Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations
Introduction
The purpose of MD&A is to provide our stockholders and other interested parties with information necessary to gain an understanding of our financial condition and disclose changes in our financial condition since the most recent fiscal year-end and results of operations during the current fiscal period as compared to the corresponding period of the preceding fiscal year. The MD&A should be read in conjunction with Part I of this Annual Report on Form 10-K as well as the consolidated financial statements and related notes included in Part II Item 8 in this Annual Report on Form 10-K.
This MD&A does not address certain items in respect of the year ended December 31, 2018. A discussion and analysis of such period may be found in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, filed with the SEC on February 24, 2020.
Overview
KBR, a Delaware corporation, delivers scientific, technology and engineering solutions to governments and companies around the world. Drawing from its rich 100-year history and culture of innovation and mission focus, KBR creates sustainable value by combining scientific, technology and engineering expertise with its full life cycle capabilities to help our clients meet their most pressing challenges. Our capabilities and offerings include the following:
•Scientific research such as quantum science and computing; health and human performance; materials science; life science research; and earth sciences;
•Defense systems engineering such as rapid prototyping; test and evaluation; aerospace acquisition support; systems and platform integration; and sustainment engineering;
•Operational support such as space domain awareness; C4ISR; human spaceflight and satellite operations; integrated supply chain and logistics; and military aviation support; and
•Information operations such as cybersecurity; data analytics; mission planning systems; virtual/augmented reality and technical training; and artificial intelligence and machine learning; and
•Technology such as licensing of proprietary, sustainability-focused process technology; advisory services focused on energy transition; and digitally-enabled asset optimization solutions.
KBR's strategic growth vectors include:
•Defense modernization;
•Space superiority;
•Health and human performance; and
•Sustainable technology.
Our stated financial policies and deployment priorities are to fund organic growth, maintain responsible leverage, maintain an attractive dividend, make strategic acquisitions and repurchase shares. Our acquisition thesis is centered around moving upmarket, expanding capabilities and broadening customer sets in its strategic growth vectors.
On October 1, 2020, we acquired Centauri, a provider of high-end engineering and development solutions for critical, well-funded, national security missions associated with space, intelligence, cyber, and emerging technologies such as directed energy and missile defense. Additional information relating to the Centauri acquisition is described in Part II of this Annual Report on Form 10-K in Note 4 to our consolidated financial statements.
KBR delivers a wide range of professional services across defense, space and other government agencies spanning program management and consulting, mission planning, operational and platform support, research and development, test and evaluation, training, and logistics and facilities management. These services are provided primarily to government agencies in the U.S., U.K., Australia and other select countries under long-term programs with key technical, scientific or mission-specific differentiation. Key customers include U.S. DoD agencies such as the Missile Defense Agency, National Geospatial-Intelligence Agency, National Reconnaissance Office and other intelligence agencies, U.S. Army, U.S. Navy and U.S. Air Force; U.S. civilian agencies such as NASA, U.S. Geological Survey and National Oceanic and Atmospheric Administration; the U.K. Ministry of Defence, London Metropolitan Police, U.K. Army, other U.K. Crown Services; and the Royal Australian Air Force, Navy and Army.
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KBR develops and prioritizes investment in process technologies that are disruptive, innovative, and sustainability- and safety-focused. These technologies and solutions enable clients to achieve a cleaner, greener, more energy efficient global future. We deliver high-end advisory solutions centered around energy transition; we license process technologies; we provide engineering and design services; we sell proprietary equipment and catalysts; and we provide asset optimization and remote facility monitoring solutions. Key customers include national governments, commercial and industrial companies, and oil and gas companies.
Business Environment and Trends
Government Outlook
The fiscal year 2021 U.S. defense budget funds a national security strategy that continues the restoration of military readiness, furthers a national security strategy to confront near peer and other threats around the world, enhances the DoD’s cybersecurity strategy and cyber warfare capabilities, increases the priority of military space superiority, and directs innovation to meet long-range emerging threats. The budget includes a number of measures to strengthen emerging technologies including cyber-science and technologies, artificial intelligence, directed energy, hypersonics, and biotechnologies.
Internationally, our Government Solutions work is performed primarily for the U.K. Ministry of Defence and the Australian Department of Defence. A significant majority of our work in the U.K. is contracted through long-term privately financed initiatives (PFIs) that are expected to provide stable, predictable earnings and cash flow over the program life, with our largest PFI extending through 2041. The Australian government continues to increase defense spending, with particular focus on enhancing regional security, modernizing defense capabilities, strengthening cyber defenses and promoting broader economic stability.
With defense and civil budgets driven in part by political instability, military conflicts, aging platforms and infrastructure and the need for technology upgrades, we expect continued opportunities to provide solutions and technologies to mission critical work aligned with our customers’ priorities.
Commercial Outlook
Long-range commercial market fundamentals are supported by global population growth, global expansion of the middle class, and acceleration of demand for energy transition and renewable energy sources for which momentum continues, even amidst COVID-19.Clients continue to prioritize investment in solutions to increase end-product flexibility and energy efficiency and reduce their environmental footprint. As companies continue to commit to near-term carbon neutrality and longer-range net-zero carbon ambitions, we expect their spending to continue in areas such as decarbonization; carbon capture, sequestration and utilization; biofuels; and plastics circular economy.Further, governments and leading companies across the world are proactively evaluating clean energy alternatives, including hydrogen and green ammonia, which are areas that favor KBR’s world-class technology portfolio and expertise.
We expect climate change and energy transition to be increasing areas of priority and investment for the Biden Administration and a more progressive Senate that holds a thin margin, as the U.S. looks to reboot its economy and invest in a cleaner future. President Biden has nominated two new cabinet-level positions focused on climate change and science.Further, through executive action, President Biden has initiated re-entry into the Paris climate accords and has begun the reversal of a number of the prior administration’s environmental policies.
Our Business
KBR's business is organized into three core and two non-core business segments as follows:
Core business segments
•Government Solutions
•Technology Solutions
•Energy Solutions
Non-core business segments
•Non-strategic Business
•Other
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See additional information on our business segments, including detail with respect to changes to our reportable segments in Notes 1 and 2 to our consolidated financial statements and under "Item 1. Business" in this Annual Report on Form 10-K.
In 2020, we initiated a strategic transition from the current three-core business segment model to a two-core business segment model comprised of Government Solutions and Technology Solutions. We expect to begin reporting under this model in fiscal year 2021.The new Technology Solutions segment is anchored by our innovative, proprietary process technologies. It will also include our highly synergistic advisory practice focused on energy transition and net-zero carbon ambitions as well as the technology-led industrial solutions focused on innovative digital operations and maintenance ("O&M") solutions and advanced remote operations capabilities to improve throughput, reliability and environmental sustainability. Infusing high-end, sustainability expertise, client relationships and innovative, technology-led O&M solutions into Technology Solutions is expected to increase resilience, generate new opportunities, simplify the business model and better position us to deliver its offerings across a broader industrial base.
Effective for fiscal year 2021, we will change the names of our reportable segments and businesses as follows:
•Government Solutions includes the following four business units: Defense & Intel, formerly the Defense Systems Engineering and Centauri businesses; Science & Space, formerly called Space & Mission Solutions; Readiness & Sustainment, formerly called Logistics; and International.
•Sustainable Technology Solutions, formerly called Technology Solutions.
Overview of Financial Results
2020 was a year of significant achievement for KBR as we successfully advanced our long-term vision. We accelerated the Company’s growth into attractive markets with the Centauri acquisition and Technology portfolio realignment; focused on agile, technology-driven, sustainability-focused; knowledge-based delivery; and advanced our ESG and sustainability strategy by establishing 2030 net-zero carbon ambitions and achieving carbon neutrality in 2019. Our teams continued to execute and deliver operational performance, healthy profitability and strong cash flow. Importantly, we drove innovation and extended our footprint through new program wins and technology advances and development. Bookings to underpin the future were strong in our GS and TS businesses. Our U.S. Government Solutions business achieved a 95% recompete win rate that included a $400 million NASA recompete award to provide intelligent systems research and a $300 million U.S. Geological Survey recompete award to perform satellite systems engineering, software development, and scientific research and application development for remote sensing data. We also expanded our footprint through new projects and program wins, including a five-year contract for over $500 million for an undisclosed client to provide high-end technical services for rapid prototyping and fielding of advanced systems and an eight-year $974 million contract to provide the U.S. Air Force sustaining operations in Europe. We continued our track record of innovation, bringing new technologies to market and advising, consulting and delivering expertise in the vital area of energy transition, hydrogen future and plastics circular economy.
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Results of Operations
The following tables set forth our results of operations for the periods presented, including by segment.
Revenues
2020 vs. 2019
Revenue of $5.8 billion represented an increase of $128 million from the prior year, primarily due to the following: (1) new program wins and on-contract expansion, including approximately $104 million, or 12%, growth in Space & Mission Solutions; approximately $50 million growth in sustaining programs within Logistics; approximately $50 million, or 7%, growth in Defense & Intel; (2) Centauri, acquired on October 1, 2020, contributed approximately $125 million of revenue; and (3) ES business segment revenue volume increased approximately $187 million primarily attributable to completion of projects in backlog. Revenue increases were partially offset by approximately $150 million of revenue associated with disaster recovery services provided to the U.S. Air Force on the AFCAP IV project in 2019 that did not recur in 2020, reduced volume in the Company’s Middle East overseas contingency operations of approximately $150 million, and reduced activity in the Company’s international government business of approximately $25 million.
2019 vs. 2018
The increase in consolidated revenues in 2019 was primarily driven by strong organic growth within our GS business segment relative to the Logistics and Defense & Intel businesses as well as increased revenues from the acquisition of SGT in April 2018. New services and consulting awards in the Middle East from our ES business segment and higher proprietary equipment sales volume from our TS business segment also contributed significantly to revenue growth in 2019.
Gross Profit
2020 vs. 2019
The $13 million increase in gross profit is primarily driven by revenue growth described above as well as favorable changes in estimates on the Aspire Defence project.While revenue increased in our ES business segment, gross profit decreased primarily due to the volume of lower margin services as we complete projects in backlog and transition away from commoditized services.
2019 vs. 2018
The $69 million increase in gross profit in 2019 includes $80 million in increased gross profit from our GS business segment primarily driven by the volume growth in revenue, incremental profits resulting from the full year of operations from SGT, and favorable settlements on several legacy matters in our GS business segment including the private security legal matter. We also recognized incremental profits from construction services related to the Aspire Defence project in the U.K. associated with index-based price adjustments. TS business segment gross profit increased by $12 million over 2018 levels based on increased volumes of proprietary equipment sales. Additionally, we recognized increased earnings of $11 million primarily due to the close-out of a completed project in our Non-strategic business segment. These increases were partially offset by reductions in gross profit from our ES business segment of $34 million due to lower margins on several major EPC projects and the non-recurrence of several favorable items including the recognition of variable consideration associated with the successful completion of an LNG project in Australia in 2018.
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Equity in Earnings of Unconsolidated Affiliates
2020 vs. 2019
Equity earnings decreased was primarily noted in our ES business segment due to the successful completion of a North Sea project in 2019 in our ES business segment resulting in favorable benefits that did not recur in 2020 and reduced earnings from other joint ventures.
2019 vs. 2018
Equity earnings decreased was primarily noted in our ES business segment due to the substantial completion of a North Sea project in 2019 in our ES business segment that contributed significantly in 2018 and to a lesser extent in 2019.Further, in 2019, the Company recognized the impact of an unfavorable arbitration ruling associated with the Ichthys LNG project as well as an impairment of an equity method investment in Latin America. In 2018, we realized a benefit associated with the release of a tax matter on an Egyptian joint venture that did not recur in 2019.See Note 6 to our consolidated financial statements for more information on the Ichthys LNG project.
Selling, General and Administrative Expenses
2020 vs. 2019
Selling, general and administrative expenses were slightly lower in 2020 compared to 2019, primarily due to reductions in corporate costs associated with austerity measures and travel restrictions related to COVID-19.These reductions were partially offset by increases in our GS business segment, including increased amortization attributable to our acquisition of Centauri, increased bid and proposal cost and favorable variances in 2019 that did not recur in 2020.
2019 vs. 2018
The increase in 2019 of $42 million in selling, general and administrative expenses as compared to 2018 was primarily related to an increase in corporate costs including increased IT, rebranding and other general corporate expenses.
Acquisition and Integration Related Costs
Acquisition and integration related costs $ (9) $ (2) $ 7 n/m $ (7) $ (5) n/m
Acquisition and integration related costs for 2020 are associated with our acquisition of Centauri on October 1, 2020. Acquisition and integration costs incurred in 2019 are comprised of integration costs related to our acquisition of SGT.
Goodwill impairment $ (99) $ — $ 99 n/m $ — $ — n/m
Restructuring charges and asset impairments (214) — 214 n/m — — n/m
See Note 7 "Restructuring charges and asset impairments" and Note 9 "Goodwill and intangible assets" to our consolidated for further discussion.
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Gain (Loss) on Disposition of Assets
Gain (loss) on disposition of assets $ 18 $ 17 $ 1 6 % $ (2) $ 19 n/m
In 2020, we recognized a favorable change in estimated revenues and gross profit associated with variable consideration resulting from resolution of a contingency on a completed LNG project as well as the liquidation of legal entities as part of a broad, ongoing legal entity rationalization project. The gain on disposition of assets in 2019 primarily reflects the gain on sale of a contract vehicle and sale of an equity method investment in our GS business segment.
Gain on Consolidation of Aspire entities
Gain on consolidation of Aspire entities $ — $ — $ — n/m $ 108 $ (108) n/m
The gain on consolidation of Aspire entities in 2018 was recognized upon the consolidation of the Aspire Defence subcontracting entities.
Interest Expense
2020 vs. 2019
The decrease in interest expense was primarily due to lower outstanding borrowings under our Senior Credit Facility during the majority of 2020 as well as lower weighted-average interest rates as a result of the favorable refinancing of our Senior Credit Facility in February 2020 and falling interest rates.See Note 12 "Debt and Other Credit Facilities" to our consolidated financial statements for further discussion.
2019 vs. 2018
The increase in interest expense in 2019 was primarily due to increased fixed-rate borrowings as a result of the Convertible Notes in November 2018 partially offset by lower outstanding borrowings and weighted-average interest rates on our variable-rate debt.
Other Non-operating Income (Loss)
Other non-operating income (loss) $ 1 $ 5 $ (4) 80 % $ (6) $ 11 (183) %
2020 vs. 2019
Other non-operating income (loss) includes interest income, foreign exchange gains and losses and other non-operating income or expense items. The decrease in 2020 was primarily due to settlement during the year of transactions that drive non-cash foreign exchange volatility.
2019 vs. 2018
The increase in other non-operating income was primarily due to the impact of favorable foreign currency movements on intercompany balance positions denominated in U.S. dollars partially offset by unfavorable variances on certain U.S. dollar cash positions held internationally.
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Provision for Income Taxes
2020 vs. 2019
The 2020 period provision for income taxes is lower than the 2019 period primarily due to a significant drop in taxable income largely driven by impairment and restructuring charges incurred in 2020.
2019 vs. 2018
The decrease in income tax expense in 2019 compared to 2018 was primarily driven by the non-recurrence of the $108 million gain recognized in 2018 resulting from our consolidation of the Aspire Defence project subcontracting joint ventures.
A reconciliation of our effective tax rates for 2020, 2019 and 2018 to the U.S. statutory federal rate and further information on the effects of the Tax Act is presented in Note 13 to our consolidated financial statements.
Net Income Attributable to Noncontrolling Interests
2020 vs. 2019
The increase in net income attributable to noncontrolling interests in 2020 was related to a favorable change in estimated variable consideration resulting from resolution of a contingency on a completed LNG project as well as the liquidation of legal entities as part of a broad, ongoing legal entity rationalization project offset by impairment loss related to the Middle East joint venture project in our ES business segment.
2019 vs. 2018
The decrease in net income attributable to noncontrolling interests in 2019 was primarily due to the non-recurrence of the recognition of variable consideration associated with the successful completion and performance testing of a major ES project in Australia in 2018, executed by a consolidated joint venture.
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Results of Operations by Business Segment
We analyze the financial results for each of our three core business segments, as well as our non-core segments. The business segments presented are consistent with our reportable segments discussed in Note 2 to our consolidated financial statements.
Years Ended December 31,
Revenues
Non-strategic Business 4 1 3 n/m 2 (1) (50) %
Gross profit (loss)
Non-strategic Business (8) 5 (13) n/m (6) 11 n/m
Equity in earnings of unconsolidated affiliates
Government Solutions $ 25 $ 29 $ (4) (14) % $ 32 $ (3) (9) %
Non-strategic Business — (13) 13 n/m (3) (10) n/m
Acquisition and integration related costs $ (9) $ (2) $ 7 n/m $ (7) $ (5) n/m
Goodwill impairment $ (99) $ — $ 99 n/m $ — $ — n/m
Restructuring charges and asset impairment $ (214) $ — $ 214 n/m $ — $ — n/m
Gain on disposition of assets $ 18 $ 17 $ 1 6 % $ (2) $ 19 n/m
Gain on consolidation of Aspire entities $ — $ — $ — n/m $ 108 $ (108) n/m
n/m - not meaningful
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Government Solutions
2020 vs. 2019
GS revenues remained relatively consistent at $3.9 billion, with a slight increase of $9 million for 2020 compared to 2019. The increase was primarily driven by growth in Space & Mission Solutions of approximately $104 million, growth in Defense & Intel of approximately $50 million, growth in sustaining programs within Logistics of approximately $50 million, growth in our Australian government business of approximately $60 million and the increased revenues of approximately $125 million from the acquisition of Centauri.These increases were partially offset by revenue of approximately $150 million associated with disaster recovery services provided to the U.S. Air Force on the AFCAP IV project in 2019 that did not recur in 2020, reduced volume in our Middle East overseas contingency operations of approximately $150 million and reduced activity in our international government business of approximately $85 million primarily related to the substantial completion and wind-down of our Aspire Capital Works program.
GS gross profit increased by $53 million, or 12%, to $483 million in 2020 compared to $430 million in 2019. This increase is principally driven by higher mix of higher margin projects as well as favorable changes in estimates on the Aspire Defence project as that project nears completion.
GS equity earnings of unconsolidated affiliates decreased by $4 million to $25 million in 2020 compared to $29 million in 2019, primarily attributable to changes in project estimates in a domestic joint venture.
2019 vs. 2018
GS revenues increased by $468 million, or 14%, to $3.9 billion in 2019, compared to $3.5 billion in 2018. This increase was primarily driven by strong growth within our GS business from new and existing U.S. government contracts including increased volumes for disaster recovery services provided to the U.S. Air Force on the AFCAP IV project, expanded services provided to the U.S. Army in Iraq and Europe on the LogCAP IV project, human performance and behavioral health services provided to the U.S. Special Operations Command and increased engineering services on various other U.S. government programs. GS revenues from the April 2018 acquisition of SGT increased by approximately $139 million in 2019 on a year-over-year basis. A new award from the U.K. MoD for services in the Middle East also contributed to the increase in revenues in 2019.
GS gross profit increased by $80 million, or 23%, to $430 million in 2019, compared to $350 million in 2018. The increase in 2019 was primarily due to the increased volumes on U.S. government contracts and the full year of operations from SGT. In addition, we received a favorable judgment to close out the private security legal matter and settled several other legacy matters on the LogCAP III contract during the year. We recognized incremental profits from construction services related to the Aspire Defence project in the U.K. as uncertainties associated with index-based price adjustments have begun to dissipate.
GS equity in earnings in unconsolidated affiliates decreased by $3 million, or 9%, to $29 million in 2019, compared to $32 million in 2018. The decrease is due to the consolidation of the Aspire Defence subcontracting entities in January 2018 as well as lower profitability from a joint venture project to provide support services on a U.S. government project.
Technology Solutions
2020 vs. 2019
TS revenues decreased by $71 million, or 19% to $303 million in 2020 compared to $374 million in 2019, primarily due to lower proprietary equipment sales and licensing revenue driven by market disruption and delays caused by COVID-19.
TS gross profit decreased by $13 million, or 11%, to $105 million in 2020, compared to $118 million in 2019, primarily due to lower revenue volume partially offset by favorable project close-outs and lower overall overhead spend.
2019 vs. 2018
TS revenues increased by $77 million, or 26%, to $374 million in 2019 compared to $297 million in 2018, primarily due to higher proprietary equipment sales.
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TS gross profit increased by $12 million, or 11%, to $118 million in 2019 compared to $106 million in 2018, primarily driven by increased revenue volume that included a higher mix of proprietary equipment sales.
Energy Solutions
2020 vs. 2019
ES revenues increased by $187 million, or 14%, to $1.5 billion in 2020, compared to $1.3 billion in 2019. The increase was largely attributable to increased volume on existing projects in the U.S. and Mexico, partially offset by the completion or near completion of projects, volume pressures attributable to the COVID-19 market downturn and ensuing KBR portfolio shaping decisions to exit certain elements of the ES business.
ES gross profit decreased by $14 million, or 14%, to $86 million in 2020, compared to $100 million in 2019. This decrease was due to a higher mix of lower margin projects in 2020, lower demand due to the downturn in the energy market caused by COVID-19, and the non-recurrence of favorable close-outs in 2019.
ES equity in earnings of unconsolidated affiliates decreased by $14 million to $5 million in 2020, compared to $19 million in 2019. This decrease was primarily due to benefits associated with the favorable completion of a North Sea project in 2019 that did not recur in 2020 and lower earnings from a U.S. joint venture primarily attributable to COVID-19 market dynamics.
2019 vs. 2018
ES revenues increased by $182 million, or 16%, to $1.3 billion in 2019, compared to $1.2 billion in 2018. Revenues increased by approximately $173 million in our Services and Consulting business primarily due to the ramp up of recently awarded projects and expansion of services internationally, primarily in the Middle East. Revenue increases from new cost-reimbursable projects along the U.S. Gulf Coast in our EPC business were substantially offset by declines resulting from the completion of various EPC projects in the U.S. as well as the Ichthys LNG project in Australia.
ES gross profit decreased by $34 million, or 25% to $100 million in 2019, compared to $134 million in 2018. This decrease was primarily due to non-recurring 2018 events including the recognition of variable consideration associated with the successful completion of an LNG project in Australia and favorable close-outs on several ammonia projects in the U.S. Also contributing to the decline were lower profits from services provided to the Ichthys LNG project joint venture. These decreases were partially offset by earnings in 2019 resulting from the ramp up of new projects in the Middle East and the favorable settlement reached with a supplier on an ammonia project completed in the U.S.
ES equity in earnings in unconsolidated affiliates decreased by $31 million, or 62%, to $19 million in 2019, compared to $50 million in 2018. This decrease was primarily due to the substantial completion of a North Sea oil project, lower earnings due to an unfavorable arbitration ruling in early 2019 associated with a subcontractor on the Ichthys LNG project, and non-recurrence of a release of a tax liability on an Egyptian joint venture in 2018. See Note 6 to our consolidated financial statements for more information on the Ichthys LNG project.
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Non-strategic Business
2020 vs. 2019
All Non-strategic Business projects are substantially complete.We continue to finalize project close-out activities and negotiate the settlement of claims and various other matters associated with these projects.
Non-strategic Business generated revenues of $4 million in 2020 compared to $1 million in 2019, primarily associated with close-out activities on completed projects.
Non-strategic Business incurred a gross loss of $8 million in 2020 primarily due to close-out activities, compared to $5 million gross profit for 2019.
Non-strategic Business earned no equity in earnings of unconsolidated affiliates for 2020 compared to a loss of $13 million for 2019 due to the recognition of an accrued loss associated with an equity investment in 2019.
2019 vs. 2018
Non-strategic Business generated revenues of $1 million in 2019 compared to $2 million in 2018. Revenues in the Non-strategic Business were primarily associated with close-out activities on completed projects as we exit the business.
Non-strategic Business earned $5 million of gross profit in 2019 primarily due to favorable benefits on the close-out of a completed project in the U.S, compared to a gross loss of $6 million in 2018 primarily due to the settlement of a legacy legal matter.
Non-strategic Business equity in earnings from unconsolidated affiliates decreased by $10 million to a loss $13 million in 2019 as compared to a loss of $3 million in 2018 primarily due to an impairment charge associated with an equity method investment in Latin America.
Acquisitions, Dispositions and Other Transactions
Information relating to various acquisitions, dispositions and other transactions is described in Notes 4, 7, 9 and 10 to our consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K and the information discussed therein is incorporated by reference into this Part II, Item 7.
Backlog of Unfilled Orders
Backlog generally represents the total dollar amount of revenues we expect to realize in the future as a result of performing work on contracts and our pro-rata share of work to be performed by unconsolidated joint ventures. We generally include total expected revenues in backlog when a contract is awarded under a legally binding agreement. In many instances, arrangements included in backlog are complex, nonrepetitive and may fluctuate over the contract period due to the release of contracted work in phases by the customer. Additionally, nearly all contracts allow customers to terminate the agreement at any time for convenience. Certain contracts provide maximum dollar limits, with actual authorization to perform work under the contract agreed upon on a periodic basis with the customer. In these arrangements, only the amounts authorized are included in backlog. For projects where we act solely in a project management capacity, we only include the expected value of our services in backlog.
For U.S. government contracts, backlog includes our estimate of the remaining future revenue from existing contracts over the base contract performance period (including customer approved option periods) for which work scope and price have been agreed with the customer. Funded backlog represents the portion of backlog for which funding currently is appropriated, less the amount of revenue we have previously recognized. Unfunded backlog represents the total backlog less the funded backlog. Our backlog does not include any estimate of future potential delivery orders that might be awarded under our government-wide acquisition contracts, agency-specific indefinite delivery/indefinite quantity contracts or other multiple-award contract vehicles nor does it include option periods that have not been exercised by the customer.
For U.K. government PFIs, we estimate backlog based on the aggregate amount that our client would contractually be obligated to pay us over the life of the project. We update our estimates of the future work to be executed under these contracts on a quarterly basis and adjust backlog if necessary.
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Refer to "Item 1A. Risk Factors" contained in Part 1 of this Annual Report on Form 10-K for a discussion of other factors that may cause backlog to ultimately convert into revenues at different amounts.
We have included in the table below our proportionate share of unconsolidated joint ventures' estimated backlog. Since these projects are accounted for under the equity method, only our share of future earnings from these projects will be recorded in our results of operations. Our proportionate share of backlog for projects related to unconsolidated joint ventures totaled $2.4 billion and $2.6 billion at December 31, 2020 and 2019, respectively. Our backlog included in the table below for projects related to consolidated joint ventures with noncontrolling interests includes 100% of the backlog associated with those joint ventures and totaled $52 million and $78 million at both December 31, 2020 and 2019.
The following table summarizes our backlog by business segment for the years ended December 31, 2020 and December 31, 2019, respectively:
Non-strategic Business — —
Backlog for the ES business segment decreased approximately $1.2 billion during the year ended December 31, 2020 primarily due to management's decision to discontinue pursuing certain projects. For further discussion, see Notes 1 and 7 to our consolidated financial statements.
We estimate that as of December 31, 2020, 28% of our backlog will be executed within one year. Of this amount, 87% will be recognized as revenue on our consolidated statement of operations and 13% will be recorded by our unconsolidated joint ventures. As of December 31, 2020, $107 million of our backlog relates to active contracts that are in a loss position.
As of December 31, 2020, 13% of our backlog was attributable to fixed-price contracts, 47% was attributable to PFIs and 40% was attributable to cost-reimbursable contracts. For contracts that contain both fixed-price and cost-reimbursable components, we classify the individual components as either fixed-price or cost-reimbursable according to the composition of the contract; however, for smaller contracts, we characterize the entire contract based on the predominant component. As of December 31, 2020, $9.3 billion of our GS backlog was currently funded by our customers.
As of December 31, 2020, we had approximately $3.9 billion of priced option periods for U.S. government contracts that are not included in the backlog amounts presented above.
The difference between backlog of $15.1 billion and the remaining performance obligation as defined by ASC 606 of $12.0 billion is primarily due to our proportionate share of backlog related to unconsolidated joint ventures which is not included in our remaining performance obligation. See Note 3 to our consolidated financial statements for discussion of the remaining performance obligations.
Liquidity and Capital Resources
Liquidity is provided by available cash and equivalents, cash generated from operations, our Senior Credit Facility and access to financial markets. Our operating cash flow can vary significantly from year to year and is affected by the mix, terms, timing and stage of completion of our projects. We often receive cash in the early phases of our larger fixed-price projects, technology projects, and those of our consolidated joint ventures in advance of incurring related costs. On reimbursable contracts, we may utilize cash on hand or availability under our Senior Credit Facility to satisfy any periodic operating cash requirements for working capital, as we incur costs and subsequently invoice our customers.
ES services projects generally require us to provide credit support for our performance obligations to our customers in the form of letters of credit, surety bonds or guarantees. Our ability to obtain new project awards in the future may be dependent on our ability to maintain or increase our letter of credit and surety bonding capacity, which may be further
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dependent on the timely release of existing letters of credit and surety bonds. As the need for credit support arises, letters of credit will be issued under our $1 billion Revolver under our Senior Credit Facility. Letters of credit may also be arranged with our banks on a bilateral, syndicated or other basis.
As discussed in Note 12 "Debt and Other Credit Facilities" of our consolidated financial statements, we amended our Senior Credit Facility on February 7, 2020, reducing the applicable margins and commitment fees associated with the various borrowings under the facility. Additionally, the amendment extended maturity dates with respect to the Revolver, PLOC and Term Loan A to February 2025 and Term Loan B to February 2027. On July 2, 2020, we amended our Senior Credit Facility to convert the $500 million capacity formerly available under our PLOC to our Revolver, thereby increasing our Revolver capacity from $500 million to $1 billion. The aggregate capacity of our Senior Credit Facility remained $1.795 billion and all other terms and conditions remain unchanged. On September 14, 2020, we further amended our Senior Credit Facility to modify the definition and calculation of Consolidated EBITDA (as defined therein) to provide for more flexibility in permitting pro forma cost reductions resulting from certain corporate transactions. We believe that existing cash balances, internally generated cash flows, availability under our Senior Credit Facility and other lines of credit are sufficient to support our business operations for the next 12 months. As of December 31, 2020, we were in compliance with all financial covenants related to our debt agreements.
Cash and equivalents totaled $436 million at December 31, 2020 and $712 million at December 31, 2019 and consisted of the following:
December 31,
Domestic U.S. cash $ 54 $ 207
Joint venture and Aspire Defence project cash 151 260
Our cash balances are held in numerous accounts throughout the world to fund our global activities. Domestic cash relates to cash balances held by U.S. entities and is largely used to support project activities of those businesses as well as general corporate needs such as the payment of dividends to shareholders, repayment of debt and potential repurchases of our outstanding common stock.
Our international cash balances may be available for general corporate purposes but are subject to local restrictions, such as capital adequacy requirements and maintaining sufficient cash balances to support our U.K. pension plan and other obligations incurred in the normal course of business by those foreign entities. Repatriations of our undistributed foreign earnings are generally free of U.S. tax but may incur withholding and/or state taxes. We consider our future U.S. and non-U.S. cash needs as 1) our anticipated foreign working capital requirements, including funding of our U.K. pension plan, 2) the expected growth opportunities across all geographical markets and 3) our plans to invest in strategic growth opportunities, which may include acquisitions around the world, including whether foreign earnings are permanently reinvested. For December 31, 2019, we changed our permanent reinvestment assertion on our undistributed earnings on a wholly owned subsidiary in Saudi Arabia. We determined that $70 million of undistributed earnings was available for future repatriation of cash for deployment in the U.S. and recorded the income tax expense expected with the future repatriation. During 2020, we repatriated the $70 million. If management were to completely remove the indefinite investment assertion on all foreign subsidiaries, the exposure to local withholding taxes would be less than $21 million.
Joint venture cash and Aspire Defence project cash balances reflect the amounts held by joint venture entities that we consolidate for financial reporting purposes. These amounts are limited to those entities' activities and are not readily available for general corporate purposes; however, portions of such amounts may become available to us in the future should there be a distribution of dividends to the joint venture partners. We expect that the majority of the joint venture cash balances will be utilized for the corresponding joint venture purposes or for paying dividends.
As of December 31, 2020, substantially all of our excess cash was held in commercial bank time deposits or interest bearing short-term investment accounts with the primary objectives of preserving capital and maintaining liquidity.
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Cash Flows
The following table summarizes our cash flows for the periods indicated:
Years ended December 31,
Cash flows provided by operating activities $ 367 $ 256 $ 165
Cash flows used in investing activities (877) (158) (491)
Cash flows provided by (used in) financing activities 225 (133) 654
Effect of exchange rate changes on cash 9 8 (28)
(Decrease) increase in cash and equivalents $ (276) $ (27) $ 300
Operating Activities. Cash flows from operating activities result primarily from earnings and are affected by changes in operating assets and liabilities which consist primarily of working capital balances for projects. Working capital levels vary from year to year and are primarily affected by the Company's volume of work. These levels are also impacted by the mix, stage of completion and commercial terms of projects. Working capital requirements also vary by project depending on the type of client and location throughout the world.
The primary components of our working capital accounts are accounts receivable, contract assets, accounts payable and contract liabilities. These components are impacted by the size and changes in the mix of our cost reimbursable versus fixed price projects, and as a result, fluctuations in these components are not uncommon in our business.
Cash provided by operations totaled $367 million in 2020 as compared to net loss in 2020 of $51 million. The difference is principally the result of non-cash restructuring charges, asset impairments, depreciation and amortization, growth in our business and transition associated with our recent acquisitions, in addition to net changes in working capital balances for projects impacting operating cash flows as discussed below:
•Accounts receivable favorable cash flow impact of $127 million primarily from factoring of receivables and increased collections on certain projects within our ES business segment and TS business segment.
•Contract assets favorable cash flow impact of $39 million was largely attributable to increased billings on U.S. government projects in our GS business segment and various projects in our ES business segment.
•Accounts payable unfavorable cash flow impact of $40 million was largely attributable to timing of payments on certain U.S. government contracts and several projects in our TS business segment.
•Contract liabilities unfavorable cash flow impact of $134 million was primarily due to progress against project advances on the Aspire Defence project and U.S. government projects in our GS business segment.
•Accrued salaries, wages and benefits favorable cash flow impact of $38 million was primarily due to the deferral of payroll tax amounts under the CARES Act.
•We received distributions of earnings from our unconsolidated affiliates of $38 million and contributed $46 million to our pension funds in 2020.
Cash provided by operations totaled $256 million in 2019 as compared to net income in 2020 of $209 million. The difference primarily results from net changes in working capital balances for projects as discussed below:
•The $16 million unfavorable cash flow impact related to accounts receivable was primarily related to increased billing volume due to the ramp up of recently awarded cost-reimbursable projects in the Middle East and several new EPC projects in the U.S. within our ES business segment offset by strong collections on several projects in our GS business segment.
•The $31 million unfavorable cash flow impact related to contract assets was largely attributable to higher activity on EPC projects in our ES business segment as well as increased volume in our TS business segment.
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•The $23 million favorable cash flow impact related to increased accounts payable on several projects in the U.S. and Middle East in our ES business segment as well as various projects in our TS business segment, offset by decreased volume as a U.S. project winds down in our GS business segment.
•The $19 million favorable cash flow impact related to contract liabilities was primarily due to advances related to growth and ramp up of new EPC and services primarily in the U.S. in our ES business segment, offset by progress on several projects in our TS business segment.
•We received distributions of earnings from our unconsolidated affiliates of $69 million and contributed $45 million to our pension funds in 2019. In addition, we collected $57 million from the U.S. Army in the private security matter contractor settlement, of which $44 million which was previously recorded in "Claims receivable" on our consolidated balance sheets.
Investing activities. Cash used in investing activities totaled $877 million in 2020 and was primarily attributable to the acquisition of Centauri, net of cash acquired of $823 million, the acquisition of SMA, and funding our proportionate share of JKC's ongoing legal and commercial costs. See Note 4 for further discussion on the acquisitions and Note 6 for further discussion of the legal and commercial costs.
Cash used in investing activities totaled $158 million in 2019 and was primarily due to investment in JKC. See Note 6 to our consolidated financial statements for discussion of the Ichthys Project and our investment contributions to JKC.
Financing activities. Cash provided by financing activities totaled $225 million in 2020 and was primarily due to approximately $245 million of net proceeds from the offering of our 4.750% Senior Notes due 2028 and borrowings of $260 million on our Senior Credit Facility, offset by $410 million in net payments on borrowings which includes voluntary principal payments related to the refinancing of our Senior Credit Facility, $11 million repayment on our non-recourse debt associated with our Fasttrax joint venture, $11 million repayment on our finance lease obligations, $54 million of dividend payments to common shareholders, and $47 million for the repurchase of common stock under our share repurchase program. See Note 12 "Debt and Other Credit Facilities" for further discussion of our Senior Credit Facility and Note 19 "Share Repurchases" for further discussion on our share repurchase program.
Cash used in financing activities totaled $133 million in 2019 and was primarily due to $70 million in payments on borrowings under our Senior Credit Facility and $46 million for dividend payments to common shareholders.
Future sources of cash. We believe that future sources of cash include cash flows from operations (including accounts receivable monetization arrangements), cash derived from working capital management, and cash borrowings under the Senior Credit Facility.
Future uses of cash. We believe that future uses of cash include working capital requirements, joint venture capital calls, capital expenditures, dividends, pension funding obligations, repayments of borrowings, share repurchases and strategic investments including acquisitions. Our capital expenditures will be focused primarily on facilities and equipment to support our businesses. In addition, we will use cash to make payments under leases and various other obligations, including potential litigation payments, as they arise.
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Other factors potentially affecting liquidity
Ichthys LNG Project. In reference to Note 6 "Unapproved Change Orders, and Claims, Against Clients and Estimated Recoveries of Claims Against Suppliers and Subcontractors” to our consolidated financial statements, JKC has included in its project estimates-at-completion significant revenues associated with unapproved change orders and claims against the client as well as estimated recoveries of claims against suppliers and subcontractors. The client has reserved their contractual rights on certain amounts previously funded to JKC and may seek recoveries of those amounts, including calling the performance and warranty letters of credit. In January 2021, the client demanded that JKC repay the Funding Deed amount and notified JKC of its intention to commence legal actions against JKC including claims on the parent company guarantees.JKC is opposing the client’s payment demand and believes that the client has not complied with the contract requirements to make these sums repayable. JKC believes the subcontractor settlement sums were properly incurred and represent reimbursable cost.
JKC incurred substantial costs to complete the power plant under the fixed-price portion of the Ichthys LNG contract. JKC believes these costs are recoverable from the Consortium who abandoned their contractual obligation to complete the power plant as the original subcontractor. We have initiated arbitrations and other legal proceedings to recover these costs which may take several years to resolve. As a result, we funded our proportionate share of JKC's capital requirements to complete the power plant as these legal proceedings progress.
We have made investment contributions to JKC of approximately $484 million through December 31, 2020 to fund our proportionate share of the project execution activities on an inception-to-date basis. We continue to fund our proportionate share of ongoing legal and commercial costs. JKC's obligations to the client are guaranteed on a joint and several basis by the joint venture partners. Negotiations and legal proceedings with the client and the subcontractors are ongoing, the goal of which is to minimize these expected outflows. If we experience unfavorable outcomes associated with the various legal and commercial disputes, our total investment contributions could increase which could have a material adverse effect on our financial position and cash flows.
As of December 31, 2020, we had $164 million in letters of credit outstanding in support of performance and warranty guarantees provided to the client.
U.K. pension obligation. We have recognized on our consolidated balance sheet a funding deficit of $381 million (measured as the difference between the fair value of plan assets and the projected benefit obligation as of December 31, 2020) for our frozen defined benefit pension plans. The total amounts of employer pension contributions paid for the year ended December 31, 2020 were $46 million and primarily related to our defined benefit plan in the U.K. The funding requirements for our U.K. pension plan are determined based on the U.K. Pensions Act 1995. Annual minimum funding requirements are based on a binding agreement with the trustees of the U.K. pension plan that is negotiated on a triennial basis which is slated to commence in 2021 and is required to be completed by April 2022. The current agreement calls for minimum annual contributions of £33 million ($45 million at current exchange rates) until the next minimum funding requirements are finalized. In the future, pension funding may increase or decrease depending on changes in the levels of interest rates, pension plan asset return performance and other factors. A significant increase in our funding requirements for the U.K. pension plan could result in a material adverse impact on our financial position.
Senior Credit Facility
Information relating to our Senior Credit Facility is described in Note 12 "Debt and Other Credit Facilities" to our consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K and the information discussed therein is incorporated by reference into this Part II, Item 7.
Senior Notes
Information relating to our Senior Notes is described in Note 12 "Debt and Other Credit Facilities" to our consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K and the information discussed therein is incorporated by reference into this Part II, Item 7.
Convertible Senior Notes
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Information relating to our Convertible Senior Notes is described in Note 12 "Debt and Other Credit Facilities" to our consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K and the information discussed therein is incorporated by reference into this Part II, Item 7.
Nonrecourse Project Finance Debt
Information relating to our nonrecourse project debt is described in Note 12 "Debt and Other Credit Facilities" to our consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K and the information discussed therein is incorporated by reference into this Part II, Item 7.
Off-Balance Sheet Arrangements
Letters of credit, surety bonds and guarantees. In the ordinary course of business, we may enter into various arrangements providing financial or performance assurance to customers on behalf of certain consolidated and unconsolidated subsidiaries, joint ventures and other jointly executed contracts. Such off-balance sheet arrangements include letters of credit, surety bonds and corporate guarantees to support the creditworthiness or project execution commitments of these entities and typically have various expiration dates ranging from mechanical completion of the project being constructed to a period beyond completion in certain circumstances such as for warranties. We may also guarantee that a project, once completed, will achieve specified performance standards. If the project subsequently fails to meet guaranteed performance standards, we may incur additional costs, pay liquidated damages or be held responsible for the costs incurred by the client to achieve the required performance standards. The potential amount of future payments that we could be required to make under an outstanding performance arrangement is typically the remaining estimated cost of work to be performed by or on behalf of third parties. For cost reimbursable contracts, amounts that may become payable pursuant to guarantee provisions are normally recoverable from the client for work performed under the contract. For lump-sum or fixed-price contracts, the performance guarantee amount is the cost to complete the contracted work, less amounts remaining to be billed to the client under the contract. Remaining billable amounts could be greater or less than the cost to complete the project. If costs exceed the remaining amounts payable under the contract, we may have recourse to third parties, such as owners, subcontractors or vendors for claims.
In our joint venture arrangements, the liability of each partner is usually joint and several. This means that each joint venture partner may become liable for the entire risk of performance guarantees provided by each partner to the customer. Typically each joint venture partner indemnifies the other partners for any liabilities incurred in excess of the liabilities the other party is obligated to bear under the respective joint venture agreement. We are unable to estimate the maximum potential amount of future payments that we could be required to make under outstanding performance guarantees related to joint venture projects due to a number of factors, including but not limited to, the nature and extent of any contractual defaults by our joint venture partners, resource availability, potential performance delays caused by the defaults, the location of the projects, and the terms of the related contracts. See “Item 1A. Risk Factors” contained in Part I of this Annual Report on Form 10-K for information regarding our fixed-price contracts and operations through joint ventures and partnerships.
In certain limited circumstances, we enter into financial guarantees in the ordinary course of business, with financial institutions and other credit grantors, which generally obligate us to make payment in the event of a default by the borrower. These arrangements generally require the borrower to pledge collateral to support the fulfillment of the borrower’s obligation. We account for both financial and performance guarantees at fair value at issuance in accordance with ASC 460-10 Guarantees and, as of December 31, 2020, we had no material guarantees of the work or obligations of third parties recorded.
We have committed and uncommitted lines of credit available to be used for letters of credit. As of December 31, 2020, our total capacity under these committed and uncommitted lines of credit was approximately $1.4 billion of which $316 million had been utilized. Information relating to our letters of credit is described in Note 12 "Debt and Other Credit Facilities" to our consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K and the information discussed therein is incorporated by reference into this Part II, Item 7. Other than as discussed in this report, we have not engaged in any material off-balance sheet financing arrangements through special purpose entities.
On October 1, 2020, the Company borrowed $260 million on the Senior Credit Facility to fund the acquisition of Centauri, as further discussed in Note 4 “Acquisitions” and Note 12 "Debt and Other Credit Facilities" to our consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K.
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Contractual obligations and commitments
Significant contractual obligations and commercial commitments as of December 31, 2020 are as follows:
Payments Due
Nonrecourse project finance debt 5 1 1 — — — 7
(a)Determined based on long-term debt borrowings outstanding at the end of 2020 using the interest rates in effect for the individual borrowings as of December 31, 2020, including the effects of interest rate swaps. The payments due for interest reflect the cash interest that will be paid, which includes interest on outstanding borrowings and commitment fees. These amounts exclude the amortization of discounts or debt issuance costs.
(b)Included in our pension funding obligations are payments related to our agreement with the trustees of our U.K. pension plan. The agreement for this plan calls for minimum annual contributions of £33 million ($45 million at current exchange rates) from 2021 through the next valuation.
(c)In the ordinary course of business, we enter into commitments to purchase software and related maintenance, materials, supplies and similar items. The purchase obligations disclosed above do not include purchase obligations that we enter into with vendors in the normal course of business that support direct project costs on existing contracting arrangements with our customers. We expect to recover such obligations from our customers.
(d)We have excluded uncertain tax positions totaling $96 million as of December 31, 2020. The ultimate timing of settlement of these obligations cannot be determined with reasonable assurance. See Note 13 to our consolidated financial statements for further discussion on income taxes. Additionally, we have excluded our proportionate share of obligations totaling $157 million as of December 31, 2020 related to the Funding Deeds on the Ichthys LNG Project. See Note 6 to our consolidated financial statements for further discussion.
Transactions with Joint Ventures
In the normal course of business, we form incorporated and unincorporated joint ventures to execute projects. In addition to participating as a joint venture partner, we often provide engineering, procurement, construction, operations or maintenance services to the joint venture as a subcontractor. Where we provide services to a joint venture that we control and therefore consolidate for financial reporting purposes, we eliminate intercompany revenues and expenses on such transactions. In situations where we account for our interest in the joint venture under the equity method of accounting, we do not eliminate any portion of our subcontractor revenues or expenses, however, we recognize profit on our subcontractor scope of work only to the extent the joint venture's scope of work to the end customer is complete. We recognize profit over time on our services provided to joint ventures that we consolidate and joint ventures that we record under the equity method of accounting. See Note 10 to our consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K for more information. The information discussed therein is incorporated by reference into this Part II, Item 7.
Recent Accounting Pronouncements
Information relating to recent accounting pronouncements is described in Note 23 to our consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K and the information discussed therein is incorporated by reference into this Part II, Item 7.
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U.S. Government Matters
Information relating to U.S. government matters commitments and contingencies is described in Note 15 to our consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K and the information discussed therein is incorporated by reference into this Part II, Item 7.
Legal Proceedings
Information relating to various commitments and contingencies is described in Notes 15 and 16 to our consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K and the information discussed therein is incorporated by reference into this Part II, Item 7.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements which have been prepared in conformity with U.S. GAAP. The preparation of our consolidated financial statements requires us to make estimates and judgments that affect the determination of financial positions, results of operations, cash flows and related disclosures. Our significant accounting policies are described in Note 1 to our consolidated financial statements. The following discussion is intended to highlight and describe those accounting policies that are especially critical to the preparation of our consolidated financial statements and to provide a better understanding of our significant accounting estimates and assumptions about future events that affect the amounts reported in our consolidated financial statements. Significant accounting estimates are important to the representation of our financial position and results of operations and involve our most difficult, subjective or complex judgments. We base our estimates on historical experience and various other assumptions we believe to be reasonable according to the current facts and circumstances through the date of the issuance of our financial statements.
Contract Revenue. We adopted ASC Topic 606 Revenue from Contracts with Customers on January 1, 2018, for our consolidated entities and for each of the unconsolidated Aspire Defence contracting entities and on January 1, 2019 for our remaining unconsolidated affiliates including the subsequent ASUs that amended and clarified the related guidance. Our policy on revenue recognition is provided in Note 1 to our consolidated financial statements for the year ended December 31, 2020. We recognize revenue on substantially all of our contracts over time, as performance obligations are satisfied, due to the continuous transfer of control to the customer. Our contracts are generally accounted for as a single performance obligation and are not segmented between types of services provided. We recognize revenue on those contracts over time using the cost-to-cost method, based primarily on contract costs incurred to date compared to total estimated contract costs at completion. Contract costs include all direct materials, labor and subcontractors costs and indirect costs related to contract performance. We believe this method is the most accurate measure of contract performance because it directly measures the value of the goods and services transferred to the customer. For all other contracts where we have the right to consideration from the customer in an amount that corresponds directly with the value received by the customer based on our performance to date, we recognized revenue when services are performed and contractually billable.
The cost-to-cost method of revenue recognition requires us to prepare estimates of cost to complete for contracts in progress. Due to the nature of the work performed on many of our performance obligations, the estimates of total revenue and cost at completion is complex, subject to many variables and require significant judgment. In making such estimates, judgments are required to evaluate contingencies such as weather, potential variances in schedule and the cost of materials, labor cost and productivity, the impact of change orders, liability claims, contract disputes and achievement of contractual performance standards. As a significant change in one or more of these estimates could affect the profitability of our contracts, we routinely review and update our significant contract estimates through a disciplined project review process in which management reviews the progress and execution of our performance obligations and estimates at completion. We have a long history of working with multiple types of projects and in preparing cost estimates. However, there are many factors that impact future cost as outlined in “Item 1A. Risk Factors” contained in Part I of this Annual Report on Form 10-K. These factors can affect the accuracy of our estimates and materially impact our future reported earnings. Changes in total estimated contract costs and losses, if any, are recognized on a cumulative catch-up basis in the period in which the changes are identified at the contract level. Such changes in contract estimates can result in the recognition of revenue in a current period for performance obligations which were satisfied or partially satisfied in a prior period. Changes in contract estimates may also result in the reversal of previously recognized revenue if the current estimate differs from the previous estimate.
It is common for our contracts to contain variable consideration in the form of incentive fees, performance bonuses, award fees, liquidated damages or penalties that may increase or decrease the transaction price. Other contract provisions also give rise to variable consideration such as unapproved change orders and claims, and on certain contracts, index-based price
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adjustments. We estimate the amount of variable consideration at the most likely amount we expect to be entitled and is included in the transaction price when it is probable that a significant reversal of cumulative revenue recognized will not occur. Our estimates of variable consideration and determination of whether to include such amounts in the transaction price are based largely on our assessment of legal enforceability, anticipated performance, and any other information (historical, current or forecasted) that is reasonably available to us. Variable consideration associated with claims and unapproved change orders is included in the transaction price only to the extent of costs incurred. We recognize claims against suppliers and subcontractors as a reduction in recognized costs when enforceability is established by the contract and the amounts are reasonably estimable and probable of recovery. Reductions in costs are recognized to the extent of the lesser of the amounts management expects to recover or actual costs incurred. As of December 31, 2020 and 2019, we had recorded $1.0 billion and $978 million, respectively, of claim revenue and subcontractor recoveries for costs incurred to date and such costs are included in our estimates at completion. See Note 6 to our consolidated financial statements for our discussion on unapproved change orders and claims.
Purchase Price Allocation. We allocate the purchase price of an acquired business to the identifiable assets and liabilities of the acquiree based on estimated fair values. The excess of the purchase price over the amount allocated to the identifiable assets and liabilities, if any, is recorded as goodwill. Fair value estimates are based on the assumptions management believes a market participant would use in pricing the asset and are developed using widely accepted valuation techniques such as discounted cash flows. When determining the fair value of the assets and liabilities of an acquired business, we make judgments and estimates using all available information to us including, but not limited to, quoted market prices, carrying values, expected future cash flows, which includes consideration of future growth rates and margins, attrition rates, future changes in technology and brand awareness, loyalty and position and discount rates. We engage third-party appraisal firms when appropriate to assist in the fair value determination of intangible assets. The purchase price allocation recorded in a business combination may change during the measurement period, which is a period not to exceed one year from the date of acquisition, as additional information about conditions existing at the acquisition date becomes available.
Goodwill Impairment Testing. Goodwill is tested annually for possible impairment, and on an interim basis when indicators of possible impairment exist such as negative financial performance, significant changes in legal factors or business climate and industry trend, among other things. For purposes of impairment testing, goodwill is assigned to the applicable reporting units based on our current reporting structure. We test for goodwill impairment at the reporting unit level as of October 1 of each fiscal year using a two-step process that involves comparing the estimated fair value of each reporting unit to its carrying value, including goodwill. The fair values of reporting units were determined using a combination of two methods, one utilizing market revenue and earnings multiples (the market approach) and the other derived from discounted cash flow models with estimated cash flows based on internal forecasts of revenues and expenses over a specified period plus a terminal value (the income approach).
For the 2020 annual goodwill impairment test under the market approach, we estimated fair value by applying earnings and revenue market multiples ranging from 4.31 to 11.59 times earnings and 0.31 to 2.09 times revenue. Under the income approach, we estimated fair value by discounting each reporting unit’s estimated future cash flows using a weighted-average cost of capital reflecting current market conditions and the risk profile of the reporting unit. To arrive at our future cash flows, we used estimates of economic and market assumptions, including growth rates in revenues, costs, tax rates and future expected changes in operating margins and cash expenditures that are consistent with changes in our business strategy. The risk-adjusted discount rates applied to our future cash flows under the income approach in 2020 ranged from 9.0% to 10.2%. We believe these two approaches are appropriate valuation techniques and we generally weight the two resulting values equally as an estimate of a reporting unit's fair value for the purposes of our impairment testing. However, we may weigh one value more heavily than the other when conditions merit doing so. Other significant estimates and assumptions include terminal value growth rates, future estimates of capital expenditures and changes in future working capital requirements. The fair value derived from the weighting of these two methods provides appropriate valuations that, in the aggregate, reasonably reconcile to our market capitalization, taking into account observable control premiums.
In addition to the earnings and revenue multiples and the discount rates disclosed above, certain other judgments and estimates are used in our goodwill impairment test. If market conditions change compared to those used in our market approach, or if actual future results of operations fall below the projections used in the income approach, our goodwill could become impaired in the future.
The fair value for a reporting unit in our ES business segment with goodwill of $119 million, exceeded its carrying value by 29% based on projected growth rates and other market inputs that are more sensitive to the risk of future variances due to adverse market conditions and reporting unit project execution. The fair value of this reporting unit and the related underlying assumptions are sensitive to the risk of future variances due to competitive market conditions and reporting unit project execution. It is possible that changes in market conditions, revenue growth rates and profitability, and other assumptions used
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in estimating the fair value of this reporting unit could change, resulting in possible impairment of goodwill in the future. We determined that the fair value of our remaining reporting units substantially exceeded their respective carrying values.
Deferred Taxes, Valuation Allowances, and Tax Contingencies. As discussed in Note 13 to our consolidated financial statements, deferred tax assets and liabilities are recognized for the expected future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. We record a valuation allowance to reduce certain deferred tax assets to amounts that are more-likely-than-not to be realized. We evaluate the realizability of our deferred tax assets by assessing the valuation allowance and by adjusting the amount of such allowance, if necessary. The factors used to assess the likelihood of realization include our forecast of the timing and character of future taxable income exclusive of reversing temporary differences and carryforwards, future reversals of existing taxable temporary differences and available tax planning strategies that could be implemented to realize the net deferred tax assets.
We consider both positive and negative evidence when evaluating the need for a valuation allowance on our deferred tax assets in accordance with ASC 740. Available evidence includes historical financial information supplemented by currently available information about future years. Generally, historical financial information is more objectively verifiable than projections of future income and is therefore given more weight in our assessment. We consider cumulative losses in the most recent twelve quarters to be significant negative evidence that is difficult to overcome in considering whether a valuation allowance is required. Conversely, we consider a cumulative income position over the most recent twelve quarters, to be significant positive evidence that a valuation allowance may not be required. Changes in the amount, timing and character of our forecasted taxable income could have a significant impact of our ability to utilize deferred tax assets and related valuation allowance.
Our ability to utilize the unreserved foreign tax credit carryforwards is based on our ability to generate income from foreign sources of approximately $762 million prior to their expiration whereas our ability to utilize other net deferred tax assets exclusive of those associated with indefinite-lived intangible assets is based on our ability to generate U.S. forecasted taxable income of approximately $605 million. Changes in our forecasted taxable income, in the appropriate character and source as well as jurisdiction, could affect the ultimate realization of deferred tax assets.
Income tax positions must meet a more-likely-than-not recognition threshold to be recognized. Income tax positions that previously failed to meet the more-likely-than-not threshold are recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not threshold are derecognized in the first subsequent financial reporting period in which that threshold is no longer met. We recognize potential interest and penalties related to unrecognized tax benefits in income tax expense.
Legal, Investigation and Other Contingent Matters. We record liabilities for loss contingencies when it is probable that a liability has been incurred and the amount is reasonably estimable. We provide disclosure when there is a reasonable possibility that the ultimate loss will exceed our recorded liability by a material amount or if the loss is not reasonably estimable but is expected to be material to our financial statements. Generally, our estimates related to these matters are developed in consultation with internal and external legal counsel. Our estimates are based upon an analysis of potential results, assuming a combination of litigation and settlement strategies. The precision of these estimates and the likelihood of future changes depend on a number of underlying assumptions and a range of possible outcomes. When possible, we attempt to resolve these matters through settlements, mediation and arbitration proceedings. If the actual settlement costs, final judgments or fines differ from our estimates, our future financial results may be materially and adversely affected. We record adjustments to our initial estimates of these types of contingencies in the periods when the change in estimate is identified. All legal expenses associated with these matters are expensed as incurred. See Notes 15 and 16 to our consolidated financial statements for further discussion of our significant legal, investigation and other contingent matters.
Pensions. Our pension benefit obligations and expenses are calculated using actuarial models and methods. Two of the more critical assumptions and estimates used in the actuarial calculations are the discount rate for determining the current value of benefit obligations and the expected rate of return on plan assets. Other assumptions and estimates used in determining benefit obligations and plan expenses include inflation rates and demographic factors such as retirement age, mortality and turnover. These assumptions and estimates are evaluated periodically and are updated accordingly to reflect our actual experience and expectations.
The discount rate used to determine the benefit obligations was computed using a yield curve approach that matches plan specific cash flows to a spot rate yield curve based on high quality corporate bonds. The expected long-term rate of return on assets was determined by a stochastic projection that takes into account asset allocation strategies, historical long-term
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performance of individual asset classes, an analysis of additional return (net of fees) generated by active management, risks using standard deviations and correlations of returns among the asset classes that comprise the plans' asset mix. Plan assets are comprised primarily of equity securities, fixed income funds and securities, hedge funds, real estate and other funds. As we have both domestic and international plans, these assumptions differ based on varying factors specific to each particular country or economic environment.
The discount rate utilized to calculate the projected benefit obligation at the measurement date for our U.S. pension plan decreased to 2.00% at December 31, 2020 from 2.89% at December 31, 2019. The discount rate utilized to determine the projected benefit obligation at the measurement date for our U.K. pension plan, which constitutes 97% of all plans, decreased to 1.40% at December 31, 2020 from 2.05% at December 31, 2019. Our expected long-term rates of return on plan assets utilized at the measurement date decreased to 5.72% from 6.09% for our U.S. pension plans and decreased to 3.70% from 5.09% for our U.K. pension plans, for the years ended December 31, 2020 and 2019, respectively.
The following table illustrates the sensitivity to changes in certain assumptions, holding all other assumptions constant, for our pension plans:
Effect on
Pretax Pension Cost in 2021 Pension Benefit Obligation at December 31, 2020
Dollars in millions U.S. U.K. U.S. U.K.
25-basis-point decrease in discount rate $ — $ (1) $ 2 $ 108
25-basis-point increase in discount rate $ — $ — $ (2) $ (102)
25-basis-point decrease in expected long-term rate of return $ — $ 4 N/A N/A
25-basis-point increase in expected long-term rate of return $ — $ (4) N/A N/A
Unrecognized actuarial gains and losses are generally recognized using the corridor method over a period of approximately 25 years, which represents a reasonable systematic method for amortizing gains and losses for the employee group. Our unrecognized actuarial gains and losses arise from several factors, including experience and assumption changes in the obligations and the difference between expected returns and actual returns on plan assets. The difference between actual and expected returns is deferred as an unrecognized actuarial gain or loss on our consolidated statement of comprehensive income (loss) and is recognized as a decrease or an increase in future pension expense. Our pretax unrecognized net actuarial loss in accumulated other comprehensive loss at December 31, 2020 was $1.0 billion, of which $33 million is expected to be recognized as a component of our expected 2021 pension expense compared to $25 million in 2020.
The actuarial assumptions used in determining our pension benefits may differ materially from actual results due to changing market and economic conditions, changes in the legislative or regulatory environment, higher or lower withdrawal rates and longer or shorter life spans of participants. While we believe that the assumptions used are appropriate, differences in actual experience, expectations, or changes in assumptions may materially affect our financial position or results of operations. Our actuarial estimates of pension expense and expected return on plan assets are discussed in Note 11 in the accompanying consolidated financial statements.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Financial Market Risks. Cash and equivalents are deposited with major banks globally. We invest excess cash and equivalents in short-term securities, primarily time deposits and money market funds, which carry a fixed rate of return. We have not incurred any credit risk losses related to deposits of our cash and equivalents.
Foreign Currency Risk. Because of the global nature of our business, we are exposed to market risk associated with changes in foreign currency exchange rates. We attempt to limit exposure to foreign currency fluctuations through contractual provisions requiring the client to pay us in currencies corresponding to the currency in which cost is incurred. In addition to this natural hedge, we may use derivative instruments such as foreign exchange forward contracts and options to hedge material exposures when forecasted foreign currency revenues and costs are not denominated in the same currency and when efficient markets exist. These derivatives are generally designated as cash flow hedges and are carried at fair value. We do not enter into derivative financial instruments for trading purposes or make speculative investments in foreign currencies. We recorded a net gain of $4 million for the years ended December 31, 2020 and 2019, and a net loss of $9 million for the year ended December 31, 2018 in "Other non-operating income (loss)" on our consolidated statements of operations. The net gain of $4 million during the year ended December 31, 2020 consisted primarily of favorable foreign currency movements on certain
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intercompany balance positions denominated in British Pounds resulting in foreign currency gains of approximately $7 million, net of $3 million related to changes in the fair value of balance sheet hedges.
We use derivative instruments to hedge foreign currency risk related to monetary assets and liabilities denominated in non-functional currencies on our consolidated balance sheets. Each period, these balance sheet hedges are marked to market through earnings and the change in their fair value is largely offset by remeasurement of the underlying assets and liabilities. The fair value of these derivatives was not material to our consolidated balance sheet for the periods presented. For more information see Note 22 to our consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K and the information discussed therein is incorporated by reference into this Part II, Item 7A.
Interest Rate Risk. We are exposed to market risk for changes in interest rates for the Revolver and term loan borrowings under our Senior Credit Facility. We had $260 million borrowings outstanding under the Revolver to partially fund the acquisition of Centauri and $801 million outstanding under the term loan portions of our Senior Credit Facility as of December 31, 2020. Borrowings under the Senior Credit Facility bear interest at variable rates as described in Note 12 to our consolidated financial statements.
We manage interest rate exposure by entering into interest rate swap agreements pursuant to which we agree to exchange, at specified intervals, the difference between fixed and variable interest amounts calculated on an agreed-upon notional principal amount. In October 2018, we entered into interest rate swap agreements covering $500 million of notional value of our outstanding term loans. Under these swap agreements, we receive one month LIBOR and pay an average monthly fixed rate of 3.055% for the term of the swaps which expire in September 2022. In March 2020, we entered into additional swap agreements covering notional value of $400 million of our outstanding loans which are effective beginning October 2022. Under these swap agreements, we will receive a one-month LIBOR and pay an average monthly fixed rate of 0.965% for the term of the swaps that expire in January 2027. The swap agreements were designated as a cash flow hedge at inception in accordance with ASC Topic 815 Accounting for Derivative and Hedging Transactions. The total fair value of these derivative instruments was a liability of approximately $33 million as of December 31, 2020.
At December 31, 2020, we had fixed rate debt aggregating $1.1 billion and variable rate debt aggregating $561 million, after taking into account the effects of the interest rate swaps. Our weighted average interest rate for the year ended December 31, 2020 was 4.00%. If interest rates were to increase by 50 basis points, pre-tax interest expense would increase by approximately $3 million in the next twelve months net of the impact from our swap agreements, based on outstanding borrowings as of December 31, 2020.
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Item 8. Financial Statements and Supplementary Data
Page No.
Report of Independent Registered Public Accounting Firm 61
Notes to Consolidated Financial Statements 71
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Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors KBR, Inc.:
Opinion on the ConsolidatedFinancial Statements
We have audited the accompanying consolidated balance sheets of KBR, Inc. and subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive income (loss), shareholders’ equity, and cash flows for each of the years in the three‐year period ended December 31, 2020, and the related notes and financial statement schedule II (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three‐year period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 25, 2021 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Variable consideration and estimated costs at completion
As discussed in Notes 1 and 6 to the consolidated financial statements, the Company recognizes a portion of its revenues over time using a cost based input measure of progress. The Company estimates variable consideration of these contracts and includes such amounts in the transaction price when it is probable that a significant reversal of cumulative revenue recognized will not occur. The Company measures progress toward completion using the cost-to-cost method, which measures progress as the ratio of (1) actual contract costs incurred to date to (2) the Company’s estimated costs at completion (EAC). In estimating the transaction price, judgments are required to determine the amounts expected to be recovered from claims against customers. In estimating the measure of progress, judgments are required to determine the estimated amount of costs to complete contracts in progress, including costs for labor and subcontractor commitments, as well as probable recoveries from claims against suppliers and subcontractors.
We identified the evaluation of variable consideration and EACs for revenues recognized using a cost-based input measure of progress as a critical audit matter. Evaluating the estimated amounts expected to be recovered from claims against customers required auditor judgment because the amounts are in dispute and the ultimate resolution of claims
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is uncertain. Evaluating the EAC for contracts in progress involves auditor judgment given the variability and uncertainty associated with (1) estimating costs, including labor and subcontractor commitments, to be incurred over a long-term contract period and (2) amounts expected to be recovered from the resolution of disputes related to claims against suppliers and subcontractors.
The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the Company’s process for estimating variable consideration and estimated costs at completion. This included controls over revenues recognized using a cost-based input measure of progress that related to (1) costs to complete for contracts in progress, including costs for labor and subcontractor commitments, as well as probable recoveries from claims against suppliers and subcontractors and (2) amounts expected to be recovered from claims against certain customers. We evaluated the Company’s ability to estimate these amounts by comparing the Company’s previous estimates to actual results. We assessed the Company’s determination of entitlement to and probability of recovery of certain claims against customers, suppliers, and subcontractors by inspecting correspondence obtained from the Company’s external legal counsel. We involved professionals with specialized skills and knowledge who assisted in evaluating the Company’s estimated probable recovery for certain claims against customers, suppliers, and subcontractors by comparing the Company’s estimate against our independently developed range of probable recoveries. We evaluated the EAC for certain contracts by (1) obtaining and inspecting contractual documents with customers and subcontractors, (2) interviewing project personnel to gain an understanding of the status of project activities, and (3) obtaining and analyzing underlying documentation for a selection of costs in the EAC, including labor costs and subcontractor commitments.
Valuation of goodwill within a reporting unit in the Energy Solutions business segment
As discussed in Notes 1 and 9 to the consolidated financial statements, the Company’s goodwill balance at December 31, 2020 was $1,761 million, which included goodwill related to certain reporting units within the Energy Solutions business segment. The Company performs goodwill impairment testing on an annual basis and whenever indicators of potential impairment exist. The estimated fair values of reporting units are determined based on internal forecasts of revenues and gross profit margins for each reporting unit over a specified period. During 2020, the Company performed goodwill impairment tests as a result of a reorganization, significant adverse economic and market conditions, and a decision to discontinue pursuing certain projects within the Energy Solutions business segment. As a result, impairment losses were recognized in the Energy Solutions business segment in the first and second quarter in the amount of $62 million and $37 million, respectively.
We identified the valuation of goodwill within a reporting unit in the Energy Solutions business segment as a critical audit matter. A high degree of auditor judgment was required to evaluate forecasted revenue and gross profit margins as the reporting unit fair values are sensitive to changes in these assumptions.
The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the Company’s goodwill impairment testing process. This included controls related to the development of forecasted revenue and gross profit margins. In addition, we compared the forecasted revenue growth and gross profit margins to historic results, considering forecasted business initiatives. We performed sensitivity analyses over forecasted revenue and gross profit margins to assess their impact on the Company’s determination of the fair value of the reporting units. To assess the Company’s ability to estimate reporting unit revenues and gross profit margins, we compared the Company’s historical forecasts to actual results. We tested the reconciliation of the fair value of the Company’s reporting units to the market capitalization of the Company.
Fair value of acquired customer relationships
As discussed in Note 4 to the consolidated financial statements, on October 1, 2020 the Company acquired Centauri Platform Holdings, LLC (Centauri) and accounted for the transaction as a business combination. As a result of the transaction, the Company recorded $198 million for customer relationships intangible assets. The estimated fair value of this identifiable intangible asset was determined using a discounted cash flow model.
We identified the evaluation of the fair value of acquired customer relationships as a critical audit matter. There was a high degree of subjectivity in evaluating the discounted future cash flows used to determine the fair value of the customer relationships. Specifically, there was a high degree of auditor judgment required to evaluate the forecasted revenue attributable to customer relationships and the weighted-average cost of capital (WACC).
The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls over the Company’s acquisition date valuation
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process. This included controls related to the determination of the fair value of the customer relationships, the forecasted revenue attributable to customer relationships, and the WACC. We evaluated the forecasted revenue attributable to customer relationships by comparing it to the acquired entity’s actual historical results. To assess the Company’s ability to estimate the acquired entity’s revenues, we compared the Company’s historical revenue forecasts to actual results for previous acquisitions. We performed sensitivity analyses over forecasted revenue attributable to customer relationships to assess its impact on the Company’s determination of the fair value of the customer relationships. In addition, we involved valuation professionals with specialized skills and knowledge who assisted in:
–evaluating the WACC by developing an independent range of WACCs using publicly available market data and comparing the result to the Company’s WACC
–reconciling the WACC to the weighted average return on assets and the internal rate of return.
/s/ KPMG LLP
We have served as the Company’s auditor since 2005.
Houston, Texas
February 25, 2021
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KBR, Inc.
Consolidated Statements of Operations
(In millions, except for per share data)
Years ended December 31,
Equity in earnings of unconsolidated affiliates 30 35 79
Selling, general and administrative expenses (335) (341) (294)
Acquisition and integration related costs (9) (2) (7)
Goodwill impairment (99) — —
Restructuring charges and asset impairments (214) — —
Gain (loss) on disposition of assets and investments 18 17 (2)
Gain on consolidation of Aspire subcontracting entities — — 108
Interest expense (83) (99) (66)
Other non-operating income (loss) 1 5 (6)
(Loss) income before income taxes and noncontrolling interests (25) 268 396
Provision for income taxes (26) (59) (86)
Net income attributable to noncontrolling interests (21) (7) (29)
Net (loss) income attributable to KBR $ (72) $ 202 $ 281
Net (loss) income attributable to KBR per share:
Basic weighted average common shares outstanding 142 141 140
Diluted weighted average common shares outstanding 142 142 141
Cash dividends declared per share $ 0.40 $ 0.32 $ 0.32
See accompanying notes to consolidated financial statements.
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KBR, Inc.
Consolidated Statements of Comprehensive Income (Loss)
(In millions)
Years ended December 31,
Other comprehensive income (loss):
Foreign currency translation adjustments 23 (12) (43)
Pension and post-retirement benefits (136) (73) 82
Changes in fair value of derivatives (13) (6) (14)
Other comprehensive (loss) income (126) (91) 25
Income tax (expense) benefit:
Foreign currency translation adjustments 1 1 (2)
Pension and post-retirement benefits 26 11 (14)
Changes in fair value of derivatives 3 2 3
Income tax (expense) benefit 30 14 (13)
Other comprehensive (loss) income, net of tax (96) (77) 12
Comprehensive (loss) income attributable to KBR $ (168) $ 125 $ 293
See accompanying notes to consolidated financial statements.
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KBR, Inc.
Consolidated Balance Sheets
(In millions, except share data)
December 31,
Assets
Current assets:
Cash and equivalents $ 436 $ 712
Accounts receivable, net of allowance for credit losses of $13 and $14 899 938
Claims and accounts receivable 30 59
Operating lease right-of-use assets 154 175
Intangible assets, net of accumulated amortization of $228 and $184 683 495
Equity in and advances to unconsolidated affiliates 881 846
Liabilities and Shareholders’ Equity
Current liabilities:
Accrued salaries, wages and benefits 283 209
Nonrecourse project debt 5 11
Operating lease liabilities 44 39
Other current liabilities 193 186
Employee compensation and benefits 110 115
Income tax payable 96 92
Deferred income taxes 26 16
Nonrecourse project debt 2 7
Operating lease liabilities 186 192
KBR shareholders’ equity:
Preferred stock, $0.001 par value, 50,000,000 shares authorized, none issued — —
Total KBR shareholders’ equity 1,580 1,839
Noncontrolling interests 29 14
Total liabilities and shareholders’ equity $ 5,705 $ 5,360
See accompanying notes to consolidated financial statements.
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KBR, Inc.
Consolidated Statements of Shareholders’ Equity
(In millions)
Dollars in millions Total PIC RetainedEarnings TreasuryStock AOCL NCI
Acquisition of noncontrolling interest 69 69 — — — —
Share-based compensation 10 10 — — — —
Tax benefit decrease related to share-based plans 1 1 — — — —
Common stock issued upon exercise of stock options 2 2 — — — —
Dividends declared to shareholders ($0.32/share) (44) — (44) — — —
Repurchases of common stock (3) — — (3) — —
Issuance of ESPP shares 3 (1) — 4 — —
Issuance of convertible debt and call spread overlay 18 18 — — — —
Distributions to noncontrolling interests (3) — — — — (3)
Other noncontrolling interests activity 2 — — — — 2
Other comprehensive income, net of tax 12 — — — 12 —
Share-based compensation 12 12 — — — —
Common stock issued upon exercise of stock options 5 5 — — — —
Dividends declared to shareholders ($0.32/share) (46) — (46) — — —
Repurchases of common stock (4) — — (4) — —
Issuance of ESPP shares 3 (1) — 4 — —
Investments by noncontrolling interests 1 — — — — 1
Distributions to noncontrolling interests (14) — — — — (14)
Other comprehensive income, net of tax (77) — — — (77) —
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Dollars in millions Total PIC RetainedEarnings TreasuryStock AOCL NCI
Share-based compensation 12 12 — — — —
Common stock issued upon exercise of stock options 4 4 — — — —
Dividends declared to shareholders ($0.40/share) (57) — (57) — — —
Repurchases of common stock (51) — — (51) — —
Issuance of ESPP shares 4 — — 4 — —
Distributions to noncontrolling interests (4) — — — — (4)
Other (2) — — — — (2)
Other comprehensive income (loss), net of tax (96) — — — (96) —
See accompanying notes to consolidated financial statements.
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KBR, Inc.
Consolidated Statements of Cash Flows
(In millions)
Years ended December 31,
Cash flows from operating activities:
Equity in earnings of unconsolidated affiliates (30) (35) (79)
Deferred income tax (benefit) expense (40) (14) 26
(Gain) loss on disposition of assets (18) (17) 2
Goodwill impairment 99 — —
Asset impairments 98 — —
Gain on consolidation of Aspire subcontracting entities — — (108)
Changes in operating assets and liabilities, net of acquired businesses:
Accounts receivable, net of allowance for credit losses 127 (16) (203)
Accrued salaries, wages and benefits 38 (9) 11
Payments on operating lease liabilities (61) (56) —
Payments from unconsolidated affiliates, net 15 10 12
Distributions of earnings from unconsolidated affiliates 38 69 75
Restructuring reserve 89 — —
Other assets and liabilities 57 (28) (7)
Total cash flows provided by operating activities 367 256 165
Cash flows from investing activities:
Purchases of property, plant and equipment (20) (20) (17)
Proceeds from sale of assets or investments 1 9 25
Investments in equity method joint ventures (26) (146) (344)
Acquisitions of businesses, net of cash acquired (832) — (354)
Adjustments to cash due to consolidation of Aspire entities — — 197
Other — (1) 2
Total cash flows used in investing activities $ (877) $ (158) $ (491)
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Years ended December 31,
Cash flows from financing activities:
Borrowings on long term debt 359 — 1,075
Borrowings on revolving credit agreement 260 — 250
Payments on short-term and long-term borrowings (281) (70) (100)
Payments on revolving credit agreement — — (720)
Debt issuance costs (5) — (57)
Proceeds from sale of warrants — — 22
Purchase of note hedges — — (62)
Issuance of convertible notes — — 350
Payments of dividends to shareholders (54) (46) (44)
Net proceeds from issuance of common stock 4 5 2
Payments to reacquire common stock (51) (4) (3)
Excess tax benefits from share-based compensation — — 1
Acquisition of remaining ownership interest in joint ventures — — (56)
Investments from noncontrolling interests — 1 —
Distributions to noncontrolling interests (4) (14) (3)
Other (3) (5) (1)
Total cash flows provided by (used in) financing activities 225 (133) 654
Effect of exchange rate changes on cash 9 8 (28)
(Decrease) increase in cash and equivalents (276) (27) 300
Cash and equivalents at beginning of period 712 739 439
Cash and equivalents at end of period $ 436 $ 712 $ 739
Supplemental disclosure of cash flows information:
Cash paid for interest $ 53 $ 80 $ 52
Cash paid for income taxes (net of refunds) $ 49 $ 54 $ 21
Noncash investing activities
Acquisition of technology licensing rights $ — $ — $ 16
Noncash financing activities
Dividends declared $ 14 $ 11 $ 11
See accompanying notes to consolidated financial statements.
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KBR, Inc.
Notes to Consolidated Financial Statements
Note 1. Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements have been prepared in accordance with U.S. GAAP and include the accounts of KBR, Inc. and the subsidiaries it controls, including VIEs where it is the primary beneficiary. We account for investments over which we have significant influence, but not a controlling financial interest, using the equity method of accounting. See Note 10 to our consolidated financial statements for further discussion of our equity investments and VIEs. All material intercompany balances and transactions are eliminated in consolidation.
Business Reorganization and Restructuring Activities
The impact of the decline in oil and gas prices, the COVID-19 pandemic and related economic and business and market disruptions over fiscal year 2020 continues to evolve and its future effects remain uncertain. The impact of these recent developments on our business will depend on many factors, many of which are beyond management's control and knowledge. During fiscal year 2020, our management initiated and approved restructuring plans in response to the dislocation of the global energy market resulting from the decline in oil prices and the COVID-19 pandemic. The restructuring plan included the reorganization of KBR's management structure primarily within our Energy Solutions business segment during the first and second quarters of 2020 and entailed approving strategic business restructuring activities and deciding to discontinue pursuing certain projects, principally lump-sum EPC and commoditized construction services. The restructuring plan is designed to refine our market focus, optimize costs, and improve operational efficiencies. As a result of these restructuring activities and adverse market conditions, we have performed interim impairment tests of our goodwill, intangible assets, significant investments and various other assets. See Note 7 "Restructuring Charges and Asset Impairments" and Note 9 "Goodwill and Goodwill Impairment" for further discussion of restructuring and impairment charges recognized during the year ended December 31, 2020.
These reorganization activities did not have an impact on our identified reportable segments. See Note 2 to our consolidated financial statements for further discussion of our segments.
Use of Estimates
The preparation of our consolidated financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of certain assets and liabilities; the reported amounts of revenues and expenses for the periods covered and certain amounts disclosed in the notes to our consolidated financial statements. These estimates are based on information available through the date of the issuance of the financial statements and actual results could differ from those estimates. Areas requiring significant estimates and assumptions by our management include the following:
•project revenues, costs and profits on our contracts, including recognition of estimated losses on uncompleted contracts
•award fees, costs and profits on government services contracts
•provisions for uncollectible receivables and client claims and recoveries of costs from subcontractors, vendors and others
•provisions for income taxes and related valuation allowances and tax uncertainties
•recoverability of goodwill
•recoverability of other intangibles and long-lived assets and related estimated lives
•recoverability of equity method investments
•valuation of pension obligations and pension assets
•accruals for estimated liabilities, including litigation accruals
•consolidation of VIEs
•valuation of share-based compensation
•valuation of assets and liabilities acquired in business combinations
Cash and Equivalents
We consider highly liquid investments with an original maturity of three months or less to be cash equivalents.
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Revenue Recognition
We adopted ASC Topic 606, Revenue from Contracts with Customers on January, 1, 2018 for our consolidated entities andfor each of the remaining unconsolidated Aspire Defence contracting entities effective January 1, 2018. Effective January 1, 2019, we adopted ASC Topic 606 for our remaining unconsolidated affiliates. Our financial results for reporting periods beginning January 1, 2018 for our consolidated entities and for each of the remaining unconsolidated Aspire Defence contracting entities and January 1, 2019 for our remaining unconsolidated affiliates are presented under the new accounting standard, while financial results for prior periods will continue to be reported in accordance with our historical accounting policy.
Revenue is measured based on the amount of consideration specified in a contract with a customer. Revenue is recognized when and as our performance obligations under the terms of the contract are satisfied which generally occurs with the transfer of control of the goods or services to the customer.
Contract Combination
To determine the proper revenue recognition method for contracts, we evaluate whether two or more contracts should be combined and accounted for as one single contract and whether the combined or single contract should be accounted for as more than one performance obligation. This evaluation requires judgment and the decision to combine a group of contracts or separate a combined or single contract into multiple performance obligations could change the amount of revenue and profit recorded in a given period. Contracts are considered to have a single performance obligation if the promise to transfer the individual goods or services is not separately identifiable from other promises in the contracts primarily because we provide a significant service of integrating a complex set of tasks and components into a single project or capability. Contracts that cover multiple phases of the product lifecycle (development, construction and maintenance & support) are typically considered to have multiple performance obligations even when they are part of a single contract.
For a limited number of contracts with multiple performance obligations, we allocate the transaction price to each performance obligation using our best estimate of the relative standalone selling price of each distinct good or service in the contract. In cases where we do not provide the distinct good or service on a standalone basis, which is more prevalent than not, the primary method used to estimate standalone selling price is the expected cost plus a margin approach, under which we forecast our expected costs of satisfying a performance obligation and then add an appropriate margin for that distinct good or service.
Contract Types
The Company performs work under contracts that broadly consist of fixed-price, cost-reimbursable or a combination of the two.Fixed-price contracts include both lump-sum and unit-rate contracts.Cost-reimbursable contracts include cost-plus fixed fee, cost-plus fixed rate, and time and material contracts.Cost-reimbursable contracts with the U.S. government are generally subject to the Federal Acquisition Regulation (FAR) and are competitively priced based on estimated or actual costs of providing the contractual goods or services.The FAR provides guidance on types of costs that are allowable in establishing prices for goods and services provided to the U.S. government and its agencies. Pricing for non-U.S. government agencies and commercial customers is based on specific negotiations with each customer.
For contracts where we have the right to consideration from the customer in an amount that corresponds directly with the value received by the customer based on our performance to date, revenue is recognized when services are performed and contractually billable.Under the typical payment terms of our services contracts, amounts are billed as work progresses in accordance with agreed-upon contractual terms, either at periodic intervals (e.g., weekly, biweekly or monthly) or upon achievement of contractual milestones.
For contracts where performance obligations are satisfied due to the continuous transfer of control to the customer, revenue is recognized over time.Where the customer contracts with us to provide a significant service of integrating a complex set of tasks and components into a single project or capability, those contracts are accounted for as single performance obligations.We recognize revenue generally using the cost-to-cost method, based primarily on contract costs incurred to date compared to total estimated contract costs at completion.This method is deemed appropriate in measuring performance towards completion because it directly measures the value of the goods and services transferred to the customer.
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Contract Costs
Contract costs include all direct materials, labor and subcontractor costs and an allocation of indirect costs related to contract performance. Customer-furnished materials are included in both contract revenue and cost of revenue when management concludes that the company is acting as a principal rather than as an agent. We recognize revenue, but not profit, on certain uninstalled materials that are not specifically produced or fabricated for a project, which revenue is recognized up to cost. Revenue for uninstalled materials is recognized when the cost is incurred and control is transferred to the customer, which revenue is recognized using the cost-to-cost method. Project mobilization costs are generally charged to the project as incurred when they are an integrated part of the performance obligation being transferred to the client. Pre-contract costs are expensed as incurred unless they are expected to be recovered from the client.
Contract costs incurred for U.S. government contracts, including indirect costs, are subject to audit and adjustment by the DCAA. If the U.S. government concludes costs charged to a contract are not reimbursable under the terms of the contract or applicable procurement regulations, these costs are disallowed or, if already reimbursed, we may be required to refund the reimbursed amounts to the customer. Such conditions may also include interest and other financial penalties.
We provide limited warranties to customers for work performed under our contracts that typically extend for a limited duration following substantial completion of our work on a project. Such warranties are not sold separately and do not provide customers with a service in addition to assurance of compliance with agreed-upon specifications. Accordingly, these types of warranties are not considered to be separate performance obligations. Historically, warranty claims have not been material.
Variable Consideration
It is common for our contracts to contain variable consideration in the form of award fees, incentive fees, performance bonuses, award fees, liquidated damages or penalties that may increase or decrease the transaction price. These variable amounts generally are awarded upon achievement of certain performance metrics, program milestones or targets and can be based on customer discretion. Other contract provisions also give rise to variable consideration such as unapproved change orders and claims, and on certain contracts, index-based price adjustments. We estimate the amount of variable consideration at the most likely amount to which we expect to be entitled. Variable consideration is included in the transaction price when it is probable that a significant reversal of cumulative revenue recognized will not occur or when the uncertainty associated with the variable consideration is resolved. Our estimates of variable consideration and determination of whether to include such amounts in the transaction price are based largely on our assessment of legal enforceability, anticipated performance, and any other information (historical, current or forecasted) that is reasonably available to us.
Variable consideration associated with claims and unapproved change orders is included in the transaction price only to the extent of costs incurred. We recognize claims against vendors, subcontractors and others as a reduction in recognized costs when enforceability is established by the contract and the amounts are reasonably estimable and probable of recovery. Reductions in costs are recognized to the extent of the lesser of the amounts management expects to recover or actual costs incurred.
Contract Estimates and Modifications
Due to the nature of the work required to be performed on many of our performance obligations, the estimation of total revenue and cost at completion is complex and subject to many variables and requires significant judgment. As a significant change in estimated total revenue and cost could affect the profitability of our contracts, we routinely review and update our contract-related estimates through a disciplined project review process in which management reviews the progress and execution of our performance obligations and the EAC. As part of this process, management reviews information including, but not limited to, outstanding contract matters, progress towards completion, program schedule and the associated changes in estimates of revenues and costs. Management must make assumptions and estimates regarding the availability and productivity of labor, the complexity of the work to be performed, the availability and cost of materials, the performance of subcontractors and the availability and timing of funding from the customer, along with other risks inherent in performing services under all contracts where we recognize revenue over time using the cost-to-cost method.
We typically recognize changes in contract estimates on a cumulative catch-up basis in the period in which the changes are identified. Such changes in contract estimates can result in the recognition of revenue in a current period for performance obligations which were satisfied or partially satisfied in prior period. Changes in contract estimates may also result in the
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reversal of previously recognized revenue if the current estimate differs from the previous estimate. If at any time the estimate of contract profitability indicates an anticipated loss on the contract, we recognize the total loss in the period it is identified.
Contracts are often modified to account for changes in contract specifications and requirements. Most of our contract modifications are for goods or services that are not distinct from existing contracts due to the significant integration provided in the context of the contract and are accounted for as if they were part of the original contract. The effect of a contract modification on the transaction price and our measure of progress for the performance obligation to which it relates, is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative catch-up basis. We account for contract modifications prospectively when the modification results in the promise to deliver additional goods or services that are distinct and the increase in price of the contract is for the same amount as the stand-alone selling price of the additional goods or services included in the modification.
Contract Assets and Liabilities
Billing practices are governed by the contract terms of each project based upon costs incurred, achievement of milestones or predetermined schedules. Billings do not necessarily correlate with revenue recognized over time using the percentage-of-completion method. Contract assets include unbilled amounts typically resulting from revenue under long-term contracts when the percentage-of-completion method of revenue recognition is utilized and revenue recognized exceeds the amount billed to the customer. Contract liabilities consist of advance payments and billings in excess of revenue recognized as well as deferred revenue.
Retainage, included in contract assets, represent the amounts withheld from billings by our clients pursuant to provisions in the contracts and may not be paid to us until the completion of specific tasks or the completion of the project and, in some instances, for even longer periods. Retainage may also be subject to restrictive conditions such as performance guarantees.
Our contract assets and liabilities are reported in a net position on a contract-by-contract basis at the end of each reporting period.
The payment terms of our contracts from time to time require the customer to make advance payments as well as interim payments as work progresses. The advance payment generally is not considered to contain a significant financing component as we expect to recognize those amounts in revenue within a year of receipt as work progresses on the related performance obligation.
Gross Profit
Gross profit represents revenues less the cost of revenues, which includes business segment overhead costs directly attributable to execution of contracts by the business segment.
Selling, General and Administrative Expenses
Our selling, general and administrative expenses represent expenses that are not associated with the execution of the contracts. Selling, general and administrative expenses include charges for such items as executive management, corporate business development, information technology, finance and accounting, human resources and various other corporate functions. The Company classifies indirect costs incurred within or allocated to its U.S. government customers as overhead (included in “Cost of revenues”) or selling, general and administrative expenses in the same in the same manner as such costs are defined in the Company’s disclosure statements under CAS.
Accounts Receivable
Accounts receivable are recorded based on contracted prices when we obtain an unconditional right to payment under the terms of our contracts. We establish an allowance for credit losses based on the assessment of our clients' willingness and ability to pay. In addition to such allowances, there are often items in dispute or being negotiated that may require us to make an estimate as to the ultimate outcome. Past due receivable balances are written off when our internal collection efforts have been unsuccessful in collecting the amounts due. See Note 22 to our consolidated financial statements for our discussion on sales of receivables.
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Property, Plant and Equipment
Property, plant and equipment are reported at cost less accumulated depreciation except for those assets that have been written down to their fair values due to impairment. Expenditures for major additions and improvements are capitalized and minor replacements, maintenance and repairs are charged to expense as incurred. The cost of property, plant and equipment sold or otherwise disposed of and the related accumulated depreciation are removed from the accounts and any resulting gain or loss is included in operating income for the respective period. Depreciation is generally provided on the straight-line method over the estimated useful lives of the related assets. Leasehold improvements are amortized using the straight-line method over the shorter of the useful life of the improvement or the lease term. See Note 8 to our consolidated financial statements for our discussion on property, plant and equipment.
Acquisitions
We account for business combinations using the acquisition method of accounting in accordance with ASC 805 - Business Combinations, which allocates the fair value of the purchase consideration to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values. The excess of the purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. We engage third-party appraisal firms when appropriate to assist in the fair value determination of intangible assets. Initial purchase price allocations are subject to revisions within the measurement period, not to exceed one year from the date of acquisition. Acquisition-related expenses and transaction costs associated with business combinations are expensed as incurred.
Goodwill and Intangible Assets
Goodwill is an asset representing the excess cost over the fair market value of net assets acquired in business combinations. In accordance with ASC 350 - Intangibles - Goodwill and Other, goodwill is not amortized but is tested annually for impairment or on an interim basis when indicators of potential impairment exist. Goodwill is tested for impairment at the reporting unit level. Our reporting units are our operating segments or components of operating segments where discrete financial information is available and segment management regularly reviews the operating results. For purposes of impairment testing, goodwill is allocated to the applicable reporting units based on our reporting structure. If the fair value of a reporting unit exceeds its carrying value, the goodwill of the reporting unit is not considered impaired. If the carrying value of a reporting unit exceeds its fair value, a second step of the goodwill impairment test is performed to measure the amount of goodwill impairment. The second step compares the implied fair value of the reporting unit goodwill to the carrying value of the reporting unit goodwill. We determine the implied fair value of the goodwill in the same manner as determining the amount of goodwill to be recognized in a business combination. We completed our annual goodwill impairment test in the fourth quarter of 2020 and determined that none of the goodwill was impaired. See Note 9 to our consolidated financial statements for reported goodwill in each of our segments and goodwill impairment recognized.
We had intangible assets with net carrying values of $683 million and $495 million as of December 31, 2020 and 2019, respectively. Intangible assets with indefinite lives are not amortized but are subject to annual impairment tests or on an interim basis when indicators of potential impairment exist. An intangible asset with an indefinite life is impaired if its carrying value exceeds its fair value. During the year ended December 31, 2020, certain of our trade name intangible assets with an indefinite life were impaired. Refer to Note 7 to our consolidated financial statements for further discussion. Intangible assets with finite lives are amortized on a straight-line basis over the useful life of those assets, ranging from 1 year to 25 years. See Note 9 to our consolidated financial statements for further discussion of our intangible assets.
Investments
We account for non-marketable investments using the equity method of accounting if the investment gives us the ability to exercise significant influence over, but not control, of an investee. Significant influence generally exists if we have an ownership interest representing between 20% and 50% of the voting stock of the investee. Under the equity method of accounting, investments are stated at initial cost and are adjusted for subsequent additional investments and our proportionate share of earnings or losses and distributions.
Equity in earnings of unconsolidated affiliates, in the consolidated statements of operations, reflects our proportionate share of the investee's net income, including any associated affiliate taxes. Our proportionate share of the investee’s other comprehensive income (loss), net of income taxes, is recorded in the consolidated statements of shareholders’ equity and consolidated statements of comprehensive income (loss). In general, the equity investment in our unconsolidated affiliates is equal to our current equity investment plus those entities' undistributed earnings.
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We evaluate our equity method investments for impairment at least annually or whenever events or changes in circumstances indicate, in management’s judgment, that the carrying value of an investment may have experienced an other-than-temporary decline in value. When evidence of loss in value has occurred, management compares the estimated fair value of the investment to the carrying value of the investment to determine whether an impairment has occurred. If the estimated fair value is less than the carrying value and management considers the decline in value to be other than temporary, the excess of the carrying value over the estimated fair value is recognized in the financial statements as an impairment. See Note 7 to our consolidated financial statements for our discussion on impairment of our equity method investments and Note 10 to our consolidated financial statements for our discussion on equity method investments.
In cases where we are unable to exercise significant influence over the investee, or when our investment balance is reduced to zero from our proportionate share of losses, the investments are accounted for under the cost method. Under the cost method, investments are carried at cost and adjusted only for other-than-temporary declines in fair value, distributions of earnings or additional investments. In cases where we have a constructive or legal obligation to fund deficits of the joint venture, we record such deficits as "Other current liabilities" on our consolidated balance sheets.
Joint Ventures and VIEs
The majority of our joint ventures are VIEs. We account for VIEs in accordance with ASC 810 - Consolidation, which requires the consolidation of VIEs in which a company has both the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and the obligation to absorb losses or the right to receive the benefits from the VIE that could potentially be significant to the VIE. If a reporting enterprise meets these conditions, then it has a controlling financial interest and is the primary beneficiary of the VIE. Our unconsolidated VIEs are accounted for under the equity method of accounting.
We assess all newly created entities and those with which we become involved to determine whether such entities are VIEs and, if so, whether or not we are their primary beneficiary. Most of the entities we assess are incorporated or unincorporated joint ventures formed by us and our partner(s) for the purpose of executing a project or program for a customer and are generally dissolved upon completion of the project or program. Many of our long-term, commercial projects are executed through such joint ventures. Although the joint ventures in which we participate own and hold contracts with the customers, the services required by the contracts are typically performed by the joint venture partners, or by other subcontractors under subcontracts with the joint ventures. Typically, these joint ventures are funded by advances from the project owner, and accordingly, require little or no equity investment by the joint venture partners but may require subordinated financial support from the joint venture partners such as letters of credit, performance and financial guarantees or obligations to fund losses incurred by the joint venture. Other joint ventures, such as PFIs, generally require the partners to invest equity and take an ownership position in an entity that manages and operates an asset after construction is complete. The assets of joint ventures are restricted for use to the obligations of the particular joint venture and are not available for our general operations.
We perform a qualitative assessment to determine whether we are the primary beneficiary once an entity is identified as a VIE. Thereafter, we continue to re-evaluate whether we are the primary beneficiary of the VIE in accordance with ASC 810 - Consolidation. A qualitative assessment begins with an understanding of the nature of the risks in the entity as well as the nature of the entity’s activities. These include the terms of the contracts entered into by the entity, ownership interests issued by the entity and how they were marketed and the parties involved in the design of the entity. We then identify all of the variable interests held by parties involved with the VIE including, among other things, equity investments, subordinated debt financing, letters of credit, financial and performance guarantees and contracted service providers. Once we identify the variable interests, we determine those activities which are most significant to the economic performance of the entity and which variable interest holder has the power to direct those activities. Though infrequent, some of our assessments reveal no primary beneficiary because the power to direct the most significant activities that impact the economic performance is held equally by two or more variable interest holders who are required to provide their consent prior to the execution of their decisions. Most of the VIEs with which we are involved have relatively few variable interests and are primarily related to our equity investment, significant service contracts and other subordinated financial support. See Note 10 to our consolidated financial statements for our discussion on variable interest entities.
Occasionally, we may determine that we are the primary beneficiary as a result of a reconsideration event associated with an existing unconsolidated VIE. We account for the change in control under the acquisition method of accounting for business combinations in accordance with ASC 805. See Note 4 to our consolidated financial statements.
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Deconsolidation of a Subsidiary
We account for a gain or loss on deconsolidation of a subsidiary or derecognition of a group of assets in accordance with ASC 810-10-40-5. We measure the gain or loss as the difference between (a) the aggregate of fair value of any consideration received, the fair value of any retained noncontrolling investment and the carrying amount of any noncontrolling interest in the former subsidiary at the date the subsidiary is deconsolidated and (b) the carrying amount of the former subsidiary’s assets and liabilities or the carrying amount of the group of assets.
Pensions
We account for our defined benefit pension plans in accordance with ASC 715 - Compensation - Retirement Benefits, which requires an employer to:
•recognize on its balance sheet the funded status (measured as the difference between the fair value of plan assets and the benefit obligation) of the pension plan;
•recognize, through comprehensive income, certain changes in the funded status of a defined benefit plan in the year in which the changes occur;
•measure plan assets and benefit obligations as of the end of the employer’s fiscal year; and
•disclose additional information.
Our pension benefit obligations and expenses are calculated using actuarial models and methods. Two of the more critical assumptions and estimates used in the actuarial calculations are the discount rate for determining the current value of benefit obligations and the expected rate of return on plan assets. Other assumptions and estimates used in determining benefit obligations and plan expenses include inflation rates and demographic factors such as retirement age, mortality and turnover. These assumptions and estimates are evaluated periodically (typically annually) and are updated accordingly to reflect our actual experience and expectations.