Kbr, Inc. Q4 FY2020 Earnings Call

Good day, and welcome to KBR Incorporate Fourth Quarter 2020 Earnings Conference Call. This conference is being recorded. As a reminder, your lines will be in a 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 opening remarks and the introductions, I would now like to turn the call over to Alison Vasquez, Vice President of Investor Relations. Please go ahead.

Good morning and thank you for attending KBR's fourth quarter and fiscal 2020 earnings call. Joining us today are Stuart Bradie, President and Chief Executive Officer; and Mark Sopp, Executive Vice President and Chief Financial Officer. Stuart and Mark will provide a recap of the year, a market update and will outline our 2021 guidance. After these remarks, we will open the call for your questions. Today's earnings presentation is available in the Investors section of our website at kbr.com. I would like to remind the audience that this discussion may include forward-looking statements reflecting KBR's views about future events and their potential impact on performance as outlined on Slide 2. These matters involve risks and uncertainties that could impact operations and financial results and cause the Company's actual results to differ significantly from our forward-looking statements. These risks are discussed in our most recent Form 10-K available on our website. I will now turn the call over to Stuart.

Thank you, Alison and thank you all for joining us today. I will start on Slide 4. And I'll start as always with a sustainability moment. With the maturity of our ESG processes under program in general, we are now able to measure our carbon footprint across our global operations including air travel. This in turn allowed us to achieve carbon neutrality in 2019 and set in motion a continued improvement program towards achieving a net-zero target by 2030. Sustainability at KBR means, however, more than just behaving as a responsible corporate citizen, as critical as this is. We also have IP, technology and deep expertise that we can and are deploying for our customers across the globe, helping them decarbonize, move towards a hydrogen economy, become more energy efficient, etc. really enabling our customers to meet their own sustainability goals and commitments. Our recent announcement on the Mura plastics-recycling technology is another great example of a solution we license that enables a circular economy and continues KBR's value-add journey, both through sustainability and for our stakeholders. We believe Mura Technology is a binder and I would encourage you to read our recent releases if you've not seen them. This is one of the reasons we are changing the name of this business area to Sustainable Technology solutions. Our ESG goals have been and will continue to be part of our exec comp program. I would also direct you to our website, but our latest sustainability report was published in December 2020. This takes us nicely onto Slide 5. 2020 was an incredible year. We did not allow this dreadful virus to hold a strategic process. Arguably, we leaned forward and moved faster. We completed the Centauri acquisition moving us into the intel and military space of scale. Our Science & Space business and Defense & Intel businesses organically grew above market and the International business performed brilliantly. Importantly, we increased our backlog and our long-term contract base. Our early move out of commoditized energy and our focus on Sustainable Technology has proven to be excellent timing. The excitement and increasing market activity across our technology portfolio is reflected in the high level of licensed work, driving margins up on the growth and backlog with three sequential quarters of strong book-to-bill. As I've said already, we've also added to our technology portfolio with the addition of Mura and with ammonia gathering real momentum as the hydrogen fuel transport, our Sustainable Technology portfolio is very well positioned in high growth areas. We also opportunistically touched the shares in Q4 when we found that volume was significantly misunderstood. As I said, 2020 was a remarkable year and one that proves that our business model is both resilient and cash generative. The numbers speak for themselves and, of course, Mark will give more detail below the group results in a moment. One of the several key takeaways today is that we grew in areas we were really targeting. Good for KBR and it's good for our stakeholders. This is in higher end and technically differentiated businesses, double-digit growth in both Science & Space and Defense & Intel. Our book-to-bill has gathered momentum through the year and closed at 1.2 for Government Solutions and 1.4 for Tech, mostly in the area of Sustainable Technology as it relates to tech, which we all know is a very hot market. So, off the back of a strong 2020, positive bookings and favorable market fundamentals, we are pleased to announce formal guidance for 2021, which is underpinned by more than 70% of work under contract today and has greater than 20% EPS growth at the midpoint. We will now give you some color on the market outlook across the business segments that will culminate with our pipeline data. So on to Slide 6. So, we'll start with Defense & Intel. Strategically, we are lined up opposite national security and defense modernization priorities. I will not read out all the words on the slide as you've seen these before. But I will reiterate that there is continued strong support for investments in these critical areas. With 23% growth in 2020, the introduction of Centauri and an overall book-to-bill of 1.3, which importantly, also increased our average contract tenure. This all lines up well for continued growth, not only in 2021 but beyond. Some key wins are shown on the right-hand side in the areas of rapid prototyping, R&D, and operationalizing national space capabilities, which should give you a good sense of the high-end capability that now sits within KBR. Our recent announcement of TENCAP reinforces this and shows the value that Centauri brings to KBR. On to Slide 7 Science & Space, strong growth in 2020, all organic and mostly on contract growth across NASA and in the human health performance areas. This is a direct reflection of execution excellence and the value-add our people bring. The market outlook for space, in particular, is starting to be a little clearer. There is strong momentum behind closer cooperation between NASA, Space Force, and the intel community. A recognition that these agencies are stronger together and that collaboration will drive faster progress, more innovative solutions, and better value. Having a footprint at scale across these three important constituents, military, intel, and civil, positions KBR nicely, especially with deep domain knowledge in areas like space domain awareness, launch support, etc. and, of course, our position in R&D. These dynamics further affirm our space superiority strategy. On the civil side, the new administration looks to be supportive of Artemis, albeit with a longer schedule. Although KBR's exposure is non-material, directionally, this bodes well, especially given our position in human space flight and health and human performance. We also expect to see a greater emphasis on agencies that support the climate change agenda of the Biden administration, agencies like NOAA and USGS. You can see from the recently announced recompete win for USGS on the right that KBR is well positioned to take advantage of such opportunities. Our operational focus and domain expertise gives us a very stable foundation, and with low recompetes in 2021 and a very active pursuit pipeline, the opportunity for continued momentum is clear. It's also worth mentioning, although still not at material levels, there is increasing engagement with commercial space, especially as they start to put humans into their missions, which we view firmly as a growing strategic opportunity. On to Slide 8, Readiness & Sustainment, we have renamed our logistics business to better reflect what it actually does today. We have repositioned this business towards O&M funding, and this is a key message of today. This business did have some headwinds coming into 2020. In 2019, you'll recall, we had disaster relief revenue from Tyndall Air Force Base. We have said that decreasing OCO-funded revenue in the Middle East was largely replaced with increasing work on North Com, which is focused on supporting training, readiness, and sustainment. In addition, we landed a few new sustaining programs overseas during 2020, expanding our existing footprint. Our base operational support work across the world, again, sustainment and O&M, performed exceptionally well with increasing digitalization and automation driving efficiency. We think this will continue into 2021 and beyond. The work we do on prepositioned stock also delivered exceptionally well for the Marines and the Army, again focused on readiness. Again, leveraging highly digital smart solutions to plan, schedule, and maintain these critical assets. We have moved quickly to adopt highly agile supply chains due to COVID and other factors. Our global presence and digitalization help us deliver, and again, this will continue to evolve. Not only is the fact that the volatility risk around the business reduced to less than material levels. This is a key message, but in addition, quarter-on-quarter growth through 2020 has created significant momentum in this business. Together with a book-to-bill of 1.3 for the year and recently announced sizable wins at year-end, which we've highlighted on the right, readiness and sustainment is very well positioned going into 2021 and beyond. On to Slide 9, International, this is more of a mixed bag. Our growth in Australia has been nothing short of sensational. It has mostly come via organic growth and a bit from one modest acquisition and enabled training area in 2020. Increasing spending, increasing scale, and Australia enters 2021 with above-average moments of growth expectation, especially in higher and technical areas where we have strong domain expertise. Areas like mission planning IT, augmented reality training, defense infrastructure, and specialist lifecycle support as highlighted in the recent wins on the right. Our UK businesses which you're well aware is underpinned by sizable base operational and maintenance contracts with long tenures. These mitigate volatility in the UK because we see the UK moving a little bit slower. That said, there will be increased funding into areas like Cyber, Space, and Intel due to the decoupling from Europe. Now on to Slide 10, Sustainable Technology; we have presented a few times recently on a Sustainable Technology portfolio, the associated market, and the immense opportunity. We have described in greater detail what sits within the new Sustainable Technology solutions business. We have given you a standalone outlook for this business in '21 of just over $1 billion with margins in the mid-teens. From this base, we also laid out the path to doubling EBITDA by 2025. I'll say that again, doubling EBITDA by 2025, and back this up with the three quarters of very strong book-to-bill, strong margin performance demonstrating cost reductions in 2020 as we exited legacy energy. Our backlog supports the forward momentum of this business, and our technology portfolio aligns well with what are really hot market fundamentals. The demand for ammonia for coal-fired power stations and hydrogen transport fuel being perfect examples. Further, we have recently announced continued growth in our portfolio with the introduction of Mura plastic-recycling technology. Climate change, decarbonization of existing assets, moving to the hydrogen economy, circular economy solutions are all real and not going away. KBR has significant IP and know-how that really differentiates us going forward, and we see growth in revenue and in margins happening concurrently beyond 2021. On to Slide 11. In summary, our pipeline some key facts on the right before talking overall volume numbers, it is a fact that our recompete win rate is 95%, again, driven by exceptional execution and the commitment of our people, but it's also a fact that 2021 is a little recompete year for KBR including Centauri. Thus, it is logical system that most of the near-term pipeline opportunities are additive. It is also fast in 2020; the backlog in government including Centauri and in technology grew 20% and 22%, respectively, underpinning continued momentum and extending contract tenure well beyond 2021. It is also a fact that the value of pursuits in the proposal negotiation phase of our pipeline is over double our current annual revenue, and it's also a fact there are a number of pursuits in the pipeline they're in excess of a $1 billion each, but we've also got a healthy mix of over 150 different pursuits, which are greater than $100 million balanced nicely across our businesses. So in short, we are very well positioned not just for 2021, but beyond. I will now hand over to Mark to cover the numbers in a bit more detail, tough on capital deployment, and of course finish up with the 2021 guidance in detail.

Great. Thank you, Stuart. I'll pick up on Slide 13, which lays out our key financial performance metrics for 2020. As I'm sure you gathered from Stuart's remarks, we're really pleased with our achievements this past year, reflecting the incredible efforts of our employees around the world. Some reflection here since our transformation, we prioritized derisking the business, and in so doing, producing stable, predictable financial results, including strong cash flow, very important. We also set out to put legacy obligations behind us and begin deploying cash flow to move KBR upmarket and also tap other value-creation opportunities. I think fiscal 2020 and these charts themselves demonstrate our commitment and our ability to do all of these things. Our shift to sustainable technologies early in 2020 yielded a derisked exposure to traditional energy markets, and as you heard, places us firmly in the new economy with attractive and highly sought-after offerings in important areas like energy efficiency, decarbonization, energy transition, circular economy and gateway technologies to hydrogen energy solutions of the future. This produced a synergistic business with high backlog, strong track record, attractive margins and also strong free cash flow. But building on this, we improved the capital structure during 2020 as well, which enables lower cost of capital and greater flexibility for deployments going forward, plus more sheer liquidity and firepower. And with those improvements, we reset expectations early in 2020 and have produced strong predictable core results through the year and positioned the Company for growth in '21. For the year, revenues, EBITDA, and adjusted earnings per share were up modestly over last year on stable margins as expected, which is a clear demonstration of our business model resilience, strategic action, strategic discipline, and also cost management. Cash flow was strong and up nicely from last year and well above our targeted operating cash flow to net income conversion factor of one. Our transformed business now has low capital intensity, low risk and produces attractive and predictable cash flows, just like we set out to do. Just a couple of remarks on the next slide, Slide 14, Q4 was as expected. You'll note, adjusted EBITDA grew 15%, demonstrating good momentum looking ahead into 2021; and margins were up to 9%, consistent with the level we set as what to expect for '21 when we announced the Centauri acquisition a few months ago. For Q4, Centauri is reflected for the full quarter and did contribute to margin improvement. Corporate G&A was seasonally low in the quarter, pretty much as we expected, effectively offsetting the effect of the lower energy segment margin profile. On adjusted cash flow, we were hot coming into the fourth quarter and improved working capital effectiveness all year, and that leveled off in the final quarter. No change in fundamentals and as you'll see in guidance, another strong year is expected for 2021. As Stuart said, backlog has been trending really well, and we finished 2020 with both government and technology up 20% year-over-year, a fantastic result that gives greater confidence for the future. On to Slide 15 and segment highlights. I'll spend a little bit more time here. I want to point out we're really seeing an important shift in our government business. Stuart highlighted this, but it’s worth digging just a little bit deeper. As we’ve invested more in upmarket areas, we produced strong organic growth across our Science & Space and Defense & Intel areas, as Stuart said a moment ago. Increased presence and growth are important here as we see these areas being more emphasized from a national security perspective. We expect faster streams of growth in these markets looking forward. And quite frankly, we're not alone in that view. We also grew in operations- and maintenance-funded readiness and sustainment activities that Stuart also outlined. These areas of growth offset contraction in contingency-funded logistics this past year, which was circa $300 million across Tyndall and our Middle East contingency work. Dependency on Middle East contingency work has now decreased significantly as a result, which I'll quantify here in a moment relative to '21 guidance. Again, this decrease has now been offset by strong growth in Science & Space, Defense & Intel, O&M-funded sustainment work as well as the addition of Centauri, which is high-end work in and of itself. The result of all this will be low single-digit mix of contingency work in our portfolio, replaced by upmarket, high-priority recurring work that can predictably deliver sustained earnings visibility for many years out. Over to Technology, the team did an extraordinary job navigating for COVID and delivered impressive profitability; and perhaps, most importantly, further progress introducing advanced technologies, which are enabling our customers to produce end products in a safer, more environmentally responsible manner, a driving factor behind renaming this business Sustainable Technology. The best evidence of customer demand is the bookings production this past year. And as Stuart said earlier, we generated backlog growth of over 20%. Further evidence is the margins, 29% for the year on strong licensing mix. This business has continued to expand its proprietary technology impact in the process technology market, offering sustainable solutions that are in demand to meet growing commitment to carbon reduction and end-product flexibility. All of this bodes well for a strong '21 and beyond. Finishing up with energy, no surprises here, revenues are tailing off as we downsize for 2021. We were profitable as committed, with lower margins on commoditized cost reimbursable contracts that are now no longer being pursued. Now over to Slide 16 and I'll shift over to capital matters. It's really pleasing to see how the strength of the Company's cash flow production is becoming much more evident. We finished the year with a healthy net leverage level at 2.4x, after having just completed the largest acquisition in the Company's history. Furthermore, we made about $50 million in buybacks in the fourth quarter, consistent with our strategy to balance capital allocation across growth, and also return of cash to shareholders. This has also resulted in increasing our regular dividend by 25% earlier in 2020. The outlook for balanced and material capital deployment allocation is terrific going forward, and our prioritization of those deployments is unchanged. Finishing up on Slide 17, our guidance for 2021 is comprised of revenues in the range of $5.8 billion to $6.2 billion, with over 70% of that work secured in backlog today; an adjusted EBITDA margin of 9%; adjusted earnings per share of $2 to $2.20, representing 20% growth over 2020 at the midpoint; and adjusted operating cash flow of $280 million to $320 million. So here's some color on the components given the changes we've made in the portfolio. On the government side, we're targeting healthy revenue growth associated with the full year of Centauri; new wins and momentum discussed earlier, particularly in the Science & Space, Defense & Intel readiness, and sustainment international areas. Importantly, our guide includes just roughly $200 million in expected '21 revenues from Middle East contingency operations compared to about $450 million in 2020 and $600 million the year before in 2019. So I want to repeat that. Our revenue guide includes only $200 million of the Middle East log cap activity compared to $450 million this past year and $600 million the year before that 2019. There is potential upside here, but we think it's best to remain conservative for now. Again, an important takeaway is the magnitude of contingency work being replaced by more core, recurring, less volatile defense, intel and space work has taken place. And on the margins front, for government, we're continuing to target annual EBITDA margins of 10%. On to technology, we are expecting a little over $1 billion of revenues from the new Sustainable Technologies segment, with EBITDA margins consistent with the earlier announced targets. We have a bit of a runoff on our legacy reimbursable projects in the first part of '21 and expect to achieve our mid-teen tech margins as we progress through the year. From there, and as indicated previously, we expect margins will continue to expand over time. This all lands us at an adjusted earnings per share of $2 to $2.20 for 2021, phasing in at a circa 40-60 split between the first half and the second half of the year, which I'll repeat, represents 20% growth over 2020 at the midpoint. Now I imagine some of you may be trying to reconcile the mid-single-digit top line growth with the 20% adjusted EPS growth. So let me try to add a little color on that point. This really essentially comes down to two things: First, we replaced high-volume, low-margin energy work with much higher margin, higher-end solutions work in Intel, Defense, Space and also from Centauri. And second, we've right-sized the go-forward cost base to suit the repositioned business. It took a lot of cost out in 2020. So together, these moves in 2020 have enabled a modest bump in top line revenues for 2021, but critically with an amplified boost in profitability. The important takeaway is that the enhanced margins and profitability represent a real inflection point for the new KBR. Bradie has indicated earlier, cash flow expectations continue to be strong with ongoing op cash flow conversion at roughly 1x net income. We expect a little more CapEx than usual this year as we're making investments in real estate consolidation and ERP systems. These are both geared to fuel economies of scale and cost reduction benefits later. CapEx is expected in the $35 million to $45 million range, still well below 1% of revenue and still producing attractive free cash flow, which we expect to deploy in a balanced fashion, as said earlier.

Thanks Mark. And on to Slide 18, our almost final slide for today. We want to leave you with a few key messages. On the right are the key takeaways from today, but I thought I might try to present these in my own words. KBR has been on a strategic journey for quite a few years, as you're well aware. Strategically, we wanted to move upmarket, be more technically differentiated, exit commoditized businesses, exit risky and volatile markets, and align our business obviously with attractive markets of the future and simply deliver what we said we were going to do, not one quarter but quarter after quarter. You're probably thinking, sure, every business wants to achieve this, and many talk about what they're going to do, but let me just say this. We begin 2021 having exited traditional energy, lump-sum EPC, construction risk, and commoditized services. We also entered 2021 having reduced our reliance on contingency funding in the Middle East to non-material levels, as Mark explained; and having retired a large number of legacy risks over the last few years and retired many poor-performing projects from our portfolio. So, I think we can make a very strong argument that we have exited commoditized and volatile markets. We begin 2021 with strong momentum in Defense & Intelligence, incredible performance in Science & Space; our reshaped readiness and sustainment business; an increasingly upmarket international portfolio; and a suite of sustainable technologies that uniquely compound our ESG story in a very hot market. Our people do things that matter; they care, and it is hugely uplifting to be part of a company that does that today. I think we can also make a strong argument that we have aligned our business opposite attractive markets of the future. We begin 2021 with revenue up a bit, margins moving up, EBITDA moving up and EPS outpacing revenue growth by quite a factor, as Mark explained. I really think this is a strong reflection of moving upmarket, being technically differentiated with real proprietary IP and domain expertise. We have delivered every quarter, not for one quarter, but for every quarter for four years. One can argue one metric over another, but what cannot be argued is that true value is reflected in cash generation. We have delivered what we said we would do consistently. Our amazing people, our team of teams quite simply deliver. We have over 70% of the work secured to meet our guidance, and we are confident we will continue into 2021 and beyond to do what we said we will do. We start '21 by no means the finish article, but certainly at the beginning of a new and exciting journey. Now on to our final slide, we will be hosting an Investor Day on the 25th of March and is themed future forward and appropriately so. Our team will present KBR's value-add ESG position. We will bring to life our people agenda. We will present in a bit more detailed strategic growth vectors and why KBR is well positioned. These will run nicely into presenting our longer-range targets through to 2025. This will, of course, be a virtual event, and we hope you can join us. Thank you. And I will now hand over to the operator, who will open the call up for questions.

Thank you. Operator Instructions. We will now move on to our first question from Sean Eastman. Please go ahead. Your line is open.

Congrats on finishing out the year strong. I just wanted to start on the $200 million of OCO-funded logistics disclosure for the 2021 outlook. It seems like you guys really want to drive that home. And just so it's clear, I mean, really, you guys are just pointing out that logistics work in the Middle East is now just a tiny percent of revenue for government services and also that you have a big cushion in there for the uncertainty around the transition and where troop counts ultimately end up in the region. Is that the takeaway there?

Yes, I think so. To provide a bit more detail, as Mark mentioned, we have around $200 million in our guidance for 2021. Half of that is associated with our work in Iraq as we conclude that part of the contract, and the other half is related to increasing our activities in Afghanistan. There's a significant level of uncertainty regarding the timing of both situations, but we've chosen to adopt a very conservative outlook. We believe there could be potential upside if things progress more quickly. Some evidence suggests that may occur, but we cannot guarantee it. The main point is the gradual decrease in our revenue base dependency, as Mark pointed out, from 2019 to 2021, and the shift from that potentially volatile funding source to more stable and predictable funding streams, especially in Operations and Maintenance, which is why we've renamed that segment to readiness and sustainment. So, we expect less volatility, more predictability, and longer contracts of this type, along with the potential for upside, as you rightly noted.

Okay, very helpful. And then just higher level for me. Just so I'm kind of level setting, I mean, the dialogue on momentum in both the bid pipeline and in the backlog of late, I mean clearly, overall budgets aren't sort of matching that momentum, right? So maybe just from a high level, help us understand exactly how you guys are seeing this velocity in the bid pipeline and the momentum in the bookings trends, that would be great.

We have addressed this to some extent, and in my closing comments, I am positioning the business in relation to well-funded and appealing markets as we look to the future. This was evident with the Centauri acquisition, aligning with national security priorities. We maintain a strong operational focus rooted in our domain expertise. This is reflected in our resilience, not only in the bid pipeline but also in our performance in 2020 and the ongoing momentum into 2021. While there will be overall budget pressures over time, this is a consistent reality. It's essential to target market segments that are promising and well-funded, particularly where we possess significant domain expertise, technical knowledge, or intellectual property that gives us an advantage. KBR has done a remarkable job of aligning with these markets. The evidence is visible in our pipeline and book-to-bill metrics. Others may discuss the pipeline, but ultimately, the true test is in our ability to grow our backlog over time. This and last year, we have shown our strong positioning in appealing markets, supported by our book-to-bill performance and backlog growth throughout the year.

We will now move on to our next question from Jamie Cook of Credit Suisse. Please go ahead. Your line is open.

I guess a couple of questions. One, can you remind us what Centauri will contribute both on revenue and EBITDA for 2021, whether that guidance has changed or not? And then I guess my other question is, given the work in the Middle East is becoming a smaller piece of the pie, can you just sort of update us as we move past 2021, how to think about the sort of organic growth of the total government portfolio in margin profile or targets over the long term? So any update there? And then, I guess, how to think about G&A now with Centauri and the sort of the cost actions you've taken?

Okay. So I'll start, and Mark will finish. The guidance for Centauri when we came out the gate is $700 million plus with margins in the low-double digits, the 10% ZIP code, and that's absolutely where it sits today in the '21 guidance. And that’s very good growth from last year as we're all aware. So that forecast and that analysis held up very, very strongly. In terms of the longer-term outlook for GS, it's in that 6% to 10% ZIP code. I mean we haven't changed that. We'll be updating obviously the longer-range targets in March when we hold our Investor Day. But that's the outlook going forward as it sits today. And I think the backlog growth would indicate that that's achievable. In terms of the SG&A, Mark, would you like to comment on the longer-term outlook for that just given some of the movements and seasonal movements in Q4?

Yes, Jamie. First, wanting to add to the Middle East question and government is if you were to strip out the reduction from '20 to '21 in contingency logistics, which is the $258 million we get between the $450 million and $200 million numbers I’ve provided. You strip that out. The organic growth in Government Solutions is in that 6% to 10% range for '21. So that's encouraging, and it is attributable to the great wins, takeaway, etc., that we've talked about here. And so that would be our view going forward. We'll talk more about that in the Investor Day in March, I'm sure. Relative to G&A, we had some savings in 2020 due to COVID and less travel, things like that. We've bumped that up a little bit for '21. We do expect to return not exactly back to normal, but more toward normal at some point and pick up activity there. Plus we, as I mentioned, are making some investments in modernizing our infrastructure. Some of that is hitting G&A. We've factored that all into the guidance. But the corporate line should still be about $100 million, which, I would say, is kind of normative. If you look back at '19 and '18, that's kind of where it was, and we kind of are expecting that range for 2021. Beyond that, I think we're going to do our best to contain or even reduce that number with the investments we're making in IT and some of the legacy structure applications that we are trying to work out of for legal entities to those sorts of things. So that's the trend. So I’d say, back to norm pretty much in '21 and then hopefully flatline that number or reduce it longer term.

We will now move on to our next question from Jerry Revich of Goldman Sachs. Please go ahead. Your line is open.

I'm wondering if you could talk about your pipeline for hydrogen decarbonization energy transition applications. Obviously, nice to see the strong pipeline in GS. I'm wondering if we might have a similar conversation about your decarbonization portfolio and the cadence of potential awards over the next couple of quarters?

Yes. Recently, we held investor events where we detailed our suite of intellectual property and demonstrated how it aligns with a broad range of Sustainable Technology offerings, not limited to hydrogen or ammonia, though ammonia is particularly exciting. Our ROSE technology for NOx and SOx reductions, our work in alkylation, and our exploration of various solutions for refining processes are all aspects that help decrease energy consumption. We have a remarkable list of opportunities. The strongest indication of this was the book-to-bill ratio in the quarter, which exceeded 2.5 in the tech segment. We mentioned earlier that the annual book-to-bill ratio showed over 20% growth in backlog. While the book-to-bill ratio has consistently been over one in Q2 and Q3, Q4 stood out with bookings significantly surpassing two in the tech sector. This serves as concrete evidence of our momentum in the Sustainable Technology portfolio. Additionally, it's important to highlight our impressive margin performance, as this business operates on negative working capital, emphasizing the strong fundamentals of this segment.

And obviously, so you had strong momentum in the quarter. I'm wondering if we might be able to have a conversation around what the bookings outlook for that business is over the course of '21. Are there any meaningful awards that you folks are in the running for? Any color on whether that bookings momentum continues into '21 that you might be willing to share?

Jerry, these are extremely active markets as you know well, especially regarding climate change. The Biden administration is contributing to that momentum. It's a thrilling time for our portfolio. We have some technologies that have innovated, such as ammonia technology, which is being utilized at coal-fired power stations to significantly cut down carbon emissions right away. The market is very promising. I can say that activity levels are rising, and the pipeline of opportunities is expanding, not diminishing. I truly believe it’s a wonderful time for us. As I mentioned earlier, the realignment of our portfolio has worked out favorably, and our team is fully occupied exploring future opportunities. My perspective today is that the market and the opportunity landscape are improving even beyond what we experienced in 2020. As the world continues to open up, we can expect to see even more activity. Yes, it's going very well. The teams have come together and are communicating effectively. Culturally, we are well aligned, and key individuals are collaborating efficiently, focusing heavily on revenue synergy. The recent TENCAP win, which was a KBR bid with Centauri, started with us as a subcontractor, but that has since changed, and it really helped us secure that award. This was recently announced for the Air Force and amounts to around $500 million over the next little while. We are making progress with R&D, fast fail initiatives, and prototyping. Overall, we are performing well in terms of revenue synergy opportunities. Regarding the back-office operations, we will be addressing that throughout the year. However, that business was not running poorly; it was effectively managed as a standalone entity. In these situations, where there is no significant issue, we have a bit more time to refine the back office. Overall, both the revenue and cultural aspects are progressing very positively.

We will now move onto our next question from Gautam Khanna from Cowen. Your line is open.

Your line is open. Apologies for interruption. Callers, your line is open. Please go ahead.

We will now move on to our next question from Steven Fisher of UBS. Please go ahead. Your line is open.

Nice 2020. So just looking at the leverage, you're now currently below the targeted leverage range. It seems like there's potentially another maybe $200 million to $300 million of capital that you could deploy and still stay within your 2.5 to 3x targeted range, and that's on top of that, say, $200 million to $300 million of free cash flow you should deliver this year. So how are you guys thinking about the potential to deploy that capital base and potential?

I’ll start, and Mark can jump in. We will provide more details on this in March, so I don't want to take up too much time on it now. Your assessment is absolutely correct in terms of our performance with cash and our net leverage being below our target range. You're also right about the free cash flow. We're in a strong position regarding liquidity, and we have options for deployment, which is always positive. Our priorities in that regard haven't changed. As you noted, we repurchased stock in Q4, and it remains a viable option for us when necessary. That's all I want to share for now since we will discuss this more comprehensively next month during our Investor Day. Mark, do you have anything to add?

I’ll just confirm, Steve, the numbers are exactly right. So there’s firepower there in levering up, but responsibly so plus the free cash flow being attractive. I did say earlier that we like a balanced capital deployment strategy, and we've proven that over time. It would be reasonable to expect similar going forward, and we'll talk more about that in March.

Got it. And then just on the quarter itself, the government margins were a little lower than I might have expected. Just curious how they compare to what you were thinking. If there's anything dragging because of the Centauri close that might have been non-recurring? And since you did guide to the 10% for 2021, how much variability would you expect around that over the course of the year?

No, I mean, not much, a few basis points variability, I guess, Steve. I think the bottom line in Q4 will come in at around 9.3 or 9.4. Another 0.1 would have rounded us up rather than down. It was not far off from expectations. There were some seasonal impacts from people taking more holidays as we approached the end of the year, but there’s nothing concerning there at all. The overall margins for the year align well with expectations, and our guidance for next year remains firm. As I mentioned before, we're committed to doing what we say we'll do. We are targeting margins of about 10% next year, and we expect to achieve that.

We will now move on to our next question from Andy Kaplowitz with Citigroup. Please go ahead. Your line is open.

So you mentioned the book-to-bill was above 2x in Q4, so obviously, a ton of momentum, sustainable technologies. But are you thinking about your original guidance for when you're doing your original guidance for 2021 in that segment, you had $1 billion of revenue, $150 million of adjusted EBITDA for '21. I think you gave us that a quarter or two ago. Could that end up being conservative in what's baked into your overall guide today?

It's a bit of a tricky question, Andy. At this point, it's great that we're achieving that level of performance for next year. We have a track record of meeting or exceeding expectations in this area, and we hope that trend continues. However, it's too early to provide a definitive answer. We'll stick to our guidance for now. It's still early, but the market is very active. There is significant momentum in that segment, and we're quite excited about the opportunities we see in our pipeline and the discussions we're having with customers globally. As we approach Q1 earnings, we will assess the business's performance. It's an excellent time for us given the market conditions and the intellectual property we have.

Can't blame me for trying there. All right. Next question. So you mentioned the contingency work is still ramping down in '21. But it sounds like there's a bit more of an international drag from UK funding constraints that you saw in Q4. We know you've given overall guidance for '21. But would you expect more of a back-end loaded year for revenue in GS? And how dependent is organic revenue improvement on some alleviation of the UK funding constraints?

Yes. I mean, I think overall, just to start with the big picture scenario, we do expect the second half to be a bit meatier than the first half, and Mark gave that color in his remarks. There’s a good reason for that as things ramp up, particularly things like the Middle East and things like that. But in terms of the UK, as you know, the majority, a very large proportion of what we do in the UK is underpinned by Aspire and MFTS and the other long-term PFI contracts. That really protects us from any real volatility risk. It’s a steady stream in the UK, just not at the same level of increase that we see in places like Australia, and that we’re seeing at national security priorities in the U.S. So it's just a more measured approach, I think, is probably the way to describe it.

We will now move on to our next question from Michael Dudas of Vertical Research. Please go ahead. Your line is open.

Stuart, first question, how do you prioritize your pipeline, which appears very robust from long-term targets to the $15 billion of near-term opportunities? How do you prioritize that relative to length of contracts, returns? Is it just whatever market is growing the fastest you're involved in and you think there'll be more opportunity there? Are you putting business development or some investment in areas where you want to shore up or enhance some of the businesses?

Yes, I think it's sort of two different questions in a way, Mike. I think, obviously, as we look inside the businesses themselves and what's coming down the pipeline, I think, as you're well aware, the procurement pipeline in the government arenas is reasonably transparent as to what's coming down, and you can position for the things where you feel that you've got the best chance of success. Our teams do a very good job. As you know, our win rates are really strong. We pick and choose our fights, if you like. In terms of the second in business development or investment, I think we would continue to invest in areas where we feel there's things like our recent announcement for Mura that we talked about a little bit in terms of plastics recycling and the opportunity set there as the market evolves in that arena. We’ve tried to align the businesses up in a way that reflects our outlook for good businesses of the future or good markets of the future. We will do so again in March in terms of where we think there are new opportunities in places like cyber as we get to understand the Centauri capability, combining that with the KBR capability to be just something that we think is more niche and exciting and aligns to spending priorities into the future. You’ll get a bit more color on that in March.

I appreciate that, Stuart. My follow-up would be, you mentioned in your response about the Mura Technology. I think that seems to be pretty exciting stuff. Can you maybe elaborate a little bit more like how it came about? What are some of the opportunities that you're seeing just from that announcement? What are you being to plan over the next several quarters to several years?

Yes, you're right. It's a very exciting market. There's a lot of capital flowing into that area, particularly in technology that is still being validated. The positive aspect of Mura is that we have several facilities that are nearing world-scale production, with the first one being constructed in Wiltshire, UK. We are attracted to this technology because it is environmentally friendly. The process recycles energy without carbon emissions. It involves pressurizing water and using high temperatures to break down plastics, not just single-use plastics or those that are easier to decompose. This technology addresses that challenge and produces an output suitable for refiners to replace their existing feedstock, aligning with their sustainability goals of using recycled materials in their processes. From our perspective, we believe we have the right intellectual property with unique attributes in the marketplace. We are very excited about this and anticipate more opportunities in this area.

That's a terrific story. I appreciate it. I look forward to the meeting next month.

Thanks.

We now move on to our next question from Brent Thielman. Please go ahead. Your line is open.

A question on the just the emphasis within the former logistics piece of government, now readiness and sustainment, particularly the O&M-related work. Can you talk a little more just about the addressable market you're after, the types of programs this business is going to look to pursue that it hadn't done before? I think you talked about higher value. How do we think about the differences in margins or profitability versus the legacy logistics work?

Yes, great question and very relevant. We've been emphasizing the shift from logistics to readiness and sustainment for some time now. Earlier this year, we tried to clarify that the margins and returns in this new business area were likely higher than what analysts believed, as there was an assumption we still had substantial reliance on traditional OCO funding, which usually brings in lower margins. However, we've been decreasing our dependence on that sector. This business has significantly expanded its international and domestic presence. We've mentioned our activities in Bahrain and elsewhere; these involve long-term operational support contracts typically based on fixed fees. As we adopt more digital processes, we can leverage clean data to enhance efficiency, which in turn boosts margins. We've demonstrated a strong track record of increasing efficiency over the past three or four years as we’ve become more digitally enabled. Recently, we've secured the UA BOSS contract in Turkey and Spain, which amounts to about $1 billion over the next decade. This positions us well for next year with a book-to-bill ratio exceeding one, which is fantastic. In terms of domestic operations and maintenance, while many assume they're OCO funded, much of it actually originates from operations and maintenance activities. Our domestic work is growing at a rate beyond our expectations, and our teams are performing exceptionally well. This work, which supports training and troop readiness, aligns perfectly with our focus on readiness and sustainment. We are also supporting original equipment manufacturers in the U.S. with various high-end tasks. All these efforts are gaining strong momentum and achieving a balanced growth between international and domestic initiatives. For instance, our prepositioned stock work for the Marines and Army is performing well. Overall, the repositioning of the business is commendable, and our margin performance aligns with our overall GS margins, indicating it's not the low-margin business some might expect. The shift in revenue mix, along with our digitalization efforts to enhance automation and reduce costs, is driving margins higher. We currently have very few items in our portfolio related to that. We made timely decisions on the businesses we exited. Our current offerings in the technology solutions and Sustainable Technology solutions portfolio focus on intellectual property that supports the global sustainability and climate change agenda. We also have an advisory business in what we refer to as technology-led Industrial Solutions, which enhances asset performance to improve energy efficiency and reduce carbon footprints. These tools are digitally enabled and particularly effective when applied to our own technology. As of now, we don't have any assets linked to KBR that we need to dispose of, as they align with our sustainability goals. We've successfully exited the businesses we intended to, winding down those operations and stepping away from those projects. There might be a small residual impact as we transition through Q1, but as Mark mentioned, that's the extent of it.

I'll just add, we sat down and looked at the same question relative to all of our offerings in the Sustainable Technologies segment, including what came over from the previous energy segment. While some offer new focus on end-product flexibility, they also offer safety and/or energy efficiency propositions. If you look at energy transition consulting, nearly every offering we have has an energy efficiency component, safety component, energy transition component, etc. That supports what Stuart said about we really have a portfolio that is squarely on this megatrend of sustainability.

It appears we have no further questions. I'd like to turn the conference back to Stuart Bradie, President and CEO, for any closing or additional remarks.

Just thank you very much, and really, just thank you for taking the time to listen today. We're obviously really proud of 2020, and a big shout out to all our people who really delivered for us in what was a unique and difficult year. I think we're very well positioned moving into '21, as we described on the call. Hopefully, most, if not all, of you can attend our virtual Investor Day on the 25th of March. Thank you. I will now hand over to the operator, who will open the call up for questions.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.