Business Context and Reporting Period
The filing is The Babcock & Wilcox Company’s Form 10-K for the fiscal year ended December 31, 2012, filed February 27, 2013. The company operates four segments: Power Generation, Nuclear Operations, Technical Services, and Nuclear Energy. Its businesses are project-oriented, capital-intensive, and substantially exposed to U.S. Government and utility spending.
The company provides fossil-fuel and renewable-fuel power systems, emissions-control equipment, naval nuclear components and fuel, U.S. Government nuclear and environmental services, commercial nuclear components, and development of the B&W mPower small modular reactor.
Key Financial Metrics
| Metric | 2012 | 2011 | Change |
|---|---|---|---|
| Revenue | $3.291 billion | $2.952 billion | +11.5% |
| Operating income | $346.6 million | $95.7 million | +$250.9 million |
| Income before tax | $319.4 million | $94.5 million | +$224.9 million |
| Net income attributable to company | $227.7 million | $78.3 million | +190.8% |
| Diluted EPS | $1.91 | $0.66 | +189.4% |
| Effective tax rate | 31.9% | 25.3% | Higher |
| Cash flow from operations | $184.9 million | $173.6 million | +$11.3 million |
| Capital expenditures | $86.6 million | $63.9 million | +$22.8 million |
Operating income as a percentage of revenue was approximately 10.5%, compared with 3.2% in 2011. Net income attributable to the company was approximately 6.9% of revenue, compared with 2.7% in 2011. These comparisons are affected by the retrospective pension-accounting change and significant 2011 project charges.
Segment Results
| Segment | 2012 Revenue | 2012 Operating Income | Change versus 2011 |
|---|---|---|---|
| Power Generation | $1.786 billion | $183.4 million | Revenue +15.9%; income essentially flat |
| Nuclear Operations | $1.098 billion | $226.3 million | Revenue +5.3%; income +$31.9 million |
| Technical Services | $107.9 million | $59.7 million | Revenue -9.9%; income -$10.2 million |
| Nuclear Energy | $326.0 million | $(62.9) million | Loss improved by $54.0 million |
- Backlog was $5.749 billion at December 31, 2012, up from $5.339 billion. Power Generation backlog was $2.483 billion, Nuclear Operations $2.984 billion, Technical Services $4 million, and Nuclear Energy $278 million.
- Approximately $3.0 billion, or 52% of total backlog, was with the U.S. Government; $180.6 million had been awarded but not funded.
- Cash, restricted cash, and investments totaled approximately $540.3 million at year-end. Management defined total liquidity as $1.0185 billion, including available credit capacity.
- The company had no borrowings under its $700 million revolving credit facility and had $542.1 million available after letters of credit. Total debt was approximately $4.5 million, including current maturities.
- Working capital increased to $441.8 million from $332.3 million. Total assets were $2.840 billion and stockholders’ equity was $1.003 billion.
- At December 31, 2012, the company had $217.3 million of letters of credit and bank guarantees and $468.6 million of surety bonds outstanding.
- The company declared and paid a fourth-quarter dividend of $0.08 per share and repurchased 3.9 million shares for approximately $96.7 million during 2012. The board authorized up to $250 million of repurchases.
Material Changes Versus the Prior Comparable Period
- Revenue growth was led by Power Generation’s new-build environmental equipment and steam-generation systems and by higher Nuclear Operations activity.
- Nuclear Operations profitability improved through better performance on U.S. Government nuclear-component programs and higher naval-fuel and downblending activity.
- Nuclear Energy’s operating loss narrowed primarily because 2011 included approximately $50.7 million of costs to complete the Columbia Generating Station condenser project. The 2012 results included approximately $18.4 million of revenue from a related claims settlement, with approximately $18.1 million of net income after related expenses.
- Technical Services declined because of lower award fees, reduced American Centrifuge work, and lower Fukushima-related support activity.
- Power Generation margins were pressured by competition and the early phase of the environmental-equipment cycle, despite strong revenue growth.
- Other expense included a $27.0 million impairment of the USEC preferred-stock investment. The investment was written down to an estimated fair value of $19.1 million.
- The company changed its pension and other postretirement accounting method to recognize actuarial gains and losses immediately in fourth-quarter earnings. The change was applied retrospectively and reduced reported 2012 operating income by approximately $31.9 million, compared with a $215.4 million pension-related reduction in 2011 under the new presentation.
- Research and development activities totaled $173.9 million, including $120.6 million expensed by the company and $53.4 million funded by customers. Spending increased from $163.0 million in 2011, primarily reflecting continued mPower development.
Guidance, Outlook, Risks, and Unusual Items
- Management expected 2012 year-end backlog to produce approximately $1.2 billion of 2013 Power Generation revenue, $1.1 billion of Nuclear Operations revenue, and $180 million of Nuclear Energy revenue, excluding change orders and new awards.
- Management expected Power Generation’s environmental cycle to extend to approximately six or seven years, rather than the previously expected three to four years, because of regulatory uncertainty, low natural-gas prices, and economic conditions.
- Technical Services operating income was expected to decline in 2013 because of a revised fee structure or possible loss of the combined Y-12/Pantex contract. A company-led joint venture was not selected for the contract in January 2013 and filed a protest.
- The Y-12 facility experienced a security breach in 2012, temporarily disrupting operations and reducing 2012 fees. Security responsibilities and leadership arrangements were subsequently changed.
- The company planned to maintain mPower development spending at approximately 2012 levels, excluding additional third-party or DOE funding. Commercialization depends on successful development, funding, and NRC certification.
- Major risks include dependence on U.S. Government appropriations, defense-budget reductions and sequestration; utility capital spending and environmental regulation; fixed-price contract losses; project delays and liquidated damages; supply-chain constraints; nuclear, environmental, cybersecurity, insurance, and litigation exposures; and risks associated with joint ventures.
- The defined-benefit pension and postretirement plans were underfunded by approximately $731.2 million. Expected 2013 pension contributions were approximately $75.3 million, with an additional $13.3 million for other postretirement plans.
- Environmental reserves were $49.6 million at year-end, and 2012 environmental compliance generated $15.3 million of pretax charges and $3.2 million of capital expenditures. Potential future remediation costs may exceed recorded reserves.
- The company disclosed approximately $6.0 million of potential liquidated damages on a Power Generation project that had not been accrued because management believed the damages were not probable; the outcome of customer discussions remained uncertain.
- Pending litigation included the Apollo and Parks matters involving alleged radioactive releases and an appeal in the ANI insurance-reimbursement litigation. The company had not recognized amounts claimed in the ANI matter because realization remained uncertain.
Investor Verification Checklist
- Verify the sustainability of 2012 profitability after excluding the pension-accounting change, the Energy Northwest settlement, the USEC impairment, and the unusually high 2011 project charges.
- Review the status and financial impact of the Y-12/Pantex contract protest and any resulting transition costs or lost fees.
- Assess the portion of backlog that is funded, expected timing of conversion to revenue, and potential cancellations, scope changes, or margin erosion.
- Monitor U.S. Government appropriations, sequestration, defense spending, and DOE/NNSA contract renewals.
- Evaluate Nuclear Energy’s continuing losses, mPower funding requirements, NRC licensing prospects, and commercialization timetable.
- Review pension funding requirements, plan assumptions, and the effect of future interest rates and asset returns on earnings and liquidity.
- Assess fixed-price contract exposures, the unaccrued liquidated-damages claim, environmental reserves, nuclear liabilities, insurance coverage, and pending litigation.
- Confirm the company’s share-repurchase pace, dividend restrictions under the credit agreement, and availability of revolving-credit and bonding capacity.