GSE Systems, Inc. (NASDAQ:GVP) Q4 2022 Earnings Call Transcript

GSE Systems, Inc. (NASDAQ:GVP) Q4 2022 Earnings Call Transcript March 30, 2023

Operator: Good afternoon, and welcome to the GSE Systems Reports Fourth Quarter and Fiscal Year 2022 Financial Results Conference Call. All participants will be in a listen-only mode today. . Please note that this event is being recorded today. I would now like to turn the conference over to Adam Lowensteiner, Vice President at Lytham Partners. Please go ahead, sir.

Adam Lowensteiner: Thank you, Joe, and good afternoon, everyone. Thank you all for joining us today to review the financial results for GSE Systems for the fourth quarter and fiscal year ended December 31, 2022. 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 or 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 now like to turn the call over to Mr. Kyle Loudermilk, President and Chief Executive Officer of GSE Solutions.

Kyle, please proceed.

Kyle Loudermilk: Thank you, Adam. I’d like to welcome everyone to GSE’s fourth quarter and fiscal year 2022 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 lay out the agenda for today’s call, I will start first with a brief update on the industry, then discuss GSE’s business in the quarter and fiscal year across our lines of business. And finally, provide a summary of our focus on sales and revenue generation. Emmett Pepe, our CFO, will review the financial results, and we’ll conclude with a Q&A session. So first, a brief update on the industry.

As I’m sure many of you have seen, the nuclear industry is in the early stages of what promises to be a long-term resurgence. Nuclear power is being universally recognized as a critical energy source for national security and achieving carbon reduction goals. Both, conservative and liberal political parties, support the emerging renewal of nuclear power. Countries in Eastern Europe are actively planning for building traditional reactors and SMRs. In the United Kingdom, there has been discernible progress to advance the development of SMRs as well as potential new builds of traditional reactors. As we’ve discussed either way, the path to consistent clean power is through nuclear. In the United States and Canada, significant planning is underway for projects that will extend the lifetime of existing facilities, undertake capital investment to produce more power from those facilities, and we have seen announcements regarding advancing construction of SMRs, most notably from NuScale and GE Hitachi.

The recent start-up of the Vogtle 3 nuclear reactor in Georgia is the first nuclear reactor to go critical in seven years in the United States and the first new build in 30 years. Unit 3 is expected to come in the full service over the next few months and Vogtle Unit 4 is nearing completion and expected to start up early next year. This is a great achievement for Southern Company and for the industry. As I mentioned, another area of focus for the industry is applying for license extensions for existing nuclear reactors. Due to recent legislation, including the Inflation Reduction Act, there are now more incentives to keep these facilities operational and invest in them to produce more power through capital improvement. The IRA has offered the nuclear industry a path to generate a reasonable return to produce the consistent and clean power from nuclear going forward.

The funding is meaningful and has helped transition the mindset of facility operators from considering shutting down five years ago to maintaining, upgrading and extending the lifetime of the plants. As an example, Xcel Energy’s North States Power in Minnesota recently applied for a 20-year operating license extension for its Monticello reactor, which currently runs through 2030. This would be the facility’s second 20-year extension. And if granted, would keep the facility open through 2050. Most facilities are granted an initial lifespan of 40 years and then, it can apply for extensions usually in 20-year increments. So far in the United States, six nuclear plants have received extensions to reach 80 years, and an additional 25 have applied for or have indicated that they will be seeking license renewals.

All these facilities will require significant engineering work for programs, maintenance and capital improvements to continually extend the operations for those plants and over time, likely apply to produce more power given the incentives in place to do so. So looking forward, the industry also continues to focus on next-generation reactors known as small modular reactors or SMRs. There’s lots of investment in the industry to make SMRs a reality in the years to come. As the industry moves towards the commercialization of SMRs, GSE remains a key partner for the industry and ready to help in delivering SMRs to the marketplace. As many of you are already aware, NuScale, a publicly traded company under the ticker SMR, is a long-term partner of GSE, and we’ve been working with them for over 10 years in helping them with their development of SMRs. We announced during the fourth quarter and early this year, the contracted work we have won to help them develop a hydrogen plant model for their Voyager SMR.

Hydrogen will be a critical fuel for the energy transition that has begun and it’s very exciting for us to be involved at the front-end of this transition. The macro-output for nuclear energy industry continues to remain strongly positive. Global awareness, the importance of nuclear power for energy security, environmental equity and grid reliability is driving further action to sustain existing nuclear power fleets, produce more power from those assets and accelerate the path towards adoption of next-generation nuclear power technology. While it takes significant time for the industry to move through the planning process to project execution and spending, we feel that the industry is entering a major cycle of long-term investment and growth barring any major disruptions.

Now for some perspective on GSE’s business in Q4 and fiscal year 2022. Fiscal 2022 is a transitional year for GSE. We had to make key changes and investments to position the company for future opportunities, all the while keeping a lid on overall costs and remaining as lean as possible. While the company’s performance needs to improve, we have entered 2023 having retooled key components of the business and with some key wins and momentum. Looking at the fourth quarter, it was a solid showing considering we’re expecting better order flow and experienced some slippage into the first quarter. This has pushed things to the right, but the good news is that the business that slipped from Q4 did close in early Q1, and we are starting to bid on more opportunities.

The company’s Performance Engineering division continued its charge during the fourth quarter and fiscal year. Revenues for the fiscal year climbed 6.3% for the division, approximately to $30 million led by systems and simulation. The solid performance of the Performance Engineering division included strong license revenue, which helped improve our gross margins year-over-year and sequentially from the third quarter. We continue to win new business in this division. Project order flow in the quarter was lower than expected, but as mentioned that was primarily the result of key orders slipping from Q4 into early Q1 in 2023. Despite this, we recorded important wins during the quarter, primarily for simulations and systems services as well as for programs and performance services.

A major deal that closed in early Q1 is the renewal contract that includes a meaningful expansion of services with two U.S. government engineering laboratories dedicated to the support of the U.S. Navy. This is a five-year contract that has options to make it worth up to $28 million over that time. GSE has been under a series of service contracts with these laboratories for over 20 years, and this renewal is a testament to the strong relationships we have created with these laboratories and the services delivered to them over that time. We are proud to serve the mission of these important national assets. Another important award that slipped from Q4 to Q1 was a new contract in partnership with the nuclear fuel technology and services supplier to support a large U.S.-based utility with new engineering program services to support a 24-month fuel cycle operation project.

Moving to a 24-month fuel cycle from a more typical 18 months is not an easy task, but when accomplished, can help the operator make the plant more efficient and create major cost savings. We are excited about this win as it also shows the breadth of the capabilities GSE can offer customers, while positioning us as a leader as we work to win similar opportunities with other operators and plants moving forward. Another significant win is the recent announcement of the upgrade of the training simulators at the Olkiluoto nuclear power plant in Finland. This contract, which is worth nearly $900,000 is expected to deliver key new capabilities for TVO once completed over the next two years. I’m really excited about these wins, and they are an excellent cross-section of the credibility we’ve built in the industry and the types of different offerings and services only we can uniquely offer to the industry.

Moving to our Workforce Solutions business. It’s been a challenging year, and the results demonstrate the issues we’ve had to overcome. Revenue was $3.3 million for the fourth quarter and $17.8 million for the year, both lower on a year-over-year basis. That said, we have been extremely busy retooling the division during 2022 and have made significant progress in rebuilding the sales and recruiting teams for this business. We are currently in the midst of turning around the division and are starting to see early returns on the investments and improvements we’ve made. While there’s more work to be done, a major positive was that during the fourth quarter, we did see new order flow improve from the third quarter. Now I’d like to discuss our focus on sales and revenue generation.

While revenues weren’t at our historic levels, this was due to customers remaining in the planning versus the execution stage for capital spending on their facilities, it’s frustrating. And as a result, we’re still eager for spending to recover to pre-pandemic levels. GSE was busy, however, during the year to make certain changes and investments and put the company on better ground with retooled capabilities and with new talent. Our most recent announcement on this front has been the hiring of Ray Hruby as our new Head of Sales for the company. As I mentioned on prior calls, GSE was in need of the new Head of Sales and finding that right person would take some time. We’re delighted to have Ray on board. He brings over 40 years of experience in nuclear and deep industry relationships for project engineering into our company.

He’s begun to get us in front of companies at executive levels to get GSE known at that level and to put us in a prime position as capital spend for engineering services starts to improve. So to summarize, we’ve made good progress during the fourth quarter and fiscal year, continued strong license revenue accompanied by recent improved orders and bookings are the result of getting out in front of customers and being aggressive to win the business that is available to us, while setting the stage to capture more business as industry spend recovers. We’re focused on targeting investment in revenue-generating positions and activities. The team is highly motivated, taking ownership of what we can control, and we’re moving forward. The many exciting developments in the industry right now continue to make me feel confident about our future.

I’ll now turn the call over to Emmett Pepe, GSE’s CFO, who will review the fourth quarter financial results. Emmett, please proceed.

Emmett Pepe: Thank you, Kyle. With the numbers highlighted in detail on the press release, let me focus my comments on a few areas and provide added color where I can. We’re pleased with the progress that we are seeing in our order flow for Q4 despite some significant deals slipping into Q1 of ’23. Gross orders for the quarter were $12.7 million, offset by $1.3 million of unused backlog on completed projects. The net orders amount of $11.4 million was a 12% increase from the prior quarter. We are starting to see the early signs of the investments that were made into the business development functions of each segment. Revenue during the fourth quarter of ’22 was $10.8 million, a decrease of 22% compared with $13.9 million in the fourth quarter of 2021 and 9% lower when compared to the $11.9 million in the third quarter of 2022.

Revenues from the company’s Performance Engineering were improved during the fourth quarter, rising 10% year-over-year but slightly lower sequentially from the third quarter of 2022. These improvements were offset by lower revenues from the Workforce Solutions division due to interim reduction in customer demand. Our Performance Engineering division continued to perform well for the company with revenues of $7.5 million for the fourth quarter of 2022, this compared to $8.1 million in the third quarter of 2022 and compared to $6.8 million in the fourth quarter of 2021. Orders for this division were lower in the fourth quarter down to $4.6 million when compared to the third quarter of 2022, which was $7.2 million, and lower when compared to the fourth quarter of 2021 when it was $7.4 million.

As Kyle mentioned briefly, we did experience some new order slippage into the first quarter and as the large order with the U.S. Navy closed during the fourth quarter, new orders — had the large order closed in the fourth quarter, new orders would have improved both, sequentially and year-over-year. Revenues in the quarter were slightly lower on a sequential basis from the third quarter due to completion of certain projects but was higher year-over-year due to more revenue within the company’s Systems and Simulation division which has been executing on backlog projects. Our Programs and Performance division, previously known as True North Consulting, showed consistent flow of revenues from prior quarter and was up slightly from a year ago.

Moving forward, we remain optimistic about the opportunity pipeline for this division. The Design and Analysis division previously known as DP Engineering, was basically in line from the third quarter and a slight decline from the fourth quarter of 2021. We are actively working this business unit to expand its reach and customer base and are encouraged by the feedback we received from customers. Now moving to our Workforce Solutions division. Revenue in the quarter was $3.3 million compared to $3.8 million in the third quarter of 2022 and compared to $7 million in the fourth quarter of 2021. Orders were significantly higher in the quarter on a sequential basis at $6.8 million, up 127% from the $3 million in the third quarter of 2022, but still lower from the fourth quarter a year ago when they were $10.5 million.

As previously discussed, during the fiscal year 2022, we have been busy retooling the division with new sales and recruiting hires to build a balanced and productive group that can bring in new customers and recruit build professionals to fill roles. We are excited about the potential opportunities that this group has identified and have made some progress as seen in the improvement in the new orders for the division during the fourth quarter. Gross profit in the fourth quarter of 2022 was $3.1 million or 28.2% of revenue. This compared to gross profit of $3.3 million or 27.4% of revenue in the third quarter of ’22 and $3.1 million or 22% of revenue in the fourth quarter of ’21. Gross margin improved due to project mix, including the benefit of our software sales and more revenue coming through Performance Engineering division, which carries higher margins.

While revenues were lower at Workforce Solutions, the margin were 16.2% in the fourth quarter, roughly flat compared to the year-ago period and slightly up from the third quarter’s 15.7%, but delivering at the higher part of that range that this division typically yields and showing the higher quality of orders coming through. We have seen an increase in direct hire placement activities, in part due to the current labor environment, but also as a result of our retooling the sales and recruiting team in Workforce Solutions segment. We are excited about growing this piece of our business as it delivers much higher margins than our traditional staff augmentation business. Operating expenses, which excludes restructured depreciation and amortization expense, in the fourth quarter of 2022 were $3.9 million compared to $4.5 million in the third quarter of 2022 and $4.6 million in the fourth quarter of 2021.

The decrease in Q4 was partially due to tighter expense controls. As we look into 2023, we are taking a critical look at our expenses and believe we have identified additional cost containment measures. As we have mentioned on previous calls, 3 facility leases are ending in a few months, which will provide an opportunity to decrease our physical footprint and our fixed costs. We’re also more generally assessing our vendor spend with an eye on improving our cash flow. Net loss in the fourth quarter of 2022 was $1.5 million or a loss of $0.07 per share compared to a loss of $1.9 million in the fourth quarter of 2021 or a loss of $0.09 per share. Adjusted net loss was $1.1 million or $0.05 per share in the fourth quarter of 2022 compared to an adjusted net loss of $1.1 million and $0.05 per share in the fourth quarter of 2021.

Adjusted EBITDA showed some improvement with a loss of $407,000 in the fourth quarter compared to a loss of $1.1 million in Q4 of 2021 and a loss of $690,000 reported in the third quarter of 2022. The company’s backlog remained healthy at the end of the quarter, but greatly improved subsequent to the quarter end due to some key new orders received, as Kyle mentioned previously. The backlog at the end of the fourth quarter was $32.9 million, a slight improvement when compared to the $32.3 million at the end of the third quarter of 2022, as the company was able to secure additional new orders during December. Backlog levels at December 31, 2021, totaled $41.3 million. The Performance Engineering segment backlog was $23.8 million, and Workforce Solutions division was $9.1 million at the end of the fourth quarter and compares to $26.7 million and $5.6 million, respectively, at the end of the third quarter.

Backlog for Performance Engineering division was $31.8 million at the end of the fourth quarter of 2021 and $9.5 million for Workforce Solutions at that same period. These backlog figures really highlight the company’s performance. While the company has burned off some older orders and reported a lower backlog versus the year ago period, there were a few orders that closed in that first quarter of ’23. And when added to the backlog levels at the end of ’22, which show a sizable improvement in backlog levels, getting the company back to levels similar to a year ago period, giving us an excellent starting point for 2023. Moving our discussion to the company’s balance sheet. We exited the fourth quarter with $2.8 million in cash and that compares to the $3.6 million at the end of 2021.

The 2022 cash levels do not include restricted cash of $1.6 million, which is to secure four Letters of Credit with various customers totaling $1.1 million and $500,000 to secure our corporate credit card programs. We continue to make payments on our convertible debt secured in February of 2022. On a monthly basis, we make a determination based on our cash balance and cash forecast on whether to repay cash, stock or a combination of both. Payments on the convertible debt will be completed in February of 2024. The company had $1 million of ERC refunds outstanding at the end of the fourth quarter. We did receive $900,000 this past January, and we are expecting to receive the remaining ERC refunds from the IRS in the next three to six months of approximately $100,000.

At this point, we have successfully received the majority of our ERC refunds to this point. While we are still working in a challenging environment, I am pleased with the actions in the fourth quarter and fiscal 2022 to maintain solid capital structure. And the results demonstrate that the company has stabilized and prepared for future growth. I’m also proud that we made the necessary investments and changes internally to improve our back office. These improvements, which include the completion of our ERP systems migration project will help the company moving forward and put us in a solid position to be awarded more business. In addition, we have additional efficiencies we believe we can put into place and are currently examining our options to lower the company’s costs.

We also want to remind investors that in addition to the leases that run off during 2023, we anticipate that there will be further cost containment capabilities, and we will report on those when appropriate. I’ll now turn the conversation back to Kyle.

Kyle Loudermilk: Thank you, Emmett. To summarize, the fourth quarter and fiscal year financial results were periods of rebuilding and investment to prepare the company for new opportunities and the renewal in the nuclear industry. The company performed well in the Engineering division that we made strides in retooling our Workforce Solutions division evidenced by better order flow in the fourth quarter. Continue to get in front of customers and work with them through the current challenges of high inflation and economic uncertainty. And we are performing and executing on what is in our control and making sure we are positioned well for future opportunities. We continue to meet with customers and potential customers more frequently to make sure we promote what GSE can do and add value to their operations.

Three key catalysts are still at the forefront for driving growth for nuclear industry, the need for stable grid, drive towards energy, security and independence, and decarbonization of the power sector. These catalysts that give us confidence that the nuclear industry will be increasingly in demand for the foreseeable future. Given our very unique situation as a heavily tech-enabled provider of essential services, to the decarbonization of the power sector and nuclear industry, we remain very confident in our opportunity to create substantial long-term value. With that said, Adam, please proceed with the question-and-answer session.

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Q&A Session

Operator: .

Kyle Loudermilk: Adam, I know you had a couple of questions that you had teed up. Why don’t you go ahead and ask those?

Adam Lowensteiner: Sure, Kyle. The large order with the U.S. Navy, maybe can you discuss, is that incremental in value compared to the last contract signed five years ago?

Kyle Loudermilk: Yes, it’s a good question. It is. It has increased in its annual value potential to GSE for this contract. Again, a real testament to the team that’s been doing a great job there and really unique capabilities, we’re working on for Navy and proud to serve that mission. We also have additional contracts with Navy, which have evolved over the past five years. So in addition to the significant contract, there are other contracts in parallel that we both, created and now are executing on. And so this is a great relationship, very grateful for the opportunity to serve Navy. And so that was a good question, Adam. Thank you.

Adam Lowensteiner: Kyle, you mentioned in the last call about a trip to Japan. How is the trip? What are the opportunities there like?

Kyle Loudermilk: Right. We have really been on the road, myself personally non-stop from August through December and, of course, engaging with clients even when not on road. But really have been underway the entire time and had the opportunity to line-up a series of visits with customers and prospects in Japan and for early to mid-December. And it’s really interesting, Japan is very committed. This was right after Japan opened up after COVID. So they opened up about a year later than the United States. So we were on one of the first flights out there to get in front of customers, work with the U.S. Embassy. I’d like to thank them and Department of Commerce for helping us establish new relationships in nuclear in Japan with new people.

And industry is very eager to start up more of their reactors, but that’s a very slow pace. So they also really are looking to us to work on implementing some data validation and reconciliation and thermal performance studies for their plants. That’s really to understand how they can produce optimal power from their existing assets that are up and running as well as there’s some nice simulation project work that is ahead of us.

Adam Lowensteiner: You mentioned that there were some new orders that came in Q1 and were supposed to close in Q4. How should investors view the improved backlog? Can you give us any additional color there?

Emmett Pepe: Hi, Adam. It’s Emmett. I think as I mentioned on the call, I think color is that we have a strong pipeline and a lot of times, the stuff does shift. I think the good news is that those deals closed early in the quarter. And as mentioned on the call, I think it puts us back in line with our historical backlog levels from 2021. And I think the bigger thing is, we’re now positioned right out of the gate in 2023 with a strong order at the beginning of the year.

Adam Lowensteiner: And one more question. Can you give us an update with the NASDAQ requirements and company plans to get back into compliance?

Emmett Pepe: I think for that, Adam, I would just reference the 8-K that we filed last November when we initially received the notice that company has until May 3. We can request an extension, and if we don’t get that, we can appeal it. I think we’re just going to follow what’s been laid out in the 8-K and as any information changes, we will communicate that.