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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, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 0-26494
GSE Systems, Inc.
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(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)
8930 Stanford Boulevard, Columbia, Maryland 21045
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (410) 312-3700
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, $.01 par value
(Title of each class)
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 6, 1998 was $5,739,857 based on closing price of such stock on that date.
Number of shares of Common Stock outstanding as of March 6, 1998:
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 1998 annual meeting
of shareholders.
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GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1997
TABLE OF CONTENTS
PART I Page
----
Item 1. Business....................................................................... 3
Item 1A. Risk Factors................................................................... 8
Item 2. Properties..................................................................... 12
Item 3. Legal Proceedings.............................................................. 12
Item 4. Submission Matters to a Vote of Security Holders............................... 12
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters........................................................ 13
Item 6. Selected Financial Data........................................................ 14
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................................. 16
Item 7A. Quantitative and Qualitative Disclosures About Market Risk..................... 22
Item 8. Financial Statements and Supplementary Data.................................... 23
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure..................................... 25
PART III
Item 10. Directors and Executive Officers of the Company*............................... 26
Item 11. Executive Compensation*........................................................ 26
Item 12. Security Ownership of Certain Beneficial Owners
and Management*............................................................ 26
Item 13. Certain Relationships and Related Transactions*................................ 26
PART IV
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K........................................................ 27
SIGNATURES.......................................................................................... 28
* to be incorporated by reference from the Proxy Statement for the registrant's
1998 Annual Meeting of Stockholders.
2
GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1997
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, data acquisition 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 Item 1A. Risk Factors. The
forward-looking statements included herein are based on current expectations
that involve numerous risks and uncertainties as set forth herein, the failure
of any one of which could materially adversely affect the operations of the
Company. The Company's plans and objectives are also based on the assumptions
that market conditions and competitive conditions within the Company's business
areas will not change materially or adversely and that there will be no material
adverse change in the Company's operations or business. Assumptions relating to
the foregoing involve judgments with respect, among other things, to future
economic, competitive and market conditions and future business decisions, all
of which are difficult or impossible to predict accurately and many of which are
beyond the control of the Company. Although the Company believes that the
assumptions underlying the forward-looking statements are reasonable, any of the
assumptions could be inaccurate and there can, therefore, be no assurance that
the forward-looking statements included in this Form 10-K will prove to be
accurate. In light of the significant uncertainties inherent in the
forward-looking statements included herein, the inclusion of such information
should not be regarded as a representation by the Company or any other person
that the objectives and plans of the Company will be achieved.
PART I
ITEM 1. BUSINESS.
GSE Systems, Inc. ("GSE Systems" or the "Company") designs, develops
and delivers business and technology solutions by applying
high-technology-related process control, data acquisition, 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 700 applications, representing
over 250 customers in 30 countries, in the following industries: specialty
chemical, food & beverage, petroleum refining, oil & gas pipelines,
pharmaceutical, fossil and nuclear power generation, metals and water treatment.
3
Recent Developments.
In 1997, the Company had poor financial results. The senior management
of the Company has been substantially changed in the last twelve months and the
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 had previously acquired Erudite Software & Consulting, Inc.
("Erudite Software"), a regional provider of client/server technology, custom
application software development, training services, hardware/software sales,
and network design and implementation services. This acquisition was made to
facilitate the Company's efforts to enter the client/server IT solutions market.
However, as a result of the Company's decision to re-focus its strategy on its
core businesses, the Company has taken steps toward the divestiture of Erudite
Software upon the receipt of an appropriate purchase offer. The Company's
current plan is to complete such a divestiture during the second quarter of
1998, however, there can be no assurance that such a divestiture will occur
within this time.
The Company had previously sought to expand its presence in overseas
markets, especially in Asia. Although the Company has made inroads in the
Asia-Pacific region from its base in Singapore, the Company has decided, as a
result of the instability caused by the recent Asian economic crisis, to
significantly reduce its presence in the region for at least the next twelve
months. The Company believes that such action will reduce its business
risk and cost in this region.
For the last several years, the Company has occupied a facility of
approximately 154,000 square feet in Columbia, Maryland. However, in order to
better meet the Company's expected facilities requirements for the foreseeable
future, the Company has entered into commitments whereby the lease for its
existing Columbia facility will be terminated and the affected operations are
scheduled to relocate into two separate facilities during the second quarter of
1998; one of these facilities will be in Columbia, Maryland (approximately
53,000 square feet); the other facility will be in Baltimore, Maryland
(approximately 33,000 square feet). The Company believes it can achieve an
annualized savings in excess of $1 million by the implementation of these
facilities arrangements.
The Company believes these actions will result in an ongoing, viable
enterprise more closely focused on its core businesses.
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").
In April 1996, the Company aligned its operating groups into three
strategic business units (SBUs) to better serve its 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.
4
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.
See "Recent Developments".
In December 1997, the Company acquired 100% of the outstanding common
stock of J.L. Ryan, Inc., ("Ryan"), a small provider of engineering
modifications and upgrade services to the power plant simulation market, for an
initial purchase price of $1 million ($600,000 of which was paid in cash upon
the closing of the transaction and the remainder through a promissory note
payable in four annual installments of $100,000 each beginning on January 2,
1999) and an amount equal to 50% of the earnings before interest, taxes and
amortization of the acquired 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 combination of the Company's pre-existing technology with the
technical staff of the acquired Ryan business positions the Company to be more
competitive for modifications and upgrade services projects within the nuclear
simulation market. This acquisition has been accounted for under the purchase
method. The acquisition was part of a comprehensive settlement of claims among
Power Systems, Ryan and certain individuals affiliated with Ryan which had been
pending in connection with a lawsuit filed by Power Systems in early 1997. See
Item 3. Legal Proceedings.
Business Strategy.
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
non-core-competency areas such as control and simulation systems.
At the same time, rapid change brought on by the popularity of
Microsoft(R) operating systems has offered users the promise of historically
equivalent technology at greatly reduced costs and/or improved technology at
equal costs. The emergence of open standards portends a future where
applications and systems adhering to these standards will work together
seamlessly regardless of what combination of software the user desires. However,
this multi-vendor systems environment is very complicated and users with fewer
resources now need more assistance to manage this new technology to meet the
specific requirements of their enterprises.
Furthermore, the Company believes change with respect to governmental
controls is occurring as a result of industry and utilities moving to a more
decentralized and unregulated posture worldwide. The Company believes the
governmental role will shift from direct control/intervention/regulation to
audit/assurance. Therefore, industrial and utility customers may be required to
train and certify their operations staffs using an approved training program
such as simulation technology, of which the Company is a worldwide leader.
By strategically focusing its products and services offerings on
opportunities created by these three convergent trends - greater reliance by the
market on key vendors, greater complexity of application and solution
integration, and growing demand for simulation technology and services -
the Company believes its prospects for the future will be strengthened.
Services and Products.
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, oil & gas; and
pharmaceuticals fields, as well as in the power generation industry, where the
Company is a world leader in nuclear power plant simulation.
5
As the Microsoft Windows NT(R) operating environment technology evolves
to have the robustness, features and benefits necessary for the requirements of
the Company's target industries, 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. Since the Company's
business model is based on recovering income via software licensing and
value-added services rather than the common industry practice of embedding
software costs inside the hardware sold, the Company can maintain its business
model in an environment of rapidly decreasing hardware costs.
The Company's proprietary products include a Distributed Control System
("DCS") product, known as the D/3 DCS(TM) that is highly flexible and open and a
family of real-time dynamic simulation tools. 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.
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.
The Company's proprietary technology also includes real-time dynamic
simulation tools and products that are used to develop high fidelity simulations
for nuclear and fossil power plants, petroleum refineries, oil & gas pipelines,
chemical processing plants and other industrial plants. This technology is both
licensed by the Company to its customers as well as used by the Company to
develop simulations for its customers. The most prominent products and tools are
known as SimSuite Pro(TM), SimSuite Pipeline(TM) and SimSuite Power(TM). Each of
these tools facilitates design verification, process optimization and operator
training.
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 700 simulation, process control and data
acquisition, and business systems to an installed base of over 250 customers
worldwide. In 1997, approximately 36.5% of the Company's worldwide revenue was
generated from customers outside the United States.
The Company's customers include, among others, Algonquin Gas
Transmission Company, Alyeska Pipeline Service Company, Archer Daniels Midland
Company, BASF Corporation, Cargill Incorporated, Exxon Company USA, Kraftwerks
Simulator Gesellschaft (Germany), Miller Brewing Company, PECO Energy, Tokyo
Electric Power Company (Japan) and USX-US Steel Group.
No individual customer represented more than 10% of the Company's 1997
revenue.
6
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: Siemens AG (Europe), All Russian Research Institute for Nuclear Power
Plant Operation (Russia), Kurchatov Institute (Russia), Beijing Aerospace
Industrial Control Automation Group Company (China), 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.
Also, the Company continues to believe that it must have strong
solutions partners as well as strong technology partners in order for it 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 client/server solutions 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: Maryland, Utah, Arizona, New Jersey, North Carolina, Georgia,
Louisiana, Texas, and Pennsylvania. Outside the U.S., the Company has offices in
Sweden, Belgium, Singapore, 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 1997, the Company continued investment 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 and the productization of its SimSuite(TM) software tools.
During the years ended December 31, 1997, 1996 and 1995, gross research and
product development expenditures for the Company were $5.1 million, $5.8 million
and $4.6 million, respectively. Capitalized software development costs totaled
$3.5 million, $3.9 million and $1.6 million during the years ended December 31,
1997, 1996 and 1995. See Note 2 of "Notes to Consolidated Financial Statements"
for a discussion of the Company's policy regarding capitalization of software
development costs.
7
Industries Served.
The following chart illustrates the approximate percentage of the
Company's 1997 and 1996 revenues, respectively, attributable to each of the
major industries served by the Company:
1997 1996
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Power............................................... 31% 45%
Process............................................. 46% 32%
Other............................................... 23% 23%
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, 1997, the Company's aggregate contract backlog totaled approximately $39.0
million. At December 31, 1996, contract backlog totaled $35.2 million.
Employees.
As of February 28, 1998, the Company had approximately 530 employees,
which represents a decrease of approximately 13% compared to February 1997. 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. Certain of the Company's
senior executives are subject to employment agreements which include
non-competition covenants. Although the Company's other key personnel are not
subject to long-term employment or non-competition agreements, they are subject
to standard confidentiality agreements.
ITEM 1A. RISK FACTORS.
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 any 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.
8
International Sales and Operations.
Sales of products and the provision of services to customers outside
the United States accounted for approximately 36.5% of the Company's revenues in
fiscal year 1997. 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 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.
9
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, process control and data acquisition technologies. The life
cycles for software modeling tools, display system software, process control,
data acquisition 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 environment,
however, there can be no assurance of customer acceptance of these Windows
NT-based products or that these products will be competitive with products
offered by the Company's competitors. Although the Company believes that no
significant trends to migrate to other operating platforms currently affect the
markets for the Company's products, there can be no assurance that customers
will not require compatibility with such other operating platforms in the
future.
Intellectual Property Rights.
Although the Company believes that factors such as the technological
and creative skills of its personnel, new product developments, frequent product
enhancements and reliable product maintenance are important to establishing and
maintaining a technological leadership position, the Company's business depends,
in part, on its intellectual property rights in its proprietary technology and
information. The Company relies upon a combination of trade secret, copyright,
patent and trademark law, contractual arrangements and technical means to
protect its intellectual property rights. The Company generally enters into
confidentiality agreements with its employees, consultants, joint venture and
alliance partners, customers and other third parties that are granted access to
its proprietary information, and generally limits access to and distribution of
its proprietary information. There can be no assurance, however, that the
Company has protected or will be able to protect its proprietary technology and
information adequately, that the unauthorized disclosure or use of the Company's
proprietary information will be prevented, that others have not or will not
develop similar technology or information independently, or, to the extent the
Company owns patents, that others have not or will not be able to design around
those patents. Furthermore, the laws of certain countries in which the Company's
products are sold do not protect the Company's products and intellectual
property rights to the same extent as the laws of the United States.
Competition.
The Company's businesses operate in highly competitive environments
with both domestic and foreign competitors, many of whom have substantially
greater financial, marketing and other resources than the Company. The principal
factors affecting competition include price, technological proficiency, ease of
system configuration, product reliability, applications expertise, engineering
support, local presence and financial stability. The Company believes that
competition in the simulation and process automation fields may further
intensify in the future as a result of advances in technology, consolidations
and/or strategic alliances among competitors, increased costs required to
develop new technology and the increasing importance of software content in
systems and products. The
10
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.
Emergence of New Requirements.
The Company is aware of general industry concerns that software
products provide consistent operation through and after the year 2000. The
Company has established a compliance program to test and, if necessary, modify
new versions of its products which are designed for use in connection with
applications for actual plant operations. An evaluation of the Company's
products which are not designed for use in connection with actual plant
operations has also been commenced. Any failure or delay in testing and/or
modifying its products to be year 2000 compliant could affect the Company's
competitive position or lead to product obsolescence.
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. Certain of the Company's senior executives are subject to
employment agreements which include noncompetition covenants. Although the
Company's other key personnel are not generally subject to long-term employment
or noncompetition agreements, they are subject to standard confidentiality
agreements.
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.
Influence of Affiliate Stockholders.
As of the date of this report, certain directors, executive officers
and other parties which are affiliates of the Company own in excess of 50% of
the Common Stock of the Company. If these stockholders vote together as a group,
they will be able to effectively control 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.
11
ITEM 2. PROPERTIES.
As of the date of this report, GSE Systems maintains its headquarters
and leases a facility of approximately 154,000 square feet in Columbia,
Maryland. However, in order to better meet the Company's expected facilities
requirements for the foreseeable future, the Company has entered into
commitments whereby the lease for its existing Columbia facility will be
terminated and the operations presently occupying such facility are scheduled to
relocate into two separate facilities during the second quarter of 1998; one of
these facilities will be in Columbia, Maryland (approximately 53,000 square
feet) and will be occupied by the Company's corporate headquarters offices, the
operations of Power Systems, as well as various other Company operations; the
other facility will be in Baltimore, Maryland (approximately 33,000 square feet)
and will be occupied by the operations of Process Solutions. 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
Arizona, Georgia, Louisiana, Texas, Pennsylvania, New Jersey, North Carolina,
and Utah, as well as in Belgium, Japan, Korea, Singapore, Sweden and Taiwan. The
Company leases these facilities for terms ending between 1998 and 2002.
ITEM 3. LEGAL PROCEEDINGS.
In December 1997, Power Systems, Ryan, and certain individuals
affiliated with Ryan reached a comprehensive settlement of the
previously-reported lawsuit pending among them; pursuant to this settlement,
Power Systems acquired all the capital outstanding stock of Ryan and all claims
among the parties were dismissed. See Item 1. Business - "Background."
Various other 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 of the Company.
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, 1997.
12
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.
1996 High Low
---- ---- ---
First Quarter........................................ $ 16 $ 13 1/4
Second Quarter....................................... $ 17 3/4 $ 12
Third Quarter........................................ $ 14 7/8 $ 9 1/4
Fourth Quarter....................................... $ 11 3/4 $ 6 1/2
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
There were approximately 50 holders of record of the Common Stock as of
March 6, 1998. Based upon information available to it, the Company believes
there are approximately 600 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 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.
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. None of the aforementioned stock option grants were
made pursuant to the Company's 1995 Long-Term Incentive Plan. Such transactions
were exempt from the registration requirements of the Securities Act of 1933, as
amended, pursuant to Section 4(2) thereunder.
13
ITEM 6. SELECTED FINANCIAL DATA.
The following tables present selected unaudited combined financial data
of Power Systems, GPI, Power Systems AB and Erudite Software with respect to the
periods beginning January 1, 1993 through April 13, 1994 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 all periods between January 1, 1993 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 1997, 1996 and 1995 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 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 since the date of its acquisition.
14
Predecessors (1) Company
---------------------- ----------------------------------------------------
Year Jan.1 Apr. 14 Year Ended December 31,
Ended through through ---------------------------------------
Dec. 31, April 13, Dec. 31,
1993 1994 1994 (2) 1995 (3) 1996 (3) 1997 (3)(4)
---- ---- -------- -------- -------- -----------
(in thousands, except per share data)
Statement of Operations Data:
Revenues .................................. $50,242 $14,659 $37,085 $96,060 $96,033 $79,711
Cost of revenue .......................... 45,656 10,380 27,932 65,592 63,679 58,326
------- ------- ------- ------- ------- -------
Gross profit ........................... 4,586 4,279 9,153 30,468 32,354 21,385
Operating expenses:
Selling, general and administrative ..... 11,342 2,628 6,313 21,815 24,192 27,320
Depreciation and amortization ........... 1,041 420 1,125 2,341 2,111 2,368
Business combination costs .............. -- -- -- -- 1,206 --
Employee severance and termination
costs.................................. -- -- -- -- -- 1,124
Total operating expenses ............
------- ------- ------- ------- ------- --------
12,383 3,048 7,438 24,156 27,509 30,812
------- ------- ------- ------- ------- --------
Operating income (loss) .................... (7,797) 1,231 1,715 6,312 4,845 (9,427)
Interest expense ........................... 48 41 402 983 387 765
Other expense (income), net ................ 57 (43) (192) (364) (394) 1,228
------- ------- ------- ------- ------- --------
Income (loss) before income taxes .......... (7,902) 1,233 1,505 5,693 4,852 (11,420)
Provision (benefit) for income taxes ....... (849) 678 552 2,017 709 (2,717)
Net income (loss) .......................... $ (7,053) $ 555 $ 953 $ 3,676 $4,143 $ (8,703)
======== ====== ====== ======= ====== ========
Earnings (loss) per common share - Basic .... $ 0.26 $ 0.91 $ 0.82 $ (1.72)
====== ======= ====== ========
- Diluted .. $ 0.26 $ 0.91 $ 0.82 $ (1.72)
====== ======= ====== ========
Weighted average common shares
outstanding - Basic .... 3,341 4,049 5,066 5,066
====== ======= ====== ========
- Diluted... 3,341 4,059 5,073 5,066
====== ======= ====== ========
As of As of As of December 31,
Dec. 31, Apr. 13, --------------------------------------------------
1993 1994 1994 1995 1996 1997
---- ---- ----- ---- ---- ----
Working capital.............................. ($2,039) ($434) $ 1,269 $16,077 $13,867 $ 1,646
Total assets................................. 29,588 35,655 42,312 54,688 51,006 48,362
Long-term liabilities........................ 10,326 15,570 15,783 6,055 2,580 2,369
Series A Preferred Stock..................... -- -- 2,400 -- -- --
Stockholders' equity (deficit)............... (3,128) (2,563) (4,229) 20,532 24,693 15,924
- ----------
(1) Historical results of operations and balance sheet data for the
Predecessors include the combined results of operations and the combined
balances on a historical cost basis of Power Systems (as a wholly-owned
subsidiary of Bicoastal Corporation until August 31, 1993 and of ManTech
thereafter), GPI, Power Systems AB and Erudite Software.
(2) Statement of operations data for the period April 14 through December 31,
1994 include the results of operations of the Company and its wholly-owned
subsidiaries Power Systems, GPI, Power Systems AB and Erudite Software.
Balance sheet data as of December 31, 1994 also includes the domestic
operations of Process Solutions, which was acquired on December 30, 1994.
(3) Statement of operations data for the year ended December 31, 1995, 1996 and
1997 includes the operations of Power Systems, GPI, Power Systems AB,
Erudite Software, the domestic operations of Process Solutions and the
international operations of Process Solutions, substantially all of which
the Company acquired in the second quarter of 1995. Balance sheet data as
of December 31, 1995, 1996 and 1997 includes Power Systems, GPI, Power
Systems AB, Erudite Software, the domestic and international operations of
Process Solutions.
(4) Statement of operations data for the year ended December 31, 1997 also
includes the operations of Ryan since its acquisition by Power Systems as
of December 1, 1997.
15
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,
------------------------------------------------------------------------
1997 1996 1995
-------------------- --------------------- -------------------
Contract revenue ........................ $ 79,711 100.0% $ 96,033 100.0% $ 96,060 100.0%
Cost of revenue ......................... 58,326 73.2 63,679 66.3 65,592 68.3
-------- ----- -------- ----- -------- -----
Gross profit ............................ 21,385 26.8 32,354 33.7 30,468 31.7
Selling, general and administrative....... 27,320 34.3 24,192 25.2 21,815 22.7
Depreciation and amortization ........... 2,368 3.0 2,111 2.2 2,341 2.4
Business combination costs .............. -- -- 1,206 1.3 -- --
Employee severance and termination costs.. 1,124 1.4 -- -- -- --
-------- ----- -------- ----- -------- -----
Operating (loss) income ................. (9,427) (11.8) 4,845 5.0 6,312 6.6
Interest expense ........................ 765 1.0 387 0.4 983 1.0
Other expense (income) ................... 1,228 1.5 (394) (0.4) (364) (0.4)
-------- ----- -------- ----- -------- -----
(Loss) income before income taxes ....... (11,420) 14.3 4,852 5.0 5,693 5.9
(Benefit from) provision for income
taxes ................................... (2,717) (3.4) 709 0.7 2,017 2.1
-------- ----- -------- ----- -------- -----
Net (loss) income ....................... $ (8,703) (10.9)% $ 4,143 4.3% $ 3,676 3.8%
======== ===== ======== ===== ======== =====
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
continues 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. 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 $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 reflects 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
16
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.
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
consists 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 the lawsuit referred to in Part I, Item 3.
Legal Proceedings. Additionally, the increase reflects 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 current Columbia, Maryland leased
facility for which the Company will 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 has 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 consist 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.
17
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 reflects 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 is 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 Expense (Income). 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.
Comparison of 1996 to 1995.
Contract Revenue. Total contract revenue was $96.0 million and $96.1
million for the years ended December 31, 1996 and 1995. There was an increase in
1996 revenues from the Company's growing client/server solutions business of 82%
or $8.8 million, which was offset by a reduction in nuclear simulation project
revenues by 14% or $7.0 million, due in part to the maturing of the nuclear
simulation business and the stoppage on a large Eastern European project due to
lack of customer funding.
Contract backlog at December 31, 1996 and 1995 totaled $35.2 million
and $60.1 million, respectively.
International sales were approximately $48.2 million or 50.2% of total
revenues in 1996 and $50.8 million or 52.8% of total revenues in 1995.
Gross Profit. Gross profit increased to $32.4 million, a gross margin
of 33.7% for the year ended December 31, 1996 from $30.5 million, a gross margin
of 31.7%, in the corresponding period of 1995. The increased gross margin was
primarily attributable to declining volume of certain low margin contracts,
settlement of claims on two international contracts, changes in contract and
warranty estimates and cost containment measures.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $24.2 million, or 25.2% of revenues, during
the year ended December 31, 1996 from $21.8 million, or 22.7% of revenues,
during the corresponding period in 1995. The increase in selling, general and
administrative expenses for 1996 was primarily attributable to increased sales
force, bid and proposal activities, a full year charge attributable to the
international operations of Process Solutions, a one time charge for severance
and employee related obligations as a result of the Company's alignment into
strategic business units and business expansion efforts. These expenses were
offset, in part, by a significant decrease in net research and development
expenses as discussed below and to a one-time $1.1 million adjustment in
connection with consolidation of duplicate facilities.
Gross research and product development expenditures were $5.8 million
and $4.6 million for the years ended December 31, 1996 and 1995, respectively.
Capitalized software development costs totaled $3.9 million and
18
$1.6 million, during the years ended December 31, 1996 and 1995, respectively.
Net research and development costs expensed and included within selling, general
and administrative expenses were $1.9 million and $3.0 million during the years
ended December 31, 1996 and 1995, respectively. During 1996, the Company
continued investing in its FlexBatch(R) recipe and process management system,
conversion of the S/3 SCADA(TM) System to Microsoft Windows NT(R) platform and
productization of SimSuite(TM) software tools.
Depreciation and Amortization. Depreciation expense amounted to $1.9
million and $1.6 million during the years ended December 31, 1996 and 1995,
respectively. This increase was attributable to higher levels of capital
expenditure in 1996.
Amortization of goodwill and intangibles was $168,000 and $766,000
during the years ended December 31, 1996 and 1995, respectively. This decrease
was attributable to the significant reduction in goodwill and other intangible
assets at December 31, 1995, as fully discussed in Note 8 of "Notes to
Consolidated Financial Statements".
Business Combination Costs. 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 in 1996.
Operating Income. Operating income amounted to $4.9 million and $6.3
million during the years ended December 31, 1996 and 1995, respectively. During
1996, excluding the non-recurring acquisition costs, operating income was $6.1
million, or 6.3% of revenues, as compared with $6.3 million, or 6.6% of revenues
during the corresponding period of 1995. The decrease in operating income for
1996 was attributable to higher expenses relating to sales and marketing efforts
and business expansion activities, which were partially offset by higher margins
on contracts, continued cost control initiatives, lower net research and
development expenses and one-time facility adjustment.
Interest Expense. Interest expense decreased to $387,000 during the
year from $983,000, during 1995. This decrease is attributable primarily to the
repayment in August 1995 of a five year promissory note to finance the Process
Solutions acquisition and temporary pay-down of the working capital bank lines
with the Company's initial public offering of Common Stock in mid-1995 ("IPO")
proceeds.
Other Expense (Income). Other income amounted to $394,000 from interest
earned from short-term investments of excess cash during the year ending
December 31, 1996 as well as proceeds from the sale of an equity interest in a
joint venture. During the corresponding period of 1995, $364,000 in interest
income was earned from short-term investments of cash proceeds from the IPO.
Income Tax Expense. The Company's effective tax rate decreased to 14.6%
in 1996 from 35.4% in 1995. The 1996 rate was decreased as a result of a one
time reduction of the tax provision of $1.1 million. This reduction reflected
the Company's assessment that it would be able to utilize previous net operating
loss carry forwards generated by its power business unit.
Liquidity and Capital Resources.
The Company has funded its activities primarily from operations and
from borrowings under lines of credit. In 1997, the Company's operating
activities used cash totaling approximately $3.8 million, primarily
19
related to the 1997 net loss of $8.7 million, together with an increase in
deferred income tax assets associated with a net operating loss carryforward,
partially offset by non-cash items such as depreciation and amortization. For
the year ended December 31, 1996, the Company's operating activities used cash
of approximately $1.9 million. At December 31, 1997, the Company had cash and
cash equivalents of $334,000 compared to $2.4 million as of December 31, 1996.
The Company used approximately $4,449,000 in cash for investing
activities, made up primarily of $3,474,000 of capitalized software development
costs and $918,000 of capital expenditures.
The Company generated cash flows from financing activities of
approximately $6,167,000, made up primarily of $6,450,000 in borrowings under
the Company's lines of credit.
The Company maintains, through its subsidiaries, two lines of credit
that provide for borrowings up to a total of $14.0 million to support foreign
letters of credit, margin requirements or foreign exchange contracts and working
capital needs. The first line for $7.0 million is 90% guaranteed by the
Export-Import Bank of the United States ("EXIM"), is collateralized by Power
Systems' contract receivables and inventory, and provides for borrowings up to
90% of eligible receivables and 60% of unbilled receivables. The second line,
also for $7.0 million, is collateralized by substantially all of Process
Solutions' assets, and provides for borrowing up to 85% of eligible receivables
and 20% of inventory (not to exceed $500,000). 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 November 1997, the Process Solutions line was amended to permit the
use of loan proceeds to support the working capital needs of Erudite Software.
In connection with this amendment, Erudite Software became fully liable for
amounts outstanding under the line and substantially all of its assets were
pledged as collateral.
In March 1998, the Company entered into agreements with the bank
whereby each of the Power Systems and Process Solutions lines of credit was
conditionally extended through June 30, 1998 and a temporary $1.5 million
over-advance limit was established for the Process Solutions line. In connection
with the aforementioned agreement concerning the Process Solutions line, 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 guaranties, the
Company has agreed to grant both GP Strategies and ManTech warrants to purchase
shares of the Company's Common Stock; the number of shares of Common Stock and
other provisions for such warrants have not been finalized as of the date of
this report. The aforementioned agreement concerning the Process Solutions line
also provides for: (i) an increase of the applicable interest rate from the
prime rate to the prime rate plus 1.00% or from LIBOR plus 1.0% to LIBOR plus
3.00%, as the case may be, and (ii) a reduction in the available borrowing
level, and a repayment of outstanding borrowings above such level, in the event
of the Company's sale or transfer of certain assets. The Power Systems line
continues to bear interest at the prime rate or LIBOR plus 1.5%, as the case may
be.
Although the Company was not in compliance with its cash flow coverage
ratio or minimum tangible net worth ratio covenants as of December 31, 1997, the
Company has received a written waiver of such covenants from its bank.
In 1997, the Company entered into an equipment lease arrangement which
provided for up to $1.2 million of available credit to be used for the
procurement of certain computer hardware and office equipment. The Company had
utilized $610,000 of credit under this arrangement, of which $521,000
related to a sale and lease-back of equipment previously purchased by the
Company, prior to expiration of the availability of credit on December 31, 1997.
The terms of the lease provide for the Company's payment of monthly lease
charges for a term of 36 months.
The Company's additional commitments as of December 31, 1997 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 $548,000, and letters of credit, amounting
to $318,000, as of December 31, 1997, furnished by its subsidiaries' respective
former parent organizations in accordance with the
20
agreement among ManTech, GP Strategies, GPC, SGLG, Vattenfall and the Company
dated April 13, 1994 (the "Formation Agreement"). 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.
During the year ended December 31, 1997, the Company generated a net
loss of $8.7 million. The Company's credit facilities expire at June 30, 1998,
and currently the Company does not have the financial wherewithal to repay these
loans. The Company plans to reduce its borrowings through the proceeds from the
sale of Erudite Software, which sale the Company is currently actively pursuing.
Further, the Company is exploring other options to enhance its liquidity through
an additional restructuring of its operations. Although the Company intends to
seek to renegotiate or replace its expiring credit facilities in connection with
these liquidity enhancing actions, there can be no assurance that such financing
will be available to the Company, or if available, will be on terms favorable to
the Company.
In the event that the sale of Erudite Software does not result in
sufficient proceeds to meet the Company's current obligations as they become
due, or in the event that the sale of Erudite Software does not occur before
June 30, 1998, certain of the Company's principal stockholders ManTech and GP
Strategies have agreed to provide working capital support to the Company through
credit enhancements, a portion of which is subject to bank approval which is
expected to be received, or by taking actions that would result in additional
liquidity to the Company. Although the specific form(s) of this working capital
support has not yet been determined, such support may be in the form of credit
enhancements, corporate guaranties and/or purchases of certain of the Company's
assets.
Management believes that the above actions will result in sufficient
liquidity and working capital resources necessary for planned business
operations, debt service requirements, planned investments and capital
expenditures.
Although the terms of the aforementioned credit working capital support
arrangements have not yet been determined, such arrangements could have a
dilutive effect on the interests of other holders of the Company's Common Stock.
Foreign Exchange.
A portion of the Company's international sales revenue is received in a
currency other than the currency in which the expenses relating to such revenue
are paid. The Company manages its foreign currency exposure primarily by
entering into foreign currency exchange agreements and purchasing foreign
currency options. The former requires the Company, on a specified date or during
a specified period, to exchange a set amount of foreign currency for United
States dollars or another base currency. The latter provides the Company with
the option to exchange foreign currency for United States dollars or another
base currency on a specified date or during a specified period. The Company
utilizes these foreign exchange agreements and options only to reduce the impact
of foreign currency fluctuations on its operating results and does not engage in
foreign currency speculation. Foreign exchange contracts do not expose the
Company to material risk because any losses on the contracts are calibrated to
be offset by gains on the value of the foreign receivables being hedged. Foreign
exchange options do not expose the Company to material risk since the Company
has the right not to exercise the option.
At December 31, 1997, the Company had forward option contracts of
$460,000 to hedge future German mark receipts and the Company's Swedish
subsidiary had forward exchange contracts of Swedish krona 7.0 million, or
approximately $900,000 to hedge future Japanese yen and German mark receipts.
Gains and losses on such contracts are recognized as part of the cost of the
underlying transactions being hedged. 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 NationsBank and Nordbanken AB. Management believes that the
risk of incurring such losses is immaterial. The Company has also entered into
foreign exchange option contracts with NationsBank, which permit, but do not
require, the Company to exchange foreign currencies at a future date with the
bank at a contracted exchange rate. Costs associated with such contracts are
amortized over the life of the contract matching the underlying receipts.
Other Matters.
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 130,
21
"Reporting Comprehensive Income," and Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information," in June 1997, which are both effective for the year ending
December 31, 1998. SFAS No. 130 establishes standards for reporting
comprehensive income in a full set of general purpose financial statements
either in the income statement or in a separate statement. SFAS No. 131
establishes standards for reporting information about operating segments,
including related disclosures about products and services, geographic areas and
major customers. These standards are not expected to have a material impact on
the financial reporting or disclosures of the Company.
Statement of Position 97-2 ("SOP 97-2") regarding Software Revenue
Recognition will be effective for transactions entered into in fiscal years
beginning after December 15, 1997. SOP 97-2 addresses contract accounting issues
in the context of the software industry. Adoption of SOP 97-2 is not expected to
have a material impact on the Company.
The Company is in the process of assessing its computer applications to
ensure their functionality with respect to the year 2000 millennium change. At
present, the Company does not anticipate that material incremental costs will be
incurred in any single future year.
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, SimSuite Pro, SimSuite Pipeline, SimSuite Power,
FlexBatch, TotalVision, SABL, D/3 DCS and S/3 SCADA are trademarks of GSE
Systems, Inc. All other trademarks and/or registered trademarks are the property
of their respective owners.
22
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, 1997 and 1996............................................................ F-2
Consolidated Statements of Operations for the years ended
December 31, 1997, 1996 and 1995..................................................................................... F-3
Consolidated Statements of Stockholders' Equity (Deficit) for the years ended
December 31, 1997, 1996 and 1995..................................................................................... F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995..................................................................................... F-5
Notes to Consolidated Financial Statements.............................................................................. F-6
23
REPORT OF INDEPENDENT ACCOUNTANTS
To The Board of Directors and Stockholders of
GSE Systems, Inc.
We have audited the accompanying consolidated balance sheets of GSE Systems,
Inc. and Subsidiaries (the Company) as of December 31, 1997 and 1996, and the
related consolidated statements of operations, changes in stockholders' equity
(deficit) and cash flows for each of the three years in the period ended
December 31, 1997. 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 in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of GSE Systems, Inc.
and Subsidiaries as of December 31, 1997 and 1996, and the consolidated results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted accounting
principles.
COOPERS & LYBRAND L.L.P.
McLean, Virginia
March 31, 1998
F-1
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
ASSETS
December 31, December 31,
1997 1996
------------ ------------
Current assets:
Cash and cash equivalents ........................................................ $ 334 $ 2,450
Contract receivables ............................................................. 24,371 27,457
Inventories ...................................................................... 2,700 3,538
Prepaid expenses and other current assets ........................................ 1,739 2,701
Deferred Income taxes ............................................................ 2,570 1,454
------- -------
Total current assets ........................................................ 31,714 37,600
Property and equipment, net ...................................................... 3,864 5,318
Investment in joint venture ...................................................... 252 --
Software development costs, net .................................................. 7,526 5,176
Goodwill and other intangible assets, net ........................................ 2,974 2,059
Deferred income taxes ............................................................ 1,730 569
Other assets ..................................................................... 302 284
------- -------
Total assets ............................................................... $48,362 $51,006
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Lines of credit .................................................................. $ 9,032 $ 2,582
Accounts payable ................................................................ 7,919 8,604
Accrued expenses ................................................................. 4,304 4,430
Obligations under capital lease ................................................. 208 186
Accrued severance costs ......................................................... 148 --
Billings in excess of revenue earned ............................................. 6,719 5,358
Accrued contract reserves ....................................................... 287 233
Accrued warranty reserves ....................................................... 625 1,408
Other current liabilities ....................................................... 513 281
Income taxes payable ............................................................. 313 651
------- -------
Total current liabilities ................................................ 30,068 23,733
Notes payable to related parties ............................................... 185 202
Obligations under capital lease .................................................. 234 420
Billings in excess of revenue earned ............................................ -- 803
Accrued contract and warranty reserves ........................................... 675 687
Other liabilities ............................................................... 1,276 468
------- -------
Total liabilities ........................................................ 32,438 26,313
------- -------
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 .................................................. 21,378 21,378
Retained earnings (deficit) - at formation ................................... (5,112) (5,112)
Retained earnings (deficit) - since formation ................................ (239) 8,464
Cumulative translation adjustment............................................. (153) (87)
------- -------
Total stockholders' equity ................................................ 15,924 24,693
------- -------
Total liabilities & stockholders' equity .................................. $48,362 $51,006
======= =======
The accompanying notes are an integral part of these
consolidated financial statements.
F-2
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Years ended December 31,
1997 1996 1995
---- ---- ----
Contract revenue...................................... $79,711 $96,033 $96,060
Cost of revenue....................................... 58,326 63,679 65,592
-------- ------- -------
Gross profit..................................... 21,385 32,354 30,468
-------- ------- -------
Operating expenses:
Selling, general and administrative................. 27,320 24,192 21,815
Depreciation and amortization....................... 2,368 2,111 2,341
Business combination costs.......................... -- 1,206 --
Employee severance and termination costs............ 1,124 -- --
-------- ------- -------
Total operating expenses............................ 30,812 27,509 24,156
-------- ------- -------
Operating (loss) income ......................... (9,427) 4,845 6,312
Interest expense, net................................. 765 387 983
Other (income) expense ............................... 1,228 (394) (364)
-------- ------- -------
(Loss) income before income taxes................ (11,420) 4,852 5,693
(Benefit from) provision for income taxes............. (2,717) 709 2,017
-------- ------- -------
Net (loss) income............................... $ (8,703) $ 4,143 $ 3,676
======== ======= =======
Basic and diluted (loss) earnings per common share.... $ (1.72) $ 0.82 $ 0.91
======== ======= =======
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands)
Retained Earnings
Common Stock (Deficit)
--------------- Additional ---------------------
Paid-in At Since
Shares Amount Capital Formation Formation
------ ------ ------- --------- ---------
Balance January 1, 1995......... 3,341 $ 33 $ -- $(5,048) $ 874
Issuance of common stock........ 1,725 17 21,121 -- --
Distribution to shareholder..... -- -- -- (64) (229)
Reductions in notes receivable.. -- -- -- -- --
Foreign currency translation.... -- -- -- -- --
Pension liability adjustment.... -- -- -- -- --
Net income... .................. -- -- -- -- 3,676
----- ------ ------- ------- -------
Balance, December 31, 1995...... 5,066 50 21,121 (5,112) 4,321
Compensation expense............ -- -- 257 -- --
Foreign currency translation.... -- -- -- -- --
Pension liability adjustment.... -- -- -- -- --
Net income...................... -- -- -- -- 4,143
----- ------ ------- ------- -------
Balance, December 31, 1996...... 5,066 50 21,378 (5,112) 8,464
Foreign currency translation.... -- -- -- -- --
Net loss........................ -- -- -- -- (8,703)
----- ------ ------- ------- -------
Balance, December 31, 1997...... 5,066 $ 50 $21,378 $(5,112) $ (239)
===== ====== ======= ======= =======
Notes Pension Foreign
Receivable from Liability Currency
Stockholders Adjustment Translation Total
------------- ---------- ----------- -----
Balance January 1, 1995......... $ (75) $ (73) $ 60 $(4,229)
Issuance of common stock........ -- -- -- 21,138
Distribution to shareholder..... -- -- -- (293)
Reductions in notes receivable.. 75 -- -- 75
Foreign currency translation.... -- -- 194 194
Pension liability adjustment.... -- (29) -- (29)
Net income... .................. -- -- -- 3,676
------- ------ ------ -------
Balance, December 31, 1995...... -- (102) 254 20,532
Compensation expense............ -- -- -- 257
Foreign currency translation.... -- -- (341) (341)
Pension liability adjustment.... -- 102 -- 102
Net income...................... -- -- -- 4,143
------- ------ ------ -------
Balance, December 31, 1996...... -- -- (87) 24,693
Foreign currency translation.... -- -- (66) (66)
Net loss........................ -- -- -- (8,703)
------- ------ ------ -------
Balance, December 31, 1997...... $ -- $ -- $ (153) $15,924
======= ====== ====== =======
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years ended December 31,
-------------------------------
1997 1996 1995
---- ---- ----
Cash Flows From Operating Activities
Net (loss) income ............................................................. $(8,703) $ 4,l43 $ 3,676
Adjustments to reconcile net (loss) income to net cash provided by
(used in) operating activities:
Depreciation and amortization.............................................. 3,492 2,747 2,813
Accrued facility reserve................................................... 852 (1,451) (348)
Provision for doubtful contract receivables ............................... 723 -- 102
Foreign currency transaction loss.......................................... 1,275 -- --
Non-cash stock compensation................................................ -- 257 --
Deferred income taxes ..................................................... (2,277) 71 627
Interest imputed on discounted note payable ............................... -- -- 17
Changes in assets and liabilities:
Contract receivables.................................................. 1,464 2,103 (7,962)
Inventories........................................................... 727 (1,245) 271
Prepaid expenses and other current assets............................. 836 355 (1,208)
Other assets.......................................................... (17) (181) (150)
Accounts payable and accrued expenses................................. (2,152) 1,399 3,645
Accrued severance .................................................... 148 -- --
Billings in excess of revenue earned.................................. 644 (6,933) 617
Accrued contract and warranty reserves................................ (710) (1,927) (2,605)
Other current liabilities............................................. 200 (780) (157)
Income taxes payable ................................................. (315) (520) 676
Other liabilities..................................................... (2) 41 (1)
------- ------- ------
Net cash provided by (used in) operating activities............................ (3,815) (1,921) 13
------- ------- ------
Cash Flows From Investing Activities:
Capital expenditures.................................................. (918) (2,834) (1,501)
Capitalization of software development costs.......................... (3,474) (3,890) (1,664)
Purchase of business, net of cash acquired............................ (578)
Proceeds from sale/leaseback transaction.............................. 521 -- --
------- ------- ------
Net cash used in investing activities.......................................... (4,449) (6,724) (3,165)
------- ------- ------
Cash Flows From Financing Activities:
Increase in (repayments under) lines of credit with bank................... 6,450 2,369 (4,024)
Cash overdraft ............................................................ -- -- (13)
Repayment to Vattenfall ................................................... -- -- (1,411)
Repayments under capital lease obligations................................. (266) (37) (75)
Principal payments under term-note......................................... -- -- (7,882)
Decrease in notes payable to related parties .............................. (17) -- (38)
Payments to shareholder at formation ...................................... -- -- (64)
Net proceeds from sale of common stock .................................... -- -- 21,138
Redemption of preferred stock ............................................. -- -- (2,400)
Net repayment of amounts due from stockholders............................. -- (204) 2,473
------- ------- ------
Net cash provided by (used in) financing activities............................ 6,167 2,128 7,704
Effect of exchange rate changes on cash........................................ (19) (49) 112
------- ------- ------
Net increase (decrease) in cash and cash equivalents........................... (2,116) (6,566) 4,664
Cash and cash equivalents at beginning of period............................... 2,450 9,016 4,352
------- ------- ------
Cash and cash equivalents at end of period..................................... $ 334 $ 2,450 $ 9,016
======= ======= =======
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Business
GSE Systems, Inc. (the "Company") designs, develops and delivers business and
technology solutions by applying process control, data acquisition, simulation,
client/server and business software, systems and services to the energy, process
and manufacturing industries worldwide. 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 does business as GSE Process Solutions, Inc.
("Process Solutions"). In May 1996, the Company acquired all of the outstanding
shares of capital stock of Erudite Software & Consulting, Inc. ("Erudite
Software"), a provider of client/server solutions through custom application
software development, training services, hardware-software sales and network
design and implementation. In December 1997, the Company acquired all of the
outstanding shares of capital stock of J.L. Ryan, Inc. ("Ryan"), a provider of
engineering modifications and upgrade services to the power plant simulation
market.
During the year ended December 31, 1997, the Company generated a net loss of
$8.7 million. The Company's credit facilities expire at June 30, 1998, and
currently the Company does not have the financial wherewithal to repay these
loans. The Company plans to reduce its borrowings through the proceeds from the
sale of Erudite Software, which sale the Company is currently actively pursuing.
Further, the Company is exploring other options to enhance its liquidity through
an additional restructuring of its operations. Although the Company intends to
seek to renegotiate or replace its expiring credit facilities in connection with
these liquidity enhancing actions, there can be no assurance that such financing
will be available to the Company, or if available, will be on terms favorable to
the Company.
In the event that the sale of Erudite Software does not result in sufficient
proceeds to meet the Company's current obligations as they become due, or in the
event that the sale of Erudite Software does not occur before June 30, 1998,
certain of the Company's principal stockholders ManTech and GP Strategies have
agreed to provide working capital support to the Company through credit
enhancements, a portion of which is subject to bank approval which is expected
to be received, or by taking actions that would result in additional liquidity
to the Company. Although the specific form(s) of this working capital support
has not yet been determined, such support may be in the form of credit
enhancements, corporate guaranties and/or purchases of certain of the Company's
assets.
Management believes that the above actions will result in sufficient
liquidity and working capital resources necessary for planned business
operations, debt service requirements, planned investments and capital
expenditures.
Although the terms of the aforementioned credit working capital support
arrangements have not yet been determined, such arrangements could have a
dilutive effect on the interests of other holders of the Company's Common Stock.
2. Summary of significant accounting policies
Formation of the Company
The Company was formed through the contribution of the businesses of Power
Systems (and its immediate parent), GPI and Power Systems AB by their parent
organizations, ManTech and certain of its employees and related parties, GP
Strategies and GP Strategies' affiliates, SGLG, Inc. ("SGLG" and formerly "GPS
Technologies, Inc." or "GPS") and General Physics Corporation ("GPC"), and
Vattenfall Engineering AB ("Vattenfall"). In exchange, the contributors received
shares of Common Stock of the Company. In addition, ManTech received shares of
preferred stock of the Company and Vattenfall received cash and notes. In light
of the equality of interests of the Company's principal stockholders, there was
no identifiable acquirer in the consolidation. Thus, the assets and liabilities
of each of the businesses contributed were recorded at historical cost.
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, Process Solutions, Erudite Software and Ryan. All
inter-company balances and transactions have been eliminated.
F-6
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 original maturities of less than three months at the
date of purchase.
Supplemental disclosures of cash flow information (in thousands):
Year Ended December 31,
---------------------------------------------
1997 1996 1995
---- ---- ----
Non cash investing & financing activities:
Obligations under capital leases........................ $ 102 $ 313 $ 90
===== ===== ===
Notes payable to related party for investment in joint
venture................................................... $ 252 $ -- $ --
===== ===== ====
Cash paid:
Interest.................................................. 741 228 882
===== ===== ====
Income taxes.............................................. 233 285 767
===== ===== ====
As discussed in Note 3 the Company acquired Process Solutions' international
operations in the second quarter of 1995 and the operations of J. L. Ryan in
December of 1997. In conjunction with these acquisitions, the purchase price
consisted of the following: (in thousands)
Cash paid................................................. $ 600 -- $ --
Long-term note payable issued............................. 900 -- 1,043
------ ------ -------
Total purchase price...................................... $1,500 -- $ 1,043
====== ====== =======
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.
F-7
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A summary of inventories is as follows (in thousands):
December 31,
1997 1996
---- ----
Raw materials.......................... $ 1,610 $ 2,115
Service parts.......................... 1,090 1,423
------- -------
$ 2,700 $ 3,538
====== ======
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 $1,580,000, $1,861,000 and $2,945,000 for the
years ended December 31, 1997, 1996 and 1995, 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.
Asset Impairments
At each balance sheet date, management evaluates the recoverability of
identifiable tangible and intangible assets using certain financial indicators,
such as historical and future ability to generate income from operations. The
Company's policy is to record an impairment loss against the net unamortized
cost of the asset in the period when it is determined that the carrying amount
of the asset may not be recoverable. This determination is based on an
evaluation of such factors as the occurrence of a significant event, a
significant change in the environment in which the business operates, or if the
expected future net cash flows (undiscounted and without interest) would become
F-8
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
less than the carrying amount of the asset. Measurement of the impairment loss
is based on the estimated fair value of the asset.
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 as a separate component of stockholders' equity. Transaction gains
and losses, resulting from changes in exchange rates, are included in operations
in the period in which they are incurred. For the year ended December 31, 1997,
the foreign currency transaction loss, which is included in other (income)
expense, was approximately $1,275,000. This transaction loss is primarily the
result of intercompany transactions which have been negatively impacted by the
poor financial condition of Asian markets. Foreign currency transaction gains
and losses were not material in 1996 and 1995.
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 sales of other products is recorded when the
products are shipped, and for software products, upon execution of a licensing
agreement, shipment of the product and the determination by management that the
resulting receivable is deemed collectible. 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. The Company has no significant vendor
obligations or collectibility risk associated with its product sales.
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. During 1997 and 1996, the Company revised its
estimate for future warranty costs. The effect of these changes in estimates was
to decrease gross profit in 1997 by approximately $(230,000) and increase gross
profit in 1996 by approximately $601,000.
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.
F-9
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Earnings per share
Effective December 31, 1997, the Company adopted Statement of Financial
Accounting Standards No. 128, "Earnings Per Share," which requires the
presentation of basic earnings per share and diluted earnings per share. Basic
earnings per share is based on the weighted average number of outstanding common
shares for the period. Diluted earnings per share adjusts the weighted average
for the potential dilution that could occur if stock options, warrants or other
convertible securities were exercised or converted into common stock. Diluted
earnings per share is the same as basic earnings per share for the year ended
December 31, 1997 because the effects of such items were anti-dilutive. The
earnings per share computations have been restated for all periods presented to
conform to FAS 128.
The number of common shares and common share equivalents used in the
determination of basic and diluted earnings (loss) per share was as follows. The
difference between these amounts in 1996 and 1995 represents dilutive options to
purchase shares of common stock computed under the treasury stock method.
1997 1996 1995
---- ---- ----
Basic................. 5,065,700 5,065,700 4,049,000
========= ========= =========
Diluted............... 5,065,700 5,073,700 4,059,000
========= ========= =========
New Accounting Standards
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income," and Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information," in June 1997, which are both effective for
the year ending December 31, 1998. SFAS No. 130 establishes standards for
reporting comprehensive income in a full set of general purpose financial
statements either in the income statement or in a separate statement. SFAS No.
131 establishes standards for reporting information about operating segments,
including related disclosures about products and services, geographic areas and
major customers.
Statement of Position 97-2 (SOP 97-2) regarding Software Revenue Recognition
will be effective for transactions entered into in fiscal years beginning after
December 15, 1997. SOP 97-2 addresses contract accounting issues in the context
of the software industry. Adoption of SOP 97-2 is not expected to have a
material impact on the Company.
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, 1997, 1996 and 1995 and there were no significant contract
receivables from a single customer at December 31, 1997 and 1996. 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.
Off balance sheet risk and foreign exchange contracts
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.
F-10
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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
The Company acquired the net assets of the domestic operations of Process
Solutions on December 30, 1994 and the international operations in the second
quarter of 1995 for an aggregate purchase price of $9,882,000. This acquisition
was accounted for under the purchase method. The financial results of Process
Solutions have been included in the results of operations from the dates of
acquisition. The acquisition was financed through a promissory note payable in
the amount of $5,882,000 with a five year term (the "TI Five-Year Note"), a
short-term promissory note payable in the amount of $2,000,000 and cash from
operations of the Company in the amount of $2,000,000. The TI Five-Year Note,
which was guaranteed by the Company and certain of its stockholders, and the
short-term promissory note, bore interest at a rate of 8% and were fully repaid
in 1995. The Company is also required to make quarterly performance payments to
TI equal to 15% of the revenue earned through December 30, 1999 attributable to
the Real Time Business Controls portion of the acquired business with a minimum
payment of $750,000 and a maximum payment of $4,000,000. The minimum amount of
$750,000 has been accrued and recorded as goodwill, and all additional payments
above $750,000 will be recorded as goodwill if paid. The acquisition resulted in
total goodwill of $2,427,000, which is being amortized over fifteen years.
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 has
been accounted for using the pooling-of-interests method of accounting and
accordingly, the Company's consolidated financial statements have been restated
to include the accounts and operations of Erudite Software for all periods prior
to the merger.
Combined and separate results of the Company and Erudite Software during the
periods preceding the merger were as follows (in thousands):
The Company Erudite Software Combined
----------- ---------------- --------
Three Months Ended March 31, 1996:
Revenue......................... $ 18,545 $ 3,758 $ 22,303
============ =========== ==========
Net income...................... $ 860 $ 231 $ 1,091
============ =========== ==========
Year Ended December 31, 1995:
Revenue......................... $ 85,302 $ 10,758 $ 96,060
============ =========== ==========
Net income...................... $ 3,490 $ 186 $ 3,676
============ =========== ==========
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
F-11
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
acquisition has been 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. The following unaudited pro forma information
has been prepared assuming that the acquisition was consummated on January 1,
1996.
Pro Forma Information (Unaudited)
Year Ended
------------------------
1997 1996
---- ----
(In thousands, except per share data)
(Unaudited)
Revenues .................................................... $ 81,239 $ 98,310
Net income .................................................. $ (8,861) $ 4,505
Basic and diluted (loss) earnings per share................... $ (1.75) $ .89
Weighted Average Number of Shares Outstanding - Basic......... 5,066 5,066
======== ========
The pro forma results are not necessarily indicative of what actually would
have occurred if the acquisition and the payment of debt had been made at the
beginning of the above periods. In addition, they are not intended to be a
projection of future results.
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. Fair value estimates of foreign
currency instruments, which are included in prepaid expenses and other current
assets in the consolidated balance sheet, were based on quotes from financial
institutions, as set forth below (in thousands):
December 31, 1997 December 31, 1996
--------------------------------- ----------------------------------
Notional/ Notional/
Carrying Fair Contract Carrying Fair Contract
Amount Value Value Amount Value Value
------ ----- ----- ------ ----- -----
Foreign currency instruments:
Options......................... $ 55 $ 62 $ 520 $ 333 $ 231 $ 3,973
Forward contracts............... $ - $ - $1,410 $ 370 $ 409 $ 4,665
Swaps........................... $ - $ - $ - $ 106 $ 89 $ 594
5. Contract receivables and billings in excess of revenue earned
Contract receivables represent balances due from a broad base of both
domestic and international customers. Due to the various billing and payment
terms, none of these individual customer balances is significant (more than
10%). All contract receivables are considered to be collectible within twelve
months. The components of contract receivables are as follows (in thousands):
F-12
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31,
---------------------
1997 1996
---- ----
Billed receivables........................................................ $ 16,994 $ 18,041
Recoverable costs and accrued profit - not billed......................... 8,398 9,714
Allowance for doubtful accounts........................................... (1,021) (298)
-------- --------
Total contract receivables............................................ $ 24,371 $ 27,457
======== ========
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 $410,000 for the year ended December 31,
1997 and to increase gross profit by approximately $1,900,000 and $1,019,000
during the years ended December 31, 1996 and 1995 respectively.
For the year ended December 31, 1995, the total estimated contract revenue
and costs at completion for two international contracts included claims revenue,
which was equal to estimated future costs, of $1,200,000. During 1996, the
Company received contract modifications totaling $2,200,000 for the claims
recognized in 1995 and for additional claims in 1996. In connection with these
contract modifications, the Company incurred total costs of approximately
$1,600,000, including costs related to the claims recognized in 1995.
Accordingly, the Company recognized additional gross profit of approximately
$600,000 during 1996.
Additionally, in early 1997, the Company settled claims and counterclaims with
its consortium partner on these international contracts for which there was no
net impact to the Company.
6. Property and equipment
Property and equipment consists of the following (in thousands):
December 31,
--------------------
1997 1996
---- ----
Computer equipment........................................................ $ 7,771 $ 7,101
Leasehold improvements.................................................... 1,889 1,829
Furniture and fixtures.................................................... 1,652 1,521
------- -------
11,312 10,451
Accumulated depreciation and amortization................................. (7,448) (5,133)
------- -------
Property and equipment, net............................................... $ 3,864 $ 5,318
======= =======
Depreciation and amortization expense was $2,149,000, $1,943,000 and
$1,575,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
The Company has $962,000 and $860,000 in assets held under capital lease as
of December 31, 1997 and 1996, respectively. Accumulated amortization on these
assets was $384,000 and $190,000 as of December 31, 1997 and 1996, respectively.
F-13
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
7. Software development costs
Software development costs, net, consist of the following (in thousands):
December 31,
-------------------
1997 1996
---- ----
Capitalized software development costs.................................... $ 9,028 $ 5,554
Accumulated amortization.................................................. (1,502) (378)
------- --------
Software development costs, net........................................... $ 7,526 $ 5,176
======== ========
Software development costs capitalized were $3,474,000, $3,890,000 and
$1,664,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
Amortization of software development costs capitalized was $1,124,000, $635,000,
$471,000 for the years ended December 31, 1997, 1996 and 1995, respectively, and
are included within cost of revenue. During 1996, the Company wrote-off
approximately $2.4 million in fully amortized capitalized software development
costs.
8. Goodwill
Goodwill consists of the following (in thousands):
December 31,
-------------------
1997 1996
---- ----
Cost...................................................................... $ 3,559 $ 2,425
Accumulated amortization.................................................. (585) (366)
------- -------
Total............................................................... $ 2,974 $ 2,059
======= =======
Amortization expense for goodwill was approximately $219,000, $168,000 and
$270,000 for the years ended December 31, 1997, 1996 and 1995, respectively. For
the year ended December 31, 1995, the Company recorded amortization expense of
$496,000 for other intangible assets that were fully amortized by December 31,
1995.
As discussed in Note 11, during 1996 and 1995, the Company reduced the
valuation allowance (against deferred tax assets) that was set up in connection
with the acquisition of Power Systems in August 1993. This resulted in a
corresponding reduction of goodwill of $109,000 and $525,000 during the years
ended December 31, 1996 and 1995, respectively, and other intangible assets by
$829,000 during the year ended December 31, 1995.
9. Accrued expenses
Accrued expenses consist of the following (in thousands):
December 31,
-----------------
1997 1996
---- ----
Accrued vacation, severance and other benefits............................ $ 1,771 $ 2,456
Accrued compensation and payroll taxes.................................... 1,260 1,504
Other accrued expenses.................................................... 1,273 470
------- -------
Total................................................................... $ 4,304 $ 4,430
======= =======
F-14
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
10. Notes payable and financing arrangements
Notes payable and financing arrangements consist of the following (in
thousands):
December 31,
---------------------
1997 1996
---- ----
Lines of credit with bank................................................. $ 9,032 $ 2,582
Notes payable to related parties.......................................... 185 202
Capital lease obligations................................................. 442 606
------- -------
Total notes payable and financing arrangements.......................... 9,659 3,390
Less amounts payable within one year...................................... (9,240) (2,768)
------- -------
Long-term portion....................................................... $ 419 $ 622
======= =======
Lines of Credit
The Company maintains, through its subsidiaries, two lines of credit that
provide for borrowings up to $14.0 million to support foreign letters of credit,
margin requirements or foreign exchange contracts and working capital needs. The
first line, through Power Systems, of $7.0 million is 90% guaranteed by the
Export-Import Bank of the United States ("EXIM") and is collateralized by Power
Systems' contract receivables and inventory. The line provides for borrowings up
to 90% of eligible receivables and 60% of unbilled receivables. The outstanding
borrowings under the Power Systems line at December 31, 1997 were $4,943,000.
The second line, through Process Solutions, of $7.0 million is collateralized by
substantially all of Process Solutions' assets and provides for borrowings up to
85% of eligible receivables and 20% of inventory (limited to $500,000). The
outstanding borrowings under the Process Solutions line at December 31, 1997
were $4,090,000. The weighted average interest rate on these borrowings was
8.3%, 8.25% and 8.5% for the years ended December 31, 1997, 1996 and 1995,
respectively.
In November 1997, the Process Solutions line was amended to permit the use
of loan proceeds to support the working capital needs of Erudite Software. In
connection with this amendment, Erudite Software became fully liable for amounts
outstanding under the line and substantially all of its assets were
pledged as collateral.
In March 1998, the Company entered into agreements with the bank whereby
each of the Power Systems and Process Solutions lines of credit was
conditionally extended through June 30, 1998 and a temporary $1.5 million
over-advance limit was established for the Process Solutions line. In connection
with the aforementioned agreement concerning the Process Solutions line, the
Company has arranged for certain guaranties to be provided on its behalf to the
bank by GP Strategies and ManTech. The aforementioned agreement concerning the
Process Solutions line also provides for: (i) an increase of the applicable
interest rate from the prime rate to the prime rate plus 1.00% or from LIBOR to
LIBOR plus 3.00%, as the case may be, and (ii) a reduction in the available
borrowing level, and a repayment of outstanding borrowings above such level, in
the event of the Company's sale or transfer of certain assets. The Power Systems
line continues to bear interest at the prime rate or LIBOR, at the Company's
option.
The aforementioned lines of credit also contain certain covenants which
restrict the Company from, among other things, incurring additional
indebtedness, entering into merger, consolidation or acquisition transactions,
disposing of all or substantially all of its assets, creating liens on assets,
and creating guaranty obligations. Further, the Company is required to comply
with certain financial ratios, including minimum levels of tangible net worth
and cash flow to fixed obligations, and is also required to provide the bank
with certain periodic financial reports. The Company was in violation of the
cash flow coverage ratio and the tangible net worth covenants as of December 31,
1997 and is probable of violating these covenants as of March 31, 1998. The bank
has waived such covenant
F-15
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
violations at December 31, 1997 and March 31, 1998. Should a violation of any
loan covenant occur at any future measurement date, the bank would have the
right to declare an event of default, and the loans would be payable on demand.
Other debt
The Company entered into capital lease agreements for property, furniture and
equipment, totaling $102,000, $313,000, and $90,000 during the years ended
December 31, 1997, 1996 and 1995, 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, 1997 are as follows: 1998,
$9,240,000; 1999, $169,000; 2000, $32,000; 2001, $25,000; 2002, $27,000; and
$166,000 thereafter.
11. Income taxes
The consolidated (loss) income before income tax, by domestic and foreign
sources, is as follows (in thousands):
Year Ended December 31,
-------------------------------------
1997 1996 1995
---- ---- ----
Domestic............................................................ ($ 8,850) $ 3,884 $ 3,844
Foreign............................................................. ($ 2,570) 968 1,849
-------- ------- -------
Total ($11,420) $ 4,852 $ 5,693
======== ======= =======
The (benefit from) provision for income taxes is as follows (in thousands):
Year Ended December 31,
---------------------------------------------
1997 1996 1995
---- ---- ----
Current:
Federal............................................... $ (27) $ (23) $ 210
State................................................. -- 29 40
Foreign............................................... (413) 642 508
-------- ----- ------
(440) 648 758
-------- ----- ------
Deferred:
Federal............................................... (2,388) 186 1,160
State................................................. (229) 23 99
Foreign............................................... 340 (148) --
------- ----- ------
(2,277) 61 1,259
-------- ----- -------
$(2,717) $ 709 $ 2,017
======= ===== =======
F-16
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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:
Year Ended December 31,
-------------------------------------------
1997 1996 1995
---- ---- ----
Statutory U.S. tax rate..................................... (34.0)% 34.0% 34.0%
State income tax, net of federal tax benefit................ (2.7) 2.7 2.8
Effect of foreign operations................................ 3.8 (6.6) 2.3
Amortization of goodwill and other intangible assets........ -- -- .5
Change in valuation allowance............................... 7.8 (19.5) (3.4)
Research and development credit............................. -- -- (1.4)
Others...................................................... 1.3 4.0 .6
----- ----- ----
Effective tax rate.......................................... (23.8)% 14.6% 35.4%
===== ===== ====
At December 31, 1997, the Company had available $20,912,000 of federal 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,
------------------------------------
1997 1996
---- ----
Deferred Tax Deferred Tax
Asset/(Liability) Asset/(Liability)
----------------- -----------------
Contract loss reserves...................................................... $ 46 $ --
Property and equipment...................................................... 135 (135)
Accrued expenses............................................................ 207 230
Net operating loss carryforwards............................................ 7,152 2,013
Book reserves not deductible for tax purposes............................... 458 859
Software development costs.................................................. (2,762) (1,753)
Deferred revenue............................................................ -- 777
Cash to accrual adjustment.................................................. (71) (142)
Foreign tax credits ........................................................ 338 214
Others...................................................................... (125) 147
------- -------
5,378 2,210
Valuation allowance......................................................... (1,078) (187)
------- -------
$ 4,300 $ 2,023
======= =======
During 1996 and 1995, the Company reduced the valuation allowance by
$1,033,000 and $1,619,000, respectively, of which $109,000 and $1,354,000,
respectively, reduced goodwill and other intangibles arising out of the
acquisition of Power Systems. The valuation allowance at December 31, 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, 1997 is realizable. The Company has tax planning
strategies available that include deferral of certain expenses for tax purposes
and the sale of certain assets, net of liabilities, of Erudite Software to
generate tax gains.
F-17
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
When combined with expected future taxable income, the tax planning
strategies will enable the Company to realize its net deferred tax asset.
Management will take these actions, if necessary, to preserve the net deferred
tax asset.
12. Capital Stock
As of December 31, 1997, 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, 1997 and 1996, 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.
F-18
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Stock option activity under the Plan is as follows:
Year Ended December 31,
---------------------------------------------------------------------------------------------
1997 1996 1995
-------------------------- ---------------------------- -------------------------
Weighted Weighted Weighted
Average Average Average
Shares Exercise Price Shares Exercise Price Shares Exercise Price
------ -------------- ------ -------------- ------ --------------
Options outstanding, beginning of
period............................ 413,366 $ 13.61 297,516 $ 14.00 -- $ --
Options canceled.................... (306,044) (11.57) (26,150) (14.07) -- --
Options granted..................... 487,693 4.12 142,000 12.89 297,516 14.00
------- ------- -------
Options outstanding, end of period.. 595,015 6.89 413,366 13.61 297,516 14.00
======= ======= =======
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 $(10,276,000) ($(2.03) per share), $3,601,000 ($0.71 per share),
and $3,219,000 ($0.79 per share) for the years ended December 31, 1997, 1996 and
1995, 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, 1997, 1996, and
1995, respectively: dividend yield of 0%, expected volatility of 80%, risk-free
interest rates of 6.51%, 6.31%, and 6.15%, and expected terms of 6 years.
As of December 31, 1997, 1996, and 1995, respectively, there were 86,442,
119,000, and 0 stock options exercisable under the Plan, and the Company had
211,634 shares of common stock reserved for the future grants under the Plan.
The weighted average fair value of options granted during 1997, 1996 and 1995
was $3.00 per share, $9.55 per share and $10.44 per share, respectively. As of
December 31, 1997, the weighted average remaining contractual life of the
options outstanding was approximately 8 years.
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 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, 1997 are approximately as
follows (in thousands):
1998....................................................... 2,765
-----
1999....................................................... 2,128
-----
2000....................................................... 1,806
-----
2001....................................................... 1,502
-----
2002....................................................... 1,130
-----
2003 and thereafter........................................ $6,500
------
Total...................................................... $15,831
=======
The Company maintains its headquarters and leases a facility of
approximately 154,000 square feet in Columbia, Maryland. However, in order
to better meet the Company's expected facilities requirements for the
foreseeable future, the Company has entered into agreements whereby the
lease for its
F-19
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
existing Columbia facility will be terminated and the operations presently
occupying such facility are scheduled to relocate into two separate facilities
during the second quarter of 1998; one of these facilities will be in Columbia,
Maryland (approximately 53,000 square feet) and will be occupied by the
Company's corporate headquarters offices, the operations of Power Systems, as
well as various other Company operations; the other facility will be in
Baltimore, Maryland (approximately 33,000 square feet) and will be occupied by
the operations of Process Solutions. Each of the leases for these smaller
facilities has a term of ten (10) years. The Company recorded an accrual of
$852,000 related primarily to future lease commitments on the excess space of
the current corporate headquarters that will provide no future economic benefit
to the Company.
During 1997, the Company sold equipment to a leasing company for
approximately $521,000 and leased back the equipment under an operating lease.
The future minimum rental payments are included in the schedule above. The
Company did not record a gain or loss associated with this transaction.
Total rent expense under operating leases was $3,220,000, $1,876,000, and
$2,487,000 for the years ended December 31, 1997, 1996 and 1995. Rent expense in
1996 is net of amortization of $348,000 and reversal of $1,103,000 of remaining
excess facility costs. Rent expense in 1995 is net of amortization of $348,000
of excess facility costs. At December 31, 1995, the Company had accrued
$1,451,000 of excess facility costs.
Letters of credit
As of December 31, 1997, the Company and certain of its subsidiaries were
contingently liable under letters of credit totaling $318,000. Further, the
performance of certain of the Company's customer contracts is collateralized by
performance guarantees totaling $548,000 by its subsidiaries' respective former
parent organizations.
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 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. The liability for these amounts is included in accrued
expenses. These advances were made in exchange for future considerations,
including the option for direct investment in the joint venture by ManTech
and/or GP Strategies subject to necessary approvals and consents in the People's
Republic of China. The operations of this joint venture were immaterial during
the year ended December 31, 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 subleases office space to ManTech at market price
based on square footage used. For the years ended December 31, 1997, 1996 and
1995, such charges amounted to $117,000, $67,000 and $46,000, respectively. A
subsidiary of the Company purchased computer run-time from ManTech until April
1996; such charges amounted to $36,000 and $63,000 in 1996 and 1995,
respectively. GPC historically has performed services as a subcontractor on
certain contracts of a subsidiary of the Company and that subsidiary may
continue to subcontract with GPC from time to time. For the years ended December
31, 1997, 1996 and 1995, such subcontract costs amounted to $0, $0, and $51,000,
respectively.
One of the Company's subsidiaries' bi-weekly payroll is processed by a
company whose owner is also a shareholder of the Company. Expenses incurred for
such payroll processing for the years ended December 31, 1997, 1996 and 1995
were $69,000, $62,000, and $42,000, respectively. The Company subleases a
portion of one of its facilities to this related party. Sublease payments by the
related party were approximately $4,700, $4,000 and $3,000 for the years ended
December 31, 1997, 1996 and 1995, respectively.
F-20
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In November 1993, the three founding stockholders of Erudite Software sold
an aggregate of 2,000 shares of common stock on a pro-rata basis to two other
individuals in exchange for demand notes totaling $200,000 with no stated
interest rate. These notes were collateralized by the shares of common stock
received by the two individuals. The founding stockholders immediately
transferred the $200,000 in notes receivable from the new stockholders to
Erudite Software in exchange for notes due from Erudite Software on demand with
no stated interest rate. For financial reporting purposes, the notes receivable
from the new stockholders were included as a part of stockholders' equity in the
accompanying financial statements until such time as the notes receivable were
fully collected and the shares of common stock no longer represented collateral
against the notes. For the year ended December 31, 1995, the notes receivable
from stockholders were reduced through cash receipts of $15,000 and through
services provided to Erudite Software of $58,000. The services provided to
Erudite Software have been valued based upon salaries, bonuses and commissions
earned by these two individuals. These notes receivable were reduced to $0
during the year ended December 31, 1995. For the years ended December 31, 1996
and 1995, cash payments to the founding stockholders in satisfaction of the note
payable totaled $189,000 and $11,000, respectively.
16. Employee benefits
In 1996, the Company began the process of terminating its defined benefit
plan for the union employees. The assets in this plan were distributed on
September 3, 1997. The Company has recognized expense of $124,000 during 1996
related to the termination of the plan. Net periodic pension expense of $29,000
was recognized for the year ended December 31, 1995.
The Company also has a qualified defined contribution plan that covers
substantially all employees and complies with 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 $524,000, $671,000, and $484,000
the years ended December 31, 1997, 1996 and 1995, respectively.
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.
F-21
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
17. Financial information by geographic area
The Company operates in a single industry segment: it designs, develops and
delivers business and technology solutions to the energy, process and
manufacturing industries worldwide. Revenue, operating income and identifiable
assets for the Company's United States, European and Asian operations are as
follows (in thousands):
Year Ended December 31, 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
========== ========= ======== ======== ========
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
========== ========= ======== ======== ========
Income from operations...................... $ 3,832 $ 1,267 $ (452) $ 198 $ 4,845
========== ========= ======== ======== ========
Identifiable assets......................... $ 54,584 $ 6,416 $ 3,057 $(13,051) $ 51,006
========== ========= ======== ======== ========
Year Ended December 31, 1995
-----------------------------------------------------------------------------
United States Europe Asia Eliminations Consolidated
------------- ------ ---- ------------ ------------
Revenue..................................... $ 87,009 $ 7,050 $ 2,001 $ -- $ 96,060
Transfers between geographic locations...... 1,173 -- -- (1,173) --
-------- --------- -------- --------- --------
Total revenue............................... $ 88,182 $ 7,050 $ 2,001 $ (1,173) $ 96,060
======== ========= ======== ========= ========
Income from operations...................... $ 5,028 $ 1,628 $ 7 $ (351) $ 6,312
======== ========= ======== ========= ========
Identifiable assets......................... $ 49,958 $ 7,298 $ 2,337 $ (4,905) $ 54,688
======== ========= ======== ========= ========
The Company has intercompany distribution arrangements with its subsidiaries.
The basis of these arrangements, disclosed as transfers between geographic
locations, is principally at market prices.
F-22
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Domestic and export sales from the Company's United States operations in
thousands of dollars and as a percentage of revenue are as follows:
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
1997 1996 1995
----------------- ---------------- -----------------
Domestic................................................. $ 52,365 72.6% $ 47,868 57.5% $ 45,222 52.0%
Export:
Germany............................................ 2,791 3.9 9.236 11.1 8,039 9.2
Remaining Western Europe........................... 1,748 2.4 2,806 3.4 12,400 14.3
Russia............................................. 6,074 8.4 7,716 9.2 9,135 10.5
Remaining Eastern Europe........................... 6,481 9.0 11,070 13.3 4,547 5.2
Asia............................................... 1,278 1.8 3,910 4.7 6,853 7.9
South America and others........................... 1,425 1.9 657 .8 813 0.9
-------- ----- -------- ----- -------- -----
$ 72,162 100.0% $ 83,263 100.0% $ 87,009 100.0%
======== ===== ======== ===== ======== =====
18 Fourth quarter data
During the fourth quarter of 1997, the Company made several adjustments which
are material to the fourth quarter results. These adjustments include an
$852,000 accrual related primarily to future lease commitments on excess space
of the corporate headquarters that will provide no future economic benefit to
the Company, $450,000 in litigation costs, an additional $230,000 in
amortization of capitalized software development costs, additional allowances of
approximately $800,000 to reduce accounts receivable and inventory to their
estimated net realizable value, approximately $1,000,000 in foreign currency
transaction losses associated with intercompany transactions which have been
negatively impacted by the poor financial conditions of Asian markets and
approximately $240,000 to reduce certain non-current assets to their estimated
net realizable value. The aggregate impact of these adjustments was to increase
the loss before income taxes, net loss and basic and diluted loss per common
share for the fourth quarter by approximately $3,572,000, $2,250,000 and $.44
per common share, respectively.
F-23
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
25
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 1998 Annual Meeting of
Stockholders.
26
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, 1997 and 1996
Consolidated Statements of Operations for each of the three years in the
period ended December 31, 1997
Consolidated Statements of Stockholders' Equity (Deficit) for the years
ended December 31, 1997 and 1996 and 1995
Consolidated Statements of Cash Flows for the years ended December 31, 1997
and 1996 and 1995
Notes to Consolidated Financial Statements
(a)(2) List of Schedules
All other schedules to the consolidated financial statements are
omitted as the required information is either inapplicable or presented in the
consolidated financial statements or related notes.
(a)(3) List of Exhibits
The Exhibits which are filed with this report or which are incorporated
by reference are set forth in the Exhibit Index hereto.
(b) Reports on Form 8-K:
No reports on Form 8-K were filed during the quarter ended December 31,
1997.
27
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 31, 1998
- ---------------------------------------
Jerome I. Feldman
/s/ CHRISTOPHER M. CARNAVOS Director and President March 31, 1998
- --------------------------------------- (Principal Executive Officer)
Christopher M. Carnavos
/s/ ROBERT W. STROUP Executive Vice President, Secretary & Treasurer March 31, 1998
- --------------------------------------- (Principal Financial and Accounting Officer)
Robert W. Stroup
/s/ EUGENE D. LOVERIDGE Director and Senior Vice-President March 31, 1998
- ---------------------------------------
Eugene D. Loveridge
28
/s/ HANS I. EBENFELT Director March 31, 1998
- ---------------------------------------
Hans I. Ebenfelt
/s/ SHELDON L. GLASHOW Director March 31, 1998
- ---------------------------------------
Sheldon L. Glashow
/s/ JOHN A. MOORE, JR. Director March 31, 1998
- ---------------------------------------
John A. Moore, Jr.
/s/ GEORGE J. PEDERSEN Director March 31, 1998
- ---------------------------------------
George J. Pedersen
/s/ MARTIN M. POLLAK Director March 31, 1998
- ---------------------------------------
Martin M. Pollak
/s/ SYLVAN SCHEFLER Director March 31, 1998
- ---------------------------------------
Sylvan Schefler
29
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 (5) Agreement and Plan of Reorganization dated as of May
17, 1996 by and among GSE Systems, Inc., GSE Erudite
Software, Inc., Erudite Software and Consulting, Inc.,
Eugene Loveridge, Daniel Masterson, Douglas Austin,
Gary Gray and Dennis Fairclough effective May 21, 1996.
2.2 (5) Agreement and Plan of Merger dated as of May 17, 1996
by and between Erudite Software and Consulting, Inc.
effective May 22, 1996.
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 (1) Asset Purchase Agreement among Texas Instruments
Incorporated, GSE Systems, Inc. and GSE Process
Solutions, Inc. concerning the Process Systems Business
of Texas Instruments Incorporated (dated as of December
28, 1994)
10.3 (3) * Form of Employment Agreement between William E.
Kuhlmann and GSE Systems, Inc.
10.4 (3) * Form of Employment Agreement between Rolf M. G.
Falkenberg and GSE Systems, Inc.
10.5 (3) * Form of Employment Agreement between Robert W. Stroup
and GSE Systems, Inc.
10.6 (3) * Form of Employment Agreement between Chian-Li Jen and
GSE Systems, Inc.
10.8 (6) * GSE Systems, Inc. 1995 Long-Term Incentive Plan, as
amended as of February 12, 1997.
10.9 (4) * Form of Option Agreement Under the GSE Systems, Inc.
1995 Long-Term Incentive Plan
10.10 (2) Letter of Credit, Loan and Security Agreement among
Maryland National Bank (now NationsBank, N.A.), MSHI,
Inc., and Simulation, Systems & Services Technologies
Company (dated as of March 17, 1994 and amended as of
June 29, 1994 and April 27, 1995)
10.11 (2) Letter of Credit, Loan and Security Agreement among
NationsBank, N.A., MSHI, Inc., and Simulation, Systems
& Services Technologies Company (dated as of September
29, 1994)
10.12 (2) Letter of Credit, Loan and Security Agreement between
CoreStates Bank, N.A. and GSE Process Solutions, Inc.
(dated as of January 31, 1995)
10.13 (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)
10.14 (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)
10.15 (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)
10.16 (5) * Employment Agreement dated as of May 17, 1996 by and
between GSE Systems, Inc. and Eugene Loveridge
effective May 22, 1996
30
10.17 (5) * Employment Agreement dated as of May 17, 1996 by and
between GSE Systems, Inc. and Daniel Masterson
effective May 22, 1996
10.18 (6) * Employment Agreement dated as of May 2, 1996 by and
between EuroSim AB and Lars-Goran Mejvik effective July
1, 1996
10.19 (7) * Letter Agreement dated January 8, 1997 between GSE
Systems, Inc. and Christopher M. Carnavos
10.20 (7) * Agreement dated as of April 3, 1997 between GSE
Systems, Inc. and William E. Kuhlmann
10.21 (7) 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)
10.22 (7) Lease Termination Agreement between 8930 Stanford
Boulevard, L.L.C. and GSE Power Systems, Inc. (dated as
of January 30, 1998)
10.23 (7) Indemnification Agreement between Genus Corporation and
GSE Power Systems, Inc. (dated as of February 2, 1998)
10.24 (7) Office Lease Agreement between Sterling Rutherford
Plaza, L.L.C. and GSE Systems, Inc. (dated as of
February 10, 1998.)
10.25 (7) Lease Agreement between Red Branch Road, L.L.C. and GSE
Systems, Inc. (dated February 10, 1998)
10.26 (7) Letter Agreement dated March 6, 1998 between CoreStates
Bank, N.A. and GSE Power Systems, Inc.
10.27 (7) Letter Agreement dated March 6, 1998 between CoreStates
Bank, N.A. and GSE Process Solutions, Inc.
11.1 (7) Statement regarding computation of earnings per share
21.1 (7) Subsidiaries of Registrant
23.1 (7) Consent of Independent Accountants
24.1 (7) Power of Attorney for Directors' 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. Forms 8-K
and 8-K-A as filed with the Securities and Exchange Commission on
June 5, 1996 and June 13, 1996, respectively, and incorporated herein
by reference.
(6) 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.
(7) Filed herewith.
* Management contract or compensatory plan.
31