Q2 2023 GSE Systems Inc Earnings Call

Participants

Emmett Anthony Pepe; CFO & Treasurer; GSE Systems, Inc.

Kyle J. Loudermilk; President, CEO & Director; GSE Systems, Inc.

Adam P. Lowensteiner; VP-New York; Lytham Partners, LLC

Presentation

Operator

Good day, and welcome to the GSE Systems, Inc. Reports Second Quarter Fiscal Year 2023 Financial Results. (Operator Instructions) Please note, this event is being recorded.
I would now like to turn the conference over to Adam Lowensteiner Vice President at Lytham Partners. Please go ahead.

Adam P. Lowensteiner

Thank you, operator, and good afternoon, everyone, and thank you all for joining us today to review the financial results for GSE Systems for the second quarter of fiscal 2023 ended June 30, 2023. With us on the call representing the company today are Kyle Loudermilk, President and CEO of GSE Systems; and Emmett Pepe, Chief Financial Officer of GSE Systems.
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 in 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. 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 the most directly comparable GAAP measures in accordance with SEC Regulation G can be found in the company's earnings release.
With that, I'd like to now turn over the call to Mr. Kyle Loudermilk, President and CEO of GSE Solutions. Kyle, please proceed.

Kyle J. Loudermilk

Thank you, Adam, and I'd like to welcome everyone to GSE's Second Quarter Fiscal 2023 Financial Results Conference Call. Earlier today, we issued a press release detailing our financial results, Hopefully, you've had a chance to review this news release, but if not, a copy can be found on our website at www.gses.com under the News section.
To layout today's agenda, I'll start with a brief update on the industry and the quarterly results. Emmett will review the financial results, and we'll conclude with a Q&A session. First, a brief update on the industry. Demand for electricity on a national and global basis continues to grow and be in high demand, especially given the higher temperatures that countries have been experiencing this summer. As a result, utilities have been busy making sure there's an ample supply of power to meet this demand. While certain fossil fuels are being utilized to meet peak load, governments understand that dependence on fossil is not a sustainable long-term strategy and the value proposition of nuclear power continues to be top of mind. As a result, many countries continue to prioritize nuclear power through planning and investment to sustain existing nuclear infrastructure investing to produce more power from this infrastructure and advancing plans to build out a new generation of nuclear power plants.
The economics for nuclear are becoming more compelling in light of geopolitical issues. The invasion of Ukraine highlighted the fragile nature of fossil fuel dependency and increased baseline consumption of fossil fuels resulting from a growing global economy also puts upward pressure on costs. This puts into clear contrast to sustainable and secure power that nuclear assets provide to achieve energy security while providing abundant affordable power. A recent case study of these benefits is being witnessed in Finland.
With the recent completion of the Olkiluoto 3 nuclear power plant, Finland's first new nuclear power plant in more than 4 decades, the power it now provides has begun to lower electricity costs in the country, which sort after the Finnish government banned electricity imports from Russia. The plant, which will produce up to 15% of the country's power demand has enabled electricity spot prices to fall by 75% from the beginning of December 2022 to April 2023.
Another country that is seeking to expand its nuclear power footprint in Canada, which plans to achieve the net-zero power grid by 2035. To get there, utility companies are already preparing with Canadian-based, Bruce Power, announcing assessment plans to add another 4.8 gigawatts to its current 6.2 gigawatt facility in Tiverton, Ontario. If approved, this would be the first conventional nuclear power plant in the province built in 3 decades, and the site would eventually become the largest nuclear power generation operating site in the world.
The United States has achieved a fantastic milestone recently with Southern Company's Vogtle 3 nuclear reactor in Georgia now commercially producing power. This is the first new build nuclear power plant in the United States in 30 years and has created tremendous excitement throughout the industry. Vogtle Unit 4 is nearing completion and expected to go commercial early next year. This is a great achievement for Southern Company and the industry and GSE.
Also, as I highlighted on the first quarter conference call, if you go into the control room with these new reactors, it's a complete digital control room, nothing like the prior generations of nuclear power plants. GSE technology is used as a basis for the simulation systems for AP1000, and we are proud to be part of the journey. This transformation to digital control rooms will play out in existing nuclear power plants as well. As older power plants obtained operating extensions, we believe the industry will go through a transition whereby the old control systems are going to transition to digital control systems for greater operational reliability, safety and to achieve optimal power generation. These upgrades require investments in the hundreds of millions of dollars per plant and we'll touch upon every service that GSE can offer from simulation to design modifications to programs and performance to Workforce Solutions.
We have had a series of press releases over the past months that highlight recent wins across our lines of business, including a significant win to assist a client to upgrade procedures for their plants as they transition to a digital control environment.
Some more color on the recent Workforce Solutions line. Subsequent to second quarter end, we announced a contract valued up to $15 million over several years, to support a project to modernize the nuclear power plants main control room to a digital environment. This contract was with one of the largest nuclear operators in the United States, and we are excited to play a critical role in this transformation. Other plants have announced similar plants to convert to digital controls. And while it's hard to determine the timing of future projects, we are optimistic that there are more to be awarded in the coming years as this conversion to digital evolves into a clear industry trend.
As mentioned, the conversion to digital controls helps the plant operate more efficiently, safely and reliably. The investment also helped set the stage to extend the lifetime of the plants and prepare for future power upgrades, the means by which existing infrastructure can be upgraded to produce more power. Producing more power through upgrades is an extraordinarily cost-effective means to produce more nuclear power versus building new plants.
Looking a bit further into the future, there's continued momentum around the development of small module reactors known as SMRs, which would be inherently safe to operate while requiring a smaller site footprint than traditional nuclear power plants. SMRs will be the wave of the future and GSE is prepared to participate in helping these new facilities come safely online. Britain recently announced it's seeking to improve their nuclear footprint to meet certain climate targets and improve energy security through SMRs. Since large new projects are very costly, British government recently opened a competition to develop SMR is aiming to see them operational within the next decade. Their stated goal is to increase nuclear power capacity to 24 gigawatts by 2050, which would put nuclear at 25% of electricity output versus 14% today. It is news like this that is great for the industry and shows the next wave of plants to be built for the nuclear industry will involve significant SMR opportunities.
Now for some perspective on GSE's business in Q2 of fiscal year 2023. The highlight of the second quarter was a meaningful improvement in our operational results. The engineering teams, in particular, kept a keen focus on utilization and this had a direct contribution to improved company performance. As the team began to execute on the significant orders won in Q1, the company performed at a high level, resulting in financial improvement when compared to the first quarter and second quarter from one year ago.
While we have more work ahead of us, we continue to focus on improving what is in our control, including keeping corporate costs down and ensuring we are properly staffed for the business we have and anticipate moving forward. Q2 orders were lower than we were looking towards due to some key orders not closing in the quarter, but those orders that slipped have closed in early Q3, and we have highlighted several of those ones in recent press releases. We also took some costs out of the business to ensure we are as lean as possible moving forward and that we'll provide more details on these initiatives.
Focusing a bit more on the highlights of the second quarter. The company's performance engineering division continued to improve, especially including year-to-date software and support sales of $2.3 million, up from roughly $1.9 million in the same period a year ago. We are very pleased with the continued pace of software sales. New orders overall for Performance Engineering during the second quarter were $4.9 million, which is an increase of 30% when compared to $3.9 million in the second quarter of 2022. While the order flow has obviously been lumpy from quarter-to-quarter, we feel that the increase in orders from the Engineering division when compared to the same period a year ago, perhaps demonstrates a tentative recovery in industry spend in this area even if lumpy.
Our Workforce Solutions business continues to experience softness in demand. The segment had revenue that was $3.3 million in the second quarter compared to $3.9 million in the first quarter and lower from $4.8 million in the second quarter in 2022. We have worked diligently to retool the division by rebuilding sales and recruiting teams for the business, but it continues to struggle and it's difficult to predict when it will turn. We have identified a book of business in the marketplace and need to execute with competition is very broad-based. And in general, the industry is still in a wait-and-see mode, but for essential projects, such as the digital control project when we highlighted. We are focusing on staffing up that project as fast as we can, but of course, this ramp depends on the customer readiness to accommodate that ramp. We are closely monitoring the division and prepared to retool if it doesn't improve.
Across the business, we are focusing on what is in our control and demonstrating improvement. We're focused on utilization and hard margin business. We see that in this quarter. This focus has yielded improved results for the quarter and revenue generation for engineering and overall gross margin improvement in the business. We have been laser-focused to contain costs, trimming overhead where we can and shedding or reducing external costs, which should have an impact in the second half of the year. We also are focused on engaging with customers on specific opportunities. Our business pipeline is strong. And while we're not in control of client decisions to move forward on projects we are ensuring we are along with them and ready to execute when projects are awarded. This focus has helped us build our opportunity pipeline and win a significant new customer logo, the uranium enrichment customer when we announced, and that is not an easy thing to do in the nuclear ecosystem.
I'm proud of our accomplishments and improvements in the second quarter. I believe they demonstrate that we are focused on turning this company around. While we wish that momentum was building faster, we do continue to make progress to reaching our goals of increasing orders, backlog and grow revenue. The new orders already received and announced in the third quarter are a step in the right direction.
I'll now turn the call over to Emmett Pepe, GSE's CFO, who will review the second quarter financial results. Emmett, please proceed.

Emmett Anthony Pepe

Thank you, Kyle. With the numbers highlighted in detail in the press release, let me focus my comments on a few areas and provide added color where I can. Revenue during the second quarter of 2023 was $12.4 million, a year-over-year decrease of 3% compared to $12.7 million in the second quarter of 2022, but sequentially higher by 14% when compared to the $10.9 million in the first quarter of 2023.
The Engineering division continued to perform well for the company with revenues of $9 million for the second quarter of '23. This compared to $6.9 million in the first quarter of 2023 and compared to $8 million in the second quarter of 2022. Orders for engineering performance were $4.9 million, which declined from $14.7 million in Q1 of 2023, which included some sizable orders. But looking year-over-year, orders compared positively by 30%, up from last year's $3.8 million in Q2 of '22.
Also, as Kyle indicated in his remarks, the company experienced some order slippage during the quarter and were placed during the early third quarter. Workforce Solutions division's revenue in the quarter was $3.3 million compared to $3.9 million in the first quarter of 2023 and compared to $4.8 million in the second quarter of 2022. Orders were $1.3 million in the second quarter of 2023 compared to $4.4 million for the first quarter of 2023 and compared to $3.1 million in the second quarter of 2022.
The shortfall of orders in the second quarter stemmed from early terminations received from some of our clients in the magnitude of $1.9 million. While it is somewhat uncommon, such terminations can occur depending on the scope of service, speed of project completion and other variables. If it weren't for the terminations, the orders for both the company and specifically Workforce Solutions would have shown year-over-year and sequential improvements. That said, the division is still experiencing some resistance from customers, but we are closely monitoring this business, and we are opportunistic about the book of business that is available to the marketplace.
Gross profit in the second quarter of 2023 was $3.2 million or 26% of revenue. This compared to gross profit of $3.2 million or 24.9% of revenue in the second quarter of 2022, and $2.4 million or 22% of revenue in the first quarter of 2023. Gross margin improved over the first quarter due to project mix, including the benefit of our software sales, and more revenue coming through the Performance Engineering division, which carries higher margins.
Operating expenses, excluding depreciation and amortization in the second quarter of 2023 were $3.8 million compared to $5 million in the first quarter of 2023 and compared to $4.6 million in the second quarter of 2022. The year-over-year decrease in Q2 was in part due to the cost containment measures implemented in the first half of the year that delivered benefits in the quarter. Many of our more significant cost reductions were implemented toward the end of the second quarter, which included facility savings from a footprint reduction that we highlighted in previous calls, vendor savings from negotiated rate reductions and labor savings primarily from our back office. These changes have aligned our operating expenses with our current book of business, and we anticipate that these changes will contribute to improvements in our operating expenses in the coming quarters.
Net loss in the second quarter of 2023 was a loss of $1.5 million or a loss of $0.06 per share compared to a loss of $3 million in the first quarter of 2023 or $0.13 per share. Net loss in Q2 of '22 was $1.4 million or $0.07 per basic and diluted share. Adjusted net loss was $1.3 million or $0.05 per share in the second quarter of 2023 compared to an adjusted net loss of $2.6 million or $0.11 per share in the first quarter of 2023. Adjusted net loss totaled $1.2 million or $0.06 per diluted share in Q2 of '22.
Adjusted EBITDA totaled loss of $361,000 for the second quarter of 2023, a $1.8 million improvement compared to the loss of $2.2 million in the first quarter of 2023. Adjusted EBITDA also improved compared to the loss of $0.7 million in Q2 of 2022. Company's backlog was utilized during the second quarter, given the tepid order flow in the quarter and ended at $34.4 million. Backlog at the end of the first quarter was $40.9 million compared to $34 million at the end of the second quarter of 2022.
Performance Engineering segment backlog was $26.9 million at the end of the second quarter compared to $31.4 million at the end of the first quarter of 2023, but higher when compared to the same period a year ago when it was $27.5 million.
Workforce Solutions division was $7.5 million at the end of Q2 '23, that compares to $9.5 million at the end of Q1 2023 and compares to $6.5 million at the end of the second quarter of 2022. As Kyle mentioned earlier, we did experience some order slippage into the third quarter. And if not for that, backlog figures would have been higher at the end of the second quarter.
Moving our discussions of the company's balance sheet. We exited the second quarter with $1.8 million in cash, and that compares to $1.3 million at the end of the first quarter of 2023. The cash levels do not include restricted cash of $1.6 million, which is to secure 4 letters of credit with various customers, totaling $1.2 million and $400,000 to secure our corporate credit programs.
For the close of the second quarter, we closed on a follow-on financing with Lind Partners, which included $1.4 million in upfront proceeds. As part of this financing, we continue to make payments on our original convertible debt secured with Lind in February of 2022 and we received an extension of repayment for another 5 months to have a repayment completed by July of 2024. This enabled the company to lower our monthly repayment by approximately $133,000. We continue to review on a monthly basis the determination of whether to repay in cash, stock or a combination of both.
While we're working in a challenging environment, continue to examine every expenditure and will reduce costs where we can to limit cash burn. We are optimistic that the company can book additional orders in the coming months and with the improved utilization resulting in increased revenue, which positions us for improved cash flow.
I'll now turn the conversation back to Kyle.

Kyle J. Loudermilk

Thank you, Emmett. To summarize, the second quarter had several key positives, including improved revenues and utilization, which is solid operational improvement. We have more work to do, including additional cost containment and improved selling, especially within Workforce Solutions. We're cautiously optimistic about the remainder of the year. We are appropriately positioning the company to be prepared for future growth and show improved results where we can. We continue to work with our customers who are still tentatively on spending -- who's still tentative on spending in the current challenges of high inflation and economic uncertainty. That said, we are performing and executing on what is in our control such as executing on projects being in front of the customers to build our opportunity pipeline and be in the ready position for when orders are indeed imported.
While we are doing what we can during this continued bull and industry spend, we feel confident in the longer term due to 3 key catalysts for the nuclear industry, the need for stable grid, the drive towards energy security and independence and the decarbonization of the power sector. These catalysts lead us to believe that the nuclear industry is entering a long-lasting upward super cycle, even at the beginnings of that super cycle alternative.
Given GSE's unique positioning as a heavily tech-enabled provider of essential services to the nuclear power industry, we remain confident in our ability to create substantial long-term value.
With that said, Adam, please proceed with the Q&A session.

Question and Answer Session

Operator

(Operator Instructions) There are no questions in the queue. Adam, I'll turn it over to you for any online questions you might have.

Adam P. Lowensteiner

Thanks, Jason. Kyle and Emmett, the Performance Engineering division is obviously performing and carrying the lead. What's working there? And why is Workforce Solutions still lagging? Are there more improvements needed on the Workforce Solutions side?

Kyle J. Loudermilk

Yes, I'll take that. I guess, look, the engineering teams are doing a great job executing on projects at a higher utilization than we've seen. And we really brought a lot of scrutiny to the efforts, make sure we are focusing on high-margin business there. The business that we won in Q1, which was substantial, some of it is already starting to flow through our teams and they're working on those projects. We still have backlog, of course, depending on which line of engineering business we're in. But that's really encouraging to see to complement the team for really stepping up their performance, big self-scrutinizing around utilization rates and being disciplined, and we need to keep that focus up. For Workforce Solutions, where there are big projects, look, we're positioned to win them as we demonstrated with that large digital control upgrade and over 5,000 procedures were upgrading and updating for the customer. But the business is still in a low. And so we're keeping focus on that, understanding what we can do to be as lean as possible, while being the already position with clients for projects as they come. So that's the nature of the 2 lines of business.

Adam P. Lowensteiner

Obviously, there were some costs removed during the quarter, but are there more to be expected? And can you quantify them?

Emmett Anthony Pepe

I'll take that question, Adam. Yes. Look, we -- we've been working on cost containment measures follow and we started reaping some of the benefits, whether it's vendor renegotiation, leases that were expiring, we have been flagging all along that around this time, we -- some of those leases just ended in May, so we didn't really reap the full benefit in the quarter, but a benefit nonetheless.
There are some one-offs in there, so both some one-off reductions and some additional costs. So there's some noise. But on a go forward, a lot of the labor changes that we did were really done at the very end of the second quarter. So I expect that we'll reap more benefits going forward with the labor reductions that occurred at the end of the second quarter. So I think you'll see some stabilization. I think we should be pretty reasonably where we're at, maybe slightly better going forward the rest of the way, while maintaining those costs as we increase the business, revenue and business.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Kyle Loudermilk for any closing remarks.

Kyle J. Loudermilk

All right. Thank you. First of all, I'd like to thank everyone for joining us. We appreciate your time and interest in GSE. If you have any questions, please reach out to Adam Lowensteiner from Lytham Partners, and we'll be happy to schedule a follow-up call. And again, thank you, everyone, and have a great day.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.