KBR, Inc. FY2018 Form 10-K Summary
Reporting period: The supplied filing is KBR’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018, filed February 26, 2019. The request metadata references “2017 Q4,” but the filing is an FY2018 annual report and includes comparative FY2017 and FY2016 information.
Business Context
KBR provides professional services, technologies, engineering, project delivery, operations and maintenance support across Government Services and Hydrocarbons. Core segments are Government Services, Technology and Hydrocarbons Services; Non-strategic Business is being exited. Government Services includes defense, space, aviation, logistics and mission support for U.S., U.K. and Australian government customers.
- Approximately 25,000 employees worldwide at December 31, 2018.
- U.S. government revenue was $2.61 billion, or 53% of consolidated revenue; U.K. government revenue was $622 million, or 13%.
- Backlog increased to $13.50 billion from $10.57 billion, with 33% expected to convert to revenue in fiscal 2019.
Financial Metrics
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Revenue | $4.913 billion | $4.171 billion | 18% |
| Gross profit | $456 million | $342 million | 33% |
| Gross margin | 9.3% | 8.2% | Up 110 bps |
| Operating income | $470 million | $266 million | 77% |
| Operating margin | 9.6% | 6.4% | Up 320 bps |
| Net income attributable to KBR | $281 million | $434 million | (35%) |
| EPS, diluted | $1.99 | $3.06 | (35%) |
| Cash flow from operations | $165 million | $193 million | (14%) |
| Cash and equivalents | $739 million | $439 million | +$300 million |
| Long-term debt | $1.226 billion | $470 million | +$756 million |
Net income attributable to KBR declined because 2017 included a $223 million release of a U.S. deferred-tax valuation allowance and an $18 million Tax Act benefit. Income before tax increased to $398 million from $249 million, while 2018 income tax expense was $88 million versus a $193 million tax benefit in 2017.
Segment Performance and Material Changes
- Government Services: Revenue rose 58% to $3.457 billion and gross profit rose 81% to $280 million. Growth reflected organic expansion, consolidation of Aspire Defence subcontracting entities and the SGT acquisition.
- Technology: Revenue increased 10% to $297 million and gross profit increased 12% to $85 million, driven by higher petrochemical, syngas and refining activity.
- Hydrocarbons Services: Revenue declined 31% to $1.157 billion and gross profit declined 11% to $99 million due to project completions, lower activity in the U.S. and Canada and the nonrecurrence of a $35 million PEMEX settlement benefit. Equity earnings from unconsolidated affiliates increased to $49 million.
- Non-strategic Business: Revenue declined to $2 million as legacy power projects were completed or nearly completed; the segment recorded an $8 million gross loss.
- Operating income included a nonrecurring $108 million gain from consolidating the Aspire Defence subcontracting entities after Carillion entered compulsory liquidation.
- KBR acquired SGT for approximately $365 million, including working-capital adjustments, and recognized $257 million of goodwill. SGT contributed $342 million of revenue and $31 million of gross profit in 2018.
- KBR adopted ASC 606 using the modified-retrospective method. The adoption increased opening retained earnings by $144 million and increased reported 2018 net income by approximately $10 million versus the prior accounting guidance.
Cash Flow, Debt and Liquidity
- Operating cash flow was $165 million, below net income of $310 million, primarily because of the noncash Aspire gain and unfavorable working-capital movements, including a $203 million increase in accounts receivable.
- Investing cash outflow was $491 million, including $354 million for acquisitions and $344 million of contributions to the Ichthys LNG joint venture, partially offset by $197 million of cash obtained through Aspire consolidation.
- Financing cash inflow was $654 million, including $1.075 billion of term-loan borrowings and $350 million of convertible notes, partially offset by debt repayments, dividends, debt issuance costs and other financing uses.
- The new Senior Credit Facility includes a $500 million revolving facility, a $500 million performance letter-of-credit facility, a $350 million Term Loan A and an $800 million Term Loan B. KBR was in compliance with its financial covenants at year-end.
- KBR issued $350 million of 2.50% convertible senior notes due 2023. The initial conversion price was approximately $25.51 per share; warrants have a $40.02 strike price and could dilute shareholders if exercised.
- Available committed and uncommitted letter-of-credit capacity was approximately $976 million at year-end.
- The company maintained a quarterly dividend of $0.08 per share, or $0.32 annually, and had $160 million remaining under its share-repurchase authorization.
Outlook, Risks and Unusual Items
Management described the Government Services outlook as favorable, supported by increased U.S. defense and space budgets, approved fiscal 2019 appropriations and long-term U.K. private-finance initiatives. Management also cited improving hydrocarbons opportunities from LNG, petrochemicals, chemicals and fertilizers, while acknowledging continued exposure to commodity-price volatility and customer capital-spending decisions.
- Ichthys LNG: KBR owns 30% of the JKC joint venture. The project has significant disputed change orders and claims. KBR contributed approximately $344 million in 2018 and expected an additional $156 million of funding to complete the power plant, with total projected contributions of approximately $500 million. KBR had $164 million of related letters of credit outstanding.
- JKC reported approximately $1.9 billion of claims against the power-plant consortium. Arbitration was scheduled for the first half of 2020. Failure to recover costs could materially affect earnings, liquidity and cash flows.
- Approximately $973 million of unapproved change orders, client claims and estimated subcontractor recoveries were included in project estimates at completion at year-end, primarily related to Ichthys.
- KBR’s defined-benefit pension plans had an aggregate funding deficit of approximately $250 million; 2018 pension contributions were $41 million and projected 2019 contributions were $39 million.
- Government-contract risks include audits, questioned costs, payment withholding, False Claims Act matters, potential contract termination and restrictions on future contracting. Outstanding U.S. government Form 1s questioned $134 million of billed costs, including $73 million recorded as claims receivable.
- Key operating risks include fixed-price cost overruns, joint-venture obligations, contract-estimate revisions, customer concentration, cybersecurity, foreign exchange, political instability, environmental compliance and hydrocarbons-market cyclicality.
- Management reported effective disclosure controls and internal control over financial reporting; however, SGT and the Aspire subcontracting entities, representing approximately $458 million of assets and $875 million of 2018 revenue, were excluded from the 2018 internal-control assessment as newly acquired businesses.
Investor Verification Checklist
- Verify the sustainability of Government Services growth and the extent to which 2018 results benefited from acquisitions and the Aspire consolidation.
- Review operating cash conversion, receivables growth and working-capital requirements relative to reported earnings.
- Monitor Ichthys funding needs, disputed claims, arbitration outcomes, letters of credit and potential exposure above KBR’s 30% ownership interest.
- Reconcile debt maturity schedules, variable-rate exposure, covenant headroom and potential dilution from the convertible notes and warrants.
- Assess the recoverability of unapproved claims and change orders totaling $973 million and the $98 million of long-term claims and accounts receivable.
- Review pension funding requirements, uncertain tax positions of $90 million and remaining deferred-tax assets subject to valuation allowances.
- Confirm the effects of ASC 606 adoption and distinguish recurring operating performance from the $108 million Aspire gain and prior-year tax benefits.