UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2007
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 May 4, 2007 was 32,909,259.
CH2M HILL COMPANIES, LTD.
TABLE OF CONTENTS
2
CH2M HILL COMPANIES, LTD.
Consolidated Balance Sheets
(Unaudited)
(In thousands, except share data)
| | March 31, 2007 | | December 31, 2006 | |
ASSETS | | | | | |
Current assets: | | | | | |
Cash and cash equivalents | | $ | 89,888 | | $ | 105,205 | |
Available-for-sale securities | | 55,920 | | 30,898 | |
Receivables, net: | | | | | |
Client accounts | | 408,062 | | 449,790 | |
Unbilled revenue | | 349,216 | | 389,039 | |
Other | | 7,348 | | 6,171 | |
Current deferred income taxes | | 41,439 | | 38,968 | |
Prepaid expenses and other current assets | | 25,841 | | 28,248 | |
Total current assets | | 977,714 | | 1,048,319 | |
Investments in unconsolidated affiliates | | 34,848 | | 30,305 | |
Property, plant and equipment, net | | 35,315 | | 32,244 | |
Goodwill | | 42,781 | | 41,968 | |
Intangible assets, net | | 22,307 | | 21,429 | |
Deferred income taxes | | 63,182 | | 59,788 | |
Other assets, net | | 47,424 | | 45,488 | |
| | | | | |
Total assets | | $ | 1,223,571 | | $ | 1,279,541 | |
| | | | | |
LIABILITIES AND SHAREHOLDERS’ EQUITY | | | | | |
Current liabilities: | | | | | |
Current portion of long-term debt | | $ | 350 | | $ | 390 | |
Accounts payable and accrued subcontractor costs | | 288,648 | | 322,104 | |
Billings in excess of revenue | | 132,253 | | 147,755 | |
Accrued payroll and employee related liabilities | | 170,258 | | 179,676 | |
Current income tax payable | | 59,183 | | 58,429 | |
Other accrued liabilities | | 71,536 | | 72,253 | |
Total current liabilities | | 722,228 | | 780,607 | |
Long-term employee related liabilities and other | | 131,866 | | 132,661 | |
Long-term debt | | 194 | | 236 | |
| | | | | |
Total liabilities | | 854,288 | | 913,504 | |
| | | | | |
Commitments and contingencies (Note 9) | | | | | |
| | | | | |
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; 32,880,000 and 32,109,200 issued and outstanding at March 31, 2007 and December 31, 2006, respectively | | 329 | | 321 | |
Additional paid-in capital | | 43,598 | | 46,330 | |
Retained earnings | | 338,008 | | 328,559 | |
Accumulated other comprehensive loss | | (12,652 | ) | (9,173 | ) |
Total shareholders’ equity | | 369,283 | | 366,037 | |
| | | | | |
Total liabilities and shareholders’ equity | | $ | 1,223,571 | | $ | 1,279,541 | |
The accompanying notes are an integral part of these consolidated financial statements.
3
CH2M HILL COMPANIES, LTD.
Consolidated Statements of Income
(Unaudited)
(In thousands, except share and per share data)
| | Three Months Ended March 31, | |
| | 2007 | | 2006 | |
| | | | | |
Gross revenue | | $ | 959,091 | | $ | 984,456 | |
Operating expenses: | | | | | |
Direct cost of services and overhead | | (761,215 | ) | (823,453 | ) |
General and administrative | | (191,307 | ) | (161,262 | ) |
| | | | | |
Operating income | | 6,569 | | (259 | ) |
| | | | | |
Other income (expense): | | | | | |
Equity in earnings of joint ventures and affiliated companies | | 5,502 | | 5,728 | |
Interest income | | 1,732 | | 591 | |
Interest expense | | (136 | ) | (918 | ) |
Income before provision for income taxes | | 13,667 | | 5,142 | |
Provision for income taxes | | (5,658 | ) | (2,036 | ) |
Net income | | $ | 8,009 | | $ | 3,106 | |
| | | | | |
Net income per common share: | | | | | |
Basic | | $ | 0.25 | | $ | 0.10 | |
Diluted | | $ | 0.24 | | $ | 0.09 | |
Weighted average number of common shares: | | | | | |
Basic | | 32,501,252 | | 32,349,754 | |
Diluted | | 33,027,296 | | 33,030,207 | |
The accompanying notes are an integral part of these consolidated financial statements.
4
CH2M HILL COMPANIES, LTD.
Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)
| | Three Months Ended March 31, | |
| | 2007 | | 2006 | |
Cash flows from operating activities: | | | | | |
Net income | | $ | 8,009 | | $ | 3,106 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | |
Depreciation and amortization | | 2,828 | | 3,839 | |
Stock-based employee compensation expense | | 8,665 | | 4,772 | |
Loss on disposal of property, plant and equipment | | 106 | | 27 | |
Allowance for uncollectible accounts | | 1,896 | | 376 | |
Deferred income taxes | | (5,641 | ) | 178 | |
Distributed (undistributed) earnings of unconsolidated affiliates, net | | (1,369 | ) | 74,973 | |
Change in operating assets and liabilities, net of business acquired: | | | | | |
Receivables and unbilled revenue | | 77,418 | | (47,828 | ) |
Prepaid expenses and other | | 988 | | (2,444 | ) |
Accounts payable and accrued subcontractor costs | | (33,501 | ) | (73,854 | ) |
Billings in excess of revenue | | (15,394 | ) | 11,481 | |
Employee related liabilities | | (9,759 | ) | (3,529 | ) |
Other accrued liabilities | | (935 | ) | 13,053 | |
Current taxes payable | | 2,192 | | (32,755 | ) |
Long term liabilities and other | | (795 | ) | 10,725 | |
Net cash provided by (used in) operating activities | | 34,708 | | (37,880 | ) |
| | | | | |
Cash flows from investing activities: | | | | | |
Capital expenditures | | (5,020 | ) | (2,447 | ) |
Acquisition and earnout payments, net of cash acquired | | (3,312 | ) | (1,262 | ) |
Investments in affiliates, net of distributions of capital received | | (3,680 | ) | (8,551 | ) |
Purchases of available-for-sale investments | | (75,793 | ) | (43,065 | ) |
Proceeds from sale of available-for-sale investments | | 50,628 | | 35,134 | |
Net cash used in investing activities | | (37,177 | ) | (20,191 | ) |
| | | | | |
Cash flows from financing activities: | | | | | |
Borrowing on line of credit | | — | | 204,100 | |
Payments on line of credit and long-term debt | | (82 | ) | (174,039 | ) |
Repurchases and retirements of stock | | (12,791 | ) | (10,102 | ) |
Excess tax benefits from stock-based compensation | | 1,542 | | 1,341 | |
Net cash (used in) provided by financing activities | | (11,331 | ) | 21,300 | |
| | | | | |
Effect of exchange rates on cash | | (1,517 | ) | (1,060 | ) |
| | | | | |
Decrease in cash and cash equivalents | | (15,317 | ) | (37,831 | ) |
| | | | | |
Cash and cash equivalents, beginning of period | | 105,205 | | 66,494 | |
| | | | | |
Cash and cash equivalents, end of period | | $ | 89,888 | | $ | 28,663 | |
| | | | | |
Supplemental disclosures: | | | | | |
Cash paid for interest | | $ | 104 | | $ | 829 | |
Cash paid for income taxes | | $ | 7,455 | | $ | 34,828 | |
The accompanying notes are an integral part of these consolidated financial statements.
5
CH2M HILL COMPANIES, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2007
(Unaudited)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited interim 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 presentation.
In the opinion of CH2M HILL Companies, Ltd.’s (CH2M HILL) management, the accompanying unaudited interim 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 interim 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, 2006. 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 three months ended March 31, 2007 are as follows (in thousands):
| | Shares | | Amount | |
Shareholders’ Equity, December 31, 2006 | | 32,109 | | $ | 366,037 | |
Net income | | — | | 8,009 | |
Cumulative effect of change in accounting principle | | — | | 1,440 | |
Shares issued in connection with stock-based compensation and employee benefit plans | | 1,274 | | 7,515 | |
Shares purchased and retired | | (503 | ) | (10,239 | ) |
Other comprehensive loss | | — | | (3,479 | ) |
Shareholders’ Equity, March 31, 2007 | | 32,880 | | $ | 369,283 | |
For a detailed discussion on the cumulative effect of the change in accounting principle relating to the adoption of Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxes: an interpretation of FASB Statement No. 109 (FIN 48), see “Recently Adopted Accounting Standards” below.
Stock-Based Compensation Plans
CH2M HILL adopted the provisions of, and accounts for stock-based compensation in accordance with Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based Payment (SFAS 123(R)), using the prospective method, under which prior periods are not revised for comparative purposes. CH2M HILL elected the prospective method of adoption effective January 1, 2006, under which prior periods are not revised for comparative purposes. Under the prospective method, the provisions of SFAS 123(R) apply to new grants on or after January 1, 2006. CH2M HILL measures the fair value of each stock option grant at the
6
date of grant using a Black-Scholes option pricing model. The weighted-average grant date fair value of options granted during the three months ended March 31, 2007 and 2006 was $3.81 and $3.77, respectively.
CH2M HILL estimates the expected term of options granted by taking the average of the vesting term and the contractual term of the option. CH2M HILL estimates the volatility of its common stock by using a weighted-average of historical volatility over the same period as the term of the option. CH2M HILL uses the U.S. Treasury zero-coupon issues for the risk-free interest rate in the option valuation model with remaining terms similar to the expected term on the options. CH2M HILL does not anticipate paying any cash dividends in the foreseeable future and therefore uses an expected dividend yield of zero in the option valuation model. CH2M HILL is required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. CH2M HILL uses historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. All stock-based payment awards are amortized on a straight-line basis over the requisite service periods of the awards, which are generally the vesting periods.
The total compensation cost recognized for share-based payments in the first quarter of 2007 and 2006 was $0.5 million and $0.1 million, respectively.
Recently Adopted Accounting Standards
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments (SFAS 155), which amends SFAS 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133), and SFAS 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 effective January 1, 2007. The adoption of SFAS 155 did not have an impact on CH2M HILL’s consolidated financial position, results of operations or cash flows.
In June 2006, the FASB issued Interpretation No. 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 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. For tax positions meeting the more likely than not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. Under CH2M HILL’s previous policy, they recognized tax positions to the extent they were probable of being sustained. CH2M HILL adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, the Company recognized a $1.4 million decrease in the liability for uncertain tax positions, which was accounted for as an increase to the January 1, 2007 balance of retained earnings. See Footnote 8 for further discussion of the impact of adopting FIN 48.
Recently Issued Accounting Standards
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159). SFAS 159 allows measurement at fair value of eligible financial assets and liabilities that are not otherwise measured at fair value. If the fair value option for an eligible item is elected, unrealized gains and losses for that item shall be reported in current earnings at each subsequent reporting date. SFAS 159 also establishes additional disclosure requirements designed to facilitate comparison between companies that choose different measurement attributes for similar type assets and liabilities. SFAS 159 is effective for CH2M HILL beginning January 1, 2008. CH2M HILL is evaluating the potential impact that SFAS 159 may have on its financial statements, if any.
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. CH2M HILL will adopt SFAS 158 on December 31, 2007. SFAS 158 also requires plan assets and benefit obligations to be measured as of the balance sheet date beginning December 31, 2008. CH2M HILL is evaluating the impact that the adoption of SFAS 158 will have on its financial statements.
7
(2) SEGMENT INFORMATION
Certain financial information relating to the three months ended March 31, 2007 and 2006 for each segment is provided below (in thousands):
Three Months Ended
March 31, 2007 | | Federal | | Civil
Infrastructure | | Industrial | | Other | | Financial
Statement
Balances | |
Revenue from external customers | | 263,494 | | 370,915 | | 324,682 | | — | | 959,091 | |
Inter-segment sales | | 2,268 | | 5,820 | | 8,815 | | (16,903 | ) | — | |
Equity in earnings of joint ventures and affiliated companies | | 5,267 | | 160 | | 75 | | — | | 5,502 | |
Segment profit (loss) | | 7,794 | | 14,810 | | (4,644 | ) | (4,293 | ) | 13,667 | |
Three Months Ended
March 31, 2006 | | Federal | | Civil
Infrastructure | | Industrial | | Other | | Financial
Statement
Balances | |
Revenue from external customers | | $ | 438,356 | | $ | 299,882 | | $ | 246,218 | | $ | — | | $ | 984,456 | |
Inter-segment sales | | 2,892 | | 5,258 | | 7,960 | | (16,110 | ) | — | |
Equity in earnings of joint ventures and affiliated companies | | 4,115 | | 1,542 | | 71 | | — | | 5,728 | |
Segment profit (loss) | | 27,502 | | 11,715 | | (30,499 | ) | (3,576 | ) | 5,142 | |
| | | | | | | | | | | | | | | | |
During the three months ended March 31, 2007, compared to the same period in 2006, the decrease in the Federal segment profit was due primarily to the completion of work associated with the Hurricane Katrina relief and cleanup effort.
During the three months ended March 31, 2006, the Industrial segment recognized a significant loss related to a manufacturing facility project. This project experienced increased costs due to project delivery issues and increased commodity prices. In addition, the clean up efforts required from Hurricane Katrina caused significant shortages in experienced craft laborers in the area and thus materially increased wage rates and reduced overall productivity.
(3) COMPREHENSIVE INCOME
Comprehensive income includes unrealized gains and losses on equity investments and foreign currency translation gains and 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 months ended March 31, 2007 and 2006 (in thousands):
| | Three Months
Ended March 31, | |
| | 2007 | | 2006 | |
Net income | | $ | 8,009 | | $ | 3,106 | |
Unrealized losses on equity investments and other | | (398 | ) | (1,122 | ) |
Foreign currency translation losses | | (3,081 | ) | (738 | ) |
Comprehensive income | | $ | 4,530 | | $ | 1,246 | |
(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.
8
The following table is a reconciliation of basic and diluted EPS for the three months ended March 31, 2007 and 2006 (in thousands, except per share amounts):
| | Three Months
Ended March 31, | |
| | 2007 | | 2006 | |
| | | | | |
Numerator: | | | | | |
Net income | | $ | 8,009 | | $ | 3,106 | |
| | | | | |
Denominator: | | | | | |
Basic income per share — weighted average shares outstanding | | 32,501 | | 32,350 | |
Dilutive effect of common stock equivalents | | 526 | | 680 | |
Diluted income per share — adjusted weighted-average shares outstanding, assuming conversion of common stock equivalents | | 33,027 | | 33,030 | |
| | | | | |
Basic net income per common share | | $ | 0.25 | | $ | 0.10 | |
Diluted net income per common share | | $ | 0.24 | | $ | 0.09 | |
(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 March 31, 2007, the assets and liabilities of the identified VIE’s that were not consolidated were $202.3 million and $192.1 million, respectively, compared to $139.4 million and $131.4 million, respectively, at December 31, 2006.
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. As of March 31, 2007 and December 31, 2006, the investments in unconsolidated affiliates were $34.8 million and $30.3 million, respectively. CH2M HILL’s proportionate share of net income or loss is included as equity in earnings of joint ventures and affiliated companies on the accompanying consolidated statements of income. In general, the equity investment in CH2M HILL’s joint ventures is equal to those entities’ undistributed earnings.
9
CH2M HILL has the following significant investments in affiliated unconsolidated companies accounted for under the equity method of accounting:
| | % Ownership | |
Domestic: | | | |
AGVIQ-CH2M HILL Joint Venture I | | 49.0 | % |
AGVIQ-CH2M HILL Joint Venture II | | 49.0 | % |
ATKINSON/CH2M HILL, Joint Venture | | 30.0 | % |
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 | % |
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 | % |
Sargent & Lundy — CH2M HILL — Worley Parsons | | 33.3 | % |
Stockton D/B Joint Venture | | 50.0 | % |
Washington Closure, LLC | | 30.0 | % |
Washington Group-IDC | | 28.0 | % |
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 | % |
Golden Crossing Constructors, Joint Venture | | 33.3 | % |
Maroochy Alliance Joint Venture | | 40.0 | % |
OMI BECA, Ltd | | 50.0 | % |
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. During the three months ended March 31, 2007 and 2006, CH2M HILL recognized earnings from CH2M-WG Idaho of $2.5 million and $3.1 million, respectively. CH2M HILL’s investment in CH2M HILL-WG Idaho as of March 31, 2007 was $18.1 million compared to $13.1 million as of December 31, 2006.
10
Summarized unaudited financial information for CH2M HILL’s unconsolidated affiliates for the three months ended March 31, 2007 and 2006 is as follows (in thousands):
| | Three Months
Ended March 31, | |
| | 2007 | | 2006 | |
RESULTS OF OPERATIONS: | | | | | |
Revenue | | $ | 669,146 | | $ | 258,260 | |
Direct costs | | (643,950 | ) | (244,397 | ) |
Gross margin | | 25,196 | | 13,863 | |
General and administrative expenses | | (850 | ) | (2,823 | ) |
Operating income | | 24,346 | | 11,040 | |
Other income (expense), net | | (420 | ) | 630 | |
Net income | | $ | 23,926 | | $ | 11,670 | |
(6) GOODWILL AND INTANGIBLE ASSETS
Intangible assets with finite lives consist of the following (in thousands):
| | Cost | | Accumulated
Amortization | | Net finite-lived
intangible
assets | |
March 31, 2007 | | | | | | | |
| | | | | | | |
Contracts-in-place | | $ | 2,513 | | $ | (2,198 | ) | $ | 315 | |
Contracted backlog | | 2,111 | | (1,684 | ) | 427 | |
Non-compete agreements and other | | 1,596 | | (357 | ) | 1,239 | |
Total finite-lived intangible assets | | $ | 6,220 | | $ | (4,239 | ) | $ | 1,981 | |
| | | | | | | |
December 31, 2006 | | | | | | | |
| | | | | | | |
Contracts-in-place | | $ | 26,594 | | $ | (26,173 | ) | $ | 421 | |
Patents and trademarks | | 5,219 | | (5,219 | ) | — | |
Contracted backlog | | 2,230 | | (2,088 | ) | 142 | |
Non-compete agreements and other | | 807 | | (267 | ) | 540 | |
Total finite-lived intangible assets | | $ | 34,850 | | $ | (33,747 | ) | $ | 1,103 | |
All intangible assets are being amortized over their expected lives up to six years. The amortization expense reflected in the accompanying consolidated statements of income was $0.2 million and $1.7 million for the three months ended March 31, 2007 and 2006, respectively.
Indefinite-lived intangible assets consist of the following (in thousands):
| | March 31,
2007 | | December 31,
2006 | |
Goodwill | | $ | 42,781 | | $ | 41,968 | |
Tradename | | 20,326 | | 20,326 | |
Total indefinite-lived intangible assets | | $ | 63,107 | | $ | 62,294 | |
In the first quarter of 2007, CH2M HILL acquired a wastewater management company for $2.5 million. The new acquisition will be reported in the Civil Infrastructure operating segment. CH2M HILL completed a preliminary purchase price allocation for this transaction based on a preliminary evaluation of the fair values of the tangible and identifiable intangible assets acquired and liabilities assumed. We may adjust this preliminary purchase price allocation based upon our final determination of the fair value of the assets acquired and liabilities assumed. Our final determination is not complete due to the short time frame since the acquisition.
During the first quarter of 2007, CH2M HILL recorded additional goodwill as a result of earn-out targets being achieved on an acquisition.
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(7) LINE OF CREDIT
CH2M HILL is party to a credit agreement which 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 CH2M HILL’s option, 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 a discount rate up to 0.25% 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 March 31, 2007, 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 in control. As of March 31, 2007, CH2M HILL was in compliance with the covenants required by the credit agreement.
At March 31, 2007, issued and outstanding letters of credit of $40.4 million were reserved against the borrowing base of the credit agreement, compared to $39.8 million at December 31, 2006.
(8) PROVISION FOR INCOME TAXES
CH2M HILL adopted the provisions of FIN 48 on January 1, 2007. FIN 48 establishes a process to recognize and measure the impact of uncertainty associated with income tax positions. For income tax benefits to be recognized, a tax position must be more likely than not to be sustained upon examination by taxing authorities. As a result of the implementation of FIN 48, CH2M HILL recorded a $1.4 million decrease in the liability for uncertain tax positions, which was accounted for as a cumulative effect of a change in accounting principle, increasing the January 1, 2007 retained earnings balance. At the adoption date of January 1, 2007, CH2M HILL had $60.7 million (net of federal and state benefit) recorded as a liability for uncertain tax positions, which would all affect the effective tax rate if recognized. At March 31, 2007, CH2M HILL had $61.5 million recorded as a liability for uncertain tax positions.
CH2M HILL recognizes interest and penalties related to uncertain tax positions in income tax expense. As of March 31, 2007 and January 1, 2007, CH2M HILL had approximately $14.0 million and $12.6 million, respectively, of accrued interest and penalties related to uncertain tax positions.
CH2M HILL has presented a claim to the Internal Revenue Service (IRS) relating to research and experimentation tax credits for the years 1996 to 2003. The amount of the tax credits claimed is significant. Although CH2M HILL is seeking resolution with the IRS, we only recognize tax benefits related to these credits for financial statement purposes when it is more likely than not that such benefits will be sustained. The ultimate amount to be realized and the timing of the recognition of the tax credits will depend upon the final resolution with the IRS. Management believes that it is reasonably possible that CH2M HILL and the IRS will reach a resolution on this issue in the next 12 months, however the amount of the settlement cannot currently be estimated.
With few exceptions, the Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities in major tax jurisdictions for years before 1997.
(9) 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
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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 $2.0 million to community projects and is taking other agreed upon steps to enhance our CWA compliance procedures at the two wastewater treatment facilities in Connecticut. CH2M HILL is halfway through this agreement and is currently in full compliance. 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 is 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 IRS relating to the research and experimentation tax credits for the years 1996 to 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 more likely than not that such benefits will be sustained. The amount of the tax credits claimed is significant; however, the ultimate amount to be realized and the timing of the recognition of the tax credits will depend upon the final resolution with the IRS.
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 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
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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, 2006, filed with the SEC on February 23, 2007. 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, 2006.
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 approximately 100 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, local and provincial governments. Our Industrial segment generally provides a comprehensive range of services to private sector clients.
Results of Operations
Revenue and Pre-Tax Profit (Loss) of our Reportable Segments
Revenue and pre-tax profit (loss) for the three months ended March 31, 2007 and 2006 by operating segment were as follows (in millions):
Three Months Ended March 31, 2007 and 2006
| | Revenue | | Pre-Tax Profit (Loss) | |
| | 2007 | | 2006 | | 2007 | | 2006 | |
Federal | | $ | 263.5 | | 27.5 | % | $ | 438.4 | | 44.5 | % | $ | 7.8 | | $ | 27.5 | |
Civil Infrastructure | | 370.9 | | 38.7 | % | 299.9 | | 30.5 | % | 14.8 | | 11.7 | |
Industrial | | 324.7 | | 33.8 | % | 246.2 | | 25.0 | % | (4.6 | ) | (30.5 | ) |
Corporate | | — | | — | | — | | — | | (4.3 | ) | (3.6 | ) |
Total | | $ | 959.1 | | 100.0 | % | $ | 984.5 | | 100.0 | % | $ | 13.7 | | $ | 5.1 | |
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Federal
Revenue decreased $174.9 million or 39.9% for the three months ended March 31, 2007, compared to the same period in the prior year. The decrease was primarily due to the government facilities and infrastructure business substantially completing its work associated with the Hurricane Katrina relief and cleanup efforts. In addition, the completion of the Mound project also contributed to this negative variance. Partially offsetting the loss of revenue was an increase in the volume of environmental services work performed in North America and the work performed on the London Olympic project.
Pre-tax profit decreased $19.7 million or 71.6% for the three months ended March 31, 2007, compared to the same period in the prior year. The decrease in pre-tax profits was primarily associated with the decrease in revenue resulting from the completion of the Hurricane Katrina cleanup efforts and the Mound project as discussed above.
Civil Infrastructure
Revenue increased $71.0 million or 23.7% for the three months ended March 31, 2007, compared to the same period in the prior year. Each of the businesses comprising the Civil Infrastructure operating segment reported a significant increase in revenue. The water business reported higher revenues due to an increase in several consulting and design build projects in North America and projects in international markets. The North American consulting growth was primarily due to design and program management services for municipal clients in the northern and southeastern United States and Canada, while the design build growth was primarily due to water treatment projects in southern California and Hawaii. The growth in our international markets was primarily due to projects in Australia, United Arab Emirates, Singapore and Iraq. Our transportation business reported growth due to program management projects in the United States and Canada. Our operations and maintenance business also reported an improvement in revenue compared to the same periods in the prior year primarily due to the new municipal operations projects in Georgia that began in December 2006.
Pre-tax profit increased $3.1 million or 26.5% for the three months ended March 31, 2007, compared to the same period in the prior year. The increase was associated with our water and operations and maintenance businesses which experienced increased business volume and better long-term project performance.
Industrial
Revenue increased $78.5 million or 31.9% for the three months ended March 31, 2007, compared to the same period in the prior year. This increase over last year’s revenue was primarily due to the significant growth in our power business driven primarily by two contracts with major utility companies. In addition, our manufacturing and life sciences business reported an increase due to the continued progress on a major engineering, procurement and construction project in North Carolina that began operations in the second quarter last year. Partially offsetting this favorable variance was the completion of a major manufacturing facility project in the southeastern United States.
Pre-tax loss improved $25.9 million or 84.9% for the three months ended March 31, 2007, compared to the same period in the prior year. This improvement was primarily due to the completion of a major manufacturing facility project, mentioned above, that had significant cost overruns in the prior year. In addition, consulting work in the power business had higher operating margins compared to the same period in the prior year.
Equity in Earnings of Joint Ventures and Affiliated Companies
For the quarters ended March 31, 2007 and 2006, we reported total equity in earnings of joint ventures and affiliated companies of $5.5 million and $5.7 million, respectively. The primary reason for the decrease was due to a $1.9 million decrease in the earnings of a water joint venture. This was due to the fact that this project was substantially complete in the first quarter of 2007. Partially offsetting this decrease was the work attributed to new joint ventures.
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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 quarters ended March 31, 2007 were $4.3 million, compared to $3.6 million for the same period in the prior year. The increase in expense for the three months ended March 31, 2007 compared to the same period in 2006 was due primarily to increased payroll costs.
Provision for Income Taxes
Our effective tax rate for the three months ended March 31, 2007 was 41.4% compared to 39.6% 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 adopted the provisions of Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxes: an interpretation of FASB Statement No. 109 (FIN 48), on January 1, 2007. FIN 48 establishes a process to recognize and measure the impact of uncertainty associated with income tax positions. For income tax benefits to be recognized, a tax position must be more likely than not to be sustained upon examination by taxing authorities. As a result of the implementation of FIN 48, we recorded a $1.4 million decrease in the liability for uncertain tax positions, which was accounted for as a cumulative effect of a change in accounting principle, increasing the January 1, 2007 retained earnings balance. At the adoption date of January 1, 2007, we had $60.7 million (net of federal and state benefit) recorded as a liability for uncertain tax positions, which would all affect our effective tax rate if recognized. At March 31, 2007, we had $61.5 million recorded as a liability for uncertain tax positions.
We recognize interest and penalties related to unrecognized tax benefits in income tax expense. As of March 31, 2007 and January 1, 2007, we had approximately $14.0 million and $12.6 million, respectively, of accrued interest and penalties related to uncertain tax positions.
We have presented a claim to the Internal Revenue Service (IRS) relating to the research and experimentation tax credits for the years 1996 to 2003. The amount of the tax credits claimed is significant. Although we are seeking resolution with the IRS, we only recognize tax benefits related to these credits for financial statement purposes when it is more likely than not that such benefits will be sustained. The ultimate amount to be realized and the timing of the recognition of the tax credits will depend upon the final resolution with the IRS. Management believes that it is reasonably possible that CH2M HILL and the IRS will reach a resolution on this issue in the next 12 months, however the amount of the settlement cannot currently be estimated.
With few exceptions, we are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities in major tax jurisdictions for years before 1997.
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 repurchases of stock presented on our internal market. During the three months ended March 31, 2007, our operating cash flows increased $72.6 million compared to the same period in the prior year. This increase was primarily due to a decrease in work in process that was associated with the substantial completion of the work associated with the Hurricane Katrina relief and cleanup efforts. These increases in operating cash flows were partially offset by the decrease in distributed earnings from unconsolidated affiliates due to a large payout received from Kaiser-Hill Company, LLC in the first quarter last year for the Rocky Flats Closure Project in Golden, Colorado.
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 March 31, 2007, 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.
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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 three months ended March 31, 2007 and 2006 were $5.0 million and $2.4 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 $12.8 million and $10.1 million in cash for repurchases of stock presented on our internal market during the three months ended March 31, 2007 and 2006, respectively.
We are party to a credit agreement which 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 London InterBank Offered Rate (LIBOR) plus 0.75% to 1.50%, or the lender’s applicable base rate less a discount rate up to 0.25% 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 March 31, 2007, we had no outstanding borrowings on the credit agreement.
It is likely, but uncertain, that we will utilize our credit agreement periodically during 2007 depending on the timing of cash receipts and disbursements.
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 March 31, 2007, we were in compliance with the covenants required by the credit agreement.
At March 31, 2007 and December 31, 2006, issued and outstanding letters of credit of $40.4 million and $39.8 million were reserved against the borrowing base of the credit agreement, respectively.
Based on our total cash and credit capacity at March 31, 2007 of $355.4 million, we believe we have sufficient resources to fund our operations, anticipated capital expenditure requirements, as well as repurchases 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 March 31, 2007 (in millions):
Cash on hand | | | | $ | 89.9 | |
Available for sale securities | | | | 55.9 | |
Line of credit capacity | | $ | 250.0 | | | |
Issued letters of credit | | (40.4 | ) | | |
Net credit capacity available | | | | 209.6 | |
Total capacity | | | | $ | 355.4 | |
| | | | | | | |
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 buildings for approximately $42.0 million. Upon completion of the lease term, we have the option to purchase the buildings 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 building from the lessor for $20.8 million. The lease matures on September 28, 2008
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and provides for five one-year renewal options. The third lease agreement calls for monthly lease payments of approximately $0.1 million through December 3, 2012 and requires that we guarantee a residual value of the building of approximately $18.5 million. Upon completion of the initial lease term, we have the option to purchase the building for $22.1 million, or extend the term of the lease for up to two successive periods of five years each.
We have interests in multiple joint ventures, some of which are considered variable interest entities under FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities (FIN46 (R)). These entities facilitate the completion of contracts that are jointly owned with our joint venture partners. 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. Our 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 our partners.
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 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.
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, 2006.
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
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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 maintenance type contracts. Typically, these contracts may include fixed and variable components along with incentive fees. Revenue is recognized on operations and maintenance 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 income tax benefits involves dealing with uncertainties in the application of complex tax regulations. For income tax benefits to be recognized, a tax position must be more likely than not to be sustained upon examination by taxing authorities.
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.
Recently Adopted Accounting Standards
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments (SFAS 155), which amends SFAS 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133), and SFAS 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 effective January 1, 2007. The adoption of SFAS 155 did not have a material impact on our consolidated financial position, results of operations or cash flows.
In June 2006, the FASB issued FIN 48, which is effective beginning on January 1, 2007. FIN 48 establishes a 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. For tax positions meeting the more likely than not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. Under our previous policy, we recognized tax positions to the extent they were probable of being sustained. We adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, we recognized a $1.4 million decrease in the liability for uncertain provisions, which was accounted for as an increase to the January 1, 2007 balance of retained earnings. See Footnote 8 to the accompanying financial statements contained in Item 1, Financial Information for further discussion of the impact of adopting FIN 48.
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Recently Issued Accounting Standards
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159). SFAS 159 allows measurement at fair value of eligible financial assets and liabilities that are not otherwise measured at fair value. If the fair value option for an eligible item is elected, unrealized gains and losses for that item shall be reported in current earnings at each subsequent reporting date. SFAS 159 also establishes additional disclosure requirements designed to facilitate comparison between companies that choose different measurement attributes for similar type assets and liabilities. SFAS 159 is effective for us beginning January 1, 2008. We are evaluating the potential impact that SFAS 159 may have on our financial statements, if any.
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. We will adopt SFAS 158 on December 31, 2007. SFAS 158 also requires plan assets and benefit obligations to be measured as of the balance sheet date beginning December 31, 2008. We are evaluating the impact that the adoption of SFAS 158 will have on our financial statements.
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, purchase of interest bearing short-term investments and building lease agreements that call 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 March 31, 2007. Our variable lease payments on the building lease agreements are estimated to be approximately $0.2 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.
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 March 31, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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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 consolidated financial statements.
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 | |
January (a) | | 3,458 | | $ | 18.75 | | — | | — | |
February | | — | | — | | — | | — | |
March (b) | | 499,173 | | 19.63 | | — | | — | |
Total | | 502,631 | | 19.62 | | — | | — | |
| | | | | | | | | | |
(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 | | |
* 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: May 4, 2007 | | /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
*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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