Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations

GSE is a world leader in real-time high-fidelity simulation, providing a wide range of simulation, training, and engineering solutions to the global power and process industries.  We 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 services that systematically help clients fill key vacancies in the organization on a short-term basis, primarily in training professionals focused on regulatory compliance and certification in the nuclear power industry.  At March 31, 2017, GSE was the parent company of:

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GSE Performance Solutions, Inc., a Delaware corporation;

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GSE Power Systems, AB, a Swedish corporation;

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GSE Engineering Systems (Beijing) Co. Ltd., a Chinese limited liability company;

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GSE Systems, Ltd., a Scottish limited liability company;

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EnVision Systems (India) Pvt. Ltd., an Indian limited liability company; and

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Hyperspring, LLC, an Alabama limited liability company.

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

Cautionary Statement Regarding Forward-Looking Statements

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

Other factors and assumptions not identified above were also involved in the formation of these forward-looking statements and the failure of such other assumptions to be realized, as well as other factors, may also cause actual results to differ materially from those projected.  Most of these factors are difficult to predict accurately and are generally beyond our control.  You should consider the areas of risk described in Item 1A - Risk Factors in our most recent annual report on Form 10-K in connection with any forward-looking statements that may be made by us. You should not place undue reliance on any forward-looking statements.  New factors emerge from time to time, and it is not possible for us to predict which factors will arise.

We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.  You are advised, however, to consult any additional disclosures we make in proxy statements, quarterly reports on Form 10-Q and current reports on Form 8-K filed with the SEC.

General Business Environment

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

Performance Improvement Solutions (approximately 59% of revenue)

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

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

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

Business Strategy

Our objective is to create a technology-enabled engineering, software and training services platform by capitalizing on near and long-term growth opportunities primarily in the nuclear industry.  We offer our differentiated suite of products and services to adjacent markets such as fossil power and the process industries where our offerings are a natural fit with a clear and compelling value proposition for the market.  Our primary growth strategy is twofold: (1) expand organically within our core markets by leveraging our market leadership position and drive increased usage and product adoption via new products and services, and (2) seek acquisitions to accelerate our overall growth in a manner that is complementary to our core business.  To accomplish this, we will pursue the following activities:

Expand our total addressable market.   Our focus on growth means introducing product capabilities or new product categories that create value for our customers and therefore expand our total addressable market.  Currently we are working on initiatives to expand our solution offerings in both our business segments which may include, but not be limited to, the following: expanding our software product portfolio to the industries we serve with enhanced power and process simulation tools and systems that are complementary to our core offerings; delivering enhanced learning management systems/solutions; offering fully outsourced training solutions to our customers; adding work flow process improvement solutions; and tailoring operational reporting and business intelligence solutions to address the unique need of our end user markets.

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

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

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

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

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

Strengthen and develop our talent.   Our experienced employees and management team are our most valuable resources.  Attracting, training, and retaining top talent is critical to our success.  To achieve our talent goals, we intend to remain focused on providing our employees with entrepreneurial opportunities to increase client contact within their areas of expertise and to expand our business within our service offerings.  We will also continue to provide our employees with training, personal and professional growth opportunities, performance-based incentives including opportunities for stock ownership, bonuses and competitive benefits as benchmarked to our industry and locations.

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

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

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

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

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

Industry Trends

Industry need for building and sustaining a highly skilled workforce

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

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

Globally, as more people increase their standard of living, their demand for power will increase, which in turn will require the on-going construction of power plants to meet this surging demand.  Developing a skilled labor force to operate these plants and keeping their skills current and their certifications in compliance with regulatory requirements is a key challenge facing the global power industry.  Similar challenges face the process industries.

Growing global power demand and the increasing emphasis on nuclear power

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

There are currently 59 nuclear plants under construction in 14 countries, including 21 in China, seven in Russia, five in India and four in the United Arab Emirates per the Nuclear Energy Institute.  Four reactors are currently under construction in the U.S., two for Southern Nuclear at the Vogtle, Georgia site and two at SCANA's VC Summer site.  Southern Nuclear and SCANA are currently determining how to complete these four reactors following the Westinghouse Bankruptcy.  Tennessee Valley Authority's Watts Bar generating facility started operations in 2016, which represents a watershed for the U.S. nuclear power industry.  Per the World Nuclear Association, there are 164 reactors in 25 countries in specific phases of planning that will be operating by 2030.  This pace of construction is surpassing the peak construction velocity of the 1970s and 1980s.

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

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

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

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

We believe GSE is well positioned to take full advantage of these strategic global and domestic trends by providing high fidelity simulation and training solutions to the global power and process industries.

Products and Services

Performance Improvement Solutions

To assist our clients in creating world-class internal training and engineering improvement processes, we offer a set of integrated and scalable products and services which provide a structured program focused on continuous skills improvement for experienced employees to engineering services, which include plant design verification and validation.  We provide the right solution to solve our clients' most pressing needs.

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

For virtual commissioning, designers of first-of-a-kind plants or existing plants need a highly accurate dynamic simulation platform to model a wide variety of design assumptions and concepts from control strategies to plant behavior to human factors.  Because new builds and upgrades to existing plants result in new technology being deployed, often involving the integration of disparate technologies for the first time, a high-fidelity simulator allows designers to see the interaction between systems for the very first time.  With our combination of simulation technology and expert engineering, GSE was chosen to build first-of-a-kind simulators for the AP1000, PBMR, and small modular reactors being built by NuScale, and mPower.

Examples of the types of simulators we sell include, but are not limited to, the following:

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

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

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Plant-Specific Operator Training Simulators:  These simulators provide an exact replication of the plant control room and plant operations.  They provide the highest level of realism and training and allow users to practice their own plant-specific procedures.  Clients can safely practice startup, shutdown, normal operations, as well as response to abnormal events we all hope they never have to experience in real life.  Since our inception, we have delivered nearly 450 plant-specific simulators to clients in the nuclear power, fossil power and process industries worldwide.

Nuclear Industry Training and Consulting

As our customers' experienced staff retire, access to experts that can help train existing and new employees in how to operate their plants is essential to ensure safe ongoing plant operations.  In addition, training needs change over time and sometimes our clients require specialized courses.  Industry needs instructors who can step in and use the client's training material.  Finding professional instructors, who know the subject, can teach it and can adapt to the client's culture, is critical.  GSE provides both qualified instructors and turnkey courses that work within the client's system and complement the training methods they already have in place.  Examples of our training program courses are senior reactor operator certification, generic fundamentals training, and simulation supervisor training.  In addition, we also provide expert support through consulting or turnkey projects for the training material upgrade and development, outage execution, planning and scheduling, corrective actions programs, and equipment reliability.

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

Westinghouse bankruptcy

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

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

Results of Operations - Three Months ended March 31, 2017 versus Three Months ended March 31, 2016

Revenue .  Revenue for the three months ended March 31, 2017 totaled $16.3 million, which was 25.9% greater than the $13.0 million of revenue for the three months ended March 31, 2016.  The increase in revenue was primarily driven by the year over year increase in revenue at Hyperspring, represented by our Nuclear Industry Training and Consulting segment, depicted below.

Performance Improvement Solutions revenue increased 9.4% primarily due to the continued work that is secured by our near-record backlog.  We recorded total Performance Improvement Solutions orders of $4.9 million and $34.8 million for the three months ended March 31, 2017 and 2016, respectively.

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

At March 31, 2017, backlog was $79.6 million: $67.0 million for the Performance Improvement Solutions segment and $12.6 million for Nuclear Industry Training and Consulting.  At December 31, 2016, the Company's backlog was $73.2 million: $68.8 million for the Performance Improvement Solutions segment and $4.4 million for Nuclear Industry Training and Consulting.

Gross profit .  Gross profit was $4.1 million, or 25.2%, for the three months ended March 31, 2017, compared to $3.6 million, or 27.9% for the same period in 2016.

The decrease in gross margin percentage for Performance Improvement Solutions for the three months ended March 31, 2017 as compared to the same period in 2016 was mainly due to three lower margin major nuclear simulation projects.

The increase in gross profit during 2017 for Nuclear Industry Training and Consulting was primarily driven by the segment's focus on entering higher margin contracts.

Selling, general and administrative expenses .  Selling, general and administrative (SG&A) expenses totaled $3.6 million and $2.8 million for the three months ended March 31, 2017 and 2016, respectively. Fluctuations in the components of SG&A spending were as follows:

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

Business development charges decreased slightly mainly due to lower headcount.

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

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

Research and development.   Research and development costs consist primarily of software engineering personnel and other related costs.  Research and development costs, net of capitalized software, totaled $402,000 and $354,000 for the three months ended March 31, 2017 and 2016, respectively. Before capitalization of software development costs, research and development totaled $431,000 and $485,000 for three months ended March 31, 2017 and 2016, respectively. The $54,000 decrease is primarily due to a more targeted research and development strategy undertaken by the Company.

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

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

Amortization of definite-lived intangible assets. Amortization expense related to definite-lived intangible assets totaled $64,000 and $73,000 for the three months ended March 31, 2017, and 2016, respectively.  The first quarter 2017 amortization expense decrease is primarily due to lower amortization of customer-related intangible assets that were recorded in conjunction with the Hyperspring acquisition in 2014.

Loss on derivative instruments, net.  Loss on derivative instruments, net increased $42,000, and relates to the Company's foreign exchange contracts and remeasurement of foreign currency-denominated contract receivables, billings in excess of revenue earned, and subcontractor accruals, that are remeasured into the functional currency using the current exchange rate at the end of the period.

For the three months ended March 31, 2017, we recognized a loss of $86,000 on the change in fair value of foreign exchange contracts, compared to a loss of $183,000 for the same period in 2016.

For the three months ended March 31, 2017, we recognized a loss of $74,000 from the remeasurement of contract receivables, billings in excess of revenue earned and subcontractor accruals, compared to a gain of $65,000 for the same period in 2016.

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

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

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

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

The Company has a full valuation allowance on its U.S., U.K., Swedish, and Chinese net deferred tax assets at March 31, 2017.

Critical Accounting Policies and Estimates

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

Liquidity and Capital Resources

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

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

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

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

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

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

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

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

Cash used in investing activities.  Net cash used in investing activities totaled $73,000 for the three months ended March 31, 2017.  Capital expenditures totaled $44,000 and capitalized software development costs totaled $29,000.

Net cash used in investing activities totaled $119,000 for the three months ended March 31, 2016.  Capital expenditures totaled $18,000 and capitalized software development costs totaled $131,000 for the three months ended March 31, 2016.  Proceeds from the sale of fixed assets totaled $31,000.

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

Net cash used in financing activities totaled $1.4 million for the three months ended March 31, 2016 due to payments of $1.4 million to the former Hyperspring owners in accordance with the 2014 purchase agreement due to the achievement of certain EBITDA targets in 2015.

At March 31, 2017, the Company had cash and cash equivalents of $21.6 million.  The Company believes that its (i) cash and cash equivalents and (ii) cash generated from normal operations will be sufficient to fund its working capital and other requirements for at least the next twelve months.

Line of Credit

Citizens Bank

The Company entered into a new three-year, $5.0 million revolving line of credit facility (RLOC) with Citizens Bank on December 29, 2016, to fund general working capital needs, including acquisitions.  Working capital advances bear interest of LIBOR plus 2.25% per annum and letter of credit fees are 1.25% per annum.  The Company is not required to maintain a restricted cash collateral account at Citizens Bank for outstanding letters of credit and working capital advances. 

The maximum availability under the RLOC is subject to a borrowing base equal to 80% of eligible accounts receivable, and is reduced for any issued and outstanding letters of credit and working capital advances.  At March 31, 2017, there were no outstanding borrowings on the RLOC and six letters of credit totaling $1.7 million.  The amount available at March 31, 2017, after consideration of the borrowing base, letters of credit and working capital advances was approximately $1.8 million.

The credit facility agreement is subject to standard financial covenants and reporting requirements. At March 31, 2017, the Company was in compliance with its financial covenants.

BB&T Bank

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

Non-GAAP Financial Measures

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

 

Adjusted Net Income and Adjusted EPS Reconciliation (in thousands, except per share amounts)

Adjusted Net Income and adjusted earnings (loss) per share (adjusted EPS) are not measures of financial performance under GAAP.  Management believes adjusted net income and adjusted EPS, in addition to other GAAP measures, provide meaningful supplemental information regarding our operational performance. Our management uses Adjusted Net Income and other non-GAAP measures to evaluate the performance of our business and make certain operating decisions (e.g., budgeting, planning, employee compensation and resource allocation). This information facilitates management's internal comparisons to our historical operating results as well as to the operating results of our competitors. Since management finds this measure to be useful, we believe that our investors can benefit by evaluating both non-GAAP and GAAP results.  These measures should be considered in addition to, and not as a substitute for or superior to, any measure of performance prepared in accordance with GAAP.  A reconciliation of non-GAAP adjusted net income and adjusted EPS to GAAP net income, the most directly comparable GAAP financial measure, is as follows:

^(a) During the three months ended March 31, 2017, the Company reported a GAAP net loss and positive adjusted net income.  Accordingly, there were 407,675 dilutive shares from options and RSUs included in the adjusted earnings per common share calculation that were considered anti-dilutive in determining the GAAP diluted loss per common share.