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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996
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 of incorporation) (I.R.S. Employer Identification Number)
8930 STANFORD BOULEVARD, COLUMBIA, MARYLAND 21045
- ------------------------------------------- -----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (410) 312-3700
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, $.01 par value
(Title of each class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of Common Stock held by non-affiliates as of
March 7, 1997 was $18,881,330 based on closing price of such stock on that
date.
Number of shares of Common Stock outstanding as of March 7, 1997:
5,065,688.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates certain information by reference from the
Registrant's definitive proxy statement to be filed for its 1997 annual meeting
of shareholders.
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GSE SYSTEMS, INC.
FORM 10-K
For the Year Ended December 31, 1996
TABLE OF CONTENTS
PART I Page
----
Item 1. Business.............................................................................. 3
Item 2. Properties............................................................................ 10
Item 3. Legal Proceedings..................................................................... 10
Item 4. Submission Matters to a Vote of Security Holders...................................... 10
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters............................................................... 11
Item 6. Selected Financial Data............................................................... 12
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................................... 14
Item 8. Financial Statements and Supplementary Data........................................... 22
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure............................................ 23
PART III
Item 10. Directors and Executive Officers of the Company....................................... 24
Item 11. Executive Compensation................................................................ 24
Item 12. Security Ownership of Certain Beneficial Owners
and Management.................................................................... 24
Item 13. Certain Relationships and Related Transactions........................................ 24
PART IV
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K............................................................... 25
SIGNATURES.............................................................................................. 26
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GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
PART I
ITEM 1. BUSINESS.
GSE Systems, Inc. ("GSE Systems" or the "Company") designs, develops and
delivers business and technology solutions by applying process control, data
acquisition, simulation, client/server, and business software, systems and
services to energy, process, and manufacturing industries worldwide. The
Company develops and utilizes high fidelity real-time process control, data
acquisition, and business software, along with third party "best of breed"
products, to gather, store and display information, and monitor and control
manufacturing and distribution processes. GSE Systems applies open systems
client/server hardware, "best of breed" software, supply chain logistics
expertise and a rapid application software methodology to solve clients'
business organization and information needs. The Company utilizes its
proprietary high fidelity real-time simulation products to replicate all or a
portion of the process function of a power or industrial plant. GSE Systems
utilizes its technologies and applications expertise to provide cost effective,
easy to use software and systems for enterprise-wide industrial business
solutions, thereby assisting its customers in improving product quality and
throughput, reducing operating expenses, and enhancing overall productivity.
The Company's products are used in over 700 applications, representing
over 250 customers in 30 countries, in the following industries: specialty
chemical, food & beverage, petroleum refining, oil & gas pipelines,
pharmaceutical, fossil and nuclear power generation, metals and water
treatment. GSE Systems' customers include, among others, Algonquin Gas
Transmission Company, Alyeska Pipeline Service Company, Archer Daniels Midland
Company, BASF Corporation, Cargill Incorporated, Exxon Company USA, Kraftwerks
Simulator Gesellschaft (Germany), Merck and Company, MEDICODE, Miller Brewing
Company, Novell, PECO Energy, Tokyo Electric Power Company (Japan) and USX-US
Steel Group. The Company has over 20 years of experience in developing systems
and has a unique insight into the needs of its customers in the energy, process
and manufacturing industries which is reflected in its wide range of quality
products, as well as its commitment to customer service.
Recent Developments.
Acquisition of Erudite Software & Consulting, Inc. On May 22, 1996, the
Company acquired all of the outstanding shares of capital stock of Erudite
Software & Consulting, Inc. now doing business as GSE Erudite Software, Inc.
("Erudite Software"), a leading provider of cost-effective client/server
solutions through providing custom application software development, training
services, hardware-software product sales and network design and implementation
services.
Erudite Software is headquartered in Salt Lake City, Utah, with a primary
development facility in Provo, Utah, and has approximately 160 employees. This
acquisition was accomplished through a merger of Erudite
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GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
Software & Consulting, Inc. into a wholly owned subsidiary of the Company.
Approximately 840,700 shares of the Company's Common Stock were exchanged for
all outstanding shares of capital stock of Erudite Software. The acquisition
has been accounted for using the pooling-of-interests method of accounting.
The accompanying consolidated financial statements of the Company have
been prepared to give retroactive effect to the acquisition of Erudite Software
on May 22, 1996. All prior period historical consolidated financial statements
presented herein have been restated to include the financial position, results
of operations, and cash flows of Erudite Software.
Costs related to the acquisition, which consist primarily of investment
banking fees, legal and accounting expenses, and compensation expense for the
shares issued to employees by the owners of Erudite Software pursuant to stock
transfer agreements, amounted to approximately $1.2 million and have been
charged to operating expenses in the second and fourth quarters of 1996.
Background.
GSE Systems was formed on April 13, 1994 by ManTech International
Corporation ("ManTech"), National Patent Development Corporation ("NPDC") and
its affiliates, General Physics Corporation ("GPC") and GPS Technologies, Inc.
("GPS"); and Vattenfall AB ("Vattenfall") to consolidate the simulation and
related businesses of their affiliates, GSE Power Systems, Inc. ("Power
Systems" and formerly known as "Simulation, Systems & Services Technologies
Company" or "S3 Technologies"), GP International Engineering & Simulation, Inc.
("GPI") and GSE Power Systems AB ("Power Systems AB" and formerly known as
"EuroSim AB" or "EuroSim"). On December 30, 1994, GSE Systems
expanded into the process control automation and supply chain management
consulting industry through its acquisition of the process systems division of
Texas Instruments Incorporated ("TI"), which the Company operates as GSE
Process Solutions, Inc. ("Process Solutions").
In April 1996, the Company aligned its operating groups into three
strategic business units (SBU) to better serve its primary vertical markets -
Power, Process Industries and Oil & Gas. The realignment allowed the Company to
focus on providing all of its technologies to these markets, while addressing
the specific needs of each market and delivering industry specific solutions.
On May 22, 1996, the Company acquired all of the outstanding shares of
capital stock of Erudite Software, a leading provider of cost-effective
client/server technology through providing custom application software
development, training services, hardware-software sales, and network design and
implementation. Erudite Software was combined with a small consulting group to
form the Company's Business Systems unit.
Power Systems, GPI, Power Systems AB and Erudite Software are collectively
referred to as the "Predecessors" with respect to all periods between January
1, 1992 and April 13, 1994.
The efforts of the Company are focused on the energy and process
manufacturing industries. These include the specialty chemical, food &
beverage, petroleum refining, oil & gas, pharmaceutical, fossil and nuclear
power generation, metals and water treatment industries. Other associated
industries include environmental control and wastewater processing.
During the 1980s, these industries applied multiple, discrete point
solutions for the management, planning, execution and control of their
businesses. Typical solutions included quality improvement, documentation
management, supervisory and process control, work in process and maintenance
management. The early 1990s brought about the integration of the total
enterprise from business systems to the factory floor. The software layer
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GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
used to connect business systems with the plant floor was termed a
manufacturing execution system ("MES"). This integration utilized independent
computing platforms, operating systems, interfaces and databases, and typically
relied on proprietary hardware and software. In addition, enterprise resource
planning ("ERP") systems emerged to address corporate planning, asset
management, finance and accounting functions at the business level.
The process manufacturing industries are now being driven by market forces
to implement total business automation strategies. Competitive pressures now
require lowest delivered cost, increased product innovation and quality,
quicker time to market, shorter cycle times, as well as improved asset
management, and production flexibility. Suppliers are looking to both increase
their customer responsiveness and lower costs by using new computer systems
technologies. The Company's client/server-based open systems, the reduction of
computing hardware costs, and the proliferation of object-oriented software
development technology facilitate this rapid technological evolution.
BUSINESS STRATEGY
Today's buyers of industrial computer and automation systems are being
driven by several converging forces. First, the systems that they buy need to
provide quicker and more demonstrable benefits. These benefits range from
optimization of the production process to automation of customer fulfillment
systems. Second, low-cost computer hardware and software technology are now
making it possible for industrial users to more quickly develop low cost custom
solutions to meet their specific operating needs. Third, the proliferation of
open systems technology is enabling firms to more quickly respond to the
marketplace by communicating customer requirements across the entire enterprise.
Fourth, these systems must be easy to implement and use since the industrial
users of these systems have reduced their in-house capability to manage these
systems. The process industries such as chemical, food, pharmaceutical, power
and oil & gas, are developing their strategy for acquiring these types of
systems around their need for total solutions that incorporate the plant system
infrastructure, which often includes some type of distributed control system
("DCS"), a local and wide area network and some sort of business system.
GSE Systems plans to utilize its current expertise in the industrial
processes of the process industries, its detailed knowledge of the computer
system infrastructure used and needed by these industries, its value added
proprietary technology in the control system and simulation arenas and its
ability to rapidly and cost effectively develop client/server solutions to
provide cost-effective and easy to use systems that add near term value to
their customers' operations. The Company's strategy is based on the need for
its solutions to be based on a foundation of a fully developed set of services
that include needs analysis, integration, implementation, maintenance,
training, support, responsive field engineering, as well as consulting. These
services must be located within reasonable reach of the customer, reasonably
priced and managed to produce a quality product. The Company plans to continue
to seek acquisitions of other companies that will expand its product and
service offerings as well as its geographical reach. The Company believes that
it must have strong solutions partners as well as strong technology partners in
order for it to address the myriad of systems needs of its customers in the
various geographical areas in which they do business.
SERVICES AND PRODUCTS.
GSE Systems has a wide range of knowledge of industrial systems and the
industrial processes those systems are intended to help improve. This knowledge
extends from the enterprise wide business systems such as ERP systems to the
real time plant floor control systems. The Company's knowledge is concentrated
heavily in the process industries, which include chemical, food,
pharmaceutical, power and oil & gas. The Company's proprietary
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GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
products include a DCS system that is highly flexible and open and a family of
real-time dynamic simulation tools. Currently the Company is moving its key
technologies to the Microsoft Windows NT(R) operating environment. The service
capabilities include, among other things, a very strong client/server solutions
capability that uses a well defined and proven methodology designed to bring
high quality results quickly.
GSE Systems offers a number of proprietary control system products. Its
DCS system is called D/3 DCS(TM). This system is a real-time system which uses
multiple process control modules to monitor, measure, and automatically control
variables in both continuous and complex batch processes. Other products
include the following: FlexBatch(R), a flexible batch manufacturing system used
to facilitate the rapid creation of various batch production processes;
TotalVision(TM), which is a graphical system that provides a client/server-
based human machine interface for real-time process and plant information; and
SABL(TM), which is a sophisticated batch and sequential manufacturing software
language that permits the scheduling and tracking of raw materials and finished
products, data collection and emergency shutdown procedures.
The Company's proprietary technology also includes real-time dynamic
simulation tools and products that are used to develop high fidelity
simulations for nuclear and fossil power plants, petroleum refineries, oil &
gas pipelines, chemical processing plants and other industrial plants. This
technology is both licensed by GSE Systems to its customers as well as used by
the Company to develop simulations for its customers. The most prominent
products and tools are known as SimSuite Pro(TM), SimSuite Pipeline(TM) and
SimSuite Power(TM). Each of these tools facilitates design verification, process
optimization and operator training.
In addition to possessing the requisite training, field engineering,
maintenance and support services, the Company believes it has a unique strength
in its ability to cost effectively and quickly deliver high quality
client/server solutions. This unique capability includes strong skills in both
the client side of system development using the new rapid application
development tools such as Visual Basic, Delphi, Powerbuilder and Oracle's
Developer 2000, as well as the server side of the system, using Oracle,
Microsoft's SQL Server and Sybase. The Company has a very strong network
design, implementation and integration capability, as well as the ability to
certify customers in the latest network technology. The Company's capabilities
in this area also include internet and intranet solutions. One other particular
strength is the Company's ability to provide supply chain consulting services
that are designed to add near term value by reengineering the customer's
business functions such as purchasing. The Company also has an ERP
implementation group.
The Company's ability to support its multi-facility, international and/or
multinational clients, is facilitated by its network of offices throughout the
U.S. and overseas. Within the U.S., the Company maintains offices in Columbia,
Maryland, South Jordan and Provo, Utah, Phoenix, Arizona, Shelby, North
Carolina, Augusta, Georgia, Baton Rouge, Louisiana, Houston, Texas, and
Pittsburgh, Pennsylvania. Outside the U.S., the Company has offices in
Nykoping, Sweden, Brussels, Belgium, Singapore, Taipei, Taiwan and Seoul,
Korea. In addition to its offices located overseas, the Company's ability to
conduct international business is enhanced by its multilingual and
multicultural work force.
CUSTOMERS.
The Company has provided over 700 simulation, process control and data
acquisition, and business systems to an installed base of over 250 customers
worldwide. In 1996, approximately 50% of the Company's worldwide revenue was
generated from customers outside the United States. No individual customer
represented more than 10% of 1996 revenue.
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GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
STRATEGIC ALLIANCES.
In recent years, a high portion of the Company's international simulation
business has come from major contracts in Europe, the republics of the former
Soviet Union and the Pacific Rim. In order to acquire and perform these
contracts, the Company entered into strategic alliances or partnerships with
entities including: Siemens AG (Europe), All Russian Research Institute for
Nuclear Power Plant Operation (Russia), Kurchatov Institute (Russia), Samsung
Electronics (Korea), Toyo Engineering Corporation (Japan), and Institute for
Information Industry (Taiwan). These alliances have enabled the Company to
penetrate work in these regions by combining its technological expertise with
the regional or local presence and knowledge of its partners.
In addition, the Company maintains strategic alliances with many major
suppliers and business partners in support of its open systems and "best of
breed" strategy. GSE Systems maintains key alliances with software and
technology suppliers such as Microsoft, Borland, Sybase, Novell, Oracle and
QAD, Inc. In addition, distribution agreements with Hewlett Packard, IBM and
Hamilton Hallmark assure support for projects that require hardware as part of
the scope of supply. The Company also maintains training and support
certifications with many of its partners.
SALES AND MARKETING.
The Company markets its products and services through a network of direct
sales staff, agents and representatives, systems integrators and strategic
alliance partners. The Company also maintains an active marketing organization
that supports corporate advertising, literature development and
exhibit/conference participation.
GSE Systems employs a direct sales force in the continental United States
which is regionally based, market focused and trained on its product and
service offerings. Market oriented business and customer development teams
define and implement specific campaigns to pursue opportunities in the power,
process, client/server solutions marketplaces. This effort is supported by an
extensive, regionally based Life Cycle Support organization focused on the
current customer installed base. The Company maintains its relationships with
customers through offices located in Columbia, Maryland; South Jordan and
Provo, Utah; Phoenix, Arizona; Shelby, North Carolina; Augusta, Georgia; Baton
Rouge, Louisiana; Houston, Texas; and Pittsburgh, Pennsylvania.
Internationally, GSE Systems maintains direct sales staff and customer
support capability in Belgium, Sweden, Germany, Japan, Taiwan, Korea, and
Singapore. Strategic alliance partners, systems integrators and agents
represent the Company's interests in Russia, Germany, Switzerland,
Spain, Czech Republic, Slovakia, United Arab Emirates, India, South Africa,
Venezuela, Mexico, Argentina, and the Peoples Republic of China.
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GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
INDUSTRIES SERVED.
The following chart illustrates the approximate percentage of the
Company's 1996 revenues attributable to each of the major industries served by
the Company:
Power...................................................................... 45%
Process.................................................................... 32%
Other...................................................................... 23%
CONTRACT BACKLOG.
The Company is transitioning away from its former reliance on the
development of large application systems having multi-year delivery schedules,
such as full-scope nuclear power plant simulators, and toward a concentration
on smaller, more short duration jobs. For example, the Company's growing
client/server business does not maintain a significant backlog because most of
its customer contracts are of a time-and-material nature. Nevertheless, the
success of the Company's simulation business remains dependent on its ability
to maintain an adequate backlog of work.
The Company does not reflect an order in backlog until it has received
a contract which specifies the terms and milestone delivery dates. As of
December 31, 1996, the Company's aggregate contract backlog totaled
approximately $35.2 million of which the Company anticipates revenue of
approximately $24.4 million in 1997. At December 31, 1995, contract backlog
totaled $60.1 million.
RESEARCH AND DEVELOPMENT
The Company believes that its success will depend in large part on its
ability to maintain and enhance its current product line, develop new products,
maintain technological competitiveness and meet an expanding range of customer
needs.
The Company's research and development activities are aimed at the
development and expansion of its library of software modeling tools, the
improvement of its display systems and workstation technologies, and the
advancement and upgrading of its simulation, process control and data
acquisition technologies. The life cycles for software modeling tools, display
system software, process control, data acquisition and simulation technologies
are variable and largely determined by competitive pressures. Consequently,
the Company will continue to make significant investments in research and
development to enhance and expand its capabilities in these areas and to
maintain its competitive advantage.
In 1996, the Company continued investment in the latest version of its
FlexBatch(R) recipe and process management system, the productization of
software tools, and the conversion of the Company's principal products to the
Microsoft Windows NT(R) platform. During the years ended December 31, 1996,
1995 and 1994, gross research and product development expenditures for the
Predecessors and the Company were $5.8 million, $4.6 million and $1.7 million,
respectively. Capitalized software development costs totaled $3.9 million, $1.6
million and $0 during the years ended December 31, 1996, 1995 and 1994. See
Note 2 of "Notes to Consolidated Financial Statements" for a discussion of the
Company's policy regarding capitalization of software development costs.
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GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
COMPETITION
The Company's businesses operate in highly competitive environments with
both domestic and foreign competitors, many of whom have substantially greater
financial, marketing and other resources than the Company. The principal
factors affecting competition include price, technological proficiency, ease of
system configuration, product reliability, applications expertise, engineering
support, local presence and financial stability. The Company believes that
competition in the simulation and process automation fields may further
intensify in the future as a result of advances in technology, consolidations
and/or strategic alliances among competitors, increased costs required to
develop new technology and the increasing importance of software content in
systems and products. The Company believes that its technology leadership,
experience, ability to provide a wide variety of solutions, product support and
related services, open architecture and international alliances will allow it
to compete effectively in these markets. However, due to the significant
international component of the Company's business, an increase in the value of
the dollar could adversely affect the Company's ability to compete
internationally.
INTELLECTUAL PROPERTY RIGHTS.
Although the Company believes that factors such as the technological and
creative skills of its personnel, new product developments, frequent product
enhancements and reliable product maintenance are important to establishing and
maintaining a technological leadership position, the Company's business
depends, in part, on its intellectual property rights in its proprietary
technology and information. The Company relies upon a combination of trade
secret, copyright, patent and trademark law, contractual arrangements and
technical means to protect its intellectual property rights. The Company
generally enters into confidentiality agreements with its employees,
consultants, joint venture and alliance partners, customers and other third
parties that are granted access to its proprietary information, and generally
limits access to and distribution of its proprietary information. There can be
no assurance, however, that the Company has protected or will be able to
protect its proprietary technology and information adequately, that the
unauthorized disclosure or use of the Company's proprietary information will be
prevented, that others have not or will not develop similar technology or
information independently, or, to the extent the Company owns patents, that
others have not or will not be able to design around those patents.
Furthermore, the laws of certain countries in which the Company's products are
sold do not protect the Company's products and intellectual property rights to
the same extent as the laws of the United States.
EMPLOYEES.
As of February 28, 1997, the Company had approximately 610 employees. GSE
Systems' operations are dependent on the efforts of its technical personnel and
its senior management. Thus, recruiting and retaining capable personnel,
particularly engineers, computer scientists and other personnel with expertise
in computer software and hardware, as well as particular customer processes
are critical to the continued growth of the Company. Competition for qualified
technical and management personnel is substantial. Certain of the Company's
senior executives are subject to employment agreements which include
non-competition covenants. Although the Company's other key personnel are not
subject to long-term employment or non-competition agreements, they are
subject to standard confidentiality agreements.
The Company considers its relations with its employees to be good.
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GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
ITEM 2. PROPERTIES.
GSE Systems maintains its headquarters and leases a facility of
approximately 154,000 square feet in Columbia, Maryland. In addition, the
Company also leases office space domestically in Phoenix, Arizona; Augusta,
Georgia; Baton Rouge, Louisiana; Houston, Texas; Pittsburgh, Pennsylvania;
Shelby, North Carolina; Provo, Utah; and South Jordan, Utah, as well as in
Belgium, Japan, Korea, Singapore, Sweden and Taiwan. The Company leases its
facilities for terms ending between 1997 and 2002.
The Company concluded its lease for facilities in Hunt Valley, Maryland
and relocated the affected operations to its Columbia, Maryland facility during
the fourth quarter of 1996.
ITEM 3. LEGAL PROCEEDINGS.
In January 1997, GSE Power Systems, Inc. filed a lawsuit in the U.S.
District Court for the District of Maryland in Baltimore against J.L. Ryan,
Inc., of Columbia, Maryland, Yankee Atomic Electric Co., of Bolton,
Massachusetts, and North Coast Software Inc., of Oswego, New York, among
others. In the suit, Power Systems alleges that the defendants committed
copyright infringement, misappropriation of trade secrets, false designation
of origin under the Lanham Act, breach of contract and unfair competition.
The subject matter of the suit is the defendants' use of a simulation
executive system which Power Systems believes to be an infringement of its
simulation executive product. The Company cannot reasonably predict the likely
outcome of this suit at this time.
Various other actions and proceedings are presently pending to which the
Company is a party. In the opinion of management, the aggregate liabilities, if
any, arising from such actions are not expected to have a material adverse
effect on the financial position of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matter was submitted to a vote of security holders during the quarter
ended December 31, 1996.
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GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
The Company's Common Stock began trading on the Nasdaq National Market
System under the Symbol "GSES" effective July 27, 1995. Prior to that date,
there was no public market for the Common Stock. The following table sets forth
for the periods indicated the high and low sale prices for the Common Stock
reported by the Nasdaq National Market System.
1995 HIGH LOW
Third Quarter (from July 27, 1995)....................... $ 16 3/4 $ 14
Fourth Quarter........................................... $ 14 3/4 $ 14
1996 HIGH LOW
First Quarter............................................ $ 16 $ 13 1/4
Second Quarter........................................... $ 17 3/4 $ 12
Third Quarter............................................ $ 14 7/8 $ 9 1/4
Fourth Quarter........................................... $ 11 3/4 $ 6 1/2
There were approximately 58 holders of record of the Common Stock as of
March 7, 1997. Based upon information available to it, the Company believes
there are approximately 600 beneficial holders of the Common Stock. The Company
has never declared or paid a cash dividend on its Common Stock. The Company
currently intends to retain future earnings to finance the growth and
development of its business, and therefore does not anticipate paying any cash
dividends in the foreseeable future.
The Company believes factors such as quarterly fluctuations in results of
operations and announcements of new products by the Company or by its
competitors may cause the market price of the Common Stock to fluctuate,
perhaps significantly. In addition, in recent years the stock market in
general, and the shares of technology companies in particular, have experienced
extreme price fluctuations. The Company's Common Stock has also experienced a
relatively low trading volume, making it further susceptible to extreme price
fluctuations. These factors may adversely affect the market price of the
Company's Common Stock.
On February 23, 1996, in exchange for services, the Company granted stock
options to two consultants to acquire 10,000 shares of Common Stock in the
aggregate at an exercise price of $14.00. These grants were not made pursuant
to the Company's 1995 Long-Term Incentive Plan. Such transactions were exempt
from the registration requirements of the Securities Act of 1933, as amended,
pursuant to Section 4(2) thereunder.
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GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
ITEM 6. SELECTED FINANCIAL DATA.
The following tables present selected unaudited combined financial
data of Power Systems, GPI, Power Systems AB and Erudite Software, collectively
the "Predecessors" for periods prior to April 14, 1994, with respect to the
periods beginning January 1, 1992 through April 13, 1994 and of the Company for
periods after April 13, 1994. Historical results of the Company from April 13,
1994 through December 31, 1994 include the operations of Power Systems, GPI,
Power Systems AB and Erudite Software. The balance sheet data of the Company
as of December 31, 1994 includes the Predecessors and Process Solutions which
was acquired on December 30, 1994, except for certain international operations
of the TI process systems business which were acquired by the Company in the
second quarter of 1995. Historical results of operations and balance sheet
data for 1996 and 1995 include the Predecessors and Process Solutions. The
financial information has been derived from the historical financial statements
of Power Systems, GPI, Power Systems AB, Erudite Software and the Company.
Erudite Software was acquired on May 22, 1996 through a merger. The merger
was accounted for by using the pooling of interests method. Accordingly
the Company's and Predecessors' financial statements have been restated
to include on a historical cost basis the accounts and operations of
Erudite Software for all periods presented.
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GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
PREDECESSORS (1) COMPANY
-------------------------- ------------------------------------
JAN. 1 APR. 14
YEAR ENDED DECEMBER 31, THROUGH THROUGH YEAR ENDED DECEMBER 31,
----------------------- APRIL 13, DEC. 31 -----------------------
1992 1993 1994 1994 (2) 1995 (3) 1996 (3)
---- ---- ---- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Statement of Operations Data:
Revenues ................................. $48,722 $ 50,242 $ 14,659 $ 37,085 $ 96,060 $ 96,033
Cost of revenue........................... 43,033 45,656 10,380 27,932 65,592 63,679
------- --------- --------- ---------- ---------- ----------
Gross profit........................... 5,689 4,586 4,279 9,153 30,468 32,354
Operating expenses:
Selling, general and administrative.... 10,674 11,342 2,628 6,313 21,815 24,192
Depreciation and amortization ......... 859 1,041 420 1,125 2,341 2,111
Business combination costs............. -- -- -- -- -- 1,206
------- --------- --------- ---------- ---------- ----------
Total operating expenses 11,533 12,383 3,048 7,438 24,156 27,509
------- --------- --------- ---------- ---------- ----------
Operating income (loss) .................. (5,844) (7,797) 1,231 1,715 6,312 4,845
Interest expense ......................... 426 48 41 402 983 387
Other expense (income), net............... (54) 57 (43) (192) (364) (394)
------- --------- --------- ---------- ---------- ----------
Income (loss) before income taxes......... (6,216) (7,902) 1,233 1,505 5,693 4,852
Provision (benefit) for income taxes...... (371) (849) 678 552 2,017 709
Cumulative effect of accounting change.... 133 -- -- -- -- --
------- --------- --------- ---------- ---------- ----------
Net income (loss) ........................ $(5,978) $ (7,053) $ 555 $ 953 $ 3,676 $ 4,143
======= ========= ========= ========== ========== ==========
Earnings per common share ................ $ 0.26 $ 0.91 $ 0.82
========== ========== ==========
Weighted average common shares
outstanding............................. 3,341 4,059 5,073
========== ========== ==========
AS OF DECEMBER 31, AS OF AS OF DECEMBER 31,
------------------ APRIL 13, ----------------------------------
1992 1993 1994 1994 1995 1996
---- ---- ---- ---- ---- ----
Working capital .......................... $10,286 ($2,039) ($434) $1,269 $16,077 $13,867
Total assets ............................. 32,407 29,588 35,655 42,312 54,688 51,006
Long-term liabilities .................... 8,521 10,326 15,570 15,783 6,055 2,580
Series A Preferred Stock ................. -- -- -- 2,400 -- --
Stockholders' equity (deficit) ........... 11,815 (3,128) (2,563) (4,229) 20,532 24,693
(1) Historical results of operations and balance sheet data for the
Predecessors include the combined results of operations and the combined
balances on a historical cost basis of Power Systems (as a wholly-owned
subsidiary of Bicoastal Corporation until August 31, 1993 and of ManTech
thereafter), GPI, Power Systems AB and Erudite Software.
(2) Statement of operations data for the period April 14 through December 31,
1994 include the results of operations of the Company and its wholly-owned
subsidiaries Power Systems, GPI, Power Systems AB and Erudite Software.
Balance sheet data as of December 31, 1994 also includes the domestic
operations of Process Solutions, which was acquired on December 30, 1994.
(3) Statement of operations data for the year ended December 31, 1995 and 1996
includes the operations of Power Systems, GPI, Power Systems AB, Erudite
Software and the domestic operations of Process Solutions and the
international operations of Process Solutions, substantially all of which
the Company acquired in the second quarter of 1995. Balance sheet data as
of December 31, 1995 and 1996 includes Power Systems, GPI, Power Systems
AB, Erudite Software and the domestic and international operations of
Process Solutions.
13
14
GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS.
This Form 10-K contains certain "forward-looking statements," within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, which are subject to
the safe harbors created by those Acts. These statements include the plans and
objectives of management for future operations, including plans and objectives
relating to the development of the Company's business in the domestic and
international marketplace. All forward-looking statements involve risks and
uncertainties, including, without limitation, risks relating to the Company's
ability to enhance existing software products and to introduce new products in
a timely and cost-effective manner, reduced development of nuclear power plants
that may utilize the Company's products, a long pay-back cycle from the
investment in software development, uncertainties regarding the ability of the
Company to grow its revenues and successfully integrate operations through
expansion of its existing business and strategic acquisitions, the ability of
the Company to respond adequately to rapid technological changes in the markets
for process control, data acquisition and simulation software and systems,
significant quarter-to-quarter volatility in revenues and earnings as a result
of customer purchasing cycles and other factors, dependence upon key personnel,
and general market conditions and competition. The forward-looking statements
included herein are based on current expectations that involve numerous risks
and uncertainties as set forth herein, the failure of any one of which could
materially adversely affect the operations of the Company. The Company's plans
and objectives are also based on the assumptions that market conditions and
competitive conditions within the Company's business areas will not change
materially or adversely and that there will be no material adverse change in
the Company's operations or business. Assumptions relating to the foregoing
involve judgments with respect, among other things, to future economic,
competitive and market conditions and future business decisions, all of which
are difficult or impossible to predict accurately and many of which are beyond
the control of the Company. Although the Company believes that the assumptions
underlying the forward-looking statements are reasonable, any of the
assumptions could be inaccurate and there can, therefore, be no assurance that
the forward-looking statements included in this Form 10-K will prove to be
accurate. In light of the significant uncertainties inherent in the
forward-looking statements included herein, the inclusion of such information
should not be regarded as a representation by the Company or any other person
that the objectives and plans of the Company will be achieved.
14
15
GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
RESULTS OF OPERATIONS.
The following table sets forth the results of operations for the periods
presented expressed in thousands of dollars and as a percentage of revenues.
COMPANY AND
COMPANY COMPANY PREDECESSORS (1)(2)
------- ------- -------------------
DECEMBER 31, 1996 DECEMBER 31, 1995 DECEMBER 31, 1994
----------------- ----------------- ------------------
Revenues ................................ $ 96,033 100.0% $ 96,060 100.0% $ 51,744 100.0%
Cost of revenue ......................... 63,679 66.3 65,592 68.3 38,312 74.0
-------- ----- -------- ---- --------- -----
Gross profit ............................ 32,354 33.7 30,468 31.7 13,432 26.0
Selling, general and
administrative expenses ................. 24,192 25.2 21,815 22.7 8,941 17.3
Depreciation and amortization ........... 2,111 2.2 2,341 2.4 1,545 3.0
Business combination costs .............. 1,206 1.3 -- -- -- --
-------- ----- -------- ---- --------- -----
Operating income ........................ 4,845 5.0 6,312 6.6 2,946 5.7
Interest expense ........................ 387 0.4 983 1.0 443 0.9
Other expenses (income) ................. (394) (0.4) (364) (0.4) (235) (0.5)
-------- ----- -------- ---- --------- -----
Income before income taxes .............. 4,852 5.0 5,693 5.9 2,738 5.3
Income tax expense ...................... 709 0.7 2,017 2.1 1,230 2.4
-------- ----- -------- ---- --------- -----
Net income .............................. $ 4,143 4.3% $ 3,676 3.8% $ 1,508 2.9%
======== ===== ======== ==== ========= =====
- ----------------------------
(1) Historical results of operations for the Predecessors are presented on a
combined basis.
(2) Includes the historical results of operations for the Predecessors from
January 1 through April 13, 1994 and of the Company from April 14 through
December 31, 1994.
15
16
GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
COMPARISON OF 1996 TO 1995.
Revenue. Total contract revenue was $96.0 million and $96.1 million for
the years ended December 31, 1996 and 1995. There was an increase in 1996
revenues from the Company's growing client/server solutions business of 82% or
$8.8 million, which was offset by a reduction in nuclear simulation project
revenues by 14% or $7.0 million, due in part to the maturing of the nuclear
simulation business and the stoppage on a large Eastern European project due to
lack of customer funding. The Company as a whole is becoming less dependent on
large multi-year application projects, such as full scope nuclear power plant
simulators, and is moving towards more smaller and shorter-term projects that
often include licenses of the Company's proprietary tools.
Contract backlog at December 31, 1996 and 1995 totaled $35.2 million and
$60.1 million, respectively. This decrease continues to reflect the Company's
transition away from larger multi-year application projects.
Revenues from fixed price contracts constitute approximately 90.0% of the
Company's revenues for the past three years. Any unexpected costs or
unanticipated delays in connection with the performance of fixed priced
contracts could adversely affect the Company's financial results.
International sales were approximately $48.2 million or 50.2% of total
revenues in 1996 and $50.8 million or 52.8% of total revenues in 1995. The
Company expects that international sales will continue to represent a
significant portion of its total revenues. The Company currently sells products
and services to customers in emerging market economies such as Russia, Ukraine
and Bulgaria. The Company's international operations are subject to various
risks, including exposure to currency fluctuation, regulatory requirements,
political and economic instability and trade restrictions. The Company has
taken steps to reduce these risks, particularly risks associated with doing
business in emerging markets, but there can be no assurance that the above
mentioned risk factors will not have a material adverse affect on the Company's
business, financial condition or results of operations.
Gross Profit. Gross profit increased to $32.4 million, a gross margin of
33.7% for the year ended December 31, 1996 from $30.5 million, a gross margin
of 31.7%, in the corresponding period of 1995. The increased gross margin is
primarily attributable to declining volume of certain low margin contracts,
settlement of claims on two international contracts, changes in contract and
warranty estimates and cost containment measures.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $24.2 million, or 25.2% of revenues,
during the year ended December 31, 1996 from $21.8 million, or 22.7% of
revenues, during the corresponding period in 1995. The increase in selling,
general and administrative expenses for the year is primarily attributable to
increased sales force, bid and proposal activities, a full year charge
attributable to the international operations of Process Solutions, a one time
charge for severance and employee related obligations as a result of the
Company's alignment into strategic business units in the second quarter and
business expansion efforts. These expenses were offset, in part, by a
significant decrease in net research and development expenses as discussed
below and to a one-time $1.1 million adjustment in connection with
consolidation of duplicate facilities.
16
17
GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
Gross research and product development expenditures were $5.8 million and
$4.6 million for the years ended December 31, 1996 and 1995, respectively.
Capitalized software development costs totaled $3.9 million and $1.6 million,
during the years ended December 31, 1996 and 1995, respectively. Net research
and development costs expensed and included within selling, general and
administrative expenses were $1.9 million and $3.0 million during the years
ended December 31, 1996 and 1995, respectively. The Company continued investing
in its FlexBatch(R) recipe and process management system, conversion of the S/3
SCADA(TM) System to Microsoft Windows NT(R) platform and productization of
SimSuite(TM) software tools.
Depreciation and Amortization. Depreciation expense amounted to $1.9
million and $1.6 million during the years ended December 31, 1996 and 1995,
respectively. This increase was attributable to higher levels of capital
expenditure in 1996.
Amortization of goodwill and intangibles was $168,000 and $766,000 during
the years ended December 31, 1996 and 1995, respectively. This decrease was
attributable to the significant reduction in goodwill and other intangible
assets at December 31, 1995, as fully discussed in Note 8 of "Notes to
Consolidated Financial Statements".
Business Combination Costs. Business combination costs related to the
acquisition of Erudite Software, which consist primarily of consulting fees,
legal and accounting expenses, and compensation expense for the shares issued
to employees by the owners of Erudite Software pursuant to stock transfer
agreements, amounted to approximately $1.2 million and were charged to
operating expenses in 1996.
Operating Income. Operating income amounted to $4.9 million and $6.3
million during the years ended December 31, 1996 and 1995, respectively. During
the year, excluding the non-recurring acquisition costs, operating income was
$6.1 million, or 6.3% of revenues, as compared with $6.3 million, or 6.6% of
revenues during the corresponding period of 1995. The decrease in operating
income for the year is attributable to higher expenses relating to sales and
marketing efforts and business expansion activities, which were partially
offset by higher margins on contracts, continued cost control initiatives,
lower net research and development expenses and one-time facility adjustment.
Interest Expense. Interest expense decreased to $387,000 during the year
from $983,000, during 1995. This decrease is attributable primarily to the
repayment in August 1995 of a five year promissory note to finance the Process
Solutions acquisition and temporary pay-down of the working capital bank lines
with the Company's initial public offering of Common Stock in mid-1995 ("IPO")
proceeds.
Other Expenses (Income). Other income amounted to $394,000 from interest
earned from short-term investments of excess cash during the year ending
December 31, 1996 as well as proceeds from the sale of an equity interest in a
joint venture. During the corresponding period of 1995, $364,000 in interest
income was earned from short-term investments of cash proceeds from the IPO.
Income Tax Expense. The Company's effective tax rate decreased to 14.6% in
1996 from 35.4% in 1995. The 1996 rate was decreased as a result of a one time
reduction of the tax provision of $1.1 million. This reduction reflects the
Company's assessment that it will be able to utilize previous net operating
loss carry forwards generated by it power business unit.
17
18
GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
COMPARISON OF 1995 TO 1994.
Revenues. The Company's revenues for 1995 increased 85.6% to $96.1 million
from $51.7 million in 1994. This increase resulted primarily from $36.0 million
of revenues generated by Process Solutions, which the Company acquired in
December 1994. Excluding Process Solutions, revenues increased by $8.3 million
or 16% in 1995 over 1994, such increase primarily resulting from increased
sales from the client/server solutions business as well as an increase in the
Company's domestic modification and upgrade business. Contract backlog at
December 31, 1995 and 1994 totaled $60.1 million and $91.4 million,
respectively.
International sales were approximately $50.8 million or 52.8% of total
revenues in 1995 and $36.3 million or 70.0% of total revenues in 1994.
Gross Profit. Gross profit increased to $30.5 million, a gross profit
margin of 31.7%, in 1995 from $13.4 million, a gross profit margin of 26.0%, in
1994. This increase in gross profit is primarily attributable to the
acquisition of Process Solutions and declining volume of certain low margin
contracts.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $21.8 million, or 22.7% of revenues, in
1995 from $8.9 million, or 17.3% of revenues, in 1994. The increase in selling,
general and administrative expenses is primarily attributable to the acquired
Process Solutions business which has higher relative selling, marketing,
research and development costs. Upon consummation of the initial public
offering on August 1, 1995, a management fee of $981 per day previously due to
certain stockholders was eliminated. Such management fee was included within
selling, general and administrative expenses and amounted to $204,000 and
$257,000 in 1995 and 1994, respectively.
Included in the selling, general and administrative expenses are research
and development expenses of $3.0 million incurred in 1995 and $1.7 million
incurred in 1994. The above research and development expenses are net of
capitalized software development costs of $1.6 million in 1995 and none in
1994. The increase in research and development expenses is primarily
attributable to the Process Solutions business which has higher research and
development costs.
Depreciation and Amortization. Depreciation expense amounted to $1.6
million and $953,000 in 1995 and 1994, respectively. This increase is
attributable to the acquisition of Process Solutions. Amortization of goodwill
and intangibles was $766,000 and $592,000 in 1995 and 1994, respectively. This
increase also is attributable to the acquisition of Process Solutions.
Operating Income. Operating income increased $3.4 million to $6.3 million,
or 6.6% of revenues, in 1995 from $2.9 million, or 5.7% of revenues, in 1994.
This increase in operating income is attributable to the acquisition of Process
Solutions and to the continued benefits realized from the consolidation of
operations of Power Systems, GPI and Power Systems AB. Operating income of the
Company in 1995, excluding Process Solutions, was $4.4 million, or 4.5% of
revenues, compared to $2.9 million, or 5.6% of revenues in 1994. The overall
improvement in the operating margin to 6.6% of the revenues was achieved
despite Process Solutions having low operating margins of 5.3% of revenues in
1995. The Company believes that Process Solutions' low operating margin, while
improving, primarily resulted from lower than anticipated sales during the
acquisition transition period.
18
19
GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
Interest Expense. Interest expense increased significantly to $983,000 in
1995 from $443,000 in 1994. This increase is primarily attributable to the
Company's issuance of a five-year promissory note that bore interest at a rate
of 8% per annum to finance the Process Solutions acquisition; the Company paid
off the note on August 7, 1995.
Other Expense (Income). Other income increased to $364,000 for the year
compared to $235,000 for the corresponding period in 1994. The increase in
interest income is a result of earnings from short-term investments of cash
proceeds from the IPO.
Income Tax Expense. The Company's effective income tax rate decreased to
35.4% in 1995 from 44.9% in 1994. The higher tax rate in 1994 is attributable
to the adjustment of deferred tax assets related to transactions between one of
the Predecessors and its parent before April 14, 1994.
LIQUIDITY AND CAPITAL RESOURCES.
The Company has funded its activities primarily from cash generated from
the IPO, from operations, and from borrowings under lines of credit. In 1996,
the Company's operating activities used cash totaling approximately $1.9
million, primarily related to reductions in billings in excess of revenue
earned and reductions in accrued contract and warranty reserves. For the year
ended December 31, 1995 and for the period April 14 through December 31, 1994,
the Company generated cash flow from operations of approximately $13,000 and
$4.2 million, respectively. At December 31, 1996, the Company had cash and cash
equivalents of $2.4 million compared to $9 million as of December 31, 1995.
In August 1995, the Company consummated the initial public offering of its
Common Stock, selling 1,725,000 shares of Common Stock, including Underwriters
Overallotment Option of 225,000 shares, for $14.00 per share. The initial
public offering resulted in net proceeds to the Company of approximately $21.1
million after deducting underwriting discounts and offering expenses. The
Company utilized $5.9 million of the proceeds from its initial public offering
to repay indebtedness in connection with the Process Solutions acquisition. In
addition, the Company used $2.5 million to pay down all outstanding
indebtedness under its then existing lines of credit, and, at December 31,
1995, there were no outstanding borrowings under such lines of credit.
The Company maintains, through its subsidiaries, two lines of credit that
provide for borrowings up to a total of $14.0 million to support foreign
letters of credit, margin requirements or foreign exchange contracts and
working capital needs. The first line for $7.0 million is 90% guaranteed by the
Export-Import Bank of the United States ("EXIM") and is collateralized by Power
Systems' contract receivables and inventory. The line bears interest at the
prime rate, provides for borrowings up to 90% of eligible receivables and 60%
of unbilled receivables, and expires January 1, 1998, subject to earlier
termination upon expiration of the EXIM guaranty (currently effective through
April 30, 1997). The second line for $7.0 million is collateralized by
substantially all of Process Solutions' assets. The line bears interest at the
prime rate and expires January 1, 1998, subject to earlier termination upon the
expiration of the EXIM guaranty for the Power Systems' line of credit. The
lines require the Company to comply with certain financial ratios and preclude
the Company from paying dividends and making acquisitions beyond certain limits
without the bank's consent.
The Company's additional commitments as of December 31, 1996 consisted
primarily of leases on its headquarters and other facilities. Further, the
performance of certain of the Company's customer contracts are
19
20
GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
secured by performance guaranties, amounting to $4.4 million, and letters of
credit, amounting to $973,000, as of December 31, 1996, furnished by its
subsidiaries' respective former parent organizations in accordance with the
agreement among ManTech, NPDC, GPC, GPS, Vattenfall and the Company dated April
13, 1994 (the "Formation Agreement"). Letters of credit are issued by the
Company in the ordinary course of business through commercial banks as required
by certain contracts and proposal requirements. The Company has also issued a
letter of credit in connection with forward foreign currency exchange margin
requirements. Such letters of credit issued by the Company at December 31, 1996
amounted to $207,000. The Company believes that its cash flow from operations
and availability under the lines of credit will be sufficient to meet its
currently anticipated needs for working capital, capital expenditures and debt
repayment requirements for at least the next twelve months.
FOREIGN EXCHANGE.
A portion of the Company's international sales revenue is received in a
currency other than the currency in which the expenses relating to such revenue
are paid. The Company manages its foreign currency exposure primarily by
entering into foreign currency exchange agreements and purchasing foreign
currency options. The former requires the Company, on a specified date or
during a specified period, to exchange a set amount of foreign currency for
United States dollars or another base currency. The latter provides the Company
with the option to exchange foreign currency for United States dollars or
another base currency on a specified date or during a specified period. The
Company utilizes these foreign exchange agreements and options only to reduce
the impact of foreign currency fluctuations on its operating results and does
not engage in foreign currency speculation. Foreign exchange contracts do not
expose the Company to material risk because any losses on the contracts are
calibrated to be offset by gains on the value of the foreign receivables being
hedged. Foreign exchange options do not expose the Company to material risk
since the Company has the right not to exercise the option.
At December 31, 1996, the Company had forward exchange contracts of $2.2
million to hedge future German mark receipts and the Company's Swedish
subsidiary had forward exchange contracts of Swedish krona 17.0 million, or
approximately $2.5 million, and swap contracts of Swedish krona 4.1 million, or
approximately $594,000, in both cases to hedge future Japanese yen receipts.
Gains and losses on such contracts are recognized as part of the cost of the
underlying transactions being hedged. Foreign exchange contracts have an
element of risk that the counterparty may not be able to meet the terms of the
agreement. However, the Company minimizes such risk exposure by limiting
counterparties to Paine Webber Financial Products Inc., CoreStates Bank,
NationsBank and Nordbanken AB. Management believes that the risk of incurring
such losses is immaterial. The Company has also entered into foreign exchange
option contracts with NationsBank, which permit but do not require the Company
to exchange foreign currencies at a future date with the bank at a contracted
exchange rate. Costs associated with such contracts are amortized over the life
of the contract matching the underlying receipts.
OTHER MATTERS.
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings Per Share" (FAS 128).
FAS 128 simplifies the existing earnings per share (EPS) computations under
Accounting Principles Board Opinion No. 15, "Earnings Per Share," revises
disclosure requirements, and increases the comparability of EPS data on an
international basis. In simplifying the EPS computations, the presentation
of primary EPS is replaced with basic EPS, with the principal difference
being that common stock equivalents are not considered in computing basic
EPS. In addition, FAS 128 requires dual presentation of basic and diluted
EPS. FAS 128 is effective for financial statements issued for periods ending
after December 15, 1997. The Company does not expect the EPS amounts calculated
under FAS 128 to be materially different from the amounts presented in
the financial statements.
In late 1996, the Company consolidated its Hunt Valley, Maryland
facilities with its Columbia facility. This resulted in prior excess space
being fully utilized, and the reversal of an accrual of $1.1 million for excess
20
21
GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
facilities which was credited against selling, general and administrative
expenses. The accrual had originally been set up at the time of ManTech
International Corporation's acquisition of S3 Technologies in August 1993.
To date, management believes inflation has not had a material impact on
the Company's operations.
GSE Systems, SimSuite Pro, SimSuite Pipeline, SimSuite Power, FlexBatch,
TotalVision, SABL, D/3 DCS and S/3 SCADA are trademarks of GSE Systems,
Inc. All other trademarks and/or registered trademarks are the property of
their respective owners.
21
22
GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEX TO FINANCIAL STATEMENTS
Page
----
GSE SYSTEMS, INC. AND SUBSIDIARIES
Report of Independent Accountants....................................................................................F-1
Consolidated Balance Sheets as of December 31, 1996 and 1995.........................................................F-2
Consolidated Statements of Operations for the years ended
December 31, 1996 and 1995 and for the period April 14, 1994 through December 31, 1994............................F-3
Consolidated Statements of Stockholders' Equity (Deficit) for the years ended December 31, 1995
and 1996 for the period April 14, 1994 through December 31, 1994..................................................F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 1996 and 1995 and for the period April 14, 1994 through December 31, 1994............................F-5
Notes to Consolidated Financial Statements...........................................................................F-6
SIMULATION, SYSTEMS & SERVICES TECHNOLOGIES COMPANY AND MSHI, INC.
Report of Independent Accountants....................................................................................F-23
Consolidated Statement of Operations for the period January 1, 1994 through April 13, 1994...........................F-24
Consolidated Statement of Stockholder's Equity for the period January 1, 1994 through April 13, 1994.................F-25
Consolidated Statement of Cash Flows for the period January 1, 1994 through April 13, 1994...........................F-26
Notes to Consolidated Financial Statements...........................................................................F-27
GP INTERNATIONAL ENGINEERING & SIMULATION, INC.
Report of Independent Accountants....................................................................................F-32
Statement of Operations for the period January 1, 1994 through April 13, 1994........................................F-33
Statement of Stockholder's Deficit for the period January 1, 1994 through April 13, 1994.............................F-34
Statement of Cash Flows for the period January 1, 1994 through April 13, 1994........................................F-35
Notes to Financial Statements........................................................................................F-36
EUROSIM AB
Report of Independent Accountants....................................................................................F-40
Statement of Operations for the period January 1, 1994 through April 13, 1994........................................F-41
Statement of Stockholder's Equity for the period January 1, 1994 through April 13, 1994..............................F-42
Statement of Cash Flows for the period January 1, 1994 through April 13, 1994........................................F-43
Notes to Financial Statements........................................................................................F-44
22
23
REPORT OF INDEPENDENT ACCOUNTANTS
To The Board of Directors and Stockholders of
GSE Systems, Inc.
We have audited the accompanying consolidated balance sheets of GSE Systems,
Inc. and Subsidiaries (the Company) as of December 31, 1996, and 1995, and the
related consolidated statements of operations, changes in stockholders' equity
(deficit) and cash flows for the years ended December 31, 1996 and 1995 and for
the period April 14, 1994 (date of inception) to December 31, 1994. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of GSE Systems, Inc.
and Subsidiaries as of December 31, 1996 and 1995, and the consoldated results
of their operations and their cash flows for the years ended December 31, 1996
and 1995 and for the period April 14, 1994 (date of inception) to December 31,
1994, in conformity with generally accepted accounting principles.
COOPERS & LYBRAND L.L.P.
Washington, D.C.
March 21, 1997
F-1
24
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
ASSETS
December 31,
1996 1995
------------ -------------
Current assets:
Cash and cash equivalents ................................................ $ 2,450 $ 9,016
Contract receivables ..................................................... 27,457 29,508
Inventories .............................................................. 3,538 2,293
Prepaid expenses and other current assets ................................ 2,701 2,889
Deferred income taxes..................................................... 1,454 472
------- -------
Total current assets ................................................ 37,600 44,178
Property and equipment, net .................................................... 5,318 4,115
Software development costs, net ................................................ 5,176 1,921
Goodwill, net .................................................................. 2,059 2,348
Deferred income taxes .......................................................... 569 1,856
Other assets 284 270
------- -------
Total ............................................................... $ 51,006 $ 54,688
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Lines of credit .......................................................... $ 2,582 $ --
Accounts payable ......................................................... 8,604 7,560
Accrued expenses ......................................................... 4,430 4,435
Notes payable to banks ................................................... -- 212
Notes payable to related parties ......................................... -- 190
Obligations under capital lease .......................................... 186 103
Billings in excess of revenue earned ..................................... 5,358 10,609
Accrued contract reserves ................................................ 233 641
Accrued warranty reserves ................................................ 1,408 2,119
Other current liabilities ................................................ 281 1,061
Income taxes payable ..................................................... 651 1,171
------ ------
Total current liabilities ........................................... 23,733 28,101
Notes payable to related parties ............................................... 202 216
Obligations under capital lease ................................................ 420 227
Billings in excess of revenue earned ........................................... 803 2,485
Accrued contract and warranty reserves ......................................... 687 1,495
Accrued facility costs ......................................................... -- 1,103
Other liabilities .............................................................. 468 529
------ ------
Total liabilities ................................................... 26,313 34,156
------ ------
Stockholders' equity:
Common stock $.01 par value, 8,000,000 shares authorized,
5,065,688 shares issued and outstanding .............................. 50 50
Additional paid-in capital ............................................... 21,378 21,121
Retained earnings (deficit) - at formation ............................... (5,112) (5,112)
Retained earnings - since formation ...................................... 8,464 4,321
Pension liability adjustment ............................................. -- (102)
Cumulative translation adjustment (87) 254
------- -------
Total stockholders' equity .......................................... 24,693 20,532
------- -------
Total liabilities & stockholders' equity ............................ $ 51,006 $ 54,688
======= =======
The accompanying notes are an integral part of these consolidated financial
statements
F-2
25
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
For the Period
Year-ended Year-ended April 14 through
December 31, December 31, December 31,
1996 1995 1994
---- ---- ----
Contract revenue .................................................. $ 96,033 $ 96,060 $ 37,085
Cost of revenue ................................................... 63,679 65,592 27,932
--------- -------- --------
Gross profit ............................................... 32,354 30,468 9,153
--------- -------- --------
Operating expenses:
Selling, general and administrative ........................ 24,192 21,815 6,313
Depreciation and amortization .............................. 2,111 2,341 1,125
Business combination costs ................................. 1,206 -- --
-------- -------- --------
Total operating expenses ................................... 27,509 24,156 7,438
-------- -------- --------
Operating income ...................................... 4,845 6,312 1,715
Interest expense .................................................. 387 983 402
Other income ...................................................... (394) (364) (192)
-------- -------- --------
Income before income taxes ................................. 4,852 5,693 1,505
Provision for income taxes ........................................ 709 2,017 552
-------- -------- --------
Net income ........................................................ 4,143 3,676 953
Preferred dividends................................................ -- -- 76
-------- -------- --------
Net income available to common shareholders................ $ 4,143 $ 3,676 $ 877
======== ======== ========
Earnings per common share ......................................... $ 0.82 $ 0.91 $ 0.26
======== ======== ========
Weighted average common shares outstanding ........................ 5,073 4,059 3,341
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
26
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE PERIOD APRIL 14, 1994 THROUGH DECEMBER 31, 1994
AND THE YEARS ENDED DECEMBER 31, 1995 AND 1996
(IN THOUSANDS)
COMMON STOCK ADDITIONAL RETAINED EARNINGS NOTES
------------ ---------- ----------------- -----
PAID-IN AT SINCE RECEIVABLE FROM
------- -- ----- ---------------
SHARES AMOUNT CAPITAL FORMATION FORMATION SHAREHOLDERS
------ ------ ------- --------- --------- ------------
Balance, April 14, 1994
as previously reported ................... -- $ -- $ -- $ 1,676 $ -- $ --
Pooling of interests with Erudite
Software (Note 3)............................ 841 8 -- -- (3) (150)
------ -------- ------- -------- ------ ------
Balance, April 14, 1994 ..................... 841 8 -- 1,676 (3) (150)
Issuance of common stock .................... 100 1 -- -- -- --
Stock dividends ............................. 2,400 24 -- (24) -- --
Issuance of preferred stock ................. -- -- -- (4,000) -- --
Distribution to shareholder ................. -- -- -- (1,000) -- --
Reductions in notes receivable .............. -- -- -- -- -- 75
Notes payable to shareholder ................ -- -- -- (1,700) -- --
Preferred dividends ......................... -- -- -- -- (76) --
Foreign currency translation ................ -- -- -- -- -- --
Pension liability adjustment ................ -- -- -- -- -- --
Net income .................................. -- -- -- -- 953 --
------ -------- ------- ------- ------ ------
Balance, December 31, 1994 .................. 3,341 33 -- (5,048) 874 (75)
Issuance of common stock .................... 1,725 17 21,121 -- -- --
Distribution to shareholder ................. -- -- -- (64) (229) --
Reductions in notes receivable .............. -- -- -- -- -- 75
Foreign currency translation ................ -- -- -- -- -- --
Pension liability adjustment ................ -- -- -- -- -- --
Net income .................................. -- -- -- -- 3,676 --
------ -------- ------- ------- ------ ------
Balance, December 31, 1995 .................. 5,066 50 21,121 (5,112) 4,321 --
Compensation expense ........................ -- -- 257 -- -- --
Foreign currency translation ................ -- -- -- -- -- --
Pension liability adjustment ................ -- -- -- -- -- --
Net income .................................. -- -- -- -- 4,143 --
------ -------- -------- -------- ------ ------
Balance, December 31, 1996 .................. 5,066 $ 50 $ 21,378 $ (5,112) $8,464 $ --
====== ======== ======== ======== ====== ======
PENSION FOREIGN
------- -------
LIABILITY CURRENCY
--------- --------
ADJUSTMENT TRANSLATION TOTAL
---------- ----------- -----
Balance, April 14, 1994
as previously reported ................... $ -- $ -- $ 1,676
Pooling of interests with Erudite
Software (Note 3)............................ -- -- (145)
------- --------- --------
Balance, April 14, 1994 ..................... -- 1,531
Issuance of common stock .................... -- -- 1
Stock dividends ............................. -- -- --
Issuance of preferred stock ................. -- -- (4,000)
Distribution to shareholder ................. -- -- (1,000)
Reductions in notes receivable............... -- -- 75
Notes payable to shareholder ................ -- -- (1,700)
Preferred dividend .......................... -- -- (76)
Foreign currency translation ................ -- 60 60
Pension liability adjustment ................ (73) -- (73)
Net income .................................. -- -- 953
------- --------- --------
Balance, December 31, 1994 .................. (73) 60 (4,229)
Issuance of common stock .................... -- -- 21,138
Distribution to shareholder ................. -- -- (293)
Reductions in notes receivable............... -- -- 75
Foreign currency translation ................ -- 194 194
Pension liability adjustment ................ (29) -- (29)
Net income .................................. -- -- 3,676
------- --------- --------
Balance, December 31, 1995 .................. (102) 254 20,532
Compensation expense ........................ -- -- 257
Foreign currency translation ................ -- (341) (341)
Pension liability adjustment ................ 102 -- 102
Net income .................................. -- -- 4,143
------- --------- --------
Balance, December 31, 1996 .................. $ -- $ (87) $ 24,693
======= ========= ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
27
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE PERIOD
APRIL 14
YEAR-ENDED THROUGH
DECEMBER 31, DECEMBER 31,
1996 1995 1994
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ..................................................................... $ 4,143 $ 3,676 $ 953
Adjustments to reconcile net income to net cash (used in) provided by
operating activities:
Depreciation and amortization ........................................... 2,747 2,813 1,476
Accrued facility costs .................................................. (1,451) (348) (278)
Non-cash stock compensation ............................................. 257 -- --
Provision for doubtful contract receivables and inventory reserve ....... -- 102 72
Deferred income taxes ................................................... 71 627 152
Interest imputed on discounted note payable ............................. -- 17 --
Changes in assets and liabilities
Contract receivables ................................................. 2,103 (7,962) 7,840
Inventories .......................................................... (1,245) 271 19
Prepaid expenses and other current assets ............................ 355 (1,208) (214)
Other assets ......................................................... (181) (150) 19
Accounts payable and accrued expenses ................................ 1,399 3,645 (133)
Billings in excess of revenue earned ................................. (6,933) 617 (4,551)
Accrued contract and warranty reserves ............................... (1,927) (2,605) (2,116)
Other current liabilities ............................................ (780) (157) 586
Income taxes payable ................................................. (520) 676 373
Other liabilities .................................................... 41 (1) 26
------- ------- -------
Net cash (used in) provided by operating activities ............................ (1,921) 13 4,224
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payment for purchase of Process Solutions ............................... -- (2,000)
Capital expenditures .................................................... (2,834) (1,501) (600)
Capitalization of software development costs ............................ (3,890) (1,664) --
------- ------- -------
Net cash used in investing activities .......................................... (6,724) (3,165) (2,600)
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings (repayments) under lines of credit with bank ................. 2,369 (4,024) 1,517
Cash overdraft .......................................................... -- (13) 478
Repayment to Vattenfall ................................................. -- (1,411) --
Repayments under capital lease obligations .............................. (37) (75) (49)
Principal payments under term-note ...................................... -- (7,882) (1,042)
Payments to shareholder at formation .................................... -- (64) (1,000)
Payments on shareholder notes ........................................... (204) (38) (767)
Net proceeds from sale of common stock .................................. -- 21,138 1
Redemption of preferred stock ........................................... -- (2,400) (1,600)
Preferred dividends ..................................................... -- -- (76)
Net repayment of amounts due from stockholder ........................... -- 2,473 2,926
------- ------- -------
Net cash provided by financing activities ...................................... 2,128 7,704 388
Effect of exchange rate changes on cash and cash equivalents ................... (49) 112 70
------- ------- -------
Net (decrease) increase in cash and cash equivalents ........................... (6,566) 4,664 2,082
Cash and cash equivalents at beginning of period ............................... 9,016 4,352 2,270
------- ------- -------
Cash and cash equivalents at end of period ..................................... $ 2,450 $ 9,016 $ 4,352
======= ======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
28
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS
GSE Systems, Inc. (the "Company") designs, develops and delivers business and
technology solutions by applying process control, data acquisition, simulation,
client/server and business software, systems and services to the energy,
process and manufacturing industries worldwide. The Company was formed on April
13, 1994 through the consolidation of operations of GSE Power Systems, Inc.
("Power Systems") (formerly "Simulation, Systems & Services Technologies
Company"), GP International Engineering & Simulation, Inc. ("GPI") and GSE
Power Systems AB ("Power Systems AB") (formerly "EuroSim AB"). In December
1994 and in the second quarter of 1995, the Company expanded into the process
control and data acquisition business through the acquisition of the net assets
of the process control systems division of Texas Instruments Incorporated
("TI"), which now does business as GSE Process Solutions, Inc. ("Process
Solutions"). In May 1996, the Company acquired all of the outstanding shares of
capital stock of Erudite Software & Consulting, Inc. ("Erudite Software"), a
provider of client/server solutions through custom applications software
development, training services, hardware-software sales and network design and
implementation. Power Systems, GPI, Power Systems AB and Erudite Software are
collectively referred to as the "Predecessors".
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Formation of the Company
The Company was formed through the contribution of the businesses of Power
Systems (and its immediate parent), GPI and Power Systems AB by their parent
organizations, ManTech International Corporation ("ManTech") and certain of its
employees and related parties, National Patent Development Corporation ("NPDC")
and NPDC's affiliates, SGLG, Inc. (formerly named GPS Technologies, Inc. and
hereinafter called "GPS") and General Physics Corporation ("GPC"), and
Vattenfall Engineering AB ("Vattenfall"). In exchange, the contributors
received shares of Common Stock of the Company. In addition, ManTech received
shares of preferred stock of the Company and Vattenfall received cash and
notes. In light of the equality of interests of the Company's principal
stockholders, there was no identifiable acquirer in the consolidation. Thus,
the assets and liabilities of each of the businesses contributed were recorded
at historical cost.
Principles of consolidation
The accompanying consolidated financial statements include the results of
operations of the Company and its wholly-owned subsidiaries: Power Systems,
GPI, Powers Systems AB, Process Solutions and Erudite Software. All inter-
company balances and transactions have been eliminated.
Accounting estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
F-6
29
GSE SYSTEMS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Cash and cash equivalents
Cash and cash equivalents consist of cash on hand and short-term highly
liquid investments with original maturities of less than three months at the
date of purchase.
Supplemental disclosures of cash flow information (in thousands):
YEAR ENDED FOR THE PERIOD
DECEMBER 31, APRIL 14 THROUGH
------------ DECEMBER 31,
------------
1996 1995 1994
---- ---- ----
Non cash investing & financing activities:
Obligations under finance leases ............... $ 313 $ 90 $ --
====== ===== =====
As discussed in Note 3, the Company acquired Process Solutions' domestic
operations in December 1994 and international operations in the second
quarter of 1995. In conjunction with these acquisitions, the purchase price
consisted of the following (in thousands):
Cash paid......................................... $ -- $ -- $ 2,000
Short-term notes payable issued................... -- -- 2,000
Long-term notes payable issued.................... -- 1,043 4,839
------ ------ -------
Total fair value of acquisition................... $ -- $1,043 $ 8,839
====== ====== =======
Cash paid for:
Interest........................................ $ 228 $ 882 $ 381
Income taxes.................................... $ 285 $ 767 $ 11
====== ====== =======
Inventories
Inventories are stated at the lower of cost, as determined by the average
cost method, or market. Obsolete or unsaleable inventory is reflected at its
estimated net realizable value. Inventory costs include raw materials and
purchased parts.
A summary of inventories is as follows (in thousands):
DECEMBER 31,
1996 1995
---- ----
Raw materials........................................ $ 2,115 $ 1,524
Service parts........................................ 1,423 769
------- -------
$ 3,538 $ 2,293
======= =======
Property and equipment
Property and equipment is recorded at cost and depreciated using the
straight-line method with estimated useful lives ranging from three to ten
years. Leasehold improvements are amortized over the life of the lease or the
estimated useful life, whichever is shorter, using the straight-line method.
Upon sale or retirement, the cost and related amortization is eliminated from
the respective accounts and any resulting gain or loss is included in
operations. Maintenance and repairs are charged to expense as incurred.
F-7
30
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Software development costs
Certain computer software development costs are capitalized in the
accompanying consolidated balance sheets. Capitalization of computer software
development costs begins upon the establishment of technological feasibility.
Capitalization ceases and amortization of capitalized costs begins when the
software product is commercially available for general release to customers.
Amortization of capitalized computer software development costs is included in
cost of revenue and is provided at the greater of the amount computed using
(a) the ratio of current gross revenues for a product to the total of current
and anticipated future gross revenue or (b) the straight-line method over the
remaining estimated economic life of the product, not to exceed five years.
Research and development
Development expenditures incurred to meet customer specifications under
contracts accounted for under the percentage of completion method are charged
to contract costs. Company sponsored research and development expenditures are
charged to operations as incurred and are included in selling, general and
administrative expenses. The amounts incurred for Company sponsored research and
development activities relating to the development of new products and services
or the improvement of existing products and services, exclusive of amounts
capitalized, were approximately $1,861,000, $2,945,000, and $963,000 for the
years ended December 31, 1996 and 1995, and for the period April 14 through
December 31, 1994, respectively.
Goodwill
Goodwill represents the excess of purchase price over the fair value of net
tangible and intangible assets acquired. These amounts are amortized on a
straight-line basis over periods ranging from ten to fifteen years.
At each balance sheet date, management evaluates the recoverability of
goodwill using certain financial indicators, such as historical and future
ability to generate income from operations. The Company's policy is to record
an impairment loss against the net unamortized cost of the intangible asset in
the period when it is determined that the carrying amount of the asset may not
be recoverable. This determination is based on an evaluation of such factors as
the occurrence of a significant event, a significant change in the environment
in which the business operates, or if the expected future net cash flows
(undiscounted and without interest) would become less than the carrying amount
of the asset.
Foreign currency translation
Balance sheet accounts for foreign operations are translated at the exchange
rate at the balance sheet date, and income statement accounts are translated at
the average exchange rate for the period. The resulting translation adjustments
are included as a separate component of stockholders' equity. Transaction gains
and losses included in income were not significant.
F-8
31
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Revenue recognition
Revenue under fixed-price contracts generally is accounted for on the
percentage-of-completion method, based on contract costs incurred to date and
estimated costs to complete. Estimated contract earnings are reviewed and
revised periodically as the work progresses and the cumulative effect of any
change is recognized in the period in which the change is determined. Estimated
losses are charged against earnings in the period such losses are identified.
The remaining liability for contract costs to be incurred in excess of contract
revenue is reflected as accrued contract reserves in the Company's consolidated
balance sheets. Revenue from sales of other products is recorded when the
products are shipped. Revenue from certain consulting or training contracts are
recognized on a time and material basis. For time-and-material type contracts,
revenue is recognized based on hours incurred at a contracted labor rate plus
expenses. The Company has no significant vendor obligations or collectibility
risk associated with its product sales.
Warranties
As the Company recognizes revenue under the percentage-of-completion method,
it provides an accrual for estimated future warranty costs based on historical
and projected claims experience. During 1996, the Company revised its estimate
for future warranty costs. The effect of this change in estimate was to
increase gross profit by approximately $601,000.
Income taxes
Deferred income taxes are provided under the asset and liability method.
Under this method, deferred income taxes are determined based on the differences
between the financial statement and tax basis of assets and liabilities using
enacted tax rates in effect for the year in which the differences are expected
to reverse. Valuation allowances are established when necessary to reduce
deferred tax assets to the amounts expected to be realized. Income tax expense
consists of the Company's current liability for federal, state and foreign
income taxes and the change in the Company's deferred income tax assets and
liabilities. No provision has been made for the undistributed earnings of the
Company's foreign subsidiaries as they are considered permanently invested.
Amounts of undistributed earnings are not material to the overall consolidated
financial statements.
Earnings per share
Net income per common share is computed based on the weighted average number
of shares of Common Stock outstanding during the period. The difference between
primary and fully-diluted per share amounts is insignificant.
New pronouncement
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings Per Share" (FAS 128).
FAS 128 simplifies the existing earnings per share (EPS) computations under
Accounting Principles Board Opinion No. 15, "Earnings Per Share," revises
disclosure requirements, and increases the comparability of EPS data on an
international basis. In simplifying the EPS computations, the presentation
of primary EPS is replaced with basic EPS, with the principal difference
being that common stock equivalents are not considered in computing basic
EPS. In addition, FAS 128 requires dual presentation of basic and diluted
EPS. FAS 128 is effective for financial statements issued for periods ending
after December 15, 1997. The Company does not expect the EPS amounts calculated
under FAS 128 to be materially different from the amounts presented in
the financial statements.
Concentration of credit risk
Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of temporary cash investments and contract
receivables. The Company restricts investments of temporary cash to financial
institutions with high credit standing. Credit risk on contract receivables is
mitigated by the nature of the Company's worldwide customer base and its credit
policies. The Company's customers are not concentrated in any specific
geographic region, but are concentrated in the energy and manufacturing
industries. No single customer accounted for a significant (greater than 10%)
amount of the Company's revenue and there were no significant contract
receivables from a single customer. The Company performs a credit evaluation
before extending credit and may require letters of credit, bank guarantees or
advance payments. Thereafter, the Company continues to monitor its contract
receivables exposure after giving effect to letters of credit, bank guarantees,
the status of work performed on contracts, and its customers' financial
condition.
F-9
32
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Off balance sheet risk and foreign exchange contracts
The Company enters into forward exchange contracts, options and swaps as
hedges against certain foreign currency commitments. The Company also enters
into letters of credit and performance guarantees in the ordinary course of
business as required by certain contracts and proposal requirements.
Gains and losses on foreign exchange contracts and swaps are recognized as
part of the cost of the underlying transactions being hedged. Foreign exchange
contracts have an element of risk that the counterparty may not be able to meet
the terms of the agreement. However, the Company minimizes such risk exposure
by limiting counterparties to nationally recognized financial institutions.
Foreign exchange options contracts permit but do not require the Company to
exchange foreign currencies at a future date with counterparties at a
contracted exchange rate. Costs associated with such contracts are amortized
over the life of the contract matching the underlying receipts.
3. ACQUISITIONS
The Company acquired the net assets of the domestic operations of Process
Solutions on December 30, 1994 and the international operations in the second
quarter of 1995 for an aggregate purchase price of $9,882,000. This acquisition
was accounted for under the purchase method. The financial results of Process
Solutions have been included in the results of operations from the date of
acquisition. The acquisition was financed through a promissory note payable in
the amounts of $5,882,000 with a five year term (the "TI Five-Year Note"), a
short-term promissory note payable in the amount of $2,000,000 and cash from
operations of the Company in the amount of $2,000,000. The TI Five-Year Note,
which was guaranteed by the Company and certain of its stockholders, and the
short-term promissory note, bore interest at a rate of 8% and were fully
repaid in 1995. The Company is also required to make quarterly performance
payments to TI equal to 15% of the revenue earned through December 30, 1999
attributable to the Real Time Business Controls portion of the acquired
business with a minimum payment of $750,000 and a maximum payment of
$4,000,000. The minimum amount of $750,000 has been accrued and recorded as
goodwill, and all additional payments above $750,000 will be recorded as
goodwill if paid. The acquisition resulted in total goodwill of $2,427,000,
which is being amortized over fifteen years.
On May 22, 1996, the Company acquired all of the outstanding shares of
capital stock of Erudite Software. The acquisition was accomplished through a
merger of Erudite Software into a wholly owned subsidiary of the Company in
which 840,688 shares of the Company's Common Stock were exchanged for all
outstanding shares of capital stock of Erudite Software. The acquisition has
been accounted for using the pooling-of-interests method of accounting and
accordingly, the Company's consolidated financial statements have been restated
to include the accounts and operations of Erudite Software for all periods
prior to the merger.
F-10
33
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Combined and separate results of the Company and Erudite Software during the
periods preceding the merger were as follows (in thousands):
THE COMPANY ERUDITE SOFTWARE COMBINED
----------- ---------------- --------
Three Months Ended March 31, 1996:
Revenue........................ $ 18,545 $ 3,758 $ 22,303
======== ======== =======
Net income..................... $ 860 $ 231 $ 1,091
======== ======== =======
Year Ended December 31, 1995:
Revenue........................ $ 85,302 $ 10,758 $ 96,060
======== ======== =======
Net income..................... $ 3,490 $ 186 $ 3,676
======== ======== =======
Period April 14, 1994 to December 31, 1994:
Revenue........................ $ 33,637 $ 3,448 $ 37,085
======== ======== =======
Net income..................... $ 999 $ (46) $ 953
======== ======== =======
PRO FORMA INFORMATION (UNAUDITED)
The Company consummated the initial public offering of its Common Stock,
selling 1,725,000 shares of Common Stock at $14.00 per share in August 1995.
Part of the proceeds from the initial public offering were used to pay down all
outstanding indebtedness. Pro forma supplementary earnings per share showing
what the earnings would have been if the acquisition of Process Solutions and
payment of debt had taken place at the beginning of each period are presented
below. The appropriate number of shares of Common Stock, whose sale proceeds
would have been required to pay down the outstanding indebtedness during each
period presented below, are included in the weighted average number shares
outstanding for that period.
YEAR ENDED
1995 1994
---- ----
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Pro Forma Revenues ........................................ $ 97,078 $ 95,997
====== ======
Pro Forma Net Income ...................................... $ 3,852 $ 3,147
====== ======
Pro Forma Earnings Per Share .............................. $ 0.96 $ 0.77
====== ======
Weighted Average Number of Shares Outstanding ............. 3,996 4,083
====== ======
The pro forma results are not necessarily indicative of what actually would
have occurred if the acquisition and the payment of debt had been made at the
beginning of the above periods. In addition, they are not intended to be a
projection of future results.
F-11
34
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. FAIR VALUES OF FINANCIAL INSTRUMENTS
The carrying amounts of cash and cash equivalents and short-term debt
approximate fair value because of the short-term maturity of these instruments.
The carrying amount of long-term debt approximates fair value based on either
market prices for the same or similar issues or the current rates offered to
the Company for similar debt of the same maturities. Fair value estimates of
foreign currency instruments, which are included in prepaid expenses and other
current assets in the consolidated balance sheet, were based on quotes from
financial institutions, as set forth below (in thousands):
DECEMBER 31, 1996 DECEMBER 31, 1995
--------------------------------- -----------------------------
CARRYING FAIR NOTIONAL/ CARRYING FAIR NOTIONAL/
AMOUNT VALUE CONTRACT VALUE AMOUNT VALUE CONTRACT VALUE
------ ----- -------------- ------ ----- --------------
Foreign currency instruments:
Options...................... $ 333 $ 231 $ 3,973 $ 326 $ 188 $ 5,004
Forward contracts............ $ 370 $ 409 $ 4,665 $ 721 $ 870 $ 12,470
Swaps........................ $ 106 $ 89 $ 594 $ 209 $ 206 $ 1,667
5. CONTRACT RECEIVABLES AND BILLINGS IN EXCESS OF REVENUE EARNED
Contract receivables represent balances due from a broad base of both domestic
and international customers. Due to the various billing and payment terms, none
of these individual customer balances is significant (more than 10%). All
contract receivables are considered to be collectible within twelve months. The
components of contract receivables are as follows (in thousands):
DECEMBER 31,
1996 1995
------ ------
Billed receivables.................................................................... $ 18,041 $ 18,804
Recoverable costs and accrued profit - not billed..................................... 9,714 11,643
Allowance for doubtful accounts....................................................... (298) (939)
------- -------
Total contract receivables........................................................ $ 27,457 $ 29,508
======= =======
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. The effect of changes in estimates of contract profits was to
increase gross profit by approximately $1,900,000 and $1,019,000 during the
years ended December 31, 1996 and 1995 respectively, and to decrease gross
profit by $633,000 during the period from April 14, 1994 through December 31,
1994, from that which would have been reported had the revised estimates been
used as the basis of recognition of contract profits in the preceding periods.
For the year ended December 31, 1995, the total estimated contract revenues
and costs at completion for two international contracts included claims
revenue, which is equal to estimated future costs of $1,200,000. During 1996,
the Company received contract modifications totaling $2,200,000 for the claims
recognized in 1995 and for additional claims in 1996. In connection with these
contract modifications, the Company incurred total costs of approximately
$1,600,000 including costs related to the claims recognized in 1995.
Accordingly, the Company recognized additional gross profit of approximately
$600,000 during 1996.
Additionally, the Company settled claims and counterclaims with its
consortium partner on these international contracts for which there was no net
impact to the Company.
F-12
35
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
DECEMBER 31,
----------------------
1996 1995
---- ----
Computer equipment................................................................... $ 7,101 $ 5,005
Leasehold improvements............................................................... 1,829 1,501
Furniture and fixtures............................................................... 1,521 838
------ ------
10,451 7,344
Accumulated depreciation and amortization............................................ (5,133) (3,229)
------ ------
Property and equipment, net.......................................................... $ 5,318 $ 4,115
===== =====
Depreciation and amortization expense was $1,943,000, $1,575,000 and
$710,000 for the years ended December 31, 1996 and 1995, and for the period
April 14, 1994 (date of inception) through December 31, 1994, respectively.
7. SOFTWARE DEVELOPMENT COSTS
Software development costs, net, consist of the following (in thousands):
DECEMBER 31,
----------------------
1996 1995
----- ----
Capitalized software development costs................................................ $ 5,554 $ 4,018
Accumulated amortization.............................................................. (378) (2,097)
----- -----
Software development costs, net....................................................... $ 5,176 $ 1,921
===== ====
Software development costs capitalized were $3,890,000, $1,664,000 and $0
for the years ended December 31, 1996 and 1995, and for the period April 14,
1994 (date of inception) through December 31, 1994, respectively. Amortization
of software development costs capitalized was $635,000, $471,000 and $351,000
for the years ended December 31, 1996 and 1995, and for the period April 14
through December 31, 1994, respectively, and are included within cost of
revenue. During 1996, the Company wrote-off approximately $2.4 million in fully
amortized capitalized software development costs from one of the Predecessors.
8. GOODWILL
Goodwill consists of the following (in thousands):
DECEMBER 31,
------------
1996 1995
---- ----
Cost....................................................................... $ 2,425 $ 2,546
Accumulated amortization................................................... (366) (198)
----- -----
Total $ 2,059 $ 2,348
===== =====
Amortization expense for goodwill was approximately $168,000, $270,000 and
$67,000 for the years ended December 31, 1996 and 1995, and for the period April
14, 1994 (date of inception) through December 31,
F-13
36
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1994, respectively. For the year ended December 31, 1995 and for the period
April 14, 1994 (date of inception) to December 31, 1994, the Company recorded
amortization expense of $496,000 and $348,000, respectively, for other
intangible assets that were fully amortized by December 31, 1995.
As discussed in Note 11, during 1996 and 1995, the Company reduced the
valuation allowance (against deferred tax assets) that was set up in connection
with the acquisition of Power Systems in August 1993. This resulted in a
corresponding reduction of goodwill of $109,000 and $525,000 during the years
ended December 31, 1996 and 1995, respectively and other intangible assets by
$829,000 during the year ended December 31, 1995.
9. ACCRUED EXPENSES
Accrued expenses consist of the following (in thousands):
DECEMBER 31,
-----------------------
1996 1995
---- ----
Accrued vacation, severance and other benefits........................................ $ 2,456 $ 2,037
Accrued compensation and payroll taxes................................................ 1,504 1,943
Due to stockholders and affiliates.................................................... -- 141
Other accrued expenses................................................................ 470 314
----- -----
Total............................................................................... $ 4,430 $ 4,435
===== =====
10. NOTES PAYABLE AND FINANCING ARRANGEMENTS
Notes payable and financing arrangements consist of the following (in
thousands):
DECEMBER 31,
-----------------
1996 1995
---- ----
Lines of credit with bank........................................................... $ 2,582 $ --
Notes payable to banks.............................................................. -- 212
Notes payable to related parties.................................................... 202 406
Capital lease obligations........................................................... 606 330
----- ---
Total notes payable and financing arrangements.................................... 3,390 948
Less amounts payable within one year................................................ (2,768) (505)
----- ---
Long-term portion................................................................. $ 622 $ 443
===== ===
F-14
37
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Lines of Credit
The Company maintains, through its subsidiaries, two lines of credit that
provide for borrowings up to $14.0 million to support foreign letters of
credit, margin requirements or foreign exchange contracts and working
capital needs. The first line, through Power Systems, of $7.0 million is
90% guaranteed by the Export-Import Bank of the United States ("EXIM") and
is collateralized by Power Systems' contract receivables and inventory. The
line bears interest at the bank's prime rate (8.25% at December 31, 1996),
provides for borrowings up to 90% of eligible receivables and 60% of unbilled
receivables, and expires January 1, 1998, subject to earlier termination upon
expiration of the EXIM guaranty (currently effective through April 30, 1997).
The outstanding borrowings under the Power Systems line at December 31, 1996
was $1,782,000.
The second line, through Process Solutions, of $7.0 million is collateralized
by substantially all of Process Solutions assets and provides for borrowings
up to 85% of eligible receivables and 20% of inventory (limited to $500,000).
The line bears interest at the bank's prime rate (8.25% at December 31, 1996)
and expires January 1, 1998, subject to earlier termination upon the expiration
of the EXIM guaranty for the Power Systems line of credit. The outstanding
borrowings under the Process Solutions line at December 31, 1996 was $800,000.
The aforementioned lines of credit also contain certain covenants which
restrict the Company from, among other things, incurring additional
indebtedness, entering into merger, consolidation or acquisition transactions,
disposing of all or substantially all of its assets, creating liens on assets,
and creating guaranty obligations. Further, the Company is required to comply
with certain financial ratios, including minimum levels of debt to net worth
and cash flow to fixed obligations, and is also required to provide the bank
with certain periodic financial reports.
Other debt
The Company entered into capital lease agreements for property,
furniture and equipment, totaling $313,000, and $90,000, and $0
during the years ended December 31, 1996 and 1995, and the period
April 14 through December 31, 1994, respectively. These obligations bear
interest at between 9% and 11% per annum and expire between 1998 and 1999.
Debt maturities
Aggregate maturities of debt as of December 31, 1996 are as follows: 1997,
$2,768,000; 1998, $512,000; and 1999, $110,000.
F-15
38
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. INCOME TAXES
The consolidated income before income tax, by domestic and foreign sources,
is as follows (in thousands):
YEAR ENDED FOR THE PERIOD
DECEMBER 31, APRIL 14, THROUGH
------------ DECEMBER 31,
-----------------
1996 1995 1994
------- ------- -------
Domestic......................................................... $ 3,884 $ 3,844 $ 232
Foreign.......................................................... 968 1,849 1,273
------ ----- -----
$ 4,852 $ 5,693 $1,505
===== ===== =====
The provision for income taxes is as follows (in thousands):
YEAR ENDED FOR THE PERIOD APRIL 14
DECEMBER 31, THROUGH DECEMBER 31,
------------ --------------------
1996 1995 1994
---- ---- ----
Current:
Federal............................................. $ (23) $ 210 $ 250
State............................................... 29 40 35
Foreign............................................. 642 508 140
---- ----- ----
648 758 425
---- ----- ----
Deferred:
Federal............................................. 186 1,160 (153)
State............................................... 23 99 (12)
Foreign............................................. (148) -- 292
----- ----- ----
61 1,259 127
----- ----- ----
$ 709 $ 2,017 $ 552
===== ===== ====
The provision for income taxes varies from the amount of income tax
determined by applying the applicable U.S. statutory rate to pre-tax income
as a result of the following:
YEAR ENDED FOR THE PERIOD APRIL 14
DECEMBER 31 THROUGH DECEMBER 31,
----------- -------------------
1996 1995 1994
---- ---- ----
Statutory U.S. tax rate................................... 34.0% 34.0% 34.0%
State income tax, net of federal tax benefit.............. 2.7 2.8 2.0
Effect of foreign operations.............................. (6.6) 2.3 --
Amortization of goodwill and other intangible assets...... -- .5 1.9
Reduction in valuation allowance.......................... (19.5) (3.4) --
Research and development credit........................... -- (1.4) --
Others.................................................... 4.0 .6 (1.2)
----- ----- -----
Effective tax rate........................................ 14.6% 35.4% 36.7%
===== ===== =====
F-16
39
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 1996, the Company had available $5,772,000 of federal net
operating loss carryforwards which expire between 2007 and 2011. These
carryforwards will be utilized to reduce taxable income in subsequent years. A
portion of the net operating losses were generated by certain of the
Predecessors prior to the formation of the Company and, as a result, there are
limitations on the amounts that can be utilized to offset taxable income in a
given year.
Deferred income taxes arise from temporary differences between the tax basis
of assets and liabilities and their reported amounts in the financial
statements. A summary of the tax effect of the significant components of
deferred income taxes is as follows (in thousands):
DECEMBER 31,
---------------------------
1996 1995
-------- --------
DEFERRED TAX DEFERRED TAX
ASSET/(LIABILITY) ASSET/(LIABILITY)
----------------- -----------------
Contract loss reserves................................................ $ -- $ 196
Property and equipment................................................ (135) (177)
Accrued expenses...................................................... 230 277
Net operating loss carryforwards...................................... 2,013 1,220
Book reserves not deductible for tax purposes......................... 859 1,748
Software development costs............................................ (1,753) (465)
Deferred revenue..................................................... 777 691
Cash to accrual adjustment............................................ (142) --
Foreign tax credits .................................................. 214 --
Others................................................................ 147 58
----- -----
2,210 3,548
Valuation allowance................................................... (187) (1,220)
----- -----
$ 2,023 $ 2,328
===== =====
During 1996 and 1995, the Company reduced the valuation allowance by
$1,033,000 and $1,619,000, respectively, of which $109,000 and $1,354,000,
respectively, reduced goodwill and other intangibles arising out of the
acquisition of Power Systems. The valuation allowance at December 31, 1996
relates to the future utilization of foreign net operating loss carry forwards
that the Company has determined are not realizable at this time.
12. CAPITAL STOCK
As of December 31, 1996, the Company had 10,000,000 total shares of capital
stock authorized, of which 8,000,000 are common stock and 2,000,000 are
preferred stock. As of December 31, 1996 and 1995, there are no shares of
preferred stock outstanding. The Board of Directors has the authority to
establish one or more classes of preferred stock and to determine, within
any class of preferred stock, the preferences, rights and other terms of
such class.
F-17
40
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. STOCK OPTIONS
LONG TERM INCENTIVE PLAN
During 1995, the Company established the 1995 Long-Term Incentive
Stock Option Plan (the "Plan") which includes all officers, key employees and
non-employee members of the Company's Board of Directors. All options to
purchase shares of the Company's common stock under the Plan expire ten years
from the date of grant and generally become exercisable in three installments
with 40% vesting on the first anniversary of the grant date and 30% vesting on
each of the second and third anniversaries of the grant date, subject to
acceleration under certain circumstances. Under the original terms of the Plan,
the Company had reserved 425,000 shares of common stock for issuance of stock
options. During 1996, this amount was increased to 625,000 shares. Stock option
activity under the Plan is as follows:
YEAR ENDED YEAR ENDED
DECEMBER 31, 1996 DECEMBER 31, 1995
----------------- -----------------
SHARES WEIGHTED-AVERAGE SHARES WEIGHTED-AVERAGE
------ ---------------- ------ ----------------
EXERCISE PRICE EXERCISE PRICE
-------------- --------------
Options outstanding beginning of period... 297,516 $ 14.00 -- $ --
Options canceled.......................... (26,150) (14.07) -- --
Options granted........................... 142,000 12.89 297,516 14.00
------- -------
Options outstanding end of period ........ 413,366 13.61 297,516 14.00
======= =======
The Company accounts for grants under the Plan in accordance with APB 25,
"Accounting for Stock issued to Employees," and related interpretations. Had
compensation expense been determined based on the fair value at the grant dates
for awards under the Plan consistent with the method of SFAS 123, "Accounting
for Stock Based Compensation," the Company's net income and net income per
share would have been reduced to approximately $3,601,000 ($0.71 per share) and
$3,219,000 ($0.79 per share) for the years ended December 31, 1996 and 1995,
respectively.
The fair value of each option is estimated on the date of grant using a
Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants during the year ended December 31, 1996 and 1995,
respectively: dividend yield of 0%, expected volatility of 80%, risk-free
interest rate of 6.41% and 6.23% and expected terms of 7 years.
As of December 31, 1996 and 1995, respectively, there were 119,000 and 0
stock options exercisable under the Plan, and the Company had 211,634 shares
of common stock reserved for the future grants under the Plan. The weighted
average fair value of options granted during 1996 and 1995 was $9.55
per share and $10.44 per share, respectively. As of December 31, 1996, the
weighted average remaining contractual life of the options outstanding was
approximately 9.3 years.
OTHER STOCK OPTIONS
On February 23, 1996, in exchange for services, the Company granted
stock options to two consultants to acquire 10,000 shares of Common Stock in
the aggregate at an exercise price of $14.00. These grants were not made
pursuant to the Plan. These options expire on December 31, 2000 and generally
become exercisable in two installments with 50% vesting as of January 1, 1997
and the remaining 50% vesting as of January 1, 1998.
F-18
41
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. COMMITMENTS AND CONTINGENCIES
Leases
The Company is obligated under certain noncancelable operating leases for
office facilities and equipment. Future minimum lease payments under
noncancelable operating leases as of December 31, 1996 are approximately as
follows (in thousands):
1997.................................................................................................. $ 3,127
1998.................................................................................................. 2,957
1999.................................................................................................. 2,528
2000.................................................................................................. 2,253
2001.................................................................................................. 2,192
Thereafter............................................................................................ 32
------
$ 13,089
======
Total rent expense under operating leases was $1,876,000, $2,487,000 and
$1,096,000 for the years ended December 31, 1996 and 1995, and for the
period April 14 through December 31, 1994. Rent expense in 1996 is net of
amortization of $348,000 and reversal of $1,103,000 of excess facility costs.
Rent expense in 1995 is net of amortization of $348,000 of excess facility
costs. Rent expense in 1994 is net of amortization of $278,000 of excess
facility costs. At December 31, 1996 and 1995, the Company had accrued $0 and
$1,451,000, respectively, of excess facility costs.
Letters of credit
As of December 31, 1996, the Company and certain of its subsidiaries were
contingently liable under letters of credit totaling $1,180,000. Further, the
performance of certain of the Company's customer contracts is collateralized by
performance guarantees totaling $4,422,000 by its subsidiaries' respective
former parent organizations.
15. RELATED PARTY TRANSACTIONS
Upon consummation of the initial public offering on August 1, 1995, a
management fee of $981 per day, previously due to certain stockholders, was
eliminated. Such management fee, was included within selling, general and
administrative expenses and amounted to $204,000 for year ended December 31,
1995 and $257,000 for the period from April 14, 1994 through December 31,
1996.
Power Systems subleases office space to ManTech at market price based on
square footage used. For the years ended December 31, 1996 and 1995 and for the
period April 14 through December 31, 1994, such charges amounted to $67,000,
$46,000 and $61,000 respectively. Power Systems purchased computer run-time
from ManTech until April 1996; such charges amounted to $36,000, $63,000 and
$89,000 in 1996 and 1995 and for the period April 14 through December 31, 1994,
respectively. GPC historically has performed services as a subcontractor on
certain GPI contracts and GPI may continue to subcontract with GPC from time
to time. For the years ended December 31, 1996 and 1995 and for the period
April 14 through December 31, 1994, such subcontract costs amounted to $0,
$51,000 and $89,000, respectively.
One of the Company's subsidiaries' bi-weekly payroll is processed by a
company whose owner is also a shareholder of the Company. Expenses incurred for
such payroll processing for the years ended December 31, 1996 and 1995 and for
the period April 14, 1994 through December 31, 1994 were $62,000, $42,000 and
$19,500, respectively. The Company subleases a portion of its facilities to
this related party. Sublease payments by the related party were approximately
$4,000, $3,000 and $1,500 for the years ended December 31, 1996 and 1995 and
for the period April 14 through December 31, 1994, respectively.
F-19
42
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. RELATED PARTY TRANSACTIONS
Upon consummation of the initial public offering on August 1, 1995, a
management fee of $981 per day, previously due to certain stockholders, was
eliminated. Such management fee, was included within selling, general and
administrative expenses and amounted to $204,000 for year ended December 31,
1995 and $257,000 for the period from April 14, 1994 through December 31,
1996.
Power Systems subleases office space to ManTech at market price based on
square footage used. For the years ended December 31, 1996 and 1995 and for the
period April 14 through December 31, 1994, such charges amounted to $67,000,
$46,000 and $61,000 respectively. Power Systems purchased computer run-time
from ManTech until April 1996; such charges amounted to $36,000, $63,000 and
$89,000 in 1996 and 1995 and for the period April 14 through December 31, 1994,
respectively. GPC historically has performed services as a subcontractor on
certain GPI contracts and GPI may continue to subcontract with GPC from time
to time. For the years ended December 31, 1996 and 1995 and for the period
April 14 through December 31, 1994, such subcontract costs amounted to $0,
$51,000 and $89,000, respectively.
One of the Company's subsidiaries' bi-weekly payroll is processed by a
company whose owner is also a shareholder of the Company. Expenses incurred for
such payroll processing for the years ended December 31, 1996 and 1995 and for
the period April 14, 1994 through December 31, 1994 were $62,000, $42,000 and
$19,500, respectively. The Company subleases a portion of its facilities to
this related party. Sublease payments by the related party were approximately
$4,000, $3,000 and $1,500 for the years ended December 31, 1996 and 1995 and
for the period April 14 through December 31, 1994, respectively.
During 1996, the Company entered into an agreement with ManTech to provide
consulting services in developing a long-term strategic growth plan. Consulting
payments were $13,000 for the year ended December 31, 1996. The agreement also
provided for a finder's fee to be paid by the Company to ManTech for any
acquisitions made pursuant to this services arrangement. A finder's fee payment
was made in the amount of $154,000 for the year ended December 31, 1996 in
connection with the Company's acquisition of Erudite Software.
F-20
43
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
During 1996, the Company entered into an agreement with ManTech to provide
consulting services in developing a long-term strategic growth plan. Consulting
payments were $13,000 for the year ended December 31, 1996. The agreement also
provided for a finder's fee to be paid by the Company to ManTech for any
acquisitions made during the period of the agreement. A finder's fee payment
was made in the amount of $154,000 for the year ended December 31, 1996 in
connection with the Company's acquisition of Erudite Software.
In November 1993, the three founding shareholders of Erudite Software sold
an aggregate of 2,000 shares of common stock on a pro-rata basis to two other
individuals in exchange for demand notes totaling $200,000 with no stated
interest rate. These notes were collateralized by the shares of common stock
received by the two individuals. The founding shareholders immediately
transferred the $200,000 in notes receivable from the new shareholders to
Erudite Software in exchange for notes due from Erudite Software on demand with
no stated interest rate. For financial reporting purposes, the notes receivable
from the new shareholders were included as a part of stockholders' equity in
the accompanying consolidated balance sheet until such time as the notes
receivable were fully collected and the shares of common stock no longer
represented collateral against the notes. For the years ended December 31, 1996
and 1995, the notes receivable from stockholders were reduced through cash
receipts of $0 and $15,000, respectively, and through services provided to
Erudite Software of $2,000 and $58,000. For the period April 14, 1994 to
December 31, 1994, the notes receivable from stockholders were reduced through
cash receipts of $25,000, and through services provided to Erudite Software of
$50,000. The services provided to Erudite Software have been valued based upon
salaries, bonuses and commissions earned by these two individuals. These notes
receivable were reduced to $0 during the year ended December 31, 1995. For the
years ended December 31, 1996 and 1995 cash payments to the founding
shareholders in satisfaction of the note payable totaled $189,000 and $11,000,
respectively. As of December 31, 1996 and 1995, the notes payable to the
founding shareholders had a balance of $0 and $189,000, respectively.
16. EMPLOYEE BENEFITS
The Company currently maintains non-qualified and qualified supplemental
defined benefit plans for certain retired employees. During 1996 the Company
began the process of terminating the defined benefit plan. The IRS has issued a
favorable determination letter and the Pension Benefit Guarantee Corporation is
considering the plan termination. The plan is fully funded for all accrued
benefits. The Company has recognized an expense of $124,000 during 1996 related
to the termination of the plan. Net periodic pension expense of $29,000 was
recognized for each of the periods ended December 31, 1995 and 1994. The
recorded unfunded liability related to these plans was $0 as of December 31,
1996 and $132,000 as of December 31, 1995. Due to the immateriality of these
plans, actuarial plan information has not been presented.
The Company also has a qualified defined contribution plan that covers
substantially all employees and complies with Section 401(k) of the Internal
Revenue Code. Under this plan, the Company's stipulated basic matching
contribution matches a portion of the participants' contributions based upon a
defined schedule. Contributions are invested by an independent investment
company in one or more of several investment alternatives. The choice of
investment alternatives is at the election of each participating employee. The
Company's contributions to the plan were approximately $671,000, $484,000, and
$134,000 the years ended December 31, 1996 and 1995, and for the period April 14
through December 31, 1994, respectively.
F-20
44
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
17. FINANCIAL INFORMATION BY GEOGRAPHIC AREA
The Company operates in a single industry segment: it designs, develops and
delivers business and technology solutions to the energy, process and
manufacturing industries worldwide. Revenue, operating income and identifiable
assets for the Company's United States, European and Asian operations are as
follows (in thousands).
YEAR ENDED DECEMBER 31, 1996
-----------------------------------------------------------------------------
UNITED STATES EUROPE ASIA ELIMINATIONS CONSOLIDATED
------------- ------ ---- ------------ ------------
Revenue..................................... $ 83,263 $ 9,026 $ 3,744 $ -- $ 96,033
Transfers between geographic locations...... 659 -- 622 (1,281) --
------- ------ ------ --------- -------
Total revenue............................... $ 83,922 $ 9,026 $ 4,366 $ (1,281) $ 96,033
======= ====== ====== ========= =======
Income from operations...................... $ 3,832 $ 1,267 $ (452) $ 198 $ 4,845
======= ====== ====== ========= =======
Identifiable assets......................... $ 54,584 $ 6,416 $ 3,057 $ (13,051) $ 51,006
======= ====== ====== ========= =======
YEAR ENDED DECEMBER 31, 1995
----------------------------------------------------------------------------
UNITED STATES EUROPE ASIA ELIMINATIONS CONSOLIDATED
------------- ------ ---- ------------ ------------
Revenue..................................... $ 87,009 $ 7,050 $ 2,001 $ -- $ 96,060
Transfers between geographic locations...... 1,173 -- -- (1,173) --
------- ------ ------ -------- -------
Total revenue............................... $ 88,182 $ 7,050 $ 2,001 $ (1,173) $ 96,060
======= ====== ====== ======== =======
Income from operations...................... $ 5,028 $ 1,628 $ 7 $ (351) $ 6,312
======= ====== ====== ======== =======
Identifiable assets......................... $ 49,958 $ 7,298 $ 2,337 $ (4,905) $ 54,688
======= ====== ====== ======== =======
FOR THE PERIOD APRIL 14 THROUGH DECEMBER 31, 1994
------------------------------------------------------------------------
UNITED STATES EUROPE ELIMINATIONS CONSOLIDATED
------------- ------ ------------ ------------
Revenue..................................... $ 32,851 $ 4,234 $ -- $ 37,085
Transfers between geographic locations...... 550 50 (600) --
------- ------ -------- -------
Total revenue............................... $ 33,401 $ 4,284 $ (600) $ 37,085
======= ====== ======== =======
Income from operations...................... $ 1,132 $ 1,183 $ (600) $ 1,715
======= ====== ======== =======
Identifiable assets......................... $ 40,623 $ 3,639 $ (2,150) $ 42,112
======= ====== ======== =======
The Company has intercompany distribution arrangements with its subsidiaries.
The basis of these arrangements, disclosed as transfers between geographic
locations, is principally at market prices.
F-21
45
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Domestic and export sales from the Company's United States operations in
thousands of dollars and as a percentage of revenue are as follows:
FOR THE PERIOD
YEAR ENDED DECEMBER YEAR ENDED APRIL 14 THROUGH
31, 1996 DECEMBER 31, 1995 DECEMBER 31, 1994
-------- ----------------- -----------------
Domestic $ 47,868 57.5% $ 45,222 52.0% $ 11,361 34.6%
Export:
Germany.......................................... 9,236 11.1 8,039 9.2 6,336 19.3
Remaining Western Europe......................... 2,806 3.4 12,400 14.3 5,578 17.0
Russia........................................... 7,716 9.2 9,135 10.5 6,413 19.5
Remaining Eastern Europe......................... 11,070 13.3 4,547 5.2 961 2.9
Asia............................................. 3,910 4.7 6,853 7.9 2,202 6.7
South America and others......................... 657 0.8 813 0.9 -- --
------- ------ ------- ------ ------- ------
$ 83,263 100.0% $ 87,009 100.0% $ 32,851 100.0%
======= ====== ======= ====== ======= ======
F-22
46
REPORT OF INDEPENDENT ACCOUNTANTS
To The Board of Directors and Stockholders of
GSE Power Systems, Inc. and MSHI, Inc.
We have audited the consolidated statements of operations, stockholder's equity
and cash flows for the period January 1, 1994 through April 13, 1994 of GSE
Power Systems, Inc. (formerly Simulation, Systems & Services Technologies
Company) and its immediate parent company, MSHI, Inc. (formerly a wholly-owned
subsidiary of ManTech International Corporation). These financial statements
are the responsibility of the companies' management. Our responsibility is to
express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated results of operations and cash flows of
GSE Power Systems, Inc. and its immediate parent company, MSHI, Inc. for the
period January 1, 1994 through April 13, 1994, in conformity with generally
accepted accounting principles.
Coopers & Lybrand L.L.P.
Washington, D.C.
March 31, 1995
F-23
47
SIMULATION, SYSTEMS & SERVICES TECHNOLOGIES COMPANY
(INCLUDING ITS IMMEDIATE PARENT MSHI, INC.)
(FORMERLY A WHOLLY OWNED SUBSIDIARY OF MANTECH INTERNATIONAL CORPORATION)
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS)
FOR THE PERIOD
JANUARY 1, 1994
TO APRIL 13,
1994
---------------
Contract revenue ............................................... $ 8,271
Cost of revenue ................................................ 5,943
-------
Gross profit ................................................... 2,328
Operating Expenses:
Selling, general and administrative ......................... 1,473
Depreciation and amortization ............................... 324
-------
Total operating expenses .................................... 1,797
-------
Operating income ............................................ 531
Interest expense ............................................... 40
Other income ................................................... (3)
Income before income taxes and cumulative -------
effect of change in accounting principle .................... 494
Provision for income taxes ..................................... 444
Net income before cumulative effect -------
of change in accounting principle ........................... 50
Cumulative effect of change in accounting principle ............ --
-------
Net income .................................................. $ 50
=======
The accompanying notes are an integral part of these consolidated
financial statements.
F-24
48
SIMULATION, SYSTEMS & SERVICES TECHNOLOGIES COMPANY
(INCLUDING ITS IMMEDIATE PARENT MSHI, INC.)
(FORMERLY A WHOLLY OWNED SUBSIDIARY OF MANTECH INTERNATIONAL CORPORATION)
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY
(IN THOUSANDS)
COMMON ADDITIONAL RETAINED
STOCK PAID-IN-CAPITAL EARNINGS
----- --------------- --------
Balance, December 31, 1993 .............. 1 49 105
Net income .............................. -- -- 50
----- ----- -----
Balance, April 13, 1994 ................. $ 1 $ 49 $155
===== ===== =====
The accompanying notes are an integral part of these consolidated
financial statements.
F-25
49
SIMULATION, SYSTEMS & SERVICES TECHNOLOGIES COMPANY
(INCLUDING ITS IMMEDIATE PARENT MSHI, INC.)
(FORMERLY A WHOLLY OWNED SUBSIDIARY OF MANTECH INTERNATIONAL CORPORATION)
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
FOR THE PERIOD
JANUARY 1, 1994
TO APRIL 13,
1994
----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ....................................................... $ 50
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization .................................... 324
Adjustments to reconcile net income to net cash provided
by operating activities:
Contract receivables ............................................ (1,683)
Inventories ..................................................... (13)
Foreign currency options ........................................ 472
Prepaid expenses and other current assets ....................... (223)
Deferred tax assets ............................................. 942
Other assets .................................................... --
Accounts payable ................................................ (257)
Accrued salaries ................................................ (90)
Billings in excess of revenue earned ............................ 5,228
Accrued facility costs .......................................... (14)
Accrued contract and warranty reserves .......................... (1,536)
Accrued retirement .............................................. 9
------
Net cash (used in) provided by operating activities .............. 3,209
------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of S3 Technologies, net of acquired cash ................ --
Purchase of property and equipment ............................... (276)
Investment in joint ventures ..................................... --
------
Net cash used in investing activities ............................ (276)
------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings ....................................................... 2,719
Repayment of borrowings .......................................... (208)
Proceeds from sale of common stock ............................... --
Principal payments under capital lease ........................... (15)
Increase (decrease) in payable to stockholder .................... (5,487)
------
Net cash provided by (used in) financing activities .............. (2,991)
------
Net increase (decrease) in cash and cash equivalents ............. (58)
Cash and cash equivalents at beginning of period ................. 58
------
Cash and cash equivalents at end of period ....................... $ 0
======
The accompanying notes are an integral part of these consolidated
financial statements.
F-26
50
SIMULATION, SYSTEMS & SERVICES TECHNOLOGIES COMPANY
(INCLUDING ITS IMMEDIATE PARENT MSHI, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS
Simulation, Systems & Services Technologies Company is a designer, developer
and supplier of high fidelity real-time simulation software, systems and
services in the energy and manufacturing industries.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
The accompanying consolidated financial statements represent the accounts of
Simulation, Systems & Services Technologies Company and its immediate parent
MSHI, Inc. (together referred to as "S3 Technologies"). MSHI, Inc. was a
wholly-owned subsidiary of ManTech International Corporation ("ManTech") until
April 13, 1994, at which time it became part of GSE Systems, Inc. (See Note
11.) All intercompany transactions have been eliminated.
The consolidated financial statements presented reflect allocations of costs
for general and administrative expenses and income taxes. Such costs and
expenses have been allocated to the Company based on actual usage or other
methods (i.e., proportional allocational method) that approximate actual usage.
Management believes that the allocation methods used are reasonable and that
allocated costs and expenses approximate what such amounts would be if the
Company had operated on a stand alone basis.
Property and equipment are depreciated using the straight-line method with
estimated useful lives ranging from three to seven years. Leasehold
improvements are amortized over the life of the lease or the estimated useful
life, whichever is shorter, using the straight-line method. Upon sale or
retirement, the cost and related accumulated depreciation or amortization are
eliminated from the respective accounts and any resulting gain or loss is
included in income. Maintenance and repairs are charged to expense as incurred.
Intangible assets consist of amounts relating to goodwill, backlog and
proposal values, all arising from acquisitions. These amounts are amortized on
a straight-line basis over periods ranging from three to four years for backlog
and proposal values and fifteen years for goodwill.
F-27
51
SIMULATION, SYSTEMS & SERVICES TECHNOLOGIES COMPANY
(INCLUDING ITS IMMEDIATE PARENT MSHI, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Revenue Recognition
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. Estimated contract earnings are reviewed and
revised periodically as the work progresses and the cumulative effect of any
change is recognized in the period in which the change is determined. Estimated
losses are charged against earnings in the period such losses are identified.
Revenues from sales of other products are recorded when the products are
shipped. The Company has no significant vendor obligations or collectibility
risk associated with its product sales.
Research and development
Development expenditures incurred to meet customer specifications under
contracts accounted for under the percentage of completion method are charged
to contract costs. Company sponsored research and development expenditures are
charged to operations as incurred and are included in selling, general and
administrative expenses. The amounts incurred for Company sponsored research
and development activities relating to the development of new products and
services or the improvement of existing products and services were
approximately $343,000 for the period from January 1, 1994 through April 13,
1994.
Warranties
As the Company recognizes revenue under the percentage of completion method,
it provides an accrual for estimated future warranty costs on historical and
projected claims experience.
Income Taxes
Through April 13, 1994, the Company was included in the consolidated federal
income tax returns of ManTech. As such, the income and losses generated by the
Company are used on an annual basis to reduce the overall tax liability of the
other members of the consolidated group. The Company is reimbursed for the
benefit provided to the consolidated group.
The Company adopted Statement of Financial Accounting Standards No. 109,
Accounting for Income Taxes, effective January 1, 1992 and the cumulative
effect of this change is reflected in the statement of operations. Under this
standard, deferred income taxes are provided under the asset and liability
method. This method requires recognition of deferred tax liabilities and assets
for the expected future tax consequences of events that have been included in
the financial statements or tax returns. Under this method, deferred income
taxes are determined based on the difference between the financial statement
and tax basis of assets and liabilities using enacted tax rates in effect for
the year in which the differences are expected to reverse. Valuation allowances
are established when necessary to reduce deferred tax assets to the amounts
expected to be realized. Income tax expense consists of the Company's current
liability, computed on a separate company basis, for federal and state income
taxes and the change in the Company's deferred income tax assets and
liabilities.
F-28
52
SIMULATION, SYSTEMS & SERVICES TECHNOLOGIES COMPANY
(INCLUDING ITS IMMEDIATE PARENT MSHI, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Concentration of credit risk
Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of contract receivables. Credit risk on
contract receivables is mitigated by the nature of the Company's worldwide
customer base and its credit policies. The Company's customers are not
concentrated in any specific geographic region, but are concentrated in the
energy and manufacturing industries. The Company performs credit evaluation
before extending credit and may require letters of credit, bank guarantees or
advance payments. Thereafter, the Company continues to monitor its contract
receivables exposure after giving effect to letters of credit, bank guarantees,
the status of the work performed on the contract, or its customers' financial
condition.
Off balance sheet risk and foreign exchange contracts
The Company enters into forward exchange contracts and options as a hedge
against certain foreign currency commitments. The Company also enters into
letters of credit and performance guarantees in the ordinary course of business
as required by certain contracts and proposal requirements.
A significant portion of the Company's international revenue is received in
a currency other than the currency in which the expenses relating to such
revenue are paid. The Company attempts to offset or "hedge" its foreign
currency exposure primarily by entering into foreign currency exchange
agreements and purchasing foreign currency options. The former require the
Company on a specified date, or during a specified period to exchange a set
amount of foreign currency for United States dollars or another base currency
at a specified exchange rate. The latter provide the Company with the option to
exchange foreign currency for United States dollars or another base currency
during a specified period or at a specified exchange rate. The Company utilizes
these foreign exchange agreements and options only to reduce the impact of
foreign currency fluctuations on its operating results and does not engage in
foreign currency speculation. Foreign exchange contracts do not expose the
Company to material risk because any losses on the contracts are offset by
gains on the value of the foreign receivables being hedged. Foreign exchange
options do not expose the Company to material risk since the Company has the
right not to exercise the option.
Foreign exchange contacts have an element of risk that the counterparty may
not be able to meet the terms of the agreement. However, the Company minimizes
such risk exposure by limiting counterparties to Paine Webber Financial
Products Inc. and NationsBank, N.A. ("NationsBank"). Management believes that
the risk of incurring such losses is immaterial. The Company has also entered
into foreign exchange option contracts with NationsBank which permit but do not
require the Company to exchange foreign currencies at a future date with the
bank at a contracted exchange rate. Costs associated with such contracts are
amortized over the life of the contract matching the underlying receipts.
The fair values of foreign exchange forward contracts and foreign exchange
options are estimated by obtaining quotes for such contracts with similar
terms, adjusted where necessary for maturity differences. However, such fair
values are offset by gains or losses on assets and liabilities hedged by such
contracts and options. Furthermore, the costs of the contracts and options are
included in the Company's estimates of costs and earnings on its long-term
fixed price contracts. Accordingly, there is no significant difference between
the recorded value and fair value of the Company's net foreign exchange
position.
Fixed-price contracts generated 89% of total revenue for the period from
January 1, 1994 through April 13, 1994.
F-29
53
SIMULATION, SYSTEMS & SERVICES TECHNOLOGIES COMPANY
(INCLUDING ITS IMMEDIATE PARENT MSHI, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. DEPRECIATION AND AMORTIZATION EXPENSE
Depreciation expense for the period January 1, 1994 through April 13, 1994,
was $148,000.
Amortization expense for the period from January 1, 1994 through April 13,
1994 was $176,000.
5. CAPITAL LEASE EXPENSE
Interest paid under this lease was $8,000 for the period from January 1,
1994 through April 13, 1994.
6. INCOME TAXES
The provisions (benefit) for income taxes on pre-tax earnings are as follows
(in thousands):
FOR THE PERIOD
JANUARY 1,
TO APRIL 13,
1994
----
Current tax expense (benefit)...................... $ (498)
Deferred tax expense............................... 942
---
Total provision (benefit)....................... $ 444
===
The provision for income taxes varies from the amount of income tax
determined by applying the applicable U.S. statutory tax rate to pre-tax income
as a result of the following:
FOR THE PERIOD
JANUARY 1,
TO APRIL 13,
1994
----
Statutory U.S. tax rate.......................... 34.0%
Increase (decrease) in rate resulting from:
State taxes, net of Federal benefit.......... 2.8%
Change in the valuation allowance............ 52.8%
Goodwill amortization........................ 0.2%
Other........................................ 0.1%
-----
Effective tax rate...................... 89.9%
=====
At April 13, 1994 the Company had available $3,962,000 of net operating
loss carryforwards which expire in 2007. These carryforwards will be utilized
to reduce taxable income in subsequent years. The net operating losses were
generated prior to the acquisition of the Company and there are limitations on
the amounts that can be utilized to offset taxable income in a given year.
7. RETIREMENT PLANS
The Company maintains a non-qualified supplemental defined benefit pension
plan for certain retired employees. The amounts related to this plan are not
material.
The Company also maintains a qualified defined benefit pension plan for
certain union employees. Pension
F-30
54
SIMULATION, SYSTEMS & SERVICES TECHNOLOGIES COMPANY
(INCLUDING ITS IMMEDIATE PARENT MSHI, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
expense for this plan was $29,000 for the period from January 1, 1994 through
April 13, 1994.
The Company established a qualified defined contribution plan during the
first quarter of 1993, which covers substantially all employees, that complies
with Section 401(k) of the Internal Revenue Code. Under this plan, the
Company's stipulated basic matching contribution matches a portion of the
participants' contributions based upon a defined schedule. Contributions are
invested by an independent investment company in one or more of several
investment alternatives. The choice of investment alternatives is at the
election of each participating employee. The Company's contributions to the
plan were $63,000 for the period from January 1, 1994 through April 13, 1994.
8. RENT EXPENSE
Rent expense totaled $404,000 for the period from January 1, 1994 through
April 13, 1994. Rent expense is net of amortization of $167,000 for the period
ended April 13, 1994 for excess facility costs.
9. RELATED PARTY TRANSACTIONS
Corporate allocations for overhead and general and administrative expenses
were $145,000 for the period from January 1, 1994 through April 13, 1994.
10. GEOGRAPHIC AND MAJOR CUSTOMER INFORMATION
The Company earns a significant portion of its revenues from contracts
outside of the United States, although it has no foreign operations. Revenues
from these international sales are as follows (in thousands):
FOR THE PERIOD
JANUARY 1,
TO APRIL 13,
1994
--------------
Germany............................................ $2,247
Russia............................................. 714
Remaining Europe................................... 1,330
China.............................................. 28
South Korea........................................ 1,140
Taiwan............................................. 398
Remaining Asia..................................... 9
Other regions...................................... --
------
Total international revenues.................... $5,866
======
No customer accounted for 10% or more of revenues for the period January 1,
1994 through April 13, 1994.
11. FORMATION OF GSE SYSTEMS, INC.
On April 13, 1994, the parent companies of the Company, GP International
Engineering & Simulation, Inc., and EuroSim AB consolidated the operations of
these subsidiaries into a new company, GSE Systems, Inc.
F-31
55
REPORT OF INDEPENDENT ACCOUNTANTS
To The Board of Directors and Stockholder of
GP International Engineering & Simulation, Inc.
We have audited the statements of operations, stockholder's deficit
and cash flows of GP International Engineering & Simulation, Inc. (the
"Company"), formerly a wholly-owned subsidiary of GPS Technologies, Inc. (now
known as SGLG, Inc.), for the period January 1, 1994 through April 13, 1994.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the results of operations and cash flows of GP
International Engineering & Simulation, Inc. for the period January 1, 1994
through April 13, 1994, in conformity with generally accepted accounting
principles.
COOPERS & LYBRAND L.L.P.
Washington, D.C.
March 31, 1995
F-32
56
GP INTERNATIONAL ENGINEERING & SIMULATION INC.
(FORMERLY A WHOLLY-OWNED SUBSIDIARY OF GPS TECHNOLOGIES, INC.
(NOW KNOWN AS SGLG, INC.))
STATEMENTS OF OPERATIONS
(IN THOUSANDS)
FOR THE PERIOD
JANUARY 1,
THROUGH APRIL 13,
1994
-----------------
Contract revenue.................................................................... $ 3,642
Cost of revenue..................................................................... 2,905
-----
737
Operating expenses:
Selling, general and administrative......................................... 381
Depreciation and amortization............................................... 26
-----
407
---
330
Other expenses...................................................................... 3
-----
327
Provision for income taxes.......................................................... 121
-----
Net income ................................................................. $ 206
=====
The accompanying notes are an integral part of these financial statements.
F-33
57
GP INTERNATIONAL ENGINEERING & SIMULATION INC.
(FORMERLY A WHOLLY-OWNED SUBSIDIARY OF GPS TECHNOLOGY INC.
(NOW KNOWN AS SGLG, INC.))
STATEMENT OF STOCKHOLDER'S DEFICIT
(IN THOUSANDS)
COMMON ACCUMULATED
STOCK DEFICIT
------ -----------
Balance, December 31, 1993.................................................................... $ 1 $ (3,656)
Net income.................................................................................... -- 206
----- --------
Balance, April 13, 1994....................................................................... $ 1 $ (3,450)
===== ========
The accompanying notes are an integral part of these financial statements.
F-34
58
GP INTERNATIONAL ENGINEERING & SIMULATION INC.
(FORMERLY A WHOLLY-OWNED SUBSIDIARY OF GPS TECHNOLOGY INC.
(NOW KNOWN AS SGLG, INC.))
STATEMENT OF CASH FLOWS
(IN THOUSANDS)
FOR THE PERIOD
JANUARY 1,
THROUGH APRIL 13,
1994
-----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income ................................................................. $ 206
Adjustments to reconcile net income to net cash used in
operating activities:
Depreciation and amortization ......................................... 146
Change in assets and liabilities:
Contract receivables ................................................ (153)
Prepaid expenses and other .......................................... (9)
Accounts payable .................................................... 537
Accrued salaries and related expenses ............................... (168)
Billings in excess of revenue earned ................................ (893)
Accrued warranty reserves ........................................... 281
Accrued contract reserves ........................................... (146)
-----
Net cash used in operating activities ......................................... (199)
-----
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, equipment, and software ............................. (39)
-----
Net cash used in investing activities ......................................... (39)
-----
CASH FLOWS FROM FINANCING ACTIVITIES:
Due to GPS Technologies, Inc. .............................................. 225
-----
Net cash provided by financing activities ..................................... 225
-----
Net decrease in cash and cash equivalents ..................................... (13)
Cash and cash equivalents at beginning of period .............................. 13
-----
Cash and cash equivalents at end of period .................................... $ --
======
The accompanying notes are an integral part of these financial statements.
F-35
59
GP INTERNATIONAL ENGINEERING & SIMULATION INC.
(FORMERLY A WHOLLY-OWNED SUBSIDIARY OF GPS TECHNOLOGY INC.
(NOW KNOWN AS SGLG, INC.))
NOTES TO FINANCIAL STATEMENTS
1. BUSINESS
GP International Engineering & Simulation, Inc. ("GPI") is a designer,
developer and supplier of high fidelity real-time simulation software, systems
and services in the energy and manufacturing industries.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
The accompanying financial statements represents the accounts of GPI, a
wholly owned subsidiary of GPS Technologies, Inc. (hereinafter "GPS" and now
known as SGLG, Inc.), until April 13, 1994, at which time it became part of GSE
Systems, Inc. (See Note 8.)
The financial statements presented reflect allocations of costs of shared
facilities, overhead, general and administrative expenses and income taxes.
Such costs and expenses have been allocated to the Company based on actual
usages or other methods (i.e., proportional cost allocation method) that
approximate actual usage. Management believes that the allocation methods used
are reasonable and that allocated costs and expenses approximate what such
amounts would be if the Company had operated on a standalone basis.
Revenue recognition
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. Estimated contract earnings are reviewed and
revised periodically as the work progresses and the cumulative effect of any
change is recognized in the period in which the change is determined. Estimated
losses are charged against earnings in the period such losses are identified.
The remaining liability for contract costs to be incurred in excess of contract
revenue is reflected as accrued contract reserves in the Company's balance
sheet. Revenue from sales of other products is recorded when the products are
shipped. The Company has no significant vendor obligations or collectibility
risk associated with its product sales.
Software development amortization
Amortization of software development costs is computed using the
straight-line method over the estimated economic life of the product of five
years. Amortization expense was approximately $120,000 for the period January
1, 1994 through April 13, 1994.
F-36
60
GP INTERNATIONAL ENGINEERING & SIMULATION INC.
(FORMERLY A WHOLLY-OWNED SUBSIDIARY OF GPS TECHNOLOGY INC.
(NOW KNOWN AS SGLG, INC.))
NOTES TO FINANCIAL STATEMENTS
Research and development
Development expenditures incurred to meet customer specifications under
contracts accounted for under the percentage of completion method are charged
to contract costs. Company sponsored research and development expenditures are
charged to operations as incurred and are included in selling, general and
administrative expenses. The amounts incurred for research and development
activities relating to the development of new products and services or the
improvement of existing products and services were approximately $203,000 for
the period January 1, 1994 through April 13, 1994.
Warranties
As the Company recognizes revenue under the percentage of completion method,
it provides an accrual for estimated future warranty costs based on historical
and projected claims experience.
Income Taxes
The Company was included in the consolidated federal income tax return of
GPS. As such, the income and losses generated by the Company are used on an
annual basis to reduce the overall tax liability of the other members of the
consolidated group. The Company is reimbursed for the benefit provided to the
consolidated group. The Company files separate income tax returns in the state
jurisdictions in which it operates.
GPS allocates its federal consolidated tax provision (benefit) to its
subsidiaries based on each subsidiary's proportionate share of its income or
loss to the consolidated totals, after adjusting for each subsidiary's
permanent differences arising between financial and tax reporting basis. The
allocated tax provision (benefit) approximates the Company's tax provision
(benefit) had income taxes been calculated on a standalone basis. The resulting
income tax payable (or receivable) is recorded as an intercompany amount due to
(or from) GPS.
Concentration of credit risk
Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of contract receivables. Credit risk on
contract receivables is mitigated by the nature of the Company's worldwide
customer base and its credit policies. The Company's customers are not
concentrated in any specific geographic region, but are concentrated in the
energy and manufacturing industries. The Company performs credit evaluation
before extending credit and may require letters of credit, bank guarantees or
advance payments. Thereafter, the Company continues to monitor its contract
receivables exposure after giving effect to letters of credit, bank guarantees,
the status of the work performed on the contract, and its customer's financial
condition.
Off balance sheet risk and foreign exchange contracts
GPS has entered into forward exchange contracts on behalf of the Company.
Foreign exchange forward contracts are legal agreements between two parties to
purchase and sell a foreign currency for a price specified at the contract
date, with delivery and settlement in the future. The Company uses such
contracts to hedge risk of changes in foreign currency exchange rates
associated with certain assets, liabilities and firm future revenue commitments
denominated in foreign currency.
F-37
61
GP INTERNATIONAL ENGINEERING & SIMULATION INC.
(FORMERLY A WHOLLY-OWNED SUBSIDIARY OF GPS TECHNOLOGY INC.
(NOW KNOWN AS SGLG, INC.))
NOTES TO FINANCIAL STATEMENTS
3. DEPRECIATION EXPENSE
Depreciation expense for the period January 1, 1994 through April 13, 1994
was $26,000.
4. INCOME TAXES
The provisions (benefit) for income taxes were as follows (in thousands):
FOR THE PERIOD
JANUARY 1,
THROUGH APRIL 13,
1994
----
Current provision (benefit).............................................. $ (1)
Deferred provision (benefit)............................................. 122
---
$ 121
===
The provision for income taxes varies from the amount of income tax
determined by applying the applicable U.S. statutory tax rate to pre-tax income
as a result the following:
FOR THE PERIOD
JANUARY 1,
THROUGH APRIL 13,
1994
----
Statutory U.S. tax rate....................................................... 34.0%
State taxes, net of Federal benefit............................................ 2.7%
----
36.7%
====
At April 13, 1994, the Company had available $256,000 of net operating loss
carryforwards that will expire by 2008. These carryforwards will be utilized to
reduce taxable income in subsequent years.
5. RETIREMENT PLANS
The Company has a qualified defined contribution plan that covers
substantially all employees and complies with Section 401(k) of the Internal
Revenue Code. Under this plan, the Company's stipulated basic matching
contribution matches a portion of the participants' contributions based upon a
defined schedule. Contributions are invested by an independent investment
company in one or more of several investment alternatives. The choice of
investment alternatives is at the election of each participating employee. The
Company's contribution to the plan was $24,000 for the period January 1, 1994
through April 13, 1994.
F-38
62
GP INTERNATIONAL ENGINEERING & SIMULATION INC.
(FORMERLY A WHOLLY-OWNED SUBSIDIARY OF GPS TECHNOLOGY INC.
(NOW KNOWN AS SGLG, INC.))
NOTES TO FINANCIAL STATEMENTS
6. RELATED PARTY TRANSACTIONS
Corporate allocations for overhead and general and administrative expenses
were $244,000 the period January 1 through April 13, 1994.
7. GEOGRAPHIC AND MAJOR CUSTOMER INFORMATION
The Company earns a significant portion of its revenues from contracts
outside of the United States, although it has no foreign operations. Revenues
from these international sales were as follows (in thousands):
FOR THE PERIOD
JANUARY 1,
THROUGH APRIL 13,
1994
------------------
Taiwan.......................................................................... $ 57
Czech Republic.................................................................. 286
Great Britain................................................................... 642
Russia.......................................................................... 1,801
Other regions................................................................... 366
-----
Total international revenues $3,152
=====
The Company earned revenues of $642,000 from a customer for the period
January 1, 1994, through April 13, 1994. The Company earned revenues of
$1,741,000 from a second customer during the period January 1, 1994 through
April 13, 1994.
8. FORMATION OF GSE SYSTEMS, INC.
On April 13, 1994, the parent companies of the Company, Simulation, Systems
& Services Technologies Company and EuroSim AB consolidated the operations of
these subsidiaries into a new company, GSE Systems, Inc.
F-39
63
REPORT OF INDEPENDENT ACCOUNTANTS
To The Board of Director and Stockholder of
GSE Power Systems AB
We have audited the statements of operations, stockholder's equity and
cash flows of GSE Power Systems AB (formerly EuroSim AB) (the "Company"),
formerly a wholly-owned subsidiary of Vattenfall Engineering AB, for the
period from January 1, 1994 through April 13, 1994. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the results of operations and cash flows of GSE Power
Systems AB for the period from January 1, 1994 through April 13, 1994, in
conformity with accounting principles generally accepted in the United States.
COOPERS & LYBRAND
Stockholm, Sweden
April 21, 1995
F-40
64
EUROSIM AB
(FORMERLY A WHOLLY-OWNED SUBSIDIARY OF VATTENFALL ENGINEERING AB)
STATEMENT OF OPERATIONS
(IN THOUSANDS)
FOR THE PERIOD
JANUARY 1,
THROUGH APRIL 13,
1994
-----------------
Contract revenue....................................................... $1,597
Cost of revenue........................................................ 734
------
Gross profit....................................................... 863
------
Operating expenses:
Selling, general and administrative................................ 440
Depreciation and amortization...................................... 29
------
469
------
394
Interest Expense....................................................... 1
Other income........................................................... (43)
------
Income before income taxes......................................... 436
Provision for income taxes............................................. 122
------
Net income ........................................................ $ 314
======
The accompanying notes are an integral part of these financial statements.
F-41
65
EUROSIM AB
(FORMERLY A WHOLLY-OWNED SUBSIDIARY OF VATTENFALL ENGINEERING AB)
STATEMENT OF STOCKHOLDER'S EQUITY
(IN THOUSANDS)
ADDITIONAL FOREIGN
COMMON PAID-IN TRANSLATION RETAINED
STOCK CAPITAL ADJUSTMENT EARNINGS
-------- -------- ----------- ----------
Balance, December 31, 1993.................................... $ 175 $ 210 $ (96) $ 64
Net Income.................................................... -- -- -- 314
Translation adjustment........................................ -- -- 8 --
---- ---- ---- -----
Balance, April 13, 1994....................................... $ 175 $ 210 $ (88) $ 378
==== ==== ==== =====
The accompanying notes are an integral part of these financial statements.
F-42
66
EUROSIM AB
(FORMERLY A WHOLLY-OWNED SUBSIDIARY OF VATTENFALL ENGINEERING AB)
STATEMENT OF CASH FLOWS
(IN THOUSANDS)
FOR THE PERIOD
JANUARY 1,
THROUGH
APRIL 13, 1994
--------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ............................................................... $ 314
Adjustments to reconcile net income
to net cash provided by
operating activities:
Depreciation and amortization.......................................... 29
Change in assets and liabilities:
Contract receivables.......................................................... (577)
Prepaid expenses and other current assets..................................... 66
Accounts payable.............................................................. 158
Accrued expenses.............................................................. (25)
Income tax payable............................................................ 122
Billings in excess of revenue earned.......................................... 617
Accrued contract reserves..................................................... 381
------
Net cash provided by operating activities 1,085
------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment....................................... (36)
------
Net cash used in investing activities........................................ (36)
------
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease in amounts due to stockholder.................................... (1,287)
------
Net cash used in financing activities........................................ (1,287)
------
Effects of exchange rate on cash............................................. 8
------
Net decrease in cash and cash equivalents.................................... (230)
Cash and cash equivalents at beginning of period............................. 2,500
------
Cash and cash equivalents at end of period................................... $ 2,270
======
The accompanying notes are an integral part of these financial statements.
F-43
67
EUROSIM AB
(FORMERLY A WHOLLY-OWNED SUBSIDIARY OF VATTENFALL ENGINEERING AB)
NOTES TO FINANCIAL STATEMENTS
1. BUSINESS
EuroSim AB ("EuroSim" or the "Company") is a designer, developer and
supplier of high fidelity real-time simulation software, systems and services
for the energy and manufacturing industries.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
The accompanying financial statements represent the accounts of EuroSim.
EuroSim was a wholly-owned subsidiary of Vattenfall Engineering AB ("Vattenfall
Engineering") until April 13, 1994, at which time it became a wholly-owned
subsidiary of GSE Systems, Inc. (See Note 11.) Vattenfall Engineering was
wholly-owned by Vattenfall AB ("Vattenfall") and was absorbed by Vattenfall
effective January 1, 1995. Effective January 1, 1992, Vattenfall became a
government-owned Swedish corporation. Prior to January 1, 1992, Vattenfall was
a public entity governed by special public rules.
The Company was formed in 1990. The Company's records are maintained in
accordance with Swedish laws and reporting requirements. These financial
statements have been prepared in accordance with United States generally
accepted accounting principles ("U.S. GAAP") and have been translated into U.S.
dollars.
The financial statements presented reflect allocations of costs of services,
insurance and consulting fees for all periods presented. Such costs and
expenses have been allocated to the Company based on actual usage. Management
believes that the allocation methods used are reasonable and that allocated
costs and expenses approximate what such amounts would be if the Company had
operated on a stand-alone basis.
Foreign currency translation
The functional currency for the Company's operations is the Swedish krona.
The translation from Swedish krona to U.S. dollars is performed for the balance
sheet accounts using the exchange rates in effect at the balance sheet date and
for revenue and expense accounts using a weighted average exchange rate during
the period. The resulting translation adjustments are recorded directly into a
separate component of stockholder's equity.
Contributions to and from Vattenfall Engineering
The Company has given group contributions to Vattenfall Engineering during
1993. Group contributions are principally made to transfer taxable income from
one group entity with the objective of reducing the group's total current tax
expenses. These contributions lead to a taxable income for the recipient and a
taxable expense for the donor. The Company's annual current tax expense has
therefore been impacted by the group contributions. Since the contributions are
permanent differences for tax purposes, no deferred tax accounting related to
group contributions has been applied.
For Swedish statutory reporting purposes, group contributions are accounted
for as an appropriation in the statement of operations. This accounting
methodology is utilized primarily to obtain an agreement between a company's
financial statement income and taxable income. Group contributions are thus not
related to a company's operations. For U.S. GAAP purposes, group contributions
provided have been treated as a transfer from stockholder's equity.
F-44
68
EUROSIM AB
(FORMERLY A WHOLLY-OWNED SUBSIDIARY OF VATTENFALL ENGINEERING AB)
NOTES TO FINANCIAL STATEMENTS
Cash and cash equivalents
Cash and cash equivalents consist of cash on hand and short-term, highly
liquid investments with original maturity dates of less than three months at
the date of purchase.
Property and equipment
Property and equipment are recorded at cost and depreciated using the
straight-line method with estimated useful lives ranging from three to five
years. Upon sale or retirement, the cost and related accumulated depreciation
or amortization are eliminated from the respective accounts and any resulting
gain or loss is included in income. Maintenance and repairs are charged to
expense as incurred.
Revenue recognition
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. Estimated contract earnings are reviewed and
revised periodically as the work progresses and the cumulative effect of any
change is recognized in the period in which the change is determined. Estimated
losses are charged against earnings in the period such losses are identified.
The remaining liability for contract costs to be incurred in excess of contract
revenue is reflected as accrued contract reserves in the Company's balance
sheet. Revenue from sales of other products is recorded when the products are
shipped. The Company has no significant vendor obligations or collectibility
risk associated with its product sales.
Research and development
Company sponsored research and development expenditures under contracts
accounted for under the percentage of completion method are charged to
operations as incurred and are included in selling, general and administrative
expenses. The amounts incurred for Company sponsored research and development
activities relating to the development of new products and services or the
improvement of existing products and services were approximately $1,000 for the
period from January 1, 1994 through April 13, 1994.
Warranties
As the Company recognizes revenue under the percentage of completion method,
it provides an accrual for estimated future warranty costs based on historical
and projected claims experience.
Income taxes
Deferred income taxes are provided under the asset and liability method.
This method requires recognition of deferred tax liabilities and assets for the
expected future tax consequences of events that have been included in the
financial statements or tax returns. Under this method, deferred income taxes
are determined based on the difference between the financial statement and tax
basis of assets and liabilities using enacted tax rates in effect for the year
in which the differences are expected to reverse. Valuation allowances are
established when necessary to reduce deferred tax assets to the amounts
expected to be realized. Income tax expense consists of the Company's current
liability for income taxes and the change in the Company's deferred income tax
assets and liabilities.
F-45
69
EUROSIM AB
(FORMERLY A WHOLLY-OWNED SUBSIDIARY OF VATTENFALL ENGINEERING AB)
NOTES TO FINANCIAL STATEMENTS
Concentration of credit risk
Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of temporary cash investments and contract
receivables. The Company restricts investments of temporary cash to financial
institutions with high credit standing. Credit risk on contract receivables is
mitigated by its credit policies. The Company's customers are concentrated in
Japan and in the energy and manufacturing industries. The Company performs
credit evaluations before extending credit and may require letters of credit,
bank guarantees or advance payments. Thereafter, the Company continues to
monitor its contract receivables exposure after giving effect to letters of
credit, bank guarantees, the status of the work performed on the contract and
its customers' financial condition.
Off balance sheet risk and foreign exchange contracts
Vattenfall Engineering has entered into forward exchange contracts on behalf
of the Company as a hedge against certain foreign currency commitments. Forward
exchange contracts are legal agreements between two parties to purchase and
sell different currencies, for a price specified at the contract date, with
delivery and settlement in the future. The Company uses such contracts to hedge
risk of changes in currency exchange rates associated with certain assets,
liabilities and firm future revenue commitments denominated in a different
currency.
3. CONTRACT RECEIVABLES AND BILLINGS IN EXCESS OF REVENUE EARNED
Fixed-price contracts generated approximately 100% of total sales for the
period from January 1, 1994 through April 13, 1994.
4. DEPRECIATION EXPENSE
Depreciation expense for the period from January 1, 1994 through April 13,
1994 was $29,000.
5. INCOME TAXES
The provisions (benefit) for income taxes on pre-tax earnings were as
follows (in thousands):
FOR THE PERIOD
JANUARY 1,
THROUGH APRIL 13,
1994
------------------
Current tax expense (benefit)......................................... $ 122
Deferred tax expense (benefit)........................................ --
-----
$ 122
=====
F-46
70
EUROSIM AB
(FORMERLY A WHOLLY-OWNED SUBSIDIARY OF VATTENFALL ENGINEERING AB)
NOTES TO FINANCIAL STATEMENTS
The provision for income taxes varies from the amount of income tax
determined by applying the applicable domestic statutory tax rate to pre-tax
income as a result of the following:
FOR THE PERIOD
JANUARY 1,
THROUGH APRIL 13,
1994
-----------------
Statutory tax rate.................................................... 28%
Effective tax rate.................................................... 28%
===
Deferred income taxes arise from temporary differences between the tax basis
of assets and liabilities and their reported amounts in the financial
statements.
6. RETIREMENT PLANS
The Company employees are covered by compulsory and voluntary pension plans.
The amount paid by the Company was $18,000 for the period January 1, 1994 to
April 13, 1994.
7. RENT EXPENSE
Rent expense totaled $47,000 for the period from January 1, 1994 through
April 13, 1994.
8. RELATED PARTY TRANSACTIONS
The components of allocated expenses included in the Company's statement of
operations are as follows (in thousands):
FOR THE PERIOD
JANUARY 1,
THROUGH APRIL 13,
1994
-----------------
Overhead and general and administrative expenses.............................. $ 82
Interest income (expense), net................................................ 42
-----
Total $ 40
=====
9. RESTRICTION ON RETAINED EARNINGS
Under the provisions of the Swedish Companies Act a legal reserve must be
established in an amount equal to 20% of the share capital. This reserve is
established by appropriating 10% of the statutory net income each year until
the prescribed amount has been appropriated. The legal reserve may be used to
absorb deficit, but usually may not be distributed as dividends.
F-47
71
EUROSIM AB
(FORMERLY A WHOLLY-OWNED SUBSIDIARY OF VATTENFALL ENGINEERING AB)
NOTES TO FINANCIAL STATEMENTS
10. GEOGRAPHIC AND MAJOR CUSTOMER INFORMATION
The Company earns a significant portion of its revenue from contracts in
Japan, although it has no operations in that country. Revenues from these
Japanese contracts totaled $1,565,000 for the period January 1, 1994 through
April 13, 1994.
The Company earned revenues of $1,134,000 from one customer during the
period January 1 through April 13, 1994.
11. FORMATION OF GSE SYSTEMS, INC.
On April 13, 1994, the parent companies of the Company, Simulation, Systems
& Services Technologies Company and GP International Engineering & Simulation,
Inc. consolidated the operations of these subsidiaries into a new company, GSE
Systems, Inc.
F-48
72
GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
23
73
GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
PART III
The information required in response to Items 10, 11, 12 and 13 is hereby
incorporated by reference to the information under the captions "Election of
Directors", "Principal Executive Officers of the Company Who Are Not Also
Directors", "Executive Compensation", "Voting Securities and Principal
Stockholders", "Security Ownership of Management", and "Certain Related
Transactions" in the Proxy Statement for the Company's 1997 Annual Meeting of
Stockholders.
24
74
GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a)(1) List of Financial Statements
The following financial statements are included in item 8:
GSE SYSTEMS, INC. AND SUBSIDIARIES
Report of Independent Accountants
Consolidated Balance Sheets as of December 31, 1996 and 1995
Consolidated Statements of Operations for the years ended December 31, 1996
and 1995 and for the period April 14, 1994 through December 31, 1994
Consolidated Statements of Stockholders' Equity (Deficit) for the years ended
December 31, 1995 and 1996 and for the period April 14, 1994 through
December 31, 1994
Consolidated Statements of Cash Flows for the years ended December 31,
1996 and 1995 and the period April 14, 1994 through December 31, 1994
Notes to Consolidated Financial Statements
SIMULATION, SYSTEMS & SERVICES TECHNOLOGIES COMPANY AND MSHI, INC.
Report of Independent Accountants
Consolidated Statement of Operations for the period January 1, 1994 through
April 13, 1994
Consolidated Statement of Stockholder's Equity for the period January 1,
1994 through April 13, 1994
Consolidated Statement of Cash Flows for the period January 1, 1994 through
April 13, 1994
Notes to Consolidated Financial Statements
GP INTERNATIONAL ENGINEERING & SIMULATION, INC.
Report of Independent Accountants
Statement of Operations for the period January 1, 1994 through April 13,
1994
Statement of Stockholder's Deficit for the period January 1, 1994
through April 13, 1994
Statement of Cash Flows for the period January 1, 1994 through April 13,
1994
Notes to Financial Statements
EUROSIM AB
Report of Independent Accountants
Statement of Operations for the period January 1, 1994 through April 13,
1994
Statement of Stockholder's Equity for the period January 1, 1994 through
April 13, 1994
Statement of Cash Flows for the period January 1, 1994 through April 13, 1994
Notes to Financial Statements
(a)(2) List of Schedules
All other schedules to the consolidated financial statements are
omitted as the required information is either inapplicable or presented in the
consolidated financial statements or related notes.
(a)(3) List of Exhibits
The Exhibits which are filed with this report or which are
incorporated by reference are set forth in the Exhibit Index hereto.
(b) Reports on Form 8-K:
No reports on Form 8-K were filed during the quarter ended December
31, 1996.
25
75
GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
GSE Systems, Inc.
By: /s/ William E. Kuhlmann
--------------------------------
WILLIAM E. KUHLMANN
Chairman of the Board,
and Chief Executive Officer
Pursuant to the requirements of the Securities Act, this Registration Statement
has been signed by the following persons in the capacities and on the dates
indicated.
SIGNATURES TITLE DATE
---------- ----- ----
/s/ WILLIAM E. KUHLMANN Chairman of the Board and Chief Executive Officer
------------------------------------ (Principal Executive Officer)
WILLIAM E. KUHLMANN March 31, 1997
/s/ MICHAEL J. CROMWELL III Vice-Chairman of Board of and Senior Vice-President March 31, 1997
------------------------------------ (Principle Financial and Accounting Officer)
MICHAEL J. CROMWELL III
/s/ ROLF M.G. FALKENBERG Director and President March 31, 1997
------------------------------------
ROLF M.G. FALKENBERG
/s/ EUGENE D. LOVERIDGE Director and Senior Vice-President March 31, 1997
------------------------------------
EUGENE D. LOVERIDGE
/s/ LARS-GORAN MEJVIK Director and Senior Vice President March 31, 1997
------------------------------------
LARS-GORAN MEJVIK
26
76
GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
SIGNATURES TITLE DATE
---------- ----- ----
/s/ HANS I. EBENFELT Director March 31, 1997
----------------------------------
HANS I. EBENFELT
/s/ JEROME I. FELDMAN Director March 31, 1997
----------------------------------
JEROME I. FELDMAN
/s/ SHELDON L. GLASHOW Director March 31, 1997
----------------------------------
SHELDON L. GLASHOW
/s/ DAVID E. JEREMIAH Director March 31, 1997
----------------------------------
DAVID E. JEREMIAH
/s/ GEORGE J. PEDERSEN Director March 31, 1997
----------------------------------
GEORGE J. PEDERSEN
/s/ MARTIN M. POLLAK Director March 31, 1997
----------------------------------
MARTIN M. POLLAK
/s/ SYLVAN SCHEFLER Director March 31, 1997
----------------------------------
SYLVAN SCHEFLER
27
77
GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
EXHIBIT INDEX
The following exhibits are either filed herewith or have been filed with the
Securities and Exchange Commission and are referred to and incorporated by
reference.
EXHIBIT
NUMBER NOTE DESCRIPTION
------ ---- -----------
2.1 (5) Agreement and Plan of Reorganization dated as of May 17, 1996 by and among GSE Systems,
Inc., GSE Erudite Software, Inc., Erudite Software and Consulting, Inc., Eugene
Loveridge, Daniel Masterson, Douglas Austin, Gary Gray and Dennis Fairclough effective May 21, 1996.
2.2 (5) Agreement and Plan of Merger dated as of May 17, 1996 by and between Erudite Software and
Consulting, Inc. effective May 22, 1996.
3.1 (1) Second Amended and Restated Certificate of Incorporation of the Company
3.2 (2) Form of Amended and Restated Bylaws of the Company
4.1 (3) Specimen Common Stock Certificate of the Company
10.1 (1) Agreement among ManTech International Corporation, National Patent Development Corporation,
GPS Technologies, Inc., General Physics Corporation, Vattenfall Engineering AB and GSE Systems, Inc.
(dated as of April 13, 1994)
10.2 (1) Asset Purchase Agreement among Texas Instruments Incorporated, GSE Systems, Inc. and
GSE Process Solutions, Inc. concerning the Process Systems Business of Texas Instruments Incorporated
(dated as of December 28, 1994)
10.3 (3) Form of Employment Agreement between William E. Kuhlmann and GSE Systems, Inc.
10.4 (3) Form of Employment Agreement between Rolf M. G. Falkenberg and GSE Systems, Inc.
10.5 (3) Form of Employment Agreement between Robert W. Stroup and GSE Systems, Inc.
10.6 (3) Form of Employment Agreement between Chian-Li Jen and GSE Systems, Inc.
10.8 (6) GSE Systems, Inc. 1995 Long-Term Incentive Plan, as amended as of February 12, 1997.
10.9 (4) Form of Option Agreement Under the GSE Systems, Inc. 1995 Long-Term Incentive Plan
10.10 (2) Letter of Credit, Loan and Security Agreement among Maryland National Bank (now NationsBank, N.A.),
MSHI, Inc., and Simulation, Systems & Services Technologies Company (dated as of March 17, 1994 and
amended as of June 29, 1994 and April 27, 1995)
10.11 (2) Letter of Credit, Loan and Security Agreement among NationsBank, N.A., MSHI, Inc., and Simulation,
Systems & Services Technologies Company (dated as of September 29, 1994)
10.12 (2) Letter of Credit, Loan and Security Agreement between CoreStates Bank, N.A. and GSE Process
Solutions, Inc. (dated as of January 31, 1995)
10.13 (4) Amended and Restated Letter of Credit, Loan and Security Agreement between CoreStates Bank, N.A.
and GSE Process Solutions, Inc. (dated as of October 13, 1995 and as amended as of February 23, 1996)
10.14 (4) Letter of Credit, Loan and Security Agreement among CoreStates Bank, N.A., MSHI, Inc., and Simulation,
Systems & Services Technologies Company (dated as of January 30, 1996)
10.15 (1) Amended and Restated Lease Agreement between CCP Development Limited Partnership No. 7 and Simulation,
Systems & Services Technologies Company (dated as of January 27, 1993)
28
78
GSE SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
EXHIBIT
NUMBER DESCRIPTION
------ -----------
10.16 (5) Employment Agreement dated as of May 17, 1996 by and between GSE Systems, Inc. and Eugene Loveridge
effective May 22, 1996
10.17 (5) Employment Agreement dated as of May 17, 1996 by and between GSE Systems, Inc. and Daniel Masterson
effective May 22, 1996
10.18 (6) Employment Agreement dated as of May 2, 1996 by and between EuroSim AB and Lars-Goran Mejvik effective
July 1, 1996.
11.1 (6) Statement regarding computation of earnings per share
21.1 (6) Subsidiaries of Registrant
23.1 (6) Consent of Independent Accountants
24.1 (6) Power of Attorney for Directors' and Officers' Signatures on SEC Form 10-K
99.1 (3) Form of Right of First Refusal Agreement
(1) Previously filed in connection with the GSE Systems, Inc. Form S-1
Registration Statement as filed with the Securities and Exchange
Commission on April 24, 1995 and incorporated herein by reference.
(2) Previously filed in connection with Amendment No. 1 to the GSE Systems,
Inc. Form S-1 Registration Statement as filed with the Securities and
Exchange Commission on June 14, 1995 and incorporated herein by reference.
(3) Previously filed in connection with Amendment No. 3 to the GSE Systems,
Inc. Form S-1 Registration Statement as filed with the Securities and
Exchange Commission on July 24, 1995 and incorporated herein by reference.
(4) Previously filed in connection with the GSE Systems, Inc. Form 10-K as
filed with the Securities and Exchange Commission on March 22, 1996 and
incorporated herein by reference.
(5) Previously filed in connection with the GSE Systems, Inc. Forms 8-K and
8-K-A as filed with the Securities and Exchange Commission on June 5, 1996
and June 13, 1996, respectively, and incorporated herein by reference.
(6) Filed herewith.
29