KBR, Inc. (KBR) Earnings Call Transcript & Summary

Good morning, and welcome to the 8th Annual Credit Suisse Industrials Conference. My name is Jamie Cook, and I am the machinery and engineering and construction analyst at Crédit Suisse. In terms of the format for today's fireside chats, I will moderate the Q&A with management. And if you do have a question that you want to ask, please feel free to e-mail me at [email protected], S-U-I-S-S-E, and I'll make sure I get that question asked for you. So without further ado, I'm very pleased to introduce today the management team of KBR. We have Byron Bright, who's the President of Government Solutions; as well as Alison Vasquez, who is the Vice President of Investor Relations. As you recall, KBR has been on a significant transformation, shifting their portfolio more to a government IT solutions firm with a high value-add technology services business. So I think it's very key that we have Byron here today to help us understand this transition the company is undergoing. Byron will kick off today's fireside chat with a brief presentation. And after that, we'll open it up to Q&A. So with that, thank you both, Byron and Alison, for being here. And Byron, I'll pass it over to you.

Thanks, Jamie, and thanks so much for hosting us. I'm really excited to be here today and tell about our story and just maybe set the stage, give a quick overview of kind of who we are today and what we've been up to. Today, we're really a provider of high-end, digitally enabled solutions in attractive end markets. As you said, about 80% of our portfolio is government, and it's sourced from the U.S. Department of Defense, NASA, but also other premier government clients like the U.K. MoD. About 20% of our portfolio comes from high-end industrial services, process technologies, where we own the IP, or advisory solutions, technology-led OpEx. And all of that work is really centered around a cleaner, greener, global future. Our people do just a vast array of work, and you can see some of that on the slide. It spans advanced scientific research, intelligence support, military systems modernization, energy transition, sustainability. And I like to say, when we talk to our people, about we do things that matter. And I use the word all the time, high-impact, mission-critical services. Because our people really care about the planet. They care about national security. And they're really involved in just an array of exciting technologies. For KBR, this fall has been really busy. Maybe a couple of highlights for everyone. As many may know, we closed on a strategic accretive acquisition of Centauri, and that gives us an at-scale intelligence and military pure-play that we -- a military space pure play, I should say, that we didn't have. We've also announced, as you mentioned, our portfolio trend transformation going down to a 2-segment model, this Government at 80% and Technology at 20%. And what that really means is we've exited a lot of the commoditized services, the lump-sum EPC. We've been very clear about our role there. And this gives us the opportunity to really focus on the higher-end technologies. From a financial standpoint, we've provided a 2021 outlook that shows that embedded double-digit organic earnings growth, plus the Centauri accretion. And we're going to give some formal guidance in connection with fourth quarter earnings. And I guess I'm most proud of just our people and the performance they've continued to deliver through this COVID environment. As everyone knows, we're doing this on video. It's not always the same. But our people in the field have just continued to be there to support NASA, flying the first astronauts into space from the U.S. soil or being deployed overseas supporting our warfare in remote locations. They've continued to perform in just incredible environments. And that's allowed us to generate cash. And I think we've raised our cash guidance twice this year up to about $270 million to $290 million. So it's been a great year for us. We've had some remarkable challenges, but our teams have responded just amazing. And we're excited to tell the rest of our story. You can just kind of see on the chart some of our metrics. I won't read them all to you. I think things that I would point out are really at the bottom of the screen. There are some of those pie charts. And just to kind of hit on the point you said about our journey we've been on, I personally been here at KBR for 10 years. So I've seen us go through just a remarkable transformation. The culture of KBR is just something I'm extremely proud of. Today, you can see we're very diversified across a lot of addressable markets in defense, space, intelligence, the industrial sectors. Very balanced today, which gives us multiple funding sources. It's really a key attribute to how we manage our business. We have a nice balance of reimbursable contracts, which keeps us a low-risk profile. And really a large number of contracts. We don't have any concentration risk. And it really helps to drive and fuel our growth. Good capital structure. And like I said, our team continues to deliver. So that's probably all I have to start, Jamie. I really look forward to the questions.

Great. So why don't we kick it off with the defense budget? Now obviously that we have a better understanding of the political environment that the U.S. is in, can you characterize the outlook for the defense budget? And which areas do you see the greatest opportunity for growth versus where we could potentially see some budget cuts?

Yes. I think what we're feeling pretty optimistic about the defense budget, especially in the short term. I'd like to think of it as where is the government aligned, regardless of your party? And if you think about 4 or 5 key areas of alignment on the DoD spend. Space, clearly, they're aligned to military space on areas like resilience, space launch, the classified sensors in space. So that -- we see that budget staying strong. Missile defense, so programs related to hypersonics, defensive hypersonics, advanced materials research, precision fires, long-range precision fires. Those programs seem strong. Unmanned autonomous systems, especially in the Navy. I mean the Air Force has been there for a while and the Navy are looking to grow more and more into the unmanned focus. Anything cyber, and cyber is one of those big words that means a lot of different things to different people. But especially around hardware, trusted microelectronics, protecting new weapon systems, anything related to communication and networks, artificial intelligence, all of those defense modernization priorities still feel very well aligned, strong and growing. The areas that might be looking to be less, I think the ground forces. I think the Army will be transitioning to smaller, more expeditionary forces. Legacy aircraft, aircraft that are not as survivable, not as stealthy. Manned systems, those type of older systems will probably have less spend. For KBR, that's part of the reason we've been on this journey for 4 or 5 years was really to align ourselves where we saw a lot of this defense spending. I think NASA remains very strong. And looking at other federal agencies, Department of State and other civilian agencies may actually get a little bit of an uptick.

Okay. Great. And I guess just on that note, you guys were obviously a big winner of LOGCAP V, and that's been impacted by COVID as one would expect. How do you think about that weighing on your 2021 outlook? And I guess you guys reiterated your 2021 $6 billion in sales, 9%, I think, EBITDA margin. So what areas of the business are doing better that could offset LOGCAP? And what are the different scenarios that you could potentially see for LOGCAP from here?

Yes. No LOGCAP has been great this year. I mean it was a slow start because of COVID. I would tell you today LOGCAP V is running very well. We've fully transitioned in Europe. And NORTHCOM has been a real bright spot for us. More exercise support than we expected. We're working well at Fort Irwin. But LOGCAP is really just a small piece of our portfolio today. It's an easy thing to talk about, but it's really not what drives our business. I think the exciting areas of our business are other areas of logistics that include supply chain support, supply chain modernization. We're seeing a lot of growth there. But really, I would say, our real bright spots that have filled that gap, if you will, have been our space and engineering business. Our space business has grown on the order of 14%, 15% year-over-year in revenue. It's just -- they've had some really, really great growth there. Our defense engineering business. And now it's Centauri, the intelligence business. They have booked just really strong backlog throughout the year, which is going to continue to fuel growth into next year. So they have great book-to-bill going. And those areas, I think, are really helping drive that growth and reaffirm that outlook that we've set for 2021. I think that's part of that diversified portfolio that we can handle this, unlike maybe 10 years ago. It's just a very different portfolio today.

Okay. And then one of the other questions I get often from investors is the margin potential within the Government Solutions business. In particular, obviously, Centauri should be accretive to the margin mix. And then KBR has spoken historically about, I think, growing more in the U.K. and Australia, which I also think is accretive to mix. So what's the longer-term potential for the margin business -- sorry, the margins for the Government Solutions business? And if you could sort of frame a base versus sort of upside scenario.

Yes. I think most people realize that the government market, a lot of it is cost reimbursable, which keeps margins kind of at pretty normative level. However, we're seeing a lot of changes in the market around new business models. So OTA, Other Transaction Authorities, that's a lot of the work that Centauri does, which is how they get better margins. So some more commercially negotiated type contracts with the government, if you will. So we do -- we've had some uptick due to that higher-end type of work, like you said with Centauri. I think the real kicker for us is our international work. In general, our international margins are double-digit margins, which add -- really add to our portfolio. So we like to think of ourselves with that -- being this kind of U.S. government pure-play company, but we've got these very attractive other parts of the business, whether that's international -- or our Technology business as well, very nice margin profile in technology. All of those adds to, again, low-risk business but a very nice margin kicker. And so we think that the norms we've set out on the government are very sustainable.

Okay. And just because you sort of touched upon that overseas should be a bigger part of the business longer term, what is your sort of outlook when you think about the U.K. or Australia relative to the U.S. just in terms of growth trajectory?

Yes. I mean, Australia is probably our -- it's obviously come from a very small base. It's not nearly the size or scale of the U.S. business, but it is our largest growth segment. I mean they've had multiyear double-digit growth in Australia. And their government has continued to reaffirm support for expanding, especially the Australian Navy, in response to geopolitical issues in that part of the world. So really, really strong growth. I think they've had on the order of 50% organic growth over this past year in Australia, which is just incredible. The U.K., if you've been watching just a couple of weeks ago, the U.K. came out and reaffirmed a commitment to, I think, it's $16.5 billion above and beyond their normal budget spend over 40 years. And what was really supportive for me was that their focus is in areas such as cyber and in areas such as space, with some very lofty goals to launch their own space platforms. So I think that just very much aligns to what we've been seeing in the international market that these European countries and other allied countries have to respond to the same threats that the U.S. is responding to and their commitment to 2% to 3% of their GDP seems to be a real bright spot for us. And we have a great presence over there.

And then as you think about your ability to increase your exposure in those markets, how much of that can be done organically versus do you need acquisitions really to get a larger presence in those markets?

I think all options are on the table for us. I think we do believe we have a lot of room organically. A lot of the acquisitions we've made over the last 2 or 3 years that have moved us upmarket in the U.S. are directly applicable to the international needs. And so -- and we've seen a lot of synergies come from that, especially in Australia. They were already in that mission planning and kind of higher-end work to start with. And so much of the acquisitions we bought the last 3 or 4 years, they definitely benefited from that capability and expertise. And so I think we can see more of that going into the U.K. That's a real focus for us organically. But yes, I think we've always said that we're very strategic in what we go after from an M&A standpoint. But we have a lot of options. We've got a very, very good balance sheet that gives us flexibility as we go forward.

Okay. And I guess we'll get to balance sheet later, but just to sort of close off here on -- well, maybe not close on government, but you mentioned the Centauri deal. Can you just give investors some better color on how this positions KBR for higher growth in a more technical sort of vectors of defense spending? Now that the deal has closed, has there been any surprises? And then I think when you initially announced the deal, you talked about, for 2021, $700 million in sales, and I think $0.25 to $0.30 in EPS accretion. Yes, how secure is that number?

Yes. So a couple of points on Centauri. They were very strategic for us in a couple of ways. First, they opened doors into the intelligence community. Over -- I think they had over 1,700 employees, and I believe 75%, 80% of them all have top secret SCI clearances, so some of the highest clearance levels. That's an area that's just very hard to get in organically. So that immediately gave us scale and exposure to a client base we really had almost virtually no exposure to. A huge amount of spending there with many different agencies. And then from a technical side, the domain expertise side, they're just in some very leading-edge efforts, developing algorithms for looking at what's happening in space. So an enemy space asset, trying to figure out what it's looking at and where it's going and what it's doing. A lot of very high-end modeling and simulation, digital engineering, to literally fly new platforms in space before they've ever been built. They do that in a physics-based model that is very high-end computer power to do that. Focusing on product development there in some of the key areas like directed energy. They are the integrator on a very important program for the Army called DE-SHORAD, and that is in the test phase as we speak and doing very, very well. So I think what they bring to us is that R&D flavor and -- along with access to customers. And that allows us to combine it with a lot of KBR's kind of more traditional engineering and scale. As far as surprises, no, not at all. I think I've been so pleased with the culture. They're much like KBR. Their employees, they care about the mission and they see KBR as a home. We're a public company. They're not going to get bought and sold like private equity. They're going to be with us for a long time. They feel very secure. So culturally, it fits really well. And as far as the numbers, yes, we're seeing no issues there. In the government, one of the great things is the long-term contracts and that visibility, and we see that. So we have about 70% to 80% of that work already secured for next year of that $700 million. And so all of that, that we announced is holding very true for next year.

Great. So I guess, just as a transition, the Technology and Energy business, the other segment that you guys have sort of collapsed together. I think investors are trying to better understand the technologies that sit within that business. I think, traditionally, people think of it as an ammonia business or maybe you have some LNG technology, whether it was OSMR. So can you just help us better understand what technologies that business has outside of ammonia? And then how this sort of portfolio can help KBR transition sort of to more of a cleaner energy focus relative to the legacy KBR.

Yes. I think right now that business is really focused in an advisory capacity at a very high level, at governmental level, at the C-suite level, helping entities figure out how to transition to this carbon-neutral economy. And because we own IP and own technology as well as have delivered mega projects, as well as understand how governments work, I think we're in this really interesting nexus for advising clients in the future. And I think that's a big part of what we see driving growth and helping us define what other technologies to invest in. But as far as the technology portfolio itself, ammonia is a key part of that. Other verticals related to chemicals, olefins, refining technologies. And we've got a big focus on research and development around green ammonia. It is a reality. I mean the technology exists today. It's not totally commercially effective yet without subsidies, but it's getting really close. And we see governments beginning to invest and figure that out. Our ROSE technology, we've talked a lot about, removes things from bottom of the barrel of fuels to make cleaner fuels and it does it more efficiently. All these technologies are really about making products safer to handle, or like our K-SAAT technology, or making plants and industrials more efficient for the owners. And I think we'll continue to invest in those technologies and that IP, and combining that with some of the legacy energy domain expertise around remote operations, around digital engineering. All of those technologies and IPs really help our customers solve problems around this clean energy and desire to have this carbon-neutral economy.

Great. And then I -- just continuing on that path. I mean, I think investors were very supportive of the shift to -- of the portfolio to the Government IT Solutions business and have mixed feelings about how they felt about sort of the Energy -- sorry, to keeping a portion of the Technology Energy business. So how do you guys -- I mean what's -- why are we holding on to this business? Do you think the market underappreciates the potential valuation of this business on a combined basis? And then I think you've said the margins in this business can go to mid-teens over time. I'm just -- sorry, to high teens by 2024. I'm just wondering if there's a pathway beyond that which investors underappreciate. So sorry, a lot there, but valuation of the business and the margin trajectory of that business.

Yes. I'll give you my thoughts on it. And then maybe, Alison, maybe you want to jump in on this one and give a little more on where you think the margins can go. I think -- for me, I think of it as it's really a high-value business. I mean it's really a good business. It's got -- we own IP. So there's barriers to entry. We have a global sales team in so many different countries that can rapidly commercialize newer technologies. It's very well run. It's low capital or negative working capital business. I'd like to think of it as where we've transformed to with this 80% government portfolio, think of us as this government business with this really high-value, high-margin technology kicker. And is it underappreciated? Maybe. I think it is. But I think it's a really, really great business that adds a lot. And having some diversity in your portfolio, I believe, is a good thing for investors. I don't know, Alison, if you want to speak a little bit more to where you think the margins can go?

Yes. So I mean, I think what we've talked about publicly is that we think the margin can expand probably 1% to 2% per year, getting up to that upper teen, I mean, possibly into the low 20s by '24. So that's kind of the path that we're on. Just really through the growth of those -- I mean it's really revenue mix as we see kind of more high-value solutions, the technologies themselves, the advisory services, which come at very attractive margins, really expanding at a greater pace. And then also, let me just -- with some continued cost takeout. I mean, this piece of the business is, I want to say, it's old. But I mean, it's been around for quite some time, and they have some -- just some legacy infrastructure items just internally that we are working on cleaning up. And so there's some additional cost takeout that will just take time. But I would say that from an energy and a technology perspective, it really -- I mean, as we look at it, it's less about collapsing those 2 things together, and it's more about the Technology business, really looking at those elements of Energy that are highly synergistic with the technology portfolio that we have today and then bringing those high-value items over. So that's the advisory piece that gets you really onto that very front end, very forward-leaning kind of tip of the spear area of where the markets are going directionally, which helps guide us from a technology where we're going to invest our money and where we're going to invest our dollars in terms of technology advancement, [ development ], those types of things. And then on the back end, it's really that, as Byron talked about, that technology-led industrial solutions that those OpEx -- remote OpEx solutions that we're adding. Those technologies and those platforms are eventually OpEx, more continuous revenue streams that we've added to the technology portfolios because they are fit-for-purpose to our technologies. They were actually designed for our technologies. So it's something that the technology team was looking into the energy sector. They were thinking that -- they were keen to bring over into the portfolio. So we really feel like the [ kind of the formation ] of the pieces of the energy portfolio that we have retained really are attractive margins, great cash profile, but really, most importantly, highly synergistic with the technology platform that we have today.

I guess I'll ask you this question. I don't think you'll answer it, but I'll try, Alison. Is there any way you can -- I mean, we understand -- I'm just wondering how people can think about the margin profile over time of the core energy business, given that we're focused. Because I feel like that's the part that weighs on -- you know what I mean, like the valuation of the company that people are going to assume it's very low single-digit margin. I'm just wondering if this is sort of a higher or low double-digit margin business in terms of where you're refocusing the legacy energy. It's different than the legacy energy, but the non-technology business.

Yes. I mean from a margin perspective, I mean, that blended kind of, I don't know, 14%, 15%, 16%, so mid-teen margin profile is the technology portfolio at its 24%, 25%, 26%. And then those elements of energy that we've brought over that are netting 8% and 11% together. So some of those services, like especially in some of the higher-end pieces of advisory and some of the more [ very ] solution, very smart things that we're doing in there earn margins that are consistent with what we're earning on the heritage technology platform. But blend it together, it's that 8%, 9%, 10% kind of margin [ profile ] that's being brought over. Really, was this year about removing all of the -- I mean, essentially pass-through very low margin, very commoditized services out of there that we're essentially diluting the margin profile, as well as taking out some of the costs associated with keeping a business platform associated with those activities that we've announced that we're exiting.

Okay. And then just one further on sort of portfolio optimization. Obviously, you guys have been comparing yourself a lot to the government IT service companies. One, Byron, first part of this is, how do you think about your organic growth profile, margin profile of the business relative to your -- the people that you -- the contract or the peers you're trying to compare yourself to? And then, Alison, I guess, the second part on that is you're still trading at a discount to the government IT services guys. People view it's because of the energy technology business. How long do you sort of give the market to appreciate the value of the business before you'd consider other portfolio opportunities?

I'll take the first part of that. I think our margin profile against our government peers is probably better than some because of some of those things we talked about, the international government business, those long-term PFIs that just add that guaranteed kind of higher-margin work or the kicker from technology coming in. And so I think if you do a comparison to many of our peers, you'll find us right there with them or better. As far as new work that's coming on, I think because we're being very selective and very focused in the technical areas we're going after and the types of contract vehicles we're going after, the programs we're supporting for the U.S. government, those are continuing to keep our margins higher than maybe historical margins. We're -- much like the energy business, we're just not doing a lot of that pass-through work and commoditized work anymore. Even in our logistics portfolio, we're focusing on supply chain modernization, adding data analytics into the supply chain for providers, not just government, but OEMs as well. We're doing a lot of higher-end work across the portfolio, whether it's in our space portfolio, our intelligence portfolio now with Centauri. And I think all of those in our pipeline, we're seeing good, solid margins. And we just don't have that pass-through work anymore inside the government work, which can keep us at or above our peers with the kickers coming over from international. Alison, do you want to add to that?

Sure. I would say that from a valuation -- I mean, we've done a number of things this year to really appropriately address the valuation. And I think a lot has happened. So for a company our size, we've done the portfolio transformation, we've done the Centauri acquisition. We've done a lot of things to really help us drive toward bridging that gap. Because I mean -- and Byron can tell you, and he's in the meetings directly with Mark and Stuart and the rest of the ELT, that -- I mean, the valuation gap is something that's recognized as important. We're taking very proactive measures to address it. But we laid out a time line in terms of [ the role ] that we have to play at the time that we have to play them in. And I would say probably over the next 12 months or so, our expectation is that we will give the market time to digest the changes that we've made, and we've made a lot. And we can probably communicate some of those a little bit more clearly in terms of what they mean for the future. We do plan to have an investor event early next year such that we can [ put ] things out in a much more concise, cohesive way, the full story of the company, which pieces of are missing at this point. So we'll get those -- that information into the market such that it can be digested, analyzed and investors can hopefully have a bit more transparency in terms of what they're looking at, not just for 2021 but really into 2022, 2023 and into the future. So that's something [ high ] on the priority list that -- Byron, please.

Actually, just -- I would just say we're not emotional about the business, right? We're going to do what's right for the shareholders. And I think you've seen us do that, been very strategic, very focused on how we do acquisitions, how we go after work. We talk about this all the time at the executive level. And I say we like the business and we think our story is getting out and is changing. I'm sorry, Jamie, you wanted to...

No, I was going to say we're over, but of course I have one more question. Just because of your balance sheet, the strong cash flow, the recent bond refinancing and where your valuation is, how are we thinking about the opportunity for share repurchase? And then I'll end with that.

Yes. We've been very upfront about our priorities and kind of maintaining very responsible leverage. I think share repurchase is on the table, and we will continue to look for M&A. We have a lot of options. And I think that's the way we think about our capital deployment strategy and our strong balance sheet is we just have a lot of optionality.

Okay. Great. Well, I can't thank you enough for being here today. I appreciate your time and the journey that you guys have been on. So thank you very much, and have a great day. And if I don't talk to you before, have a great, happy and safe holiday. Thank you.

Thanks, Jamie.

Thank you, Jamie.

Thanks.