Exhibit 99.3
GSE SYSTEMS, INC. AND SUBSIDIARIES
Unaudited Pro Forma Condensed Combined Financial Information
On February 15, 2019, GSE Systems, Inc. (GSE, the Company), through its wholly-owned subsidiary GSE Performance Solutions, Inc. (Performance Solutions), entered into a membership interest purchase 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. The acquisition was completed through the drawdown of $14.3 million (including transaction costs) of the term loan. An escrow of approximately $1.7 million was funded at the closing and is available to GSE and Performance Solutions to satisfy indemnification claims for 18 months after the closing.
The following unaudited pro forma condensed combined financial statements are based on our historical consolidated financial statements and DP Engineering’s historical financial statements as adjusted to give effect to the Company’s acquisition of DP Engineering and the related financing transaction. The unaudited pro forma condensed combined statement of operations for the nine months ended September 30, 2018 and 12 months ended December 31, 2017, gives effect to these transactions as if they had occurred on January 1, 2018. The unaudited pro forma condensed combined balance sheets as of September 30, 2018 give effect to these transactions as if they have occurred on September 30, 2018.
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 Quarterly Report on Form 10-Q for nine months ended September 30, 2018, and Annual Report on Form 10-K for the year ended December 31, 2018 and 2017. The historical financial statements of DP Engineering for the nine months ended September 30, 2018 and for the year ended December 31, 2017 are included herein.
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GSE SYSTEMS, INC. AND SUBSIDIARIES
Unaudited Pro Forma Condensed Combined Balance Sheet
As of September 30, 2018
(in thousands)
Historical | Pro Forma | Pro Forma | |||||||||||||||
GSE | DP Engineering | Adjustments | Note 4 | Combined | |||||||||||||
ASSETS | |||||||||||||||||
Current assets: | |||||||||||||||||
Cash and cash equivalents | $ | 9,831 | $ | 1,982 | $ | (1,868 | ) | (a) | $ | 9,945 | |||||||
Restricted cash | 9 | - | - | 9 | |||||||||||||
Contract receivables, net | 19,238 | 2,591 | 343 | (b) | 22,172 | ||||||||||||
Prepaid expenses and other current assets | 1,624 | 53 | 155 | (b) | 1,832 | ||||||||||||
Total current assets | 30,702 | 4,626 | (1,370 | ) | 33,958 | ||||||||||||
Equipment, software, and leasehold improvements, net | 1,165 | 274 | (63 | ) | (b) | 1,376 | |||||||||||
Software development costs, net | 662 | - | - | 662 | |||||||||||||
Goodwill | 12,185 | 653 | 5,080 | (b) | 17,918 | ||||||||||||
Intangible assets, net | 6,597 | 6,798 | (g) | 13,395 | |||||||||||||
Deferred tax assets | 6,203 | - | - | 6,203 | |||||||||||||
Other assets | 37 | 23 | 1,787 | (b) | 1,847 | ||||||||||||
Total assets | $ | 57,551 | $ | 5,576 | $ | 12,232 | $ | 75,359 | |||||||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||||||||||||
Current liabilities: | |||||||||||||||||
Current portion of long-term debt | $ | 1,901 | $ | - | $ | 2,853 | (c) | $ | 4,754 | ||||||||
Accounts payable | 1,096 | 161 | (51 | ) | (b) | 1,206 | |||||||||||
Accrued expenses | 2,324 | 1,365 | (796 | ) | (b) | 2,893 | |||||||||||
Accrued compensation | 3,532 | - | 706 | (b) | 4,238 | ||||||||||||
Billings in excess of revenue earned | 7,810 | 364 | (302 | ) | (b) | 7,872 | |||||||||||
Accrued warranty | 1,105 | - | - | 1,105 | |||||||||||||
Contingent consideration | - | - | 1,200 | (a) | 1,200 | ||||||||||||
Other current liabilities | 1,035 | 28 | - | 1,063 | |||||||||||||
Total current liabilities | 18,803 | 1,918 | 3,610 | 24,331 | |||||||||||||
Long-term debt, less current portion | 7,089 | - | 11,410 | (c) | 18,499 | ||||||||||||
Other liabilities | 1,545 | 172 | 1,326 | (b) | 3,043 | ||||||||||||
Total liabilities | 27,437 | 2,090 | 16,346 | 45,873 | |||||||||||||
Stockholders’ equity: | |||||||||||||||||
Common stock | 214 | - | - | 214 | |||||||||||||
Additional paid-in capital | 77,876 | - | - | 77,876 | |||||||||||||
Accumulated deficit | (43,248 | ) | 3,486 | (4,114 | ) | (d) | (43,876 | ) | |||||||||
Accumulated other comprehensive loss | (1,729 | ) | - | - | (1,729 | ) | |||||||||||
Treasury stock at cost | (2,999 | ) | - | - | (2,999 | ) | |||||||||||
Total stockholders’ equity | 30,114 | 3,486 | (4,114 | ) | 29,486 | ||||||||||||
Total liabilities and stockholders’ equity | $ | 57,551 | $ | 5,576 | $ | 12,232 | $ | 75,359 |
See accompanying notes to the unaudited Pro Forma Condensed Combined Financial Information
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GSE SYSTEMS, INC. AND SUBSIDIARIES
Unaudited Pro Forma Condensed Combined Statement of Operations
Nine Months Ended September 30, 2018
(in thousands, except per share information)
Historical | Pro Forma | Pro Forma | |||||||||||||||
GSE | DP Engineering | Adjustments | Note 4 | Combined | |||||||||||||
Revenue | $ | 69,394 | $ | 17,008 | $ | - | $ | 86,402 | |||||||||
Cost of revenue | 52,735 | 8,830 | - | 61,565 | |||||||||||||
Gross profit | 16,659 | 8,178 | - | 24,837 | |||||||||||||
Operating expenses: | |||||||||||||||||
Selling, general and administrative | 13,686 | 6,962 | - | 20,648 | |||||||||||||
Research and development | 765 | - | - | 765 | |||||||||||||
Restructuring charges | 1,177 | - | - | 1,177 | |||||||||||||
Depreciation | 411 | 70 | - | 481 | |||||||||||||
Amortization of definite-lived intangible assets | 1,094 | - | 970 | (g) | 2,064 | ||||||||||||
Total operating expenses | 17,133 | 7,032 | 970 | 25,135 | |||||||||||||
Operating income | (474 | ) | 1,146 | (970 | ) | (298 | ) | ||||||||||
Interest income (expense), net | (153 | ) | (12 | ) | (386 | ) | (e) | (551 | ) | ||||||||
Gain (loss) on derivative instruments, net | (306 | ) | - | - | (306 | ) | |||||||||||
Other (expense) income, net | 24 | 43 | - | 67 | |||||||||||||
Income before income taxes | (909 | ) | 1,177 | (1,356 | ) | (1,088 | ) | ||||||||||
Provision for income taxes | 124 | 149 | (45 | ) | (f) | 228 | |||||||||||
Net income | $ | (1,033 | ) | $ | 1,028 | $ | (1,311 | ) | $ | (1,316 | ) | ||||||
Basic earnings per common share | $ | (0.05 | ) | $ | (0.07 | ) | |||||||||||
Diluted earnings per common share | $ | (0.05 | ) | $ | (0.07 | ) | |||||||||||
Weighted-average shares: | |||||||||||||||||
Basic | 19,620,207 | 19,620,207 | |||||||||||||||
Diluted | 19,620,207 | 19,620,207 |
See accompanying notes to the unaudited Pro Forma Condensed Combined Financial Information
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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 | DP Engineering | Adjustments | Note 4 | Combined | |||||||||||||
Revenue | $ | 70,880 | $ | 26,604 | $ | - | $ | 97,484 | |||||||||
Cost of revenue | 52,336 | 13,642 | - | 65,978 | |||||||||||||
Gross profit | 18,544 | 12,962 | - | 31,506 | |||||||||||||
Operating expenses: | |||||||||||||||||
Selling, general and administrative | 15,469 | 10,037 | - | 25,506 | |||||||||||||
Research and development | 1,391 | - | - | 1,391 | |||||||||||||
Restructuring charges | 778 | - | - | 778 | |||||||||||||
Depreciation | 342 | 92 | - | 434 | |||||||||||||
Amortization of definite-lived intangible assets | 335 | - | 1,731 | (g) | 2,066 | ||||||||||||
Total operating expenses | 18,315 | 10,129 | 1,731 | 30,175 | |||||||||||||
Operating income | 229 | 2,833 | (1,731 | ) | 1,331 | ||||||||||||
Interest income (expense), net | 80 | - | (638 | ) | (e) | (558 | ) | ||||||||||
Gain (loss) on derivative instruments, net | 99 | - | - | 99 | |||||||||||||
Other (expense) income, net | (4 | ) | (8 | ) | - | (12 | ) | ||||||||||
Income before income taxes | 404 | 2,825 | (2,369 | ) | 860 | ||||||||||||
Provision for income taxes | (4,980 | ) | 140 | 182 | (f) | (4,658 | ) | ||||||||||
Net income | $ | 5,384 | $ | 2,685 | $ | (2,551 | ) | $ | 5,518 | ||||||||
Basic earnings per common share | $ | 0.28 | $ | 0.29 | |||||||||||||
Diluted earnings per common share | $ | 0.27 | $ | 0.28 | |||||||||||||
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
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GSE SYSTEMS, INC. AND SUBSIDIARIES
Notes to Unaudited Pro Forma Condensed Combined Financial Information
1. | Basis of Presentation |
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.
2. | Financing Transaction |
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.
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4. | 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 |
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(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:
Estimated Fair Value | Estimated Useful Life | Amortization Method | Amortization Expense | Amortization Expense | |||||||||||||
(in thousands) | (in years) | Nine Months Ended September 30, 2018 | Year End December 31, 2017 | ||||||||||||||
(in thousands) | (in thousands) | ||||||||||||||||
Customer contracts and relationships | $ | 4,898 | 15 | Other(1) | $ | 773 | $ | 1,468 | |||||||||
Tradename | 1,172 | 10 | Straight-line | 88 | 117 | ||||||||||||
Non-compete agreements | 728 | 5 | Straight-line | 109 | 146 | ||||||||||||
Total | $ | 6,798 | $ | 970 | $ | 1,731 |
(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 of Customer Contracts and Relationships | ||||
Year 1 | $ | 1,468 | ||
Year 2 | 1,031 | |||
Year 3 | 725 | |||
Year 4 | 516 | |||
Year 5 | 362 | |||
Thereafter | 796 | |||
Total | $ | 4,898 |
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