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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, 2004
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, 2004 was $22,195,271 based on the closing price of such stock on that
date of $2.48.
Number of shares of Common Stock outstanding as of March 1, 2005: 8,999,706
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates certain information by reference from the
Registrant's definitive proxy statement to be filed for its 2005 Annual Meeting
of Shareholders.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 2004
TABLE OF CONTENTS
PART I Page
----
Item 1. Business 3
Item 2. Properties............................................................................ 23
Item 3. Legal Proceedings..................................................................... 24
Item 4. Submission of Matters to a Vote of Security Holders.................................. 24
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters............................................................... 24
Item 6. Selected Financial Data............................................................... 25
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................................... 27
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............................................ 41
Item 9A. Controls and Procedures............................................................... 41
Item 9B. Other Information.......................................................................... 42
PART III
Item 10. Directors and Executive Officers of the Registrant*................................... 43
Item 11. Executive Compensation*............................................................... 43
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters*................................... 43
Item 13. Certain Relationships and Related Transactions*....................................... 43
Item 14. Principal Accountant Fees and Services*............................................... 43
PART IV
Item 15. Exhibits and Financial Statement Schedules............................................
44
SIGNATURES............................................................................ 45
Exhibits Index........................................................................ 46
* to be incorporated by reference from the Proxy Statement for the
registrant's 2005 Annual Meeting of Shareholders.
RETACT(R), GSE Systems(R), Thor(R), OpenSim(R), SmartTutor(R), SimSuite Pro(R),
ESmart(R), and GAARDS(R) are registered trademarks and GFLOW+(TM), GLOGIC+(TM),
GCONTROL+(TM), GPower+(TM), SimSuite Power(TM), SimExec(TM), eXtreme I/STM,
RACS(TM), PEGASUS Plant Surveillance and Diagnosis System(TM), SIMON(TM),
BRUS(TM), SensBase(TM), Vista PIN(TM), and Java Applications & Development
Environment (JADE)TM are trademarks of GSE Systems, Inc. All other trademarks
used in this document are the property of their respective owners.
Cautionary Statement Regarding Forward-Looking Statements.
This report contains certain forward-looking statements. Any statements
contained herein that are not statements of historical facts may be deemed
forward-looking statements. These statements are based on management's current
beliefs and expectations and are subject to numerous risks and uncertainties and
changes in circumstances. Actual results may differ materially from these
forward-looking statements due to changes in global, economic, business,
governmental, technical, competitive, market and regulatory factors.
PART I
ITEM 1. BUSINESS.
GSE Systems, Inc. ("GSE Systems", "GSE" or the "Company") is a world leader
in real-time, high fidelity simulation. The Company provides simulation
solutions and services to the nuclear and fossil electric utility industry, the
chemical and petrochemical industries and to the US Military Complex. In
addition, the Company provides plant monitoring, 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,
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.
The Company had a fair order year, with the receipt of several significant
domestic and international simulation projects. Total orders for the year
exceeded $18 million, but backlog decreased to $19.6 million at December 31,
2004 from $30.4 million as of December 31, 2003. Several large projects that the
Company expected would close in 2004 in the power sector were delayed until 2005
due to customer budget constraints. The US nuclear power market remained dormant
in terms of new plant orders. However, the Company invested heavily in Business
Development in 2004 and has in excess of $63 million in outstanding proposals at
March 1, 2005. We expect many of these opportunities to close in 2005. Despite
the lower order activity in 2004, the Company's revenue for the year increased
to $29.5 million representing an 18.0% increase over the prior year. Operating
income for the Company was $2,000 for the year, compared to a $991,000 loss in
2003.
In conjunction with the divestiture of the Process Automation business in
2003, the Company restructured its Power Simulation Business in order to reduce
expenses and focus on business development. 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
reorganized in early 2004, creating a dedicated worldwide business development
organization under the direction of one manager, and consolidated 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 positioned 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. Nineteen plants have received license extensions in
the last four years and twenty-nine 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.
In addition, the Company has developed strategic partnerships with two
companies in China to better position itself to take advantage of the
opportunities in nuclear power in this region of the world. Over the next ten
years, China expects to build 20 new nuclear power plants utilizing Western
technology. Most of these new plants will require a stand alone simulator for
which the Company is best qualified to supply.
The Company continues to focus on the fossil power segment of the power
industry. Over 15 fossil plant simulator projects were awarded to GSE in 2004,
including full scope simulator projects, model upgrades, engineering services
and license sales, 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.
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 partnership with an industry leading optimization
company, GSE will be participating in DOE grant programs to utilize simulation
and optimization for DOE's clean coal power initiative.
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 research firm ARC estimates the market
for Operator Training Simulators will grow at a rate of over 16% over the next
several years, with growth rates in Latin America and China exceeding a growth
rate of 21% annually. The Company's SimSuite Pro product and experience in the
process industries provide the Company with excellent capabilities to service
these needs.
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 2004, the Company developed two major proposals to build
simulation training centers in the Gulf Region of the Middle East. If
successful, GSE will provide power, process and desalination plant simulators,
and General Physics would provide the training materials and initial instructor
training.
In addition to expanding the Company's simulation capability into the
non-nuclear power market and the process industries market, it made a major
investment in developing business with the US government and in particular its
military component. There are two areas of emphasis in this market - Homeland
Security and Military Defense simulation. In Homeland Security, the Company has
turned its attention to opportunities for simulation in disaster recovery and
terrorist threat response. In 2004, the Company continued development of its
REMITS product used 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 first responder 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. The Company is currently
installing REMITS with the State of Nevada EOC as a Beta site.
With regard to military defense simulation, the Company successfully
recruited a very experienced business development team, and developed and is in
the process of executing an extensive plan to capitalize on what is clearly
recognized as the biggest simulation spender in the world. In 2004, the Company
executed over $2 million in simulation work for the US Navy on their nuclear
propulsion program. The Navy selected GSE's technology for this program which is
expected to extend through the year 2025. In addition, GSE is a significant part
of a team in competition for NAVAIR's Fielded Training Systems Support
procurement, a procurement which will award contracts valued at over $800
million in simulation work to an estimated seven companies. GSE was recently
advised that the team is in the final stage of selection.
Research and Development
The Company's R&D expenditures in 2004 were related to:
* Additional enhancements to JADE (Java Application & Development
Environment), a Java based application software package that provides
real time simulation modeling tools, and an instructor station for the
trainer to control and monitor simulator training exercises. JADE 3.0
will be released in the second quarter 2005.
* The development of new functionality for the Company's Jtools
software modeling tools.
* The modification of the Company's simulation technology to simulate the
operation of Emergency Operations Centers (EOC) run by municipal and
state governments.
* The development of a software product that will allow doctors to create
digital patient records through the use of a personal digital assistant
(PDA) instead of manually recording patient information.
* The embedding of the Company's full scope simulator software into
classroom training materials by segmenting its simulation software into
"pieces" so that the software can be utilized to teach specific skills
in operating the nuclear electric utilities without the need for
control room panels.
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.
In October 2002, GSE purchased the stock of ManTech Automation Systems
(Beijing) Company Ltd, from ManTech International Corp. The Chinese company,
which has eight 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. (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.
Simulation Business.
The Company is comprised of three divisions: Power Simulation, Process
Simulation and US Government and Military 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 and safety
parameter display 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.
* XtremeControl, 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.
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 four
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 extend its simulation products into the Transmission and Distribution sector.
Third, it intends to market its existing and upgraded simulation products and
its newly designed signal analysis products as plant optimization asset
management and condition monitoring tools. Fourth, it intends to leverage its
existing engineering staff to provide additional services to domestic and
international clients.
Traditional Simulation Market. Nuclear power currently accounts for about
20% of the electrical power grid capacity in the United States and this
percentage will likely remain the same even as total capacity increases. Any new
nuclear power plants will likely be of the advanced reactor designs created by
Westinghouse, General Electric and Siemens. These new designs require new
simulators and training programs, as they are different from the nuclear power
plant designs currently in operation. In addition to new power plants, existing
nuclear power plants will likely be required to remain on-line for a longer
period than originally expected. In order to stay in operation, many plants will
require life extension modifications. Since all existing 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 25 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. GSE has received several projects in the last
two years for implementing digital turbine control systems in U.S. plants.
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. This is particularly the case in China and the Gulf Region of the
Middle East. In 2004 the Company made significant investments in both of these
regions, and as a result has identified a number of high impact opportunities
for full scope simulators. GSE is increasing its marketing efforts in both of
these areas.
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.
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 12
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, 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, a significant 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);
PowerGen (England); Risk Engineering Ltd. (Bulgaria); Samsung Electronics
(Korea); Toyo Engineering Corporation (Japan); and the Institute for Information
Industry (Taiwan).
In 2004, the Company successfully negotiated strategic partnerships with
the Shanghai Automation and Instrumentation Co., LTD and the Shanghai University
of Electric Power for the purpose of marketing and delivering simulators to the
Chinese power and process industries.
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 L-3 Communications MAPPS Inc. 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 2004,
approximately 65% of the Company's revenue was generated from end users outside
the United States. Customers include, among others, Arizona Public Service,
Commission Federal De Electricidad, Emerson Process Management, Entergy Nuclear
Operations, Honeywell Hi-Spec Solutions, Karnaraft Sakerhet & Utbildning AB,
Nationalina Elecktrischecka Kompania, Nebraska Public Power District, Orgrez SC,
Battelle's Pacific Northwest National Laboratory, Seimens Westinghouse Power
Corp., and Tennessee Valley Authority.
For the years ended December 31, 2004, 2003, and 2002 one Power Simulation
customer (Battelle's Pacific Northwest National Laboratory) accounted for
approximately 24%, 29%, and 23%, 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
RSI. 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.
US Government 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.
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 various partner companies to develop new
business in the Homeland Security industry. One company, General Physics, a GSE
affiliate, 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 U.S. Homeland Security industry through
its existing sales channels and foreign markets through existing power
simulation partners and agents.
US Military Simulation
Industry
It is estimated that the US Government averages yearly simulation
procurements of over $4 billion for its military complex. The simulation
services range from building new simulators, to upgrading and re-hosting
existing simulators, to maintaining the installed base. The simulators are for
Air Force and Naval planes and helicopters, Navy ships and shipboard systems,
and Army tanks, trucks and ordinance systems, among many other applications.
GSE's Solution
The Company's core simulation products and expertise have been judged by
the marketplace as superior. The recent selection by the US Navy to utilize
GSE's technology and platform on its long term Nuclear Navy program is a
testament to support this statement. Our intention is to package these core
simulation products and expertise for military applications, and promote our
long term history of building, upgrading and maintaining simulators since the
year 1929.
Strategy
In this market, it is critical to have past government performance and a
government contracting infrastructure. GSE's past performance is not extensive,
and prior to 2004, a government infrastructure did not exist. In regards to
creating a government business-focused infrastructure, the Company's strategy
entails recruiting personnel with significant government experience, and
building the necessary contract, security, finance and marketing functions. This
work was accomplished in 2004, and the Company is now positioned to market and
bid government projects of any size. In regard to past performance, the
Company's strategy relies on forming teams where the expertise of one or more
companies are forged together to provide a more effective solution to the
government. This is a common practice in government contracting. Over the course
of 2004, GSE established teaming relationships with twelve companies, and has
several active proposal efforts with these partners. The partner companies
provide expertise that does not exist within GSE such as F-16 avionics
expertise, aircraft systems expertise, Abrams tank fire control system
expertise, etc.
Competition and Competitive Advantage
The competitors in this market range from very large companies like
Lockheed Martin and Northrup Grumman to government defined small and
disadvantaged businesses such as Eshota (Indian Nation) and DEI (small, minority
owned). GSE maintains a price advantage over the larger competitors in that it
maintains a lower overhead structure and charges the government lower pass
through costs on its subcontractors and materials. It maintains a technology and
stability advantage, in most cases, over the smaller competitors. The
competition in this fertile area is fierce, and it takes a combination of
superior technology, competitive pricing and the ability to develop effective
teams to succeed. The Company invested heavily in 2004 on developing these
teams, and believes it is well positioned to take advantage of this investment
in 2005.
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 144 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 65% of the Company's 2004
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 eight registered U.S. trademarks: RETACT, GSE Systems, THOR,
OpenSim, Smart Tutor, SimSuite Pro, ESmart and GAARDS. Some of these trademarks
have also been registered in foreign countries. The Company also claims
trademark rights to GLOW+, GLOGIC+, GCONTROL+, GPower+, SimSuite Power, SimExec,
eXtreme I/S, RACS, PEGASUS Plant Surveillance and Diagnosis System, SIMON, BRUS,
Sens Base 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
2004, 2003, and 2002 revenues by industries served:
2004 2003 2002
------------- ------------- ------------
Nuclear power industry 85% 89% 86%
Fossil power industry 10% 9% 12%
Other 5% 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, 2004, the Company's aggregate contract backlog totaled approximately $19.6
million. Approximately $13.5 million or 69% of the backlog is expected to be
converted to revenue by December 31, 2005. As of December 31, 2003, the
Company's aggregate contract backlog totaled approximately $30.4 million.
Employees.
As of December 31, 2004, the Company had 144 employees as compared to 146
employees at December 31, 2003.
Segment Information.
Following the disposition of the Process business, the Company operates in
one business segment.
RISK FACTORS.
The Company has limited cash resources. If the Company is unable to
generate adequate cash flow from operations, it will need additional capital to
fund its operations.
For the years ended December 31, 2002 and 2003, the Company experienced net
losses from continuing operations of $4.3 million and $1.9 million,
respectively, and has only $82,000 income from continuing operations
for the year ended December 31, 2004. The Company's backlog has decreased from
$30.4 million at December 31, 2003 to $19.6 million at December 31, 2004.
Although the Company has a credit facility of $1.5 million, which had not been
utilized at December 31, 2004, if the Company' income from continuing operations
does not improve, it may need additional capital to fund its operations. If
adequate funds are not available, GSE may be required to curtail its operations.
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 65.1% of the Company's consolidated
revenue in 2004. 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 20.7%, 28.7%, and 22.8% of the Company's consolidated revenue in 2004, 2003,
and 2002, 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, 2004, 2003, and 2002, one Power Simulation
customer (Battelle's Pacific Northwest National Laboratory) accounted for
approximately 24.0%, 28.7%, and 22.8%, 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 2004, 85% 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 technology. The life cycles for software modeling tools,
graphical user interfaces, and simulation technology 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 15, 2005, 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 uses General
Physics' financial system. (General Physics is a GP Strategies subsidiary.) In
2004, GSE was charged $685,000 for General Physics' services. The agreement has
been extended through December 31, 2005 without an increase in the fee. 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 2006 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 conjunction with the move of its Process Automation business to its
Columbia, Maryland facility in May 2003, the Company subleased most of its
vacated facility in Baltimore, Maryland to Alpharma USPD Inc. for a five-year
period, although Alpharma could terminate the lease at the end of the second
year provided a six-month notice was given. In October, 2004, Alpharma notified
the Company that they will terminate the sublease on April 30, 2005. The
Company's broker is actively seeking another subtenant, and management believes
that a subtenant will be found prior to the end of the sublease. However, if a
subtenant is not found or the terms of a new subtenant lease arrangement are not
consistent with those of the Alpharma lease, the Company may be required to
record an additional charge related to the lease for the vacated facility. The
Company's lease, which expires July, 2008, requires annual rent of approximately
$550,000. The Company currently has a loss accrual of $158,000.
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. The
sublease is currently on a month to month basis.
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, 2004.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
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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:
2004
- ---------------------------------------
Quarter High Low
- -------------
First $ 2.33 $ 1.72
Second $ 2.70 $ 1.45
Third $ 2.78 $ 2.35
Fourth $ 2.70 $ 1.95
2003
- ---------------------------------------
Quarter High Low
- -------------
First $ 1.62 $ 1.05
Second $ 1.71 $ 1.05
Third $ 2.13 $ 1.25
Fourth $ 2.08 $ 1.57
The following table sets forth the equity compensation plan information
for the year ended December 31, 2004:
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 1,866,776 $3.96 686,844
approved by security
holders
- -----------------------------------------------------------------------------------------------------------------------
Equity compensation plan
not approved by security
holders -- --- --
- -----------------------------------------------------------------------------------------------------------------------
Total 1,866,776 $3.96 686,844
The Company's common stock is listed on the American Stock Exchange, where
it trades under the symbol "GVP".
There were approximately 33 holders of record of the common stock as of
March 1, 2005. Based upon information available to it, the Company believes
there are approximately 800 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. At the date of the conversion, the Company's credit facility
restricted the Company from paying any dividends on the preferred stock. At
December 31, 2004, the Company had accrued dividends payable to ManTech of
$366,000. The unpaid dividends accrue interest at 6% per annum. At December 31,
2004 the Company had an accrual for interest payable of $38,000.
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) 2004 2003 2002 2001 2000
-------- ---------- ---------- -------- --------
Contract revenue $ 29,514 $ 25,019 $ 20,220 $ 25,509 $ 30,507
Cost of revenue 22,715 19,175 16,660 19,744 21,708
-------- ---------- ---------- -------- --------
Gross profit 6,799 5,844 3,560 5,765 8,799
-------- ---------- ---------- -------- --------
Operating expenses:
Selling, general and administrative 6,517 6,443 6,506 6,036 7,981
Depreciation and amortization 280 392 395 1,098 872
-------- ---------- ---------- -------- --------
Total operating expenses 6,797 6,835 6,901 7,134 8,853
-------- ---------- ---------- -------- --------
Operating income (loss) 2 (991) (3,341) (1,369) (54)
Interest expense, net (176) (504) (55) (469) (174)
Other income (expense), net 316 (273) 37 442 55
-------- ---------- ---------- -------- --------
Loss from continuing operations
before income taxes 142 (1,768) (3,359) (1,396) (173)
Provision (benefit) for income taxes 60 93 891 (153) 541
-------- ---------- ---------- -------- --------
Income (loss) from continuing
operations 82 (1,861) (4,250) (1,243) (714)
-------- ---------- ---------- -------- --------
Income (loss) from discontinued
operations, net of income taxes - (1,409) (1,693) 1,502 (8,100)
Income (loss) on sale of discontinued
operations, net of icome taxes 36 (262) - - -
-------- ---------- ---------- -------- --------
Income (loss) from discontinued 36 (1,671) (1,693) 1,502 (8,100)
operations -------- ---------- ---------- -------- --------
Net income (loss) $ 118 $(3,532) $ (5,943) $ 259 $ (8,814)
======== ========== ========== ======== ========
Basic income (loss) per common share:
Continuing operations $ 0.01 $ (0.61) $ (0.76) $ (0.24) $ (0.14)
Discontinued operations 0.00 (0.26) (0.29) 0.29 (1.56)
-------- ---------- ---------- -------- --------
Net income (loss) $ 0.01 $ (0.87) $ (1.05) $ 0.05 $ (1.70)
======== ========== ========== ======== ========
Diluted income (loss) per common share:
Continuing operations $ 0.01 $ (0.61) $ (0.76) $ (0.24) $ (0.14)
Discontinued operations 0.00 (0.26) (0.29) 0.29 (1.56)
-------- ---------- ---------- -------- --------
Net income (loss) $ 0.01 $ (0.87) $ (1.05) $ 0.05 $ (1.70)
======== ========== ========== ======== ========
Weighted average common shares outstanding:
-Basic 8,950 6,542 5,863 5,217 5,182
======== ========== ========== ======== ========
-Diluted 9,055 6,542 5,863 5,259 5,182
======== ========== ========== ======== ========
As of December 31,
------------------------------------------------
2004 2003 2002 2001 2000
-------- ---------- ---------- -------- --------
Working capital $ 2,658 $ 2,537 $ 6,036 $ 7,063 $ 5,522
Total assets 14,228 16,536 28,894 33,674 35,949
Long-term liabilities 502 441 9,617 7,263 12,390
Stockholders' equity 5,945 5,679 8,111 13,852 8,713
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 Simulation 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
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.
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, GSE
became a 58%-owned subsidiary of GP Strategies.
The Company enters 2005 with no bank debt and only $9,000 of other notes
payable. However, the Company's backlog has decreased 36% in 2004, and the
Company is investing heavily in business development activities to expand its
simulation business into the Homeland Security and US Military industries. The
Company expects to improve its profitability in 2005, and the Company's cash
flow is expected to be sufficient for its operating needs during 2005 although
the Company will utilize its line of credit during 2005. 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 (85% of revenue in 2004). 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's efforts to expand its simulation business into the
Homeland Security and US Military industries may not generate
sufficient revenues and margins in 2005 to offset the increased
business development spending.
* The Company relies on one customer, Battelle's Pacific Northwest
National Laboratory (24% of revenue in 2004) 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 65% of the Company's
revenue in 2004. 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,
2004, the Company has net capitalized software development costs of $909,000. 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, 2004, the Company's deferred tax assets
related primarily to a U.S. net operating loss carryforward of $16.1 million
which expires in various amounts over the next twenty years. The amount of loss
carryforward which can be used by the Company may be limited to approximately
$500,000 annually. Other than the net deferred tax assets that are related to
the Company's Swedish subsidiary, the recovery of the net deferred tax asset
could not be substantiated by currently available objective evidence.
Accordingly, the Company has established an $8.7 million valuation allowance for
the deferred tax assets that are not related to the Swedish subsidiary. The
valuation allowance will be reduced if the Company's US operations are able to
realize taxable income in the future.
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,
-----------------------------------------------------------------------------------
2004 % 2003 % 2002 %
----------- ----------- ----------- ----------- ------------ -----------
Contract revenue $ 29,514 100.0 % $ 25,019 100.0 % $ 20,220 100.0 %
Cost of revenue 22,715 76.9 % 19,175 76.6 % 16,660 82.4 %
----------- ----------- ----------- ----------- ------------ -----------
Gross profit 6,799 23.1 % 5,844 23.4 % 3,560 17.6 %
----------- ----------- ----------- ----------- ------------ -----------
Operating expenses:
Selling, general and administrative 6,517 22.1 % 6,443 25.8 % 6,506 32.2 %
Depreciation and amortization 280 1.0 % 392 1.6 % 395 1.9 %
----------- ----------- ----------- ----------- ------------ -----------
Total operating expenses 6,797 23.1 % 6,835 27.4 % 6,901 34.1 %
----------- ----------- ----------- ----------- ------------ -----------
Operating income (loss) 2 0.0 % (991) (4.0)% (3,341) (16.5)%
Interest expense, net (176) (0.6)% (504) (2.0)% (55) (0.3)%
Other income (expense), net 316 1.1 % (273) (1.1)% 37 0.2 %
----------- ----------- ----------- ----------- ------------ -----------
Income (loss) from continuing operations
before income taxes 142 0.5 % (1,768) (7.1)% (3,359) (16.6)%
Provision for income taxes 60 0.2 % 93 0.3 % 891 4.4 %
----------- ----------- ----------- ----------- ------------ -----------
Income (loss) from continuing operations 82 0.3 % (1,861) (7.4)% (4,250) (21.0)%
----------- ----------- ----------- ----------- ------------ -----------
Loss from discontinued operations,
net of income taxes - 0.0 % (1,409) (5.6)% (1,693) (8.4)%
Income (loss) on sale of discontinued
operations, net of income taxes 36 0.1 % (262) (1.1)% - 0.0 %
----------- ----------- ----------- ----------- ------------ -----------
Income (loss) from discontinued operations 36 0.1 % (1,671) (6.7)% (1,693) (8.4)%
----------- ----------- ----------- ----------- ------------ -----------
Net income (loss) $ 118 0.4 % $ (3,532) (14.1)% $ (5,943) (29.4)%
=========== =========== =========== =========== ============ ===========
Comparison of 2004 to 2003.
Contract Revenue. Revenue for the year ended December 31, 2004 was
$29.5 million versus $25.0 million for the year ended December 31, 2003, an
18.0% increase. The increase reflects the significant order volume logged in
2003. At December 31, 2004, the Company's backlog was $19.6 million of which
approximately $13.5 million will be recognized as revenue in 2005.
Gross Profit For the year ended December 31, 2004, gross profit increased
from $5.8 million (23.4% of revenue) for the year ended December 31, 2003 to
$6.8 million (23.1% of revenue) for the year ended December 31, 2004. The slight
decrease in gross profit percentage is mainly attributable to adjustments made
by the Company in the third quarter 2004 to the estimated costs to complete
several of its long-term contracts which resulted in a net reduction of the
project-to-date revenue and gross profit recognized on the projects of
approximately $288,000. The impact of these adjustments was partially offset by:
* a 13.7% decrease in the Company's overhead costs in 2004 together with
a higher revenue base to recover the Company's relatively fixed
overhead costs, and
* Higher stand-alone license revenue in 2004 ($1.0 million) as compared
to the prior year ($175,000) which have higher margins than projects.
Selling, General and Administrative Expenses. Selling, general and
administrative ("SG&A") expenses totaled $6.5 million for the year ended
December 31, 2004, a slight increase from the $6.4 million spent on SG&A in
2003. Business development costs increased from $1.8 million for the year ended
December 31, 2003 to $2.8 million in 2004. This reflects the Company's renewed
focus on business development in 2004 and the reassignment of four operating
personnel into the business development function on January 1, 2004. In
addition, the Company hired several consultants in 2004 to assist in the bidding
and proposal activities of its new US government and military simulation
division. The Company's corporate and G&A expenses decreased from $4.3 million
in 2003 to $3.5 million in 2004 reflecting the outsourcing of the Company's
corporate function to GP Strategies on January 1, 2004. Gross spending on
software product development ("development") totaled $552,000 in the year ended
December 31, 2004 as compared to $856,000 in 2003. The reduction in gross
development spending mainly reflects the release of JADE version 2.0 at the end
of 2003. JADE is 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.
The Company capitalized $361,000 of development expenditures in 2004 as
compared to $542,000 in 2003. The Company's development expenditures in 2004,
certain of which were capitalized, were related to:
* The development of new functionality for the Company's Jtools software
modeling tools.
* The modification of the Company's simulation technology to simulate
the operation of Emergency Operations Centers (EOC) run by municipal
and state governments.
* The development of a software product that will allow doctors to
create digital patient records through the use of a personal digital
assistant (PDA) instead of manually recording patient information.
* The embedding of the Company's full scope simulator software into
classroom training materials by segmenting its simulation software
into "pieces" so that the software can be utilized to teach specific
skills in operating the nuclear electric utilities without the need
for control room panels.
* Additional enhancements to JADE (Java Applications & Development
Environment), a Java-based application that provides a window into the
simulation station and takes advantage of the web capabilities of
Java, allowing customers to access the simulator and run scenarios
from anywhere they have access to the web. JADE 3.0 will be release in
the second quarter 2005.
The Company anticipates that its gross development spending in 2005 will
approximate the same level as 2004. 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.
Administrative Charges from GP Strategies. 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 uses General Physics' financial system. (General Physics is a
subsidiary of GP Strategies.) In 2004, GSE was charged $685,000 for General
Physics' services. The agreement has been extended through December 31, 2005
without an increase in the fee. The agreement can be renewed for successive
one-year terms.
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 continued as a GP Strategies
employee throughout most of 2004, although he devoted 100% of his time to the
performance of his duties as CEO of GSE. On December 16, 2004, Mr. Moran became
a GSE employee. For 2004, GSE was charged $289,000 by GP Strategies for Mr.
Moran's compensation and benefits.
In December 2003, GSE agreed to pay to General Physics approximately
$35,000 for services performed by General Physics personnel in the fourth
quarter 2003 for the implementation of the Management Services Agreement
discussed above. In addition, GSE was charged $30,000 by General Physics for
coverage under General Physics' directors and officers liability and umbrella
insurance for November and December 2003. Finally, GSE was charged $35,000 by GP
Strategies for Mr. Moran's compensation and benefits.
Depreciation and Amortization. For the years ended December 31, 2004 and
2003, depreciation expense totaled $280,000 and $392,000, respectively. The
reduction reflects certain assets becoming fully depreciated.
Operating Income (Loss). The Company had an operating income of $2,000 for
the year ended December 31, 2004, as compared with an operating loss of $991,000
(4.0% of revenue) for the prior year. The variances were due to the factors
outlined above.
Interest Expense, Net. Net interest expense decreased from $504,000 in the
year ended December 31, 2003 to $176,000 for the year ended December 31, 2004.
Such amounts included amortization of deferred financing costs of $108,000 and
$111,000, respectively.
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 was included in the
costs of the discontinued business. The Company did not borrow against its $1.5
million credit facility in 2004.
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 was amortized over the one-year period; GSE recognized $45,000
of interest expense in the first quarter 2004 which completed the amortization
of these costs.
Other Income (Expense), Net. At December 31, 2004, the Company had
contracts for sale of approximately $4.6 million Japanese Yen at fixed rates.
The Company has not designated the contracts as hedges and, accordingly, has
recorded the estimated fair value of the contracts of $203,000 in other income
(expense).
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.
Provision for Income Taxes. The Company's tax provision in 2004 was
$90,000; $60,000 related to continuing operations and $30,000 related to
discontinued operations. The provision consisted of state taxes of $18,000, U.S.
alternative minimum tax of $1,000, foreign taxes of $121,000 and deferred taxes
of ($50,000).
In 2003, the Company recorded an income tax provision of $119,000; $93,000
related to the continuing operations and $26,000 related to discontinued
operations. The provision is comprised of foreign and state income taxes. The
Company had 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.
Loss from Discontinued Operations, net of income taxes. 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 operating results of the Company's Process
business prior to the sale have been classified as discontinued operations in
the Consolidated Statements of Operations.
For the year ended December 31, 2003, contract revenue for the discontinued
Process business was $13.7 million. Net loss for the discontinued Process
business in 2003 was $1.7 million.
Loss on Sale of Discontinued Operations, net of income taxes. In
conjunction with the Company's sale of its Process business in September 2003,
the Company received $5.5 million in cash, subject to certain adjustments. The
Company recognized a loss on this transaction of $262,000. In connection 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, including a $100,000 accrual for possible post-closing
claims from Novatech in the twelve months following the sale, as outlined in
various provisions of the Asset Purchase Agreement. In the third quarter 2004,
the Company reduced the accrual by $66,000 to management's best estimate of the
Company's exposure to loss.
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.
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. Gross spending on software product development
totaled $856,000 in the year ended December 31, 2003 as compared to $763,000 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 released at the end of 2003.
The Company capitalized $542,000 of development expenditures in 2003 as
compared to $555,000 in 2002.
Administrative Charges from GP Strategies. 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 began to use General Physics' financial system in 2004.
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 continued as a GP Strategies
employee throughout most of 2004, although he devoted 100% of his time to the
performance of his duties as CEO of GSE.
In December 2003, GSE agreed to pay to General Physics approximately
$35,000 for services performed by General Physics personnel in the fourth
quarter 2003 for the implementation of the Management Services Agreement
discussed above. In addition, GSE was charged $30,000 by General Physics for
coverage under General Physics' directors and officers liability and umbrella
insurance for November and December 2003. Finally, GSE was charged $35,000 by GP
Strategies for Mr. Moran's compensation and benefits.
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 $119,000; $93,000 related to continuing operations and $26,000
related to discontinued operations. 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 $1.4 million in 2002;
$891,000 related to continuing operations and $498,000 related to discontinued
operations. 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.
Liquidity and Capital Resources.
As of December 31, 2004, GSE had cash and cash equivalents of $868,000
versus $1.4 million at December 31, 2003.
Cash from operating activities. For the year ended December 31, 2004, net
cash used in operating activities was $393,000; $357,000 was used by continuing
operations and $36,000 was used by discontinued operations. Significant changes
in the Company's assets and liabilities in 2004 included:
* a $734,000 decrease in contracts receivable. The Company invoices
customers upon the completion of contract-specified milestones;
milestone billings were lower in the fourth quarter 2004 compared to
the fourth quarter 2003 due to lower contract activity. The Company's
receivables continue to be collected on a timely basis without the
need of significant reserves.
* a $547,000 reduction in prepaid expenses and other assets. The
reduction reflects (1) lower prepaid insurance expense due to the
participation of the Company in some of GP Strategies' insurance
programs, (2) the collection from Novatech of expenses paid by the
Company on behalf of Novatech after the sale of the Process business
in 2003 and (3) a reduction in capitalized bank commitment fees.
* an increase in accounts payable, accrued compensation and accrued
expenses of $200,000. The increase reflects the increase in project
activity in 2004 as compared to the prior year and the related
increase in obligations to the Company's subcontractors.
* a decrease in billings in excess of revenues earned by $2.8 million.
In 2003, the Company had entered into a $6.6 million contract with a
Mexican customer for a full scope simulator that allowed the Company
to invoice the customer for 20% of the contract upon the receipt of
the purchase order as an advance payment. The reduction in billings in
excess of revenues earned largely reflects the completion of work
which has reduced the Company's liability to the customer for the
advance payment.
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.
* 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.
Cash provided by (used in) investing activities. Net cash used in investing
activities was $110,000 for the year ended December 31, 2004, consisting of
$361,000 of capitalized software development costs and $222,000 of capital
expenditures, offset by the expiration of stand-by letters of credit for which
the $473,000 of 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.
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.
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.
Cash provided by (used in) financing activities. For the year ended
December 31, 2004, the Company used $33,000 in financing activities related to
the pay down of a note payable.
For the year ended December 31, 2003, 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.
Credit Facilities.
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% (5.4% as of December 31, 2004), with interest
only payments due monthly. At December 31, 2004, the Company's available
borrowing base was $1.5 million, none of which had been utilized. The credit
facility expires on August 12, 2006.
Other. The following summarizes the Company's contractual cash obligations
at December 31, 2004, and the effect these obligations are expected to have on
its liquidity and cash flow in future periods:
Payments Due by Period
- -------------------------------------------------------------------------------------------------------------
(in thousands)
- -------------------------------------------------------------------------------------------------------------
Cash Obligations Total Less than 1 year 1-3 Years 4-5 Years After 5 Years
- --------------------------------------------------------------------------------------------------------------
Long Term Debt $ - $ - $ - $ - $ -
- --------------------------------------------------------------------------------------------------------------
Related Party $ 9 $ 9 $ - $ - $ -
Long Term Debt
- --------------------------------------------------------------------------------------------------------------
Purchase Commitments $ 3,955 $ 3,684 $ 271 $ - $ -
- --------------------------------------------------------------------------------------------------------------
Net future minimum $ 4,958 $ 1,559 $ 3,399 $ - $ -
lease payments
- -------------------------------------------------------------------------------------------------------------
Contractual Cash $ 8,922 $ 5,252 $ 3,670 $ - $ -
- -------------------------------------------------------------------------------------------------------------
In conjunction with the move of its Process Automation business to its
Columbia, Maryland facility in May 2003, the Company subleased most of its
vacated facility in Baltimore, Maryland to Alpharma USPD Inc. for a five-year
period, although Alpharma could terminate the lease at the end of the second
year provided a six-month notice was given. In October, 2004, Alpharma notified
the Company that they will terminate the sublease on April 30, 2005. The
Company's broker is actively seeking another subtenant, and management believes
that a subtenant will be found prior to the end of the sublease. However, if a
subtenant is not found or the terms of a new subtenant lease arrangement are not
consistent with those of the Alpharma lease, the Company may be required to
record an additional charge related to the lease for the vacated facility. The
Company's lease, which expires July, 2008, requires annual rent of
approximately $550,000. The Company currently has a loss accrual of $158,000.
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. The
lease is currently on a month to month basis.
As of December 31, 2003, the Company was contingently liable for one
letter of credit totaling $29,000. The letter of credit represents a payment
bond on a contract and has been cash collateralized. In addition, the Company
was contingently liable at December 31, 2004 for approximately $36,000 under a
performance bond on one contract which was secured by a bank guarantee of the
Company's foreign subsidiary.
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, 2004.
New Accounting Standards.
In December 2004, the FASB issued SFAS No. 123 - Revised (SFAS No. 123R),
"Share-Based Payment", which revises SFAS No. 123, "Accounting for Stock-Based
Compensation", and supercedes APB No. 25, "Accounting for Stock Issued to
Employees." Currently, the Company does not record compensation expense for
certain stock-based compensation. Under SFAS No. 123R, the Company will measure
the cost of employee services received in exchange for stock, based on the
grant-date fair value (with limited exceptions) of the stock award. Such cost
will be recognized over the period during which the employee is required to
provide service in exchange for the stock award (usually the vesting period).
The fair value of the stock award will be estimated using an option-pricing
model, with excess tax benefits, as defined in SFAS No. 123R, being recognized
as an addition to paid in capital. SFAS No. 123R is effective as of July 1,
2005. The Company is currently in the process of evaluating the impact of SFAS
No. 123R on our financial statements.
Other Matters.
To date, management believes inflation has not had a material impact on
the Company's operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company's market risk is principally confined to changes in foreign
currency exchange rates. During the year ended December 31, 2004, 3% and 13% 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, 2003, 4% and 11% of the Company's
revenue was denominated in 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, 2004,
2003 and 2002, 16%, 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 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.
At December 31, 2004, the Company had contracts for the sale of
approximately $4.6 million Japanese Yen at fixed rates. The contracts expire on
various dates through May, 2007. The Company has not designated the contracts as
hedges and, accordingly, has recorded the estimated fair value of the contracts
of $203,000 at December 31, 2004 as an other asset in the consolidated balance
sheet and other income (expense) in the consolidated statements of operations.
The Company is also subject to market risk related to the interest rates on
its existing line of credit. As of March 15, 2005, such interest rates are based
on the prime rate plus 100 basis-points.
As of December 31, 2004 and throughout the full year ending December 31,
2004, the Company did not have any outstanding debt that was subject to variable
interest rates.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEX TO FINANCIAL STATEMENTS
Page
GSE Systems, Inc. and Subsidiaries
Report of Independent Registered Public Accounting Firm ............................................................. F-1
Consolidated Balance Sheets as of December 31, 2004 and 2003......................................................... F-2
Consolidated Statements of Operations for the years ended
December 31, 2004, 2003, and 2002................................................................................ F-3
Consolidated Statements of Comprehensive Income (Loss) for the years ended
December 31, 2004, 2003, and 2002................................................................................ F-4
Consolidated Statements of Changes in Stockholders' Equity for the years ended
December 31, 2004, 2003, and 2002................................................................................ F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 2004, 2003, and 2002................................................................................ F-6
Notes to Consolidated Financial Statements........................................................................... F-7
Report of Independent Registered Public Accounting Firm
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, 2004 and 2003, and the related
consolidated statements of operations, comprehensive income (loss), changes in
stockholders' equity and cash flows for each of the years in the three-year
period ended December 31, 2004. 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 the standards of the Public Company
Accounting Oversight Board (United States). 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, 2004 and 2003, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2004 in conformity with generally accepted U.S. accounting
principles.
/s/KPMG LLP
Baltimore, Maryland
March 15, 2005
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
December 31,
---------------------------
2004 2003
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 868 $ 1,388
Restricted cash 29 473
Contract receivables 8,723 9,457
Prepaid expenses and other current assets 819 1,635
------------ ------------
Total current assets 10,439 12,953
Equipment and leasehold improvements, net 596 643
Software development costs, net 909 946
Goodwill, net 1,739 1,739
Other assets 545 255
------------ ------------
Total assets $ 14,228 $ 16,536
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 9 $ 33
Accounts payable 2,998 2,946
Due to GP Strategies Corporation 291 100
Accrued expenses 1,608 1,418
Accrued compensation and payroll taxes 1,523 1,752
Billings in excess of revenue earned 1,079 3,927
Other current liabilities 273 240
------------ ------------
Total current liabilities 7,781 10,416
Long-term debt - 9
Accrued warranty reserves 483 407
Other liabilities 19 25
------------ ------------
Total liabilities 8,283 10,857
------------ ------------
Commitments and contingencies
Stockholders' equity:
Preferred stock $.01 par value, 2,000,000 shares authorized, no shares issued and
outstanding - -
Common stock $.01 par value, 18,000,000 shares authorized, shares issued and
outstanding 8,949,706 in 2004 and 2003 89 89
Additional paid-in capital 30,815 30,815
Accumulated deficit - at formation (5,112) (5,112)
Accumulated deficit - since formation (19,044) (19,162)
Accumulated other comprehensive loss (803) (951)
------------ ------------
Total stockholders' equity 5,945 5,679
------------ ------------
Total liabilities and stockholders' equity $ 14,228 $ 16,536
============ ============
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,
-------------------------------------------
2004 2003 2002
------------- ------------- -------------
Contract revenue $ 29,514 $ 25,019 $ 20,220
Cost of revenue 22,715 19,175 16,660
------------- ------------- -------------
Gross profit 6,799 5,844 3,560
------------- ------------- -------------
Operating expenses
Selling, general and administrative 6,517 6,443 6,506
Depreciation and amortization 280 392 395
------------- ------------- -------------
Total operating expenses 6,797 6,835 6,901
------------- ------------- -------------
Operating income (loss) 2 (991) (3,341)
Interest expense, net (176) (504) (55)
Other income (expense), net 316 (273) 37
------------- ------------- -------------
Income (loss) from continuing operations before income taxes 142 (1,768) (3,359)
Provision for income taxes 60 93 891
------------- ------------- -------------
Income (loss) from continuing operations 82 (1,861) (4,250)
------------- ------------- -------------
Loss from discontinued operations, net of income taxes - (1,409) (1,693)
Income (loss) on sale of discontinued operations, net
of income taxes 36 (262) -
------------- ------------- -------------
Income (loss) from discontinued operations 36 (1,671) (1,693)
------------- ------------- -------------
Net income (loss) 118 (3,532) (5,943)
Preferred stock dividends and beneficial conversion premium - (2,140) (234)
------------- ------------- -------------
Net income (loss) attributed to common shareholders $ 118 $ (5,672) $ (6,177)
============= ============= =============
Basic earnings (loss) per common share:
Continuing operations $ 0.01 $ (0.61) $ (0.76)
Discontinued operations 0.00 (0.26) (0.29)
------------- ------------- -------------
Net income (loss) $ 0.01 $ (0.87) $ (1.05)
============= ============= =============
Diluted earnings (loss) per common share
Continuing operations $ 0.01 $ (0.61) $ (0.76)
Discontinued operations 0.00 (0.26) (0.29)
------------- ------------- -------------
Net loss $ 0.01 $ (0.87) $ (1.05)
============= ============= =============
The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
Years ended December 31,
-------------------------------------------
2004 2003 2002
------------- ------------- ------------
Net income (loss) $ 118 $ (3,532) $ (5,943)
Foreign currency translation adjustment 148 236 128
------------- ------------- ------------
Comprehensive income (loss) $ 266 $ (3,296) $ (5,815)
============= ============= ============
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, 2002 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
Foreign currency
translation adjustment - - - - - - - 148 148
Net income - - - - - - 118 - 118
---------- --------- -------- ------- ----------- ----------- ----------- ------------- -------
Balance, December 31, 2004 8,950 $ 89 - $ - $ 30,815 $(5,112) $ (19,044) $ (803) $5,945
========== ========= ======== ======= =========== =========== =========== ============ ========
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years ended December 31,
------------------------------------------
2004 2003 2002
------------ ------------- -------------
Cash flows from operating activities:
Net income (loss) $ 118 $ (3,532) $ (5,943)
Loss from discontinued operations - (1,409) (1,693)
Income (loss) on sale of discontinued operations 36 (262) -
------------ ------------- -------------
Income (loss) from continuing operations 82 (1,861) (4,250)
Adjustments to reconcile income (loss) from continuing operations to
net cash provided by (used in) operating activities:
Depreciation and amortization 678 731 653
Foreign currency transaction gain (52) (5) (34)
Stock option compensation - - 45
Deferred income taxes (50) - 1,600
Changes in assets and liabilities:
Contract receivables 734 (3,010) 1,248
Prepaid expenses and other assets 547 (624) 272
Accounts payable, accrued compensation and accrued expenses 200 2,060 230
Due to GP Strategies Corporation 191 100 -
Billings in excess of revenue earned (2,829) 3,335 (674)
Accrued warranty reserves 158 (158) (60)
Other liabilities (50) (26) (61)
Income taxes payable 34 (36) (64)
------------ ------------- -------------
Net cash provided by (used in) continuing operations (357) 506 (1,095)
Net cash provided by (used in) discontinued operations (36) 883 (110)
------------ ------------- -------------
Net cash provided by (used in) operating activities (393) 1,389 (1,205)
------------ ------------- -------------
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)
Capital expenditures (222) (191) (170)
Capitalized software development costs (361) (542) (768)
Releases (restrictions) of cash as collateral under letters of credit, net 473 245 (243)
Other cash used in discontinued operations, net - (506) (1,997)
------------ ------------- -------------
Net cash provided by (used in) investing activities (110) 3,736 (3,223)
------------ ------------- -------------
Cash flows from financing activities:
Proceeds from issuance of common stock - - 1,583
Repayment on note payable to related party - - (350)
(Decrease) increase in borrowings under line of credit - (5,431) 443
Other financing repayments (33) (30) (269)
Other cash provided by discontinued operations, net - - 2,589
------------ ------------- -------------
Net cash provided by (used in) financing activities (33) (5,461) 3,996
------------ ------------- -------------
Effect of exchange rate changes on cash 16 107 9
------------ ------------- -------------
Net decrease in cash and cash equivalents (520) (229) (423)
Cash and cash equivalents at beginning of year 1,388 1,617 2,040
------------ ------------- -------------
Cash and cash equivalents at end of year $ 868 $ 1,388 $ 1,617
============ ============= =============
The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003, and 2002
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.
GP Strategies Corporation (GP Strategies) owned approximately 58% of the
Company's outstanding common stock at December 31, 2003 and 2004.
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.
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.
Revenue from the sale of software licenses which do not require significant
modifications or customization for the Company's modeling tools are recognized
when the license agreement is signed, the license fee is fixed and determinable,
delivery has occurred, and collection is considered probable.
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.
Development expenditures
Development expenditures incurred to meet customer specifications under
contracts are charged to contract costs. Company sponsored development
expenditures are charged to operations as incurred and are included in selling,
general and administrative expenses. The amounts incurred for Company sponsored
development activities relating to the development of new products and services
or the improvement of existing products and services, were approximately
$552,000, $856,000, and $763,000, for the years ended December 31, 2004, 2003
and 2002, 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 2004, 2003 or 2002.
Goodwill
Goodwill and intangible assets with indefinite useful lives are not
amortized, but instead tested for impairment at least annually. On December 31,
2002, 2003 and 2004, the Company completed its analysis of goodwill and
determined no impairment charge was necessary.
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, 2004, 2003, and 2002, foreign currency transaction gains were
approximately $52,000, $5,000, and $34,000, 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,
- ----------------------------------------------------------------------------
2004 2003 2002
- ----------------------------------------------------------------------------
Beginning balance $ 509 $ 667 $ 727
Current year provision 312 470 686
Current year claims (154) (628) (746)
------------ ----------- ------------
Ending balance $ 667 $ 509 $ 667
============ ============ ============
As of December 31, 2004 and 2003, $483,000, and $407,000, 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,
---------------------------------------------------
2004 2003 2002
------------ ------------ ---------
Net income (loss) attributed to
common stockholders, as reported $ 118 $ (5,672) $ (6,177)
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 (51) (381) (422)
----------- ----------- ----------
Pro forma net loss $ 67 $ (6,053) $ (6,554)
=========== =========== ==========
Net income (loss) per share, as reported:
Basic $ 0.01 $ (0.87) $ (1.05)
Diluted $ 0.01 $ (0.87) $ (1.05)
Proforma net income (loss) per share:
Basic $ 0.01 $ (0.93) $ (1.12)
Diluted $ 0.01 $ (0.93) $ (1.12)
The fair value of each option is estimated on the date of grant using a
Black-Scholes option-pricing model. There were no options granted during 2004,
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,
------------------------------------------
2004 2003 2002
---------- ------------ ------------
Numerator:
Net income (loss) $ 118 $ (3,532) $ (5,943)
Stock dividend- beneficial conversion premium - (1,950) -
Preferred stock dividends (190) (234)
---------- ------------ ------------
Net income (loss) attributed to
common stockholders $ 118 $ (5,672) $ (6,177)
========== ============ ============
Denominator:
Weighted-average shares outstanding for
basic earnings per share 8,949,706 6,542,000 5,863,134
Effect of dilutive securities:
Employee stock options, warrants and
options outside the plan 105,736 - -
Adjusted weighted-average shares outstanding---------- ---------- ------------
and assumed conversions for diluted
earnings per share 9,055,442 6,542,000 5,863,134
=========== ========== ============
Shares related to dilutive securities
excluded because inclusion would be
anti-dilutive: 1,294,826 1,903,976 3,166,456
========== ========== ===========
Basic income (loss) per common share:
Continuing operations $ 0.01 $ (0.61) $ (0.76)
Discontinued operations $ 0.00 $ (0.26) (0.29)
---------- ------------ -----------
Net income (loss) $ 0.01 $ (0.87) $ (1.05)
========== =========== ===========
Diluted income (loss) per common share:
Continuing operations $ 0.01 $ (0.61) $ (0.76)
Discontinued operations $ 0.00 (0.26) (0.29)
---------- ---------- -----------
Net income (loss) $ 0.01 $ (0.87) $ (1.05)
========== ========== ===========
The difference between the basic and diluted number of weighted average
shares outstanding for the year ended December 31, 2004 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
loss for the years ended December 31, 2003 and 2002 was decreased by preferred
stock dividends and related charges of $2,140,000, and $234,000, 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 year ended December 31, 2002 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, 2004,
2003 and 2002, one customer accounted for approximately 24%, 29%, and 23%,
respectively, of the Company's revenue. At December 31, 2004, the contracts
receivable balance related to this significant customer was approximately $1.4
million, or 16% of contract receivables, of which $646,000 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, 2004, the Company had contracts for the sale of
approximately $4.6 million Japanese Yen at fixed rates. The contracts expire on
various dates through May, 2007. The Company has not designated the contracts as
hedges and, accordingly, has recorded the estimated fair value of the contracts
of $203,000 at December 31, 2004 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 December 2004, the FASB issued SFAS No. 123 - Revised (SFAS No. 123R),
"Share-Based Payment", which revises SFAS No. 123, "Accounting for Stock-Based
Compensation", and supercedes APB No. 25, "Accounting for Stock Issued to
Employees." Currently, the Company does not record compensation expense for
certain stock-based compensation. Under SFAS No. 123R, the Company will measure
the cost of employee services received in exchange for stock, based on the
grant-date fair value (with limited exceptions) of the stock award. Such cost
will be recognized over the period during which the employee is required to
provide service in exchange for the stock award (usually the vesting period).
The fair value of the stock award will be estimated using an option-pricing
model, with excess tax benefits, as defined in SFAS No. 123R, being recognized
as an addition to paid in capital. SFAS No. 123R is effective as of July 1,
2005. The Company is currently in the process of evaluating the impact of SFAS
No. 123R on our financial statements.
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 income (loss) for the discontinued Process
business was:
(in thousands) Years ended December 31,
----------------------------------------------
2004 2003 2002
----------- --------- -----------
Contract revenue $ - $ 13,693 $ 22,896
Income (loss) from discontinued operations 36 (1,671) (1,693)
Income (loss) from discontinued operations includes losses in 2003 and
2002 of $115,000, and $2.8 million, respectively, from the write down of the
Company's investment in Avantium International BV. The $36,000 of income in 2004
relates to the favorable resolution of certain contingencies which the Company
had provided for at the date of sale net of income taxes.
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,
--------------------------
2004 2003
----------- -------------
Billed receivables $ 4,491 $ 5,069
Recoverable costs and accrued profit not billed 4,256 4,395
Allowance for doubtful accounts (24) (7)
----------- -------------
Total contract receivables $ 8,723 $ 9,457
=========== =============
5. Prepaid expenses and other current assets
Prepaid expenses and other current assets consist of the following:
(in thousands) December 31,
---------------------------
2004 2003
------------ ------------
Prepaid expenses $ 610 $ 1,485
Employee advances 17 16
Other current assets 192 134
------------ ------------
Total $ 819 $ 1,635
============ ============
6. Equipment and leasehold improvements
Equipment and leasehold improvements consist of the following:
(in thousands) December 31,
--------------------------
2004 2003
----------- ------------
Computer equipment $ 3,095 $ 2,772
Leasehold improvements 703 692
Furniture and fixtures 942 1,158
----------- ------------
4,740 4,622
Accumulated depreciation and amortization (4,144) (3,979)
----------- ------------
Equipment and leasehold improvements, net $ 596 $ 643
=========== ============
Depreciation and amortization expense was approximately $280,000, $392,000, and
$395,000 for the years ended December 31, 2004, 2003, and 2002, respectively.
7. Software development costs
Software development costs, net, consist of the following:
(in thousands) December 31,
---------------------------
2004 2003
------------- ------------
Capitalized software development costs $1,568 $1,207
Accumulated amortization (659) (261)
------------- ------------
Software development costs, net $909 $946
============= ============
Software development costs capitalized were approximately $361,000, $542,000,
and $555,000 for the years ended December 31, 2004, 2003 and 2002, respectively.
Amortization of software development costs capitalized was approximately
$398,000, $339,000, and $256,000, for the years ended December 31, 2004, 2003
and 2002, respectively, and were included in cost of revenue.
8. Long-term Debt
The Company's long-term debt consists of an unsecured promissory note to
a former employee with a remaining balance of $9,000 at December 31, 2004 which
is due March 31, 2005.
Line of Credit
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% (5.4% as of December 31, 2004), with interest
only payments due monthly. At December 31, 2004, the Company's available
borrowing base was $1.5 million, none of which had been utilized. The credit
facility expires on August 12, 2006.
The credit facility requires the Company to comply with certain financial
ratios. At December 31, 2004, the Company was in compliance with its financial
ratio covenants.
In March, 2003, GP Strategies extended their $1.8 million limited guarantee
of the Company's previous 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 were amortized
over the one-year life of the guarantee through March 2004.
Notes Payable to Related Parties
On June 25, 2001, the Company issued an 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.
9. Income taxes
The consolidated income (loss) before income taxes, by domestic and foreign
sources, is as follows:
(in thousands) Years ended December 31,
--------------------------------------
2004 2003 2002
---------- ----------- -----------
Domestic $ 42 $ (3,609) $ (3,866)
Foreign 166 196 (688)
---------- ----------- -----------
Total $ 208 $ (3,413) $ (4,554)
========== =========== ===========
The provision for income taxes is as follows:
(in thousands) Years ended December 31,
------------------------------------------
2004 2003 2002
------------- ------------- ------------
Current:
Federal $ 1 $ - $ (112)
State 18 53 (57)
Foreign 121 66 (42)
------------- ------------- ------------
Subtotal 140 119 (211)
------------- ------------- ------------
Deferred:
Federal and state - - 1,694
Foreign (50) - (94)
------------- ------------- ------------
Subtotal (50) - 1,600
------------- ------------- ------------
Total $ 90 $ 119 $ 1,389
============= ============= ============
The allocation of the provision for income taxes to continuing and discontinued operations is as
follows:
Continuing operations $ 60 $ 93 $ 891
Discontinued operations 30 26 498
------------- ------------- ------------
$ 90 $ 119 $ 1,389
============= ============= ============
The provision for income taxes varies from the amount of income tax
determined by applying the applicable U.S. statutory rate to pre-tax income
(loss) as a result of the following:
Effective tax rate percentage (%)
Years ended December 31,
----------------------------------------
2004 2003 2002
---------- ---------- ----------
Statutory U.S. tax rate 34.0 % (34.0)% (34.0)%
State income tax, net of federal tax benefit 5.7 1.0 (2.0)
Effect of foreign operations (6.0) (0.1) 0.9
Change in valuation allowance 1.0 36.1 61.8
Other, principally permanent differences 8.6 0.5 3.8
---------- ---------- ----------
Effective tax rate 43.3 % 3.5 % 30.5 %
========== ========== ==========
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,
---------------------------------------
2004 2003 2002
------------ ----------- -----------
Net operating loss carryforwards $ 6,246 $ 6,133 $ 6,246
Investments 1,658 1,570 1,512
Foreign tax credits 378 378 379
Accrued expenses 260 288 243
Expenses not currently deductible for tax purposes 285 268 878
Alternative minimum tax credit carryforwards 162 162 162
Property and equipment (29) 34 (90)
Software development costs (322) (347) (1,615)
Other 145 95 60
------------ ----------- -----------
Subtotal 8,783 8,581 7,775
Valuation allowance (8,733) (8,581) (7,775)
------------ ----------- -----------
Total $ 50 $ - $ -
============ =========== ===========
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. Other than the net deferred tax assets that are related
to the Company's Swedish subsidiary, management could not substantiate recovery
of the net deferred tax assets with currently available objective evidence.
Accordingly, the Company has established an $8,733,000 valuation allowance for
the deferred tax assets that are not related to the Swedish subsidiary. The
valuation allowance will be reduced if the Company's U.S. operations are able to
realize taxable income in the future. The valuation allowance for deferred tax
assets increased by $152,000 in 2004, by $806,000 in 2003, and by $2,845,000 in
2002.
At December 31, 2004, the Company had available $16,119,000 and $1,049,000
of domestic and foreign net operating loss carryforwards, respectively, which
expire between 2012 and 2024. 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.
In June 2003, the Company received a $6.6 million order from the Mexican
utility Comission 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.
As of December 31, 2004, the Company has reserved 1,866,776 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. At the date of the conversion, the Company's
credit facility restricted the Company from paying any dividends on the
preferred stock. At December 31, 2004, the Company had accrued dividends payable
to ManTech of $366,000. The unpaid dividends accrue interest at 6% per annum. At
December 31, 2004 the Company had an accrual for interest payable of $38,000.
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, 2004, the Company had
686,844 shares of common stock reserved for the future grants under the Plan.
Stock option and warrant activity is as follows:
Weighted
Average
Shares Exercise Price
---------------- ----------------
Options and warrants outstanding, as of January 1, 2002 2,306,655 $ 3.73
Options and warrants exercised (128,000) (2.05)
Options and warrants canceled (39,179) (2.00)
Options and warrants granted - -
----------------
Options and warrants outstanding, as of December 31, 2002 2,139,476 $ 3.28
Options and warrants exercised 100,000 1.33
Options and warrants canceled (335,500) 2.36
Options and warrants granted - -
----------------
Options and warrants outstanding, as of December 31, 2003 1,903,976 $ 3.95
Options and warrants exercised - -
Options and warrants canceled (37,200) 3.79
Options and warrants granted - -
----------------
Options and warrants outstanding, as of December 31, 2004 1,866,776 $ 3.96
================
The following table summarizes information relating to currently outstanding and
exercisable options and warrants at December 31, 2004:
Options and Warrants Outstanding Options and Warrants Exercisable
------------------------------------------------- --------------------------------------
Weighted
Average
Options Remaining Weighted Options Weighted
Range of and Warrants Contract Average and Warrants Average
Exercise Prices Outstanding Life in Years Exercise Price Exercisable Exercise Price
- ------------------------ --------------- --------------- --------------- ---------------- ----------------
$0.00 - $1.48 175,000 2.5 $ 1.19 175,000 $ 1.19
$1.48 - $2.95 528,350 3.0 2.15 528,350 2.15
$2.96 - $4.43 789,485 1.6 3.67 789,485 3.67
$4.44 - $5.90 200,000 2.1 4.75 200,000 4.75
$5.91 - $7.38 10,000 2.3 6.38 10,000 6.38
$7.39 - $8.85 20,000 2.2 7.50 20,000 7.50
$8.86 - $11.80 17,700 2.1 11.25 17,700 11.25
$11.81 - $14.75 126,241 0.7 14.11 126,241 14.11
--------------- ----------------
Total 1,866,776 2.1 $ 3.96 1,866,776 $ 3.96
=============== ================
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, 2004 are as follows:
(in thousands) Gross future Sublease Net future
minimum lease rental minimum lease
payments income payments
------------------ ------------ ----------------
2005 $ 1,706 $ (147) $ 1,559
2006 1,388 - 1,388
2007 1,364 - 1,364
2008 646 - 646
Thereafter - - -
------------------ ------------ ----------------
Total $ 5,104 $ (147) $ 4,957
================== ============ ================
Total rent expense under operating leases for the years ended December 31,
2004, 2003, and 2002 was approximately $1.2 million, $998,000, and $999,000,
respectively.
The Company has 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. For the years
ended December 31, 2004, 2003 and 2002, such sublease rentals amounted to
$41,000, $32,000, and $32,000 respectively
The Company has 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 conjunction with the move of its Process Automation business to its
Columbia, Maryland facility in May 2003, the Company subleased most of its
vacated facility in Baltimore, Maryland to Alpharma USPD Inc. for a five-year
period, although Alpharma could terminate the lease at the end of the second
year provided a six-month notice was given. In October, 2004, Alpharma notified
the Company that they will terminate the sublease on April 30, 2005. The
Company's broker is actively seeking another subtenant, and management believes
that a subtenant will be found prior to the end of the sublease. However, if a
subtenant is not found or the terms of a new subtenant lease arrangement are not
consistent with those of the Alpharma lease, the Company may be required to
record an additional charge related to the lease for the vacated facility. The
Company's lease, which expires July, 2008, requires annual rent of approximately
$550,000. The Company currently has a loss accrual of $158,000.
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. This sublease is
currently on a month to month basis.
Letters of credit and performance bonds
As of December 31, 2004, the Company was contingently liable for
approximately $29,000 under one letter of credit used as a payment bond on a
contract, which was secured by a cash deposit classified as restricted cash in
the consolidated balance sheet. In addition, the Company was contingently liable
at December 31, 2004 for approximately $36,000 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
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 continued as a GP Strategies
employee, however, Mr. Moran devoted 100% of his time to the performance of his
duties as CEO of GSE. In 2003, GSE was charged $35,000 by GP Strategies for his
compensation and benefits; in 2004 GSE was charged $289,000 by GP Strategies for
Mr. Moran's compensation and benefits. On December 16, 2004, Mr. Moran became an
employee of GSE.
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 uses General
Physics' financial system. (General Physics is a subsidiary of GP Strategies.)
In 2004, GSE was charged $685,000 for GP Strategies' services. The agreement has
been extended through December 31, 2005 without an increase in the fee. The
agreement can be renewed for successive one-year terms.
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. In addition, GSE was charged $30,000 by
General Physics 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 $110,000, $239,000, and $215,000, for the years ended
December 31, 2004, 2003, and 2002, respectively. The reduction in the Company's
contributions in 2004 reflects the sale of the Company's Process Automation
business in September, 2003.
16. Acquisitions
In October 2002, the Company completed an acquisition 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 current assets and property and equipment.
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 US Government& Military Simulation.
For the years ended December 31, 2004, 2003, and 2002, one customer
(Battelle's Pacific Northwest National Laboratory) accounted for approximately
24%, 29%, and 23%, 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, 2004, 2003, and 2002, 85%, 89%, and 86% 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 65%, 70%,
and 56% of the Company's 2004, 2003 and 2002 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, 2004, 2003, and 2002
are as follows:
(in thousands) Year Ended December 31, 2004
---------------------------------------------------------------------
United States Europe Asia Eliminations Consolidated
-------------- ----------- ---------- ------------ -------------
Contract revenue $ 24,774 $ 4,724 $ 16 $ - $ 29,514
Transfers between geographic locations 132 10 70 (212) -
-------------- ----------- ---------- ------------ -------------
Total contract revenue $ 24,906 $ 4,734 $ 86 $ (212) $ 29,514
============== =========== ========== ============ =============
Operating income (loss) $ 89 $ (7) $ (80) $ - $ 2
============== =========== ========== ============ =============
Identifiable assets, at December 31 $38,711 $3,618 $33 $ (28,134) $ 14,228
============== =========== ========== ============ =============
(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
============== =========== ========== ============ =============
18. Supplemental disclosure of cash flow information
(in thousands) Years ended December 31,
2004 2003 2002
----------- ------------ -----------
Issuance of options/warrants to
non-employees (see Note 10) $ - $ 86 $ -
=========== ============ ===========
Conversion of related party note payable to
common stock $ - $ 787 $ -
=========== ============ ===========
Conversion of preferred stock to
common stock $ - $ 3,900 $ -
=========== ============ ===========
Cash paid:
Interest $ 96 $ 668 $ 485
=========== ============ ===========
Income taxes $ 94 $ 138 $ 385
=========== ============ ===========
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.
Note 19 Quarterly Financial Data (Unaudited)
(in thousands, except per share data) Year ended December 31, 2004 Quarterly Data
----------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------ -------------- ----------- ----------
Contract revenue $ 7,561 $ 7,597 $ 7,340 $ 7,016
Operating income (loss) 224 333 (255) (300)
Income (loss) from continuing operations 64 276 (197) (61)
Income from discontinued operations - - 60 (24)
------------ -------------- ----------- ----------
Net income (loss) $ 64 $ 276 $ (137) $ (85)
============ ============== =========== ==========
Basic earnings (loss) per common share:
Continuing operations $ 0.01 $ 0.03 $ (0.02) $ (0.01)
Discontinued operations - - - -
------------ -------------- ----------- ----------
Net income (loss) $ 0.01 $ 0.03 $ (0.02) $ (0.01)
============ ============== =========== ==========
Diluted earnings (loss) per common share:
Continuing operations $ 0.01 $ 0.03 $ (0.02) $ (0.01)
Discontinued operations - - - -
------------ -------------- ----------- ----------
Net income (loss) $ 0.01 $ 0.03 $ (0.02) $ (0.01)
============ ============== =========== ==========
(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 (250) (482) (313) (816)
Loss from discontinued operations (268) (650) (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)
============ ============== =========== ==========
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 2004
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 9A. CONTROLS AND PROCEDURES.
The Company maintains disclosure controls and procedures that are designed
to ensure that information required to be disclosed by it in its reports filed
or submitted pursuant to the Securities Exchange Act of 1934, as amended
(Exchange Act), is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms
and that information required to be disclosed by the Company in its Exchange Act
reports is accumulated and communicated to management, including the Company's
Chief Executive Officer and Chief Financial Officer, to allow timely decisions
regarding required disclosure.
Under the supervision and the participation of the Company's management,
including the Company's Chief Executive Officer and Chief Financial Officer, the
Company carried out an evaluation of the effectiveness of the design and
operation of the Company's disclosure controls and procedures pursuant to
Exchange Act Rule 13a-15(e) as of December 31, 2004. Based upon that evaluation
the Company identified a material weakness with respect to the identification
and accounting for derivative transactions in accordance with the requirements
of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities".
(A material weakness is a significant deficiency, or combination of significant
deficiencies, that result in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected.)
Based upon the Company's evaluation and the material weakness described
above, the Chief Executive Officer and Chief Financial Officer concluded that
the Company's disclosure controls and procedures were not effective as of that
date.
Subsequent to the review, the Company is revising its controls around
derivative transactions to ensure that these transactions will be captured and
accounted for in a timely manner.
There have been no other significant changes in internal controls, or in
factors that could significantly affect internal controls, subsequent to the
date of the Chief Operating Officer and Chief Financial Officer complete their
evaluation.
Limitation of Effectiveness of Controls
It should be noted that any system of controls, however well designed and
operated, can provide only reasonable, and not absolute, assurance that the
objectives of the system will be met. The design of any control system is based,
in part, upon the benefits of the control system relative to its costs. Because
of the inherent limitations in all control systems, no evaluation of controls
can provide absolute assurance that all control issues and instances of fraud,
if any, within the Company have been detected. These inherent limitations
include the realities that judgments in decision making can be faulty, and that
controls can be circumvented by the individual acts of some persons, by
collusion of two or more people or by management override of control. In
addition, over time controls may become inadequate because of changes in
conditions, or the degree of compliance with the policies or procedures may
deteriorate. In addition, the design of any control system is based in part upon
certain assumptions about the likelihood of future events. Because of inherent
limitations in a cost-effective control system, misstatements due to error or
fraud may occur and not be detected. The Company's controls and procedures are
designed to provide a reasonable level of assurance of achieving their
objectives.
ITEM 9B. OTHER INFORMATION
None.
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 2005 Annual Meeting of Shareholders.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) (1) List of Financial Statements
The following financial statements are included in Item 8:
GSE Systems, Inc. and Subsidiaries
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2004 and 2003
Consolidated Statements of Operations for the years ended
December 31, 2004, 2003, and 2002
Consolidated Statements of Comprehensive Income (Loss) for the years ended
December 31, 2004, 2003, and 2002
Consolidated Statements of Changes in Stockholders' Equity for the years
ended December 31, 2004, 2003, and 2002
Consolidated Statements of Cash Flows for the years ended December 31,
2004, 2003, and 2002
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.
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: March 17, 2005 / S / JOHN MORAN
------------------------------------
John Moran, Chief Executive Officer
(Principal Executive Officer)
Date: March 17, 2005 / S / JEFFERY G. HOUGH
-------------------------------------
Jeffery G. Hough, Senior Vice President
and Chief Financial Officer
(Principal Financial and Accounting
Officer)
Date: March 17, 2005
(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 )
(Chin-our Jerry Jen, Director )
(Andrea Kantor, Director )
(Joseph W. Lewis, Director )
(George J. Pedersen, Director )
(Douglas Sharp, Director )
A Power of Attorney, dated January 5, 2005, authorizing Jeffery G. Hough to
sign this Annual Report on Form 10-K for the fiscal year ended December 31, 2004
on behalf of certain of the directors of the Registrant is filed as Exhibit 24
to this Annual Report.
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. 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.
g. 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. *
h. $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.
i. 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.
j. 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.
k. Management Services Agreement between GSE Systems, Inc. and GP
Strategies Corporation dated January 1, 2004. Previously filed in
connection with the GSE Systems, Inc. Form 10-K filed with the
Securities and Exchange Commission on April 14, 2004 and
incorporated herein by reference.
l. 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. Previously filed in
connection with the GSE Systems, Inc. Form 10-K filed with the
Securities and Exchange Commission on April 14, 2004 and
incorporated herein by reference.
m. Third Amendment dated July 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. Previously filed in
connection with the GSE Systems, Form 10-Q filed with the
Securities and Exchange Commission on November 14, 2004 and
incorporated herein by reference.
21. Subsidiaries.
a. List of Subsidiaries of Registrant at December 31, 2004. **
23. Consents of Experts and Counsel
a. Consent of KPMG LLP **
24. Power of Attorney
a. Power of Attorney for Directors' and Officers' Signatures on SEC
Form 10-K. **
Exhibit Description of Exhibit
31.1 Certification of the Chief Executive Officer of the Company pursuant
to Securities and Exchange Act Rule 13d-14 (a)/15d-14(a), as adopted
pursuant to Section 302 and 404 of the Sarbanes-Oxley Act of 2002. **
31.2 Certification of the Chief Financial Officer pursuant to Securities
and Exchange Act Rule 13d-14(a)/15d-14(a), as adopted pursuant to
Section 302 and 404 of the Sarbanes-Oxley Act of 2002. **
32.1 Certification of the Chief Executive Officer and Chief Financial
Officer of the Company pursuant to 18 U.S.C. Section 1350 as adopted
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.