UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

Form 10-Q

 

(Mark One)

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
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)

 

 

 

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 ý  No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).     Yes ý  No o

 

As of November 1, 2004, the registrant had 31,101,572 shares of common stock, $0.01 par value per share, issued and outstanding.

 

 

CH2M HILL COMPANIES, LTD.

 

SEPTEMBER 30, 2004

 

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION
Item 1.		Consolidated Condensed Financial Statements (unaudited):
		Balance Sheets as of September 30, 2004 and December 31, 2003
		Statements of Income for the Three- and Nine-Month Periods Ended September 30, 2004 and 2003
		Statements of Cash Flows for the Nine-Month Periods Ended September 30, 2004 and 2003
		Notes to Consolidated Condensed Financial Statements
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.		Quantitative and Qualitative Disclosures about Market Risk
Item 4.		Controls and Procedures
PART II.  OTHER INFORMATION
Item 1.		Legal Proceedings
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds
Item 4.		Submission of Matters to a Vote of Security Holders
Item 6.		Exhibits
SIGNATURES

 

 

Part I - FINANCIAL INFORMATION

Item 1 - Consolidated Condensed Financial Statements

CH2M HILL COMPANIES, LTD.

Consolidated Condensed Balance Sheets

(Unaudited)

(Dollars in thousands)

 

		September 30, 2004			December 31, 2003
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	28,548		$	30,885
Receivables, net -
Client accounts		340,677			328,323
Unbilled revenue		187,107			154,141
Other		8,776			8,521
Prepaid expenses and other		15,272			17,799
Total current assets		580,380			539,669
PROPERTY, PLANT and EQUIPMENT, net		25,366			25,695
GOODWILL		31,025			26,690
INTANGIBLE ASSETS, net		33,544			39,676
OTHER ASSETS, net		128,901			116,936
TOTAL ASSETS		$	799,216		$	748,666
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable		$	94,939		$	146,383
Billings in excess of revenues		90,776			84,642
Employee related liabilities		108,237			100,229
Accrued subcontractors costs		69,135			35,980
Current taxes payable		14,111			8,490
Other current liabilities		96,428			79,674
Total current liabilities		473,626			455,398
OTHER LONG-TERM LIABILITIES		97,419			86,123
LINE OF CREDIT		2,500			—
LONG-TERM DEBT		4,386			6,971
Total liabilities		577,931			548,492
COMMITMENTS AND CONTINGENCIES (See Notes)
SHAREHOLDERS’ EQUITY
Common stock, $0.01 par value, 100,000,000 shares authorized; 31,087,156 and 31,023,886 issued and outstanding at September 30, 2004 and December 31, 2003, respectively		311			310
Additional paid-in capital		34,394			40,976
Retained earnings		202,197			175,681
Accumulated other comprehensive loss		(15,617		)	(16,793		)
Total shareholders’ equity		221,285			200,174
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$	799,216		$	748,666

 

The accompanying notes are an integral part of these consolidated condensed financial statements.

 

1

 

CH2M HILL COMPANIES, LTD.

Consolidated Condensed Statements of Income

(Unaudited)

(Dollars in thousands except share and per share data)

 

		Three-Month Period Ended September 30,						Nine-Month Period Ended September 30,
		2004			2003			2004			2003
Gross revenue		$	733,881		$	516,773		$	2,016,508		$	1,574,482
Operating expenses:
Direct cost of services and overhead		(596,578		)	(410,965		)	(1,622,990		)	(1,259,058		)
General and administrative		(129,773		)	(103,046		)	(374,460		)	(304,746		)
Operating income		7,530			2,762			19,058			10,678
Other income (expense):
Equity in earnings of joint ventures and affiliated companies		7,745			6,576			22,337			19,443
Interest income and gains on equity investments		1,213			403			2,342			1,264
Interest expense		(505		)	(161		)	(1,566		)	(482		)
Income before provision for income taxes		15,983			9,580			42,171			30,903
Provision for income taxes		(5,099		)	(3,780		)	(15,655		)	(13,012		)
Net income		$	10,884		$	5,800		$	26,516		$	17,891
Earnings per common share:
Basic		$	0.35		$	0.19		$	0.84		$	0.57
Diluted		$	0.34		$	0.18		$	0.83		$	0.56
Weighted-average number of common shares:
Basic		31,323,644			31,314,258			31,584,593			31,151,033
Diluted		31,774,043			32,223,432			32,002,881			32,115,600

 

The accompanying notes are an integral part of these consolidated condensed financial statements.

 

2

 

CH2M HILL COMPANIES, LTD.

Consolidated Condensed Statements of Cash Flows

(Unaudited)

(Dollars in thousands)

 

		Nine-Month Period Ended September 30,
		2004			2003
Cash flows from operating activities:
Net income		$	26,516		$	17,891
Adjustments to reconcile net income to net cash provided by (used in) operating activities -
Depreciation and amortization		11,599			8,113
Stock-based employee compensation expense		21,525			17,966
Allowance for uncollectible accounts		1,875			2,012
Deferred income tax expense		1,565			2,608
Equity in undistributed earnings of unconsolidated affiliates		(9,421		)	(9,427		)
Change in current assets and liabilities:
Receivables and unbilled revenue		(49,480		)	(26,648		)
Prepaid expenses and other		3,740			(1,314		)
Accounts payable		(50,413		)	(4,792		)
Billings in excess of revenues		5,985			(2,792		)
Employee related liabilities		8,818			15,517
Other accrued liabilities		48,555			(16,440		)
Current taxes payable		7,251			(12,568		)
Other		2,984			(4,398		)
Net cash provided by (used in) operating activities		31,099			(14,272		)
Cash flows from investing activities:
Capital expenditures		(4,731		)	(3,547		)
Investments in affiliates and acquisitions, net		213			(3,002		)
Net cash used in investing activities		(4,518		)	(6,549		)
Cash flows from financing activities:
Borrowing on line of credit		418,100			—
Payments on line of credit and long-term debt		(417,625		)	(2,444		)
Purchases of stock		(28,662		)	(21,114		)
Net cash used in financing activities		(28,187		)	(23,558		)
Effect of exchange rate changes on cash		(731		)	(114		)
Decrease in cash and cash equivalents		(2,337		)	(44,493		)
Cash and cash equivalents, beginning of period		30,885			106,438
Cash and cash equivalents, end of period		$	28,548		$	61,945
Supplemental disclosures:
Cash paid for income taxes		$	8,430		$	20,157
Cash paid for interest		$	773		$	641

 

The accompanying notes are an integral part of these consolidated condensed financial statements.

 

3

 

CH2M HILL COMPANIES, LTD.

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

 

(1)         SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

The accompanying financial information has been prepared in accordance with the interim reporting rules and regulations of the U.S. Securities and Exchange Commission and therefore does not necessarily include all information and footnotes necessary for a fair presentation of financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States (GAAP). 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 and the disclosure of contingencies at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period. Estimates have been prepared on the basis of the most current and best available information and actual results could differ from those estimates.  Certain amounts in the prior period have been reclassified to conform to current period presentation.

 

In the opinion of CH2M HILL Companies, Ltd.’s (CH2M HILL) management, the accompanying unaudited consolidated condensed financial statements of the interim periods presented contain all adjustments necessary to present fairly the financial position of CH2M HILL as of September 30, 2004 and the results of operations and cash flows for the periods presented. All such adjustments are of a normal recurring nature. The results of operations for the three- and nine-month periods ended September 30, 2004 are not necessarily indicative of the results that may be achieved for a full year and cannot be used to indicate financial performance for the entire year. These financial statements should be read in conjunction with the notes to the consolidated financial statements contained in CH2M HILL’s Annual Report on Form 10-K for the year ended December 31, 2003.

 

Shareholders’ Equity

 

Changes in shareholders’ equity during the nine-month period ended September 30, 2004 are as follows:

 

		Shares		Amount
Shareholders’ Equity, December 31, 2003		31,023,886		$	200,174
Net income		—		26,516
Shares issued in connection with stock-based compensation and employee benefit plans		2,328,215		22,081
Shares purchased and retired		(2,264,945	)	(28,662		)
Unrealized gains (losses) on equity investments and hedge transactions, net of tax		—		1,025
Foreign currency translation adjustment		—		151
Shareholders’ Equity, September 30, 2004		31,087,156		$	221,285

 

Stock-Based Compensation Plans

 

CH2M HILL accounts for its stock-based employee compensation plans using the intrinsic value method under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. The following table illustrates the proforma effect on net income and earnings per share if CH2M HILL had applied the fair value recognition provisions of Statement of Financial Accounting Standard (SFAS) No. 123, “Accounting for Stock-Based Compensation,” to stock-based employee compensation.

 

4

 

		Three-Month Period Ended September 30,						Nine-Month Period Ended September 30,
		2004			2003			2004			2003
Net income, as reported		$	10,884		$	5,800		$	26,516		$	17,891
Add: Stock-based employee compensation expense included in reported net income, net of tax		6,211			3,286			13,174			10,995
Deduct: Stock-based employee compensation expense determined under fair value method for all awards, net of tax		(6,498		)	(3,580		)	(14,074		)	(11,894		)
Pro forma net income		$	10,597		$	5,506		$	25,616		$	16,992
Earnings per share:
Basic – as reported		$	0.35		$	0.19		$	0.84		$	0.57
Basic – pro forma		$	0.34		$	0.18		$	0.81		$	0.55
Diluted – as reported		$	0.34		$	0.18		$	0.83		$	0.56
Diluted – pro forma		$	0.33		$	0.17		$	0.80		$	0.53

 

New Accounting Standards

 

In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation (FIN) No. 46, “Consolidation of Variable Interest Entities,” which provides guidance on when to consolidate variable interest entities (VIEs). In December 2003, the FASB revised FIN 46 with FIN 46R. In addition to conforming to previously issued FASB Staff Positions, FIN 46R deferred the implementation date for certain VIEs. CH2M HILL adopted the provisions of FIN 46R immediately for entities created after December 31, 2003.  For entities created before December 31, 2003, CH2M HILL will adopt FIN 46R in the first quarter of 2005, as required.

 

CH2M HILL has interests in multiple joint ventures that are considered VIEs under FIN 46R.  These entities facilitate the completion of service contracts that are jointly owned with CH2M HILL’s 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.  In accordance with FIN 46R, management has identified several joint ventures that are considered VIEs.  CH2M HILL also has an interest in the Meridian 26 Trust (Trust), which has also been identified as a VIE.  CH2M HILL has classified entities identified as VIEs into two groups, the first of which includes those entities that CH2M HILL will be required to consolidate under the guidance of FIN46R in the first quarter of 2005, subject to further evaluation, and the second group which includes those entities which CH2M HILL will not be required to consolidate.  At September 30, 2004, the assets and liabilities, including minority interest balances, of the identified VIEs that may be consolidated are $88,295 and $80,435, respectively, of which CH2M HILL currently consolidates $8,100 and $3,929, respectively.  At September 30, 2004, the assets and liabilities of the identified VIEs that will not be consolidated are $21,215 and $17,823, respectively.

 

In December 2003, the FASB issued SFAS No. 132 (Revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits. “ SFAS No. 132(R) increases the existing disclosure requirements by requiring more details about pension plan assets, benefit obligations, cash flows, benefit costs and related information. Companies will be required to segregate plan assets by category, such as debt, equity and real estate, and to provide certain expected rates of return and other informational disclosures. The new disclosure requirements required by SFAS No. 132(R) are effective for CH2M HILL for years ending after June 15, 2004.  CH2M HILL will adopt the new SFAS No. 132(R) disclosure requirements for the year ending December 31, 2004.

 

5

 

(2) SEGMENT INFORMATION

 

During 2003, management reevaluated how the business was organized and announced a new organizational model that became effective on January 1, 2004.  This model, recognizing and reflective of the distinct needs of CH2M HILL’s clients, is centered on three operating segments:

 

•                  Federal (U.S. and international governments)

•                  Civil Infrastructure (state and local governments)

•                  Industrial (private sector clients)

 

Certain financial information relating to the three- and nine-month periods ended September 30, 2004 and 2003 for each segment is provided below.  The financial information for the three- and nine-month periods ended September 30, 2003 for each segment has been restated to conform to current period presentation.

 

Three-Month Period Ended September 30, 2004		Federal			Civil Infrastructure			Industrial			Other			Financial Statement Balances
Revenues from external customers		$	293,156		$	211,109		$	229,616		$	—		$	733,881
Inter-segment sales		1,743			4,197			2,599			(8,539		)	—
Equity in earnings of joint ventures and affiliated companies		6,326			1,350			69			—			7,745
Segment profit (loss)		9,085			9,893			1,228			(4,223		)	15,983

 

Three-Month Period Ended September 30, 2003		Federal			Civil Infrastructure			Industrial			Other			Financial Statement Balances
Revenues from external customers		$	199,243		$	232,358		$	85,172		$	—		$	516,773
Inter-segment sales		8,549			12,323			448			(21,320		)	—
Equity in earnings of joint ventures and affiliated companies		5,384			1,154			38			—			6,576
Segment profit (loss)		8,016			7,925			(3,783		)	(2,578		)	9,580

 

Nine-Month Period Ended September 30, 2004		Federal			Civil Infrastructure			Industrial			Other			Financial Statement Balances
Revenues from external customers		$	756,137		$	630,312		$	630,059		$	—		$	2,016,508
Inter-segment sales		7,083			12,488			3,582			(23,153		)	—
Equity in earnings of joint ventures and affiliated companies		17,594			4,641			102			—			22,337
Segment profit (loss)		26,754			20,520			4,630			(9,733		)0	42,171

 

Nine-Month Period Ended September 30, 2003		Federal			Civil Infrastructure			Industrial			Other			Financial Statement Balances
Revenues from external customers		$	635,084		$	681,288		$	258,110		$	—		$	1,574,482
Inter-segment sales		12,442			17,934			652			(31,028		)	—
Equity in earnings of joint ventures and affiliated companies		16,333			3,017			93			—			19,443
Segment profit (loss)		21,459			28,892			(12,253		)	(7,195		)	30,903

 

6

 

(3) COMPREHENSIVE INCOME

 

Comprehensive income includes unrealized gains and losses on equity investments and hedge transactions and foreign currency translation gains or 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-month periods ended September 30, 2004 and 2003:

 

		Three-Month Period Ended September 30,						Nine-Month Period Ended September 30,
		2004			2003			2004			2003
Net income		$	10,884		$	5,800		$	26,516		$	17,891
Change in unrealized gains on equity investments and hedge transactions, net of tax		(711		)	—			1,025			—
Change in foreign currency translation gains (losses)		859			(409		)	151			45
Comprehensive income		$	11,032		$	5,391		$	27,692		$	17,936

 

CH2M HILL holds a common stock investment in a Korean company which became publicly listed on a Korean stock exchange during the first quarter of 2004.  This investment is classified as available for sale with any unrealized gains or losses included in shareholders’ equity as a component of other comprehensive income.  At September 30, 2004, the fair value of the investment was $2,366 and the corresponding unrealized gain in comprehensive income was $1,082, net of tax.  Through September 30, 2004, CH2M HILL received proceeds of $1,937 on various sales of this investment and recognized gains of $743 and $1,528 during the three- and nine-month periods ended September 30, 2004.

 

Occasionally, CH2M HILL enters into derivative financial transactions to hedge the effects of exchange rate changes on cash exposures from receivables and payables denominated in foreign currencies. CH2M HILL does not enter into derivative transactions for speculative or trading purposes.  Management recognizes derivative transactions on the accompanying consolidated condensed balance sheets at fair value.  Changes in the derivative’s fair value are recognized in other comprehensive income or loss until the hedged item is recognized in earnings.  Any ineffective portion of a derivative’s change in fair value is immediately recognized in earnings. Recognized gains or losses on derivatives entered into to manage foreign exchange risk are included in the accompanying consolidated condensed statements of income and were minimal for the three- and nine-month periods ended September 30, 2004.

 

(4) EARNINGS PER SHARE

 

Basic earnings per share (EPS) excludes the dilutive effect of potential common stock 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 potential common stock, which consist of stock options, and is computed using the weighted-average number of shares and potential common stock outstanding during the period.

 

7

 

A reconciliation of basic and diluted EPS for the three- and nine-month periods ended September 30, 2004 and 2003 follows (in thousands, except per share amounts):

 

		Three-Month Period Ended September 30,						Nine-Month Period Ended September 30,
		2004			2003			2004			2003
Numerator:
Net Income		$	10,884		$	5,800		$	26,516		$	17,891
Denominator:
Basic income per share- weighted-average shares outstanding		31,324			31,314			31,585			31,151
Dilutive effect of potential common stock		450			909			418			965
Diluted income per share- weighted-average shares outstanding, assuming conversion of potential common stock		31,774			32,223			32,003			32,116
Basic net income per share		$	0.35		$	0.19		$	0.84		$	0.57
Diluted net income per share		$	0.34		$	0.18		$	0.83		$	0.56

 

(5) INVESTMENTS IN UNCONSOLIDATED AFFILIATES

 

CH2M HILL routinely enters into joint ventures to service the needs of its clients.  Such arrangements are customary in the engineering and construction industry and generally are project specific.  CH2M HILL accounts for its investments in affiliated unconsolidated companies using the equity method of accounting. As of September 30, 2004 and December 31, 2003, the investments in unconsolidated affiliates were approximately $62,998 and $53,492, respectively, and are reflected in the accompanying consolidated condensed balance sheets in other assets. 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 condensed statements of income.

 

CH2M HILL’s largest joint venture is Kaiser-Hill Company, LLC (Kaiser-Hill), in which CH2M HILL owns a 50% interest.  Kaiser-Hill’s revenues are derived from the U.S. Department of Energy’s (DOE) Performance Based Integrating Management Contract for the Rocky Flats Closure Project in Golden, Colorado.  Kaiser-Hill is compensated through a base fee affected, up or down, by its performance against the agreed site target closure costs.  The ultimate fee will also be impacted by the schedule to achieve site closure and the safety of Kaiser-Hill’s performance.

 

During the three-month period ended September 30, 2004 and 2003, CH2M HILL recognized undistributed earnings from Kaiser-Hill of $5,110 and $5,032, respectively and $8,536 and $9,425 for the nine-month period ended September 30, 2004 and 2003, respectively.  Kaiser-Hill’s ability to distribute cash is based on pre-negotiated payment terms in accordance with its contract with the DOE and can be different from the earnings recognized for accounting purposes.  As the cleanup of the site progresses toward the targeted closure date of 2006, undistributed earnings, and therefore the investment balance, could continue to increase if Kaiser-Hill continues to perform at better than cost and schedule targets.  As of September 30, 2004 and December 31, 2003, the investment in Kaiser-Hill was $41,010 and $32,416, respectively.

 

8

 

Summarized financial information for the three- and nine-month periods ended September 30, 2004 and 2003, for CH2M HILL’s unconsolidated affiliates is as follows:

 

		Three-Month Period Ended September 30,						Nine-Month Period Ended September 30,
		2004			2003			2004			2003
RESULTS OF OPERATIONS:
Revenues		$	243,910		$	240,224		$	631,403		$	714,108
Direct costs		(221,905		)	(217,709		)	(572,828		)	(654,588		)
Gross margin		22,005			22,515			58,575			59,520
General and administrative expenses		(6,613		)	(7,733		)	(15,305		)	(17,185		)
Operating income		15,392			14,782			43,270			42,335
Other income (expense), net		(140		)	77			(630		)	138
Net Income		$	15,252		$	14,859		$	42,640		$	42,473

 

(6) GOODWILL AND INTANGIBLE ASSETS

 

Intangible assets with finite lives consist of the following:

 

		Cost			Accumulated Amortization			Net Finite-Lived Intangible Assets
September 30, 2004
Contract-in-place		$	27,051		$	(17,921	)	$	9,130
Patents and trademarks		5,219			(1,965		)	3,254
Contracted backlog		1,956			(1,159		)	797
Non-compete agreements and other		1,010			(973		)	37
Total finite-lived intangible assets		$	35,236		$	(22,018	)	$	13,218
December 31, 2003
Contract-in-place		$	27,051		$	(14,552	)	$	12,499
Patents and trademarks		5,219			(836		)	4,383
Contracted backlog		1,545			—			1,545
Non-compete agreements and other		1,034			(611		)	423
Total finite-lived intangible assets		$	34,849		$	(15,999	)	$	18,850

 

The contract-in-place is being amortized on a straight-line basis over the total life of the contract of seven years. The other intangible assets are being amortized over their expected useful lives of one to six years.  The amortization expense reflected in the accompanying consolidated condensed statements of income totaled $1,988 and $1,322 for the three-month periods ended September 30, 2004 and 2003, respectively, and $6,528 and $3,966 for the nine-month periods ended September 30, 2004 and 2003, respectively.

 

Indefinite-lived intangible assets consist of the following:

 

		September 30, 2004			December 31, 2003
Goodwill		$	31,025		$	26,690
Tradename		20,326			20,826
Total indefinite-lived intangible assets		$	51,351		$	47,516

 

The initial purchase price and fair value estimates recorded upon the December 12, 2003 acquisition of Lockwood Greene Engineers, Inc., were adjusted during the second and third quarters of 2004 to reflect changes in working capital pursuant to the provisions of the terms and conditions of the purchase agreement and continue to be subject to change as the review and valuation procedures are completed.

 

9

 

(7) LINE OF CREDIT

 

During December 2003, CH2M HILL amended its unsecured revolving line of credit to increase the maximum borrowing capacity from $125,000 to $160,000. During June 2004, CH2M HILL amended its unsecured revolving line of credit and extended the expiration date. The credit facility may be used for general corporate purposes, permitted acquisitions and to support letters of credit. During the third quarter of 2004, CH2M HILL borrowed an average of $16,465 under this credit facility for general corporate purposes. The amount outstanding under the line of credit at September 30, 2004 was $2,500 and there were no amounts outstanding at December 31, 2003.

 

The credit facility, as amended, expires in July 2008, however, with the lender’s consent, the credit facility can be extended for an additional one year prior to July 2005.  At the option of CH2M HILL, the credit facility bears interest at a rate equal to either the London InterBank Offered Rate plus 1.00% to 1.75%, or the lender’s applicable base rate plus margin of 0.0% to 0.25% based on CH2M HILL’s ratio of funded debt to earnings before interest, taxes, depreciation and amortization, as defined. A commitment fee of approximately 0.20% to 0.35% 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.

 

The agreement requires CH2M HILL to, among other things, maintain minimum levels of net worth, a minimum coverage ratio of certain fixed charges, and a minimum leverage ratio of earnings before interest, taxes, depreciation and amortization to funded debt (all as defined in the agreement). As of September 30, 2004, CH2M HILL was in compliance with the covenants required by the agreement.

 

The agreement also allows CH2M HILL to issue letters of credit to support various trade activities. Issued letters of credit are reserved against the borrowing base of the line of credit. At September 30, 2004 and December 31, 2003, there were $21,941 and $40,680 issued and outstanding letters of credit, respectively.

 

(8) COMMITMENTS AND CONTINGENCIES

 

CH2M HILL maintains a variety of commercial 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 certain contractual guarantees and various legal actions arising in the normal course of its business.  From time-to-time, agencies of the U.S. Government investigate whether our operations are being conducted in accordance with applicable regulatory requirements.  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.  U.S. Government 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.

 

Management believes, after consultation with counsel, that such guarantees, litigation, and U. S. Government contract-related audits, investigations and claims should not have any material adverse effect on CH2M HILL’s consolidated financial statements.

 

CH2M HILL has a lease with the Trust.  The Trust is owned by third parties and was formed to fund the construction and own CH2M HILL’s corporate headquarters and another building.  In association with CH2M HILL’s lease with the Trust, CH2M HILL provides a residual value guarantee of the building of $42,000.

 

CH2M HILL has presented a claim to the Internal Revenue Service (IRS) relating to the research and experimentation tax credit for the years 1996 through 1999.  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 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.

 

10

 

CH2M HILL COMPANIES, LTD.

 

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

 

The following discussion and analysis explains our general 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 revenues and profits

•      The source of our revenues and profits

•      Why those revenues and profits were different from period to period

•      Where our cash came from and how it was used

•      How all of this affects our overall financial condition

 

The following discussion contains, in addition to historical information, forward-looking statements that involve risks and uncertainties. Our actual results may differ significantly from the results discussed in the forward-looking statements.  As you read this section, you should also refer to our consolidated condensed financial statements and the accompanying notes as well as our Annual Report on Form 10-K for the year ended December 31, 2003. These consolidated financial statements provide additional information regarding our financial activities and condition. This analysis may be important to you in making decisions about your investment in CH2M HILL Companies, Ltd. (CH2M HILL).

 

Introduction

 

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 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 capital strength. We believe that we are well positioned geographically, technically and financially to compete worldwide in the markets we have elected to pursue and clients we serve.

 

Newly Aligned Operating Segments

 

During 2003, we reevaluated how our business was organized and announced a new organizational model that became effective on January 1, 2004.  This model, recognizing and reflective of the distinct needs of our clients, is centered on three operating segments:

 

•                  Federal (U.S. and international governments)

•                  Civil Infrastructure (state and local governments)

•                  Industrial (private sector clients)

 

This change was brought about by discussions among senior management and our Board of Directors, who recognized that our path to success was critically dependent on understanding and meeting the differing needs and requirements of our clients.  The new structure is intended to provide for better decision making on an enterprise-wide basis.

 

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Acquisition of Lockwood Greene Engineers, Inc.

 

On December 12, 2003, we acquired substantially all of the assets and assumed certain liabilities of Lockwood Greene Engineers, Inc. (Lockwood Greene).  Lockwood Greene is an industrial engineering and construction firm focused on national and multi-national clients.  The operations of Lockwood Greene are included in our industrial operating segment.  Due to the timing of the acquisition, the operations of Lockwood Greene had minimal impact on our revenues and pre-tax profits during 2003.

 

Summary

 

Revenues and pre-tax profit or loss for the three- and nine-month periods ended September 30, 2004 and 2003 by operating segment were as follows:

 

Three-Month Period Ended September 30,

(in millions)

 

		Revenues										Pre-Tax Profit (Loss)
		2004					2003					2004			2003
Federal		$	293.2		40.0	%	$	199.2		38.5	%	$	9.1		$	8.0
Civil Infrastructure		211.1			28.8	%	232.4			45.0	%	9.9			7.9
Industrial		229.6			31.2	%	85.2			16.5	%	1.2			(3.8		)
Corporate		—			—		—			—		(4.2		)	(2.5		)
Total		$	733.9		100.0	%	$	516.8		100.0	%	$	16.0		$	9.6

 

Nine-Month Period Ended September 30,

(in millions)

 

		Revenues										Pre-Tax Profit (Loss)
		2004					2003					2004			2003
Federal		$	756.1		37.5	%	$	635.1		40.3	%	$	26.8		$	21.5
Civil Infrastructure		630.3			31.3	%	681.3			43.3	%	20.5			28.9
Industrial		630.1			31.2	%	258.1			16.4	%	4.6			(12.3		)
Corporate		—			—		—			—		(9.7		)	(7.2		)
Total		$	2,016.5		100.0	%	$	1,574.5		100.0	%	$	42.2		$	30.9

 

Results of Operations for the Three- and Nine-Month Periods Ended September 30, 2004 Compared to the Same Periods of 2003

 

Federal

 

Revenues increased for the three- and nine-month periods ended September 30, 2004, compared to the same periods in the prior year by $94.0 million and $121.0 million, or 47.2% and 19.1%, respectively. The increase was a result of our federal outsourcing and privatization business beginning work on three reconstruction contracts in Iraq, Qatar and Jordan that were awarded by the U.S. Department of Defense.  Our environmental services business reported increased volume from U.S. Federal Government contracts including increased work on the Johnson Atoll in the Pacific under the ENRAC contract, Superfund work for the U.S. Environmental Protection Agency and continued expansion of our regulatory work and construction work for the U.S. Air Force. These increases were offset by decreased revenues in our nuclear business as we continued to experience significant delays in the timing of delivery efforts at the U.S. Department of Energy’s (DOE) Hanford River Protection Project and certain other DOE projects.  However, despite this decline in revenue, our nuclear business continues to drive a significant portion of our total consolidated revenues, particularly through our major contracts at Rocky Flats and Hanford.

 

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Pre-tax profit continued to increase for the three- and nine-month periods ended September 30, 2004, compared to the same periods last year by $1.1 million and $5.3 million, or 13.8% and 24.7%, respectively.  While revenues have decreased within our nuclear business, as discussed above, our earnings on certain nuclear projects (primarily with the DOE) have increased from the same periods last year offset, in part, by extensive business development costs for two major DOE project proposals. The revenue growth discussed above and the approval of additional project scope in our federal outsourcing and privatization business also positively impacted our pre-tax profits.  Additionally, we continue to be successful in our administrative cost containment efforts.

 

Civil Infrastructure

 

Revenues decreased for the three- and nine-month periods ended September 30, 2004, compared to the same periods last year by $21.3 million and $51.0 million, or 9.2% and 7.5%, respectively. The decrease was primarily attributable to project and pursuit delays in our water and wastewater business. These delays resulted in lower volume of new business compared to last year at this time for our domestic consulting and design-build businesses.  These delays are a result of longer than expected finalization of contract terms and delays in the funding of several projects. This decline in revenue was partially offset by improvements in our international consulting and design-build businesses, particularly Asia Pacific and the Middle East, where we recently won an Iraq water reconstruction contract. The international market remains strong and we believe we are well positioned for future large design-build projects.  These opportunities and their timing are driven by strong population and economic growth in certain regions, aging infrastructure, capacity shortfalls and regulatory requirements.  Offsetting the decline in revenue in our water and wastewater business was continued growth from successful pursuits in design-build services with key cruise terminal and highway bridge projects, an increase in transportation consulting and an increase in transportation projects in Canada.

 

Pre-tax profit increased by $2.0 million, or 25.3%, for the three-month period ended September 30, 2004 and decreased by $8.4 million, or 29.1%, for the nine-month period ended September 30, 2004, compared to the same periods last year. The increase for the three-month period ended September 30, 2004 was largely due to our transportation business’s performance of work that was greater than anticipated under the original scope of the contracts. Also contributing to the increase in pre-tax profit were significant cost containment efforts. Additionally, our operations and maintenance business showed improvement in pre-tax profit due to the decision to exit two projects with negative margins in 2004.

 

The decline in pre-tax profit for the nine-month period ended September 30, 2004 is primarily attributable to increased costs on certain operations and maintenance projects and a deterioration of project margins driven by competition for market share. Additionally, our transportation business incurred costs on certain projects that were greater than anticipated due to project delivery issues. We have also incurred increased business development expenditures in our transportation business.

 

Industrial

 

Revenues increased significantly for the three- and nine-month periods ended September 30, 2004 compared to the same periods last year by $144.4 million and $372.0 million, or 169.5% and 144.1%, respectively. The increase is primarily due to the December 2003 acquisition of Lockwood Greene.  Lockwood Greene contributed revenues of $83.1 million and $255.9 million for the three- and nine-month periods ended September 30, 2004.  These revenues from Lockwood Greene were primarily generated in projects related to power, pharmaceutical, chemicals and general manufacturing sectors.

 

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Additional growth was attributable to the implementation of our strategy to provide engineering and consulting solutions to support the telecommunications sector, and to pursue clients’ capital spending dollars which have increased after historical lows for the past three years.  We are also experiencing a slight but more sustained recovery in the communications sector both in the U.S. and in Southeast Asia.  Our industrial design operations have experienced some growth in revenues as a result of more opportunities in the semiconductor and microelectronics industries.  We continue to experience growth in our energy and industrial systems business primarily resulting from an increase in spending and the volume of awards being generated from federal government clients.  However, recoveries have not been as strong or as enduring as had been initially predicted.  Overall, the outlook for our Industrial segment is uncertain because of the continued fluctuations in the industrial client sector.

 

Pre-tax profit continued to increase for the three- and nine-month periods ended September 30, 2004, compared to the same periods last year by $5.0 million and $16.9 million, or 131.6% and 137.4%, respectively. The increase is directly related to the increase in revenue, discussed above, as well as our successful efforts to implement indirect cost savings initiatives.

 

In October 2004, we acquired the assets of MicroSource, Inc. (MicroSource) for a purchase price of $4.5 million plus potential additional contingent consideration.  MicroSource provides network managed services focused on data networks for private sector and local government enterprises. We believe that this acquisition will provide a platform for our telecommunications business to obtain long-term network operations and maintenance contracts from private sector and local government enterprise clients.

 

Joint Ventures

 

We routinely enter into joint ventures to service the needs of our clients. Such arrangements are customary in the engineering and construction industry and generally are project specific. Our largest joint venture is Kaiser-Hill Company, LLC (Kaiser-Hill), in which we own a 50% interest. This joint venture is included in our Federal operating segment.  Kaiser-Hill’s current contract with the DOE, which has been effective since 2000, is a site closure contract and does not have a defined term.  We are targeting closure of the site in 2006.  Under the contract, Kaiser-Hill is compensated through a base fee affected, up or down, by its performance against the agreed site target closure timetable and costs.  For every dollar that the DOE saves, Kaiser-Hill receives a fee increase ranging from 20 to 30 cents.  At the same time, for every dollar the cleanup is over budget, the fee is reduced by 20 to 30 cents down to an agreed minimum.  The ultimate fee will also be impacted by the schedule to achieve site closure and the safety of our performance.

 

The earnings from Kaiser-Hill are reported as equity in earnings of joint ventures and affiliated companies, along with other joint ventures that are individually insignificant.  For the three-month period ended September 30, 2004 and 2003, we reported total equity in earnings of joint ventures and affiliated companies of $7.7 million and $6.6 million, respectively, and for the nine-month period ended September 30, 2004 and 2003, we reported $22.3 million and $19.4 million, respectively. The earnings from the Kaiser-Hill joint venture for the three-month periods ended September 30, 2004 and 2003 were $5.1 million and $5.0 million, respectively, and for the nine-month periods ended September 30, 2004 and 2003 were $15.5 million and $15.4 million, respectively.

 

During the three-month period ended September 30, 2004 and 2003, we recognized undistributed earnings from Kaiser-Hill of $5.1 million and $5.0 million, respectively, and $8.5 million and $9.4 million for the nine-month period ended September 30, 2004 and 2003, respectively.  Kaiser-Hill’s ability to distribute cash is based on pre-negotiated payment terms in accordance with its contract with the DOE and can be different from the earnings recognized for accounting purposes.  As the cleanup of the site progresses toward the targeted closure date of 2006, undistributed earnings could continue to increase if Kaiser-Hill continues to perform at better than cost and schedule targets.  This could result in an increase in our investment in Kaiser-Hill, which was $41.0 million and $32.4 million as of September 30, 2004 and December 31, 2003, respectively.

 

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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 legal, treasury, accounting, tax and general business development efforts.  Corporate expenses increased for the three- and nine-month periods ended September 30, 2004 compared to the same periods last year by $1.7 million and $2.5 million, or 68.0% and 34.7%, respectively. This increase was due primarily to an increase in expenses associated with our implementation efforts to comply with provisions of the Sarbanes-Oxley Act of 2002 and increased deferred compensation program expenses offset, in part, by reduced incentive compensation costs.

 

Income Taxes

 

		Three-Month Period Ended September 30,						Nine-Month Period Ended September 30,
		2004			2003			2004			2003
Income Tax Provision (in millions)		$	5.1		$	3.8		$	15.7		$	13.0
Effective Tax Rate		31.9		%	39.5		%	37.1		%	42.1		%

 

The decrease in the effective tax rate for the three- and nine-month periods ended September 30, 2004 compared to the same periods in 2003 is primarily due to an increase in tax benefits realized under the Extraterritorial Income Exclusion rules, an increase in the utilization of the companies foreign tax credits for U.S. income tax purposes and the realization of previously deferred foreign losses.  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 Internal Revenue Service (IRS) relating to the research and experimentation tax credit for the years 1996 through 1999.  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 most significant source of cash is historically from operations.  If cash flows from operations are insufficient to cover our working capital needs, we have access to our unsecured revolving line of credit.  At September 30, 2004, our total cash and credit capacity available for general corporate purposes, acquisitions and letters of credit is as follows (in millions):

 

 

During the nine-month period ended September 30, 2004, we borrowed an average of $16.5 million under our credit facility for general corporate purposes. In late December 2003, we borrowed $47.0 million under our credit facility to ensure sufficient liquidity to close our Lockwood Greene acquisition. This borrowing was repaid within approximately 20 days from cash flows from operations. It is likely, but uncertain, that we will continue to utilize our credit facility periodically during the remainder of 2004 depending on the timing of cash receipts and disbursements.  The amount outstanding under our line of credit at September 30, 2004 was $2.5 million compared to no amounts outstanding last year.

 

15

 

During December 2003, we amended our unsecured revolving line of credit to increase the maximum borrowing capacity from $125.0 million to $160.0 million. During June 2004, we amended our unsecured revolving line of credit and extended the expiration date. The credit facility may be used for general corporate purposes, permitted acquisitions and to support letters of credit.  The credit facility, as amended, expires in July 2008, however, with the lender’s consent, the credit facility can be extended for an additional year prior to July 2005.  At our option, the credit facility bears interest at a rate equal to either the London InterBank Offered Rate plus 1.00% to 1.75%, or the lender’s applicable base rate plus margin of 0.0% 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 0.20% to 0.35% 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.

 

The agreement requires us to, among other things, maintain minimum levels of net worth, a minimum coverage ratio of certain fixed charges, and a minimum leverage ratio of earnings before interest, taxes, depreciation and amortization to funded debt (all as defined in the agreement). As of September 30, 2004 we were in compliance with the covenants required by the agreement.

 

The agreement also allows us to issue letters of credit to support various trade activities. Issued letters of credit are reserved against the borrowing base of the line of credit. At September 30, 2004 there were $21.9 million issued and outstanding letters of credit.

 

Based upon our cash flow from operations and our credit capacity discussed above, we believe that we have access to adequate financial resources to fund our contractual obligations and fund our operations in the remainder of 2004 and beyond, including working capital requirements, capital expenditures and potential future acquisitions or strategic investments.

 

We used $28.7 million in cash for purchases of stock presented on our internal market compared to $21.1 million in cash used for purchases of stock presented on our internal market for the third quarter last year.

 

Off-Balance Sheet Arrangements

 

During 2001, we entered into an agreement with Meridian 26 Trust (Trust) whereby the Trust acquired land in Englewood, Colorado for the purpose of constructing and owning our new corporate headquarters and another building. The construction of these two buildings was completed in October 2002. The Trust was formed to fund the construction, own the land and the two buildings and subsequently lease the facilities to us. The Trust was funded by equity and debt investments from independent third parties. The lease agreement was effective upon completion of construction. The lease agreement 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, subject to certain limitations, we have the option to purchase the facilities from the Trust at fair market value.

 

We are party to another building lease agreement that 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 the additional building of approximately $17.6 million.  Upon completion of the lease term, subject to certain limitations, we have the option to purchase the building from the lessor at fair market value.  The lease matures on September 28, 2008 and provides for five one year renewal options.

 

Aggregate Commercial Commitments

 

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 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.  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.

 

16

 

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 accounting principles generally accepted in the United States of America. 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 our 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 your understanding of our financial results and condition and require complex management judgment are summarized below. Further detail and information regarding our other accounting policies is included in our Annual Report on Form 10-K for the year ended December 31, 2003.

 

Revenue Recognition

 

We earn our revenues from different types of services under a variety of different types of contracts, including cost-plus, firm fixed-price and time-and-materials. To recognize revenue, we evaluate each contractual arrangement to determine the appropriate authoritative literature to apply. We recognize revenue and profit for most 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, or 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 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.

 

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 revenues and expenses.

 

We must assess the likelihood that we will be able to recover our deferred tax assets.  If recovery is not likely, we record 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.

 

17

 

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 Statement of Financial Accounting Standard (SFAS) No. 87, “Employers’ Accounting for Pensions,” 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.

 

New Accounting Standards

 

In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation (FIN) No. 46, “Consolidation of Variable Interest Entities,” which provides guidance on when to consolidate variable interest entities (VIEs). In December 2003, the FASB revised FIN 46 with FIN 46R. In addition to conforming to previously issued FASB Staff Positions, FIN 46R deferred the implementation date for certain VIEs.  We adopted the provisions of FIN 46R immediately for entities created after December 31, 2003. For entities created before December 31, 2003, we will adopt FIN 46R in the first quarter of 2005, as required.

 

We have interests in multiple joint ventures that are considered VIEs under FIN 46R.  These entities facilitate the completion of service 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. In accordance with FIN 46R, we have identified several joint ventures that would be considered VIEs.  We also have an interest in the Meridian 26 Trust (Trust), which has also been identified as a VIE.  We have classified entities identified as VIEs into two groups, the first of which includes those entities that we will be required to consolidate under the guidance of FIN 46R in the first quarter of 2005, subject to further evaluation, and the second group which includes those entities which we will not be required to consolidate.  At September 30, 2004, the assets and liabilities, including minority interest balances, of the identified VIEs that may be consolidated are $88.3 million and $80.4 million, respectively, of which we currently consolidate $8.1 million and $3.9 million, respectively.  At September 30, 2004, the assets and liabilities of the identified VIEs that will not be consolidated are $21.2 million and $17.8 million, respectively.

 

In December 2003, the FASB issued SFAS No. 132 (Revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” SFAS No. 132(R) increases the existing disclosure requirements by requiring more details about pension plan assets, benefit obligations, cash flows, benefit costs and related information. Companies will be required to segregate plan assets by category, such as debt, equity and real estate, and to provide certain expected rates of return and other informational disclosures. The new disclosure requirements required by SFAS No. 132(R) are effective for us for years ending after June 15, 2004.  We will adopt the new SFAS No. 132(R) disclosure requirements for the year ending December 31, 2004.

 

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 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.

 

18

 

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 revolving credit agreement on a limited basis. During the third quarter of 2004, we borrowed an average of $16.5 million under our revolving credit agreement and our amount outstanding under the line of credit was $2.5 million at September 30, 2004. 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 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.  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.

 

In conjunction with our preparation toward compliance with Section 404 of the Sarbanes-Oxley Act of 2002, we identified deficiencies in our internal controls over financial reporting and are in the process of implementing certain enhancements.  These deficiencies and enhancements have been disclosed to our independent accountants and discussed with the Audit and Finance Committee of our Board of Directors.  We, including the Chief Executive Officer and Chief Financial Officer, expect that these enhancements will be in place by the end of the year.  However, the provisions of Section 404 require that such procedures operate for a period of time before we can assess their effectiveness. As a result, these items may have an impact on management’s or our independent accountant’s reports on internal controls over financial reporting issued in connection with our 2004 Annual Report on Form 10-K.

 

Part II. OTHER INFORMATION

 

Item 1.    Legal Proceedings

 

We are party to certain contractual guarantees and various legal actions arising in the normal course of our business.  From time-to-time, agencies of the U.S. Government investigate whether our operations are being conducted in accordance with applicable regulatory requirements.  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.  U.S. Government 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.

 

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Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds

 

The following table covers the purchases of our securities by CH2M HILL during the period covered by this report.

 

Period		Total Number of Shares		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)		19,724		$	12.11		—		—
August (a)		43,393		$	12.79		—		—
September (b)		401,215		$	13.04		—		—
Total		464,332		$	12.98		—		—

 

(a)          Shares repurchased pursuant to a surrender by shareholders of previously owned shares in payment of the option exercise price.

 

(b)         Includes shares purchased by CH2M HILL in the Internal Market and surrender by shareholders of previously owned shares in payment of the option exercise price.

 

Item 4.    Submission of Matters to a Vote of Security Holders

 

(a)           We held our Annual Meeting of Shareholders on May 4, 2004.

 

(b)                                 Pursuant to the directors’ election listed under Item 4(c)(i), William T. Dehn, Donald S. Evans, Jerry D. Geist and Susan D. King were each elected as directors for a three-year term.  Carolyn Chin, Ralph R. Peterson, M. Catherine Santee, Thomas G. Searle and Barry L. Williams were each elected at the 2003 Annual Meeting for a term of three years and continue as directors.  James J. Ferris, Michael D. Kennedy, David B. Price and Nancy R. Tuor were each elected at the 2002 Annual Meeting for a term of three years and continue as directors.

 

(c)                                  Our shareholders voted on the following matters:

 

(i)                                     Election of four directors.  All directors proposed by management were elected.

 

 

(ii)                                  Approval of the 2004 Stock Option Plan.

 

For		26,424,899
Against		690,755
Abstain		727,971

 

(iii)                               Approval of amendment to the Payroll Deduction Stock Purchase Plan to increase the number of shares reserved under the Plan from 3,000,000 to 13,000,000 shares.

 

For		26,645,671
Against		746,999
Abstain		450,955

 

 

(iv)                              Ratification of the appointment of KPMG LLP as independent auditors of CH2M HILL for the year ending December 31, 2004.

 

For		27,264,270
Against		227,874
Abstain		351,481

 

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