Kyle Loudermilk - President and CEO Jeff Hough - CFO Chris Sorrells - Interim COO Kalle Ahl - The Equity Group

Greetings, and welcome to the GSE Systems' First Quarter 2016 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Kalle Ahl. Thank you. You may begin.

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 Securities and Exchange Commission, including those set forth in periodic reports filed under the forward-looking statements and the 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 and adjusted EBITDA which are not measures of financial performance under generally accepted accounting principles or GAAP. Management believes EBITDA and adjusted EBITDA in addition to operating profit, net income and other GAAP measures are useful to investors to evaluate the company’s results because they exclude certain items that are not directly related to the company’s core operating performance that may or could have a disproportionate positive or negative impact on the company’s results for any particular period. Investors should recognize that EBITDA and adjusted EBITDA might not be comparable to similarly titled measures of other companies. This measure 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 EBITDA and adjusted EBITDA to the most directly comparable GAAP measure in accordance with SEC Regulation G can be found the company’s earnings release and on its Web site. I’d now like to turn the call over to Mr. Kyle Loudermilk, Chief Executive Officer of GSE Systems. Kyle, please go ahead.

Thanks, Kalle, and good afternoon. I’d like to welcome everyone to GSE Systems’ first quarter 2016 earnings conference call. Also on today's call are Chris Sorrells, our Interim Chief Operating Officer and Jeff Hough, our CFO. Earlier today, we issued a press release covering our first quarter 2016 financial results. Hopefully, you had a chance to review the news release. But if you have not, a copy can be found on our Web site at www.gses.com under the Investor Relations section. Today, we reported our second consecutive quarter of positive adjusted EBITDA, operating income and net earnings. In spite of some unusual non-recurring expenses during the first quarter of 2016, our operating performance significantly improved over the prior year, primarily due to our efforts to reduce costs and focus on project profitability. Jeff will provide a recap of our first quarter financial results later in the call. Among our accomplishments this quarter, we won a major contract to design, engineer and deliver three full scope simulator systems to one of our longstanding nuclear power plants. This was one of the larger contracts to come up for bid in the North American market in recent years, and we believe our established track record, deep technical knowhow and unique technology platform helped us win the business. We have commenced work on this project and expect to deliver three reference plant simulators over the next 18 to 24 months. We started recognizing modest revenue from this project in the first quarter but expect revenue to significantly ramp starting in the third and fourth quarters. As previously mentioned, we are acting as prime on this contract, which makes GSE responsible for ordering and assembling hardware resulting in lower gross margin and our typical margins for our Performance Improvement segment. Our quarter end backlog increased 56% to $74.5 million, the highest level in GSE’s history from 47.9 million at the end of last year, driven by the large contract for full scope simulators we won in March 2016. We are pursuing a number of new business development initiatives to strengthen our backlog further. Globally, we are seeing the greatest activity in the United States followed by our international divisions focused on China, Korea as well as Japan as the country restarts their nuclear reactors. In addition, we are optimistic about key industry initiatives such as NEI delivering the nuclear promise for ongoing identification of efficiency improvements and innovation that can be implemented at nuclear power plants. Delivering the nuclear promise has a goal of achieving a meaningful reduction in the cost to produce electric power from nuclear energy and to do so by 2020. In order to achieve this goal, operators much streamline CapEx, O&M and nuclear fuel getting more from their asset base through efficiency gains and innovation. GSE’s people, knowhow and technology platform ideally position us to take advantage of this and similar initiatives to deliver significant value to the industry. To address these and other opportunities, we continue to build out our team and focus for growth. On that note, this quarter we appointed Sean Fuller as GSE’s new SVP of Sales. Sean, a former General Electric sales executive has extensive experience selling globally to the power industry and in particular to the nuclear sector. We are extremely excited to have Sean on board and are already benefitting from his 25 years of experience running global sales forces. In summary, over the past nine months, we have significantly improved GSE’s cost structure, streamlined our operations and filled critical leadership positions to revitalize growth. Backlog has increased materially since the start of the year and following a strain of more than three years of quarterly losses, we have reported two consecutive quarters of positive adjusted EBITDA, operating income and net income. With the majority of our operating initiatives in place, we can now focus on our growth strategy. As I have mentioned in past calls, we have been formulating a growth gain plan. We expect to provide a longer term operating model as we move forward. For now, I can tell you that we are evaluating a combination of exciting new organic and inorganic opportunities while continuing to build our current book of business. While we experienced period-to-period variability as we implement our growth plan we expect to deliver positive adjusted EBITDA in 2016. I now would like to turn the call over to Chris Sorrells, our Interim COO, who will provide some additional color on our growth strategies. Chris, please go ahead.

Thanks, Kyle. As we’ve discussed on prior investor calls, our leadership team primary focus during our first year was on three main primaries; one, stable the business allowing the core asset to shine. Our results show our progress to-date. Two, enhance our senior leadership team to accelerate our ability to execute. That process is nearing completion. Three, establish GSE as a platform upon which to grow, clearly articulating a three to five-year growth strategy that is compelling to our customers, employees and shareholders. Having made significant progress on our first two priorities, we are now able to focus our attention to leveraging GSE as a platform from which to grow. At this time, we can frame our approach to identifying and evaluating investment decisions and/or acquisition candidates. First, let me reiterate. Philosophically, we remain extremely careful in our capital allocation decisions. We have a strong balance sheet and will only deploy our cash in a selective and disciplined manner. Management is highly aligned with shareholders and while equity will be a component of future deal structures, it will be utilized in a responsible manner. Our approach will be to pay a fair price, ensure that we have aligned interest in issuing equity as a component of consideration and swiftly integrate the company. While we have spent the majority of our time up until now improving the operational aspects of the business, we have also made progress in developing our growth strategy. To-date, we have built a robust pipeline of potential acquisition targets. To give you an idea, our internal database includes information accumulated on more than 75 acquisition candidates. So there is reasonable doubt to potential deal flow, and now the question becomes can we acquire companies that advance the growth thesis and do so at market base terms and conditions while being accretive. We are active in the process and have started looking at potential deals. This is very exciting. Currently, we see a number of attractive opportunities in software and the power sector in particular, a key area of focus. We are also looking at businesses that could expand our training and consulting platform. These are just a few examples but broadly speaking we’ll be looking at natural adjacencies for our business. The five main criteria that will guide us during the evaluation process include the following. One, earnings accretion. We will prioritize deals that deliver immediate and near-term earnings accretion. Two, strong business fundamentals. We are seeking target companies with favorable fundamentals, including but not limited to, one or more of the following qualities; stable reoccurring revenues, strong free cash flow potential, relatively high margins and/or proprietary technology and knowhow. Three, strategic fit. We are partial to opportunities that are highly complementary to our current business with a high degree of cross-selling potential and capacity to the leverage of global footprint in the power and process industries. Four, potential for synergies. We will favor opportunities in which we have identified significant high probability, revenue, growth and cost synergies. Five, ease of integration. We will access all transactions for ease of integration evaluating factors such as business model, caliber of management team, ultra, et cetera. While it is still early, we wanted to provide you with 10,000 foot view of a very exciting growth strategy we are advancing. With that, I’ll now turn it over to Jeff for his review of the quarter.

Thanks, Chris. I will begin with a review of backlog and new business. As Kyle mentioned, we ended the quarter with record backlog of 74.5 million, up 56% from backlog of 49.7 million at December 31, 2015. Our backlog at the end of Q1 2016 includes 67.6 million of Performance Improvement Solutions backlog and 6.9 million of Nuclear Industry Training and Consulting backlog. In the first quarter of 2016, our Performance Improvement Solutions bookings totaled 34.8 million compared to 11.1 million in the first quarter of 2015, an increase of over 200% with orders across multiple sectors and multiple geographies. New Performance Improvement Solutions contracts in the first quarter of 2016 included 30.1 million for simulator upgrades and services in the nuclear power market, 3.6 million for new full scope simulators and other projects in the fossil power market, 0.7 million for various tutorials and simulators for customers in the oil and gas industry and 0.4 million for miscellaneous engineering services and training projects. Nuclear Industry Training and Consulting orders totaled 5 million in the first quarter of 2016 compared to 7 million in the first quarter of 2015. Now on to a review of our financial results for the first quarter. Total revenue for the first quarter of 2016 was 13 million compared to 14 million in the first quarter of 2015. Performance Improvement Solutions revenue remained flat at approximately 8.8 million in both the first quarter of 2016 and 2015. Nuclear Industry Training and Consulting revenue was 4.1 million in the first quarter of 2016 compared to 5.2 million in the first quarter of 2015. Gross profit in the first quarter of 2016 was 3.6 million or 27.9% of revenue, up from 3.3 million or 23.5% of revenue in the first quarter of 2015. Performance Improvement Solutions gross profit was 3.1 million or 35.6% of revenue in the first quarter of 2016 compared to 2.8 million or 31.4% of revenue in the first quarter of 2015. The 420 basis point increase in gross margin namely reflected a decrease in overhead costs from 1.2 million in the first quarter of '15 to 0.8 million in the first quarter of 2016. This reduction mainly reflects a reduction in operations personnel in conjunction with the company’s 2015 restructuring. Nuclear Industry Training and Consulting gross profit was 0.5 million or 11.6% of revenue in the first quarter of 2016 compared to 0.5 million or 10% of revenue in the first quarter of 2015. SG&A expenses in the first quarter of 2016 was 3.1 million, down 5% from 3.3 million in the first quarter of 2015. SG&A was lower in the first quarter of 2016 primarily due to the beneficial impact of our companywide cost reduction program partially offset by the following items. A 220,000 increase in audit tax and legal costs, a 208,000 increase in accrued employee bonuses tied to achievement of year-end 2016 audited financial metrics and 152,000 in higher consulting costs relating to improving our revenue recognition for our software products. Operating income for the first quarter of 2016 was $215,000 compared to an operating loss of 324,000 in first quarter of 2015. Pre-tax income for the first quarter of 2016 was 226,000 compared to a pre-tax loss of 384,000 in the first quarter of 2015. Provision for income taxes was 88,000 in the both the first quarter of 2016 and 2015. Net income for the first quarter of 2016 was $138,000 or $0.01 per basic and diluted share compared to a net loss of 472,000 or $0.03 per basic and diluted share in the first quarter of 2015. EBITDA, earnings before interest, taxes, depreciation and amortization, for the first quarter of 2016 was $372,000 compared to an EBITDA loss of 159,000 in the first quarter of 2015. Excluding gains from the change in fair value of contingent consideration, restructuring charges, stock-based compensation expense and consulting support for revenue recognition analysis, adjusted EBITDA in the first quarter of 2016 was 753,000 compared to an adjusted EBITDA loss of $8,000 in the first quarter of 2015. GSE’s cash position at March 31, 2016 was 11.2 million excluding 3.6 million of restricted cash as compared to cash and equivalents of 11.1 million excluding 3.6 million of restricted cash at December 31, 2015. At the end of the first quarter, we have no long-term debt and working capital of 9.8 million. I’ll now turn the conversation back to Kyle.

Thanks very much, Jeff. I’ll now ask the operator to open the floor for questions.

At this time, we will be conducting a question-and-answer session. [Operator Instructions]. Our first question comes from Larry Kaplan from LK Management [ph]. Please go ahead.

Hi, Kyle.

Hi, Larry.

A question, why the great difference from the fourth quarter to this quarter as far as EBITDA and operating income, and is that something we can expect in the oncoming quarters different gyrations in earnings or will it spot the level off a little bit? And what kind of EBITDA do you think we can expect for the balance of the year?

Okay. In the fourth quarter, the company had one large hardware shipment. It was an item that we recognized upon shipment versus our normal POC revenue recognition. And that particular order had around a 60% gross profit. So, obviously, it had a very significant impact on our earnings in the fourth quarter. And obviously there was nothing comparable to that in the first quarter of '16. But I would say going ahead forward, as we look at EBITDA, we would assume you’d see something comparable to the first quarter. We’re expecting net income probably to fluctuate not wildly as we have the cost cutting efforts have taken effect and we’re continuing to build our pipeline and increase our revenues going forward.

And what would be the normalized earnings in the first quarter? Would that be the 700,000?

Well, the adjusted EBITDA would be the 700k, Larry. Is that what your question was?

Yes. So going forward, the adjusted EBITDA would – because there shouldn’t be anything extraordinary in the second, third and fourth quarter would be in that area. Is that --?

Larry, it’s Chris. I think as we said on the fourth quarter call, the company as you well know is coming out of a turnaround. And there have been lots of opportunities for us to overlay best practice and to drive enhanced operating performance. And I think you can see the work that Kyle and the rest of the team here has done to drive that in relatively short order. Where we’re not, we’re not in a position to take results in run rate, I mean just candidly. And I think we mentioned that off the fourth quarter call. I’m not sure if we’re still there in the first quarter and you have to remember, this is a company that just appointed a VP of Sales. And sales is the lifeblood of a company. So we are still building that confidence and which we could then walk out and give you run rate guidance I guess is what you’re asking for.

Right.

What we have committed to do is to run a profitable business and that’s really where we are today. And we want to continue to under-promise, over-deliver and I think you’re starting to see that if you track the earnings calls, this is our third earnings call to-date – second earnings call really in which we’ve owned the results now for six months.

Good. Okay, thank you.

Thank you, Larry.

Our next question comes from [indiscernible]. Please go ahead.

Hi. Good afternoon, gentlemen. Thank you for taking my questions. Before I begin I would like to congratulate the team. I’ve been watching the transformation and I think you guys have done an incredible job in a very short timeframe, and used your experience and connections to bring a good set of candidates at the management level. So that’s just great. And my question today center around the large increase in the backlog with the signing of this client. Was this basically a project that you guys have been working on for some time or was it just new that came within the last few quarters, if you can comment on that? And also, during the call, I think Kyle you mentioned that with this project GSE being the prime contractor, the margin profile would be less but have been more revenue, if you could just clarify on that?

So, I’ll break the questions, so to start with the first part and give some clarity. To reiterate, the customer that awarded this contract to GSE is a longstanding customer of GSE’s, a great relationship with them. We’re committed to having competitive win for us, which we’re very proud of but it is a new order, so to clarify the first part of the question. The second part, we are prime. It’s a quite significant order. And while the margins are lower than the typical small projects that the Performance Solutions division delivers, the order of magnitude of the project is just that, order of magnitude larger. So while the margins are lower rather than our typical business, so too is the revenue much higher than our typical business. So when you put the two together, you’ll see a ramp in our revenue as well as a ramp in our profits.

I see. That’s great. And looking at this quarter, I think the training and the consulting revenue came a little less than the Q1 of '15. Was this like – this isn’t that you guys made to not go after the low margin revenue or what was the reason behind it?

Well, the reason is the mix of business. We’re not going after any business. We did have a delivered strategy and focus to go after higher margin business to deploy our resources with the Nuclear Industry Training and Consulting group on business that we can generate a higher margin from than historically out of that sector. And I think this first quarter tested the thesis and showed that we win that higher margin business.

I see. Kyle, you have mentioned I think in the last call that regarding the product strategy that there could be a recurring portion that you guys would be working on. You have had a new CTO hire. If you can just commence on the product, how do you – do you think there is a recurring portion that you guys are working on?

Well, certainly, as we flush out our growth strategy and have more to share, I think you’ll see very much what that revenue mix will look like. Traditional companies that have a technology component will get a report out around services, maintenance, license, recurring revenue. And that’s certainly something that we want to frame and have as part of our growth strategy.

Okay, all right. Well, congratulations guys again and we’ll be waiting to hear more on the growth part.

Thanks, Albert [ph].

[Operator Instructions]. Our next question comes from [indiscernible] from Market Edge. Please go ahead.

Hi, guys. Thanks for the call. I have a comment and a question. The first comment is just for future I think it will be good if you did actually report a non-GAAP EPS number also. I think it would help a lot of investors, especially those that run scree, does not screen if they have those available to them, they’ll be able to maybe take a look at those numbers and see what the number looks like with all the noise even on the EPS number too. I know you’re doing EBITDA adjusted, but it would be nice to have I think in the press release also the EPS also. Just food for thought. And secondly a question, relatively view this story [ph] I was wondering if you could define and quickly if you can I guess your opportunity within your current customer base right now? I know you probably have opportunity within your customer base and outside your customer base but I was wondering if you maybe define maybe this low hanging fruit that’s going on within your current customer base and maybe what is outside that also, outside that?

Matt [ph], good comment on the first one, duly noted. And on the second, look, we’ve just added Sean Fuller as Head of Sales for the company. And Sean is here really to test the thesis and get out into the marketplace as a sales professional and really drive the GSE message into you, our existing customers and see what new opportunities exist in that client base as well as into customers that may not be our customers today, and get them to move. So we won’t give a quantitative prediction of what that will lead to but I will say having Sean on board is a huge win for us. We now have somebody who is highly incentivized to generate revenue for the company and has a very proven track record of doing just that. And we’re absolutely delighted to have him on board and that is his mission. It’s all our mission collectively but we now have somebody in the chair that is real expert in this.

And you have specific opportunity to get more revenue of your current customer base, so I guess that’s a --

Well, we’ll certainly going to test that thesis with Sean. GSE has been in business for decades. We have a great longstanding track record with the industry. We’re now showing what our asset can shine and what it looks like, and now that we have a revenue generating head as part of our component that’s what we’re going to test the thesis moving forward. And remain highly confident in where that’s going to lead us.

Great. And I guess one more question. Do you think an acquisition is a potential scenario this year or that would include the 2017 to see that?

We’re not going to predict exact timing but as Chris outlined, where he created a market landscape with a list of primary research for his detailed hard work, research that’s identified in our screening over 75 potential candidates. So we’re moving down several swim lanes at once affecting practices in the company, streamlining how we operate, showing that we can be profitable and create a great platform. We don’t have routes into that swim lane that you constantly swim down it. And in parallel, we’ve been moving down this path of looking at adjacent tuck-in opportunities and where that could lead. So all I can say is stay tuned on that, but we remain optimistic I believe.

Great. Thank you.

Thank you.

Now I’d like to turn the floor back over to Mr. Loudermilk for any closing remarks.

I don’t have any. I’ll like to thank everybody for joining us and we’ll look forward to speaking with you moving forward.

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