KBR, INC. quarterly report, Q1 FY2010

KBR, Inc. Form 10-Q Summary

Reporting period: Three months ended March 31, 2010. The filing text identifies this as the 2010 first quarter, although the request metadata references 2009 Q1. Comparisons are to the three months ended March 31, 2009.

Business context

KBR is a global engineering, construction and services company serving energy, petrochemical, government, power, industrial and infrastructure markets. Reportable segments are Hydrocarbons, Infrastructure, Government and Power, Services, and Other. During the quarter, KBR reorganized its business units and adopted new variable-interest-entity consolidation guidance, resulting in consolidation of the Fasttrax project.

Financial performance

Metric	Q1 2010	Q1 2009	Change
Total revenue	$2.631 billion	$3.200 billion	Down 18%
Operating income	$99 million	$144 million	Down 31%
Income before taxes and noncontrolling interests	$93 million	$150 million	Down 38%
Net income attributable to KBR	$46 million	$77 million	Down 40%
Diluted earnings per share	$0.29	$0.48	Down $0.19
Operating margin	3.8%	4.5%	Down approximately 70 basis points
Effective tax rate	Approximately 36%	Approximately 36%	Unchanged
Cash flow from operations	$(5) million	$(172) million	Improved by $167 million

Revenue decreased primarily because North America Government and Defense revenue declined $553 million, largely from lower Iraq-related LogCAP III activity. Hydrocarbons revenue increased $38 million, while Services revenue decreased $60 million.

Segment results and margins

Hydrocarbons: Revenue was $922 million, up 4%; segment income was $76 million versus $77 million. Downstream and Technology improved, while Gas Monetization income declined.
Infrastructure, Government and Power: Revenue was $1.274 billion, down 30%; segment income was $46 million versus $85 million. North America Government and Defense income fell 51%, primarily due to lower LogCAP III volume and the absence of comparable award-fee revenue.
Services: Revenue was $415 million, down 13%; segment income increased to $21 million from $19 million.
Other and Ventures: Ventures revenue increased to $15 million from $8 million, partly because Fasttrax was consolidated beginning January 1, 2010.

Liquidity, cash flow and debt

Cash and equivalents were $908 million at March 31, 2010, compared with $941 million at December 31, 2009. Cash included $264 million held by consolidated joint ventures and $134 million associated with a contract in progress, which were not generally available for corporate purposes.
Operating cash use was $5 million. Investing cash use was $38 million, including $20 million for a 25-year technology license and $14 million of capital expenditures.
Financing activities provided $1 million, including a $17 million return of cash collateral, offset by $8 million of shareholder dividends, $7 million of distributions to noncontrolling interests and $1 million of share repurchases.
KBR had no borrowings under its $1.1 billion unsecured revolving credit facility, but had $348 million of letters of credit outstanding under the facility. KBR was in compliance with its financial covenants.
Consolidation of Fasttrax added approximately $105 million of non-recourse project-finance debt, including $8 million current and $97 million noncurrent. The debt is non-recourse to KBR.
Total letters of credit and financial guarantees outstanding were approximately $541 million under KBR facilities, plus $204 million issued under facilities guaranteed by Halliburton.

Material changes and unusual items

LogCAP III award-fee accounting changed materially. Following a February 2010 determination that no award fees would be granted for January-April 2008, KBR ceased accruing future award fees unless reliably estimable or awarded. KBR recognized no LogCAP III award fees in the quarter, compared with $21 million in Q1 2009. It had reversed approximately $132 million of previously accrued award fees in Q4 2009.
KBR adopted revised variable-interest-entity consolidation guidance and consolidated Fasttrax prospectively, increasing assets, liabilities and reported activity without recognizing a gain or loss.
The company reorganized its operating segments and restated prior-period segment information to conform to the new presentation.
On April 5, 2010, after quarter-end, KBR acquired Energo Engineering for approximately $16 million in cash, subject to a $6 million escrowed holdback. The purchase price allocation was not complete at filing.

Backlog and outlook

Backlog was $13.342 billion at March 31, 2010, down from $14.098 billion at December 31, 2009. Approximately 54% was expected to be completed within one year; 19% was fixed-price and 81% cost-reimbursable.
Hydrocarbons backlog was $7.221 billion, IGP backlog was $3.003 billion, Services backlog was $2.338 billion and Ventures backlog was $780 million.
Management expected LogCAP III activity to continue declining as work transitions to LogCAP IV and military deployments shift. KBR expected the Canadian oil sands and North American maintenance markets to improve during 2010 and 2011, while noting that infrastructure and project awards remained sensitive to economic conditions and funding.
No quantitative earnings guidance is provided in the filing text. Future earnings could increase if pending LogCAP III award-fee evaluations result in awards.

Risks, contingencies and legal matters

DCAA Form 1 notices recommended suspension of approximately $296 million of prior-year contract costs; approximately $153 million had been withheld from KBR billings. The government also demanded repayment of $121 million of disapproved costs. Outcomes remain uncertain.
Government contract disputes include private-security costs, containerized housing, dining facilities, transportation costs and construction services. KBR believes several claims are defensible, but acknowledged reasonably possible additional losses for certain dining-facility and transportation matters that could not be estimated.
The Department of Justice filed an April 1, 2010 False Claims Act complaint concerning private-security costs. KBR had not accrued amounts or reduced revenue for this matter.
First Kuwaiti Trading Company sought approximately $133 million in arbitration claims; KBR had recorded no accrual and could not estimate a loss.
Burn-pit, convoy-ambush and electrocution litigation remained unresolved, with no accruals recorded because outcomes or potential losses could not be reasonably estimated.
KBR recorded a $19 million expense for a judgment in the Paul Morell litigation and appealed the judgment.
Unapproved government-contract claims of $102 million were recognized as revenue and considered probable of collection.
Environmental liabilities were accrued at approximately $7 million, with possible costs estimated at up to $14 million. Unaccrued potential liquidated damages totaled $18 million.
The company remains subject to foreign corruption investigations and a corporate-monitoring obligation. Halliburton had paid $464 million of DOJ and SEC settlement amounts through March 31, 2010, while KBR had paid approximately $12 million of its portion. Certain Halliburton indemnities may not cover all potential liabilities.

Most important facts to verify

Whether LogCAP IV awards and the continued decline of LogCAP III offset lost volume and award fees.
The timing and amount of any future LogCAP award-fee determinations.
Resolution of DCAA disallowances, government withholdings and the DOJ False Claims Act complaint.
Recoverability and timing of the $351 million PEMEX arbitration award, classified as a long-term receivable.
Potential exposure from First Kuwaiti, dining-facility, private-security, convoy, burn-pit and other litigation.
Availability of unrestricted cash, given project and joint-venture restrictions, letters of credit and funding commitments.
Progress on backlog conversion, particularly the $7.221 billion Hydrocarbons backlog and the $3.003 billion IGP backlog.