10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Quarterly Period Ended September 30, 2012.

or

[  ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Transition Periodfrom to .

Commission File Number: 001-14785

GSE SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

Delaware	52-1868008
(State of incorporation)	(I.R.S. Employer Identification No.)

1332 Londontown Blvd., Suite 200, Sykesville, MD 21784

(Address of principal executive office and zip code)

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such period that the registrant was required to submit and post such files). Yes [ X ]   No [   ]

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

Large accelerated filer  [  ]	Accelerated filer  [  ]	Non-accelerated filer [  ]	Smaller reporting company [ X ]
		(Do not check if a smaller reporting company)

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

There were 18,348,336 shares of common stock, with a par value of $.01 per share outstanding as of November 12, 2012.

1

GSE SYSTEMS, INC.

QUARTERLY REPORT ON FORM 10-Q

INDEX

		PAGE
PART I.	FINANCIAL INFORMATION	3
Item 1.	Financial Statements:
	Consolidated Balance Sheets as of September 30, 2012 and December 31, 2011	3
	Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2012 and September 30, 2011	4
	Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2012 and September 30, 2011	5
	Consolidated Statement of Changes in Stockholders’ Equity for the Nine Months Ended September 30, 2012	6
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2012 and September 30, 2011	7
	Notes to Consolidated Financial Statements	8
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	18
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	29
Item 4.	Controls and Procedures	30
PART II.	OTHER INFORMATION	31
Item 1.	Legal Proceedings	31
Item 1A.	Risk Factors	31
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	32
Item 3.	Defaults Upon Senior Securities	32
Item 4.	Mine Safety Disclosures	32
Item 5.	Other Information	32
Item 6.	Exhibits	32
	SIGNATURES	33

2

PART I - FINANCIAL INFORMATION
Item 1.  Financial Statements
GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
	Unaudited
	September 30, 2012			December 31, 2011
ASSETS
Current assets:
Cash and cash equivalents	$	21,304		$	20,326
Restricted cash		3,761			3,505
Contract receivables, net		19,441			20,356
Prepaid expenses and other current assets		3,314			3,733
Total current assets		47,820			47,920
Equipment and leasehold improvements		6,683			5,206
Accumulated depreciation		(4,604	)		(4,105	)
Equipment and leasehold improvements, net		2,079			1,101
Software development costs, net		2,193			1,815
Goodwill		4,502			4,462
Intangible assets, net		990			1,207
Long-term restricted cash		1,177			897
Other assets		1,987			1,413
Total assets	$	60,748		$	58,815
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	4,886		$	4,077
Accrued expenses		1,779			1,581
Accrued compensation and payroll taxes		2,350			2,754
Billings in excess of revenue earned		4,954			5,261
Accrued warranty		2,157			2,300
Other current liabilities		2,302			1,707
Total current liabilities		18,428			17,680
Other liabilities		1,213			2,352
Total liabilities		19,641			20,032
Commitments and contingencies		-			-
Stockholders' equity:
Preferred stock $.01 par value, 2,000,000 shares authorized,
shares issued and outstanding none in 2012 and 2011		-			-
Common stock $.01 par value, 30,000,000 shares authorized,
shares issued 19,421,892 in 2012 and 19,254,681 in 2011		194			193
Additional paid-in capital		71,117			70,167
Accumulated deficit		(27,559	)		(29,063	)
Accumulated other comprehensive loss		(574	)		(865	)
Treasury stock at cost, 1,047,461 shares in 2012, 824,374 in 2011		(2,071	)		(1,649	)
Total stockholders' equity		41,107			38,783
Total liabilities and stockholders' equity	$	60,748		$	58,815
The accompanying notes are an integral part of these consolidated financial statements.

3

GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(Unaudited)
	Three Months ended						Nine Months ended
	September 30,						September 30,
	2012			2011			2012		2011
Contract revenue	$	13,009		$	12,549		$	39,581	$	36,128
Cost of revenue		7,960			7,931			26,143		24,278
Gross profit		5,049			4,618			13,438		11,850
Operating expenses:
Selling, general and administrative		3,483			3,302			10,663		9,920
Depreciation		131			137			406		365
Amortization of definite-lived intangible assets		79			204			235		629
Total operating expenses		3,693			3,643			11,304		10,914
Operating income		1,356			975			2,134		936
Interest income, net		36			29			121		91
Gain (loss) on derivative instruments, net		20			(129	)		36		49
Other income (expense), net		(97	)		31			82		70
Income before income taxes		1,315			906			2,373		1,146
Provision (benefit) for income taxes		499			48			869		(481	)
Net income	$	816		$	858		$	1,504	$	1,627
Basic income per common share	$	0.04		$	0.05		$	0.08	$	0.09
Diluted income per common share	$	0.04		$	0.05		$	0.08	$	0.08
The accompanying notes are an integral part of these consolidated financial statements.

4

GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
(Unaudited)
	Three Months ended					Nine Months ended
	September 30,					September 30,
	2012		2011			2012		2011
Net income	$	816	$	858		$	1,504	$	1,627
Foreign currency translation adjustment		442		(378	)		291		(62	)
Comprehensive income	$	1,258	$	480		$	1,795	$	1,565
The accompanying notes are an integral part of these consolidated financial statements.

5

GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands)
(Unaudited)
									Accumulated
	Common			Additional					Other			Treasury
	Stock			Paid-in		Accumulated			Comprehensive			Stock
	Shares	Amount		Capital		Deficit			Loss			Shares		Amount			Total
Balance, December 31, 2011	19,255	$	193	$	70,167	$	(29,063	)	$	(865	)	(824	)	$	(1,649	)	$	38,783
Stock-based compensation expense	-		-		678		-			-		-			-			678
Common stock issued for
options exercised	167		1		272		-			-		-			-			273
Foreign currency
translation adjustment	-		-		-		-			291		-			-			291
Treasury stock at cost	-		-		-		-			-		(223	)		(422	)		(422	)
Net income	-		-		-		1,504			-		-			-			1,504
Balance, September 30, 2012	19,422	$	194	$	71,117	$	(27,559	)	$	(574	)	(1,047	)	$	(2,071	)	$	41,107
The accompanying notes are an integral part of these consolidated financial statements.

6

GSE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
	Nine Months ended
	September 30,
	2012			2011
Cash flows from operating activities:
Net income	$	1,504		$	1,627
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation		406			365
Amortization of definite-lived intangible assets		235			629
Capitalized software amortization		536			612
Amortization of deferred financing costs		9			-
Change in fair value of contingent consideration		245			331
Stock-based compensation expense		678			569
Equity (gain) loss on investment in GSE-UNIS Simulation Technology Co. Ltd.		(27	)		22
Gain on derivative instruments		(36	)		(49	)
Changes in assets and liabilities:
Contract receivables		884			(2,980	)
Prepaid expenses and other assets		262			(1,359	)
Accounts payable, accrued compensation and accrued expenses		609			(1,597	)
Billings in excess of revenue earned		(225	)		656
Accrued warranty reserves		(143	)		401
Other liabilities		97			(844	)
Net cash provided by (used in) operating activities		5,034			(1,617	)
Cash flows from investing activities:
Capital expenditures		(1,404	)		(370	)
Capitalized software development costs		(914	)		(572	)
Investment in GSE-UNIS Simulation Technology Co. Ltd.		(469	)		(456	)
Acquisitions, net of cash acquired		-			(830	)
Restrictions of cash as collateral under letters of credit		(1,734	)		(5,171	)
Releases of cash as collateral under letters of credit		1,197			1,178
Drawdown of cash collateral on Emirates Simulation Academy, LLC line of credit		-			(79	)
Net cash used in investing activities		(3,324	)		(6,300	)
Cash flows from financing activities:
Proceeds from issuance of common stock		273			119
Payments of the liability-classified contingent consideration arrangements		(845	)		-
Treasury stock purchases		(422	)		(1,127	)
Net cash used in financing activities		(994	)		(1,008	)
Effect of exchange rate changes on cash		262			6
Net increase (decrease) in cash and cash equivalents		978			(8,919	)
Cash and cash equivalents at beginning of year		20,326			26,577
Cash and cash equivalents at end of period	$	21,304		$	17,658
The accompanying notes are an integral part of these consolidated financial statements.

7

GSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Three and Nine Months ended September 30, 2012 and 2011

(Unaudited)

1.   Basis of Presentation and Revenue Recognition

Basis of Presentation

The consolidated interim financial statements included herein have been prepared by GSE Systems, Inc. (the “Company” or “GSE”) without independent audit.  In the opinion of the Company's management, all adjustments and reclassifications of a normal and recurring nature necessary to present fairly the financial position, results of operations and cash flows for the periods presented have been made.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted.  The results of operations for interim periods are not necessarily an indication of the results for the full year.  These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the period ended December 31, 2011 filed with the Securities and Exchange Commission on March 8, 2012.

The Company has only one reportable segment.  The Company has a wide range of knowledge of simulation systems and the processes those systems are intended to control and model.  The Company’s knowledge is concentrated heavily in simulation technology and model development.  The Company is primarily engaged in simulation for the power generation industry and the process industries.  Contracts typically range from twelve months to three years.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements as well as reported amounts of revenues and expenses during the reporting period.  The Company’s most significant estimates relate to revenue recognition, capitalization of software development costs, valuation of intangible assets acquired, contingent consideration issued in business acquisitions, and the recoverability of deferred tax assets.  Actual results could differ from these estimates and those differences could be material.

Revenue Recognition

The majority of the Company’s revenue is derived through the sale of uniquely designed systems containing hardware, software and other materials under fixed-price contracts.  Revenue under these fixed-price contracts is accounted for on the percentage-of-completion method.  This methodology recognizes revenue and earnings as work progresses on the contract and is based on an estimate of the revenue and earnings earned to date, less amounts recognized in prior periods.  The Company bases its estimate of the degree of completion of the contract by reviewing the relationship of costs incurred to date to the expected total costs that will be incurred on the project. Estimated contract earnings are reviewed and revised periodically as the work progresses, and the cumulative effect of any change in estimate is recognized in the period in which the change is identified.  Estimated losses are charged against earnings in the period such losses are identified.  The Company recognizes revenue arising from contract claims either as income or as an offset against a potential loss only when the amount of the claim can be estimated reliably and realization is probable and there is a legal basis for the claim.

Uncertainties inherent in the performance of contracts include labor availability and productivity, material costs, change order scope and pricing, software modification and customer acceptance issues.  The reliability of these cost estimates is critical to the Company’s revenue recognition as a significant change in the estimates can cause the Company’s revenue and related margins to change significantly from the amounts estimated in the early stages of the project.

8

As the Company recognizes revenue under the percentage-of-completion method, it provides an accrual for estimated future warranty costs based on historical experience and projected claims.  The Company’s long-term contracts generally provide for a one-year warranty on parts, labor and any bug fixes as it relates to software embedded in the systems.

The Company’s system design contracts do not normally provide for “post customer support service” (“PCS”) in terms of software upgrades, software enhancements or telephone support.  In order to obtain PCS, the customers must normally purchase a separate contract.  Such PCS arrangements are generally for a one-year period renewable annually and include customer support, unspecified software upgrades, and maintenance releases.  The Company recognizes revenue from these contracts ratably over the life of the agreements.

Revenue from the sale of software licenses which do not require significant modifications or customization for the Company’s modeling tools are recognized when the license agreement is signed, the license fee is fixed and determinable, delivery has occurred, and collection is considered probable.

Revenue from certain consulting or training contracts is recognized on a time-and-material basis.  For time-and-material type contracts, revenue is recognized based on hours incurred at a contracted labor rate plus expenses.

The following customers have provided more than 10% of the Company’s consolidated revenue for the indicated periods:

	Three Months ended		Nine Months ended
	September 30,		September 30,
	2012	2011	2012	2011
BP Products North America	15.6%	0.1%	6.2%	0.1%
Slovenské elektrárne, a.s.	2.3%	12.5%	4.8%	12.3%

2.   Recently Adopted Accounting Pronouncements

In September 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2011-08, Intangibles — Goodwill and Other (Topic 350) — Testing Goodwill for Impairment (“ASU 2011-08”), to allow entities to use a qualitative approach to test goodwill for impairment. ASU 2011-08 permits an entity to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value.  If it is concluded this is the case, it is necessary to perform the currently prescribed two-step goodwill impairment test.  Otherwise, the two-step goodwill impairment test is not required. ASU 2011-08 is effective for the Company for interim and annual periods ending during 2012, with earlier application permitted.  The adoption of this guidance had no impact on the Company’s consolidated financial statements.

In May 2011, the FASB issued Accounting Standards Update No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (Topic 820) — Fair Value Measurement (“ASU 2011-04”), to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between U.S. generally accepted accounting principles and International Financial Reporting Standards.  ASU 2011-04 changes certain fair value measurement principles and enhances the disclosure requirements particularly for Level 3 fair value measurements.  ASU 2011-04 is effective for the Company for interim and annual periods ending during 2012 and will be applied prospectively.  The adoption of this guidance had no impact on the Company’s consolidated financial statements.

9

3.   Basic and Diluted Income Per Common Share

Basic income per share is based on the weighted average number of outstanding common shares for the period.  Diluted income per share adjusts the weighted average shares outstanding for the potential dilution that could occur if stock options or warrants were exercised into common stock.  The number of common shares and common share equivalents used in the determination of basic and diluted income per share were as follows:

(in thousands, except for share amounts)	Three Months ended				Nine Months ended
	September 30,				September 30,
	2012		2011		2012		2011
Numerator:
Net income	$	816	$	858	$	1,504	$	1,627
Denominator:
Weighted-average shares outstanding for
basic earnings per share		18,390,034		18,879,757		18,370,907		19,101,284
Effect of dilutive securities:
Employee stock options		69,900		112,841		112,235		202,913
Adjusted weighted-average shares outstanding and
assumed conversions for diluted earnings per share		18,459,934		18,992,598		18,483,142		19,304,197
Shares related to dilutive securities excluded because inclusion would be anti-dilutive		2,847,203		1,573,896		2,799,268		1,544,504

4.   Contract Receivables

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

(in thousands)	September 30,  2012		December 31, 2011
Billed receivables	$	7,858	$         8,258
Recoverable costs and accrued profit not billed		11,719	12,234
Allowance for doubtful accounts		(136)	(136)
Total contract receivables, net	$	19,441	$      20,356

10

Recoverable costs and accrued profit not billed totaled $11.7 million and $12.2 million as of September 30, 2012 and December 31, 2011, respectively.  During October 2012, the Company invoiced $1.8 million of the unbilled amounts.

The following customers account for more than 10% of the Company’s consolidated contract receivables for the indicated periods:

	September 30,2012		December 31, 2011
Slovenské elektrárne, a.s.		15.7%	24.2%
Shandong Nuclear Power Co. Ltd.		15.3%	5.0%
Kraftwerkesschule E.V.		12.4%	7.9%

In May 2012, Slovenské elektrárne, a.s. (“SE”) notified the Company of its decision to suspend work under the contract due to changes in the Slovakian regulation requiring SE to redesign certain aspects of the plant.  The Company and SE are currently discussing amendments to the existing contract addressing (i) substantial additional scope of work for the Company,  (ii) costs related to suspension of the contract and its restart,  (iii) the Company’s continued support of the project during the suspension period and (iv) withdrawal of  SE outstanding claims.  At September 30, 2012, the Company had a $188,000 outstanding invoice included in accounts receivable, $2.9 million of recoverable costs and accrued profit not billed, and a $2.9 million performance bond in place to secure completion of the contract.

5.   Software Development Costs

Certain computer software development costs are capitalized in the accompanying consolidated balance sheets.  Capitalization of computer software development costs begins upon the establishment of technological feasibility.  Capitalization ceases and amortization of capitalized costs begins when the software product is commercially available for general release to customers.  Amortization of capitalized computer software development costs is included in cost of revenue and is determined using the straight-line method over the remaining estimated economic life of the product, typically three years.

Software development costs capitalized were $306,000 and $914,000 for the three and nine months ended September 30, 2012, respectively, and $186,000 and $572,000 for the three and nine months ended September 30, 2011, respectively.  Total amortization expense was $168,000 and $536,000 for the three and nine months ended September 30, 2012, respectively, and $218,000 and $612,000 for the three and nine months ended September 30, 2011, respectively.

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6.   Fair Value of Financial Instruments

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

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

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

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

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

The Company considers the recorded value of certain of its financial assets and liabilities, which consist primarily of cash, accounts receivable and accounts payable, to approximate the fair value of the respective assets and liabilities at September 30, 2012 and December 31, 2011 based upon the short-term nature of the assets and liabilities.

The following table presents assets and liabilities measured at fair value at September 30, 2012:

		Quoted Prices		Significant
		in Active		Other			Significant
		Markets for		Observable			Unobservable
		Identical Assets		Inputs			Inputs
(in thousands)		(Level 1)		(Level 2)			(Level 3)		Total
Money market fund		$	15,429	$	-		$	-	$	15,429
Certificates of deposit			3,942		-			-		3,942
Foreign exchange contracts			-		507			-		507
	Total assets	$	19,371	$	507		$	-	$	19,878
Foreign exchange contracts		$	-	$	(370	)	$	-	$	(370	)
	Total liabilities	$	-	$	(370	)	$	-	$	(370	)

12

The following table presents assets and liabilities measured at fair value at December 31, 2011:

		Quoted Prices		Significant
		in Active		Other			Significant
		Markets for		Observable			Unobservable
		Identical Assets		Inputs			Inputs
(in thousands)		(Level 1)		(Level 2)			(Level 3)		Total
Money market fund		$	8,163	$	-		$	-	$	8,163
Certificates of deposit			5,976		-			-		5,976
Foreign exchange contracts			-		483			-		483
	Total assets	$	14,139	$	483		$	-	$	14,622
Foreign exchange contracts		$	-	$	(314	)	$	-	$	(314	)
	Total liabilities	$	-	$	(314	)	$	-	$	(314	)

7.   Derivative Instruments

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

As of September 30, 2012, the Company had foreign exchange contracts outstanding of approximately 1.0 million Pounds Sterling, 13.3 million Euro, and 70.8 million Japanese Yen at fixed rates.  The contracts expire on various dates through May 2016.  At December 31, 2011, the Company had contracts outstanding of approximately 3.1 million Pounds Sterling, 12.0 million Euro, and 383.5 million Japanese Yen at fixed rates.  The Company has not designated any of the foreign exchange contracts outstanding as hedges and has recorded the estimated fair value of the contracts in the consolidated balance sheets as follows:

	September 30,			December 31,
(in thousands)	2012			2011
Asset derivatives
Prepaid expenses and other current assets	$	481		$	393
Other assets		26			90
		507			483
Liability derivatives
Other current liabilities		(203	)		(258	)
Other liabilities		(167	)		(56	)
		(370	)		(314	)
Net fair value	$	137		$	169

13

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

The foreign currency denominated contract receivables, billings in excess of revenue earned and subcontractor accruals that are related to the outstanding foreign exchange contracts are remeasured at the end of each period into the functional currency using the current exchange rate at the end of the period.  The gain or loss resulting from such remeasurement is also included in net gain (loss) on derivative instruments in the consolidated statements of operations.

For the three and nine months ended September 30, 2012 and 2011, the Company recognized a net gain (loss) on its derivative instruments as outlined below:

	Three Months ended						Nine Months ended
	September 30,						September 30,
(in thousands)	2012			2011			2012			2011
Foreign exchange contracts- change in fair value	$	(134	)	$	(143	)	$	(42	)	$	(298	)
Remeasurement of related contract receivables, billings in excess of revenue earned, and subcontractor accruals		154			14			78			347
Gain (loss) on derivative instruments, net	$	20		$	(129	)	$	36		$	49

8.   Stock-Based Compensation

The Company recognizes compensation expense for all equity-based compensation awards issued to employees, directors and non-employees that are expected to vest.  Compensation cost is based on the fair value of awards as of the grant date.  The Company recognized $231,000 and $183,000 of stock-based compensation expense for the three months ended September 30, 2012 and 2011, respectively, under the fair value method and recognized $678,000 and $569,000 of stock-based compensation expense for the nine months ended September 30, 2012 and 2011, respectively.  The Company granted 0 and 152,870 stock options for the three and nine months ended September 30, 2012, respectively.  The fair value of the granted options at the grant date was $145,000.  The Company granted 60,000 and 102,000 stock options for the three and nine months ended September 30, 2011, respectively.  The fair value of the options granted for the three and nine months ended September 30, 2011 was $75,000 and $135,000, respectively.

14

9.   Long-Term Debt

At September 30, 2012 and December 31, 2011, the Company had no long-term debt outstnading.

Line of Credit

The Company has a Master Loan and Security Agreement and Revolving Credit Note with Susquehanna Bank (“Susquehanna”).  The Company and its subsidiaries, GSE Power Systems, Inc., and GSE EnVision LLC, are jointly and severally liable as co-borrowers.  The Loan Agreement provides a $7.5 million revolving line of credit for the purpose of (i) issuing stand-by letters of credit and (ii) providing working capital. Working capital advances bear interest at a rate equal to the Wall Street Journal Prime Rate of Interest, floating with a floor of 4 ½%.  The two-year agreement is to expire on November 1, 2013.

As collateral for the Company’s obligations, the Company granted a first lien and security interest in all of the assets of the Company, including but not limited to, accounts receivable, inventory, proceeds and products, intangibles, trademarks, patents, intellectual property, machinery and equipment.

Issuances of stand-by letters of credit and advances of working capital (collectively referred to as the “Advances”) require that the Company maintain a minimum cash balance of $3.0 million at all times (the “Cash Balance Requirement”).  The Cash Balance Requirement will remain at the minimum amount as long as the Company’s quarterly net income (exclusive of gains and losses on derivative instruments and stock option expense) as defined (“Net Income”) remains positive and the Company is in compliance with the covenants.  If the Company’s quarterly consolidated Net Income is negative or the Company is not in compliance with the covenants, the Cash Balance Requirement will revert to the amount of the Advances, until the Company attains positive Net Income for two consecutive quarters.  The credit agreements contain certain restrictive covenants regarding future acquisitions, and incurrence of debt.  In addition, the credit agreements contain financial covenants with respect to the Company’s cash flow coverage ratio, minimum tangible capital base, quick ratio, and tangible capital base ratio.  At September 30, 2012, the Company had not made any borrowings for over one year.  As such, the cash flow coverage ratio is not applicable at September 30, 2012.

		As of
	Covenant	September 30, 2012
Minimum tangible capital base	Must Exceed $26.0 million	$33.4 million
Quick ratio	Must Exceed 2.00 : 1.00	2.59 : 1.00
Tangible capital base ratio	Not to Exceed .75 : 1.00	.59 : 1.00

As the Company’s Net Income for the nine months ended September 30, 2012 was positive and the Company is in compliance with its covenants, the Company is currently required to maintain the minimum cash balance of $3.0 million with Susquehanna.  At September 30, 2012, the Company had $328,000 in Advances, all of which consisted of outstanding stand-by letters of credit.

As of September 30, 2012, the Company was contingently liable for eleven standby letters of credit and five surety bonds totaling $6.3 million which represent performance and bid bonds on eleven contracts.  The Company has deposited the full value of eight standby letters of credit in certificates of deposit and escrow accounts ($4.8 million) which have been restricted in that the Company does not have access to these funds until the related letters of credit have expired.  The cash has been recorded on the Company’s balance sheet at September 30, 2012 as restricted cash.

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10.   Product Warranty

As the Company recognizes revenue under the percentage-of-completion method, it provides an accrual for estimated future warranty costs based on historical experience and projected claims.  The activity in the warranty account is as follows:

(in thousands)
Balance at December 31, 2011	$	2,300
Warranty provision		727
Warranty claims		(897	)
Currency adjustment		27
Balance at September 30, 2012	$	2,157

11.   Income Taxes

The Company files 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 from years 1997 forward and is subject to foreign tax examinations by tax authorities for years 2005 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.

An uncertain tax position taken or expected to be taken in a tax return is recognized in the 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, through its acquisition of EnVision Systems Inc. (“EnVision”) on January 4, 2011, recognized deferred tax liabilities of $1.0 million.  As a result of this acquisition, in accordance with ASC-805 Business Combinations, the Company reduced the valuation allowance on its U.S. net deferred tax assets and recognized the change in the valuation allowance ($1.0 million) through the income tax provision in the three months ended March 31, 2011.

The Company, through its acquisition of EnVision on January 4, 2011, also recorded $320,000 of unrecognized tax benefits as well as a receivable from the EnVision shareholders for the same amount as indemnity for this tax position.  During 2011, the Company also recorded $126,000 of unrecognized tax benefits in 2011 for certain foreign tax contingencies.  During the nine months ended September 30, 2012, the Company recorded $29,000 of unrecognized tax benefits for certain foreign tax contingencies.  The Company records interest and penalties associated with uncertain tax positions as a component of income tax expense.  The Company does not expect any material changes to its uncertain tax positions in the next twelve months.

The Company expects to pay income taxes in Sweden, India, and China in 2012.  In 2011, the Company paid income taxes to Sweden, India, China, and the United Kingdom.  In addition, the Company will pay foreign income tax withholding on several non-U.S. contracts in 2012, which is consistent with the foreign income tax withholdings in 2011.  The Company has a full valuation allowance on its U.S. net deferred tax assets at September 30, 2012.

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12.   Preferred Stock Rights

On March 21, 2011, the Board of Directors of the Company declared a dividend, payable to holders of record as of the close of business on April 1, 2011, of one preferred stock purchase right (a Right) for each outstanding share of common stock, par value $0.01 per share, of the Company (the Common Stock).  In addition, the Company will issue one Right with each new share of Common Stock issued.  In connection therewith, on March 21, 2011, the Company entered into a Stockholder Protection Rights Agreement (as amended from time to time, the Rights Agreement) with Continental Stock Transfer & Trust Company, as Rights Agent, which has a term of three years, unless amended by the Board of Directors in accordance with the terms of the Rights Agreement.  Upon approval of both an independent committee of the Board of Directors and the Board of Directors, the Rights Plan can be extended for up to three years.  The Rights will initially trade with and be inseparable from the Common Stock and will not be evidenced by separate certificates unless they become exercisable.  Each Right entitles its holder to purchase from the Company one-hundredth of a share of participating preferred stock having economic and voting terms similar to the Common Stock at an exercise price of $8.00 per Right, subject to adjustment in accordance with the terms of the Rights Agreement, once the Rights become exercisable.  Under the Rights Agreement, the Rights become exercisable if any person or group acquires 20% or more of the Common Stock or, in the case of any person or group that owned 20% or more of the Common Stock as of March 21, 2011, upon the acquisition of any additional shares by such person or group.  The Company, its subsidiaries, employee benefit plans of the Company or any of its subsidiaries and any entity holding Common Stock for or pursuant to the terms of any such plan are accepted.  Upon exercise of the Right in accordance with the Rights Agreement, the holder would be able to purchase a number of shares of Common Stock from the Company having an aggregate market price (as defined in the Rights Agreement) equal to twice the then-current exercise price for an amount in cash equal to the then-current exercise price.  In addition, the Company may, in certain circumstances and pursuant to the terms of the Rights Agreement, exchange the Rights for one share of Common Stock or an equivalent security for each Right or, alternatively, redeem the Rights for $0.001 per Right.  The Rights will not prevent a takeover of our Company, but may cause substantial dilution to a person that acquires 20% or more of the Company’s Common Stock.

13.   Share Repurchase Plan

On March 21, 2011, the Board of Directors authorized the purchase of up to $3.0 million of the Company’s common stock in accordance with the safe harbor provisions of Rule 10b-18 of the Securities Exchange Act of 1934.  During the three and nine months ended September 30, 2012 the Company repurchased 60,700 and 223,087 shares at an aggregate cost of $119,000 and $422,000, respectively.  During the three and nine months ended September 30, 2011 the Company repurchased 370,519 and 521,400 shares at an aggregate cost of $792,000 and $1.1 million, respectively.

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

GSE Systems, Inc. (“GSE Systems”, “GSE” or the “Company”) is a world leader in real-time high fidelity simulation.  The Company provides simulation and educational solutions and services to the nuclear and fossil electric utility industry, and the chemical and petrochemical industries.

GSE is the parent company of:

¨   GSE Power Systems, Inc., a Delaware corporation;

¨   GSE Power Systems, AB, a Swedish corporation;

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

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

¨   TAS Engineering Consultants Ltd., an English limited liability company;

¨   GSE EnVision, LLC, a New Jersey limited-liability company; and

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

The Company has a 49% minority interest in GSE-UNIS Simulation Technology Co., Ltd., a Chinese limited liability company, and has a 10% minority interest in Emirates Simulation Academy, LLC, a United Arab Emirates limited liability company.  The Company has only one reportable segment.

Cautionary Statement Regarding Forward-Looking Statements

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward looking statements.  Forward-looking statements are not statements of historical facts, but rather reflect our current expectations concerning future events and results.  We use words such as “expects”, “intends”, “believes”, “may”, “will” and “anticipates” to indicate forward-looking statements. Because these forward-looking statements involve risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements, including, but not limited to, those factors set forth under Item 1A - Risk Factors of the Company’s 2011 Annual Report on Form 10-K and those other risks and uncertainties detailed in the Company’s periodic reports and registration statements filed with the Securities and Exchange Commission. We caution that these risk factors may not be exhaustive.  We operate in a continually changing business environment, and new risk factors emerge from time to time.  We cannot predict these new risk factors, nor can we assess the effect, if any, of the new risk factors on our business or the extent to which any factor or combination of factors may cause actual results to differ from those expressed or implied by these forward-looking statements.

If any one or more of these expectations and assumptions proves incorrect, actual results will likely differ materially from those contemplated by the forward-looking statements.  Even if all of the foregoing assumptions and expectations prove correct, actual results may still differ materially from those expressed in the forward-looking statements as a result of factors we may not anticipate or that may be beyond our control.  While we cannot assess the future impact that any of these differences could have on our business, financial condition, results of operations and cash flows or the market price of shares of our common stock, the differences could be significant.  We do not undertake to update any forward-looking statements made by us, whether as a result of new information, future events or otherwise.  You are cautioned not to unduly rely on such forward-looking statements when evaluating the information presented in this report.

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General Business Environment

It has been over 18 months since a 9.0 magnitude earthquake and subsequent tsunami occurred along the northeast coast of Japan which damaged the Fukushima Daiichi I Nuclear Power Plant, which is maintained by the Tokyo Electric Power Company (TEPCO).

Most countries with nuclear programs reacted to the Fukushima disaster by announcing the delay of new nuclear plants while they conducted reviews of their programs.  On March 9, 2012, the U.S. Nuclear Regulatory Commission (NRC) approved the first three new regulatory requirements to deal with safety issues based on eight changes identified by the NRC’s Fukushima task force, with implementation required by the end of 2016.   The three orders require safety enhancements of operating reactors, construction permit holders, and combined license holders.  These orders require nuclear power plants to implement safety enhancements related to (1) mitigation strategies to respond to extreme natural events resulting in the loss of power at plants, (2) ensuring reliable hardened containment vents, and (3) enhancing spent fuel pool instrumentation.  In addition, the NRC requested each reactor reevaluate the seismic and flooding hazards at their site using present-day methods and information.

On May 31, 2012, the State Council, China’s Cabinet, approved a nuclear safety plan for 2011-2015 following a nine month safety inspection of China’s 41 nuclear power plants, which are either operating or under construction.  The inspection reportedly showed that most of China’s nuclear power stations meet both Chinese and International Atomic Energy Agency standards.  According to the Council’s statements, the main issues have been for some nuclear power plants to meet new standards on flood protection and for some research reactors to meet new earthquake requirements.  Some power plants must also develop better procedures for severe accident prevention and mitigation.  Although the Chinese government has not made a decision on when to start approving new nuclear plant projects, there are signs that the decision may come soon.  China National Nuclear Power, the biggest nuclear power developer in the country, announced plans to raise money for projects worth more than $27 billion through what could be one of the biggest initial public offerings (IPO) in China and the first for a nuclear power company.  The Ministry of Environmental Protection has approved the IPO plan, which must still be submitted to the China Securities Regulatory Commission for approval.

In Japan, all of the country’s 54 commercial nuclear reactors had gone offline since the Fukushima disaster.  The Japanese government has asked the plant operators to conduct stress tests: computer simulations designed to show how the reactors would hold up during a large natural disaster. In April, 2012, the Japanese nuclear regulators issued a list of 30 lessons from the Fukushima disaster.  Although the Japanese Prime Minister, Yoshihiko Noda, has called for restarting the plants as soon as possible, he has said that the reactors will not restart without the approval of local community leaders.  Many such local leaders have stated that the stress tests are not enough and want additional guidelines issued before the nuclear reactors are restarted. However, on July 1, 2012, Japan restarted the reactor No. 3 at Ohi nuclear power plant.

Previous nuclear accidents have resulted in new regulations requiring additional operator training, higher fidelity models and new testing scenarios.  Accordingly, as evidenced by the new safety rules that the NRC has recently issued, the Chinese State Council’s Safety Plan, and the debate in Japan as to the need for new regulatory guidelines, it is likely that there will be additional governmental regulations requiring plant modifications and new testing scenarios that will result in the need for higher simulator fidelity, such as that designed and supplied by GSE.

GSE has developed PSA-HD™, an engineering-grade nuclear simulation solution that allows operations personnel to train for and develop responses to severe accident scenarios based on the operations of their specific facility.  PSA-HD utilizes MAAP 5.0 as the calculation engine, with GSE’s real-time executive and graphical interface to provide a dynamic, real-time solution for severe accident analysis.  MAAP 5.0 is an Electric Power Research Institute (EPRI) software program that performs severe accident analysis for nuclear power plants including assessments of core damage and radiological transport.  A valid license to MAAP 5.0 from EPRI is required to use MAAP 5.0 with PSA-HD.  PSA-HD’s real-time code can be integrated with a nuclear plant’s existing full-scope training simulator and is applicable to all current nuclear plant designs.  PSA-HD can be used to validate the utility’s severe accident management guidelines (SAMGs), demonstrate the safety of current plant designs to regulators and stakeholders, and identify potential issues with existing plant design that may require modification.  PSA-HD includes high-fidelity models of the plant’s reactor core, containment structures and spent fuel pool.  The models simulate severe accident conditions which mirror those that occurred at the Fukushima facility, such as the release of radioactive materials due to overheating of the core, exposure of the fuel rods in the spent fuel pool, and hydrogen build up in the containment building.

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In order to meet the world’s growing energy needs, the growth of all forms of energy is critical.  Per the ExxonMobil 2012 the Outlook for Energy: A View to 2040, “By 2040 electricity generation will account for more than 40% of global energy consumption.  Oil will remain the most widely used fuel, but natural gas will grow fast enough to overtake coal for the number-two position.  For both oil and natural gas, an increasing share of global supply will come from unconventional sources, such as those from shale formations.  Demand for natural gas will rise by more than 60% through 2040.”  For more than three decades, GSE has leveraged the simulation capability that we initially developed for nuclear power for non-nuclear projects.  Globally we have delivered 121 fossil power plant simulators and 96 process industry simulators.  Our EnVision™ products include interactive multi-media tutorials and simulation models primarily for the petrochemical and oil & gas refining industries.  These products provide a foundation in process fundamentals, as well as plant operations and interaction.  GSE now has a tiered offering when it comes to simulation, as well as a large library of training content in multiple languages.

According to the U.S. Energy Information Administration, world energy consumption is forecasted to increase by 52% from 505 quadrillion BTU in 2008 to 770 quadrillion BTU in 2035.  New consumption means new production, which means new plants, new workers, and an enormous amount of training to provide a skilled workforce.  GSE recognized this growing need for energy industry training several years ago and began developing various training solutions leveraging the use of our simulation technology.  GSE created a 163 module, five-simulator training course that was sold to the Emirates Simulation Academy LLC, in the UAE, a training academy that was created by GSE and two other partners in 2007. The Company worked with the University of Strathclyde in Glasgow, Scotland to incorporate GSE’s simulation into the University’s degreed and industrial education programs.  GSE developed a 20-week “Nuclear Operator Jump Start Training Program” for Southern Nuclear Company in Augusta, GA utilizing the Company’s VPanel™ interactive visual training simulator.  The advantage of the VPanel simulator is its scalability and ease of configuration for both team and individual training, plant specific or cross training.  The VPanel allows customers to utilize their existing simulator load while bringing many full scope simulator capabilities directly into the classroom for a fraction of the cost.  The “Operator Jump Start” program helps customers screen and train new operator candidates.  This training program is designed to provide essential knowledge and skills to potential nuclear plant operators and to determine if candidates have the ability to successfully complete the customer’s own operator licensing programs.  The program includes instruction on fundamental sciences (including Generic Fundamentals Examinations “GFES”), plant components, systems, and operations.

A compounding problem is facing the energy industry.  While experiencing rapid growth requiring new plants and new workers, the incumbent industry workforce is aging and facing dramatic turnover.  Per the Nuclear Energy Institute, as of 2008 nearly 38% of the U.S. nuclear power industry would be eligible to retire by 2013.  According to the Center for Energy Workforce Development, an estimated 46% of the current energy industry workforce may need to be replaced by 2015 due to attrition and retirement.  While the data is readily available in the nuclear industry because it is so heavily regulated, similar demographics exist in the fossil, oil & gas, chemical and petrochemical industries.  The impact of this pending workforce turnover has been somewhat delayed due to the recent global economic downturn which has forced many employees to postpone their retirements.  Accordingly, the Company anticipates that in the near future, a larger number of employees are likely to retire within a shorter time span and the need to find qualified employees to replace them will become an acute issue.

Except for some insightful early adopters, many companies tend to put off spending on training until their training needs become acute.  Often it is viewed as a cost rather than an investment, and is often one of the first expenditures to be reduced during economic downturns.  However, the statistics associated with new plant builds and the aging workforce are undeniable, and training will be required to supply the skilled employees that will be needed to staff the new plants and replace the retirees.  Therefore, when the energy industry recognizes the need to train, they will want training that is faster and better than what is traditionally available.  Additionally, they will have to consider the nature of the next generation workforce who has grown up with a computer and vast amounts of interactive multimedia.  Standard classroom training will not provide the efficacy that will be needed nor satisfy the interest level of the new workforce.

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In fact, according to the NTL Institute’s statistics on adult learner retention only 5% of information is retained from lecture, and only 10% from reading.  However, 75% retention is accomplished when learners practice by doing.  These statistics support GSE’s success with the Nuclear Operator Jump Start Training Program at Southern Nuclear Company, as our design combines traditional instructor-led classroom training with structured simulator exercises supporting the concepts learned.  This model is transportable globally to anywhere a new energy workforce is needed.

Case studies demonstrate that the inclusion of “serious gaming” technology such as immersive 3D environments can reduce training time and improve learning significantly.  In fact, the Royal Canadian Army was able to reduce the cost of training and increase the pass rate of students by incorporating gaming into the curriculum.  Due to the advancement of computer processing power and graphics technology, immersive commercially viable off-the-shelf 3D game engines are readily available.  Additionally, this style of learning also lends itself to the next generation workforce, and as such GSE is investing significantly in 3D visualization training products.  This investment comes in the form of strategic hires, investment in technology, and software product development.  Through development efforts already undertaken, GSE’s engineers have discovered how to link our industry-leading, high fidelity models to commercially off-the-shelf game engines.  This enables us to make the invisible visible, for example seeing the inside of an operating reactor, steam generator, or turbine generator.  Blending the learning strategy by incorporating 3D visualization interfacing high fidelity real time simulation models will allow GSE to provide the energy industry with better, faster, less costly training ideally suited for the next generation workforce, which we have branded as ACTIV-3Di.  In September 2012, the Company introduced the Virtual Flow Loop TrainerTM. It can cost approximately $1.0 million to construct a brick and mortar flow loop facility for training plant operating and maintenance staff. The Virtual Flow Loop Trainer is a practical and cost-effective alternative that operates on personal computers across a company’s existing IT infrastructure. The Virtual Flow Loop Trainer provides the same level of training in a convenient, flexible environment. The Virtual Flow Loop Trainer is applicable across all industries and learning organizations that need to train their staff and students on both the fundamental and practical operations of a wide variety of pumps, valves, controllers, and instrumentation.  We received our first 3D visualization orders in 2011 and will recognize modest revenue from 3D visualization training products in 2012.  

Besides new employees, the dramatic increase in energy demand world-wide over the next 30 years will require new plants of all sources, too.  Obviously, these new plants will need to be engineered and designed prior to construction, and GSE’s modeling tools are being used more and more to verify and validate control system design and overall plant designs.  Finding design errors during engineering rather than construction allows plant startup to occur sooner saving countless dollars and allowing revenue generation sooner.  GSE is developing new design solutions leveraging our high fidelity simulation models to improve and streamline the plant engineering process.

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Results of Operations

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

(in thousands)	Three Months ended September 30,												Nine Months ended September 30,
	2012			%			2011			%			2012		%			2011			%
Contract revenue	$	13,009			100.0	%	$	12,549			100.0	%	$	39,581		100.0	%	$	36,128			100.0	%
Cost of revenue		7,960			61.2	%		7,931			63.2	%		26,143		66.0	%		24,278			67.2	%
Gross profit		5,049			38.8	%		4,618			36.8	%		13,438		34.0	%		11,850			32.8	%
Operating expenses:
Selling, general and administrative		3,483			26.8	%		3,302			26.3	%		10,663		27.0	%		9,920			27.5	%
Depreciation		131			1.0	%		137			1.1	%		406		1.0	%		365			1.0	%
Amortization of definite-lived intangible assets		79			0.6	%		204			1.6	%		235		0.6	%		629			1.7	%
Total operating expenses		3,693			28.4	%		3,643			29.0	%		11,304		28.6	%		10,914			30.2	%
Operating income		1,356			10.4	%		975			7.8	%		2,134		5.4	%		936			2.6	%
Interest income, net		36			0.3	%		29			0.2	%		121		0.3	%		91			0.3	%
Gain (loss) on derivative instruments, net		20			0.2	%		(129	)		(1.0	)%		36		0.1	%		49			0.1	%
Other income (expense), net		(97	)		(0.8	)%		31			0.2	%		82		0.2	%		70			0.2	%
Income before income taxes		1,315			10.1	%		906			7.2	%		2,373		6.0	%		1,146			3.2	%
Provision (benefit) for income taxes		499			3.8	%		48			0.4	%		869		2.2	%		(481	)		(1.3	)%
Net income	$	816			6.3	%	$	858			6.8	%	$	1,504		3.8	%	$	1,627			4.5	%

Critical Accounting Policies and Estimates

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

A summary of the Company’s significant accounting policies as of December 31, 2011 is included in Note 2 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011.  Certain of our accounting policies require higher degrees of judgment than others in their application.  These include revenue recognition on long-term contracts, capitalization of computer software development costs, valuation of intangible assets acquired, contingent consideration issued in business acquisitions, and the recoverability of deferred tax assets.  These critical accounting policies and estimates are discussed in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section in the 2011 Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

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Results of Operations - Three and Nine months ended September 30, 2012 versus Three and Nine months ended September 30, 2011

Contract Revenue.  Total contract revenue for the three months ended September 30, 2012 totaled $13.0 million, which was 3.7% greater than the $12.5 million total revenue for the three months ended September 30, 2011.  For the nine months ended September 30, 2012, contract revenue totaled $39.6 million, a $3.5 million increase from the $36.1 million for the nine months ended September 30 2011.  The Company recorded total orders of $34.9 million in the nine months ended September 30, 2012 compared to $28.4 million for the nine months ended September 30, 2011.  During the second quarter of 2012, GSE’s wholly-owned subsidiary, GSE EnVision LLC (“EnVision”), received a multi-year contract to provide simulation and computer-based learning modules to the subsidiary of a global energy services company.  Revenue from such contract for the three and nine months ended September 30, 2012 was $2.0 million and $2.4 million, respectively.  Revenue related to the $26.9 million full scope simulator and digital control system order from  Slovenské elektrárne, a.s. (“SE”) was $293,000 (2.3% of revenue) and $1.6 million (12.5% of revenue) for the three months ended September 30, 2012 and 2011, respectively.  For the nine months ended September 30, 2012 and 2011, revenue from SE was $1.9 million (4.8% of revenue) and $4.5 million (12.3% of revenue), respectively.At September 30, 2012, the Company’s backlog was $47.2 million, of which $4.1 million is related to the SE contract.  At December 31, 2011 the Company’s backlog totaled $51.5 million. 

Gross Profit.  Gross profit totaled $5.0 million for the three months ended September 30, 2012 compared to $4.6 million for the same period in 2011.  As a percentage of revenue, gross profit increased from 36.8% for the three months ended September 30, 2011 to 38.8% for the three months ended September 30, 2012.  For the nine months ended September 30, 2012, gross profit increased from $11.9 million during the same period in 2011 to $13.4 million and as a percentage of revenue, gross profit increased from 32.8% to 34.0%, respectively.  The increase in revenue from EnVision which has an overall gross profit significantly higher than the Company’s normal gross profits, and the decrease in revenue on the Slovakia contract, which has an overall gross profit lower than the Company’s normal gross profits, have contributed to the increase in gross profit for the three and nine months ended September 30, 2012.  In addition, during the three months ended September 30, 2011, the Company received a $3.0 million change order related to the SE project which increased the overall gross margin on the project and generated an additional $679,000 in gross profit on the project for both the three and nine months ended September 30, 2011.

Selling, General and Administrative Expenses.  Selling, general and administrative (“SG&A”) expenses totaled $3.5 million in the three months ended September 30, 2012, a 5.5% increase from the $3.3 million for the same period in 2011.  For the nine months ended September 30, 2012 and 2011, SG&A expenses totaled $10.7 million and $9.9 million, respectively.  The increase reflects the following spending variances:

¨   Business development and marketing costs increased from $1.3 million to $1.7 million for the three months ended September 30, 2011 and 2012, respectively, and increased from $4.1 million to $5.0 million for the nine months ended September 30, 2011 and 2012, respectively.  The Company hired three business development resources in the United States and hired two additional business development resources in Europe as compared to the prior year.  Included in business development and marketing costs are bidding and proposal costs, which are the costs of operations personnel assisting with the preparation of contract proposals.  Bidding and proposal costs increased by $128,000 and $301,000 during the three and nine months ended September 30, 2012 to $463,000 and $1.4 million, respectively, as compared to the three and nine months ended September 30, 2011.

¨   The Company’s general and administrative expenses (“G&A”) decreased from $1.7 million to $1.5 million for the three months ended September 30, 2011 and 2012, respectively and decreased from $5.2 million to $4.7 million for the nine months ended September 30, 2011 and 2012, respectively.  The fluctuations were primarily attributable to the following:

o   The Company incurred $0 and $206,000 of acquisition related expenses, primarily composed of legal, audit, and due diligence expenses for the three and nine months ended September 30, 2011, respectively.  The Company did not incur any acquisition related expenses during the three and nine months ended September 30, 2012.

o   The change in the fair value of contingent consideration (accretion expense) related to the TAS and EnVision acquisitions totaled $102,000 and $245,000 for the three and nine months ended September 30, 2012, respectively, versus $47,000 and $331,000 for the three and nine months ended September 30, 2011, respectively.

23

¨   Gross spending on software product development (“development”) expenses for the three and nine months ended September 30, 2012 totaled $587,000 and $1.9 million, respectively, as compared to $454,000 and $1.2 million for the three and nine months ended September 30, 2011, respectively.  The Company capitalized $306,000 and $914,000 of product development expenses for the three and nine months ended September 30, 2012, respectively, and $186,000 and $572,000 for the same periods in 2011, respectively.  Net development spending increased from $268,000 for the three months ended September 30, 2011 to $281,000 for the three months ended September 30, 2012 and from $628,000 for the nine months ended September 30, 2011 to $950,000 for the nine months ended September 30, 2012.

o   The Company created a 3D visualization team in January 2011 to develop 3D technology to add to our training programs.  The Company incurred $70,000 and $306,000 of costs related to this effort in the three and nine months ended September 30, 2012, respectively, as compared to $104,000 and $231,000 for the same periods in 2011.

o   Spending on other software product development totaled $517,000 and $1.6 million for the three and nine months ended September 30, 2012, respectively.  For the three and nine months ended September 30, 2011, development expense totaled $350,000 and $969,000, respectively.  The Company’s development expenses were mainly related to three projects, an enhanced graphical user interface for our JADE™ modeling toolset, secondly, advancements were made to our configuration management system, ISIS™, which is a central data warehouse that supports various forms of data on a simulator, and thirdly, development work was performed on our new product, PSA-HD, which is used to train operators and power plant personnel on the sequence of events during severe accident conditions.

Depreciation.  Depreciation expense totaled $131,000 and $137,000 during the three months ended September 30, 2012 and 2011, respectively.  For the nine months ended September 30, 2012 and 2011, depreciation expense totaled $406,000 and $365,000, respectively.

Amortization of definite-lived intangible assets. Amortization expense related to definite-lived intangible assets totaled $79,000 and $204,000 for the three months ended September 30, 2012 and 2011, respectively.  For the nine months ended September 30, 2012 and 2011, amortization expense related to definite-lived intangible assets totaled $235,000 and $629,000, respectively.  The Company recorded intangible assets of $1.5 million in conjunction with the EnVision acquisition which included the following:

¨   Contractual customer relationships acquired totaled $438,000 and are being amortized in proportion to the projected revenue streams of the related contracts over three years.

¨   Non-contractual customer relationships acquired totaled $433,000 and are being amortized in proportion to the projected revenue streams of the related relationships over eight years.

¨   Developed technology acquired totaled $471,000 and is being amortized on a straight line method over an eight year period.

¨   In process research and development acquired totaled $152,000 and is being amortized over eight years in proportion to the projected revenue streams of the related in-process research and development.

¨   Domain names and other marketing related intangibles acquired totaled $15,000 and are being amortized on a straight line method over an estimated useful life of three years.

Operating Income.  The Company had operating income of $1.4 million (10.4% of revenue) during the three months ended September 30, 2012, as compared with operating income of $975,000 (7.8% of revenue) for the same period in 2011.  For the nine months ended September 30, 2012 and 2011, the Company had operating income of $2.1 million (5.4% of revenue) and operating income of 936,000 (2.6% of revenue), respectively.  The variances were due to the factors outlined above.

24

Interest Income, Net.  Net interest income totaled $36,000 and $29,000 for the three months ended September 30, 2012 and 2011, respectively.  For the nine months ended September 30, 2012 and 2011, net interest income totaled $121,000 and $91,000, respectively.

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.  As of September 30, 2012, the Company had foreign exchange contracts outstanding of approximately 1.0 million Pounds Sterling, 13.3 million Euro, and 70.8 million Japanese Yen at fixed rates.  The contracts expire on various dates through May 2016.  The Company has not designated the contracts as hedges and has recognized losses on the change in the estimated fair value of the contracts of ($134,000) and ($42,000) for the three and nine months ended September 30, 2012, respectively.

At September 30, 2011, the Company had foreign exchange contracts of approximately 2.3 million Pounds Sterling, 17.0 million Euro and 682.9 million Japanese Yen at fixed rates.  The contracts expire on various dates through February 2014.  The Company had not designated the contracts as hedges and had recognized losses on the change in the estimated fair value of the contracts of ($143,000) and ($298,000) for the three and nine months ended September 30, 2011, respectively.

The foreign currency denominated contract receivables, billings in excess of revenue earned, and subcontractor accruals that are related to the outstanding foreign exchange contracts were remeasured into the functional currency using the current exchange rate at the end of the period.  For the three and nine months ended September 30, 2012, the Company recognized gains of $154,000 and $78,000, respectively, from the remeasurement of such contract receivables, billings in excess of revenue earned and subcontractor accruals.  For the same periods in 2011, the Company recognized gains of $14,000 and $347,000, respectively.

Other Income (Expense), net.  For the three and nine months ended September 30, 2012, other income, net was ($97,000) and $82,000, respectively.  For the three and nine months ended September 30, 2011, other income (expense), net was $31,000 and $70,000, respectively.  The major components of other income (expense), net included the following items:

¨   For the three and nine months ended September 30, 2012, the Company recognized a gain(loss) of ($107,000) and $27,000, respectively, relating to its pro rata share of operating results from GSE-UNIS Simulation Technology Co., Ltd.  For the three and nine months ended September 30, 2011, the Company recognized a gain of $3,000 and a loss of $22,000, respectively, relating to its pro rata share of operating results from GSE-UNIS Simulation Technology Co.,Ltd.

¨   The Company had other miscellaneous income for the three and nine months ended September 30, 2012 of $10,000 and $55,000, respectively.  For the three and nine months ended September 30, 2011, other miscellaneous income amounted to $28,000 and $92,000, respectively.

Provision for Income Taxes.

The Company files 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 from years 1997 and forward and is subject to foreign tax examinations by tax authorities for years 2005 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.

An uncertain tax position taken or expected to be taken in a tax return is recognized in the 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.

25

During the nine months ended September 30, 2012, the Company recorded $29,000 of unrecognized tax benefits for certain foreign tax contingencies.  The Company, through its acquisition of EnVision on January 4, 2011, recorded $320,000 of unrecognized tax benefits as well as a receivable from the EnVision shareholders for the same amount as indemnity for this tax position.  The Company does not expect any material changes to its uncertain tax positions in the next twelve months.

The Company, through its acquisition of EnVision on January 4, 2011, recognized deferred tax liabilities of $1.0 million.  As a result of this acquisition, in accordance with ASC-805 Business Combinations, the Company reduced the valuation allowance on its U.S. net deferred tax assets and recognized the change in the valuation allowance ($1.0 million) through the income tax provision in the nine months ended September 30, 2011.

The Company expects to pay income taxes in Sweden, India, and China in 2012.  In 2011, the Company paid income taxes to Sweden, India, China, and the United Kingdom.  In addition, the Company will pay foreign income tax withholding on several non-U.S. contracts in 2012, which is consistent with the foreign income tax withholdings in 2011.  The Company has a full valuation allowance on its U.S. net deferred tax assets at September 30, 2012.

26

Liquidity and Capital Resources

As of September 30, 2012, the Company’s cash and cash equivalents totaled $21.3 million compared to $20.3 million at December 31, 2011.

Cash provided by (used in) operating activities.  For the nine months ended September 30, 2012, net cash provided by  operations totaled $5.0 million.  Significant changes in the Company’s assets and liabilities in the nine months ended September 30, 2012 included:

¨   An $884,000 decrease in the Company’s contract receivables.  The Company’s trade receivables, net of the allowance for doubtful accounts, decreased from $8.1 million at December 31, 2011 to $7.7 million at September 30, 2012.  At September 30, 2012, trade receivables outstanding for more than 90 days, net of the bad debt reserve, totaled approximately $1.4 million versus $278,000 at December 31, 2011.  The Company’s unbilled receivables decreased by approximately $500,000 to $11.7 million at September 30, 2012.  The decrease in the unbilled receivables is due to the timing of contracted billing milestones of the Company’s current projects.  In October 2012, the Company invoiced $1.8 million of the unbilled amounts; the balance is expected to be invoiced and collected within one year.

¨   A $609,000 increase in accounts payable, accrued compensation and accrued expenses.  The increase is due to the timing of payments made by the Company to vendors and subcontractors.

Net cash used in operations for the nine  months ended September 30, 2011, totaled $1.6 million.  Significant changes in the Company’s assets and liabilities in the nine months ended September 30, 2011 included:

¨   A $3.0 million increase in the Company’s contract receivables.   The Company’s trade receivables, net of the allowance for doubtful accounts, increased from $5.7 million at December 31, 2010 to $9.0 million at September 30, 2011.  At September 30, 2011, trade receivables outstanding for more than 90 days, net of the bad debt reserve, totaled approximately $491,000 versus $318,000 at December 31, 2010.   The Company’s unbilled receivables increased by approximately $1.3 million to $12.8 million at September 30, 2011.  The increase in the unbilled receivables was due to the timing of contracted billing milestones of the Company’s current projects.  In October 2011, the Company invoiced over $4.2 million of the unbilled amounts.

¨   A $1.6 million decrease in accounts payable, accrued compensation and accrued expenses.  The decrease was due to the timing of payments made by the Company to vendors and subcontractors

Cash used in investing activities.  Net cash used in investing activities totaled $3.3 million for the nine months ended September 30, 2012.  During the nine months ended September 30, 2012 the Company was required to cash collateralize $1.7 million of stand-by letters of credit with certain foreign customers.  Cash provided by the release of cash as collateral under letters of credit totaled $1.2 million for the nine months ended September 30, 2012.

Capital expenditures totaled $1.4 million. The majority of the capital expenditures are related to the Company’s new Enterprise Resource Planning (ERP) software that is being implemented across our global operations.  The Company has spent approximately $1.1 million on the new ERP software during the nine months ended September 30, 2012.  Capitalized software development costs totaled $914,000 for the nine months ended September 30, 2012.

During the nine months ended September 30, 2012, the Company made its final equity contribution of $469,000 to GSE-UNIS Simulation Technology Co., Ltd. (“GSE-UNIS”).  GSE-UNIS is 51% owned by Beijing UNIS Investment Co., Ltd. and 49% owned by GSE.

 Net cash used was investing activities totaled $6.3 million for the nine months ended September 30, 2011.  The increase was primarily the result of Bank of America’s amendments to the Company’s then existing revolving credit agreements effective March 14, 2011, which required the Company to cash collateralize all existing and future letters of credit.  At September 30, 2011 the Company had cash collateralized $4.3 million of standby letters of credit. This balance represented a $4.1 million increase from December 31, 2010.

27

The Company acquired EnVision Systems Inc. on January 4, 2011.  The present value of the purchase price totaled $4.0 million with $1.2 million paid in cash at closing. The balance is payable on the first, second and third anniversaries of the closing date based upon the attainment of various revenue and cash targets.  In the second quarter of 2011, the Company made payments of $74,000 to EnVision’s shareholders related to billed receivables included on the Closing Date balance sheet.  An additional payment of $109,000 to the EnVision shareholders was made during the second quarter of 2011 related to the working capital true-up provisions of the purchase agreement.   GSE acquired approximately $550,000 in cash through the acquisition of EnVision.

During the nine months ended September 30, 2011, the Company made an additional equity contribution totaling $456,000 to GSE-UNIS.

As of September 30, 2011 capital expenditures totaled $370,000 and capitalized software development costs totaled $572,000.  GSE had $79,000 of cash on deposit with Union National Bank (“UNB”) as a partial guarantee against the Emirates Simulation Academy, LLC (“ESA”) line of credit, was withdrawn by UNB during the nine months ended September 30, 2011.  As of September 30, 2011, GSE had a full reserve for the amount in the restricted cash account.

Cash used in financing activities.  Net cash used in financing activities totaled $994,000 for the nine months ended September 30, 2012.  During the nine months ended September 30, 2012, the Company made payments of $73,000 and $772,000, in relation to the liability classified contingent-consideration associated with the acquisitions of TAS and EnVision, respectively.The Company repurchased 223,087 shares of the Company’s common stock at an aggregate cost of $422,000 for the nine months ended September 30, 2012.  Proceeds from the issuance of common stock for the nine months ended September 30, 2012 totaled $273,000.

For the nine months ended September 30, 2011, net cash used in financing activities totaled $1.0 million.  The Company repurchased 521,400 shares of the Company’s common stock at an aggregate cost of $1.1 million for the nine months ended September 30, 2011.  Proceeds from the issuance of common stock for the nine months ended September 30, 2011 totaled $119,000.

At September 30, 2012, the Company had cash and cash equivalents of $21.3 million.  Based on the Company’s forecasted expenditures and cash flow, the Company believes that it will generate sufficient cash through its normal operations to meet its liquidity and working capital needs for the next twelve months.

Credit Facilities

The Company has a Master Loan and Security Agreement and Revolving Credit Note with Susquehanna.  The Company and its subsidiaries, GSE Power Systems, Inc., and GSE EnVision LLC, are jointly and severally liable as co-borrowers.  The Loan Agreement provides a $7.5 million revolving line of credit for the purpose of (i) issuing stand-by letters of credit and (ii) providing working capital. Working capital advances bear interest at a rate equal to the Wall Street Journal Prime Rate of Interest, floating with a floor of 4 ½%.  The two-year agreement is to expire on November 1, 2013.

As collateral for the Company’s obligations, the Company granted a first lien and security interest in all of the assets of the Company, including but not limited to, accounts receivable, inventory, proceeds and products, intangibles, trademarks, patents, intellectual property, machinery and equipment.

28

Issuances of stand-by letters of credit and advances of working capital (collectively referred to as the “Advances”) require that the Company maintain a minimum cash balance of $3.0 million at all times (the “Cash Balance Requirement”).  The Cash Balance Requirement will remain at the minimum amount as long as the Company’s quarterly consolidated net income (exclusive of gains and losses on derivative instruments and stock option expense) as defined (“Net Income”), remains positive and the Company is in compliance with the covenants.  If the Company’s quarterly Net Income is negative or the Company is not in compliance with the covenants, the Cash Balance Requirement will revert to the amount of the Advances, until the Company attains positive Net Income for two consecutive quarters.  The credit agreements contained certain restrictive covenants regarding future acquisitions, and incurrence of debt.  In addition, the credit agreements contained financial covenants with respect to the Company’s cash flow coverage ratio, minimum tangible capital base, quick ratio, and tangible capital base ratio.  At September 30, 2012, the Company had not paid any interest or principal payments related to any borrowings for over one year.  As such the cash flow coverage ratio is not applicable at September 30, 2012.

		As of
	Covenant	September 30, 2012
Minimum tangible capital base	Must Exceed $26.0 million	$33.4 million
Quick ratio	Must Exceed 2.00 : 1.00	2.59 : 1.00
Tangible capital base ratio	Not to Exceed .75 : 1.00	.59 : 1.00

As the Company’s Net Income for the three months ended September 30, 2012 is positive and the Company is in compliance with its covenants, the Company is currently required to maintain the minimum cash balance of $3.0 million with Susquehanna.  At September 30, 2012, the Company had $328,000 in Advances, all of which consisted of outstanding stand-by letters of credit.

As of September 30, 2012, the Company was contingently liable for eleven standby letters of credit and five surety bonds totaling $6.3 million which represent performance and bid bonds on eleven contracts.  The Company has deposited the full value of eight standby letters of credit in certificates of deposit and escrow accounts ($4.8 million) which have been restricted in that the Company does not have access to these funds until the related letters of credit have expired.  The cash has been recorded on the Company’s balance sheet at September 30, 2012 as restricted cash.

Item 3.  Quantitative and Qualitative Disclosure about Market Risk

The Company’s market risk is principally confined to changes in foreign currency exchange rates.  The Company’s exposure to foreign exchange rate fluctuations arises in part from customer contracts that are denominated in currencies other than the Company’s functional currency as well as from inter-company accounts in which costs incurred in one entity are charged to other entities in different foreign jurisdictions.  The Company is also exposed to foreign exchange rate fluctuations as the financial results of all foreign subsidiaries are translated into U.S. dollars in consolidation.  As exchange rates vary, those results when translated may vary from expectations and adversely impact overall expected profitability.

The Company utilizes forward foreign currency exchange contracts to manage market risks associated with the fluctuations in foreign currency exchange rates.  The principal currencies for which such forward exchange contracts are entered into are the Pound Sterling, the Euro and the Japanese Yen.  It is the Company’s policy to use such derivative financial instruments to protect against market risk arising in the normal course of business in order to reduce the impact of these exposures.  The Company minimizes credit exposure by limiting counterparties to nationally recognized financial institutions.

As of September 30, 2012, the Company had foreign exchange contracts outstanding of approximately 1.0 million Pounds Sterling, 13.3 million Euro, and 70.8 million Japanese Yen at fixed rates.  The contracts expire on various dates through May 2016.  The Company had not designated the contracts as hedges and has recognized a losses on the change in the estimated fair value of the contracts of ($134,000) and ($42,000) for the three and nine months ended September 30, 2012, respectively.  A 10% fluctuation in the foreign currency exchange rates up or down as of September 30, 2012 would have increased/decreased the change in the estimated fair value of the contracts by $14,000.

29

As of September 30, 2011, the Company had foreign exchange contracts of approximately 2.3 million Pounds Sterling, 17.0 million Euro and 682.9 million Japanese Yen at fixed rates.  The contracts expire on various dates through February 2014.  The Company had not designated the contracts as hedges and recognized losses on the change in the estimated fair value of the contracts of ($143,000) and ($298,000) for the three and nine months ended September 30, 2011, respectively.

Item 4.  Controls and Procedures

(a) Evaluation of disclosure controls and procedures.  The Company maintains adequate internal disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), as amended) as of the end of the period covered by this quarterly report on Form 10-Q pursuant to Rule 13a-15(b) under the Exchange Act that are designed to ensure that information required to be disclosed by it in its reports filed or submitted pursuant to the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms and that information required to be disclosed by the Company in its Exchange Act reports is accumulated and communicated to management, including the Company’s Chief Executive Officer (“CEO”), who is its principal executive officer, and Chief Financial Officer (“CFO”), who is its principal financial officer, to allow timely decisions regarding required disclosure.

The Company’s CEO and CFO are responsible for establishing and maintaining adequate internal control over the Company’s financial reporting.  They have reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-14 as of September 30, 2012 in order to ensure the reporting of material information required to be included in the Company’s periodic filings with the Commission comply with the Commission’s requirements for certification of this Form 10-Q.  Based on that evaluation, the Company’s CEO and CFO have concluded that as of September 30, 2012 the Company’s disclosure controls and procedures were effective.

 (b) Changes in internal control.   In the ordinary course of business, the Company reviews its system of internal control over financial reporting to evaluate whether to implement any changes to its systems and processes to improve such controls and increase efficiency, while ensuring that we maintain an effective internal control environment. During the three months ended September 30, 2012, the Company implemented a new system for financial reporting and accumulation of financial data. The new financial system is a significant component of the Company’s internal control over financial reporting, but was not made in response to any deficiency in our internal controls.

Other than the implementation of the new financial system described above, no changes in the Company’s internal control over financial reporting (as defined in Exchange Act Rule 13a-15) occurred during the quarter ended September 30, 2012 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Limitation of Effectiveness of Controls

It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system will be met.  The design of any control system is based, in part, upon the benefits of the control system relative to its costs.  Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.  These inherent limitations include the realities that judgments in decision making can be faulty, and that controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of control.  In addition, over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.  In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events.  Because of inherent limitation in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.  The Company’s controls and procedures are designed to provide a reasonable level of assurance of achieving their objectives.

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PART II - OTHER INFORMATION

Item 1.  Legal Proceedings

None.

Item 1A.  Risk Factors

The risk factors set forth in the Annual Report on Form 10-K for the period ended December 31, 2011 are hereby updated as follows:

Risks related to contract with Slovenské elektrárne, a.s.

In 2009, the Company entered into a contract with Slovenské elektrárne, a.s. (“SE”) to provide a full scope simulator for a two unit reactor plant in Slovakia.  The Company has subsequently received several change orders which have increased the contract value to $26.9 million, including a $3.0 million change order of which $2.1 million related to compensation provided by SE to the Company for a nine and half month delay caused by SE. To date, the Company has recognized $22.9 million of revenue on the contract.

In November and December 2011 and January 2012, SE notified the Company of various alleged breaches of the contract.  In the notification, SE claimed a contractual penalty for delay in the amount of $1.0 million related to the Company’s failure to complete Factory Acceptance Testing (“FAT”) for the simulator and unspecified potential damages for other alleged breaches of the contract.

Based upon the schedule for the completion of FAT contained in the contract, which currently does not take into account the acknowledged nine and a half month delay caused by SE, the Company does not believe that it is responsible for the delay in FAT completion.  After engaging in discussions with SE, the Company formally responded to all of the claims in January 2012.  In March 2012, the Company completed a modified FAT.

In May 2012, SE notified the Company of its decision to suspend work under the contract due to changes in the Slovakian regulation requiring SE to redesign certain aspects of the plant.  Since May 2012, at the request of SE, the Company has provided a two person project team, who are providing support services during the project suspension currently expected to continue until May 2013.  In addition, the Company has provided a proposal to SE covering the cost of (i) demobilization and mobilization of GSE’s project team and the monthly suspension costs and (ii) reduction of GSE’s project team and the costs related thereto during suspension period.

In September 2012, the Company received a $3.7 million payment from SE with respect to an outstanding $5.6 million receivable and SE agreed to pay the remaining $1.9 million upon completion of the Site Acceptance Test, which is currently expected to take place in November 2013. In October 2012, SE paid the Company $188,000 within thirty days from the date of invoice for the services provided by the Company’s two person project team referred to above.

The Company and SE are currently discussing amendments to the existing contract addressing (i) substantial additional scope of work for the Company,  (ii) costs related to suspension of the contract and its restart,  (iii) the Company’s continued support of the project during the suspension period and (iv) withdrawal of  SE outstanding claims.  At September 30, 2012, the Company had a $188,000 outstanding invoice included in accounts receivable, $2.9 million of recoverable costs and accrued profit not billed, and a $2.9 million performance bond in place to secure completion of the contract.

31

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

Issuer Purchases of Equity Securities

The following table provides information about the Company’s share repurchase activity for the nine months ended September 30, 2012:

Month	Total number of shares purchased		Average price paid per share		Total number of shares purchased as part of publicly announced program		Approximate dollar value of shares that may yet be purchased under the program
January 1 - January 31		68,684	$	1.87		893,058	$	1,222,521
February 1 - February 29		59,878	$	1.89		952,936	$	1,109,569
March 1 - March 31		33,825	$	1.81		986,761	$	1,048,231
April 1- April 30		-	$	-		986,761	$	1,048,231
May 1 - May 31		-	$	-		986,761	$	1,048,231
June 1 - June 30		-	$	-		986,761	$	1,048,231
July 1 - July 31		-	$	-		986,761	$	1,048,231
August 1 - August 31		33,200	$	1.98		1,019,961	$	982,565
September 1 - September 30		27,500	$	1.95		1,047,461	$	928,905

Item 3.  Defaults Upon Senior Securities

None

Item 4.  Mine Safety Disclosures

Not applicable.

Item 5.  Other Information

None

Item 6.  Exhibits

31.1 Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes- Oxley Act of 2002, filed herewith.

31.2 Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.

32.1 Certification of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.

101.INS* XBRL Instance Document

101.SCH* XBRL Taxonomy Extension Schema

101.CAL* XBRL Taxonomy Extension Calculation Linkbase

101.DEF* XBRL Taxonomy Extension Definition Linkbase

101.LAB* XBRL Taxonomy Extension Label Linkbase

101.PRE* XBRL Taxonomy Extension Presentation Linkbase

32

SIGNATURES

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

Date:  November 14, 2012                                              

GSE SYSTEMS, INC.

/S/ JAMES A. EBERLE

James A. Eberle

Chief Executive Officer

(Principal Executive Officer)

/S/ JEFFERY G. HOUGH

Jeffery G. Hough

Senior Vice President and Chief Financial Officer

(Principal Financial and Accounting Officer)

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EX-31.1

Exhibit 31.1

Certification of the Chief Executive Officer

I, James A. Eberle, certify that:

1.   I have reviewed this quarterly report on Form 10-Q of GSE Systems, Inc.;

2.   Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.   Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant, as of, and for, the periods presented in this report;

4.   The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a)   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)   Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c)   Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d)   Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.   The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors:

a)   All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)   Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:  November 14, 2012	/s/ James A. Eberle
	James A. Eberle
	Chief Executive Officer (Principal Executive Officer)

EX-31.2

Exhibit 31.2

Certification of the Chief Financial Officer

I, Jeffery G. Hough, certify that:

1.   I have reviewed this quarterly report on Form 10-Q of GSE Systems, Inc.;

2.   Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.   Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant, as of, and for, the periods presented in this report;

4.   The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a)   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)   Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c)   Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d)   Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.   The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors:

a)   All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)   Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:  November 14, 2012	/s/ Jeffery G. Hough
	Jeffery G. Hough
	Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the quarterly report on Form 10-Qof GSE Systems, Inc. (the “Company”) for the quarter ended September 30, 2012 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, James A. Eberle, Chief Executive Officer of the Company, and I, Jeffery G. Hough, Senior Vice President and Chief Financial Officer, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that,

1.   The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2.   To my knowledge, the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date:  November 14, 2012	/s/ James A. Eberle	/s/ Jeffery G. Hough
	James A. Eberle	Jeffery G. Hough
	Chief Executive Officer	Senior Vice President and Chief
		Financial Officer

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Preferred Stock Rights (Details) (USD $)	Sep. 30, 2012	Dec. 31, 2011	Mar. 21, 2011
Preferred Stock Rights [Abstract]
Number of preferred stock purchase right declared for each outstanding common stock			1
Common stock, par value (in dollars per share)	$ 0.01	$ 0.01
Number of rights issued with each issuance of common stock			1
Term of stockholder protection rights agreement (in years)			3Y
Maximum period that can be extended for right plan (in years)			3 years 0 months 0 days
Fraction of participating preferred stock that can be exercised as a result of right			0.01
Exercise price of right			$ 8.00
Minimum percentage of common stock owned for right to become exercisable (in hundredths)			20.00%
Redemption price per right (in dollars per share)			$ 0.001
Number of common stock exchange for rights (in shares)			1
Percentage of common stock acquired to cause substantial dilution (in hundredths)			20.00%

XML

Fair Value of Financial Instruments (Details) (USD $) In Thousands, unless otherwise specified	Sep. 30, 2012	Dec. 31, 2011
Quoted Prices in Active Markets for Identical Assets (Level 1) [Member]
Assets and liabilities measured at fair value [Abstract]
Money market fund	$ 15,429	$ 8,163
Certificate of deposit	3,942	5,976
Foreign exchange contracts - Assets	0	0
Total assets	19,371	14,139
Foreign exchange contracts - Liabilities	0	0
Total liabilities	0	0
Significant Other Observable Inputs (Level 2) [Member]
Assets and liabilities measured at fair value [Abstract]
Money market fund	0	0
Certificate of deposit	0	0
Foreign exchange contracts - Assets	507	483
Total assets	507	483
Foreign exchange contracts - Liabilities	370	314
Total liabilities	370	314
Significant Unobservable Inputs (Level 3) [Member]
Assets and liabilities measured at fair value [Abstract]
Money market fund	0	0
Certificate of deposit	0	0
Foreign exchange contracts - Assets	0	0
Total assets	0	0
Foreign exchange contracts - Liabilities	0	0
Total liabilities	$ 0	$ 0

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Fair Value of Financial Instruments (Tables)

9 Months Ended

Sep. 30, 2012

Fair Value of Financial Instruments [Abstract]

Assets and liabilities measured at fair value

The following table presents assets and liabilities measured at fair value at September 30, 2012:

		Quoted Prices		Significant
		in Active		Other			Significant
		Markets for		Observable			Unobservable
		Identical Assets		Inputs			Inputs
(in thousands)		(Level 1)		(Level 2)			(Level 3)		Total
Money market fund		$	15,429	$	-		$	-	$	15,429
Certificates of deposit			3,942		-			-		3,942
Foreign exchange contracts			-		507			-		507
	Total assets	$	19,371	$	507		$	-	$	19,878
Foreign exchange contracts		$	-	$	(370	)	$	-	$	(370	)
	Total liabilities	$	-	$	(370	)	$	-	$	(370	)

The following table presents assets and liabilities measured at fair value at December 31, 2011:

		Quoted Prices		Significant
		in Active		Other			Significant
		Markets for		Observable			Unobservable
		Identical Assets		Inputs			Inputs
(in thousands)		(Level 1)		(Level 2)			(Level 3)		Total
Money market fund		$	8,163	$	-		$	-	$	8,163
Certificates of deposit			5,976		-			-		5,976
Foreign exchange contracts			-		483			-		483
	Total assets	$	14,139	$	483		$	-	$	14,622
Foreign exchange contracts		$	-	$	(314	)	$	-	$	(314	)
	Total liabilities	$	-	$	(314	)	$	-	$	(314	)

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Product Warranty (Details) (USD $) In Thousands, unless otherwise specified	9 Months Ended
	Sep. 30, 2012
Activities in product warranty account [Abstract]
Balance at December 31, 2011	$ 2,300
Warranty provision	727
Warranty claims	897
Currency adjustment	27
Balance at September 30, 2012	$ 2,157

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Recently Adopted Accounting Pronouncements

9 Months Ended

Sep. 30, 2012

Recently Adopted Accounting Pronouncements [Abstract]

Recently Adopted Accounting Pronouncements

2.   Recently Adopted Accounting Pronouncements

In September 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2011-08, Intangibles — Goodwill and Other (Topic 350) — Testing Goodwill for Impairment (“ASU 2011-08”), to allow entities to use a qualitative approach to test goodwill for impairment. ASU 2011-08 permits an entity to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value.  If it is concluded this is the case, it is necessary to perform the currently prescribed two-step goodwill impairment test.  Otherwise, the two-step goodwill impairment test is not required. ASU 2011-08 is effective for the Company for interim and annual periods ending during 2012, with earlier application permitted.  The adoption of this guidance had no impact on the Company’s consolidated financial statements.

In May 2011, the FASB issued Accounting Standards Update No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (Topic 820) — Fair Value Measurement (“ASU 2011-04”), to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between U.S. generally accepted accounting principles and International Financial Reporting Standards.  ASU 2011-04 changes certain fair value measurement principles and enhances the disclosure requirements particularly for Level 3 fair value measurements.  ASU 2011-04 is effective for the Company for interim and annual periods ending during 2012 and will be applied prospectively.  The adoption of this guidance had no impact on the Company’s consolidated financial statements.

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Basis of Presentation and Revenue Recognition (Details)	3 Months Ended		9 Months Ended
	Sep. 30, 2012	Sep. 30, 2011	Sep. 30, 2012	Sep. 30, 2011
Basis of Presentation and Revenue Recognition [Abstract]
Number of reportable segment			1
Minimum term of contract (in months)			12M
Maximum term of contract (in years)			3Y
Term of warranty (in years)			1Y
Period of post customer support service (PCS) (in years)			1Y
Benchmark to disclose customers of consolidated revenue, minimum percentage (in hundredths)			10.00%
Revenue [Member] | Slovenske elektrarne, a.s. [Member]
Revenue by major customers [Abstract]
Percentage of revenue contributed by major customers (in hundredths)	2.30%	12.50%	4.80%	12.30%
Revenue [Member] | BP Products North America [Member]
Revenue by major customers [Abstract]
Percentage of revenue contributed by major customers (in hundredths)	15.60%	0.10%	6.20%	0.10%

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Product Warranty (Tables)

9 Months Ended

Sep. 30, 2012

Product Warranty [Abstract]

Activities in the product warranty accounts

The activity in the warranty account is as follows:

(in thousands)
Balance at December 31, 2011	$	2,300
Warranty provision		727
Warranty claims		(897	)
Currency adjustment		27
Balance at September 30, 2012	$	2,157

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Basic and Diluted Income (Loss) Per Common Share (Details) (USD $) In Thousands, except Share data, unless otherwise specified	3 Months Ended		9 Months Ended
	Sep. 30, 2012	Sep. 30, 2011	Sep. 30, 2012	Sep. 30, 2011
Numerator:
Net income	$ 816	$ 858	$ 1,504	$ 1,627
Denominator:
Weighted-average shares outstanding for basic earnings per share (in shares)	18,390,034	18,879,757	18,370,907	19,101,284
Effect of dilutive securities:
Employee stock options (in shares)	69,900	112,841	112,235	202,913
Adjusted weighted-average shares outstanding and assumed conversions for diluted earnings per share (in shares)	18,459,934	18,992,598	18,483,142	19,304,197
Shares related to dilutive securities excluded because inclusion would be anti-dilutive (in shares)	2,847,203	1,573,896	2,799,268	1,544,504

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Contract Receivables (Details) (USD $) In Thousands, unless otherwise specified	1 Months Ended	9 Months Ended
	Oct. 31, 2012	Sep. 30, 2012	Sep. 30, 2011	Dec. 31, 2011
Contract Receivables [Abstract]
Maximum term of contract receivables (in months)			12M
Components of contract receivables [Abstract]
Billed receivables		$ 7,858		$ 8,258
Recoverable costs and accrued profit not billed		11,719		12,234
Allowance for doubtful accounts		136		136
Total contract receivables, net		19,441		20,356
Unbilled Contract Receivables Billed during October 2012	1,800
Maximum period of unbilled contract receivable (in years)		1
Benchmark to disclose customers of total accounts receivable, minimum percentage (in hundredths)		10.00%
Percentage of contract receivable by major customer [Abstract]
Outstanding billed receivables with Slovenske elektrame, a.s.		188
The amount of recoverable costs and accrued profit not billed with Slovenske elektrame, a.s.		2,900
The value of performance bond issued in connection with the contract with Slovenske elektrame, a.s.		$ 2,900
Contract Receivable [Member]
Percentage of contract receivable by major customer [Abstract]
Percentage of contract receivables accounted by major customers (in hundredths)		12.40%		7.90%
Contract Receivable [Member] | Slovenske elektrarne, a.s. [Member]
Percentage of contract receivable by major customer [Abstract]
Percentage of contract receivables accounted by major customers (in hundredths)		15.70%		24.20%
Contract Receivable [Member] | Shandong Nuclear Power Co. Ltd. [Member]
Percentage of contract receivable by major customer [Abstract]
Percentage of contract receivables accounted by major customers (in hundredths)		15.30%		5.00%

XML

Basis of Presentation and Revenue Recognition

9 Months Ended

Sep. 30, 2012

Basis of Presentation and Revenue Recognition [Abstract]

Basis of Presentation and Revenue Recognition

1.   Basis of Presentation and Revenue Recognition

Basis of Presentation

The consolidated interim financial statements included herein have been prepared by GSE Systems, Inc. (the “Company” or “GSE”) without independent audit.  In the opinion of the Company's management, all adjustments and reclassifications of a normal and recurring nature necessary to present fairly the financial position, results of operations and cash flows for the periods presented have been made.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted.  The results of operations for interim periods are not necessarily an indication of the results for the full year.  These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the period ended December 31, 2011 filed with the Securities and Exchange Commission on March 8, 2012.

The Company has only one reportable segment.  The Company has a wide range of knowledge of simulation systems and the processes those systems are intended to control and model.  The Company’s knowledge is concentrated heavily in simulation technology and model development.  The Company is primarily engaged in simulation for the power generation industry and the process industries.  Contracts typically range from twelve months to three years.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements as well as reported amounts of revenues and expenses during the reporting period.  The Company’s most significant estimates relate to revenue recognition, capitalization of software development costs, valuation of intangible assets acquired, contingent consideration issued in business acquisitions, and the recoverability of deferred tax assets.  Actual results could differ from these estimates and those differences could be material.

Revenue Recognition

The majority of the Company’s revenue is derived through the sale of uniquely designed systems containing hardware, software and other materials under fixed-price contracts.  Revenue under these fixed-price contracts is accounted for on the percentage-of-completion method.  This methodology recognizes revenue and earnings as work progresses on the contract and is based on an estimate of the revenue and earnings earned to date, less amounts recognized in prior periods.  The Company bases its estimate of the degree of completion of the contract by reviewing the relationship of costs incurred to date to the expected total costs that will be incurred on the project. Estimated contract earnings are reviewed and revised periodically as the work progresses, and the cumulative effect of any change in estimate is recognized in the period in which the change is identified.  Estimated losses are charged against earnings in the period such losses are identified.  The Company recognizes revenue arising from contract claims either as income or as an offset against a potential loss only when the amount of the claim can be estimated reliably and realization is probable and there is a legal basis for the claim.

Uncertainties inherent in the performance of contracts include labor availability and productivity, material costs, change order scope and pricing, software modification and customer acceptance issues.  The reliability of these cost estimates is critical to the Company’s revenue recognition as a significant change in the estimates can cause the Company’s revenue and related margins to change significantly from the amounts estimated in the early stages of the project.

As the Company recognizes revenue under the percentage-of-completion method, it provides an accrual for estimated future warranty costs based on historical experience and projected claims.  The Company’s long-term contracts generally provide for a one-year warranty on parts, labor and any bug fixes as it relates to software embedded in the systems.

The Company’s system design contracts do not normally provide for “post customer support service” (“PCS”) in terms of software upgrades, software enhancements or telephone support.  In order to obtain PCS, the customers must normally purchase a separate contract.  Such PCS arrangements are generally for a one-year period renewable annually and include customer support, unspecified software upgrades, and maintenance releases.  The Company recognizes revenue from these contracts ratably over the life of the agreements.

Revenue from the sale of software licenses which do not require significant modifications or customization for the Company’s modeling tools are recognized when the license agreement is signed, the license fee is fixed and determinable, delivery has occurred, and collection is considered probable.

Revenue from certain consulting or training contracts is recognized on a time-and-material basis.  For time-and-material type contracts, revenue is recognized based on hours incurred at a contracted labor rate plus expenses.

The following customers have provided more than 10% of the Company’s consolidated revenue for the indicated periods:

	Three Months ended		Nine Months ended
	September 30,		September 30,
	2012	2011	2012	2011
BP Products North America	15.6%	0.1%	6.2%	0.1%
Slovenské elektrárne, a.s.	2.3%	12.5%	4.8%	12.3%

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Software Development Costs (Details) (USD $) In Thousands, unless otherwise specified	3 Months Ended		9 Months Ended
	Sep. 30, 2012	Sep. 30, 2011	Sep. 30, 2012	Sep. 30, 2011
Software Development Costs [Abstract]
Estimated economic life (in years)			3 years
Total capitalized software development cost	$ 306	$ 186	$ 914	$ 572
Total capitalized software amortization expense	$ 168	$ 218	$ 536	$ 612

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Share Repurchase Plan (Details) (USD $)	3 Months Ended		9 Months Ended
	Sep. 30, 2012	Sep. 30, 2011	Sep. 30, 2012	Sep. 30, 2011	Mar. 21, 2011
Share Repurchase Plan [Abstract]
Date on which the share repurchase plan was approved by Board of Directors			Mar. 21, 2011
Authorized amount under share repurchase plan by Board of Directors					$ 3,000,000
Stock repurchased during period (in shares)	60,700	370,519	223,087	521,400
Stock repurchased during period	$ 119,000	$ 792,000	$ 422,000	$ 1,100,000

XML

CONSOLIDATED BALANCE SHEETS (USD $) In Thousands, unless otherwise specified	Sep. 30, 2012	Dec. 31, 2011
Current assets:
Cash and cash equivalents	$ 21,304	$ 20,326
Restricted cash	3,761	3,505
Contract receivables, net	19,441	20,356
Prepaid expenses and other current assets	3,314	3,733
Total current assets	47,820	47,920
Equipment and leasehold improvements	6,683	5,206
Accumulated depreciation	(4,604)	(4,105)
Equipment and leasehold improvements, net	2,079	1,101
Software development costs, net	2,193	1,815
Goodwill	4,502	4,462
Intangible assets, net	990	1,207
Long-term restricted cash	1,177	897
Other assets	1,987	1,413
Total assets	60,748	58,815
Current liabilities:
Accounts payable	4,886	4,077
Accrued expenses	1,779	1,581
Accrued compensation and payroll taxes	2,350	2,754
Billings in excess of revenue earned	4,954	5,261
Accrued warranty	2,157	2,300
Other current liabilities	2,302	1,707
Total current liabilities	18,428	17,680
Other liabilities	1,213	2,352
Total liabilities	19,641	20,032
Commitments and contingencies	0	0
Stockholder's equity:
Preferred stock $.01 par value, 2,000,000 shares authorized, shares issued and outstanding none in 2012 and 2011	0	0
Common stock $.01 par value, 30,000,000 shares authorized, shares issued 19,421,892 in 2012 and 19,254,681 in 2011	194	193
Additional paid-in capital	71,117	70,167
Accumulated deficit	(27,559)	(29,063)
Accumulated other comprehensive loss	(574)	(865)
Treasury stock at cost, 1,047,461 shares in 2012, 824,374 in 2011	(2,071)	(1,649)
Total stockholders' equity	41,107	38,783
Total liabilities and stockholders' equity	$ 60,748	$ 58,815

XML

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (USD $) In Thousands, except Share data	Common Stock	Additional Paid-in Capital	Accumulated Deficit	Accumulated Other Comprehensive Loss	Treasury Stock	Total
Balance at Dec. 31, 2011	$ 193	$ 70,167	$ (29,063)	$ (865)	$ (1,649)	$ 38,783
Balance (in shares) at Dec. 31, 2011	19,254,681				(824,374)
Stock-based compensation expense		678				678
Common stock issued for options exercised	1	272				273
Common stock issued for options exercised (in shares)	167,211
Foreign currency translation adjustment				291		291
Treasury stock at cost - Total					(422)	(422)
Treasury stock purchased (in shares)					(223,087)	(223,087)
Net income			1,504			1,504
Balance at Sep. 30, 2012	$ 194	$ 71,117	$ (27,559)	$ (574)	$ (2,071)	$ 41,107
Balance (in shares) at Sep. 30, 2012	19,421,892				(1,047,461)

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Stock-Based Compensation (Details) (USD $) In Thousands, except Share data, unless otherwise specified	3 Months Ended		9 Months Ended
	Sep. 30, 2012	Sep. 30, 2011	Sep. 30, 2012	Sep. 30, 2011
Stock-Based Compensation [Abstract]
Pre-tax share based compensation expense	$ 231	$ 183	$ 678	$ 569
Shares granted under stock options (in shares)	0	60,000	152,870	102,000
Fair value of shares granted under stock option plan	$ 0	$ 75	$ 145	$ 135

XML

Basis of Presentation and Revenue Recognition (Tables)

9 Months Ended

Sep. 30, 2012

Basis of Presentation and Revenue Recognition [Abstract]

Percentage of revenue by major customers

The following customers account for more than 10% of the Company’s consolidated contract receivables for the indicated periods:

	September 30,2012		December 31, 2011
Slovenské elektrárne, a.s.		15.7%	24.2%
Shandong Nuclear Power Co. Ltd.		15.3%	5.0%
Kraftwerkesschule E.V.		12.4%	7.9%

XML

Long-Term Debt (Details) (USD $)	9 Months Ended
	Sep. 30, 2012
Performance Bond Abstract
Number of Standby Letters of Credit	11
Number of Surety Bonds	5
Letter of Credit and Surety Bonds	$ 6,300,000
Number of Performance and Bid Bonds issued in relation to contracts	11
Number of stand by letters of credit deposited in certificates of deposit	8
Amount of certificate of deposit, which are restricted until eleven standby letters of credit have expired	4,800,000
First Line of Credit [Member]
Line of Credit Facility [Line Items]
Number of Credit Agreements	1
Susquehanna Bank co-borrower: GSE Power Systems, Inc.	GSE Power Systems, Inc.
Susquehanna Bank co-borrower: GSE EnVision LLC	GSE EnVision LLC
Principal amount of the Susquehanna line of credit	7,500,000
Interest rate floor related to Susquehanna Bank agreement	4.50%
Line of credit facility term in years	2Y
Expiration date of credit agreements with Susquehanna Bank	November 1, 2013
Minimum Cash Balance Requirement	3,000,000
Minimum tangible capital base - Covenant Description	Must Exceed 26.0 million
Minimum tangible capital base - Covenant Compliance	$33.4 million
Quick ratio - Covenant Description	Must Exceed 2.00 : 1.00
Quick ratio- Covenant Compliance	2.59 : 1.00
Tangible capital base ratio - Covenant Description	Not to Exceed .75 : 1.00
Tangible capital base ratio - Covenant Compliance	.59 : 1.00
Issuances of stand-by letters of credit and advances as of period end	$ 328,000

XML

Contract Receivables (Tables)

9 Months Ended

Sep. 30, 2012

Contract Receivables [Abstract]

Components of contract receivables

The components of contract receivables are as follows:

(in thousands)	September 30,  2012		December 31, 2011
Billed receivables	$	7,858	$         8,258
Recoverable costs and accrued profit not billed		11,719	12,234
Allowance for doubtful accounts		(136)	(136)
Total contract receivables, net	$	19,441	$      20,356

Concentration Risk [Line Items]

Contract receivable by major customers

The following customers account for more than 10% of the Company’s consolidated contract receivables for the indicated periods:

	September 30,2012		December 31, 2011
Slovenské elektrárne, a.s.		15.7%	24.2%
Shandong Nuclear Power Co. Ltd.		15.3%	5.0%
Kraftwerkesschule E.V.		12.4%	7.9%

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CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (USD $) In Thousands, unless otherwise specified	9 Months Ended
	Sep. 30, 2012	Sep. 30, 2011
Cash flows from operating activities:
Net income	$ 1,504	$ 1,627
Adjustments to reconcile net income to net cash provided by (used in) operating activities
Depreciation	406	365
Amortization of definite-lived intangible assets	235	629
Capitalized software amortization	536	612
Amortization of deferred financing costs	9	0
Change in fair value of contingent consideration	245	331
Stock-based compensation expense	678	569
Equity (gain) loss on investment in GSE-UNIS Simulation Technology Co. Ltd.	(27)	22
Gain on derivative instruments	(36)	(49)
Changes in assets and liabilities:
Contract receivables	884	(2,980)
Prepaid expenses and other assets	262	(1,359)
Accounts payable, accrued compensation and accrued expenses	609	(1,597)
Billings in excess of revenue earned	(225)	656
Accrued warranty reserves	(143)	401
Other liabilities	97	(844)
Net cash provided by (used in) operating activities	5,034	(1,617)
Cash flows from investing activities:
Capital expenditures	(1,404)	(370)
Capitalized software development costs	(914)	(572)
Investment in GSE-UNIS Simulation Technology Co. Ltd.	(469)	(456)
Acquisitions, net of cash acquired	0	(830)
Restrictions of cash as collateral under letters of credit	(1,734)	(5,171)
Releases of cash as collateral under letters of credit	1,197	1,178
Drawdown of cash collateral on Emirates Simulation Academy, LLC line of credit	0	(79)
Net cash used in investing activities	(3,324)	(6,300)
Cash flows from financing activities:
Proceeds from issuance of common stock	273	119
Payments of the liability-classified contingent consideration arrangements	(845)	0
Treasury stock purchases	(422)	(1,127)
Net cash used in financing activities	(994)	(1,008)
Effect of exchange rate changes on cash	262	6
Net increase (decrease) in cash and cash equivalents	978	(8,919)
Cash and cash equivalents at beginning of year	20,326	26,577
Cash and cash equivalents at end of period	$ 21,304	$ 17,658

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CONSOLIDATED BALANCE SHEETS (Parenthetical) (USD $)	Sep. 30, 2012	Dec. 31, 2011
Stockholder's equity:
Preferred stock, par value (in dollars per share)	$ 0.01	$ 0.01
Preferred stock, shares authorized (in shares)	2,000,000	2,000,000
Preferred stock, shares issued (in shares)	0	0
Preferred stock, shares outstanding (in shares)	0	0
Common stock, par value (in dollars per share)	$ 0.01	$ 0.01
Common stock, shares authorized (in shares)	30,000,000	30,000,000
Common stock, shares issued (in shares)	19,421,892	19,254,681
Treasury stock, shares acquired (in shares)	1,047,461	824,374

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Product Warranty

9 Months Ended

Sep. 30, 2012

Product Warranty [Abstract]

Product Warranty

10.   Product Warranty

As the Company recognizes revenue under the percentage-of-completion method, it provides an accrual for estimated future warranty costs based on historical experience and projected claims.  The activity in the warranty account is as follows:

(in thousands)
Balance at December 31, 2011	$	2,300
Warranty provision		727
Warranty claims		(897	)
Currency adjustment		27
Balance at September 30, 2012	$	2,157

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Document And Entity Information (USD $)	9 Months Ended
	Sep. 30, 2012
Document and Entity Information [Abstract]
Entity Registrant Name	GSE SYSTEMS INC
Entity Central Index Key	0000944480
Current Fiscal Year End Date	--12-31
Entity Well-known Seasoned Issuer	No
Entity Voluntary Filers	No
Entity Current Reporting Status	No
Entity Filer Category	Smaller Reporting Company
Entity Public Float	$ 41,250,576
Entity Common Stock, Shares Outstanding	19,388,892
Document Fiscal Year Focus	2012
Document Fiscal Period Focus	Q3
Document Type	10-Q
Amendment Flag	false
Document Period End Date	Sep. 30, 2012

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Income Taxes

9 Months Ended

Sep. 30, 2012

Income Taxes [Abstract]

Income Taxes

11.   Income Taxes

The Company files 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 from years 1997 forward and is subject to foreign tax examinations by tax authorities for years 2005 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.

An uncertain tax position taken or expected to be taken in a tax return is recognized in the 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, through its acquisition of EnVision Systems Inc. (“EnVision”) on January 4, 2011, recognized deferred tax liabilities of $1.0 million.  As a result of this acquisition, in accordance with ASC-805 Business Combinations, the Company reduced the valuation allowance on its U.S. net deferred tax assets and recognized the change in the valuation allowance ($1.0 million) through the income tax provision in the three months ended March 31, 2011.

The Company, through its acquisition of EnVision on January 4, 2011, also recorded $320,000 of unrecognized tax benefits as well as a receivable from the EnVision shareholders for the same amount as indemnity for this tax position.  During 2011, the Company also recorded $126,000 of unrecognized tax benefits in 2011 for certain foreign tax contingencies.  During the nine months ended September 30, 2012, the Company recorded $29,000 of unrecognized tax benefits for certain foreign tax contingencies.  The Company records interest and penalties associated with uncertain tax positions as a component of income tax expense.  The Company does not expect any material changes to its uncertain tax positions in the next twelve months.

The Company expects to pay income taxes in Sweden, India, and China in 2012.  In 2011, the Company paid income taxes to Sweden, India, China, and the United Kingdom.  In addition, the Company will pay foreign income tax withholding on several non-U.S. contracts in 2012, which is consistent with the foreign income tax withholdings in 2011.  The Company has a full valuation allowance on its U.S. net deferred tax assets at September 30, 2012.

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CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (USD $) In Thousands, except Per Share data, unless otherwise specified	3 Months Ended		9 Months Ended
	Sep. 30, 2012	Sep. 30, 2011	Sep. 30, 2012	Sep. 30, 2011
Consolidated Statements of Operations (Unaudited)
Contract revenue	$ 13,009	$ 12,549	$ 39,581	$ 36,128
Cost of revenue	7,960	7,931	26,143	24,278
Gross profit	5,049	4,618	13,438	11,850
Operating expenses:
Selling, general and administrative	3,483	3,302	10,663	9,920
Depreciation	131	137	406	365
Amortization of definite-lived intangible assets	79	204	235	629
Total operating expenses	3,693	3,643	11,304	10,914
Operating income	1,356	975	2,134	936
Interest income, net	36	29	121	91
Gain (loss) on derivative instruments, net	20	(129)	36	49
Other income (expense), net	(97)	31	82	70
Income before income taxes	1,315	906	2,373	1,146
Provision (benefit) for income taxes	499	48	869	(481)
Net income	$ 816	$ 858	$ 1,504	$ 1,627
Basic income per common share (in dollars per share)	$ 0.04	$ 0.05	$ 0.08	$ 0.09
Diluted income per common share (in dollars per share)	$ 0.04	$ 0.05	$ 0.08	$ 0.08

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Software Development Costs

9 Months Ended

Sep. 30, 2012

Software Development Costs [Abstract]

Software Development Costs

5.   Software Development Costs

Certain computer software development costs are capitalized in the accompanying consolidated balance sheets.  Capitalization of computer software development costs begins upon the establishment of technological feasibility.  Capitalization ceases and amortization of capitalized costs begins when the software product is commercially available for general release to customers.  Amortization of capitalized computer software development costs is included in cost of revenue and is determined using the straight-line method over the remaining estimated economic life of the product, typically three years.

Software development costs capitalized were $306,000 and $914,000 for the three and nine months ended September 30, 2012, respectively, and $186,000 and $572,000 for the three and nine months ended September 30, 2011, respectively.  Total amortization expense was $168,000 and $536,000 for the three and nine months ended September 30, 2012, respectively, and $218,000 and $612,000 for the three and nine months ended September 30, 2011, respectively.

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Contract Receivables

9 Months Ended

Sep. 30, 2012

Contract Receivables [Abstract]

Contract Receivables

4.   Contract Receivables

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

(in thousands)	September 30,  2012		December 31, 2011
Billed receivables	$	7,858	$         8,258
Recoverable costs and accrued profit not billed		11,719	12,234
Allowance for doubtful accounts		(136)	(136)
Total contract receivables, net	$	19,441	$      20,356

Recoverable costs and accrued profit not billed totaled $11.7 million and $12.2 million as of September 30, 2012 and December 31, 2011, respectively.  During October 2012, the Company invoiced $1.8 million of the unbilled amounts.

The following customers account for more than 10% of the Company’s consolidated contract receivables for the indicated periods:

	September 30,2012		December 31, 2011
Slovenské elektrárne, a.s.		15.7%	24.2%
Shandong Nuclear Power Co. Ltd.		15.3%	5.0%
Kraftwerkesschule E.V.		12.4%	7.9%

In May 2012, Slovenské elektrárne, a.s. (“SE”) notified the Company of its decision to suspend work under the contract due to changes in the Slovakian regulation requiring SE to redesign certain aspects of the plant.  The Company and SE are currently discussing amendments to the existing contract addressing (i) substantial additional scope of work for the Company,  (ii) costs related to suspension of the contract and its restart,  (iii) the Company’s continued support of the project during the suspension period and (iv) withdrawal of  SE outstanding claims.  At September 30, 2012, the Company had a $188,000 outstanding invoice included in accounts receivable, $2.9 million of recoverable costs and accrued profit not billed, and a $2.9 million performance bond in place to secure completion of the contract.

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Basic and Diluted Income (Loss) Per Common Share (Tables)

9 Months Ended

Sep. 30, 2012

Basic and Diluted Income (Loss) Per Common Share [Abstract]

Number of common shares and common share equivalents used in the determination of basic and diluted income (loss) per share

The number of common shares and common share equivalents used in the determination of basic and diluted income per share were as follows:

(in thousands, except for share amounts)	Three Months ended				Nine Months ended
	September 30,				September 30,
	2012		2011		2012		2011
Numerator:
Net income	$	816	$	858	$	1,504	$	1,627
Denominator:
Weighted-average shares outstanding for
basic earnings per share		18,390,034		18,879,757		18,370,907		19,101,284
Effect of dilutive securities:
Employee stock options		69,900		112,841		112,235		202,913
Adjusted weighted-average shares outstanding and
assumed conversions for diluted earnings per share		18,459,934		18,992,598		18,483,142		19,304,197
Shares related to dilutive securities excluded because inclusion would be anti-dilutive		2,847,203		1,573,896		2,799,268		1,544,504

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Preferred Stock Rights

9 Months Ended

Sep. 30, 2012

Preferred Stock Rights [Abstract]

Preferred Stock Rights

12.   Preferred Stock Rights

On March 21, 2011, the Board of Directors of the Company declared a dividend, payable to holders of record as of the close of business on April 1, 2011, of one preferred stock purchase right (a Right) for each outstanding share of common stock, par value $0.01 per share, of the Company (the Common Stock).  In addition, the Company will issue one Right with each new share of Common Stock issued.  In connection therewith, on March 21, 2011, the Company entered into a Stockholder Protection Rights Agreement (as amended from time to time, the Rights Agreement) with Continental Stock Transfer & Trust Company, as Rights Agent, which has a term of three years, unless amended by the Board of Directors in accordance with the terms of the Rights Agreement.  Upon approval of both an independent committee of the Board of Directors and the Board of Directors, the Rights Plan can be extended for up to three years.  The Rights will initially trade with and be inseparable from the Common Stock and will not be evidenced by separate certificates unless they become exercisable.  Each Right entitles its holder to purchase from the Company one-hundredth of a share of participating preferred stock having economic and voting terms similar to the Common Stock at an exercise price of $8.00 per Right, subject to adjustment in accordance with the terms of the Rights Agreement, once the Rights become exercisable.  Under the Rights Agreement, the Rights become exercisable if any person or group acquires 20% or more of the Common Stock or, in the case of any person or group that owned 20% or more of the Common Stock as of March 21, 2011, upon the acquisition of any additional shares by such person or group.  The Company, its subsidiaries, employee benefit plans of the Company or any of its subsidiaries and any entity holding Common Stock for or pursuant to the terms of any such plan are accepted.  Upon exercise of the Right in accordance with the Rights Agreement, the holder would be able to purchase a number of shares of Common Stock from the Company having an aggregate market price (as defined in the Rights Agreement) equal to twice the then-current exercise price for an amount in cash equal to the then-current exercise price.  In addition, the Company may, in certain circumstances and pursuant to the terms of the Rights Agreement, exchange the Rights for one share of Common Stock or an equivalent security for each Right or, alternatively, redeem the Rights for $0.001 per Right.  The Rights will not prevent a takeover of our Company, but may cause substantial dilution to a person that acquires 20% or more of the Company’s Common Stock.

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Stock-Based Compensation

9 Months Ended

Sep. 30, 2012

Stock-Based Compensation [Abstract]

Stock-Based Compensation

8.   Stock-Based Compensation

The Company recognizes compensation expense for all equity-based compensation awards issued to employees, directors and non-employees that are expected to vest.  Compensation cost is based on the fair value of awards as of the grant date.  The Company recognized $231,000 and $183,000 of stock-based compensation expense for the three months ended September 30, 2012 and 2011, respectively, under the fair value method and recognized $678,000 and $569,000 of stock-based compensation expense for the nine months ended September 30, 2012 and 2011, respectively.  The Company granted 0 and 152,870 stock options for the three and nine months ended September 30, 2012, respectively.  The fair value of the granted options at the grant date was $145,000.  The Company granted 60,000 and 102,000 stock options for the three and nine months ended September 30, 2011, respectively.  The fair value of the options granted for the three and nine months ended September 30, 2011 was $75,000 and $135,000, respectively.

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Fair Value of Financial Instruments

9 Months Ended

Sep. 30, 2012

Fair Value of Financial Instruments [Abstract]

Fair Value of Financial Instruments

6.   Fair Value of Financial Instruments

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

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

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

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

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

The Company considers the recorded value of certain of its financial assets and liabilities, which consist primarily of cash, accounts receivable and accounts payable, to approximate the fair value of the respective assets and liabilities at September 30, 2012 and December 31, 2011 based upon the short-term nature of the assets and liabilities.

The following table presents assets and liabilities measured at fair value at September 30, 2012:

		Quoted Prices		Significant
		in Active		Other			Significant
		Markets for		Observable			Unobservable
		Identical Assets		Inputs			Inputs
(in thousands)		(Level 1)		(Level 2)			(Level 3)		Total
Money market fund		$	15,429	$	-		$	-	$	15,429
Certificates of deposit			3,942		-			-		3,942
Foreign exchange contracts			-		507			-		507
	Total assets	$	19,371	$	507		$	-	$	19,878
Foreign exchange contracts		$	-	$	(370	)	$	-	$	(370	)
	Total liabilities	$	-	$	(370	)	$	-	$	(370	)

The following table presents assets and liabilities measured at fair value at December 31, 2011:

		Quoted Prices		Significant
		in Active		Other			Significant
		Markets for		Observable			Unobservable
		Identical Assets		Inputs			Inputs
(in thousands)		(Level 1)		(Level 2)			(Level 3)		Total
Money market fund		$	8,163	$	-		$	-	$	8,163
Certificates of deposit			5,976		-			-		5,976
Foreign exchange contracts			-		483			-		483
	Total assets	$	14,139	$	483		$	-	$	14,622
Foreign exchange contracts		$	-	$	(314	)	$	-	$	(314	)
	Total liabilities	$	-	$	(314	)	$	-	$	(314	)

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Derivative Instruments

9 Months Ended

Sep. 30, 2012

Derivative Instruments [Abstract]

Derivative Instruments

7.   Derivative Instruments

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

As of September 30, 2012, the Company had foreign exchange contracts outstanding of approximately 1.0 million Pounds Sterling, 13.3 million Euro, and 70.8 million Japanese Yen at fixed rates.  The contracts expire on various dates through May 2016.  At December 31, 2011, the Company had contracts outstanding of approximately 3.1 million Pounds Sterling, 12.0 million Euro, and 383.5 million Japanese Yen at fixed rates.  The Company has not designated any of the foreign exchange contracts outstanding as hedges and has recorded the estimated fair value of the contracts in the consolidated balance sheets as follows:

	September 30,			December 31,
(in thousands)	2012			2011
Asset derivatives
Prepaid expenses and other current assets	$	481		$	393
Other assets		26			90
		507			483
Liability derivatives
Other current liabilities		(203	)		(258	)
Other liabilities		(167	)		(56	)
		(370	)		(314	)
Net fair value	$	137		$	169

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

The foreign currency denominated contract receivables, billings in excess of revenue earned and subcontractor accruals that are related to the outstanding foreign exchange contracts are remeasured at the end of each period into the functional currency using the current exchange rate at the end of the period.  The gain or loss resulting from such remeasurement is also included in net gain (loss) on derivative instruments in the consolidated statements of operations.

For the three and nine months ended September 30, 2012 and 2011, the Company recognized a net gain (loss) on its derivative instruments as outlined below:

	Three Months ended						Nine Months ended
	September 30,						September 30,
(in thousands)	2012			2011			2012			2011
Foreign exchange contracts- change in fair value	$	(134	)	$	(143	)	$	(42	)	$	(298	)
Remeasurement of related contract receivables, billings in excess of revenue earned, and subcontractor accruals		154			14			78			347
Gain (loss) on derivative instruments, net	$	20		$	(129	)	$	36		$	49

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Long-Term Debt

9 Months Ended

Sep. 30, 2012

Debt Disclosure [Abstract]

Long-Term Debt

9.   Long-Term Debt

At September 30, 2012 and December 31, 2011, the Company had no long-term debt outstnading.

Line of Credit

The Company has a Master Loan and Security Agreement and Revolving Credit Note with Susquehanna Bank (“Susquehanna”).  The Company and its subsidiaries, GSE Power Systems, Inc., and GSE EnVision LLC, are jointly and severally liable as co-borrowers.  The Loan Agreement provides a $7.5 million revolving line of credit for the purpose of (i) issuing stand-by letters of credit and (ii) providing working capital. Working capital advances bear interest at a rate equal to the Wall Street Journal Prime Rate of Interest, floating with a floor of 4 ½%.  The two-year agreement is to expire on November 1, 2013.

As collateral for the Company’s obligations, the Company granted a first lien and security interest in all of the assets of the Company, including but not limited to, accounts receivable, inventory, proceeds and products, intangibles, trademarks, patents, intellectual property, machinery and equipment.

Issuances of stand-by letters of credit and advances of working capital (collectively referred to as the “Advances”) require that the Company maintain a minimum cash balance of $3.0 million at all times (the “Cash Balance Requirement”).  The Cash Balance Requirement will remain at the minimum amount as long as the Company’s quarterly net income (exclusive of gains and losses on derivative instruments and stock option expense) as defined (“Net Income”) remains positive and the Company is in compliance with the covenants.  If the Company’s quarterly consolidated Net Income is negative or the Company is not in compliance with the covenants, the Cash Balance Requirement will revert to the amount of the Advances, until the Company attains positive Net Income for two consecutive quarters.  The credit agreements contain certain restrictive covenants regarding future acquisitions, and incurrence of debt.  In addition, the credit agreements contain financial covenants with respect to the Company’s cash flow coverage ratio, minimum tangible capital base, quick ratio, and tangible capital base ratio.  At September 30, 2012, the Company had not made any borrowings for over one year.  As such, the cash flow coverage ratio is not applicable at September 30, 2012.

		As of
	Covenant	September 30, 2012
Minimum tangible capital base	Must Exceed $26.0 million	$33.4 million
Quick ratio	Must Exceed 2.00 : 1.00	2.59 : 1.00
Tangible capital base ratio	Not to Exceed .75 : 1.00	.59 : 1.00

As the Company’s Net Income for the nine months ended September 30, 2012 was positive and the Company is in compliance with its covenants, the Company is currently required to maintain the minimum cash balance of $3.0 million with Susquehanna.  At September 30, 2012, the Company had $328,000 in Advances, all of which consisted of outstanding stand-by letters of credit.

As of September 30, 2012, the Company was contingently liable for eleven standby letters of credit and five surety bonds totaling $6.3 million which represent performance and bid bonds on eleven contracts.  The Company has deposited the full value of eight standby letters of credit in certificates of deposit and escrow accounts ($4.8 million) which have been restricted in that the Company does not have access to these funds until the related letters of credit have expired.  The cash has been recorded on the Company’s balance sheet at September 30, 2012 as restricted cash.

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Derivative Instruments (Details)	3 Months Ended		9 Months Ended
	Sep. 30, 2012 USD ($)	Sep. 30, 2011 USD ($)	Sep. 30, 2012 USD ($)	Sep. 30, 2011 USD ($)	Sep. 30, 2012 EUR (€)	Sep. 30, 2012 GBP (£)	Sep. 30, 2012 JPY (¥)	Dec. 31, 2011 EUR (€)	Dec. 31, 2011 GBP (£)	Dec. 31, 2011 JPY (¥)	Sep. 30, 2012 Not designated as Hedges [Member] USD ($)	Dec. 31, 2011 Not designated as Hedges [Member] USD ($)	Sep. 30, 2012 Not designated as Hedges [Member] Prepaid Expenses and Other Current Assets [Member] USD ($)	Dec. 31, 2011 Not designated as Hedges [Member] Prepaid Expenses and Other Current Assets [Member] USD ($)	Sep. 30, 2012 Not designated as Hedges [Member] Other assets [Member] USD ($)	Dec. 31, 2011 Not designated as Hedges [Member] Other assets [Member] USD ($)	Sep. 30, 2012 Not designated as Hedges [Member] Other Current Liabilities [Member] USD ($)	Dec. 31, 2011 Not designated as Hedges [Member] Other Current Liabilities [Member] USD ($)	Sep. 30, 2012 Not designated as Hedges [Member] Other liabilities [Member] USD ($)	Dec. 31, 2011 Not designated as Hedges [Member] Other liabilities [Member] USD ($)
Derivative Instruments [Abstract]
Foreign exchange contract outstanding					€ 13,300,000	£ 1,000,000	¥ 70,800,000	€ 12,000,000	£ 3,100,000	¥ 383,500,000
Estimated fair value of the contracts in the consolidated balance sheets [Abstract]
Asset derivatives											507,000	483,000	26,000	90,000	481,000	393,000
Liability derivatives											(370,000)	(314,000)					(203,000)	(258,000)	(167,000)	(56,000)
Net fair value											137,000	169,000
Gain (loss) from derivative instruments [Abstract]
Foreign exchange contracts- change in fair value	(134,000)	(143,000)	(42,000)	(298,000)
Remeasurement of related contract receivables, billings in excess of revenue earned, and subcontractor accruals	154,000	14,000	78,000	347,000
Gain (loss) on derivative, net	$ 20,000	$ (129,000)	$ 36,000	$ 49,000

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Basis of Presentation and Revenue Recognition (Policies)

9 Months Ended

Sep. 30, 2012

Basis of Presentation and Revenue Recognition [Abstract]

Basis of Presentation

Basis of Presentation

The consolidated interim financial statements included herein have been prepared by GSE Systems, Inc. (the “Company” or “GSE”) without independent audit.  In the opinion of the Company's management, all adjustments and reclassifications of a normal and recurring nature necessary to present fairly the financial position, results of operations and cash flows for the periods presented have been made.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted.  The results of operations for interim periods are not necessarily an indication of the results for the full year.  These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the period ended December 31, 2011 filed with the Securities and Exchange Commission on March 8, 2012.

The Company has only one reportable segment.  The Company has a wide range of knowledge of simulation systems and the processes those systems are intended to control and model.  The Company’s knowledge is concentrated heavily in simulation technology and model development.  The Company is primarily engaged in simulation for the power generation industry and the process industries.  Contracts typically range from twelve months to three years.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements as well as reported amounts of revenues and expenses during the reporting period.  The Company’s most significant estimates relate to revenue recognition, capitalization of software development costs, valuation of intangible assets acquired, contingent consideration issued in business acquisitions, and the recoverability of deferred tax assets.  Actual results could differ from these estimates and those differences could be material.

Revenue Recognition

Revenue Recognition

Revenue Recognition

The majority of the Company’s revenue is derived through the sale of uniquely designed systems containing hardware, software and other materials under fixed-price contracts.  Revenue under these fixed-price contracts is accounted for on the percentage-of-completion method.  This methodology recognizes revenue and earnings as work progresses on the contract and is based on an estimate of the revenue and earnings earned to date, less amounts recognized in prior periods.  The Company bases its estimate of the degree of completion of the contract by reviewing the relationship of costs incurred to date to the expected total costs that will be incurred on the project. Estimated contract earnings are reviewed and revised periodically as the work progresses, and the cumulative effect of any change in estimate is recognized in the period in which the change is identified.  Estimated losses are charged against earnings in the period such losses are identified.  The Company recognizes revenue arising from contract claims either as income or as an offset against a potential loss only when the amount of the claim can be estimated reliably and realization is probable and there is a legal basis for the claim.

Uncertainties inherent in the performance of contracts include labor availability and productivity, material costs, change order scope and pricing, software modification and customer acceptance issues.  The reliability of these cost estimates is critical to the Company’s revenue recognition as a significant change in the estimates can cause the Company’s revenue and related margins to change significantly from the amounts estimated in the early stages of the project.

As the Company recognizes revenue under the percentage-of-completion method, it provides an accrual for estimated future warranty costs based on historical experience and projected claims.  The Company’s long-term contracts generally provide for a one-year warranty on parts, labor and any bug fixes as it relates to software embedded in the systems.

The Company’s system design contracts do not normally provide for “post customer support service” (“PCS”) in terms of software upgrades, software enhancements or telephone support.  In order to obtain PCS, the customers must normally purchase a separate contract.  Such PCS arrangements are generally for a one-year period renewable annually and include customer support, unspecified software upgrades, and maintenance releases.  The Company recognizes revenue from these contracts ratably over the life of the agreements.

Revenue from the sale of software licenses which do not require significant modifications or customization for the Company’s modeling tools are recognized when the license agreement is signed, the license fee is fixed and determinable, delivery has occurred, and collection is considered probable.

Revenue from certain consulting or training contracts is recognized on a time-and-material basis.  For time-and-material type contracts, revenue is recognized based on hours incurred at a contracted labor rate plus expenses.

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Derivative Instruments (Tables)

9 Months Ended

Sep. 30, 2012

Derivative Instruments [Abstract]

Estimated fair value of the contracts in the consolidated balance sheets

The Company has not designated any of the foreign exchange contracts outstanding as hedges and has recorded the estimated fair value of the contracts in the consolidated balance sheets as follows:

	September 30,			December 31,
(in thousands)	2012			2011
Asset derivatives
Prepaid expenses and other current assets	$	481		$	393
Other assets		26			90
		507			483
Liability derivatives
Other current liabilities		(203	)		(258	)
Other liabilities		(167	)		(56	)
		(370	)		(314	)
Net fair value	$	137		$	169

Gain (loss) from derivative instruments

For the three and nine months ended September 30, 2012 and 2011, the Company recognized a net gain (loss) on its derivative instruments as outlined below:

	Three Months ended						Nine Months ended
	September 30,						September 30,
(in thousands)	2012			2011			2012			2011
Foreign exchange contracts- change in fair value	$	(134	)	$	(143	)	$	(42	)	$	(298	)
Remeasurement of related contract receivables, billings in excess of revenue earned, and subcontractor accruals		154			14			78			347
Gain (loss) on derivative instruments, net	$	20		$	(129	)	$	36		$	49

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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) (USD $) In Thousands, unless otherwise specified	3 Months Ended		9 Months Ended
	Sep. 30, 2012	Sep. 30, 2011	Sep. 30, 2012	Sep. 30, 2011
Consolidated Statements of Comprehensive Income (Loss)
Net income	$ 816	$ 858	$ 1,504	$ 1,627
Foreign currency translation adjustment	442	(378)	291	(62)
Comprehensive income	$ 1,258	$ 480	$ 1,795	$ 1,565

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Basic and Diluted Income (Loss) Per Common Share

9 Months Ended

Sep. 30, 2012

Basic and Diluted Income (Loss) Per Common Share [Abstract]

Basic and Diluted Income (Loss) Per Common Share

3.   Basic and Diluted Income Per Common Share

Basic income per share is based on the weighted average number of outstanding common shares for the period.  Diluted income per share adjusts the weighted average shares outstanding for the potential dilution that could occur if stock options or warrants were exercised into common stock.  The number of common shares and common share equivalents used in the determination of basic and diluted income per share were as follows:

(in thousands, except for share amounts)	Three Months ended				Nine Months ended
	September 30,				September 30,
	2012		2011		2012		2011
Numerator:
Net income	$	816	$	858	$	1,504	$	1,627
Denominator:
Weighted-average shares outstanding for
basic earnings per share		18,390,034		18,879,757		18,370,907		19,101,284
Effect of dilutive securities:
Employee stock options		69,900		112,841		112,235		202,913
Adjusted weighted-average shares outstanding and
assumed conversions for diluted earnings per share		18,459,934		18,992,598		18,483,142		19,304,197
Shares related to dilutive securities excluded because inclusion would be anti-dilutive		2,847,203		1,573,896		2,799,268		1,544,504

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Long-Term Debt (Tables)

9 Months Ended

Sep. 30, 2012

Line of Credit Facility [Table]

Susquehanna Bank Loan Agreement debt covenants

		As of
	Covenant	September 30, 2012
Minimum tangible capital base	Must Exceed $26.0 million	$33.4 million
Quick ratio	Must Exceed 2.00 : 1.00	2.59 : 1.00
Tangible capital base ratio	Not to Exceed .75 : 1.00	.59 : 1.00

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Income Taxes (Details) (USD $)	3 Months Ended	9 Months Ended	12 Months Ended
	Mar. 31, 2011	Sep. 30, 2012	Dec. 31, 2011	Jan. 04, 2011
Income Taxes [Abstract]
Recognized deferred tax liabilities				$ 1,000,000
Change in valuation allowance	1,000,000
Unrecognized tax benefits from acquisitions				320,000
Receivable from acquisition shareholders related to unrecognized tax benefit				320,000
Unrecognized tax benefits for foriegn tax contingencies		$ 29,000	$ 126,000

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Share Repurchase Plan

9 Months Ended

Sep. 30, 2012

Share Repurchase Plan [Abstract]

Share Repurchase Program

13.   Share Repurchase Plan

On March 21, 2011, the Board of Directors authorized the purchase of up to $3.0 million of the Company’s common stock in accordance with the safe harbor provisions of Rule 10b-18 of the Securities Exchange Act of 1934.  During the three and nine months ended September 30, 2012 the Company repurchased 60,700 and 223,087 shares at an aggregate cost of $119,000 and $422,000, respectively.  During the three and nine months ended September 30, 2011 the Company repurchased 370,519 and 521,400 shares at an aggregate cost of $792,000 and $1.1 million, respectively.