GSE SYSTEMS INC MANAGEMENT REPORT AND ANALYSIS OF FINANCIAL POSITION AND RESULTS OF OPERATIONS. (Form 10-K)

We are a leading provider of professional and technical engineering, staffing
services and simulation software to clients in the power and process industries.
We provide customers with simulation, engineering and plant services that help
clients reduce risks associated with operating their plants, increase revenue
through improved plant and employee performance, and lower costs through
improved operational efficiency. In addition, we provide professional services
that 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.

Early in 2020 as the COVID-19 pandemic unfolded, the end markets that we serve,
namely the power industries, delayed certain essential services and dramatically
cut back on non-essential services. Although these delays and reductions
impacted us, as an essential services provider to an essential industrial base,
we benefited from maintaining a baseline of business to continue and align
itself to the realities of the pandemic.  Additionally, staffing shortages have
resulted in new opportunities for our Workforce Solutions segment. In 2021, the
effects of the pandemic still impacted the end markets we serve, but those
effects have been mitigated by a number of factors, including the following: the
pandemic largely has had a targeted effect on the population? a number of
vaccines in the market being distributed and, despite logistical challenges,
making substantial progress for those in most need? the economy of the United
States has not had as much disruption as was initially feared, which has
benefited our end markets? and most importantly our end markets seem poised to
contract  with us for essential services that had been delayed as a result of
the pandemic. As we end 2021 and begin 2022, we have had a number of significant
contract wins that have been publicly announced, which we hope will be a
harbinger of a more attractive business environment for the power industries we
serve.

As a result of the COVID-19 pandemic, we have sought and obtained support
through various business assistance programs. We applied for and, on April 23,
2020, received the PPP Loan under the CARES Act, as administered by the SBA. The
application for receipt of the PPP Loan required us to certify, in good faith,
that the attendant economic uncertainty made the loan necessary to support our
ongoing operations. The PPP Loan bore interest at a rate of 1% per annum and
would mature on April 23, 2022, with the first payment deferred until September
2021. We used the proceeds of the PPP Loan for payroll and related costs, rent
and utilities. Pursuant to the regulations promulgated by the SBA, in order to
request forgiveness of the PPP Loan, we were required to submit an application
to the Lender substantiating that we were entitled to the PPP Loan and used the
proceeds of the PPP Loan as permitted under the CARES Act. The Lender reviewed
our application for forgiveness and associated documentation, and on February
26, 2021 forwarded our application to the SBA with the Lender's determination
that the loan is fully forgivable. On August 5, 2021, we received notice that
full principal amount and all accrued interest thereon of the PPP Loan was
formally forgiven by the SBA.

During the second quarter of 2021, we performed analysis to determine our first
quarter 2021 eligibility for the Employee Retention Credit available under the
CARES Act . We amended certain payroll tax filings and applied for a refund of
$2.4 million dollars in April 2021. For the second quarter of 2021, we have
applied for a refund of $1.8 million dollars from the IRS with the timely filing
of Form 941 and have already recognized a benefit of $900,000 in value from
unremitted payroll taxes as allowable. For the third quarter of 2021, we have
applied for a refund of $1.0 million from the IRS with the timely filing of Form
941 and have recognized a benefit of $1.4 million in value from unremitted
payroll taxes as allowable. Subsequent to the year end, we received refunds of
$1.1 million, which was included in the other current assets balance at December
31, 2021.

We entered into a contract with a subcontractor to purchase large equipment from
Siemens in order to build a simulator for project Slovenske Elektrarne Mochovce
Full Scope Simulator Upgrade in December 2018. The total contract price was
about $2.7 million and included VAT taxes of approximately $450,000. We paid the
VAT taxes and had pursued the collection of this VAT refund for a couple of
years. In May 2021, we were informed that this VAT refund was no longer
collectable. As a result, we wrote off this VAT receivable during 2021.

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On September 9, 2021, President Biden released the COVID-19 Action Plan, Path
Out of the Pandemic (the "Plan"), with the stated goal of getting more people
vaccinated. As part of the Plan, Executive Order 14042, Ensuring Adequate COVID
Safety Protocols for Federal Contractors (the "Order"), creates the Safer
Federal Workforce Task Force (the "Task Force"), which released guidance for
U.S. Government contractors and their subcontractors. This guidance included
mandatory vaccination of all employees working on or for a government contract,
either directly or indirectly, by January 4, 2022 (subject to medical and
religious exemptions). As a part of the Plan and Order, President Biden also
directed, the Department of Labor's Occupational Safety and Health
Administration ("OSHA") to issue an Emergency Temporary Standard ("ETS")
requiring that all employers with at least 100 employees ensure that their
U.S.-based employees are fully vaccinated for COVID-19 or obtain a negative
COVID-19 test at least once a week. On November 4, 2021, OSHA issued this ETS,
however the implementation of the ETS was blocked by federal appeals courts,
pending resolution of ongoing litigation challenging the constitutionality of
the ETS, and the ETS was withdrawn by OSHA on January 25, 2022. OSHA, however
has not withdrawn the proposed rule that would effectuate the same mandate, and
it cannot be known whether OSHA may reissue the ETS or otherwise issue new
emergency temporary standards imposing similar mandates. We have already
received notice by both government customers and prime contractors serving
government customers regarding the vaccination requirement and its application
to our business with those customers.  As an employer of more than 100
employees, we would also be subject to the ETS or a similar mandate should it
become effective. It is possible that additional jurisdictions where we do
business may impose similar mandates that would apply to our employees.  In
addition, certain of our customers may require vaccines for those of our
employees who provide on-site service at their facilities. We will continue to
monitor the status of these or other mandates or regulations and their
application to us and our business.

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  Table of Contents


Results of Operations.

The following table presents the results of operations for the periods presented expressed as a percentage of revenues.

($ in thousands)                                              Years ended December 31,
                                                     2021          %           2020           %
Revenue                                            $ 55,183       100.0 %    $  57,620       100.0 %
Cost of revenue                                      43,325        78.5 %       42,835        74.3 %

Gross profit                                         11,858        21.5 %       14,785        25.7 %
Operating expenses
Selling, general and administrative                  14,908        27.0 %       15,765        27.4 %
Research and development                                626         1.1 %          686         1.2 %
Restructuring charges                                   798         1.4 %        1,297         2.3 %
Loss on impairment                                        3           -          4,302         7.5 %
Depreciation                                            284         0.5 %          330         0.6 %
Amortization of definite-lived intangible assets      1,213         2.2 %        1,943         3.4 %
Total operating expenses                             17,832        32.3 %       24,323        42.2 %

Operating loss                                       (5,974 )     (10.8 %)      (9,538 )     (16.6 %)

Interest expense                                       (159 )      (0.3 %)        (623 )      (1.1 %)
Gain (loss) on derivative instruments, net               19         0.0 %          (17 )       0.0 %
Other income (expense), net                          16,884        30.6 %           (4 )       0.0 %

Income (loss) before taxes                           10,770        19.5 %      (10,182 )     (17.7 %)
Provision for income taxes                              163         0.3 %          355         0.6 %

Net income (loss)                                  $ 10,607        19.2 %    $ (10,537 )     (18.3 %)

Comparison of the years ended December 31, 2021 for December 31, 2020.


Revenue.  Revenue for the year ended December 31, 2021, totaled $55.2 million,
which was 4.2% less than the $57.6 million of revenue for the year ended
December 31, 2020.

(in thousands)                                   Year ended December 31,
                                      2021         2020              Change
Revenue:                                                         $             %

Performance Improvement Solutions $28,140 $32,790 (4,650 )

 (14.2 )%
Workforce Solutions                   27,043       24,830        2,213         8.9 %
Total revenue                       $ 55,183     $ 57,620       (2,437 )      (4.2 )%



Performance Improvement Solutions revenue decreased 14.2% from $32.8 million to
$28.1 million for the years ended December 31, 2020 and 2021, respectively. The
decrease of revenue was primarily due to several significant projects ending in
the prior fiscal year. We recorded total Performance Improvement Solutions
orders of $30.0 million and $26.2 million for the years ended December 31, 2021
and 2020, respectively.

For the year ended December 31, 2021, Workforce Solutions revenue increased 8.9%
to $27.0 million compared to revenue of $24.8 million for the year ended
December 31, 2020. The increase in revenue was primarily due a significant new
customer obtained in Q1 2021. We recorded total new orders of $26.5 million and
$19.1 million for the years ended December 31, 2021 and 2020, respectively.

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As of December 31, 2021, our backlog was $41.3 million, $31.8 million was
attributed to the Performance Improvement Solutions segment and $9.5 million was
attributed to the Workforce Solutions segment. As of December 31, 2020, our
backlog was $40.4 million with $30.3 million attributed to the Performance
Improvement Solutions segment and $10.1 million attributed to the Workforce
Solutions segment. The increase in our backlog over fiscal year 2020 was
primarily due to higher orders in the Performance Improvement Solutions during
fiscal year 2021.

Gross profit.  Gross profit was $11.9 million, or 21.5% of revenue, for the year
ended December 31, 2021 compared to $14.8 million, or 25.7% of revenue, for the
year ended December 31, 2020.

($ in thousands)                             Years ended December 31,
                                      2021         %          2020         %
Gross profit:
Performance Improvement Solutions   $  8,124       28.9 %   $ 11,395       34.8 %
Workforce Solutions                    3,734       13.8 %      3,390       13.7 %
Consolidated gross profit           $ 11,858       21.5 %   $ 14,785       25.7 %



The Performance Improvement Solutions segment's gross profit decreased by $3.3
million during fiscal year 2021 over fiscal year 2020. The decrease is primarily
related to lower revenue and several significant projects completed in the prior
year.

Workforce Solutions segment gross margin increased by $0.3 million in fiscal 2021 compared to fiscal 2020. The increase in gross margin is mainly due to an increase in revenue from the Workforce Solutions segment.

Selling, general and administrative expenses. Selling, general and administrative (SG&A) expenses totaled $14.9 million and $15.8 million for the years ended December 31, 2021 and 2020, respectively. The fluctuations in the components of SG&A expenses were as follows:


($ in thousands)                                          Years ended

the 31st of December,

                                                  2021          %          2020          %
Selling, general and administrative expenses:
Corporate charges                               $ 10,305        69.1 %   $ 10,881        69.0 %
Business development                               3,024        20.3 %      3,364        21.3 %
Facility operation & maintenance (O&M)               872         5.8 %        928         5.9 %
Provision for loss on legal settlement                 -         0.0 %        477         3.0 %
Bad debt expense                                     691         4.6 %        103         0.7 %
Other                                                 16         0.1 %         12         0.1 %
Total                                           $ 14,908       100.0 %   $ 15,765       100.0 %



Corporate charges decreased $0.6 million in 2021 compared to 2020. The decrease
was primarily due to a reduction of external legal, audit, and consultants fees
of $0.8 million. Additionally, the Company saw a reduction in realized foreign
exchange rate loss of $0.3 million during the fiscal year 2021.

Business development expenses decreased $0.3 million in 2021 compared to 2020. The decrease is mainly due to the decrease in the workforce in 2021.

Plant operation and maintenance expenses decreased $0.1 million for the year ended December 31, 2021 compared to the year ended December 31, 2020. The decrease in fiscal year 2021 is mainly due to lease terminations in the first half of 2020.


Provision for loss on legal settlement. On August 17, 2020, Absolute entered
into a Settlement Agreement with the plaintiffs (Joyce), which resulted a final
settlement cost, including plaintiff's attorney fees of approximately $1.4
million. On September 29, 2020, the Company received $952 thousand from a
general escrow account, originally set up as part of the Company's purchase of
Absolute during fiscal 2017. The Company presented the loss on Joyce legal
settlement and the benefit from the proceeds from the release of escrow from the
Absolute transaction in selling, general and administrative expenses, in the
amount of $477 thousand for the year ended December 31, 2020. There were no
similar transactions during the same period of 2021.

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Bad debt expense. We recorded bad debt expense of $691 thousand and $103
thousand for the years ended December 31, 2021 and December 31, 2020,
respectively.  GSE's bad debt allowance is based on historical trends of past
due accounts, write-offs, and specific identification and review of customer
accounts. Included in the current year provision is an impairment of unbilled
receivables of $824 thousand related to a customer contract with our GSE Beijing
entity offset by $133 thousand recovery of bad debt from previously written off
balances.

As of December 31, 2021, management considered the following factors when
assessing the unbilled receivable balance in question for impairment: the
overall geopolitical environment, the Company's inability to travel to China to
meet with the customer to resolve their concerns, and the restrictions on
restarting the project due to both regulatory constraints and our ability to
meet future milestones.  Based on these factors we determined that the unbilled
was impaired and a reserve for unbilled was recorded resulting in bad debt
expense of $824 thousand.  We will continue to pursue billing and collections of
this balance.

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 $0.6 million and $0.7
million for both the years ended December 31, 2021 and 2020, respectively.

Restructuring charges. Restructuring charges totaled $0.8 million and $1.3
million for the years ended December 31, 2021 and 2020, respectively. On
December 27, 2017, the Board of GSE Systems, Inc. approved an international
restructuring plan to streamline and optimize the Company's global operations.
Under this international restructuring plan, we have incurred cumulative
restructuring charges of $3.9 million. The Company expects no future charges
relating to the international restructuring plan, excluding any tax impacts and
cumulative translation adjustments from the final disposal of foreign entities.
Additionally, during the third quarter of 2019, the Company implemented a
restructuring plan as a result of the work suspension of DP Engineering's
largest customer and subsequent notification on August 6, 2019 that the EOC
contract was being terminated. This plan was put in place to align the workforce
with the expected level of business moving forward. Under this restructuring
plan, we have incurred total restructuring of $2.6 million. In the twelve months
ending December 31, 2020, we recorded $1.0 million to international
restructuring, and $0.2 million of related employee termination benefits. The
decrease in our 2021 restructuring plan charges was mainly due to final charges
related to the liquidation of our Sweden operations during the period, pursuant
to our foreign restructuring plan.

Loss on impairment of goodwill and definite-lived intangible assets. We
recognized a $3 thousand ROU asset impairment during the fiscal year 2021. We
recognized a $4.3 million intangible asset impairment during the fiscal year
2020.

Depreciation. Depreciation expense totaled $0.3 million and $0.3 million for the years ended December 31, 2021 and 2020, respectively.


Amortization of definite-lived intangible assets. Amortization expense related
to definite-lived intangible assets totaled $1.2 million and $1.9 million for
the years ended December 31, 2021 and 2020, respectively. The decrease in
amortization expense was primarily due to the reduction in the carrying value of
DP Engineering's intangible assets, due to the $4.3 million impairment in Q1
2020. Additionally, certain intangible assets such as Customer Contracts &
Relationships have larger amortization the earlier they are in their useful
lives.

Interest expense. Interest expense totaled $0.2 million and $0.6 million for the
years ended December 31, 2021 and 2020. The decrease was due to a reduction in
total indebtedness during the fiscal year 2021.

Gain (loss) on derivative instruments, net. The Company periodically enters into
forward foreign exchange contracts to manage market risks associated with the
fluctuations in foreign currency exchange rates on foreign-denominated trade
receivables. The Company had not designated the contracts as hedges and
recognized a loss on the change in the estimated fair value of the contracts of
$17 thousand for the years ended December 31, 2020. We had no foreign exchange
contracts outstanding as of December 31, 2021.

The foreign currency denominated trade receivables, unbilled receivables,
billings in excess of revenue earned and subcontractor accruals that are related
to the outstanding foreign exchange contracts are remeasured at the end of each
period into the functional currency using the current exchange rate at the end
of the period. The gain or loss resulting from such remeasurement is also
included in gain (loss) on derivative instruments net in the consolidated
statements of operations. For the years ended December 31, 2021 and 2020, the
Company incurred a gain of $19 thousand and $15 thousand, respectively, related
to the remeasurement of such assets and liabilities.

Other income (expense), net. The Company recognized $16.9 million of other
income, net and $(4) thousand of other expense, net for the years ended
December 31, 2021 and 2020, respectively. The increase was primarily due to the
recording of $10.1 million PPP loan forgiveness by SBA and $7.2 million Employee
Retention Credit during the period, offset by VAT write-off of $0.5 million, We
paid VAT taxes for a subcontractor equipment purchase and had pursued the
collection of this VAT refund for a couple of years. In May 2021, we were
informed that this VAT refund was no longer collectable.

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Provision for Income Taxes. The Company files tax returns in the United States
federal jurisdiction and in several state and foreign jurisdictions. Because of
the net operating loss carryforwards, the Company is subject to U.S. federal and
state income tax examinations for tax years 2000, and forward, and is subject to
foreign tax examinations by tax authorities for the years 2016 and forward. Open
tax years related to state and foreign jurisdictions remain subject to
examination but are not considered material to our financial position, results
of operations or cash flows.

The Company’s tax expense in 2021 was $0.2 millionrepresenting an annual effective tax rate of 1.5%, and composed of $0.1 million the current tax provision and $0.1 million deferred tax liability linked to the portion of goodwill that cannot be offset by deferred tax assets. The Company’s tax expense in 2020 was $0.4 millionrepresenting an effective annual rate of (3.5)% and composed of $0.4 million of the current tax provision.


The significant change of $0.8 million in net operating loss carryforwards was
primarily driven by the release of the U.S. uncertain tax position on the U.K.
worthless stock deduction which originally offset the federal and state net
operating losses.

The difference between the effective rate and statutory rate primarily resulted
from a change in valuation allowance, permanent differences, including PPP loan
forgiveness and foreign restructuring, accruals related to uncertain tax
positions, the tax impact of stock compensation forfeitures, foreign tax
expense, and state tax expense. Please see Note 15 for additional information.

Coronavirus Aid, Relief and Economic Security Act


On March 27, 2020, the United States enacted the Cares Act. The Cares Act is an
emergency economic stimulus package that includes spending and tax breaks to
strengthen the United States economy and fund a nationwide effort to curtail the
effect of COVID-19. While the CARES Act provides sweeping tax changes in
response to the COVID-19 pandemic, some of the more significant provisions which
are expected to impact our consolidated financial statements include removal of
certain limitations on utilization of net operating losses and increasing the
ability to deduct interest expense, as well as amending certain provisions of
the previously enacted Tax Cuts and Jobs Act. On April 23, 2020, we received $10
million in funds under the Paycheck Protection Program (PPP), a part of the
CARES Act. On August 5, 2021, the Company was notified that the Small Business
Administration ("SBA") had forgiven the PPP loan including all accrued interest
thereon was forgiven. 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.

Consolidated Credits Act


On December 27, 2020, the Consolidated Appropriations Act, 2021 (CAA) was signed
into law. The CAA included additional funding through tax credits as part of its
economic package for 2021. We evaluated these items in our tax computation as of
December 31, 2021 and determined that the items do not have a material benefit
on our consolidated financial statements as of December 31, 2021.

Significant 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.  Those accounting estimates that have the
most significant impact on our operating results and place the most significant
demands on management's judgment are discussed below.  For all of these
policies, management cautions that future events rarely develop exactly as
forecasted, and the best estimates may require adjustment.

Revenue Recognition. We derive our revenue through three broad revenue streams:
1) System Design and Build ("SDB"), 2) software, and 3) training and consulting
services. We recognize revenue from SDB and software contracts mainly through
the Performance Improvement Solutions segment and revenue from training and
consulting services through both the Performance Improvement Solutions segment
and Workforce Solutions segment.


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The SDB contracts are typically fixed-price and consist of initial design,
engineering, assembly and installation of training simulators which include
hardware, software, labor, and post contract support ("PCS") on the software. We
generally have two main performance obligations for an SDB contract: the
training simulator build and PCS period. The training simulator build
performance obligation generally includes hardware, software, and labor. The
transaction price under the SDB contracts is allocated to each performance
obligation based on its standalone selling price. We recognize the training
simulator build revenue over the construction and installation period using the
cost-to-cost input method as our performance creates or enhances assets with no
alternative use to us, and we have an enforceable right to payment for
performance completed to date. Cost-to-cost input method best measures the
progress toward complete satisfaction of the performance obligation. PCS revenue
is recognized ratably over the service period, as PCS is deemed as a stand-ready
obligation.

In applying the cost-to-cost input method, we use the actual costs incurred to
date relative to the total estimated costs to measure the work progress toward
the completion of the performance obligation and recognize revenue accordingly.
Estimated contract costs are reviewed and revised periodically as the work
progresses, and the cumulative effect of any change in estimates is recognized
in the period in which the change is identified. Estimated losses are recognized
in the period such losses are identified. Uncertainties inherent in the
performance of contracts include labor availability and productivity, material
costs, change order scope and pricing, software modification and customer
acceptance issues. The reliability of these cost estimates is critical to our
revenue recognition as a significant change in the estimates can cause the our
revenue and related margins to change significantly from the amounts estimated
in the early stages of the project.

The SDB contracts generally provide a one-year base warranty on the systems. The
base warranty is not accounted for as a separate performance obligation under
the contract because it does not provide the customer with a service in addition
to the assurance that the completed project complies with agreed-upon
specifications. Warranties extended beyond our typical one-year period, if any,
are evaluated on a case by case basis to determine if it provides more than just
assurance that the product operates as intended, which would require carve-out
as a separate performance obligation.

Revenue from the sale of perpetual standalone and term software licenses, which
do not require significant modification or customization, is recognized upon its
delivery to the customer.  Revenue from the sale of cloud-based
subscription-based software licenses is recognized ratably over the term of such
licenses following delivery to the customer. Delivery is considered to have
occurred when the customer receives a copy of the software and is able to use
and benefit from the software.

A software license sale contract with multiple performance obligations typically
includes the following elements: license, installation and training services and
PCS. The total transaction price of a software license sale contract is
typically fixed and is allocated to the identified performance obligations based
on their relative standalone selling prices. Revenue is recognized as the
performance obligations are satisfied. Specifically, license revenue is
recognized when the software license is delivered to the customer; installation
and training revenue is recognized when the installation and training is
completed without regard to a detailed evaluation of the point in time criteria
due to the short-term nature of the installation and training services (one to
two days on average); and PCS revenue is recognized ratably over the service
period, as PCS is deemed as a stand-ready obligation.

The contracts within the training and consulting services revenue stream are
either time and materials ("T&M") based or fixed-price based. Under a typical
T&M contract, we are compensated based on the number of hours of approved time
provided by workers and the bill rates which are fixed per type of work, as well
as approved expenses incurred. Our customers are billed on a regular basis, such
as weekly, biweekly or monthly. In accordance with Accounting Standards
Codification ("ASC") 606-10-55-18, we elected to apply the "right to invoice"
practical expedient, under which we recognize revenue in the amount to which we
have the right to invoice. The invoice amount represents the number of hours of
approved time worked by each worker multiplied by the bill rate for the type of
work, as well as approved expenses incurred. Under a typical fixed-price
contract, we recognize the revenue on a percentage of completion basis as it
relates to construction contracts with revenue recognized based on project
delivery over time. Revenue from the sale of short-term contracts with a
delivery period of one month or less is recognized in the month completed.

For contracts with multiple performance obligations, we allocate the contract
price to each performance obligation based on its relative standalone selling
price. We generally determine standalone selling prices based on the prices
charged to customers.


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Impairment of Intangible Assets, including Goodwill. Our intangible assets
impairment analysis includes the use of undiscounted cash flow and discounted
cash flow models that require management to make assumptions regarding estimates
of revenue growth rates and operating margins used to calculate projected future
cash flows, risk-adjusted discount rates and future economic factors that may
impact each asset group. We review goodwill and intangible assets for impairment
annually as of December 31 and whenever events or changes in circumstances
indicate the carrying value of an asset may not be recoverable. We test goodwill
at the reporting unit level. A reporting unit is an operating segment, or one
level below an operating segment, as defined by U.S. GAAP (See Note 7).

Accounting Standards Update ("ASU") 2011-08, Intangibles - Goodwill and Other
(Topic 350): Testing Goodwill for Impairment ("ASU 2011-08"). ASU 2011-08
permits an entity to first assess qualitative factors to determine whether it is
more likely than not that the fair value of a reporting unit is less than its
carrying amount as a basis for determining whether it is necessary to perform
the two-step goodwill impairment test.  An entity is not required to perform
step one of the goodwill impairment test for a reporting unit if it is more
likely than not that its fair value is greater than its carrying amount (Step
0).  If the Step 0 test indicates the fair value of a reporting unit is less
than its carrying value, then additional impairment testing is required in
accordance with the provisions of ASC 350, Intangibles - Goodwill and Other.

ASU 2017-04, Simplifying the Test for Goodwill Impairment ("ASU 2017-04"). ASU
2017-04 simplifies the accounting for goodwill impairment by eliminating Step 2
of the current goodwill impairment test, which required a hypothetical purchase
price allocation. Goodwill impairment will now be the amount by which the
reporting unit's carrying value exceeds its fair value, limited to the carrying
value of the goodwill.

As of December 31, 2020, we performed a quantitative step 1 analysis and have
concluded that the estimated fair values of each of our reporting units as of
December 31, 2020, is more likely than not, greater than their respective
carrying values.

Our goodwill impairment analysis includes the use of a discounted cash flow
model that requires management to make assumptions regarding estimates of growth
rates used to forecast revenue, operating margin and terminal value as well as
determining the appropriate risk-adjusted discount rates and other factors that
impact fair value determinations. Determining the fair value of a reporting unit
is judgmental in nature and involves the use of significant estimates and
assumptions. These estimates and assumptions include revenue growth rates and
operating margins used to calculate projected future cash flows, risk-adjusted
discount rates, future economic and market conditions and determination of
appropriate market comparable. We base our fair value estimates on assumptions
we believe to be reasonable but that are unpredictable and inherently uncertain.
Actual future results may differ from those estimates. In addition, we make
certain judgments and assumptions in allocating shared assets and liabilities to
determine the carrying values for each of our reporting units. The timing and
frequency of our goodwill impairment tests are based on an ongoing assessment of
events and circumstances that would indicate a possible impairment. We will
continue to monitor our goodwill and intangible assets for impairment and
conduct formal tests when impairment indicators are present.

Capitalization of Computer Software Development Costs.  In accordance with U.S.
GAAP, we capitalize computer software development costs incurred after
technological feasibility has been established, but prior to the release of the
software product for sale to customers.  Once the product is available to be
sold, we amortize the costs, on a straight-line method, over the estimated
useful life of the product, which is typically three years. As of December 31,
2021, we have net capitalized software development costs of $0.5 million. On an
annual basis, and more frequently as conditions indicate, we assess the recovery
of the unamortized software development costs by estimating the net undiscounted
cash flows expected to be generated by the sale of the product. If the
undiscounted cash flows are not sufficient to recover the unamortized software
costs, we will write-down the investment to its estimated fair value based on
future discounted cash flows. The excess of any unamortized computer software
costs over the related net realizable value is written down and charged to
operations. Included in capitalized software development costs are certain
expenses associated with the development software services. These are similarly
capitalized, although not subjected to the same recoverability considerations.
Significant changes in the sales projections could result in an impairment with
respect to the capitalized software that is reported on our consolidated balance
sheets.

Deferred Income Tax Valuation Allowance. Deferred income taxes arise from
temporary differences between the tax basis of assets and liabilities and their
reported amounts in the consolidated financial statements.  Management makes a
regular assessment of the ability to realize our deferred tax assets. In making
this assessment, management considers whether it is more likely than not that
some or all of the deferred tax assets will not be realized. The ultimate
realization of deferred tax assets is dependent upon the generation of future
taxable income during the periods in which those temporary differences become
deductible. Management considers the scheduled reversal of our deferred tax
liabilities and projected future taxable income in making this assessment. A
valuation allowance is recorded to reduce the total deferred income tax asset to
its realizable value. As of December 31, 2021, our largest deferred tax asset
was $6.2 million of net operating losses. It primarily relates to a U.S. net
operating loss carryforward of $6.2 million; $4.5 million of the net operating
loss carryforward expires in various amounts between 2023 and 2037; $1.7 million
of the net operating loss carryforward is an indefinite-lived deferred tax
asset. We do not believe that it is more likely than not that we will be able to
realize our deferred tax assets for our U.S. and foreign deferred tax assets as
of December 31, 2021, and therefore we have recorded a $9.4 million valuation
allowance for our net deferred tax assets. The Company has a deferred tax
liability in the amount of $0.1 million at December 31, 2021 related to the
portion of goodwill which cannot be offset by deferred tax assets


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Cash and capital resources.

From December 31, 2021we had cash and cash equivalents of $3.6 million
compared to $6.7 million at December 31, 2020.

For the years ended December 31, 2021 and 2020, the net cash used in operating activities was $0.2 million and provided by operating activities has been $1.1 million, respectively. The year-over-year decrease in cash provided by operating activities is largely explained by:

• A $6.2 million the decrease in net inflows related to changes in net working capital was

primarily due to increased recoveries due to large milestone payments from

major projects of the previous year.

• A $2.1 million decrease in operating expenses (excluding non-cash items

expenses) mainly due to a reduction in external legal and audit costs in

   2021.

• A $2.9 million decrease in gross margin, mainly due to lower revenues due to

   to COVID-19.



Net cash used in investing activities. For the year ended December 31, 2021, net
cash used in investing activities was $0.8 million compared to net cash of $0.3
million used in investing activities in the prior year. The increase in cash
outflow in 2021 was primarily related to the systems implementation, see note 10
for further details.

Net cash used in financing activities.  For the years ended December 31, 2021
and 2020, net cash used in financing activities totaled $2.2 million and $6.1
million, respectively. The decrease in cash used in financing activities of $3.8
million was driven by a $2.0 million repayment of line of credit in 2021
compared to a repayment on term loans of $18.5 million offset by proceeds of the
PPP Loan of $10 million.

Paycheck Protection Program Loan (“PPP Loan”)


We applied for and, on April 23, 2020, received a payroll protection program
loan in the amount of $10.0 million (the "PPP Loan") under the CARES Act, as
administered by the SBA. The application for receipt of the PPP Loan required us
to certify, in good faith, that the attendant economic uncertainty made the loan
necessary to support our ongoing operations. The PPP Loan bore interest at a
rate of 1% per annum and would mature on April 23, 2022, with the first payment
deferred until September 2021. We used the proceeds of the PPP Loan for payroll
and related costs, rent and utilities. Pursuant to the regulations promulgated
by the SBA, in order to request forgiveness of the PPP Loan, we were required to
submit an application to the Lender substantiating that we were entitled to the
PPP Loan and used the proceeds of the PPP Loan as permitted under the CARES Act.
The Lender reviewed our application for forgiveness and associated
documentation, and on February 26, 2021 forwarded our application to the SBA
with the Lender's determination that the loan is fully forgivable. On August 5,
2021, we received notice that full principal amount and all accrued interest
thereon of the PPP Loan was formally forgiven by the SBA.

Credit facilities


On December 29, 2016, we entered a 3-year $5.0 million revolving line of credit
facility ("RLOC") with the Citizens Bank, N.A. (the "Bank") to fund general
working capital needs and acquisitions. On May 11, 2018, we entered into the
Amended and Restated Credit and Security Agreement (the "Credit Agreement" or
the "Credit Facility") to (a) expand the RLOC to include a letter of credit
sub-facility and not be subject to a borrowing base and (b) to add a $25.0
million term loan facility, available to finance permitted acquisitions over the
following 18 months. The credit facility was subject to certain financial
covenants and reporting requirements and was scheduled to mature on May 11, 2023
and accrue interest at the USD LIBOR, plus a margin that varies depending on our
overall leverage ratio. We subsequently amended and ratified the Credit
Agreement a number of times, and as a part of the Eighth Amendment and
Reaffirmation Agreement, we repaid the entire outstanding balance on the term
loan facility. Due to a projected violation of the leverage ratio at the end of
the first quarter of 2021, we signed the Ninth Amendment and Reaffirmation
Agreement with an effective date of March 29, 2021 (See FN 13).

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Following the Ninth Amendment, we experienced continued delays in commencing new
projects and thus our ability to recognize revenue was delayed for some
contracts. Reductions in orders and other negative changes to orders experienced
at the beginning of the pandemic started to reverse in 2021, but not at the
level expected as ongoing COVID concerns continue to hinder the pace of
recovery. This deterioration in the recovery plan resulted in breaching the
Minimum Liquidity ratio subsequent to both June 30, 2021 and at September 30,
2021 as well as projected breaching of the Leverage and Fixed Charges ratio
covenant. On November 12, 2021, due to these covenant violations, we signed the
Tenth Amendment and Reaffirmation Agreement with an effective date of November
12, 2021 to adjust the thresholds for future covenants to ease the risk of
non-compliance. Per the Tenth Amendment, we received a waiver for  the fixed
charge coverage ratio and leverage ratio for the quarters ending September 30
and December 31, 2021, and we agreed, (i) interest on the outstanding principal
amount of the RLOC shall accrue at the interest rate in effect for the RLOC from
time to time, but the interest due and payable on the RLOC on each Interest
Payment Date shall be determined by subtracting seventy-five (75) basis points
from the Applicable Margin and (ii) the seventy-five (75) basis points of
accrued interest on the RLOC not paid on any Interest Payment Date pursuant to
clause (i) above shall be due and payable on the Termination Date or the date of
payment in full of the RLOC. RLOC Amount" means (i) $3,500,000 (ii) on each date
a payment in the amount of $250,000 is made pursuant to Subsection 2.1.5(d), the
RLOC Amount immediately prior to such payment reduced by $250,000 and (iii) on
March 31, 2022 and on each June 30, September 30, December 31 and March 31
thereafter, the RLOC Amount immediately prior to each such date reduced by
$37,500. In addition, we agreed, by December 31, 2021, we will pay the Bank
$250,000 to be applied to the principal amount outstanding under the RLOC.
Commencing on March 31, 2022 and on each June 30, September 30, December 31 and
March 31 thereafter, we will pay the Bank $75,000 to be applied to the principal
amount outstanding under the RLOC. In addition, within the fifth (5th) Business
Day after we have received, subsequent to November 1, 2021, Employee Retention
Credits in an aggregate amount not less than $500,000, we will pay the Bank
$250,000 to be applied to the principal amount outstanding under the RLOC. We
are also required to maintain a minimum of $2.25 million in aggregate USA
liquidity. We incurred $15 thousand of amendment fee related to this amendment.

During the year ended December 31, 2021, we repaid for $2 million and had a draw
of $0.8 million on our RLOC. As of December 31, 2021, we had outstanding
borrowings of $1.8 million under the RLOC and four letters of credit totaling
$1.1 million outstanding to certain of our customers. The total borrowing
capacity under RLOC was $3.25 million as of December 31, 2021. After
consideration of letters of credit and the $0.5 million reserved for issuance of
new letters of credit, there was no amount available for borrowing under the
RLOC.

Subsequent to the year ended December 31, 2021, the Company issued a Convertible
Note (further described in Note 24 to Consolidated Financial Statements). The
proceed received from this Note were used to repay in full, all outstanding
indebtedness owed to Citizens, and the Amended and Restated Credit and Security
Agreement between us, our subsidiaries, and Citizens has been terminated. We
will continue to maintain a cash management account and certain letters of
credit with Citizens and, accordingly, have entered into a certain Cash
Management Agreement with Citizens, as well as certain Cash Pledge Agreements in
amounts corresponding to the current outstanding letters of credits with
customers (as further described in Note 13 to the Consolidated Financial
Statements).

Exchange


A portion of our international sales revenue has been and may be received in a
currency other than the currency in which the expenses relating to such revenue
are paid. Accordingly, we periodically enter into forward foreign exchange
contracts to manage the market risks associated with the fluctuations in foreign
currency exchange rates. As of December 31, 2021, we did not hold a position in
forward foreign exchange contracts.

GSE SYSTEMS INC MANAGEMENT REPORT AND ANALYSIS OF FINANCIAL POSITION AND RESULTS OF OPERATIONS. (Form 10-K)

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