GSE Systems Earnings 2020-06-30

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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 June 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 20,553,913 shares of common stock, with a par value of $0.01 per share outstanding as of July 31, 2020.

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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 June 30, 2020 (unaudited) and December 31, 2019	3
	Unaudited Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2020 and 2019	4
	Unaudited Consolidated Statements of Comprehensive Loss for the Three and Six Months Ended June 30, 2020 and 2019	5
	Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the Three and Six Months Ended June 30, 2020 and 2019	6
	Unaudited Consolidated Statements of Cash Flows for the Six months Ended June 30, 2020 and 2019	8
	Notes to Consolidated Financial Statements	9
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	23
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	37
Item 4.	Controls and Procedures	37
PART II.	OTHER INFORMATION	38
Item 1.	Legal Proceedings	38
Item 1A.	Risk Factors	38
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	40
Item 5.	Other Information	40
Item 6.	Exhibits	41

GSE SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)

		June 30, 2020				December 31, 2019
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	18,298			$	11,691
Contract receivables, net			12,335				17,207
Prepaid expenses and other current assets			1,935				1,880
Total current assets			32,568				30,778
Equipment, software and leasehold improvements, net of accumulated depreciation of ($4,659) and ($4,584)			756				939
Software development costs, net			633				641
Goodwill			13,339				13,339
Intangible assets, net			5,063				10,479
Deferred tax assets, net			-				57
Right-of-use assets, net			1,839				2,215
Other assets			61				61
Total assets		$	54,259			$	58,509
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Line of credit		$	3,500			$	-
Debt, net of issuance costs and discount			9,815				18,481
Accounts payable			505				1,097
Accrued expenses			1,109				1,871
Accrued compensation			2,445				1,876
Billings-in-excess of revenue earned			7,132				7,613
Accrued warranty			952				921
Income taxes payable			1,707				1,341
Other current liabilities			2,042				1,234
Total current liabilities			29,207				34,434
Paycheck Protection Program Loan (PPP)			10,000				-
Operating lease liabilities noncurrent			2,405				3,000
Other noncurrent liabilities			636				956
Total liabilities			42,248				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, 22,149,735 shares issued, 20,550,824 shares outstanding as of June 30, 2020; 21,838,963 shares issued, 20,240,052 shares outstanding as of December 31, 2019			221				218
Additional paid-in capital			79,676				79,400
Accumulated deficit			(63,061	)			(54,654	)
Accumulated other comprehensive loss			(1,826	)			(1,846	)
Treasury stock at cost, 1,598,911 shares at June 30, 2020 and December 31, 2019			(2,999	)			(2,999	)
Total stockholders' equity			12,011				20,119
Total liabilities and stockholders' equity		$	54,259			$	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								Six months ended
		June 30, 2020				June 30, 2019				June 30, 2020				June 30, 2019
Revenue		$	14,340			$	23,458			$	32,045			$	45,652
Cost of revenue			10,778				17,591				24,368				35,049
Gross profit			3,562				5,867				7,677				10,603
Operating expenses:
Selling, general and administrative			4,722				4,343				9,670				8,766
Research and development			179				156				389				396
Restructuring charges			-				2				10				2
Loss on impairment			-				-				4,302				5,464
Depreciation			70				102				178				193
Amortization of intangible assets			444				638				1,114				1,208
Total operating expenses			5,415				5,241				15,663				16,029
Operating (loss) income			(1,853	)			626				(7,986	)			(5,426	)
Interest expense, net			(187	)			(316	)			(428	)			(524	)
Gain (loss) on derivative instruments, net			47				(101	)			4				(8	)
Other income (expense), net			24				(19	)			53				3
(Loss) income before income taxes			(1,969	)			190				(8,357	)			(5,955	)
Provision for (benefit from) income taxes			180				406				50				(1,442	)
Net loss		$	(2,149	)		$	(216	)		$	(8,407	)		$	(4,513	)
Net loss per common share - basic and diluted		$	(0.11	)		$	(0.01	)		$	(0.41	)		$	(0.23	)
Weighted average shares outstanding used to compute net loss per share - basic and diluted			20,407,958				20,006,492				20,375,446				19,979,018

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								Six months ended
		June 30, 2020				June 30, 2019				June 30, 2020				June 30, 2019
Net loss		$	(2,149	)		$	(216	)		$	(8,407	)		$	(4,513	)
Cumulative translation adjustment			206				27				20				(60	)
Comprehensive loss		$	(1,943	)		$	(189	)		$	(8,387	)		$	(4,573	)

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
Six 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 expense			-				-				324				-				-				-				-				324
Common stock issued for RSUs vested			311				3				(3	)			-				-				-								-
Shares withheld to pay taxes			-				-				(45	)			-				-				-								(45	)
Foreign currency translation adjustment			-				-				-				-				20				-								20
Net loss			-				-				-				(8,407	)			-				-								(8,407	)
Balance at June 30, 2020			22,150			$	221			$	79,676			$	(63,061	)		$	(1,826	)			(1,599	)		$	(2,999	)		$	12,011
Balance at January 1, 2019			21,485			$	214			$	78,118			$	(42,569	)		$	(1,635	)			(1,599	)		$	(2,999	)		$	31,129
Stock-based compensation expense			-				-				1,069				-				-				-				-				1,069
Common stock issued for options exercised			9				1				74				-				-				-				-				75
Common stock issued for RSUs vested			205				2				(2	)			-				-				-				-				-
Shares withheld to pay taxes			-				-				(231	)			-				-				-				-				(231	)
Foreign currency translation adjustment			-				-				-				-				(60	)			-				-				(60	)
Net loss			-				-				-				(4,513	)			-				-				-				(4,513	)
Balance at June 30, 2019			21,699			$	217			$	79,028			$	(47,082	)		$	(1,695	)			(1,599	)		$	(2,999	)		$	27,469

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 April 1, 2020			21,979			$	219			$	79,495			$	(60,912	)		$	(2,032	)			(1,599	)		$	(2,999	)		$	13,771
Stock-based compensation expense			-				-				177				-				-				-				-				177
Common stock issued for RSUs vested			171				2				(2	)			-				-				-				-				-
Shares withheld to pay taxes			-				-				6				-				-				-				-				6
Foreign currency translation adjustment			-				-				-				-				206				-				-				206
Net loss			-				-				-				(2,149	)			-				-				-				(2,149	)
Balance at June 30, 2020			22,150			$	221			$	79,676			$	(63,061	)		$	(1,826	)			(1,599	)		$	(2,999	)		$	12,011

Balance at April 1, 2019			21,595			$	216			$	78,578			$	(46,866	)		$	(1,722	)			(1,599	)		$	(2,999	)		$	27,207
Stock-based compensation expense			-				-				499				-				-				-				-				499
Common stock issued for options exercised			8				-				33				-				-				-				-				33
Common stock issued for RSUs vested			96				1				(1	)			-				-				-				-				-
Shares withheld to pay taxes			-				-				(81	)			-				-				-				-				(81	)
Foreign currency translation adjustment			-				-				-				-				27				-				-				27
Net loss			-				-				-				(216	)			-				-				-				(216	)
Balance at June 30, 2019			21,699			$	217			$	79,028			$	(47,082	)		$	(1,695	)			(1,599	)		$	(2,999	)		$	27,469

GSE SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

		Six months ended
		June 30, 2020				June 30, 2019
Cash flows from operating activities:
Net loss		$	(8,407	)		$	(4,513	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Loss on impairment			4,302				5,464
Depreciation			178				193
Amortization of intangible assets			1,114				1,208
Amortization of capitalized software development costs			159				228
Change in fair value of contingent consideration			-				(1,200	)
Stock-based compensation expense			324				1,036
Bad debt expense			93				-
(Gain) loss on derivative instruments, net			(4	)			8
Deferred income taxes			57				(1,590	)
Gain on sale of assets			(5	)			(7	)
Changes in assets and liabilities:
Contract receivables			4,656				4,878
Prepaid expenses and other assets			531				(4	)
Accounts payable, accrued compensation and accrued expenses			309				(2,276	)
Billings-in-excess of revenue earned			(396	)			(4,512	)
Accrued warranty			(110	)			117
Other liabilities			(781	)			61
Cash provided by (used in) operating activities			2,020				(909	)
Cash flows from investing activities:
Capital expenditures			(1	)			(25	)
Capitalized software development costs			(152	)			(212	)
Proceeds from sale of equipment, software and leasehold improvements			11				13
Acquisition of DP Engineering, net of cash acquired			-				(13,521	)
Cash used in investing activities			(142	)			(13,745	)
Cash flows from financing activities:
Proceeds from line of credit			3,500				-
Proceeds from issuance of long-term debt			-				14,263
Repayment of long-term debt			(8,595	)			(1,841	)
Proceeds from Paycheck Protection Program Loan			10,000				-
Proceeds from issuance of common stock			-				75
Deferred financing costs			(70	)			-
Shares withheld to pay taxes			(45	)			(231	)
Cash provided by financing activities			4,790				12,266
Effect of exchange rate changes on cash and cash equivalents			(61	)			(63	)
Net increase (decrease) in cash and cash equivalents			6,607				(2,451	)
Cash and cash equivalents at the beginning of the year			11,691				12,123
Cash and cash equivalents at the end of the period		$	18,298			$	9,672

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 available and as mandated by local, state and federal regulations. Employees almost entirely work from home for 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 on new business. For our staff augmentation, we have seen certain contracts for our Nuclear Industry Training and Consulting ("NITC") customers paused and 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 business has seen its billable employee base decline 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 had 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 are experiencing a negative impact on our financial position and results of operations. We are likely to 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, our ability to refinance existing indebtedness and our ability to access new capital, and this has caused us to violate our debt covenants as of June 30, 2020. We received $10 million from the Paycheck Protection Program ("PPP") and indicated without these funds, the risk of employee terminations, layoffs and other drastic cost reductions exists. While the PPP funds have provided us with additional liquidity, these funds did not prevented us from failing to meet our minimum EBITDA covenant on our Citizens Bank credit facility at June 30, 2020 or other debt covenants requirement in the future. 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 is being significantly impacted by the COVID-19 pandemic, we believe it is probable we will not remain in compliance with our debt covenants throughout the remainder of fiscal 2020. As a result of the June 30, 2020 minimum EBITDA covenant violation and future expected debt covenant violations, we have classified our debt as short-term in our consolidated balance sheets as of June 30, 2020 and December 31, 2019, which creates substantial doubt regarding our ability to continue as a going concern.  

We are currently in negotiations with the Bank to resolve the minimum EBITDA debt covenant for the quarter ended June 30, 2020, as well as addressing future covenant requirements. To resolve these matters, the Bank may charge us additional fees and require us to pay a portion of our outstanding debt on accelerated payment terms.

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. The ASU is effective for public companies for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years. 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. We 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.

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 potential dilutive common shares outstanding are 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								Six months ended
		June 30, 2020				June 30, 2019				June 30, 2020				June 30, 2019
Numerator:
Net loss		$	(2,149	)		$	(216	)		$	(8,407	)		$	(4,513	)
Denominator:
Weighted-average shares outstanding for basic loss per share			20,407,958				20,006,492				20,375,446				19,979,018
Effect of dilutive securities:
Stock options and restricted stock units			-				-				-				-
Adjusted weighted-average shares outstanding and assumed conversions for diluted loss per share			20,407,958				20,006,492				20,375,446				19,979,018
Shares related to dilutive securities excluded from calculation because inclusion would be anti-dilutive			74,732				263,241				56,373				175,848

We entered into the Paycheck Protection Program Loan (the "PPP Loan") agreement with Citizens Bank, (our or the "Bank") which was approved by the bank 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 principle and interest payments are due for any portion of the loan balance that is not forgiven and deferred for ten months after the last day of the covered period, August 9, 2021.

The PPP Loan funds were received on April 24, 2020. 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 amount may qualify for loan forgiveness in accordance with the terms of CARES Act. We are not yet able to determine the amount that might be forgiven. To the extent the loan amount is not forgiven under the PPP, we are obligated to make equal monthly payments of principal and interest, beginning after determination of forgiveness by the Bank. We may apply for forgiveness any time on or before the maturity date of the loan. 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 June 30, 2020, the Company was in full compliance with all requirements in order to apply for forgiveness under the PPP Loan.

We have classified the full $10 million of the PPP Loan as long-term in our consolidated balance sheet as of June 30, 2020 and recorded $18 thousand in interest expense during the three and six months ended June 30, 2020.

 

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)		June 30, 2020				December 31, 2019
Billed receivables		$	6,657			$	11,041
Unbilled receivables			6,080				6,624
Allowance for doubtful accounts			(402	)			(458	)
Total contract receivables, net		$	12,335			$	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 six months ended June 30, 2020 and 2019, we recorded bad debt expense of $93 thousand and $0, respectively.

During the month of July 2020, we invoiced $3.0 million of the unbilled amounts as of the period ended June 30, 2020. We expect to bill the remaining unbilled amounts during the remainder of fiscal 2020.

As of June 30, 2020, we had two customers that accounted for 12% and 11% 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, Performance and 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 three months ended June 30, 2020.

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 three months ended June 30, 2020.

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

(in thousands)		As of June 30, 2020
		Gross Carrying Amount				Accumulated Amortization				Impact of Impairment				Net
Amortized intangible assets:
Customer relationships		$	11,730			$	(4,910	)		$	(3,102	)		$	3,718
Trade names			2,467				(884	)			(778	)			805
Developed technology			471				(471	)			-				-
Non-contractual customer relationships			433				(433	)			-				-
Noncompete agreements			949				(290	)			(422	)			237
Alliance agreements			527				(224	)			-				303
Others			167				(167	)			-				-
Total		$	16,744			$	(7,379	)		$	(4,302	)		$	5,063

(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 $444 thousand and $638 thousand for the three months ended June 30, 2020 and 2019 and $1.1 million and $1.2 million for the six months ended June 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)		$	829
2021			1,213
2022			911
2023			640
2024			435
and thereafter			1,035
Total		$	5,063

 

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 June 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.

As of June 30, 2020, we had four standby letters of credit totaling $1.2 million, which represent performance bonds on four contracts.

For the three and six months ended June 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 June 30, 2020.

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

The following table presents assets and liabilities measured at fair value at June 30, 2020:

(in thousands)		Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)				Total
Money market funds		$	434			$	-			$	-			$	434
Total assets			434				-				-				434
Liability awards			-				(3	)			-				(3	)
Interest rate swap contract			-				(234	)			-				(234	)
Total liabilities		$	-			$	(237	)		$	-			$	(237	)

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	)

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

We utilize forward 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 June 30, 2020, we had no foreign exchange contracts outstanding.

Interest Rate Risk Management

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.

The foreign currency denominated contract receivables, billings in excess of revenue earned and subcontractor accruals that are related to the outstanding foreign exchange contracts are remeasured at the end of each period into 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 recognized a net gain (loss) on our derivative instruments as outlined below:

		Three months ended								Six months ended
(in thousands)		June 30, 2020				June 30, 2019				June 30, 2020				June 30, 2019
Interest rate swap - change in fair value		$	23			$	(62	)		$	(74	)		$	(88	)
Foreign exchange contracts			-				(32	)			17				70
Remeasurement of related contract receivables, billings-in-excess of revenue earned, and subcontractor accruals			24				(7	)			61				10
Gain (loss) on derivative instruments, net		$	47			$	(101	)		$	4			$	(8	)

During the six months ended June 30, 2020, we realized a gain of $17 thousand for foreign exchange contracts due to their close out during fiscal 2020, and we recorded a loss of $74 thousand related to the change in the fair value of foreign exchange contracts for the six months ended June 30, 2019.

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 June 30, 2020 and 2019, we recognized $177 thousand and $499 thousand of stock-based compensation expense related to equity awards, respectively. We recognized $324 thousand and $1.1 million of stock-based compensation expense related to equity awards for the six months ended June 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 June 30, 2020 and 2019, respectively. During the six months ended June 30, 2020, the Company recorded stock-based compensation expense of $6 thousand and income of $33 thousand for the same period ended 2019 for the fair value of cash-settled RSUs, respectively.

During three and six months ended June 30, 2020, we granted approximately 10,000 and 40,000 time-based RSUs with an aggregate fair value of approximately $10 thousand and $31 thousand, respectively. For three and six months ended June 30, 2019, we granted approximately 200,000 and 500,000 time-based RSUs with an aggregate fair value of $600 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 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 other Company 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 June 30, 2020, we did not grant any performance-based RSUs to employees and during the six months ended June 30, 2020 we granted approximately 510,000 performance-based RSUs with an aggregate fair-value of $600 thousand to key employees. Based upon our current forecasts, we expect these performance-based RSUs to vest and recognized stock-based compensation expense related to these awards of $50 thousand and $62 thousand for the three and six months ended June 30, 2020. These awards vest over three years based upon achieving certain financial metrics during fiscal 2022. Approximately 50% of these awards are based upon obtaining certain revenue targets, and the remainder are based upon achieving certain Adjusted EBITDA targets. During the three months ended June 30, 2019, we did not grant any performance-based RSUs to employees and during the six months ended June 30, 2019, we granted approximately 350,000 performance-based RSUs to key employees with an aggregate fair-value of $926 thousand. These awards vest over three years based upon achieving certain financial metrics achieved during fiscal 2021 for revenue and Adjusted EBITDA.

We did not grant any stock options for three and six months ended June 30, 2020 and 2019.

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

 

On June 28, 2019, we entered into the Fifth Amendment and Reaffirmation Agreement, which changed our fixed charge coverage ratio from 1.25 to (i) 2.75 to 1.00 for the period ending March 31, 2020; (ii) 2.50 to 1.00 for the periods ending June 30, 2020 and September 30, 2020; (iii) 2.25 to 1.00 for the periods ending December 31st, March 31st, June 30th and September 30^th, thereafter.  

 

On January 8, 2020, due to an expected violation of our covenants, we entered into the Sixth Amendment and Reaffirmation Agreement and with an effective date of December 31, 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.  

 

On April 17, 2020, we entered into the Seventh Amendment and Reaffirmation Agreement and effective March 31, 2020, which requires 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 $20 thousand of debt issuance costs and $50 thousand of debt amendment fees related to the sixth and seventh amendments to our Credit Agreement during the six months ended June 30, 2020.

 

Revolving Line of Credit (“RLOC”)

 

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. 

 

As of June 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. The amount available under our RLOC as of June 30, 2020, after consideration of letters of credit, was approximately $0.3 million. 

We were in breach of our debt covenants as of June 30, 2020. The Bank may declare the obligations under the Credit Agreement to be immediately due and payable and may terminate the credit facilities.

 

Term Loan 

 

As discussed in Note 4, we acquired DP Engineering on February 15, 2019 for approximately $13.5 million in cash from proceeds of $14.3 million from a term loan with the Bank to finance the acquisition. The loan matures five years from the borrowing date and bears 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. 

 

Additionally, to fund the acquisition of True North, we borrowed $10.3 million on May 11, 2018, $0.5 million of which was repaid to the Bank on the same day. The loan matures in five years from the borrowing date and bears interest at the adjusted one-month USD LIBOR, plus a margin ranging between 2.00% and 2.75% depending on our overall leverage ratio. We incurred $0 in debt issuance costs and $75 thousand of loan origination fees related to this transaction. Debt issuance costs and loan origination fees are reported as a direct deduction from the carrying amount of the loan and amortized over the term of the loan using the effective interest method. 

 

As discussed in Note 1, due to the violation of our Q2 minimum EBITDA covenant violation and our forecasted future debt covenant violations, we are in technical default of our credit agreement. While we work with our bank to resolve this issue, our debt has been classified as current in our consolidated balance sheets as of June 30, 2020 and December 31, 2019.

 

The Credit Agreement contains customary covenants, as described above, and restrictions typical for a financing of this type, that, among other things, restricts our ability to incur additional debt, pay dividends, make distributions, make certain investments and acquisitions, repurchase our stock and prepay certain indebtedness, create liens, enter into agreements with affiliates, modify the nature of our business, enter into sale-leaseback transactions, transfer and sell material assets and merge or consolidate. Non-compliance with one or more of the covenants and restrictions after any applicable grace period could result in the obligations under the Credit Agreement becoming immediately due and payable and termination of the facilities. If an event of default under the Credit Agreement occurs and is continuing, then the Bank may declare the obligations under the Credit Agreement to be immediately due and payable and may terminate the credit facilities. 

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 $952 thousand and the remaining $263 thousand is classified as long-term within other liabilities. The activity in the accrued warranty accounts during the current period is as follows:

(in thousands)
Balance at January 1, 2020		$	1,323
Current period provision			2
Current period claims			(112	)
Currency adjustment			2
Balance at June 30, 2020		$	1,215

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 six months ended June 30, 2020 and 2019, along with the reporting segment for each category:

		Three months ended								Six months ended
(in thousands)		June 30, 2020				June 30, 2019				June 30, 2020				June 30, 2019
Performance segment
SDB		$	3,249			$	5,595			$	7,062			$	12,037
Software			723				635				1,633				1,384
Training and consulting			4,300				6,780				9,288				11,779
NITC segment
Training and consulting			6,068				10,448				14,062				20,452
Total revenue		$	14,340			$	23,458			$	32,045			$	45,652

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								Six months ended
		June 30, 2020				June 30, 2019				June 30, 2020				June 30, 2019
Revenue recognized in the period from amounts included in Billings-in-Excess of Revenue Earned at the beginning of the period		$	939			$	2,813			$	4,701			$	7,853

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

(in thousands)		Three months ended								Six months ended
		June 30, 2020				June 30, 2019				June 30, 2020				June 30, 2019
Provision for (benefit from) income taxes		$	180			$	406			$	50			$	(1,442	)
Effective tax rate			9.1	%			213.7	%			0.6	%			(24.2	)%

Our income tax benefit for the interim periods presented is determined using an estimate of our annual effective tax rate, adjusted for discrete items arising in that quarter. Total income tax expense for the six months ended June 30, 2020 was comprised mainly of foreign and state tax expense. Total income tax expense for the six months ended June 30, 2019 was comprised mainly of the tax impact of the loss for impairment, federal, foreign and state tax expense.

Our income effective tax rate was 9.1% and 0.6% for the three and six months ended June 30, 2020, respectively. For the three months ended June 30, 2020, the difference between our income tax expense at an effective tax rate of 9.1% and a benefit at the U.S. statutory federal income tax rate of 21% was primarily due to accruals related to uncertain tax positions for certain U.S. and foreign tax contingencies, a change in tax valuation allowance in our US and China subsidiaries and discrete item adjustments for U.S. and foreign taxes. For the six months ended June 30, 2020, the difference between income tax expense at an effective tax rate of 0.6% and a benefit at the U.S. statutory federal income tax rate of 21% was primarily due to permanent differences, accruals related to uncertain tax positions for certain U.S. and foreign tax contingencies, a change in tax valuation allowance in our US and China subsidiaries, discrete item adjustments for the U.S. and foreign taxes and the tax impact of the loss for impairment.

Because of our net operating loss carryforwards, we are subject to U.S. federal and state income tax examinations from the year 2000 and forward. We are subject to foreign tax examinations by tax authorities for years 2014 and forward in Sweden, 2015 and forward in China, 2015 and forward in India and 2016 and forward in the United Kingdom.

An uncertain tax position taken or expected to be taken in a tax return is recognized in the consolidated financial statements when it is more likely than not (i.e., a likelihood of more than 50%) that the position would be sustained upon examination by tax authorities that have full knowledge of all relevant information. A recognized tax position is then measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. Interest and penalties related to income taxes are accounted for as income tax expense.

We recognize deferred tax assets to the extent that it is believed that these assets are more likely than not to be realized. We have evaluated all positive and negative evidence and