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Table of Contents

 

 

 

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 SEPTEMBER 30, 2009

 

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
incorporation or organization)

 

(I.R.S. Employer
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 o No x

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes o No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, and “small reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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 October 30, 2009 was 32,129,370.

 

 

 

 



Table of Contents

 

CH2M HILL COMPANIES, LTD.

 

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION

 

 

 

Item 1.

FINANCIAL INFORMATION

3

 

Consolidated Balance Sheets as of September 30, 2009 and December 31, 2008 (unaudited)

3

 

Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2009 and 2008 (unaudited)

4

 

Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2009 and 2008 (unaudited)

5

 

Notes to Consolidated Financial Statements (unaudited)

6

 

 

 

Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

13

 

 

 

Item 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

20

 

 

 

Item 4.

CONTROLS AND PROCEDURES

20

 

 

 

PART II. OTHER INFORMATION

Item 1.

LEGAL PROCEEDINGS

21

 

 

 

Item 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

21

 

 

 

Item 6.

EXHIBITS

21

 

 

 

SIGNATURES

22

 

2



Table of Contents

 

CH2M HILL COMPANIES, LTD.

 

Consolidated Balance Sheets

 

(Unaudited)

 

(In thousands, except share data)

 

 

 

September 30,
2009

 

December 31,
2008

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

166,564

 

$

114,282

 

Available-for-sale securities

 

1,912

 

327

 

Receivables, net—

 

 

 

 

 

Client accounts

 

596,440

 

670,243

 

Unbilled revenue

 

422,985

 

446,763

 

Other

 

16,425

 

13,280

 

Deferred income taxes

 

44,578

 

50,246

 

Income tax receivable

 

6,095

 

16,837

 

Prepaid expenses and other current assets

 

59,814

 

65,558

 

Total current assets

 

1,314,813

 

1,377,536

 

Investments in unconsolidated affiliates

 

88,352

 

37,322

 

Property, plant and equipment, net

 

200,684

 

214,037

 

Goodwill

 

130,354

 

134,840

 

Intangible assets, net

 

63,849

 

88,819

 

Deferred income taxes

 

96,254

 

82,326

 

Other assets

 

45,165

 

36,961

 

Total assets

 

$

1,939,471

 

$

1,971,841

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Current portion of long-term debt

 

$

14,191

 

$

24,652

 

Accounts payable and accrued subcontractor costs

 

390,981

 

447,747

 

Billings in excess of revenue

 

303,592

 

289,230

 

Accrued payroll and employee related liabilities

 

242,702

 

278,684

 

Other accrued liabilities

 

101,856

 

93,309

 

Total current liabilities

 

1,053,322

 

1,133,622

 

Long-term employee related liabilities and other

 

325,826

 

300,247

 

Long-term debt

 

40,598

 

151,223

 

Total liabilities

 

1,419,746

 

1,585,092

 

Commitments and contingencies (Note 11)

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Preferred stock, $0.01 par value, 50,000,000 shares authorized; none issued

 

 

 

Common stock, $0.01 par value, 100,000,000 shares authorized; 31,926,353 and 31,604,336 issued and outstanding at September 30, 2009 and December 31, 2008, respectively

 

319

 

316

 

Additional paid-in capital

 

34,206

 

9,947

 

Retained earnings

 

510,235

 

428,054

 

Accumulated other comprehensive loss

 

(39,744

)

(54,086

)

Total CH2M HILL common shareholders’ equity

 

505,016

 

384,231

 

Noncontrolling interests

 

14,709

 

2,518

 

Total equity

 

519,725

 

386,749

 

Total liabilities and shareholders’ equity

 

$

1,939,471

 

$

1,971,841

 

 

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

 

3



Table of Contents

 

CH2M HILL COMPANIES, LTD.

 

Consolidated Statements of Income

 

(Unaudited)

 

(In thousands, except share and per share data)

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

Gross revenue

 

$

1,441,281

 

$

1,446,979

 

$

4,148,958

 

$

4,041,272

 

Equity in earnings of joint ventures and affiliated companies

 

18,469

 

10,058

 

45,997

 

21,112

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Direct cost of services and overhead

 

(1,187,643

)

(1,162,344

)

(3,367,925

)

(3,241,325

)

General and administrative

 

(248,244

)

(270,350

)

(750,517

)

(769,495

)

 

 

 

 

 

 

 

 

 

 

Gain on sale of operating assets

 

58,235

 

 

58,235

 

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

82,098

 

24,343

 

134,748

 

51,564

 

 

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

506

 

604

 

952

 

2,892

 

Interest expense

 

(1,228

)

(3,993

)

(5,922

)

(12,337

)

Income before provision for income taxes

 

81,376

 

20,954

 

129,778

 

42,119

 

Provision for income taxes

 

(24,614

)

(6,155

)

(34,964

)

(13,391

)

 

 

 

 

 

 

 

 

 

 

Net income

 

56,762

 

14,799

 

94,814

 

28,728

 

Less: Loss (income) attributable to noncontrolling interests

 

1,505

 

(4,889

)

(12,633

)

(10,061

)

Net income attributable to CH2M HILL

 

$

58,267

 

$

9,910

 

$

82,181

 

$

18,667

 

 

 

 

 

 

 

 

 

 

 

Net income per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

1.82

 

$

0.29

 

$

2.58

 

$

0.56

 

Diluted

 

$

1.78

 

$

0.29

 

$

2.52

 

$

0.54

 

Weighted average number of common shares:

 

 

 

 

 

 

 

 

 

Basic

 

31,985,190

 

33,599,143

 

31,903,629

 

33,631,817

 

Diluted

 

32,673,958

 

34,498,126

 

32,576,869

 

34,544,697

 

 

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

 

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Table of Contents

 

CH2M HILL COMPANIES, LTD.

 

Consolidated Statements of Cash Flows

 

(Unaudited)

 

(In thousands)

 

 

 

Nine Months Ended
September 30,

 

 

 

2009

 

2008

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

94,814

 

$

28,728

 

Adjustments to reconcile net income from continuing operations to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

64,555

 

68,822

 

Gain on sale of operating assets

 

(58,235

)

 

Stock-based employee compensation expense

 

55,828

 

34,496

 

Loss (gain) on disposal of property, plant and equipment

 

2,234

 

(25

)

Allowance for uncollectible accounts

 

8,798

 

2,759

 

Deferred income taxes

 

(8,663

)

(13,957

)

Undistributed earnings from unconsolidated affiliates

 

(45,997

)

(21,112

)

Distributions from unconsolidated affiliates

 

28,760

 

39,140

 

Change in assets and liabilities, net of businesses acquired:

 

 

 

 

 

Receivables and unbilled revenue

 

64,762

 

10,915

 

Prepaid expenses and other

 

(4,595

)

(1,707

)

Accounts payable and accrued subcontractor costs

 

(51,629

)

(39,567

)

Billings in excess of revenue

 

19,283

 

15,526

 

Employee related liabilities

 

(7,823

)

23,071

 

Other accrued liabilities

 

11,590

 

(19,186

)

Income taxes payable

 

(7,667

)

(7,968

)

Long term liabilities and other

 

37,686

 

8,757

 

Net cash provided by operating activities

 

203,701

 

128,692

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(27,775

)

(35,151

)

Acquisitions and earn-out payments, net of cash acquired

 

 

(22,134

)

Investments in unconsolidated affiliates

 

(62,462

)

(76,595

)

Distributions of capital from unconsolidated affiliates

 

29,512

 

45,856

 

Proceeds from sale of operating assets

 

70,971

 

 

Proceeds from sale of property, plant and equipment

 

61

 

642

 

Proceeds from sale of investments

 

 

1,054

 

Net cash provided by (used in) investing activities

 

10,307

 

(86,328

)

Cash flows from financing activities:

 

 

 

 

 

Borrowings on line of credit and long-term debt

 

746,110

 

801,900

 

Payments on line of credit and long-term debt

 

(867,196

)

(804,385

)

Repurchases and retirements of stock

 

(55,650

)

(42,986

)

Excess tax benefits from stock-based compensation

 

4,806

 

5,068

 

Net contributions from noncontrolling interests

 

(1,487

)

721

 

Net cash used in financing activities

 

(173,417

)

(39,682

)

Effect of exchange rates on cash

 

11,691

 

(3,101

)

Increase (decrease) in cash and cash equivalents

 

52,282

 

(419

)

Cash and cash equivalents, beginning of period

 

114,282

 

124,105

 

Cash and cash equivalents, end of period

 

$

166,564

 

$

123,686

 

Supplemental disclosures:

 

 

 

 

 

Cash paid for interest

 

$

7,125

 

$

10,774

 

Cash paid for income taxes

 

$

29,798

 

$

37,609

 

 

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

 

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Table of Contents

 

CH2M HILL COMPANIES, LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

September 30, 2009

 

(Unaudited)

 

(1) SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES

 

Summary of Business

 

CH2M HILL Companies, Ltd. and subsidiaries (CH2M HILL) is a project delivery firm that was founded in 1946. CH2M HILL provides engineering, consulting, design, construction, procurement, operations and maintenance, and program and project management services to federal, state, municipal and local government entities and U.S. federal government agencies, as well as private industry, in the U.S. and internationally. CH2M HILL is an employee-owned Oregon corporation. A substantial portion of CH2M HILL’s professional fees arises from projects that are funded directly or indirectly by government entities.

 

Basis of Presentation

 

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and with the instructions to Form 10-Q and Article 10 of Regulation S-X for interim financial statements. Accordingly, these statements do not include all of the information required by GAAP or the 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. Actual results could differ from those estimates. Certain prior period amounts have been reclassified to conform to the current presentation.

 

In the opinion of CH2M HILL’s 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, 2008. In the following text, the terms “we,” “our,” “our company,” and “us” may refer to CH2M HILL.

 

Effective May 2009, we reorganized the business and began making strategic and operating decisions with regards to assessing performance and allocating resources based on a new segment structure. Results for 2008 have been adjusted to reflect the new structure and comparative information has been restated and presented consistent with the new organizational structure. Refer to Note 2 for a description of the segments.

 

Subsequent Events

 

We have evaluated subsequent events and transactions for potential recognition or disclosure in the financial statements through November 4, 2009, the day the financial statements were issued.

 

Revenue Recognition

 

CH2M HILL earns its revenue from different types of contracts, including cost-plus, fixed-price and time-and-materials. CH2M HILL primarily performs engineering and construction related services and recognizes revenue for these 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 estimated. Management evaluates when a change order is probable based upon its experience in negotiating change orders or the customer’s written approval of such changes. 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.

 

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CH2M HILL also performs operations and maintenance services. Revenue is recognized on operations and maintenance contracts on a straight-line basis over the life of the contract once CH2M HILL has an arrangement, service has begun, the price is fixed or determinable and collectability is reasonably assured.

 

Unbilled Revenue and Billings in Excess of Revenue

 

Unbilled revenue represents the excess of contract revenue recognized over billings to date on contracts in process. These amounts become billable according to the contract terms, which usually consider the passage of time, achievement of certain milestones or completion of the project.

 

Billings in excess of revenue represent the excess of billings to date, per the contract terms, over revenue recognized on contracts in process.

 

Shareholders’ Equity

 

The changes in shareholders’ equity for the nine months ended September 30, 2009 are as follows (in thousands):

 

 

 

Shares

 

Amount

 

Shareholders’ equity, December 31, 2008

 

31,604

 

$

386,749

 

Net income attributable to CH2M HILL

 

 

82,181

 

Shares issued and to be issued in connection with stock-based compensation and employee benefit plans

 

1,673

 

67,725

 

Shares and share equivalents purchased, retired and cancelled

 

(1,351

)

(43,463

)

Other comprehensive income

 

 

14,342

 

Noncontrolling interests

 

 

12,191

 

Shareholders’ equity, September 30, 2009

 

31,926

 

$

519,725

 

 

Stock-Based Compensation Plans

 

CH2M HILL accounts for stock-based compensation in accordance with Accounting Standards Codification (ASC) Topic 718, Stock Compensation, using the prospective method. Under the prospective method, the provisions of ASC Topic 718 apply to new grants made on or after January 1, 2006. CH2M HILL measures the fair value of stock option grants at the date of grant using a Black-Scholes option pricing model. The weighted-average grant date fair value of options granted during the three and nine months ended September 30, 2009 was $5.80 and $5.58, respectively, compared to $5.59 and $5.92 for the same periods in the prior year.

 

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 expected term of the option. CH2M HILL uses the U.S. Treasury bill issues for the risk-free interest rate in the option valuation model with original maturities similar to the expected term of 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 option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. The fair value of stock-based payment awards is amortized into stock-based compensation 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 for stock options during the three and nine months ended September 30, 2009 was $1.0 million and $3.1 million, respectively, compared to $1.1 million and $3.4 million for the three and nine months ended September 30, 2008.

 

Recently Adopted Accounting Standards

 

In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, which was primarily codified into ASC Topic 105, Generally Accepted Accounting Standards. ASC Topic 105 will become the single source of authoritative nongovernmental GAAP, superseding existing FASB, American Institute of Certified Public Accountants (AICPA), Emerging Issues Task Force (EITF), and related accounting literature. This standard reorganizes the GAAP pronouncements into accounting topics and displays them using a consistent structure. This guidance impacts

 

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the Company’s financial statements and related disclosures as all references to authoritative accounting literature reflect the newly adopted codification. CH2M HILL adopted ASC Topic 105 on September 30, 2009.

 

In December 2007, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 141(R), Business Combinations, which was primarily codified into ASC Topic 805, Business Combinations. This standard establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interests in the acquiree and the goodwill acquired. ASC Topic 805 also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. CH2M HILL adopted ASC Topic 805 on January 1, 2009.

 

On January 1, 2009, CH2M HILL adopted SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements-An Amendement of ARB No. 51, which was primarily codified into ASC Topic 810, Consolidations. Noncontrolling interests are defined as the portion of equity (net assets) in a subsidiary not attributable, directly or indirectly, to a parent. ASC Topic 810 establishes accounting and reporting standards for noncontrolling interests, the amount of consolidated net income attributable to the parent and to the noncontrolling interests, changes in a parent’s ownership interest and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. ASC Topic 810 also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. CH2M HILL adopted the accounting provisions of ASC Topic 810 on a prospective basis as of the beginning of our 2009 fiscal year. The presentation and disclosure requirements of ASC Topic 810 were adopted on a retrospective basis, and resulted in a reclassification of minority interests to noncontrolling interests of $2.5 million at December 31, 2008.

 

In May 2009, the FASB issued SFAS No. 165, Subsequent Events, which was primarily codified into ASC Topic 855, Subsequent Events.  ASC Topic 855 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financials statements are issued or are available to be issued. CH2M HILL adopted ASC Topic 855 on June 30, 2009. Adoption did not have a material impact on the consolidated financial statements.

 

Recently Issued Accounting Standards

 

In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R) (SFAS 167), which has not yet been codified in the ASC. This guidance is a revision to pre-existing guidance pertaining to the consolidation and disclosures of variable interest entities. Specifically, it changes how a reporting entity determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a reporting entity is required to consolidate another entity is based on, among other things, the other entity’s purpose and design and the reporting entity’s ability to direct the activities of the other entity that most significantly impact the other entity’s economic performance. This guidance will require a reporting entity to provide additional disclosures about its involvement with variable interest entities and continually assess any significant changes in risk exposure due to that involvement. SFAS 167 is effective for CH2M HILL beginning January 1, 2010. The Company is in the process of evaluating the impacts of this statement.

 

On December 30, 2008, the FASB issued FSP FAS 132(R)-1, Employers’ Disclosures about Postretirement Benefit Plan Assets, which was primarily codified into ASC Topic 715, Compensation-Retirement Benefit. The statement provides guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. ASC Topic 715 requires employers of entities to disclose more information about how investment allocation decisions are made, more information about major categories of plan assets, and the fair value techniques and inputs used to measure plan assets. ASC Topic 715 is effective for CH2M HILL for the year ending December 31, 2009.

 

(2) SEGMENT INFORMATION

 

As discussed in Note 1, the chief operating decision maker began regularly reviewing operating results using a new segment structure effective in the second quarter 2009. In accordance with ASC Topic 280, Segment Reporting, we reviewed our reportable segments and determined that, based on the current business environment in which we operate, the economic characteristics of our operating segments, and management’s view of the business, a revision of our reportable segments was appropriate. Based on this determination, our new reportable segments are: Government, Environment and Nuclear (GEN), Facilities and Infrastructure, and Energy. The primary change from our previously reported segments is the former Civil Infrastructure and Industrial client groups have been strategically redeployed within the new segments.

 

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Table of Contents

 

In accordance with ASC Topic 280, we have restated prior period segment disclosures in these consolidated financial statements based on our new reportable segments. Certain financial information relating to the three and nine months ended September 30, 2009 and 2008 for each segment is provided below (in thousands):

 

Three Months Ended September 30, 2009

 

Government,
Environment
and Nuclear

 

Facilities and
Infrastructure

 

Energy

 

Other

 

Financial
Statement
Balances

 

Revenue from external customers

 

$

549,437

 

$

478,372

 

$

413,472

 

$

 

$

1,441,281

 

Equity in earnings of joint ventures and affiliated companies

 

14,843

 

3,291

 

335

 

 

18,469

 

Operating income (loss)

 

84,239

 

14,706

 

(5,488

)

(11,359

)

82,098

 

 

Three Months Ended September 30, 2008

 

Government,
Environment
and Nuclear

 

Facilities and
Infrastructure

 

Energy

 

Other

 

Financial
Statement
Balances

 

Revenue from external customers

 

$

413,440

 

$

518,048

 

$

515,491

 

$

 

$

1,446,979

 

Equity in earnings of joint ventures and affiliated companies

 

7,588

 

1,304

 

1,166

 

 

10,058

 

Operating income (loss)

 

23,533

 

3,955

 

6,333

 

(9,478

)

24,343

 

 

Nine Months Ended September 30, 2009

 

Government,
Environment
and Nuclear

 

Facilities and
Infrastructure

 

Energy

 

Other

 

Financial
Statement
Balances

 

Revenue from external customers

 

$

1,423,685

 

$

1,456,021

 

$

1,269,252

 

$

 

$

4,148,958

 

Equity in earnings of joint ventures and affiliated companies

 

29,868

 

15,162

 

967

 

 

45,997

 

Operating income (loss)

 

107,852

 

42,894

 

17,069

 

(33,067

)

134,748

 

 

Nine Months Ended September 30, 2008

 

Government,
Environment
and Nuclear

 

Facilities and
Infrastructure

 

Energy

 

Other

 

Financial
Statement
Balances

 

Revenue from external customers

 

$

1,200,765

 

$

1,457,628

 

$

1,382,879

 

$

 

$

4,041,272

 

Equity in earnings (losses) of joint ventures and affiliated companies

 

28,874

 

(10,967

)

3,205

 

 

21,112

 

Operating income (loss)

 

45,926

 

7,089

 

32,410

 

(33,861

)

51,564

 

 

During the second quarter, our chief operating decision maker began making strategic and operating decisions with regards to assessing performance and allocating resources based on a new segment structure. We now operate under the following segments— Government, Environment and Nuclear (GEN), Facilities and Infrastructure, and Energy—which are aligned with the types of clients we serve. Our GEN segment generally provides a comprehensive range of services to the U.S. Federal government as well as services to international governments and industry. Our Facilities and Infrastructure segment generally provides a comprehensive range of services to various industry segments, and state, local and provincial governments. Our Energy segment generally provides a comprehensive range of services to private sector clients.

 

(3) COMPREHENSIVE INCOME

 

Comprehensive income includes foreign currency translation adjustments, benefit plan adjustments, and unrealized gains/losses on equity investments that have been reflected as a component of shareholders’ equity and have not impacted net income. The following table summarizes the components of comprehensive income for the three and nine months ended September 30, 2009 and 2008 (in thousands):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

Net income

 

$

56,762

 

$

14,799

 

$

94,814

 

$

28,728

 

Unrealized gains (losses) on equity investments and other, net of tax

 

381

 

(233

)

540

 

(1,428

)

Foreign currency translation adjustments

 

8,271

 

(2,800

)

14,847

 

(3,840

)

Comprehensive income

 

65,414

 

11,766

 

110,201

 

23,460

 

Comprehensive income attributable to noncontrolling interests

 

1,088

 

(4,487

)

(13,678

)

(9,705

)

Comprehensive income attributable to CH2M HILL

 

$

66,502

 

$

7,279

 

$

96,523

 

$

13,755

 

 

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(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 primarily of stock options, and is computed using the weighted-average number of shares and common stock equivalents outstanding during the period.

 

The following table is a reconciliation of basic and diluted EPS for the three and nine months ended September 30, 2009 and 2008 (in thousands, except per share amounts):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income attributable to CH2M HILL

 

$

58,267

 

$

9,910

 

$

82,181

 

$

18,667

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

Basic income per share — weighted average shares outstanding

 

31,985

 

33,599

 

31,904

 

33,632

 

Dilutive effect of common stock equivalents

 

689

 

899

 

673

 

913

 

Diluted income per share — adjusted weighted-average shares outstanding, assuming conversion of common stock equivalents

 

32,674

 

34,498

 

32,577

 

34,545

 

 

 

 

 

 

 

 

 

 

 

Basic net income per common share

 

$

1.82

 

$

0.29

 

$

2.58

 

$

0.56

 

Diluted net income per common share

 

$

1.78

 

$

0.29

 

$

2.52

 

$

0.54

 

 

(5) SALE OF OPERATING ASSETS

 

During the current quarter, the Company completed the sale of certain assets and liabilities of its Enterprise Management Solutions (EMS) business. The selling price was $86.6 million, net of amounts due for estimated working capital adjustments of $12.7 million. The final selling price is subject to final working capital and other customary adjustments. The Company recorded a pre-tax gain of approximately $58.2 million during the three months ended September 30, 2009. During the second quarter of 2009, the operations of EMS were presented as discontinued operations. In the third quarter of 2009, the presentation was revised to present the results of EMS as part of continuing operations due to the nature of CH2M HILL’s continuing involvement with that entity after disposition.

 

(6) INVESTMENTS IN 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 and facilitate the completion of 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. 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.

 

CH2M HILL’s interests in certain joint ventures are considered variable interest entities (VIE’s) under ASC Topic 810, Consolidation. A VIE is an entity with one or more of the following characteristics, (a) the total equity investment at risk is not sufficient to permit the entity to finance its activities without additional financial support; (b) as a group, the holders of the equity investment at risk lack the ability to make certain decisions, or (c) the equity investors have voting rights that are not proportional to their economic interests. ASC Topic 810 requires a VIE to be consolidated in the financial statements of the entity that is determined to be the primary beneficiary of the VIE. For VIE’s where CH2M HILL is not the primary beneficiary and those entities which are unconsolidated voting interest entities, CH2M HILL accounts for its investments in affiliated unconsolidated companies primarily using the equity method of accounting.

 

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 ASC Topic 810, as CH2M HILL is considered the primary beneficiary, and the second group that includes those entities which CH2M HILL was not required to consolidate. As of September 30, 2009, the assets and

 

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liabilities of VIE’s that were consolidated were $136.8 million and $94.8 million, respectively. As of September 30, 2009, the assets and liabilities of the identified VIE’s that were not consolidated were $391.8 million and $312.0 million, respectively.

 

As of September 30, 2009 and December 31, 2008, the investments in unconsolidated affiliates were $88.4 million and $37.3 million, respectively. CH2M HILL’s proportionate share of net income or loss is included as equity in earnings of joint ventures and affiliated companies in the consolidated statements of income. In general, the equity investment in our joint ventures is equal to our current equity investment plus those entities’ undistributed earnings. CH2M HILL provides certain services, including engineering, construction management and computer and telecommunications support, to these unconsolidated entities. These services are billed to the joint ventures in accordance with the provisions of the joint venture agreements.

 

Summarized unaudited financial information for CH2M HILL’s unconsolidated affiliates for the three months and nine months ended September 30, 2009 and 2008 is as follows (in thousands):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

RESULTS OF OPERATIONS:

 

 

 

 

 

 

 

 

 

Revenue

 

$

639,701

 

$

592,382

 

$

1,671,539

 

$

1,693,375

 

Direct costs

 

(586,837

)

(559,556

)

(1,542,058

)

(1,641,719

)

Gross margin

 

52,864

 

32,826

 

129,481

 

51,656

 

General and administrative expenses

 

820

 

(2,378

)

(317

)

(5,226

)

Operating income

 

53,684

 

30,448

 

129,164

 

46,430

 

Other expense, net

 

(2,955

)

(4,455

)

(8,814

)

(14,160

)

Net income

 

$

50,729

 

$

25,993

 

$

120,350

 

$

32,270

 

 

(7) GOODWILL AND INTANGIBLE ASSETS

 

Intangible assets with finite lives consist of the following (in thousands):

 

 

 

Cost

 

Accumulated
Amortization

 

Net finite-lived
intangible assets

 

September 30, 2009

 

 

 

 

 

 

 

Contracted backlog

 

$

58,871

 

$

(56,462

)

$

2,409

 

Customer relationships

 

57,922

 

(16,856

)

41,066

 

Non-compete agreements and other

 

902

 

(854

)

48

 

 

 

$

117,695

 

$

(74,172

)

$

43,523

 

December 31, 2008

 

 

 

 

 

 

 

Contracted backlog

 

$

58,871

 

$

(38,038

)

$

20,833

 

Customer relationships

 

57,922

 

(10,651

)

47,271

 

Non-compete agreements and other

 

1,100

 

(711

)

389

 

 

 

$

117,893

 

$

(49,400

)

$

68,493

 

 

Indefinite-lived intangible assets consist of the following (in thousands):

 

 

 

September 30,
2009

 

December 31,
2008

 

Goodwill

 

$

130,354

 

$

134,840

 

Tradename

 

20,326

 

20,326

 

 

 

$

150,680

 

$

155,166

 

 

All finite-lived intangible assets are being amortized over their expected lives up to seven years. The amortization expense reflected in the accompanying consolidated statements of income was $7.3 million and $9.5 million for the three months ended September 30, 2009 and 2008, respectively, and $24.8 million and $27.7 million for the nine months ended September 30, 2009 and 2008, respectively. These intangible assets are expected to be fully amortized in 2014.

 

(8) PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment consists of the following (in thousands):

 

 

 

September 30, 2009

 

December 31, 2008

 

Land

 

$

23,503

 

$

25,409

 

Buildings

 

69,889

 

66,775

 

Furniture, fixtures and equipment

 

187,767

 

189,210

 

Leasehold improvements

 

62,433

 

44,387

 

 

 

343,592

 

325,781

 

Less: Accumulated depreciation

 

(142,908

)

(111,744

)

Property, plant and equipment, net

 

$

200,684

 

$

214,037

 

 

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Depreciation expense reflected in the consolidated statements of income was $13.4 million and $13.6 million for the three months ended September 30, 2009 and 2008, respectively, and $39.8 million and $41.4 million for the nine months ended September 30, 2009 and 2008, respectively. The majority of depreciation expense relates to property, plant and equipment held in the Energy segment.

 

(9) LINE OF CREDIT

 

CH2M HILL is party to a credit agreement which provides for a $500.0 million committed revolving credit facility (RLOC) which expires on August 31, 2012. The credit agreement includes an option to increase the initial borrowing capacity by up to an additional $250.0 million. The credit agreement has been used for general corporate purposes and permitted acquisitions. It also provides that up to $250.0 million is available for the issuance of letters of credit to support various operating 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 CH2M HILL’s ratio of funded debt to earnings before interest, taxes, depreciation and amortization. A commitment fee of approximately 0.10% to 0.25% per year on the unused portion of the line of credit is payable based on CH2M HILL’s ratio of funded debt to earnings before interest, taxes, depreciation and amortization. As of September 30, 2009, CH2M HILL did not have any borrowings outstanding on the RLOC. Additionally, at the end of the current period, issued and outstanding letters of credit of $68.4 million were reserved against the borrowing base of the credit agreement, compared to $51.3 million at December 31, 2008. While the management of CH2M HILL continues to carefully monitor the unfolding global financial situation to assess any impacts this might have on our banks in the RLOC and their ability to meet their legal funding obligations to us, the RLOC is a committed facility and CH2M HILL believes the potential financial exposure is limited.

 

In the first quarter of 2008, CH2M HILL entered into two derivative financial transactions to reduce the effects of interest rate changes on cash flows due to changes in interest rates on its outstanding debt. As of September 30, 2009, CH2M HILL has two interest rate swaps with a total notional amount of $50.0 million. The Company has not designated these derivative instruments as effective hedges as defined by ASC Topic  815, Derivatives and Hedging, and therefore, interest expense related to periodic settlements on these interest rate swaps and the change in fair value of these swap agreements is recognized in earnings in the current period. These interest rate swaps mature in March 2010. The fair value of these derivative assets is not significant.

 

The RLOC agreement contains financial and other covenants, as well as 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 September 30, 2009, CH2M HILL was in compliance with the covenants required by the credit agreement.

 

(10) PROVISION FOR INCOME TAXES

 

The effective tax rate for the three months ended September 30, 2009 was 29.7% compared to 38.3% for the same period in the prior year. The tax rate for the nine months ended September 30, 2009 was 29.9% compared to the 41.8% for the same period in the prior year. The effective tax rate for the three and nine months ended September 30, 2009 was favorably impacted by the recognition of benefits from statute expirations, taxing jurisdiction settlements, and by improved foreign operating results. CH2M HILL’s effective tax rate continues to be negatively impacted by the effect of non-deductible foreign net operating losses, the disallowed portion of executive compensation, and disallowed portions of meals and entertainment expenses.

 

As of September 30, 2009 and December 31, 2008, we had $25.5 million and $25.4 million, respectively, recorded as a liability for uncertain tax positions.

 

CH2M HILL recognizes interest and penalties related to unrecognized tax benefits in income tax expense. As of September 30, 2009 and December 31, 2008, CH2M HILL had approximately $4.2 million and $3.8 million, respectively, of accrued interest and penalties related to uncertain tax positions.

 

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Table of Contents

 

CH2M HILL files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. In the normal course of business, we are subject to examination by taxing authorities throughout the world, including such major jurisdictions as the United States and Canada. With few exceptions, CH2M HILL 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 2002.

 

(11) COMMITMENTS AND CONTINGENCIES

 

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 outcomes of pending proceedings are often difficult to predict, CH2M HILL’s management estimates 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.

 

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 operating income

 

·                  The sources of our revenue and operating income

 

·                  Variations of revenue and operating income from period to period

 

·                  Cash sources and utilizations

 

·                  The impact of the above on our overall financial condition

 

In the following text, the terms, “we,” “our,” “our company,” and “us” may refer to CH2M HILL.

 

The following discussion and information contains, in addition to historical information, forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including without limitation, statements containing the words “believes,” “anticipates,” “expects” and words of similar import and statements regarding our strategy, financial performance and operations that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those described under Item 1A, Risk Factors (which is expressly incorporated herein by reference) of our Annual Report on Form 10-K for the year ended December 31, 2008, filed with the SEC on February 24, 2009. 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, 2008.

 

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.

 

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Table of Contents

 

Overview

 

We are one of the largest engineering services firms worldwide and are employee-owned. Our business provides engineering, construction, operations, maintenance, project management and related technical services to municipal, state, federal and private sector clients worldwide. Founded in 1946, we operate in more than 80 countries and have 25,000 employees in offices 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.

 

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.

 

During the second quarter, our chief operating decision maker began making strategic and operating decisions with regards to assessing performance and allocating resources based on a new segment structure. We now operate under the following segments—Government, Environment and Nuclear (GEN), Facilities and Infrastructure, and Energy—which are aligned with the types of clients we serve. Our GEN segment generally provides a comprehensive range of services to the U.S. Federal government as well as services to international governments and industry. Our Facilities and Infrastructure segment generally provides a comprehensive range of services to various industry segments, and state, local and provincial governments. Our Energy segment generally provides a comprehensive range of services to private sector clients.

 

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Table of Contents

 

Results of Operations

 

Revenue and Operating Income of our Reportable Segments

 

The results of operations for the three and nine months ended September 30, 2009 and 2008 by operating segment were as follows (in millions):

 

Three Months Ended September 30, 2009 and 2008

 

 

 

2009

 

2008

 

Change

 

 

 

Revenue

 

Equity in
Earnings

 

Operating
Income (Loss)

 

Revenue

 

Equity in
Earnings

 

Operating
Income
(Loss)

 

Revenue

 

Equity in
Earnings

 

Operating
Income (Loss)

 

Government, Environment and Nuclear

 

$

549.4

 

$

14.8

 

$

84.2

 

$

413.5

 

$

7.6

 

$

23.5

 

$

135.9

 

32.9

%

$

7.2

 

$

60.7

 

n/a

 

Facilities and Infrastructure

 

478.4

 

3.3

 

14.7

 

518.0

 

1.3

 

4.0

 

(39.6

)

(7.6

)%

2.0

 

10.7

 

n/a

 

Energy

 

413.5

 

0.4

 

(5.5

)

515.5

 

1.2

 

6.3

 

(102.0

)

(19.8

)%

(0.8

)

(11.8

)

n/a

 

Other

 

 

 

(11.3

)

 

 

(9.5

)

 

 

 

(1.8

)

(18.9

)%

Total

 

$

1,441.3

 

$

18.5

 

$

82.1

 

$

1,447.0

 

$

10.1

 

$

24.3

 

$

(5.7

)

 

 

$

8.4

 

$

57.8

 

 

 

 

Nine Months Ended September 30, 2009 and 2008

 

 

 

2009

 

2008

 

Change

 

 

 

Revenue

 

Equity in
Earnings

 

Operating
Income (Loss)

 

Revenue

 

Equity in
Earnings

 

Operating
Income
(Loss)

 

Revenue

 

Equity in
Earnings

 

Operating
Income (Loss)

 

Government, Environment and Nuclear

 

$

1,423.7

 

$

29.9

 

$

107.8

 

$

1,200.8

 

$

28.9

 

$

45.9

 

$

222.9

 

18.6

%

$

1.0

 

$

61.9

 

n/a

 

Facilities and Infrastructure

 

1,456.0

 

15.1

 

42.9

 

1,457.6

 

(11.0

)

7.1

 

(1.6

)

(0.1

)%

26.1

 

35.8

 

n/a

 

Energy

 

1,269.3

 

1.0

 

17.1

 

1,382.9

 

3.2

 

32.4

 

(113.6

)

(8.2

)%

(2.2

)

(15.3

)

(47.2

)%

Other

 

 

 

(33.1

)

 

 

(33.8

)

 

 

 

 

0.7

 

2.1

%

Total

 

$

4,149.0

 

$

46.0

 

$

134.7

 

$

4,041.3

 

$

21.1

 

$

51.6

 

$

107.7

 

 

 

$

24.9

 

$

83.1

 

 

 

 

Government, Environment and Nuclear

 

Revenue from this segment increased for the three and nine months ended September 30, 2009, compared to the same periods in the prior year by $135.9 million or 32.9%, and $222.9 million or 18.6%, respectively. The increase in revenue is substantially due to higher volume of work in Texas supporting Hurricane Ike recovery, partially offset by delays in finalizing newly awarded governmental contracts in our continental U.S. design build markets. Also contributing to the increase in revenues is the award of a domestic nuclear contract and the award of a program management project in the United Arab Emirates.

 

Operating income significantly increased for the three months and nine months ended September 30, 2009 compared to the same periods in the prior year by $60.7 million and $61.9 million, respectively. The increase for the three and nine months ended September 30, 2009 compared to the same periods in the prior year is primarily due the gain on the sale of certain operating assets in addition to the startup of a domestic and an international nuclear project partially offset by the substantial completion of two nuclear projects.

 

Facilities and Infrastructure

 

Revenue from our Facilities and Infrastructure segment decreased for the three and nine months ended September 30, 2009, compared to the same periods in 2008 by $39.6 million or 7.6%, and $1.6 million, respectively. The decrease for the three months ended September 30, 2009 compared to the same period in the prior year is largely attributable to significant decreases in both full service and traditional service revenue in the manufacturing and life sciences markets.  Additionally, the operations and maintenance business experienced delays and scope reductions. The decrease is partially offset by growth in our North American consulting and international markets. North American consulting growth is due in part to design and program management services for municipal clients in the northeast and southwest United States, while international growth was driven primarily by large program management projects located in the United Kingdom and United Arab Emirates.

 

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Operating income increased significantly for the three and nine months ended September 30, 2009, compared to the same periods in the prior year by $10.7 million and $35.8 million, respectively. The increase in operating income compared to the prior year is partly attributable to the increased volume within our transportation business discussed above. During the second quarter of 2008, a significant loss was recognized on a transportation project within one of its joint ventures. The increase in operating income is partially offset by schedule and cost impacts on two projects in the Middle East within our transportation and water business.

 

Energy

 

Revenue from our Energy segment decreased for the three and nine months ended September 30, 2009, compared to the same periods in 2008 by $102.0 million or 19.8%, and $113.6 million or 8.2%, respectively. The decrease in revenue is primarily attributable to a decrease in full service revenue due to a slow down in economic activity and depressed oil and gas prices. Also contributing to the decrease were delays and contract value reduction in certain businesses and the cancellation of a project in Canada. The decrease is partially offset by increased volume in Alaska and the related work on the North Slope within our energy and chemicals business as well as two engineering-procurement-construction (EPC) projects awarded during 2007 that are now in the peak of their construction cycles within our power business.

 

Operating income decreased significantly for the three and nine months ended September 30, 2009 compared to the same period in the prior year by $11.8 million and $15.3 million, respectively. The decrease in operating income is primarily attributable to the delays, contract value reduction and cancellation as discussed above. Further, the two EPC projects discussed above contribute to the increased operating income.

 

Other

 

Other primarily includes corporate expenses which 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, tax, and general business development efforts. Expenses increased for both the three and nine months ended September 30, 2009 due to higher employee related expenses. For the nine months ended September 30, 2009, the increase was offset by decreased expenditures related to overhead cost reduction efforts and strategic initiatives.

 

Provision for Income Taxes

 

The effective tax rate for the three months ended September 30, 2009 was 29.7% compared to 38.3% for the same period in the prior year. The tax rate for the nine months ended September 30, 2009 was 29.9% compared to the 41.8% for the same period in the prior year. The effective tax rate for the three and nine months ended September 30, 2009 was favorably impacted by the recognition of benefits from statute expirations, taxing jurisdiction settlements, and by improved foreign operating results. CH2M HILL’s effective tax rate continues to be negatively impacted by the effect of non-deductible foreign net operating losses, the disallowed portion of executive compensation, and disallowed portions of meals and entertainment expenses.

 

Liquidity and Capital Resources

 

Our primary sources of liquidity are cash flows from operations, borrowings under our revolving line of credit and other financing arrangements. 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 nine months ended September 30, 2009, we generated $203.7 million of cash from our operations compared to $128.7 million of cash provided by operating activities in the same period last year. The improvement in operating cash flow during the current period was attributable to an increase in cash collections of accounts receivable as well as higher earnings and timing of cash receipts from unconsolidated affiliates.

 

We continuously monitor collection efforts and assess the allowance for doubtful accounts. Based on our assessment at September 30, 2009, we have deemed the allowance for doubtful accounts to be adequate; however, 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.

 

Cash generated in investing activities was $10.3 million in the nine months ended September 30, 2009 compared to $86.3 million used in investing activities for the same period in 2008. The majority of cash used in our investing activities relates to payments made for the purchase of property, plant, and equipment and investments in our joint ventures. We spent $27.8 million and $35.2 million on capital expenditures in the nine months ended September 30, 2009 and 2008, respectively. The net cash flows related to our investments in affiliates changed from period to period primarily due to investments in a significant transportation unconsolidated affiliate and distributions of capital received in a significant nuclear unconsolidated affiliate. The majority of cash provided by our investing activities was attributable to the proceeds from the sale of certain operating assets within our GEN segment.

 

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We finance our operations, acquisitions and capital expenditures using a variety of capital vehicles. Depending on the applicable terms and conditions on new debt or equity offerings compared to the opportunity cost of using our internally generated cash we may either choose to finance new opportunities using leverage in the form of our revolving line of credit facility (RLOC), or other debt. In some instances we may use a combination of one or more of these financing mechanisms. As of September 30, 2009, our outstanding debt obligations were approximately $54.8 million. The majority of the funds from these obligations financed our recent acquisitions, including the assumption and issuance of notes payable and mortgage notes related to property, plant and equipment.

 

We have a credit agreement which provides for a $500.0 million RLOC that expires on August 31, 2012. The credit agreement includes an option to increase the initial borrowing capacity by up to an additional $250.0 million. The RLOC is used for general corporate purposes and permitted acquisitions. It also provides that up to $250.0 million is available for the issuance of letters of credit to support various operating 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. 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. While we continue to carefully monitor the unfolding global financial situation to assess any impacts this might have on our banks in the RLOC and their ability to meet their legal funding obligations to us, the RLOC is a committed facility and we believe the potential financial exposure is limited.

 

During 2008, we entered into derivative financial transactions to reduce the effects of interest rate changes on cash flows due to changes in interest rates on our outstanding debt. As of September 30, 2009, we have two interest rate swaps with a total notional amount of $50.0 million. We do not enter into derivative transactions for speculative purposes. As of September 30, 2009, we had not designated these derivative instruments as effective hedges as defined by ASC Topic 815, Derivatives and Hedging. Therefore, interest expense related to periodic settlements on these interest rate swaps and the change in fair market value of these interest rate swaps are recognized in earnings in the current period. These interest rate swaps expire in March 2010. The fair value of these derivatives is not significant.

 

As of September 30, 2009, we did not have any borrowings outstanding on the RLOC. Additionally we had issued and outstanding letters of credit of $68.4 million reserved against the RLOC’s borrowing base. Based on our total cash and credit capacity at September 30, 2009 and our cash generated from operations, we believe we have sufficient resources to fund our operations and repurchases of stock presented on our internal market, should we choose to do so, for the next 12 months. If and when we identify potential business acquisition candidates or incur additional capital expenditures, we will determine the combination of financing options that provides us the most efficient cost of capital.

 

Our RLOC agreement contains financial and other covenants, as well as 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 September 30, 2009, we were in compliance with the covenants required by the credit agreement.

 

We pay for capital expenditures used in our operations through operating leases, long-term debt, other credit arrangements and from cash flow. The available terms, the length of time we expect to use the asset and the expected residual value of the asset are factors we evaluate in determining the best ways to finance these purchases. In most cases these notes are secured by the assets purchased. Depending on the conditions of these financing arrangements, if we are in default, the lender may have the right to take control of the collateralized assets or require full payment of the outstanding principal balance owed, or both.

 

Our nonrecourse debt consists of two mortgage notes related to buildings and property. As of September 30, 2009, approximately $17.0 million of these mortgages were outstanding. One of the mortgage notes pertains to offices in Anchorage, Alaska and the second relates to a building used for warehousing spare parts. Both of the mortgage notes are secured by buildings and real estate.

 

Off-Balance Sheet Arrangements

 

We have interests in multiple joint ventures, some of which are considered variable interest entities under ASC Topic 810, Consolidation. 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.

 

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As noted above, we entered into derivative financial transactions to reduce the effects of interest rate changes on cash flows due to changes in interest rates on our outstanding debt. The fair value of these derivatives is not significant.

 

There were no substantial changes to other off-balance sheet arrangements or contractual commitments in the three months ended September 30, 2009, when compared to the disclosures provided in our Annual Report on Form 10-K for the year ended December 31, 2008.

 

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, 2008.

 

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 contract. In making such estimates, judgments are required to evaluate potential variances in schedule, the cost of materials and labor, productivity, liability claims, contract disputes and achievement of contract performance standards.

 

Change orders are included in total estimated contract revenue when it is probable that the change order will result in an addition to contract value and can be reliably estimated. Losses on construction and engineering contracts in process are recognized in their entirety when the loss becomes evident and the amount of loss can be reasonably estimated.

 

We have a history of making reasonable estimates of the extent of progress towards completion, total contract revenue and total contract costs on our engineering and construction contracts. However, due to uncertainties inherent in the estimation process, it is possible that actual total contract revenue and completion costs may vary from estimates.

 

A portion of our contracts are operations and 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 collectability 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 deferred tax assets. Deferred tax assets and liabilities arise from temporary differences between the tax return and the financial statement recognition of revenue and expenses.

 

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We must assess the likelihood that we will be able to recover our deferred tax assets. If recovery is not likely, we increase our tax provision by recording a valuation allowance for the deferred tax assets that do not meet the more likely than not recognition criteria.

 

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 ultimate settlement.

 

Pension and Postretirement Employee Benefits

 

We have two frozen and one active noncontributory defined benefit pension plans, a medical benefit plan for retired employees and other benefit plans. The determination of pension plan expense and the requirements for funding our pension plans are based on a number of actuarial assumptions. 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. For our medical benefit plan, which provides certain health care benefits to qualified retired employees, critical assumptions in determining the employee benefit expense are the discount rate applied to benefit obligations and the assumed health care cost trend rates used in the calculation of benefit obligations. 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.

 

On December 31, 2007, the Company adopted ASC Topic 715, Compensation-Retirement Benefits, 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. ASC Topic 715 also requires plan assets and benefit obligations to be measured as of December 31, 2008. As a result, CH2M HILL changed its measurement date from October 31st to December 31st in 2008 in accordance with ASC Topic 715.

 

Recently Adopted Accounting Standards

 

In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, which was primarily codified into ASC Topic 105, Generally Accepted Accounting Standards. ASC Topic 105 will become the single source of authoritative nongovernmental GAAP, superseding existing FASB, American Institute of Certified Public Accountants (AICPA), Emerging Issues Task Force (EITF), and related accounting literature. This standard reorganizes the GAAP pronouncements into accounting topics and displays them using a consistent structure. This guidance impacts the Company’s financial statements and related disclosures as all references to authoritative accounting literature reflect the newly adopted codification. CH2M HILL adopted ASC Topic 105 on September 30, 2009.

 

In December 2007, the FASB issued SFAS No. 141(R), Business Combinations, which was primarily codified into ASC Topic 805, Business Combinations. This standard establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interests in the acquiree and the goodwill acquired. ASC Topic 805 also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. CH2M HILL adopted ASC Topic 805 on January 1, 2009.

 

On January 1, 2009, CH2M HILL adopted SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements-An Amendement of ARB No. 51, which was primarily codified into ASC Topic 810, Consolidations. Noncontrolling interests are defined as the portion of equity (net assets) in a subsidiary not attributable, directly or indirectly, to a parent. ASC Topic 810 establishes accounting and reporting standards for noncontrolling interests, the amount of consolidated net income attributable to the parent and to the noncontrolling interests, changes in a parent’s ownership interest and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. ASC Topic 810 also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. CH2M HILL adopted the accounting provisions of ASC Topic 810 on a prospective basis as of the beginning of our 2009 fiscal year. The presentation and disclosure requirements of ASC Topic 810 were adopted on a retrospective basis, and resulted in a reclassification of minority interests to noncontrolling interests of $2.5 million at December 31, 2008.

 

In May 2009, the FASB issued SFAS No. 165, Subsequent Events, which was primarily codified into ASC Topic 855, Subsequent Events.  ASC Topic 855 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financials statements are issued or are available to be issued. CH2M HILL adopted ASC Topic 855 on June 30, 2009. Adoption did not have a material impact on the consolidated financial statements.

 

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Recently Issued Accounting Standards

 

In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R) (SFAS 167), which has not yet been codified in the ASC. This guidance is a revision to pre-existing guidance pertaining to the consolidation and disclosures of variable interest entities. Specifically, it changes how a reporting entity determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a reporting entity is required to consolidate another entity is based on, among other things, the other entity’s purpose and design and the reporting entity’s ability to direct the activities of the other entity that most significantly impact the other entity’s economic performance. This guidance will require a reporting entity to provide additional disclosures about its involvement with variable interest entities and continually assess any significant changes in risk exposure due to that involvement. SFAS 167 is effective for CH2M HILL beginning January 1, 2010. The Company is in the process of evaluating the impacts of this statement.

 

On December 30, 2008, the FASB issued FSP FAS 132(R)-1, Employers’ Disclosures about Postretirement Benefit Plan Assets, which was primarily codified into ASC Topic 715, Compensation-Retirement Benefit.. The statement provides guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. ASC Topic 715 requires employers of entities to disclose more information about how investment allocation decisions are made, more information about major categories of plan assets, and the fair value techniques and inputs used to measure plan assets. ASC Topic 715 is effective for CH2M HILL for the year ending December 31, 2009.

 

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 flows.

 

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. Although historically we have not, we may engage in forward foreign exchange contracts to reduce our economic exposure to changes in exchange rates. A five percent change in foreign currency rates would not have a significant impact on our financial position, results of operations or cash flows.

 

Interest rates.  Our interest rate exposure is generally limited to our unsecured revolving credit agreement, purchase of interest bearing short-term investments and the holdback contingency balance outstanding related to our acquisition of VECO. As of September 30, 2009 there was not a balance on the unsecured revolving credit agreement, but there was approximately $50.3 million outstanding on the holdback contingency. 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. Based upon the amount outstanding under the holdback contingency, a one percentage point change in the assumed interest rate would change our annual interest expense by approximately $0.5 million.

 

Item 4.  CONTROLS AND PROCEDURES

 

We carried out an evaluation as of the last day of the period covered by this Quarterly Report on Form 10-Q, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (Exchange Act). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures (a) are effective to ensure that information required to be disclosed by us in reports filed or submitted under the Exchange Act is timely recorded, processed, summarized and reported and (b) include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in reports filed or submitted under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

There have been no changes in our internal control over financial reporting during the quarter ended September 30, 2009 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 outcomes 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 common shares by CH2M HILL during the period covered by this report.

 

Period

 

Total Number of
Shares Purchased

 

Average Price
Paid per Share

 

Total Number of Shares
Purchased as Part of Publicly
Announced Plans or Programs

 

Maximum Number of Shares
that May Yet Be Purchased
Under the Plans or Programs

 

July(a)

 

11,084

 

$

31.21

 

 

 

August

 

 

 

 

 

September(b)

 

202,636

 

35.72

 

 

 

Total

 

213,720

 

35.48

 

 

 

 


(a)                                  Shares purchased by CH2M HILL from terminated employees.

 

(b)                                 Shares purchased by CH2M HILL in the Internal Market.

 

Item 6.  EXHIBITS

 

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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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

CH2M HILL Companies, Ltd.

 

 

Date: November 4, 2009

/s/ M. CATHERINE SANTEE

 

M. Catherine Santee

 

Chief Financial Officer

 

 

 

/s/ JOANN SHEA

 

JoAnn Shea

 

Vice President and Chief Accounting Officer

 

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