GSE Systems Earnings 2020-09-30

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

(Mark One)
☒		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ended September 30, 2020
		or
☐		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition period from ____ to ____

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes [ X ]   No [   ]

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such period that the registrant was required to submit such files). Yes [ X ]   No [   ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company or an emerging growth company. See the definitions of "large accelerated filer", "accelerated filer", and "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ☐	Accelerated filer  ☐	Non-accelerated filer ☐	Smaller reporting company ☒
Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]

Indicate by check mark whether the registrant is a shell company (as defined in rule 12(b)-2 of the Exchange Act).    Yes  [  ]  No [X]

Securities registered pursuant to Section 12(b) of the Act:

There were 20,621,413 shares of common stock, with a par value of $0.01 per share outstanding as of October 31, 2020.

GSE SYSTEMS INC. AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

		Page
PART I.	FINANCIAL INFORMATION	3
Item 1.	Financial Statements (unaudited)
	Consolidated Balance Sheets as of September 30, 2020 (unaudited) and December 31, 2019	4
	Unaudited Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2020	5
	Unaudited Consolidated Statements of Comprehensive Loss for the Three and Nine Months Ended September 30, 2020	6
	Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the Three and Nine Months Ended September 30, 2020	7-8
	Unaudited Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2020 and 2019	9
	Notes to Consolidated Financial Statements	10
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	31
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	46
Item 4.	Controls and Procedures	47
PART II.	OTHER INFORMATION	49
Item 1.	Legal Proceedings	49
Item 1A.	Risk Factors	50
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	53
Item 5.	Other Information	53
Item 6.	Exhibits	54

GSE SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)

		September 30, 2020				December 31, 2019
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	7,660			$	11,691
Contract receivables, net			11,143				17,207
Prepaid expenses and other current assets			1,717				1,880
Total current assets			20,520				30,778
Equipment, software and leasehold improvements, net of accumulated depreciation of $4,737 and $4,584			683				939
Software development costs, net			642				641
Goodwill			13,339				13,339
Intangible assets, net			4,649				10,479
Deferred tax assets, net			-				57
Right-of-use assets, net			1,726				2,215
Other assets			58				61
Total assets		$	41,617			$	58,509
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Line of credit		$	3,506			$	-
PPP Loan, current portion			447				-
Debt, net of issuance costs and discount			-				18,481
Accounts payable			482				1,097
Accrued expenses			983				1,871
Accrued compensation			2,240				1,876
Billings-in-excess of revenue earned			6,362				7,613
Accrued warranty			843				921
Income taxes payable			1,830				1,341
Other current liabilities			1,442				1,234
Total current liabilities			18,135				34,434
PPP Loan, noncurrent portion			9,597				-
Operating lease liabilities noncurrent			2,100				3,000
Other noncurrent liabilities			350				956
Total liabilities			30,182				38,390
Commitments and contingencies (Note 16)
Stockholders' equity:
Preferred stock $0.01 par value, 2,000,000 shares authorized, no shares issued and outstanding			-				-
Common stock $0.01 par value; 60,000,000 shares authorized, 22,220,324 shares issued, 20,621,413 shares outstanding as of September 30, 2020; 21,838,963 shares issued, 20,240,052 shares outstanding as of December 31, 2019			222				218
Additional paid-in capital			79,676				79,400
Accumulated deficit			(63,722	)			(54,654	)
Accumulated other comprehensive loss			(1,742	)			(1,846	)
Treasury stock at cost, 1,598,911 shares at September 30, 2020 and December 31, 2019			(2,999	)			(2,999	)
Total stockholders' equity			11,435				20,119
Total liabilities and stockholders' equity		$	41,617			$	58,509

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

GSE SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

		Three months ended								Nine months ended
		September 30, 2020				September 30, 2019				September 30, 2020				September 30, 2019
Revenue		$	12,922			$	20,031			$	44,967			$	65,683
Cost of revenue			9,603				15,358				33,971				50,407
Gross profit			3,319				4,673				10,996				15,276
Operating expenses:
Selling, general and administrative			2,878				3,465				12,548				12,231
Research and development			137				130				526				526
Restructuring charges			185				740				195				742
Loss on impairment			-				-				4,302				5,464
Depreciation			76				107				254				300
Amortization of intangible assets			414				596				1,528				1,804
Total operating expenses			3,690				5,038				19,353				21,067
Operating loss			(371	)			(365	)			(8,357	)			(5,791	)
Interest expense, net			(128	)			(288	)			(556	)			(812	)
Gain (loss) on derivative instruments, net			31				(61	)			35				(69	)
Other (expense) income, net			(77	)			59				(24	)			62
Loss before income taxes			(545	)			(655	)			(8,902	)			(6,610	)
Provision for (benefit from) income taxes			116				568				166				(874	)
Net loss		$	(661	)		$	(1,223	)		$	(9,068	)		$	(5,736	)
Net loss per common share - basic and diluted		$	(0.03	)		$	(0.06	)		$	(0.44	)		$	(0.29	)
Weighted average shares outstanding used to compute net loss per share - basic and diluted			20,563,452				20,007,469				20,438,571				20,021,829

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

GSE SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

(unaudited)

	Three months ended								Nine months ended
	September 30, 2020				September 30, 2019				September 30, 2020				September 30, 2019
Net loss		$	(661	)		$	(1,223	)		$	(9,068	)		$	(5,736	)
Cumulative translation adjustment			84				(89	)			104				(149	)
Comprehensive loss		$	(577	)		$	(1,312	)		$	(8,964	)		$	(5,885	)

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

GSE SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY

(in thousands)

(unaudited)

		Common Stock																				Treasury Stock
Nine months ended		Shares				Amount				Additional Paid-in Capital				Accumulated Deficit				Accumulated Other Comprehensive Loss				Shares				Amount				Total
Balance at January 1, 2020			21,839			$	218			$	79,400			$	(54,654	)		$	(1,846	)			(1,599	)		$	(2,999	)		$	20,119
Stock-based compensation			-				-				357				-				-				-				-				357
Common stock issued for RSUs vested			381				4				(4	)			-				-				-								-
Shares withheld to pay taxes			-				-				(77	)			-				-				-								(77	)
Foreign currency translation adjustment			-				-				-				-				104				-								104
Net loss			-				-				-				(9,068	)			-				-								(9,068	)
Balance at September 30, 2020			22,220			$	222			$	79,676			$	(63,722	)		$	(1,742	)			(1,599	)		$	(2,999	)		$	11,435
Balance at January 1, 2019			21,485			$	214			$	78,118			$	(42,569	)		$	(1,635	)			(1,599	)		$	(2,999	)		$	31,129
Stock-based compensation			-				-				1,238				-				-				-				-				1,238
Common stock issued for options exercised			9				1				89				-				-				-				-				90
Common stock issued for RSUs vested			295				3				(3	)			-				-				-				-				-
Shares withheld to pay taxes			-				-				(304	)			-				-				-				-				(304	)
Foreign currency translation adjustment			-				-				-				-				(149	)			-				-				(149	)
Net loss			-				-				-				(5,736	)			-				-				-				(5,736	)
Balance at September 30, 2019			21,789			$	218			$	79,138			$	(48,305	)		$	(1,784	)			(1,599	)		$	(2,999	)		$	26,268

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

GSE SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY

(in thousands)

(unaudited)

		Common Stock																				Treasury Stock
Three months ended		Shares				Amount				Additional Paid-in Capital				Accumulated Deficit				Accumulated Other Comprehensive Loss				Shares				Amount				Total
Balance at July 1, 2020			22,150			$	221			$	79,676			$	(63,061	)		$	(1,826	)			(1,599	)		$	(2,999	)		$	12,011
Stock-based compensation			-				-				33				-				-				-				-				33
Common stock issued for RSUs vested			70				1				(1	)			-				-				-				-				-
Shares withheld to pay taxes			-				-				(32	)			-				-				-				-				(32	)
Foreign currency translation adjustment			-				-				-				-				84				-				-				84
Net loss			-				-				-				(661	)			-				-				-				(661	)
Balance at September 30, 2020			22,220			$	222			$	79,676			$	(63,722	)		$	(1,742	)			(1,599	)		$	(2,999	)		$	11,435

Balance at July 1, 2019			21,699			$	217			$	79,028			$	(47,082	)		$	(1,695	)			(1,599	)		$	(2,999	)		$	27,469
Stock-based compensation			-				-				169				-				-				-				-				169
Common stock issued for options exercised			-				-				15				-				-				-				-				15
Common stock issued for RSUs vested			90				1				(1	)			-				-				-				-				-
Shares withheld to pay taxes			-				-				(73	)			-				-				-				-				(73	)
Foreign currency translation adjustment			-				-				-				-				(89	)			-				-				(89	)
Net loss			-				-				-				(1,223	)			-				-				-				(1,223	)
Balance at September 30, 2019			21,789			$	218			$	79,138			$	(48,305	)		$	(1,784	)			(1,599	)		$	(2,999	)		$	26,268

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

GSE SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

		Nine months ended
		September 30, 2020				September 30, 2019
Cash flows from operating activities:
Net loss		$	(9,068	)		$	(5,736	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Loss on impairment			4,302				5,464
Depreciation			254				300
Amortization of intangible assets			1,528				1,804
Amortization of capitalized software development costs			248				293
Amortization of deferred financing fees			155				-
Change in fair value of contingent consideration			-				(1,200	)
Stock-based compensation expense			357				1,150
Bad debt expense			103				48
(Gain) loss on derivative instruments, net			(35	)			69
Deferred income taxes			57				(1,276	)
Gain on sale of assets			(5	)			(7	)
Changes in assets and liabilities:
Contract receivables			6,114				7,314
Prepaid expenses and other assets			983				438
Accounts payable, accrued compensation and accrued expenses			(1,536	)			(2,400	)
Billings-in-excess of revenue earned			(1,195	)			(6,777	)
Accrued warranty			(285	)			102
Other liabilities			(332	)			82
Cash provided by (used in) operating activities			1,645				(332	)
Cash flows from investing activities:
Capital expenditures			(4	)			(127	)
Capitalized software development costs			(250	)			(326	)
Proceeds from sale of equipment			11				8
Acquisition of DP Engineering, net of cash acquired			-				(13,521	)
Cash used in investing activities			(243	)			(13,966	)
Cash flows from financing activities:
Proceeds from line of credit			4,200				-
Repayment of line of credit			(694	)			-
Proceeds from issuance of long-term debt			-				14,263
Repayment of long-term debt			(18,480	)			(3,029	)
Interest rate swap			(209	)			-
Proceeds from Paycheck Protection Program Loan			10,000				-
Proceeds from issuance of common stock			-				90
Deferred financing costs			(80	)			-
Shares withheld to pay taxes			(77	)			(304	)
Cash (used in) provided by financing activities			(5,340	)			11,020
Effect of exchange rate changes on cash and cash equivalents			(93	)			(239	)
Net decrease in cash and cash equivalents			(4,031	)			(3,517	)
Cash and cash equivalents at the beginning of the year			11,691				12,123
Cash and cash equivalents at the end of the period		$	7,660			$	8,606

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

GSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Basis of Presentation

GSE Systems, Inc. is a leading provider of professional and technical engineering, staffing services and simulation software to clients in the power and process industries. References in this report to "GSE" or "we" or "our" or "the Company" are to GSE Systems, Inc. and our subsidiaries, collectively.

The consolidated interim financial statements included herein have been prepared by GSE and are unaudited. In the opinion of our management, all adjustments and reclassifications of a normal and recurring nature necessary to present fairly the financial position, results of operations and cash flows for the periods presented, have been made. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles ("U.S. GAAP") have been condensed or omitted.

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. GAAP for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X. The accompanying balance sheet data for the year ended December 31, 2019 was derived from our audited financial statements, but it does not include all disclosures required by U.S. GAAP.

The results of operations for interim periods are not necessarily an indication of the results for the full year. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2019, filed with the U.S. Securities and Exchange Commission on June 11, 2020.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as reported amounts of revenues and expenses during the reporting period. Our most significant estimates relate to revenue recognition on contracts with customers, allowance for doubtful accounts, product warranties, valuation of goodwill and intangible assets acquired including the determination of fair value in impairment tests, valuation of long-lived assets to be disposed of, valuation of contingent consideration issued in business acquisitions, valuation of stock-based compensation awards and the recoverability of deferred tax assets. Actual results of these, and other items not listed, could differ from these estimates and those differences could be material.

COVID-19

GSE employees began working remotely during the first quarter of 2020 due to the COVID-19 pandemic and will continue to do so when practical and as mandated by local, state and federal directives and regulations. Employees almost entirely work from home within our Performance Improvement Solutions ("Performance") segment, except when required to be at the client site for essential project work. Our Performance contracts, which are considered an essential service, are permitted to and mostly continue without pause; however, we have experienced certain delays in new business. For our staff augmentation business, we have seen certain contracts for our Nuclear Industry Training and Consulting ("NITC") customers paused or delayed as clients shrink their own on-premise workforces to the minimum operating levels in response to the pandemic; as a result, our NITC segment has experienced a decline in its billable employee base since the start of the pandemic. Although we cannot fully estimate the length or gravity of the impact of the COVID-19 pandemic to our business at this time, we have experienced delays in commencing new projects and thus our ability to recognize revenue has been delayed for some contracts. We have also experienced order reductions or other negative changes to orders due to the pandemic. We routinely monitor our operating expenses as a result of contract delays and have made adjustments to keep our gross profit at a sustainable level. As a result of the COVID-19 pandemic, we expect our financial results for the fiscal year 2020 to be lower than fiscal 2019 and forecasts we prepared at the beginning of the 2020 year.

Going Concern

As a result of the COVID-19 pandemic, we have experienced a negative impact on our fiscal 2020 financial position and results of operations. We will likely continue to experience delays in commencing work on outstanding orders or loss of orders altogether, disruption of our business as a result of worker illness or mandated shutdowns, and decline in our ability to refinance existing indebtedness and access new capital.

We signed the Eighth Amendment and Reaffirmation Agreement (the “Eighth Amendment”) with Citizens Bank National Association (the “Bank"), resulting in the full payoff of our long-term debt during the three months ended September 30, 2020, in response to the breach of our Adjusted EBITDA debt covenant during the three months ended June 30, 2020. The Eighth Amendment also altered or removed certain of our debt covenants and required a minimum US liquidity of $3.5 million to be tested biweekly (see Note 10). We continue to experience a negative impact to our results of operations and financial position from the COVID-19 pandemic. Based upon our current projections and outstanding balance on our revolving line of credit, we may be in violation of our leverage ratio in Q1 2021; however, we believe we have various options available to remediate or prevent the potential violation. Our options include continuing to development new revenue opportunities, reducing our operating costs such as our workforce, including reductions in compensation and benefits or eliminating fixed costs such as office space. In addition, we may further pay down outstanding debt balances by repatriating cash held in foreign operations. If necessary, we could potentially refinance our debt obligations, to an asset based or other loan arrangement.  Also, working with our bank, we could potentially obtain additional debt amendments, including waivers of potential covenant breaches. We have no assurance that it will be possible to implement any of these on acceptable terms, however.

We received $10 million pursuant to the Paycheck Protection Program (““PPP”) under the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) and indicated that without these funds, the risk of employee terminations, layoffs and other drastic cost reductions exists. Although the PPP funds have provided us with additional liquidity, these funds did not prevent us from failing to comply with our minimum Adjusted EBITDA covenant with our Bank during the three months ended June 30, 2020. While the Company expects the PPP loan to be forgiven, we are unable to determine with certainty whether we will receive forgiveness from the Small Business Administration (see Note 4).

Including the proceeds from the PPP, we believe we have sufficient cash to meet our operating requirement needs for at least the next twelve months; however, since some of our loan covenants are related to operating performance and our operating performance continues to be impacted by the COVID-19 pandemic, we may be in violation with our amended debt covenants during fiscal 2021. If we are unable to maintain compliance with our covenants, the Bank may call our outstanding Revolving Line of Credit due, which may create substantial doubt regarding our ability to continue as a going concern.

Accounting pronouncements recently adopted

In January 2017, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2017-04, Simplifying the Test for Goodwill Impairment ("ASU 2017-04"). ASU 2017-04 simplifies the accounting for goodwill impairment by eliminating Step 2 of the current goodwill impairment test, which required a hypothetical purchase price allocation. Goodwill impairment will now be the amount by which the reporting unit's carrying value exceeds its fair value, limited to the carrying value of the goodwill. ASU 2017-04 is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2019.

We adopted the new standard and began using the simplified approach on January 1, 2020.

Accounting pronouncements not yet adopted

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses, which introduces new guidance for credit losses on instruments within its scope. The new guidance introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments, including, but not limited to, trade and other receivables, held-to-maturity debt securities, loans and net investments in leases. The new guidance also modifies the impairment model for available-for-sale debt securities and requires the entities to determine whether all or a portion of the unrealized loss on an available-for-sale debt security is a credit loss. The standard also indicates that entities may not use the length of time a security has been in an unrealized loss position as a factor in concluding whether a credit loss exists. Early adoption is permitted for all entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. On October 16, 2019, the FASB voted to defer the deadlines for private companies and certain small public companies, including smaller reporting companies, to implement the new accounting standards on credit losses. The new effective date is January 1, 2023. As a smaller reporting company, we have elected to defer adoption in line with new deadlines and are currently evaluating the effects, if any, that the adoption of this guidance will have on our consolidated financial position, results of operations and cash flows.

In January 2020, the FASB issued ASU 2020-01, Investments – Equity Securities, Investments – Equity Method and Joint Ventures, and Derivatives and Hedging, which provides clarity for companies that holds equity securities at cost to first update the fair value of an investment, immediately prior to applying the Equity Method of Accounting; or clarity for companies that enter into forward contracts to purchase additional shares of an equity security that would then require the investee to account for the investment via the Equity Method. This ASU is applicable for public companies starting with fiscal years beginning after December 31, 2020 and interim periods within those fiscal years. The Company plans to adopt ASU 2020-01 in Q1 of Fiscal 2021 and does not currently hold any investments at cost, and thus expects no impact to its financial statements.

In September 2020, the FASB issued ASU 2020-10, Codification Improvements, which is part of an ongoing attempt to improve the consistency of the codification. Previously the option to disclose information it the footnotes to the financial statements was in one of two sections: Disclosure Section (Section 50) or Other Presentation Matters (Section 45). ASU 2010-10 conforms the disclosure requirements into Section 50 and provides additional information on specific guidance that was previously unclear or not included in the codification. This ASU is applicable for Public Companies starting with fiscal years beginning after December 15, 2020, with early adoption available for interim and annual financial statements not already filed and using the retrospective approach. Currently, the Company is reviewing the guidance for applicability; however, the FASB does not believe that this should change any of the current reporting or disclosure requirements. The Company plans to adopt ASU 2020-10 starting in Q1 of Fiscal 2021.

Basic loss per share is computed by dividing net loss by the weighted average number of outstanding shares of common stock for the period. Diluted net loss per share adjusts the weighted average shares outstanding for the potential dilution that could occur if outstanding vested stock options were exercised and restricted stock units ("RSU") were vested, unless the impact of such potential dilutive common shares outstanding would be anti-dilutive. Since we experienced a net loss in each period presented, basic and diluted net loss per common share were the same.

The number of common shares and common share equivalents used in the determination of basic and diluted loss per common share were as follows:

(in thousands, except for share amounts)		Three months ended								Nine months ended
		September 30, 2020				September 30, 2019				September 30, 2020				September 30, 2019
Numerator:
Net loss		$	(661	)		$	(1,223	)		$	(9,068	)		$	(5,736	)
Denominator:
Weighted-average shares outstanding for basic loss per share			20,563,452				20,007,469				20,438,571				20,021,829
Effect of dilutive securities:
Stock options and restricted stock units			-				-				-				-
Adjusted weighted-average shares outstanding and assumed conversions for diluted loss per share			20,563,452				20,007,469				20,438,571				20,021,829
Shares related to dilutive securities excluded from calculation because inclusion would be anti-dilutive			66,261				578,676				12,172				397,131

We entered into the PPP Loan agreement with our Bank, which was approved and funded on April 24, 2020, pursuant to the Paycheck Protection Program under the Coronavirus Aid, Relief and Economic Security Act (the "CARES Act"). The PPP Loan matures on April 24, 2022 and bears interest at a rate of 1.0% per annum. Monthly amortized principal and interest payments are due for any portion of the loan balance that is not forgiven and are automatically deferred for ten months after the last day of our covered period on August 9, 2021.

The PPP Loan contains events of default and other provisions customary for a loan of this type. The Payroll Protection Program provides that (1) the use of PPP Loan amount shall be limited to certain qualifying expenses, (2) 100% of the principal amount of the loan is guaranteed by the Small Business Administration ("SBA") and (3) an amount up to the full principal and any accrued interest may qualify for loan forgiveness in accordance with the terms of CARES Act. We are not yet able to determine the amount that might be forgiven, but we have accumulated forgivable expenses beyond our original loan amount and are currently assessing any potential limiting factors as a part of the process to file with the Bank. We are ultimately subject to the SBA’s review process for forgiveness. To the extent the loan amount is not forgiven under the PPP, we are obligated to make equal monthly payments of principal and interest, beginning after review of forgiveness by the Bank.

The SBA provides for certain customary events of default, including if the Company (i) fails to do anything required by the Note and other Loan Documents; (ii) does not disclose, or anyone acting on its behalf does not disclose, any material fact to the Bank or the SBA; (iii) makes, or anyone acting on its behalf makes, a materially false or misleading representation to lender or the SBA; (iv) reorganizes, merges, consolidates or otherwise changes ownership or business structure without the Bank’s prior written consent; (v) takes certain prohibited actions after the Bank makes a determination that the PPP Loan is not entitled to full forgiveness. Upon default the Bank may require immediate payment of all amounts owing under the PPP Loan or file suit and obtain judgment.

As of September 30, 2020, we have classified the $10 million of outstanding PPP Loan and accrued interest of $44 thousand as debt in our consolidated balance sheets. We classified $0.4 million as current and $9.6 million as noncurrent in our consolidated balance sheets. We recorded $26 thousand and $44 thousand of interest expense during the three and nine months ended September 30, 2020, respectively.

As of September 30, 2020, the Company believes it was in full compliance with all requirements in order to apply for forgiveness under the PPP Loan. We may apply for forgiveness any time on or before the maturity date of the loan.

Contract receivables represent our unconditional rights to consideration due from our domestic and international customers. We expect to collect all contract receivables within the next twelve months.

The components of contract receivables were as follows:

(in thousands)		September 30, 2020				December 31, 2019
Billed receivables		$	5,319			$	11,041
Unbilled receivables			6,239				6,624
Allowance for doubtful accounts			(415	)			(458	)
Total contract receivables, net		$	11,143			$	17,207

Management reviews collectability of receivables periodically and records an allowance for doubtful accounts to reduce the Company's receivables to their net realizable value when management determines it is probable that we will not be collect all amounts according to the contractual terms of the receivable. The allowance for doubtful accounts is based on historical trends of past due accounts, write-offs, specific identification and review of customer accounts.

During the three months ended September 30, 2020 and 2019, we recorded bad debt expense of $10 thousand and $48 thousand, respectively. During the nine months ended September 30, 2020 and 2019, we recorded bad debt expense of $0.1 million and $48 thousand, respectively.

During the month of October 2020, we invoiced $2.6 million of the unbilled amounts as of the period ended September 30, 2020. We expect to bill the remaining unbilled amounts during the remainder of fiscal 2020.

As of September 30, 2020, we had two customers that accounted for 9% and 7% of our consolidated contract receivables. As of December 31, 2019, we had two customers that accounted for 13% and 10% of our consolidated contract receivables.

Goodwill

We review goodwill for impairment annually as of December 31 and whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable. We test goodwill at the reporting unit level. A reporting unit is an operating segment, or one level below an operating segment, as defined by U.S. GAAP. We have determined that we have two reporting units, which are the same as our two operating segments: (i) Performance Improvement Solutions ("Performance") and (ii) Nuclear Industry Training and Consulting ("NITC").

We reviewed our goodwill for impairment as of the first quarter of fiscal 2020, due to the COVID-19 interim triggering event. Based upon our analysis, we determined the fair value of our goodwill at the reporting unit level exceeded the carrying value and determined no impairment charge was required as of the period ended March 31, 2020. No other triggering event was noted during the nine months ended September 30, 2020.

The table below reflects the net carrying amount of goodwill from January 1, 2020 to September 30, 2020 for each reporting segment:

(in thousands)

		Performance				NITC				Total
Balance at January 1, 2020		$	4,908			$	8,431			$	13,339
Balance at September 30, 2020		$	4,908			$	8,431			$	13,339

Intangible Assets Subject to Amortization

Amortization of intangible assets other than goodwill is recognized on a straight-line basis over the estimated useful life of the intangible assets, except for customer relationships, which are recognized in proportion to the related projected revenue streams. Intangible assets with definite lives are reviewed for impairment if indicators of impairment arise. GSE does not have any intangible assets with indefinite useful lives other than goodwill.

During the first quarter of fiscal 2020, we determined that the impact of the COVID-19 pandemic on our operations was an indicator of a triggering event that could result in an impairment of our long-lived assets. As such, we performed an interim analysis to determine if an impairment existed as of the period ended March 31, 2020 by its individual asset groupings, which management determined to be at the subsidiary level. We used a discounted cash flow analysis to test for impairment and concluded that the carrying value of the definite-lived intangible assets of DP Engineering exceeded its fair value by $4.3 million, and we recorded an impairment for this amount as of the three months ended March 31, 2020.

Management determined no additional triggering impact occurred during the nine months ended September 30, 2020.

Changes in the gross carrying amount, accumulated amortization and impairment of definite-lived intangible assets were as follows:

(in thousands)		As of September 30, 2020
		Gross Carrying Amount				Accumulated Amortization				Impact of Impairment				Net
Amortized intangible assets:
Customer relationships		$	11,730			$	(5,207	)		$	(3,102	)		$	3,421
Trade names			2,467				(952	)			(778	)			737
Developed technology			471				(471	)			-				-
Non-contractual customer relationships			433				(433	)			-				-
Noncompete agreements			949				(313	)			(422	)			214
Alliance agreements			527				(250	)			-				277
Others			167				(167	)			-				-
Total		$	16,744			$	(7,793	)		$	(4,302	)		$	4,649

(in thousands)		As of December 31, 2019
		Gross Carrying Amount				Accumulated Amortization				Net
Amortized intangible assets:
Customer relationships		$	11,730			$	(4,079	)		$	7,651
Trade names			2,467				(727	)			1,740
Developed technology			471				(471	)			-
Non-contractual customer relationships			433				(433	)			-
Noncompete agreements			949				(217	)			732
Alliance agreements			527				(171	)			356
Others			167				(167	)			-
Total		$	16,744			$	(6,265	)		$	10,479

Amortization expense related to definite-lived intangible assets totaled $0.4 million and $0.6 million for the three months ended September 30, 2020 and 2019. Amortization expense totaled $1.5 million and $1.8 million for the nine months ended September 30, 2020 and 2019, respectively. The following table shows the estimated amortization expense of our definite-lived intangible assets for the next five years and thereafter:

(in thousands)
Years ended December 31:
2020 (remainder)		$	415
2021			1,213
2022			911
2023			640
2024			435
and thereafter			1,035
Total		$	4,649

ASC 820, Fair Value Measurement, defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The levels of the fair value hierarchy established by ASC 820 are:

Level 1:  inputs are quoted prices, unadjusted, in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

Level 2:  inputs are other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. A Level 2 input must be observable for substantially the full term of the asset or liability. The Monte Carlo model was used to calculate the fair value of level 2 instrument liability award. The inputs used are current stock price, expected term, risk-free rate, number of trials, volatility and interest rates.

Level 3:  inputs are unobservable and reflect the reporting entity’s own assumptions about the assumptions that market participants would use in pricing the asset or liability.

As of September 30, 2020 and December 31, 2019, we considered the recorded value of certain of our financial assets and liabilities, which consist primarily of cash and cash equivalents, contract receivable and accounts payable, to approximate fair value based upon their short-term nature.

For the three and nine months ended September 30, 2020 and 2019, we did not have any transfers between fair value Level 1, Level 2 or Level 3. We did not hold any non-financial assets or non-financial liabilities subject to fair value measurements on a recurring basis as of September 30, 2020.

Money market funds as of both September 30, 2020 and December 31, 2019 are included in cash and cash equivalents in the respective consolidated balance sheets.

The following table presents assets measured at fair value at September 30, 2020:

The following table presents assets and liabilities measured at fair value at December 31, 2019:

(in thousands)		Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)				Total
Money market funds		$	434			$	-			$	-			$	434
Foreign exchange contracts			-				49				-				49
Total assets		$	434			$	49			$	-			$	483
Liability awards		$	-			$	(9	)		$	-			$	(9	)
Interest rate swap contract			-				(160	)			-				(160	)
Total liabilities		$	-			$	(169	)		$	-			$	(169	)

As of December 31, 2019, we had classified our foreign exchange contracts within Other Assets. Our interest rate swap contract and liability awards were classified within other noncurrent assets as of the period ended December 31, 2019.

In the normal course of business, our operations are exposed to fluctuations in foreign currency values and interest rate changes. We may seek to control a portion of these risks through a risk management program that includes the use of derivative instruments.

Foreign Currency Risk Management

Our foreign currency denominated contract receivables, billings in excess of revenue earned and subcontractor accruals that are related to the outstanding foreign exchange contracts are remeasured at the end of each period into our functional currency, using the current exchange rate at the end of the period. The gain or (loss) resulting from such remeasurement is also included in gain (loss) on derivative instruments, net in the consolidated statements of operations.

We utilize foreign currency exchange contracts to manage market risks associated with fluctuations in foreign currency exchange rates and to minimize credit exposure by limiting counterparties to nationally recognized financial institutions.

As of September 30, 2020, we had no foreign exchange contracts outstanding.

Interest Rate Risk Management

As discussed in Note 10, we signed the Eighth Amendment and Reaffirmation Agreement with our Bank and repaid the $9.1 million outstanding balance on our term loans. Accordingly, we exited the swap agreement related to this loan and paid $0.2 million in cash.

For the periods presented, we did not elect to designate any of our derivative contracts as hedges. Changes in the fair value of the derivative contracts are included in gain (loss) on derivative instruments, net in the consolidated statements of operations.

We recognized a net gain (loss) on our derivative instruments as outlined below:

		Three months ended								Nine months ended
(in thousands)		September 30, 2020				September 30, 2019				September 30, 2020				September 30, 2019
Interest rate swap		$	25			$	(1	)		$	(49	)		$	(89	)
Foreign exchange contracts			-				(45	)			17				25
Remeasurement of related contract receivables, billings-in-excess of revenue earned, and subcontractor accruals			6				(15	)			67				(5	)
Gain (loss) on derivative instruments, net		$	31			$	(61	)		$	35			$	(69	)

We recognize compensation expense for all equity-based compensation awards issued to employees and directors that are expected to vest. Stock compensation is calculated based upon the fair value of awards as of the grant date. During the three months ended September 30, 2020 and 2019, we recognized $0.03 million in stock-based compensation expense and $0.2 million of stock-based compensation expense related to equity awards, respectively. We recognized $0.4 million and $1.2 million of stock-based compensation expense related to equity awards for the nine months ended September 30, 2020 and 2019, respectively, under the fair value method. In addition to the equity-based compensation expense recognized, the Company also recognized $0 and $60 thousand of stock-based compensation related to the change in the fair value of cash-settled restricted stock units (RSUs) during the three months ended September 30, 2020 and 2019, respectively. During the nine months ended September 30, 2020, the Company recorded stock-based compensation income of $6 thousand and income of $88 thousand for the same period ended 2019 for the fair value of cash-settled RSUs, respectively.

During the three and nine months ended September 30, 2020, we granted approximately 130,000 and 170,000 time-based RSUs with an aggregate fair value of approximately $0.1 million and $0.2 million, respectively. During the three and nine months ended September 30, 2019, we granted approximately 8,500 and 509,000 time-based RSUs with an aggregate fair value of $20 thousand and $1.4 million, respectively. A portion of the time-based RSUs vest quarterly in equal amounts over the course of eight quarters, and the remainder vest annually in equal amounts over the course of one to three years. The fair value of the time-based RSUs is expensed ratably over the requisite service period, which ranges from one to three years.

GSE’s 1995 long-term incentive program ("LTIP") provides for the issuance of performance-vesting and time-vesting restricted stock units to certain executives and employees. Vesting of the performance-vesting restricted stock units ("PRSU") is contingent upon the employee's continued employment and the Company's achievement of certain performance goals during designated performance periods as established by the Compensation Committee of the Company's Board of Directors. We recognize compensation expense, net of estimated forfeitures, for PRSU's on a straight-line basis over the performance period based on the probable outcome of achievement of the financial targets. At the end of each reporting period, we estimate the number of PRSUs that are expected to vest, based on the probability and extent to which the performance goals will be met, and take into account these estimates when calculating the expense for the period. If the number of shares expected to be earned changes during the performance period, we make a cumulative adjustment to compensation expense based on the revised number of shares expected to be earned.

During the three months ended September 30, 2020, we did not grant any performance-based RSUs to employees and during the nine months ended September 30, 2020 we granted approximately 512,000 performance-based RSUs with an aggregate fair-value of $0.6 million to key employees. Based upon our current forecasts, we do not expect to achieve the Adjusted EBITDA targets. A cumulative adjustment reversing $0.1 million of expense recognized in the first half of 2020 was recorded in the three months ended September 30, 2020 upon determination that vesting was no longer probable for the revenue and EBITDA targets.

During the nine months ended September 30, 2019, we granted approximately 350,000 performance-based RSUs to key employees with an aggregate fair-value of $0.9 million. These awards vest over three years based upon achieving certain financial metrics achieved during fiscal 2021 for revenue and Adjusted EBITDA. A cumulative adjustment reversing $0.2 million of expense recognized in the first half of 2019 was recorded in the three months ended September 30, 2019 upon determination that vesting was no longer probable for the revenue and EBITDA targets.

The Company did not grant any stock options for three and nine months ended September 30, 2020 and 2019.

On December 29, 2016, we entered a 3-year $5.0 million revolving line of credit facility with Citizens Bank National Association (the “Bank") to fund general working capital needs and acquisitions. On May 11, 2018, we entered into the Amended and Restated Credit and Security Agreement (the “Credit Agreement” or the “Credit Facility”) to (a) expand the $5.0 million revolving line of credit (the “RLOC”) to include a letter of credit sub-facility and not be subject to a borrowing base and (b) to add a $25.0 million term loan facility, available to finance permitted acquisitions over the following 18 months. The credit facility was subject to certain financial covenants and reporting requirements and was scheduled to mature in five years on May 11, 2023 and accrued interest at the one-month USD LIBOR, plus a margin that varies depending on our overall leverage ratio. The RLOC had required monthly payments of only interest, with principal due at maturity, while our term loan draws required monthly payments of principal and interest based on an amortization schedule. Our obligations under the Credit Agreement was guaranteed by our wholly owned subsidiaries Hyperspring, Absolute, True North, DP Engineering and by any future material domestic subsidiaries (collectively, "the Guarantors").

On January 8, 2020, due to an expected violation of our covenants, we entered into the Sixth Amendment and Reaffirmation Agreement with an effective date of December 31, 2019, with our Bank to relax the fixed charge coverage ratio and leverage ratio and delay testing of both financial covenants. We agreed to an additional covenant, requiring us to maintain a consolidated Adjusted EBITDA target of $4.25 million, tested quarterly as of December 31, 2019, March 31, 2020 and June 30, 2020. Further, we agreed to maintain a minimum USA liquidity of at least $5.0 million in the aggregate, tested bi-weekly as of the fifteenth and the last day of each month, beginning on December 31, 2019 and until June 30, 2020. In addition to the revised covenants, we agreed to make accelerated principal payments of $3.0 million on January 6, 2020; $1.0 million on March 31, 2020; and $0.5 million on June 30, 2020. We incurred $20 thousand of debt issuance costs related to this amendment.

 

On April 17, 2020, we entered into the Seventh Amendment and Reaffirmation Agreement and effective March 31, 2020, which required us to maintain a minimum fixed charge coverage ratio of 1.25 to 1.00, tested quarterly as of the last day of each quarter, beginning with the quarter ending June 30, 2021. In addition, we agreed to not exceed a maximum leverage ratio, tested quarterly as of the last day of each quarter and beginning with the quarter ending September 30, 2020 as follows:  (i) 3.00  to 1.00 for the period ending on September 30, 2020; (ii) 2.50 to 1.00 for the period ending on December 31, 2020; and (iii) 2.25 to 1.00 for the period ending on March 31, 2021 and for the periods ending December 31, March 31, June 30 and September 30, thereafter. We additionally agreed to make accelerated principal payments of $0.75 million on April 17, 2020 and $0.5 million on June 30, 2020. We incurred $50 thousand of debt issuance costs related to this amendment.

On August 28, 2020, we signed the Eighth Amendment and Reaffirmation Agreement, “the Eighth Amendment”, with an effective date of June 29, 2020, due to violating our minimum Adjusted EBITDA covenant during the three months ended June 30, 2020. As part of the amendment, we agreed to pay $10 million to the Bank during the three months ended September 30, 2020, of which $694 thousand was paid to reduce our RLOC. We paid $9.1 million of our long-term debt and paid out $0.2 million for the unwinding of the interest rate swap agreement during the quarter. We incurred $10 thousand in additional debt issuance costs related to the amendment, which we expensed during the three months ended September 30, 2020.

The amendment removed our minimum Adjusted EBITDA covenant and changed our other debt covenants on an ongoing basis as follows: our maximum fixed charge coverage ratio will be tested quarterly as of the last day of each quarter, beginning with the quarter ending December 31, 2021 and must be 1.00 to 1.00; our leverage ratio will be tested quarterly, starting on March 31, 2021 as follows: (i) 3.00 to 1.00 for the period ending March 31, 2021; (ii) 2.75 to 1.00 for the period ending on June 30, 2021, (iii) 2.50 to 1.00 for the period ending on September 30, 2021, and (iv) 2.00 to 1.00 for the period ending on December 31, 2021 and for the periods ending on each December 31st, March 31st, June 30th and September 30th thereafter. We are also required to maintain a minimum of $3.5 million in aggregate USA liquidity, which was tested on September 15, 2020 and will be tested bi-weekly on an on-going basis. We are currently projecting to be in violation of our Q1 2021 leverage ratio and are considering several options at our disposal to address the matter (See Note 1).

The PPP Loan does not factor into the expenses or liabilities used in the calculation of our debt covenants, unless we determine that more than $1 million of the original PPP Loan balance will not be forgiven.

The Bank also agreed to remove its collateral agreement with the Company’s subsidiaries as part of the Eighth Amendment and repayment of our outstanding term loans during the three months ended September 30, 2020.

Revolving Line of Credit (“RLOC”)

 

During the three months ended September 30, 2020, we paid down $0.7 million on our RLOC as part of the Eighth Amendment and Reaffirmation Agreement, discussed above. We immediately drew down $0.7 million on the RLOC to fund our working capital needs. As of September 30, 2020, we had outstanding borrowings of $3.5 million under the RLOC and four letters of credit totaling $1.2 million outstanding to certain of our customers. After consideration of letters of credit, the amount available under the RLOC was approximately $0.3 million as of September 30, 2020. 

We intend to continue using the RLOC for short-term working capital needs and the issuance of letters of credit in connection with business operations. 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. 

Term Loans 

As part of the Eight Amendment and Reaffirmation Agreement discussed above, we repaid all of $9.1 million outstanding balance on our term during the three months ended September 30, 2020.

We acquired DP Engineering on February 15, 2019 for approximately $13.5 million in cash, mainly from proceeds of $14.3 million from a term loan with our Bank. As of September 30, 2020, the loan is fully repaid and incurred interest at the adjusted USD LIBOR, plus a margin ranging between 2.00% and 2.75% depending on our overall leverage ratio. There were no debt issuance costs or loan origination fees associated with this transaction. 

 

To fund the acquisition of True North, we borrowed $10.3 million on May 11, 2018, and immediately repaid $0.5 million to the Bank on the same day. The loan is fully repaid and incurred interest at the one-month USD LIBOR, plus a margin ranging between 2.00% and 2.75% depending on our overall leverage ratio. We incurred $70 thousand in debt issuance costs and $75 thousand of loan origination fees related to this transaction, which were fully amortized as of the period ended September 30, 2020, due to a write-off of $0.1 million previously unamortized debt issuance costs during the quarter.

We accrue for estimated warranty costs at the time the related revenue is recognized and based on historical experience and projected claims. Our System Design and Build contracts generally include a one year base warranty on the systems. The portion of our warranty provision expected to be incurred within 12 months is classified as current within accrued warranty and totals $0.8 million and the remaining $0.2 million is classified as long-term within other noncurrent liabilities. The activity in the accrued warranty accounts during the current period is as follows:

(in thousands)
Balance at January 1, 2020		$	1,323
Current period provision			(136	)
Current period claims			(149	)
Currency adjustment			9
Balance at September 30, 2020		$	1,047

We primarily generate revenue through three distinct revenue streams: (1) System Design and Build ("SDB"), (2) Software and (3) Training and Consulting Services across our Performance and NITC segments. We recognize revenue from SDB and software contracts mainly through our Performance segment. We recognize training and consulting service contracts through both segments.

The following table represents a disaggregation of revenue by type of goods or services for three and nine months ended September 30, 2020 and 2019, along with the reporting segment for each category:

		Three months ended								Nine months ended
(in thousands)		September 30, 2020				September 30, 2019				September 30, 2020				September 30, 2019
Performance segment
SDB		$	2,473			$	4,435			$	9,535			$	16,472
Software			942				786				2,575				2,170
Training and consulting			3,842				6,196				13,130				17,975
NITC segment
Training and consulting			5,665				8,614				19,727				29,066
Total revenue		$	12,922			$	20,031			$	44,967			$	65,683

SDB contracts are typically fixed-priced, and we receive payments based on a billing schedule established in our contracts. We generally have two main performance obligations: (1) the training simulator build and (2) the Post Contract Support ("PCS") period. Fees for PCS are normally paid in advance of the related service period.

The training simulator build generally includes hardware, software and labor. We recognize revenue for the training simulator build over the construction and installation period, using the cost-to-cost input method. In applying the cost-to-cost input method, we use the actual costs incurred to date, relative to the total estimated costs, to measure the work progress towards the completion of the performance obligation and recognize revenue accordingly. Estimated contract costs are reviewed and revised periodically during the contract period, and the cumulative effect of any change in estimates is recognized in the period in which the change is identified. Estimated losses are recognized in the period such losses are identified. Uncertainties inherent in the performance of contracts include labor availability and productivity, material costs, change order scope and pricing, software modification and customer acceptance issues. The reliability of these cost estimates is critical to our revenue recognition as a significant change in the estimates can cause our revenue and related margins to change significantly from the amounts estimated in the early stages of the project.

The transaction price for Software contracts is generally fixed, and we recognize revenue upon delivery of the software, with fees due in advance or shortly after delivery of the software.

We recognize Training and Consulting Services revenue as services are performed and bill our customers for services that we have provided on a regular basis (i.e. weekly, biweekly or monthly) and in time with revenue recognition.

Contract liability, which we classify as billing-in-excess of revenue earned, relates to payments received in advance of performance under the contract. Contract liabilities are recognized as revenue as performance obligations are satisfied.

The following table reflects revenue recognized in the reporting periods presented that was included in contract liabilities from contracts with customers as of the beginning of the periods presented:

(in thousands)	Three months ended								Nine months ended
	September 30, 2020				September 30, 2019				September 30, 2020				September 30, 2019
Revenue recognized in the period from amounts included in Billings-in-Excess of Revenue Earned at the beginning of the period		$	1,520			$	762			$	6,221			$	8,615

The following table presents the provision for (benefit from) income taxes and our effective tax rates:

(in thousands)		Three months ended								Nine months ended
		September 30, 2020				September 30, 2019				September 30, 2020				September 30, 2019
Loss before income taxes		$	(545	)		$	(655	)		$	(8,902	)		$	(6,610	)
Provision for (benefit from) income taxes