KBR, Inc. FY2016 Form 10-K Summary
Business context and reporting period
This filing is KBR’s annual report for the fiscal year ended December 31, 2016, not a 2015 fourth-quarter filing. KBR provides government services, hydrocarbons technology and consulting, engineering and construction, and non-strategic contract services in more than 40 countries.
In 2016, KBR materially rebalanced toward government services through the acquisitions of Wyle and Honeywell Technology Solutions Inc. (HTSI), while continuing to wind down non-strategic businesses and reduce exposure to large fixed-price EPC projects.
Key financial metrics
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Revenue | $4,268 million | $5,096 million | Down 16% |
| Gross profit | $112 million | $325 million | Down 66% |
| Gross margin | 2.6% | 6.4% | Down 3.8 percentage points |
| Operating income | $28 million | $310 million | Down 91% |
| Operating margin | 0.7% | 6.1% | Down 5.4 percentage points |
| Net income attributable to KBR | $(61) million | $203 million | Declined to a loss |
| Diluted EPS | $(0.43) | $1.40 | Declined to a loss |
| Cash flow from operations | $61 million | $47 million | Up $14 million |
| Cash and equivalents | $536 million | $883 million | Down $347 million |
| Backlog | $10.938 billion | $12.333 billion | Down 11% |
Operating results included $91 million of equity earnings from unconsolidated affiliates, $39 million of asset impairment and restructuring charges, and a $7 million gain on asset dispositions. The reported income tax provision was $84 million despite a pretax income of $33 million, primarily because KBR recognized no tax benefit on $343 million of U.S. project losses. Cash dividends declared were $0.32 per share.
Segment revenue and gross profit were: Government Services revenue of $1.359 billion and gross profit of $137 million; Technology & Consulting revenue of $347 million and gross profit of $73 million; Engineering & Construction revenue of $2.352 billion and gross profit of $7 million; and Non-strategic Business revenue of $210 million and a gross loss of $105 million.
Material changes versus the prior comparable period
- Government Services revenue more than doubled, increasing 105% to $1.359 billion, primarily from the Wyle and HTSI acquisitions and expansion of U.S. government contracts. The segment generated $137 million of gross profit versus a $3 million gross loss in 2015.
- Engineering & Construction revenue fell 32% and gross profit fell 97% to $7 million. The decline reflected completion or reduced activity on Australian LNG projects, the deconsolidation of Industrial Services Americas, and significant project cost increases.
- Consolidated revenue declined primarily because of lower activity on two Australian LNG projects and two U.S. ammonia projects, which together reduced revenue by approximately $759 million.
- Unfavorable project estimate revisions totaled approximately $231 million on an EPC ammonia project and a power project, plus a $112 million charge on a downstream EPC project that became loss-making.
- Non-strategic Business gross profit declined from $27 million to a $105 million loss, principally because of an additional $117 million estimated loss on a power project.
- KBR spent $911 million on business acquisitions and invested an additional $56 million in the Brown & Root Industrial Services joint venture. These uses were financed partly through $700 million of revolver borrowings.
- Backlog declined to $10.938 billion. Government Services backlog increased to $7.821 billion, while Engineering & Construction backlog declined to $2.769 billion. Approximately 38% of total backlog was expected to be recognized within one year.
Liquidity, debt and financial condition
- KBR had $536 million of cash and equivalents at year-end, including $56 million held by consolidated joint ventures that was restricted to project activities.
- Revolving credit debt was $650 million at December 31, 2016, under a $1 billion unsecured facility maturing in September 2020. KBR stated that it intended to seek long-term financing to replace part of this debt in 2017.
- The company reported compliance with its debt covenants at year-end. The amended leverage covenant generally requires debt to consolidated EBITDA not to exceed 3.5-to-1, with a 3.25-to-1 limit effective after December 31, 2017.
- Letters of credit outstanding totaled $450 million, including $85 million under the credit agreement. KBR reported approximately $900 million of remaining capacity in committed and uncommitted lines after outstanding revolver borrowings.
- Total shareholders’ equity declined to $745 million from $1.052 billion, principally reflecting the net loss and a $219 million after-tax reduction in other comprehensive income, largely from pension actuarial losses.
- Pension obligations were $526 million, and KBR expected to contribute $36 million to its pension plans in 2017. Operating lease commitments totaled $708 million, and disclosed contractual obligations totaled $1.899 billion.
Outlook, commentary, risks and unusual items
Management expects government services to provide more than 50% of 2017 revenue and believes the acquired businesses should provide steadier earnings and cash flow than large EPC projects. Management also expects continued government-services opportunities and selective midstream, LNG and downstream hydrocarbons opportunities, while oil-price volatility continues to constrain upstream capital spending.
- The Ichthys LNG joint venture included $857 million of contract price adjustments in estimated revenues and costs, including $300 million of unapproved claims that remained disputed. KBR’s proportionate share of unapproved change orders and claims was $257 million. Amounts received under the settlement mechanism could require repayment if the dispute is not resolved by December 31, 2020.
- A major Ichthys subcontractor issued a termination notice in January 2017. The joint venture expected completion costs to exceed the subcontract value and intended to pursue recovery, creating potential exposure to KBR’s pro rata share of unrecovered costs.
- The EPC ammonia project, downstream EPC project and power project remained exposed to further cost, productivity, schedule and warranty risks. The power project was approximately 94% complete and expected to finish in the first half of 2017; the downstream EPC project was 58% complete and delayed until 2018.
- KBR reported $131 million of long-term claims and accounts receivable, including disputed U.S. government costs. The U.S. government had questioned $173 million of billed costs, of which $83 million remained recorded as claims receivable, net of a $64 million reserve for potentially unallowable costs.
- KBR has ongoing U.S. government contract closeout matters, audits, False Claims Act and qui tam litigation, and investigations involving government contracts and Unaoil. The filing states that losses in several matters were remote, while a reserve was recorded for the DOJ Iraq subcontractor matter.
- KBR recorded $400 million of current claims receivable related to the PEMEX/PEP arbitration and expected settlement in 2017. The arbitration award was approximately $351 million plus interest and PEP had posted $465 million as security, but final timing and recovery remained uncertain.
- Management identified a cumulative $13 million error in LNG contract cost estimates, corrected in the fourth quarter of 2016, and concluded it was not material to prior periods or 2016 results.
- Management and KPMG expressed unqualified opinions on the financial statements and internal control over financial reporting. However, controls over Wyle and HTSI, representing approximately $1.2 billion of assets and $487 million of 2016 revenue, were excluded from the 2016 assessment and were to be integrated in 2017.
Most important facts for investors to verify
- Whether the government-services acquisitions generate the expected recurring revenue, margin and cash-flow stability.
- The remaining cost and schedule exposure on the ammonia, downstream EPC, power and Ichthys LNG projects.
- The recoverability and timing of PEMEX/PEP arbitration proceeds and disputed U.S. government receivables.
- KBR’s ability to refinance or repay the $650 million revolver while funding pension obligations, project losses and working capital.
- Compliance with leverage and net-worth covenants, particularly after the stricter leverage limit takes effect.
- The impact of oil and gas capital-spending trends, foreign exchange movements, Brexit-related uncertainty and government budget changes.
- Integration of Wyle and HTSI controls and the potential for goodwill impairment, given year-end goodwill of $959 million.