KBR, INC. quarterly report, Q3 FY2018

KBR, Inc. Form 10-Q Summary

Reporting period: Three and nine months ended September 30, 2018. The request metadata identifies “2017 Q3,” but the filing is the 2018 third-quarter Form 10-Q, filed October 30, 2018. Amounts are in millions except per-share data.

Business context and reporting period

KBR provides professional services, technologies, engineering, construction, program management, logistics, operations and maintenance services to government, defense, space, aviation and hydrocarbons customers. Reportable segments are Government Services, Technology, Hydrocarbons Services, Non-strategic Business and Other.

Effective January 1, 2018, KBR renamed its Engineering & Construction segment Hydrocarbons Services and moved its consulting business into that segment. KBR also adopted ASC 606 using the modified retrospective method and consolidated certain Aspire Defence subcontracting entities beginning January 15, 2018. KBR acquired Stinger Ghaffarian Technologies in April 2018.

Financial performance and position

Metric	Q3 2018	Q3 2017	9M 2018	9M 2017
Revenue	$1,278	$1,034	$3,583	$3,234
Gross profit	$122	$87	$333	$277
Operating income	$103	$73	$382	$239
Net income attributable to KBR	$58	$45	$238	$159
Diluted EPS	$0.41	$0.32	$1.68	$1.12
Operating cash flow	Not separately provided	Not separately provided	$36	$238

Q3 revenue increased 24%, gross profit increased 40%, operating income increased 41% and net income attributable to KBR increased 29%. Nine-month revenue increased 11%, gross profit increased 20%, operating income increased 60% and net income attributable to KBR increased 50%.

Approximate margins were 9.5% gross, 8.1% operating and 4.5% net attributable to KBR in Q3 2018, compared with 8.4%, 7.1% and 4.4%, respectively, in Q3 2017. Nine-month 2018 margins were approximately 9.3% gross, 10.7% operating and 6.6% net attributable to KBR, compared with 8.6%, 7.4% and 4.9% in the prior-year period.

Government Services: Q3 revenue was $928, up 59%; gross profit was $81, up 108%. Nine-month revenue was $2,473, up 51%; gross profit was $204, up 81%. Growth reflected organic logistics and engineering growth, Aspire consolidation and the SGT acquisition.
Technology: Q3 revenue was $81, up 35%, and gross profit was $23, up 21%. Nine-month revenue was $215, up 10%, and gross profit was $61, up 22%.
Hydrocarbons Services: Q3 revenue was $268, down 31%, and gross profit was $23, down 12%. Nine-month revenue was $894, down 34%, and gross profit was $75, down 34%, primarily due to project completions, reduced activity and the absence of the 2017 PEMEX settlement.
Backlog: Total backlog was $13.5 billion at September 30, 2018, compared with $10.6 billion at December 31, 2017. Remaining performance obligations under ASC 606 were $10.1 billion, with approximately 30% expected to be recognized within one year.

Cash flow, liquidity and debt

Cash and equivalents were $581 at September 30, 2018, compared with $439 at December 31, 2017. Approximately $303 was held by consolidated joint ventures and Aspire Defence entities and was restricted to project activities.
Operating cash flow fell to $36 for the first nine months from $238 in the prior-year period, primarily because of a $144 increase in accounts receivable, a $63 reduction in contract liabilities and other working-capital requirements.
Investing cash outflows were $428, including $354 for acquisitions and $257 invested in the Ichthys LNG joint venture, partially offset by $197 of cash obtained through consolidation of Aspire entities.
Financing cash inflows were $552, reflecting new borrowings, partially offset by debt repayments, $47 of debt issuance costs, $56 paid to acquire joint-venture interests and $34 of dividends.
At September 30, total debt was approximately $1,146, including $256 of Term Loan A, $798 of Term Loan B and $115 of revolver borrowings, net of debt issuance costs. KBR had $21 of current maturities.
The new Senior Credit Facility includes a $500 revolving facility, a $500 performance letter-of-credit facility, a $350 Term Loan A and an $800 Term Loan B. KBR was in compliance with its financial covenants at quarter-end.
Remaining committed and uncommitted letter-of-credit capacity was approximately $862. Management stated that cash, operating cash flow and available credit were sufficient for expected needs over the next 12 months.

Material changes versus the prior comparable period

Government Services became the principal growth driver, benefiting from Aspire Defence consolidation, SGT and organic growth.
Hydrocarbons Services contracted materially as projects in the United States and Canada reached completion or neared completion.
Operating income included a $113 gain from consolidating the Aspire Defence subcontracting entities. The transaction also increased goodwill by approximately $44 and brought substantial project assets and liabilities onto the balance sheet.
SGT contributed $126 of Q3 revenue and $12 of Q3 gross profit, and $216 of nine-month revenue and $19 of gross profit.
ASC 606 increased opening retained earnings by $144. At September 30, reported accounts receivable was $257 higher and contract assets were $257 lower than under the prior accounting presentation.
Interest expense increased to $20 in Q3 and $43 for the nine months, versus $6 and $16, respectively, due to higher borrowings and borrowing costs.
Net income attributable to noncontrolling interests increased to $23 for the nine months from $5, largely reflecting project-related earnings.

Guidance, outlook, risks and unusual items

Management did not provide a specific numerical earnings or revenue forecast in the filing. Management described the government-services outlook as favorable, citing defense and space spending, and expects a significant increase in Government Services revenue, income and cash flow in 2018. Hydrocarbons opportunities were described as improving, particularly in LNG, petrochemicals, chemicals and fertilizers, although customer capital spending remains sensitive to commodity prices and market conditions.

Ichthys LNG: KBR owns 30% of the JKC joint venture. The project remains subject to claims, delayed completion of the power plant, subcontractor disputes and client funding issues. KBR contributed approximately $257 in the first nine months and projected approximately $250 of additional funding to complete the project, excluding recoveries.
JKC reported approximately $1.9 billion of claims against the abandoned power-plant consortium. KBR’s recovery estimates and project profitability depend on arbitration, litigation, client approvals and the financial ability of counterparties to pay.
KBR’s proportionate share of Ichthys amounts funded under the Funding Deed was $163 at September 30, 2018. Amounts could require repayment if claims remain unresolved by December 31, 2020.
KBR had $959 of unapproved change orders, customer claims and estimated subcontractor recoveries included in project estimates at completion. Management cautioned that these estimates may prove inaccurate.
The company had a $328 pension funding deficit and contributed $30 during the first nine months against an estimated $40 contribution for 2018. Future U.K. pension funding could increase.
U.S. government claims and disputes included $73 of questioned costs subject to Form 1s and $96 of long-term claims and accounts receivable. Timing and ultimate recoveries remain uncertain.
Potential liquidated damages not considered probable totaled $9. KBR also continues to face government audits, litigation, investigations and False Claims Act-related matters, although management generally assessed the likelihood of material losses as remote or accrued its best estimate where appropriate.
The company had not completed its accounting for all effects of the Tax Cuts and Jobs Act and expected further IRS guidance could change provisional tax amounts.
On October 10, 2018, after quarter-end, KBR entered into $500 of interest-rate swaps intended to convert LIBOR-based exposure to a fixed rate for four years.

Most important facts for an investor to verify

Whether Ichthys claims and recoveries are ultimately approved and whether the estimated $250 of additional KBR funding is sufficient.
The collectability and timing of the $73 of U.S. government Form 1 claims and the broader $96 claims receivable balance.
The sustainability of Government Services growth after incorporating Aspire Defence and SGT acquisition-related contributions.
Whether Hydrocarbons Services revenue and margins stabilize as major projects complete.
Actual cash conversion, given $36 of nine-month operating cash flow against $261 of net income.
Debt reduction, interest-rate exposure, covenant headroom and availability under the Senior Credit Facility.
Future U.K. pension contributions and the results of the 2019 funding valuation.
The effects of ASC 606 adoption, including the comparability of 2018 results with 2017 results that were not restated.