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.
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.
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 2014 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.
2331
General Business Environment
GSE Systems, Inc. ("GSE Systems", "GSE", the "Company", "we", "us" or "our"), a NYSE MKT company trading under symbol GVP, is a team of dedicated people that help customers meet their performance improvement goals and reduce their risk. We do this by combining expertise in simulation, visualization, engineering, equipment operations, and training to improve both plant and human performance.
We execute projects globally with over 354 employees operating from offices in the U.S., China, India, Sweden and the United Kingdom. While the majority of revenue comes from the nuclear and fossil power generation markets, we also serve the oil and gas, refining, chemicals, petrochemicals, industrial gas, manufacturing, transportation and plant utilities markets.
GSE Systems was formed on March 30, 1994 to consolidate the simulation and related businesses of S3 Technologies, General Physics International Engineering & Simulation and EuroSim, each separately owned and operated by ManTech International Corporation, GP Strategies Corporation and Vattenfall AB, respectively.
On April 26, 2010, we completed the acquisition of TAS Holdings Ltd ("TAS") and subsequently merged TAS into our UK subsidiary, GSE Systems Ltd. Our UK operations, located in Stockton-on-Tees, England provides engineering consulting, specifically in electrical system design, instrumentation and controls engineering and automation engineering. The majority of our UK customers are in the petroleum refining, oil and gas, chemical and petrochemical industries.
On January 4, 2011, we acquired EnVision Systems, Inc. ("EnVision"). The EnVision product line consists of interactive computer-based tutorials and related simulation models primarily for the petrochemical and oil & gas refining industries. The EnVision products provide a foundation in process fundamentals and plant operations and interaction. We have more than 750 installations of EnVision products in over 28 countries, and our approximately 130 clients include Shell Oil Company, BP Products North America ("BP"), Total and Chevron.
On November 14, 2014, we acquired Hyperspring, LLC, an Alabama limited liability company. Hyperspring is a staff augmentation company that hires personnel to fulfill staff positions on a short-term basis for energy industry customers, primarily nuclear power customers. Hyperspring personnel provide training, operations and maintenance support including: generic fundamentals exams (GFES), accreditation training visit (ATV) preparation, senior reactor operator (SRO) certification, procedure development, work management, tagging/labeling, outage execution, planning/scheduling, corrective action, self-assessments and equipment reliability. Customers include TVA, Entergy, PSEG Nuclear LLC and NRG Energy Inc.
In conjunction with the Hyperspring acquisition, the Company acquired a 50% ownership stake in IntelliQlik, LLC, a Delaware limited liability company. IntelliQlik is developing a software platform for online learning and learning management for the energy market. A former Member of Hyperspring also has a 50% ownership stake in IntelliQlik.
On December 31, 2014 the Company merged EnVision with GSE Power Systems, Inc. and changed the name of GSE Power Systems, Inc. to GSE Performance Solutions, Inc. The change reflects our growing focus on providing solutions to improve Human and Plant Performance Lifecycles.
Operating Segments
With the acquisition of Hyperspring, we now operate through two reportable business segments. We are organized by operating groups primarily based upon the services performed by each group.segments: Performance Improvement Solutions and Nuclear Industry Training and Consulting. Each operating group consists of business units which are focusedsegment focuses on providing specific products and servicesdelivering 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 operating groupseach segment to support existing customer accounts and new customer development. Our two business segments are:
· | Performance Improvement Solutions |
As evidenced through the change in the company name of our U.S. operating company to GSE Performance Solutions, Inc., ourOur Performance Improvement Solutions business segment primarily encompasses all of the solution-oriented technologiesour next-generation power plant and services traditionally associated with GSE which focus on both our client's people and their plants and operations.process simulation solutions, as well as engineering solutions. This segment includes various simulation products, engineering services, and operation training and engineering products and servicessystems delivered across the breadth of industries we serve.serve: primarily nuclear and fossil power generation, and the petroleum industry. Our simulation solutions include platforms ranging fromthe following: (1) simulation tools and services, including operator training systems, for the non-specific plantnuclear power industry, (2) simulation tools and services, including operator training systems, of our EnVision product linefor 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, to (2) custom plant-specific simulators used to train plant operators, to (3) engineering-grade simulation solutions used to help clients verify and validate control systems prior to new plant construction or modification of existing plants, to (4) engineering-grade simulation solutions used for human factors engineering. Training applications include turnkey and custom training services and 3D visualization training products to make training more effective. Our engineering services include plant design, automation and control systems design, functional safety and compliance analysis, and engineering consultations.employees.
Nuclear Industry Training and Consulting Staff Augmentation services provideNuclear Industry Training and Consulting provides highly specialized workforce solutions primarilyand skilled nuclear operations instructors and other consultants to the nuclear power industry. These employees work at our clients' facilities under client direction. Examples of staff augmentationthese highly skilled positions includeare primarily senior reactor operations instructors, procedure writers, work management specialists, planners outage execution specialists, corrective action and self-assessment specialists, and training material developers. This business is managed through our Hyperspring LLC subsidiary. The business model, management focus, margins and other factors clearly separate this business line from the rest of the GSE product and service portfolio. Hyperspring has been providing these services since 2005.
Financial information about our business segments and geographic operations and revenue are provided in Note 15 of the accompanying Consolidated Financial Statements.
Products, Services, Strategy
Industry Trends
We believe the most serious future challenge facing the industries we serve is not their access to technology, their access to markets, nor their access to operating capital. Instead the challenge will be their access toand continued development of a trained and efficient workforce. This challenge manifests itself due to bothin the increasing pace of the knowledge that will be lost as a large percentage of the experienced workforce reaches retirement age inover the next ten years and theyears. The replacement of these experienced workers by a new generation who have different learning styles and work expectations.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 supportedretiring, new nuclear capacity will be coming into operation. According to the International 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 finance new reactors at the Hinkley Point site and set the stage for additional reactor projects in the UK in the future.
According to the World Nuclear Association, there are 165 reactors in 27 countries in specific phases of planning 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 CO2 emission reduction targets recommended by the following trends as reportedscientific community. According to the UN's Intergovernmental Panel on Climate Change and research from the National Renewable Energy Laboratory, greenhouse gas emissions across the entire lifecycle of nuclear energy from uranium mining to decommissioning, are comparable with those of wind power.
Workforce Trends
Power Engineering Magazine article: Who will Replace Power Aging Workforce? cites the Nuclear Energy Institute estimates that 39% of the nuclear workforce will be eligible to retire by 2018 resulting in the U.S.need for 20,000 new workers to replace them. The article goes on to discuss the US Department of Energy's National Energy Technology Laboratory 2013 report entitled Emerging Workforce TrendsLabor estimates as much as 50% of the nation's utility workforce will be retiring in the U.S. Energy and Mining Industries: A Call to Action.
· | 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 skills needed for many energy jobs, |
· | 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 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.
Business 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.
26Our 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 our clients in creating world-class internal training and performance improvement programs, we are building the E2E (Entry2Expert) Performance Solution, a set of integrated and scalable products and services which provide a structured program from employee selection and onboarding through continuous skills improvement for experienced employees. GSE can now provide the right training solution for the right step in each employee's career.
The major elements of the E2E Performance Solution include:
· | Employee Screening and Selection: Leveraging the use of simulation and providing experts in employee assessments, we help clients ensure their candidates for employment possess both technical aptitude as well as personality traits suited for the specific job functions.
|
· | Training Needs Assessments: We help clients define their specific training needs by analyzing the job functions and processes specific to their plant. This is the first step in creating a structured training program that will provide consistent and predictable results.
|
· | Training Program Development: Following the ADDIE (Analyze, Design, Develop, Implement, and Evaluate) model for training program management, we can structure the entire training program for the client, including training media and modes, such as self-paced e-Learning, instructor-led classroom, in-depth simulation, and serious gaming.
|
· | Self-Paced Training Tutorials: We have a full complement of e-Learning material. The products include basic equipment and component fundamentals that are applicable across a variety of industries, as well as comprehensive training for the oil and gas and refining markets. Using a blended learning approach, students learn the overall purpose of plant systems, the major equipment, how the equipment is operated and controlled. This methodology ensures the students know the basics before entering a plant-specific training program. We have delivered over 500 such tutorial programs in multiple languages worldwide.
|
· | Instructor-Led Training: We provide classroom and simulator instructors as adjunct staff or to teach turnkey training programs using training materials that either we or the client have developed. Turnkey courses include ANSI Fundamentals (math and sciences), Generic Fundamentals (nuclear plant components, systems, and reactor theory), Senior Reactor Operator (SRO) Certification, and Engineering Systems Program courses.
|
· | Universal Training Simulators: These products complement the Self-Paced Training Tutorials by reinforcing what the student learned in the tutorial by putting it into practice on the Universal Simulator. The simulation models are high fidelity and engineering correct, but represent a typical plant or typical process, versus the exact replication of a client's plant. We have delivered over 250 such simulation models to clients consisting of major oil companies and educational institutions.
|
· | Part-Task Training Simulators: Like the Universal Simulators, we provide other unique training solutions such as a generic nuclear plant simulator, VPanel displays which replicate control room hardware and simulator solutions specific to industry need, such as Severe Accident models to train on and aid in the understanding of events such as the Fukushima Daiichi accident.
|
· | 3D Visualization: Being able to visualize complex processes, or detailed maintenance tasks significantly improves understanding and retention while reducing the learning process. We provide 3D visualization solutions to help customers "see" and understand the internal workings complex systems such as nuclear reactors, or how to maintain complicated pieces of equipment. Blending the learning strategy of incorporating 3D visualization with high-fidelity, real-time simulation models enables us to provide the energy industry with better, faster, and less costly training in an immersive environment that is ideally suited for the next generation workforce.
|
· | Plant-Specific Operator Training Simulators: These simulators provide an exact replication of the plant control room and plant operations. They provide the highest level of realism and training and allow users to practice their own plant-specific procedures. Clients can safely practice startup, shutdown, normal operations, as well as response to abnormal events we all hope they never have to experience in real life. We have delivered nearly 450 plant-specific simulators to clients in the nuclear power, fossil power and process industries worldwide.
|
The goal of our E2E performance lifecycle offering is to ensurehelp improve our customer's bottom line through superior human achievement in screening and selecting the dimensions of:
· | Recruiting, screening, and selecting the right workforce |
· | Shortening the learning process |
· | Mitigate effects of retirement and turnover |
· | Improve workforce agility |
· | Achieve and maintain certifications and compliance |
· | All of which improve our customers' bottom lines |
right workforce, shortening the learning process, reducing human errors, improving worker agility and mitigating the effects of retirements and turnover.
The dramatic increase in energy demand world-wide over the next 30 years will require significant amounts of training for new employees and also require new plants using energy of all sources. Obviously, these new plants will need to be engineered and designed prior to construction, and due to their high-fidelity our modeling tools are being increasingly used to verify and validate control system and overall plant designs.
Design2Decom Performance Cycle
Just like the Entry2Expert (E2E)E2E process helps improve the performance of our customers' people, Design2Decom (D2D)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 lifecycle, services include:
· | Engineering Consultancy, Project Execution and Project Management: Whether in the feasibility, concept or detail design stages of a plant or for plant modifications, we help clients design and implement engineering projects across several disciplines:
|
o | Instrumentation Engineering |
o | Control Systems Engineering |
o | Automation Design Engineering |
o | Electrical Design Engineering |
· | Virtual commissioning of plants. Our high-fidelity, simulation-based engineering solutions test design assumptions and provide feedback throughout the design process for:
|
o | Integrated systems design validation |
o | Control strategy design validation |
o | Human factors engineering support |
o | Operating procedure validation |
o | Control system validation |
· | Safety and Compliance: Our engineering expert de-risk operations through engineering assessments and remediation services to ensure safety and legislative compliance in the following areas:
|
engineering and specialized plant support services, virtual commissioning of plants and plant changes, safety and compliance services and assistance in decommissioning.
· | Specialized Plant Support: As our customers' experienced staffs retire, access to experts that can help with specialized plant projects is critical. Through the acquisition of Hyperspring, we also provide expert support either through staff augmentation or turnkey projects for the following:
|
o | Training Material Upgrade and Development |
· | Decommissioning: As plants reach the end of their useful life, decommissioning and deconstruction is a critical service, particularly in the nuclear industry where contaminated material must be handled in safe and precise manners. Our engineering, simulation and visualization capabilities enable clients to plan for, train for, and execute decommissioning while minimizing exposure to hazardous materials and saving money.
|
The goal of Design2Decom (D2D) is to help clients optimize plant performance and compliance in terms of the following:
· | Finding design errors during engineering rather than construction allowing plant startup to occur sooner saving countless man-hours and dollars while simultaneously allowing revenue generation sooner. |
· | Ensuring plants are safely operated within the regulatory requirements. |
· | Providing expert support for specialized projects and to augment an aging workforce. |
· | Limiting cost and hazards exposure through intelligent decommissioning 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 acquisition of the specialized engineering capabilities of TAS Holding, entry and intermediate level training solutions via our EnVision acquisition, and now extensive training and plant support capabilities by acquiring Hyperspring.
Competitive Advantages
While there is competition in various industry niches, there are few companies in our space that can combine the engineering, simulation and training expertise we now have through the execution of our acquisition strategy. None of our traditional competitors serve the broader performance improvement market.
· | Unique Combination of Talent. Nobody in our market space brings together the sophistication of simulation technology with the engineering expertise, training expertise and visualization expertise to provide the holistic people and plant performance improvement solutions.
|
· | Reputation for Customer Satisfaction. As part of its ISO-9000 Quality Program Certification, GSE measures customer satisfaction across numerous factors such as On-Time Delivery, Problem Solving, and Customer Communication. In each category measured we routinely exceed customer expectations.
|
· | Industry Expertise. GSE is a leading innovator and developer of real-time software with more than 40 years of experience producing high-fidelity, real-time simulators. As a result, the Company has acquired substantial applications expertise in the energy and industrial process industries. The Company employs a highly educated and experienced multinational workforce of over 300 employees, including approximately 180 engineers and scientists. Of the almost 180 engineers, approximately 49% of these engineers and scientists have advanced science and technical degrees in fields such as chemical, mechanical and electrical engineering, applied mathematics and computer sciences, while an additional 33% have master degrees, and another 12% have doctorate degrees in the aforementioned fields.
|
· | Proprietary Software Tools. GSE has developed a library of proprietary software tools including auto-code generators and system models that substantially facilitate and expedite the design, production and integration, testing and modification of software and systems. These tools are used to automatically generate the computer code and systems models required for specific functions commonly used in simulation applications, thereby enabling it or its customers to develop high-fidelity, real-time software quickly, accurately and at lower costs. The Company has a substantial library of Process-Specific Simulation models and eLearning Modules aimed at the oil and gas, refining and specialty chemicals market.
|
· | Training Curricula. The Company has developed hundreds of detailed courses and simulator exercise material or specific industrial applications including oil and gas refining, gas-oil production, nuclear and combined cycle gas turbine power plant and desalination.
|
· | In the area of training and training related products, Hyperspring can now include: state of the art 3D graphics and simulation to enhance our offerings and differentiate us from our competitors. The area of staff augmentation is mostly focused on training and operations support. The senior management of Hyperspring has strong active ties to the industries we serve which allows us to interface with our customers directly in the course of doing business versus having to periodically call on customers. Our proximity allows us a significant competitive advantage in that we can immediately offer solutions and therefore bypass lengthy bid processes. |
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 March 31, | | | Three Months ended September 30, | | | Nine Months ended September 30, | |
| | | 2015 | | | % | | | 2014 | | | % | | | 2015 | | | % | | | 2014 | | | % | | | 2015 | | | % | | | 2014 | | | % | |
| Contract revenue | | $ | 13,996 | | | | 100.0 | % | | $ | 8,724 | | | | 100.0 | % | | $ | 14,961 | | | | 100.0 | % | | $ | 7,823 | | | | 100.0 | % | | $ | 42,589 | | | | 100.0 | % | | $ | 24,823 | | | | 100.0 | % |
| Cost of revenue | | | 10,774 | | | | 77.0 | % | | | 6,500 | | | | 74.5 | % | | | 11,158 | | | | 74.6 | % | | | 5,368 | | | | 68.6 | % | | | 32,649 | | | | 76.7 | % | | | 17,497 | | | | 70.5 | % |
| Write-down of capitalized software development costs | | | | 1,538 | | | | 10.3 | % | | | - | | | | 0.0 | % | | | 1,538 | | | | 3.6 | % | | | - | | | | 0.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Gross profit | | | 3,222 | | | | 23.0 | % | | | 2,224 | | | | 25.5 | % | | | 2,265 | | | | 15.1 | % | | | 2,455 | | | | 31.4 | % | | | 8,402 | | | | 19.7 | % | | | 7,326 | | | | 29.5 | % |
| Operating expenses: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Selling, general and administrative | | | 3,366 | | | | 24.0 | % | | | 4,144 | | | | 47.5 | % | | | 3,811 | | | | 25.5 | % | | | 3,954 | | | | 50.5 | % | | | 11,031 | | | | 25.9 | % | | | 11,939 | | | | 48.0 | % |
| Restructuring charges | | | | 1,600 | | | | 10.7 | % | | | 272 | | | | 3.5 | % | | | 1,746 | | | | 4.1 | % | | | 883 | | | | 3.6 | % |
| Depreciation | | | 129 | | | | 0.9 | % | | | 139 | | | | 1.6 | % | | | 119 | | | | 0.8 | % | | | 140 | | | | 1.8 | % | | | 383 | | | | 0.9 | % | | | 413 | | | | 1.7 | % |
| Amortization of definite-lived intangible assets | | | 123 | | | | 0.9 | % | | | 36 | | | | 0.4 | % | | | 123 | | | | 0.8 | % | | | 36 | | | | 0.5 | % | | | 370 | | | | 0.9 | % | | | 108 | | | | 0.4 | % |
| Total operating expenses | | | 3,618 | | | | 25.8 | % | | | 4,319 | | | | 49.5 | % | | | 5,653 | | | | 37.8 | % | | | 4,402 | | | | 56.3 | % | | | 13,530 | | | | 31.8 | % | | | 13,343 | | | | 53.7 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Operating loss | | | (396 | ) | | | (2.8 | )% | | | (2,095 | ) | | | (24.0 | )% | | | (3,388 | ) | | | (22.7 | )% | | | (1,947 | ) | | | (24.9 | )% | | | (5,128 | ) | | | (12.1 | )% | | | (6,017 | ) | | | (24.2 | )% |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest income, net | | | 27 | | | | 0.2 | % | | | 31 | | | | 0.4 | % | | | 19 | | | | 0.1 | % | | | 44 | | | | 0.6 | % | | | 67 | | | | 0.2 | % | | | 103 | | | | 0.4 | % |
| Gain (loss) on derivative instruments, net | | | (48 | ) | | | (0.4 | )% | | | 104 | | | | 1.2 | % | | | 20 | | | | 0.1 | % | | | 69 | | | | 0.9 | % | | | (59 | ) | | | (0.1 | )% | | | 178 | | | | 0.7 | % |
| Other expense, net | | | (39 | ) | | | (0.3 | )% | | | (10 | ) | | | (0.2 | )% | | | (156 | ) | | | (0.9 | )% | | | - | | | | 0.0 | % | | | (235 | ) | | | (0.6 | )% | | | (7 | ) | | | 0.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loss before income taxes | | | (456 | ) | | | (3.3 | )% | | | (1,970 | ) | | | (22.6 | )% | | | (3,505 | ) | | | (23.4 | )% | | | (1,834 | ) | | | (23.4 | )% | | | (5,355 | ) | | | (12.6 | )% | | | (5,743 | ) | | | (23.1 | )% |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Provision for income taxes | | | 88 | | | | 0.6 | % | | | 54 | | | | 0.6 | % | | | 50 | | | | 0.4 | % | | | 61 | | | | 0.8 | % | | | 211 | | | | 0.5 | % | | | 162 | | | | 0.7 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net loss | | $ | (544 | ) | | | (3.9 | )% | | $ | (2,024 | ) | | | (23.2 | )% | | $ | (3,555 | ) | | | (23.8 | )% | | $ | (1,895 | ) | | | (24.2 | )% | | $ | (5,566 | ) | | | (13.1 | )% | | $ | (5,905 | ) | | | (23.8 | )% |
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, 2014 is included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 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 2014 Annual Report on Form 10-K for the fiscal year ended December 31, 2014.
3236
Results of Operations - Three and Nine Months ended March 31,September 30, 2015 versus Three and Nine Months ended March 31,September 30, 2014
Contract Revenue. ContractTotal contract revenue for the three months ended March 31,September 30, 2015 totaled $14.0$15.0 million, which was 60.4%91.2% more than the $7.8 million total revenue for the quarter ended September 30, 2014. For the nine months ended September 30, 2015, contract revenue totaled $42.6 million, which was 71.6% greater than the $8.7$24.8 million of revenue for the threenine months ended March 31,September 30, 2014. The increase in revenue was primarily driven by the acquisition of Hyperspring, represented by our Staff AugmentationNuclear Industry Training and Consulting segment, depicteddescribed below.
| (in thousands) | Three Months ended | | |
| | March 31, | | Three Months ended | | | Nine Months ended | |
| | 2015 | | 2014 | | September 30, | | | September 30, | |
| | | | | | | | |
| (in thousands) | | 2015 | | 2014 | | | 2015 | | 2014 | |
| Contract Revenue: | | | | | | | | | | | | | | | | | | |
| Performance Improvement Solutions | | $ | 8,816 | | | $ | 8,724 | | | $ | 9,903 | | | $ | 7,823 | | | $ | 26,911 | | | $ | 24,823 | |
| Staff Augmentation | | | 5,180 | | | | - | | |
| Nuclear Industry Training and Consulting | | | | 5,058 | | | | - | | | | 15,678 | | | | - | |
| Total Contract Revenue | | $ | 13,996 | | | $ | 8,724 | | | $ | 14,961 | | | $ | 7,823 | | | $ | 42,589 | | | $ | 24,823 | |
Performance Improvement Solutions revenue increased 1.1%26.6% from $8.7$7.8 million for the three months ended March 31,September 30, 2014 to $8.8$9.9 million for the March 31,three months ended September 30, 2015. 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 $11.1$3.8 million in the three months ended March 31,September 30, 2015 as compared to $6.3$17.6 million in the three months ended March 31,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 Staff AugmentationNuclear 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 March 31,September 30, 2015 totaled $5.2$5.1 million. Staff AugmentationNuclear Industry Training and Consulting orders totaled $7.0$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 March 31,September 30, 2015, backlog was $52.4$47.5 million: $44.0$42.1 million for the Performance Improvement Solutions business segment and $8.4$5.4 million for Staff Augmentation.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 Staff Augmentation.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. GrossExcluding the $1.5 million write-down of software development costs, gross profit totaled $3.2was $3.8 million for the three months ended March 31,September 30, 2015 compared to $2.2$2.5 million for the same period in 2014. As a percentage of revenue, gross profit decreased from 25.5%31.4% for the three months ended March 31,September 30, 2014 to 23.0%25.4% for the three months ended March 31,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 $7.3 million for the same period in 2014. As a percentage of revenue, gross profit decreased from 29.5% for the nine months ended September 30, 2014 to 23.3% for the nine months ended September 30, 2015. The additionreduction in gross profit in 2015 reflects the Company's acquisition of the Staff AugmentationHyperspring LLC in November 2014. Hyperspring, which comprises our Nuclear Industry Training and Consulting segment, which has an overall gross profit which is significantly lower than the Company's historical gross profit of our Performance Improvement Solution segment gross profits, has contributed to the decrease in gross profit percentage for the three months ended March 31, 2015.segment.
| ($ in thousands) | Three Months ended | |
| | March 31, | |
| | 2015 | | | % | | 2014 | | | % | |
| Gross Profit: | | | | | | | | | | | | |
| Performance Improvement Solutions | | $ | 2,705 | | | | 30.7 | % | | $ | 2,224 | | | | 25.5 | % |
| Staff Augmentation | | | 517 | | | | 10.0 | % | | | - | | | | 0.0 | % |
| Consolidated Gross Profit | | $ | 3,222 | | | | 23.0 | % | | $ | 2,224 | | | | 25.5 | % |
| | | 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'Solutions had gross profit of $2.7$3.1 million or 30.7%31.6% of segment revenue for the three months ended March 31,September 30, 2015 increased $0.5 million from $2.2compared to $2.5 million or 25.5%31.4% of segment revenue for the threequarter 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 March 31,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 threenine months ended March 31,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 $3.4$3.8 million in the three months ended March 31,September 30, 2015, an 18.8%a 3.6% decrease from the $4.1$4.0 million for the same period in 2014. For the nine months ended September 30, 2015 and 2014, SG&A expenses totaled $11.0 million and $11.9 million, respectively. The decrease reflectsdecreases reflect the following spending variances:
| · | Business development and marketing costs decreased from $1.4 million to $1.3$1.5 million for the three months ended March 31,September 30, 2014 to $1.2 million for the three months ended September 30, 2015, and 2015, respectively.decreased from $4.5 million for the nine months ended September 30, 2014 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 $92,000 to $285,000were $180,000 and $420,000 for the three months ended March 31,September 30, 2015 as compared toand 2014, respectively, and $679,000 and $1.2 million for the threenine months ended March 31,2014.September 30, 2015 and 2014, respectively. |
| · | The Company's general and administrative expenses ("G&A") decreasedincreased to $2.2 million from $2.1 million to $1.7 million for the three months ended March 31,September 30, 2015 and 2014, respectively, and increased to $5.9 million from $5.2 million for the nine months ended September 30, 2015 and 2014, respectively. TheSome components of G&A reflected the following variances:are as follows: |
| o | The Company incurred a foreign currency translation gain of $30,000 forFor the three months ended March 31,September 30, 2015 compared to a loss of $172,000 forand 2014, contingent consideration accretion expense was $306,000 and $22,000, respectively. For the threenine months ended March 31, 2014.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 is associated with the deferred contingent consideration due to the former Hyperspring members if certain EBITDA targets are met. |
| o | In 2014, the first quarterCompany's Board of Directors agreed to waive their fees for 2014. These fees were reinstated in 2015 and totaled $51,000 and $149,000 in the three and nine months ended September 30, 2015. |
| o | For the three and nine months ended September 30, 2014, the Company incurred severance costsacquisition expenses of $281,000 associated with$35,000 and $108,000, respectively, related to the separationacquisition of an executive from our Swedish operations.Hyperspring. No acquisition expenses were incurred in 2015. |
3339
| · | Gross spending on software product development ("development") expenses for the three and nine months ended March 31,September 30, 2015 totaled $866,000 and 2014 totaled $901,000$2.6 million, respectively, as compared to $1.0 million and $790,000,$2.8 million for the three and nine months ended September 30, 2014, respectively. The Company capitalized $506,000$473,000 and $155,000$1.4 million of product development expenses for the three and nine months ended March 31,September 30, 2015, respectively, and $241,000 and $590,000 for the same periods in 2014, respectively. Net development spending decreased from $635,000$795,000 for the three months ended March 31,September 30, 2014 to $395,000$393,000 for the three months ended March 31,September 30, 2015 and decreased from $2.2 million for the nine months ended September 30, 2014 to $1.2 million for the nine months ended September 30, 2015. |
| o | Spending on simulationsimulator 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 $601,000$760,000 and $661,000$2.2 million for the three and nine months ended March 31, 2015 andSeptember 30, 2014, respectively. The Company's development expenses were mainly related to EDM™, oura new configuration management system and enhancements to ourthe enhancement of JADE™ applicationsand 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 $268,000$276,000 and $83,000$233,000 for the three months ended March 31,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 $32,000$72,000 and $46,000$108,000 of costs related to this effort during the three and nine months ended March 31,September 30, 2015, respectively, as compared to $43,000 and $178,000 for the same periods in 2014, respectively. The Company's 3D development activities have been curtailed as a part of the third quarter 2015 restructuring. |
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 $380,000 charge in the third quarter 2015 in severance expense related to the termination of Mr. 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 and $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 2014 related to the renegotiation of our Swedish office lease to reduce the size of the office.
Depreciation. Depreciation expense totaled $129,000$119,000 and $139,000 during$140,000 for the quartersthree months ended March 31,September 30, 2015 and 2014, respectively. For the nine months ended September 30, 2015 and 2014, depreciation expense totaled $383,000 and $413,000, respectively.
Amortization of definite-lived intangible assets.Definite-lived Intangible Assets. Amortization expense related to definite-lived intangible assets totaled $123,000 and $36,000 for the three months ended March 31,September 30, 2015 and 2014, respectively. The increase in first quarterFor the nine months ended September 30, 2015 and 2014, amortization expense reflectsrelated 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 $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 recorded withamortization relates to the Hyperspring acquisition in November 2014amortization of EnVision and TAS intangible assets which is being amortizedrecognized on a straight-line basis over seven years.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 $0.4$3.4 million (2.8%(22.7% of revenue) forduring the three months ended March 31,September 30, 2015, as compared with an operating loss of $2.1$1.9 million (24.0%(24.9% of revenue) for the same period in 2014. For the nine months ended September 30, 2015 and 2014, the Company had an operating loss of $5.1 million (12.1% of revenue) and an operating loss of $6.0 million (24.2% of revenue), respectively. The variances were due to the factors outlined above. Excluding the impact of the $1.5 million capitalized software write-down from the three and nine months ended September 30, 2015 and the $1.6 million and $1.7 million restructuring charges for the three and nine months ended September 30, 2015, respectively, the Company generated an operating loss of $250,000 (1.7% of revenue) during the three months ended September 30, 2015, and an operating loss of $1.8 million (4.3% of revenue) during the nine months ended September 30, 2015.
Interest Income, Net. Net interest income totaled $27,000$19,000 and $31,000$44,000 for the three months ended March 31,September 30, 2015 and 2014, respectively. For the nine months ended September 30, 2015 and 2014, net interest income totaled $67,000 and $103,000, respectively.
Gain (loss)(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 March 31,September 30, 2015, the Company had foreign exchange contracts outstanding of approximately 0.32.6 million Euro, 0.6 Pounds Sterling, 2.2 million Euro, and 0.70.5 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 no gain or loss on the change in the estimated fair value of the contracts for the three months ended March 31, 2015.
As of March 31, 2014, the Company had foreign exchange contracts outstanding of approximately 0.2 million Pounds Sterling, 5.3 million Euro, and 2.2 million Japanese Yen at fixed rates. The contracts expired on various dates through May 2016. The Company had not designated the contracts as hedges and had recognized a gain on the change in the estimated fair value of the contracts of $243,000$34,000 for both the three months ended March 31, 2014.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 1.5 million Euro, 0.1 million Pounds Sterling and 33,000 Canadian Dollars at fixed rates. The contracts expire on various dates through June 2016. The Company had not designated the contracts as hedges and had 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.
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. 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 March 31,September 30, 2015, the Company recognized a losslosses of $48,000$14,000 and $6,000, respectively, from the remeasurement of such contract receivables, billings in excess of revenue earned and subcontractor accruals. For the same periodperiods in 2014, the Company recognized a gain of $11,000 and a loss of $139,000.
34
$134,000, respectively.
Other Expense, netNet. For the three and nine months ended March 31,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 $39,000$0 and $10,000,$7,000, 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 upon the attainment byshould IntelliQlik ofattain certain development milestones by September 30, 2015. IntelliQlik is jointly owned by GSE Performance and oneBased on a review of the former shareholderssoftware platform as of Hyperspring. ForSeptember 30, 2015, GSE concluded that the three months ended March 31, 2015,required development milestones had not been met and did not contribute the additional $250,000 investment. The Company recognized a $39,000 equity loss onwrote-off the remaining $126,000 balance of its IntelliQlik investment in IntelliQlik.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 threenine months ended March 31,September 30, 2014, the Company recognized a $27,000 equity loss onof $38,000 relating to its equitypro rata share of operating results from GSE-RUS. Although the company's entire investment in GSE RUS.GSE-RUS was written off by the end of December 2014, we have not received a request for additional funding from the joint venture and, due to the political issues with Russia regarding the conflict in Ukraine, we do not intend to contribute additional equity in the foreseeable future. |
| · | The Company had other miscellaneous incomelosses of $17,000$2,000 for the three and nine months ended March 31, 2014.September 30, 2015, respectively. For the nine months ended September 30, 2014, the Company had other miscellaneous income of $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 and the UK in 2015. In 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., Swedish, and Chinese net deferred tax assets at March 31,September 30, 2015.
Liquidity and Capital Resources
As of March 31,September 30, 2015, the Company's cash and cash equivalents totaled $11.6$12.8 million compared to $13.6 million at December 31, 2014.
Cash provided by (used in) operating activities. For the threenine months ended March 31,September 30, 2015, net cash used inprovided by operations totaled $0.5$1.3 million. Significant changes in the Company's assets and liabilities in the threenine months ended March 31,September 30, 2015 included:
| · | A $0.6$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 $8.4$7.5 million at March 31,September 30, 2015. At March 31,September 30, 2015, trade receivables outstanding for more than 90 days, net of the bad debt reserve, totaled approximately $0.9$1.1 million as compared to $0.4 million$369,000 at December 31, 2014. The Company believes the entire 90-day balance at March 31,September 30, 2015 will be received. The Company's unbilled receivables increaseddecreased by approximately $1.7 million$291,000 to $6.8$4.8 million at March 31,September 30, 2015 as compared to December 31, 2014. The increasedecrease in the unbilled receivables is due to the timing of contracted billing milestones of the Company's current projects. In AprilOctober 2015, the Company invoiced $2.3$1.9 million of the unbilled amounts; the balance is expected to be invoiced and collected within one year. |
| · | A $0.4$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 decreaseincrease was due to the timing of payments made by the Company to vendors and subcontractors. |
For the threenine months ended March 31,September 30, 2014, net cash provided by operations totaled $5.8$5.2 million. Significant changes in the Company's assets and liabilities in the threenine months ended March 31,September 30, 2014 included:
| · | AAn $9.911.9 million decrease in the Company's contract receivables. The Company's trade receivables, net of the allowance for doubtful accounts, decreased from $19.0 million at December 31, 2013 to $6.8$6.2 million at March 31,September 30, 2014. At March 31,September 30, 2014, trade receivables outstanding for more than 90 days, net of the bad debt reserve, totaled approximately $1.1 million versus $0.6 million$549,000 as compared to $623,000 at December 31, 2013. The Company's unbilled receivables increased by approximately $2.2 million$760,000 to $7.7$6.3 million at March 31, 2015September 30, 2014 as compared to December 31, 2013. The increase in the unbilled receivables was due to the timing of contracted billing milestones of the Company's current projects.
|
| · | A $2.2$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. |
Cash used in investing activities. Net cash used in investing activities totaled $0.6$1.0 million for the threenine months ended March 31,September 30, 2015. Capital expenditures totaled $104,000$217,000 and capitalized software development costs totaled $506,000$1.4 million for the threenine months ended March 31,September 30, 2015. Restrictions of cash used as collateral underfor outstanding letters of credit totaled $216,000decreased by $676,000 for the threenine months ended March 31, 2015. Releases of restricted cash as collateral under letters of credit totaled $180,000 for the three months ended March 31,September 30, 2015.
Net cash used in investing activities totaled $201,000$4.0 million for the threenine months ended March 31,September 30, 2014. Capital expenditures totaled $80,000$240,000 and capitalized software development costs totaled $155,000$590,000 for the threenine months ended March 31,September 30, 2014. On September 30, 2014 Susquehanna Bank collateralized the Company's outstanding letters of credit and segregated $3.2 million into a restricted cash account. Releases of restricted cash as collateral under letters of credit totaled $34,000 for the threenine months ended March 31,September 30, 2014.
Cash used in financing activities. Cash used in financing activities totaled $657,000$839,000 for the threenine months ended March 31,September 30, 2015. HyperspringThe Company has a working capital line of credit with IberiaBank. TheIberiaBank for its Hyperspring subsidiary. In the first quarter 2015, the Company paid down $339,000 of the outstanding balance of the line of credit, during$339,000, and at September 30, 2015, the threeCompany had no outstanding borrowings. During the nine months ended March 31, 2015. During the three months ended March 31,September 30, 2015, the Company made payments of $318,000 in relation$500,000 to the liability classified contingent-consideration associatedformer EnVision Systems, Inc. members in accordance with the acquisition2011 purchase agreement due to the achievement of EnVision Systems, Inc.certain revenue targets in 2014.
Net cash used in financing activities totaled $500,000 for the threenine months ended March 31,September 30, 2014. During the threenine months ended March 31,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.certain revenue targets in 2013.
At March 31,September 30, 2015, the Company had cash and cash equivalents of $11.6$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.
3645
Credit Facilities
Susquehanna Bank
At March 31,September 30, 2015, the Company had a Master Loan and Security Agreement and Revolving Credit Note with Susquehanna Bank ("Susquehanna"). The Company and its subsidiary, GSE Performance Solutions, Inc., were 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 1/2%. The agreement expires on June 30, 2015.2016.
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, proceeds and products, intangibles, trademarks, patents, intellectual property, 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 is to maintain a segregated 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, Susquehanna Bank shall have complete and unconditional control over the cash collateral account.
On September 30, 2014, Susquehanna Bank collateralized the outstanding letters of credit issued under the line of credit. At MarchSeptember 30, 2015 and December 31, 2015,2014, the cash collateral account totaled $3.6 million and $4.2 million, and wasrespectively. The balances were classified as restricted cash on the balance sheet.
The credit agreement containsagreements contain certain restrictive covenants regarding future acquisitions and incurrence of debt. In addition,On July 31, 2015, the credit agreement containsCompany 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.covenant targets were adjusted.
| | | As of |
| | Covenant | March 31,September 30, 2015 |
| | | |
Cash flow coverage ratio | Must Exceed 1.20 : 1.00 | -4.41 : 1.00 |
| Minimum tangible capital base | Must Exceed $26.0$10.5 million | $14.510.9 million |
| Quick ratio | Must Exceed 2.001.00 : 1.00 | 1.63 : 1.00 |
Tangible capital base ratio | Not to Exceed .75 : 1.00 | 1.411.43 : 1.00 |
As of March 31,September 30, 2015, the Company was not in compliance with any of its covenants as defined above, however, the Company has received a written waiver from Susquehanna Bank for noncompliance.above.
On November 14, 2014, the acquisition date,IberiaBank
At September 30, 2015, Hyperspring, LLC had a $1.0 million working capital line of credit with IberiaBank. Interest wasUnder the executed promissory note, interest is payable monthly at athe rate of 1.00 percentage points over the prime rate of interest as published in the money rate section of the Wall Street Journal plus 2.50%. Theresulting in an effective rate at November 14, 2014 was 5.750%. The line was secured by all accounts of Hyperspring and was guaranteed by the members of Hyperspring, LLC.
On December 7, 2014, the working capital line of credit matured while the Company was renegotiating the new terms with IberiaBank subsequent to the acquisition of Hyperspring. On January 22, 2015, a promissory note was executed between Hyperspring, LLC and IberiaBank to extend the $1.0 million line of credit until June 30, 2015. Under the new terms, interest is payable monthly at a rate of the prime rate of interest as published in the money rate section of the Wall Street Journal plus 1.00 %. The effective rate at the date of the promissory note was 4.25 %.4.25%. The line is secured by all accounts of Hyperspring and guaranteed by GSE Systems, Inc.
At December 31, 2014 the outstanding balance on the The line of credit was $339,000.expires on July 6, 2016. At March 31,September 30, 2015, the Company had no balance was outstanding onamounts under the line of credit.
The Company draws on the IberiaBank lineLetters of credit as needed mainly to provide for payroll funding for Hyperspring. The line is replenished through collection of receivables obtained in the following weeks.
Contingent LiabilitiesCredit and Bonds
As of March 31,September 30, 2015, the Company was contingently liable for fourteenhad thirteen standby letters of credit and one surety bond totaling $4.3$3.6 million which represent advance payment and performance bonds on twelve contracts. The Company has deposited the full value of fourteenthirteen 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 March 31,September 30, 2015 as restricted cash.
3747
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 Australian Dollar.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 March 31,September 30, 2015, the Company had foreign exchange contracts outstanding of approximately 0.32.6 million Euro, 0.6 million Pounds Sterling, 0.70.5 million Australian Dollars and 2.212.5 million EuroJapanese Yen at fixed rates. The contracts expire on various dates through December 2016. The Company had not designated the contracts as hedges and hashad recognized no changea 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 March 31, 2015.September 30, 2015, respectively. A 10% fluctuation in the foreign currency exchange rates up or down as of March 31,September 30, 2015 would have increased/decreased the change in the estimated fair value of the contracts by $7,100.$1,700.
As of March 31,September 30, 2014, the Company had foreign exchange contracts outstanding of approximately 0.21.5 million Euro, 0.1 million Pounds Sterling, 5.3 million Euro, and 2.2 million Japanese Yen34,000 Canadian Dollars at fixed rates. The contracts expire on various dates through MayJune 2016. The Company had not designated the contracts as hedges and had recognized lossesgains on the change in the estimated fair value of the contracts of $243,000$58,000 and $312,000 for the three and nine months ended March 31, 2014.September 30, 2014, respectively. A 10% fluctuation in the foreign currency exchange rates up or down as of March 31,September 30, 2014 would have increased/decreased the change in the estimated fair value of the contracts by $27,000.$1,400.
3848
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 March 31,September 30, 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
There were no changes in the Company's internal control over financial reporting that occurred during the most recent fiscal quarter that have materially affected or are reasonably likely to materially affect the Company's internal control over financial reporting.
(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.
3949
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, 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.
4050
None
| | 10.1 | ExtensionForm of Restricted Stock Unit Agreement Under the $7,500,000 Revolving Credit Note, dated May 12, 2015, filed herewith. |
| | |
| 10.2 | Amendment to Membership Interests Purchase Agreement, dated May 13, 2015,GSE Systems, Inc. 1995 Long-Term Incentive Plan, as amended and restated effective March 6, 2014, filed herewith. |
| | | |
| | 31.1 | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes- Oxley Act of 2002, filed herewith. |
| | | |
| | 31.2 | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith. |
| | | |
| | 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. |
| | | |
| | 101.INS* | XBRL Instance Document |
| | | |
| | 101.SCH* | XBRL Taxonomy Extension Schema |
| | | |
| | 101.CAL* | XBRL Taxonomy Extension Calculation Linkbase |
| | | |
| | 101.DEF* | XBRL Taxonomy Extension Definition Linkbase |
| | | |
| | 101.LAB* | XBRL Taxonomy Extension Label Linkbase |
| | | |
| | 101.PRE* | XBRL Taxonomy Extension Presentation Linkbase |
| | |
| | |
| | |
| | |
| | |
| | |
4151
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: May 14,November 12, 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)
4252