BWX Technologies, Inc. (NYSE:BWXT) Q2 2023 Earnings Call Transcript

BWX Technologies, Inc. (NYSE:BWXT) Q2 2023 Earnings Call Transcript August 3, 2023

BWX Technologies, Inc. beats earnings expectations. Reported EPS is $0.65, expectations were $0.59.

Operator: Ladies and gentlemen, welcome to BWX Technologies Second Quarter 2023 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to our host, Chase Jacobson, BWXT’s Vice President of Investor Relations. Please go ahead.

Chase Jacobson: Thank you, Brianna. Good evening and welcome to today’s call. Joining me are Rex Geveden, President and CEO; and Robb LeMasters, Senior Vice President and CFO. On today’s call, we will reference the second quarter 2023 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 the appendix of the earnings presentation that can be found on the Investors section of the BWXT website. I would now like to turn the call over to Rex.

Rex Geveden: Thank you, Chase and good evening to everyone. Earlier today, we reported solid second quarter results that were slightly ahead of our expectations, highlighted by robust double-digit organic revenue growth, good execution and improved free cash flow. Given our strong performance in the first half of the year, coupled with favorable demand trends, we now expect high single-digit revenue growth and are raising the low end of our 2023 adjusted EPS guidance by $0.05 to $2.85 to $3. Before I dive into the highlights of the quarter, I would like to provide a state of the union on what we are seeing in our key nuclear end markets. There are several underlying secular themes supported by the increasing use of nuclear solutions in our global security clean energy and nuclear medicine end markets.

And given the BWXT’s extensive experience in the industry, our exceptional nuclear design capabilities, robust manufacturing footprint and vertical scale, we are very well positioned to benefit from the growing demand that we see in the years ahead. The first of two emerged on large themes driving heightened interest in nuclear is the great power competition. This drives the global security market, but is becoming an increasingly important stimulant in the commercial nuclear power market as well. Before explaining that, let me note that the U.S. government strategy to bulk up on our strategic force capabilities, including a recapitalization of the U.S. naval nuclear fleet is in direct response to this geopolitical reality. We have supported this strategy with investment in BWXT’s Navy plants to enable a greater level of naval nuclear shipbuilding, especially in the second half of this decade and beyond, something the industry required given its aging infrastructure.

The current 30-year shipbuilding plan calls for 10 years of serial procurement of Columbia class submarines beginning in 2026 and the potential for the Ford-class aircraft carrier to move to 4-year centers beginning in 2028. This is on top of consistent procurement of Virginia-class submarines and a new demand for submarines from Australia as part of the Australia, UK, U.S. trilateral security agreement known as AUKUS. Beyond our core naval propulsion business, we are seeing the precipitation of demand for advanced nuclear reactors by various government agencies looking for innovative clean power and propulsion solutions in space and other domains. These systems can improve the security posture of the U.S., especially in emergency or war fighting scenarios.

Last year, BWXT was awarded separate contracts by the Department of Defense’s Strategic Capabilities Office, to build a prototype micro-reactor called Project Pele and to manufacture the TRISO fuel to power that reactor. The ultimate objective of this program is to supply high-density, off-grid power to military bases among other applications. We are tracking well on this project and are seeing new interest from various defense agencies who view this as a potent and differentiated capability. Just this quarter, I joined other BWXT executives in an engagement with a combatant command to discuss how Pele can be deployed in an off-grid application to eliminate vulnerabilities related to the diesel and broader supply chain and provide reliable high-density power for baseload radars, missile defense systems and electric transportation fleets.

Of note, Project Pele and a related rider to support a study about a potential microreactor in Guam received strong bipartisan support in the Senate Armed Service Committee’s markup of the fiscal 2024 National Defense Authorization Act. And just last week, we were selected along with our prime partner, Lockheed Martin for the DRACO project, the first demonstration of a nuclear thermal rocket engine in space. With this contract expected to be valued at over $200 million, we will have the government’s cornerstone nuclear fuel and reactor programs in our portfolio, serving the terrestrial and space domains to complement our Navy franchise. Beyond national security applications, the commercial markets are pivoting to nuclear energy solutions to meet future power demand and to improve their energy security posture, notably nations in Western Europe, which won’t stop their investment in nuclear are now announcing plans to begin new large reactor build-outs and/or construction of multiunit small modular reactor plants.

We have exposure to these opportunities through our capabilities in fuel and fuel handling, component manufacturing, field services and design knowledge. We are anticipating potential new builds in Canada and in other interesting markets, including the U.S., UK, Poland, Romania, South Korea and others. We possess the largest operating nuclear qualified manufacturing site in North America, where we serve a range of projects, including SMR development, plant life extensions and operation support for the installed nuclear base. Our scope on SMRs can range from around $50 million to over $100 million per reactor. Importantly, our role as a merchant supplier serves as a vital resource to reactor designers that are in need of well-established and qualified manufacturing and supply chain management.

On this note, yesterday, we announced that Terra Power selected BWXT to design the intermediate heat exchanger for its Natrium demonstration project in Wyoming and they highlighted our role as a designer and fabricator as key to the project’s planned achievements. As opportunities like this develop with new and existing customers, we are in the early days of assessing our capacity to satisfy this burgeoning demand to take an even larger leadership role in the commercial nuclear market. This transitions well into the second major theme driving nuclear interest and that is decarbonization of the grid. As technologies advance, nuclear is increasingly seen as the obvious and preferred source for reliable baseload clean energy production. Last month, Ontario Power Generation announced it is planning for 3 additional BWRX-300 small modular reactors at the Darlington site in addition to the one planned for completion by the end of the decade.

Also in Canada, Bruce Power launched the study to assess the feasibility of adding nearly 5 gigawatts of large-scale nuclear power as the Ontario government seeks to double the scale of the grid by 2050 to meet projected demand. There is growing demand outside of Canada as well. Earlier in the year, the United States Department of Energy invited utilities to apply for up to $6 billion in civil nuclear tax credits. Some of the largest domestic utilities like the Tennessee Valley Authority as well as large industrial companies around the world are considering new nuclear investment. In Europe, the UK government recently opened a competition to develop SMRs as it seeks to increase its nuclear power generation capacity to 24 gigawatts by 2050 from approximately 6.5 gigawatts today and many other countries and large utilities in Europe are signaling interest in nuclear as well.

With the growing demand for nuclear power, we were seeing new technologies for SMRs and micro reactors come to the market from both established and the startup nuclear companies, we view this as positive for the industry overall and believe that our full suite of nuclear solutions, including reactor design, fuel fabrication manufacturing, manufacturing and services position us well to maintain a leading market position in commercial nuclear power. We feel even more convicted that our long view and persistent investments in nuclear, even in uncertain times, have positioned BWXT to capitalize on the significant up-cycle we anticipate in these compelling markets. To be clear, we do intend to continue to drive our business through innovation. And following a super cycle of investment in our infrastructure in the past few years, in particular, in naval reactors and nuclear medicine manufacturing, we are positioned to continue growing at healthy organic rates with much more modest CapEx investments.

By layering in incremental CapEx to support growing demand for micro-reactors or SMR component manufacturing capacity or even novel automated or AI-driven naval manufacturing equipment, we expect to balance earnings growth alongside free cash flow and achievement of high returns on invested capital. Our growth investments also extended human capital. Over the last year, we have made multiple additions to our executive leadership team and are continuing to add to our operational and functional support teams to ensure we have superior talent necessary to address the strong growth we see ahead. Turning back to the quarter. Our second quarter results were ahead of expectations. The quarter was boosted by robust 11% organic growth, leading to a record level of second quarter revenue.

Despite this growth and as expected, our adjusted EBITDA and earnings per share declined year-over-year due to the margin impacts of onboarding new team members, operational improvement investments as well as less favorable product mix and the impact of lower pension income and higher interest expense on earnings per share. Turning to our segments. In government operations, we reached an important milestone during the quarter. I am pleased to report that we shipped the final missile tube under our Block 2 contract, originally signed in 2017. While this business line has had its challenges, I am extremely proud of our team’s dedication and hard work to complete this project and deliver a superb product to our Navy customer. We are working with our partners to recover costs associated with this contract and expect a resolution given our steadfast support to the Navy over the course of this challenging product evolution.

As we discussed last quarter, we expected some near-term noise in our government operations margin performance quarter-to-quarter as the streamlined hiring and training processes that we implemented over the last year, began to kick in and we integrate a less experienced workforce. Because of this, along with the timing of work across our portfolio and less favorable product mix, mainly related to strong increase in advanced technologies, which has mostly cost reimbursable contracts, we experienced some transient margin pressure in the second quarter. Despite that, our businesses performed well and we expect to see improving margins in the third and fourth quarters. Robb will provide more detail during his remarks. In April, a BWXT-led joint venture was awarded the 10-year Hanford Integrated Tank Disposition contract by the DOE because of our superior bid.

After going through a protest process with the DOJ, the contract decision is now back in the hands of the DOE and there are a variety of options that can take in deciding the best path forward. We will provide an update on this process as appropriate. But at this point, we do not expect a contractor transition at the site occurring until at least early 2024. Other projects in our Technical Services Group are performing well and we are seeking multiple new award opportunities such as the Portsmouth, Paducah operations and site mission support and the Pantex management and operations contracts among others. Moving on to commercial operations. Our core nuclear power business performed well during the quarter, driven by ongoing refurbishment and life extension projects and a number of reactors in the Canadian fleet.

As I mentioned earlier, the Canadian government and large Canadian utilities are committed not only to maintaining and extending the lives of their existing fleets of nuclear power plants, but also to adding new nuclear capacity with the installation of SMRs and potentially new large plants as well. At BWXT Medical, we had another solid quarter with over 20% organic revenue growth in the first quarter of positive EBITDA. We faced the nuclear medicine market as a full-service player in radioisotopes with a base of diagnostic isotopes, additional layers of therapeutic isotopes and contract drug manufacturing. We are enjoying strong demand for diagnostic isotopes such as strong team in germanium that are used in cardiac and cancer image studies as well as in therapeutics where we expect significant growth opportunities in the manufacturing of active pharmaceutical ingredients, like lutetium and actinium that support innovators and pharmaceutical companies engaged in late-stage clinical trials of products that will change the face of cancer therapy.

As it relates to our Tech-99 product deployment, we received formal communication from the FDA in June with questions and data requests required for final approval. With no significant surprises in that communication and in follow-up discussions, we now have formal consent to pivot directly to our target delivery system at the OPG Darlington site. This will enable us to achieve commercialization of the full product suite, including large generators in 2024. With a generator product that is essentially identical or superior to those on the market today, we intend to stabilize the nuclear medicine ecosystem with this critical and foundational diagnostic device used in thousands of procedures every year. To sum it up, we had a good first half of the year with strong organic revenue growth, good execution, solid cash flow and a number of important wins across our businesses.

Our end markets are gaining momentum and we are investing in our facilities and our people to ensure that we are positioned to attack the most promising opportunities in these extremely compelling nuclear markets. Let me now turn it over to Robb to discuss the second quarter financial results in more detail and to discuss our updated 2023 guidance.

Robb LeMasters: Thanks, Rex and good evening everyone. I’ll start with some total company financial highlights on Slide 4 of the earnings presentation. Second quarter revenue was up 11% on a consolidated basis, with government operations up 13% and commercial operations up 2%. This growth led to robust second quarter revenue of $612 million. Despite our strong revenue growth, second quarter adjusted EBITDA was down year-over-year as expected. Adjusted EBITDA was $107 million, down 7% year-over-year as higher revenue was offset by lower margins in both segments due to onboarding inefficiencies, operational improvement investments, and less favorable product and services mix in both government operations and commercial power as well as higher corporate costs.

Adjusted earnings per share, was $0.65 compared to $0.82 in the prior year quarter. As you can see in the EPS bridge on Slide 5, the year-over-year decline was dominated by non-operational items, including lower pension income and higher interest expense. Despite lower net income, free cash flow improved to $41 million compared to $35 million in the second quarter of 2022 driven by improved working capital management and slightly lower capital expenditures. Our capital expenditures of roughly $40 million in the quarter were down modestly compared to last year and consisted of maintenance CapEx and select growth initiatives. Our target for the next couple of year is that capital expenditures consists most of maintenance spending with additional investments to support specific projects or visible growth opportunities.

Just as the case will be in 2023, previously signaled $125 million to account for maintenance CapEx and a top up to finish the build-out of our BWXT Innovation Campus in Lynchburg, Virginia, that we announced late last year and set up this year. That campus will be the home of our terrestrial microreactor team for the foreseeable future. We are doing our final estimates for the time phasing of CapEx related to Project DRACO that we announced just last week between 2023 and 2024. But as we have said in the past this space microreactor build out will be inside of what we spend for Pele. In any instance, we are confident the efforts around working capital management and its effect on operating cash flow will allow us to absorb any potentially higher 2023 CapEx and still achieve our goal of $200 million in free cash flow this year.

Moving now to the segment results on Slide 6. In government operations, second quarter revenue was up 13% to $492 million a very strong second quarter level, driven by higher naval nuclear component production and microreactor volume that was partially offset by lower long lead material procurement. Second quarter adjusted EBITDA in the segment was $96 million, essentially flat with last year as higher revenue was offset by less favorable mix and the new hiring inefficiencies Rex discussed. In commercial operations, revenue was up 2%, driven by higher increased field service activity in our commercial nuclear business, as well as higher BWXT medical revenue and mitigate by lower fuel fabrication and nuclear component manufacturing volume. Second quarter commercial operations adjusted EBITDA was down approximately $2 million as revenue was skewed toward field service refurbishment activity and less outage work compared to last year.

This was partially offset by improved profitability in medical and by ongoing cost controls in the business. Turning now to guidance on Slide 7. Following a strong first half and with more clarity into the remainder of the year, we are raising the lower end of our 2023 adjusted EPS guidance. We project revenue of over $2.4 billion, up high single digits organically compared to 2022 versus our initial target of mid to high single-digit annual growth. This industry-leading growth is driven by high single-digit growth in government and mid-single-digit growth in commercial. While we expect modest EBITDA margin improvement at the segment level, this is somewhat offset by slightly higher corporate expense. Our previous guidance was for corporate EBITDA expense to be roughly in line with the 2019 to 2021 historical average of about $11 million.

We will still be in the same ZIP code, but may push closer to the higher end of the $10 million to $15 million range we had previously forecasted. This increase is driven by human capital investment as we enter our next phase of growth and focus on driving operational performance throughout the organization. Overall, we continue to expect adjusted EBITDA margins of approximately 20%, leading to adjusted EBITDA of about $475 million, up high single digits compared to 2022, driven almost entirely by organic growth, consistent with our prior guidance. Adjusted EBITDA growth in 2023 is expected to be offset by non-operational items such as lower pension income and higher interest expense. As such, we expect adjusted pretax income of around $350 million and adjusted EPS in the range of $2.85 to $3 per share.

The increase in the lower end of the range is due to our solid first half results, good visibility into the second half and slightly lower interest expense. This is offset by the modest bump in corporate expenses and the timing of the DRACO and Hanford awards. As we look to the second half of the year, I want to identify a few details related to the quarterly cadence of earnings. While we reach the low point for government EBITDA margin in Q2. We expect another quarter of lower than normal EBITDA margins in Q3. Over the last couple of years, government EBITDA margins have averaged approximately 21.5%. We expect Q3 to be somewhere between the Q2 level and that average with a significant improvement to near all-time high EBITDA margins in Q4.

In Q3, government operations margins will steadily increase as we work through the impacts of onboarding inefficiencies as well as the impacts of project mix and timing on newer programs. Also, as a reminder, Q3 is typically one of the lower revenue quarters in our commercial power business as there are fewer outages during the peak summer months. In Q4, we expect a significant sequential increase in volume, fewer onboarding inefficiencies and the potential to recognize the recovery on non-nuclear components. Overall, BWXT is growing across the portfolio and is building on our strategic successes and competitive positioning, enabling another strong year of operational growth and positioning us to accelerate and achieve our medium-term financial targets.

Not only will we remain focused on growth, but also on building a stable and enduring management infrastructure with mature processes. This will add better predictability and free cash flow conversion that will provide tangible and sustainable shareholder value over time. And with that, we look forward to taking your questions.

See also 25 Most Powerful Passports in the World and 20 Cheapest Places to Retire in Europe.

Q&A Session

Operator: [Operator Instructions] Your first question comes from Peter Skibitski with Alembic Global. Your line is now open.

Peter Skibitski: Hi, guys. Rex, a lot going on, that’s for sure. Maybe we could start by talking about labor. I don’t know if you guys can quantify the amount of net hiring that took place in the second quarter. It seemed like that enabled the growth at government. And maybe what the net hiring goals are for the second half?

Rex Geveden: Yes, I’ll put a little color on that, Peter. I’m really super pleased with what’s going on with hiring right now. Our Chief Administrative Officer, Bob Duffy, and his human capital team basically completely redesigned the talent acquisition process, did kind of a kaizen approach to that and took out days and weeks and even months in that process. And so the onboarding process, the hiring process is really streamlined and really functioning. And at the same time, if you look at our attrition rate, it’s – we’ve gone through six quarters of sequential improvement of trailing 12-month attrition and now we’re trending back down toward our historical averages, which are around mid-single-digit voluntary attrition.

So it’s trending the right way. The hiring is accelerating and the attrition is decelerating. So we’re making great strides there. And that’s really giving us, there is sort of two factors in the business, but one is that’s giving us the capacity for more volume, which is good for the business, but it’s also creating some inefficiencies on the front end because of training and indirect charges related to that. So two impacts on the business. But altogether, super well pleased. We’ve got more work to do, but we’re climbing the hill really fast right now. And I like where we are – And maybe, Robb, you could offer a little bit more color on that.

Robb LeMasters: Yes. No, thanks for the question. Yes, so I’m tracking the data pretty closely. We’ve seen, as Rex said, as we talked about last quarter, we had that bulge of pending starts, and we got those through the funnel. And actually, as I tracked it over the course of the month, every single month during the quarter, we sort of built a larger number of net hires into the company. Ultimately, when I looked at the whole quarter, we’re running at about 2x the first quarter number in terms of total net hires. So that’s having a really good impact. We don’t have the July data in front of us for the full month. But I am sure that shaping up nicely too. So people are coming through. It’s also, as Rex said, having a noticeable impact on our utilization.

So when I look at the data here on a utilization front, some of our key sites where we’re taking in a lot of people, we’re seeing a year-over-year impact as we expected, and that’s what’s causing a strain. So – in three of our major sites in the – in our core naval business, we’re seeing almost a 200-plus decline year-over-year in utilization. And so as we ramp those people up, that utilization come through. The third area is just to highlight that we’re trying to do increased data runs on is trying to figure out how, for the remainder of the year, as you said, we feather those people in nicely. So we’re looking at different sites, and we now have so much more data to try to understand how direct versus indirect come into the business, how we can layer those and ever better and how we can really know, when people are going to hit the site and be able to train them quickly.

So coming through as we expected and having the strain in Q2 that we expected and ultimately, we will see a little step up in Q3 in terms of margin. And ultimately, I think we will work through the hardest part and be fully primed by Q4.

Peter Skibitski: Okay. Well, it’s great to hear the pretty active management there and the progress, guys. Before I get back in queue, let’s just talk about DRACO, if we can. I guess, first of all, Rex, this is an OTA contract, right? So it can’t be protested. Maybe you can validate that and maybe give us a sense of whether or not it was within the second quarter or it will go into backlog in the third quarter. And my understanding, it sounds like it’s roughly a 3-year contract. So will you book revenue on it this year? And did that give any sort of upward push to guidance this year that was offset elsewhere, just some color about all that would be great. Thank you.

Rex Geveden: Yes. Lots to impact there, Pete. Yes, exciting win for us. That was booked in the third quarter. So we will start to see revenues hit the book in the second, third quarter. We would see the bulk of the revenues on that program going through ‘24 and ‘25 and bleeding into 2026 and ‘27 as we apply that mission, but the bulk of it in the next couple of years after this. Correct that, that contracting mechanism is done through another transactional authority and OTA. So it’s not subject to federal acquisition regulations in that standard format. So there is no appeal path for it. So that’s a win. And it’s an exciting one. As I said in the script back there, we’ve won the flagship program for the space domain.

And then last year with Pele, the flagship – government flagship program for the terrestrial domain, we have that’s the Navy franchise and it’s a pretty important set of projects for us, particularly from the competitive context. So really happy with that when and excited to see that program go forward.