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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, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number 0-26494
GSE Systems, Inc.
(Exact name of registrant as specified in its charter)
Delaware 52-1868008
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(State of incorporation) (I.R.S. Employer
Identification Number)
9189 Red Branch Road, Columbia, Maryland 21045
- ---------------------------------------- -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (410) 772-3500
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Common Stock, $.01 par value
(Title of each class)
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
-- --
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of Common Stock held by non-affiliates as of
March 15, 1999 was $13,476,996 based on closing price of such stock on that
date.
Number of shares of Common Stock outstanding as of March 15, 1999: 5,065,688.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates certain information by reference from the
Registrant's definitive proxy statement to be filed for its 1999 annual meeting
of shareholders.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
TABLE OF CONTENTS
PART I Page
Item 1. Business.................................................... 3
Item 2. Properties.................................................. 13
Item 3. Legal Proceedings........................................... 13
Item 4. Submission of Matters to a Vote of Security Holders........ 13
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters....................................... 14
Item 6. Selected Financial Data................................... 15
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.............................. 16
Item 7A Quantitative and Qualitative Disclosures About Market Risk 24
Item 8. Financial Statements and Supplementary Data............... 25
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure................. 26
PART III
Item 10. Directors and Executive Officers of the Company*............. 27
Item 11. Executive Compensation*...................................... 27
Item 12. Security Ownership of Certain Beneficial Owners
and Management*........................................ 27
Item 13. Certain Relationships and Related Transactions*.............. 27
PART IV
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K.................................... 28
SIGNATURES.............................................................. 29
* to be incorporated by reference from the Proxy Statement for the
registrant's 1999 Annual Meeting of Stockholders.
Cautionary Statement Regarding Forward-Looking Statements.
This Form 10-K contains certain "forward-looking statements," within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, which are subject to the safe
harbors created by those Acts. These statements include the plans and objectives
of management for future operations, including plans and objectives relating to
the development of the Company's business in the domestic and international
marketplace. All forward-looking statements involve risks and uncertainties,
including, without limitation, risks relating to the Company's ability to
enhance existing software products and to introduce new products in a timely and
cost-effective manner, reduced development of nuclear power plants that may
utilize the Company's products, a long pay-back cycle from the investment in
software development, uncertainties regarding the ability of the Company to grow
its revenues and successfully integrate operations through expansion of its
existing business and strategic acquisitions, the ability of the Company to
respond adequately to rapid technological changes in the markets for process
control and simulation software and systems, significant quarter-to-quarter
volatility in revenues and earnings as a result of customer purchasing cycles
and other factors, dependence upon key personnel, and general market conditions
and competition. See Risk Factors, below. The forward-looking statements
included herein are based on current expectations that involve numerous risks
and uncertainties as set forth herein, the failure of any one of which could
materially adversely affect the operations of the Company. The Company's plans
and objectives are also based on the assumptions that market conditions and
competitive conditions within the Company's business areas will not change
materially or adversely and that there will be no material adverse change in the
Company's operations or business. Assumptions relating to the foregoing involve
judgments with respect, among other things, to future economic, competitive and
market conditions and future business decisions, all of which are difficult or
impossible to predict accurately and many of which are beyond the control of the
Company. Although the Company believes that the assumptions underlying the
forward-looking statements are reasonable, any of the assumptions could be
inaccurate and there can, therefore, be no assurance that the forward-looking
statements included in this Form 10-K will prove to be accurate. In light of the
significant uncertainties inherent in the forward-looking statements included
herein, the inclusion of such information should not be regarded as a
representation by the Company or any other person that the objectives and plans
of the Company will be achieved.
PART I
ITEM 1. BUSINESS.
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GSE Systems, Inc. ("GSE Systems", or the "Company") designs, develops and
delivers business and technology solutions by applying high-technology-related
process control, high fidelity simulation, systems and services into
applications for worldwide industries including energy and process
manufacturing. The Company's solutions and services assist customers in
improving quality, safety and throughput; reducing operating expenses; and
enhancing overall productivity.
The Company's products are used in over 500 applications, representing over
200 customers in 30 countries, in the following industries: specialty chemical,
food & beverage, petroleum refining, pharmaceutical, fossil and nuclear power
generation, and metals.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
Recent Developments.
In 1998, the Company had significantly improved financial results over
1997. The third and fourth quarters of 1998 generated positive operating results
for the core businesses of controls and simulation. These improved financial
results are reflective of the Company's strategy, as previously disclosed, to
return to its strengths within these core businesses, while controlling and
reducing costs. The divestiture of certain operations outside of the core
businesses was an integral part of this strategy.
In May 1998, the Company completed the sale of substantially all of the
assets of GSE Erudite Software, Inc. ("Erudite Software") to Keane, Inc.
("Keane"), pursuant to an asset purchase agreement, dated as of April 30, 1998,
by and among the Company, Erudite Software and Keane. In November 1998, the
Company completed the sale of certain assets related to activities of its Oil &
Gas business unit ("O&G"), to Valmet Automation (USA), Inc. ("Valmet"), pursuant
to an asset purchase agreement, effective as of October 30, 1998, by and between
the Company and Valmet. Both sales are more fully explained in "Liquidity and
Capital Resources", and in "Notes to Consolidated Financial Statements."
Due to the poor financial results in 1997, the senior management of the
Company has been substantially changed and current management has set a course
to reduce costs and to return the Company's focus to its core businesses of
controls and simulation. The Company is implementing this strategy utilizing two
business units:
* Power, which is primarily concentrated in the power generation
industry, and
* Process, which utilizes process controls and simulation in various
process industries.
Having completed the initial phase of its strategy to return to its core
businesses, the Company has begun pursuit of strategic growth opportunities
consistent with these core businesses. Generally, the Company is seeking
complimentary opportunities that management believes can be implemented without
diverting the focus of the Company or its management from its internal strengths
and plans for organic growth.
The Company's Common Stock had previously traded on the NASDAQ National
Market System under the symbol "GSES". In January 1999, the Company's Common
Stock was approved for listing the American Stock Exchange, where it now trades
under the symbol "GVP".
Further changes to senior management of the Company have been completed
over the last twelve months and the current management plans to continue to
manage costs and maintain the Company's focus on its core businesses of controls
and simulation.
The management team of the Company believes that aforementioned
developments will provide for a viable operating entity and will position the
Company for success in the future.
Background.
GSE Systems was formed on April 13, 1994, by ManTech International
Corporation ("ManTech"), GP Strategies Corporation ("GP Strategies" and formerly
known as "National Patent Development Corporation" or "NPDC") and its
affiliates, General Physics Corporation ("GPC") and SGLG, Inc. ("SGLG" and
formerly known as "GPS Technologies, Inc." or "GPS"); and Vattenfall AB
("Vattenfall") to consolidate the simulation and related businesses of their
affiliates, GSE Power Systems, Inc. ("Power Systems" and formerly known as
"Simulation, Systems & Services Technologies Company" or "S3 Technologies"), GP
International Engineering & Simulation, Inc. ("GPI") and GSE Power Systems AB
("Power Systems AB" and formerly known as "EuroSim AB" or "EuroSim"). 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 ("TI"), which the
Company operates as GSE Process Solutions, Inc. ("Process Solutions").
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
In April 1996, the Company aligned its operating groups into three
strategic business units (SBUs) to better serve its then primary vertical
markets - Power, Process and Oil & Gas. The realignment allowed the Company to
focus on providing all of its technologies to these markets, while addressing
the specific needs of each market and delivering industry specific solutions.
In May 1996, the Company acquired Erudite Software, a regional provider of
client/server technology, custom application software development, training
services, hardware/software sales, and network design and implementation
services. Erudite Software was subsequently combined with a small pre-existing
consulting group within the Company to form the Company's Business Systems unit.
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 has positioned the Company to be more competitive for modifications and
upgrade services projects within the nuclear simulation market.
In April 1998, the Company divested the Erudite Software business to Keane
Inc. for approximately $9 million in cash. In addition to the cash at closing,
Keane has issued a promissory note for an additional $1 million to be paid to
GSE Systems on the first anniversary of the closing, subject to offset in the
case of any claims for indemnification. See "Liquidity and Capital Resources"
and "Notes to Consolidated Financial Statements".
In November 1998, the Company divested certain assets of the Oil & Gas
business unit to Valmet Automation (USA), Inc. ("Valmet") for cash, plus the
assumption of certain identified liabilities. The transaction also provides that
the Company remain responsible for certain cost overruns, claims and unassumed
liabilities. Included in the sale was an assignment to Valmet of all the
Company's rights to the S/3 SCADA (TM) product, a license for Valmet to use the
Company's SimSuite Pipeline(TM) product, and an assignment of GSE's rights and
obligations under certain customer contracts, maintenance and support
arrangements. See "Liquidity and Capital Resources" and "Notes to Consolidated
Financial Statements".
Business Strategy.
GSE Systems possesses the ability to combine real-time control automation,
real-time simulation and application engineering for true problem solving
techniques and solutions. The Company believes this provides a technological
advantage which, when combined with its focused efforts on targeted industry
markets and defined Application Solution approach, allows its staff to assess,
define, develop, and apply innovative solutions that meet the current and future
industry-specific needs of its customers.
Users in the markets served by the Company want to focus their resources on
their own customers and wish to spend less resources on managing areas such as
control and simulation systems, which are the core strengths of GSE. Its
products and services are designed to help its customers solve problems and
create opportunity within these areas.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
Within the targeted industry segments, the Company seeks customers who will
make investments based primarily on one of the following four basic goals:
* Increase in yield or efficiency
* Improvement in quality
* Solution to an environmental concern
* Solution a safety concern
All of these directly or indirectly impact the profitability of a
particular customer. GSE Systems utilizes its expertise within real-time control
automation, real-time simulation and application engineering to provide
solutions to its customers in those areas.
The Company believes that GSE Systems can partner with customers to help
provide them with cost-effective solutions for problems associated with
simulation and control, which would allow its customers to focus their resources
on their own strengths.
Services and Products.
GSE Systems has developed its knowledge and expertise in process control
and simulation systems which are utilized to improve, control and model
processes. This expertise is concentrated heavily in the process industries,
which include the chemicals, food & beverage, and pharmaceuticals fields, as
well as in the power generation industry, where the Company is a world leader in
nuclear power plant simulation.
As the Microsoft Windows NT(R) operating environment continues to evolve,
the Company has continued the migration of its products to this platform in such
a way as to assure current customers' legacy applications will function properly
while at the same time offering the advantages of the new technology. Although
the Company uses open standards for its products, the Company's standard system
configurations are based on proprietary technology and know-how, which are
necessary to meet the requirements of its customers in the controls and
simulation markets.
The Company's business model is based on software licensing and value-added
services, as well as hardware sales. Because this model is based primarily on
software and value-added services, the Company believes that it can maintain its
business model in an environment of rapidly decreasing hardware costs.
In the Process Business Unit, the flagship product is a Distributed Control
System ("DCS") product, known as the D/3 DCS(TM) that is highly flexible and
open. This product is a real-time system, which uses multiple process control
modules to monitor, measure, and automatically control variables in both
continuous and complex batch processes, as well as form the platform for
plant-wide information for use by operators, engineers and management.
Other products include the following:
* FlexBatch(R), a flexible batch manufacturing system used to facilitate
the rapid creation of various batch production processes;
* TotalVision(TM), which is a graphical system that provides a
client/server-based human-machine interface for real-time process and
plant information; and
* SABL(TM), which is a sophisticated batch and sequential manufacturing
software language that permits the scheduling and tracking of raw
materials and finished products, data collection and emergency
shutdown procedures.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
The Company's proprietary technology also includes real-time, dynamic
simulation tools and products that are used to develop high fidelity simulations
for use in petroleum refineries, chemical processing plants and other industrial
plants. The most prominent set of products and tools is know as SimSuite
Pro(TM), which facilitates design verification, process optimization and
operator training.
The Power Business Unit focuses on developing high fidelity, real time,
dynamic simulators for nuclear and fossil power plants for use in both operator
training and plant optimization. GSE's SimSuite Power (TM) set of auto-code
generators provides state of the art simulation of flow processes, logic and
control systems and electrical distribution systems within a power plant. This
technology is both licensed by the Company to its customers as well as used by
the Company to develop simulators for its customers.
In addition, other products include:
* SimExec (TM), a Windows NT(R) based simulation executive system which
controls all simulation activities and allows for off-line software
development environment in parallel with the training environment.
* RACS, a fully integrated Access Control and Intrusion Detection System
ideally suited for nuclear power plant security applications, and
other large, multi-access facilities.
* SIMON (TM), a computer workstation system used for monitoring
stability of boiling water reactors plants. SIMON(TM) assists the
operator in determining potential instability events, enabling
corrective action to be taken to prevent unnecessary plant shutdowns.
The Company also provides value-added services to help users plan, design,
implement, and manage/support simulation and control systems. Services include
application engineering, project management, training, site services,
maintenance contracts and repair.
Customers.
The Company has provided over 500 simulation and process control systems to
an installed base of over 200 customers worldwide. In 1998, approximately 47% of
the Company's worldwide revenue was generated from end users outside the United
States.
The Company's customers include, among others, Archer Daniels Midland
Company, Bethlehem Steel Corporation, BASF Corporation, Cargill Incorporated,
Carolina Power and Light Company, Commonwealth Edison Company, Eskom South
Africa, Karnaraft Sakerhet & Utbildning AB, Miller Brewing Company, and Pacific
Northwest National Laboratory.
No individual customer represented more than 10% of the Company's 1998
revenue.
Strategic Alliances.
In recent years, a high portion of the Company's international business has
come from major contracts in Europe, the republics of the former Soviet Union,
and the Pacific Rim. In order to acquire and perform these contracts, the
Company entered into strategic alliances or partnerships with various entities
including: Automation Systems Co. Inc., a subsidiary of ManTech China Systems
Corporation; Siemens AG (Europe); All Russian Research Institute for Nuclear
Power Plant Operation (Russia); Kurchatov Institute (Russia); Samsung
Electronics (Korea); Toyo Engineering Corporation (Japan); and Institute for
Information Industry (Taiwan). These alliances have enabled the Company to
penetrate work in these regions by combining its technological expertise with
the regional or local presence and knowledge of its partners.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
Also, the Company continues to believe that it must have strong solutions
partners as well as strong technology partners in order to address the myriad of
systems needs of its customers in the various geographical areas in which they
do business.
Sales and Marketing.
The Company markets its products and services through a network of direct
sales staff, agents and representatives, systems integrators and strategic
alliance partners. The Company also employs personnel that support corporate
advertising, literature development and exhibit/conference participation.
GSE Systems employs a direct sales force in the continental United States
which is regionally based, market focused and trained on its product and service
offerings. Market-oriented business and customer development teams define and
implement specific campaigns to pursue opportunities in the power, process and
manufacturing marketplaces. This effort is supported by an extensive,
regionally-based support organization focused on the current customer installed
base. The Company's ability to support its multi-facility, international and/or
multinational clients, is facilitated by its network of offices throughout the
U.S. and overseas. Within the U.S., the Company maintains offices in: Georgia,
Louisiana, Maryland, North and South Carolina, Pennsylvania and Texas. Outside
the U.S., the Company has offices in Sweden, Belgium, Singapore, Japan, Taiwan
and Korea. In addition to its offices located overseas, the Company's ability to
conduct international business is enhanced by its multilingual and multicultural
work force.
Strategic alliance partners, systems integrators and agents represent the
Company's interests in Russia, Germany, Switzerland, Spain, Czech Republic,
Slovakia, United Arab Emirates, India, South Africa, Venezuela, Mexico,
Argentina, and the Peoples Republic of China.
Product Development.
In 1998, the Company continued investment in the conversion of its D/3
DCS(TM) product to the Microsoft Windows NT(R) platform, and the productization
of its SimSuite(TM) software tools. During the years ended December 31, 1998,
1997 and 1996, gross research and product development expenditures for the
Company were $4.3 million, $5.1 million and $5.8 million, respectively.
Capitalized software development costs totaled $2.3 million, $3.5 million and
$3.9 million during the years ended December 31, 1998, 1997 and 1996. See Note 2
of "Notes to Consolidated Financial Statements" for a discussion of the
Company's policy regarding capitalization of software development costs.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
Industries Served.
The following chart illustrates the approximate percentage of the Company's
1998, 1997 and 1996 revenues, respectively, attributable to each of the major
industries served by the Company:
1998 1997 1996
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Power 42 % 31 % 45 %
Process 49 % 46 % 32 %
Other 9 % 23 % 23 %
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Total 100 % 100 % 100 %
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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, 1998, the Company's aggregate contract backlog totaled approximately $52.7
million. At December 31, 1997, contract backlog totaled $39.0 million.
Employees.
As of December 31, 1998, the Company had 371 employees, which represents a
decrease of approximately 30% compared to December 1997. This decrease is
primarily attributable to the termination of employment of 151 and 21
individuals in connection with the divestitures of the assets of Erudite
Software and O&G, respectively.
GSE Systems' operations are dependent on the efforts of its technical
personnel and its senior management. Thus, recruiting and retaining capable
personnel, particularly engineers, computer scientists and other personnel with
expertise in computer software and hardware, as well as particular customer
processes, are critical to the future performance of the Company. Competition
for qualified technical and management personnel is substantial.
RISK FACTORS.
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Fluctuations in Quarterly Operating Results, Market Price.
The Company's operating results have fluctuated in the past and may
fluctuate significantly in the future as a result of a variety of factors,
including purchasing patterns, timing of new products and enhancements by the
Company and its competitors, and fluctuating foreign economic conditions. Since
the Company's expense levels are based in part on its expectations as to future
revenues, the Company may be unable to adjust spending in a timely manner to
compensate for any revenue shortfall and such revenue shortfalls would likely
have a disproportionate adverse effect on net income. The Company believes that
these factors may cause the market price for 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.
See Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
International Sales and Operations.
Sales of products and the provision of services to end users outside the
United States accounted for approximately 47% of the Company's consolidated
revenues in 1998. The Company anticipates that international sales and services
will continue to account for a significant portion of its revenues in the
foreseeable future. As a result, the Company may be subject to certain risks,
including risks associated with the application and imposition of protective
legislation and regulations relating to import or export (including export of
high technology products) or otherwise resulting from trade or foreign policy
and risks associated with exchange rate fluctuations. Additional risks include
potentially adverse tax consequences, tariffs, quotas and other barriers,
potential difficulties involving the Company's strategic alliances and managing
foreign sales agents or representatives and potential difficulties in accounts
receivable collection. The Company currently sells products and provides
services to customers in emerging market economies such as Russia, Ukraine,
Bulgaria, and the Czech Republic, as well as to customers in countries whose
economies have suffered in the recent Asian financial crisis. The Company has
taken steps designed to reduce the additional risks associated with doing
business in these countries, but the Company believes that such risks may still
exist and include, among others, general political and economic instability,
lack of currency convertibility, as well as uncertainty with respect to the
efficacy of applicable legal systems. There can be no assurance that these and
other factors will not have a material adverse effect on the Company's business,
financial condition or results of operations. Furthermore, the Company's ability
to expand its business into certain emerging international markets is dependent,
in part, on the ability of its customers to obtain financing.
Revenues in the Nuclear Power Industry.
Although, the Company has reduced its reliance on the development of large
application systems having multi-year delivery schedules, such as full-scope
nuclear power plant simulation projects, the Company will continue to derive a
significant portion of its revenues from customers in the nuclear power
industry, particularly the international nuclear power industry, for the
foreseeable future. The Company's ability to supply nuclear power plant
simulators and related products and services is dependent on the continued
operation of nuclear power plants and, to a lesser extent, on the construction
of new nuclear power plants. A wide range of factors affects the continued
operation and construction of nuclear power plants, including the political and
regulatory environment, the availability and cost of alternative means of power
generation, the occurrence of future nuclear incidents, general economic
conditions and the ability of customers to obtain adequate financing.
Revenues in the Chemicals Industry.
The Company derives a portion of its revenues from companies in the
chemicals industry. Accordingly, the Company's future performance is dependent
to a certain extent upon the demand for the Company's products by customers in
the chemical industry. The Company's revenues may be subject to period-to-period
fluctuations as a consequence of industry cycles, as well as general domestic
and foreign economic conditions and other factors affecting spending by
companies in the Company's target process industries. There can be no assurance
that such factors will not have a material adverse effect on the Company's
business, operating results and financial condition.
Product Development and Technological Change.
The Company believes that its success will depend in large part on its
ability to maintain and enhance its current product line, develop new products,
maintain technological competitiveness and meet an expanding range of customer
needs. The Company's product development activities are aimed at the development
and expansion of its library of software modeling tools, the improvement of its
display systems and workstation technologies, and the advancement and upgrading
of its simulation and process control technologies. The life cycles for software
modeling tools, display system software, process control and simulation
technologies are variable and largely determined by competitive pressures.
Consequently, the Company will need to continue to make significant investments
in research and development to enhance and expand its capabilities in these
areas and to maintain its competitive advantage.
The Company's products are offered in markets affected by technological
change and emerging standards which are influenced by customer preferences. The
Company has expended significant resources in developing versions of its core
products which operate in the increasingly-popular Windows NT(R) environment,
however, there can be no assurance of customer acceptance of these Windows
NT(R)-based products or that these products will be competitive with products
offered by the Company's competitors. Although the Company believes that no
significant trends to migrate to other operating platforms currently affect the
markets for the Company's products, there can be no assurance that customers
will not require compatibility with such other operating platforms in the
future.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
Intellectual Property Rights.
Although the Company believes that factors such as the technological and
creative skills of its personnel, new product developments, frequent product
enhancements and reliable product maintenance are important to establishing and
maintaining a technological leadership position, the Company's business depends,
in part, on its intellectual property rights in its proprietary technology and
information. The Company relies upon a combination of trade secret, copyright,
patent and trademark law, contractual arrangements and technical means to
protect its intellectual property rights. The Company generally enters into
confidentiality agreements with its employees, consultants, joint venture and
alliance partners, customers and other third parties that are granted access to
its proprietary information, and generally limits access to and distribution of
its proprietary information. There can be no assurance, however, that the
Company has protected or will be able to protect its proprietary technology and
information adequately, that the unauthorized disclosure or use of the Company's
proprietary information will be prevented, that others have not or will not
develop similar technology or information independently, or, to the extent the
Company owns patents, that others have not or will not be able to design around
those patents. Furthermore, the laws of certain countries in which the Company's
products are sold do not protect the Company's products and intellectual
property rights to the same extent as the laws of the United States.
Competition.
The Company's businesses operate in highly competitive environments with
both domestic and foreign competitors, many of whom have substantially greater
financial, marketing and other resources than the Company. The principal factors
affecting competition include price, technological proficiency, ease of system
configuration, product reliability, applications expertise, engineering support,
local presence and financial stability. The Company believes that competition in
the simulation and process automation fields may further intensify in the future
as a result of advances in technology, consolidations and/or strategic alliances
among competitors, increased costs required to develop new technology and the
increasing importance of software content in systems and products. The Company
believes that its technology leadership, experience, ability to provide a wide
variety of solutions, product support and related services, open architecture
and international alliances will allow it to compete effectively in these
markets. As the Company's business has a significant international component,
changes in the value of the dollar could adversely affect the Company's ability
to compete internationally.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
Year 2000 Legal Climate, Generally.
Significant uncertainty exists in the software industry concerning the
potential effects of failure of computer programs and embedded systems to
adequately function through and after the Year 2000 millenium change. The
Company is currently implementing a testing and compliance program to ascertain
whether and to what extent the Company may need to update certain of its
software products to become Year 2000 ready. The Company does not intend to test
or modify all prior versions of its software products, test the behavior of
current products when used on non-Year 2000-ready computer systems, test custom
applications developed by or for customers, or test certain current software
products that the Company plans to replace with either new software products or
Year 2000 ready releases by the end of 1999. Certain of the Company's software
products are currently Year 2000 ready; however, the Company has not yet
completed testing on many of the other software products that it intends to
test. There can be no assurance that the Company will complete in a timely
manner the testing of such software products or the development of any updates
necessary to render such software products Year 2000 ready. There can be no
assurance that the Company will not encounter Year 2000 problems arising from
recently acquired technologies or any other technologies that the Company may
acquire in the future. Moreover, the ability of the Company's software products
to comply with Year 2000 requirements depends in part upon the availability of
Year 2000 ready versions of operating systems and software applications used by
or with the Company's products. There can be no assurance that Year 2000
problems will not cause the Company to incur material expenses in responding to
such problems, result in third-party claims against the Company or otherwise
have a material adverse effect on the Company's business, operating results and
financial condition.
The Company has reviewed certain internal information systems to assess
Year 2000 compliance. The Company expects that its internal system development
plans will address the Year 2000 issue and will correct mission-critical
systems. The Company believes that the cost of any modifications will not be
material. However, the Company's ability to implement its information systems
plan and to make the necessary modifications or replacements may be adversely
affected by a number of factors outside the control of the Company, including
the availability and cost of trained personnel and the ability of such personnel
to acquire Year 2000 ready systems and otherwise to locate and correct all
relevant computer codes.
The Company is also conducting an assessment of certain other systems that
may affect its operations in order to more fully identify and plan for any Year
2000 risks. If there are unidentified dependencies on such systems to operate
the business, or if any required modifications are not completed on a timely
basis or are more costly to implement than currently anticipated, the Company's
business, financial condition or results of operations could be materially
adversely affected.
Reliance on Key Technical and Executive Personnel.
The Company's operations are dependent on the efforts of its technical
personnel and its senior management. Thus, recruiting and retaining capable
personnel, particularly engineers, computer scientists and other personnel with
expertise in computer software and hardware, are critical to the future
performance of the Company. Competition for qualified technical and management
personnel is substantial, and there can be no assurance that the Company will be
successful in attracting and retaining the personnel it requires to continue to
operate profitably.
Legal Liability.
The Company's business could expose it to third party claims with respect
to product, environmental and other similar liabilities. Although the Company
has sought to protect itself from these potential liabilities through a variety
of legal and contractual provisions as well as through liability insurance, the
effectiveness of such protections has not been fully tested. The failure or
malfunction of one of the Company's systems or devices could create potential
liability for substantial monetary damages and environmental cleanup costs. Such
damages or claims could exceed the applicable coverage of the Company's
insurance. Although management has no knowledge of material liability claims
against the Company to date, such potential future claims could have a material
adverse effect on the business or financial condition of the Company. Certain of
the Company's products and services are used by the nuclear power industry;
although the Company believes that it does not have significant liability
exposure associated with such use as nearly all such products and services
relate to training, and 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.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
Influence of Affiliate Stockholders.
As of the date of this report, certain directors, executive officers and
other parties which are affiliates of the Company beneficially own approximately
45% of the Common Stock of the Company. If these stockholders vote together as a
group, they will be able to exert significant influence on the business and
affairs of the Company, including the election of individuals to the Company's
Board of Directors, and the outcome of actions which require stockholder
approval.
ITEM 2. PROPERTIES.
----------
In early 1998, the Company entered agreements whereby the lease for its
then-existing Columbia facility was terminated and the operations that occupied
such facility were relocated into two separate facilities during the second
quarter of 1998; one of these facilities is in Columbia, Maryland (approximately
53,000 square feet) and is occupied by the operations of Power Systems, as well
the Company's corporate headquarters offices and support functions; the other
facility is in Baltimore, Maryland (approximately 33,000 square feet) and is
occupied by the operations of Process Solutions. During the first quarter of
1999, the Company has leased an additional 6,000 square feet in the Baltimore
facility. Each of the leases for these smaller facilities has a term of ten (10)
years.
In addition, the Company also leases office space domestically in Georgia,
Louisiana, Texas, Pennsylvania, North and South Carolina, as well as in Belgium,
Japan, Korea, Singapore, Sweden and Taiwan. The Company leases these facilities
for terms ending between 1999 and 2002.
ITEM 3. LEGAL PROCEEDINGS.
-----------------
The Company is from time to time involved in legal proceedings incidental
to the conduct of its business. The Company currently is not a party to legal
proceedings which, in the opinion of management, are likely to have a material
adverse effect on the Company's business, financial condition or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
---------------------------------------------------
No matter was submitted to a vote of security holders during the quarter
ended December 31, 1998.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
---------------------------------------------------------------------
The following table sets forth for the periods indicated the high and low
sale prices for the Common Stock reported by the Nasdaq National Market System.
1997 High Low
First Quarter............................... $ 11 $ 5 3/4
Second Quarter.............................. $ 7 1/4 $ 4 3/8
Third Quarter............................... $ 6 3/4 $ 3 3/4
Fourth Quarter.............................. $ 6 3/4 $ 3
1998 High Low
First Quarter............................... $ 3 1/2 $ 2
Second Quarter.............................. $ 5 $ 2 1/4
Third Quarter............................... $ 3 11/16 $ 1
Fourth Quarter.............................. $ 3 1/2 $ 2 1/4
The Company's Common Stock had previously traded on the NASDAQ National
Market System under the symbol "GSES". In January 1999, the Company's Common
Stock was approved for listing the American Stock Exchange, where it now trades
under the symbol "GVP".
There were approximately 41 holders of record of the Common Stock as of
March 15, 1999. Based upon information available to it, the Company believes
there are approximately 700 beneficial holders of the Common Stock. The Company
has never declared or paid a cash dividend on its Common Stock. The Company
currently intends to retain future earnings to finance the growth and
development of its business, and therefore does not anticipate paying any cash
dividends in the foreseeable future.
The Company believes factors such as quarterly fluctuations in results of
operations and announcements of new products by the Company or by its
competitors may cause the market price of the Common Stock to fluctuate, perhaps
significantly. In addition, in recent years the stock market in general, and the
shares of technology companies in particular, have experienced extreme price
fluctuations. The Company's Common Stock has also experienced a relatively low
trading volume, making it further susceptible to extreme price fluctuations.
These factors may adversely affect the market price of the Company's Common
Stock.
In 1998, the Company granted stock options to two directors to acquire
50,000 shares of Common Stock in the aggregate at an exercise price of $2.25
(each such director has agreed that he would not exercise his option with
respect to more that 12,500 shares until such time as stockholder approval is
obtained).
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
ITEM 6. SELECTED FINANCIAL DATA.
-----------------------
The following tables present selected combined financial data of Power
Systems, GPI, Power Systems AB and Erudite Software with respect to the period
January 1, 1994 through April 13, 1994 (unaudited) and of the Company for
periods after April 13, 1994. Historical results of the Company from April 13,
1994 through December 31, 1994 include the operations of Power Systems, GPI,
Power Systems AB and Erudite Software. Power Systems, GPI, Power Systems AB and
Erudite Software are collectively referred to as the "Predecessors" with respect
to the period between January 1, 1994 and April 13, 1994. The balance sheet data
of the Company as of December 31, 1994 includes the Predecessors and Process
Solutions which was acquired on December 30, 1994, except for certain
international operations of the TI process systems business which were acquired
by the Company in the second quarter of 1995. Historical results of operations
and balance sheet data for 1998, 1997, and 1996 include the Predecessors and
Process Solutions. The financial information has been derived from the
historical financial statements of the Predecessors and the Company. Erudite
Software was acquired on May 22, 1996 through a merger. The merger was accounted
for by using the pooling of interests method. Accordingly the Company's and
Predecessors' financial statements have been restated to include, on a
historical cost basis, the accounts and operations of Erudite Software for all
periods presented. The Company disposed of substantially all of the assets of
Erudite Software as of April 30, 1998. In November 1998, the Company completed
the sale of certain assets related to activities of its Oil & Gas business unit
("O&G"), effective as of October 30, 1998. The balance sheet data of the Company
as of December 31, 1997 includes the operations of Ryan which was acquired by
Power Systems as of December 1, 1997. The statement of operations data for the
year ended December 31, 1997 includes the activity of Ryan from the date of its
acquisition.
For information and disclosures regarding the Company's business segments, see
Note 17 to the Consolidated Financial Statements.
Predecessors Company
Jan. 1 Apr. 14
through through
April 13, December 31, Year Ended December 31,
1994 1994 1995 1996 1997 1998
(in thousands, except per share data)
-----------------------------------------------------------------------------------------------------
Statement of Operations Data:
Revenues $ 14,659 $ 37,085 $ 96,060 $ 96,033 $ 79,711 $ 73,718
Cost of revenue 10,380 27,932 65,592 63,679 58,326 49,814
----------- ----------- ----------- ----------- ----------- -----------
Gross profit 4,279 9,153 30,468 32,354 21,385 24,004
Operating expenses:
Selling, general and
administrative 2,628 6,313 21,815 24,192 27,320 20,345
Depreciation and
amorization 420 1,125 2,341 2,111 2,368 1,768
Business combination costs - - - 1,206 - -
Employee severance and
terminations costs - - - - 1,124 -
----------- ----------- ------------ ----------- ----------- ------------
Total operating expenses 3,048 7,438 24,156 27,509 30,812 22,113
----------- ----------- ------------ ----------- ----------- ------------
Operating income (loss) 1,231 1,715 6,312 4,845 (9,427) 1,891
Gain on sale of assets 550
Interest expense (41) (402) (983) (387) (765) (350)
Other (expense) income, net 43 192 364 394 (1,228) 326
----------- ----------- ------------ ----------- ----------- ------------
Income (loss) before income
taxes 1,233 1,505 5,693 4,852 (11,420) 2,417
Provision (benefit) for
income taxes 678 552 2,017 709 (2,717) 1,020
----------- ----------- ------------ ----------- ----------- ------------
Net income (loss) $ 555 $ 953 $ 3,676 $ 4,143 $ (8,703) $ 1,397
=========== =========== ============ =========== =========== ============
Earnings (loss) per
common share
- Basic $ 0.26 $ 0.91 $ 0.82 $ (1.72) $ 0.28
=========== ============ =========== =========== ============
- Diluted $ 0.26 $ 0.91 $ 0.82 $ (1.72) $ 0.27
=========== ============ =========== =========== ============
Weighted average common
shares outstanding
- Basic 3,341 4,049 5,066 5,066 5,066
=========== ============ =========== =========== ============
- Diluted 3,341 4,059 5,073 5,066 5,107
=========== ============ =========== =========== ============
As of As of December 31,
Apr. 13, -----------------------------------------------------------------------------------
1994 1994 1995 1996 1997 1998
Working capital $ (434) $ 1,269 $ 16,077 $ 13,867 $ 1,646 $ 4,058
Total assets 35,655 42,312 54,688 51,006 48,362 48,743
Long-term liabilities 15,570 15,783 6,055 2,580 2,369 3,350
Series A Preferred Stock - 2,400 - - - -
Stockholders' equity (deficit) (2,563) (4,229) 20,532 24,693 15,924 17,089
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
-------------
Results of Operations.
The following table sets forth the results of operations for the periods
presented expressed in thousands of dollars and as a percentage of revenues.
Year ended December 31,
---------------------------------------------------------------------
1998 % 1997 % 1996 %
---- --- ---- --- ---- ---
Contract revenue $ 73,818 100.0% $ 79,711 100.0% $ 96,033 100.0%
Cost of revenue 49,814 67.5% 58,326 73.2% 63,679 66.3%
--------- ------ -------- ------- --------- ------
Gross profit 24,004 32.5% 21,385 26.8% 32,354 33.7%
Operating Expenses:
Selling, general and administrative 20,345 27.6% 27,320 34.3% 24,192 25.2%
Depreciation and amortization 1,768 2.4% 2,368 3.0% 2,111 2.2%
Business combination costs - - - - 1,206 1.3%
Employee severance and termination costs - - 1,124 1.4% - -
--------- ------- -------- ------- --------- ------
Total operating expenses 22,113 30.0% 30,812 38.7% 27,509 28.6%
--------- ------- -------- ------- --------- ------
Operating income (loss) 1,891 2.6% (9,427) -11.8% 4,845 5.0%
Gain on sale of assets 550 0.7% - - - -
Interest expense (350) -0.5% (765) -1.0% (387) -0.4%
Other income (expense) 326 0.4% (1,228) -1.5% 394 0.4%
--------- ------- -------- ------- --------- ------
Income (loss) before income taxes 2,417 3.3% (11,420) -14.3% 4,852 5.0%
Provision for (benefit from) taxes 1,020 1.4% (2,717) -3.4% 709 0.7%
---------- ------- --------- ------- ---------- ------
Net income (loss) $ 1,397 1.9% $ (8,703) -10.9% $ 4,143 4.3%
========= ======= ========= ======= ========== ======
Comparison of 1998 to 1997.
Contract Revenue. Total contract revenue was $73.8 million and $79.7
million for the years ended December 31, 1998 and 1997, respectively. This $5.9
million (7.4%) decrease in revenue was primarily attributable to the disposition
of substantially all of the assets of its wholly owned subsidiary, Erudite
Software, and the disposition of certain assets related to activities of O&G, as
previously disclosed. Revenue of $5.3 million and $18.0 million from Erudite
Software are included in 1998 and 1997, respectively and revenue of $1.1 million
and $2.3 million from O&G are included in 1998 and 1997, respectively.
Revenue from its two core businesses, operated through the Process and
Power business units, increased in 1998. The Process business unit increased
revenue by $1.7 million to $36.5 million in 1998 from $34.8 million in 1997, or
4.9%, due to increases in customer orders. The Power business unit increased
revenue by $6.4 million to $30.9 million in 1998 from $24.5 million in 1997, or
26.1% primarily due to revenues generated by its domestic service contracts
resulting from the acquisition of Ryan, as previously disclosed, and increases
in customer orders.
The majority of the Company's revenues are from fixed price contracts. Any
unexpected costs or unanticipated delays in connection with the performance of
fixed priced contracts could adversely affect the Company's financial results.
International sales were approximately $35 million or 47% of total revenues
in 1998 and $29.1 million or 36.5% of total revenues in 1997, an increase which
reflects increases in the core businesses. The Company expects that
international sales will continue to represent a significant portion of its
total revenues. The Company currently sells products and services to customers
in emerging market economies such as Russia, Ukraine, Bulgaria, and the Czech
Republic, as well as customers in countries whose economies have suffered in the
recent Asian financial crisis. The Company's international operations are
subject to various risks, including exposure to currency fluctuation, regulatory
requirements, political and economic instability and trade restrictions. The
Company has taken steps to reduce these risks, particularly risks associated
with doing business in emerging markets, but there can be no assurance that the
above mentioned risk factors will not have a material adverse affect on the
Company's business, financial condition or results of operations.
Gross Profit. Gross profit increased to $24.0 million in 1998 from $21.4
million in 1997, or 12.2%, primarily due to increased customer orders and
improved margins in the core businesses, and the disposition of unprofitable
businesses. Gross profit percentage was 32.5% in 1998 compared to 26.8% in 1997,
reflecting improved margins in the core businesses and the disposition of
unprofitable businesses.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased to $20.3 million, or 27.6% of revenues, during
the year ended December 31, 1998 from $27.3 million, or 34.3% of revenue, during
the corresponding period in 1997. The decrease in these expenses in 1998 is
attributable to the disposition of unprofitable businesses, reduced facilities
costs in 1998 due to the relocation of the primary offices of the Company, and
the continuing cost containment efforts previously disclosed, as well as
increased costs in 1997 for professional services related to a lawsuit, a
reserve of $600,000 recorded to reduce certain Korean receivables to their
estimated realizable value as a result of the Asian financial crisis, and costs
of $852,000 associated primarily with the future lease commitments on the unused
portion of the former Columbia, Maryland leased facility for which the Company
will derive no future benefit.
Gross research and product development expenditures were $4.3 million and
$5.1 million for the years ended December 31, 1998 and 1997, respectively.
Capitalized software development costs totaled $2.3 million and $3.5 million,
during the years ended December 31, 1998 and 1997, respectively. Net research
and development costs included in selling, general and administrative expenses
were $2.1 million and $1.6 million during the years ended December 31, 1998 and
1997, respectively. The Company continued investing in the conversion of its D/3
DCS(TM) product to the Microsoft Windows NT(R) platform and the productization
of its SimSuite(TM) software tools.
Employee Severance and Termination Costs. The Company recorded a net charge
for severance and other employee obligations of $1.1 million in 1997 in
connection with cost reduction efforts initiated to offset the impact of a
decrease in contract revenues. Of this charge, $976,000 was expended as of
December 31, 1997 and the remaining balance was expended in 1998.
Depreciation and Amortization. Depreciation expense amounted to $1.2
million and $2.1 million during the years ended December 31, 1998 and 1997,
respectively. This decrease was primarily attributable to the disposition of
assets included in the Erudite Software and O&G sales.
Amortization of goodwill and intangibles was $365,000 and $219,000 during
the years ended December 31, 1998 and 1997, respectively. This increase
primarily resulted from the amortization of certain intangible assets acquired
as a result of the acquisition of Ryan in December of 1997.
Operating Income (Loss). Operating income amounted to $1.9 million, or 2.6%
of revenues, and operating (loss) amounted to ($9.4) million, or (11.8%) of
revenues, during the years ended December 31, 1998 and 1997, respectively. This
significant increase in operating income reflects the disposition of
unprofitable businesses, increases in customer orders, improved margins and
reduced selling, general and administrative expenses in 1998 as compared to
1997.
Gain on sale of assets. Gain on sale of assets reflects the net pre-tax
gain realized on the disposition of the Erudite Software and the O&G assets, as
previously disclosed. In the third quarter of 1998, the Company recognized a
($5.0) million pre-tax loss on the disposition of the O&G assets. During the
second quarter, the Company recorded a gain of $5.6 million on the sale of the
Erudite Software assets. These sales and related gains and losses are described
more fully under Note 3, Disposal of Assets - "Notes to Consolidated Financial
Statements", "Liquidity and Capital Resources", below and by the provisions of
the asset purchase agreements for such transactions, have been previously
disclosed and are incorporated herein by reference.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
Interest Expense. Interest expense decreased to $350,000 in 1998 from
$765,000 in 1997. This decrease is attributable primarily to a significant
decrease in the Company's borrowings under its lines of credit made during the
period to fund working capital requirements.
Other Income (Expense). Other income amounted to $326,000 in 1998, and
other expenses amounted to $1.2 million in 1997, resulting almost exclusively
from recognized foreign exchange gains in 1998 and recognized foreign exchange
losses in 1997 from the Company's Asian operations.
Provision for (Benefit from) Income Taxes. The Company's effective tax rate
amounted to 42.2% in 1998. The difference between the statutory U.S. tax rate
and the Company's effective tax rate for 1998 is primarily the result of the
effects of foreign operations at different tax rates, state income taxes, and
other non-deductible expenses reflected in the calculation of the 1998 tax
provision. Due to the loss experienced in 1997, the Company recognized a tax
benefit of $2.7 million.
Comparison of 1997 to 1996.
Contract Revenue. Total contract revenue was $79.7 million and $96.0
million for the years ended December 31, 1997 and 1996, respectively. This $16.3
million (17%) decrease in revenue was primarily attributable to a significant
decrease in power plant simulation revenue, resulting from the conclusion of
several full-scope nuclear power plant simulation projects in the first half of
1997, and a decrease in third party hardware sales by the Company's Business
Systems unit, which decreases were only partially offset by a 12% increase in
the domestic revenue of the Company's Process business. The Company as a whole
continued its transition towards smaller and shorter-term projects that often
include licenses of the Company's proprietary tools.
Revenues from fixed price contracts constitute approximately 90% of the
Company's revenues for the past three years.
International sales were approximately $29.1 million or 36.5% of total
revenues in 1997 and $48.2 million or 50.2% of total revenues in 1996, a
decrease which reflected the significant reduction in power plant simulation
revenue in 1997. This decrease notwithstanding, the Company expects that
international sales will continue to represent a significant portion of its
total revenues. The Company currently sells products and services to customers
in emerging market economies such as Russia, Ukraine, Bulgaria, and the Czech
Republic, as well as customers in countries whose economies have suffered in the
recent Asian financial crisis. The Company's international operations are
subject to various risks, including exposure to currency fluctuation, regulatory
requirements, political and economic instability and trade restrictions. The
Company has taken steps to reduce these risks, particularly risks associated
with doing business in emerging markets, but there can be no assurance that the
above mentioned risk factors will not have a material adverse affect on the
Company's business, financial condition or results of operations.
Gross Profit. Gross profit decreased to $21.4 million in 1997 from $32.4
million in 1996, a decline of 33.9%, primarily due to lower revenues generated
by power plant simulation contracts. Gross profit percentage was 26.8% in 1997
compared to 33.7% in 1996, reflecting a higher percentage of government
contract-related revenues in the power simulation business with corresponding
lower margins, an increase to the amortization of software development costs
capitalized, lower labor utilization within the Business Systems unit, as well
as reserves taken against certain contracts in 1997.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $27.3 million, or 34.3% of revenues, during
the year ended December 31, 1997 from $24.2 million, or 25.2% of revenues,
during the corresponding period in 1996. The increase in these expenses in 1997
consisted of increased sales and marketing costs, primarily within the Business
Systems unit, increased recruiting and relocation costs, and increased costs for
professional services related to a lawsuit referred to in Part I, Item 3. Legal
Proceedings, in the 1997 10-K. Additionally, the increase reflected a reserve of
$600,000 recorded to reduce certain Korean receivables to their estimated
realizable value as a result of the Asian financial crisis. In the fourth
quarter of 1997, the Company also recorded costs of $852,000 associated
primarily with the future lease commitments on the unused portion of the former
Columbia, Maryland leased facility for which the Company would derive no future
benefit.
Gross research and product development expenditures were $5.1 million and
$5.8 million for the years ended December 31, 1997 and 1996, respectively.
Capitalized software development costs totaled $3.5 million and $3.9 million,
during the years ended December 31, 1997 and 1996, respectively. Net research
and development costs expensed and included within selling, general and
administrative expenses were $1.6 million and $1.9 million during the years
ended December 31, 1997 and 1996, respectively. The Company continued investing
in the conversion of its D/3 DCS(TM) product to the Microsoft Windows NT(R)
platform, enhancement of its S/3 SCADA(TM) System for the Microsoft Windows
NT(R) platform and the productization of its SimSuite(TM) software tools.
Employee Severance and Termination Costs. The Company recorded a net charge
for severance and other employee obligations of $1.1 million in connection with
cost reduction efforts initiated to offset the impact of a decrease in contract
revenues. Of this charge, $976,000 had been expended as of December 31,1997.
Depreciation and Amortization. Depreciation expense amounted to $2.1
million and $1.9 million during the years ended December 31, 1997 and 1996,
respectively. This increase was attributable to higher capital expenditures made
in 1997 and 1996.
Amortization of goodwill and intangibles was $219,000 and $168,000 during
the years ended December 31, 1997 and 1996, respectively. This increase resulted
from amortization of certain intangible assets which were fully amortized as of
December 31, 1997.
Business Combination Costs. In 1996, business combination costs related to
the acquisition of Erudite Software, which consisted primarily of consulting
fees, legal and accounting expenses, and compensation expense for the shares
issued to employees by the owners of Erudite Software pursuant to stock transfer
agreements, amounted to approximately $1.2 million and were charged to operating
expenses.
Operating (Loss) Income. Operating loss amounted to ($9.4) million, or
(11.8%) of revenues, and operating income amounted to $4.9 million, or 5% of
revenues, during the years ended December 31, 1997 and 1996, respectively. This
significant decrease in operating income reflected the reduction in margin from
power plant simulation projects, increased sales and marketing costs and
employee severance and termination costs as well as several other fourth quarter
adjustments. See Note 18 of "Notes to Consolidated Financial Statements".
Interest Expense. Interest expense increased to $765,000 in 1997 from
$387,000 in 1996. This increase was attributable primarily to a significant
increase in the Company's borrowings under its lines of credit made during the
period to fund working capital requirements.
Other Income (Expense). Other expenses amounted to $1.2 million in 1997,
resulting almost exclusively from recognized foreign exchange losses of the
Company's Asian operations. During 1996, $394,000 in interest income was earned
from short-term investments of excess cash during the year as well as proceeds
from the sale of an equity interest in a joint venture.
(Benefit from) Provision for Income Taxes. Due to the loss experienced in
1997, the Company recognized a tax benefit of $2.7 million as compared to the
tax provision of $709,000 recognized in 1996. The effective tax rate was
different in 1997 as a result of reductions in the valuation allowance
recognized as income by the Company in 1996.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
Liquidity and Capital Resources.
The Company has funded its activities primarily from borrowings under lines
of credit. In 1998, the Company's operating activities used cash totaling
approximately $30,000, primarily related to the 1998 net income of $1.4 million,
together with increases in current assets and decreases to current liabilities,
partially offset by non-cash items such as depreciation, amortization, the gain
on the sale of assets and deferred income taxes. Management believes that it is
more likely than not that the net deferred tax asset at December 31, 1998 is
recoverable. For the year ended December 31, 1997, the Company's operating
activities used cash of approximately $3.8 million. At December 31, 1998, the
Company had cash and cash equivalents of $2.2 million compared to $334,000 as of
December 31, 1997.
The Company generated approximately $4.6 million in cash from investing
activities, made up primarily of $9.0 million from the sale of assets, which was
partially offset by $2.3 million of capitalized software development costs and
$2.1 million of capital expenditures.
The Company's financing activities used cash of approximately $2.6 million,
consisting primarily of $2.3 million in repayments under the Company's lines of
credit.
The Company maintains, through its subsidiaries, two lines of credit that
have been extended through June 30, 1999, based on modification agreements dated
January 1, 1999. These lines of credit, which are cross-collateralized, provide
for borrowing up to a total of $8.0 million to support foreign letters of
credit, margin requirements or foreign exchange contracts and working capital
needs. The first line, for $7.0 million, used by Power Systems, is 90%
guaranteed by the Export-Import Bank of the United States ("EXIM"), is
collateralized by substantially all of Power Systems' assets, and provides for
borrowings up to 90% of eligible receivables and 50% of unbilled receivables.
The continuation of this line is conditional based upon the Company's obtaining
an extension on the EXIM guarantee through at least June 30, 1999. The Company
has received preliminary approval from EXIM to extend the EXIM guarantee, which
expires April 30, 1999, through March 31, 2000. Under the terms of the
preliminary approval, the Power Systems' line would be reduced to $6 million in
connection with such an extension of the guarantee. The second line, for $1.0
million, used by Process Solutions, is collateralized by substantially all of
Process Solutions' assets, and provides for borrowing up to 85% of eligible
receivables. Both lines are guaranteed by the Company and collateralized by
substantially all of the Company's assets.
The lines require the Company to comply with certain financial ratios and
preclude the Company from paying dividends and making acquisitions beyond
certain limits without the bank's consent. In connection with the extension
obtained as of January 1, 1999, certain of these covenants were modified,
retroactive to December 31, 1998. The Company was in compliance with all
modified covenants at December 31, 1998 and expects to maintain compliance with
the covenants through maturity.
The Company has received a commitment letter from a financial institution
to provide a new credit facility with a maturity date of March 31, 2000, which
the Company expects to finalize by April 30, 1999. The terms and conditions of
the new facility, which would provide for a $6 million Power Systems' line and a
$3 million Process Solutions' line, are substantially the same as the current
facility, including the requirement for the EXIM guarantee and the guarantees
described below.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
In connection with the aforementioned existing lines of credit and the new
facility, the Company has arranged for certain guaranties to be provided to the
bank on its behalf by GP Strategies and ManTech. As previously disclosed, in
consideration for the above-mentioned guaranties, the Company has granted each
of ManTech and GP Strategies warrants to purchase shares of the Company's common
stock; each of such warrants provide the right to purchase at least 150,000
shares of the Company's common stock at $2.375 per share. The Company has
recognized $300,000 as the estimated fair value of such warrants in the
consolidated financial statements. During 1998, the Company recognized $180,000
of expense related to these warrants. The Company will expense the remainder of
the fair value over the term of the guaranties.
Although the Company intends to replace its expiring credit facilities, as
described above, there can be no assurance that such financing will be
completed. In the event that the Company is unsuccessful in extending or
obtaining new lines of credit, GP Strategies and ManTech each have agreed to
provide working capital support of up to $1.8 million ($3.6 million in the
aggregate) to the Company.
Management believes that the above actions will result in sufficient
liquidity and working capital resources necessary in 1999 for planned business
operations, debt service requirements, planned investments and capital
expenditures.
In November 1998, the Company completed the sale of certain assets related
to activities of its Oil & Gas business unit ("O&G"), to Valmet Automation
(USA), Inc. ("Valmet"), pursuant to an asset purchase agreement, effective as of
October 30, 1998, by and between the Company, and Valmet. The Company has
recognized a loss before income taxes on this transaction, in the quarter ended
September 30, 1998, of $5.0 million. In connection with the sale of these
assets, the Company has written off approximately $2.9 million in capitalized
software development costs, since all operations that would support the
recoverability of these costs have been sold. The write-off of these costs is
reflected in the calculation of the loss on the sale. The Company received
approximately $742,000 in cash, subject to certain adjustments, and Valmet
assumed certain identified liabilities. Valmet purchased assets with a book
value of approximately $3.0 million.
The agreement with Valmet further stipulates that, subject to the
occurrence of certain events, the Company is entitled to royalties over a
five-year period relative to certain software of the Company, which was licensed
to Valmet. Such royalties would not exceed $1 million in the aggregate and would
be recorded as earned. The Company is liable for any cost overruns on certain
development and project contracts, beyond estimates stipulated in the asset
purchase agreement, such liabilities not to exceed $800,000. In addition to the
$800,000 overrun liability, the Company remains responsible for certain
liabilities not assumed by Valmet, including certain liabilities unknown as of
the date of closing. The Company has accrued $400,000 and included such amount
in the loss recognized on this transaction, based on a present estimate of
exposure relative to these liabilities. The foregoing description of the Valmet
asset purchase agreement is qualified in its entirety by the full text of such
agreement, which was included as an exhibit to the Company's report on Form 8-K
dated November 30, 1998, and is incorporated herein by reference. See Note 3,
Acquisitions and Dispositions - "Notes to Consolidated Financial Statements" for
a further discussion of the sale.
In May 1998, the Company completed the sale of substantially all of the
assets of Erudite Software to Keane, Inc. ("Keane"), pursuant to an asset
purchase agreement, dated as of April 30, 1998, by and among the Company,
Erudite Software and Keane. The purchase price for the Erudite Software assets
was $9.9 million ($8.9 million in cash and $1.0 million in the form of an
unsecured promissory note due on April 30, 1999, subject to certain adjustments)
plus the assumption by Keane of certain operating liabilities totaling
approximately $2.2 million. Net cash proceeds to be received in 1998 in
connection with the sale of Erudite Software, including transaction costs, is
estimated at $4.1 million, after reducing outstanding debt as described below.
The foregoing description of the Keane asset purchase agreement is qualified in
its entirety by the full text of the such agreement, which was included as an
exhibit to the Company's Form 10-Q for the quarter ended March 31, 1998 and is
incorporated herein by reference. See Note 3, Acquisitions and Dispositions -
"Notes to Consolidated Financial Statements" for a further discussion of the
sale.
The Company's additional commitments as of December 31, 1998 consisted
primarily of leases on its headquarters and other facilities. Further, the
performance of certain of the Company's customer contracts are secured by
performance guaranties, amounting to $258,000, and letters of credit, amounting
to $803,000, as of December 31, 1998, furnished by its subsidiaries' respective
former parent organizations in accordance with the agreement among ManTech, GP
Strategies, GPC, SGLG, Vattenfall and the Company dated April 13, 1994 (the
"Formation Agreement") and letters of credit amounting to $803,000, as of
December 31, 1998. Letters of credit are issued by the Company in the ordinary
course of business through commercial banks as required by certain contracts and
proposal requirements.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
Year 2000
General. The Company is aware of general industry concerns regarding the
Year 2000 problem. The Year 2000 problem concerns the inability of information
systems to properly recognize and process date-sensitive information beyond
January 1, 2000. The Company has established a compliance program intended to
bring its software and systems into Year 2000 compliance in time to minimize any
significant detrimental effects on operations. This program covers Company's own
products and installed base, significant vendors and customers, and financial
and administrative systems. The Company's program recognizes that date-sensitive
systems may fail at different points in time depending on their function.
Systems having forward-looking planning and production functions may fail
earlier and require corrective actions sooner to allow for reasonable testing.
Other applications may fail only during the transition to Year 2000. The Company
plans to utilize internal personnel, contractors and vendors to identify Year
2000 noncompliance problems, modify code and test the modifications. In some
cases, non-compliant software and hardware will be replaced.
Current Product Offerings. The Company believes that it has identified
substantially all potential Year 2000 problems with the current versions of the
software products it develops and markets. However, management also believes
that it is not possible to determine with complete certainty that all Year 2000
problems affecting the Company's software products have been identified or
corrected due to complexity of these products and the fact that these products
interact with other third party vendor products and integrate on computer
systems which are not under the Company's control. The Company's program
includes the testing and, if necessary, the modification of new versions of its
products to ensure Year 2000 readiness.
Previous Versions and Installed Base. Older versions of the Company's
software will require modification to work properly through and after the Year
2000. The Company offers Year 2000 evaluation services to its customers having
older systems to determine the scope of work required to correct any problems.
The Company's program also includes the development of patches for certain
previous versions of the Company's products, which may be purchased by
customers. However, there can be no assurance that such patches would correct
all Year 2000 problems in such previous versions, and there can be no assurance
that evaluation services and patches will be purchased and implemented by the
Company's customers.
Suppliers. The Company has initiated communications with third party
suppliers of the major computer system components, software, and other equipment
used, operated, or maintained by the Company to identify and, to the extent
possible, to resolve issues involving the Year 2000 problem. However, the
Company has limited or no control over the actions of these third party
suppliers. Thus, while the Company expects that it will be able to resolve any
significant Year 2000 problems with these systems, there can be no assurance
that these suppliers will resolve any or all Year 2000 problems with these
systems before the occurrence of a material disruption to the business of the
Company or any of its customers.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
Financial and Administrative Systems. The Company also relies on various
administrative and financial applications (e.g., order processing and collection
systems) that require correction to properly handle Year 2000 dates. In the
event one of these systems is not adequately corrected, the Company's ability to
capture, schedule and fulfill customer demands could be impaired. Likewise, if a
collection processing system were to fail, the Company may not be able to
properly apply payments to customer balances or correctly determine cash
balances. The Company plans to update its primary accounting system in the
spring of 1999 and centrally contolled administrative applications are being
aessed and tested. Various non-centrally controlled systems are also utilized by
the Company's businesses. The impact of a failure of these systems would be
limited to the business using the affected system, and then only to the extent
that manual or other alternate processes were not able to meet processing
requirements. Such an occurrence is not expected to have a significant adverse
impact on the Company.
Significant Customers. The Company is also dependent upon its customers for
sales and cash flow. Year 2000 interruptions in the Company's customers'
operations could result in reduced sales, increased inventory or receivable
levels and cash flow reductions. While these events are possible, the Company
anticipates that its customer base is broad enough to minimize the affects of
such interruptions. The Company plans, however, to monitor the status of the
Company's customers as a means of determining risks and alternatives.
Costs. The Company estimates that the aggregate costs to address the Year
2000 issue will not exceed approximately $1.9 million in 1999. The Company
believes that most of the customer related costs associated with the Year 2000
issue would have occurred as part of its normal operations. The Company does not
track these costs separately, and prior to 1999, the Company did not separately
budget for costs related to the Year 2000 issue. Of the amount to be expended in
1999, the Company believes that approximately $225,000, primarily related to
upgrades to internal systems, is incremental to normal operating costs. While
the Company believes its efforts will provide reasonable assurance that material
disruptions to its internal systems and installed products will not occur, the
potential for interruption still exists. The Company's policy is to expense as
incurred information system maintenance costs and to capitalize the cost of new
software and hardware and amortize or depreciate it over the assets' useful
lives. There can be no assurance that the cost estimates associated with the
Company's Year 2000 issues will prove to be accurate or that the actual costs
will not have a material adverse effect on the Company's business, results of
operations or financial condition.
Contingency Plans. The Company is currently developing contingency plans to
be implemented as part of its efforts to identify and correct Year 2000 problems
affecting its internal systems and installed products. Depending on the systems
affected, these plans could include accelerated replacement of affected
equipment or software, short to medium-term use of backup equipment and
software, increased work hours for Company personnel or use of contract
personnel to correct on an accelerated schedule any Year 2000 problems that
arise or to provide manual workarounds for information systems, and similar
approaches. If the Company is required to implement any of these contingency
plans, it could have a material adverse effect on the Company's financial
condition and results of operations.
THE ABOVE DISCUSSION OF THE COMPANY'S EFFORTS, AND MANAGEMENT'S EXPECTATIONS,
RELATING TO YEAR 2000 COMPLIANCE ARE FORWARD-LOOKING STATEMENTS. THE COMPANY'S
ABILITY TO ACHIEVE YEAR 2000 COMPLIANCE AND THE LEVEL OF INCREMENTAL COSTS
ASSOCIATED THEREWITH, COULD BE ADVERSELY IMPACTED BY, AMONG OTHER THINGS, THE
AVAILABILITY AND COST OF PROGRAMMING AND TESTING RESOURCES, SUPPLIERS' ABILITY
TO BRING THEIR SYSTEMS INTO YEAR 2000 COMPLIANCE, AND UNANTICIPATED PROBLEMS
IDENTIFIED IN THE COMPANY'S ONGOING COMPLIANCE REVIEW.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
Foreign Exchange.
A portion of the Company's international sales revenue has been and may be
received in a currency other than the currency in which the expenses relating to
such revenue are paid. When necessary, the Company manages its foreign currency
exposure primarily by entering into foreign currency exchange agreements and
purchasing foreign currency options.
Other Matters.
To date, management believes inflation has not had a material
impact on the Company's operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
----------------------------------------------------------
Not applicable.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
-------------------------------------------
INDEX TO FINANCIAL STATEMENTS
Page
----
GSE Systems, Inc. and Subsidiaries
Report of Independent Accountants........................................ F-1
Consolidated Balance Sheets as of December 31, 1998
and 1997......................................................... F-2
Consolidated Statements of Operations for the years ended
December 31, 1998, 1997 and 1996................................. F-3
Consolidated Statements of Comprehensive Income (Loss) for the years ended
December 31, 1998, 1997 and 1996................................. F-4
Consolidated Statements of Changes in Stockholders' Equity
for the years ended December 31, 1998, 1997 and 1996 ............ F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996................................. F-6
Notes to Consolidated Financial Statements............................... F-7
REPORT OF INDEPENDENT ACCOUNTANTS
To The Board of Directors
and Stockholders of GSE Systems, Inc.
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, comprehensive income (loss),
changes in stockholders' equity and cash flows present fairly, in all
material respects, the financial position of GSE Systems, Inc. and its
subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
McLean, Virginia
February 24, 1999
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
ASSETS
December 31,
1998 1997
----------------- ---------------
Current assets:
Cash and cash equivalents $ 2,240 $ 334
Contract receivables 24,426 24,371
Note receivable 1,000 -
Inventories 2,892 2,700
Prepaid expenses and other current assets 1,654 1,739
Deferred income taxes 150 2,570
----------------- ---------------
Total current assets 32,362 31,714
Property and equipment, net 2,714 3,864
Software development costs, net 4,715 7,526
Goodwill, net 2,781 2,974
Deferred income taxes 3,366 1,730
Other assets 2,805 554
----------------- ---------------
Total assets $ 48,743 $ 48,362
================= ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Lines of credit $ 6,746 $ 9,032
Accounts payable 8,407 7,919
Accrued expenses 4,344 4,304
Obligations under capital lease 143 208
Billings in excess of revenue earned 6,359 6,719
Accrued contract and warranty reserves 846 912
Other current liabilities 1,308 661
Income taxes payable 151 313
------------------ ----------------
Total current liabilities 28,304 30,068
Notes payable to related parties 148 185
Obligations under capital lease 10 234
Accrued contract and warranty reserves 596 675
Other liabilities 2,596 1,276
------------------ ----------------
Total liabilities 31,654 32,438
------------------ ----------------
Stockholders' equity:
Common stock $.01 par value, 8,000,000 shares authorized,
5,065,688 shares issued and outstanding 50 50
Additional paid-in capital 21,678 21,378
Retained earnings (deficit) - at formation (5,112) (5,112)
Retained earnings (deficit) - since formation 1,158 (239)
Accumulated other comprehensive income (loss) (685) (153)
------------------ ----------------
Total stockholders' equity 17,089 15,924
------------------ ----------------
Total liabilities & stockholders' equity $ 48,743 $ 48,362
================== ================
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,
1998 1997 1996
Contract revenue $ 73,818 $ 79,711 $ 96,033
Cost of revenue 49,814 58,326 63,679
-------------- -------------- --------------
Gross profit 24,004 21,385 32,354
------------- -------------- --------------
Operating expenses
Selling, general and administrative 20,345 27,320 24,192
Depreciation and amortization 1,768 2,368 2,111
Business combination costs - - 1,206
Employee severance and termination costs - 1,124 -
-------------- -------------- --------------
Total operating expenses 22,113 30,812 27,509
-------------- -------------- --------------
Operating income (loss) 1,891 (9,427) 4,845
Gain on sale of assets 550 - -
Interest expense (350) (765) (387)
Other income (expense) 326 (1,228) 394
-------------- -------------- --------------
Income (loss) before income taxes 2,417 (11,420) 4,852
Provision for (benefit from) income taxes 1,020 (2,717) 709
-------------- -------------- --------------
Net income (loss) $ 1,397 $ (8,703) $ 4,143
============== ============== ==============
Basic earnings (loss) per common share $0.28 $(1.72) $0.82
============== ============== ==============
Diluted earnings (loss) per common share $0.27 $(1.72) $0.82
============== ============== ==============
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,
1998 1997 1996
Net income (loss) $ 1,397 $ (8,703) $ 4,143
Other comprehensive income (loss)
Foreign currency translation adjustment (532) (66) (341)
Pension liability adjustment - - 102
-------------- -------------- --------------
Comprehensive income (loss) $ 865 $ (8,769) $ 3,904
============== ============== ==============
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
(Deficit)
-----------------
Common Additional Accumulated
Stock Paid-in At Since Other
----------------- Comprehensive
Shares Amount Capital Formation Formation Income (Loss) Total
------ ------ ------- --------- --------- -------------------- -----
Balance, January 1, 1996 5,066 $ 50 $ 21,121 $ (5,112) $ 4,321 $ 152 $ 20,532
Compensation expense - - 257 - - - 257
Foreign currency
translation adjustment - - - - - (341) (341)
Pension liability adjustment - - - - - 102 102
Net income - - - - 4,143 - 4,143
------ ------ ------- --------- --------- -------------------- ------
Balance, December 31, 1996 5,066 50 21,378 (5,112) 8,464 (87) 24,693
Foreign currency translation - - - - - (66) (66)
Net (loss) - - - - (8,703) - (8,703)
------ ------ ------- --------- --------- -------------------- ------
Balance, December 31, 1997 5,066 50 21,378 (5,112) (239) (153) 15,924
Foreign currency translation
adjustment - - - - - (532) (532)
Issuance of warrants - - 300 - - - 300
Net income - - - - 1,397 - 1,397
---------- --------- ---------- -------- -------- --------------------- ----------
Balance, December 31, 1998 5,066 $ 50 $ 21,678 $ (5,112) $ 1,158 $ (685) $ 17,089
========== ========= ========== ======== ======== ===================== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years ended December 31,
1998 1997 1996
------------- ------------- ------------
Cash flows from operating activities:
Net income (loss) $ 1,397 $ (8,703) $ 4,143
Adjustments to reconcile net income (loss) to net cash
(used in) operating activities:
Depreciation and amortization 3,492 3,492 2,747
Accrued facility costs - 852 (1,451)
Provision (credit) for doubtful contract receivables (255) 723 -
Foreign currency transaction (gain) loss (326) 1,275 -
Fair value of warrants issued to non-employees 180 - -
Non-cash stock compensation - - 257
Deferred income taxes 301 (2,277) 71
Gain on sale of assets (550) - -
Changes in assets and liabilities
Contract receivables (2,344) 1,464 2,103
Inventories (185) 727 (1,245)
Prepaid expenses and other current assets 178 836 355
Other assets (1,558) (17) (181)
Accounts payable and accrued expenses (2,600) (2,152) 1,399
Accrued severance - 148 -
Billings in excess of revenue earned 83 644 (6,933)
Accrued contract and warranty reserves 102 (710) (1,927)
Other current liabilities 1,655 200 (780)
Income taxes payable (114) (315) (520)
Other liabilities 514 (2) 41
------------- --------------- ------------
Net cash used in operating activities (30) (3,815) (1,921)
------------- --------------- ------------
Proceeds from sale of assets 8,955 (578) -
Capital expenditures (2,061) (918) (2,834)
Capitalization of software development costs (2,304) (3,474) (3,890)
Proceeds from sale/leaseback transaction - 521 -
------------- --------------- ------------
Net cash provided by (used in) investing activities 4,590 (4,449) (6,724)
------------- --------------- ------------
Cash flows from financing activities:
(Decrease) increase in lines of credit with banks (2,287) 6,450 2,369
(Repayments) borrowings under capital lease obligations (265) (266) (37)
Net repayment of amounts due from stockholders - - (204)
Decrease in notes payable to related parties (12) (17) -
------------- --------------- ------------
Net cash provided by (used in) financing activities (2,564) 6,167 2,128
------------- --------------- ------------
Effect of exchange rate changes on cash (90) (19) (49)
------------- --------------- ------------
Net increase (decrease) in cash and cash equivalents 1,906 (2,116) (6,566)
Cash and cash equivalents at beginning of period 334 2,450 9,016
------------- --------------- ------------
Cash and cash equivalents at end of period $ 2,240 $ 334 $ 2,450
============= =============== ============
The accompanying notes are an integral part of these consolidated financial
statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. Business
GSE Systems, Inc. ("GSE Systems" or the "Company") designs, develops and
delivers business and technology solutions by applying high-technology-related
process control, high fidelity simulation, systems and services into
applications for worldwide industries including energy and process
manufacturing. The Company's solutions and services assist customers in
improving quality, safety and throughput; reducing operating expenses; and
enhancing overall productivity. The Company was formed on April 13, 1994 through
the consolidation of operations of GSE Power Systems, Inc. ("Power Systems" and
formerly "Simulation, Systems & Services Technologies Company" and its immediate
parent MSHI, Inc.), GP International Engineering & Simulation, Inc. ("GPI") and
GSE Power Systems AB ("Power Systems AB" and formerly "EuroSim AB"). In December
1994 and in the second quarter of 1995, the Company expanded into the process
control and data acquisition business through the acquisition of the net assets
of the process control systems division of Texas Instruments Incorporated
("TI"), which now operates as GSE Process Solutions, Inc. ("Process Solutions").
The Company's operations are subject to certain risks and uncertainties,
including, among other things, rapidly changing technology, risks associated
with doing business internationally and reliance on key technical and executive
personnel.
As discussed in Note 10, the Company's credit facilities expire on June 30,
1999. The Company has received a commitment letter from a financial institution
to obtain a new credit facility with a maturity date of March 31, 2000, which
the Company expects to finalize by April 30, 1999. The terms and conditions of
the new facility, which would provide for a $6 million line of credit for Power
Systems and a $3 million line of credit for Process Solutions, are substantially
the same as the new facility, including the requirement for the EXIM guarantee
and the additional guarantees described in Note 10.
Although the Company intends to replace its expiring credit facilities,
there can be no assurance that such financing will be completed. In the event
that the Company is unsuccessful in extending or obtaining new lines of credit,
GP Strategies Corporation ("GP Strategies")and ManTech International Corporation
("ManTech") each have agreed to provide working capital support of up to $1.8
million ($3.6 million in the aggregate) to the Company.
2. Summary of significant accounting policies
Principles of consolidation
The accompanying consolidated financial statements include the results of
operations of the Company and its wholly-owned subsidiaries: Power Systems, GPI,
Power Systems AB, and Process Solutions. The results of operations of GSE
Erudite Software, Inc. ("Erudite Software") are included through April 30, 1998.
All inter-company balances and transactions have been eliminated.
Accounting estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and cash equivalents
Cash and cash equivalents consist of cash on hand and short-term highly
liquid investments with maturities of less than three months at the date of
purchase.
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
Inventories
Inventories are stated at the lower of cost, as determined by the average
cost method, or market. Obsolete or unsaleable inventory is reflected at its
estimated net realizable value. Inventory costs include raw materials and
purchased parts.
A summary of inventories is as follows (in thousands):
December 31,
1998 1997
------- -------
Raw materials $ 1,873 $ 1,610
Service parts 1,019 1,090
------- -------
Total inventories $ 2,892 $ 2,700
======= =======
Property and equipment
Property and equipment are recorded at cost and depreciated using the
straight-line method with estimated useful lives ranging from three to ten
years. Leasehold improvements are amortized over the life of the lease or the
estimated useful life, whichever is shorter, using the straight-line method.
Upon sale or retirement, the cost and related amortization is 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 at the greater of the amount computed using (a)
the ratio of current gross revenues for a product to the total of current and
anticipated future gross revenue or (b) the straight-line method over the
remaining estimated economic life of the product, not to exceed five years.
Research and development
Development expenditures incurred to meet customer specifications under
contracts accounted for under the percentage of completion method are charged to
contract costs. Company sponsored research and development expenditures are
charged to operations as incurred and are included in selling, general and
administrative expenses. The amounts incurred for Company sponsored research and
development activities relating to the development of new products and services
or the improvement of existing products and services, exclusive of amounts
capitalized, were approximately $2,051,000, $1,580,000, and $1,861,000 for the
years ended December 31, 1998, 1997 and 1996, respectively.
Goodwill
Goodwill represents the excess of purchase price over the fair value of net
tangible and intangible assets acquired. These amounts are amortized on a
straight-line basis over periods ranging from seven to fifteen years.
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
Asset impairments
The Company periodically evaluates the recoverability of its long-lived
assets. This evaluation consists of a comparison of the carrying value of the
assets with the assets' expected future cash flows, undiscounted and without
interest costs. Estimates of expected future cash flows represent management's
best estimate based on reasonable and supportable assumptions and projections.
If the expected future cash flow, undiscounted and without interest charges,
exceeds the carrying value of the asset, no impairment is recognized. Impairment
losses are measured as the difference between the carrying value of long-lived
assets and their fair value. No such impairment losses were incurred in 1998,
1997 or 1996.
Foreign currency translation
Balance sheet accounts for foreign operations are translated at the
exchange rate at the balance sheet date, and income statement accounts are
translated at the average exchange rate for the period. The resulting
translation adjustments are included in accumulated other comprehensive income
(loss) in stockholders' equity. Transaction gains and losses, resulting from
changes in exchange rates, are included in operations in the period in which
they are occur. For the year ended December 31, 1998, the foreign currency
transaction gain, which is included in other income (expense), was approximately
$326,000. In 1997, the Company experienced a foreign currency loss of
approximately $1,275,000, which was primarily the result of intercompany
transactions were been negatively impacted by the poor financial condition of
Asian markets. Foreign currency transaction gains and losses were not material
in 1996.
Revenue recognition
Revenue under fixed-price contracts generally is accounted for on the
percentage-of-completion method, based on contract costs incurred to date and
estimated costs to complete. Estimated contract earnings are reviewed and
revised periodically as the work progresses and the cumulative effect of any
change is recognized in the period in which the change is determined. Estimated
losses are charged against earnings in the period such losses are identified.
The remaining liability for contract costs to be incurred in excess of contract
revenue is reflected as accrued contract reserves in the Company's consolidated
balance sheets. Revenue from certain consulting or training contracts are
recognized on a time and material basis. For time-and-material type contracts,
revenue is recognized based on hours incurred at a contracted labor rate plus
expenses.
Warranties
As the Company recognizes revenue under the percentage-of-completion
method, it provides an accrual for estimated future warranty costs based on
historical and projected claims experience.
Income taxes
Deferred income taxes are provided under the asset and liability method.
Under this method, deferred income taxes are determined based on the differences
between the financial statement and tax basis 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. Income tax expense
consists of the Company's current liability for federal, state and foreign
income taxes and the change in the Company's deferred income tax assets and
liabilities. No provision has been made for the undistributed earnings of the
Company's foreign subsidiaries as they are considered permanently invested.
Amounts of undistributed earnings are not material to the overall consolidated
financial statements.
Earnings per share
Basic earnings per share is computed based on the weighted average number
of outstanding common shares for the period. Diluted earnings per share adjusts
such weighted average for the potential dilution that could occur if stock
options, warrants or other convertible securities were exercised or converted
into common stock. Diluted earnings per share is the same as basic earnings per
share for the year ended December 31, 1997 because the effects of such items
were anti-dilutive.
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
The number of common shares and common share equivalents used in the
determination of basic and diluted earnings (loss) per share was as follows:
Year ended December 31,
------------------------------------------------
1998 1997 1996
-------------- -------------- --------------
Weighted average shares outstanding - Basic 5,065,688 5,065,688 5,065,688
============== ============== ==============
Weighted average shares outstanding - Diluted 5,107,428 5,065,688 5,073,700
============== ============== ==============
The difference between the amounts in 1998 and 1996 represents dilutive
options and/or warrants to purchase shares of common stock computed under the
treasury stock method, using the average market price during the related
periods.
Segment reporting
In 1998, the Company adopted Statement of Financial Accounting Standards
131, "Disclosures about Segments of an Enterprise and Related Information." FAS
131 supersedes FAS 14, "Financial Reporting for Segments of a Business
Enterprise," replacing the "industry segment approach" with the "management
approach." The management approach designates the internal organization that is
used by management for making operating decisions and assessing performance as
the source of the Company's reportable segments. FAS 131 also requires
disclosures about products and services, geographic areas and major customers.
The adoption of FAS 13 did not affect results of operations or financial
position, but did affect the disclosure of segment information.
Comprehensive income
Statement of Financial Accounting Standards 130, "Reporting Comprehensive
Income" was adopted effective for the year ended December 31, 1998. FAS 130
requires additional reporting with respect to certain changes in assets and
liabilities that previously were reported in stockholder's equity. The 1997 and
1996 financial statements have been reclassified for comparative purposes as
required by FAS 130.
New Accounting Standards
In June 1998 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards 133, "Accounting for Derivative Instruments and
Hedging Activities." This statement requires that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. The Company will be
required to adopt this new accounting standard by January 1, 2000. Management
does not anticipate early adoption. The Company does not believe that the effect
of the adoption of FAS 133 will be material.
Concentration of credit risk
Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of contract receivables. Credit risk on
contract receivables is mitigated by the nature of the Company's worldwide
customer base and its credit policies. The Company's customers are not
concentrated in any specific geographic region, but are concentrated in the
energy and manufacturing industries. No single customer accounted for a
significant (greater than 10%) amount of the Company's revenue during the years
ended December 31, 1998, 1997 and 1996 and there were no significant contract
receivables from a single customer at December 31, 1998. The Company typically
performs a credit evaluation before extending credit and may require letters of
credit, bank guarantees or advance payments. Thereafter, the Company continues
to monitor its contract receivables exposure after giving effect to letters of
credit, bank guarantees, the status of work performed on contracts, and its
customers' financial condition.
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
Off balance sheet risk and foreign exchange contracts
When necessary, the Company enters into forward exchange contracts, options
and swaps as hedges against certain foreign currency commitments. The Company
also enters into letters of credit and performance guarantees in the ordinary
course of business as required by certain contracts and proposal requirements.
The Company does not hold any derivative financial instruments for trading
purposes.
Gains and losses on foreign exchange contracts and swaps are recognized as
part of the cost of the underlying transactions being hedged in the period in
which the exchange rates changed. Foreign exchange contracts have an element of
risk that the counterparty may not be able to meet the terms of the agreement.
However, the Company minimizes such risk exposure by limiting counterparties to
nationally recognized financial institutions. Foreign exchange options contracts
permit but do not require the Company to exchange foreign currencies at a future
date with counterparties at a contracted exchange rate. Costs associated with
such contracts are amortized over the life of the contract matching the
underlying receipts.
3. Acquisitions and dispositions
Acquisitions
On December 1, 1997, the Company acquired 100% of the outstanding common
stock of J.L. Ryan, Inc. ("Ryan") for an initial purchase price of $1,000,000
and contingent consideration based on the performance of the business from 1998
to 2002; a minimum of $250,000 of such earnings payments for each of 1998 and
1999 has been guaranteed by the Company. The Company paid $600,000 in cash upon
the closing of the transaction and entered into a promissory note payable in
four annual installments of $100,000 each beginning on January 2, 1999. This
acquisition was accounted for under the purchase method. The financial results
of Ryan have been included in the results of operations from the date of
acquisition. The acquisition resulted in total goodwill of $1,133,976, which is
being amortized over seven years. For 1998, the contingent consideration in
addition to the minimum guaranteed amount was approximately $172,000, which the
Company has recorded as an addition to goodwill.
On May 22, 1996, the Company acquired all of the outstanding shares of
capital stock of Erudite Software. The acquisition was accomplished through a
merger of Erudite Software into a wholly owned subsidiary of the Company in
which 840,688 shares of the Company's Common Stock were exchanged for all
outstanding shares of capital stock of Erudite Software. The acquisition was
accounted for using the pooling-of-interests method of accounting and
accordingly, the Company's consolidated financial statements were restated to
include the accounts and operations of Erudite Software for all periods prior to
the merger.
Dispositions
On November 10, 1998, the Company completed the sale of certain assets
related to activities of its Oil & Gas business unit ("O&G"), to Valmet
Automation (USA), Inc. ("Valmet"), pursuant to an Asset Purchase Agreement,
effective as of October 30, 1998, by and between the Company, and Valmet. The
Company has recognized a loss before income taxes on this transaction, in the
quarter ended September 30, 1998, of $5.0 million, including the write-off of
approximately $2.9 million in capitalized software development costs, since all
operations that would support the recoverability of these capitalized costs have
been sold. The Company received approximately $742,000 in cash, subject to
certain adjustments, and Valmet assumed certain identified liabilities. Valmet
purchased assets with a book value of approximately $3.0 million. The agreement
stipulates that, subject to the occurrence of certain events, the Company is
entitled to royalties over a five-year period relative to certain software of
the Company which was licensed to Valmet. Such royalties would not exceed $1
million in the aggregate and would be recorded as earned. The Company is liable
for any cost overruns on certain development and project contracts, beyond
estimates stipulated in the Asset Purchase Agreement, such liabilities not to
exceed $800,000. In addition to the $800,000 liability for overruns, the Company
remains responsible for certain liabilities not assumed by Valmet. The Company
has accrued $400,000 and included such amount in the loss recognized on this
transaction, based on a present estimate of exposure relative to these
liabilities. Included in operations for 1998 are revenues of $1.1 million and
operating losses of $721,000 attributable to the Oil & Gas business unit prior
to the sale to Valmet.
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
On May 1, 1998, the Company completed the sale of substantially all of the
assets of Erudite Software, to Keane, Inc. ("Keane"), pursuant to an Asset
Purchase Agreement, dated as of April 30, 1998, by and among the Company,
Erudite Software and Keane. The aggregate purchase price for the Erudite assets
was approximately $9.9 million (consisting of $8.9 million in cash and $1.0
million in the form of an unsecured promissory note due on April 30, 1999,
subject to certain adjustments described in the next paragraph). In connection
with the transaction, Keane purchased certain assets with a book value of $4.4
million and assumed certain operating liabilities totaling approximately $2.2
million. The Company recognized a gain before income taxes on this transaction,
of $5.6 million. In connection with the sale of these assets, the Company has
written off approximately $800,000 in capitalized software development costs, as
well as $321,000 of purchased software, since all operations that would support
the recoverability of these costs have been sold. The write-off of these costs
is reflected in the calculation of the gain on the sale. Included in operations
for 1998 are revenues of $5.3 million and operating losses of $64,000
attributable to Erudite Software prior to the sale to Keane.
4. Fair values of financial instruments
The carrying amounts of cash and cash equivalents and short-term debt
approximate fair value because of the short-term maturity of these instruments.
The carrying amount of long-term debt approximates fair value based on either
market prices for the same or similar issues or the current rates offered to the
Company for similar debt of the same maturities.
5. 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. The components of contract receivables are
as follows (in thousands):
December 31,
-------------------
1998 1997
--------- ---------
Billed receivables $ 16,469 $ 16,994
Recoverable costs and accrued profit - not billed 8,839 8,398
Allowance for doubtful accounts (882) (1,021)
--------- ---------
Total contract receivables $ 24,426 $ 24,371
========= =========
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.
Revisions in estimated contract costs at completion are reflected in the
period during which facts and circumstances necessitating such a change first
become known. The effect of changes in estimates of contract profits was to
decrease gross profit by approximately $45,000 during the year ended December
31, 1998, decrease gross profit by approximately $410,000 during the year ended
December 31, 1997, and to increase gross profit by approximately $1,900,000
during the year ended December 31, 1996.
6. Property and equipment
Property and equipment consists of the following (in thousands):
December 31,
1998 1997
------ -------
Computer equipment $ 6,399 $ 7,771
Leasehold improvements 1,085 1,889
Furniture and fixtures 2,134 1,652
-------- --------
9,618 11,312
Accumulated depreciation and amortization (6,904) (7,448)
-------- --------
Property and equipment, net $ 2,714 $ 3,864
======== ========
Depreciation and amortization expense was $1,218,000, $2,149,000 and
$1,943,000 for the years ended December 31, 1998, 1997 and 1996 respectively.
The Company has $404,000 and $962,000 in assets held under capital lease as
of December 31, 1998 and 1997, respectively. Accumulated amortization on these
assets was $142,000 and $384,000 as of December 31,1998 and 1997, respectively.
7. Software development costs
Software development costs, net, consist of the following (in thousands):
December 31,
1998 1997
------------ ------------
Capitalized software development costs $ 7,407 $ 9,028
Accumulated amortization (2,692) (1,502)
------------ ------------
Software development costs, net $ 4,715 $ 7,526
============ ============
Software development costs capitalized were $2,304,000, $3,474,000 and
$3,890,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
Amortization of software development costs capitalized, excluding write-offs in
connection with asset dispositions, was $1,900,000, $1,124,000 and $635,000 for
the years ended December 31, 1998, 1997 and 1996, respectively, and are included
in cost of revenue.
8.Goodwill
Goodwill consists of the following (in thousands):
December 31,
1998 1997
------------- -------------
Goodwill, at cost $ 3,731 $ 3,559
Accumulated amortization (950) (585)
------------- -------------
Goodwill, net $ 2,781 $ 2,974
============= =============
Amortization expense for goodwill was approximately $365,000, $219,000 and
$168,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
9. Accrued expenses
Accrued expenses consist of the following (in thousands):
December 31,
1998 1997
------------- -------------
Accrued vacation, severance and other benefits $ 872 $ 1,771
Accrued compensation and payroll taxes 1,204 1,260
Accrued reserves, dispositions 926 -
Othere accrued expenses 1,342 1,273
------------- -------------
Total $ 4,344 $ 4,304
============= =============
10. Notes payable and financing arrangements
Notes payable and financing arrangements consist of the following (in
thousands):
December 31,
1998 1997
----------- ----------
Lines of credit with bank $ 6,746 $ 9,032
Notes payable to related parties 174 185
Notes payable, other 1,760 -
Obligations under sales-type lease 1,680 -
Capital lease obligations 153 442
------------- -----------
Total notes payable and financing arrangements 10,513 9,659
Less amounts payable within one year (8,530) (9,240)
------------- -----------
Long-term portion $ 1,983 $ 419
============= ===========
Lines of Credit
The Company maintains, through its subsidiaries, two lines of credit that
have been extended through June 30, 1999, based on modification agreements dated
January 1, 1999. These lines of credit, which are cross-collateralized, provide
for borrowings up to a total of $8.0 million to support foreign letters of
credit, margin requirements or foreign exchange contracts and working capital
needs. The first line, for $7.0 million, used by Power, is 90% guaranteed by the
Export-Import Bank of the United States ("EXIM"), is collateralized by
substantially all of Power's assets, and provides for borrowings up to 90% of
eligible receivables and 50% of unbilled receivables. The extension of this line
is conditional based upon the Company's obtaining an extension on the EXIM
guarantee through at least June 30, 1999. The Company has received preliminary
approval from EXIM to extend the EXIM guarantee, which currently expires April
30, 1999, through March 31, 2000. Under the terms of the preliminary approval,
the Power line will be reduced to $6 million, when the approval becomes final.
The second line, for $1.0 million, used by Process, is collateralized by
substantially all of Process' assets, and provides for borrowing up to 85% of
eligible receivables. Both lines are guaranteed by the Company and
collateralized by substatnially all of the Company's assets.
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
The lines require the Company to comply with certain financial ratios and
preclude the Company from paying dividends and making acquisitions beyond
certain limits without the bank's consent. In connection with the extension
obtained as of January 1, 1999, certain of these covenants were modified,
retroactive to December 31, 1998. The Company was in compliance with all
modified covenants at December 31, 1998 and expects to maintain compliance with
the covenants.
The Company has received a commitment letter from a financial institution
for a new credit facility with a maturity date of March 31, 2000, which the
Company expects to finalize by April 30, 1999. The terms and conditions of the
new facility, which would provide for a $6 million Power Systems line and a $3
million Process Solutions line, are substantially the same as the existing
facility, including the requirement for the EXIM guarantee and the guarantees
described below.
In connection with the aforementioned existing lines of credit and the new
facility, the Company has arranged for certain guaranties to be provided on its
behalf to the bank by GP Strategies and ManTech. In consideration for the
above-mentioned guaranties, the Company has granted each of ManTech and GP
Strategies warrants to purchase shares of the Company's common stock; each of
such warrants provides the right to purchase at least 150,000 shares of the
Company's common stock at $2.375 per share. The Company has recognized $300,000
as the estimated fair value of such warrants in the consolidated financial
statements. During 1998, the Company recognized $180,000 of expense related to
these warrants. The Company will expense the remainder of the fair value over
the term of the guarantees. The fair value of the warrants was determined using
the Black - Scholes valuation model. Assumptions used in the calculation were as
follows:dividend yield of 0%, expected volatility of 61%, risk-free interest
rates of 5.6% and expected terms of 2.5 years.
Although the Company intends to replace its expiring credit facilities, as
described above, there can be no assurance that such financing will be
completed. In the event that the Company is unsuccessful in extending or
obtaining new lines of credit, GP Strategies and ManTech each have agreed to
provide working capital support of up to $1.8 million ($3.6 million in the
aggregate) to the Company.
Obligations under sales-type lease
In December 1998, the Company entered into a contract with a customer for
the lease of certain hardware and software under a 36-month lease. The Company
has accounted for this lease as a sales-type lease. The current position of the
net investment in sales-type lease is in prepaid expenses and other current
assets, while the non-current portion is included in other assets. The
components of the net investment in sales-type lease are as follows (in
thousands):
Minimum rentals receivable $ 1,994
less: unearned interest income (314)
----------
Net investment in sales-type lease $ 1,680
==========
Minimum rental receivable under this lease at December 31, 1998 are as follows
(in thousands):
1999 $ 720
2000 640
2001 634
----------
Total $ 1,994
==========
The $1,680,000 obligation related to this lease is included in other
current liabilities and other liabilities.
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
Notes payable, other
Notes payable, other includes notes related to acquisitions and insurance,
which are included in other current liabilities and other liabilities.
Other debt
The Company entered into capital lease agreements for furniture and
equipment, totaling $58,000, $102,000, and $313,000 during the years ended
December 31, 1998, 1997 and 1996, respectively. These obligations bear interest
at between 9% and 11% per annum and expire between 1998 and 2000.
Debt maturities
Aggregate maturities of debt as of December 31, 1998 are as follows:
1999 $ 8,530
2000 1,110
2001 700
2002 30
Thereafter 40
----------
Total $ 10,513
==========
11. Income taxes
The consolidated (loss) income before income tax, by domestic and foreign
sources, is as follows (in thousands):
Years ended December 31,
------------------------------------
1998 1997 1996
--------- ---------- ----------
Domestic $ 1,379 $ (8,850) $ 3,884
Foreign 1,038 (2,570) 968
--------- ---------- ----------
Total $ 2,417 $ (11,420) $ 4,852
========= ========== ==========
The provision for (benefit from) income taxes is as follows (in thousands):
Years ended December 31,
------------------------------------
1998 1997 1996
--------- ---------- ----------
Current:
Federal $ - $ (27) $ (23)
State 157 - 29
Foreign 257 (413) 642
--------- ---------- ----------
$ 414 $ (440) $ 648
--------- ---------- ----------
Deferred:
Federal 556 (2,388) 186
State - (229) 23
Foreign 50 340 (148)
--------- ---------- ----------
606 (2,277) 61
--------- ---------- ----------
$ 1,020 $ (2,717) $ 709
========= ========== ==========
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
The (benefit from) provision for income taxes varies from the amount of
income tax determined by applying the applicable U.S. statutory rate to pre-tax
(loss) income as a result of the following:
Years ended December 31,
--------------------------------------------------
1998 1997 1996
------------ ------------ ------------
Statutory U.S. tax rate 34.0 % (34.0)% 34.0 %
State income tax, net of federal tax benefit 2.7 (2.7) 2.7
Effect of foreign operations (2.2) 3.8 (6.6)
Change in valuation allowance (0.8) 7.8 (19.5)
Non-deductible amortization expense related to warrants 2.7 - -
Others 5.8 1.3 4.0
------------ ------------ ------------
Effective tax rate 42.2 % (23.8)% 14.6 %
============ ============ ============
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATD FINANCIAL STATEMENTS
DECEMBER 31, 1998
At December 31, 1998, the Company had available $11,854,000 of foreign and
domestic net operating loss carryforwards which expire between 2007 and 2017. In
addition, the Company had $338,000 of foreign tax credit carryforwards which
expire between 2000 and 2001. These carryforwards will be utilized to reduce
taxable income in subsequent years. A portion of the net operating losses were
generated by certain of the Predecessors prior to the formation of the Company
and, as a result, there are limitations on the amounts that can be utilized to
offset taxable income in a given year.
Deferred income taxes arise from temporary differences between the tax
basis of assets and liabilities and their reported amounts in the financial
statements. A summary of the tax effect of the significant components of
deferred income taxes is as follows (in thousands):
December 31,
------------------------
1998 1997
---- ----
Deferred tax
------------------------
Asset (Liability)
------------------------
Contract loss reserves $ 48 $ 46
Property and equipment 340 135
Accrued expenses 164 207
Net operating loss carryforwards 4,945 7,152
Book reserves not deductible for tax purposes 876 458
Book income deducted for tax purposes (645) -
Software development costs (1,731) (2,762)
Cash to accrual adjustment (58) (71)
Foreign tax credits 338 338
Others 297 (125)
-------- -------
4,574 5,378
Valuation allowance (1,058) (1,078)
-------- -------
Total $ 3,516 $ 4,300
======== =======
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
During 1996, the Company reduced the valuation allowance by $1,033,000, of
which $109,000 reduced goodwill and other intangibles arising out of the
acquisition of Power Systems. The valuation allowance at December 31, 1998 and
1997 primarily relates to the future utilization of foreign net operating loss
carryforwards and foreign tax credits that the Company has determined are not
realizable at this time. Management believes that it is more likely than not
that the net deferred tax asset as of December 31, 1998 is realizable.
12. Capital stock
As of December 31, 1998, the Company had 10,000,000 total shares of capital
stock authorized, of which 8,000,000 are common stock and 2,000,000 are
preferred stock. As of December 31, 1998 and 1997, there are no shares of
preferred stock outstanding. The Board of Directors has the authority to
establish one or more classes of preferred stock and to determine, within any
class of preferred stock, the preferences, rights and other terms of such class.
13. Stock options
Long term incentive plan
During 1995, the Company established the 1995 Long-Term Incentive Stock
Option Plan (the "Plan"), which includes all officers, key employees and
non-employee members of the Company's Board of Directors. All options to
purchase shares of the Company's common stock under the Plan expire ten years
from the date of grant and generally become exercisable in three installments
with 40% vesting on the first anniversary of the grant date and 30% vesting on
each of the second and third anniversaries of the grant date, subject to
acceleration under certain circumstances. Under the original terms of the Plan,
the Company had reserved 425,000 shares of common stock for issuance of stock
options, which amount was increased to 625,000 shares in 1996 by action of the
Company's directors and stockholders.
Upon a determination in 1997 by the executive and compensation committees
of the Company's Board of Directors that the purposes of the Company's 1995
Long-Term Incentive Plan were no longer being met with respect to those
individuals holding nonstatutory stock options with exercise prices greater than
the then-current market value of the Company's Common Stock, the Company offered
certain employees and non-management directors who were holders of outstanding
options under the 1995 Long-Term Incentive Plan as of December 1, 1997 the
opportunity to exchange such options for replacement stock options at an
exercise price of $3.875 per share, the fair market value of the Company's
Common Stock at the close of business on that date. Each option holder accepting
such offer was required to surrender his or her existing option and enter into
new stock option agreements whereby each option's three-phased vesting period
(40% vested as of the first anniversary of the date of grant, 70% vested as of
the second anniversary of the date of grant, and 100% vested as of the third
anniversary of the date of grant) would re-commence as of December 1, 1997, the
new date of grant. A total of 84 individuals were eligible to participate in
this replacement of options, and those individuals' existing options had an
average exercise price of $13.26 per share prior to the replacement. Of such
individuals, 81 participated in the replacement of options, representing a total
of 295,837 options which are included in the stock option activity table as new
options granted and options cancelled.
In November of 1998, the Company amended the Plan such that the term of any
future options granted would be seven years and that upon termination, the
option holder would have 90 days in which to exercise options. Prior to the
amendment, the term of options granted was ten years and there were no time
frames related to termination.
Stock option activity under the plan is as follows:
Year Ended December 31,
------------------------------------------------------------------------------------
1998 1997 1996
----------------------- ------------------------- -------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- ----------- --------- ----------- --------- -----------
Options outstanding, beginning of period 595,015 $ 6.89 413,366 $ 13.61 297,516 $ 14.00
Options canceled (246,009) (4.77) (306,044) (11.57) (26,150) (14.07)
Options granted 186,200 2.79 487,693 4.12 142,000 12.89
------- ---------- --------- ----------- --------- -----------
Options outstanding, end of period 535,206 $ 5.93 595,015 $ 6.89 413,366 $ 13.61
======= ========== ========= =========== ========= ===========
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
The Company accounts for grants under the Plan in accordance with APB 25,
"Accounting for Stock Issued to Employees," and related interpretations. Had
compensation expense been determined based on the fair value at the grant dates
for awards under the Plan consistent with the method of SFAS 123, "Accounting
for Stock Based Compensation," the Company's net income (loss) and basic and
diluted net income (loss) per share would have been reduced (increased) to
approximately $ 900,000 ($0.18 per share), $(10,276,000) ($(2.03) per share),
and $3,601,000 ($0. 71 per share) for the years ended December 31, 1998, 1997
and 1996, respectively.
The fair value of each option is estimated on the date of grant using a
Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants during the years ended December 31, 1998, 1997 and
1996, respectively: dividend yield of 0%, expected volatility of 61% for 1998
and 80% for 1997 and 1996, and risk-free interest rates of 6.51%, 6.31%, and
6.15%, and expected terms of 6 years.
As of December 31, 1998, 1997 and 1996, respectively, there were 215,080,
86,442, and 119,000 stock options exercisable under the Plan, and the Company
had 89,294 shares of common stock reserved for the future grants under the Plan.
The weighted average fair value of options granted during 1998, 1997 and 1996
was $2.79 per share, $3.00 per share and $9.55 per share, respectively. As of
December 31, 1998, the weighted average remaining contractual life of the
options outstanding was approximately 7 years.
In 1998, the Company granted stock options to two directors to acquire
50,000 shares of Common stock in the aggregate at an exercise price or $2.25.
Each such director has agreed that he would not exercise his option with respect
to more than 12,500 shares until such time as stockholder approval is obtained.
In 1997, the Company granted one of its senior executives a stock option to
acquire 25,000 shares of Common Stock at an exercise price of $11.25. This grant
was not made pursuant to the Plan. This option expires ten years from the date
of grant and becomes exercisable in the three installments with 40% vesting on
the first anniversary of the date of grant and 30% vesting on each of the second
and third anniversaries of the date of grant.
In 1996, in exchange for services, the Company granted stock options to two
consultants to acquire 10,000 shares of Common Stock in the aggregate at an
exercise price of $14.00. These grants were not made pursuant to the Plan. These
options expire on December 31, 2000 and became exercisable in two installments
with 50% vesting as of January 1, 1997 and the remaining 50% vesting as of
January 1, 1998.
14. Commitments and contingencies
Leases
The Company is obligated under certain noncancelable operating leases for
office facilities and equipment. Future minimum lease payments under
noncancelable operating leases as of December 31, 1998 are approximately as
follows (in thousands):
1999 $ 1,993
2000 1,851
2001 1,608
2002 1,230
2003 1,196
Thereafter 5,845
-----------
Total $ 13,723
===========
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
The future minimum lease payments above include $1,142,000 for
noncancellable leases entered during the first quarter of 1999. Total rent
expense under operating leases was $2,134,000, $3,220,000, and $1,876,000 for
the years ended December 31, 1998, 1997 and 1996.
During 1998, the Company entered into agreements whereby the lease for its
existing Columbia facility was terminated and the operations that occupied such
facility were relocated into two separate facilities. One of these facilities is
in Columbia, Maryland (approximately 53,000 square feet) and is occupied by the
operations of Power Systems, as well the Company's corporate headquarters
offices and support functions. The other facility is in Baltimore, Maryland
(approximately 33,000 square feet) and is occupied by the operations of Process
Solutions. During the first quarter of 1999, the Company has leased an
additional 6,000 square feet in the Baltimore facility. Each of the leases for
these smaller facilities has a term of ten (10) years.
Letters of credit
As of December 31, 1998, the Company and certain of its subsidiaries were
contingently liable under letters of credit totaling $803,000. Further, the
performance of certain of the Company's customer contracts is collateralized by
performance guarantees totaling $258,000 by its subsidiaries' respective former
parent organizations. During 1998, the Company placed approximately $332,000 in
escrow as a performance bond deposit in connection with a simulator contract in
Taiwan. Of this amount, approximately $221,000 will be held in escrow until
April 30, 2000 and approximately $111,000 will be held in escrow until April 30,
2003. In connection with that same contract, the Company placed approximately
$180,000 in a letter of credit for payment bond, which will be held in escrow
until April 30, 2000.
Contingencies
Various actions and proceedings are presently pending to which the Company
is a party. In the opinion of management, the aggregate liabilities, if any,
arising from such actions are not expected to have a material adverse effect on
the financial position, results of operations or cash flows of the Company.
15. Related party transactions
In 1997, a subsidiary of the Company entered into certain agreements
regarding the formation of a joint venture with a company organized in the
People's Republic of China. In connection with the initial capitalization of
this joint venture, each of ManTech and GP Strategies made advances of $126,000
on behalf of the Company. During 1998, ManTech assumed control of the joint
venture. The operations of this joint venture were immaterial during the years
ended December 31, 1998 and 1997.
During 1997, ManTech entered into arrangements for the consulting services
of a member of the Company's finance staff. Payments to the Company for such
services were $92,000 for the year ended December 31, 1997.
A subsidiary of the Company subleased office space to ManTech based on
square footage used through May of 1998. . For the years ended December 31,
1998, 1997 and 1996, such charges amounted to $30,000, $117,000 and $67,000,
respectively.
16. Employee benefits
The Company has a qualified defined contribution plan that covers
substantially all 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 $468,000, $524,000, and $671,000 for the years ended December
31, 1998, 1997 and 1996, respectively.
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
During 1997, the Company recorded a net charge for severance and other
employee obligations of $1.1 million in connection with cost reduction efforts
initiated to offset the impact of a decrease in contract revenues. Of this
charge, $976,000 was expended as of December 31, 1997, with the remainder being
expended in 1998.
17. Segment Information
In 1998, GSE adopted FAS 131. The prior years' segment information has been
restated to present GSE's two reportable segments, Process and Power, its core
business units.
The accounting policies of the segments are the same as those described in
the "Summary of Significant Accounting Policies". The Company is primarily
organized on the basis of these two business units. GSE Systems has a wide range
of knowledge of control and simulation systems and the processes those systems
are intended to improve, control and model. The Company's knowledge is
concentrated heavily in the process industries, which include the chemicals,
food & beverage, and pharmaceuticals fields, as well as in the power generation
industry. The Process Business Unit is primarily engaged in process control and
simulation in a variety of commercial industries. Contracts typically range from
three to nine months. The Power Business Unit is primarily engaged in simulation
to the power generation industry, with the vast majority of customers being in
the nuclear power industry. Contracts typically range from 18 months to three
years or longer.
GSE evaluates the performance of its business units utilizing "Business
Unit Contribution", which is substantially equivalent to earnings before
interest and taxes (EBIT) before allocating any corporate expenses to the
business units.
The segment information regarding the two divested businesses is included
in "All Other" (See Note 3).
The table below presents information about reported segments:
(in thousands)
Years ended December 31,
--------------------------------------
1998
--------------------------------------
Process Power Total
Contract revenue $ 36,484 $ 30,930 $ 67,414
========== ========= =========
Business unit contribution $ 3,444 $ 4,535 $ 7,979
========== ========= =========
1997
--------------------------------------
Process Power Total
Contract revenue $ 34,837 $ 24,552 $ 59,389
========== ========= =========
Business unit contribution $ 3,480 $ 718 $ 4,198
========== ========= =========
1996
--------------------------------------
Process Power Total
Contract revenue $ 32,145 $ 42,558 $ 74,703
========== ========= =========
Business unit contribution $ 3,353 $ 9,218 $ 12,571
========== ========= =========
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
A reconciliation of segment contract revenue to consolidated contract
revenue and segment business unit contribution to consolidate income before
taxes for the years ended December 31, 1998, 1997 and 1996 is as follows:
(in thousands)
Years ended December 31,
--------------------------------------
1998 1997 1996
---------- --------- ---------
Total segment sales $ 67,414 $ 59,389 $ 74,703
All other 6,404 20,322 21,330
---------- --------- ---------
Consolidated contract $ 73,818 $ 79,711 $ 96,033
revenue ========== ========= =========
Segment business unit $ 7,979 $ 4,198 $ 12,571
contribution
All other business unit (491) (4,848) (1,781)
contribution
Corporate expenses (5,271) (8,881) (5,551)
Severance cost - (1,124) -
Gain on sales of assets 550 - -
Interest expense (350) (765) (387)
---------- --------- ----------
Consolidated income (loss) $ 2,417 $(11,420) $ 4,852
before taxes ========== ========= ==========
The Company designs, develops and delivers business and technology solutions to
the energy, process and manufacturning industries worldwide. Revenue, operating
income and identifiable assets for the Company's United States, European and
Asian operations are as follows (in thousands):
Year Ended December 31, 1998
----------------------------------------------------------------------------------
United States Europe Asia Eliminations Consolidated
------------- -------- -------- ------------ ------------
Revenue $ 62,689 $ 8,241 $ 2,888 $ - $ 73,818
Transfers between
geographic locations $ 1,761 $ 423 $ - $ (2,184) $ -
------------- -------- -------- ------------ ------------
Total revenue $ 64,450 $ 8,664 $ 2,888 $ (2,184) $ 73,818
------------- -------- -------- ------------ ------------
Gain or (Loss) from
operations $ 1,571 $ 592 $ (272) $ - $ 1,891
============= ======== ======== ============ ============
Identifiable assets $ 50,904 $ 5,836 $ 953 $ (8,950) $ 48,743
============= ======== ======== ============ ============
Year Ended December 31, 1997
----------------------------------------------------------------------------------
United States Europe Asia Eliminations Consolidated
------------- -------- -------- ------------ ------------
Revenue $ 70,580 $ 5,907 $ 3,224 $ - $ 79,711
Transfers between
geographic locations $ 1,582 $ - $ 1,314 $ (2,896) $ -
------------- -------- -------- ------------ ------------
Total revenue $ 72,162 $ 5,907 $ 4,538 $ (2,896) $ 79,711
------------- -------- -------- ------------ ------------
Gain or (Loss) from
operations $ (6,930) $ (324) $ (2,173) $ - $ (9,427)
============= ======== ======== ============ ============
Identifiable assets $ 50,296 $ 3,686 $ 2,111 $ (7,731) $ 48,362
============= ======== ======== ============ ============
Year Ended December 31, 1996
----------------------------------------------------------------------------------
United States Europe Asia Eliminations Consolidated
------------- -------- -------- ------------ ------------
Revenue $ 83,263 $ 9,026 $ 3,744 $ - $ 96,033
Transfers between
geographic locations $ 659 $ - $ 622 $ (1,281) $ -
------------- -------- -------- ------------ ------------
Total revenue $ 83,922 $ 9,026 $ 4,366 $ (1,281) $ 96,033
------------- -------- -------- ------------ ------------
Gain or (Loss) from
operations $ 3,832 $ 1,267 $ (452) $ 198 $ 4,845
============= ======== ======== ============ ============
Identifiable assets $ 54,584 $ 6,416 $ 3,057 $ (13,051) $ 51,006
============= ======== ======== ============ ============
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
Domestic and export sales from the Company's United States operation in
thousands of dollars and as a percentage of revenue as follows:
Year Ended December 31,
------------------------------------------------------------------------------------
1998 1997 1996
----------------------- ------------------------- -------------------------
Domestic $ 38,860 62.0% $ 50,783 72.0% $ 47,868 57.5%
Export:
Germany 661 1.1% 2,791 4.0% 9,236 11.1%
Remaining Western Europe 1,642 2.6% 1,748 2.5% 2,806 3.4%
Russia 4,749 7.6% 6,074 8.6% 7,716 9.3%
Remaining Easter Europe 12,222 19.5% 6,481 9.2% 11,070 13.3%
Asia 2,828 3.6% 1,278 1.8% 3,910 4.7%
South America and others 2,273 3.6% 1,425 2.0% 657 0.8%
--------- ------ --------- ------ --------- ------
$ 62,689 100.0% $ 70,580 100.0% $ 83,263 100.0%
========= ====== ========= ====== ========= ======
18. Supplemental disclosure of cash flow information (in thousands):
Year Ended December 31,
-------------------------------
1998 1997 1996
Non cash investing & financing activities:
Obligations under capital leases $ 58 $ 102 $ 313
====== ====== ======
Execution of investment in sales-type leases $1,680 $ - $ -
====== ====== ======
Notes payable to related party for
investment in joint venture $ - $ 252 $ -
====== ====== ======
Asset acquisitions financed with debt to seller:
Cash paid $ 130 $ 600 $ -
Note payable issued 250 900 -
------ ------ ------
Total purchase price $ 380 $1,500 $ -
====== ====== ======
Cash Paid:
Interest $ 350 $ 741 $ 228
====== ====== ======
Income taxes $ 426 $ 233 $ 285
====== ====== ======
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
--------------------
None.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
PART III
The information required in response to Items 10, 11, 12 and 13 is hereby
incorporated by reference to the information under the captions "Election of
Directors", "Principal Executive Officers of the Company Who Are Not Also
Directors", "Executive Compensation", "Voting Securities and Principal
Stockholders", "Security Ownership of Management", and "Certain Related
Transactions" in the Proxy Statement for the Company's 1999 Annual Meeting of
Stockholders.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
----------------------------------------------------------------
(a)(1) List of Financial Statements
The following financial statements are included in Item 8:
GSE Systems, Inc. and Subsidiaries
Report of Independent Accountants
Consolidated Balance Sheets as of December 31, 1998 and 1997
Consolidated Statements of Operations for the years ended December 31,
1998, 1997 and 1996
Consolidated Statements of Comprehensive Income (Loss) for the years ended
December 31, 1998, 1997 and 1996
Consolidated Statements of Changes in Stockholders' Equity for the years
ended December 31, 1998 and 1997 and 1996
Consolidated Statements of Cash Flows for the years ended December 31,
1998, 1997 and 1996
Notes to Consolidated Financial Statements
(a)(2) List of Schedules
All other schedules to the consolidated financial statements are omitted as
the required information is either inapplicable or presented in the consolidated
financial statements or related notes.
(a)(3) List of Exhibits
The Exhibits which are filed with this report or which are incorporated by
reference are set forth in the Exhibit Index hereto.
(b) Reports on Form 8-K:
1. On April 17, 1998, the Company filed a Report on Form 8-K dated April 14,
1998 with respect to a press release of the Company announcing the signing
a letter of intent for the sale of the Company's Erudite Software business
to Keane, Inc. The Form 8-K included as an exhibit the text of such press
release.
2. On September 24, 1998, the Company filed a Report on Form 8-K dated
September 21, 1998 with respect to a press release of the Company
announcing the signing a letter of intent for the sale of the Company's Oil
& Gas Business Unit to Valmet Automation (USA), Inc. The Form 8-K included
as an exhibit the text of such press release.
3. On October 30, 1998, the Company filed a Report on Form 8-K dated October
22, 1998 with respect to a press release of the Company announcing the
signing a letter of intent for a proposed transaction involving BatchCAD
Limited. The Form 8-K included as an exhibit the text of such press
release.
4. On November 30, 1998, the Company filed a Report on Form 8-K dated November
10, 1998 providing disclosure pertaining to the Company's completion of the
divestiture of certain assets of its Oil & Gas Business Unit to Valmet
Automation (USA), Inc. This Form 8-K included as exhibits the texts of the
Asset Purchase Agreement and the License Agreement for such transaction.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
SIGNATURES
- ----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
GSE Systems, Inc.
By:/S/ CHRISTOPHER M. CARNAVOS
---------------------------
Christopher M. Carnavos
Director and President
Pursuant to the requirements of the Securities Act, this report has been signed
by the following persons in the capacities and on the dates indicated.
Signatures Title Date
---------- ----- ----
/S/ JEROME I. FELDMAN Chairman of the Board March 30, 1999
- ---------------------------
Jerome I. Feldman
/S/ CHRISTOPHER M. CARNAVOS Director and President March 30, 1999
- ---------------------------
Christopher M. Carnavos (Principal Executive Officer)
/S/ JEFFERY G. HOUGH Senior Vice President March 30, 1999
- --------------------------- and
Jeffery G. Hough Chief Financial Officer
(Principal Financial and
Accounting Officer)
/S/ SHELDON L. GLASHOW Director March 30, 1999
- ---------------------------
Sheldon L. Glashow
/S/ JOHN A. MOORE, JR. Director March 30, 1999
- ---------------------------
John A. Moore, Jr.
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
/S/ GEORGE J. PEDERSEN Director March 30, 1999
- ---------------------------
George J. Pedersen
/S/ SYLVAN SCHEFLER
- --------------------------- Director March 30, 1999
Sylvan Schefler
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
EXHIBIT INDEX
The following exhibits are either filed herewith or have been filed with the
Securities and Exchange Commission and are referred to and incorporated by
reference.
Exhibit
Number Note Description
- ------- ---- -----------
2.1 (7) Asset Purchase Agreement among GSE Systems, Inc., GSE
Erudite Software, Inc. and Keane, Inc. dated as of April 30,
1998.
2.2 (8) Asset Purchase Agreement among GSE Systems, Inc., GSE
Process Solutions, Inc., GSE Process Solution B.V., GSE
Process Solutions Belgium N.V., GSE Process Solutions
Singapore (Pte) Limited and Valmet Automation (USA) Inc.
dated as of November 10, 1998.
2.3 (8) Software License Agreement among GSE Process Solutions,
Inc., The Sage Systems Division of Valmet Automation (USA)
Inc. and The Sage Systems Division of Valmet Automation
(Canada) Ltd. dated as of November 10, 1998.
3.1 (1) Second Amended and Restated Certificate of Incorporation of
the Company.
3.2 (2) Form of Amended and Restated Bylaws of the Company.
4.1 (3) Specimen Common Stock Certificate of the Company.
10.1 (1) 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).
10.2 (9) * GSE Systems, Inc. 1995 Long-Term Incentive Plan, as
amended as of November 20, 1998.
10.3 (4) * Form of Option Agreement Under the GSE Systems, Inc.
1995 Long-Term Incentive Plan.
10.4 (2) Letter of Credit, Loan and Security Agreement between
CoreStates Bank, N.A. and GSE Process Solutions, Inc. (dated
as of January 31, 1995).
10.5 (4) Amended and Restated Letter of Credit, Loan and Security
Agreement between CoreStates Bank, N.A. and GSE Process
Solutions, Inc. (dated as of October 13, 1995 and as amended
as of February 23, 1996).
10.6 (4) Letter of Credit, Loan and Security Agreement among
CoreStates Bank, N.A., MSHI, Inc., and Simulation, Systems &
Services Technologies Company (dated as of January 30,
1996).
10.7 (1) Amended and Restated Lease Agreement between CCP Development
Limited Partnership No. 7 and Simulation, Systems & Services
Technologies Company (dated as of January 27, 1993)
10.8 (6) * Letter Agreement dated January 8, 1997 between GSE
Systems, Inc. and Christopher M. Carnavos
10.9 (6) Amendment Number Two to Amended and Restated Letter of
Credit, Loan and Security Agreement between CoreStates Bank,
N.A. and GSE Process Solutions, Inc. (dated as of November
11, 1997)
10.11 (6) Indemnification Agreement between Genus Corporation and GSE
Power Systems, Inc. (dated as of February 2, 1998)
10.12 (6) Office Lease Agreement between Sterling Rutherford Plaza,
L.L.C. and GSE Systems, Inc.(dated as of February 10, 1998)
10.13 (6) Lease Agreement between Red Branch Road, L.L.C. and GSE
Systems, Inc. (dated February 10, 1998)
10.14 (6) Letter Agreement dated March 6, 1998 between CoreStates
Bank, N.A. and GSE Power Systems, Inc.
10.15 (6) Letter Agreement dated March 6, 1998 between CoreStates
Bank, N.A. and GSE Process Solutions, Inc.
10.16 (7) Termination of Employment Agreement among GSE Systems, Inc.,
GSE Erudite Software, Inc. and Eugene D. Loveridge, dated as
of April 30, 1998
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1998
10.17 (7) Termination of Employment Agreement among GSE Systems, Inc.,
GSE Erudite Software, Inc. and Daniel Masterson, dated as of
April 30, 1998
10.18 (9) Modification Agreement by and among GSE Power Systems, Inc.,
MSHI, Inc., GSE Process Solutions, Inc,. GSE Systems, Inc.,
GP International Engineering & Simulation, Inc., GP
Strategies Corporation, ManTech International Corporation,
GSE Process Solutions B.V., GSE Process Solutions Singapore
(Pte) Limited, GSE Process Solutions Belgium N.V., and First
Union National Bank dated as of January 1, 1999.
10.19 (9) Unconditional Guaranty by GSE Systems, Inc. in favor of
First Union National Bank dated as of January 1, 1999.
10.20 (9) Unconditional Guaranty by GP Strategies Corporation in favor
of First Union National Bank dated as of January 1, 1999.
10.21 (9) Unconditional Guaranty by ManTech International Corporation
in favor of First Union National Bank dated as of January 1,
1999.
21.1 (9) Subsidiaries fo Registrant
23.1 (9) Consent of Independent Accountants
24.1 (9) Power of Attorney for Dirctors' and Officers' Signatures on
SEC Form 10-K
99.1 (3) Form of Right of First Refusal Agreement
- --------------------
(1) 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.
(2) 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.
(3) Previously filed in connection with Amendment No. 3 to the GSE Systems,
Inc. Form S-1 Registration Statement as filed with the Securities and
Exchange Commission on July 24, 1995 and incorporated herein by reference.
(4) 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.
(5) Previously filed in connection with the GSE Systems, Inc. Form 10-K as
filed with the Securities and Exchange Commission on March 31, 1997 and
incorporated herein by reference.
(6) Previously filed in connection with the GSE Systems, Inc. Form 10-K as
filed with the Securites and Exchange Commission on March 31, 1998 and
incorporated herein by reference.
(7) Previously filed in connection with the GSE Systems, Inc. Form 10-Q as
filed with the Securites and Exchange Commission on May 15, 1998 and
incorporated herein by reference.
(8) Previously filed in connection with the GSE Systems, Inc. Form 8-K as filed
with the Securites and Exchange Commission on November 30, 1998 and
incorporated herein by reference.
(9) Filed herewith.
* Management contract or compensatory plan.
Commission File No. 0-26494