KBR'S IPO Oddity

By Chris Byron
New York Post
October 30, 2006

FOR the past two years, this column has pretty much been a voice alone in asking a question that no one at the Securities and Exchange Commission has ever been forced to answer: Are taxpayers really getting their money's worth from the $1 billion a year they lavish on the agency to enforce the rule of law on Wall Street?

Finally, the same question is being asked in Congress, and it has sent SEC Chairman Christopher Cox scurrying all over town to show folks that the 72-year-old agency has still got game.

Cox would be better off spending less time on spin control and more on reminding his employees why they have jobs in the first place: to keep chiselers, cheats and corner-cutters out of the financial markets.

But a PR mindset dominated SEC thinking long before Cox showed up and he's simply been carrying on with the tradition.

This week, we'll look at a modest but useful service the SEC could be performing for investors if its chairman wasn't so preoccupied with convincing the world that he's ready to start keel-hauling Wall Street's bad guys right after lunch, if we'd only just let him sing us this song first.

A series of filings by KBR Inc. suggests that deep in the bowels of the SEC's corporate finance department, there sits a nameless but noble public servant who apparently harbors some concerns about the accuracy or completeness of a request by KBR Inc., first filed last April, to sell stock to the public in an IPO.

Since then, KBR has turned in three follow-up filings, the most recent of which was submitted less than two weeks ago.

There's no reasonable way to tell from the filings, which now run to a total of more than 500 pages, why these amendments were asked for, and no such disclosures are required by law. Maybe they should be.

Reason: A report released last week by the Office of the Special Inspector General for Iraq Reconstruction, which documents a history of disturbing billing practices by KBR and four other U.S. contractors in the reconstruction effort, appears to have some obvious discrepancies with the company's financials as spelled out in the IPO filings.

These discrepancies may be or may not be relevant. But an investor shouldn't have to figure it out for himself when someone at the SEC might well know the answer.

Yet unless companies that are required to file amended financials are also required to spell out, in plain English, exactly why the SEC has asked for the amended filing to begin with, there's just no way for an investor to know what is actually going on.

Instead of such issues, what seems to be on Cox's mind at the moment is a letter that Senate Finance Committee Chairman Charles Grassley sent to the comptroller general of the Government Accountability Office on Sept. 19.

In it, Grassley accuses the SEC of being a poorly led and ineffective organization that no longer seems to police the markets of Wall Street effectively. To find out what went wrong, and why, Grassley called on the GAO to conduct what amounts to a public strip-search investigation of what goes on behind the drawn curtains of the SEC's secretive Division of Enforcement. The GAO has agreed to do so.

No doubt realizing that the SEC will soon release numbers showing that it brought fewer new cases last year than in any year since 2000 (something that we warned in this space was on the way nearly two months ago), Cox has gone on the offensive, talking up plans for the SEC to "step up" its efforts at law enforcement next year.

Tactically, this has been a mistake. In the past, the SEC has ducked charges that its declining case totals show lax enforcement by insisting that they are falling because fewer people are breaking the law. Yet by now promising to get the totals back up again next year, Cox is acknowledging that the SEC's previous statements on the matter were nonsense and that the interpretation of case totals is just another form of SEC spin control.

And case totals are only one of the SEC's problems. No effort at law enforcement will have any deterrent value if nearly every case is settled out of court, as with virtually all SEC actions.

Worse still, the fines defendants agree to pay are often waived and rarely collected. Typical result: Last week, a federal judge in Illinois entered a final consent decree judgment along with $737,000 in penalties and interest against two defendants in a penny stock fraud case, then waived 96 percent of the total because the defendants cried poor and the SEC didn't object.

Add to that such embarrassments as the SEC's bungled effort to regulate hedge funds, which a federal judge declared illegal, and the commission's bizarre decision to subpoena the notebooks of journalists to find out whether short-sellers were spreading falsehoods about various companies to the media, and it's clear that the GAO's investigation for Sen. Grassley will be covering a lot of ground.

Meanwhile, the kinds of help that the SEC really ought to be providing to investors, as suggested by KBR's filings, are almost certain not to be delivered.

KBR is a wholly owned subsidiary of Halliburton Inc., the Houston-based oil services company that was once headed by Vice President Dick Cheney, which hardly commends it as a topic of inquiry to anyone in the Bush administration.

However, the company's audited filings for an IPO present some troubling possibilities in light of the aforementioned inspector general's report on Iraq reconstruction.

Taken in isolation, KBR's IPO financials seem rather ordinary and unimpressive. The company puts some big top-line numbers on the board - a little less than $10.15 billion in revenue in 2005. But it's so-called "cost of services" (what the company has to shell out as expenses in order to deliver on its contracts) eats up 96 percent of that amount right off the bat, meaning a gross margin of barely 4 percent on the business, which is worse than the gross margin of a supermarket.

Take out another $195 million for asset sales and administrative overhead, and KBR's actual operating income last year totaled barely $235 million. In the two previous years, the company actually had no operating income at all.

These numbers in turn put the inspector general for Iraq reconstruction's report on KBR in a different and more disturbing light, for they show that during the period in question (February through November of 2004) KBR reported administrative overhead costs of more than $52 million on contracts in which the company actually incurred just $13 million in direct costs.

This of course is exactly the opposite of the ratios for the company overall as set forth in the IPO filings, in which administrative overhead appears as but a tiny fraction of gross revenues. In the inspector general's report, by contrast, administrative overhead dwarfed direct costs, and were far in excess of any other company discussed in the report. They were so out of line, in fact, that in August of 2004 a contracting officer in the program sent KBR a letter of concern, calling them "exorbitant."

Over the years, KBR's contract work in Iraq has brought it a mountain of bad publicity, and you'll find the subject referenced one way or another in all the company's IPO filings. But you won't find any specific mention of the inspector general's report, which may mean it's of no significance one way or another. Or it may also mean that a fourth amendment is now on the way, and after that, who knows.

Just don't expect the SEC to focus on any of this so long as its chairman remains absorbed in his spin control dance to head off Grassley and the GAO. It's your tax dollars that are paying for it, folks, so enjoy the show.

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