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The Babcock & Wilcox Company (NYSE:BWC)

Q4 2011 Earnings Conference Call

March 01, 2012, 08:30 a.m. ET

Executives

Michael Dickerson - VP and IR Officer

Brandon Bethards - President and CEO

Mary Pat Salomone - SVP and COO

Tony Colatrella - SVP and CFO

James Canafax - SVP, General Counsel and Corporate Secretary

Analysts

Brandon Verblow - UBS

Alan Fleming - Barclays Capital

Scott Levine - JPMorgan

Linda Yuan - Credit Suisse

Saagar Parikh - Keybanc Capital Markets

John Rogers - D.A. Davidson

Chase Jacobson - William Blair & Company

Rob Norfleet - BB&T Capital Markets

Greg Elek - Goldman Sachs

Operator

Ladies and gentlemen, thank you for standing by and welcome to The Babcock & Wilcox Company Fourth Quarter 2011 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’d now like to turn the call over to our host Mr. Michael Dickerson, B&W’s Vice President and Investor Relations Officer. Please go ahead.

Michael Dickerson

Thank you, Janetta, and good morning everyone. Welcome to The Babcock & Wilcox Company’s fourth quarter 2011 earnings conference call. As she said, I’m Mike Dickerson, Vice President and Investor Relations Officer at B&W.

Joining me this morning are Brandon Bethards, B&W’s President and Chief Executive Officer; Mary Pat Salomone, our Chief Operating Officer; Tony Colatrella, our Chief Financial Officer; and James Canafax, our General Counsel.

Many of you have already seen the copy of our press release issued last night. For those of you that have not it is available on First Call and on our website at babcock.com. During this call, certain statements we make will be forward-looking. I want to call your attention to our Safe Harbor provision for forward-looking statements that can be found at the end of our press release. The Safe Harbor provision identifies risk factors that may cause actual results to differ materially from the content of our forward-looking statements. Our Annual Report on Form 10-K and quarterly reports on Form 10-Q on file with the SEC provide further detail about the risk factors related to our business. Additionally, I want to remind you that except as required by law, B&W undertakes no obligation to update any forward-looking statement to reflect events or circumstances that may arise after the date of this call.

The format for today’s call will begin with some remarks by Brandon about the current business conditions and overall results for the quarter. Second, Mary Pat will take you through the performance of each of our business segments, followed by Tony who will provide some additional financial details about the quarter. Lastly, Brandon will conclude with some final remarks.

With that I’d now like to turn the call over to Brandon.

Brandon Bethards

Thank you, Mike, and good morning everyone. Let me start by describing my view of our performance this quarter and by making a few comments about the current business environment we are experiencing. I’m pleased to report the company ended the year on a very strong note.

Revenues of 800.8 million were up 95.6 million or 13.6% in the fourth quarter compared to the year ago quarter. This is the fifth quarter in a row of positive year-over-year consolidated revenue growth. Equally important on a full year basis each of our four business segments reported year-over-year growth. Also I think it is important to note that our consolidated quarterly growth rate has accelerated throughout the year.

Our reported revenue growth rates over the corresponding prior-year periods in 2011 were 4.4% in the first quarter; 9.3% in the second quarter; 11.8% in Q3; and as I mentioned previously, 13.6% in Q4. This is principally a result of higher customer demand for fossil and nuclear power generation parts, service and construction projects, as well as our success winning decommissioning and decontamination contracts from the environmental management programs of the Department of Energy.

This quarter’s ending backlog of $5.34 billion represents an increase of 137 million or 2.6% from the fourth quarter ending backlog of 2010 and a 14.9% improvement over the third quarter of 2011. The increase in backlog on a year-over-year basis was driven primarily by a 24.5% increase in the Power Generation segment which Mary Pat will cover in more detail later.

Consolidated operating income for the fourth quarter of 2011 was 93.3 million compared to 74.5 million in the fourth quarter of 2010. The increase in operating income was primarily due to improvements in revenues and operating margins in the Power Generation segment.

Margin improvement at PGG was aided by the closeout of a large OEM new coal-fired power plant project that contributed approximately 5.7 million of incremental operating income in the quarter. Additionally, strong execution of the company’s M&O sites in 2011 resulted in the achievement of record performance scores and therefore, additional fee earned across the company’s National Nuclear Security Administration sites.

Safety, as you may know, is one of the key metrics we use to measure our performance and in that regard, B&W has performed very well in 2011. I personally see a direct correlation to good safety performance and profitability. I also correlate good safety performance to effective leadership in our operations.

For 2011, the company reported safety metrics better than our 2011 targets. In 2011, we achieved a loss time frequency rate 42% below the prior year. Result of such favorable performance is a workers’ comp rate that we estimate to be approximately 40% below the average industrial workers’ comp rates generating real returns to the bottom line.

Before we move on to the individual segment discussion, I want to mention a couple of recent developments that are relative to our business. Specifically, EPA regulations and comments recently made by the Department of Defense related to the 2013 it's important to note that's the 2013not 2012, budget planning process.

First, EPA regulations. On December 30, the Federal Appeals Court issued a stay on the Cross-State Air Pollution Rule or CSAPR. We understand that arguments are scheduled be heard by the Court in April with a decision in late summer or fall of this year. While we do not know what the outcome of this litigation will be the impact of deferring the timing of CSAPR regulation will be to push some SCR and scrubber work to later in the cycle, potentially extending the cycle from four to five years to five to seven years. In my opinion, this adjusted timeframe increases the likelihood that B&W may capture a larger portion of the opportunity that may have been otherwise unavailable to us with the prior schedule.

Also, in December, the final Mercury and Air Toxic Standards, or MATS, were issued. The most significant change in the final rules from the draft version being a change in the standard for measuring particulate matter. The finalization of the rule goes a long way towards reducing regulatory uncertainty in the market and providing more information for utilities that is necessary for them to make decisions on their compliance strategy and capital spending requirements.

Our environmental capture team has been assessing our estimated addressable market opportunity based on the MATS rules as finalized. Because of the change to the previous draft in measuring particulate matter, we believe that in some situations, if a power generation unit is already equipped with an SCR electrostatic precipitator and a scrubber that they may not need to convert to a (inaudible) and dedicated mercury removal system. Rather the existing equipment as installed or with some engineered upgrades may be able to achieve the modified MATS emissions requirements. Net-net this will likely reduce the required capital outlined by the utilities, but the technical requirements match very well to the core capabilities of B&W products and services offerings.

Accordingly, our revised estimated addressable opportunity based on the current technical details of the regulations as finalized, will be somewhat lower than under the previous draft. Also, since we first identified an addressable market range, there has been a year's worth of work awarded in the industry. After deducting the 2011 awards and adjusting for the new rules, our latest review suggests a remaining addressable market opportunity, net of awarded work of approximately 12 to 18 billion. Clearly, we continue to view this as a very significant opportunity.

Also as you may have noticed, environmental award activity in the industry was robust in 2011, particularly in the fourth quarter in which the company booked 278 million of environmental awards and for the full-year 2011 we booked over 500 million for new environmental projects. We were working with several large utilities throughout the second half of 2011 to assist them in planning for the new environmental requirements. These early movers are acting. However, we expect that the award activity was slow somewhat over the first half of 2012 as those utilities that have not acted evaluate the potential outcome of CSAPR.

The second item I want to discuss before turning the call over to Mary Pat is the recent speech given by Defense Secretary, Panetta related to program procurement changes in future budget years. I want to say upfront, it is still too early to have any clear indication of the impact if any these potential program changes will have on B&W.

The process will require significant discussion, evaluation and negotiation and will eventually be dependent upon a detailed budget that must be approved by Congress and the President. So the following comments are our early considerations to any potential impact on B&W. In the Secretary speech, three items were mentioned related to programs that are important to B&W.

First, the Ohio class replacement program which was reported to be deferred by two years from an initial procurement in 2019 to 2021. The likely impact we foresee from this event would be a delay of initial manufacturing from the mid part of this decade until approximately 2017 or so. At this time, our involvement in the program is limited to performing R&D and detailed engineering of certain components of the new propulsion system.

At this time, it is not clear how this R&D and engineering work will be impacted. However, given the limited scope of this work at this time, we expect any deferral to have little to no impact to our financial results over the next few years.

The Secretary also mentioned that the U.S. would continue to maintain the carrier fleet at 11, with no specific reference to delays in procurement. However, he did indicate that the pace of building new ships could be slowed in order to protect strategic priorities. As a result we are constantly monitoring the situation for any indication of changes to the procurement schedule of the carriers and the corresponding advanced procurements for our components.

Lastly, Secretary Panetta specifically indicated that the procurement cycle for the Virginia class submarine would be altered. The current schedule has two subs being procured in 2014, ‘15, ‘16 and ‘17 with a single procurement in 2018 for a total of nine subs over this five-year period. The procurement schedule suggested by the secretary in his speech would have one sub in 2014 and two each in ‘15, ‘16, ‘17 and ‘18. Saying it another way, for the five-year period of 2014 through 2018, there would be nine submarines procured under either schedule.

This is important because it suggests that the long-term procurement schedule for new Virginia Class submarines remains essentially intact. We do not know how the Department of Energy will respond if at all to this new schedule as it relates to the procurement of long lead nuclear components that we provide. It may be several months before we know. It is possible that the DOE will alter its long lead component procurement to align with the new schedule. If so, this would likely result in a slower component procurement schedule and somewhat lower revenues and operating earnings in 2014 with the ramp up to follow shortly thereafter.

Alternatively, the DOE may decide that the most cost-effective solution is to maintain a level loaded manufacturing base over the same five year period for mass procurements, in which case, we would experience no change in the manufacturing schedule, revenues or operating income all things being equal.

The final point that I’d like to make on the subject is that the changes outlined by the Secretary do not address an additional 600 billion in budget cuts required over 10 years if sequestration kicks in. The Secretary appears to be operating under the assumption that sequestration is an unacceptable situation and that Congress will fix the problem.

B&W will be working very closely with our government customer over the next several months to evaluate options and the impact of those options relative to the actual procurement cycle for this equipment.

As I’ve said when I started this discussion, it is much too early to determine the long-term impact to B&W. However, we do know that over the next two years, there is little to no impact expected related to the potential changes.

With that let me now turn the call over to Mary Pat, who will take you through the results of each of our business segments. Mary Pat?

Mary Pat Salomone

Thanks Brandon. I’d like to walk you through the results for each of our reported business segment. Revenues in the Power Generation segment of $411.4 million for the fourth quarter of 2011 increased $48.2 million or 13.3% compared to the $363.2 million reported in the fourth quarter of 2010. This result was principally due to increased new build environmental projects as well as biomass and waste to energy new build power generation boilers and auxiliary systems.

Revenues in our aftermarket parts and service business were essentially flat compared to the year-ago period after having ramped up throughout the year. Aftermarket parts and services ended the full-year 2011 up nearly 17% over 2010. As the environmental regulations became clearer this year with the finalization of the CSAPR and the MATS rules, as well as various other state regulations, we have experienced a significant increase in environmental project bidding activity as Brandon mentioned earlier.

As you think about the conversion of awards into revenues, remember that many of these large projects which maybe 18 to 36 months in duration will typically ramp up slowly for a couple of quarters, while the detailed engineering and design work is being completed. This is typically followed by procurement, construction, and finally commissioning.

Specifically in the fourth quarter of 2011, we booked approximately $278 million of environmental awards. You can think of these bookings as potentially being converted into revenues in late 2012 through 2014.

Operating income in the Power Generation segment including the equity income of our global joint ventures in that segment was $46.4 million in the fourth quarter of 2011 an increase of $12.5 million or 36.9% compared to the fourth quarter of 2010. The year-over-year increase in operating income was primarily due to improvements in revenues as I just discussed, as well as improved levels of productivity throughout the business, particularly in fossil power and construction. Additionally, the closeout of a new coal power plant project contributed an additional $5.7 million as a result of strong project execution and the recovery of contingencies and other items in the estimated project cost.

Backlog in the Power Generation segment of $1.97 billion increased sequentially $225 million or 13.1% from the end of the third quarter of 2011 and is up 24.5% from the end of the fourth quarter in 2010. This backlog figure includes approximately $48 million from the acquisition of Loibl completed during the quarter. Bookings in the quarter were again at a level similar to the third quarter, which had reached their highest level since 2007.

Looking at the makeup of the Power Generation segment backlog, approximately 24% of the backlog relates to new build environmental, which grew $168.3 million or 56.7% while 29% of the backlog is related to new build steam generation systems, primarily waste energy and industrial applications, which grew $132.1 million or 29.8% including the addition of Loibl backlog. The balance of 47% relates to aftermarket parts and services projects, including the value of O&M contracts, which grew $74.8 million or 8.5%.

I mentioned Loibl a moment ago. Let me expand on that a bit. In the fourth quarter, B&W acquired a material handling business in Germany that serves a variety of power generation and industrial markets in Europe. This operation will be integrated into our Diamond Power, Allen-Sherman-Hoff division, a recognized global leader in fly ash and bottom ash handling technologies. The combined capabilities and global reach of the new organization will bring new technologies and solutions to our customers and allow us to serve a variety of new industries.

Nuclear Operations segment revenues of $265.7 million decreased $5.5 million or 2% in the fourth quarter of 2011 compared to the fourth quarter of 2010. This decrease is primarily due to lower revenue recognition resulting from the favorable effect of improved year-over-year manufacturing efficiency (inaudible) volumes. Said another way, improvements in efficiency reduce the amount of costs that are billable to our customer as they share in the efficiencies that we can generate. At the income line, you will see that these efficiencies translate into higher earnings and margins. Nuclear Operations operating income was $43.7 million in the fourth quarter of 2011 representing an operating margin of 16.4%. This compares to $38.2 million in operating income and a 14.1% margin in the fourth quarter of 2010.

Backlog in Nuclear Operations increased sequentially as expected as the funding of our naval reactor contract were completed the government’s first fiscal quarter of 2012. Recall, that this segment typically books the majority of its annual award in the fourth quarter of the year as it is highly correlated to the annual budget cycle of the U.S. Government. In that regard, during the fourth quarter of 2011, the company booked $778 million of nuclear component, fuel and support activities contracts. The Nuclear Operations segment ended 2011 with backlog of $3 billion.

Nuclear Energy segment revenues of $100.7 million increased $52.8 million in the fourth quarter of 2011 compared to the fourth quarter of 2010. The increase in revenues is due principally to the success achieved supplying nuclear equipment and volume associated with the nuclear project contract. Operating loss of $10.4 million in the fourth quarter includes $6 million of non-cash, non-deductible in-kind R&D expenses received by Generation mPower and consolidated on the books of B&W as well as $18.3 million of B&W funded mPower R&D and SG&A expenses.

Technical Services segment revenues of $32.1 million increased $4.6 million or 16.7% in the fourth quarter of 2011, compared to the fourth quarter of 2010.

Operating income of $20.9 million increased $8.4 million or 67.2% in the fourth quarter of 2011, compared to the fourth quarter of 2010. This increase in operating income is due principally to the ramp up of new environmental remediation, decontamination and decommissioning contracts received in the second half of 2010 and the first half of 2011, principally for the DOE, as well as the record performance scores received throughout the NNSA complex, in which we operate, which resulted in increased fees throughout the year.

Lastly, before turning the call over to Tony, I’d like to make a comment on behalf of Brandon, Tony, myself and the entire B&W executive staff. We want to personally congratulate the Nuclear Operations and Technical Services teams for each achieving their highest ever operating earnings in 2011. These teams exemplify the standards and culture that we at B&W have instilled throughout the company, focus each day on providing our employees with a safe and secure workplace and our customer with high quality product, services and flawless execution.

Let me now turn the call over to Tony, who will provide some additional financial details. Tony?

Tony Colatrella

Thanks, Mary Pat. Let me start by reminding you of the accounting treatment for Generation mPower. Generation mPower is currently receiving research, development and detailed design in-kind for engineering services from our minority partner. From an accounting standpoint, the LLC is recording these services as in-kind research and development expense, which is then consolidated on the books of B&W. To the extent that the services received because of timing differences are greater or less than in a given quarter, the minority partners contractual share of the development costs, the recognition of these non-cash, non-deductible in-kind services results in a consolidated net income or loss impact after taking into account the impact of our partners non-controlling interest.

In the fourth quarter of 2011, the value of the in-kind services recorded was greater than the minority partner share of the development costs due to the timing of R&D program expenditures resulting in non-cash, non-deductible net expense at the operating income line of $6 million and a $3.4 million loss at the net income line after taking into account the impact of non-controlling interest. This impact is consistent with our guidance last quarter.

We expect the net impact of this accounting to be plus or minus a couple of pennies a share in each of the next two years. However, over the life of the mPower development program the cumulative net effect is expected to be zero on the consolidated books of B&W.

During the fourth quarter, the company generated cash flow from operating activities of approximately $219 million. The company’s cash and investments position, net of debt, was 543.7 million at the end of the fourth quarter of 2011, an increase of $186.6 million compared to 357.1 million at the end of the third quarter 2011.

Seasonally, the fourth quarter typically represents the highest cash flow quarter of the year. In the fourth quarter, B&W’s strong free cash flow performance was the result of again the strength of our operating income, the timing of payments from the U.S. government related to fees earned, dividends received from joint ventures and an improvement in working capital levels at the Nuclear Operations and Power Generation segments. It is also worth noting that relative to previous quarters in 2011, the company made essentially no pension contributions in the fourth quarter of this year.

In addition to net cash, the company maintains a $700 million revolving credit agreement facility which had approximate 488.6 million of availability as of the end of the fourth quarter. The company believes it maintains adequate liquidity to fund operations which could include increased working capital requirements, internal growth and R&D programs as well as additional needs for product and geographic expansion.

Consolidated research and development expense was $31.9 million in the fourth quarter, including the $6 million of in-kind Generation mPower R&D that I discussed earlier. Cash R&D expense in the fourth quarter was $25.9 million, an increase of 7.4 million from the fourth quarter of 2010 and in line with our expectations for the quarter as we discussed at the last earnings call. This increase was principally a result of higher spending related to the company’s mPower initiative. For the full-year 2012, the company expects consolidated R&D expenses including in-kind received by Generation mPower to be approximately $100 million with cash R&D expense expected to be approximately $90 million.

Before I turn the call over to Brandon, I want to mention the current status of our pension plan. During the year, we contributed about $146 million into the domestic pension plans. This funding level exceeds the level of benefits payment and by itself would have improved the funded status of the plan. The lower than expected asset returns and continuing reductions in discount rates, however, offset much of this benefit. We ended the year underfunded by approximately $769 million. We are evaluating alternatives to the current funding and accounting of our pension plan with an eye towards derisking the plan overtime and reducing the ongoing expense being absorbed by the business. This has being done against the backdrop of market and capital allocation consideration. Assuming there are no changes to our pension funding approach for 2012, I’d expect cash contributions for our domestic plans to be in the neighborhood of $150 million.

Now let me turn the call over to Brandon for some final remarks.

Brandon Bethards

Thank you, Tony. In closing, I’d like to talk a bit about our outlook for 2012. As you know, we traditionally do not give specific revenue and earnings guidance, but I want to get everyone oriented in the right directions.

We mentioned in our earnings release last night an expectation for double-digit revenue growth. We expect this growth to come disproportionately from our Power Generation segment, while our combined Government segments are expected to continue to operate around the record levels achieved in 2011.

Revenue and earnings growth are expected to come from the Power Generation segment, primarily driven by the environmental new build cycle with backlog continuing to build for environmental projects, I would expect that growth to be somewhat back end loaded due to the revenue roll off profile of these projects that Mary Pat mentioned earlier.

Our Nuclear Engineering segment revenues in 2011 included approximately 33 million related to a condenser replacement project completed in the first half of last year. This project represented a bit more than 10% of the total segment revenue in that year. This means that B&W will need to achieve double-digit revenue growth in this segment just to match the top line of 2011. We think this is achievable.

There are a few items partially offsetting our consolidated growth expectations that you should be aware of. With the ongoing reduction in discount rates and the subpar asset performance of the markets in 2011, we expect pension expense to be somewhat higher in 2012 than in 2011. We estimate this increase to be approximately 10 to 15 million.

Our Asian operations have come through a strong cyclical period of growth principally resulting from orders placed during the high local growth rate periods of a couple years ago. This performance was also aided by favorable material price adjustments for some of the older contracts.

With cyclical declines facing late cycle products such as ours in the Chinese economy, the nonrecurring nature of the favorable price adjustments and the short-term dilutive effect of establishing a new startup venture in India, we expect the equity income contributions in the power segment to be approximately 10 to 15 million lower in 2012 compared to 2011.

Also, our effective tax rate in 2011 has been aided by some discrete tax items as well as a higher mix of foreign earnings. This resulted in a 2011 full-year effective tax rate of 31.1%. As we plan to move into 2012 given what we estimate for geographic mix of income, we expect a full-year effective tax rate of between 32 and 35%.

To summarize, we ended 2012 on a very strong note. All four business segments experienced year-over-year growth and consolidated earnings per share continue to grow as well. As we look forward to the current year, again, we expect double-digit top line growth in 2012 compared to 2011.

That concludes our prepared remarks. I will now turn the call over to the operator who will assist us in taking your questions. Janetta?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) your first question comes from the line of Steven Fisher with UBS. Please proceed.

Brandon Verblow - UBS

This is Brandon Verblow in for Steve. My first question relates to the Nuclear Energy segment. It seems like that (inaudible) projects being a lot slower than it has been. First, is that correct and do you expect the benefits from that project to continue in 2012?

Brandon Bethards

Mary Pat, would you like to address that?

Mary Pat Salomone

That project was a project that was started in the fourth quarter of 2011, and has been largely finished at this point in time. So, it's very cyclical there in terms of the project has been started and completed.

Brandon Verblow - UBS

The loss next quarter will probably be more than it was this quarter?

Brandon Bethards

I think we may have some confusion around which projects you are addressing. That is not a loss project. What Mary Pat is talking about is a service project in Canada taking place during the late fourth quarter of ‘11 and should be completed or near completion in the first quarter of 2012. So, maybe we didn’t understand your question.

Tony Colatrella

Remember that the loss in Nuclear Energy also includes north of $20 million of Generation mPower in-kind R&D and some SG&A as well. So, the base business is actually a very profitable business.

Brandon Verblow - UBS

Okay, that explains. And the second question for the Nuclear Operations business, do you expect that to grow next year? It seems like based on your comment in the press release that government would be flat and I think in the 10-K you said that Technical Services would be down. So, does that mean you expect the Nuclear Operations business to grow next year?

Brandon Bethards

We would expect that there is opportunity for normal inflation type growth opportunity as well the continuation of efficiency gains. We have a very experienced and professional group that operates that and our operational excellence program is a continuous process improvement program from which we expect to see continuous improvement. And as I mentioned in my previous remarks, we would expect operating income from the consolidated government businesses to operate around their record level that they produced in 2011.

Brandon Verblow - UBS

Okay, that’s helpful. And lastly on mPower, related to the federal subsidies that you expect to get from that, once you do get those subsidies will that lower the amount of dollars you have to spend on that project or will it just accelerate the pace of that project, than you continue to spend the same amount that you have for the spending?

Brandon Bethards

Actually a combination of both. We’re in the process of preparing our proposal for this DOE cost share program for SMRs. When we prevail in that activity, it will both reduce the amount of spend out of pocket for ourselves and our partner and will assist in accelerating the program. We should know, third quarter of this year, the outcome of that assuming that the DOE schedule stays on process, we don’t really see much impact of that with regard to 2012, but it will have a bigger impact in 2013 and 2014.

Operator

Your next question comes from the line of Andy Kaplowitz with Barclays Capital. Please proceed.

Alan Fleming - Barclays Capital

It's Alan Fleming standing in for Andy this morning. Nice quarter. I appreciate taking my questions. I wanted to start with a question around power margins. I think, even after adjusting for the 5.5 million or so close-out gain in the quarter, margin still looked pretty strong in the underlying business. And I just wanted to see if you could comment on the outlook for margins in that business. I think in the past you had said a 7 to 10% range, we could expect as revenues approach the $2 billion mark. So, are these margins that we see this quarter, are they sustainable and if you could give some color on that?

Brandon Bethards

Certainly, this is Brandon. As you may know that the margins in the Power Generation business can be somewhat cyclical or somewhat volatile depending upon work mix, timing on the roll-off of major milestones within certain projects, and the execution to perfection that results in harvesting contingency and warranty costs associated with the equipment supplies. But all things considered, we would expect to see that business continues to operate and target that range of 7 to 10% that you mentioned early. We would hope you to see escalation more towards the higher side out in the future as we continue to lever up the enterprise with the backlog build and higher levels of revenue, but that is going to be more likely a future event out two or three or four quarters.

Alan Fleming - Barclays Capital

So it's more 2013, we should think of margins kind of at the higher end of that 7 to 10% range?

Brandon Bethards

I think that would be correct.

Alan Fleming - Barclays Capital

Okay. That's helpful. I appreciate that. And if I ask if I could an unrelated follow-up, I'd be interested to hear your views on kind of the low cost natural gas and coal-fired generation market here in the States. We’ve heard about some utility customers switching given the low cost of natural gas. And I wanted to see if you guys had any common about what the impact of that could be on your partner service and maintenance business. Are you seeing any impact and what’s your outlook for ‘12?

Brandon Bethards

That’s a very good question, but it deserves a complex answer. There is a lot of factors in play. And one let me start by saying that as we mentioned back in 2009 and ’10, that as we went to this economic recession and then modest recovery, the utility industry was very good at traveling back their spend on replacement parts, what that does is if you take the analogy of defer and maintenance on your car, you can defer it for a while, but eventually it catches up with you anyhow to overspend for a period of time to get back to your normal maintenance outcomes. You see some of that in play that is actually working at this point in the cycle to drive up from that part of our business.

The other thing that you have to consider that is the ratio of fuel competition, in other words the cost per Btu of natural gas so that of coal. In most of the middle aged coal plants, you have a cost advantage for coal as long as that differential is in the 1.5 to 2.0 range. In the eastern part of the country, where you have all units relying principally on Appalachian based coal supplies, you have a higher delivered cost per Btu for coal and a lot of that power is been displaced by natural gas at the current pricing levels. However, those are the units that are most likely targeted for shutdown as a result of the new environmental regulations and they have been on sort of a life support program for a number of years now, and we haven’t seen substantial amount of engineered upgrades and major component replacements is just basically breakdown maintenance parts.

So, net-net, when you consider that and the fact that there are still certain parts of the country where gas is simply not available to serve the regional markets, we think we are going to continue to see a pretty strong parts and services business going forward for the foreseeable future.

Operator

Your next question comes from the line of Scott Levine with JPMorgan. Please proceed.

Scott Levine - JPMorgan

I was hoping for a little bit more color on the environmental outlook there, if you could comment on how much of a swing factor you see the outcome of the proceedings on CSAPR being to the intermediate term outlook for spend. And then secondly you highlighted 270 million worth of environmental bookings in the quarter without asking for specifics. Can you give us an indication perhaps of how that might compare to the order flow we anticipate as 2012 plays out. Should we see acceleration in bookings or shift in the mix of type of booking, any additional color on that as well as utility spending trends, that you are seeing anticipate.

Brandon Bethards

Yes, we did have a very good year in 2011 as we mentioned over 500 million in bookings for the total year with approximately 275, 280 million coming in the fourth quarter. And the other thing that I’d like to point out is that we observe a pretty disciplined and rather conservative approach to what we call bookings. We may book a contract that has a total value of let’s call up 100, but we only book what the customer has released us to work on. And if they tell us to go through the engineering phase and the initial raw material procurement that maybe 35 or 40% of that, that’s what we take into our backlog. Often the customers and particularly in this market seem to be placing their construction order separate from the equipment and that will usually follow one to two quarters behind the release for engineering and procurement.

So, you have that in play with regard to the timing. And I mentioned that the total addressable market net of the work already awarded is still substantial, but you have the factor of the delay in CSAPR that’s likely to spread that out over another year or two. And that’s actually a good thing for us because you do not hit capacity constraints and you do not out a lot of pressure on the downstream supply side of our suppliers. So that actually gives us more opportunity over the long period. However, as I mentioned earlier, the early movers are acting now and that’s a result of a lot of the bookings that you saw us receive in the year and particularly in the fourth quarter.

And then there are another group of customers that are more heavily depended upon the CSAPR requirements, that are going to take some additional to evaluate the impact of the stay on their final decisions. So, we would see that leveling off to maybe trending down for a couple of quarters and then starting to ramp back up through 2012 and 2013 with regards to the awards or bookings as we referenced them. I hope that answers your question.

Scott Levine - JPMorgan

It does. And Brandon as a follow-up, is it possible to break the 12 to 18 billion out between what is MATS driven versus CSAPR driven or is that not really instructive exercise.

Brandon Bethards

I will tell you that we do a very detail bottoms up unit by plant by customer analysis, and it gets factored into the equation, but from the end result outcome it's not a useful exercise, because there is an overlapping play between the two rules and really MATS becomes the back stop that is the final piece of missing information. The rest of it is just timing.

Scott Levine - JPMorgan

One follow-up if I may then, you mentioned the headwinds in the Asian equity income and JVs. Anything about 2013 asking guidance there, should we expect up with the (inaudible) JV ramping up and what might we think qualitatively beyond 2012 for the equity income line.

Brandon Bethards

Well the remarks that I had in the prepared comments was directed toward that subject. We are late cycle boiler suppliers in the normal economic cycle that China has been going through. We are starting to see the impact of that, it's likely to last for a year or two, and then that cycle starts to repeat itself. In India, we are just nearing the completion or well near the completion of our joint venture fabrication facilities later this year. And that market is also seeing somewhat of the same cyclical nature of that in China, but as we have mentioned over the long-term with regard to India and China, we would expect to harvest about the same amount of net income out of both of those markets although China is substantially larger than India for the foreseeable decade or two. And it has to do with the way the markets were differently in the two countries, but we do see inclusive of all of those moving parts, a decline in our equity income from those joint ventures and part of that is driven simply by the capital that’s needed for the startup company in India.

Operator

Your next question comes from the line of Jamie Cook with Credit Suisse. Please proceed.

Linda Yuan - Credit Suisse

This is Linda Yuan in for Jamie. I have a question regarding your 2012 outlook, are there any potential cost headwinds that you expect to see in 212 and could you talk any awards there expected to come through the year?

Brandon Bethards

From a cost profile standpoint, no we don’t see any abnormal cost pressures coming into the market at this time.

Tony Colatrella

Other than the pension expense if we noted already.

Brandon Bethards

As Tony mentioned, it was pension expense, I was talking primarily of project execution costs both in engineering raw materials. We have a pretty risk management policies and procedures in place to analyze defer and account for those type of risk. That becomes more difficult when it becomes extremely volatile, but we have key targets that allow us to place those raw material price, those raw material orders shortly after award that takes that risk off the table.

Linda Yuan - Credit Suisse

And then question regarding your backlog, on the Nuclear segments declined year-over-year, could you give some color on what drove that and how these segments will go over the next few quarters.

Brandon Bethards

Are you speaking to the commercial or the government Nuclear segments?

Linda Yuan - Credit Suisse

Just segments in general, Nuclear and energy.

Mary Pat Salomone

Operations finished with the $3 billion backlog for year based on the bookings that was as anticipated through our normal booking, normal pattern with the government.

Brandon Bethards

And I will also add to Mary Pat’s comment that on the commercial side with regard to revenue I mentioned that where there is a non-recurring project that we work early in 2011, but that was a significant growth in top line revenue in that business in 2011. And we have to get double-digit growth ex that project to get back to those levels for 2012, but we think that’s doable, and you will continue to see some volatility in the top line of the commercial nuclear business because it is a positive both service project that are highly depended upon the outage schedule of our customers and then there is also largely driven by large replacement component orders that come through in a lumpy manner if you will and sometimes they overlap on each other and sometimes they don’t. So, you can see quite a bit of variation from one year to next as the top line of the nuclear energy business. However, we would expect this year to be a good year.

Operator

Your next question comes from the line of Tahira Afzal with Keybanc Capital Markets. Please proceed.

Saagar Parikh - Keybanc Capital Markets

This is Saagar Parikh for Tahira. So, my first question relates to your power environmental bookings. As you guys noted, you saw a nice uptick in the fourth quarter, and solid bookings for all of 2011. Looking forward and you guys had mentioned you revised your plan for that area. Where do you really see peak bookings falling for that power segment on the environmental side now?

Brandon Bethards

We didn't revise our plan. We reassessed the market based on the cash per stay and the final technical changes in the MATS rule. And also we factored in the addressable market that we mentioned this time last year to take into account the amount of awards that have already been awarded. So, we would expect to see double-digit bookings growth in the current year coming from that market.

Saagar Parikh - Keybanc Capital Markets

And then with peak potentially in the mid to late 2013 timeframe?

Brandon Bethards

I believe that would be correct. The ‘12, ‘13 and ‘14 should still be a very solid booking opportunity years for that business.

Saagar Parikh - Keybanc Capital Markets

Then, one unrelated question related to your maintenance related spending on the utility side. For coal plants historically, have you guys seen that pretty well correlated with utilization of those plants?

Brandon Bethards

Yes. Obviously, there is a correlation between utilization and that spend that utilities have to place, however, you can have face shifting in it for a period of time depending upon what the customer’s cash management plan is for a year or two. You can get away with deferring some maintenance for some amount of time but then you usually have to have a period of overspend to cover off that deferred maintenance spend.

Saagar Parikh - Keybanc Capital Markets

From what you guys are seeing from your customers, is that changing now going forward where utilities are at the point where they can’t defer anymore?

Brandon Bethards

I think you have a certain amount of that but also you just have the general growth in power demand and a recovery of confidence from the utility as the economy continues to improve and also, there you’re looking for clarity in the environment rules so that they can do their capital investment plans out into the future and reanalyze the compatibility or the competitiveness of their various generation assets and if you look back through the historical information from previous quarters, I think you will see that our revenue from that part of the business was up about 17% in 2011.

Operator

Your next question comes from the line of John Rogers with D.A. Davidson. Please proceed.

John Rogers - D.A. Davidson

Brandon or Mary Pat, one of you mentioned that the environmental projects you thought that or your bookings were about $500 million for the year and you talked about the addressable market of 12 to 18 billion. Do you know what that $500 million represents as a portion of the market that was led in 2011?

Brandon Bethards

You can never be 100% sure that you’ve got every piece of it. But when we look through rearview mirror at 2011, we believe that there was approximately 2.2 billion in awards in that industry. We bid about, I don’t know in the neighborhood of 1.8 to 1.9 billion, and so you can take that and do the translation. It's going to give you something from 30 to 35% share.

John Rogers - D.A. Davidson

And as you look at the potential for a longer cycle that you mentioned with some of these rulings and does that give you an opportunity to increase that share, is that what you were implying?

Brandon Bethards

Not necessarily increase the share, but we have a very good portfolio of technologies that really gives us what we believe to be a competitive edge in working with our customers to help bring the maximum value solution to their environmental compliance needs. Now, if you had a real steep peaked market with a short time span, you are probably going to forgo some of that opportunity just due to a lack of capacity, okay. So the other opportunity is, we like an environment where we have a reasoned and informed customer that has the appropriate amount of time to make a solid and informed decision, and that is really the benefit of the expanded time and the thing that's driving that extended timeframe relates to the previous question too, is the outcome with regard to the stay on CSAPR.

Right now you basically have the old CAIR rules backstopping that and then you're trying to the customers who are trying to factor that outcome whatever it may be into what they have to do with regard to the MATS rules and come up with an integrated system solution that gets them to where they need to be with regard to the regulatory compliance and maintain their generating assets with the most profitable profile. So, really complexity and time to analyze, actually I believe works in our favor.

John Rogers - D.A. Davidson

And then the other thing is, just in terms of the federal programs that are scheduled or contracts work that is scheduled to be led in calendar ‘12. How does that look compared to ‘11, same sort of renewal process and progress because of the submarine work sounds like it comes in ‘13, ‘14?

Brandon Bethards

Well the submarine works, if I led you to that conclusion that would be incorrect. The message that we had in the prepared remarks was that the Virginia class program as announced by the Secretary remains substantially intact. You have got a nine vote procurement over five years in either scenario. It's just a matter of the odd year procurement for one vessel which were most in that five year program. And we really don't see any measurable impact for the current year and probably even 2013, and it remains to be seen, you have to remember that the defense area procures the boats under one order and we are what you would call an advanced procurement, and our facilities operate best when they are load levelized and the customer will recognize that he gets tremendous value out of being able to maintain a fairly steady profile of work through our manufacturing facilities. And since we are long lead-time and often precede a boat award release, there's a great deal of thought and care given by our customer in optimizing their value, which usually means that they can go ahead and if they choose to do so, release long lead-time components on a more smoother basis than they might on the actual boat procurements.

Mary Pat Salomone

And as you know, our bookings in the Nuclear Operations segment are typically in the latter part of the year, and so basically we have already announced the $778 million worth of awards there that came through in a couple of different pieces for the fuel and the components there. So, that work has already been announced and been booked. We wouldn't anticipate large that is its normal pattern there towards the end of our calendar year. With regard to the Technical Services Group, there is the Pantex Y-12 contract is up for rebid. That bid is due in March and we really don’t typically discuss what M&O opportunities and such that we are looking at, but there really aren’t loss of opportunities beyond Y-12 Pantex out over the next several years.

John Rogers - D.A. Davidson

So, the $1 billion roughly is bookings between Nuclear Operations and Technical Services, I mean which is down from what you had last year 2010, but that's a reasonable run rate now?

Brandon Bethards

I’d say you have to be careful on how you look at that. As Mary Pat mentioned, in the naval reactors business, that business is procured under a market basket concept. So, it goes out many years, but we take a very conservative approach. We don’t put all of that into our backlog. We do not book that work until that it has been through the appropriations process in Washington. So, you will see some further steps in some of that depending on how the budgets come out, whether you get into a continuing resolution fact, but we would expect there is an opportunity I think coming later, may be probably the second quarter or a forward fit portion of work that didn't carry through in the market basket program. And once that gets factored into the equation, you will see that the bookings and backlog over time when you iron out those wrinkles are pretty consistent from one year to the next and should be so going forward.

John Rogers - D.A. Davidson

I mean I guess that's the heart of it. I just feel that business continues to look relatively stable for the next three, four, five years?

Brandon Bethards

We believe that to be true.

Operator

Your next question comes from the line of Chase Jacobson with William Blair. Please proceed.

Chase Jacobson - William Blair & Company

So looking at the Nuclear Energy business, Brandon, you said a few times that you expect double-digit revenue or you expect that you could get revenue growth in that business. Are there some large projects early in the year that you expect? Is it reentry into the U.S. or is it just more of the book and burn business that you think can get you there given that the backlog is down year-over-year?

Brandon Bethards

Well, we actually achieved good revenue growth in 2011, and the comments that I was making was related to the possibility to basically be able to sustain something in that particular area in 2012 that we thought would be possible. And a lot of that comes through the roll-off of some of the large component contracts and then growth opportunities with regard to the technical or with regard to the outage services business.

Chase Jacobson - William Blair & Company

And then lastly in terms of cash, you are clearly doing a good job generating cash with the higher pension and the R&D costs. When looking into 2012, how should we think about any other uses of cash? Is there a possibility that you look to add something may be in the Government business given your expectations for flattish results there. Any color on the use of cash would be great. Thanks.

Brandon Bethards

Well, I think you pretty much nailed it. The classical uses of our cash is for our maintenance CapEx which is modest, and pretty repetitive from year-over-year. We have at least for the near term the pension issue. The thing that has been sort of discouraging in the last couple of years would be somewhat modest returns from the markets and the declining discount rate we’ve sort of been chasing on our tail on the pension situation, but at some point in time that is likely to turn and we hope in 2013 and 2014 we start to see some mitigation of that process with the discount factors and market performance. And then we have the other uses with regard to, we mentioned Loibl, which was a modest acquisition in the fourth quarter and then we have investment protocol for the joint venture in India that we will work through, I believe India this may be the peak year for capital spend on that. Other than that, we are always looking for opportunities, whether in – for investment opportunities in our existing operations or leveraged opportunities that relate to one of our businesses, such as Loibl.

Tony Colatrella

To the extent we also grow the top line revenue, we would likely have some additional working capital.

Brandon Bethards

Working capital. That's correct.

Operator

Your next question comes from the line of Rob Norfleet with BB&T Capital Markets. Please proceed.

Rob Norfleet - BB&T Capital Markets

Most of my questions have been asked, but just a couple. One, on the 278 million in environmental work that you booked in the fourth quarter, in terms of these bookings, can you discuss the types of technologies that your customers are selecting and is the margin booked on this work any higher than the traditional fossil work?

Brandon Bethards

Let me just classify, the type of work is primarily in the particulate collection and sulfur removal areas, less so in nitrous oxide removal systems. The margins obviously are, we consider information that we like to keep close to the best for a number of competitive reasons. But typically, you can look back and try to get some gauge of what those margins might be in past performance. And the other thing I would say that during the first phase of a growth cycle like an environmentally driven regulatory growth cycle like this, we have come off of a period of rather a few linear and our competitors contend to be pretty aggressive in their pricing. We hold a very disciplined and rigid pricing performance because we expect to get paid, our shareholders expect us to get paid for the value that we bring to our customers and I think a number of our customers respect that, but you do see some pressure on margins in the first part of the cycle, and you see more opportunity for margin expansion in the middle of that procurement cycle which will come later in the year, but nonetheless, it's good.

Rob Norfleet - BB&T Capital Markets

And secondly, would you mind just providing us an update with Generation mPower in terms of the timetable with the NRC, how the research center is, how that’s going in terms of implementation and then any progress with TBA or additional customers?

Mary Pat Salomone

With regard to the integrated system test facility, as you know that was completed and dedicated last year. We are starting up of the systems there, had they been going through a whole series of testing of the systems, we actually expect testing to start here in the near-term with regard to the actual testing related to mPower. We are still working towards submitting the design certification application in the fourth quarter of 2013. We have regular communication with the NRC. We continue to work with TVA. We are continuing to work with TVA, as being very supportive of us through our submittal to the DOE for the cost share program here that we expect to happen in the second quarter in terms of the submittal of that proposal.

Brandon Bethards

Operator, we are going to take one last call.

Operator

Your last question comes from the line of Joe Ritchie with Goldman Sachs. Please proceed.

Greg Elek - Goldman Sachs

This is Greg Elek in for Joe. I just wanted to follow-up on the Asian JVs here. It seems like a pretty significant ramp down over the past two years. I want to get a better understanding in terms of the capacity that you have there and where you see kind of market moving forward. Is this really kind of a China slowing factor or any additional color would be helpful.

Tony Colatrella

Well, remember this is a net impact of some slowdown in China, cyclical slowdown in China, which we expect we’ve seen before and expect to navigate through just as we have in the past, but it's net of also the investment expense for the startup company in India. So when you filter out to the China slowdown it's there, but it should be moderate and it will take a year or two for this cycle to usually reverse itself. But when it does, we should see improving opportunities in China coupled with booking and revenue opportunity out of few years in the India market as that business starts to get traction.

Greg Elek - Goldman Sachs

Right. So, there is an opportunity for that segment to get above the prior peak which you saw around 30 million or so in a couple of years, right?

Tony Colatrella

That's correct.

Greg Elek - Goldman Sachs

And just my follow-up question, thank you. It has to do with just USEC, any kind of update there in relation to timing on kind of the second tranche maybe moving forward?

Mary Pat Salomone

As you know, USEC was unsuccessful in getting their loan guarantee last year. They did obtain the $44 million of funding for the first phase of that $300 million RD&D program that they are talking about, in which really that $44 million keeps us working at kind of the low level of production that we worked at through last year for the first quarter of this year. The RD&D program is intended to be a $300 million program. They’ve obtained $44 million worth of funding, and it is all intended to be a bridge to the loan guarantee. But USEC continues to work very hard to get the full funding of the RD&D, but that’s still not in place. They are still working actively to try and make that occur and we continue to be supportive there and continue to work with them as we can.

Brandon Bethards

I would also add to that, that the GY ‘13 budget from the administration did include 150 million for the GY ‘13 period and the 44 is basically in the current year, and are looking at other opportunities. I’d say that I find excellent support on both sides of the aisle for the need to proceed with the American Centrifuge Project, but you have the current political complexities. They are trying to do something that everybody agrees on in Washington these days, but USEC is working very hard to solve that problem. We have great deal of confidence in building something.

Operator

This concludes the Q&A section for today’s call. I’d now like to turn the call back over to Mr. Michael Dickerson for any closing remarks.

Michael Dickerson

Thanks, Janetta, and thank you for joining us everyone this morning. That concludes our call. We will have a replay of this call available for a limited time on our website. We will also have in our website a company overview that’s got some additional information that we will share with investors and analysts through the balance of this quarter. If there is anybody left in the queue or would like any follow-up, I will be available throughout the day, please give me a call directly. Thanks everyone and goodbye.

Operator

Ladies and gentlemen that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

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