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BWC > SEC Filings for BWC > Form 10-Q on 12-Nov-2013All Recent SEC Filings

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Form 10-Q for BABCOCK & WILCOX CO


12-Nov-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

The following information should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included under Item 1 of this report and the audited consolidated and combined financial statements and the related notes and Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our annual report on Form 10-K for the year ended December 31, 2012 (our "2012 10-K").

In this quarterly report on Form 10-Q, unless the context otherwise indicates, "we," "us" and "our" mean The Babcock & Wilcox Company ("B&W") and its consolidated subsidiaries.

We are including the following discussion to inform our existing and potential security holders generally of some of the risks and uncertainties that can affect our company and to avail ourselves of the "safe harbor" protection for forward-looking statements provided by federal securities law, including
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act").

From time to time, our management or persons acting on our behalf make forward-looking statements to inform existing and potential security holders about our company. These statements may include projections and estimates concerning the timing and success of specific projects and our future backlog, revenues, income and capital spending. Forward-looking statements are generally accompanied by words such as "estimate," "project," "predict," "believe," "expect," "anticipate," "plan," "goal" or other words that convey the uncertainty of future events or outcomes. In addition, sometimes we will specifically describe a statement as being a forward-looking statement and refer to this cautionary statement.

These forward looking statements include, but are not limited to, statements that relate to, or statements that are subject to risks, contingencies or uncertainties that relate to:

our business strategy;

future levels of revenues (including our backlog and project claims to the extent either may be viewed as an indicator of future revenues), operating margins, income from operations, net income or earnings per share;

anticipated levels of demand for our products and services;

future levels of research and development, capital, environmental or maintenance expenditures;

our beliefs regarding the timing and effects on our businesses of certain environmental and tax legislation, rules or regulations;

the success or timing of completion of ongoing or anticipated capital or maintenance projects;

expectations regarding the acquisition or divestiture of assets and businesses;

our share repurchase or other return of capital activities;

our ability to maintain appropriate insurance and indemnities;

the potential effects of judicial or other proceedings, including tax audits, on our business or businesses, financial condition, results of operations and cash flows;

the anticipated effects of actions of third parties such as competitors, or federal, foreign, state or local regulatory authorities, or plaintiffs in litigation;

the effective date and expected impact of accounting pronouncements;

our plans regarding the design, research and development, financing and deployment of the B&W mPowerTM reactor; and

anticipated benefits, timing and changes associated with cost reduction and efficiency improvement activities.

In addition, various statements in this quarterly report on Form 10-Q, including those that express a belief, expectation or intention, as well as those that are not statements of historical fact, are forward-looking statements.

These forward-looking statements speak only as of the date of this report; we disclaim any obligation to update these statements unless required by securities law, and we caution you not to rely on them unduly. We have based these forward-looking statements on our current expectations and assumptions about future events. While our management considers these expectations and assumptions to be reasonable, they are inherently subject to significant business, economic, competitive, regulatory and other risks, contingencies and uncertainties, most of which are difficult to predict and many of which are beyond our control. These risks, contingencies and uncertainties relate to, among other matters, the following:

general economic and business conditions;


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general developments in the industries in which we are involved;

decisions on spending and trends by power-generating companies and by the U.S. Government, including the automatic budget cuts (or sequestration) established by the Budget Control Act of 2011;

the highly competitive nature of our businesses;

cancellations of and adjustments to backlog and the resulting impact from using backlog as an indicator of future earnings;

our ability to perform projects on time, in accordance with the schedules established by the applicable contracts with customers;

the ability of our suppliers to deliver raw materials in sufficient quantities and in a timely manner;

volatility and uncertainty of the credit markets;

our ability to comply with covenants in our credit agreements and other debt instruments and the availability, terms and deployment of capital;

the impact of our unfunded pension liabilities on liquidity, and our ability to fund such liabilities in the future, including our ability to continue being reimbursed by the U.S. Government for a portion of our pension funding obligations, which is contingent on maintaining our government contracts;

the continued availability of qualified personnel;

the operating risks normally incident to our lines of business, including the potential impact of project losses and liquidated damages;

changes in, or our failure or inability to comply with, government regulations;

adverse outcomes from legal and regulatory proceedings;

impact of potential regional, national and/or global requirements to significantly limit or reduce greenhouse gas emissions in the future;

our ability to successfully manage research and development projects and costs, including our efforts to develop the mPower Plant based on B&W mPowerTMtechnology;

our ability to continue to obtain funding for our B&W mPowerTM technology under the Cooperative Agreement with the U.S. Department of Energy ("DOE");

impact of potential regulatory and industry response affecting the timing and cost of future nuclear development as a result of the damage caused by the March 11, 2011 earthquakes and tsunami on certain of Japan's nuclear facilities;

changes in, and liabilities relating to, existing or future environmental regulatory matters;

rapid technological changes;

the consequences of significant changes in interest rates and currency exchange rates;

results of tax audits, including a determination by the IRS that the spin-off or certain transactions should be treated as a taxable transaction, and the realization of deferred tax assets;

our ability to manage our capital structure, including our access to capital, credit ratings, debt and ability to raise additional financing;

difficulties we may encounter in obtaining regulatory or other necessary approvals of any strategic transactions;

the risks associated with integrating businesses we acquire;

our ability to realize adequate returns and related dividends on our investments in unconsolidated affiliates;

our ability to maintain operational support for our information systems against service outages and data corruption, as well as protection against cyber-based network security breaches and theft of data;

social, political and economic situations in foreign countries where we do business;

the possibilities of war, other armed conflicts or terrorist attacks;

the effects of asserted and unasserted claims;

our ability to obtain and maintain surety bonds, letters of credit and similar financing;

our ability to obtain and maintain builder's risk, liability, property and other insurance in amounts and on terms we consider adequate and at rates that we consider economical;

our ability to successfully develop competitive new technologies and products;

the aggregated risks retained in our captive insurance subsidiary; and

the impact of the loss of insurance rights as part of the Chapter 11 bankruptcy settlement concluded in 2006 involving several of our subsidiaries.


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We believe the items we have outlined above are important factors that could cause estimates in our financial statements to differ materially from actual results and those expressed in a forward-looking statement made in this report or elsewhere by us or on our behalf. We have discussed many of these factors in more detail elsewhere in this report and in Item 1A in our 2012 10-K. These factors are not necessarily all the factors that could affect us. Unpredictable or unanticipated factors we have not discussed in this report could also have material adverse effects on actual results of matters that are the subject of our forward-looking statements. We do not intend to update our description of important factors each time a potential important factor arises, except as required by applicable securities laws and regulations. We advise our security holders that they should (1) be aware that factors not referred to above could affect the accuracy of our forward-looking statements and (2) use caution and common sense when considering our forward-looking statements.

GENERAL

We operate in five segments: Power Generation, Nuclear Operations, Technical Services, Nuclear Energy and mPower. Prior to 2013, we reported four segments:
Power Generation, Nuclear Operations, Technical Services and Nuclear Energy. Our small modular nuclear reactor business previously included in our Nuclear Energy segment is now being reported as a separate segment, mPower. The change in our reportable segments had no impact on our previously reported results of operations, financial condition or cash flows. For additional information regarding our change to the segments, see Note 1 to the condensed consolidated financial statements in this report.

Business Segments

In general, we operate in capital-intensive industries and rely on large contracts for a substantial amount of our revenues. We are currently exploring growth strategies across our segments through acquisitions to expand and complement our existing businesses. As we pursue these opportunities, we expect they would be funded by cash on hand, external financing (including debt), equity or some combination thereof.

Power Generation Segment

Our Power Generation segment's overall activity depends mainly on the capital expenditures of electric power generating companies and other steam-using industries. Several factors influence these expenditures, including:

prices for electricity, along with the cost of production and distribution;

prices for coal and natural gas and other sources used to produce electricity;

demand for electricity, paper and other end products of steam-generating facilities;

availability of other sources of electricity, paper or other end products;

requirements for environmental improvements;

impact of potential regional, state, national and/or global requirements to significantly limit or reduce greenhouse gas emissions in the future;

level of capacity utilization at operating power plants, paper mills and other steam-using facilities;

requirements for maintenance and upkeep at operating power plants and paper mills to comply with environmental regulations and combat the accumulated effects of wear and tear;

ability of electric power generating companies and other steam users to raise capital; and

relative prices of fuels used in boilers, compared to prices for fuels used in gas turbines and other alternative forms of generation.

Our Power Generation segment plans to continue efforts to expand international offerings through organic growth and potential partnering arrangements or acquisitions.

Nuclear Operations Segment

The revenues of our Nuclear Operations segment are largely a function of defense spending by the U.S. Government. As a supplier of major nuclear components for certain U.S. Government programs, this segment is a significant participant in the defense industry.

The collective bargaining agreement covering approximately 350 employees at our Barberton, Ohio manufacturing facility has expired. As of September 30, 2013, these employees continued to work under the terms of the expired contract while we negotiate a new agreement and we continue to remain focused on meeting our customer's needs. It is difficult to predict the outcome of these negotiations as of the date of this report. For additional discussion of risks associated with labor union negotiations, see the detailed risk factors contained in Item 1A of our 2012 10-K.


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Technical Services Segment

The revenues and equity in income of investees of our Technical Services segment are largely a function of spending by the U.S. Government and the performance scores we and our consortium partners earn in managing and operating high-consequence operations at U.S. nuclear weapons sites and national laboratories. With its specialized capabilities of full life-cycle management of special nuclear materials, facilities and technologies, our Technical Services segment participates in the cleanup, operation and management of the nuclear sites and weapons complexes maintained by the DOE.

On April 29, 2013, the Government Accountability Office ("GAO") announced that it sustained the protest filed by our joint venture, Nuclear Production Partners, LLC, regarding the procurement decision for the combined management and operating contract at the Y-12 National Security Complex and Pantex Plant. On June 17, 2013, Nuclear Production Partners, LLC filed a new protest with the GAO expressing concern over the fairness of the procurement and selection process and the form and scope of the revised request for proposals issued to bidders on June 6, 2013. On September 24, 2013, portions of this protest were dismissed as premature. However, the GAO did deny the assertion that the National Nuclear Security Administration ("NNSA") should be required to amend the solicitation to reflect changes that have occurred due to the passage of time. On November 1, 2013, we received notification that Nuclear Production Partners, LLC was not selected by NNSA in the re-affirmed procurement decision. We will evaluate information received during the NNSA debriefing process to determine our next steps. In the meantime, we will continue to manage these sites under existing contracts through our joint ventures and during any transition period, which has yet to be determined.

Nuclear Energy Segment

Our Nuclear Energy segment's overall activity depends mainly on the demand and competitiveness of nuclear energy. The activity of this segment depends on capital expenditures and maintenance spending of nuclear utilities.

mPower Segment

This segment is actively developing the B&W mPowerTM reactor and the associated mPower Plant through its majority-owned joint venture, Generation mPower LLC ("GmP"). Its activity is a function of research and development efforts for the B&W mPowerTM reactor and the potential orders to be generated from various mPower deployment initiatives. As part of this initiative, we have been selected to receive funding and have signed a Cooperative Agreement with the DOE under its Small Modular Reactor Licensing Technical Support Program ("Funding Program"), which is expected to provide financial assistance initially totaling at least $150 million for small modular reactor ("SMR") design engineering and licensing activities supporting a planned commercial operating date for the first mPower Plant by 2022.

The Funding Program is a cost-sharing award that requires us to use the DOE funds to cover first-of-a-kind engineering costs associated with SMR design certification and licensing efforts. The DOE will provide cost reimbursement for up to 50%, subject to the overall size of the award, of qualified expenditures incurred during the period from April 1, 2013 to March 31, 2018. The DOE has authorized $99.3 million of funding for this award program as of September 30, 2013. The remaining anticipated DOE funding has not yet been authorized and is subject to Congressional appropriations. The Cooperative Agreement also provides for reimbursement of pre-award costs incurred from October 1, 2012 to March 31, 2013. During the three and nine months ended September 30, 2013, we recognized $16.4 million and $54.2 million, respectively, of the cost-sharing award, including $21.5 million of pre-award cost reimbursement, as a reduction of research and development costs on our condensed consolidated statements of income.


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Global Competitiveness Initiative

We launched the Global Competitiveness Initiative ("GCI") in the third quarter of 2012 to enhance competitiveness, better position B&W for growth, and improve profitability. We have identified a wide range of cost reduction activities including operational and functional efficiency improvements, organizational design changes, and manufacturing optimization. Once fully executed, these actions are expected to produce at least $60 million to $70 million in annual savings. The majority of the annual savings are expected to result from efficiency improvements that are planned to be completed by the end of 2013. The balance of the cost savings relates to manufacturing initiatives that are expected to be completed by mid-2015. In order to achieve these savings, we expect to incur total restructuring charges (cash and non-cash) not to exceed $60 million. We incurred $25.5 million of costs associated with GCI for the nine months ended September 30, 2013.

For a summary of the critical accounting policies and estimates that we use in the preparation of our unaudited condensed consolidated financial statements, see Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 2012 10-K. There have been no material changes to these policies during the nine months ended September 30, 2013, except as disclosed in Note 1 of the notes to the condensed consolidated financial statements included in this report.

Accounting for Contracts

As of September 30, 2013, in accordance with the percentage-of-completion method of accounting, we have provided for our estimated costs to complete all of our ongoing contracts. However, it is possible that current estimates could change due to unforeseen events, which could result in adjustments to overall contract costs. A principal risk on fixed-priced contracts is that revenue from the customer is insufficient to cover increases in our costs. It is possible that current estimates could materially change for various reasons, including, but not limited to, fluctuations in forecasted labor productivity or steel and other raw material prices. In some instances, we guarantee completion dates related to our projects or provide performance guarantees. Increases in costs on our fixed-price contracts could have a material adverse impact on our consolidated results of operations, financial condition and cash flows. Alternatively, reductions in overall contract costs at completion could materially improve our consolidated results of operations, financial condition and cash flows. In the nine months ended September 30, 2013 and 2012, we recognized changes in estimate related to long-term contracts accounted for on the percentage-of-completion basis, which increased operating income by approximately $11.9 million and $75.6 million, respectively. Included in the nine months ended September 30, 2013 were contract losses totaling $30.2 million for additional estimated costs to complete a project in our Power Generation segment. These losses are in addition to contract losses recorded for this project during 2012. In addition, in the nine months ended September 30, 2012, we recognized revenues totaling $18.4 million attributable to the settlement of a contract claim related to a condenser replacement contract in our Nuclear Energy segment.

Some of our contracts contain provisions that require us to pay liquidated damages if we are responsible for the failure to meet specified contractual milestone dates and the applicable customer asserts a claim under these provisions. These contracts define the conditions and timing under which our customers may make claims against us for liquidated damages. In the majority of cases in which we have had potential exposure for liquidated damages, such damages ultimately were determined not to be caused by our actions or were not otherwise asserted by our customers. Accordingly, we do not accrue liabilities for liquidated damages unless probable and estimable. As of September 30, 2013, we had not accrued for approximately $3.0 million of potential liquidated damages that are reasonably possible to be asserted based upon our current expectations of the time to complete a certain project.

RESULTS OF OPERATIONS - THREE MONTHS ENDED SEPTEMBER 30, 2013 VS. THREE MONTHS ENDED SEPTEMBER 30, 2012

The Babcock & Wilcox Company (Consolidated)

Consolidated revenues decreased 4.1%, or $32.8 million, to $774.8 million in the three months ended September 30, 2013 compared to $807.6 million for the corresponding period in 2012 primarily due to decreases in revenues from our Nuclear Energy segment totaling $22.5 million. We also experienced decreases in revenues in our Nuclear Operations and Technical Services segments totaling $2.4 million and $0.8 million, respectively.


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Consolidated operating income decreased $2.3 million to $82.1 million in the three months ended September 30, 2013 from $84.4 million for the corresponding period in 2012. Operating income for the three months ended September 30, 2013 includes special charges for restructuring activities totaling $4.8 million related to the initiative we launched to enhance competitiveness, better position B&W for growth, and improve profitability. These costs consist of approximately $0.7 million of employee termination benefits, $2.5 million of consulting and other program administrative costs, and $1.6 million of facility consolidation charges due to planned reorganization of manufacturing activities. Operating income in our Power Generation and Nuclear Energy segments decreased by $2.3 million and $9.5 million, respectively. These decreases in operating income were partially offset by increases in our Nuclear Operations, Technical Services and mPower segments of $6.9 million, $6.7 million and $2.0 million, respectively. We also had higher unallocated corporate expenses totaling $1.3 million for the 2013 period as compared to 2012.

Power Generation

Revenues were flat at $427.0 million in the three months ended September 30, 2013 compared to $426.4 million in the corresponding period of 2012. Revenues for our aftermarket services business increased $45.3 million, which were offset by a decrease in our new build steam environmental equipment business of $32.9 million and a decrease in our new build steam generation systems business of $15.4 million. The increase in aftermarket services was primarily due to construction activity on a boiler retrofit project and a higher level of industrial plant maintenance outage services. The decrease in revenues from the new build businesses were due to the decline in project activities related to the advancement of various projects.

Operating income decreased $2.3 million to $38.3 million in the three months ended September 30, 2013 compared to $40.6 million in the corresponding period of 2012. The decrease in operating income is primarily attributable to lower margins on construction and outage maintenance services when compared to the project mix in the prior period and a lower level of net favorable project close-outs as compared to the prior period. The decrease was partially offset by lower overhead costs and a $3.1 million reduction in selling, general and administrative expenses due to ongoing cost reduction initiatives.

Nuclear Operations

Revenues decreased 0.8%, or $2.4 million, to $282.1 million in the three months ended September 30, 2013 compared to $284.5 million in the corresponding period of 2012, primarily attributable to decreased activity in the manufacturing of nuclear components for U.S. Government programs totaling $9.8 million, partially offset by increased activity in our naval nuclear fuel and downblending activities totaling $7.4 million.

Operating income increased $6.9 million to $63.8 million in the three months ended September 30, 2013 compared to $56.9 million in the corresponding period in 2012, primarily due to increased income associated with naval nuclear fuel and downblending activities totaling $4.1 million. Income from the manufacturing of nuclear components for U.S. Government programs increased $2.8 million. These increases are related to improved contract performance associated with contract cost reductions.

Technical Services

Revenues decreased 3.1%, or $0.8 million, to $25.2 million in the three months ended September 30, 2013 compared to $26.0 million for the corresponding period of 2012, primarily attributable to lower reimbursable costs at our Naval Reactor decommissioning and decontamination project.

Operating income increased $6.7 million to $18.4 million in the three months ended September 30, 2013 compared to $11.7 million for the corresponding period of 2012. This increase is primarily attributable to improved project performance resulting in higher estimated award fees and $1.8 million of lower selling, general, and administrative expenses compared to the corresponding period of 2012 primarily due to timing of new proposals resulting in lower business development expenses.

Nuclear Energy

Revenues decreased 30.0%, or $22.5 million, to $52.5 million in the three months ended September 30, 2013 compared to $75.0 million in the corresponding period of 2012, primarily attributable to decreased activity in our nuclear services and nuclear equipment businesses of $39.2 million associated with the completion of several large contracts that were ongoing in the same period of the prior year. This decline in revenue was partially offset by increased project activities associated with a contract in our nuclear projects business.


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Operating income decreased $9.5 million to $0.0 million in the three months ended September 30, 2013 compared to $9.5 million in the corresponding period of 2012, attributable to the decline in revenue noted above and lower margins due to unfavorable project mix compared to the prior period, which was partially . . .

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