GSE SYSTEMS, INC. AND SUBSIDIARIES
GSE SYSTEMS, INC. AND SUBSIDIARIES
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 DP Engineering’s assets acquired and liabilities assumed and conformed the accounting policies of DP Engineering 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 DP Engineering as a result of planned cost savings initiatives following the completion of the business combination.
The Company completed the acquisition of DP Engineering for approximately $14.3 million in cash, which was subject to a post-close working capital adjustment. The Company financed the purchase by drawdown a five-year term loan of approximately $14.3 million. 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. 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 entered membership agreement with Steven L. Pellerin, Christopher A. Davenport, and DP Engineering (The “DP Engineering Purchase Agreement”), to purchase 100% of the member interests in DP Engineering for $13.5 million. The purchase price is subject to customary pre- and post-closing working capital adjustments plus an additional earn-out amount not to exceed $5.0 million, potentially payable in 2020 and 2021 depending on DP Engineering’s satisfaction of certain targets for Adjusted EBITDA in calendar years 2019 and 2020, respectively.
Based on preliminary forecasted adjusted EBITDA of DP Engineering for year 2019 and 2020, the fair value of total earn-out amount is $1.2 million on the acquisition day.
The following table summarizes the calculation of adjusted purchase price as of the acquisition date (in thousands):
| Base purchase price per agreement | | $ | 13,500 | |
| Pre closing working capital adjustment | | | 155 | |
| Fair value of contingent consideration | | | 1,200 | |
| Total purchase price | | $ | 14,855 | |
The Company has performed a preliminary valuation analysis of the fair market value of DP Engineering’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 | | $ | 14,855 | |
| | | | | |
| Purchase price allocation: | | | | |
| Cash | | | 134 | |
| Contract receivables | | | 2,934 | |
| Prepaid expenses and other current assets | | | 208 | |
| Property, and equipment, net | | | 211 | |
| Other assets | | | 1,810 | |
Intangible assets, net
| | | 6,798
| |
| Accounts payable | | | (110 | ) |
| Accrued expenses | | | (597 | ) |
| Billings in excess of revenue earned | | | (62 | ) |
| Accrued compensation | | | (706 | ) |
Other liabilities
| | | (1,498 | ) |
| Total identifiable net assets | | | 9,122
| |
| | | | | |
Goodwill
| | | 5,733 | |
| | | | | |
| Net assets acquired | | $ | 14,855 | |
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 term loan, the fair value of contingent consideration, 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 | | $ | (14,855 | ) |
Fair value of contingent consideration
| | | 1,200
| |
| Issuance of new term loan | | | 14,263 | |
| Purchase consideration funded by debt | | | 608 | |
| Working capital adjustment based on purchase price allocation | | | (1,848 | ) |
| Estimated transaction costs | | | (628 | ) |
| Pro Forma adjustment to Cash | | $ | (1,868 | ) |
| (b) | Reflects the working capital adjustments based on the purchase price allocation as of the acquisition date as shown in Note 3. |
| (c) | Represents the new term loan incurred to finance the acquisition of DP Engineering. Details are listed below (in thousands): |
| Term loan | | | 14,263 | |
| | | | | |
| Current portion of long-term debt | | $ | 2,853 | |
| Long-term debt, less current portion | | $ | 11,410 | |
| (d) | Reflects the elimination of DP Engineering’s historical members’ equity and the estimated transaction costs. Details are listed below (in thousands): |
| | September 30, | |
| | 2018 | |
| Elimination of DP’s historical members’ equity | | $ | (3,486 | ) |
| Transaction costs paid in connection with the acquisition | | | (628 | ) |
| Pro Forma adjustment to accumulated deficit | | $ | (4,114 | ) |
| (e) | Reflects the interest expense resulting from the drawdown of term loan to finance the acquisition of DP Engineering. 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.
The interest rate assumed for the purpose of preparing this pro forma financial information is 4.99%, 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 $12,000 for the nine months ended September 30, 2018, and $16,000 for the year ended December 31, 2017.
| (f) | Represents the income tax effect of DP Engineering’s income and pro forma adjustments based on the estimated blended federal and state statutory tax rate of 25% for nine months ended September 30, 2018 and 40% for the year ended December 31, 2017, respectively. Before the acquisition, DP Engineering had elected to be taxed as an S Corporation under the Internal Revenue Code. As a result, earnings or losses of DP Engineering passed through to its members. Therefore, no provision for income taxes had been included in their historical statements of operations. The income tax adjustment was made as if DP Engineering’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 DP Engineering (in thousands):
| | | Nine Months Ended September 30, 2018 | | | Year ended December 31, 2017 | |
| DP Engineering’s pre-tax income | | $ | 1,177 | | | $ | 2,825 | |
| Pro forma adjustment | | | (1,356 | ) | | | (2,369 | ) |
| Estimated taxable income | | | (179 | ) | | | 456 | |
| Estimated blended statutory tax rate | | | 25 | % | | | 40 | % |
| Pro forma tax adjustment | | $ | (45 | ) | | $ | 182 | |
| (g) | Reflects preliminary estimated fair value of the intangible assets recognized upon the acquisition of DP Engineering.
|
As part of the preliminary valuation analysis, the Company identified intangible assets, including customer contracts and relationships, trade name, and non-compete agreements. 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 DP Engineering’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:
(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:
