GSE Systems Inc (GVP) 2011 Q1 法說會逐字稿

Greetings and welcome to the GSE Systems First-Quarter 2011 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation.

(Operator Instructions)

As a reminder, this Conference is being recorded. It is now my pleasure to introduce your host, Mr. Devin Sullivan, Senior Vice President for the Equity Group. Thank you Mr. Sullivan, you may begin.

Thank you Manny, and good afternoon everyone. Thank you for joining us today.

Before we begin, I'd like to remind everyone that statements made during the course of this call may be considered 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. These statements reflect our current expectations concerning future events and results. Words such as expect, intent, believe, may, will, should, could, anticipate, and similar expressions are words that are used to identify forward-looking statements, but their absence does not mean a statement is not forward-looking. These statements are not guarantees of future performance and are subject to risks and uncertainties, and other important factors that could cause actual performance or achievements to be materially different from those projected.

For full discussion of these risks, uncertainties and factors, you're encouraged to read GSE's documents on file with the Securities and Exchange Commission, including those set forth in periodic reports filed under the Forward-Looking Statements and Risk Factors section. GSE does not intend to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

Now I'd like to turn the call over to Mr. Jim Eberle, Chief Executive Officer of GSE Systems. Please go ahead, Jim.

Good afternoon. I'd like to welcome each of you to GSE Systems 2011 First-Quarter Conference Call. I'm joined today by our CFO, Jeff Hough, and Larry Gordon, our Senior Vice President and General Counsel.

This afternoon we issued a release covering our financial results for the first quarter, and $5.3 million in new contract wins. I'll make my prepared remarks brief so we can get right to your questions.

We are encouraged by our results for the first quarter, and our continuing success in winning new business. These developments not only reflect the health of GSE during some challenging times, but as importantly, validate our belief that the results in the fourth quarter of 2010 were truly an aberration.

Challenges remain, specifically, the expected lingering negative margin impact in 2011 associated with the large overseas energy customer, which is close to being resolved, and the simulation project in Slovakia, due to the significant hardware portion of this contract. These projects are expected to wind down by the first quarter of 2012, and we expect that their impact will, to some extent, be offset by new business we have won and expect to win throughout 2011.

Year to date, and taking into account today's announcement, we have won approximate $15 million in new contracts in 2011.

Revenue in the first quarter of 2011 rose to $12.3 million, up from $11.2 million in the first quarter of 2010, driven by the acquisitions of TAS Engineering Consultants and GSE Envision, formerly known as EnVision Systems.

Gross profit improved on both a dollar basis and as a percentage of revenue, due to higher total revenue, and a $500,000 decline in revenue associated with the Slovakian project. In the first quarter of 2011, Slovakian revenue comprised 14.2% of total revenue, as compared to 19.9% of total revenue in the first quarter of 2010.

As previously reported, this $23.8 million project carries a lower margin, because of the impact associated with the $16.4 million hardware portion of the contract, the largest portion of which is a Siemens digital control system.

Excluding approximate $200,000 of non-recurring acquisition-related costs, we had a modest operating loss in the first quarter of 2011 of just under $100,000, compared to operating income of about $450,000 in the first quarter of 2010, driven primarily by a $1.1 million increase in operating expenses.

The initial increase is due to $773,000 of operating expenses incurred by the recently acquired tax engineering consultants and GSE EnVision, including charges of $146,000 due to the change in the fair value of the contingent liabilities related to these acquisitions, and $217,000 from amortization of the intangible assets acquired, a $197,000 increase in business development costs, a $100,000 increase in costs incurred related to acquisition efforts, and approximately $50,000 for the creation of a 3-D visualization team to develop gaming features to enhance GSE's training solution.

I'll take a minute to discuss the 3-D team we've assembled. Case studies demonstrate that the inclusion of quote-unquote serious gaming technologies, such as immersive 3-D 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 their curriculum. Due to the advancement of computer processing power and graphics technology, immersive 3-D game engines are readily available off the shelf at commercially viable prices. Additionally, this style of learning lends itself to the next generation workforce, and as such, GSE is investing significantly in 3-D visualization.

This investment comes in the form of strategic hires, research and development, and investment in technology. Through research and development efforts already undertaken, GSE's engineers have discovered how to link our industry-leading, high-fidelity models to commercial 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 3-D visualization will allow GSE to provide the energy industry with better, faster, less-costly training, ideally suited for the next-generation workforce. We expect modest revenues from 3-D visualization sales in 2011, and we expect to scale dramatically over the coming years.

A $600,000 gain on derivative instruments resulted in a pre-tax income of approximately $400,000, as compared to pre-tax income of about $166,000 in last years first quarter, which included a $300,000 loss on derivative instruments

The benefit for income taxes in Q1 2011 was $600,000, compared to a benefit of about $300,000 in the first quarter of 2010. In conjunction with the acquisition of EnVision Systems in January 2011, GSE recorded deferred tax liabilities of $1 million. This reduced the consolidated US net deferred tax asset by $1 million. As the Company had a full valuation allowance on its US net deferred tax assets prior to the acquisition, the Company reduced the valuation allowance by $1 million in the first quarter of 2011.

Higher revenue, improved gross margin, a gain on derivative instruments, and an income tax benefit combined to produce net earnings of $1 million, or $0.05 per basic and diluted share, compared to net income of $400,000, or $0.02 per basic and diluted share in the first quarter of 2010.

Moving to the balance sheet, the Company's cash balance at March 31, 2011, was $19.5 million, or $1 per diluted share, as compared to $26.6 million, or $1.40 per diluted share at December 31, 2010. The change was primarily attributable to the use of approximately $1.2 million of cash in the first quarter of 2011 related to the acquisition of EnVision, as well as $3.5 million, which was used to cash collateralize standby letters of credit, which are used as performance bonds on several projects. The cash collateralization of these standby letters of credit was required as part of the changes to our credit facility, as previously announced. The cash collateral is included in the restricted cash captions on our balance sheet.

At March 31, 2011, we had a total of $4.5 million of restricted cash. The remainder of difference in cash was due to normal working capital fluctuations.

I'll remind everyone that with nearly $20 million of unrestricted cash and zero long-term debt, along with forecasted positive cash flow, we are comfortable in our ability to meet our liquidity and working capital needs for the next 12 months, as well as pursue our acquisition strategy.

Backlog at March 31, 2011, was $57 million, up from $55.9 million at December 31, 2010. Not included in backlog at March 31, 2011, was approximately $5.3 million of new contracts awarded subsequent to quarter end. Backlog at March 31, 2011, did include approximately $8.1 million of backlog associated with work at two reactors in Japan, of which we expect approximately $4 million to translate into revenue in the balance of 2011.

I'd like to segue from the Japanese backlog to address the larger issues of the vitality and viability of the nuclear industry. Much of a narrative in the marketplace is being formed by the events at the Fukushima Daiichi nuclear plant in Japan, perhaps understandably so.

First, and as we have stated previously, what the Japanese are dealing with is well beyond the design specifications of the plant. And yet, while events are continuing to unfold, they also appear to be stabilizing, which is good news for the people of Japan.

At this time, none of our ongoing nuclear simulator projects have been postponed or delayed in the wake of this tragedy. The Japanese government recently announced it will continue to rely on nuclear power for its energy needs, despite the tragedy. We believe that this is in large part due to the fact that nuclear energy provides more than one-third of Japan's electricity. We also understand that the NRC should, by the end of this month, be in a position to provide an initial assessment of the condition of the 104 US reactors, with respect to the systems that would be affected by a Fukushima-like incident.

From our perspective, what happened at Fukushima proves how critical training is, and nothing is more effective for training than simulation. We are currently reviewing and evaluating a number of potential solutions to address the training and simulation needs arising from the events at Fukushima Daiichi. We expect to be in a better position to begin pursuing these ideas in the weeks and months following the NRC's comments.

I also want to point to comments made last week by Microsoft's Bill Gates regarding nuclear power. Mr. Gates was speaking at Wired Magazine's Third Annual Business Conference. He noted that one of the best aspects of nuclear power at the moment, is its lack of innovation thus far, which leaves it ripe for disruption in the coming years. In Mr. Gates' world, and ours, disruption is a good thing. As Mr. Gates correctly noted, the Fukushima plants are older second-generation reactors. Third-generation plants, as well as upcoming fourth-generation plants can readily avoid many of the issues that doomed the Fukushima reactors, because they can effectively address the decay heat that results after a nuclear plant shuts down.

With nuclear energy generating 20% of the global and US electricity, and turmoil in the Middle East continuing, we believe that nuclear power is here to stay. Mr. Gates predicts that by 2030, hundreds of new fourth-generation nuclear power plants will be online. For those of you who might not know what a generation four reactor is, it is a set of theoretical nuclear reactor designs currently being researched. Relative to current nuclear power plant technology, claimed benefits for the fourth-generation reactors include nuclear waste that lasts a few centuries instead of millennia, 100 to 300 times more energy yield from the same amount of nuclear fuel, the ability to consume existing nuclear waste in the production of electricity, and improved operating safety. These plants aren't expected to be available for commercial construction for at least a decade.

Most relevant to GSE, Mr. Gates also discussed software simulation, which helps new plants prepare for potential issues like the post-quake tsunami that shut down Fukushima. He said that computer simulation is necessary because there is quote no way humans can predict these things, unquote. We couldn't agree more.

In closing, I'd like to remind everyone that well before the Japanese natural disaster occurred, we took steps to broaden our sphere of operations. In the first quarter of 2011, approximately 37% of our revenue was generated from non-nuclear projects, compared to 24% in the first quarter of 2010. While proud of our heritage, we are more than a nuclear software simulation company. Our mission is broader, and involves servicing the workforce development needs of the entire energy world, including fossil, oil and gas, and alternate energies.

We appreciate your time today and would now be happy to take your questions. Operator, please go ahead.

Thank you.

(Operator Instructions)

Our first question is from the line of Mark Tobin with Roth Capital Partners. Please go ahead.

Hello, thanks for taking my question.

Sure thing, Mark.

A couple of things, more on the housekeeping side. One, with Mochovce, how much revenue is remaining on that contract? How much of it is hardware, and when do you expect that to be recognized?

Okay. Mark, at the close of the first quarter, we have approximately $6.1 million of backlog remaining on that job. Approximately $2.7 million of that is associated with the equipment, and we expect about $1.5 million of that $6.1 million to actually be generated in the first quarter of 2012. Our current expectation is that project will be completed in the first quarter of 2012.

Okay, then how about with that $1.5 million that goes into 2012, would that also include some hardware revenue as well?

Yes. We accrue those expected hardware costs, so yes, we expect some.

Okay, from a modeling standpoint, is best for us to just look at the $2.7 million and spread it over the next four quarters?

Yes, that's correct.

Okay. Secondly, on the other negative margin project, you had made reference to being close to resolution, can you give us a little more color on that, and what type of impact and timing you expect?

Yes, absolutely. Things have become, certainly, much clearer since the last call. We have an agreement in principle with the utility as to scope, schedule, as well as the amount of the change order. What we are working on now is negotiating the final language of the, essentially, legal agreement. In spirit, we have an agreement. At the project level we have agreement, so right now we're wrapping up what I would characterize as sort of T's and C's associated with that agreement.

What you can expect there is approximately $3.2 million of revenue remaining on that job, approximately $1 million of which will be generated in the first quarter of 2012. We expect that job also to wrap up in the first quarter of 2012.

Okay. These change orders that you're definitizing, does that bring it to your standard margin, or that brings its to zero margin?

Unfortunately, it brings it to a less negative margin from where we were. So I would, based on our agreement in principle, I would expect a small pick-up in the second quarter. This is due to when we closed the fourth quarter, we had what we believed the resolution would be, or the agreement on the change order amount, and through negotiations we were able to increase that modestly. Based on the difference between what we took in the fourth quarter, and what we expect the final agreement to be, we would expect a small pick-up in the second quarter.

Okay. That makes sense. And then the 3-D team that you've added, what's the timing of that, and is that reflected in your SG&A run rate here in Q1, or is that more incremental to what we're seeing?

The way the team started was a single strategic hire of a previous business owner who had his own Company doing this that was bought by a much larger Company endeavoring in this space, basically using 3-D gaming technology for military training. And when he became available, it also came at the point that we as GSE felt that this was going to be an important part of our strategy moving forward, to leverage it for training solutions.

So we made the strategic hire of this gentleman, and through part of the end of the fourth quarter, as well as into the first quarter, that gentleman worked with our R&D team to generate demonstration models that we could essentially take around the world to customers, also present at conferences, to essentially validate our study that this would be not only interesting, but would be a revenue-generating opportunity, at significantly higher margins than our normal simulation business.

After that was validated, then we moved forward, actually recently, with hiring a small team of artists and developers. So the idea is -- so what you see in the first quarter is a small amount, approximately $50,000, of investment into that team. Going forward, we will see an increase there, because we have validated the business case. As I mentioned, we expect modest revenue in this year, but we definitely expect to sell jobs this year, and we expect to scale it in the coming years.

Got it. Then final question, did you re-purchase any shares during the quarter?

We did not. We were in a blackout, from the time that we made the announcement, and actually through May 15 of this month, is that correct?

Two days from now.

Two days from now, I apologize. Two days from now, we were in a blackout.

Okay. I jump back in the queue. Thank you very much.

Thanks Mark.

(Operator Instructions)

Our next question is from the line of Dick Ryan with Dougherty. Please go ahead.

Good afternoon, Jim.

Good afternoon, Dick.

Question on -- I didn't catch it, you gave a number for either non-nuke or nuke of the business for Q1 versus a year ago, I didn't catch this quarter.

Sure. It was 37% non-nuclear for the first quarter of 2011, as compared to 24% in Q1 of 2010.

Okay, how does that relate to backlog, the breakdown nuke versus non-nuke?

Nuclear's still around 85% of the backlog.

Okay. Jim, in Japan they've shut down a good chunk of reactors. Can you talk about whether your business there that you think will flow through is with facilities that are still up and running, or have they been shutdown?

Yes, our -- we don't expect any -- from the beginning of the accident until today, through all of our conversations with customers, we still have no indication that our backlog nor our revenue generation are in jeopardy. So that is where we are today.

Okay. Can you talk a little bit about training Center? What you're seeing there? Also you highlighted some growth in your small modular reactor program, can you hit those two points for me?

Sure. So the jumpstart program is continuing as we have been. We will be executing the next class shortly. We remain at 100% pass rate on the NRC GFES. So the validation of the classroom training, combined with simulation reinforcement in the class, driving a shorter duration to teach the concepts as well as the retention, continues to be validated. We continue to pursue the jump-start program globally. All the places that you would think a jump-start program would be desirable, we are talking to. And as I mentioned several times, with training you can't sell training before the prospective customer realizes they need training.

How many classes have you put through Southern at this point?

At this point, we've completed five, we're completing number six, and number seven begins in the summer.

Okay, great. And the small modular reactor program?

Yes, as you saw in the press release, part of that $5.3 million of new work was the award of a full-scope simulator. It is an engineering simulator. It's one of the light water, small-module reactors. It will be a phased project, and we're real excited about our continued wins in the small-modular space. As I mentioned several times, we believe that is going to be an important part of the nuclear industry in the future, and also lends itself to GSE lengthening our list of first-of-a-kind projects, which the way I look at that is, when customers want a low-risk solution, they come to us.

Great. Thanks, Jim.

Sure.

Thank you. We have no one else in queue at this time. I would like to turn the floor back over to Management for closing comments.

Okay. Thank you everyone for attending. Thank you for the questions and the interest, and I hope to see some of you at the Benchmark Conference on Thursday. Have a good afternoon.

Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.