Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2010, for The Babcock & Wilcox Company (BWX). A material event during this period was the company's spin-off from its former parent, McDermott International, Inc. (MII), on July 30, 2010. Consequently, the financial statements for the nine months ended September 30, 2010, present combined results for the first seven months (as a subsidiary of MII) and consolidated results for the final two months (as an independent public company). The company operates in two segments: Power Generation Systems and Government Operations.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2010 | Nine Months Ended Sep 30, 2010 |
|---|---|---|
| Revenues | $632.8 million | $1,983.6 million |
| Operating Income | $65.1 million | $189.5 million |
| Net Income (Attributable to BWX) | $35.9 million | $100.4 million |
| Diluted EPS | $0.31 | $0.85 |
| Cash and Cash Equivalents | $177.7 million | (Balance Sheet Item) |
| Net Cash Used in Operating Activities | (Not provided for Q3) | ($38.5 million) |
| Total Debt (Current + Long-Term) | $8.2 million | (Balance Sheet Item) |
| Available Credit Facility | $474.4 million | (Unused portion of $700M facility) |
Material Changes vs. Prior Period
- Revenue Decline: Revenues decreased 2% ($16.2 million) in Q3 2010 and 8% ($182.5 million) for the nine-month period compared to 2009. The Power Generation Systems segment drove this decline with a 14% revenue drop year-over-year for the nine months, attributed to reduced utility capital spending and delays in new coal-fired plant construction due to regulatory uncertainty.
- Operating Income Improvement (Q3): Despite lower revenues, Q3 operating income increased 41% to $65.1 million from $46.1 million in Q3 2009. This was primarily due to a 143% increase in operating income from the Government Operations segment ($48.1 million vs. $19.8 million), offsetting a decline in Power Generation Systems.
- Operating Income Decline (9 Months): For the nine-month period, operating income decreased 18% to $189.5 million from $232.0 million in 2009, reflecting the significant revenue contraction in the Power Generation segment.
- Cash Flow Shift: Net cash provided by operating activities turned negative, with a net use of $38.5 million for the nine months ended September 30, 2010, compared to $146.4 million provided in the prior year period. This shift was largely due to changes in net contracts in progress and advance billings.
- Spin-Off Transactions: The company paid a $100 million dividend to MII in June 2010 and settled intercompany payables, significantly impacting cash balances and equity structure.
Guidance, Outlook, and Risks
- Regulatory Uncertainty: Management notes that uncertainty regarding new environmental legislation and EPA regulations has caused major customers (electric utilities) to delay capital expenditures for new plants and upgrades. The company anticipates EPA rule revisions in 2011, which may trigger future demand for environmental equipment.
- Government Operations Recovery: The Nuclear Fuel Services, Inc. subsidiary, which suspended operations in late 2009 following safety incidents, has resumed production operations and is substantially fully operational. The commercial development line is expected to restart in Q3 2011.
- Strategic Investments: BWX made a $37.5 million initial investment in USEC Inc. as part of a potential $100 million strategic investment, contingent on DOE loan guarantees for the American Centrifuge project.
- Backlog: Total backlog stood at $4.36 billion as of September 30, 2010, down from $4.74 billion at year-end 2009. Government Operations backlog ($2.34 billion) is substantially fully funded.
- Risks: Key risks include the impact of unfunded pension liabilities (estimated underfunding of ~$869 million as of Dec 31, 2009), volatility in credit markets, and the potential for project cancellations or modifications in the backlog.
Investor Verification Checklist
- Spin-Off Accounting: Verify the treatment of the July 30, 2010 spin-off, specifically the $100 million dividend to MII and the settlement of intercompany balances, to understand the true cash position of the standalone entity.
- Pension Liability: Review the $472 million pension liability on the balance sheet and the risk factors regarding potential increases in funding requirements due to lower discount rates.
- Power Generation Demand: Assess the impact of delayed utility capital spending and the timeline for EPA regulatory changes on the Power Generation Systems segment's future revenue recovery.
- USEC Investment: Monitor the conditions for the remaining $62.5 million investment in USEC Inc., specifically the DOE loan guarantee status.
- Working Capital: Analyze the negative working capital position (excluding cash) of $60.1 million and the reliance on the $700 million credit facility for liquidity.