Kbr, Inc. Q2 FY2024 Earnings Call

Good morning, everyone. Welcome to KBR’s Second Quarter 2024 Earnings Conference Call. My name is Kiki, and I will be your conference operator today. I will now hand you over to your host, Jamie DuBray, Vice President of Investor Relations, to begin. Jamie, please go ahead.

Thank you. Good morning, and welcome to KBR's second quarter fiscal 2024 earnings call. Joining me are Stuart Bradie, President and Chief Executive Officer, as well as Mark Sopp, Executive Vice President and Chief Financial Officer. Stuart and Mark will provide highlights from the quarter and then open the call for your questions. Today's earnings presentation is available on the investor section of our website at KBR.com. This discussion includes 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 cause actual results to differ significantly from these forward-looking statements as discussed in our most recent Form 10-K available on our website. This discussion also includes non-GAAP financial measures that the company believes to be useful metrics for investors. A reconciliation of these non-GAAP measures to the nearest GAAP measure is included at the end of our earnings presentation. I will now turn the call over to Stuart.

Thanks, Jamie, and welcome to our second quarter earnings presentation. I will start on Slide 5. As you've heard me say many times, KBR is a company that puts its people first. We strive to ensure our people have a strong sense of belonging, that they feel connected to each other and the company, and can grow within an environment where they can bring their whole selves to work every day. To test that we are actually delivering for people in a broader sense, we regularly conduct an anonymous people survey. The feedback ensures we're focusing on the right areas as we seek continual improvement and helps us avoid any complacency. The survey results are also important, particularly as we bring new entities or employees into KBR. This year, participation levels increased by 10%, and we're over 70%, which is our highest to date and gives a solid representation of how our people feel about being part of KBR. I'm pleased to share that we've been certified as a Great Place to Work in 13 countries, and over 84% of our team members feel KBR is indeed a great place to work and would recommend KBR to friends. From an inclusion perspective, 85% feel they can be themselves, are heard, and this is a value I hold very dear. Obviously, we are not perfect, but hopefully this gives you a good feel that we walk the talk when it comes to our people. Moving on to Slide 6 and discussing the quarter, Q2, similar to the first quarter, was a clean quarter with businesses performing at or above expectations across all key metrics. Revenue was up 6% year-on-year, but more importantly, adjusted EBITDA was up 13%, with margins at the group level up 75 basis points. Year-to-date cash conversion was a terrific 121%. Following a strong Q1, this gives us confidence to raise guidance, which Mark will cover in a moment. In short, our people and thus KBR continue to deliver. On the business growth side, our group book-to-bill on a trailing 12-month basis was 1, and after adjusting for the large LNG project was 1.2 times. Considering we also have substantially increased bid volume and warrants awaiting decision, this really represents a strong quarter. We booked approximately $2 billion at the group level and currently sit at 92% of work under contract for 2024. This is an important takeaway, especially with continued volatility, both politically and geopolitically. Now on to Slide 7. Firstly, we'll start on STS. The book-to-bill after adjusting for the large LNG project sits at 1.1 for the quarter, so good performance, and 1.2 on a trailing 12-month basis. As you can see from the awards highlighted below, we continue to lead the market in green ammonia with our first project in India and our 10th project overall. Blue ammonia continues to be more prominent due to affordability, and the contract with OCI reflects this. It's critical that we continue to ensure there is value-add by delivering solutions that drive efficiency and improve yield, enabling the energy transition—this is a key area of differentiation for KBR. In fact, there are only two blue ammonia projects in the world that have reached final investment decision, and both are using KBR's technology. These are the OCI plant in Bowman, Texas, and Fertiglobes in the UAE, which will make KBR's proprietary process technology the first to produce blue ammonia. This, in addition to our industry position in green ammonia, puts us in a very strong position. We're also excited about the award of a five-year contract to help the Iraqi government develop its future plans across infrastructure, energy, and sustainable development. This demonstrates a strong position in the Middle East that we highlighted at investor day and ensures we are part of the early development conversations. On the government side, our book-to-bill sits at 1.1 times in the quarter and 1.2 times on a trailing 12-month basis—again, terrific performance. Awards under the IAC MAC IDIQ contract vehicle continued to be solid. We've highlighted the win on the B52 program that we've had for eight years, which had a significantly increased value and additional scope for cybersecurity as a trend. We expect award volume to pick up in Q3 in this area with over $2 billion worth of bids submitted and awaiting award under the IAC MAC program alone. We've highlighted two large multiple award contract wins also in the quarter. Both are effectively a license to hunt and enable rapid response mobilization if required. Notably, MQS2 is with a new customer, which is always positive, the Defense Health Agency. We'll report ongoing progress as we move on to task orders under these contract vehicles in the coming months. As we highlighted at investor day, our volume of bids overall in the government business across that portfolio has increased significantly in 2024 and currently sits at over $8 billion. I will now hand over to Mark, who will give more detail on the financial performance.

Fantastic. Hello, everyone. Thanks, Stuart. I'll pick up on Slide 9. As you've just heard, we're really pleased with our Q2 performance, and that follows an already strong Q1, registering healthy top-line growth, strong profit margins, double-digit adjusted EPS growth, and year-to-date cash flow conversion of over 120%—all leading to a bump up in our full-year guidance. As I have said many times before, the day-to-day project performance across hundreds of engagements is the foundation of our consistently strong financial results. This also pays recurring dividends concerning client retention and employee engagement. We've seen delivering for our clients in critically important missions and projects around the world as a key enabler for the people survey results that Stuart just covered. Of particular note, adjusted EBITDA margins came in at about 11.5%. This reflects superb client delivery and good cost discipline. Operating cash flow is $170 million for the quarter and $261 million year-to-date, as we continue progress on driving lower days sales outstanding and overall demonstration of our low capital intensity business model. On to Slide 10 for details on the segments. Sustainable tech has continued to deliver double-digit year-over-year growth, excellent profit margins, and a good contribution to enterprise cash flow generation. Revenues grew by 14% to $458 million, with all parts of the business contributing to that result. Margins were 21.4%, up from last year on a combination of intellectual property license mix, joint venture performance, and a highly efficient cost structure. For government, revenue grew 3% overall, where we saw growth in international defense intelligence and science and space, up 11%, 5%, and 1% respectively. This was offset in part by contraction in readiness and sustainment, particularly for UCOM activity down as funding delays earlier in the year are still trickling through related to the Ukraine conflict. However, this is beginning to reverse as sequential growth from Q1 was up 7% in the readiness and sustainment segment, pretty much attributed to this Ukraine area. Profit margins hit 10.4%, pretty much in line with expectations for government services in Q2. Now on to Slide 11, good capital deployment starts with good cash flow generation, which as discussed earlier was terrific for Q2. This enabled higher buybacks this quarter and also year-to-date, yet still reduced our leverage, which finished the quarter at 1.9 times trailing 12 adjusted EBITDA. Specifically, we bumped up our buybacks to about $100 million in Q2 on top of the $50 million in Q1. Together with increased dividends in Q1, we have returned almost $200 million in cash to shareholders through the first half. Now let me briefly cover how we plan to finance the acquisition of LinQuest. While we have cash and current revolver capacity to cover the full purchase price, we have commenced the process of tapping additional term loans to maximize our liquidity. Assuming we do that, we expect any new debt to be at the same or better rates than our existing debt. We'll also structure any new debt to allow for repayments, so we have the option of delevering as cash flows are generated down the road. We expect the transaction to raise our pro forma net leverage to approximately 2.7 times post-closing. This leverage ratio is still at a comfortable level, and thus we still have capital deployment optionality across M&A, buybacks, and debt reduction options. Now on to Slide 12, forward guidance. We are raising our guidance for the year on profit and cash metrics, which is all organically driven. We are not and will not factor in any expected contribution from LinQuest until it closes. We will consider an update then depending on when closing occurs and the materiality to the year at that point in time. Revenue guidance is unchanged at $7.4 billion to $7.7 billion. However, with strong first half operating performance, we are bumping up adjusted EBITDA to a range of $825 million to $850 million with a midpoint of $838 million. Our adjusted EPS guidance is also increasing to $3.15 to $3.30 with a midpoint of $3.23. Finally, with a strong year-to-date cash flow conversion, we're increasing our adjusted operating cash flow guidance to $460 million to $480 million. In summary, the core business is performing really well and we are increasing the outlook for profit and cash flow production, certainly a great testament to the performance of our STS and GS operating teams. In addition, we're truly excited about the addition of LinQuest. In fact, I've known this business for a really long time and have high confidence we will be an excellent home for their employees. The cultures align really well and we expect robust synergy and customer delivery benefits for years to come. All of us really just can't wait to get started with our new colleagues on this exciting front. With that, back to Stuart.

Thanks, Mark. Terrific job as always. On to Slide 13 to talk about LinQuest. What you see on the slide is the same as we published in our announcement last week. Slide 5 I would cover only a couple of points and then I would touch on how the feedback has been since the acquisition was announced and how we're thinking about integration. LinQuest has over 1,500 people. They do amazing work across National Security Space—think Space Force, Future Air Dominance, the Air Force, and JADC 2—and connected battlespace, meaning interoperability and digital. Their capability is highly complementary to KBR’s with little overlap, which I think gives exciting synergy opportunities. We've highlighted how those work on the slide. We're also excited about the fact that they have double-digit margins as well as a robust pre-synergy growth profile, which is terrific. From a people perspective, the feedback on the announcement has been incredibly positive—positive on both sides. We've hosted our first Town Hall with the LinQuest team last week, and there's a lot of excitement. LinQuest is a business we know very well, as Mark said earlier. We're located in many of the same locations, we’ve collaborated on numerous occasions, and importantly, the people know and respect each other, which is unique. We have common values and a commitment to mission. From a cultural perspective, we see this as a terrific fit. In terms of integration, we're feeling optimistic. LinQuest already operates on many of the same ERP platforms, and for those who have done this before, that is a big deal. This greatly reduces the risk and importantly, the burden on the teams doing the integration. So, I'm sure you can tell we're super excited about LinQuest joining the KBR family. This acquisition is a great fit with little overlap, and focuses on delivering revenue synergies in very well-funded and critical end markets. Obviously, in the coming weeks, we'll be working through the HSR process, and hopefully, we'll close soon. More to come, and we’ll provide an update at our next earnings call. Now onto Slide 14, key takeaways. Firstly, we’ve delivered a strong first half performance across all key metrics. As a result, we are pleased to raise full-year 2024 guidance on profit and cash flow. Secondly, our work under contract for 2024 today stands at 92%, and bookings ensure continued momentum. The bids submitted and awaiting awards are at very high levels, as we discussed earlier. Thirdly, LinQuest is a strategic fit, and we are excited about it—double-digit growth and double-digit margins, a really cool business. Lastly, at Investor Day, we emphasized our vision to continually move KBR into technology-enabled markets where our high-end technical, digital, and deep domain expertise allow us to differentiate while adding value in critical areas for our customers around the world. Following these points from Investor Day, with LinQuest as a catalyst, we believe there are opportunities to realign our business to operate even better based on our capabilities and markets. The objective of this realignment will be to reduce complexity, realize synergies like AUKUS and One Saudi as we presented at Investor Day. We will likely manage both segments globally to allow for greater standardization and business process optimization, which should drive efficiency. We will work on this through the remainder of 2024 and expect to report results along these lines in full year 2025. To be clear, the segments and enterprise targets for 2027 will remain intact through this realignment. This is very much a heads-up, and we will continue to work through the remainder of the year, with updates as progress is made. Thank you again for listening. I'll now hand back to the operator to open the call up for questions.

Thank you. The first question we received is from Tobey Sommer from Trist Company. Tobey, your line is now open. Please go ahead.

Thank you. Good morning. I was wondering if you could expand on that last bit and offer some more color, Stuart, on the realignment and what you think that will achieve for the firm.

Thanks, Tobey. The objective will be to, as I said, reduce complexity. We'll move from three business units to two effectively with bits of what we've been describing as GSI. I'll give you a good example: The Diriyah Gate project, which is a full-on project management of a new sustainable city in Saudi Arabia, currently sits in the government segment but could—given its commercial contractual basis, its program management at scale, and its location—realize our One Saudi vision by leveraging our position across our broader customer base. That sort of project will move into STS going forward. Another example would be the Sellafield decommissioning that we do in the nuclear arena, a very much sustainable project, currently sits within GSI. This involves big programmatic work, reducing carbon footprint, managing tricky nuclear decommissioning, and managing a significant supply chain. Those are the types of projects we will be pushing across. STS will grow larger as a consequence. The guide we've given won't change, so we expect margins to hold steady in STS as we go through this. But it will give us an advantage concerning overhead, standardization, and more commercial acumen in the areas where it's required. The clear objective is to realize the synergies from the realignment. Does that make sense?

Absolutely. If I may sneak in a follow-up, from a geographic perspective, where do you see the most rapid growth across the enterprise over the next year or two?

I think ultimately you're going to see a lot of growth in what we describe as the Golden South, particularly the Middle East. You’ve seen that in our documents, and for this quarter, you'll see the increase in activity in the Middle East. I see that from an energy perspective being the area of significant activity. In terms of the government side, obviously, with the LinQuest acquisition, we also see a lot of activity happening in the U.S. Additionally, I think there's continued emphasis in the Pacific, so we see increasing activity across things like AUKUS and sharing intelligence data across Allied forces. I think you're going to see it in multiple places depending on which business, Tobey.

Good morning, Jamie, Stuart, Mark.

Good morning, Mike.

Stuart, you talked about visibility in the pipeline and highlighted some government service opportunities. Could you share a little bit on the STS side, on the pipeline? Looking at 2025, how comfortable are you relative to what's in backlog and near-term bookings today to achieve your growth targets?

As we presented, the bookings in STS in the quarter, excluding the LNG project, were 1.1, so there's strong momentum there. I think that's similar to last quarter, actually, and on a trailing 12-month basis, it sits at 1.2. We have a strong pipeline globally, but as I said earlier, a lot of activity is in the Middle East. I was in Saudi last week with Jay, and there's continued confidence in their investment profiles. We aren’t seeing any slowdown in that area. Energy security is very much the agenda in a decarbonized way, as we've talked about before and addressing energy transition. Energy transition is moving a little slower due to affordability questions, but that makes energy security more important as the demand for energy remains high.

Thank you. Any early read on the new government in the UK and how things may shake out?

Good question. The UK moves a bit quicker than some jurisdictions in this election process, occurring in a few weeks. The new government was elected on July 4, and the cabinet was in place by July 5. It's a fully operational government now. Parliament's back. There will be a review process, as there always is with new governments, regarding defense and other areas. So far, the UK is committed to NATO and supporting Ukraine. The defense and foreign ministers have engaged with Zelensky, and we don't see any slowdown in commitment there. Their commitment to new energy also appears strong. In fact, Labor is even more committed to energy transition, which we see as a good opportunity moving forward.

Thank you. Good morning, afternoon, Mark and Stuart. It was a really strong second quarter for STS, and the EBITDA growth exceeded expectations. Sales growth remains strong. I know you monitor the book-to-bill for this business, and there are concerns about what the future holds as certain factors begin to change. Could you share some insights on what you anticipate for the second half? Do you foresee these growth rates continuing? Looking toward 2025, 2026, 2027, and beyond, you mentioned the Middle East. We are still waiting for updates on a significant program regarding liquid chemicals with Aramco. Any information on that?

We're standing by our guidance. I was clear on that, but I'll move up the guidance a bit for this year, obviously. Our 2027 growth rates that we committed to at Investor Day still stand and are robust. STS is performing very well. We're seeing some movement in the LNG industry post the Biden moratorium. Some projects have been released, and that will be progressive until Election Day in November, which will likely start moving again. The Middle East is more than just LNG, with commitments around ammonia and new gas development. We're very well present in those markets. LTC is frustrating, but we're very client-friendly, and while we cannot announce anything on that program, we still feel really good about it. We're not yet at liberty to disclose anything until we get customer permission, which is still forthcoming.

That's super helpful, thank you, Stuart. As a follow-up on the government side, you discussed a significant ramp-up in bids. Could you clarify what changes occurred by segment? Based on what Mark mentioned, 5% growth in D&I and 1% in S&S? How do those fit into your Investor Day targets? Additionally, regarding R&S, can you provide some color on early home sales?

Our bid target for this year is approximately $12 billion in government services, and I believe we’ve achieved that to date, which is terrific. We've refined costs and focused more effort on business development to keep our rates competitive. We’ve centralized our large-scale project group to oversee and drive volume and quality through the pipeline, which is visibly manifesting. I think our strong IDIQ machine opposite IAC MAC has significant potential. We have $2 billion awaiting award in one program alone, which is substantial. We expect some ramp-up in award volumes between now and October due to the government cycle, with expectations to see that in Q3. This was part of how we strategically aligned our targets based on everything we presented at Investor Day—this is strategy in action and our teams are doing just that.

And on the wholesale side, how is that progressing so far?

The early efforts have gone very well with terrific feedback on quality and service. The volumes are still low, but we are carefully monitoring progress. TRANSCOM came out in May stating that we will progressively ramp up, especially in the fall with interstate moves aligned with our program. We are testing the system currently, and all looks good with a view to conducting full domestic moves in the busy season of 2025. The targets presented at Investor Day are conservative, but we're doing all we can to line up behind that expectation.

Can you talk about your expectations for R&S and your activities in Europe as you move into the second half of the year?

R&S is interesting regarding activity levels. It slowed a bit recently as the Ukraine supplemental was delayed and CR was behind us. We’re seeing movement in EUCOM, and the sequential growth in R&S is largely driven by non-LOGCAP activities, which is fantastic because we're expecting EUCOM impacts to surface in Q3 and Q4 based on outlook. This dynamic is promising.

R&S is more diversified than one might think, and they have been active. As we stated, we've increased bid submissions by 50% this year. They're expanding their reach in their markets and are achieving strong results. The trickle-down effect from the Ukraine situation did pick up toward the end of Q2, leading to optimism for the second half being stronger than the first. We will continue to adapt as the government dictates longer-term.

We have a couple of recent bids that, as usual, have gone into protest. We think these will be additive if the protests resolve in our favor, and we'll update you on that hopefully in Q3 earnings. We're feeling confident about R&S and overall business performance.

Can you elaborate on the opportunities in LNG as we move forward?

In the 2027 guidance, we included various opportunities around LNG. We have project management work in Abu Dhabi, and activities in the broader Middle East including Oman. While we remain optimistic about LNG picking up in the U.S., our 2027 targets are not wholly dependent on LNG. Our projections factor in various global opportunities.

Thank you.

Thanks. I want to bridge the old EBITDA and EPS guidance to the new guidance. Was it more around contingency captures in the first half that drove the increase or business wins? Additionally, any constraints or new headwinds that came up affecting that guidance?

The increase in guidance was driven by operational performance, full stop. Our people deliver consistently, and that is the main reason behind it. We prudently raised guidance given the current environment. We are about to head into volatile times in the U.S. with looming elections and the noise surrounding them. We’ve been judicious and sensible about how much we've raised. We'll monitor performance as we progress through Q3, assess what's included in the backlog, and remain open to adjustments based on performance.

What’s the growth rate you’re embedding in the LinQuest forecast, and will it be immediately accretive?

The growth we project for 2025 is low double-digit and excludes synergies. The diligence shows they have the backlog for that growth. The acquisition is accretive from day one on a cash basis, and we believe we paid a sensible multiple for it.

You mentioned the volume of bids at GS is increasing substantially. Are these new bids similar to current work or do you see KBR addressing a wider scope?

It’s both. We do see a mixture of familiar types of work in our markets and a lot of new activity in areas like human health performance, which we’ve engaged with through NASA, leading to additional contracts. We also see significant opportunities in the digital cyber world, enhancing our scope. We're continually pushing to align ourselves towards differentiated market needs with new types of bids.

Good morning, everyone.

Good morning, Andy.

Stuart, you’re optimistic about STS GS. Do you think you could grow backlog in STS over the next few quarters? Can you elaborate on the transition from energy transition projects in STS to energy security?

Energy demand continues to grow, especially in the Global South as developing nations progress. Energy transition projects grow but not as quickly as expected due to affordability issues around green versus blue molecules. Energy security must grow faster. Projects like liquid to chemicals, gas monetization, LNG projects, and traditional hydrocarbons using renewable power or carbon sequestration will be key to addressing that demand. We believe we are well-positioned on both sides and can cater to this demand.

Equity and earnings from unconsolidated affiliates continue to grow. Presently, the Plaquemines contribution is at peak levels but should start to decrease in ’25 and more significantly in ’26. We're experiencing success with programs like ASPIRE, benefiting from the dynamics relating to energy security. Equity earnings might decrease slightly this year but will remain steady.

Can you tell us when to expect the book-to-build headwind from Plaquemines to go away?

Probably halfway through next year.

Was the LinQuest acquisition part of a competitive process? Are you seeing more or less of those kinds of deals nowadays?

Yes, it was a competitive process, but through this process, we aligned well with management on values and opportunities, which helped us secure the position. There is currently activity in the market, but we remain disciplined in seeking acquisitions that align strategically.

What are the mechanics expected in liquid to chemicals, regarding backlog and milestones?

Aramco performs work authorization requests, so it will be more incremental than a significant lump sum booking. We’ll provide clear updates on what is and isn't in the backlog.

What was the actual dollar value of orders received in the quarter for STS?

As indicated, it was 1.1 times the revenue stamped, which is approximately $500 million.

Does LinQuest have any set-aside business that might fade over time?

It's 100% full and open; there are no small business set-asides.

You may now disconnect your lines. Thank you.