium,
valued at $1,950,000 based upon the closing market price per share ($1.88) as of
October 23, 2003, and a reduction in income attributable to common stockholders.
The terms of the $650,000 subordinated note were amended by the Company to allow
the conversion of the subordinated debt to GSE common stock at a rate of $1.5526
which was below the market rate ($1.88) on the date the amendment was adopted.
Accordingly, the Company recognized additional interest expense of $137,000
reflecting the beneficial conversion. GP Strategies elected to convert the note
on October 23, 2003 and received 418,653 shares of GSE common stock. As a result
of these transactions, GP Strategies owns approximately 58% of the total
outstanding common stock of GSE at December 31, 2003.
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. 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. Estimated contract earnings are reviewed and revised periodically as
the work progresses, and the cumulative effect of any change in estimate 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 long-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. Such PCS arrangements are generally for a one-year period
renewable annually and include customer support, unspecified software upgrades,
and maintenance releases. 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.
Equipment and leasehold improvements, net
Equipment is 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 $856,000, $763,000, and $605,000, for the years
ended December 31, 2003, 2002 and 2001, 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 2003, 2002 or 2001.
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 $1.7 million. 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 and 2003, the Company completed a further
analysis of goodwill and determined no impairment charge was necessary.
Net income and net income per share for the year ended December 31, 2001,
adjusted to eliminate historical amortization of goodwill and related tax
effects, are as follows:
(in thousands, except for per share amounts) December 31,
2001
-----------------
Net income attributed to common stockholders, as reported $ 242
Add: goodwill amortization, net of taxes 602
-----------------
Net income, as adjusted $ 844
=================
Net income per share, as reported:
Basic earnings (loss) per common share:
Continuing operations $ (0.24)
Discontinued operations 0.29
-----------------
Net income $ 0.05
=================
Diluted earnings (loss) per common share
Continuing operations $ (0.24)
Discontinued operations 0.29
-----------------
Net income $ 0.05
=================
Net income per share, as adjusted:
Basic earnings (loss) per common share:
Continuing operations $ (0.14)
Discontinued operations 0.30
-----------------
Net income $ 0.16
=================
Diluted earnings (loss) per common share
Continuing operations $ (0.14)
Discontinued operations 0.30
-----------------
Net income $ 0.16
=================
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, 2003, 2002, and 2001, foreign currency transaction gains were
approximately $5,000, $34,000, and $253,000, 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:
(in thousands)
- -
For the years ended December 31,
------------------------------------------
2003 2002 2001
--------- --------- ---------
Beginning balance $ 667 $ 727 $ 642
Current year provision 569 686 666
- -
Current year claims (628) (746) (581)
--------- --------- ---------
Ending balance $ 609 $ 667 $ 727
========= ========= =========
As of December 31, 2003 and 2002, $407,000 and $586,000, respectively, of
the warranty reserve was recorded as a long-term liability with the balance
recorded as a current liability.
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
prescribed 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,
--------------------------------------------------
2003 2002 2001
---------------- ------------- -------------
Net income (loss) attributed to
common stockholders, as reported $ (5,672) $ (6,177) $ 242
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 awards, net of tax (381) (422) (878)
---------------- ------------- -------------
Pro forma net loss $ (6,053) $ (6,554) $ (636)
================ ============= =============
Net income (loss) per share, as reported:
Basic $ (0.87) $ (1.05) $ 0.05
Diluted $ (0.87) $ (1.05) $ 0.05
Proforma net loss per share:
Basic $ (0.93) $ (1.12) $ (0.12)
Diluted $ (0.93) $ (1.12) $ (0.12)
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 year ended December 31, 2001: expected
volatility of 110%; dividend yield of 0%; risk-free interest rate of 4.0%; and
expected lives of 4.5 years. The weighted-average fair value of options granted
during 2001 was $1.55 per share. There were no options granted during 2003 or
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 for share and per share amounts)
Years ended December 31,
------------------------------------------
2003 2002 2001
------------ ---------- ----------
Numerator:
Net income (loss) $ (3,532) $ (5,943) $ 259
Stock dividend- beneficial conversion (1,950) - -
premium
Preferred stock dividends (190) (234) (17)
----------- ---------- ----------
Net income (loss) attributed to
common stockholders $ (5,672) $ (6,177) $ 242
=========== ========== ===========
Denominator:
Weighted-average shares outstanding for basic
earnings per share 6,542,000 5,863,134 5,217,453
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 6,542,000 5,863,134 5,259,016
=========== =========== ==============
Shares related to dilutive securities
excluded because inclusion would
be anti-dilutive: 1,903,976 3,166,456 3,436,195
=========== =========== =============
The difference between the basic and diluted number of weighted average
shares outstanding for the year ended December 31, 2001 represents dilutive
stock options and warrants to purchase shares of common stock computed under
the treasury stock method, using the average market price during the period. The
net income (loss) for the years ended December 31, 2003, 2002 and 2001 was
decreased by preferred stock dividends and related charges of $2,140,000,
$234,000 and $17,000, respectively, in calculating the per share amounts. The
preferred stock was converted into common stock on October 23, 2003. 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 industry. For the years ended December 31, 2003,
2002 and 2001, one customer accounted for approximately 29%, 23%, and 33%,
respectively, of the Company's revenue. At December 31, 2003, the contracts
receivable balance related to this significant customer was approximately $2.5
million, or 26.8% of contract receivables, of which $774,000 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.
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.
At December 31, 2003, the Company had contracts for the sale of
approximately $81,000 and $746,000 of Euros and Japanese Yen, respectively, at
fixed rates. The contracts expire on various dates through June, 2004. The
Company has not designated the contracts as hedges and, accordingly, has
recorded the estimated fair value of the contracts of $1,000 at December 31,
2003 as an other asset 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 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. The
Company implemented SFAS No. 146 on January 1, 2003. Adoption had no material
impact on results for the year ended December 31, 2003.
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 has not
issued any such guarantees other than product warranties.
In December 2003, the FASB issued Interpretation No. 46R, Consolidation of
Variable Interest Entities, which requires the consolidation of certain types of
entities. The Company does not participate in any variable interest entities.
3. Discontinued Operations
In September 2003, the Company completed the sale of substantially all of
the assets of GSE Process Solutions, Inc. (Process) to Novatech, LLC (Novatech)
pursuant to an Asset Purchase Agreement, effective as of September 25, 2003, by
and between the Company, Process and Novatech. The Company received $5.5 million
in cash, subject to certain adjustments. The Company recognized a loss on this
transaction of $262,000. In conjunction with the transaction, Novatech purchased
certain assets with a book value of $11.7 million and assumed certain operating
liabilities totaling approximately $6.8 million. The Company incurred
approximately $865,000 of closing costs associated with the transaction. Results
of operations have been restated to classify the net earnings, assets and
liabilities of the Process business as discontinued operations.
The contract revenue and net income (loss) for the discontinued Process
business was:
(in thousands) Years ended December 31,
-----------------------------------------
2003 2002 2001
--------- --------- ---------
Contract revenue 13,693 22,896 24,822
Income (loss) from discontinued operations (1,671) (1,693) 1,502
Income (loss) from discontinued operations includes income in 2001 of
$3.3 million from the sale of the Company's VirtualPlant business technology and
assets, developed by the Process Business, to Avantium International BV
("Avantium") and losses in 2003, 2002 and 2001 of $115,000, $2.8 million and
$4.6 million, respectively, from the write down of the Company's investment in
Avantium.
Significant categories of assets and liabilities from the discontinued
operations at December 31, 2002 are included in the table below:
(in thousands) December 31,
2002
-------------
Contract receivables $ 4,313
Inventories 1,561
Prepaid expenses and other current assets 1,915
Property and equipment, net 764
Software development costs, net 3,659
Goodwill, net 1,162
Other assets 2,024
-------------
Total assets 15,398
-------------
Current portion of long-term debt 1,875
Accounts payable 240
Accrued expenses 488
Accrued compensation and payroll taxes 404
Billings in excess of revenue earned 2,467
Accrued warranty reserves 410
Long-term debt 1,909
Billings in excess of revenue earned- long term 998
-------------
Total liabilities 8,791
-------------
Net assets $ 6,607
=============
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,
---------------------------
2003 2002
------------ -------------
Billed receivables $ 5,069 $ 2,853
Recoverable costs and accrued profit not billed 4,395 3,631
Allowance for doubtful accounts (7) (35)
------------ -------------
Total contract receivables $ 9,457 $ 6,449
============ =============
5. Prepaid expenses and other current assets
Prepaid expenses and other current assets consist of the following:
(in thousands) December 31,
---------------------------
2003 2002
------------- -------------
Prepaid expenses $ 1,485 $ 446
Employee advances 16 49
Other current assets 134 246
------------- -------------
Total $ 1,635 $ 741
============= =============
6. Equipment and leasehold improvements
Equipment and leasehold improvements consist of the following:
(in thousands) December 31,
---------------------------
2003 2002
------------- ------------
Computer equipment $ 2,772 $ 2,900
Leasehold improvements 692 828
Furniture and fixtures 1,158 1,304
------------- ------------
4,622 5,032
Accumulated depreciation and amortization (3,979) (4,099)
------------- ------------
Equipment and leasehold improvements, net $ 643 $ 933
============= ============
Depreciation and amortization expense was approximately $392,000, $395,000, and
$1,098,000, for the years ended December 31, 2003, 2002, and 2001, respectively.
7. Software development costs
Software development costs, net, consist of the following:
(in thousands) December 31,
---------------------------
2003 2002
------------- ------------
Capitalized software development costs $1,207 $986
Accumulated amortization (261) (244)
------------- ------------
Software development costs, net $946 $742
============= ============
Software development costs capitalized were approximately $542,000, $555,000,
and $140,000, for the years ended December 31, 2003, 2002 and 2001,
respectively. Amortization of software development costs capitalized was
approximately $339,000, $256,000, and $575,000, for the years ended December 31,
2003, 2002 and 2001, respectively, and were included in cost of revenue.
8. Long-term Debt
The Company's long-term debt consists of the following notes payable and
other financing arrangements:
(in thousands) December 31,
---------------------------
2003 2002
------------ ------------
Line of credit with bank $ - $ 5,431
Note payable to related parties (see Note 16) - 650
Notes payable, other 42 72
------------ ------------
Total notes payable and financing arrangements 42 6,153
Less amounts payable within one year 33 30
------------ ------------
Long-term portion $ 9 $ 6,123
============ ============
Line of Credit
The Company has a $1.5 million bank line of credit. The credit facility
provides for borrowings to support working capital needs and foreign letters of
credit. The line is collateralized by substantially all of the Company's assets
and provides for borrowings up to 85% of eligible accounts receivable and 50% of
eligible unbilled receivables (up to a maximum of $250,000). The interest rate
on this line of credit is based on the bank's prime rate plus 1.00% (5.00% as of
December 31, 2003), with interest only payments due monthly. At December 31,
2003, the Company's available borrowing base was $1.5 million, none of which had
been utilized. The current credit facility was scheduled to expire on May 31,
2004; but on March 30, 2004, the Company has entered into a new loan and
security agreement with another financial institution. See Note 20, Subsequent
events for a discussion of the new credit facility.
In March, 2003, GP Strategies extended their $1.8 million limited
guarantee of the Company's bank facility. In consideration for the extension of
the guarantee, the Company issued 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. The Company recorded
the value of $180,000 as deferred financing cost with a corresponding credit to
common stock and additional paid-in capital. The deferred costs are being
amortized over the life of the guarantee.
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 11).
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 was
subordinated to the Company's credit facility. During 2002, the Company repaid
ManTech $350,000, plus $247,000 of interest. In 2003, the Company paid $35,000
of interest.
On October 23, 2003, ManTech sold this subordinated note to GP Strategies
Corporation. The terms of the subordinated note were amended to allow the
conversion of the subordinated debt to GSE common stock at a rate of $1.5526
which was below the market rate ($1.88) on the date the amendment was adopted.
Accordingly, the Company recognized additional interest expense of $137,000
reflecting the beneficial conversion premium. GP Strategies elected to convert
the note on October 23, 2003 and received 418,653 shares of GSE common stock.
Debt maturities
Aggregate maturities of debt outstanding at December 31, 2003 are as follows:
(in thousands)
2004 $ 33
2005 9
------------
Total $ 42
============
9. Income taxes
The consolidated loss before income taxes, by domestic and foreign
sources, is as follows:
(in thousands) Years ended December 31,
----------------------------------------
2003 2002 2001
----------- ------------ ------------
Domestic $ (3,609) $ (3,866) $ (135)
Foreign 196 (688) 41
----------- ------------ ------------
Total $ (3,413) $ (4,554) $ (94)
=========== ============ ============
The provision (benefit)for income taxes is as follows:
(in thousands) Years ended December 31,
------------------------------------------
2003 2002 2001
------------- ------------ ------------
Current:
Federal $ - $ (112) $ 54
State 53 (57) 26
Foreign 66 (42) 43
------------- ------------ ------------
Subtotal 119 (211) 123
------------- ------------ ------------
Deferred:
Federal and state - 1,694 (448)
Foreign - (94) (28)
------------- ------------ ------------
Subtotal - 1,600 (476)
------------- ------------ ------------
Total $ 119 $ 1,389 $ (353)
============= ============ ============
The allocation of the provision (benefit)
for income taxes to continuing and
discontinued operations is as follows:
Continuing operations $ 93 $ 891 $ (153)
Discontinued operations 26 498 (200)
------------- ------------ ------------
$ 119 $ 1,389 $ (353)
============= ============ ============
The provision (benefit)for income taxes varies from the amount of
income tax determined by applying the applicable U.S. statutory rate to pre-tax
loss as a result of the following:
Effective tax rate percentage (%)
Years ended December 31,
--------------------------------------------
2003 2002 2001
------------ ---------- ----------
Statutory U.S. tax rate (34.0)% (34.0)% (34.0)%
State income tax, net of federal tax benefit 1.0 (2.0) 31.0
Effect of foreign operations (0.1) 0.9 6.2
Change in valuation allowance 36.1 61.8 (447.6)
Other, principally permanent differences 0.5 3.8 68.9
------------ ---------- ----------
Effective tax rate 3.5 % 30.5 % (375.5)%
============ ========== ==========
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,
---------------------------
2003 2002
----------- -------------
Net operating loss carryforwards $ 6,133 $ 6,246
Investments 1,570 1,512
Foreign tax credits 378 379
Accrued expenses 288 243
Expenses not currently deductible for tax purposes 268 878
Alternative minimum tax credit carryforwards 162 162
Property and equipment 34 (90)
Software development costs (347) (1,615)
Other 95 60
----------- -------------
Subtotal 8,581 7,775
Valuation allowance (8,581) (7,775)
----------- -------------
Total $ - $ -
=========== =============
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 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 $8,581,000 at December 31, 2003.
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 $806,000 in 2003, an increase of
$2,845,000 in 2002 and a reduction of $420,000 in 2001.
At December 31, 2003, the Company had available $15,890,000 and $955,000
of domestic and foreign net operating loss carryforwards, respectively, which
expire between 2012 and 2023. In addition, the Company had $378,000 of foreign
tax credit carryforwards, which expire in various amounts during 2004 and 2005.
The amount of loss carryforward which can be used by the Company may be
limited to approximately $500,000 annually.
10. 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 April 5, 1999, the Company agreed to replace the outstanding warrants
of two non-employees as consideration for their consulting services relative to
the Company's equity raising initiatives. One non-employee had 6,000 warrants,
the other had 24,000. The replacement warrants have an exercise price of $4.125
and expire 5 years from the date of grant.
On March 6, 2001, the Company granted warrants to purchase shares of the
Company's common stock to two non-employees for certain services rendered. The
warrants provide the right for each employee 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, 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.
In March, 2003 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 issued 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. The Company recorded the value of $180,000 as deferred financing cost
with a corresponding credit to common stock and additional paid-in capital. The
deferred costs are being amortized over the life of the guarantee.
In June 2003, the Company received a $6.6 million order from the Mexican
utility Comision Federal de Electricidad (CFE) for a major simulator upgrade to
the Laguna Verde nuclear plant near Vera Cruz, Mexico. The contract required
that the Company issue an advance payment bond ($1.8 million) and a performance
bond ($1.3 million) to CFE. On July 9, 2003, the Company entered into a
Collateral Agreement with ManTech in which ManTech agreed to issue two letters
of credit on the Company's behalf to a Mexican surety company as collateral for
the bonds. One letter of credit will be outstanding for at least 30 months or
until the advance payment bond is released, which ever is later, and the other
letter of credit will be outstanding for at least 42 months or until the
performance bond is released, which ever is later. As consideration of ManTech's
issuance of the letters of credit, the Company issued 100,000 warrants at an
exercise price of $1.33 per share, the closing price on July 8, 2003 and will
pay ManTech a fee equal to 7% per annum on the total amount of the then-existing
value of the letters of credit, payable on a quarterly basis. The Company is
amortizing the estimated fair value of these warrants ($86,000) over the live of
the related letters of credit as additional contract costs.
On October 23, 2003 ManTech converted its preferred stock to 2,511,915
shares of GSE common stock. See the discussion of this transaction in Note 11,
Series A Convertible Preferred Stock.
On October 23, 2003 GP Strategies purchased a $650,000 unsecured
subordinated promissory note from ManTech. The terms of the subordinated note
were amended by the Company to allow the conversion of the subordinated debt to
GSE common stock at a rate of $1.5526. GP Strategies elected to convert the note
on October 23, 2003 and received 418,653 shares of GSE common stock. See Note 8,
Long-term debt for further discussion of this transaction.
As of December 31, 2003, the Company has reserved 1,903,976 shares of
common stock for issuance upon exercise of stock options and warrants.
11. 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 determined that the conversion of this debt into
preferred stock did not constitute a beneficial conversion. The Series A
convertible preferred stock had no voting rights and bore dividends at the rate
of 6% per annum payable quarterly. Dividends accumulated if not paid quarterly
and compounded interest accrued on any unpaid dividends. As of December 31, 2003
and 2002, the Company had accrued dividends payable of $366,000 and $176,000,
respectively
ManTech, at its discretion, had 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. On September 29, 2003 the Company amended the Preferred Stock issuance
agreement to revise the conversion rate to $1.5526 per share. The change in
conversion rate increased the number of common shares available upon conversion
from 1,474,480 to 2,511,915. On October 23, 2003 ManTech elected to convert all
of its preferred stock to common stock in conjunction with the sale of its
ownership in GSE to GP Strategies. The additional common shares that ManTech
received in the conversion due to the change in conversion rate have been
recorded as a beneficial conversion premium, valued at $1,950,000 based upon the
closing market price per share ($1.88) as of October 23, 2003, and a reduction
in income attributable to common stockholders.
12. 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, 2003, the Company had
679,644 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, 2001 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
Options exercised - -
Options canceled (35,500) (2.28)
Options granted - -
---------------
Options outstanding, as of December 31, 2003 1,656,476 $ 4.19
===============
The following table summarizes information relating to currently outstanding and
exercisable options at December 31, 2003:
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 - $2.95 510,550 4.0 $ 2.15 393,550 $ 2.18
$2.96 - $4.43 789,485 2.6 3.67 389,485 3.83
$4.44 - $5.90 200,000 3.1 4.75 200,000 4.75
$5.91 - $7.38 10,000 3.3 6.38 10,000 6.38
$7.39 - $8.85 20,000 3.2 7.50 20,000 7.50
$8.86 - $11.80 200 2.6 11.25 200 11.25
$11.81 - $14.75 126,241 1.7 14.11 126,241 14.11
---------------- ---------------
Total 1,656,476 3.0 $ 4.19 1,139,476 $ 4.65
================ ===============
In 1997, the Company granted one of its senior executives a stock option
to acquire 25,000 shares of common stock at an exercise price of $11.25. This
grant was not made pursuant to the Plan. This option expires ten years from the
date of grant and was exercisable in three installments with 40% vesting on the
first anniversary of the date of grant and 30% vesting on each of the second and
third anniversaries of the date of grant. During 1999, the executive terminated
employment with the Company and was vested in 70% of the stock options (17,500)
at the date of termination.
In 1998, the Company granted stock options to two directors to acquire
12,500 shares each of common stock at an exercise price of $2.25. The grants
were not made pursuant to the Plan.
13. 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, 2003 are as follows:
(in thousands) Gross future Sublease Net future
minimum lease rental minimum lease
payments income payments
------------------- ------------ ----------------
2004 $ 1,515 $ (688) $ 827
2005 1,522 (147) 1,375
2006 1,409 - 1,409
2007 1,363 - 1,363
2008 642 - 642
Thereafter - - -
------------------- ------------ ----------------
Total $ 6,451 $ (835) $ 5,616
=================== ============ ================
Total rent expense under operating leases for the years ended December
31, 2003, 2002, and 2001 was approximately $998,000, $999,000, and $902,000,
respectively.
In September 2001, the Company entered into a sublease agreement with
ManTech International, Inc. in which ManTech subleases 1,432 sq. feet of space
in the Columbia, Maryland facility. The sublease is currently on a month to
month basis.
In September 2001, the Company entered into a sublease agreement with MECx
in which MECx subleases 2,088 sq. feet of space in the Columbia, Maryland
facility. The sublease is currently on a month to month basis.
In May, 2003, the Company moved its Process Automation business to its
Columbia, Maryland facility from the 34,000 square foot facility in Baltimore,
Maryland where this business had been headquartered. The Company entered into a
sublease agreement with Alpharma USPD Inc. to sublease 29,000 square feet of
this 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.
In conjunction with the sale of the Process business to Novatech LLC in
September, 2003, the Company entered into a sublease agreement with Novatech to
sublease a portion of the Columbia, Maryland facility for a one-year period.
Letters of credit and performance bonds
As of December 31, 2003, the Company was contingently liable for
approximately $502,000 under six 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. In addition, the Company was
contingently liable at December 31, 2003 for approximately $65,000 under a
performance bond on one contract, which was secured by a bank guarantee of the
Company's foreign subsidiary.
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.
14. Other related party transactions
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. 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 1,432 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, 2003, 2002 and 2001, such sublease rentals amounted to $32,000,
$32,000 and $13,000, respectively.
In September 2001, the Company entered into an alliance with General
Physics Corporation, one of the leading suppliers 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 10.2% 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 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 the year ended December 2002, the
Company recorded a loss $59,000 on this investment. In 2003, the Company
wrote-off the remaining balance of its investment,$279,000 as the decline in
fair value was deemed to be other than temporary.
In October 2002, the Company purchased a Chinese subsidiary of ManTech.
See the discussion of this transaction in Note 16. Acquisitions.
In December 2003, GSE's Board of Directors elected John Moran, a GP
Strategies executive with experience in the power industry and simulation
technology, as Chief Executive Officer. Mr. Moran will continue as a GP
Strategies employee, however, Mr. Moran will devote 100% of his time to the
performance of his duties as CEO of GSE. For 2003, GSE will reimburse GP
Strategies $35,000 for his compensation and benefits; in 2004 GSE will reimburse
GP Strategies $300,000 for Mr. Moran's compensation and benefits.
In December 2003, GSE agreed to pay to General Physics, a fully-owned
subsidiary of GP Strategies, approximately $35,000 for services performed by
General Physics personnel in the fourth quarter 2003 for the implementation of
the Management Services Agreement effective January 1, 2004. See Note 20,
Subsequent events. In addition, GSE will reimburse General Physics $30,000 for
coverage under General Physics' directors and officers liability and umbrella
insurance for November and December 2003.
15. 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 $239,000, $215,000, and $293,000, for the years ended
December 31, 2003, 2002, and 2001, respectively.
16. 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 year ended
December 31, 2002, the contingent consideration totaled approximately $515,000,
which the Company recorded as an addition to goodwill. For the year ended
December 31, 2001, there was no contingent consideration.
17. Segment information
With the sale of the Company's Process business, the Company has only one
reportable segment. The Company has a wide range of knowledge of simulation
systems and the processes those systems are intended to control and
model. The Company's knowledge is concentrated heavily in the power generation
industry. The Company is primarily engaged in simulation 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 is comprised of three
divisions: Power Simulation, Process Simulation, and Emergency Management
Simulation.
For the years ended December 31, 2003, 2002, and 2001, one customer
(Battelle's Pacific Northwest National Laboratory) accounted for approximately
29%, 23%, and 33%, 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, 2003, 2002, and 2001, 88%, 85%, and 76%
of the Company's consolidated revenue was from customers in the nuclear power
industry, respectively. The Company designs, develops and delivers business and
technology solutions to the energy industry worldwide. Approximately 70%, 56%
and 73% of the Company's 2003, 2002, and 2001 revenue, respectively, was derived
from international sales of its products and services. Revenue, operating income
(loss) and identifiable assets for the Company's United States, European, and
Asian operations as of and for the years ended December 31, 2003, 2002, and 2001
are as follows:
(in thousands) Year Ended December 31, 2003
----------------------------------------------------------------------
United States Europe Asia Eliminations Consolidated
-------------- ----------- ---------- ------------- --------------
Contract revenue $ 21,214 $ 3,661 $ 144 $ - $ 25,019
Transfers between geographic locations 162 - - (162) -
-------------- ----------- ---------- ------------- --------------
Total contract revenue $ 21,376 $ 3,661 $ 144 $ (162) $ 25,019
============== =========== ========== ============= ==============
Operating income (loss) $ (1,313) $ 346 $ (24) $ - $ (991)
============== =========== ========== ============= ==============
Identifiable assets, at December 31 $ 41,423 $ 2,651 $ 40 $ (27,578) $ 16,536
============== =========== ========== ============= ==============
(in thousands) Year Ended December 31, 2002
----------------------------------------------------------------------
United States Europe Asia Eliminations Consolidated
-------------- ----------- ---------- ------------- --------------
Contract revenue $ 18,600 $ 1,575 $ 45 $ - $ 20,220
Transfers between geographic locations 92 - - (92) -
-------------- ----------- ---------- ------------- --------------
Total contract revenue $ 18,692 $ 1,575 $ 45 $ (92) $ 20,220
============== =========== ========== ============= ==============
Operating income (loss) $ (2,607) $ (716) $ (18) $ - $ (3,341)
============== =========== ========== ============= ==============
Identifiable assets, at December 31 $ 36,000 $ 1,363 $ 52 $ (8,521) $ 28,894
============== =========== ========== ============= ==============
(in thousands) Year Ended December 31, 2001
----------------------------------------------------------------------
United States Europe Asia Eliminations Consolidated
-------------- ----------- ---------- ------------- --------------
Contract revenue $ 23,070 $ 2,439 $ - $ - $ 25,509
Transfers between geographic locations 123 37 - (160) -
-------------- ----------- ---------- ------------- --------------
Total contract revenue $ 23,193 $ 2,476 $ - $ (160) $ 25,509
============== =========== ========== ============= ==============
Operating income (loss) $ (1,388) $ (52) $ 71 $ - $ (1,369)
============== =========== ========== ============= ==============
Identifiable assets, at December 31 $ 40,168 $ 1,921 $ 101 $ (8,516) $ 33,674
============== =========== ========== ============= ==============
18. Supplemental disclosure of cash flow information
(in thousands) Years ended December 31,
---------------------------------
2003 2002 2001
--------- ---------- ----------
Issuance of options/warrants to
non-employees (see Note 10) $ 86 $ - $ 194
========= ========== ==========
Conversion of related party note payable to
preferred stock (see Note 11) $ - $ - $ 3,900
========= ========== ==========
Conversion of related party note payable to
common stock (see Note 11) $ 787 $ - $ -
========= ========== ==========
Conversion of preferred stock to
common stock $ 3,900 $ - $ -
========= ========== ==========
Cash paid:
Interest $ 668 $ 485 $ 845
========= ========== ==========
Income taxes $ 138 $ 385 $ 434
========= ========== ==========
19. 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, 2003 Quarterly Data
------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
----------- ---------- ----------- ----------
Contract revenue $ 4,975 $ 5,545 $ 6,139 $ 8,360
Operating loss (157) (400) (197) (237)
Loss from continuing operations (135) (597) (313) (816)
Loss from discontinued operations (383) (535) (383) (370)
----------- ---------- ----------- ----------
Net loss $ (518) $ (1,132) $ (696) $ (1,186)
=========== ========== =========== ==========
Basic loss per common share:
Continuing operations $ (0.03) $ (0.11) $ (0.06) $ (0.34)
Discontinued operations (0.07) (0.09) $ (0.07) (0.04)
----------- ---------- ----------- ----------
Net loss $ (0.10) $ (0.20) $ (0.13) $ (0.38)
=========== ========== =========== ==========
Diluted loss per common share:
Continuing operations $ (0.03) $ (0.11) $ (0.06) $ (0.34)
Discontinued operations (0.07) (0.09) (0.07) (0.04)
----------- ---------- ----------- ----------
Net loss $ (0.10) $ (0.20) $ (0.13) $ (0.38)
=========== ========== =========== ==========
(in thousands, except per share data) Year ended December 31, 2002 Quarterly Data
------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
----------- ---------- ----------- ----------
Contract revenue $ 4,573 $ 5,215 $ 5,483 $ 4,949
Operating loss (772) (694) (336) (1,539)
Loss from continuing operations (1,558) (1,053) (382) (1,257)
Income (loss) from discontinued 1,990 1,176 300 (5,159)
operations ----------- ---------- ----------- ----------
Net income (loss) $ 432 $ 123 $ (82) $ (6,416)
=========== ========== =========== ==========
Basic earnings (loss) per common share:
Continuing operations $ (0.27) $ (0.19) $ (0.07) $ (0.22)
Discontinued operations $ 0.33 0.20 0.05 (0.88)
----------- ---------- ----------- ----------
Net income (loss) $ 0.06 $ 0.01 $ (0.02) $ (1.10)
=========== ========== =========== ==========
Diluted earnings (loss) per common share:
Continuing operations $ (0.27) $ (0.19) $ (0.07) $ (0.22)
Discontinued operations 0.33 0.20 0.05 (0.88)
----------- ---------- ----------- ----------
Net income (loss) $ 0.06 $ 0.01 $ (0.02) $ (1.10)
=========== ========== =========== ==========
The fourth quarter 2002 net loss includes a $2.8 million pre-tax write
down of an investment and a $2.8 million increase in the Company's deferred tax
valuation allowance.
20. Subsequent events
General Physics Corporation is a wholly owned subsidiary of GP Strategies.
On March 30, 2004, the Company was added as an additional borrower under the
Financing and Security Agreement between General Physics Corporation and a
financial institution. Under the terms of the agreement, $1.5 million of General
Physics' available credit facility has been carved out for use by the Company.
The line is collateralized by substantially all of the Company's assets and
provides for borrowings up to 80% of eligible accounts receivable and 80% of
eligible unbilled receivables. The interest rate on this line of credit is based
upon the LIBOR Market Index Rate plus 3%, with interest only payments due
monthly. The credit facility expires on August 23, 2005.
On January 1, 2004, the Company entered into a Management Services
Agreement with GP Strategies Corporation in which GP Strategies agreed to
provide corporate support services to GSE, including accounting, finance, human
resources, legal, network support and tax. In addition, GSE will use General
Physics' financial system. GSE will pay an annual fee to General Physics of
$685,000. The term of the agreement is one year, subject to earlier termination
only upon the mutual consent of the parties to the agreement. The agreement can
be renewed for successive one-year terms.
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.
ITEM 9A. CONTROLS AND PROCEDURES.
Within the 90-day period prior to the filing of this report, GSE
management, including the Chief Executive 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.
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 13, and 14 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", "Certain Related
Transactions" and "Principal Accountant Fees and Services" in the Proxy
Statement for the Company's 2004 Annual Meeting of Shareholders.
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, 2003 and 2002
Consolidated Statements of Operations for the years ended
December 31, 2003, 2002, and 2001
Consolidated Statements of Comprehensive Loss for the years
ended December 31, 2003, 2002, and 2001
Consolidated Statements of Changes in Stockholders' Equity for the
years ended December 31, 2003, 2002, and 2001
Consolidated Statements of Cash Flows for the years ended
December 31, 2003, 2002, and 2001
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 October 8, 2003 in which the Company filed the Sixth
Modification of the Company's Loan and Security agreement between
GSE Systems, Inc. and PNC Bank N.A.
Form 8-K was filed by the Registrant with the Securities and Exchange
Commission on October 10, 2003 regarding the sale of the Company's Process
Solutions business unit to NovaTech LLC on September 25, 2003.
Form 8-K was filed by the Registrant with the Securities and Exchange
Commission on November 7, 2003 announcing the change in control in the ownership
of the Company.
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/ JOHN MORAN
John Moran
Chief Executive Officer
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: April 13, 2004 /s/ JOHN MORAN
John Moran, Chief Executive Officer
(Principal Executive Officer)
Date: April 13, 2004 /s/ JEFFERY G. HOUGH
Jeffery G. Hough, Senior Vice President
and Chief Financial Officer
(Principal Financial and Accounting
Officer)
Date: April 13, 2004
(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 )
(Andrea Kantor, Director )
(Joseph W. Lewis, Director )
(John A. Moore, Jr., Director )
(George J. Pedersen, Director )
(Douglas Sharp, Director )
A Power of Attorney, dated March 12, 2004, authorizing Jeffery G. Hough
to sign this Annual Report on Form 10-K for the fiscal year ended December 31,
2003 on behalf of certain of the directors of the Registrant is filed as Exhibit
24 to this Annual Report.
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 Description of Exhibit
- ------------- -------------------------------------------------------------------
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.
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.*
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.
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.
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.
r. Sixth Modification Agreement dated September 25, 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, 2002
which was transferred on or about January 15, 2002 to PNC Bank, National
Association. Previously filed in connection with the GSE Systems, Inc.
Form 8-K as filed with the Securities and Exchange Commission on October
8, 2003 and incorporated herein by reference.
s. Asset Sale and Purchase Agreement between GSE Systems, Inc. and Novatech
LLC dated September 25, 2003. Previously filed in connection with the GSE
Systems, Inc. Form 8-K as filed with the Securities and Exchange
Commission on October 10, 2003 and incorporated herein by reference.
t. Management Services Agreement between GSE Systems, Inc. and GP Strategies
Corporation dated January 1, 2004.**
u. First Amendment dated March 30, 2004 to the Financing and Security
Agreement among General Physics Corporation, Skillright, Inc., GSE
Systems, Inc., GSE Power Systems, Inc., and MSHI, Inc. and Wachovia Bank,
National Association.**
21. Subsidiaries.
a. List of Subsidiaries of Registrant at December 31, 2003.**
23. Consents of Experts and Counsel
a. Independent Auditors' Consent.**
24. Power of Attorney
a. Power of Attorney for Directors' and Officers' Signatures on SEC Form
10-K.**
31. Section 302 Certification
a. Certification of the Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002. **
b. Certification of the Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002. **
32. Section 906 Certification
a. Certification of the Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.**
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.
** Filed herewith.