GSE Systems Inc (GVP) 2010 Q3 法說會逐字稿

Good day, and welcome to the GSE Systems Incorporated third-quarter 2010 earnings conference call. Today's conference is being recorded. At this time I would like to turn the conference over to our Chief Executive Officer, Mr. Jim Eberle. Please go ahead sir.

Thank you. Good afternoon and welcome everyone to GSE's 2010 third-quarter conference call. I am Jim Eberle, GSE's Chief Executive Officer. I am joined here today with our Chief Financial Officer, Jeff Hough.

As most of you are aware, GSE historically has hosted a year-end and a midyear conference call. Since this is the Company's first quarterly financial reporting since I became CEO, I wanted to make an exception to our two call per year format and speak with everyone today.

Today's call will begin with a brief overview of our third-quarter financial results. This will be followed by an overview of several significant new contract wins since our last call. Then an update on our recent acquisition of TAS Holdings. I would then like to share with you some of my near and longer term goals for the Company, as well as share some general insights into what I will call strategic initiatives that the Company will be undertaking in order to expand our presence in several of our existing markets, as well as pursuing new opportunities.

But 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 markets and others.

We refer you to the documents that the Company files from time to time with the Securities and Exchange Commission, which is 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 its current expectations and from the forward-looking statements made in this presentation.

Thank you, Jeff. Before our financial results for the third quarter I would like to convey how excited I am to lead GSE through the Company's next phase of growth. I'm happy to be able to bring the knowledge and experience in nuclear power I obtained in the United States Navy, as well as the adult for-profit training and education business from my 14 years at General Physics Corporation.

I am also happy to report that since joining GSE five months ago I found a solid Company full of brilliant, talented and dedicated professionals. We have many opportunities to grow, both organically and via acquisition. And by leveraging the strength of our balance sheet I have every confidence that we will grow, and grow significantly.

Now onto our third-quarter financial results. As noted in our press release today, we reported revenue for the three months ended September 30, 2010, of $11.9 million. That is a 16.5% increase from the revenue reported for the three months ended September 30, 2009, of $10.2 million.

Included in the revenue for the three months ended September 30, 2010, was $3.6 million of revenue from our $23.8 million contract to provide a new nuclear power plant operator training simulator to a Slovak power plant. This contract includes approximately $16.4 million of hardware, the largest portion being a Siemens digital control system.

The Company accrues the cost of the digital control system based upon its estimate of the work completed by Siemens. As the purchase price of the digital control system is denominated in euros, we must remeasure the approved price -- excuse me, the accrued cost into US dollars each quarter based upon the quarter end exchange rate.

For the three months ended September 30, 2010, the Company recognized an unrealized currency loss of $506,000 on the accrued cost of this system, which was recorded in the cost of revenue.

Excluding the currency impact, gross profit percentage would have been 24.4% for the three months ended September 30, 2010 versus 24.5% for the three months ended September 30, 2009.

We had an operating loss of $328,000 for the third quarter of 2010 as compared to operating income of $428,000 in the third quarter of 2009. Excluding the currency impact, the Company would have had an operating profit of $178,000 for the three months ended September 30, 2010, as compared to an operating income of $381,000 for the three months ended September 30, 2009.

Our net loss for the third quarter of 2010 was $548,000 or $0.03 per share on both a basic and diluted basis, as compared to net income of $458,000 or $0.03 per share on both a basic and diluted basis for the third quarter of 2009.

Our revenue for the nine months ended September 30, 2010, was $34.9 million, a 20.3% increase from the revenue reported for the nine months ended September 30, 2009 of $29 million.

For the nine months ended September 30, 2010, the Company generated $25.3 million, or 74% of our total revenue, from nuclear simulation; $7.5 million, or 21% of our total revenue, from non-nuclear simulation; $2.1 million, or 5% of total revenue, from the training and engineering consulting services sector.

Our operating income was $877,000 for the nine months ended September 30, 2010, as compared with an operating income of $1.617 million for the nine months ended September 30 2009.

We generated net income of $271,000 for the nine months ended September 30, 2010, or $0.01 per share on both a basic and diluted basis, compared to net income of $1.362 million or $0.08 per share by both a basic and diluted basis for the nine months ended September 30, 2009.

During the first nine months of the year we had no borrowings against our revolving lines of credit with Bank of America. The lines are being used to collateralized standby letters of credit, which have been issued to customers as performance bonds.

At September 30, 2010, our available borrowing base under the lines of credit was $4.1 million.

The Company's cash balance at September 30, 2010, was $33.8 million. And after making payments of just over $8.5 million to our subcontract on our Slovakian nuclear power plant contract, our current cash balance is approximately $24 million.

GSE, as most of you know, 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. Again, the purpose and structure of the foreign exchange contracts that GSE has entered into are designed to protect the contract value and margins at the time the contracts are signed, and not designed to speculate on the direction of any currency up or down.

Keep in mind that the gain or loss reported due to these contracts will net out to zero at the time the contracts expire.

For the three months ended September 30, 2010, the Company incurred a $47,000 pretax non-cash gain on its foreign exchange contracts. For the nine months ended September 30, 2010, the Company incurred a $631,000 pretax non-cash loss on its foreign exchange contracts.

Our backlog as of September 30, 2010 was approximately $59.1 million compared to $53.9 million at the end of 2009. Backlog is defined as the remaining value of signed contracts, and does not including any value for contracts being negotiated or for contracts that have been signed since September 30, 2010.

Of the $59.1 million backlog, 83% was in the nuclear simulation sector, 14% in the nonnuclear sector, and 3% in the training and engineering consulting service sector.

While we were pleased with our increased revenue, strong backlog, and excellent liquidity, we are not satisfied with our operating and net income. The major contributors to the reduced income are the currency impact related to Slovakian contract, the continued low-margin revenue associated with the Mochovce project in Slovakia, increased business development, research and development, and management transition costs.

While winning the Mochovce project increased our revenue significantly, it obviously eroded our gross margin percentages due to the significant hardware portion of this contract, which had minimal margin.

Regardless of the percentages, the project has and continues to add margin dollars. While this project is expected to be completed in December of 2011, as you can see by our increased backlog we are replacing Mochovce with new projects at normal gross margin percentages. Therefore, it is reasonable to expect overall gross margin percentages and dollars to gradually increase.

Our increased expenses and business development and research and development are conscious decisions to grow the business and improve our technology. Now that the CEO transition is complete, the financial effect of that transition will be significantly reduced.

Now I would like to discuss some recent significant wins. On September 23, 2010, we announced the award of the second AP1000 nuclear power plant simulator in the United States. The contract value for the simulator being engineered and constructed for SCANA Corporation's V.C. Summer Plant site located in South Carolina came within our expected range for follow-on, highly standardized US plants of between $2 million and $4 million.

However, we expect the gross margin percentages on these standardized AP1000 plant simulator projects to be higher than our normal margins for exactly the same reason, and that is, the high level of standardization.

I want to make it clear that this lower price range and higher-margin expectation is for the domestic and Chinese AP1000 market. We expect to the AP1000 market work outside these countries will still be within our $6 million to $8 million range, with our historical margins of between 25% and 30%.

In our most recent press release we announced the award of $5.8 million of new work in our nuclear power simulation sector. Included in these awards were engineering services and simulator update projects in North America, Europe and Asia. Among the contracts are projects for simulation products and engineering services for various US government organizations, delivery of GSE's RELAP5-HD solution, and several sales of GSE's unique VPanel simulation platform.

The solid work of our research and development team put into our RELAP5-HD offering is really starting to pay off. It is becoming globally recognized as the industry's best solution for modeling reactor cores. And customers are purchasing the product not only to enhance their training simulators, but also to use with our engineering design, verification and validation V&V platforms.

Additionally, our VPanel products, which provides an extremely cost effective way for customers to train their operations staff, is gaining wide acceptance across our customer base. As I alluded to in the press release, a number of these awards are very strategic, and I believe it will positively affect our nuclear business well into the future.

Our technology is being recognized and selected by influential government entities. [SAMSA] said GSA is the standard by which all other offerings are judged. Also, we continue to pursue and win projects with strategic customers that we believe will make significant inroads into the nuclear industry in the years to come.

At this time I would like to provide an update on TAS. As you recall, on April 26, 2010, the Company announced the acquisition of TAS Holdings Ltd., a private company located in Stockton-on-Tees in the UK.

To refresh you on TAS, they are an engineering and consulting company specializing in electrical systems design, instrumentation and controls engineering, automation engineering and safety consultancy. Importantly, they also provide computer modeling services for major electrical generation and distribution systems.

The majority of TAS customers reside in the petroleum refining, oil and gas, chemical, petrochemical, and power industries. As we mentioned in our last call, since the acquisition GSE TAS' proposal activity has significantly increased in both the number of proposals developed, as well as their size. Additionally, their financial performance has modestly exceeded expectations.

More importantly, they have already begun working with traditional GSE business units supporting simulation projects. And they have received a letter of intent to proceed on phase one of a GBP1.1 million project that they would not have even bid on had they not been a part of GSE.

Next, I would like to cover some of our near and long-term goals and strategic initiatives. Organically we are focused on continuing to leverage our key strengthen in the global nuclear industry where we enjoy a commanding marketshare, as well as expanding our marketshare in the other energy markets, such as fossil, oil and gas, and establishing ourselves with offerings in the renewable space.

We continue to pursue replicating the success of our nuclear operated Jump Start program globally. Additionally, we are very focused on improving margins. We are looking at all aspects of our business to improve margins, including pricing, product execution, and the current level of expenses. I am confident that over time we will make significant progress in each of these areas.

Lastly, I would like to convey that our M&A program is very active, and our goal is to complete a significant acquisition in the next 12 months.

In closing, despite some weakness in our few of our financial metrics, largely due to things I consider transitory in nature, I am confident and optimistic about the Company's outlook as we head into 2011.

The management team and I understand the challenges and opportunities that lie in front of us, and we look forward to working hard to achieve the results we are capable of and that will create significant shareholder value.

Thank you for taking the time to listen to our presentation. I will now turn it over to Q&A.

(Operator Instructions). Mark Tobin, ROTH Capital Partners.

Thanks for taking my call. Quick, a couple of housekeeping questions first. First on the Slovakia project, how much hardware revenue did you recognize during the quarter, and how much is remaining on that project?

Sure. So in the quarter we recognized $3.58 million in revenue on that project. There was $3.4 million in Siemens DCS system costs. So what we have remaining to close out the project is approximately $10 million in backlog.

Is that total backlog or hardware related?

That is total. That would be total revenue.

Okay, do you know how much of that is hardware, how much of the $10 million?

I do. Approximately $5 million in hardware.

Okay, and then with TAS, how much revenue did TAS contribute during the third quarter here?

TAS contributed approximately $900,000 in revenue for the third quarter.

Great. One thing, strategically looking ahead, I briefly was able to go through the Q, but your China joint venture with UNIS, can you give us an update on what the status is and what your expectations are over the next 12 months or so?

I can. So things are a little slower than we had hoped in the joint venture. However, we expect that in 2011 we will start to see at least what we expected to see. And we believe that there is upside.

We are expecting to start with more than 100 engineers in the JV, which is up from original estimate. And we are working on a number of nuclear opportunities.

Okay, and how do you view the competitive situation in China? Are some of the nuclear companies trying to home grow some of their own simulation capability?

Yes, so far we view the landscape in a very positive way. There is a joint venture that was formed between Guangdong Nuclear and Western Services. However, one of the awards we have already announced is a V&V platform, and that is with Guangdong on the engineering side. So for the CPR1000 reactors we will have an offering and we will be able to compete.

And then also we currently are the only simulator provider in China who is executing AP1000. And we had a number of follow-on opportunities in the AP space.

Is there hope on the regulatory side within China that something similar to the US where they will actually require high fidelity simulation training as well as V&V for these new plants?

There are certainly discussions around that. China is taking, obviously, this situation very seriously. And they are reaching out to us, as well as other entities, looking into those types of regulations, but it is obviously extremely difficult for us to speculate on what the country will do.

Understood. Okay, I will jump back in the queue. Thanks again.

(Operator Instructions). Dick Ryan, Dougherty.

A question on the $5.8 million contract, and I don't recall, was that -- is that in the backlog of stated or is that in addition to?

All but about $1.4 million is in the backlog.

Sorry, $1.4 million --?

Is not in the backlog.

Okay. Just a housekeeping item on taxes, how should we view taxes going forward?

If you don't mind, I'm going to let Jeff handle that one.

Obviously, you can see when you look at the year-to-date taxes, the tax provision is $88,000, but if you remember in the first quarter, we had a $400,000 credit when we reversed the withholding tax accrual for our job with SINOPEC.

So right now we actually have a 135% tax rate year-to-date without that credit. That is because, again, the components of our taxes right now, the main items are coming from our Swedish subsidiary, which has about a 26% tax rate and foreign withholding taxes.

We are doing business in China, Canada, Mexico and Korea, all of which have withholding taxes when you provide services locally. Basically going into the fourth quarter we are basically -- you are going to be seeing basically the same kind of composition of our taxes, again, being driven by Sweden and our withholding taxes. So it is still likely that as a percent of pretax income we are still going to be around that 135% mark for the rest of the year.

Okay. Can you talk a little bit on the pipeline, Jim, opportunities, whether that is on the nuke side or the fossil side?

And maybe just kind of a follow-on on the training center. I don't think I heard any commentary that -- it looks like you had some pretty good experience with Southern Company. Is there opportunities to broaden that with them and with other utilities?

Sure. So the pipeline is very encouraging. Looking at nuclear and globally look at what we have proposed, as well as things that are identified opportunities but not proposed yet, and as well as in the nonnuclear space. What I find encouraging is when I look at what we have proposed in the nonnuclear space, as all of our investors know, we tend to have higher gross margins in our nonnuclear jobs. And in the proposal pipeline we have a significant significantly higher percentage than our normal 20%, 25% of nonnuclear work.

In the training space we have a number of opportunities. We are certainly talking -- as we announced, we have the second simulator job with SCANA. We are talking with them and they are certainly interested, but no decisions have been made. The thing about the Jump Start program, while we have some -- certainly some very encouraging results, we can't sell it to people who don't need a workforce.

So we are looking across the globe. Timing, the date that they expect to go critical, backing that up a number of years to where they would need a workforce, and actively pursuing that.

Additionally, the VPanel has really done well. We expect that will continue. It was introduced last year and it was an intra-budgetary timeframe for our customers. Now they have had an entire budget cycle to go through. We will be demonstrating the VPanel at the [Conte] show later this -- I'm sorry, early next year.

Later this year we are also going to be presenting at Westrain. And this is a significant event. 30 to 60 nuclear training managers will attend. As I understand it, we are the only service provider that will be presenting. And it was quite an honor to get that opportunity. We will be showing the VPanel, as well as making a presentation. And these are certainly the candidates or prospects that we would want to present this technology and opportunity to. So we are quite helpful that we are moving forward in all fronts.

We have training center opportunities. Of course, these are big, large projects, and typically have some political aspects. I am planning a trip early 2011 to the Middle East to pursue some of the existing training center opportunities.

Is there any update on the UAE or the Emirates?

Nothing of significance to report. We do continue to monitor and pulse that situation. As you know, financially we have not fully written-off, but we have taken the accrual to account for it. So if anything positive comes out, it will only be upside.

Okay, and he may have mentioned it, but I may have caught it wrong. But you mentioned -- did you mention Jump Start on the TAS side or the energy side of the house, your Jump Start opportunity?

Well, the Jump Start as mentioned was SCANA, would be the next possible US candidate, as obviously they are the next nuclear power plant being built. We are talking with the other nuclear power plants that are on the books in Texas. And recently the Bellefonte plant has announced that they are going to move forward with their -- one of their plants that was mothballed sometime ago. It was 88% complete, but they are going to finish with current design. So we are also talking with them.

Did you guys -- did GSE do the simulators for the Bellefonte 1 and 2?

Dick, I'm not sure. I can find out and get back to you on that.

Okay, good. All right, Jim, thanks.

Elias Moosa, Yerba Buena Group.

Good afternoon. I had a couple of questions. Could you clarify a little bit your China comments. Have you decided to take the AP1000 business, I guess not the Chinese derivatives, but the Westinghouse designs of AP1000 in China through the JV now?

No, if it is a Westinghouse AP1000 then it is excluded from the JV. So GSE would be able to pursue those ourselves. But the likelihood of Westinghouse AP1000 going forward is relatively small, because the Chinese -- and Westinghouse is working with the Chinese on coming up with a Chinese version of the AP1000, which would be the CAP1000. Beyond that, they are looking at a CAP1400 and a CAP1700. And those would be done through the joint venture.

I understand. Now there are though some AP1000s in the construction pipeline in China right now, other than Haiyang and Sanmen, isn't that not the case, or do you expect to do work for those?

The ones we have seen haven't been in construction, but they have -- some of the other smaller power producers did select AP1000 as their technology. In that case if they do progress and move forward with Westinghouse then we would certainly be doing that work. If, of course, once the CAP version is available, and we expect that would be at a much lower cost, there is the potential because of the long lead time in the pipeline that they would change their mind. Either way, we believe that we are very well positioned to win many -- a very large percentage of the AP or the CAP designs.

Would those fall under the agreement you have with Westinghouse where they would provide the front end of the simulator or would they not?

If it is a true AP1000 design, then yes. If it is the CAP, then no.

I see. Is that new -- something new that was negotiated that if it was a true AP1000 design it would fall under the Westinghouse agreement? I was not -- I thought it was previously had only applied to the US AP1000.

No, that is not new. That is existing.

Got you. Okay. And a question for Jeff the OpEx front. You guys have indicated that some of the costs might not be repeated here in the near term. Could you give us a better idea of what OpEx is looking like here in the fourth quarter by any chance?

Well, so far obviously we have been watching the rates. We hedge when we think it is appropriate. We also try to monitor if we have offsetting internal hedges, receivable versus payables, and try to make decisions based on our overall picture. We have been -- obviously, when we look at currency we also deal with Bank of America, who also tries to give us their input as to where the rates are going.

At this point for the quarter certainly things had been much calmer than they were in the second and third quarter. We are, especially, of course, sensitive to the euro with the contract that we have with Mochovce. So at this point I can only tell you that it appears, at least so far this quarter, that we haven't seen much volatility compared to the last two quarters.

I guess I was wondering more about the operational expenses, R&D and SG&A, not just the Forex exposure. Just if you have some visibility into what you're going to spend for OpEx in the fourth quarter?

What we're going to spend for -- I'm sorry, OpEx?

Yes, OpEx.

Operational, yes, SG&A, R&D, salaries, things like that, just the total operational expense number.

Basically the only real variable we have going forward right now we believe is our acquisition expenses, depending on what kind of activity we have there. The run rate that you have seen so far this year probably will be certainly going into the fourth quarter with that one variable.

Just to clarify, a significant component of the variation from, say, third-quarter OpEx this year to third-quarter of '09 is the acquisition of TAS. So if you just compare there is a $602,000 difference in total operating expenses year-over-year, approximately $300,000 of that is associated with TAS.

Please keep in mind also this year in this quarter we hosted our Simworld users conference in Sweden. That was approximately $120,000. And there was the conscious decision by the Company over the past almost year to bring on four business development assets. And if you look at [Berton] salaries, so the combination is about $250,000. So between TAS of about $300,000, about $250,000 was somewhere up in the [hires, 500, 600,] that almost wipes out the difference between last year and this year.

Got it. Okay, thanks.

(Operator Instructions). There are no further questions. I will turn the conference back over to management for any closing or additional comments.

Well, thank you everyone for dialing in with your questions. And I look forward to our year-end call.

Ladies and gentlemen, that does conclude today's conference. We thank you for your participation.