GSE Systems' (GVP) CEO Kyle Loudermilk on Q1 2019 Results - Earnings Call Transcript

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About: GSE Systems, Inc. (GVP)
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Earning Call Audio

GSE Systems, Inc. (NASDAQ:GVP) Q1 2019 Earnings Conference Call May 15, 2019 4:30 PM ET

Company Participants

Kalle Ahl - IR, The Equity Group

Kyle Loudermilk - CEO

Chris Sorrells - COO

Emmett Pepe - CFO

Conference Call Participants

Josh Vogel - Sidoti & Company

Tate Sullivan - Maxim Group

Operator

Greetings, and welcome to the GSE Systems First Quarter 2019 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A 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, Kalle Ahl, with The Equity Group. Please go ahead, sir.

Kalle Ahl

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 maybe 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 would now like to turn the call over to Mr. Kyle Loudermilk, Chief Executive Officer of GSE Systems. Kyle, please go ahead.

Kyle Loudermilk

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 have had a chance to review this news release, but if you have not a 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.

For revenue and 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 also 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 two major customers including 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 experience 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're taking decisive actions to increase new order flow and backlog in the coming quarters. For market opportunities that look promising, we have added two salespeople since the beginning of the year to pursue and capture business. While early, we feel they are 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 a large order in Q1 2016. This is an encouraging sign that our strategy of building a diversified solutions portfolio for nuclear will lead to 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 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're 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 work through a customer issue arising from pre-acquisition design modification work that required us to record a non-cash 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 for 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 with a significant alliance of operators, and recently becoming an approved supplier to provide engineering services to 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 in 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 and extraordinarily and talented employee base; specialized technologies that I believe are second to none in the industry. As always, we're committed to operating our assets as cleanly 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.

Chris Sorrells

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 analysis. Both DP and the customer have now completed their respective causal analysis and GSE now understands the customer has indicated that Future Awards will be suspended for up to six months or until September 2019 up to is key here.

The 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 impairment, we analyzed the fair value of the asset.

As a result of that analysis, we recognize the 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 longstanding 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 score sheet. 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 your acquisitions to-date and review on our M&A strategy. We acquired three companies during the past three 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 timeframe has not responded as much as we would have liked given our progress in 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 on 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 12th, Ohio Lawmakers introduced a Clean Energy Bill HB 6 that would create the Ohio Clean Air program and provide clean energy credits to zero 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 states' zero emission credit policies and affirming states rights to favor clean energy including nuke over carbon-based sources.

On April 19, New Jersey regulators approved zero emissions credits totaling $300 million for all three of the states' nuclear reactors supporting the states 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 in 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 of four reactors commencing in June.

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

Emmett Pepe

Thank you, Chris.

Total revenue in the first quarter of 2019 totaled $22.2 million compared to $22.9 million in the 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 two major customers.

Gross profit in Q1 of 2019 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 2019 from $4.5 million in Q1 of 2018. The slight decrease was primarily due to $1.2 million of non-cash 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, 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 contribute 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 non-cash 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 2019 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.

Kyle Loudermilk

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

Question-and-Answer Session

Operator

Thank you. We're now conducting a question-and-answer session. [Operator Instructions].

Our first question today is coming from Josh Vogel from Sidoti & Company. Your line is now live.

Josh Vogel

Thank you. Good afternoon guys. 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?

Chris Sorrells

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.

Josh Vogel

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

Kyle Loudermilk

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

Josh Vogel

Okay, got it. Thank you. 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?

Kyle Loudermilk

Yes, give me a moment here, Josh. See, yes, if you look back over the prior few years obviously in 2016, we have a $30 million order drop in to 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, in 2018 was $24 million as we highlighted this year $14 million. So you can see it went from roughly call it excluding that one-time 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 that there are obviously some significant orders in there. I just don't recall them off the top of my head.

Josh Vogel

Okay. No worries, thank you. And Chris, you mentioned that there is a big investment that China is going to put into nuclear and 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?

Chris Sorrells

Kyle, you want me to answer that?

Kyle Loudermilk

Yes. I mean he directed it to you Chris but maybe I can take it, Chris.

Chris Sorrells

Okay.

Kyle Loudermilk

Josh for China, so far at least we haven't seen an effective tariffs affecting our business, deal flow, anticipated deal flow, current activities with our office in Beijing for those that may be 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 it's serving the China market we have had a historical Steady Eddie business in China. We're continuing that. We usually help out with one of the three nuclear power operators within China and to the extent they need us for support, we worked with them as well as other U.S. vendors serving that market appropriately.

Josh Vogel

Okay, great. 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 leak from a diffusion plant in Ohio. And obviously this is very fresh news and I believe one of your -- one of your competitors is a lead contractor to that plant but does that potentially because that hurt the legislation that the Ohio government put into place. Or do you have any thoughts around that news today?

Kyle Loudermilk

Obviously, 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?

Josh Vogel

It was a diffusion plant.

Kyle Loudermilk

Okay.

Josh Vogel

Yes. I can offline, I can follow-up. I can send you the link that I read about it. But it was Portsmouth Gaseous Diffusion Plant.

Kyle Loudermilk

Yes, so that is a -- that 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 either of the plants and zero carbon because gas diffusion is not the same as energy production.

Josh Vogel

Sure, okay. It was just, yes, I was just discussion around my contaminants that were released and I just wasn't sure maybe the Ohio government would kind of put their brakes on that type of work but okay, that's all I have right now. Thank you very much.

Kyle Loudermilk

All right. Thanks, Josh.

Operator

Thank you. [Operator Instructions].

Our next question is coming from Tate Sullivan from Maxim Group. Your line is now live.

Tate Sullivan

Hi, thank you. A couple of things and thanks for the context on DP and I think you've noted a lot of that in your last 8-K first but zeroing in on the 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 income statement to $1.2 million?

Emmett Pepe

So, I'm sorry make sure I understood. Why are we adjusting it out for non-GAAP?

Tate Sullivan

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

Emmett Pepe

Yes, subsequently we've historically adjusted for contingent consideration. If you look back historically when we had continued consideration for the Hyperspring acquisition. Any changes in that fair value quite frankly is sort of non-cash based. It just fluctuates based on forecasts and performance. And we take the lumpiness out of that the equation there by treating it as non-GAAP item.

Tate Sullivan

Okay. Does that probably tend [ph]?

Emmett Pepe

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

Tate Sullivan

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

Emmett Pepe

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

Tate Sullivan

Okay. Thank you. And then you had I think backfilled orders were above my forecast for the quarter and in the press release you noted some significant actions to increase orders in backlog in the coming quarters? Kyle can you talk about that, what's that imply besides growth in orders?

Kyle Loudermilk

Yes. So we've taken specific action or some meat 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?

Tate Sullivan

So it’s based on that. 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?

Kyle Loudermilk

Yes. Yes, for cultivating this business that we see out there and some meat opportunities.

Tate Sullivan

Okay great. And the last from me is you mentioned, it was a triggering event to write-down DP. What's the specific triggering event to take a quarterly impairment as opposed to being allowed to evaluate it after annual basis?

Kyle Loudermilk

Emmett, do you want to take that?

Emmett Pepe

Yes, I think -- look there's some judgment here. We spent 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 some subsequent activity host that event that's what really was the triggering event. And I think, as Chris mentioned, most conservative view based on the GAAP guidance was to treat it as a triggering event in Q1.

Tate Sullivan

Okay, okay.

Emmett Pepe

But there was definitely discussion over other options.

Tate Sullivan

Okay. Thank you for all that detail. Thank you. Have a good night.

Kyle Loudermilk

Thank you, Tate.

Operator

Thank you. We've 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.

Kyle Loudermilk

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. We'll 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.

Operator

Thank you. And 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.