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Edited Transcript of KBR earnings conference call or presentation 24-Feb-17 2:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 KBR Inc Earnings Call

HOUSTON Feb 24, 2017 (Thomson StreetEvents) -- Edited Transcript of KBR Inc earnings conference call or presentation Friday, February 24, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Lynn Nazareth

KBR Inc - VP of IR

* Stuart Bradie

KBR Inc - President & CEO

* Brian Ferraioli

KBR Inc - EVP & CFO

* Mark Sopp

KBR Inc - EVP

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Conference Call Participants

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* Robert Norfleet

Alembic Global Advisors - Analyst

* Chad Dillard

Deutsche Bank - Analyst

* Jamie Cook

Credit Suisse - Analyst

* Tahira Afzal

KeyBanc Capital Markets - Analyst

* Steven Fisher

UBS - Analyst

* Andrew Kaplowitz

Barclays Capital - Analyst

* Anna Kaiminsksaya

BofA Merrill Lynch - Analyst

* Brent Thielman

D.A. Davidson & Co. - Analyst

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Presentation

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Operator [1]

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Good day and welcome to KBR's conference call. This call is being recorded.

(Operator Instructions)

For opening remarks and introductions, I would like to turn the call over to Lynn Nazareth, Vice President Investor Relations. Please go ahead.

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Lynn Nazareth, KBR Inc - VP of IR [2]

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Good morning and thank you for joining us today to discuss KBR's fourth quarter and 2016 financial results and 2017 guidance. Joining us on today's call will be KBR's President and Chief Executive Officer, Stuart Bradie, KBR's Executive Vice President and Chief Financial Officer, Brian Ferraioli, and KBR's Executive Vice President, Mark Sopp, who will assume the role of Chief Financial Officer on February 28. Stuart, Brian and Mark will discuss KBR's financial and operational results, discuss our market outlook and provide guidance and our earnings expectations for 2017.

Please refer to the accompanying presentation that is posted on our website in the Investors section of KBR.com. Following their prepared remarks, we will take your questions.

Today's call is also being webcast, and a replay will be available on KBR's website for seven days at KBR.com. The press release announcing KBR's fourth-quarter results and our annual Form 10-K are available on KBR's website as well.

Before turn the call over to Stuart, I would like to remind our audience that today's discussion may include forward-looking statements reflecting KBR's views about future events and their potential impact on performance. 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 KBR's fourth quarter earnings press release, Form 10-K for the period ended December 31, 2016, and current reports on Form 8-K.

You can find all of these documents on our website. Now, I'll turn the call over to Stuart.

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Stuart Bradie, KBR Inc - President & CEO [3]

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Thank you, Lynn, and welcome again this morning. Moving to slide 4, we start as usual with safety.

Our commitment to zero harm is unwavering and our progress on safety metrics as a result of our commitment and engrained culture over the last few years is shown on the graph. We have achieved a 47% decrease in our incident rate. But this is a never ending journey, and to this end, we celebrated globally a zero harm day yesterday to reemphasize the importance of KBR's interdependent safety culture.

Today you'll hear a little bit more from myself, but also from Mark, our incoming CFO, and I wish to publicly welcome Mark to the KBR team. And for the last time, we will be hearing from Brian, and I wish to thank Brian from all of us at KBR for all he's done over the time he's been here but also from me personally. His sage advice and guidance has been invaluable, and I wish him the very best in his retirement.

So now moving to slide 5. 2016 was an absolute transformative year for KBR. We actively made the shift to becoming a global professional services company, providing differentiated technical and professional services and technologies across the asset and program lifecycle within the government and hydrocarbons industries. There were multiple elements to making this strategic pivot.

Thusly, we completed several strategic acquisitions in three key focus areas, and we've previously highlighted these areas to the market. Firstly, Wiley and Honeywell technical services businesses in high-end government services. Certain technologists from [Cameter] and our technology and consulting segment, and speciality welding and turnaround capabilities through our Brown & Root joint venture which will help us grow our maintenance and services business in North America. This acquisition falls within our E&C segment.

In addition, we've seen the expansion of our LogCAP IV contract, with a growing presence in Iraq and Eastern Europe that. We've had significant and highly strategic wins in the UK. We continued with steady earnings and high margins in our technology and consulting segment, and we've been awarded multiple FEED and pre FEED studies in certain strategic areas and we've seen good growth coming out of our E&C business in the middle east and Astoria.

Sizable employee growth has been achieved over the last two years, and you can see the numbers on the slide. And this is in a highly reimbursable business environment, and this has really helped stabilize our revenue base

Now moving on to slide 6. Despite the significant milestones and the strategic achievements in 2016, we did take charges on certain legacy lump sum EPC projects during the year. The project for which we took charges in the fourth quarter is the final domestic EPC project that needs to be addressed. The charges were due primarily to weather and productivity issues.

The lessons learned and the subsequent actions taken during the year to strengthen our risk management, and importantly our bidding processes, will substantially reduce the risk of our portfolio going forward. It's worth clarifying that the key finding is that the charges were not in the main, and this is across the projects, not just the final project but all the projects, in the main were not due to poor execution but due to signing up to poor deals at the outset.

In addition, we continued our significant effort to settle, resolve and conclude on a number of legal and commercial disputes and issues. Including PEP, or PEMEX, on which settlement negotiations are currently advanced. Sodium dichromate, we have talked about in earlier quarters which is now behind us, and in this quarter we also resolved the electrocution case.

For the number of [key calms] and we have not had one go against us yet, and we've resolved a number through the year. And we have made this quarter progress on the burn pit matter, particularly on cost recovery. We've closed out all of the audits related to the significant performance years on LogCAP III, and these have all been settled well within reserve.

In addition, we've go pending resolution with the SEC and with the class-action lawsuits associated with the 2013 restatement and this matter should be behind as soon. We've also closed out a number of commercial matters, which we do on an ongoing basis across several projects.

Now on to the business outlook which starts on slide 7. Government services. This segment between the organic growth of our contracts with the US military and the new wins on work with the UK Ministry of Defense, as well as the acquisitions, really give our total GS segment some considerable scale where we expect to execute almost $3 billion in contracts in 2017.

Noting that a large portion of the UK work doesn't come through the revenue line, but rather comes through the equity in earnings line as the work is executed through unconsolidated joint ventures. This segment now performs much higher technical and professional services for the government it serves in a growing market, therefore the outlook of this segment is strong.

So really quickly touching on the bullet points, in short, we expect growth across all our key markets in the US, the UK, and Australia. We see continued opportunities across the lifecycle, including synergy opportunities that we called out earlier. And one of the key points I want to highlight again is that we've got the ability to access the three key US government funding sources, and really the key takeaway from this slide for me is really organic growth is highly underpinned by boot work and there are no major recompetes in 2017.

Both the US work now executed under the KBRwyle brand and the UK and Astoria work is for customers with whom we held very strong relationships. And target margins in this segment given the mix between consolidated and unconsolidated operations, is expected to be in the high single digits to low double digits going forward.

Now moving on to slide 8. Technology and consulting. The outlook for this business, this segment, is steady to growing. We developed an increasing business servicing the revamp and expansion of market, and we have a significant install base across our technologies in ammonia, petrochemical and refining, and so we expect that business to continue to do well into 2017.

We do have an expanding portfolio of proprietary technologies, and we also work very closely with customers to monetize their technologies through strong engineers and technical know-how, but also leveraging our best-in-class global salesforce. We see in 2017 quite a mix of brownfield and greenfield opportunities, and interestingly enough we're starting to see the green shoots of opportunity come through the consulting sector in the upstream area.

I guess the key takeaways for this business are that our technologies are in the main gas spacing, and the contracts are smaller, global in nature, and lower risk. With the ability to take advantage of both brownfield opportunities and greenfield opportunities as we start to come back, given slightly rising commodity prices and underlying global demand. Target margins in this segment can fluctuate a little bit as we've seen in 2016, however, on balance the margins will be again in the low 20%s and it will be higher or lower depending on the mix of proprietary equipment.

Okay, moving on to slide 9. So the outlook for E&C. We see growth in a OpEx facing business, and believe we are well-positioned for CapEx recovery.

In E&C, we've continued to transform our business. We've had a very, very strong focus on OpEx and small projects while we position the Company for the recovery for larger CapEx projects, both onshore and offshore.

We have really expanded our maintenance business significantly, and have a full-service offering. And that's across not only the US, but also in the Middle East and Europe and Indonesia. And next year just to give us some context, KBR's share of that business, because some of it is in joint ventures, will be somewhere between $600 million to $800 million. So quite a substantial business in our portfolio.

We're seeing key wins and growing opportunities coming through in Asia-Pacific, and in Australian infrastructure services market, including LNG opportunities. We have got a very strong engagement with customers in North America, predominantly in the downstream sector, but we continue to work as we've previously talked about on mid-scale and large-scale LNG opportunities in the Americas. And we're working on a number of concept pre-FEED and FEED studies as we speak.

With the markets that we're starting to see recoveries, as we said, in the consulting area, and really with our pipeline of opportunities, we do expect backlog to grow in E&C. But it will be weighted to the later half of 2017. Our focus initially in the year is to work off our lump sum contracts and position very carefully for (inaudible) studies and consulting engagements that are in the main reimbursable in nature, but which position us for break out growth opportunities in downstream, and LNG and other areas.

For large scale EPC, we expect 2017 to continue to be a challenging year, but as I said earlier, we see indications that activity is picking up. So I guess the key takeaways are that together with the new business pipeline and our ongoing opportunities, we feel that backlog will grow in the latter half of 2017 and target margins are expected to be in the mid to high single digits. So with that, I will now hand over to Brian.

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Brian Ferraioli, KBR Inc - EVP & CFO [4]

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Thank you, Stuart, and good morning, everyone. Turning to slide 11. Q4 revenues were up approximately $117 million from the prior year, as this quarter reflects the first full quarter for the two recently acquired government services businesses.

These acquisitions contributed approximately $290 million to the quarterly revenue. Additionally, the Heritage KBR government services business continues to expand, and collectively government services more than offset a decline in the E&C revenues caused by the market challenges that that segment has been facing for some time.

For the full year, it is important to remember that the 2016 revenues no longer include revenues from our industrial services business which is now part of a 50-50 joint venture that Stuart mentioned earlier. Revenues from that business were $367 million in 2015. Gross profit for the quarter includes the $94 million in charges that Stuart mentioned earlier on the E&C project, and also includes the correction of a cumulative error that spanned several years and reduced gross profit by $13 million.

Q4 equity in earnings were below the typical volume expected for that portion of our business, largely from a reduction in the percentage of completion estimate on an LNG project. This was caused by increase in the forecast of reimbursable costs to complete, which has the effect of reducing the percentage of completion estimate used for financial reporting purposes which is based on ratio of costs incurred to date to total forecast costs. The effect of this change is merely to delay profit recognition to future periods. Equity in earnings was also negatively impacted by reduced activity in our Mexican offshore maintenance joint venture.

We continued our restructuring efforts in Q4, and incurred approximately $18 million in expense, including $12 million for impairments to releases and related leasehold improvements. These efforts are part of our efforts to consolidate excess office space, particularly here in Houston. The Q4 tax provision largely reflects [foreign] taxes, and as a reminder we do not tax effect domestic project losses.

The combination of these two factors resulted in an abnormally high effective tax rate, and as we will discuss later in the presentation, we expect the 2017 effective tax rate to return to more normal levels. The net of all these resulted in a net loss for the quarter and for the year.

On the cash side, we generated $53 million in operating cash flow for the quarter and $61 million for the year. With this, I'll hand the discussion over to Mark who talk about 2017 forward expectations.

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Mark Sopp, KBR Inc - EVP [5]

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Okay. Thank you, Brian. Before I jump into slide 13, a few opening remarks.

Foremost, I'm really pleased and privileged to be joining the KBR team. Particularly amidst the transformational stage that Stuart summarized earlier on where we are changing the course for the future, transitioning to deliver balanced growth and more predictable and stable profits and cash flows in the years ahead.

Having been with the defense industry for number of years, I can certainly say firsthand that this Company has a strong and well-deserved reputation for providing mission-critical services to the US military and our allies. And as I am seeing since I started, also to other governments like NASA and many others.

I've also had some experience in the E&C sector, and long had deep respect for KBR's rich history and continued leadership in providing leading-edge technologies and services to the hydrocarbons industry. Truly game-changing capabilities that we have here, very impressive. Accordingly, it is really exciting to join Stuart and the rest of the KBR family to build on the brand's strengths and also to leverage the recent transformational actions to bring a new era of growth and shareholder value creation for all constituents.

With respect to the CFO transition process, I have spent a good chunk of the last two months or so inside the Company, but also at other KBR locations abroad. Mostly focusing on the 2017 financial outlook, which I'll be discussing here in a moment. I will say that Stuart, Brian, Lynn, and many others here have been generous with their time and introducing me to the Company, and all the various dynamics that we will be dealing with.

And as for Brian, he certainly leaves big shoes to fill in this role. I can now see firsthand how Brian has significantly and positively impacted the evolution of the Company, and very importantly I am personally grateful for his mentoring to me over the past couple of months which I trust will be ongoing for at least some period of time. I certainly join many folks in the Company in wishing Brian the very best in his retirement.

Before moving on, I did want to cover some of my initial priorities in this position. I know the Company has a lot of operational strengths, and my general intentions are to build on those strengths and also aggressively address areas that could benefit from more focus. Up front, there are some enduring foundational elements that will always be front and center for me.

First, ensuring there is a culture of candor, integrity, transparency, and collaboration in everything we do and we'll communicate on that same basis to the street. Second, ensuring our accounting and financial reporting is timely, accurate, predicable, and insightful for both internal decision-making and for the investment community.

Third, I really believe cash is king. There will be laser focus on working capital management to maximize cash flow, and to optimize capital deployment opportunities for value creation.

Fourth, demonstrating leadership in promoting profitable growth. We will have continual focus on cost reduction, leveraging different business models, performing financial analysis to identify profit and cash flow opportunities, supporting priced to win strategies and a number of others.

And finally, perhaps most importantly, focusing on our people. This is a people business. It's important we build the business acumen and the professional development to drive the strong results for our customers, for our shareholders, for our lenders, and for our fellow employees.

In addition to these ever present fundamentals, there are a couple foreseeable priorities, Which include the successful integration and growth trajectory of our two recent government services acquisitions, and also the longer-term financing to replace the recent borrowings we made on our revolving line of credit to fund those acquisitions.

Now let me turn to slide 13 and the presentation which cover the underlying conditions that underpin our 2017 operating plan. To key this up, the favorable factors for 2017 include, one, the improved government and hydrocarbons market conditions that Stuart discussed earlier, two, the fact that our cost structure now reflects $200 million of annualized cost reductions made over the course of the last two years, which will make us more competitive in all of our markets.

Three, a substantially higher portion of cost reimbursable contracts in our overall portfolio. And finally, four, the progress we've made on a number of legal matters including the PEP matter that Stuart also addressed earlier.

The challenging factors for 2017 include reduced but ongoing execution risk in our existing EPC projects, and second, that we will see large cash outflows to fund losses on these EPC projects. Which for 2017, will depress otherwise improved cash flow fundamentals across the business.

Let me touch on the liquidity story a little bit more. I think the key takeaway is that the transformational actions we've undertaken should deliver improved and more consistent cash flow for KBR in the long term.

Importantly however, we have significant short-term funding requirements associated with the EPC loss contracts over the next 12 months. And as a result, the real impact of this transformation in our cash flow model will be more evident in 2018 and beyond.

With the short-term project outflows and with the assumed PEP settlement inflow, we expect 2017 net operating cash flow to be positive but much lower than it would otherwise be in a more normative year. With this, we expect to have ample liquidity to fund our operations, to maintain our regular dividend which or course is vitally important, and meet all of our debt covenant requirements.

As for our overall capital structure, it is still a near-term priority to refinance the revolver borrowings we made on the recent acquisitions. We are assessing the optimal time to launch this given our results, our outlook, and of course the state of the capital markets.

Now let me move to slide 14 with all of this as background. Our guidance for EPS for 2017 is $1.10 to $1.40 per share. This excludes legacy legal fees as we have consistently done in the past. This range also reflects organic growth in our government services segment and our T&C segment, and within the E&C segment reflects organic growth in our OpEx projects with contraction in our CapEx projects.

We are assuming targeted margin performance in all of our segments. Guidance also includes $24 million or $0.17 per share in amortization costs. Finally, the upper end of guidance includes our projected impact from the potential settlement of PEP.

The EBITDA reflected in our EPS guidance range is $300 million to $350 million for the year. As the bullet on the bottom of the slide shows, we have a strong confidence factor for this, with over 70% of our earnings already booked in backlog coming into the year.

The projected effective tax rate for 2017 is expected to be roughly 27%. This rate is below our statutory rate due to foreign tax credits offsetting much of our planned US source income in 2017, as well as the jurisdictional mix of our planned non-US income.

Finally, to quarterly timing. Overall revenue should be a little higher the first half of the year, and reduce modestly in the second half as the EPC projects ramp down. Conversely, we expect our net profits to be weighted in the second half of the year due to low margin EPC project burn off earlier in the year and a high proportion of T&C license and other higher margin revenues in the second half.

That wraps it up for me. While we certainly have a lot of hard work ahead of us, this is an exciting and consequential time for KBR, and I look forward to getting after it. Stuart, back to you.

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Stuart Bradie, KBR Inc - President & CEO [6]

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Thank you, Mark. So we thought, moving to slide 15, we thought we would give you a little bit more color around the backlog. And certainly across the piece I guess the message is the significantly lower risk profile.

But looking by business segment, 71% of the backlog is in government services, T&C 3% as you would expect because I guess the smaller projects and quicker turn around in that area, and 26% in E&C. To key piece to take away in the E&C backlog is that 65% of that E&C backlog is in cost reimbursable contracts, and that is in the maintenance and (inaudible) et cetera.

If you look at backlog by contract type, just to give a little bit more color. 84% across reimbursable PFI and services contracts, and then the other 60% is going to split in two. That gets you lump-sum contracts in E&C and 8% in lump-sum contracts, but with much lower risk profile in government services than T&C. So the total backlog just under $11 billion, but as Mark said, and importantly over 70% of earnings already in backlog against our plan for 2017.

A couple of things that are not in here that will come to market reasonably soon. We've been awarded the NASA Gizmodo contract, this is really the satellites contract for NASA, which is the key Heritage HTSI contract. We won the contract.

And is usual these days, it's under protest. So we will let you know when that is resolved, but we are the incumbent, we're feeling pretty good about that.

And then there is an imminent award in Indonesia by a major IOC for a five-year maintenance contract in the oil and gas region. So again, very much in line with our strategy and it will certainly add to backlog through the first little bit of the year.

Now just moving on to 2016 to give you a like-for-like comparison, a costs and currency [comparitor] of backlog. We were negatively impacted by I guess the effects of Brexit with the lower pound rate against the US dollar, and that reduced our backlog by just over $1 billion, $1.1 billion in 2016.

So we'd show that to you on a constant currency basis, and also include as we talked before and this is norm then the government contracts, I guess the options and the task order elements. And it shows the backlog growing through the course of 2016 to just under $14 billion. So a pretty healthy picture.

So moving onto slide 17. And just to conclude, 2016 was a pivotal year for KBR, very, very -- quite a noisy year with ups and downs and acquisitive growth and of course charges on some of these legacy projects where we've learned many a lesson. And we've paid quite a high price as I call it for the ticket to the dance to really understand our cost base and the factors we need for bidding going forward. So we feel pretty good about that.

We've very much working towards completed the transition to a global provider of high-end differentiated professional services and technologies, and we've very much well done our part and 2017 is looking -- we're very optimistic for 2017. We're very well-positioned for growth in both government services and hydrocarbons, and we've stabilized the revenue and significantly derisked the future of the business and across all of KBR.

So the legacy projects are being worked off, and as we move forward that significantly reduces our risk profile. Our cost structure, we have talked about it many times, is now efficient and it's scalable. And with a strong operational focus, as I said, we have learned many a lesson to bid and to execute or deliver stronger earnings. More predictability, and of course a high level of secured backlog, and associated strong free cash flow beyond 2017 and attended capital deployment options.

With that, I'd also like to just announce that on May 12 as part of our future and as we complete the pivot of the Company, we'll be having an investor day and we'll be holding that in the New York Stock Exchange. You are all cordially invited to that and more details to follow. With that, thank you very much for listening and I would just like to hand it back over to the operator. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

We'll take our first from Robert Norfleet, Alembic Global Advisors.

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Robert Norfleet, Alembic Global Advisors - Analyst [2]

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A quick question. So in E&C, obviously backlog right now is at $2.7 billion, traditionally that you guys had burned about 60% of that on an annual basis. So I guess should we expect a similar amount of burn in 2017?

And secondly, you all cited that you would expect some backlog growth at E&C in the second half the year. As a result of that, do you think you can grow revenue in 2017 -- in 2018, and will there be enough new award activity? And based on the timing of those EPC contracts, should we actually expect to see revenue growth in 2018?

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Stuart Bradie, KBR Inc - President & CEO [3]

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Good question, Robert. The reason we made the statement around the green shoots coming to the consulting arena, I think you've heard from others that there feels to be a bottoming out. But there are companies that have certainly -- they've had time to reset their business to today's oil price, and we're starting to see activity in the sector.

But we're trying to be realistic in the sense that it does take time for these projects to come to fruition and get through FID hurdles, and we think that the bookings of those will be in the latter part of 2017. And the reason we have made that statement is because then you'll realize the value from those bookings into 18 and beyond. So to answer your question, the answer is yes, we see backlog growth coming through E&C in 2017 but in the latter half, and I guess the earnings associated with that backlog will come through in 2018.

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Robert Norfleet, Alembic Global Advisors - Analyst [4]

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Okay, great. And my last question deals with -- I understand obviously the cash outflows that we expect in 2017. Can you walk us through what the triggers are? I know you're not in violation of debt covenants, but obviously with the cash outflows it does prohibit you from doing certain things like buying back stock. What needs to happen and what are the triggers for you to be in compliance in order to, for example, buy back stock of be more active in capital allocation?

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Mark Sopp, KBR Inc - EVP [5]

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First of all, we are in compliance with all our covenants, so that is not the constraint. The constraint is more, as you say, we have to fund these project losses, and we obviously are obviously are also very hopeful of the recovery of the PEMEX money.

So the only constraint we have, if you want to call it that, is really the funding of the losses. We had been talking for some time that the first half of the year would not be a strong cash flow period given the losses that we have previously announced, and that remains unchanged.

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Robert Norfleet, Alembic Global Advisors - Analyst [6]

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Okay, thanks. And I'll get back in the queue.

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Operator [7]

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We'll take the next question from Chad Dillard, Deutsche Bank.

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Chad Dillard, Deutsche Bank - Analyst [8]

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So you mentioned that you expect to grow E&C backlog in the second half 2017. Can you speak more about to visibility there? Are there any large-scale projects wins cooked in, what end markets are driving optimism and how much comes from OpEx?

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Stuart Bradie, KBR Inc - President & CEO [9]

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There's a significant portion comes from OpEx, but the statement around growth and backlog is really around the CapEx market share. As you know, we are heavily involved in the very front end of projects around our consulting and our technology business, and the activity levels there are picking up, both onshore and offshore.

The US domestic market because of the continued cheap gas, the activity there continues. I think we've talked and I think the markets talked about this, we're not the only ones of course, 2023 is the crossover between supply and demand and LNG. And if you walk backwards, we see projects needing to move forward in the end of 2017 into 2018 to meet that demand.

So I think it's really across downstream, petrochemical and LNG, that's where the activity levels will be highest. In terms of geographies, likely be in the Middle East and the US. As we've said before, we don't think that's changing.

I think were very well-positioned to take the opportunity. But what is clear and I think the key point here is that we do see the market bottoming out and we do see activity levels picking up in the consulting area, and we're involved in these projects today and leading to larger EPCM wins in the future near the end of 2017.

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Chad Dillard, Deutsche Bank - Analyst [10]

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That's helpful. Then could you also just provide more color on the project charges? When we went to the $94 million charge as well as the LNG. Can you walk through a little bit more specifically what happened, what's the percentage completion on these projects, we do you expect them to complete, are they still profitable? Then more broadly overall, how much of your backlog is in loss position right now?

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Stuart Bradie, KBR Inc - President & CEO [11]

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Again, good question. And as we have gone through the analysis of the legacy projects, I think the key takeaway for me is that as much that we can improve an execution, but the real issue is not execution. The real issue is signing up to deals that were probably not good deals at the beginning, so reasonably harsh commercial terms.

And really productivity assumptions that I think you've seen it with others in the market, particularly around the Gulf Coast, that people cannot deliver on today. That's been a key lesson for us as we've worked through these legacy projects.

In terms of the type of project, it's a downstream project. It's almost 60%, 58%, 59% complete. We are at the ground, so the weather impacts are far, far less of an issue for us, but it we did have I guess really bad weather in and around the US Gulf Coast of the last couple years particularly at last year with the rains.

And if you're stuck in the ground, it's difficult to get out of the ground. But we are at the ground in that particular project, so that should be less of an issue going forward. And we've factored in the productivity norms that we've seen across multiple projects, as I said, it's been a very expensive ticket to that dance as far as I'm concerned and quite painful for us but quite painful for our shareholders as well. And I am very well aware of that, but we do understand it now and the forecast to complete includes those norms.

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Chad Dillard, Deutsche Bank - Analyst [12]

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Great, thank you.

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Operator [13]

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We'll move next to Jamie Cook, Credit Suisse.

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Jamie Cook, Credit Suisse - Analyst [14]

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A couple questions. One more strategic, and then just second on the guidance. I guess, Stuart, I appreciate the shift towards the government business and derisking KBR's profile.

But I guess that's at a point where you just did a bunch of government acquisitions, and the E&C business is traughy because the business has been depressed. So I'm trying to I understand your approach to E&C going forward, your willingness on a go-forward basis as the market picks up to do fixed-price work. And if you won't do fixed-price work, how does that impact you competitively?

I'm not sure you can be a competitor if you don't, or maybe it implies the business really isn't as strategic to you as it was before. Which is interesting as well with Mark coming on with his background. So just how you approach the market and whether this is a core business going forward?

Then my second question is on the guide. I'm just trying to understand how I think about the core earnings of your business given HTSI and Wiley, et cetera. So can you help us in terms of what's your are assuming for -- did your forecast change in terms of the contribution from the acquisitions? I'm assuming there was a gorgon closeout in there, obviously PEMEX could help. So if you could help me understand those dynamics within the guide. Thanks.

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Stuart Bradie, KBR Inc - President & CEO [15]

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I think a little bit of two plus two equals five there, Jamie, in terms of the strategic piece. We've been very consistent since day one. Our approach is to move KBR into a more professional services arena, that's across oil and gas, hydrocarbons and we do a bit of infrastructure and the [stereansome] mining work in Australia. It's just dependent where the markets are.

And in government, the strategic push is to be differentiated and go up the food chain somewhat so that they're at the highest skilled, and therefore increasing margins. And we been consistent through that. Our core sectors remain oil and gas, remain government, and as one goes up one goes down it gives a good balance to the business and we've seen that.

We knew we were going to have headwind challenges in the oil and gas market. I think we were one of the first to call that out and start to take cost out in that sector. But at the same time, we also knew that we had to add earnings power in other areas so that we could stabilize earnings and we have managed to achieve that.

We also recognized early on that as the market shifted, that the oil companies would try to put more onerous terms on the contracting community and shift risk. So we wanted to make sure that we were in a position that we did not have to really take on onerous contract terms and conditions and we could be far more considered. And again, I think we've proven that by the number of times we've talked to you and to others about certain jobs we were prepared to do and others we were not prepared to do.

We've been highly consistent that we will be in the EPC lump sum business, but we're not going to work for the sake of revenue. We're going to do what we can execute using norms that make sense in today's market, and under terms and conditions we think are fair.

We have booked the Magnolia LNG project, that was a negotiated deal. We have gone back, we've signed it, we haven't entered it into backlog obviously. But we've signed it, and we've gone back and checked the estimate against the norms that we now fully understand and it holds scrutiny. And the difference there being that we have negotiated that deal and it's going to free up commercial terms, it was in low-cost wins.

So I think that our strategic positioning has been consistent, I think we've delivered on our strategic promises, and I think we've strategically shifted the business into more recurring revenue, professional services earnings, and that's across a number of sectors. And that is the core of our business is professional services. That is the core going forward and we will do lump sum EPC when it makes sense, and we will continue to pursue those opportunities. And that's what I'm talking about in terms of the tail end of 2017 in terms of backlog growing.

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Jamie Cook, Credit Suisse - Analyst [16]

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But is there a limit in terms of fixed-price risk as a percent of the total portfolio that you would look at? Is there a ratio we should be thinking about going forward? Because everyone always says they did the fixed-price job differently this time, and then the same thing happens.

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Stuart Bradie, KBR Inc - President & CEO [17]

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I agree with that. But I think it is a business that you need to be highly considered because of the risk profile, and you've seen that through the market in recent times and we re very conscious of that. Do we have a ratio in mind, I think the answer to that is no. And because what's more important to us are the commercial terms you contract under, and if we sign a significant bit of work we would consider signing another piece of work of sizable scale doing EPC, that would depend on whether we had the quality of team and the quality of people accepted to execute so again we'd be highly considered.

I think the takeaway here is there are no set ratios. I think I've talked before about KBR's history of big, big project and big project risk being the cake. Now it's the candles on the cake because we have got such a large services business across the industries we service as the cake and the candles on the cake are the EPC projects when they make sense.

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Jamie Cook, Credit Suisse - Analyst [18]

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Okay. Then sorry, just help on the guide. I'm trying to figure our core versus what's HTI, we have project close outs, we have PEMEX. I'm just trying to think about the different dynamics there.

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Stuart Bradie, KBR Inc - President & CEO [19]

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I have to say that that word core -- the core business for us includes all our government work, and it includes our services work, it includes the -- the business not core is actually working off these legacy projects that we inherited with what I think are both norms and challenges and commercial terms that we would not sign up to today. That's the bit that's not core.

In terms of PEMEX, I'm sure someone will ask the question, we're in the middle of with [Pat] of negotiating that. It is very difficult in the middle of a negotiation, as I'm sure you will appreciate, to give any numbers, but we have talked often about what's in our history in terms of the revenue that's been moved to just over $400 million.

The max we can get is $465 million because that's what's in escrow, and so it is a negotiation. Our view of the impact of that in earnings, we don't know the ultimate outcome although we're fairly well advanced in these discussions, we don't know the ultimate outcome. But the impact in earnings is not that significant, the key bit for us is the cash.

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Jamie Cook, Credit Suisse - Analyst [20]

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Okay, thank you. That's helpful, I will get back in queue.

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Operator [21]

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We will go next to Tahira Afzal, KeyBanc Capital Markets.

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Tahira Afzal, KeyBanc Capital Markets - Analyst [22]

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And I apologize if I had this question got asked earlier on. But I guess I'm glad to hear that you don't have too much for fixed-price profile in your backlog going forward, but how should I think about some of the awards that a lot of us focus on? Which some of the mid-scale LNG, et cetera, which do seem to be more fixed price, and still being bid out in a very competitive environment. How should we think about the risk on that?

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Stuart Bradie, KBR Inc - President & CEO [23]

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I think the way you need to think about that here is that we are involved in a number of those mid scale's, as we've talked about before some are less competitive than others. The ones that are competitive we will put in pricing that we feel is appropriate, and we'll try to come up with smart solutions, et cetera. But at the end of the day, we will put in a price that's sensible and with the commercial risk profile that we think we can live with, as I said before.

And if we end up losing the project, so be it. If others want to take more risk, that's up to them. And I think we've got enough innovation and ingenuity and solutions oriented people in the business to come up with some smart thinking to get cost and schedule down and we're probably not before. That's kind of how we got there on Magnolia.

So I think we're well-positioned in that regard. But when it becomes competitive, it becomes competitive. And if we can't win on terms that make sense, we're not going to win. And so I think the way to think about that is to think about it that our EPC backlog as it grows it will be in a manner that's less risky than the past, because it will be more considered with norms that we fully understand and with commercial terms that make sense.

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Tahira Afzal, KeyBanc Capital Markets - Analyst [24]

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Got it. But do you think if that ends up being the scenario that you will be able to grow your E&C business in terms of operating income over the next couple of years?

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Stuart Bradie, KBR Inc - President & CEO [25]

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Yes, we do.

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Tahira Afzal, KeyBanc Capital Markets - Analyst [26]

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Got it, okay. And then the other question, which is more of a fun question. The SLS rocket that seems to be getting a lot of fanfare from the commercial space industry, it seems to have really upped NASA whereas some of the private space competitors there. Could you talk about the opportunity set within that development, and the fact that NASA's budget might be moving more towards back to space and some of its traditional operations which could be positive for you guys?

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Stuart Bradie, KBR Inc - President & CEO [27]

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That's exactly right, that would be very positive for us. I think historically we have done some work for the private sector around space, it's been very modest to date. But if you think that we've supported particularly in the life sciences area every astronaut that has gone to space and we supported a number of the private ventures in that arena as well, I think that can only give us good opportunity going forward.

We also think that as NASA has said and as you say, we'll focus very much on this space, particularly deep space, area, which positions us very well. But as the -- as we look at opportunities for the private sector, I think there's going to be -- there has to be a lot of connection into what happens in NASA. There is certain connections between the public-private type partnership solutions that we feel is a great opportunity.

And we've done quite a lot of that in the UK, as you know, through what's called PFI in the UK, [PPP] here. So we actually think there are actually solutions that are not yet at market. They are market making where we can bring capability and had to cut somewhat around PPP and do some off balance sheet financing that can create value to the private sector, but also to NASA themselves, but also keep that that level of regulation that is required in that endeavor.

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Tahira Afzal, KeyBanc Capital Markets - Analyst [28]

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Got it. Thank you very much.

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Operator [29]

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We'll go next to Steven Fisher, UBS.

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Steven Fisher, UBS - Analyst [30]

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I know, Stuart, you said you can't give a specific numbers on PEMEX, but I want to make sure I'm interpreting the message on slide 13 correctly. On the operating cash flow section where you say that there are potential offsets from PEMEX to the outflows from the lost contracts. So should this be interpreted that the drag from the loss projects would more than offset the PEMEX collection, or that's not the right way to think about it?

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Stuart Bradie, KBR Inc - President & CEO [31]

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I think we're very clear that we have got loss making projects going forward, they will be a gain in cash. We said that's predominantly in the first half of the year, and that we're consistent on that. The PEMEX settlement, we have not disclosed the number, so it's difficult to give guidance on that, Steve.

But I think you can make your own assessments, I think that certainly PEMEX will be a great help from a cash flow perspective. I think there's no doubt about that, and it will allow us to deal with these loss making projects going forward.

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Steven Fisher, UBS - Analyst [32]

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Okay. And then can you talk about maybe the when of this PEMEX situation and when that would be resolved?

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Stuart Bradie, KBR Inc - President & CEO [33]

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We're still obviously in advanced negotiations. It will certainly be -- we think it will be resolved within -- certainly before the end of Q2.

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Steven Fisher, UBS - Analyst [34]

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Okay. Then quickly on the Australian LNG project, how far into 2018 is that now going to run for you? And how should we think broadly about your equity income in E&C in 2017. Because I'm just wondering if this project can -- if you do end up having delays to some of these big CapEx projects you're assuming get booked in the second half of 2017, can the equity income in this Australian project still support your E&C earnings nicely into 2018?

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Brian Ferraioli, KBR Inc - EVP & CFO [35]

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Steve, this is Brian. What I would say is the equity in earnings line should return to more normative type of levels in 2017. Remember we've got that MFPS project that really has not contributed to earnings yet, so that will ramp up in the second half of this year. We also have army 2020, which is just ramping up as well.

And to your point, we have the Australian LNG which is getting to the back end of that project, that's been ramping down and will continue to do so throughout the year and into 2018 as you correctly state. But in general, taking a step back on all of the equity in earnings line, it's going to be back to the more normal type of rates of probably even a little bit higher than maybe it's been recently.

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Stuart Bradie, KBR Inc - President & CEO [36]

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And in addition to that, through the equity in earnings line in 2016, which we haven't talked about very much is our maintenance business in the US. And we did -- we had acquisitive growth there with the acquisition of MEI, we had field costs et cetera that impacted the equity in earnings line.

And going forward, we've tried to give some flavor as to the sale of that business in the presentation, that will be a good contributor to earnings going into 2017. And that business goes into the year with over 90% over 90% of its work booked.

So it's a very, very predictable earnings base, a good growth story as we've added over 2,000 people in the last in the last little while in that business alone. You saw the people numbers in the presentation earlier, but in that business alone it's over 2,000 people. So it's a growing piece of our business that will come through the equity in earnings line, I think it's a good growth story for us.

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Steven Fisher, UBS - Analyst [37]

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Thanks and best wishes, Brian, and welcome, Mark.

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Mark Sopp, KBR Inc - EVP [38]

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Thank you.

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Operator [39]

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We will go next to Andrew Kaplowitz, Citi.

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Andrew Kaplowitz, Barclays Capital - Analyst [40]

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Brian, congratulations again, Mark, welcome.

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Mark Sopp, KBR Inc - EVP [41]

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Thank you.

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Andrew Kaplowitz, Barclays Capital - Analyst [42]

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Stuart, maybe I can ask Jamie's question in a different way. When you look at Wyle and HTSI in the quarter in 4Q, did you see organic growth in those businesses, and have you seen improvement in growth?

I know it's early, but have you seen improvement in growth in those two acquisitions since you bought them, or maybe revenue synergies since you bought them? I think you gave an example last quarter. Then is it fair to say that the accretion you expected from the businesses in 2017 and 2018 hasn't changed, maybe something like $0.20 in 2017 for both and $0.30 to $0.40 in 2018?

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Stuart Bradie, KBR Inc - President & CEO [43]

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I'll try an answer your question in the [vash]. The accretion has not changed, in fact it's probably a little bit better. That is the first statement.

In terms of the synergies, yes, we have had some synergy wins and some cost synergies as well as the consolidated some of the functions, which has been good. But at the end of the day, we've only had one quarter of earnings from HTSI. So although going into next year the plan is we start to see some synergy upside, the growth is modest across that.

But when you layer it in and think that we're actually integrating it with our legacy GS America's business, overall, that business is going very well. So I don't really want to -- I think it is fair question to ask about our statements before around accretion and are they still holding, and the answer to that is yes we're going to do a bit better.

In terms of the overall government business splitting out going forward into legacy HTSI and legacy Wyle is probably inappropriate. I think you have to look at the overall government services sector in the US as a solution because of the way we're structuring the business going forward. It is a fully integrated business under the KBRwyle brand as we move into 2017.

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Brian Ferraioli, KBR Inc - EVP & CFO [44]

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And, Andy, I would add that we had $487 million in revenues for the year from the two acquisitions, and $38 million of gross profit. And all of that is detailed in the footnote in the 10-K.

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Andrew Kaplowitz, Barclays Capital - Analyst [45]

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Okay, Brian, that's helpful. Stuart, this might be an early question too, so feel free to intercept it. But I wanted to ask Mark his initial impressions? He has a government services background, and now he's taking on this role with the E&C business, you're trying to turn it around here. So my question to Mark is, in the first couple months here, do you see any low hanging fruit that you'd go after to help improve the business?

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Mark Sopp, KBR Inc - EVP [46]

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I think I'd prefer to spend more time in the business to answer that directly. But I will say that a major attraction to coming to KBR, it always comes down to fit and people. And I've always been attracted to the combination of professional services and technology with my recent jobs.

And they had that element, and that was a significant part of looking at this opportunity. Talking about the future with Stuart and being very attracted to the notion that there is really very interesting technology on both sides, government services, and in the hydrocarbon space that can allow us to differentiate with our customers on one hand but to also combine forces across those verticals in a number of cases to deliver new capabilities broadly.

So that was a major attraction, and my time thus far has confirmed those capabilities are differentiated and exciting. I think we can make a great story out of it in the long term.

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Andrew Kaplowitz, Barclays Capital - Analyst [47]

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Mark, that's helpful. Then maybe one more cleanup question for Brian. Operating margin, when I look at government services was already low teens in the quarter. I think and that's before adding some of these bigger contracts where you're going to get more equity earnings from the UK, and I think including acquisition related purchase accounting. So why would margin go back to high single digits per your guidance for 2017, you said high single digits to low teens?

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Brian Ferraioli, KBR Inc - EVP & CFO [48]

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Yes. The government services business was pretty consistent throughout the markets we deal with in terms of margins. You are going to always going to be in the high single digits, possibly in the low double digits. So that is just the norm.

The fluctuation that we may get just has to do more with the math. If you get more of the equity in earnings line, and obviously you've got earnings with no revenues so the margin looks higher. If you get more at the revenue side, the margins go down, but the underlying business is always going to be in that high single digits to at best the low double digits.

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Andrew Kaplowitz, Barclays Capital - Analyst [49]

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Thanks, guys.

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Operator [50]

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We'll take a next question from Anna Kaminskaya, Bank of America Merrill Lynch.

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Anna Kaiminsksaya, BofA Merrill Lynch - Analyst [51]

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Brian, this the second time me saying good luck in you retirement. I guess most of my questions have been answered. I wanted to touch on margins in both segments.

I think before you were saying how E&C business will be running in the high single digits, I think now you're saying mid to high single digits in 2017. Is it more a function of the contract you have running through 2017, or is it just more of a structural shift down as you move from large EPC contracts into more maintenance service type contracts? So how should we think about that margin in 2018, 2019?

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Stuart Bradie, KBR Inc - President & CEO [52]

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Anna, I think Mark alluded to the fact that in the first half of the year, we do have these lump sum projects with -- in essence and we've taken charges. No margin being worked off, and that's what suppresses the margin somewhat through the year. I think getting back to the high single digit returns is where the business will be heading at we'll say the tail end of the year as Mark alluded to and that will continue into 2018 and 2019 and so forth.

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Anna Kaiminsksaya, BofA Merrill Lynch - Analyst [53]

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Okay. Then on the government services side, I think some your competitors are talking more about high single digit margin. I think you're talking about high single digit to double digit. So is it just more of a function of more of your contracts being booked on an equity basis or what's driving that?

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Stuart Bradie, KBR Inc - President & CEO [54]

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Yes. That's exactly right. We'll get typical government services margins which are high single digits, and because of the equity in earnings

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Anna Kaiminsksaya, BofA Merrill Lynch - Analyst [55]

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Okay. And can I just squeeze one more on 2017 outlook. I guess people ask it several times. But given the results in the last couple of quarters, how conservative is this guidance? How much face can we put into the numbers, at least at the low end? How much visibility do you have, is it all -- does it all just come down to your execution of how can we be comfortable that next quarter we can have a number in line with expectations?

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Stuart Bradie, KBR Inc - President & CEO [56]

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That's certainly the intent. Probably the best way to answer that is that we've talked that this is -- the charges we're taking on this downstream project, it's our last domestic legacy EPC project, it's the last one in the portfolio. We've got 70% of our work -- over 70% of our earnings booked in 2017. We've talked about the balance between reimbursable and lump sum contracts.

I guess the one thing we've not talked about and we have just -- we'll talk more about this at the analyst day is really what can this business do beyond 2017. We have had a look -- I guess just to give you a little bit of flavor. Going into 2018 on a like-for-like basis, we would have booked close to 60% of our work going into 2018 already just by the very nature of the long-term nature of some of these contracts.

So I think we're starting to see the fruits of our labor in terms of predictability, we're starting to see the fruits of our label in terms of less volatility. Certainly our intent here is that we've dealt with many of the legacy issues, it should give us some clean water going forward. And if that proves out, then we should be on expectation moving forward. We certainly don't want to get out in front of us is probably a good way to put it, but that probably give you a bit of color.

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Anna Kaiminsksaya, BofA Merrill Lynch - Analyst [57]

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Great, thank you so much.

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Operator [58]

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We'll take our next question from Brent Thielman, DA Davidson.

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Brent Thielman, D.A. Davidson & Co. - Analyst [59]

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On the E&C backlog and the second half turnaround, thanks for all the color thus far. I guess my question is, as you look at this, how much of that turn is dependent on the project owners looking to execute work again versus -- KBR's seeing th right opportunities out there. I know you have been ratcheting this down over the last few years looking for the right work. How do you weigh the two?

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Stuart Bradie, KBR Inc - President & CEO [60]

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I think there is a balance for sure, but even in our statement around I guess backlog growth was really around the CapEx arena. That is the area where -- we see the OpEx side growing regardless, and I think we've put a lot of attention, focus, investment and passion around that. And I think again, we're seeing some good results in that area. And as I said earlier, our plan, earnings plan for 2017 is attractive in that space.

I think in addition with the CapEx coming through again, we are starting to see that activity increase. And we are actively involved in a number of those projects, I guess that's where the confidence comes from, whether it be in the concept of pre-FEED phase. We understand the customer base, we understand the market dynamics around those opportunities, whether it be capital or whether it be commodity off take pricing and things like that. So that's why we say -- we've made the statements that we have made, and why we've given the timing that we have given.

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Brent Thielman, D.A. Davidson & Co. - Analyst [61]

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Okay. And then in T&C, another great margin performance this quarter. Understand the comment on the longer-term percentage in the lower 20%s. But does the 2017 guide incorporate something higher than that, maybe just you had something in the backlog that runs at a higher-margin?

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Stuart Bradie, KBR Inc - President & CEO [62]

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Again, I think we've been consistent since day one, a low 20%s business, and the predictability is difficult on the mix quarter to quarter. But I think over the piece, I think it's a -- that guidance reflects those low 20%s margins.

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Brent Thielman, D.A. Davidson & Co. - Analyst [63]

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Okay, thank you.

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Operator [64]

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And that concludes today's conference. We thank you for your participation. You may now disconnect.

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Stuart Bradie, KBR Inc - President & CEO [65]

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Thank you.