We became eligible for the Employee Retention Credit for the first quarter of 2021 and have applied for a refund of $2.4 million dollars in April 2021. We believe we are eligible to receive the employee retention credit in the second quarter of 2021 and are currently reducing our payroll taxes as permitted under the Coronavirus Aid, Relief and Economic Security Act (See Note 17).
The Company’s management continues to explore raising capital through its access to the public markets or entering into alternative finance arrangements. Continued negative trends in operating results could be mitigated through various cost cutting measures including adjustments to headcount or compensation, vendor augmentation or delay of investment initiatives in the Company’s corporate office.
These actions, which are further supported by positively trending macroeconomic conditions, and the potential of recovery of business and orders may ease the risk of further bank covenant violations. However, when considering the unpredictability of the above, there continues to be substantial doubt the Company will continue as a going concern.
Note 2 - Recent Accounting Pronouncements
Accounting pronouncements recently adopted
In January 2020, the FASB issued ASU 2020-01, Investments – Equity Securities, Investments – Equity Method and Joint Ventures, and Derivatives and Hedging, which provides clarity for companies that hold equity securities at cost to first update the fair value of an investment, immediately prior to applying the Equity Method of Accounting; or clarity for companies that enter into forward contracts to purchase additional shares of an equity security that would then require the investee to account for the investment via the Equity Method. This ASU is applicable for public companies starting with fiscal years beginning after December 31, 2020 and interim periods within those fiscal years. The Company adopted ASU 2020-01 on January 1, 2021. This standard did not have a significant impact to our consolidated financial statements since the Company does not currently hold any investments at cost.
In September 2020, the FASB issued ASU 2020-10, Codification Improvements, which is part of an ongoing attempt to improve the consistency of the codification. Previously the option to disclose information in the footnotes to the financial statements was in one of two sections: Disclosure Section (Section 50) or Other Presentation Matters (Section 45). ASU 2020-10 conforms the disclosure requirements into Section 50 and provides additional information on specific guidance that was previously unclear or not included in the codification. This ASU is applicable for public companies starting with fiscal years beginning after December 15, 2020, with early adoption available for interim and annual financial statements not already filed and using the retrospective approach. however, the FASB does not believe that this should change any of the current reporting or disclosure requirements. The Company adopted ASU 2020-10 on January 1, 2021. The adoption of this standard did not have a material impact to our consolidated financial statements.
Accounting pronouncements not yet adopted
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses, which introduces new guidance for credit losses on instruments within its scope. The new guidance introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments, including, but not limited to, trade and other receivables, held-to-maturity debt securities, loans and net investments in leases. The new guidance also modifies the impairment model for available-for-sale debt securities and requires the entities to determine whether all or a portion of the unrealized loss on an available-for-sale debt security is a credit loss. The standard also indicates that entities may not use the length of time a security has been in an unrealized loss position as a factor in concluding whether a credit loss exists. Early adoption is permitted for all entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. On October 16, 2019, the FASB voted to defer the deadlines for private companies and certain small public companies, including smaller reporting companies, to implement the new accounting standards on credit losses. The new effective date is January 1, 2023. As a smaller reporting company, we have elected to defer adoption in line with new deadlines and are currently evaluating the effects, if any, that the adoption of this guidance will have on our consolidated financial position, results of operations and cash flows.
Management has evaluated other recently issued accounting pronouncements and does not believe that any of these pronouncements will have a significant impact on our consolidated financial statements and related disclosures.
Note 3 - Basic and Diluted Loss per Share
Basic earnings per share is based on the weighted average number of outstanding common shares for the period. Diluted earnings per share adjusts the weighted average shares outstanding for the potential dilution that could occur if outstanding vested stock options were exercised. Basic and diluted earnings per share are based on the weighted average number of outstanding shares for the period.
The weighted average number of common shares and common share equivalents used in the determination of basic and diluted loss per share were as follows:
| (in thousands, except for share amounts) | | Three months ended March 31, | |
| | | 2021 | | | 2020 | |
| Numerator: | | | | | | |
| Net (loss) income attributed to common stockholders | | $ | (2,205 | ) | | $ | (6,258 | ) |
| Denominator: | | | | | | | | |
| Weighted-average shares outstanding for basic earnings per share | | | 20,628,669 | | | | 20,342,933 | |
| Effect of dilutive securities: | | | | | | | | |
| Employee stock options and warrants | | | - | | | | - | |
| Adjusted weighted-average shares outstanding and assumed conversions for diluted earnings per share | | | 20,628,669 | | | | 20,342,933 | |
| Shares related to dilutive securities excluded because inclusion would be anti-dilutive | | | 43,937 | | | | 59,421 | |
Note 4 - Paycheck Protection Program Loan
On March 27, 2020, the United States enacted the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”). The CARES Act’s purpose is to extend liquidity to small businesses and assist in retaining employees during the COVID-19 pandemic. On April 23, 2020, GSE was approved for and on the next day received a $10 million PPP Loan (“PPP Loan” or “Loan”) from the Small Business Administration (SBA) as part of the CARES Act from the Bank. On June 5, 2020, the Paycheck Protection Program Flexibility Act (“PPPFA”) was signed into law. This new law acted to ease some of the burden of the first legislation in order to expand the amount of forgiveness available.
The aim of the PPP Loan is to provide funding for businesses for certain payroll and nonpayroll costs. Proceeds for the PPP Loan are eligible for complete forgiveness, if used at least 60% for payroll cost with up to 40% for certain other nonpayroll costs. Forgiveness for amounts less than the total amount of the PPP Loan ($10 million) is allowed, retaining 60/40 requirements, but will be limited based upon the amount of funds used for payroll costs and further reduced by a full-time employee and salary/hourly rate wage reduction limitation. GSE has relied primarily on eligible wages and expenses and is well within the ratios.
The SBA has stated that PPP loans above $2 million will be subject to audit for appropriate usage of the funds and confirmation of loan forgiveness. GSE has stated, as part of the initial application, that the receipt of such funds were required in order to maintain its employees during the pandemic, and GSE was confident in its ability to report on the proper use the funds and obtain full forgiveness. GSE has also prepared and performed extensive review in its submission of the mandated Form 3590 – PPP Loan Necessity Questionnaire and remains confident to that end.
The terms of the loan are as follows: The July 5 legislation provides for an automatic 10 month deferment, after the coverage period, on the first payment, placing it on August 9, 2021. Subsequent payments, in accordance with our loan documentation, will occur monthly in equal monthly proportions, beginning with the first full month following the deferment period and will be comprised of principal and interest, with the loan fully due on April 23, 2022. Although the first payment is not required until September 2021, the loan balance accrues at an interest rate of 1% from April 23, 2020. If the loan is forgiven, the related interest incurred is also forgiven.
We realized all possible PPP Loan (“PPP Loan” or “Loan”) forgiveness expenses through the 24 week coverage period during the 2020 fiscal year. We have applied for forgiveness in Q1 of 2021, with expected response in Q2 of 2021. Any balance unforgiven by the SBA and accruing 1% interest since inception will be payable starting on the date instructed by the SBA and in equal monthly payments with the final balance due by April 23, 2022. Loan forgiveness is achieved by applying for forgiveness with the Company’s lender, the Bank, with expenses eligible for forgiveness as incurred and receiving final clearance from the SBA. The Bank has successfully completed their review and provided the loan forgiveness application and support to the SBA on February 26, 2021 for their process to begin, legislated to take no more than an additional 90 days. Upon receipt of the funds, a Loan Payable – PPP balance of $10 million was recorded and related interest expense is being accrued. As of December 31, 2020, GSE reported half of the loan balance and accrued interest as a short term payable.
The PPP Loan contains events of default and other provisions customary for a loan of this type. The Payroll Protection Program provides that (1) the use of PPP Loan amount shall be limited to certain qualifying expenses, (2) 100% of the principal amount of the loan is guaranteed by the Small Business Administration.
The SBA provides for certain customary events of default, including if the Company (i) fails to do anything required by the Note and other Loan Documents; (ii) does not disclose, or anyone acting on its behalf does not disclose, any material fact to the Bank or the SBA; (iii) makes, or anyone acting on its behalf makes, a materially false or misleading representation to lender or the SBA; (iv) reorganizes, merges, consolidates or otherwise changes ownership or business structure without the Bank’s prior written consent; (v) takes certain prohibited actions after the Bank makes a determination that the PPP Loan is not entitled to full forgiveness. Upon default the Bank may require immediate payment of all amounts owing under the PPP Loan or file suit and obtain judgment.
As of March 31, 2021, we had $10 million of outstanding PPP Loan and accrued interest of $93 thousand as debt, which we classified $8.8 million as current and $1.3 million as noncurrent in our consolidated balance sheets. We recorded $25 thousand of interest expense during the three months ended March 31, 2021.
As of March 31, 2021, the Company was in full compliance with respect to the PPP Loan and believes the eligible expenses accumulated during the coverage period satisfy forgiveness criteria.
Note 5 - Contract Receivables
Contract receivables represent our unconditional rights to consideration due from our domestic and international customers. We expect to collect all contract receivables within the next twelve months.
The components of contract receivables were as follows:
| (in thousands) | | March 31, 2021 | | | December 31, 2020 | |
| | | | | | | |
| Billed receivables | | $ | 5,202 | | | $ | 5,694 | |
| Unbilled receivable | | | 6,906 | | | | 5,160 | |
| Allowance for doubtful accounts | | | (359 | ) | | | (360 | ) |
| Total contract receivables, net | | $ | 11,749 | | | $ | 10,494 | |
Management reviews collectability of receivables periodically and records an allowance for doubtful accounts to reduce the Company’s receivables to their net realizable value when management determines it is probable that we will not be able to collect all amounts due from customers. The allowance for doubtful accounts is based on historical trends of past due accounts, write-offs, specific identification and review of customer accounts.
During the three months ended March 31, 2021 and 2020, we recorded bad debt expense of $4 thousand and $93 thousand, respectively.
During the month of April 2021, we invoiced $2.0 million of the unbilled amounts as of the three months ended March 31, 2021.
As of March 31, 2021 and December 31, 2020 , we had no customer that accounted over 10% of our consolidated contract receivables.
Note 6 - Goodwill and Intangible Assets
During the three months ended March 31, 2020, we determined that the impact of the COVID-19 pandemic on the Company’s operations was an indicator of a triggering event that could result in potential impairment of goodwill. As such we performed a Step 1 goodwill analysis whereby, we compared the fair value of each reporting unit to its respective carrying value. Based upon this analysis, we determined the fair value of goodwill at the reporting unit levels exceeded the carrying value and thus there was no impairment for the period ended March 31, 2020. The Step 1 analysis was updated as of December 31, 2020 for our annual impairment test and did not identify any impairment of goodwill as of such date.
Our goodwill impairment analysis includes the use of a discounted cash flow model that requires management to make assumptions regarding estimates of growth rates used to forecast revenue, operating margin and terminal value as well as determining the appropriate risk-adjusted discount rates and other factors that impact fair value determinations.
Due to the impact of the COVID-19 pandemic, definite-lived intangible assets were reviewed for impairment. The undiscounted cash flows evidenced impairment for the DP Engineering asset group. As such, we used a discounted cash flow model to determine the fair value of the DP Engineering asset group and recorded an impairment charge of $4.3 million for the period ended March 31, 2020.
The Company’s intangible assets impairment analysis includes the use of undiscounted cash flow and discounted cash flow models that requires management to make assumptions regarding estimates of growth rates used to forecast revenue, operating margin and terminal value as well as determining the appropriate risk adjusted discount rates and other factors that impact fair value determinations.
Management concluded that there were no triggering events that occurred during the three months ended March 31, 2021.
The following table shows the gross carrying amount and accumulated amortization of definite-lived intangible assets:
| (in thousands) | | As of March 31, 2021 | |
| | | Gross Carrying Amount | | | Accumulated Amortization | | | Net | |
| Amortized intangible assets: | | | | | | | | | |
| Customer relationships | | $ | 8,628 | | | $ | (5,772 | ) | | $ | 2,856 | |
| Trade names | | | 1,689 | | | | (1,042 | ) | | | 647 | |
| Developed technology | | | 471 | | | | (471 | ) | | | - | |
| Non-contractual customer relationships | | | 433 | | | | (433 | ) | | | - | |
| Noncompete agreement | | | 527 | | | | (360 | ) | | | 167 | |
| Alliance agreement | | | 527 | | | | (304 | ) | | | 223 | |
| Others | | | 167 | | | | (167 | ) | | | - | |
| Total | | $ | 12,442 | | | $ | (8,549 | ) | | $ | 3,893 | |
(in thousands) | | As of December 31, 2020 | |
| | | Gross Carrying Amount | | | Accumulated Amortization | | | Impact of Impairment | | | Net | |
| Amortized intangible assets: | | | | | | | | | | | | |
| Customer relationships | | $ | 11,730 | | | $ | (5,504 | ) | | $ | (3,102 | ) | | $ | 3,124 | |
| Trade names | | | 2,467 | | | | (1,020 | ) | | | (778 | ) | | | 669 | |
| Developed technology | | | 471 | | | | (471 | ) | | | - | | | | - | |
| Non-contractual customer relationships | | | 433 | | | | (433 | ) | | | - | | | | - | |
| Noncompete agreement | | | 949 | | | | (336 | ) | | | (422 | ) | | | 191 | |
| Alliance agreement | | | 527 | | | | (277 | ) | | | - | | | | 250 | |
| Others | | | 167 | | | | (167 | ) | | | - | | | | - | |
| Total | | $ | 16,744 | | | $ | (8,208 | ) | | $ | (4,302 | ) | | $ | 4,234 | |
Amortization expense related to definite-lived intangible assets totaled $0.3 million and $0.7 million for the three months ended March 31, 2021 and 2020, respectively. The following table shows the estimated amortization expense of the definite-lived intangible assets for the next five years and thereafter:
| (in thousands) | | | |
| Years ended December 31: | | | |
| 2021 | | $ | 874 | |
| 2022 | | | 910 | |
| 2023 | | | 640 | |
| 2024 | | | 435 | |
| 2025 | | | 334 | |
| Thereafter | | | 700 | |
| Total | | $ | 3,893 | |
Note 7 - Equipment, Software and Leasehold Improvements
Equipment, software and leasehold improvements, net consist of the following:
| (in thousands) | | | | | | |
| | | March 31, 2021 | | | December 31, 2020 | |
| Computer and equipment | | $ | 2,233 | | | $ | 2,229 | |
| Software | | | 1,845 | | | | 1,695 | |
| Leasehold improvements | | | 659 | | | | 660 | |
| Furniture and fixtures | | | 848 | | | | 848 | |
| | | | 5,585 | | | | 5,432 | |
| Accumulated depreciation | | | (4,891 | ) | | | (4,816 | ) |
| Equipment, software and leasehold improvements, net | | $ | 694 | | | $ | 616 | |
Depreciation expense was $76 thousand and $108 thousand for the three months ended March 31, 2021 and 2020, respectively. Capitalization of internal-use software cost of $150 thousand was recorded in software for the three months ended March 31, 2021.
Note 8 - Fair Value of Financial Instruments
ASC 820, Fair Value Measurement, 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.
As of March 31, 2021 and December 31, 2020, we considered the recorded value of certain of our financial assets and liabilities, which consist primarily of cash and cash equivalents, contract receivable and accounts payable, to approximate fair value based upon their short-term nature.
For the three months ended March 31, 2021, we did not have any transfers into or out of Level 3.
The following table presents assets measured at fair value at March 31, 2021:
| (in thousands) | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | | Significant Other Observable Inputs (Level 2) | | | Significant Unobservable Inputs (Level 3) | | | Total | |
| | | | | | | | | | | | | |
| Money market funds | | $ | 15 | | | $ | - | | | $ | - | | | $ | 15 | |
| Total assets | | | 15 | | | | - | | | | - | | | | 15 | |
The following table presents assets and liabilities measured at fair value at December 31, 2020:
| (in thousands) | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | | Significant Other Observable Inputs (Level 2) | | | Significant Unobservable Inputs (Level 3) | | | Total | |
| | | | | | | | | | | | | |
| Money market funds | | $ | 435 | | | $ | - | | | $ | - | | | $ | 435 | |
| Total assets | | $ | 435 | | | $ | - | | | $ | - | | | $ | 435 | |
Note 9 - Stock-Based Compensation
The Company recognizes compensation expense on a pro rata straight-line basis over the requisite service period for stock-based compensation awards with both graded and cliff vesting terms. The Company recognizes the cumulative effect of a change in the number of awards expected to vest in compensation expense in the period of change. The Company has not capitalized any portion of its stock-based compensation. The Company’s forfeiture rate is based on actuals.
During the three months ended March 31, 2021 and 2020, the Company recognized $38 thousand and $147 thousand, respectively, of stock-based compensation expense under the fair value method.
During the three months ended March 31, 2021, we did not grant RSUs to employees.
During three months ended March 31, 2020, we granted approximately 30,000 time-vesting RSUs to employees with an aggregate fair value of approximately $43 thousand. A portion of the time-vesting RSUs vest quarterly in equal amounts over the course of eight quarters, and the remainder vest annually in equal amounts over the course of one to three years. The fair value of the time-vesting RSUs is expensed ratably over the requisite service period, which ranges from one year to three years.
During the three months ended March 31, 2020, we granted approximately 510,000 performance-based RSUs to key employees with an aggregate fair-value of $600 thousand. These awards vest over three years based upon achieving certain financial metrics achieved during fiscal 2022 for revenue and Adjusted EBITDA.
We did not grant stock options for the three months ended March 31, 2021 or 2020.
Note 10 - Debt
On December 29, 2016, we entered a 3-year $5.0 million revolving line of credit facility with the Bank to fund general working capital needs and acquisitions. On May 11, 2018, we entered into the Amended and Restated Credit and Security Agreement (the “Credit Agreement” or the “Credit Facility”) to (a) expand the $5.0 million revolving line of credit (the “RLOC”) to include a letter of credit sub-facility and not be subject to a borrowing base and (b) to add a $25 million term loan facility, available to finance permitted acquisitions over the following 18 months. The credit facility was subject to certain financial covenants and reporting requirements and was scheduled to mature in five years on May 11, 2023 and accrued interest at the one-month USD LIBOR, plus a margin that varies depending on our overall leverage ratio. The RLOC had required monthly payments of only interest, with principal due at maturity, while our term loan draws required monthly payments of principal and interest based on an amortization schedule. Our obligations under the Credit Agreement are guaranteed by our wholly owned subsidiaries; Hyperspring, Absolute, True North, DP Engineering and by any future material domestic subsidiaries (collectively, “the Guarantors”).
On January 6, 2020, due to an expected violation of our covenants, we entered into the Sixth Amendment and Reaffirmation Agreement with an effective date of December 31, 2019, with our Bank to relax the fixed charge coverage ratio and leverage ratio and delay testing of both financial covenants. We agreed to an additional covenant, requiring us to maintain a consolidated Adjusted EBITDA target of $4.3 million, tested quarterly as of December 31, 2019, March 31, 2020 and June 30, 2020. Further, we agreed to maintain a minimum USA liquidity of at least $5.0 million in the aggregate, tested bi-weekly as of the fifteenth and the last day of each month, beginning on December 31, 2019 and until June 30, 2020. In addition to the revised covenants, we agreed to make accelerated principal payments of $3.0 million on January 6, 2020; $1.0 million on March 31, 2020; and $1.0 million on June 30, 2020. We incurred $20 thousand of debt issuance costs related to this amendment.
On April 17, 2020, effective March 31, 2020, we entered into the Seventh Amendment and Reaffirmation Agreement, which required us to maintain a minimum fixed charge coverage ratio of 1.25 to 1.00, tested quarterly as of the last day of each quarter, beginning with the quarter ending June 30, 2021. In addition, we agreed to not exceed a maximum leverage ratio, tested quarterly as of the last day of each quarter and beginning with the quarter ending September 30, 2020 as follows: (i) 3.00 to 1.00 for the period ending on September 30, 2020; (ii) 2.50 to 1.00 for the period ending on December 31, 2020; and (iii) 2.25 to 1.00 for the period ending on March 31, 2021 and for the periods ending December 31, March 31, June 30 and September 30, thereafter. We additionally agreed to make accelerated principal payments of $0.75 million on April 17, 2020 and $0.5 million on June 30, 2020. We incurred $50 thousand of debt issuance costs related to this amendment.
On August 28, 2020, we signed the Eighth Amendment and Reaffirmation Agreement, “the Eighth Amendment”, with an effective date of June 29, 2020, due to violating our minimum Adjusted EBITDA covenant during the three months ended June 30, 2020. As part of the amendment, we agreed to pay $10 million to the Bank during the three months ended September 30, 2020, of which $0.7 million was paid to reduce our RLOC. We paid $9.1 million of our long-term debt and paid out $0.2 million for the unwinding of the interest rate swap agreement during the quarter. We incurred $10 thousand in additional debt issuance costs related to the amendment, which we expensed along with a $70 thousand previously deferred debt issuance cost during the year ended December 30, 2020.
The Eighth Amendment removed our minimum Adjusted EBITDA covenant and changed our other debt covenants on an ongoing basis as follows: our maximum fixed charge coverage ratio will be tested quarterly as of the last day of each quarter, beginning with the quarter ending December 31, 2021 and must be 1.00 to 1.00; our leverage ratio will be tested quarterly, starting on March 31, 2021 as follows: (i) 3.00 to 1.00 for the period ending March 31, 2021; (ii) 2.75 to 1.00 for the period ending on June 30, 2021, (iii) 2.50 to 1.00 for the period ending on September 30, 2021, and (iv) 2.00 to 1.00 for the period ending on December 31, 2021 and for the periods ending on each December 31st, March 31st, June 30th and September 30th thereafter. We are also required to maintain a minimum of $3.5 million in aggregate USA liquidity, which was tested on September 15, 2020 and will be tested bi-weekly on an on-going basis.
On March 29, 2021, due to a projected violation of Q1 2021 leverage ratio, we signed the Ninth Amendment and Reaffirmation Agreement with an effective date of March 29, 2021, with our bank to waive the fixed charge coverage ratio and leverage ratio for the quarters ending March 31 and June 30, 2021, and we agreed, for each quarter hereafter, fixed charge coverage ratio shall not be less than 1.10 to 1.00. In addition, we agreed to not exceed a maximum leverage ratio and starting on September 30, 2021 as follows: (i) 3.25 to 1.00 for the period ending September 30, 2021; (ii) 3.00 to 1.00 for the period ending on December 31, 2021, (iii) 2.75 to 1.00 for the period ending March 31, 2022; (iv) 2.50 to 1.00 for the period ending June 30, 2022 and (v) 2.00 to 1.00 for the periods ending September 30, 2022 and each December 31st, March 31st, June 30th and September 30th thereafter. We are also required to maintain a minimum of $2.5 million in aggregate USA liquidity. As part of the amendment, we agreed, at closing, (i) to make a $0.5 million pay down of RLOC; (ii) RLOC commitment to be reduced to $4.25 million; and (iii) $0.5 million of RLOC will only be available for issuance of Letters of Credit. We also agreed to pay $0.5 million to reduce RLOC to $3.75 million by June 30, 2021 and to $3.5 million by September 30, 2021. Commencing December 31, 2021 and on the last day of each quarter, we will pay $75 thousand to reduce the RLOC. We incurred $25 thousand fees related to this amendment during the year ended December 31, 2020.
Revolving Line of Credit (“RLOC”)
During the three months ended March 31, 2021, we paid down $0.5 million on our RLOC as part of the Ninth Amendment as discussed above. As of March 31, 2021, we had outstanding borrowings of $2.5 million under the RLOC and three letters of credit totaling $933 thousand outstanding to certain of our customers. After consideration of letters of credit, the amount available under the RLOC was approximately $0.3 million with a $4.25 million total borrowing capacity as of March 31, 2021.
We intend to continue using the RLOC for short-term working capital needs and the issuance of letters of credit in connection with business operations provided, we remain in compliance with our covenants. As discussed above, we signed the Ninth Amendment on our credit facility as such our covenants have been waived through June 30, 2021. Letter of credit issuance fees range between 1.25% and 2.00% of the value of the letter of credit, depending on our overall leverage ratio. We pay an unused RLOC fee quarterly based on the average daily unused balance.
Paycheck Protection Program Loan
We applied for the PPP Loan with the Bank, which was approved by the bank and funded on April 23, 2020, pursuant to the Paycheck Protection Program under the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”). The PPP Loan matures on April 23, 2022, and bears interest at a rate of 1.0% per annum. Monthly amortized principal and interest payments are deferred for ten months after the last day of the covered period, August 9, 2021. The PPP Loan contains events of default and other provisions customary for a loan of this type. The Payroll Protection Program provides that (1) the use of PPP Loan amount shall be limited to certain qualifying expenses, (2) 100% of the principal amount of the loan is guaranteed by the Small Business Administration and (3) an amount up to the full principal amount may qualify for loan forgiveness in accordance with the terms of CARES Act. We are not yet able to determine the amount that might be forgiven. As of March 31, 2021, the Company was in full compliance with respect to the PPP Loan and believes the eligible expenses accumulated during the coverage period satisfy forgiveness criteria. Forgiveness was applied for with the SBA, through our bank on February 26, 2021.
Note 11 - Product Warranty
We accrue for estimated warranty costs at the time the related revenue is recognized and based on historical experience and projected claims. Our System Design and Build contracts generally include a one-year base warranty on the systems. The portion of our warranty provision expected to be incurred within 12 months is classified as current within accrued warranty and totals $587 thousand, and the remaining $179 thousand is classified as long-term within other liabilities.
The activity in the accrued warranty accounts during the current period is as follows:
| (in thousands) | | | |
| Balance at January 1, 2021 | | $ | 922 | |
| Current period provision | | | (119 | ) |
| Current period claims | | | (36 | ) |
| Currency adjustment | | | (1 | ) |
| Balance at March 31, 2021 | | $ | 766 | |
Note 12 - Revenue
We account for revenue in accordance with ASC 606, Revenue from Contracts with Customers. We primarily generate revenue through three distinct revenue streams: (1) System Design and Build (“SDB”), (2) Software and (3) Training and Consulting Services across our Performance and NITC (workforce solutions) segments. We recognize revenue from SDB and software contracts mainly through our Performance segment. We recognize training and consulting service contracts through both segments.
The following table represents a disaggregation of revenue by type of goods or services for the three months ended March 31, 2021 and 2020, along with the reportable segment for each category:
(in thousands)
| | | Three months ended | |
| | | March 31, 2021 | | | March 31, 2020 | |
| Performance Improvement Solutions segment | | | | | | |
| System Design and Build | | $ | 1,862 | | | $ | 3,813 | |
| Point in time | | | - | | | | - | |
| Over time | | | 1,862 | | | | 3,813 | |
| | | | | | | | | |
| Software and Support | | | 813 | | | | 910 | |
| Point in time | | | 95 | | | | 640 | |
| Over time | | | 718 | | | | 270 | |
| | | | | | | | | |
| Training and Consulting Services | | | 4,406 | | | | 4,988 | |
| Point in time | | | 68 | | | | 29 | |
| Over time | | | 4,338 | | | | 4,959 | |
| | | | | | | | | |
| Nuclear Industry Training and Consulting segment | | | | | | | | |
| Training and Consulting Services | | | 6,023 | | | | 7,994 | |
| Point in time | | | 86 | | | | - | |
| Over time | | | 5,937 | | | | 7,994 | |
| | | | | | | | | |
| Total revenue | | $ | 13,104 | | | $ | 17,705 | |
SDB contracts are typically fixed-priced, and we receive payments based on a billing schedule established in our contracts. We generally have two main performance obligations: (1) the training simulator build and (2) the Post Contract Support (“PCS”) period. Fees for PCS are normally paid in advance of the related service period. The training simulator build performance obligation generally includes hardware, software, and labor. The transaction price under the SDB contracts is allocated to each performance obligation based on its standalone selling price. We recognize the training simulator build revenue over the construction and installation period using the cost-to-cost input method. In applying the cost-to-cost input method, we use the actual costs incurred to date relative to the total estimated costs to measure the work progress toward the completion of the performance obligation and recognize revenue over time as control transfers to a customer. Estimated contract costs are reviewed and revised periodically during the contract period, and the cumulative effect of any change in estimates is recognized in the period in which the change is identified. Estimated losses are recognized in the period such losses become known.
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 previous estimates.
Management judgments and estimates involved in the initial creation and subsequent updates to the Company’s estimates-at-completion and related profit recognized are critical to our revenue recognition associated with SDB contracts. Inputs and assumptions requiring significant management judgment included anticipated direct labor, subcontract labor, and other direct costs required to deliver on unfinished performance obligations.
The transaction price for Software contracts is generally fixed, and we recognize revenue upon delivery of the software, with fees due in advance or shortly after delivery of the software.
We recognize Training and Consulting Services revenue as services are provided, and we bill our customers for these services at fixed intervals (i.e., weekly, biweekly or monthly) based on contract terms.
Contract asset, which we classify as unbilled receivables, relates to performance under the contract for obligations that are satisfied but not yet billed. Contract assets are recognized as revenue as they occur.
Contract liability, which we classify as billing-in-excess of revenue earned, relates to payments received in advance of performance under the contract. Contract liabilities are recognized as revenue as performance obligations are satisfied.
The following table reflects the revenue recognized in the reporting periods that were included in contract liabilities from contracts with customers:
(in thousands)
| | | Three months ended | |
| | | March 31, 2021 | | | March 31, 2020 | |
| Revenue recognized in the period from amounts included in Billings in Excess of Revenue Earned at the beginning of the period | | $ | 2,189 | | | $ | 3,762 | |
Note 13 - Income Taxes
The following table shows the provision for (benefit from) income taxes and our effective tax rates:
| (in thousands) | | Three months ended | |
| | | March 31, 2021 | | | March 31, 2020 | |
| Loss before income taxes | | $ | (2,240 | ) | | $ | (6,388 | ) |
| Provision for (benefit from) income taxes | | | (35 | ) | | | (130 | ) |
| Effective tax rate | | | 1.6 | % | | | 2.0 | % |
Our income tax benefit for the interim periods presented is determined using an estimate of our annual effective tax rate, adjusted for discrete items arising in that quarter. Total income tax benefit for the three months ended March 31, 2021 and 2020 was comprised mainly of foreign and state tax benefit.
Our income effective tax rate was 1.6% and 2.0% for the three months ended March 31, 2021 and 2020, respectively. For the three months ended March 31, 2021, the difference between our income tax benefit at an effective tax rate of 1.6% and a benefit at the U.S. statutory federal income tax rate of 21% was primarily due to accruals related to uncertain tax positions for certain foreign tax contingencies, a change in tax valuation allowance in our U.S. entity, and discrete item adjustments for U.S. and foreign taxes. For the three months ended March 31, 2020, the difference between income tax benefit at an effective tax rate of 2.0% and a benefit at the U.S. statutory federal income tax rate of 21% was primarily due to accruals related to uncertain tax positions for certain foreign tax contingencies, a change in tax valuation allowance in our U.S. and China subsidiaries, and discrete item adjustments for U.S. and foreign taxes.
Because of our net operating loss carryforwards, we are subject to U.S. federal and state income tax examinations from the year 2000 and forward and are subject to foreign tax examinations by tax authorities for years 2015 and forward.
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 an estimated $0.8 million of tax benefit that will be realized in the third quarter of 2021 upon the expiration of the statute of limitations of the tax year in which the uncertain tax position was taken.
We recognize deferred tax assets to the extent that it is believed that these assets are more likely than not to be realized. We have evaluated all positive and negative evidence and determined that it will continue to assess a full valuation allowance on our U.S., Chinese, and Slovakian net deferred assets as of March 31, 2021. We have determined that it is not more likely than not that the Company will realize the benefits of its deferred taxes in the U.S. and foreign jurisdictions.
Note 14 - Leases
According to ASC 842 Leases (Topic 842), for leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. If a lessee makes this election, it should recognize lease expense for such leases generally on a straight-line basis over the lease term. Leases generally have remaining terms of one to six years, whereas leases with an initial term of twelve months or less are not recognized on our consolidated balance sheet. We recognize lease expense for minimum lease payments on a straight-line basis over the term of the lease. We maintain leases of office facilities and equipment, and certain leases include options to renew or terminate. Renewal options are exercisable based upon our discretion and vary based on the nature of each lease, with renewal periods generally ranging from one to five years. The term of the lease includes renewal periods, only if we are reasonably certain that we will exercise the renewal option. When determining if a renewal option is reasonably certain of being exercised, we consider several factors, including but not limited to, the cost of moving to another location, the cost of disruption to our operations, the purpose or location of the leased asset and the terms associated with extending the lease.
Operating lease Right-of-Use (“ROU”) assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. The operating lease ROU assets represent the lease liability, plus any lease payments made at or before the commencement date, less any lease incentives received. Our real estate leases, which are comprised primarily of office spaces, represent most of our remaining lease liability. Most of our lease payments are fixed, although an immaterial portion of payments are variable in nature. These lease payments vary based on changes in facts and circumstances related to the use of the ROU asset and are recorded as incurred. We use an incremental borrowing rate based on rates available at commencement in determining the present value of future payments.
We have lease agreements with lease and non-lease components, which are accounted for as a single lease. We apply a portfolio approach to effectively account for the operating lease ROU assets and liabilities.
Lease contracts are evaluated at inception to determine whether they contain a lease and whether we obtain the right to control an identified asset. The following table summarizes the classification of operating ROU assets and lease liabilities on the consolidated balance sheets (in thousands):
| | | | | | As of | |
| Operating Leases | | | Classification | | March 31, 2021 | | | December 31, 2020 | |
| | | | | | | | | | |
| Leased Assets | | | | | | | | | |
| Operating lease - right of use assets | | | Long term assets | | $ | 1,413 | | | $ | 1,562 | |
| | | | | | | | | | | | |
| Lease Liabilities | | | | | | | | | | | |
| Operating lease liabilities - Current | | | Other current liabilities | | | 1,121 | | | | 1,138 | |
| Operating lease liabilities | | | Long term liabilities | | | 1,565 | | | | 1,831 | |
| | | | | | $ | 2,686 | | | $ | 2,969 | |
We executed a sublease agreement with a tenant to sublease 3,650 square feet from the office space in Sykesville on May 1, 2019. This agreement is in addition to the 3,822 of square feet previously subleased, which was entered into on April 1, 2017. The sublease does not relieve us of our primary lease obligation. The lessor agreements are both considered operating leases, maintaining the historical classification of the underlying lease. We do not recognize any underlying assets for the subleases as a lessor of operating leases. The net amount received from the sublease is recorded within selling, general and administrative expenses.
The table below summarizes lease income and expense recorded in the consolidated statements of operations incurred during three months ended March 31, 2021, (in thousands):
| | | | | | Three months ended | |
| Lease Cost | | | Classification | | March 31, 2021 | | | March 31, 2020 | |
| | | | | | | | | | |
Operating lease cost (1) | | | Selling, general and administrative expenses | | $ | 192 | | | $ | 321 | |
Short-term leases costs (2) | | | Selling, general and administrative expenses | | | 16 | | | | 1 | |
Sublease income (3) | | | Selling, general and administrative expenses | | | (32 | ) | | | (32 | ) |
| Net lease cost | | | | | $ | 176 | | | $ | 290 | |
(1) Includes variable lease costs which are immaterial.
(2) Includes leases maturing less than twelve months from the report date.
(3) Sublease portfolio consists of two tenants, which sublease parts of our principal executive office located at 1332 Londontown Blvd, Suite 200, Sykesville, MD.
The Company is obligated under certain noncancelable operating leases for office facilities and equipment. Future minimum lease payments under noncancelable operating leases as of March 31, 2021 are as follows (in thousands):
(in thousands) | | Gross Future Minimum Lease Payments | |
| 2021 remainder | | $ | 941 | |
| 2022 | | | 1,166 | |
| 2023 | | | 631 | |
| 2024 | | | 116 | |
| 2025 | | | 3 | |
| Total lease payments | | $ | 2,857 | |
| Less: Interest | | | 171 | |
| Present value of lease payments | | $ | 2,686 | |
We calculated the weighted-average remaining lease term, presented in years below and the weighted-average discount rate for our operating leases. As noted in our lease accounting policy, we use the incremental borrowing rate as the lease discount rate.
| Lease Term and Discount Rate | | March 31, 2021 | | | December 31, 2020 | |
| Weighted-average remaining lease term (years) | | | | | | |
| Operating leases | | | 2.42 | | | | 2.64 | |
| Weighted-average discount rate | | | | | | | | |
| Operating leases | | | 5.00 | % | | | 5.00 | % |
The table below sets out the classification of lease payments in the consolidated statement of cash flows.
| (in thousands) | | Three months ended | |
| Cash paid for amounts included in measurement of liabilities | | March 31, 2021 | | | March 31, 2020 | |
| Operating cash flows used in operating leases | | $ | 327 | | | $ | 339 | |
Note 15 - Segment Information
We have two reportable business segments. The Performance Improvement Solutions segment provides simulation, training and engineering products and services delivered across the breadth of industries we serve. Solutions include simulation for both training and engineering applications. Example engineering services include, but are not limited to, plant design verification and validation, thermal performance evaluation and optimization programs, and engineering programs for plants for ASME code and ASME Section XI. The Company provides these services across all market segments through our Performance, True North consulting, and DP Engineering subsidiaries. Example training applications include turnkey and custom training services. Contract terms are typically less than two years.
On February 15, 2019, through our wholly-owned subsidiary GSE Performance Solutions, Inc., the Company entered into the DP Engineering Purchase Agreement, to purchase 100% of the membership interests in DP Engineering. DP Engineering is a provider of value-added technical engineering solutions and consulting services to nuclear power plants with an emphasis on preparation and implementation of design modifications during plant outages. For reporting purposes, DP Engineering is included in our Performance segment due to similarities in services provided including engineering solutions and implementation of design modifications to the nuclear power sector.
The Nuclear Industry Training and Consulting (workforce solutions) segment provides specialized workforce solutions primarily to the nuclear industry, working at clients’ facilities. This business is managed through our Hyperspring and Absolute subsidiaries. The business model, management focus, margins and other factors clearly separate this business line from the rest of the GSE product and service portfolio.
The following table summarizes the revenue and operating results attributable to our reportable segments and includes a reconciliation of segment revenue to consolidated revenue and segment loss to consolidated loss before income taxes. Inter-segment revenue is eliminated in consolidation and is not significant.
| (in thousands) | | Three months ended | |
| | | March 31, 2021 | | | March 31, 2020 | |
| Revenue: | | | | | | |
| Performance Improvement Solutions | | $ | 7,081 | | | $ | 9,711 | |
| Nuclear Industry Training and Consulting | | | | | | | 7,994 | |
| Total revenue | | $ | 13,104 | | | $ | 17,705 | |
| | | | | | | | | |
| Operating loss | | | | | | | | |
| Performance Improvement Solutions | | $ | (1,403 | ) | | $ | (1,272 | ) |
| Nuclear Industry Training and Consulting | | | (784 | ) | | | (559 | ) |
| Loss on impairment | | | - | | | | (4,302 | ) |
| Operating loss | | | (2,187 | ) | | | (6,133 | ) |
| | | | | | | | | |
| Interest expense, net | | | (54 | ) | | | (241 | ) |
| Gain (loss) on derivative instruments, net | | | - | | | | (43 | ) |
| Other income, net | | | 1 | | | | 29 | |
| Loss before income taxes | | $ | (2,240 | ) | | $ | (6,388 | ) |
Note 16 - Commitments and Contingencies
Joyce v. Absolute Consulting, Inc.
On March 29, 2019, a former employee of Absolute Consulting, Inc., filed a putative class action against Absolute and the Company, Joyce v. Absolute Consulting Inc., case number 1:19 cv 00868 RDB, in the United States District Court for the District of Maryland. The lawsuit alleged that the plaintiff and certain other employees were not properly compensated for overtime hours worked. The Company was subsequently dismissed from the case, leaving Absolute as the sole defendant.
On August 17, 2020, Absolute entered into a Settlement Agreement with the plaintiffs, with a maximum settlement amount of $1.5 million, which required Court approval. On September 8, 2020, the Settlement Agreement between Absolute and the plaintiffs was ratified by the Court, and the case was dismissed, although the parties remain bound by the terms of the settlement agreement. Following Court approval, Absolute made an initial payment toward the settlement amount, including legal fees, of $625 thousand. After the passing of an opt-in notice period expired, the final cost of settling this case, including plaintiff’s attorney fees was approximately $1.4 million. As of March 31, 2021, approximately $15 thousand of the outstanding liability remains to be paid and we are expecting this to occur as payment information is confirmed with the plaintiff’s attorneys over the next few quarters.
On September 29, 2020, the Company received $952 thousand from a general escrow account, originally set up as part of the Company’s purchase of Absolute during fiscal 2017. The Company presented the loss on Joyce legal settlement and the benefit from the proceeds from the release of escrow from the Absolute transaction in selling, general and administrative expenses, in the amount of $477 thousand for the year ended December 31, 2020.
Per ASC 450 Accounting for Contingencies, the Company reviews potential items and areas where a loss contingency could arise. In the opinion of management, we are not a party to any legal proceeding, the outcome of which, in management’s opinion, individually or in the aggregate, would have a material effect on our consolidated results of operations, financial position or cash flows, other than as noted above. We expense legal defense costs as incurred.
The Company is involved in litigation in the ordinary course of business. While it is too early to determine the outcome of such matters, management does not expect the resolution of these matters to have a material impact on the Company’s financial position or results of operations.
Note 17 - Subsequent Events
On April 14, 2021, Swedish Companies Registration Office (Bolagsverket) registered the closure of the GSE Power Systems AB liquidation.
We became eligible for the Employee Retention Credit for the first quarter of 2021 and have applied for a refund of $2.4 million in April 2021. We believe we are eligible to receive the employee retention credit in the second quarter of 2021 and are currently reducing our payroll taxes as permitted under the Coronavirus Aid, Relief and Economic Security Act.
Cautionary Statement Regarding Forward-Looking Statements
This report and the documents incorporated by reference herein contain “forward-looking” statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) that are based on management’s assumptions, expectations and projections about us, and the industry within which we operate, and that have been made pursuant to the Private Securities Litigation Reform Act of 1995 reflecting our expectations regarding our future growth, results of operations, performance and business prospects and opportunities. Wherever possible, words such as “anticipate”, “believe”, “continue”, “estimate”, “intend”, “may”, “plan”, “potential”, “predict”, “expect”, “should”, “will” and similar expressions, or the negative of these terms or other comparable terminology, have been used to identify these forward-looking statements. These forward-looking statements may also use different phrases. These statements regarding our expectations reflect our current beliefs and are based on information currently available to us. Accordingly, these statements by their nature are subject to risks and uncertainties, including those listed under Item 1A - Risk Factors in our most recent annual report on Form 10-K, which could cause our actual growth, results, performance and business prospects and opportunities to differ from those expressed in, or implied by, these forward-looking statements. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements we make. Except as otherwise required by federal securities law, we are not obligated to update or revise these forward-looking statements to reflect new events or circumstances. We caution you that a variety of factors, including but not limited to the factors described under Item 1A - Risk Factors in our most recent annual report on Form 10-K, could cause our business conditions and results to differ materially from what is contained in forward-looking statements.
Other factors and assumptions not identified above were also involved in the formation of these forward-looking statements and the failure of such other assumptions to be realized, as well as other factors, may also cause actual results to differ materially from those projected. Most of these factors are difficult to predict accurately and are generally beyond our control. You should consider the areas of risk described in Item 1A - Risk Factors in our most recent annual report on Form 10-K in connection with any forward-looking statements that may be made by us. You should not place undue reliance on any forward-looking statements. New factors emerge from time to time, and it is not possible for us to predict which factors will arise.
We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any additional disclosures we make in proxy statements, quarterly reports on Form 10-Q and current reports on Form 8-K filed with the SEC.
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
GSE is a leading provider of professional and technical engineering, staffing services and simulation software to clients in the power and process industries. We provide customers with simulation, engineering and plant services that help clients reduce risks associated with operating their plants, increase revenue through improved plant and employee performance, and lower costs through improved operational efficiency. In addition, we provide professional services that systematically help clients fill key vacancies in the organization on a short-term basis, primarily in procedures, engineering, technical support and training focused on regulatory compliance and certification in the nuclear power industry. Our operations also include interactive computer-based tutorials and simulation software for the refining, chemical, and petrochemical industries.
Early in 2020 as the pandemic unfolded, the end markets that GSE serves, namely the power industries, delayed the essential services and dramatically cut back on non-essential services. Although this impacted GSE, as an essential services provider to an essential industrial base, GSE benefited from maintaining a baseline of business to continue and align itself to the realities of the pandemic. As GSE enters 2021, the effects of the pandemic are still impacting the end markets we serve, but those effects may be mitigated for a number of factors, including the following: the pandemic largely has had a targeted effect on the population; there now are a number of vaccines in the market being distributed and, despite logistical challenges, making solid progress for those in most need; the economy of the United States has not had as much disruption as was initially feared which has benefited our end markets; and most importantly the end markets of GSE seem poised to spend to catch up on essential services that had been delayed as a result of the pandemic. As GSE ended 2020 and began 2021, we have had a number of significant contract wins that have been publicly announced, which we hope is a harbinger of a more solid 2021 business environment.
On April 23, 2020, we received $10 million in funds under the Paycheck Protection Program, a part of the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”). The loan is serviced by Citizens Bank (the “Bank”), and the application for these funds required us to, in good faith, certify that the current economic uncertainty made the loan necessary to support our ongoing operations. We used funds for payroll and related costs, rent and utilities. The receipt of these funds, and the forgiveness of the PPP Loan attendant to these funds, is dependent on our ability to adhere to the forgiveness criteria. The PPP Loan bears interest at a rate of 1% per annum and matures on April 23, 2022, with the first payment deferred until August 9, 2021. Under the terms of the PPP Loan, certain amounts may be forgiven if they are used in accordance with the CARES Act. As of the period end, we have maintained compliance with all of the requirements to obtain forgiveness of the full amount of the PPP Loan. We believe that our use of the proceeds and other conditions consistent with the requirements for forgiveness have been met but are unable to determine the amount that may be ultimately forgiven.
General Business Environment
We operate through two reportable business segments: Performance Improvement Solutions and Nuclear Industry Training and Consulting. The NITC segment is referred to as workforce solutions to account for the increasing activity outside of our core nuclear industry focus. Each segment focuses on delivering solutions to customers within our target markets. Marketing and communications, accounting, finance, legal, human resources, corporate development, 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. The business units collaborate to facilitate cross-selling and the development of new solutions. The following is a description of our business segments:
Performance Improvement Solutions (approximately 54% of revenue at March 31, 2021)
Our Performance Improvement Solutions segment primarily encompasses our power plant high-fidelity simulation solutions, technical engineering services for ASME programs, power plant thermal performance optimization, and interactive computer based tutorials/simulation focused on the process industry. The Performance Solutions 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 process industries. Our simulation solutions include the following: (1) simulation software and services, including operator training systems, for the nuclear power industry, (2) simulation software and services, including operator training systems, for 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 and for ongoing workforce development and training. GSE and its predecessors have been providing these services since 1976.
Our engineering solutions include the following: (1) in-service testing for engineering programs focused on ASME OM code including Appendix J, balance of plant programs, and thermal performance; (2) in-service inspection for specialty engineering including ASME Section XI; (3) software solutions; and (4) mechanical design, civil/structural design, electrical, instrumentation and controls design, digital controls/cyber security, and fire protection for nuclear power plant design modifications. Our GSE True North Consulting and GSE DP Engineering businesses typically work as either the engineer of choice or specialty engineer of choice for our clients under master services agreements and are included in our Performance Improvement Solutions segment due to their service offerings. GSE has been providing these engineering solutions and services since 1995.
Nuclear Industry Training and Consulting (approximately 46% of revenue at March 31, 2021)
Nuclear Industry Training and Consulting (workforce solutions) provides highly specialized and skilled nuclear operations instructors, procedure writers, technical engineers, 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 senior reactor operations instructors, procedure writers, project managers, work management specialists, planners and training material developers. This business is managed through Hyperspring and Absolute subsidiaries. The business model, management focus, margins and other factors clearly separate the business line from the rest of the Company’s product and service portfolio. GSE has been providing these services since 1997.
Business Strategy
Serve existing customers and adjacencies with compelling solutions, with a focus on decarbonization:
Our objective has been to create a leading business focused on decarbonizing the power industries by providing a diverse set of highly unique and essential services and technologies. GSE is now one of the leading, publicly traded engineering and technology companies serving the zero-carbon energy sector of nuclear power and adjacent nuclear markets in DOE, US Navy and related defense sectors. As a result of this effort and established leadership position in key sectors, GSE is positioned to expand into essential clean energy opportunities that may arise such as wind, solar, hydrogen production, and others. In 2021, we will focus on organic growth in the sectors we serve by: cross selling and upselling in our existing markets as we focus on delivering significant value to our customers in a manner of excellence; create new and compelling solutions in-house as a result of advancing our technology offerings in sponsorship with industry early adopters focused on critical business need; develop new services as a result of combining the expertise of the Company; and expand into compelling adjacent markets such as clean energy as they may arise with renewed sales focus.
Cross sell and upsell into existing markets:
GSE has spent the past several years conducting a rollup of essential services providers to the industry. To ensure efficient and streamlined operations for the business, the Company has brought all of the engineering services together into one organization with one leader; and the NITC teams together as one team under one leader. The business units operating uniformly within their respective structure. As such, the opportunity to cross-sell the capabilities across the entire customer base is greatly enhanced. This further differentiates GSE as a unique provider to industry vs. providers of specific niche services. The unified go-to market efforts, such as cross-selling capability should lead to greater share of available spending within the customer base, which in turn should lead to significant upselling opportunity. As a result of a rejuvenated marketing effort, the Company is equipped to take this new approach to market. In particular, with the US government rejoining the Paris Climate Agreement and driving to decarbonize the energy grid by 2035, and create a carbon neutral economy by 2050, decarbonization of the energy sector will require significant investment for decades to come. As a key provider of essential services to the power sector, with a focus on decarbonization, GSE is poised to benefit from and exploit this investment.
Organic growth through new and compelling technology:
While the company was managing through the pandemic, in parallel the leadership was working to investigate compelling opportunities by which new offerings that uniquely result from the combination of capabilities across GSE could create significant value for the industry and advance the efforts of decarbonizing the power sector. As a result, the Company has identified a robust pipeline of new and compelling technology solutions to develop and take to market. Net new solutions would create new revenue streams with the potential of on-going annuities through license revenue, software maintenance and services revenue. As the Company has demonstrated in the past few years, small wins over time accrue into meaningful revenue on an on-going basis. This is a key element of our organic growth thesis: focusing on creating and bringing to market compelling technology solutions.
Focus on compelling adjacencies in clean energy, defense, and national labs:
- Research and development (R&D). We invest in R&D to deliver unique solutions that add value to our end-user markets. Our software tools leverage the high-end expertise of our experienced staff in helping plants operate better and more efficiently. Our software technology together with our deep staff expertise supports multiple industries including the nuclear industry, as a part of the larger decarbonization drive. GSE’s software technology includes decision-support tools for engineering simulation supporting design and plant commissioning, operational performance tools, and training platform.
One area of significant recent enhancement is in improving the thermal performance of power plants. We have introduced the next generation platform in TSM Enterprise, providing the technology solution to centralize and continuously monitor plant thermal performance. The solution benefits our customers by automating standardized reporting in modern dashboards available to engineers and decision makers across the fleet, leverage automation to facilitate troubleshooting plant performance issues, reducing time and error with direct access to source data, and applying industry guidelines for problem resolution. This platform also supports integration with Data Validation and Reconciliation (DVR) (implemented by GSE’s True North division) that enhances the quality of data for analysis and decision making, providing a solution to better detect and identify faulty measurements/sensors and thus reduce maintenance costs by focusing on critical components.
In the area of engineering simulations, we deliver 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 DesignEP® 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 OpenSim TM platforms enables customers to be more efficient in the daily operation of their simulators. We have brought SimExec® and OpenSimTM together into a next generation unified environment that adds new capabilities as requested by clients and driven by market need.
We intend to continue to make pragmatic and measured investments in R&D that first and foremost are driven by the market and complement 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 that is easier to use, at lower total cost of ownership than any alternative available to customers. GSE has pioneered a number of industry standards and intends to continue to be one of the most innovative companies in our industry.
- Strengthen and develop our talent while delivering high-quality solutions. Over the past several years GSE has assembled a unique and highly experienced group of talented individuals through organic growth and strategic acquisition. Our Engineering team comprised of design, simulation, regulatory compliance, and performance optimization capabilities are unique to the industry and capable of addressing the entire power generation life cycle.
Our experienced employees and management team are our most valuable resources. The continued integration of our team in parallel with attracting, training, and retaining top talent is critical to our success. To achieve our goals, we intend to remain focused on providing our employees with opportunities to increase client contact within their areas of expertise and to expand and deepen our service offerings. As we refine our product and service areas to best align with the critical areas listed above, we will also integrate and apply our composite employee talent to the fullest extent possible combining employee personal and professional growth opportunities with fulfillment of cutting-edge industry needs. Performance-based incentives including opportunities for stock ownership, bonuses and competitive benefits as benchmarked to our industry and locations will also be utilized to ensure continuity of our approach.
We have developed a strong reputation for quality services based upon our industry-recognized depth of experience, ability to attract and retain quality professionals, and exceptional expertise across multiple service sectors. As we continue to integrate and leverage our individual company components assembled over the past several years, our capabilities and reputation will further strengthen.
Employees
As of March 31, 2021, we had approximately 339 employees, which includes approximately 197 employees in our Performance segment and approximately 142 employees in our NITC segment.
Backlog
As of March 31, 2021, we had approximately $40.2 million of total gross revenue backlog, which included $28.7 million of Performance backlog and $11.5 million of NITC backlog. With respect to our backlog, it includes only those amounts that have been funded and authorized and does not reflect the full amounts we may receive over the term of such contracts. Our backlog includes future expected revenue at contract rates, excluding contract renewals or extensions that are at the discretion of the client. We calculate backlog without regard to possible project reductions or expansions or potential cancellations unless and until such changes may occur.
Backlog is expressed in terms of gross revenue and, therefore, may include significant estimated amounts of third-party or pass-through costs to subcontractors and other parties. Because backlog is not a GAAP measurement, our computation of backlog may not necessarily be comparable to that of our industry peers.
Product and Services
- Performance Improvement Solutions
Our engineering team, comprised of design, simulation, regulatory compliance, and performance optimization capabilities are unique to the industry and capable of addressing the entire power generation life cycle. As we move forward in alignment with client and industry goals targeting clean energy production and overall decarbonization we are positioned to be at the forefront in three critical areas:
| | • | optimization of existing generation assets |
| | • | design support and deployment of advanced reactor designs |
| | • | integration with renewable power sources |
Optimizing Existing Generation Assets
As the existing fleet of nuclear reactors age and competitive pressures increase, we find ever increasing significance in being able to provide value to their continued operation. Maximizing power production through a variety of methods such as digital verification and reconciliation, a statistical based analysis used to lower uncertainty, and thus increase recognized power output is instrumental in helping these facilities face current competitive pressures. Other approaches involving safe reduction of testing and inspection requirements or performance periodicities are also at the forefront of our cost saving techniques with defined services and products providing a clear and positive return on investment. In all cases these efforts are aligned with keeping this important source of carbon free base power economically and technically viable.
Advanced Reactor Designs & Deployment
Designers of first-of-a-kind plants or existing plants need a highly accurate dynamic simulation platform to model a wide variety of design assumptions and concepts from control strategies to plant behavior to human factors. Because new builds and upgrades to existing plants result in deployment of new technology, often involving the integration of disparate technologies for the first time, a high-fidelity simulator enables designers to model the interaction between systems in advance of construction. With our combination of simulation technology and expert engineering, GSE was chosen to build first-of-a-kind simulators for the AP1000, PBMR, and small modular reactors such as those being built by NuScale. Going forward we also envision many of the optimization techniques and strategies currently emphasized for the existing reactor fleet incorporated with new-build prototypes as they begin to add value and assume a larger component of our clean, carbon free, power requirements.
Renewable Integration
A significant component of overall decarbonization regarding power generation will ultimately fall to renewable sources such as wind, solar, and hydro generation. These technologies are individually well on their way towards assuming a significant share of the overall generation make-up and are expected to significantly increase. One of the particular needs is the ability to safely and efficiently integrate these renewable sources with our existing and planned nuclear generation. We are on the cutting edge, working closely with academia and industry support organizations to design, model, and evaluate creative approaches to support this integration. Base load production, renewable availability, and other pertinent factors are at the core of the solutions we are exploring.
Engineering Solutions for Decarbonization
With overall decarbonization as our primary focus, we will blend our current and future efforts in those areas described above to best support that goal positioning our Engineering team as recognized leaders in the pursuit of Clean Energy. An overview highlighting many areas of our current and planned involvement as well as the associated benefits is summarized below:
With nuclear power being such a high percentage of carbon free power generation, the continued safe and efficient operation of these plants is critical to meeting decarbonization goals. We help the industry achieve these goals through better training and provide engineering services to optimize performance while maintaining regulatory compliance. Our focus is on products and services to improve the efficiency and lower operating costs for existing power generation assets. We also help the next generation of carbon free power plants achieve design approval and plant startup as quickly as possible.
Training plant operators and engineers is critical to safe operations and continued viability of the industry. Using state-of-the-art modeling tools combined with our leading nuclear power modeling expertise, GSE provides simulation solutions that achieve unparalleled fidelity and accuracy. We have also adapted these solutions to provide highly accurate training across a variety of delivery platforms. These include universal or generic simulators which are excellent in teaching fundamental concepts, systems, and plant behaviors. They are also used by academia for research on improved plant operations, human factors design and the development of automated procedures and decision support systems for the next generation of reactors. Our part task simulators and virtual control panels are cost effective solutions enabling customers broader freedom in where they deliver simulation training and opening the door for plant engineers and maintenance staff to access high fidelity training without interrupting the operator training program. Our full scope simulators use the most sophisticated modeling technology. For these reasons, GSE has delivered more nuclear power plant simulators than any other company in the world.
Even prior to the COVID pandemic, GSE had delivered training products though the cloud. This delivery method reduces our customers infrastructure and ownership costs and provides anytime, anywhere access to rich learning content. Innovative Critical Thinking Exercises enable autonomous simulation training to take place, reducing the burden on instructors and increasing training touch time for students and employees. All of which enabling the training organization to be more flexible and efficient.
GSE’s simulation solutions not only address industry training needs, but are used for Simulation Assisted Engineering, the process of using simulation to virtually test and commission plant designs prior to construction. Because new builds and upgrades to existing plants result in deployment of new technology, GSE’s high-fidelity simulator enables designers to model the interaction between systems in advance of construction. With our combination of simulation technology and expert engineering, GSE was chosen to build first-of-a-kind simulators for the AP1000, PBMR, and small modular reactors such as those being built by NuScale. This technique reduces design costs, accelerates design approvals, de-risks projects, and provides clients with a tool to sell their new plant designs to both customers and regulators. In essence, enabling our customers to get to market faster.
Beyond training, GSE technology is used to improve the efficiency of existing power generation assets. Our Thermal System Monitoring System provide live insights into plant operations, by monitoring performance of key plant equipment, analyzes degradation and advises actions to be taken. When combined with Data Validation and Reconciliation techniques, GSE can help reduce operating and maintenance cost. DVR enhances the quality of data for analysis and decision making, providing a solution to better detect and identify faulty measurements/sensors and thus reduce maintenance costs by focusing on critical components.
Our EP-Plus software suite provides one common platform for all Engineering Programs, helping client engineers keep track of Engineering Program inspection and monitoring requirements aimed at safe plant operations. This reduces the engineering workload of our customers, saving costs and enabling staff to focus on the most critical activities.
All of these technologies leverage the vast experience and industry expertise of GSE’s engineering organization. Our Engineering team helps our clients throughout the entire plant lifecycle. GSE is the engineer of choice in areas such as:
| | • | Design engineering for plant mechanical, electrical, I&C, civil and structural, fire protection and cyber systems |
| | • | Engineering Programs addressing ASME codes, balance of plant programs other regulatory programs and economic driven programs such as plant thermal performance |
| | • | Simulation engineering for nuclear, thermal and process plant training and virtual commissioning |
We see organic growth through closer integration of these engineering activities and technologies to provide solutions to improve the performance of our customers’ people and plants.
- Workforce Solutions: Nuclear Industry Training and Consulting
As our customers’ experienced employees retire, access to industry experts to operate and train existing and new employees how to operate nuclear plants is essential to ensure safe, ongoing plant operation. In addition, operating and training needs change over time and sometimes our clients require fixed priced, discrete projects or specialized courses in contrast to straight staff augmentation. The industry needs operating personnel, including procedure writers, engineers, operators and instructors who can step in and use, as well as update the client’s operating methods, procedures, training material and more. Finding technical professionals and instructors, who know the subject, can perform the work or teach it to others and can adapt to the client’s culture is critical. GSE provides qualified professionals, instructors and turnkey projects/courses that work within the client’s system and complement the operating or training methods they already have in place. Examples of our training program courses include senior reactor operator certification, generic fundamentals training, and simulation supervisor training. GSE also provides expert support through workforce solutions, consulting, or turnkey projects for procedure writing, technical engineers, project managers, training material upgrade and development, outage execution, planning and scheduling, corrective actions programs, and equipment reliability. Our workforce solutions include traditional staffing services, such as temporary and direct hire, as well as customized approaches in which we work with our customers to evaluate their specific needs and put together a strategic plan specifically to meet their unique needs. Workforce solutions is not only a complement to our other service offerings; it often leads the way as the preferred method for many of our clients to execute entire projects and/or supplement their own staff during project peak periods or with specialized skill sets that are often hard to find. Our staffing experts give our customers the ability to ramp up quickly, eliminate risks, and provide more flexible options as situations often demand.
In addition to the core training and staffing business lines in the nuclear sector, we have significant organic growth opportunity with our workforce solutions and consulting services by expanding our service offerings to meet the evolving needs of the energy industry as well as other opportunities that support decarbonization and major infrastructure projects. Due to the experience within our team, we are already well positioned to offer expanded workforce solutions through our existing relationships and industry knowledge. This growth is occurring both with existing and new customers. We are placing a greater emphasis on cross-selling the services offered by our NITC organization with our Engineering and Performance group. NITC is expanding our footprint with companies dedicated to the support of decarbonization, and we have already been awarded contracts to support engineering, manufacturing, and construction projects with companies focused on clean energy solutions. Further the U.S. government has already announced intentions to increase spending in key areas such as communication, clean energy, manufacturing, transportation, and environmental projects. We anticipated these developments and have made key hires to better position GSE to support those opportunities. As the pandemic has shown, we must also be able to adapt quickly to evolving staffing needs. This has certainly been demonstrated with companies adjusting and allowing more employees to work from home. Our workforce solutions offer our customers more flexibility to support ever changing needs. This flexibility combined with our ability to support all of these areas position GSE both for current and future staffing needs.
We recognize the necessity to listen to the needs of our customers and provide the right solution. Whether the answer is one of our traditional service offerings or putting together a customized approach, we have the capabilities to help our customers get the job done. We bring together the collection of skills we have 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, backed by the extensive nuclear industry training and consulting (workforce solutions) services of Absolute and Hyperspring, and now strengthened by our ability to successfully adapt, diversify, and offer a solutions based approach with our workforce solutions.
Results of Operations
The following table sets forth our results of operations, expressed in thousands of dollars and as a percentage of revenue:
| | | Three Months ended | |
| (in thousands) | | March 31, 2021 | | | March 31, 2020 | |
| | | $ | | |
| % | | | $ | | |
| % | |
| Revenue | | $ | 13,104 | | | | 100.0 | % | | $ | 17,705 | | | | 100.0 | % |
| Cost of revenue | | | 10,176 | | | | 77.7 | % | | | 13,590 | | | | 76.8 | % |
| Gross profit | | | 2,928 | | | | 22.3 | % | | | 4,115 | | | | 23.2 | % |
| | | | | | | | | | | | | | | | | |
| Operating expenses: | | | | | | | | | | | | | | | | |
| Selling, general and administrative | | | 3,734 | | | | 28.5 | % | | | 4,948 | | | | 27.9 | % |
| Research and development | | | 157 | | | | 1.2 | % | | | 210 | | | | 1.2 | % |
| Restructuring charges | | | 808 | | | | 6.2 | % | | | 10 | | | | 0.1 | % |
| Loss on impairment | | | - | | | | 0.0 | % | | | 4,302 | | | | 24.3 | % |
| Depreciation | | | 76 | | | | 0.6 | % | | | 108 | | | | 0.6 | % |
| Amortization of definite-lived intangible assets | | | 340 | | | | 2.6 | % | | | 670 | | | | 3.8 | % |
| Total operating expenses | | | 5,115 | | | | 39.0 | % | | | 10,248 | | | | 57.9 | % |
| Operating loss | | | (2,187 | ) | | | (16.8 | )% | | | (6,133 | ) | | | (34.7 | )% |
| Interest expense, net | | | (54 | ) | | | (0.4 | )% | | | (241 | ) | | | (1.4 | )% |
| Gain (loss) on derivative instruments, net | | | - | | | | 0.0 | % | | | (43 | ) | | | (0.2 | )% |
| Other income, net | | | 1 | | | | 0.0 | % | | | 29 | | | | 0.2 | % |
| Loss before income taxes | | | (2,240 | ) | | | (17.1 | )% | | | (6,388 | ) | | | (36.1 | )% |
| Provision for income taxes | | | (35 | ) | | | (0.3 | )% | | | (130 | ) | | | (0.7 | )% |
| Net loss | | $ | (2,205 | ) | | | (16.8 | )% | | $ | (6,258 | ) | | | (35.3 | )% |
Revenue
Revenue for the three months ended March 31, 2021 totaled $13.1 million, which was 26% less than the $17.7 million of revenue for the three months ended March 31, 2020.
| | | Three Months ended | |
| (in thousands) | | March 31, 2021 | | | March 31, 2020 | | | Change | |
| Revenue: | | | | | | | | $ | | |
| % | |
| Performance Improvement Solutions | | $ | 7,081 | | | $ | 9,711 | | | | (2,630 | ) | | | (27 | )% |
| Nuclear Industry Training and Consulting | | | 6,023 | | | | 7,994 | | | | (1,971 | ) | | | (25 | )% |
| Total revenue | | $ | 13,104 | | | $ | 17,705 | | | | (4,601 | ) | | | (26 | )% |
Performance Improvement Solutions revenue decreased 27% from $9.7 million to $7.1 million for the three months ended March 31, 2021 and 2020, respectively. The decrease of revenue was primarily due to several significant SDB projects ending in the prior fiscal year and delays in commencing new contracts remotely due to the COVID-19 pandemic. We recorded total Performance Improvement Solutions orders of $5.6 million and $5.4 million for the three months ended March 31, 2021 and 2020, respectively.
For the three months ended March 31, 2021, Nuclear Industry Training and Consulting (workforce solutions) revenue decreased 25% to $6.0 million compared to revenue of $8.0 million for the three months ended March 31, 2020. The decrease in revenue was primarily due to stoppage of existing projects, ending of some large projects and delays in commencing new contracts due to the COVID-19 pandemic resulting a reduction in demand for staffing from our major customers. We recorded total new orders of $7.4 million and $14.3 million for the three months ended March 31, 2021 and 2020, respectively.
As of March 31, 2021, our backlog was $40.2 million, of which, $28.7 million was attributed to the Performance segment and $11.5 million was attributed to the Nuclear Industry Training and Consulting (workforce solutions) segment. As of December 31, 2020, our backlog was $40.4 million with $30.3 million attributed to our Performance segment and $10.1 million to Nuclear Industry Training and Consulting (workforce solutions).
Gross Profit
Gross profit was $2.9 million or 22.3% of revenue and $4.1 million or 23.2% of revenue for the three months ended March 31, 2021 and 2020, respectively.
| | | Three Months ended | |
| | | March 31, 2021 | | | March 31, 2020 | |
| (in thousands) | | $ | | |
| % | | | $ | | |
| % | |
| Gross profit: | | | | | | | | | | | | | | |
| Performance Improvement Solutions | | $ | 2,192 | | | | 31.0 | % | | $ | 3,028 | | | | 31.2 | % |
| Nuclear Industry Training and Consulting | | | 736 | | | | 12.2 | % | | | 1,087 | | | | 13.6 | % |
| Total gross profit | | $ | 2,928 | | | | 22.3 | % | | $ | 4,115 | | | | 23.2 | % |
The Performance Improvement Solutions segment’s gross profit decreased by $0.8 million during three months ended March 31, 2021 over three months ended March 31, 2020. The decrease is primarily related to lower revenue, underutilization of staff and several significant SDB projects completed in the prior year that were not replaced with new orders.
The Nuclear Industry Training and Consulting (workforce solutions) segment’s gross profit decreased by $0.4 million during three months ended March 31, 2021 over three months ended March 31, 2020. The decrease in gross profit was primarily driven by a decrease in revenue in the NITC business and new contracts undertaken at lower margins, partially offset by a reduction in direct costs.
Selling, general and administrative expenses (“SG&A”)
Selling, general and administrative (SG&A) expenses totaled $3.7 million and $4.9 million for the three months ended March 31, 2021 and 2020, respectively. Fluctuations in the components of SG&A spending were as follows.
| | | | | | Three Months ended | | | | |
| (in thousands) | | March 31, 2021 | | | % | | | March 31, 2020 | | | % | |
| | | | | | | | | | | | | |
| Selling, general and administrative expenses: | | | | | | | | | | | | |
| Corporate charges | | $ | 2,758 | | | | 73.9 | % | | $ | 3,679 | | | | 74.4 | % |
| Business development | | | 767 | | | | 20.5 | % | | | 936 | | | | 18.9 | % |
| Facility operation & maintenance (O&M) | | | 200 | | | | 5.4 | % | | | 236 | | | | 4.8 | % |
| Bad debt expense | | | 4 | | | | 0.1 | % | | | 93 | | | | 1.9 | % |
| Other | | | 5 | | | | 0.1 | % | | | 4 | | | | 0.1 | % |
| Total | | $ | 3,734 | | | | 100.0 | % | | $ | 4,948 | | | | 100.0 | % |
Corporate charges
During the three months ended March 31, 2021, corporate charges decreased by $0.9 million over the same period of the prior year. The decrease was primarily due to a reduction of external legal and consulting fees of $0.5 million and the capitalization of Indirect Labor in relation to internal-use software implementation of $0.1 million in Q1 2021.
Business development expenses
Business development expense decreased $0.2 million during the three months ended March 31, 2021 over the same period of the prior fiscal year. The decrease was primarily due to lower commission costs and reduced headcount in Q1 2021.
Facility operation & maintenance (“O&M”)
Facility O&M expenses decreased $36 thousand for three months ended March 31, 2021, respectively, compared to the same period in 2020. The decrease in facility O&M during fiscal 2021 was mainly due to lease terminations in the first half of 2020.
Bad debt expense
We recorded $4 thousand and $93 thousand of bad debt expense during the three months ended March 31, 2021 and 2020, respectively.
Research and development
Research and development costs consist primarily of software engineering personnel and other related costs. Research and development costs, net of capitalized software, totaled $157 thousand and $210 thousand for the three months ended March 31, 2021 and 2020, respectively. The decrease was mainly due to lower headcount.
Restructuring
During the three months ended March 31, 2021 and 2020, we recorded restructuring charges of $808 thousand and $10 thousand, respectively. The increase was mainly due to final charges related to the liquidation of our Sweden operations in Q1 2021, pursuant to our foreign restructuring plan.
Loss on impairment of goodwill and definite-lived intangible assets
No impairment was recorded during the three months ended March 31, 2021. Due to the impact of the COVID-19 pandemic, definite-lived intangible assets were reviewed for impairment as of March 31, 2020. The undiscounted cash flows evidenced impairment for the DP Engineering asset group. As such, the Company used a discounted cash flow model to determine the fair value of the DP Engineering asset group and recorded an impairment charge of $4.3 million for the three months ended March 31, 2020.
Depreciation
We recorded depreciation expense of $76 thousand and $108 thousand for the three months ended March 31, 2021 and 2020, respectively. The reduction of $32 thousand for the three months ended March 31, 2021 over the same period in 2020 was due primarily to fully depreciated assets in 2021.
Amortization of intangible assets
Amortization expense related to definite-lived intangible assets totaled $0.3 million and $0.7 million for the three months ended March 31, 2021 and 2020, respectively. The decrease in amortization expense was primarily due to the reduction in the carrying value of DP Engineering’s intangible assets due to the $4.3 million impairment in Q1 2020.
Interest expense, net
Interest expense totaled $54 thousand and $241 thousand for the three months ended March 31, 2021 and 2020, respectively. The decrease was mainly due to a reduction in total indebtedness compared to Q1 2020.
Other income, net
For the three months ended March 31, 2021 and 2020, we recognized other income, net of $1 thousand and $29 thousand, respectively.
Income taxes benefit
Income tax expense (benefit) for interim periods is determined using an estimate of our annual effective tax rate, adjusted for discrete items arising in that quarter. Total income tax benefit of $(35) thousand and $(130) thousand for the three months ended March 31, 2021 and 2020 were comprised mainly of foreign and state tax expense.
Our income effective tax rate was 1.6% and 2.0% for the three months ended March 31, 2021 and 2020, respectively. For the three months ended March 31, 2021, the difference between our income tax benefit at an effective tax rate of 1.6% and a benefit at the U.S. statutory federal income tax rate of 21% was primarily due to accruals related to uncertain tax positions for certain foreign tax contingencies, a change in tax valuation allowance in our U.S. entity, and discrete item adjustments for U.S. and foreign taxes. For the three months ended March 31, 2020, the difference between income tax benefit at an effective tax rate of 2.0% and a benefit at the U.S. statutory federal income tax rate of 21% was primarily due to accruals related to uncertain tax positions for certain foreign tax contingencies, a change in tax valuation allowance in our U.S. and China subsidiaries, and discrete item adjustments for U.S. and foreign taxes.
Critical Accounting Policies and Estimates
In preparing our consolidated financial statements, Management makes several estimates and assumptions that affect our reported amounts of assets, liabilities, revenues and expenses. Our most significant estimates relate to revenue recognition on contracts with customers, product warranties, valuation of goodwill and intangible assets acquired, valuation of long-lived assets to be disposed, valuation of stock-based compensation awards and the recoverability of deferred tax assets. These critical accounting policies and estimates are discussed in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section in our most recent Annual Report on Form 10-K, filed with the SEC on April 13, 2021. For all accounting policies described in this document, management cautions that future events rarely develop exactly as forecasted and even our best estimates may require adjustment as facts and circumstances change.
Liquidity and Capital Resources
As of March 31, 2021, our cash and cash equivalents totaled $3.7 million, compared to $6.7 million as of December 31, 2020.
For the three months ended March 31, 2021 and 2020, net cash used in operating activities was $2.0 million and net cash provided by operating activities was $1.6 million, respectively. The decrease of $3.6 million in cash flows used in operating activities was primarily driven by slower billing in the first quarter of 2021 and increased attention on collection of contract receivables in the prior year.
Net cash used in investing activities totaled $0.2 million and $0.1 million for the three months ended March 31, 2021 and 2020, respectively. The increase in the cash outflow for investing activities year over year was primarily driven by the increase of capital expenditures during the three months ended March 31, 2021.
For the three months ended March 31, 2021 and 2020, cash used in financing activities totaled $0.7 million and $1.7 million, respectively. The decrease in cash used in financing activities of $1.0 million was driven by a repayment on term loans of $5.2 million offset by a draw on the line of credit of $3.5 million during the three months ended March 31, 2020.
Paycheck Protection Program Loan (“PPP Loan”)
We entered into the PPP Loan agreement with the Bank, which was approved and funded on April 23, 2020, pursuant to the Paycheck Protection Program under the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”). The PPP Loan matures on April 23, 2022, and bears interest at a rate of 1.0% per annum. Monthly amortized principal and interest payments are due for any portion of the loan balance that is not forgiven and are automatically deferred for ten months after the last day of our covered period through August 9, 2021.
The PPP Loan contains events of default and other provisions customary for a loan of this type, including: (1) the use of PPP Loan amount shall be limited to certain qualifying expenses, (2) 100% of the principal amount of the loan is guaranteed by the Small Business Administration (“SBA”) and (3) an amount up to the full principal amount may qualify for loan forgiveness in accordance with the terms of CARES Act. We have accumulated forgivable expenses beyond our loan amount and provided all prescribed support with our application for forgiveness with our Bank. Our Bank has reviewed our application for forgiveness and associated documentation and forwarded it on February 26, 2021 to the SBA with their determination that the loan is fully forgivable. However, we are ultimately subject to the SBA’s process and conclusion for forgiveness. To the extent the loan amount is not forgiven under the PPP, we are obligated to make equal monthly payments of principal and interest, beginning after determination of forgiveness by the SBA.
As of March 31, 2021, we classified $8.8 million of the PPP loan as current and $1.3 million as noncurrent in our consolidated balance sheets. We recorded $93 thousand of interest expense during the three months ended March 31, 2021.
We believe that the Company was eligible for the PPP Loan under the CARES Act, complied with respect to the use of proceeds stipulated under the CARES Act and satisfied all forgiveness criteria.
Credit Facilities
On December 29, 2016, we entered into a 3-year $5.0 million revolving line of credit facility (“RLOC”) with the Bank to fund general working capital needs and provide funding for acquisitions. The credit facility agreement was subject to certain financial covenants and reporting requirements. The Bank amended the agreement with us several times for acquisition lending and covenant violations.
On March 29, 2021, due to a projected violation of Q1 2021 leverage ratio, we signed the Ninth Amendment and Reaffirmation Agreement dated March 29, 2021 (the “Ninth Amendment”), with the Bank to waive the fixed charge coverage ratio and leverage ratio for the quarters ending March 31 and June 30, 2021, and we agreed, for each quarter thereafter, that the fixed charge coverage ratio would not be less than 1.10 to 1.00. In addition, we agreed to not exceed a maximum leverage ratio (starting on September 30, 2021) as follows: (i) 3.25 to 1.00 for the period ending September 30, 2021; (ii) 3.00 to 1.00 for the period ending on December 31, 2021, (iii) 2.75 to 1.00 for the period ending March 31, 2022; (iv) 2.50 to 1.00 for the period ending June 30, 2022 and (iv) 2.00 to 1.00 for the periods ending September 30, 2022 and each December 31st, March 31st, June 30th and September 30th thereafter. We are also required to maintain a minimum of $2.5 million in aggregate USA liquidity pursuant to the Ninth Amendment. As part of the amendment, we agreed, at closing, (i) to make a $0.5 million pay down of RLOC; (ii) RLOC commitment to be reduced to $4.25 million; and (iii) $0.5 million of RLOC will only be available for issuance of Letters of Credit. We also agreed to pay $0.5 million to reduce RLOC to $3.75 million by June 30, 2021 and to $3.5 million by September 30, 2021. Commencing December 31, 2021 and on the last day of each quarter, we will pay $75 thousand to reduce the RLOC. We incurred $25 thousand of amendment fees related to this amendment during the year ended December 31, 2020.
The PPP Loan does not factor into the expenses or liabilities used in the calculation of our debt covenants, unless we determine that more than $1 million of the original PPP Loan balance will not be forgiven. The Bank agreed to remove its collateral agreement with the Company’s subsidiaries as part of the repayment of our outstanding term loans during the year ended December 31, 2020.
During the three months ended March 31, 2021, we paid down $0.5 million on our RLOC as part of the Ninth Amendment as discussed above. As of March 31, 2021, we had outstanding borrowings of $2.5 million under the RLOC and three letters of credit totaling $933 thousand outstanding to certain of our customers. After consideration of letters of credit, the amount available under the RLOC was approximately $0.3 million with a $4.25 million total borrowing capacity as of March 31, 2021.
We intend to continue using the RLOC for short-term working capital needs and the issuance of letters of credit in connection with business operations provided, we remain in compliance with our covenants. As discussed in Note 10, we entered into a 9th Amendment on our credit facility, as such our covenants have been waived through June 30, 2021. Letter of credit issuance fees range between 1.25% and 2.00% of the value of the letter of credit, depending on our overall leverage ratio. We pay an unused RLOC fee quarterly based on the average daily unused balance.
Going Concern Consideration
In 2020 we had several projects (primarily in our NITC business segment) delayed and new orders postponed because of the COVID-19 pandemic. We amended our credit facility with Citizens Bank, N.A. (“the Bank”) in 2020 based upon expected covenant violations and have been required to curtail term debt in exchange for revised financial covenants. Scheduled term loan repayments and agreed upon curtailment required us to use $18.5 million in available cash to pay-off our term debt in 2020. We signed a Ninth Amendment and Reaffirmation Agreement (the “Ninth Amendment”) with the Bank on March 29, 2021 to waive the fixed charge coverage ratio and leverage ratio for the quarters ending March 31 and June 30, 2021, and to adjust the thresholds for future covenants to ease the risk of non-compliance experienced in previous quarters (See Note 10). Our working capital position on March 31, 2021 was a deficit of $7.5 million. This working capital deficit was primarily due to the $8.8 million of current maturities on our PPP loan at March 31, 2021. We expect the PPP loan will be forgiven and have not received any indications to the contrary (See Note 4). If the PPP loan is not forgiven, in part or in whole, we will work with our bank to extend repayment terms as permitted to mitigate the impact on our cashflows. However, if unforgiven and unamended, our PPP loan would be due on April 23, 2022, in part or in whole, and may stress our free cash flow and the business to a degree that may cause our covenants to fail.
The COVID-19 macroeconomic environment is considered fluid and although recovery is anticipated to steadily occur over the next 12 months, a further decline will stress our ability to meet covenant requirements. Further continuance of delays in commencing work on outstanding orders or a continued loss of orders, and further disruption of our business because of worker illness or mandated shutdowns may also exacerbate the situation. Jurisdictions where our businesses operate across the country are pushing toward re-opening places of business and government support, through the American Rescue Plan Act of 2021, will continue to support the broader economy. However, the timing of these elements taking place are not predictable and may not serve to mitigate our situation or improve our specific company's health. Following the Ninth Amendment, our new covenant compliance remains dependent on meeting future projections, which are subject to the variability and unknown speed and extent of post-COVID-19 recovery.
The Company’s management continues to explore raising capital through its access to the public markets or entering into alternative finance arrangements. Continued negative trends in operating results could be mitigated through various cost cutting measures including adjustments to headcount or compensation, vendor augmentation or delay of investment initiatives in the Company’s corporate office.
These actions, which are further supported by positively trending macroeconomic conditions, and the potential to see recovering business and orders may ease the risk of further bank covenant violations. However, when considering the unpredictability of the above, there continues to be substantial doubt the Company will continue as a going concern.
We became eligible for the Employee Retention Credit for the first quarter of 2021 and have applied for a refund of $2.4 million dollars in April 2021. We believe we are eligible to receive the employee retention credit in the second quarter of 2021, and are currently reducing our payroll taxes as permitted under the Coronavirus Aid, Relief and Economic Security Act (See Note 17).
Non-GAAP Financial Measures
Adjusted EBITDA
References to “EBITDA” mean net (loss) income, before considering interest expense (income), provision for income taxes, depreciation and amortization. References to Adjusted EBITDA excludes provision for legal settlement, loss on impairment, impact of the change in fair value of contingent consideration, restructuring charges, stock-based compensation expense, impact of the change in fair value of derivative instruments, and acquisition-related expense. EBITDA and Adjusted EBITDA are not measures of financial performance under generally accepted accounting principles (GAAP). Management believes EBITDA and Adjusted EBITDA, in addition to operating profit, net income and other GAAP measures, are useful to investors to evaluate the Company’s results because it excludes certain items that are not directly related to the Company’s core operating performance that may, or could, have a disproportionate positive or negative impact on our results for any particular period. Investors should recognize that EBITDA and Adjusted EBITDA might not be comparable to similarly-titled measures of other companies. This measure should be considered in addition to, and not as a substitute for or superior to, any measure of performance prepared in accordance with GAAP. A reconciliation of non-GAAP EBITDA and Adjusted EBITDA to the most directly comparable GAAP measure in accordance with SEC Regulation G follows:
(in thousands)
| | | Three Months ended | |
| | | March 31, 2021 | | | March 31, 2020 | |
| Net loss | | $ | (2,205 | ) | | $ | (6,258 | ) |
| Interest expense, net | | | 54 | | | | 241 | |
| Provision for income taxes | | | (35 | ) | | | (130 | ) |
| Depreciation and amortization | | | 513 | | | | 853 | |
| EBITDA | | | (1,673 | ) | | | (5,294 | ) |
| Loss on impairment | | | - | | | | 4,302 | |
| Restructuring charges | | | 808 | | | | 10 | |
| Stock-based compensation expense | | | 38 | | | | 147 | |
| Change in fair value of derivative instruments | | | - | | | | 43 | |
| Acquisition-related expense | | | - | | | | 181 | |
| Adjusted EBITDA | | $ | (827 | ) | | $ | (611 | ) |
Adjusted Net (Loss) Income and Adjusted (Loss) Earnings per Share Reconciliation
References to Adjusted Net (Loss) Income excludes the impact of provision for legal settlement, loss on impairment, impact of the change in fair value of contingent consideration, restructuring charges, stock-based compensation expense, impact of the change in fair value of derivative instruments, acquisition-related expenses and amortization of intangible assets related to acquisitions, net of income tax expense impact of adjustments. Adjusted Net (Loss) Income and Adjusted (Loss) Earnings per Share (adjusted EPS) are not measures of financial performance under generally accepted accounting principles (GAAP). Management believes adjusted net (loss) income and adjusted (loss) earnings per share, in addition to other GAAP measures, are useful to investors to evaluate the Company’s results because they exclude certain items that are not directly related to the Company’s core operating performance and non-cash items that may, or could, have a disproportionate positive or negative impact on our results for any particular period, such as stock-based compensation expense. These measures should be considered in addition to, and not as a substitute for or superior to, any measure of performance prepared in accordance with GAAP. A reconciliation of non-GAAP adjusted net (loss) income and adjusted (loss) earnings per share to GAAP net loss, the most directly comparable GAAP financial measure, is as follows:
| (in thousands) | | Three Months ended | |
| | | March 31, 2021 | | | March 31, 2020 | |
| | | | | | | |
| Net loss | | $ | (2,205 | ) | | $ | (6,258 | ) |
| Loss on impairment | | | - | | | | 4,302 | |
| Restructuring charges | | | 808 | | | | 10 | |
| Stock-based compensation expense | | | 38 | | | | 147 | |
| Change in fair value of derivative instruments | | | - | | | | 43 | |
| Acquisition-related expense | | | - | | | | 181 | |
| Amortization of intangible assets related to acquisitions | | | 340 | | | | 670 | |
| Adjusted net loss | | $ | (1,019 | ) | | $ | (905 | ) |
| Adjusted loss per common share – Diluted | | $ | (0.05 | ) | | $ | (0.04 | ) |
Weighted average shares outstanding used to compute adjusted net loss per share - basic and diluted(1) | | | 20,628,669 | | | | 20,342,933 | |
(1) During the three months ended March 31, 2021 and 2020, we reported a GAAP net loss and an adjusted net income. Accordingly there was no dilutive shares from RSUs included in the adjusted earnings per share calculation that were considered anti-dilutive when calculating the net loss per share.
| Item 3. | Quantitative and Qualitative Disclosure about Market Risk |
Not required of a smaller reporting company.
| Item 4. | Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period covered by this Quarterly Report on Form 10-Q. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their control objectives. Based on the evaluation of our disclosure controls and procedures as of the end of the period covered by this quarterly report and our annual report, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were not effective; we are currently in remediation of our internal controls to address material weaknesses identified in our Form 10-K for the year ended December 31, 2020.
Through Management’s evaluation of controls as of December 31, 2020, it was determined that a material weakness existed and related to management’s review of reconciliations over unbilled receivables and billings in excess of revenue earned. Our remediation of this material weakness was initiated by hiring additional skilled personnel to prepare and review reconciliations over unbilled receivables and billings in excess of revenue earned.
Changes in Internal Control over Financial Reporting
There were no changes in our internal controls over financial reporting that occurred during the most recent fiscal quarter that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.
Limitation of Effectiveness of Controls
Internal control over financial reporting has inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements will not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.
PART II – OTHER INFORMATION
The Company and its subsidiaries are from time to time involved in ordinary routine litigation incidental to the conduct of its business. The Company and its subsidiaries are not a party to, and its property is not the subject of, any material pending legal proceedings that, in the opinion of management, are likely to have a material adverse effect on the Company’s business, financial condition or results of operations.
On March 29, 2019, a former employee of Absolute Consulting, Inc., filed a putative class action against Absolute and the Company, Joyce v. Absolute Consulting Inc., case number 1:19 cv 00868 RDB, in the United States District Court for the District of Maryland. The lawsuit alleges that plaintiff was not properly compensated for overtime hours that he worked. In addition, he alleges that there is a class of employees who were not properly compensated for overtime hours worked. Following a mediation session on July 14, 2020, the parties entered into a Settlement Agreement and Release on August 17, 2020, providing that the case would be settled and dismissed in exchange for Absolute’s payment of a gross settlement amount not to exceed $1.5 million. The court approved the settlement and dismissed the case with prejudice on September 8, 2020. After the passing of an opt-in notice period expired, the final cost of settling this case, including plaintiff’s attorney fees was approximately $1.4 million. As of March 31, 2021, approximately $15 thousand of the outstanding liability remains to be paid and we are expecting this to occur as payment information is confirmed with the plaintiff’s attorneys over the next few quarters.
The Company is involved in litigation in the ordinary course of business. While it is too early to determine the outcome of such matters, management does not expect the resolution of these matters to have a material impact on the Company’s financial position or results of operations.
The following additional risk factors should be read in conjunction with the risk factors set forth under “Item 1A. Risk Factors” in our 2020 Form 10-K. Except as described herein, there have been no material changes with respect to the risk factors disclosed in our 2020 Form 10-K.
A novel strain of coronavirus, the COVID-19 virus has adversely affected our business operations and financial condition.
In December 2019, an outbreak of the COVID-19 virus was reported in Wuhan, China. On March 11, 2020, the World Health Organization declared the COVID-19 virus a global pandemic and on March 13, 2020, President Donald J. Trump declared the virus a national emergency in the United States. This highly contagious disease spread to most of the countries in the world and throughout the United States, during the first half of fiscal 2020, creating a serious impact on customers, workforces and suppliers, disrupting economies and financial markets and potentially leading to a world-wide economic downturn.
It has caused a disruption of the normal operations of many businesses, including the temporary closure or scale-back of business operations and/or the imposition of either quarantine or remote work or meeting requirements for employees, either by government order or on a voluntary basis. The pandemic may adversely affect our customers’ operations, our employees and our employee productivity. It may also impact the ability of our subcontractors, partners and suppliers to operate and fulfill their contractual obligations and result in an increase in costs, delays or disruptions in performance. These supply chain effects, and the direct effect of the virus and the disruption on our employees and operations, may negatively impact both our ability to meet customer demand and our revenue and profit margins.
Our employees, in many cases, are working remotely and using various technologies to perform their functions. We have experienced delays or changes in customer demand, particularly due to customer funding priorities and the necessity to socially distance. Further, in reaction to the spread of COVID-19 in the United States, many businesses have instituted social distancing policies, including the closure of offices and worksites and deferring planned business activity. Our Performance segment, as they are classified essential, for the most part continue without pause. With regard to our NITC business segment, because of the embedded presence of our on-site workforce, if COVID-19 or a similar outbreak of infectious disease were to prevent our workers from being deployed to the applicable customer site, it may disrupt our NITC service offerings, interrupt performance on our Nuclear Industry Training and Consulting (workforce solutions) contracts with clients and negatively impact our business, financial condition and results of operations.
Additionally, the disruption and volatility in the global and domestic capital markets may increase the cost of capital and limit our ability to access capital. Both the health and economic aspects of the COVID-19 virus are highly fluid and the future course of each is uncertain. For these reasons and other reasons that may come to light if the coronavirus pandemic and associated protective or preventative measures expand, we may experience a material adverse effect on our business operations, revenues and financial condition; however, its ultimate impact is highly uncertain and subject to change.
If we cannot comply with the financial or other restrictive covenants in our credit agreement, or obtain waivers or other relief from our lender, we may cause an event of default to occur, which could result in loss of our sources of liquidity and acceleration of our debt.
To fund our recent acquisitions, we borrowed under a delayed-draw term loan facility. Our ability to generate sufficient cash flow from operations to make scheduled payments on our term loan will depend on a range of economic, competitive and business factors, some of which are outside our control. If we are unable to meet our debt service obligations, we may need to refinance or restructure all or a portion of our debt on or before its stated maturity date, sell assets, pay down our outstanding debt and/or raise equity. We may not be able to refinance or restructure any of our debt, sell assets or raise equity, in each case on commercially reasonable terms or at all, which could cause us to default on our obligations and impair our liquidity. Our inability to generate sufficient cash flow to satisfy our debt obligations or to refinance or restructure our obligations on commercially reasonable terms could have a material adverse effect on our business, financial condition, results of operations and cash flows. Our credit agreement also contains financial and other restrictive covenants. Our ability to comply with the covenants in our credit agreement will depend upon our future performance and various other factors, some of which are beyond our control. We may not be able to maintain compliance with all of our debt covenants. In that event, we would need to seek an amendment to our credit agreement, a waiver from our lender, utilize cash to pay down outstanding debt and/or refinance or restructure our debt. There can be no assurance that we could obtain future amendments or waivers of our credit agreement, or refinance or restructure our debt, in each case on commercially reasonably terms or at all. Our failure to maintain compliance with the covenants under our credit agreement could result in an event of default, subject to applicable notice and cure provisions. Upon the occurrence of an event of default under our credit agreement, our lender could elect to declare all amounts outstanding thereunder to be immediately due and payable, terminate all commitments to extend further credit and cease making further loans. If we were unable to repay all outstanding amounts in full, our lender could exercise various remedies including instituting foreclosure proceedings against our assets pledged to them as collateral to secure that debt.
We have incurred indebtedness under the CARES Act, which will be subject to review, may not be forgiven in whole or in part and may eventually have to be repaid.
We received funds under the Paycheck Protection Program on April 24, 2020, in the amount of $10 million, serviced by Citizens Bank. The application for these funds requires us to, in good faith, certify that the current economic uncertainty made the loan request necessary to support our ongoing operations. This certification further requires the Company to take into account our current business activity and our ability to access other sources of liquidity sufficient to support ongoing operations in a manner that is not significantly detrimental to the business. The receipt of these funds, and the forgiveness of the loan attendant to these funds, is dependent on the Company having initially qualified for the loan and qualifying for the forgiveness of such loan based on our future adherence to the forgiveness criteria.
We used the proceeds from the PPP for eligible payroll costs (as defined in the CARES Act), covered rent, covered utility payments and certain other expenditures that, while permitted, would not result in forgiveness of a corresponding portion of the loan. Following recent amendments to the PPP, after an eight- or twenty-four-week period starting with the disbursement of the loan proceeds, the Company may apply for forgiveness of some or all of the loan, with the amount which may be forgiven equal to the sum of eligible payroll costs, mortgage interest (not applicable to the Company), covered rent and covered utility payments, in each case incurred by the Company during the eight- or twenty-four-week period following the date of first disbursement. Certain reductions in the Company’s payroll costs or full-time equivalent employees (when compared against the applicable measurement period) may reduce the amount of the Loan eligible for forgiveness.
The U.S. Department of the Treasury (the “Treasury”) and the U.S. Small Business Administration (“SBA”) have announced that they will review all PPP Loans equal to or greater than $2 million. The PPP has been amended twice with the latest amendment significantly altering the timeline associated with the PPP spending and loan forgiveness. While the Company believes that it acted in good faith and has complied with all requirements to obtain forgiveness of the PPP Loan, if the SBA determines that the Company’s loan application was not made in good faith or that we did not otherwise meet the eligibility requirements of the PPP, we may not receive forgiveness of the loan (in whole or in part), and we could be required to return the loan or a portion thereof. Further, there is no guarantee that we will receive forgiveness for any portion of the loan and forgiveness will be subject to review by our Bank based upon information and documentation that we submit, as required by SBA and the lender.
A failure to obtain forgiveness of the PPP Loan will adversely impact our loan covenants under our senior credit facility. Per the Eighth Amendment (See Note 10), if we determine that $1 million or more of the original $10 million of the PPP Loan will not be forgiven by our Bank, this amount will be used in the calculation of our debt covenants. In the event of a violation of our debt covenants, we may need to seek an amendment to our credit agreement, a waiver from our lender, utilize cash to repay the PPP Loan and/or refinance or restructure our outstanding debt. There can be no assurance that we could obtain future amendments or waivers of our credit agreement, or refinance or restructure our debt, in each case on commercially reasonably terms or at all.
Our failure to maintain compliance with the covenants under our credit agreement could result in an event of default, subject to applicable notice and cure provisions. Upon the occurrence of an event of default under our credit agreement, our lender could elect to declare all amounts outstanding thereunder to be immediately due and payable, terminate all commitments to extend further credit and cease making further loans. If we were unable to repay all outstanding amounts in full, our lender could exercise various remedies including instituting foreclosure proceedings against our assets pledged to them as collateral to secure that debt.
Substantial doubt has been raised in our ability to continue as going concern as a result of the economic slowdown caused the global COVID 19 pandemic and continued deterioration of business could have an adverse effect.
The global COVID-19 pandemic has continued to have a negative impact on our financial position and results of operations during the quarter ended March 31, 2021. We have experienced cancelled and delayed orders, canceled or paused projects, disruption of our business as a result of worker illness or mandated shutdowns and thus challenges to our ability to maintain compliance with loan covenants. The deterioration of our business due to the COVID-19 pandemic made us miss our minimum Adjusted EBITDA covenants, during the second quarter of fiscal 2020. As such, we agreed to repay $10 million to the Bank during the third quarter of fiscal 2020 and are now subject to minimum liquidity testing and other debt covenants (see Note 10).
As the pandemic continues to distort our projections, we cannot rely on forecasted future earnings and could continue to see further deterioration in business causing non-compliance. Management believes the entity will be able to continue to develop new opportunities and will be able to obtain additional debt amendments; however, there is no assurance. We have cash from the PPP loan and from ongoing operations to meet our operating requirements for at least the next twelve months.
If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results, and current and potential stockholders may lose confidence in our financial reporting.
We are required by the SEC to establish and maintain adequate internal control over financial reporting that provides reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements in accordance with U.S. generally accepted accounting principles. We are likewise required, on a quarterly basis, to evaluate the effectiveness of our internal controls and to disclose any changes and material weaknesses in those internal controls.
Based on management's assessment, management has concluded that the Company's internal control over financial reporting was not effective as of March 31, 2021 or at December 31, 2020 due to the existence of a material weaknesses in internal control over management's review of reconciliations over unbilled receivables and billings in excess of revenue earned. Our remediation of these control weakness was actioned by hiring additional skilled personnel to prepare and review reconciliations over unbilled receivables and billings in excess of revenue earned.
Although we believe that these efforts have strengthened our internal control over financial reporting and address the concern that gave rise to the material weakness as of December 31, 2020, we cannot be certain that our expanded knowledge and revised internal control procedures will ensure that we maintain adequate internal control over our financial reporting in future periods. Any failure to maintain such internal controls could adversely impact our ability to report our financial results on a timely and accurate basis. If our financial statements are not accurate, investors may not have a complete understanding of our operations. Likewise, if our financial statements are not filed on a timely basis as required by the SEC and The NASDAQ Capital Market (Nasdaq), we could confront an enforcement action from the SEC and/or delisting from Nasdaq. In either case, such an event could have a material adverse effect on our business. Finally, inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our common stock.
A disruption, failure or breach of our networks or systems, including cyber-attacks, could harm our business.
Global cyber security threats can range from uncoordinated individual attempts to gain unauthorized access to our information technology (IT) systems to sophisticated and targeted measures known as advanced persistent threats. While we employ comprehensive measures to prevent, detect, address and mitigate these threats (including access controls, data encryption, vulnerability assessments, continuous monitoring of our IT networks and systems, and maintenance of backup and protective systems), cyber security incidents, depending on their nature and scope, could potentially result in the misappropriation, destruction, corruption or unavailability of critical data and confidential or proprietary information (our own or that of third parties) and the disruption of business operations. The potential consequences of a material cyber security incident include reputational damage, litigation with third parties, civil or regulatory liability for loss of sensitive or protected information such as personal data, incident response costs, diminution in the value of our investment in research, development and engineering, loss of intellectual property, and increased cyber security protection and remediation costs, which in turn could adversely affect our competitiveness and results of operations.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
None
| Item 3. | Defaults Upon Senior Securities |
None
| Item 4. | Mine Safety Disclosures |
Not applicable.
None.
| | | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes- Oxley Act of 2002, filed herewith. |
| | | |
| | | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith. |
| | | |
| | | Certification of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith. |
| | | |
| | | Eighth Amendment |
| | | |
| | 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 |
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| Date: May 17, 2021 | |
| | |
| | GSE SYSTEMS, INC. |
| | |
| | /S/ KYLE J. LOUDERMILK |
| | Kyle J. Loudermilk |
| | Chief Executive Officer |
| | (Principal Executive Officer) |
| | |
| | /S/ EMMETT A. PEPE |
| | Emmett A. Pepe |
| | Chief Financial Officer |
| | (Principal Financial and Accounting Officer) |
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