KBR's (KBR) CEO Stuart Bradie on Q2 2016 Results - Earnings Call Transcript

| About: KBR, Inc. (KBR)

KBR Inc. (NYSE:KBR)

Q2 2016 Earnings Conference Call

July 29, 2016 9:00 AM ET

Executives

Lynn Nazareth - Vice President of Investor Relations

Stuart Bradie - President and Chief Executive Officer

Brian Ferraioli - Executive Vice President and Chief Financial Officer

Analysts

John Rogers - D.A. Davidson

Tahira Afzal - KeyBanc

Jamie Cook - Credit Suisse

Robert Norfleet - Olympic Global Advisors

Steven Fisher - UBS

Andrew Kaplowitz - Citi

Chad Dillard - Deutsche Bank

Jerry Revich - Goldman Sachs

Anna Kaminskaya - Bank of America-Merrill Lynch

Operator

Good day and welcome to KBR's Conference Call. [Operator Instructions]

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

Lynn Nazareth

Thank you, David. Good morning and thank you for joining us for KBR's Second Quarter Earnings Conference Call. This morning you’ll hear from Stuart Bradie, President and Chief Executive Officer and Brian Ferraioli, Executive Vice President and Chief Financial Officer.

Stuart and Brian will discuss KBR's financial and operational results, provide an update on our progress against our strategic objectives and discuss our market outlook.

Please refer to the accompanying presentation that is posted on our website in the investor section at kbr.com. After our prepared remarks, we will open the floor for questions. Today's call is also being webcast and the replay will be available on KBR's website for seven days at kbr.com. The press release announcing KBR's second quarter results and our second quarter Form 10-Q are available on KBR's website as well.

Before turning the call over to Stuart, I would like to remind our audience that today's discussion may include forward-looking statements reflecting KBR's views about future events and their potential impact on performance. These matters involve risks and uncertainties that could impact operations and financial results and cause our actual results to differ significantly from our forward-looking statements. These risks are discussed in KBR's second quarter earnings press release; KBR's Form 10-Q for the period ended June 30, 2016; and KBR's current reports on the Form 8-K. You can find all these documents on our website.

Now, I'll turn the call over to Stuart. Stuart?

Stuart Bradie

Thank you, Lynn and good morning. So starting at slide 3, looking after ourselves and the people who’re under us, as I’ve said before is the core value at KBR. The fundamental belief is that Zero Harm is achievable and I’m pleased to report that we continue our progress towards that goal. You can now see we’re performing very much at the top quartile performance and we’ll continue to endeavor to improve on that, so a great performance from the team in the safety area.

So moving on to slide 4, so just in summary a solid earnings quarter for KBR, still in the levels for the same period in 2005, we expect that 2005 one time gain associated with the sale of the Building Group, so earnings holding up which is pleasing. We then had four or five risks and opportunities identified at the beginning of the year that outcomes have caused, essentially net each other off and I’ll talk about each in turn. But what it means overall, is the underlying operating earnings is thus at the $0.32 sort of area.

So firstly, we signed an agreement with the U.S. Government on reimbursement of legal cost and I guess future potential legal cost or potential awards to plaintiffs if they appeal the recent judgment. And I think that’s associated with sodium dichromate, I think as importantly is directionally we’ve started stayed for some time and we believe that we will win these cases on the merits and that we have certain indemnities in place regardless.

And I think directly that has borne out to be true in this particular case and we could probably go fees associated with defending those cases which have been going on for a number of years, so very, very good de-risking of the business in this area.

In E&C we have some puts and takes. We closed an LNG project in Africa to the good. We then had some equipment failures associated in the commissioning phase of an ammonia facility in the U.S. to the dawn and we have also had some increases in costs related to closing out one of the prior projects in the Non-Strategic area. And as I said before together with I guess, some of the transaction costs and together with some of the restructuring charges, when you look at them altogether turn each other apart.

We also continued to win key contracts and contract extensions in the government sector and we’ve been very successful in Australia in a number of sort of in the E&C infrastructure area in the Australian marketplace. And we’ve put together some more wins in technology and a strong performance from technology and the revenue line this quarter just started increasing.

So I guess, progress on initiatives, of course Government Services continues to be a growing market, somewhat offsetting the headwinds in hydrocarbons and we just talked about that previously and it continues to be the case, which leads us into the sort of – we’re pleased to report we closed on the Wyle acquisition on the July 1.

The real focus initially on our business, there are no overlaps as we cleanly saw presented, so the focus is very much on the revenue synergy area and pleasingly we’re starting to see quite a lot of personnel moving across from the E&C side of the business into Government Services, some good synergy there.

On the cost saving side again moving against the target, well, we’ve identified the 200 million we set out to achieve and we continue to look for more savings in that area.

We will continue to look for additional acquisition opportunities in three focus areas we previously announced, and we will be very disciplined around what we are looking at strategically, and those are adding to the technology portfolio, higher end Government Services, and expanding our Maintenance Industrial Services based globally under the U.S. for that market.

We do continue to make progress on resolving other parts of the legal disputes with the U.S. government and the audit fees is really behind us now, which is terrific as sodium dichromate as I previously stated. Pemex, no real update, we’re awaiting a ruling, so it’s a question that we often get asked post [indiscernible] upfront.

So now I’m going to hand over to Brian, who will put a little bit meat on the bone around the various segments. Brian.

Brian Ferraioli

Thank you, Stuart and good morning. Turning to slide 5, you see the awards during the quarter of 331 million and you see the backlog about $11 million. The backlog reflects the work off of two of the large LNG projects in Australia, but it also includes a reduction of about $500 million for the quarter related to the devaluation of the UK British Pound against the U.S. dollar. This relates primarily to our Government Services business in UK, which has a 20 plus year contract with the Ministry of Defense.

That contract is all denominated in Pound Sterling both the revenues and the cost. So the devaluation of the pound has no real economic impact to that business, but it does translate into lower U.S. dollars equivalent, in terms of the financial reporting, so 500 million reduction for the quarter and 600 million year-to-date just due to the currency fluctuation.

Revenues are down from the prior year, but it reflects $187 million reduction due to the deconsolidation of our Industrial Services business, which is 119 of it and 68 million which relates to non-strategic businesses which we have sold over the past year. It also reflects the reduced activity on the non-strategic power plant as we had two power plants going last year and only one this year, as we are exiting that business, and also reflects the reduced activity on those LNG projects in Australia.

There is a 20 million decline in gross profit and equity and earnings, and that reflects the reduced volume. But there are number of large discrete items this quarter that Stuart touched on initially. $39 million in cost related to complete the E&C project, the ammonia project which had the equipment failure, and $21 million increase in cost on the power project in our Non-Strategic segment.

But they were offset by normal growth in the Government Services business as well as the $33 million gain on the settlement with the U.S. government related to the reimbursement of the legal fees on the sodium dichromate cases as well as the $36 million gain as we closed out another project, LNG project in Africa. So when you net all of those together, it’s about $9 million, looks good [ph], and that is largely offset by the restructuring charges of 12 million for the quarter and gain on disposition of assets. So if you net all of those together they basically zero out.

On the G&A line, you see we continue with the cost reductions, but also included in there is $1.4 million related to the Wyle deal, which as we mentioned previously closed on July 1. 2015 also included $28 million gain from the sale of the Building Group which obviously did not repeat. So the net of all of this is $0.32 per share, down from a year ago, but if you eliminated the gain on the sale of Building Group from a year ago, the EPS actually would be up year-over-year.

Turning on to slide 6 on the segments, Technology and Consulting, the revenues were 98 million for the quarter, which is an increase of 18 million from a year ago, and that’s due to increased sales of proprietary equipment, which is up to almost 60% of the total revenue. If you recall last year, we had – higher percentage of the revenues were related to the license sales associated with the technology, and as those projects move through the cycle, we are into the proprietary equipment supply days of it.

This started around the year end, beginning of the first quarter we expected to continue for several more quarters. The gross profit decreased as a result because the proprietary equipment had a lower margin than the license fee typically do. And we believe that this is a timing issue, as gross margin in 2015 was approximately 24% driven by those license fees, and now we are back down into the teens because of the proprietary equipment. And we continue to believe on a long term run rate basis that the margins for this business should be somewhere in the low 20s in terms of percentage.

Not surprisingly, the market for the upstream consulting services, which is the smallest component of this segment remains challenged, but this business continues to focus on the technology side and downstream projects, and that’s where the vast majority of both revenues and earnings are coming from this year.

Moving on to Engineering and Construction on slide 7, revenues were 621 million, which was down from a year ago and 119 million of the declines related to the deconsolidation of our Industrial Services business. If you recall, we sold 50% of it to a partner and we’ve deconsolidated it as well as the declines related to reduced activity on those LNG projects in Australia. There was also increased revenues from domestic projects here in the U.S. and $36 million relating to the settlements and close that activities of the LNG project we previously discussed.

Gross profit for the quarter was 35 million, which is a reduction of about 17 million from a year ago, and again that reflects the lower volume of work in General and the LNG projects as well as the deconsolidation of the Industrial Services business, and then you have the increase in the estimated cost on the ammonia plant offset by the settlement on the LNG project, and finally, you have the overhead reductions continuing to help on the earnings line [ph].

Equity in earnings were down 17 million from a year ago, but if you recall, we had a $15 million positive adjustment to this line a year ago, which obviously did not repeat, there was a catch-up of some earnings from prior years that was taken into account a year ago.

Moving on to Government Services, as Stuart mentioned, they continue to perform very well. Their revenues for the quarter were 229 million, which is an increase of about 71 million from a year ago, that’s largely due to work supporting the U.S. government internationally during the first half, as well as the settlement for the sodium dichromate as we previously discussed.

Gross profit increased significantly to 41 million, and again a large part of that is the $31 million pick up related to the sodium settlement, as well as the higher volume on the U.S. government support work.

Equity in earnings was 10 million for the quarter that was down slightly from a year ago, and as you recall, a year ago we were still doing some of the construction related to that long-term annuity side contract in the UK. That construction has ended and that reflects the decline of the activity right now. It continues to be to run the facilities for 23 years to go and this is the first phase of the project.

And as Stuart mentioned earlier, the Army 2020 prospect is really the second phase of this project, which we continue to attract, and expect to be awarded before the end of the year. And then obviously none of these numbers include any revenue or earnings from Wyle, since the transaction closed on the July 1. And then we’ve previously talked about the impact of the foreign exchange on the translation of the earnings of this business, but really not much impact on an economic basis.

Turning to slide 9, looking at Government Services with the addition of Wyle, as you recall it’s the strategic acquisition, it provides high value, low risk, and it’s primarily U.S. based which fits very nicely with our traditional Government Services business, which was predominantly outside of the U.S. and it provides these long-term annuity type revenue streams, with very low overlap to KBR’s historic business.

So now we think we have a full service Government Services organization executing about $2 billion worth of contracts each year and it’s also a growing market. Also importantly to us, it adds immediate earnings power and it also acts as a different funding source from our traditional business.

The Wyle government funding typically comes from the research and development aspects of the government budget where our traditional government work for the U.S. comes from the overseas contingency fund. So it diversifies the funding sources and also we believe it reduces our overall risk as the vast majority of the Wyle contracts are reimbursable.

Like the cultural fit, the management team as adapted well to the KBR organization and we believe that Wyle’s high end technical capabilities domestically match very, very well with KBR’s well established international capabilities and logistic support. And as Stuart mentioned, the acquisition is really a sly on revenue synergies. We believe we should be able to achieve at least 250 million in revenue synergies by 2020.

As I said before that we’re immediately accretive in 2016, $0.05 to $0.08 and that includes the deal and transition cost and then you see for 2017, we expect that to be more or like $0.15 to $0.22 per share, which also includes some transition cost. The charts to the left give you some context in terms of the impact that Wyle will have on revenues. The top circle shows a pro forma estimate of revenues excluding Wyle and you see the Government Services is about 20%, and if you include a full 2016 revenues for Wyle, you see that the equivalent would have been about 34% of expected revenues this year.

Moving on to slide 10 and cash, at the end of the quarter we had $804 million in cash. We used 200 million of it on the July 1 to complete the Wyle transaction and we used $400 million from our revolving credit facility, we are in process of putting in place permanent financing and we expect to have that closed by the end of the year.

Turning to slide 11, we get questions from time to time on our capital allocations, so we thought it would be good to take a look in and explain again our thinking on capital allocation in the way I think about it. There is really two columns, the columns to the left relates to investments in the business, where the column to the right really reflects shareholders.

And within the business, obviously we support the ongoing businesses although we don’t have to invest much capital, we are a service company, other than working capital and that’s really the focus on capital allocation for the existing businesses, that’s managing working capital, try to maintain our revolver and strong balance sheet which will give us good bonding capacity when the markets return on the hydrocarbon side.

But we also have divested or exiting underperforming businesses, sold the Building Group, the Infrastructure Group, closed the U.S. mining business in 2015, we were sub-optimal in those businesses, and we also sold off 50% of our industrial services to try to grow that business with a partner. And as we mentioned previously we’re exiting the power business here in the U.S.

As Stuart pointed earlier, acquisitions continue to be a strategic focus for us, with the three-pronged approach, Technology, the Government Services and the Industrial Services on a global basis. We particularly like the first two that are higher multiples than the oil field services type businesses these days. And we did one acquisition in the first quarter on the technology side and now Wyle is the latest on the high end Government Services and we continue to look at other opportunities in those two sections as well as international Industrial Services and maintenance opportunities.

These are billing in geographic holes for us, but they provide long-term and reliable earnings and we plan to continue to use a combination of cash and debt for acquisition. We try not to forget our shareholders, we pay a dividend $0.08 per share for quarter and we have one of the highest paying dividends among the U.S. peers approximately 2.2% yield. We’ve returned to little over $300 million since the spin via dividends, we also have a buyback program in place and you can see that we have returned almost $800 million since the spin. We continue to look at that as more of an opportunistic basis.

So with that, I’ll turn it back over to Stuart and he’ll talk a little bit more about 2017.

Stuart Bradie

Good, thank you, Brian. So, as this position [ph] last time be a little bit upfront will probably be the key question in some people’s lips today and that’s really around the issue of backlog, the backlog question particularly as it relates to 2017. I guess, looking back at the wheel, the circle that Brian mentioned, the pro forma revenue percentage shows that we are moving close to sort of half the business sitting – is sitting between Technology and Consulting and Government Services, and that’s on a pro forma basis. We haven’t got the – when you start to think about the growth in those sectors and you start to look at the Wyle backlog, which again we will only show that the funded elements of the Wyle backlog and as we presented last time around there is a substantial multiples of that number in unfunded committed backlog. But again we’ll give more color on that next quarter.

And then in the Army 2020 opportunities that Brian talked about earlier that will come to fruition later this year, and that should give pretty good visibility in recurring revenue streams, annuity type contracts going into 2017. So really I guess, the outlook, thinking about that as it’s a higher proportion of earnings driven by Government Services and Technology in 2017 and that really gives a good balance for us between hydrocarbons and Government Services and we start to see quite a bit of synergy particularly personnel movement between E&C and Government Services, which is good. 2020, we’ve talked about and the focus in hydrocarbons, we really talked there about Industrial Services and I guess driving field [ph] opportunities, expansion opportunities, debottlenecking opportunities.

So we are seeing continued activity in the ethylene area and we are still seeing what I would call sort of not one-off, but I guess multiple isolated projects that will proceed under the current environment even under the capital constraints of our customers. And there is a number of those that we are looking at today. I think will come to fruition before the end of the year or early in ’17. The lower E&C contract margins as a reality there is a squeeze on in that particular sector, I’m sure you are hearing that from the peer group, but for us that’s largely sort of offset by cost reductions and we do well in that particular area.

We continue to expand capabilities and we’re executing our growth plans in the Middle East and to some extent in the Americas. We are underrepresented in the Middle East, particularly outside of Saudi Arabia and feel there is head room for organic growth in Middle East despite taking market share in those markets where our brand is very strong. And as Brian alluded to, we plan to acquire additional earnings power with long-term and stable earnings via focused M&A, and we talked about those three strategic areas before.

So just coming back to the guidance, our previous guidance holds no change to that, including Wyle and the reason for that is that we’ve got Wyle coming in that’s accretive, but we do have to account for integration costs and acquisition costs associated with that deal as we move it into KBR holistically.

So that’s really – moving on to slide 14, in terms of conclusions. High focused business strategy, I believe differentiated offerings covering the entire lifecycle through specialized consulting, proprietary technology and strong global engineering expertise and brand, still very gas-focused with E&C and a growing long-term annuity-type contract revenue base in the Government Services business.

Pleasingly, we continue to make major progress on resolving the legal disputes for the U.S. government on the sodium dichromate settlement results historic and future legal costs associated with that case. But I think directionally very, very important in terms of de-risking KBR. Moving our product to a lean unlinear [ph] cost structure and we will continue with our balanced capital allocation strategy that we’ve been consistent about I think over the last couple of years.

So that’s it. Thank you.

Question-and-Answer Session

Operator

Thank you. The question-and-answer session will be conducted electronically. [Operator Instructions] And we’ll take our first question from John Rogers with D.A. Davidson.

John Rogers

Hi, good morning.

Brian Ferraioli

Good morning, John.

Stuart Bradie

Good morning.

John Rogers

Stuart, I appreciate the comments on 2017 particularly, but could you talk a little bit more about the – specifically the E&C project opportunities, not so much that they’d have an impact necessarily on earnings even in ’17, but – so what are the booking opportunities out there for KBR, I mean in the past you’ve talked around the global, what’s out there. Obviously, the market is in disarray and what’s your sense of what’s out there in the –

Stuart Bradie

Yeah, I think the way to answer that question John is to look at I guess the market in its totality. So if you look at say, the LNG market, it’s a good example. LNG market at the moment – people are struggling with off takes from a lot of distortion in that market. But what is clear and what is consistent from the analysis I’ve read in the market – outlooks I’ve read, is that there will be a – the supply demand curves cross again in ’21 – 2021 to 2022 and if you think of the gestation period to sort of design and build LNG projects, you know the four to five years in tenure is the minimum. So, when you start to walk that backwards, you can see that that market will start to – will need to start to pickup in 2017 to actually meet the demand cycles into the future. So I guess that’s as good an indication in that market as probably anyone can give it at this juncture. I think there will be selected opportunities in LNG more than you’ll see nudging forward and as we’ve talked before, we have crossed probably five or six of those today. And the reason we’re not being specific on either of those is it’s not absolutely certain that which ones will go and which ones will not go.

John Rogers

Sure.

Stuart Bradie

And so I don’t really want to set ourselves up by saying something that we can’t stand behind. In terms of the – I guess the offshore oil and gas market there’s – again the supply demand curves would show that reservoirs deplete overtime and the level of investment going into, I guess offshore campaigns and the drilling and exploration side of the business has got to such a low level to start to be supply demand issues happening in certain areas of the world. And certainly for companies that – oil companies that have valued on their – basically what they’ve got and sort of I guess oil and gas backlog for want of a better description in their reserve base. And so you start to see certain projects move to almost competitive for them in their avenue portfolio.

And all this happened is that over the last little while they’ve taken stock and they’ve prioritized what those are that reassess the market in terms of going out for retender because the market has reset itself on sort of vendor pricing et cetera and the aggressiveness of the competition. So you’ll start to see selected opportunities in the Gulf, you’ll start to see selected opportunities in the UK in particular. And so when you think of that necessarily the ones that are probably the most give the greatest return on investment because of the cost of development or cost of barrel, if you like it at the lowest levels in their project portfolio.

John Rogers

Okay. And just one follow-up, the Army 2020 opportunities, did you say what the booking value or the prospects of that is?

Stuart Bradie

No, we’ve not disclosed that because it’s still of a highly confidential nature given to the customers, but it’s a sizable award.

John Rogers

Okay, thank you.

Stuart Bradie

And those two elements of course is the construction element itself and then of course is the, I guess the long-term annuity, additional sort of facilities management peace of it that would be added as to what we do today.

John Rogers

Okay, thank you.

Operator

And we’ll take our next question from Tahira Afzal with KeyBanc.

Tahira Afzal

Hi, folks.

Stuart Bradie

Hey, Tahira.

Brian Ferraioli

Good morning.

Tahira Afzal

Good morning. So Stuart, thank you for talking a bit about 2017, but I think you did a nifty job of not really talking about color – sort of clarifying some degree the big question out there. We do have maybe a gap as one of your LNG projects somewhat complete into next year. From what we have been reading, some OPEC project activity has been pushed out into 2017. So all the moving parts you mentioned and given what’s happening at this particular LNG project, is Wyle going to be enough to really offset the moving parts as you may execute well or is the fall off you talked about in the last quarter – it closes the gap a bit but not fully.

Stuart Bradie

So I think that – let me address the LNG piece first. I mean, I think when I first joined KBR, everyone was worried we are going to fall off on earnings equipment on LNG because Gorgon was going to a conclusion, everyone’s aware of that and really what has happened through the pieces that our LNG earnings have caught up very well over the last couple of years. I mean, that was the stage for one of those projects in Australia as you rightly pointed out, is essentially complete for us. So – but the other one will continue well through 2017. So, the sort of levels of fall offs that you’re thinking about are not going to happen and at this time we got close to – right now, we’re going into our – we’ll start our planning cycle in the next month or so for next year. But when you start to put that in context, I think that the sort of cliff and the sort of concerns around that are understandable, but that’s not what’s going to happen in practice.

Tahira Afzal

Got it, that’s very helpful Stuart. And Stuart, the ammonia project startup issue. Obviously, you had some legacy gains that helps the EBITDA for the guidance for this year, but kind of reentering [ph] these project are more representative of the execution terms et cetera going forward in this macro environment, should we be concerned that we could see such hiccups again or you have been through your portfolio and your execution teams and you feel very comfortable.

Stuart Bradie

I think the latter. I mean, certainly the terms and conditions that are associated with this particular ammonia project were signed up to well before the troubles in the hydrocarbons sector. But I think to give you maybe a little bit more comfort, we sat down a year ago and looked at what our performance and guidance [ph] should be in 2016, and we knew the risk associated with the projects because we’ve been through that, there was products in some detail and we knew the potential sort of risk, but also the opportunities associated across the other projects et cetera. And we ran a – we ran a balance across that such that we got the guidance we can stand behind. So, you are always going to get puts and takes, it’s incumbent on us to make sure that whatever guidance we give isn’t the best outcome in every possible scenario because that’s just unrealistic.

Tahira Afzal

Got it, thank you folks.

Operator

[Operator Instructions] Next we’ll go to Jamie Cook with Credit Suisse.

Jamie Cook

Hi, good morning. A clarification, I guess two clarifications and then my real question. Brian, when you talk about with Wyle, obviously it’s nice contribution and start to your portfolio, the $2 billion in revenues on a combined basis is the low-teens margins the right way to think about it still, as we look just combining the two?

Brian Ferraioli

Probably, yes, is the question, we got to go through the planning cycle to math that out, but as the –

Jamie Cook

But it shouldn’t be too far, if it’s 9%, 12%, I mean high single digit to low-teens, there’s no way of freezing, I think it’s not somewhere in that range.

Brian Ferraioli

Correct, correct. And the only hesitation is really when – depending upon where entities or business or future projects get accounted for, whether they are in the revenue line or they come through in the equity and earnings line. As you know we have quite a mix there [indiscernible].

Jamie Cook

Okay.

Brian Ferraioli

So they should not change dramatically.

Jamie Cook

And then I think the most interesting thing – when you’re in your – your slide 12, when you talk about outlook for 2017 you say, there should be a greater balance between hydrocarbons and Government Service. When you’re talking hydrocarbons, you are just talking E&C not Technology and Consulting as well or they both?

Stuart Bradie

I think, I mean of course as you increase the earnings in Government Services it will be approximately across 4 [ph]. But I guess that the point we were trying to making in the slide, Jamie the one that I actually said. Our technology business continues to grow, we see continued pipeline opportunities, pipeline of opportunities there, it’s a good business margin wise and – but the way that the backlog works for that is it’s more of a creditive type of work. So, you don’t see the big bump in backlog, but it’s a recurring business, so not truly the thinking there in the way that we’ve shown it so there, the pro forma shows we are at 43% across those two.

Jamie Cook

But I guess the point that’s interesting that I’m trying to make and I think the positive for KBR as we think to 2017, if you have a $2 billion business that let’s say, it’s even 9% margin that’s 180 million in profit. And if – like you are applying to hydrocarbons, should theoretically be that big, is that the wrong way to look at it based on what you’re saying the balance between – do you mean the balance between the two should be more equal. I mean, I’m just trying to figure out what you’re trying to say because that would imply, when I think about your profit for 2017 back to the point that Tahira was sort of asking, like it doesn’t imply – I mean, it implies at least sort of be flat assuming more on including government services, I’m just trying to think about if I’m way off base.

Stuart Bradie

No, I guess, go on Brian.

Brian Ferraioli

As I said Jamie, I think what we’re trying to say here is, we’re trying to move to more of a balance between the two rather than guide you to a specific number. And I would also point out on the E&C that number will move around obviously in terms of percentage if we would book any of these negative projects like another LNG or ethylene cracker or something like that. So the intent is really to say it should be much more balanced and not huge to the E&C like it has been more recently.

Jamie Cook

I know I was just trying to say government is that big in terms of profit and hydrocarbon and T&C can hold, I mean again I think that would be better than what the market is expecting. I guess my last question Brian, you talk about greater focus sort of an M&A, can you install – because I think people were constructive on the Wyle acquisition and how you are thinking about balancing the portfolio. Can you sort of talk about your comfort level with leverage as you move to a more O&F type business model and just sort of the opportunities out there for 2017 and I’ll get back in queue.

Brian Ferraioli

I mean…

Stuart Bradie

I was going to say, I’ll start out Jamie on the leverage side. Clearly, these businesses are lower risks that were focused on Technology, reimbursable Government Services and reimbursable maintenance turnaround, Industrial Services type businesses. So, they lend themselves to being able to support debt maybe a little bit better than some of the traditional E&C type activities. It really depends on the specifics, it really depends on the cash flow, it really depends on the risk profile and Wyle for example, with 97% reimbursable contract was owned by a private equity before us. So they are accustomed to operating in a levered environment. So I would think that we are – we do have a bit more appetite for a leverage with those type targets than maybe I would traditional EPC type projects or activities.

Jamie Cook

Okay. Thank you. I’ll get back in queue.

Operator

And we’ll take our next question from Robert Norfleet with Olympic Global Advisors.

Robert Norfleet

Good morning and congrats on a nice quarter.

Stuart Bradie

Thanks, Rob.

Robert Norfleet

A quick question, I just wanted to kind of – I guess my first question revolves a little around the backlog. Brian, I understand obviously the devaluation clearly hit backlog this quarter, but if we look at where we ended backlog around $11 billion and I assume devaluation is not going to the current second half of the year. Based on the opportunities of E&C in front of you in Q3 and Q4, do you think this is kind of a trough for backlog or maybe let me put it this way, do you think that we should end the backlog at a higher level than where it is today?

Brian Ferraioli

I’m not sure. We haven’t given backlog guidance, so I really can’t answer that question specifically. But I just pointed to the Army 2020 that’s a pretty substantial booking. Although we haven’t given a dollar amount, we have said in the past that it’s hundreds of millions of dollars. So that clearly would be an important aspect to book that, and then anything else on the hydrocarbon side would be great. So I am not going to be too specific on the guidance, but we have some good opportunities in the second half of the year to at least match the revenues going forward.

Robert Norfleet

Okay, and just trying to get back to the question people have been asking on LNG, again I know you guys don’t breakdown the contribution of LNG related work in the hydrocarbons and the E&C business, but obviously a number of us have tried to kind of model out what the contribution is from the various contracts. So I guess my question is, with the one remaining Australian LNG contract that will be contributing to operating income in 2017, would the level of contribution in 2017 from that one contract be similar to what we are seeing in ’16 or is there going to be a significant decline?

Brian Ferraioli

Well, I guess one of the things that we think we hear routinely is that people seem to expect earnings to fall off a cliff and the way any project operates – it doesn’t work that way. You think about kind of a balance sheet curve, you hit the peak and then you are gradually declining. So there is no immediate drop-off, as Stuart mentioned earlier, Gorgon is more than complete, they already shipped some LNG from the first train. That’s been trending down for a couple of years. This will be a similar model. So there is no dramatic falloff, it’s more of a glide rather than a significant step-down.

Robert Norfleet

Okay great. And lastly, can you just give us an update on the BCP partnership? I know you guys have talked about leveraging that into adjacent markets as well as being able to expand the relationship. Can you kind of just give us an update on where you are with that?

Stuart Bradie

Yeah, I mean it’s focused in the Americas, which includes Canada and certain companies in Latin America. I mean, it’s a 50-50 joint venture. It’s grown its base business in terms of building out more contracts and hiring more people across what it does particularly in Gulf Coast and around Louisiana. We have added engineering capabilities to that through inquisitive process with a company called WINK Engineering, again based in Baton Rouge, and we’ve also added I guess, additional capabilities in the scaffolding area, so that we are becoming a sort of I guess a one – sort of a one stop shop to be able to provide that sort of construction, sort of small construction maintenance turnaround services across the growing number of facilities in –particularly around the Gulf Coast. And so we see that business growing, we see the customer base growing, which is that [indiscernible] those customer’s response outside of the Gulf Coast across the U.S. we have a solid deployment facilities for example across all of the U.S. and the Americas for that matter. So we see that as an attractive business, it’s a recurring revenue base typically long-term contracts and now we continue to look for opportunities to expand that with BCP.

Brian Ferraioli

And I’ll add that that’s likely to help us in 2017 as well as that business continues to ramp up.

Robert Norfleet

Great, thank you so much guys.

Operator

And next we will go to Steven Fisher with UBS.

Steven Fisher

Thanks good morning.

Stuart Bradie

Good morning.

Steven Fisher

Good morning. In terms of the technology segment, it sounds like the mixed headwinds that you have there on the margins will last for a few quarters. What kind of visibility do you have as to what happens after those few quarters. When could that technology shift back to a more profitable mix and do you have any visibility as to what might cause that shift back?

Brian Ferraioli

I think Steven; we have been quite consistent in our sort of guidance around technology in the sort of low 20s, we still stand by that. And it just becomes phasing in terms of whether it’s proprietary equipment or licensing fees that are coming through beyond and so it’s a cycle we still think we are tying those with 20 margins are consistent. I don’t think it’s an up or down type question.

Steven Fisher

But you have the visibility like you have the list of projects that you know or assignments that are going to come in after those next few quarters that will shift it back or should we get to that point and it just kind of lingers on to the mix [ph]?

Brian Ferraioli

No, no, I mean again it depends on the cycle of that, so the way that our business works in terms of technologies to sign up the license fee and the basic engineering which is I guess higher returns and as the project comes into execution you provide the proprietary equipment. So again it’s a timing across the fees in terms of visibility across that pipeline, yes of course we do, we got that product quite a ways into the future.

Steven Fisher

Okay and then I think Stuart you mentioned you are shifting people from E&C to Government Services, just curious on your cost management in this environment. How aggressively are you actually taking it out as people come off E&C projects that are getting finished? How are you making the decisions as to whether you keep them on in hopes of projects moving forward versus making more quick decisions to manage cost? And I guess related to that, is there upside to the 200 million of cost savings here?

Stuart Bradie

No, I mean going backwards, I think yes. I mean we continue to look for more opportunity beyond the 200 million, in terms of the people we are highly considered about capability drain, but at the same time I think the cost that we have taken out of the business, we have been very clear, it’s a net cost, it’s not a gross cost. So it actually stands [ph] for people that are not chargeable to project, we want to hold them in the business. So we have taken out more than 200 million in cost. We are trying very hard to move people across because the key skills we want to retain in KBR, I guess as again perhaps others of our peer groups, who don’t have that opportunity to retain staff to other businesses that are growing, it’s a good opportunity for KBR.

Steven Fisher

Can you give a more sense of how much of that 200 plus will fall from the bottom-line?

Stuart Bradie

I mean I don’t think we have given any guidance at all as to how much will drop to the bottom line because this continuing margin pressure that comes along with taking the cost of is – as you are well aware.

Steven Fisher

Okay, thank you.

Operator

Next we will go to Andrew Kaplowitz with Citi.

Andrew Kaplowitz

Good morning guys.

Stuart Bradie

Hi, Andy.

Brian Ferraioli

Good morning.

Andrew Kaplowitz

Stuart and Brian, you added $0.05 to $0.08 from Wyle this year, you beat our EPS estimate by about $0.06, you didn’t change your ’16 EPS guidance, is it just relatively weak oil and gas markets and you have a pretty wide range of it and so you want to stay pretty conservative. Isn’t it really more likely that you do the high end of your range at this point, given you have done almost $0.70 in the first half of the year, and now you are adding on Wyle on top of that?

Brian Ferraioli

We gave the range and we are going to stick to that without trying to hone in on one end or the other. There is still a fair way to go and $0.05 to $0.08 just to me doesn’t change significantly the guidance we had given from the beginning of the year with the range that we have, so we are still well within that range and we will see where we come out. I don’t want to be too optimistic in terms of the earnings, but we are pretty confident we will come in within that $1.20 to $1.45.

Andrew Kaplowitz

Okay, that’s fair guys. Maybe I could ask you more specifically about Wyle now that it’s disclosed, can you talk a little bit more about the organic growth potential of the company. I mean you guys have been talking a lot about the 250 million of revenue synergies, but what’s the underlying growth of Wyle coming in and how quickly can you get some of the synergies that you talked about.

Stuart Bradie

I think we have identified a number of sort of quick win synergies, where Wyle can be – it’s usually added us to our sort of competitive position on ongoing tenders that are firmly in the pipeline and happening today and vice versa. So I think there are some low hanging fruit there is quickly added from a revenue perspective across the piece. We are also – the level of enthusiasm from our government businesses and in UK and particularly Australia, which does a lot of similar work to Wyle, where we can actually start to – start capability into businesses outside the U.S. is – it’s quite an exciting proposition and one that we are working hard because in many government areas outside the U.S. we operate in a different way and we think the model with the U.S. employees were taking sort of from cradle to grave approach in some of our platform makes perfect sense. So it give us – it give us the model is proven we can take to each other areas across the world.

Andrew Kaplowitz

Stuart, is it right to think of it, low single digit grower, mid-single digit grower like how should we just inherently think about it?

Stuart Bradie

Yeah, I mean I think when you model like you shouldn’t look at Wyle – KBR, Wyle in isolation, I think you should look at the global services market and its entirety, I mean you are seeing the growth come through our government – our existing government business and you can see how that has come from last year to this year and it continues to grow quarter-on-quarter, when you lay Wyle on top of that and think about synergy opportunities you can quickly I guess think about that revolving out sort of give specific numbers on it. I think you guys can put that out, but it’s an excitement feature for the combination of those businesses in the markets they are in today.

Andrew Kaplowitz

Okay. And you haven’t seen any interruption from the Brexit type announcement; you haven’t seen anything going on with the model right?

Stuart Bradie

No, not at all, in fact a lot of the sort of the civil service people are [indiscernible] I guess Defense Secretary is still the same et cetera. So we are not see any change from Brexit I think in that area and I guess the only effective part is that was the backlog question we had earlier in terms of the volume in the backlog and it translates into U.S. dollars, that’s it.

Andrew Kaplowitz

Great, guys. Thanks.

Operator

And next we’ll go to Chad Dillard with Deutsche Bank.

Chad Dillard

Hi, good morning.

Stuart Bradie

Hi, Chad.

Chad Dillard

So just a follow up on Andy’s question, so the Wyle earnings contribution 2017 over $0.15 to $0.22, can you talk about what it would take to get to that high end of that range. Do you currently have the prospects in pipeline and maybe you can just talk a little bit about whether you are seeing it more from the domestic side or more from the international side.

Stuart Bradie

Yeah. I think actually more from the domestic side just because that it’s brand and its sort of customer basis there. I think we get a range is that there is a number of thing around [indiscernible] contract mechanism to another, and so it really relates to the timing and I think the opportunity that affords Wyle at the moment is to press on and not get distracted and make sure it develops these in a timing fashion and that will push numbers up to the higher end of that range.

Chad Dillard

Okay. And so you won several re-completes on the government sides in the quarter, can you just comment on whether you’re seeing in any change the contract terms. People focus more or so on pricing versus your initial debt. And then secondly, can you just give a little more color on the cost of crystal ammonia plant one of the project end and what percentage if it’s a complete and is the project still possible?

Stuart Bradie

Yeah, I mean the project is – I will answer the second one first, if you don’t mind, the ammonia project is at the final close of commissioning and performance testing. Their expectation is that that will be – the project will be finished early in Q3. So that’s very near the end I guess that’s the answer to the question. And then I guess in terms of the other piece of the question Brian is probably better placed to answer that.

Brian Ferraioli

It is not a profitable job now.

Operator

Okay. And we’ll go to our next question from Jerry Revich with Goldman Sachs.

Jerry Revich

Hi, good morning, everyone.

Brian Ferraioli

Good morning.

Stuart Bradie

Good morning.

Jerry Revich

Brian, I know you’re looking at wider different M&A possibilities, just can you touch on in terms of the opportunities that are at the top of your pipeline, if you will, how we should be thinking about evaluations compared to what we just saw in the Wyle acquisition and in terms of the synergies that you folks are targeting as your value and these opportunities that would imagine it’s different by transaction, but can you just talk about from high level standpoint, revenue synergies, cost opportunities just frame that out for us, if you could base on what’s at the top of your focus last year?

Brian Ferraioli

Well, we really can’t comment more than we have about opportunities on M&A and so we actually have a transaction, what we can say is you need to have multiple opportunities, multiple targets for you to get one over the goal line into the ends on. So we are looking at opportunities across a number of those target areas that we would say very focus in the technology and technology does it have to be an acquisition, it can be partnership, an alliance agreement and licensing of technologies, so the multiple angles to attack technology on the high end Government Services and the turnaround maintenance et cetera. We have a number of opportunities that we’re considering, but as you know Jerry, until you get one closed you can’t predict what it’s going to be and then obviously each one of the mask its own characteristics. We really like much more of the revenue, the strategic opportunities rather than doing an acquisition focused primarily on cost reduction.

Jerry Revich

Okay, thank you. And then can you comment – so now that you are month end on Wyle. So can you talk about the systems integration is going and how do you overall integration plan is playing out versus what you initially planned out and talk about any variances versus expectations?

Brian Ferraioli

I think pretty much to plan. As we said, there is not a lot of overlap and that as one of the big attractions for us in this acquisition. So it makes the integration that much easier and so far, so good and very much according to plan, no surprises.

Jerry Revich

And so just the clarification on the ERP systems, can you talk about transitioning on over to your ERP systems there, what your plan is there?

Brian Ferraioli

We are still looking at that, that’s more of a longer term project. As a matter of fact one of the things we’re looking about, does it make sense for us to transition our Government Services activity into their platform. So as we said, they were a standalone company with their own system, so that’s not an immediate decision that needs to be taken, but it is something we are looking at going frankly the other way, since they have more customized systems for government activity. So that is an opportunity for us maybe to move our historic government activities to their platform.

Operator

And next we’ll go to Anna Kaminskaya with Bank of America Merrill Lynch.

Anna Kaminskaya

Good morning guys. I think my first question will be around the free cash flow. I think can you update us if you still think you would be more or less free cash flow breakeven for 2016 and what would it take for you to retain that maybe to more normalize 100% conversion?

Brian Ferraioli

Well Anna, we said at the end of the first quarter that we would be relatively flat for the balance of the year. So down a bit for the year versus the first quarter with a negative and that holds pretty much true as of today. Obviously, excluding the acquisition, the use of $200 million for Wyle and then also will exclude if we were able to close on any additional acquisition between now and yearend.

Anna Kaminskaya

But more looking to 2017, 2018, what should be thinking about your free cash flow conversion profile?

Brian Ferraioli

It should be better, it should be better. We get these – the power project behind us and the ammonia project will be behind us. So clearly cash flow should improve.

Operator

That concludes today’s question and answer session. I’ll now turn the call back over to Stuart for any additional comments or closing remarks.

Stuart Bradie

No. Thank you very much for taking the time to listening, we appreciate. And yeah, I’m sure there will be lots of follow up calls, as I say a solid quarter from an earnings perspective and hopefully we have given you more color into 2017 earnings. So thank you again and I look forward to talking to some of you individually during the course of the next day or weeks ahead. Thank you very much.

Operator

And that does conclude today’s conference. And we thank you for your participation. You may now disconnect.

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