Conformed SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Quarterly Period Ended September 30, 1998. 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. (Exact name of registrant as specified in its charter) Delaware 52-1868008 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 9189 Red Branch Road, Columbia, Maryland, 21045 (Address of principal executive office and zip code) Registrant's telephone number, including area code: (410) 772-3500 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 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 ___ ___ As of November 14, 1998, there were 5,065,688 shares of the Registrant's common stock (par-value $ .01 per share) outstanding. GSE SYSTEMS, INC. QUARTERLY REPORT ON FORM 10-Q INDEX PAGE PART I. FINANCIAL INFORMATION Item 1. Financial Statements: Consolidated Balance Sheets as of September 30, 1998 and December 31, 1997 4 Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 1998 and 1997 5 Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 1998 and 1997 6 Notes to Condensed Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition 10 Item 3. Quantitative and Qualitative Disclosure about Market Risk 13 PART II. OTHER INFORMATION Item 1. Legal Proceedings 13 Item 2. Changes in Securities and Use of Proceeds 13 Item 3. Defaults upon Senior Securities 13 Item 4. Submission of Matters to a Vote of Security Holders 14 Item 5. Other Information 14 Item 6. Exhibits and Reports on Form 8-K 15 PART I - FINANCIAL INFORMATION Item 1. Financial Statements GSE SYSTEMS, INC, AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands, except share and per share data) ASSETS Unaudited September 30, December 31, 1998 1997 ----------- ------------ Current assets: Cash and cash equivalents $ 1,937 $ 334 Contract receivables 22,913 24,371 Note Receivable 1,000 - Inventories 2,825 2,700 Prepaid expenses and other current assets 1,223 1,739 Deferred income taxes 41 2,570 ----------- ------------ Total current assets 29,939 31,714 Property and equipment, net 2,297 3,864 Investment in joint venture - 252 Software development costs, net 4,844 7,526 Goodwill and other intangible assets, net 3,194 2,974 Deferred income taxes 3,893 1,730 Other assets 1,347 302 ----------- ------------ Total assets $ 45,514 $ 48,362 =========== ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Lines of credit $ 5,668 $ 9,032 Accounts payable 7,347 7,919 Accrued expenses 3,959 4,304 Obligations under capital lease 223 208 Accrued severance costs - 148 Billings in excess of revenue earned 8,873 6,719 Accrued contract reserves 211 287 Accrued warranty reserves 569 625 Other current liabilities 198 513 Income taxes payable 196 313 ----------- ------------ Total current liabilities 27,244 30,068 Notes payable to related parties 173 185 Obligations under capital lease 50 234 Accrued contract and warranty reserves 421 675 Other liabilities 1,634 1,276 ----------- ------------ Total liabilities 29,522 32,438 ----------- ------------ Stockholders' equity: Common stock $.01 par value, 8,000,000 shares authorized,5,065,688 shares issued and outstanding 50 50 Additional paid-in capital 21,679 21,378 Retained earnings (deficit) - at formation (5,112) (5,112) Retained earnings (deficit) - since formation (97) (239) Cumulative translation adjustment (528) (153) ----------- ------------ Total stockholders' equity 15,992 15,924 ----------- ------------ Total liabilities & stockholders' equity $ 45,514 $ 48,362 =========== ============ The accompanying notes are an integral part of these consolidated financial statements. GSE SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except share and per share data) (Unaudited) Three months ended Nine months ended September 30, September 30, 1998 1997 1998 1997 ------------------ ---------------- Contract revenue $ 19,244 $ 19,021 $ 53,418 $ 58,978 Cost of revenue 12,695 13,527 37,012 41,825 -------- -------- -------- -------- Gross profit 6,549 5,494 16,406 17,153 Operating expenses Selling, general and administrative 4,404 6,068 14,891 19,257 Depreciation and amortization 405 675 1,340 1,875 Employee severance and termination costs - (225) - 1,124 -------- -------- -------- -------- Total operating expenses 4,809 6,518 16,231 22,256 -------- -------- -------- -------- Operating income (loss) 1,740 (1,024) 175 (5,103) Gain (loss) on sale of assets (5,025) - 550 - Interest (expense) (81) (207) (295) (566) Other (expense) income (80) 83 370 (30) -------- -------- -------- -------- Income (loss) before income taxes (3,446) (1,148) 800 (5,699) Provision for (benefit from) income taxes (1,276) (242) 659 (1,767) -------- -------- -------- -------- Net income (loss) $ (2,170) $ (906) $ 141 $ (3,932) ======== ======== ======== ======== Basic earnings (loss) per common share $ (0.43) $ (0.18) $ 0.03 $ (0.78) ======== ======== ======== ======== Diluted earnings (loss) per common share $ (0.43) $ (0.18) $ 0.03 $ (0.78) ======== ======== ======== ======== The accompanying notes are an integral part of these consolidated financial statements. GSE SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW (In thousands) (Unaudited) For the nine months ended September 30, 1998 1997 -------- -------- Cash flows from operating activities: Net income (loss) $ 141 $ (3,932) Adjustments to reconcile net income (loss) to net cash provided by used in operating activities: Depreciation and amortization 2,936 2,331 Accrued severance - 413 Provision for doubtful contract receivables (245) (31) Fair value of warrants issued to non-employees 120 - Deferred income taxes 409 (1,682) Equity in loss of investee 128 - Gain on disposal of assets (550) - Changes in assets and liabilities Contract receivables (1,618) 2,130 Inventories (117) 130 Prepaid expenses and other current assets (485) 266 Other assets (638) (189) Accounts payable and accrued expenses (2,156) (1,307) Billings in excess of revenues earned 2,458 (1,215) Accrued contract and warranty reserves (42) (579) Other current liabilities (677) 72 Income taxes payable 572 (301) Other liabilities 83 (2) -------- -------- Net cash provided by operating activities 319 (3,896) -------- -------- Cash flows from investment activities: Proceeds from sale of assets 8,955 - Capital expenditures (1,591) (1,002) Capitalization of software development costs (2,414) (2,804) Proceeds from sale/leaseback transaction - 521 -------- -------- Net cash provided by (used in) investing activities 4,950 (3,285) -------- -------- Cash flows from financing activities: (Decrease)increase in lines of credit with banks (3,364) 6,282 Repayments under capital lease obligations (143) (203) Principal payments under long term notes - (99) Decrease in notes payable to related parties (12) (12) -------- -------- Net cash provided by (used in) financing activities (3,519) 5,968 -------- -------- Effect of exchange rate changes on cash (147) (113) -------- -------- Net increase (decrease) in cash and cash equivalents 1,603 (1,326) Cash and cash equivalents at beginning of period 334 2,450 ======== ======== Cash and cash equivalents at end of period $ 1,937 $ 1,124 ======== ======== The accompanying notes are an integral part of these consolidated financial statements. GSE SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998 (Unaudited) 1. Basis of Presentation The condensed consolidated financial statements included herein have been prepared by the Company without independent audit. In the opinion of the Company's management, all adjustments and reclassifications of a normal and recurring nature necessary to present fairly the financial position, results of operations and cash flows for the periods presented have been made. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the period ended December 31, 1997 filed with Securities and Exchange Commission on March 31, 1998. The results of operations for the period ended September 30, 1998 are not necessarily indicative of what the operating results for the full year will be. 2. Disposition of Assets Oil & Gas. On November 10, 1998, the Company completed the sale of certain assets related to activities of its Oil & Gas business unit ("O&G"), to Valmet Automation (USA), Inc. ("Valmet"), pursuant to an Asset Purchase Agreement, effective as of October 30, 1998, by and between the Company and Valmet. The Company has recognized a loss on this transaction, in the quarter ended September 30, 1998, of $5.0 million, including the write-off of approximately $2.9 million in capitalized software development costs, since all operations that would support the recoverability of these captialized costs have been sold. The Company received approximately $742,000 in cash, subject to certain adjustments described in the next paragraph, and Valmet assumed certain identified liabilities. Valmet purchased assets with a book value of approximately $3.0 million. The Company will use the proceeds to pay for transaction expenses and for general corporate purposes. The purchase price is subject to post-closing adjustment based upon a balance sheet as of closing (the "Closing Balance Sheet"). If the net assets purchased on the Closing Balance differ from the calculated purchase price, the purchase price would be increased or decreased by that positive or negative difference. The agreement further stipulates that, subject to the occurrence to certain events, the Company is entitled to royalties over a five-year period relative to certain software of the Company which has been licensed to Valmet. Such royalties would not exceed $1 million in the aggregate and would be recorded as earned. The Company is liable for any cost overruns on certain development and project contracts, beyond estimates stipulated in the asset purchase agreement, such liabilities not to exceed $800,000. In addition to the $800,000 overruns liability, the Company remains responsible for certain liabilities not assumed by Valmet, including liabilities unknown as of the date of closing. The Company has accrued $400,000 and included such amount in the loss recognized on this transaction, based on a present estimate of exposure relative to these liabilities. Included in the Consolidated Statement of Operations for the nine month period ended September 30, 1998, are revenues of $1.1 million and net operating losses of $3.9 million attributable to the Oil & Gas business unit. Erudite. On May 1, 1998, the Company completed the sale of substantially all of the assets of its wholly owned subsidiary, GSE Erudite Software, Inc. ("Erudite"), to Keane, Inc. ("Keane"), pursuant to an Asset Purchase Agreement, dated as of April 30, 1998, by and among the Company, Erudite and Keane. The aggregate purchase price for the Erudite assets was approximately $9.9 million (consisting of $8.9 million in cash and $1.0 million in the form of an unsecured promissory note due on April 30, 1999, subject to certain adjustments described in the next paragraph). In connection with the transaction, Keane purchased certain assets of approximately $4.4 million and assumed certain operating liabilities totaling approximately $2.2 million. The Company has recognized a gain on this transaction, of $5.6 million. In connection with the sale of these assets, the Company has written off approximately $800,000 in capitalized software development costs, as well as $321,000 of purchased software, since all operations that would support the recoverability of these costs have been sold. The write-off of these costs is reflected in the calculation of the gain on the sale. As previously disclosed, the purchase price was subject to post-closing adjustment based upon a balance sheet as of closing (the "Closing Balance Sheet"). The Closing Balance Sheet indicated that if the "Net Asset Value" (defined in the Asset Purchase Agreement), as an amount equal to (a) the assets purchased by Keane minus (b) the assumed liabilities, was greater than, or less than $2.2 million, the purchase price would be increased or decreased by that positive or negative difference (the "Closing Net Book Value Adjustment"). Keane informed the Company, subsequent to closing, that, under the terms of the agreement, the Closing Net Book Value Adjustment resulted in an additional amount due Keane of approximately $186,000. The Company has engaged in communications with Keane regarding certain differences in valuation amounts. The Company has accrued $186,000 as a reduction to the gain on the sale of the Erudite assets. With the proceeds from the sale of the Erudite assets, the Company reduced its outstanding borrowings under credit facilities by approximately $3.8 million, and is using the remainder of the proceeds to pay for transaction expenses and for general corporate purposes. 3. Basic and Diluted Loss Per Common 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 three months ended September 30, 1998 and 1997 and the nine months ended September 30, 1998 and 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 following is a reconciliation of the weighted average number of outstanding common shares and potential common shares during each period presented for purposes of computing basic and diluted earnings per share. Three months ended Six months ended September 30, September 30, 1998 1997 1998 1997 ------------------ ---------------- Weighted average shares outstanding - basic 5,065,688 5,065,688 5,065,688 5,065,688 Potential common shares - - 153,733 - --------- --------- --------- --------- Weighted average shares outstanding - Diluted 5,065,688 5,065,688 5,219,421 5,065,688 ========= ========= ========= ========= 4. 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. Inventories, net, consist of the following (in thousands) at: September 30, December 31, 1998 1997 ------------ ------------ Raw Materials $ 1,678 $ 1,610 Service parts 1,147 1,090 ------------ ------------ Total inventories $ 2,825 $ 2,700 ============ ============ 5. 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 revenues 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 revenues or (b) the straight-line method over the remaining estimated economic life of the product, not to exceed five years. Software development costs capitalized were $690,000 and $720,000 for the three months ended September 30, 1998 and 1997, respectively, and $1.9 million and $2.8 million for the nine months ended September 30, 1998 and 1997, respectively. Total amortization expense was $339,000 and $298,000 for the three months ended September 30, 1998 and 1997, respectively, and $1,368,000 and $475,000 for the nine months ended September 30, 1998 and 1997, respectively. 6. Financing Arrangements The Company maintains, through it subsidiaries, two lines of credit that provide for borrowings up to $10.0 million to support foreign letters of credit, margin requirements on foreign exchange contracts and working capital needs. The lines of credit expire December 31, 1998. The line of credit related to theCompnay's Power Systems unit is 90% guaranteed by the Export Import Bank of the United States ("EXIM"), which guaranty expires November 30, 1998. The Company is currently engaged in duscussions with EXIM regarding the EXIM guaranty, however, there can be no assurance that an extension to such guaranty will be granted. At September 30, 1998, there were $5.7 million of borrowings under the lines of credit, and letters of credit issued in the ordinary course of business amounted to approximately $730,000. The aforementioned lines of credit contain certain restrictive covenants. Although the Company was in violation of the cash flow coverage ratio as of September 30, 1998, the bank has waived such covenant violations. With respect to the potential liquidity issues related to the maturity date on the lines of credit, certain of the Company's principal stockholders, ManTech International Corporation ("ManTech") and GP Strategies Corporation ("GP Strategies"), have agreed to provide working capital support to the Company through June 30, 1999, in the form of credit enhancements or by taking actions that would result in additional liquidity to the Company. 7. Contract Receivables The components of contract receivables are as follows (in thousands): September 30, December 31, 1998 1997 ------------ ------------ Bill receivables $ 13,078 $ 16,994 Recoverable costs and accruals profit not billed 10,611 8,398 Allowance for doubtful accounts (776) (1,021) ------------ ------------ Total contract receivables $ 22,913 $ 24,371 ============ ============ Recoverable costs and accrued profit not billed represent costs incurred and 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. Revenue under long-term, 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. The effect of changes in estimates of contract profits for all periods presented is immaterial. 8. Income Taxes The Company's effective tax rate is based on the best current estimate of its expected annual effective tax rate. The difference between the statutory U.S. tax rate and the Company's effective tax rate for the three and nine months ended September 30, 1998 is primarily the results of a valuation allowance against all of the net operating losses generated during the six months ended June 30, 1998, the effects of foreign operations at different tax rates and state income taxes. For the three months ended September 30, 1998 and 1997, the Company recorded an income tax benefit on the pre-tax losses incurred by the Company's domestic operations. The benefit recorded in the third quarter of 1998 is based on management's estimate that the Company will generate income before income taxes for the year ending December 31, 1998. 9. Comprehensive Income Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" is effective for the nine months ended September 30, 1998. SFAS No. 130 establishes standards for reporting comprehensive income on an annual basis in a full set of general purpose financial statements either in the statement of operations or in a separate statement. For the three months ended September 30, 1998 and 1997, the Company had a comprehensive net (loss) of $(2.5) million and $(1.1) million, respectively. For the nine months ended September 30, 1998 and 1997 the Company had a comprehensive loss of $(234,000) and $(4.3) million, respectively. The difference between the comprehensive income (loss) and the net income (loss) as reported in the statements of operations is related to foreign currency translation adjustments. 10. Recent Pronouncements The Financial Accounting Standards Board has issued Statement of Financial Accounting Standard No. 131, "Disclosure about Segments of an Enterprise and Related Information." SFAS No. 131 establishes standards for reporting information about operating segments, including related disclosures, and products, services, geographic areas and major customers and is effective for the year ending December 31, 1998. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities. This Statement requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The Company will be required to adopt this new accounting standard by January 1, 2000. Management does not anticipate early adoption. The Company believes that the effect of adoption of SFAS No.133 will not be material. Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition General Business Environment The Company designs, develops and delivers business solutions by applying high-technology-related process control and 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; addressing environmental issues; and enhancing overall productivity. As previously disclosed, the Company has made senior management changes, and has set a course to reduce costs and to return the Company's focus to its core businesses of controls and simulation. The results to date of the efforts to re-focus and reduce costs are evidenced by the improvement in operating results for the three months and nine months ended September 30, 1998 as compared to the three months and nine months ended September 30, 1997. This is reflected in the operating income of $1.7 million and $175,000 versus operating (losses) of $(1.0 million) and $(5.1 million), for the three and nine months periods ended September 30, 1998 and 1997, respectively. The operating results for the first three quarters of 1998 were a substantial improvement over each quarter in 1997. The Company believes these actions will result in an ongoing, viable enterprise more closely focused on its core businesses. Results of Operations The following table sets forth the results of operations for the periods presented expressed as a percentage of revenues. Three months ended September 30, Nine months ended September 30, 1998 % 1997 % 1998 % 1997 % ------------------------------------ ------------------------------------ Contract revenue 19,244 100.0% 19,021 100.0% 53,418 100.0% 58,978 100.0% Cost of revenue 12,695 66.0% 13,527 71.1% 37,012 69.3% 41,825 70.9% ------ ----- ------ ------ ------ ----- ------ ----- Gross profit 6,549 34.0% 5,494 28.9% 16,406 30.7% 17,153 29.1% Operating Expenses: Selling, general and administrative 4,404 22.9% 6,068 31.9% 14,891 27.9% 19,257 32.7% Depreciation and amortization 405 2.1% 675 3.5% 1,340 2.5% 1,875 3.2% Employee severance and termination costs - 0.0% (225) -1.2% - 0.0% 1,124 1.9% ------ ----- ------ ------ ------ ----- ------ ----- Total operating expenses 4,809 25.0% 6,518 34.3% 16,231 30.4% 22,256 37.7% ------ ----- ------ ------ ------ ----- ------ ----- Operating income (loss) 1,740 9.0% (1,024) -5.3% 175 0.3% (5,103) -8.7% Gain/(loss) on disposition of assets (5,025) -26.1% - 0.0% 550 1.0% - 0.0% Interest (expense) (81) -0.4% (207) -1.1% (295) -0.6% (566) -1.0% Other (expense) income (80) -0.4% 83 0.4% 370 0.7% (30) -0.1% ------ ----- ------- ------ ------ ----- ------ ----- Income (loss) before income taxes (3,446) -17.9% (1,148) -6.0% 800 1.5% (5,699) -9.7% Provision for (benefit from) taxes (1,276) -6.6% (242) -1.3% 659 1.2% (1,767) -3.0% ------ ----- ------- ------ -------- ----- ------ ----- Net income (loss) (2,170) -11.3% (906) -4.8% 141 0.3% (3,932) -6.7% ====== ===== ======= ====== ======== ===== ====== ===== Revenues. Revenues for the three and nine months ended September 30, 1998 amounted to $19.2 million and $53.4 million, respectively, as compared with revenues of $19.0 million and $59.0 million in the three and nine months ended September 30, 1997, respectively. This decrease for the nine months was mainly due to the disposal of the Erudite assets. In the three and nine months ended September 30, 1998, Erudite accounted for no sales and $5.3 million of revenue, respectively, compared with $5.5 million and $13.5 million during the same periods in 1997. Excluding Erudite, the increase in revenue was mainly due to increases in customer orders in the core businesses. Gross Profit. Gross profit increased to $6.5 million, a gross margin of 34.0%, in the three months ended September 30, 1998 from $5.5 million, a gross margin of 28.9%, in the corresponding period of 1997. Gross profit decreased to $16.4 million, a gross margin of 30.7%, in the nine months ended September 30, 1998 from $17.2 million, a gross margin of 29.1%, in the corresponding period of 1997. The increase for the three months is primarily due to more profitable contracts. The decrease in the gross profit for the nine months is primarily attributable to lower revenues resulting from the disposition of the Erudite assets, which was offset by higher margins in the core businesses. Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased to $4.4 million, or 22.9% of revenues, during the three months ended September 30, 1998 from $6.1 million, or 31.9% of revenues, during the corresponding period in 1997. Selling, general and administrative expenses decreased to $14.9 million, or 27.9% of revenue during the nine months ended September 30, 1998 from $19.3 million, or 32.7% of revenues, during the corresponding period in 1997. The decrease in selling, general and administrative expenses is primarily attributable to the disposition of the Erudite assets and the Company's ongoing efforts to reduce costs. Gross research and product development expenditures were $1.4 million and $1.2 million in the three months ended September 30, 1998 and 1997, respectively, and $3.9 million and $4.0 million in the nine months ended September 30, 1998 and 1997, respectively. Capitalized software development costs totaled $690,000 and $720,000 during the quarters ended September 30, 1998 and 1997 and $2.4 million and $2.8 million during the nine months ended September 30, 1998 and 1997, respectively. Net research and development costs expensed and included within selling, general and administrative expenses were $710,000 and $480,000 during the quarters ended September 30, 1998 and 1997, respectively, and $2.5 million and $1.2 million during the nine months ended September 30, 1998 and 1997, respectively. The Company continued investing in the conversion of its DCS product to the Windows NT platform, SCADA system enhancements for the Windows NT platform and the productization of its SimSuite software tools. Depreciation and Amortization. Depreciation expense amounted to $324,000 and $609,000 during the three months ended September 30, 1998 and 1997, respectively. Depreciation expense amounted to $1.1 and $1.7 million during the nine months ended September 30, 1998 and 1997, respectively. This decrease was attributable to the sale of the Erudite assets, and lower depreciation expense after the facilities move. Amortization of goodwill and intangibles was $81,000 and $66,000 during the three months ended September 30, 1998 and 1997, respectively, and $245,000 and $223,000 during the nine months ended September 30, 1998 and 1997, respectively. The increase for the nine months was due to the previously-reported acquisition of J. L. Ryan, Inc. in December of 1997. Employee Severance and Termination. For the three and nine months ending September 30, 1998, there were no charges for severance. During the nine months ended September 30, 1997, there was a a net charge for severance and other employee obligations of $1.1 million, after a third quarter reduction of $225,000, in connection with cost reduction efforts initiated to offset the impact of a decrease in project revenues. Operating Income (Loss) . Operating income (loss) for the three months ended September 30, 1998, increased to $1.7 million or 9.0% of revenues, from $(1.0 million), or (5.3%) of revenues, during the corresponding period of 1997. Operating income (loss) for the nine months ended September 30, 1998, increased to $175,000, or 0.3% of revenues, from $(5.1) million, or (8.6%) of revenues, during the corresponding period of 1997. The 1998 increases are attributable to the increase in revenue and gross margin within the core businesses, decrease in Employee Severance and Termination Costs, as well as decreased selling, and general administrative expenses. Erudite accounted for $(700,000) and $(1.4) million of the loss, respectively, for the three and nine months ended September 30, 1997. Gain (Loss) on Disposal of Assets. For the three months ended September 30, 1998, the Company recognized a $(5.0 million) loss on the disposition of the O&G assets. During the second quarter, the Company recorded a gain of $5.6 million on the sale of the Erudite assets. The sales and related gains and losses are described more fully under Note 2, Disposal of Assets - "Notes to the Condensed Consolidated Financial Statements", "Liquidity and Capital Resources" below, and by the provisions of the applicable asset purchase agreement, which, in the case of the Erudite assets, was included as Exhibit 2.3 to the Company's Form 10-Q for the quarter ended March 31, 1998 and is incorporated herein by reference. Interest Expense. Interest expense decreased to $81,000 and $295,000 during the three and nine months ended September 30, 1998, respectively, from $207,000 and $566,000 during the three and nine months ended September 30, 1997, respectively. The decreases are due to lower levels of borrowings during the periods. Other Income (Expense). Other income (expense) fluctuated significantly during the periods presented primarily due to the effect of gains and losses on foreign currency transactions from the Company's Asian operations. Income Taxes. The Company's effective tax rate is based on the best current estimate of its expected annual effective tax rate. The difference between the statutory U.S. tax rate and the Company's effective tax rate for the three months and nine months ended September 30, 1998 and 1997 is primarily the result of a valuation allowance against all of the net operating losses generated during the six months ended June 30, 1998, the effects of foreign operations at different tax rates and state income taxes. For the three and nine months ended September 30, 1997, the Company recorded an income tax benefit on the pre-tax losses incurred by the domestic operations. Liquidity and Capital Resources During the nine months ended September 30, 1998, the Company's operations used $181,000 of net cash. At September 30, 1997, net cash used by operations was $3.9 million. At September 30, 1998, the Company had cash and cash equivalents totaling approximately $1.9 million. In November 1998, the Company completed the sale of certain assets related to activities of its Oil & Gas business unit ("O&G"), to Valmet Automation (USA), Inc. ("Valmet"), pursuant to an Asset Purchase Agreement, effective as of October 30, 1998, by and between the Company, and Valmet. The Company has recognized a loss on this transaction, in the quarter ended September 30, 1998, of $5.0 million. In connection with the sale of these assets, the Company has written off approximately $2.9 million in capitalized software development costs, since all operations that would support the recoverability of these costs have been sold. The write-off of these costs is reflected in the calculation of the loss on the sale. The Company received approximately $742,000 in cash, subject to certain adjustments described in the next paragraph, and Valmet assumed certain identified liabilities. Valmet purchased assets with a book value of approximately $3.0 million. The Company will use the proceeds to pay for transaction expenses and for general corporate purposes. The purchase price is subject to post-closing adjustment based upon a balance sheet as of closing (the "Closing Balance Sheet"). If the net assets purchased on the Closing Balance differ from the calculated purchase price, the purchase price would be increased or decreased by that positive or negative difference. The agreement further stipulates that, subject to the occurrence to certain events, the Company is entitled to royalties over a five-year period relative to certain software of the Company which has been licensed to Valmet. Such royalties would not exceed $1 million in the aggregate and would be recorded as earned. The Company is liable for any cost overruns on certain development and project contracts, beyond estimates stipulated in the asset purchase agreement, such liabilities not to exceed $800,000. In addition to the $800,000 overruns liability, the Company remains responsible for certain liabilities not assumed by Valmet, including liabilities unknown as of the date of closing. The Company has accrued $400,000 and included such amount in the loss recognized on this transaction, based on a present estimate of exposure relative to these liabilities. In May 1998, the Company completed the sale of substantially all of the assets of Erudite to Keane, pursuant to an Asset Purchase Agreement, dated as of April 30, 1998, by and among the Company, Erudite and Keane. The purchase price for the Erudite assets was $9.9 million ($8.9 million in cash and $1.0 million in the form of an unsecured promissory note due on April 30, 1999, subject to certain adjustments) plus the assumption by Keane of certain operating liabilities totaling approximately $2.2 million. Net cash proceeds to be received in 1998 in connection with the sale of Erudite, including transaction costs, is estimated at $4.1 million, after reducing outstanding debt as described below. The foregoing description of the Asset Purchase Agreement is qualified in its entirety by the full text of the Asset Purchase Agreement, which was included as Exhibit 2.3 to the Company's Form 10-Q for the quarter ended March 31, 1998 and is incorporated herein by reference. Refer to Note 2, Disposal of Assets - "Notes to Consolidated Financial Statements" for a further discussion of the sale. The Company continues to maintain two lines of credit amounting to $10.0 million. The first line for $7.0 million is collateralized by the contract receivable and inventory of GSE Power Systems, Inc. ("Power Systems"), and provides for borrowings of up to 90% of eligible receivable and 60% of unbilled receivables. The second line for $3.0 million is collateralized by substantially all the assets of GSE Process Solutions, Inc. ("Process Solutions"), and provides for borrowing up to 85% of eligible receivables and 20% of inventory (not to exceed $500,000). At September 30, 1998, there were $5.7 million in borrowings under these lines of credit, and letters of credit issued in the ordinary course of business amounted to $730,000. The lines of credit expire December 31, 1998; however, the Company anticipates that these lines will be extended or replaced. The Company intends to continue to seek to replace or renegotiate its credit facilities, which expire on December 31, 1998. For further discussion, see Note 6, Financing Arrangements - "Notes to Consolidated Financial Statements". The line of credit related to the Power Systems is 90% guaranteed by the Export Import Bank of the United States ("EXIM"), which guaranty expires November 30, 1998. The Company is currently engaged in discussions with EXIM regarding the EXIM guaranty, however, there can be no assurance that an extension to such guaranty will be granted. The aforementioned lines of credit contain certain restrictive covenants. Although the Company was in violation of the cash flow coverage ratio as of September 30, 1998, the bank has waived such covenant violations. Certain of the Company's principal stockholders, ManTech and GP Strategies, have agreed to provide working capital support to the Company through June 30, 1999, in the form of credit enhancements or by taking actions that would result in additional liquidity to the Company. Furthermore, each of ManTech and GP Strategies has previously provided certain guaranties to the Company's bank on behalf of the Company. As previously disclosed, in consideration for the above-mentioned guaranties, the Company has granted each of ManTech and GP Strategies warrants to purchase shares of the Company's common stock; each of such warrants provide the right to purchase at least 150,000 shares of common stock at $2.375 per share. The Company has recognized $300,000 as the estimated fair value of such warrants in the consolidated financial statements. During the three months and nine months ended September 30, 1998, the Company recognized $60,000 and $120,000 respectively of expense related to these warrants. The Company will expense the remainder of the fair value over the term of the guarantees. Management believes the Company has sufficient liquidity and working capital resources necessary for currently planned business operations, debt service requirements, planned investments, and capital expenditures. Year 2000 General. The Company is aware of general industry concerns regarding the Year 2000 problem. The Year 2000 problem concerns the inability of information systems to properly recognize and process date-sensitive information beyond January 1, 2000. The Company has established a compliance program intended to bring its software and systems into Year 2000 compliance in time to minimize any significant detrimental effects on operations. This program covers the Company's own products and installed base, significant vendors and customers, and financial and administrative systems. The Company's program recognizes that date-sensitive systems may fail at different points in time depending on their function. Systems having forward-looking planning and production functions may fail earlier and require corrective actions sooner to allow for reasonable testing. Other applications may fail only during the transition to Year 2000. The Company plans to utilize internal personnel, contractors and vendors to identify Year 2000 noncompliance problems, modify code and test the modifications. In some cases, non-compliant software and hardware will be replaced. Current Product Offerings. The Company believes that it has identified substantially all potential Year 2000 problems with the current versions of the software products it develops and markets. However, management also believes that it is not possible to determine with complete certainty that all Year 2000 problems affecting the Company's software products have been identified or corrected due to complexity of these products and the fact that these products interact with other third party vendor products and integrate with computer systems which are not under the Company's control. The Company's program includes the testing and, if necessary, the modification of new versions of its products to ensure Year 2000 readiness. Previous Versions and Installed Base. Older versions of the Company's software will require modification to work properly through and after the Year 2000. The Company offers Year 2000 evaluation services to its customers having older systems to determine the scope of work required to correct any problems. The Company's program also includes the development of patches for certain previous versions of the Company's products, which may be purchased by customers. However, there can be no assurance that such patches would correct all Year 2000 problems in such previous versions, and there can be no assurance that evaluation services and patches will be purchased and implemented by the Company's customers. Suppliers. The Company has initiated communications with third party suppliers of the major computer system components, software, and other equipment used, operated, or maintained by the Company to identify and, to the extent possible, to resolve issues involving the Year 2000 problem. However, the Company has limited or no control over the actions of these third party suppliers. Thus, while the Company expects that it will be able to resolve any significant Year 2000 problems with these systems, there can be no assurance that these suppliers will resolve any or all Year 2000 problems with these systems before the occurrence of a material disruption to the business of the Company or any of its customers. Financial and Administrative Systems. The Company also relies on various administrative and financial applications (e.g., order processing and collection systems) that require correction to properly handle Year 2000 dates. In the event one of these systems is not adequately corrected, the Company's ability to capture, schedule and fulfill customer demands could be impaired. Likewise, if a collection processing system were to fail, the Company may not be able to properly apply payments to customer balances or correctly determine cash balances. The Company plans to implement a replacement of its primary accounting system in the second quarter of 1999 and other centrally controlled administrative applications are being assessed and tested. Various non-centrally controlled systems are also utilized by the Company's businesses. The impact of a failure of these systems would be limited to the business using the affected system, and then only to the extent that manual or other alternate processes were not able to meet processing requirements. Such an occurrence is not expected to have a significant adverse impact on the Company. Significant Customers. The Company is also dependent upon its customers for sales and cash flow. Year 2000 interruptions in the Company's customers' operations could result in reduced sales, increased inventory or receivable levels and cash flow reductions. While these events are possible, the Company anticipates that its customer base is broad enough to minimize the affects of a such interruptions. The Company plans, however, to monitor the status of the Company's customers as a means of determining risks and alternatives. Costs. The Company is currently quantifying the impact of the incremental costs associated with the initiatives outlined above. Although this cost estimate has not yet been completed, the majority of these costs are expected to be incurred during the next twelve months. While the Company believes its efforts will provide reasonable assurance that material disruptions to its internal systems and installed products will not occur, the potential for interruption still exists. The Company's policy is to expense as incurred information system maintenance costs and to capitalize the cost of new software and hardware and amortize or depreciate it over the assets' useful lives. Contingency Plans. The Company is currently developing contingency plans to be implemented as part of its efforts to identify and correct Year 2000 problems affecting its internal systems and installed products. The Company expects to complete its contingency plans by the end of 1998. Depending on the systems affected, these plans could include accelerated replacement of affected equipment or software, short to medium-term use of backup equipment and software, increased work hours for Company personnel or use of contract personnel to correct on an accelerated schedule any Year 2000 problems that arise or to provide manual workarounds for information systems, and similar approaches. If the Company is required to implement any of these contingency plans, it could have a material adverse effect on the Company's financial condition and results of operations. THE ABOVE DISCUSSION OF THE COMPANY'S EFFORTS, AND MANAGEMENT'S EXPECTATIONS, RELATING TO YEAR 2000 COMPLIANCE ARE FORWARD-LOOKING STATEMENTS. THE COMPANY'S ABILITY TO ACHIEVE YEAR 2000 COMPLIANCE AND THE LEVEL OF INCREMENTAL COSTS ASSOCIATED THEREWITH, COULD BE ADVERSELY IMPACTED BY, AMONG OTHER THINGS, THE AVAILABILITY AND COST OF PROGRAMMING AND TESTING RESOURCES, SUPPLIERS' ABILITY TO BRING THEIR SYSTEMS INTO YEAR 2000 COMPLIANCE, AND UNANTICIPATED PROBLEMS IDENTIFIED IN THE COMPANY'S ONGOING COMPLIANCE REVIEW. Item 3. Quantitative and Qualitative Disclosure about Market Risk Not Applicable PART II - OTHER INFORMATION Item 1. Legal Proceedings. The Company is not a party to any current litigation; various actions and proceedings are 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 effect on the financial condition of the Company. Item 2. Changes in Securities None Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None Acquisition or Disposition of Assets In November 1998, the Company completed the sale of certain assets related to activities of its Oil & Gas business unit ("O&G"), to Valmet Automation (USA), Inc. ("Valmet"), pursuant to an Asset Purchase Agreement, effective as of October 30, 1998, by and between the Company, and Valmet. The Company received approximately $742,000 in cash, subject to certain adjustments described in the next paragraph and Valmet assumed certain identified liabilities. Valmet purchased assets with a book value of approximately 3.0 million. The Company has recognized a loss on this transaction, in the quarter ended September 30, 1998, of $5.0 million. In connection with the sale of these assets, the Company has written off approximately $2.9 million in capitalized software development costs, since all operations that would support the recoverability of these costs have been sold. The write-off of these costs is reflected in the calculation of the gain on the sale. The purchase price is subject to post-closing adjustment based upon a balance sheet as of closing (the "Closing Balance Sheet"). If the net assets purchased on the Closing Balance Sheet differ from the calculated purchase price, the purchase price would be increased or decreased by that positive or negative difference. The Company will use the proceeds to pay for transaction expenses and for general corporate purposes. The agreement further stipulates that, subject to the occurrence to certain events, the Company is entitled to royalties over a five-year period relative to certain software of the Company which has been licensed to Valmet. Such royalties would not exceed $1 million in the aggregate and would be recorded as earned. The Company is liable for any cost overruns on certain development and project contracts, beyond estimates stipulated in the asset purchase agreement, such liabilities not to exceed $800,000. In addition to the $800,000 overruns liability, the Company remains responsible for liabilities not assumed by Valmet, including certain liabilities unknown as of the date of closing. The Company has accrued $400,000 and included such amount in the loss recognized on this transaction, based on a present estimate of exposure relative to these liabilities.(Refer to Item 2, Management's Discussion and Analysis of the Results of Operations and Financial Condition, General Business Environment and Liquidity and Capital Resources, above, and Note 2, Subsequent Event - Disposal of Assets - "Notes to the Condensed Consolidated Financial Statements" for a further discussion of the sale). Pro Forma Financial Statements The following unaudited Pro Forma Balance Sheet as of September 30, 1998 and Pro Forma Consolidated Statements of Operations for the three and nine months ended September 30, 1998 and the year ended December 31, 1997, are presented to give effect to the sale of the O&G assets. Historical financial data used to prepare the pro forma financial statements were derived from the audited consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 1997 and the unaudited condensed consolidated financial statements included in the Company's Quarterly Report on Forms 10-Q herein for the nine-months September 30, 1998. These pro forma financial statements should be read in conjunction with such historical financial statements and notes thereto. The pro forma adjustments reflected herein are based on available information and certain assumptions that the Company's management believes are reasonable. Pro Forma adjustments to the unaudited pro forma Balance Sheet assume that the sale of Oil & Gas was consummated on September 30, 1998. Pro forma adjustments to the unaudited Pro Forma Consolidated Statements of Operations assume that the sale of O&G was consummated on January 1, 1998 and January 1, 1997 in the unaudited Pro Forma Statements of Operations for the nine months ended September 30, 1998 and for the year ended December 31, 1997, respectively. The Pro Forma Statements of Operations are based on assumptions and approximations and, therefore, do not reflect the impact of the transaction on the historical financial statements. In addition, such pro forma financial statements should not be used as a basis for forecasting the future operations of the Company. GSE SYSTEMS, INC. AND SUBSIDIARIES PROFORMA CONSOLIDATED BALANCE SHEET (in thousands, except share and per share data) As of September 30, 1998 Unaudited ASSETS Proforma Historical Adjustments Proforma Current assets: Cash and cash equivalents $ 1,937 $ 642 $ 2,579 Contract receivables 22,913 22,913 Note Receivable 1,000 1,000 Inventories 2,825 2,825 Prepaid expenses and other current assets 1,223 1,223 Deferred income taxes 41 41 -------- -------- ------- Total current assets 29,939 642 30,581 Property and equipment, net 2,297 2,297 Software development costs, net 4,844 4,844 Goodwill and other intangible assets, net 3,194 3,194 Deferred income taxes 3,893 3,893 Other assets 1,347 1,347 -------- -------- -------- Total assets $ 45,514 $ 642 $ 46,156 ======== ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Lines of credit $ 5,668 $ - $ 5,668 Accounts payable 7,347 7,347 Accrued expenses 3,959 642 4,601 Obligations under capital lease 223 223 Billings in excess of revenue earned 8,873 8,873 Accrued contract reserves 211 211 Accrued warranty reserves 569 569 Other current liabilities 198 198 Income taxes payable 196 196 ------- -------- ------- Total current liabilities 27,244 642 27,886 Notes payable to related parties 173 173 Obligations under capital lease 50 50 Accrued contract and warranty reserves 421 421 Other liabilities 1,634 1,634 ------- -------- ------- Total liabilities 29,522 642 30,164 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 21,679 21,679 Retained earnings (deficit) - at formation (5,112) (5,112) Retained earnings (deficit) - since formation (97) (97) Cumulative translation adjustment (528) (528) -------- -------- -------- Total stockholders' equity 15,992 - 15,992 -------- -------- -------- Total liabilities & stockholders' equity $ 45,514 $ 642 $ 46,156 ======== ======== ======== The accompanying notes are an integral part of these consolidated financial statements. GSE SYSTEMS, INC. PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS For the nine months ended September 30, 1998 (In thousands, except per share data) (Unaudited) Less Pro forma Historical O&G adjustments Pro Forma Contract revenue $ 53,418 $ 1,137 $ $ 52,281 Cost of revenue 37,012 1,061 35,951 ------ ------ ------ ------ Gross profit 16,406 76 16,330 ------ ------ ------ ------ Operating expenses: Selling, general and administrative 14,891 1,177 13,714 Depreciation and amortization 1,340 47 1,293 ------ ------ ------ ------ Total operating expenses 16,231 1,224 15,007 ------ ------ ------ ------ Operating (loss) income 175 (1,148) 1,323 Gain (loss) on disposal of assets 550 (5,025) 5,575 Interest expense, net (295) (295) Other income expense 370 370 ------ ------ ------ ------ Income (loss) before income taxes 800 (6,173) 6,973 Benefit from (provision for) income taxes (659) 2,284 (2,943) ------ ------ ------ ------ Net income (loss) $ 141 $ 3,889 $ $ 4,030 ====== ====== ====== ====== Basic earnings per common share $ 0.03 $ (0.77) $ 0.00 $ 0.80 ====== ====== ====== ====== Diluted earnings per share $ 0.03 $ (0.77) $ 0.00 $ 0.77 ====== ====== ====== ====== GSE SYSTEMS, INC. PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS For the year ended December 31, 1997 (In thousands, except per share data) (Unaudited) Less Pro forma Historical O&G adjustments Pro Forma Contract revenue $ 79,711 $ 2,323 $ $ 77,388 Cost of revenue 58,326 2,288 56,038 ------ ------ ------ ------ Gross profit 21,385 35 21,350 ------ ------ ------ ------ Operating expenses: Selling, general and administrative 27,320 2,353 24,967 Depreciation and amortization 2,368 201 2,167 Employee severance and termination costs 1,124 1,124 ------ ------ ------ ------ Total operating expenses 30,812 2,554 28,258 ------ ------ ------ ------ Operating income (loss) (9,427) (2,519) (6,908) Interest expense, net (765) (765) Other income expense (1,228) (1,228) ------ ------ ------ ------ Income (loss) before income taxes (11,420) (2,519) (8,901) Benefit from (provision for) income taxes 2,717 932 1,785 ------ ------ ------ ------ Net (loss) income $ (8,703) $ 1,587 $ 0.00 $ (7,116) ====== ====== ====== ====== Basic and diluted (loss) earnings per common $ (1.72) $ 0.31 $ 0.00 $ (1.40) share ====== ====== ====== ====== GSE SYSTEMS, INC. NOTES TO PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Historical. The historical balances represent the results of operations for the nine months ended September 30, 1998 and for the year ended December 31, 1997 as reported in the historical consolidated financial statements of GSE Systems, Inc. (the Company), by reference to the Annual Report on Form 10-K of GSE Systems, Inc. for the year ended December 31, 1997. 2. Sale of the O&G assets. The Company has sold substantially all the O&G assets. The O&G operations, as set forth in this column, have been excluded from the historical statements of operations of the Company in the unaudited pro forma consolidated statements of operations for the nine months ended September 30, 1998 and the year ended December 31, 1997, respectively. 3. Pro Forma adjustment. The adjustment in the Pro Forma Consolidated Balance Sheet reflects the receipt of cash for the net assets sold. The Oil & Gas assets sold have not been presented separately as all the assets disposed of and the resulting loss on the disposition are reflected in the historical amounts as of September 30, 1998. Forward Looking Statements This Form 10-Q contains certain "forward-looking statements," within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the safe harbors created by those Acts. These statements include the plans and objectives of management for future operations, including plans and objectives relating to the development of the Company's business in the domestic and international marketplace. All forward-looking statements involve risks and uncertainties, including, without limitation, risks relating to the Company's ability to enhance existing software products and to introduce new products in a timely and cost-effective manner, reduced development of nuclear power plants that may utilize the Company's products, a long pay-back cycle from the investment in software development, uncertainties regarding the ability of the Company to grow its revenues and successfully integrate operations through expansion of its existing business and strategic acquisitions, the ability of the Company to respond adequately to rapid technological changes in the markets for process control and simulation software and systems, significant quarter-to-quarter volatility in revenues and earnings as a result of customer purchasing cycles and other factors, dependence upon key personnel, and general market conditions and competition. 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-Q 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. Item 6. Exhibits and Reports on Form 8-K (a) Exhibit Index None (b) Reports on Form 8-K The Company filed a report on Form 8-K (September 24, 1998) regarding a letter of intent between the Company and Valmet Automation, Inc. with respect to Valmet's intention to purchase the Company's Oil & Gas business unit. This report on Form 8-K included the text of a press release dated September 21, 1998. SIGNATURES Pursuant to the requirements 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. Date: November 14, 1998 GSE SYSTEMS, INC. /S/ Christopher M. Carnavos Christopher M. Carnavos President and Director (Principal Executive Officer) /S/ Stephen J. Fogarty Stephen J. Fogarty Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)