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spk00: Good day and welcome to the KBOR third quarter 2020 earnings conference call. This call is being recorded. As a reminder, your lines will be in the listen only mode for the duration of the call. There will be a question and answer session immediately following prepared remarks. You will receive instructions at that time. For the opening remarks and the introductions, I would now like to turn the conference over to Alison Vasquez. Please go ahead.
spk01: Thank you. Good morning, and thank you for attending KBR's third quarter 2020 earnings call. Joining us today are Stuart Brady, President and Chief Executive Officer, and Mark Sopp, Executive Vice President and Chief Financial Officer. Stuart and Mark will provide highlights from the quarter, a market update, and present our updated guidance. 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 two. 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 Form 10K, available on our website. I will now turn the call over to Stuart.
spk05: Thank you, Alison, for another perfect lead-in. And thank you all for joining us this morning. I would like to start on slide four. You have seen our sustainability platform before, so nothing new here. This has now been rolled out globally under our expanded zero harm courage to care branding. And I'm very pleased to report that the take up across the organization has been way above expectation, huge enthusiasm. At KBR, we kick off every meeting with a zero harm moment that focuses in on one of the 10 pillars. And this really allows our people right across the organization to promote and educate others on what they are particularly passionate about or what is directly relevant to them and their business today. So from an ESG perspective, this has really facilitated a cultural shift with Turing KBR towards a far more aware, responsible, and sustainable company, which takes us nicely onto slide five. really covering mental health and fitness. I mean, this is a really important topic today, as I'm sure you're all aware, particularly with COVID-19 and the associated potential isolation. I guess the different pressures that this creates for some, perhaps working from home with homeschooling, people are experiencing some burnout, etc., which, of course, can increase the general anxiety and, of course, stress levels. So KBR, we formed a Global Mental Health and Wellbeing Task Force. This is led by Jenny Miles, our Chief People Officer, to ensure our people are supported in these uncertain times. As you can see, our strategy focuses on creating a positive culture and equipping our people with the knowledge and, of course, the awareness and the resources to ensure that together we're all focused on both mental and physical fitness. Personally, I really like thinking about mental fitness, similar in a way we think about physical fitness. You know, there are times when we all feel fitter and times when we all feel less fit. And I think this approach really destigmatizes mental health in that we're all on the curve and our objective is to improve mental fitness, much like we typically want to improve our physical fitness. We're also lucky at KBR because we have some really strong in-house capability. And a couple of weeks ago, our people organized a global town hall with experts from our POTIV program to talk about the work they do to support mental health and fitness for the U.S. Special Forces. And they shared practical tips and advice, of course, on ways each of us can also maintain a healthy balance. And it was really rewarding to see the level of engagement across the globe for our leading health and fitness experts to add value internally, as well as the great work they do externally. Onto slide six. We're going to start with some third quarter key takeaways. KBR continues to prove resilient in these volatile and difficult times. Our strategy of moving upmarket into higher end offerings is really paying off. The growth and momentum in our space, human health performance, technology, science and cyber, and high-end technical defense engineering businesses is clearly evident in the quarter, which also aligns well, of course, with the introduction of Centauri to the KBR family. And I would like to formally welcome our new colleagues as we close that deal on the 1st of October. Our people do an absolutely amazing job, and they truly deliver operational and execution excellence. The commitment to the WIC mission is unwavering. And from a numbers perspective, this, I think, is reflected in the margins. And without exception, this quarter, all segments met or exceeded EBITDA margin targets, a terrific result. Earnings and cash were once again strong. We have great momentum across the business and the robust book-to-bill, particularly in GS and TS, will help ensure this momentum and our resilience continues. Our year-to-date performance, combined with the closing of Centauri on the 1st of October, allows us to raise EPS guidance. And once again, our teams across the world knocked it out of the park on cash, so we'll also be increasing our cash flow guidance. More on this later from Mark. Coming out of the gate in Q4, post-funding Centauri, our leverage is kind of at the bottom of our range, and thus our balance sheet strength combined with our attractive risk profile and our solid book of business, of course, gives us deployable optionality. Now onto slide seven. This is our strategic model. It's the same one we presented at our investor date in May 2019. It seems a long, long time ago now, especially with all that's happened this year. So we felt it might be useful just to refresh people's memories. In short, our people are at the centre of all we do and who we are. The quality of talent and the culture of collaboration, team ethos and mission focus is very powerful and hugely uplifting. Our people do things that matter and they care. Our core business remains robust, as you've seen, and resilient. And we have attractive long-term contracts and strong domain expertise in solid areas of the market that really help ensure that this will continue. Our breakout growth factors and strategic themes remain intact. I think this is important as strategic discipline is essential in volatile times. When we presented the Centauri acquisition, the strategic fit and alignment to defense modernization and space superiority should have been clear. We continue to move up market and our future focused on attractive and well-funded end markets. I will not read all the bullets, but the takeaway here is that our strategy remains valid and we are executing that strategy. As you can see from the wheel, the balance across our areas of focus is absolutely terrific giving access to multiple funding streams and customers across the globe and our customer base today is around 80 percent government and 20 percent commercial the risk profile across our business is consistent and it really delivers more predictable learnings and of course excellent cash conversion as we have demonstrated We are well positioned and continue to secure work in attractive end markets that support continued growth. So let's now have a look at the market drivers in our key end markets. So on to slide eight. So we'll start off with space and mission solutions. The growth in this segment year on year has absolutely been terrific. We've seen attractive on-contract growth as existing programs perform well across both NASA and DoD. As you can see on the right, we continue to win contracts to perform high-end IT and data analytics solutions. Space and Mission Solutions is about a billion-dollar revenue business, and thus having a backlog of 2.3 billion sets us up well for the next few years. From a market outlook perspective, much like we saw in the cyber domain, we continue to see greater collaboration across space. Our position within NASA and our presence via Centauri in military space and intelligence aligns well. Our human health and performance contracts for NASA and the special forces fits within this business, and this we believe is also a strategic growth factor for KBR going forward. On to slide nine, defense systems engineering. Again, double-digit growth year on year, a brilliant book to build in the quarter, and all in really high-end technical areas. You can see on the right a few highlights, R&D on next-gen electronics, systems engineering for unmanned naval warfare, and R&D for missile systems. This is high-end work for emerging defense modernization needs. As we've explained before, this is a business that thrives on IDIQ contracts via customer intimacy. Lots of smaller scale but limited competition pursuits and projects. Very few protests as a consequence. The annual revenue is again about a billion dollars and the backlog of $2.1 billion again sets us up well going forward. From an outlook perspective, the near-peer threats are not going away and are arguably increasing. We are lined up well opposite national security priorities, and this is enhanced, of course, with the introduction of Centauri. To be clear, the numbers and the contract wins, et cetera, on this slide are only for our existing defense system engineering business and do not yet reflect Centauri. Onto slide 10, logistics. This, I think, is our least well-understood business area within KBR. The investment community has a tendency to relate what we do here holistically to what KBR was doing back many years ago in the Iraq war days. The shape of this business is very, very different today. The focus is very much on recurring readiness and sustainment activities funded by O&M budgets. Through this, we have seen a major reduction of business mix funded by OCO. Our book to bill in the quarter of 1.4 was very, very pleasing and supports continued momentum in the readiness and sustainment areas. And our recent UA boss win is not yet reflected in the backlog. You can see this on the right-hand side, modernizing and upgrading automated fuel handling systems, increasing the volume as we transition onto NORFCOM. Both of these are all about readiness, training, et cetera. The long-term contracts in Saudi, Europe, and Djibouti are focused on smart, digitally-enabled, sustaining activities. The outlook for KBR is far more predictable as we have transitioned to more O&M funding streams. The complexity has increased, which suits our capabilities with the changing supply chain environment and the demand for more efficiency and predictability via more digitalization. Trip levels have and could likely continue to reduce in the Middle East, which impacts, of course, our level of effort. But our proportional exposure to this has reduced significantly, as highlighted earlier. Also, the margins associated with this business are in line with our overall outlook and not at the low end, as you may presume. The revenue of this business for KBR is just over a billion dollars. And again, the backlog and strong bookings sets us up very well for the future. Onto slide 11. Our international GS business is a clear differentiator and is just under a billion dollars in revenue. As you're aware, the business is underpinned by sizeable, very long-term, high-performing PFI contracts, which is reflected in the backlog. A very strong, predictable and resilient business, which I think is particularly important as the UK manages through not only the challenges of COVID, but also Brexit. In Australia, defence betting has actually been increased in recent times as the Australian government looked to advance economic recovery while modernising their defence forces. In Australia, our business is at the forefront of software development and implementation for mission planning, virtual and augmented reality, sustainment, systems engineering and naval training. As you can see, the growth year on year in Australia has been very impressive, and recent wins on the right set us up nicely as we move into next year. Now onto slide 12. With our announced exit from lump sum EPC, including direct higher construction, and our exit from low margin commoditized services, we will concentrate today on the realigned technology solutions. As we stated previously, we forecast this business to be circa $1 billion in revenue in 2021, with an overall margin in the mid-teens. And we reaffirmed that again today. As you'll see in a moment when Mark takes over, the heritage IP technology area of this segment continues to deliver amazingly strong margins in the quarter and had a book-to-bill of 1.3%. With this positive booking momentum, margin performance, and a combined backlog of $1.9 billion, we feel increasingly positive about our strategic shift and realignment to more higher-end technology-enabled services. We're also well advanced in removing significant overhead costs. From a market perspective, the drive to lower emissions, product diversification, energy efficiency, and more sustainable technologies and solutions is clear. The demand for our technologies across ammonia for food productions, olefins for non-single-use plastics, and in refining for product diversification and more green solutions to meet tighter environmental standards continues. A strategic shift into IP-enabled maintenance is also gaining traction, and we continue to see increasing activity across our advisory portfolio, particularly in energy transition. And we've highlighted some recent successes on the right to demonstrate this. On to slide 13. In summary, these market dynamics culminate in a very, very healthy pipeline for KBR. with significant pursuits distributed across our portfolio. As I've mentioned previously, 2020 and 2021 are low-recompete years, enabling increased focus on winning new business, and the team is absolutely laser-focused on this objective. We have almost $20 billion in pursuits that will be awarded over the next six to 12 months. I mean, this is sort of three times annual revenue run rate, a very healthy metric indeed. And this excludes Centauri, which we'll add in the fourth quarter. So in short, it's all good. So I will now hand over to Mark, who will walk you through the numbers in a little bit more detail.
spk03: Mark. Terrific, and thank you, Stuart. I'll pick it up on slide 15, which lays out our key financial performance metrics for the quarter. So overall, as Stuart summarized, the business is tracking on or ahead of plan on each of these key metrics. Our people, our strategy, and our balanced portfolio of businesses have collectively shown resiliency and predictability in the current environment, enabling scale in the business, healthy profitability, strong cash flow, and continued bookings which support growth targets going forward. Revenues have grown remarkably well in our higher-end solutions and services in our government business that Stuart just summarized. And this is offset by some reduction in contingency support driven by changes in military up-tempo in select areas. This shifting mix to more up-market work is good for our business as these areas are more consistently prioritized and funded and hence less volatile. On exiting commoditized energy, we are seeing measured reductions in revenues as expected, primarily from the de-risking changes we made in our energy business earlier this year. This is also good for our business as we shift to a greater mix of higher margin technology-led solutions. As you see, profitability is consistent year-over-year at 9%, with annualized EBITDA running at about $500 million. This scale of profit in low-risk, well-demonstrated business areas certainly boded well in our recent credit offering and credit upgrades. Incidentally, this 9% is consistent with the 2021 outlook we recently gave with the Centauri acquisition announcement back in August. Adjusted earnings per share was 44 cents for Q3, where most non-operating items were pretty much consistent with expectations. Cash flow is really good again in Q3 at $90 million and representing continued strong income to cash flow conversion. Adjusted year-to-date op cash flow is circa $270 million, which now exceeds the total result we had last year and is the basis for the bump up in guidance that I'll cover here in a moment. I'll add all segments are contributing nicely to strong cash flow processes and, of course, the results you see. We complemented all of this with good bookings across the business both in quantum and in quality for the quarter with a book-to-bill exceeding 1.0, rounding out nice balance across project execution, profits, cash flow, and winning new business for the future. On to slide 16 for segment results. Government was up slightly over last year, as Stuart said, with double-digit growth in both space and defense systems engineering, with the offset again being the contingency component of logistics. The main driver for the contingency logistics offset has been lower levels of troops in the Middle East. and delay in transition to our role in Afghanistan under Log Cap 5 due primarily to the COVID situation. However, the Northern Command component of the Log Cap 5 win is ramping up nicely. Furthermore, most of our work in NORTHCOM is funded out of the O&M accounts of the DoD, just like Stuart indicated earlier. And this is important as these activities are part of the baseline defense budget and thus more stable and predictable. Moving over to technology, tech had a great quarter of new bookings and deliveries with a high concentration of license mix in recent wins. This led to significantly better margins this quarter in contrast to a higher mix of proprietary equipment sales in Q3 of last year. That drove higher volume but lower margins last year, as you might recall. Energy is transitioning and performing as planned. We are gaining traction with our advisory tech-led industrial solutions and high-end professional services offerings here and are posting nice margins here as well. At the same time, we are ramping down the commoditized activities and overhead costs in accordance with the decisions we made earlier this year. These elements working together delivered modest profitability in Q3 as we have managed through this transition and in accordance with how we've guided. As Stuart mentioned, our outlook for new tech solutions in 2021 is roughly $1 billion in revenue with mid-teen EBITDA margins. You can see the progress we have been making toward this goal right here on this chart. Here you can see the combined EBITDA of TS and ES this quarter was 37 million. That's just about 150 million on an annualized basis and right in line with the 2021 implied profit outlook. This reflects the attractive profit production in our heritage tech solutions business, the profitable synergistic elements of the ES business that we are transitioning over to TS, and the significant overhead cost reductions we have been making that wraps up my comments on a good stable quarter plus the progress we have made in reimagining tech solutions and move on now to slide 17. here are just a few points on the centauri transaction just reiterating stewart's earlier comments we are super excited about the strategic and cultural fit we are seeing with this business The integration efforts are already revealing remarkable areas where our combined capabilities can generate value for our customers, KBR, and of course also our shareholders. The acquisition catapults KBR to a leadership position serving the military and intelligence communities with leading space and other higher technology sticky offerings that directly enable some of the higher priority national security programs today. These same areas are highly synergistic with our leadership position at NASA and its connections with the commercial space community, particularly as all of these areas together form vital components of the integrated U.S. Space Force strategy going forward. We closed the transaction on October 1st, the first day of course of Q4, and completed the associated financing transactions with excellent terms and rates. One of the financing elements, the bond offering, closed in late September and did cause a bump up in our reported cash and debt balances at the end of Q3. That will, of course, all true up with the full transaction effects in Q4 that you'll see in a couple of months. As we will have one full quarter of 2020 with Centauri, we are bumping up our EPS and cash flow guidance to reflect its inclusion. together with the incremental financing costs going forward. I'll hit more of that in a moment. Consistent with past practice, we are excluding from adjusted EPS guidance the one-time deal costs and the ultimate non-cash amortization expense for purchased intangibles, which will be determined later this quarter. Now onto slide 18. Here I'll reiterate the overall capital structure for KBR today is excellent. And this enabled the Centauri acquisition at an opportune time, and which also leaves us in a strong liquidity position after completing this deal. Post-Centauri, our leverage is at the low side of our targeted net leverage ratio. This, coupled with predictable and attractive future cash flows, allows for ongoing capital deployments. Our priorities are unchanged with deploying excess capital in this regard. And finishing up on slide 19, we have performed at or above expectations in and through Q3 this year, particularly in operating cash flow. We now add Centauri for the fourth quarter, which is expected to be accretive to adjusted earnings and cash flow in line with what we announced back in August. We are raising adjusted EPS guidance to $1.60 to $1.80. and raising adjusted operating cash flow to $270 million to $290 million. So that sums up the financial picture. Now back to Stuart to finish up his remarks.
spk05: Thanks a lot. Brilliant. I'll move on and I'll finish up on slide 20. Another strong quarter across all key metrics, earnings, cash, book to bill, and margins. I think the year-on-year growth in high-end differentiated areas that sit opposite national security and defence priorities with strong bipartisan support is terrific. And Centauri is clearly additive to this. You know, we gave you colour on the backlog and outlook across the different areas. right across our business that are extremely well balanced, well positioned in attractive markets, and have a book of business and a robust pipeline to set us up well going into next year and beyond. For Centauri, as Mark described, our balance sheet is healthy, and we have retained deployment optionality. When we announced the Centauri deal, we gave you a 2021 pro forma outlook. Over 80% of our customer base would be government and 20% commercial. At a group level, we'd be heading towards revenues of around $6 billion, with group EBITDA margins circa 9%. And as Mark said earlier, this margin is in line with what we achieved this quarter. Centauri now is obviously closed. The new TS is well advanced with a clear line of sight to deliver, as we have stated. and with our strong bookings momentum and continued strong operational and execution performance. And although this is not formal guidance, as this comes out obviously for 2021 next quarter, but from what we know and we can see today, the outlook we gave you with the Centauri acquisition holds. So thank you for listening, and I will now hand it back to the operator who will open the call up for questions. Thanks.
spk00: Thank you. If you wish to ask a question at this time, please press star one on your telephone keypad. Please ensure the mute function on your telephone is switched off to allow your signal to reach our equipment. We will pause for a moment to allow everyone to signal. We will now take our first question from Jamie Cook from Credit Suisse. Your line is open. Please go ahead.
spk02: As pertains to the government solutions business, understanding the backlog's been there and the market outgrowth that you guys have talked about on the slides have been appear robust over the longer term. But the organic growth of the government solutions business over the past couple of quarters on the top line has been a little lower than expectations. understanding some of the things that you pointed out in the slides, but do you view the organic growth trajectory of the government solutions business? I mean, should we expect it to sort of accelerate from here, or how do we think about that over the next sort of 12 to 18 months? And then the ability to, you know, harvest potential upside on margins. Thank you.
spk05: Thanks, Janet. I think that this is a real good news story if you look at the actual mix of how the revenue has flowed through. As I told before, the logistics business, I think, has been a little bit misunderstood. I think its exposure to OCO funding, which is more volatile, has obviously played on people's minds. And as you've seen through time, as we've changed the business mix at KBR, Our exposure to OCO has changed significantly. So the organic growth coming through on our science and space business and our engineering, you know, our systems engineering business is fantastic. And you can see that in the numbers as we present it. And that mix and that growth in that area of business, of course, has really sort of I guess, offset any potential reduction that we've had with troop levels coming down in the Middle East. And at the same time, we've actually transitioned on to NORTHCOM, which is around operations and maintenance funding, as Mark said. So again, far less volatile and far more predictable going forward. So this is quite a significant shift. We'll give a bit more colour on the quantums around that shift into next quarter, but it's a really, really good news story. And I think the The growth momentum we have in our high-end engineering and space and science businesses is evident, and we expect that to continue. You know, the pipeline would back that up. And then you have the introduction of Centauri coming in, and I think the ability to obviously, you know, drive synergy in the areas is, you know, I managed to get, you know, around the Centauri businesses as it closed in early October, and I'm super excited about the quality of individual and the programs that they're on. I think there's probably more synergy opportunity there than we really envisaged as going into this deal. I think all of that bears well for the future, Jamie. I think, you know, we'll be talking about overall growth going forward, organic and acquisitive, of course, but it all culminates in an overall growth pattern that I think really supports the strategic shift up market. And I think you're seeing that coming through now in the numbers.
spk02: I guess, Stuart, and then one more question. Just on the technology, energy solutions business on a go-forward basis, I get a lot of questions from investors that think about this portfolio sort of in the traditional energy focus relative to maybe greener energy or energy transition. So can you talk about just how we should think about, you know, the key drivers of the technology solutions business and whether it can be sort of greener, more energy transition versus the traditional energy view of KBR historically. Thanks, and I'll get back in queue.
spk05: No, Jamie, that's a terrific question and it gives me a great opportunity to say that that's exactly how you should be thinking about KBR in this context. The tech business itself, as I've laid out in the slides, is driven by three major elements. One is food production around ammonia, which is all around a sustainable future for the planet and is driven normally by people moving into middle class and GDP growth around food production. And that business has been terrific over many, many years, and we're arguably the world leader in that space. And then secondly, around olefins, which is really plastics, non-single-use plastics, but they're used in, again, buildings and cars and things like that, that, again, are more driven by people moving into middle class and GDP growth. So, again, the dynamics are not really driven at all by traditional oil and glass. And then The third one, which is all around green, is really what we do in sustainable technology around refining. And I've talked many times about the technologies in that area that we have developed, that we're market leaders in, and not in all, of course, but in a number of our technology portfolio there. And we continue to see very strong demand there. And at the same time, we've put a lot of effort into positioning our advisory business, and that's all around advising governments and companies about energy efficiency, reduction in carbon, and also energy transition and hydrogen being a key component where We do think the transportation medium for hydrogen going forward is likely to be ammonia. And we've just talked about our position there from a technology perspective. And once you store hydrogen, the world leaders in hydrogen storage happen to be NASA because of how they fuel their rockets. And of course, we're heavily engaged in that side as well. So we've got A lot of critical components we can bring to bear, looking at the way the world evolves as energy transition sort of gains momentum, which is happening today. And then we talked a little bit more today about our IP-led or technology-led industrial maintenance business. And what that really means is that we have very proven digital solutions that we can actually remote monitor facilities remotely. you know, from a central hub, and we can actually advise customers on how to enhance production and throughput and reduce energy, et cetera, because of our knowledge of the IP. And we're seeing a lot of traction around those services. So everything that's happening in UTS is all connected to technology and future-facing, I guess, aspects of energy transition and climate change. So it's very much moved away from your traditional energy focus or how you would have historically thought about KBR, and that's a key part of the message here.
spk02: Okay, great. Thank you. I'll let someone else ask a question.
spk00: We will now take our next question from Toby Summer from Trust. Please go ahead.
spk04: Thank you. If we get a federal spending decline following all the stimulus debt accumulation, which aspects of your government business do you feel has the best prospects for continued growth and which ones are you less confident about?
spk05: I mean, I think, Toby, I think there's a lot of fact patterns there that, you know, from an overall business perspective, you've got to remember we're differentiated with our international government profile that actually is not impacted by what's happening in the U.S. today, nor really is a tech business. And when you come back into what we're looking at across what we're doing for the DOD and NASA, I think really we've tried to demonstrate with the presentation today we're very much lined up opposite national security priorities. You know, our people do things that matter. And, you know, we're very proud of that fact. We're very much at the operational end as well of a lot of what we do. And, you know, those assets are not going away. You know, supporting the International Space Station is not going away. So I really think that the one area that probably is – so I'm not really worried about the mainstay of the business, and I think we've got long-term contracts that underpin that performance. I think we're – you know, defense modernization, space superiority, and growth in the intelligence community is going to continue. Those near-peer threats are not going away. The area that may change, depending on a reduction in government spending, may well be what happens in the Middle East and Afghanistan. And I think our long-term strategy of reducing our exposure to OCO funding, again, I think is paying off because we've got a far more predictable outlook than we've had. And again, when we get to Q4 and looking at our Our guidance for next year will give some color as to the quantums involved there, but it won't be material going forward in it. So that would be the area, but I think we've mitigated that risk significantly.
spk04: Just sort of a question about the medium-term growth algorithm for the company. Could you comment on that over sort of a – go-forward basis, you know, two or three years in
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