KBR, Inc. Form 10-Q Summary
Reporting period: Quarterly and nine-month periods ended September 30, 2017, compared with the corresponding 2016 periods. The request metadata identifies “2016 Q3,” but the filing itself is the 2017 third-quarter Form 10-Q.
Business Context
KBR provides professional services, technologies, engineering, construction, program management, operations, maintenance, and mission support to government, military, and hydrocarbons customers. Core segments are Government Services, Technology & Consulting, and Engineering & Construction. Non-core activities include the Non-strategic Business segment, which is being exited, and corporate activities.
The filing reflects the full-period contribution of the 2016 Wyle and Honeywell Technology Solutions acquisitions, continued expansion of U.S. and international government-services contracts, and reduced activity in several engineering and construction projects.
Financial Performance and Key Metrics
| Metric | Three months ended September 30 | Nine months ended September 30 | ||
|---|---|---|---|---|
| 2017 | 2016 | 2017 | 2016 | |
| Revenue | $1,034 million | $1,073 million | $3,234 million | $3,078 million |
| Gross profit | $87 million | $(36) million | $277 million | $106 million |
| Operating income | $73 million | $(67) million | $239 million | $61 million |
| Net income attributable to KBR | $45 million | $(63) million | $159 million | $26 million |
| Diluted EPS | $0.32 | $(0.44) | $1.12 | $0.18 |
| Operating cash flow | Not provided separately | Not provided separately | $238 million | $8 million |
Margins: Third-quarter gross margin was approximately 8.4%, operating margin 7.1%, and net margin attributable to KBR 4.4%. Nine-month gross margin was approximately 8.6%, operating margin 7.4%, and net margin attributable to KBR 4.9%. Comparable 2016 margins were approximately negative 3.4%, negative 6.2%, and negative 5.9% for the quarter, and 3.4%, 2.0%, and 0.8% for the nine months, respectively.
- Segment revenue, nine months: Government Services $1,640 million, Technology & Consulting $236 million, Engineering & Construction $1,321 million, and Non-strategic Business $37 million.
- Government Services: Nine-month revenue increased 95% to $1,640 million, principally from Wyle and HTSI and expanded U.S. government contracts.
- Engineering & Construction: Nine-month revenue declined 27% to $1,321 million, while gross profit increased to $113 million, including a $35 million benefit from the PEMEX settlement and the non-recurrence of significant 2016 project losses.
- Equity earnings: Declined to $64 million from $81 million for the nine months, primarily because of lower progress and higher estimated costs and claims at the Ichthys LNG joint venture.
- Dividends and repurchases: Dividends declared were $0.08 per share for the quarter and $0.24 per share year to date. KBR repurchased approximately 3.5 million shares for $52 million during the nine months.
Cash Flow, Debt, and Liquidity
- Cash and equivalents were $511 million at September 30, 2017, compared with $536 million at December 31, 2016. Approximately $68 million was held by consolidated joint ventures and was restricted to project activities.
- Operating cash flow was $238 million, compared with $8 million in the prior-year period. The improvement primarily reflected collections, including the PEMEX settlement, and favorable working-capital changes.
- Investing cash outflow was $4 million, compared with $922 million in 2016, when acquisitions required $911 million of cash.
- Financing cash outflow was $272 million, including $180 million of revolving-credit repayments, $52 million of share repurchases, and $34 million of dividends.
- Revolving credit borrowings were $470 million under a $1 billion unsecured facility maturing in September 2020. Letters of credit outstanding under the facility were $35 million, leaving approximately $495 million of facility capacity after borrowings and letters of credit.
- Total nonrecourse project debt was $42 million. KBR reported compliance with its financial covenants at September 30, 2017.
- Management stated that cash balances, internally generated cash flow, and available credit were sufficient for expected operations for at least the next 12 months. KBR intended to seek long-term financing to replace a portion of revolving-credit borrowings.
Material Changes, Outlook, and Unusual Items
- Quarterly revenue declined 4% because of project completions and reduced Engineering & Construction activity, but profitability improved substantially as major 2016 losses in the ammonia and power projects did not recur.
- The $435 million PEMEX and PEP settlement was received in April 2017. KBR paid approximately $91 million of related Mexican taxes, repaid $180 million of debt, repurchased $50 million of shares, and retained approximately $114 million primarily for operations and recognized project losses.
- Backlog was $10.3 billion at September 30, 2017, compared with $10.9 billion at December 31, 2016. Government Services backlog increased to $8.2 billion, while Engineering & Construction backlog declined to $1.9 billion. Approximately 34% of backlog was expected to be executed within one year; $112 million related to active loss-position contracts.
- The company expects continued opportunities in government services, including defense, space, aviation, and mission support. Hydrocarbons demand remains sensitive to customer capital spending, commodity prices, project delays, and cancellations.
- Management expects to adopt the new revenue-recognition standard on January 1, 2018 using the modified retrospective method. The filing states that the effect was still under evaluation and could affect performance obligations, variable consideration, contract unit of account, and disclosures.
- A prior-period error correction increased second-quarter 2017 equity earnings by $9 million and net income attributable to KBR by $11 million. Management concluded the cumulative error was not material to previously issued financial statements.
Risks and Contingencies
- Ichthys LNG joint venture: KBR’s proportionate share of unapproved change orders, customer claims, and estimated supplier/subcontractor recoveries included in project estimates increased materially. If claims are not resolved or amounts funded under the settlement mechanism must be refunded, KBR could bear its pro rata share of additional costs. KBR estimated that near-term joint-venture funding could reach approximately $100 million if client funding became inadequate.
- Ichthys fixed-price power plant: A subcontractor terminated work, and the joint venture is pursuing arbitration and recovery of completion costs. Failure to recover those costs could materially reduce project profit and require additional funding.
- Government claims and audits: The U.S. government had outstanding Form 1 objections to $171 million of billed costs, with $83 million recorded as claims receivable. KBR had accrued a $56 million reserve for unallowable costs and could not predict the timing or ultimate resolution of disputed matters.
- Pension obligations: Defined-benefit pension plans had an aggregate funding deficit of approximately $520 million, primarily related to the U.K. plan. Future funding requirements could increase after the next triennial valuation beginning in April 2018.
- Legal and regulatory matters: The company continues to face qui tam, False Claims Act, shareholder derivative, SEC, DOJ, and U.K. Serious Fraud Office-related matters. The filing states that the likelihood of material loss was remote for several identified matters, but certain matters remained indeterminate.
- Customer concentration: U.S. government revenue represented 44% of consolidated revenue for the nine months. Contract delays, cancellations, protests, funding changes, or changes in government priorities could materially affect results.
- Market exposure: Revolving-credit borrowings carried variable interest rates; a 50-basis-point increase was estimated to increase pretax interest expense by approximately $2 million over the next 12 months. Foreign currency fluctuations also affected results.
Investor Verification Checklist
- Verify the ultimate recovery, timing, and cash-funding requirements associated with Ichthys claims, change orders, subcontractor disputes, and potential refunds.
- Monitor U.S. government Form 1s, LogCAP closeout matters, audits, and related receivables and reserves.
- Assess the sustainability of earnings excluding the $35 million PEMEX-related benefit and the non-recurrence of significant 2016 project losses.
- Review the impact of Wyle and HTSI integration, government contract renewals, funding levels, and customer concentration.
- Evaluate leverage, variable-rate exposure, planned refinancing, pension funding requirements, and remaining share-repurchase capacity.
- Confirm the eventual accounting and balance-sheet impact of adopting the revenue-recognition standard in 2018.