| GSE SYSTEMS INC Item 1A Risk Factors |
| If the Company is unable to generate adequate cash flow from operations, it will need additional capital to fund its operations |
| In 2005, the Company incurred a significant operating loss |
| The Companyapstas revenue and profitability were impacted by the low volume of orders logged in 2004 and 2005 and the Companyapstas backlog decreased from dlra19dtta6 million at December 31, 2004 to dlra12dtta3 million at December 31, 2005 |
| In addition, the Company continued to spend heavily on business development activities in order to expand the Companyapstas simulation business into new sectors, such as integrating its simulation capabilities with broader training and educational programs |
| Accordingly, the Companyapstas cash position weakened during the year, with total cash used in operating activities of dlra1dtta9 million |
| The Company received dlra2dtta0 million through the sale of a Senior Subordinated Secured Convertible Note to Dolphin Direct Equity Partners, LP ( "e Dolphin "e ) in May 2005, and the Company utilized dlra1dtta2 million of its dlra1dtta5 million credit facility in 2005 |
| The Company took actions that will reduce its operating expenses in 2006, including the termination of a number of employees and by restructuring two facility leases |
| In order to ensure that the Company has sufficient working capital in 2006, the Company completed several financing transactions in early 2006 |
| On February 28, 2006, the Company and Dolphin entered into a Cancellation and Warrant Exchange Agreement (the "e Cancellation Agreement "e ) under which Dolphin agreed to cancel its Senior Subordinated Secured Convertible Promissory Note and cancel its outstanding warrant to purchase 380cmam952 shares of GSE common stock at an exercise price of dlra2dtta22 per share |
| In exchange for Dolphinapstas agreement to enter into the Cancellation Agreement and for the participation of Dolphin Offshore Partners, LP in the Preferred Stock transaction discussed below, the Company paid off the Dolphin Note and agreed to issue a new warrant to purchase 900cmam000 shares of GSE common stock at an exercise price of dlra0dtta67 per share |
| Dolphin must exercise the new warrant promptly after the Company certifies to Dolphin on or after May 30, 2006 (the "e Mandatory Exercise Date "e ) that, among other things, the current stock price shall not be less than dlra1dtta25 on the Mandatory Exercise Date and that the average of the current stock prices for each trading day of the 30 calendar day period up to and including the Mandatory Exercise Date is not less than dlra1dtta25 |
| On February 28, 2006, the Company raised dlra4dtta25 million through the sale of 42cmam500 shares of Series A Cumulative Convertible Preferred Stock and Warrants by means of a private placement to "e accredited investors "e , as that term is used in rules and regulations of the Securities and Exchange Commission |
| The Convertible Preferred Stock is convertible at any time into a total of 2cmam401cmam130 shares of GSE common stock at a conversion price of dlra1dtta77 per share |
| The conversion price was equal to 110prca of the closing price of the Companyapstas Common Stock on February 28, 2006, the date the sale of the Convertible Preferred Stock was completed |
| Each investor received a five-year warrant to purchase GSE common stock equal to 20prca of the shares they would received from the conversion of the Convertible Preferred Stock, at an exercise price of dlra1dtta77 |
| In total, the Company issued warrants to purchase a total of 480cmam226 shares of GSE common stock |
| The proceeds were used to payoff the Dolphin Note and the Companyapstas line of credit balance and for other working capital purposes |
| On March 7, 2006, the Company entered into a new loan and security agreement with Laurus Master Fund, Ltd |
| The new agreement established a dlra5dtta0 million line of credit for the Company |
| The line is collateralized by substantially all of the Companyapstas assets and provides for borrowings up to 90prca of eligible accounts receivable, and 40prca of eligible unbilled receivables (up to a maximum of dlra1dtta0 million) |
| The interest rate on this line of credit is based on the prime rate plus 200-basis points, with interest only payments due monthly |
| After the completion of the transactions discussed above, the Company believes that it has sufficient liquity and working capital for its operations in 2006 |
| However, if the Company is unable to operate profitably and generate sufficient cash from operations, the availability under its new line of credit may note be sufficient and the Company may be required to look for additional capital to fund its operations |
| There can be no assurance that the Company would be successful in raising such additional funds |
| The Companyapstas expense levels are based upon its expectations as to future revenues, so it may be unable to adjust spending to compensate for a revenue shortfall |
| Accordingly, any revenue shortfall would likely have a disproportionate effect on the Companyapstas operating results |
| The Companyapstas revenue was dlra22dtta0 million, dlra29dtta5 million and dlra25dtta0 million for the years ended December 31, 2005, 2004 and 2003, respectively |
| The Companyapstas operating income (loss) was (dlra4dtta7 million), dlra2cmam000 and (dlra1dtta0 million) in 2005, 2004 and 2003, respectively |
| The Companyapstas operating results have fluctuated in the past and may fluctuate significantly in the future as a result of a variety of factors, including purchasing patterns, timing of new products and enhancements by the Company and its competitors, and fluctuating foreign economic conditions |
| Since the Companyapstas expense levels are based in part on its expectations as to future revenues, the Company may be unable to adjust spending in a timely manner to compensate for any revenue shortfall and such revenue shortfalls would likely have a disproportionate adverse effect on operating results |
| The Company believes that these factors may cause the market price for its common stock to fluctuate, perhaps significantly |
| In addition, in recent years the stock market in general, and the shares of technology companies in particular, have experienced extreme price fluctuations |
| The Companyapstas common stock has also experienced a relatively low trading volume, making it further susceptible to extreme price fluctuations |
| Risk of International Sales and Operations |
| Sales of products and the provision of services to end users outside the United States accounted for approximately 63prca of the Companyapstas consolidated revenue in 2005 |
| The Company anticipates that international sales and services will continue to account for a significant portion of its revenue in the foreseeable future |
| As a result, the Company may be subject to certain risks, including risks associated with the application and imposition of protective legislation and regulations relating to import or export (including export of high technology products) or otherwise resulting from trade or foreign policy and risks associated with exchange rate fluctuations |
| Additional risks include potentially adverse tax consequences, tariffs, quotas and other barriers, potential difficulties involving the Companyapstas strategic alliances and managing foreign sales agents or representatives and potential difficulties in accounts receivable collection |
| Although end users in the Ukraine accounted for 18prca, 21prca, and 29prca of the Companyapstas consolidated revenue in 2005, 2004, and 2003, respectively, GSEapstas customer for these projects was Battelleapstas Pacific Northwest National Laboratory, which is the purchasing agent for the US Department of Energy |
| Accordingly, the Company is not subject to the political and financial risks that are normally faced when doing business in the Ukraine |
| The Company has taken steps designed to reduce the additional risks associated with doing business in these countries, but the Company believes that such risks may still exist and include, among others, general political and economic instability, lack of currency convertibility, as well as uncertainty with respect to the efficacy of applicable legal systems |
| There can be no assurance that these and other factors w ill not have a material adverse effect on the Companyapstas business, financial condition or results of operations |
| The loss of this customer would have a material adverse effect upon the Companyapstas revenues and results of operations |
| For the years ended December 31, 2005, 2004, and 2003, one Power Simulation customer (Battelleapstas Pacific Northwest National Laboratory) accounted for approximately 25prca, 24prca, and 29prca, respectively, of the Companyapstas consolidated revenue |
| The Pacific Northwest National Laboratory is the purchasing agent for the Department of Energy and the numerous projects the Company performs in Eastern and Central Europe |
| If the Company lost this customer, the Companyapstas revenue and results of operations would be materially and adversely affected |
| The Companyapstas business is substantially dependent on sales to the nuclear power industry |
| Any disruption in this industry would have a material adverse effect upon the Companyapstas revenue |
| The Company will continue to derive a significant portion of its revenue from customers in the nuclear power industry for the foreseeable future |
| The Companyapstas ability to supply nuclear power plant simulators and related products and services is dependent on the continued operation of nuclear power plants and, to a lesser extent, on the construction of new nuclear power plants |
| A wide range of factors affect the continued operation and construction of nuclear power plants, including the political and regulatory environment, the availability and cost of alternative means of power generation, the occurrence of future nuclear incidents, and general economic conditions |
| The Companyapstas debt agreement as of December 31, 2005 imposes significant operating and financial restrictions, which may prevent it from capitalizing on business opportunities |
| GSEapstas debt agreement imposes significant operating and financial restrictions |
| These restrictions affect, and in certain cases limit, among other things, the Companyapstas ability to: * incur additional indebtedness and liens; * make capital expenditures; * make investments and acquisitions and sell assets; * consolidate, merge or sell all or substantially all of its assets |
| There can be no assurance that these restrictions will not adversely affect the Companyapstas ability to finance its future operations or capital needs or to engage in other business activities that may be in the interest of stockholders |
| The Company is dependent on product innovation and research and development, which costs are incurred prior to revenues for new products and improvements |
| The Company believes that its success will depend in large part on its ability to maintain and enhance its current product line, develop new products, maintain technological competitiveness and meet an expanding range of customer needs |
| The Companyapstas product development activities are aimed at the development and expansion of its library of software modeling tools, the improvement of its display systems and workstation technologies, and the advancement and upgrading of its simulation technology |
| The life cycles for software modeling tools, graphical user interfaces, and simulation technology are variable and largely determined by competitive pressures |
| Consequently, the Company will need to continue to make significant investments in research and development to enhance and expand its capabilities in these areas and to maintain its competitive advantage |
| The Company relies upon its intellectual property rights for the success of its business; however, the steps it has taken to protect its intellectual property may be inadequate |
| Although the Company believes that factors such as the technological and creative skills of its personnel, new product developments, frequent product enhancements and reliable product maintenance are important to establishing and maintaining a technological leadership position, the Companyapstas business depends, in part, on its intellectual property rights in its proprietary technology and information |
| The Company relies upon a combination of trade secret, copyright, patent and trademark law, contractual arrangements and technical means to protect its intellectual property rights |
| The Company enters into confidentiality agreements with its employees, consultants, joint venture and alliance partners, customers and other third parties that are granted access to its proprietary information, and limits access to and distribution of its proprietary information |
| There can be no assurance, however, that the Company has protected or will be able to protect its proprietary technology and information adequately, that the unauthorized disclosure or use of the Companyapstas proprietary information will be prevented, that others have not or will not develop similar technology or information independently, or, to the extent the Company owns patents, that others have not or will not be able to design around those patents |
| Furthermore, the laws of certain countries in which the Companyapstas products are sold do not protect the Companyapstas products and intellectual property rights to the same extent as the laws of the United States |
| The industries in which GSE operates are highly competitive |
| This competition may prevent the Company from raising prices at the same pace as its costs increase |
| The Companyapstas businesses operate in highly competitive environments with both domestic and foreign competitors, many of whom have substantially greater financial, marketing and other resources than the Company |
| The principal factors affecting competition include price, technological proficiency, ease of system configuration, product reliability, applications expertise, engineering support, local presence and financial stability |
| The Company believes that competition in the simulation fields may further intensify in the future as a result of advances in technology, consolidations and/or strategic alliances among competitors, increased costs required to develop new technology and the increasing importance of software content in systems and products |
| The Company believes that its technology leadership, experience, ability to provide a wide variety of solutions, product support and related services, open architecture and international alliances will allow it to compete effectively in these markets |
| As the Companyapstas business has a significant international component, changes in the value of the dollar could adversely affect the Companyapstas ability to compete internationally |
| GSE will continue to pursue new acquisitions and joint ventures, and any of these transactions could adversely affect its operating results or result in increased costs or other problems |
| The Company intends to continue to pursue new acquisitions and joint ventures, a pursuit which could consume substantial time and resources |
| Identifying appropriate acquisition candidates and negotiating and consummating acquisitions can be a lengthy and costly process |
| The Company may also encounter substantial unanticipated costs or other problems associated with the acquired businesses |
| The risks inherent in this strategy could have an adverse impact on the Companyapstas results of operation or financial condition |
| The nuclear power industry, the Companyapstas largest customer group, is associated with a number of hazards which could create significant liabilities for the Company |
| The Companyapstas business could expose it to third party claims with respect to product, environmental and other similar liabilities |
| Although the Company 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 |
| Certain of the Companyapstas products and services are used by the nuclear power industry primarily in operator training |
| Although the Companyapstas contracts for such products and services typically contain provisions designed to protect the Company from potential liabilities associated with such use, there can be no assurance that the Company would not be materially adversely affected by claims or actions which may potentially arise |