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.

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.

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. And 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…

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…

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 solution 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.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from the line of Bob Labick with CJS Securities. Please go ahead.

Good afternoon. Congratulations on the priority review.

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

Thanks Bob.

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 time line for that is given that you have the priority review in hand now?

Yes, sure, Bob. So the way that looks is send you a letter with a priority review designation along with a bunch of questions that we need to answer. And then they perform in the next -- over the next month or two of sort of a facility inspection of our product line, our manufacturing line in Kanata. The time line that they commit to on a priority review is six months, but there's some discussion around that point. When the FDA gets to a place where it requires more information from the producer of the product, BWXT in this case, they kind of hit the snooze button on the clock, and so it pauses for a period of time. And so we've always hedged that by saying that the time line is something like six to nine months. And I think that's still consistent with our view. So great to get the priority review, and so I'd say, the time line of six to nine months. As to any product sales in 2023, we do expect those to be modest because recall that we're using the research reactor at Missouri the MURR reactor to irradiate our target material in the beginning and that means we can only offer a limited suite of products to the radiopharmacies. The real growth comes from irradiating our target materials on the Darlington reactor that belongs to OPG. And so, I'd see that that business building nicely into 2024 and 2025. So I'd say, modest expectations for 2023 as we see the market and create demand and start entering into long-term supply agreements.

Yes. Bob, I'll just remind you that as we laid out that page for BWXT Medical that built on those couple of different businesses, we were really not expecting much if anything from -- in 2023 to hit those statistics that we outlined. The underlying business is actually doing quite well. We're really scratching as we had outlined to you up in Kanata. That business is getting to about a $60 million run rate business, and we expect teens growth rate next year as well. So it's building quite nicely. We hope to get some sales possibly in 2023 but that really won't impact ultimately delivering on the financials that we've laid out for you at the Investor Day and we've affirmed recently.

Okay. Great. And then, as it relates to the target delivery system, TDS time line, how does that work as it relates to the review for the current generator? And -- so, I guess, first will you have that installed this year early next? And then what's the time line on that product coming to market? I think you just said obviously 2024 and 2025 and beyond, but just, maybe give us the steps that we should look forward to on the TDS installation.

Yes. So the way that works -- so I'll talk about the implications for the FDA application and then talk about the time line for the TDS. So we're in the -- we just started installing that onto the Darlington reactor Unit number 2 actually and that will go on over the next several months and be completed sometime next year. As it relates to our FDA application, what happens there is we'll get approved hopefully for our product manufacturing configuration in Kanata which you've seen, but also for the irradiation source, which in this case is the MURR reactor, because the neutron spectrum does matter to the FDA. The different neutron spectrum can create slightly different product characteristics. And so, you have to account for that in the application. And so, what we would do is, assuming approval in our current configuration with the MURR reactor, we would submit a supplemental application to the FDA for irradiation at the Darlington site. Now, that's typically a shorter time line. So think of that as two or three-month approval time line would be typical. And so, that's how that will work. After we receive the approval on the initial configuration, then we would supplement.

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

Yes. Thank you, Bob.

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

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.

Yes. Certainly, both of those factors are conspiring against the business right now. To think about how attrition is impacting the business, I'll take that one first Scott. Typical attrition for our business would be kind of mid-single digits historically. And in that I'm talking about both kind of planned attrition the standard -- the kind of forecastable retirement rates along with some unplanned attrition. That would typically, let's call it, 6% in the business historically. That number has crept up into the high single digits over the last year or two. And so, we've got a higher turnover rate. And when you think about that on the scale of a workforce of 7,000 people, so think of that as a turnover in the range of 500 or more over the course of the year and that's what we're facing right now. And so, that is a challenge. We've tried to hire a net 500 this year. We are trying to hire a net 500 this year. We've been -- we've succeeded in hiring over 800, but we also lost in the range of 500. So we've netted about 250 to 300 along the way. So that's the kind of churn that we're dealing with. And as you imply in your question that affects us in a couple of ways. One is, obviously, we're not ramped up fully to our workforce plan, which impacts production and also absorption. But the second thing is, obviously, with new workers we have a higher learning curve and we've also got more intense training requirements. So that's kind of the two-part problem that we're dealing with.

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?

Yes. We're seeing it -- we're monitoring this every day, obviously. But if you look at the month-to-month numbers, it looks like our attrition peaked in about the middle of the year and has been improving sequentially since that time modestly, but it has been improving. So I think we've hit an inflection point on that one. And as to the latter point, I do believe that the challenging macroeconomic environment actually favors a company like BWXT, I mean, for a couple of reasons. One is that, with reduced 401(k) balances we see a lower retirement rate and that helps a little bit. But the other thing, of course, is that as you walk into a recessionary period, stability starts to have a higher value than it does maybe in the past couple of years. And so, we expect that attrition rate to move favorably for us, if the economy does weaken like we anticipate it to do.

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.

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.

Okay. Thank you so much.

Thank you, Scott.

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

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?

Yeah. I'd say that's mostly correct, Pete. The factors that differentiate those businesses are -- we tend to have a slightly older workforce in our Government businesses particularly in the Navy manufacturing business. And so we've seen higher retirement rates. I think people sort of rethought their personal considerations when they went through the COVID period. So that's part of it. It's also -- that's the part of the business that has the most intense touch labor in it the craft labor. And so that's where you feel it the most acutely, I would say. And then, the other side of that is, I would say that we are experiencing that same labor problem in other parts of the business but the growth is sort of masking it out. I mentioned on a couple of calls this year, the challenge we've had in finding qualified RAD-Techs in our medical business for example which actually lengthened our campaign for the Tech-99 program, but the growth has overwhelmed there frankly. And so it's just showing up more in the Navy business.

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?

Yeah. I think we're in a really good competitive position in that market. And it's because of where we positioned ourselves strategically in that market. I'd say the competition is most intense at the level of reactor design and supply, those whom are marketing designing small modular reactors. Although, I think they can -- many of them can win because the demand is going to be impressive, I believe in the long run. But where we sit is kind of at the top of the supply chain and would look to supply companies like GE and others who are let me call them prime contractors. The reason that we stand out, BWXT stands out in that market is, because we have capabilities for manufacturing large components that are unmatched in North America. I mentioned -- we mentioned here in the script that we have the largest nuclear manufacturing clean room in North America. We manufacture fuel. We design components. We design nuclear reactors. And so we can really answer the mail for a lot of companies who are attempting to sell reactors in that market. And so -- and we've been let me call it design-agnostic a merchant supplier kind of if you will and we feel very well positioned for the uptake in that market.

I might add just from an overall geography as you know we're based in Canada. That country, and specifically the province of Ontario has, really been forward-leading just about how much nuclear can be part of the clean energy solution. And so that allowed us to essentially be in business for building new stuff, while other geographies were not. And so we've continued to maintain such a unique posture in that market. And then if you even see what they're doing on the SMR side, they're really forward leaning there too. So, having that position -- that incumbency position and then also seeing where they're going on the SMR rates really kind of allows us to be on the forefront. And we see that a couple of years earlier than some other players in other geographies. So, that's been sometimes better to be lucky than good.

All right, great. Thanks for taking the question.

Thank you.

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

Thanks. Good evening.

Hey David.

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?

No, we're not counting on the labor. So, generally our fourth quarter always is the time that we're sort of snow plow all the efficiency efforts that we have all year and sort of open up the EACs and take a look. So, that's just a natural time that we look at that business. Secondly, as you know some of the businesses that we've announced over the course of the year both Savannah River as well as SCO, you really had to ramp up to a certain level and gain efficiency. So, that will be a big quarter there. The last one I would call out is we do have some really good growth in our non -- what you think of as our core sort of nuclear operations businesses around both down blending and HEU metal. And those businesses are just lining up to have a very good fourth quarter. So, when you swirl all that up it seems achievable. It definitely is a large quarter, but we think we're going to hit that for the fourth quarter.

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?

It is David. As we were thinking about -- I mean there's a couple of different things just to roll up. Depreciation as you say will be an incremental headwind across the business and particularly, in NOG, right? They've finally brought on some of their capital. It's taken a little while to get that productive. So, we had a little bit of a lighter result in 2022 than we thought and that's why we brought down ultimately over the course of the year the depreciation, but we'll get that load to the tune of about $5 million or $10 million headwind to earnings next year. The second item that we've called out for you is the $55 million of sort of below-the-line headwind that really comes for the $15 million of interest expense. That's from that $0.5 billion of sort of revolver that we have that -- those rates have gone up almost 3%. And so you just take 3% on $0.5 billion that gets you to $15 million. And then the other part of that $55 million is the $40 million that we have from pension. As you know that's really broken down into two pieces which is the asset performance underlying. We're pretty fully funded a little bit over $1 billion of both assets and liabilities. And when you just think about we're generally expecting about a 7% return there as that balance has come down about 25% that's about half of the $40 million, so that's about $20 million of the $40 million. And then the other $20 million is just what's going on with interest rates. So, the liability has come down, but the interest rate has gone up over 3%. And so you've got a doubling of the interest rate on your liability balance. So,…

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?

Yes. So as we've said that our -- let's deal with the easy one, which is CapEx. Nothing's changed there. And then I'll maybe outline a little bit about where we stand on operating cash flow for this year as well as next. So, on a CapEx basis, we still see about $100 million of maintenance CapEx. And then we're -- one of the reasons we downgraded CapEx guidance is that we just haven't deployed a significant amount of that SCO-related Project Pele CapEx. And so if you think about where we started the year we were at $180 million to $200 million, call it $190 million, and we were able to spend $5 million. We'll see how the fourth quarter goes $5 million to $10 million on that SCO project. And so that stub if you will of the remaining $25 million to $30 million will come on top of the $100 million next year. That's how we're seeing sort of 2023, so that's the CapEx part of the equation. And then on an operating cash flow standpoint, we do see a good improvement versus our guidance this year, which is $260 million to $290 million. I think, we've been running at about a $300 million LTM number. We'll see how we come in the fourth quarter, but I see doing greater than $300 million, obviously, in order to get to that $200 million next year. And so those are all those initiatives that we talked about earlier that just take some time to bear fruit. So I see greater than $300 million by about that $120-ish million of CapEx, if you scroll it up that's where we're getting around the $200 million free cash flow number.

All right. Great. Thanks very much.

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

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.

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.

That's terrific. And then just back to the labor commentary. So you said I think in your prepared remarks, you're running about 10% below the headcount plan and then you walked through some of the differences on attrition. Is that -- should we expect you're trying to do a similar plan for next year as you can kind of continue to scale up? And just wondering if you're approaching the labor market any differently as you're thinking about it now? Thanks.

Yes. One correction, Peter, what I said in the script was we were off as much as 10% at certain sites. If you look at the aggregate number, it's more like 5% across the entire business, but I think we're not planning with the expectation of dramatic improvements in the labor market for next year's plan, particularly because of the two factors that I talked about, which are one is the attrition rate itself and being able to hire to our growth. And we do see more growth next year. So it's another -- it's an even higher hurdle. And then of course, we have some efficiency challenges around new employees that are unique to this labor environment. So I'd say, we're not planning on -- our thinking is not that we're going to have a full recovery from that problem next year.

Appreciate that. Thanks, Rex.

Yeah. Thanks, Peter.

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

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?

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.

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

Yeah. I mean, overall, I really don't think anything has changed our overall commentary. We basically had the $180 million to $200 million this year. We bumped that by as you recall, I think it was last quarter by $15 million, just basically trying to draw a line in the sand of saying half of that, we've estimated the SCO bill to be about $30 million. We really didn't get after a full load of that. So we're kind of coming in at our midpoint overall of non-Pele, and then just a little bit and we'll see how the fourth quarter goes to tuck us under the $200 million. And then whatever is left let's just take – if we only spend about $5 million of the Project Pele in 2022, well then the remainder of call it $25 million to get to a full $30 million we hope to do it for less than $30 million we have line of sight to that. But if you just take that scenario, you would layer $25 million on top of the $100 million that we've been talking about for maintenance to ultimately have a CapEx guide next year of $125 million. And from that point, we're kind of at that project. We're hoping to deliver that prototype in 2024. So Project Pele will kind of be behind us, we think in 2023 and then you'll be back to kind of $100 million cadence, if you will for 2024. Now, why would that change? We are buying for a special project that will require some outfitting of the facility that we're in for Project Pele, but there's some different things that we're doing on the fuel side specifically on the DARPA project, the DRACO that some of you know about, that might…

Thank you, very much Robb

Sure. Thanks for the questions.

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

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.

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