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.

General Business Environment

It has now been over one year 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. In February 2012, the U.S. Nuclear Regulatory Commission (NRC) voted to issue the first three new rules to deal with safety issues based on eight changes identified by the NRC's Fukushima task force, with implementation expected by the end of 2016. The rules, subject to review and commission action, will require all U.S. nuclear operators to develop plans to deal with extreme situations, such as earthquakes, floods and other natural disasters that could affect multiple reactors operating at a single site. In addition, all plants would have to improve instrumentation in the pools used to store spent nuclear fuel and have to make changes to containment "vent" structures at plants similar in design to the Daiichi nuclear plant.

In early March 2012, the state-run China Daily cited Deputy Director of the Committee of Population, Resources and Environment of the Chinese People's Political Consultative Conference National Committee, Wang Yuqing, as saying that the ban on the proposed new atomic energy plants that was put in place following the Fukushima disaster would soon be removed as a comprehensive plan on nuclear safety control has been submitted to the State Council.

In Japan, all of the country's 54 commercial nuclear reactors have gone offline since the Fukushima disaster, with the last 2 units shutting down in May 2012. 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.

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 voted to issue, the comments in the China Daily, 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.

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.

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. We received our first 3D visualization orders in 2011 and will incurred modest revenue from 3D visualization training products in 2012. However, we anticipate 3D visualization training product revenues to scale dramatically over the coming years.

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.

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 March 31,
                                             2012            %           2011            %
Contract revenue                           $  13,389         100.0 %   $  12,322         100.0 %
Cost of revenue                                9,470          70.7 %       8,847          71.8 %

Gross profit                                   3,919          29.3 %       3,475          28.2 %
Operating expenses:
  Selling, general and administrative          3,486          26.1 %       3,420          27.8 %
  Depreciation                                   137           1.0 %         125           1.0 %
  Amortization of definited-lived
intangible assets                                 78           0.6 %         217           1.8 %
Total operating expenses                       3,701          27.7 %       3,762          30.6 %

Operating income (loss)                          218           1.6 %        (287 )        (2.4 )%

Interest income, net                              51           0.4 %          33           0.3 %
Gain on derivative instruments, net              400           3.0 %         588           4.8 %
Other income, net                                 86           0.6 %          65           0.5 %

Income before income taxes                       755           5.6 %         399           3.2 %

Provision (benefit) for income taxes             225           1.6 %        (614 )        (5.0 )%

Net income                                 $     530           4.0 %   $   1,013           8.2 %

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, and deferred income tax valuation allowances. 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.

Results of Operations - Three Months ended March 31, 2012 versus Three Months ended March 31, 2011

Contract Revenue. Total contract revenue for the quarter ended March 31, 2012 totaled $13.4 million, which was 8.7% greater than the $12.3 million total revenue for the quarter ended March 31, 2011. The Company recorded total orders of $17.8 million in the three months ended March 31, 2012 versus $10.5 million for the three months ended March 31, 2011. The increase in revenue is primarily due to additional revenue generated from the Company's fossil fuel simulation projects. Fossil fuel simulation revenue increased 30% from $2.4 million for the three months ended March 31, 2011 to $3.1 million for the three months ended March 31, 2012. Revenue related to the $26.8 million full scope simulator and digital control system order from a Slovak utility was $1.1 million or (8.0% of revenue) and $1.7 million or (14.2% of revenue) for the three months ended March 31, 2012 and 2011, respectively. At March 31, 2012, the Company's backlog was $56.5 million, of which $4.7 million related to the Slovakia contract. The backlog increased 9.6% from December 31, 2011 when the Company's backlog totaled $51.5 million.

Gross Profit. Gross profit totaled $3.9 million for the quarter ended March 31, 2012 versus $3.5 million for the same quarter in 2011. As a percentage of revenue, gross profit increased from 28.2% for the three months ended March 31, 2011 to 29.3% for the three months ended March 31, 2012. The decrease in revenue on the Slovakia contract, which has an overall gross profit lower than the Company's normal gross profits, along with an increase in revenue from our core business have contributed to the increase in gross profit for the three months ended March 31, 2012.

Selling, General and Administrative Expenses. Selling, general and administrative ("SG&A") expenses totaled $3.5 million in the quarter ended March 31, 2012, a 2% increase from the $3.4 million for the same period in 2011. The increase reflects the following spending variances:

¨ Business development and marketing costs increased from $1.0 million in the first quarter 2011 to $1.2 million in the first quarter of 2012. Bidding and proposal costs, which are the costs of operations personnel assisting with the preparation of contract proposals, increased by $78,000 in the first quarter 2012 to $475,000 as compared to the first quarter 2011. The Company hired an additional business development resource in in the United States during the fourth quarter 2011 and hired an additional business development resource in Europe during the first quarter 2012.

¨ The Company's general and administrative expenses ("G&A") were $1.4 million for the three months ended March 31, 2012 as compared to $1.9 million for the three months ended March 31, 2011. The decrease is primarily attributable to the following:

o In the first quarter of 2011, the Company incurred $204,000 of acquisition related expenses, primarily composed of legal, audit, and due diligence expenses.

o The change in the fair value of contingent consideration (accretion expense) related to the TAS and EnVision acquisitions totaled $45,000 for the three months ended March 31, 2012 versus $146,000 for the three months ended March 31, 2011.

o TAS incurred $131,000 and $197,000 of G&A expenses for the three months ended March 31, 2012 and 2011, respectively.

¨ Gross spending on software product development ("development") expenses for the three months ended March 31, 2012 totaled $670,000 as compared to $343,000 for the three months ended March 31, 2011. The Company capitalized $269,000 for the three months ended March 31, 2012 and $180,000 for the same period in 2011. Net development spending increased from $163,000 for the three months ended March 31, 2011 to $401,000 for the three months ended March 31, 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 $47,000 and $114,000 of costs related to this effort as headcount increased from one to seven in the three months ended March 31, 2011 and 2012, respectively.

o Spending on other software product development totaled $556,000 for the three months ended March 31, 2012. For the three months ended March 31, 2011, development expense totaled $296,000. The Company's development expenses were mainly related to advancements of new configuration management system which is a central data warehouse that supports various forms of data on a simulator, as well as development of a new product, PSA-HDTM, which is used to train operators and power plant personnel on the sequence of events during severe accident conditions.

Depreciation. Depreciation expense totaled $137,000 and $125,000 during the quarters ended March 31, 2012 and 2011, respectively.

Amortization of definite-lived intangible assets. Amortization expense related to definite-lived intangible assets totaled $78,000 and $217,000 for the quarters ended March 31, 2012 and 2011, 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 (loss). The Company had operating income of $218,000 (1.6% of revenue) in the first quarter 2012, as compared with an operating loss of $287,000 (-2.4% of revenue) for the same period in 2011. The variances were due to the factors outlined above.

Interest Income, Net. Net interest income totaled $51,000 and $33,000 for the three months ended March 31, 2012 and 2011, respectively.

Gain 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 March 31, 2012, the Company had foreign exchange contracts outstanding of approximately 2.4 million Pounds Sterling, 13.7 million Euro, and 378.6 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 a gain on the change in the estimated fair value of the contracts of $186,000 for the three months ended March 31, 2012.

At March 31, 2011, the Company had foreign exchange contracts for sale of approximately 2.6 million Pounds Sterling, 14.6 million Euro and 763.8 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 a gain on the change in the estimated fair value of the contracts of $560,000 for the three months ended March 31, 2011.

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 months ended March 31, 2012, the Company recognized a gain of $214,000, from the remeasurement of such contract receivables and billings in excess of revenue earned. For the same periods in 2011, the Company recognized a $28,000 gain.

Other Income, net. For the three Months ended March 31, 2012, other income, net was $86,000. For the three months ended March 31, 2011, other income, net was . . .