GSE Systems Inc (GVP) 2019 Q1 法說會逐字稿

Greetings, and welcome to the GSE Systems First Quarter 2019 Financial Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Kalle Ahl with The Equity Group.

Thank you, Kevin, and good afternoon, everyone. Thank you for joining us today. Before we begin, I would 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 Act of 1934.

These statements reflect current expectations concerning future events and results. Words such as expect, intend, 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 a full discussion of these risks, uncertainties and factors, you are 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.

On this call, management may refer to EBITDA, adjusted EBITDA, adjusted net income and adjusted EPS, which are not measures of financial performance under generally accepted accounting principles or GAAP. Management believes that these non-GAAP figures, in addition to other GAAP measures, provide meaningful supplemental information regarding the company's operational performance. Management uses these non-GAAP measures to evaluate the performance of GSE's business and to make certain operating decisions such as budgeting, planning, employee compensation and resource allocation.

This information facilitates management's internal comparisons to GSE's historical operating results as well as the operating results of its competitors. Since management finds these measures useful, GSE believes that investors may benefit by evaluating both GAAP and non-GAAP results. Investors should recognize that these non-GAAP figures might not be comparable to similarly titled measures of other companies. These measures should be considered in addition to and not as a substitute for or superior to any measure of performance prepared in accordance with GAAP. A reconciliation of non-GAAP measures to their most directly comparable GAAP measures in accordance with SEC Regulation G can be found in the company's earnings release.

I'd now like to turn the call over to Mr. Kyle Loudermilk, Chief Executive Officer of GSE systems. Kyle, please go ahead.

Thank you, Kalle. I'd like to welcome everyone to GSE Systems' First Quarter 2019 Financial Results Conference Call. Also on today's call are Chris Sorrells, our Chief Operating Officer; and Emmett Pepe, our Chief Financial Officer.

Earlier today, we issued a press release covering our first quarter 2019 financial results. Hopefully, you've had a chance to review this news release. But if you have not, the copy can be found on our website at www.gses.com under the News section.

We reported revenue of $22.2 million, which was slightly below our revenue of $22.9 million in Q1 2018. Adjusted EBITDA was $0.2 million, down from $0.8 million in prior year quarter. We're disappointed in these results, which were impacted by unusual items related to the timing of projects in both of our business segments; heavier OpEx in the quarter related to higher accounting and consulting costs; the added SG&A costs of our DP acquisition; as well as customer issue at DP Engineering, which we acquired in February 2019. The revenue in orders, Q1 is traditionally a weaker quarter for the year for GSE, and this quarter was no exception.

As we have shared in the past, quarter-to-quarter fluctuations should be expected given the lumpy nature of our business and typical quarterly puts and takes. That certainly was the case this quarter.

In our Performance Solutions segment, Q1 revenue from DP Engineering was lower than expected due to the unanticipated customer issue, and Q1 revenue from True North declined after a great Q4 2018. Historically, True North is stronger in the second half of the year, so this is not entirely surprising.

On a positive note, our simulation business had a solid Q1. This quarter, we essentially completed the significant full-scope simulator project for a southern nuclear utility operator that, all told, accounted for nearly $30 million in Performance Solutions backlog being burned down since March 2016.

In our NITC segment, we continue to deliver effective staff augmentation services with 2 major customers concluding large staff augmentation projects heading into Q1. By all indications, our clients are delighted with our work product which is significant.

With the completion of these projects, we had a larger-than-normal revenue gap to fill in the quarter and the RFP flow didn't quite get us there. Capturing new business more quickly is a keen area of focus for us. In NITC, we typically experienced a stronger second half of the year, and we will work to ensure that is the case in 2019.

The fundamentals of our end markets remain solid as the nuclear power industry continues to invest for safety, operational reliability, extension of plant life and performance improvement to generate more power from existing assets.

We are taking decisive actions to increase new order flow and backlog in the coming quarters. For market opportunities that look promising, we have added 2 salespeople since the beginning of the year to pursue and capture business. While early, we feel they're off to a good start and we should see solid business from them in ensuing quarters.

We also are positioning GSE effectively with our customers as one company offering a broad array of services. This has helped us elevate our discussions beyond the shop floor to executive budget holders, and we are gaining traction in these efforts.

It is our experience that, with time, this effort will yield solid results for GSE as we deliver greater value to our customers as a comprehensive solutions provider.

At the end of Q1, our backlog was $69 million. Despite the burn-down of the $30 million project for the southern nuclear utility customer, our backlog as of the end of Q1 is essentially unchanged from the backlog shortly after booking the large order in Q1 2016. This is an encouraging sign that our strategy of building a diversified solutions portfolio for nuclear will lead to a sustainable business serving the industry for the long term.

Our business in Q1 was really a series of meat and potato deals without any major deal -- swing deals such as full-scope simulator projects, which are episodic in nature. We had nice wins across our customer base for NITC and Performance Solutions with a solid pipeline of similar opportunities for us to capture moving forward.

We are not aware of losing any significant deals, and we are poised to aggressively pursue and capture those that may develop while continuously capturing and delivering on the essential stream of projects that reflect the current state of the industry.

Returning to DP. The acquisition increased our first quarter SG&A expense with limited contribution to revenue as we worked through a customer issue arising from pre-acquisition design modification work that required us to record a noncash impairment of $5.4 million. We believe the extraordinary customer issue at DP led to an approximate $600,000 negative swing in this quarter's EBITDA. We are focusing on addressing the issue for the customer and ensuring we continue to provide DP's essential capabilities to the market.

Since acquiring DP, we have been highly engaged with the customer to ensure the projects we are delivering fully delight them and we rebuild their trust. DP has had positive developments elsewhere, including receiving an invitation to bid on an EOC contract as a significant alliance of operators and recently becoming an approved supplier to provide engineering services to a significant equipment provider for the nuclear industry. GSE will work diligently to win new DP business that arises from these opportunities. We've also had effective cross-selling meetings with our respective customers. Chris will provide additional color on DP a bit later in the call.

We believe that the first quarter is not indicative of the earnings capacity of GSE due to these unusual items and the general seasonal weakness at the start of the year. We remain incredibly enthusiastic about GSE's position and the dynamic vendor ecosystem that serves the nuclear power market, which is increasingly recognized in the U.S. and throughout the world as a critical source of carbon-free baseload power.

We have constructed a strategic set of assets, an extraordinarily talented employee base, specialized technologies that, I believe, are second to none in the industry. As always, we are committed to operating our assets as leanly as possible while focusing on winning new projects and delivering efficiently as we go. Through operational focus, we've created optionality for our business, and our focus will continue on this.

I'll now turn over the call to Chris Sorrells, our COO. Chris, please go ahead.

Thanks, Kyle. I'll begin with an update on DP Engineering. As previously disclosed, following the acquisition of DP, an event occurred at a customer location that affected plant operations. After that event, the customer initially suspended DP's ongoing work on projects. At the time of our last earnings call, approximately 25% of the impacted projects had been restarted at the request of the customer. As of today, essentially 100% of the projects have restarted, and we are working through several months of existing backlog related to this customer. Although the customer authorized DP to resume work on virtually all existing projects, the customer informed DP that it would be prohibited from receiving new projects until DP and the customer completed their causal analyses. Both DP and the customer have now completed their respective causal analyses, and GSE now understands that the customer has indicated that future awards will be suspended for up to 6 months or until September 2019. Up to is key here.

GSE and DP are working to get the customer relationship back on track as quickly as possible. We took swift action to properly align the DP workforce to the current business. After concluding that a triggering event occurred in the first quarter, which required us to test for an impairment, we analyzed the fair value of the asset.

As a result of that analysis, we recognized a material impairment to the intangibles and goodwill associated with the acquisition of DP. The timing of the testing of the impairment was based on a conservative assessment of the events that triggered the suspension and available GAAP guidance. We believe DP will be a drag on GSE's overall performance in both the second and third, and then we anticipate the new work orders will ramp back up in the fourth quarter. Notwithstanding the short-term financial impact of this new work suspension, we remain enthusiastic about the expertise that DP brings to GSE for the long term, including a core competence and nuclear facility outage work, which takes place approximately every 18 months.

In a normalized scenario, we believe DP will enhance our gross margin and free cash flow generation profile. GSE strives to provide clients with the highest standards of service, quality, safety and effectiveness. After learning more from DP and the customer about issues surrounding this design modification project, we took decisive corrective action to enhance related internal processes, controls, communications and staff alignment. We continue to be an engineer of choice for this long-standing client and are committed to providing them and all of our valued clients with superior work and maintaining a strong relationship. In fact, in April, we completed another design modification project for this customer and received a rare perfect score of 100% on their internal quality review scoresheet. Our DP business, meanwhile, continues to diversify its customer base and business mix consistent with our original acquisition thesis.

Let me take a minute to comment on our acquisitions to date and a review on our M&A strategy. We acquired 3 companies during the past 3 years: Absolute Consulting, True North and DP. The overall results have been good, as reflected in nearly a doubling of GSE's revenue and a roughly 50% increase in adjusted EBITDA from 2016 to 2018.

Our share price over this time frame has not responded as much as we would have liked given our progress and positioning GSE as a value-creating acquisition platform. Our thesis has been to identify and pursue compelling opportunities in the fragmented vendor ecosystem serving the global power industry. We continue to see ample pipeline of attractive targets in our core areas.

Our Vision 2020 goals of over $200 million in revenue and $20 million of adjusted EBITDA on an annual run rate basis by the end of 2020 assumes that we can secure capital necessary to close deals in a way that does not jeopardize shareholder value.

However, as is always the case, management continuously assesses the strategy and makes decisions necessary to ensure that we maintain optionality for our business, allowing us to maximize shareholder value. We pay close attention to and assess the decisions we make, the effectiveness of those decisions and develop options for our path forward to ensure that we serve our customers, employees and shareholders well.

Now moving on to some favorable industry policy developments. At the state level, on April 12, Ohio lawmakers introduced a clean energy bill, HB 6, that would create the Ohio clean air program and provide clean energy credits to 0 emission power producers, including nuke.

Furthermore, on April 15, the U.S. Supreme Court let stand appellate court decisions in Illinois and New York, upholding the state's 0 emission credit policies and affirming state's rights to favor clean energy, including nuke, over carbon-based sources.

On April 19, New Jersey regulators approved 0 emissions credits totaling $300 million for all 3 of the state's nuclear reactors, supporting the state's goal of boosting the use of carbon-free resources to over 50% in the next decade.

These policy developments make sense when you consider that nuke leads the way and CO2 emissions avoided by the U.S. power industry. According to NEI, nuclear energy represents approximately 55% of emissions-free electricity fuel in the U.S. and avoids nearly 530 metric tons of carbon emissions every year.

Finally, briefly on the international front, China announced in March that it plans to invest $12 billion in new reactors, with construction on 4 reactors commencing in June.

With that, I'd like to turn it over to Emmett, who will review the first quarter financial results.

Thank you, Chris. Total revenue in first quarter of '19 totaled $22.2 million compared to $22.9 million in first quarter of 2018, reflecting $2.3 million increase in our performance improvement segment revenue, which is more than offset by a $3 million decrease in our NITC segment revenue. The increase in performance improvement revenue was driven by our acquisition of True North in Q2 of 2018 and DP engineering in Q1 of this year, which together contributed $3.7 million to this quarter's revenue, partially offset by a decrease of $1.2 million related to the completion of the major full-scope simulator project in Q1 of 2019. The decline in NITC revenue was primarily due to the lower staff augmentation needs from 2 major customers.

Gross profit in Q1 of '19 totaled $4.7 million compared to $4.9 million in Q1 of 2018. Performance improvement gross profit improved by approximately $400,000 to $3.7 million, primarily driven by the acquisitions of True North and DP Engineering as well as significant cost savings realized on certain major simulator projects. The significant cost savings on percentage of completion projects allowed us to capture additional margin on work completed in prior quarters.

The NITC segment's gross profit decreased approximately $600,000 year-over-year, due primarily to the decrease in revenues and a higher mix of lower-margin projects.

SG&A expenses decreased to $4.4 million in Q1 of '19 from $4.5 million in Q1 of 2018. The slight decrease was primarily due to $1.2 million of noncash change in the fair value of contingent consideration and $500,000 of savings as a result of our international restructuring plan, along with corporate cost-savings initiatives, offset by $1 million of additional G&A expenses related to our acquisitions of True North and DP Engineering and $600,000 of acquisition deal costs.

As a reminder, the first quarter of the year tends to be GSE's seasonally weakest quarter. Significant audit, tax, consulting fees for year-end work required of publicly traded companies contributed to this weakness.

In Q1 of 2019, following an event at DP Engineering's customer location and subsequent notice from the customer that the company would be suspended from receiving new orders for an indeterminate period, we recorded a noncash impairment charge of approximately $5.4 million to lower the carrying amount of goodwill and intangible assets related to the acquisition of DP Engineering in accordance with U.S. GAAP accounting rules. As Chris mentioned, we have restarted most of the work at our existing client and are cautiously optimistic that new work orders will resume as soon as Q4 2019.

Non-GAAP adjusted EBITDA, as defined in our earnings release, totaled approximately $200,000 in Q1 '19 compared to approximately $800,000 in Q1 2018. We concluded the first quarter with a cash position of $11.3 million and total debt of $22.1 million.

I'll now turn the conversation back to Kyle.

Thanks, Emmett. Operator, please open the floor for questions.

(Operator Instructions) Our first question today is coming from Josh Vogel from Sidoti & Company.

My first question is, Chris, I know you mentioned that there's still ample opportunities on the acquisition front, but I was just curious with as you navigate through DP, does this kind of put on hold any acquisition plans? I know you're still very diligent on that front, but does it kind of divert your attention away from doing something in the near term?

So at this time, we and the Board have not altered anything related to Vision 2020. We continue to evaluate the options around our M&A activities. We do see a pipeline of attractive acquisitions. That has not changed. That being said, we're constantly reviewing the activity. We're assessing outcomes and the decision-making process that led to those outcomes. So it's evolving. I think we indicated in the script pretty clearly, we take the shareholder value part very serious. And anything we do, we're going to use that prism to really make decisions, be it dilution, debt or risk.

Okay. I appreciate the insight there. I just want to make sure I'm reading this right. In the press release, you mentioned the conclusion of 2 significant projects in the NITC segment, but also that there were lower staff augmentation needs from 2 major customers. Was that basically you're expecting the conclusion of these projects but the lower needs by these clients were not expected?

This is Kyle. I'll take that, Josh. They're one and the same. These customers -- NITC is a timing material business. There were 2 contracts, so 2 particular customers, that had a particular duration, during which NITC was billing against those contracts and those contracts came to a conclusion.

And so that was fully expected. No surprises. We, obviously, have been working hard to backfill the revenue and backlog associated with that. But the RFPs across the entirety of the business could not make up for the full-term natural expiry, I should say, natural conclusion of those 2 deals, those 2 contracts.

Okay. Got it. Looking at the new orders that totaled $14.4 million, down from a year ago. I was curious, was there anything of note in the year-ago quarter that inflated that number? And can you maybe talk to where that $14.4 million number compares to your other historical first quarters?

Just give me a moment here, Josh. Let's see. Yes. If you look back over the prior few years, obviously, 2016, we had a $30 million order drop into that quarter. If you take that out, we had roughly a $10 million quarter. $20 million in Q1 of 2016 in orders -- excuse me, in 2017 in orders, and 2018 was $24 million. As we highlighted, this year, $14 million. So you can see it went from roughly, call it, excluding that onetime episodic significant order, went from $10 million to $19 million to $24 million to $14 million. So that's not uncommon.

And as we said, we didn't have any one of these large episodic full-scope simulators in the quarter so that certainly would account for some of that. But I don't have the deal breakdown, Josh, in last year's Q1 2018. My sense is to the scale of it, there were obviously some significant orders in there. I just don't recall them off the top of my head.

Okay. No worries. And Chris, you mentioned that there is a big investment that China is going to put into nuclear. I was wondering, do you think you can capture some of that opportunity? And maybe just on a slight tangent, just from a more macro standpoint, do the ongoing negotiations with China around tariffs, does that have any fallout on your business or your prospects of doing business there?

Kyle, do you want me to answer that?

Yes. I mean he directed it to you, Chris, but maybe I can take it, Chris. Josh, for China, so far at least, we haven't seen an effective tariffs affecting our business, deal flow and suspended deal flow, current activities with our office in Beijing. For those that maybe new to this call, GSE does have an office in Beijing. It's been there for, I think, over 20 years. And we do serve the Chinese market uniquely from that office with some support from the United States as appropriate. So the tariffs really haven't affected our business at all, Josh. So that's at least so far, and we're not anticipating any major effects.

With that said, so far as serving the China market, we have had a historical steady Eddie business in China. We're continuing that. We usually help out with 1 of the 3 nuclear power operators within China. And to the extent they need us for support, we work with them as well as other U.S. vendors serving that market appropriately.

Okay. And just one last one. Obviously, some really encouraging developments on the policy front. I actually read a report today about some contaminants that leaked from a diffusion plant in Ohio. And obviously, this is very fresh news, and I believe one of your competitors is a lead contractor to that plant. But does that potentially -- could that hurt the legislation that the Ohio government put into place? Or do you have any thoughts around that news today?

Obviously, we -- it just broke today. We don't have a lot of thinking on that, Josh. I'd have to look at who the producer is and see how this plays out. But I think you said diffuser. Did I hear that correctly?

It was a diffusion plant. I can -- off-line I could follow up. I could send you the link that I read about it. But it was the Portsmouth Gaseous Diffusion Plant.

Yes. So that is a -- this is separate, the nuclear power production, so that's just not a market we serve. But again, it's too early to say. I'd be surprised if it affected the plants and zero-carbon because gas diffusion is not the same as energy production.

Sure. Okay. I was just -- yes, I was just discussion around like contaminants that were released and I just wasn't sure if maybe the Ohio government would kind of put their brakes on that type of work. But okay. That's all I have right now.

(Operator Instructions) Our next question is coming from Tate Sullivan from Maxim Group.

A couple things, and thanks for the context on DP and I think you noted a lot of that in your last 8-K first. But zeroing in on operations of everything else besides DP. On adjusted EBITDA, I mean, I think you mentioned, why are you backing out the impact of the change in fair value contingent consideration? And is that on the income statement, too, of $1.2 million?

So -- I'm sorry, to make sure I understood the question, why are we adjusting it out for non-GAAP?

Yes. Yes, from EBITDA. Because if I don't take that out, I mean, you -- it's a much -- obviously a much better adjusted EBITDA figure. But yes, can you just walk through how that works, please?

Yes. Effectively, we've historically adjusted for contingent consideration. If you look back historically when we had contingent consideration for the Hyperspring acquisition, any changes in that fair value, quite frankly, is sort of noncash-based. It just fluctuates based on forecast and performance, and we take the lumpiness out of that, the equation there, by treating it as a non-GAAP item. And that's been consistent.

Okay. Does that broadly then...

So effectively in this situation, due to the DP issue, fair value went down to 0, and that's why the number is so large.

Okay. So no. based on what occurred, the unexpected event, after the close, no earnout payment. Correct?

That's currently as it's tracking, yes.

Okay. And then you had -- I mean, the orders were above my forecast for the quarter. And in the press release, you noted some significant actions to increase orders and backlog in the coming quarters. Kyle, can you talk about that? What does that imply besides growth in orders?

Yes. So we've taken specific action or some neat opportunities in the market where we've made some new business development hires. Pretty excited about it. And that's in the NITC segment. So does that answer your question, Tate?

So it's based on the -- so when you referred in the press release, I think the wording was decisive actions, it's the business development hires that you mentioned before. Is that correct?

Yes. yes. For cultivating this -- the business that we see out there and some neat opportunities.

Okay. Great. And the last for me is you mentioned it was a triggering event to write down DP. But what's the specific triggering event to take a quarterly impairment as opposed to being allowed to evaluate it after -- at the annual basis?

Emmett, do you want to take that?

Yes. I think, look, there's some judgment here. We spend a lot of time in consultation with our auditors as to -- when we received the notice in Q1, there's been a lot of root cause analysis and subsequent activity post that event that -- what really was the triggering event. And I think in the -- as Chris mentioned, most conservative view based on the GAAP guidance was to treat it as a triggering event in Q1. But there was definitely discussion over other options.

We reached the end of our question-and-answer session. I'd like to turn the floor back over to Kyle for any further or closing comments.

All right. Thanks very much, everyone, for joining us. In closing, we're working hard to build GSE's book of business and resolve the customer issue at DP Engineering.

I will be representing our company at the B. Riley FBR Conference in California on May 22. For those of you attending, I hope to see you there and look forward to it. And thank you again for your time and interest in GSE.

Thank you. That does conclude today's teleconference. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.