KBR, Inc. Form 10-Q Summary
Period covered: Three months ended March 31, 2011. The request metadata identifies “2010 Q1,” but the filing is the first-quarter 2011 Form 10-Q, filed April 27, 2011. Financial statements are unaudited and stated in millions except per-share data.
Business Context and Reporting Period
KBR is a global engineering, construction and services company serving the energy, petrochemicals, government services, industrial and civil infrastructure markets. Reportable segments are Hydrocarbons, Infrastructure, Government and Power, Services, and Other.
Management noted continued growth in international hydrocarbons activity and minerals-related markets, while U.S. military support work under LogCAP III continued to decline as troops exited Iraq. The filing states that interim results are not necessarily indicative of full-year 2011 results.
Key Financial Metrics
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Total revenue | $2,321 | $2,631 | Down 12% |
| Operating income | $144 | $99 | Up 45% |
| Operating margin | 6.2% | 3.8% | Up approximately 240 bps |
| Net income | $117 | $59 | Up 98% |
| Net income attributable to KBR | $105 | $46 | Up 128% |
| Net margin attributable to KBR | 4.5% | 1.7% | Improved |
| Diluted EPS | $0.69 | $0.29 | Up $0.40 |
| Cash flow from operations | $225 | $(5) | Improved by $230 |
| Capital expenditures | $26 | $14 | Up $12 |
| Cash and equivalents | $788 | $908 at March 31, 2010 | Down $120 year over year |
Income before taxes was $139 million versus $93 million. The effective tax rate was approximately 16% versus 36% in the prior-year quarter; excluding discrete items, the 2011 rate was approximately 32%. The lower reported rate reflected foreign earnings, joint-venture tax treatment and discrete tax benefits.
Total assets were $5.467 billion at March 31, 2011, compared with $5.417 billion at December 31, 2010. Total liabilities were $3.178 billion, and total shareholders’ equity was $2.289 billion.
Debt consisted primarily of $106 million of non-recourse project-finance debt associated with a consolidated variable-interest entity. KBR had no outstanding borrowings or cash drawings under its $1.1 billion revolving credit facility, although $268 million of letters of credit was outstanding under that facility. Total letters of credit outstanding were $600 million against approximately $1.9 billion of committed and uncommitted capacity. KBR reported compliance with its credit-facility covenants.
Cash provided by operations was driven by earnings, collections of receivables, customer advance payments and affiliate-related cash flows. Cash used in financing activities was $202 million, including $164 million to acquire the remaining interest in M.W. Kellogg Limited, $37 million of distributions to noncontrolling interests and $8 million of shareholder dividends.
Material Changes Versus the Prior Comparable Period
- Revenue declined $310 million, primarily because North America Government and Defense revenue fell $405 million, including a $538 million reduction in LogCAP III activity. LogCAP IV revenue increased $116 million.
- Hydrocarbons revenue increased $125 million, or 14%, led by Gas Monetization, Oil & Gas and Technology. Hydrocarbons operating segment income increased $23 million to $99 million.
- IGP revenue declined $419 million, or 33%, but segment income increased $15 million to $61 million because of $16 million of LogCAP III award fees, improved contract performance and lower unallowable costs.
- Services revenue declined $18 million and segment income declined $8 million, primarily from completed or nearly completed U.S. and Canadian construction projects and delays in new awards.
- Total operating income improved by $45 million, reflecting stronger Hydrocarbons and IGP profitability, lower corporate general and administrative expense, and improved labor cost absorption.
- KBR recognized $16 million of LogCAP III award-fee revenue in the quarter, compared with no award fees in the first quarter of 2010.
- Equity in earnings of unconsolidated affiliates increased to $44 million from $15 million, including an approximately $8 million gain on the sale of KBR’s 50% interest in an Indonesian LNG joint venture.
- The company reduced remaining unpaid commercial-agent fee cost estimates related to the Bonny Island project, increasing operating income by $4 million.
- Backlog was essentially unchanged at $12.040 billion versus $12.041 billion at December 31, 2010. Approximately 59% was expected to be executed within one year; 80% was attributable to cost-reimbursable contracts and 20% to fixed-price contracts.
Guidance, Outlook, Risks and Unusual Items
- Management expects LogCAP III activity to continue declining through 2011 as U.S. troops leave Iraq, with further overall volume reductions expected beginning in the second half of 2011. LogCAP IV partially offsets this decline but is competitively bid.
- Management reported improving or strengthening opportunities in international hydrocarbons, minerals and metals, infrastructure and certain U.S. construction and maintenance markets, while noting that some U.S. and U.K. infrastructure markets remain affected by economic conditions and project delays.
- Government contract matters remain significant. DCAA Form 1 notices recommended suspension of approximately $377 million of prior-year contract costs, of which approximately $162 million had been withheld from current billings. The company also reported $84 million of customer demand letters for disallowed costs that it believes it is not legally obligated to pay.
- Government-related contingencies include disputes involving private security costs, containerized housing, dining facilities, transportation costs, employee replacement costs and construction services. Outcomes and potential losses may differ materially from recorded accruals.
- KBR reported $147 million of unapproved government-contract claims considered probable of collection and previously recognized as revenue.
- The PEMEX arbitration award remains recorded as a long-term receivable. Collection timing is uncertain, although a U.S. judgment recognized an award of approximately $356 million plus interest and PEMEX continues related appeals. Additional gain recognition could occur upon collection.
- More than 50 burn-pit lawsuits, electrocution litigation and convoy-ambush litigation had no accrued amounts because outcomes or loss ranges could not be reliably estimated. The DOJ False Claims Act complaint concerning private security remained pending.
- Environmental liabilities accrued were approximately $7 million, compared with a possible cost range of up to $13 million. Potential liquidated damages not accrued totaled approximately $19 million.
- Known Bonny Island corruption investigations were described as concluded. KBR paid approximately $11 million to the U.K. Serious Fraud Office during the quarter, with an approximately $6 million indemnification receivable from Halliburton.
- Management stated that no material changes had occurred in previously disclosed risk factors and that disclosure controls were effective as of March 31, 2011.
Important Facts for Investors to Verify
- Confirm the reporting-period discrepancy between the request metadata and the filing’s March 31, 2011 period.
- Assess whether the improvement in earnings and margins is sustainable after the $16 million LogCAP III award-fee recognition, the $8 million LNG joint-venture gain and the $4 million commercial-agent fee reversal.
- Monitor the pace of LogCAP III revenue decline, LogCAP IV task-order wins and the effect of U.S. military drawdowns.
- Evaluate collectability and timing of the PEMEX receivable and the $147 million of unapproved government-contract claims.
- Track DCAA, DOJ, ASBCA and U.S. Court of Federal Claims proceedings, including potential losses beyond recorded accruals and amounts withheld from KBR or subcontractors.
- Verify liquidity available for operations after excluding $207 million of cash held by consolidated joint ventures and $15 million of restricted cash.
- Review letters-of-credit exposure, including $172 million with expirations near or beyond the revolving facility’s November 2012 maturity and the potential need for cash collateral.