| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
We are a leading provider of professional and technical engineering, staffing services and simulation software to clients in the power and process industries. Our primary market is the nuclear power industry, predominantly in the United States, but also serving the global nuclear sector with projects in the United Kingdom, Slovakia, Korea, Japan and elsewhere. We also serve natural adjacencies to the commercial nuclear power market such as the United States Department of Energy, and the broader nuclear ecosystem. We additionally serve other heavy industry sectors such as refining, petrochemical, Liquefied Natural Gas ('LNG") and others, with staffing services and our simulation technology and know-how. 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 help clients fill key vacancies in their respective organizations, 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.
As a result of the COVID-19 pandemic, we have sought and obtained support through various business assistance programs. We applied for and, on April 23, 2020, received the PPP Loan under the CARES Act, as administered by the SBA. We used the PPP Loan proceeds to sustain our business during the pandemic, as intended, and we were eligible for full forgiveness of the loan under the CARES act. On August 5, 2021, we received notice that full principal amount and all accrued interest thereon of the PPP Loan was formally forgiven by the SBA.
In 2021, we participated in the Employee Retention Credit (ERC) program available under the CARES Act. The Company recognized total cumulative ERC credits of $7.2 million consisting of both refunds sought by the Company and credits from unremitted payroll taxes. We applied for $5.0 million in refunds from the IRS with filing of our 941s and achieved $2.2 million in credits from unremitted payroll taxes as allowed. We didn't receive any refunds for the three months ended September 30, 2022. There was a remaining receivable of $1.4 million at September 30, 2022. Subsequently, in October 2022, we received a refund of $0.4 million.
On September 9, 2021, President Biden released the 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). As a part of the Plan and Order, President Biden also directed, 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 this ETS, however the implementation of the ETS was blocked by federal appeals courts, pending resolution of ongoing litigation challenging the constitutionality of the ETS, and the ETS was withdrawn by OSHA on January 25, 2022. OSHA, however has not withdrawn the proposed rule that would effectuate the same mandate, and it cannot be known whether OSHA may reissue the ETS or otherwise issue new emergency temporary standards imposing similar mandates. We have already received notice by both government customers and prime contractors serving government customers regarding the vaccination requirement and its application to our business with those customers. As an employer of more than 100 employees, we would also be subject to the ETS or a similar mandate should it become effective. It is possible that additional jurisdictions where we do business may impose similar mandates that would apply to our employees. In addition, certain of our customers may require vaccines for those of our employees who provide on-site service at their facilities. We will continue to monitor the status of these or other mandates or regulations and their application to us and our business.
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 beyond 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 61% of revenue for the nine months ended September 30, 2022)
Our Performance Improvement Solutions segment primarily encompasses our simulation solutions, technical engineering services for ASME programs, power plant thermal performance optimization, all primarily focused on the nuclear power industry and adjacencies. We also provide interactive computer-based tutorials/simulation solutions focused on the process industries, including but not limited to refining, petrochemical and LNG sectors. 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, now positioned for go-to-market as GSE Programs and Performance; GSE DP Engineering, now positioned for go-to-market as GSE Design and Analysis, businesses typically work as either the engineer of choice or specialty engineer of choice for our clients under master services agreements, These lines of business 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 39% of revenue for the nine months ended September 30, 2022)
Workforce Solutions, comprised to GSE Technical Staffing and Training Services, provides highly specialized and skilled, predominantly white collar “above the shoulders” labor on a contingency basis to the nuclear power industry and other heavy industry sectors, including but not limited to, LNG, petrochemical, refining, and specialty manufacturing sectors. 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. 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. We are now one of the few, publicly traded engineering and technology companies serving the zero-carbon energy sector of nuclear power and adjacent nuclear markets in Department of Energy, US Navy and related sectors. As a result of this effort and established leadership position in key sectors, we are positioned to expand into essential clean energy opportunities that may arise such as wind, solar, hydrogen production, and others. In 2022, we are keenly focused 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; 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 our expertise; expand into compelling adjacent markets such as clean energy as they may arise with renewed sales focus. The focus on organic growth is a reflection of our need to grow in a self-funded manner to achieve cash flow break even route to recovering to our pre-pandemic revenue levels.
Cross sell and upsell into existing markets:
For the past several years, we have devoted considerable time and effort to diversify the Company’s solutions capabilities for the nuclear power sector via a rollup of essential services providers to the industry. To ensure efficient and streamlined operations for the business, we have brought all of the engineering services together into one organization under one leader, and the Workforce Solutions teams together as one team under one leader. The business units operate uniformly within their respective structure. As such, the opportunity to cross-sell the capabilities across the entire customer base is greatly enhanced and a clear focus of our sales efforts. This further differentiates us as a unique provider to industry vs. providers of specific niche services. Our goals are for the unified go-to-market efforts, such as cross-selling capability, could and should lead to greater share of available spending within the customer base, which in turn should lead to significant upselling opportunity. Just as the broader economy was impacted by the onset of the pandemic, so as to our end markets been affected. Our perspective is that the industries we serve are quick to respond to a crisis and disruption, but slow to emerge and recover to pre-crisis operations. This is understandable for our primary market of nuclear power, and this cycle has repeated itself for the past with other market and industry disruptions such as the 2008 global economic crisis, the Fukushima disaster in 2011 and the global pandemic and ongoing economic disruption that has resulted. As with past disasters, our end markets usually catch up to delays in work years after the onset of the disruption and our Company is positioned to take advantage of the recovery if and when it occurs. As a result of a rejuvenated cross-sell and upsell effort, we are equipped to take this new approach to the 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, we are poised to benefit from and exploit this investment as it rolls out to the vendor ecosystem serving these key sectors. We have also spent significant effort to put in place Master Services Agreements (“MSA’s”) with key utility operators. Having this commercial infrastructure in place is a significant step forward to facilitate ease of consumption of our solutions once a decision to do so is made by these clients/prospects.
Organic growth through new and compelling technology:
While managing through the pandemic, in parallel, our leadership was investigating compelling opportunities by which we could utilize our capabilities to create significant value for the industry and advance the efforts of decarbonizing the power sector. As a result, we have identified a robust pipeline of new and compelling technology solutions to develop and take to market. Net new solutions, such as Data Validation and Reconciliation (“DVR”) and Thermal System Monitoring (“TSM”), have created new revenue streams with the potential of on-going annuities through license revenue, software maintenance and services revenue. More on DVR and TSM below. GSE has announced a handful of new wins for these new solutions, which were created through our unique combination of our industry/engineering know-how and software development capabilities. As we have 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. Our 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, providing the technology platform 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 DVR (implemented by True North) that enhances the quality of data for plant performance insights, 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 OpenSimTM 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.
Additionally, enhancements to training content and delivery continue through the EnVision On-Demand platform, allowing our customers to access training content from anywhere in synchronous and asynchronous modes, thus increasing their efficiency and reducing infrastructure costs. 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. We have pioneered a number of industry standards and intend to continue to be one of the most innovative companies in our industry. During the three months ended September 30, 2022 and 2021, we had R&D expenditures totaling $186 thousand and $149 thousand, respectively. During the nine months ended September 30, 2022 and 2021, we had R&D expenditures totaling $510 thousand and $460 thousand, respectively.
Strengthen and develop our talent while delivering high-quality solutions.
Over the past several years, we have assembled a unique and highly experienced group of talent through organic growth and strategic acquisition. Our engineering team is comprised of design, simulation, regulatory compliance, and performance optimization professionals who 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.
The Company is not immune to the intense pressure and business risks associated with attracting and retaining talented professionals in this current environment. 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. Attracting and retaining excellent professionals is a key effort for the company.
Employees
As of September 30, 2022, we had approximately 273 employees, which includes approximately 198 employees in our Performance segment and approximately 75 employees in our Workforce Solutions segment.
Backlog
As of September 30, 2022, we had approximately $32.3 million of total gross revenue backlog, which included $26.7 million of Performance backlog and $5.6 million of Workforce Solutions backlog. As of December 31, 2021, our backlog was $41.3 million with $31.8 million attributed to our Performance segment and $9.5 million to Workforce Solutions. 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 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; and
|
| • | 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, we were 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. We are grateful to see the positive headlines in the news about nuclear power being recognized as a key means by which to achieve energy security and zero carbon goals. Yet, the Company has yet to see a recovery to pre pandemic levels of spending from the sector. We are focused on organic growth from where pend is flowing today, while positioning ourselves to benefit from these very significant, multi-decade projects that are being announced in the US and overseas.
Renewable Integration
A significant component of overall decarbonization regarding power generation will ultimately fall to renewable sources such as wind, solar, and “green” hydrogen 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. If and as spending unfold to advanced engineering and simulation solutions for these efforts, GSE should be well positioned to take advantage of this spend.
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 low carbon energy as the world progresses on the current energy transition efforts. 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 as well as 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, we provide 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, we have delivered more nuclear power plant simulators than any other company in the world.
We deliver training products through 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 enable the training organization to be more flexible and efficient.
Our 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, our high-fidelity simulator enables designers to model the interaction between systems in advance of construction. With our combination of simulation technology and expert engineering, we were 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, our technology is used to improve the efficiency of existing power generation assets. Our TSM 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 DVR techniques, we 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 our engineering team. Our engineering team helps our clients throughout the entire plant lifecycle. We are the Engineer of Choice (“EOC”) 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 or pursue other opportunities, access to industry experts is essential to ensure ongoing quality operations. Our Workforce Solutions division provides flexible staffing services, knowledge transfer support, end to end workforce management programs, procedures services, and specialized training programs and services. Staffing and training needs change over time and sometimes our clients need options. Options we can offer include fixed-price, discrete projects, new or updated methods, customized search, or specialized courses in contrast to traditional straight staff augmentation. Further, we understand the importance and necessity of fully understanding the unique needs of each customer, and we have the ability to provide the needed solutions.
The industries we serve need talent, including operating personnel, procedure writers, engineers, operators, technical professionals, and instructors, just to name a few. Our customers need talent who can step in and use, as well as, update the client’s operating methods, procedures, training material and more. Finding technical professionals, who know the needed subject matters, can perform the work or teach it to others and can adapt to the client’s culture is critical. We provide qualified professionals, instructors and turnkey projects/courses that work within the client’s system and complement the methods they already have in place.
We provide 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. Examples of our training program courses include senior reactor operator (“SRO”) certification, generic fundamentals training, and simulation supervisor training. Our Workforce Solutions segment includes 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 continue to see organic growth opportunity with our Workforce Solutions segment by expanding our service offerings to meet the evolving needs of the energy and engineering industries as well as other opportunities that support decarbonization and major infrastructure projects. Due to the experience within our team, we are well positioned to expand our Workforce Solutions segment offerings through our existing relationships and industry knowledge. This growth is occurring both with existing and new customers. We place great emphasis on cross-selling the services offered by our Workforce Solutions segment with our Performance Improvement Solutions segment. The Workforce Solutions segment continues expanding our footprint with companies dedicated to the support of decarbonization, and our success is showing with contract awards, scope expansion, and targeted opportunities to support engineering, manufacturing, and construction projects with companies dedicated to clean energy solutions. We continue to better position ourselves to support these opportunities with strategic hires and staff alignment. As the recent increases in employment transition have demonstrated, companies must also be able to adapt quickly to evolving staffing needs. This has certainly been demonstrated with companies needing to adjust compensation packages, adjusting and allowing more employees to work from home, and expanding options for acquiring the needed talent. Employees are making changes in their professional lives for many reasons, and our workforce solutions offer our customers added support and more flexibility to support ever changing needs. In fact, Workforce Solutions is uniquely positioned for growth in these types of employment environments. Our flexible solutions, and specialized industry experience position us 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, 2022 | | | September 30, 2021 | | | September 30, 2022 | | | September 30, 2021 | |
| | | $ | | |
| % | | | $
| | |
| % | | | $
| | |
| % | | | $
| | |
| % | |
| Revenue | | $ | 11,898 | | | | 100.0 | % | | $ | 14,686 | | | | 100.0 | % | | $ | 36,918 | | | | 100.0 | % | | $ | 41,312 | | | | 100.0 | % |
| Cost of revenue | | | 8,642 | | | | 72.6 | % | | | 11,503 | | | | 78.3 | % | | | 28,063 | | | | 76.0 | % | | | 32,512 | | | | 78.7 | % |
| Gross profit | | | 3,256 | | | | 27.4 | % | | | 3,183 | | | | 21.7 | % | | | 8,855 | | | | 24.0 | % | | | 8,800 | | | | 21.3 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Operating expenses: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Selling, general and administrative | | | 4,336 | | | | 36.4 | % | | | 3,265 | | | | 22.2 | % | | | 13,253 | | | | 35.9 | % | | | 10,521 | | | | 25.5 | % |
| Research and development | | | 186 | | | | 1.6 | % | | | 149 | | | | 1.0 | % | | | 510 | | | | 1.4 | % | | | 460 | | | | 1.1 | % |
| Restructuring (benefit) charges | | | - | | | | 0.0 | % | | | (10 | ) | | | (0.1 | )% | | | - | | | | 0.0 | % | | | 798 | | | | 1.9 | % |
| Goodwill and intangible asset impairment charge | | | 7,505 | | | | 63.1 | % | | | 3 | | | | 0.0 | % | | | 7,505 | | | | 20.3 | % | | | 3 | | | | 0.0 | % |
| Depreciation | | | 69 | | | | 0.6 | % | | | 69 | | | | 0.5 | % | | | 213 | | | | 0.6 | % | | | 216 | | | | 0.5 | % |
| Amortization of intangible assets | | | 209 | | | | 1.8 | % | | | 286 | | | | 1.9 | % | | | 700 | | | | 1.9 | % | | | 929 | | | | 2.2 | % |
| Total operating expenses | | | 12,305 | | | | 103.4 | % | | | 3,762 | | | | 25.6 | % | | | 22,181 | | | | 60.1 | % | | | 12,927 | | | | 31.3 | % |
| Operating loss | | | (9,049 | ) | | | (76.1 | )% | | | (579 | ) | | | (3.9 | )% | | | (13,326 | ) | | | (36.2 | )% | | | (4,127 | ) | | | (10.1 | )% |
| Interest expense, net | | | (422 | ) | | | (3.5 | )% | | | (32 | ) | | | (0.2 | )% | | | (928 | ) | | | (2.5 | )% | | | (135 | ) | | | (0.3 | )% |
| Change in fair value of derivative instruments, net | | | 263 | | | | 2.2 | % | | | - | | | | 0.0 | % | | | 377 | | | | 1.0 | % | | | - | | | | 0.0 | % |
| Other (loss) income, net | | | (2 | ) | | | 0.0 | % | | | 12,215 | | | | 83.2 | % | | | (58 | ) | | | (0.2 | )% | | | 16,853 | | | | 40.8 | % |
| (Loss) income before income taxes | | | (9,210 | ) | | | (77.4 | )% | | | 11,604 | | | | 79.0 | % | | | (13,935 | ) | | | (37.7 | )% | | | 12,591 | | | | 30.5 | % |
| (Benefit from) provision for income taxes | | | (218 | ) | | | (1.8 | )% | | | 166 | | | | 1.1 | % | | | (108
| )
| | | 0.3 | % | | | 127 | | | | 0.3 | % |
| Net (loss) income | | $ | (8,992 | ) | | | (75.6 | )% | | $ | 11,438 | | | | 77.9 | % | | $ | (13,827 | ) | | | (37.5 | )% | | $ | 12,464 | | | | 30.2 | % |
Revenue
Consolidated revenue for the three months ended September 30, 2022 totaled $11.9 million, which was 19% less than the $14.7 million of revenue for the three months ended September 30, 2021. Revenue for the nine months ended September 30, 2022 totaled $36.9 million, which was 11% less than the $41.3 million of revenue for the nine months ended September 30, 2021.
| | | Three Months Ended | | | Nine Months Ended | |
| (in thousands) | | September 30, 2022 | | | September 30, 2021 | | | Change | | | September 30, 2022 | | | September 30, 2021 | | | Change | |
| Revenue: | | | | | | | | $
| | |
| % | | | | | | | | | $ | | |
| % | |
| Performance | | $ | 8,052 | | | $ | 7,375 | | | | 677 | | | | 9 | % | | $ | 22,402 | | | $ | 21,318 | | | | 1,084 | | | | 5 | % |
| Workforce Solutions | | | 3,846 | | | | 7,311 | | | | (3,465 | ) | | | (47 | )% | | | 14,516 | | | | 19,994 | | | | (5,478 | ) | | | (27 | )% |
| Total revenue | | $ | 11,898 | | | $ | 14,686 | | | | (2,788 | ) | | | (19 | )% | | $ | 36,918 | | | $ | 41,312 | | | | (4,394 | ) | | | (11 | )% |
Performance Improvement Solutions revenue for the three months ended September 30, 2022 totaled $8.1 million, which was a 9% increase from the $7.4 million of revenue for the three months ended September 30, 2021. The increase in revenue was primarily attributable to the projects awarded with higher margins and improved processes. Total Performance Improvement Solutions orders of $7.2 million and $11.2 million were recorded for the three months ended September 30, 2022 and 2021, respectively.
Performance Improvement Solutions revenue for the nine months ended September 30, 2022 totaled $22.4 million, which was a 5% increase from the $21.3 million of revenue for the nine months ended September 30, 2021. The increase of revenue was primarily attributable to several significant contracts awarded with high margin performance obligations completed efficiently which began later in 2022. Total Performance Improvement Solutions orders of $17.4 million and $22.6 million were recorded for the nine months ended September 30, 2022 and 2021, respectively.
For the three months ended September 30, 2022, Workforce Solutions revenue decreased by 47% to $3.8 million compared to revenue of $7.3 million for the three months ended September 30, 2021. The decrease in revenue was due to a reduction in staffing needs from our major customers. Total new orders of $3.0 million and $3.5 million were recorded for the three months ended September 30, 2022 and 2021, respectively.
For the nine months ended September 30, 2022, Workforce Solutions revenue decreased by 27% to $14.5 million compared to revenue of $20.0 million for the nine months ended September 30, 2021. The decrease in revenue was primarily due to the wind down of large projects resulting in a reduction in demand for staffing from our major customers. Total new orders of $10.8 million and $15.9 million were recorded for the nine months ended September 30, 2022 and 2021, respectively.
As of September 30, 2022, our backlog was $32.3 million, of which, $26.7 million was attributed to the Performance segment and $5.6 million was attributed to the Workforce Solutions segment. As of December 31, 2021, our backlog was $41.3 million with $31.8 million attributed to our Performance segment and $9.5 million to Workforce Solutions.
Gross Profit
Gross profit was $3.3 million and 27.4% of revenue and $3.2 million and 21.7% of revenue for the three months ended September 30, 2022 and 2021, respectively. Gross profit was $8.9 million and 24.0% of revenue and $8.8 million and 21.3% of revenue for the nine months ended September 30, 2022 and 2021, respectively.
| (in thousands) | | Three Months Ended | | | Nine Months Ended | |
| | | September 30, 2022 | | | September 30, 2021 | | | September 30, 2022 | | | September 30, 2021 | |
| | | $ | | |
| % | | | $ | | |
| % | | | $ | | |
| % | | | $ | | |
| % | |
| Gross profit: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Performance Improvement Solutions | | $ | 2,654 | | | | 33.0 | % | | $ | 2,252 | | | | 30.5 | % | | $ | 7,037 | | | | 31.4 | % | | $ | 6,204 | | | | 29.1 | % |
| Workforce Solutions | | | 602 | | | | 15.7 | % | | | 931 | | | | 12.7 | % | | | 1,818 | | | | 12.5 | % | | | 2,596 | | | | 13.0 | % |
| Total gross profit | | $ | 3,256 | | | | 27.4 | % | | $ | 3,183 | | | | 21.7 | % | | $ | 8,855 | | | | 24.0 | % | | $ | 8,800 | | | | 21.3 | % |
The Performance Improvement Solutions segment’s gross profit increased by $0.4 million during the three months ended September 30, 2022 over three months ended September 30, 2021. The Performance Improvement Solutions segment’s gross profit increased by $0.8 million during nine months ended September 30, 2022 over nine months ended September 30, 2021. The increase is primarily related to the projects with higher margins, shorter lead times and improved processes, in addition to increased software sales.
The Workforce Solutions segment’s gross profit decreased by $0.3 million during the three months ended September 30, 2022 over the three months ended September 30, 2021. The Workforce Solutions segment’s gross profit decreased by $0.8 million during the nine months ended September 30, 2022 over the nine months ended September 30, 2021. The decrease in the three months and nine months ended September 30, 2022 was primarily due to the reduction in the demand from existing customers for additional workforce professionals.
Selling, general and administrative expenses (“SG&A”)
Selling, general and administrative (SG&A) expenses totaled $4.3 million and $3.3 million for the three months ended September 30, 2022 and 2021, respectively. Selling, general and administrative (SG&A) expenses totaled $13.3 million and $10.5 million for the nine months ended September 30, 2022 and 2021, respectively. Fluctuations in the components of SG&A spending were as follows.
| | | Three months ended | | | Nine months ended | |
| (in thousands) | | September 30, 2022 | | | September 30, 2021 | | | September 30, 2022 | | | September 30, 2021 | |
| | | | | | | | | | | | | |
| Corporate charges | | $ | 3,201 | | | $ | 2,364 | | | $ | 10,058 | | | $ | 7,754 | |
| Business development | | | 951 | | | | 714 | | | | 2,511 | | | | 2,230 | |
| Facility operation & maintenance (O&M) | | | 182 | | | | 186 | | | | 575 | | | | 654 | |
| Bad debt expense | | | - | | | | - | | | | 97 | | | | (133 | ) |
| Other | | | 2 | | | | 1 | | | | 12 | | | | 16 | |
| Total | | $ | 4,336 | | | $ | 3,265 | | | $ | 13,253 | | | $ | 10,521 | |
Corporate charges
During the three months ended September 30, 2022, corporate charges increased by $0.8 million over the same period of the prior year. During the nine months ended September 30, 2022 corporate charges increased by $2.3 million over the same period of the prior year. The increase was primarily due to a $0.9 million increase in stock compensation expense, a $0.6 million increase in indirect labor & burden cost due to increased headcount, a $0.3 million increase related to business insurance, and a $0.5 million increase in legal fees and other business expenses during the nine months ended September 30, 2022.
Business development expenses
Business development expense increased $237 thousand during the three months ended September 30, 2022 over the same period of the prior year. Business development expense increased $281 thousand during the nine months ended September 30, 2022 over the same period of the prior fiscal year. The increase was primarily due to increased recruiting fees, commission expense, and Indirect Labor & Burden due to increased headcount during the nine months ended September 30, 2022.
Facility operation & maintenance (“O&M”)
Facility O&M expenses decreased $4 thousand for three months ended September 30, 2022, compared to the same period in 2021. Facility O&M expenses decreased $79 thousand for nine months ended September 30, 2022, compared to the same period in 2021. The decrease in facility O&M during the nine months ended September 30, 2022 was mainly due to an increased allocation of facility cost from O&M to COGS.
Bad debt (recovery) expense
We recorded no bad debt expense (recovery) during the three months ended September 30, 2022 and 2021. We recorded $97 thousand and $(133) thousand of bad debt expense (recovery) during the nine months ended September 30, 2022 and 2021, 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 $186 thousand and $149 thousand for the three months ended September 30, 2022 and 2021, respectively. Research and development costs totaled $510 thousand and $460 thousand for the nine months ended September 30, 2022 and 2021, respectively. The increase was mainly due to higher headcount.
Restructuring
We recorded no restructuring charges for the three and nine months ended September 30, 2022. During the three and nine months ended September 30, 2021, we recorded restructuring (benefit) charges of $(10) thousand and $798 thousand, respectively. The decrease was mainly due to final charges related to the liquidation of our Sweden operations during the prior period, pursuant to our foreign restructuring plan.
Goodwill and Intangible asset impairment charge
We recognized a $7.5 million goodwill and intangible asset impairment charge during the three and nine months ended September 30, 2022. We recognized a $3 thousand ROU asset impairment during the three and nine months ended September 30, 2021. In the interim period ended September 30, 2022, we determined that the deterioration in sales, decline in revenues, delayed pipeline opportunities, and overall downward performance results and the forecast related to the Workforce Solutions business segment was material enough to be considered a triggering event that could result in impairment of our long-lived assets. As a result of the ASC 350 and 360 analysis, there was determined to be an impairment of both the goodwill and intangible assets, totaling $7.5 million.
Depreciation
We recorded depreciation expense of $69 thousand for both the three months ended September 30, 2022 and 2021. Depreciation expense was $213 thousand and $216 thousand for the nine months ended September 30, 2022 and 2021, respectively. The reduction of $3 thousand for the nine months ended September 30, 2022 over the same period in 2021 was due primarily due to assets becoming fully depreciated in 2022.
Amortization of intangible assets
Amortization expense related to definite-lived intangible assets totaled $209 thousand and $286 thousand for the three months ended September 30, 2022 and 2021, respectively, and $700 thousand and $929 thousand for the nine months ended September 30, 2022 and 2021, respectively. The decrease in amortization expense was primarily due to the amortization of Customer Contracts and Relationships, which are amortized at a declining rate over the 15-year useful life.
Interest expense, net
Interest expense totaled $422 thousand and $32 thousand for the three months ended September 30, 2022 and 2021, respectively. Interest expense totaled $928 thousand and $135 thousand for the nine months ended September 30, 2022 and 2021, respectively. The increase for the three and nine month periods was due to an increase in total indebtedness compared to prior period.
Other (loss) income, net
For the three months ended September 30, 2022 and 2021, we recognized other (loss) income, net of $(2) thousand and $12.2 million, respectively. For the nine months ended September 30, 2022 and 2021, we recognized other (loss) income, net of $(58) thousand and $16.9 million, respectively. The decrease was primarily due to $10.1 million of PPP loan forgiveness granted during the three months ended September 30, 2021. Additionally, we recorded $2.1 million and $7.2 million Employee Retention Credit during the three and nine months ended September 30, 2021 offset by a Value-Added Tax (VAT) write-off of $0.5 million during the second quarter of 2021. We paid VAT taxes for subcontractor equipment purchase and had pursued the collection of this VAT refund for multiple years. In May of 2021, we were informed by our tax advisor that this VAT refund was no longer collectable.
Income tax (benefit) 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 benefit of $(218) thousand for the three months ended September 30, 2022 was comprised mainly of current foreign tax benefit, deferred federal and state tax benefit related to the portion of goodwill which cannot be offset by deferred tax assets, and state tax expense. The total income tax expense of $166 thousand for the three months ended September 30, 2021 was comprised mainly of current state and foreign tax expense. Total income tax expense of $(108) thousand for the nine months ended September 30, 2022 was comprised mainly of current foreign tax benefit, deferred federal and state tax benefit related to the portion of goodwill which cannot be offset by deferred tax assets, and state tax expense. Total tax expense of $127 thousand for the nine months ended September 30, 2021 was comprised mainly of current state and foreign tax expense.
Our effective income tax rate was 2.37% and (0.78)% for the three and nine months ended September 30, 2022, respectively. For the three and nine months ended September 30, 2022, the difference between our income tax expense and (benefit), at an effective tax rate of 2.37% and (0.78)% 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 valuation allowance in our U.S. entity, the permanent disallowance of interest expense related to disqualified debt, and discrete item adjustments for U.S. and foreign taxes. For the three and nine months ended September 30, 2021, the difference between our income tax expense at an effective 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 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 March 31, 2022. In addition, in the quarter ended March 31, 2022, we established mark-to-market liabilities related to certain common stock purchase warrants and certain embedded features included in our convertible debt. The fair values of these are estimated upon issuance and at each reporting period thereafter. 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, 2022, our cash, cash equivalents and restricted cash totaled $5.2 million, compared to $3.6 million as of December 31, 2021.
As of September 30, 2022, we have current restricted cash and long-term restricted cash of $0.7 million and $0.9 million, respectively. We have restricted cash of $1.1 million to secure four letters of credit with various customers and $0.5 million to secure our corporate credit card program.
For the nine months ended September 30, 2022 and 2021, net cash provided by operating activities were $0.8 million and net cash used in operating activities were $0.3 million, respectively. The increase in cash flows provided by operating activities was primarily driven by ERC refunds and increased collections in the nine months ended September 30, 2022 and slower billing in the nine months ended September 30, 2021.
Net cash used in investing activities totaled $0.4 million and 0.6 million for the nine months ended September 30, 2022 and 2021, respectively.
For the nine months ended September 30, 2022 and 2021, net cash provided by financing activities was $1.5 million and net cash used in financing activities was $1.7 million, respectively. The increase in cash provided by financing activities of $3.3 million was primarily driven by $4.8 million of proceeds received from issuance of Convertible Note, offset by a $1.8 million repayment of the line of credit and a $0.3 million repayment of Convertible Note during the nine months ended September 30, 2022.
Paycheck Protection Program Loan
We applied for and, on April 23, 2020, received the PPP Loan under the CARES Act, as administered by the SBA (further described in Note 4 to Consolidated Financial Statements). Citizens reviewed our application for forgiveness and associated documentation, and on February 26, 2021 forwarded our application to the SBA with Citizens’ determination that the loan is fully forgivable. On August 5, 2021, we received notice that full principal amount and all accrued interest thereon of the PPP Loan was formally forgiven by the SBA.
Credit Facilities
On February 23, 2022, the Company issued a Convertible Note (further described in Note 10 to Consolidated Financial Statements). The proceeds received from the Convertible Note were used to repay in full, all outstanding indebtedness of $1.8 million owed to Citizens, and the Amended and Restated Credit and Security Agreement between us, our subsidiaries, and Citizens has been terminated. As of September 30, 2022, we had four letters of credit totaling $1.1 million outstanding to certain customers which were secured with restricted cash.
Non-GAAP Financial Measures
Adjusted EBITDA
References to “EBITDA” mean net (loss) income, before considering interest expense, provision for income taxes, depreciation and amortization. References to Adjusted EBITDA excludes goodwill and intangible asset impairment charges, employee retention credit, PPP loan and accumulated interest forgiveness, restructuring charges, stock-based compensation expense, impact of the change in fair value of derivative instruments 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-U.S. 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, 2022 | | | September 30, 2021 | | | September 30, 2022 | | | September 30, 2021 | |
| Net (loss) income | | $ | (8,992 | ) | | $ | 11,438 | | | $ | (13,827 | ) | | $ | 12,464 | |
| Interest expense, net | | | 422 | | | | 32 | | | | 928 | | | | 135 | |
| Provision for income taxes | | | (218 | ) | | | 166 | | | | (108
| )
| | | 127 | |
| Depreciation and amortization | | | 365 | | | | 432 | | | | 1,167 | | | | 1,426 | |
| EBITDA | | | (8,423 | ) | | | 12,068 | | | | (11,840 | ) | | | 14,152 | |
| Goodwill and intangible asset impairment charge | | | 7,505 | | | | 3 | | | | 7,505 | | | | 3 | |
| Employee retention credit | | | - | | | | (2,087 | ) | | | - | | | | (7,162 | ) |
| PPP loan and accumulated interest forgiveness | | | - | | | | (10,127 | ) | | | - | | | | (10,127 | ) |
| Restructuring charges | | | - | | | | (10 | ) | | | - | | | | 798 | |
| Stock-based compensation expense | | | 491 | | | | 283 | | | | 1,592 | | | | 784 | |
| Change in fair value of derivative instruments, net | | | (263 | ) | | | - | | | | (377 | ) | | | - | |
| VAT write-off | | | - | | | | - | | | | - | | | | 450 | |
| Adjusted EBITDA | | $ | (690 | ) | | $ | 130 | | | $ | (3,120 | ) | | $ | (1,102 | ) |
Adjusted Net Loss and Adjusted Loss per Share Reconciliation
References to Adjusted Net Loss excludes the goodwill and intangible asset impairment charges, employee retention credit, PPP loan and accumulated interest forgiveness, restructuring charges, stock-based compensation expense, impact of the change in fair value of derivative instruments, VAT write off and amortization of intangible assets. Adjusted Net Loss and Adjusted Loss per Share (adjusted EPS) are not measures of financial performance under U.S. GAAP. Management believes Adjusted Net Loss and Adjusted Loss 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-U.S. GAAP Adjusted Net Loss and Adjusted Loss per common Share to U.S. GAAP net (loss) income, the most directly comparable U.S. GAAP financial measure, is as follows:
| (in thousands) | | Three Months Ended | | | Nine Months Ended | |
| | | September 30, 2022 | | | September 30, 2021 | | | September 30, 2022 | | | September 30, 2021 | |
| | | | | | | | | | | | | |
| Net (loss) income | | $ | (8,992 | ) | | $ | 11,438 | | | $ | (13,827 | ) | | $ | 12,464 | |
| Goodwill and intangible asset impairment charge | | | 7,505 | | | | 3 | | | | 7,505 | | | | 3 | |
| Employee retention credit | | | - | | | | (2,087 | ) | | | - | | | | (7,162 | ) |
| PPP loan and accumulated interest forgiveness | | | - | | | | (10,127 | ) | | | - | | | | (10,127 | ) |
| Restructuring charges | | | - | | | | (10 | ) | | | - | | | | 798 | |
| Stock-based compensation expense | | | 491 | | | | 283 | | | | 1,592 | | | | 784 | |
| Change in fair value of derivative instruments, net | | | (263 | ) | | | - | | | | (377 | ) | | | - | |
| VAT write-off | | | - | | | | - | | | | - | | | | 450 | |
| Amortization of intangible assets related to acquisitions | | | 209 | | | | 286 | | | | 700 | | | | 929 | |
| Adjusted net loss | | $ | (1,050 | ) | | $ | (214 | ) | | $ | (4,407 | ) | | $ | (1,861 | ) |
| | | | | | | | | | | | | | | | | |
| Adjusted net loss per common share – diluted | | $ | (0.05 | ) | | $ | (0.01 | ) | | $ | (0.21 | ) | | $ | (0.09 | ) |
| | | | | | | | | | | | | | | | | |
Weighted average shares outstanding used to compute adjusted net loss per share - diluted(1) | | | 21,288,883 | | | | 20,863,479 | | | | 21,101,942 | | | | 20,714,068 | |
(1) During the three and nine months ended September 30, 2022, we reported a U.S. GAAP net loss and an adjusted net loss. Accordingly, there was no dilutive shares from RSUs included in the adjusted net loss per share calculation that were considered anti-dilutive when calculating the net loss per share.
(1) During the three and nine months ended September 30, 2021, we reported a U.S. GAAP net loss 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.
| 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, 2021, filed with the SEC on March 31, 2022, in our form 10-Q for the quarter ended March 31, 2022, filed with the SEC on May 15, 2022, and in our Form 10-Q for the quarter ended June 30, 2022, filed with the SEC on August 15, 2022.
Through management’s evaluation of controls as of December 31, 2021 it was determined that the material weakness related to management’s review of reconciliations over unbilled receivables and billings in excess of revenue earned were unremediated. In the course of our assessment of the internal control over financial reporting as of March 31, 2022, we identified an additional material weakness in our control environment related to the review of the financial statements. No additional material weaknesses were identified in the course of our assessment of our internal controls as of September 30, 2022, and we continue to remediate the material weaknesses identified as of December 31, 2021, and as of June 30, 2022.
Our remediation of the remaining control weakness from 2021 included the hiring of additional skilled personnel to prepare and review reconciliations over unbilled receivables and billings in excess of revenue earned and to continue to enhance our processes to reconcile, review, and evaluate the unbilled receivables and billing in excess of revenue accounts on a monthly basis. In the interim, we will utilize members of the financial management team to perform the review of such reconciliations. As it relates to the control weakness identified in the period ended March 31, 2022, remediation and testing will be performed over the review of financial statements with focused attention on proper presentation of elements of the financial statements. Remediation procedures will include developing enhanced documentation of review steps performed prior to distributing financial statements for reporting, as well as for conclusion on the financial presentation for items noted on a list of significant and unusual transactions identified for the respective reporting period.
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
We are, from time to time, involved in ordinary routine litigation incidental to the conduct of our business. Neither we nor any of our subsidiaries are a party to, nor is any of our property the subject of, any material pending legal proceedings that, in the opinion of our management, are likely to have a material adverse effect on our business, financial condition 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 2021 Form 10-K. Except as described herein, there have been no material changes with respect to the risk factors disclosed in our 2021 Form 10-K.
If we are unable to maintain compliance with Nasdaq’s listing requirements, our common stock may be delisted from The Nasdaq Stock Market, which would allow our Lender to deliver a demand for payment, result in an event of default under that certain February 23, 2022 Senior Convertible Note, could have a material adverse effect on the Company’s financial condition and could make it more difficult for holders of the Company’s common stock to sell their shares.
The company’s common stock is listed on the Nasdaq Capital Market and we are therefore subject to its continued listing requirements, including requirements with respect to the market value of publicly-held shares, market value of listed shares, minimum bid price per share, and minimum stockholder’s equity, among others, and requirements relating to board and committee independence. If we fail to satisfy one or more of these continued listing requirements, our common stock may be delisted from the Nasdaq Capital Market. On November 4, 2022, the Company received a written notice (from the Listing Qualifications Department of The Nasdaq Stock Market LLC (“Nasdaq”) stating that the Company failed to maintain a minimum closing bid price of $1.00 per share for the prior 30 consecutive trading day period, as set forth in Nasdaq Listing Rule 5550(a)(2).
Under that certain Senior Convertible Promissory Note issued by the Company to Lind Global Fund II LP (“Lind”) on February 23, 2024 (the Note”), if our common stock ceases to be listed on Nasdaq (or another stock exchange), Lind (or the holder of such note) may deliver a demand for payment to the Company and, if such a demand is delivered, the Company shall, within ten (10) Business Days following receipt of the demand for payment from the Holder, pay all of the outstanding principal amount or, at its election, Lind may elect to convert all or a portion of the outstanding principal amount and the conversion price shall be adjusted to the lower of the then-current conversion price and eighty percent (80%) of the average of the three (3) lowest daily variable average weighted prices during the twenty (20) trading days prior to delivery. Additionally, if we are unable to maintain our listing on Nasdaq, it will constitute an event of default under the Note, which would trigger certain obligation under the Note including, but not limited to, causing an amount equal one hundred twenty percent (120%) of the outstanding principal amount of the Note to immediately become due.
Delisting from Nasdaq also may adversely affect our ability to raise additional financing through the public or private sale of equity securities, may significantly affect the ability of investors to trade our securities and may negatively affect the value and liquidity of our common stock. Delisting also could have other negative results, including the potential loss of investor confidence or interest in strategic transactions or opportunities, as well as negatively impact our ability to recruit and retain personnel through equity incentive awards.
The notice provided that we have a period of 180 calendar days, or until May 3, 2023, to regain compliance with the minimum bid price requirement. During this period, our common stock will continue to trade on the Nasdaq Capital Market.
We intend to actively monitor the closing bid price of our common stock and will evaluate available options to regain compliance with the minimum bid price requirement. However, there can be no assurance that the Company will be able to regain compliance with the minimum bid price requirement or maintain compliance with any of the other Nasdaq continued listing requirements.
The Company’s board may determine to implement a reverse stock split to attempt to regain compliance with the minimum bid price requirement. However, there can be no assurance that the reverse stock split, if approved by the stockholders and implemented, will increase the market price of our common stock in proportion to the reverse split ratio or result in a sustained increase in the market price of our common stock. In addition, it is possible that the reduced number of issued shares of common stock resulting from a reverse stock split could adversely affect the liquidity of our common stock.
| 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. |
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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 |
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| Date: November 14, 2022 | |
| | 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) |
