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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of The Securities Exchange
Act of 1934
For the fiscal year ended December 31, 2004
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 1-7234
GP STRATEGIES CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 13-1926739
(State of Incorporation) (I.R.S. Employer Identification No.)
777 Westchester Avenue, White Plains, NY 10604
(Address of principal executive offices) (Zip Code)
(914) 249-9700
Registrant's telephone number, including area code:
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of each exchange on which registered:
------------------- ------------------------------------------
Common Stock, $.01 par value New York Stock Exchange, Inc.
Securities registered pursuant to Section 12(g) of the Act: None
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.
Indicate by check mark whether the registrant is an accelerated filer.
Yes X No
----- -----
The aggregate market value of the outstanding shares of the Registrant's Common
Stock, par value $.01 per share and Class B Capital Stock, par value $.01 per
share held by non-affiliates as of June 30, 2004 was approximately $83,228,000.
The number of shares outstanding of each of the Registrant's Common Stock and
Class B Stock as of March 10, 2005:
Class Outstanding
----- -----------
Common Stock, par value $.01 per share 16,736,262 shares
Class B Capital Stock, par value $.01 per share 1,200,000 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement for its 2005 Annual
Meeting of Stockholders are incorporated herein by reference into Part III
hereof.
PAGE
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PART I
Item 1. Business 3
Item 2. Properties 17
Item 3. Legal Proceedings 18
Item 4. Submission of Matters to a Vote of Security Holders 19
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters 20
Item 6. Selected Financial Data 22
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 23
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 37
Item 8. Financial Statements and Supplementary Data 38
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 91
Item 9A. Controls and Procedures
Item 9B. Other Information 91
PART III
Item 10. Directors and Executive Officers of the Registrant * 92
Item 11. Executive Compensation * 92
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters* 92
Item 13. Certain Relationships and Related Transactions* 92
Item 14. Principal Accountant Fees and Services* 92
PART IV
Item 15. Exhibits and Financial Statement Schedules 92
SIGNATURES 94
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS 95
EXHIBIT INDEX 96
* To be incorporated by reference from the proxy statement for the
Registrant's 2004 and 2005 Annual Meeting of Shareholders.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
The forward-looking statements contained herein reflect GP Strategies'
management's current views with respect to future events and financial
performance. We use words such as "expects", "intends" and "anticipates" to
indicate forward-looking statements. These forward-looking statements are
subject to certain risks and uncertainties that could cause actual results to
differ materially from those in the forward-looking statements, all of which are
difficult to predict and many of which are beyond the control of GP Strategies,
including, but not limited to, our inability to generate funds by selling any
assets that were included in the spin-off, our holding company structure,
failure to continue to attract and retain personnel, loss of business from
significant customers, failure to keep pace with technology, changing economic
conditions, competition, our ability to implement procedures that will reduce
the likelihood that material weaknesses in internal control over financial
reporting will not occur in the future, and those other risks and uncertainties
detailed in GP Strategies' periodic reports and registration statements filed
with the Securities and Exchange Commission.
If any one or more of these expectations and assumptions proves incorrect,
actual results will likely differ materially from those contemplated by the
forward-looking statements. Even if all of the foregoing assumptions and
expectations prove correct, actual results may still differ materially from
those expressed in the forward-looking statements as a result of factors we may
not anticipate or that may be beyond our control. While we cannot assess the
future impact that any of these differences could have on our business,
financial condition, results of operations and cash flows or the market price of
shares of our common stock, the differences could be significant. We do not
undertake to update any forward-looking statements made by us.
PART I
ITEM 1: BUSINESS
GENERAL DEVELOPMENT OF BUSINESS
GP Strategies Corporation ("the Company" or "we") was incorporated in Delaware
in 1959. The Company is a New York Stock Exchange listed company traded under
the symbol GPX.
Prior to November 24, 2004 the Company had five operating business segments:
Manufacturing & Process, Information Technology, Simulation, Optical Plastics
and Home Improvement Distribution. On November 24, 2004, we completed the
distribution, which we refer to as the "spin-off," of the common stock of
National Patent Development Corporation ("NPDC"), which comprised our Optical
Plastics and Home Improvement Distribution segments and certain other non-core
assets. In the spin-off, holders of record on November 18, 2004 of the Company's
common stock and Class B capital stock received one share of NPDC common stock
for each share of the Company's common stock or Class B capital stock owned.
Shares of NPDC common stock are quoted on the OTC Bulletin Board under the
symbol "NPDV.OB." Shares of the Company's common stock will continue to be
listed on The New York Stock Exchange under the symbol "GPX." The Company
obtained a tax ruling from the Internal Revenue Service to the effect that the
spin-off was tax-free for U.S. federal income tax purposes to the Company and
its stockholders under Sections 355 and 368(a) of the Internal Revenue Code. We
continue to own and operate our majority owned subsidiary, GSE Systems Inc.
("GSE"), formerly the Simulation segment; and our wholly owned subsidiary,
General Physics Corporation ("General Physics"), comprised of our former
Manufacturing & Process and Information Technology
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segments. We reorganized our Manufacturing & Process and Information Technology
segments into the new General Physics segment because we monitor and operate the
General Physics subsidiary as a single business and reporting unit.
Subsequent to the spin-off, we have reclassified the operations of NPDC as
discontinued in our consolidated financial statements for all periods presented.
The business description below of the Company is as it exists after the
spin-off.
General Physics is a workforce development company that improves the
effectiveness of organizations by providing training, management consulting,
e-Learning solutions and engineering services that are customized to meet the
specific needs of clients. Additional information about General Physics may be
found at www.gpworldwide.com.
GSE develops and delivers business and technology solutions by applying
simulation software, systems and services to the energy, process and
manufacturing industries worldwide. Additional information about GSE may be
found at www.gses.com
Company Information Available on the Internet
The Company's internet address is www.gpstrategies.com. The Company makes
available free of charge through its internet site, its annual reports on Form
10-K; quarterly reports on Form 10-Q; current reports on Form 8-K; and any
amendment to those reports filed or furnished pursuant to the Securities
Exchange Act of 1934, or the "Exchange Act," as soon as reasonably practicable
after such material is electronically filed with, or furnished to, the U.S.
Securities and Exchange Commission.
GENERAL PHYSICS CORPORATION
Organization and Operations
General Physics provides performance improvement services and products to
multinational companies in manufacturing and process industries, electric power
utilities and other commercial and governmental customers. General Physics is a
global leader in performance improvement, with over three decades of experience
in providing solutions to optimize workforce performance. Since its
incorporation in 1966, General Physics has provided clients with the products
and services they need to successfully integrate their people, processes and
technology. General Physics' instructional delivery capabilities include
traditional classroom, structured on-the-job training (OJT), just-in-time
methods, electronic performance support systems (EPSS) and the full spectrum of
e-learning technologies. For businesses, government agencies and other
organizations, General Physics offers services and products spanning the entire
lifecycle of production facilities. General Physics' products and services
include plant, equipment and process launch assistance; operations and
maintenance practice training and consulting services; curriculum development
and delivery; facility and enterprise change and configuration management; lean
enterprise consulting; plant and process engineering review and re-design;
business continuity planning and support services; alternative fuels engineering
consulting, facility design and construction services; business process
outsourcing; training outsourcing; e-learning hosting, consulting and systems
implementation; and development and delivery of information technology (IT)
training on an enterprise-wide scale. General Physics' personnel bring a wide
variety of professional, technical and military backgrounds together to create
cost-effective solutions for modern business and governmental challenges.
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General Physics provides services and sells products within a structure that is
integrated both vertically and horizontally. Vertically, General Physics is
organized into Strategic Business Units (SBUs), Business Units (BUs) and Groups
focused on providing a wide range of products and services to clients and
prospective clients predominantly within targeted markets. Horizontally, General
Physics is organized across SBUs, BUs and Groups to integrate similar service
lines, technology, information, work products, client management and other
resources. Communications and market research, accounting, finance, legal, human
resources, information systems and other administrative services are organized
at the corporate level. Business development and sales resources are aligned
with operating units to support existing customer accounts and new customer
development.
General Physics provides technology-based training, engineering, consulting and
technical services to leading companies in the automotive, steel, power, oil and
gas, chemical, energy, electronics and semiconductor, pharmaceutical and food
and beverage industries, as well as to the government sector, and focuses on
developing long-term relationships with Fortune 500 companies, their suppliers
and government agencies. Through this segment General Physics provides training,
Business Process Outsource (BPO), training outsourcing, IT applications training
and courseware development, engineering and technical support services to
clients, whether involving workforce development, product/process/ plant launch,
modification of existing facilities and systems or regulatory compliance.
General Physics frequently supports the introduction of new work practices
associated with lean manufacturing, self-directed work teams and engineering.
Adult learning delivery capabilities include traditional classroom, structured
on-the-job training (OJT), just in time methods, and the full spectrum of
e-Learning technologies. General Physics e-Learning services, which enable it to
function as a single-source e-learning solution provider through its integration
services and hosting, the development and provisioning of proprietary content
and the aggregation and distribution of third party content.
General Physics Products and Services
Training. General Physics' provides training services and products to support
existing, as well as the launch of new, plants, products, equipment,
technologies and processes. The range of services includes fundamental analysis
of a client's training needs, curriculum design, instructional material
development (in hard copy, electronic/software or other format), information
technology service support and delivery of training using an instructor-led,
on-the-job, computer-based, web-based, video-based or other technology-based
method. General Physics has available an existing curriculum of business and
technical courses and also is involved in the management of the training
business operations for several of its customers. Training products include
instructor and student training manuals, instructional materials on CD-ROM and
PC-based simulators.
Consulting. Consulting services include not only training-related consulting
services, but also more traditional business management, engineering and other
disciplines. General Physics is able to provide high-level lean enterprise
consulting services, as well as training in the concept, methods and application
of lean enterprise and other quality practices, organizational development and
change management. General Physics also provides engineering consulting services
to support regulatory and environmental compliance, modification of facilities
and processes, plant performance improvement, reliability-centered maintenance
practices and plant start-up activities. Consulting services also include
operations continuity assessment, planning, training and procedure development.
Consulting products include copyrighted training and reference materials.
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Technical Support and Engineering. General Physics is staffed and equipped to
provide engineering and technical support services and products to clients.
General Physics has civil, mechanical and electrical engineers who provide
consulting, design and evaluation services regarding facilities, process and
systems. General Physics believes that it is a leader in the design and
construction of alternative fuel stations, cryogenic systems and high pressure
systems. Technical support services include procedure writing and configuration
control for capital intensive facilities, plant start-up assistance, logistics
support (e.g., inventory management and control), implementation and engineering
assistance for facility or process modifications, facility management for high
technology training environments, staff augmentation and help-desk support for
standard and customized client desktop applications. Technical support products
include General Physics' proprietary EtaPRO(TM) and Virtual Plant software
applications.
Contracts
General Physics is currently performing under time-and-materials, fixed-price
and cost-reimbursable contracts. General Physics' contracts with the United
States Government have predominantly been cost-reimbursable contracts and
fixed-price contracts. General Physics is required to comply with Federal
Acquisition Regulations and Government Cost Accounting Standards with respect to
services provided to the United States Government and agencies thereof. These
Regulations and Standards govern the procurement of goods and services by the
United States Government and the nature of costs that can be charged with
respect to such goods and services. All such contracts are subject to audit by a
designated government audit agency, which in most cases is the Defense Contract
Audit Agency (the DCAA). The DCAA has audited General Physics' contracts through
2001 without any material disallowances.
The following table illustrates the percentage of total revenue of General
Physics attributable to each type of contract for the year ended December 31,
2004:
Fixed-price 70%
Time and materials, including fixed rate 18%
Cost-reimbursable 12%
---
Total revenue 100%
===
General Physics' fixed-price contracts provide for payment to General Physics of
pre-determined amounts as compensation for the delivery of specific products or
services, without regard to the actual cost incurred by General Physics. General
Physics bears the risk that increased or unexpected costs required to perform
the specified services may reduce General Physics' profit or cause General
Physics to sustain a loss, but General Physics has the opportunity to derive
increased profit if the costs required to perform the specified services are
less than expected. Fixed-price contracts generally permit the client to
terminate the contract on written notice; in the event of such termination,
General Physics would typically, at a minimum, be paid a proportionate amount of
the fixed price.
6
General Physics' time-and-materials contracts generally provide for billing of
services based upon the hourly billing rates of the employees performing the
services and the actual expenses incurred multiplied by a specified mark-up
factor up to a certain aggregate dollar amount. General Physics'
time-and-materials contracts include certain contracts under which General
Physics has agreed to provide training, engineering and technical services at
fixed hourly rates (subject to adjustment for labor costs). Time-and-materials
contracts generally permit the client to control the amount, type and timing of
the services to be performed by General Physics and to terminate the contract on
written notice. If a contract is terminated, General Physics typically is paid
for the services provided by it through the date of termination.
General Physics' cost-reimbursable contracts provide for General Physics to be
reimbursed for its actual direct and indirect costs plus a specified fee. These
contracts also are generally subject to termination at the convenience of the
client. If a contract is terminated, General Physics typically would be
reimbursed for its costs to the date of termination, plus the cost of an orderly
termination and paid a proportionate amount of the fee.
No significant terminations of General Physics' contracts have occurred over the
last five years.
International
General Physics conducts its business outside the United States and Canada
primarily through its wholly-owned subsidiaries General Physics (UK) Ltd.,
General Physics Corporation Mexico, S.A. de C.V., General Physics Asia, Pte.
Ltd. and General Physics (Malaysia) Sdn Bhd. Through these companies, General
Physics is capable of providing substantially the same services and products as
are available to clients in the United States, although modified as appropriate
to address the language, business practices and cultural factors unique to each
client and country. In combination with its subsidiaries, General Physics is
able to coordinate the delivery to multi-national clients of services and
products that achieve consistency on a global, enterprise-wide basis.
GSE
GSE is a world leader in real-time power plant simulation. GSE provides
simulation solutions and services to the nuclear and fossil electric utility
industry, as well as process industries such as the chemical and petrochemical
industries. In addition, GSE provides plant monitoring, security access and
control and signal analysis monitoring and optimization software primarily to
the power industry.
Prior to September 25, 2003, GSE also had a process automation and control
business. The automation products of this business unit optimized batch and
hybrid plant control for the specialty chemical, food and beverage and
pharmaceutical industries. On September 25, 2003, GSE completed the sale of
substantially all of the assets of this business to Novatech, LLC. GSE is
currently comprised of three divisions: Power Simulation, Process Simulation and
Emergency Management Simulation.
GSE is positioning itself to take advantage of emerging trends in the power
industry. The operating licenses for numerous nuclear power plants will expire
over the next several years. Fourteen plants have already received license
extensions and sixteen more have applications pending. Many plants are also
planning significant upgrades to the physical equipment and control room
technology in conjunction with the license extensions. Both will result in the
need to modify or replace the existing plant control
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room simulators. GSE, having the largest installed base of existing simulators,
is well positioned to capture the majority of this business.
To address the varying levels of technology that exists across GSE's installed
base, GSE has developed a Java-based graphical overlay technology called JADE
(Java Application Development Environment). JADE provides a common look and feel
to GSE's various simulation tools regardless of whether the underlying
technology is UNIX, LINUX or Microsoft Windows XP. JADE also works with all of
GSE's tools for building electrical, logic and control and flow system models
for plants.
GSE continues to focus on the fossil power segment of the power industry.
Several fossil plant simulator projects were awarded in 2004, expanding GSE's
presence in the market and establishing key strategic relationships with power
industry DCS providers. GSE expects continued growth in this market segment and
is focusing on second time simulation buyers that now demand the more
sophisticated and realistic simulation models offered by GSE. Sales and
marketing resources have been expanded for the fossil power industry.
While GSE simulators are primarily utilized for power plant operator training,
the uses are expanding to include engineering analysis, plant modification
studies and operation efficiency improvements for both nuclear and fossil
utilities. During plant construction, simulators are used to test control
strategies and ensure on-time start-up. After commissioning, the same tools can
be used to increase plant availability and optimize plant performance for the
life of the facility. In 2004, GSE demonstrated its ability to link its
simulation models to plant optimization tools of third parties to provide a
unique and broad based optimization solution. GSE and its partners will be
bringing these new products to market in 2005.
GSE has targeted the Process simulation business as an area with a significant
potential for growth. The process industries, particularly oil and gas and
chemical, are expanding worldwide and are faced with the challenges of
performance improvement at existing facilities and training of personnel to
staff new and upgraded facilities. GSE's SimSuite Pro product and experience in
the process industries provide GSE with excellent capabilities to service these
needs. Dedicated sales and marketing resources have been assigned to Process
simulation to facilitate this initiative.
In 2004, GSE continued to expand the sale of its plant optimization tools based
on advanced signal analysis technology. GSE's Pegasus Plant Surveillance and
Diagnosis System helps improve plant availability, safety and economy. Pegasus
is a software package for semi-automatic plant surveillance and diagnostics and
enables site engineers to perform detailed analysis for specified component
faults, allowing the identification of degraded performance and replacement of
components before they fail. SensBase provides comprehensive sensor test
services, thus ensuring that changes in transmitters and other instruments do
not jeopardize the function of the nuclear plant protection systems. BRUS, a
noise analysis program package, is a collection of signal analysis tools which
allow users to detect developing abnormalities in the plant. GSE's worldwide
reputation for boiling water reactor stability training lead to an increase in
sales of both stability training courses and GSE's SIMON Stability Monitoring
equipment. GSE has been very successful in selling this technology to European
and Asian customers and is investigating its viability in the US market.
The acquisition by the Company of controlling interest in GSE has led to further
cooperation between General Physics and GSE. In addition to cooperating in the
marketing of individual products, the companies have combined some of General
Physics' extensive training materials and programs with
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GSE's power plant simulation models to provide truly interactive and adaptive
total training solutions. Cooperative marketing activities between General
Physics and GSE are intended to enable GSE to extend simulation capabilities
into industries beyond Power and Process and to expand the range of products and
services offered to customers.
In 2003, GSE began to aggressively market its access control and intrusion
detection system to the nuclear and process industries, however, the market has
been slow to develop. The nuclear industry security focus has been on investing
in technology to detect the approach of intruders farther away from the plant
perimeter. As a result, much of the anticipated sales of GSE's GAARDS system
have failed to materialize. At the end of 2003, GSE made the decision to reduce
its investment in this market segment until the market rebounds.
In lieu of pursuing physical security system projects, GSE has turned its
attention to opportunities for simulation in disaster recovery and terrorist
threat response. In 2003, GSE modified its simulation technology to simulate the
operation of Emergency Operations Centers (EOC) run by municipal and state
governments. REMITS is a Real-time Emergency Management Interactive Training
System designed to simulate emergency situations and enable EOC staffs to train
without requiring human participation in the field. REMITS enables the EOC staff
to stay current with the technology and enables instructors to introduce new
problems and challenges during the exercise to test the EOC staff response to
changing situations. As the Federal Government spends billions in first
responder training, GSE believes its REMITS product will find a large market in
the developing field of training for disaster recovery and terrorist threat
response.
CUSTOMERS
General Physics currently provides services to approximately 500 customers.
Significant customers include multinational automotive manufacturers, such as
General Motors Corporation, Ford Motor Company, Mercedes-Benz and Daimler
Chrysler Corporation; commercial electric power utilities, such as Bruce Power,
L.P., First Energy, Consolidated Edison Company of New York, Public Service
Electric & Gas Company and Entergy Operations, Inc.; governmental agencies, such
as the U.S. Department of Defense, U.S. Department of Treasury, Office of
Personnel Management, the U.S. Department of Homeland Security, and U.S. Social
Security Administration; U.S. government prime contractors, such as
Northrop-Grumman, Washington Group International, and Lockheed Martin; and other
large multinational companies, such as Texas Instruments, Merck & Co., Eli Lilly
& Co, IBM Corporation, United Technologies Corporation, Anheuser-Busch Company,
Siemens Dematic Corporation, Agilent Technologies, Inc, and Gerdau Ameristeel
Corporation. Revenue from the United States Government accounted for
approximately 38% of General Physics' revenue for the year ended December 31,
2004. Revenue was derived from many separate contracts and subcontracts with a
variety of Government agencies and contractors that are regarded by General
Physics as separate customers. In 2004, revenue from the Department of the Army,
which is included in United States Government revenue, accounted for
approximately 19% of General Physics' revenue. No other customer accounted for
more than 10% of General Physics' revenue in 2004.
GSE has provided approximately 200 simulation systems to an installed base of
over 75 customers worldwide. GSE's largest customer (Batelle's Pacific Northwest
National Laboratory, a purchasing agent for the U.S. Department of Energy and
the numerous projects GSE performs in Eastern and Central Europe) accounted for
approximately 24% and 29%, respectively, of its revenue in 2004 and
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2003. In 2004, approximately 65% of GSE revenue was generated from customers
outside the United States.
EMPLOYEES
At December 31, 2004, the Company and its subsidiaries employed 1,449 persons,
including 10 in the Company's headquarters, 1,295 at General Physics and 144 at
GSE.
General Physics' principal resource is its personnel. General Physics' future
success depends to a significant degree upon its ability to continue to attract,
retain and integrate into its operations instructors, engineers, technical
personnel and consultants who possess the skills and experience required to meet
the needs of its clients. As of December 31, 2004, General Physics employed
1,295 employees and over 100 adjunct instructors.
General Physics utilizes a variety of methods to attract and retain personnel.
General Physics believes that the compensation and benefits offered to its
employees are competitive with the compensation and benefits available from
other organizations with which it competes for personnel. In addition, General
Physics maintains the professional development of its employees, both internally
via General Physics University (its own internal training resource) and through
third parties, and also offers tuition reimbursement for job-related educational
costs. General Physics believes its relations with its employees are good.
GSE employs a highly educated and experienced multinational workforce of 144
employees, including approximately 80 engineers and scientists. Approximately
60% of these engineers and scientists have advanced science and technical
degrees in fields such as chemical, mechanical and electrical engineering,
applied mathematics and computer sciences. GSE believes its employees offer a
competitive advantage that enhances its position to compete in the Simulation
markets.
COMPETITION
General Physics' services and products face a highly competitive environment.
The principal competitive factors are the experience and capability of service
personnel, performance, quality and functionality of products, reputation and
price. Consulting services such as those provided by General Physics are
performed by many of the customers themselves, large architectural and
engineering firms that have expanded their range of services beyond design and
construction activities, large consulting firms, information technology
companies, major suppliers of equipment, degree-granting colleges and
universities, vocational and technical training schools, continuing education
programs, small privately held training providers and individuals and
independent service companies similar to General Physics. The training industry
is highly fragmented and competitive, with low barriers to entry and no single
competitor accounting for a significant market share. Some of General Physics'
competitors offer services and products that are similar to those of General
Physics at lower prices, and some competitors have significantly greater
financial, managerial, technical, marketing and other resources than does
General Physics. There can be no assurance that General Physics will be
successful against such competition.
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The Power Simulation business encounters intense competition. In the nuclear
simulation market, GSE competes directly with larger firms primarily from Canada
and Germany, such as Canadian Aerospace & Electronics (CAE) and STN Atlas. The
fossil simulation market is represented by smaller companies in the U.S. and
overseas. Several of GSE's competitors have greater capital and other resources
than it has, including, among other advantages, more personnel and greater
marketing, financial, technical and research and development capabilities.
Customer purchasing decisions are generally based upon price, the quality of the
technology, experience in related projects and the financial stability of the
supplier. GSE's competitors in Process Simulation include major corporations
offering a wide range of products and services that include operator training
simulators, companies focused on Process Technology and manufacturing
enhancement, companies with specific industry niches that enables them to
compete in operator training simulation and smaller training companies that
compete at the lower cost levels of Computer Based Training (CBT) or simple
simulations close to CBT. GSE's competition in Emergency Management Simulation
is unclear at this time.
MARKETING
General Physics has approximately 40 employees dedicated primarily to marketing
its services and products. General Physics uses attendance at trade shows,
presentations of technical papers at industry and trade association conferences,
press releases, public courses and workshops given by General Physics personnel
to serve an important marketing function. General Physics also does selective
advertising and sends a variety of sales literature to current and prospective
clients. By staying in contact with clients and looking for opportunities to
provide further services, General Physics sometimes obtains contract awards or
extensions without having to undergo competitive bidding. In other cases,
clients request General Physics to bid competitively. In both cases, General
Physics submits proposals to the client for evaluation. The period between
submission of a proposal to final award can range from 30 days or less
(generally for non-competitive, short-term contracts), to a year or more
(generally for large, competitive multi-year contracts with governmental
clients).
GSE markets its Power Simulation products and services through a network of
direct sales staff, agents and representatives, systems integrators and
strategic alliance partners. A direct sales force is employed in the continental
United States. Market-oriented business and customer development teams define
and implement specific campaigns to pursue opportunities in the power
marketplace. GSE's ability to support its multi-facility, international and/or
multinational Power Simulation clients is facilitated by its network of offices
and strategic partners in the U.S. and overseas. Power Simulation offices are
maintained in Maryland and Georgia, and outside the U.S. in Sweden, China and
Japan. GSE markets its Process Simulation technologies through a combination of
techniques including its existing direct sales channel, sales agents and
strategic alliance partners. GSE markets its product in the U.S. Homeland
Security industry through the existing sales channels of General Physics and
foreign markets through existing power simulation partners and agents.
BACKLOG
General Physics' backlog for services under signed contracts and subcontracts as
of December 31, 2004 was approximately $105.2 million compared to $74.9 million
as of December 31, 2003. General Physics anticipates that most of its backlog as
of December 31, 2004 will be recognized as revenue during fiscal year 2005,
however, the rate at which services are performed under certain contracts, and
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thus the rate at which backlog will be recognized, is at the discretion of the
client and most contracts are, as mentioned above, subject to termination by the
client upon written notice.
As of December 31, 2004, GSE's aggregate contract backlog totaled approximately
$19.4 million, down from a backlog of $30.4 million as of December 31, 2003.
Approximately $13.3 million or 69% of the backlog is expected to be converted to
revenue by December 31, 2005.
INSURANCE
By providing services to the commercial electric power industry, in the area of
alternative fuel construction management and to the United States Armed Forces,
the Company is engaged in industries in which there are substantial risks of
potential liability. The Company maintains a consolidated insurance program
(including general liability coverage) and claims made by any covered insured
will reduce the amount of available insurance for the other insureds. In
addition, certain liabilities associated with the Company's business are not
covered by these insurance policies. In addition, such liabilities may not be
covered by Federal legislation providing a liability protection system for
licensees of the Nuclear Regulatory Commission (typically utilities) for certain
damages caused by nuclear incidents, since the Company is not such a licensee.
Finally, few of the Company's contracts with clients contain a waiver or
limitation of liability. Thus, to the extent a risk is neither insured nor
indemnified against nor limited by an enforceable waiver or limitation of
liability, the Company could be materially adversely affected by a nuclear
incident. Certain other environmental risks, such as liability under the
Comprehensive Environmental Response, Compensation and Liability Act, as amended
(Superfund), also may not be covered by the Company's insurance.
ENVIRONMENTAL STATUTES AND REGULATIONS
General Physics provides environmental engineering services to its clients,
including the development and management of site environmental remediation
plans. Due to the increasingly strict requirements imposed by Federal, state and
local environmental laws and regulations (including, without limitation, the
Clean Water Act, the Clean Air Act, Superfund, the Resource Conservation and
Recovery Act and the Occupational Safety and Health Act), General Physics'
opportunities to provide such services may increase.
General Physics' activities in connection with providing environmental
engineering services may also subject General Physics itself to such Federal,
state and local environmental laws and regulations. Although General Physics
subcontracts most remediation construction activities and all removal and
offsite disposal and treatment of hazardous substances, General Physics could
still be held liable for clean-up or violations of such laws as an "operator" or
otherwise under such Federal, state and local environmental laws and regulations
with respect to a site where it has provided environmental engineering and
support services. General Physics believes, however, that it is in compliance in
all material respects with such environmental laws and regulations.
The nuclear power industry is associated with a number of hazards which could
create significant liabilities for GSE. GSE's business could expose it to third
party claims with respect to product, environmental and other similar
liabilities. Although GSE has sought to protect itself from these potential
liabilities through a variety of legal and contractual provisions as well as
through liability insurance, the effectiveness of such protections has not been
fully tested. The failure or malfunction of
12
one of GSE's systems or devices could create potential liability for substantial
monetary damages and environmental cleanup costs. Such damages or claims could
exceed the applicable coverage of their insurance. Although management has no
knowledge of material liability claims against GSE to date, such potential
future claims could have a material adverse effect on their business or
financial condition.
FACTORS AFFECTING OUR FUTURE PERFORMANCE
Set forth below and elsewhere in this report and in other documents the Company
files with the Securities and Exchange Commission are risks and uncertainties
that could cause the Company's actual results to differ materially from the
results contemplated by the forward-looking statements contained in this report
and other public statements the Company makes.
Our holding company structure could adversely affect our ability to pay our
expenses.
Our principal operations are conducted through our General Physics subsidiary.
General Physics' credit agreement currently limits its ability to dividend or
pay funds to us, which could adversely affect our ability to pay our expenses.
We recently identified material weaknesses in our internal controls over
financial reporting, and in our disclosure controls and procedures, and cannot
assure you that we will not find further such weaknesses.
Section 404 of the Sarbanes-Oxley Act of 2002 requires us to conduct an annual
review and evaluation of our internal control of financial reporting and to
include a report on, and an attestation by our independent registered public
accountants, KPMG LLP, of, the effectiveness of these controls, beginning in
this Annual Report on Form 10-K for the fiscal year ending December 31, 2004. On
November 30, 2004, the Securities and Exchange Commission issued an exemptive
order under which certain companies are permitted to delay, for up to 45 days
after the due date of their Annual Report on Form 10-K, the filing of the
internal control report and the related attestation of the independent
registered public accountants. We qualify under the provisions of this exemptive
order for such 45-day delay. In reliance on this exemptive order, this Annual
Report on Form 10-K does not include the internal control report or related
attestation, which we plan to file by amendment prior to the expiration of the
45-day extension.
We are currently performing our assessment of the effectiveness of our internal
control over financial reporting as of December 31, 2004, and have devoted
considerable resources to this effort. In the course of this assessment, we have
identified certain material weaknesses in our internal control over financial
reporting. These material weaknesses arose from deficiencies with respect to our
accounting for income taxes and with respect to the preparation and review of
certain consolidated financial statement footnote disclosures. See Item 9A,
Controls and Procedures.
We are in the process of remediating these deficiencies. In addition, we have
not yet completed this assessment, and cannot assure you that additional
deficiencies or weaknesses in our controls and procedures will not be
identified. The material weaknesses already identified, as well as any other
weaknesses or deficiencies, could harm our business and operating results,
result in adverse publicity and a loss in investor confidence in our financial
reports, which in turn could have an adverse effect on our stock price, and, if
they are not properly remediated, could adversely affect our ability to report
our financial results on a timely and accurate basis.
Failure to continue to attract and retain qualified personnel could harm our
business.
Our principal resource is our personnel. A significant portion of our revenue is
derived from services and products that are delivered by instructors, engineers,
technical personnel and consultants. Our success depends upon our ability to
continue to attract and retain instructors, engineers, technical personnel and
consultants who possess the skills and experience required to meet the needs of
our clients. In order to initiate and develop client relationships and execute
our growth strategy, we must maintain and continue to hire qualified
salespeople. We must also continue to attract and develop capable management
personnel to guide our business and supervise the use of our resources.
Competition for qualified personnel can be intense. We cannot assure you that
qualified personnel will continue to be available to us. Any failure to attract
or retain qualified instructors, engineers, technical personnel, consultants,
salespeople and managers in sufficient numbers could adversely affect our
business and financial condition.
The loss of our key personnel, including our executive management team, could
harm our business.
Our success is largely dependent upon the experience and continued services of
our executive management team and our other key personnel. The loss of one or
more of our key personnel and a failure to attract or promote suitable
replacements for them may adversely affect our business.
13
Our revenue and financial condition could be adversely affected by the loss of
business from significant customers.
For the years ended December 31, 2002, 2003 and the 2004, revenue from the
United States Government represented approximately 32%, 32% and 37% of our
revenue, respectively. However, the revenue was derived from a number of
separate contracts and subcontracts with a variety of government agencies and
contractors we regard as separate customers. Most of our contracts and
subcontracts are subject to termination on written notice, and therefore our
operations are dependent on our clients' continued satisfaction with our
services and their continued inability or unwillingness to perform those
services themselves or to engage other third parties to deliver such services.
Failure to keep pace with technology and changing market needs could harm our
business.
Traditionally, most of our training and performance improvement services and
products have been delivered through instructors, written materials or video.
Our future success will depend upon our ability to gain expertise in
technological advances rapidly and respond quickly to evolving industry trends
and client needs. We intend to deliver many of our training and development
services and products, including some services and products previously delivered
in "traditional" formats, via interactive multimedia software, such as CD-ROM,
and distance-based media, such as video conferencing, intranets and the
Internet. We cannot assure you that we will be successful in adapting to
advances in technology, addressing client needs on a timely basis, or marketing
our services and products in multimedia software and distance-based media
formats. In addition, services and products delivered in the newer formats may
not provide comparable training results. Furthermore, subsequent technological
advances may render moot any successful expansion of the methods of delivering
our services and products. If we are unable to develop new means of delivering
our services and products due to capital, personnel, technological or other
constraints, our business and financial condition could be adversely affected.
Our business and financial condition could be adversely affected by government
limitations on contractor profitability and the possibility of cost
disallowance.
A significant portion of our revenue and profit is derived from contracts and
subcontracts with the United States Government. The United States Government
places limitations on contractor profitability; therefore, government related
contracts may have lower profit margins than the contracts we enter into with
commercial customers. Furthermore, United States Government contracts and
subcontracts are subject to audit by a designated government agency. Although we
have not experienced any material cost disallowances as a result of these
audits, we may be subject to material disallowances in the future.
Changing economic conditions in the United States or the United Kingdom could
harm our business and financial condition.
Our revenues and profitability are related to general levels of economic
activity and employment in the United States and the United Kingdom. As a
result, any significant economic downturn or recession in one or both of those
countries could harm our business and financial condition. A significant portion
of our revenues is derived from Fortune 1000-level companies and their
international equivalents, which historically have adjusted expenditures for
external training during economic downturns. If the economies in which these
companies operate weaken in any future period, these companies may not
14
increase or may reduce their expenditures on external training, which could
adversely affect our business and financial condition.
Our financial results are subject to quarterly fluctuations.
We experience, and expect to continue to experience, fluctuations in quarterly
operating results. Consequently, you should not deem our results for any
particular quarter to be necessarily indicative of future results. These
fluctuations in our quarterly operating results may vary because of, among other
things, the overall level of performance improvement services and products sold,
the gain or loss of material clients, the timing, structure and magnitude of
acquisitions, the commencement or completion of client engagements or custom
services and products in a particular quarter, and the general level of economic
activity. To the extent they are unexpected, downward fluctuations may result in
a decline in the trading price of our Common Stock.
Competition could adversely affect our performance.
The training industry is highly fragmented and competitive, with low barriers to
entry and no single competitor accounting for a significant market share. Our
competitors include several large publicly traded and privately held companies,
vocational and technical training schools, degree-granting colleges and
universities, continuing education programs and thousands of small privately
held training providers and individuals. In addition, many of our clients
maintain internal training departments. Some of our competitors offer similar
services and products at lower prices, and some competitors have significantly
greater financial, managerial, technical, marketing and other resources.
Moreover, we expect to face additional competition from new entrants into the
training and performance improvement market due, in part, to the evolving nature
of the market and the relatively low barriers to entry.
Our history of net losses could cause us to need additional capital.
While we had income from continuing operations of $22.4 million for the year
ended December 31, 2004, for the years ended December 31, 2001, 2002 and 2003,
we experienced net looses of, $945,000, $5,228,000 and $8,276,000, respectively.
If such net losses recur, we will need additional capital to fund our
operations. If adequate funds are not available it may have a negative impact on
our ability to conduct our operations at optimal levels.
We are subject to potential environmental liabilities and liabilities associated
with nuclear incidents.
We provide services that could subject us to significant environmental, third
party and professional liability. If we were found to have been negligent or to
have breached our obligations to our clients, we could be exposed to significant
fines and penalties and third-party liabilities and our reputation could be
adversely affected. The Company maintains a consolidated insurance program
(including general liability coverage) and claims made by any covered insured
will reduce the amount of available insurance for the other insureds. Although
we believe that we currently have appropriate insurance coverage, we may not be
able to obtain appropriate coverage on a cost-effective basis in the future. In
addition, we do not presently have coverage for all of the risks to which we are
subject. For example, liabilities associated with nuclear incidents may not be
covered by our insurance policies, or by indemnification provisions contained in
agreements with clients. In addition, because we are not a licensee, these
liabilities may not be covered by federal legislation providing liability
protection for licensees of the Nuclear Regulatory Commission, typically
utilities, for some damages caused by
15
nuclear incidents. Finally, few of our contracts with clients contain a waiver
or limitation of liability. A nuclear incident could adversely affect our
business and financial condition.
We also provide environmental engineering services to our clients, including the
development and management of site environmental remediation plans. Although we
subcontract most remediation construction activities, and in all cases
subcontract the removal and off-site disposal and treatment of hazardous
substances, we could be subject to liability relating to the environmental
services we perform directly or through subcontracts. Specifically, if we were
deemed under federal and state legislation, including "Superfund" legislation,
to be an "operator" of sites to which we provide environmental engineering and
support services, we could be subject to liabilities. Our insurance policies may
not provide coverage for these risks. Various mechanisms exist whereby the
United States Government may limit liability for environmental claims and losses
or indemnify us for such claims or losses under governmental contracts.
Nonetheless, incurrence of any substantial "Superfund" or other environmental
liability could adversely affect our business and financial condition.
We do not anticipate paying cash dividends on our Common Stock.
We do not, in the foreseeable future, anticipate paying any cash dividends on
our Common Stock.
Our Chief Executive Officer and directors can exercise significant influence
over GP Strategies.
The holder of a share of our Common Stock is entitled to one vote per share and
the holder of a share of our Class B capital stock is entitled to ten votes per
share. As of March 10, 2005, Jerome I. Feldman, our Chairman and Chief Executive
Officer, beneficially owned shares of Common Stock and Class B capital stock
constituting approximately 20% of our voting stock; Harvey Eisen, one of our
directors, beneficially owned shares of Common Stock and Class B capital stock
constituting approximately 18% of our voting stock; and EGI-Fund (02-04)
Investors, L.L.C., which has designated Mathew Zell to be one of our directors,
beneficially owns shares of Common Stock and Class B capital stock constituting
15% of our voting stock. Messrs. Feldman and Eisen and EGI will be able to
influence our management and affairs and all matters requiring stockholder
approval, including the election of directors and approval of significant
corporate transactions. This concentration of ownership may have the effect of
delaying, discouraging or preventing a change in control and might affect the
market price of our Common Stock.
Our stockholder rights plan and authorized preferred stock could make a
third-party acquisition of us difficult.
We have a stockholder rights plan. Our stockholder rights plan would cause
substantial dilution to any person or group that attempts to acquire us on terms
not approved in advance by our Board of Directors. In addition, our certificate
of incorporation allows us to issue up to 5,000,000 shares of preferred stock,
the rights, preferences, qualifications, limitations and restrictions of which
may be fixed by the Board of Directors without any further vote or action by the
stockholders. The stockholder rights plan, the ability to issue preferred stock
and certain provisions in our by-laws may have the effect of delaying,
discouraging or preventing a change in control and might affect the market price
of our Common Stock.
Our certificate of incorporation may discourage foreign ownership of our Common
Stock.
16
The United States Departments of Energy and Defense have policies regarding
foreign ownership, control or influence over government contractors who have
access to classified information, and inquire as to whether any foreign interest
has beneficial ownership of 5% or more of a contractor's or subcontractor's
voting securities. If either Department determines that an undue risk to the
common defense and security of the United States exists, it may, among other
things, terminate the contractor's or subcontractor's existing contracts. Our
certificate of incorporation allows us to redeem or require the prompt
disposition of all or any portion of the shares of our Common Stock owned by a
foreign stockholder beneficially owning 5% or more of the outstanding shares of
our Common Stock if either Department threatens termination of any of our
contracts as a result of such an ownership interest. These provisions may have
the additional effect of delaying, discouraging or preventing a change in
control and might affect the market price of our Common Stock.
FINANCIAL INFORMATION
For financial information about segments and geographic operations and revenue,
see note 15 to notes to Consolidated Financial Statements. Foreign operations
and export sales represent less than 10% of the Company's revenue.
ITEM 2: PROPERTIES
The following information describes the material physical properties owned or
leased by the Company and its subsidiaries.
The Company leases approximately 10,000 square feet of space for its White
Plains, New York principal executive offices. General Physics leases
approximately 30,700 square feet in an office building in Elkridge, Maryland and
approximately 172,000 square feet of office, classroom and warehouse space at
various other locations throughout the United States, the United Kingdom,
Canada, Mexico and Malaysia.
GSE is headquartered in an approximately 53,000 square feet facility in
Columbia, Maryland which also houses their support functions. In addition, GSE
leases office space domestically in Georgia and internationally in China, Japan
and Sweden. GSE leases these facilities for terms ending between 2005 and 2008.
The facilities owned or leased by the Company are considered to be suitable and
adequate for their intended uses and are considered to be well maintained and in
good condition.
ITEM 3: LEGAL PROCEEDINGS
On January 3, 2001, the Company commenced an action alleging that MCI
Communications Corporation, ("MCI') MCI's Systemhouse subsidiaries
("Systemhouse"), and Electronic Data Systems Corporation, as successor to
Systemhouse, ("EDS") committed fraud in connection with the Company's 1998
acquisition of Learning Technologies from the defendants for $24.3 million. The
Company seeks actual damages in the amount of $117.9 million plus interest,
punitive damages in an amount to be determined at trial, and costs. Such damages
are subject to reduction by the amount recovered in the arbitration described
below.
The complaint, which is pending in the New York State Supreme Court, alleges
that the defendants fraudulently induced the Company to acquire Learning
Technologies by concealing the poor
17
performance of Learning Technologies' United Kingdom operation. The complaint
also alleges that the defendants represented that Learning Technologies would
continue to receive new business from Systemhouse even though the defendants
knew that the sale of Systemhouse to EDS was imminent and that such new business
would cease after such sale. In February 2001, the defendants filed answers
denying liability. No counterclaims against the plaintiffs have been asserted.
Although discovery had not yet been completed, defendants made a motion for
summary judgment, which was submitted in April 2002. The motion was denied by
the court due to the MCI bankruptcy described below, but with leave to the other
defendants to renew, as described below.
The defendants other than MCI then made an application to the court to stay the
fraud action until a later-commenced arbitration, alleging breach of the
acquisition agreement and of a separate agreement to refer business to General
Physics on a preferred provider basis and seeking actual damages in the amount
of $17.6 million plus interest, is concluded. In a decision dated May 9, 2003,
the court granted the motion and stayed the fraud action pending the outcome of
the arbitration.
The arbitration hearings began on May 17, 2004 and concluded on May 24, 2004
before JAMS, a private dispute resolution firm. On September 10, 2004, the
arbitrator issued an interim award in which she found that the sellers of
Learning Technologies breached certain representations and warranties contained
in the acquisition agreement. In a final award dated November 29, 2004, the
arbitrator awarded General Physics $12.3 million in damages and $6.0 million in
interest. EDS made a payment of $18.4 million, which includes an additional $0.1
million of accrued interest, to General Physics in December 2004 to satisfy its
obligation under the arbitration award. The Company recognized a gain on
arbitration settlement, net of legal fees and expenses, of $13.7 million in
2004. EDS subsequently agreed that the arbitration award is final and binding
and that it will take no steps of any kind to vacate or otherwise challenge the
award.
As a result of the conclusion of the arbitration, the state court has lifted the
stay of the fraud claim against EDS. The Company is now proceeding with the
fraud claim against EDS. On February 14, 2005, EDS filed a new motion for
summary judgment dismissing the Company's fraud claim. The Company must respond
to the motion by March 17, 2005. The motion is currently scheduled for argument
on April 4, 2005.
The fraud action against MCI had been stayed as a result of the bankruptcy of
MCI. In February 2004, the Bankruptcy Court lifted the stay so that the state
court could rule on the merits of MCI's summary judgment motion. MCI has stated
that it intends to ask the Bankruptcy Court to reinstate the stay.
In connection with the spin-off of NPDC by the Company, which occurred on
November 24, 2004, the Company agreed to make an additional capital contribution
to NPDC in an amount equal to the first $5 million of any proceeds (net of
litigation expenses and taxes incurred, if any), and 50% of any proceeds (net of
litigation expenses and taxes incurred, if any) in excess of $15 million,
received with respect to the foregoing arbitration and litigation claims.
Pursuant to such agreement, in January 2005, the Company has made a $5 million
additional capital contribution to NPDC from the proceeds of the arbitration
award. After payment of such additional capital contribution and legal fees, the
net proceeds retained by General Physics are $8.5 million. A portion of such net
proceeds was used in January 2005 to reduce to zero the outstanding balance of
General Physics' revolving credit facility.
18
The Company is not a party to any legal proceeding, the outcome of which is
believed by management to have a reasonable likelihood of having a material
adverse effect upon the financial condition and operating results of the
Company.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
19
PART II
ITEM 5: MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock, $.01 par value, is traded on the New York Stock
Exchange. The following table presents its high and low market prices for the
last two fiscal years. During the periods presented below, the Company has not
paid any dividends.
2004
-------------
QUARTER HIGH LOW
- ---------- ----- -----
First $7.93 $6.29
Second 7.60 6.27
Third 7.45 6.05
Fourth (1) 8.95 6.64
2003
-------------
QUARTER HIGH LOW
- ---------- ----- -----
First $5.30 $4.72
Second 6.60 4.62
Third 7.44 5.90
Fourth 8.00 7.01
(1) On November 24, 2004, the Company distributed 100% of the common stock of
NPDC to the Company's shareholders on record date of November 18, 2004.
Holders of recorded received one share of NPDC common stock for each share
of GP Strategies common stock or Class B capital stock owned. The closing
price of the NPDC stock was $1.00 per share on November 24, 2004.
The number of shareholders of record of the Common Stock as of March 10, 2005
was 1,282 and the closing price of the Common Stock on the New York Stock
Exchange on that date was $8.02.
The Company has not declared or paid any cash dividends on its Common Stock
during the two most recent fiscal years. The Company currently intends to retain
future earnings to finance the growth and development of its business. In
addition, the General Physics Credit Agreement (see Item 7 below) contains
restrictive covenants, including a prohibition on the payment of dividends.
General Physics is currently restricted from paying dividends or management fees
to the Company in excess of $1.0 million in any fiscal year.
20
Equity Compensation Plan information as of December 31, 2004
GP STRATEGIES
NON-QUALIFIED CORPORATION'S
STOCK OPTION 2003 INCENTIVE
PLAN STOCK PLAN
------------- --------------
Plan category:
Equity compensation plans not approved by security holders:
(A) Number of securities to be issued upon exercise
of outstanding options (1) 1,821,829
(B) Weighted average exercise price of outstanding
options (1) $ 4.73
(C) Number of securities remaining available for future
issuance under equity compensation plans
(excluding securities reflected in row (a)) (2) 1,366,299
Equity compensation plans approved by security holders:
(A) Number of securities to be issued upon exercise
of outstanding options, warrants and rights --
(B) Weighted average exercise price of outstanding
options, warrants and rights $ --
(C) Number of securities remaining available for future
issuance under equity compensation plans 2,000,000
(1) Does not include warrants to purchase 300,000 shares of Common Stock issued
to a financial consulting firm at an exercise price of $3.21 per share and
warrants to purchase 937,500 shares issued and sold to four Gabelli funds
in conjunction with the 6% Conditional Subordinated Notes due 2008 at an
exercise price of $6.14 per share.
(2) Does not include shares of Common Stock that may be issued to directors of
the Company as director's fees.
For a description of the material terms of the Company's Non-Qualified Stock
Option Plan and the Company's 2003 Incentive Stock Plan, see note 14 to the
notes to the Consolidated Financial Statements.
Directors of the Company who are not employees of the Company or its
subsidiaries receive an annual fee of $10,000, payable quarterly. At the option
of each director up to one-half of the annual fee could be paid in Common Stock.
In addition, the directors receive $1,500 for each meeting of the Board of
Directors attended, and generally do not receive any additional compensation for
service on the committees of the Board of Directors other than the Audit
Committee. Employees of the Company or its subsidiaries do not receive
additional compensation for serving as directors.
21
ITEM 6: SELECTED CONSOLIDATED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
The selected financial data presented below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our consolidated financial statements and the notes thereto
included elsewhere in this report. Our consolidated statement of operations data
for the years ended December 31, 2004, 2003, and 2002 and our consolidated
balance sheet data as of December 31, 2004 and 2003 have been derived from our
audited consolidated financial statements included elsewhere in this report
which have been audited by KPMG LLP, whose report is included elsewhere in this
report. Our statement of operations data for the years ended December 31, 2001
and 2000 and our balance sheet data as of December 31, 2002, 2001, and 2000 have
been derived from unaudited consolidated financial statements, which are not
presented in this report.
On November 24, 2004, we completed the spin-off of NPDC. The results of
operations of NPDC have been reclassified as discontinued operations in the
consolidated statements of operations for all periods presented.
YEARS ENDED DECEMBER 31,
----------------------------------------------------
(in thousands, except per share amounts) 2004 2003 2002 2001 2000
-------- -------- -------- -------- --------
Revenue $193,973 $140,034 $142,237 $175,422 $186,452
Gross profit 25,963 17,095 15,366 20,332 17,633
Gain from arbitration settlement, net 13,660 -- -- -- --
Interest expense 2,113 3,123 2,467 4,418 5,559
Income (loss) from continuing operations before taxes
and minority interests 14,424 (7,186) (4,799) 3,937 (33,611)
Income (loss) from continuing operations 22,445 (8,111) (4,504) 428 (25,012)
Income (loss) from discontinued operations, net of taxes 75 (165) (724) (1,373) (380)
Net income (loss) 22,520 (8,276) (5,228) (945) (25,392)
Diluted income (loss) per share:
Income (loss) from continuing operations $ 1.23 $ (0.47) $ (0.29) $ 0.04 $ (2.01)
Income (loss) from discontinued operations -- (0.01) (0.05) (0.13) (0.03)
Net income (loss) 1.23 (0.48) (0.34) (0.09) (2.04)
DECEMBER 31,
----------------------------------------------------
BALANCE SHEET DATA (1) 2004 2003 2002 2001 2000
- ---------------------- -------- -------- -------- -------- --------
Cash and cash equivalents $ 2,417 $ 4,416 $ 1,516 $ 1,705 $ 11,317
Short-term borrowings 6,068 26,521 22,058 32,338 36,162
Working capital (deficit) 20,601 17,998 780 (2,750) 1,834
Total assets 156,035 188,323 144,905 160,824 212,578
Long-term debt 11,051 14,861 6,912 6,863 17,612
Stockholders' equity 91,620 92,812 92,982 95,943 112,518
(1) On November 24, 2004, the Company distributed net assets of $26.0 million
to NPDC in connection with its spin-off.
22
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS:
RESULTS OF OPERATIONS
General Overview
The Company's primary operating entity is General Physics, a global workforce
development company that improves the effectiveness of organizations by
providing training, management consulting, e-Learning solutions and engineering
services that are customized to meet the specific needs of clients. Clients
include Fortune 500 companies, manufacturing, process and energy companies and
other commercial and governmental customers.
The Company's other operating entity is its majority owned subsidiary, GSE
Systems Inc. ("GSE"), which was formerly called the Simulation segment. GSE is a
world leader in real-time high fidelity simulation technology and model
development and provides simulation solutions and services to the power
generation industry, the process industries, and the U.S. Government sector. In
addition, GSE provides plant monitoring and signal analysis monitoring and
optimization software primarily to the power industry, and develops specialized
software applications for emerging technologies.
Prior to November 24, 2004 the Company had five operating business segments:
Manufacturing & Process, Information Technology, Simulation, Optical Plastics
and Home Improvement Distribution. On November 24, 2004, we completed the
distribution, which we refer to as the "spin-off," of the common stock of
National Patent Development Corporation ("NPDC"), which comprised our Optical
Plastics and Home Improvement Distribution segments and certain other non-core
assets. We reorganized the Manufacturing & Process and Information Technology
segments into the General Physics segment. Effective with the spin-off, the
operations of NPDC were reclassified as discontinued operations for all periods
presented.
General Physics Overview
General Physics provides performance improvement services and products to
multinational companies in manufacturing and process industries, electric power
utilities and other commercial and governmental customers. General Physics is a
global leader in performance improvement, with over three decades of experience
in providing solutions to optimize workforce performance.
In 2004 General Physics showed a significant increase in profit, and continued
to post improved revenue results. The improvement in performance is primarily
attributable to the company's key initiatives; business process outsourcing and
training, e-Learning; and Domestic Preparedness and Emergency Management. The
company experienced growth in the last two years across each of these areas
contributing to the improved revenue and profit margins. General Physics plans
to continue to focus on growth in these areas in 2005. General Physics also
experienced an improvement in the training market in 2004.
On December 30, 2004, EDS made a payment of $18.4 million, which included $0.1
million of accrued interest, to General Physics to satisfy its obligation under
the arbitration award regarding the Learning Technologies acquisition. General
Physics recognized a gain on arbitration settlement, net of legal fees and
expenses, of $13.7 million in 2004. The net cash proceeds to General Physics was
approximately
23
$8.5 million after legal fees and a $5.0 million distribution to NPDC. On
January 6, 2005, General Physics used a portion of the proceeds to fully pay off
its $6.1 million of short term borrowings outstanding under the Credit Agreement
as of December 31, 2004. General Physics has no plans for any significant
capital expenditures in 2005, and expects the amounts generated from cash and
operations and cash available for borrowing under its Credit Agreement of
approximately $20.0 million, to be sufficient to finance it's ongoing
operations.
GSE Overview
GSE is a world leader in real-time power plant simulation. GSE provides
simulation solutions and services to the nuclear and fossil electric utility
industry, as well as process industries such as the chemical and petrochemical
industries. In addition, GSE provides plant monitoring, security access and
control and signal analysis monitoring and optimization software primarily to
the power industry.
GSE enters 2005 with no bank debt and only $9,000 of other notes payable.
However, GSE's backlog has decreased 36% in 2004, and GSE is investing heavily
in business development activities to expand its simulation business into the
Homeland Security and US Military industries. GSE's business is substantially
dependent on sales to the nuclear power industry (85% of revenue in 2004).
Spending by companies in this targeted industry is subject to period-to-period
fluctuations as a consequence of industry cycles, economic conditions, political
and regulatory environments and other factors; GSE's efforts to expand its
simulation business into the Homeland Security and US Military industries may
not generate sufficient revenues and margins in 2005 to offset the increased
business development spending; GSE relies on one customer, Battelle's Pacific
Northwest National Laboratory (24% of revenue in 2004) for a substantial portion
of its revenues. The loss of this customer would have a material adverse effect
upon GSE's results. Sales of products and the provision of services to end users
outside the United States accounted for approximately 65% of GSE's revenue in
2004. Thus, GSE is subject to risks associated with the application and
imposition of protective legislation and regulations relating to import or
export or otherwise resulting from trade or foreign policy.
Spin-off of National Patent Development Corporation
In July 2002, the Company's Board of Directors approved a spin-off of certain of
its non-core assets into a separate corporation, NPDC, leaving the Company's
business comprised of its training and workforce development business operated
by General Physics and the GSE simulation business. The separation of these
businesses was accomplished through a pro-rata distribution (the Distribution)
of 100% of the outstanding common stock of NPDC to the Company's stockholders on
the record date of the Distribution. NPDC is a stand-alone public company owning
all of the stock of MXL, the interest in Five Star and certain other non-core
assets. Following the spin-off, the Company ceased to have any ownership
interest in NPDC.
On March 21, 2003, the Internal Revenue Service issued a favorable tax ruling,
which enabled the Distribution to be tax-free. In the spin-off, holders of
record on November 18, 2004 of GP Strategies common stock and Class B capital
stock on November 24, 2004 received one share of NPDC common stock for each
share of GP Strategies common stock or Class B capital stock owned.
The spin-off is expected to result in several benefits to the Company and its
shareholders. By engaging in the spin-off, the Company believes that it will
improve its access to capital and significantly improve
24
its borrowing capacity, thereby facilitating its ability to raise additional
funds as well as achieving other corporate benefits. Having two separate public
companies will enable financial markets to better evaluate each company more
effectively, thereby enhancing stockholder value over the long term and making
the stock more attractive as currency for future acquisitions.
In accordance with Statement of Financial Accounting Standards (SFAS) No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS 144),
discontinued businesses are removed from the results of continuing operations
and are classified as discontinued operations in the consolidated statements of
operations. The following table sets forth the components of income (loss) from
discontinued operations for the period from January 1, 2004 to November 24, 2004
and for the fiscal years ended December 31, 2003 and 2002 (in thousands):
2004 2003 2002
-------- ------- ------
Revenue $104,067 $28,644 $9,996
Operating income (loss) 1,594 (189) 286
Interest expense (1,108) (502) (303)
Income taxes (expense) benefit (333) 99 524
Income (loss) from discontinued operations, net
of income taxes 75 (165) (724)
The results of the discontinued operations for 2004 include the results of Five
Star, which were consolidated with the Company effective October 8, 2003, when
the Company increased its ownership interest to 54%. Previously the Company
accounted for its investment in Five Star under the equity method (see note 6 to
the consolidated financial statements). In accordance with SFAS No. 144, only
those overhead costs that are solely attributable to the discontinued business
segments have been allocated to discontinued operations. As a result, 2004, 2003
and 2002 include overhead expenses that were incurred for the benefit of both
our continuing and discontinued operations, which are included in continuing
operations. Consolidated interest expense in periods prior to the spin-off has
been allocated to discontinued operations using a basis of net assets of each of
the continuing and discontinued business segments as of November 24, 2004.
25
The assets and liabilities distributed to NPDC in connection with the spin-off
included those specific to MXL, Five Star and certain other non-core assets. The
following table summarizes the net assets and liabilities distributed to NPDC on
November 24, 2004 (in thousands):
Assets:
Cash and cash equivalents $ 2,453
Due from GP Strategies (arbitration award) 5,000
Accounts and other receivables 14,002
Inventories 25,691
Prepaid expenses and other current assets 391
Investments and marketable securities 1,593
Property, plant and equipment, net 5,553
Deferred tax assets, net 4,045
Goodwill and other assets 2,818
-------
Total assets 61,546
-------
Liabilities:
Accounts payable and accrued expenses 12,672
Short-term borrowings 18,330
Long-term debt 2,961
Minority interest and other liabilities 1,616
-------
Total liabilities 35,579
-------
Net assets distributed to NPDC $25,967
=======
Operating Highlights
YEAR ENDED DECEMBER 31, 2004 COMPARED TO THE YEAR ENDED DECEMBER 31, 2003
Revenue
YEARS ENDED DECEMBER 31,
------------------------
(Dollars in Thousands) 2004 2003
-------- --------
General Physics $165,066 $133,975
GSE 28,907 6,059
-------- --------
$193,973 $140,034
======== ========
26
Revenue of General Physics increased by $31.1 million from 2003 to 2004
primarily due to increases in revenue from the organization's government
training, business process outsource and e-Learning businesses. Contract awards
continued to increase in 2004 for government training and domestic preparedness
services. The business process outsource organization received new contracts
from both government and commercial clients at the end of 2003 and in 2004 to
provide outsourced training management services. The e-Learning organization was
awarded several new contracts in 2004 with the U.S. government to provide
hosting and learning management systems integration services. The segment also
experienced a revenue increase of approximately $5.4 million in 2004 related to
hurricane relief services provided in the State of Florida. The Company does not
anticipate that these services will be a continuing stream of revenue going
forward. The overall increase in revenue was offset by a continued decline in
training-related revenue with certain automotive clients.
Revenue of GSE increased by $22.8 million from 2003 to 2004 primarily
attributable to the consolidation of GSE. In the fourth quarter of 2003 the
Company acquired additional shares of GSE, bringing its ownership to 58% as of
October 23, 2003. As a result, revenue of GSE was only consolidated in the
Company's results in the fourth quarter of 2003, while 2004 includes a full year
of GSE revenue.
Gross Profit
YEARS ENDED DECEMBER 31,
-----------------------------------------
(Dollars in thousands) 2004 2003
------------------- -------------------
% Revenue % Revenue
--------- ---------
General Physics $19,947 12.1% $15,501 11.6%
GSE 6,016 20.8% 1,594 26.3%
------- ---- ------- ----
$25,963 13.4% $17,095 12.2%
======= ==== ======= ====
General Physics gross profit of $19.9 million or 12.1% of revenue, in 2004
increased by $4.4 million or 28.7%, when compared to gross profit of $15.5
million, or 11.6% of revenue, in 2003. This increase in gross profit was
primarily driven by increases in revenue from the government training, business
process outsource and e-Learning businesses. While overhead expenses remained
flat year over year, the incremental profit increase was offset slightly by
increases in employee benefits due to the growth of the business.
GSE gross profit of $6.0 million or 20.8% of revenue in 2004 increased by $4.4
million, when compared to gross profit of $1.6 million, or 26.3% of revenue, in
2003, was attributable to the consolidation of GSE. In the fourth quarter of
2003 the Company acquired a majority ownership in GSE and as a result, gross
profit of GSE was only consolidated in the Company's results in the fourth
quarter of 2003, while 2004 includes a full year of GSE gross profit. GSE's
revenue for full year 2003 was $25.0 million.
Selling, General and Administrative Expense
SG&A increased $0.8 million or 3.5% from 2003 to 2004. This increase relates to
the following off-setting variances: GSE consolidation for a full year in 2004,
increased SG&A by $5.0 million; Corporate SG&A decreased in 2004 approximately
$4.2 million primarily due to reduced executive
27
compensation and payroll costs of $1.5 million and reduced legal and other
professional fees of $2.5 million; SG&A included corporate overhead expenses
that were for the benefit of both continuing and discontinued operations. Only
those costs that were solely attributable to the discontinued business segments
have been allocated to discontinued operations.
Interest Expense
The decrease in interest expense of $1.0 million from 2003 to 2004 was primarily
attributable to the Company's write-off of deferred financing costs on its prior
credit agreement of $0.9 million, as well as lower General Physics interest
expense, due to lower average borrowing levels in 2004 as compared to 2003.
Other Income
Other income of $0.6 million for 2004 was primarily related to interest income
on loans receivable of $0.3 million and other income of $0.3 million.
The Company recognized a gain of $13.7 million from the arbitration award paid
by EDS in the fourth quarter of 2004 (see General Physics Overview - above).
2003 - See year ended December 31, 2003 compared to the year ended December 31,
2002.
Income Taxes
Income tax benefit was $8.0 million in 2004 as a result of the Company's
reduction in valuation allowance offset by current tax provision. Income tax
expense was $1.0 million in 2003. In 2004, the Company's taxable income before
utilization of net operating loss carry forwards was approximately $22.0
million. In assessing the realizability of it's deferred tax assets, management
considered it more likely than not that it's deferred tax assets would be
realized and reduced its deferred tax valuation allowance by $12.2 million. As
of December 31, 2004, the Company had federal net operating loss carry forwards
of $19.3 million, which expire during 2022 and 2023.
28
YEAR ENDED DECEMBER 31, 2003 COMPARED TO THE YEAR ENDED DECEMBER 31, 2002
Revenue
YEARS ENDED DECEMBER 31,
------------------------
(Dollars in thousands) 2003 2002
-------- --------
General Physics $133,975 $142,237
GSE 6,059 --
-------- --------
$140,034 $142,237
======== ========
Revenue of General Physics, decreased by $8.3 million from 2002 to 2003
primarily due to a decrease in engineering and related services in connection
with Liquefied Natural Gas projects, decreased services provided to nuclear
power utilities, a decline in attendance at General Physics open enrollment
courses primarily due to reduced spending on training within the automotive
industry, General Physics's decision to focus on higher margin projects and
discontinue certain work with lower margins, and a general decline in client
spending (and budgets for spending) on consulting, training services, and
technology due to overall economic conditions in 2003. The decline in revenue
was partially offset by an increase in revenue from the US Government for
domestic preparedness training services for the Department of Homeland Security.
GSE revenue increased by $6.1 million in 2003 attributable to the consolidation
of GSE. In the fourth quarter of 2003 the Company acquired additional shares of
GSE, bringing its ownership to 58% as of October 23, 2003. As a result, revenue
of GSE was consolidated in the Company's results for the fourth quarter of 2003,
while 2002 does not include GSE revenue.
Gross Profit
YEARS ENDED DECEMBER 31,
----------------------------------------
(Dollars in thousands) 2003 2002
------------------- ------------------
% Revenue %Revenue
--------- --------
General Physics $15,501 11.6% $15,366 10.8%
GSE 1,594 26.3% -- --
------- ---- ------- ----
$17,095 12.2% $15,366 10.8%
======= ==== ======= ====
General Physics gross profit of $15.5 million or 11.6% of revenue, in 2003
increased by $135,000 or 0.9% when compared to gross profit of $15.4 million or
10.8% of revenue, in 2002. During this time General Physics experienced a
revenue decline which resulted in a loss of margin. However, General Physcis
made a decision to focus on higher gross margin opportunities and undertook cost
savings initiatives to preserve margin. The results of these initiatives allowed
General Physics to slightly increase gross profit in both dollars and as a
percentage of revenue.
29
GSE gross profit increased by $1.6 million from 2002 to 2003 attributable to the
consolidation of GSE. In the fourth quarter of 2003 the gross profit of GSE was
consolidated in Company's fourth quarter of 2003, while 2002 does not include
GSE gross profit.
Selling, General and Administrative Expense
The increase in SG&A of $3.7 million in 2003 from 2002 was primarily
attributable the following factors: $1.2 million of SG&A for the consolidation
of GSE in the Company's financial statements subsequent to the GSE acquisition;
executive incentive bonuses of $3.0 million; a non-cash debt conversion expense
of $0.6 million; and a decrease in the non-cash credit to compensation expense
of $1.1 million, relating to certain stock options to purchase stock of an
affiliate accounted for using the fair value method. The increase was offset by
a decrease in severance and related expense of $2.1 million.
Interest Expense
The increase in interest expense in 2003 of $0.7 million is primarily due to the
write off of $0.9 million of deferred financing costs as a result of the early
termination of the Company's prior credit agreement. This expense is included in
interest expense for year ended December 31, 2003.
Other Income
2003
The investment and other loss of $0.2 million for 2003 was primarily related to
an equity loss of GSE of $0.7 million (before its consolidation), offset by
interest income on loans receivable of $0.4.
The gains on marketable securities of $0.6 million in 2003 were primarily due to
the Company's disposal of shares of Millennium. Gains on sale of shares of
Millennium prior to the transfer of 1,000,000 shares of Millennium to MXL in
repayment of certain intercompany debt on October 17, 2003, are recorded as part
of operating results from continuing operations. Gains on sale of Millennium by
MXL after October 17, 2003 are recorded as part of operating results from
discontinued operations.
Pursuant to a Note and Warrant Purchase Agreement dated August 8, 2003, the
Company issued and sold to four Gabelli Funds $7,500,000 aggregate principal
amount of 6% Conditional Subordinated Notes due 2008 (the "Gabelli Notes") and
937,500 warrants ("GP Warrants"), each entitling the holder thereof to purchase
(subject to adjustment) one share of the Company's common stock. The changes in
the fair market value of the GP Warrants were marked to market through December
8, 2003 with the adjustment shown as other income in the consolidated statement
of operations. The Company recognized a gain of $1.4 million in its December 8,
2003 valuation adjustment of the liability relating to the GP Warrants using the
Black-Scholes model.
2002
The investment and other loss of $0.7 million for 2003 was primarily related to
an equity loss of GSE of $1.2 million, offset by interest income on loans
receivable of $0.6 million.
The gains on marketable securities of $2.3 million in 2002 were primarily due to
the Company's disposal of shares of Millennium.
30
Income Taxes
The Company recognized income tax expense of $1.0 million in 2003 and an income
tax benefit of $0.3 million in 2002.
Income (Loss) on Discontinued Operations
The decreased loss from discontinued operation of $0.6 million in 2003 was
primarily due to 2002 equity in losses of Valera Pharmaceuticals.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2004, the Company had cash and cash equivalents totaling $2.4
million. In addition the Company had cash held in escrow of $13.8 million from
the EDS arbitration award, of which the Company received approximately $8.5
million in January 2005, net of the $5.0 million distribution to NPDC. The
Company believes that cash generated from operations and borrowings availability
under the Credit Agreement (described below), will be sufficient to fund the
working capital and other requirements of the Company for the foreseeable
future. The Company does not believe the spin-off of NPDC will significantly
impact the Company's liquidity.
For the year ended December 31, 2004, the Company's working capital increased by
$2.6 million from $18.0 million to $20.6 million. The Company has increased
working capital during the year ended December 31, 2004 mainly due to receiving
the proceeds of the arbitration award against EDS, as well as increases in
current assets such as accounts receivable and unbilled receivables, due to
increased revenues.
The decrease in cash and cash equivalents of $2.0 million for the year ended
December 31, 2004 resulted from cash used in investing activities of $1.4
million and cash used in financing activities of $4.9 million; offset by cash
provided by operations of $4.2 million and the effect of exchange rate changes
on cash of $0.1 million. Net cash used in investing activities of $1.4 million
includes $1.8 million of capital expenditures and $0.3 million in additions to
intangible assets; offset by proceeds from the sale of marketable securities of
$0.6 million. Net cash used in financing activities of $4.9 million consisted of
cash distributed in the spin-off of $2.5 million; repayments of short-term
borrowings of $2.1 million; and repayments of long-term debt of $1.1 million;
offset by net proceeds from exercises of stock options of $0.9 million.
On October 23, 2003, the Company purchased from ManTech International
("ManTech") additional shares of GSE common stock in exchange for a 5% note for
$5.3 million due in full in October 2008. Interest is payable quarterly. Each
year during the term of the note, ManTech has the option to convert up to 20% of
the original principal amount of the note into common stock of the Company at
the then market price of the Company's common stock, but only in the event that
the Company's common stock is trading at $10 per share or more. In the event
that less than 20% of the principal amount of the note is not converted in any
year, such amount not converted will be eligible for conversion in each
subsequent year until converted or until the note is repaid in cash.
On August 13, 2003, General Physics, General Physics' subsidiary SkillRight,
Inc. and MXL Industries Inc. ("MXL") entered into a two-year $25 million
Financing and Security Agreement (Credit Agreement) with a bank, the proceeds of
which were used to repay the Company's previous credit
31
facility. The interest rate on borrowings under the Credit Agreement is at Libor
Market Index Rate plus 3%. The Credit Agreement, as amended in March 2004 to
include GSE, is secured by certain assets of General Physics. The Credit
Agreement also provides for an unsecured guaranty from the Company. The Credit
Agreement also contains certain restrictive covenants including a prohibition on
future acquisitions, incurrence of debt and the payment of dividends. The
Company received a waiver under the Credit Agreement with respect to the GSE
Acquisition. General Physics is currently restricted from paying dividends and
management fees to the Company in excess of $1.0 million in any fiscal year. On
July 30, 2004, General Physics received a waiver and paid the Company an
additional $1.0 million. The Company repaid in full the $6.1 million outstanding
under the Credit Agreement as of December 31, 2004 in January of 2005, using the
proceeds received from the EDS arbitration award (see Item 3). On March 9, 2005,
General Physics received a waiver to loan GSE a maximum of $1.0 million to
satisfy any GSE short-term capital requirements over the next 15 months.
Pursuant to a Note and Warrant Purchase Agreement dated August 8, 2003, the
Company issued and sold to four Gabelli funds $7.5 million aggregate principal
amount of 6% Conditional Subordinated Notes due 2008 and 937,500 warrants, each
entitling the holder thereof to purchase (subject to adjustment) one share of
the Company's common stock. The aggregate purchase price for the Gabelli Notes
and GP Warrants was $7.5 million. The Gabelli Notes are secured by a mortgage on
the Company's former property located in Pawling, New York which was distributed
to NPDC. In addition, at any time that less than $1.0 million principal amount
of the Gabelli Notes are outstanding, the Company may defease the obligations
secured by the mortgage and obtain a release of the mortgage by depositing with
an agent for the Noteholders, bonds or government securities with an investment
grade rating by a nationally recognized rating agency which, without
reinvestment, will provide cash on the maturity date of the Gabelli Notes in an
amount not less than the outstanding principal amount of the Gabelli Notes. The
Company used $5.8 million of the proceeds to repay its previous credit facility.
The Company and NPDC agreed to allocate to NPDC $1.9 million of the $7.5 million
received for the Gabelli Notes and Warrants, which the Company transferred to
NPDC prior to the spin-off of NPDC.
On March 30, 2004, GSE was added as an additional borrower under the General
Physics Credit Agreement. Under the terms of the Credit Agreement, as amended,
$1.5 million of General Physics' Credit Agreement has been allocated for use by
GSE. The Credit Agreement was amended to provide for additional collateral
consisting of substantially all of the GSE's assets as well as certain covenants
specific to GSE. It provides for borrowings by GSE up to 80% of eligible
accounts receivable and 80% of eligible unbilled receivables, up to a maximum of
$1.5 million. The interest rate is based upon the LIBOR Market Index Rate plus
3%, with interest only payments due monthly. The Company agreed to guarantee
GSE's borrowings under the Credit Agreement, as amended, in consideration for a
fee pursuant to the Management Services Agreement.
Contractual Obligations and Commitments
The following table summarizes long-term debt, capital lease commitments,
operating lease commitments, purchase commitments and employment agreements as
of December 31, 2004 (in thousands):
32
PAYMENTS DUE IN
-----------------------------------------------
2006 - 2008 AFTER
2005 2007 2009 2009 TOTAL
------- ------- ------- ------- -------
Long-term debt $ 9 $ -- $12,751 $ -- $12,760
Capital lease commitments 91 90 -- -- 181
Operating lease commitments 4,964 6,621 2,669 5,313 19,567
Purchase commitments 28,496 2,678 29 31,203
Employment agreements 2,080 3,093 471 5,644
------- ------- ------- ------- -------
Total $35,640 $12,482 $15,920 $ 5,313 $69,355
======= ======= ======= ======= =======
Off-Balance Sheet Commitments
The Company has guaranteed the leases for Five Star New Jersey and Connecticut
warehouses, totaling $1.6 million per year through the first quarter of 2007.
The Company's guarantee of such leases was in effect when Five Star was
originally a wholly owned subsidiary of the Company prior to the sale by the
Company in 1998 of substantially all of the operating assets of Five Star Group
to the predecessor company of Five Star. As part of this transaction, the
landlords of the New Jersey and Connecticut facilities did not consent to the
release of the Company's guarantee. The Company's guarantee of Five Star's
leases was not affected by the spin-off of NPDC.
General Physics has two letters of credit outstanding, which as of December 31,
2004 amount to approximately $0.3 million and expire in 2005. In addition the
Company guarantees MXL loans totaling approximately $2.9 million as of December
31, 2004.
The Company does not have any off-balance sheet financing, other than operating
leases and letters of credit entered into in the normal course of business and
disclosed above. GSE utilizes various derivative financial instruments to manage
market risks associated with the fluctuations in foreign currency exchange
rates. It is GSE's policy to use derivative financial instruments to protect
against market risk arising in the normal course of business. The criteria GSE
uses for designating an instrument as a hedge includes the instrument's
effectiveness in risk reduction and one-to-one matching of derivative
instruments to underlying transactions. GSE monitors its foreign currency
exposures to maximize the overall effectiveness of its foreign currency hedge
positions. Principal currencies hedged include the Euro and the Japanese yen.
GSE's objectives for holding derivatives are to minimize the risks using the
most effective methods to reduce the impact of these exposures. GSE minimizes
credit exposure by limiting counterparties to nationally recognized financial
institutions. As of December 31, 2004, GSE had contracts for the sale of
approximately $4.6 million Japanese Yen at fixed rates. The contracts expire on
various dates through May, 2007. The contracts do not qualify for hedge
treatment under SFAS No. 133, as amended. Accordingly, GSE has recorded the
estimated fair value of the contracts of approximately $200,000 as of December
31, 2004 as other assets in the consolidated balance sheet and other income in
the consolidated statement of operations.
MANAGEMENT DISCUSSION OF CRITICAL ACCOUNTING POLICIES
The preparation of our consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires us to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities at
33
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Our estimates, judgments and assumptions
are continually evaluated based on available information and experience. Because
of the use of estimates inherent in the financial reporting process, actual
results could differ from those estimates.
Certain of our accounting policies require higher degrees of judgment than
others in their application. These include contract revenue and cost
recognition, valuation of accounts receivable, accounting for investments,
impairment of long-lived and intangible assets and income tax recognition of
deferred tax items which are summarized below. In addition, note 2 to the
Consolidated Financial Statements includes further discussion of our significant
accounting policies.
CONTRACT REVENUE AND COST RECOGNITION.
Revenue Recognition
General Physics contract revenue and cost recognition. General Physics provides
services under time-and-materials, cost-plus-fixed fee and fixed-price
contracts. Each contract has different terms based on the scope, deliverables
and complexity of the engagement, requiring General Physics to make judgments
and estimates about recognizing revenue. In general, revenue is recognized on
these arrangements as the services are performed. Under time-and-material
contracts, as well as certain cost-plus-fixed fee and certain fixed-price
contracts, the contractual billing schedules are based on the specified level of
resources General Physics is obligated to provide. As a result, on those
"level-of-effort" contracts, the contractual billing amount for a given period
acts as a measure of performance and, therefore, revenue is typically recognized
in that amount.
For other fixed price contracts, the contractual billing schedules are not based
on the specified level of resources General Physics is obligated to provide.
These arrangements typically do not have milestones or other reliable measures
of performance. As a result, revenue on these arrangements is recognized using
the percentage-of-completion method based on the relationship of costs incurred
to total estimated costs expected to be incurred over the term of the contract.
General Physics believes this methodology provides a reasonable measure of
performance on these arrangements since performance primarily involves personnel
costs and the customer typically is required to pay General Physics for the
proportionate amount of work and cost incurred in the event of contract
termination. Revenue for unpriced change orders is not recognized until the
customer agrees with the changes. Costs and estimated earnings in excess of
billings on uncompleted contracts are recorded as a current asset. Billings in
excess of costs and estimated earnings on uncompleted contracts are recorded as
a current liability. Generally contracts provide for the billing of costs
incurred and estimated earnings on a monthly basis.
Risks relating to service delivery, usage, productivity and other factors are
considered when making estimates of total contract cost, contract profitability
and progress towards completion. If sufficient risk exists, a reduced-profit
methodology is applied to a specific client contract's percentage-of-completion
model whereby the amount of revenue recognized is limited to the amount of costs
incurred until such time as the risks have been partially or wholly mitigated
through performance. General Physics' estimates of total contract cost and
contract profitability change periodically in the normal course of business,
occasionally due to modifications of contractual arrangements. In addition, the
implementation of cost saving initiatives and achievement of productivity gains
generally results in a
34
reduction of estimated total contract expenses on affected client contracts.
Such changes in estimate are recognized in the period the changes are
determined. For all client contracts, provisions for estimated losses on
individual contracts are made in the period in which the loss first becomes
apparent.
As part of General Physics' on-going operations to provide services to its
customers, incidental expenses, which are commonly referred to as
"out-of-pocket" expenses, are billed to customers, either directly as a
pass-through cost or indirectly as a cost estimated in proposing on fixed-price
contracts. Out-of-pocket expenses include expenses such as airfare, mileage,
hotel stays, out-of-town meals and telecommunication charges. General Physics'
policy provides for these expenses to be recorded as both revenue and direct
cost of services in accordance with the provisions of EITF 01-14, Income
Statement Characterization of Reimbursements Received for "Out-of-Pocket"
Expenses Incurred.
GSE revenue recognition. The majority of GSE's revenue is derived through the
sale of uniquely designed systems containing hardware, software and other
materials under fixed-price contracts. In accordance with Statement of Position
81-1, Accounting for Performance of Construction-Type and Certain
Production-Type Contracts, the revenue under these fixed-price contracts 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
identified. Estimated losses are charged against earnings in the period such
losses are identified.
As GSE recognizes revenue under the percentage-of-completion method, it provides
an accrual for estimated future warranty costs based on historical and projected
claims experience. GSE's longer-term contracts generally provide for a one-year
warranty on parts, labor and any bug fixes as it relates to software embedded in
the systems.
GSE's system design contracts do not provide for "post customer support service"
(PCS) in terms of software upgrades, software enhancements or telephone support.
In order to obtain PCS, the customers must purchase a separate contract at the
date of system installation. Such PCS arrangements are generally for a one-year
period renewable annually and include customer support, unspecified software
upgrades, maintenance releases. GSE recognizes revenue from these contracts
ratably over the life of the agreements in accordance with Statement of Position
97-2, Software Revenue Recognition.
Revenue from the sale of software licenses for the Company's modeling tools,
which do not require significant modification or customization, are recognized
when the license agreement is signed, the license fee is fixed and determinable,
delivery has occurred, and collection is considered probable.
Revenues 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.
VALUATION OF ACCOUNTS RECEIVABLES
Provisions for allowance for doubtful accounts are made based on specific credit
risks identified by the Company. Measurement of such losses requires
consideration of the historical loss experience of the Company and its
subsidiaries, judgments about customer credit risk and the need to adjust for
current economic conditions. The allowance for doubtful accounts was $0.8
million at December 31, 2004.
35
IMPAIRMENT OF LONG-LIVED TANGIBLE AND INTANGIBLE ASSETS
Impairment of long-lived tangible and intangible assets with finite lives result
in a charge to operations whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of
long-lived tangible assets to be held and used is measured by a comparison of
the carrying amount of the asset to future undiscounted net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by determining the amount by which the
carrying amount of the assets exceeds the fair value of the asset.
The measurement of the future net cash flows to be generated is subject to
management's reasonable expectations with respect to the Company's future
operations and future economic conditions which may affect those cash flows.
In accordance with SFAS No. 142, goodwill is no longer amortized, but instead
tested for impairment at least annually. The goodwill impairment test requires
the Company to identify its reporting units and obtain estimates of the fair
values of those units as of the testing date. The Company estimates the fair
values of its reporting units using discounted cash flow valuation models. The
Company estimates these amounts by evaluating historical trends, current
budgets, operating plans and industry data. The estimated fair value of each
reporting unit exceeded