Earnings Call Transcript - BWXT Q3 2022

Operator, Operator

Ladies and gentlemen, welcome to BWX Technologies Third Quarter 2022 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, Mark Kratz, BWXT’s Vice President of Investor Relations. Please go ahead.

Mark Kratz, Vice President of Investor Relations

Thank you, Tia. Good evening and welcome to BWXT’s third quarter 2022 earnings call. Joining me today are Rex Geveden, President and CEO; and Robb LeMasters, Senior Vice President and CFO. On today’s call, we will reference the third quarter earnings presentation that is available on the Investors section of the BWXT website. We will also discuss certain matters that constitute forward-looking statements. These statements involve risks and uncertainties, including those described in the Safe Harbor provision found in the investor materials and the company’s SEC filings. We will frequently discuss non-GAAP financial measures, which are reconciled to GAAP measures in a separate presentation that can also be found on the Investors section of the BWXT website. I would now like to turn the call over to Rex.

Rex Geveden, President and CEO

Thank you, Mark, and good evening to everyone. Earlier today, we reported third quarter earnings of $0.69 a share in line with our forecast and consistent with our framing in the last earnings call. Revenue was up 5%. Free cash flow was up $25 million. Adjusted EBITDA was down 5% and strong performance in Commercial Operations and company-wide cost controls nearly offset labor challenges in Government operations. Despite macro market volatility this year, the company has exhibited solid underlying financial performance from its core operations. The labor challenges that have emerged have been largely offset by cost controls and outperformance from our commercial-facing businesses, resulting in high single-digit EBITDA growth on an extension basis. Given our performance to date and the impacts of macro headwinds, we have narrowed 2022 earnings per share guidance to just below the original midpoint issued about a year ago in a very different overall economic environment. Revenue and EBITDA have both moved favorably from our initial 2022 outlook in February. Before I turn the call over to Robb to go through the financial details, let me give you an update on the business and the optimistic long-term outlook we have on BWXT's nuclear end markets. In our Government business, we continue to see strong demand for our naval products, including components reactors and nuclear fuel. The Columbia submarine program continues to ramp and we recently shipped some of the first components for the lead boat. The reactor components and fuel for the Virginia program are progressing at a regular cadence and we are continuing to work on multiple Ford-class carrier propulsion chipsets. Although we are starting the Government fiscal year with a continuing resolution, we don't anticipate any disruption to these critical and well-supported national security programs. We recently kicked off the next multiyear pricing negotiation with our Navy customer and anticipate getting that next set of orders negotiated and under contract in the first half of 2023. This agreement is for reactor components and fuel for the next two fiscal years and supports the Navy's 30-year shipbuilding plan, which includes stable production of Virginia fast-attack submarines and additional content on the Columbia program, as we approach an annual ordering tempo for reactor components and fuel for the new ballistic missile submarine. We also continue to support the US Navy and the government as they negotiate the details of the August trilateral security agreement. If called upon, BWXT stands ready to utilize our unique capabilities, facilities and licenses to help enable this important global security effort. As I noted and not unlike our market peers we are experiencing some difficulties in our core business in this post-pandemic dislocated labor market. Finding and retaining skilled manufacturing labor is our most acute problem at some of our nuclear manufacturing sites we are tracking almost 10% below our net headcount plan. Said another way, we are simply struggling to sufficiently hire to satisfy our growth needs, as we stretch to meet demand from our customers. This has a twofold effect of limiting progress against the backlog and reducing planned overhead absorption. To address these labor shortages, we have implemented a set of comprehensive actions. For recruiting, we've expanded our employee referral programs and conducted a detailed Kaizen exercise to streamline the talent acquisition process. The recruiting battle rhythm includes daily tracking and reporting to ensure constancy of purpose and process visibility. We've also hired more site-level recruiting resources to more effectively market our unique career offerings to top candidates. For retaining and onboarding new team members, we are expanding and accelerating our training programs to improve their skill sets and create a foundation for competency and success. Beyond the labor impacts this year, we are doubling down on operational excellence to drive efficiency to offset increasing costs and improved schedule and quality. Having made significant capital investments in the Navy business, we are in the process of optimizing throughput to reduce span times and drive efficiency as we execute the backlog. While we've always had a continuous improvement culture and formal operational excellence functions, we are taking a fresh look at improving the business by getting back to the basics, deploying lean manufacturing tools, including visual flow boards, process mapping and key performance indicators to name a few and standardizing their usage across the enterprise. We are firmly invested in the belief that our new leaders, third-party assessment and continuous commitment to rigor and discipline will create additional capacity for the business, drive efficiency and position us to exceed customer expectations. In any case, the outlook for this business is superb despite these near-term labor and financial pressures and these efforts better position us for the future and serve as an accelerator of our naval performance as macro headwinds abate. On micro reactors, Project Pele is ramping, albeit at a slower pace than we had planned given the challenge finding engineering talent needed for this special project. That said we have begun procurements for long lead items, baselined our schedule and configured the supply chain for this prototype reactor. Our interactions with the DOD strategic capabilities office and future potential customers have been very positive. On a related topic, we anticipate a contract option award in the near term for TRISO fuel to be used in this mobile reactor, which is separate from and incremental to our existing $300 million contract to build the prototype reactor. We remain optimistic about the microreactor market and continue to see strong government demand for nuclear space power and propulsion manifesting in multiple opportunities including the DRACO program at DARPA, Vision surface power and space nuclear propulsion for NASA. And as we have noted on multiple calls before, the ideal end state for this market is continuous production of microreactors and fuel and we remain bullish about those possibilities over the long-term. The services business continues to track upward. The new Savannah River site remediation contract is executing well. And outside of that performance scores have been trending favorably. Our strategy to leverage BWXT's unique nuclear knowledge and site management and complex nuclear environmental restoration is working. And we are building back our portfolio through market share gains enabling us to reach historical levels of operating profit. The next stairstep opportunity for growth in the pipeline is the Hanford integrated tank disposition contract, which we anticipate to be awarded by early next year. Beyond that, there are smaller scale, but fairly near-term opportunities at the decommissioned enrichment plants in Portsmouth, Ohio and Paducah, Kentucky. In the longer term, there remain large opportunities to manage and operate the Pantex and Y-12 sites, the scopes of which are clearly in our sweet spot. Lastly, on the Government side, we see near-term growth in processing special nuclear materials. In March of last year, BWXT was awarded a contract from the National Nuclear Security Administration to design and pilot a process for uranium purification and conversion services. This first phase is tracking ahead of schedule and we anticipate a larger second phase award next summer. Now switching gears to BWXT's commercial-facing markets. Momentum is building in our Nuclear Medicine business. In September, we submitted a new drug application to the FDA for BWXT's Tc-99 generator. In that same time frame, we hosted investors, customers and others at BWXT Medical's headquarters and major production facility in Kanata, Ontario. Last week, the FDA requested dates to conduct a pre-approval inspection of our Tc-99 generator line and accepted our application for priority review. In a related matter, we have begun installation of the target delivery system or TDS at the Darlington site near Toronto. The TDS is a first-of-a-kind system used to irradiate target material for the Tc-99 generator. The system which we expect to be fully operational next year will have the highest production capacity of any radioisotope irradiation system globally. It bears mention that beyond our Tc-99 application, the target delivery system can be utilized for multiple other neutron capture isotopes and will be a major industry accelerant. For instance, the system can irradiate targets to produce Yttrium-90 of the active pharmaceutical ingredient in the TheraSphere product that we manufacture. It also has the potential to deliver an unprecedented scale of irradiated lutetium-177, an isotope of growing demand for radiotherapeutic applications. On that topic, we are making substantial progress on important therapeutic isotopes including the development of our lutetium-177 product and related preparation of the master drug file for sale of that product as an active pharmaceutical ingredient. In addition, the business recently completed and shipped the first trial batch of actinium-225 to Bayer for use in their therapeutic clinical trials. In summary, we see tangible progress in positioning the nuclear medicine business for accelerating growth. Finally, we continue to see positive sentiment around commercial nuclear power, particularly in light of the current geopolitical environment, wherein energy security is increasingly viewed as a component of broader national and economic security considerations. This coupled with net-zero emissions targets has created an intense focus on new commercial nuclear power solutions globally. To that end, we are pleased to announce receipt of a new contract from GE Hitachi for engineering design of the BWRX-300 small module reactor pressure vessel, which we expect will lead to material procurement and manufacturing. Not only do we see serious interest in the GE Hitachi design for potential customers in Canada, the US and Poland to name a few but other small modular reactor designers and integrators are also gaining traction for potential orders. BWXT occupies a premium position in the commercial nuclear supply chain in North America and can support multiple technologies and designs given our capacity, which includes the largest nuclear clean room manufacturing facility in North America. In summary, all of our markets are growing and BWXT maintains enviable competitive positioning across its entire portfolio amid a strengthening macro demand signal for nuclear. Having a highly differentiated and diverse nuclear portfolio is advantageous as we navigate the near-term macro challenges in the broader context of steady long-term growth in markets characterized by growing demand and high entry barriers.

Robb LeMasters, Senior Vice President and CFO

Thanks, Rex and good evening, everyone. Let's start with total company results on Slide 4 of the earnings presentation. Third quarter revenue was up 5% to $524 million, driven by growth in both operating segments, but most notably in commercial operations. Third quarter adjusted EBITDA was down, as anticipated by 5% to $100 million, which was driven by higher revenues and solid cost controls in commercial operations, which were more than offset by government operations headwinds including the hiring and labor challenges that Rex mentioned as well as lower recoverable CAS pension income. As a result, non-GAAP earnings were down $0.07 per share as we outlined on our previous earnings call. A more detailed quarterly bridge can be found on Slide 5 of the earnings presentation. Net operational headwinds were about $0.03 per share, which was further reduced by $0.03 per share from lower recoverable CAS pension income. Higher interest rates, some foreign exchange losses and a higher tax rate contributed another $0.03 per share headwind. These were all partially offset by a lower share count from last year's share repurchases which contributed $0.02 to EPS. Lastly, free cash flow was up $25 million, primarily driven by a decrease in CapEx as we continue to wind down the two major capital campaigns in the Navy and Medical businesses. Moving now to segment results on Slide 6. In Government operations, third quarter revenue was up 1% to $423 million, driven by higher naval production and microreactor volume that was partially offset by lower long lead material. Third quarter adjusted EBITDA was down 8% year-over-year to $90.4 million, as decreased efficiencies from a challenging hiring dynamic resulting in fewer favorable contract adjustments. Year-over-year results were also down given lower recoverable CAS pension costs, which were partially offset by higher income from our technical services joint ventures. In commercial operations, revenue was up 22%, driven by higher field service activity and fuel handling. BWXT Medical revenue was also up year-over-year. Third quarter commercial operations adjusted EBITDA was up 12%, through a combination of higher revenue a more favorable business mix and segment cost controls. Turning now to guidance on Slide 7. As we noted in the earnings release, we are narrowing 2022 guidance for revenue, EBITDA and EPS. We now expect consolidated revenue growth of 6.5% to 7% this year, with government operations expected to come in at the low end of the prior range at around 6%. Commercial Operations is expected to land at the higher end of the prior range at around 8.5%. Consolidated adjusted EBITDA, which includes a $17 million pension headwind, is now expected to grow about 5% with government operations now anticipated to be lower than previously expected at $395 million due to labor issues. Commercial Operations is expected to be slightly better than prior guidance at about $50 million. We also anticipate lower corporate unallocated costs for the year. This overall outcome was enabled by a diverse set of businesses and end markets, all pulling together to achieve a great operating result. Many companies in our industry have sought to hold or end up at the lower end of their operational guidance, whereas we are proud to be able to drive all year to the upper end of our initial operating range. We started 2022 with mid- to high single-digit EBITDA growth guidance on an ex-pension basis. And today, we are affirming that we will be squarely in the upper end of that guidance range, growing nearly double digits on that metric. However, we anticipate some modest nonoperational headwinds including a higher tax rate, as well as a little less income from other income from minor foreign exchange losses that will dampen overall EPS performance. The summation of these operational and nonoperational factors is keeping non-GAAP EPS relatively stable from prior guidance. We now see earnings in a tight range of $3.10 to $3.15 per share. The EPS guidance bridge is on Slide 8. From an operating cash flow standpoint, we still anticipate a broader range of $260 million to $290 million, as working capital items can fluctuate at the end of the year. Given the R&D tax amortization, legislation has not changed as well as overall net income performance to date, we expect to land in the low end of that range. I will note that currency hedging activity to neutralize key balance sheet items, expresses its benefit in the financing section of the cash flow statement under settlement of forward contracts. Those hedges provided over $10 million of cash settlement proceeds in the third quarter, and we are tracking well to have an equivalent cash inflow from financing in the fourth quarter this year. On the CapEx side, we have revised our expectation to less than $200 million this year. This change was driven by a combination of a slower ramp in spending on some of our investments primarily Project Pele, as well as some modest savings from rationalizing and reprioritizing spend. Before turning to our preliminary 2023 outlook, I did want to make a few comments on our recent balance sheet enhancements, through an improved capital structure. Last month, we amended and extended our credit agreement resulting in $250 million of additional liquidity at generally the same or more favorable terms, including an enhanced interest rate pricing grid and generally better flexibility. While we don't currently anticipate a need to utilize this expanded liquidity, we did want to take advantage of the favorable environment for companies like BWXT that lenders see as stable credits in this unique financing environment. BWXT now has no debt maturities until 2027. Turning now to our preliminary 2023 outlook, that we have summarized on Slide 9, of the earnings presentation. Overall, we expect to see another strong year of operational growth that is likely to be more than offset by below-the-line headwinds, namely lower noncash pension income and higher interest expense. Operationally, we anticipate mid-single-digit revenue growth, driven by the government operations segment with the main driver being the ramp-up of the Project Pele microreactor, as well as some modest anticipated growth in our uranium processing activities. Our Naval Nuclear reactors business, is expected to remain roughly flat next year. In Commercial Operations, we anticipate that the growth in BWXT Medical will be offset by a downshift in field services after strong volumes in 2022 from that business line. Margins should expand given various dynamics in both segments. In Government Operations, not only do we anticipate better margin contribution from more technical services work, but we expect to claw back labor volume and associated efficiencies as the year progresses. Initially the benefits from creating non-CapEx long-term capacity and efficiency won't bleed through until we move past the shorter term headwinds of having a newer workforce. Next year we are seeking to simply maintain margins in our core Navy business but should begin to build on that over the medium-term. Finally in this segment and as we have highlighted in our last 10-Q filing, we continue to explore opportunities for recovery of contract changes and associated cost growth related to non-nuclear components. We help stand up to American manufacturing of some of these key components and have absorbed unforeseen costs related to changing work scopes and design instability in the execution phase. We intend to seek adjustments for the past few years of grappling with this situation and bearing the cost through our bottom line. In commercial, margins are anticipated to expand as a lower mix of field services relative to a growing medical business will serve as a tailwind. All of these factors will enable consolidated adjusted EBITDA growth to outpace revenue growth next year. As we highlighted on our last earnings call, 2023 is setting up to potentially experience some meaningful non-operational and non-cash headwinds, which are expected to dampen our earnings outlook. We will finalize estimates for pension asset and liability balances as part of our standard year-end process and we'll specifically guide to these non-cash and macro-driven items on our fourth quarter earnings call in February. As a preview we are using the latest September 2022 asset performance and forward interest rate curves to provide an initial outlook. We currently anticipate about $55 million of headwinds for both non-cash pension income and interest expense similar to the relative magnitude seen by several of our defense peers. The most significant component of next year's non-operational headwinds is the accounting treatment for pension expense and income, which is presented in the other income line of the P&L. Last quarter we provided the sensitivities related to pension accounting's impact on the income statement and we are enhancing that by providing a table in the appendix of the presentation that depicts our pension estimates for next year against asset returns and discount rates. Currently returns and discount rates suggest a $40 million non-cash FAS pension headwind given year-to-date asset returns, down about 25% and a discount rate that has moved up almost 300 basis points from the start of the year. So simply put, standing here today that other income line to which we just guided a $48 million number to you in 2022 could be under $10 million in 2023. As a reminder non-cash pension income is an add-back in operating cash flow. So there is no cash impact from this reduction to income nor does it affect the strategic and operational condition of the business. Higher discount rates also enhance the funded status of the pension, which will likely finish the year at a nearly fully funded position. We continue to anticipate no material cash contributions to the pension in the years ahead. For interest expense, we anticipate a headwind of about $15 million, driven by significant increases in interest rates applied to our floating rate debt, which currently stands just above $500 million. Broadly projected interest rates are up about 275 basis points compared with this year's weighted average. Lastly, for 2023 we continue to focus on achievement of another important aspect of our medium-term guidance, the inflection in free cash flow and conversion of earnings into cash. Next year, we anticipate about $200 million of free cash flow, which will be driven by improvements in operating cash flow management across the business and a significant moderation of CapEx. There has been no change to our view that after several years of significant investment and two large capital campaigns that we will be able to return to the maintenance levels of CapEx of roughly $100 million with the need for only tens of millions of dollars for any top-up strategic investments. A prime example of incremental strategic investment is the Pele microreactor project, which can be supported by bite-sized amounts of capital. That project, in particular, only requires $30 million or less of incremental CapEx, most of which we expect to place throughout 2023. With years of solid investment across the company's facilities, we believe we can sustain and accelerate the strong adjusted EBITDA growth rates we are delivering this year and that we anticipate for next year. And with that, I will turn the call back to Rex for some closing remarks.

Rex Geveden, President and CEO

Thanks, Robb. We remain excited about the underlying growth of the business this year and next that is largely masked by exogenous factors and are committed to navigating near-term operating and macro market challenges, which do not change the long-term trajectory of the business. BWXT's growth verticals across multiple defense and commercial markets are building rapidly and the backdrop for nuclear solutions remains extremely positive. This gives us continued confidence in our plans to accelerate growth over the medium-term, and we thank our shareholders for embracing the value of the core businesses and our growth aspirations. We now look forward to taking your questions.

Operator, Operator

We will now begin the question-and-answer session. The first question comes from Bob Labick with CJS Securities. Please go ahead.

Bob Labick, Analyst

Good afternoon. Congratulations on the priority review.

Rex Geveden, President and CEO

Yes. Thank you, Bob. Big, big day for us.

Robb LeMasters, Senior Vice President and CFO

Thanks Bob.

Bob Labick, Analyst

Yes. No, that's great. So I just wanted to kind of following-up on that a little bit. Could you give us an update now on next milestones timing, and if there maybe impact the opportunity for initial sales late 2023 or what your timeline for that is given that you have the priority review in hand now?

Rex Geveden, President and CEO

Yes, absolutely, Bob. The process involves sending you a letter regarding the priority review designation along with a series of questions we need to respond to. Following that, there will be a facility inspection of our product and manufacturing line in Kanata over the next month or two. The FDA commits to a timeline of six months for a priority review, although there can be discussions around that timeframe. If the FDA requires more information from the product producer, in this case, BWXT, they essentially pause the review clock, which can extend the timeline. Therefore, we have been cautious in stating the timeline could be around six to nine months, which still aligns with our perspective. While it's encouraging to receive the priority review, I expect sales in 2023 to be modest. We are currently utilizing the research reactor at Missouri, known as the MURR reactor, to irradiate our target material initially, which limits the number of products we can offer to the radiopharmacies. The significant growth is anticipated to come from irradiating our target materials at the Darlington reactor owned by OPG. Consequently, I foresee that segment developing well into 2024 and 2025. In summary, we have modest sales expectations for 2023 as we assess the market and generate demand while also beginning long-term supply agreements.

Robb LeMasters, Senior Vice President and CFO

Yes, Bob, I want to remind you that when we presented the details for BWXT Medical, we didn't anticipate much, if anything, in 2023 to meet the statistics we shared. However, the underlying business is performing quite well. As we discussed, the operation in Kanata is reaching about a $60 million run rate, and we expect growth in the teens next year. It's developing positively. We hope to generate some sales possibly in 2023, but that is unlikely to significantly affect the financial targets we outlined during Investor Day and have recently confirmed.

Bob Labick, Analyst

Okay. Great. Regarding the target delivery system timeline, how does it relate to the review of the current generator? Will you have that installed this year or early next year? Also, what is the timeline for that product to come to market? You mentioned it would be in 2024 and 2025 and beyond, but please provide the steps we should anticipate for the TDS installation.

Rex Geveden, President and CEO

Yes. I will discuss the implications for the FDA application and then the timeline for the TDS. We just started installing it onto the Darlington reactor Unit number 2, and that process will continue over the next several months, finishing sometime next year. Regarding our FDA application, we hope to get approval for our product manufacturing configuration in Kanata as well as for the irradiation source, which is the MURR reactor. The neutron spectrum is important to the FDA because different neutron spectra can result in slightly different product characteristics, which we need to address in the application. Assuming we receive approval for our current configuration with the MURR reactor, we would then submit a supplemental application to the FDA for irradiation at the Darlington site. This typically has a shorter timeline, generally around two to three months for approval. After we receive approval on the initial configuration, we would proceed with the supplementation.

Bob Labick, Analyst

Super. Very exciting stuff. Congratulations. I’ll jump back in queue.

Rex Geveden, President and CEO

Yes. Thank you, Bob.

Operator, Operator

Thank you. The next question comes from the line of Scott Deuschle with Credit Suisse. Please proceed.

Scott Deuschle, Analyst

Hey, good evening. Thank you for taking my questions. Rex, are the labor challenges more acute in retention, or is it more about hiring new talent? I know the two kind of go hand in hand in terms of the net shortfall, but I'm just curious, I would think the productivity would differ between those two groups. So just curious if you can disaggregate the labor challenges for us a little bit more? Thank you.

Rex Geveden, President and CEO

Certainly, both attrition and hiring challenges are affecting the business right now. Historically, our typical attrition rate has been around 6%, which includes planned retirements and some unplanned turnover. However, over the past year or two, that number has increased into the high single digits. With a workforce of 7,000, this translates to a turnover of approximately 500 employees annually. Currently, we are working to hire an additional 500 employees this year and have successfully brought in over 800, but we've also lost about 500, resulting in a net gain of only 250 to 300 employees. This high turnover presents challenges for us in a couple of ways. Firstly, we are not fully aligned with our workforce plan, which affects production and absorption. Secondly, new hires come with a steeper learning curve and require more intensive training. So, that's the dual challenge we are facing.

Scott Deuschle, Analyst

That's super helpful. Has the attrition gotten any better in recent weeks, as people maybe digest the slower macro environment and risk of going somewhere beyond BWXT. Has that dynamic that you just described, has it changed at all in the past month?

Rex Geveden, President and CEO

Yes, we're monitoring this every day. If you examine the month-to-month figures, it appears that our attrition peaked around the middle of the year and has been improving slightly since then. I believe we've reached an inflection point. Regarding the macroeconomic environment, I think it actually benefits a company like BWXT for a couple of reasons. First, with decreased 401(k) balances, we observe a lower retirement rate, which helps us somewhat. Additionally, during recessionary periods, stability tends to be valued more than it has in the past couple of years. Therefore, we expect the attrition rate to improve for us if the economy weakens as we anticipate.

Scott Deuschle, Analyst

Got it. Well, I can attest to the point on 401(k)s. Just for Robb, quickly for you. Can you walk through the working capital trends you're expecting for the business over the next few years? I think that's been an area of focus for you. So just curious what your thoughts are on working capital and the opportunity for improvement near-term or the medium-term as well? Thank you.

Robb LeMasters, Senior Vice President and CFO

Yeah. Yeah. We monitor that pretty closely. We've got a lot of different efforts going on. As you know it takes some time to get the analysis straight and to actually figure out where you're going to attack, but if you've been watching our trends our managed working capital has kind of been flattening out the past couple of quarters. And we expect next year some of the big headwinds that we had this year specifically the steam generator project that we brought up in the past we're seeing sort of our worst year of headwinds of about $20 million headwind this year. We've called that out in the past. That's going to flatten out and not be a headwind next year we hope. That's our plan in terms of what we look at from a billing standpoint. And then, it will get positive in 2024 and 2025. So that's been the biggest kind of headwind overall to manage working capital. And then I would just call out onesie-twosie things that we're just going to look through procurement supply chain and really get after some of our terms, how we're billing our customers. We have a good handle on where the opportunities lie. And now it's just really getting our hands around it. So we've been looking at working capital days and a percentage of sales. And we think both of those can really be driven. And I think we'll be successful in 2023 and beyond.

Scott Deuschle, Analyst

Okay. Thank you so much.

Robb LeMasters, Senior Vice President and CFO

Thank you, Scott.

Operator, Operator

Thank you. The next question comes from the line of Pete Osterland with Truist Securities. Please go ahead.

Pete Osterland, Analyst

I'm on for Mike Ciarmoli tonight. Thanks for taking our question. So firstly I just wanted to clarify on the labor situation. It sounds like it's mostly impacting the Government ops business and you're not seeing similar issues regarding labor in commercial ops. Is that correct? And what's driving the difference there?

Rex Geveden, President and CEO

I'd say that's mostly correct, Pete. The factors that differentiate those businesses are that we tend to have a slightly older workforce in our Government operations, particularly in Navy manufacturing. We've seen higher retirement rates, as people rethought their personal considerations during the COVID period. Additionally, this part of the business involves the most intense touch labor, so the impact is felt most acutely there. On the other hand, we are experiencing the same labor challenges in other areas of the business, but the growth is somewhat masking those issues. As I mentioned in a couple of calls this year, we've faced challenges finding qualified RAD-Techs in our medical business, which actually prolonged our campaign for the Tech-99 program, but the growth has overwhelmed that issue. So, it's more apparent in the Navy business.

Pete Osterland, Analyst

Okay. That's helpful color. Thanks. And then kind of switching gears. I just wanted to broadly ask on the SMR market. What are you seeing so far in terms of the competitive environment? How much competition is currently out there for the content that BWX would provide on SMRs? And what do you see as your base advantage in capturing growth in this market?

Rex Geveden, President and CEO

I believe we are in a strong competitive position in that market due to our strategic positioning. The competition is particularly fierce in reactor design and supply, especially among those marketing small modular reactors. While many of them have the potential to succeed because of the impressive long-term demand, we are positioned at the top of the supply chain, supplying prime contractors like GE and others. BWXT stands out in this market because we possess unmatched capabilities for manufacturing large components in North America. We have the largest nuclear manufacturing clean room in North America, and we manufacture fuel, design components, and develop nuclear reactors. This allows us to effectively support many companies trying to sell reactors in this market. Moreover, we have remained design-agnostic as a merchant supplier, positioning ourselves well for growth in this market.

Robb LeMasters, Senior Vice President and CFO

I want to mention that since we are based in Canada, particularly in Ontario, the province has been very proactive in incorporating nuclear energy into the clean energy mix. This supportive environment has enabled us to engage in new projects while other regions have not been as active. We have been able to sustain a unique position in that market. Furthermore, Ontario is also making significant advancements in small modular reactors (SMRs), which allows us to be at the forefront of developments in that area. As a result, we are experiencing opportunities earlier than some competitors in other regions. Sometimes, luck can play a role in our success.

Pete Osterland, Analyst

All right, great. Thanks for taking the question.

Robb LeMasters, Senior Vice President and CFO

Thank you.

Operator, Operator

Thank you. The next question is from the line of David Strauss with Barclays. You may proceed.

David Strauss, Analyst

Thanks. Good evening.

Rex Geveden, President and CEO

Hey David.

David Strauss, Analyst

Hey. So, your guidance for government growth for the full year implies a pretty big fourth quarter. Can you just run through what's driving that exactly? Are you counting on a recovery on the labor side to be able to get there?

Robb LeMasters, Senior Vice President and CFO

No, we're not relying on labor for that. Typically, our fourth quarter is the time when we consolidate all the efficiency efforts we've implemented throughout the year and assess the EACs. It's a natural point for us to evaluate that segment of the business. Additionally, some projects we've announced this year, like Savannah River and SCO, required a ramp-up to achieve certain levels of efficiency. This quarter will be significant for those. I also want to mention that we are seeing notable growth in our non-core nuclear operations, particularly in down blending and HEU metal, which are positioned for a strong fourth quarter. Considering all this, it seems achievable. While it is a substantial quarter, we believe we will meet our targets for the fourth quarter.

David Strauss, Analyst

Okay. It looks like you're applying double-digit growth for the fourth quarter. I just wanted to make sure. Okay. And depreciation is that factored in? Is the big step-up in depreciation is that still factor in as a headwind next year as well at least from a bottom line EPS standpoint?

Robb LeMasters, Senior Vice President and CFO

It is David. As we consider various aspects, depreciation will be an incremental challenge across the business, especially in NOG. They've finally started to utilize some of their capital, which took longer to become productive. Consequently, our 2022 results were somewhat lighter than anticipated, leading to a downward adjustment in depreciation throughout the year. We foresee that this could contribute a headwind of approximately $5 million to $10 million to earnings next year. Another point we've noted is the $55 million of below-the-line headwind that stems from $15 million in interest expenses related to our $0.5 billion revolver, where rates have increased almost 3%. So, a 3% rise on $0.5 billion amounts to $15 million. The remaining $40 million in that $55 million figure is tied to pension costs, which consists of two parts: asset performance and interest rates. We are fairly well funded, with over $1 billion in both assets and liabilities, and we typically anticipate around a 7% return. However, with a 25% decrease in that balance, about $20 million of the $40 million pension figure comes from the return expectations. The other $20 million is attributable to the rise in interest rates; while liabilities have decreased, interest rates have increased by over 3%, effectively doubling the interest on our liability balance. So, while it may seem that the liabilities are down, the impact of higher interest rates complicates the picture. Alongside depreciation and interest expenses, these pension components are the primary challenges we see. Nevertheless, we are optimistic about our growth prospects next year, expecting mid-single-digit revenue growth and potential margin improvement, which may lead to a 5% to 7% increase in EBITDA. Looking at this year's EBITDA, applying that growth rate while starting last year with similar mid-single-digit expectations could allow us to recapture the $55 million deficit and mitigate the depreciation headwind. However, it's going to be a tough year ahead, and we project earnings between $3.10 to $3.15. Balancing everything, we anticipate a solid operating performance, but overcoming that $55 million hurdle may keep earnings from exceeding $3 a share. Throughout the year, we will be addressing these pension and interest challenges as we target our goals for next year.

David Strauss, Analyst

Great. That's helpful color. And then just a follow-up on the prior question. The $200 million free cash flow next year, Robb, are you baking in neutral working capital, or are you baking in some sort of net working capital headwind into that number?

Robb LeMasters, Senior Vice President and CFO

Yes. As we've mentioned, our capital expenditures remain unchanged. I’d like to provide an update on our operating cash flow for this year and next. We continue to project about $100 million for maintenance capital expenditures. One reason for our downgrade in capital expenditure guidance is the limited deployment of funds for the SCO-related Project Pele. At the beginning of the year, we estimated expenditures between $180 million and $200 million, around $190 million, but we have only spent $5 million so far. We expect to spend an additional $5 million to $10 million on that project in the fourth quarter. The remaining $25 million to $30 million from this project will be added to next year's $100 million. So, that's the situation with capital expenditures for 2023. Regarding operating cash flow, we anticipate better results than our guidance of $260 million to $290 million. We have been operating at a $300 million LTM figure and expect to exceed $300 million in the fourth quarter, which will help us reach the $200 million target next year. These initiatives we discussed earlier will take some time to show results. Therefore, with the projected capital expenditures around $120 million, we are aiming for a free cash flow number of approximately $200 million.

David Strauss, Analyst

All right. Great. Thanks very much.

Operator, Operator

Thank you. The next question comes from the line of Peter Arment with Baird. Please proceed.

Peter Arment, Analyst

Yes. Good evening, Rex and Robb. Hey, Rex congrats on kind of the commentary around the SMR work. Can you give us a little bit of a understanding the cadence of how revenues would begin to be reflected. I know that Darlington like Ontario Power has selected that to be kind of target for 2028. So how would that impact for you guys from a revenue perspective? Thanks.

Rex Geveden, President and CEO

Yes. We said earlier, Peter, a couple of calls ago, I think, that we expect revenue opportunities in the range of $100 million for each of those small modular reactors that are of the GE type. And it's kind of similar to the situation that we saw on the refurbishment projects in Canada in the sense that a lot of the long lead material design work hardware work gets done early. And so that favors us from a revenue perspective, because we're getting into design work for that reactor vessel right now. And so we would expect to be ordering long-lead materials probably as early as next year. So, that would ramp relatively soon for us.

Peter Arment, Analyst

That's great. Regarding the labor situation, you mentioned in your prepared comments that you're operating about 10% below your headcount plan, and you discussed some differences in attrition. Should we anticipate a similar strategy for next year as you continue to scale up? Also, are you considering a different approach to the labor market now? Thanks.

Rex Geveden, President and CEO

Yes, I need to clarify that what I mentioned in the script about being off by as much as 10% at certain sites is not entirely accurate. When looking at the overall numbers, the shortfall is closer to 5% across the entire business. However, we are not anticipating significant improvements in the labor market for our plans next year, especially considering two key factors: our current attrition rate and our ability to hire in line with our growth ambitions. We do expect more growth next year, which presents an even greater challenge. Additionally, we are facing some efficiency issues related to new employees that are specific to the current labor environment. Therefore, we are not operating under the assumption that there will be a full recovery from these issues next year.

Peter Arment, Analyst

Appreciate that. Thanks, Rex.

Rex Geveden, President and CEO

Yeah. Thanks, Peter.

Operator, Operator

The next question comes from the line of Tate Sullivan with Maxim Group. Please proceed.

Tate Sullivan, Analyst

Hi. Thank you. On your comments about the 2023 outlook and with what you commented on the labor market, what are the sources of the expanding margins in 2023? If you can comment on some of the drivers there, please?

Robb LeMasters, Senior Vice President and CFO

Yeah. There's a couple of factors that we have, maybe just moved through the couple of different businesses. So as you know, our mix and Government operations will improve over the course of the year. We do expect as we said to try to call back some of those non-nuclear businesses. Those could come in at a high margin, because we've basically taken the pain there. So that's one contributor. The second contributor is that as we build our TSG business, as you know that doesn't come with revenue. And then as we just bring on a better base of microreactor business within AT, that's just absorbing overall cost better. So those are our main businesses. And the final one, I'd call out is within the non-nuclear operations business. We're really ramping a contract there, which looks very similar to our down blending contract that we've called out of HEU metal. So we're doing a processing business. That also is a high-margin business that will be ramping next year. So that's sort of the government operations part of the story. In 2023 versus 2022 for the commercial business specifically that really comes down to we've had a blockbuster year in field services overall in terms of dollars of profit, but those are a little bit lower margin for us relative to other businesses we have in that legacy NPG segment. So that will drop away whereas the BWXT Medical really has higher margins. So you're really kind of dropping field services, lower margin for higher-margin base of business there with BWXT Medical.

Tate Sullivan, Analyst

Great. Thank you, Robb. And then, can you just review the comments on CapEx? So with the slightly lower CapEx for 2022 the timeline – anticipated timeline to reduce the maintenance CapEx levels? And then what's a reasonable decline in CapEx if you can comment on it for 2023?

Robb LeMasters, Senior Vice President and CFO

Overall, I don't think our general commentary has changed. We expect to have between $180 million to $200 million this year, which we increased by $15 million last quarter. We estimate that we will allocate about $30 million for the SCO bill, but we haven't fully utilized that amount yet. We're aiming to stay around our midpoint for non-Pele expenses and will see how the fourth quarter impacts us as we strive to stay under $200 million. If we only spend about $5 million on Project Pele in 2022, we will aim to use the remaining funds, about $25 million, to keep our total under $30 million, which we believe is achievable. In this scenario, we would add $25 million to the $100 million we've discussed for maintenance, resulting in a projected CapEx of $125 million for next year. We anticipate delivering the prototype for Project Pele in 2024, so we expect to move past that project by 2023 and return to a $100 million spending pattern in 2024. However, we may incur additional CapEx for outfitting our facility for Project Pele and through activities related to the DARPA DRACO project. We're also making good progress in our nuclear medicine business, focusing on the therapeutics market. We've established our capabilities with active pharmaceutical ingredients (APIs) through our irradiation methods, but we will need additional investments to manufacture drugs like TheraSphere. As we move into contract drug manufacturing, these typically come with multiyear contracts that require significant financial commitment, estimated to be an additional $20 million to $30 million beyond the $125 million. Thus, we see two main areas for potential capital investment: microreactors and nuclear medicine.

Tate Sullivan, Analyst

Thank you very much Robb

Robb LeMasters, Senior Vice President and CFO

Sure. Thanks for the questions.

Operator, Operator

Thank you. There are no additional questions at this time. I will pass it back to the management team for closing remarks.

Mark Kratz, Vice President of Investor Relations

Thanks, Tia and thank you everyone for joining us today. If you have further questions, you can reach us by phone at 980-365-4300 or by e-mail through investors@bwxt.com.

Operator, Operator

That concludes today's conference call. Thank you. You may now disconnect your line.