1.	Summary of Significant Accounting Policies

Basis of Presentation

The consolidated interim financial statements included herein have been prepared by GSE Systems, Inc. (the "Company," "GSE," "we," "us," or "our") 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 year ended December 31, 2015 filed with the Securities and Exchange Commission on March 25, 2016. Certain reclassifications have been made to prior period amounts to conform to the current presentation.

The Company has two reportable segments as follows:

·	Performance Improvement Solutions (approximately 68% of revenue)

The Company's Performance Improvement Solutions segment primarily encompasses next generation power plant and process high-fidelity simulation solutions, as well as engineering solutions. This segment includes various simulation products, engineering services, and operation training systems delivered across the industries the Company serves: primarily nuclear and fossil fuel power generation, and the process industries. Simulation solutions include the following: (1) simulation software and services, including operator training systems, for the nuclear power industry, (2) simulation software and services, including operator training systems, for the fossil power industry, and (3) simulation software and services for the process industries used to teach fundamental industry processes and control systems to newly hired employees and for ongoing workforce development and training.

·	Nuclear Industry Training and Consulting (approximately 32% of revenue)

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

Financial information about the two business segments is provided in Note 14 of the accompanying consolidated financial statements.

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 on long-term contracts, product warranties, capitalization of software development costs, valuation of goodwill and intangible assets acquired, valuation of 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 Company has (1) fixed price contracts for the sale of uniquely designed/customized systems containing hardware and software, (2) fixed price contracts for the sale of software licenses which may include post contract support and other elements such as installation and training, and (3) time and material contracts for support and service agreements.

In accordance with Accounting Standards Codification ("ASC") 605-35, "Construction-Type and Production-Type Contracts", the Performance Improvement Solutions segment recognizes revenue for its fixed-price contracts for the sale of customized systems using 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 of 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 and projected claims experience. The Company's long-term contracts generally provide for a one-year warranty on parts, labor and any bug fixes as it relates to customized software embedded in the systems.

The Company evaluates customized system contracts for multiple deliverables under ASC 605-25, "Revenue Recognition-Multiple Element Arrangements", and when appropriate, separates the contracts into separate units of accounting for revenue recognition. Contracts with multiple element arrangements typically include, but are not limited to, components such as training and post contract support ("PCS"), which are embedded in the contract. When a contract contains multiple deliverables, the Company allocates revenue to each deliverable based on its relative selling price which is determined based on its vendor specific objective evidence ("VSOE") if available, third party evidence ("TPE") if VSOE is not available, or estimated selling price if neither VSOE nor TPE is available. Amounts allocated to training and support services are based on VSOE and revenue is deferred until the services have been performed.

The Company also provides stand-alone PCS contracts. 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 without other elements in the contract and 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. The Company utilizes written contracts as a means to establish the terms and conditions by which products support and services are sold to customers. Delivery is considered to have occurred when title and risk of loss have been transferred to the customer, which generally occurs after a license key has been delivered electronically to the customer.

The Company also recognizes revenue from the sale of software licenses with multiple deliverables. These software license sales are evaluated under ASC 985-605, "Software Revenue Recognition". Contracts with multiple element arrangements typically include, but are not limited to, components such as installation, training, licenses, and PCS listed in the contract. The Company has not established that VSOE exists for all elements of its software license sales. If a PCS element exists in the software license arrangement, revenue is recognized ratably over the PCS service period. If no PCS element exists in the arrangement, revenue is deferred until all elements have been delivered.

The Company recognizes revenue under time and materials contracts primarily from the Nuclear Industry Training and Consulting segment and certain cost-reimbursable contracts. Revenue on time and material contracts is recognized as services are rendered and performed. Under a typical time-and-materials billing arrangement, customers are billed on a regularly scheduled basis, such as biweekly or monthly. Any unbilled amounts are typically billed the following month. Under cost-reimbursable contracts, which are subject to a contract ceiling amount, the Company is reimbursed for allowable costs and paid a fee, which may be fixed or performance based. However, if costs exceed the contract ceiling or are not allowable under the provisions of the contract or applicable regulations, the Company may not be able to obtain reimbursement for all such costs.

The following customer provided more than 10% of the Company's consolidated revenue:

	Three months ended March 31,
	2016	2015⁽¹⁾
Tennessee Valley Authority	12.6 %	20.9 %

(1) The prior year amounts have been revised to correct misstatements that were deemed to be immaterial to the prior period, as described in Note 1 - Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements.

Tennessee Valley Authority ("TVA") is a customer of Hyperspring, LLC.

Revisions

Historically, the Company recognized revenue on multiple element arrangements which included sales of its EnVision software product as delivery occurred on each element except PCS. PCS revenue was recognized ratably over the PCS term. During the fourth quarter of 2015, management determined that the Company had not established VSOE of the fair value for any of the elements in multiple element transactions including sales of its EnVision software licenses. Accordingly, the consolidated financial statements were revised to recognize all revenue on multiple element transactions including EnVision software license sales ratably over the PCS terms on these transactions since VSOE did not exist for any of the non-software elements in these multiple element transactions. The revision resulted in an increase to revenue of $17,000, a decrease to cost of revenue of $55,000, and a decrease in operating loss of $72,000 for the three months ended March 31, 2015.

Certain prior year amounts have also been revised in the consolidated statements of cash flows to reflect the corrections to net loss and changes in billings in excess of revenue earned, prepaid expenses and other assets. The revision had no impact on cash provided by operations or the net decrease in cash and cash equivalents.

The Company assessed the materiality of these misstatements on prior periods' consolidated financial statements in accordance with SEC Staff Accounting Bulletin ("SAB") No. 99, Materiality, codified in ASC 250, Accounting Changes and Error Corrections, and concluded that these misstatements were not material to any prior annual or interim periods. Accordingly, in accordance with ASC 250 (SAB No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements"), the consolidated financial statements as of March 31, 2015, which are presented herein, have been revised.

GSE SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

	Three months ended March 31, 2015
	As Reported			Adjustment			As Revised

Contract revenue	$	13,996		$	17		$	14,013
Cost of revenue		10,774			(55	)		10,719
Gross profit		3,222			72			3,294

Operating loss		(396	)		72			(324	)

Loss before income taxes		(456	)		72			(384	)

Net loss	$	(544	)	$	72		$	(472	)


Basic loss per common share	$	(0.03	)	$	-		$	(0.03	)

Diluted loss per common share	$	(0.03	)	$	-		$	(0.03	)

GSE SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

	Three months ended March 31, 2015
	As Reported			Adjustment		As Revised

Net loss	$	(544	)	$	72	$	(472	)

Comprehensive loss	$	(780	)	$	72	$	(708	)

GSE SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

	Three months ended March 31, 2015
	As Reported			Adjustment			As Revised

Cash flows from operating activities:
Net loss	$	(544	)	$	72		$	(472	)
Changes in assets and liabilities:
Contract receivables, net		583			27			610
Prepaid expenses and other assets		86			(55	)		31
Billings in excess of revenue earned		(791	)		(44	)		(835	)
Net cash provided by operating activities	$	(472	)	$	-		$	(472	)

Net decrease in cash and cash equivalents	$	(1,993	)	$	-		$	(1,993	)