Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such period that the registrant was required to submit and post such files). Yes [ X ] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in rule 12(b)-2 of the Exchange Act). Yes [ ] No [X]
GSE SYSTEMS, INC.
GSE SYSTEMS, INC. AND SUBSIDIARIES
The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
The accompanying notes are an integral part of these consolidated financial statements.
GSE SYSTEMS, INC. AND SUBSIDIARIES
The accompanying notes are an integral part of these consolidated financial statements.
The consolidated interim financial statements included herein have been prepared by GSE Systems, Inc. (the "Company" or "GSE") without independent audit. In the opinion of the Company's management, all adjustments and reclassifications of a normal and recurring nature necessary to present fairly the financial position, results of operations and cash flows for the periods presented have been made. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles ("GAAP") have been condensed or omitted. The results of operations for interim periods are not necessarily an indication of the results for the full year. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 20132014 filed with the Securities and Exchange Commission on March 26, 2014.19, 2015. Certain reclassifications have been made to prior period amounts to conform to the current presentation.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements as well as reported amounts of revenues and expenses during the reporting period. The Company's most significant estimates relate to revenue recognition on long-term contracts, product warranties, capitalization of software development costs, valuation of goodwill and intangible assets acquired, valuation of contingent consideration issued in business acquisitions, and the recoverability of deferred tax assets. Actual results could differ from these estimates and those differences could be material.
Uncertainties inherent in the performance of contracts include labor availability and productivity, material costs, change order scope and pricing, software modification and customer acceptance issues. The reliability of these cost estimates is critical to the Company's revenue recognition as a significant change in the estimates can cause the Company's revenue and related margins to change significantly from the amounts estimated in the early stages of the project.
As the Company recognizes revenue under the percentage-of-completion method, it provides an accrual for estimated future warranty costs based on historical experience and projected claims.claims experience. The Company's long-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.
The Company's system design contracts do not normally provide for "post customer support service" ("PCS")(PCS) in terms of software upgrades, software enhancements or telephone support. In order to obtain PCS, the customers normally must normally purchase a separate contract. Such PCS arrangements are generally for a one-year period renewable annually and include customer support, unspecified software upgrades, and maintenance releases. The Company recognizes revenue from these contracts ratably over the life of the agreements.
Revenue from the sale of software licenses which do not require significant modifications or customization for the Company's modeling tools are recognized when the license agreement is signed, the license fee is fixed and determinable, delivery has occurred, and collection is considered probable.
Basic loss per share is based on the weighted average number of outstanding common shares for the period. Diluted loss per share adjusts the weighted average shares outstanding for the potential dilution that could occur if stock options were exercised into common stock.
The number of common shares and common share equivalents used in the determination of basic and diluted loss per share were as follows:
Contract receivables represent balances due from a broad base of both domestic and international customers. All contract receivables are considered to be collectible within twelve months. Recoverable costs and accrued profit not billed represent costs incurred and associated profit accrued on contracts that will become billable upon future milestones or completion of contracts.
Certain computer software development costs are capitalized in the accompanying consolidated balance sheets. Capitalization of computer software development costs begins upon the establishment of technological feasibility. Capitalization ceases and amortization of capitalized costs begins when the software product is commercially available for general release to customers. Amortization of capitalized computer software development costs is included in cost of revenue and is determined using the straight-line method over the remaining estimated economic life of the product, typically three years. On an annual basis, and more frequently as conditions indicate, the Company assesses the recovery of the unamortized software development costs by estimating the net undiscounted cash flows expected to be generated by the sale of the product. If the undiscounted cash flows are not sufficient to recover the unamortized software costs the Company will write-down the investment to its estimated fair value based on future undiscounted cash flows. The excess of any unamortized software development costs over the related net realizable value is written down and charged to cost of revenue.
During the second quarter of 2013, the Company incurred a charge of $2.2 million related to the write-down of certain capitalized software development costs based on the net realizable value analysis. The Company did not recognize any write-downs of software development costs in 2014.18
| 6.7. | Goodwill and Intangible Assets |
Goodwill
The Company reviewsWe review goodwill for impairment annually as of November 30 orand whenever events or changes in circumstances indicate the carrying value of goodwillan asset may not be recoverable in accordance with recoverable. We test goodwill at the reporting unit level. A reporting unit is an operating segment, or one level below an operating segment, as defined by U.S. generally accepted accounting principles. After the acquisition of Hyperspring, LLC ("Hyperspring") on November 14, 2014, our reporting units are: (i) Performance Improvement Solutions and (ii) Nuclear Industry Training and Consulting. At September 30, 2015 and December 31, 2014, the $5.6 million of goodwill balance was related to the Hyperspring acquisition and is assigned to our Nuclear Industry Training and Consulting segment.
Accounting Standards CodificationUpdate ("ASC"ASU") 350,2011-08, Intangibles —Testing Goodwill and Otherfor Impairment. The provisions of ASC 350 require that we perform a two-step impairment test on goodwill. In the ("ASU 2011-08") permits an entity to first step, we compareassess qualitative factors to determine whether it is more likely than not that the fair value of oura reporting unit tois less than its carrying value. The Company has only one reporting unit. Ifamount as a basis for determining whether it is necessary to perform the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit,two-step goodwill impairment test. Under ASU 2011-08, an entity is not impaired, and we are not required to perform further testing. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then we must perform the second step of the impairment test in order to determine the implied fair value of the reporting unit's goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit's assets and liabilities in a manner similar to a purchase price allocation, with any residual fair value allocated to goodwill. If the carrying value of the reporting unit's goodwill exceeds its implied fair value, then we record an impairment loss equal to the difference.
Based upon indicators of impairment in the second quarter of 2013, which included a substantial decrease in the Company's market capitalization following the announcement of the Company's first quarter 2013 earnings, and significantly lower than projected revenue and profits as a result of a change in market conditions, the Company performed an interim impairment test as of June 30, 2013.
The fair value of our reporting unit was estimated using a combination of appropriately weighted income and market approaches. The cash flows employed in the income approach were based on forecasts and business plans developed in the second quarter of 2013, as well as various growth rate assumptions for the years beyond the current business plan period, discounted using an estimated weighted average cost of capital ("WACC"). The WACC is comprised of (1) a risk free rate of return, (2) an equity and size risk premium that is based on the rate of return on equity of publicly traded companies with business characteristics comparable to our reporting unit, (3) the current after-tax market rate of return on debt of companies with business characteristics similar to our reporting unit, each weighted by the relative market value percentages of our equity and debt, and (4) an industry and specific company risk factor.
The results of the ASC 350 Step 1 goodwill impairment analysis indicated that the estimated fair value of our reporting unit was less than the carrying value. The reporting unit was unfavorably impacted by a combination of lower current and projected cash flows. Because our reporting unit's fair value estimate was lower than its carrying value, we applied the second step of the goodwill test, in accordance with ASC 350.
The second stepone of the goodwill impairment analysis indicated that the carrying value of the goodwill associated with thetest for a reporting unit exceededif it is more likely than not that its implied fair value resulting in a $4.5 million goodwillis greater than its carrying amount. As of September 30, 2015, no impairment charge, non-deductible for tax purposes. As a result of the analysis, the Company recorded a full goodwill impairment. The impairment was non-cash in nature and did not affect the Company's liquidity nor impact the debt covenants under the Company's credit facility.has been recognized on goodwill.
Intangible Assets Subject to Amortization
The Company's intangible assets include amounts recognized in connection with business acquisitions, including customer relationships, contract backlog and technology. Intangible assets are initially valued at fair market value using generally accepted valuation methods appropriate for the type of intangible asset. Amortization is recognized on a straight-line basis over the estimated useful life of the intangible assets, except for contract backlog and contractual customer relationships which are recognized in proportion to the related projected revenue streams. Intangible assets with definite lives are reviewedThe Company reviews specific definite-lived intangibles for impairment if indicators of impairment arise. The failure of step 1 of the goodwill impairment analysis was an impairment indicatorwhen events occur that may impact their value in the second quarter of 2013, but the undiscounted cash flows associatedaccordance with the other intangible assets were greater than the carrying value, and therefore, no impairment was present.respective accounting guidance for long-lived assets.
7.8. | Fair Value of Financial Instruments |
ASC 820, Fair Value Measurements and Disclosures("ASC 820"), defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
The levels of the fair value hierarchy established by ASC 820 are:
Level 1: inputs are quoted prices, unadjusted, in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
Level 2: inputs are other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. A Level 2 input must be observable for substantially the full term of the asset or liability.
Level 3: inputs are unobservable and reflect the reporting entity's own assumptions about the assumptions that market participants would use in pricing the asset or liability.
The Company considers the recorded value of certain of its financial assets and liabilities, which consist primarily of accounts receivable and accounts payable, to approximate the fair value of the respective assets and liabilities at September 30, 20142015 and December 31, 20132014 based upon the short-term nature of the assets and liabilities.
The following table presents assets and liabilities measured at fair value at September 30, 2014:2015:
| | Quoted Prices in Active Markets for Identical Assets | | | Significant Other Observable Inputs | | | Significant Unobservable Inputs | | | | | | Quoted Prices in Active Markets for Identical Assets | | | Significant Other Observable Inputs | | | Significant Unobservable Inputs | | | | |
(in thousands) | | (Level 1) | | | (Level 2) | | | (Level 3) | | | Total | | | (Level 1) | | | (Level 2) | | | (Level 3) | | | Total | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Money market funds | | $ | 12,945 | | | $ | - | | | $ | - | | | $ | 12,945 | | | $ | 12,129 | | | $ | - | | | $ | - | | | $ | 12,129 | |
Foreign exchange contracts | | | - | | | | 30 | | | | - | | | | 30 | | | | - | | | | 124 | | | | - | | | | 124 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total assets | | $ | 12,945 | | | $ | 30 | | | $ | - | | | $ | 12,975 | | | $ | 12,129 | | | $ | 124 | | | $ | - | | | $ | 12,253 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Foreign exchange contracts | | $ | - | | | $ | (16 | ) | | $ | - | | | $ | (16 | ) | | $ | - | | | $ | (107 | ) | | $ | - | | | $ | (107 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total liabilities | | $ | - | | | $ | (16 | ) | | $ | - | | | $ | (16 | ) | | $ | - | | | $ | (107 | ) | | $ | - | | | $ | (107 | ) |
The following table presents assets and liabilities measured at fair value at December 31, 2013:2014:
| | Quoted Prices in Active Markets for Identical Assets | | | Significant Other Observable Inputs | | | Significant Unobservable Inputs | | | | | | Quoted Prices in Active Markets for Identical Assets | | | Significant Other Observable Inputs | | | Significant Unobservable Inputs | | | | |
(in thousands) | | (Level 1) | | | (Level 2) | | | (Level 3) | | | Total | | | (Level 1) | | | (Level 2) | | | (Level 3) | | | Total | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Money market funds | | $ | 10,553 | | | $ | - | | | $ | - | | | $ | 10,553 | | | $ | 11,661 | | | $ | - | | | $ | - | | | $ | 11,661 | |
Foreign exchange contracts | | | - | | | | 142 | | | | - | | | | 142 | | | | - | | | | 92 | | | | - | | | | 92 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total assets | | $ | 10,553 | | | $ | 142 | | | $ | - | | | $ | 10,695 | | | $ | 11,661 | | | $ | 92 | | | $ | - | | | $ | 11,753 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Foreign exchange contracts | | $ | - | | | $ | (655 | ) | | $ | - | | | $ | (655 | ) | | $ | - | | | $ | (24 | ) | | $ | - | | | $ | (24 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total liabilities | | $ | - | | | $ | (655 | ) | | $ | - | | | $ | (655 | ) | | $ | - | | | $ | (24 | ) | | $ | - | | | $ | (24 | ) |
8.9. | Derivative Instruments |
The Company utilizes forward foreign currency exchange contracts to manage market risks associated with the fluctuations in foreign currency exchange rates. It is the Company's policy to use such derivative financial instruments to protect against market risk arising in the normal course of business in order to reduce the impact of these exposures. The Company minimizes credit exposure by limiting counterparties to nationally recognized financial institutions.
As of September 30, 2014,2015, the Company had foreign exchange contracts outstanding of approximately 106,0002.6 million Euro, 0.6 million Pounds Sterling, 34,000 Canadian dollars,0.5 million Australian Dollars, and 1.512.5 million EuroJapanese Yen at fixed rates. The contracts expire on various dates through JuneDecember 2016. At December 31, 2013,2014, the Company had contracts outstanding of approximately 237,0001.4 million Euro, 0.3 million Pounds Sterling, 13.30.8 million Euro,Australian Dollars, and 10.10.5 million Japanese YenMalaysian Ringgits at fixed rates.
The Company has not designated any of the foreign exchange contracts outstanding as hedges and has recorded the estimated fair value of the contracts in the consolidated balance sheets as follows:
| | September 30, | | | December 31, | | | September 30, | | | December 31, | |
(in thousands) | | 2014 | | | 2013 | | | 2015 | | | 2014 | |
| | | | | | | | | | | | |
Asset derivatives | | | | | | | | | | | | |
Prepaid expenses and other current assets | | $ | 23 | | | $ | 140 | | | $ | 121 | | | $ | 71 | |
Other assets | | | 7 | | | | 2 | | | | 3 | | | | 21 | |
| | | 30 | | | | 142 | | | | 124 | | | | 92 | |
Liability derivatives | | | | | | | | | | | | | | | | |
Other current liabilities | | | (14 | ) | | | (637 | ) | | | (15 | ) | | | (23 | ) |
Other liabilities | | | (2 | ) | | | (18 | ) | | | (92 | ) | | | (1 | ) |
| | | (16 | ) | | | (655 | ) | | | (107 | ) | | | (24 | ) |
| | | | | | | | | | | | | | | | |
Net fair value | | $ | 14 | | | $ | (513 | ) | | $ | 17 | | | $ | 68 | |
The changes in the fair value of the foreign exchange contracts are included in net gain (loss) on derivative instruments in the consolidated statements of operations.
The foreign currency denominated contract receivables, billings in excess of revenue earned and subcontractor accruals that are related to the outstanding foreign exchange contracts are remeasured at the end of each period into the functional currency using the current exchange rate at the end of the period. The gain or loss resulting from such remeasurement is also included in net gain (loss) on derivative instruments in the consolidated statements of operations.
For the three and nine months ended September 30, 20142015 and 2013,2014, the Company recognized a net gain (loss) on its derivative instruments as outlined below:
| | Three Months ended September 30, | | | Nine Months ended September 30, | | | Three Months ended September 30, | | | Nine Months ended September 30, | |
(in thousands) | | 2014 | | | 2013 | | | 2014 | | | 2013 | | | 2015 | | | 2014 | | | 2015 | | | 2014 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Foreign exchange contracts- change in fair value | | $ | 58 | | | $ | (481 | ) | | $ | 312 | | | $ | (480 | ) | | $ | 34 | | | $ | 58 | | | $ | (53 | ) | | $ | 312 | |
Remeasurement of related contract receivables, billings in excess of revenue earned, and subcontractor accruals | | | 11 | | | | 403 | | | | (134 | ) | | | 259 | | | | (14 | ) | | | 11 | | | | (6 | ) | | | (134 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Gain (loss) on derivative instruments, net | | $ | 69 | | | $ | (78 | ) | | $ | 178 | | | $ | (221 | ) | | $ | 20 | | | $ | 69 | | | $ | (59 | ) | | $ | 178 | |
9.10. | Stock-Based Compensation |
The Company recognizes compensation expense for all equity-based compensation awards issued to employees, directors and non-employees that are expected to vest. Compensation cost is based on the fair value of awards as of the grant date. The Company recognized $175,000$136,000 and $203,000$175,000 of stock-based compensation expense for the three months ended September 30, 20142015 and 2013,2014, respectively, under the fair value method and recognized $514,000$407,000 and $641,000$514,000 of stock-based compensation expense for the nine months ended September 30, 2015 and 2014, respectively.
In the third quarter 2015, the Company granted 975,000 Restricted Stock Unit's with an aggregate fair value of $673,500. The RSUs vest upon the achievement of specific performance measures. The fair value of the RSUs is expensed ratably over the requisite service period, which ranges between one and 2013,five years.
The Company granted 10,000 and 60,000 stock options for the three and nine months ended September 30, 2015, respectively. The fair value of the options granted for the three and nine months ended September 30, 2015 was $8,000 and $48,000, respectively. The Company granted 0 and 60,000 stock options for the three and nine months ended September 30, 2014, respectively. The fair value of the options granted for the nine months ended September 30, 2014 was $56,000. The Company granted 0 and 64,500 stock options for the three and nine months ended September 30, 2013, respectively. The fair value of the granted options at the grant date was $78,000.$56,000.
At September 30, 20142015 and December 31, 2013,2014, the Company had no long-term debt outstanding.debt.
LineLines of Credit
Susquehanna Bank
TheAt September 30, 2015, the Company hashad a Master Loan and Security Agreement and Revolving Credit Note with Susquehanna Bank ("Susquehanna"). The Company and its subsidiaries,subsidiary, GSE Power Systems,Performance Solutions, Inc., and GSE EnVision LLC, arewere jointly and severally liable as co-borrowers. The Loan Agreement provides a $7.5 million revolving line of credit for the purpose of (i) issuing stand-by letters of credit and (ii) providing working capital. Working capital advances bear interest at a rate equal to the Wall Street Journal Prime Rate of Interest, floating with a floor of 4.5%4 1/2%. InThe agreement expires on June 2014, Susquehanna extended the Revolving Credit Expiration Date to March 31, 2015.
30, 2016.
As collateral for the Company's obligations, the Company granted a first lien and security interest in all of the assets of the Company, including but not limited to, accounts receivable, inventory, proceeds and products, intangibles, trademarks, patents, intellectual property, and machinery and equipment.
On September 9, 2014, the Company signed a Third Comprehensive Amendment to the Master Loan and Security Agreement. According to the Third Amendment, the Company wasis to maintain a segregated cash collateral account ("Cash Collateral Account") at Susquehanna Bank equal to the greater of (i) $3.0 million or (ii) the aggregate principal amounts of all Loans outstanding under the Revolving Credit Facility (including any issued and outstanding letters of credit, working capital advances, and negative foreign exchange positions) as security for the Company's obligations. Under this amendment,Amendment, Susquehanna Bank shall have complete and unconditional control over the Cash Collateral Account.
cash collateral account.
On September 30, 2014, Susquehanna Bank collateralized the outstanding letters of credit issued under the master line of credit. The Cash CollateralAt September 30, 2015 and December 31, 2014, the cash collateral account totaled $3.1$3.6 million and was$4.2 million, respectively. The balances were classified as restricted cash on the balance sheet.
The credit agreements contain certain restrictive covenants regarding future acquisitions and incurrence of debt. In addition,On July 31, 2015, the credit agreements containCompany signed a Fifth Comprehensive Amendment to the Master Loan and Security Agreement in which the Company's financial covenants with respectwere reduced from four to two, and the Company's cash flow coverage ratio, minimum tangible capital base, quick ratio, and tangible capital base ratio. At September 30, 2014, the Company had not paid any interest or principal payments related to any borrowings for over one year. As such, the cash flow coverage ratio is not applicable at September 30, 2014.covenant targets were adjusted.
| | As of |
| Covenant | September 30, 20142015 |
| | |
Minimum tangible capital base | Must Exceed $26.0$10.5 million | $22.610.9 million |
Quick ratio | Must Exceed 2.001.00 : 1.00 | 2.10 : 1.00 |
Tangible capital base ratio | Not to Exceed .75 : 1.00 | .691.43 : 1.00 |
As of September 30, 2014,2015, the Company was not in compliance with its "After tax net income" financial covenant and its "Minimum tangible capital base" covenant,covenants as defined above. As noted above,
IberiaBank
At September 30, 2015, Hyperspring, LLC has a $1.0 million working capital line of credit with IberiaBank for a one year period. Under the executed promissory note, interest is payable monthly at the rate of 1.00 percentage points over the prime rate of interest as published in the money rate section of the Wall Street Journal resulting in an effective interest rate of 4.25%. The line is secured by all accounts of Hyperspring and guaranteed by GSE Systems, Inc. The line of credit expires on July 6, 2016. At September 30, 2015, the Company has cash collateralized allhad no outstanding amounts under the line of its outstanding letterscredit.
Letters of credit as a result of the Third Amendment to its Master Loan Agreement.
Credit and Bonds
As of September 30, 2014,2015, the Company was contingently liable for twelvehas thirteen standby letters of credit and twoone surety bondsbond totaling $4.4$3.6 million which represent advance payment and performance bonds on twelve contracts. The Company has deposited the full value of twelvethirteen standby letters of credit in escrow accounts, amounting to $4.2$3.6 million, which have been restricted in that the Company does not have access to these funds until the related letters of credit have expired. The cash has been recorded on the Company's balance sheet at September 30, 20142015 as restricted cash.
As the Company recognizes revenue under the percentage-of-completion method, it provides an accrual for estimated future warranty costs based on historical experience and projected claims. The activity in the warranty account is as follows:
(in thousands) | | | |
| | | |
Balance at December 31, 2013 | | $ | 1,851 | |
Warranty provision | | | 574 | |
Warranty claims | | | (905 | ) |
Currency adjustment | | | (18 | ) |
Balance at September 30, 2014 | | $ | 1,502 | |
12. | Contingent Consideration |
ASC 805 requires that contingent consideration be recognized at fair value on the acquisition date and be remeasured each reporting period with subsequent adjustments recognized in the consolidated statement of operations.
As of September 30, 2014 and December 31, 2013, contingent consideration included in the other current liabilities on the consolidated balance sheet totaled $471,000 and $492,000, respectively. As of September 30, 2014 and December 31, 2013, the Company also had accrued contingent consideration totaling $0 and $409,000, respectively, which is included in other long-term liabilities on the consolidated balance sheet and represents the portion of contingent consideration estimated to be payable greater than twelve months from the balance sheet date. During the three and nine months ended September 30, 2014, the Company made payments of $0 and $500,000 related to the liability-classified contingent consideration arrangements. During the three and nine months ended September 30, 2013, the Company made payments of $702,000 and $1.9 million related to the liability-classified contingent consideration arrangements.
(in thousands) | | | |
| | | |
Balance at December 31, 2014 | | $ | 1,456 | |
Warranty provision | | | 514 | |
Warranty claims | | | (312 | ) |
Currency adjustment | | | (44 | ) |
Balance at September 30, 2015 | | $ | 1,614 | |
The Company files in the United States federal jurisdiction and in several state and foreign jurisdictions. Because of the net operating loss carryforwards, the Company is subject to U.S. federal and state income tax examinations from years 1997 forward and is subject to foreign tax examinations by tax authorities for years 2007 and forward. Open tax years related to state and foreign jurisdictions remain subject to examination but are not considered material to our financial position, results of operations or cash flows.
An uncertain tax position taken or expected to be taken in a tax return is recognized in the financial statements when it is more likely than not (i.e., a likelihood of more than 50%) that the position would be sustained upon examination by tax authorities that have full knowledge of all relevant information. A recognized tax position is then measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. Interest and penalties related to income taxes are accounted for as income tax expense. The Company has appropriately accounted for its uncertain tax positions.
The Company expects to pay income taxes in India in 2014. In 2013,2014, the Company paid income taxes in the UK and India.India and expects to do so again in 2015. The Company has a full valuation allowance on its U.S., ChineseSwedish, and SwedishChinese net deferred tax assets at September 30, 2014.2015.
14. | Preferred Stock Rights |
On March 21, 2011, the Board of Directors of the Company declared a dividend, payable to holders of record as of the close of business on April 1, 2011, of one preferred stock purchase right (a "Right") for each outstanding share of common stock, par value $0.01 per share, of the Company (the "Common Stock"). In addition, the Company will issue one Right with each new share of Common Stock issued. In connection therewith, on March 21, 2011, the Company entered into a Stockholder Protection Rights Agreement (as amended from time to time, the Rights Agreement) with Continental Stock Transfer & Trust Company, as Rights Agent, which has a term of three years, unless amended by the Board of Directors in accordance with the terms of the Rights Agreement. On March 21, 2014, the Rights Agreement was amended to extend the term an additional two years. The Rights Agreement will now expire on March 21, 2016. The Rights trade with and are inseparable from the Common Stock and are not evidenced by separate certificates unless they become exercisable. Each Right entitles its holder to purchase from the Company one-hundredth of a share of participating preferred stock having economic and voting terms similar to the Common Stock at an exercise price of $8.00 per Right, subject to adjustment in accordance with the terms of the Rights Agreement, once the Rights become exercisable. Under the Rights Agreement, the Rights become exercisable if any person or group acquires 20% or more of the Common Stock or, in the case of any person or group that owned 20% or more of the Common Stock as of March 21, 2011, upon the acquisition of any additional shares by such person or group. The Company, its subsidiaries, employee benefit plans of the Company or any of its subsidiaries and any entity holding Common Stock for or pursuant to the terms of any such plan are accepted. Upon exercise of the Right in accordance with the Rights Agreement, the holder would be able to purchase a number of shares of Common Stock from the Company having an aggregate market price (as defined in the Rights Agreement) equal to twice the then-current exercise price for an amount in cash equal to the then-current exercise price. In addition, the Company may, in certain circumstances and pursuant to the terms of the Rights Agreement, exchange the Rights for one share of Common Stock or an equivalent security for each Right or, alternatively, redeem the Rights for $0.001 per Right. The Rights will not prevent a takeover of our Company, but may cause substantial dilution to a person that acquires 20% or more of the Company's Common Stock.
On March 21, 2011, the Board of Directors authorized the purchase of up to $3.0 million of the Company's common stock in accordance with the safe harbor provisions of Rule 10b-18 of the Securities Exchange Act of 1934.
15.Segment Information
The Company completedhas two reportable business segments. The Performance Improvement Solutions business segment provides simulation, training and engineering products and services delivered across the share repurchase program in October 2013breadth of industries we serve. Solutions include simulation for both training and thus will not be repurchasing shares during 2014. Duringengineering applications. Example training applications include turnkey and custom training services, while engineering services include plant design verification and validation. We provide these services across all our market segments. Contracts typically range from ten months to three years.
The Nuclear Industry Training and Consulting services segment provides specialized workforce solutions primarily to the threeU.S. nuclear industry, working at our clients' facilities. This business is managed through our Hyperspring, LLC subsidiary. Hyperspring has been providing these services since 2005.
The following table sets forth the revenue and nine months ended September 30, 2013 the Company repurchased 177,755operating results attributable to each reportable segment and 395,254 shares, respectively, at an aggregate costincludes a reconciliation of $283,000segment revenue to consolidated revenue and $651,000, respectively.operating results to consolidated loss before income tax expense:
(in thousands) | | Three Months ended September 30, | | | Nine Months ended September 30, | |
| | 2015 | | | 2014 | | | 2015 | | | 2014 | |
| | | | | | | | | | | | |
Contract revenue: | | | | | | | | | | | | |
Performance Improvement Solutions | | $ | 9,903 | | | $ | 7,823 | | | $ | 26,911 | | | $ | 24,823 | |
Nuclear Industry Training and Consulting | | | 5,058 | | | | - | | | | 15,678 | | | | - | |
| | $ | 14,961 | | | $ | 7,823 | | | $ | 42,589 | | | $ | 24,823 | |
| | | | | | | | | | | | | | | | |
Operating income (loss): | | | | | | | | | | | | | | | | |
Performance Improvement Solutions | | $ | (3,604 | ) | | $ | (1,905 | ) | | $ | (5,493 | ) | | $ | (5,948 | ) |
Nuclear Industry Training and Consulting | | | 442 | | | | - | | | | 1,104 | | | | - | |
Loss on change in fair value of contingent consideration, net | | | (226 | ) | | | (42 | ) | | | (739 | ) | | | (69 | ) |
| | | | | | | | | | | | | | | | |
Operating loss | | $ | (3,388 | ) | | $ | (1,947 | ) | | $ | (5,128 | ) | | $ | (6,017 | ) |
| | | | | | | | | | | | | | | | |
Interest income, net | | | 19 | | | | 44 | | | | 67 | | | | 103 | |
Gain (loss) on derivative instruments, net | | | 20 | | | | 69 | | | | (59 | ) | | | 178 | |
Other expense, net | | | (156 | ) | | | - | | | | (235 | ) | | | (7 | ) |
Loss before income taxes | | $ | (3,505 | ) | | $ | (1,834 | ) | | $ | (5,355 | ) | | $ | (5,743 | ) |
Per the Hyperspring LLC Purchase Agreement, a $1.2 million payment was due to the former Hyperspring members if Hyperspring were successful in renewing its contract with the Tennessee Valley Authority ("TVA") for at least a two year period for substantially the same scope as was being provided at the acquisition date and with substantially the same economics. On November 14, 2014,September 24, 2015, TVA executed a three-year renewal contract with Hyperspring; accordingly, the Company through its operating subsidiary, GSE Power Systems, Inc. ("GSE Power"), acquiredpaid the $1.2 million payment to the former Hyperspring LLC ("Hyperspring") pursuant to a Membership Interests Purchase Agreement ("Purchase Agreement") with the sellers of Hyperspring ("Sellers"). Hyperspring, headquarteredmembers in Huntsville, Alabama, specializes in training and development, plant operations support services, and staff augmentation, primarily in the United States nuclear industry. Hyperspring will operate as a wholly-owned subsidiary of GSE Power.October 2015.
GSE Power paid the Sellers an aggregate of $3.0 million in cash at the closing date. The initial $3.0 million payment is subject to adjustments based on the subsequent determination of the actual working capital balance as of the closing date. In addition, GSE Power may be required, pursuant to the terms of the Purchase Agreement, to pay the Sellers up to an additional $8.4 million if Hyperspring attains certain EBITDA (earnings before interest, taxes, depreciation and amortization) targets for the three-year period ending November 13, 2017.
In conjunction with the Hyperspring acquisition, GSE Power invested $250,000 for a 50 % interest in IntelliQlik, LLC ("IntelliQlik") and is obligated to contribute an additional $250,000 upon the attainment by IntelliQlik of certain milestones. IntelliQlik is jointly owned by GSE Power and one of the former shareholders of Hyperspring. IntelliQlik will develop a software platform for online learning and learning management for all energy sectors, including nuclear, thermal, oil & gas, and hydro-electric. The IntelliQlik platform will also include applications to support plant engineering, operations and maintenance, as well as provide a platform for Software as a Service to deliver learning materials, industry recruitment services, and specialized simulator training programs.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
GSE Systems, Inc. ("GSE Systems", "GSE" or the "Company") is a world leader in real-time high fidelity simulation. The Company provides simulation and educational solutions and services to the nuclear and fossil electric utility industry, and the chemical and petrochemical industries.
GSE is the parent company of:of the following entities:
· | GSE Performance Solutions, Inc. (formerly GSE Power Systems, Inc.), a Delaware corporation; |
· | GSE Power Systems, AB, a Swedish corporation; |
· | GSE Engineering Systems (Beijing) Co. Ltd., a Chinese limited liability company; |
· | GSE Systems, Ltd., a Scottish limited liability company; |
· | GSE EnVision, LLC, a New Jersey limited-liability company; |
· | EnVision Systems (India) Pvt. Ltd., an Indian limited liability company; and |
· | Hyperspring, LLC, an Alabama limited liability company. |
The Company has a 50% interest in IntelliQlik, LLC, a Delaware limited liability company and a 50% interest in General Simulation Engineering RUS LLC, a Russian closed joint-stock company.
The Company has two reportable business segments: Performance Improvement Solutions which provides simulation, engineering, and training solutions and services to the nuclear and fossil fuel power industry and to the chemical and petrochemical industries and Nuclear Industry Training and Consulting (formerly our "Staff Augmentation" segment) which provides personnel to fulfill staff positions on a short-term basis to energy industry customers.
Cautionary Statement Regarding Forward-Looking Statements
This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward looking statements. Forward-looking statements are not statements of historical facts, but rather reflect our current expectations concerning future events and results. We use words such as "expects", "intends", "believes", "may", "will" and "anticipates" to indicate forward-looking statements. Because these forward-looking statements involve risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements, including, but not limited to, those factors set forth under Item 1A - Risk Factors of the Company's 20122014 Annual Report on Form 10-K and those other risks and uncertainties detailed in the Company's periodic reports and registration statements filed with the Securities and Exchange Commission. We caution that these risk factors may not be exhaustive. We operate in a continually changing business environment, and new risk factors emerge from time to time. We cannot predict these new risk factors, nor can we assess the effect, if any, of the new risk factors on our business or the extent to which any factor or combination of factors may cause actual results to differ from those expressed or implied by these forward-looking statements.
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, whether as a result of new information, future events or otherwise. You are cautioned not to unduly rely on such forward-looking statements when evaluating the information presented in this report.
General Business Environment
We operate through two reportable business segments: Performance Improvement Solutions and Nuclear Industry Training and Consulting. Each segment focuses on delivering solutions to certain classes of customers or within targeted markets. Marketing and communications, accounting, finance, legal, human resources, information systems and other administrative services are organized at the corporate level. Business development and sales resources are generally aligned with each segment to support existing customer accounts and new customer development. Our two business segments are:
On November 14, 2014,Performance Improvement Solutions
Our Performance Improvement Solutions business segment primarily encompasses our next-generation power plant and process simulation solutions, as well as engineering solutions. This segment includes various simulation products, engineering services, and operation training systems delivered across the Company,industries we serve: primarily nuclear and fossil power generation, and the petroleum industry. Our simulation solutions include the following: (1) simulation tools and services, including operator training systems, for the nuclear power industry, (2) simulation tools and services, including operator training systems, for the fossil power industry, (3) simulation tools and services for the petroleum industry used to teach fundamental industry processes and control systems to newly hired employees.
Nuclear Industry Training and Consulting
Nuclear Industry Training and Consulting provides highly specialized and skilled nuclear operations instructors and other consultants to the nuclear power industry. These employees work at our clients' facilities under client direction. Examples of these highly skilled positions are primarily senior reactor operations instructors, procedure writers, work management specialists, planners and training material developers. This business is managed through its operating subsidiary, GSE Power Systems, Inc. ("GSE Power") completed the acquisition ofour Hyperspring LLC subsidiary. The business model, management focus, margins and made an investmentother factors clearly separate this business line from the rest of the GSE product and service portfolio. Hyperspring has been providing these services since 2005.
Industry Trends
We believe the most serious future challenge facing the industries we serve is access to and continued development of a trained and efficient workforce. This challenge manifests itself in IntelliQlik, LLC, in which GSE Power is nowthe increasing pace of the knowledge lost as a 50% owner.large percentage of the experienced workforce reaches retirement age over the next ten years. The additionreplacement of these two companiesexperienced workers by a new generation who have different learning styles and work expectations is a critical challenge that the power and process industries must address. Globally, as more people increase their standard of living so too will global power demand increase, which will require the on-going construction of power plants. Developing a skilled labor force to operate these plants and keep their skills honed and evergreen is another key challenge facing the global power industry. Additionally, there seems to be an emerging enlightenment that nuclear energy is an increasingly desirable form of energy production as there are no greenhouse gas emissions associated with nuclear power generation. We believe that GSE is well positioned to take advantage of these trends as they emerge.
Growing Global Power Demand
At the same time that experienced nuclear workforce is retiring, new nuclear capacity will be coming into operation. According to the GSE familyInternational Energy Agency's, World Energy Outlook 2014, global energy demand is projected to rise 37% by 2040. Similarly the BP Energy Outlook 2035 projects a 41% rise in global energy consumption between 2012 and 2035. While a diverse mix of power generation technologies will be used to satisfy the increasing demand, nuclear energy will continue to play a significant role. Nuclear energy output is expected to rise at around 1.9% per year until 2035. There are currently 67 nuclear plants under construction in 15 countries, including 24 in China, 9 in Russia, 6 in India and 4 in the United Arab Emirates according to the Nuclear Energy Institute. Other countries with multiple reactors under construction include Slovakia, Korea, Pakistan, Belarus and Japan.
Five reactors are currently under construction in the US including two for Southern Nuclear at the Vogtle Site; two at SCANA's VC Summer site and one at the Tennessee Valley Authority's Watts Bar generating facility. The UK recently announced collaboration with Chinese nuclear entities that will help usfinance new reactors at the Hinkley Point site and set the stage for additional reactor projects in the UK in the future.
According to achieve our goalthe World Nuclear Association, there are 165 reactors in 27 countries in specific phases of "Changingplanning that will be operating by 2030.
Growing awareness of strategic environmental advantages of nuclear energy
The growth in nuclear energy is aided by its increasing recognition as a critical technology for reaching the WayCO2 emission reduction targets recommended by the scientific community. According to the UN's Intergovernmental Panel on Climate Change and research from the National Renewable Energy Industry Learns."Laboratory, greenhouse gas emissions across the entire lifecycle of nuclear energy from uranium mining to decommissioning, are comparable with those of wind power.
Hyperspring provides a diverse suite of solutions toWorkforce Trends
Power Engineering Magazine article: Who will Replace Power Aging Workforce? cites the energy industry, including training, staffing, and operations support, including: Procedure Development, Work Management, Tagging/Labeling, Outage Execution, Planning/Scheduling, Corrective Action, Self-Assessments, and Equipment Reliability. In addition to these services, Hyperspring also provides turnkey training programs for, Generic Fundamentals Exams (GFES), Maintenance, Accreditation Training Visit (ATV) preparation and Senior Reactor Operator (SRO) Certification. Customers include TVA, Entergy, PSEG Nuclear LLC, and NRG Energy Inc.
IntelliQlik has been formed to create a delivery platform for on-line training and learning management for the energy industry. Through Nuclear University, Power Systems University, Gas Turbine University, Oil and Gas University, and other platforms, IntelliQlik will train and certify qualified candidates for an energy industry with an ever increasing need for skilled professionals.
For years we have described ourselves as a Simulation, Training and Engineering company, providing mainly simulation and engineering solutions to improve designs, de-risk projects and train operators. With the acquisition of Hyperspring and the formation of IntelliQlik, we are transforming into a Human and Plant Performance Improvement Lifecycle Company. Together we will improve human performance through turnkey training solutions, with our unique visualization and simulation environment, with a next-generation learning delivery platform through IntelliQlik and though a staff of instructors, engineers and specialists to support our clients' internal projects. When we further add our engineering and simulation capabilities, we not only address human performance, but performance of an entire plant from design through operations and optimization.
Why is there a need to focus on the performance improvement lifecycle for the energy industry? The National Research CouncilInstitute estimates that 39% of the National Academies was hirednuclear workforce will be eligible to retire by the U.S. Department of Energy's National Energy Technology Laboratory to conduct a study of the emerging workforce trends2018 resulting in the U.S. energy and mining industries. The study included an analysis of (1) the need for and availability20,000 new workers to replace them. The article goes on to discuss the US Department of workers forLabor estimates as much as 50% of the oil, natural gas, coal, geologic carbon sequestration, nuclear, geothermal, solar, wind and nonfuel minerals industries; (2) the availability of skilled labor at both entry level and more senior levels; and (3) recommendations for actions needed to meet future labor requirements. The results of this study were released in their 2013 report entitled Emerging Workforce Trendsnation's utility workforce will be retiring in the U.S. Energy and Mining Industries: A Call to Action.
The study identified three significant trends:
· | About 1/3 of the U.S. energy industry workforce is comprised of "baby boomers" (those born between 1946 and 1964), and they are poised to retire in great numbers by the end of this decade, |
· | There are too few younger workers in the pipeline to replace them, and many of the younger workers lack the necessary science, technology, engineering and math (STEM) skills needed for many energy jobs, and |
· | There is a critical need to capture the knowledge of experienced employees before they leave. |
next 5-10 years.
Exacerbating this workforce trend is the continuing domestic and global population increases which will continue to increase the overall demand for energy. As the U.S.' current educational system is not able to provide the needed trained workers in adequate numbers, the onus is on the energy industry itself to address its training needs at both entry levels and more senior levels. A complete lifecycle of training, from a worker's entry into the energy industry through to the achievement of expert knowledge and capability,skills, is now required for the energy industry more than ever.
Power Magazine article Manpower Report: Power Industry Faces Talent Shortage, (May 2014) cites a survey by Manpower which say 58% of executives struggle finding the talent they need. Students are consistently underperforming in science, technology, engineering and math and, on average, only 45% of applicants are passing basic skilled-trade aptitude tests.
21Business leaders are recognizing the problem and the challenge ahead. A study published in Harvard Business Review (May 28, 2013) revealed that Boards of Directors identified Talent Management as their number one concern. Those same executives rated their companies very poorly on key elements of talent management including attracting, hiring, assessing and developing top talent.
As companies are always under pressure to improve productivity, reduce costs and improve operating margins, energy industry companies have been working to create leaner, more competent organizations that can rapidly respond to a changing environment. Increasing pressures to improve profitability have resulted in flatter organizational structures within companies with less middle management to exercise control. According to the International Atomic Energy Agency (IAEA) article, A Systematic Approach to Human Performance Improvement in Nuclear Power Plants: Training Solutions, companies understand and value the potential contribution that every employee can make to their overall success. As a result, companies have been emphasizing the quality of their human performance processes and the building of excellent educational processes for their employees.
Our Solutions
Our two overarching solution sets, Entry2Expert (E2E) and Design2Decom (D2D) bring together the collection of skills GSE has amassed over more than 40 years from its traditional roots in custom simulation to the recent acquisition of the specialized engineering and training capabilities.
Entry2Expert Performance Cycle
To assist energy companiesour clients in creating world-class internal training and performance improvement programs, GSE iswe are building the E2E (Entry to Expert) Performance Improvement Cycle solutions,Solution, a set of integrated extensibleand scalable products and services which provide a structured program from employee selection and onboarding through continuous skills improvement for experienced employees and includes:
· | Employee Recruiting, Screening, and Selection |
· | Training Needs Assessments |
· | Training Course Development |
· | Self Paced Training Tutorials |
· | Universal Training Simulators |
· | Plant-Specific Operator Training Simulators |
· | Plant-Specific Engineering Design Simulators |
employees. GSE can now provide the right training solution for the right step in each employee's career.
The goal of our E2E Performance Improvement Cycle offeringsperformance lifecycle offering is to ensurehelp improve our customer's bottom line through superior human achievement in screening and selecting the dimensions of:
· | Risk reduction by minimizing mistakes |
· | Mitigation of the effects of retiring workforce |
· | Workforce agility via commonality of learning tools/models |
· | Certification/compliance |
22
right workforce, shortening the learning process, reducing human errors, improving worker agility and mitigating the effects of retirements and turnover.
GSE recognized this growing need for energy industry training several years ago and began developing various training solutions leveragingDesign2Decom Performance Cycle
Just like the useE2E process helps improve the performance of our simulation technology. For example,
· | GSE created a 163 module, five-simulator training course that we sold to the Emirates Simulation Academy (ESA) LLC, in the UAE, a training academy that was created by GSE and two other partners in 2007. GSE continues to use and re-sell these training courses. |
· | GSE worked with the University of Strathclyde in Glasgow, Scotland to incorporate GSE's simulation into the University's degreed and industrial education programs. |
· | GSE acquired EnVision training products (GSE EnVision) to provide a full suite of training materials to the petroleum and process industry. This training material includes computer-based tutorials and universal process simulators and is available in multiple languages. |
· | GSE developed and taught multiple 20-week "Nuclear Operator Jump Start Training Programs" for Southern Nuclear Company in Augusta, GA, successfully training the operators and instructors for the first advanced nuclear plant in the United States. GSE used our VPanel™ interactive visual training simulator, which was a key reason that this training was extremely successful. |
· | GSE developed multiple innovative and interactive 3D training devices for the electric generating and petroleum process industries. GSE's ACTIV3Di training devices are being used worldwide by members of the Electric Power Research Institute (EPRI) for training and troubleshooting complex components. These training devices incorporate knowledge from subject matter experts (SMEs) using computers and tablet displays that new learners value highly. |
· | GSE developed a Generic Pressurized Water Reactor (GPWR) product that is being used worldwide for research and training in research centers and universities. The GPWR includes a full-scope simulator, operating procedures, plant system descriptions, and training materials and can be used on GSE's VPanel™ or commonly available computer equipment. |
· | GSE provided innovative training tools and simulators to EDF Energy's Cannington Court training center, helping to transform the 900 year old facility into a showcase training center. |
Case studies demonstrate thatcustomers' people, D2D encompasses a range of services and technologies aimed at improving plant performance. From getting a client's system on-line faster, to operating safety, and support from experienced staff throughout the inclusionlifecycle, services include: engineering and specialized plant support services, virtual commissioning of "serious gaming" technology such as immersive 3D environments can reduce training timeplants and improve learning significantly. In fact, the Royal Canadian Army was able to reduce the cost of trainingplant changes, safety and increase the pass rate of students by incorporating gaming into the curriculum. Due to the advancement of computer processing powercompliance services and graphics technology, immersive commercially viable off-the-shelf 3D game engines are readily available. Additionally, this style of learning also lends itself to the next generation workforce, and as such, GSE is investing significantlyassistance in 3D visualization training products. This investment comes in the form of strategic hires, investment in technology, and software product development. Through development efforts already undertaken, GSE's engineers have discovered how to link our industry-leading, high fidelity models to commercially available off-the-shelf game engines. This enables us to "make the invisible visible". The use of GSE's 3D visualization technology allows users to now see the inside of various components of a power plant such as the inside of an operating reactor, steam generator, or turbine generator. Blending the learning strategy of incorporating 3D visualization with high-fidelity, real time simulation models will allow GSE to provide the energy industry with better, faster, and less costly training ideally suited for the next generation workforce, which we have branded as ACTIV-3Di.
The dramatic increase in energy demand world-wide over the next 30 years will not only require significant amounts of training for new employees but also require new plants of all sources, too. Obviously, these new plants will need to be engineered and designed prior to construction, and GSE's modeling tools are being used more and more to verify and validate control system design and overall plant designs. Finding design errors during engineering rather than construction allows plant startup to occur sooner saving countless dollars and allowing revenue generation sooner. GSE is developing new design solutions leveraging our high fidelity simulation models to improve and streamline the plant engineering process.decommissioning.
Results of Operations
The following table sets forth the results of operations for the periods presented expressed in thousands of dollars and as a percentage of revenue:
(in thousands) | | Three Months ended September 30, | | | Nine Months ended September 30, | | | Three Months ended September 30, | | | Nine Months ended September 30, | |
| | 2014 | | | % | | | 2013 | | | % | | | 2014 | | | % | | | 2013 | | | % | | | 2015 | | | % | | | 2014 | | | % | | | 2015 | | | % | | | 2014 | | | % | |
Contract revenue | | $ | 7,823 | | | | 100.0 | % | | $ | 11,883 | | | | 100.0 | % | | $ | 24,823 | | | | 100.0 | % | | $ | 35,300 | | | | 100.0 | % | | $ | 14,961 | | | | 100.0 | % | | $ | 7,823 | | | | 100.0 | % | | $ | 42,589 | | | | 100.0 | % | | $ | 24,823 | | | | 100.0 | % |
Cost of revenue | | | 5,368 | | | | 68.6 | % | | | 8,811 | | | | 74.1 | % | | | 17,497 | | | | 70.5 | % | | | 26,332 | | | | 74.6 | % | | | 11,158 | | | | 74.6 | % | | | 5,368 | | | | 68.6 | % | | | 32,649 | | | | 76.7 | % | | | 17,497 | | | | 70.5 | % |
Write-down of capitalized software development costs | | | - | | | | 0.0 | % | | | - | | | | 0.0 | % | | | - | | | | 0.0 | % | | | 2,174 | | | | 6.2 | % | | | 1,538 | | | | 10.3 | % | | | - | | | | 0.0 | % | | | 1,538 | | | | 3.6 | % | | | - | | | | 0.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Gross profit | | | 2,455 | | | | 31.4 | % | | | 3,072 | | | | 25.9 | % | | | 7,326 | | | | 29.5 | % | | | 6,794 | | | | 19.2 | % | | | 2,265 | | | | 15.1 | % | | | 2,455 | | | | 31.4 | % | | | 8,402 | | | | 19.7 | % | | | 7,326 | | | | 29.5 | % |
Operating expenses: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Selling, general and administrative | | | 4,226 | | | | 54.0 | % | | | 3,808 | | | | 32.1 | % | | | 12,822 | | | | 51.6 | % | | | 11,919 | | | | 33.8 | % | | | 3,811 | | | | 25.5 | % | | | 3,954 | | | | 50.5 | % | | | 11,031 | | | | 25.9 | % | | | 11,939 | | | | 48.0 | % |
Goodwill impairment loss | | | - | | | | 0.0 | % | | | - | | | | 0.0 | % | | | - | | | | 0.0 | % | | | 4,462 | | | | 12.6 | % | |
Restructuring charges | | | | 1,600 | | | | 10.7 | % | | | 272 | | | | 3.5 | % | | | 1,746 | | | | 4.1 | % | | | 883 | | | | 3.6 | % |
Depreciation | | | 140 | | | | 1.8 | % | | | 135 | | | | 1.1 | % | | | 413 | | | | 1.7 | % | | | 434 | | | | 1.2 | % | | | 119 | | | | 0.8 | % | | | 140 | | | | 1.8 | % | | | 383 | | | | 0.9 | % | | | 413 | | | | 1.7 | % |
Amortization of definite-lived intangible assets | | | 36 | | | | 0.5 | % | | | 51 | | | | 0.5 | % | | | 108 | | | | 0.4 | % | | | 155 | | | | 0.4 | % | | | 123 | | | | 0.8 | % | | | 36 | | | | 0.5 | % | | | 370 | | | | 0.9 | % | | | 108 | | | | 0.4 | % |
Total operating expenses | | | 4,402 | | | | 56.3 | % | | | 3,994 | | | | 33.7 | % | | | 13,343 | | | | 53.7 | % | | | 16,970 | | | | 48.0 | % | | | 5,653 | | | | 37.8 | % | | | 4,402 | | | | 56.3 | % | | | 13,530 | | | | 31.8 | % | | | 13,343 | | | | 53.7 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Operating loss | | | (1,947 | ) | | | (24.9 | )% | | | (922 | ) | | | (7.8 | )% | | | (6,017 | ) | | | (24.2 | )% | | | (10,176 | ) | | | (28.8 | )% | | | (3,388 | ) | | | (22.7 | )% | | | (1,947 | ) | | | (24.9 | )% | | | (5,128 | ) | | | (12.1 | )% | | | (6,017 | ) | | | (24.2 | )% |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest income, net | | | 44 | | | | 0.6 | % | | | 22 | | | | 0.2 | % | | | 103 | | | | 0.4 | % | | | 85 | | | | 0.2 | % | | | 19 | | | | 0.1 | % | | | 44 | | | | 0.6 | % | | | 67 | | | | 0.2 | % | | | 103 | | | | 0.4 | % |
Gain (loss) on derivative instruments, net | | | 69 | | | | 0.9 | % | | | (78 | ) | | | (0.7 | )% | | | 178 | | | | 0.7 | % | | | (221 | ) | | | (0.6 | )% | | | 20 | | | | 0.1 | % | | | 69 | | | | 0.9 | % | | | (59 | ) | | | (0.1 | )% | | | 178 | | | | 0.7 | % |
Other expense, net | | | - | | | | 0.0 | % | | | (49 | ) | | | (0.4 | )% | | | (7 | ) | | | 0.0 | % | | | (60 | ) | | | (0.2 | )% | | | (156 | ) | | | (0.9 | )% | | | - | | | | 0.0 | % | | | (235 | ) | | | (0.6 | )% | | | (7 | ) | | | 0.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Loss before income taxes | | | (1,834 | ) | | | (23.4 | )% | | | (1,027 | ) | | | (8.7 | )% | | | (5,743 | ) | | | (23.1 | )% | | | (10,372 | ) | | | (29.4 | )% | | | (3,505 | ) | | | (23.4 | )% | | | (1,834 | ) | | | (23.4 | )% | | | (5,355 | ) | | | (12.6 | )% | | | (5,743 | ) | | | (23.1 | )% |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Provision (benefit) for income taxes | | | 61 | | | | 0.8 | % | | | (32 | ) | | | (0.3 | )% | | | 162 | | | | 0.7 | % | | | (23 | ) | | | (0.1 | )% | |
Provision for income taxes | | | | 50 | | | | 0.4 | % | | | 61 | | | | 0.8 | % | | | 211 | | | | 0.5 | % | | | 162 | | | | 0.7 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Net loss | | $ | (1,895 | ) | | | (24.2 | )% | | $ | (995 | ) | | | (8.4 | )% | | $ | (5,905 | ) | | | (23.8 | )% | | $ | (10,349 | ) | | | (29.3 | )% | | $ | (3,555 | ) | | | (23.8 | )% | | $ | (1,895 | ) | | | (24.2 | )% | | $ | (5,566 | ) | | | (13.1 | )% | | $ | (5,905 | ) | | | (23.8 | )% |
2435
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at 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.
A summary of the Company's significant accounting policies as of December 31, 20132014 is included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2013.2014. Certain of our accounting policies require higher degrees of judgment than others in their application. These include revenue recognition on long-term contracts, capitalization of computer software development costs, valuation of contingent consideration issued in business acquisitions, and the recoverability of deferred tax assets. These critical accounting policies and estimates are discussed in the Management's Discussion and Analysis of Financial Condition and Results of Operations section in the 20132014 Annual Report on Form 10-K for the fiscal year ended December 31, 2013.2014.
Results of Operations - Three and Nine Months ended September 30, 20142015 versus Three and Nine Months ended September 30, 20132014
Contract Revenue. Total contract revenue for the three months ended September 30, 20142015 totaled $7.8$15.0 million, which was 34.2% less91.2% more than the $11.9$7.8 million total revenue for the three monthsquarter ended September 30, 2013.2014. For the nine months ended September 30, 2014,2015, contract revenue totaled $42.6 million, which was 71.6% greater than the $24.8 million a $10.5 million decrease from the $35.3 millionof revenue for the nine months ended September 30, 2013. For the three months ended September 30, 2014, the Company recorded orders of $17.6 million bringing the nine month year-to-date order total to $33.5 million. For the three and nine months ended September 30, 2013, the Company recorded orders of $11.1 million and $20.6 million, respectively.2014. The decreaseincrease in revenue from 2013 to 2014 reflectswas primarily driven by the completionacquisition of the $36.6 million full scope simulatorHyperspring, represented by our Nuclear Industry Training and digital control system order from Slovenské elektrárne, a.s. ("SE") in April 2014. The Company did not have any revenue from the SE project for the three months ended September 30, 2014 but had $3.7 million (31.1% of revenue) for the three months ended September 30, 2013. For the nine months ended September 30, 2014 and 2013, revenue from the SE project was $770,000 (3.1% of revenue) and $9.1 million (25.6% of revenue), respectively. During the three and nine months ended September 30, 2014, the Company's fossil fuel simulation revenue has decreased $0.6 million and $2.8 million, respectively, as compared to the same period in the prior year. The decrease in the fossil fuel simulation revenue is attributable to both the completion of several large fossil fuel simulation projects in 2013 and the delay of capital expenditures by fossil fueled power generation companies due to the economic and regulatory uncertainty regarding coal-fired power plants. At September 30, 2014, the Company's backlog was $45.7 million. At December 31, 2013, the Company's backlog totaled $38.0 million.Consulting segment, described below.
Write-down of capitalized software development costs. The Company makes ongoing evaluations of the recoverability of its capitalized software projects by comparing the unamortized amount for each product to the estimated net realizable value of the product. If such evaluations indicate that the unamortized software development costs exceed the net realizable value, we write off the amount by which the unamortized software development costs exceed net realizable value. During the quarter ended June 30, 2013, we incurred a charge of $2.2 million related to the write-off of certain capitalized software development costs. No capitalized software development costs were written-off during 2014.
| Three Months ended | | | Nine Months ended | |
| September 30, | | | September 30, | |
(in thousands) | 2015 | | 2014 | | | 2015 | | 2014 | |
Contract Revenue: | | | | | | | | | | | | |
Performance Improvement Solutions | | $ | 9,903 | | | $ | 7,823 | | | $ | 26,911 | | | $ | 24,823 | |
Nuclear Industry Training and Consulting | | | 5,058 | | | | - | | | | 15,678 | | | | - | |
Total Contract Revenue | | $ | 14,961 | | | $ | 7,823 | | | $ | 42,589 | | | $ | 24,823 | |
Gross Profit. Excluding the $2.2 million write-down of capitalized software development costs in the second quarter of 2013, gross profit totaled $2.5Performance Improvement Solutions revenue increased 26.6% from $7.8 million for the three months ended September 30, 2014 compared to $3.1$9.9 million for the same period in 2013. As a percentage of revenue, gross profit increased from 25.9% for the three months ended September 30, 20132015. The main driver of this increase was a $1.0 million increase in Fossil project revenue. In addition, Performance Improvement Solutions saw increases in revenue from a mix of other industries between those periods, including Nuclear and Process. We recorded total Performance Improvement Solutions orders of $3.8 million in the three months ended September 30, 2015 as compared to 31.4% for$17.6 million in the three months ended September 30, 2014. For the nine months ended September 30, 2015 Performance Improvement Solutions revenue was $26.9 million compared to $24.8 million for the nine months ended September 30, 2014. Again, the main driver of this increase was Fossil project revenue which increased $3.4 million in the third quarter 2015 as compared to the third quarter 2014. The increase in Fossil project revenue for the nine months ended September 30, 2015 compared to the nine months ended September 30, 2014 was partially offset by decreases in project revenue in a mix of other industries. We recorded total Performance Improvement Solutions orders of $27.6 million in the nine months ended September 30, 2015 as compared to $33.5 million in the nine months ended September 30, 2014.
As discussed earlier, our Nuclear Industry Training and Consulting business segment was created due to the acquisition of Hyperspring, LLC on November 14, 2014. Revenue for the three months ended September 30, 2015 totaled $5.1 million. Nuclear Industry Training and Consulting orders totaled $1.5 million during the same period. Revenue for the nine months ended September 30, 2015 totaled $15.7 million and orders totaled $14.6 million during the same period.
At September 30, 2015, backlog was $47.5 million: $42.1 million for the Performance Improvement Solutions business segment and $5.4 million for Nuclear Industry Training and Consulting. At December 31, 2014, the Company's backlog was $48.4 million: $41.7 million for the Performance Improvement Solutions business segment and $6.7 million for Nuclear Industry Training and Consulting.
Write-down of capitalized software development costs. The Company makes ongoing evaluations of the recoverability of its capitalized software projects. During the third quarter of 2015, the Company's new CEO conducted a review of the Company's organizational and cost structures and software development plans. As a result of this review, the Company has terminated further development of its Enterprise Data Management ("EDM") system and has concluded that the capitalized software development costs relating to EDM were no longer recoverable. Accordingly, in the three months ended September 30, 2015, GSE recorded a $1.5 million write-down of software development costs which was the full capitalized balance of the EDM configuration management system.
Gross Profit. Excluding the $1.5 million write-down of software development costs, gross profit was $7.3$3.8 million which was an 18.3% decrease fromfor the $9.0three months ended September 30, 2015 compared to $2.5 million recognized duringfor the same period in 2013.2014. As a percentage of revenue, gross profit increaseddecreased from 31.4% for the three months ended September 30, 2014 to 25.4% for the three months ended September 30, 2015. Excluding the $1.5 million write-down of software development costs, for the nine months ended September 30, 2015, gross profit was $9.9 million compared to $7.3 million for the same period in 2014. As a percentage of revenue, gross profit decreased from 29.5% for the nine months ended September 30, 20132014 to 23.3% for the nine months ended September 30, 2015. The reduction in gross profit in 2015 reflects the Company's acquisition of Hyperspring LLC in November 2014. Hyperspring, which comprises our Nuclear Industry Training and 2014, respectively. The decrease in revenue on the Slovakia contract, whichConsulting segment, has an overall gross profit which is significantly lower than the Company's normal gross profits, has contributed to the increase inhistorical gross profit percentageof our Performance Improvement Solution segment.
| | Three Months ended | | | Nine Months ended | |
| | September 30, | | | September 30, | |
(in thousands) | | 2015 | | | % | | | 2014 | | | % | | | 2015 | | | % | | | 2014 | | | % | |
Gross Profit: | | | | | | | | | | | | | | | | | | | | | | | | |
Performance Improvement Solutions | | $ | 3,127 | | | | 31.6 | % | | $ | 2,455 | | | | 31.4 | % | | $ | 8,158 | | | | 30.3 | % | | $ | 7,326 | | | | 29.5 | % |
Nuclear Industry Training and Consulting | | | 676 | | | | 13.4 | % | | | - | | | | 0.0 | % | | | 1,782 | | | | 11.4 | % | | | - | | | | 0.0 | % |
Consolidated Gross Profit Excluding Write-down | | | 3,803 | | | | 25.4 | % | | | 2,455 | | | | 31.4 | % | | | 9,940 | | | | 23.3 | % | | | 7,326 | | | | 29.5 | % |
Write-down of capitalized software development costs | | | (1,538 | ) | | | 10.3 | % | | | - | | | | 0.0 | % | | | (1,538 | ) | | | 3.6 | % | | | - | | | | 0.0 | % |
Consolidated Gross Profit | | $ | 2,265 | | | | 15.1 | % | | $ | 2,455 | | | | 31.4 | % | | $ | 8,402 | | | | 19.7 | % | | $ | 7,326 | | | | 29.5 | % |
Excluding the $1.5 million write-down of software development costs, Performance Improvement Solutions had gross profit of $3.1 million or 31.6% of segment revenue for the three andmonths ended September 30, 2015 compared to $2.5 million or 31.4% of segment revenue for the quarter ended September 30, 2014.
Excluding the $1.5 million write-down of software development costs, Performance Improvement Solutions had gross profit of $8.2 million or 30.3% of segment revenue for the nine months ended September 30, 2015 compared to gross profit of $7.3 million or 29.5% of segment revenue for the nine months ended September 30, 2014. The increase in gross margin percent for Performance Improvement Solutions for the nine months ended September 30, 2015 as compared to the same period in 2014 is mainly due to:
· | The restructuring of our Swedish operations in 2014 which has reduced their operations overhead costs and facility expenses in 2015, |
· | The completion in 2014 of a process simulation project that had a 14% gross margin, and |
· | Higher margined engineering consulting projects in 2015 for our UK subsidiary. |
Selling, General and Administrative Expenses. Selling, general and administrative ("SG&A") expenses totaled $4.2$3.8 million in the three months ended September 30, 2014, an 11.0% increase2015, a 3.6% decrease from the $3.8$4.0 million for the same period in 2013.2014. For the nine months ended September 30, 20142015 and 2013,2014, SG&A expenses totaled $12.8$11.0 million and $11.9 million, respectively. The increasesdecreases reflect the following spending variances:
· | Business development and marketing costs remained even at $1.1decreased from $1.5 million for both the three months ended September 30, 2014 and 2013, respectively,to $1.2 million for the three months ended September 30, 2015, and decreased to $3.3 million from $3.6$4.5 million for the nine months ended September 30, 2014 and 2013, respectively.to $4.0 million for the nine months ended September 30, 2015. Bidding and proposal costs, a component of business development costs which are the costs of operations personnel assisting with the preparation of contract proposals, decreased slightly year over year. Biddingwere $180,000 and proposal costs were $420,000 and $448,000 for the three months ended September 30, 20142015 and 2013,2014, respectively, and $1.2 million$679,000 and $1.4$1.2 million for the nine months ended September 30, 20142015 and 2013,2014, respectively. |
· | The Company's general and administrative expenses ("G&A") increased to $1.9$2.2 million from $1.6$1.7 million for the three months ended September 30, 20142015 and 2013,2014, respectively, and increased to $6.1$5.9 million from $5.9$5.2 million for the nine months ended September 30, 20142015 and 2013,2014, respectively. Some components of G&A are as follows: |
o | The Company incurred foreign currency exchange losses of $83,000 forFor the three months ended September 30, 2015 and 2014, compared to gains of $179,000 for the three months ended September 30, 2013.contingent consideration accretion expense was $306,000 and $22,000, respectively. For the nine months ended September 30, 2015 and 2014, contingent consideration accretion expense was $739,000 and $69,000, respectively. The increase in contingent consideration is a result of the Hyperspring acquisition on November 14, 2014 and 2013,is associated with the Company incurred foreign currency exchange losses of $197,000 and gains of $41,000, respectively.deferred contingent consideration due to the former Hyperspring members if certain EBITDA targets are met. |
o | Costs related to maintainingIn 2014, the Company's global Enterprise Resource Planning systemBoard of Directors agreed to waive their fees for 2014. These fees were reinstated in 2015 and totaled $59,000$51,000 and $204,000 for$149,000 in the three and nine months ended September 30, 2014 as compared to $63,000 and $352,000 for the three and nine months ended September 30, 2013, respectively. 2015. |
o | DuringFor the three and nine months ended September 30, 2014, the Company incurred severance costs of $272,000acquisition expenses of $35,000 and $746,000,$108,000, respectively, associated with terminations in both the U.S. and Swedish offices. In addition, we recorded a $137,000 charge in the second quarter of 2014 related to the renegotiationacquisition of our Swedish office lease to downsize the office. The CompanyHyperspring. No acquisition expenses were incurred $39,000 and $160,000 in severance costs during the three and nine months ended September 30, 2013.
|
o | The Company has reduced administrative costs by $215,000 and $706,000 for the three and nine months ended September 30, 2014, respectively, as compared to the same periods in the prior year predominantly as a result of spending reductions in numerous areas including corporate salaries, audit and tax services, and corporate travel.2015. |
· | Gross spending on software product development ("development") expenses for the three and nine months ended September 30, 20142015 totaled $1.0 million$866,000 and $2.8$2.6 million, respectively, as compared to $745,000$1.0 million and $2.2$2.8 million for the three and nine months ended September 30, 2013,2014, respectively. The Company capitalized $241,000 (23.3% of development expenses)$473,000 and $590,000 (20.8% of development expenses)$1.4 million of product development expenses for the three and nine months ended September 30, 2014,2015, respectively, and $167,000 (22.4% of development expenses)$241,000 and $1.2 million (52.1% of development expenses)$590,000 for the same periods in 2013,2014, respectively. Net development spending increaseddecreased from $578,000 for the three months ended September 30, 2013 to $795,000 for the three months ended September 30, 2014 and from $1.1 millionto $393,000 for the ninethree months ended September 30, 2013 to2015 and decreased from $2.2 million for the nine months ended September 30, 2014.2014 to $1.2 million for the nine months ended September 30, 2015. |
o | Spending on simulator software development and modeling tools totaled $518,000 and $1.7 million for the three and nine months ended September 30, 2015, respectively. Spending on software product development totaled $760,000 and $2.2 million for the three and nine months ended September 30, 2014, respectively. The Company's development expenses were mainly related to a new configuration management system and the enhancement of JADE™ and SimExec® applications. However, the Company wrote off the capitalized costs related to the new configuration management system in the third quarter 2015. See Write-down of capitalized software development costs, above. |
o | During the three months ended September 30, 2015 the Company completed its new Propane Refrigeration Process and Feed Gas Conditioning Process computer based tutorial and simulation training tools. Development expense related to the EnVision product line totaled $276,000 and $233,000 for the three months ended September 30, 2015 and 2014, respectively. For the nine months ended September 30, 2015 and 2014, EnVision incurred $775,000 and $455,000 of development expense, respectively. |
o | The Company's 3D visualization team, which develops 3D technology to add to our training programs, incurred $43,000$72,000 and $178,000$108,000 of costs related to this effort during the three and nine months ended September 30, 2014,2015, respectively, as compared to $0$43,000 and $69,000$178,000 for the same periods in 2013, respectively. |
o | Development expense related to the EnVision product line totaled $233,000 and $68,000 for the three months ended September 30, 2014, and 2013, respectively. For the nine months ended September 30, 2014 and 2013, EnVision incurred $455,000 and $308,000 of development expense, respectively. In 2014, the Company began development of new natural gas liquefaction and liquefied natural gas process simulation training tools and tutorials. |
o | Spending on other software product development totaled $760,000 and $2.2 million for the three and nine months ended September 30, 2014, respectively. Spending on other software product development totaled $677,000 and $1.9 million for the three and nine months ended September 30, 2013, respectively. The Company's 3D development expenses were mainly related toactivities have been curtailed as a new configuration management system and maintenancepart of JADE™ applications. the third quarter 2015 restructuring. |
Goodwill Impairment Loss.Restructuring Charges. In July 2015, GSE entered into a separation and release agreement with James Eberle, the former Chief Executive Officer of the company. Effective July 31, 2015, Mr. Eberle resigned his position as Chief Executive Officer and as a director on GSE's board of directors. The Company incurred a goodwill impairment loss$380,000 charge in the third quarter 2015 in severance expense related to the termination of $4.5Mr. Eberle.
In the third quarter 2015, the Board of Directors of the Company approved restructuring actions for the Company's worldwide operations. For the three and nine months ended September 30, 2015, the Company incurred $1.2 million duringand $1.3 million, respectively, of restructuring charges including severance expense, facility closing costs, and other restructuring costs. The restructuring actions were designed to deliver cost reductions and operating efficiencies throughout the Company and reduce both operations overheads and selling, general, and administrative expenses.
During the three and nine months ended September 30, 2014, the Company incurred severance costs of $193,000 and $474,000, respectively, associated with the downsizing of our Swedish operations. We also incurred severance costs of $272,000 for terminations in the U.S. in the third quarter 2014. In addition, we recorded a $137,000 charge in the second quarter of 2013. Refer2014 related to the Liquidity and Capital Resources section below for further discussion regardingrenegotiation of our Swedish office lease to reduce the factors leading tosize of the impairment loss and the valuation methodologies and assumptions used in the goodwill impairment test.office.
Depreciation. Depreciation expense totaled $119,000 and $140,000 and $135,000 duringfor the quartersthree months ended September 30, 20142015 and 2013,2014, respectively. For the nine months ended September 30, 20142015 and 2013,2014, depreciation expense totaled $413,000$383,000 and $434,000,$413,000, respectively.
Amortization of Definite-lived Intangible Assets. Amortization expense related to definite-lived intangible assets totaled $36,000$123,000 and $51,000$36,000 for the three months ended September 30, 20142015 and 2013,2014, respectively. For the nine months ended September 30, 20142015 and 2013,2014, amortization expense related to definite-lived intangible assets totaled $370,000 and $108,000, respectively.
In conjunction with the Hyperspring acquisition on November 14, 2014, we recorded $779,000 of customer-related intangible assets which is being amortized on a waterfall basis over seven years. We recognized $91,000 and $155,000,$274,000 of amortization expense for the Hyperspring intangibles for the three and nine months ended September 30, 2015, respectively.
The balance of the intangible asset amortization relates to the amortization of EnVision and TAS intangible assets which is recognized on a straight-line basis over the estimated useful life of the intangible assets, except for contractual customer relationships and contract backlog which are recognized in proportion to the related projected revenue streams.
Operating Loss. The Company had an operating loss of $1.9$3.4 million (24.9%(22.7% of revenue) during the three months ended September 30, 2014,2015, as compared with an operating loss of $922,000 (7.8%$1.9 million (24.9% of revenue) for the same period in 2013.2014. For the nine months ended September 30, 20142015 and 2013,2014, the Company had an operating loss of $6.0$5.1 million (24.2 %(12.1% of revenue) and an operating loss of $10.2$6.0 million (28.8%(24.2% of revenue), respectively. The variances were due to the factors outlined above. Excluding the impact of the second quarter 2013 $2.2$1.5 million capitalized software write downwrite-down from the three and nine months ended September 30, 2015 and the $4.5$1.6 million goodwill impairment,and $1.7 million restructuring charges for the three and nine months ended September 30, 2015, respectively, the Company generated an operating loss of $3.5$250,000 (1.7% of revenue) during the three months ended September 30, 2015, and an operating loss of $1.8 million (10.0%(4.3% of revenue) during the nine months ended September 30, 2013. The variances were due to the factors outlined above.2015.
Interest Income, Net. Net interest income totaled $44,000$19,000 and $22,000$44,000 for the three months ended September 30, 20142015 and 2013,2014, respectively. For the nine months ended September 30, 20142015 and 2013,2014, net interest income totaled $103,000$67,000 and $85,000,$103,000, respectively.
Gain (Loss) on Derivative Instruments, Net. The Company periodically enters into forward foreign exchange contracts to manage market risks associated with the fluctuations in foreign currency exchange rates on foreign-denominated trade receivables. As of September 30, 2015, the Company had foreign exchange contracts outstanding of approximately 2.6 million Euro, 0.6 Pounds Sterling, 0.5 million Australian Dollars and 12.5 million Japanese Yen at fixed rates. The contracts expire on various dates through December 2016. The Company has not designated the contracts as hedges and has recognized a gain on the change in the estimated fair value of the contracts of $34,000 for both the three months ended September 30, 2015 and a loss $53,000 for the nine months ended September 30, 2015.
As of September 30, 2014, the Company had foreign exchange contracts outstanding of approximately 106,000 1.5 million Euro, 0.1 million Pounds Sterling and 33,000 Canadian Dollars and 1.5 million Euro at fixed rates. The contracts expire on various dates through June 2016. The Company hashad not designated the contracts as hedges and hashad recognized gains of on the change in the estimated fair value of the contracts of $58,000 and $312,000 for the three and nine months ended September 30, 2014, respectively.
As of September 30, 2013, the Company had foreign exchange contracts outstanding of approximately 0.4 million Pounds Sterling, 17.7 million Euro, and 11.8 million Japanese Yen at fixed rates. The contracts expire on various dates through May 2016. The Company had not designated the contracts as hedges and had recognized losses on the change in the estimated fair value of the contracts of $481,000 and $480,000 for the three and nine months ended September 30, 2013, respectively.
The foreign currency denominated contract receivables, billings in excess of revenue earned, and subcontractor accruals that are related to the outstanding foreign exchange contracts were remeasured into the functional currency using the current exchange rate at the end of the period. For the three and nine months ended September 30, 2014,2015, the Company recognized a gainlosses of $11,000$14,000 and a loss of $134,000,$6,000, respectively, from the remeasurement of such contract receivables, billings in excess of revenue earned and subcontractor accruals. For the same periods in 2013,2014, the Company recognized gainsa gain of $403,000$11,000 and $259,000,a loss of $134,000, respectively.
Other Expense, Net. For the three and nine months ended September 30, 2015, the Company recognized other expense, net of $156,000 and $235,000, respectively. For the three and nine months ended September 30, 2014, the Company recognized other expense, net of $0 and $7,000, respectively. For the three and nine months ended September 30, 2013, the Company recognized other expense, net of $49,000 and $60,000, respectively. The major components of other expense, net included the following items:
· | On November 14, 2014, in conjunction with the Hyperspring acquisition, the Company invested $250,000 for a 50% interest in IntelliQlik, LLC ("IntelliQlik"). For the three and nine months ended September 30, 2015, the Company recognized equity losses of $28,000 and $107,000, respectively, on its investment in IntelliQlik. IntelliQlik is developing a software platform for online learning and learning management for the energy market. The Company was obligated to contribute an additional $250,000 should IntelliQlik attain certain development milestones by September 30, 2015. Based on a review of the software platform as of September 30, 2015, GSE concluded that the required development milestones had not been met and did not contribute the additional $250,000 investment. The Company wrote-off the remaining $126,000 balance of its IntelliQlik investment in Q3 2015. |
· | On May 22, 2013, the Company and Electrobalt Holding, a Russian Federation closed joint-stock company, created a 50/50 joint venture called General Simulation Engineering RUS Limited Liability Company ("GSE RUS"). For the nine months ended September 30, 2014, the Company recognized a loss of $38,000 relating to its pro rata share of operating results from GSE-RUS. No equity gains or losses onAlthough the GSE RUScompany's entire investment were recorded in 2013. |
· | ForGSE-RUS was written off by the three and nine months ended September 30, 2013, the Company recognized lossesend of $52,000 and $148,000, respectively, relating to its pro rata share of operating resultsDecember 2014, we have not received a request for additional funding from GSE-UNIS Simulation Technology Co., Ltd. The Company and its joint venture partner, Beijing Unis Investment Co., Ltd., (UNIS) agreed in principal to terminate the GSE-UNIS joint venture as of July 31, 2013. As a result of UNIS agreeing in principal to purchase GSE's 49% ownership interest in the joint venture and, due to the Company reclassified its $1.2 million investmentpolitical issues with Russia regarding the conflict in Ukraine, we do not intend to Other Current Assets.
|
· | As a 10% owner of the Emirates Simulation Academy ("ESA")contribute additional equity in the UAE, the Company was required to provide a guarantee of 10% of ESA's credit facility. The Company provided the guarantee by depositing cash into an interest bearing, restricted account with the Union National Bank ("UNB"). In 2009, the Company wrote off the entire balance in this account. In the second quarter of 2013, the Company was notified by UNB that the ESA line of credit had been paid off by utilizing the guarantees from the three owners. The balance remaining in our account after the settlement of the guarantee, $82,000, was transferred to us and the UNB account was closed.foreseeable future. |
· | The Company had other miscellaneous incomelosses of $31,000$2,000 for the nine months ended September 30, 2014. For the three and nine months ended September 30, 2013,2015, respectively. For the nine months ended September 30, 2014, the Company had other miscellaneous income of $3,000 and $6,000, respectively.$31,000. |
Provision (Benefit) for Income Taxes
The Company files in the United States federal jurisdiction and in several state and foreign jurisdictions. Because of the net operating loss carryforwards, the Company is subject to U.S. federal and state income tax examinations from years 1997 and forward and is subject to foreign tax examinations by tax authorities for years 2007 and forward. Open tax years related to state and foreign jurisdictions remain subject to examination but are not considered material to our financial position, results of operations or cash flows.
An uncertain tax position taken or expected to be taken in a tax return is recognized in the financial statements when it is more likely than not (i.e., a likelihood of more than fifty percent) that the position would be sustained upon examination by tax authorities that have full knowledge of all relevant information. A recognized tax position is then measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Interest and penalties related to income taxes are accounted for as income tax expense. The Company has appropriately accounted for its uncertain tax positions.
The Company expects to pay income taxes in India in 2014. In 2013,2014, the Company paid income taxes toin the UK and India.India and expects to do so again in 2015. The Company has a full valuation allowance on its U.S., ChineseSwedish, and SwedishChinese net deferred tax assets at September 30, 2014.2015.
Liquidity and Capital Resources
As of September 30, 2014,2015, the Company's cash and cash equivalents totaled $16.0$12.8 million compared to $15.6$13.6 million at December 31, 2013.2014.
Cash provided by (used in) operating activities. For the nine months ended September 30, 2015, net cash provided by operations totaled $1.3 million. Significant changes in the Company's assets and liabilities in the nine months ended September 30, 2015 included:
· | A $3.6 million decrease in the Company's contract receivables. The Company's trade receivables, net of the allowance for doubtful accounts, decreased from $10.8 million at December 31, 2014 to $7.5 million at September 30, 2015. At September 30, 2015, trade receivables outstanding for more than 90 days, net of the bad debt reserve, totaled approximately $1.1 million as compared to $369,000 at December 31, 2014. The Company believes the entire 90-day balance at September 30, 2015 will be received. The Company's unbilled receivables decreased by approximately $291,000 to $4.8 million at September 30, 2015 as compared to December 31, 2014. The decrease in the unbilled receivables is due to the timing of contracted billing milestones of the Company's current projects. In October 2015, the Company invoiced $1.9 million of the unbilled amounts; the balance is expected to be invoiced and collected within one year. |
· | A $1.6 million decrease in billings in excess of revenue earned. The decrease is due to the timing of contracted billing milestones of the Company's current projects. |
· | A $1.3 million increase in accounts payable, accrued compensation and accrued expenses. The increase was due to the timing of payments made by the Company to vendors and subcontractors. |
For the nine months ended September 30, 2014, net cash provided by operations totaled $5.2 million. Significant changes in the Company's assets and liabilities in the nine months ended September 30, 2014 included:
· | An $11.9$11.9 million decrease in the Company's contract receivables, excluding any gains or losses on derivatives.receivables. The Company's trade receivables, net of the allowance for doubtful accounts, decreased from $19.0 million at December 31, 2013 to $6.2 million at September 30, 2014. At September 30, 2014, trade receivables outstanding for more than 90 days, net of the bad debt reserve, totaled approximately $549,000 as compared to $623,000 at December 31, 2013. The Company believes the entire 90-day balance at September 30, 2014 will be received. The Company's unbilled receivables increased by approximately $760,000 to $6.3 million at September 30, 2014 as compared to December 31, 2013. The increase in the unbilled receivables iswas due to the timing of contracted billing milestones of the Company's current projects. In October 2014, the Company invoiced $1.4 million of the unbilled amounts; the balance is expected to be invoiced and collected within one year. |
· | A $2.3 million decrease in accounts payable, accrued compensation, and accrued expenses. The decrease was due to the timing of payments made by the Company to vendors and subcontractors. |
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For the nine months ended September 30, 2013, net cash used in operations totaled $671,000. Significant changes in the Company's assets and liabilities in the nine months ended September 30, 2013 included:
· | A $3.1 million decrease in the Company's contract receivables. The Company's trade receivables, net of the allowance for doubtful accounts, decreased from $12.4 million at December 31, 2012 to $6.2 million at September 30, 2013. At September 30, 2013, trade receivables outstanding for more than 90 days, net of the bad debt reserve, totaled approximately $1.2 million versus $2.5 million at December 31, 2012. The Company's unbilled receivables increased by approximately $3.4 million to $14.8 million at September 30, 2013. The increase in the unbilled receivables was due to the timing of contracted billing milestones of the Company's current projects.
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· | A 1.4 million decrease in accounts payable, accrued compensation, and accrued expenses. The decrease was due to the timing of payments made by the Company to vendors and subcontractors. |
Cash used in investing activities. Net cash used in investing activities totaled $1.0 million for the nine months ended September 30, 2015. Capital expenditures totaled $217,000 and capitalized software development costs totaled $1.4 million for the nine months ended September 30, 2015. Restrictions of cash used as collateral for outstanding letters of credit decreased by $676,000 for the nine months ended September 30, 2015.
Net cash used in investing activities totaled $4.0 million for the nine months ended September 30, 2014. Capital expenditures totaled $240,000 and capitalized software development costs totaled $590,000 for the nine months ended September 30, 2014. On September 30, 2014 Susquehanna Bank collateralized the Company's outstanding letters of credit and segregated $3.1$3.2 million into a restricted cash account. Releases of restricted cash as collateral under letters of credit totaled $34,000 for the nine months ended September 30, 2014.
Net cashCash used in investingfinancing activities. Cash used in financing activities totaled $1.7 million$839,000 for the nine months ended September 30, 2013. Capital expenditures totaled $287,0002015. The Company has a working capital line of credit with IberiaBank for its Hyperspring subsidiary. In the first quarter 2015, the Company paid down the outstanding balance of the line of credit, $339,000, and capitalized software development costs totaled $1.2 million forat September 30, 2015, the Company had no outstanding borrowings. During the nine months ended September 30, 2013.2015, the Company made payments of $500,000 to the former EnVision Systems, Inc. members in accordance with the 2011 purchase agreement due to the achievement of certain revenue targets in 2014.
Cash used in financing activities. CashNet cash used in financing activities totaled $500,000 for the nine months ended September 30, 2014. During the nine months ended September 30, 2014, the Company made payments of $500,000 in relationaccordance with the 2011 purchase agreement due to the liability classified contingent-consideration associated with the acquisitionachievement of EnVision Systems, Inc.
Net cash usedcertain revenue targets in financing activities totaled $2.5 million for the nine months ended September 30, 2013. During the nine months ended September 30, 2013, the Company made payments of $1.9 million in relation to the liability classified contingent-consideration associated with the acquisition of EnVision. The Company repurchased 217,499 shares of the Company's common stock at an aggregate cost of $651,000 for the nine months ended September 30, 2013. Proceeds from the issuance of common stock for the nine months ended September 30, 2013 totaled $44,000.
At September 30, 2014,2015, the Company had cash and cash equivalents of $16.0$12.8 million. The Company believes that its (i) cash and cash equivalents and (ii) cash generated from normal operations will be sufficient to fund its working capital and other requirements for at least the next twelve months. However, notwithstanding the foregoing, the Company may be required to look for additional capital to fund its operations if the Company is unable to operate profitably and generate sufficient cash from operations. There can be no assurance that the Company would be successful in raising such additional funds.
Credit Facilities
TheSusquehanna Bank
At September 30, 2015, the Company hashad a Master Loan and Security Agreement and Revolving Credit Note with Susquehanna.Susquehanna Bank ("Susquehanna"). The Company and its subsidiaries,subsidiary, GSE Power Systems,Performance Solutions, Inc., and GSE EnVision LLC, arewere jointly and severally liable as co-borrowers. The Loan Agreement provides a $7.5 million revolving line of credit for the purpose of (i) issuing stand-by letters of credit and (ii) providing working capital. Working capital advances bear interest at a rate equal to the Wall Street Journal Prime Rate of Interest, floating with a floor of 4.5%4 1/2%. InThe agreement expires on June 2014, Susquehanna extended the Revolving Credit Expiration Date to March 31, 2015.
30, 2016.
As collateral for the Company's obligations, the Company granted a first lien and security interest in all of the assets of the Company, including but not limited to, accounts receivable, inventory,proceeds and products, intangibles, trademarks, patents, intellectual property, machinery and equipment, and the proceeds and products from these assets.
equipment.
On September 9, 2014, the Company signed a Third Comprehensive Amendment to the Master Loan and Security Agreement. According to the Third Amendment, the Company wasis to maintain a segregated cash collateral account ("Cash Collateral Account") at Susquehanna Bank equal to the greater of (i) 3.0$3.0 million or (ii) the aggregate principal amounts of all Loans outstanding under the Revolving Credit Facility (including any issued and outstanding letters of credit, working capital advances, and negative foreign exchange positions) as security for the Company's obligations. Under this amendment,Amendment, Susquehanna Bank shall have complete and unconditional control over the Cash Collateral Account.
cash collateral account.
On September 30, 2014, Susquehanna Bank collateralized the outstanding letters of credit issued under the master line of credit. The Cash CollateralAt September 30, 2015 and December 31, 2014, the cash collateral account totaled $3.1$3.6 million and was$4.2 million, respectively. The balances were classified as restricted cash on the balance sheet.
The credit agreements contain certain restrictive covenants regarding future acquisitions and incurrence of debt. On July 31, 2015, the Company signed a Fifth Comprehensive Amendment to the Master Loan and Security Agreement in which the Company's financial covenants were reduced from four to two, and the covenant targets were adjusted.
| | As of |
| Covenant | September 30, 20142015 |
| | |
Minimum tangible capital base | Must Exceed $26.0$10.5 million | $22.610.9 million |
Quick ratio | Must Exceed 2.001.00 : 1.00 | 2.10 : 1.00 |
Tangible capital base ratio | Not to Exceed .75 : 1.00 | .691.43 : 1.00 |
As of September 30, 2014,2015, the Company was not in compliance with its "After tax net income" financial covenant and its "Minimum tangible capital base" covenant,covenants as defined above. As noted above,
IberiaBank
At September 30, 2015, Hyperspring, LLC had a $1.0 million working capital line of credit with IberiaBank. Under the executed promissory note, interest is payable monthly at the rate of 1.00 percentage points over the prime rate of interest as published in the money rate section of the Wall Street Journal resulting in an effective interest rate of 4.25%. The line is secured by all accounts of Hyperspring and guaranteed by GSE Systems, Inc. The line of credit expires on July 6, 2016. At September 30, 2015, the Company has cash collateralized allhad no outstanding amounts under the line of its outstanding letterscredit.
Letters of credit as a result of the Third Amendment to its Master Loan Agreement.
Credit and Bonds
As of September 30, 2014,2015, the Company was contingently liable for 12had thirteen standby letters of credit and 2one surety bondsbond totaling $4.4$3.6 million which represent advance payment and performance bonds on 12twelve contracts. The Company has deposited the full value of 12thirteen standby letters of credit in escrow accounts, amounting to $4.2$3.6 million, which have been restricted in that the Company does not have access to these funds until the related letters of credit have expired. The cash has been recorded on the Company's balance sheet at September 30, 20142015 as restricted cash.
Item 3. Quantitative and Qualitative Disclosure about Market Risk
The Company's market risk is principally confined to changes in foreign currency exchange rates. The Company's exposure to foreign exchange rate fluctuations arises in part from customer contracts that are denominated in currencies other than the Company's functional currency as well as from inter-company accounts in which costs incurred in one entity are charged to other entities in different foreign jurisdictions. The Company is also exposed to foreign exchange rate fluctuations as the financial results of all foreign subsidiaries are translated into U.S. dollars in consolidation. As exchange rates vary, those results when translated may vary from expectations and adversely impact overall expected profitability.
The Company utilizes forward foreign currency exchange contracts to manage market risks associated with the fluctuations in foreign currency exchange rates. The principal currencies for which such forward exchange contracts are entered into are the Pound Sterling, the Euro and the Japanese Yen. It is the Company's policy to use such derivative financial instruments to protect against market risk arising in the normal course of business in order to reduce the impact of these exposures. The Company minimizes credit exposure by limiting counterparties to nationally recognized financial institutions.
As of September 30, 2015, the Company had foreign exchange contracts outstanding of approximately 2.6 million Euro, 0.6 million Pounds Sterling, 0.5 million Australian Dollars and 12.5 million Japanese Yen at fixed rates. The contracts expire on various dates through December 2016. The Company had not designated the contracts as hedges and had recognized a gain of $34,000 and a loss of $53,000 in the estimated fair value of the contracts for the three and nine months ended September 30, 2015, respectively. A 10% fluctuation in the foreign currency exchange rates up or down as of September 30, 2015 would have increased/decreased the change in the estimated fair value of the contracts by $1,700.
As of September 30, 2014, the Company had foreign exchange contracts outstanding of approximately 106,0001.5 million Euro, 0.1 million Pounds Sterling, and 34,000 Canadian Dollars and 1.5 million Euro at fixed rates. The contracts expire on various dates through June 2016. The Company had not designated the contracts as hedges and hashad recognized gains on the change in the estimated fair value of the contracts of $58,000 and $312,000 for the three and nine months ended September 30, 2014, respectively. A 10% fluctuation in the foreign currency exchange rates up or down as of September 30, 2014 would have increased/decreased the change in the estimated fair value of the contracts by $1,400.
As of September 30, 2013, the Company had foreign exchange contracts outstanding of approximately 0.4 million Pounds Sterling, 17.7 million Euro, and 11.8 million Japanese Yen at fixed rates. The contracts expire on various dates through May 2016. The Company had not designated the contracts as hedges and had recognized losses on the change in the estimated fair value of the contracts of $481,000 and $480,000 for the three and nine months ended September 30, 2013, respectively. A 10% fluctuation in the foreign currency exchange rates up or down as of September 30, 2013 would have increased/decreased the change in the estimated fair value of the contracts by $51,200.48
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed by it in its reports filed or submitted pursuant to the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms and that information required to be disclosed by the Company in its Exchange Act reports is accumulated and communicated to management, including the Company's Chief Executive Officer ("CEO"), who is its principal executive officer, and Chief Financial Officer ("CFO"), who is its principal financial officer, to allow timely decisions regarding required disclosure. At the end of the period covered by this report, an evaluation was performed under the supervision and with the participation of our management including our CEO and our CFO, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13-15(e) of the Exchange Act. Based on the evaluation of our disclosure controls and procedures as of September 30, 2014,2015, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective.
(b) Changes in internal control over financial reporting
Management is responsible for establishing and maintaining adequateThere were no changes in the Company's internal control over financial reporting as defined in Rule 13a-15(f) underthat occurred during the Exchange Act. Internal control over financial reporting is a process designedmost recent fiscal quarter that have materially affected or are reasonably likely to provide reasonable assurance regardingmaterially affect the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S GAAP. The effectiveness of any system ofCompany's internal control over financial reporting is subject to inherent limitations, including the exercise of judgment in designing, implementing, operating and evaluating the controls and procedures. Because of these inherent limitations, internal control over financial reporting cannot provide absolute assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. GAAP and may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that internal controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A "material weakness" as defined by Public Company Accounting Oversight Board ("PCAOB") Auditing Standard No. 5, "An Audit of Internal Control over Financial Reporting That is Integrated with an Audit of Financial Statements" ("Auditing Standard No. 5") is "a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis." A "deficiency" in internal control over financial reporting as defined by Auditing Standard No. 5 "exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely basis." Set forth below were the Company's material weaknesses in internal control over financial reporting.
As of December 31, 2013 it was determined that the Company's control over expense cut-off was not designed appropriately to prevent or detect errors that could be material to the Company's financial statements. The Company had one employee who was responsible for both review of the vendor invoices for appropriate accounting treatment as well as recording the invoices in the appropriate period. This was considered to be a material weakness in our internal control over financial reporting as of December 31, 2013. As a result of this material weakness in the design of our internal control over financial reporting, we performed additional review and analysis over our consolidated financial statements for the year ended December 31, 2013. During the first quarter of 2014, we redesigned our control over expense cut-off to include an additional employee who now reviews the invoices for appropriate accounting treatment before the invoices are recorded. As a result of these procedures, we believe that we have remediated the material weakness described above.
(c) Limitation of Effectiveness of Controls
Internal control over financial reporting has inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements will not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate this risk.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
None.
The Company has no material changes to the disclosure on this matter made in its Annual Report on Form 10-K for the fiscal year ended December 31, 2013.2014.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Mine Safety Disclosures
Not applicable.
None
| 10.1 | Second Comprehensive Amendment to Master LoanForm of Restricted Stock Unit Agreement filed herewith. |
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| 10.2 | Third Comprehensive Amendment to Master Loan Agreement,Under the GSE Systems, Inc. 1995 Long-Term Incentive Plan, as amended and restated effective March 6, 2014, filed herewith. |
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| 31.1 | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes- Oxley Act of 2002, filed herewith. |
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| 31.2 | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith. |
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| 32.1 | Certification of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith. |
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| 101.INS* | XBRL Instance Document |
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| 101.SCH* | XBRL Taxonomy Extension Schema |
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| 101.CAL* | XBRL Taxonomy Extension Calculation Linkbase |
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| 101.DEF* | XBRL Taxonomy Extension Definition Linkbase |
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| 101.LAB* | XBRL Taxonomy Extension Label Linkbase |
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| 101.PRE* | XBRL Taxonomy Extension Presentation Linkbase |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: November 14, 201412, 2015 GSE SYSTEMS, INC.
/S/ JAMES A. EBERLEKYLE J. LOUDERMILK
James A. EberleKyle J. Loudermilk
Chief Executive Officer
(Principal Executive Officer)
/S/ JEFFERY G. HOUGH
Jeffery G. Hough
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
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