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Edited Transcript of KBR earnings conference call or presentation 31-Jul-19 12:30pm GMT

Q2 2019 KBR Inc Earnings Call

HOUSTON Aug 9, 2019 (Thomson StreetEvents) -- Edited Transcript of KBR Inc earnings conference call or presentation Wednesday, July 31, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alison Vasquez

KBR, Inc. - VP of IR

* Mark W. Sopp

KBR, Inc. - Executive VP & CFO

* Stuart J. B. Bradie

KBR, Inc. - CEO, President & Director

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Conference Call Participants

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* Alexander Daniel Hamid Khan

Crédit Suisse AG, Research Division - Research Analyst

* Brent Edward Thielman

D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst

* George Stephen Kasiaras

Deutsche Bank AG, Research Division - Research Associate

* Jeffrey Joseph Molinari

Cowen and Company, LLC, Research Division - Research Associate

* Jerry David Revich

Goldman Sachs Group Inc., Research Division - VP

* Michael Stephan Dudas

Vertical Research Partners, LLC - Partner

* Piyush Avasthy

Citigroup Inc, Research Division - Senior Associate

* Tahira Afzal

KeyBanc Capital Markets Inc., Research Division - MD, Associate Director of Equity Research, and Equity Research Analyst

* Tobey O'Brien Sommer

SunTrust Robinson Humphrey, Inc., Research Division - MD

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Presentation

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Operator [1]

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Good day, and welcome to KBR Inc. Second Quarter 2019 Earnings Conference Call. This call is being recorded. (Operator Instructions).

For opening remarks and introductions, I would like to turn the call over to Alison Vasquez. Please go ahead.

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Alison Vasquez, KBR, Inc. - VP of IR [2]

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Good morning, and thank you for attending KBR Second Quarter 2019 Earnings Call. Joining us today are Stuart Bradie, President and Chief Executive Officer; and Mark Sopp, Executive Vice President and Chief Financial Officer. Stuart and Mark will discuss highlights from the quarter, our market outlook and financial results. After these remarks, we will open the call for questions. Today's earnings presentation is available on the Investor Section of our website at kbr.com.

I would like to remind the audience that this discussion may include forward-looking statements reflecting KBR's views about future events and their potential impact on performance as outlined on Slide 2. These matters involve risks and uncertainties that could impact operations and financial results and cause our actual results to differ significantly from our forward-looking statements. These risks are discussed in our most recent 10-K available on our website.

I will now turn the call over to Stuart.

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Stuart J. B. Bradie, KBR, Inc. - CEO, President & Director [3]

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Thanks, Allison. Good morning, and thank you, for joining us and for your interest in KBR. I'd like to start as usual on Slide 4, excellence in health, safety, security and, of course, the environment. It takes every person, all 38,000 at KBR, to be aligned and fully committed to achieving Zero Harm to deliver the performance you see on the graph. We've had a great first half and a great start to 2019. And since inception of Zero Harm and Courage to Care program and belief has become a cornerstone of our culture and values. The results speak for themselves, and I wish to thank all of KBR for their unwavering passion. As a people company, this is essential.

On to Slide 5. At our Investor Day in May, we presented new KBR as a growth and a value story. After a strong Q1, our performance in Q2 and collectively for the first half of 2019 supports the story. A 12% growth in revenue year-on-year delivered 16% growth in EBITDA. Margin performance was thus very pleasing and, of course, in line with our long-term targets. If I continued leading organic growth in Government Solutions and in Technology. And on cash, positive cash performance has been delivered and a cash conversion year-to-date of 92% is also very pleasing, more from Mark on this later.

This is the 10th consecutive quarter performing at or above expectation. The quality of earnings and our backlog and our delivery focus has and continues to deliver growth that is both more predictable and sustainable. Our overall book-to-bill for the quarter was 1.5. The pushing momentum in Energy Solutions from Q1 has continued into Q2 and with the recently announced Methanex FID, will continue in Q3. Note, all major awards are for reimbursable services. Our book-to-bill in Government Solution was 1.4, and this does not include LOGCAP V, which, as you know, is under protest with the protest period expiring in early to mid-August.

As you can see, overall backlog is up and momentum continues. I will give more color on our pipeline in a moment, but let's briefly touch on our market outlook on to Slide 6. First Government Solutions. The big news is, of course, the bipartisan support for the U.S. defense budgets for 2020 and 2021. But there's still a lot that needs to happen to pass the budget this fall we're reassured by this progress. A 2-year defense budget would allow DoD to continue its focus on military strength and modernization. These are areas where KBR is well positioned to provide mission-critical, full life cycle services enabled by our very, very deep domain expertise. Our international GS business continues to be very well positioned. We've taken market share with our recent Sellafield and U.K., Middle East wins, and our Australian business has experienced significant growth. Both are delivering outstanding results and strong margins and it's a business as you well know that is underpinned by unique, long term, enduring relationships and contracts.

In Technology, our pipeline of opportunities is very exciting. Recent stabilization and long-term ammonia prices is fueling renewed interest in both green and brownfield CapEx investment. We're also seeing increased demand for our disruptive technology K-SAAT that delivers a safe and cost-effective alkylation solution. We just sold another K-SAAT license in the U.S. and note that we own the proprietary catalyst for K-SAAT and thus the opportunity for ongoing revenue is clear.

In our energy markets, the downstream sector in the U.S. and the Middle East continue to provide excellent opportunities that fit our risk appetite. Our pipeline of opportunities is very healthy. Our global customers are accelerating investment in the U.S. and our focus on execution and innovation is opening doors to repeat business, both domestically and across geographical boundaries.

The LNG market for KBR is very, very attractive going forward. Robust project opportunities with the changing competitive dynamic have got us all excited about the future. I'm sure there will be a few questions about LNG in the Q&A.

So our backlog is up with a demonstrated quality of associated earnings and our market outlook across all of our segments remains positive and with less uncertainty. So this takes us nicely on to Slide 7 to quickly talk about continued growth. You can see the pipeline numbers for yourself, dining times with a total pipeline of $180 billion with $46 billion near term. Pleasingly, we don't have all our eggs in one basket with over 180 pursuits over $100 million, which really mitigates any concentration risk. Looking to the graph on the right, at our Investor Day, we presented revenue growth targets of 10% to 14% for overall KBR. This was supported by work under contract, recompetes, et cetera, of approximately about 60% to deliver those targets through 2022.

It's just a couple of months since our Investor Day, but I'm pleased to report this number has now grown to 63% driven primarily by a new NASA win. But Freeport LNG achieves FID, you can see there on the graph. This will bump up another 10%. We'll update this slide periodically. With the quality of earnings and the cash generative attributes of our backlog, I believe it should give investors confidence and support KBR's growth and value future.

I will now hand over to Mark, who will give you more detail on the financials and the segment.

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Mark W. Sopp, KBR, Inc. - Executive VP & CFO [4]

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Great, Stuart. Thanks. I'll take it up on Slide 9. Although I would like to point out the image on the previous cover slide, this shows the heavy equipment transporting order vehicles that we have successfully managed under our PFI contract for the United Kingdom Ministry of Defense over the past 16 years. We maintain and provision these vehicles around the world to meet U.K. and allied military needs, and our team has won a number of awards in doing so, including the best MoD PFI project and also number of safety awards along the way, so really cool stuff.

Now onto the results on Slide 9. Our results were strong across the Board and consistent with our expectations at this point in the year. A couple of highlights worth pointing out here. First, the ongoing strength and organic revenue growth with the consolidated business at $5.7 billion run rate, which is starting to provide the scale benefits that we envisioned in our long-term strategy. There's some distortion in the gross profit and operating income comparisons, as last year we had a favorable project completion gain on an LNG project which disproportionately benefited these lines in Q2 of 2018. This was largely offset by a $16 million expense for noncontrolling interest representing our JV partner share of that benefit which you can see towards the bottom of this table. When you adjust for this, the gross and operating margin profiles are essentially flat year-over-year, we've added tables in the appendix showing this effect and also segment EBITDA by quarter as many have requested.

Equity in earnings was stronger in Q2 this year and a little above normative with a favorable lump-sum project close out, but also on consistently good results out of our Brown & Root Industrial Services joint venture. SG&A was up a little more than norm driven by cost to launch our new brand and our new website, also some continued ERP implementation costs in our GS business and also some tax planning costs. Normal level is about $85 million per quarter.

Adjusted EPS was up nicely at 17% year-over-year, predominantly on the continued strong revenue growth and also strong margins particularly in Government Services. Operating cash flow for Q2 was $33 million and amounts to $81 million on a year-to-date basis, well ahead of last year at a year-to-date cash conversion ratio of 0.92. We got a system conversion on April 1, which went well overall, but did nudge up our DSO a little bit. This gives us opportunity for even better cash conversion in the second half.

Moving on Slide 10. Looking at the segment trends. You can see the GS business is now on a $4 billion revenue run rate, still producing double-digit organic growth for the sixth straight quarter. GS organic growth was 16% in Q2. 9%, excluding our base restoration work at Tyndall Air Force Base. This remains best-in-class organic growth in the GS space. Profit margins have consistently been in the high single digits. In Q2, we were little above that with a gain on the sale of a small contract in the U.K. and also definitization of fees on the work we've been doing at Tyndall.

Those are being contributed from logistics and base operations support, systems engineering and integration and space and human performance, including our human health and performance, POTFF contract ramp up, which is going really well. Technology Services also continues to produce excellent growth, while mix was a little equipment heavy in Q2, which brought in margin at 21%. No change to our overall outlook for margins in the mid-20% range for this segment.

Our Energy Solutions conditions keep improving. While still down modestly year-over-year, this is the second straight quarter of sequential growth that continued to close out projects favorably and overhead utilization is up as well driving good profitability. As we discussed in our recent Investor Day, Services is currently the growth driver here with 17% top line improvement over last year, now with an annual run rate of just about $1 billion. This is the second straight quarter with a book-to-bill greater than 2x for the ES segment overall.

As Stuart said earlier, pretty much all with cost reimbursable work in recent wins. Together with Methanex achieving FID in Q3 and Freeport is still ahead of us, all bodes well for driving growth to the long-term levels consistent with the growth targets we talked about in May.

Now Slide 11, addressing new capital structure and liquidity matters. There's more good news here. We're much improved over last year on a year-to-date operating cash flow basis, which has helped us continue to delever the business with a combination of ongoing EBITDA growth and debt reduction. Debt reduction this quarter totaled at just about $50 million of which a little over $30 million was discretionary. This brought our gross debt EBITDA leverage ratio to below 3.0 as we have been targeting, ahead of schedule, by the way, and at a 1.5x leverage ratio net of cash. While much of the cash we have on the balance sheet is from client advances and is dedicated to projects like Aspire, we've targeted to improve the pooling of other cash globally to free up capital for debt reduction. This bore fruit in Q2, and we are working on more for future quarters.

With the Ichthys funding requirement nearly complete, virtually all operating cash flow going forward will be available for deployment in the prioritization we provided to you in our May investor conference.

Finishing up with Slide 12. So far the year is going well and consistent with our expectations. You see earnings continuing to increase over the second half driven by stability and mass from our GS business, improvement in TS profitability on better mix and continued ramp up of new services and project delivery work across our ES segment. In addition, we see the tax rate coming down in the second half as we expect to recognize tax credits that were always part of our plan for the year, deliver the guided 23% to 25% effective tax rate range. We therefore, reaffirm our existing adjusted EPS guidance of $1.58 to $1.73 and operating cash flow guidance at $175 million to $205 million with a stronger second half consistent with our recent experience.

Back to Stuart to wrap it up.

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Stuart J. B. Bradie, KBR, Inc. - CEO, President & Director [5]

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Thanks, Mark. And onto Slide 13 aptly titled growth and value. It is a fantastic time to be at KBR. Our people continue to reshape KBR and deliver outstanding results. Our consecutive quarters of performance, backlog with attractive quality of earnings and cash characteristics are growing nicely across energy and government. Combined with market dynamics and an attractive pipeline, we continue to increase certainty and create opportunities to deliver against our long-term targets.

Thank you. And I will now hand back to the operator who will open the call up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll take our first question from Brent Thielman with D.A. Davidson.

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Brent Edward Thielman, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [2]

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Congratulations on the quarter. And Stuart, congrats on Freeport. I know you've talked for some time about KBR's ability to be selective on these sort of projects and pick the best fit. I guess, I want to get your thoughts into kind of managing this portfolio of Government and Energy Solutions whether you have a desire to add another LNG project to the mix?

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Stuart J. B. Bradie, KBR, Inc. - CEO, President & Director [3]

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I mean only if we've got the -- an A team simply on it. Only if we can get the terms and conditions that make sense and with the customer who's going to behave properly. And I think we've got -- we have the opportunity. I've talked about this probably before too to do we think one LNG in the U.K. because it got a strong execution capability there. Quite that's where we're bidding Nigeria LNG from and 2 in the U.S. concurrently. So I still think there's headroom from an LNG perspective, but I'll come back to the statement we've made many times where we highly considered about what we do, what terms we do it under and who we do it for. And hopefully, if we can't believe we've got a good quality of earnings with any backlog, we won't do it and we don't need to do it. And I think we've been very consistent in that messaging.

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Brent Edward Thielman, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [4]

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Okay. Great. And I guess my follow-up, you've had a lot of new award and recompete successes in Government thus far this year. I guess, as you look out at the pipeline into next year how do you see the size and kind of scale of opportunity shaping up if we were to put LOGCAP V aside, I guess, are the opportunities as robust to kind of keep this bookings momentum that you're seeing this here?

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Stuart J. B. Bradie, KBR, Inc. - CEO, President & Director [5]

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Well, I mean it's been quite an interesting dynamic over the last little while. You're quite right, our recompete win rate has been outstanding and the team's done an enormously good job in terms of ongoing delivery and positioning for those recompete. So that's been very pleasing. I think that with SENSE and others, I think you've got the awards and hence some of the losses, of course, that have happened over the period, our pipeline actually went up from last quarter to this quarter in Government Services with those coming out. So I think the market is there. The way we're positioned in the market is highly exciting and attractive. The number of pursuits over $100 million is significant and quite near term. So we're feeling really good about the replacement pipeline that's come in the last quarter because it's going up but also the quality of what's in front of us.

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Operator [6]

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(Operator Instructions) We'll take our next question from Jamie Cook with Crédit Suisse.

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Alexander Daniel Hamid Khan, Crédit Suisse AG, Research Division - Research Analyst [7]

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This is Alex Khan on for Jamie. So question on Energy Solutions. So as you said, that was the only segment is on the quarter to have a year-over-year decline, but there's been some sequential improvement over the past couple of quarters. I was wondering there, given the award outlook for the business, including as you called out Freeport and I guess, the general LNG outlook which you've highlighted when we could expect to see like a bigger uptick in revenue over the segment, whether that be in 2020 or the back half of this year?

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Stuart J. B. Bradie, KBR, Inc. - CEO, President & Director [8]

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Yes. No we -- I think we're quite particular about stating that in our Investor Day that '19 would be -- a lot of the growth is coming from the services piece and winning LNG. So it wraps up after the period of engineering. The interesting characteristic with Freeport LNG is because it's an identical fourth train of 3 trains being built today, the level of engineering is actually not as high as is typical and as a consequence of that, we actually get to the field sooner. So assuming the FID happens in the latter part of this year, early next year, we will actually mobilize the field very quickly thereafter, so you'll start to see quite a significant ramp up on the LNG side. And as far as construction is concerned and as we progress through 2020 probably faster than is typical. I'd also say that we're mobilizing to the field right now on BLADE for Exxon. And we're obviously moving into the EPC phase of Methanex, and we shall improve procurement as well as actually mobilizing to the field as we move into 2020. So I think you will see quite a significant uptick in activity and volume as we move into 2020 and progressively so. So I think you'll see quite a push in 2020 and beyond.

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Operator [9]

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We'll take our next question from Tahira Afzal with KeyBanc.

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Tahira Afzal, KeyBanc Capital Markets Inc., Research Division - MD, Associate Director of Equity Research, and Equity Research Analyst [10]

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Congratulations on the quarter, Stuart. So I guess, first question for me, we've been tracking all the pretty big announcements coming out on the NASA front. To the extent, the moon mission and time line are what -- are being enforced. Can you comment a bit now that we've seen a bit of time fly by on the potential upsize on the NASA budget? From everything I've read, the $2 billion-or-so does not seem big enough. And does that essentially mean that your $700 million-or-so per annum could sizably go up over the next few years?

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Stuart J. B. Bradie, KBR, Inc. - CEO, President & Director [11]

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Yes. I think -- Yes, I mean, I think, of course, it could go up over the next few years with the activity that's happening, not just on the moon shot but actually the other areas of space where we're busy on the human health, which falls under our space sector. So I think that all bears well in terms of actually the moon shot itself, there's a -- I don't think there's clarity there yet in terms of the levels of activity and where that will be. We are seeing a lot of interest. We've got a lot of dialogue going on in terms of how we best position to support that moon shot. And I think we need to sort of come back to the market as things become clear. But certainly, there's a huge amount of activity in that area, and I think we're very well positioned to take advantage of it.

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Tahira Afzal, KeyBanc Capital Markets Inc., Research Division - MD, Associate Director of Equity Research, and Equity Research Analyst [12]

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Got it. Good. And then -- and just a follow-up on the LNG question. When you look out and you look at the cycles, Stuart, how many of these projects are in terms of cadence do you really see going ahead realistically? Are we going to see a flurry this year and for the next 12 months and then it ends? And the reason I ask is, I think we all follow that you're well positioned on Nigeria LNG as well, but then there are sleepers that will come and surprise like BlackMINE, I believe you guys are very well positioned on an outsize, and I'm trying to assess how real those are?

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Stuart J. B. Bradie, KBR, Inc. - CEO, President & Director [13]

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Yes. I think like all of these waves or cycles as we've seen in the past, they tend to last longer than people expect because projects have -- they take longer to get up or move forward or there's delays in FID or whatever there might be. So I think that not all will go ahead. You're quite right, Tahira. But I think the ones we're tracking at the moment and we've talked about these a few times in terms of Nigeria and the next -- the sort of Lake Charles as we're bidding that now, we're doing the front-end EPC bid for that and we should hear another. So we're trying to be very focused then on sort of really opportunities that we feel will go ahead because of backed up with clients of substance and the developer clients that these are harder projects to move forward. And one or 2 will be successful. I'm sure it's very difficult to say which ones will go ahead and which ones won't because depend on so much particularly credibility and their ability to get the offtakes in place. But I think for us in terms of our outlook, we've set our stall out to win one LNG. I think we've not announced this publicly yet, but we actually signed the EPC contract for Freeport yesterday, and that's all in good shape too. And we've got a limited notice to proceed to advance a number of sort of pre-sites activities. So that all bears well for that. And so when we -- if our stall our whole sort of targets that we laid out in May, we're really based on securing sort of one midsized LNG, which is really Freeport is that project, if you like, and not SENSE. And so anything above that is really additive to our growth story. And I think we've got a great opportunity to convert that additive. And it's difficult to say which ones will go ahead and which ones won't, but what I would say is that, the ones that we talk about more publicly has probably got better chance to go ahead, just given their -- I guess, the potential net present value associated with expansions versus greenfield projects and then secondly who the customers are.

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Operator [14]

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(Operator Instructions) We'll take our next question from Jerry Revich with Goldman Sachs.

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Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [15]

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Yes, sorry, can you hear me now?

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Stuart J. B. Bradie, KBR, Inc. - CEO, President & Director [16]

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Yes, clear enough.

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Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [17]

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Okay, perfect. So really nice performance across the portfolio from booking standpoint maybe we can just dive into (inaudible) discussion a bit more. So it's nice that you folks were able to win Freeport after a couple of other contractors have had cost overruns in LNG. Can you just talk about what the competitive environment was in that contract discussion? And (inaudible) get a project (technical difficulty)

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Stuart J. B. Bradie, KBR, Inc. - CEO, President & Director [18]

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I think, Jerry, the line is not -- yes, the line is not super clear, but I think what you're asking was the fact that we won Freeport and others are having challenges on the cost overruns, while we feel we're well positioned not to do that. I think that's really the question. But I think with -- if you look at what's happening in Freeport LNG, it's the fourth train of 3 identical trains. I think we've just finished a project right next door to that site for Yara BSF, quite a bit syngas job that adds a very similar level of manpower on-site. And so we know the area well, the dynamics of the labor force. We know the potash. We know the mayor. We know how to operate right next door. We're going to have the advantage of all the stock up lessons learned and the executions lessons learned as we move into get the fourth train. And we also understand obviously productivity norms and labor costs and the dynamics that are associated with cost in that arena. And so I think there's some very unique sort of risk mitigators associated with that. And we'll likely not disclose our pricing for signing this contract or later on as we get closer to FID as the -- in line with the customer. And I think that as -- when that pricing comes to market, that we've said very clear all along that we are not booking revenue for the sake of booking revenue to do something smart with our share price. We're actually booking quality of earnings associated with long-term growth, and we've been very consistent there and this is no different. So I think there's some unique attributes to this and that derisk it significantly. And I think we know the existing pricing of the incumbent and they've been quite, I guess, vocal recently that the train that they were doing has actually been profitable and the pricing for that is quite public. So you'll get some clear benchmarks as we move forward. And then when I start to look at things like Nigeria LNG, that's the seventh train of 6 trains. It's driven to be all identical and we built the first 6 trains. And we know that environment very well. We know the customer very well. We know the build and subcontractor and how to do business in that part of the world. So again, quite a significant derisking associated with what we're doing there. And at the end of the day, our pricing associated with something in Nigeria will, again, reflect the fact that we want to have earnings return, not just revenue growth. And so -- but I think everything is driving the same way and hopefully the message is consistent and if not please ask questions, but we're trying to be highly considered, and the market is quite interesting at the moment. Competitive landscape is tightening. And we were one of 2 -- on which side, we were 1 of 2 on Freeport, we were 1 of 2 on Nigeria. We were 1 of 2 on Lake Charles. And so I think really it's -- will we win everything? Maybe. If we win a fair share, that's significant for us. But certainly having a 50-50 chance on these deals is a pretty good place to be, and we feel now the competitive landscape is improving also because people have had these significant project issues. And so the willingness of the appetite to do something silly is lessened.

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Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [19]

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That's great. And then you folks have had a good win rate for hydrocarbons reimbursable projects as well. And it sounds like based on your prepared remarks, the order outlook is pretty interesting from here. Can you just expand on what end markets you expect to drive that outside of ammonia? Your outlook sounds more positive in terms of the prospect list as compared to a few others in this space?

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Stuart J. B. Bradie, KBR, Inc. - CEO, President & Director [20]

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Yes. I mean I said we have no ammonia at this point. We've got 1 or 2 opportunities in front of us. But actually, a lot of what we're doing is in the midstream area, in the Permian. We've announced that, our newest refinery expansions, there's methanol plants. It's really taking advantage of the market dynamics associated with monetizing cheap gas in the U.S. And that's what driving a lot of the activity. Plus, I guess, what we're doing in Azerbaijan, which is going very, very well and where we're well positioned in the Middle East. So there's 2 or 3 key markets, but the one that's driven a lot of the book-to-bill in the last couple of quarters actually has been the U.S. and that sort of mid and downstream sector.

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Operator [21]

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We'll take our next question from Gautam Khanna with Cowen and Company.

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Jeffrey Joseph Molinari, Cowen and Company, LLC, Research Division - Research Associate [22]

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This is Jeff Molinari on for Gautam Khanna. So first question -- well, congratulations on the LOGCAP V win. Looks like the protest expires in Q3, upon which you will book a formal award. What's the latest expectation, if you do get a -- if the protest does expire, what's the latest expectation for annual sales and margin impact going forward from that project?

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Stuart J. B. Bradie, KBR, Inc. - CEO, President & Director [23]

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Yes. I think I'll answer the first part just on timing and then I'll let Mark talk a little bit about the numbers. So ultimately, you're quite right, the protest period is actually over in, I think, early to mid-August. And then we'll understand where we're at. We've said quite clearly in our Investor Day there's a transition period as you move from one contractor to another. And that likely will take about 6 months and so there'll be very little impact to our current outlook for '19. In fact, no impact has been assumed at all. And so the ramp up associated with the change will actually come through in 2020. So that's the sort of timing aspect of this. And Mark?

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Mark W. Sopp, KBR, Inc. - Executive VP & CFO [24]

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Yes. So Stuart, exactly right, no impact to 2019. We've been very clear about that. As we prepare our plans for next year, we'll, of course, know more and guide accordingly. But in terms of what is in our targets that we talked about in May, we looked very hard at the objective data for what the previous contractors had done in the regions that will be new to us, most particularly Afghanistan. And we have taken a more conservative view relative to our targets to those areas, just for purposes of being conservative and cautious. We also would recognize that the takeover, if you will, of NORTHCOM is really good for us. It's a nice book of business. It is more funded out of the O&M area for training and sustaining as opposed to OCO. So we like the stability and predictability of that. At the end of the day, we've taken a more conservative view relative to the data we see from the incumbents. That said, we expect to be modestly above our current run rate, once LOGCAP V really gets going, sometime in 2020 as a result of our increased presence with NORTHCOM being added and with Afghanistan being ostensibly a larger footprint than our previous CENTCOM work.

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Jeffrey Joseph Molinari, Cowen and Company, LLC, Research Division - Research Associate [25]

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I got one more question, just switching gears to the other side of the business. Do you mind providing an update on the Ichthys project? I know the release said the funding expectations remains unchanged, which was -- we were happy to see that. But when do you expect to complete the turnover to the client and kind of what are the expectations first for the site and time frame for recoveries?

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Stuart J. B. Bradie, KBR, Inc. - CEO, President & Director [26]

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I'll try and be a little bit short and succinct on that. I mean, at the moment, we -- I think everyone is aware we're finishing the power station and we've got the steam turbines only to finish. Everything else, the gas turbines, et cetera, are all care, custody and control of the customer. Those 3 steam turbines were, I was hoping on this call to be able to say we're exporting power, and I can. We have exported power from SGT 1 and 2, with SGT 3 in a couple of weeks. And they are 3 identical steam turbines. So it's fair to assume that if 1 is performing, all 3 will perform and certainly, 2 are performing today. So that's fantastic progress. We expect to close out the commissioning and the tuning of those through the month of August, with handover probably in September, and then we'll be off the site completely.

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Operator [27]

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We'll take our next question from Michael Dudas with Vertical Research.

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Michael Stephan Dudas, Vertical Research Partners, LLC - Partner [28]

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So Stuart, I guess, Slide #7 and very helpful, looking at the funnel and the outlook. When you think about the 27% of what you need to book over the next several years to achieve these targets, it sounds just from the discussion of what we've been reading and following here that there's quite a bit of opportunity. How do we -- is it more -- is it risk relative to improved margin, utilization of the talent that you have, without having to go get others? How do you think through it when you're trying to fill those buckets to achieve the optimal level of risk-return, growth, cash flow that we should anticipate over the next several years?

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Stuart J. B. Bradie, KBR, Inc. - CEO, President & Director [29]

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I think you should anticipate the targets that we've published in May, Mike, as really the -- where we are aiming to take the business. And there's no resource constraint or margin impact at all in achieving that. I think the piece that is -- the dynamic here on the green part of that chart, which is something we haven't talked about is the fact that we do have a book of business that is short term and recurring in our advisory consulting business piece of what we do in Technology, even sort of small engineering and front-end design tasks and things like that. And that carries usually, 10% to 15% of our book of business on an ongoing basis. So if we actually portrayed that within those green bars, obviously, the 27% would be down significantly. But of course, we haven't booked it, so we just told the truth. But that's the recurring nature of our business in those areas. So I think all we're trying to do with those graphs is that we've changed the dynamic in KBR in a way that we've got long-term contracts that have built-in margin profile and more -- as importantly or even more importantly, cash-generative qualities. And as a consequence of that, we're trying to show the investment community the quality of that backlog and what it means going through 2022. Are there opportunities to do better, there? Yes, of course, because of the way that we've taken a conservative view on some areas. But I think it's a balanced view. And we've said all along that this is a growth story and it's also a value story in terms of the way we generate cash. And we believe our margins will be consistent through the piece we've actually -- we might get a little bit of uptake with economies of scale. But at the end of the day, that's not what we're banking on here. We're actually banking on being very well positioned to grow the company, and I think we're proving that out.

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Michael Stephan Dudas, Vertical Research Partners, LLC - Partner [30]

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I appreciate that. Just a quick follow-up. As -- maybe for Mark, as you look at the balance sheet and the tremendous performance we've seen on leverage ratios and the cash generation and anticipated, when do you think KBR from a balance sheet standpoint and from a business standpoint might be ready to think about an acquisition program? I'm assuming we're thinking maybe 2020. But just maybe just highlight that a little bit on where we're thinking after getting through the issues -- the positive issues on driving that balance sheet lower?

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Mark W. Sopp, KBR, Inc. - Executive VP & CFO [31]

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Well, I think we've been pretty clear about our intent to have a strong balance sheet overall. That would enable us a number of strategic alternatives. We've been very clear that absent compelling M&A in recent years, we would, for 1 year or so, we would focus on deleveraging and we've done that, I think, quite well. And I think we've got a good chance to cross our targeted leverage in this fiscal year, by the end of the year, so that's great. But we've always said that we, as Stuart says, kiss a lot of frogs and look at opportunities that come forward all the time. And M&A has been very favorably transformative for this company. And so we pay keen attention to that. And so we're always aware of what's out there and I would say from a priority perspective, with the criteria of having a strong balance sheet and flexible strategic alternatives, we would avail ourselves in opportunities of M&A as it pertains to, for example, Technology. We've talked about Industrial Services on a global basis being something of interest. We've talked about furthering our space portfolio as well as we have become a leader in that area. And so, again, as opportunities present themselves, if they can generate revenue synergies for our business and allow us to move up market, if you will, relative to barriers to entry and businesses that are protected from a competitive perspective, we're interested. And what we like about the portfolio we have today is it's very cash-generative. It's low capital intensity, and it does enable those alternatives to be pursued. And when they're not there, we've been very clear, buybacks are a very attractive alternative for value creation as well. And we're certainly near the point where we can be more aggressive there.

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Operator [32]

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We'll take our next question from Andy Kaplowitz with Citi.

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Piyush Avasthy, Citigroup Inc, Research Division - Senior Associate [33]

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This is Piyush on behalf of Andy.

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Stuart J. B. Bradie, KBR, Inc. - CEO, President & Director [34]

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Proceed, thank you for joining us.

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Piyush Avasthy, Citigroup Inc, Research Division - Senior Associate [35]

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Technology had another strong quarter. At this point, do you see any pullback in growth rate for the remainder of the year? Or do you think like 2019 growth for Technology would be on the higher end of your long-term range? And also, if you could highlight any constraints that stops you from beating the target range for this year?

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Stuart J. B. Bradie, KBR, Inc. - CEO, President & Director [36]

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So yes. I mean Technology at the moment is very exciting, particularly, the, I guess, the traction we're getting in disruptive technologies like K-SAAT and I guess the ongoing demand across our portfolio. And I think as Mark said, there's been a stabilization of ammonia pricing that's allowing people to make investment decisions in that arena where we're a world leader. So we're actually seeing a very, very healthy pipeline in front of us for Technology. And I think my expectation is that we are well on track to be in the ZIP Code of the targets that we laid out in May. So that all bears well. Going forward, the new rev rec rules actually help us there as well because we get more consistency of performance as revenue and margins are recognized over a longer forward period than they had been historically. So there's more stability in the earnings profile of that business. So that bears very well. Is there anything that could disrupt that? I mean, I think rather than -- other than sort of unforeseen geopolitical things or some other disruptive technology coming onto the market that we're not aware of, I would say at this point, we're pretty confident about where we're heading in Technology.

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Piyush Avasthy, Citigroup Inc, Research Division - Senior Associate [37]

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That was helpful. And you touched briefly on, in your prepared remarks, but can you elaborate on your cash flow performance for this quarter? Was this in line with your expectations? And how should we think about the cadence for the cash for the remainder of the year?

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Mark W. Sopp, KBR, Inc. - Executive VP & CFO [38]

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Sure. I would say that we were a little ahead of our expectations in the first quarter and slightly behind in the second. And on a year-to-date basis, we are right on track. I will say that when you really step back from this, we are still integrating some acquisitions. We, I think to our credit, are very externally focused on winning recompetes, generating synergies, having superb organic growth. And so the team is very busy, and we're also doing things like ERP implementation on the inside as well to prepare for the future and the ability to scale very efficiently and effectively. And with that, it's a little challenging to manage working capital along that path of activity, but it is a key focus. We can do better. We will do better. It will take some time. But we expect the conversion ratio to be stronger in the second half. We're very comfortable with our guidance for the year, and again, a very cash-generative business. We still operate on a consolidated basis with net negative working capital, with the advances we get from our customers, so we're quite effective there. But I can assure you that with all the other priorities we have, the speed of billing, the speed of collection, is an important priority for -- of the finance function but also the program managers and the whole team, it's a team sport. And we are fine-tuning our skills there as we have grown this business so impressively.

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Operator [39]

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We'll take our next question from Chad Dillard with Deutsche Bank.

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George Stephen Kasiaras, Deutsche Bank AG, Research Division - Research Associate [40]

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This is George Kasiaras on for Chad. Couple of things. First, could you quantify the benefit of the closeout in GS for the quarter?

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Mark W. Sopp, KBR, Inc. - Executive VP & CFO [41]

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We don't talk about specific items within our segments like that, but it was a half to a full turn in terms of percentage points for the asset sale of the definitization in aggregate. So you've seen our normative margins in GS, usually between 9% and 10%. And we shipped above 10 this quarter for those reasons.

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George Stephen Kasiaras, Deutsche Bank AG, Research Division - Research Associate [42]

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Got it. That's helpful. And second thing, how much of your energy project pipeline is cost reimbursable? And do you continue to see more customers being comfortable with doing that type of work with you guys?

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Stuart J. B. Bradie, KBR, Inc. - CEO, President & Director [43]

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Yes. So -- yes, no, we're seeing that we're getting significant opportunities because of performance. And I guess, the good measure, the best business development you can do is, quite funnily enough, actually just do a good job and you get repeat business. And we're seeing quite a lot of that activity. And I think as I said before, the dynamic of our overseas customers, people like SABIC and Saudi Aramco investing in the U.S., and we're able to bring our relationships and our performance with what we're doing in Saudi, et cetera, into the U.S. And so those dynamics are affording us significant opportunity in the reimbursable environment, Methanex, of course, on top of that. So we are seeing a lot of opportunity there.

And all the work that we've booked and sort of the major pieces of that work are all cost-reimbursable in the book-to-bill that we've posted in Q1 and Q2. So we've also been very clear with our customers and with the market that we're only interested in doing lump sum turnkey in LNG. And we've been very, very focused in on that. And the reason for that is quite clear, we've done the analysis and looking back, we have made money on LNG projects regardless of the contractual structure, consistently and holistically, in fact, in all the jobs that we've done in the past. So we feel pretty -- that we're pretty confident and we have the right resource base and management skills and technology understanding to do well in LNG, and we've decided that quite frankly, to manage that risk, it needs to be very focused. And as a consequence of that, we're going to put our A teams on to those jobs. And we're not going to be distracted doing lump sum turnkey elsewhere.

What does that mean is that we have a very clear, I guess, risk focus. But also, what is also interesting is the dynamic and the other aspects to the market where we're actually booking significant work on a reimbursable basis. So today, when we look at our little chart there that shows the work going on to 2022, excluding the 1 LNG project at 10%, everything in the main is cost-reimbursable or time and materials within that book-to-bill.

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Operator [44]

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We'll take our next question from Tobey Sommer with SunTrust.

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Tobey O'Brien Sommer, SunTrust Robinson Humphrey, Inc., Research Division - MD [45]

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In the Government Solutions area, could you discuss win rate trends in -- including recompetes and takeaways and how those trends inform your bid and proposal investments?

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Mark W. Sopp, KBR, Inc. - Executive VP & CFO [46]

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I can certainly say the recompete win rate has been particularly pleasing. We entered this year with quite a concentration, with LOGCAP V and with Marine Corps preposition stock, we won both of those. On a dollar basis, we are above 95% on recompetes. On a unit basis, we are well above 90% this year. And hats off to the team for the focus they've had on those recompetes, they're never easy. But it -- what underpins that is the execution and innovation they bring to the customers every day. That's what really wins recompetes more than anything else, more than a fancy bid. And I think the team has done that remarkably well. The overall win rate, including recompetes and new pursuits is about 40%. And from my experience, that's pretty strong. So -- and we are taking our shot at some hard things too along the way and we're winning our fair share of those, like the launch activities with NASA, something that we're really proud of that we're up and running now starting in Q3, with a launch here in a week or 2 to support. So the team has built quite a bit of credibility as it's come together across the Wyle, Honeywell, SGT and legacy KBR elements. It's 1 team and they're quite good. And so we -- when I mentioned earlier about the benefits of scale with now a -- and a $4 billion run rate in this business, we have the rates that enable us to go after procurements in wider scale than we're able to do before. And the team has demonstrated to Stuart and I that they can and should be more aggressive in terms of seeking market share takeaways, like we saw with POTFF, and the range win at NASA and others. So we're -- we pretty much leave it to them in an entrepreneurial way to go after pursuits aggressively, and they've got capital to do that and track record is excellent. So we wish to see more of the same.

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Stuart J. B. Bradie, KBR, Inc. - CEO, President & Director [47]

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Yes. It's interesting, totally depending on how you're doing your analysis. If we did our analysis based on value, just because of the scale of the Marine Corps recompete and the LOGCAP V win, you know that the win percentage is well above 70%. If you did it on numbers of proposals submitted, it's closer to where Mark is. But I think one of the pleasing things that's happened over the last few quarters and we don't talk about this enough, is actually our engineering business. Our engineering business has grown significantly with very strong win rates and sort of close to the 50% ZIP Code and it continues to grow very nicely and we've got a lot of cool stuff in there. And it doesn't get the noise because a lot of the awards are circa $50 million and not the $1 billion ones, but we win a lot of them. And that business has grown double digits in the last little while and continues to really outperform. And so we're very, very pleased with the way that, that business is behaving and it really is a fantastic part of our portfolio.

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Tobey O'Brien Sommer, SunTrust Robinson Humphrey, Inc., Research Division - MD [48]

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With respect to contract mix, are you seeing any changes in the Government Solutions arena among your principal customers as to their appetite to move towards contract types or solutions-based arrangements that could be more profitable to the company and more cost-effective for the customer?

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Stuart J. B. Bradie, KBR, Inc. - CEO, President & Director [49]

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Yes. I think we've seen an increasing trend towards more best value rather than just lowest price technically acceptable. And that's been happening for a while. I think in all the bids that we are seeing now, they're looking for more solutions rather than just turning up with resource or historical capability. You have to come with innovation and digital solutions across all that we do today, and I think we're -- our team has demonstrated we've been very laser-like in the way that we've actually introduced those solutions. And a good example in the logistics arena would be becoming very, very, I guess, smart around the way we use our logistics management tools. It's called Maximo, which is off-the-shelf, but we've enhanced that significantly with KBR, I guess, more sort of efficiency-driven tools and solutions that allow us to do more with less. So if you're in a fixed price-based operations, over multiyears, you become more efficient year-on-year driving margins up. But at the same time, you're also working with the customer and minimizing sort of spend in IDIQs and things like that. So I think that's a complete win-win and you're driving efficiency through the smart use of artificial intelligence and things like that. So it's worked out really, really well. So I think we are -- that we've recognize that change some time ago, and I think we are at the -- we're recognizing that we need to just continue to have that culture within the business to look for innovation and solutions that add value to both. You're quite right, it needs to be to us, but also to the customer.

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Mark W. Sopp, KBR, Inc. - Executive VP & CFO [50]

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And I'll add to that, Tobey, that I don't think we are seeing any major shift in contract types.

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Stuart J. B. Bradie, KBR, Inc. - CEO, President & Director [51]

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That's true.

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Mark W. Sopp, KBR, Inc. - Executive VP & CFO [52]

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But we are moving up market in the systems engineering and integration and technologies that Stuart referred to. And so that is helping us move up the value chain, but mostly still in the cost-reimbursable sense, I would say, in the U.S. What is different about KBR is the 1/3 exposure, if you will, to international markets where we're not seeing a big shift in type either, but the overall margin profile of that business is much more attractive than the U.S., and it's growing really well and balanced over the past couple of years. And as a result, that's beneficial to our overall margins. As we've discussed, 9% to 10% is pretty good for the amount of logistics and space work that we do.

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Operator [53]

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This concludes today's question-and-answer session. I'd like to turn the conference back to Stuart Bradie for closing remarks.

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Stuart J. B. Bradie, KBR, Inc. - CEO, President & Director [54]

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Thank you. Thank you very much, Patrick. So yes, just thank you very much for taking the time, and thanks for your interest in KBR. It's another good quarter and the 10th in a row, and upwards and onwards. This is -- is really the thinking and we've got a lot of hard work, but I think great opportunity in front of us. So let the snowball continue rolling down the hill, as they say. So thank you again for your time.

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Operator [55]

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This concludes today's call. Thank you for your participation. You may now disconnect.