KBR Reports In-Line Earnings On Lower Top Line; Stock Down

Shares of premium technology, engineering, procurement and construction company KBR, Inc. (NYSE:KBR) sank 4.1% on Jul 29, following a tepid second-quarter 2016 earnings performance.

KBR broke its beat streak that ran for five consecutive quarters, as its second-quarter adjusted earnings of 32 cents met the Zacks Consensus Estimate.

Meanwhile, the earnings figure tumbled 25.6% compared with the year-ago tally of 43 cents. However, there was a $28 million pre-tax gain on the sale of a non-strategic business which boosted earnings in second-quarter 2015.

KBR’s bottom-line performance was driven by strong operational execution and strength in Technology and Government Services business. However, overall weakness in top line proved to be a drag.

Inside the Headlines

Revenues fell 26.9% year over year to $1,009 million, owing to absence of revenues from the deconsolidation of certain businesses in 2015. Also, low oil prices have been restricting the capital spending by clients which in turn compounded the top-line decline. Also, revenues lagged the consensus mark of $1,024 million.

Segment-wise, Technology & Consulting revenues continued to be strong and were up 22.5% year over year to $98 million on the back of increased proprietary equipment sales and inorganic revenue growth from previously completed acquisitions.

Additionally, Government Services revenues charted phenomenal growth as it soared nearly 45% to $229 million on a year-over-year basis. Revenues benefited from the solid expansion of existing U.S. government contracts and task orders in support of the U.S. Military. The company reached an agreement with the U.S. government regarding reimbursement of $33 million in legal fees related to the sodium dichromate legal disputes.

However, Engineering & Construction revenues continued their weak trajectory, and deteriorated 34.8% year over year to $621 million. Reduced activities in a major LNG project and several other projects as they approach completion hurt segmental revenues. Also, deconsolidation of KBR's Americas Industrial Services business proved to be a major headwind.

Also, non-strategic business revenues plummeted 67.9% year over year to $98 million owing to lower revenues from two recently completed power projects as well as divestiture of the Building Group business in second-quarter 2015.

As of Jun 30, 2016, the company’s total backlog stood at $11 billion, down 8.2% on a year-over-year basis. Of the total backlog, about $6.4 billion is booked under the Government Services segment (down 7.4% on a y-o-y basis) and around $4.2 billion under the Engineering & Construction segment (down 8.3% on a y-o-y basis). While Technology and Consulting accounted for $394 million of the backlog (down 8.6% on a year-over-year basis), non-strategic Business had $100 million in backlog (down 39.4%).

Significant Developments

Concurrent with the earnings release, KBR declared that it is on track to exceed its planned target of annual cost savings in 2016, as it has already identified more than $200 million of the target at the end of second-quarter 2016. Furthermore, the company is strategically pursuing its restructuring activities and has incurred $12 million in pre-tax restructuring costs during the quarter.

Also, sale of assets associated with certain Corporate real estate assets during the quarter helped the company garner $2 million in pre-tax gains. Going forward, KBR plans to continue with its portfolio restructuring actions and thereby channelize resources specifically into the International Government Services and Global Hydrocarbons segments to maximize profits.

In addition, the quarter saw KBR win two contract extensions with the U.S. Department of Defense, as well as a multi-year services contract for the Australian Defense Department.

Wyle Acquisition

On Jul 1, KBR closed the $570 million acquisition of California-based Wyle Inc. — a provider of specialized engineering and technical services.The firm delivers an extensive range of revolutionary, differentiated solutions, and caters primarily to the U.S. Department of Defense, NASA and other federal agencies. Wyle will function within KBR’s government services segment under the name “KBRwyle”, thus retaining the legacies of both the companies.

The acquisition will help expand KBR’s government services capabilities and service offerings, enabling the company to reduce its reliance on the hydrocarbon market. In addition, over the long term, Wyle is set to unlock synergistic opportunities in markets where KBR can combine its large-scale logistics and project management capabilities with Wyle's expert technical capabilities.

In addition to creating the equivalent of a global $2 billion government services organization, the acquisition also enhances KBR's overall risk profile by enabling it to leverage higher-margin and largely cost-reimbursable work through other government funding sources. KBR anticipates Wyle to be immediately accretive to its earnings and generate a positive cash flow.

Liquidity & Cash Flow

As of Jun 30, 2016, KBR’s cash and equivalents were $804 million, down from $883 million as of Dec 31, 2015.

For the quarter, cash flow generated from operating activities during the quarter totaled $9 million, compared with cash generation of $20 million in the prior-year quarter.

Guidance Reiterated

KBR has reiterated its guidance for full-year 2016. The company expects earnings per share within $1.20 to $1.45, excluding legal costs associated with the legacy U.S. government contracts. The guidance includes contribution from KBRwyle for the second half of 2016, which will likely add between $0.05 and $0.08 per share. Legal costs are projected at around $15 million or $0.11 per share for 2016.

Our Take

Despite weak performance this quarter, KBR’s ability to sustain its earnings growth over the past few quarters bears a testimony to the company’s diligent restructuring actions. Going forward, KBR believes that its Government Services will keep acting as a strong growth driver as it continues to enhance technical knowhow and advance support services to intelligence agencies. The Wyle acquisition will further KBR’s relationships with U.S. government clients and expand its footprint in the space.

Overall, the company’s lucrative contract wins and its ability to execute large-scale logistics and project management services efficiently adds to its strength and is expected to boost its financials. In addition, the company’s capital allocation strategies and partnerships are expected to propel growth in the forthcoming quarters.

Despite these positives, KBR’s precipitous revenue decline over the past few quarters owing to macroeconomic concerns are putting the company’s financials under pressure. Also, the slump in oil prices are compounding the challenges for the hydrocarbons markets, thereby thwarting top-line performance.

KBR currently carries a Zacks Rank #3 (Hold). Better-ranked stocks in the broader sector include Jacobs Engineering Group Inc. (NYSE:JEC) , Envestnet, Inc. (NYSE:ENV) and Fidelity National Information Services, Inc. (NYSE:FIS) . All these stocks hold a Zacks Rank #2 (Buy).