KBR

KBR, Inc. Q1 2007 Filing Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2007. KBR, Inc. is a global engineering, construction, and services company operating in three segments: Energy and Chemicals (E&C), Government and Infrastructure (G&I), and Ventures. The quarter was marked by the company's separation from Halliburton, which was completed on April 5, 2007, via a tax-free exchange offer. KBR reorganized its operations during the quarter to establish "Ventures" as a distinct reportable segment.

Key Financial Metrics

Note: Operating cash flow improved significantly from a $386 million outflow in Q1 2006 to a negligible $3 million outflow in Q1 2007. Cash balances increased substantially due to the IPO proceeds received in late 2006.

Material Changes vs. Prior Period

• Revenue Stability: Total revenue remained flat at approximately $2.25 billion. E&C revenue increased 6% driven by gas monetization projects, while G&I revenue decreased 3% due to reduced activity in Iraq and other government contracts.
• Profitability: Net income increased slightly to $28 million. However, E&C operating income dropped 70% to $13 million, primarily due to an $18 million impairment charge on the Brown & Root Condor Spa (BRC) investment and other charges.
• Segment Performance: The new Ventures segment reported an operating loss of $6 million, a significant improvement from the $36 million loss in Q1 2006 (which included a $26 million impairment on the Alice Springs-Darwin railroad).
• Interest Expense: Related party interest expense dropped to zero from $17 million in the prior year following the paydown of intercompany notes in November 2006.

Outlook, Risks, and Contingencies

Guidance and Outlook: Management forecasts an effective tax rate of 44% for 2007. Capital spending for 2007 is expected to be approximately $90 million. The company expects a decline in overall work volume as the U.S. government scales back services in Iraq, though a recent troop surge may slow this decline.

Key Risks and Contingencies:

• Escravos Project (Nigeria): The project faces significant delays due to civil unrest and security issues. KBR expects to incur additional costs but believes they are recoverable via change orders. If not recoverable, material losses could occur as early as Q2 2007.
• Government Contract Disputes: The U.S. Army has indicated an intent to adjust payments under the LogCAP III contract regarding private security costs. A potential 6% suspension of subcontractor costs could result in approximately $400 million in suspended costs. No accrual has been made as the company disputes the Army's position.
• FCPA Investigations: Ongoing investigations by the SEC and DOJ regarding the Bonny Island project in Nigeria and potential improper payments. Halliburton has agreed to indemnify KBR for fines and penalties related to pre-separation violations, but reputational damage and debarment risks remain.
• Barracuda-Caratinga Arbitration: Petrobras has submitted a claim for $220 million plus interest regarding defective bolts. KBR disputes the claim and expects Halliburton to indemnify cash costs.
• Export Control Issues: KBR has reported potential export violations regarding personal protection equipment to the Department of State and Commerce and is responding to a DoD Inspector General subpoena.

Investor Verification Checklist

• Recoverability of Escravos Costs: Verify the status of change order negotiations with the project owner to assess the risk of material losses.
• LogCAP III Security Dispute: Monitor the resolution of the U.S. Army's 6% security cost assessment, which could impact $400 million in revenue recognition.
• FCPA Indemnification Scope: Confirm the specific terms of Halliburton's indemnification regarding FCPA fines and whether it covers all potential jurisdictions and penalties.
• BRC Joint Venture: Track the dissolution or sale discussions with Sonatrach regarding the Brown & Root Condor Spa investment.
• Backlog Composition: Review the 64% of backlog attributed to cost-reimbursable contracts versus fixed-price contracts to understand margin risk exposure.