BWX Technologies, Inc. Q2 FY2020 Earnings Call

Ladies and gentlemen, welcome to BWX Technologies Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the Company's prepared remarks, we will conduct a question-and-answer session and instructions will be given at that time. I would now like to turn the call over to our host, Mr. Mark Kratz, BWXT's Director of Investor Relations. Please go ahead.

Thanks, Jason. Good morning, and thank you for joining BWXT's second quarter 2020 earnings call. Joining me today are Rex Geveden, President and Chief Executive Officer; and David Black, Senior Vice President and Chief Financial Officer. On today's call, we will discuss certain matters that constitute forward-looking statements and involve risks and uncertainties, including those described in the Safe Harbor provision found in yesterday's earnings release and our SEC filings. We will also provide non-GAAP financial measures, which are reconciled to GAAP measures in the quarterly materials. Copies of these documents, along with today's earnings presentation are available on the Investors section of our website. With that, Rex, I’ll turn the call over to you.

Thank you, Mark, and good morning. Yesterday, we reported strong second quarter results with non-GAAP earnings per share of $0.71, up 15% on 7% of revenue growth, while delivering robust free cash flow of $111 million, three times the second quarter last year. These results extend BWXT’s exceptional first quarter and produce a very strong first-half performance, with non-GAAP earnings per share of 33% on 18% of revenue growth, and positive free cash flow despite substantial capital investments to lay the foundation for future organic growth. This performance leads us to increase 2020 earnings per share guidance, despite negative impacts related to COVID-19 in commercial business lines. Second quarter and year-to-date, our outperformance are driven by the Nuclear Operations Group, through the Columbia Class product line ramp, and accelerated work volume and long lead material production. These were bolstered by contract performance improvements through operational excellence, as we execute against the robust backlog. Over the last several months, both the House and Senate have made significant progress on the 2021 NDAA. Budget authorization is trending well for BWXT programs, particularly for a second Virginia Class nuclear propulsion system in 2021. Both the House and Senate passed two bills that contain increased funding for the Virginia program, with the House adding an incremental $272 million, and the Senate allocating $472 million for long lead items for a second Virginia ship. Additionally, the House Appropriations Committee's FY'21 Defense Appropriations Bill includes the same $272 million increase for Virginia Advanced Procurement. As I discussed on the last earnings call, there was a scenario where the entire second Virginia Class submarine is not ordered, but the nuclear propulsion equipment for a second submarine is ordered. This is the action by the Senate thus far with the House fully funding the program. Consequently, the actions of both chambers are trending favorably for BWXT to maintain the production cadence on the Virginia program. Beyond Navy programs, we are pleased with the support for DOE site funding and new nuclear technology programs, including micro reactors for the strategic capabilities office, DARPA and NASA along with TRISO fuel. In the second quarter, NOG was awarded a $26 million competitive contract to expand and upgrade the TRISO nuclear fuel manufacturing line. This win adds to the string of events and progress for this fuel production line that is unique to BWXT. We anticipate future production options for the fabrication and delivery of TRISO fuel for DOD and NASA Demonstration Missions. We're also pleased with the progress in the other government segment and Nuclear Services Group. In May, the BWXT led team was awarded the DOE's $13 billion Hanford Tank closure contract. This hallmark win demonstrates the company's deep nuclear operations pedigree, which is a key differentiator for nuclear remediation projects. Shortly after the award, the win was protested, which will impact transition timing. In light of the protest timing, we see incremental pressure on NSG operating income guidance for the year, but nonetheless remain optimistic about future growth in this segment. Beyond Hanford, the DOE opportunity pipeline remains attractive, as we have outlined in the Investor presentation materials. In fact, some opportunities have accelerated, namely the recompete for the National Nuclear Security Administration uranium hub at Y-12, and the central assembly and disassembly site for nuclear weapons at Pantex. Last week, the Department of Energy released a pre-solicitation notice for the management and operations of Pantex and Y-12, and we expect a request for proposal to follow later this year with a potential award in the fall of 2021. Lastly, for NSG we recently divested the U.S. commercial services business, which we viewed to be subscale and non-core, as we look to sharpen our focus on government nuclear remediation projects and site operations in this segment. The facility we obtained in the transaction is located adjacent to the major NOG production site in Lynchburg, Virginia and would allow for much needed shop floor capacity for anticipated future expansion in the space and defense micro reactors as that government-driven market matures. As anticipated on the last call, second quarter Nuclear Power Group results were down as customer-driven COVID-19 impacts were most evident in this commercial segment. Within Canadian Commercial Power, utility customers continued to navigate the COVID-19 environment to limit personnel exposure and have pushed out some refurbishment and service outage activities. However, we believe most of this impact is behind us, and are well-positioned for business recovery to begin in the back half of the year through the resumption of service outages and increased fuel demand. I've also tasked the business to look for incremental opportunities and to evaluate all possible cost actions at our disposal during this extended disruption. We will also consider any potential government reimbursement programs that could offset negative financial pressure from carrying a fuller set of resources, as we maintain a posture that is aligned with the return to more normal future conditions. In the medical radioisotopes business, we witnessed weaker demand for products in the second quarter, as hospitals prioritized resources for COVID-19, and doctors continued to limit patient exposure. This trend is more difficult to predict as we move into the second half of the year, and may continue as COVID-19 cases are on the rise for a second time in certain geographies. On the other hand, we are progressing as planned on the Moly-99 product line. The radiochemical and radiopharmacy designs are complete and facility modifications and construction are well underway. Overall, I am very pleased with the progress the team is making as we rapidly retire costs and schedule contingency with each step towards production readiness. The mid-2022 product introduction target, which includes schedule and cost margins for any unforeseen risks, is on track. And I look forward to providing future progress updates. Lastly, I want to emphasize my gratitude to the 6,600 BWXT employees for their professionalism in dealing with the COVID-19 work environment. We remain committed to protecting employee health and safety first, while also maintaining business viability. Company protocols continued to demonstrate effectiveness in minimizing employee exposure and business interruption, as evidenced by the limited number of cases within the company and the absence of workplace transmission. We remain cautiously optimistic about the trajectory of the business through the remainder of the year as we navigate through this unprecedented pandemic. And with that, I will turn the call over to David.

Thanks, Rex, and good morning, everyone. Starting with total company results on Slide 4 of the earnings presentation. Second quarter and year-to-date revenues were up 7% and 18%, respectively, and as Rex mentioned, were driven primarily from outperformance in the Nuclear Operations Group. The strong execution this year resulted in second quarter earnings per share of 15% and year-to-date EPS of $1.50, up 33% when compared with the first half of 2019. First-half operating margins expanded 140 basis points to 17.7%. So year-to-date earnings growth was dominated by segment operations, which is depicted on Slide 5 of the presentation. Operating segments drove $0.28 of improvement and corporate cost controls resulted in $0.04 of improvement. Lastly, we drove $0.05 of EPS improvement through higher pension income and lower interest expense. Our year-to-date cash generation has been strong, resulting in lower borrowings. And the actions we took in the first six months of this year to restructure debt resulted in more liquidity, a credit facility with lower rates and an extended debt maturity schedule with no debt due until 2025. Moving to second quarter segment results on Slide 6. The Nuclear Operations Group delivered another solid quarter, with revenue up 14% to $410 million. We continue to see accelerated material production in the second quarter, including higher volume from the Columbia product line, as well as higher volume from naval nuclear fuel and downblending. NOG operating income was $86 million, resulting in a 21% operating margin for the quarter. The Nuclear Power Group produced $68 million of revenue in the second quarter, a 22% decrease when compared with the second quarter last year, primarily driven by lower components manufacturing and commercial nuclear power, and lower medical isotope volume as demand for procedures remain depressed due to COVID-19. NPG second quarter non-GAAP operating income was $2.4 million, resulting in a non-GAAP operating margin of 3.5%. Operating income and margin were down significantly when compared to the second quarter 2019 for several reasons. First, COVID-19 impacts drove lower demand in both commercial nuclear power outages and services and medical isotopes. Second, we had an unfavorable shift in product line mix, including the absence of the China steam generator project when compared with the prior year period. And lastly, the segment was impacted by higher foreign exchange rates between the Canadian and U.S. dollar. The Nuclear Services Group delivered operating income of $5.1 million in the second quarter, up $3.3 million versus the prior year period, as a result of lower expenses associated with business development activities. Turning now to year-to-date results on Slide 7, Nuclear Operations Group year-to-date revenues were up 26% and operating income was up 33%. Year-to-date energy margins were robust at 21.1%. Year-to-date nuclear power revenues are down 9% and segment margins were 7.1%, in part from business impacts of COVID-19. And the Nuclear Service Group is trending well, up about $8 million in operating income year-to-date, through a combination of increased income from U.S. commercial services early in the year, and lower costs from bid and proposal activities. As Rex mentioned, we are increasing our 2020 guidance shown on Slide 8. NOG has had exceptional performance year-to-date, and so we now expect that segment revenue to be up about 10% versus our prior expectations of about 9%. NOG first-half performance has offset some negative pressure from COVID-19 in the commercial businesses. As we looked at the balance of the year, we felt it was prudent to increase our earnings estimates. We are now providing a non-GAAP EPS guidance range of 280 to 290 to account for certain unknowns, largely in the commercial business lines, but still represents upside from our original EPS guidance and results and the modest increase with an EPS midpoint of 285. All other components of guidance remain consistent with our prior outlook on the year, and we have updated the 2020 guidance bridge on Slide 9, to reflect the change driven primarily from upside in operations. Lastly, I would like to conclude with some remarks on cash, liquidity and capital allocation. The company generated robust cash of $162 million from operating activities in the second quarter, about 2.5 times that of the second quarter last year. Cash and short-term investments remained solid at $65 million at the end of the second quarter. And we are well-positioned with over $700 million in total liquidity. We continued to return cash to shareholders through a combination of dividends and share repurchases, and have returned nearly $57 million year-to-date. As we progress on our current capital allocation priority to invest in the business over the near term and navigate through the COVID-19 environment, we continue to evaluate the best use of cash to generate long-term value for our shareholders, as we look to a strategic allocation of capital. We are progressing well on our capital investments for future organic growth. We have diligently spent $115 million year-to-date, and remain on track to spend the expected $270 million in capital expenditures for 2020. We still anticipate elevated CapEx levels in 2021 and expect to return to near maintenance levels in 2022. And with that, I will ask the operator to open the line for questions.

Thank you. We will now begin the question-and-answer session. The first question is from Pete Skibitski from Alembic Global. Please go ahead.

Good morning, guys. Nice quarter. On the strong first-half growth NOG, coming into this year did you guys kind of expect this? It's very strong growth. I know most of it is I think Columbia related. I don't know if you expected coming into this year more kind of a level load across the year, or if some materials purchases just kind of been pulled in from 2021. I'm just wondering how surprised you are or kind of in line with expectations this phenomenon is? Because, it obviously implies kind of a weaker relative second-half of the year.

Yes. Pete, good morning. Yes, certainly we performed relative to our expectations in the first half. And as we said, some of that's contract performance through operational excellence, a good amount of that is long lead materials. And so, it's a bit of a surprise, a bit of an upside surprise in the first half. And I would say that, one of the reasons we give annual guidance instead of quarterly guidance is because the materials component of our performance can be pretty lumpy and a little bit unpredictable. And the reason for that is because a lot of that comes through suppliers, who are making, for example, forgings and alloys for the business. And they can pull on their backlog and book and bill to us. We can take percentage completion credit on that and book and bill our customer. So, there is that amount of unpredictability in it, and certainly a pleasant surprise in the first half, and wouldn't expect the same kind of upsides in a second half. But, we should have a good second half as well.

Okay. That makes sense. I appreciate it. And just on the MPG margin guidance of 11%. You're calling for a big ramp in the second half. What's going to kind of drive those margins higher in H2?

There are a few key factors to consider. We experienced some currency pressure that has recently shifted in our favor, with the conversion rate improving from $1.40 to $1.34. This has provided some support. We are optimistic about a rebound in the isotope business, which, despite facing some pressure, has high gross margins. This could positively affect margins significantly. Additionally, the commercial nuclear segment of our Nuclear Power Group was weak in the first half, impacted partly by COVID-related delays, as some service outages were postponed from the first half to the second half of the year. Originally, we anticipated five outages in the first half and two in the second half, but now we expect three in the first half and four in the second half. Therefore, there will be more outages in the second half compared to the first half. We are also maintaining a robust production pace in our component manufacturing during the second half. Overall, these factors are expected to contribute to a slight improvement in the second half.

Okay. I appreciate all the color, guys. One last quick one. On the Hanford protest, do you have a date when that's supposed to be adjudicated by?

No, I think that's a little bit unpredictable. So, we don't know. I don't expect we'll get much of anything out of that in 2020 at this point though.

Okay. Thanks, guys.

Thanks, Pete.

The next question comes from Robert Spingarn from Credit Suisse. Please go ahead.

Hi, good morning. I wanted to first ask on the Nuclear Operations Group, just on the back of the comments that were just made in Pete's question. But, with respect to Virginia funding that Rex talked about earlier and the overall visibility that you have in the business, I'm wondering if there's anything you can say to help us level set in terms of growth for next year, especially you talked about the material purchases and the trend this year, first half to second half. How do we think about our NOG growth next year, with potentially the second Virginia and again the cadence on the material purchases?

So, Rob, we're certainly not going to get into forecasting '21 at this juncture. We do expect some growth there. We've got some residual growth from the accelerated Ford aircraft carrier procurement, but we will characterize our 2021 at a later time.

All right. And then just separately, we saw some news regarding the possibility of the U.S. developing nuclear-powered icebreakers. I'm wondering if that's a real possibility, if there's anything you can offer in terms of the timeline or value of such a thing.

Yes. Rob, I think it absolutely is a possibility, as you know the White House asked the Coast Guard to go and develop plans for some nuclear-powered icebreakers. And that plan is due to the White House this month, actually. There are only a couple of active icebreakers in the Coast Guard fleet right now operating in the Arctic region. And so the administration has said it would like to have a fleet of about 10. The mix between nuclear and non-nuclear I don't think is clear at this point. They're certainly on a path to add some non-nuclear icebreakers in the first half of this decade. So, I think it's an interesting possibility. If that should transpire, we would certainly be in a position to supply those reactors to that application. But, I wouldn't expect anything meaningful to happen until probably the second half of this decade when we might see some order activity should that opportunity transpire.

Okay. Thank you.

Thank you.

Thanks, Rob.

The next question comes from Peter Arment from Baird. Please go ahead.

Yes. Good morning, Rex, David, Mark.

Good morning, Peter.

Rex, maybe I just want to come back to Rob's question a little bit on your growth for '21 and NOG, just because when we think about how your backlog converts. There's quite a bit of a step up in the backlog conversion for next year. So, is there something that offsets that? Or is it just the timing of the way the revenues flow through?

Reframe that question for me, Peter. I didn't get that.

In considering the growth profile for 2021, the backlog indicates a significant increase in what you're planning to recognize next year, particularly in Q4 for NOG. I'm curious if there is anything that might offset that growth or if it is primarily related to timing. I'm looking to gain a clearer understanding of the growth outlook for 2021.

Yes. Peter, this is David. As you look at our backlog, obviously, we do provide that. We provide future run off there. As we look at NOG, there's a couple of things going into play here. One of the things is, as Rex mentioned, there was some pull ahead of some materials, so, that will have some offset depending on what we forecasted last year or next year to this year. But, Rex also said there is growth in next year. We're just at this point in time not defining what that growth is, at this time. And we'll do that when we talk about the 2021 guidance.

Okay, that's helpful. And then just David, just quickly on kind of your cash outlook, really strong free cash flow in 2Q, CapEx still ramps. Are you expecting this year still to be kind of around the breakeven level? Or what's your thoughts on how the timing is there?

Breakeven on the cash?

Yes, on free cash flow?

Yes. So, I mean, once again, we are forecasting $270 million of CapEx for the year. And you know the other elements of what we're forecasting. So, because of the high CapEx, we're still forecasting. We haven't given the operating or the free cash flow number, but as you have forecasted, that number has not changed.

Okay. That's helpful. Thanks very much.

Thanks, Peter.

The next question comes from Michael Ciarmoli from Truist Securities. Please go ahead.

Hey, good morning, guys. Thanks for taking the question. Maybe, I'll take another swipe at the NOG in the second half and '21 here. I mean, is it fair to say guys that the positive developments with the Virginia Class, and you didn't really mention the impacts of potentially a multiyear contracting for the Columbia Class. But, it sounds like the visibility for NOG improves in the second half. And then if we think about, I guess we're actually talking about the forging and other casting suppliers. Some of those guys also cater to the commercial aerospace markets. Maybe they're directing more resources towards defense now. I mean, is it fair to say that your visibility and momentum as we sit here today is a lot better than where you were three months ago?

I don't think we have noticed a significant change in our visibility. It's a long cycle and a somewhat predictable business. If you examine the situation with Congress regarding the second Virginia for 2021, it certainly enhances our outlook. Therefore, we still expect to maintain a pace of two Virginias and one Columbia by the end of the normal tempo for that program, as well as the Fords every five years. So, I believe our visibility remains largely the same.

What would be the implications of a multi-contract with a Columbia Class? Accelerate, okay.

Yes, I think it would be kind of the same effect as the advance Ford procurement, the two Ford carrier buy. We would be able to order materials earlier. We'd be able to offer some potential savings to our customers on that, which would be the appeal of it. So, I think it would pull forward some volume in a way that would be meaningful to the business.

Got it. Perfect. And then any additional color on where we stand with missile tubes in terms of how you guys are thinking about? That market going forward, do you think you're going to have some leverage to get the pricing and the margins you want, if you stay in that? Or have you kind of definitively made a decision to pump on that business?

Yes. In terms of the missile tube, maybe two categories of an answer here, Michael. On the repairs that's going according to plan. We feel quite good about where that is. And we'll be starting to ship completed missile tubes pretty shortly. In terms of future opportunities, I think it just doesn't have the margin profile that we want to see in the business. And so, we're not likely to pursue that in the future.

Got it. Perfect. Thanks, guys. I'll jump back in the queue.

Thanks, Michael.

Next question is from Ron Epstein from Bank of America. Please go ahead.

Yes. Hey, good morning, guys. Just a question and when you look at the National Nuclear Security Administration budget and the request for 2021, it's up relative to 2020. And if you actually look for the preceding maybe four years, it's gone up every year, and then the projections going out have gone up a lot, too. So, what kind of opportunities does that present for you guys? Because if you look at the 2021, and then let's say budget relative to 2020, it is materially higher than the 2020 budget. So, what's that present for you guys?

So, Ron, I think, most of that opportunity for us lies in the area of management and operations of DOE in an assay site. And so what you see there is largely increased funding in places like Los Alamos and Livermore and Sandia, Nevada, and then Pantex and Y-12. And so, it shows up at the labs for the most part, and the opportunity for us is a significant boost in equity income around the management of those sites for DOE. That's the most tangible I think opportunity for us in that budget trajectory.

Got you. And then maybe just a detail on the R&D amortization change that's going to happen in 2022. If it were to happen in 2022 as stated, what impact do you expect that to have on your cash flow? I mean, we've heard from other contractors that relatively big numbers relative to their operating cash flow. I don't know if you guys thought about it or if you're comfortable to talk about it. But, as the R&D amortization were to change, like it's supposed to, if the law doesn't change, what impact would that have on your cash flow?

Now, when you look at our R&D, we're less than 1% of our revenue. So, it's not as much of an impact for us, as it would be others. But once again, when we see the change then we'll talk about what that does to us. But, if the amortization changes then, you get the same benefits that others get ours would just be a lot smaller.

Okay. Thank you.

Thanks, Ron.

The next question comes from Matt Akers from Barclays. Please go ahead.

Good morning, guys. Thanks for the question. Can you talk a little bit about working capital and how that could trend either in terms of that absolute dollars or days or percent of revenue, kind of as we go through the Columbia ramp and if that could be kind of a meaningful impact to free cash flow?

So, anytime we build up in the business, you're going to have additional working capital to support that build of your manufacturing. You've got to remember that when we talk about our largest customers, the U.S. government, we do have terms by which we build twice a month, and when we build we get paid very quickly. So, there is an initial pop of working capital, but we tend to manage that. And so, there is some fluctuation change here. Now, when we look at the future, and we look at the isotope business, there'll be changes in working capital there and the commercial line of businesses. But once again, our biggest impact being the government, there doesn't tend to be a long-term working capital issue.

Got it. Thanks. And then I guess on tax. So, I think I know that the CARES Act, you get to defer some of the payroll taxes from 2020 into 2021. Can you give us what the impact of that would be for this year?

We have included a tax forecast and you can see our year-to-date progress. Everything is accounted for. From our perspective regarding tax and cash, part of the reason our free cash flow has increased is that we have postponed some payments until next year, which positively affects our free cash flow. We anticipate that our tax range will align closely with our initial projections for the year.

Got it. Thanks. And then I guess just one more following up on the missile tube question. But to me, you're getting out of that business. I think you talked about maybe repurposing some of those facilities for other uses. Is that something you could still do? And if so, when that? Does that have any sort of positive offset versus CapEx that you might otherwise spend?

Yes, we certainly will repurpose that facility. That's at Mount Vernon, Indiana, which is the production site for some of our largest components for naval reactors, and so there's plenty of volume there. So repurpose that entire facility for those large components that are coming through and there is a bit of a benefit on CapEx, not striking, but it's incrementally positive to the business.

All right. Thanks guys.

Operator, we'll take our last question.

Okay. Last question is the follow-up from Michael Ciarmoli from Truist Securities. Please go ahead.

Hey, thanks, guys. Just on the Columbia Class, Rex. If the second one is going to get ordered in 2024, when should we expect you guys to start booking some revenue for the long lead materials there?

Yes. So Michael, you know that for the reactor components. Those precede the ship procurement schedule by the shipyards by two years. So for the 2021 Columbia, the first one that business began to pick up for us in 2019 as an example, and we ramped that through last year. So, for the 2024 Columbia, you'll see that start to hit our business in 2022, and then ramp up through that year and pick up beyond that. And so, from our investor deck, you see how those Columbia's layer into our future business. And on a seven-year delivery tempo, you see some accumulation of volume over the course of time.

Yes, perfect. All right. Thanks guys.

Yes. Thanks, Michael.

This concludes our question-and-answer session. I would like to turn the conference back over to Mark Kratz for any closing remarks.

Thank you, and thank you for joining us this morning. This concludes our second quarter 2020 conference call. If you have further questions, please call me at 980-365-4300.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.