UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-Q
ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
Commission File Number 000-27261
CH2M HILL Companies, Ltd.
(Exact name of registrant as specified in its charter)
Oregon | | 93-0549963 |
(State or other jurisdiction of | | (I.R.S. Employer |
incorporation or organization) | | Identification Number) |
| | |
9191 South Jamaica Street, | | |
Englewood, CO | | 80112-5946 |
(Address of principal executive offices) | | (Zip Code) |
(303) 771-0900
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer o | Accelerated Filer x | Non-Accelerated Filer o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
The number of shares outstanding of the registrant’s common stock as of November 1, 2006 was 32,184,012.
CH2M HILL COMPANIES, LTD.
TABLE OF CONTENTS
2
CH2M HILL COMPANIES, LTD.
Condensed Consolidated Balance Sheets
(Unaudited)
(In thousands, except share data)
| | September 30, 2006 | | December 31, 2005 | |
ASSETS | | | | | |
Current assets: | | | | | |
Cash and cash equivalents | | $ | 71,515 | | $ | 66,494 | |
Receivables, net: | | | | | |
Client accounts | | 384,236 | | 398,642 | |
Unbilled revenue | | 396,138 | | 305,937 | |
Other | | 6,054 | | 5,556 | |
Prepaid expenses and other current assets | | 28,966 | | 23,138 | |
Total current assets | | 886,909 | | 799,767 | |
Investments in unconsolidated affiliates | | 41,248 | | 114,679 | |
Property, plant and equipment, net | | 35,311 | | 32,050 | |
Goodwill | | 41,968 | | 40,730 | |
Intangible assets, net | | 21,762 | | 26,168 | |
Other assets, net | | 45,242 | | 39,712 | |
Deferred income taxes | | 50,833 | | 50,833 | |
| | | | | |
Total assets | | $ | 1,123,273 | | $ | 1,103,939 | |
| | | | | |
LIABILITIES AND SHAREHOLDERS’ EQUITY | | | | | |
Current liabilities: | | | | | |
Current portion of long-term debt | | $ | 885 | | $ | 1,344 | |
Accounts payable and accrued subcontractor costs | | 233,232 | | 261,232 | |
Billings in excess of revenue | | 169,083 | | 121,604 | |
Accrued incentive compensation | | 31,678 | | 31,081 | |
Accrued payroll and employee related liabilities | | 130,459 | | 118,027 | |
Current income tax payable | | 7,285 | | 63,021 | |
Other accrued liabilities | | 72,626 | | 67,314 | |
Current deferred income taxes | | 8,377 | | 7,631 | |
Total current liabilities | | 653,625 | | 671,254 | |
Other long-term liabilities | | 127,411 | | 109,925 | |
Long-term debt | | 2,089 | | 2,780 | |
| | | | | |
Total liabilities | | 783,125 | | 783,959 | |
| | | | | |
Commitments and contingencies (Note 8) | | | | | |
| | | | | |
Shareholders’ equity: | | | | | |
Preferred stock, Class A $0.02 par value, 50,000,000 shares authorized; none issued | | — | | — | |
Common stock, $0.01 par value, 100,000,000 shares authorized; 32,166,443 and 31,892,048 issued and outstanding at September 30, 2006 and December 31, 2005, respectively | | 322 | | 319 | |
Additional paid-in capital | | 39,878 | | 45,325 | |
Retained earnings | | 314,265 | | 289,658 | |
Accumulated other comprehensive loss | | (14,317 | ) | (15,322 | ) |
Total shareholders’ equity | | 340,148 | | 319,980 | |
| | | | | |
Total liabilities and shareholders’ equity | | $ | 1,123,273 | | $ | 1,103,939 | |
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
CH2M HILL COMPANIES, LTD.
Condensed Consolidated Statements of Income
(Unaudited)
(In thousands, except share and per share data)
| | Three Months Ended September 30, | | Nine Months Ended September 30, | |
| | 2006 | | 2005 | | 2006 | | 2005 | |
| | | | | | | | | |
Gross revenue | | $ | 996,785 | | $ | 801,105 | | $ | 3,002,340 | | $ | 2,267,182 | |
Operating expenses: | | | | | | | | | |
Direct cost of services and overhead | | (820,978 | ) | (643,168 | ) | (2,483,477 | ) | (1,821,060 | ) |
General and administrative | | (162,501 | ) | (151,713 | ) | (494,849 | ) | (432,279 | ) |
| | | | | | | | | |
Operating income | | 13,306 | | 6,224 | | 24,014 | | 13,843 | |
| | | | | | | | | |
Other income (expense): | | | | | | | | | |
Equity in earnings of joint ventures and affiliated companies | | 3,454 | | 82,918 | | 16,812 | | 99,393 | |
Interest income | | 1,055 | | 585 | | 2,107 | | 1,457 | |
Interest expense | | (660 | ) | (531 | ) | (2,457 | ) | (1,337 | ) |
Income before provision for income taxes | | 17,155 | | 89,196 | | 40,476 | | 113,356 | |
Provision for income taxes | | (6,793 | ) | (34,967 | ) | (15,869 | ) | (44,589 | ) |
Net income | | $ | 10,362 | | $ | 54,229 | | $ | 24,607 | | $ | 68,767 | |
| | | | | | | | | |
Net income per common share: | | | | | | | | | |
Basic | | $ | 0.32 | | $ | 1.69 | | $ | 0.76 | | $ | 2.15 | |
Diluted | | $ | 0.31 | | $ | 1.66 | | $ | 0.74 | | $ | 2.12 | |
Weighted average number of common shares: | | | | | | | | | |
Basic | | 32,430,430 | | 32,084,654 | | 32,503,009 | | 31,927,810 | |
Diluted | | 33,045,897 | | 32,625,806 | | 33,135,030 | | 32,496,308 | |
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
CH2M HILL COMPANIES, LTD.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)
| | Nine Months Ended September 30, | |
| | 2006 | | 2005 | |
Cash flows from operating activities: | | | | | |
Net income | | $ | 24,607 | | $ | 68,767 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | |
Depreciation and amortization | | 11,075 | | 11,782 | |
Stock-based employee compensation expense | | 24,490 | | 21,947 | |
Loss on disposal of property, plant and equipment | | 151 | | 339 | |
Allowance for uncollectible accounts | | 2,258 | | 1,965 | |
Deferred income tax benefit | | 1,923 | | 29,232 | |
Distributed (undistributed) earnings of unconsolidated affiliates, net | | 87,006 | | (61,420 | ) |
Change in operating assets and liabilities, net of business acquired: | | | | | |
Receivables and unbilled revenue | | (81,402 | ) | (43,280 | ) |
Prepaid expenses and other | | (12,155 | ) | (4,076 | ) |
Accounts payable and accrued subcontractor costs | | (27,218 | ) | 45,677 | |
Billings in excess of revenue | | 47,598 | | 12,708 | |
Employee related liabilities | | 13,095 | | 67 | |
Other accrued liabilities | | 4,081 | | (39,808 | ) |
Current taxes payable | | (53,684 | ) | (11,783 | ) |
Long term liabilities and other | | 17,529 | | (363 | ) |
Net cash provided by operating activities | | 59,354 | | 31,754 | |
| | | | | |
Cash flows from investing activities: | | | | | |
Capital expenditures | | (8,805 | ) | (7,448 | ) |
Cash increase upon adoption of FIN 46(R) | | — | | 7,699 | |
Payments for acquisition earnouts | | (1,238 | ) | — | |
Investments in affiliates, net of cash received | | (16,593 | ) | (14,256 | ) |
Net cash used by investing activities | | (26,636 | ) | (14,005 | ) |
| | | | | |
Cash flows from financing activities: | | | | | |
Borrowing on line of credit | | 447,900 | | 102,700 | |
Payments on line of credit and long-term debt | | (449,093 | ) | (105,382 | ) |
Purchases and retirements of stock | | (30,499 | ) | (19,393 | ) |
Net cash used by financing activities | | (31,692 | ) | (22,075 | ) |
| | | | | |
Effect of exchange rates on cash | | 3,995 | | (1,086 | ) |
| | | | | |
Increase (decrease) in cash and cash equivalents | | 5,021 | | (5,412 | ) |
| | | | | |
Cash and cash equivalents, beginning of period | | 66,494 | | 55,885 | |
| | | | | |
Cash and cash equivalents, end of period | | $ | 71,515 | | $ | 50,473 | |
| | | | | |
Supplemental disclosures: | | | | | |
Cash paid for interest | | $ | 2,574 | | $ | 1,437 | |
Cash paid for income taxes | | $ | 69,052 | | $ | 24,245 | |
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
CH2M HILL COMPANIES, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
(In thousands, except per share data)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) and with the instructions to Form 10-Q and Article 10 of Regulation S-X for interim financial information. Accordingly, these statements do not include all of the information required by GAAP or Securities and Exchange Commission (SEC) rules and regulations for complete financial statements. The preparation of financial statements, in conformity with GAAP, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Estimates and assumptions have been prepared on the basis of the most current and best available information and actual results could differ from those estimates. Certain prior period amounts have been reclassified to conform to current year presentation.
In the opinion of CH2M HILL Companies, Ltd.’s (CH2M HILL) management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the results for the interim periods presented. The results of operations for any interim period are not necessarily indicative of results for the full year. These unaudited condensed consolidated financial statements should be read in conjunction with our consolidated financial statements and notes thereto included in CH2M HILL’s Annual Report on Form 10-K for the year ended December 31, 2005. In the following text, the terms “we,” “our,” “our company,” and “us” may refer to CH2M HILL.
Shareholders’ Equity
The significant changes in shareholders’ equity for the nine months ended September 30, 2006 are as follows:
| | Shares | | Amount | |
Shareholders’ Equity, December 31, 2005 | | 31,892 | | $ | 319,980 | |
Net income | | — | | 24,607 | |
Shares issued in connection with stock-based compensation and employee benefit plans | | 1,525 | | 18,569 | |
Shares purchased and retired | | (1,251 | ) | (24,013 | ) |
Other comprehensive income | | — | | 1,005 | |
Shareholders’ Equity, September 30, 2006 | | 32,166 | | $ | 340,148 | |
Stock-Based Compensation Plans
On January 1, 2006, CH2M HILL adopted the provisions of, and accounted for stock-based compensation in accordance with, Statement of Financial Accounting Standard (SFAS) No. 123 — revised 2004, Share-Based Payment (SFAS 123(R)), which replaced SFAS No. 123, Accounting for Stock-Based Compensation (SFAS 123) and supersedes Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees (APB 25). Under the fair value recognition provisions of SFAS 123(R), stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the vesting period. CH2M HILL is utilizing the prospective method of adoption under which prior periods are not revised for comparative purposes. Under the prospective method of adoption under SFAS 123(R), the valuation provisions apply only to new grants and not to outstanding grants as of the effective date, January 1, 2006. Accordingly, at the adoption date, SFAS 123(R) had no impact on CH2M HILL’s financial statements. SFAS 123(R) was not applied to CH2M HILL’s Payroll Deduction Stock Purchase Plan (PDSPP) as the plan is available to all shareholders and incorporates no option features such as a look-back period. Accordingly, no compensation cost is recognized in the financial statements for the PDSPP.
CH2M HILL has a Restricted Stock Plan which provides eligible individuals with added incentives to continue in the long-term service of CH2M HILL. The awards are made for no consideration and vest over various periods, but are considered outstanding at the time of issuance as the shareholders are entitled to voting rights.
6
CH2M HILL recognizes compensation costs, net of estimated forfeitures, over the vesting term based on the fair value of the restricted stock at the date of grant. Compensation expense recognized during the three and nine months ended September 30, 2006 relating to restricted stock was $687 and $2,239, respectively. In determining the amount of compensation expense, CH2M HILL has estimated that forfeitures of restricted stock shares will be less than 3% of total restricted stock shares outstanding based upon prior experience. As of September 30, 2006, there was $5,018 of unrecognized compensation costs related to non-vested restricted stock grants. The impact of applying SFAS 123(R) during the nine months ended September 30, 2006 for all other stock-based payments did not have a material impact on CH2M HILL’s consolidated financial position, results of operations or cash flows.
The following table summarizes the restricted stock activity for the nine months ended September 30, 2006:
Restricted Stock | | Non-vested
Shares | | Weighted Average
Grant Date
Fair Value | |
Beginning of period – December 31, 2005 | | 199 | | $ | 12.54 | |
Awarded | | 329 | | 18.01 | |
Vested | | (47 | ) | 15.14 | |
Forfeited | | (5 | ) | 13.91 | |
End of period – September 30, 2006 | | 476 | | 16.72 | |
| | | | | | |
New Accounting Standards
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments (SFAS 155), which amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133), and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (SFAS 140). SFAS 155 simplifies the accounting for certain derivatives embedded in other financial instruments by allowing them to be accounted for as one if the holder elects to account for the whole instrument on a fair value basis. SFAS 155 also clarifies and amends certain other provisions of SFAS 133 and SFAS 140. SFAS 155 is effective for all financial instruments acquired, issued or subject to a remeasurement event occurring in fiscal years beginning after September 15, 2006. Earlier adoption is permitted, provided the company has not yet issued financial statements, including for interim periods, for that fiscal year. CH2M HILL does not expect the adoption of SFAS 155 to have a material impact on its consolidated financial position, results of operations or cash flows.
In July 2006, the FASB issued FASB Interpretation 48, Accounting for Uncertainty in Income Taxes: an interpretation of FASB Statement No. 109 (FIN 48), which is effective beginning on January 1, 2007. FIN 48 establishes a different process to measure the impact of uncertainty associated with an income tax position. Under FIN 48, the effect of an income tax position on the income tax provision must be recognized at the amount that is more likely than not to be sustained upon examination by the relevant taxing authority. FIN 48 also requires additional disclosures about unrecognized tax benefits associated with uncertain income tax positions and a reconciliation of the change in the unrecognized benefit. CH2M HILL is evaluating the impact that the adoption of FIN 48 will have on its financial results.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157), which defines fair value, establishes guidelines for measuring fair value and expands disclosure regarding fair value measurements. SFAS 157 does not require new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those years. Earlier adoption is permitted, provided the company has not yet issued financial statements, including interim periods for that fiscal year. CH2M HILL does not expect the adoption of SFAS 157 to have a material impact on its financial results.
In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of SFAS No. 87, 88, 106 and 132(R) (SFAS 158), which requires employers to recognize the funded status of pension and other postretirement benefit plans on the balance sheet and to recognize changes in the funded status through comprehensive income in the year in which the changes occur. For companies that are not publicly traded, SFAS 158 is effective for the fiscal years ending after June 15, 2007, however footnote disclosure is required for fiscal years ending after December 15, 2006, unless it has applied the recognition provisions of the statement in preparing the financial statements.
7
SFAS 158 also requires plan assets and benefit obligations to be measured as of the balance-sheet date for fiscal years ending after December 15, 2008. Earlier adoption is permitted provided early application is applied to all of the company’s employer benefit plans and the company has not yet issued financial statements including for interim periods, for that fiscal year. CH2M HILL is evaluating the impact that the adoption of SFAS 158 will have on its financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108), which provides interpretive guidance on how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in the current year financial statements. SAB 108 requires registrants to quantify misstatements using both the income statement and balance sheet approach and evaluate whether either approach results in a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. SAB 108 is effective for fiscal years ending on or after November 15, 2006, with earlier adoption encouraged. CH2M HILL does not expect that the adoption of SAB 108 will have a material impact on its financial statements.
(2) SEGMENT INFORMATION
Certain financial information relating to the three and nine months ended September 30, 2006 and 2005 for each segment is provided below.
Three Months Ended
September 30, 2006 | | Federal | | Civil
Infrastructure | | Industrial | | Other | | Financial
Statement
Balances | |
Revenue from external customers | | $ | 309,413 | | $ | 333,548 | | $ | 353,824 | | $ | — | | $ | 996,785 | |
Inter-segment sales | | 2,835 | | 8,768 | | 6,355 | | (17,958 | ) | — | |
Equity in earnings of joint ventures and affiliated companies | | 1,493 | | 1,371 | | 590 | | — | | 3,454 | |
Segment profit (loss) | | 11,620 | | 20,359 | | (10,720 | ) | (4,104 | ) | 17,155 | |
| | | | | | | | | | | | | | | | |
Three Months Ended
September 30, 2005 | | Federal | | Civil
Infrastructure | | Industrial | | Other | | Financial
Statement
Balances | |
Revenue from external customers | | $ | 279,907 | | $ | 270,036 | | $ | 251,162 | | $ | — | | $ | 801,105 | |
Inter-segment sales | | 2,381 | | 5,803 | | 4,427 | | (12,611 | ) | — | |
Equity in earnings of joint ventures and affiliated companies | | 81,665 | | 1,008 | | 245 | | — | | 82,918 | |
Segment profit (loss) | | 84,359 | | 7,156 | | 1,889 | | (4,208 | ) | 89,196 | |
| | | | | | | | | | | | | | | | |
Nine Months Ended
September 30, 2006 | | Federal | | Civil
Infrastructure | | Industrial | | Other | | Financial
Statement
Balances | |
Revenue from external customers | | $ | 1,155,867 | | $ | 968,806 | | $ | 877,667 | | $ | — | | $ | 3,002,340 | |
Inter-segment sales | | 8,824 | | 18,301 | | 21,334 | | (48,459 | ) | — | |
Equity in earnings of joint ventures and affiliated companies | | 9,703 | | 6,268 | | 841 | | — | | 16,812 | |
Segment profit (loss) | | 52,139 | | 40,949 | | (38,517 | ) | (14,095 | ) | 40,476 | |
| | | | | | | | | | | | | | | | |
Nine Months Ended
September 30, 2005 | | Federal | | Civil
Infrastructure | | Industrial | | Other | | Financial
Statement
Balances | |
Revenue from external customers | | $ | 837,820 | | $ | 760,510 | | $ | 668,852 | | $ | — | | $ | 2,267,182 | |
Inter-segment sales | | 6,807 | | 15,693 | | 14,285 | | (36,785 | ) | — | |
Equity in earnings of joint ventures and affiliated companies | | 93,251 | | 5,971 | | 171 | | — | | 99,393 | |
Segment profit (loss) | | 97,426 | | 22,286 | | 4,340 | | (10,696 | ) | 113,356 | |
| | | | | | | | | | | | | | | | |
8
During the three and nine months ended September 30, 2006, the Industrial segment recognized a loss related to a manufacturing facility project. The total estimated loss was included in direct cost of services. This loss was primarily due to significant cost overruns. This project was bid under fixed price commercial terms where the risk of certain variances remains with the Company. The project has experienced increased costs due to project delivery issues and increased commodity prices. In addition, the clean up efforts required from Hurricane Katrina have caused significant shortages in experienced craft laborers in the area and thus have materially increased wage rates and reduced overall productivity. The project is scheduled for completion in the fourth quarter of 2006. While management believes that the current estimated costs at completion are reasonable, uncertainties exist until the project is complete.
During the three and nine months ended September 30, 2005, CH2M HILL recognized earnings from our joint venture, Kaiser-Hill Company, LLC (Kaiser-Hill), of $76,150 and $86,374, respectively.
(3) COMPREHENSIVE INCOME
Comprehensive income includes unrealized gains (losses) on equity investments and foreign currency translation gains (losses) that have been reflected as a component of shareholders’ equity and have not impacted net income. The following table summarizes the components of comprehensive income for the three and nine months ended September 30, 2006 and 2005:
| | Three Months Ended
September 30, | | Nine Months Ended
September 30, | |
| | 2006 | | 2005 | | 2006 | | 2005 | |
Net income | | $ | 10,362 | | $ | 54,229 | | $ | 24,607 | | $ | 68,767 | |
Change in unrealized gains (losses) on equity investments | | 314 | | 321 | | (1,857 | ) | 775 | |
Change in foreign currency translation gains (losses) | | 1,291 | | (813 | ) | 2,862 | | (960 | ) |
Comprehensive income | | $ | 11,967 | | $ | 53,737 | | $ | 25,612 | | $ | 68,582 | |
(4) EARNINGS PER SHARE
Basic earnings per share (EPS) excludes the dilutive effect of common stock equivalents and is computed by dividing net income by the weighted-average number of shares outstanding during the period. Diluted EPS includes the dilutive effect of common stock equivalents, which consist of stock options, and is computed using the weighted-average number of shares and common stock equivalents outstanding during the period.
The following table is a reconciliation of basic and diluted EPS for the three and nine months ended September 30, 2006 and 2005:
| | Three Months Ended
September 30, | | Nine Months Ended
September 30, | |
| | 2006 | | 2005 | | 2006 | | 2005 | |
| | | | | | | | | |
Net income | | $ | 10,362 | | $ | 54,229 | | $ | 24,607 | | $ | 68,767 | |
| | | | | | | | | |
Denominator: | | | | | | | | | |
Basic income per share – weighted average shares outstanding | | 32,430 | | 32,085 | | 32,503 | | 31,928 | |
Dilutive effect of common stock equivalents | | 616 | | 541 | | 632 | | 568 | |
Diluted income per share – adjusted weighted-average shares outstanding, assuming conversion of common stock equivalents | | 33,046 | | 32,626 | | 33,135 | | 32,496 | |
| | | | | | | | | |
Basic net income per common share | | $ | 0.32 | | $ | 1.69 | | $ | 0.76 | | $ | 2.15 | |
Diluted net income per common share | | $ | 0.31 | | $ | 1.66 | | $ | 0.74 | | $ | 2.12 | |
9
(5) INVESTMENTS IN UNCONSOLIDATED AFFILIATES
CH2M HILL routinely enters into joint ventures to service the needs of its clients. These joint ventures are formed to leverage the skills of the respective partners and include consulting, construction, design, project management and operations and maintenance contracts. Such arrangements are customary in the engineering and construction industry and generally are project specific. CH2M HILL’s risk of loss on joint ventures is similar to what the risk of loss would be if the project was self-performed, other than the fact that the risk is shared with CH2M HILL’s partner(s).
CH2M HILL’s interests in certain joint ventures are considered variable interest entities (VIE’s) under FASB Interpretation (FIN) No. 46 - revised, Consolidation of Variable Interest Entities (FIN 46(R)). CH2M HILL has classified entities identified as VIE’s into two groups, the first of which includes those entities that CH2M HILL has consolidated under the guidance of FIN 46(R), as CH2M HILL is considered the primary beneficiary, and the second group which includes those entities which CH2M HILL was not required to consolidate. As of September 30, 2006, the assets and liabilities of the identified VIE’s that were not consolidated are $126,395 and $119,739, respectively.
For VIE’s where CH2M HILL is not the primary beneficiary and those entities which are not VIE’s, CH2M HILL accounts for its investments in affiliated unconsolidated companies using the equity method of accounting. CH2M HILL’s proportionate share of net income (loss) is included as equity in earnings of joint ventures and affiliated companies in the accompanying condensed consolidated statements of income. As of September 30, 2006, CH2M HILL had the following significant investments in affiliated unconsolidated companies accounted for under the equity method of accounting:
| | % Ownership | |
Domestic: | | | |
ATKINSON/CH2M HILL, Joint Venture | | 30.0 | % |
AGVIQ-CH2M HILL Joint Venture | | 49.0 | % |
CH2M HILL/TILDEN COIL Joint Venture | | 50.0 | % |
CH2M HILL/URS Team, Joint Venture | | 50.0 | % |
CH2M HILL/ VT Griffin, Joint Venture | | 49.0 | % |
CH2M – WG Idaho, LLC | | 50.5 | % |
Coastal Estuary Services, LLC | | 49.9 | % |
Connecting Idaho Partners | | 49.0 | % |
Golden Crossing Constructors, Joint Venture | | 33.3 | % |
IAP–Hill, LLC | | 25.0 | % |
Kaiser-Hill Company, LLC | | 50.0 | % |
Kakivik Asset Management, LLC | | 33.0 | % |
Milwaukee Transportation Partners, LLC | | 50.0 | % |
MW/CH2M HILL, Joint Venture | | 50.0 | % |
National Security Technologies, LLC | | 10.0 | % |
OMI Caribe LLC | | 50.0 | % |
OMI/Thames Water Stockton, Inc. | | 50.0 | % |
Parsons CH2M HILL Program Management Consultants, Joint Venture | | 45.0 | % |
Stockton D/B Joint Venture | | 50.0 | % |
Washington Closure, LLC | | 30.0 | % |
Washington Group-IDC | | 24.0 | % |
Foreign: | | | |
CH2M HILL BECA, Ltd. | | 50.0 | % |
CH2M HILL/ Parsons, Joint Venture | | 50.0 | % |
CH2M PB JV, Pte, Ltd. | | 50.0 | % |
CHDE Water | | 50.0 | % |
CHBM Water Joint Venture | | 50.0 | % |
CLM Delivery Partner, Limited | | 37.5 | % |
Maroochy Alliance Joint Venture | | 40.0 | % |
Simo Management Inc. | | 49.9 | % |
10
As of September 30, 2006 and December 31, 2005, the investments in unconsolidated affiliates were $41,248 and $114,679, respectively. On October 13, 2005, Kaiser-Hill declared physical completion of the activities at the site. During the first quarter of 2006, Kaiser-Hill distributed earnings of $85,000. No amounts from Kaiser-Hill have been distributed since that date. Consequentially, CH2M HILL’s remaining investment in Kaiser-Hill as of September 30, 2006 was $2,295, as compared to $87,295 as of December 31, 2005.
In the first quarter of 2005, CH2M HILL and Washington Group International formed a joint venture, CH2M-WG Idaho, LLC (CH2M-WG Idaho) of which CH2M HILL owns a 50.5% interest. The contract is for the U.S. Department of Energy’s (DOE) cleanup of a federal nuclear facility located in Idaho. CH2M-WG Idaho began operations in the third quarter of 2005. During the three and nine months ended September 30, 2006, CH2M HILL recognized earnings from CH2M-WG Idaho of $1,858 and $7,591, respectively, and received $3,030 and $8,333, respectively, of distributed earnings. CH2M HILL’s investment in CH2M-WG Idaho as of September 30, 2006 was $17,863 compared to $5,979 as of December 31, 2005.
Summarized unaudited financial information for CH2M HILL’s unconsolidated affiliates for the three and nine months ended September 30, 2006 and 2005 is as follows:
| | Three Months Ended
September 30, | | Nine Months Ended
September 30, | |
| | 2006 | | 2005 | | 2006 | | 2005 | |
RESULTS OF OPERATIONS: | | | | | | | | | |
Revenue | | $ | 343,208 | | $ | 564,714 | | $ | 967,723 | | $ | 1,056,290 | |
Direct costs | | (332,522 | ) | (393,422 | ) | (924,903 | ) | (844,359 | ) |
Gross margin | | 10,686 | | 171,292 | | 42,820 | | 211,931 | |
General and administrative expenses | | (1,439 | ) | (2,889 | ) | (7,226 | ) | (10,235 | ) |
Operating income | | 9,247 | | 168,403 | | 35,594 | | 201,696 | |
Other income (expense), net | | 790 | | (199 | ) | 3,414 | | (65 | ) |
Net income | | $ | 10,037 | | $ | 168,204 | | $ | 39,008 | | $ | 201,631 | |
(6) INTANGIBLE ASSETS AND GOODWILL
Intangible assets with finite lives consist of the following:
| | Cost | | Accumulated
Amortization | | Net finite-lived
intangible
assets | |
September 30, 2006 | | | | | | | |
| | | | | | | |
Contracts-in-place | | $ | 23,759 | | $ | (23,022 | ) | $ | 737 | |
Patents and trademarks | | 5,219 | | (5,219 | ) | — | |
Contracted backlog | | 2,230 | | (2,099 | ) | 131 | |
Non-compete agreements and other | | 807 | | (239 | ) | 568 | |
Total finite-lived intangible assets | | $ | 32,015 | | $ | (30,579 | ) | $ | 1,436 | |
| | | | | | | |
December 31, 2005 | | | | | | | |
| | | | | | | |
Contracts-in-place | | $ | 23,759 | | $ | (20,049 | ) | $ | 3,710 | |
Patents and trademarks | | 5,219 | | (5,206 | ) | 13 | |
Contracted backlog | | 2,230 | | (734 | ) | 1,496 | |
Non-compete agreements and other | | 807 | | (184 | ) | 623 | |
Total finite-lived intangible assets | | $ | 32,015 | | $ | (26,173 | ) | $ | 5,842 | |
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The contracts-in-place are amortized on a straight-line basis over the total life of the contracts up to seven years. The other intangible assets are being amortized over their expected lives up to nine years. The amortization expense reflected in the accompanying condensed consolidated statements of income was $1,409 and $1,974 for the three months ended September 30, 2006 and 2005, respectively, and $4,406 and $5,926 for the nine months ended September 30, 2006 and 2005, respectively.
Indefinite-lived intangible assets consist of the following:
| | September 30,
2006 | | December 31,
2005 | |
Goodwill | | $ | 41,968 | | $ | 40,730 | |
Tradename | | 20,326 | | 20,326 | |
Total indefinite-lived intangible assets | | $ | 62,294 | | $ | 61,056 | |
During the first quarter of 2006, CH2M HILL recorded additional goodwill as a result of earn-out targets being achieved on an acquisition.
(7) LINE OF CREDIT
CH2M HILL entered into a Senior Unsecured Revolving Credit Agreement (the Credit Agreement) on September 29, 2006 which replaced a prior credit facility. The Credit Agreement provides for a $250,000 revolving credit facility which expires on September 29, 2011. The Credit Agreement includes an option to increase the initial borrowing capacity by up to an additional $100,000. While the Credit Agreement may be used for general corporate purposes and permitted acquisitions, it also provides that up to $200,000 is available for the issuance of letters of credit to support various trade activities. At the option of CH2M HILL, the Credit Agreement bears interest at a rate equal to either the London InterBank Offered Rate (LIBOR) plus 0.75% to 1.50%, or the lender’s applicable base rate less 0.25% up to 0.00% based on CH2M HILL’s ratio of funded debt to earnings before interest, taxes, depreciation and amortization, as defined. A commitment fee of approximately 0.10% to 0.25% per year on the unused portion of the line of credit is payable based on CH2M HILL’s ratio of funded debt to earnings before interest, taxes, depreciation and amortization, as defined. As of September 30, 2006, CH2M HILL had no outstanding borrowings on the Credit Agreement.
The Credit Agreement contains customary financial and other covenants, including minimum levels of net worth, a minimum coverage ratio of certain fixed charges, and a maximum leverage ratio of earnings before interest, taxes, depreciation and amortization to funded debt, as well as customary limitations on other indebtedness, liens, acquisitions, mergers and dispositions. The Credit Agreement also contains customary events of default, including a default of covenant, a material inaccuracy of representations or warranties, bankruptcy events, and a change of control. As of September 30, 2006, CH2M HILL was in compliance with the covenants required by the Credit Agreement.
The Credit Agreement replaces CH2M HILL’s $160,000 senior unsecured revolving credit agreement initially entered into in 2003. During the three and nine months ended September 30, 2006, CH2M HILL borrowed an average of $2,544 and $21,204, respectively, for general corporate purposes.
At September 30, 2006, issued and outstanding letters of credit of $34,881 were reserved against the borrowing base of the Credit Agreement. At December 31, 2005, issued and outstanding letters of credit of $25,663 were reserved against the borrowing base of the Former Credit Agreement.
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(8) COMMITMENTS AND CONTINGENCIES
CH2M HILL maintains a variety of commitments that are generally made available to provide support for various provisions in its engineering and construction contracts. Letters of credit are provided to clients in the ordinary course of the contracting business in lieu of retention or for performance and completion guarantees on engineering and construction contracts. CH2M HILL also posts surety bonds, which are contractual agreements issued by a surety, for the purpose of guaranteeing our performance on contracts. Bid bonds are also issued by a surety to protect owners and are subject to full or partial forfeiture for failure to perform obligations arising from a successful bid.
CH2M HILL is party to various contractual guarantees and legal actions arising in the normal course of business. Because a large portion of CH2M HILL’s business comes from federal, state and municipal sources, CH2M HILL’s procurement practices at times are also subject to review and occasional investigations by U.S. and state attorneys offices. Such state and U.S. government investigations, whether relating to government contracts or conducted for other reasons, could result in administrative, civil or criminal liabilities, including repayments, fines or penalties or could lead to suspension or debarment from future U.S. government contracting. These investigations often take years to complete and many result in no adverse action. Damages assessed in connection with and the cost of defending any such actions could be substantial. While the outcome of pending proceedings are often difficult to predict, CH2M HILL’s management believes that the levels of insurance coverage (after retentions and deductibles) are generally adequate to cover CH2M HILL’s liabilities, if any, with regard to such claims. Any amounts that are probable of payment by CH2M HILL are accrued when such amounts are estimable.
In January 2006, a subsidiary entered into a Deferred Prosecution Agreement (DPA) with the office of the United States Attorney for the District of Connecticut. The DPA relates to an investigation of a Clean Water Act (CWA) violation at two wastewater treatment facilities in Connecticut. Pursuant to the DPA, the subsidiary contributed $2,000 to community projects and is taking other agreed upon steps to enhance our CWA compliance procedures at the two wastewater treatment facilities in Connecticut. Provided CH2M HILL complies with its obligations under the DPA, the U.S. District Attorney for the District of Connecticut will recommend dismissal of all actions against the subsidiary in connection with this matter. The violation related to failure to comply with sampling and reporting requirements of the CWA and there is no evidence the violation resulted in harm to human health or the environment.
CH2M HILL has presented a claim to the Internal Revenue Service (IRS) relating to the research and experimentation tax credit for the years 1996-2003. Although CH2M HILL is seeking resolution with the IRS, CH2M HILL only recognizes tax benefits related to these credits for financial statement purposes when it is probable that such benefits will be realized. The amount of the tax credit claimed is significant; however, the ultimate amount to be realized and the timing of the recognition of the tax credit will depend upon the final resolution with the IRS.
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis is intended to assist in providing an understanding of our financial condition, changes in financial condition and results of operations as a whole and for each of our operating segments including:
· Factors affecting our business
· Our revenue and profits
· The source of our revenue and profits
· Variations of revenue and profits from year to year
· Cash sources and utilizations
· The impact of the above on our overall financial condition
The capitalized terms used below have been defined in the notes to the condensed consolidated financial statements. In the following text, the terms, “we,” “our,” “our company,” and “us” may refer to CH2M HILL.
The following discussion and information contains, in addition to historical information, forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including without limitation, statements containing the words “believes,” “anticipates,” “expects” and words of similar import and statements regarding our strategy, financial performance and operations that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those described under Item 1A, Risk Factors (which is expressly incorporated herein by reference) of our Annual Report on Form 10-K for the year ended December 31, 2005, filed with the SEC on February 27, 2006. You should review this section in conjunction with our financial statements and related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2005.
Our reports are available free of charge through our website as soon as reasonably practicable after we file them with, or furnish them to, the SEC. Our website address is www.ch2m.com. Our SEC filings, which include our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to such filings, are located in the About Us/Employee Ownership section of our website.
Overview
We are one of the largest engineering services firms worldwide and are employee-owned. Our business provides engineering, construction, operation, major project management and related technical services to municipal, state, federal and private sector clients worldwide. Founded in 1946, we operate in more than 110 countries and have over 17,000 employees worldwide.
We believe we provide our clients with innovative project delivery using cost-effective approaches and advanced technologies. We continuously monitor acquisition and investment opportunities that will expand our portfolio of services, add value to the projects undertaken for clients, or enhance our capital strength. We believe that we are well positioned geographically, technically and financially to compete worldwide in the key markets we have elected to pursue and the clients we serve.
The engineering and construction industry continues to undergo substantial change as public and private clients privatize and outsource many of the services that were formerly provided internally. Numerous mergers and acquisitions in the industry have resulted in a group of larger firms that offer a full complement of single-source services including studies, designs, construction, operations, maintenance and in some instances, facility ownership. Included in the current trend is the movement towards longer-term contracts for the expanded array of services, e.g., 5 to 20 year contracts. These larger, longer, more full-service contracts require us to have substantially greater financial capital than has historically been necessary to remain competitive.
We provide services to our clients through three operating segments — Federal, Civil Infrastructure and Industrial — which are aligned with the types of clients we serve. The structure provides for better decision making on an enterprise-wide basis. Our Federal segment generally provides a comprehensive range of services to the U.S. Federal government as well as services to international governments. Our Civil Infrastructure segment generally provides a comprehensive range of services to various state and local governments. Our Industrial segment generally provides a comprehensive range of services to various private sector clients.
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Results of Operations
Revenue and Pre-Tax Profit (Loss) of our Reportable Segments
Revenue and pre-tax profit (loss) for the three and nine months ended September 30, 2006 and 2005 by operating segment were as follows:
Three Months Ended September 30, 2006 and 2005
(In millions)
| | Revenue | | Pre-Tax Profit (Loss) | |
| | 2006 | | 2005 | | 2006 | | 2005 | |
Federal | | $ | 309.4 | | 31.0 | % | $ | 279.9 | | 34.9 | % | $ | 11.6 | | $ | 84.4 | |
Civil Infrastructure | | 333.6 | | 33.5 | % | 270.0 | | 33.7 | % | 20.4 | | 7.1 | |
Industrial | | 353.8 | | 35.5 | % | 251.2 | | 31.4 | % | (10.7 | ) | 1.9 | |
Corporate | | — | | — | | — | | — | | (4.1 | ) | (4.2 | ) |
Total | | $ | 996.8 | | 100.0 | % | $ | 801.1 | | 100.0 | % | $ | 17.2 | | $ | 89.2 | |
Nine Months Ended September 30, 2006 and 2005
(In millions)
| | Revenue | | Pre-Tax Profit (Loss) | |
| | 2006 | | 2005 | | 2006 | | 2005 | |
Federal | | $ | 1,155.8 | | 38.5 | % | $ | 837.8 | | 37.0 | % | $ | 52.1 | | $ | 97.5 | |
Civil Infrastructure | | 968.8 | | 32.3 | % | 760.5 | | 33.5 | % | 41.0 | | 22.3 | |
Industrial | | 877.7 | | 29.2 | % | 668.9 | | 29.5 | % | (38.5 | ) | 4.3 | |
Corporate | | — | | — | | — | | — | | (14.1 | ) | (10.7 | ) |
Total | | $ | 3,002.3 | | 100.0 | % | $ | 2,267.2 | | 100.0 | % | $ | 40.5 | | $ | 113.4 | |
Federal
Revenue increased for the three and nine months ended September 30, 2006, compared to the same periods in the prior year by $29.5 million or 10.5% and $318.0 million or 38.0%, respectively. Our government facilities and infrastructure and environmental services businesses reported a significant increase in revenue for the three and nine months ended September 30, 2006, compared to the same periods in the prior year, primarily due to work associated with the Hurricane Katrina relief and cleanup efforts during the first six months of 2006. Partially offsetting these favorable results was a decline in our nuclear business primarily due to reduced spending on our contract with the DOE at the Hanford River Protection Project.
Pre-tax profit decreased for the three and nine months ended September 30, 2006, compared to the same periods in the prior year by $72.8 million or 86.3% and $45.4 million or 46.6%, respectively. The decrease in pre-tax profits is primarily associated with the completion of the Kaiser-Hill project which contributed $76.2 million and $86.3 million in equity in earnings of joint ventures during the three and nine months ended September 30, 2005, respectively. The decrease in pre-tax profit is also due to lower pre-tax profits at the Mound project as it is in the final stages of completion. This decrease is partially offset by pre-tax profits from Hurricane Katrina relief in the government facilities and infrastructure business in addition to improved project performance including the CH2M HILL – WG Idaho project which contributed $1.9 million and $7.6 million in equity earnings of joint ventures during the three and nine months ended September 30, 2006, respectively.
Civil Infrastructure
Revenue increased for the three and nine months ended September 30, 2006, compared to the same periods in the prior year by $63.6 million or 23.6% and $208.3 million or 27.4%, respectively. Each of the three businesses comprising the Civil Infrastructure operating segment reported a significant increase in revenue. The largest increase was attributable to growth in our water business due primarily to an increase in several projects in North America and international markets. The growth in North America is primarily due to a water treatment project in Southern California and the growth in our international markets is primarily due to a sewerage system project in Singapore. Our transportation business reported continued growth due to successful pursuits in design/build projects and a slight increase in consulting. These new projects included significant highway contracts in Colorado, Washington, Virginia and Vancouver, British Columbia and increased program management projects. Our operations and maintenance business (O&M) reported a significant improvement in revenue compared to the same periods in the prior year primarily due to a new municipal operations project in Georgia, an amendment on an existing project and new work in Las Vegas and Puerto Rico.
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Pre-tax profit increased for the three and nine months ended September 30, 2006, compared to the same periods in the prior year by $13.3 million or 187.3% and $18.7 million or 83.9%, respectively. The increase in pre-tax profits is primarily associated with our water business which produced significant improvements due to an increase in North American consulting and international revenue as described above. Our O&M and transportation businesses also experienced growth in pre-tax profits due to revenue growth, as described above.
Industrial
Revenue increased for the three and nine months ended September 30, 2006, compared to the same periods in the prior year by $102.6 million or 40.8% and $208.8 million or 31.2%, respectively. The increase in revenue is primarily due to significant new business in our power, manufacturing, energy and industrial systems and communications solutions businesses. For the nine months ended September 30, 2006, compared to the same period in the prior year, we experienced significant growth in our power business driven primarily from two new contracts with major utility companies. Our manufacturing business has experienced new business growth in 2006 as a result of business development pursuits. The energy and industrial systems business revenue growth for the current quarter was associated with operations and maintenance support services at two petroleum facilities and increased consulting business. Our communications business has had signs of renewed spending by clients particularly in the wireless sectors worldwide which has increased revenue. These increases were partially offset from declines in our chemicals and plastics business due to low volume and a decline in our bio-pharma businesses due to the completion of several projects in Puerto Rico and the continued delay in some customer awards of large projects.
The Industrial segment reported pre-tax loss of $10.7 million and $38.5 million for the three and nine months ended September 30, 2006, respectively, and pre-tax income of $1.9 million and $4.3 million for the three and nine months ended September 30, 2005, respectively. The pre-tax loss was primarily due to significant cost overruns on a project to construct a manufacturing facility. This project was bid under fixed price commercial terms where the risk of certain variances remains with the Company. The project has experienced increased costs due to project delivery issues and increased commodity prices. In addition, the clean up efforts required from Hurricane Katrina have caused significant shortages in experienced craft laborers in the area and thus have materially increased wage rates and reduced overall productivity. The project is scheduled for completion in the fourth quarter of 2006. While management believes that the current estimated costs at completion are reasonable, uncertainties exist until the project is complete.
Equity in Earnings of Joint Ventures and Affiliated Companies
For the three and nine months ended September 30, 2006, we reported total equity in earnings of joint ventures and affiliated companies of $3.4 million and $16.8 million, respectively. For the three and nine months ended September 30, 2005, we reported total equity in earnings of joint ventures and affiliated companies of $82.9 million and $99.4 million, respectively. During the three and nine months ended September 30, 2006, we recognized no earnings from Kaiser-Hill compared to $76.2 million and $86.3 million in earnings for the three and nine months ended September 30, 2005, respectively. The DOE continues to review our submitted costs and perform normal cost audit activities associated with any governmental contract. We expect these activities will continue throughout 2006 and beyond and believe any findings will not have a material effect on our earnings. During the first quarter of 2006, Kaiser-Hill distributed earnings of $85.0 million. No amounts from Kaiser-Hill have been distributed since that date. Our investment in Kaiser-Hill as of September 30, 2006 was $2.3 million compared to $87.3 million at December 31, 2005.
Partially offsetting the decrease in earnings from Kaiser-Hill was the results of operations from our joint venture with Washington Group International, CH2M-WG Idaho. This joint venture is completing a DOE contract for the cleanup of a nuclear facility located in Idaho. We own a 50.5% interest in CH2M–WG Idaho. Operations began in the third quarter of 2005 and are expected to last approximately seven years. During the three and nine months ended September 30, 2006, CH2M HILL recognized earnings from CH2M–WG Idaho of $1.9 million and $7.6 million, respectively, and had recognized no earnings related to the joint venture during the three and nine months ended September 30, 2005. Our investment in CH2M–WG Idaho as of September 30, 2006 was $17.9 million compared to $6.0 million as of December 31, 2005.
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Corporate Expenses
Corporate expenses represent centralized management costs that are not allocable to individual operating segments and primarily include expenses associated with administrative functions such as executive management, legal, treasury, accounting and tax. Corporate expenses for the three and nine months ended September 30, 2006 were $4.1 million and $14.1 million, respectively, compared to $4.2 million and $10.7 million for the same periods in the prior year. Although corporate expenses for the three months ended September 30, 2006 compared to the same period in the prior year remained relatively flat, the increase in expense for the nine months ended September 30, 2006 compared to the same period in the prior year was due primarily to increased interest expense, payroll costs and increased incentive compensation costs.
Provision for Income Taxes
Our effective tax rate for the three months ended September 30, 2006 was 39.6% compared to 39.2% for the same period in the prior year and the tax rate for the nine months ended September 30, 2006 was 39.2% compared to 39.3% for the same period in the prior year. Our effective tax rate continues to be higher than the U.S. statutory income tax rate of 35.0% due to the effect of state income taxes, non-deductible foreign net operating losses and disallowed portions of meals and entertainment expenses.
We have presented a claim to the IRS relating to the research and experimentation tax credit for the years 1996-2003. Although we are seeking resolution with the IRS, we only recognize tax benefits related to these credits for financial statement purposes when it is probable that such benefits will be realized. The amount of the tax credit claimed is significant. However, the ultimate amount to be realized and the timing of the recognition of the tax credit will depend upon the final resolution with the IRS.
Liquidity and Capital Resources
Our primary sources of liquidity are cash flows from operations and borrowings under our revolving line of credit. Our primary uses of cash are to fund our working capital, acquisitions, capital expenditures and purchases of stock presented on our internal market. During the nine months ended September 30, 2006, our operating cash flows increased $27.6 million, from $31.8 million cash provided by operating activities to $59.4 million cash provided by operating activities. This increase was primarily due to the receipt of funds from our joint ventures, primarily Kaiser-Hill, which was partially offset by increased project spending, an increase in the payment of accounts payable and income tax payments made in 2006.
Billings and collections on accounts receivable can impact our operating cash flows. We continuously monitor collection efforts and assess the allowance for doubtful accounts. Based on our assessment at September 30, 2006, we have deemed the allowance for doubtful accounts to be adequate; however, future economic conditions may adversely impact some of our clients’ ability to pay our bills or the timeliness of their payments. Consequently, the timing of the receipt of cash may impact our ability to meet our operating needs.
We are a professional services organization and, therefore, we do not require significant outflows of cash for capital expenditures. Our capital expenditures are primarily for office equipment and leasehold improvements. Capital expenditures during the nine months ended September 30, 2006 and 2005 were $8.8 million and $7.4 million, respectively. We have a formal operating lease program under which most of our computers and related equipment is procured on an ongoing basis.
We used $30.5 million and $19.4 million in cash for purchases of stock presented on our internal market during the nine months ended September 30, 2006 and 2005, respectively.
We entered into a credit agreement in September 2006 which replaced our prior credit facility. The new credit agreement provides for a $250.0 million revolving credit facility which expires on September 29, 2011. The credit agreement includes an option to increase the initial borrowing capacity by up to an additional $100.0 million. While the credit agreement may be used for general corporate purposes and permitted acquisitions, it also provides that up to $200.0 million is available for the issuance of letters of credit to support various trade activities. At our option, the credit agreement bears interest at a rate equal to either the LIBOR plus 0.75% to 1.50%, or the lender’s applicable base rate less 0.25% up to 0.00% based on our ratio of funded debt to earnings before interest, taxes, depreciation and amortization, as defined. A commitment fee of approximately 0.10% to 0.25% per year on the unused portion of the line of credit is payable based on our ratio of funded debt to earnings before interest, taxes, depreciation and amortization, as defined. As of September 30, 2006, we had no outstanding borrowings on the credit agreement.
It is likely that we will utilize the credit agreement periodically during the remainder of 2006 depending on the timing of cash receipts and disbursements.
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The credit agreement contains customary financial and other covenants, including minimum levels of net worth, a minimum coverage ratio of certain fixed charges, and a maximum leverage ratio of earnings before interest, taxes, depreciation and amortization to funded debt, as well as customary limitation on other indebtedness, liens, acquisitions, mergers and dispositions. The credit agreement also contains customary events of default, including a default of covenant, a material inaccuracy of representations or warranties, bankruptcy events, and a change in control. As of September 30, 2006, we were in compliance with the covenants required by the credit agreement.
At September 30, 2006, issued and outstanding letters of credit of $34.9 million were reserved against the borrowing base of the credit agreement. At December 31, 2005, issued and outstanding letters of credit of $25.7 million were reserved against the borrowing base of the prior credit agreement.
Based on our total cash and credit capacity at September 30, 2006 of $286.6 million, we believe we have sufficient resources to fund our operations, anticipated capital expenditure requirements, as well as purchases of stock presented on our internal market, should we choose to do so, for the next 12 months and beyond.
The following table reflects our available capacity as of September 30, 2006 (in millions):
Cash on hand | | | | $ | 71.5 | |
Line of credit capacity | | $ | 250.0 | | | |
Issued letters of credit | | (34.9 | ) | | |
Net credit capacity available | | | | 215.1 | |
Total capacity | | | | $ | 286.6 | |
| | | | | | | |
Off-Balance Sheet Arrangements
We are party to three lease agreements related to our corporate headquarters and three adjacent buildings. One of the lease agreements calls for monthly lease payments of approximately $0.4 million through March 3, 2013 and requires that we guarantee a residual value of the facilities for approximately $42.0 million. Upon completion of the lease term, we have the option to purchase the facilities for $53.0 million. The second lease agreement calls for monthly lease payments at a variable interest rate, estimated to be approximately $0.1 million per month, based on current interest rates. The lease agreement requires that we guarantee a residual value of this building of approximately $17.6 million. Upon completion of the lease term, we have the option to purchase the additional building from the lessor for $20.8 million. The lease matures on September 28, 2008 and provides for five one year renewal options.
The third operating lease facility is being used for the construction of a fourth building adjacent to our corporate headquarters in Colorado. The building is expected to be completed in 2007 and the lease term will be approximately sixty-nine months. Annual payments on the lease are estimated to be approximately $1.5 million and the lease requires us to guarantee a residual value of the facility equal to an amount not greater than 85% of the total facility costs. The total facility costs are estimated to be $22.5 million.
Aggregate Contractual Obligations
We maintain a variety of commercial commitments that are generally made available to provide support for various provisions in engineering and construction contracts. Letters of credit are available to clients in the ordinary course of the contracting business in lieu of retention or for performance and completion guarantees on engineering and construction contracts. We also post surety bonds, which are contractual agreements issued by a surety, for the purpose of guaranteeing our performance on contracts. Bid bonds are also issued by a surety to protect owners and are subject to full or partial forfeiture for failure to perform obligations arising from a successful bid.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect both the results of operations as well as the carrying values of our assets and liabilities. Some of our accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. We base estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities as of the date of the financial statements that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
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The accounting policies that we believe are most critical to the understanding of our financial condition and results of operations and require complex management judgment are summarized below. Further detail and information regarding our critical accounting policies and estimates are included in our Annual Report on Form 10-K for the year ended December 31, 2005.
Revenue Recognition
We earn our revenue from different types of services under a variety of different types of contracts, including cost-plus, firm fixed-price and time-and-materials. In recognizing revenue, we evaluate each contractual arrangement to determine the appropriate authoritative literature to apply. We recognize revenue and profit for a majority of our contracts on the percentage-of-completion method where progress towards completion is measured by relating the actual cost of work performed to date to the current estimated total cost of the respective contracts. In making such estimates, judgments are required to evaluate potential variances in schedule, the cost of materials and labor, productivity, liability claims, contract disputes, and achievement of contract performance standards.
Change orders are included in total estimated contract revenue when it is probable that the change order will result in an addition to contract value and can be reliably estimated. Losses on construction and engineering contracts in process are recognized in their entirety when the loss becomes evident and the amount of loss can be reasonably estimated.
We have a history of making reasonable estimates of the extent of progress towards completion, total contract revenue and total contract costs on our engineering and construction contracts. However, due to uncertainties inherent in the estimation process, it is possible that actual total contract revenue and completion costs may vary from estimates.
A portion of our contracts are operations and management type contracts. Typically, these contracts may include fixed and variable components along with incentive fees. Revenue is recognized on operations and management contracts on a straight line basis over the life of the contract once we have an arrangement, delivery has occurred, the price is fixed or determinable and collectibility is reasonably assured.
Income Taxes
In determining net income for financial statement purposes, we must make estimates and judgments in the calculation of tax assets and liabilities and in the determination of the recoverability of the deferred tax assets. The tax assets and liabilities arise from temporary differences between the tax return and the financial statement recognition of revenue and expenses.
We must assess the likelihood that we will be able to recover our deferred tax assets. If recovery is not likely, we must increase our tax provision by recording a valuation allowance for the deferred tax assets that we estimate will not ultimately be recoverable.
In addition, the calculation of our tax assets and liabilities involves dealing with uncertainties in the application of complex tax regulations. We may recognize a tax asset or adjust taxes payable for anticipated state or federal tax credits, such as those relating to the research and experimentation tax credit.
Pension Benefits
We have two frozen and one active noncontributory defined benefit pension plans. Our earnings and shareholders’ equity may be impacted by these qualified defined benefit plans because SFAS No. 87, Employers’ Accounting for Pensions (SFAS 87), requires that the amounts we record be computed using actuarial valuations. These valuations include many assumptions, but the two most critical assumptions are the discount rate and the expected long-term rate of return on plan assets. We use judgment in selecting these assumptions each year because we have to consider not only current market conditions, but also make judgments about future market trends, changes in the interest rates and equity market performance. We also have to consider factors like the timing and amounts of expected contributions to the plans and benefit payments to plan participants.
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New Accounting Standards
In February 2006, the FASB issued SFAS 155, which amends SFAS 133 and SFAS 140. SFAS 155 simplifies the accounting for certain derivatives embedded in other financial instruments by allowing them to be accounted for as one if the holder elects to account for the whole instrument on a fair value basis. SFAS 155 also clarifies and amends certain other provisions of SFAS 133 and SFAS 140. SFAS 155 is effective for all financial instruments acquired, issued or subject to a remeasurement event occurring in fiscal years beginning after September 15, 2006. Earlier adoption is permitted, provided the company has not yet issued financial statements, including for interim periods, for that fiscal year. We do not expect the adoption of SFAS 155 to have a material impact on our consolidated financial position, results of operations or cash flows.
In July 2006, the FASB issued FIN 48 which is effective beginning on January 1, 2007. FIN 48 establishes a different process to measure the impact of uncertainty associated with an income tax position. Under FIN 48, the effect of an income tax position on the income tax provision must be recognized at the amount that is more likely than not to be sustained upon examination by the relevant taxing authority. FIN 48 also requires additional disclosures about unrecognized tax benefits associated with uncertain income tax positions and a reconciliation of the change in the unrecognized benefit. We are evaluating the impact that the adoption of FIN 48 will have on our financial results.
In September 2006, the FASB issued SFAS 157, which defines fair value, establishes guidelines for measuring fair value and expands disclosure regarding fair value measurements. SFAS 157 does not require new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those years. Earlier adoption is permitted, provided we have not yet issued financial statements, including interim periods for that fiscal year. We do not expect that the adoption of SFAS 157 will have a material impact on our financial results.
In September 2006, the FASB issued SFAS 158, which requires employers to recognize the funded status of pension and other postretirement benefit plans on the balance sheet and to recognize changes in the funded status through comprehensive income in the year in which the changes occur. For companies that are not publicly traded, SFAS 158 is effective for the fiscal years ending after June 15, 2007, however footnote disclosure is required for fiscal years ending after December 15, 2006, unless it has applied the recognition provisions of the statement in preparing the financial statements. SFAS 158 also requires plan assets and benefit obligations to be measured as of the balance-sheet date for fiscal years ending after December 15, 2008. Earlier adoption is permitted provided early application is applied to all of our employer benefit plans and we have not yet issued financial statements including for interim periods, for that fiscal year. We are evaluating the impact that the adoption of SFAS 158 will have on our financial results.
In September 2006, the SEC issued SAB 108, which provides interpretive guidance on how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in the current year financial statements. SAB 108 requires registrants to quantify misstatements using both the income statement and balance approach and evaluate whether either approach results in a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. SAB 108 is effective for fiscal years ending on or after November 15, 2006, with earlier adoption encouraged. We do not expect that the adoption of SAB 108 will have a material impact on our financial results.
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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the ordinary course of our operations, we are exposed to certain market risks, primarily changes in foreign currency exchange rates and interest rates. This risk is monitored to limit the effect of foreign currency exchange rate and interest rate fluctuations on earnings and cash flow.
Foreign currency exchange rates. We are exposed to foreign currency exchange risks in the normal course of our international business operations. Our investments in foreign subsidiaries with a functional currency other than the U.S. dollar are generally considered long-term. We may engage in forward foreign exchange contracts to reduce our economic exposure to changes in exchange rates. Generally, forward contracts are entered into to hedge specific commitments and anticipated transactions but not for speculative or trading purposes.
Interest rates. Our interest rate exposure is generally limited to our unsecured revolving credit agreement and a building lease agreement that calls for monthly lease payments at a variable interest rate. Historically, we have used short-term variable rate borrowings under the unsecured revolving credit agreement on a limited basis. There were no amounts outstanding under the unsecured revolving credit agreement at September 30, 2006. Our variable lease payments on the building lease agreement are estimated to be approximately $0.1 million per month, based on current interest rates. We have assessed the market risk exposure on these financial instruments and determined that any significant changes to the fair value of these instruments would not have a material impact on our consolidated results of operations, financial position or cash flows. Additionally, management believes that a change of 100 basis points in interest rates would not have a material impact on our consolidated results of operations.
Item 4. CONTROLS AND PROCEDURES
We carried out an evaluation as of the last day of the period covered by this Quarterly Report on Form 10-Q, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (Exchange Act). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures (a) are effective to ensure that information required to be disclosed by us in reports filed or submitted under the Exchange Act is timely recorded, processed, summarized and reported and (b) include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in reports filed or submitted under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
There have been no changes in our internal control over financial reporting during the quarter ended September 30, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Part II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
We are a party to various contractual guarantees and legal actions arising in the normal course of our business. From time-to-time, agencies of the U.S. government investigate whether we conduct our operations in accordance with applicable regulatory requirements. Because a large portion of our business comes from federal, state, and municipal sources, our procurement practices at times also are subject to review and occasional investigations by U.S. and state attorneys offices. Such state and U.S. government investigations, whether relating to government contracts or conducted for other reasons, could result in administrative, civil or criminal liabilities, including repayments, fines or penalties. These investigations often take years to complete and many result in no adverse action. Damages assessed in connection with and the cost of defending any such actions could be substantial. While the outcome of pending proceedings are often difficult to predict, as of the date of this filing, our management believes that no ongoing litigation or investigation is likely to result in a material adverse impact on our condensed consolidated financial statements.
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Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Issuer Purchases of Equity Securities
The following table covers the purchases of our securities by CH2M HILL during the period covered by this report.
Period | | Total Number of
Shares Purchased | | Average Price Paid
per Share | | Total Number of Shares
Purchased as Part of Publicly
Announced Plans or Programs | | Maximum Number of Shares
that May Yet Be Purchased
Under the Plans or Programs | |
July (a) | | 4,819 | | $ | 17.83 | | — | | — | |
August | | — | | — | | — | | — | |
September (b) | | 440,179 | | 18.70 | | — | | — | |
Total | | 444,998 | | 18.69 | | — | | — | |
| | | | | | | | | | |
(a) Shares purchased by CH2M HILL from terminated employees.
(b) Shares purchased by CH2M HILL in the Internal Market.
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Item 6. EXHIBITS
Exhibits | | |
| | |
*10.1 | | Senior Unsecured Revolving Credit Agreement dated as of September 29, 2006, Wells Fargo Bank, National Association, as Agent and Arranger filed herein |
| | |
* 31.1 | | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | |
*31.2 | | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | |
*32.1 | | Certification of Chief Executive Officer pursuant to the requirements set forth in Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. Section 1350) |
| | |
*32.2 | | Certification of Chief Financial Officer pursuant to the requirements set forth in Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. Section 1350) |
*Filed herewith
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| CH2M HILL Companies, Ltd. |
| |
| |
Date: November 3, 2006 | /s/ Samuel H. Iapalucci | |
| Samuel H. Iapalucci |
| Executive Vice President and Chief Financial Officer |
| |
| |
| /s/ JoAnn Shea | |
| JoAnn Shea |
| Vice President and Chief Accounting Officer |
| | | |
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Index of Exhibits
*10.1 | | Senior Unsecured Revolving Credit Agreement dated as of September 29, 2006, Wells Fargo Bank, National Association, as Agent and Arranger filed herein |
| | |
* 31.1 | | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | |
*31.2 | | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | |
*32.1 | | Certification of Chief Executive Officer pursuant to the requirements set forth in Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. Section 1350) |
| | |
*32.2 | | Certification of Chief Financial Officer pursuant to the requirements set forth in Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. Section 1350) |
*Filed herewith
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