Business Context and Reporting Period
The Babcock & Wilcox Company, now BWX Technologies, Inc., filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2011. The company operated through four segments: Power Generation, Nuclear Operations, Technical Services, and Nuclear Energy.
The 2011 results are consolidated results of B&W, while the 2010 comparative results include the combined operations of B&W Operations of McDermott International, Inc. for one month in the quarter and seven months in the nine-month period before the July 30, 2010 spin-off. Accordingly, certain comparative amounts, including allocated corporate expenses, may not be directly comparable to results as an independent company.
Financial Results and Key Metrics
| Metric | Q3 2011 | Q3 2010 | Change |
|---|---|---|---|
| Revenue | $707.6 million | $632.8 million | Up 11.8% |
| Operating income | $57.6 million | $65.1 million | Down 11.6% |
| Operating margin | 8.1% | 10.3% | Down 2.2 percentage points |
| Net income attributable to B&W | $45.7 million | $35.9 million | Up 27.2% |
| Diluted EPS | $0.39 | $0.31 | Up $0.08 |
| Metric | Nine Months 2011 | Nine Months 2010 | Change |
|---|---|---|---|
| Revenue | $2.151 billion | $1.984 billion | Up 8.5% |
| Operating income | $142.7 million | $189.5 million | Down 24.7% |
| Operating margin | 6.6% | 9.6% | Down 3.0 percentage points |
| Net income attributable to B&W | $105.4 million | $100.4 million | Up 5.0% |
| Diluted EPS | $0.89 | $0.85 | Up $0.04 |
- Quarterly revenue increased in every segment. Power Generation revenue rose 14.6%, Nuclear Operations 4.4%, Technical Services 29.4%, and Nuclear Energy 77.2%.
- Nine-month revenue increased in every segment, led by Nuclear Energy, up 48.7%, and Technical Services, up 39.9%.
- Nuclear Energy generated operating losses of $37.5 million in the quarter and $108.3 million for the nine months, compared with losses of $11.2 million and $24.9 million, respectively, in the prior periods.
- Quarterly net income benefited from $2.7 million of other income versus $6.5 million of other expense in the prior-year quarter, primarily reflecting currency effects. Nine-month other income was $4.1 million versus $13.5 million of other expense in 2010.
- Effective tax rates were 33.2% for the quarter and 31.3% for the nine months, compared with 38.2% and 39.3%, respectively, in 2010.
Cash Flow, Liquidity, Debt, and Balance Sheet
- Cash used in operating activities was $45.7 million for the nine months, compared with $38.5 million used in 2010. Working capital increased to $300.8 million from $227.3 million at December 31, 2010.
- Cash used in investing activities was $89.0 million, including $44.0 million of capital expenditures and $31.8 million of net investments in equity and cost-method investees.
- Cash provided by financing activities was $7.7 million, compared with $183.6 million used in 2010, when the company paid a $100.0 million dividend to McDermott International and made other separation-related payments.
- Cash and cash equivalents were $261.6 million at September 30, 2011, compared with $391.1 million at December 31, 2010. Restricted cash and cash equivalents totaled approximately $48.8 million, and investments had a fair value of $56.1 million.
- Total debt was approximately $5.3 million, consisting of current maturities and long-term debt. No borrowings were outstanding under the $700 million revolving credit facility; $221.4 million of letters of credit were issued and $478.6 million remained available.
- The company was in compliance with all credit facility covenants at September 30, 2011. Contract-related bank guarantees totaled $34.5 million and outstanding surety bonds totaled approximately $299.6 million.
- Pension liability was $414.8 million, down from $579.0 million at December 31, 2010, while environmental liabilities were $46.0 million.
Material Changes Versus the Prior Comparable Period
- Revenue growth did not translate into operating profit growth. Nine-month operating income declined $46.8 million, primarily because of Nuclear Energy project cost increases, higher mPower reactor research and development spending, and related expansion costs.
- Nuclear Energy recorded additional costs to complete projects of $3.1 million in the quarter and $50.7 million for the nine months, attributable to productivity, scheduling, and execution issues. The affected project was complete by the filing date.
- Nuclear Energy research and development expense increased substantially, including $10.6 million of non-cash, non-deductible expense related to in-kind services contributed by the minority partner in Generation mPower LLC. This reduced quarterly and nine-month net income attributable to B&W by approximately $4.7 million.
- Nuclear Operations benefited from improved activity at Nuclear Fuel Services following a substantial shutdown in 2010 and recognized approximately $10.9 million from a settlement with the former owner of NFS.
- Backlog declined to $4.648 billion from $5.202 billion at December 31, 2010. Power Generation backlog increased to $1.722 billion, while Nuclear Operations backlog declined to $2.482 billion and Nuclear Energy backlog declined to $428 million.
Guidance, Outlook, Commentary, and Risks
The filing does not provide a formal quantitative earnings or revenue guidance range. Management stated that quarterly and year-to-date results are not necessarily indicative of full-year results.
- Management expects EPA air-quality rules, including CSAPR and pending Utility MACT requirements, to create opportunities for environmental remediation, equipment, and aftermarket services.
- The company is pursuing growth through acquisitions and partnering arrangements, particularly in international Power Generation markets. Potential transactions could be funded with cash, debt, equity, or a combination.
- Development of the B&W mPower small modular reactor remains a significant investment and execution risk. Future nuclear demand may be affected by regulatory responses and market uncertainty following the Fukushima accident.
- Fixed-price and percentage-of-completion contracts expose the company to labor productivity, scheduling, raw-material costs, claims, liquidated damages, and estimate changes. Contract losses may materially affect future periods.
- Material contingencies include an approximately 140-plaintiff lawsuit involving Nuclear Fuel Services and approximately 150 claimants in Apollo and Parks Township litigation alleging radioactive releases. Management expects insurance, indemnity, or Price-Anderson coverage may apply, but adverse outcomes could materially affect results if coverage is unavailable.
- The company filed a breach-of-contract lawsuit against Energy Northwest concerning the Columbia Generating Station condenser project and is seeking unspecified damages.
- The company had not recognized amounts sought in its insurance litigation against American Nuclear Insurers because the amount ultimately recoverable remained uncertain.
- The standstill period relating to the proposed American Centrifuge uranium enrichment investment was expected to be extended to January 15, 2012, subject to an unresolved DOE research, development, and demonstration condition.
- Other key risks include government funding and appropriations, unfunded pension obligations, environmental and nuclear liabilities, insurance and surety capacity, foreign exchange exposure, tax positions, and backlog cancellations or modifications.
Facts Investors Should Verify
- Reconcile the comparability of 2010 combined results with 2011 consolidated results following the McDermott spin-off.
- Assess whether Nuclear Energy project execution has stabilized after the $50.7 million nine-month cost provision and whether additional loss provisions or claims may arise.
- Monitor operating cash flow, receivables, contracts in progress, advance billings, and the decline in cash and investments.
- Review the sustainability of the $4.648 billion backlog, particularly the $2.482 billion Nuclear Operations backlog dependent on U.S. Government funding.
- Evaluate pension funding requirements, government reimbursement assumptions, environmental liabilities, and available insurance or indemnity coverage.
- Track the NFS and Apollo and Parks Township litigation, the ANI coverage litigation, and the Columbia condenser dispute for potential financial exposure.
- Verify the status and funding of the mPower program and the American Centrifuge investment and DOE commitment.