GSE Systems, Inc. (NASDAQ:GVP) Q3 2023 Earnings Call Transcript

GSE Systems, Inc. (NASDAQ:GVP) Q3 2023 Earnings Call Transcript November 14, 2023

Operator: Good day, and welcome to the GSE Systems Inc. Reports Third Quarter Fiscal Year 2023 Financial Results Conference Call. [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 Lowensteiner: Thank you, Dave, and good afternoon, everyone, and thank you all for joining us today to review the financial results for GSE Systems Third Quarter Fiscal 2023 ended September 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 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 or words that are used to identify forward-looking statements, but their absence does not mean a statement is not forward-looking.

A software engineer working on web development for an e-commerce enablement project.

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’re 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 not be — 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 the SEC Regulation G can be found in the company’s earnings release. With that, I’d like to now turn the call over to Mr. Kyle Loudermilk, President and Chief Executive Officer of GSE Solutions.

Kyle, please proceed.

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Q&A Session

Kyle Loudermilk: Thank you, Adam. I’d like to welcome everyone to GSE’s Third 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 lay out the agenda for today’s call, I will start with a brief update on the industry and then highlights of our quarterly results. Emmett will then review the financial results, and we’ll conclude with the Q&A session. First, a brief update on the industry. The nuclear industry continues to gain global momentum, especially as more countries recognize that to attain certain decarbonization levels, nuclear has to be a part of the equation in accomplishing these goals.

That said, there are many macro trends in geopolitics that are causing certain shifts in the energy industry as well as other industries. On that front, due to the current inflationary environment and higher interest rates, we are seeing industry-wide pressures where our customers are reluctant to spend on projects that can be delayed. That said, customer spend is currently focused on necessary projects to keep their existing facilities running efficiently and up to regulatory requirements. As a result, GSE has won many orders this year aligned to these priorities. A little more on that later in my remarks. We believe that given the nature of the economy, nonessential projects within the power industry are being canceled or put on hold. Many clean tech projects are not providing the same economics now that interest rates are at higher levels.

Not only are the financing costs higher, but construction costs are much higher due to the inflation — current inflationary environment and labor-constrained environment. So where does that leave the industry? While interest rates fluctuate, they aren’t returning any time soon to prior levels, and as a result, we’re witnessing a shift from new project mode to need to refurbish upgrades to existing facilities. Society has come to realize the importance of nuclear for achieving clean energy goals and energy security. And as a result, the U.S. government is supporting industry from the Federal level through initiatives, including the inflation Reduction Act and infrastructure bills. The existing fleet of facilities are being recognized for the value they provide and will be relied upon for many, many years to come.

It is nearly impossible today to justify a newbuild given the economics, complexities and extended time lines associated with such an endeavor. In contrast, existing facilities can be upgraded and refurbished to produce more power over time and do so at reasonable incremental costs. The United States leads the world in the ability to produce more power from existing assets over time. GSE is well positioned to benefit from this trend, and we see that playing out. We have issued a series of press releases over the past few 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 and other — as well as announcing other engineering contracts aligned to the priorities outlined earlier.

During the third quarter, 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 is one of the largest nuclear operators in the United States and we are excited to play a critical role in this transformation. We expect client spending to ramp up on this project as they work through supply chain issues regarding their actual control systems in 2024. Other plants have announced similar plants to convert to digital controls and while it is 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 to a clear industry trend.

As plants convert to digital control systems, they’ll operate more efficiently, safely and reliably. The investment also helps sets the stage to extend the lifetime of the plants and prepare for future power upgrades. The means by which this existing infrastructure can be upgraded to produce more power. As mentioned, producing more power through upgrades is an extraordinarily cost-effective means to produce more nuclear power versus building new plants. This is a critical area of focus for the nuclear power industry and GSE is well positioned to capitalize these maintenance and upgrade opportunities. Now for some perspective on GSE’s business in Q3 of fiscal year 2023. The company performed at a much improved level during the third quarter and the financial results and new orders demonstrate that.

While the industry is still conservative with regards to capital spending, investors should take note of not only the GSE’s improved order flow, but also the diverse types of projects we’ve been awarded. Given the dampened spend from industry overall, we have focused on winning business with higher margin and that shows in our results. Other positive result in the quarter was the improved utilization of our [indiscernible] engineers. This has enabled the company to improve financial efficiencies and drive the business back to adjusted EBITDA positive. We believe we are on the right path and the third quarter results reflect that. In addition, several orders that were awarded earlier this year have commenced, and that progress is now hitting our income statement.

One project in particular that I’d like to highlight is the 5-year contract with the expansion of specialized support services to U.S. government engineering laboratories dedicated to the support of the United States Navy. This contract has been a key win for GSE and has showed growth in the services we’ve historically provided this customer. Given the nature of the services, we are able to maintain solid margins as well. This business has definitely become a cornerstone for GSE, and we are delighted to serve the mission of Navy and the Department of Energy. As expressed in the last conference call, we continue to ring cost out of the business and made key strides to lower expenses compared to the second quarter a year ago. When adjusting for onetime costs of approximately $1 million during the quarter that are nonrecurring in nature, our expenses are at a much improved level.

This helps to put the company on better footing going forward. Emmett will provide more details on our cost management initiatives in his remarks. The company’s performance Engineering division continued to demonstrate improvements with a nice stream of wins of new business, many of which we have announced during the quarter and recently wins of strategic new logos, expansion of engineering services to provide value added to a uranium enrichment company, 2 nuclear operators in Texas, just to name a few. The Performance Engineering division also is where we have our software and support sales, which were $1.4 million during the quarter and $3.7 million year-to-date, up 3% from the same period a year ago. As we mentioned in the past, the software side of the business has provided excellent margins and now represents a growing annuity.

It’s beginning to look much like a software business. New orders for performance engineering during the third quarter were $13 million, significantly higher from the second quarter, which were $4.9 million due to timing of some orders that closed in Q3 instead of Q2. With that said, year-over-year increases in orders were better for the division, which were compared to $7.2 million. We feel that this improved order flow for engineering and services and technology licenses is a leading indicator that industry is slowly ramping back. The improvement, I feel also demonstrates GSE’s tenacity in being able to develop and win more business through tight interaction with customers, and I’m proud of the team effort here and promising early results of our alignment with the market.

Our Workforce Solutions business continues to experience challenges. Segment had revenue of $2.9 million in the third quarter of 2023, sequentially lower from $3.3 million in the second quarter and compared to $3.8 million 1 year ago. While we have retooled the division as expressed in prior conference calls, the division continues to lag as customers are still being selective with regards to on-site staff augmentation services. We have aligned this business to critical new opportunities in nuclear such as the $15 million project win highlighted earlier. We’re eager for client spend on the project to ramp as their supply chain challenges get addressed. We did have some solid order flow in the quarter, which were offset by early project terminations by customers in the tune of $1.7 million.

it’s hard to predict or estimate any early project terminations, but it is an inherent part of this business as customers either complete projects or allocate funds to different projects that may be deemed as a higher priority. While these challenges persist, I’m pleased that the division despite lower volumes, reported a breakeven quarter on an adjusted EBITDA basis. This gives us some solace that the division has potential upside with customers start to ramp up spending on certain projects. To summarize, we have successfully rightsized the company in order to improve our utilization on an ongoing basis. I believe the third quarter really demonstrates that success. It was our first adjusted EBITDA positive quarter in 2 years and our strongest positive adjusted EBITDA quarter since 2020.

We continue to engage with as many customers and potential new customers as well. We are making sure that the vendor — we are the vendor of choice and educating them in the breadth of services we can offer them by using GSE as a key provider. Our recent contract wins announced over the prior weeks demonstrate meaningful progress in this dimension. Our business pipeline continues to remain strong. And while we are not in control of client decisions to move forward on projects, we are doing all we can to engage with customers and prospects and develop wins. While the industry spend is still at a very conservative level compared to prepandemic norms, things are improving at GSE for order flow on the engineering side as a result of our efforts.

Our GSE new order flow for the first 9 months so far of 2023 is $39 million. This equals the order flow for the entire year of 2022. We are optimistic this momentum will continue. I’m proud of our team’s accomplishments in driving improvement in the third quarter. I believe this demonstrates we’re focused on turning this company around. While we were — that momentum was building faster, we do continue to make progress towards achieving our goals and increasing orders, backlog and revenue growth. The new orders already received and announced in the third quarter are a step in that right direction. I’ll now turn the call over to Emmett Pepe, GSE’s CFO, who will review the third quarter financial results. Emmett, please proceed.

Emmett 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 third quarter of 2023 was $11.6 million, a year-over-year decrease of 3% compared to $11.9 million in the third quarter of 2022 and sequentially lower by 7% when compared to $12.4 million in the second quarter of 2023. The Engineering division continued to perform well for the company with revenues of $8.7 million for the third quarter of 2023. This compared to $9 million in the second quarter of 2023 and compared to $8.1 million in the third quarter of 2022. Orders for engineering performance were $13 million, which demonstrated significant increases from the $4.9 million in Q2 of 2023, which is up from last year’s $7.2 million in Q3 of 2022.

The increases are due to an improved order flow environment for engineering services as well as the timing of when the orders are received. Workforce Solutions division revenue in the quarter was $2.9 million compared to $3.3 million in the second quarter of 2023 and compared to $3.8 million in the third quarter of 2022. Orders were $1.7 million in the third quarter of 2023, which was slightly improved on a sequential basis when compared to $1.3 million in the second quarter of 2023. Looking year-over-year, the division continues to experience some challenges with revenues recorded at $3.8 million in the third quarter of 2022. The decrease in orders in the third quarter stem from early terminations we received from our clients in the magnitude of $1.7 million.

Terminations can occur depending on the scope of service, speed of project completion and other variables. The division is still experiencing some resistance from customers. We were close to monitoring this business, and we are optimistic about the book of business that is available to the marketplace. Gross profit in the third quarter of 2023 was $3.7 million or 32.1% of revenue. This compared to gross profit of $3.2 million or 26% of revenue in the second quarter of 2023 and $3.3 million or 27.4% of revenue in the third quarter of 2022. Gross margin improved over the second quarter of 2023 and third quarter of 2022 due primarily to greater percentage of engineering revenue, increased utilization and margin improvements on our large engineering projects.

Gross profit margin of 32.1% was the highest it’s been since 2016. In the beginning of Q3, we implemented a utilization initiative for the Engineering segment that has reduced unproductive labor costs and improved margins. Operating expenses, excluding depreciation and amortization in the third quarter of 2023 were $4.4 million compared to $3.8 million in the second quarter of 2023 compared to $4.5 million in the third quarter of 2022. The operating expenses in the quarter were affected by a couple of nonrecurring expenses driven primarily by a $750,000 settlement of a lawsuit stemming from a technical dispute in our workforce Solutions division and the repayment of this settlement will be done quarterly during 2024. If these expenses were not incurred, operating expenses would have been around $3.4 million, which is lower than OpEx costs of $3.8 million in Q2 of this year and the $4.4 million in Q3 of a year ago.

We are confident in the expense cutting that was conducted in the past few quarters and that the OpEx per quarter should remain at similar levels in future quarters. The net loss in the third quarter of 2023 was $2 million or a loss of $0.82 per share compared to a loss of $1.5 million in the second quarter of 2023 or $0.62 per share. The net loss in Q3 of 2022 was $9 million or $4.22 loss per basic and diluted share, which included a loss on impairment of $7.5 million. The net loss in the third quarter of 2023 also included a loss on impairment of $900,000 coming from the revaluation of the company’s Workforce Solutions business. Due to the market capitalization of the company and the slowdown in Workforce Solutions divisions, we reformed an impairment analysis on both segments of which resulted in the lowering of the goodwill carrying value of the Workforce Solutions division.

While the Workforce Solutions division has not shown the stability and growth that we would have liked, it is still a critical piece of our business and has promising opportunities moving forward, such as the $15 million project Kyle mentioned expected to ramp up in 2024. Adjusted net income was a positive $175,000 or $0.07 per share in the third quarter of 2023 compared to an adjusted net loss of $1.3 million or $0.53 per share in the second quarter of 2023. And adjusted net loss totaled $1.1 million or $0.49 per diluted share in Q3 of ’22. Adjusted EBITDA totaled positive $659,000 for the third quarter of 2023, an improvement compared to the negative adjusted EBITDA of $361,000 in Q2 of ’23 and the negative adjusted EBITDA of $690,000 in the third quarter from a year ago.

The company’s backlog improved during the third quarter to $38 million as order flow gained in the quarter primarily within the Engineering performance division. There was an improvement from $34 million at the end of Q2 of ’23 and higher than the $32 million level a year ago. Performance Engineering segment backlog was $31.4 million at the end of the of Q3 2023 compared to $26.9 million at the end of Q2 2023. It also improved when compared to the $26.9 million in the same period a year ago. Workforce Solutions division was $6.2 million at the end of the third quarter of ’23 compared to $7.5 million at the end of Q2 of this year, and then that compares to $5.6 million at the end of Q3 of a year ago. Moving our discussion to the company’s balance sheet.

We exited the third quarter with $2 million in cash, which compares to $1.8 million at the end of the second quarter of 2023. The cash levels do not include restricted cash of $1.5 million which is to secure [4 letters] of credit with various customers totaling $1.1 million and $400,000 to secure our corporate credit card program. We continue to make payments on our convertible debt secured with [Lind] and anticipate full repayment by March of 2025. We continue to review on a monthly basis the determination on whether to repay cash stock or a combination of both. And given recent improvements in the business, we’ve been paying in cash in the past 5 months. On October 30, we implemented the reverse stock split and have subsequently traded above the minimum stock price threshold for more than 10 consecutive days.

And as the company previously disclosed in its Form 8-K filed on November 3, the company expected to regain compliance with the NASDAQ listing standards on November 10. The company is now in compliance with all applicable NASDAQ listing standards, and we received a confirmatory letter to that effect from NASDAQ this afternoon. While we are still working in a challenging environment, we continue to examine every expenditure and will reduce costs where we can to preserve our cash position. That said, we have reduced our expenditures by roughly $1 million per quarter as compared to 1 year ago. And I’ll reiterate that while there is always some quarterly shifts of costs, lowering our quarterly expenses to around $3.4 million. We are optimistic that the company can book additional orders in the coming months, which will improve our utilization and result in improved cash flow.

I’ll now turn the conversation back to Kyle.

Kyle Loudermilk: Thank you, Emmett. To summarize, the third quarter demonstrated improvements to the business as we removed additional costs, and we’re able to drive better efficiencies through our engineering division. We’re laser-focused on winning more business where we can, and this has been seen in recent wins we announced during the fourth quarter. We’re cautiously optimistic about the remainder of the year in the longer term. While we’re doing what we can during this continued lull in industry spend, we remain positive that in the longer term that the nuclear industry is undergoing a long-term resurgence for the reasons we outlined on this call. There are 3 key drivers to this such as the future — for the future of the nuclear industry.

One, the need for a stable grid; two, the drive towards energy security and independence; and three, and not least, the decarbonization of the power sector. Given GSE’s unique positioning as a heavily tech-enabled provider of the essential services to the nuclear power industry, we remain optimistic in our opportunity to create substantial long-term value. With that said, Adam, please proceed with the question-and-answer session. Or operator, first, you may wish to open it up to anyone on the call. And if we don’t, Adam, you can ask some questions.

Operator: [Operator Instructions] At this time, we are showing no questions. Would management like to.

Adam Lowensteiner: Dave, it’s Adam Lowensteiner from Lytham Partners. I’ll ask a few questions in the meantime. Kyle, order flow improved nicely in the quarter. Can you discuss the quality of your orders and how your margins are improving as a result?

Kyle Loudermilk: Yes. Good question, Adam. Thank you. Look, the order flow has really improved on the engineering side. We have a great team leading the 3 lines of business: simulation, we have our design and analysis group, and we have our programs and performance. And we’ve seen very solid quarter across the board, including winning new logos, such as the uranium enrichment provider which is a mission-critical program for the United States to produce its own HALEU and light-enriched uranium. And that’s been a great relationship that keeps growing. Likewise, we recently announced these 2 wins in — to be — provide engineering services to 2 significant nuclear power operators in the state of Texas. And again, we feel this is just the momentum is building.

So that order flow has been solid because it’s on the engineering side, that explains our improvement in gross margin. Engineering margin is much higher than the Workforce Solutions side of the house. And so we expect that trend to continue.

Adam Lowensteiner: You’ve had a very good diversification of services provided on the engineering side of the business. This shows some great depth at GSE and as well as the industry. How many more types of these contracts exist? Could potentially every nuclear plant operator have a need for the various service wins that you’ve been awarded recently? .

Kyle Loudermilk: Yes. Another good question, Adam. The fact of the matter is we are aligned to the key drivers as a company. GSE is a purpose-built company that is aligned to the critical drivers that are leading the nuclear plant operators to make investments in extending the lifetime of the plants. And therefore, also applying for lifetime operating license extension. So in extending lifetime of the plants through operating license extensions and investing in their plants to produce more power from those plants over time versus building new nuclear power plants. Those are 2 things that we’re already aligned to as a business. We really took advantage of what we could during COVID to make sure we put in commercial infrastructure throughout new customers and existing customers.

And as they start to head down the path to spend on these 2 dimensions, spend the lifetime to the plant, produce more power, every plant should be taking about what GSE has to offer. And we’re still a small company. call it, $50 million-ish. But the amount of engineering services consumed by the U.S. nuclear fleet by conservative estimates could be as much as $0.5 billion a year and then some. So we’re a small player in what has a very large, served available market. And so there’s a lot of upside ahead for us as we execute and deliver, improve our quality and customer value.

Adam Lowensteiner: What’s the feedback from salespeople with regards to the project flow? It seems although a bit lumpy that the tempo bidding has improved. Is that correct? .

Kyle Loudermilk: I’d say, it’s a little multidimensional. What we see is, by and large, and this is — we’ve done our own channel checks with other vendors that serve the nuclear power industry as well as from customers and prospects that we deal with. They’re in a very conservative spend mode. They’re only spending money where they have to spend money either to keep up with regulatory compliance issues or to address these critical projects around addressing lifetime extension and/or preparing to invest more in the plants to produce more power. Other than that, it’s really noise. So what we see from the industry is conservative, focused on 2 things, very cautious about how they’re moving forward. And so the only way we can affect that is to be in front of these customers on a regular basis, make sure they’re aware of our story and capabilities, make sure that what we’re doing for them is delivered on time, on budget and of high quality, but they are building their confidence as they get to know GSE and that improves our likelihood of giving us the next opportunity.

Adam Lowensteiner: The company has done a great job in rightsizing itself and getting expenses down. Are there any more cost cuts to be had? .

Emmett Pepe: Adam, this is Emmett. I’ll take that one. I think it’s important to note, we positioned ourselves through the actions we’ve taken that. As the company grows, we will not need to add any significant costs, right? So that’s an important aspect, I believe we always look — we changed the culture. We’ll continue to monitor our utilization and not let that slip. And vendor spend is always something we’re going to look at. As the supplier agreements come up for any renewals, we’ll look to take costs out of the business on an ongoing basis for sure.

Kyle Loudermilk: Well, look, thanks for joining us, everybody. Just to make some conclusionary remarks here. We really appreciate your time and interest in GSE. And I think we’re headed in the right direction. And this quarter can demonstrate where we’re headed. If you have any questions, please reach out to Adam Lowensteiner from Lytham Partners, and we’d be happy to schedule a follow-up call. We’re always available. Thanks again, everyone, and have a great day. .

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