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GSE Systems, Inc. (NYSEMKT:GVP)

Q3 2013 Earnings Conference Call

November 14, 2013 4:30 pm ET

Executives

Devin Sullivan – Senior Vice President of Equity Group

Jim Eberle – Chief Executive Officer

Jeff Hough – Senior Vice President and Chief Financial Officer

Larry Gordon – Senior Vice President and General Counsel

Analysts

Mark Schappel – The Benchmark Company

Operator

Greetings, and welcome to the GSE Systems Reports Third Quarter 2013 Financial Results. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instruction). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Devin Sullivan, Senior Vice President of the Equity Group. Thank you, Mr. Sullivan. You may begin.

Devin Sullivan

Thank you, Manny, 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 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 in the risk factor section. GSE does not intend to update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

With that said, I would now like to turn the call over to Jim Eberle, Chief Executive Officer of GSE Systems. Jim, please go ahead.

Jim Eberle

Thank you, Devin and good afternoon. I would like to welcome everyone to GSE Systems 2013 third quarter conference call. Also on today’s call are Senior Vice President and CFO, Jeff Hough and Larry Gordon, our Senior Vice President and General Counsel. Earlier this afternoon we issued a press release covering our quarterly financial results, a copy of which can be found on our website at www.gses.com under the Investor Relations section.

On sequential quarterly basis our third quarter results were significant improvement from the second quarter of 2013, although none of us are pleased with the continuing losses, we are encouraged that the proactive steps we took last quarter to reduce cost and improve efficiency are beginning to take hold. These measures should save us approximately $1 million dollars on an annualized basis and success thus far in combination with increased orders supports our forecast our return to profitable operations in the current fourth quarter. Of the $17 million of orders that we had initially believed we closed in the first half of 2013, we have closed several and several more remain pending. We now expect the remaining decisions to be made between now and the end of the first quarter of 2014.

Some challenges persist in a Post-Fukushima nuclear world most notably as it relates to the substantially lower revenues in Japan. Where as of September 2013 all of the countries nuclear reactors have been shutdown and Germany which has decided to abandon nuclear energy by 2022. In the U.S. regulatory concern, public pressure and lower cost fuel sources notably natural gas have combined this all the once [indiscernible] nuclear renaissance. We are also continuing to invest in combining our Immersive 3D gaming technology with physics-correct simulation models to provide immersive highly effective training solution.

Although our Activ3Di business has grown over the last several years and is expected to be a breakeven or be quite positive this year, industry appreciation of the profound impact of this next generation technology will have in the training – forecloses faster and better is still developing.

After a difficult first three quarters of the 2013, we are beginning to see improvements in our operations in end markets. It will be a slow process, but we are making progress. We continue to believe that GSE’s future lies in the intersection of growing global energy demand and the shortage of qualified energy workers and that our engineering and train solutions can bridge that gap for energy employees around the world.

We are still very optimistic about the long-term prospects for our business and we repurchased 177,755 shares of GSE’s common stock in the quarter of 2013, as well as completing our $3 million share repurchase plan in October 2013, repurchasing an additional 99,170 shares during the month. In total, the company has repurchased just under 1.6 million shares of common stock during our repurchasing plan.

I’ll now turn the conversation over to Jeffery Hough, who’ll our results for the quarter.

Jeffery Hough

Thanks Jim and thanks to each of you for joining us today. Revenue for the third quarter, declined by 8.7% to $11.9 million from $13 million in the third quarter of 2012. Although the revenue we recognized on our $36 million Slovakia simulator project increased by $3.4 million in the third quarter of 2013 as compared to third quarter of 2012. This increase was more than offset by decreases in our EnVision product revenue.

We recognized $2 million in the third quarter of 2012 on an EnVision contract to provide simulation and computer based training model to a global energy services company. And as we've noted in prior quarters this year, we incurred lower revenue from nuclear customers in both Japan and Germany as part of the aftermath to the Fukushima earthquake and tsunami which occurred over two years ago.

At September 30, 2013, we had 2.7 million of backlog remaining on our Slovakia project, this project is scheduled to be completed in the first quarter of 2014. Gross profit for the quarter was $3.1 million or 25.9% of revenue as compared to $5 million or 38.8% of revenue in the third quarter of 2012. Gross profit was impacted by the higher percentage of revenue associated with the Slovakian project in Q3 2013, as compared to Q3 2012, it was 31.1% of our revenue in the third quarter of 2013, versus only 2.3% in the third quarter of 2012. And lower revenue from EnVision projects as we’ve mentioned.

The Slovakia project, because of our high hardware component, has an overall gross profit lower then GEC’s normal gross profits, while the gross profit for EnVision products is significantly higher than the company’s normal gross profits. Selling, general and administrative expenses for Q3 of 2013, was $3.8, an increase of 9.3% from $3.5 million in the third quarter of 2012. The increase is related mainly to operating expenses for the new Oracle ERP system, which was implemented in the fourth quarter of 2012; higher facility costs related to our new U.K. office and higher software product development expenses net of capitalization.

We recorded a net loss of $1 million or $0.06 per diluted share in the third quarter of 2013, compared to net income of $816 or $0.04 per diluted share in last years third quarter. Our balance sheet remains very strong at September 30, 2013 our cash balance excluding $2.2 million of restricted cash was $17.6 million or $0.98 per share. We had working capital of $26.5 million and no long-term debt.

I will now turn things back to Jim.

Jim Eberle

Thanks, Jeff. Well the nuclear industry in Japan, Germany and U.S. are under considerable pressure, we still see significant opportunity in markets where nuclear power will grow. In China, we’re 28 plants on a construction, 53 are plan and 118 are proposed we remain in a strong and are actively strengthening that position. We have substantially finished dissolving our joint venture in China both through turnover $1 million to cash and allow us to retain 100% of the revenue and profit from our future orders in China.

In South Korea, we’ve signed agreements with in country partners to pursue work within Koreas as well as with Korean exports. We are positioning ourselves to pursue new nuclear work in the Middle East and southeast Asia and we remain very strong in the small module reactor space, which we believe long-term will be a significant technology in the future of nuclear power.

We continue to enhance our diversified offerings and are increasing our engineering services work, we’ve closed a number of contracts globally to provide our post-Fukushima solutions, we are utilizing our high fidelity modeling and engineering capability to perform a feasibility study on a brand new first of the kind of power plant technology for a leading international provider of energy products and services.

Additionally, we have received our first true software development contract to provide a graphical user interface for an engineering grade to do excellent analysis code. And in the U.K. we receive contracts for our first fracking simulator and a world’s first engineering simulator that will be use analysis tool associated with nuclear fuel transport.

We have terminated certain under performing business development asses and had brought on and are pursuing certain other strategic business development hires. We remain focused on M&A both here and abroad, we have progressed negotiations with the prospects, we’ve provided term sheet as I mentioned on the last call and we have follow on targets with whom we are in the early stages of discussion and negotiation.

Lastly the game changing opportunities that I referred to in the last call remain active and we’ve have achieved additional significant milestones necessary to bring them to fruition.

Now, I would like to open the call up for questions-and-answer.

Questions-and-Answer Session

Operator

Thank you, we will now be conducting a question-and-answer session. (Operator Instructions). Our first question is from Mark Schappel of Benchmark. Please go ahead.

Mark Schappel – The Benchmark Company

Hi, good evening. Jim what was the nuclear non-nuclear [0:58] of this quarter.

Jim Eberle

Jeff.

Jeffery Hough

Yes, for the order it was 76% nuclear and for revenue it was 63% nuclear.

Mark Schappel – The Benchmark Company

63% revenue and 76% orders okay. And how about the percentage of backlog what does that look like?

Jeffery Hough

Backlog still remains about 75% nuclear.

Mark Schappel – The Benchmark Company

And on the Slovakian simulator project probably, correct me that one is down in the first quarter of next year, is that right?

Jeffery Hough

That’s correct substantially it will be complete in this quarter, but there is a little bit of trailing into the first quarter. So we can confidently say we will wrap it up in the first quarter of next year.

Mark Schappel – The Benchmark Company

And would you expect gross margins to kind of river back into historical norms at that point?

Jeffery Hough

I would it; I would expect to see gross margins at a percent to get back up. Obviously its lot of revenue to replace, so we would expect to see revenue dropped from where have been. But again it will be higher quality margin resident.

Mark Schappel – The Benchmark Company

Okay, and Jim why don’t if you go into a little bit more delayed on the delayed deals for the first half of the year. It sounds like you closed some of those this year excuse me this quarter and it looks like it’s going to be another several quarters before they come in. Is that a good read?

Jim Eberle

Yes it is Mark we were; obviously we had expected some of them in 2012. Then it looked like we are expecting $20 million in orders in the first quarter of this year and $17 million of orders between those quarters push to what we have hoped would close in the second half. We have closed a good number of those. Our orders in the third quarter was essentially double, those of the first and second quarter. And we expect actually higher orders in the fourth quarter. However, some of the orders that we anticipate and few close had slipped into the first quarter of next year. There are some rarities there’s one job that I can think of in particular out of our Swedish operation that is postponed on a multi-year basis so that’s one job.

Mark Schappel – The Benchmark Company

Okay thank you that’s all from me.

Jim Eberle

Thanks Mark.

Operator

Thank you. (Operator Instructions). Okay gentlemen we have no further questions in queue at this time. Would you like to make any closing remarks?

Jim Eberle

Sure, as always, I would like to thank all the talented hardworking women and men worldwide who make GSE what it is. And I thank all of you on the call for you time and continued in GSE Systems.

Operator

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

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