GSE Systems Inc (GVP) 2009 Q2 法說會逐字稿

Good day, and welcome to the GSE Systems second quarter and mid year conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. John Moran. Please go ahead sir.

Thank you. Welcome, everyone, to GSE's mid-year 2009 conference call. I am John Moran, GSE's CEO. and I am joined here today by our Chief Financial Officer, Jeff Hough. Today's call will begin with a brief overview of our second quarter and mid-year 2009 financial results. That will be followed by an update on our nuclear simulation, non-nuclear simulation and training services business sectors. We will conclude with some comments on what we expect for the balance of the year, followed by about 30 minutes for any questions that you may have. Before we begin, I would like to turn it over to Jeff to address the subject of forward-looking statements.

This presentation contains forward-looking statements regarding the future performance of GSE Systems, Inc. that involve risks and uncertainties that could cause actual results to differ materially, including but not limited to economic conditions, customer demand, increased competition in the relevant market, and others. We refer you to the documents that the company files from time to time with the Securities and Exchange Commission such as the Form 10-K, Form 10-Q and Form 8-K reports which contain additional important factors that could cause actual results to differ from the current expectations and from the forward-looking statements made in this presentation.

Thanks, Jeff. Okay. Let's begin with the financial summary. As noted in our press release, the company reported that revenue for the three months ended June 30, 2009 was $10.65 million, a 62% increase from the revenue reported for the three months ended June 30, 2008 of $6.6 million. GSE reported operating income of $658,000 for the second quarter of 2009 as compared to operating loss of $148,000 in the second quarter of 2008.

Net income for the June 30, 2009 quarter was $571,000 or $0.04 per share on a basic basis and $0.03 per share on a fully diluted basis, as compared to a net loss of $270,000 or $0.02 per share on both a basic and diluted basis for the second quarter of 2008. GSE reported revenue for the six months ended June 30, 2009 of $18.8 million, a 38% increase from the revenue reported for the first six months ended June 30, 2008 of $13.6 million. In the first six months of 2009, the company generated $12.4 million or 6% of our total revenue for nuclear simulation, $5.9 million or 31% of the total revenue for non-nuclear simulation and $441,000, or 3% of the total for training and educational services.

GSE reported operating income of $1.189 million for the six months ended June 30, 2009 as compared to an operating loss of $322,000 for the six months ended June 30, 2008. Net income attributed to shareholders was $904,000 for the six months ended June 30, 2009 or $0.06 per share on a basic basis and $0.05 per share on fully diluted basis, compared to a net loss of $563,000 or $0.04 per share on both a basic and diluted basis for the six months ended June 30, 2008. The company continues to utilize the derivative instruments, specifically foreign exchange contracts to manage market risks associated with the fluctuations in foreign currency exchange rates on foreign-dominated trade receivables.

The purpose and structure of the derivative statements GSE has entered into are designed to protect the contact value and margins at the time the contracts are signed, and are not designed to speculate on the direction of any currency, either up or down. For the three months ended June 30, 2009, the company incurred a $194,000 pretax, noncash gain on its derivative instruments and this is reflected in the numbers that I just reported.

GSE's backlog as of June 30, 2009 was approximately $62.3 million compared to $38 million at December 31, 2008. Backlog is defined as the remaining value of signed contracts and does not include any value for contracts being negotiated, or for contracts that have been signed since June 30, 2009.

In June, we announced that GSE had finalized contracts for the two new full-scope nuclear simulators in Japan. Therefore, the approximate $10 million of remaining value is included in the contract backlog of $62.3 million. However, it does not include the expected value the full scope nuclear simulator currently being built for Westinghouse Electric Company's Haiyang project in China. What's important to understand is that we have been organized to work on the Haiyang project, and we're booking revenue on the initial phases of this work no differently than any other project.

To conclude the financial discussion, the company filed an S-3 Shelf registration with the SEC on August 6, 2009. Our purpose for filing the shelf registration is that we want the company to have all available options at its disposal, should future opportunities present themselves. Over the past 18 months or so, we've evaluated several interesting acquisition and joint venture opportunities that would have required a capital component had we decided to move on them. Having said that, I want to point out that we closed the quarter with over $5.5 million cash in the bank in unused line of credit and we generated cash from operations. So this shelf filing simply gives us added flexibility for potential future opportunities.

Okay, let's turn our attention now to the business sector updates. As most of you an aware, the company has three business sectors. Nuclear power simulation, non-nuclear power simulation and our training and educational services sector. In the nuclear sector, customers around the world continue to purchase our simulators to train and certify control room operators, engineers and managers, and to verify and validate new plant designs and control systems. In the US,

GSE has built or modified approximately 86 of the 100 the full scope simulators in operation today, and on a global basis, we built or modified over 60% of the total number of nuclear power plant simulators, and that would be 75% if France was eliminated from the calculation. The company enjoys a very strong presence in the nuclear power industry, and works with most reactor vendors, contractors, and operators such as Westinghouse and New Scale here in the United States, JAPC in Japan, Guan Dong Nuclear in China, the Russian Research Institute and the Pebble Bed Reactor in South Africa to name just a few.

With the recent multi-million dollar award from Westinghouse to build an AP1000 Nuclear Power Plant simulator, based upon Westinghouse's design for domestic customers, we are currently working on nine new full scope nuclear plant simulators. The recent Westinghouse award is significant for a number of reasons. First, it represents the first of a number of contracts for nuclear plant simulators in the US the company expects to secure over the course of the next few years. Mind you, this is the first such award in the United States in the last 30 years. Through my many discussions with people in the investment community and outside it, there has been a healthy skepticism around the US nuclear market. As many of you know, even I have referred to the potential US nuclear market as our "icing on the cake".

This award under scores the fact that the US nuclear market is for real, and that GSE is well-positioned to capitalize on the opportunity. It now appears that the new build activity in the United States will very likely become a meaningful contributor to our nuclear sector growth in the not too distant future. Having said that, the vast majority of our nuclear work is still sourced from customers outside of the United States and we expect this trend to continue for the foreseeable future.

The second reason the Westinghouse award is significant is that it reinforces the fact that US nuclear utilities are demonstrating the need for full scope simulators to train new nuclear workers early in the licensing, design and construction process. Finally, the nature of the contract is important to understand. The first phase of work will focus on building high fidelity simulation models for the AP1000 nuclear systems. These models will be largely common to all future US-based AP1000 plants, and therefore highly reusable. The remaining plant systems, which the company expects awards in the future, are expected to be different, and therefore, the company expects these contracts to be issued on a plant-specific basis.

The Westinghouse AP1000 is the technology of choice for no less than 14 announced US nuclear power plants, including six for which engineering, procurement and construction contracts have already been signed. Providing a full-scope simulator at each site is included within the scope of work between Westinghouse and these US-based customers. The full value of the first US-based AP1000 simulator will likely be in the range of $6 million to $8 million. This is typical of the price range we have discussed many times for a new full scope nuclear simulator. The value of the contracts for the follow-on US-based AP1000 simulators will depend upon how similar the design of the plants are. We'll have a better handle on this as the plant-specific work starts to roll in, likely in the 2010 time frame.

Continuing with the nuclear sector, and again, this is an important point to understand, we still generate about 50% of our revenue from servicing and modifying the world's existing installed base of nuclear plant simulators, our own, as well as those of our competitors. Over $7 million of revenue has been generated from this line of business since the beginning of the year. For the remainder of 2009 and beyond, we anticipate a continuing stream of upgrade and modification work in Korea, Japan, Russia, the UK and greater Europe and of course the United States, as well as additional new full scope simulators.

Let's turn our attention to the non-nuclear simulation sector. Just as a reminder, our non-nuclear simulation business is comprised of two primary areas. Conventional power plant simulators and petroleum-related simulators. Our work in the conventional power plant area continues to be driven by new plant construction, the development of new and complex emission control systems, and the movement to modernize control rooms from the old analog control systems to the new digital control systems or DCSs. Our strategic relationship with Emerson process management, one of the largest DCS vendors in the world, has never been stronger, but we also work with most of the world's DCS vendors including Siemens, ABB, GE, Inventus, and others. Our bookings in this area have increased from $2 million in 2004 to approximately $15 million in 2008.

Our activity in the petroleum area continues to be driven by new work in Europe, the Arab gulf region, and in China. In the first quarter, we completed our first major project with SINOPEC, one of the largest oil and gas producers in the world. As many of you know, one of our core growth strategies is to extend our simulation capability to providing turnkey training solutions. That means GSE now has the capability to not only build and deliver the best simulators in the world, but also provide the training programs associated with the simulators and even the instructors when our customers need this service.

Our overarching objective in this area is to help our customers create new skilled workforces where they are needed. As an example, the electric power sector has been largely dormant for the better part of of the last 25 years, and the industry is facing a skilled workforce crisis. Electric power workers continue to retire in large numbers at exactly the same time as power companies are planning to build new capacity. To further amplify this point in the US nuclear industry, the average age of a nuclear worker is 48. 35% of the workforce is eligible to retire within five years. An estimated additional 25,000 new employees will be required to keep the 104 operating reactors running in this country. Each new plant will require about 500 new employees.

So, a new skilled nuclear workforce of over 120,000 will be needed to be created globally. The exciting news in this area is that in July, the company initiated a training program on schedule for new candidate nuclear plant operators at the Augusta Technical College in Georgia. In the fourth quarter of 2008, GSE announced that it had been awarded a nuclear plant operator training program with one the country's largest nuclear utilities. The scope of the award included developing and delivering an electronic copy of an existing full scope simulator, previously developed by GSE for this customer. Using the technology, the control room, instrumentation and controls are depicted on a large-screen touch sensitive computer displays. Operator trainees are able to manipulate the plant controls by touching the depiction of the control on the screen, versus manually manipulating the control, as they would on a traditional simulator or in an actual control room.

This unique technology was pioneered by GSE. And provides a very realistic control room environment that can be delivered quickly and at significantly less cost than a traditional full scope simulator. For this project, GSE also developed course materials for a licensed operator preparation course, which includes modules on nuclear plant fundamentals, nuclear plant systems, and integrated plant operations. We are also responsible for delivering the training program which consists of classes that run for approximately 20 weeks. The customer has indicated that they will initially require at least 12 classes that will run sequentially over the next six years. Although very early in the game, the initial results from the training program have been very positive. Many of the utilities in the US and from overseas have already visited Augusta or are scheduled to visit to view firsthand the first nuclear plant operator training academy built in the last 30 years.

Now, let's take a look at the outlook for the remainder of 2009 and beyond. keeping in mind that GSE does not give quantitative revenue and net income guidance, we stated in our year-end 2008 conference call, that based upon the backlog, pipeline and current level of bid activity as well as our internal expectations of new business awards, we believe 2009 would generate markedly improved financial results versus 2008.

With our first half financial results announced today, I feel that we are solidly on track to meet those expectations. Our previously stated expectations regarding gross margins and expense levels remain unchanged, our tax rate is slightly higher than the 19 to 23% we discussed during the year-end 2008 conference call. We are now estimating an overall tax rate of about 25% for the year. In addition, we continue to remain largely immune to the conditions which are affecting much of the broader economy. We have not experienced any meaningful project delays or cancellations thus far in 2009. We are continuing to recruit engineers at all of our global locations to meet our ever-increasing project obligations.

In summary, I am very pleased with our overall progress and performance during the past six months. Our cost structure is sound. Our balance sheet remains in excellent shape. We are debt free, and we are producing cash from operations. We continue to maintain a record pipeline of both near and longer-term opportunities. We therefore remain very optimistic about our growth prospects and positive trends going forward. Our relationships with many of the world's largest and leading engineering and construction companies, integrated energy companies, nuclear contractors, utilities and state run enterprises position GSE for an exciting multi year period of growth as our customers programs continue to gain momentum.

I will now turn the call over to Q&A for the next 30 minutes or so.

(Operator Instructions). We will take our first question from Mark Tobin with Roth Capital Partners.

Quick question on gross margins. Can you give a little bit more color about the dip during the quarter down in the 24% range?

Sure. It was 24.5, Mark, and I think we are going to still stick with the projections or expectation of 25 to 30% for the year. We had a good sized hardware component in the second quarter. And that was for the Mahase project. If you normalize the gross margins without the hardware component, then we are at the upper end of the 25 to 30% range.

Now, the hardware revenue is going to be difficult to predict. We do have more hardware coming, that is not a bad thing. It is a good thing. And it does have the effect of dampening the gross margin. And for the year, we are still comfortable with the expectation of 25 to 30% overall.

Can you give me a ballpark what that hardware component was for the quarter, just for modeling purposes?

For Mahase, in the second quarter, it was $1.1 million. I am going to look at Jeff to confirm that. He is confirming $1.1 million.

Okay. I will jump back into queue. Thank you.

We will take our next question from Mark Schappel from The Benchmark Company.

Hi, good afternoon, and nice job on the quarter. John, I was wondering if you can give us an idea of what the implied backlog was. You have given that number out in the past.

There is only one major component to that. That is the Haiyang job. And they were still basically reviewing the design and the differences between Haiyang and Salmon, so there's probably about another $4 million to $6 million in that project, And Siemens and to be determined.

Okay. And the Westinghouse project is in full backlog, then, it's not implied?

The Westinghouse contract that we just won is in the backlog, but it's not reflected in the second quarter backlog because it was awarded after June 30, you will see the Westinghouse contract in the third quarter backlog.

Great. Then finally hiring is obviously an issue in the nuclear power industry and I was just wondering if you had any comments of how that progressed in the quarter.

So far, we have been doing very well. We're aggressively recruiting in all of our offices. We have got offices in Sweden, and in Beijing, China and two here in the United States. It gives us a broad base to recruit from and as I said, we are aggressively hiring in each of those production offices and so far, we are being quite successful.

We will take our next question from Jeremy Hellman from Singular Research.

On the training segment, I wanted to get more color, you have the Academy in the Emirates and you know what's going on with the project in Georgia. With China's overall nuclear plans, how are they addressing training skilled labor over there? And the follow on to that is what opportunities would you see as a result of that?

I would say that in China, they are a little bit unique in terms of the way they train their nuclear operators, and it is a little bit of an anomaly from the rest of the world. They basically rely on the university systems and the university systems get into what we perceive as a NRC based operator training program, which of course, that is quite different than here in the United States and in the rest of the world, where the universities don't do that. Once we get our training program up and rolling and we have got some results coming in from the work that we are doing with the US- based program, then I anticipate it will be significant interest on the part of the Chinese to work with us in developing their workforce.

Okay. Thanks. One follow up. Back to the Emirates simulation academy. Project is basically wrapped up. Is that something that you still think may generate revenue in a meaningful way? What can you tell us about that?

There are two ways to generate revenue. Of course, there's follow-on project work and then there's our 10% ownership. We got our first -- and recall the plan from the very beginning was for us to operate that facility. And we think, and of course, the customer decided that they did not want to go in the direction, we think that's one of the reasons we're still absorbing some losses, but they did get their first set of meaningful revenue, and so that's a start and so we are hopeful that perhaps it will turn a profit. And we will pick up our 10% share of that.

Thanks.

We will take our next question from Peter McMullin from IPP.

Hi, John.

Hi, Peter, how are you doing?

Oh, just tip top. Hope you are the same. Lovely quarter. A couple of quick question. I think you had 120 employees at the end of the year. You were going to take it to at least 200. Can you give us a figure. And how many are kind of nuclear engineers. And also, would like to hear if there has been any progress or more understanding about the current administration's view on nuclear? And I have one more. But I will come back in queue if you will.

Okay. We are closing in on the 200 mark very rapidly. Most of our new hires, I would say, probably follow our backlog percentages, so probably, 70% to 80% of the people that we are bringing in are nuclear or applied to nuclear projects. Remember, if you look at a nuclear power plant, the core is certainly quite different than a conventional power plant. But the remaining systems, thermohydraulic systems are largely the same. We can take good hydraulic engineers and apply them to nuclear jobs. We are closing in on the 200 very rapidly.

The second question was the Obama administration. And we have taken a look at statements from the Department of Energy. And the leadership there, and they are positive on nuclear now, he has not come out with a definitive, we're going to go build 45 plants like McCain did. And if you look at the Department of Energy and some of the communications coming out of there, it is very clear that nuclear is going to play a significant role in the energy gap, closing the energy gap here in the United States. In fact, in one recent news release, they're basically accelerating, trying to find ways to accelerate the licensing process for the 34-some-odd accelerated construction operating license requests that they anticipate.

The Wall Street Journal seems to have an infatuation with nuclear in the last week or so.

Well, it looks like, as I said. It looks like the global renaissance has finally reached the United States.

I will get back in queue.

Okay.

(Operator Instructions). We will take the follow up question from Mark Tobin from Roth Capital Partners.

Hi, John, following up on the China discussion. I saw last month that the NDRC was looking at raising the target from 60 to 70 gigawatts to 86 gigawatts by 2020, however it is not finalized yet. Do you have any, or do your guys in China have any insight into the progress for that?

I think they are absolutely serious about, obviously they are. They are pouring concrete on the initial set of plans and they're moving ahead with a great deal of speed on that nuclear buildout. So, how it goes is going to be. If it goes, is not going to be the question.

The question is going to be, how does it go? How many are going to be AP1000s. How many are going to be Arriva, how many are going to be the Chinese CPR 1000s. And our insight is that we think the AP1000s are going to do pretty well. But, things have a way -- as you know, you lived over there for a couple of years. Things have a way of changing very rapidly. But right now, Westinghouse, I can speak from our discussions with them, is feeling pretty good about the Chinese market.

Are your opportunities limited to AP1000? I know you have done some CPR1000 work as well. I guess, just trying to understand. Sizing the opportunity for you over there.

Absolutely. In fact, one of the full-scope simulators we are building is a CPR1000 for Guangdong down in the south. So no, we are not restricted from any market in China. However, having said that, there is one caveat, and that is Arriva is of course, a deadly competitor with Westinghouse, and they recognize the close relationship we have with Westinghouse and Arriva has just purchased, recall, there are a couple of competitors in the world. Cories is a French company that we consider competition, and And Arriva just completed the acquisition of Cories. Whether we get the new-build Arriva plants in China is yet to be seen. Because we face that same issue with General Electric, and we're pretty successful in approaching the customer directly in those cases and getting the simulator contract broken out.

Okay. Thank you, that's helpful.

We will take our next question from [Zach Matthews with Matthews Capital.]

Hey, guys. How are you?

Good. How are you doing today?

Good, thanks. I am just trying to reconcile the backlog. The way I'm looking at is, the backlog, real backlog plus implied equals $70 million in the March quarter. If you take out $10.6 million in revenue and add the $5 million of new projects announced in early July, I'm not getting to the right number. Even if I add in another $5 million for the, I guess the Westinghouse China project? Which might not be included.

Don't forget the Japanese job. The Japanese job slipped from implied backlog into hard backlog in the second quarter.

I'm just looking at the hard backlog plus implied.

Right.

So, I go from $70 million in March. And so. All right. So the, there is the Westinghouse project that you announced on July 30th, right?

Right.

That's for the domestic plant?

Yes.

Is that included in the backlog?

No. Not in the 62.3 million.

Then the Westinghouse China project is also an implied not hard.

Correct. The remaining value of that contract, which we don't know at this point, but we're estimating, as I had mentioned, somewhere in the 4 to 6, 4 to 5, $6 million range.

Okay. So if I want to look at an apples to apples comparison, hard backlog plus implied, that number was $70 million at the end of March and then 60, what was your hard backlog? 62-point --

$62.3 million and then let's say, add $5 million, right.

So $67.3 million.

Right. That's correct. I think your arithmetic is right.

It seems like it is $2 million off though. Because if I take $70 million minus $10.6 million plus the $5 million you booked. Plus the $5 million implied. It is $2 million off.

Hang on, we are doing some calculations.

Right in your range of your estimate for -- Seimen Haiyang, I guess.

And rounding numbers. And the $5 million of contracts is a little more than $5 million. And the China project.

You only booked 2.6.

Yes. So, your question is on -- Your question is actually on the arithmetic.

Yes. It just seems I am off by $2 million.

Why don't we take a look at it. There could be a few other contracts that are in the implied backlog that we haven't discussed. And that I am not recalling. I don't know.

But I think the hard number at least on the surface -- not on the surface -- the hard number is $62.3 for the quarter. And then assume that the Haiyang project, the full value of the Haiyang project is not included in that $62.3 million.

Okay. And then looking to the September quarter, we can add the domestic Westinghouse.

Yes, the first phase of that.

Okay. Great. Thank you very much.

You're welcome.

We will take a follow up question from Peter McMullin with IPC.

Back again, John. Could you just walk me through as you grow the company. Where you can pick up some leverage from the top line to the bottom line. Or is it to more parallel?

No, I think we have -- I have made this statement many times. I think we have great operating leverage, because expenses, and we have held them, are going to -- at least for the foreseeable future, as far into the future as we have vision. We are going to hold those expenses and we give expectation of between $8 million and $8.3 million for the year, or let's say just roughly, just over $2 million for the quarter and we hit that yet again. So, anything that we put on the top line, assuming that our expectation of 25% to 30% gross margin, that flows pretty much directly to the bottom line.

So there's no change contemplated in the business model, in terms of more consulting or some leverage on various things you have already done and can duplicate?

I would say that let's see how it goes. Intuitively, you would think there would be sine improvement in gross margin. But we are in a brave new world here, in particular with nuclear. The one change that you will see is there will be increased training and educational services revenue and right now, at least at the beginning, the very very beginning of that journey, we are seeing gross margins that are higher than our typical gross margins. And so, you can expect to see more training revenue. That's for sure. And if the margins hold, we will see that at higher margins.

Thank you.

We will take a follow up question from Jeremy Hellman from Singular Research.

Hi. One follow-up on your comments. Could I get that revenue breakdown again between nuclear and non-nuclear power?

Sure, stand by. So, for the first six months in 2009, Jeremy, the company generated $12.4 million or 66% of our total revenue from nuclear simulation, and then $5.9 million or 31% of the total revenue from the non-nuclear simulation sector, and then $441,000 or 3% of the total revenue from the training and education services sector.

Of the $5.9 million, can you break it into non-nuke power and also petro?

The vast majority is -- hang on for one second, is fossil. So yes, we've got, in fossil power, it is revenues of about $4.5 million, process is revenues of about $1.4 million.

Okay, and then one more question for me. Just on the pollution control theme. With the cap and trade discussions out there. Is there any kicking the tires quote activity? Do you get any feel that there might be a significant bump in business, along that line, people just waiting to see what the ultimate legislation is going to be?

I think people are waiting to say what the ultimate legislation is going to be. And I am not really in a position to comment on that. We will see how it goes. What we are seeing is an increase in business in the emission controls area. And these systems are starting to become pretty complex, which is good for us. But I think it is a little bit too early in the game to make any predictions around how that might impact our business.

Thanks.

At this time, it appears there are no further questions. I would like to turn the conference back over to our speakers for any additional or closing comments.

I have no closing comments. I'd like to thank everyone -- other to thank everyone for participating. I look forward to the next conference call, which will be at the 2009 year-end time frame. Thank you very much.

That conclude today's conference, we thank you for your participation.