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 March 31, 20162017
 
    
  or 
    
☐ 
Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
for the transition period from ____ to ____
 

Commission File Number 001-14785
 
GSE Systems, Inc.
(Exact name of registrant as specified in its charter)

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)

Registrant's telephone number, including area code:  (410) 970-7800

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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such period that the registrant was required to submit and post 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.  See the definitions of "large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ☐
Accelerated filer  ☐
Non-accelerated filer ☐
Smaller reporting company ☒
  (Do not check if a smaller reporting company) 

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]

There were 18,031,76519,183,968 shares of common stock, with a par value of $.01$0.01 per share outstanding as of May 13, 2016.12, 2017.

1

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 March 31, 20162017 (unaudited) and December 31, 2015
2016		3
  
Unaudited Consolidated Statements of Operations for the Three Months Ended March 31, 20162017 and March 31, 2015
2016		4
  
Unaudited Consolidated Statements of Comprehensive Income (Loss) for the Three Months Ended March 31, 20162017 and March 31, 2015
2016		5
  
Unaudited Consolidated Statement of Changes in Stockholders' Equity for the Three Months Ended March 31, 2016
2017		6
  
Unaudited Consolidated Statements of Cash Flows for the Three Months Ended March 31, 20162017 and March 31, 2015
2016		7
  
Notes to Consolidated Financial Statements
8
Item 2. 
Management's Discussion and Analysis of Financial Condition and Results of Operations
2521
Item 3. 
Quantitative and Qualitative Disclosures About Market Risk
4137
Item 4. 
Controls and Procedures
4237
    
PART II. 
OTHER INFORMATION
4438
Item 1. 
Legal Proceedings
4438
Item 1A. 
Risk Factors
4438
Item 2. 
Unregistered Sales of Equity Securities and Use of Proceeds
4438
Item 3. 
Defaults Upon Senior Securities
4438
Item 4. 
Mine Safety Disclosures
4438
Item 5. 
Other Information
4538
Item 6. 
Exhibits
4538
  
SIGNATURES
4639

2

PART I - FINANCIAL INFORMATION
Item 1. 
Item 1.Financial Statements

GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)

 Unaudited     March 31, 2017  December 31, 2016 
 March 31, 2016  December 31, 2015  (Unaudited)    
ASSETSASSETS ASSETS 
Current assets:            
Cash and cash equivalents $11,225  $11,084  $21,625  $21,747 
Restricted cash  1,877   1,771   1,140   1,140 
Contract receivables, net  12,780   13,053   13,897   18,863 
Prepaid expenses and other current assets  2,934   2,506   4,024   2,052 
Total current assets  28,816   28,414   40,686   43,802 
                
Equipment, software and leasehold improvements  7,012   7,003 
Equipment, software, and leasehold improvements  6,845   6,759 
Accumulated depreciation  (5,531)  (5,407)  (5,648)  (5,527)
Equipment, software and leasehold improvements, net  1,481   1,596 
Equipment, software, and leasehold improvements, net  1,197   1,232 
                
Software development costs, net  1,195   1,145   894   982 
Goodwill  5,612   5,612   5,612   5,612 
Intangible assets, net  696   775   402   454 
Long-term restricted cash  1,734   1,779 
Other assets  94   50   72   1,574 
Total assets $39,628  $39,371  $48,863  $53,656 
                
LIABILITIES AND STOCKHOLDERS' EQUITYLIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES AND STOCKHOLDERS' EQUITY 
Current liabilities:                
Accounts payable $2,116  $1,238  $587  $923 
Accrued expenses  1,727   1,723   2,389   2,437 
Accrued compensation and payroll taxes  2,781   2,431 
Accrued compensation  2,015   2,624 
Billings in excess of revenue earned  8,785   9,229   18,192   21,444 
Accrued warranty  1,410   1,614   1,209   1,137 
Current contingent consideration  1,115   2,647 
Contingent consideration  1,508   2,105 
Other current liabilities  1,055   826   750   716 
Total current liabilities  18,989   19,708   26,650   31,386 
                
Contingent consideration  1,127   1,085 
Other liabilities  706   210   1,261   1,149 
Total liabilities  20,822   21,003   27,911   32,535 
Commitments and contingencies        
                
Stockholders' equity:                
Preferred stock $.01 par value, 2,000,000 shares authorized, shares issued and outstanding none in 2016 and 2015  -   - 
Common stock $.01 par value, 30,000,000 shares authorized, 19,522,483 shares issued and 17,923,572 shares outstanding in 2016, 19,510,770 shares issued and 17,911,859 shares outstanding in 2015  195   195 
Preferred stock $0.01 par value, 2,000,000 shares authorized, no shares issued and outstanding  -   - 
Common stock $0.01 par value, 30,000,000 shares authorized, 20,777,168 and 20,433,608 shares issued and 19,178,257 and 18,834,697 shares outstanding  208   204 
Additional paid-in capital  73,732   73,481   75,120   75,120 
Accumulated deficit  (50,711)  (50,849)  (49,693)  (49,427)
Accumulated other comprehensive loss  (1,411)  (1,460)  (1,684)  (1,777)
Treasury stock at cost, 1,598,911 shares in 2016 and 2015  (2,999)  (2,999)
Treasury stock at cost, 1,598,911 shares in 2017 and 2016  (2,999)  (2,999)
Total stockholders' equity  18,806   18,368   20,952   21,121 
Total liabilities and stockholders' equity $39,628  $39,371  $48,863  $53,656 

The accompanying notes are an integral part of these consolidated financial statements.
3

GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(Unaudited)

 
Three months ended
March 31,
  
Three months ended
March 31,
 
 2016  2015  2017  2016 
            
Contract revenue $12,976  $14,013 
Revenue $16,342  $12,976 
Cost of revenue  9,352   10,719   12,220   9,352 
Gross profit  3,624   3,294   4,122   3,624 
                
Operating expenses:                
Selling, general and administrative  3,111   3,269   3,592   2,757 
Research and development  402   354 
Restructuring charges  125   97   45   125 
Depreciation  100   129   76   100 
Amortization of definite-lived intangible assets  73   123   64   73 
Total operating expenses  3,409   3,618   4,179   3,409 
                
Operating income (loss)  215   (324)
Operating (loss) income  (57)  215 
                
Interest income, net  27   27   27   27 
Loss on derivative instruments, net  (118)  (48)  (160)  (118)
Other income (expense), net  102   (39)
Income (loss) before income taxes  226   (384)
Other (expense) income, net  (3)  102 
(Loss) income before income taxes  (193)  226 
                
Provision for income taxes  88   88   73   88 
Net income (loss) $138  $(472)
Net (loss) income $(266) $138 
                
                
Basic earnings (loss) per common share $0.01  $(0.03)
Basic (loss) earnings per common share $(0.01) $0.01 
                
Diluted earnings (loss) per common share $0.01  $(0.03)
Diluted (loss) earnings per common share $(0.01) $0.01 

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


4


GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
(Unaudited)

  
Three months ended
March 31,
 
  2016  2015 
       
       
Net income (loss) $138  $(472)
         
Foreign currency translation adjustment  49   (236)
         
Comprehensive income (loss) $187  $(708)
  
Three months ended
March 31,
 
  2017  2016 
       
       
Net (loss) income $(266) $138 
         
Foreign currency translation adjustment  93   49 
         
Comprehensive (loss) income $(173) $187 

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

5


GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands)
(Unaudited)

 
Common
Stock
  
Additional
Paid-in
  Accumulated  
Accumulated
Other Comprehensive
  
Treasury
Stock
     
Common
Stock
         
Treasury
Stock
   
 Shares  Amount  Capital  Deficit  Loss  Shares  Amount  Total  Shares  Amount  
Additional
Paid-in
Capital
  
Accumulated
Deficit
  
Accumulated
Other Comprehensive
Loss
  Shares  Amount  Total 
Balance, December 31, 2015  19,511  $195  $73,481  $(50,849) $(1,460)  (1,599) $(2,999) $18,368 
Balance, January 1, 2017  20,434  $204  $75,120  $(49,427) $(1,777)  (1,599) $(2,999) $21,121 
                                                                
Stock-based compensation expense  -   -   247   -   -   -   -   247   -   -   614   -   -   -   -   614 
Common stock issued for options exercised  2   -   4   -   -   -   -   4   31   1   61   -   -   -   -   62 
Common stock issued for RSUs vested  9   -   -   -   -   -   -   -   312   3   (3)  -   -   -   -   - 
Vested RSU shares withheld to pay taxes  -   -   (672)  -   -   -   -   (672)
Foreign currency translation adjustment  -   -   -   -   49   -   -   49   -   -   -   -   93   -   -   93 
Net income  -   -   -   138   -   -   -   138 
Balance, March 31, 2016  19,522  $195  $73,732  $(50,711) $(1,411)  (1,599) $(2,999) $18,806 
Net loss  -   -   -   (266)  -   -   -   (266)
Balance, March 31, 2017  20,777  $208  $75,120  $(49,693) $(1,684)  (1,599) $(2,999) $20,952 

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

6

GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)

 
Three months ended
March 31,
  
Three months ended
March 31,
 
 2016  2015  2017  2016 
Cash flows from operating activities:            
Net income (loss) $138  $(472)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:        
Net (loss) income $(266) $138 
Adjustments to reconcile net (loss) income to net cash provided by operating activities:        
Depreciation  100   129   76   100 
Amortization of definite-lived intangible assets  73   123   64   73 
Capitalized software amortization  81   90 
Amortization of capitalized software development costs  117   81 
Change in fair value of contingent consideration  (69)  (80)  254   (69)
Stock-based compensation expense  247   134   596   247 
Equity loss on investments  -   39 
Loss on derivative instruments  118   48 
Loss on derivative instruments, net  160   118 
Deferred income taxes  36   36   -   36 
Gain on sales of equipment, software, and leasehold improvements  (1)  - 
Gain on sale of equipment, software, and leasehold improvements  -   (1)
Changes in assets and liabilities:                
Contract receivables  334   610 
Contract receivables, net  4,937   334 
Prepaid expenses and other assets  (515)  31   (523)  (515)
Accounts payable, accrued compensation and accrued expenses  1,226   (358)
Accounts payable, accrued compensation, and accrued expenses  (1,184)  1,226 
Billings in excess of revenue earned  (492)  (835)  (3,279)  (492)
Accrued warranty  (101)  51   67   (101)
Other liabilities  465   (18)  325   465 
Net cash provided by (used in) operating activities  1,640   (472)
Cash provided by operating activities  1,344   1,640 
                
Cash flows from investing activities:                
Proceeds from sale of equipment, software, and leasehold improvements  31   - 
Proceeds from sale of equipment, software and leasehold improvement  -   31 
Capital expenditures  (18)  (104)  (44)  (18)
Capitalized software development costs  (131)  (506)  (29)  (131)
Restrictions of cash as collateral under letters of credit  (2)  (216)  -   (2)
Releases of cash as collateral under letters of credit  1   180   -   1 
Net cash used in investing activities  (119)  (646)
Cash used in investing activities  (73)  (119)
                
Cash flows from financing activities:                
Proceeds from issuance of common stock  4   - 
Payments on line of credit  -   (339)
Payments of the liability-classified contingent consideration arrangements  (1,421)  (318)
Net cash used in financing activities  (1,417)  (657)
Proceeds from issuance of common stock on the exercise of stock options  62   4 
Contingent consideration payments to Hyperspring, LLC  (851)  (1,421)
RSUs withheld to pay taxes  (672)  - 
Cash used in financing activities  (1,461)  (1,417)
                
Effect of exchange rate changes on cash  37   (218)  68   37 
Net increase (decrease) in cash and cash equivalents  141   (1,993)
Net (decrease) increase in cash and cash equivalents  (122)  141 
Cash and cash equivalents at beginning of year  11,084   13,583   21,747   11,084 
Cash and cash equivalents at end of period $11,225  $11,590  $21,625  $11,225 

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


7
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Three Months ended March 31, 2016 and 2015
(Unaudited)

1.Summary of Significant Accounting Policies

Basis of Presentation

The consolidated interim financial statements included herein have been prepared by GSE Systems, Inc. (the "Company," "GSE," "we," "us," or "our") without independent audit.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 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, 20152016, filed with the Securities and Exchange Commission on March 25, 2016.28, 2017.  Certain reclassifications have been made to prior period amounts to conform to the current presentation.  Subcontractor payables have been reclassified on the Consolidated Balance Sheets from Accounts payable to Accrued expenses.  In addition, the Company reclassified research and development costs from Selling, general and administrative expenses and presented them as a separate caption within operating expenses on the consolidated statement of operations.  The Company also reclassified the current portion of deferred taxes to noncurrent within other assets and other liabilities on the consolidated balance sheets.

The Company has two reportable segments as follows:

·●Performance Improvement Solutions (approximately 68%59% of revenue)
The Company's
Our Performance Improvement Solutions segment primarily encompasses next generationour power plant and process high-fidelity simulation solutions, as well as engineering solutions.solutions and interactive computer based tutorials/simulation focused on the process industry.  This segment includes various simulation products, engineering services, and operation training systems delivered across the industries the Company serves:we serve: primarily nuclear and fossil fuel power generation, andas well as the process industries.  SimulationOur simulation solutions include the following: (1) simulation software and services, including operator training systems, for the nuclear power industry, (2) simulation software and services, including operator training systems, for the fossil power industry, and (3) simulation software and services for the process industries used to teach fundamental industry processes and control systems to newly hired employees and for ongoing workforce development and training.  GSE and its predecessors have been providing these services since 1976.


·●Nuclear Industry Training and Consulting (approximately 32%41% of revenue)

Nuclear Industry Training and Consulting provides highly specialized and skilled nuclear operations instructors and other consultants to the nuclear power industry.  These employees work at our clients' facilities under client direction.  Examples of these highly skilled positions are senior reactor operations instructors, procedure writers, work management specialists, planners and training material developers.  This business is managed through theour Hyperspring subsidiary.  The business model, management focus, margins and other factors clearly separate this business line from the rest of the GSECompany's product and service portfolio.  Hyperspring has been providing these services since 2005.

Financial information about the two business segments is provided in Note 1415 of the accompanying consolidated financial statements.

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 long-term contracts, product warranties, capitalization of software development costs, valuation of goodwill and intangible assets acquired, valuation of contingent consideration issued in business acquisitions, and the recoverability of deferred tax assets.  Actual results could differ from these estimates and those differences could be material.

8

Revenue recognition
Revenue Recognition
The Company has (1)recognizes revenue through fixed price contracts for the sale of uniquely designed/customized systems containing hardware, and software (2) fixed price contracts for the sale of software licenses which may include post contract support and other elements such as installationmaterials which generally apply to the Performance Improvement Solutions segment and training, and (3) time and material contracts for Nuclear Industry Training and Consulting support and service agreements.

In accordance with Accounting Standards Codification ("ASC")(ASC) 605-35, "Construction-TypeConstruction-Type and Production-Type Contracts"Contracts (ASC 605), the Performance Improvement Solutions segment recognizesaccounts for revenue for itsunder fixed-price contracts for the sale of customized systems using the percentage-of-completion method.  This methodology recognizes revenue and earnings as work progresses on the contract and is based on an estimate of the revenue and earnings earned to date, less amounts recognized in prior periods.  The Company bases its estimate of the degree of completion of the contract by reviewing the relationship of costs incurred to date compared to the expected total costs that will be incurred onestimated cost to complete the project.  Estimated contract earnings are reviewed and revised periodically as the work progresses, and the cumulative effect of any change in estimate is recognized in the period in which the change is identified.  Estimated losses are charged against earnings in the period such losses are identified.  The Company recognizesWe recognize revenue arising from contract claims either as income or as an offset against a potential loss only when the amount of the claim can be estimated reliably and realization is probable and there is a legal basis of the claim.

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 the Company'sour revenue recognition as a significant change in the estimates can cause the Company'sour revenue and related margins to change significantly from the amounts estimated in the early stages of the project.

As the Company recognizeswe recognize revenue under the percentage-of-completion method, it provideswe provide an accrual for estimated future warranty costs based on historical and projected claims experience.  The Company'sOur long-term contracts generally provide for a one-year warranty on parts, labor and any bug fixes as it relates to customized software embedded in the systems.
The Company evaluates customized
Our system design contracts for multiple deliverables under ASC 605-25, "Revenue Recognition-Multiple Element Arrangements", and when appropriate, separates the contracts into separate units of accounting for revenue recognition. Contracts with multiple element arrangements typically include, but aredo not limited to, components such as training andnormally provide for post contract support ("PCS"), which are embedded(PCS) in terms of software upgrades, software enhancements or telephone support.  To obtain PCS, the contract. Whencustomers must normally purchase a contract contains multiple deliverables, the Company allocates revenue to each deliverable based on its relative selling price which is determined based on its vendor specific objective evidence ("VSOE") if available, third party evidence ("TPE") if VSOE is not available, or estimated selling price if neither VSOE nor TPE is available. Amounts allocated to training and support services are based on VSOE and revenue is deferred until the services have been performed.
The Company also provides stand-alone PCS contracts.separate contract.  Such PCS arrangements are generally for a one-year period renewable annually and include customer support, unspecified software upgrades, and maintenance releases.  The Company recognizesWe recognize revenue from these contracts ratably over the lifeterm of the agreements.

Revenue from the sale of software licenses without other elements in the contract and which do not require significant modifications or customization for the Company's modeling tools are recognized when the license agreement is signed, the license fee is fixed and determinable, delivery has occurred, and collection is considered probable.  The Company utilizesWe utilize written contracts as a means to establish the terms and conditions by which productsproduct support and services are sold to customers.  Delivery is considered to have occurred when title and risk of loss have been transferred to the customer, which generally occurs after a license key has been delivered electronically to the customer.
9

The CompanyWe also recognizesrecognize revenue from the sale of software licenses from contracts with multiple deliverables.  These software license sales are evaluated under ASC 985-605, "Software Revenue Recognition"Recognition.  Contracts with multiple element arrangements typically include, but are not limited to, components such as installation, training, licenses, and PCS listed in the contract.  The Company hasconcluded that vendor specific objective evidence does not established that VSOE existsexist for all elements of its software license sales.  If a PCS or professional services element exists in the software license arrangement, revenue is recognized ratably over the PCSlongest service period.  If no PCS or professional services element exists in the arrangement, revenue is deferred until all elements have beenthe last undelivered element is delivered.
The Company recognizes
We recognize revenue under time and materials contracts primarily from the Nuclear Industry Training and Consulting segment and certain cost-reimbursable contracts.  Revenue on time and material contracts is recognized as services are rendered and performed.  Under a typical time-and-materials billing arrangement, customers are billed on a regularly scheduled basis, such as biweekly or monthly.  Any unbilled amounts are typically billed the following month.  Under cost-reimbursable contracts, which are subject to a contract ceiling amount, the Company iswe are reimbursed for allowable costs and paid a fee, which may be fixed or performance based.  However, if costs exceed the contract ceiling or are not allowable under the provisions of the contract or applicable regulations, the Companywe may not be able to obtain reimbursement for all such costs.


The following customer provided more than 10% of the Company's consolidated revenue:

   
Three months ended
March 31,
   2016 
2015(1)
Tennessee Valley Authority  12.6 % 20.9 %
(1) The prior year amounts have been revised to correct misstatements that were deemed to be immaterial to the prior period, as described in Note 1 - Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements.

Tennessee Valley Authority ("TVA") is a customer of Hyperspring, LLC.

Revisions

Historically, the Company recognized revenue on multiple element arrangements which included sales of its EnVision software product as delivery occurred on each element except PCS.  PCS revenue was recognized ratably over the PCS term.  During the fourth quarter of 2015, management determined that the Company had not established VSOE of the fair value for any of the elements in multiple element transactions including sales of its EnVision software licenses.  Accordingly, the consolidated financial statements were revised to recognize all revenue on multiple element transactions including EnVision software license sales ratably over the PCS terms on these transactions since VSOE did not exist for any of the non-software elements in these multiple element transactions.  The revision resulted in an increase to revenue of $17,000, a decrease to cost of revenue of $55,000, and a decrease in operating loss of $72,000 for the three months ended March 31, 2015. 
Certain prior year amounts have also been revised in the consolidated statements of cash flows to reflect the corrections to net loss and changes in billings in excess of revenue earned, prepaid expenses and other assets.  The revision had no impact on cash provided by operations or the net decrease in cash and cash equivalents.
109


The Company assessed the materiality of these misstatements on prior periods' consolidated financial statements in accordance with SEC Staff Accounting Bulletin ("SAB") No. 99, Materiality, codified in ASC 250, Accounting Changes and Error Corrections, and concluded that these misstatements were not material to any prior annual or interim periods.  Accordingly, in accordance with ASC 250 (SAB No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements"), the consolidated financial statements as of March 31, 2015, which are presented herein, have been revised.



GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)

  Three months ended March 31, 2015 
  As Reported  Adjustment  As Revised 
          
Contract revenue $13,996  $17  $14,013 
Cost of revenue  10,774   (55)  10,719 
Gross profit  3,222   72   3,294 
             
Operating loss  (396)  72   (324)
             
Loss before income taxes  (456)  72   (384)
             
Net loss $(544) $72  $(472)
             
             
Basic loss per common share $(0.03) $-  $(0.03)
             
Diluted loss per common share $(0.03) $-  $(0.03)
11

GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)

  Three months ended March 31, 2015 
  As Reported  Adjustment  As Revised 
          
Net loss $(544) $72  $(472)
             
Comprehensive loss $(780) $72  $(708)


GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

  Three months ended March 31, 2015 
  As Reported  Adjustment  As Revised 
          
Cash flows from operating activities:         
Net loss $(544) $72  $(472)
Changes in assets and liabilities:            
Contract receivables, net  583   27   610 
Prepaid expenses and other assets  86   (55)  31 
Billings in excess of revenue earned  (791)  (44)  (835)
Net cash provided by operating activities $(472) $-  $(472)
             
Net decrease in cash and cash equivalents $(1,993) $-  $(1,993)

12

2.Recent Accounting Pronouncements

Accounting Pronouncements Recently Adoptedpronouncements recently adopted

In NovemberJuly 2015, the Financial Accounting Standards Board ("FASB")(FASB) issued Accounting Standards Update (ASU) No. 2015-11, Simplifying the Measurement of Inventory (ASU 2015-17, "Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes"2015-11).  The standard  ASU 2015-11 requires that deferred tax assetsan entity measure inventory at the lower of cost and liabilities be classified as noncurrent on the balance sheet rather than being separated into current and noncurrent.net realizable value.  This ASU 2015-17 isdoes not apply to inventory measured using last-in, first-out.  ASU 2015-11 was effective for fiscal years, and interimannual reporting periods within those years, beginning after December 15, 2016.  Early adoption is permitted and the standard may be applied either retrospectively or on a prospective basis to all deferred tax assets and liabilities.  The Company early2016, including interim periods within that reporting period.  We adopted ASU 2015-17 during2015-11 effective January 1, 2017.  The adoption of this standard did not have a significant impact on our consolidated financial position, results of operations or cash flows.

In March 2016, the first quarterFASB issued ASU No. 2016-09, Compensation - Stock Compensation: Topic 718: Improvements to Employee Share Based Accounting (ASU 2016-09).  The new guidance is intended to simplify the accounting for share based payment award transactions.  The amendments in the update include the following aspects for share based accounting: accounting for income taxes, classification of fiscal year 2016 on a retrospective basis.  Accordingly, the Company reclassified the current deferred taxes to noncurrentexcess tax benefits on the March 31,statement of cash flows, forfeitures, minimum statutory tax withholding requirements, and classification of employee taxes paid on the statement of cash flows when an employer withholds shares for tax withholding purposes.  The adoption of ASU 2016-09 was required for fiscal reporting periods beginning after December 15, 2016, including interim reporting periods within those fiscal years.  We adopted ASU 2016-09 effective January 1, 2017. The adoption of this standard did not have a significant impact on our consolidated balance sheets, which increased noncurrent deferred tax assets by $6,000.financial position, results of operations or cash flows.

Accounting Pronouncements Not Yet Adoptedpronouncements not yet adopted

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers(ASU 2014-09), which provides guidance for revenue recognition. The standard's core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under today's guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. This guidance will be effective for the Company infor the first quarter of its fiscal year ending December 31, 2018, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). The Company isWe are currently in the process of evaluating the impact of its pendingthe adoption of this ASU on the Company'sour consolidated financial statements and has not yet determinedour method of adoption.  The adoption is expected to impact our revenue recognition and related disclosures.  For example, our revenue from software arrangements with multiple elements including services are currently recognized ratably due to the method by which itlack of vendor-specific objective evidence (VSOE) of fair value.  We will adopt the standard in 2018.be required to separate these performance obligations under these arrangements and recognize them as delivered.

10
In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)".  The new standard establishes a right-of-use ("ROU")(ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months.  Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement.  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 forwith capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the consolidated financial statements, with certain practical expedients available.  The Company isWe are still evaluating the impact of the pending adoption of the new standard on the consolidated financial statements, and the Company expectswe expect that, upon adoption, the recognition of ROU assets and lease liabilities could be material.

In MarchAugust 2016, the FASB issued ASU No. 2016-09,2016-15, "Compensation - Stock Compensation: Topic 718: Improvements to Employee Share Based Accounting"Classification of Certain Cash Receipts and Cash Payments (ASU-2016-15).  The new guidance is intendedaddresses eight specific cash flow issues and applies to simplify the accounting for share based payment award transactions.  The amendments in the update include the following aspects for share based accounting: accounting for income taxes, classification of excess tax benefits on theall entities that are required to present a statement of cash flows, forfeitures, minimum statutory tax withholding requirements, and classification of employee taxes paid on the statement of cash flows when an employer withholds shares for tax withholding purposes.flows.  Adoption of ASU 2016-092016-15 is required for fiscal reporting periods beginning after December 15, 20162017, including interim reporting periods within those fiscal years.  We are currently evaluating the potential impact of the pending adoption of ASU 2016-092016-15 on our consolidated financial statements.

In November 2016, the FASB issued ASU No. 2016-18, Restricted Cash (ASU 2016-18).  The new guidance applies to all entities that have restricted cash or restricted cash equivalents and are required to present a statement of cash flows.  This update is intended to reduce diversity in cash flow presentation of restricted cash and restricted cash equivalents and requires entities to include all cash and cash equivalents, both restricted and unrestricted, in the beginning-of-period and end-of-period totals presented on the statement of cash flows.  Adoption of ASU 2016-18 is required for fiscal reporting periods beginning after December 15, 2017, including interim reporting periods within those fiscal years.  We are currently evaluating the potential impact of the adoption of ASU 2016-18 on our consolidated financial statements.

In January 2017, the FASB issued ASU No. 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.
1311

3.Basic and Diluted Earnings (Loss) per Common Share

Basic earnings (loss) per share is based on the weighted average number of outstanding common shares for the period.  Diluted earnings (loss) per share adjusts the weighted average shares outstanding for the potential dilution that could occur if outstanding vested stock options were exercised into common stock.exercised.

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

(in thousands, except for share amounts) Three months ended  Three months ended 
 March 31,  March 31, 
 2016  2015  2017  2016 
Numerator:            
Net income (loss) $138  $(472)
Net (loss) income $(266) $138 
                
Denominator:                
Weighted-average shares outstanding for basic earnings per share  17,912,045   17,887,859 
Weighted-average shares outstanding for basic (loss) income per share  19,094,382   17,912,045 
                
Effect of dilutive securities:                
Employee stock options  221,697   - 
Stock options and restricted stock units  -   221,697 
                
Adjusted weighted-average shares outstanding and assumed conversions for diluted earnings per share  18,133,742   17,887,859 
Adjusted weighted-average shares outstanding and assumed conversions for diluted (loss) income per share  19,094,382   18,133,742 
                
Shares related to dilutive securities excluded because inclusion would be anti-dilutive  752,042   2,565,067   564,833   752,042 
14


4.Contingent Consideration

Acquisitions may include contingent consideration payments based on future financial measures of an acquired company. Under ASC 805, "Business Combinations"Combinations, requires that contingent consideration is required to be recognized at fair value onas of the acquisition date and be re-measured each reporting period with subsequent adjustments recognized in the consolidated statement of operations. The Company estimatesdate. We estimate the fair value of contingent considerationthese liabilities based on financial projections of the acquired companies and estimated probabilities of achievement and discount the liabilities to present value using a weighted-average cost of capital. Contingent consideration is valued using significant inputs that are not observable in the market which are defined as Level 3 inputs pursuant to fair value measurement accounting.  The Company believes that the estimates and assumptions are reasonable, however, there is significant judgment involved.achievement. At each reporting date, the contingent consideration obligation is revalued to estimated fair value and changes in fair value subsequent to the acquisitionsacquisition are reflected in income or expense in the consolidated statements of operations, and could cause a material impact to and volatility in, theour 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.

As of March 31, 20162017, and December 31, 2015,2016, the current contingent consideration totaled $1.1$1.5 million and $2.6$2.1 million, respectively.  As of both March 31, 2016 and December 31, 2015, the Company also had accrued contingent consideration totaling $1.1 million which is included in other liabilities on the consolidated balance sheets and represents the portion of contingent consideration estimated to be payable greater than twelve months from the balance sheet date.  During the three months ended March 31, 20162017 and March 31, 2015,2016, the Company made payments of $1.4$0.9 million and $318,000,$1.4 million, respectively, related to the liability-classified contingent consideration arrangements.arrangement.

12
5.Contract Receivables

Contract receivables represent balances due from a broad base of both domestic and international customers.  All contract receivables are considered to be collectible within twelve months.  Unbilled receivablesRecoverable costs and accrued profit not yet billed represent costs incurred and associated profit accrued on contracts that will become billable upon future milestones or completion of contracts.

The components of contract receivables are as follows:

(in thousands) March 31,  December 31,  March 31,  December 31, 
 2016  2015  2017  2016 
            
Billed receivables $7,631  $9,831  $5,971  $13,325 
Unbilled receivables  5,171   3,325 
Recoverable costs and accrued profit not yet billed  7,944   5,555 
Allowance for doubtful accounts  (22)  (103)  (18)  (17)
Total contract receivables, net $12,780  $13,053  $13,897  $18,863 

Unbilled receivables totaled $5.2 million and $3.3 million as of March 31, 2016 and December 31, 2015, respectively.  During April 2016,2017, the Company invoiced $1.8$1.6 million of the unbilled amounts related to the balance at March 31, 2016.2017.

As of both March 31, 2016 and2017, the Company had one customer that accounted for 21% of the Company's consolidated contract receivables.  As of December 31, 2015,2016, the Company did not have any customers that accounted for more than 10% of the Company's consolidated contract receivables.

6. Prepaid Expenses and Other Current Assets

Prepaid expenses and other current assets consist of the following:

(in thousands) March 31,  December 31, 
  2017  2016 
       
Inventory $2,158  $- 
Income taxes receivable  380   446 
Prepaid expenses  583   422 
Other current assets  903   1,184 
Total prepaid expenses and other current assets $4,024  $2,052 

At March 31, 2017, prepaid expenses and other current assets are comprised primarily of inventory that is being purchased to support the construction of three major nuclear simulation projects related to a significant contract that was executed during the first quarter of 2016. Inventory is recorded at the lower of cost or market value in accordance with ASC 330, Inventory.  At December 31, 2016, inventory related to the simulation projects was classified as a long-term asset within other assets on the consolidated balance sheet. The earliest completion date of these projects is expected to occur in the first quarter of 2018.

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6.7.Software Development Costs, Net

Certain computer software development costs are capitalized in the accompanying consolidated balance sheets.  Capitalization of computer software development costs begins upon the establishment of technological feasibility. Capitalization ceases and amortization of capitalized costs begins when the software product is commercially available for general release to customers.  Amortization of capitalized computer software development costs is included in cost of revenue and is determined using the straight-line method over the remaining estimated economic life of the product, typically three years.  On an annual basis, and more frequently as conditions indicate, the Company assesses the recovery of the unamortized software development costs by estimating the net undiscounted cash flows expected to be generated by the sale of the product.  If the undiscounted cash flows are not sufficient to recover the unamortized software costs the Company will write-down the investmentcarrying amount of such asset to its estimated fair value based on the future undiscounteddiscounted cash flows.  The excess of any unamortized computer software development costs over the related net realizablefair value is written down and charged to cost of revenue.operations.

Software development costs capitalized were $131,000approximately $29,000 and $506,000$131,000 for the three months ended March 31, 20162017 and March 31, 2015,2016, respectively.  Total amortization expense was approximately $117,000 and $81,000 for the three months ended March 31, 2017 and 2016, and $90,000 for the three months ended March 31, 2015.respectively.

7.8.Goodwill and Intangible Assets

GoodwillThe Company's intangible assets include amounts recognized in connection with business acquisitions, including goodwill, customer relationships, contract backlog, and software.

The Company reviews goodwill for impairment annually as of December 31 and whenever events or changes in circumstances indicate the carrying value of an assetgoodwill 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. generally accepted accounting principles.  The Company'sGAAP. After the acquisition of Hyperspring on November 14, 2014, the Company determined that it had two reporting units, are:which are the same as our two operating segments: (i) Performance Improvement SolutionsSolutions; and (ii) Nuclear Industry Training and Consulting.Consulting (which includes Hyperspring).  As of March 31, 20162017, and December 31, 2015, the2016, goodwill of $5.6 million of goodwill balance originated from the Hyperspring acquisition in 2014 and is assignedrelated to the Nuclear Industry Training and Consulting segment.  No events or circumstances occurred during the current reporting period that would indicate impairment of such goodwill.

Intangible Assets Subject to Amortization

The Company's of intangible assets include amounts recognized in connection with business acquisitions, including customer relationships, contract backlog and technology.  Intangible assets are initially valued at fair market value using generally accepted valuation methods appropriate for the type of intangible asset.  Amortizationother than goodwill is recognized on a straight-line basis over the estimated useful life of the intangible assets, except for contract backlog and contractual 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 reviews specific definite-liveddoes not have any intangible assets forwith indefinite useful lives, other than goodwill. There were no indications of impairment when events occur that may impact their value in accordance withof intangible assets other than goodwill during the respective accounting guidance for long-lived assets.current reporting period.

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8.9.Fair Value of Financial Instruments

ASC 820, "Fair Value Measurement"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.

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 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 the fair value of the respective assets and liabilities at March 31, 20162017, and December 31, 20152016, based upon the short-term nature of the assets and liabilities.
17
For the three months ended March 31, 2017, 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 March 31, 2017.

The following table presents assets and liabilities measured at fair value at March 31, 2016:2017:

 
Quoted Prices
in Active
Markets for Identical Assets
  
Significant
Other
Observable Inputs
  
Significant
Unobservable
Inputs
    
(in thousands) (Level 1)  (Level 2)  (Level 3)  Total  
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 $10,355  $-  $-  $10,355  $12,145  $-  $-  $12,145 
Foreign exchange contracts  -   39   -   39   -   71   -   71 
                
Total assets $10,355  $39  $-  $10,394  $12,145  $71  $-  $12,216 
                                
Foreign exchange contracts $-  $(159) $-  $(159) $-  $(36) $-  $(36)
Contingent consideration liability  -   -   (2,242)  (2,242)
                
Contingent consideration  -   -   (1,508)  (1,508)
Total liabilities $-  $(159) $(2,242) $(2,401) $-  $(36) $(1,508) $(1,544)

15
The following table presents assets and liabilities measured at fair value at December 31, 2015:2016:

 
Quoted Prices
in Active
Markets for Identical Assets
  
Significant
Other
Observable Inputs
  
Significant
Unobservable
Inputs
    
(in thousands) (Level 1)  (Level 2)  (Level 3)  Total  
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 $8,979  $-  $-  $8,979  $16,435  $-  $-  $16,435 
Foreign exchange contracts  -   121   -   121   -   141   -   141 
                
Total assets $8,979  $121  $-  $9,100  $16,435  $141  $-  $16,576 
                                
Foreign exchange contracts $-  $(57) $-  $(57) $-  $(20) $-  $(20)
Contingent consideration liability  -   -   (3,732)  (3,732)
Contingent consideration  -   -   (2,105)  (2,105)
Total liabilities $-  $(20) $(2,105) $(2,125)
                                
Total liabilities $-  $(57) $(3,732) $(3,789)

The following table provides a roll-forward of the fair value of the contingent consideration categorized as Level 3 for the three months ended March 31, 2016:2017:

(in thousands) Three months ended 
  March 31, 2016 
Contingent consideration:   
Beginning balance $3,732 
Payments made on contingent liabilities  (1,421)
Change in fair value and other  (69)
Ending balance $2,242 
(in thousands)   
    
    
Balance, January 1, 2017 $2,105 
Payments made on contingent liabilities  (851)
Change in fair value  254 
Balance, March 31, 2017 $1,508 

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9.10.Derivative Instruments

The Company utilizes forward foreign currency exchange contracts to manage market risks associated with the fluctuations in foreign currency exchange rates.  It is the Company's policy to use such derivative financial instruments to protect against market risk arising in the normal course of business in order to reduce the impact of these exposures.  The Company minimizes credit exposure by limiting counterparties to nationally recognized financial institutions.

As of March 31, 2016,2017, the Company had foreign exchange contracts outstanding of approximately 2.2281.4 million Japanese Yen, 0.2 million Euro, 0.60.4 million CanadianAustralian Dollars, 0.3 million Pounds Sterling, and 0.3 million AustralianCanadian Dollars at fixed rates.  The contracts expire on various dates through January 2017.December 2018.  At December 31, 2015,2016, the Company had contracts outstanding of approximately 2.1281.4 million Japanese Yen, 0.1 million Euro, 1.30.6 million CanadianAustralian Dollars, and 0.5 million Pounds Sterling, and 0.4 million AustralianCanadian Dollars at fixed rates.

The Company hashad not designated any of the foreign exchange contracts outstanding as hedges and has recorded the estimated net fair valuevalues of the contracts inon the consolidated balance sheets as follows:

 March 31,  December 31,  March 31,  December 31, 
(in thousands) 2016  2015  2017  2016 
            
Asset derivatives            
Prepaid expenses and other current assets $39  $115  $27  $57 
Other assets  -   6   44   84 
  39   121   71   141 
Liability derivatives                
Other current liabilities  (159)  (57)  (36)  (20)
  (159)  (57)  (36)  (20)
                
Net fair value $(120) $64  $35  $121 

The changes in the fair value of the foreign exchange contracts are included in net loss on derivative instruments, net in the consolidated statements of operations.
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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 net loss on derivative instruments, net in the consolidated statements of operations.

For the three months ended March 31, 20162017 and March 31, 2015,2016, the Company recognized a net loss on its derivative instruments as outlined below:

 
Three months ended
March 31,
  
Three months ended
March 31,
 
(in thousands) 2016  2015  2017  2016 
            
Foreign exchange contracts- change in fair value $(183) $- 
Remeasurement of related contract receivables,
billings in excess of revenue earned, and
subcontractor accruals
  65   (48)
Foreign exchange contracts - change in fair value $(86) $(183)
Remeasurement of related contract receivables,
and billings in excess of revenue earned
  (74)  65 
Loss on derivative instruments, net $(118) $(48) $(160) $(118)
2017


10.11.Stock-Based Compensation

The Company recognizes compensationshare-based payment expense for all equity-based compensation awards issued to employees, directors and non-employees that are expected to vest.  Compensation costShare-based payment expense is based on the fair value of awards as of the grant date.  The Company recognized $614,000 and $247,000 and $134,000 of stock-based compensationshare-based payment expense related to equity awards for the three months ended March 31, 20162017 and March 31, 2015,2016, respectively, under the fair value method. Offsetting this expense during the three months ended March 31, 2017, was a reduction in the fair value of cash-settled RSUs totaling approximately $18,000.

During the three months ended March 31, 2017, the Company granted 223,802 time-based restricted stock units (RSUs) to employees with an aggregate fair value of $783,000, of which a portion will vest quarterly in equal amounts over the course of eight quarters and the remainder will vest annually in equal amounts over the course of three years.  During the three months ended March 31, 2016, the Company granted 160,000 performance-based restricted stock units ("RSUs")129,824 time-based RSUs to employees with an aggregate fair value of $282,000.$286,000, which will vest quarterly in equal amounts over the course of eight quarters.  The fair value of the time-based RSUs is expensed ratably over the requisite service period, which ranges from two to three years.

During the three months ended March 31, 2017, the Company did not grant performance-based RSUs.  The Company granted 160,000 performance-based RSUs with an aggregate fair value of $282,000 during the three months ended March 31, 2016.  These RSUs vest upon the achievement of specific performance measures.  The fair value of the performance-based RSUs is expensed ratably over the requisite service period, which ranges between one and four years.

DuringThe Company did not grant stock options during the three months ended March 31, 2016, the Company also granted 129,824 time-based RSUs with an aggregate fair value of $286,000, which will vest quarterly in equal amounts over the course of the next eight quarters.  The fair value of the RSUs is expensed ratably over the next eight quarters.

The Company2017 and granted 40,000 stock options for the three months ended March 31, 2016.  The aggregate fair value of the options granted for the three months ended March 31, 2016 was $46,000.  The Company granted 50,000 stock options for the three months ended March 31, 2015.  The aggregate fair value of the granted options at the grant date was $40,000.$46,000.


11.  Long-Term
12.Debt

At March 31, 2016 and December 31, 2015, the Company had no long-term debt.
LinesLine of Credit

BB&TCitizens Bank
At March 31, 2016, the Company had a Master Loan and Security Agreement and Revolving Credit Note with BB&T Bank. 
The Company and its subsidiary, GSE Performance Solutions, Inc., were jointly and severally liable as co-borrowers.  The Loan Agreement providesentered into a $7.5new three-year, $5.0 million revolving line of credit for the purpose of (i) issuing stand-by letters of credit and (ii) providingfacility (RLOC) with Citizens Bank on December 29, 2016, to fund general working capital.capital needs, including acquisitions.  Working capital advances bear interest at a rate equal to the Wall Street Journal Prime Rate of Interest, floating with a floorLIBOR plus 2.25% per annum and letter of 4.5%.  The agreement expires on June 30, 2016.
As collateral for the Company's obligations, the Company granted a first lien and security interest in all of the assets of the Company, including but not limited to, accounts receivable, proceeds and products, intangible assets, equipment, software and leasehold improvements.
21

credit fees are 1.25% per annum.  The Company is not required to maintain a segregatedrestricted cash collateral account at BB&TCitizens Bank for outstanding letters of credit and working capital advances. 

The maximum availability under the RLOC is subject to a borrowing base equal to the greater80% of (i) $3.0 million or (ii) the aggregate principal amounts of all Loans outstanding under the Revolving Credit Facility (includingeligible accounts receivable, and is reduced for any issued and outstanding letters of credit and working capital advances.  At March 31, 2017, there were no outstanding borrowings on the RLOC and six letters of credit totaling $1.7 million.  The amount available at March 31, 2017, after consideration of the borrowing base, letters of credit and working capital advances was approximately $1.8 million.

The credit facility agreement is subject to standard financial covenants and negative foreign exchange positions) as security forreporting requirements. At March 31, 2017, the Company's obligations.  Under this Amendment, Company was in compliance with its financial covenants.

BB&T Bank has complete and unconditional control over the cash collateral account.

At March 31, 20162017, we had four letters of credit with BB&T totaling $1.0 million, which we expect to terminate during the second quarter of 2017.  At March 31, 2017, and December 31, 2015,2016, the cash collateral account with BB&T totaled $3.6$1.1 million and $3.5 million, respectively. The balances werewas classified as restricted cash on the consolidated balance sheets.

The credit agreement contains certain restrictive covenants regarding future acquisitions and incurrence of debt.  In addition, the credit agreement contains financial covenants with respect to the Company's minimum tangible capital base and quick ratio.  

  As of
CovenantMarch 31, 2016
Minimum tangible capital baseMust exceed $10.5 million$11.3 million
Quick ratioMust exceed 1.00 : 1.001.52 : 1.00

As of March 31, 2016, the Company was in compliance with its financial covenants as defined above.

IberiaBank
At March 31, 2016, Hyperspring, LLC has a $1.0 million working capital line of credit with IberiaBank.  Under the executed promissory note, interest is payable monthly at the rate of 1.00 percentage points over the prime rate of interest as published in the money rate section of the Wall Street Journal resulting in an effective interest rate of 4.25%. The line is secured by all accounts of Hyperspring and guaranteed by GSE Systems, Inc.  The line of credit expires on July 6, 2016.  At March 31, 2016, the Company had no outstanding amounts under the line of credit.
Letters of Credit and Bonds
As of March 31, 2016, the Company has eleven standby letters of credit totaling $3.6 million which represent advance payment and performance bonds on ten contracts.  The Company has deposited the full value of eleven standby letters of credit in escrow accounts, amounting to $3.6 million, which have been restricted in that the Company does not have access to these funds until the related letters of credit have expired.  The cash has been recorded on the Company's consolidated balance sheets at March 31, 2016 as restricted cash.
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12.13.Product Warranty

As theThe Company recognizes revenue under the percentage-of-completion method, it provides an accrualaccrues for estimated future warranty costs at the time the related revenue is recognized based on historical experience and projected claims.  The Company's long-term contracts generally provide for a one-year warranty on parts, labor and any bug fixes as it relates to customized software embedded in the systems.  The portion of the warranty provision expected to be incurred within 12 months is classified as current within accrued warranty ($1.4 million),and totals $1.2 million, while the remaining amount$0.4 million is classified as long-term within other liabilities ($106,000).liabilities.  The activity related toin the accrued warranty accrualaccounts is as follows:

(in thousands)   
    
Balance at December 31, 2015 $1,614 
Warranty provision  145 
Warranty claims  (245)
Currency adjustment  2 
Balance at March 31, 2016 $1,516 
(in thousands)   
    
Balance, January 1, 2017 $1,478 
Current period provision  235 
Current period claims  (62)
Currency adjustment  2 
Balance, March 31, 2017 $1,653 


13.14.Income Taxes


The following table presents the provision for income taxes and the effective tax rates:

(dollars in thousands)
Three months ended
March 31,
 
2016 2015 
Three months ended
March 31,
 
($ in thousands)2017 2016 
            
Provision for income taxes $88  $88  $73  $88 
Effective tax rate  38.6%  (22.9)%  (37.8%)  38.6%

The Company's highermovement in effective tax rate for 20162017 as compared to 20152016 resulted mainly from a reducedan increase in pre-tax loss in the U.S.  The Company's income tax provision for interim periods is determined using an estimate of its annual effective tax rate, adjusted for discrete items arising in that quarter.  Tax expense in both years is comprised mainly of foreign income tax expense, Alternative Minimum Tax, state taxes, and deferred tax expense relating to the tax amortization of goodwill.

Because of its net operating loss carryforwards, the Company is subject to U.S. federal and state income tax examinations from the year 1997 forward.  The Company is subject to foreign tax examinations by tax authorities for years 2010 forward for Sweden, 2012 forward for China, and 2014 forward for both India and the UK.

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.(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.  The Company has recorded uncertain tax positions for certain foreign tax contingencies in China, South Korea, and the Ukraine.

The Company recognizes deferred tax assets to the extent that it is believed that these assets are more likely than not to be realized.  The Company has evaluated all positive and negative evidence and determined that it will continue to assess a full valuation allowance on its U.S., Swedish, U.K., and Chinese net deferred assets as of March 31, 2017.  The Company has determined that it is more likely than not that it will realize the benefits of its deferred taxes in India.  In 2015,2016, the Company paid income taxes in the UK and India and expects to do so again in 2016.  The Company has a full valuation allowance on its U.S., Swedish, and Chinese net deferred tax assets at March 31, 2016.2017.
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14.Segment Information
15.Segment Information

The Company has two reportable business segments.  The Performance Improvement Solutions business segment provides simulation, training products, and engineering products and services delivered across the breadth of industries the Company serves.we serve.  Solutions include simulation for both training and engineering applications.  EngineeringExample training applications include turnkey and custom training services, while engineering services include plant design verification and validation. The Company provides these services across all of its market segments.  Contracts typically range from ten9 months to three years.24 months.  The Company and its predecessors have been providing these services since 1976.

The Nuclear Industry Training and Consulting business segment provides specialized workforce solutions primarily to the U.S. nuclear industry, working at our clients' facilities.  This business is managed through our Hyperspring LLC subsidiary.  The business model, management focus, margins and other factors clearly separate this business line from the rest of the GSE product and service portfolio.  Hyperspring has been providing these services since 2005.

The following table sets forth the revenue and operating results attributable to each reportable segment and includes a reconciliation of segment contract revenue to consolidated revenue and operating results to consolidated income (loss) before income taxes:

(in thousands) Three months ended  Three months ended 
 March 31,  March 31, 
 2016  2015  2017  2016 
Contract revenue:      
Revenue:      
Performance Improvement Solutions $8,843  $8,833  $9,670  $8,843 
Nuclear Industry Training and Consulting  4,133   5,180   6,672   4,133 
  12,976   14,013  $16,342  $12,976 
                
Operating income (loss):                
Performance Improvement Solutions  (42)  (704) $(738) $(42)
Nuclear Industry Training and Consulting  188   300   935   188 
Gain on change in fair value of contingent consideration, net  69   80 
  215   (324)
Change in fair value of contingent consideration, net  (254)  69 
Operating (loss) income  (57)  215 
                
Interest income, net  27   27   27   27 
Loss on derivative instruments, net  (118)  (48)  (160)  (118)
Other income (expense), net  102   (39)
Income (loss) before income taxes $226  $(384)
Other (expense) income, net  (3)  102 
(Loss) income before income taxes $(193) $226 
                

16.Commitments and Contingencies

Westinghouse Electric Company ("Westinghouse") filed for Chapter 11 Bankruptcy protection on March 29, 2017.  Westinghouse is a customer in our Performance Improvement Solutions segment.  At March 31, 2017, the Company had approximately $0.5 million in billed and unbilled pre-petition receivables attributable to Westinghouse. The Company has assessed the recoverability of these amounts and concluded that the likelihood of loss is not probable, and therefore, none of the outstanding amounts have been reserved at March 31, 2017.

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Item 2. 
Item 2.Management's Discussion and Analysis of Financial Condition and Results of Operations

GSE is a performance improvement company.world leader in real-time high-fidelity simulation, providing a wide range of simulation, training, and engineering solutions to the global power and process industries.  We improve plant performanceprovide customers with a combination of simulation, engineering and plant services that help clients improvereduce risks associated with operating their plant's profitability, productivityplants, increase revenue through improved plant and safety.employee performance, and lower costs through improved operational efficiency. In addition, we provide services that systematically help clients fill key vacancies in the organization on a short-term basis, primarily in training professionals focused on regulatory compliance and certification in the nuclear power industry.  At March 31, 2017, GSE iswas the parent company of the following entities:of:

·●GSE Performance Solutions, Inc. (formerly GSE Power Systems, Inc.), a Delaware corporation;
·●GSE Power Systems, AB, a Swedish corporation;
·●GSE Engineering Systems (Beijing) Co. Ltd., a Chinese limited liability company;
·●GSE Systems, Ltd., a Scottish limited liability company;
·●EnVision Systems (India) Pvt. Ltd., an Indian limited liability company; and
·●Hyperspring, LLC, an Alabama limited liability company.

The Company has a 50% interest in IntelliQlik, LLC, a Delaware limited liability company.

  The Company also has a 50% interest in General Simulation Engineering RUS LLC, a Russian closed joint-stock company, which we are currently in the process of winding down.

Cautionary Statement Regarding Forward-Looking Statements

This report contains forward-lookingand the documents incorporated by reference herein contain "forward-looking" statements within the meaning of Section 27A of the Securities Act of 1933 as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  Theamended (the "Exchange Act") that are based on management's assumptions, expectations and projections about us, and the industry within which we operate, and that have been made pursuant to the Private Securities Litigation Reform Act of 1995 provides a "safe harbor" forreflecting our expectations regarding our future growth, results of operations, performance and business prospects and opportunities.  Wherever possible, words such as "anticipate", "believe", "continue", "estimate", "intend", "may", "plan", "potential", "predict", "expect", "should", "will" and similar expressions, or the negative of these terms or other comparable terminology, have been used to identify these forward-looking statements.  Forward-lookingThese forward-looking statements are notmay also use different phrases.  These statements of historical facts, but ratherregarding our expectations reflect our current expectations concerning future eventsbeliefs and results.  We use words such as "expects", "intends", "believes", "may", "will"are based on information currently available to us.  Accordingly, these statements by their nature are subject to risks and "anticipates"uncertainties, including those listed under Item 1A - Risk Factors in our most recent annual report on Form 10-K, which could cause our actual growth, results, performance and business prospects and opportunities to indicatediffer from those expressed in, or implied by, these forward-looking statements.  BecauseWe may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements we make. Except as otherwise required by federal securities law, we are not obligated to update or revise these forward looking statements to reflect new events or circumstances.  We caution you that a variety of factors, including but not limited to the factors described under Item 1A - Risk Factors in our most recent annual report on Form 10-K, could cause our business conditions and results to differ materially from what is contained in forward-looking statements.

Other factors and assumptions not identified above were also involved in the formation of these forward-looking statements involve risks and uncertainties, there are importantthe failure of such other assumptions to be realized, as well as other factors, that couldmay also cause actual results to differ materially from those expressed or implied byprojected.  Most of these forward-looking statements, including, but not limitedfactors are difficult to those factors set forth underpredict accurately and are generally beyond our control.  You should consider the areas of risk described in Item 1A - Risk Factors of the Company's 2015 Annual Reportin our most recent annual report on Form 10-K and those other risks and uncertainties detailed in the Company's periodic reports and registrationconnection with any forward-looking statements filed with the Securities and Exchange Commission. We caution that these risk factors may be made by us. You should not be exhaustive.  We operate in a continually changing business environment, and new riskplace undue reliance on any forward-looking statements.  New factors emerge from time to time.  We cannottime, and it is not possible for us to predict these new riskwhich factors nor can we assess the effect, if any, of the new risk factors on our business or the extent to which any factor or combination of factors may cause actual results to differ from those expressed or implied by these forward-looking statements.will arise.

If any one or more of these expectations and assumptions proves incorrect, actual results will likely differ materially from those contemplated by the forward-looking statements.  Even if all of the foregoing assumptions and expectations prove correct, actual results may still differ materially from those expressed in the forward-looking statements as a result of factors we may not anticipate or that may be beyond our control.  While we cannot assess the future impact that any of these differences could have on our business, financial condition, results of operations and cash flows or the market price of shares of our common stock, the differences could be significant.  We do not undertake no obligation to publicly update any forward-looking statements, made by us, whether as a result of new information, future events or otherwise.  You are cautioned notadvised, however, to unduly relyconsult any additional disclosures we make in proxy statements, quarterly reports on such forward-looking statements when evaluatingForm 10-Q and current reports on Form 8-K filed with the information presented in this report.SEC.


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General Business Environment

We operate through two reportable business segments:  Performance Improvement Solutions and Nuclear Industry Training and Consulting.  Each segment focuses on delivering solutions to customers within our targeted markets - primarily the power and process industries.  Marketing and communications, accounting, finance, legal, human resources, information systems and other administrative services are organized at the corporate level.  Business development and sales resources are generally aligned with each segment to support existing customer accounts and new customer development.  Our twoThe following is a description of our business segments are:

segments:

Performance Improvement Solutions (approximately 68%59% of revenue)

Our Performance Improvement Solutions segment primarily encompasses our next generation power plant and process high-fidelity simulation solutions, as well as engineering solutions.solutions and interactive computer based tutorials/simulation focused on the process industry.  This segment includes various simulation products, engineering services, and operation training systems delivered across the industries we serve: primarily nuclear and fossil fuel power generation, andas well as the process industries.  Our simulation solutions include the following: (1) simulation software and services, including operator training systems, for the nuclear power industry, (2) simulation software and services, including operator training systems, for the fossil power industry, and (3) simulation software and services for the process industries used to teach fundamental industry processes and control systems to newly hired employees and for ongoing workforce development and training.

  GSE and its predecessors have been providing these services since 1976.

Nuclear Industry Training and Consulting (approximately 32%41% of revenue)

Nuclear Industry Training and Consulting provides highly specialized and skilled nuclear operations instructors and other consultants to the nuclear power industry.   These employees work at our clients' facilities under client direction.  Examples of these highly skilled positions are senior reactor operations instructors, procedure writers, work management specialists, planners and training material developers.  This business is managed through our Hyperspring subsidiary.  The business model, management focus, margins and other factors clearly separate this business line from the rest of the GSECompany's product and service portfolio.  Hyperspring has been providing these services since 2005.

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Business Strategy

Our objective is to be the leading provider ofcreate a technology-enabled engineering, software and technology-enabledtraining services and know-how to the global power industriesplatform by capitalizing on near and long-term growth opportunities primarily in the nuclear power industry.  We will offer our differentiated suite of products and services to adjacent markets such as fossil power and the process industries where our offerings are a natural fit with a clear and compelling value proposition for the market.  Our primary growth strategy is twofold: (1) expand organically within our core markets by leveraging our market leadership position and drive increased usage and product adoption via new products and services, and (2) seek acquisitions to accelerate our overall growth.growth in a manner that is complementary to our core business.  To accomplish this, we will pursue the following activities:
·
Expand our total addressable market.   Our focus on growth means introducing product  capabilities or new product categories that create value for our customers and therefore expand our total addressable market.  Currently we are working on initiatives to expand our solution offerings in both our business segments which may include, but not be limited to, the following: expanding our software product portfolio to the industries we serve with enhanced power and process simulation tools and systems that are complementary to our core offerings; delivering enhanced learning management systems/solutions; offering fully outsourced training solutions to our customers; adding work flow process improvement solutions; and tailoring operational reporting and business intelligence solutions to address the unique need of our end user markets.  Initiatives such as these will broaden our scope and enable us to engage more deeply with the segments we serve.

·
Pursue strategic acquisitions opportunistically.   We intend to complement our organic growth strategy through selective acquisitions of other software and service businesses, both domestic and international, which would enhance our existing portfolio of products, strengthen our relationships with our existing customers, and potentially expand our footprint to include new customers in our core served industries.  We have made several small acquisitions in recent years and believe the opportunity exists to do more.  For example, in January 2011 we acquired EnVision Systems Inc., which provided interactive multi-media tutorials and simulation models, primarily to the process industries.  We have integrated the technology assets from this acquisition and expanded the firm's application to other industries, and we intend to repeat this successful process.  We acquired Hyperspring in 2014, which enabled GSE to offer highly skilled nuclear operations and consulting know-how on site at a large segment of our client base on an operational basis providing essential services.  This deepened our relationship with existing clients and won business for us at new client sites in the nuclear industry.  This acquisition has proven to be very synergistic, enabling cross selling domestically, and in 2015, expanding these services internationally for the first time.
Expand our total addressable market.  Our focus on growth means introducing product capabilities or new product categories that create value for our customers and therefore expand our total addressable market.  Currently we are working on initiatives to expand our solution offerings in both our business segments which may include, but not be limited to, the following: expanding our software product portfolio to the industries we serve with enhanced power and process simulation tools and systems that are complementary to our core offerings; delivering enhanced learning management systems/solutions; offering fully outsourced training solutions to our customers; adding work flow process improvement solutions; and tailoring operational reporting and business intelligence solutions to address the unique need of our end user markets.

Initiatives such as these will broaden our scope and enable us to engage more deeply with the segments we serve.  Recently, we have delivered a compelling new solution, the GSE GPWRTM Generic Pressurized Water Reactor simulation technology, proving that our modeling technology can be sold via traditional license terms and conditions to the nuclear industry ecosystem.  We have both upgraded and expanded the EnVision library of simulation and eLearning tutorials for the process industries with specific new products for training clients in the upstream segment of the oil and gas industry.  We continue to provide cutting edge training systems by adapting our technology to systems to meet the specific needs of customers such as U.S. government laboratories.

Pursue strategic acquisitions opportunistically.  We intend to complement our organic growth strategy through selective acquisitions of other software, technical engineering, and nuclear oriented training, staffing and consulting service businesses, both domestic and international. We are focusing our efforts on acquisitions that would enhance our existing portfolio of products and services, strengthen our relationships with our existing customers, and potentially expand our footprint to include new customers in our core served industries.  We have made several acquisitions since 2010 and believe the opportunity exists to acquire businesses that are complementary to ours, allowing us to accelerate our growth strategy.

In January 2011, we acquired a software company called EnVision Systems Inc., which provided interactive multi-media tutorials and simulation models, primarily to the process industries.  We have integrated the technology assets from this acquisition and expanded the firm's application to other industries, and we intend to repeat this successful process.  In 2014, we acquired Hyperspring, which enabled GSE to offer highly skilled nuclear operations and consulting know-how on site at a large segment of our client base on an operational basis providing essential services.  This deepened our relationship with existing clients and won business for us at new client sites in the nuclear industry.  This acquisition has proven to be synergistic, enabling cross selling domestically, and in 2015, expanding these services internationally for the first time.

Research and development (R&D). We invest in R&D in order to deliver unique solutions that add value to our end-user markets.  We have delivered nuclear core and Balance-of-Plant modeling and visualization systems to the industry.  To address the nuclear industry's need for more accurate simulation of both normal and accident scenarios, we provide our DesignEP® and RELAP5-HD® solutions.  Our entire JADETM suite of simulation software, including industry leading JTOPMERET® and JElectricTM software, provides the most accurate simulation of Balance-of-Plant and electrical systems available to the nuclear and fossil plant simulation market. The significant enhancements we have made to our SimExec® and OpenSimTM platforms enables customers to be more efficient in the daily operation of their simulators.  We are bringing SimExec® and OpenSimTM together into a next generation unified environment that will add new capabilities as requested by clients and driven by market need.

We intend to continue to make prudent investments in R&D that first and foremost are driven by the market, and are complementary to advancing our growth strategy.  Such investments in R&D may result in on-going enhancement of existing solutions as well as the creation of new solutions to serve our target markets, ensuring that we add greater value, in an easier to use fashion, than any alternative available to customers.  GSE has pioneered a number of industry standards over our lifetime and will continue to be one of the most innovative companies in our industry.

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·
Continue to provide technology-enabled, market-leading solutions. We invest in research and development ("R&D") in order to deliver unique solutions that add tremendous value to our end-user markets.  Recently we have delivered nuclear core and balance of plant modeling and visualization systems to the industry.  To address the nuclear industry's need for more accurate simulation of both normal and accident scenarios, we provide our DesignEPTM and RELAP5-HD® solutions.  Our entire JADETM suite of simulation software, including industry leading JTOPMERET® and JElectricTM software, provides the most accurate simulation of Balance of Plant and electrical systems available to the nuclear and fossil plant simulation market.  The significant enhancements we have made to our SimExec® and OpenSimTM platforms enables customers to be more efficient in the daily operation of their simulators.  We have both upgraded and expanded the EnVision library of simulation and eLearning tutorials for the process industries with specific new products for training clients in the upstream segment of the oil and gas industry.  We continue to provide cutting edge training systems by adapting our technology to systems to meet the specific needs of customers such as U.S. government laboratories.   We intend to continue to make prudent investments in R&D that first and foremost are driven by the market, and are complementary to advancing our growth strategy.  Such investments in R&D may result in on-going enhancement of existing solutions as well as the creation of new solutions to serve our target markets, ensuring that we add greater value, in an easier to use fashion, than any alternative available to customers and that we delight them in the process.  GSE has pioneered a number of industry standards over our lifetime and will continue to be one of the most innovative companies in our industry.  We have a recognized high-value brand as one of the most respected providers of software and services to the industry, as evidenced by our marquee client base and significant market wins over the past year.
·
Expand International Operations in Selected Markets. We believe there are additional opportunities for us to market our software and services to international customers, and do so in a cost effective manner.  For example, we believe partnerships with Value Added Resellers ("VAR") could significantly expand our sales pipeline for the EnVision software suite.  Such VARs may yield positive results for our pursuing international nuclear opportunities globally (see industry trends below).  We may explore the creation of appropriate joint ventures to target nuclear new-build programs in key growth regions.
Strengthen and develop our talent.  Our experienced employees and management team are our most valuable resources.  Attracting, training, and retaining top talent is critical to our success.  To achieve our talent goals, we intend to remain focused on providing our employees with entrepreneurial opportunities to increase client contact within their areas of expertise and to expand our business within our service offerings.  We will also continue to provide our employees with training, personal and professional growth opportunities, performance-based incentives including opportunities for stock ownership, bonuses and competitive benefits as benchmarked to our industry and locations.

Continue to deliver industry-recognized high quality services.  We have developed a strong reputation for quality services based upon our industry-recognized depth of experience, ability to attract and retain quality professionals, and expertise across multiple service sectors.  We have received many industry certificates and awards including being recognized for outstanding work on projects by Bechtel's Nuclear, Security & Environmental global business unit (NS&E) at the Bechtel Supply Chain Recognition awards in April 2016.  In addition, we have a recognized high-value brand as one of the most respected providers of software and services to the industry, as evidenced by our marquee client base and significant market wins over the past year.  A recently conducted survey of clients with projects underway and/or just delivered validates our brand with a Net Promoter Score of +65, a compelling score for an industrial technology and services company.

Expand international operations in selected markets. We believe there are additional opportunities for us to market our software and services to international customers, and to do so in a cost effective manner.  For example, we believe partnerships with Value Added Resellers (VAR) could significantly expand our sales pipeline for the EnVision software suite.  In 2016, we entered into a reseller agreement with an entity in the Middle East that has an established track record of success selling simulation and workforce development solutions to the process industries throughout the region.  Such VARs may yield positive results for our pursuit of international nuclear opportunities globally (see industry trends below).  We may explore the creation of appropriate joint ventures to target nuclear new-build programs in key growth regions.

Employees.  As of March 31, 2017, we had approximately 286 employees, which includes approximately 174 in our Performance Improvement segment and 112 in our Nuclear Industry Training and Consulting segment.  In addition, we have approximately 100 licensed engineers and other advanced degreed professionals.  To date, we have been able to locate and engage highly qualified employees as needed and we expect our growth efforts to be addressed through attracting top talent.

Backlog.  As of March 31, 2017, we had approximately $79.6 million of total gross revenue backlog.  Most of our contracts range from 9 to 24 months. With respect to our backlog, it includes only those amounts that have been funded and authorized and does not reflect the full amounts we may receive over the term of such contracts.  Our backlog includes future expected revenue at contract rates, excluding contract renewals or extensions that are at the discretion of the client.  We calculate backlog without regard to possible project reductions or expansions or potential cancellations unless and until such changes may occur.

Backlog is expressed in terms of gross revenue and, therefore, may include significant estimated amounts of third-party or pass-through costs to subcontractors and other parties.  Because backlog is not a defined accounting term, our computation of backlog may not necessarily be comparable to that of our industry peers.

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Industry Trends

Industry need for building and sustaining a highly skilled workforce

We believe a critical ongoing challenge facing the industries we serve is access to, and continued development of, a highly trained and efficient workforce.  This challenge manifests primarily in two ways: the increasing pace of the knowledge and experience lost as a significant percentage of the existing experienced workforce reaches retirement age over the next several years; and the fact that as new power plants come on-line, there is an increased demand for more workers to staff and operate those plants in addition to the plants in the existing fleet.

According to Power Engineering magazine (December 2014), in the United States every sector in the energy industry is expected to lose a large percentage of its workforce within the next few years as baby boomers retire on the traditional schedule.  The power sector alone will be forced to replace more than 100,000 skilled workers by 2018 simply to replace those retiring.  The Nuclear Energy Institute estimates that 39% of the nuclear workforce will be eligible to retire by 2018.  As the nuclear industry expands its fleet and strains to maintain the high standards of training the existing workforce, existing plant simulator systems, which provide these training services, are operating 24 hours a day.  With workers retiring and the need to backfill as well as expand the workforce for new units, certain operators are exploring the opportunity to de-bottleneck their existing simulator capabilities through the creation of dual reference simulators.

Globally, as more people increase their standard of living, their demand for power will increase, which in turn will require the on-going construction of power plants to meet this surging demand.  Developing a skilled labor force to operate these plants and keeping their skills current and their certifications in compliance with regulatory requirements is a key challenge facing the global power industry.  Similar challenges face the process industries as well.industries.
An important emerging trend to note seems to be a growing recognition that nuclear energy is an increasingly desirable form of energy production fulfilling a key component of zero carbon initiatives across the globe.  Support for generating power from zero carbon emissions sources is evidenced by initiatives such as the 2015 United Nations Climate Change Conference.  Nuclear power generation is a critical means of zero carbon power generation that is growing in importance as a result.  We believe that GSE is well positioned to take advantage of these trends as they emerge and develop.
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Growing Global Power Demandglobal power demand and the Increasing Emphasisincreasing emphasis on Nuclear Powernuclear power

World Energy Outlook 2015 projects that electricity demand will increase by more than 70% over the time period from 2013 to 2040 time period.2040.  At the same time, countries globally are pledging to reduce greenhouse gas emissions despite this growth in demand for power.  These trends are increasingly favorable to nuclear power.  The United Kingdom illustrates this trend, with a recently announced energy policy that places a much greater reliance on nuclear power and unveiled plans for a new nuclear fleet, while slashing subsidies for solar energy and an eyeseeking to phase out coal fired power plants.  With plans to build at least three new nuclear plants, the UK plans to add 16GWe of new nuclear capacity operating by 2030 according to World Nuclear Association.

There are currently 6559 nuclear plants under construction in 1514 countries, including 2421 in China, nineseven in Russia, sixfive in India and four in the United Arab Emirates according toper the Nuclear Energy Institute.  FiveFour reactors are currently under construction in the U.S. including, two for Southern Nuclear at the Vogtle, site;Georgia site and two at SCANA's VC Summer sitesite.  Southern Nuclear and one atSCANA are currently determining how to complete these four reactors following the Westinghouse Bankruptcy.  Tennessee Valley Authority's Watts Bar generating facility (which is plannedstarted operations in 2016, which represents a watershed for commercial production imminently).  According tothe U.S. nuclear power industry.  Per the World Nuclear Association, there are 165164 reactors in 2725 countries in specific phases of planning that will be operating by 2030.  This pace of construction is surpassing the peak construction velocity of the 1970's1970s and 1980's.1980s.

In addition to new plants, generating more power through enhanced plant performance - especially reducing unplanned outage time - is a critical objective for the nuclear power industry to meet growing global electricity demand.  Capacity factors, also known as load factors, have been greater than 90% in the U.S. in five of the seven years betweenfrom 2007 andto 2013.  The U.S. is recognized as the leader in load factor performance.  The U.S. accounts for nearly one thirdone-third of the world's nuclear electricity, highlighting its importance as a market as well as its need for high levels of performance.

For the existing nuclear U.S. fleet, there is recognition that these plants are essential to meeting goals of reducing carbon emissions even as renewable energy sources are introduced.  This recognition of the importance of nuclear providing zero-carbon baseload is demonstrated most recently by the state of New York's Clean Energy Standard that values the emission-free energy of New York's nuclear fleet and in so doing providing an emissions-free subsidy of 1.7¢/kWh.  This subsidy helps ensure the state's existing nuclear plants remain economically viable in an era of low cost natural gas and even with wind and solar receiving a subsidy of 4.5¢/kWh.  In addition, the Illinois Legislature passed the Future Energy Jobs Bill on December 2, 2016, a measure that ensures the continued operation of the Clinton and Quad Cities nuclear power plants in that state.  In a statement, the Nuclear Energy Institute said the bill's passage was a "remarkable moment" for the state and the nuclear industry. Gov. Bruce Rauner signed the bill into law on December 7, 2016.  The Future Energy Jobs Bill provides Exelon and Commonwealth Edison with a $235 million annual credit for the carbon-free energy produced by the Clinton and Quad Cities nuclear plants. The actions of New York and Illinois starts a trend which may continue to states such as Ohio, Pennsylvania, New Jersey and Connecticut to recognize the value of zero carbon power produced by nuclear plants in those states.  This would be similar to how the Renewable Portfolio Standard was rolled out across more than half the states in the U.S. to recognize the benefits of zero carbon renewable power.

In regulated markets where the economy is growing, the nuclear fleet is profitable and expanding, with four reactors under construction in the southeast U.S.  Longer term, the trends for nuclear power are favorable as well.  The U.S. Department of Energy recently released a draft plan to double America's nuclear power capacity by 2050.  The plan, dubbed "Vision 2050", promotes expanding America's nuclear capacity through advanced reactor designs including small and medium-size reactors.

As countries around the world recognize the importance of lowering carbon emissions from power generation, nuclear energy is an essential component of the solution.  India and the UK have recently announced plans to significantly expand nuclear power generation capacity through new builds.  China continues to aggressively build out its fleet.  In Japan, the strategic importance of nuclear power had led the Institute of Energy and Economics to estimate that 19 of Japan's temporarily shut down reactors will restart before March 2018.

We believe GSE is well positioned to take full advantage of these strategic global and domestic trends through ourby providing high fidelity simulation and training solutions to the global power and process industries.
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Products and Services
Entry2Expert®
Performance CycleImprovement Solutions

To assist our clients in creating world-class internal training and performanceengineering improvement programs,processes, we are offering the Entry2Expert® Performance Solution,offer a set of integrated and scalable products and services which provide a structured program from employee selection and onboarding throughfocused on continuous skills improvement for experienced employees.  GSE can nowemployees to engineering services, which include plant design verification and validation.  We provide the right solution to solve our clients' most pressing needs.

For workforce development and training, students and instructors alike must have a high degree of confidence that their power plant simulator truly reflects plant behavior across the entire range of operations.  To achieve this, GSE's simulation solution starts with the most robust engineering approach possible.  Using state-of-the-art modeling tools combined with our leading nuclear power modeling expertise, GSE provides simulation solutions that achieve unparalleled fidelity and accuracy.  The solutions that GSE provides are also known for ease of use, resulting in increased productivity by end-users.  For these reasons, GSE has delivered more nuclear power plant simulators than any other company in the world.

For virtual commissioning, designers of first-of-a-kind plants or existing plants need a highly accurate dynamic simulation platform to model a wide variety of design assumptions and concepts from control strategies to plant behavior to human factors.  Because new builds and upgrades to existing plants result in new technology being deployed, often involving the integration of disparate technologies for the right step in each employee's career.first time, a high-fidelity simulator allows designers to see the interaction between systems for the very first time.  With our combination of simulation technology and expert engineering, GSE was chosen to build first-of-a-kind simulators for the AP1000, PBMR, and small modular reactors being built by NuScale, and mPower.
The major elements
Examples of the Entry2Expert Performance Solutiontypes of simulators we sell include, defining specific training needs by analyzing job functions; following proven processesbut are not limited to, structure the entire training program for clients;  providing world-class training content and series of simulation solutions for both the new employee and most experienced workers; and providing the expert training staff and consultants to ensure this is all implemented effectively.following:

·●
Universal Training Simulators: These products complement the Self-Paced Training Tutorials by reinforcing what the student learned in the tutorial, putting it into practice on the Universal Simulator.  The simulation models are high fidelity and engineering correct, but represent a typical plant or typical process, versusrather than the exact replication of a client's plant.  We have delivered over 250 such simulation models to clients consisting of major oil companies and educational institutions.

·●
Part-Task Training Simulators: Like the Universal Simulators, we provide other unique training solutions such as a generic nuclear plant simulator and VPanelVPanel® displays, which replicate control room hardware and simulator solutions specific to industry needs such as severe accident models to train on and aid in the understanding of events like the Fukushima Daiichi accident.

·●
Plant-Specific Operator Training Simulators: These simulators provide an exact replication of the plant control room and plant operations.  They provide the highest level of realism and training and allow users to practice their own plant-specific procedures.  Clients can safely practice startup, shutdown, normal operations, as well as response to abnormal events we all hope they never have to experience in real life.  WeSince our inception, we have delivered nearly 450 plant-specific simulators to clients in the nuclear power, fossil power and process industries worldwide.
The goal of our Entry2Expert performance lifecycle offering is to ensure superior human achievement in the dimensions of:
·Shortening the learning process

·Reducing human errors

·Mitigating the effects of retirement and turnover

·Improving workforce agility

·Achieving and maintaining certifications and compliance

·All of these dimensions help to improve our customers' bottom lines

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The dramatic increase in energy demand world-wide over the next 30 years will require significant amounts of training for new employeesNuclear Industry Training and also will require new plants using energy of all sources.   These new plants will need to be engineered and designed prior to construction, and GSE high-fidelity modeling tools are being used increasingly to verify and validate control system and overall plant designs.Consulting
Specialized Plant Support:
As our customers' experienced staffsstaff retire, access to experts that can help withtrain existing and new employees in how to operate their plants is essential to ensure safe ongoing plant operations.  In addition, training needs change over time and sometimes our clients require specialized plant projectscourses.  Industry needs instructors who can step in and use the client's training material.  Finding professional instructors, who know the subject, can teach it and can adapt to the client's culture, is critical.  ThroughGSE provides both qualified instructors and turnkey courses that work within the client's system and complement the training methods they already have in place.  Examples of our Hyperspring subsidiary,training program courses are senior reactor operator certification, generic fundamentals training, and simulation supervisor training.  In addition, we also can provide expert support either through staff augmentationconsulting or turnkey projects for the following:training material upgrade and development, outage execution, planning and scheduling, corrective actions programs, and equipment reliability.
oProcedure Development

oTraining Material Upgrade and Development

oWork Management

oOutage Execution

oPlanning and Scheduling

oCorrective Actions

oSelf-Assessments

oEquipment Reliability

Entry2Expert bringsWe bring together the collection of skills GSE haswe have amassed over more than 40 years beginning with its traditional roots in custom high fidelity simulation and training solutions for the power industries, extended through the acquisition of specialized engineering capabilities, enhanced by the entry and intermediate level training solutions of EnVision and the extensive nuclear industry training and consulting services of Hyperspring.

Westinghouse bankruptcy

On March 29, 2017, Westinghouse, a customer of our Performance Improvement Solutions segment, filed for Chapter 11 bankruptcy protection in the United States Bankruptcy Court for the Southern District of New York, Case No. 17-10751. The U.S. Bankruptcy Court overseeing the Westinghouse Bankruptcy approved, on an interim basis, an $800 million Debtor-in-Possession Financing Facility to allow Westinghouse to finance its business operations during the reorganization process.  In April 2017, Southern Company and SCANA Corporation reached interim agreements with Westinghouse to continue construction on the Vogtle and V.C. Summer nuclear plants, respectively. Westinghouse also announced that it intends to continue projects in China, and that generally operations in Asia, Europe, the Middle East and Africa will not be affected by the bankruptcy filing.

At March 31, 2017, the Company had approximately $0.5 million in billed and unbilled pre-petition receivables attributable to Westinghouse. The Company has assessed the recoverability of these amounts and concluded that the likelihood of loss is not probable, and therefore, none of the outstanding amounts have been reserved at March 31, 2017.
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Results of Operations

The following table sets forth the results of operations for the periods presented expressed in thousands of dollars and as a percentage of revenue:

(in thousands) Three months ended March 31, 
  2016  %  
2015 (1)
  % 
Contract revenue $12,976   100.0% $14,013   100.0%
Cost of revenue  9,352   72.1%  10,719   76.5%
                 
Gross profit  3,624   27.9%  3,294   23.5%
Operating expenses:                
Selling, general and administrative  3,111   24.0%  3,269   23.3%
Restructuring charges  125   1.0%  97   0.7%
Depreciation  100   0.8%  129   0.9%
Amortization of definite-lived intangible assets  73   0.5%  123   0.9%
Total operating expenses  3,409   26.3%  3,618   25.8%
                 
Operating income (loss)  215   1.6%  (324)  (2.3)%
                 
Interest income, net  27   0.2%  27   0.2%
Loss on derivative instruments, net  (118)  (0.9)%  (48)  (0.3)%
Other income (expense), net  102   0.8%  (39)  (0.3)%
                 
Income (loss) before income taxes  226   1.7%  (384)  (2.7)%
                 
Provision for income taxes  88   0.6%  88   0.7%
                 
Net income (loss) $138   1.1% $(472)  (3.4)%
(1) The prior year amounts have been revised to correct misstatements that were deemed to be immaterial to the prior period, as described in Note 1 - Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements.



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Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our estimates, judgments and assumptions are continually evaluated based on available information and experience.  Because of the use of estimates inherent in the financial reporting process, actual results could differ from those estimates.

A summary of the Company's significant accounting policies as of December 31, 2015, is included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2015.  Certain of our accounting policies require higher degrees of judgment than others in their application.  These include revenue recognition, impairment of intangible assets, including goodwill, capitalization of computer software development costs, valuation of contingent consideration for business acquisitions, and deferred income tax valuation allowance.  These critical accounting policies and estimates are discussed in the Management's Discussion and Analysis of Financial Condition and Results of Operations section in the 2015 Annual Report on Form 10-K for the fiscal year ended December 31, 2015.
($ in thousands) Three months ended March 31, 
  2017  %  2016  % 
Revenue $16,342   100.0% $12,976   100.0%
Cost of revenue  12,220   74.8%  9,352   72.1%
                 
Gross profit  4,122   25.2%  3,624   27.9%
Operating expenses:                
Selling, general and administrative  3,592   22.0%  2,757   21.2%
Research and development  402   2.4%  354   2.7%
Restructuring charges  45   0.3%  125   1.0%
Depreciation  76   0.5%  100   0.8%
Amortization of definite-lived intangible assets  64   0.4%  73   0.6%
Total operating expenses  4,179   25.6%  3,409   26.3%
                 
Operating (loss) income  (57)  (0.4)%  215   1.6%
                 
Interest income, net  27   0.2%  27   0.2%
Loss on derivative instruments, net  (160)  (1.0)%  (118)  (0.9)%
Other (expense) income, net  (3)  0.0%  102   0.8%
                 
(Loss) income before income taxes  (193)  (1.2)%  226   1.7%
                 
Provision for income taxes  73   0.4%  88   0.7%
                 
Net (loss) income $(266)  (1.6)% $138   1.1%


Results of Operations - Three Months ended March 31, 20162017 versus Three Months ended March 31, 20152016

Contract Revenue.  Contract revenueRevenue for the three months ended March 31, 20162017 totaled $13.0$16.3 million, which was 7.4% less25.9% greater than the $14.0$13.0 million of revenue for the three months ended March 31, 2015.2016.  The decreaseincrease in revenue was primarily driven by the year over year decreaseincrease in revenue at Hyperspring, represented by our Nuclear Industry Training and Consulting segment, depicted below.
(in thousands)Three months ended 
 March 31, 
 2016 
2015(1)
 
       
Contract Revenue:      
Performance Improvement Solutions $8,843  $8,833 
Nuclear Industry Training and Consulting  4,133   5,180 
Total Contract Revenue $12,976  $14,013 
($ in thousands)Three months ended 
 March 31, 
 2017 2016 
       
Revenue:      
Performance Improvement Solutions $9,670  $8,843 
Nuclear Industry Training and Consulting  6,672   4,133 
Total revenue $16,342  $12,976 

(1)The prior year amounts have been revised to correct misstatements that were deemed to be immaterial to the prior period, as described in Note 1 - Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements.29

Performance Improvement Solutions revenue was $8.8 million for bothincreased 9.4% primarily due to the three months ended March 31, 2016, and March 31, 2015.  The Companycontinued work that is secured by our near-record backlog.  We recorded total Performance Improvement Solutions orders of $34.8$4.9 million in the three months ended March 31, 2016, as compared to $11.1 million in the three months ended March 31, 2015.
Nuclear Industry Training and Consulting revenue decreased 20.2% from $5.2$34.8 million for the three months ended March 31, 2015, 2017 and 2016, respectively.

Nuclear Industry Training and Consulting revenue increased 61.4% to $4.1$6.7 million from $4.1 million for the three months ended March 31, 2016.2016 and 2017, respectively.  The decreaseincrease was primarily due to a year-over-year declineincrease in customer staffing needs of a major customer. Nuclear Industry Training and Consulting orders totaled $14.9 million and $5.0 million for the three months ended March 31, 2017 and 2016, as compared to $7.0 million in the three months ended March 31, 2015.respectively.

At March 31, 2016,2017, backlog was $74.5$79.6 million: $67.6$67.0 million for the Performance Improvement Solutions business segment and $6.9$12.6 million for Nuclear Industry Training and Consulting.  At December 31, 2015,2016, the Company's backlog was $47.9$73.2 million: $41.9$68.8 million for the Performance Improvement Solutions business segment and $6.0$4.4 million for Nuclear Industry Training and Consulting.
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Gross profit.  Gross profit totaled $3.6was $4.1 million, or 25.2%, for the three months ended March 31, 2016,2017, compared to $3.3$3.6 million, or 27.9% for the same period in 2015.  As a percentage of revenue, gross profit increased from 23.5% for the three months ended March 31, 2015, to 27.9% for the three months ended March 31, 2016.

($ in thousands)Three months ended Three months ended 
March 31, March 31, 
2016  % 
2015(1)
  % 2017  % 2016  % 
Gross profit:                        
Performance Improvement Solutions $3,145   35.6% $2,777   31.4% $3,044   31.5% $3,145   35.6%
Nuclear Industry Training and Consulting  479   11.6%  517   10.0%  1,078   16.2%  479   11.6%
Consolidated Gross Profit $3,624   27.9% $3,294   23.5%
Consolidated gross profit $4,122   25.2% $3,624   27.9%
(1)The prior year amounts have been revised to correct misstatements that were deemed to be immaterial to the prior period, as described in Note 1 - Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements.

Performance Improvement Solutions' gross profit of $3.1 million or 35.6% of revenue for the three months ended March 31, 2016, increased $0.3 million from $2.8 million or 31.4% of revenue for the three months ended March 31, 2015.  The increasedecrease in gross margin percentpercentage for Performance Improvement Solutions for the three months ended March 31, 2016,2017 as compared to the same period in 2015 is2016 was mainly due to the decreasethree lower margin major nuclear simulation projects.

The increase in total overhead costs.
Total overhead costs (including capitalized software amortization) decreased from approximately $1.2 milliongross profit during 2017 for the three months ended March 31, 2015, to $852,000 for the three months ended March 31, 2016.  Thus total overhead decreased from 13.1% in 2015 to 9.7% in 2016 as a percent of revenue.  The reduction mainly reflects the reduction in operations headcount in conjunction with the Company's September 2015 restructuring.
Nuclear Industry Training and Consulting grosswas primarily driven by the segment's focus on entering higher margin decreased by $38,000 for the three months ended March 31, 2015, compared to the three months ended March 31, 2016, but as a percent of revenue, increased from 10.0% for the three months ended March 31, 2015, to 11.6% for the three months ended March 31, 2016.  Despite the 20.2% decrease in revenue, the business unit's revenue mix consisted of a higher percentage of fixed price projects which have better gross margins than time and material contracts.

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Selling, general and administrative expenses.  Selling, general and administrative (SG&A) expenses totaled $3.1$3.6 million inand $2.8 million for the three months ended March 31, 2017 and 2016, a 4.8% decrease fromrespectively. Fluctuations in the $3.3components of SG&A spending were as follows:

($ in thousands) Three months ended 
  March 31, 
  2017  %  2016  % 
Selling, general and administrative expenses:            
Corporate charges $2,442   68.0% $1,783   64.7%
Business development  685   19.0%  786   28.5%
Contingent consideration  254   7.1%  (69)  (2.5%)
Other  211   5.9%  257   9.3%
Total $3,592   100.0% $2,757   100.0%

Corporate charges increased $0.7 million primarily due to higher stock-based compensation expense and higher professional fees.

Business development charges decreased slightly mainly due to lower headcount.

Contingent consideration increased $0.3 million primarily due to fair value adjustments related to our 2014 Hyperspring acquisition.  The contingent consideration liability expires in November 2017 with the final payment expected to be made in January 2018.

Other charges are primarily comprised of facility charges, which decreased $46,000.

Research and development.  Research and development costs consist primarily of software engineering personnel and other related costs.  Research and development costs, net of capitalized software, totaled $402,000 and $354,000 for the same period in 2015.three months ended March 31, 2017 and 2016, respectively. Before capitalization of software development costs, research and development totaled $431,000 and $485,000 for three months ended March 31, 2017 and 2016, respectively. The $54,000 decrease reflectsis primarily due to a more targeted research and development strategy undertaken by the following spending variances:
·Business development costs decreased 40.6% from $1.3 million to $790,000 for the three months ended March 31, 2015, and 2016, respectively.  The reduction in business development costs is largely due to the Company's restructuring actions in 2015 which reduced the number of business development personnel.  Included within business development costs are bidding and proposal costs, which are the costs of operations personnel assisting with the preparation of contract proposals. Bidding and proposal costs decreased from $285,000 to $95,000 for the three months ended March 31, 2016, as compared to the three months ended March 31, 2015.  This reduction is also a result of the Company's 2015 restructuring, as the number of operations personnel has decreased, and accordingly, the availability of operations personnel for proposal support has diminished.

·The Company's general and administrative expenses increased from $1.6 million for the three months ended March 31, 2015, to $2.0 million for the three months ended March 31, 2016.  The increase of $0.4 million is primarily attributable to the following:
oIn the three months ended March 31, 2016, the Company hired an outside consultant to review and document its procedures regarding revenue recognition, with special focus on software license and software maintenance revenue.  The total cost incurred for these services was $152,000.
oIn the three months ended March 31, 2016, audit, tax, and legal expense totaled $264,000 compared to $149,000 in the three months ended March 31, 2015.
oIn the three months ended March 31, 2016, the Company accrued bonus expense of $219,000 for an employee bonus program which was initiated in 2016 plus targeted executive bonuses per their existing compensation contracts.  However, these bonus payments are contingent upon the Company achieving certain levels of profitability.  In the three months ended March 31, 2015, the Company accrued bonus expense of $11,000.
oThe Company's Swedish subsidiary decreased their bad debt reserve in the three months ended March 31, 2016, by $62,000 due to the collection of the related trade receivables.
oGross spending on software product development ("development") expenses for the three months ended March 31, 2016, and March 31, 2015, totaled $485,000 and $901,000, respectively. The Company capitalized $131,000 and $506,000 of product development expenses for the three months ended March 31, 2016, and March 31, 2015, respectively.  Net development spending decreased from $395,000 for the three months ended March 31, 2015, to $354,000 for the three months ended March 31, 2016.
Company.

Restructuring charges.  Restructuring charges totaled $125,000$45,000 and $97,000$125,000 for the three months ended March 31, 2017 and 2016, and March 31, 2015, respectively.  The decrease of $80,000 is primarily due to the winding down of the Company's restructuring activities initiated during 2015.

Depreciation.  Depreciation expense totaled $76,000 and $100,000 and $129,000 duringfor the three months ended March 31, 2016,2017 and March 31, 2015,2016, respectively.

Amortization of definite-lived intangible assets. Amortization expense related to definite-lived intangible assets totaled $73,000$64,000 and $123,000$73,000 for the three months ended March 31, 2016,2017, and 2015,2016, respectively.  The decrease in first quarter 20162017 amortization expense reflects a decrease is primarily due to lower amortization of amortization related to thecustomer-related intangible assets that were recorded in conjunction with the Hyperspring acquisition in November 2014 which are being amortized over seven years.2014.

Operating income (loss).  The Company had operating income of $215,000 (1.6% of revenue) for the three months ended March 31, 2016, as compared with an operating loss of $324,000 (2.3% of revenue) for the same period in 2015.  The variances were due to the factors outlined above.

Interest income, net.  Net interest income totaled $27,000 for the three months ended March 31 2016, and March 31, 2015, respectively.
35


Loss on derivative instruments, net.  The Company periodically enters into forwardLoss on derivative instruments, net increased $42,000, and relates to the Company's foreign exchange contracts to manage market risks associated with the fluctuations inand remeasurement of foreign currency exchange rates on foreign-denominated trade receivables.  As of March 31, 2016, the Company had foreign exchange contracts outstanding of approximately 2.2 million Euro, 0.6 million Canadian Dollars, 0.3 million Pounds Sterling, and 0.3 million Australian Dollars at fixed rates.  The contracts expire on various dates through January 2017.  The Company has not designated the contracts as hedges and has recognized a loss of $183,000 on the change in the estimated fair value of the contracts for the three months ended March 31, 2016.

As of March 31, 2015, the Company had foreign exchange contracts outstanding of approximately 2.2 million Euro, 0.7 million Australian Dollars, and 0.3 million Pounds Sterling at fixed rates.  The contracts expire on various dates through December 2016.  The Company had not designated the contracts as hedges and had not recognized a gain or loss on the change in the estimated fair value of the contracts for the three months ended March 31, 2015.

The foreign currency denominatedcurrency-denominated contract receivables, billings in excess of revenue earned, and subcontractor accruals, that are related to the outstanding foreign exchange contracts were remeasured 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 loss on derivative instruments, net in the consolidated statements of operations. 

For the three months ended March 31, 2016, the Company2017, we recognized a gainloss of $65,000$86,000 on the change in fair value of foreign exchange contracts, compared to a loss of $183,000 for the same period in 2016.

For the three months ended March 31, 2017, we recognized a loss of $74,000 from the remeasurement of such contract receivables, billings in excess of revenue earned and subcontractor accruals.  Foraccruals, compared to a gain of $65,000 for the same period in 2015, the Company recognized a loss of $48,000.2016.

Other (expense) income, (expense), net.  ForThe Company recognized $3,000 of other expense, net and $102,000 of other income, net for the three months ended March 31, 2016,2017 and March 31, 2015, the Company recognized other income, net of $102,000 and other expenses net of $39,000,2016, respectively. The major components2016 amount was primarily related to a $101,000 refund of other income (expense), net includedValue Added Tax that was received by our Chinese subsidiary that did not recur in the following items:2017 period.

·For the three months ended March 31, 2016, the Company's Chinese subsidiary received a $101,000 refund of Value Added Tax.  The Company had other miscellaneous income of $1,000.
·For the three months ended March 31, 2015, the Company recognized a $39,000 equity loss on its investment in IntelliQlik LLC.

Provision for Income Taxes

income taxes.  Income tax expense was $73,000, or an effective income tax rate of (37.8%), for the three months ended March 31, 2017, compared to $88,000, or an effective income tax rate of 38.6%, for the three months ended March 31, 2016, compared to $88,000, or an effective income tax rate of 22.9%, for the three months ended March 31, 2015.2016.  The Company's income tax provision for interim periods is determined using an estimate of its annual effective tax rate, adjusted for discrete items arising in that quarter.  Tax expense in both years is comprised mainly of foreign income tax expense, alternative minimum tax, and deferred tax expense relating to the tax amortization of goodwill.

Because of the net operating loss carryforwards, the Company is subject to U.S. federal and state income tax examinations from years 1997 and forward.  The Company is subject to foreign tax examinations by tax authorities for years 2010 and forward for Sweden, 2012 and forward for China, and 2014 and forward for both India and the UK.

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 fifty percent) 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 fifty percent likely of being realized upon ultimate settlement. Interest and penalties related to income taxes are accounted for as income tax expense.  The Company has recorded uncertain tax positions for certain foreign tax contingencies in China, South Korea and the Ukraine.

In 2015, the Company paid income taxes in the UK and India and expects to do so again in 2016.  The Company has a full valuation allowance on its U.S., U.K., Swedish, and Chinese net deferred tax assets at March 31, 2016.2017.

Critical Accounting Policies and Estimates

In preparing the Company's consolidated financial statements, management makes several estimates and assumptions that affect the Company's reported amounts of assets, liabilities, revenues and expenses.  Those accounting estimates that have the most significant impact on the Company's operating results and place the most significant demands on management's judgment include revenue recognition, impairment of intangible assets, including goodwill, capitalization of computer software development costs, valuation of contingent consideration for business acquisitions, and deferred income tax valuation allowance.  These critical accounting policies and estimates are discussed in the Management's Discussion and Analysis of Financial Condition and Results of Operations section in our most recent Annual Report on Form 10-K.  For all of these policies, management cautions that future events rarely develop exactly as forecast, and the best estimates may require adjustment.

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Liquidity and Capital Resources

As of March 31, 2016,2017, the Company's cash and cash equivalents totaled $11.2$21.6 million compared to $11.1$21.7 million at December 31, 2015.2016.

Cash provided by (used in) operating activities.  For the three months ended March 31, 2017, net cash provided by operations totaled $1.3 million. Significant changes in the Company's assets and liabilities in the three months ended March 31, 2017, included:

●
A $4.9 million decrease in the Company's contract receivables, which is comprised of trade receivables and unbilled receivables. The Company's trade receivables, net of allowance for doubtful accounts, decreased approximately $7.4 million primarily due to the collection of $6.4 million in receivables during the first quarter of 2017 from a significant customer.  At March 31, 2017, trade receivables outstanding for more than 90 days, net of the bad debt reserve, totaled approximately $0.6 million as compared to $0.3 million at December 31, 2016.  The Company believes the entire 90-day balance at March 31, 2017, is collectible.  The Company's unbilled receivables increased by approximately $2.4 million to $7.9 million at March 31, 2017, as compared to December 31, 2016. The increase in the unbilled receivables is due to the timing of contracted billing milestones of the Company's current projects, most of which relates to Hyperspring's largest customer.  In April 2017, the Company invoiced $1.6 million of the unbilled amounts; the remaining balance is expected to be invoiced and collected within one year.

●A $3.3 million decrease in billings in excess of revenue earned. The decrease is due to the timing of contracted billing milestones of the Company's current projects.

●A $1.2 million decrease in accounts payable, accrued compensation and accrued expenses.  The decrease primarily reflects a decrease in Hyperspring accrued payroll due to the timing of their biweekly payroll cycle and the timing of payments made by the Company to vendors and subcontractors.

For the three months ended March 31, 2016, net cash provided by operations totaled $1.6 million.  Significant changes in the Company's assets and liabilities in the three months ended March 31, 2016, included:

·●
A $0.3 million decrease in the Company's contract receivables.  The Company's trade receivables, net of the allowance for doubtful accounts, decreased from $9.7 million at December 31, 2015 to $7.6 million at March 31, 2016.  At March 31, 2016, trade receivables outstanding for more than 90 days, net of the bad debt reserve, totaled approximately $0.9 million as compared to $0.6 million at December 31, 2015.  The Company believes the entire 90-day balance at March 31, 2016, will be received.  is collectible.  The Company's unbilled receivables increased by approximately $1.8 million to $5.2 million at March 31, 2016 as compared to December 31, 2015.  The increase in the unbilled receivables is due to the timing of contracted billing milestones of the Company's current projects.  In April 2016, the Company invoiced $1.8 million of the unbilled amounts; the balance is expected to be invoiced and collected within one year.

·●A $1.2 million increase in accounts payable, accrued compensation and accrued expenses.  The increase reflects an increase in Hyperspring accrued payroll due to the timing of their biweekly payroll cycle and the timing of payments made by the Company to vendors and subcontractors.

ForCash used in investing activities.  Net cash used in investing activities totaled $73,000 for the three months ended March 31, 2015, net cash used in operations2017.  Capital expenditures totaled $0.5 million.  Significant changes in the Company's assets$44,000 and liabilities in the three months ended March 31, 2015, included:
·
An $0.6 million decrease in the Company's contract receivables.  The Company's trade receivables, net of the allowance for doubtful accounts, decreased from $10.8 million at December 31, 2014, to $8.4 million at March 31, 2015.  At March 31, 2015, trade receivables outstanding for more than 90 days, net of the bad debt reserve, totaled approximately $0.9 million as compared to $0.4 million at December 31, 2014.  The Company's unbilled receivables increased by approximately $1.7 million to $6.8 million at March 31, 2015, as compared to December 31, 2014.  The increase in the unbilled receivables was due to the timing of contracted billing milestones of the Company's current projects.  
·A $0.4 million decrease in accounts payable, accrued compensation, and accrued expenses.  The decrease was due to the timing of payments made by the Company to vendors and subcontractors.
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capitalized software development costs totaled $29,000.

Cash used in investing activities.  Net cash used in investing activities totaled $119,000 for the three months ended March 31, 2016.  Capital expenditures totaled $18,000 and capitalized software development costs totaled $131,000 for the three months ended March 31, 2016.  Proceeds from the sale of fixed assets totaled $31,000.
Net cash used in investing activities totaled $646,000 for the three months ended March 31, 2015.  Capital expenditures totaled $104,000 and capitalized software development costs totaled $506,000 for the three months ended March 31, 2015.  Restrictions of cash used as collateral for outstanding letters of credit totaled $216,000 for the three months ended March 31, 2015.  Releases of restricted cash as collateral under letters of credit totaled $180,000 for the three months ended March 31, 2015.

Cash used in financing activities.  Net cash used in financing activities totaled $1.5 million for the three months ended March 31, 2017.  During the three months ended March 31, 2017, the Company made payments of $0.9 million to the former Hyperspring owners in accordance with the 2014 purchase agreement due to the achievement of certain EBITDA targets in 2016 and withheld approximately $0.7 million in RSUs to pay employees' payroll withholding taxes.

Net cash used in financing activities totaled $1.4 million for the three months ended March 31, 2016.  During the three months ended March 31, 2016 the Company madedue to payments of $1.4 million to the former Hyperspring owners in accordance with the 2014 purchase agreement due to the achievement of certain EBITDA targets in 2015.  During the three months ended March 31, 2016, the Company received $4,000 for stock options exercised.
Net cash used in financing activities totaled $657,000 for the three months ended March 31, 2015.  Hyperspring has a working capital line of credit with IberiaBank.  The Company paid down $339,000 of the outstanding balance of the line of credit during the three months ended March 31, 2015.  During the three months ended March 31, 2015, the Company made payments of $318,000 in relation to the liability classified contingent-consideration associated with the acquisition of EnVision Systems, Inc.
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At March 31, 2016,2017, the Company had cash and cash equivalents of $11.2$21.6 million.  The Company believes that its (i) cash and cash equivalents and (ii) cash generated from normal operations will be sufficient to fund its working capital and other requirements for at least the next twelve months.  However, notwithstanding the foregoing, the Company may be required to look for additional capital to fund its operations if the Company is unable to operate profitably and generate sufficient cash from operations.  There can be no assurance that the Company would be successful in raising such additional funds.
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Line of Credit Facilities

Branch Banking and TrustCitizens Bank ("BB&T")
At March 31, 2016, the Company had a Master Loan and Security Agreement and Revolving Credit Note with BB&T Bank. 
The Company and its subsidiary, GSE Performance Solutions, Inc., were jointly and severally liable as co-borrowers.  The Loan Agreement providesentered into a $7.5new three-year, $5.0 million revolving line of credit for the purpose of (i) issuing stand-by letters of credit and (ii) providingfacility (RLOC) with Citizens Bank on December 29, 2016, to fund general working capital.capital needs, including acquisitions.  Working capital advances bear interest at a rate equal to the Wall Street Journal Prime Rate of Interest, floating with a floorLIBOR plus 2.25% per annum and letter of 4.5%.  The agreement expires on June 30, 2016.
As collateral for the Company's obligations, the Company granted a first lien and security interest in all of the assets of the Company, including but not limited to, accounts receivable, proceeds and products, intangible assets, equipment, software and leasehold improvements.
credit fees are 1.25% per annum.  The Company is not required to maintain a segregatedrestricted cash collateral account at BB&TCitizens Bank for outstanding letters of credit and working capital advances. 

The maximum availability under the RLOC is subject to a borrowing base equal to the greater80% of (i) $3.0 million or (ii) the aggregate principal amounts of all Loans outstanding under the Revolving Credit Facility (includingeligible accounts receivable, and is reduced for any issued and outstanding letters of credit and working capital advances.  At March 31, 2017, there were no outstanding borrowings on the RLOC and six letters of credit totaling $1.7 million.  The amount available at March 31, 2017, after consideration of the borrowing base, letters of credit and working capital advances was approximately $1.8 million.

The credit facility agreement is subject to standard financial covenants and negative foreign exchange positions) as security forreporting requirements. At March 31, 2017, the Company's obligations.  Under this Amendment, Company was in compliance with its financial covenants.

BB&T Bank has complete and unconditional control over the cash collateral account.

At March 31, 2016,2017, we had four letters of credit with BB&T totaling $1.0 million, which we expect to terminate during the second quarter of 2017.  At March 31, 2017 and December 31, 2015,2016, the cash collateral account with BB&T totaled $3.6$1.1 million and $3.5 million, respectively. The balances werewas classified as restricted cash on the consolidated balance sheets.
The credit agreements contain
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Non-GAAP Financial Measures

EBITDA and Adjusted EBITDA are not measures of financial performance under generally accepted accounting principles (GAAP).  Management believes EBITDA and Adjusted EBITDA, in addition to operating profit, net income and other GAAP measures, are useful to investors to evaluate the Company's results because it excludes certain restrictive covenants regarding future acquisitions and incurrence of debt.  In addition, the credit agreement contains financial covenants with respectitems that are not directly related to the Company's minimum tangible capital basecore operating performance that may, or could, have a disproportionate positive or negative impact on our results for any particular period. Investors should recognize that EBITDA and quick ratio.Adjusted EBITDA might not be comparable to similarly-titled measures of other companies.  This measure should be considered in addition to, and not as a substitute for or superior to, any measure of performance prepared in accordance with GAAP.  A reconciliation of non-GAAP EBITDA and Adjusted EBITDA to the most directly comparable GAAP measure in accordance with SEC Regulation G follows:

  As of
CovenantMarch 31, 2016
Minimum tangible capital baseMust exceed $10.5 million$11.3 million
Quick ratioMust exceed 1.00 : 1.001.52 : 1.00
  Three Months ended 
  March 31, 
(in thousands)  2017  2016 
Net (loss) income $(266) $138 
Interest income, net  (27)  (27)
Provision for income taxes  73   88 
Depreciation and amortization  140   173 
EBITDA  (80)  372 
Loss (gain) from the change in fair value of contingent consideration  254   (69)
Restructuring charges  45   125 
Stock-based compensation expense  596   247 
Consulting support for finance restructuring  -   78 
Adjusted EBITDA $815  $753 

As of March 31, 2016, the Company was in compliance with its covenants as defined above.
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Adjusted Net Income and Adjusted EPS Reconciliation (in thousands, except per share amounts)

IberiaBankAdjusted Net Income and adjusted earnings (loss) per share (adjusted EPS) are not measures of financial performance under GAAP.  Management believes adjusted net income and adjusted EPS, in addition to other GAAP measures, provide meaningful supplemental information regarding our operational performance. Our management uses Adjusted Net Income and other non-GAAP measures to evaluate the performance of our business and make certain operating decisions (e.g., budgeting, planning, employee compensation and resource allocation). This information facilitates management's internal comparisons to our historical operating results as well as to the operating results of our competitors. Since management finds this measure to be useful, we believe that our investors can benefit by evaluating both non-GAAP and GAAP results.  These measures should be considered in addition to, and not as a substitute for or superior to, any measure of performance prepared in accordance with GAAP.  A reconciliation of non-GAAP adjusted net income and adjusted EPS to GAAP net income, the most directly comparable GAAP financial measure, is as follows:
At
  Three Months ended 
  March 31, 
  2017  2016 
       
Net (loss) income $(266) $138 
Loss (gain) from the change in fair value of contingent consideration  254   (69)
Restructuring charges  45   125 
Stock-based compensation expense  596   247 
Consulting support for finance restructuring  -   78 
Adjusted net income $629  $519 
         
Diluted (loss) earnings per common share $(0.01) $0.01 
         
Adjusted earnings per common share – Diluted(a)
 $0.03  $0.03 
         
Weighted average shares outstanding – Diluted(a)
  19,502,057   18,133,742 
         

(a) During the three months ended March 31, 2016, Hyperspring, LLC had2017, the Company reported a $1.0 million working capital line of credit with IberiaBank.  Under the executed promissory note, interest is payable monthly at the rate of 1.00 percentage points over the prime rate of interest as publishedGAAP net loss and positive adjusted net income.  Accordingly, there were 407,675 dilutive shares from options and RSUs included in the money rate section ofadjusted earnings per common share calculation that were considered anti-dilutive in determining the Wall Street Journal resulting in an effective interest rate of 4.25%. The line is secured by all accounts of Hyperspring and guaranteed by GSE Systems, Inc.  The line of credit expires on July 6, 2016.  At March 31, 2016, the Company had no outstanding amounts under the line of credit.
Letters of Credit and Bonds
As of March 31, 2016, the Company had eleven standby letters of credit totaling $3.6 million which represent advance payment and performance bonds on ten contracts.  The Company has deposited the full value of eleven standby letters of credit in escrow accounts, amounting to $3.6 million, which have been restricted in that the Company does not have access to these funds until the related letters of credit have expired.  The cash has been recorded on the Company's consolidated balance sheets at March 31, 2016, as restricted cash.GAAP diluted loss per common share.
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Item 3. 
Item 3.Quantitative and Qualitative Disclosure about Market Risk

The Company's market risk is principally confined to changes in foreign currency exchange rates.  The Company's exposure to foreign exchange rate fluctuations arises in part from customer contracts that are denominated in currencies other than the Company's functional currency as well as from inter-company accounts in which costs incurred in one entity are charged to other entities in different foreign jurisdictions.  The Company is also exposed to foreign exchange rate fluctuations as the financial resultsNot required of all foreign subsidiaries are translated into U.S. dollars in consolidation.  As exchange rates vary, those results when translated may vary from expectations and adversely impact overall expected profitability.
The Company utilizes forward foreign currency exchange contracts to manage market risks associated with the fluctuations in foreign currency exchange rates.  The principal currencies for which such forward exchange contracts are entered into are the Pound Sterling, the Euro, the Canadian Dollar and the Australian Dollar.  It is the Company's policy to use such derivative financial instruments to protect against market risk arising in the normal course of business in order to reduce the impact of these exposures.  The Company minimizes credit exposure by limiting counterparties to nationally recognized financial institutions.
As of March 31, 2016, the Company had foreign exchange contracts outstanding of approximately 2.2 million Euro, 0.6 million Canadian Dollars, 0.3 million Pounds Sterling, and 0.3 million Australian Dollars at fixed rates.  The contracts expire on various dates through January 2017.  The Company had not designated the contracts as hedges and had recognized losses on the change in the estimated fair value of the contracts of $183,000 for the three months ended March 31, 2016.  The foreign currency denominated contract receivables, billings in excess of revenue earned, and subcontractor accruals that are related to the outstanding foreign exchange contracts were remeasured 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 net gain (loss) on derivative instruments in the consolidated statements of operations.  For the three months ended March 31, 2016, the Company recognized a gain of $65,000 from the remeasurement of such contract receivables, billings in excess of revenue earned and subcontractor accruals.  A 10% fluctuation in the foreign currency exchange rates up or down as of March 31, 2016, would have increased/decreased the change in the estimated fair value of the contracts by $12,000.smaller reporting company.

As of March 31, 2015, the Company had foreign exchange contracts outstanding of approximately 2.2 million Euro, 0.7 million Australian Dollars, and 0.3 million Pounds Sterling at fixed rates.  The contracts expire on various dates through December 2016.  The Company had not designated the contracts as hedges and had recognized no change in the estimated fair value of the contracts for the three months ended March 31, 2015.  A 10% fluctuation in the foreign currency exchange rates up or down as of March 31, 2015, would have increased/decreased the change in the estimated fair value of the contracts by $1,400.

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Item 4. 
Item 4.Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed by it in its reports filed or submitted pursuant to the Securities Exchange Act of 1934, as amended (the "Exchange Act")Exchange Act), is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms and that information required to be disclosed by the Company in its Exchange Act reports is accumulated and communicated to management, including the Company's Chief Executive Officer ("CEO")(CEO), who is its principal executive officer, and Chief Financial Officer ("CFO")(CFO), who is its principal financial officer, to allow timely decisions regarding required disclosure.  At the end of the period covered by this report, an evaluation was performed under the supervision and with the participation of our management including our CEO and our CFO, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13-15(e) of the Exchange Act.  Based on the evaluation of our disclosure controls and procedures as of March 31, 2016,2017, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were not effective because of the material weakness identified below.


(b)  Changes in internal controlInternal Control over Financial Reporting

OurAs described in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2016, management is responsible for establishing and maintaining adequateassessed the effectiveness of the Company's internal control over financial reporting and concluded that they were not effective as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed by, or under the supervision of our Chief Executive Officer and Chief Financial Officer, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that:

·pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;

·provide reasonable assurance that transactions are recorded as necessary to permit preparation of  the consolidated financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and

·provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the consolidated financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subjectDecember 31, 2016, due to the riskfact that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
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Athere was a material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis.  Set forth below are the Company's material weaknesses inits internal control over financial reporting.

As of DecemberMarch 31, 2015,2017, management identified: (i)concluded that additional work was still required to remediate control deficiencies in the Company's internal controls associated with revenue recognition on software license contracts with multiple deliverables, and (ii) the need to revise prior period financial statements. The material weakness in internal control over financial reporting identified is as follows:
Revenue Recognition — The controls over revenue recognition on software license sales with multiple deliverables were improperly designeddue to inadequate design and were not effective in identifying the absence of vendor specific objective evidence ("VSOE") for all elements sold together with the Company's software license sales. The Company reviewed its contracts from EnVision product software sales with multiple elements and used a contract review template to determine the correct revenue recognition methodology and whether or not VSOE existed on any elements of the sale.  The Company's control to have management review the contract revenue recognition template failed at identifying that VSOE was absent for all elements of its EnVision product software sales.  As a result, the Company incorrectly concluded it had VSOE of the fair value for each element of multiple element arrangements sold together with its software sales and applied the relative selling price method to the contracts including post contract support ("PCS").  Revenue was recognized on each element as delivery occurred, and the PCS element was recognized ratably over the PCS term.  However, the Company was unable to substantiate that VSOE existed for all elements sold together with its software license sales.  As such, the software license sales should have had the full contract value recognized ratably over the PCS period upon delivery of all other elements.  As a result of this material weakness in the design of our internal control over financial reporting, we adjusted our policy on revenue recognition on software license sales and revised our consolidated financial statements for the years ended December 31, 2015 and 2014.
 As of March 31, 2016, the Company has not completed the implementation of control procedures to ensure that the material weakness related to revenue recognition on software license sales has been mitigated.operation.  As a result of this material weakness in our internal control over financial reporting, we performed additional review and analysis over our consolidated financial statements for the three months ended March 31, 2016.2017.  As a result of these procedures, we believe that our consolidated financial statements are presented in accordance with U.S. GAAP.  We anticipate that we will have completedcomplete the revisionremediation of our controls over revenue recognition on software license sales with multiple deliverables in the third quarter 2016.during 2017.
Because of the material weakness
Except as described above, management has concluded that we did not maintain effective internal control over financial reporting during the three months ended March 31, 2016, based on the "Internal Control - Integrated Framework (2013)" issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO").  However, we believe these additional procedures were sufficient to provide a basis for management's certifying that the financial statements presented in this Report are presented fairly, in all material respects, in accordance with U.S. GAAP. 

(c)  Changes in internal control over financial reporting

Therethere were no changes in the Company's internal control over financial reporting that occurred during the most recent fiscal quarter that have materially affected or are reasonably likely to materially affect the Company's internal control over financial reporting.

(d)(c)  Limitation of Effectiveness of Controls

Internal control over financial reporting has inherent limitations.  Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures.  Internal control over financial reporting also can be circumvented by collusion or improper management override.  Because of such limitations, there is a risk that material misstatements will not be prevented or detected on a timely basis by internal control over financial reporting.  However, these inherent limitations are known features of the financial reporting process.  Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.
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PART II - OTHER INFORMATION

Item 1. 
Item 1.Legal Proceedings

None.

Item 1A. 
Item 1A.Risk Factors

The Company has no material changes to the disclosure on this matter made in its Annual Report on Form 10-K for the fiscal year ended December 31, 2015.2016.

Item 2. 
Item 2.Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3. 
Item 3.Defaults Upon Senior Securities

None

Item 4. 
Item 4.Mine Safety Disclosures

Not applicable.
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Item 5.Other Information

NoneNone.

Item 6.Exhibits

10.1Employment Agreement between Bahram Meyssami and GSE Systems, Inc. dated as of December 1, 2015, filed herewith.
10.2Restricted Share Unit Agreement between Bahram Meyssami and GSE Systems, Inc. dated as of December 1, 2015, filed herewith.
10.3Amendment to Restricted Share Unit Agreement between Bahram Meyssami and GSE Systems, Inc. dated as of July 1, 2016, filed herewith.
 31.1Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes- Oxley Act of 2002, filed herewith.
   
 31.2Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.
   
 32.1Certification of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.
   
 101.INS*XBRL Instance Document
   
 101.SCH*XBRL Taxonomy Extension Schema
   
 101.CAL*XBRL Taxonomy Extension Calculation Linkbase
   
 101.DEF*XBRL Taxonomy Extension Definition Linkbase
   
 101.LAB*XBRL Taxonomy Extension Label Linkbase
   
 101.PRE*XBRL Taxonomy Extension Presentation Linkbase
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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


Date:  May 16, 201615, 2017
GSE SYSTEMS, INC.

/S/ KYLE J. LOUDERMILK
Kyle J. Loudermilk
Chief Executive Officer
(Principal Executive Officer)



/S/ JEFFERY G. HOUGHEMMETT A. PEPE
Jeffery G. HoughEmmett A. Pepe
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)


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