GSE Systems Earnings 2019-09-30

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, 2019
		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.

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 20,007,469 shares of common stock, with a par value of $0.01 per share outstanding as of October 31, 2019.

GSE SYSTEMS, INC.

QUARTERLY REPORT ON FORM 10-Q

INDEX

			PAGE
PART I.		FINANCIAL INFORMATION	3
Item 1.		Financial Statements:
		Consolidated Balance Sheets as of September 30, 2019 (unaudited) and December 31, 2018	3
		Unaudited Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2019, and September 30, 2018	5
		Unaudited Consolidated Statements of Comprehensive (Loss) Income for the Three and Nine Months Ended September 30, 2019, and September 30, 2018	6
		Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the Three and Nine Months Ended September 30, 2019, and September 30, 2018	7
		Unaudited Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2019 and September 30, 2018	9
		Notes to Consolidated Financial Statements	10
Item 2.		Management's Discussion and Analysis of Financial Condition and Results of Operations	36
Item 3.		Quantitative and Qualitative Disclosures About Market Risk	51
Item 4.		Controls and Procedures	51
PART II.		OTHER INFORMATION	52
Item 1.		Legal Proceedings	52
Item 1A.		Risk Factors	52
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds	52
Item 3.		Defaults Upon Senior Securities	52
Item 4.		Mine Safety Disclosures	52
Item 5.		Other Information	52
Item 6.		Exhibits	52
		SIGNATURES	54

GSE SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)

		September 30, 2019				December 31, 2018
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	8,606			$	12,123
Contract receivables, net			16,566				21,077
Prepaid expenses and other current assets			1,836				1,800
Total current assets			27,008				35,000
Equipment, software, and leasehold improvements			5,627				5,293
Accumulated depreciation			(4,525	)			(4,228	)
Equipment, software, and leasehold improvements, net			1,102				1,065
Software development costs, net			648				615
Goodwill			16,709				13,170
Intangible assets, net			7,960				6,080
Deferred tax assets			6,635				5,461
Operating lease - right of use assets, net			3,720				-
Other assets			77				49
Total assets		$	63,859			$	61,440
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt, net of debt issuance costs and original issue discount		$	4,778			$	1,902
Accounts payable			1,174				1,307
Accrued expenses			1,820				2,646
Accrued compensation			2,904				3,649
Billings in excess of revenue earned			3,870				10,609
Accrued warranty			1,185				981
Income taxes payable			1,368				1,176
Other current liabilities			1,078				60
Total current liabilities			18,177				22,330
Long-term debt, less current portion, net of debt issuance costs and original issue discount			14,968				6,610
Operating lease liabilities			3,121				-
Other liabilities			1,070				1,371
Total liabilities			37,336				30,311
Commitments and contingencies
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, 21,788,525 shares issued, 20,189,614 shares outstanding as of September 30, 2019; 60,000,000 shares authorized, 21,485,445 shares issued, 19,886,534 shares outstanding as of December 31, 2018			218				214
Additional paid-in capital			79,138				78,118
Accumulated deficit			(48,050	)			(42,569	)
Accumulated other comprehensive loss			(1,784	)			(1,635	)
Treasury stock at cost, 1,598,911 shares on September 30, 2019 and December 31, 2018			(2,999	)			(2,999	)
Total stockholders' equity			26,523				31,129
Total liabilities and stockholders' equity		$	63,859			$	61,440

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 September 30,								Nine months ended September 30,
		2019				2018				2019				2018
Revenue		$	20,031			$	21,801			$	65,683			$	69,394
Cost of revenue			15,358				16,380				50,407				52,735
Gross profit			4,673				5,421				15,276				16,659
Operating expenses:
Selling, general and administrative			3,465				4,366				12,231				13,686
Research and development			130				247				526				765
Restructuring charges			740				70				742				1,177
Loss on impairment			-				-				5,464				-
Depreciation			107				132				300				411
Amortization of definite-lived intangible assets			494				632				1,550				1,094
Total operating expenses			4,936				5,447				20,813				17,133
Operating loss			(263	)			(26	)			(5,537	)			(474	)
Interest (expense), net			(288	)			(114	)			(812	)			(153	)
Loss on derivative instruments, net			(61	)			(59	)			(69	)			(306	)
Other income (expense), net			59				(5	)			62				24
Loss before income taxes			(553	)			(204	)			(6,356	)			(909	)
Provision (benefit) for income taxes			568				314				(874	)			124
Net loss		$	(1,121	)		$	(518	)		$	(5,482	)		$	(1,033	)
Basic loss per common share		$	(0.06	)		$	(0.03	)		$	(0.27	)		$	(0.05	)
Diluted loss per common share		$	(0.06	)		$	(0.03	)		$	(0.27	)		$	(0.05	)
Weighted average shares outstanding - Basic			20,007,469				19,786,888				20,021,829				19,620,207
Weighted average shares outstanding - Diluted			20,007,469				19,786,888				20,021,829				19,620,207

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 September 30,								Nine months ended September 30,
		2019				2018				2019				2018
Net loss		$	(1,121	)		$	(518	)		$	(5,482	)		$	(1,033	)
Cumulative translation adjustment			(89	)			(31	)			(149	)			(258	)
Comprehensive loss		$	(1,210	)		$	(549	)		$	(5,631	)		$	(1,291	)

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

GSE SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' 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, January 1, 2019			21,485			$	214			$	78,118			$	(42,569	)		$	(1,635	)			(1,599	)		$	(2,999	)		$	31,129
Stock-based compensation expense			-				-				1,238				-				-				-				-				1,238
Common stock issued for options exercised			9				1				89				-				-				-				-				90
Common stock issued for RSUs vested			294				3				(3	)			-				-				-				-				-
Shares withheld to pay taxes			-				-				(304	)			-				-				-				-				(304	)
Foreign currency translation adjustment			-				-				-				-				(149	)			-				-				(149	)
Net loss			-				-				-				(5,482	)			-				-				-				(5,482	)
Balance, September 30, 2019			21,789			$	218			$	79,138			$	(48,050	)		$	(1,784	)			(1,599	)		$	(2,999	)		$	26,523

Balance, January 1, 2018			21,024			$	210			$	76,802			$	(42,870	)		$	(1,471	)			(1,599	)		$	(2,999	)		$	29,672
Cumulative effect of adopting ASC 606			-				-				-				655				-				-				-				655
Stock-based compensation expense			-				-				1,370				-				-				-				-				1,370
Common stock issued for options exercised			214				2				37				-				-				-				-				39
Common stock issued for RSUs vested			194				2				(2	)			-				-				-				-				-
Shares withheld to pay taxes			-				-				(331	)			-				-				-				-				(331	)
Foreign currency translation adjustment			-				-				-				-				(258	)			-				-				(258	)
Net loss			-				-				-				(1,033	)			-				-				-				(1,033	)
Balance, September 30, 2018			21,432			$	214			$	77,876			$	(43,248	)		$	(1,729	)			(1,599	)		$	(2,999	)		$	30,114

		Common Stock																				Treasury Stock
Three Months Ended		Shares				Amount				Additional Paid-in Capital				Accumulated Deficit				Accumulated Other Comprehensive Loss				Shares				Amount				Total
Balance, July 1, 2019			21,699			$	217			$	79,028			$	(46,930	)		$	(1,695	)			(1,599	)		$	(2,999	)		$	27,622
Stock-based compensation expense			-				-				169				-				-				-				-				169
Common stock issued for options exercised			0				-				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			-				-				-				(1,121	)			-				-								(1,121	)
Balance, September 30, 2019			21,789			$	218			$	79,138			$	(48,050	)		$	(1,784	)			(1,599	)		$	(2,999	)		$	26,523
Balance, July 1, 2018			21,311			$	213			$	77,611			$	(42,730	)		$	(1,698	)			(1,599	)		$	(2,999	)		$	30,397
Stock-based compensation expense			-				-				402				-				-				-				-				402
Common stock issued for options exercised			84				-				(56	)			-				-				-				-				(56	)
Common stock issued for RSUs vested			37				1				-				-				-				-				-				1
Shares withheld to pay taxes			-				-				(81	)			-				-				-				-				(81	)
Foreign currency translation adjustment			-				-				-				-				(31	)			-				-				(31	)
Net income			-				-				-				(518	)			-				-				-				(518	)
Balance, September 30, 2018			21,432			$	214			$	77,876			$	(43,248	)		$	(1,729	)			(1,599	)		$	(2,999	)		$	30,114

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,
		2019				2018
Cash flows from operating activities:
Net loss		$	(5,482	)		$	(1,033	)
Adjustments to reconcile net loss to net cash used in operating activities:
Loss on impairment			5,464				-
Depreciation			300				411
Amortization of definite-lived intangible assets			1,550				1,094
Amortization of capitalized software development costs			293				353
Change in fair value of contingent consideration			(1,200	)			-
Stock-based compensation expense			1,150				1,535
Loss on derivative instruments, net			69				306
Bad debt expense			48				146
Deferred income taxes			(1,276	)			74
Gain on sale of equipment, software, and leasehold improvements			(7	)			-
Changes in assets and liabilities:
Contract receivables, net			7,314				(3,165	)
Prepaid expenses and other assets			438				948
Accounts payable, accrued compensation, and accrued expenses			(2,400	)			(965	)
Billings in excess of revenue earned			(6,777	)			(5,800	)
Accrued warranty			102				(256	)
Other liabilities			82				(8	)
Cash used in operating activities			(332	)			(6,360	)
Cash flows from investing activities:
Proceeds from sale of equipment, software and leasehold improvements			8				-
Purchase of equipment, software and leasehold improvements			(127	)			(510	)
Capitalized software development costs			(326	)			(325	)
Acquisition of True North Consulting, net of cash acquired			-				(9,635	)
Acquisition of DP Engineering, net of cash acquired			(13,521	)			-
Cash used in investing activities			(13,966	)			(10,470	)
Cash flows from financing activities:
Proceeds from issuance of long-term debt			14,263				10,154
Repayment of long-term debt			(3,029	)			(1,164	)
Proceeds from issuance of common stock			90				39
Contingent consideration payments to former owners of Hyperspring, LLC			-				(1,701	)
Shares withheld to pay taxes			(304	)			(331	)
Cash provided by financing activities			11,020				6,997
Effect of exchange rate changes on cash			(239	)			(398	)
Net decrease in cash, cash equivalents and restricted cash			(3,517	)			(10,231	)
Cash, cash equivalents, and restricted cash, beginning balance			12,123				20,071
Cash, cash equivalents, and restricted cash, ending balance		$	8,606			$	9,840

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,” the “Company,” “we” and “our” are to GSE Systems and its subsidiaries, collectively.

 

The consolidated interim financial statements included herein have been prepared by GSE and are unaudited. In the opinion of the Company's 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 10 of Regulation S-X. The accompanying balance sheet data for the year ended December 31, 2018 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 the Company's Annual Report on Form 10-K for the year ended December 31, 2018, filed with the Securities and Exchange Commission on March 27, 2019.

 

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. The Company’s 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 could differ from these estimates and those differences could be material.

 

Going Concern Consideration

The Company is currently in compliance with its debt covenants; however, it is probable, based on our forecasts, that we will not be in compliance with these covenants at future measurement dates in the following twelve-month period. We do have the ability to cure one of the two financial covenants, the leverage ratio, by paying down an amount of debt necessary to meet the leverage ratio and we are considering taking this action. Regarding the fixed charge coverage ratio, we anticipate reducing fixed charges, namely excess real estate at the DP Engineering office and other space to be made idle. We will be working with Citizens Bank, National Association (the Bank) to obtain a modification of our covenant requirements that would, based on our projections, provide forecasted compliance with the covenants. If at such future time a covenant violation were to occur and if we are unable to agree to amended financial covenant measures with the Bank before such time or obtain a waiver in the event of subsequent non-compliance, the Company would likely not be able to repay the entirety of the outstanding debt in the event the Bank were to call the debt, thus leading to substantial doubt about the Company’s ability to continue as a going concern until such amendments or waivers are in place.

Based on our cash flow projection, we believe our funds from operations and availability of cash provide us with sufficient funds to cure one of the forecasted violations if we choose to; have sufficient cash to fund our on-going operations and make our scheduled debt repayments in the normal course of business.

 

Accounting pronouncements recently adopted

 

In February 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Updates ("ASU") No. 2016-02, Leases (Topic 842), a new standard related to leases to increase transparency and comparability among organizations by requiring the recognition of right-of-use (“ROU”) assets and lease liabilities on the balance sheet. Most prominent among the changes in the standard is the recognition of ROU assets and lease liabilities by lessees for those leases classified as operating leases under current U.S. GAAP. Under the standard, disclosures are required to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees with capital and operating leases existing at, or entered into after, the beginning of the earliest applicable period presented in the consolidated financial statements, with certain practical expedients available.

The Company adopted the new standard using the modified retrospective approach effective on January 1, 2019. The Company's adoption included lease codification improvements that were issued by the FASB through June 2019.

The FASB made available several practical expedients in adopting the new lease accounting guidance. The Company elected the package of practical expedients permitted under the transition guidance within the amended guidance, which among other things, allowed registrants to carry forward historical lease classification. The Company elected the practical expedient that allows the combination of both lease and non-lease components as a single component and account for it as a lease for all classes of underlying assets. The Company elected not to apply the new guidance to short term leases with an initial term of twelve months or less. The Company recognizes those lease payments in the consolidated statements of operations on a straight-line basis over the lease term. The Company elected to use a single discount rate for a portfolio of leases with reasonably similar characteristics.

The most significant impact was the recognition of ROU assets and related lease liabilities for operating leases on the consolidated balance sheets. The Company recognized ROU assets and related lease liabilities of $2.7 million and $3.0 million respectively, related to operating lease commitments, as of January 1, 2019. The operating lease ROU asset represents the lease liability, plus any lease payments made at or before the commencement date, less any lease incentives received. The new guidance did not have a material impact on the Company's cash flows or results of operations. See Note 16 of the consolidated financial statements.

Accounting pronouncements not yet adopted

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses, which introduces new guidance for credit losses on instruments within its scope. The new guidance introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments, including, but not limited to, trade and other receivables, held-to-maturity debt securities, loans and net investments in leases. The new guidance also modifies the impairment model for available-for-sale debt securities and requires the entities to determine whether all or a portion of the unrealized loss on an available-for-sale debt security is a credit loss. The standard also indicates that entities may not use the length of time a security has been in an unrealized loss position as a factor in concluding whether a credit loss exists. 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. The Company is currently evaluating the effects, if any, that the adoption of this guidance will have on the Company's consolidated financial position, results of operations and cash flows.

In January 2017, the FASB issued 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 are currently evaluating the potential impact of the adoption of ASU 2017-04 on our consolidated financial statements.

Basic (loss) income per share is computed by dividing net (loss) income by weighted average number of outstanding shares of common stock outstanding for the period. Diluted net (loss) income 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 share are the same. The diluted loss per share, in each period present, excludes the impact of potentially dilutive securities since they would have an anti-dilutive effect.

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

(in thousands, except for share amounts)		Three months ended								Nine months ended
		September 30,								September 30,
		2019				2018				2019				2018
Numerator:
Net loss		$	(1,121	)		$	(518	)		$	(5,482	)		$	(1,033	)
Denominator:
Weighted-average shares outstanding for basic loss per share			20,007,469				19,786,888				20,021,829				19,620,207
Effect of dilutive securities:
Stock options and restricted stock units			-				-				-				-
Adjusted weighted-average shares outstanding and assumed conversions for diluted loss per share			20,007,469				19,786,888				20,021,829				19,620,207
Shares related to dilutive securities excluded because inclusion would be anti-dilutive			578,676				713,024				397,131				645,714

 

2019 Acquisition

 

 

On February 15, 2019, through its wholly-owned subsidiary Performance Solutions, the Company entered into a membership interest purchase agreement with Steven L. Pellerin, Christopher A. Davenport, and DP Engineering (the “DP Engineering Purchase Agreement”), to purchase 100% of the membership interests in DP Engineering for $13.5 million. The purchase price is subject to customary pre- and post-closing working capital adjustments plus an additional earn-out amount not to exceed $5 million, potentially payable in 2020 and 2021 depending on DP Engineering’s satisfaction of certain targets for adjusted earnings before interest, tax, depreciation and amortization ("EBITDA") in calendar years 2019 and 2020, respectively.  The acquisition was completed through the drawdown of $14.3 million (including transaction costs) of the term loan. An escrow of approximately $1.7 million was funded at the closing and is available to GSE to satisfy indemnification claims arising within 18 months after the closing.

 

DP Engineering is a provider of value-added technical engineering solutions and consulting services to nuclear power plants with an emphasis on preparation and implementation of design modifications during plant outages, which is in line with our Performance segment. The Company's allocation of the purchase price remains preliminary and the net assets are subject to adjustments within the measurement period, which is not to exceed one year from the acquisition date.

 

Based on preliminary forecasted adjusted EBITDA of DP Engineering for the years 2019 and 2020, as of the acquisition date, the estimated fair value of the total earn-out amount was $1.2 million and was recorded as contingent consideration. Subsequent to the acquisition, it was determined that the conditions related to the contingent consideration would not be met and hence $1.2 million was taken to income in the first quarter of 2019.

 

The following table summarizes the calculation of adjusted purchase price as of the acquisition date (in thousands):

 

The following table summarizes the consideration paid to acquire DP Engineering and the preliminary fair value of the assets acquired and liabilities assumed at the date of the transaction. Due to the recent completion of the acquisition, the Company recorded the assets acquired and liabilities assumed at their preliminary estimated fair value. As of September 30, 2019, the Company had not finalized the determination of the fair value allocated to various assets and liabilities, including, but not limited to, contract receivables, prepaid expenses and other current assets, intangible assets, accounts payable, accrued expenses, contingent consideration, accrued compensation and the residual amount allocated to goodwill. The following amounts except for cash are all reflected in the consolidated statement of cash flows within the "Acquisition of DP Engineering, net of cash acquired" line caption.

 

(in thousands)

Total purchase price		$	14,855
Purchase price allocation:
Cash			134
Contract receivables			2,934
Prepaid expenses and other current assets			209
Property, and equipment, net			210
Intangible assets			6,798
Other assets			1,806
Accounts payable and accrued expenses			(1,375	)
Other liabilities			(1,494	)
Total identifiable net assets			9,222
Goodwill			5,633
Net assets acquired		$	14,855

The fair value of the assets acquired includes gross trade receivables of $2.9 million, of which the Company has collected in full. GSE did not acquire any other class of receivable as a result of the acquisition of DP Engineering.

 

The goodwill is primarily attributable to value-added technical engineering solutions and consulting services to nuclear power plants with an emphasis on preparation and implementation of design modification during plant outages, the workforce of the acquired business and the significant synergies expected to arise after the acquisition of DP Engineering. The total amount of goodwill is expected to be tax deductible. All of the $5.6 million of goodwill was assigned to our Performance segment. As discussed above, the goodwill amount is provisional pending receipt of the final valuations of various assets and liabilities and is subject to adjustments within the measurement period, which is not to exceed one year from the acquisition date.

 

The Company identified other intangible assets of $6.8 million, including customer contracts and relationships, tradename, and non-compete agreements, with amortization periods of five years to fifteen years.

 

Approximately one week following our acquisition of DP Engineering, an adverse event occurred at one of DP Engineering’s major customer's location that affected plant operations. This incident adversely impacted the relationship between DP Engineering and its customer. The Company determined this represented a triggering event requiring an interim assessment for impairment. As a result of the impairment analysis, we recognized the impairment charges of $2.1 million on goodwill and $3.4 million on definite-lived intangible assets related to the acquisition of DP Engineering during the quarter ended March 31, 2019. On August 6, 2019, as a follow on to the Notice of Suspension, the Company received a Notice of Termination from this customer, notifying the Company that they were terminating their Engineer of Choice consulting service agreement with DP Engineering.  Please see Note 8 for further analysis on the carrying amount change due to impairment on goodwill and definite-lived intangible assets during the nine months ended September 30, 2019. Additionally, also see Item 2. Management’s Discussion and Analysis for further discussion regarding the termination of Engineer of Choice of DP Engineering’s major customer.

The following table summarizes the fair value of intangible assets acquired at the date of acquisition and the related weighted average amortization period:

 

Intangible Assets		Weighted average amortization period				Fair Value
		(in years)				(in thousands)
Customer relationships			15			$	4,898
Tradename			10				1,172
Non-compete agreements			5				728
Total						$	6,798

DP Engineering contributed revenue of $6.5 million to GSE for the period from February 15, 2019 to September 30, 2019.

2018 Acquisition

 

 

On May 11, 2018, GSE, through its wholly-owned subsidiary Performance Solutions, entered into a membership interest purchase agreement with Donald R. Horn, Jenny C. Horn, and True North Consulting LLC (the "True North Purchase Agreement") to purchase 100% of the membership interests in True North Consulting LLC ("True North") for $9.75 million. The purchase price was subject to customary pre- and post-closing working capital adjustments, resulting in total consideration of $9.9 million. The True North Purchase Agreement contains customary representations, warranties, covenants, and indemnification provisions subject to certain limitations. An escrow of $1.5 million was funded from the cash paid to the sellers of True North at the closing and is available to GSE to promote retention of key personnel and satisfy indemnification claims arising within 18 months after the closing. The acquisition of True North was completed on an all-cash transaction basis. In connection with the acquisition, we drew down a $10.3 million term loan to finance the transaction (including the transaction costs). See Note 12, for further details of the loan.

 

True North is a provider of technical engineering solutions to nuclear and fossil fuel power plants with an emphasis on regulatory-driven ASME code programs. Located in Montrose, Colorado, True North is a well-regarded service provider to leading companies in the power industry. The acquisition of True North is expected to broaden our engineering services offering, expand our relationships with several of the largest nuclear energy providers in the United States, and add a highly specialized, complementary talent pool to our employee base.

 

The following table summarizes the consideration paid to acquire True North and the preliminary fair value of the assets acquired and liabilities assumed at the date of the transaction. The Company recorded the assets acquired and liabilities assumed at their preliminary estimated fair value. As of September 30, 2019, the Company had finalized the determination of the fair value allocated to various assets and liabilities, including, but not limited to, contract receivables, prepaid expenses and other current assets, intangible assets, accounts payable, accrued expenses, accrued compensation and the residual amount allocated to goodwill.

(in thousands)

Total purchase price		$	9,915
Purchase price allocation:
Cash			306
Contract receivables			1,870
Prepaid expenses and other current assets			8
Property, and equipment, net			1
Intangible assets			5,088
Accounts payable, accrued expenses			(1,744	)
Accrued compensation			(353	)
Total identifiable net assets			5,176
Goodwill			4,739
Net assets acquired		$	9,915

The fair value of the assets acquired includes gross trade receivables of $1.9 million, of which the Company has collected in full as of September 30, 2019. GSE did not acquire any other class of receivable as a result of the acquisition of True North.

The goodwill is primarily attributable to a broader engineering service offering to new and existing customers, the workforce of the acquired business and the significant synergies expected to arise after the acquisition of True North. The total amount of goodwill is tax deductible. All of the $4.7 million of goodwill was assigned to our Performance segment.

The Company identified other intangible assets of $5.1 million, including customer relationships, tradename, non-compete agreements, and alliance agreements, with amortization periods of four years to fifteen years. The fair value of the intangible assets is finalized per final valuations for these assets.

The following table summarizes the fair value of intangible assets acquired at the date of acquisition and the related weighted average amortization period:

Intangible Assets		Weighted average amortization period				Fair Value
		(in years)				(in thousands)
Customer relationships			15			$	3,758
Tradename			10				582
Non-compete agreements			4				221
Alliance agreements			5				527
Total						$	5,088

Unaudited Pro Forma Financial Information

The unaudited pro forma financial information in the table below summarizes the combined results of operations for GSE, True North and DP Engineering as if the business combinations had occurred on January 1, 2018.

Three months ended September 30,										Nine months ended September 30,
		2019				2018				2019				2018
		(unaudited and in thousands)
Revenue		$	20,031			$	26,932			$	68,667			$	89,679
Net loss			(919	)			(1,204	)			(5,371	)			(1,509	)

The pro forma financial information for all periods presented has been calculated after applying GSE's accounting policies and has also included pro forma adjustments resulting from these acquisitions, including amortization charges of the intangible assets identified from these acquisitions, interest expenses related to the financing transaction in connection with the acquisition of DP Engineering, and the related tax effects as if aforementioned companies were combined as of January 1, 2018.

For the nine months ended September 30, 2019, the Company has incurred $0.6 million of selling, general and administrative costs related to the acquisition of DP Engineering. Due to a triggering event described in Note 8, an impairment test was conducted, which resulted in substantially writing down the estimated fair value of goodwill and some of the definite-lived intangible assets initially recognized upon the acquisition. These expenses are included in general and administrative expense on GSE's consolidated statements of operations and are reflected in pro forma loss for the nine months ended September 30, 2019, in the table above.

 

For the nine months ended September 30, 2018, the Company has incurred $0.5 million of selling, general and administrative costs related to the acquisition of True North. These expenses are included in general and administrative expense on GSE's consolidated statements of operations and are reflected in pro forma loss for the nine months ended September 30, 2018, in the table above.

 

The pro forma financial information is not intended to reflect the actual results of operations that would have occurred if the acquisition had been completed on January 1, 2018, nor is it intended to be an indication of future operating results.

International Restructuring

 

On December 27, 2017, the board of GSE approved an international restructuring plan to streamline and optimize the Company's global operations. Beginning in December 2017, GSE has been in the process of consolidating its engineering services and R&D activities to Maryland and ceasing an unprofitable non-core business in the United Kingdom (UK). As a result, the Company closed its offices in Nyköping, Sweden; Chennai, India; and Stockton-on-Tees, UK. These actions are designed to improve Company productivity by eliminating duplicate employee functions, increasing GSE's focus on its core business, improving efficiency and maintaining the full range of engineering capabilities while reducing costs and organizational complexity.

 

GSE eliminated approximately 40 positions since 2017 due to these changes, primarily in Europe and India, and will continue to undertake other cost-savings measures. The international restructuring plan is expected to be completed by the end of 2019. As a result of these efforts, GSE expects to record a total restructuring charge of approximately $2.2 million, primarily related to the international workforce reductions, contract termination costs and asset write-offs due to the exit activities. As of September 30, 2019, we had recorded total restructuring charges of $2.0 million since 2017. We incurred $2,000 of costs during the nine months ended September 30, 2019. We recognized $1.3 million of restructuring cost for the year ended December 31, 2018. In addition to the restructuring costs recognized to date, the Company has an estimated $1.3 million of cumulative translation adjustments that will be charged against net loss and an estimated $1.0 million of tax benefits that will be realized upon liquidation of these foreign entities. GSE expects to recognize the remaining restructuring costs, currency translation adjustments and tax benefits by the end of 2019.

 

For the nine months ended September 30, 2019,  we made payments related to our restructuring for employee termination benefits and other legal expenses in the amount of $54,000 that had been previously accrued.

 

DP Engineering Restructuring

During the third quarter of 2019, the Company implemented a restructuring plan as a result of the work suspension of DP Engineering's largest customer and subsequent notification on August 6, 2019 that the Engineer of Choice contract was being terminated.  Accordingly, the Company took the necessary measures to reduce DP’s workforce by approximately 12 FTE’s and in addition terminated one of its office leases early resulting in one-time costs of $293,000 being paid in the quarter.  This reduction in force aligns the workforce to the current level of business going forward. 

Collectively, for the nine months ended September 30, 2019, the Company recorded restructuring charges of approximately $0.7 million, of which $0.3 million related to DP Engineering severance and lease termination and $0.4 million related to an executive departure related to the suspension of the Company’s acquisition strategy.

Acquisitions may include contingent consideration payments based on future financial measures of an acquired company. Under ASC 805, Business Combinations, contingent consideration is required to be recognized at fair value as of the acquisition date. We estimate the fair value of these liabilities based on financial projections of the acquired companies and estimated probabilities of achievement. At each reporting date, the contingent consideration obligation is revalued to estimated fair value and changes in fair value subsequent to the acquisition are reflected in income or expense in the consolidated statements of operations and could cause a material impact to our operating results. Changes in the fair value of contingent consideration obligations may result from changes in discount periods and rates, changes in the timing and amount of revenue and/or earnings estimates and changes in probability assumptions with respect to the likelihood of achieving the various earn-out criteria.

In connection with the acquisition of DP Engineering on February 15, 2019, the Company recognized the estimated fair value of contingent consideration for $1.2 million. During the nine months ended September 30, 2019, as a result of the triggering event described in Note 8, an impairment test was conducted on DP Engineering's goodwill and definite-lived intangible assets and the Company determined the $1.2 million of contingent consideration recognized upon acquisition of DP Engineering has reduced to zero since the related earn-out payment is no longer expected to be paid. We have recorded this reduction as an offset to selling, general and administrative expenses in unaudited consolidated statements of operations. There was no contingent liability as of September 30, 2019.

 

Contract receivables represent the Company's unconditional rights to consideration due from a broad base of both domestic and international customers. All contract receivables are considered to be collectible within twelve months.

The components of contract receivables are as follows:

(in thousands)		September 30,				December 31,
		2019				2018
Billed receivables		$	8,281			$	15,998
Unbilled receivables			8,754				5,506
Allowance for doubtful accounts			(469	)			(427	)
Total contract receivables, net		$	16,566			$	21,077

Management reviews collectability of receivables periodically and records an allowance for doubtful accounts to reduce our receivables to their net realizable value when it is probable that the Company will not be able to 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 nine months ended September 30, 2019 and 2018, the Company did not record any allowances for doubtful accounts. The minor fluctuation on the balance of allowances for doubtful accounts was due to foreign currency exchange rates.

During October 2019, the Company invoiced $6.3 million of the September 30, 2019 unbilled amounts.

As of September 30, 2019, the Company had one customer that accounted for 26.3% its consolidated contract receivables. As of December 31, 2018, the Company had one customer that accounted for 16.8% of its consolidated contract receivables.

 

 

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. The Company does not have any intangible assets with indefinite useful lives, other than goodwill.

As discussed in Note 4, we recognized definite-lived intangible assets of $6.8 million upon acquisition of DP Engineering on February 15, 2019, including customer contracts and relationships, trademarks and non-compete agreements, with amortization periods of 5 to 15 years. Amortization of our definite-lived intangible assets is recognized on a straight-line basis over the estimate useful life of the associated assets.

 

Following the February 23, 2019 event occurring at a DP Engineering customer location and subsequent receipt of the Notice of Suspension on February 28, 2019, the Company concluded that DP Engineering's relationship with it's largest customer has been adversely impacted. The DP Engineering customer contracts and relationships were the major component of the definite-lived intangible assets recognized in connection with the acquisition of DP Engineering. Accordingly, the Company determined that a triggering event had occurred requiring an interim assessment of whether a potential impairment of definite-lived intangible asset impairment test was necessary.

 

Therefore, the impairment test of the definite-lived intangible assets recognized upon the acquisition of DP Engineering was also conducted according to ASC 350, Intangibles-Goodwill and other.

 

The interim impairment test was based on the present value of revised cash flow projected for five to fifteen years. The result of the impairment test indicated that the current estimated fair value of noted definite-lived intangible assets had declined below their initial estimated fair value. As a result, the Company recognized an impairment charge of $3.4 million at March 31, 2019. The fair value of definite-lived intangible assets recognized upon the acquisition of DP Engineering is still provisional and subject to further measurement period adjustment according to purchase price allocation rules. The impairment charge of $3.4 million on definite-lived intangible assets was recorded within "Loss on impairment" in our consolidated statements of operations. Due to the August 6^th Notice of Termination of the EOC agreement with DP Engineering, the Company performed  additional impairment testing as of September 30th, 2019 and at this time have determined no further impairment is needed.

Changes in the gross carrying amount, accumulated amortization, addition and impairment of definite-lived intangible assets from December 31, 2018 through September 30, 2019 were as following:

(in thousands)

		For the Nine Months Ended September 30, 2019
		Beginning Gross				Accumulated				Addition				Impairment				Net
		Carrying Amount				Amortization
Amortized intangible assets:
Customer relationships		$	6,833			$	(3,411	)		$	4,898			$	(3,370	)		$	4,950
Trade names			1,295				(621	)			1,172				-				1,846
Developed technology			471				(471	)			-				-				-
Non-contractual customer relationships			433				(433	)			-				-				-
Noncompete agreement			221				(167	)			728				-				782
Alliance agreement			527				(145	)			-				-				382
Others			167				(167	)			-				-				-
Total		$	9,947			$	(5,415	)		$	6,798			$	(3,370	)		$	7,960

(in thousands)		As of December 31, 2018
		Gross Carrying Amount				Accumulated Amortization				Net
Amortized intangible assets:
Customer relationships		$	6,831			$	(2,375	)		$	4,456
Trade names			1,295				(318	)			977
Developed technology			471				(471	)			-
Non-contractual customer relationships			433				(433	)			-
Noncompete agreements			221				(35	)			186
Alliance agreement			527				(66	)			461
Others			167				(167	)			-
Total		$	9,945			$	(3,865	)		$	6,080

Amortization expense related to definite-lived intangible assets totaled $0.5 million and $0.6 million for the three months ended September 30, 2019 and 2018, and $1.6 million and $1.1 million for the nine months ended September 30, 2019, and 2018, respectively. The following table shows the estimated amortization expense of the definite-lived intangible assets for the next five years and thereafter:

 

(in thousands)
Years ended December 31:
2019 (remainder)		$	495
2020			1,974
2021			1,471
2022			1,152
2023			868
Thereafter			2,000
Total		$	7,960

Goodwill

 

The Company reviews 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. The Company tests 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. After the acquisition of Hyperspring on November 14, 2014, the Company determined that it had two reporting units, which are the same as our two operating segments: (i) Performance Improvement Solutions; and (ii) Nuclear Industry Training and Consulting (which includes Hyperspring and Absolute).

On February 15, 2019, we acquired DP Engineering (as described in Note 4) and preliminarily recorded goodwill and identified intangible assets as part of the acquisition. On February 23, 2019, an unexpected event occurred at one of DP Engineering's significant customers and all pending work for that customer was suspended pending a root cause analysis on February 28, 2019. While that analysis is now complete, and virtually all of the suspended projects have been restarted, the customer terminated the existing contract on August 6th 2019. The Company determined that the notice of suspension was a triggering event necessitating a goodwill impairment test.

 

On May 10, 2019, the Company determined that a material impairment had occurred, requiring an assessment for impairment to be completed related to $5.6 million of goodwill recorded in the acquisition.

 

The impairment test used an income-based approach with discounted cash flow method, and market-based approach including both guideline public company method and merger and acquisition method.

 

The impairment test results indicated that the current estimated fair value of goodwill recorded from the acquisition of DP Engineering had declined below its initial estimated fair value at the acquisition date. As a result, the Company recognized an impairment charge of $2.1 million to write down the goodwill on DP Engineering. The fair value of goodwill recognized from the acquisition of DP Engineering is still provisional and subject to further measurement period adjustment based upon the preliminary purchase price allocation. The Company determined that the impact of the suspension of obtaining new contracts from that customer resulted in a material downward revision to DP Engineering's revenue and profitability forecasts when compared to the acquisition date valuation. The impairment charge on goodwill was recorded within "Loss on impairment" in our consolidated statements of operations. Due to the August 6^th Notice of Termination of the EOC agreement with DP Engineering, the Company performed, under ASC 350 guidance, additional impairment testing as of September 30th, 2019 and at this time have determined no further impairment is needed.

 

Changes in the net carrying amount of goodwill from December 31, 2018 through September 30, 2019 were due to the acquisition of DP Engineering, and were comprised of the following items:

 

(in thousands)

		Performance Improvement Solutions				Nuclear Industry Training and Consulting				Total
Balance, January 1, 2019		$	4,739			$	8,431			$	13,170
Acquisition			5,633				-				5,633
Dispositions			-				-				-
Goodwill impairment loss			(2,094	)			-				(2,094	)
Balance, September 30, 2019		$	8,278			$	8,431			$	16,709

 

ASC 820, Fair Value Measurement (ASC 820), 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. The contingent consideration was based on EBITDA.

 

At September 30, 2019, and December 31, 2018, the Company considers the recorded value of certain of its financial assets and liabilities, which consist primarily of cash equivalents, accounts receivable and accounts payable, to approximate fair value based upon their short-term nature.

 

As of September 30, 2019, the Company had four standby letters of credit totaling $1.2 million which represent performance bonds on four contracts.

 

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

The following table presents assets and liabilities measured at fair value at September 30, 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		$	375			$	-			$	-			$	375
Foreign exchange contracts			-				68				-				68
Total assets		$	375			$	68			$	-			$	443
Liability awards		$	-			$	(18	)		$	-			$	(18	)
Interest rate swap contract			-				(192	)			-				(192	)
Total liabilities		$	-			$	(210	)		$	-			$	(210	)

Money market funds at both September 30, 2019 and December 31, 2018 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 December 31, 2018:

(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		$	824			$	-			$	-			$	824
Foreign exchange contracts			-				43				-				43
Total assets		$	824			$	43			$	-			$	867
Liability awards		$	-			$	(118	)		$	-			$	(118	)
Interest rate swap contract			-				(103	)			-				(103	)
Total liabilities		$	-			$	(221	)		$	-			$	(221	)

The following table provides a roll-forward of the fair value of the contingent consideration categorized as Level 3 for the nine months ended September 30, 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

The Company utilizes forward foreign currency exchange contracts to manage market risks associated with the fluctuations in foreign currency exchange rates and minimize credit exposure by limiting counterparties to nationally recognized financial institutions.

As of September 30, 2019, the Company had one foreign exchange contract outstanding of approximately 1.0 million Euro. The contract is set to expire in March 2020. At December 31, 2018, the Company had contracts outstanding of approximately 3.2 million Euro at fixed rates.

Interest Rate Risk Management

The Company reports all derivatives at fair value. These contracts are recognized as either assets or liabilities, depending upon the derivative’s fair value. The estimated net fair values of the derivative contracts on the consolidated balance sheets are as follows:

		September 30,				December 31,
(in thousands)		2019				2018
Prepaid expenses and other current assets
Foreign exchange contracts		$	68			$	43
Total asset derivatives			68				43
Other liabilities
Interest rate swaps			(192	)			(103	)
Total liability derivatives			(192	)			(103	)
Net fair value		$	(124	)		$	(60	)

The Company has not designated the derivative contracts as hedges. The 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 the 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.

For the three and nine months ended September 30, 2019 and 2018, the Company recognized a net (loss) gain on its derivative instruments as outlined below:

		Three months ended September 30,								Nine months ended September 30,
(in thousands)		2019				2018				2019				2018
Interest rate swap - change in fair value		$	(1	)		$	(28	)		$	(89	)		$	(39	)
Foreign exchange contracts-change in fair value			(45	)			(14	)			25				(178	)
Remeasurement of related contract receivables,  billings in excess of revenue earned, and  subcontractor accruals			(15	)			(17	)			(5	)			(89	)
Loss on derivative instruments, net		$	(61	)		$	(59	)		$	(69	)		$	(306	)