KBR, Inc. — Form 10-Q Summary
Reporting period: Three months ended March 31, 2017, compared with the three months ended March 31, 2016. The request metadata identifies “2016 Q1,” but the filing is the March 31, 2017 Form 10-Q.
Business Context
KBR provides government services, technology and consulting, and engineering and construction services to governments, energy companies, refiners, petrochemical and fertilizer producers, and other industrial customers. The company also reported non-strategic businesses being exited as existing contracts are completed. The 2016 acquisitions of Wyle and Honeywell Technology Solutions significantly expanded Government Services.
Financial Results and Key Metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $1,106 million | $996 million | 11% increase |
| Gross profit | $82 million | $68 million | 21% increase |
| Operating income | $63 million | $65 million | 3% decrease |
| Net income attributable to KBR | $37 million | $42 million | 12% decrease |
| Diluted EPS | $0.26 | $0.30 | Decrease |
| Operating cash flow | $(115) million | $(21) million | Greater use of cash |
| Cash and equivalents | $410 million | $824 million | Compared with March 31, 2016 |
Margins: Gross margin improved to approximately 7.4% from 6.8%. Operating margin declined to approximately 5.7% from 6.5%, and net margin attributable to KBR declined to approximately 3.3% from 4.2%.
- Government Services: Revenue increased to $515 million from $210 million, primarily from Wyle and KTS and growth in U.S. government contracts. Gross profit increased to $37 million from $21 million.
- Technology & Consulting: Revenue declined to $76 million from $97 million because of completed or substantially completed projects; gross profit declined to $14 million from $17 million.
- Engineering & Construction: Revenue declined to $489 million from $606 million. Gross profit increased to $33 million from $29 million, but equity earnings declined to zero from $18 million, primarily because of lower progress and revised estimates on the Ichthys LNG joint venture.
- Non-strategic Business: Revenue declined to $26 million from $83 million and produced a $2 million gross loss versus $1 million of gross profit, reflecting the wind-down of power and infrastructure projects.
Liquidity, Cash Flow, Debt and Backlog
- Cash declined by $126 million during the quarter, ending at $410 million. Operating cash flow was negative $115 million, primarily because of unfavorable project working-capital movements, including a $124 million reduction in billings in excess of costs and estimated earnings.
- The company had $650 million outstanding under its $1 billion unsecured revolving credit agreement, used primarily to fund the Wyle and KTS acquisitions. The facility matures in September 2020. KBR was in compliance with its financial covenants at March 31, 2017.
- Nonrecourse project debt totaled $44 million, including $9 million current and $35 million noncurrent.
- Letters of credit outstanding totaled approximately $385 million, including $39 million under the revolving credit agreement and $346 million under uncommitted bank lines. Management stated that liquidity and credit capacity were adequate for at least the next 12 months.
- Total backlog was $10.595 billion at March 31, 2017, down from $10.938 billion at December 31, 2016. Government Services represented $7.711 billion, Engineering & Construction $2.537 billion, and Technology & Consulting $333 million. Approximately 36% of backlog was expected to be executed within one year.
Material Changes, Outlook and Unusual Items
- Revenue growth was driven by the Wyle and KTS acquisitions and expansion of existing government contracts, partially offset by project completions and the nonrecurrence of favorable 2016 estimate changes.
- Equity earnings declined by $20 million, to $9 million, largely because of Ichthys LNG project developments. The company recognized lower progress and delayed profit recognition while pursuing claims and change orders.
- On April 6, 2017, after the quarter-end, KBR settled its PEMEX/PEP arbitration for $435 million. The payment was received in April; $150 million was used to repay revolving-credit borrowings, approximately $100 million was expected to fund Mexican income taxes, and the remaining amount was primarily intended for operating needs and previously recognized project losses.
- Management expects continued opportunities in government services, particularly higher-value engineering services and military support. Hydrocarbons activity remains affected by customer capital-spending reductions and commodity-price volatility, although KBR cited opportunities in LNG, midstream gas, chemicals and fertilizers.
- The company intends to seek long-term financing to replace part of its revolving-credit borrowings during 2017.
Risks, Contingencies and Other Matters
- The Ichthys LNG joint venture faces disputed subcontractor claims, additional costs and a potential refund obligation under a deed of settlement if claims are not resolved by December 31, 2020. KBR also faces potential pro-rata exposure if the terminated power-plant subcontractor does not reimburse completion costs.
- Unapproved change orders and claims included in project estimates-at-completion totaled $416 million at March 31, 2017, of which $344 million had been recognized on a percentage-of-completion basis. Recovery remains uncertain and could affect future earnings, cash flow and financial position.
- KBR reported $176 million of backlog associated with contracts currently in a loss position. Potential liquidated damages of approximately $10 million had not been accrued because management considered them not probable.
- Claims and accounts receivable included $83 million related to U.S. government Form 1s questioning billed costs. KBR had accrued a $64 million reserve for unallowable costs and stated that timing and ultimate recovery remain uncertain.
- Government contract audits, False Claims Act matters, qui tam litigation, SEC and other regulatory inquiries, and additional commercial and shareholder litigation remain outstanding. Several matters have no accrued loss or an indeterminate outcome.
- U.S. government customers represented 40% of consolidated revenue in the quarter, creating customer concentration and contract-renewal risk. The company also faces competition, pricing pressure, potential changes in government spending, project execution risk, foreign exchange risk and variable-rate interest exposure.
Investor Verification Checklist
- Verify the post-quarter-end $435 million PEMEX/PEP settlement, related taxes, debt repayment and remaining cash usage.
- Track Ichthys LNG claims, subcontractor recovery efforts, the December 2020 deed-of-settlement deadline and any resulting estimate changes.
- Monitor operating cash flow, project working-capital requirements, recognized loss projects and repayment or refinancing of the $650 million revolver balance.
- Assess whether Government Services growth from Wyle and KTS offsets declines in Engineering & Construction, Technology & Consulting and non-strategic projects.
- Review the collectability and resolution timeline for the $83 million of disputed U.S. government costs and related litigation or audit matters.
- Confirm backlog conversion, cancellation or termination provisions, funded U.S. government backlog, and the $7.4 billion proportionate share of unconsolidated-joint-venture backlog.