KBR, INC. quarterly report, Q3 FY2011

KBR, Inc. Form 10-Q Summary

Reporting period: The supplied filing is for the quarter ended September 30, 2011, not 2010 Q3 as indicated in the request metadata. Results are unaudited and presented in millions except per-share data.

Business Context and Reporting Period

KBR is a global engineering, construction and services company serving the energy, petrochemicals, government services, industrial and civil infrastructure markets. Reportable segments are Hydrocarbons, Infrastructure, Government and Power, Services, and Other. Management expected declining LogCAP III activity as U.S. troops exited Iraq, while hydrocarbon, infrastructure, minerals and selected power markets showed continuing or improving demand.

Financial Performance and Position

Metric	Q3 2011	Q3 2010	9M 2011	9M 2010
Total revenue	$2,387	$2,455	$7,165	$7,757
Operating income	$138	$163	$451	$461
Operating margin	5.8%	6.6%	6.3%	5.9%
Net income attributable to KBR	$185	$97	$390	$249
Diluted EPS	$1.22	$0.62	$2.55	$1.56
Operating cash flow	Not separately provided	Not separately provided	$312	$541

Q3 net income included significant discrete tax benefits, including $68 related to the Barracuda-Caratinga arbitration award and $24 from a reduction in Australian deferred tax liabilities. The reported quarterly effective tax rate was approximately negative 40%.
Nine-month net income attributable to KBR increased 57%, despite an 8% revenue decline. The increase was substantially affected by the discrete tax benefits and lower income attributable to noncontrolling interests.
Cash and equivalents were $690 at September 30, 2011, down from $786 at December 31, 2010. Approximately $205 was held by consolidated joint ventures and was restricted to project activities.
Current assets were $3,366 and current liabilities were $2,295, implying a current ratio of approximately 1.47. Total shareholders’ equity was $2,475.
Non-recourse project-finance debt of a consolidated variable interest entity totaled $99, consisting of $9 current and $90 noncurrent. KBR had no advances outstanding under its $1.1 billion revolving credit facility; $253 of letters of credit were issued under the facility.
Operating cash flow declined to $312 from $541, while investing cash outflows were $77 and financing cash outflows were $324. Financing uses included $164 to acquire the remaining MWKL noncontrolling interest, $96 for share repurchases, $57 of noncontrolling-interest distributions and $23 of dividends.
Backlog was $11.7 billion at September 30, 2011 versus $12.0 billion at December 31, 2010. Approximately 56% was expected to be executed within one year; 77% was cost-reimbursable and 23% fixed-price.

Material Changes Versus Comparable Period

Q3 revenue decreased 3%, and nine-month revenue decreased 8%, primarily because of reduced North American government and logistics activity, especially LogCAP III, and lower Services revenue as projects were completed or approached completion.
Hydrocarbons revenue increased 15% in Q3 and 13% for nine months, driven principally by Gorgon LNG, Escravos GTL and other gas monetization activity. Hydrocarbons operating segment income declined 4% in Q3 but increased 8% for nine months.
IGP revenue decreased 11% in Q3 and 24% for nine months. North American Government and Logistics revenue declined 22% in Q3 and 33% for nine months, partly offset by Infrastructure and Minerals growth and new LogCAP IV activity.
Services revenue decreased 23% in Q3 and 10% for nine months, primarily due to completed or substantially completed U.S. and Canadian construction projects.
Operating income declined 15% in Q3 and 2% for nine months. Corporate general and administrative expense increased to $61 in Q3 from $53 and to $163 for nine months from $157, partly due to information technology and enterprise resource planning costs.
The company acquired the remaining 44.94% interest in MWKL for approximately $164 and acquired R&S in December 2010. R&S contributed to Infrastructure and Minerals growth.
Share repurchases totaled approximately 3 million shares and $96 during the first nine months. A new authorization permits repurchase of up to 10 million shares.

Guidance, Outlook, Risks and Unusual Items

Management expected LogCAP III volume to continue declining through the remainder of 2011 as U.S. military activity in Iraq wound down. A final LogCAP III award-fee letter was expected in Q4 2011, with an available pool of approximately $5.
September 2011 LogCAP III award fees were approximately $22, representing about 80% of the available pool for the applicable performance period. This compared with $34 recognized in Q3 2010.
The Barracuda-Caratinga arbitration panel awarded Petrobras approximately $193. KBR recorded a corresponding liability and an indemnification receivable from Halliburton for the same amount; Halliburton’s indemnity and any challenge to the award should be verified.
The PEMEX arbitration receivable remained classified as long term. KBR reported a U.S. judgment of approximately $356 plus taxes and interest, but the U.S. appeal and related Mexican proceedings remained unresolved. KBR also faced approximately $80 of performance bonds that PEMEX was permitted to call following an October 2011 Mexican appellate decision.
DCAA Form 1 notices recommending suspension of approximately $359 of prior-year contract costs remained open; approximately $155 had been withheld from current billings. Customer demand letters sought $69 of disallowed costs, which KBR disputed.
Government-contract disputes included private-security costs, containerized housing, dining facilities, transportation, employee replacement costs and construction services. The company had recognized revenue for certain unapproved government claims totaling $150 and considered them probable of collection.
Other litigation and contingencies included the DOJ False Claims Act complaint concerning private security, First Kuwaiti arbitration, TES litigation, electrocution, burn-pit and convoy-ambush claims. Several matters had no accrued liability because outcomes or loss ranges could not be reliably estimated or were considered remote.
Environmental liabilities accrued were approximately $7, with possible costs estimated as high as $13. Potential liquidated damages of approximately $21 had not been accrued.
KBR had approximately $1.8 billion of committed and uncommitted credit lines supporting letters of credit, of which $653 was utilized. The revolving facility expires in November 2012, and approximately $158 of facility-issued letters of credit had expiration dates near or beyond the facility maturity.
The filing states that there were no material changes to previously disclosed risk factors and that disclosure controls and procedures were effective as of September 30, 2011.

Investor Verification Checklist

Confirm the reporting-period discrepancy: the filing is for Q3 2011, not Q3 2010.
Separate recurring operating performance from the $92 of identified Q3 discrete tax benefits and the $193 Barracuda-Caratinga liability/indemnification accounting.
Monitor cash conversion, including the decline in operating cash flow and the portion of cash held by consolidated joint ventures.
Track the transition from LogCAP III to LogCAP IV, future award fees and the effect of declining Iraq activity on revenue and margins.
Assess collectability and timing of the PEMEX receivable, government unapproved claims and related withholding or disallowance proceedings.
Review Halliburton indemnification obligations, including the Barracuda-Caratinga award and former-parent tax-sharing balances.
Evaluate letter-of-credit utilization, maturity-related collateral requirements and the $122 remaining distribution-cap availability under the revolving credit agreement.
Reconcile backlog changes, particularly the $1.2 billion decline in Hydrocarbons backlog and the $810 increase in IGP backlog, and assess the risk profile of the 77% cost-reimbursable versus 23% fixed-price mix.