KBR, Inc. Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2016. The request metadata identifies “2015 Q3,” but the supplied filing is the 2016 third-quarter Form 10-Q.
Business Context
KBR provides engineering, construction, technology, consulting, government services, mission support, operations, maintenance and logistics services to government and hydrocarbons-sector customers. Its core segments are Technology & Consulting, Engineering & Construction, and Government Services. Non-core activities include the Non-strategic Business segment, which KBR intends to exit after completing remaining contracts.
The business environment remained challenging because of reduced oil and gas capital spending, project completions and execution issues. KBR expanded its government-services platform through the acquisitions of Wyle and Honeywell Technology Solutions Inc. (HTSI).
Key Financial Metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Revenue | $1,073 million | $1,199 million | $3,078 million | $4,016 million |
| Gross profit (loss) | $(36) million | $87 million | $106 million | $231 million |
| Gross margin | (3.4%) | 7.3% | 3.4% | 5.8% |
| Operating income (loss) | $(67) million | $75 million | $61 million | $235 million |
| Net income (loss) attributable to KBR | $(63) million | $55 million | $26 million | $161 million |
| Diluted EPS | $(0.44) | $0.38 | $0.18 | $1.11 |
| Operating cash flow | Not separately provided | Not separately provided | $8 million | $(85) million |
Q3 operating margin was approximately (6.2%), compared with 6.3% in the prior-year quarter. Nine-month operating margin was approximately 2.0%, compared with 5.8% in the prior-year period.
Liquidity, Debt and Balance Sheet
- Cash and equivalents were $569 million at September 30, 2016, down from $883 million at December 31, 2015. Approximately $52 million was held by joint ventures and was not readily available for general corporate purposes.
- Cash used in investing activities was $922 million for the nine months, primarily reflecting $911 million spent on acquisitions.
- Financing activities provided $600 million, including $700 million of revolving-credit borrowings and $50 million of repayments.
- Revolving-credit debt was $650 million at September 30, 2016, under a $1 billion unsecured facility maturing in September 2020. Letters of credit outstanding under the facility were $95 million.
- Total liabilities were $3.145 billion and shareholders’ equity was $1.097 billion at September 30, 2016.
- Management stated that the company was in compliance with its financial covenants at September 30 and expected compliance at December 31, 2016, subject to achieving internal forecasts. KBR intended to seek long-term financing to refinance part of the acquisition-related debt in early 2017.
- Cash dividends declared were $0.08 per share in the quarter and $0.24 per share for the nine months.
Material Changes Versus Prior Comparable Period
- Revenue declined 11% in Q3 and 23% for the nine months, primarily because of project completions, lower activity in Engineering & Construction, and prior-year business dispositions. These declines were partly offset by Government Services growth and acquisitions.
- Government Services revenue increased 128% in Q3 and 72% for the nine months. Wyle and HTSI contributed $198 million of Q3 revenue and were acquired for net cash consideration of approximately $623 million and $275 million, respectively.
- Engineering & Construction gross profit fell to $1 million in Q3 from $48 million, reflecting $40 million of additional estimated losses on a U.S. ammonia project. Nine-month unfavorable estimate changes on that project totaled $110 million.
- The Non-strategic Business segment recorded an $86 million Q3 gross loss and a $102 million nine-month gross loss, primarily from $86 million and $112 million of additional forecast costs, respectively, on a power project.
- General and administrative expense decreased 7% for the nine months because of cost reductions, although acquisition-related costs increased expenses by $11 million for the period.
- Backlog was $11.431 billion at September 30, 2016, down from $12.333 billion at December 31, 2015. Government Services backlog increased to $7.404 billion, while Engineering & Construction backlog declined to $3.612 billion.
Outlook, Commentary, Risks and Unusual Items
- Management expects continued opportunities in government services, including higher-value technical engineering, defense, space and mission-support work. Wyle and HTSI are intended to increase margins and reduce execution risk in this segment.
- KBR expects hydrocarbons opportunities to remain selective, with potential in LNG, midstream gas and downstream markets, while acknowledging continued pressure from low commodity prices and deferred customer capital spending.
- The remaining loss-making power project, with a contract value of $572 million and approximately 85% complete at September 30, was expected to finish in the first half of 2017. KBR intends to pursue customer change orders and subcontractor recoveries, but no recoveries were included in the estimated project loss.
- The ammonia project was expected to be completed by the end of 2016. Remaining punch-list and warranty obligations could affect the final loss estimate.
- KBR recorded a $33 million favorable settlement with the U.S. government for reimbursement of sodium dichromate legal fees and a $59 million favorable estimate change related to closing an African LNG project.
- KBR recorded $400 million in long-term claims and accounts receivable related to the PEMEX/PEP arbitration award. Collection timing remains uncertain, although PEP posted $465 million as security for the judgment.
- U.S. government contract closeout, Form 1 disputes, audits, qui tam matters, False Claims Act litigation and other investigations remain potential sources of cash-flow and reputational risk. The company also reported ongoing DOJ and SEC investigations concerning its interactions with Unaoil.
- Other risks include customer concentration, government-contract performance and security-clearance requirements, Brexit-related currency and operating volatility, variable-rate debt, covenant compliance, project-estimate revisions and potential goodwill impairment.
- The filing provides no formal earnings or revenue guidance. Management’s outlook is qualitative and depends on project execution, acquisitions, government awards, customer spending and successful resolution of claims.
Important Facts for Investors to Verify
- Whether the power project and ammonia project are completed within the stated timelines and whether additional losses or cash requirements arise.
- Progress on refinancing the $650 million revolving-credit balance and compliance with the 3.5-to-1 debt-to-EBITDA covenant.
- Integration, margins, backlog conversion and cash generation from the Wyle and HTSI acquisitions.
- Recoverability and timing of the $400 million PEMEX/PEP receivable and other disputed government claims.
- Final outcomes of U.S. government audits, Form 1 disputes, False Claims Act matters, shareholder litigation and DOJ/SEC investigations.
- Whether the $11.431 billion backlog converts to revenue and cash as expected, particularly the $143 million of backlog associated with loss-position contracts.
- Potential goodwill impairment, tax-rate volatility and restrictions on use of international and joint-venture cash.