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

Good morning, everyone, and thank you for joining us at Stifel's Annual Cross Sector Insights Conference Day 2. I think we've had a lot of good conversations so far, but I'm excited about this one. KBR, I think, has one of the best stories here across both the Government Services business, which is benefiting from defense spending growth. And then there's sustainable technology business, which is benefiting from a variety of tailwinds. So we have, on my right over here, Mark Sopp, CFO; right here, Byron Bright, Head of Government -- sorry, Government Solutions. Sorry, everyone's got a different name for their segment. So with that, I think I'll just kick it over to Mark, if you want to give a quick overview of KBR, and then we can go to some questions after that.

Okay. And Byron and I are going to tag team it, but I'll just introduce it real quickly, but first, Bert, thank you and Stifel for having us here. We're proud to be here, and thank you all for your interest in KBR. We're having fun with KBR these days. Just as a refresher, we're a Fortune 500 company. We have about 30,000 employees. We would do revenues between $6 billion and $7 billion per year, and we provide scientific, technical and engineering solutions to government customers that Byron will talk about, but also many companies in the commercial sector, and we are very global in this respect. That is a differentiator that you'll hear more about. Our government business is the largest of the two. It does have some very unique elements to it that Byron will talk about. We've built it up very successfully over the past several years. I'm really proud of it, and it is a top performing asset in the sector in our view. And then secondly, we have a Sustainable Technologies business, which we're working very hard for people to understand, but it is a true gem. It has intellectual property that at its core that helps our clients either make more money or produce better products or produce in a safer environment and also produce cleaner outputs that are good for the economy. And we think that's a compelling set of offerings to have, not only commercially in the world we live in, but our government customers do need to deal with that as well. And we think it's important that we have this in our portfolio for that reason. So I'll turn it over to Byron.

Yes. I don't have a lot to add. I think, like you said, we're having a lot of fun. The company has been doing really, really well. I'll hit on the government a little bit just to give you some flavor of the types of work we do there. I mean we do things that are really -- that really matter, very operationally focused. So we're right there with our customer in all kind of major world events or major programs we support around the world, as Mark said, international governments, such as the U.K. and Australia. Obviously, with events overseas, that's become a heightened kind of focus for investment internationally. In the U.S., we're really in those marquee areas. We are a top-tier support contractor for NASA. Pretty much anything you see they're doing, we're probably involved in some way. We train astronauts. We work with commercial space companies as they begin their journey. We're flying satellites that are looking at climate change around the world. So we're very active in all elements of those things that really, really matter. On the Defense & Intel side, we're working across just a spectrum of programs and technologies, really focused around helping the customers use this technology in a way that makes the mission better, that makes them -- help them make decisions faster. So I'll save some time for you to ask the questions, but a really, really great diverse portfolio, and it's really embedded around our people. We just have an amazing group of people that really care about what they do.

So I don't typically start these conversations with mention of guidance, but you guys have put out there [ 4 75 ] by '25, which for people's reference, the company is guiding to the mid-2s for this year, so that's pretty substantial growth. Can you just talk about, one, why you feel confident in those targets, maybe Mark? And two, you've mentioned you have more than 70% of the revenue booked to get to those levels. Is that something that gives you this confidence? And sort of where do you need to go from here in order to keep building toward that?

Great question. That is correct, that is the guide. We have had long-term guidance out there for some time, and we've kept pace with it. In fact, we've bumped it up. So we have some credibility relative to this topic. We have a book of business that is highly visible, particularly in our government business. And within that, we have some very long-term contracts that drive meaningful economics that is pretty unique in our sector, and I would credit our international piece for a chunk of that, but also domestic programs have some duration as well. And we're in a good part of the cycle, not a lot of recompetes last year or this year, even next year relatively light. So the book of business is indeed actually over 70% of all the revenue we need to meet those targets is in-house today. And so it gives us a lot of time and a lot of capital to focus on growth. So that's one element. I would also say, our end markets are really in great shape right now. So on the government side, unfortunately, there's this conflict happening, but we are well positioned to provide for our customers in this environment and enhance national security on a global scale, which is important. And so that is part of the equation. Our commercial business has a number of beneficial elements in the addressable market right now. So they're first started with the social mandate and in some cases, legislative mandate to operate in a greener way across the entire industrial sector, and we provide very unique, very compelling capabilities there. Now you have higher oil prices, which is putting more capital into the equation in that market and that helps drive greater capacity for capital projects that also still have that same mandate. And then we have the disruption that is happening with the global supply chain with Russia and Ukraine, where what used to be produced in those areas relative to petrochemicals, refining, ammonia, things like that, need to now be produced elsewhere, and we are seeing enhanced demand there. And not only that more traditional things like LNG have been displaced and we have offerings in this regard as well. Low risk offerings, combination of IP, combination of services, and so these end market conditions have only improved since we issued those targets, and the book of business has only improved since we've issued those targets relative to backlog. And so for those reasons, we're quite confident in that outlook.

I said I'd stay away from crack spreads, but we'll save that for another conversation. If we think about that other 25% to 30% of revenue you've yet to book, can you help us put that in context of how big your pipeline is, and how much work you think you would need to win to get there?

Yes. I mean, as Mark said, I mean, both end markets, whether the commercial end markets or our defense end markets are really, really strong. So we carry a pipeline that's on the order of $100 billion of opportunities over several years, and so it is a very active pipeline. We've got a number of bids on the order of $8 billion that are waiting to be awarded right now, sitting on our customers' desk. So I think there's -- we have plenty in the pipeline to feed that -- to cover that. We go into -- in my government business, in particular, we go into any given year with about 80% under contract for that year. So that's a very normative kind of level for us, and so we feel, like you said, to have it all the way out as we are today at about 70% for outdoor long-term targets is quite robust and healthy, and we feel very confident that our pipeline meets that.

So not to take a bearish view here, but if you don't hit those targets, I think there's certainly people who think you will not, why would that be the case? I mean, I think the story you've told has been great. You've got a lot of the revenue in-house. You've been doing all the right things and growing, but if you were to miss those targets, given they're pretty lofty, why do you think it would be?

I don't think we'll miss them. I think we're going to hit on. Obviously, there are macro events in the world, right? There's macro economy or some geopolitical event or things like that, that could be a big shift. But I think the thing about our business is exciting is this diversity and breadth. I mean we are in the international markets. We're in the U.S. markets. We're in the energy transition area. So we're in -- it's such a diversified portfolio that we really don't have concentration risk. The size of our individual programs are not so huge that any small misstep is going to really impact our strategic story. So we believe in our strategic story. We believe in our [ MAXs ]. We bet on ourselves all the time, and I think we put those out because we do what we say we're going to do.

So Byron, you guys won a massive contract, HomeSafe, which is -- for those that don't know, it's $20 billion over 9.5 years. So it's going to become a substantial part of your business. There's been some hurdles as there are typically with large contracts like that. Can you just give us an overview of where things stand now? And sort of how you expect that to start to materialize into your numbers?

Sure. And real quick for those that don't know, this was a very large kind of outsourcing initiative, really transformational initiative for the U.S. government and how they move military families and civilian families around the world. And so our role in that is really as that change agent, and we're in there to infuse technology to make the experience better. So I mean it's -- we're not going to own trucks. We're not going to own warehouses. This is a low-capital business, but we will be the single move manager that really coordinates the entire process end-to-end for the entire military, which does on the order of 300,000 individual moves a year. So it's massive. It's global. And really, our strength is, one, understanding that end user, the needs of the war fighter, understanding global logistics and supply chains, but really adding our technology focus. So developing an application -- a front-end application that the end user can use that's secure in cloud-based and mobile, but really the exciting part to me is behind the scenes where you're really doing that, adding some of that optimization in AI into how you manage the supply chain. So a really exciting project. To answer your question on the ramp, it's in protest right now. We expect that to be adjudicated in October. So we're very bullish on that outcome. And then there's a pretty long ramp-up period, about 9 months where we're really working on that technology development and deployment. And then there's a nice ramp-up of when you start to take on various moves and really transform the supply chain and all of the vendors throughout the supply chain. We think this is going to be a great impact for small businesses. That's a big focus of the government is to really take out some of the middleman and make the -- and use small businesses in a better way and improve the experience for the war fighter. So -- but that should ramp over a couple of year period to get to a run rate on the order of $2 billion a year. So it's a very substantial revenue, really exciting time, and we're bullish on it.

But you would expect that once we get into 2023, all things equal, that will start to sort of become hundreds of millions of dollars of revenue.

Yes. I would say, late '23, you'll start to see some coming in pretty late. It depends on when the protest resolved. So it could be very late '23 and really ramping through '24 and get to full run rates in '25.

Okay. So there's -- there no real outcome where that starts to hit the P&L in 2022?

Not in a significant way.

Okay. You mentioned earlier, global business. That's unique for this space, typically government services, very focused on the U.S. government customer. Can you talk a little bit about your U.K. and Australian franchises? And what you think those bring to KBR as a whole both in terms of providing revenue growth opportunities, but the margins there tend to be higher as well. Why is that? And how can you take advantage of that?

We've got a really exciting business both in the U.K. and Australia, and it's a different business model. It's much more commercial over there. The U.S. is so large and so regulated. So I think the nature of the way they go to contracts in the book of that business, and we have a lot of, what you might call, public private partnership type deals that some go out to -- the longest one goes up like 2041. So really long-term contracts that drive really good underlying margins. So that's the reason that's different. But what excites me is -- and I think, unfortunately, the events of Ukraine and Russia has really changed the focus of international governments, and they now realize that they have to invest more in their own sovereign capabilities. So in the U.K., we're perceived, and we are a U.K. company that's been there for decades and so they really trust us. And you've seen our investments in companies like Harmonic and Frazer-Nash and that is to transition that portfolio into those higher-end advisory services, whether that's cyber, space, intelligence, data. The same needs the U.S. government has and has been investing in so do the international governments. One of the unique things that I'm excited about is August. That is where the Australians have made a decision to go with a nuclear submarine and that's going to be a kind of a trilateral, if you will, a partnership between the U.K., Australia and the U.S. And I think of all the companies, we're poised to support that and that's a long-term game. It's going to be a decades-long efforts, but we are well regarded down in Australia in particular and have some -- already some leads that are helping the government think through what that means. So I'm very bullish on all of that.

So while this is not an international government part of your business, you guys did win a position on LOGCAP V, which for those that don't know, this $83 billion contract that encompasses sort of all of the different regions of the world. You guys won European Command. I think initially that didn't look as good as it does now just in terms of there being so much more OPTEMPO in that region. Can you talk about how sizable that is within your business today? Where do you think it could go? And how you expect some of those task orders to perhaps hold that unfold?

Yes. And we actually won 3 regions. We won North America. So North America, Europe and Afghanistan. Obviously, there's no work in Afghanistan today, but in Europe, we have a steady state business in there we have had for years where we support some sustainment and training and exercises. And that's a nice, solid, sustaining year-over-year piece of the portfolio. Obviously, with the events in Eastern Europe, we're very active. I think we've announced about $100 million of kind of added revenue due to that specific effort. As Mark said, it's -- we're not happy about those kind of efforts. We must rather be doing training and support than the kind of activities we're doing now. But our people really care and that they're making a difference. We're in about 13 different countries, supporting lots of different activities around the region. So I think you're going to see that. Who knows how these kind of events play out, but there will be kind of increased level of activity definitely through the end of this year. And then as you go into next year, regardless of kind of what happens there, I think the world's changed, and there's going to be continued investments in technology across Eastern Europe. There's going to be more interoperability between our allies in the U.S. I think our systems engineering, our integration kind of credentials on all of whether you're talking about command and control systems, secure communications, I mean that activity is just going to increase with our allies. And so very excited about what that can mean for the longer term, but we're well poised to help our customer in those end markets.

You guys have, at least in your Government Services business, pretty well diversified segments. You've got Defense & Intel space side of things, the readiness, sustainment, the international piece. They're all sort of similar. Space is probably the biggest. How should we think about each piece? They're all just exposed to positive demand tailwinds and you would expect the sort of each grow in a healthy way from sort of here forward?

Yes. I mean every business ebbs and flows as you go through that. I think all of the businesses have been growing organically over the last couple of years. Just depending on which contracts are coming up and down, you can see some minor movement. Our Science & Space segment, I think, was a little lighter maybe in Q1, but if you looked at Q4 to Q1, it was actually some good growth there. I think we've got some good opportunities in science space. We're looking at the future of commercial space suits. We're partnered with several companies looking at what that next generation of space suit looks like from a development side, but also from a long-term sustainment side, we're supporting a lot of different missions. We announced in the end of Q1 there beginning of Q2 that we had won our largest recompete of the year at Goddard Space Flight Center, which is where we fly all of the Earth observation satellites. So it's about a $650 million contract over about 5 years. So a very large contract that we've been on for a long time and really provide really critical deep support to satellite operations for NASA. So again, all the businesses have different dynamics in them, but I think they're all very similar in that they focus on that end user, and we've got pretty good tailwinds in that operational focus and investments in modernization and science space.

Thinking about that actually hitting the P&L, one thing that we've noticed with Government Services in the first 6 fiscal months of the year, first 7 as well, the outlays are as low as they've been as a percent of the budget since 2003. So 20-year lows we're dealing with now, despite everything we're talking about. Appropriations, more need, obviously, more geopolitical risk. Nonetheless, outlays are low. What is your expectation for the rest of this fiscal year? Do we get to a position where there's just a ton of money that materializes because it has to be spent? Or do you think money gets left on the table?

Unfortunately, they were so late this year, right? It was March when they finally got through the continuing resolution. We are seeing an uptick right now as their contracting officers are trying to get that money put on contract. So I do expect to see kind of Q2, Q3 start to movement on awards and those kind of things. We're already seeing a lot of activity, the discussions, and questions and things going on in final negotiations. So I'm positive they're going to get a lot of it out. So I'm hopeful we'll get some on-contract growth and other things kind of at the very end of Q3 as they go into 1 October, but I do think they'll leave some money on the table. I just think they're too late and too -- it's hard for them to get that much money out, but I think right now, we're seeing a lot of activity in the summer.

So Mark, maybe pivoting to you. Earlier, you mentioned largest part of your business is Government Solutions. Can you give us a little bit of a history and how things evolved into -- how we got where we are now? And then maybe some thoughts on the Sustainable Tech side of things because at least when I look at that piece of the portfolio, that's probably the one that's changed the most since you guys had your Investor Day in terms of demand catalyst. So how should we think about that evolving next year and then into your '25 goals?

Not sure I get the question, Bert. Do you want me to walk through the transformation? Or do you really want me to focus on the...

Really the transformation of the business because I think it's sort of instructive because business has changed so much in recent years to get to where you are today. Today, you're about 80% Government Solutions, but that's obviously very different than where you were, and perhaps, it will be different than where you're going if Sustainable Technology grows a lot faster.

We shall see. But yes, I think it was more than flip-flopped about 5, 6 years ago in terms of those numbers. So we were more like 80-20 commercial to government. Maybe even more so. And so dramatic and very deliberate transformation took place. We had a conviction that we had a long-term presence in government, but we were single-threaded in readiness and sustainment. And particularly, overseas contingency operations and so that had some high times and some low times and is volatile, and we don't like volatility, know to you. And so we had a deliberate path to acquire diversification Wyle, Honeywell, SGT and on, to build a robust portfolio that Byron really runs really well. And it has access to R&D budgets and O&M budgets and even procurement. And so -- and it's global, it's domestic, it's international. You've heard him say the value proposition there, and it's a $5 billion-plus business. It was $500 million -- sorry, $500 million, yes, $500 million about 2015. So I'll give you a size for that. And so we're really proud of it, and it does what we wanted it to do, deliver at scale mission-critical solutions to our customers that would inspire our people and deliver stable earnings and cash flow -- free cash flow that we could then use to invest in other things. So that's the big change there, and we wish to add more capability in that area, but very selectively and very disciplined going forward. I think we've demonstrated that. On the commercial side, we were very involved in very mega scale energy projects for a long time in the history of KBR, and those 2 brought a lot of volatility and that was not our strategic intent starting in 2014, 2015. So we want a very deliberate path to derisk that business. Over time, maybe the most significant singular move was the decision to no longer pursue lump sum EPC contracts ever again in early 2020. And at that moment in time, we didn't have any in-house either, and so there are none. There were none in the portfolio at that time. We had a little bit of legacy legal work to clean up, and we really embarked on a situation where today, you have a core intellectual property offering that has over 70 proprietary intellectual property assets that span refining process technology, petrochemical technology, synthetic gas technology and more recently, plastics recycling technology with 4 value propositions, help our clients make more money, help them operate safer, help them use less energy, help them clean up the environment. And with that, we have put a front end wrapper of advisory services on the front end to steer clients to the proper technology to solve their problem and a back-end integration of those technologies into their plants and to digitally operate remotely and more efficiently those plants with modern technology. And so it's a turnkey set of solutions. We can turn some, turn off as clients need change. And of course, there's this massive global environment today where customers, not only commercial side, but the government side, really need those types of solutions to meet the demands of society as well as the demands of our shareholders, and we deliver that very well.

So on the ammonia side of that portfolio, that's a place where you guys have been a player a long time. You have significant market share. I think it's over 50% in the production of that or the technologies that's leading to the production of that. Can you talk about -- I think that's a big part of what we're talking about here in terms of STS being better positioned today than it was a year ago. It's just the end markets that are using those products have improved. How do you think about sort of the opportunity set for STS, maybe not this year, but next year as some of this money starts getting spent on improving these projects.

Well, I think ammonia itself is one of our offerings, but it is a major market share presence for KBR and has been for a very long time, but we've continued to enhance the underlying technology to meet today's needs and tomorrow's needs. What's interesting about ammonia is, it has always been tied to fertilizer production, which is a pretty stable, but low growth profile kind of tied to population growth. But more recently, it has been realized by us and others that ammonia can be a very significant enabler for a greener future in terms of powering the world. And what I mean by that is, ammonia can be used to co-fire in coal plants to reduce their NOx emissions. Ammonia can be a fuel to move vessels around the world in the marine environment. Ships are now -- there are some ships going into production that will be fired by ammonia-powered sources. And longer term, when we overtime figure out a way to produce hydrogen more economically through technology, the safest way to move hydrogen around is to have it converted to ammonia, transport it and then convert it into hydrogen where it is needed. And we think that all of those things working together will improve or enhance -- not enhance, but transform in a very major way the amount of production of ammonia that is needed in this world by many fold potentially. And with a 50% addressable market, that's a great place to be. And some of that is nearer term, like the coal co-firing. Some of that's more medium term, like the marine transport and some of that is longer, term like the hydrogen transportation medium. And so that gives this business incredible and sustaining growth opportunity for many, many years to come. So really excited about that.

I think the thing that doesn't -- I think there's at least a decent knowledge about your ammonia opportunity, which is, like you said, very strong. Maybe less people less familiar with the recycling opportunity. And you just did -- you put an investment into Mura Technologies. Can you talk about why that's going to be an important part of sustainable tech as well?

Yes. This is really exciting, and there's a lot to do to explain it properly, but I'll leave you with a few points here. So Mura, in many ways with this $100 million investment is a bet on ourselves because over the last roughly 2 years, we've been working very directly with the Mura team to codevelop their technology and to productize it so that it can be commercially successful. And we all know the world could benefit from commercial success in plastic recycling. That's good for everybody, but it's also particularly good for our current customers. Our current customers make plastics, they produce plastics, and they want nothing more than to use recycled feedstock instead of feedstock out of the earth. And this technology delivers that, and we believe it is the vastly superior technology. It is not paralysis based, it is super critical water based. It's safer. It's cleaner. It's more efficient, and it's protected. Mura is the only one that we know of that has this capability. And so we can help the world by significantly enhancing the range of plastics that can be recycled. We can help our customers make that transition to not using feedstock out of the earth, but in a circular way, they can do so in a very energy-efficient way. And finally, there's a financial proposition to all of this, right? So we make acquisitions all the time. In this particular case, there are three value propositions financially for KBR as we help Mura be successful and our clients successful. Mura has a project build component, so they will build their own plants and sell feedstock to producers, but they will also, together with us, license that technology to those that can build their own facilities at the front end of their plants. There is an earnings stream that we can get from helping them bring those projects to life in a low-risk way like we do all day every day in our STS business. So there will be some near-term accretion from that work alone, which you would expect from making an investment. As Mura becomes profitable, having an equity interest will bring in equity and earnings into the P&L at some point in time. And then finally, there is a monetization option here because certainly, it would be the intent of Mura at some point to IPO or otherwise monetize. And we would have, at this point, 18% ownership. And so we think that's a triple whammy of economic benefits, but as important as that is, we really like the societal benefit and the client benefit as well.

So as we get closer to sort of the end of our discussion, I think it's important to think a little bit more near term. I think you have guidance out there for getting to around [ 2 60 ] or so in earnings this year. For the listeners here, what helps you either get to the high end or beat that guidance? And in the off chance you're looking -- you end up on the low end of that, why do you think that would have been?

Well, I'd say, our government business is very predictable and has a lot of backlog and things move slower on the government side, and there's good and bad with that, right? And so I think there's not a lot of volatility we would expect on the government side for half a year left, and I think your other clients would probably say the same thing. But I do think on the commercial side, the cycles are shorter. The world is changing very fast, and so there are opportunities in all the things we've already talked about that could yield some upside, but things can also slow down there, too. So that's the one that tends to lag around a little bit.

And then, Mark, on the inorganic side of things, we haven't really covered that. How do you think about that? Can you explain what's included in the '25 targets in terms of your assumptions for leverage? And how do you think about inorganic from here? I assume that's primarily on the Government Solutions side, but are there particular areas you guys would be interested in?

So we said that in the long-term plan through '25, we expect to generate about $3.5 billion of deployable capital. That's a lot of money. That was before the Ichthys settlement, so that goose that up by [ 250 ] roughly. And so we have -- and we have a very healthy balance sheet to start, and arguably, we're underlevered today at 2.3x coming out of our last quarter. So we think in the business we have, which is stable, predictable earnings and cash flow and low risk as we've derisked, we could afford meaningfully more leverage. $3 billion is very doable, $3.5 billion is very doable for this business, but we do tend to be conservative, so that's probably the right zone. And so that $3.5 billion assumes a 3.0 leverage level. So there is some possible upside there. In terms of what we plan to do with it, we have a very attractive dividend right now. We've increased it 3 years in a row. That's one thing. Secondly, we actually believe with the story you've heard here today that there is multiple upside in our story and meaningfully so, and therefore, buybacks have been and remain attractive at this level. But we do have a bias to add capability, as I said earlier, and so M&A is something we spent a lot of time on. We're very selective. We're very disciplined. We know what our multiple is and we know where we can buy, and that does play into the equation. But culture, synergies, helping our clients is a big part of that equation as well. So there is a very tangible monetary measure, and there's a qualitative measure, and we balance those very carefully.

So we're about a minute over. I appreciate that. I do want to get my last question in which I'm asking all the management team. So Byron, what is your expectation for the duration of a CR? And are you taking the over or the under on 6% defense spending growth?

It's 100%, there'll be a CR, I think. And duration wise, I think it will probably go to January, I'll pick a month. And definitely, after the midterms, I believe, and I'll take the over. I'm going to then I'll take the over.

Okay. Great. Well, Byron, Mark, thanks so much for your time. Thank you, KBR.

Thank you.