UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q

(Mark One)   
☒ 
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
for the Quarterly Period Ended September 30, 2015March 31, 2016
 
    
  or 
    
☐ 
Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
for the transition period from ____ to ____
 

Commission File Number 001-14785
 
GSE Systems, Inc.
(Exact name of registrant as specified in its charter)

Delaware 52-1868008
(State of incorporation) 
(I.R.S. Employer Identification Number)
 
1332 Londontown Blvd., Suite 200, Sykesville MD 21784
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code:  (410) 970-7800

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.

Large accelerated filer  ☐
Accelerated filer  ☐
Non-accelerated filer ☐
Smaller reporting company ☒
  (Do not check if a smaller reporting company) 

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]

There were 17,897,85918,031,765 shares of common stock, with a par value of $.01 per share outstanding as of November 11, 2015.May 13, 2016.

1

GSE SYSTEMS, INC.
QUARTERLY REPORT ON FORM 10-Q
INDEX

   PAGE
PART I. 
FINANCIAL INFORMATION
3
Item 1. 
Financial Statements:
 
  
Consolidated Balance Sheets as of September 30, 2015March 31, 2016 and December 31, 20142015
3
  
Consolidated Statements of Operations for the Three and Nine Months Ended September 30,March 31, 2016 and March 31, 2015 and September 30, 2014
4
  
Consolidated Statements of Comprehensive LossIncome (Loss) for the Three and Nine Months Ended September 30,March 31, 2016 and March 31, 2015 and September 30, 2014
5
  
Consolidated Statement of Changes in Stockholders' Equity for the NineThree Months Ended September 30, 2015March 31, 2016
6
  
Consolidated Statements of Cash Flows for the NineThree Months Ended September 30,March 31, 2016 and March 31, 2015 and September 30, 2014
7
  
Notes to Consolidated Financial Statements
8
Item 2. 
Management's Discussion and Analysis of Financial Condition and Results of Operations
3025
Item 3. 
Quantitative and Qualitative Disclosures About Market Risk
4841
Item 4. 
Controls and Procedures
4942
    
PART II. 
OTHER INFORMATION
5044
Item 1. 
Legal Proceedings
5044
Item 1A. 
Risk Factors
5044
Item 2. 
Unregistered Sales of Equity Securities and Use of Proceeds
5044
Item 3. 
Defaults Upon Senior Securities
5044
Item 4. 
Mine Safety Disclosures
5044
Item 5. 
Other Information
5145
Item 6. 
Exhibits
5145
  
SIGNATURES
5246
2

PART I - FINANCIAL INFORMATION
Item 1.  Financial Statements

GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)

 Unaudited    Unaudited    
 September 30, 2015  December 31, 2014  March 31, 2016  December 31, 2015 
ASSETSASSETS ASSETS 
Current assets:          
Cash and cash equivalents $12,832  $13,583  $11,225  $11,084 
Restricted cash  223   613   1,877   1,771 
Contract receivables, net  12,240   15,830   12,780   13,053 
Prepaid expenses and other current assets  2,380   1,703   2,934   2,506 
Total current assets  27,675   31,729   28,816   28,414 
                
Equipment, software and leasehold improvements  7,039   7,055   7,012   7,003 
Accumulated depreciation  (5,387)  (5,229)  (5,531)  (5,407)
Equipment, software and leasehold improvements, net  1,652   1,826   1,481   1,596 
                
Software development costs, net  996   1,414   1,195   1,145 
Goodwill  5,612   5,612   5,612   5,612 
Intangible assets, net  903   1,279   696   775 
Long-term restricted cash  3,305   3,591   1,734   1,779 
Other assets  78   548   94   50 
Total assets $40,221  $45,999  $39,628  $39,371 
                
LIABILITIES AND STOCKHOLDERS' EQUITYLIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES AND STOCKHOLDERS' EQUITY 
Current liabilities:                
Line of credit $-  $339 
Accounts payable  2,015   2,330  $2,116  $1,238 
Accrued expenses  1,944   1,554   1,727   1,723 
Accrued compensation and payroll taxes  3,707   2,595   2,781   2,431 
Billings in excess of revenue earned  7,062   8,684   8,785   9,229 
Accrued warranty  1,614   1,456   1,410   1,614 
Current contingent consideration  2,601   2,842   1,115   2,647 
Other current liabilities  444   473   1,055   826 
Total current liabilities  19,387   20,273   18,989   19,708 
                
Contingent consideration  2,221   1,948   1,127   1,085 
Other liabilities  238   38   706   210 
Total liabilities  21,846   22,259   20,822   21,003 
                
Stockholders' equity:                
Preferred stock $.01 par value, 2,000,000 shares authorized, shares issued and outstanding none in 2015 and 2014  -   - 
Common stock $.01 par value, 30,000,000 shares authorized, 19,496,770 shares issued and 17,897,859 shares outstanding in 2015, 19,486,770 shares issued and 17,887,859 shares outstanding in 2014  195   195 
Preferred stock $.01 par value, 2,000,000 shares authorized, shares issued and outstanding none in 2016 and 2015  -   - 
Common stock $.01 par value, 30,000,000 shares authorized, 19,522,483 shares issued and 17,923,572 shares outstanding in 2016, 19,510,770 shares issued and 17,911,859 shares outstanding in 2015  195   195 
Additional paid-in capital  73,324   72,917   73,732   73,481 
Accumulated deficit  (50,708)  (45,142)  (50,711)  (50,849)
Accumulated other comprehensive loss  (1,437)  (1,231)  (1,411)  (1,460)
Treasury stock at cost, 1,598,911 shares in 2015 and 2014  (2,999)  (2,999)
Treasury stock at cost, 1,598,911 shares in 2016 and 2015  (2,999)  (2,999)
Total stockholders' equity  18,375   23,740   18,806   18,368 
Total liabilities and stockholders' equity $40,221  $45,999  $39,628  $39,371 

The accompanying notes are an integral part of these consolidated financial statements.
3

GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(Unaudited)

  
Three Months ended
September 30,
  
Nine Months ended
September 30,
 
  2015  2014  2015  2014 
         
Contract revenue $14,961  $7,823  $42,589  $24,823 
                 
Cost of revenue  11,158   5,368   32,649   17,497 
Write-down of capitalized software development costs  1,538   -   1,538   - 
Gross profit  2,265   2,455   8,402   7,326 
                 
Operating expenses:                
Selling, general and administrative  3,811   3,954   11,031   11,939 
Restructuring charges  1,600   272   1,746   883 
Depreciation  119   140   383   413 
Amortization of definite-lived intangible assets  123   36   370   108 
Total operating expenses  5,653   4,402   13,530   13,343 
                 
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)
                 
Provision for income taxes  50   61   211   162 
Net loss $(3,555) $(1,895) $(5,566) $(5,905)
                 
                 
Basic loss per common share $(0.20) $(0.11) $(0.31) $(0.33)
                 
Diluted loss per common share $(0.20) $(0.11) $(0.31) $(0.33)

The accompanying notes are an integral part of these consolidated financial statements.

4

GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)
(Unaudited)

  
Three Months ended
September 30,
  
Nine Months ended
September 30,
 
  2015  2014  2015  2014 
         
         
Net loss $(3,555) $(1,895) $(5,566) $(5,905)
                 
Foreign currency translation adjustment, net of tax  (76)  (261)  (206)  (362)
                 
Comprehensive loss $(3,631) $(2,156) $(5,772) $(6,267)
  
Three months ended
March 31,
 
  2016  2015 
       
Contract revenue $12,976  $14,013 
Cost of revenue  9,352   10,719 
  Gross profit  3,624   3,294 
         
Operating expenses:        
Selling, general and administrative  3,111   3,269 
Restructuring charges  125   97 
Depreciation  100   129 
Amortization of definite-lived intangible assets  73   123 
Total operating expenses  3,409   3,618 
         
Operating income (loss)  215   (324)
         
Interest income, net  27   27 
Loss on derivative instruments, net  (118)  (48)
Other income (expense), net  102   (39)
Income (loss) before income taxes  226   (384)
         
Provision for income taxes  88   88 
Net income (loss) $138  $(472)
         
         
Basic earnings (loss) per common share $0.01  $(0.03)
         
Diluted earnings (loss) per common share $0.01  $(0.03)

The accompanying notes are an integral part of these consolidated financial statements.
54


GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
(Unaudited)

  
Three months ended
March 31,
 
  2016  2015 
       
       
Net income (loss) $138  $(472)
         
Foreign currency translation adjustment  49   (236)
         
Comprehensive income (loss) $187  $(708)

The accompanying notes are an integral part of these consolidated financial statements.
5


GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands)
(Unaudited)

  
Common
Stock
  
Additional
Paid-in
  Accumulated  
Accumulated
Other Comprehensive
  
Treasury
Stock
   
  Shares  Amount  Capital  Deficit  Loss  Shares  Amount  Total 
Balance, December 31, 2014  19,487  $195  $72,917  $(45,142) $(1,231)  (1,599) $(2,999) $23,740 
                                 
Stock-based compensation expense  -   -   392   -   -   -   -   392 
Common stock issued for services provided  10   -   15   -   -   -   -   15 
Foreign currency translation adjustment  -   -   -   -   (206)  -   -   (206)
Net loss  -   -   -   (5,566)  -   -   -   (5,566)
Balance, September 30, 2015  19,497  $195  $73,324  $(50,708) $(1,437)  (1,599) $(2,999) $18,375 
  
Common
Stock
  
Additional
Paid-in
  Accumulated  
Accumulated
Other Comprehensive
  
Treasury
Stock
    
  Shares  Amount  Capital  Deficit  Loss  Shares  Amount  Total 
Balance, December 31, 2015  19,511  $195  $73,481  $(50,849) $(1,460)  (1,599) $(2,999) $18,368 
                                 
Stock-based compensation expense  -   -   247   -   -   -   -   247 
Common stock issued for options exercised  2   -   4   -   -   -   -   4 
Common stock issued for RSUs vested  9   -   -   -   -   -   -   - 
Foreign currency translation adjustment  -   -   -   -   49   -   -   49 
Net income  -   -   -   138   -   -   -   138 
Balance, March 31, 2016  19,522  $195  $73,732  $(50,711) $(1,411)  (1,599) $(2,999) $18,806 

The accompanying notes are an integral part of these consolidated financial statements.

6

GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)

 
Nine Months ended
September 30,
  
Three months ended
March 31,
 
 2015  2014  2016  2015 
Cash flows from operating activities:          
Net loss $(5,566) $(5,905)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:        
Write-down of capitalized software development costs  1,538   - 
Net income (loss) $138  $(472)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:        
Depreciation  383   413   100   129 
Amortization of definite-lived intangible assets  370   108   73   123 
Capitalized software amortization  291   173   81   90 
Change in fair value of contingent consideration  739   69   (69)  (80)
Stock-based compensation expense  407   514   247   134 
Equity loss on investments  233   38   -   39 
(Gain) loss on derivative instruments  59   (178)
Loss on derivative instruments  118   48 
Deferred income taxes  36   36 
Gain on sales of equipment, software, and leasehold improvements  (1)  - 
Changes in assets and liabilities:                
Contract receivables  3,580   11,928   334   610 
Prepaid expenses and other assets  (409)  419   (515)  31 
Accounts payable, accrued compensation and accrued expenses  1,262   (2,292)  1,226   (358)
Billings in excess of revenue earned  (1,618)  792   (492)  (835)
Accrued warranty reserves  158   (349)
Accrued warranty  (101)  51 
Other liabilities  (120)  (575)  465   (18)
Net cash provided by operating activities  1,307   5,155 
Net cash provided by (used in) operating activities  1,640   (472)
                
Cash flows from investing activities:                
Proceeds from sale of equipment, software, and leasehold improvements  31   - 
Capital expenditures  (217)  (240)  (18)  (104)
Capitalized software development costs  (1,411)  (590)  (131)  (506)
Restrictions of cash as collateral under letters of credit  (1,148)  (3,159)  (2)  (216)
Releases of cash as collateral under letters of credit  1,824   34   1   180 
Net cash used in investing activities  (952)  (3,955)  (119)  (646)
                
Cash flows from financing activities:                
Proceeds from issuance of common stock  4   - 
Payments on line of credit  (339)  -   -   (339)
Payments of the liability-classified contingent consideration arrangements  (500)  (500)  (1,421)  (318)
Net cash used in financing activities  (839)  (500)  (1,417)  (657)
                
Effect of exchange rate changes on cash  (267)  (315)  37   (218)
Net increase (decrease) in cash and cash equivalents  (751)  385   141   (1,993)
Cash and cash equivalents at beginning of year  13,583   15,643   11,084   13,583 
Cash and cash equivalents at end of period $12,832  $16,028  $11,225  $11,590 

The accompanying notes are an integral part of these consolidated financial statements.


7
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Three and Nine Months ended September 30,March 31, 2016 and 2015 and 2014
(Unaudited)

1.BasisSummary of Presentation and Revenue RecognitionSignificant Accounting Policies

Basis of Presentation

The consolidated interim financial statements included herein have been prepared by GSE Systems, Inc. (the "Company""Company," "GSE," "we," "us," or "GSE""our") 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, 20142015 filed with the Securities and Exchange Commission on March 19, 2015.25, 2016.  Certain reclassifications have been made to prior period amounts to conform to the current presentation.

The Company has two reportable segments as follows:

·Performance Improvement Solutions (approximately 68% of revenue)
OurThe Company's Performance Improvement Solutions business segment primarily encompasses all of the solution-oriented technologiesnext generation power plant and services traditionally associated with GSE which focus on both our client's people and their plants and operations.process high-fidelity 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. Our simulationthe Company serves: primarily nuclear and fossil fuel power generation, and the process industries.  Simulation solutions include platforms ranging fromthe following: (1) simulation software and services, including operator training systems, for the non-specific plantnuclear power industry, (2) simulation software and services, including operator training systems, of our EnVision product linefor the fossil power industry, and (3) simulation software and services for the process industries 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 turnkeyongoing workforce development and custom training services to make training more effective. Our engineering services include plant design, automation and control systems design, functional safety and compliance analysis, and engineering consultations.training.


·Nuclear Industry Training and Consulting (formerly our "Staff Augmentation" segment)(approximately 32% of revenue)
Nuclear Industry Training and Consulting services provideprovides 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 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 ourthe 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 the two business segments is provided in Note 1514 of the accompanying Consolidated Financial Statements.consolidated financial statements.
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.
8

Revenue Recognition on Long-Term Contracts
The Company recognizes revenue throughhas (1) fixed price contracts onfor the sale of uniquely designeddesigned/customized systems containing hardware and software, (2) fixed price contracts for the sale of software licenses which may include post contract support and other materialelements such as installation and (2)training, and (3) time and material contracts primarily for Nuclear Industry Training and Consulting support and service agreements.
In accordance with ASCAccounting Standards Codification ("ASC") 605-35 Construction-Type, "Construction-Type and Production-Type Contracts, ourContracts", the Performance Improvement Solutions segment accountsrecognizes revenue for revenue underits fixed-price contracts for the sale of customized systems using the percentage-of-completion method.  This methodology recognizes revenue and earnings as work progresses on the contract and is based on an estimate of the revenue and earnings earned to date, less amounts recognized in prior periods.  The Company bases its estimate of the degree of completion of the contract by reviewing the relationship of costs incurred to date to the expected total costs that will be incurred on the project.  Estimated contract earnings are reviewed and revised periodically as the work progresses, and the cumulative effect of any change in estimate is recognized in the period in which the change is identified.  Estimated losses are charged against earnings in the period such losses are identified.  The Company recognizes revenue arising from contract claims either as income or as an offset against a potential loss only when the amount of the claim can be estimated reliably and realization is probable and there is a legal basis of the claim.
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 and projected 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 customized software embedded in the systems.
The Company'sCompany evaluates customized system design contracts do not normally provide for "post customer support service" (PCS) in terms of software upgrades, software enhancements or telephone support. In order to obtain PCS, the customers normally must 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.
9

We evaluate our contracts for multiple deliverables under ASC 605-605-25,25 Revenue "Revenue Recognition-Multiple Element ArrangementsArrangements", and when appropriate, separateseparates the contracts into separate units of accounting for revenue recognition. Contracts with multiple element arrangements typically include, but are not limited to, components such as training licenses, and PCS, as described above,post contract support ("PCS"), which are embedded in the agreement.contract. When a contract contains multiple deliverables, the Company allocates revenue to each deliverable based on its relative selling price which is determined based on its vendor specific objective evidence ("VSOE") if available, third party evidence ("TPE") if VSOE is not available, or estimated selling price if neither VSOE nor TPE is available. Amounts allocated to training and support services are based on VSOE and revenue is deferred until the services have been performed. Amounts allocated to
The Company also provides stand-alone PCS contracts.  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 without other elements in the contract and 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.  The Company utilizes written contracts as a means to establish the terms and conditions by which products support and services are sold to customers.  Delivery is considered to have occurred when title and risk of loss have been transferred to the customer, which generally occurs after a license key has been delivered electronically to the customer.
9

The Company also based on VSOE. Revenue related torecognizes revenue from the sale of software licenses with multiple deliverables.  These software license sales are evaluated under ASC 985-605, "Software Revenue Recognition".  Contracts with multiple element arrangements typically include, but are not limited to, components such as installation, training, licenses, and PCS listed in the contract.  The Company has not established that VSOE exists for all elements of its software license sales.  If a PCS element exists in the software license arrangement, revenue is recognized onceratably over the license hasPCS service period.  If no PCS element exists in the arrangement, revenue is deferred until all elements have been delivered.
The Company recognizes revenue under time and materials contracts primarily from the Nuclear Industry Training and Consulting segment and certain consulting agreements.cost-reimbursable contracts.  Revenue on time and materialsmaterial contracts is recognized as services are rendered and performed.  Under a typical time-and-materials billing arrangement, customers are billed on a regularly scheduled basis, such as biweekly or monthly.  At the end of each accounting period, revenue is estimated and accrued for services performed since the last billing cycle. TheseAny unbilled amounts are typically billed the following month.   Under cost-reimbursable contracts, which are subject to a contract ceiling amount, the Company is reimbursed for allowable costs and paid a fee, which may be fixed or performance based.  However, if costs exceed the contract ceiling or are not allowable under the provisions of the contract or applicable regulations, the Company may not be able to obtain reimbursement for all such costs.

For the three and nine months ended September 30, 2015 and 2014, the
The following customerscustomer provided more than 10% of the Company's consolidated revenue:

  
Three Months ended
September 30,
 
Nine Months ended
September 30,
  2015 2014 2015 2014
Tennessee Valley Authority 14.3 % 0.0 % 17.9 % 0.0 %
Public Service Enterprise Group Inc. 11.3 % 0.6 % 10.6 % 0.6 %
   
Three months ended
March 31,
   2016 
2015(1)
Tennessee Valley Authority  12.6 % 20.9 %
(1) The prior year amounts have been revised to correct misstatements that were deemed to be immaterial to the prior period, as described in Note 1 - Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements.

Tennessee Valley Authority ("TVA") is a customer of Hyperspring, LLC.

Revisions

Historically, the Company recognized revenue on multiple element arrangements which included sales of its EnVision software product as delivery occurred on each element except PCS.  PCS revenue was recognized ratably over the PCS term.  During the fourth quarter of 2015, management determined that the Company had not established VSOE of the fair value for any of the elements in multiple element transactions including sales of its EnVision software licenses.  Accordingly, the consolidated financial statements were revised to recognize all revenue on multiple element transactions including EnVision software license sales ratably over the PCS terms on these transactions since VSOE did not exist for any of the non-software elements in these multiple element transactions.  The revision resulted in an increase to revenue of $17,000, a decrease to cost of revenue of $55,000, and a decrease in operating loss of $72,000 for the three months ended March 31, 2015. 
Certain prior year amounts have also been revised in the consolidated statements of cash flows to reflect the corrections to net loss and changes in billings in excess of revenue earned, prepaid expenses and other assets.  The revision had no impact on cash provided by operations or the net decrease in cash and cash equivalents.
10


The Company assessed the materiality of these misstatements on prior periods' consolidated financial statements in accordance with SEC Staff Accounting Bulletin ("SAB") No. 99, Materiality, codified in ASC 250, Accounting Changes and Error Corrections, and concluded that these misstatements were not material to any prior annual or interim periods.  Accordingly, in accordance with ASC 250 (SAB No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements"), the consolidated financial statements as of March 31, 2015, which are presented herein, have been revised.



GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)

  Three months ended March 31, 2015 
  As Reported  Adjustment  As Revised 
          
Contract revenue $13,996  $17  $14,013 
Cost of revenue  10,774   (55)  10,719 
Gross profit  3,222   72   3,294 
             
Operating loss  (396)  72   (324)
             
Loss before income taxes  (456)  72   (384)
             
Net loss $(544) $72  $(472)
             
             
Basic loss per common share $(0.03) $-  $(0.03)
             
Diluted loss per common share $(0.03) $-  $(0.03)
11

GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)

  Three months ended March 31, 2015 
  As Reported  Adjustment  As Revised 
          
Net loss $(544) $72  $(472)
             
Comprehensive loss $(780) $72  $(708)


GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

  Three months ended March 31, 2015 
  As Reported  Adjustment  As Revised 
          
Cash flows from operating activities:         
Net loss $(544) $72  $(472)
Changes in assets and liabilities:            
Contract receivables, net  583   27   610 
Prepaid expenses and other assets  86   (55)  31 
Billings in excess of revenue earned  (791)  (44)  (835)
Net cash provided by operating activities $(472) $-  $(472)
             
Net decrease in cash and cash equivalents $(1,993) $-  $(1,993)

12

2.Recent Accounting Pronouncements Not Yet Adopted

Accounting Pronouncements Recently Adopted
In May 2014,November 2015, the Financial Accounting Standards Board ("FASB") issued ASU 2015-17, "Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes".  The standard requires that deferred tax assets and liabilities be classified as noncurrent on the balance sheet rather than being separated into current and noncurrent.  ASU 2015-17 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016.  Early adoption is permitted and the standard may be applied either retrospectively or on a prospective basis to all deferred tax assets and liabilities.  The Company early adopted ASU 2015-17 during the first quarter of fiscal year 2016 on a retrospective basis.  Accordingly, the Company reclassified the current deferred taxes to noncurrent on the March 31, 2016 consolidated balance sheets, which increased noncurrent deferred tax assets by $6,000.
Accounting Standards Update ("ASU")Pronouncements Not Yet Adopted
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which provides guidance for revenue recognition. The standard's core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under today's guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. This guidance will be effective for the Company in the first quarter of its fiscal year ending December 31, 2018, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). The Company is currently in the process of evaluating the impact of its pending adoption of this ASU on the Company's consolidated financial statements and has not yet determined the method by which it will adopt the standard in 2018.

11In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)".  The new standard establishes a right-of-use ("ROU") model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months.  Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement.  The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.  A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the consolidated financial statements, with certain practical expedients available.  The Company is still evaluating the impact of the pending adoption of the new standard on the consolidated financial statements, and the Company expects that upon adoption the recognition of ROU assets and lease liabilities could be material.

In March 2016, the FASB issued ASU No. 2016-09, "Compensation - Stock Compensation: Topic 718: Improvements to Employee Share Based Accounting".  The new guidance is intended to simplify the accounting for share based payment award transactions.  The amendments in the update include the following aspects for share based accounting: accounting for income taxes, classification of excess tax benefits on the statement of cash flows, forfeitures, minimum statutory tax withholding requirements, and classification of employee taxes paid on the statement of cash flows when an employer withholds shares for tax withholding purposes.  Adoption of ASU 2016-09 is required for fiscal reporting periods beginning after December 15, 2016 including interim reporting periods within those fiscal years.  We are currently evaluating the potential impact of the pending adoption of ASU 2016-09 on our consolidated financial statements.


13

3.Basic and Diluted LossEarnings (Loss) per Common Share

Basic lossearnings (loss) per share is based on the weighted average number of outstanding common shares for the period.  Diluted lossearnings (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 lossearnings (loss) per share were as follows:

(in thousands, except for share amounts) Three Months ended  Nine Months ended  Three months ended 
 September 30,  September 30,  March 31, 
 2015  2014  2015  2014  2016  2015 
Numerator:              
Net loss $(3,555) $(1,895) $(5,566) $(5,905)
Net income (loss) $138  $(472)
                        
Denominator:                        
Weighted-average shares outstanding for basic earnings per share  17,894,272   17,887,859   17,890,020   17,887,859   17,912,045   17,887,859 
                        
Effect of dilutive securities:                        
Employee stock options  -   -   -   -   221,697   - 
        
Adjusted weighted-average shares outstanding and assumed conversions for diluted earnings per share  17,894,272   17,887,859   17,890,020   17,887,859   18,133,742   17,887,859 
                        
Shares related to dilutive securities excluded because inclusion would be anti-dilutive  2,513,321   2,736,703   2,548,401   2,730,558   752,042   2,565,067 
1214


4.AcquisitionContingent Consideration

Hyperspring, LLC

On November 14, 2014, (the "Closing Date") the Company, through its operating subsidiary, GSE Power Systems, Inc. (now GSE Performance Solutions, Inc. "GSE Performance"),  acquired Hyperspring, LLC ("Hyperspring") pursuant to a Membership Interests Purchase Agreement ("Purchase Agreement") with the sellers of Hyperspring ("Sellers").  Hyperspring, headquartered in Huntsville, Alabama, specializes in training and development, plant operations support services, and Nuclear Industry Training and Consulting, primarily in the United States nuclear industry.  Hyperspring operates as a wholly-owned subsidiary of GSE Performance Solutions, Inc.  The purchase price allocation included customer relationship intangible assets valued at $779,000 which are being amortized over seven years.
GSE Performance paid the Sellers an aggregate of $3.0 million in cash at the closing date.  Per the 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 a two year period for substantially the same scope as was currently being provided and with substantially the same economics.  On September 24, 2015, TVA executed a three-year renewal contract with Hyperspring; accordingly the Company paid the $1.2 million payment to the former Hyperspring members in October 2015.
In addition, GSE may be required, pursuant to the terms of the Purchase Agreement, to pay the Sellers up to an additional $7.2 million if Hyperspring attains certain EBITDA (earnings before interest, taxes, depreciation and amortization) targets for the three-year period ending November 13, 2017. Accordingly, the total cash paid to the former Hyperspring members may total $11.4 million.
13

The following table summarizes the purchase price and purchase price allocation for the acquisition of Hyperspring, LLC, acquired on November 14, 2014.

(in thousands)  
   
Cash purchase price $3,000 
Fair value of contingent consideration  3,953 
Total purchase price $6,953 
     
Purchase price allocation:    
Cash $152 
Contract receivables  1,719 
Prepaid expenses and other current assets  23 
Property and equipment, net  12 
Intangible assets  779 
Goodwill  5,612 
Total assets  8,297 
     
Line of credit  749 
Accounts payable, accrued expenses, and other liabilities  586 
Billings in excess of revenue earned  9 
Total liabilities  1,344 
     
Net assets acquired $6,953 

14

Pro forma results.  Our consolidated financial statements include the operating results of Hyperspring as of the date of acquisition.  For the nine months ended September 30, 2015 and 2014, the unaudited pro forma financial information below assumes that our material business acquisition of Hyperspring occurred on January 1, 2014.

(in thousands except per share data)(unaudited) 
 Three Months ended Nine Months ended 
 September 30, September 30, 
Pro forma financial information including the acquisition of Hyperspring2015 2014 2015 2014 
Revenue $14,961  $12,307  $42,589  $37,930 
Operating loss  (3,195)  (1,785)  (4,701)  (5,848)
Net loss  (3,363)  (1,697)  (5,140)  (5,749)
Loss per common share — basic $(0.19) $(0.09) $(0.29) $(0.32)
Loss per common share — diluted $(0.19) $(0.09) $(0.29) $(0.32)

IntelliQlik LLC
In conjunction with the Hyperspring acquisition, GSE Performance invested $250,000 for a 50% interest in IntelliQlik, LLC ("IntelliQlik").  IntelliQlik is developing a software platform for online learning and learning management for the energy market and is jointly owned by GSE Performance and a former Hyperspring member.  GSE Performance 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 the third quarter 2015.  The loss was recorded under other expense, net.
15

Contingent Consideration

Accounting Standards CodificationASC 805, "Business Combinations Combinations",("ASC 805") requires that contingent consideration be recognized at fair value on the acquisition date and be re-measured each reporting period with subsequent adjustments recognized in the consolidated statement of operations. We estimateThe Company estimates the fair value of contingent consideration liabilities based on financial projections of the acquired companies and estimated probabilities of achievement and discount the liabilities to present value using a weighted-average cost of capital. Contingent consideration is valued using significant inputs that are not observable in the market which are defined as Level 3 inputs pursuant to fair value measurement accounting.  We believe ourThe Company believes that the estimates and assumptions are reasonable, however, there is significant judgment involved. At each reporting date, the contingent consideration obligation is revalued to estimated fair value, and changes in fair value subsequent to the acquisitions are reflected in income or expense in the consolidated statements of operations, and could cause a material impact to, and volatility in, ourthe operating results.  Changes in the fair value of contingent consideration obligations may result from changes in discount periods, changes in the timing and amount of revenue and/or earnings estimates and changes in probability assumptions with respect to the likelihood of achieving the various earn-out criteria.
As of September 30, 2015March 31, 2016 and December 31, 2014,2015, the current contingent consideration totaled $2.6$1.1 million and $2.8$2.6 million, respectively.  As of September 30, 2015both March 31, 2016 and December 31, 2014, we2015, the Company also had accrued contingent consideration totaling $2.2$1.1 million which is included in other liabilities on the consolidated balance sheets and $1.9 million, respectively, which 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,March 31, 2016 and March 31, 2015, the Company made payments of $182,000$1.4 million and $500,000,$318,000, respectively, related to the former EnVision shareholders in accordance with the purchase agreements.  For the nine months ended September 30, 2015, the Company did not make any payments to the former owners of Hyperspring.  Refer to the Subsequent Event footnote in regards to the $1.2 million payout to the former Hyperspring members in October 2015.

(in thousands)  
  September 30,  December 31, 
  2015  2014 
Hyperspring, LLC $2,601  $2,152 
IntelliQlik, LLC  -   213 
EnVision Systems, Inc.  -   477 
Current contingent consideration $2,601  $2,842 
         
Hyperspring, LLC $2,221  $1,948 
Contingent consideration $2,221  $1,948 

16
liability-classified contingent consideration arrangements.

5.Contract Receivables

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 billedUnbilled receivables represent costs incurred and associated profit accrued on contracts that will become billable upon future milestones or completion of contracts.

The components of contract receivables are as follows:

(in thousands) September 30,  December 31,  March 31,  December 31, 
 2015  2014  2016  2015 
          
Billed receivables $7,473  $10,792  $7,631  $9,831 
Recoverable costs and accrued profit not billed  4,769   5,060 
Unbilled receivables  5,171   3,325 
Allowance for doubtful accounts  (2)  (22)  (22)  (103)
Total contract receivables, net $12,240  $15,830  $12,780  $13,053 

Recoverable costs and accrued profit not billedUnbilled receivables totaled $4.8$5.2 million and $5.1$3.3 million as of September 30, 2015March 31, 2016 and December 31, 2014,2015, respectively.  During October 2015,April 2016, the Company invoiced $1.9$1.8 million of the unbilled amounts.amounts related to March 31, 2016.

The followingAs of both March 31, 2016 and December 31, 2015, the Company did not have any customers that accounted for more than 10% of the Company's consolidated contract receivables as of September 30, 2015 and December 31, 2014, respectively:receivables.

 September 30, 2015 December 31, 2014
China Nuclear Power Engineering Company14.7 % 3.9 %
State Nuclear Power Automation System Engineering Co.0.4 % 10.2 %
1715

6.Software Development Costs

Certain computer software development costs are capitalized in the accompanying consolidated balance sheets.  Capitalization of computer software development costs begins upon the establishment of technological feasibility.  Capitalization ceases and amortization of capitalized costs begins when the software product is commercially available for general release to customers.  Amortization of capitalized computer software development costs is included in cost of revenue and is 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 third quarter of 2015,  the Company's new CEO conducted a review of the Company's organizational and cost structure and software development plans.  Based upon this review, GSE decided to terminate the Enterprise Data Management ("EDM") development program.  As a result, GSE believes that the full value of the capitalized software development costs relating to EDM are no longer recoverable.  As of September 30, 2015, GSE recorded a $1.5 million write-down of software development costs which was the full capitalized balance of its EDM development projects.

Software development costs capitalized were $473,000$131,000 and $1.4 million$506,000 for the three and nine months ended September 30,March 31, 2016 and March 31, 2015, respectively, and $241,000 and $590,000 for the three and nine months ended September 30, 2014, respectively.  Total amortization expense was $96,000 and $291,000$81,000 for the three and nine months ended September 30, 2015, respectively,March 31, 2016 and $78,000 and $173,000$90,000 for the three and nine months ended September 30, 2014, respectively.

18
March 31, 2015.

7.Goodwill and Intangible Assets

Goodwill

We reviewThe Company reviews goodwill for impairment annually as of November 30December 31 and whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable.  We testThe Company tests 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, ourThe Company's reporting units are: (i) Performance Improvement Solutions and (ii) Nuclear Industry Training and Consulting.  At September 30, 2015As of March 31, 2016 and December 31, 2014,2015, the $5.6 million of goodwill balance was related tooriginated from the Hyperspring acquisition in 2014 and is assigned to ourthe Nuclear Industry Training and Consulting segment.
Accounting Standards Update ("ASU") 2011-08, Testing Goodwill for Impairment ("ASU 2011-08") permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. Under ASU 2011-08, an entity is not required to perform step one of the goodwill impairment test for a reporting unit if it is more likely than not that its fair value is greater than its carrying amount. As of September 30, 2015, no impairment 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.   The Company reviews specific definite-lived intangiblesintangible assets for impairment when events occur that may impact their value in accordance with the respective accounting guidance for long-lived assets.
1916

8.Fair Value of Financial Instruments

ASC 820, "Fair Value Measurements and Disclosures Measurement"("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, 2015March 31, 2016 and December 31, 20142015 based upon the short-term nature of the assets and liabilities.
2017

The following table presents assets and liabilities measured at fair value at September 30, 2015:March 31, 2016:

 
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 $12,129  $-  $-  $12,129  $10,355  $-  $-  $10,355 
Foreign exchange contracts  -   124   -   124   -   39   -   39 
                                
Total assets $12,129  $124  $-  $12,253  $10,355  $39  $-  $10,394 
                                
Foreign exchange contracts $-  $(107) $-  $(107) $-  $(159) $-  $(159)
Contingent consideration liability  -   -   (2,242)  (2,242)
                                
Total liabilities $-  $(107) $-  $(107) $-  $(159) $(2,242) $(2,401)

The following table presents assets and liabilities measured at fair value at December 31, 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 $11,661  $-  $-  $11,661  $8,979  $-  $-  $8,979 
Foreign exchange contracts  -   92   -   92   -   121   -   121 
                                
Total assets $11,661  $92  $-  $11,753  $8,979  $121  $-  $9,100 
                                
Foreign exchange contracts $-  $(24) $-  $(24) $-  $(57) $-  $(57)
Contingent consideration liability  -   -   (3,732)  (3,732)
                                
Total liabilities $-  $(24) $-  $(24) $-  $(57) $(3,732) $(3,789)

The following table provides a roll-forward of the fair value of the contingent consideration categorized as Level 3 for the three months ended March 31, 2016:

(in thousands) Three months ended 
  March 31, 2016 
Contingent consideration:   
Beginning balance $3,732 
Payments made on contingent liabilities  (1,421)
Change in fair value and other  (69)
Ending balance $2,242 
2118

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, 2015,March 31, 2016, the Company had foreign exchange contracts outstanding of approximately 2.62.2 million Euro, 0.6 million Canadian Dollars, 0.3 million Pounds Sterling, 0.5and 0.3 million Australian Dollars and 12.5 million Japanese Yen at fixed rates.  The contracts expire on various dates through December 2016.January 2017.  At December 31, 2014,2015, the Company had contracts outstanding of approximately 1.42.1 million Euro, 0.31.3 million Canadian Dollars, 0.5 million Pounds Sterling, 0.8and 0.4 million Australian Dollars and 0.5 million Malaysian 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, 
(in thousands) 2015  2014 
     
Asset derivatives    
Prepaid expenses and other current assets $121  $71 
Other assets  3   21 
   124   92 
Liability derivatives        
Other current liabilities  (15)  (23)
Other liabilities  (92)  (1)
   (107)  (24)
         
Net fair value $17  $68 
22
  March 31,  December 31, 
(in thousands) 2016  2015 
       
Asset derivatives      
Prepaid expenses and other current assets $39  $115 
Other assets  -   6 
   39   121 
Liability derivatives        
Other current liabilities  (159)  (57)
   (159)  (57)
         
Net fair value $(120) $64 

The changes in the fair value of the foreign exchange contracts are included in net gain (loss)loss on derivative instruments in the consolidated statements of operations.
19

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)loss on derivative instruments in the consolidated statements of operations.

For the three and nine months ended September 30,March 31, 2016 and March 31, 2015, and 2014, the Company recognized a net gain (loss)loss on its derivative instruments as outlined below:

 
Three Months ended
September 30,
  
Nine Months ended
September 30,
  
Three months ended
March 31,
 
(in thousands) 2015  2014  2015  2014  2016  2015 
              
Foreign exchange contracts- change in fair value $34  $58  $(53) $312  $(183) $- 
Remeasurement of related contract receivables,
billings in excess of revenue earned, and
subcontractor accruals
  (14)  11   (6)  (134)  65   (48)
                
Gain (loss) on derivative instruments, net $20  $69  $(59) $178 
Loss on derivative instruments, net $(118) $(48)
2320


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 $136,000$247,000 and $175,000$134,000 of stock-based compensation expense for the three months ended September 30,March 31, 2016 and March 31, 2015, and 2014, respectively, under the fair value method and recognized $407,000 and $514,000 of stock-based compensation expense formethod.

During the ninethree months ended September 30, 2015 and 2014, respectively.

In the third quarter 2015,March 31, 2016, the Company granted 975,000 Restricted Stock Unit's160,000 performance-based restricted stock units ("RSUs") with an aggregate fair value of $673,500.$282,000.  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 fivefour years.

During the three months ended March 31, 2016, the Company also granted 129,824 time-based RSUs with an aggregate fair value of $286,000, which will vest quarterly in equal amounts over the course of the next eight quarters.  The fair value of the RSUs is expensed ratably over the next eight quarters.

The Company granted 10,000 and 60,00040,000 stock options for the three and nine months ended September 30, 2015, respectively.March 31, 2016.  The aggregate fair value of the options granted for the three and nine months ended September 30, 2015March 31, 2016 was $8,000 and $48,000, respectively.$46,000.  The Company granted 0 and 60,00050,000 stock options for the three and nine months ended September 30, 2014, respectively.March 31, 2015.  The aggregate fair value of the granted options at the grant date was $56,000.$40,000.


11.  Long-Term Debt

At September 30, 2015March 31, 2016 and December 31, 2014,2015, the Company had no long-term debt.
Lines of Credit
SusquehannaBB&T Bank
At September 30, 2015,March 31, 2016, the Company had a Master Loan and Security Agreement and Revolving Credit Note with Susquehanna Bank ("Susquehanna").BB&T Bank.  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%4.5%.  The agreement expires on June 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, proceeds and products, intangibles, trademarks, patents, intellectual property, machineryintangible assets, equipment, software and equipment.leasehold improvements.
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On September 9, 2014, the Company signed a Third Comprehensive Amendment to the Master Loan and Security Agreement.  According to the Third Amendment, theThe Company is to maintain a segregated cash collateral account at SusquehannaBB&T 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, SusquehannaBB&T Bank shall havehas 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 September 30, 2015March 31, 2016 and December 31, 2014,2015, the cash collateral account totaled $3.6 million and $4.2$3.5 million, respectively. The balances were classified as restricted cash on the consolidated balance sheet.sheets.

The credit agreements containagreement contains certain restrictive covenants regarding future acquisitions and incurrence of debt.  On July 31, 2015,In addition, the Company signed a Fifth Comprehensive Amendmentcredit agreement contains financial covenants with respect to the Master LoanCompany's minimum tangible capital base and Security Agreement in which the Company's financial covenants were reduced from four to two, and the covenant targets were adjusted.quick ratio.  

    As of
 CovenantSeptember 30, 2015March 31, 2016
     
Minimum tangible capital baseMust Exceedexceed $10.5 million$10.911.3 million
Quick ratioMust Exceedexceed 1.00 : 1.001.431.52 : 1.00

As of September 30, 2015,March 31, 2016, the Company was in compliance with its financial covenants as defined above.

IberiaBank
At September 30, 2015,March 31, 2016, Hyperspring, LLC has a $1.0 million working capital line of credit with IberiaBank for a one year period.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,March 31, 2016, the Company had no outstanding amounts under the line of credit.
Letters of Credit and Bonds
As of September 30, 2015,March 31, 2016, the Company has thirteeneleven standby letters of credit and one surety bond totaling $3.6 million which represent advance payment and performance bonds on twelveten contracts.  The Company has deposited the full value of thirteeneleven standby letters of credit in escrow accounts, amounting to $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 consolidated balance sheetsheets at September 30, 2015March 31, 2016 as restricted cash.
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12.Product Warranty

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 inportion of the warranty accountprovision expected to be incurred within 12 months is classified as current within accrued warranty ($1.4 million), while the remaining amount is classified as long-term within other liabilities ($106,000).  The activity related to the warranty accrual is as follows:

(in thousands)     
     
Balance at December 31, 2014 $1,456 
Balance at December 31, 2015 $1,614 
Warranty provision  514   145 
Warranty claims  (312)  (245)
Currency adjustment  (44)  2 
Balance at September 30, 2015 $1,614 
Balance at March 31, 2016 $1,516 

13.Income Taxes


The Company filesfollowing table presents the provision for income taxes and the effective tax rates:

(dollars in thousands)
Three months ended
March 31,
 
 2016 2015 
       
Provision for income taxes $88  $88 
Effective tax rate  38.6%  (22.9)%

The Company's higher effective tax rate for 2016 compared to 2015 resulted mainly from a reduced pre-tax loss in the United States federal jurisdictionU.S.  The Company's income tax provision for interim periods is determined using an estimate of its annual effective tax rate, adjusted for discrete items arising in that quarter.  Tax expense in both years is comprised mainly of foreign income tax expense and in several state and foreign jurisdictions. deferred tax expense relating to the tax amortization of goodwill.

Because of theits net operating loss carryforwards, the Company is subject to U.S. federal and state income tax examinations from yearsthe year 1997 forward andforward.  The Company is subject to foreign tax examinations by tax authorities for years 20072010 forward for Sweden, 2012 forward for China, and forward. Open tax years related to state2014 forward for both India and foreign jurisdictions remain subject to examination but are not considered material to our financial position, results of operations or cash flows.the UK.

An uncertain tax position taken or expected to be taken in a tax return is recognized in the consolidated 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 itsrecorded uncertain tax positions.positions for certain foreign tax contingencies in China and the Ukraine.

In 2014,2015, the Company paid income taxes in the UK and India and expects to do so again in 2015.2016.  The Company has a full valuation allowance on its U.S., Swedish, and Chinese net deferred tax assets at September 30, 2015.March 31, 2016.
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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.
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15. Segment Information

The Company has two reportable business segments.  The Performance Improvement Solutions business segment provides simulation, training products, and engineering products and services delivered across the breadth of industries we serve.the Company serves.  Solutions include simulation for both training and engineering applications.  Example training applications include turnkey and custom training services, while engineeringEngineering services include plant design verification and validation. We provideThe Company provides these services across all ourof its market segments.  Contracts typically range from ten months to three years.

The Nuclear Industry Training and Consulting servicesbusiness segment provides specialized workforce solutions primarily to the U.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 operating results attributable to each reportable segment and includes a reconciliation of segment contract revenue to consolidated revenue and operating results to consolidated lossincome (loss) before income tax expense:taxes:

(in thousands)
 
Three Months ended
September 30,
  
Nine Months ended
September 30,
  Three months ended 
 2015  2014  2015  2014  March 31, 
         2016  2015 
Contract revenue:              
Performance Improvement Solutions $9,903  $7,823  $26,911  $24,823  $8,843  $8,833 
Nuclear Industry Training and Consulting  5,058   -   15,678   -   4,133   5,180 
 $14,961  $7,823  $42,589  $24,823   12,976   14,013 
                        
Operating income (loss):                        
Performance Improvement Solutions $(3,604) $(1,905) $(5,493) $(5,948)  (42)  (704)
Nuclear Industry Training and Consulting  442   -   1,104   -   188   300 
Loss on change in fair value of contingent consideration, net  (226)  (42)  (739)  (69)
Gain on change in fair value of contingent consideration, net  69   80 
                  215   (324)
Operating loss $(3,388) $(1,947) $(5,128) $(6,017)
                        
Interest income, net  19   44   67   103   27   27 
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)
Loss on derivative instruments, net  (118)  (48)
Other income (expense), net  102   (39)
Income (loss) before income taxes $226  $(384)
        
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16.Subsequent Events

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 September 24, 2015, TVA executed a three-year renewal contract with Hyperspring; accordingly, the Company paid the $1.2 million payment to the former Hyperspring members in October 2015.
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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 providesperformance improvement company.  We improve plant performance with a combination of simulation, engineering and educational solutionsplant services that help clients improve their plant's profitability, productivity and services to the nuclear and fossil electric utility industry, and the chemical and petrochemical industries.safety.  GSE is the parent company 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;
·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.


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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 lookingforward-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 20142015 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.
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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 our targeted markets.markets - primarily the power and process industries.  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:


Performance Improvement Solutions (approximately 68% of revenue)
Our Performance Improvement Solutions business segment primarily encompasses our next-generationnext generation power plant and process high-fidelity simulation solutions, as well as engineering solutions.  This segment includes various simulation products, engineering services, and operation training systems delivered across the industries we serve: primarily nuclear and fossil fuel power generation, and the petroleum industry.process industries.  Our simulation solutions include the following: (1) simulation toolssoftware and services, including operator training systems, for the nuclear power industry, (2) simulation toolssoftware and services, including operator training systems, for the fossil power industry, and (3) simulation toolssoftware and services for the petroleum industryprocess industries used to teach fundamental industry processes and control systems to newly hired employees.employees and for ongoing workforce development and training.


Nuclear Industry Training and Consulting (approximately 32% of revenue)
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 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.

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Business Strategy

Our objective is to be the leading provider of software and technology-enabled services and know-how to the global power industries by capitalizing on near and long-term growth opportunities primarily in the nuclear power industry.  We will offer our differentiated suite of products and services to adjacent markets such as fossil power and the process industries where our offerings are a natural fit with a clear and compelling value proposition for the market.  Our primary growth strategy is twofold: (1) expand organically within our core markets by leveraging our market leadership position and drive increased usage and product adoption via new products and services, and (2) seek acquisitions to accelerate our overall growth.  To accomplish this, we will pursue the following activities:
·
Expand our total addressable market.   Our focus on growth means introducing product  capabilities or new product categories that create value for our customers and therefore expand our total addressable market.  Currently we are working on initiatives to expand our solution offerings in both our business segments which may include, but not be limited to, the following: expanding our software product portfolio to the industries we serve with enhanced power and process simulation tools and systems that are complementary to our core offerings; delivering enhanced learning management systems/solutions; offering fully outsourced training solutions to our customers; adding work flow process improvement solutions; and tailoring operational reporting and business intelligence solutions to address the unique need of our end user markets.  Initiatives such as these will broaden our scope and enable us to engage more deeply with the segments we serve.
·
Pursue strategic acquisitions opportunistically.   We intend to complement our organic growth strategy through selective acquisitions of other software and service businesses, both domestic and international, which would enhance our existing portfolio of products, strengthen our relationships with our existing customers, and potentially expand our footprint to include new customers in our core served industries.  We have made several small acquisitions in recent years and believe the opportunity exists to do more.  For example, in January 2011 we acquired EnVision Systems Inc., which provided interactive multi-media tutorials and simulation models, primarily to the process industries.  We have integrated the technology assets from this acquisition and expanded the firm's application to other industries, and we intend to repeat this successful process.  We acquired Hyperspring in 2014, which enabled GSE to offer highly skilled nuclear operations and consulting know-how on site at a large segment of our client base on an operational basis providing essential services.  This deepened our relationship with existing clients and won business for us at new client sites in the nuclear industry.  This acquisition has proven to be very synergistic, enabling cross selling domestically, and in 2015, expanding these services internationally for the first time.
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·
Continue to provide technology-enabled, market-leading solutions. We invest in research and development ("R&D") in order to deliver unique solutions that add tremendous value to our end-user markets.  Recently we have delivered nuclear core and balance of plant modeling and visualization systems to the industry.  To address the nuclear industry's need for more accurate simulation of both normal and accident scenarios, we provide our DesignEPTM and RELAP5-HD® solutions.  Our entire JADETM suite of simulation software, including industry leading JTOPMERET® and JElectricTM software, provides the most accurate simulation of Balance of Plant and electrical systems available to the nuclear and fossil plant simulation market.  The significant enhancements we have made to our SimExec® and OpenSimTM platforms enables customers to be more efficient in the daily operation of their simulators.  We have both upgraded and expanded the EnVision library of simulation and eLearning tutorials for the process industries with specific new products for training clients in the upstream segment of the oil and gas industry.  We continue to provide cutting edge training systems by adapting our technology to systems to meet the specific needs of customers such as U.S. government laboratories.   We intend to continue to make prudent investments in R&D that first and foremost are driven by the market, and are complementary to advancing our growth strategy.  Such investments in R&D may result in on-going enhancement of existing solutions as well as the creation of new solutions to serve our target markets, ensuring that we add greater value, in an easier to use fashion, than any alternative available to customers and that we delight them in the process.  GSE has pioneered a number of industry standards over our lifetime and will continue to be one of the most innovative companies in our industry.  We have a recognized high-value brand as one of the most respected providers of software and services to the industry, as evidenced by our marquee client base and significant market wins over the past year.
·
Expand International Operations in Selected Markets. We believe there are additional opportunities for us to market our software and services to international customers, and do so in a cost effective manner.  For example, we believe partnerships with Value Added Resellers ("VAR") could significantly expand our sales pipeline for the EnVision software suite.  Such VARs may yield positive results for our pursuing international nuclear opportunities globally (see industry trends below).  We may explore the creation of appropriate joint ventures to target nuclear new-build programs in key growth regions.

Industry Trends

Industry need for building and sustaining a highly skilled workforce
We believe the most serious futurea critical ongoing challenge facing the industries we serve is access to and continued development of a highly trained and efficient workforce.  This challenge manifests itselfprimarily in two ways: the increasing pace of the knowledge and experience lost as a largesignificant percentage of the existing experienced workforce reaches retirement age over the next ten years.several years; and the fact that as new power plants come on-line, there is an increased demand for more workers to staff and operate those plants in addition to the plants in the existing fleet.
According to Power Engineering magazine, in the United States every sector in the energy industry is expected to lose a large percentage of its workforce as baby boomers retire on the traditional schedule.  The replacement of these experiencedpower sector alone will be forced to replace more than 100,000 skilled workers by a new generation who have different learning styles and work expectations is a critical challenge2018 simply to replace those retiring.  The Nuclear Energy Institute estimates that 39% of the power and process industries must address. nuclear workforce will be eligible to retire by 2018.
Globally, as more people increase their standard of living, so tootheir demand for power will global power demand increase, which in turn will require the on-going construction of power plants.plants to meet this surging demand.  Developing a skilled labor force to operate these plants and keepkeeping their skills honedcurrent and evergreentheir certifications in compliance with regulatory requirements is anothera key challenge facing the global power industry.  Additionally, thereSimilar challenges face the process industries as well.
An important emerging trend to note seems to be an emerging enlightenmenta growing recognition that nuclear energy is an increasingly desirable form of energy production fulfilling a key component of zero carbon initiatives across the globe.  Support for generating power from zero carbon emissions sources is evidenced by initiatives such as there are no greenhouse gas emissions associated with nuclearthe 2015 United Nations Climate Change Conference.  Nuclear power generation.generation is a critical means of zero carbon power generation that is growing in importance as a result.  We believe that GSE is well positioned to take advantage of these trends as they emerge.emerge and develop.
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Growing Global Power Demand and the Increasing Emphasis on Nuclear Power
World Energy Outlook 2015 projects that electricity demand will increase by more than 70% over the 2013 to 2040 time period.  At the same time, countries globally are pledging to reduce greenhouse gas emissions despite this growth in demand for power.  These trends are increasingly favorable to nuclear power.  The United Kingdom illustrates this trend, with a recently announced energy policy that experiencedplaces a much greater reliance on nuclear workforce is retiring,power and unveiled plans for a new nuclear fleet, while slashing subsidies for solar energy and an eye to phase out coal fired power plants.  With plans to build at least three new nuclear plants, the UK plans to add 16GWe of new nuclear capacity will be coming into operation.  Accordingoperating by 2030 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.  Association.
There are currently 6765 nuclear plants under construction in 15 countries, including 24 in China, 9nine in Russia, 6six in India and 4four 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 USU.S. including two for Southern Nuclear at the Vogtle Site;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 stagefacility (which is planned for additional reactor projects in the UK in the future.
commercial production imminently).  According to the World Nuclear Association, there are 165 reactors in 27 countries in specific phases of planning that will be operating by 2030.  This pace of construction is surpassing peak construction velocity of the 1970's and 1980's.
Growing awarenessIn addition to new plants, generating more power through enhanced plant performance, especially reducing unplanned outage time, is a critical objective for the nuclear power industry to meet growing global electricity demand.  Capacity factors, also known as load factors, have been greater than 90% in the U.S. in five of strategic environmental advantagesthe seven years between 2007 and 2013.  The U.S. is recognized as the leader in load factor performance.  The U.S. accounts for nearly one third of the world's nuclear energy
The growth in nuclear energy is aided byelectricity, highlighting its increasing recognitionimportance as a critical technologymarket as well as its need for reaching the CO2 emission reduction targets recommended by the scientific community.  Accordinghigh levels of performance.
We believe GSE is well positioned to take full advantage of these strategic global and domestic trends through our providing high fidelity simulation and training solutions to the UN's Intergovernmental Panel on Climate Changeglobal power 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 need for 20,000 new workers to replace them. The article goes on to discuss the US Department of Labor estimates as much as 50% of the nation's utility workforce will be retiring in the 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.process industries.
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As companies are always under pressure to improve productivity, reduce costsProducts 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, Services
A Systematic Approach to HumanEntry2Expert® Performance Improvement in Nuclear Power Plants: Training SolutionsCycle, 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 our clients in creating world-class internal training and performance improvement programs, we are buildingoffering the E2EEntry2Expert® 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 Entry2Expert Performance Solution include defining specific training needs by analyzing job functions; following proven processes to structure the entire training program for clients;  providing world-class training content and series of simulation solutions for both the new employee and most experienced workers; and providing the expert training staff and consultants to ensure this is all implemented effectively.
·
Universal Training Simulators: These products complement the Self-Paced Training Tutorials by reinforcing what the student learned in the tutorial, 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 and VPanel displays, which replicate control room hardware and simulator solutions specific to industry needs such as severe accident models to train on and aid in the understanding of events like the Fukushima Daiichi accident.
·
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 E2EEntry2Expert performance lifecycle offering is to help improve our customer's bottom line throughensure superior human achievement in screening and selecting the right workforce, shortening the learning process, reducing human errors, improving worker agility and mitigating the effects of retirements and turnover.dimensions of:
·Shortening the learning process

·Reducing human errors

·Mitigating the effects of retirement and turnover

·Improving workforce agility

·Achieving and maintaining certifications and compliance

·All of these dimensions help to improve our customers' bottom lines

Design2Decom Performance Cycle
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Just like
The dramatic increase in energy demand world-wide over the E2E process helps improve the performancenext 30 years will require significant amounts of training for new employees and also will require new plants using energy of all sources.   These new plants will need to be engineered and designed prior to construction, and GSE high-fidelity modeling tools are being used increasingly to verify and validate control system and overall plant designs.
Specialized Plant Support: As our customers' people, D2D encompasses a range of services and technologies aimed at improving plant performance. From getting a client's system on-line faster,experienced staffs retire, access to operating safety, and support from experienced staff throughout the lifecycle, services include: engineering andexperts that can help with specialized plant projects is critical.  Through our Hyperspring subsidiary, we also can provide expert support either through staff augmentation or turnkey projects for the following:
oProcedure Development

oTraining Material Upgrade and Development

oWork Management

oOutage Execution

oPlanning and Scheduling

oCorrective Actions

oSelf-Assessments

oEquipment Reliability

Entry2Expert brings together the collection of skills GSE has amassed over more than 40 years beginning with its traditional roots in custom high fidelity simulation and training solutions for the power industries, extended through the acquisition of specialized engineering capabilities, enhanced by the entry and intermediate level training solutions of EnVision, and the extensive nuclear industry training and consulting services virtual commissioning of plants and plant changes, safety and compliance services and assistance in decommissioning.Hyperspring.

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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 March 31, 
 2015  %  2014  %  2015  %  2014  %  2016  %  
2015 (1)
  % 
Contract revenue $14,961   100.0% $7,823   100.0% $42,589   100.0% $24,823   100.0% $12,976   100.0% $14,013   100.0%
Cost of revenue  11,158   74.6%  5,368   68.6%  32,649   76.7%  17,497   70.5%  9,352   72.1%  10,719   76.5%
Write-down of capitalized software development costs  1,538   10.3%  -   0.0%  1,538   3.6%  -   0.0%
                                                
Gross profit  2,265   15.1%  2,455   31.4%  8,402   19.7%  7,326   29.5%  3,624   27.9%  3,294   23.5%
Operating expenses:                                                
Selling, general and administrative  3,811   25.5%  3,954   50.5%  11,031   25.9%  11,939   48.0%  3,111   24.0%  3,269   23.3%
Restructuring charges  1,600   10.7%  272   3.5%  1,746   4.1%  883   3.6%  125   1.0%  97   0.7%
Depreciation  119   0.8%  140   1.8%  383   0.9%  413   1.7%  100   0.8%  129   0.9%
Amortization of definite-lived intangible assets  123   0.8%  36   0.5%  370   0.9%  108   0.4%  73   0.5%  123   0.9%
Total operating expenses  5,653   37.8%  4,402   56.3%  13,530   31.8%  13,343   53.7%  3,409   26.3%  3,618   25.8%
                                                
Operating loss  (3,388)  (22.7)%  (1,947)  (24.9)%  (5,128)  (12.1)%  (6,017)  (24.2)%
Operating income (loss)  215   1.6%  (324)  (2.3)%
                                                
Interest income, net  19   0.1%  44   0.6%  67   0.2%  103   0.4%  27   0.2%  27   0.2%
Gain (loss) on derivative instruments, net  20   0.1%  69   0.9%  (59)  (0.1)%  178   0.7%
Other expense, net  (156)  (0.9)%  -   0.0%  (235)  (0.6)%  (7)  0.0%
Loss on derivative instruments, net  (118)  (0.9)%  (48)  (0.3)%
Other income (expense), net  102   0.8%  (39)  (0.3)%
                                                
Loss before income taxes  (3,505)  (23.4)%  (1,834)  (23.4)%  (5,355)  (12.6)%  (5,743)  (23.1)%
Income (loss) before income taxes  226   1.7%  (384)  (2.7)%
                                                
Provision for income taxes  50   0.4%  61   0.8%  211   0.5%  162   0.7%  88   0.6%  88   0.7%
                                                
Net loss $(3,555)  (23.8)% $(1,895)  (24.2)% $(5,566)  (13.1)% $(5,905)  (23.8)%
Net income (loss) $138   1.1% $(472)  (3.4)%
(1) The prior year amounts have been revised to correct misstatements that were deemed to be immaterial to the prior period, as described in Note 1 - Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements.



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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, 20142015, is included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2014.2015.  Certain of our accounting policies require higher degrees of judgment than others in their application.  These include revenue recognition, on long-term contracts,impairment of intangible assets, including goodwill, capitalization of computer software development costs, valuation of contingent consideration issued infor business acquisitions, and the recoverability of deferred income tax assets.valuation allowance.  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 20142015 Annual Report on Form 10-K for the fiscal year ended December 31, 2014.2015.

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Results of Operations - Three and Nine Months ended September 30, 2015March 31, 2016 versus Three and Nine Months ended September 30, 2014March 31, 2015

Contract Revenue.  Total contractContract revenue for the three months ended September 30, 2015March 31, 2016 totaled $15.0$13.0 million, which was 91.2% more7.4% less 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 $24.8$14.0 million of revenue for the ninethree months ended September 30, 2014.March 31, 2015.  The increasedecrease in revenue was primarily driven by the acquisition ofyear over year decrease in revenue at Hyperspring, represented by our Nuclear Industry Training and Consulting segment, depicted below.
(in thousands)Three months ended 
 March 31, 
 2016 
2015(1)
 
       
Contract Revenue:      
Performance Improvement Solutions $8,843  $8,833 
Nuclear Industry Training and Consulting  4,133   5,180 
Total Contract Revenue $12,976  $14,013 
(1)The prior year amounts have been revised to correct misstatements that were deemed to be immaterial to the prior period, as described below.in Note 1 - Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements.

 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 

Performance Improvement Solutions revenue increased 26.6% from $7.8was $8.8 million for both the three months ended September 30, 2014 to $9.9 million for the three months ended September 30,March 31, 2016, and March 31, 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. WeCompany recorded total Performance Improvement Solutions orders of $3.8$34.8 million in the three months ended September 30, 2015March 31, 2016, as compared to $17.6$11.1 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.March 31, 2015.
As discussed earlier, our Nuclear Industry Training and Consulting business segment was created due to the acquisition of Hyperspring, LLCrevenue decreased 20.2% from on November 14, 2014.  Revenue$5.2 million for the three months ended September 30,March 31, 2015, totaled $5.1 million.to $4.1 million for the three months ended March 31, 2016.  The decrease was primarily due to a year-over-year decline in customer staffing needs of a major customer.  Nuclear Industry Training and Consulting orders totaled $1.5$5.0 million during the same period.  Revenue for the ninethree months ended September 30, 2015 totaled $15.7March 31, 2016, as compared to $7.0 million and orders totaled $14.6 million duringin the same period.three months ended March 31, 2015.
At September 30, 2015,March 31, 2016, backlog was $47.5$74.5 million: $42.1$67.6 million for the Performance Improvement Solutions business segment and $5.4$6.9 million for Nuclear Industry Training and Consulting.  At December 31, 2014,2015, the Company's backlog was $48.4$47.9 million: $41.7$41.9 million for the Performance Improvement Solutions business segment and $6.7$6.0 million for Nuclear Industry Training and Consulting.
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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 Profitprofit.  Excluding the $1.5 million write-down of software development costs, grossGross profit was $3.8totaled $3.6 million for the three months ended September 30, 2015March 31, 2016, compared to $2.5$3.3 million for the same period in 2014.2015.  As a percentage of revenue, gross profit decreasedincreased from 31.4%23.5% for the three months ended September 30, 2014March 31, 2015, to 25.4%27.9% 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, 2014 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 Consulting segment, has an overall gross profit which is significantly lower than the historical gross profit of our Performance Improvement Solution segment.March 31, 2016.

($ in thousands)Three months ended 
 March 31, 
 2016  % 
2015(1)
  % 
Gross profit:            
Performance Improvement Solutions $3,145   35.6% $2,777   31.4%
Nuclear Industry Training and Consulting  479   11.6%  517   10.0%
Consolidated Gross Profit $3,624   27.9% $3,294   23.5%

  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%

(1)The prior year amounts have been revised to correct misstatements that were deemed to be immaterial to the prior period, as described in Note 1 - Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements.

Excluding the $1.5 million write-down of software development costs, Performance Improvement Solutions hadSolutions' gross profit of $3.1 million or 31.6%35.6% of segment revenue for the three months ended September 30, 2015 compared to $2.5March 31, 2016, increased $0.3 million from $2.8 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 ninethree 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.March 31, 2015.  The increase in gross margin percent for Performance Improvement Solutions for the ninethree months ended September 30, 2015March 31, 2016, as compared to the same period in 20142015 is mainly due to:to the decrease in total overhead costs.
·The restructuring of our Swedish operations in 2014 which has reduced their operations overhead costs and facility expenses in 2015,
Total overhead costs (including capitalized software amortization) decreased from approximately $1.2 million for the three months ended March 31, 2015, to $852,000 for the three months ended March 31, 2016.  Thus total overhead decreased from 13.1% in 2015 to 9.7% in 2016 as a percent of revenue.  The reduction mainly reflects the reduction in operations headcount in conjunction with the Company's September 2015 restructuring.
·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.


Nuclear Industry Training and Consulting gross margin decreased by $38,000 for the three months ended March 31, 2015, compared to the three months ended March 31, 2016, but as a percent of revenue, increased from 10.0% for the three months ended March 31, 2015, to 11.6% for the three months ended March 31, 2016.  Despite the 20.2% decrease in revenue, the business unit's revenue mix consisted of a higher percentage of fixed price projects which have better gross margins than time and material contracts.
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Selling, Generalgeneral and Administrative Expensesadministrative expenses.  Selling, general and administrative ("SG&A") expenses totaled $3.8$3.1 million in the three months ended September 30, 2015,March 31, 2016, a 3.6%4.8% decrease from the $4.0$3.3 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.2015.  The decreases reflectdecrease reflects the following spending variances:

·Business development and marketing costs decreased 40.6% from $1.5$1.3 million to $790,000 for the three months ended September 30, 2014 to $1.2 million for the three months ended September 30,March 31, 2015, and decreased from $4.5 million for2016, respectively.  The reduction in business development costs is largely due to the nine months ended September 30, 2014 to $4.0 million forCompany's restructuring actions in 2015 which reduced the nine months ended September 30, 2015. Bidding and proposal costs, a componentnumber of business development personnel.  Included within business development costs are bidding and proposal costs, which are the costs of operations personnel assisting with the preparation of contract proposals, were $180,000proposals. Bidding and $420,000proposal costs decreased from $285,000 to $95,000 for the three months ended September 30, 2015 and 2014, respectively, and $679,000 and $1.2 million forMarch 31, 2016, as compared to the ninethree months ended September 30,March 31, 2015.  This reduction is also a result of the Company's 2015 restructuring, as the number of operations personnel has decreased, and 2014, respectively.accordingly, the availability of operations personnel for proposal support has diminished.

·The Company's general and administrative expenses ("G&A") increased to $2.2 million from $1.7$1.6 million for the three months ended September 30,March 31, 2015, and 2014, respectively, and increased to $5.9 million from $5.2$2.0 million for the nine months ended September 30, 2015 and 2014, respectively.  Some components of G&A are as follows:
oFor the three months ended September 30, 2015 and 2014, 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.March 31, 2016.  The increase in contingent considerationof $0.4 million is a result of the Hyperspring acquisition on November 14, 2014 and is associated with the deferred contingent consideration dueprimarily attributable to the former Hyperspring members if certain EBITDA targets are met.following:
oIn 2014, the Company's Board of Directors agreedthree months ended March 31, 2016, the Company hired an outside consultant to waive their feesreview and document its procedures regarding revenue recognition, with special focus on software license and software maintenance revenue.  The total cost incurred for 2014.  These fees were reinstated in 2015these services was $152,000.
oIn the three months ended March 31, 2016, audit, tax, and legal expense totaled $51,000 and$264,000 compared to $149,000 in the three and nine months ended September 30,March 31, 2015.
oForIn the three and nine months ended September 30, 2014,March 31, 2016, the Company incurred acquisition expensesaccrued bonus expense of $35,000 and $108,000, respectively, related to$219,000 for an employee bonus program which was initiated in 2016 plus targeted executive bonuses per their existing compensation contracts.  However, these bonus payments are contingent upon the acquisitionCompany achieving certain levels of Hyperspring.  No acquisition expenses were incurred in 2015.profitability.  In the three months ended March 31, 2015, the Company accrued bonus expense of $11,000.
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oThe Company's Swedish subsidiary decreased their bad debt reserve in the three months ended March 31, 2016, by $62,000 due to the collection of the related trade receivables.
·oGross spending on software product development ("development") expenses for the three and nine months ended September 30,March 31, 2016, and March 31, 2015, totaled $866,000$485,000 and $2.6 million, respectively, as compared to $1.0 million and $2.8 million for the three and nine months ended September 30, 2014,$901,000, respectively. The Company capitalized $473,000$131,000 and $1.4 million$506,000 of product development expenses for the three and nine months ended September 30,March 31, 2016, and March 31, 2015, respectively, and $241,000 and $590,000 for the same periods in 2014, respectively.  Net development spending decreased from $795,000$395,000 for the three months ended September 30, 2014March 31, 2015, to $393,000$354,000 for the three months ended 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 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.
oDuring 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.
oThe Company's 3D visualization team, which develops 3D technology to add to our training programs, incurred $72,000 and $108,000 of costs related to this effort during the three and nine months ended 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.March 31, 2016.

Restructuring Chargescharges.  In July 2015, GSE entered into a separationRestructuring charges totaled $125,000 and release agreement with James Eberle,$97,000 for the former Chief Executive Officer of the company.  Effective Julythree months ended March 31, 2016, and March 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.
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respectively.

Depreciation.  Depreciation expense totaled $119,000$100,000 and $140,000 for$129,000 during the three months ended September 30,March 31, 2016, and March 31, 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$73,000 and $36,000$123,000 for the three months ended September 30,March 31, 2016, and 2015, and 2014, respectively.  For the nine months ended September 30, 2015 and 2014,The decrease in first quarter 2016 amortization expense reflects a decrease of amortization related to definite-livedthe intangible assets totaled $370,000 and $108,000, respectively.
In conjunctionrecorded with the Hyperspring acquisition onin November 14, 2014 we recorded $779,000 of customer-related intangible assets which isare 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 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 Lossincome (loss).  The Company had an operating lossincome of $3.4 million (22.7%$215,000 (1.6% of revenue) duringfor the three months ended September 30, 2015,March 31, 2016, as compared with an operating loss of $1.9 million (24.9%$324,000 (2.3% 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.2015.  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, Netincome, net.  Net interest income totaled $19,000 and $44,000$27,000 for the three months ended September 30,March 31, 2016, and March 31, 2015, and 2014, respectively.  For the nine months ended September 30, 2015 and 2014, net interest income totaled $67,000 and $103,000, respectively.
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Gain (Loss)Loss on Derivative Instruments, Net.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,March 31, 2016, the Company had foreign exchange contracts outstanding of approximately 2.2 million Euro, 0.6 million Canadian Dollars, 0.3 million Pounds Sterling, and 0.3 million Australian Dollars at fixed rates.  The contracts expire on various dates through January 2017.  The Company has not designated the contracts as hedges and has recognized a loss of $183,000 on the change in the estimated fair value of the contracts for the three months ended March 31, 2016.

As of March 31, 2015, the Company had foreign exchange contracts outstanding of approximately 2.62.2 million Euro, 0.6 Pounds Sterling, 0.5 0.7 million Australian Dollars, and 12.50.3 million Japanese YenPounds Sterling at fixed rates.  The contracts expire on various dates through December 2016.  The Company hashad not designated the contracts as hedges and hashad not recognized a gain or loss 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,March 31, 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 loss on derivative instruments, net in the consolidated statements of operations.  For the three and nine months ended September 30, 2015,March 31, 2016, the Company recognized lossesa gain of $14,000 and $6,000, respectively,$65,000 from the remeasurement of such contract receivables, billings in excess of revenue earned and subcontractor accruals.  For the same periodsperiod in 2014,2015, the Company recognized a gain of $11,000 and a loss of $134,000, respectively.$48,000.

Other Expense, Netincome (expense), net.  For the three and nine months ended September 30,March 31, 2016, and March 31, 2015, the Company recognized other expense,income, net of $156,000$102,000 and $235,000, respectively.  For the three and nine months ended September 30, 2014, the Company recognized other expense,expenses net of $0 and $7,000,$39,000, respectively.  The major components of other expense,income (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,March 31, 2016, 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.  Although the company's entire investment in GSE-RUS was written off by the end of December 2014, we have notCompany's Chinese subsidiary 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 losses$101,000 refund of $2,000 for the three and nine months ended September 30, 2015, respectively. For the nine months ended September 30, 2014, theValue Added Tax.  The Company had other miscellaneous income of $31,000.$1,000.
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·For the three months ended March 31, 2015, the Company recognized a $39,000 equity loss on its investment in IntelliQlik LLC.

Provision (Benefit) for Income Taxes

Income tax expense was $88,000 or an effective income tax rate of 38.6%, for the three months ended March 31, 2016, compared to $88,000, or an effective income tax rate of 22.9%, for the three months ended March 31, 2015.  The Company filesCompany's income tax provision for interim periods is determined using an estimate of its annual effective tax rate, adjusted for discrete items arising in that quarter.  Tax expense in both years is comprised mainly of foreign income tax expense and deferred tax expense relating to the United States federal jurisdiction and in several state and foreign jurisdictions. tax amortization of goodwill.

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 andforward.  The Company is subject to foreign tax examinations by tax authorities for years 20072010 forward for Sweden, 2012 forward for China, and forward.  Open tax years related to state2014 forward for both India and foreign jurisdictions remain subject to examination but are not considered material to our financial position, results of operations or cash flows.the UK.

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 itsrecorded uncertain tax positions.positions for certain foreign tax contingencies in China and the Ukraine.

In 2014,2015, the Company paid income taxes in the UK and India and expects to do so again in 2015.2016.  The Company has a full valuation allowance on its U.S., Swedish, and Chinese net deferred tax assets at  September 30, 2015.
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March 31, 2016.


36
Liquidity and Capital Resources

As of September 30, 2015,March 31, 2016, the Company's cash and cash equivalents totaled $12.8$11.2 million compared to $13.6$11.1 million at December 31, 2014.2015.

Cash provided by (used in) operating activities.  For the ninethree months ended September 30, 2015,March 31, 2016, net cash provided by operations totaled $1.3$1.6 million.  Significant changes in the Company's assets and liabilities in the ninethree months ended September 30,March 31, 2016, included:
·
A $0.3 million decrease in the Company's contract receivables.  The Company's trade receivables, net of the allowance for doubtful accounts, decreased from $9.7 million at December 31, 2015, to $7.6 million at March 31, 2016.  At March 31, 2016, trade receivables outstanding for more than 90 days, net of the bad debt reserve, totaled approximately $0.9 million as compared to $0.6 million at December 31, 2015.  The Company believes the entire 90-day balance at March 31, 2016, will be received.  The Company's unbilled receivables increased by approximately $1.8 million to $5.2 million at March 31, 2016, as compared to December 31, 2015.  The increase in the unbilled receivables is due to the timing of contracted billing milestones of the Company's current projects.  In April 2016, the Company invoiced $1.8 million of the unbilled amounts; the balance is expected to be invoiced and collected within one year.
·A $1.2 million increase in accounts payable, accrued compensation and accrued expenses.  The increase reflects an increase in Hyperspring accrued payroll due to the timing of their biweekly payroll cycle and the timing of payments made by the Company to vendors and subcontractors.

For the three months ended March 31, 2015, net cash used in operations totaled $0.5 million.  Significant changes in the Company's assets and liabilities in the three months ended March 31, 2015, included:
·
A $3.6An $0.6 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$8.4 million at September 30,March 31, 2015.  At September 30,March 31, 2015, trade receivables outstanding for more than 90 days, net of the bad debt reserve, totaled approximately $1.1$0.9 million as compared to $369,000$0.4 million at December 31, 2014.  The Company believes the entire 90-day balance at September 30, 2015 will be received.  The Company's unbilled receivables decreasedincreased by approximately $291,000$1.7 million to $4.8$6.8 million at September 30,March 31, 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 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 $6.2 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'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 was due to the timing of contracted billing milestones of the Company's current projects.  
·A $2.3$0.4 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.
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Cash used in investing activities.  Net cash used in investing activities totaled $1.0 million$119,000 for the ninethree months ended September 30, 2015.March 31, 2016.  Capital expenditures totaled $217,000$18,000 and capitalized software development costs totaled $1.4 million$131,000 for the ninethree months ended September 30,March 31, 2016.  Proceeds from the sale of fixed assets totaled $31,000.
Net cash used in investing activities totaled $646,000 for the three months ended March 31, 2015.  Capital expenditures totaled $104,000 and capitalized software development costs totaled $506,000 for the three months ended March 31, 2015.  Restrictions of cash used as collateral for outstanding letters of credit decreased by $676,000totaled $216,000 for the ninethree months ended September 30,March 31, 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 $3.2 million into a restricted cash account.  Releases of restricted cash as collateral under letters of credit totaled $34,000$180,000 for the ninethree months ended September 30, 2014.March 31, 2015.

Cash used in financing activities.  CashNet cash used in financing activities totaled $839,000$1.4 million for the ninethree months ended September 30,March 31, 2016.  During the three months ended March 31, 2016, the Company made payments of $1.4 million to the former Hyperspring owners in accordance with the 2014 purchase agreement due to the achievement of certain EBITDA targets in 2015.  TheDuring the three months ended March 31, 2016, the Company received $4,000 for stock options exercised.
Net cash used in financing activities totaled $657,000 for the three months ended March 31, 2015.  Hyperspring has a working capital line of credit with IberiaBank for its Hyperspring subsidiary.  In the first quarter 2015, theIberiaBank.  The Company paid down $339,000 of the outstanding balance of the line of credit $339,000, and at September 30, 2015,during the Company had no outstanding borrowings.three months ended March 31, 2015.  During the ninethree months ended September 30,March 31, 2015, the Company made payments of $500,000$318,000 in relation to the formerliability classified contingent-consideration associated with the acquisition of EnVision Systems, Inc. members in accordance with the 2011 purchase agreement due to the achievement of certain revenue targets in 2014.
Net 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 accordance with the 2011 purchase agreement due to the achievement of certain revenue targets in 2013.
At September 30, 2015,March 31, 2016, the Company had cash and cash equivalents of $12.8$11.2 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.
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Credit Facilities

SusquehannaBranch Banking and Trust Bank ("BB&T")
At September 30, 2015,March 31, 2016, the Company had a Master Loan and Security Agreement and Revolving Credit Note with Susquehanna Bank ("Susquehanna").BB&T Bank.  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%4.5%.  The agreement expires on June 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, proceeds and products, intangibles, trademarks, patents, intellectual property, machineryintangible assets, equipment, software and equipment.leasehold improvements.
On September 9, 2014, the Company signed a Third Comprehensive Amendment to the Master Loan and Security Agreement.  According to the Third Amendment, theThe Company is to maintain a segregated cash collateral account at SusquehannaBB&T 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, SusquehannaBB&T Bank shall havehas 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 September 30, 2015March 31, 2016, and December 31, 2014,2015, the cash collateral account totaled $3.6 million and $4.2$3.5 million, respectively. The balances were classified as restricted cash on the consolidated balance sheet.sheets.
The credit agreements contain certain restrictive covenants regarding future acquisitions and incurrence of debt.  On July 31, 2015,In addition, the Company signed a Fifth Comprehensive Amendmentcredit agreement contains financial covenants with respect to the Master LoanCompany's minimum tangible capital base and Security Agreement in which the Company's financial covenants were reduced from four to two, and the covenant targets were adjusted.quick ratio.

    As of
 CovenantSeptember 30, 2015March 31, 2016
     
Minimum tangible capital baseMust Exceedexceed $10.5 million$10.911.3 million
Quick ratioMust Exceedexceed 1.00 : 1.001.431.52 : 1.00

As of September 30, 2015,March 31, 2016, the Company was in compliance with its covenants as defined above.
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IberiaBank
At September 30, 2015,March 31, 2016, 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,March 31, 2016, the Company had no outstanding amounts under the line of credit.
Letters of Credit and Bonds
As of September 30, 2015,March 31, 2016, the Company had thirteeneleven standby letters of credit and one surety bond totaling $3.6 million which represent advance payment and performance bonds on twelveten contracts.  The Company has deposited the full value of thirteeneleven standby letters of credit in escrow accounts, amounting to $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 consolidated balance sheetsheets at September 30, 2015March 31, 2016, as restricted cash.
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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, the Canadian Dollar and the Japanese Yen.Australian Dollar.  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,March 31, 2016, the Company had foreign exchange contracts outstanding of approximately 2.2 million Euro, 0.6 million Canadian Dollars, 0.3 million Pounds Sterling, and 0.3 million Australian Dollars at fixed rates.  The contracts expire on various dates through January 2017.  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 $183,000 for the three months ended March 31, 2016.  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 months ended March 31, 2016, the Company recognized a gain of $65,000 from the remeasurement of such contract receivables, billings in excess of revenue earned and subcontractor accruals.  A 10% fluctuation in the foreign currency exchange rates up or down as of March 31, 2016, would have increased/decreased the change in the estimated fair value of the contracts by $12,000.

As of March 31, 2015, the Company had foreign exchange contracts outstanding of approximately 2.62.2 million Euro, 0.6 million Pounds Sterling, 0.50.7 million Australian Dollars, and 12.50.3 million Japanese YenPounds Sterling 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 $53,000no change in the estimated fair value of the contracts for the three and nine months ended September 30, 2015, respectively.March 31, 2015.  A 10% fluctuation in the foreign currency exchange rates up or down as of September 30,March 31, 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 1.5 million Euro, 0.1 million Pounds Sterling, and 34,000 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 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.

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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, 2015,March 31, 2016, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective.not effective because of the material weakness identified below.


(b)  Changes in internal control

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that:

·pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;

·provide reasonable assurance that transactions are recorded as necessary to permit preparation of  the consolidated financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and

·provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the consolidated financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
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A material weakness 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 company's annual or interim financial statements will not be prevented or detected on a timely basis.  Set forth below are the Company's material weaknesses in internal control over financial reporting.

As of December 31, 2015, management identified: (i) control deficiencies in the Company's internal controls associated with revenue recognition on software license contracts with multiple deliverables, and (ii) the need to revise prior period financial statements. The material weakness in internal control over financial reporting identified is as follows:
Revenue Recognition — The controls over revenue recognition on software license sales with multiple deliverables were improperly designed and were not effective in identifying the absence of vendor specific objective evidence ("VSOE") for all elements sold together with the Company's software license sales. The Company reviewed its contracts from EnVision product software sales with multiple elements and used a contract review template to determine the correct revenue recognition methodology and whether or not VSOE existed on any elements of the sale.  The Company's control to have management review the contract revenue recognition template failed at identifying that VSOE was absent for all elements of its EnVision product software sales.  As a result, the Company incorrectly concluded it had VSOE of the fair value for each element of multiple element arrangements sold together with its software sales and applied the relative selling price method to the contracts including post contract support ("PCS").  Revenue was recognized on each element as delivery occurred, and the PCS element was recognized ratably over the PCS term.  However, the Company was unable to substantiate that VSOE existed for all elements sold together with its software license sales.  As such, the software license sales should have had the full contract value recognized ratably over the PCS period upon delivery of all other elements.  As a result of this material weakness in the design of our internal control over financial reporting, we adjusted our policy on revenue recognition on software license sales and revised our consolidated financial statements for the years ended December 31, 2015 and 2014.
 As of March 31, 2016, the Company has not completed the implementation of control procedures to ensure that the material weakness related to revenue recognition on software license sales has been mitigated.  As a result of this material weakness in our internal control over financial reporting, we performed additional review and analysis over our consolidated financial statements for the three months ended March 31, 2016.  As a result of these procedures, we believe that our consolidated financial statements are presented in accordance with U.S. GAAP.  We anticipate that we will have completed the revision of our controls over revenue recognition on software license sales with multiple deliverables in the third quarter 2016.
Because of the material weakness described above, management has concluded that we did not maintain effective internal control over financial reporting during the three months ended March 31, 2016, based on the "Internal Control - Integrated Framework (2013)" issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO").  However, we believe these additional procedures were sufficient to provide a basis for management's certifying that the financial statements presented in this Report are presented fairly, in all material respects, in accordance with U.S. GAAP. 

(c)  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)(d)  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.
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PART II - OTHER INFORMATION

Item 1.  Legal Proceedings

None.

Item 1A.  Risk Factors

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, 2014.2015.

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.
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Item 5.Other Information

None

Item 6.Exhibits

10.1Form of Restricted Stock Unit Agreement Under the GSE Systems, Inc. 1995 Long-Term Incentive Plan, as amended and restated effective March 6, 2014, filed herewith.
 31.1Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes- Oxley Act of 2002, filed herewith.
   
 31.2Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.
   
 32.1Certification 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
   
   
   
   
   
   
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SIGNATURES

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 12, 2015May 16, 2016 GSE SYSTEMS, INC.

/S/ KYLE J. LOUDERMILK
Kyle 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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