Business Context and Reporting Period
Company: KBR, Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2006
Corporate Status: KBR was incorporated in March 2006 as a subsidiary of Halliburton Company. In November 2006, KBR completed an Initial Public Offering (IPO) of 32,016,000 shares at $17.00 per share, raising net proceeds of $511 million. Halliburton retained an 81% ownership stake. The company operates through two segments: Energy and Chemicals (E&C) and Government and Infrastructure (G&I).
Key Financial Metrics
| Metric | 2006 | 2005 | 2004 |
|---|---|---|---|
| Total Revenue | $9,633 million | $10,146 million | $11,906 million |
| Operating Income | $246 million | $455 million | $(357 million) |
| Net Income | $168 million | $240 million | $(303 million) |
| Operating Margin | 2.6% | 4.5% | (3.0%) |
| Cash and Equivalents | $1,461 million | $394 million | $234 million |
| Total Debt | $20 million | $808 million | $1,248 million |
| Backlog (Continuing Ops) | $13,516 million | $10,589 million | N/A |
Segment Performance (2006):
- Government and Infrastructure (G&I): Revenue of $7,249 million (down 11% from 2005); Operating Income of $201 million.
- Energy and Chemicals (E&C): Revenue of $2,384 million (up 19% from 2005); Operating Income of $45 million.
Material Changes vs. Prior Period
- Revenue Decline: Consolidated revenue decreased 5% to $9.6 billion, driven primarily by a $698 million reduction in G&I revenue from Iraq-related activities (LogCAP III contract) and a decrease in hurricane repair work.
- Operating Income Decline: Operating income fell 46% to $246 million. The E&C segment saw a significant drop due to a $157 million charge related to the Escravos GTL project in Nigeria. The G&I segment recorded impairment charges totaling $68 million related to the Alice Springs-Darwin railroad and a UK road project.
- Debt Reduction: Total debt plummeted from $808 million in 2005 to $20 million in 2006. KBR used $450 million of IPO proceeds to repay Subordinated Intercompany Notes owed to Halliburton.
- Discontinued Operations: KBR sold its Production Services group in May 2006, recording a pre-tax gain of $120 million. Results from this group are reported as discontinued operations.
Guidance, Outlook, and Risks
Outlook and Commentary:
- LogCAP IV Contract: KBR is bidding for the LogCAP IV contract to replace LogCAP III. Management expects the contract to be awarded in Q2 2007 but anticipates a decline in overall work volume as the U.S. government scales back services in Iraq, though a troop surge may slow this decline.
- E&C Market Conditions: Worldwide resource constraints and escalating material prices are causing delays or cancellations of major gas monetization projects. Three of eight very large-scale projects in pursuit were cancelled or awarded to competitors.
- Separation Costs: KBR anticipates incurring approximately $35 million in additional annual costs in 2007 associated with operating as a separate public company (including stock-based compensation and IT system replacements).
Material Risks and Contingencies:
- FCPA Investigations: The SEC and DOJ are investigating potential violations of the Foreign Corrupt Practices Act (FCPA) regarding the Bonny Island LNG project in Nigeria and other projects. Halliburton has agreed to indemnify KBR for fines and penalties related to these matters, but the investigation remains ongoing with potential for debarment from government contracts.
- LogCAP III Security Costs: The U.S. Army indicated it may withhold 6% of subcontractor costs (approx. $400 million) related to private security services. KBR disputes this position and believes the costs are allowable.
- Project Losses: The Escravos GTL project in Nigeria continues to face cost overruns due to civil unrest and security issues. While $264 million in change orders were settled in Q4 2006, $43 million in unapproved change orders remain.
- Barracuda-Caratinga Dispute: Petrobras has submitted a $220 million arbitration claim regarding failed subsea flow-line bolts. KBR disputes liability, and Halliburton has agreed to indemnify KBR for cash costs related to bolt replacement.
Investor Verification Checklist
- FCPA Indemnity Scope: Verify the specific limitations of Halliburton's indemnity agreement regarding FCPA fines and whether it covers all potential jurisdictions and entities (e.g., TSKJ joint venture).
- LogCAP IV Award Probability: Assess the risk of not being awarded the LogCAP IV contract, given the shift to a multiple-award task order structure and the potential for reduced Iraq spending.
- Escravos Project Viability: Monitor the status of unapproved change orders and the potential for further cost overruns due to security conditions in Nigeria.
- Security Cost Withholding: Track the resolution of the U.S. Army's potential $400 million withholding on private security costs under LogCAP III.
- Stand-Alone Bonding Capacity: Confirm KBR's ability to secure necessary performance bonds and letters of credit without Halliburton's guarantee for future projects.