KBR, INC. quarterly report, Q3 FY2019

KBR, Inc. Form 10-Q Summary

Reporting period: Quarter and nine months ended September 30, 2019; comparative periods are September 30, 2018. The request metadata identifies “2018 Q3,” but the supplied filing is the 2019 third-quarter Form 10-Q, filed October 31, 2019.

Business Context

KBR provides professional services, technologies, engineering, construction, program management, logistics, operations and maintenance services across government services and hydrocarbons markets. Reportable segments are Government Solutions, Technology Solutions, Energy Solutions, Non-strategic Business and Other.

Management described government services demand as favorable, supported by defense, space and infrastructure spending. Hydrocarbons opportunities were improving, particularly in LNG, petrochemicals, chemicals and fertilizers, although customer capital spending remains sensitive to commodity prices and market conditions.

Financial Performance and Position

Metric	Three months ended September 30		Nine months ended September 30
	2019	2018	2019	2018
Revenue	$1,425 million	$1,278 million	$4,187 million	$3,583 million
Gross profit	$169 million	$149 million	$482 million	$427 million
Operating income	$104 million	$99 million	$274 million	$378 million
Net income attributable to KBR	$56 million	$54 million	$144 million	$234 million
Diluted EPS	$0.39	$0.38	$1.01	$1.66
Operating cash flow	Not separately provided	Not separately provided	$199 million	$36 million

Third-quarter revenue increased 12%, gross profit increased 13%, and operating income increased 5%. Approximate gross margin was 11.9% versus 11.7%; operating margin was 7.3% versus 7.7%.
Nine-month revenue increased 17% and gross profit increased 13%, but operating income declined 28% and net income attributable to KBR declined 38%. Approximate gross margin was 11.5% versus 11.9%; operating margin was 6.5% versus 10.5%.
Nine-month results benefited from $199 million of operating cash flow, compared with $36 million in the prior-year period. Working-capital benefits included $83 million from accounts payable and $82 million from contract liabilities, partly offset by increases in receivables and contract assets.
Cash and equivalents were $681 million at September 30, 2019, compared with $739 million at December 31, 2018. Cash held by consolidated joint ventures and Aspire Defence entities totaled $324 million and was restricted to project activities.
Long-term debt, net of current maturities, was $1.185 billion; total long-term debt before the current portion was $1.212 billion. KBR had no revolver borrowings and was in compliance with its debt covenants.
Available capacity under committed and uncommitted letter-of-credit facilities was approximately $1.1 billion. Letters of credit outstanding included $164 million supporting Ichthys performance and warranty obligations.
Backlog increased to $14.643 billion from $13.497 billion at December 31, 2018. Energy Solutions backlog increased to $3.426 billion from $1.896 billion, while Government Solutions backlog declined to $10.742 billion from $11.005 billion.

Material Changes Versus the Prior Comparable Period

Government Solutions revenue increased 21% for the nine-month period, driven by AFCAP IV disaster-recovery services, new programs, expanded scope and the SGT acquisition. Government Solutions gross profit increased 23%.
Technology Solutions revenue increased 31% for the nine-month period, primarily from higher proprietary equipment sales, while gross profit increased 8%.
Energy Solutions revenue increased only 3% for the nine-month period, while gross profit declined 22% because favorable variable consideration and project benefits recognized in 2018 did not recur.
Equity earnings from unconsolidated affiliates declined to $24 million from $50 million, reflecting reduced activity, an unfavorable Ichthys LNG legal ruling and an impairment associated with a Latin American investment.
Operating income comparisons were reduced by the absence of the $113 million gain on consolidation of Aspire subcontracting entities recognized in 2018. Interest expense increased to $76 million from $43 million, primarily because of the 2018 issuance of convertible notes.
KBR adopted the new lease standard in 2019, recognizing $183 million of operating lease right-of-use assets and $243 million of operating lease liabilities at September 30, 2019. The adoption was not material to operating results or cash flows.
KBR corrected previously issued immaterial errors related to equity earnings. The nine-month 2018 net income attributable to KBR was reduced by $4 million to $234 million.

Guidance, Outlook, Risks and Unusual Items

The filing does not provide a specific quantitative earnings or revenue guidance target. Management expects government-services opportunities to remain favorable and sees improving hydrocarbons investment opportunities, while noting competitive bidding, government-budget changes, commodity-price volatility and project timing risks.
The Ichthys LNG project remains a major contingency. KBR owns 30% of the JKC joint venture, has recorded substantial unapproved change orders and claims, and contributed approximately $141 million during the first nine months of 2019. KBR’s share of the Funding Deed claims was $153 million. If claims remain unresolved by December 31, 2020, JKC may be required to refund client funding.
JKC had approximately $1.9 billion of claims against the power-plant consortium. Unfavorable arbitration or inability of the consortium to pay could require KBR to absorb its pro-rata share of unrecovered costs and materially affect earnings, financial position and cash flow.
KBR reported $945 million of unapproved change orders, customer claims and estimated supplier or subcontractor recoveries in project estimates at September 30, 2019, predominantly related to Ichthys. These estimates may change materially.
U.S. government matters include $72 million of disputed costs recorded as claims and accounts receivable, $41 million of reserves for unallowable costs, and ongoing LogCAP III litigation, audits and investigations. KBR believes recovery of certain amounts is probable, but timing and ultimate outcomes remain uncertain.
Other contingencies include DOJ, SEC and U.K. Serious Fraud Office investigations relating to Unaoil; a Chadian employee class action involving a claimed $122 million; and North West Rail Link claims of up to approximately A$300 million, for which KBR cannot reasonably estimate the outcome.
KBR had a $192 million pension funding deficit and expects minimum annual U.K. pension contributions of $44 million under its 2019 agreement with plan trustees.
Management identified a material weakness in internal control over financial reporting related to an ERP implementation and account reconciliations in part of Government Solutions during the second quarter. Management stated that remediation was completed during the third quarter and disclosure controls were effective as of September 30, 2019.

Facts Investors Should Verify

Reconcile the sharp nine-month decline in operating income and EPS, including the absence of the 2018 Aspire consolidation gain, lower Energy Solutions profitability and lower equity earnings.
Assess the collectability, timing and legal resolution of Ichthys claims, Funding Deed exposure, power-plant arbitration claims and the $164 million of related letters of credit.
Review the quality and availability of the $681 million cash balance, particularly the $324 million held by consolidated joint ventures and Aspire entities.
Evaluate leverage, covenant headroom, refinancing requirements and interest-rate exposure on $1.212 billion of long-term debt.
Monitor disputed U.S. government receivables, Form 1s, litigation reserves and unresolved government audits.
Confirm that the ERP-related material weakness remains remediated and that subsequent filings do not identify control deficiencies.
Examine backlog conversion, fixed-price exposure, loss-position contracts and the significant reliance on estimates for claims, change orders and recoveries.