| 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 COVID-19 pandemic unfolded, the end markets that GSE serves, namely the power industries, delayed certain 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. In 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. In the end of 2020 and through the end of the third quarter of 2021, we have had a number of significant contract wins that have been publicly announced, which we hope will be a harbinger of a more solid 2021 business environment.
As a result of the COVID-19 pandemic, we have sought and obtained support through various business assistance programs. On April 23, 2020, we received $10 million in funds under the Paycheck Protection Program (PPP), a part of the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”). The loan was serviced by Citizens Bank, N.A. (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, was dependent on our ability to adhere to the forgiveness criteria. The PPP Loan bore interest at a rate of 1% per annum and matures on April 23, 2022, with the first payment deferred until September 2021. Under the terms of the PPP Loan, certain amounts would be forgiven if they were used in accordance with the CARES Act. On August 5, 2021, the Company was notified that the Small Business Administration ("SBA") had forgiven the PPP loan including all accrued interest thereon was forgiven.
During the second quarter of 2021, we performed analysis to determine our first quarter 2021 eligibility for the Employee Retention Credit available under the CARES Act . We amended certain payroll tax filings and applied for a refund of $2.4 million dollars in April 2021. For the second quarter of 2021, we have applied for a refund of $1.8 million dollars from the IRS with the timely filing of Form 941 and have already recognized a benefit of $0.9 million dollars in value from unremitted payroll taxes as allowable. For the third quarter of 2021, we have applied for a refund of $1.0 million from the IRS with the timely filing of Form 941 and have recognized a benefit of $1.4 million in value from unremitted payroll taxes as allowable.
GSE entered into a contract with a subcontractor to purchase large equipment from Siemens to build a simulator for project SLE-005 in December 2018. The total contract price was about $2.7 million and included VAT taxes of approximately $450 thousand. GSE paid the VAT taxes and had pursued the collection of this VAT refund for a couple of years. In May 2021, we were informed that this VAT refund was no longer collectable. As a result, we wrote off this VAT receivable.
On September 9, 2021, President Biden released his COVID-19 Action Plan, Path Out of the Pandemic (the “Plan”), with the stated goal of getting more people vaccinated. As part of the Plan, Executive Order 14042, Ensuring Adequate COVID Safety Protocols for Federal Contractors (the “Order”), creates the Safer Federal Workforce Task Force (the “Task Force”), which released guidance for U.S. Government contractors and their subcontractors. This guidance included mandatory vaccination of all employees working on or for a government contract, either directly or indirectly, by January 4, 2022 (subject to medical and religious exemptions). We have been put on notice by both government customers and prime contractors serving government customers of the COVID-19 vaccination requirement. President Biden also directed, on September 9, 2021, the Department of Labor's Occupational Safety and Health Administration (“OSHA”) to issue an Emergency Temporary Standard (“ETS”) requiring that all employers with at least 100 employees ensure that their U.S.-based employees are fully vaccinated for COVID-19 or obtain a negative COVID-19 test at least once a week. On November 4, 2021, OSHA issued an ETS requiring that all employers with 100 or more employees ensure that their employees are fully vaccinated against COVID-19 by January 4, 2022, or tested weekly. Further, by December 5, 2021, employers must comply with all other OSHA ETS vaccine requirements, including providing paid time off for employees to get vaccinated and ensuring that unvaccinated workers wear face coverings in the workplace. For our sites and employees that are not already affected by the Order, as a company with more than 100 employees, we would be required to mandate COVID-19 vaccination of our workforce or require our unvaccinated employees to be tested on a weekly basis. On November 4, 2021, the 5th U.S. Circuit Court of Appeals granted an emergency stay of the OSHA ETS vaccine requirement. It is not currently possible to predict with any certainty the outcome of the legal challenges of the OSHA ETS or Order, the exact impact on the Company of the OSHA ETS or Order, or the requirements for U.S. Government contractors and their subcontractors.
General Business Environment
We operate through two reportable business segments: Performance Improvement Solutions and Workforce Solutions. The Workforce Solutions 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 52% of revenue at September 30, 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.
Workforce Solutions (approximately 48% of revenue at September 30, 2021)
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; creating 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; developing new services as a result of combining the expertise of the Company; and expanding 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 executing an acquisition strategy to rollup providers of essential services to the industry. To ensure efficient and streamlined operations for the business, the Company has consolidated all of the engineering services together into one organization with one leader; and the Workforce Solutions 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 creating 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, leveraging 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, provides 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 is 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 September 30, 2021, we had approximately 330 employees, which includes approximately 197 employees in our Performance segment and approximately 133 employees in our Workforce Solutions segment.
Backlog
As of September 30, 2021, we had approximately $37.5 million of total gross revenue backlog, which included $31.5 million of Performance backlog and $6.0 million of Workforce Solutions 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 U.S. 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 is 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. 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
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 Workforce Solutions organization with our Engineering and Performance group. Workforce Solutions 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 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 | | | Nine Months Ended | |
| (in thousands) | | September 30, 2021 | | | September 30, 2020 | | | September 30, 2021 | | | September 30, 2020 | |
| | | $ | | |
| % | | | $ | | |
| % | | | $ | | |
| % | | | $
| | |
| % | |
| Revenue | | $ | 14,686 | | | | 100.0 | % | | $ | 12,922 | | | | 100.0 | % | | $ | 41,312 | | | | 100.0 | % | | $ | 44,967 | | | | 100.0 | % |
| Cost of revenue | | | 11,503 | | | | 78.3 | % | | | 9,603 | | | | 74.3 | % | | | 32,512 | | | | 78.7 | % | | | 33,971 | | | | 75.5 | % |
| Gross profit | | | 3,183 | | | | 21.7 | % | | | 3,319 | | | | 25.7 | % | | | 8,800 | | | | 21.3 | % | | | 10,996 | | | | 24.5 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Operating expenses: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Selling, general and administrative | | | 3,265 | | | | 22.2 | % | | | 2,878 | | | | 22.3 | % | | | 10,521 | | | | 25.5 | % | | | 12,548 | | | | 27.9 | % |
| Research and development | | | 149 | | | | 1.0 | % | | | 137 | | | | 1.1 | % | | | 460 | | | | 1.1 | % | | | 526 | | | | 1.2 | % |
| Restructuring charges | | | (10 | ) | | | (0.1 | )% | | | 185 | | | | 1.4 | % | | | 798 | | | | 1.9 | % | | | 195 | | | | 0.4 | % |
| Loss on impairment | | | 3 | | | | 0.0 | % | | | - | | | | 0.0 | % | | | 3 | | | | 0.0 | % | | | 4,302 | | | | 9.6 | % |
| Depreciation | | | 69 | | | | 0.5 | % | | | 76 | | | | 0.6 | % | | | 216 | | | | 0.5 | % | | | 254 | | | | 0.6 | % |
| Amortization of intangible assets | | | 286 | | | | 1.9 | % | | | 414 | | | | 3.2 | % | | | 929 | | | | 2.2 | % | | | 1,528 | | | | 3.4 | % |
| Total operating expenses | | | 3,762 | | | | 25.6 | % | | | 3,690 | | | | 28.6 | % | | | 12,927 | | | | 31.3 | % | | | 19,353 | | | | 43.0 | % |
| Operating loss | | | (579 | ) | | | (3.9 | )% | | | (371 | ) | | | (2.9 | )% | | | (4,127 | ) | | | (10.1 | )% | | | (8,357 | ) | | | (18.7 | )% |
| Interest expense, net | | | (32 | ) | | | (0.2 | )% | | | (128 | ) | | | (1.0 | )% | | | (135 | ) | | | (0.3 | )% | | | (556 | ) | | | (1.2 | )% |
| Gain on derivative instruments, net | | | - | | | | 0.0 | % | | | 31 | | | | 0.2 | % | | | - | | | | 0.0 | % | | | 35 | | | | 0.1 | % |
| Other income, net | | | 12,215 | | | | 83.2 | % | | | (77 | ) | | | (0.6 | )% | | | 16,853 | | | | 40.8 | % | | | (24 | ) | | | (0.1 | )% |
| Income (loss) before income taxes | | | 11,604 | | | | 79.0 | % | | | (545 | ) | | | (4.2 | )% | | | 12,591 | | | | 30.5 | % | | | (8,902 | ) | | | (19.8 | )% |
| Provision for income taxes | | | 166 | | | | 1.1 | % | | | 116 | | | | 0.9 | % | | | 127 | | | | 0.3 | % | | | 166 | | | | 0.4 | % |
| Net income (loss) | | | 11,438 | | | | 77.9 | % | | | (661 | ) | | | (5.1 | )% | | $ | 12,464 | | | | 30.2 | % | | $ | (9,068 | ) | | | (20.2 | )% |
Revenue
Revenue for the three months ended September 30, 2021 totaled $14.7 million, which was 14% more than the $12.9 million of revenue for the three months ended September 30, 2020. Revenue for the nine months ended September 30, 2021 totaled $41.3 million, which was 8% less than the $45.0 million of revenue for the nine months ended September 30, 2020.
| | | Three Months Ended | | | Nine Months Ended | |
| (in thousands) | | September 30, 2021 | | | September 30, 2020 | | | Change | | | September 30, 2021 | | | September 30, 2020 | | | Change | |
| Revenue: | | | | | | | | $ | | |
| % | | | | | | | | | $ | | |
| % | |
| Performance | | $ | 7,375 | | | $ | 7,257 | | | | 118 | | | | 2 | % | | $ | 21,318 | | | $ | 25,240 | | | | (3,922 | ) | | | (16 | )% |
| Workforce Solutions | | | 7,311 | | | | 5,665 | | | | 1,646 | | | | 29 | % | | | 19,994 | | | | 19,727 | | | | 267 | | | | 1 | % |
| Total revenue | | $ | 14,686 | | | $ | 12,922 | | | | 1,764 | | | | 14 | % | | $ | 41,312 | | | $ | 44,967 | | | | (3,655 | ) | | | (8 | )% |
Performance Improvement Solutions revenue increased by 2% from $7.3 million to $7.4 million for the three months ended September 30, 2021 and 2020, respectively. The increase in revenue was primarily attributable to improvements in specialized engineering and consulting services offset by lower revenue on the SDB part of the business. We recorded total Performance Improvement Solutions orders of $11.2 million and $9.3 million for the three months ended September 30, 2021 and 2020, respectively.
Performance Improvement Solutions revenue decreased by 16% from $25.2 million to $21.3 million for the nine months ended September 30, 2021 and 2020, respectively. The decrease of revenue was primarily due to several significant SDB projects ended in the prior fiscal year which were not replaced by new orders. We recorded total Performance Improvement Solutions orders of $22.6 million and $21.8 million for the nine months ended September 30, 2021 and 2020, respectively.
For the three months ended September 30, 2021, Workforce Solutions revenue increased by 29% to $7.3 million compared to revenue of $5.7 million for the three months ended September 30, 2021. The increase was primarily due to existing ongoing projects started in Q1 of 2021. We recorded total new orders of $3.5 million and $1.6 million for the three months ended September 30, 2021 and 2020, respectively.
For the nine months ended September 30, 2021, Workforce Solutions revenue increased by 1% to $20.0 million compared to revenue of $19.7 million for the nine months ended September 30, 2020. The increase in revenue was primarily due to existing ongoing projects started in Q1 of 2021, offset by ending of some large projects resulting in a reduction in demand for staffing from our major customers. We recorded total new orders of $15.9 million and $15.6 million for the nine months ended September 30, 2021 and 2020, respectively.
As of September 30, 2021, our backlog was $37.5 million, of which, $31.5 million was attributed to the Performance segment and $6.0 million was attributed to the 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 Workforce Solutions.
Gross Profit
Gross profit was $3.2 million or 21.7% of revenue and $3.3 million or 25.7% of revenue for the three months ended September 30, 2021 and 2020 , respectively. Gross profit was $8.8 million or 21.3% of revenue and $11.0 million or 24.5% of revenue for the nine months ended September 30, 2021 and 2020, respectively.
| (in thousands) | | Three Months Ended | | Nine Months Ended | |
| | | September 30, 2021 | | September 30, 2020 | | September 30, 2021 | | September 30, 2020 | |
| | | $ | | |
| % | | $ | | |
| % | | $ | | |
| % | | $ | | |
| % | |
| Gross profit: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Performance Improvement Solutions | | $ | 2,252 | | | | 30.5 | % | | $ | 2,482 | | | | 34.2 | % | | $ | 6,204 | | | | 29.1 | % | | $ | 8,240 | | | | 32.6 | % |
| Workforce Solutions | | | 931 | | | | 12.7 | % | | | 837 | | | | 14.8 | % | | | 2,596 | | | | 13.0 | % | | | 2,756 | | | | 14.0 | % |
| Total gross profit | | $ | 3,183 | | | | 21.7 | % | | $ | 3,319 | | | | 25.7 | % | | $ | 8,800 | | | | 21.3 | % | | $ | 10,996 | | | | 24.5 | % |
The Performance Improvement Solutions segment’s gross profit decreased by $235 thousand during three months ended September 30, 2021 over three months ended September 30, 2020. The Performance Improvement Solutions segment’s gross profit decreased by $2.0 million during nine months ended September 30, 2021 over nine months ended September 30, 2020. The decrease is primarily related to lower revenue due to several significant SDB projects ended in the prior fiscal year which were not replaced by new orders.
The Workforce Solutions segment’s gross profit increased by $99 thousand during three months ended September 30, 2021 over three months ended September 30, 2020. The increase was primarily due to a new customer added in Q1 of 2021. The Workforce Solutions segment’s gross profit decreased by $160 thousand during nine months ended September 30, 2021 over nine months ended September 30, 2020. The decrease in gross profit was primarily driven by the loss of a major project due to the COVID-19 pandemic offset by a new customer added in Q1 of 2021.
Selling, general and administrative expenses (“SG&A”)
Selling, general and administrative (SG&A) expenses totaled $3.3 million and $2.9 million for the three months ended September 30, 2021 and 2020, respectively. Selling, general and administrative (SG&A) expenses totaled $10.5 million and $12.5 million for the nine months ended September 30, 2021 and 2020, respectively. Fluctuations in the components of SG&A spending were as follows.
| | | Three months ended | | | Nine Months ended | |
| (in thousands) | | September 30, 2021 | | | September 30, 2020 | | | September 30, 2021 | | | September 30, 2020 | |
| | | | | | | | | | | | | |
| Corporate charges | | $ | 2,364 | | | $ | 2,565 | | | $ | 7,754 | | | $ | 9,036 | |
| Business development | | | 714 | | | | 1,013 | | | | 2,230 | | | | 2,759 | |
| Facility operation & maintenance (O&M) | | | 186 | | | | 241 | | | | 654 | | | | 732 | |
| Provision for loss on legal settlement | | | - | | | | (952 | ) | | | - | | | | (91 | ) |
| Bad debt (recovery) expense | | | - | | | | 10 | | | | (133 | ) | | | 103 | |
| Other | | | 1 | | | | 1 | | | | 16 | | | | 9 | |
| Total | | $ | 3,265 | | | $ | 2,878 | | | $ | 10,521 | | | $ | 12,548 | |
Corporate charges
During the three months ended September 30, 2021, corporate charges decreased by $0.2 million over the same period of the prior year. During the nine months ended September 30, 2021 corporate charges decreased by $1.3 million over the same period of the prior year. The decrease was primarily due to a reduction of external legal, audit, and worker’s fees of $0.8 million. Additionally, the Company saw a reduction in realized foreign exchange rate loss of $0.3 million during the nine months ended September 30, 2021.
Business development expenses
Business development expense decreased $0.3 million during the three months ended September 30, 2021 over the same period of the prior fiscal year. Business development expense decreased $0.5 million during the nine months ended September 30, 2021 over the same period of the prior fiscal year. The decrease was primarily due to lower commission costs and reduced headcount during the nine months ended September 30, 2021.
Facility operation & maintenance (“O&M”)
Facility O&M expenses decreased $55 thousand for three months ended September 30, 2021, compared to the same period in 2020. The decrease was mainly due to a utility fee during the three months ended September 30, 2021. Facility O&M expenses decreased $78 thousand for nine months ended September 30, 2021, 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.
Provision for loss on legal settlement
During the three months ended September 30, 2020, we received $1.0 million in cash, pursuant to a settlement agreement related to the purchase agreement of Absolute in fiscal 2017. The $1.0 million of cash proceeds was recorded as an offset against the $0.9 million provision for loss on legal settlement with a class of former employees of Absolute, recorded in the second quarter of fiscal 2020. For the nine months ended September 30, 2020, we had recorded a provision for loss on legal settlement, net as a reduction to corporate charges of $91 thousand. There were no similar transactions during the same period of 2021
Bad debt (recovery) expense
We recorded $(133) thousand and $103 thousand of bad debt (recovery) expense during the nine months ended September 30, 2021 and 2020, respectively. The bad debt recovery as of September 30, 2021 was driven by payment received for previously recorded bad debt.
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 $149 thousand and $137 thousand for the three months ended September 30, 2021 and 2020, respectively. Research and development costs totaled $460 thousand and $526 thousand for the nine months ended September 30, 2021 and 2020, respectively. The decrease was mainly due to lower headcount.
Restructuring
We recorded restructuring charges of $(10) thousand and $185 thousand during three months ended September 30, 2021 and 2020. During the nine months ended September 30, 2021 and 2020, we recorded restructuring charges of $798 thousand and $195 thousand, respectively. The increase was mainly due to final charges related to the liquidation of our Sweden operations during the period, pursuant to our foreign restructuring plan.
Loss on impairment of goodwill and definite-lived intangible assets
We recognized a $3 thousand ROU asset impairment during the three and nine months ended September 30, 2021. We recognized a $4.3 million intangible asset impairment during the nine months ended September 30, 2020.
Depreciation
We recorded depreciation expense of $69 thousand and $76 thousand for the three months ended September 30, 2021 and 2020, respectively. Depreciation expense was $216 thousand and $254 thousand for the nine months ended September 30, 2021 and 2020, respectively. The reduction of $38 thousand for the nine months ended September 30, 2021 over the same period in 2020 was due primarily to assets becoming fully depreciated in 2021.
Amortization of intangible assets
Amortization expense related to definite-lived intangible assets totaled $0.3 million and $0.4 million for the three months ended September 30, 2021 and 2020 and $0.9 million and $1.5 million for the nine months ended September 30, 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 $32 thousand and $128 thousand for the three months ended September 30, 2021 and 2020, respectively. Interest expense totaled $135 thousand and $556 thousand for the nine months ended September 30, 2021 and 2020, respectively. The decrease for the three and nine month periods was due to a reduction in total indebtedness compared to nine months ended September 30, 2020.
Other income, net
For the three months ended September 30, 2021 and 2020, we recognized other income, net of $12.2 million and $(77) thousand, respectively. For the nine months ended September 30, 2021 and 2020, we recognized other income, net of $16.9 million and $(24) thousand, respectively. The increase was primarily due to the recording of $10.1 million PPP loan forgiveness by SBA and $7.2 million Employee Retention Credit during the period offset by VAT write-off of $0.5 million, We paid VAT taxes for subcontractor equipment purchase and had pursued the collection of this VAT refund for a couple of years. In May of 2021, we were informed by our tax advisor that this VAT refund was no longer collectable.
Income taxes expense
Income tax expense 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 expense of $166 thousand and $116 thousand for the three months ended September 30, 2021 and 2020, respectively, were comprised mainly of foreign and state tax expense. Total income tax expense of $127 thousand and tax expense of $166 thousand for the nine months ended September 30, 2021 and 2020, respectively, were comprised mainly of foreign and state tax expense.
Our income effective tax rate was 1.4% and 1.0% for the three and nine months ended September 30, 2021, respectively. For the three and nine months ended September 30, 2021, the difference between our income tax expense at an effective tax rate of 1.4% and 1.0% respectively, and 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.
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 September 30, 2021, our cash and cash equivalents totaled $4.0 million, compared to $6.7 million as of December 31, 2020.
For the nine months ended September 30, 2021 and 2020, net cash used in operating activities was $0.3 million and net cash provided by operating activities was $1.6 million, respectively. The decrease of $1.9 million in cash flows used in operating activities was primarily driven by increased collections due to large milestone payments of large projects in the prior year.
Net cash used in investing activities totaled $0.6 million and $0.2 million for the nine months ended September 30, 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 nine months ended September 30, 2021.
For the nine months ended September 30, 2021 and 2020, net cash used in financing activities was $1.7 million and $5.3 million, respectively. The decrease in cash used in financing activities of $3.6 million was driven by a $1.7 million repayment of line of credit during the nine months ended September 30, 2021 compared to.a repayment on term loans of $15.5 million offset by proceeds of the PPP Loan of $10 million during the nine months ended September 30, 2020.
Paycheck Protection Program Loan (“PPP Loan”)
On April 23, 2020, we received $10 million in funds under the Paycheck Protection Program (PPP), a part of the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”). The loan was serviced by Citizens Bank, N.A. (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, was dependent on our ability to adhere to the forgiveness criteria. The PPP Loan bore interest at a rate of 1% per annum and matures on April 23, 2022, with the first payment deferred until September 2021. Under the terms of the PPP Loan, certain amounts would be forgiven if they were used in accordance with the CARES Act. On August 5, 2021, the Company was notified that the Small Business Administration ("SBA") had forgiven the PPP loan including all accrued interest thereon was forgiven.
Credit Facilities
On December 29, 2016, we entered a 3-year $5.0 million revolving line of credit facility (“RLOC”) with the Citizens Bank, N.A. (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 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 on May 11, 2023 and accrue interest at the USD LIBOR, plus a margin that varies depending on our overall leverage ratio. We subsequently amended and ratified the Credit Agreement a number of times. Due to a projected violation of the leverage ratio at the end of the first quarter, we signed the Ninth Amendment and Reaffirmation Agreement with an effective date of March 29, 2021. Pursuant to the Ninth Amendment and Reaffirmation Agreement, the Bank waived 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 shall 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 (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 were 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.
Following the Ninth Amendment and Reaffirmation Agreement, we experienced continued delays in commencing new projects and thus our ability to recognize revenue has been delayed for some contracts. Reductions in orders and other negative changes to orders experienced at the beginning of the pandemic have started to reverse in 2021, but not at the level expected as ongoing COVID concerns continue to hinder the pace of recovery. This deterioration in the recovery plan has resulted in our breaching the Minimum Liquidity ratio subsequent to both June 30, 2021 and September 30, 2021 as well as a projected breach of the Leverage and Fixed Charges ratio covenants.
We have experienced delays in commencing new projects and thus our ability to recognize revenue has been delayed for some contracts. Reductions in orders and other negative changes to orders experienced at the beginning of the pandemic have started to reverse in 2021, but not at the level expected as ongoing COVID concerns continue to hinder the pace of recovery. This deterioration in the recovery plan has resulted in breaching the Minimum Liquidity ratio subsequent to both June 30, 2021 and at September 30, 2021 as well as projected breaching of the Leverage and Fixed Charges ratio covenant. On November 12, 2021, due to these covenant violations, we signed the Tenth Amendment and Reaffirmation Agreement with an effective date of November 12, 2021 to adjust the thresholds for future covenants to ease the risk of non-compliance (See Note 17).
During the nine months ended September 30, 2021, we paid down $1.7 million and had a draw of $0.8 million on our RLOC. As of September 30, 2021, we had outstanding borrowings of $2.1 million under the RLOC and four letters of credit totaling $1.1 million outstanding to certain of our customers. The total borrowing capacity under RLOC was $3.5 million as of September 30, 2021. After consideration of letters of credit and the $0.5 million reserved for issuance of new letters of credit, there was no amount available for borrowing under the RLOC.
We intend to continue using the RLOC for short-term working capital needs when capacity is available and the issuance of letters of credit in connection with business operations provided, we remain in compliance with our covenants. 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 Workforce Solutions 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 September 30, 2021 was $6.7 million. This working capital was primarily due to the $10.1 million of PPP loan forgiveness at September 30, 2021. On August 5, 2021, the Company received approval from SBA that the PPP loan including all accrued interest thereon was forgiven.
The COVID-19 macroeconomic environment is considered fluid and although recovery is anticipated to steadily occur over the next 12 months, issues that could result for the delta virus could cause a further decline in revenue or stress our ability to meet covenant requirements. 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. We have recorded $5.0 million employee retention tax credits to be refunded from the IRS and recorded an additional $2.2 million employee retention tax credit from unremitted payroll taxes made available under the CARES Act. However, the timing of these elements taking place are not predictable and may not serve to mitigate our situation or improve the 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. On November 12, 2021, due to the violation of Q3 2021 leverage ratio, we signed the Tenth Amendment and Reaffirmation Agreement with an effective date of November 12, 2021 to adjust the thresholds for future covenants to ease the risk of non-compliance (See Note 17).
The Company’s management continues to explore raising capital through its access to the public markets or entering into alternative financing arrangements. Furthermore, while recovery has been slower to materialize than expected the Company has experience an improvement in orders as well as a higher rate of opportunities across business segments. Future 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.
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, employee retention credit, PPP loan forgiveness, 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 expense and VAT write-off. EBITDA and Adjusted EBITDA are not measures of financial performance under U.S. GAAP. Management believes EBITDA and Adjusted EBITDA, in addition to operating profit, net income and other U.S. 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 U.S. GAAP. A reconciliation of non-GAAP EBITDA and Adjusted EBITDA to the most directly comparable U.S. GAAP measure in accordance with SEC Regulation G follows:
| | | Three Months Ended | | | Nine Months Ended | |
| | | September 30, 2021 | | | September 30, 2020 | | | September 30, 2021 | | | September 30, 2020 | |
| Net income (loss) | | $ | 11,438 | | | $ | (661 | ) | | $ | 12,464 | | | $ | (9,068 | ) |
| Interest expense, net | | | 32 | | | | 128 | | | | 135 | | | | 556 | |
| Provision for income taxes | | | 166 | | | | 116 | | | | 127 | | | | 166 | |
| Depreciation and amortization | | | 432 | | | | 579 | | | | 1,426 | | | | 2,030 | |
| EBITDA | | | 12,068 | | | | 162 | | | | 14,152 | | | | (6,316 | ) |
| Provision for legal settlement | | | - | | | | (952 | ) | | | - | | | | (91 | ) |
| Loss on impairment | | | 3 | | | | - | | | | 3 | | | | 4,302 | |
| Employee retention credit | | | (2,087 | ) | | | -
| | | | (7,162 | ) | | | - | |
| PPP Loan and accumulated interest forgiveness | | | (10,127 | ) | | | - | | | | (10,127 | ) | | | - | |
| Restructuring charges | | | (10 | ) | | | 185 | | | | 798 | | | | 195 | |
| Stock-based compensation expense | | | 283 | | | | 33 | | | | 784 | | | | 357 | |
| Change in fair value of derivative instruments | | | - | | | | (31 | ) | | | - | | | | (35 | ) |
| Acquisition-related expense | | | - | | | | 3 | | | | - | | | | 191 | |
| VAT write-off | | | - | | | | - | | | | 450 | | | | - | |
| Adjusted EBITDA | | $ | 130 | | | $ | (600 | ) | | $ | (1,102 | ) | | $ | (1,397 | ) |
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, employee retention credit, PPP loan forgiveness, 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, and VAT write-off. Adjusted Net (Loss) Income and Adjusted (Loss) Earnings per Share (adjusted EPS) are not measures of financial performance under U.S. GAAP. Management believes adjusted net (loss) income and adjusted (loss) earnings per share, in addition to other U.S. 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 U.S. GAAP. A reconciliation of non-GAAP adjusted net (loss) income and adjusted (loss) earnings per share to U.S. GAAP net loss, the most directly comparable U.S. GAAP financial measure, is as follows:
| (in thousands) | | Three Months Ended | | | Nine Months Ended | |
| | | September 30, 2021 | | | September 30, 2020 | | | September 30, 2021 | | | September 30, 2020 | |
| | | | | | | | | | | | | |
| Net income (loss) | | $ | 11,438 | | | $ | (661 | ) | | $ | 12,464 | | | $ | (9,068 | ) |
| Provision for legal settlement | | | - | | | | (952 | ) | | | - | | | | (91 | ) |
| Loss on impairment | | | 3 | | | | - | | | | 3 | | | | 4,302 | |
| Employee retention credit | | | (2,087 | ) | | | - | | | | (7,162 | ) | | | - | |
| PPP Loan and accumulated interest forgiveness | | | (10,127 | ) | | | - | | | | (10,127 | ) | | | - | |
| Restructuring charges | | | (10 | ) | | | 185 | | | | 798 | | | | 195 | |
| Stock-based compensation expense | | | 283 | | | | 33 | | | | 784 | | | | 357 | |
| Change in fair value of derivative instruments | | | - | | | | (31 | ) | | | - | | | | (35 | ) |
| Acquisition-related expense | | | - | | | | 3 | | | | - | | | | 191 | |
| VAT write-off | | | - | | | | - | | | | 450 | | | | - | |
| Amortization of intangible assets related to acquisitions | | | 286 | | | | 414 | | | | 929 | | | | 1,528 | |
| Adjusted net loss | | $ | (214 | ) | | $ | (1,009 | ) | | $ | (1,861 | ) | | $ | (2,621 | ) |
| | | | | | | | | | | | | | | | | |
| Adjusted net loss per common share – diluted | | $ | (0.01 | ) | | $ | (0.05 | ) | | $ | (0.09 | ) | | $ | (0.13 | ) |
| | | | | | | | | | | | | | | | | |
Weighted average shares outstanding used to compute adjusted net loss per share - diluted(1) | | | 20,863,479 | | | | 20,563,452 | | | | 20,714,068 | | | | 20,438,571 | |
(1) During the three and nine months ended September 30, 2021, we reported a U.S. GAAP net income and an adjusted net income. Accordingly there were no dilutive shares per share when calculating the diluted net income per common share for the three and nine months ended September 30, 2021.
(1) During the three and nine months ended September 30, 2020, we reported a U.S. GAAP net loss and an adjusted net loss. Accordingly there were 66,261 and 12,172 dilutive shares from RSUs that were excluded from the adjusted net loss per common 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.
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.
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.
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 September 30, 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.
Our beliefs regarding our ability to contribute to global decarbonization may be based on materially inaccurate assumptions
An 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, primarily to serve the nuclear power industry, which we believe will be essential to decarbonization. While we believe that nuclear power will meaningfully contribute to decarbonization, these beliefs are based on certain assumptions, including, but not limited to, the immediate impact of global warming and the inability to meaningfully address global warming without maximizing nuclear power and other alternative energy sources. To the extent our assumptions are materially incorrect or incomplete, it could adversely impact our business, prospects, financial condition and operating results due to a reduction in demand for our services.
| 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. |
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| | | Certification of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith. |
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| | | Eighth Amendment |
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| | 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 |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| Date: November 15, 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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