BWX Technologies, Inc.

INCOME TAXES

We are subject to federal income tax in the U.S. and Canada as well as income tax within multiple U.S. state jurisdictions. We provide for income taxes based on the enacted tax laws and rates in the jurisdictions in which we conduct our operations. These jurisdictions may have regimes of taxation that vary with respect to nominal rates and with respect to the basis on which these rates are applied. This variation, along with the changes in our mix of income within these jurisdictions, can contribute to shifts in our effective tax rate from period to period.

On December 22, 2017, H.R. 1, the Tax Cuts and Jobs Act (the "Act") was enacted, making significant changes to existing U.S. tax laws that impact BWXT, including, but not limited to, a reduction to the U.S. corporate income tax rate from 35% to 21% for tax years beginning after December 31, 2017, a one-time transition tax on certain undistributed foreign earnings and additional deduction limitations on executive compensation. We have obtained and analyzed all necessary information to record the effect of the change in tax law resulting from the Act and have recognized the income tax effects in our 2017 financial statements. Upon completion of our 2017 U.S. income tax return in 2018, we may identify additional remeasurement adjustments to our recorded deferred tax assets. Additionally, should the Internal Revenue Service and/or state taxing authorities issue further guidance, interpretations or legislative changes related to certain aspects of the new tax law, we may have future adjustments to record. Our Canadian operations continue to be subject to tax at a local statutory rate of approximately 25%.

We are currently under audit by various state and international authorities. With few exceptions, we do not have any returns under examination for years prior to 2014.

We apply the provisions of FASB Topic Income Taxes regarding the treatment of uncertain tax positions. A reconciliation of unrecognized tax benefits (exclusive of interest and federal and state benefits) is as follows:



	Year Ended December 31,
	2017		2016			2015
	(In thousands)
Balance at beginning of period	$	1,651	$	2,222		$	8,597
Increases based on tax positions taken in the current year	—		—			185
Increases based on tax positions taken in the prior years	—		—			—
Decreases based on tax positions taken in the prior years	—		—			(134		)
Decreases due to settlements with tax authorities	—		(571		)	(5,934		)
Decreases due to lapse of applicable statute of limitation	—		—			(492		)
Other, net	29		—			—
Balance at end of period	$	1,680	$	1,651		$	2,222

The unrecognized tax benefits balance of $1.7 million at December 31, 2017 would reduce our effective tax rate if recognized.

We believe that, within the next 12 months, it is reasonably possible that our previously unrecognized tax benefits could decrease by $1.4 million.

Deferred income taxes reflect the net tax effects of temporary differences between the financial and tax bases of assets and liabilities. Deferred tax assets and liabilities are measured based on the enacted tax rates that will apply in the years in which the temporary differences are expected to be recovered or paid. As such, we have remeasured our U.S. deferred tax assets and liabilities based on the reduction of the U.S. corporate income tax rate from 35% to 21% as a result of the passage of the Act in 2017. This remeasurement resulted in a total decrease in our net deferred tax asset position of $49.5 million. Significant components of deferred tax assets and liabilities as of December 31, 2017 and 2016 were as follows:



	December 31,
	2017			2016
	(In thousands)
Deferred tax assets:
Pension liability	$	59,229		$	129,603
Accrued warranty expense	3,482			3,868
Accrued vacation pay	6,557			9,892
Accrued liabilities for self-insurance (including postretirement health care benefits)	6,355			7,663
Accrued liabilities for executive and employee incentive compensation	8,647			20,670
Environmental and products liabilities	17,195			34,798
Investments in joint ventures and affiliated companies	8,343			15,067
Long-term contracts	4,057			10,039
State tax net operating loss carryforward	8,460			5,573
Tax credit carryforward	1,016			160
Other	8,638			9,373
Total deferred tax assets	131,979			246,706
Valuation allowance for deferred tax assets	(15,252		)	(17,226		)
Deferred tax assets	116,727			229,480
Deferred tax liabilities:
Property, plant and equipment	11,573			10,249
Long-term contracts	—			11,920
Intangibles	27,875			35,920
Other	—			—
Total deferred tax liabilities	39,448			58,089
Net deferred tax assets	$	77,279		$	171,391

Income from continuing operations before provision for income taxes and noncontrolling interest were as follows:



	Year Ended December 31,
	2017		2016		2015
	(In thousands)
U.S.	$	255,194	$	215,572	$	211,285
Other than U.S.	40,586		41,696		9,780
Income before Provision for Income Taxes	$	295,780	$	257,268	$	221,065

The components of Provision for Income Taxes were as follows:



	Year Ended December 31,
	2017			2016			2015
	(In thousands)
Current:
U.S. – federal	$	26,632		$	73,383		$	95,854
U.S. – state and local	3,023			3,068			3,498
Other than U.S.	24,299			4,436			(2,170		)
Total current	53,954			80,887			97,182
Deferred:
U.S. – federal	107,844			(12,665		)	(25,981		)
U.S. – state and local	(158		)	222			3,423
Other than U.S.	(14,225		)	5,212			5,792
Total deferred	93,461			(7,231		)	(16,766		)
Provision for Income Taxes	$	147,415		$	73,656		$	80,416

The following is a reconciliation of our income tax provision related to continuing operations from the U.S. statutory federal tax rate (35%) to our consolidated effective tax rate:



	Year Ended December 31,
	2017		2016		2015
U.S. federal statutory tax rate	35.0	%	35.0	%	35.0	%
State and local income taxes	1.2	%	0.8	%	3.3	%
Foreign rate differential	(1.4	)%	(1.5	)%	(0.4	)%
Foreign operations	—	%	(1.4	)%	1.7	%
Excess tax deductions on equity compensation	(2.0	)%	(0.9	)%	—	%
Impact of U.S. Tax Cuts & Jobs Act	17.7	%	—	%	—	%
Manufacturing deduction	(1.4	)%	(2.6	)%	(2.9	)%
Minority interest	(0.1	)%	(1.9	)%	0.3	%
Other	0.8	%	1.1	%	(0.6	)%
Effective tax rate	49.8	%	28.6	%	36.4	%

At December 31, 2017, we had a valuation allowance of $15.3 million for deferred tax assets, which we expect cannot be realized through carrybacks, future reversals of existing taxable temporary differences and our estimate of future taxable income. We believe that our remaining deferred tax assets are more likely than not realizable through carrybacks, future reversals of existing taxable temporary differences and our estimate of future taxable income. Any changes to our estimated valuation allowance could be material to our consolidated financial statements. As a result of the passage of the Act, we have remeasured our valuation allowances based on the reduction of the U.S. corporate income tax rate from 35% to 21%. This remeasurement resulted in a total decrease in our valuation allowances of $3.7 million.

The following is an analysis of our valuation allowance for deferred tax assets:



	Beginning Balance			Charges To Costs and Expenses		Charged To Other Accounts		Ending Balance
	(In thousands)
Year Ended December 31, 2017	$	(17,226	)	2,544		(570	)	$	(15,252	)
Year Ended December 31, 2016	$	(17,752	)	(760	)	1,286		$	(17,226	)
Year Ended December 31, 2015	$	(14,239	)	(3,513	)	—		$	(17,752	)

We have state net operating losses of $10.6 million ($8.4 million net of federal tax benefit) available to offset future taxable income in various states. Our state net operating loss carryforwards begin to expire in the year 2018. We are carrying a valuation allowance of $9.4 million ($7.4 million, net of federal tax benefit) against the deferred tax asset related to the state loss carryforwards.

We would be subject to withholding taxes if we were to distribute earnings from certain foreign subsidiaries. For the year ended December 31, 2017, the undistributed earnings of these subsidiaries were approximately $89.2 million. As of December 31, 2017, our unrecognized deferred income tax liabilities of approximately $4.5 million would be payable upon the distribution of these earnings. All of our foreign earnings are considered indefinitely reinvested.