KBR, Inc. Form 10-Q Summary
Reporting period: The supplied filing is KBR’s unaudited Form 10-Q for the quarter and nine months ended September 30, 2015, filed November 2, 2015. The request metadata identifies “2014 Q3,” but the filing itself clearly reports 2015 Q3 and compares results with 2014.
Business context
KBR provides engineering, procurement, construction, technology, consulting, operations, maintenance, and government services for global hydrocarbons and international government customers. The company reports Technology & Consulting, Engineering & Construction, Government Services, Non-strategic Business, and Other segments. Management reorganized the business in December 2014 to focus on core operations and dispose of or exit non-strategic activities.
Financial performance and key metrics
| Metric | Three months ended September 30, 2015 | Three months ended September 30, 2014 | Nine months ended September 30, 2015 | Nine months ended September 30, 2014 |
|---|---|---|---|---|
| Revenue | $1,199 million | $1,657 million | $4,016 million | $4,949 million |
| Gross profit | $87 million | $30 million | $231 million | $97 million |
| Operating income | $75 million | $10 million | $235 million | $45 million |
| Net income attributable to KBR | $55 million | $30 million | $161 million | $(21) million |
| Diluted EPS | $0.38 | $0.21 | $1.11 | $(0.14) |
| Operating cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $(85) million | $178 million |
Revenue declined 28% in the quarter and 19% year to date, primarily because major LNG, EPC, construction, Canadian fabrication, and other projects were completed or winding down. Gross margin improved to approximately 7.3% from 1.8% in the quarter and 5.8% from 2.0% year to date. Operating margin improved to approximately 6.3% from 0.6% in the quarter and 5.9% from 0.9% year to date.
- Engineering & Construction: Third-quarter revenue was $828 million, down 31%, while gross profit increased to $48 million from $46 million. Nine-month revenue was $2.758 billion, down 22%, while gross profit rose to $155 million from $108 million.
- Government Services: Third-quarter revenue was $176 million and gross profit was $8 million, compared with $24 million of gross profit in the prior year. Nine-month gross profit fell to $3 million from $28 million, reflecting reduced activity and $13 million of legal fees related to legacy U.S. government contracts.
- Non-strategic Business: Third-quarter gross profit improved to $14 million from a $58 million loss; nine-month gross profit improved to $16 million from an $87 million loss. The improvement reflected better power-project execution, favorable settlements, and the absence of prior-year charges.
- Equity earnings: Equity in earnings of unconsolidated affiliates was $35 million in the quarter and $123 million year to date, compared with $38 million and $118 million, respectively, in the prior-year periods.
Liquidity, cash flow, debt, and capital resources
- Cash and equivalents were $768 million at September 30, 2015, down from $970 million at December 31, 2014. Cash included $69 million held by consolidated joint ventures and $395 million of international cash, which may be subject to local restrictions and repatriation taxes.
- Year-to-date operating cash flow was negative $85 million, primarily due to $100 million of funding for loss projects, $40 million of net foreign-exchange hedge settlements, and $37 million of pension contributions, partly offset by $84 million of distributions from unconsolidated affiliates.
- Investing activities provided $48 million, primarily from $71 million of asset and investment sale proceeds. Financing activities used $128 million, including $40 million for an acquisition of a noncontrolling interest, $35 million of dividends, $22 million of share repurchases, and $21 million of distributions to noncontrolling interests.
- On September 25, 2015, KBR entered into a new $1 billion unsecured revolving credit facility maturing in September 2020. At quarter-end, no cash borrowings were outstanding and $130 million of letters of credit had been issued. KBR reported compliance with its financial covenants.
- Nonrecourse project debt totaled $66 million on the balance sheet, consisting of $10 million current and $56 million noncurrent debt.
- Total liabilities were $2.677 billion and shareholders’ equity was $974 million at September 30, 2015. Pension obligations were $444 million.
Material changes versus the prior comparable period
- Profitability increased substantially despite lower revenue, primarily because prior-year project losses did not recur, non-strategic project performance improved, overhead declined, and favorable settlements were recorded.
- General and administrative expense declined 34% in the quarter and 33% year to date, reflecting headcount reductions, cost controls, and cancellation of the ERP implementation project.
- KBR recorded $15 million of third-quarter and $34 million of year-to-date asset impairment and restructuring charges, including severance, lease termination costs, and impairment of Canadian ERP assets.
- Gain on disposition of assets was $6 million in the quarter and $34 million year to date, including gains from the sale of the Building Group and deconsolidation of the Industrial Services business.
- KBR formed the Brown & Root Industrial Services joint venture with Bernhard Capital Partners and retained a 50% interest. It also invested in EPIC Piping and contributed most of its Canadian pipe fabrication and module assembly business to the partnership.
- Backlog increased to $13.3 billion from $10.9 billion at December 31, 2014. The increase included a $5.358 billion policy change for the estimated value of work under U.K. private finance initiative contracts beyond five years; 35% of backlog was expected to be executed within one year.
- The company corrected a cumulative error related to Mexican offshore maintenance joint-venture transactions, producing a $15 million favorable second-quarter 2015 impact. Management concluded the error was not material to previously issued financial statements.
Outlook, risks, contingencies, and unusual items
Management expects near-term pressure from low oil prices and reduced activity in certain hydrocarbons projects, but views LNG, brownfield, petrochemical, chemical, fertilizer, and recurring government-services work as longer-term opportunities. Management stated that the company’s cash balances and internally generated cash flows should support ordinary operations for at least the next 12 months, subject to project working-capital needs and restrictions on certain cash balances.
- Loss reserves for uncompleted contracts declined to $54 million from $159 million at year-end. Approximately $41 million related primarily to two power projects, with one expected to be completed in 2017. Actual costs may differ from current estimates.
- KBR recorded $401 million of long-term claims and accounts receivable related to the PEMEX/PEP EPC 1 arbitration. Collection remains subject to ongoing U.S. appellate proceedings and the timing of recovery is uncertain.
- U.S. government contract matters remain significant. Outstanding Form 1s totaled $174 million, including $83 million withheld by the government; KBR also reported $142 million of claims for costs incurred under various government contracts. The LogCAP III closeout process is expected to continue through at least 2017.
- Legal proceedings include False Claims Act matters, qui tam litigation, employee and military-related injury claims, shareholder securities litigation related to the 2013 restatement, and other government-contract disputes. KBR generally considers losses beyond recorded accruals remote, but some matters remain unresolved and certain losses cannot yet be estimated.
- KBR is exposed to foreign-currency risk, pension funding requirements, fixed-price project execution risk, customer concentration, claims recoverability, liquidated damages, and potential cost overruns. Chevron represented 11% of consolidated revenue for the nine months ended September 30, 2015.
- Subsequent to September 30, 2015, KBR reached a definitive agreement to sell its U.S. Infrastructure business within the Non-strategic Business segment.
Most important facts for investors to verify
- Whether the improved earnings are sustainable after excluding favorable settlements, asset-disposition gains, nonrecurring prior-year losses, and restructuring items.
- The timing and ultimate collectability of the $401 million PEMEX/PEP receivable and other U.S. government claims.
- Cash conversion, given $161 million of year-to-date net income but negative $85 million of operating cash flow.
- Remaining cash requirements and cost-to-complete for the loss-making power projects and other fixed-price contracts.
- The impact of the new backlog policy, which added $5.358 billion related to U.K. private finance initiative contracts.
- Progress on the sale of U.S. Infrastructure and the company’s broader exit from non-strategic operations.
- Potential exposure from U.S. government audits, False Claims Act proceedings, shareholder litigation, pension obligations, and uncertain tax positions.