Exhibit 99.2
GSE SYSTEMS, INC. AND SUBSIDIARIES
Unaudited Pro Forma Condensed Combined Financial Information
On May 11, 2018, GSE Systems, Inc. (GSE, the Company), through its wholly-owned subsidiary GSE Performance Solutions, Inc. (Performance Solutions), entered into a membership interest purchase agreement (the True North Purchase Agreement) with Donald R. Horn, Jenny C. Horn, and True North Consulting LLC (True North). Pursuant to the True North Purchase Agreement, Performance Solutions purchased 100% of the membership interests in True North for $9.75 million. The purchase price was subject to customary pre- and post-closing working capital adjustments. The acquisition of True North was completed on an all-cash transaction basis. The Company paid cash consideration of $9.9 million on closing. The amount was subject to post-closing working capital adjustments. The Company financed the acquisition by incurring a floating-rate term loan of $9.6 million, net of $0.1 million in debt issuance costs.
The following unaudited pro forma condensed combined financial statements are based on our historical consolidated financial statements and True North's historical financial statements as adjusted to give effect to the Company's acquisition of True North and the related financing transaction. The unaudited pro forma condensed combined statement of operations for the 12 months ended December 31, 2017 gives effect to these transactions as if they had occurred on January 1, 2017. The unaudited pro forma condensed combined balance sheet as of December 31, 2017 gives effect to these transactions as if they have occurred on December 31, 2017.
The assumptions and estimates underlying the unaudited adjustments to the pro forma condensed combined financial statements are described in the accompanying notes, which should be read together with the pro forma condensed combined financial statements.
The unaudited pro forma condensed combined financial statements should be read together with the Company's historical financial statements, which are included in the Company's Annual Report on Form 10-K for the year ended December 31, 2017, and the historical financial statements of True North for the year ended December 31, 2017 are included herein.
GSE SYSTEMS, INC. AND SUBSIDIARIES
Unaudited Pro Forma Condensed Combined Balance Sheet
As of December 31, 2017
(in thousands)
| | | Historical | | Pro Forma | | | | Pro Forma |
| | | GSE | | True North | | Adjustments | | Notes | | Combined |
| ASSETS | | | | | | | | | | | | | | |
| Current assets: | | | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | 19,111 | | $ | 1,465 | | $ | (2,142) | | (a) | | $ | 18,434 |
| Restricted cash | | | 960 | | | - | | | - | | | | | 960 |
| Contract receivables, net | | | 13,997 | | | 4,122 | | | (2,785) | | (b) | | | 15,334 |
| Prepaid expenses and other current assets | | | 2,795 | | | 1 | | | 3 | | (b) | | | 2,799 |
| Total current assets | | | 36,863 | | | 5,588 | | | (4,924) | | | | | 37,527 |
| | | | | | | | | | | | | | | |
| Equipment, software, and leasehold improvements, net | | | 1,063 | | | 1 | | | - | | | | | 1,064 |
| Software development costs, net | | | 690 | | | - | | | - | | | | | 690 |
| Goodwill | | | 8,431 | | | - | | | 4,911 | | (c) | | | 13,342 |
| Intangible assets, net | | | 2,604 | | | - | | | 3,911 | | (d) | | | 6,515 |
| Deferred tax assets | | | 7,167 | | | - | | | - | | | | | 7,167 |
| Other assets | | | 37 | | | - | | | - | | | | | 37 |
| Total assets | | $ | 56,855 | | $ | 5,589 | | $ | 3,898 | | | | $ | 66,342 |
| | | | | | | | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | | | | | | | | |
| Current liabilities: | | | | | | | | | | | | | | |
| Current portion of long-term debt | | $ | - | | $ | - | | $ | 1,950 | | (e) | | $ | 1,950 |
| Accounts payable | | | 1,251 | | | 78 | | | 41 | | (b) | | | 1,370 |
| Accrued expenses | | | 2,276 | | | 946 | | | (946) | | (b) | | | 2,276 |
| Accrued compensation | | | 2,866 | | | 113 | | | 141 | | (b) | | | 3,120 |
| Billings in excess of revenue earned | | | 14,543 | | | - | | | - | | | | | 14,543 |
| Accrued warranty | | | 1,433 | | | - | | | - | | | | | 1,433 |
| Contingent consideration | | | 1,701 | | | - | | | - | | | | | 1,701 |
| Other current liabilities | | | 1,182 | | | - | | | - | | | | | 1,182 |
| Total current liabilities | | | 25,252 | | | 1,137 | | | 1,186 | | | | | 27,575 |
| | | | | | | | | | | | | | | |
| Long-term debt, less current portion | | | - | | | - | | | 7,655 | | (e) | | | 7,655 |
| Other liabilities | | | 1,931 | | | - | | | - | | | | | 1,931 |
| Total liabilities | | | 27,183 | | | 1,137 | | | 8,841 | | | | | 37,161 |
| | | | | | | | | | | | | | | |
| Stockholders' equity: | | | | | | | | | | | | | | |
| Common stock | | | 210 | | | 1 | | | (1) | | (f) | | | 210 |
| Additional paid-in capital | | | 76,802 | | | - | | | - | | | | | 76,802 |
| Accumulated deficit | | | (42,870) | | | 4,451 | | | (4,942) | | (g) | | | (43,361) |
| Accumulated other comprehensive loss | | | (1,471) | | | - | | | - | | | | | (1,471) |
| Treasury stock at cost | | | (2,999) | | | - | | | - | | | | | (2,999) |
| Total stockholders' equity | | | 29,672 | | | 4,452 | | | (4,943) | | | | | 29,181 |
| Total liabilities and stockholders' equity | | $ | 56,855 | | $ | 5,589 | | $ | 3,898 | | | | $ | 66,342 |
See accompanying notes to the unaudited Pro Forma Condensed Combined Financial Information
GSE SYSTEMS, INC. AND SUBSIDIARIES
Unaudited Pro Forma Condensed Combined Statement of Operations
Year Ended December 31, 2017
(in thousands, except per share information)
| | | Historical | | Pro Forma | | | | Pro Forma |
| | | GSE | | True North | | Adjustments | | Notes | | Combined |
| Revenue | | $ | 70,880 | | $ | 11,030 | | $ | - | | | | $ | 81,910 |
| Cost of revenue | | | 52,336 | | | 8,249 | | | - | | | | | 60,585 |
| Gross profit | | | 18,544 | | | 2,781 | | | - | | | | | 21,325 |
| | | | | | | | | | | | | | | |
| Operating expenses: | | | | | | | | | | | | | | |
| Selling, general and administrative | | | 15,469 | | | 1,362 | | | - | | | | | 16,831 |
| Research and development | | | 1,391 | | | - | | | - | | | | | 1,391 |
| Restructuring charges | | | 778 | | | - | | | - | | | | | 778 |
| Depreciation | | | 342 | | | - | | | - | | | | | 342 |
| Amortization of definite-lived intangible assets | | | 335 | | | - | | | 1,086 | | (h) | | | 1,421 |
| Total operating expenses | | | 18,315 | | | 1,362 | | | 1,086 | | | | | 20,763 |
| | | | | | | | | | | | | | | |
| Operating income | | | 229 | | | 1,419 | | | (1,086) | | | | | 562 |
| | | | | | | | | | | | | | | |
| Interest income (expense), net | | | 80 | | | - | | | (514) | | (i) | | | (434) |
| Gain (loss) on derivative instruments, net | | | 99 | | | - | | | - | | | | | 99 |
| Other (expense) income, net | | | (4) | | | (2) | | | - | | | | | (6) |
| Income before income taxes | | | 404 | | | 1,417 | | | (1,600) | | | | | 221 |
| | | | | | | | | | | | | | | |
| Provision for income taxes | | | (4,980) | | | - | | | (73) | | (j) | | | (5,053) |
| Net income | | $ | 5,384 | | $ | 1,417 | | $ | (1,527) | | | | $ | 5,274 |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
| Basic earnings per common share | | $ | 0.28 | | | | | | | | | | $ | 0.27 |
| | | | | | | | | | | | | | | |
| Diluted earnings per common share | | $ | 0.27 | | | | | | | | | | $ | 0.27 |
| | | | | | | | | | | | | | | |
| Weighted-average shares: | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
| Basic | | | 19,259,966 | | | | | | | | | | | 19,259,966 |
| | | | | | | | | | | | | | | |
| Diluted | | | 19,605,427 | | | | | | | | | | | 19,605,427 |
See accompanying notes to the unaudited Pro Forma Condensed Combined Financial Information
GSE SYSTEMS, INC. AND SUBSIDIARIES
Notes to Unaudited Pro Forma Condensed Combined Financial Information
The historical consolidated financial statements have been adjusted in the pro forma condensed combined financial statements to give effect to pro forma events that are (1) directly attributable to the business combination, (2) factually supportable and (3) with respect to the pro forma condensed combined statements of operations, expected to have a continuing impact on the combined results following the business combination.
The business combination was accounted for under the acquisition method of accounting in accordance with Accounting Standards Codification (ASC) 805, Business Combinations. As the acquirer for accounting purposes, the Company has estimated the fair value of True North's assets acquired and liabilities assumed and conformed the accounting policies of True North to its own accounting policies.
The pro forma combined financial statements do not necessarily reflect what the combined company's financial condition or results of operations would have been had the acquisition occurred on the dates indicated. They also may not be useful in predicting the future financial condition and results of operations of the combined company. The actual financial position and results of operations may differ significantly from the pro forma amounts reflected herein due to a variety of factors.
The combined pro forma financial information does not reflect the realization of any expected cost savings or other synergies from the acquisition of True North as a result of planned cost savings initiatives following the completion of the business combination.
The Company completed the acquisition of True North for approximately $9.9 million in cash, which was subject to a post-close working capital adjustment. The Company financed the purchase by incurring a five-year term loan of approximately $9.6 million, net of $0.1 million in debt issuance costs. The loan bears interest at adjusted one-month LIBOR plus a margin ranging between 2% and 2.75% depending on the overall leverage ratio of the Company. In connection with the term loan, the Company also entered into a pay-fixed, receive-floating interest rate swap contract with a notional amount of $9.0 million to partially lock the interest rate on the loan. The notional values amortize monthly based on the terms of the agreements to match the principal borrowings as they are repaid.
| 3. | Preliminary Purchase Price Allocation |
The Company has performed a preliminary valuation analysis of the fair market value of True North's assets and liabilities. The following table summarizes the allocation of the preliminary purchase price as of the acquisition date (in thousands):
| Total purchase price | | $ | 9,941 |
| | | | |
| Purchase price allocation: | | | |
| Cash | | | 150 |
| Contract receivables | | | 1,337 |
| Prepaid expenses and other current assets | | | 4 |
| Property, and equipment, net | | | 1 |
| Intangible assets | | | 3,911 |
| Accounts payable | | | (119) |
| Accrued compensation | | | (254) |
| Total identifiable net assets | | | 5,030 |
| | | | |
| Goodwill | | | 4,911 |
| | | | |
| Net assets acquired | | $ | 9,941 |
This preliminary purchase price allocation has been used to prepare pro forma adjustments in the pro forma balance sheet and statement of operations. Due to the recent completion of the acquisition, the determination of the purchase price and the allocation of the purchase price used in the unaudited pro forma condensed combined financial information are based upon preliminary estimates, which are subject to change during the measurement period (up to one year from the acquisition date) as we finalize the valuations of the assets acquired and liabilities assumed, including, but not limited to, contract receivables, prepaid expenses and other current assets, intangible assets, accounts payable, accrued compensation and the residual amount allocated to goodwill. The final allocation could differ materially from the preliminary allocation used in the pro forma adjustments.
The pro forma adjustments included in the unaudited pro forma condensed combined financial information are as follows:
| (a) | Represents the purchase consideration funded by existing cash, the working capital adjustment based on the purchase price allocation as of the acquisition date as shown in Note 3, and the payment of the estimated transaction costs. The following table summarizes the adjustments to this account (in thousands): |
| Total purchase price | | $ | (9,941) |
| Issuance of new term loan, net of debt issuance costs and discounts | | | 9,605 |
| Purchase consideration funded by existing cash | | | (336) |
| Working capital adjustment based on purchase price allocation | | | (1,315) |
| Estimated transaction costs | | | (491) |
| Pro Forma adjustment to Cash | | $ | (2,142) |
| (b) | Reflects the working capital adjustments based on the purchase price allocation as of the acquisition date as shown in Note 3. |
| (c) | Reflects goodwill recorded associated with the acquisition of $4.9 million as shown in Note 3. |
| (d) | Reflects preliminary estimated fair value of the intangible assets recognized upon the acquisition of True North. |
As part of the preliminary valuation analysis, the Company identified intangible assets, including customer contracts and relationships, trade name, non-compete agreements, alliance agreements and assembled workforce. The fair value of identifiable intangible assets is determined primarily using the "income approach", which requires a forecast of the expected future cash flows. Since the detailed valuation analysis of True North's identifiable intangible assets has not been completed, the preliminary estimates of fair value will likely differ from final amounts the Company will calculate after completing a detailed valuation analysis.
The following table summarizes the preliminary fair value of intangible assets acquired at the date of acquisition and their estimated useful lives and amortization expense based on their respective useful lives and amortization methods:
| | | Estimated Fair Value | | Estimated Useful Life | | Amortization Method | | Amortization Expense |
| | | (in thousands) | | (in years) | | | | Year ended December 31, 2017 |
| | | | | | | | | | | |
| Customer contracts and relationships | | $ | 2,581 | | 15 | | Other (1) | | $ | 868 |
| Tradename | | | 582 | | 10 | | Straight-line | | | 58 |
| Non-compete agreements | | | 221 | | 4 | | Straight-line | | | 55 |
| Alliance agreements | | | 527 | | 5 | | Straight-line | | | 105 |
| Total | | $ | 3,911 | | | | | | $ | 1,086 |
(1) Customer contracts and relationships are amortized in proportion to the related projected revenue streams over the estimated useful life. The following table summarizes the amortization of customer contracts and relationships:
| | | Amortization |
| Year 1 | | $ | 868 |
| Year 2 | | | 577 |
| Year 3 | | | 385 |
| Year 4 | | | 255 |
| Year 5 | | | 170 |
| Thereafter | | | 326 |
| Total | | $ | 2,581 |
| (e) | Represents the new term loan incurred to finance the acquisition of True North, net of debt issuance costs and discounts. Details are listed below (in thousands): |
| Term loan incurred | | $ | 9,750 |
| Less: debt issuance costs | | | (70) |
| Less: loan origination fees | | | (75) |
| Term loan, net of debt issuance costs and discounts | | | 9,605 |
| | | | |
| Current portion of long-term debt | | $ | 1,950 |
| Long-term debt, less current portion | | $ | 7,655 |
| (f) | Reflects the elimination of True North's historical equity. |
| (g) | Reflects the elimination of True North's historical equity and the estimated transaction costs. Details are listed below (in thousands): |
| Elimination of True North's historical shareholders' equity as of December 31, 2017 | | $ | (4,451) |
| Transaction costs paid in connection with the acquisition | | | (491) |
| Pro Forma adjustment to accumulated deficit | | $ | (4,942) |
| (h) | Represents amortization expense of the intangible assets acquired upon acquisition of True North. Please refer to adjustment (d) for details. |
| (i) | Reflects the interest expense resulting from the new term loan incurred to finance the acquisition of True North and the amortization of related debt issuance costs and discounts. We used effective interest method to calculate the interest expense. |
As discussed in Note 2, the loan bears interest at adjusted one-month LIBOR plus a margin ranging between 2% and 2.75% depending on the overall leverage ratio of the Company. In connection with the term loan, the Company also entered into a pay-fixed, receive-floating interest rate swap contract with a notional amount of $9.0 million to partially lock the interest rate on the loan. The term of the swap requires the Company to pay interest on the basis of a fixed rate of 3.02% and the Company receives interest on the basis of one-month USD-LIBOR-BBA.
The interest rate assumed for the purpose of preparing this pro forma financial information is 5.88%, which comprises the fixed rate of 3.02% plus certain margin specified in the loan agreement. A 0.125% increase or decrease in interest rates would result in a change to interest expense of approximately $11,000 for the year ended December 31, 2017.
| (j) | Represents the income tax effect of True North's income and pro forma adjustments based on the estimated blended federal and state statutory tax rate of 40%. Before the acquisition, True North had elected to be taxed as an S Corporation under the Internal Revenue Code. As a result, earnings or losses of True North passed through to its shareholders. Therefore, no provision for income taxes had been included in their historical statements of operations. The income tax adjustment was made as if True North's income had been consolidated with the Company upon the acquisition and was taxed at the Company level. |
The following table summarizes the calculation of the income tax effect of the acquisition of True North (in thousands):
| | | Year ended December 31, 2017 |
| True North's pre-tax income | | $ | 1,417 |
| Pro forma adjustment | | | (1,600) |
| Estimated taxable income | | | (183) |
| Estimated blended statutory tax rate | | | 40% |
| Pro forma tax adjustment | | $ | (73) |
