3. | Basic and Diluted (Loss) Income per Common Share |
Basic (loss) incomeloss per share is computed by dividing net (loss) incomeloss by the weighted average number of outstanding shares of common stock outstanding for the period. Diluted net (loss) incomeloss per share adjusts the weighted average shares outstanding for the potential dilution that could occur if outstanding vested stock options were exercised and restricted stock units ("RSU") were vested, unless the impact of potential dilutive common shares outstanding are anti-dilutive. Since we experienced a net loss in each period presented, basic and diluted net loss per common share arewere the same. The diluted loss per share, in each period present, excludes the impact
The number of common shares and common share equivalents used in the determination of basic and diluted loss per common share were as follows:
| (in thousands, except for share amounts) | | Three months ended | | | Nine months ended | | | Three months ended | | | Six months ended | |
| | | September 30, | | | September 30, | | |
| | | 2019 | | | 2018 | | | 2019 | | | 2018 | | | June 30, 2020 | | | June 30, 2019 | | | June 30, 2020 | | | June 30, 2019 | |
| Numerator: | | | | | | | | | | | | | | | | | | | | | | | | |
| Net loss | | $ | (1,121 | ) | | $ | (518 | ) | | $ | (5,482 | ) | | $ | (1,033 | ) | | $ | (2,149 | ) | | $ | (216 | ) | | $ | (8,407 | ) | | $ | (4,513 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Denominator: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Weighted-average shares outstanding for basic loss per share | | | 20,007,469 | | | | 19,786,888 | | | | 20,021,829 | | | | 19,620,207 | | | | 20,407,958 | | | | 20,006,492 | | | | 20,375,446 | | | | 19,979,018 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Effect of dilutive securities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Stock options and restricted stock units | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
| Adjusted weighted-average shares outstanding and assumed conversions for diluted loss per share | | | 20,007,469 | | | | 19,786,888 | | | | 20,021,829 | | | | 19,620,207 | | | | 20,407,958 | | | | 20,006,492 | | | | 20,375,446 | | | | 19,979,018 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Shares related to dilutive securities excluded because inclusion would be anti-dilutive | | | 578,676 | | | | 713,024 | | | | 397,131 | | | | 645,714 | | |
| Shares related to dilutive securities excluded from calculation because inclusion would be anti-dilutive | | | | 74,732 | | | | 263,241 | | | | 56,373 | | | | 175,848 | |
Note 4 - Paycheck Protection Program Loan
We entered into the Paycheck Protection Program Loan (the "PPP Loan") agreement with Citizens Bank, (our or the "Bank") which was approved by the bank and funded on April 24, 2020, pursuant to the Paycheck Protection Program under the Coronavirus Aid, Relief and Economic Security Act (the "CARES Act"). The PPP Loan matures on April 24, 2022 and bears interest at a rate of 1.0% per annum. Monthly amortized principle and interest payments are due for any portion of the loan balance that is not forgiven and deferred for ten months after the last day of the covered period, August 9, 2021.
The PPP Loan funds were received on April 24, 2020. The PPP Loan contains events of default and other provisions customary for a loan of this type. The Payroll Protection Program provides that (1) the use of PPP Loan amount shall be limited to certain qualifying expenses, (2) 100% of the principal amount of the loan is guaranteed by the Small Business Administration ("SBA") and (3) an amount up to the full principal amount may qualify for loan forgiveness in accordance with the terms of CARES Act. We are not yet able to determine the amount that might be forgiven. To the extent the loan amount is not forgiven under the PPP, we are obligated to make equal monthly payments of principal and interest, beginning after determination of forgiveness by the Bank. We may apply for forgiveness any time on or before the maturity date of the loan. The SBA provides for certain customary events of default, including if The Company (i) Fails to do anything required by the Note and other Loan Documents (ii) does not disclose, or anyone acting on its behalf does not disclose, any material fact to the Bank or the SBA (iii) makes, or anyone acting on its behalf makes, a materially false or misleading representation to lender or the SBA (iv) reorganizes, merges, consolidates or otherwise changes ownership or business structure without the Bank’s prior written consent (v) Takes certain prohibited actions after the Bank makes a determination that the PPP Loan is not entitled to full forgiveness. Upon default the Bank may require immediate payment of all amounts owing under the PPP Loan or file suit and obtain judgment.
As of June 30, 2020, the Company was in full compliance with all requirements in order to apply for forgiveness under the PPP Loan.
We have classified the full $10 million of the PPP Loan as long-term in our consolidated balance sheet as of June 30, 2020 and recorded $18 thousand in interest expense during the three and six months ended June 30, 2020.
2019 Acquisition
DP Engineering
On February 15, 2019, through its wholly-owned subsidiary Performance Solutions, the Company entered into a membership interest purchase agreement with Steven L. Pellerin, Christopher A. Davenport, and DP Engineering (the “DP Engineering Purchase Agreement”), to purchase 100% of the membership interests in DP Engineering for $13.5 million. The purchase price is subject to customary pre- and post-closing working capital adjustments plus an additional earn-out amount not to exceed $5 million, potentially payable in 2020 and 2021 depending on DP Engineering’s satisfaction of certain targets for adjusted earnings before interest, tax, depreciation and amortization ("EBITDA") in calendar years 2019 and 2020, respectively. The acquisition was completed through the drawdown of $14.3 million (including transaction costs) of the term loan. An escrow of approximately $1.7 million was funded at the closing and is available to GSE to satisfy indemnification claims arising within 18 months after the closing.
DP Engineering is a provider of value-added technical engineering solutions and consulting services to nuclear power plants with an emphasis on preparation and implementation of design modifications during plant outages, which is in line with our Performance segment. The Company's allocation of the purchase price remains preliminary and the net assets are subject to adjustments within the measurement period, which is not to exceed one year from the acquisition date.
Based on preliminary forecasted adjusted EBITDA of DP Engineering for the years 2019 and 2020, as of the acquisition date, the estimated fair value of the total earn-out amount was $1.2 million and was recorded as contingent consideration. Subsequent to the acquisition, it was determined that the conditions related to the contingent consideration would not be met and hence $1.2 million was taken to income in the first quarter of 2019.
The following table summarizes the calculation of adjusted purchase price as of the acquisition date (in thousands):
| Base purchase price per agreement | | $ | 13,500 | |
| Pre closing working capital adjustment | | | 155 | |
| Fair value of contingent consideration | | | 1,200 | |
| Total purchase price | | $ | 14,855 | |
The following table summarizes the consideration paid to acquire DP Engineering and the preliminary fair value of the assets acquired and liabilities assumed at the date of the transaction. Due to the recent completion of the acquisition, the Company recorded the assets acquired and liabilities assumed at their preliminary estimated fair value. As of September 30, 2019, the Company had not finalized the determination of the fair value allocated to various assets and liabilities, including, but not limited to, contract receivables, prepaid expenses and other current assets, intangible assets, accounts payable, accrued expenses, contingent consideration, accrued compensation and the residual amount allocated to goodwill. The following amounts except for cash are all reflected in the consolidated statement of cash flows within the "Acquisition of DP Engineering, net of cash acquired" line caption.
(in thousands)
| Total purchase price | | $ | 14,855 | |
| Purchase price allocation: | | | | |
| Cash | | | 134 | |
| Contract receivables | | | 2,934 | |
| Prepaid expenses and other current assets | | | 209 | |
| Property, and equipment, net | | | 210 | |
| Intangible assets | | | 6,798 | |
| Other assets | | | 1,806 | |
| Accounts payable and accrued expenses | | | (1,375 | ) |
| Other liabilities | | | (1,494 | ) |
| Total identifiable net assets | | | 9,222 | |
| Goodwill | | | 5,633 | |
| Net assets acquired | | $ | 14,855 | |
The fair value of the assets acquired includes gross trade receivables of $2.9 million, of which the Company has collected in full. GSE did not acquire any other class of receivable as a result of the acquisition of DP Engineering.
The goodwill is primarily attributable to value-added technical engineering solutions and consulting services to nuclear power plants with an emphasis on preparation and implementation of design modification during plant outages, the workforce of the acquired business and the significant synergies expected to arise after the acquisition of DP Engineering. The total amount of goodwill is expected to be tax deductible. All of the $5.6 million of goodwill was assigned to our Performance segment. As discussed above, the goodwill amount is provisional pending receipt of the final valuations of various assets and liabilities and is subject to adjustments within the measurement period, which is not to exceed one year from the acquisition date.
The Company identified other intangible assets of $6.8 million, including customer contracts and relationships, tradename, and non-compete agreements, with amortization periods of five years to fifteen years.
Approximately one week following our acquisition of DP Engineering, an adverse event occurred at one of DP Engineering’s major customer's location that affected plant operations. This incident adversely impacted the relationship between DP Engineering and its customer. The Company determined this represented a triggering event requiring an interim assessment for impairment. As a result of the impairment analysis, we recognized the impairment charges of $2.1 million on goodwill and $3.4 million on definite-lived intangible assets related to the acquisition of DP Engineering during the quarter ended March 31, 2019. On August 6, 2019, as a follow on to the Notice of Suspension, the Company received a Notice of Termination from this customer, notifying the Company that they were terminating their Engineer of Choice consulting service agreement with DP Engineering. Please see Note 8 for further analysis on the carrying amount change due to impairment on goodwill and definite-lived intangible assets during the nine months ended September 30, 2019. Additionally, also see Item 2. Management’s Discussion and Analysis for further discussion regarding the termination of Engineer of Choice of DP Engineering’s major customer.
The following table summarizes the fair value of intangible assets acquired at the date of acquisition and the related weighted average amortization period:
| Intangible Assets | | Weighted average amortization period | | | Fair Value | |
| | | (in years) | | | (in thousands) | |
| Customer relationships | | | 15 | | | $ | 4,898 | |
| Tradename | | | 10 | | | | 1,172 | |
| Non-compete agreements | | | 5 | | | | 728 | |
| Total | | | | | | $ | 6,798 | |
DP Engineering contributed revenue of $6.5 million to GSE for the period from February 15, 2019 to September 30, 2019.
2018 Acquisition
True North
On May 11, 2018, GSE, through its wholly-owned subsidiary Performance Solutions, entered into a membership interest purchase agreement with Donald R. Horn, Jenny C. Horn, and True North Consulting LLC (the "True North Purchase Agreement") to purchase 100% of the membership interests in True North Consulting LLC ("True North") for $9.75 million. The purchase price was subject to customary pre- and post-closing working capital adjustments, resulting in total consideration of $9.9 million. The True North Purchase Agreement contains customary representations, warranties, covenants, and indemnification provisions subject to certain limitations. An escrow of $1.5 million was funded5 - from the cash paid to the sellersContract Receivables of True North at the closing and is available to GSE to promote retention of key personnel and satisfy indemnification claims arising within 18 months after the closing. The acquisition of True North was completed on an all-cash transaction basis. In connection with the acquisition, we drew down a $10.3 million term loan to finance the transaction (including the transaction costs). See Note 12, for further details of the loan.
True North is a provider of technical engineering solutions to nuclear and fossil fuel power plants with an emphasis on regulatory-driven ASME code programs. Located in Montrose, Colorado, True North is a well-regarded service provider to leading companies in the power industry. The acquisition of True North is expected to broaden our engineering services offering, expand our relationships with several of the largest nuclear energy providers in the United States, and add a highly specialized, complementary talent pool to our employee base.
The following table summarizes the consideration paid to acquire True North and the preliminary fair value of the assets acquired and liabilities assumed at the date of the transaction. The Company recorded the assets acquired and liabilities assumed at their preliminary estimated fair value. As of September 30, 2019, the Company had finalized the determination of the fair value allocated to various assets and liabilities, including, but not limited to, contract receivables, prepaid expenses and other current assets, intangible assets, accounts payable, accrued expenses, accrued compensation and the residual amount allocated to goodwill.
(in thousands)
| Total purchase price | | $ | 9,915 | |
| | | | | |
| Purchase price allocation: | | | | |
| Cash | | | 306 | |
| Contract receivables | | | 1,870 | |
| Prepaid expenses and other current assets | | | 8 | |
| Property, and equipment, net | | | 1 | |
| Intangible assets | | | 5,088 | |
| Accounts payable, accrued expenses | | | (1,744 | ) |
| Accrued compensation | | | (353 | ) |
| Total identifiable net assets | | | 5,176 | |
| Goodwill | | | 4,739 | |
| Net assets acquired | | $ | 9,915 | |
The fair value of the assets acquired includes gross trade receivables of $1.9 million, of which the Company has collected in full as of September 30, 2019. GSE did not acquire any other class of receivable as a result of the acquisition of True North.
The goodwill is primarily attributable to a broader engineering service offering to new and existing customers, the workforce of the acquired business and the significant synergies expected to arise after the acquisition of True North. The total amount of goodwill is tax deductible. All of the $4.7 million of goodwill was assigned to our Performance segment.
The Company identified other intangible assets of $5.1 million, including customer relationships, tradename, non-compete agreements, and alliance agreements, with amortization periods of four years to fifteen years. The fair value of the intangible assets is finalized per final valuations for these assets.
The following table summarizes the fair value of intangible assets acquired at the date of acquisition and the related weighted average amortization period:
| Intangible Assets | �� | Weighted average amortization period | | | Fair Value | |
| | | (in years) | | | (in thousands) | |
| Customer relationships | | | 15 | | | $ | 3,758 | |
| Tradename | | | 10 | | | | 582 | |
| Non-compete agreements | | | 4 | | | | 221 | |
| Alliance agreements | | | 5 | | | | 527 | |
| Total | | | | | | $ | 5,088 | |
Unaudited Pro Forma Financial Information
The unaudited pro forma financial information in the table below summarizes the combined results of operations for GSE, True North and DP Engineering as if the business combinations had occurred on January 1, 2018.
| Three months ended September 30, | | | Nine months ended September 30, | |
| | | 2019 | | | 2018 | | | 2019 | | | 2018 | |
| | | (unaudited and in thousands) | |
| | | | | | | | | | | | | |
| Revenue | | $ | 20,031 | | | $ | 26,932 | | | $ | 68,667 | | | $ | 89,679 | |
| Net loss | | | (919 | ) | | | (1,204 | ) | | | (5,371 | ) | | | (1,509 | ) |
The pro forma financial information for all periods presented has been calculated after applying GSE's accounting policies and has also included pro forma adjustments resulting from these acquisitions, including amortization charges of the intangible assets identified from these acquisitions, interest expenses related to the financing transaction in connection with the acquisition of DP Engineering, and the related tax effects as if aforementioned companies were combined as of January 1, 2018.
For the nine months ended September 30, 2019, the Company has incurred $0.6 million of selling, general and administrative costs related to the acquisition of DP Engineering. Due to a triggering event described in Note 8, an impairment test was conducted, which resulted in substantially writing down the estimated fair value of goodwill and some of the definite-lived intangible assets initially recognized upon the acquisition. These expenses are included in general and administrative expense on GSE's consolidated statements of operations and are reflected in pro forma loss for the nine months ended September 30, 2019, in the table above.
For the nine months ended September 30, 2018, the Company has incurred $0.5 million of selling, general and administrative costs related to the acquisition of True North. These expenses are included in general and administrative expense on GSE's consolidated statements of operations and are reflected in pro forma loss for the nine months ended September 30, 2018, in the table above.
The pro forma financial information is not intended to reflect the actual results of operations that would have occurred if the acquisition had been completed on January 1, 2018, nor is it intended to be an indication of future operating results.
5. | Restructuring Activities |
International Restructuring
On December 27, 2017, the board of GSE approved an international restructuring plan to streamline and optimize the Company's global operations. Beginning in December 2017, GSE has been in the process of consolidating its engineering services and R&D activities to Maryland and ceasing an unprofitable non-core business in the United Kingdom (UK). As a result, the Company closed its offices in Nyköping, Sweden; Chennai, India; and Stockton-on-Tees, UK. These actions are designed to improve Company productivity by eliminating duplicate employee functions, increasing GSE's focus on its core business, improving efficiency and maintaining the full range of engineering capabilities while reducing costs and organizational complexity.
GSE eliminated approximately 40 positions since 2017 due to these changes, primarily in Europe and India, and will continue to undertake other cost-savings measures. The international restructuring plan is expected to be completed by the end of 2019. As a result of these efforts, GSE expects to record a total restructuring charge of approximately $2.2 million, primarily related to the international workforce reductions, contract termination costs and asset write-offs due to the exit activities. As of September 30, 2019, we had recorded total restructuring charges of $2.0 million since 2017. We incurred $2,000 of costs during the nine months ended September 30, 2019. We recognized $1.3 million of restructuring cost for the year ended December 31, 2018. In addition to the restructuring costs recognized to date, the Company has an estimated $1.3 million of cumulative translation adjustments that will be charged against net loss and an estimated $1.0 million of tax benefits that will be realized upon liquidation of these foreign entities. GSE expects to recognize the remaining restructuring costs, currency translation adjustments and tax benefits by the end of 2019.
For the nine months ended September 30, 2019, we made payments related to our restructuring for employee termination benefits and other legal expenses in the amount of $54,000 that had been previously accrued.
DP Engineering Restructuring
During the third quarter of 2019, the Company implemented a restructuring plan as a result of the work suspension of DP Engineering's largest customer and subsequent notification on August 6, 2019 that the Engineer of Choice contract was being terminated. Accordingly, the Company took the necessary measures to reduce DP’s workforce by approximately 12 FTE’s and in addition terminated one of its office leases early resulting in one-time costs of $293,000 being paid in the quarter. This reduction in force aligns the workforce to the current level of business going forward.
Collectively, for the nine months ended September 30, 2019, the Company recorded restructuring charges of approximately $0.7 million, of which $0.3 million related to DP Engineering severance and lease termination and $0.4 million related to an executive departure related to the suspension of the Company’s acquisition strategy.
6. | Contingent Consideration |
Acquisitions may include contingent consideration payments based on future financial measures of an acquired company. Under ASC 805, Business Combinations, contingent consideration is required to be recognized at fair value as of the acquisition date. We estimate the fair value of these liabilities based on financial projections of the acquired companies and estimated probabilities of achievement. At each reporting date, the contingent consideration obligation is revalued to estimated fair value and changes in fair value subsequent to the acquisition are reflected in income or expense in the consolidated statements of operations and could cause a material impact to our operating results. Changes in the fair value of contingent consideration obligations may result from changes in discount periods and rates, changes in the timing and amount of revenue and/or earnings estimates and changes in probability assumptions with respect to the likelihood of achieving the various earn-out criteria.
In connection with the acquisition of DP Engineering on February 15, 2019, the Company recognized the estimated fair value of contingent consideration for $1.2 million. During the nine months ended September 30, 2019, as a result of the triggering event described in Note 8, an impairment test was conducted on DP Engineering's goodwill and definite-lived intangible assets and the Company determined the $1.2 million of contingent consideration recognized upon acquisition of DP Engineering has reduced to zero since the related earn-out payment is no longer expected to be paid. We have recorded this reduction as an offset to selling, general and administrative expenses in unaudited consolidated statements of operations. There was no contingent liability as of September 30, 2019.
Contract receivables represent the Company'sour unconditional rights to consideration due from a broad base of bothour domestic and international customers. AllWe expect to collect all contract receivables are considered to be collectible within the next twelve months.
The components of contract receivables arewere as follows:
| (in thousands) | | September 30, | | | December 31, | | | June 30, 2020 | | | December 31, 2019 | |
| | | 2019 | | | 2018 | | |
| | | | | | | | | | | | | |
| Billed receivables | | $ | 8,281 | | | $ | 15,998 | | | $ | 6,657 | | | $ | 11,041 | |
| Unbilled receivables | | | 8,754 | | | | 5,506 | | | | 6,080 | | | | 6,624 | |
| Allowance for doubtful accounts | | | (469 | ) | | | (427 | ) | | | (402 | ) | | | (458 | ) |
| Total contract receivables, net | | $ | 16,566 | | | $ | 21,077 | | | $ | 12,335 | | | $ | 17,207 | |
Management reviews collectability of receivables periodically and records an allowance for doubtful accounts to reduce ourthe Company's receivables to their net realizable value when management determines it is probable that the Companywe will not be able to collect all amounts according to the contractual terms of the receivable. The allowance for doubtful accounts is based on historical trends of past due accounts, write-offs, specific identification and review of customer accounts. During the ninesix months ended SeptemberJune 30, 20192020 and 2018, the Company did not record any allowances for doubtful accounts. The minor fluctuation on the balance2019, we recorded bad debt expense of allowances for doubtful accounts was due to foreign currency exchange rates.$93 thousand and $0, respectively.
During October 2019, the Companymonth of July 2020, we invoiced $6.3$3.0 million of the Septemberunbilled amounts as of the period ended June 30, 20192020. We expect to bill the remaining unbilled amounts.amounts during the remainder of fiscal 2020.
As of SeptemberJune 30, 2019, the Company2020, we had one customertwo customers that accounted for 26.3% its12% and 11% of our consolidated contract receivables. As of December 31, 2018, the Company2019, we had one customertwo customers that accounted for 16.8%13% and 10% of itsour consolidated contract receivables.
8 | Goodwill and Intangible Assets |
Goodwill
We review goodwill for impairment annually as of December 31 and whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable. We test goodwill at the reporting unit level. A reporting unit is an operating segment, or one level below an operating segment, as defined by U.S. GAAP. We have determined that we have two reporting units, which are the same as our two operating segments, Performance and NITC.
We reviewed our goodwill for impairment as of the first quarter of fiscal 2020, due to the COVID-19 interim triggering event. Based upon our analysis, we determined the fair value of our goodwill at the reporting unit level exceeded the carrying value and determined no impairment charge was required as of the period ended March 31, 2020. No other triggering event was noted during the three months ended June 30, 2020.
Intangible Assets Subject to Amortization
Amortization of intangible assets other than goodwill is recognized on a straight-line basis over the estimated useful life of the intangible assets, except for customer relationships, which are recognized in proportion to the related projected revenue streams. Intangible assets with definite lives are reviewed for impairment if indicators of impairment arise. The CompanyGSE does not have any intangible assets with indefinite useful lives other than goodwill.
As discussedDuring the first quarter of fiscal 2020, we determined that the impact of the COVID-19 pandemic on our operations was an indicator of a triggering event that could result in Note 4, we recognized definite-lived intangible assets of $6.8 million upon acquisition of DP Engineering on February 15, 2019, including customer contracts and relationships, trademarks and non-compete agreements, with amortization periods of 5 to 15 years. Amortizationan impairment of our definite-lived intangible assets is recognized on a straight-line basis over the estimate useful lifelong-lived assets. As such, we performed an interim analysis to determine if an impairment existed as of the associated assets.
Followingperiod ended March 31, 2020 by its individual asset groupings, which management determined to be at the February 23, 2019 event occurring atsubsidiary level. We used a DP Engineering customer locationdiscounted cash flow analysis to test for impairment and subsequent receipt of the Notice of Suspension on February 28, 2019, the Company concluded that DP Engineering's relationship with it's largest customer has been adversely impacted. The DP Engineering customer contracts and relationships were the major componentcarrying value of the definite-lived intangible assets recognized in connection with the acquisition of DP Engineering. Accordingly, the Company determined that a triggering event had occurred requiring an interim assessment of whether a potential impairment of definite-lived intangible asset impairment test was necessary.
Therefore, the impairment test of the definite-lived intangible assets recognized upon the acquisition of DP Engineering was also conducted according to ASC 350, exceeded its fair value by $Intangibles-Goodwill4.3 million, and other.
The interimwe recorded an impairment test was based on the present value of revised cash flow projected for five to fifteen years. The resultthis amount as of the impairment test indicated that the current estimated fair value of noted definite-lived intangible assets had declined below their initial estimated fair value. As a result, the Company recognized an impairment charge of $3.4 million atthree months ended March 31, 2019. The fair value of definite-lived intangible assets recognized upon the acquisition of DP Engineering is still provisional and subject to further measurement period adjustment according to purchase price allocation rules. The impairment charge of $3.4 million on definite-lived intangible assets was recorded within "Loss on impairment" in our consolidated statements of operations. Due to the August 6th Notice of Termination of the EOC agreement with DP Engineering, the Company performed additional impairment testing as of September 30th, 2019 and at this time have2020. Management determined no further impairment is needed.
additional triggering impact occurred during the three months ended June 30, 2020.
Changes in the gross carrying amount, accumulated amortization addition and impairment of definite-lived intangible assets from December 31, 2018 through September 30, 2019 were as following:follows:
(in thousands)
| | | For the Nine Months Ended September 30, 2019 | | |
| | | Beginning Gross | | | Accumulated | | | Addition | | | Impairment | | | Net | | |
(in thousands) | | | As of June 30, 2020 | |
| | | Carrying Amount | | | Amortization | | | | | | | | | | | | Gross Carrying Amount | | | Accumulated Amortization | | | Impact of Impairment | | | Net | |
| Amortized intangible assets: | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Customer relationships | | $ | 6,833 | | | $ | (3,411 | ) | | $ | 4,898 | | | $ | (3,370 | ) | | $ | 4,950 | | | $ | 11,730 | | | $ | (4,910 | ) | | $ | (3,102 | ) | | $ | 3,718 | |
| Trade names | | | 1,295 | | | | (621 | ) | | | 1,172 | | | | - | | | | 1,846 | | | | 2,467 | | | | (884 | ) | | | (778 | ) | | | 805 | |
| Developed technology | | | 471 | | | | (471 | ) | | | - | | | | - | | | | - | | | | 471 | | | | (471 | ) | | | - | | | | - | |
| Non-contractual customer relationships | | | 433 | | | | (433 | ) | | | - | | | | - | | | | - | | | | 433 | | | | (433 | ) | | | - | | | | - | |
| Noncompete agreement | | | 221 | | | | (167 | ) | | | 728 | | | | - | | | | 782 | | |
| Alliance agreement | | | 527 | | | | (145 | ) | | | - | | | | - | | | | 382 | | |
| Noncompete agreements | | | | 949 | | | | (290 | ) | | | (422 | ) | | | 237 | |
| Alliance agreements | | | | 527 | | | | (224 | ) | | | - | | | | 303 | |
| Others | | | 167 | | | | (167 | ) | | | - | | | | - | | | | - | | | | 167 | | | | (167 | ) | | | - | | | | - | |
| Total | | $ | 9,947 | | | $ | (5,415 | ) | | $ | 6,798 | | | $ | (3,370 | ) | | $ | 7,960 | | | $ | 16,744 | | | $ | (7,379 | ) | | $ | (4,302 | ) | | $ | 5,063 | |
| (in thousands) | | As of December 31, 2018 | | | As of December 31, 2019 | |
| | | Gross Carrying Amount | | | Accumulated Amortization | | | Net | | | Gross Carrying Amount | | | Accumulated Amortization | | | Net | |
Amortized intangible assets: | | | | | | | | | | |
| Amortized intangible assets: | | | | | | | | | | |
| Customer relationships | | $ | 6,831 | | | $ | (2,375 | ) | | $ | 4,456 | | | $ | 11,730 | | | $ | (4,079 | ) | | $ | 7,651 | |
| Trade names | | | 1,295 | | | | (318 | ) | | | 977 | | | | 2,467 | | | | (727 | ) | | | 1,740 | |
| Developed technology | | | 471 | | | | (471 | ) | | | - | | | | 471 | | | | (471 | ) | | | - | |
| Non-contractual customer relationships | | | 433 | | | | (433 | ) | | | - | | | | 433 | | | | (433 | ) | | | - | |
| Noncompete agreements | | | 221 | | | | (35 | ) | | | 186 | | | | 949 | | | | (217 | ) | | | 732 | |
| Alliance agreement | | | 527 | | | | (66 | ) | | | 461 | | |
| Alliance agreements | | | | 527 | | | | (171 | ) | | | 356 | |
| Others | | | 167 | | | | (167 | ) | | | - | | | | 167 | | | | (167 | ) | | | - | |
| Total | | $ | 9,945 | | | $ | (3,865 | ) | | $ | 6,080 | | | $ | 16,744 | | | $ | (6,265 | ) | | $ | 10,479 | |
Amortization expense related to definite-lived intangible assets totaled $0.5 million$444 thousand and $0.6 million$638 thousand for the three months ended SeptemberJune 30, 20192020 and 2018,2019 and $1.6$1.1 million and $1.1$1.2 million for the ninesix months ended SeptemberJune 30, 2019,2020 and 2018,2019, respectively. The following table shows the estimated amortization expense of theour definite-lived intangible assets for the next five years and thereafter:
| (in thousands) | | | | | | |
| Years ended December 31: | | | | | | |
| 2019 (remainder) | | $ | 495 | | |
| 2020 | | | 1,974 | | |
2020 (remainder) | | | $ | 829 | |
| 2021 | | | 1,471 | | | | 1,213 | |
| 2022 | | | 1,152 | | | | 911 | |
| 2023 | | | 868 | | | | 640 | |
| Thereafter | | | 2,000 | | |
| 2024 | | | | 435 | |
| and thereafter | | | | 1,035 | |
| Total | | $ | 7,960 | | | $ | 5,063 | |
Goodwill
The Company reviews goodwill for impairment annually asNote 7 - Fair Value of December 31 and whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable. The Company tests goodwill at the reporting unit level. A reporting unit is an operating segment, or one level below an operating segment, as defined by U.S. GAAP. After the acquisition of Hyperspring on November 14, 2014, the Company determined that it had two reporting units, which are the same as our two operating segments: (i) Performance Improvement Solutions; and (ii) Nuclear Industry Training and Consulting (which includes Hyperspring and Absolute).
On February 15, 2019, we acquired DP Engineering (as described in Note 4) and preliminarily recorded goodwill and identified intangible assets as part of the acquisition. On February 23, 2019, an unexpected event occurred at one of DP Engineering's significant customers and all pending work for that customer was suspended pending a root cause analysis on February 28, 2019. While that analysis is now complete, and virtually all of the suspended projects have been restarted, the customer terminated the existing contract on August 6th 2019. The Company determined that the notice of suspension was a triggering event necessitating a goodwill impairment test.
On May 10, 2019, the Company determined that a material impairment had occurred, requiring an assessment for impairment to be completed related to $5.6 million of goodwill recorded in the acquisition.
The impairment test used an income-based approach with discounted cash flow method, and market-based approach including both guideline public company method and merger and acquisition method.
The impairment test results indicated that the current estimated fair value of goodwill recorded from the acquisition of DP Engineering had declined below its initial estimated fair value at the acquisition date. As a result, the Company recognized an impairment charge of $2.1 million to write down the goodwill on DP Engineering. The fair value of goodwill recognized from the acquisition of DP Engineering is still provisional and subject to further measurement period adjustment based upon the preliminary purchase price allocation. The Company determined that the impact of the suspension of obtaining new contracts from that customer resulted in a material downward revision to DP Engineering's revenue and profitability forecasts when compared to the acquisition date valuation. The impairment charge on goodwill was recorded within "Loss on impairment" in our consolidated statements of operations. Due to the August 6th Notice of Termination of the EOC agreement with DP Engineering, the Company performed, under ASC 350 guidance, additional impairment testing as of September 30th, 2019 and at this time have determined no further impairment is needed.
Changes in the net carrying amount of goodwill from December 31, 2018 through September 30, 2019 were due to the acquisition of DP Engineering, and were comprised of the following items:
(in thousandsFinancial Instruments)
| | | Performance Improvement Solutions | | | Nuclear Industry Training and Consulting | | | Total | |
| Balance, January 1, 2019 | | $ | 4,739 | | | $ | 8,431 | | | $ | 13,170 | |
| Acquisition | | | 5,633 | | | | - | | | | 5,633 | |
| Dispositions | | | - | | | | - | | | | - | |
| Goodwill impairment loss | | | (2,094 | ) | | | - | | | | (2,094 | ) |
| Balance, September 30, 2019 | | $ | 8,278 | | | $ | 8,431 | | | $ | 16,709 | |
9. | Fair Value of Financial Instruments |
ASC 820, Fair Value Measurement(ASC 820), defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
The levels of the fair value hierarchy established by ASC 820 are:
Level 1: inputs are quoted prices, unadjusted, in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
Level 2: inputs are other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. A Level 2 input must be observable for substantially the full term of the asset or liability. The Monte Carlo model was used to calculate the fair value of level 2 instrument liability award. The inputs used are current stock price, expected term, risk-free rate, number of trials, volatility and interest rates.
Level 3: inputs are unobservable and reflect the reporting entity’s own assumptions about the assumptions that market participants would use in pricing the asset or liability. The contingent consideration was based on EBITDA.
At SeptemberAs of June 30, 2019,2020 and December 31, 2018, the Company considers2019, we considered the recorded value of certain of itsour financial assets and liabilities, which consist primarily of cash and cash equivalents, accountscontract receivable and accounts payable, to approximate fair value based upon their short-term nature.
As of SeptemberJune 30, 2019, the Company2020, we had four standby letters of credit totaling $1.2$1.2 million, which represent performance bonds on four contracts.
For the three and ninesix months ended SeptemberJune 30, 2020 and 2019 the Company, we did not have any transfers between fair value Level 1, Level 2 or Level 3. The CompanyWe did not hold any non-financial assets or non-financial liabilities subject to fair value measurements on a recurring basis at Septemberas of June 30, 2019.2020.
Money market funds as of both June 30, 2020 and December 31, 2019 are included in cash and cash equivalents in the respective consolidated balance sheets.
The following table presents assets and liabilities measured at fair value at SeptemberJune 30, 2019:2020:
| (in thousands) | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | | Significant Other Observable Inputs (Level 2) | | | Significant Unobservable Inputs (Level 3) | | | Total | |
| | | | | | | | | | | | | |
| Money market funds | | $ | 375 | | | $ | - | | | $ | - | | | $ | 375 | |
| Foreign exchange contracts | | | - | | | | 68 | | | | - | | | | 68 | |
| Total assets | | $ | 375 | | | $ | 68 | | | $ | - | | | $ | 443 | |
| | | | | | | | | | | | | | | | | |
| Liability awards | | $ | - | | | $ | (18 | ) | | $ | - | | | $ | (18 | ) |
| Interest rate swap contract | | | - | | | | (192 | ) | | | - | | | | (192 | ) |
| Total liabilities | | $ | - | | | $ | (210 | ) | | $ | - | | | $ | (210 | ) |
| | | | | | | | | | | | | | | | | |
Money market funds at both September 30, 2019 and December 31, 2018 are included in cash and cash equivalents in the respective consolidated balance sheets.
| (in thousands) | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | | Significant Other Observable Inputs (Level 2) | | | Significant Unobservable Inputs (Level 3) | | | Total | |
| | | | | | | | | | | | | |
| Money market funds | | $ | 434 | | | $ | - | | | $ | - | | | $ | 434 | |
| Total assets | | | 434 | | | | - | | | | - | | | | 434 | |
| | | | | | | | | | | | | | | | | |
| Liability awards | | | - | | | | (3 | ) | | | - | | | | (3 | ) |
| Interest rate swap contract | | | - | | | | (234 | ) | | | - | | | | (234 | ) |
| Total liabilities | | $ | - | | | $ | (237 | ) | | $ | - | | | $ | (237 | ) |
| | | | | | | | | | | | | | | | | |
The following table presents assets and liabilities measured at fair value at December 31, 2018:2019:
| (in thousands) | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | | Significant Other Observable Inputs (Level 2) | | | Significant Unobservable Inputs (Level 3) | | | Total | | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | | Significant Other Observable Inputs (Level 2) | | | Significant Unobservable Inputs (Level 3) | | | Total | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Money market funds | | $ | 824 | | | $ | - | | | $ | - | | | $ | 824 | | | $ | 434 | | | $ | - | | | $ | - | | | $ | 434 | |
| Foreign exchange contracts | | | - | | | | 43 | | | | - | | | | 43 | | | | - | | | | 49 | | | | - | | | | 49 | |
| Total assets | | $ | 824 | | | $ | 43 | | | $ | - | | | $ | 867 | | | $ | 434 | | | $ | 49 | | | $ | - | | | $ | 483 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Liability awards | | $ | - | | | $ | (118 | ) | | $ | - | | | $ | (118 | ) | | $ | - | | | $ | (9 | ) | | $ | - | | | $ | (9 | ) |
| Interest rate swap contract | | | - | | | | (103 | ) | | | - | | | | (103 | ) | | | - | | | | (160 | ) | | | - | | | | (160 | ) |
| Total liabilities | | $ | - | | | $ | (221 | ) | | $ | - | | | $ | (221 | ) | | $ | - | | | $ | (169 | ) | | $ | - | | | $ | (169 | ) |
The following table provides a roll-forward of the fair value of the contingent consideration categorized as Level 3 for the nine months ended September 30, 2019:
(in thousands) | | | |
Balance, January 1, 2019 | | $ | - | |
Issuance of contingent consideration in connection with acquisitions | | | 1,200 | |
Change in fair value | | | (1,200 | ) |
Balance, September 30, 2019 | | $ | - | |
10. | Derivative Instruments |
In the normal course of business, our operations are exposed to fluctuations in foreign currency values and interest rate changes. We may seek to control a portion of these risks through a risk management program that includes the use of derivative instruments.
Foreign Currency Risk Management
The Company utilizesWe utilize forward foreign currency exchange contracts to manage market risks associated with the fluctuations in foreign currency exchange rates and to minimize credit exposure by limiting counterparties to nationally recognized financial institutions.
As of SeptemberJune 30, 2019, the Company2020, we had oneno foreign exchange contract outstanding of approximately 1.0 million Euro. The contract is set to expire in March 2020. At December 31, 2018, the Company had contracts outstanding of approximately 3.2 million Euro at fixed rates.outstanding.
Interest Rate Risk Management
As discussed in Note 12, the Company10, we entered into a term loan to finance the acquisition of True Northan amended Credit Agreement in May 2018 and revised via the Seventh Amendment and Reaffirmation Agreement on June 28, 2019.April 17, 2020. The loan bears interest at adjusted one-month USD LIBOR, plus a margin ranging between 2.00% and 2.75% depending on theour overall leverage ratio of the Company. Asratio. In June 2018, as part of our overall risk management policies, in June 2018, the Companywe entered into a pay-fixed, receive-floating interest rate swap contract with a notional amount of $9.0 million to reduce the impact associated with interest rate fluctuations. The notional value amortizes monthly in equal amounts based on the 5-year principal repayment terms. ThePer the terms of the swap, require the Companywe are required to pay interest on the basis of a fixed rate of 3.02%, and the Company willwe receive interest on the basis of one-month USD-LIBOR-BBA-Bloomberg.USD LIBOR.
The Company reports all derivatives at fair value. These contracts are recognized as either assets or liabilities, depending uponFor the derivative’s fair value. The estimated net fair valuesperiods presented, we did not elect to designate any of the derivative contracts on the consolidated balance sheets are as follows:
| | | September 30, | | | December 31, | |
| (in thousands) | | 2019 | | | 2018 | |
| Prepaid expenses and other current assets | | | | | | |
| Foreign exchange contracts | | $ | 68 | | | $ | 43 | |
| Total asset derivatives | | | 68 | | | | 43 | |
| | | | | | | | | |
| Other liabilities | | | | | | | | |
| Interest rate swaps | | | (192 | ) | | | (103 | ) |
| Total liability derivatives | | | (192 | ) | | | (103 | ) |
| | | | | | | | | |
| Net fair value | | $ | (124 | ) | | $ | (60 | ) |
The Company has not designated theour derivative contracts as hedges. The changesChanges in the fair value of the derivative contracts are included in gain (loss) on derivative instruments, net in the consolidated statements of operations.
The foreign currency denominated contract receivables, billings in excess of revenue earned and subcontractor accruals that are related to the outstanding foreign exchange contracts are remeasured at the end of each period into theour functional currency, using the current exchange rate at the end of the period. The gain or loss(loss) resulting from such remeasurement is also included in gain (loss) on derivative instruments, net in the consolidated statements of operations.
For the three and nine months ended September 30, 2019 and 2018, the CompanyWe recognized a net (loss) gain (loss)on itsour derivative instruments as outlined below:
| | | Three months ended September 30, | | | Nine months ended September 30, | |
| (in thousands) | | 2019 | | | 2018 | | | 2019 | | | 2018 | |
| | | | | | | | | | | | | |
| Interest rate swap - change in fair value | | $ | (1 | ) | | $ | (28 | ) | | $ | (89 | ) | | $ | (39 | ) |
| Foreign exchange contracts-change in fair value | | | (45 | ) | | | (14 | ) | | | 25 | | | | (178 | ) |
Remeasurement of related contract receivables, billings in excess of revenue earned, and subcontractor accruals | | | (15 | ) | | | (17 | ) | | | (5 | ) | | | (89 | ) |
| Loss on derivative instruments, net | | $ | (61 | ) | | $ | (59 | ) | | $ | (69 | ) | | $ | (306 | ) |
| | Three months ended | | | Six months ended | |
| (in thousands) | | June 30, 2020 | | | June 30, 2019 | | | June 30, 2020 | | | June 30, 2019 | |
| | | | | | | | | | | | | |
| Interest rate swap - change in fair value | | $ | 23 | | | $ | (62 | ) | | $ | (74 | ) | | $ | (88 | ) |
| Foreign exchange contracts | | | - | | | | (32 | ) | | | 17 | | | | 70 | |
| Remeasurement of related contract receivables, billings-in-excess of revenue earned, and subcontractor accruals | | | 24 | | | | (7 | ) | | | 61 | | | | 10 | |
| Gain (loss) on derivative instruments, net | | $ | 47 | | | $ | (101 | ) | | $ | 4 | | | $ | (8 | ) |
During the six months ended June 30, 2020, we realized a gain of $17 thousand for foreign exchange contracts due to their close out during fiscal 2020, and we recorded a loss of $74 thousand related to the change in the fair value of foreign exchange contracts for the six months ended June 30, 2019.
11. | Stock-Based Compensation |
Note 9 - Stock-based Compensation
The Company recognizesWe recognize compensation expense for all equity-based compensation awards issued to employees and directors that are expected to vest. Compensation costStock compensation is calculated based onupon the fair value of awards as of the grant date. The CompanyDuring the three months ended June 30, 2020 and 2019, we recognized $0.2 million$177 thousand and $0.4$499 thousand of stock-based compensation expense related to equity awards, respectively. We recognized $324 thousand and $1.1 million of stock-based compensation expense related to equity awards for the threesix months ended SeptemberJune 30, 20192020 and 2018, respectively, and recognized $1.2 million and $1.4 million of stock-based compensation expense related to equity awards for the nine months ended September 30, 2019 and 2018,, respectively, under the fair value method. In addition to the equity-based compensation expense recognized, the Company also recognized income of $(55,000)$0 and expense of $105,000$60 thousand of stock-based compensation related to the change in the fair value of cash-settled restricted stock units (RSUs) during the three months ended SeptemberJune 30, 20192020 and 2018,2019, respectively. During the ninesix months ended SeptemberJune 30, 2019 and 2018,2020, the Company recorded a net reductionstock-based compensation expense of $88,000$6 thousand and an increaseincome of $165,000 in$33 thousand for the same period ended 2019 for the fair value of cash-settled RSUs, respectively.
During the three and ninesix months ended SeptemberJune 30, 2019, the Company2020, we granted approximately 8,50010,000 and 508,50040,000 time-based RSUs with an aggregate fair value of $0.02 millionapproximately $10 thousand and $1.4 million,$31 thousand, respectively. For the three and ninesix months ended SeptemberJune 30, 2018, the Company2019, we granted approximately 0200,000 and 400,000500,000 time-based RSUs with an aggregate fair value of $0.0 million$600 thousand and $1.3$1.4 million, respectively. A portion of the time-based RSUs vest quarterly in equal amounts over the course of eight quarters, a portion vest one year after grant and the remainder vest annually in equal amounts over the course of three years.years. The fair value of the time-based RSUs is expensed ratably over the requisite service period, which ranges from one year to three years.years.
The Company'sGSE’s 1995 long-term incentive program ("LTIP") provides for the issuance of performance-vesting and time-vesting restricted stock units to certain executives and other Company employees. Vesting of the performance-vesting restricted stock units (PRSU's)("PRSU") is contingent upon the employee's continued employment and the Company's achievement of certain performance goals during designated performance periods as established by the Compensation Committee of the Company's Board of Directors. We recognize compensation expense, net of estimated forfeitures, for PRSU's on a straight-line basis over the performance period based on the probable outcome of achievement of the financial targets. At the end of each reporting period, we estimate the number of PRSUs that are expected to vest, based on the probability and extent to which the performance goals will be met, and take into account these estimates when calculating the expense for the period. If the number of shares expected to be earned changes during the performance period, we make a cumulative adjustment to compensation expense based on the revised number of shares expected to be earned.
During ninethe three months ended SeptemberJune 30, 2019, the Company granted approximately 350,0002020, we did not grant any performance-based RSUs to employees and during the six months ended June 30, 2020 we granted approximately 510,000 performance-based RSUs with an aggregate fair valuefair-value of $0.9 million. A cumulative adjustment reversing $150,000 of$600 thousand to key employees. Based upon our current forecasts, we expect these performance-based RSUs to vest and recognized stock-based compensation expense recognized in the first half of 2019 was recorded in the three-month period ended September 30, 2019 upon determination that vesting was no longer probable related to these awards of $50 thousand and $62 thousand for the three and six months ended June 30, 2020. These awards vest over three years based upon achieving certain financial metrics during fiscal 2022. Approximately 50% of these awards are based upon obtaining certain revenue targets, and the remainder are based upon achieving certain Adjusted EBITDA targets. During the three months ended SeptemberJune 30, 2019 the Company, we did notnot grant any performance-based RSUs. DuringRSUs to employees and during the three and ninesix months ended SeptemberJune 30, 2018, the Company did not grant any2019, we granted approximately 350,000 performance-based RSUs. The CompanyRSUs to key employees with an aggregate fair-value of $926 thousand. These awards vest over three years based upon achieving certain financial metrics achieved during fiscal 2021 for revenue and Adjusted EBITDA.
We did not grant any stock options during the for three and ninesix months ended SeptemberJune 30, 20192020 and 2018.2019.
The CompanyOn December 29, 2016, we entered into a 3-year, $5.03-year and $5.0 million revolving line of credit facility ("RLOC")and amended it on with Citizens Bank National Association (the Bank) on December 29, 2016“Bank") to fund general working capital needs and provide funding for acquisitions. OnWe amended this facility on May 11, 2018 GSE entered into anwith the Citizens Bank National Association (the “Bank") to fund general working capital needs and acquisitions. We amended this facility on Amended and Restated Credit and Security Agreement (the Credit Agreement) with“Credit Agreement" or the Bank, amending and restating“Credit Facility”) to (a) expand the Company's existing Credit and Security Agreement with the Bank, which included a $5.0 million asset-based revolving credit facility between the Company and the Bank, to now include (a) a $5.0$5.0 million revolving line of credit facilityto include a letter of credit sub-facility and not subject to a borrowing base including a letter of credit sub-facility,("the RLOC") and (b) to add a $25.0$25.0 million delayed draw term loan facility, available to be drawn upon for up to 18 months and to finance certain permitted acquisitions byover the Company.following 18 months. The credit facilities maturefacility is subject to certain financial covenants and reporting requirements, matures in five years on May 11, 2023 and bearbears interest at the one-month USD LIBOR, plus a margin that varies depending on theour overall leverage ratioratio. The RLOC has required monthly payments of the Company and its subsidiaries. Revolving loans are interest-onlyonly interest, with principal due at maturity, while our term loansloan draws require monthly payments of principal and interest, based on an amortization schedule. The Company'sWe are not required to maintain a restricted cash collateral account at Citizens Bank for the RLOC. Our obligations under the Credit Agreement are guaranteed by the Company's wholly owned subsidiaries. The credit facilities are secured by liens on all assets of the Company. Attendant to the Company's acquisition ofour wholly-owned subsidiaries Hyperspring, Absolute, True North, DP Engineering the Company and the Bank entered into a Third Amendment and Reaffirmation Agreement and a Fourth Amendment and Reaffirmation Agreement on February 15, 2019 and March 20, 2019, respectively. by any future material domestic subsidiaries (collectively, "the Guarantors").
On June 28, 2019, the Company and the Bankwe entered into athe Fifth Amendment and Reaffirmation Agreement, which changed theour fixed charge coverage ratio from 1.25 to four different ratios ranging from 1.05 to 1.25 among different time periods and changed the leverage ratio to: (i) 2.75 to 1.00 for the periodsperiod ending on June 30, 2019, September 30, 2019, December 31, 2019 and March 31, 2020; (ii) 2.50 to 1.00 for the periods ending June 30, 2020 and September 30, 2020; (iii) 2.25 to 1.00 for the periods ending December 31st,31st, March 31st,31st, June 30th30th and September 30th, thereafter.
RLOCOn January 8, 2020, due to an expected violation of our covenants, we entered into the Sixth Amendment and Reaffirmation Agreement and with an effective date of December 31, with our Bank to relax the fixed charge coverage ratio and leverage ratio and delay testing of both financial covenants. We agreed to an additional covenant, requiring us to maintain a consolidated Adjusted EBITDA target of $4.25 million, tested quarterly as of December 31, 2019, March 31, 2020 and June 30, 2020. Further, we agreed to maintain a minimum USA liquidity of at least $5.0 million in the aggregate, tested bi-weekly as of the fifteenth and the last day of each month, beginning on December 31, 2019 and until June 30, 2020. In addition to the revised covenants, we agreed to make accelerated principal payments of $3.0 million on January 6, 2020; $1.0 million on March 31, 2020; and $0.5 million on June 30, 2020.
On April 17, 2020, we entered into the Seventh Amendment and Reaffirmation Agreement and effective March 31, 2020, which requires us to maintain a minimum fixed charge coverage ratio of 1.25 to 1.00, tested quarterly as of the last day of each quarter, beginning with the quarter ending June 30, 2021. In addition, we agreed to not exceed a maximum leverage ratio, tested quarterly as of the last day of each quarter and beginning with the quarter ending September 30, 2020 as follows: (i) 3.00 to 1.00 for the period ending on September 30, 2020; (ii) 2.50 to 1.00 for the period ending on December 31, 2020; and (iii) 2.25 to 1.00 for the period ending on March 31, 2021 and for the periods ending December 31, March 31, June 30 and September 30, thereafter. We additionally agreed to make accelerated principal payments of $0.75 million on April 17, 2020 and $0.5 million on June 30, 2020.
We incurred $20 thousand of debt issuance costs and $50 thousand of debt amendment fees related to the sixth and seventh amendments to our Credit Agreement during the six months ended June 30, 2020.
Revolving Line of Credit (“RLOC”)
We intend to continue using the RLOC for short-term working capital needs and the issuance of letters of credit in connection with business operations. Letter of credit issuance fees range between 1.25% and 2%2.00% of the value of the letter of credit, depending on the Company’sour overall leverage ratio, and the Company paysratio. We pay an unused RLOC fee quarterly based on the average daily unused balance.
At SeptemberAs of June 30, 2019, there were no2020, we had outstanding borrowings of $3.5 million under the RLOC and four letters of credit totaling $1.2 million.$1.2 million outstanding to certain of our customers. The amount available at Septemberunder our RLOC as of June 30, 2019,2020, after consideration of letters of credit, was approximately $3.8$0.3 million.
We were in breach of our debt covenants as of June 30, 2020. The Bank may declare the obligations under the Credit Agreement to be immediately due and payable and may terminate the credit facilities.
Term Loan
As discussed in Note 4, we acquired DP Engineering on February 15, 2019 for approximately $13.5$13.5 million in cash. The purchase price was subject to customary pre- and post-closing working capital adjustments plus an additional earn-out amount not to exceed $5.0cash from proceeds of $14.3 million potentially payable in 2020 and 2021. We drew down $14.3 millionfrom a term loan with the Bank to finance the acquisition of DP Engineering.acquisition. The loan matures five years from the borrowing date and bears interest at the adjusted USD LIBOR, plus a margin ranging between 2%2.00% and 2.75% depending on theour overall leverage ratio of the Company and matures in five years.ratio. There were no debt issuance costs andor loan origination fees associated with the loan related for our acquisitionthis transaction.
As discussed in Note 4, we also acquired True North on May 11, 2018 for approximately $9.75 million in cash. The purchase price was subjectAdditionally, to customary pre and post-closing working capital adjustments. We drew down $10.3 million to financefund the acquisition of True North, $0.5we borrowed $10.3 million on May 11, 2018, $0.5 million of which was repaid to the Bank on the same day. The loan matures in five years from the borrowing date and bears interest at the adjusted one-month USD LIBOR, plus a margin ranging between 2%2.00% and 2.75% depending on theour overall leverage ratio of the Company and maturesratio. We incurred $0 in five years. We also incurred $70,000 debt issuance costs and $75,000$75 thousand of loan origination fees related to the Credit Agreement.this transaction. Debt issuance costs and loan origination fees are reported as a direct deduction from the carrying amount of the loan and are amortized over the term of the loan using the effective interest method.
Violation of minimum EBITDA debt covenantduring the three months ended June 30, 2020
The outstanding long-termAs discussed in Note 1, due to the violation of our Q2 minimum EBITDA covenant violation and our forecasted future debt under the delayed draw term loan facility wascovenant violations, we are in technical default of our credit agreement. While we work with our bank to resolve this issue, our debt has been classified as follows:current in our consolidated balance sheets as of June 30, 2020 and December 31, 2019.
| (in thousands) | | September 30, 2019 | | | December 31, 2018 | |
| Long-term debt, net of discount | | $ | 19,746 | | | $ | 8,512 | |
| Less: current portion of long-term debt | | | (4,778 | ) | | | 1,902 | |
| Long-term debt, less current portion | | $ | 14,968 | | | $ | 6,610 | |
The Credit Agreement contains customary covenants, as described above, and restrictions typical for a financing of this type, that, among other things, require the Company to satisfy certain financial covenants and restrict the Company'srestricts our ability to incur additional debt, pay dividends, and make distributions, make certain investments and acquisitions, repurchase itsour stock and prepay certain indebtedness, create liens, enter into agreements with affiliates, modify the nature of itsour business, enter into sale-leaseback transactions, transfer and sell material assets and merge or consolidate. Non-compliance with one or more of the covenants and restrictions after any applicable grace period could result in the obligations under the Credit Agreement becoming immediately due and payable and termination of the credit facilities. In addition to non-compliance with covenants and restrictions, the Credit Agreement also contains other customary events of default. If an event of default under the Credit Agreement occurs and is continuing, then the Bank may declare the obligations under the Credit Agreement to be immediately due and payable and may terminate the credit facilities. At September 30, 2019, the Company was in compliance with its financial covenants. See Note 1 going concern consideration regarding future covenant compliance.
Note 11 - Product Warranty
The Company accruesWe accrue for estimated warranty costs at the time the related revenue is recognized and based on historical experience and projected claims. The Company's SDBOur System Design and Build contracts generally provideinclude a one-yearone year base warranty on the systems. The portion of theour warranty provision expected to be incurred within 12 months is classified as current within accrued warranty and totals $1.2 million, while$952 thousand and the remaining $0.5 million$263 thousand is classified as long-term within other liabilities. The activity in the accrued warranty accounts during the current period is as follows:
| (in thousands) | | | |
| Balance, January 1, 2019 | | $ | 1,621 | |
| Current period provision | | | 185 | |
| Current period claims | | | (83 | ) |
| Currency adjustment | | | (7 | ) |
| Balance at September 30, 2019 | | $ | 1,716 | |
| (in thousands) | | | |
| Balance at January 1, 2020 | | $ | 1,323 | |
| Current period provision | | | 2 | |
| Current period claims | | | (112 | ) |
| Currency adjustment | | | 2 | |
| Balance at June 30, 2020 | | $ | 1,215 | |
We account for revenue in accordance with ASC 606, Revenue from Contracts with Customers, upon the adoption of ASU 2014-09, Revenue from Contracts with Customers, and all the related updates (collectively, the new revenue standard) on January 1, 2018, using the modified retrospective transition method.
Weprimarily generate revenue primarily through three broad distinct revenue streams: 1)(1) System Design and Build ("SDB"), 2)(2) Software and 3)(3) Training and Consulting Services.Services across our Performance and NITC segments. We recognize revenue from SDB and software contracts mainly through theour Performance Improvement Solutions segment and thesegment. We recognize training and consulting service contracts through both the Performance Improvement Solutions segment and Nuclear Industry Training and Consulting segment.segments.
The following table represents a disaggregation of revenue by type of goods or services for the three and ninesix months ended SeptemberJune 30, 20192020 and 2018,2019, along with the reportablereporting segment for each category:
(in thousands)
| | | Three months ended September 30, | | | Nine months ended September 30, | |
| | | 2019 | | | 2018 | | | 2019 | | | 2018 | |
| Performance Improvement Solutions segment | | | | | | | | | | | | |
| System Design and Build | | $ | 4,435 | | | $ | 5,109 | | | $ | 16,472 | | | $ | 19,904 | |
| Software | | | 786 | | | | 586 | | | | 2,170 | | | | 2,001 | |
| Training and Consulting Services | | | 6,196 | | | | 4,154 | | | | 17,975 | | | | 8,709 | |
| | | | | | | | | | | | | | | | | |
| Nuclear Industry Training and Consulting segment | | | | | | | | | | | | | | | | |
| Training and Consulting Services | | | 8,614 | | | | 11,952 | | | | 29,066 | | | | 38,780 | |
| | | | | | | | | | | | | | | | | |
| Total revenue | | $ | 20,031 | | | $ | 21,801 | | | $ | 65,683 | | | $ | 69,394 | |
| | Three months ended | | | Six months ended | |
| (in thousands) | | June 30, 2020 | | | June 30, 2019 | | | June 30, 2020 | | | June 30, 2019 | |
| Performance segment | | | | | | | | | | | | |
| SDB | | $ | 3,249 | | | $ | 5,595 | | | $ | 7,062 | | | $ | 12,037 | |
| Software | | | 723 | | | | 635 | | | | 1,633 | | | | 1,384 | |
| Training and consulting | | | 4,300 | | | | 6,780 | | | | 9,288 | | | | 11,779 | |
| | | | | | | | | | | | | | | | | |
| NITC segment | | | | | | | | | | | | | | | | |
| Training and consulting | | | 6,068 | | | | 10,448 | | | | 14,062 | | | | 20,452 | |
| | | | | | | | | | | | | | | | | |
| Total revenue | | $ | 14,340 | | | $ | 23,458 | | | $ | 32,045 | | | $ | 45,652 | |
SDB contracts are typically fixed-priced, and we receive payments based on a billing schedule as established in our contracts. The transaction price for software contracts isWe generally fixed. Fees for software are normally due in advance of or shortly after delivery ofhave two main performance obligations: (1) the software.training simulator build and (2) the Post Contract Support ("PCS") period. Fees for PCS are normally paid in advance of the related service period. For Training and Consulting Services, the customers are generally billed on a regular basis, such as weekly, biweekly or monthly, for services provided. Contract liability, which we classify as billing in excess of revenue earned, relates to payments received in advance of performance under the contract. Contract liabilities are recognized as revenue as performance obligations are satisfied.
The following table reflects the revenue recognized in the reporting periods that were included in the contract liabilities from contracts with customers:
(in thousands17)
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | | 2019 | | | 2018 | | | 2019 | | | 2018 | |
| Revenue recognized in the period from amounts included in Billings in Excess at the beginning of the period | | $ | 762 | | | $ | 1,980 | | | $ | 8,615 | | | $ | 9,934 | |
For an SDB contract, we generally have two main performance obligations: the training simulator build and post contract support ("PCS"). The training simulator build generally includes hardware, software and labor. We recognize revenue for the training simulator build revenue over the construction and installation period, using the cost-to-cost input method. In applying the cost-to-cost input method, we use the actual costs incurred to date, relative to the total estimated costs, to measure the work progress towardtowards the completion of the performance obligation and recognize revenue accordingly. Estimated contract costs are reviewed and revised periodically asduring the work progresses,contract period, and the cumulative effect of any change in estimates is recognized in the period in which the change is identified. Estimated losses are recognized in the period such losses are identified. Uncertainties inherent in the performance of contracts include labor availability and productivity, material costs, change order scope and pricing, software modification and customer acceptance issues. The reliability of these cost estimates is critical to 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.
ForThe transaction price for Software contracts is generally fixed, and we recognize revenue upon delivery of the three and nine months ended September 30, 2019,software, with fees due in advance or shortly after delivery of the Company recognized revenue of $0.7 million and $2.4 million related to performance obligations satisfied in previous periods, respectively.software.
As of September 30, 2019, the aggregate amount of transaction price allocated to the remaining performance obligations of SDB, softwareWe recognize Training and fixed-price training and consulting services contracts is $27.4 million. The Company will recognize theConsulting Services revenue as services are performed and bill our customers for services that we have provided on a regular basis (i.e. weekly, biweekly or monthly) and in time with revenue recognition.
Contract liability, which we classify as billing-in-excess of revenue earned, relates to payments received in advance of performance under the contract. Contract liabilities are recognized as revenue as performance obligations are satisfied, which is expected to occur over the next 12 months.satisfied.
The following table reflects revenue recognized in the reporting periods presented that was included in contract liabilities from contracts with customers as of the beginning of the periods presented:
(in thousands) | | Three months ended | | | Six months ended | |
| | | June 30, 2020 | | | June 30, 2019 | | | June 30, 2020 | | | June 30, 2019 | |
| Revenue recognized in the period from amounts included in Billings-in-Excess of Revenue Earned at the beginning of the period | | $ | 939 | | | $ | 2,813 | | | $ | 4,701 | | | $ | 7,853 | |
The following table presents the provision (benefit) for (benefit from) income taxes and theour effective tax rates:
| (in thousands) | | Three months ended September 30, | | | Nine months ended September 30, | | | Three months ended | | | Six months ended | |
| | | 2019 | | | 2018 | | | 2019 | | | 2018 | | | June 30, 2020 | | | June 30, 2019 | | | June 30, 2020 | | | June 30, 2019 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Provision (benefit) for income taxes | | $ | 568 | | | $ | 314 | | | $ | (874 | ) | | $ | 124 | | |
| Provision for (benefit from) income taxes | | | $ | 180 | | | $ | 406 | | | $ | 50 | | | $ | (1,442 | ) |
| Effective tax rate | | | (102.7 | )% | | | (153.9 | )% | | | 13.8 | % | | | (13.6 | )% | | | 9.1 | % | | | 213.7 | % | | | 0.6 | % | | | (24.2 | )% |
The Company'sOur income tax provision (benefit)benefit for the interim periods presented is determined using an estimate of itsour annual effective tax rate, adjusted for discrete items arising in that quarter. Total income tax expense for the ninesix months ended SeptemberJune 30, 2019 is2020 was comprised mainly of the tax impact of the loss on impairment, federal, foreign and state tax expense. Total income tax expense for the ninesix months ended SeptemberJune 30, 2018 is2019 was comprised mainly of the tax impact of the loss for impairment, federal, foreign and state tax expense.
Our income effective tax rates were (102.7)%rate was 9.1% and 13.8%0.6% for the three and ninesix months ended SeptemberJune 30, 2019,2020, respectively. For the three months ended SeptemberJune 30, 2019,2020, the difference between our income tax expense at an effective tax rate of (102.7)%9.1% and a benefit at the U.S. statutory federal income tax rate of 21% was primarily due to accruals related to uncertain tax positions for certain U.S. and foreign tax contingencies, a change in tax valuation allowance in our US and China subsidiaries and discrete item adjustments for U.S. and foreign taxes. For the six months ended June 30, 2020, the difference between income tax expense at an effective tax rate of 0.6% and a benefit at the U.S. statutory federal income tax rate of 21% was primarily due to permanent differences, accruals related to uncertain tax positions for certain U.S. and foreign tax contingencies, a change in tax valuation allowance in our US and China subsidiary,subsidiaries, discrete item adjustments for the U.S. and foreign taxes the excess book deduction related to stock options and restricted stock units that were exercised or vested during the quarter, and the impact of the loss on impairment. For the nine months ended September 30, 2019, the difference between the effective tax rate of 13.8% and the U.S. statutory federal income tax rate of 21% was primarily due to permanent differences, accruals related to uncertain tax positions for certain foreign tax contingencies, and discrete item adjustments, including the tax impact of the loss onfor impairment.
Because of itsour net operating loss carryforwards, the Company iswe are subject to U.S. federal and state income tax examinations from the year 2000 and forward. The Company isWe are subject to foreign tax examinations by tax authorities for years 20112014 and forward forin Sweden, 2015 and forward forin China, 2015 and forward forin India and 2016 and forward forin the UK.United Kingdom.
An uncertain tax position taken or expected to be taken in a tax return is recognized in the consolidated financial statements when it is more likely than not (i.e., a likelihood of more than 50%) that the position would be sustained upon examination by tax authorities that have full knowledge of all relevant information. A recognized tax position is then measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. Interest and penalties related to income taxes are accounted for as income tax expense.
The Company recognizesWe recognize deferred tax assets to the extent that it is believed that these assets are more likely than not to be realized. The Company hasWe have evaluated all positive and negative evidence and determined that it will continue to assess a full valuation allowance on its India,U.S., Swedish U.K., Chinese and U.K.Slovakian net deferred assets as of SeptemberJune 30, 2019. The Company has2020. We have determined that it will continue to assess a valuation allowance on its China deferred tax asset related to transfer pricing. The Company has determined that it is not more likely than not that itthe Company will realize the benefits of its deferred taxes in the U.S. Refer to Note 1 – Going Concern Considerations which highlights possible events which could negatively impact the realization of deferred tax assets.
U.S and foreign jurisdictions.
Note 14 - Leases
We maintain leases of office facilities and equipment. Leases generally have remaining terms of one year to six years,three, whereas leases with an initial term of twelve months or less are not recordedrecognized on the Consolidated Balance Sheets. The Company recognizesour consolidated balance sheet. We recognize lease expense for minimum lease payments on a straight-line basis over the term of the lease. Certain leases include options to renew or terminate. Renewal options are exercisable per thebased upon our discretion of the Company and vary based on the nature of each lease, with renewal periods generally ranging from one year to five years.years. The term of the lease includes renewal periods, only if the Company iswe are reasonably certain that itwe will exercise the renewal option. When determining if a renewal option is reasonably certain of being exercised, the Company considerswe consider several factors, including but not limited to, the cost of moving to another location, the cost of disruption to our operations, whether the purpose or location of the leased asset is unique and the contractual terms associated with extending the lease.
Upon the adoption of the new lease standard ASU 2016-02, on January 1, 2019, the Company elected the package of practical expedients permitted under the transition guidance within the amended guidance, which among other things, allowed registrants to carry forward historical lease classification. Accordingly, all existing leases that were classified as operating leases by the Company historically, were classified as operating leases.
Operating lease ROURight-of-Use ("ROU") assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. The operating lease ROU assets represent the lease liability, plus any lease payments made at or before the commencement date, less any lease incentives received. The Company'sOur real estate leases, which are comprised primarily of office spaces, represent a majority of theour remaining lease liability. The majority of our lease payments are fixed, although an immaterial portion of payments are variable in nature. Variable lease payments vary based on changes in facts and circumstances related to the use of the ROU and are recorded as incurred. The Company usesWe use an incremental borrowing rate based on rates available at commencement in determining the present value of future payments.
The Company hasWe have lease agreements with lease and non-lease components, which are accounted for as a single lease component. The Company applieslease. We apply a portfolio approach to effectively account for the operating lease ROU assets and liabilities.
Lease contracts are evaluated at inception to determine whether they contain a lease where the Company obtainsand whether we obtain the right to control an identified asset. The following table summarizes the classification of operating ROU assets and lease liabilities on the consolidated balance sheets (in thousands):
| | | | As of |
| Operating Leases | Classification | | September 30, 2019 | | | Classification | | June 30, 2020 | | December 31, 2019 |
| | | | | | | | |
| Leased Assets | | | | | | | | | | |
| Operating lease - right of use assets | Long term assets | | $ | 3,720 | | | Long term assets | $ | 1,839 | $ | 2,215 |
| | | | | | | | | | | | |
| Lease Liabilities | | | | | | | | | | | |
| Operating lease liabilities - Current | Other current liabilities | | | 1,024 | | |
| Operating lease liabilities - current | | | Other current liabilities | | 1,121 | | 1,153 |
| Operating lease liabilities | Long term liabilities | | | 3,121 | | | Long term liabilities | | 2,405 | | 3,000 |
| | | | $ | 4,146 | | | | $ | 3,526 | $ | 4,153 |
The CompanyWe executed a sublease agreement with a tenant to rent out sublease 3,650 square feet from the lease at itsoffice space in Sykesville office on May 1, 2019.2019. This agreement is in addition to the 3,822 of square feet previously subleased, which was entered into on April 1, 2017.2017. The sublease does not relieve the Companyus of itsour primary lease obligation. The lessor agreements are both considered operating leases, maintaining the historical classification of the underlying lease. The Company doesWe do not recognize any underlying assets for the subleases as a lessor of operating leases. The net amount received from the sublease is recorded within selling, general and administrative expenses.
The table below summarizes the lease income and expenses recorded in the consolidated statements of operations incurred during the three and ninesix months ended SeptemberJune 30, 2020 and 2019, (in thousands):
| | | | | Six months ended | |
| Lease Cost | Classification | | Three Months Ended September 30, 2019 | | | Nine Months Ended September 30, 2019 | | Classification | | June 30, 2020 | | | June 30, 2019 | |
| | | | | | | | |
Operating lease cost (1) | Selling, general and administrative expenses | | $ | 307 | | | $ | 852 | | Selling, general and administrative expenses | | $ | 418 | | | $ | 545 | |
Short-term leases costs (2) | Selling, general and administrative expenses | | | 46 | | | | 119 | | Selling, general and administrative expenses | | | 1 | | | | 73 | |
Sublease income (3) | Selling, general and administrative expenses | | | (43 | ) | | | (75 | ) | Selling, general and administrative expenses | | | (64 | ) | | | (32 | ) |
| Net lease cost | | | $ | 310 | | | $ | 896 | | | | $ | 355 | | | $ | 586 | |
(1) Includes variable lease costs which are immaterial.
(2) IncludeIncludes leases maturing less than twelve months from the report date.
(3) Sublease portfolio consists of 2two tenants, which sublease parts of our principal executive office located at 1332 Londontown Blvd, Suite 200, Sykesville, MD.
The future minimum lease payments under non-cancellable operating leases are reflected below. This table also reflects the reconciliation of the undiscounted cash flows to the discounted operating lease liabilities as recognized at SeptemberJune 30, 20192020 in our consolidated balance sheetssheet (in thousands):
| | | Operating Leases | | | Operating Leases | |
| 2019 | | $ | 305 | | |
| 2020 | | | 1,199 | | | $ | 647 | |
| 2021 | | | 1,181 | | | | 1,255 | |
| 2022 | | | 1,156 | | | | 1,166 | |
| 2023 | | | 622 | | | | 631 | |
| After 2023 | | | 107 | | |
| 2024 | | | | 116 | |
| and thereafter | | | | - | |
| Total lease payments | | $ | 4,570 | | |
| 3,815 | |
| Less: Interest | | | 424 | | | | 289 | |
| Present value of lease payments | | $ | 4,146 | | | $ | 3,526 | |
The Company hasWe calculated the weighted-average remaining lease term, presented in years below and the weighted-average discount rate for our operating leases. As noted in our lease accounting policy, the Company useswe use the incremental borrowing rate as the lease discount rate.
Lease Term and Discount Rate | | Nine Months Ended September 30, 2019 | |
Weighted-average remaining lease term (years) | | | |
Operating leases | | | 4.00 | |
Weighted-average discount rate | | | | |
Operating leases | | | 5 | % |
| Lease Term and Discount Rate | | June 30, 2020 | | December 31, 2019 |
| Weighted-average remaining lease term (years) | | | | |
| Operating leases | | 3.11 | | 3.51 |
| Weighted-average discount rate | | | | |
| Operating leases | | 5.00% | | 5.00% |
The table below sets out the classification of lease payments in the consolidated statement of cash flows. The right-of-use assets obtained in exchange for operating lease liabilities represent new operating leases obtained through our business combination during the nine months ended September 30, 2019.
| (in thousands) | | Six months ended | |
| Other Information | | June 30, 2020 | | | June 30, 2019 | |
| | | | | | | |
| Operating cash flows used in operating leases | | $ | 675 | | | $ | 567 | |
| Cash paid for amounts included in measurement of liabilities | | | 675 | | | | 567 | |
(in thousands)
| Other Information | | Nine Months Ended September 30, 2019 | |
| - Operating cash flows used in operating leases | | $ | 893 | |
| Cash paid for amounts included in measurement of liabilities | | | 893 | |
| | | | | |
| Right-of-use assets obtained in exchange for new operating liabilities | | $ | 1,777 | |
Note 15 - Segment Information
The Company has We have two reportable business segments. TheOur Performance segment provides simulation, training and engineering products and services delivered across the breadth of industries we serve. Solutions include simulationThe Performance segment provides simulations for both training and engineering applications. ExampleExamples of engineering services include, but are not limited to, plant design verification and validation, thermal performance evaluation and optimization programs and engineering programs for plants for the ASME "(American Society of Mechanical Engineers") code and ASME Section XI. The Company providesWe provide these services through GSE, True North and DP Engineering across all market segments. ExampleExamples of training applications include turnkey and custom training services. Contractservices, and our contract terms are typically less than two years.years.
The NITC segment provides specialized workforce solutions primarily to the nuclear industry, working primarily at our clients' facilities. This business is managed through our Hyperspring and Absolute subsidiaries. The business model, management focus, margins and other factors clearly separate this business line from the rest of the GSE productour products and service portfolio.
On February 15, 2019, through our wholly-owned subsidiary GSE Performance Solutions, Inc., the Company entered into the DP Engineering Purchase Agreement, to purchase 100% of the membership interests in DP Engineering. DP Engineering is a provider of value-added technical engineering solutions and consulting services to nuclear power plants with an emphasis on preparation and implementation of design modifications during plant outages. For reporting purposes, DP Engineering is included in our Performance segment due to similarities in services provided including engineering solutions and implementation of design modifications to the nuclear power sector.
On May 11, 2018, GSE, through our wholly-owned subsidiary GSE Performance Solutions, Inc., entered into the True North Purchase Agreement to purchase 100% of the membership interests in True North. True North is a provider of technical engineering solutions to nuclear and fossil fuel power plants with an emphasis on regulatory-driven ASME code programs. The acquisition of True North is expected to broaden our engineering services offering, expand our relationships with several of the largest nuclear energy providers in the United States, and add a highly specialized, complimentary talent pool to our employee base. For reporting purposes, True North is included in our Performance segment due to similarities in services provided including technical engineering solutions to the nuclear and fossil fuel power sector.
Due to the impairment described in Note 8 related to DP Engineering, we recognized charges totaling $5.5 million related to the impairment of certain definite-lived intangible assets and goodwill in our Performance segment.
Our primary measure of segment performance, as shown in the table below, excludedexcludes the loss on impairment of intangible assets and goodwill, the provision for loss on legal settlement (see Note 16) and the change in fair value of contingent consideration, net related to the DP Engineering acquisition in fiscal 2019, which we do not believe are representative ofaccurately represent the ongoing operations of the Performance segment. Excludingour operating segments. Management believes that excluding these discrete items from ourthe segment measure of performance allows for better period over period comparison.
The following table sets forth the revenue and operating results attributable to each reportable segment and includes a reconciliation of segment revenue to consolidated revenue and operating results to consolidated income before income taxes. Inter-segment revenue is eliminated in consolidation and is not significant:
(in thousands) | | Three months ended September 30, | | | Nine months ended September 30, | |
| | | 2019 | | | 2018 | | | 2019 | | | 2018 | |
| | | | | | | | | | | | | |
| Revenue: | | | | | | | | | | | | |
| Performance Improvement Solutions | | $ | 11,417 | | | $ | 9,849 | | | $ | 36,617 | | | $ | 30,614 | |
| Nuclear Industry Training and Consulting | | | 8,614 | | | | 11,952 | | | | 29,066 | | | | 38,780 | |
| | | | 20,031 | | | | 21,801 | | | | 65,683 | | | | 69,394 | |
| | | | | | | | | | | | | | | | | |
| Operating income (loss): | | | | | | | | | | | | | | | | |
| Performance Improvement Solutions | | | 77 | | | | 494 | | | | 285 | | | | 110 | |
| Nuclear Industry Training and Consulting | | | (340 | ) | | | (520 | ) | | | (1,558 | ) | | | (584 | ) |
| Loss on impairment | �� | | - | | | | - | | | | (5,464 | ) | | | - | |
| Change in fair value of contingent consideration, net | | | - | | | | - | | | | 1,200 | | | | - | |
| | | | | | | | | | | | | | | | | |
| Operating loss | | | (263 | ) | | | (26 | ) | | | (5,537 | ) | | | (474 | ) |
| | | | | | | | | | | | | | | | | |
| Interest (expense), net | | | (288 | ) | | | (114 | ) | | | (812 | ) | | | (153 | ) |
| Loss on derivative instruments, net | | | (61 | ) | | | (59 | ) | | | (69 | ) | | | (306 | ) |
| Other income (expense), net | | | 59 | | | | (5 | ) | | | 62 | | | | 24 | |
| Loss before income taxes | | $ | (553 | ) | | $ | (204 | ) | | $ | (6,356 | ) | | $ | (909 | ) |
| | Three months ended | | | Six months ended | |
| (in thousands) | | June 30, 2020 | | | June 30, 2019 | | | June 30, 2020 | | | June 30, 2019 | |
| | | | | | | | | | | | | |
| Revenue: | | | | | | | | | | | | |
| Performance | | $ | 8,273 | | | $ | 13,010 | | | $ | 17,984 | | | $ | 25,200 | |
| NITC | | | 6,067 | | | | 10,448 | | | | 14,061 | | | | 20,452 | |
| Total revenue | | | 14,340 | | | | 23,458 | | | | 32,045 | | | | 45,652 | |
| | | | | | | | | | | | | | | | | |
| Operating (loss) income: | | | | | | | | | | | | | | | | |
| Performance | | | (695 | ) | | | 919 | | | | (1,967 | ) | | | 56 | |
| NITC | | | (297 | ) | | | (293 | ) | | | (856 | ) | | | (1,218 | ) |
| Provision for legal settlement | | | (861 | ) | | | - | | | | (861 | ) | | | - | |
| Loss on impairment | | | - | | | | - | | | | (4,302 | ) | | | (5,464 | ) |
| Change in fair value of contingent consideration, net | | | - | | | | - | | | | - | | | | 1,200 | |
| | | | | | | | | | | | | | | | | |
| Operating (loss) income | | | (1,853 | ) | | | 626 | | | | (7,986 | ) | | | (5,426 | ) |
| | | | | | | | | | | | | | | | | |
| Interest expense, net | | | (187 | ) | | | (316 | ) | | | (428 | ) | | | (524 | ) |
| Gain (loss) on derivative instruments, net | | | 47 | | | | (101 | ) | | | 4 | | | | (8 | ) |
| Other income (expense), net | | | 24 | | | | (19 | ) | | | 53 | | | | 3 | |
| (Loss) income before income taxes | | $ | (1,969 | ) | | $ | 190 | | | $ | (8,357 | ) | | $ | (5,955 | ) |
18. Non-consolidated Variable Interest Entity
The Company, through its wholly owned subsidiary DP Engineering, effectively holds a 48% membership interest in DP-NXA Consultants LLC ("DP-NXA").
DP-NXA was established to provide industrial services that include civil, structural, architectural, electrical, fire protection, plumbing, mechanical consulting engineering services to customers. DP-NXA sub-contracts their work to its two owners, NXA Consultants LLC ("NXA"), which owns 52% of the entity,Note 16 - Commitments and DP Engineering. DP Engineering and NXA contributed $48 and $52, respectively, for 48% and 52% interest in DP-NXA. DP Engineering recorded the contributed cash as an equity investment.
The Company evaluated the nature of DP Engineering's investment in DP-NXA and determined that DP-NXA is a variable interest entity (“VIE”). Since the Company does not have the power to direct activities that most significantly impact DP-NXA, it cannot be DP-NXA’s primary beneficiary. Furthermore, the Company concluded that it did not hold a controlling financial interest in DP-NXA since NXA, the VIE's majority owner, makes all operation and business decisions. The Company accounts for its investment in DP-NXA using the equity method of accounting due to the fact the Company exerts significant influence with its 48% of membership interest, but does not control the financial and operating decisions.
The Company's maximum exposure to any losses incurred by DP-NXA is limited to its investment. As of September 30, 2019, the Company has not made any additional contributions to DP-NXA and believes its maximum exposure to any losses incurred by DP-NXA was not material. As of September 30, 2019, the Company does not have existing guarantee with or to DP-NXA, or any third-party work contracted with it.
For the three and nine months ended September 30, 2019, the carrying value of the investment in DP-NXA is zero. We do not have any investment income or loss from DP-NXA for the three and nine months ended September 30, 2019.
The following table presents the carrying amount and classification of the assets related to the Company’s variable interests in non-consolidated VIE and the maximum exposure to loss at September 30, 2019.
(In thousands) | | September 30, 2019 | |
| Assets | | | |
| Cash: | | | |
| Checking account | | $ | 254 | |
| Total assets | | $ | 254 | |
| Liabilities | | | | |
| Credit card and other payables | | | 254 | |
| Total liabilities | | | 254 | |
| Total net assets | | $ | - | |
| Maximum exposure to loss | | $ | - | |
19 | Commitments and Contingencies |
ContingenciesJoyce v. Absolute Consulting, Inc.
On March 29, 2019, a former employee of Absolute Consulting, Inc., filed a putative class action against Absolute and the Company,us, Joyce v. Absolute Consulting Inc.Inc., case number 1:19 cv 00868 RDB, in the United States District Court for the District of Maryland. The lawsuit alleges that plaintiff wasand certain other employees were not properly compensated for overtime hours that hethey worked. The Company andhas been dismissed from the case, but Absolute intendintends to vigorously defend this litigation.litigation with the Company’s assistance and support. Absolute has entered into a settlement agreement as of August 17, 2020 and, pending court approval, anticipates the probable conclusion of this matter to be dismissal of the case in exchange for Absolute’s payment of a settlement amount and fees totaling $861 thousand. The Company is unablehas provisioned for this amount in its financial statements for the period ended June 30, 2020. Certain terms of the settlement agreement would require Absolute to concludepay up to $639 thousand in additional claims that the likelihood of an unfavorable outcome inmay be asserted, for a total potential liability not to exceed $1.5 million, however no other claims are known at this matter is remote or probable, but the Company andtime. Absolute continuecontinues to deny the allegations and defend the case. LegalThe Company has asserted an indemnification claim related to this litigation against the sellers of Absolute, which holds approximately a $1 million escrow balance.
Per ASC 450 Accounting for Contingencies, we review potential items and areas where a loss contingency could arise. In the opinion of management, we are not a party to any legal proceeding, the outcome of which, in management's opinion, individually or in the aggregate, would have a material effect on our consolidated results of operations, financial position or cash flows, other than as noted above. We expense legal defense costs are expensed as incurred.
Note 17 - Subsequent Events
See Note 10 - Debt and Note 16 - Commitments and Contingencies for details of subsequent events.
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
GSE is a leading provider of professional and technical engineering, staffing services, and simulation software to clients in the power and process industries. We provide customers with simulation, engineering and plant services that help clients reduce risks associated with operating their plants, increase revenue through improved plant and employee performance, and lower costs through improved operational efficiency. In addition, we provide professional services that systematically help clients fill key vacancies in the organization on a short-term basis, primarily in procedures, engineering, technical support, and training focused on regulatory compliance and certification in the nuclear power industry. Our operations also include interactive computer-based tutorials and simulation software for the refining, chemical, and petrochemical industries.
On February 15, 2019, GSE acquired DP Engineering for $13.5 million (subject to pre- and post-closing working capital adjustments). DP Engineering is a provider of value-added technical engineering solutions and consulting services to nuclear power plants with an emphasis on preparation and implementation of design modifications during plant outages. The Company's allocation of the purchase price remains incomplete and the net assets are subject to adjustments within the measurement period, which is not to exceed one year from the acquisition date. For reporting purposes, DP Engineering is included in our Performance segment due to similarities in services provided including engineering solutions and implementation of design modifications to the nuclear power sector.
Approximately one week following our acquisition of DP Engineering, an adverse event occurred at one of DP Engineering’s major customer's location that affected plant operations. In its initial analysis of the causes of that event, the customer identified a prior plant modification by DP Engineering as meriting further analysis. As is customary in the industry, pursuant to an Engineer of Choice agreement, the customer issued DP Engineering a Notice of Suspension while a root cause analysis was completed. We completed our root cause analysis and presented it to the customer on April 25, 2019. Following the initial analysis, the customer had DP Engineering restart all existing work with the Company, however, the customer also informed DP Engineering that it was suspended from bidding new contracts. This incident adversely impacted the relationship between DP Engineering and its customer. As a result, DP Engineering experienced a significant decline in new orders from this customer and was not able or permitted to bid on new work. The Company determined this represented a triggering event requiring an interim assessment for impairment. As a result of the impairment analysis, we recognized the impairment charges of $2.1 million on goodwill and $3.4 million on definite-lived intangible assets related to the acquisition of DP Engineering during the quarter ended March 31, 2019. On August 6, 2019, as a follow on to the Notice of Suspension, the Company received a Notice of Termination from this customer, notifying the Company that they were terminating their Engineer of Choice consulting service agreement with DP Engineering. Accordingly, DP Engineering is completing work under any open Contract Orders in accordance with the terms of the respective Contract Orders and the Agreement, which shall be deemed to remain in effect for purposes only of completing any such Contract Orders. Upon notice of termination from the customer, management has been assessing the impact of this customer loss on DP Engineering and the likelihood of additional impairment that would be recognized against goodwill and intangible assets. Due to the recentness of this acquisition, we have not finalized the allocation of our purchase price to the tangible and intangible assets of DP Engineering we purchased. As such, we may need to record additional expense once the purchase price allocation is final.
Cautionary Statement Regarding Forward-Looking Statements
This report and the documents incorporated by reference herein contain "forward-looking" statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended (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 reflecting 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. These forward-looking statements may also use different phrases. These statements regarding our expectations reflect our current beliefs and are based on information currently available to us. Accordingly, these statements by their nature are subject to risks and 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 differ from those expressed in, or implied by, these forward-looking statements. We 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 and the failure of such other assumptions to be realized, as well as other factors, may also cause actual results to differ materially from those projected. Most of these factors are difficult to predict accurately and are generally beyond our control. You should consider the areas of risk described in Item 1A - Risk Factors in our most recent annual report on Form 10-K in connection with any forward-looking statements that may be made by us. You should not place undue reliance on any forward-looking statements. New factors emerge from time to time, and it is not possible for us to predict which factors will arise.
We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any additional disclosures we make in proxy statements, quarterly reports on Form 10-Q and current reports on Form 8-K filed with the SEC.
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
GSE is a leading provider of professional and technical engineering, staffing services and simulation software to clients in the power and process industries. We provide customers with simulation, engineering and plant services that help clients reduce risks associated with operating their plants, increase revenue through improved plant and employee performance, and lower costs through improved operational efficiency. In addition, we provide professional services that systematically help clients fill key vacancies in the organization on a short-term basis, primarily in procedures, engineering, technical support and training focused on regulatory compliance and certification in the nuclear power industry. Our operations also include interactive computer-based tutorials and simulation software for the refining, chemical, and petrochemical industries.
In December 2019, a novel strain of coronavirus, the COVID-19 virus, was reported in Wuhan, China. On March 11, 2020, the WHO declared the COVID-19 virus a global pandemic and on March 13, 2020, President Donald J. Trump declared the virus a national emergency in the United States. As of the date of this report, both the health and economic aspects of the COVID-19 virus are highly fluid and the future course of each is uncertain. As such, the ultimate impact the pandemic will have on the Company’s financial condition, liquidity and future results of operations is highly uncertain and subject to change. Management is actively monitoring the situation on its financial condition, liquidity, operations, industry, supplies and workforce. The Company's operating results for the six months ended June 30, 2020 have been impacted by the COVID-19 pandemic, and we expect the financial results for the remainder of fiscal year 2020 will be negatively affected as a result of the pandemic.
During the six months ended June 30, 2020, we determined that the COVID-19 virus was an indicator of a triggering event that could result in an impairment of our assets. Based upon this assessment, we performed an interim analysis of our individual asset groupings at the subsidiary level and concluded that the carrying value of the assets of DP Engineering exceeded its fair value. We used an undiscounted cash flow analysis to test for impairment and calculated that the carrying value exceeded the fair value of the DP Engineering definite-lived intangible assets by $4.3 million and recorded an impairment for this amount as of March 31, 2020.
On April 24, 2020, we received funds under the Paycheck Protection Program, a part of the CARES Act. The loan is serviced by Citizen’s Bank, and the application for these funds required us to, in good faith, certify that the current economic uncertainty made the loan necessary to support our ongoing operations. We plan to use the funds for payroll and related costs, rent, utilities and other debt obligations incurred before February 15, 2020. The receipt of these funds, and the forgiveness of the PPP Loan attendant to these funds, is dependent on our ability to adhere to the forgiveness criteria. The PPP Loan bears interest at a rate of 1% per annum and matures on April 24, 2022, with the first payment deferred until August 9, 2021. Under the terms of the PPP Loan, certain amounts may be forgiven if they are used in accordance with the CARES Act. As of the period end, we have maintained compliance with all of the requirements to obtain forgiveness of the full amount of the PPP Loan. We believe that our use of the proceeds and other conditions consistent with the requirements for forgiveness have been met but are unable to determine the amount that may be ultimately forgiven.
General Business Environment
We operate through two reportable business segments: Performance Improvement Solutions and Nuclear Industry Training and Consulting.NITC. 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, corporate development, information systems and other administrative services are organized at the corporate level. Business development and sales resources are generally aligned with each segment to support existing customer accounts and new customer development. The business units collaborate to facilitate cross-selling and the development of new solutions. The following is a description of our business segments:
Performance Improvement Solutions (approximately 56% of revenue at SeptemberJune 30, 2019 2020)
Our Performance segment primarily encompasses our power plant high-fidelity simulation solutions, engineering services for ASME programs, thermal performance optimization and plan design modifications 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, as well as natural adjacencies in the process industries. Our simulation solutions include the following: (1) simulation software and services, including operator training systems, for the nuclear power industry, (2) simulation software and services, including operator training systems, for the fossil power industry, and (3) simulation software and services for the process industries used to teach fundamental industry processes and control systems to newly hired employees and for ongoing workforce development and training. GSE and its predecessors have been providing these services since 1976.
Our engineering solutions include the following: (1) in-service testing for engineering programs focused on ASME OM code including Appendix J, balance of plant programs, and thermal performance; (2) in-service inspection for specialty engineering including ASMEAmerican Society of Mechanical Engineers (“ASME”) Section XI; (3) software solutions; and (4) mechanical design, civil/structural design, electrical, instrumentation and controls design, digital controls/cyber security and fire protection for nuclear power plant design modifications. Our True North and DP Engineering businesses typically work as either the engineer of choice or specialty engineer of choice for our clients under master services agreements. GSE and its predecessors have been providing these engineering solutions and services since 1995.
On February 15, 2019, through its wholly-ownedwholly owned subsidiary GSE Performance Solutions, Inc., the Company entered into the DP Engineering Purchase Agreement, to purchase 100% of the membership interests in DP Engineering. For reporting purposes, DP Engineering is included in our Performance segment due to similarities in services provided including engineering solutions and implementation of design modifications to the nuclear power sector.
On May 11, 2018, GSE, through GSE Performance Solutions, Inc., entered into the True North Purchase Agreement to purchase 100% of the membership interests in True North. For reporting purposes, True North is included in our Performance Improvement Solutions segment due to similarities in services provided including technical engineering solutions to the nuclear and fossil fuel power sector.
Nuclear Industry Training and Consulting (approximately 44% of revenue at SeptemberJune 30, 2019)2020)
Nuclear Industry Training and ConsultingNITC provides highly specialized, expert-professionals 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, project managers, work management specialists, planners and training material developers. This business is managed through the Hyperspring and Absolute subsidiaries. The business model, management focus, margins and other factors clearly separate the business line from the rest of the Company's product and service portfolio. GSE and its predecessors have been providing these training and consulting services since 1997.
Business Strategy
Our objective has been to create a leading specialty engineering, expert staffing and technology delivery platform focused primarily on the nuclear power industry. We offer our differentiated suite of products and services to adjacent markets such as the defense industry, the fossil power and process industries where our offerings are a natural fit, delivering a clear and compelling value proposition to the market. Our primary growth strategy had beenwas twofold: (1) seek acquisitions to accelerate our overall growth in a manner that is complementary to our core business and (2) expand organically within our core markets by leveraging our market leadership position and drive increased usage and product adoption via new products and services. To accomplish this objective, we
Due to recent developments in fiscal 2020 and the impact of the COVID-19 pandemic, management has changed its business strategy and will pursue the following activities:
Strategic pause in ourits executed roll-up acquisition strategy. We
Over the past few years we have complemented our organic growth strategy throughwith selective acquisitions including, but not limited to, the following: engineering; training, staffing and consulting service businesses for the power industry, with a particular focus on nuclear power; and software utilized in the power industry, both domestic and international. We deliberately had focused our acquisition efforts toon opportunities that would enhance our 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. WeFollowing this strategy, we have made three acquisitions since 2017 and2017. Although we believe the opportunity existsopportunities still exist to acquire more businesses that arewould be complementary to ours, allowing us to accelerate our growth strategy. Givengiven our current desire to focus on cross selling and upselling across our existing business portfolio and the current impact of the COVID-19 pandemic on our business, we have paused our acquisition of tuck-ins is on pause. We will focusstrategy. Our current efforts are focused on organic growth across the portfolio and leveragewhile utilizing free cash flow to pay down debt associated with our acquisition line of credit with our bank.delayed-draw term loan facility. While our roll-up acquisition strategy is on pause, the company remainswe remain open to transformational opportunities that may present themselves.
Summary of recent acquisitions: acquisitions, prior to pause in company acquisitions
In February 2019, we acquired DP Engineering, a specialized provider of high-value engineering services and solutions to the nuclear power industry. In May 2018, we acquired True North, a leading provider of specialty engineering solutions to the nuclear power industry, and in September 2017, we acquired Absolute, a provider of technical consulting and staffing solutions to the global nuclear power industry. The acquisitions of Absolute, True North, and DP Engineering are expected to strengthen the Company's global leadershipcollectively enhanced our unique capabilities in the nuclear services area. The acquisitions have added new capabilities to the GSE solution offering and bring new highly complementary customers to GSE, while at the same time deepening GSE relationships with existing clients. These acquisitions together with our earlier acquisition of Hyperspring in November 2014, are a significant proof point of the thesis that GSE is a compelling platform for consolidating a fragmented vendor ecosystem for nuclear power. We believe the acquisitions addhave added scale and focus to the business, while positioning GSE as a "go to"“go to” provider of technical and consulting solutions to the power industry, in particularparticularly nuclear power. We feel that now is a goodthe time to focus on organic growth opportunities through cross selling and upselling GSE’s full range of products and services to the industry.
Expand our total addressable market.market
Our focus on organic growth means introducingenhancing our product capabilities or new product and introduce new service 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 of our business segments that may include, but are not be limited to, the following: expanding our software product portfolio to include 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 flowworkflow process improvement solutions; tailoring operational reporting and business intelligence solutions to address the unique need of our end user markets; and adding new services to broaden our market reach. To reiterate,With the current focuspause of theseour roll-up acquisition strategy, our current expansion efforts are primarily organic in nature.
We are unique among engineering firms in the nuclear market in ability to serve the entire lifecycle of a plant through a combination of expert service not found in other engineers of choice. We offer clients the ability to perform the upfront engineering design, address and optimize regulatory compliance, optimize designs through simulation assisted engineering and provide all temporary professional staffing needed for a wide variety of specialized engineering projects.
Initiatives such as these will broaden our scope and enable us to engage more deeply with the segments we serve and to address the needs of customers in adjacent segments. We have delivered a compelling solution, the GSE GPWRTM Generic Pressurized Water Reactor(“GPWR”) simulation technology, proving that our modeling technology can be sold in generic form 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 including launching a new cloud-based training platform, EnVision™ Learning On-Demand, that significantly extends the capabilities of its industry leading EnVision™ tutorials and simulations. We continue to provide cutting edge training systems by adapting our technology to systems that meet the specific needs of customers such as U.S. government laboratories.
Research and development (R&D).
We invest in R&D 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®DesignEP® and RELAP5-HD®RELAP5-HD® solutions. Our entire JADETMJADETM suite of simulation software, including industry leading JTOPMERET®JTOPMERET® and JElectricTMJElectricTM software, provides the most accurate simulation of Balance-of-Plantbalance of plant and electrical systems available to the nuclear and fossil plant simulation market. The significant enhancements we have made to our SimExec®SimExec® and OpenSimTMOpenSimTM platforms enables customers to be more efficient in the daily operation of their simulators. We are bringing SimExec® SimExec® and OpenSimTM 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 pragmatic and measured investments in R&D that first and foremost are driven by the market and complement our growth strategy. Such investments in R&D may result in on-going enhancement of existing solutions as well as the creation of new solutions to serve our target markets, ensuring that we add greater value that is easier to use, at lower total cost of ownership than any alternative available to customers. GSE has pioneered a number of industry standards and intends to continue to be one of the most innovative companies in our industry.
Strengthen and develop our talent while delivering high-quality solutions.
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 and deepen 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. We have developed a strong reputation for quality services based upon our industry-recognized depth of experience, ability to attract and retain quality professionals, and exceptional expertise across multiple service sectors. We have received numerous industry certificates and awards over the years for outstanding service.
Employees. Employees
As of SeptemberJune 30, 2019,2020, we had approximately 411300 employees, which includes approximately 219185 employees in our Performance Improvement segment and approximately 192115 employees in our Nuclear Industry Training and ConsultingNITC segment. 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. Backlog
As of SeptemberJune 30, 2019,2020, we had approximately $53.7$46.6 million of total gross revenue backlog, which included $37.8$31.2 million of Performance Improvement Solutions backlog and $15.9$15.4 million of Nuclear Industry Training and ConsultingNITC backlog. 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,GAAP measurement, our computation of backlog may not necessarily be comparable to that of our industry peers.
ProductsProduct and Services
Performance Improvement Solutions
To assist our clients in creating world-class internal training and engineering improvement processes, we offer a set of integrated and scalable products and services that provide a structured program focused on continuous skills improvement for experienced employees to engineering services, including plant design verification and validation, ASME code compliance, and design plant modification work. We provide the right solutions to solve our clients'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 earn this confidence, GSE'sGSE’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 for 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 deployment of new technology, often involving the integration of disparate technologies for the first time, a high-fidelity simulator enables designers to model the interaction between systems in advance of construction. With our combination of simulation technology and expert engineering, GSE was chosen to build first-of-a-kind simulators for the AP1000, PBMR, and small modular reactors such as those being built by NuScale.
Examples of the types of simulators we sell include but are not limited to, the following:
| ● | Universal Training Simulators: TheseOur products complement theour 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, rather than the exact replication of a client'sclient’s plant. We have delivered over 360 such simulation models to clients consisting of major oil companies and educational institutions. This learning content is now being offered through a cloud-bases subscription model that enables easier access and wider use of the content. Two of the world’s largest refiners are using the platform across all global refining facilities, one signing a new five year SaaS contract at the end of 2019. |
| ● | Part-Task Training Simulators: Like our Universal Simulators, we provide other unique training solutions such as a generic nuclear plant simulator and VPanel®VPanel® 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 ofexactly replicate the plant control room and plant operations. Theyoperations and provide the highest level of realism and training available and allowfor users to practice their own plant-specific procedures. Clients can safely practice startup, shutdown and simulate other normal operations, as well as responserespond to abnormal events we all hope they never have to experience in expectation for real life.life events. Since our inception, we have delivered over 480490 plant-specific simulators to clients in the nuclear power, fossil power and process industries worldwide. |
Nuclear Industry Training and Consulting
As our customers'customers’ experienced staff retire, access to experts that can help operate and train existing and new employees in how to operate their plants is essential to ensure safe ongoing plant operations. In addition, operating and training needs change over time and sometimes our clients require fixed priced discrete projects or specialized courses in contrast to straight staff augmentation. The industry needs operating personnel, including procedure writers, engineers, operators and instructors who can step in and use as well as update the client'sclient’s operating methods, procedures, training material and more. Finding technical professionals and instructors, who know the subject, can perform the work or teach it to others and can adapt to the client'sclient’s culture, is critical. GSE provides qualified professionals, instructors and turnkey projects/courses that work within the client'sclient’s system and complement the operating or training methods they already have in place. Examples of our training program courses include senior reactor operator certification, generic fundamentals training, and simulation supervisor training. In addition, we also provide expert support through consulting or turnkey projects for procedure writing, technical engineers, project managers, training material upgrade and development, outage execution, planning and scheduling, corrective actions programs and equipment reliability.
We bring together the collection of skills we have amassed over more than 40 years beginning with its traditional roots in custom high-fidelity simulation and training solutions for the power industries, extended through the acquisition of specialized engineering capabilities, enhanced by the entry and intermediate level training solutions of EnVision and the extensive nuclear industry training and consulting services of Absolute and Hyperspring.
Results of Operations
The following table sets forth theour results of operations, for the periods presented expressed in thousands of dollars and as a percentage of revenue:
| | | | Three months ended | | | Six months ended | |
| (in thousands) | | Three months ended September 30, | | | Nine months ended September 30, | | | June 30, 2020 | | | June 30, 2019 | | | June 30, 2020 | | | June 30, 2019 | |
| | | 2019 | | | % | | | 2018 | | | % | | | 2019 | | | % | | | 2018 | | | % | | | $
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| Revenue | | $ | 20,031 | | | | 100.0 | % | | $ | 21,801 | | | | 100.0 | % | | $ | 65,683 | | | | 100.0 | % | | $ | 69,394 | | | | 100.0 | % | | $ | 14,340 | | | | 100.0 | % | | $ | 23,458 | | | | 100.0 | % | | $ | 32,045 | | | | 100.0 | % | | $ | 45,652 | | | | 100.0 | % |
| Cost of revenue | | | 15,358 | | | | 76.7 | % | | | 16,380 | | | | 75.1 | % | | | 50,407 | | | | 76.7 | % | | | 52,735 | | | | 76.0 | % | |
| Gross profit | | | 4,673 | | | | 23.3 | % | | | 5,421 | | | | 24.9 | % | | | 15,276 | | | | 23.3 | % | | | 16,659 | | | | 24.0 | % | |
| Cost of Revenue | | | | 10,778 | | | | 75.2 | % | | | 17,591 | | | | 75.0 | % | | | 24,368 | | | | 76.0 | % | | | 35,049 | | | | 76.8 | % |
| Gross Profit | | | | 3,562 | | | | 24.8 | % | | | 5,867 | | | | 25.0 | % | | | 7,677 | | | | 24.0 | % | | | 10,603 | | | | 23.2 | % |
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| Operating expenses: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Selling, general and administrative | | | 3,465 | | | | 17.3 | % | | | 4,366 | | | | 20.0 | % | | | 12,231 | | | | 18.6 | % | | | 13,686 | | | | 19.7 | % | | | 4,722 | | | | 32.9 | % | | | 4,343 | | | | 18.5 | % | | | 9,670 | | | | 48.9 | % | | | 8,766 | | | | 35.1 | % |
| Research and development | | | 130 | | | | 0.6 | % | | | 247 | | | | 1.1 | % | | | 526 | | | | 0.8 | % | | | 765 | | | | 1.1 | % | | | 179 | | | | 1.2 | % | | | 156 | | | | 0.7 | % | | | 389 | | | | 1.2 | % | | | 396 | | | | 0.9 | % |
| Restructuring charges | | | 740 | | | | 3.7 | % | | | 70 | | | | 0.3 | % | | | 742 | | | | 1.1 | % | | | 1,177 | | | | 1.7 | % | | | - | | | | - | | | | 2 | | | | - | | | | 10 | | | | 0.0 | % | | | 2 | | | | 0.0 | % |
| Loss on impairment | | | - | | | | 0.0 | % | | | - | | | | 0.0 | % | | | 5,464 | | | | 8.3 | % | | | - | | | | 0.0 | % | | | - | | | | - | | | | - | | | | - | | | | 4,302 | | | | 13.4 | % | | | 5,464 | | | | 12.0 | % |
| Depreciation | | | 107 | | | | 0.5 | % | | | 132 | | | | 0.6 | % | | | 300 | | | | 0.5 | % | | | 411 | | | | 0.6 | % | | | 70 | | | | 0.5 | % | | | 102 | | | | 0.4 | % | | | 178 | | | | 0.6 | % | | | 193 | | | | 0.4 | % |
| Amortization of definite-lived intangible assets | | | 494 | | | | 2.5 | % | | | 632 | | | | 2.9 | % | | | 1,550 | | | | 2.4 | % | | | 1,094 | | | | 1.6 | % | |
| Amortization of intangible assets | | | | 444 | | | | 3.1 | % | | | 638 | | | | 2.7 | % | | | 1,114 | | | | 3.5 | % | | | 1,208 | | | | 2.6 | % |
| Total operating expenses | | | 4,936 | | | | 24.6 | % | | | 5,447 | | | | 25.0 | % | | | 20,813 | | | | 31.7 | % | | | 17,133 | | | | 24.7 | % | | | 5,415 | | | | 37.8 | % | | | 5,241 | | | | 22.3 | % | | | 15,663 | | | | 48.9 | % | | | 16,029 | | | | 35.1 | % |
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| Operating loss | | | (263 | ) | | | (1.3 | )% | | | (26 | ) | | | (0.1 | )% | | | (5,537 | ) | | | (8.4 | )% | | | (474 | ) | | | (0.7 | )% | |
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| Interest (expense), net | | | (288 | ) | | | (1.4 | )% | | | (114 | ) | | | (0.5 | )% | | | (812 | ) | | | (1.2 | )% | | | (153 | ) | | | (0.2 | )% | |
| Loss on derivative instruments, net | | | (61 | ) | | | (0.3 | )% | | | (59 | ) | | | (0.3 | )% | | | (69 | ) | | | (0.1 | )% | | | (306 | ) | | | (0.4 | )% | |
| Operating (loss) income | | | | (1,853 | ) | | | (13.0 | )% | | | 626 | | | | 2.7 | % | | | (7,986 | ) | | | (24.9 | )% | | | (5,426 | ) | | | (11.9 | )% |
| Interest expense, net | | | | (187 | ) | | | (1.3 | )% | | | (316 | ) | | | (1.3 | )% | | | (428 | ) | | | (1.3 | )% | | | (524 | ) | | | (1.1 | )% |
| Gain (loss) on derivative instruments, net | | | | 47 | | | | 0.3 | % | | | (101 | ) | | | (0.4 | )% | | | 4 | | | | 0.0 | % | | | (8 | ) | | | 0.0 | % |
| Other income (expense), net | | | 59 | | | | 0.3 | % | | | (5 | ) | | | 0.0 | % | | | 62 | | | | 0.1 | % | | | 24 | | | | 0.0 | % | | | 24 | | | | 0.2 | % | | | (19 | ) | | | (0.1 | )% | | | 53 | | | | 0.2 | % | | | 3 | | | | 0.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loss before income taxes | | | (553 | ) | | | (2.8 | )% | | | (204 | ) | | | (0.9 | )% | | | (6,356 | ) | | | (9.7 | )% | | | (909 | ) | | | (1.3 | )% | |
| Provision (benefit) for income taxes | | | 568 | | | | 2.8 | % | | | 314 | | | | 1.4 | % | | | (874 | ) | | | (1.3 | )% | | | 124 | | | | 0.2 | % | |
| (Loss) income before income taxes | | | | (1,969 | ) | | | (13.7 | )% | | | 190 | | | | 0.8 | % | | | (8,357 | ) | | | (26.1 | )% | | | (5,955 | ) | | | (13.0 | )% |
| Provision for (benefit from) income taxes | | | | 180 | | | | 1.3 | % | | | 406 | | | | 1.7 | % | | | 50 | | | | 0.2 | % | | | (1,442 | ) | | | (3.2 | )% |
| Net loss | | $ | (1,121 | ) | | | (5.6 | )% | | $ | (518 | ) | | | (2.4 | )% | | $ | (5,482 | ) | | | (8.3 | )% | | $ | (1,033 | ) | | | (1.5 | )% | | $ | (2,149 | ) | | | (15.0 | )% | | $ | (216 | ) | | | (0.9 | )% | | $ | (8,407 | ) | | | (26.2 | )% | | $ | (4,513 | ) | | | (9.9 | )% |
Results of Operations - Three and nine months ended September 30, 2019, versus three and nine months ended September 30, 2018Revenue
Revenue. Total revenue for the three months ended SeptemberJune 30, 20192020 decreased 8.1%38.9% as compared to the three months ended SeptemberJune 30, 2018.2019. For the ninesix months ended SeptemberJune 30, 20192020 revenue decreased 5.3%29.8% as compared to the nine months ended September 30, 2018. The decreasesame period in revenue was primarily due to decrease in revenue in the Nuclear Industry Training and Consulting segment, as described below.2019.
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| (in thousands) | | 2019 | | | 2018 | | | 2019 | | | 2018 | | | June 30, 2020 | | | June 30, 2019 | | | Change | | | June 30, 2020 | | | June 30, 2019 | | | Change | |
| Revenue: | | | | | | | | | | | | | | | | | | | | $
| | |
| % | | | | | | | | | $
| | |
| % | |
| Performance Improvement Solutions | | $ | 11,417 | | | $ | 9,849 | | | $ | 36,617 | | | $ | 30,614 | | |
| Nuclear Industry Training and Consulting | | | 8,614 | | | | 11,952 | | | | 29,066 | | | | 38,780 | | |
| Performance | | | $ | 8,273 | | | $ | 13,010 | | | $
| (4,737 | ) | | | (36.4 | )% | | $ | 17,984 | | | $ | 25,200 | | | $
| (7,216 | ) | | | (28.6 | )% |
| NITC | | | | 6,067 | | | $ | 10,448 | | | | (4,381 | ) | | | (41.9 | )% | | | 14,061 | | | $ | 20,452 | | | | (6,391 | ) | | | (31.2 | )% |
| Total revenue | | $ | 20,031 | | | $ | 21,801 | | | $ | 65,683 | | | $ | 69,394 | | | $ | 14,340 | | | $ | 23,458 | | | $
| (9,118 | ) | | | (38.9 | )% | | $ | 32,045 | | | $ | 45,652 | | | $
| (13,607 | ) | | | (29.8 | )% |
Performance Improvement Solutions revenue increaseddecreased approximately $1.6$4.7 million or 15.9%36.4% during the three months ended SeptemberJune 30, 20192020 compared to the same period in the prior year. The increasedecrease in revenue was primarily due to headwinds we experienced from the acquisition ofCOVID-19 pandemic and our inability to commence certain contracts remotely, several significant projects ending in the prior year, and also a reduction in revenue for DP Engineering, which contributeddue to $2.2an incident with one of its customers in fiscal 2019. Total new orders for the Performance segment were $7.1 million during the quarter ended June 30, 2020, an increase of revenue$3.4 million when compared to the segment$3.7 million in the new orders during the three monthsquarter ended SeptemberJune 30, 2019. This2019. The increase was partially offset by a decline of $0.4 million from foreign subsidiaries that we will close by the end of 2019. The decline in new orders is due to a combination of factors including expected new orders being delayed until the second half of the year, the cyclical nature of our industryadditional funding for long standing time & material contracts and business,various smaller system design and the re-establishment of our business development strategy in the first half of the year. Total new orders for this segment were $10.7 million during the three months ended September 30, 2019, a decrease of $(6.5) million when compared to the $17.2 million in the new orders during the three months ended September 30, 2018.build projects.
For the ninesix months ended SeptemberJune 30, 20192020, Performance Improvement Solutions revenue was $36.6$18.0 million compared to $30.6$25.2 million for the nine months ended September 30, 2018.same period in 2019. The decrease of $7.2 million in revenue during fiscal 2020 over the same period in 2019 was due primarily to a reduction of revenue in our DP Engineering subsidiary due to an incident with one of its customers in fiscal 2019, several significant projects ending in the prior fiscal year and headwinds due to the COVID-19 pandemic and related delays in commencing new contracts. We also reduced our foreign operations due to planned restructuring and to focus on our domestic operations We recorded total new orders for Performance of $19.0$12.5 million during the ninesix months ended SeptemberJune 30, 2019, a decrease2020, an increase of $(12.7)$4.2 million compared to $31.7$8.3 million induring the ninesix months ended SeptemberJune 30, 2018. The increase in revenue for the nine months ended September 30, 2019 compared due primarily to the prior year was mainly driven by the acquisitionbookings of True North Consultingvarious system design and DP Engineering, which contributed $10.3 million of revenue, partially offset by a decrease from foreign operations of $1.5 million for the period.build projects.
For the three months ended September 30, 2019, Nuclear Industry Training and Consulting revenue decreased $(3.3) approximately $4.4 million or 27.9%41.9% during the three months ended June 30, 2020 compared to the three months ended September 30, 2018. Total new orders for this segment were $8.3 millionsame period in the three months ended September 30, 2019 compared to $10.7 million in the prior year.. The decrease in the revenue was largely due to lower customer demand for staffing and headwinds that we experienced from the COVID-19 pandemic. We recorded a net reduction in orders of $(0.3) million during the three months ended SeptemberJune 30, 2019.2020, a decrease compared to $5.8 million of orders during the same period of the prior year. The declinedecrease in new orders is due to a combination of factors including customer budget cut,project stoppages due to the COVID-19 pandemic and the cyclical nature of our industry and business, and the re-establishment of our business development strategy in the first half of the year.business.
For the ninesix months ended SeptemberJune 30, 2019, Nuclear Industry Training and Consulting2020, NITC revenue decreased $(9.7)$6.4 million or 25.0%31.2% compared to the nine months ended September 30, 2018.same period of fiscal 2019. The decrease in revenue was primarily due to stoppage of existing projects and delays in commencing new contracts due to the COVID-19 pandemic and a reduction in demand for staffing from our major customers. We recorded total new orders of $23.9$14.0 million induring the ninesix months ended SeptemberJune 30, 2019,2020 compared to $36.9$15.6 million induring the ninesix months ended SeptemberJune 30, 2018. The $(9.7) million decrease in revenue was primarily due to lower customer demand for staffing from the Company's major customers for the nine months ended September 30, 2019.2019.
As of SeptemberJune 30, 2019,2020, our backlog was $53.7 million: $37.8$46.6 million, forof which $31.2 million was attributed to the Performance Improvement Solutions business segment and $15.9$15.4 million for Nuclear Industry Training and Consulting.was attributed to the NITC segment. As of December 31, 2018, the Company's2019, our backlog was $70.6 million: $49.4$52.7 million for thewith $37.2 million attributed to our Performance Improvement Solutions business segment and $21.2$15.5 million for Nuclear Industry Training and Consulting.to NITC. The decrease ofin our backlog over the prior fiscal year is primarily due to lower orders in 2019. Orders have decreased by $25.7 million (37.5%): $12.7 million (40.1%) for Performance Improvement Solutions, and $13.0 million (35.2%) for NITC.
during the first six months of 2020.
Gross Profit.
Gross profit totaled $4.7$3.6 million or 24.8% of revenue and $5.9 million or 25.0% of revenue for the three months ended SeptemberJune 30, 2020 and 2019, respectively. For the six months ended June 30, 2020, gross profit totaled $7.7 million compared to $5.4$10.6 million for the same period in 2018.2019. As a percentage of revenue, gross profit decreased from 24.9%was 24.0% and 23.2% for the threesix months ended SeptemberJune 30, 2018, to 23.3% for the three months ended September 30, 2019. For the nine months ended September 30, 2020 and 2019 gross profit was $15.3 million compared to $16.7 million for the same period in 2018. As a percentage of revenue,, respectively.
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| (in thousands) | | $
| | |
| % | | | $
| | |
| % | | | $
| | |
| % | | | $
| | |
| % | |
| Gross profit: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Performance | | $ | 2,730 | | | | 33.0 | % | | $ | 4,540 | | | | 34.9 | % | | $ | 5,758 | | | | 32.0 | % | | $ | 8,239 | | | | 32.7 | % |
| NITC | | | 832 | | | | 13.7 | % | | | 1,327 | | | | 12.7 | % | | | 1,919 | | | | 13.6 | % | | | 2,364 | | | | 11.6 | % |
| Total gross profit | | $ | 3,562 | | | | 24.8 | % | | $ | 5,867 | | | | 25.0 | % | | $ | 7,677 | | | | 24.0 | % | | $ | 10,603 | | | | 23.2 | % |
Performance gross profit decreased from 24.0% for the nineduring three and six months ended SeptemberJune 30, 2018, to 23.3% for the nine months ended September 30, 2019.
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| (in thousands) | | 2019 | | | % | | | 2018 | | | % | | | 2019 | | | % | | | 2018 | | | % | |
| Gross profit: | | | | | | | | | | | | | | | | | | | | | | | | |
| Performance Improvement Solutions | | $ | 3,548 | | | | 31.1 | % | | $ | 3,638 | | | | 36.9 | % | | $ | 11,787 | | | | 32.2 | % | | $ | 11,318 | | | | 37.0 | % |
| Nuclear Industry Training and Consulting | | | 1,125 | | | | 13.1 | % | | | 1,783 | | | | 14.9 | % | | | 3,489 | | | | 12.0 | % | | | 5,341 | | | | 13.8 | % |
| Consolidated gross profit | | $ | 4,673 | | | | 23.3 | % | | $ | 5,421 | | | | 24.9 | % | | $ | 15,276 | | | | 23.3 | % | | $ | 16,659 | | | | 24.0 | % |
In Performance Improvement Solutions, three2020 by $1.8 million and nine months ended September 30, 2019, gross margin percentage decreased 5.8% and 4.8%$2.5 million, respectively. This decrease is primarily related to DP Engineering, which decreased gross margin percentage by 7.9% and 7.9% forseveral significant projects completed in the three and nine months ended September 30, 2019 respectively.prior year that were not replaced with new orders.
TheGross profit in our NITC segment was lower during three and six months ended June 30, 2020 compared to the same periods in fiscal 2019 by $495 thousand and $445 thousand, respectively. Compared to the same period in fiscal 2019, the decrease in gross profit percentage in Nuclear Industry Consultingwas primarily driven by project stoppages and Training was slightly lower during the three and nine months ended September 30, 2019, as compared to other periods, mainlynew contract delays due to normal changes in the mix of projects with different margins and overall lower utilization rates.
.COVID-19 pandemic.
Selling, General and Administrative Expenses. Selling, general and administrative (SG&A)expenses
SG&A expenses totaled $3.5$4.7 million infor the three monthsquarter ended SeptemberJune 30, 2019, a 20.6% decrease2020 or an increase of 8.7% from the $4.4$4.3 million for the same period in 2018.2019. For the ninesix months ended SeptemberJune 30, 2019 and 2018,2020, SG&A expenses totaled $12.2$9.7 million and $13.7$8.8 million, respectively. Fluctuations in the componentsComponents of SG&A spending were as follows:
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| (in thousands) | | 2019 | | | 2018 | | | 2019 | | | 2018 | | | June 30, 2020 | | | June 30, 2019 | | | June 30, 2020 | | | June 30, 2019 | |
| | | | | | | | | | | | | | |
| Corporate charges | | $ | 2,321 | | | $ | 3,265 | | | $ | 9,800 | | | $ | 10,034 | | | $ | 2,792 | | | $ | 3,046 | | | $ | 6,471 | | | $ | 7,479 | |
| Business development | | | 747 | | | | 844 | | | | 2,549 | | | | 2,727 | | |
| Facility operation & maintenance (O&M) | | | 348 | | | | 228 | | | | 1,027 | | | | 775 | | |
| Provision for loss on legal settlement | | | | 861 | | | | - | | | | 861 | | | | - | |
| Change in contingent consideration | | | | - | | | | - | | | | - | | | | (1,200 | ) |
| Business development expenses | | | | 810 | | | | 858 | | | | 1,746 | | | | 1,802 | |
| Facility operation & maintenance | | | | 255 | | | | 434 | | | | 491 | | | | 679 | |
| Bad debt expense | | | 48 | | | | 29 | | | | 48 | | | | 146 | | | | - | | | | - | | | | 93 | | | | - | |
| Change in contingent consideration | | | - | | | | - | | | | (1,200 | ) | | | - | | |
| Other | | | 1 | | | | - | | | | 7 | | | | 4 | | | | 4 | | | | 5 | | | | 8 | | | | 6 | |
| Total | | $ | 3,465 | | | $ | 4,366 | | | $ | 12,231 | | | $ | 13,686 | | |
| Total SG&A | | | $ | 4,722 | | | $ | 4,343 | | | $ | 9,670 | | | $ | 8,766 | |
Corporate charges
Corporate charges were $3.3$2.8 million for the three monthsquarter ended SeptemberJune 30, 20182020 compared to $2.3$3.0 million for the threesame period of the prior fiscal year. For the six months ended SeptemberJune 30, 2019. For the nine months ended September 30, 2019 and 2018, the Company, we incurred corporate charges of $9.8$6.5 million and $10.0$7.5 million, respectively. The acquisition of DP Engineering and True North Consulting, increased Corporate charges by $1.3 million which was offset primarily by a $1.4 million dollar reduction in incentive compensation, and $0.1 million reduction in severance expense included as corporate charges.
Business development expense decreased $(0.1) million and $(0.2) million forcharges during the three and ninesix months ended SeptemberJune 30, 2019, respectively, compared2020 was due to charges of $628 thousand in the same periods in 2018.
Facility O&M expenses increased $120,000 and $252,0002019 fiscal period for the three and nine months ended September 30, 2019, respectively, compared to the same periods in 2018. The increase in 2019 was mainly due to the acquisition of DP Engineering with no similar charges during fiscal 2020 and offset by additional consulting charges predominately for accounting, tax and legal due to the impact of COVID-19 pandemic.
Change in February 2019, which resulted in the lease of additional office space in Fort Worth, Texas, Baton Rouge, Louisiana, and Russellville, Arkansas.contingent consideration
As a result of the triggering event occurring atwith our subsidiary DP Engineering the Companyin fiscal 2019, we determined the fair value of the contingent consideration recorded in connection with the acquisition of DP Engineering in February 2019 was zero andzero. We recorded the reduction in the contingent consideration as an offset to selling, general and administrative expenses.expenses in the amount of $1.2 million for the six months ended June 30, 2019.
Provision for loss on legal settlement
During the three and six months ended June 30, 2020, we recorded a $861 thousand charge to operations as a provision for an expected legal settlement between our consolidated subsidiary Absolute Consulting, Inc. and a former employee, who claims Absolute did not fully pay the former employee for overtime hours worked (see Note 16 to the consolidated financial statements).
Business development expenses
Business development expense decreased $48 thousand and $56 thousand to $810 thousand and $1.7 million for the three and six months ended June 30, 2020, respectively, compared to the same periods in 2019 due primarily to less travel for client acquisition.
Facility operation & maintenance (“O&M”)
Facility O&M expenses decreased $179 thousand and $188 thousand for three and six months ended June 30, 2020, respectively, compared to the same periods in 2019. The decrease in 2020 was mainly due to lease abandonments in the second half of fiscal 2019 and the first half of fiscal 2020.
Bad debt expense
During the six months ended June 30, 2020 and 2019, we recorded bad debt expense of $93 thousand and $0, respectively. We recorded zero in bad debt expense during the three months ended June 30, 2020 and 2019.
Research and Development Expenses. development
Research and development (R&D) costs consist primarily of software engineering personnel and other related costs. R&D costs, net of capitalized software, totaled $0.1$179 thousand and $0.2$156 thousand for the three months ended SeptemberJune 30, 20192020 and 2018,2019, respectively. Before capitalization of software development costs, R&D costs totaled $0.2 million$389 thousand and $0.3 million$396 thousand for each of the threesix months ended SeptemberJune 30, 20192020 and 2018. R&D costs, net of capitalized software, totaled $0.5 million and $0.8 million for the nine months ended September 30, 2019 and 2018, respectively. R&D expenses before capitalization of software development costs totaled $0.9 million and $1.1 million for each of the nine months ended September 30, 2019 and 2018.. The decrease in R&D expenses in 2019fiscal 2020 was mainly due to less headcount in the current year.
Restructuring Charges. On December 27, 2017,Loss on impairment of goodwill and definite-lived intangible assets
We determined that the BoardCOVID-19 pandemic was a triggering event, requiring an interim impairment test to be performed on our long-lived assets as of GSE Systems, Inc. approvedthe period ended March 31, 2020. Based upon our analysis, we determined that the carrying value of the definite-lived intangible assets of DP Engineering exceeded its fair value and recognized a $4.3 million impairment during the three and six months ended June 30, 2020. In the prior year, we recognized an international restructuring planimpairment charge of $5.6 million related to streamlinegoodwill, upon the acquisition of DP Engineering, during the three and optimize the Company's global operationssix months ended June 30, 2019.
Depreciation
We recorded depreciation expense of $70 thousand and we announced we expected restructuring charges to total $2.2 million, excluding any tax impacts and cumulative translation adjustments. As of September 30, 2019, we had incurred restructuring charges of $2 million, and we expect the remaining restructuring charges of approximately $0.2 million by the end of 2019. Additionally$102 thousand for the nine months ended September 30, 2018 we incurred restructuring charges of $1.1 million, which represented costs associated to the restructuring plan initiated in 2015. For the three months ended SeptemberJune 30, 2020 and 2019, respectively. For the Companysix months ended June 30, 2020 and 2019, we recorded restructuring chargesdepreciation expense of approximately $0.7 million$178 thousand and $193 thousand, respectively. The reduction of which $0.3 million related$32 thousand and $15 thousand for the three and six months ended June 30, 2020 over the same period in 2019 was due primarily to DP Engineering severancefully depreciated assets in 2020, no acquisitions in the current fiscal year and $0.4 million related to an executive departure related toa reduction of capital expenditures of $24 thousand over the suspension of the Company’s acquisition strategy.six months ended June 30, 2019.
Depreciation. Depreciation expense decreased $(25,000) and $(111,000) for the three and nine months ended September 30, 2019, compared to the same periods in 2018.Amortization of intangible assets
Amortization of Definite-lived Intangible Assets. Amortization expense related to definite-lived intangible assets totaled $0.5 million$444 thousand and $0.6 million$638 thousand for the three monthsquarter ended SeptemberJune 30, 20192020 and 2018,2019, respectively. For the ninesix months ended SeptemberJune 30, 20192020 and 2018,2019, amortization expense related to definite-lived intangible assets totaled $1.6$1.1 million and $1.1$1.2 million, respectively. The increasedecrease in amortization of intangible assets in fiscal 2020 was primarily due to a reduction in the carrying value of definite-lived intangible assets in 2019 was primarily due to the acquisition ofimpairments recorded for DP Engineering in the six months ended June 30, 2020 and True North.2019.
Interest (expense),expense, net.
Interest expense totaled $0.3 million$187 thousand and $0.8 million$316 thousand for the three and nine months ended SeptemberJune 30, 2020 and 2019, respectively. Interest expense totaled $0.1 million$428 thousand and $0.2 million$524 thousand for the three and ninesix months ended SeptemberJune 30, 2018,2020 and 2019, respectively. The Company issued a five-year term loan of $14.3 millionreduction in February 2019 to finance the acquisition of DP Engineering, and recorded interest expense, of $0.2 million and $0.4 millionnet for the period ended June 30, 2020 compared to June 30, 2019 was due primarily to a reduction in total indebtedness, net of the Paycheck Protection Program Loan, from $20.9 million as of June 30, 2019 compared to $13.3 million as of June 30, 2020.
Other income (expense), net
For the three months ended SeptemberJune 30, 2020 and 2019 respectively, related to the term loan.
Loss on derivative instruments, net. In the normal course, we recognized other income, net of business, our operations are exposed to fluctuations in foreign currency values$24 thousand and interest rate changes. We control a portion of these risks through a risk management program that includes the use of derivative instruments. (Loss) gain on derivative instruments relates to the Company's interest rate swap contracts, foreign exchange contracts and remeasurement of foreign currency denominated contract receivables, billings in excess of revenue earned, and subcontractor accruals. The following table summarizes the components of the (loss) gain recognized for the three and nine months ended September 30, 2019 and 2018:
| | | Three months ended September 30, | | | Nine months ended September 30, | |
| | | 2019 | | | 2018 | | | 2019 | | | 2018 | |
| Interest rate swap - change in fair value | | $ | (1 | ) | | $ | (28 | ) | | $ | (89 | ) | | $ | (39 | ) |
| Foreign exchange contracts- change in fair value | | | (45 | ) | | | (14 | ) | | | 25 | | | | (178 | ) |
| Remeasurement of related contract receivables, billings in excess of revenue earned, and subcontractor accruals | | | (15 | ) | | | (17 | ) | | | (5 | ) | | | (89 | ) |
| Loss on derivative instruments, net | | $ | (61 | ) | | | (59 | ) | | $ | (69 | ) | | $ | (306 | ) |
Other Income (Expense), Net. For the three and nine months ended September 30, 2019, the Company recognized other expense, net of $59,000$19 thousand, respectively. For the six months ended June 30, 2020 and 2019, we recognized other income, net of $53 thousand and other income, net of $62,000,$3 thousand, respectively. For the three and nine months ended September 30, 2018, the Company recognized other income, net, of ($5,000) and other income, net, of $24,000, respectively.
Provision (benefit) for (benefit from) Income Taxes
Income tax expense (benefit) was $0.6 million and $(0.9) million with effective income tax rates of (102.7)% and 13.8%benefit for the three and nine months ended September 30, 2019, respectively. This is compared to income tax expense of $0.3 million and $0.1 million with effective income tax rates of (153.9)% and (13.6)%, for the three and nine months ended September 30, 2018, respectively. The Company's income tax provision (benefit) for interim periods presented is determined using an estimate of itsour annual effective tax rate, adjusted for discrete items arising in that quarter. TaxTotal income tax expense infor the six months ended June 30, 2020 was comprised mainly of foreign and state tax expense. Total income tax expense for the six months ended June 30, 2019 is was comprised mainly of the tax impact of the loss for loss on impairment, and federal, foreign, and state tax expense. Tax expense in 2018 is comprised mainly of federal, foreign and state tax expense.
Total income tax expense for the six months ended June 30, 2020 was comprised mainly of foreign and state tax expense. Total income tax expense for the six months ended June 30, 2019 was comprised mainly of the tax impact of the loss for impairment, federal, foreign and state tax expense.
Our income effective tax rates were (102.7)%rate was 9.1% and 13.8%0.6% for the three and ninesix months ended SeptemberJune 30, 2019.2020, respectively. For the three months ended SeptemberJune 30, 2019,2020, the difference between our income tax expense at an effective tax rate of (102.7)%9.1% and a benefit at the U.S. statutory federal income tax rate of 21% was primarily due to accruals related to uncertain tax positions for certain U.S. and foreign tax contingencies, a change in tax valuation allowance in our US and China subsidiaries and discrete item adjustments for U.S. and foreign taxes. For the six months ended June 30, 2020, the difference between the income tax expense at an effective tax rate of 0.6% and a benefit at the U.S. statutory federal income tax rate of 21% was primarily due to permanent differences, accruals related to uncertain tax positions for certain U.S. and foreign tax contingencies, a change in tax valuation allowance in our US and China subsidiary,subsidiaries, discrete item adjustments for the U.S. and foreign taxes the excess book deduction related to stock options and restricted stock units that were exercised or vested during the quarter, and the tax impact of the loss on impairment. For the nine months ended September 30, 2019, the difference between the effective tax rate of 13.8% and the U.S. statutory federal income tax rate of 21% was primarily due to permanent differences, accruals related to uncertain tax positions for certain foreign contingencies, and discrete item adjustments, including the tax impact of the loss on impairment.
Because of itsour net operating loss carryforwards, the Company iswe are subject to U.S. federal and state income tax examinations from the year 2000 and forward. The Company isWe are subject to foreign tax examinations by tax authorities for years 20112014 and forward forin Sweden, 2015 and forward forin China, 2015 and forward forin India and 2016 and forward forin the UK.United Kingdom.
An uncertain tax position taken or expected to be taken in a tax return is recognized in the consolidated financial statements when it is more likely than not (i.e., a likelihood of more than 50%) that the position would be sustained upon examination by tax authorities that have full knowledge of all relevant information. A recognized tax position is then measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. Interest and penalties related to income taxes are accounted for as income tax expense.
The Company has recorded full valuation allowances for its Chinese, U.K., and Swedish netWe recognize deferred tax assets at Septemberto the extent that it is believed that these assets are more likely than not to be realized. We have evaluated all positive and negative evidence and determined that it will continue to assess a full valuation allowance on its U.S., Swedish U.K., Chinese and Slovakian net deferred assets as of June 30, 2019.2020. We have determined that it is not more likely than not that it will realize the benefits of its deferred taxes in the U.S and foreign jurisdictions.
Critical Accounting Policies and Estimates
In preparing the Company'sour consolidated financial statements, managementManagement makes several estimates and assumptions that affect the Company'sour reported amounts of assets, liabilities, revenues and expenses. The Company'sOur most significant estimates relate to revenue recognition on contracts with customers, allowance for doubtful accounts, product warranties, valuation of goodwill and intangible assets acquired, valuation of long-lived assets to be disposed of, valuation of contingent consideration issued in business acquisitions, valuation of stock based compensation awards and the recoverability of deferred tax assets. 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.10-K, filed with the SEC on June 11, 2020. For all of theseaccounting policies described in this document, management cautions that future events rarely develop exactly as forecast,forecasted and theeven our best estimates may require adjustment.adjustment as facts and circumstances change.
Liquidity and Capital Resources
As of SeptemberJune 30, 2019, the Company’s2020, our cash and cash equivalents totaled $8.6$18.3 million, compared to $12.1$11.7 million at as of December 31, 2018.2019.
For the ninesix months ended SeptemberJune 30, 2019 and 2018,2020, net cash used inprovided by operating activities was $(0.3)$2 million and $(6.4) million, respectively.net cash used in operating activities was $909 thousand. The increase of $6.0$2.9 million in cash flows provided by operating activities was primarily drivendue to collections of previously billed revenue offset by the collection of contract receivables during the period.a reduction in net income.
Net cash used in investing activities totaled $(14.0) million$146 thousand and $(10.6)$13.7 million for the ninesix months ended SeptemberJune 30, 20192020 and 2018,2019, respectively. The increasedecrease in the cash outflow in 2019for investing activities year over year was primarily driven by the acquisition of DP Engineering in the six months ended June 30, 2019, for which the net cash consideration of which was $13.5 million.
For the ninesix months ended SeptemberJune 30, 20192020 and 2018,2019, cash provided by financing activities totaled $11.0$4.8 million and $7.0$12.3 million, respectively. The increasedecrease in the cash inflow fromprovided by financing activities was largely driven by the proceeds from draw down of a term loan of $14.3 million; the increase was partially offset by an increase in payments on long term debt of repayments$6.8 million, offset by a draw on our revolving line of $3.0credit of $3.5 million onand proceeds of the term loan.PPP Loan of $10.0 million during the six months ended June 30, 2020 over the same period of the prior fiscal year.
As discussed above, we received $10 million in funds under the Paycheck Protection Program during the period. We have used and plan to continue to use these funds for payroll and related costs, rent, utilities and other debt obligations incurred before February 15, 2020. At Septemberthis time, we are unable to determine if we will obtain forgiveness from the Bank but were in compliance with all of the restrictions of the PPP as of the period end.
Paycheck Protection Program Loan
We entered into the Paycheck Protection Program Loan (the "PPP") agreement with Citizens Bank, (our or the "Bank") which was approved by the bank and funded on April 24, 2020, pursuant to the Paycheck Protection Program under the Coronavirus Aid, Relief and Economic Security Act (the "CARES Act"). The PPP Loan matures on April 24, 2022 and bears interest at a rate of 1% per annum. Monthly amortized principle and interest payments are deferred for ten months after the last day of the covered period, August 9, 2021. The PPP Loan funds were received on April 24, 2020. The PPP Loan contains events of default and other provisions customary for a loan of this type. The Payroll Protection Program provides that (1) the use of PPP Loan amount shall be limited to certain qualifying expenses, (2) 100 percent of the principal amount of the loan is guaranteed by the Small Business Administration and (3) an amount up to the full principal amount may qualify for loan forgiveness in accordance with the terms of CARES Act. We are not yet able to determine the amount that might be forgiven. As of June 30, 2019,2020, the Company had cashwas in full compliance with all covenants with respect to the PPP Loan.
We have classified the full $10 million of the PPP Loan as long-term in our consolidated balance sheet as of June 30, 2020 and cash equivalents of $8.6 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 leastrecorded $18 thousand in interest expense during the next twelve months.three months ended June 30, 2020.
Credit Facilities
Citizens Bank
The CompanyOn December 29, 2016, we entered into a three-year, $5.03-year, $5.0 million revolving line of credit facility (RLOC)("RLOC") with Citizens Bank National Association (the Bank) on December 29, 2016 to fund general working capital needs. needs and provide funding for acquisitions. We are not required to maintain a restricted cash collateral account at Citizens Bank for outstanding letters of credit and working capital advances. The credit facility agreement is subject to certain financial covenants and reporting requirements.
On June 28, 2019, GSE and Performance Solutions (collectively, the Borrower)May 11, 2018, we entered into an Amended and Restated Credit and Security Agreement (the("the Credit Agreement)Agreement") with the Bank amending and restating the Company's existing Credit and Security Agreement with the Bank, which included a $5.0 million asset-based revolving credit facility between the Borrower and the Bank, to now include (a) a $5.0$5.0 million revolving credit facility, not subject to a borrowing base, includingwith a letter of credit sub-facility, and (b) a $25.0$25.0 million delayed draw term loan facility available to be drawn upon for up to 18 months and to finance certain permitted acquisitionsacquisitions. The credit facilities mature in five years and bear interest at one-month USD LIBOR plus a margin that varies depending on our overall leverage ratio. Revolving loans are interest-only with principal due at maturity, while term loans require monthly payments of principal and interest based on an amortization schedule.
Our obligations under the Credit Agreement are guaranteed by our wholly owned subsidiaries Hyperspring, Absolute, True North, DP Engineering and by any future material domestic subsidiaries (collectively, the Company.Guarantors). On June 28, 2019, we entered into the Fifth Amendment and Reaffirmation Agreement on June 28, 2019. This agreement changed the fixed charge coverage ratio from 1.25, to four different ratios ranging from 1.05 to 1.25 among different time periods and changed the leverage ratio to: (i) 2.75 to 1.00 for the period ending March 31, 2020; (ii) 2.50 to 1.00 for the periods ending June 30, 2020 and September 30, 2020; (iii) 2.25 to 1.00 for the periods ending December 31st, March 31st, June 30th and September 30th thereafter.
On May 11, 2018, upon acquisitionJanuary 8, 2020, due to an expected violation of True North,our covenants, we entered into the Company drew down approximately $10.3Sixth Amendment and Reaffirmation Agreement and effective on December 31, with our Bank to relax the fixed charge coverage ratio and leverage ratio and delay testing of both financial covenants. We agreed to an additional covenant, requiring us to maintain a consolidated Adjusted EBITDA target of $4.25 million, tested quarterly as of December 31, 2019, March 31, 2020 and June 30, 2020. Further, we agreed to fundmaintain a minimum USA liquidity of at least $5.0 million in the transaction, $0.5 millionaggregate, tested bi-weekly as of which was repaidthe fifteenth and the last day of each month, beginning on December 31, 2019 and until June 30, 2020. In addition to the revised covenants, we agreed to make accelerated principal payments of $3.0 million on January 6, 2020; $1.0 million on March 31, 2020; and $0.5 million on June 30, 2020.
On April 17, 2020, we entered into the Seventh Amendment and Reaffirmation Agreement and effective March 31, 2020, which requires us to maintain a minimum fixed charge coverage ratio of 1.25 to 1.00, tested quarterly as of the last day of each quarter, beginning with the quarter ending June 30, 2021. In addition, we agreed to not exceed a maximum leverage ratio, tested quarterly as of the last day of each quarter and beginning with the quarter ending September 30, 2020 as follows: (i) 3.00 to 1.00 for the period ending on September 30, 2020; (ii) 2.50 to 1.00 for the period ending on December 31, 2020; and (iii) 2.25 to 1.00 for the period ending on March 31, 2021 and for the periods ending December 31, March 31, June 30 and September 30, thereafter. We additionally agreed to make accelerated principal payments of $0.75 million on April 17, 2020 and $0.5 million on June 30, 2020.
We incurred $0 of debt issuance costs and $75 thousand of debt amendment fees related to the amendments entered into with our Bank as of the six months ended June 30, 2020.
We have the option to refinance the term loan facility if certain requirements are met, including certain covenant thresholds.
Revolving Line of Credit
We intend to continue using the RLOC for short-term working capital needs and the issuance of letters of credit in connection with business operations. Letter of credit issuance fees range between 1.25% and 2.00% depending on our overall leverage ratio, and we pay an unused RLOC fee quarterly based on the same day. On February 15, 2019, upon acquisitionaverage daily unused balance.
As of DP Engineering, the Company drew down approximately $13.5 million to fund the transaction. At SeptemberJune 30, 2019, the outstanding balance of the long-term debt was $19.7 million.
At September 30, 2019, there were no2020, we had outstanding borrowings onof $3.5 million under the RLOC and four letters of credit totaling $1.2 million.$1.2 million outstanding to certain of our customers. The amount available at Septemberunder our RLOC as of June 30, 2019,2020, after consideration of the letters of credit, was approximately $3.8$0.3 million.
TheWe were in breach of our debt covenants as of June 30, 2020. Per our agreement with the Bank, the full $3.5 million on our line of credit facility agreement is subject to financial covenants, some of which was amended on June 28, 2019, and reporting requirements. At September 30, 2019, the Company was in compliance with its financial covenants.callable as due.
Going Concern Consideration
The CompanyAs a result of the COVID-19 pandemic, we are experiencing a negative impact on our financial position and results of operations. We are likely to continue to experience delays in commencing outstanding orders or loss of orders altogether, disruption of our business as a result of worker illness or mandated shutdowns, our ability to refinance existing indebtedness and our ability to access new capital, and this has caused us to violate our debt covenants for the three months ended June 30, 2020. We received $10 million from the PPP and indicated without these funds, the risk of employee terminations, layoffs and other drastic cost reductions exists. While the PPP funds have provided us with additional liquidity, these funds did not prevented us from meeting the minimum EBITDA covenant on our Citizens Bank credit facility at June 30, 2020 or other of our debt covenants in the future. Including the proceeds from the PPP, we believe we have sufficient cash to meet our operating requirement needs for at least the next twelve months; however since some of our loan covenants are related to operating performance, and our operating performance is being significantly impacted by the COVID-19 pandemic, we are currently not in compliance with its debt covenants; however,our EBITDA covenant and believe it is probable based on our forecasts, that we will not beremain in compliance with theseour debt covenants at future measurement dates inthroughout the following twelve-month period. We do have the ability to cure oneremainder of fiscal 2020. As a result of the two financial covenants, the leverage ratio, by paying down an amount of debt necessary to meet the leverage ratio and we are considering taking this action. Regarding the fixed charge coverage ratio, we anticipate reducing fixed charges, namely excess real estate at the DP Engineering office and other space to be made idle. We will be working with the Bank to obtain a modification of our covenant requirements that would, based on our projections, provide forecasted compliance with the covenants. If at such future time aJune 30, 2020 minimum EBITDA covenant violation were to occur and iffuture expected debt covenant violations, we are unable to agree to amended financial covenant measures with the Bank before such time or obtain a waiverhave classified our debt as short-term in the eventour consolidated balance sheets as of subsequent non-compliance, the Company would likely not be able to repay the entirety of the outstanding debt in the event the Bank were to call the debt, thus leading toJune 30, 2020 and December 31, 2019, which creates substantial doubt about the Company’sregarding our ability to continue as a going concern until such amendments or waiversconcern.
We are currently in place.negotiations with the Bank to resolve the minimum EBITDA debt covenant for the quarter ended June 30, 2020, as well as addressing future covenant requirements. To resolve these matters, the Bank may charge us additional fees and require us to pay a portion of our outstanding debt on accelerated payment terms.
Based on our cash flow projection, we believe our funds from operations and availability of cash provide us with sufficient funds to cure one of the forecasted violations if we choose to; have sufficient cash to fund our on-going operations and make our scheduled debt repayments in the normal course of business.
Non-GAAP Financial Measures
Adjusted EBITDA
References to “EBITDA” mean net (loss) income, before taking into account interest expense (income), provision for income taxes, depreciation and amortization. References to Adjusted EBITDA exclude loss on impairment, impact of the change in fair value of contingent consideration, restructuring charges, stock-based compensation expense, impact of the change in fair value of derivative instruments, and acquisition-related expense. 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 items that are not directly related to the Company’s core operating performance that may, or could, have a disproportionate positive or negative impact on our results for any particular period. Investors should recognize that EBITDA and Adjusted EBITDA might not be comparable to similarly-titled measures of other companies. This measure should be considered in addition to, and not as a substitute for or superior to, any measure of performance prepared in accordance with GAAP. A reconciliation of non-GAAP EBITDA and Adjusted EBITDA to the most directly comparable GAAP measure in accordance with SEC Regulation G follows:
(in thousands)
| | | Three months ended | | | Nine months ended | |
| | | September 30, | | | September 30, | |
| | | 2019 | | | 2018 | | | 2019 | | | 2018 | |
| Net loss | | $ | (1,121 | ) | | $ | (518 | ) | | $ | (5,482 | ) | | $ | (1,033 | ) |
| Interest expense (income), net | | | 288 | | | | 114 | | | | 812 | | | | 153 | |
| Provision for income taxes | | | 568 | | | | 314 | | | | (874 | ) | | | 124 | |
| Depreciation and amortization | | | 666 | | | | 573 | | | | 2,143 | | | | 1,858 | |
| EBITDA | | | 401 | | | | 483 | | | | (3,401 | ) | | | 1,102 | |
| Loss on impairment | | | - | | | | - | | | | 5,464 | | | | - | |
| Impact of the change in fair value of contingent consideration | | | - | | | | - | | | | (1,200 | ) | | | - | |
| Restructuring charges | | | 740 | | | | 70 | | | | 742 | | | | 1,107 | |
| Stock-based compensation expense | | | 114 | | | | 401 | | | | 1,150 | | | | 1,535 | |
| Impact of the change in fair value of derivative instruments | | | 61 | | | | 59 | | | | 69 | | | | 306 | |
| Acquisition-related expense | | | 116 | | | | 491 | | | | 744 | | | | 491 | |
| Bad debt expense due to customer bankruptcy | | | - | | | | 65 | | | | - | | | | 65 | |
| Adjusted EBITDA | | $ | 1,432 | | | $ | 1,569 | | | $ | 3,568 | | | $ | 4,606 | |
| | | Three months ended | | | Six months ended | |
| | | June 30, 2020 | | | June 30, 2019 | | | June 30, 2020 | | | June 30, 2019 | |
| Net loss | | $ | (2,149 | ) | | $ | (216 | ) | | $ | (8,407 | ) | | $ | (4,513 | ) |
| Interest expense, net | | | 187 | | | | 316 | | | | 428 | | | | 524 | |
| Provision for (benefit from) income taxes | | | 180 | | | | 406 | | | | 50 | | | | (1,442 | ) |
| Depreciation and amortization | | | 593 | | | | 839 | | | | 1,451 | | | | 1,629 | |
| EBITDA | | | (1,189 | ) | | | 1,345 | | | | (6,478 | ) | | | (3,802 | ) |
| Provision for legal settlement | | | 861 | | | | - | | | | 861 | | | | - | |
| Loss on impairment | | | - | | | | - | | | | 4,302 | | | | 5,464 | |
| Impact of the change in contingent consideration | | | - | | | | - | | | | - | | | | (1,200 | ) |
| Restructuring charges | | | - | | | | 2 | | | | 10 | | | | 2 | |
| Stock-based compensation expense | | | 177 | | | | 439 | | | | 324 | | | | 1,036 | |
| Gain (loss) on derivative instruments | | | (47 | ) | | | 101 | | | | (4 | ) | | | 8 | |
| Acquisition-related expenses | | | 7 | | | | - | | | | 188 | | | | 628 | |
| Adjusted EBITDA | | $ | (191 | ) | | $ | 1,887 | | | $ | (797 | ) | | $ | 2,136 | |
Adjusted Net Income (Loss) and Adjusted EPS Reconciliation(in thousands, except share and per share amounts)
References to Adjusted net incomeNet Income (Loss) exclude the impact of gain from loss on impairment, impact of the change in fair value of contingent consideration, restructuring charges, stock-based compensation expense, impact of the change in fair value of derivative instruments, acquisition-related expense, and amortization of intangible assets related to acquisitions, net of income tax expense impact of adjustments. Adjusted Net Income and adjusted earnings per share (adjusted EPS) are not measures of financial performance under generally accepted accounting principles (GAAP). Management believes adjusted net income and adjusted EPS, in addition to other GAAP measures, are useful to investors to evaluate the Company’s results because they exclude certain items that are not directly related to the Company’s core operating performance and non-cash items that may, or could, have a disproportionate positive or negative impact on our results for any particular period, such as stock-based compensation expense. These measures should be considered in addition to, and not as a substitute for or superior to, any measure of performance prepared in accordance with 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:
| (in thousands) | | Three months ended | | | Nine months ended | | | Three months ended | | | Six months ended | |
| | | September 30, | | | September 30, | | | June 30, 2020 | | | June 30, 2019 | | | June 30, 2020 | | | June 30, 2019 | |
| | | 2019 | | | 2018 | | | 2019 | | | 2018 | | | | | | | | | | | | | |
| Net loss | | $ | (1,121 | ) | | $ | (518 | ) | | $ | (5,482 | ) | | $ | (1,033 | ) | | $ | (2,149 | ) | | $ | (216 | ) | | $ | (8,407 | ) | | $ | (4,513 | ) |
| Provision for legal settlement | | | | 861 | | | | - | | | | 861 | | | | - | |
| Loss on impairment | | | - | | | | - | | | | 5,464 | | | | - | | | | - | | | | - | | | | 4,302 | | | | 5,464 | |
| Impact of the change in fair value of contingent consideration | | | - | | | | - | | | | (1,200 | ) | | | - | | | | - | | | | - | | | | - | | | | (1,200 | ) |
| Restructuring charges | | | 740 | | | | 70 | | | | 742 | | | | 1,107 | | | | - | | | | 2 | | | | 10 | | | | 2 | |
| Stock-based compensation expense | | | 114 | | | | 401 | | | | 1,150 | | | | 1,535 | | | | 177 | | | | 439 | | | | 324 | | | | 1,036 | |
| Impact of the change in fair value of derivative instruments | | | 61 | | | | 59 | | | | 69 | | | | 306 | | |
| Gain (loss) on derivative instruments, net | | | | (47 | ) | | | 101 | | | | (4 | ) | | | 8 | |
| Acquisition-related expense | | | 116 | | | | 491 | | | | 744 | | | | 491 | | | | 7 | | | | - | | | | 188 | | | | 628 | |
| Amortization of intangible assets related to acquisitions | | | 494 | | | | 312 | | | | 1,550 | | | | 1,094 | | | | 444 | | | | 638 | | | | 1,114 | | | | 1,208 | |
| Bad debt expense due to customer bankruptcy | | | - | | | | 65 | | | | - | | | | 65 | | |
| Income tax expense impact of adjustments | | | 186 | | | | (63 | ) | | | (1,761 | ) | | | (1,165 | ) | |
| Adjusted net income | | $ | 590 | | | $ | 817 | | | $ | 1,276 | | | $ | 2,400 | | |
| Adjusted net (loss) income | | | $ | (707 | ) | | $ | 964 | | | $ | (1,612 | ) | | $ | 2,633 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Adjusted earnings per common share – Diluted | | $ | 0.03 | | | $ | 0.04 | | | $ | 0.06 | | | $ | 0.12 | | |
| Adjusted (loss) earnings per common share – basic and diluted | | | $ | (0.03 | ) | | $ | 0.05 | | | $ | (0.08 | ) | | $ | 0.13 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Weighted average shares outstanding - Diluted(1) | | | 20,586,145 | | | | 20,166,912 | | | | 20,418,960 | | | | 19,932,921 | | |
Weighted average shares outstanding used to compute adjusted net (loss) earnings per share - basic and diluted(1) | | | | 20,407,958 | | | | 20,269,733 | | | | 20,375,446 | | | | 20,154,866 | |
(1) During the ninethree and six months ended SeptemberJune 30, 2019 and 2018, the Company2020, we reported both a GAAP net loss and positivean adjusted net loss. Accordingly, there were 74,732 and 56,373 dilutive shares from RSUs that were excluded from the adjusted net loss calculation during fiscal 2020.
(1) During the three and six months ended June 30, 2019, we reported a GAAP net loss and an adjusted net income. Accordingly, there were 397,131263,241 and 645,714175,848 of dilutive shares from options and RSUsthat were included in the adjusted earnings per common share calculation that were considered anti-dilutive in determiningexcluded when calculating the GAAP dilutednet loss per common share.
(1) During the three months ended September 30, 2019 and 2018, the Company reported a GAAP net loss and positive adjusted net income. Accordingly, there were 578,676 and 713,024 dilutive shares from options and RSUs included in the adjusted earnings per common share calculation, that were considered anti-dilutive in determining the GAAP diluted loss per common share.36
| Item 3. | Quantitative and Qualitative Disclosure about Market Risk |
Not required of a smaller reporting company.
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period covered by this Quarterly Report on Form 10-Q. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their control objectives. Based on the evaluation of our disclosure controls and procedures as of the end of the period covered by this quarterly report and our annual report, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective.
On February 15, 2019,not effective; we are currently in remediation of our internal controls to address the Company completed the purchase of DP Engineering. DP Engineering constitutes 16.8% of total assets of the Company at September 30, 2019, and 10% of the Company's consolidated revenue for the nine months ended September 30, 2019. As permitted by SEC guidance for newly acquired businesses, because it was not possible to complete an effective assessment of the acquired company's controls by the quarter-end, the Company's management has excluded DP Engineering from its evaluation of disclosure controls and procedures from the date of such acquisition through September 30, 2019.
On May 11, 2018, the Company completed the acquisition of True North, LLC (True North). True North constitutes 23.7% of total assets of the Company at December 31, 2018, and 8.6% of the Company's consolidated revenuefollowing material weaknesses identified in our Form 10-K for the year ended December 31, 2018. Our2019:
Material Weaknesses Identified
| 1. | Misapplication of U.S. GAAP guidance in our evaluation of significant or unusual transactions, resulting in a correction of an error in previously issued interim financial statements regarding the calculation and recognition of an impairment charge, creating the risk that the misapplication of other guidance could give rise to material errors; |
| 2. | Controls over financial reporting close process including journal entry review and approval, balance sheet reconciliation preparation and review, and monthly flux variance analysis controls. |
Management realizes that two material weaknesses in our internal controls surrounding the evaluation of significant or unusual transactions and financial reporting close process are serious matters and require thoughtful responses. To address the control environment surrounding the evaluation of significant or unusual transactions and application of guidance, management has focused on: (i) hiring dedicated staffing and (ii) revision of controls in application of guidance. Management has hired key management level staffing, including a permanent Controller with a background in remediating control environments and a permanent SEC reporting manager. We are performing a review of our controls surrounding the application of guidance with experts in control environments in order to remediate our controls and prevent the misapplication of guidance in the future.
To address the control environment surrounding the financial reporting process, management has implemented GSE's disclosuremeasures focusing on four key areas: (i) hiring of dedicated staffing; (ii) shortening the close process; (iii) new revenue process tools and controls; and (iv) expanding our mitigating controls. Management has redesigned the tools used in its monthly flux reviews to evaluate differences at a more precise level in order to identify and prevent errors in the financial close process. In addition to addressing accounting resource turnover, management added additional staffing at the level which will provide the necessary support required to observe all accounting controls and procedures overworkflow processes to perform the acquired operation of True North as of June 30, 2019.financial reporting controls. Furthermore, management has realigned its accounting resources to optimize workflows and has set in motion a plan to shorten the close cycle. A plan management believes, with the additional staffing resources, will allow for increased time spent on performing analytics and using newly implemented tools to observe control activities necessary to identify errors in our financial statements. Additionally, management has redesigned revenue process controls and the tools used in its monthly reviews to evaluate differences at a more precise level to identify and prevent errors in the financial close process.
Changes in Internal Control over Financial Reporting
Other than changes to apply our internal control structure to True North, thereThere were no changes in the Company'sour internal controlcontrols over financial reporting that occurred during the most recent fiscal quarter that have materially affected or are reasonably likely to materially affect the Company'sour internal control over financial reporting.
Limitation of Effectiveness of Controls
Internal control over financial reporting has inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements will not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.
PART II
-– OTHER INFORMATION
GSE and its subsidiaries are from time to time involved in litigation incidental to the conduct of its business. GSE and its subsidiaries are not a party to, and its property is not the subject of, any material pending legal proceedings that, in the opinion of management, are likely to have a material adverse effect on the Company’s business, financial condition or results of operations.
On March 29, 2019, a former employee of Absolute Consulting, Inc., filed a putative class action against Absolute and the Company, Joyce v. Absolute Consulting Inc.Inc., case number 1:19 cv 00868 RDB, in the United States District Court for the District of Maryland. The lawsuit alleges that plaintiff wasand certain other employees were not properly compensated for overtime hours that hethey worked. In addition, he alleges that there is a class of employees who were not properly compensated for overtime hours worked. Absolute and theThe Company waived service and, on May 28, 2019, Absolute filed an answer to the complaint and the Company filed a motion to dismiss asserting that the Company was not the plaintiff’s employer and, therefore, not a proper party to the litigation. The plaintiff has responded and opposed the motion to dismiss. No scheduling order has been issued anddismissed from the motion to dismiss remains pending. The Company andcase, but Absolute intendintends to vigorously defend this litigation.litigation with the Company’s assistance and support. Absolute has entered into a settlement agreement as of August 17, 2020 and, pending court approval, anticipates the probable conclusion of this matter to be dismissal of the case in exchange for Absolute’s payment of a settlement amount and fees totaling $861 thousand. The Company is unablehas provisioned for this amount in its financial statements for the period ended June 30, 2020. Certain terms of the settlement agreement would require Absolute to concludepay up to $639 thousand in additional claims that the likelihood of an unfavorable outcome inmay be asserted, for a total potential liability not to exceed $1.5 million, however no other claims are known at this matter is remote or probable, but the Company and Absolute continue to deny the allegations and defend the case.time. The Company has asserted an indemnification claim related to this litigation against the sellers of Absolute.Absolute, which holds approximately a $1 million escrow balance.
The Company has addedfollowing additional risk factors should be read in conjunction with the below risk factorfactors set forth under "Item 1A. Risk Factors" in our 2019 Form 10-K. Except as described herein, there have been no material changes with respect to the disclosure.risk factors disclosed in our 2019 Form 10-K.
A novel strain of coronavirus, the COVID-19 virus has adversely affected our business operations and financial condition.
In December 2019, an outbreak of the COVID-19 virus was reported in Wuhan, China. On March 11, 2020, the World Health Organization declared the COVID-19 virus a global pandemic and on March 13, 2020, President Donald J. Trump declared the virus a national emergency in the United States. This highly contagious disease spread to most of the countries in the world and throughout the United States, during the first half of fiscal 2020, creating a serious impact on customers, workforces and suppliers, disrupting economies and financial markets, and potentially leading to a world-wide economic downturn. It has caused a disruption of the normal operations of many businesses, including the temporary closure or scale-back of business operations and/or the imposition of either quarantine or remote work or meeting requirements for employees, either by government order or on a voluntary basis. The pandemic may adversely affect our customers’ operations, our employees and our employee productivity. It may also impact the ability of our subcontractors, partners and suppliers to operate and fulfill their contractual obligations and result in an increase in costs, delays or disruptions in performance. These supply chain effects, and the direct effect of the virus and the disruption on our employees and operations, may negatively impact both our ability to meet customer demand and our revenue and profit margins. Our employees, in many cases, are working remotely and using various technologies to perform their functions. We have experienced delays or changes in customer demand, particularly due to customer funding priorities and the necessity to socially distance. Further, in reaction to the spread of COVID-19 in the United States, many businesses have instituted social distancing policies, including the closure of offices and worksites and deferring planned business activity. Our Performance Improvement Solutions business segment, as they are classified essential, for the most part continue without pause. With regard to our NITC business segment, because of the embedded presence of our on-site workforce, if COVID-19 or a similar outbreak of infectious disease were to prevent our workers from being deployed to the applicable customer site, it may disrupt our NITC service offerings, interrupt performance on our Nuclear Industry Training and Consulting contracts with clients and negatively impact our business, financial condition and results of operations. Additionally, the disruption and volatility in the global and domestic capital markets may increase the cost of capital and limit our ability to access capital. Both the health and economic aspects of the COVID-19 virus are highly fluid and the future course of each is uncertain. For these reasons and other reasons that may come to light if the coronavirus pandemic and associated protective or preventative measures expand, we may experience a material adverse effect on our business operations, revenues and financial condition; however, its ultimate impact is highly uncertain and subject to change.
If we cannot comply with the financial or other restrictive covenants in our credit agreement, or obtain waivers or other relief from our lender, we may cause an event of default to occur, which could result in loss of our sources of liquidity and acceleration of our debt.
In order to fund our recent acquisitions, we borrowed under a delayed-draw term loan.loan facility. Our ability to generate sufficient cash flow from operations to make scheduled payments on our term loan will depend on a range of economic, competitive and business factors, some of which are outside our control. If we are unable to meet our debt service obligations, we may need to refinance or restructure all or a portion of our debt on or before its stated maturity date, sell assets, pay down our outstanding debt and/or raise equity. We may not be able to refinance or restructure any of our debt, sell assets or raise equity, in each case on commercially reasonable terms or at all, which could cause us to default on our obligations and impair our liquidity. Our inability to generate sufficient cash flow to satisfy our debt obligations or to refinance or restructure our obligations on commercially reasonable terms could have a material adverse effect on our business, financial condition, results of operations and cash flows. Our credit agreement also contains financial and other restrictive covenants. Our ability to comply with the covenants in our credit agreement will depend upon our future performance and various other factors, some of which are beyond our control. We may not be able to maintain compliance with all of these covenants. In that event, we would need to seek an amendment to our credit agreement, a waiver from our lender, utilize cash to pay down outstanding debt and/or refinance or restructure our debt. There can be no assurance that we could obtain future amendments or waivers of our credit agreement, or refinance or restructure our debt, in each case on commercially reasonably terms or at all. Our failure to maintain compliance with the covenants under our credit agreement could result in an event of default, subject to applicable notice and cure provisions. Upon the occurrence of an event of default under our credit agreement, our lender could elect to declare all amounts outstanding thereunder to be immediately due and payable, terminate all commitments to extend further credit and cease making further loans. If we were unable to repay all outstanding amounts in full, our lender could exercise various remedies including instituting foreclosure proceedings against our assets pledged to them as collateral to secure that debt.
We have incurred indebtedness under the CARES Act, which will be subject to review, may not be forgivable in whole or in part and may eventually have to be repaid.
We received funds under the Paycheck Protection Program on April 24, 2020, in the amount of $10 million, serviced by Citizens Bank. The application for these funds requires us to, in good faith, certify that the current economic uncertainty made the loan request necessary to support our ongoing operations. This certification further requires the Company to take into account our current business activity and our ability to access other sources of liquidity sufficient to support ongoing operations in a manner that is not significantly detrimental to the business. The receipt of these funds, and the forgiveness of the loan attendant to these funds, is dependent on the Company having initially qualified for the loan and qualifying for the forgiveness of such loan based on our future adherence to the forgiveness criteria.
We plan to continue to use the proceeds from the Paycheck Protection Program for eligible payroll costs (as defined in the CARES Act), covered rent, covered utility payments and certain other expenditures that, while permitted, would not result in forgiveness of a corresponding portion of the loan. Following recent amendments to the Paycheck Protection Program, after an eight- or twenty-four-week period starting with the disbursement of the loan proceeds, the Company may apply for forgiveness of some or all of the loan, with the amount which may be forgiven equal to the sum of eligible payroll costs, mortgage interest (not applicable to the Company), covered rent, and covered utility payments, in each case incurred by the Company during the eight- or twenty-four-week period following the date of first disbursement. Certain reductions in the Company’s payroll costs or full-time equivalent employees (when compared against the applicable measurement period) may reduce the amount of the Loan eligible for forgiveness.
The U.S. Department of the Treasury ("Treasury") and the U.S. Small Business Administration ("SBA") have announced that they will review all Payroll Protection Program loans that equal or exceed $2.0 million. Guidance from Treasury and SBA has been slow to develop and occasionally unclear. At the same time, the Payroll Protection Program has been amended twice with the latest series of amendments significantly altering the timeline associated with the Payroll Protection Program spending and loan forgiveness. While the Company believes that it acted in good faith and has complied with all requirements of the Payroll Protection Program, if Treasury or SBA determined that the Company’s loan application was not made in good faith or that the we did not otherwise meet the eligibility requirements of the Payroll Protection Program, we may not receive forgiveness of the loan (in whole or in part) and we could be required to return the loan or a portion thereof. Further, there is no guarantee that we will receive forgiveness for any amount and forgiveness will be subject to review by our Bank of information and documentation that we submit, as required by SBA and the lender.
A failure to obtain forgiveness of the Payroll Protection Program loan may adversely impact loan covenants under our senior credit facility. In the event that our Payroll Protection Program loan was not forgiven in whole or in part, we may need to seek an amendment to our credit agreement, a waiver from our lender, utilize cash to repay the Payroll Protection Program debt and/or refinance or restructure our outstanding debt. There can be no assurance that we could obtain future amendments or waivers of our credit agreement, or refinance or restructure our debt, in each case on commercially reasonably terms or at all. Our failure to maintain compliance with the covenants under our credit agreement could result in an event of default, subject to applicable notice and cure provisions. Upon the occurrence of an event of default under our credit agreement, our lender could elect to declare all amounts outstanding thereunder to be immediately due and payable, terminate all commitments to extend further credit and cease making further loans. If we were unable to repay all outstanding amounts in full, our lender could exercise various remedies including instituting foreclosure proceedings against our assets pledged to them as collateral to secure that debt.
Substantial doubt has been raised in our ability to continue as going concern as a result of the economic slowdown caused the global COVID 19 pandemic and continued deterioration of business could have an adverse effect.
The global COVID-19 pandemic has continued to have a negative impact on our financial position and results of operations during the quarter ended June 30, 2020. We have experienced cancelled and delayed orders, canceled or paused projects, possible disruption of business as a result of worker illness or mandated shutdowns, our ability to maintain compliance with loan covenants and/or refinance existing indebtedness and access to new capital. The deterioration of our business due to the COVID-19 pandemic made us miss our minimum EBITDA covenants and possibly leverage ratios associated with covenants contained in our senior credit facility.
We were not in compliance with the amended financial covenants contained in our debt agreement, which were amended in April 2020. As the pandemic continues to distort our projections, we cannot rely on forecasted future earnings and could continue to see further deterioration in business causing non-compliance. Management believes the entity will be able to continue to develop new opportunities and will be able to obtain additional debt amendments; however, there is no assurance. We do have cash from the PPP loan and from ongoing operations to meet our operating requirements for at least the next twelve months.
If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results, and current and potential stockholders may lose confidence in our financial reporting.
We are required by the SEC to establish and maintain adequate internal control over financial reporting that provides reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements in accordance with U.S. generally accepted accounting principles. We are likewise required, on a quarterly basis, to evaluate the effectiveness of our internal controls and to disclose any changes and material weaknesses in those internal controls.
Based on management’s assessment, management has concluded that the Company’s internal control over financial reporting was not effective as of June 30, 2020 or at December 31, 2019 due to the existence of two material weaknesses in internal control over financial reporting surrounding the evaluation of significant or unusual transactions and certain controls within the financial reporting close process. Management realizes that two material weaknesses in our internal controls are serious matters and require thoughtful responses. We developed and implemented a remediation plan to address the identified material weakness as follows: (i) hiring of dedicated staffing, (ii) revision of controls to improve review of complex transactions and application of guidance, (iii) shortening the close process, (iv) new revenue process tools and controls and (v) and expanding our mitigating controls.
Although we believe that these efforts have strengthened our internal control over financial reporting and address the concern that gave rise to the material weakness as of December 31, 2019, we cannot be certain that our expanded knowledge and revised internal control procedures will ensure that we maintain adequate internal control over our financial reporting in future periods. Any failure to maintain such internal controls could adversely impact our ability to report our financial results on a timely and accurate basis. If our financial statements are not accurate, investors may not have a complete understanding of our operations. Likewise, if our financial statements are not filed on a timely basis as required by the SEC and The NASDAQ Capital Market (Nasdaq), we could confront an enforcement action from the SEC and/or delisting from Nasdaq. In either case, such an event could have a material adverse effect on our business. Finally, inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our common stock.
A disruption, failure or breach of our networks or systems, including as a result of cyber-attacks, could harm our business.
Global cyber security threats can range from uncoordinated individual attempts to gain unauthorized access to our information technology (IT) systems to sophisticated and targeted measures known as advanced persistent threats. While we employ comprehensive measures to prevent, detect, address and mitigate these threats (including access controls, data encryption, vulnerability assessments, continuous monitoring of our IT networks and systems, and maintenance of backup and protective systems), cyber security incidents, depending on their nature and scope, could potentially result in the misappropriation, destruction, corruption or unavailability of critical data and confidential or proprietary information (our own or that of third parties) and the disruption of business operations. The potential consequences of a material cyber security incident include reputational damage, litigation with third parties, civil or regulatory liability for loss of sensitive or protected information such as personal data, incident response costs, diminution in the value of our investment in research, development and engineering, loss of intellectual property, and increased cyber security protection and remediation costs, which in turn could adversely affect our competitiveness and results of operationsoperations.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
None
| Item 3. | Defaults Upon Senior Securities |
None
| Item 4. | Mine Safety Disclosures |
Not applicable.
None.
| | Separation Agreement of Christopher D. Sorrells, dated September 18, 2019, including Amendment to Restricted Share Unit Agreements. |
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| | | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes- Oxley Act of 2002, filed herewith. |
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| | | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith. |
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| | | Certification of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith. |
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| | | PPP Loan Agreement |
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| 101.INS* | XBRL Instance Document |
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| | 101.SCH* | XBRL Taxonomy Extension Schema |
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| | 101.CAL* | XBRL Taxonomy Extension Calculation Linkbase |
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| | 101.DEF* | XBRL Taxonomy Extension Definition Linkbase |
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| | 101.LAB* | XBRL Taxonomy Extension Label Linkbase |
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| | 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: NovemberAugust 19, 20192020
GSE SYSTEMS, INC.
/S/ KYLE J. LOUDERMILK
Kyle J. Loudermilk
Chief Executive Officer
(Principal Executive Officer)
/S/ EMMETT A. PEPE
Emmett A. Pepe
Chief Financial Officer
(Principal Financial and Accounting Officer)