U.S. Markets closed

Edited Transcript of GVP earnings conference call or presentation 15-May-18 8:30pm GMT

Thomson Reuters StreetEvents

Q1 2018 GSE Systems Inc Earnings Call

SYKESVILLE May 23, 2018 (Thomson StreetEvents) -- Edited Transcript of GSE Systems Inc earnings conference call or presentation Tuesday, May 15, 2018 at 8:30:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Christopher D. Sorrells

GSE Systems, Inc. - COO & Director

* Devin Sullivan

The Equity Group, Inc. - SVP

* Emmett Anthony Pepe

GSE Systems, Inc. - CFO & Treasurer

* Kyle J. Loudermilk

GSE Systems, Inc. - President, CEO & Director

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Greetings, and welcome to the GSE Systems First Quarter 2018 Financial Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I'd now like to turn the conference over to your host, Devin Sullivan. Thank you, you may begin.

--------------------------------------------------------------------------------

Devin Sullivan, The Equity Group, Inc. - SVP [2]

--------------------------------------------------------------------------------

Thank you, Matt, 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 U.S. 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 businesses 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 for the operating results of its competitors. Since management finds these measures useful, GSE believes that investors may benefit by evaluating both non-GAAP and 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.

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

--------------------------------------------------------------------------------

Kyle J. Loudermilk, GSE Systems, Inc. - President, CEO & Director [3]

--------------------------------------------------------------------------------

Thanks, Devin, and good afternoon. I'd like to welcome everybody to GSE Systems First Quarter 2018 Results Conference Call. Also on today's call are Chris Sorrells, our Chief Operating Officer; and Emmett Pepe, our Chief Operating Officer.

Earlier today, we issued a press release covering GSE's first quarter 2018 financial results. Hopefully, you all 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.

Before I touch on GSE's first quarter financial highlights, I'd like to share my thoughts on our exciting acquisition of True North Consulting, which we announced yesterday. In True North, we acquired a highly regarded provider of specialty engineering solutions to the nuclear power industry. Since its founding in 1999, True North has developed expertise in areas such as in-service testing for engineering programs, with an emphasis on ASME OM Code; balance-of-plant programs; thermal performance; in-service inspection for specialty engineering, including ASME Section XI; and software solutions. We believe True North is a tremendous strategic fit with GSE.

The suggested earnings-accretive acquisition broadens our engineering services portfolio, expands our relationships with several of the largest nuclear energy providers in the United States and adds a highly specialized complementary talent pool to our employee base. The purchase of True North comes on the heels of our acquisition of Absolute Consulting less than 8 months ago and represents another key milestone in our strategy to leverage GSE as a compelling platform for consolidating a fragmented vendor ecosystem for nuclear power.

True North also advances our progress towards the company's Vision 2020 objectives, which imply annual adjusted EBITDA potential between $20 million and $30 million within 3 years. Chris will provide some additional color on the True North transaction and other M&A opportunities a bit later. But let me reiterate that we're really delighted with this deal and expect more like it to follow. Given the current pipeline, we remain confident we can maintain an appropriate cadence of acquisitions to help us achieve our Vision 2020 goals.

Moving on to our first quarter 2018 financial highlights. For Q1 2018, our revenue and gross profit increased 40% and 19%, respectively, year-over-year. We produced a strong quarterly order total of $24.7 million, which is a 25% increase over Q1 2017. Our quarter-end backlog remained strong at $72.4 million compared to $71.4 million at the end of 2017. Total backlog consisted of $41.5 million of Performance Improvement Solutions and $30.9 million of Nuclear Industry Training and Consulting. While these results were solid, we had experienced lower adjusted EBITDA than we expected. Emmett will provide more color in his section. Net-net, we do believe we have addressed a number of onetime issues, and we expect to see better results over the next two quarters.

Among our orders this quarter, a large EPC company awarded GSE a subcontract for the continuation of support services to 2 prominent U.S. government engineering laboratories dedicated to supporting the U.S. Navy's nuclear program. This is the continuation of a long-standing customer relationship that goes back more than 15 years. Under the subcontract, GSE will continue to provide simulation and test specialists as well as build and test training devices used across a variety of government locations. The contract commenced on February 1 and adds approximately $4 million to our backlog. Assuming continuation of another 4 optional years, the contract could have a total value of approximately $19 million, the remainder of which is not included in our backlog.

In addition, we announced today 2 orders for projects in China worth approximately $4 million. These are yet additional significant wins for GSE from a country that is investing heavily in nuclear power. These 2 deals closed in our Q2, and therefore, are not reflected in our Q1 results.

In conclusion, we're focusing on growing our revenue and EBITDA in 2018 by executing operationally on our backlog, driving sales and effectuating our corporate development strategy. Our whole team is fired up over our start to the year, and we're optimistic for healthy growth in 2018.

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

--------------------------------------------------------------------------------

Christopher D. Sorrells, GSE Systems, Inc. - COO & Director [4]

--------------------------------------------------------------------------------

Thanks, Kyle. I'll begin with some additional comments on True North. We are very excited to add True North to GSE's platform. True North is a well-respected, well-run specialty engineering company with high EBITDA margins of approximately 20%, with a high conversion rate of EBITDA to free cash flow given the low CapEx requirements of its business. We expect True North to be immediately accretive to GSE's adjusted diluted earnings per share and anticipate it will add approximately $2 million to our annual adjusted EBITDA after identified synergies are implemented. It would also add approximately $4 million to our backlog. We purchased True North for $9.75 million in cash, an attractive price for a company with high barriers to entry due to the complex nature of its technical work. We paid $8.29 million at close and will hold the difference, approximately $1.5 million, in escrow for indemnity and leadership retention purposes.

Regarding leadership retention, we are fortunate that True North's founder and former owner, Don Horn, has agreed to stay with the business and will continue running it mostly as is, but with some integration with our back office and coordination with our business development team. Don is well known in the industry with a proven track record that spans two decades. He has gained the confidence of several of the country's largest utilities, which have designated True North as their specialty engineer of choice for their fleets. True North's customer base is approximately 85% nuclear and 15% fossil, and its largest customer only accounts for approximately 20% of its revenue, which is very low for a typical nuke services company. We are keeping the True North name, given its brand recognition within the industry. With each acquisition, the plan is to brand each with a GSE company mark beneath each logo. So in this instance, we are talking about True North, a GSE company.

We expect to see the financial impact from True North beginning in the second quarter as the acquisition closed on May 11. It will be part of our Performance Improvement Solutions segment. Prior to transaction close, we prepared a detailed 100-day plan to integrate True North with GSE. We will move swiftly to ensure that True North is fully integrated by the third quarter. True North fits well with our stated M&A goals. And our pro forma LTM revenue and adjusted EBITDA now exceed $100 million and $7.5 million, respectively.

Stepping back and putting our external growth progress into perspective, I'd like to point out that in the last 8 months, through the strategic acquisitions of Absolute Consulting and True North, we've added $40 million to $50 million in annual revenue and $3.5 million to $4 million plus in annual adjusted EBITDA to GSE's business. That's significant. We purchased both companies with cash and at attractive prices. LTM adjusted EBITDA multiples are 4 to 5, providing a good margin of safety plus opportunity for meaningful accretion. We're very pleased with these deals.

Even after the purchase of Absolute and True North, our balance sheet remains strong with approximately $12 million in cash. Our strong liquidity position positions us well to pursue and execute on the pipeline of deals currently under evaluation. Our M&A efforts continue to advance favorably, and we remain on track to hopefully close at least one more deal this year. As we consummate additional deals like True North, we envision an uptick in our own valuation as investors realize that we're capitalizing on our reoccurring value-creation opportunity.

Our four target areas remain unchanged; technical engineering, staffing consulting, software solutions and value-added components. As always, we will remain very focused on our publicly stated criteria for M&A to ensure that each transaction provides our investors with asymmetrical risk reward, attractive IRR and an ROIC that exceeds our cost of capital.

Let me conclude briefly, touching on some recent industry news. In a positive development for the industry in April, New Jersey lawmakers approved bills that provide an estimated $300 million in annual subsidies to keep PSE&G, Salem and Hope Creek nuclear plants open, aiming to bolster the state's renewable electricity standard by limiting greenhouse gases.

In April, New Hampshire also issued a paradigm shift in its energy strategy, recommending that the state's renewable portfolio standard includes 0-carbon-emission resources such as NextEra's Seabrook nuclear plant. Nuclear power generated more than half of New Hampshire's energy in 2016, and preserving Seabrook, the state's only nuclear plant, is an optimal way to manage emissions.

Minnesota, Ohio and Pennsylvania state legislatures also continue to draft legislation that would provide support to nuclear plants facing premature closure. We continue to see evidence that states are increasingly recognizing the value of nuclear as a safe source of carbon-free and reliable baseload electricity.

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

--------------------------------------------------------------------------------

Emmett Anthony Pepe, GSE Systems, Inc. - CFO & Treasurer [5]

--------------------------------------------------------------------------------

Thank you, Chris. I'll begin with a review of new business. Our Performance Improvement Solutions segment bookings totaled $5.9 million in Q1 2018 compared to $4.9 million in Q1 2017. The increase in Performance Solutions orders is a result of the large contract to provide support services to two prominent U.S. government engineering laboratories that Kyle detailed previously.

Nuclear Industry Training and Consulting orders totaled $18.8 million in Q1 2018 compared to $14.9 million in Q1 2017. Absolute Consulting contributed $9.7 million of orders in Q1 2018. Our strong orders performance in this segment is the result of our continued support at 2 significant customers.

Now on to review our financial results for the quarter. Total revenue in Q1 2018 increased 40.1% to $22.9 million from $16.3 million in Q1 2017. Nuclear Industry Training and Consulting revenue rose 95% to $13 million in Q1 2018 from $6.7 million in Q1 2017, reflecting a full quarter of revenues from Absolute Consulting. Performance Improvement Solutions revenue in Q1 2018 increased 2% to $9.9 million from $9.7 million in Q1 2017. Our modest year-over-year increase in the Performance Improvement Solutions segment is lower than expected, partly driven by modest delays from a key vendor in one of our larger projects. We believe it to be favorably resolved, and we should see better results over the next 2 quarters. These delays resulted in us delaying recognition of approximately $2.5 million of revenue and more importantly, the associated profit.

Gross profit in Q1 2018 increased 18.8% to $4.9 million or 21.4% of revenue from $4.1 million or 25.2% of revenue in Q1 2017. For the Nuclear Industry Training and Consulting segment, the Q1 2018 gross profit increased 53% to $1.6 million from $1.1 million in Q1 2017. Absolute Consulting contributed $800,000 to the gross profit for the Nuclear Industry Training and Consulting segment in Q1 2018. The Performance Improvement segment's Q1 2018 gross profit increased 7% to $3.3 million from $3 million in Q1 2017.

SG&A expenses in Q1 2018 totaled $4.5 million or 19.8% of revenue compared to $3.6 million or 22% of revenue in Q1 2017. The percentage decrease begins to demonstrate the effects of operating leverage as we scale the business. The increase in SG&A expense resulted from the acquisition of Absolute Consulting, which contributed $500,000 to Q1 2018 SG&A expenses. In addition, we incurred largely onetime higher professional fees of approximately $300,000 as a result of our year-end work related to the release of our valuation allowance, tax reform and the new revenue accounting standard, which impacted our adjusted EBITDA given we chose not to add -- back out those fees.

Net loss in Q1 2018 was approximately $1.5 million or $0.08 per basic and diluted share compared to $300,000 net loss or $0.01 per basic and diluted share in Q1 of 2017. The loss in Q1 of 2018 is largely a result of our ongoing international restructuring efforts, which contributed $900,000 of expense in Q1 2018, and higher tax provisions due to the accrual related to uncertain tax positions for certain foreign tax contingencies. We are eager to realize the positive financial effects of our restructuring efforts, which are planned to be largely completed by the end of Q2 2018.

Non-GAAP adjusted EBITDA, as defined in our earnings release, was approximately $800,000 in Q1 2018 compared to approximately $1.1 million in Q1 2017. The decrease is largely due to the 2 items previously mentioned: the delay in revenue recognition for one of our larger projects, which resulted in an approximate delay of $400,000 of EBITDA; and the increased largely onetime professional fees.

Our cash position at March 31, 2018, totaled $12.4 million compared to $20.1 million at December 31, 2017. As mentioned previously, the delays in one of our larger projects caused a temporary decline in cash as of March 31. As these project reach completion over the next 2 quarters, we expect our cash position to return to normal operating levels of approximately $15 million of cash, excluding any new uses of cash, such as acquisitions, by the end of the year.

As Chris noted, on May 11, 2018, we entered into an amended and restated credit agreement with Citizens Bank consisting of a five-year $5 million revolving line of credit and a five-year $25 million delayed-draw term loan facility to fund acquisitions approved by Citizens. We drew down approximately $10 million to fund the acquisition of True North at close. Interest is floating rate based on LIBOR plus applicable margin of between 200 to 275 basis points, which depends on leverage thresholds specified in the agreement. The fact that GSE can do this demonstrates how far GSE has come in the past few years since management initiated the turnaround and growth strategy.

I'll now turn the conversation back to Kyle.

--------------------------------------------------------------------------------

Kyle J. Loudermilk, GSE Systems, Inc. - President, CEO & Director [6]

--------------------------------------------------------------------------------

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

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Our first question is from [Lawrence Kaplan] from [LK Management].

--------------------------------------------------------------------------------

Unidentified Analyst, [2]

--------------------------------------------------------------------------------

Congratulations on the quarter and on the True North acquisition. Just a question on the True North acquisition. Is True North a growing company? I mean, is it just a stable company that does a couple of million of EBITDA and $10 million of sales? Or what should we expect in the future with True North?

--------------------------------------------------------------------------------

Christopher D. Sorrells, GSE Systems, Inc. - COO & Director [3]

--------------------------------------------------------------------------------

Larry, it's Chris. Thanks for the question. Yes, it's a company -- I mean, if you think of nuke, and that's U.S. domestic nuke, it generally grows -- it's a GDP-like industry. So a couple percent to 4% or 5% is what you might typically see. True North has done a little better than that over the past couple of years, mostly driven by these 2 new opportunities, say, in the past 2 years, in which they were entrusted, as I said in my comment, to become the specialty engineer of choice for 2 pretty prominent nuke players. So that really picked it up, call it, over the past 2 or 3 years. When we talk about things, Larry, you kind of know us, we tend to prefer to underpromise and overdeliver. So we're looking at the transaction as, what we bought, what we get. If that is the case, we should be happy. Anything that accrues on the upside is gravy.

--------------------------------------------------------------------------------

Unidentified Analyst, [4]

--------------------------------------------------------------------------------

Great. Also, the EBITDA is very confusing, to say the least. There is -- what do you expect with the timing issues with revenue, costs that are affecting the EBITDA shortfall? And what do we expect for the balance of the year? Does somewhere this all get adjusted out and we get more -- yes, I just think the story is confusing right now. And I think that's part of the problem, why people don't appreciate the acquisition and what you're growing. And I'm just wondering how you feel about this. And what are you going to do to really get the story out there and get new people involved in the company?

--------------------------------------------------------------------------------

Kyle J. Loudermilk, GSE Systems, Inc. - President, CEO & Director [5]

--------------------------------------------------------------------------------

I'll take it from a high level, and maybe, Chris or Emmett, you can follow up with a breakdown.

--------------------------------------------------------------------------------

Christopher D. Sorrells, GSE Systems, Inc. - COO & Director [6]

--------------------------------------------------------------------------------

Okay.

--------------------------------------------------------------------------------

Kyle J. Loudermilk, GSE Systems, Inc. - President, CEO & Director [7]

--------------------------------------------------------------------------------

Larry, I'll unpack the question. On the first side, the EBITDA shift out the profit of these 2 large projects we were mentioning, that's not money lost, that's not an opportunity lost, it's just a timing issue. So we expect to fully get that. So there's a little bit of chop in when that comes in based on project milestones and other items that we highlighted in the call. Second part of the question is -- we're really excited by our story here of being able to leverage GSE as a platform to pull neat, highly specialized nuke services, technology and related entities on to our platform. It's a highly concentrated market, high moats to serve that market, not any new player can pop out of the woodwork and serve nuclear. And I've seen the movie before. With a highly concentrated industry base, with a highly fragmented ecosystem of vendors, it's a very compelling opportunity ahead of us. And we see that playing out between Absolute, True North and are excited by our pipeline. So we feel if we do the right things, execute on our strategy, operate the business, get the story out through investor conferences, that, look, those are the things in our control that we can do. Chris, any other further comments?

--------------------------------------------------------------------------------

Christopher D. Sorrells, GSE Systems, Inc. - COO & Director [8]

--------------------------------------------------------------------------------

I guess, the clarification. We had the 2 things Emmett did a nice job explaining, Larry. We delivered $800,000. We lost $300,000 to truly kind of onetime items with the professional fees. You're probably aware of the new revenue standard, 606. I mean, that was a very involved and expensive process. You don't see that every year. That costs money to adhere to. Equally important, and this is really a generational thing, the Tax Cuts and Jobs Act. And there was tremendous work that had to go into the deferred tax assets and things that you saw in the fourth quarter, and some of that continued into the first. We went from a 35% effective tax rate corporate to 21%. I mean, not a bad thing, but there's money in the impacts of that. So that was about $300,000 right there to EBITDA. And then with the projects getting pushed and that was -- there were multiple reasons, but largely supplier-driven, I mean, there went $400,000-ish of EBITDA. So now you're talking a $1.5 million quarter versus $1 million, $1.1 million, and that would have been great year-over-year, that would have looked good. So we kind of got hit. Do we think we'll get the $400,000? We do. The $300,000? No, that's gone, right? We spent it and it's unfortunate, but that's regulations for you and that's a public company. There were some other things too, that we didn't necessarily highlight and that probably added up to another couple hundred kind of onetime quirky things when you go year-over-year comparison. So I mean, when you look at it, yes, disappointing, but we got good explanations, and as Kyle said, we're super-excited with what we see ahead of us.

--------------------------------------------------------------------------------

Unidentified Analyst, [9]

--------------------------------------------------------------------------------

Are you ready to start to give some projections for the year? Like you had mentioned the $100 million and $7.5 million. Is that -- was that for this year? Or is that the run rate of? Or -- I wasn't quite sure how that was worded.

--------------------------------------------------------------------------------

Kyle J. Loudermilk, GSE Systems, Inc. - President, CEO & Director [10]

--------------------------------------------------------------------------------

That's trailing 12 months. So we don't give guidance, Larry. We're not going to look forward to providing guidance, at least at this time. But when we give numbers like that, it's on a trailing basis, just to give people a sense of what's going on. Any other questions?

--------------------------------------------------------------------------------

Operator [11]

--------------------------------------------------------------------------------

(Operator Instructions) And if there are no further questions, do you have any closing comments to make?

--------------------------------------------------------------------------------

Kyle J. Loudermilk, GSE Systems, Inc. - President, CEO & Director [12]

--------------------------------------------------------------------------------

Well, that's great. Look, thanks, everyone, for joining us. Really excited about what's going on here and glad to share with everyone our progress. In closing, I'd like to say we're very pleased with our progress and reiterate our continued focus on improvement. In the coming months, I hope to get the chance to meet and speak with many of you, especially we have some upcoming investor conferences. We'll be at LD Micro in first week of June out in Los Angeles. So Chris will be there. And we'll have some others that come onto the calendar as the summer unfolds. So thanks, everyone. And with that, I'd like to thank you for your time and interest in GSE.

--------------------------------------------------------------------------------

Operator [13]

--------------------------------------------------------------------------------

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.