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

Good morning, everyone. Welcome to our fireside chat with KBR. I'm Jerry Revich from Goldman Sachs. And with us today from KBR, we're pleased to have Mark Sopp, Executive Vice President and Chief Financial Officer; and Alison Vasquez, Vice President of Investor Relations. Mark, Alison, thank you very much for joining us.

Jerry, thank you. We're really pleased to be at your conference today, and thank you for all the participants, for your interest in KBR. We're always delighted to tell our story with you. So what we're going to do, Jerry, is a fairly brief 5- to 10-minute overview of KBR here at the start, and then I'll turn it back to you if that's okay for the fireside chat without a fire.

Terrific. Thank you.

Okay. So folks, I'll advance to the next slide here just to show we do have a safe harbor statement here on forward-looking statements. So this is all about -- so you can read that at your leisure. And so next slide is just a very brief overview of KBR. We've done a lot of messaging lately. We have a lot of content on our website from a recent investor conference, and I would encourage you to look at all of that. These slides here are a small subset. Takeaway for KBR in terms of who we are, it's about a $6 billion business that is a government business primarily. But it has a very interesting and exciting technology kicker that serves the commercial sector, and it's quite synergistic also with the government business, which is very unique in the government sector, to have a commercial business that is proven, that is profitable, that is low-risk and synergistic with the government side. So really excited about that. On the government side, we serve defense modernization, space, human health and performance as our primary growth drivers within which we have cybersecurity. We have trusted microelectronics as a new thrust. And so we participate in parts of the government markets that are faster growing. We're very attractive because they are national priority needs; the United States, the United Kingdom and Australia, those are the 3 primary markets we serve on the government side. This is a business that has improved very much in quality over the years, used to be quite focused in readiness and sustainment and logistics. This has now very broadly diversified into these more appealing, faster-growing areas within defense budgets and federal civil agency budgets. And as I said before, we have a commercial business, call it sustainable technology and its services, the industrial sector, primarily in clean energy and clean process technologies that serve plastics markets, syngas markets, in the refining markets with advanced capabilities that serve sustainable agendas for cleaner fuels, cleaner processing methodologies. And that's, of course, a very exciting area to be in today. We do all of this in a low capital intensity business model, very low-risk as well. And it has proven to be a stable, predictable generator of profits and cash flow. And with that, we've built a very strong balance sheet as we've migrated to this fairly simple, straightforward, low-risk model. Next slide, please. So real simple. We deliver science technology and engineering solutions to both governments and commercial companies around the world, and we do so synergistically. On the right, you can see how well this business is balanced across 4 primary areas on the government side and the commercial sustainable technology. We like that because we have access to different funding sources, O&M budgets, capital budgets, domestic budgets, international budgets and so forth. And so it's an attractive mix and it lowers risk and improves opportunity access when there are certain pockets of growth across the standard business. We have a pretty large chunk of reimbursable business, exclusively on the government side, very low risk, very predictable margins and profitability. But we also have a pretty good chunk in the government side and the commercial side for performance-based where we have to put our skin in the game to perform. But when we do so, there's margin improvement opportunity. And there's increasing opportunity to innovate for the customers and to be incentivized and recognized for that to continue repeating that sort of business level with them. I'll move on to the next slide. Now this is from our investor conference, we laid out our value proposition relative to financial metrics pretty clearly there. Starting with the top here, we are participating in very exciting areas of growth in government. I mentioned some of them: cybersecurity; military space; space overall, together with the space force; trusted microelectronics; defense modernization; and the increasing pace of outsourcing in government that is benefiting our readiness and sustainment business. The sustainable technology is really all about the emerging mandate socially, politically for industries and governments to have better sustainable outcomes for the environment, primarily in this case, and we deliver very innovative solutions in this regard in our sustainable technologies business. It is laser-focused on that space, and it's performed well for a long time, but the outlook is quite robust given that mandate, if you will, on the environmental side. We're projecting organic revenue growth of 6% to 9% over the next several years to grow our business to approximately $8 billion by 2025. We're expecting to improve our margins, particularly on the commercial side over this period of time, primarily through economies of scale and better mix, together, producing adjusted EPS growth of 15% to 20% on a compounded annual growth basis. And a very attractive return on invested capital as well. I can't see the one part of the slide because I can see the beautiful faces on the right side. So that's hard for me to see. But importantly, we're looking at earnings per share on an adjusted basis of $4 by 2025, using a very conservative capital deployment assumption of just 50% of our firepower, but $6 in the case of deploying all of our free cash flow and maintaining a leverage ratio of just 3.0x. Next slide, please. This shows the capital deployment firepower a little more clearly. So with a low capital intensity business and a very predictable level of profits and attractive cash flow conversion. We see, first of all, free cash flow converting to net income on a one-to-one basis. So $4 of adjusted EPS would translate to $4 of free cash flow per share. Our deployment opportunities are to, of course, focus on organic reinvestment, which we do very well. Maintaining responsible leverage, we do pay an attractive dividend. And importantly, we raised our dividend this year, and we raised it 25% last year. We do expect to deploy some capital for M&A when it meets our strategic criteria. And we've articulated that a number of times, I won't repeat them here. But we also expect to do buybacks over this period of time when we don't have compelling M&A opportunities right in front of us. We are expecting to convert free cash flow on a one-to-one basis. That shows the build of the $3 billion over this period of time and then maintaining leverage adds to that stack, putting $3 billion of capital at work over this 5-year period. And that really has pretty exciting prospects on the earnings per share and free cash flow per share line. And so today, we're targeting $2.1 as the midpoint for 2021 guide and expecting attractive revenue growth, all organic, in the 6% to 9% range, margin improvement over this period of time, generating $4 on a conservative capital allocation basis, $6 on a full deployment basis with a very simple buyback model being assumed there. So I think there's levels of conservatism relative to the leverage ratio itself, and there's levels of conservatism relative to a buyback assumption because, quite frankly, we expect to do some M&A along this period of time, we would expect M&A to produce more accretion than a simple buyback scenario. And next slide. That is it. So Jerry, hopefully, that was a good overview and happy to turn it over to you for our chat.

Terrific. Thanks, Mark, and I hope my video was working when you said pretty faces, it threw for me a loop there. On the $4 to $6 target you laid out for 2025, I would love to dig into the pieces a little bit more. Government solutions, 5 to 8 points of organic growth CAGR is pretty attractive relative to your end markets. Can you just rank order for us the growth outlook by platform? Where are you most optimistic -- between the science and space, I'm assuming is at the top of that list, but maybe I could get you to flesh that out for us.

Well, I think the good news is this, Jerry, big question. Some people have difficulty understanding that, the defense budget that has been approved for this year and what is envisioned in the President's request for next year is relatively flat. And so 5% to 8% in the context of a flat DoD budget is a question mark, but you have to understand that within the Department of Defense, there are faster streams of growth in certain areas and there are areas of contraction in others. In addition to that, even in a flat defense budget, when the demographics of the government workforce are decreasing, they are increasingly outsourcing tasks yet spending the same or even less. And so we very deliberately and strategically repositioned KBR over the last several years to focus on those faster springs of growth. And now we have substantial chunks of our business on defense modernization. So we're helping the Air Force modernize the Army. We're helping missile defense modernize very significantly. That sector is our biggest -- or business unit is the biggest of our government business, and it produced a very attractive 7% organic growth last year, for example, with a great portfolio of IDIQ contracts, very attractive pipeline. The U.S. government and the MoD in the U.K. and in Australia, all are putting more money into modernizing their existing defense platforms because they can't afford to spend a lot of money on brand-new platforms. And that modernization comes in the form of electronic warfare, cyberprotecting the assets, command and control, that sort of thing. Another area that's very attractive within the defense budget is, as Jerry mentioned, space. Space is a domain, is a war-fighting domain. That's what gave rise to the U.S. Space Force. The U.S. Space Force mission is to converge technologies from the military with the intelligence community, with the civil agency like NASA and also with commercial enterprises like SpaceX. And all of those parts have to come together to achieve and retain space superiority against our adversaries. And there is a lot of spending that is happening there that is increasing the addressable market within a flat defense environment in the United States, and we are participating very directly in that convergence as well as high end technologies needed to enable space superiority. This is command and control of satellites. This is understanding weather patterns as space assets can deliver. This is detecting threats to come from adversaries using space assets. We do all of that and many more things. This is an area for superior growth within a defense budget that's relatively flat. And then there's things like trusted microelectronics and cybersecurity that perpetuate everything in the government space. Everything is going digital, and that's a whole another series of threats that has to be protected. We've really built a strong cybersecurity franchise. We briefed this in our investor conference recently. It's growing, starting at about $500 million and growing very attractively every year. A lot of that is built around making sure our space program and our space assets are protected from cybersecurity threats while they're performing their mission. It's a really exciting place to be. Then you have situations where there is growth in defense budgets, like the MoD has announced increases in their defense budgets and Australia, a very aggressive investment plan over the next several years to modernize its military, particularly it's Navy, and we're very involved in that. So we see addressable market growth in every area I've mentioned, even in a flattish defense environment in the United States, but a growing one in the U.K., in the United Kingdom and Australia, we participated significantly there. Much of our 5% to 8% addressable -- sorry, 5% to 8% organic growth target is from those and addressable markets growing in the low to mid- to even upper single digits across those areas, and there are even pockets that are double-digit growth within those areas I mentioned, military space being one of them, in our view. So that's one. And then we have this really special business called readiness and sustainment, which is maybe the oldest part of our government business. And they do very sophisticated logistics planning and supply chain management for the U.S. military, and we also help run installations in the U.S. and abroad for the military, so they can focus on war fighting. And that's the business that has LOGCAP V, for example. And LOGCAP V was a really big one for us about 1.5 years ago. That's provided a lot of stability in our revenue base. But amazingly, we've seen the Middle East part of that come down, and that business unit has cranked out 15% organic growth in Q1 alone by winning other outsourcing work of the U.S. government and also ramping up on the North comp element of LOGCAP IV. So it's a creative team. They focus on faster streams of growth within the defense and government budgets. We're very strategic in picking assets and buying assets that can participate in those faster streams. And that's come through our strong organic growth numbers we've posted in the last several years and certainly, in the example of Q1, the readiness and sustainment business doing the 15%. So how do I rank these? And sorry for the very long answer, Jerry, but it's very hard to say who's going to lead the pack with this group. They're kind of internally competitive, but they're highly collaborative. We have just seen in the past 5 quarters, one beat the other and then another one beats the other one. We've had readiness sustainment outperform in Q1. We had space outperform for the second half of last year and the first half of last year, we had defensive intelligence outperformed. So it's tough to pick your horses here. All of them have very attractive pipelines. All of them have bids in the pipeline that have specific opportunities north of $1 billion. And I think which one captures the greater share of those $1 billion prices will probably be the one that has the best organic growth, but it's very hard to say which one would deliver that. But we'll see. We'll keep you posted. It will probably oscillate from quarter to quarter.

And Mark, in terms of the larger contract opportunities, can you talk about the cadence? When do you expect -- you mentioned a couple of billion-dollar-plus opportunities in the pipeline. When do you expect those to be awarded? And it sounds like based on the end market growth that you highlighted for your specific markets, it doesn't sound like you need a number of these to hit to get to your targets. It sounds like if you get these larger projects, that could potentially be upside to the 5% to 8% organic growth based on what you just laid out. But can I get you to comment on those 3 areas, please?

Fair question. The larger bids in our pipeline are expected for decision, and we always factor in some delay in that decision because that happens in the government procurement circles. And so I would say that we do have a couple that should be decided this year. And then we do have, I'd say, the rest of them are fairly evenly spread over '22, '23 and 24. It's very appropriate in the government arena to be pursuing large opportunities many years in advance because those come to market in a very predictable fashion, in a recompete sense usually, and we are very selective in what we're going to go after. And we start the capture process, in many cases, 3 years in advance or sometimes even more. And it's appropriate to do so to make sure that you put together a strong team with a very compelling fit. By doing that, we have had a really strong win rate. We've talked about our recompete win rate being in excess of 95%, and we've been steady at that performance level for quite some time now. But even in the new win category, we have been well, collectively, above 50% for all activity and the new win is very strong, approaching that 50% number as well. So a great business development team. It's been a constant team over a number of years now. When we buy an acquisition like Centauri, we bring their business development team into our business development team, so they can start working on synergies on day 1. And we've already achieved some for Centauri, TENCAP win, which was $500 million in Q1, was a combined KBR and Centauri effort, where the past performance of both parties was put at play. And I think that increased our Pwin quite a bit and took us over the edge to win that work. So you didn't ask, but M&A has always been part of our strategy. We only pursue M&A when we can generate revenue synergies because the people in the company we acquire when that happens and their career is enhanced, but revenue synergies just add to our past performance portfolio, and that can have a snowball effect for future bids as you go forward. So we're really focused on that. And we deliver very attractive synergies from all the acquisitions we've made, Wyle, Honeywell, SGT and now, Centauri right out of the gate.

And in terms of the dependence of the outlook on any of these chunky wins, can you just comment on that aspect of it based on the end market growth that you outlined, a mid-single-digit for your addressable markets, part of the budget. It does sound like that to get to the low end, you essentially just keep doing what you're doing and win the recompetes. And if you win some of these chunky ones, it sounds like that could get you above the high end of the range, depending on how the pieces fall out. Is that a reasonable way of thinking about it, Mark?

It is. I think, Jerry, I would not say we are dependent on winning the big elephants relative to the $1 billion plus. It's nice to have those to further fuel our growth. But I would say if we can continue to have a strong win rate in the opportunities that are below that threshold, we can very much achieve our performance. But sure, the big ones can help us escalate. And we certainly think we have a fair share on a number of them.

And Mark, can you talk about the M&A pipeline? How does that look today? And are you seeing any increased urgency from sellers because there could be a potential change in tax law?

Not sure I would particularly ascribe the motivations, but I will say on the government side, there are a more than normative number of properties on the market, if you will, right now. We've always taken a look at opportunities that come across the transom, if you will, and spend our fair share evaluating them. And we usually decline to go further, but sometimes, something does hit our strategic criteria and financial criteria, and we proceed, and we think done that very well, but very selectively. So there are a number of them there today. So our M&A folks are fairly busy. We'll see if any of those hit the mark as we get through our work. And good news is we have a strong balance sheet to take action if we find something that is compelling. And it will proceed as all other ones before it. And there's also opportunities on the commercial side and most sustainable technologies. It's an area where it's maybe newer stage technology in this area, but there's a lot going on relative to cleaning solutions, and ours team scouring the earth, looking for ways to improve our portfolio there. And I think the Mura acquisition -- or not acquisition but investment that we made in Q1 was very strategic, something we've been working on for a long time to refine the right play on plastics recycling, and we're quite excited about our relationship with them. So it is on both sides of the aisle relative to government and sustainable tech, but there is quite a bit of activity on the government side for whatever reason right now.

And in terms of the point about revenue synergies, Mark, in terms of any potential government solutions acquisitions, that's a broad opportunity set for you, right, just because the way you get revenue synergies like the TENCAP example where you automatically qualify with a higher score? So is that a fair characterization? You folks have a pretty broad range in terms of applicable markets to look at within government solutions that would check that box for revenue synergies for you?

Yes. I think that's true. I will say that we don't want to put ourselves in a box relative to where we may want to add capability. But I will say that we don't feel we need to acquire anything right now. We have a very well-balanced and high-performing government business. And I think the investment community is really starting to appreciate the quality of that business in the recent months as opposed to its previous perception. So we're very happy with what we have. It's a great, marvelous leadership team that really works well together, and that makes synergies possible when something is added. We have a leadership position in space. It's -- there's always something new happening in space. And if there's more capability we can add there, that would be lovely. Everything in the military and intelligence community is about IT. And IT capabilities are really important to win new work and execute all work. And so any time we can add IT capability, that's of course, of interest. And there's little pockets of that may be synergistic, whether it's areas of cyber, even parts of our international business. There might be opportunities there. We have a nice platform internationally that really no one else has in the government sector. And there are increasing budgets in those markets, as I said earlier. So that could be attractive as well. But I'll say that the supply there tends to be a little thinner relative to targets.

Got it. And in terms of -- you alluded to potential technology being in the mix on the M&A side. Can you talk about what the financial profile would look like of a technology business that fit within yours? Would you folks underwrite a business that's in an investment phase now? Or does it have to be cash flowing today? Just how should we think about the parameters if you do close a deal in that area?

It's important that we do what we say we're going to do. We've always stuck to that, right? So we have long-term targets out there. And everything we do in the tech side or the government side is going to be done to achieve those targets or exceed those targets. So we can't go off course with a very capital intensive, high-risk investment and roll the dice, if you will. We will run a afoul of our objectives there. So in the case of Mura, bite-size, pretty small, less than 10% equity stake, but we get exclusive worldwide rights to a very exciting technology. So fairly low cost, low risk, not much downside, a lot of upside. And so that's entirely consistent with our goals and objectives and the risk appetite. But I will say that the tech side for acquisitions we've made in recent years, Mura aside for a second, they have been pure play tech additions to our portfolio like polycarbonate, for example. Very little amount of capital involved, but an incredibly robust platform on which to add it, both from a technology perspective and just a worldwide sales force that really knows how to kind of operate in that theater. And so we've taken a pretty small investment in polycarbonate, a few million dollars, and we put it to work and generated tens of millions of gross margin and profit by enhancing that technology and putting it into our greater solutions and making it more sustainable. So that's what we'll continue to look for. And if something big comes along, those are pretty rare, but they would also have to meet all the criteria we've talked about.

Got it. And can we transition to sustainable technology? On that note, really robust outlook for your business that you folks laid out at the Analyst Day. I think organically, the math implies something to the tune of $1.2 billion in incremental sustainable technology revenue in '25 versus '20. Can we go through a similar bridge that we spoke about in terms of addressable market growth for government solutions and talk about that here? Do we need to get big chunky wins to get that incremental billion dollar plus in revenue. Just how would you bridge our visibility towards that attractive target?

Yes, Jerry, sure. I'll do my best here. There's a lot going on in that business. Very exciting. So just to refresh memories, if you will, the sustainable technology business has 4 main components, and they are all complementary to each other. So there's a front-end advisory piece that is focused on helping clients understand what is required to go through an energy transition plan from old technology to more sustainable greener solutions, whether that's hydrogen or decarbonization or things like that. So that can be an advisory on how to go from gray to blue ammonia or all the way to ultimately, a green ammonia over a period of time, which is something that is in mind for our consulting projects with Japan and Singapore, for example, which are underway. And then the heritage technology is the process technology business that most people know most about because it was separately reported before, $300 million to $400 million was its historical size. It's been growing with great book-to-bill in trailing quarters. And here, we primarily serve 3 main areas: They're syngas and ammonia, where we have 50% market share; there's olefins, which is the production of industrial-grade plastics; and then there is refining. And though some of those sound old and legacy and dirty, but actually every one of our offerings, whether it's K-COT, whether it's K-SAAT, whether it's K-PRO, offers the client an environmental edge relative to energy efficiency in the process, but also the end products. It offers a safer means of process technology for the employees that work there, and it offers a more energy-efficient process in and of itself. And it offers usually a variety of economic benefits in terms of lowering their cost of ownership, increasing the variety of their outputs and that sort of thing. So that's an exciting area that we have an integration solutions business that helps put in place the technologies that we or, in some cases, others provide into operating plants. And then we have a digitally led offering that helps clients more remotely operate their facilities using digital prowess, if you will. And that improved safety, that improves reliability, that lowers O&M cost, et cetera. So it's a life cycle business on all of those elements. And what we see in the future is ongoing demand for our core offerings in the heritage check piece. So fertilizers will be needed. Ammonia is a requisite there. We see ongoing growth in fertilizer demand, but at a fairly predictable, low single-digit sort of rate. But the exciting part of that business is increased demand for cleaner fuels on the refining side, increased demand for better production of plastics in a more responsible way and to do so in conjunction with Paris accord standards. And then the real exciting one, ammonia, where we see ammonia having potentially explosive demand as it is used increasingly for marine transport for co-firing of coal plants and ultimately, for the production of hydrogen as an energy source using just water and air. So we see the addressable market for our heritage technology business growing minimally double digits, but perhaps well above that if this plays out as we see it. And we see the other elements I mentioned as complementing that. So customers will need more advice on how to engage in a modernization plan to achieve better sustainable results in their operations on the commercial side, we also now see that on the government side. And we see just a compelling need to run their operations more digitally than what they've done in the past. We expect double-digit growth for the advisory business, for the heritage tech business and for the tech-led industrial solutions part, because those offerings are so compelling. And the mandates are there, both socially and government-wise when we think about things like Paris accord or IMO regulations in the case of fuels. So we have that really nice forcing function of regulation on one side, but the social pressure for cleaner solutions, I think, will be a major driver for double-digit growth in that business for the next 5-year horizon, which is what we've guided. But what's interesting about this is the potentially explosive growth, particularly as it pertains to ammonia to go well, would be well beyond the 5-year period and continue to sustain this business for a very long period of time in terms of growth.

That's terrific. And Mark, to your point, on the bookings pace for the legacy heritage business, you folks have been running 1.5 book-to-bill for a couple of quarters now. Can you talk about the cadence of awards? Is that level of backlog growth sustainable based on what you see in front of you over the next couple of quarters?

We do. We see the mega trends driving increased demand, as I probably said moments ago. That team has been on a great track record, 1.5 on top of greater than 2 for Q4 was marvelous to see in Q1. Even last year, COVID was tough to start the year, but we came back very strong in Q2 and 3 and 4 with strong bookings in that environment. So it was really impressive and telling of the end market dynamics here. Any one quarter can be high or low, and so we're not going to overly focus on that. But we see substantially north of 1.0 book-to-bill rates as far as the eye can see, because of the demand for the process technologies we have and the benefits they give to their customers. And so we expect that. We also expect that on our advisory and our TLIS business over time as well. Even though those are earlier start businesses, they're really showing good initial results.

How far can I see? What's the pipeline visibility? How far does that extend?

Well, because the transition to sustainable technologies is so important for the entire industrial base, not to mention the government side, this is why we provided five year targets, and not a lot of people are doing that. But we see continued increased demand of the addressable market, the need for capital projects to go through that transition, the need for smarter OpEx. You're spending more on capital, you want to spend less on OpEx. And the way to do that is with digital solutions. And so we see a greater than 1.0 book-to-bill over a given multiple quarter period, every year in our five-year target. And we need to do that to hit our double-digit growth. So we're quite bullish that the team can do that. We're quite bullish if the end markets are there.

And in terms of just pulling the pieces together, you folks are targeting high teens margins for sustainable technology in 2025. You're at 11% margins in the base period. So essentially, we would need the heritage technology business to quadruple over that time frame, is what I think the math is. And so is that the way to think about it? And we're on our way north of 1.5 book-to-bill so essentially, we're operating ahead of plan based on where bookings are attracting now, but that's the magnitude of growth that we're thinking about directionally. Is that right, Mark?

The way I like to think about it is we're on plan. We achieved a lot of progress last year in derisking and simplifying our sustainable tech business to those 4 areas I mentioned before. We took a lot of cost out last year. That was a really important thing to do. And we've come out of the game with really, really good bookings for the whole segment, if you will. We guided -- we guide on an annual basis, not on a quarterly basis. And so we have guided mid-teen margins for this fiscal year. Some quarters will -- Q1 was ahead of that, and we were pretty careful to say, there was reasons for that. But we're comfortable in that number for the year, and we're very comfortable that as we grow organically over a period of time, double digits, 10% to 12%, there will be a very direct economy of scale relative to the cost structure of that business, pure commercial, pure fixed price. And so margins will improve just from growth. And there's an opportunity to improve the mix relative to licensing as we see K-COT getting more penetration, K-GreeN probably further out in time, but K-PRO certainly had some nice recent activity, K-SAAT has been gaining steam. And so those proprietary technologies come at very attractive margins when we sell a license and we always sell a license when the clients use those. So there's opportunity there for improved mix over time. Every once in a while, as you might recall, we get a pretty large proprietary equipment order to help our clients install the technology that we own. That can move the needle on revenue. It can depress margins a little bit, but it's still attractive. And so there'll be some little volatility when that happens, and that's all a good thing. But think about on the annual terms, starting off mid-single digits and just creeping our way up 1% to 2% per year as we deliver those economies of scale.

Perfect. Well, with that, that's all the time we have. Mark, Alison, thank you so much for telecommuting and joining our virtual conference. Nice to see you, and thank you, everyone, for tuning in.

Thank you for your interest, Jerry. Thanks once again for hosting. We appreciate it.

Thanks, Jerry.