KBR, Inc. Form 10-Q Summary
Reporting period: The provided filing is for the quarter and six months ended June 30, 2018, although the request metadata identifies “2017 Q2.” The financial statements are unaudited and presented in millions except per-share data.
Business Context and Reporting Period
KBR provides professional services, technologies, engineering, project delivery, logistics, operations and maintenance services to government, defense and hydrocarbons customers. Reportable segments are Government Services, Technology, Hydrocarbons Services, Non-strategic Business and Other.
Effective January 1, 2018, KBR reorganized its segments and adopted ASC 606, Revenue from Contracts with Customers, using the modified retrospective method. Prior-period segment information was recast, but prior-period financial statements were not restated for ASC 606.
Financial Performance and Position
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $1,267 | $1,094 | $2,305 | $2,200 |
| Gross profit | $130 | $108 | $211 | $190 |
| Operating income | $98 | $103 | $279 | $166 |
| Net income attributable to KBR | $42 | $77 | $180 | $114 |
| Diluted EPS | $0.30 | $0.54 | $1.27 | $0.80 |
| Operating cash flow | Not separately provided | Not separately provided | $(36) | $210 |
Q2 gross margin was approximately 10.3%, operating margin 7.7% and net margin attributable to KBR 3.3%. Six-month gross margin was approximately 9.2%, operating margin 12.1% and net margin attributable to KBR 7.8%; the six-month operating result includes a $115 million gain from consolidating the Aspire Defence entities.
- Government Services: Q2 revenue increased 60% to $868 million and gross profit increased 92% to $71 million. Six-month revenue increased 46% to $1.545 billion and gross profit increased 66% to $123 million.
- Technology: Q2 revenue increased 3% to $72 million and gross profit increased 29% to $22 million. Six-month revenue declined 1% to $134 million, while gross profit increased 23% to $38 million.
- Hydrocarbons Services: Q2 revenue declined 31% to $327 million and gross profit declined 33% to $37 million. Six-month revenue declined 36% to $626 million and gross profit declined 41% to $52 million.
At June 30, 2018, cash and equivalents were $519 million versus $439 million at December 31, 2017. Approximately $302 million was held by consolidated joint ventures and Aspire project entities and was restricted primarily to project activities.
Total debt was approximately $1.1 billion, consisting principally of $163 million of Term Loan A, $800 million of Term Loan B and $115 million drawn on the Revolver. The new senior secured credit facility matures in 2023 for the Revolver and Term Loan A and in 2025 for Term Loan B. KBR was in compliance with its financial covenants at June 30, 2018.
Remaining performance obligations were $10.1 billion, with approximately 31% expected to be recognized within one year. Total backlog was $13.5 billion, including $10.8 billion in Government Services, $509 million in Technology and $2.1 billion in Hydrocarbons Services.
Material Changes Versus the Prior Comparable Period
- Revenue growth was driven primarily by the consolidation of Aspire Defence entities, the April 2018 acquisition of Stinger Ghaffarian Technologies, and organic growth in LogCAP IV and other government contracts.
- KBR acquired SGT for total consideration of $368 million, recognizing $260 million of goodwill and $74 million of intangible assets. SGT contributed $90 million of revenue and $7 million of gross profit from acquisition through June 30, 2018.
- Following Carillion plc’s liquidation, KBR consolidated certain Aspire Defence subcontracting joint ventures effective January 15, 2018. This generated a $115 million remeasurement gain and increased KBR’s ownership-related exposure to the project.
- Q2 net income attributable to KBR declined despite higher revenue because of increased interest expense, higher noncontrolling interests, lower equity earnings and weaker Hydrocarbons Services results. The prior-year period included a $35 million PEMEX and PEP arbitration settlement.
- Operating cash flow declined to an outflow of $36 million from inflow of $210 million, primarily because of unfavorable working-capital changes, including higher receivables and contract assets and lower contract liabilities.
- Investing cash outflows increased to $332 million, primarily from the SGT acquisition and a $162 million investment in the Ichthys LNG joint venture.
- ASC 606 increased reported six-month revenue by $11 million and net income by $9 million compared with amounts that would have been reported without adoption; it also increased opening retained earnings by $144 million.
Guidance, Outlook, Risks and Unusual Items
Management expects continued growth opportunities in Government Services, supported by potential increases in defense spending, aging military platforms and technology upgrades. Management also expects the SGT acquisition and increased Aspire participation to materially increase Government Services revenue in 2018. The government contracting market remains competitive and subject to procurement delays, protests, changing budgets and customer termination-for-convenience rights.
Hydrocarbons Services remains exposed to customer capital spending, commodity prices, project delays and execution risk. KBR is emphasizing recurring and reimbursable services while applying greater discipline to fixed-price EPC projects.
- Ichthys LNG: KBR’s 30%-owned JKC joint venture had significant unapproved change orders, customer claims and estimated recoveries. KBR invested approximately $162 million during the first six months and expects to invest approximately $140 million to $240 million over the next 12 months. KBR could be required to fund additional amounts, including above its ownership percentage under joint-and-several obligations.
- JKC’s proportionate share of amounts funded under the Deed of Settlement was $168 million at June 30, 2018. If unresolved by December 31, 2020, amounts may need to be refunded to the client.
- JKC is pursuing recovery of costs related to a fixed-price power plant subcontractor dispute. The claim notified to the consortium was $1.7 billion, with arbitration scheduled for October 2019. Recovery estimates and ultimate exposure remain uncertain.
- KBR reported $933 million of unapproved change orders, claims and estimated supplier or subcontractor recoveries included in project estimates at completion, most of which related to Ichthys.
- U.S. government Form 1s questioned $171 million of billed costs at June 30, 2018; $83 million remained recorded as receivable or contract assets. KBR had a $55 million reserve for unallowable costs.
- KBR had $104 million of long-term claims and accounts receivable, primarily related to disputed U.S. government contract costs.
- The company reported a $349 million pension obligation, primarily associated with its U.K. defined benefit plans, and contributed $19 million during the first six months of 2018.
- KBR had $1.1 billion of variable-rate borrowings. Management estimated that a 50-basis-point increase in interest rates would increase pre-tax interest expense by approximately $5 million over the next 12 months.
- The company stated that it had not completed its accounting for the U.S. Tax Cuts and Jobs Act and may revise provisional tax amounts as further guidance becomes available.
- The DOJ, SEC and U.K. Serious Fraud Office continue investigations related to Unaoil. The filing also disclosed ongoing securities litigation for which the likelihood of loss could not yet be determined.
Important Facts for Investors to Verify
- Reconcile reported earnings with the $115 million Aspire consolidation gain and assess the sustainability of earnings excluding this unusual item.
- Monitor operating cash conversion, receivables, contract assets and contract liabilities following ASC 606 adoption.
- Track Ichthys funding requirements, disputed claims, arbitration outcomes and potential joint-and-several liabilities.
- Evaluate leverage, variable-rate exposure, covenant headroom and the availability of Revolver and letter-of-credit capacity.
- Assess the performance and integration of SGT and the financial impact of consolidating Aspire entities.
- Review the collectability and timing of U.S. government claims and Form 1-related receivables.
- Compare backlog and remaining performance obligations with funded amounts, customer termination rights and the portion attributable to unconsolidated joint ventures.