UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q

(Mark One)
      
☒
  
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
for the quarterly period ended September 30, 2023
  
       
   
or
  
       
☐
  
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
for the transition period from ____ to ____
  

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

Delaware
  
52-1868008
(State of incorporation)
  
(I.R.S. Employer Identification Number)

6940 Columbia Gateway Dr., Suite 470, Columbia MD
  
21046
(Address of principal executive offices)
  
(Zip Code)

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

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

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

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

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

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

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

Securities registered pursuant to Section 12(b) of the Act:
 
Title of each class
  
Trading Symbol(s)
  
Name of each exchange on which registered
Common Stock, $0.01 Par Value
  
GVP
  
The NASDAQ Capital Market

There were 2,607,241 shares of common stock, with a par value of $0.01 per share outstanding as of October 31, 2023.

GSE SYSTEMS INC. AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS

   
Page
PART I.
3
Item 1.
Financial Statements (unaudited)
  
 
3
  4
  5
  6
 
8
  9
Item 2.
 28
Item 3.
 38
Item 4.
 39
PART II.
39
Item 1.
39
Item 1A. 
39
Item 2.
39
Item 3
39
Item 4
39
Item 5.
39
Item 6.
40

2
Table of Contents
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)

   
September 30, 2023
    
December 31, 2022
  
   
(unaudited)
        
ASSETS
  
Current assets:
            
Cash and cash equivalents
  
$
2,041
    
$
2,789
  
Restricted cash, current
    378       1,052  
Contract receivables, net of allowance for credit loss
    
10,697
      
10,064
  
Prepaid expenses and other current assets
    
569
      
2,165
  
Total current assets
    
13,685
      
16,070
  
                 
Equipment, software and leasehold improvements, net
    
648
      
772
  
Software development costs, net
    
698
      
574
  
Goodwill
    
5,362
      
6,299
  
Intangible assets, net
    
1,287
      
1,687
  
Restricted cash - long term     1,081       535  
Operating lease right-of-use assets, net
    
518
      
506
  
Other assets
    
42
      
53
  
Total assets
  
$
23,321
    
$
26,496
  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
                
Current liabilities:
                
Current portion of long-term note
  
$
1,445
    
$
3,038
  
Accounts payable
    
2,346
      
1,262
  
Accrued expenses
    
1,832
      
2,084
  
Accrued compensation
    
1,790
      
1,071
  
Billings in excess of revenue earned
    
4,215
      
4,163
  
Accrued warranty
    
265
      
370
  
Income taxes payable
    
1,629
      
1,774
  
Derivative liabilities
     1,538       603  
Other current liabilities
    
987
      
1,286
  
Total current liabilities
    
16,047
      
15,651
  
                 
Long-term note, less current portion
    
942
      
310
  
Operating lease liabilities noncurrent
    
315
      
160
  
Other noncurrent liabilities
    
168
      
144
  
Total liabilities
    
17,472
      
16,265
  
                 
Commitments and contingencies (Note 16)
            
                 
Stockholders’ equity:
                
Preferred stock $0.01 par value; 2,000,000 shares authorized; no shares issued and outstanding
    
-
      
-
  
Common stock $0.01 par value; 60,000,000 shares authorized, 2,648,085 and 2,404,681 shares issued, 2,488,194 and 2,244,790 shares outstanding, respectively
    
26
      
24
  
Additional paid-in capital
    
85,196
      
83,127
  
Accumulated deficit
    
(76,455
)
    
(69,927
)
Accumulated other comprehensive income
    
81
      
6
  
Treasury stock at cost, 159,891 shares
    
(2,999
)
    
(2,999
)
Total stockholders’ equity
    
5,849
      
10,231
  
Total liabilities and stockholders’ equity
  
$
23,321
    
$
26,496
  

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

3
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
   
Three months ended
    
Nine months ended
  
   
September 30,
2023
    
September 30,
2022
    
September 30,
2023
    
September 30,
2022
  
                         
Revenue
  
$
11,566
    
$
11,898
    
$
34,826
    
$
36,918
  
Cost of revenue
    
7,850
      
8,642
      
25,500
      
28,063
  
Gross profit
    
3,716
      
3,256
      
9,326
      
8,855
  
Operating expenses:
                                
Selling, general and administrative
    
4,301
      
4,336
      
12,742
      
13,253
  
Research and development
    
139
      
186
      
474
      
510
  
Goodwill and intangible asset impairment charge
     937       7,505       937       7,505  
Depreciation
    
43
      
69
      
144
      
213
  
Amortization of intangible assets
    
108
      
209
      
400
      
700
  
Total operating expenses
    
5,528
      
12,305
      
14,697
      
22,181
  
Operating loss
    
(1,812
)
    
(9,049
)
    
(5,371
)
    
(13,326
)
                                 
Interest expense, net
    
(430
)
    
(422
)
    
(1,483
)
    
(928
)
Change in fair value of derivative instruments, net
    
180
      
263
      
420
      
377
  
Other loss, net
    
(30
)
    
(2
)
    
(118
)
    
(58
)
Loss before income taxes
    
(2,092
)
    
(9,210
)
    
(6,552
)
    
(13,935
)
Benefit from income taxes    
(70
)
    
(218
)
    
(81
)
    
(108
)
Net loss
  
$
(2,022
)
  
$
(8,992
)
  
$
(6,471
)
  
$
(13,827
)
                                 
Net loss per common share - basic and diluted
  
$
(0.82
)
  
$
(4.22
)
  
$
(2.70
)
  
$
(6.55
)
                                 
Weighted average shares outstanding used to compute net loss per share - basic and diluted
    
2,480,505
      
2,128,888
      
2,398,468
      
2,110,194
  

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

4
Table of Contents
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)
(unaudited)

   
Three months ended
    
Nine months ended
  
   
September 30, 2023
    
September 30, 2022
    
September 30, 2023
    
September 30, 2022
  
Net loss
  
$
(2,022
)
  
$
(8,992
)
  
$
(6,471
)
  
$
(13,827
)
Cumulative translation adjustment
    
15
      
91
   
75
      
166
  
Comprehensive loss
  
$
(2,007
)
  
$
(8,901
)
  
$
(6,396
)
  
$
(13,661
)

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

5
Table of Contents
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(in thousands)
(unaudited)


  
Common Stock
    
               
Treasury Stock
        
Nine Months Ended
  
Shares
    
Amount
    
Additional
Paid-in
Capital
    
Accumulated
Deficit
    
Accumulated Other
Comprehensive Loss
    
Shares
    
Amount
    
Total
  
                                                 
Balance, January 1, 2023
    
2,405
    
$
24
    
$
83,127
    
$
(69,927
)
  
$
6
      
(160
)
  
$
(2,999
)
  
$
10,231
  
                                                                 
Adoption of ASC 326 Current Expected Credit Losses (CECL)
    -       -       -       (57 )     -       -       -       (57 )
                                                                 
Adjusted balance, January 1, 2023
     2,405       24       83,127       (69,984 )     6       (160 )     (2,999 )     10,174  
                                                                 
Stock-based compensation expense
    
-
      
-
      
865
      
-
      
-
      
-
      
-
      
865
  
Common stock issued for RSUs vested
    
46
      
-
      
-
      
-
      
-
      
-
      
-
      
-
  
Shares withheld to pay taxes
    
-
      
-
      
(88
)
    
-
      
-
      
-
      
-
      
(88
)
Foreign currency translation adjustment
    
-
      
-
      
-
      
-
      
75
      
-
      
-
      
75
  
Repayment of convertible note in shares
     197       2       1,292       -       -       -       -       1,294  
Net loss
    
-
      
-
      
-
      
(6,471
)
    
-
      
-
      
-
      
(6,471
)
                                                                 
Balance, September 30, 2023
    
2,648
    
$
26
    
$
85,196
    
$
(76,455
)
  
$
81
      
(160
)
  
$
(2,999
)
  
$
5,849
  
                                                                 
Balance, January 1, 2022
    
2,253
    
$
23
    
$
80,708
    
$
(54,584
)
  
$
(104
)
    
(160
)
  
$
(2,999
)
  
$
23,043
  
                                                                 
Stock-based compensation expense
    
-
      
-
      
1,504
      
-
      
-
      
-
      
-
      
1,504
  
Common stock issued for RSUs vested
    
44
      
-
      
(1
)
    
-
      
-
      
-
      
-
      
(1
)
Shares withheld to pay taxes
    
-
      
-
      
(226
)
    
-
      
-
      
-
      
-
      
(226
)
Foreign currency translation adjustment
    
-
      
-
      
-
      
-
      
166
      
-
      
-
      
166
  
Repayment of convertible note in shares
     34       -       320       -       -       -       -       320  
Net income
    
-
      
-
      
-
      
(13,827
)
    
-
      
-
      
-
      
(13,827
)
                                                                 
Balance, September 30, 2022
    
2,332
    
$
23
    
$
82,305
    
$
(68,411
)
  
$
62
      
(160
)
  
$
(2,999
)
  
$
10,980
  

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

6
Table of Contents
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(in thousands)
(unaudited)


  
Common Stock
    
               
Treasury Stock
        
Three Months Ended
  
Shares
    
Amount
    
Additional
Paid-in
Capital
    
Accumulated
Deficit
    
Accumulated Other
Comprehensive Loss
    
Shares
    
Amount
    
Total
  
                                                 
Balance, July 1, 2023
    
2,640
    
$
26
    
$
84,879
    
$
(74,433
)
  
$
66
      
(160
)
  
$
(2,999
)
  
$
7,539
  
                                                                 
Stock-based compensation expense
    
-
      
-
      
327
      
-
      
-
      
-
      
-
      
327
  
Common stock issued for RSUs vested
    
8
      
-
      
-
      
-
      
-
      
-
      
-
      
-
  
Shares withheld to pay taxes
    
-
      
-
      
(10
)
    
-
      
-
      
-
      
-
      
(10
)
Foreign currency translation adjustment
    
-
      
-
      
-
      
-
      
15
      
-
      
-
      
15
  
Net loss
    
-
      
-
      
-
      
(2,022
)
    
-
      
-
      
-
      
(2,022
)
                                                                 
Balance, September 30, 2023
    
2,648
    
$
26
    
$
85,196
    
$
(76,455
)
  
$
81
      
(160
)
  
$
(2,999
)
  
$
5,849
  
                                                                 
Balance, July 1, 2022
    
2,285
    
$
23
    
$
81,529
    
$
(59,419
)
  
$
(29
)
    
(160
)
  
$
(2,999
)
  
$
19,105
  
                                                                 
Stock-based compensation expense
    
-
      
-
      
479
      
-
      
-
      
-
      
-
      
479
  
Common stock issued for RSUs vested
    
13
      
-
      
-
      
-
      
-
      
-
      
-
      
-
  
Shares withheld to pay taxes
    
-
      
-
      
(23
)
    
-
      
-
      
-
      
-
      
(23
)
Foreign currency translation adjustment
    
-
      
-
      
-
      
-
      
91
      
-
      
-
      
91
  
Repayment of convertible note in shares
     34       -       320       -       -       -       -       320  
Net income
    
-
      
-
      
-
      
(8,992
)
    
-
      
-
      
-
      
(8,992
)
                                                                 
Balance, September 30, 2022
    
2,332
    
$
23
    
$
82,305
    
$
(68,411
)
  
$
62
      
(160
)
  
$
(2,999
)
  
$
10,980
  

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

7
Table of Contents
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

   
Nine months ended
  
   
September 30, 2023
    
September 30, 2022
  
Cash flows from operating activities:
            
Net loss
  
$
(6,471
)
  
$
(13,827
)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
                
Goodwill and intangible asset impairment charge
    937       7,505  
Depreciation
    
144
      
213
  
Legal settlement
    750       -  
Amortization of intangible assets
    
400
      
700
  
Amortization of capitalized software development costs
    
248
      
255
  
Amortization of deferred financing costs
    
22
      
11
  
Amortization of debt discount
     981       925  
Loss on debt settled in shares
    145       21  
Stock-based compensation expense
    
853
      
1,592
  
Credit loss expense
    
24
      
97
  
Change in fair value of derivative instruments, net
    
(420
)
    
(377
)
Foreign currency transaction (gain) loss
     152
       178
  
Deferred income taxes
     3       (80 )
Changes in assets and liabilities:
                
Contract receivables, net
    
(736
)
    
922
  
Prepaid expenses and other assets
    
1,891
      
3,638
  
Accounts payable, accrued compensation and accrued expenses
    
1,572
      
539
  
Billings in excess of revenue earned
    
76
      
(818
)
Accrued warranty
    
(98
)
    
(163
)
Other liabilities
    
(167
)
    
(581
)
Net cash provided by operating activities
    
306
      
750
  
                 
Cash flows from investing activities:
                
Capital expenditures
    
(19
)
    
(171
)
Capitalized software development costs
    
(372
)
    
(276
)
Net cash used in investing activities
    
(391
)
    
(447
)

               
Cash flows from financing activities:
                
Repayment of line of credit
    
-
      
(1,817
)
Repayment of insurance premium financing
    
(729
)
    
(906
)
Proceeds from issuance of long-term debt and warrants
    
1,800
      
5,750
  
Payments of debt issuance and original discount on issuance of long-term debt and warrants
    (386 )     (968 )
Principal repayment of convertible note
     (1,327 )     (319 )
Tax paid for shares withheld
    
(88
)
    
(226
)
Net cash (used in) provided by financing activities
    
(730
)
    
1,514
  
                 
Effect of exchange rate changes on cash
    
(61
)
    
(124
)
Net (decrease) increase in cash, cash equivalents and restricted cash
    
(876
)
    
1,693
  
Cash, cash equivalents and restricted cash at beginning of the period
    
4,376
      
3,550
  
Cash, cash equivalents and restricted cash at the end of the period
  
$
3,500
    
$
5,243
  
                 
Cash and cash equivalents   $ 2,041     $ 3,660  
Restricted cash, current     378       651  
Restricted cash included in other long-term assets     1,081       932  
Total cash, cash equivalents and restricted cash   $ 3,500     $ 5,243  
                 
Supplemental cash flow disclosures:                
Non-cash financing activities
                
Repayment of convertible note in shares
   $ 1,293     $ 320  
Establishment of new right-of-use assets
  $
333     $
60  
Establishment of new operating lease liability
  $
(333 )   $
(58 )
Discount on issuance of convertible note
   $ 300     $ 750  

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

8
GSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 1 - Summary of Significant Accounting Policies

Basis of Presentation

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

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

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. GAAP for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X. The accompanying balance sheet data as of December 31, 2022 was derived from our audited financial statements, but it does not include all disclosures required by U.S. GAAP.

The results of operations for interim periods are not necessarily an indication of the results for the full year. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2022, filed with the U.S. Securities and Exchange Commission on April 17, 2023.

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

Reverse Stock Split

On October 30, 2023, the Company effected a ten-for-one reverse stock split of the Company’s common stock whereby each ten shares of the Company’s authorized and outstanding common stock was replaced with one share of common stock. The par value of the common stock was not adjusted. Following the reverse split, the outstanding shares of common stock was adjusted to 2,607,241. All common share and per share amounts for all periods presented in the consolidated financial statements and the notes to the consolidated financial statements have been retrospectively adjusted to give effect to the reverse stock split.

Liquidity and Going Concern

The accompanying consolidated financial statements of the Company have been prepared assuming the Company will continue as a going concern and in accordance with U.S. GAAP. The going concern basis of presentation assumes that the Company will continue in operation one year after the date these financial statements are issued and will be able to realize its assets and satisfy its liabilities and commitments in the normal course of business. Pursuant to the requirements of the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) Topic 205-40, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, management must evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the Company’s ability to continue as a going concern for one year from the date these financial statements are issued. This evaluation does not take into consideration the potential mitigating effect of management’s plans that have not been fully implemented or are not within control of the Company as of the date the financial statements are issued. When substantial doubt exists under this methodology, management evaluates whether the mitigating effect of its plans sufficiently alleviates substantial doubt about the Company’s ability to continue as a going concern. The mitigating effect of management’s plans, however, are only considered if both (1) it is probable that the plans will be effectively implemented within one year after the date that the financial statements are issued, and (2) it is probable that the plans, when implemented, will mitigate the relevant conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. Management determined that as of November 14, 2023 substantial doubt exits about the Company’s ability to continue as a going concern within the next twelve months. The implemented plans to mitigate relevant conditions may not alleviate management’s concerns that raise substantial doubt about the Company’s ability to continue as a going concern within the twelve months ended November 14, 2024.

9
On November 4, 2022, the Company received a notification letter from NASDAQ related to NASDAQ Listing Rules informing us that the Company no longer meets the requirement to maintain a minimum bid price of $1.00 per share. The Company filed a Form 8-K on November 8, 2022, to disclose receipt of this letter. The Company had an initial 180-day period (or until May 3, 2023) to cure this deficiency by maintaining a closing bid price of $1 per share for at least 10 consecutive trading days, and if compliance was not achieved within the initial 180 calendar days we could petition NASDAQ for an additional period of 180 calendar days in which to increase the stock price. Anticipating that it would not regain compliance with the NASDAQ minimum closing bid price requirement by May 3, 2023, on April 19, 2023, the Company submitted a request for an additional 180-day period within which to regain compliance.  On May 4, 2023, the Company received a letter from NASDAQ advising that the 180-day extension – expiring on October 30, 2023 – had been granted due to the facts that the Company:

•
had met the market value of publicly held shares requirement for continuing listing,
•
had met all other listing requirements for NASDAQ (other than bid price requirement), and
•
had provided written notice to NASDAQ with a plan of how it intends to regain compliance with the bid price requirement during the second 180-day period.

The Company’s plan to regain compliance included continuing to monitor the closing bid price of its Common Stock and, if appropriate, implementing available options including, but not limited to, undertaking a reverse stock split of its outstanding securities at a ratio within the range of one-for-five to one-for-ten, which will have the initial effect of multiplying the trading price of the Company’s Common Stock by the same ratio. Because such an action requires stockholder approval, the Company put the matter before its stockholders for approval at the 2023 annual meeting of stockholders, which was held on June 12, 2023.

On October 25, 2023, the Company filed a Certificate of Amendment to its Restated Certificate of Incorporation with the Secretary of State of Delaware to effect a ten-for-one reverse stock split (the “Reverse Stock Split”) of the Common Stock. The Reverse Stock Split went effective at 12:01 a.m. Eastern Time on October 30, 2023, and the Common Stock was quoted on the NASDAQ Capital Market on a post-split basis at the open of business on October 30, 2023. All shares and per share amounts in the these consolidated financial statements and accompanying notes have been retroactively adjusted to give effect to the reverse stock split. Immediately following the reverse stock split, the Company’s issued and outstanding shares of Common Stock decreased from 26,072,411 pre-split to approximately 2,607,241 post-split shares. Due to the nature of the Minimum Bid Price Requirement, however, the Company was required to have effectuated the Reverse Stock Split not later than ten business or trading days prior to October 30, 2023, or October 17, 2023. While the Company effectuated the reverse stock split by October 30, 2023, due to an administrative oversight, the Company failed to satisfy this earlier deadline. On October 31, 2023, the Company received a telephone call from the staff of NASDAQ notifying the Company that, due to the Company’s failure to effectuate the Reverse Stock Split by October 17, 2023, and to establish ten trading dates to satisfy the Minimum Bid Price Requirement, the Company failed to establish compliance with the Minimum Bid Price Requirement per NASDAQ Listing Rule 5550(a)(2). NASDAQ followed with a written a staff determination letter dated October 31, 2023 (the “Staff Determination”), which provides that the Company had not regained compliance with the Minimum Bid Price Requirement and, as a result, unless the Company requests a timely appeal of the Staff Determination by November 9, 2023, the Company’s securities would be delisted.

On November 1, 2023, the Company submitted a timely appeal and request for hearing before a NASDAQ Hearings Panel (the “Panel”) to appeal the Staff Determination (the “Appeal”). The Company noted for the Panel that the Company has already effectuated the Reverse Stock Split and has satisfied the Minimum Bid Price Requirement through the submission of the Appeal. On November 2, 2023, the Company received a letter from the Panel (the “Panel Letter”) establishing a February 1, 2024 date for the hearing and stating that the delisting action referenced in the Staff Determination letter would be stayed pending a final written decision by the Panel. On November 3, 2023, in response to the Panel Letter, the Company submitted an expedited appeal and plan of compliance.

10
While there can be no assurance that the Company will ultimately regain and sustain compliance for listing of its securities on NASDAQ, based upon discussions with the staff of NASDAQ, the Company expects that if it continues to meets the Minimum Bid Price Requirement through November 10, 2023, no further action will be taken by NASDAQ, the Staff Determination may be withdrawn at the discretion of the Nasdaq staff and the hearing scheduled before the Panel would become moot.

If the Company’s Common Stock ceases to be listed on NASDAQ, which will not occur prior to the February 1, 2024 hearing before the Panel, Lind Global Fund II LP (“Lind Global”), as the holder of that certain convertible promissory note in the amount of $5,750,000 (as amended, the “2022 Convertible Note”) and that certain convertible promissory note in the amount of $1,800,000 (the “2023 Convertible Note” and, together with the 2022 Convertible Note, the “Convertible Notes”) (see Note 10 for further details), may deliver a notice of event of default together with a demand for payment to the Company for payment in full. If such a demand is delivered, the Company shall, within ten business days, pay all of the outstanding principal amount or, at its election, Lind Global may elect to convert all or a portion of the outstanding principal amount and the conversion price shall be adjusted to the lower of the then-current conversion price and 80% of the average of the three lowest daily variable average weighted prices during the twenty trading days prior to delivery. Additionally, if we are unable to maintain our listing on NASDAQ, it will constitute an event of default under the Convertible Notes, which would trigger certain obligations under the Convertible Notes including, but not limited to, causing an amount equal to 120% of the outstanding principal amount of the Convertible Notes to immediately become due. Although there can be no assurance that the Company will be able to regain compliance with the minimum bid price requirement within the time period(s) permitted by NASDAQ or maintain compliance with any of the other NASDAQ continued listing requirements, having obtained the required stockholder vote at our annual meeting, we believe we will be able to remediate the noncompliance.

The Company has incurred operating losses and has not demonstrated an ability to generate cash in excess of its operating expenses for a sustained period of time. During the year ended December 31, 2022, the Company generated a loss from operations of $14.4 million, which includes non-cash impairment charges of long-lived assets and goodwill from our Workforce Solutions segment totaling $7.5 million. During the nine months ended September 30, 2023, the Company generated $0.3 million of net cash provided by operating activities. As of September 30, 2023, the Company had unrestricted cash and cash equivalents of $2.0 million which is not sufficient to fund the Company’s planned operations through one year after the date the consolidated financial statements are issued. These factors create substantial doubt about the Company’s ability to continue as a going concern for at least one year after the date that our audited consolidated financial statements are issued.

In making this assessment we performed a comprehensive analysis of our current circumstances and to alleviate these conditions, management is monitoring the Company’s performance and evaluating strategies to obtain the required additional funding for future operations. These strategies may include, but are not limited to, restructuring of operations to grow revenues and decrease expenses, obtaining equity financing, issuing debt, or entering into other financing arrangements. The analysis used to determine the Company’s ability to continue as a going concern does not include cash sources outside the Company’s direct control that management expects to be available within the next twelve months.


Note 2 - Recent Accounting Pronouncements



Accounting pronouncements recently adopted



In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326) to replace the incurred loss impairment methodology under U.S. GAAP. This ASU introduces a new accounting model, the Current Expected Credit Losses model (CECL), which could result in earlier recognition of credit losses and additional disclosures related to credit risk. The CECL model will require the Company to use a forward-looking expected credit loss impairment methodology for the recognition of credit losses for financial instruments at the time the financial asset is originated or acquired, and require a loss be recognized before it is realized. The expected credit losses are adjusted each period for changes in expected lifetime credit losses. The new standard will apply to accounts receivable, loans, and other financial instruments with credit risk. This standard was effective for the Company beginning January 1, 2023. The Company adopted the new guidance starting January 1, 2023 on a modified retrospective basis. The impact of this ASU is reflected in the consolidated financial statements and was not material.


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Table of Contents

Management has evaluated other recently issued accounting pronouncements and does not believe that any of these pronouncements will have a significant impact on our consolidated financial statements and related disclosures.

Note 3 - Basic and Diluted Loss per Share

Basic earnings per share is based on the weighted average number of outstanding common shares for the period. Diluted earnings per share adjusts the weighted average shares outstanding for the potential dilution that could occur if outstanding RSU’s, stock options and warrants were exercised. Basic and diluted earnings per share are based on the weighted average number of outstanding shares for the period.

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 data)
  
Three months ended
    
Nine months ended
  
   
September 30, 2023
    
September 30, 2022
    
September 30, 2023
    
September 30, 2022
  
Numerator:
                        
     Net loss attributed to common stockholders
  
$
(2,022
)
  
$
(8,992
)
  
$
(6,471
)
  
$
(13,827
)
                                 
Denominator:
                                
Weighted-average shares outstanding for basic earnings per share
    
2,480,505
      
2,128,888
      
2,398,468
      
2,110,194
  
                                 
Adjusted weighted-average shares outstanding and assumed conversions for diluted earnings per share
    
2,480,505
      
2,128,888
      
2,398,468
      
2,110,194
  
                                 
Total shares considered for dilution
    
1,103,556
      
520,376
      
1,176,007
      
520,376
  

Note 4 - Coronavirus Aid, Relief and Economic Security Act

Employee Retention Credits (ERC)

Employee retention tax credits, made available under the CARES Act, allow eligible employers to claim a refundable tax credit against the employer share of Social Security tax equal to 70% of the qualified wages they pay to employees, initially from March 27, 2020 until June 30, 2021, and extended through September 30, 2021. In 2021, we applied for $5.0 million in refunds from the Internal Revenue Service with filing of our 941s and achieved $2.2 million in credits from unremitted payroll taxes as allowed. We recorded other income of $7.2 million related to the employee retention tax credits earned for the year ended December 31, 2021. During the three months ended June 30, 2023, we received $0.1 million refund, closing out our Employee tax refund credits totaling $5.0 million.

Note 5 - Contract Receivables

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

The components of contract receivables were as follows:

(in thousands)
  
September 30, 2023
   
December 31, 2022
 
             
Billed receivables
  
$
4,385
    
$
6,074
  
Unbilled receivables
    
6,755
      
5,146
  
Allowance for credit loss
    
(443
)
    
(1,156
)
Total contract receivables, net
  
$
10,697
    
$
10,064
  
12

During the first quarter of 2023, the Company adopted ASU 2016-13, “Credit Losses (Topic 326) Measurement of Credit Losses on Financial Instruments.” This ASU replaces the incurred loss impairment model with an expected credit loss impairment model for financial instruments, including accounts receivable. Under the new guidance, an entity recognizes its estimate of lifetime expected credit losses as an allowance, which the FASB believes will result in more timely recognition of such losses. Under the CECL impairment model, the Company develops and documents its allowance for credit losses on its contract receivables based on three portfolio segments by customer geographic location:  North America, China, Rest of World (ROW). The determination of portfolio segments is based primarily on the qualitative consideration of the nature of the Company’s business operations and the characteristics of the underlying trade receivables.


The following table sets forth the activity in the allowance for credit losses for the nine months ended September 30, 2023.


(in thousands)
      
Beginning balance at January 1, 2023
  
$
1,156
  
Adoption of ASC326 Current Expected Credit Losses (CECL)
     57  
Adjusted balance at January 1, 2023
     1,213  
Current period provision for expected credit (recovery) loss
    
(1
)
Write-offs charged against the allowance, net of recoveries
    
(729
)
Currency adjustment
    (40 )
Balance at September 30, 2023
  
$
443
  

During the three months ended September 30, 2023 we recorded credit loss expense of $(6) thousand, and no credit loss expense was recorded during the three months ended September 30, 2022. During the nine months ended September 30, 2023 and 2022, we recorded credit loss expense of $24 thousand and  $97 thousand, respectively. The write-offs charged against the allowance, net of recoveries is related to an unbilled receivable balance for a customer contract with our GSE Beijing entity, and had been fully reserved during the year ended 2021. During the three months ended June 30, 2023, management determine this amount to be fully uncollectible and was written off against the allowance.

During the month of October 2023, we invoiced $3.2 million of the unbilled receivables as of September 30, 2023.

Our foreign currency denominated contract receivables, billings in excess of revenue earned and subcontractor accruals that are related to the outstanding foreign exchange contracts are remeasured at the end of each reporting period into our functional currency, using the current exchange rate at the end of the period. The gain or loss resulting from such remeasurement is included in other income, net in the consolidated statements of operations. During the three months ended September 30, 2023 and 2022, we recognized a (loss) gain on remeasurement of these foreign exchange contracts of ($32) thousand and $6 thousand, respectively. During the nine months ended September 30, 2023 and 2022, we recognized a loss on remeasurement of these foreign exchange contracts of $(15) thousand and $(51) thousand, respectively.

Note 6 - Goodwill and Intangible Assets

The Company monitors operating results and events and circumstances that may indicate potential impairment of intangible assets. Management concluded that triggering events had occurred during the three and nine months ended September 30, 2023 and 2022.

During the three months ended September 30, 2022, we determined that the deterioration in sales, decline in revenues, delayed pipeline opportunities, and overall downward performance results and the forecast related to the Workforce Solutions business segment was material enough to be considered a triggering event that could result in impairment of our long-lived assets. We performed an interim analysis and determined an impairment existed at September 30, 2022 in accordance with ASC 350 & ASC 360. As such, we recorded an impairment of the related goodwill and definite-lived intangible assets of $7.0 million and $0.5 million, for the three months ended September 30, 2022, respectively. Goodwill impairment was allocated to the Training Services and Technical Staffing business units based on their pro rata share of Workforce Solution’s book value of Goodwill
13
During the three months ended September 30, 2023, we determined that the overall market capitalization deterioration due to the falling share price, decline in revenues, and delayed pipeline opportunities was material enough to be considered a triggering event that could result in impairment of our long-lived assets. We performed an interim analysis and determined an impairment existed for the Workforce Solutions business segment at September 30, 2023 in accordance with ASC 350 & ASC 360. As such, we recorded an impairment of the related goodwill of $0.9 million for the three and nine months ended September 30, 2023 to the Training Services and Technical Staffing business units based on their pro rata share of Workforce Solution’s book value of Goodwill. No impairment was identified related to any other asset grouping.

Goodwill

The following table shows the gross carrying amount and impairment of goodwill:

(in thousands)

 
  
Goodwill
    
Accumulated
Impairment
    
Net
  

                 
Engineering
  
$
8,278
    
$
(3,370
)
  
$
4,908
  
Workforce Solutions
    
8,431
      
(7,977
)
    
454
  
Net book value at September 30, 2023
  
$
16,709
    
$
(11,347
)
  
$
5,362
  

(in thousands)

 
  
Goodwill
    
Accumulated
Impairment
    
Net
  

                 
Engineering
  
$
8,278
    
$
(3,370
)
  
$
4,908
  
Workforce Solutions
    
8,431
      
(7,040
)
    
1,391
  
Net book value at December 31, 2022
  
$
16,709
    
$
(10,410
)
  
$
6,299
  

Intangible assets

The following table shows the gross carrying amount and accumulated amortization of definite-lived intangible assets:

(in thousands)
  
As of September 30, 2023
  
   
Gross Carrying
Amount
    
Accumulated
Amortization
     Impairment    
Net
  
Amortized intangible assets:
                        
Customer relationships
  
$
8,628
    
$
(7,318
)
   $ (464 )  
$
846
  
Trade names
    
1,689
      
(1,261
)
     -      
428
  
Developed technology
    
471
      
(471
)
     -      
-
  
Non-contractual customer relationships
    
433
      
(433
)
     -      
-
  
Noncompete agreement
    
527
      
(514
)
     -      
13
  
Alliance agreement
    
527
      
(527
)
     -      
-
  
Others
    
167
      
(167
)
     -      
-
  
Total
  
$
12,442
    
$
(10,691
)
   $ (464 )  
$
1,287
  

14
(in thousands)
  
As of December 31, 2022
  
   
Gross Carrying
Amount
    
Accumulated Amortization
    
Impairment
    
Net
  
Amortized intangible assets:
                        
Customer relationships
  
$
8,628
    
$
(7,050
)
  
$
(464
)
  
$
1,114
  
Trade names
    
1,689
      
(1,196
)
    
-
      
493
  
Developed technology
    
471
      
(471
)
    
-
      
-
  
Non-contractual customer relationships
    
433
      
(433
)
    
-
      
-
  
Noncompete agreement
    
527
      
(486
)
    
-
      
41
  
Alliance agreement
    
527
      
(488
)
    
-
      
39
  
Others
    
167
      
(167
)
    
-
      
-
  
Total
  
$
12,442
    
$
(10,291
)
  
$
(464
)
  
$
1,687
  

Amortization expense related to definite-lived intangible assets totaled $0.1 million and $0.2 million for the three months ended September 30, 2023 and 2022 and $0.4 million and $0.7 million for the nine months ended September 30, 2023 and 2022, respectively. The following table shows the estimated amortization expense of the definite-lived intangible assets for the next five years and thereafter:
 
(in thousands)
      
Years ended December 31:
      
2023 remainder
  
$
108
  
2024
    
332
  
2025
    
255
  
2026
    
204
  
2027
    
169
  
Thereafter
    
219
  
Total
  
$
1,287
  

Note 7 - Equipment, Software and Leasehold Improvements

Equipment, software and leasehold improvements, net consist of the following:

(in thousands)
            
   
September 30, 2023
    
December 31, 2022
  
Computer and equipment
  
$
2,375
    
$
2,363
  
Software
    
2,292
      
2,291
  
Leasehold improvements
    
660
      
659
  
Furniture and fixtures
    
840
      
838
  
     
6,167
      
6,151
  
Accumulated depreciation
    
(5,519
)
    
(5,379
)
Equipment, software and leasehold improvements, net
  
$
648
    
$
772
  

Depreciation expense was $43 thousand and $69 thousand for the three months ended September 30, 2023 and 2022, respectively. Depreciation expense was $144 thousand and $213 thousand for the nine months ended September 30, 2023 and 2022, respectively.

Note 8 - Fair Value of Financial Instruments

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

15
The levels of the fair value hierarchy established by ASC 820 are:

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

Level 2:  inputs are other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. A Level 2 input must be observable for substantially the full term of the asset or liability.

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

As of September 30, 2023 and December 31, 2022, we considered the recorded value of certain of our financial assets and liabilities, which consist primarily of cash and cash equivalents, contract receivable and accounts payable, to approximate fair value based upon their short-term nature.

Our convertible debt issued in February 2022, amended in June 2023 and our new convertible debt issued in June 2023 (see Note 10) includes certain embedded redemption features that are required to be bifurcated as embedded derivatives and measured at fair value on a recurring basis. We estimate the fair value using a Monte Carlo simulation based on estimates of our future stock price and assumptions about the possible redemption scenarios.

The Company used the Monte Carlo simulation model to determine the fair value of the Warrants (see Note 10) and Cash-Settled PRSUs, which required the input of subjective assumptions. The fair value of the Warrants as of September 30, 2023 was estimated with the following assumptions.
 

 
Amended 2022
Convertible Note
   
2023 Convertible
Note
  

           
Exercise Price
   $ 19.40     $ 5.00  
Common Stock Price
   $ 2.02    
$
2.02
  
Risk Free Rate
     4.7 %     4.13 %
Volatility
     80.0 %     80.0 %
Term (in years)
   3.4 yrs.     4.7 yrs.
 

The following table presents assets and liabilities measured at fair value at September 30, 2023:

(in thousands)
  
Quoted Prices
in Active Markets
for Identical Assets
(Level 1)
    
Significant
Other Observable
Inputs
(Level 2)
    
Significant
Unobservable
Inputs
(Level 3)
    
Total
  
                         
Derivative liability   $ -     $ -     $ 1,064     $ 1,064  
Warrant liability
     -       -       474       474  
Cash settled performance-vesting restricted stock units
     -       -       82       82  
 Total liabilities   $ -     $ -     $ 1,620     $ 1,620  

16
The following table presents assets and liabilities measured at fair value at December 31, 2022:

(in thousands)
  
Quoted Prices
in Active Markets
for Identical Assets
(Level 1)
    
Significant
Other Observable
Inputs
(Level 2)
    
Significant
Unobservable
Inputs
(Level 3)
    
Total
  
                         
Derivative liability   $ -     $ -     $ 285     $ 285  
Warrant liability
     -       -       267       267  
Cash settled performance-vesting restricted stock units
     -       -       51       51  
 Total liabilities   $ -     $ -     $ 603     $ 603  

The following table summarizes changes in the fair value of our Level 3 liabilities during the nine months ended September 30, 2023.

(in thousands)
  
Embedded
Redemption
Features
     Warrant    
Cash Settled
PRSUs
    Level 3 Total
 
Balance at December 31, 2022
  
$
285
     $ 267     $ 51     $ 603  
FV of derivatives with new convertible note issuance
     286       1,120       -       1,406  
Change in FV included in gain on derivative instruments, net
     493       (913 )     -       (420 )
Stock compensation less payments made
     -
       -
       31
       31
  
Balance at September 30, 2023
  
$
1,064
     $ 474     $ 82     $ 1,620  

Note 9 - Stock-Based Compensation

We recognize compensation expense on a pro rata straight-line basis over the requisite service period for stock-based compensation awards with both graded and cliff vesting terms. We recognize the cumulative effect of a change in the number of awards expected to vest in compensation expense in the period of change. We have not capitalized any portion of our stock-based compensation. Our forfeiture rate is based on actuals.


During the three months ended September 30, 2023 and 2022, we recognized $0.3 million and $0.5 million of stock-based compensation expense related to RSU and PRSU awards, respectively, under the fair value method. We recognized $0.9 million and $1.5 million of stock-based compensation expense related to RSU and PRSU awards for the nine months ended September 30, 2023 and 2022, respectively.



During the three and nine months ended September 30, 2023, we granted approximately 45,455 and 90,782 time-based restricted stock units (“RSUs”) with an aggregate fair value of approximately $0.1 million and $0.3 million, respectively. During the nine months ended September 30, 2022, we granted approximately 96,025 time-based RSUs with an aggregate fair value of approximately $1.5 million. We granted no time-based RSUs during the three months ended September 30, 2022. During the three months ended September 30, 2023 and 2022, we vested approximately 54,999 and 11,299 RSUs, respectively. During the nine months ended September 30, 2023 and 2022, we vested approximately 98,446 and 49,281 RSUs, respectively. Typically RSUs vest quarterly in equal amounts over the course of one to three years.

GSE’s 1995 long-term incentive program (“LTIP”) provides for the issuance of performance-vesting and time-vesting RSUs to certain executives and employees. Vesting of the performance-vesting restricted stock units (“PRSU”) is contingent upon the employee’s continued employment and the Company’s achievement of certain performance goals during designated performance periods as established by the Compensation Committee of the Company’s Board of Directors. We recognize compensation expense, net of estimated forfeitures, for PRSUs 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.

17
During the nine months ended September 30, 2023, we granted approximately 59,767 PRSU’s. These grants are subject to multiple vesting criteria including reaching a 20-day VWAP of $15.00 prior to the expiration of the awards, and a time-vesting restriction, which will vest in equal parts over the next 18 quarters. During the nine months ended September 30, 2022, there were 80,000 PRSUs granted, including 20,000 cash-settled grants to employees. These grants are subject to multiple vesting criteria including reaching a 20-day VWAP of $19.40 prior to the expiration of the awards, and a time-vesting restriction, which will vest in equal portions over the next 15 quarters ending December 31, 2025. There were no PRSUs granted during the three months ended September 30, 2023 or September 30, 2022. During the nine months ended September 30, 2023 and 2022, we vested 15,000 PRSUs, of which, 3,750 PRSUs were cash-settled, respectively. The market vesting criteria for the Q1 2022 PRSU grant was achieved in April 2022 for the 80,000 PRSUs which will fully vest over the next 9 quarters.

We did not grant any stock options for the nine months ended September 30, 2023 and 2022.

Note 10 - Debt

Convertible Note

On February 23, 2022, we entered into a Securities Purchase Agreement, as amended, with Lind Global, pursuant to which we issued to Lind Global the 2022 Convertible Note (see Note 1) and a common stock purchase warrant to acquire 128,373 shares of our Common Stock (the “2022 Warrant”). The 2022 Convertible Note does not bear interest but was issued at a $0.75 million discount (“OID”). We received proceeds of approximately $4.8 million net of the OID and expenses.


On June 23, 2023, we entered into an Amended & Restated Agreement to amend the February 23, 2022 Securities Purchase Agreement (Original Note).

(in thousands)  
2022
Convertible
Note
    
2023
Convertible
Note
    
Total
Convertible
Notes
  
   
Amount
     Amount     Amount  
                   
Convertible Note issued
   $ 5,750     $ 1,800     $ 7,550  
Debt discount
     (750 )     (300 )     (1,050 )
Issuance cost:
                        
Commitment fee
     (175 )     (52 )     (227 )
Balance of investor’s counsel fees
     (43 )     (34 )     (77 )
Net proceeds of Convertible Note
   $ 4,782     $ 1,414     $ 6,196  
                       
Additional OID costs not in original funds flow     (121 )     (15 )     (136 )
Fair value of Warrant Liabilities on issuance     (724 )     (1,119 )     (1,843 )
Fair value of Conversion Feature on issuance     (306 )     (286 )     (592 )
Allocated OID costs to Warrants     25       30       55  
Additional OID costs not in original funds flow
     (660 )     660       -  
Interest expense accrued on Convertible Note as of September 30, 2023     2,645       135       2,780  
Principal and interest payments through September 30, 2023     (4,073 )     -       (4,073 )
                       
Balance of Convertible Note as of September 30, 2023   $ 1,568     $ 819     $ 2,387  

18
The Convertible Note provides for 18 monthly principal repayments of $319 thousand beginning 180 days from issuance.  Payments could be made in the form of cash, shares, or a combination of both at the discretion of GSE.

The 2022 Convertible Note is convertible into our Common Stock at any time after the earlier of six months from issuance of the Convertible Note or the date of an effective registration statement filed with the SEC covering the underlying shares. The conversion price of the 2022 Convertible Note is equal to $19.40 per share, subject to customary adjustments. The 2022 Convertible Note matures in February of 2024, although we are permitted to prepay the 2022 Convertible Note, provided that Lind Global shall have the option to convert up to one third of the outstanding principal of the 2022 Convertible Note at a price per share equal to the lessor of the Repayment Share price or the conversion price (as described below). The 2022 Convertible Note is guaranteed by each of our subsidiaries and is secured by a first priority lien on all of our assets. The 2022 Convertible Note is not subject to any financial covenants and events of default under the 2022 Convertible Note are limited to events related to payment, market capitalization, certain events pertaining to conversion and the underlying shares of Common Stock and other customary events including, but not limited to, bankruptcy or insolvency. Upon the occurrence of an event of default, the 2022 Convertible Note will become immediately due and payable at an amount equal to 120% of the outstanding principal, subject to any cure periods described in the 2022 Convertible Note, and the customer may demand that all or a portion of the outstanding principal amount be converted into shares of common stock at the lower of the then current conversion price and 80% of the average of the three lowest daily volume-weighted average price (“VWAPs”) during the twenty days prior to delivery of the conversion notice. If there is a change of control of the Company, Lind Global has the right to require us to prepay the outstanding principal amount of the 2022 Convertible Note.

On June 23, 2023, the Company and Lind Global agreed to amend and restate the 2022 Convertible Note. The 2022 Convertible Note, as now amended, is now secured, interest free convertible promissory note in the principal amount of $2,747,228, such amount being the outstanding balance of the 2022 Convertible Note as of June 23, 2023. Just prior to the amendment, there was an event of default (EOD) related to the total market capitalization provision in the original 2022 Convertible Note. The EOD that occurred was waived, and we incurred a 20% charge included in the amended and restated 2022 Convertible Note, which the Company has treated as additional interest. The 2022 Convertible Note now has a maturity date of August 23, 2024 and is now payable, commencing on July 23, 2023, in twelve (12) consecutive monthly payments of $186,343 each and two (2) final payments of $255,556 each. The remainder of the terms of the 2022 Convertible Note, including terms around payment, prepayment, default and conversion, are unchanged.

On October 6, 2023, the Company and Lind Global entered into that certain First Amendment to the 2022 Convertible Note (“A&R Note Amendment”), amending the 2022 Convertible Note. The A&R Note Amendment amended Section 2.1 pertaining to events of default by deleting and replacing Section 2.1(r), which previously provided for an event of default under the Note in the event that the Company’s Market Capitalization was below $7 million for ten (10) consecutive days. As amended, the A&R Note provides that, at any time after January 31, 2024, an event of default will occur in the event that the Company’s Market Capitalization is below $7 million for ten (10) consecutive days. Prior to the Amendment, the “Conversion Price” in Section 3.1(b) of the A&R Note “means $19.40, and shall be subject to adjustment as provided herein.” The A&R Note Amendment amended the definition of “Conversion Price” “the lower of (i) $19.40 and (ii) eighty-five percent (85%) of the average of the three (3) lowest daily VWAPs during the twenty (20) Trading Days prior to the delivery by the Holder of the applicable notice of conversion.”

The 2022 Warrant entitles Lind Global to purchase up to 128,373 shares of our Common Stock until February 23, 2027, at an exercise price of $19.40 per share, subject to customary adjustments described therein.  The Warrant is recorded at fair value upon issuance of $0.7 million and is classified as a current liability to be remeasured at each reporting period (see Note 8). The discount created by allocating proceeds to the Warrant results in a debt discount to be amortized as additional interest expense over the term of the Convertible Note.

On June 23, 2023 in connection with the 2022 amended and restated Convertible Note transaction, the Company evaluated the amendment and concluded it qualified as a troubled debt restructuring.  The restructuring did not result in a gain or loss but revised the effective interest rate used to amortized the note going forward.


On June 23, 2023, the Company entered into a second Securities Purchase Agreement (the “2023 Purchase Agreement”) with Lind Global, pursuant to which the Company issued to Lind Global the 2023 Convertible Note.  The Company and Lind Global also amended and restated the 2022 Convertible Note.  The closings of the transactions contemplated under the 2023 Purchase Agreement may occur in tranches.  The first closing occurred on June 23, 2023, and consisted of the issuance of a secured, two-year interest free convertible promissory note with a funding amount of $1,500,000 and a principal amount of $1,800,000 (the “2023 Convertible Note”) and the issuance of common stock purchase warrant to acquire 426,427 shares of the Company’s common stock (the “2023 Warrant” and, together with the 2022 Warrant, the “Warrants”). The proceeds from the transactions contemplated by the 2023 Purchase Agreement were for general working capital purposes and other corporate purposes.

19
On October 6, 2023, the Company and Lind Global entered into that certain First Amendment to Senior Convertible Promissory Note, amending the Company’s 2023 Convertible Note (the “Note Amendment”). The Note Amendment amended Section 2.1 of the 2023 Convertible Note pertaining to events of default by deleting and replacing Section 2.1(r), which previously provided for an event of default under the Note in the event that the Company’s Market Capitalization (as defined in the Note) was below $7 million for ten (10) consecutive days. As amended, the Note provides that, at any time after January 31, 2024, an event of default will occur in the event that the Company’s Market Capitalization is below $7 million for ten (10) consecutive days.


Commencing one year after the issuance of the 2023 Convertible Note, the Company shall pay the outstanding principal amount of the 2023 Convertible Note in twelve (12) consecutive monthly payments of $150,000 each. At the option of the Company, the monthly payment can be made in cash, shares of the common stock of the Company (the “Repayment Shares”) at a price based on 90% of the average five (5) consecutive daily VWAPs during the twenty (20) days prior to the payment date, or a combination of cash and Repayment Shares, subject to the terms of the 2023 Convertible Note.  The Repayment Shares must either be eligible for immediate resale under Rule 144 or be registered. The number of Repayment Shares is limited such that, when added to the number of shares of common stock issued and issuable pursuant to the transactions contemplated by the 2023 Purchase Agreement, it may not exceed 493,727 shares of common stock unless the Company obtains stockholder approval to issue additional Repayment Shares. The holder of the 2023 Convertible Note may elect with respect to no more than two (2) of the above described monthly payments to increase the amount of such monthly payment up to $300,000 each in Repayment Shares upon notice to the Company. Any such increased payment shall be deducted from the amount of the last monthly payment owed under the 2023 Convertible Note.  The Company can prepay Lind Global all the outstanding principal amount of the 2023 Convertible Note, provided that Lind Global shall have the option to convert up to one third (1/3) of the outstanding principal amount of the 2023 Convertible Note at a price per share equal to the lesser of the Repayment Share price or the conversion price (as described below).


Upon the occurrence of an event of default as described in the 2023 Convertible Note, the 2023 Convertible Note will become immediately due and payable at the default premium described in the 2023 Convertible Note, subject to any cure periods described in the 2023 Convertible Note. Events of default include, but are not limited to, a payment default on any other indebtedness in excess of $250,000; the shares no longer publicly being traded or cease to be listed on a trading market; if after six months, the shares are not available for immediate resale under Rule 144; and the Company’s market capitalization is below $7,000,000 for ten (10) consecutive days. Upon an event of default, subject to any applicable cure period, the holder of the 2023 Convertible Note can, among other things, accelerate payment of the 2023 Convertible Note and demand full payment and demand that all or a portion of the outstanding principal amount be converted into shares of common stock at the at the lower of the then current conversion price and 85% of the average of the three (3) lowest daily VWAPs during the twenty (20) days prior to delivery of the conversion notice.  If there is a change of control of the Company, Lind Global has the right to require the Company to prepay 105% of the outstanding principal amount of the 2023 Convertible Note. A change of control includes a change in the composition of a majority of the Board of Directors of the Company, at a single shareholder meeting, a change, without prior written consent of Lind Global where a majority of the individuals that were directors as of June 20, 2023 cease to be directors of the Company (provided that any individual who is nominated by the board of directors (or a duly authorized committee thereof) as of June 20, 2023 and is elected or appointed as a director of the Company shall be deemed a member of the board of directors of the Company for all such purposes), a shareholder acquiring beneficial ownership of more than 50% of the common stock of the Company, or the sale or other disposition of the Company of all or substantially all of its assets.  The 2023 Convertible Note is convertible into common stock of the Company at any time after the earlier of six (6) months from issuance or the date the registration statement is effective, provided that no such conversion may be made that would result in beneficial ownership by Lind Global and its affiliates of more than 4.99% of the Company’s outstanding shares of common stock. The conversion price of the 2023 Convertible Note is equal to $5.00, subject to customary adjustments.


20
The 2023 Warrant entitles Lind Global to purchase up to 426,427 shares of common stock of the Company until the earlier of (a) June 23, 2028 and (b) a merger, sale event or other reclassification of the Company’s common stock, at an exercise price of $5.00 per share, subject to customary adjustments described therein. The 2023 Warrant is in addition to the 2022 Warrant.

The Company evaluated the Convertible Notes and concluded that certain embedded redemption features are required to be accounted for as a derivative liability. Embedded redemption features were recorded at fair value upon issuance of $0.3 million and are classified as current liabilities to be remeasured at each reporting period (see Note 8). The discount created by allocating proceeds to the derivative liability results in a debt discount to be amortized as additional interest expense over the term of the Convertible Notes. The Warrants are accounted for as a derivative liability based on certain features included within the Convertible Note which caused the Company to not be able to assert that it would have sufficient shares in all cases to be able to settle the Warrants. As such, the proceeds (approximately $4.8 million, net of original issue discounts and other payments to lender) were allocated first to the fair value of the Warrants with the residual allocated to the Convertible Notes host instrument. The proceeds allocated to the Convertible Notes were further allocated first to the bifurcated derivative liability based on its fair value with the residual being allocated to the Convertible Notes host instrument.

Upon issuance of the 2023 Convertible Note, the Company re-evaluated the 2022 Convertible Note, in accordance with ASC 815-40-25-10 and its sequencing policy, and concluded that the embedded conversion option is required to be bifurcated and accounted for as a derivative liability as a result of the Company not being able to assert that it would have sufficient shares in all cases to be able to settle the conversion of the 2022 Convertible Note.  The embedded conversion option will be combined with the bifurcated redemption features as a single derivative and is classified as a current liability to be remeasured at each reporting period.  The discount resulting from bifurcating the embedded conversion option will be amortized as additional interest expense over the term of the 2022 Convertible Note.

The direct and incremental costs incurred are allocated to the Convertible Note and the Warrant based on a systematic and rational approach. The costs allocated to the Warrants have been expensed as incurred while those allocated to the Convertible Note have been capitalized and will be amortized as interest expense over the life of the Convertible Notes based on the effective interest rate. The Company will record ongoing changes to the fair value of the derivative liabilities as other non-operating income (expense).

The Convertible Notes are evaluated as a potentially dilutive security in both periods of loss and income for diluted earnings per share purposes. The Warrants are considered a participating security and was not included in the calculation of basic earnings per share for the period ended September 30, 2023 as Company reflected net loss for this period. The Warrant will be included in the calculation of diluted earnings per share in periods of net income.

The issuance costs with respect to the Convertible Notes, which are recorded as a debt discount, are deferred and amortized using the effective interest method as additional interest expense over the terms of the Convertible Note at an effective interest rate of 68.6%.

The Company incurred total interest expense related to the Convertible Notes of $1.5 million, including $0.5 million default charge and the amortization of the various discounts for the nine months ended September 30, 2023, respectively. The Company incurred total interest expense related to the Convertible Notes of $0.4 million for both the three months ended September 30, 2023 and 2022.

Revolving Line of Credit

In February 2022, using proceeds from the Convertible Note, we repaid in full, all outstanding indebtedness of $1.8 million owed on our Amended and Restated Credit and Security Agreement between us, our subsidiaries, and Citizens Bank, N.A. (“Citizens”) was terminated. Certain letters of credit remain in place with Citizens. As of September 30, 2023, we had four letters of credit totaling $1.1 million outstanding to certain customers which were secured with restricted cash.
 
21
Note 11 - Product Warranty

We accrue estimated warranty costs at the time the related revenue is recognized and based on historical experience and projected claims. Our System Design and Build contracts generally include a one year base warranty on the systems. The portion of our warranty provision expected to be incurred within twelve months is classified as current within accrued warranty and totals $265 thousand, and the remaining $137 thousand is classified as long-term within other non-current liabilities.

The activity in the accrued warranty accounts during the current period is as follows:

(in thousands)
      
Balance at January 1, 2023
  
$
503
  
Current period recovery
    
(73
)
Current period claims
    
(29
)
Currency adjustment
    
1
Balance at September 30, 2023
  
$
402
  

Note 12 - Revenue

We account for revenue in accordance with ASC 606, Revenue from Contracts with Customers. We primarily generate revenue through three distinct revenue streams: (1) System Design and Build (“SDB”), (2) Software and (3) Training and Consulting Services across our Engineering and Workforce Solutions segments. We recognize revenue from SDB and software contracts mainly through our Engineering segment. We recognize training and consulting service contracts through both segments.
The following table represents a disaggregation of revenue by type of goods or services for the three and nine months ended September 30, 2023 and 2022, along with the reporting segment for each category:

(in thousands)
  
Three months ended
    
Nine months ended
  
   
September 30,
2023
    
September 30,
2022
    
September 30,
2023
    
September 30,
2022
  
Engineering
                        
System Design and Build
  
$
1,192
    
$
1,537
    
$
4,801
    
$
4,991
  
Over time     1,192       1,537       4,801       4,991  
                                 
Software and Support
    
1,373
      
2,010
      
3,662
      
3,560
  
Point in time
    
259
      
530
      
627
      
662
  
Over time
    
1,114
      
1,480
      
3,035
      
2,898
  
                                 
Training and Consulting Services
    
6,092
      
4,505
      
16,180
      
13,851
  
Point in time
    
131
      
195
      
428
      
428
  
Over time
    
5,961
      
4,310
      
15,752
      
15,752
  
                                 
Workforce Solutions                                
Training and Consulting Services
    
2,909
      
3,846
      
10,183
      
14,516
  
Point in time
    
16
      
52
      
225
      
52
  
Over time
    
2,893
      
3,794
      
9,958
      
14,464
  
                                 
Total revenue
  
$
11,566
    
$
11,898
    
$
34,826
    
$
36,918
  

22
The following table reflects revenue recognized in the reporting periods presented that was included in contract liabilities from contracts with customers as of the beginning of the periods presented:

(in thousands)
  
Three months ended
    
Nine months ended
  
   
September 30,
2023
    
September 30,
2022
    
September 30,
2023
    
September 30,
2022
  
Revenue recognized in the period from amounts included in billings in excess of revenue earned at the beginning of the period
  
$
466
    
$
174
    
$
3,571
    
$
2,666
  


Note 13 - Income Taxes

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

(in thousands)
  
Three months ended
    
Nine months ended
  
   
September 30,
2023
    
September 30,
2022
    
September 30,
2023
    
September 30,
2022
  
Loss before income taxes
  
$
(2,092
)
  
$
(9,210
)
  
$
(6,552
)
  
$
(13,935
)
Benefit from income taxes
    
(70
)
    
(218
)
    
(81
)
    
(108
)
Effective tax rate
    
3.35
%
    
2.4
%
    
1.24
%
    
0.8
%


Our income tax expense for the interim periods presented is determined using an estimate of our annual effective tax rate, adjusted for discrete items arising in that quarter. Total income tax benefit for the three and nine months ended September 30, 2023 was comprised mainly of current foreign tax benefit, deferred state tax benefit related to the portion of goodwill which cannot be offset by deferred tax assets and state tax expense. Total income tax benefit for the three and nine months ended September 30, 2022 was comprised mainly of current foreign tax benefit and deferred federal and state tax benefit related to the portion of goodwill which cannot be offset by deferred tax assets, and state tax expense.



For the three and nine months ended September 30, 2023, the difference between our income tax benefit at an effective tax rate of 3.35% and 1.24% respectively, and the U.S. statutory federal income tax rate of 21% was primarily due to accruals related to uncertain tax positions for certain foreign tax contingencies, a change in valuation allowance in our U.S. entity, the permanent disallowance of interest expense related to disqualified debt, and discrete item adjustments for U.S. taxes. For the three and nine months ended September 30, 2022, the difference between our income tax benefit at an effective rate of 2.4% and 0.8% respectively, and the U.S. statutory federal income tax rate of 21% was primarily due to accruals related to uncertain tax positions for certain foreign tax contingencies, a change in tax valuation allowance in our U.S. entity, the permanent disallowance of interest expense related to disqualified debt, and discrete item adjustments for U.S. and foreign taxes.



Because of our net operating loss carryforwards, we are subject to U.S. federal and state income tax examinations from the year 2003 and forward and are subject to foreign tax examinations by tax authorities for years 2017 and forward.



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



We recognize deferred tax assets to the extent that it is believed that these assets are more likely than not to be realized. We have evaluated all positive and negative evidence and determined that we will continue to assess a full valuation allowance on our U.S., China, and Slovakia net deferred assets as of September 30, 2023. We have determined that it is not more likely than not that the Company will realize the benefits of its deferred taxes in the U.S. and foreign jurisdictions.
Note 14 - Leases

We have lease agreements with lease and non-lease components, which are accounted for as a single lease. We apply a portfolio approach to effectively account for the operating lease ROU assets and liabilities. The operating lease ROU amortization was $311 thousand and $467 thousand for the nine months ended September 30, 2023 and 2022, respectively. For the three months ended September 30, 2023 and 2022, we recorded ROU amortization of $81 thousand and $159 thousand, respectively.

23
Lease contracts are evaluated at inception to determine whether they contain a lease and 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, 2023
    
December 31, 2022
  
                 
Leased Assets
                
Operating lease - right of use assets
  
Long term assets
 
$
518
    
$
506
  
                     
Lease Liabilities
                    
Operating lease liabilities - Current
   Other current liabilities
    
226
      
418
  
Operating lease liabilities
  
Long term liabilities
   
315
      
160
  
         
$
541
    
$
578
  

On June 7, 2023 we entered into an office lease agreement to lease 2,704 square feet in Fort Worth, Texas for an initial lease term ending November 7, 2030. We entered into a lease agreement to lease 2,200 square feet of office space in Columbia, Maryland on September 26, 2022, through November 30, 2024.

On December 15, 2022, we terminated our lease for 1332 Londontown Boulevard, Eldersburg, Maryland (our former headquarters) and entered into a release and settlement agreement whereby we agreed to pay, and the landlord agreed to accept, a reduced monthly payment through May 1, 2023 in exchange for early termination of the lease. As a part of this agreement, we assigned both active subleases to the landlord effective as of the execution date.

The table below summarizes lease income and expense recorded in the consolidated statements of operations incurred during the three and nine months ended September 30, 2023 and 2022, (in thousands):

            
Three months ended
     Nine months ended
 
Lease Cost
  
Classification
  
September 30, 2023
    
September 30, 2022
     September 30, 2023     September 30, 2022  
                             
Operating lease cost (1)
  
Selling, general and administrative expenses
  
$
90
    
$
174
     $ 333     $ 534  
Short-term leases costs (2)
  
Selling, general and administrative expenses
    
2
      
15
       27       45  
Sublease income (3)
  
Selling, general and administrative expenses
    
-
      
(18
)
     -       (55 )
Net lease cost
      
$
92
    
$
171
     $ 360     $ 524  

(1) Includes variable lease costs which are immaterial.
(2) Includes leases maturing less than twelve months from the report date.
(3) Sublease portfolio consists of two tenants, which subleased parts of our principal executive office located at 1332 Londontown Blvd, Suite 200, Sykesville, MD.

24
The Company is obligated under certain noncancelable operating leases for office facilities and equipment. Future minimum lease payments under noncancelable operating leases as of September 30, 2023 are as follows:

(in thousands)
  
Gross Future
Minimum Lease
Payments
  
2023 remainder
  
$
62
  
2024
    
220
  
2025
    
96
  
2026
    
91
  
2027
    
142
  
Thereafter
     -  
Total lease payments
  
$
611
  
Less: Interest
    
70
  
Present value of lease payments
  
$
541
  

We calculated the weighted-average remaining lease term, presented in years below and the weighted-average discount rate for our operating leases, and we use the incremental borrowing rate as the lease discount rate.

Lease Term and Discount Rate
  
September 30, 2023
    
December 31, 2022
 
Weighted-average remaining lease term (years)
  
   
 
Operating leases
   
3.59
      
1.51
  
Weighted-average discount rate
                
Operating leases
     6.21 %     5.00 %

The table below sets out the classification of lease payments in the consolidated statements of cash flows.

(in thousands)
  
Nine months ended
  
Cash paid for amounts included in measurement of liabilities
  
September 30, 2023
    
September 30, 2022
 
Operating cash flows used in operating leases
  
$
410
    
$
934
  

Note 15 - Segment Information

We have two reportable business segments. The Engineering segment provides simulation, training and engineering products and services delivered across the breadth of industries we serve. Solutions include simulation for both training and engineering applications. Example 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 American Society of Mechanical Engineers (“ASME”) code and ASME Section XI. The Company provides these services across all market segments through our Performance, True North consulting, and DP Engineering subsidiaries. Example training applications include turnkey and custom training services. Contract terms are typically less than two years.

Workforce Solutions segment provides specialized workforce solutions primarily to the nuclear industry, working at 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 product and service portfolio.

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:

   
Three months ended
    
Nine months ended
  
(in thousands)
  
September 30, 2023
    
September 30, 2022
    
September 30, 2023
    
September 30, 2022
  
                         
Revenue:
                        
Engineering
  
$
8,657
    
$
8,052
    
$
24,643
    
$
22,402
  
   Workforce Solutions
    
2,909
      
3,846
      
10,183
      
14,516
  
Total revenue
    
11,566
      
11,898
      
34,826
      
36,918
  
                                 
Gross Profit
                               
Engineering
     3,346
       2,654
       7,968
       7,037
  
Workforce Solutions
    370       602       1,358       1,818  
Total gross profit
    3,716       3,256       9,326       8,855  
                                 
Operating loss
                                
   Engineering
    
(7
)
    
(1,403
)
    
(3,048
)
    
(5,511
)
   Workforce Solutions
    
(1,055
)
    
(7,646
)
    
(1,573
)
    
(7,815
)
Provision for legal settlement     (750 )     -       (750 )     -  
                                 
Operating loss
    
(1,812
)
    
(9,049
)
    
(5,371
)
    
(13,326
)
                                 
Interest expense, net
    
(430
)
    
(422
)
    
(1,483
)
    
(928
)
Change in fair value of derivative instruments, net    
180
      
263
      
420
      
377
  
Other loss, net
    
(30
)
    
(2
)
    
(118
)
    
(58
)
Loss before income taxes
  
$
(2,092
)
  
$
(9,210
)
  
$
(6,552
)
  
$
(13,935
)

25
Table of Contents
Note 16 - Commitments and Contingencies

Three former employees of Absolute Consulting, Inc. and Hyperspring, LLC, filed putative class action lawsuits against  the Company, alleging that the Company failed to pay overtime wages as required by the Fair Labor Standards Act and state law. The three cases Natalie Adams v. Absolute Consulting, Inc., Case No. 6:20-cv-01099, Matthew Waldecker v. Hyperspring, LLC, Case No. 2:20-cv-1948, Don Pharr v. Absolute Consulting, Inc., Case No. 23-cv-01558-JRR were filed on December 2, 2020, December 15, 2020, and June 8, 2023 respectively.
On August 22, 2023, Plaintiffs in Adams, Waldecker and Pharr and GSE Systems, Inc., Hyperspring and Absolute participated in private mediation. The mediation was successful and an agreement in principle was reached before the conclusion of the mediation to resolve and dismiss all three pending matters in exchange for a settlement payment.
The parties’ settlement agreement was executed on October 30, 2023 and will result in the dismissal of all three cases. In addition to customary terms, GSE Systems, Hyperspring and Absolute will be obligated to make a series of payments in 2024, eventually totaling $750,000 inclusive of attorneys’ fees and costs. As this amount was probable and estimable, we have accrued the $750,000 as a part of Selling, general and administrative for the three and nine months ended September 30, 2023.
Per ASC 450 Accounting for Contingencies, the Company reviews 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 as incurred.

26
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 Part II, 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 Part II, 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.

27
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

We are a leading provider of professional and technical engineering, staffing services and simulation software to clients in the power and process industries. Our primary market is the nuclear power industry, predominantly in the United States, but also serving the global nuclear sector with projects in the United Kingdom, Slovakia, Korea, Japan and elsewhere. We also serve natural adjacencies to the commercial nuclear power market such as the United States Department of Energy, and the broader nuclear ecosystem. We additionally serve other heavy industry sectors such as refining, petrochemical, Liquefied Natural Gas ("LNG") and others, with staffing services and our simulation technology and know-how. 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 help clients fill key vacancies in their respective organizations, 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.

General Business Environment

We operate through two reportable business segments: Engineering and Workforce Solutions. Each segment focuses on delivering solutions to customers within our target markets. Marketing and communications, accounting, finance, legal, human resources, corporate development, information systems and other administrative services are organized at the corporate or parent 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.

Engineering (approximately 71% of revenue for the nine months ended September 30, 2023)

Our Engineering segment primarily encompasses our power plant high-fidelity simulation solutions, technical engineering services for ASME programs, power plant thermal performance optimization, and interactive computer-based tutorials/simulation focused on the process industry. The Engineering segment includes various simulation products, engineering consulting services, and operation training systems delivered across the industries we serve: primarily in the nuclear, fossil fuel power generation and 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. We and our predecessors have been providing these services since 1976.
 
28
Our Engineering segment also provides 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 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 subsidiaries, True North and DP Engineering, typically work as either the EOC or specialty EOC for our clients under master services agreements and are included in our Engineering segment due to their service offerings. We have been providing these engineering solutions and services since 1995.

Workforce Solutions (approximately 29% of revenue for the nine months ended September 30, 2023)

The Workforce Solutions segment supports entire project lifecycles and provides highly specialized and skilled talent throughout the energy and engineering industries. Hyperspring provides training and professional service solutions.  Absolute, provides technical and professional staffing and procedure writing experts. Together, our Workforce Solutions team reduces risk and costs, boosts agility and responsiveness, to eliminate non-productive time, all while providing timely, flexible, and effective solutions. Examples of some of the highly skilled positions we fill are senior reactor operations instructors, procedure writers, project managers, engineers, work management specialists, planners and training material developers. These employees work at our clients’ facilities under client direction. The business model, management focus, margins and other factors clearly separate the business line from the rest of our product and service portfolio. We have been providing these services since 1997.

Financial information is provided in Note 15 of the accompanying consolidated financial statements regarding our business segments.

Business Strategy

Serve existing customers and adjacencies with compelling solutions with a focus on decarbonization:
 
Our objective has been to create a leading business focused on decarbonizing the power industries by providing a diverse set of highly unique and essential services and technologies, primarily in the nuclear power industry. We are now one of the few, publicly traded engineering and technology companies serving the zero-carbon energy sector of nuclear power and adjacent nuclear markets in Department of Energy, US Navy and related sectors. As a result of this effort and established leadership in key sectors, we are positioned to expand into essential clean energy opportunities that may arise such as wind, solar, hydrogen production, and others. The engineering services and technology that we provide to industry are focused on essential capabilities to help plants extend their operating lifetimes, capture the value of the power they produce on to the grid, produce more power from existing assets, and most importantly operate safely in an optimal manner. In 2023, we are keenly focused on organic growth in the sectors we serve by: cross-selling and upselling in our existing markets as we focus on delivering significant value to our customers; creating new and compelling solutions in-house as a result of advancements in our technology offerings in partnership with industry early adopters focused on critical business needs; developing new services through combination of our expertise; expanding into compelling adjacent markets such as clean energy as they may arise with renewed sales focus. The focus on organic growth reflects our need to grow in a self-funded manner to achieve cash flow break even and, ultimately, recover to our pre-pandemic revenue levels.

29
Cross sell and upsell into existing markets:
 
We have devoted considerable time and effort over the past several years to diversify the capabilities of our Company’s solutions for the nuclear power sector across both of our segments, via a rollup of essential services provided to the industry. To ensure efficient and streamlined operations for the business, we have brought in new engineering experts who are deeply credentialed in the nuclear power industry. We have also retooled our Workforce Solutions sales and recruiting efforts to ensure we are covering the industry broadly. The business units operate uniformly within their respective structure. This structure greatly enhances the opportunity to cross-sell our capabilities across our entire customer base, fostering an important focus of our sales efforts. This further differentiates us as a comprehensive provider to industry versus providers of specific, niche services. Our expectation is that unified go-to-market efforts, such as cross-selling capabilities, will lead to greater share of available spending within the customer base, which in turn will lead to significant upselling opportunity. Just as the broader economy was impacted by the onset of the pandemic, so too have our end markets been affected. Our perspective is that the industries we serve are quick to respond to a crisis and disruption, but slow to emerge and recover to pre-crisis operations. This is understandable, especially for our primary market of nuclear power. This cycle has been demonstrated in the past with other market and industry disruptions such as the 2008 global economic crisis, the Fukushima disaster in 2011 and, most recently, the global pandemic and its ongoing economic disruption. As with past disasters, our end markets usually catch up to delays in work years after the onset of the disruption.

Our Company is positioned to take advantage of the recovery if and when it occurs. As a result of a rejuvenated cross-sell and upsell effort, we are equipped to take this new approach to the market. In particular, with the Infrastructure Investment and Jobs Act passed in November 2021, for the first time there are specific economic incentives from the US Government for nuclear power development and the production of more nuclear baseload power to the grid. We are eager for these incentives to flow to industry spurring the capital investment required to extend the lifetime of the plants and production of more power. With economic incentives in place, the industry can now plan to make such investments. The challenge we are seeing is that the industry is still slow to advance investments that will result in an uptick in business for companies like GSE that serve the sector. Although we believe it is only a matter of time until this rollout progresses but the current pace presents a challenge in the interim. As a key provider of essential services to the nuclear power sector, with a focus on decarbonization, we are poised to benefit from industry investment as it rolls out to the vendor ecosystem. As mentioned, we have spent significant effort during 2022 to retool our Workforce Solutions sales and recruiting efforts and brought in key engineering talent to retool our efforts for the Engineering business. We have also spent significant effort putting in place Master Services Agreements (“MSAs”) with key utility operators. Having this commercial infrastructure in place is a significant step forward to facilitate ease of consumption of our solutions once a decision to do so is made by clients' prospects.

Organic growth through new and compelling technology:
 
While managing through the pandemic, in parallel, our leadership was investigating compelling opportunities by which we could utilize our capabilities to create significant value for the industry and advance the efforts of decarbonizing the power sector. As a result, we have identified a robust pipeline of new and compelling technology solutions to develop and take to market. Net new solutions, such as Data Validation and Reconciliation (“DVR”) and Thermal System Monitoring (“TSM”), have created new revenue streams with the potential of on-going licensing revenue, software maintenance and services revenue. Additional information on our DVR and TSM developments is included below. GSE has announced a number of new wins for these new solutions, which were created through our unique combination of our industry/engineering know-how and software development capabilities. As we have demonstrated in the past few years, small wins over time accrue into meaningful revenue on an on-going basis. This is a key element of our organic growth thesis: focusing on creating and bringing to market compelling technology solutions.

Focus on compelling adjacencies in clean energy, defense, and national labs:
 
Research and development (R&D). We invest in R&D to deliver unique solutions that add value to our end-user markets. Our software tools leverage the high-end expertise of our experienced staff in helping plants operate better and more efficiently. Our software technology together with our deep staff expertise supports multiple industries including the nuclear industry, as a part of the larger decarbonization drive. Our software technology includes decision-support tools for engineering simulation supporting design and plant commissioning, operational performance tools, and training platform.

One area of significant recent enhancement is in improving the thermal performance of power plants. We have introduced and continually enhanced the next generation platform in TSM, providing the technology platform to centralize and continuously monitor plant thermal performance. The solution benefits our customers by automating standardized reporting in modern dashboards available to engineers and decision makers across the fleet, leveraging automation to facilitate troubleshooting plant performance issues, reducing time and error with direct access to source data, and applying industry guidelines for problem resolution. This platform also supports integration with DVR (implemented by True North) that enhances the quality of data for plant performance insights, analysis and decision making, providing a solution to better detect and identify faulty measurements/sensors and thus reduce maintenance costs by focusing on critical components. Furthermore, we have expanded the capability of the platform to support Engineering in order to reduce compliance requirements.

30
In the area of engineering simulations, we deliver nuclear core and Balance-of-Plant modeling and visualization systems to the industry. To address the nuclear industry’s need for more accurate simulation of both normal and accident scenarios, we provide our DesignEP® and RELAP5-HD® solutions. Our entire JADETM suite of simulation software, including industry leading JTOPMERET® and JElectricTM software, provides the most accurate simulation of Balance-of-Plant and electrical systems available to the nuclear and fossil plant simulation market. The significant enhancements we have made to our SimExec® and OpenSimTM platforms enable customers to be more efficient in the daily operation of their simulators. We have brought SimExec® and OpenSimTM together into a next generation unified environment that adds new capabilities as requested by clients and driven by market need.

Additionally, enhancements to training content and delivery continue through the EnVision On-Demand platform, allowing our customers to access training content from anywhere in synchronous and asynchronous modes, thus increasing their efficiency and reducing infrastructure costs. We 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. We have pioneered a number of industry standards and intend to continue to be one of the most innovative companies in our industry.

Strengthen and develop our talent while delivering high-quality solutions.

Over the past several years, we have assembled a unique and highly experienced group of talent through organic growth and strategic acquisition. Our engineering team is comprised of design, simulation, regulatory compliance, and performance optimization professionals who are unique to the industry and capable of addressing the entire power generation life cycle.

Our experienced employees and management team are our most valuable resources. The continued integration of our team in parallel with attracting, training, and retaining top talent is critical to our success. To achieve our goals, we intend to remain focused on providing our employees with opportunities to increase client contact within their areas of expertise and to expand and deepen our service offerings. As we refine our product and service areas to best align with the critical areas listed above, we will also integrate and apply our composite employee talent to the fullest extent possible combining employee personal and professional growth opportunities with fulfillment of cutting-edge industry needs. Performance-based incentives including opportunities for stock ownership, bonuses and competitive benefits as benchmarked to our industry and locations will also be utilized to ensure continuity of our approach.

The Company is not immune to the intense pressure and business risks associated with attracting and retaining talented professionals in this current environment. 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. As we continue to integrate and leverage our individual company components assembled over the past several years, our capabilities and reputation will further strengthen. Attracting and retaining excellent professionals is a key effort for the company.

Employees

As of September 30, 2023, we had approximately 275 employees, which includes approximately 195 employees in our Engineering segment and approximately 80 employees in our Workforce Solutions segment.

31
Backlog

As of September 30, 2023, we had approximately $37.6 million of total gross revenue backlog, which included $31.4 million of Engineering backlog and $6.2 million of Workforce Solutions backlog. As of December 31, 2022, our backlog was $32.9 million with $23.8 million attributed to our Engineering segment and $9.1 million to Workforce Solutions. 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 U.S. GAAP measurement, our computation of backlog may not necessarily be comparable to that of our industry peers.

Results of Operations

The following table sets forth our results of operations, expressed in thousands of dollars and as a percentage of revenue:

   
Three Months Ended
    
Nine Months Ended
  
(in thousands)
  
September 30, 2023
    
September 30, 2022
    
September 30, 2023
    
September 30, 2022
  
     $    

%
      $    

%
      $    

%
      $    

%
  
Revenue
  
$
11,566
      
100.0
%
  
$
11,898
      
100.0
%
  
$
34,826
      
100.0
%
  
$
36,918
      
100.0
%
Cost of revenue
    
7,850
      
67.9
%
    
8,642
      
72.6
%
    
25,500
      
73.2
%
    
28,063
      
76.0
%
Gross profit
    
3,716
      
32.1
%
    
3,256
      
27.4
%
    
9,326
      
26.8
%
    
8,855
      
24.0
%
                                                                 
Operating expenses:
                                                                
Selling, general and administrative
    
4,301
      
37.2
%
    
4,336
      
36.4
%
    
12,742
      
36.6
%
    
13,253
      
35.9
%
Research and development
    
139
      
1.2
%
    
186
      
1.6
%
    
474
      
1.4
%
    
510
      
1.4
%
Goodwill and intangible asset impairment charge
    
937
      
8.1
%
    
7,505
      
63.1
%
    
937
      
2.7
%
    
7,505
      
20.3
%
Depreciation
    
43
      
0.4
%
    
69
      
0.6
%
    
144
      
0.4
%
    
213
      
0.6
%
Amortization of intangible assets
    
108
      
0.9
%
    
209
      
1.8
%
    
400
      
1.1
%
    
700
      
1.9
%
Total operating expenses
    
5,528
      
47.8
%
    
12,305
      
103.4
%
    
14,697
      
42.2
%
    
22,181
      
60.1
%
Operating loss
    
(1,812
)
    
(15.7
)%
    
(9,049
)
    
(76.1
)%
    
(5,371
)
    
(15.5
)%
    
(13,326
)
    
(36.2
)%
Interest expense, net
    
(430
)
    
(3.7
)%
    
(422
)
    
(3.5
)%
    
(1,483
)
    
(4.3
)%
    
(928
)
    
(2.5
)%
Change in fair value of derivative instruments, net
    
180
      
1.6
%
    
263
      
2.2
%
    
420
      
1.2
%
    
377
      
1.0
%
Other loss, net
    
(30
)
    
(0.3
)%
    
(2
)
    
0.0
%
    
(118
)
    
(0.3
)%
    
(58
)
    
(0.2
)%
Loss before income taxes
    
(2,092
)
    
(18.1
)%
    
(9,210
)
    
(77.4
)%
    
(6,552
)
    
(18.8
)%
    
(13,935
)
    
(37.7
)%
Benefit from income taxes
    
(70
)
    
(0.6
)%
    
(218
)
    
(1.8
)%
    
(81
)
    
(0.2
)%
    
(108
)
    
(0.3
)%
Net loss
  
$
(2,022
)
    
(17.5
)%
  
$
(8,992
)
    
(75.6
)%
  
$
(6,471
)
    
(18.6
)%
  
$
(13,827
)
    
(37.5
)%

32
Revenue

Consolidated revenue for the three months ended September 30, 2023 totaled $11.6 million, which was 3% less than the $11.9 million of revenue for the three months ended September 30, 2022. Revenue for the nine months ended September 30, 2023 totaled $34.8 million, which was 6% less than the $36.9 million of revenue for the nine months ended September 30, 2022.

   
Three Months Ended
    
Nine Months Ended
  
(in thousands)
  
September 30, 2023
    
September 30, 2022
    
Change
    
September 30, 2023
    
September 30, 2022
    
Change
  
Revenue:
                $    

%
                  $    

%
  
Engineering
  
$
8,657
    
$
8,052
      
605
      
8
%
  
$
24,643
    
$
22,402
      
2,241
      
10
%
Workforce Solutions
    
2,909
      
3,846
      
(937
)
    
(24
)%
    
10,183
      
14,516
      
(4,333
)
    
(30
)%
Total revenue
  
$
11,566
    
$
11,898
      
(332
)
    
(3
)%
  
$
34,826
    
$
36,918
      
(2,092
)
    
(6
)%

Engineering revenue for the three months ended September 30, 2023 totaled $8.7 million, which was a 8% increase from the $8.1 million of revenue for the three months ended September 30, 2022. The increase in revenue was primarily attributable to increased orders across the segment. Total Engineering orders of $13.0 million and $7.2 million were recorded for the three months ended September 30, 2023 and 2022, respectively. The increase in orders is primarily due to renewed training and consulting work with a long standing customer and two large orders during the three months ended September 30, 2023, for SDB work including software and maintenance components.

Engineering revenue for the nine months ended September 30, 2023 totaled $24.6 million, which was a 10% increase from the $22.4 million of revenue for the nine months ended September 30, 2022. The increase of revenue was primarily attributable to several significant contracts awarded with high margin performance obligations which began later in 2022, as well as, continued order volume increases through September 30, 2023. Total Engineering orders of $32.6 million and $17.4 million were recorded for the nine months ended September 30, 2023 and 2022, respectively. The increase in orders is primarily due to renewed training and consulting work with a long standing customer and two large orders during the nine months ended September 30, 2023, for SDB work including software and maintenance components.

For the three months ended September 30, 2023, Workforce Solutions revenue decreased by 24% to $2.9 million compared to revenue of $3.8 million for the three months ended September 30, 2022. The decrease in revenue was due to a reduction in staffing needs from our major customers. Total new orders of $1.7 million and $3.0 million were recorded for the three months ended September 30, 2023 and 2022, respectively.

For the nine months ended September 30, 2023, Workforce Solutions revenue decreased by 30% to $10.2 million compared to revenue of $14.5 million for the nine months ended September 30, 2022. The decrease in revenue was primarily due to the wind down of large projects resulting in a reduction in demand for staffing from our major customers. Total new orders of $7.3 million and $10.8 million were recorded for the nine months ended September 30, 2023 and 2022, respectively.

Gross Profit

Gross profit was $3.7 million and 32.1% of revenue and $3.3 million and 27.4% of revenue for the three months ended September 30, 2023 and 2022, respectively. Gross profit was $9.3 million and 26.8% of revenue and $8.9 million and 24.0% of revenue for the nine months ended September 30, 2023 and 2022, respectively.

(in thousands)
  
Three Months Ended
    
Nine Months Ended
  
   
September 30, 2023
    
September 30, 2022
    
September 30, 2023
    
September 30, 2022
  
     $    

%
      $    

%
      $    

%
      $    

%
  
Gross profit:
                                                        
Engineering
  
$
3,346
      
38.7
%
  
$
2,654
      
33.0
%
  
$
7,968
      
32.3
%
  
$
7,037
      
31.4
%
Workforce Solutions
    
370
      
12.7
%
    
602
      
15.7
%
    
1,358
      
13.3
%
    
1,818
      
12.5
%
Total gross profit
  
$
3,716
      
32.1
%
  
$
3,256
      
27.4
%
  
$
9,326
      
26.8
%
  
$
8,855
      
24.0
%

33
The Engineering segment’s gross profit increased by $0.7 million during the three months ended September 30, 2023 over the three months ended September 30, 2022. The Engineering segment’s gross profit increased by $0.9 million during the nine months ended September 30, 2023 over the nine months ended September 30, 2022. The increase is driven by segment revenue growth related to increased project efficiency on large simulator projects.

The Workforce Solutions segment’s gross profit decreased by $0.2 million during the three months ended September 30, 2023 over the three months ended September 30, 2022. The Workforce Solutions segment’s gross profit decreased by $0.5 million during the nine months ended September 30, 2023 over the nine months ended September 30, 2022. The decrease in the three months and nine months ended September 30, 2023 was primarily due to the reduction in the demand from existing customers for additional workforce professionals.

Selling, general and administrative expenses (“SG&A”)

Selling, general and administrative (SG&A) expenses totaled $4.3 million and $4.3 million for the three months ended September 30, 2023 and 2022, respectively. Selling, general and administrative (SG&A) expenses totaled $12.7 million and $13.3 million for the nine months ended September 30, 2023 and 2022, respectively. Fluctuations in the components of SG&A spending were as follows.

   
Three months ended
    
Nine months ended
  
(in thousands)
  
September 30,
2023
    
September 30,
2022
    
September 30,
2023
    
September 30,
2022
  
                         
Corporate charges
  
$
3,320
    
$
3,201
    
$
9,252
    
$
10,058
  
Business development
    
902
      
951
      
3,080
      
2,511
  
Facility operation & maintenance (O&M)
    
85
      
182
      
372
      
575
  
Credit loss expense (recovery)
    
(6
)
    
-
      
24
      
97
  
Other
    
-
      
2
      
14
      
12
  
Total
  
$
4,301
    
$
4,336
    
$
12,742
    
$
13,253
  

Corporate charges

During the three months ended September 30, 2023, corporate charges increased by $0.1 million over the same period of the prior year. During the nine months ended September 30, 2023 corporate charges decreased by $0.8 million over the same period of the prior year. The decrease was primarily due to a $0.8 million decrease in stock compensation expense, $0.4 million decrease in indirect labor & burden cost due to decreased headcount, $.02 million decrease in business insurance expense, partially offset by increased litigation expense of $0.8 million during the nine months ended September 30, 2023.

Business development expenses

Business development expenses decreased $49 thousand during the three months ended September 30, 2023 over the same period of the prior year. Business development expenses increased by $569 thousand during the nine months ended September 30, 2023 over the same period of the prior fiscal year. The increase was primarily due to increased indirect labor & burden due to increased headcount during the nine months ended September 30, 2023.

Facility operation & maintenance (“O&M”)

Facility O&M expenses decreased $97 thousand for three months ended September 30, 2023, compared to the same period in 2022. Facility O&M expenses decreased $203 thousand for nine months ended September 30, 2023, compared to the same period in 2022. The decrease in facility O&M during the nine months ended September 30, 2023 was primarily due to the termination of the Sykesville lease in Q4 2022 and reduced lease space under the new Fort Worth lease executed in Q2 2023.

34
Credit loss expense (recovery)

We recorded a $(6) thousand credit (recovery) during the three months ended September 30, 2023 and no credit loss expense during the three months ended September 30, 2022. We recorded $24 thousand and $97 thousand of credit loss expense during the nine months ended September 30, 2023 and 2022, respectively.

Research and development

Research and development costs consist primarily of software engineering personnel and other related costs. Research and development costs, net of capitalized software, totaled $139 thousand and $186 thousand for the three months ended September 30, 2023 and 2022, respectively.  Research and development costs totaled $474 thousand and $510 thousand for the nine months ended September 30, 2023 and 2022, respectively. The decrease in both the three and nine months ended periods was due to a higher percentage of total R&D costs capitalized, as we continue to expand our software capabilities to deliver unique solutions to our end users.

Depreciation

We recorded depreciation expense of $43 thousand and $69 thousand for the three months ended September 30, 2023 and 2022, respectively. Depreciation expense was $144 thousand and $213 thousand for the nine months ended September 30, 2023 and 2022, respectively. The reduction of $69 thousand for the nine months ended September 30, 2023 over the same period in 2022 was due primarily due to assets becoming fully depreciated during the period.

Amortization of intangible assets

Amortization expense related to definite-lived intangible assets totaled $108 thousand and $209 thousand for the three months ended September 30, 2023 and 2022, respectively, and $400 thousand and $700 thousand for the nine months ended September 30, 2023 and 2022, respectively. The decrease in amortization expense was primarily due to Workforce Solutions' definite-lived intangible assets being fully impaired at September 30, 2022. Further the amortization of Customer Contracts and Relationships decreased, as they are amortized at a declining rate over the 15-year useful life.

Interest expense, net

Interest expense totaled $430 thousand and $422 thousand for the three months ended September 30, 2023 and 2022, respectively. Interest expense totaled $1,483 thousand and $928 thousand for the nine months ended September 30, 2023 and 2022, respectively. The increase for the three and nine month periods was primarily due to an additional $0.5 million interest charge related to the amendment of the  2022 Lind financing arrangement during Q2 2023.

Other loss, net

For the three months ended September 30, 2023 and 2022, we recognized other loss, net of $(30) thousand and $(2) million, respectively. For the nine months ended September 30, 2023 and 2022, we recognized other loss, net of $(118) thousand and $(58) million, respectively.

Income tax (benefit) expense

Income tax expense for interim periods is determined using an estimate of our annual effective tax rate, adjusted for discrete items arising in that quarter. Total income tax benefit of $70 thousand for the three months ended September 30, 2023 was comprised mainly of current foreign tax benefit, deferred state tax benefit related to the portion of goodwill which cannot be offset by deferred tax assets, and state tax expense. The total income tax benefit of $218 thousand for the three months ended September 30, 2022 was comprised mainly of current foreign tax benefit, deferred federal and state tax benefit related to the portion of goodwill which cannot be offset by deferred tax assets, and state tax expense. Total income tax benefit of $81 thousand for the nine months ended September 30, 2023 was comprised mainly of current foreign tax benefit, deferred state tax benefit related to the portion of goodwill which cannot be offset by deferred tax assets, and state tax expense. Total tax benefit of $108 thousand for the nine months ended September 30, 2022 was comprised mainly of current foreign tax benefit, deferred federal and state tax benefit related to the portion of goodwill which cannot be offset by deferred tax assets, and state tax expense.

35
For the three and nine months ended September 30, 2023, the difference between our income tax benefit, at an effective tax rate of 3.35% and 1.24% respectively, and the U.S. statutory federal income tax rate of 21% was primarily due to accruals related to uncertain tax positions for certain foreign tax contingencies, a change in valuation allowance in our U.S. entity, the permanent disallowance of interest expense related to disqualified debt, and discrete item adjustments for U.S. taxes. For the three and nine months ended September 30, 2022, the difference between our income tax benefit at an effective rate of 2.4% and 0.8% respectively, and the U.S. statutory federal income tax rate of 21% was primarily due to accruals related to uncertain tax positions for certain foreign tax contingencies, a change in tax valuation allowance in our U.S. entity, the permanent disallowance of interest expense related to disqualified debt, and discrete item adjustments for U.S. and foreign taxes.

Critical Accounting Policies and Estimates

In preparing our consolidated financial statements, Management makes several estimates and assumptions that affect our reported amounts of assets, liabilities, revenues and expenses. Our most significant estimates relate to revenue recognition on contracts with customers, product warranties, valuation of goodwill and intangible assets acquired including the determination of fair value in impairment tests, valuation of long-lived assets, 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, filed with the SEC on April 17, 2023. In addition, in the quarter ended March 31, 2023, we established mark-to-market liabilities related to certain common stock purchase warrants and certain embedded features included in our convertible debt. The fair values of these are estimated upon issuance and at each reporting period thereafter. For all accounting policies described in this document, management cautions that future events rarely develop exactly as forecasted and even our best estimates may require adjustment as facts and circumstances change.

Liquidity and Capital Resources

As of September 30, 2023, our cash, cash equivalents and restricted cash totaled $3.5 million, compared to $4.4 million as of December 31, 2022.

As of September 30, 2023, we have current restricted cash and long-term restricted cash of $0.4 million and $1.1 million, respectively. We have restricted cash of $1.1 million to secure four letters of credit with various customers and $0.4 million to secure our corporate credit card program.

Though management believes the Company is positioned for growth and a rebound from the COVID-19 pandemic, the Company has determined that there is substantial doubt about our ability to continue as a going concern through August 17, 2024. The inability to generate sufficient cash flows to satisfy repayment obligations or to refinance or restructure debt obligations on commercially reasonable terms could have a material adverse effect on our business, financial condition, results of operations and cash flows.

During the three months ended June 30, 2023 management initiated cost saving measures to address going concern doubts, such as, headcount reductions, the new Lind financing arrangement, and other third party cost reductions. These initiatives have driven improved cashflow for the three months ended September 30, 2023 and are expected to drive continued cashflow improvements in future periods.

For the nine months ended September 30, 2023 and 2022, net cash provided by operating activities were $0.3 million and $0.8 million, respectively. The decrease in cash flows provided by operating activities was primarily driven by decreased collections in the nine months ended September 30, 2023.

Net cash used in investing activities totaled $0.4 million for the nine months ended September 30, 2023 and 2022.

36
For the nine months ended September 30, 2023 and 2022, net cash used in financing activities was $(0.7) million and net cash provided by financing activities was $1.5 million, respectively. The decrease in cash provided by financing activities of $2.2 million was primarily driven by $5.8 million of proceeds received from issuance of Convertible Note, offset by a $1.8 million repayment of the line of credit during the nine months ended September 30, 2022 compared to $1.8 million proceeds received from issuance of Convertible Note during the nine months ended September 30, 2023 .

Credit Facilities

On February 23, 2022, the Company issued a Convertible Note (further described in Note 10 to Consolidated Financial Statements). The proceeds received from the Convertible Note were used to repay in full, all outstanding indebtedness of $1.8 million owed to Citizens, and the Amended and Restated Credit and Security Agreement between us, our subsidiaries, and Citizens has been terminated. As of September 30, 2023, we had four letters of credit totaling $1.1 million outstanding to certain customers which were secured with restricted cash.

Non-GAAP Financial Measures

Adjusted EBITDA

References to “EBITDA” mean net loss, before considering interest expense, benefit from income taxes, depreciation and amortization. References to Adjusted EBITDA excludes irregular or non-recurring items and are not directly related to the Company’s core operating performance. EBITDA and Adjusted EBITDA are not measures of financial performance under U.S. GAAP. Management believes EBITDA and Adjusted EBITDA, in addition to operating profit, net income and other U.S. GAAP measures, are useful to investors to evaluate the Company’s results because it excludes certain items 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 U.S. GAAP. A reconciliation of non-U.S. GAAP EBITDA and Adjusted EBITDA to the most directly comparable U.S. GAAP measure in accordance with SEC Regulation G follows:

   
Three Months Ended
    
Nine Months Ended
  
   
September 30,
2023
    
September 30,
2022
    
September 30,
2023
    
September
30, 2022
  
Net loss
  
$
(2,022
)
  
$
(8,992
)
  
$
(6,471
)
  
$
(13,827
)
Interest expense, net
    
430
      
422
      
1,483
      
928
  
Benefit from income taxes
    
(70
)
    
(218
)
    
(81
)
    
(108
)
Depreciation and amortization
    
232
      
365
      
792
      
1,167
  
EBITDA
    
(1,430
)
    
(8,423
)
    
(4,277
)
    
(11,840
)
Stock-based compensation expense
    
322
      
491
      
853
      
1,592
  
Change in fair value of derivative instruments, net
    
(180
)
    
(263
)
    
(420
)
    
(377
)
Goodwill and intangible asset impairment charge
    
937
      
7,505
      
937
      
7,505
  
Advisory fees
    
260
      
-
      
260
      
-
  
Provision for legal settlement
    
750
      
-
      
750
      
-
  
Adjusted EBITDA
  
$
659
    
$
(690
)
  
$
(1,897
)
  
$
(3,120
)

37
Adjusted Net Loss and Adjusted Loss per Share Reconciliation

References to Adjusted Net Loss excludes 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. Adjusted Net Loss and Adjusted Loss per Share (adjusted EPS) are not measures of financial performance under U.S. GAAP. Management believes Adjusted Net Loss and Adjusted Loss per Share, in addition to other U.S. GAAP measures, are useful to investors to evaluate the Company’s results because the excluded items may, or could, have a disproportionate positive or negative impact on our results for any particular period. 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 U.S. GAAP. A reconciliation of non-U.S. GAAP Adjusted Net Loss and Adjusted Loss per common Share to U.S. GAAP net loss, the most directly comparable U.S. GAAP financial measure, is as follows:

(in thousands)
  
Three Months Ended
    
Nine Months Ended
  
   
September 30, 2023
    
September 30, 2022
    
September 30, 2023
    
September 30, 2022
  
                         
Net loss
  
$
(2,022
)
  
$
(8,992
)
  
$
(6,471
)
  
$
(13,827
)
Stock-based compensation expense
    
322
      
491
      
853
      
1,592
  
Change in fair value of derivative instruments, net
    
(180
)
    
(263
)
    
(420
)
    
(377
)
Goodwill and intangible asset impairment charge
    
937
      
7,505
      
937
      
7,505
  
Advisory fees
    
260
      
-
      
260
      
-
  
Provision for legal settlement
    
750
      
-
      
750
      
-
  
Amortization of intangible assets related to acquisitions
    
108
      
209
      
400
      
700
  
Adjusted net loss
  
$
175
    
$
(1,050
)
  
$
(3,691
)
  
$
(4,407
)
                                 
Adjusted net loss per common share – diluted
  
$
0.07
    
$
(0.49
)
  
$
(1.54
)
  
$
(2.09
)
                                 
Weighted average shares outstanding used to compute adjusted net loss per share - diluted(1)
    
2,480,505
      
2,128,888
      
2,398,468
      
2,110,194
  

(1) During the three and nine months ended September 30, 2023, we reported a U.S. GAAP net loss and an adjusted net loss. Accordingly, there were no dilutive shares from RSUs, warrants, or other dilutive instruments that are included in the adjusted net loss per share calculation, as all shares were considered anti-dilutive when calculating the net loss per share.

(1) During the three and nine months ended September 30, 2022, we reported a U.S. GAAP net income and an adjusted net loss. Accordingly, there were no dilutive shares from RSUs, warrants, or other dilutive instruments that are included in the adjusted net loss per share calculation, as all shares were considered anti-dilutive when calculating the net loss per share.

Item 3.
Quantitative and Qualitative Disclosure about Market Risk

Not required of a smaller reporting company.

38
Item 4.
Controls and Procedures

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.

Changes in Internal Control over Financial Reporting

There were no changes in our internal controls over financial reporting that occurred during the most recent fiscal quarter that have materially affected or are reasonably likely to materially affect our 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

Item 1.
Legal Proceedings

We are, from time to time, involved in ordinary routine litigation incidental to the conduct of our business. Neither we nor any of our subsidiaries are a party to, nor is any of our property the subject of, any material pending legal proceedings that, in the opinion of our management, are likely to have a material adverse effect on our business, financial condition or results of operations.

Item 1A.
Risk Factors

None.

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.

Item 5.
Other Information

None.
39
Item 6.
Exhibits

 
Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes- Oxley Act of 2002, filed herewith.
 
 
 
 
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.
 
 
 
 
Certification of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.
 
 
 
 
101.INS*
XBRL Instance Document
 
 
 
 
101.SCH*
XBRL Taxonomy Extension Schema
 
 
 
 
101.CAL*
XBRL Taxonomy Extension Calculation Linkbase
 
 
 
 
101.DEF*
XBRL Taxonomy Extension Definition Linkbase
 
 
 
 
101.LAB*
XBRL Taxonomy Extension Label Linkbase
 
 
 
 
101.PRE*
XBRL Taxonomy Extension Presentation Linkbase

40
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: November 14, 2023
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)



41