KBR, Inc. (NYSE:KBR) Q3 2023 Earnings Call Transcript

KBR, Inc. (NYSE:KBR) Q3 2023 Earnings Call Transcript November 2, 2023

KBR, Inc. beats earnings expectations. Reported EPS is $0.75, expectations were $0.73.

Operator: Hello all and welcome to KBR Inc’s Third Quarter 2023 Earnings Conference Call. My name is Lydia and I’ll be your operator today. [Operator Instructions] It’s my pleasure to now hand you over to your host, Jamie DuBray, VP of Investor Relations to begin. Please go ahead.

Jamie DuBray: Thank you. Good morning, and welcome to KBR’s third quarter fiscal year 2023 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 Investors section of our website @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.

Stuart Bradie: Thank you, Jamie, and a warm welcome to our Q3 earnings presentation. So let’s start on slide five. Our zero harm moment today attempts to give you a high-level view of how KBR is engaged in space sustainability and security. This for us is both from space looking back to Earth and in the space environment itself. So starting on the left of the slide, we have highlighted a couple of programs in which data is generated in space to enhance our environmental understanding of what is happening on our planet. And this gives real-time analysis and trending of things like deforestation, arable land development, et cetera. In the middle, we have highlighted our proprietary technology, Iron Stallion, that digitally tracks satellites and space debris using proprietary algorithms, advanced AI, and machine learning to predict, estimate, and validate future events.

In addition to the U.S. DoD, two of our allies have acquired and are using Iron Stallion today. And on the right, we have highlighted two programs focused on going to space, working on next-generation satellites for Earth monitoring with the added objective of resurfacing and recycling existing assets to minimize space junk. And the exciting work being done at NASA Ames, which is in Silicon Valley, a key research center for NASA where KBR has been engaged for many years looking at water and ice on the moon to sustain human exploration. And this is KBR playing in the knowledge economy in the space vertical across both civil and technologies. And I have to say, it’s pretty cool stuff. Our people really do amazing things that matter every day.

So, on to slide six and a quick look at our overall business well-being and business health slide. On the people front, we have increased headcount by no double digits since this time last year, I think a good indicator of managed, sustained growth in the services and technology business. From an innovation perspective, we’re in the middle of our first Global Hackathon. Now, this is a competition where volunteers competed in 145 teams across the world, innovating to develop and present solutions in the areas of sustainability, digitalization, AI, and branding. The six regional winners will be coming together to compete in the final later this month. The leadership group and myself have all reviewed the six final submissions, and I have to say they were absolutely terrific and will certainly be taking a number of their ideas and solutions forward.

So I think really, truly a value-add process. So also in a world where there is more working from home, and thus I think a greater risk of creating silos, this is the added benefit of connecting people and fostering collaboration across non-traditional boundaries; so very, very successful. And lastly, on the people front, we were notified within the last week that we have been once again recognized by Forbes as one of the world’s top companies for women in 2023. And this recognition, I think for the third consecutive year, really underscores our commitment to fostering an inclusive and empowering environment for all our employees, and we are proud to be forging forward in gender equality in the workplace. Now, on to HSSE, our people continue to really impress with their unparalleled commitment to health, safety, security, and to the environments they are working in, looking after themselves and those around them.

And I think the statistics really speak for themselves, and they’re really, truly best in class. This obviously helps with recruitment, and it’s a very clear example of our values-driven culture, and it’s also a key differentiator with clients and with partners around the world. Now as Zero Harm is a broader ESG and sustainability program, and internally we link our activities to the UN Sustainability Development Goals. So we thought we would present what KBR is doing opposite one of these goals each quarter going forward. So we started today with water and sanitation. So just to give you a flavor, KBR today runs the combat water supply for the UK military. We run both potable and wastewater in a number of sites across the world from Djibouti to Kosovo.

We are heavily engaged across Australia, supporting the major water authorities in upgrades, expansions, modernizations of the various cities’ water and wastewater infrastructure. And we engage with local communities and schools to educate on plastics in the oceans, organize river and beach cleanups, et cetera, through our One Ocean program. And you’ve seen that before. So, just as we did for space sustainability, I think this gives you a different lens into and across KBR. On to business growth on the bottom left, a really, really strong booking squatter reflecting continued momentum as we continue to 24 and beyond. As you would expect, our work under contract to allow us to finish strongly this year is over 95% and on to the financials at a high level, 9% growth, all organic.

I’ll say that again, 9% all organic at the revenue line with margins at the group level of 11%, a really terrific performance from our people around the world, delivering for customers, for each other, and ultimately our shareholders. Cash was a standout in the quarter with conversions ahead of pace at 125%. And in a world of higher interest rates and volatility, this was a critical focus area for us, as I’m sure it is for many, many companies out there, but our people really stepped up once again. And Mark will also cover other positive activities in cash in a moment, which all help to provide deployment optionality. And as promised, and of course linked to cash, one subsequent event of note is that we retired the remaining convertible principal of $250 million in cash on the first of the month as it matured.

That’s the first of November, a clear demonstration of our belief in the value upside of KBR. Now, on to slide seven, the markets remain buoyant across the energy trilemma, as we’ve discussed previously. Ongoing geopolitical instability, I think, only adds to this, particularly in the energy security area. And we continue to see high levels of activity across aging assets as owners continually recognize the need to become more efficient, but also in a de-carbonized way using a engineering technologies, including digital and data-enabled tools. STS trailing 12 months book to bill was 1.3, and we’ve highlighted three of multiple awards this quarter. Firstly, we announced that we had been awarded the world’s first commercial ammonium cracking project with Daesan in Korea.

This is effectively taking liquid ammonia and cracking it back into hydrogen so that you can transport and utilize it as a gas in existing facilities, infrastructure, and networks. Now, this is a big deal and a real enabler, as it allows countries committed to a hydrogen future to deliver on that commitment, and importantly for KBR, can have the effect of significantly increasing demand for ammonia production, where, of course, as we have a very high market share. In the UK, we are deeply engaged with EET Hydrogen and the UK’s leading industrial decarbonization project. This project is the largest blue hydrogen project in the UK and is a fantastic example of synergy across all of sustainable technology solutions. It combines our innovative d-ecarbonizing IP with best-in-class engineering services and digitalization.

And finally, in the energy security market, where we believe gas is the transition fuel, we were awarded a reimbursable EPCM fully aligned to our existing risk profile services contract for the Pluto LNG train one modifications in Australia for Woodside. Now, on to government, so on the government side, the market in the US continues to be robust as we look beyond with budgets in critical areas and emerging technologies growing, with a focus on operationalizing these as quickly as possible, which is a sweet spot for KBR, as we’ve discussed many times. Ongoing and recent world events elevate these priorities and the need for greater multi-government collaboration, like AUKUS, which emphasizes the significance and value of our global GS segment as we can play a critical role in addressing these challenges.

We believe that our GS international business is a real differentiator, engaged in high-end consulting services in critical areas of defense, energy transition, and critical infrastructure. Book to bill this quarter was excellent. GS alone was 1.6, bringing our trailing 12 months for the whole segment back up to 1.1 times. Now, you may recall GS International had a strong booking last quarter, so the whole segment is well positioned as we move into 2024. We’ve highlighted a number of awards for the quarter in a science and space business. In total, these awards are well over $2.5 billion and, importantly, are all multi-year. With these awards coming through in Q3, and with the IMOEC re-compete increasing in value by several hundred million dollars, and with OMS and Cs all being additive as both were takeaways, it’s easy to see that on a full run rate basis, 2024 for science and space should be a good growth year.

Very exciting! Similarly, in defense and Intel, we’ve had several key awards in the quarter, some real nice wins in the Intel side with customers like the NRO, but unfortunately, we can’t say too much more about these. It was also nice to see awards under the IAC-MAC contract vehicle pick up cadence in the quarter. Similar to science and space, our defense and Intel business are in real good shape for growth as we move into 2024. From a technology perspective, KBR’s proprietary secured cloud and mission services platform has been prioritized for the federal risk management program. A platform called Bolt is one of only six prioritized platforms and is just one example of the investment we are making in the AI space. Investments in this area continue to open new opportunities for KBR, both with government and with commercial customers.

And although not specifically shown on the slides, registered sustainment after a flourish for slightly down few months in Europe has been awarded new multi-year task orders that will also provide opportunity as we head into 2024. The final point to make on new businesses, while KBR generated 9% of organic growth in Q3, we also finished the quarter to record high backlog and options since our transformation. I think really indicative of great momentum and demand across all of KBR. And not to forget on HomeSafe, as Transcom leadership said in early October, the program hasn’t quite started yet as readiness is still being evaluated. As you’re aware, the number one priority of this effort is to improve the moving experience of service members, civilians and their families.

And Transcom and ourselves are fully committed to delivering this via HomeSafe from day one. And thus we are jointly adopting a careful and calculated approach to ensuring this outcome. I’m sure you’ll recall that we assumed no moves this year in our targets with a significant ramp up during 2024 with modest initial margins, mainly due to the newness of the program. Although it hasn’t started yet, we do expect moves to start in Q1 2024 and ramp progressively. But today it still remains unclear what that ramp will look like. There should be more clarity when we report full year results and ’24 guidance in late February next year. Now we’ve always said, given the uniqueness and the dynamic nature of the markets and the businesses that we are in, that there were many ways to meet our targets.

And interestingly, the over-performance of STS will fill the EBITDA we planned for HomeSafe in 2024. If one then assumes that we do get started with moves in 2024, we should be in real good shape from an EBITDA perspective at the group level. As we’ve said consistently for many quarters, KBR is a Company with multiple pathways to earnings growth and the real focus needs to be on EBITDA for the whole corporation. So in short, KBR continues to move up market, increasingly playing in the knowledge economy growing EBITDA, delivering strong cash and truly performing. And has secured the right work and exciting well-funded verticals to keep on pace to close out ’23 and keep momentum as we head into ’24 and beyond. With that, I will now hand over to Mark, who will add his own color of course and back up the words with the numbers.

Mark?

Mark Sopp: All right. Thank you, Stuart. Hello, everyone. I’ll start on page nine or slide nine. So we’re certainly pleased with our team’s ability to deliver strong and well-rounded performance in the third quarter. As you see in the Stuart’s revenues are up 9% all organic, reflecting a balance of ramp up on recent wins and production of on-contract growth across both segments. Adjusted EBITDA was up the same on constant margins and at the levels we expected. Focused program execution is required to deliver these healthy margins. I’ve said that before. This continues to be the case across all of our operations in Q3. So, a big shout out to the people who constantly deliver on this front across KBR. Amazing. Adjusted EPS grew 15% to $0.75 per share, driven by the EBITDA growth and net favorable below the line items compared to last year.

Voluntary expense was higher year over year as expected. The team really pulled together to generate strong cash flow and also debt reduction actions which kept financing costs in check. While effective tax rates are also trending up a bit, we did have a favorable resolution of an R&D tax credit which did keep us in line with our tax rate guidance as well. So our treasury and tax folks really did a superb job mitigating the more challenging interest and tax environments that we have today. I just mentioned cash flow was strong again in Q3 at about $90 million, with year-to-date adjusted op cash flow of $380 million, reflecting a conversion ratio of approximately 125%. Quite good! Consolidated DSOs improved two days on increased focus by the team across the board.

This will continue to be pressed with course. Free cash flow year-to-date is $320 million, and I’ll remind you, CapEx is running about twice the normative rate this year due to two specific project requirements. So that’s the big picture for the enterprise results. Now, on to slide 10 for segment performance, starting with SPS, we’re seeing tremendous growth and profit margins. In addition, while not shown here, SPS is generating excellent cash flow as well, with year-to-date free cash flow conversion of well over 100%. This entire segment runs on negative working capital. We’ve said that before, that remains the case. Top-line growth was almost 30%, and balanced across technology and sustainable services. EBITDA margin was 21%, with EBITDA totaling just under $90 million.

As is evident in Stuart’s remarks back on slide 7, we’re seeing high demand and increasing adoption of our proprietary solutions and technology service offerings all around the That’s what we do. Over to government, organic growth was 4% in Q3, which is pretty consistent across the four business units. As Stuart mentioned, strong bookings in Q3 provide opportunity for improved growth prospects moving forward as we head into 2024. On to slide 11 in capital matters. With strong year-to-date adjusted cash flow of, again, $380 million, effective cash repatriation actions, and with year-to-date adjusted EBITDA growth of almost 10%, at the end of Q3, we actually kept our leverage ratio steady from the start of the year at 2.0 times. That’s really saying something after deploying over $200 million on buybacks, dividends, and $200 million on the convert and related warrants, $130 million on the legacy legal settlement, and higher interest costs.

So, quite an accomplishment keeping the leverage ratio steady after going through all of that. Consistent with our messaging at the beginning of the year, our capital priority was and is to resolve the maturity of the convertible notes that mature November 1, and the attendant warrants which expire a little later. So as Stuart just said, we did retire the note yesterday, November 1, which culminated in a cash payment of $250 million. That was funded with $200 million of revolver debt and $50 million of cash on hand accumulated from pre-cash flow. As for the warrants, there’s an open window to seek early settlement of those in the next two months or so. Doing so will depend on what terms can be negotiated, so we’ll see how that goes, but we certainly have the capital capacity to do so.

On to slide 12 for forward guidance. While the numbers through Q3 suggest we are ahead of pace, including the raised EBITDA guide from last quarter, there is seasonality to factor in to Q4, including having fewer productive days due to holidays and things like that. With excellent growth, margins, cash flow, and EPS production embodied in our current guide, we’re sticking to that outlook for the rest of the year. With all that’s happening in the world in KBR, here’s a quick update on how we’re tracking toward our long-term 2025 targets. For things under our control, we are well ahead of pace on EBITDA and on pace for cash flow. For EPS, which is more influenced by external factors, $4.75 EPS by 2025 is looking much harder to achieve, primarily due to the uncertainty that we have on the ramp up of HomeSafe and with interest rates now expected to stay higher for longer and all the implications of that.

For the more controllable factors, we see our end markets as strong or stronger than our original baseline, and our ability to capture demand for our offerings is the same. Government is on pace to meet our targeted EBITDA, and as Stuart said, SPS is well ahead of pace. We see this momentum continuing through 2025 and beyond. So that’s it for me for the quarter, pretty short report. I’ll turn it back to Stuart to wrap it up.

Stuart Bradie: Thanks, Mark. Great job! But just to emphasize what Mark said a few moments ago, our EBITDA trajectory is well ahead of pace, including associated cash conversions. However, there are headwinds due to external factors beyond our control, making the 25 EPS target of $4.75 more difficult to achieve. With that, now let me summarize the key takeaways that are in our control and are going really well. Firstly, we continue to deliver for our customers, our shareholders, and other key stakeholders through our people-centric, values-driven culture, consistent delivery, resilient, organic growth, and increasingly so into the knowledge economy with another great quarter. Continued strong organic growth across all businesses and the group is a key takeaway.

Cash management was absolutely terrific across many elements, as Mark said; repatriation of trapped cash, DSO reduction, interest management, et cetera. We have paid the convert principle in cash as we promised, once again doing what we said we would do. Responsible leverage and strong cash management gives us optionality on capital deployment going forward. That’s another key takeaway. Bookings were strong across the group, especially in GSUS in the quarter. Now, with a light re-compete year in 2024, the inbuilt organic growth as a consequence of bookings happening in the latter half will deliver targeted growth into next year. STS continues to win work across the energy trilemma and energy transition with outstanding delivery, growth, and margin performance as you see quarter on quarter.

The key takeaway here is strong bookings underpin continued momentum and organic growth into 2024. HomeSafe moves should ramp up in 2024, but likely at a slower pace than originally was expected. We’ll know much more by year-end earnings. However, we do expect STS to over-perform, thus mitigating any shortfall, even that, from HomeSafe in 2024. Finally, the key takeaway here is that there are multiple pathways to EBITDA success. This is a result of our differentiated, diversified, global, and resilient business model operating across multiple verticals within the knowledge economy. Thank you again for listening, and I will now hand the call back to the operator who will open it up for questions. Thank you.

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Q&A Session

Operator: Thank you. [Operator instructions] Our first question today comes from Toby Sommer of Truist. Your line is open. Please go ahead.

Jasper Bibb: Hey, good morning. This is Jasper Bibb on for Toby. I can appreciate that there’s still quite a bit of uncertainty on HomeSafe here, but any additional color you could share with us on the ramp would be appreciated. I think with the expectation of the first moves happening in 1-2-24, is there an underlying expectation there for the share of total volume that you’re going to be taking over at that point, and do you think it’s still feasible to hit the full revenue run rate at some point in 2025?

Stuart Bradie: I mean, it’s still not clear what the ramp is like, and I will try to be quite distinct about that in our prepared remarks. Is it possible we can still get to full run rate by summer of ’25? Yes, it is. But until we get through the next few months and get to February, as we said, we’ll have more clarity then. But yeah, it’s difficult to say what’s going to happen in ’24. Could you get to full run rate by ’25? The answer is yes. Is that guaranteed? No. And that’s just the bare truth of it today. We’re not pulling any punches. That’s just the facts, and there’s so much uncertainty at the moment on timing because of what’s happening across the world, as I’m sure you can understand, totally not in our control. But that’s just the way it is, and we’re trying to be very upfront and transparent in that message.

Jasper Bibb: No, that definitely makes sense. And then I think you said it was going to be harder to hit the 475 EPS target because of higher interest rates. Just curious if you could frame the relative headwind from those higher rates versus your initial plan? Like, is there an EPS headwind that you could tie to that? That’s more specific. Thanks.

Stuart Bradie: Yeah. I mean, there’s two factors, of course. The 475 has the embedded wrap-up on HomeSafe, which may or may not be achievable, as we just talked about. And in terms of interest rates, I think the difference that’s happened over the last three, four months in particular is the yield curves are now looking that interest rates are higher for longer. They were coming down. If you went back a few months, the yield curves would say they were coming down, which means, of course, it’s accretive to borrow money and then buy back stock. And at the moment, that mass is on the edge, I would say. And so obviously, if you’re using free cash flow, it’s accretive. If you’re putting it on your balance sheet, it’s a more difficult decision. And I think that’s really the message we’re trying to give around that and the implications of the higher interest rates. Mark, any?

Mark Sopp: Yeah. I think it’s an opportunity just to clarify that, absent real compelling M&A, we intend to use all of our free cash flow for buybacks. We think that’s a terrific return over the long term for our shareholders. But as Stuart suggested, these days to lever up and buy back stock is kind of a push from an accretion perspective. That was not our assumption in the original targets when we had lower rates and so forth. And so that part won’t deliver the accretion we once assumed. But all other things operationally, as we said in our prepared remarks, really strong, more stronger than planned. A little bit of headwind on tax rates and FX since the derivation of those targets, but not that dramatic relative to the interest rates, which were the biggest move as well at the home safe timing, which is uncertain.

Jasper Bibb: Appreciate the detail there. Thanks for taking the questions, guys.

Operator: Our next question today comes from Bert Subin of Stifel. Your line is open.